10-K 1 d659585d10k.htm 10-K 10-K
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-K

 

 

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the fiscal year ended December 31, 2013

OR

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

For the transition period from                 to                

Commission file number 001-32379

 

 

SOTHERLY HOTELS INC.

(Exact name of registrant as specified in its charter)

 

 

 

MARYLAND   001-32379   20-1531029

(State or Other Jurisdiction of

Incorporation or Organization)

  (Commission File Number)  

(I.R.S. Employer

Identification No.)

 

 

SOTHERLY HOTELS LP

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   001-36091   16-1456454

(State or Other Jurisdiction of

Incorporation or Organization)

  (Commission File Number)  

(I.R.S. Employer

Identification No.)

410 West Francis Street

Williamsburg, Virginia 23185

(Address of Principal Executive Officers) (Zip Code)

757-229-5648

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Registrant

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Sotherly Hotels Inc.   Common Stock, $0.01 par value   The NASDAQ Stock Market LLC
Sotherly Hotels LP   8.0% Senior Unsecured Notes due 2018   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

(Title of Class)

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.

Sotherly Hotels Inc.    Yes  ¨    No  x         Sotherly Hotels LP    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Sotherly Hotels Inc.    Yes  ¨    No  x         Sotherly Hotels LP    Yes  ¨    No  x

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.

Sotherly Hotels Inc.    Yes  x    No  ¨         Sotherly Hotels LP    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such file.

Sotherly Hotels Inc.    Yes  x    No  ¨         Sotherly Hotels LP     Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934).

Sotherly Hotels Inc.

 

Large Accelerated Filer  ¨   Accelerated Filer  ¨    Non-accelerated Filer  ¨   Smaller Reporting Company  x

Sotherly Hotels LP

 

Large Accelerated Filer  ¨   Accelerated Filer  ¨    Non-accelerated Filer  x   Smaller Reporting Company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Sotherly Hotels Inc.    Yes  ¨    No  x        Sotherly Hotels LP    Yes  ¨    No  x

The aggregate market value of common stock held by non-affiliates of Sotherly Hotels Inc. as of June 28, 2013, the last business day of Sotherly Hotels Inc.’s most recently completed second fiscal quarter, was approximately $39,193,950 based on the closing price quoted on the NASDAQ® Stock Market.

As of March 25, 2014, there were 10,243,677 shares of Sotherly Hotels Inc.’s common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Form 10-K incorporates by reference certain portions of Sotherly Hotels Inc.’s proxy statement for its 2014 annual meeting of stockholders to be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this report.

 

 

 


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SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

INDEX

 

         Page  
 

PART I

  
Item 1.  

Business

     5   
Item 1A.  

Risk Factors

     15   
Item 1B.  

Unresolved Staff Comments

     39   
Item 2.  

Properties

     39   
Item 3.  

Legal Proceedings

     39   
Item 4.  

Mine Safety Disclosure

     39   
 

PART II

  
Item 5.  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     40   
Item 6.  

Selected Financial Data

     43   
Item 7.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46   
Item 7A.  

Quantitative and Qualitative Disclosures About Market Risk

     64   
Item 8.  

Financial Statements and Supplementary Data

     65   
Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     65   
Item 9A.  

Controls and Procedures

     65   
Item 9B.  

Other Information

     67   
 

PART III

  
Item 10.  

Directors, Executive Officers and Corporate Governance

     68   
Item 11.  

Executive Compensation

     68   
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     68   
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

     68   
Item 14.  

Principal Accountant Fees and Services

     69   
 

PART IV

  
Item 15.  

Exhibits and Financial Statement Schedules

     70   

 

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EXPLANATORY NOTE

We refer to Sotherly Hotels Inc. as the “Company,” Sotherly Hotels LP as the “Operating Partnership,” the Company’s common stock as “Common Stock,” the Company’s preferred stock as “Preferred Stock,” and the Operating Partnership’s preferred interest as the “Preferred Interest.” References to “we” and “our” mean the Company, its Operating Partnership and its subsidiaries and predecessors, collectively, unless the context otherwise requires or where otherwise indicated.

The Company conducts virtually all of its activities through the Operating Partnership and is its sole general partner. The partnership agreement provides that the Operating Partnership will assume and pay when due, or reimburse the Company for payment of, all costs and expenses relating to the ownership and operations of, or for the benefit of, the Operating Partnership. The partnership agreement further provides that all expenses of the Company are deemed to be incurred for the benefit of the Operating Partnership.

This report combines the Annual Reports on Form 10-K for the period ended December 31, 2013 of the Company and the Operating Partnership. We believe combining the annual reports into this single report results in the following benefits:

 

    combined reports better reflect how management and investors view the business as a single operating unit;

 

    combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;

 

    combined reports are more efficient for the Company and the Operating Partnership and result in savings of time, effort and expense; and

 

    combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.

To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:

 

    Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – selected portions;

 

    Item 9A – Controls and Procedures;

 

    Consolidated Financial Statements;

 

    the following Notes to Consolidated Financial Statements:

 

    Note 8 – Equity; and

 

    Note 14 – Earnings (Loss) Per Share and Unit; and

 

    Certifications of CEO and CFO Pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Information included and incorporated by reference in this Form 10-K may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and as such may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words, such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,” “anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity,” and similar expressions, whether in the negative or affirmative, but the absence of these words does not necessarily mean that a statement is not forward looking. All statements regarding our expected financial position, business and financing plans are forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

 

    national and local economic and business conditions that affect occupancy rates and revenues at our hotels and the demand for hotel products and services;

 

    risks associated with the hotel industry, including competition, increases in wages and other labor costs, energy costs and other operating costs;

 

    the magnitude and sustainability of the economic recovery in the hospitality industry and in the markets in which we operate;

 

    the availability and terms of financing and capital and the general volatility of the securities markets;

 

    risks associated with the level of our indebtedness and our ability to meet covenants in our debt agreements and, if necessary, to refinance or seek an extension of the maturity of such indebtedness or modify such debt agreements;

 

    management and performance of our hotels;

 

    risks associated with the conflicts of interest of the Company’s officers and directors;

 

    risks associated with redevelopment and repositioning projects, including delays and cost overruns;

 

    supply and demand for hotel rooms in our current and proposed market areas;

 

    our ability to acquire additional properties and the risk that potential acquisitions may not perform in accordance with expectations;

 

    our ability to successfully expand into new markets;

 

    legislative/regulatory changes, including changes to laws governing taxation of real estate investment trusts (“REITs”);

 

    the Company’s ability to maintain its qualification as a REIT; and

 

    our ability to maintain adequate insurance coverage.

Additional factors that could cause actual results to vary from our forward-looking statements are set forth under the Section titled “Risk Factors” in Item 1A of this report.

These risks and uncertainties should be considered in evaluating any forward-looking statement contained in this report or incorporated by reference herein. All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are qualified by the cautionary statements in this section. We undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report, except as required by law. In addition, our past results are not necessarily indicative of our future results.

 

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PART I

Item 1. Business

Organization

Sotherly Hotels Inc. (the “Company”) is a self-managed and self-administered lodging real estate investment trust, or REIT, that was formed in August 2004 to own, acquire, renovate and reposition full-service, primarily upscale and upper-upscale hotel properties located in primary markets in the Mid-Atlantic and Southern United States. On December 21, 2004, the Company successfully completed its initial public offering and elected to be treated as a self-advised REIT for federal income tax purposes. The Company conducts its business through Sotherly Hotels LP, its operating partnership (the “Operating Partnership”), of which the Company is the general partner. The Company owns approximately 78.1% of the partnership units in the Operating Partnership. Limited partners (including certain of the Company’s officers and directors) own the remaining Operating Partnership units.

As of February 28, 2014, our portfolio consists of eleven full-service, primarily upscale and upper-upscale hotels located in eight states with an aggregate of 2,683 rooms and approximately 134,512 square feet of meeting space. Ten of these hotels are wholly-owned by subsidiaries of the Operating Partnership and operate under the Hilton, Crowne Plaza, DoubleTree, Sheraton and Holiday Inn brands, and are managed on a day to day basis by MHI Hotels Services, LLC (“MHI Hotels Services”). We also own a 25.0% indirect noncontrolling interest in the 311-room Crowne Plaza Hollywood Beach Resort through a joint venture with The Carlyle Group (“Carlyle”).

In order for the Company to qualify as a REIT, it cannot directly manage or operate our wholly-owned hotels. Therefore, we lease our wholly-owned hotel properties to MHI Hospitality TRS, LLC (“TRS Lessee”), which in turn has engaged MHI Hotels Services, an eligible independent management company, to manage our hotels. Our TRS Lessee is a wholly-owned subsidiary of MHI Hospitality TRS Holding, Inc. (“MHI Holding”, and collectively, “MHI TRS”). MHI TRS is a taxable REIT subsidiary for federal income tax purposes.

Our corporate office is located at 410 West Francis Street, Williamsburg, Virginia 23185. Our telephone number is (757) 229-5648.

Our Properties

In connection with the Company’s initial public offering, the Company acquired six hotel properties for aggregate consideration of approximately $15.0 million in cash, 3,817,036 units of interest in our Operating Partnership and the assumption of approximately $50.8 million in debt. The six initial hotel properties, the Hilton Philadelphia Airport, the Holiday Inn Brownstone, the Holiday Inn Downtown Williamsburg, the Hilton Wilmington Riverside, the Hilton Savannah DeSoto and the Holiday Inn Laurel West (formerly the Best Western Maryland Inn), are located in Pennsylvania, North Carolina, Virginia, North Carolina, Georgia, and Maryland, respectively.

On July 22, 2005, we acquired the Crowne Plaza Jacksonville Riverfront (formerly, the Hilton Jacksonville Riverfront) located in Jacksonville, Florida, for $22.0 million.

During 2006, we sold the Holiday Inn Downtown Williamsburg for $4.75 million. We also purchased the Louisville Ramada Riverfront Inn located in Jeffersonville, Indiana for approximately $7.7 million including transfer costs and, after extensive renovations, re-opened the property in May 2008 as the Sheraton Louisville Riverside.

During 2007, through our joint venture with CRP/MHI Holdings, LLC, an affiliate of Carlyle Realty Partners V, L.P., and Carlyle, we acquired a 25.0% indirect, noncontrolling interest in the Crowne Plaza Hollywood Beach Resort, a 311-room hotel in Hollywood, Florida for approximately $75.8 million including transfer costs. We also purchased a hotel formerly known as the Tampa Clarion Hotel in Tampa, Florida for

 

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approximately $13.8 million including transfer costs, which, after extensive renovations, re-opened in March 2009 as the Crowne Plaza Tampa Westshore.

During 2008, we acquired the Hampton Marina Hotel located in Hampton, Virginia for approximately $7.8 million, including transfer costs. In October 2008, the hotel was re-branded and renamed the Crowne Plaza Hampton Marina.

During 2013, we acquired the Crowne Plaza Houston Downtown located in Houston, Texas at an aggregate value of approximately $30.9 million, including some closing costs.

In connection with the Company’s initial public offering, the Company also acquired two leasehold interests in the Shell Island Resort, a 160-unit condominium resort property in Wrightsville Beach, North Carolina, which were purchased for $3.5 million. Our Operating Partnership entered into sublease arrangements to sublease our entire leasehold interests in the property at Shell Island to affiliates of MHI Hotels Services. Through December 2011, the management company operated the property as a hotel and managed a rental program for the benefit of the condominium unit owners. Our Operating Partnership received fixed annual rent and incurred annual lease expenses in connection with the subleases of such property. Consequent to the cancellation of the management company’s contract to manage the condominium rental program and expiration of the underlying leases in December 2011, our Operating Partnership has and will continue to receive a reduced set of minimum payments through December 2014.

See Item 2 of this Form 10-K for additional detail on our properties.

Our Strategy and Investment Criteria

Our strategy is to grow through acquisitions of full-service, upscale and upper-upscale hotel properties located in the primary markets of the Southern United States. We intend to grow our portfolio through disciplined acquisitions of hotel properties and believe that we will be able to source significant external growth opportunities through our management team’s extensive network of industry, corporate and institutional relationships.

Our investment criteria are further detailed below:

 

    Geographic Growth Markets: We are focusing our growth strategy on the major markets in the Southern region of the United States. Our management team remains confident in the long-term growth potential associated with this part of the United States. We believe these markets have, during the Company’s and our predecessors’ existence, been characterized by population growth, economic expansion, growth in new businesses and growth in the resort, recreation and leisure segments. We will continue to focus on these markets, including coastal locations, and will investigate other markets for acquisitions only if we believe these new markets will provide similar long-term growth prospects.

 

    Full-Service Hotels: We focus our acquisition strategy on the full-service hotel segment. Our full-service hotels fall primarily under the upscale to upper-upscale categories and include such brands as Hilton, Doubletree by Hilton, Sheraton and Crowne Plaza. We do not own economy branded hotels. We believe that full-service hotels, with upscale to upper-upscale brands will outperform the broader U.S. hotel industry, and thus offer the highest returns on invested capital.

 

    Significant Barriers to Entry: We intend to execute a strategy that entails the acquisition of hotels in prime locations with significant barriers to entry. We seek to acquire properties that will benefit from the licensing of brands that are not otherwise present in the market and provide us with geographic exclusivity which helps to protect the value of our investment.

 

    Proximity to Demand Generators: We seek to acquire hotel properties located in central business districts near multiple demand generators for both leisure and business travelers within the respective markets, including large state universities, airports, convention centers, corporate headquarters, sports venues and office parks.

 

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We typically define underperforming hotels as those that are poorly managed, suffer from significant deferred maintenance and capital improvement and that are not properly positioned in their respective markets. In pursuing these opportunities, we hope to improve revenue and cash flow and increase the long-term value of the underperforming hotels we acquire. Our ultimate goal is to achieve a total investment that is substantially less than replacement cost of a hotel or the acquisition cost of a market performing hotel. In analyzing a potential investment in an underperforming hotel property, we typically characterize the investment opportunity as one of the following:

 

    Up-branding Opportunity: The acquisition of properties that can be upgraded physically and enhanced operationally to qualify for what we view as higher quality franchise brands, including Hilton, Doubletree by Hilton, Crowne Plaza and Sheraton.

 

    Shallow-Turn Opportunity: The acquisition of an underperforming but structurally sound hotel that requires moderate renovation to re-establish the hotel in its market.

 

    Deep-Turn Opportunity: The acquisition of a hotel that is closed or functionally obsolete and requires a restructuring of both the business components of the operations as well as the physical plant of the hotel, including extensive renovation of the building, furniture, fixtures and equipment.

Typically, in our experience, a deep turn opportunity takes a total of approximately four years from the initial acquisition of a property to achieving full post-renovation stabilization. Therefore, when evaluating future opportunities in underperforming hotels, we intend to focus on up-branding and shallow-turn opportunities, and to pursue deep-turn opportunities on a more limited basis and in joint venture partnerships if possible.

Investment Vehicles. In pursuit of our investment strategy, we may employ various traditional and non-traditional investment vehicles:

 

    Direct Purchase Opportunity: Our traditional investment strategy is to acquire direct ownership interests via our Operating Partnership in properties that meet our investment criteria, including opportunities that involve full-service, upscale and upper-upscale properties in identified geographic growth markets that have significant barriers to entry for new product delivery. Such properties, or portfolio of properties, may or may not be acquired subject to a mortgage by the seller or third-party.

 

    Distressed Debt Opportunities: In sourcing acquisitions for our core growth strategy, we may pursue investments in debt instruments that are collateralized by hotel properties. In certain circumstances, we believe that owning these debt instruments is a way to (i) ultimately acquire the underlying real estate asset and (ii) provide a non-dilutive current return to the Company’s stockholders in the form of interest payments derived from the ownership of the debt. Our principal goal in pursuing distressed debt opportunities is ultimately to acquire the underlying real estate. By owning the debt, we believe that we may be in a position to acquire deeds to properties that fit our investment criteria in lieu of foreclosures.

 

    Joint Venture/Mezzanine Lending Opportunities: We may, from time to time, undertake a significant renovation and rehabilitation project that we characterize as a deep-turn opportunity. In such cases, we may acquire a functionally obsolete hotel whose renovation may be very lengthy and require significant capital. In these projects, we may choose to structure such acquisitions as a joint venture, or mezzanine lending program, in order to avoid severe short-term dilution and loss of current income commonly referred to as the “negative carry” associated with such extensive renovation programs. We will not pursue joint venture or mezzanine programs in which we would become a “de facto” lender to the real estate community.

Portfolio and Asset Management Strategy

We intend to ensure that the management of our hotel properties maximizes market share, as evidenced by revenue per available room (“RevPAR”) penetration indices, and that our market share yields the optimum level

 

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of revenues for our hotels in their respective markets. Our strategy is designed to actively manage our hotels’ operating expenses in an effort to maximize hotel earnings before interest, taxes, depreciation and amortization (“Hotel EBITDA”).

Over our long history in the lodging industry we have refined many portfolio and asset management techniques that we believe provide for exceptional cash returns at our hotels. We undertake extensive budgeting due diligence wherein we examine market trends, one-time or exceptional revenue opportunities, and/or changes in the regulatory climate that may impact costs. We review daily revenue results and revenue management strategies at the hotels, and we focus on MHI Hotels Services’ ability to produce high quality revenues that translate to higher marginal profitability. We look for alternative forms of revenues, such as leasing roof-top space for cellular towers and other communication devices and also look to lease space to third parties in our hotels, which may include, but are not limited to, gift shops or restaurants. Our efforts further include periodic review of property insurance costs and coverage, and the cost of real and personal property taxes. We generally appeal tax increases in an effort to secure lower tax payments and routinely pursue strategies that allow for lower overall insurance costs, such as purchasing re-insurance and participating in state-sponsored insurance pools.

We also require detailed and refined reporting data from MHI Hotels Services, which includes detailed accounts of revenues, revenue segments, expenses and forecasts based on current and historic booking patterns. We also believe we optimize and successfully manage capital costs at our hotels while ensuring that adequate product standards are maintained to provide guest satisfaction and compliance with franchise brand standards.

None of our hotels is managed by a major national or global hotel franchise company. Through our long history in the lodging industry, we have found that management of our hotels by management companies other than franchisors is preferable to and more profitable than management derived from the major franchise companies, specifically with respect to optimization of operating expenses and the delivery of guest services.

Our portfolio management strategy includes our effort to optimize labor costs. The labor force in our hotels is predominately non-unionized, with only one property, the Jacksonville Crowne Plaza, having a total of approximately six employees electing to participate under a collective bargaining arrangement. Further, the labor force at our hotels is eligible to receive health and other insurance coverage through MHI Hotels Services, which self-insures. Self-insuring has, in our opinion, provided significant cash savings over traditional insurance company sponsored plans.

Asset Disposition Strategy. When a property no longer fits with our investment objectives, we will pursue a direct sale of the property for cash so that our investment capital can be redeployed according to the investment strategies outlined above. Where possible, we will seek to subsequently purchase a hotel in connection with the requirements of a tax-free exchange. Such a strategy may be deployed in order to mitigate the tax consequence that a direct sale may cause.

Our Principal Agreements

Strategic Alliance Agreement

MHI Hotels Services is currently the management company for each of our hotels.

On December 21, 2004, we entered into a ten-year strategic alliance agreement with MHI Hotels Services pursuant to which (i) MHI Hotels Services agrees to refer to us (on an exclusive basis) hotel acquisition opportunities in the United States presented to MHI Hotels Services, and (ii) unless a majority of the Company’s independent directors in good faith concludes for valid business reasons that another management company should manage a hotel owned by us, we agree to offer MHI Hotels Services or its subsidiaries the right to manage hotel properties that we acquire in the United States.

 

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In addition, during the term of the agreement, which expires in December 2014, MHI Hotels Services has the right to nominate one person for election to the Company’s board of directors at the Company’s annual meeting of stockholders, subject to the approval of such nominee by the Company’s Nominating, Corporate Governance and Compensation Committee (the “NCGC Committee”) for so long as certain of the Company’s officers and directors, Andrew Sims, Kim Sims, and Christopher Sims, and their families and affiliates, hold, in the aggregate, not less than 1.5 million units of the Operating Partnership or shares of the Company’s common stock.

Lease Agreements

In order for the Company to maintain qualification as a REIT, neither the Company nor the Operating Partnership or its subsidiaries can operate our hotels directly. Our wholly-owned hotels are leased to our TRS Lessee, which has engaged MHI Hotels Services to manage the hotels. Each lease for the wholly-owned hotels has a non-cancelable term of three to ten years, subject to earlier termination upon the occurrence of certain contingencies described in the lease.

During the term of each lease, our TRS Lessee is obligated to pay a fixed annual base rent plus a percentage rent and certain other additional charges. Base rent accrues and is paid monthly. Percentage rent is calculated by multiplying fixed percentages by gross room revenues, in excess of certain threshold amounts and is paid monthly or quarterly, according to the terms of the agreement.

Management Agreements

Pursuant to the terms of three management agreements, we, through our TRS Lessee, have engaged MHI Hotels Services as the property manager for our existing hotel portfolio. One of the management agreements, which we refer to as the master management agreement, covers all our wholly-owned hotels in our portfolio, excluding the Crowne Plaza Tampa Westshore and the Crowne Plaza Houston Downtown, respectively. The second and third agreements relate to the Crowne Plaza Tampa Westshore and the Crowne Plaza Houston Downtown. Except as described below, we intend to offer MHI Hotels Services the opportunity to manage any hotels we acquire in the future that we lease to our TRS Lessee. In addition, the joint venture entity which leases the Crowne Plaza Hollywood Beach Resort has also entered into a management agreement with MHI Hotels Services on terms that vary from those described below. The following terms apply only to our wholly-owned hotels.

Term. The management agreements with MHI Hotels Services have initial terms of ten years from the date of commencement of management activities at each property. The master management agreement covering our wholly-owned hotels, excluding the Crowne Plaza Tampa Westshore and Crowne Plaza Houston Downtown, expires between December 2014 and April 2018. The separate management agreements covering the Crowne Plaza Tampa Westshore and the Crowne Plaza Houston Downtown expire in March 2019 and April 2016, respectively. The term of the management agreements with respect to each hotel, excluding the Crowne Plaza Houston Downtown, may be renewed by MHI Hotels Services for two successive periods of five years each upon the mutual agreement of MHI Hotels Services and our TRS Lessee, subject to the satisfaction of certain performance tests, provided that at the time the option to renew is exercised, MHI Hotels Services is not then in default under the management agreements. If at the time of the exercise of any renewal period MHI Hotels Services is in default, then the exercise of the renewal option will be conditional on timely cure of such default, and if such default is not timely cured, then our TRS Lessee may terminate the management agreements. If MHI Hotels Services desires to exercise any option to renew, it must give our TRS Lessee written notice of its election to renew the management agreements no less than 90 days before the expiration of the then current term of the management agreements. The Crowne Plaza Houston Downtown may be renewed by MHI Hotels Services for one successive period of five years upon the mutual agreement of MHI Hotels Services and our TRS Lessee.

Any amendment, supplement or modification of the management agreements must be in writing signed by all parties and approved by a majority of the Company’s independent directors.

 

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Amounts Payable under the Management Agreements. MHI Hotels Services receives a base management fee, and, if the hotels exceed certain financial thresholds, an additional incentive management fee for the management of our hotels.

The base management fee for each of our initial hotels and for any subsequent hotels we directly acquire will be a percentage of the gross revenues of the hotel and will be due monthly. The applicable percentage of gross revenue for the base management fee for each of our wholly-owned hotels is as follows:

 

     2016     2015     2014     2013     2012     2011     2010  

Crowne Plaza Hampton Marina(1)

     3.0     3.0     3.0     3.0     3.0     3.0     2.0

Crowne Plaza Houston Downtown(2)

     2.0     2.0     2.0     2.0     N/A        N/A        N/A   

Crowne Plaza Tampa Westshore(3)

     3.0     3.0     3.0     3.0     3.0     2.5     2.0

Crowne Plaza Jacksonville Riverfront

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

DoubleTree by Hilton Brownstone – University

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

Hilton Philadelphia Airport

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

Hilton Savannah DeSoto

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

Hilton Wilmington Riverside

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

Holiday Inn Laurel West

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

Sheraton Louisville Riverside(4)

     3.0     3.0     3.0     3.0     3.0     3.0     3.0

 

(1) In 2010, the management company abated the increase in management fee for the Crowne Plaza Hampton for 2010.
(2) In November 2013, we assumed the existing management agreement with MHI Hotels Services for the management of the Crowne Plaza Houston Downtown. The provision of the agreement provide for a base management fee of 2.0% and no incentive management fee.
(3) In January 2009, we entered a separate management agreement with MHI Hotels Services for the management of the Crowne Plaza Tampa Westshore. The provisions of the new agreement related to base management fee are the same as those contained in the master management agreement. The provisions of the new agreement related to the incentive management fee are the same as those contained in the master management agreement except that it is calculated separately and not aggregated with the other properties covered by the master management agreement.
(4) Pursuant to the master management agreement, the term for each of the initial properties, which included the Holiday Inn Downtown Williamsburg, was 10 years. The management company agreed to substitute the Sheraton Louisville Riverside for the Holiday Inn Downtown Williamsburg for remainder of the term of the agreement.

The base management fee for a hotel acquired in the future which is first leased by our TRS Lessee, other than on the first day of a fiscal year, will be 2.0% for the partial year such hotel is first leased and for the first full fiscal year such hotel is managed. There is no fee cap on the base management fee.

Subsequently Acquired Hotel Properties

 

First full calendar year and any partial calendar year

     2.0

Second calendar year

     2.5

Third calendar year and thereafter

     3.0

The incentive management fee under the master management agreement, if any, will be due annually in arrears within 90 days of the end of the fiscal year and will be equal to 10.0% of the amount by which the gross operating profit of all our hotels, with the exception of the Tampa and Houston properties, on an aggregate basis for a given year exceeds the gross operating profit for the same hotels, on an aggregate basis, for the prior year. The incentive fee may not exceed 0.25% of the aggregate gross revenue of all of the hotels included in the incentive fee calculation for the year in which the incentive fee is earned. The calculation of the incentive fee will

 

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not include results of hotels for the fiscal year in which they are initially leased, or for the fiscal year in which they are sold, and newly acquired or leased hotels will be included in the calculation beginning in the second full calendar year such hotel is managed. The management agreement for the management of the Tampa property includes a similar provision for payment of an incentive management fee on a stand-alone basis. The management agreement for the Houston property does not include a provision for payment of an incentive management fee.

Early Termination. The master management agreement may be terminated with respect to one or more of the hotels earlier than the stated term, if certain events occur, including:

 

    a sale of a hotel or the substitution of a newly acquired hotel for an existing hotel;

 

    the failure of MHI Hotels Services to satisfy certain performance standards with respect to any of the future hotels or with respect to the six initial hotels after the expiration of the initial 10-year term;

 

    in the event of a casualty to, condemnation of, or force majeure involving a hotel; or

 

    upon a default by MHI Hotels Services or us that is not cured prior to the expiration of any applicable cure periods.

The management agreement for the Crowne Plaza Tampa Westshore may also be terminated for convenience with ninety days notice to MHI Hotels Services.

The management agreement for the Crowne Plaza Houston Downtown may also be terminated if certain events occur, including:

 

    a sale of the hotel;

 

    gross negligence in the performance of its duties as the manager;

 

    if the operating profit of the hotel is less than the annual amount of the original permanent debt service.

Termination Fees. In certain cases of early termination of the management agreements for the Crowne Plaza Houston Downtown or the master management agreement with respect to one or more of the hotels covered under that agreement, we must pay MHI Hotels Services a termination fee, plus any amounts otherwise due to MHI Hotels Services pursuant to the terms of that management agreement. We will be obligated to pay termination fees in such circumstances provided that MHI Hotels Services is not then in default, subject to certain cure and grace periods.

The management agreement for our Tampa property included certain termination fees if we terminated the management agreement for convenience during the initial year of management. As the initial year of management has been completed, there is no termination fee for the termination of the management agreement for our Tampa property.

New Acquisitions; Strategic Alliance Agreement. Pursuant to the strategic alliance agreement with MHI Hotels Services, we have agreed to engage MHI Hotels Services for the management of any hotels acquired in the future unless a majority of the Company’s independent directors in good faith concludes, for valid business reasons, that another management company should manage any newly acquired hotels. If the management agreement terminates as to all of the hotels covered in connection with a default under the management agreement, the strategic alliance agreement will also terminate.

Franchise Agreements

As of December 31, 2013, our hotels operate under franchise licenses from national hotel companies. On January 13, 2014, we entered into an agreement to purchase an independent full-service hotel in Atlanta, Georgia, that does not operate under a franchise license.

 

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We anticipate that, for the near term, most of the additional hotels we acquire will be operated under franchise licenses. We believe that the public’s perception of quality associated with a franchisor is an important feature in the operation of a hotel. Franchisors provide a variety of benefits for franchisees, which include national advertising, publicity and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards and centralized reservation systems. We may, however, own and operate hotels that are not encumbered with franchise licenses, if such ownership meets our strategic investment criteria.

Our TRS Lessee holds the franchise licenses for our wholly-owned hotels. MHI Hotels Services must operate each of our hotels it manages in accordance with and pursuant to the terms of the franchise agreement for the hotel.

The franchise licenses generally specify certain management, operational, record keeping, accounting, reporting and marketing standards and procedures with which the franchisee must comply. Under the franchise licenses, the franchisee must comply with the franchisors’ standards and requirements with respect to:

 

    training of operational personnel;

 

    safety;

 

    maintaining specified insurance;

 

    the types of services and products ancillary to guest room services that may be provided;

 

    display of signage;

 

    marketing techniques including print media, billboards, and promotions standards; and

 

    the type, quality and age of furniture, fixtures and equipment included in guest rooms, lobbies and other common areas.

Additionally, as the franchisee, our TRS Lessee is required to pay the franchise fees described below.

The following table sets forth certain information for the franchise licenses of our wholly-owned hotel properties:

 

     Franchise Fee(1)     Marketing/
Reservation
Fee(1)
    Expiration
Date
 

Crowne Plaza Hampton Marina

     5.0     3.5     10/06/2018   

Crowne Plaza Houston Downtown

     5.0     3.5     04/12/2016   

Crowne Plaza Jacksonville Riverfront

     5.0     3.5     04/01/2016   

Crowne Plaza Tampa Westshore

     5.0     3.5     03/06/2019   

DoubleTree by Hilton Brownstone – University

     5.0     4.0     11/30/2021   

Hilton Philadelphia Airport

     5.0     3.5     10/31/2014   

Hilton Savannah DeSoto

     5.0     4.0     07/31/2017   

Hilton Wilmington Riverside

     5.0     4.0     03/31/2018   

Holiday Inn Laurel West

     5.0     2.5     10/05/2015   

Sheraton Louisville Riverside

     5.0     3.5     04/25/2023   

 

(1) Percentage of room revenues payable to the franchisor.

Tax Status

The Company elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Code”), commencing with its taxable year ended December 31, 2004. In order to

 

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maintain its qualification as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute, as “qualifying distributions”, at least 90.0% of its taxable income (determined without regard to the deduction for dividends paid and by excluding its net capital gains and reduced by certain non-cash items) to its stockholders. The Company has adhered to these requirements each taxable year since its formation in 2004 and intends to continue to adhere to these requirements and maintain its qualification for taxation as a REIT. As a REIT, the Company generally will not be subject to federal corporate income tax on that portion of its taxable income (including its net capital gain) that is distributed to its stockholders. If the Company fails to qualify for taxation as a REIT in any taxable year, and no relief provision applies, it will be subject to federal income taxes at regular corporate rates (as well as any applicable alternative minimum tax) and it would be disqualified from re-electing treatment as a REIT until the fifth taxable year after the year in which it failed to qualify as a REIT. Even if the Company qualifies for taxation as a REIT, it may be 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, taxable income from non-REIT activities managed through taxable REIT subsidiaries is subject to federal, state and local income taxes.

While the Operating Partnership is generally not subject to federal and state income taxes, the unitholders of the Operating Partnership, including the Company, are subject to tax on their respective allocable shares of the Operating Partnership’s taxable income.

The Company has one taxable REIT subsidiary, MHI Holding, in which it owns an interest through the Operating Partnership. MHI Holding is subject to federal, state and local income taxes. MHI Holding has operated at a cumulative taxable loss through December 31, 2013 of $2.9 million and has paid no income taxes since its formation. In addition to a deferred tax asset of approximately $1.0 million for these cumulative tax loss carryforwards, MHI Holding had a deferred tax asset of approximately $0.3 million attributable to start-up expenses related to the opening of several of its hotels which was not deductible when incurred and is being amortized over 15 years and deferred tax assets of approximately $0.2 million attributable to year-to-year timing differences for accrued, but not deductible, vacation and sick pay amounts.

Environmental Matters

In connection with the ownership and operation of the hotels, we are subject to various federal, state and local laws, ordinances and regulations relating to environmental protection. Under these laws, a current or previous owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on, under, or in such property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances. In addition, the presence of contamination from hazardous or toxic substances, or the failure to remediate such contaminated property properly, may adversely affect the owner’s ability to borrow using such property as collateral. Furthermore, a person who arranges for the disposal or treatment of a hazardous or toxic substance at a property owned by another, or who transports such substance to or from such property, may be liable for the costs of removal or remediation of such substance released into the environment at the disposal or treatment facility. The costs of remediation or removal of such substances may be substantial, and the presence of such substances may adversely affect the owner’s ability to sell such real estate or to borrow using such real estate as collateral. In connection with the ownership and operation of the hotels, we may be potentially liable for such costs.

We believe that our hotels are in compliance, in all material respects, with all federal, state and local environmental ordinances and regulations regarding hazardous or toxic substances and other environmental matters, the violation of which would have a material adverse effect on us. We have not received written notice from any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental matters in connection with any of our present hotel properties.

 

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Employees

As of February 28, 2014, we employed nine full-time persons, all of whom work at our corporate office in Williamsburg, Virginia. All persons employed in the day-to-day operations of the hotels are employees of MHI Hotels Services, the management company engaged by our TRS Lessee to operate such hotels.

Subsequent Events

On January 13, 2014, the Company entered into an agreement to acquire an independent full-service hotel in Atlanta, Georgia for the aggregate purchase price of approximately $61.0 million. We anticipate that the purchase will be funded with a first mortgage in the amount of $41.5 million, a $19.0 million loan secured by interests in another asset, and working capital. We hope to close the transaction by the end of the first quarter, or shortly thereafter. We plan to continue to operate the hotel as an independent full-service hotel.

Available Information

We maintain an Internet site, http://www.sotherlyhotels.com, which contains additional information concerning Sotherly Hotels Inc. We make available free of charge through our Internet site all our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, definitive proxy statements and other reports filed with the Securities and Exchange Commission as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We have also posted on this website the Company’s Code of Business Conduct and the charters of the Company’s Audit and NCGC Committees of the Company’s board of directors. We intend to disclose on our website any changes to, or waivers from, the Company’s Code of Business Conduct. Information on the Company’s Internet site is neither part of nor incorporated into this Form 10-K.

 

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Item 1A. Risk Factors

The following are the material risks that may affect us. Any of the risks discussed herein can materially adversely affect our business, liquidity, operations, industry or financial position or our future financial performance.

Risks Related to Our Debt and the Recent Economic Crisis

We have substantial financial leverage.

As of December 31, 2013, we had consolidated debt of approximately $188.0 million, which is comprised of approximately $160.4 million secured debt, and approximately $27.6 million unsecured debt related to the 8.0% senior unsecured notes due September 30, 2018 (the “Notes” or, individually, a “Note”). Historically, we have incurred debt for acquisitions and to fund our renovation, redevelopment and rebranding programs. Limitations upon our access to additional debt could adversely affect our ability to fund these programs or acquire hotels in the future.

Our financial leverage could negatively affect our business and financial results, including the following:

 

    require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for operations, working capital, capital expenditures, future business opportunities, paying dividends or other purposes;

 

    limit our ability to obtain additional financing for working capital, renovation, redevelopment and rebranding plans, acquisitions, debt service requirements and other purposes;

 

    adversely affect our ability to satisfy our financial obligations, including those related to the Notes;

 

    limit our ability to refinance existing debt;

 

    require us to agree to additional restrictions and limitations on our business operations and capital structure to obtain financing;

 

    force us to dispose of one or more of our properties, possibly on unfavorable terms;

 

    increase our vulnerability to adverse economic and industry conditions, and to interest rate fluctuations;

 

    force us to issue additional equity, possibly on terms unfavorable to existing shareholders;

 

    limit our flexibility to make, or react to, changes in our business and our industry; and

 

    place us at a competitive disadvantage, compared to our competitors that have less debt.

We must comply with financial covenants in our mortgage loan agreements and in the indenture.

Our mortgage loan agreements and indenture contain various financial covenants. Failure to comply with these financial covenants could result from, among other things, changes in the local competitive environment, general economic conditions and disruption caused by renovation activity or major weather disturbances.

If we violate the financial covenants contained in our mortgage loan agreements, we may attempt to negotiate waivers of the violations or amend the terms of the applicable mortgage loan agreement with the lender; however, we can make no assurance that we would be successful in any such negotiation or that, if successful in obtaining waivers or amendments, such waivers or amendments would be on attractive terms. Some mortgage loan agreements provide alternate cure provisions which may allow us to otherwise comply with the financial covenants by obtaining an appraisal of the hotel, prepaying a portion of the outstanding indebtedness or by providing cash collateral until such time as the financial covenants are met by the collateralized property without consideration of the cash collateral. Alternate cure provisions which include prepaying a portion of the outstanding indebtedness or providing cash collateral may have a material impact on our liquidity.

 

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If we violate the financial covenants in the indenture, we may attempt to cure that violation by engaging in one or more transactions pursuant to the cure provision in the indenture.

If we are unable to negotiate a waiver or amendment or satisfy alternate cure provisions, if any, or unable to meet any alternate cure requirements and a default were to occur, we would possibly have to refinance the debt through debt financing, private or public offerings of debt securities, additional equity financing, or by disposing of an asset. We are uncertain whether we will be able to refinance these obligations or if refinancing terms will be favorable.

We have debt obligations maturing in 2014 and 2015, and if we are not successful in extending the term of this indebtedness or in refinancing this debt on acceptable economic terms or at all, our overall financial condition could be materially and adversely affected.

We will be required to seek additional capital in the near future to refinance or replace existing long-term mortgage debt that is maturing. Based on current market conditions, the availability of financing is, and may continue to be, limited. There can be no assurance that we will be able to obtain future financings on acceptable terms, if at all.

On June 28, 2013, we entered into an agreement with TowneBank to extend the maturity of the mortgage on the Crowne Plaza Hampton Marina until June 30, 2014. Under the terms of the extension, we made a principal payment of approximately $1.1 million to reduce the principal balance on the loan to $6.0 million. We may extend the maturity date of such mortgage until June 2015, subject to certain terms and conditions. In July 2015, the mortgage on our Crowne Plaza Jacksonville Riverfront matures, but we may extend such mortgage until July 2016 pursuant to certain terms and conditions. The total aggregate amount of our debt obligations maturing in 2014 is approximately $34.6 million, which represents approximately 18.4% of our total debt obligations. In August 2014, the mortgage on the Hilton Philadelphia Airport matures, but we may extend such mortgage until March 2017 pursuant to certain terms and conditions.

We will need to, and plan to, renew, replace or extend our long-term indebtedness prior to their respective maturity dates. If we are unable to extend these loans, we may be required to repay the outstanding principal amount at maturity or a portion of such indebtedness upon refinance. If we do not have sufficient funds to repay any portion of the indebtedness, it may be necessary to raise capital through debt financing, private or public offerings of debt securities or equity financings. We are uncertain whether we will be able to refinance these obligations or if refinancing terms will be favorable. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancing, increases in interest expense would lower our cash flow, and, consequently, cash available to meet our financial obligations. If we are unable to obtain alternative or additional financing arrangements in the future, or if we cannot obtain financing on acceptable terms, we may not be able to execute our business strategies or we may be forced to dispose of hotel properties on disadvantageous terms, potentially resulting in losses and potentially reducing cash flow from operating activities if the sale proceeds in excess of the amount required to satisfy the indebtedness could not be reinvested in equally profitable real property investments. Moreover, the terms of any additional financing may restrict our financial flexibility, including the debt we may incur in the future, or may restrict our ability to manage our business as we had intended. To the extent we cannot repay our outstanding debt, we risk losing some or all of our hotel properties to foreclosure and we could be required to invoke insolvency proceedings including, but not limited to, commencing a voluntary case under the U.S. Bankruptcy Code.

For tax purposes, a foreclosure of any of our hotels would be treated as a sale of the hotel for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the hotel, we would recognize taxable income on foreclosure, but we would not receive any cash proceeds, which could hinder the Company’s ability to meet the REIT distribution requirements imposed by the Code. In addition, we may give full or partial guarantees to lenders of mortgage debt

 

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on behalf of the entities that own our hotels. When we give a guarantee on behalf of an entity that owns one of our hotels, we will be responsible to the lender for satisfaction of the debt if it is not paid by such entity.

Our borrowing costs are sensitive to fluctuations in interest rates.

While we have reduced the amount of floating rate debt over the last year, higher interest rates could increase our debt service requirements and interest expense. Currently, our floating rate debt is limited to the mortgage on the Crowne Plaza Hampton Marina, the mortgage on the Hilton Philadelphia Airport, and the mortgage on the Crowne Plaza Jacksonville Riverfront. Each of these mortgages bears interest at rates tied to the 30-day London Interbank Offered Rate (“LIBOR”) and provide for minimum rates of interest. To the extent that increases in the LIBOR rate of interest cause the interest on the mortgages to exceed the minimum rates of interest, we are exposed to rising interest rates.

Our mortgage on the Crowne Plaza Hampton Marina matures within the next six months. Should we obtain new debt financing or refinance existing indebtedness, we may increase the amount of floating rate debt that currently exists. In addition, adverse economic conditions could also cause the terms on which we borrow to be unfavorable.

Our shares may be delisted from the NASDAQ Global Market if the closing price for our shares is not maintained at $1.00 per share or higher.

NASDAQ imposes, among other requirements, listing maintenance standards as well as minimum bid and public float requirements. The price of our shares must trade at or above $1.00 to comply with NASDAQ’s minimum bid requirement for continued listing on the NASDAQ Global Market.

If the closing price of our shares fails to meet NASDAQ’s minimum bid price requirement for 30 consecutive days, or if we otherwise fail to meet all other applicable requirements of the NASDAQ Global Market, NASDAQ may make a determination to delist our shares of common stock. Any such delisting could have adverse effects by, among other things:

 

    Reducing the trading liquidity and market price of the Company’s common stock;

 

    Reducing the number of investors willing to hold or acquire the Company’s common stock, thereby restricting our ability to obtain equity financing;

 

    Causing an event of default under certain of our debt agreements, which could serve to accelerate the indebtedness; and

 

    Reducing our ability to retain, attract and motivate directors, officers and employees.

Risks Related to Our Business and Properties

If the economy falls back into a recessionary period or fails to maintain positive growth, our operating performance and financial results may be harmed by declines in occupancy, average daily room rates and/or other operating revenues.

The performance of the lodging industry and the general economy historically have been closely linked. In an economic downturn, business and leisure travelers may seek to reduce costs by limiting travel and/or reducing costs on their trips. Our hotels, which are all full-service hotels, may be more susceptible to a decrease in revenue, as compared to hotels in other categories that have lower room rates. A decrease in demand for hotel stays and hotel services will negatively affect our operating revenues, which will lower our cash flow and may affect our ability to make distributions to stockholders and to maintain compliance with our loan obligations. We incurred a net loss of approximately $3.8 million for our 2013 fiscal year. A renewed economic downturn may produce continued losses. A weakening of the economy may adversely and materially affect our industry, business and results of operations and we cannot predict the likelihood, severity or duration of any such

 

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downturn. Moreover, reduced revenues as a result of a weakening economy may also reduce our working capital and impact our long-term business strategy.

We own a limited number of hotels and significant adverse changes at one hotel could have a material adverse effect on our financial performance and may limit our ability to make distributions to stockholders.

As of December 31, 2013, our portfolio consisted of ten wholly-owned properties and one joint venture property with a total of 2,683 rooms. Significant adverse changes in the operations of any one hotel could have a material adverse effect on our financial performance and, accordingly, on our ability to make distributions to stockholders.

We are subject to risks of increased hotel operating expenses and decreased hotel revenues.

Our leases with our TRS Lessee provide for the payment of rent based in part on gross revenues from our hotels. Our TRS Lessee is subject to hotel operating risks including decreased hotel revenues and increased hotel operating expenses, including but not limited to the following:

 

    wage and benefit costs;

 

    repair and maintenance expenses;

 

    energy costs;

 

    property taxes;

 

    insurance costs; and

 

    other operating expenses.

Any increases in these operating expenses can have a significant adverse impact on our TRS Lessee’s ability to pay rent and other operating expenses and, consequently, our earnings and cash flow.

In keeping with our investment strategy, we may acquire, renovate and/or re-brand hotels in new or existing geographic markets as part of our repositioning strategy. Unanticipated expenses and insufficient demand for newly repositioned hotels could adversely affect our financial performance and our ability to comply with covenants in the indenture and to make distributions to the Company’s stockholders.

We have in the past, and may in the future, develop or acquire hotels in geographic areas in which our management may have little or no operating experience. Additionally, those properties may also be renovated and re-branded as part of a repositioning strategy. Potential customers may not be familiar with our newly renovated hotel or be aware of the brand change. As a result, we may have to incur costs relating to the opening, operation and promotion of those new hotel properties that are substantially greater than those incurred in other geographic areas. These hotels may attract fewer customers than expected and we may choose to increase spending on advertising and marketing to promote the hotel and increase customer demand. Unanticipated expenses and insufficient demand at new hotel properties, therefore, could adversely affect our financial performance and our ability to comply with covenants in the indenture and to make distributions to the Company’s stockholders.

We do not have the authority to require any hotel to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel and as a result, our returns are dependent on the management of our hotels by MHI Hotels Services.

Since federal income tax laws restrict REITs and their subsidiaries from operating or managing hotels, we do not operate or manage our hotels. Instead, we lease all of our hotels to subsidiaries of our TRS Lessee, and our TRS Lessee retains third-party managers to operate our hotels pursuant to management agreements.

 

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Under the terms of our management agreements with MHI Hotels Services and the REIT qualification rules, our ability to participate in operating decisions regarding the hotels is limited. We will depend on MHI Hotels Services to operate our hotels as provided in the management agreements. We do not have the authority to require any hotel to be operated in a particular manner or to govern any particular aspect of the daily operations of any hotel. Thus, even if we believe our hotels are being operated inefficiently or in a manner that does not result in satisfactory occupancy rates, RevPAR, and average daily rates (“ADR”), we may not be able to force MHI Hotels Services to change its method of operating our hotels. Additionally, in the event that we need to replace MHI Hotels Services or any other management companies in the future, we may be required by the terms of the applicable management agreement to pay substantial termination fees and may experience significant disruptions at the affected hotels.

Our ability to make distributions to the Company’s stockholders is subject to fluctuations in our financial performance, operating results and capital improvement requirements.

As a REIT, the Company is required to distribute, as “qualifying distributions”, at least 90.0% of its REIT taxable income (determined without regard to the dividends-paid deduction and by excluding its net capital gains, and reduced by certain non-cash items), each year to the Company’s stockholders. However, several factors may make us unable to declare or pay distributions to the Company’s stockholders, including poor operating results and financial performance or unanticipated capital improvements to our hotels, including capital improvements that may be required by our franchisors.

We lease all of our hotels to our TRS Lessee. Our TRS Lessee is subject to hotel operating risks, including risks of sustaining operating losses after payment of hotel operating expenses, including management fees. Among the factors which could cause our TRS Lessee to fail to make required rent payments are reduced net operating profits or operating losses, increased debt service requirements and capital expenditures at our hotels, including capital expenditures required by the franchisors of our hotels. Among the factors that could reduce the net operating profits of our TRS Lessee are decreases in hotel revenues and increases in hotel operating expenses. Hotel revenue can decrease for a number of reasons, including increased competition from a new supply of hotel rooms and decreased demand for hotel rooms. These factors can reduce both occupancy and room rates at our hotels.

The amount of any dividend distributions to holders of the Company’s common stock is in the sole discretion of the Company’s board of directors, which will consider, among other factors, our financial performance, debt service obligations, debt covenants and capital expenditure requirements. We cannot assure you that we will continue to generate sufficient cash to fund distributions.

Geographic concentration of our hotels makes our business vulnerable to economic downturns in the Mid-Atlantic and Southern United States.

Our hotels are located in the Mid-Atlantic and Southern United States. As a result, economic conditions in the Mid-Atlantic and Southern United States significantly affect our revenues and the value of our hotels to a greater extent than if we had a more geographically diversified portfolio. Business layoffs or downsizing, industry slowdowns, changing demographics and other similar factors that may adversely affect the economic climate in these areas could have a significant adverse impact on our business. Any resulting oversupply or reduced demand for hotels in the Mid-Atlantic and Southern United States and in our markets in particular would therefore have a disproportionate negative impact on our revenues and limit our ability to make distributions to stockholders.

Hedging against interest rate exposure may adversely affect us and our hedges may fail to protect us from the losses that the hedges were designed to offset.

Subject to maintaining the Company’s qualification as a REIT, we may continue to manage our exposure to interest rate volatility by using interest rate hedging arrangements, such as cap agreements and swap agreements.

 

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These agreements involve the risks that these arrangements may fail to protect or adversely affect us because, among other things:

 

    interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;

 

    available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;

 

    the financial instruments we select may not have the effect of reducing our interest rate risk;

 

    the duration of the hedge may not match the duration of the related liability;

 

    the credit quality of the hedging counterparty owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

 

    the hedging counterparty owing money in the hedging transaction may default on its obligation to pay.

As a result of any of the foregoing, our hedging transactions, which are intended to limit losses, may fail to protect us from the losses that the hedges were designed to offset and could have a material adverse effect on us.

Our investment opportunities and growth prospects may be affected by competition for acquisitions.

We compete for investment opportunities with other entities, some of which have substantially greater financial resources than we do. This competition may generally limit the number of suitable investment opportunities offered to us, which may limit our ability to grow. This competition may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms, or at all.

If we fail to maintain an effective system of internal controls, we may not be able to accurately determine our financial results or prevent fraud. As a result, the Company’s stockholders could lose confidence in our financial results, which could harm our business and the value of the Company’s common shares.

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal controls over financial reporting. Our internal controls and financial reporting are not subject to attestation by our independent registered public accounting firm pursuant to the exemption provided to issuers that are not “large accelerated filers” or “accelerated filers” under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. While we have undertaken substantial work to comply with Section 404, we cannot be certain that we will be successful in maintaining adequate internal controls over our financial reporting and financial processes in the future. We may in the future discover areas of our internal controls that need improvement. Furthermore, as we grow our business, our internal controls will become more complex, and we will require significantly more resources to ensure our internal controls remain effective. If we or our independent auditors discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce the market value of the Company’s common shares. Additionally, the existence of any material weakness or significant deficiency would require management to devote significant time and incur significant expense to remediate any such material weaknesses or significant deficiencies and management may not be able to remediate any such material weaknesses or significant deficiencies in a timely manner.

 

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Risks Related to Conflicts of Interest of Our Officers and Directors

Conflicts of interest could result in our executive officers and certain of our directors acting in a manner other than in the Company’s stockholders’ best interest.

Conflicts of interest relating to MHI Hotels Services, the entity that manages the properties, and the terms of its management agreements may lead to management decisions that are not in the stockholders’ best interest.

Conflicts of interest relating to MHI Hotels Services may lead to management decisions that are not in the stockholders’ best interest. Certain of our officers and directors including Andrew M. Sims, our chairman and chief executive officer and Kim E. Sims, who currently serves on our board of directors, together own a substantial interest in MHI Hotels Services which manages our hotel properties. In addition, until December 2014, unless a majority of independent directors concludes otherwise, MHI Hotels Services has a right of first offer to manage hotels we acquire in the future, subject to certain exceptions, and receives substantial management fees based on the revenues and operating profit of our hotels. Our management agreements with MHI Hotels Services, including the financial terms thereof, were not negotiated on an arm’s-length basis and may be less favorable to us than we could have obtained from third parties.

Our management agreements establish the terms of MHI Hotels Services’ management of our hotels. Under certain circumstances, if we terminate our master management agreement as to one of the hotels, we will be required to pay MHI Hotels Services a termination fee. If we were to terminate the master management agreement with respect to all covered hotels in connection with a sale of those hotels, and also terminate the management agreement with respect to the Crowne Plaza Houston Downtown Hotel in connection with a sale of the hotel, the aggregate termination fee would be approximately $2.7 million as of December 31, 2013. There is currently no termination fee for the termination of the management agreement for our Tampa property. As significant owners of MHI Hotels Services, which would receive any management and management termination fees payable by us under the management agreement, Andrew M. Sims and Kim E. Sims may influence our decisions to sell a hotel or acquire or develop a hotel when it is not in the best interests of the Company’s stockholders to do so. In addition, Andrew M. Sims will have conflicts of interest with respect to decisions to enforce provisions of the management agreement, including any termination thereof.

There can be no assurance that provisions in our bylaws will always be successful in mitigating conflicts of interest.

Under our bylaws, a committee consisting of only independent directors must approve any transaction between us and MHI Hotels Services or its affiliates or any interested director. However, there can be no assurance that these policies always will be successful in mitigating such conflicts, and decisions could be made that might not fully reflect the interests of all of the Company’s stockholders.

Certain of our officers and directors hold units in our Operating Partnership and may seek to avoid adverse tax consequences, which could result from transactions that would otherwise benefit the Company’s stockholders.

Holders of units in our Operating Partnership, including members of our management team, may suffer adverse tax consequences upon our sale or refinancing of certain properties. Therefore, holders of units, including Andrew M. Sims, Kim E. Sims, Edward S. Stein, and a trust controlled by Andrew M. Sims, Kim E. Sims and a former member of our board of directors, may have different objectives than holders of the Company’s common stock regarding the appropriate pricing and timing of a property’s sale, or the timing and amount of a property’s refinancing. These individuals, together with their affiliates, owned as of December 31, 2013, in the aggregate, approximately 9.6% of the outstanding units in our Operating Partnership. These individuals may influence us not to sell or refinance certain properties, even if such sale or refinancing might be financially advantageous to the Company’s stockholders, or they may influence us to enter into tax-deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in our best interest.

 

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Contractual obligations require us to nominate affiliates of the Sims family as two of our directors.

Pursuant to a strategic alliance agreement we entered into in December 2004, during the term of the agreement, which expires in December 2014, MHI Hotels Services has a contractual right to nominate one person for election as a director, to our board of directors, and, pursuant to his employment agreement with us, Andrew M. Sims has the right to be nominated as a director. These provisions in effect provide the Sims family and their affiliates the right to nominate two of our directors. As discussed herein, such persons have conflicts of interest with the Company.

Our tax indemnification obligations, which were not the result of arm’s-length negotiations and which apply in the event that we sell certain properties, could subject us to liability, which we currently estimate to be approximately $4.6 million, and limit our operating flexibility and reduce our returns on our investments.

If we dispose of certain of our hotels in taxable dispositions, we would be obligated to indemnify the original contributors (including their permitted transferees and persons who are taxable on the income of a contributor or permitted transferee) against certain tax consequences of the sale pursuant to the tax indemnity agreements, the terms of which were not the result of arm’s-length negotiations. These original contributors include Andrew M. Sims, the Company’s chairman and chief executive officer, William J. Zaiser, the Company’s former executive vice president and chief financial officer, Kim E. Sims, a current Company director, and Christopher L. Sims, a former Company director. We have agreed to pay a certain amount of a contributor’s tax liability with respect to gains allocated to such contributor under Section 704(c) of the Code if we dispose of a property contributed by such contributor in a taxable transaction during a “protected period,” which continues until the earlier of:

 

    10 years after the contribution of such property; or

 

    the date on which the contributor no longer owns, in the aggregate, at least 25.0% of the units we issued to the contributor at the time of its contribution of property to our Operating Partnership.

This tax indemnity will be equal to a certain amount of the federal and state income tax liability a contributor incurs with respect to the gain allocated to such contributor upon such sale based on a sliding scale percentage. Specifically, we are responsible for indemnifying the contributors for 100.0% of their tax liability during the first five years after contribution and for 50.0% of their tax liability during the sixth year, and will indemnify them for: 40.0%, during the seventh year; 30.0%, during the eighth year; 20.0%, during the ninth year; and 10.0%, during the tenth year. The terms of the tax indemnity agreements also require us to gross up the tax indemnity payment for the amount of income taxes due as a result of the tax indemnity payment.

As over nine years have elapsed since the properties were contributed, if we were to sell, during 2014 in a taxable transaction, the five hotels that were contributed to us in the Company’s initial public offering in exchange for partnership units in the Operating Partnership (including our property in Jeffersonville, Indiana which we substituted under the tax indemnity and related agreements for the property in Williamsburg, Virginia as part of an exchange pursuant to Section 1031 of the Code) our estimated total tax indemnification obligation to our indemnified contributors, including the gross-up payment, would be approximately $4.6 million, which amount will decrease until the end of 2014 at which time the indemnification agreement expires.

Our agreements with MHI Hotels Services and its affiliates, including the contribution agreements, management agreements, strategic alliance agreement, subleases, partnership agreement of our Operating Partnership and employment agreements, were not negotiated on an arms’ length basis and may be less favorable to us than we could have obtained from third parties.

In connection with the Company’s initial public offering, we entered into various agreements with MHI Hotels Services and its affiliates, including contribution agreements, a master management agreement, a strategic alliance agreement, subleases, the partnership agreement of our Operating Partnership and employment agreements. In addition, we entered into separate management agreements with MHI Hotels Services relating to

 

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our Tampa, Florida property and our joint venture for the Hollywood, Florida property. In November 2013, we assumed the existing management agreement with MHI Hotels Services for the management of our Houston, Texas property. The terms of all of these agreements were determined by our management team, who had conflicts of interest as described above and ownership interests in MHI Hotels Services and its affiliates. The terms of all of these agreements may be less favorable to us than we could have obtained from third parties.

We may realize reduced revenue because our management company may experience conflicts of interest in connection with the management of its other properties.

MHI Hotels Services may experience conflicts of interest in connection with the management of other properties located nearby in the same geographic market as our hotel properties. Currently, MHI Hotels Services manages a small city-center property in the same geographic market as one of our hotel properties and also manages another property in the same geographic market as a second property in our portfolio. The fees that MHI Hotels Services earns for managing our properties are largely fixed under our management agreements and may be less than the fees it earns for other properties it manages or may manage in the future. Because MHI Hotels Services oversees the marketing and solicitation of individual and group business, it may have a greater financial incentive to direct prospective guests and customers to properties that we do not own, which would have a negative impact on our revenue and our financial condition.

Risks Related to the Lodging Industry

Our ability to comply with the terms of the indenture, our ability to make distributions to the Company’s stockholders and the value of our hotels in general, may be adversely affected by factors in the lodging industry.

Operating Risks

Our hotel properties are subject to various operating risks common to the lodging industry, many of which are beyond our control, including the following:

 

    competition from other hotel properties in our markets;

 

    over-building of hotels in our markets, which adversely affects occupancy and revenues at our hotels;

 

    dependence on business and commercial travelers and tourism;

 

    increases in energy costs and other expenses affecting travel, which may affect travel patterns and reduce the number of business and commercial travelers and tourists;

 

    increases in operating costs due to inflation and other factors, including increases in labor costs, that may not be offset by increased room rates;

 

    changes in interest rates and in the availability, cost and terms of debt financing;

 

    changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances;

 

    adverse effects of international, national, regional and local economic and market conditions;

 

    adverse effects of a downturn in the lodging industry; and

 

    risks generally associated with the ownership of hotel properties and real estate, as we discuss in detail below.

These factors could reduce the net income of our TRS Lessee, which in turn could adversely affect the value of our hotels and our ability to comply with the terms of the indenture and to make distributions to the Company’s stockholders.

 

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Competition for Acquisitions

We may compete for investment opportunities with entities that may have substantially greater financial resources than we do. These entities generally may be able to accept more risk than we choose to prudently manage. This competition may generally limit the number of suitable investment opportunities offered to us. This competition may also increase the bargaining power of property owners seeking to sell to us, making it more difficult for us to acquire new properties on attractive terms.

Seasonality of the Hotel Business

The lodging industry is seasonal in nature, which can be expected to cause quarterly fluctuations in our revenues. Our quarterly earnings may be adversely affected by factors outside our control, including weather conditions and poor economic factors. As a result, we may have to enter into short-term borrowings in certain quarters in order to offset these fluctuations in revenues and to make distributions to the Company’s stockholders.

Investment Concentration in Particular Segments of a Single Industry

Our entire business is lodging-related. Therefore, a downturn in the lodging industry, in general, and the full-service, upscale and upper-upscale segments in which we operate, in particular, will have a material adverse effect on the value of our hotels, our financial condition and the extent to which cash may be available for distribution to the Company’s stockholders.

Capital Expenditures

Our hotel properties have an ongoing need for renovations and other capital improvements, including replacements, from time to time, of furniture, fixtures and equipment. The franchisors of our hotels also require us to make periodic capital improvements as a condition of keeping the franchise licenses. In addition, several of our mortgage lenders require that we set aside amounts for capital improvements to the secured properties on a monthly basis. For the years ended December 31, 2013 and 2012, we spent approximately $4.9 million and approximately $2.9 million, respectively, on capital improvements to our hotels. Capital improvements and renovation projects may give rise to the following risks:

 

    possible environmental problems;

 

    construction cost overruns and delays;

 

    a possible shortage of available cash to fund capital improvements and the related possibility that financing for these capital improvements may not be available to us on affordable terms; and

 

    uncertainties as to market demand or a loss of market demand after capital improvements have begun.

The costs of all these capital improvements as well as future capital improvements could adversely affect our financial condition and amounts available for distribution to the Company’s stockholders.

Operating our hotels under franchise agreements could increase our operating costs and lower our net income.

Our hotels operate under franchise agreements which subject us to risks in the event of negative publicity related to one of our franchisors.

The maintenance of the franchise licenses for our hotels is subject to our franchisors’ operating standards and other terms and conditions. Our franchisors periodically inspect our hotels to ensure that we, our TRS Lessee, and the management company follow their standards. Failure by us, our TRS Lessee or the management

 

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company to maintain these standards or other terms and conditions could result in a franchise license being canceled. If a franchise license terminates due to our failure to make required improvements or to otherwise comply with its terms, we may also be liable to the franchisor for a termination payment, which varies by franchisor and by hotel. As a condition of continuing a franchise license, a franchisor may require us to make capital expenditures, even if we do not believe the capital improvements are necessary or desirable or will result in an acceptable return on our investment. Nonetheless, we may risk losing a franchise license if we do not make franchisor-required capital expenditures.

If a franchisor terminates the franchise license, we may try either to obtain a suitable replacement franchise license or to operate the hotel without a franchise license. The loss of a franchise license could significantly decrease the revenues at the hotel and reduce the underlying value of the hotel because of the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor. A loss of a franchise license for one or more hotels could materially and adversely affect our revenues. This loss of revenues could, therefore, also adversely affect our financial condition and results of operations, our ability to comply with the terms of the indenture and reduce our cash available for distribution to stockholders.

Restrictive covenants in certain of our franchise agreements contain provisions that may operate to limit our ability to sell or refinance our hotels, which could have a material adverse effect on us.

Franchise agreements typically contain covenants that may affect our ability to sell or refinance a hotel, including requirements to obtain the consent of the franchisor in the event of such a sale or refinancing transaction. In the event that a franchisor’s consent is not forthcoming, the terms of a sale or refinancing may be less favorable to us than would otherwise be the case. Some of our franchise agreements provide the franchisor with a right of first offer in the event of certain sales or transfers of a hotel and provide that the franchisor has the right to approve any change in the hotel management company engaged to manage the hotel. Generally, we may be limited in our ability to sell, lease or otherwise transfer hotels unless the transferee is not a competitor of the franchisor and the transferee agrees to assume the related franchise agreements. If the franchisor does not consent to the sale or financing of our hotels, we may be unable to consummate transactions that are in our best interests or the terms of those transactions may be less favorable to us, which could have a material adverse effect on our financial condition and the execution of our strategies.

Hotel re-development is subject to timing, budgeting and other risks that would increase our operating costs and limit our ability to make distributions to stockholders.

We intend to acquire hotel properties from time to time as suitable opportunities arise, taking into consideration general economic conditions, and seek to re-develop or reposition these hotels. Redevelopment of hotel properties involves a number of risks, including risks associated with:

 

    construction delays or cost overruns that may increase project costs;

 

    receipt of zoning, occupancy and other required governmental permits and authorizations;

 

    development costs incurred for projects that are not pursued to completion;

 

    acts of God such as earthquakes, hurricanes, floods or fires that could adversely impact a project;

 

    financing; and

 

    governmental restrictions on the nature or size of a project.

We cannot assure you that any re-development project will be completed on time or within budget. Our inability to complete a project on time or within budget would increase our operating costs and reduce our net income.

 

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The hotel business is capital intensive and our inability to obtain financing could limit our growth.

Our hotel properties will require periodic capital expenditures and renovation to remain competitive. Acquisitions or development of additional hotel properties will require significant capital expenditures. In addition, several of our mortgage lenders require that we set aside annual amounts for capital improvements to the secured property. We may not be able to fund capital improvements or acquisitions solely from cash provided from our operating activities because we must distribute at least 90.0% of our REIT taxable income, excluding net capital gains, each year to maintain our REIT tax status. As a result, our ability to fund significant capital expenditures, acquisitions or hotel development through retained earnings is very limited. Consequently, we rely upon the availability of debt or equity capital to fund any significant investments or capital improvements, but due to the recent recession and disruption of capital markets, these sources of funds may not yet be available to us on reasonable terms and conditions. Our ability to grow through acquisitions or development of hotels will be limited if we cannot obtain satisfactory debt or equity financing which will depend on market conditions. Neither our charter nor our bylaws limit the amount of debt that we can incur. However, we cannot assure you that we will be able to obtain additional equity or debt financing or that we will be able to obtain such financing on favorable terms.

Uninsured and underinsured losses could adversely affect our operating results and our ability to make distributions to the Company’s stockholders.

We maintain comprehensive insurance on each of our hotel properties, including liability, fire and extended coverage, of the type and amount we believe are customarily obtained for or by hotel owners. There are no assurances that current coverage will continue to be available at reasonable rates. Various types of catastrophic losses, like earthquakes and floods, such as Hurricane Sandy in October 2012 and Hurricane Katrina in New Orleans in August 2005, losses from foreign terrorist activities, such as those on September 11, 2001, or losses from domestic terrorist activities, such as the Oklahoma City bombing on April 19, 1995, may not be insurable or may not be economically insurable. Currently, our insurers provide terrorism coverage in conjunction with the Terrorism Risk Insurance Program sponsored by the federal government through which insurers are able to receive compensation for insured losses resulting from acts of terrorism. The program is currently set to expire on December 31, 2014. If the program is not renewed, we do not intend to obtain terrorism insurance on our hotel properties as we anticipate it will be costly or unavailable. Lenders may require such insurance and our failure to obtain such insurance could constitute a default under loan agreements. Depending on our access to capital, liquidity and the value of the properties securing the affected loan in relation to the balance of the loan, a default could reduce our net income and limit our ability to obtain future financing.

In the event of a substantial loss, our insurance coverage may not be sufficient to cover the full current market value or replacement cost of our lost investment. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenue from the hotel. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position on the damaged or destroyed property.

Noncompliance with governmental regulations could adversely affect our operating results.

Environmental Matters

Our hotels may be subject to environmental liabilities. An owner of real property can face liability for environmental contamination created by the presence or discharge of hazardous substances on the property. We may face liability regardless of:

 

    our knowledge of the contamination;

 

    the timing of the contamination;

 

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    the cause of the contamination; or

 

    the party responsible for the contamination of the property.

There may be unknown environmental problems associated with our properties. If environmental contamination exists on our properties, we could become subject to strict, joint and several liability for the contamination by virtue of our ownership interest.

The presence of hazardous substances on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs. The discovery of environmental liabilities attached to our properties could have a material adverse effect on our results of operations and financial condition and our ability to comply with our covenants and to pay distributions to stockholders.

Americans with Disabilities Act and Other Changes in Governmental Rules and Regulations

Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet various federal requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access barriers, and non-compliance could result in the U.S. government imposing fines or in private litigants winning damages. If we are required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and regulations, our financial condition, results of operations and ability to comply with the terms of the indenture and to make distributions to the Company’s stockholders could be adversely affected.

Our hotels may be subject to unknown or contingent liabilities which could cause us to incur substantial costs.

The hotel properties that we acquire may be subject to unknown or contingent liabilities for which we may have no recourse, or only limited recourse, against the sellers. Contingent or unknown liabilities with respect to entities or properties acquired might include:

 

    liabilities for environmental conditions;

 

    losses in excess of our insured coverage;

 

    accrued but unpaid liabilities incurred in the ordinary course of business;

 

    tax, legal and regulatory liabilities;

 

    claims of customers, vendors or other persons dealing with the Company’s predecessors prior to our formation or acquisition transactions that had not been asserted or were unknown prior to the Company’s formation or acquisition transactions; and

 

    claims for indemnification by the general partners, officers and directors and others indemnified by the former owners of our properties.

In general, the representations and warranties provided under the transaction agreements related to the sales of the hotel properties may not survive the closing of the transactions. While we will likely seek to require the sellers to indemnify us with respect to breaches of representations and warranties that survive, such indemnification may be limited and subject to various materiality thresholds, a significant deductible or an aggregate cap on losses. As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that may be incurred with respect to liabilities associated with these hotels may exceed our expectations, and we may experience other unanticipated adverse effects, all of which may adversely affect our financial condition, results of operations and our ability to make distributions to the Company’s stockholders.

Future terrorist activities may adversely affect, and create uncertainty in, our business.

Terrorism in the United States or elsewhere could have an adverse effect on our business, although the degree of impact will depend on a number of factors, including the U.S. and global economies and global

 

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financial markets. Previous terrorist attacks in the United States and subsequent terrorism alerts have adversely affected the travel and hospitality industries over the past several years. Such attacks, or the threat of such attacks, could have a material adverse effect on our business, our ability to finance our business, our ability to insure our properties and/or our results of operations and financial condition, as a whole.

We face risks related to pandemic diseases, which could materially and adversely affect travel and result in reduced demand for our hotels.

Our business could be materially and adversely affected by the effect of a pandemic disease on the travel industry. For example, the outbreaks of SARS and avian flu in 2003 had a severe impact on the travel industry, and the outbreaks of H1N1 flu in 2009 threatened to have a similar impact. A prolonged recurrence of SARS, avian flu, H1N1 flu or another pandemic disease also may result in health or other government authorities imposing restrictions on travel. Any of these events could result in a significant drop in demand for our hotels and adversely affect our financial conditions and results of operations.

General Risks Related to the Real Estate Industry

Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties in our portfolio in response to changing economic, financial and investment conditions is limited.

The real estate market is affected by many factors that are beyond our control, including:

 

    adverse changes in international, national, regional and local economic and market conditions;

 

    changes in interest rates and in the cost and terms of debt financing;

 

    absence of liquidity in credit markets which limits the availability and amount of debt financing;

 

    changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances;

 

    the ongoing need for capital improvements, particularly in older structures;

 

    changes in operating expenses; and

 

    civil unrest, acts of God, including earthquakes, floods and other natural disasters such as Hurricane Sandy in October 2012 and Hurricane Katrina in New Orleans in August 2005, which may result in uninsured losses, and acts of war or terrorism, including the consequences of terrorist acts, such as those that occurred on September 11, 2001.

We may decide to sell our hotels in the future. We cannot predict whether we will be able to sell any hotel property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a hotel property.

We may be required to expend funds to correct defects or to make improvements before a hotel property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. In acquiring a hotel property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could have a material adverse effect on our operating results and financial condition, as well as our ability to comply with the terms of the indenture and to pay distributions to stockholders.

 

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Future acquisitions may not yield the returns expected, may result in disruptions to our business, may strain management resources and may result in stockholder dilution.

Our business strategy may not ultimately be successful and may not provide positive returns on our investments. Acquisitions may cause disruptions in our operations and divert management’s attention away from day-to-day operations. The issuance of equity securities in connection with any acquisition could be substantially dilutive to the Company’s stockholders.

Our hotels may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem.

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property, which would reduce our cash available for distribution. In addition, the presence of significant mold could expose us to liability from our guests, employees or the management company and others if property damage or health concerns arise and could harm our reputation.

Increases in property taxes would increase our operating costs, reduce our income and adversely affect our ability to make distributions to the Company’s stockholders.

Each of our hotel properties is subject to real and personal property taxes. These taxes may increase as tax rates change and as the properties are assessed or reassessed by taxing authorities. If property taxes increase, our financial condition, results of operations and our ability to make distributions to the Company’s stockholders could be materially and adversely affected and the market price of the Company’s common shares could decline.

Risks Related to Our Organization and Structure

Our ability to effect a merger or other business combination transaction may be restricted by our Operating Partnership agreement.

In the event of a change of control of the Company, the limited partners of our Operating Partnership will have the right, for a period of 30 days following the change of control event, to cause the Operating Partnership to redeem all of the units held by the limited partners for a cash amount equal to the cash redemption amount otherwise payable upon redemption pursuant to the partnership agreement. This cash redemption right may make it more unlikely or difficult for a third party to propose or consummate a change of control transaction, even if such transaction were in the best interests of the Company’s stockholders.

Provisions of the Company’s charter may limit the ability of a third party to acquire control of the Company.

Aggregate Share and Common Share Ownership Limits

The Company’s charter provides that no person may directly or indirectly own more than 9.9% of the value of the Company’s outstanding shares of capital stock or more than 9.9% of the number of the Company’s outstanding shares of common stock. These ownership limitations may prevent an acquisition of control of the Company by a third party without the Company’s board of directors’ approval, even if the Company’s stockholders believe the change of control is in their interest. The Company’s board of directors has discretion to waive that ownership limit if, including other considerations, the board receives evidence that ownership in excess of the limit will not jeopardize the Company’s REIT status.

 

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Authority to Issue Stock

The Company’s amended and restated charter authorizes our board of directors to issue up to 49,000,000 shares of common stock and up to 1,000,000 shares of preferred stock, to classify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares. Issuances of additional shares of stock may have the effect of delaying or preventing a change in control of the Company, including transactions at a premium over the market price of the Company’s stock, even if stockholders believe that a change of control is in their interest. The Company will be able to issue additional shares of common or preferred stock without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which the Company’s securities may be listed or traded.

Provisions of Maryland law may limit the ability of a third party to acquire control of the Company.

Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of the Company’s common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including:

 

    “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10.0% or more of the voting power of our shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and

 

    “control share” provisions that provide that “control shares” of the Company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by the Company’s stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

The Company has opted out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL by resolution of the Company’s board of directors, and in the case of the control share provisions of the MGCL pursuant to a provision in the Company’s bylaws. However, the Company’s board of directors may by resolution elect to opt in to the business combination provisions of the MGCL and the Company may, by amendment to its bylaws, opt in to the control share provisions of the MGCL in the future. The Company’s board of directors has the exclusive power to amend the Company’s bylaws.

Additionally, Title 8, Subtitle 3 of the MGCL permits the Company’s board of directors, without stockholder approval and regardless of what is currently provided in the Company’s charter or bylaws, to implement takeover defenses, some of which (for example, a classified board) the Company does not currently have. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for the Company or of delaying, deferring or preventing a change in control of the Company under the circumstances that otherwise could provide the holders of the Company’s common stock with the opportunity to realize a premium over the then current market price.

Provisions in the Company’s executive officers’ employment agreements and the strategic alliance agreement may make a change of control of the Company more costly or difficult.

The Company’s employment agreements with Andrew M. Sims, its chief executive officer, David R. Folsom, its president and chief operating officer, and Anthony E. Domalski, its chief financial officer, contain provisions providing for substantial payments to these officers in the event of a change of control of the

 

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Company. Specifically, if the Company terminates these executive’s employment without cause or the executive resigns with good reason, which includes a failure to nominate Andrew M. Sims to the Company’s board of directors or his involuntary removal from the Company’s board of directors, unless for cause or by vote of the stockholders, or if there is a change of control, each of these executives is entitled to the following:

 

    any accrued but unpaid salary and bonuses;

 

    vesting of any previously issued stock options and restricted stock;

 

    payment of the executive’s life, health and disability insurance coverage for a period of five years following termination;

 

    any unreimbursed expenses; and

 

    a severance payment equal to three times for Andrew M. Sims’, David R. Folsom’s and Anthony E. Domalski’s respective combined salary and actual bonus compensation for the preceding fiscal year.

In addition, these executives will receive additional payments to compensate them for the additional taxes, if any, imposed on them under Section 4999 of the Code by reason of receipt of excess parachute payments. We will not be able to deduct any of the above amounts paid to the executives for tax purposes.

These provisions may make a change of control of the Company, even if it is in the best interests of the Company’s stockholders, more costly and difficult and may reduce the amounts the Company’s stockholders would receive in a change of control transaction.

Our ownership limitations may restrict or prevent you from engaging in certain transfers of the Company’s common stock.

In order to maintain the Company’s REIT qualification, it cannot be closely held (i.e., more than 50.0% in value of our outstanding stock cannot be owned, directly or indirectly, by five or fewer individuals during the last half of any taxable year (other than the first year for which a REIT election is made)). To preserve the Company’s REIT qualification, the Company’s charter contains a 9.9% aggregate share ownership limit and a 9.9% common share ownership limit. Generally, any shares of the Company’s stock owned by affiliated persons will be added together for purposes of the aggregate share ownership limit, and any shares of common stock owned by affiliated owners will be added together for purposes of the common share ownership limit.

If anyone transfers shares in a way that would violate the aggregate share ownership limit or the common share ownership limit, or prevent the Company from continuing to qualify as a REIT under the federal income tax laws, those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by us or sold to a person whose ownership of the shares will not violate the aggregate share ownership limit or the common share ownership limit. If this transfer to a trust fails to prevent such a violation or fails to preserve the Company’s continued qualification as a REIT, then the Company will consider the initial intended transfer to be null and void from the outset. The intended transferee of those shares will be deemed never to have owned the shares. Anyone who acquires shares in violation of the aggregate share ownership limit, the common share ownership limit or the other restrictions on transfer in the Company’s charter bears the risk of suffering a financial loss when the shares are redeemed or sold if the market price of the Company’s stock falls between the date of purchase and the date of redemption or sale.

The board of directors’ revocation of the Company’s REIT status without stockholder approval may decrease the Company’s stockholders’ total return.

The Company’s charter provides that the Company’s board of directors may revoke or otherwise terminate the Company’s REIT election, without the approval of the Company’s stockholders, if the Company’s board of directors determines that it is no longer in the Company’s best interest to continue to qualify as a REIT. If the Company ceases to be a REIT, it would become subject to federal income tax on its taxable income and would no

 

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longer be required to distribute most of its taxable income to the Company’s stockholders, which may have adverse consequences on our total return to the Company’s stockholders.

The ability of the Company’s board of directors to change the Company’s major corporate policies may not be in your best interest.

The Company’s board of directors determines the Company’s major corporate policies, including its acquisition, financing, growth, operations and distribution policies. The Company’s board of directors may amend or revise these and other policies from time to time without the vote or consent of the Company’s stockholders.

We do not have the ability to control the sale of any hotel properties acquired through our joint venture program with Carlyle.

We own, through our joint venture program with Carlyle, a 25.0% indirect noncontrolling interest in the Crowne Plaza Hollywood Beach Resort. Carlyle controls all major decisions relating to this investment, including, but not limited to, the sale of the property. We will not be able to control the timing and terms and conditions of sale of our interest in the Crowne Plaza Hollywood Beach Resort.

Joint venture investments could be adversely affected by our lack of sole decision-making authority, our reliance on a joint venture partners’ financial condition and disputes between our joint venture partners and us.

In August 2007, we purchased a 25.0% indirect, noncontrolling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with Carlyle. Carlyle owns a 75.0% controlling interest in the joint venture and is in a position to exercise sole decision-making authority regarding the property including, but not limited to, the method and timing of disposition of the property.

We may co-invest in the future with Carlyle or other third parties through partnerships, joint ventures or other entities, acquiring noncontrolling interests in or sharing responsibility for managing the affairs of a property, partnership, joint venture or other entity. In such event, we would not be in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity. Investments in partnerships, joint ventures or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or joint venture partners might become bankrupt or fail to fund their share of required capital contributions. Partners or joint venture partners may have economic or other business interests or goals, which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives. Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we, nor the partner or joint venture partner, would have full control over the partnership or joint venture. Disputes between us and partners or joint venture partners may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and effort on our business. Consequently, actions by, or disputes with, partners or joint venture partners might result in subjecting properties owned by the partnership or joint venture to additional risk. We may also, in certain circumstances, be liable for the actions of our third-party partners or joint venture partners. For example, we may be required to guarantee indebtedness incurred by a partnership, joint venture or other entity for the purchase or renovation of a hotel property. Such a guarantee may be on a joint and several basis with our partner or joint venture partner in which case we may be liable in the event such party defaults on its guaranty obligation.

Our success depends on key personnel whose continued service is not guaranteed.

We depend on the efforts and expertise of our chairman and chief executive officer, Andrew M. Sims; our president and chief operating officer, David R. Folsom; and our chief financial officer, Anthony E. Domalski, to manage our day-to-day operations and strategic business direction. The loss of any of their services could have an adverse effect on our operations.

 

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Federal Income Tax Risks Related to the Company’s Status as a REIT

The federal income tax laws governing REITs are complex.

The Company intends to operate in a manner that will maintain its qualification as a REIT under the federal income tax laws. The REIT qualification requirements are extremely complex, however, and interpretations of the federal income tax laws governing qualification as a REIT are limited. The Company has not requested or obtained a ruling from the Internal Revenue Service, or the IRS, that it qualifies as a REIT. Accordingly, we cannot be certain that the Company will be successful in operating in a manner that will permit it to qualify as a REIT. At any time, new laws, interpretations or court decisions may change the federal tax laws or the federal income tax consequences of the Company’s qualification as a REIT. We cannot predict when or if any new federal income tax law, regulation or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. The Company and its stockholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation. We are not aware, however, of any pending tax legislation that would adversely affect the Company’s ability to qualify as a REIT.

Failure to make distributions could subject the Company to tax.

In order to maintain its qualification as a REIT, each year the Company must pay out to its stockholders in distributions, as “qualifying distributions”, at least 90.0% of its REIT taxable income, computed without regard to the deductions for dividends paid and excluding net capital gains and reduced by certain non-cash items. To the extent that the Company satisfies this distribution requirement, but distributes less than 100.0% of its taxable income (including its net capital gain), it will be subject to federal corporate income tax on its undistributed taxable income. In addition, the Company will be subject to a 4.0% nondeductible excise tax if the actual amount that it pays out to its stockholders as a “qualifying distribution” for a calendar year is less than the sum of: (A) 85% of our ordinary income for such calendar year, plus (B) 95% of our capital gain net income for such calendar year. The Company’s only recurring source of funds to make these distributions comes from rent received from its TRS Lessee whose only recurring source of funds with which to make these payments and distributions is the net cash flow (after payment of operating and other costs and expenses and management fees) from hotel operations, and any dividend and other distributions that it may receive from MHI Holding. Accordingly, the Company may be required to borrow money or sell assets to make distributions sufficient to enable it to pay out enough of its taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4.0% nondeductible excise tax in a particular year.

Failure to qualify as a REIT would subject the Company to federal income tax.

If the Company fails to qualify as a REIT in any taxable year, it will be required to pay federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. The resulting tax liability might cause the Company to borrow funds, liquidate some of its investments or take other steps that could negatively affect its operating results in order to pay any such tax. Unless it is entitled to relief under certain statutory provisions, the Company would be disqualified from treatment as a REIT for the four taxable years following the year in which it lost its qualification. If the Company lost its REIT status, its net earnings available for investment or distribution to stockholders would be significantly reduced for each of the years involved. In addition, the Company would no longer be required to make distributions to its stockholders, and it would not be able to deduct any stockholder distributions in computing its taxable income. This would substantially reduce the Company’s earnings, cash available to pay distributions, and the value of common stock.

Failure to qualify as a REIT may cause the Company to reduce or eliminate distributions to its stockholders, and the Company may face increased difficulty in raising capital or obtaining financing.

If the Company fails to remain qualified as a REIT, it may have to reduce or eliminate any distributions to its stockholders in order to satisfy its income tax liabilities. Any distributions that the Company does make to its

 

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stockholders would be treated as taxable dividends to the extent of its current and accumulated earnings and profits. This may result in negative investor and market perception regarding the market value of the Company’s common stock, and the value of its common stock may be reduced. In addition, the Company and the Operating Partnership may face increased difficulty in raising capital or obtaining financing if the Company fails to qualify or remain qualified as a REIT because of the resulting tax liability and potential reduction of its market valuation.

MHI Holding increases our overall tax liability.

Our TRS Lessee is a single-member limited liability company that is wholly-owned by MHI Holding, a taxable REIT subsidiary that is wholly-owned by the Operating Partnership. Our TRS Lessee is disregarded as an entity separate from MHI Holding for U.S. federal income tax purposes, such that the assets, liabilities, income, gains, losses, credits and deductions of our TRS Lessee are treated as the assets, liabilities, income, gains, losses, credits and deductions of MHI Holding for U.S. federal income tax purposes. MHI Holding is subject to federal and state income tax on its taxable income, which will consist of the revenues from the hotels leased by the Company’s TRS Lessee, net of the operating expenses for such hotels and rent payments. Accordingly, although the Company’s ownership of MHI Holding and the TRS Lessee will allow it to participate in the operating income from its hotels in addition to receiving rent, that operating income will be fully subject to income tax. The after-tax net income of MHI Holding, if any, will be available for distribution to the Company.

The Company will incur a 100.0% excise tax on its transactions with MHI Holding and the TRS Lessee that are not conducted on an arm’s-length basis. For example, to the extent that the rent paid by the TRS Lessee exceeds an arm’s-length rental amount, such amount potentially will be subject to this excise tax. The Company intends that all transactions among itself, MHI Holding and the TRS Lessee will be conducted on an arm’s-length basis and, therefore, that the rent paid by the TRS Lessee will not be subject to this excise tax.

Even if the Company remains qualified as a REIT, it may face other tax liabilities that reduce its cash flow.

Even if the Company remains qualified for taxation as a REIT, it may be subject to certain federal, state and local taxes on its income and assets. For example:

 

    it will be required to pay tax on undistributed REIT taxable income (including net capital gain);

 

    it may be required to pay “alternative minimum tax” on its items of tax preference;

 

    if it has net income from the disposition of foreclosure property held primarily for sale to customers in the ordinary course of business or other non-qualifying income from foreclosure property, it must pay tax on that income at the highest corporate rate;

 

    if it sells a property in a “prohibited transaction,” its gain from the sale would be subject to a 100.0% penalty tax. A “prohibited transaction” would be a sale of property, other than a foreclosure property, held primarily for sale to customers in the ordinary course of business;

 

    MHI Holding is a fully taxable corporation and is required to pay federal and state taxes on its taxable income; and

 

    it may experience increases in its state and/or local income tax burdens as states and localities continue to look to modify their tax laws in order to raise revenues, including by (among other things) changing from a net taxable income-based regime to a gross receipts-based regime, suspending and/or limiting the use of net operating losses, increasing tax rates and fees, imposing surcharges and subjecting partnerships to an entity-level tax, and limiting or disallowing certain U.S. federal deductions such as the dividends-paid deduction.

Complying with REIT requirements may cause the Company to forgo attractive opportunities that could otherwise generate strong risk-adjusted returns and instead pursue less attractive opportunities, or none at all.

To qualify as a REIT for federal income tax purposes, the Company must continually satisfy tests concerning, among other things, the sources of its income, the nature and diversification of its assets, the

 

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amounts it distributes to its stockholders and the ownership of its stock. Thus, compliance with the REIT requirements may hinder the Company’s ability to operate solely on the basis of generating strong risk-adjusted returns on invested capital for its stockholders.

Complying with REIT requirements may force the Company to liquidate otherwise attractive investments, which could result in an overall loss on its investments.

To maintain qualification as a REIT, the Company must ensure that at the end of each calendar quarter at least 75.0% of the value of its assets consists of cash, cash items, government securities and qualified REIT real estate assets. The remainder of the Company’s investment in securities (other than government securities, qualified real estate assets and securities of one or more taxable REIT subsidiaries) generally cannot include more than 10.0% of the outstanding voting securities of any one issuer or more than 10.0% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5.0% of the value of the Company’s assets (other than government securities, qualified real estate assets and securities of one or more taxable REIT subsidiaries) can consist of the securities of any one issuer, and no more than 25.0% of the value of the Company’s total assets can be represented by securities of one or more taxable REIT subsidiaries. If the Company fails to comply with these requirements at the end of any calendar quarter, it must correct such failure within 30 days after the end of the calendar quarter to avoid losing its REIT status and suffering adverse tax consequences. If the Company fails to comply with these requirements at the end of any calendar quarter, and the failure exceeds a de minimis threshold, the Company may be able to preserve its REIT status if the failure was due to reasonable cause and not to willful neglect. In this case, the Company will be required to dispose of the assets causing the failure within six months after the last day of the quarter in which the failure occurred, and it will be required to pay an additional tax of the greater of $50,000 or the product of the highest applicable tax rate multiplied by the net income generated on those assets.

As a result, the Company may be required to liquidate otherwise attractive investments.

Taxation of dividend income could make the Company’s common stock less attractive to investors and reduce the market price of its common stock.

The federal income tax laws governing REITs, or the administrative interpretations of those laws, may be amended at any time. Any new laws or interpretations may take effect retroactively and could adversely affect the Company or could adversely affect its stockholders. Under recently-enacted legislation, “qualified dividends,” which include dividends from domestic C corporations that are paid to non-corporate stockholders, are subject to a reduced maximum U.S. federal income tax rate of 20.0%. Because REITs generally do not pay corporate-level taxes as a result of the dividends-paid deduction to which they are entitled, dividends from REITs generally are not treated as qualified dividends and thus do not qualify for a reduced tax rate. Non-corporate investors could view an investment in non-REIT corporations as more attractive than an investment in REITs because the dividends they would receive from non-REIT corporations would be subject to lower tax rates.

If the Operating Partnership fails to qualify as a partnership for federal income tax purposes, the Company could cease to qualify as a REIT and suffer other adverse consequences.

We believe that the Operating Partnership will continue to qualify to be treated as a partnership for U.S. federal income tax purposes. As a partnership, the Operating Partnership is not subject to federal income tax on its income. Instead, each of its partners, including the Company, will be required to pay tax on its allocable share of the Operating Partnership’s income. We cannot assure you, however, that the IRS will not challenge the Operating Partnership’s status as a partnership for U.S. federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating the Operating Partnership as a corporation for federal income tax purposes, the Company could fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, cease to qualify as a REIT. Also, the failure of the Operating Partnership to qualify as a partnership would cause the Company to become subject to federal and state corporate income tax,

 

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which would reduce significantly the amount of cash available for debt service and for distribution to its partners, including the Company.

The Company’s failure to qualify as a REIT would have serious adverse consequences to its stockholders.

The Company elected to be taxed as a REIT under Sections 856 through 860 of the Code, commencing with its taxable year ended December 31, 2004. The Company believes it has operated so as to qualify as a REIT under the Code and believes that its current organization and method of operation comply with the rules and regulations promulgated under the Code to enable the Company to continue to qualify as a REIT. However, it is possible that the Company has been organized or has operated in a manner that would not allow it to qualify as a REIT, or that its future operations could cause it to fail to qualify. Qualification as a REIT requires the Company to satisfy numerous requirements (some on an annual and others on a quarterly basis) established under highly technical and complex sections of the Code for which there are only limited judicial and administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within its control. For example, in order to qualify as a REIT, the Company must satisfy a 75.0% gross income test pursuant to Code Section 856(c)(3) and a 95.0% gross income test pursuant to Code Section 856(c)(2) each taxable year. In addition, the Company must pay dividends, as “qualifying distributions”, to its stockholders aggregating annually at least 90.0% of its REIT taxable income (determined without regard to the dividends-paid deduction and by excluding capital gains, and reduced by certain non-cash items) and must satisfy specified asset tests on a quarterly basis. While historically the Company has satisfied the distribution requirement discussed above by making cash distributions to its stockholders, the Company may choose to satisfy this requirement by making distributions of cash or other property, including, in limited circumstances, its stock. The provisions of the Code and applicable Treasury regulations regarding qualification as a REIT are more complicated in the Company’s case because its holds its assets through the Operating Partnership.

If MHI Holding does not qualify as a taxable REIT subsidiary, or if the Company’s hotel manager does not qualify as an “eligible independent contractor,” the Company would fail to qualify as a REIT and would be subject to higher taxes and have less cash available for distribution to its shareholders.

Rent paid by a lessee that is a “related party tenant” of ours will not be qualifying income for purposes of the two gross income tests applicable to REITs. The Company currently leases substantially all of its hotels to the TRS Lessee, which is a disregarded entity for U.S. federal income tax purposes and is wholly-owned by MHI Holding, a taxable REIT subsidiary, and expects to continue to do so. So long as MHI Holding qualifies as a taxable REIT subsidiary, it will not be treated as a “related party tenant” with respect to the Company’s properties that are managed by an independent hotel management company that qualifies as an “eligible independent contractor.” The Company believes that MHI Holding will continue to qualify to be treated as a taxable REIT subsidiary for federal income tax purposes, but there can be no assurance that the IRS will not challenge this status or that a court would not sustain such a challenge. If the IRS were successful in such challenge, it is possible that the Company would fail to meet the asset tests applicable to REITs and substantially all of its income would fail to be qualifying income for purposes of the two gross income tests. If the Company failed to meet any of the asset or gross income tests, it would likely lose its REIT qualification for federal income tax purposes.

Additionally, if the Company’s hotel manager does not qualify as an “eligible independent contractor,” the Company would fail to qualify as a REIT. Each hotel manager that enters into a management contract with the TRS Lessee must qualify as an “eligible independent contractor” under the REIT rules in order for the rent paid by the TRS Lessee to be qualifying income for purposes of the REIT gross income tests. Among other requirements, in order to qualify as an eligible independent contractor, a hotel manager must not own, directly or through its shareholders, more than 35.0% of the Company’s outstanding shares, taking into account certain ownership attribution rules. The ownership attribution rules that apply for purposes of these 35.0% thresholds are complex. Although the Company intends to monitor ownership of its shares by its hotel manager and their owners, there can be no assurance that these ownership levels will not be exceeded.

 

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Foreign investors may be subject to U.S. tax on the disposition of the Company’s stock if the Company does not qualify as a “domestically controlled” REIT.

A foreign person disposing of a “U.S. real property interest,” which includes stock of a U.S. corporation whose assets consist principally of U.S. real property interests, is generally subject to U.S. federal income tax under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) on the gain recognized on the disposition. Additionally, the transferee will be required to withhold 10% on the amount realized on the disposition. This 10% is creditable against the U.S. federal income tax liability of the foreign transferor in connection with such transferor’s disposition of the Company’s stock. FIRPTA does not apply, however, to the disposition of stock in a REIT if the REIT is “domestically controlled” (i.e., less than 50% of the REIT’s capital stock, by value, has been owned directly or indirectly by persons who are not qualifying U.S. persons during a continuous five-year period ending on the date of disposition or, if shorter, during the entire period of the REIT’s existence). We cannot be sure that the Company will qualify as a “domestically controlled” REIT. If the Company does not so qualify, gain realized by foreign investors on a sale of the Company’s stock would be subject to U.S. income and withholding tax under FIRPTA, unless the Company’s stock were traded on an established securities market and a foreign investor did not at any time during a specified testing period directly or indirectly own more than 5% of the value of the Company’s outstanding stock.

Investors may be subject to a 3.8% Medicare tax in connection with an investment in the Company’s common stock or the Notes.

The U.S. tax laws impose a 3.8% “Medicare tax” on the “net investment income” (i.e., interest, dividends, capital gains, annuities, and rents that are not derived in the ordinary course of a trade or business) of individuals with income exceeding $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately), and of estates and trusts. Interest on the Notes and gains from the disposition of the Notes may be subject to the Medicare tax. Prospective investors should consult with their independent advisors as to the applicability of the Medicare tax to an investment in the Notes in light of such investors’ particular circumstances.

Investors may be subject to U.S. withholding tax under the “Foreign Account Tax Compliance Act.”

On March 18, 2010, the Hiring Incentives to Restore Employment Act, or the HIRE Act, was enacted in the United States. The HIRE Act includes provisions known as the Foreign Account Tax Compliance Act, or FATCA, that generally impose a 30% U.S. withholding tax on “withholdable payments,” which consist of (i) U.S.-source dividends, interest, rents and other “fixed or determinable annual or periodical income” paid after June 30, 2014 and (ii) certain U.S.-source gross proceeds paid after December 31, 2016 to (a) “foreign financial institutions” unless (x) they enter into an agreement with the IRS to collect and disclose to the IRS information regarding their direct and indirect U.S. owners or (y) they comply with the terms of any FATCA intergovernmental agreement executed between the authorities in their jurisdiction and the U.S., and (b) “non-financial foreign entities” (i.e., foreign entities that are not foreign financial institutions) unless they certify certain information regarding their direct and indirect U.S. owners. Final regulations under FATCA were issued by the IRS on January 17, 2013, which were supplemented by additional regulations and guidance. FATCA does not replace the existing U.S. withholding tax regime. However, the FATCA regulations contain coordination provisions to avoid double withholding on U.S.-source income.

A foreign investment that receives dividends on the Company’s common stock or gross proceeds from a disposition of shares of the Company’s common stock may be subject to FATCA withholding tax with respect to such dividends or gross proceeds.

 

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Under a grandfathering rule, FATCA does not apply to any payments made under an obligation that is outstanding on July 1, 2014 (provided such obligation is not materially modified subsequent to such date) and any gross proceeds from the disposition of such obligation. The Notes will be grandfathered obligations for FATCA purposes provided they are not materially modified after July 1, 2014. However, if the Notes are materially modified after July 1, 2014, interest on the Notes may be subject to FATCA withholding. Prospective investors should consult their own tax advisors regarding the potential implications of FATCA with respect to an investment in the Notes in light of their particular circumstances.

Foreign investors will be subject to U.S. withholding tax on the receipt of ordinary dividends on the Company’s stock.

The portion of dividends received by a foreign investor payable out of the Company’s current and accumulated earnings and profits which are not attributable to capital gains and which are not effectively connected with a U.S. trade or business of the foreign investor will generally be treated as ordinary income and will be subject to U.S. withholding tax at the rate of 30%. This 30% withholding tax may be reduced by an applicable income tax treaty. The IRS recently issued additional temporary and final FATCA regulations that are complex and considerable in length. Even if the 30% withholding is reduced or eliminated by treaty for payments made to a foreign investor, FATCA withholding of 30% could apply depending upon the foreign investor’s FATCA status. Foreign investors should consult with their independent advisors as to the U.S. withholding tax consequences to such investors with respect to their investment in the Company’s stock in light of their particular circumstances, as well as determining the appropriate documentation required to reduce or eliminate U.S. withholding tax.

Foreign investors will be subject to U.S. income tax on the receipt of capital gain dividends on the Company’s stock.

Under FIRPTA, distributions that we make to a foreign investor that are attributable to gains from our dispositions of U.S. real property interests (“capital gain dividends”) will be treated as income that is effectively connected with a U.S. trade or business in the hands of the foreign investor. A foreign investor will be subject to U.S. federal income tax (at the rates applicable to U.S. investors) on any capital gain dividends, and will also be required to file U.S. federal income tax returns to report such capital gain dividends. Furthermore, capital gain dividends are subject to an additional 30% “branch profits tax” (which may be reduced by an applicable income tax treaty) in the hands of a foreign corporate investor.

Legislative or regulatory action could adversely affect you.

Because our operations are governed to a significant extent by the federal tax laws, new legislative or regulatory action could adversely affect our investors. You are strongly encouraged to consult with your own tax advisor with respect to the status of any legislative, regulatory or administrative developments, announcements and proposals and their potential impact on your investment in the Company’s stock.

 

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Item 1B. Unresolved Staff Comments

Not applicable.

Item  2. Properties

As of February 28, 2014, our portfolio consisted of the following properties:

 

Wholly-Owned Properties

  Number of
Rooms
    Occupancy
2013
    ADR
2013
    RevPAR
2013
    Occupancy
2012
    ADR
2012
    RevPAR
2012
    Occupancy
2011
    ADR
2011
    RevPAR
2011
 

Crowne Plaza Hampton Marina, Hampton, Virginia

    173        50.1   $ 95.27      $ 47.72        56.1   $ 90.50      $ 50.82        61.7   $ 88.48      $ 54.63   

Crowne Plaza Houston Downtown, Houston, Texas(1)

    259        74.6     133.51        99.64        68.7     124.16        85.34        64.2     121.51        78.04   

Crowne Plaza Jacksonville Riverfront, Jacksonville, Florida

    292        58.5     97.51        57.05        61.9     95.72        59.25        53.2     101.29        53.85   

Crowne Plaza Tampa Westshore, Tampa, Florida

    222        67.1     99.12        66.46        70.8     100.77        71.33        64.6     96.82        62.58   

DoubleTree by Hilton Brownstone – University, Raleigh, North Carolina

    190        69.9     111.56        78.03        67.9     104.12        70.73        59.4     85.87        51.02   

Hilton Philadelphia Airport, Philadelphia, Pennsylvania

    331        78.2     134.40        105.13        77.0     134.21        103.38        76.8     128.57        98.75   

Hilton Savannah DeSoto, Savannah, Georgia

    246        73.7     137.77        101.61        74.2     132.59        98.32        75.6     123.85        93.61   

Hilton Wilmington Riverside, Wilmington, North Carolina

    272        73.3     140.44        102.91        74.0     129.48        95.82        73.6     124.81        91.81   

Holiday Inn Laurel West, Laurel, Maryland

    207        61.5     87.68        53.90        66.9     88.66        59.34        60.8     89.01        54.14   

Sheraton Louisville Riverside, Jeffersonville, Indiana

    180        67.9     133.19        90.42        63.2     123.73        78.15        62.9     118.37        74.51   
 

 

 

                   

Subtotal

    2,372                     

Joint Venture Property

                                                           

Crowne Plaza Hollywood Beach Resort, Hollywood, Florida

    311        82.2   $ 157.87      $ 129.79        79.2   $ 147.37      $ 116.66        79.4   $ 133.29      $ 105.82   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    2,683                     
 

 

 

                   

 

(1) The operating statistics for the Crowne Plaza Houston Downtown rely on information from both the period prior to, and the period subsequent to, the Company’s acquisition of the hotel.

Item 3. Legal Proceedings

We are not involved in any material litigation, nor to our knowledge, is any material litigation threatened against us. We are involved in routine litigation arising out of the ordinary course of business, all of which is expected to be covered by insurance, and none of which is expected to have a material impact on our financial condition or results of operations.

Item 4. Mine Safety Disclosure

Not applicable.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Sotherly Hotels Inc.

Market Information

Prior to March 11, 2008, the Company’s common stock traded on the American Stock Exchange, or AMEX, under the symbol “MDH”. On March 11, 2008, we terminated our listing on the AMEX and listed the Company’s common stock on the NASDAQ® Global Market also under the symbol “MDH”. Upon completion of its name change, the Company changed its symbol to “SOHO”. The following table sets forth, for the indicated period, the high and low sales prices for the common stock, as reported on NASDAQ:

 

     Price Range  
         High              Low      

Year Ended December 31, 2013

     

First Quarter

   $     4.35       $     3.19   

Second Quarter

   $ 4.81       $ 3.29   

Third Quarter

   $ 4.80       $ 4.11   

Fourth Quarter

   $ 5.95       $ 4.46   

Year Ended December 31, 2012

     

First Quarter

   $ 2.95       $ 2.23   

Second Quarter

   $ 3.80       $ 2.71   

Third Quarter

   $ 4.10       $ 3.40   

Fourth Quarter

   $ 4.10       $ 2.88   

The closing price of the Company’s common stock on the NASDAQ Global Market on February 28, 2014 was $6.17 per share.

Stockholder Information

As of February 28, 2014, there were 79 holders of record of the Company’s common stock and as of February 28, 2014, there were 2,609 beneficial owners of the Company’s common stock.

In order to comply with certain requirements related to the Company’s qualification as a REIT, the Company’s charter, subject to certain exceptions, limits the number of common shares that may be owned by any single person or affiliated group to 9.9% of the outstanding common shares.

Recent Sales of Unregistered Securities

On each of March 1, 2013 and August 14, 2013, Kim E. Sims, a director of the Company, through the KES Family Limited Partnership, LLP, a holder of units in the Operating Partnership, redeemed 50,000 units in the Operating Partnership for an equivalent number of shares of the Company’s common stock. The shares of common stock were issued to the unitholder pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

On April 1, 2013, a holder of units in the Operating Partnership redeemed 31,641 units for an equivalent number of shares of the Company’s common stock. The shares of common stock were issued to the unitholder pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

 

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Sotherly Hotels LP

Market Information

There is no established trading market for partnership units of the Operating Partnership. The Operating Partnership does not currently propose to offer partnership units to the public, and does not currently expect that a public market for those units will develop.

Partnership Unitholder Information

As of February 28, 2014, there were 13 holders of the Operating Partnership’s partnership units.

Recent Sales of Unregistered Securities

From time to time, the Operating Partnership issues limited partnership units to the Company, as required by the Amended and Restated Agreement of Limited Partnership of the Operating Partnership, to mirror the capital structure of the Company to reflect additional issuances by the Company and to preserve equitable ownership ratios.

In connection with the acquisition of the Crowne Plaza Houston Downtown Hotel in November 2013, the Operating Partnership issued 32,929 units of limited partnership interests to MHI Hotels, L.L.C. (“MHI Hotels”) in exchange for its 1.0% limited partnership interest in Houston Hotel Associates Limited Partnership, L.L.P. (“HHA”), the entity that owned the property. The aggregate value of the units issued was $153,636. The indirect equity owners of MHI Hotels include the Company’s chief executive officer, Andrew M. Sims, and a member of the Company’s board of directors, Kim E. Sims. Following an initial one year holding period, the Operating Partnership is obligated to redeem each unit at the request of the holder thereof for the cash value of one share of common stock or, at the Company’s option, one share of common stock. The units of limited partnership interests were issued by the Operating Partnership to MHI Hotels pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended.

Use of Proceeds from Registered Securities

On September 24, 2013, the Operating Partnership’s Registration Statement on Form S-11 (SEC File No. 333-189821) was declared effective by the Securities and Exchange Commission, pursuant to which the Operating Partnership sold 8.00% senior unsecured notes due 2018 in the aggregate amount of $27.6 million (including $3.6 million issued pursuant to the underwriters’ over-allotment option) at a price of $25 per Note.

On November 13, 2013, the Operating Partnership used approximately $9.4 million of the proceeds from the Note offering towards the acquisition of 100% of the partnership interests of HHA. HHA is the sole owner of the entity that indirectly owns the Crowne Plaza Houston Downtown.

On December 23, 2013, the Operating Partnership used the remaining proceeds from the Note offering, along with available working capital, to redeem 1,000,000 Issuable Warrant Units, as defined in the Warrant, issued to the Company for an aggregate cash redemption price of approximately $4.0 million. Concurrently with the redemption of the 1,000,000 Issuable Warrant Units, the Company used the same cash received from the Operating Partnership to redeem a portion of the Warrant corresponding to an aggregate of 1,000,000 Issuable Warrant Shares for an aggregate cash redemption price of approximately $4.0 million.

 

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Sotherly Hotels Inc. and Sotherly Hotels LP

Dividend and Distribution Information

The Company elected to be taxed as a REIT commencing with our taxable year ending December 31, 2004. To maintain qualification as a REIT, we are required to make annual distributions to the Company’s stockholders of at least 90.0% of our REIT taxable income, excluding net capital gain, which does not necessarily equal net income as calculated in accordance with generally accepted accounting principles. Our ability to pay distributions to the Company’s stockholders will depend, in part, upon our receipt of distributions from our Operating Partnership which may depend upon receipt of lease payments with respect to our properties from our TRS Lessee, and in turn, upon the management of our properties by our hotel manager. Distributions to the Company’s stockholders will generally be taxable to the Company’s stockholders as ordinary income; however, because a portion of our investments will be equity ownership interests in hotels, which will result in depreciation and non-cash charges against our income, a portion of our distributions may constitute a tax-free return of capital. To the extent not inconsistent with maintaining our REIT status, our TRS Lessee may retain any after-tax earnings.

The following table sets forth the Company’s common stock dividend payments to the Company’s stockholders for fiscal year 2012 to present. The same table sets forth the Operating Partnership’s distributions per common partnership unit for fiscal year 2012 to present:

 

Dividend (Distribution) Payments

 

Date Declared

  

For the Quarter Ended

  

Date Paid

   Amount per Share and Unit  

January 2012

   March 31, 2012    April 11, 2012    $     0.020   

April 2012

   June 30, 2012    July 11, 2012    $ 0.020   

July 2012

   September 30, 2012    October 11, 2012    $ 0.030   

October 2012

   December 31, 2012    January 11, 2013    $ 0.030   

January 2013

   March 31, 2013    April 11, 2013    $ 0.035   

April 2013

   June 30, 2013    July 11, 2013    $ 0.035   

July 2013

   September 30, 2013    October 11, 2013    $ 0.040   

October 2013

   December 31, 2013    January 10, 2014    $ 0.045   

January 2014

   March 31, 2014    April 11, 2014    $ 0.045   

In December 2008, in the interest of capital preservation and based on the expectation that the U.S. economy, and in particular the lodging industry, would continue to face declining operating trends through 2010, the Company amended its dividend policy and reduced the level of its cash dividend payments. Reducing and suspending the Company’s dividend during 2009 and 2010 did not jeopardize the Company’s REIT status as our 2009 distributions exceeded the minimum annual distribution requirement and operating losses in 2010 eliminated any distribution requirement for 2010. In July 2011, in part due to improving operating trends, we reevaluated our quarterly dividend policy and reinstated our quarterly common stock dividend (distribution), as outlined in the above table.

The amount of future common stock distributions will be based upon quarterly operating results, general economic conditions, requirements for capital improvements, the availability of debt and equity capital, the Code’s annual distribution requirements, and other factors, which the Company’s board of directors deems relevant. The amount, timing and frequency of distributions will be authorized by the Company’s board of directors and declared by us based upon a variety of factors deemed relevant by our directors, and no assurance can be given that our distribution policy will not change in the future.

 

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Item 6. Selected Financial Data

The following table sets forth selected historical financial data for Sotherly Hotels Inc. and Sotherly Hotels LP for the years ended December 31, 2013, 2012, 2011, 2010 and 2009. The financial results for the Crowne Plaza Hollywood Beach Resort, in which we have a 25.0% indirect interest, are not consolidated as we account for our investment under the equity method of accounting. The following selected historical financial data was derived from audited consolidated financial statements contained elsewhere in this Annual Report on Form 10-K and in prior filings. The Company’s financial statements for the years ended December 31, 2013 and 2012 have been audited by PBMares, LLP (formerly Witt Mares, PLC, which audited the Company’s financial statements for the years ended December 31, 2011, 2010 and 2009), our independent registered public accounting firm for such periods. The audited historical financial statements include reclassifications and all adjustments, consisting of normal recurring adjustments, which we consider necessary for a fair presentation of our financial condition and the results of operations as of those dates and for those periods under accounting principles generally accepted in the United States of America.

The information presented below is only a summary and does not provide all of the information contained in our consolidated financial statements, including notes thereto, and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

 

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SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

SELECTED HISTORICAL FINANCIAL DATA

 

    Year Ended
December 31,
2013
    Year Ended
December 31,
2012
    Year Ended
December 31,
2011
    Year Ended
December 31,
2010
    Year Ended
December 31,
2009
 

Statement of Operations

         

Total Revenues

  $ 89,374,527      $ 87,343,220      $ 81,172,504      $ 77,382,344      $ 71,518,726   

Total Operating Expenses excluding Depreciation and Amortization

    (69,829,527     (68,376,569     (65,807,786     (62,451,362     (59,224,407

Depreciation and Amortization

    (8,467,228     (8,661,769     (8,702,880     (8,506,802     (8,420,085

Net Operating Income

    11,077,772        10,304,882        6,661,838        6,424,180        3,874,234   

Interest Income

    17,914        16,158        14,808        22,305        41,999   

Interest Expense

    (11,647,141     (12,382,146     (10,821,815     (10,030,517     (9,661,871

Other Income (Expense) – Net

    (2,362,548     (1,965,376     (1,424,620     546,115        (927,924

Income Tax Benefit (Provision)

    (1,521,182     (1,301,229     (905,455     (214,344     1,807,126   

Net Loss

    (4,435,185     (5,327,711     (6,475,243     (3,252,261     (3,010,587

Net Loss Attributable to Noncontrolling Interest

    (981,126     (1,223,036     (1,630,797     (869,317     (1,036,757

Net Income (Loss) Attributable to the Company

  $ (3,454,059   $ (4,104,675   $ (4,844,446   $ (2,382,944   $ (1,973,830

Statement of Cash Flows

         

Cash from Operations – net

  $ 9,594,751      $ 9,011,957      $ 7,550,142      $ 4,728,270      $ 3,182,605   

Cash used in Investing – net

    (29,527,589     (3,156,121     (6,130,273     (3,469,608     (11,007,214

Cash from (used in) Financing – net

    22,133,750        (3,090,079     (2,798     (1,756,261     9,595,949   

Net Increase (Decrease) in Cash and Cash Equivalents

  $ 2,200,912      $ 2,765,757      $ 1,417,071      $ (497,599   $ 1,771,340   

Balance Sheet

         

Investments in Hotel Properties – net

  $ 202,645,633      $ 176,427,904      $ 181,469,432      $ 183,898,660      $ 188,587,507   

Total Assets(1)

    228,040,102        204,030,869        209,299,446        209,583,431        213,959,755   

Line of Credit

    —          —          25,537,290        75,197,858        75,522,858   

Mortgage Loans

    160,363,549        135,674,432        94,157,825        72,192,253        72,738,250   

Unsecured Notes

    27,600,000        —          —          —          —     

Redeemable Preferred Stock

    —          14,227,650        25,353,698        —          —     

Total Liabilities

    196,868,723        166,698,739        165,416,203        158,775,128        160,118,529   

Noncontrolling Interest(1)

    5,746,114        7,390,545        8,947,405        11,867,096        15,660,933   

Total Sotherly Hotels Inc. Stockholders’ Equity(1)

    25,425,265        29,941,585        34,935,838        38,941,207        38,180,293   

Operating Data

         

Average Number of Available Rooms

    2,148        2,113        2,111        2,110        2,071   

Total Number of Available Room Nights

    783,936        773,358        770,334        770,150        755,942   

Occupancy Percentage(2)

    67.4     68.9     66.2     66.0     60.4

Average Daily Rate (ADR)(2)

  $ 118.91      $ 114.22      $ 110.24      $ 104.42      $ 107.21   

RevPAR(2)

  $ 80.16      $ 78.65      $ 72.94      $ 68.93      $ 64.74   

Additional Financial Data

         

FFO(3)

  $ 4,577,710      $ 3,924,733      $ 2,923,539      $ 5,971,900      $ 5,997,948   

Adjusted FFO(3)

    10,897,524        9,470,684        5,577,805        5,315,321        2,848,314   

Hotel EBITDA(4)

    23,279,809        22,439,770        18,708,019        17,639,548        14,771,907   

Loss Per Basic Share

  $ (0.34   $ (0.41   $ (0.50   $ (0.25   $ (0.28

 

(1) As of the period end.
(2) Occupancy Percent is calculated by dividing the total daily number of rooms sold by the total daily number of rooms available. ADR, is calculated by dividing the total daily room revenue by the total daily number of rooms sold. RevPAR is calculated by dividing the total daily room revenue by the total daily number of rooms available.

 

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(3) Industry analysts and investors use Funds from Operations (“FFO”) as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). FFO, as defined by NAREIT, represents net income or loss determined in accordance with generally accepted accounting principles (“GAAP”), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after adjustment for any noncontrolling interest from unconsolidated partnerships and joint ventures.

 

   Adjusted FFO accounts for certain additional items that are not in NAREIT’s definition of FFO, including any unrealized gain (loss) on hedging instruments or warrant derivative, loan impairment charges, investment in hotel property impairment, losses on early extinguishment of debt, change in the deferred income taxes, aborted offering costs, costs associated with the departure of a executive officers and acquisition transaction costs.

The following is a reconciliation of net loss to FFO and Adjusted FFO for the years ended December 31, 2013, 2012, 2011, 2010 and 2009.

 

    Year Ended
December 31,
2013
    Year Ended
December 31,
2012
    Year Ended
December 31,
2011
    Year Ended
December 31,
2010
    Year Ended
December 31,
2009
 

Net Loss

  $ (4,435,185   $ (5,327,711   $ (6,475,243   $ (3,252,261   $ (3,010,587

Depreciation and Amortization

    8,467,228        8,661,769        8,702,880        8,506,802        8,420,085   

Equity in Depreciation on Joint Venture

    545,667        590,675        567,803        546,055        545,580   

(Gain)/ Loss on Asset Disposal

    —          —          128,099        171,304        42,870   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Funds From Operations

  $ 4,577,710      $ 3,924,733      $ 2,923,539      $ 5,971,900      $ 5,997,948   

Realized and Unrealized (Gain)/Loss on Hedging Activities(A)

    (89,998     13,752        77,152        (830,614     (1,220,161

Realized and Unrealized Loss on Warrant Derivative

    2,205,248        2,026,677        1,309,075        —          —     

(Increase)/Decrease in Deferred Income Taxes

    1,463,160        1,412,467        685,189        174,035        (1,929,473

Impairment of Investment in Hotel Properties, Net

    611,000        —          —          —          —     

Impairment of Note Receivable

    —          110,871        —          —          —     

Aborted Offering Costs

    —          —          582,850        —          —     

Acquisition Costs

    89,743        —          —          —          —     

Loss on Early Extinguishment of Debt(A)(B)

    2,040,662        1,982,184        —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted FFO

  $ 10,897,525      $ 9,470,684      $ 5,577,805      $ 5,315,321      $ 2,848,314   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (A) Includes equity in unrealized (gain)/loss on hedging activities and loss on early extinguishment of debt of joint venture.
  (B) Except for the portion representing equity in loss on early extinguishment of debt of joint ventures, amounts are reflected in interest expense for the periods presented above.

 

(4) Hotel EBITDA represents the portion of net operating income before depreciation and amortization and corporate general and administrative expenses that related to our wholly-owned properties.

 

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The following is a reconciliation of net loss to Hotel EBITDA for the years ended December 31, 2013, 2012, 2011, 2010 and 2009.

 

    Year Ended
December 31,
2013
    Year Ended
December 31,
2012
    Year Ended
December 31,
2011
    Year Ended
December 31,
2010
    Year Ended
December 31,
2009
 

Net Loss

  $ (4,435,185   $ (5,327,711   $ (6,475,243   $ (3,252,261   $ (3,010,587

Interest Expense

    11,647,141        12,382,146        10,821,815        10,030,517        9,661,871   

Interest Income

    (17,914     (16,158     (14,808     (22,305     (41,999

Income Tax Provision (Benefit)

    1,521,182        1,301,229        905,455        214,344        (1,807,126

Depreciation and Amortization

    8,467,228        8,661,769        8,702,880        8,506,802        8,420,085   

Equity in (Earnings)/Loss of Joint Venture

    (453,700     (172,172     60,094        (16,931     249,367   

(Gain)/ Loss on Asset Disposal

    —          —          128,099        171,304        42,870   

Realized and Unrealized (Gain)/Loss on Hedging Activities

    —          —          (72,649     (700,488     (1,220,161

Realized and Unrealized Loss on Warrant Derivative

    2,205,248        2,026,677        1,309,075        —          —     

Impairment of Investment in Hotel Properties, Net

    611,000        —          —          —          —     

Impairment of Note Receivable

    —          110,871        —          —          —     

Corporate General and Administrative Expenses

    4,360,583        4,078,826        4,025,794        3,389,764        3,170,627   

Net Lease Rental Income

    (350,000     (350,000     (447,000     (443,000     (445,000

Other Fee Income

    (275,775     (255,707     (235,493     (238,198     (248,040
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Hotel EBITDA

  $ 23,279,808      $ 22,439,770      $ 18,708,019      $ 17,639,548      $ 14,771,907   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company is a self-managed and self-administered lodging REIT incorporated in Maryland in August 2004 to pursue opportunities in the full-service, primarily upscale and upper-upscale segments of the hotel industry located in primary and secondary markets in the Mid-Atlantic and Southern United States. We commenced operations in December 2004 when the Company completed its initial public offering and thereafter consummated the acquisition of six initial hotel properties. Since the Company’s initial public offering, we have engaged in the following acquisitions and dispositions:

 

    On July 22, 2005, we acquired the Crowne Plaza Jacksonville Riverfront (formerly, the Hilton Jacksonville Riverfront).

 

    On August 10, 2006, we sold the Holiday Inn Downtown Williamsburg.

 

    On September 20, 2006, we acquired the Louisville Ramada Riverfront Inn, which went through an extensive renovation and re-opened in May 2008 as the Sheraton Riverside Louisville.

 

    On August 8, 2007, through our joint venture with Carlyle, we acquired a 25.0% indirect noncontrolling interest in the Crowne Plaza Hollywood Beach Resort, a newly renovated 311-room hotel in Hollywood, Florida.

 

    On October 29, 2007, we acquired a hotel in Tampa, Florida, formerly known as the Tampa Clarion Hotel, which went through an extensive renovation and re-opened in March 2009 as the Crowne Plaza Tampa Westshore.

 

    On April 24, 2008, we acquired the Hampton Marina Hotel in Hampton, Virginia, which has been renovated and was converted to the Crowne Plaza Hampton Marina in October 2008.

 

    On November 13, 2013, we acquired the Crowne Plaza Houston Downtown in Houston, Texas.

 

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Our hotel portfolio currently consists of eleven full-service, primarily upscale and upper-upscale hotels with 2,683 rooms, which operate under well-known brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn. Ten of these hotels, totaling 2,372 rooms, are 100% owned by subsidiaries of the Operating Partnership. We also own a 25.0% indirect non-controlling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with Carlyle. As of December 31, 2013, we owned the following hotel properties:

 

Property

   Number
of Rooms
    

Location

  

Date of Acquisition

   Chain Designation

Wholly-owned

           

Crowne Plaza Hampton Marina

     173       Hampton, VA    April 24, 2008    Upscale

Crowne Plaza Houston Downtown

     259       Houston, TX    November 13, 2013    Upscale

Crowne Plaza Jacksonville Riverfront

     292       Jacksonville, FL    July 22, 2005    Upscale

Crowne Plaza Tampa Westshore

     222       Tampa, FL    October 29, 2007    Upscale

Doubletree by Hilton Brownstone-University

     190       Raleigh, NC    December 21, 2004    Upscale

Hilton Philadelphia Airport

     331       Philadelphia, PA    December 21, 2004    Upper Upscale

Hilton Savannah DeSoto

     246       Savannah, GA    December 21, 2004    Upper Upscale

Hilton Wilmington Riverside

     272       Wilmington, NC    December 21, 2004    Upper Upscale

Holiday Inn Laurel West

     207       Laurel, MD    December 21, 2004    Upper Mid-Scale

Sheraton Louisville Riverside

     180       Jeffersonville, IN    September 20, 2006    Upper Upscale
  

 

 

          
     2,372            

Joint Venture Property

           

Crowne Plaza Hollywood Beach Resort

     311       Hollywood, FL    August 9, 2007    Upscale
  

 

 

          

Total

     2,683            
  

 

 

          

We conduct substantially all our business through the Operating Partnership, Sotherly Hotels LP. The Company is the sole general partner of the Operating Partnership and owns an approximate 78.1% interest in the Operating Partnership, with the remaining interest being held by limited partners who were contributors of our original hotel properties and related assets.

To qualify as a REIT, neither the Company nor the Operating Partnership can operate our hotels. Therefore, our wholly-owned hotel properties are leased to our TRS Lessee, a wholly-owned subsidiary of the Operating Partnership, which then engages a hotel management company to operate the hotels under a management agreement. Our TRS Lessee has engaged MHI Hotels Services to manage our hotels. Our TRS Lessee, and its parent, MHI Hospitality TRS Holding, Inc., are consolidated into each of our financial statements for accounting purposes. The earnings of MHI Hospitality TRS Holding, Inc. are subject to taxation similar to other C corporations.

Key Operating Metrics

In the hotel industry, room revenue is considered the most important category of revenue and drives other revenue categories such as food, beverage, catering, parking and telephone. There are three key performance indicators used in the hotel industry to measure room revenues:

 

    Occupancy, or the number of rooms sold, usually expressed as a percentage of total rooms available;

 

    Average daily rate, or ADR, which is total room revenue divided by the number of rooms sold; and

 

    Revenue per available room or RevPAR, which is total room revenue divided by the total number of available rooms.

RevPAR changes that are primarily driven by changes in occupancy have different implications for overall revenues and profitability than changes that are driven primarily by changes in ADR. For example, an increase in occupancy at a hotel would lead to additional variable operating costs (such as housekeeping services, laundry,

 

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utilities, room supplies, franchise fees, management fees, credit card commissions and reservations expense), but could also result in increased non-room revenue from the hotel’s restaurant, banquet or parking facilities. Changes in RevPAR that are primarily driven by changes in ADR typically have a greater impact on operating margins and profitability as they do not generate all the additional variable operating costs associated with higher occupancy.

We also use FFO, Adjusted FFO and Hotel EBITDA as measures of our operating performance. See “Non-GAAP Financial Measures”.

Results of Operations

Comparison of Year Ended December 31, 2013 to Year Ended December 31, 2012

The following table illustrates the key operating metrics for the years ended December 31, 2013 and 2012 for our 10 wholly-owned properties (“actual” properties) as well as the nine wholly-owned properties that were under our control during all of 2013 and 2012 (“same-store” properties). Accordingly, the same-store data does not reflect the performance of the Crowne Plaza Houston Downtown, which was acquired in November 2013.

 

     Year Ended December 31, 2013     Year Ended December 31, 2012  
       Actual         Same-Store         Actual         Same-Store    

Occupancy %

     67.4     67.6     68.9     68.9

ADR

   $ 118.91      $ 118.82      $ 114.22      $ 114.22   

RevPAR

   $ 80.16      $ 80.32      $ 78.65      $ 78.65   

Revenue. Total revenue for the year ended December 31, 2013 was approximately $89.4 million, an increase of approximately $2.1 million, or 2.3%, from total revenue for the year ended December 31, 2012 of approximately $87.3 million. Approximately $1.4 million of the increase is attributable to our acquisition of the Crowne Plaza Houston Downtown. Within the remainder of the portfolio, revenue increases were strongest at our DoubleTree by Hilton Brownstone – University and the Sheraton Louisville Riverfront properties. These increases offset revenue decreases at our properties in Hampton, Virginia; Jacksonville, Florida; Laurel, Maryland and Tampa, Florida.

Room revenues at our properties for the year ended December 31, 2013 increased approximately $2.0 million, or 3.3%, to approximately $62.8 million compared to room revenues for the year ended December 31, 2012 of approximately $60.8 million. Approximately $0.9 million of the increase is attributable to our acquisition of the Crowne Plaza Houston Downtown. Within the remainder of the portfolio, room revenue increases were strongest at our DoubleTree by Hilton Brownstone – University; Hilton Wilmington Riverside and the Sheraton Louisville Riverfront properties. These increases offset revenue decreases at our properties in Hampton, Virginia; Jacksonville, Florida; Laurel, Maryland and Tampa, Florida. We continue to expect occupancy and ADR to increase as demand continues to strengthen as the overall economy continues to improve.

Food and beverage revenues at our properties for the year ended December 31, 2013 increased approximately $0.1 million, or 0.4%, to approximately $22.1 million compared to food and beverage revenue of approximately $22.0 million for the year ended December 31, 2012. A significant increase in food and beverage revenue at the DoubleTree by Hilton Brownstone – University in Raleigh, North Carolina as well as food and beverage revenue of approximately $0.4 million associated with our acquisition of the Crowne Plaza Houston Downtown offset decreases at several other properties in our portfolio.

Other operating revenues for the year ended December 31, 2013 decreased approximately $0.1 million, or 1.6%, to approximately $4.5 million compared to other operating revenues for the year ended December 31, 2012 of approximately $4.6 million. Most of the decrease was associated with lower guaranteed no-show fees.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, indirect expenses, and management fees, increased approximately $1.2 million, or 1.8%, for the year ended December 31, 2013 to approximately $65.5 million compared to hotel operating

 

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expenses for the year ended December 31, 2012 of approximately $64.3 million. The entire increase is attributable to the acquisition of the Crowne Plaza Houston Downtown.

Rooms expense at our properties for the year ended December 31, 2013 increased approximately $0.6 million, or 3.6%, to approximately $17.2 million compared to rooms expense of approximately $16.6 million for the year ended December 31, 2012. The increase in rooms expense was directly related to the 3.3% increase in room revenue.

Food and beverage expenses at our properties for the year ended December 31, 2013 decreased approximately $0.2 million, or 1.5%, to approximately $14.1 million compared to food and beverage expense of approximately $14.3 million for the year ended December 31, 2012. The decrease in food and beverage expense was generally attributable to operating efficiencies which produced higher profit margins on very little change in food and beverage revenue.

Indirect expenses at our properties for the year ended December 31, 2013 increased approximately $0.8 million, or 2.3%, to approximately $33.7 million compared to indirect expenses of approximately $32.9 million for the year ended December 31, 2012. Sales and marketing costs, franchise fees, utilities, repairs and maintenance, insurance, management fees, real and personal property taxes as well as general and administrative costs at the property level are included in indirect expenses. Most of the increase in indirect expenses related to expenses that increase proportionally with increases in occupancy and/or revenue, including management fees and franchise fees. Approximately $0.6 million of the increase was attributable to the acquisition of the Crowne Plaza Houston Downtown. Decreases in energy costs, real estate taxes and incentive management fees offset increases in other indirect costs.

Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2013 decreased approximately $0.2 million, or 2.2%, to approximately $8.5 million compared to depreciation and amortization expense of approximately $8.7 million for the year ended December 31, 2012. We expect depreciation and amortization to increase as a result of the acquisition of the Crowne Plaza Houston Downtown.

Corporate General and Administrative. Corporate general and administrative expenses for the year ended December 31, 2013 increased approximately $0.3 million, or 6.9%, to approximately $4.4 million compared to corporate general and administrative expenses of approximately $4.1 million for the year ended December 31, 2012. The increase in corporate and administrative costs is attributable to acquisition charges related to the Crowne Plaza Houston Downtown, costs associated with the Company’s name change as well as higher staff costs.

Interest Expense. Interest expense for the year ended December 31, 2013 decreased approximately $0.8 million, or 5.9%, to approximately $11.6 million compared to approximately $12.4 million of interest expense for the year ended December 31, 2012. If not for the premiums paid to redeem shares of Preferred Stock in June 2012, March 2013, August 2013 and September 2013 and the associated write-off of unamortized issue costs as well as the write-off of unamortized loan costs associated with the extinguishment of the credit facility in March 2013 and the refinance of the mortgage on the DoubleTree by Hilton Raleigh Brownestone – University in August 2013, we would have experienced a reduction in interest expense of approximately $1.4 million due mostly to a lower effective average interest rate on our debt.

Equity Income (Loss) in Joint Venture. Equity in the income of the joint venture increased approximately $0.3 million, or 163.5%, to approximately $0.5 million for the year ended December 31, 2013 compared to equity in the income of the joint venture of approximately $0.2 million for the year ended December 31, 2012 and represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. A 45.1% increase in net operating income contributed significantly to the increase in net income. For the year ended December 31, 2013, the Crowne Plaza Hollywood Beach Resort reported occupancy of 82.2%, ADR of $157.87 and RevPAR of $129.79. This compares with results reported by the hotel for the year ended December 31, 2012 of occupancy of 79.2%, ADR of $147.37 and RevPAR of $116.66.

 

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Realized and Unrealized Loss on Warrant Derivative. The realized and unrealized loss on the Warrant derivative for the year ended December 31, 2013 increased approximately $0.2 million, or 8.8%, to approximately $2.2 million compared to the unrealized loss of approximately $2.0 million for the year ended December 31, 2012. The losses are predominantly attributable to the increase in market price of the underlying common stock. With the redemption of the warrants in the fourth quarter 2013, we do not expect any further charges.

Impairment of Investment in Hotel Properties, Net. The impairment of investment in hotel properties, net for the years ended December 31, 2013 and 2012 was $611,000 and $0, respectively. Our review of possible impairment at one of our hotel properties revealed an excess of current carrying cost over the estimated undiscounted future cash flows of $611,000, as of December 31, 2013.

Income Tax Provision. The income tax provision for the year ended December 31, 2013 increased approximately $0.2 million, or 16.9%, to approximately $1.5 million compared to an income tax provision of approximately $1.3 million for the year ended December 31, 2012. The income tax provision is primarily derived from the operations of our TRS Lessee. Our TRS Lessee realized greater operating income for the year ended December 31, 2013 compared to the year ended December 31, 2012.

Net Loss. Net loss for the year ended December 31, 2013 decreased approximately $1.5 million, or 28.2%, to approximately $3.8 million compared to net loss of approximately $5.3 million for the year ended December 31, 2012 as a result of the operating results discussed above.

Comparison of Year Ended December 31, 2012 to Year Ended December 31, 2011

The following table illustrates the key operating metrics for the years ended December 31, 2012 and 2011 for our nine wholly-owned properties that were under our control for all of 2012 and 2011.

 

     Year Ended
December 31, 2012
    Year Ended
December 31, 2011
 

Occupancy %

     68.9     66.2

ADR

   $ 114.22      $ 110.24   

RevPAR

   $ 78.65      $ 72.94   

Revenue. Total revenue for the year ended December 31, 2012 was approximately $87.3 million, an increase of approximately $6.1 million, or 7.6%, from total revenue for the year ended December 31, 2011 of approximately $81.2 million. Revenue increases were strongest at our DoubleTree by Hilton Brownstone – University and the Crowne Plaza Tampa Westshore properties.

Room revenues at our properties for the year ended December 31, 2012 increased approximately $4.6 million, or 8.3%, to approximately $60.8 million compared to room revenues for the year ended December 31, 2011 of approximately $56.2 million. The increase in room revenue was mostly attributable to increases in occupancy at our properties in Raleigh, North Carolina; Laurel, Maryland; Jacksonville, Florida and Tampa, Florida. Our recently renovated property in Raleigh, North Carolina as well as our property in Savannah, Georgia experienced significant increases in ADR as well.

Food and beverage revenues at our properties for the year ended December 31, 2012 increased approximately $1.5 million, or 7.2%, to approximately $22.0 million compared to food and beverage revenues for the year ended December 31, 2011 of approximately $20.5 million. Most of the increase in food and beverage revenue was attributable to increased revenues at the DoubleTree by Hilton Brownstone – University, the Holiday Inn Laurel West and the Crowne Plaza Tampa Westshore.

 

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Other operating revenues for the year ended December 31, 2012 increased approximately $0.1 million, or 1.2%, to approximately $4.6 million compared to other operating revenues for the year ended December 31, 2011 of approximately $4.5 million. Higher guaranteed no-show fees and garage revenue offset a decrease in the payments received in respect of the expired Shell Island sublease.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, indirect expenses, and management fees, increased approximately $2.5 million, or 4.1%, for the year ended December 31, 2012 to approximately $64.3 million compared to hotel operating expenses for the year ended December 31, 2011 of approximately $61.8 million. Increases in expenses that vary directly with increases in revenue, such as food and beverage expense, management fees and franchise fees, accounted for more than two-thirds of the increase in hotel operating expenses.

Rooms expense at our properties for the year ended December 31, 2012 increased approximately $0.8 million, or 4.9%, to approximately $16.6 million compared to rooms expense of approximately $15.8 million for the year ended December 31, 2011. The increase in rooms expense was directly related to the 8.3% increase in room revenue.

Food and beverage expenses at our properties for the year ended December 31, 2012 increased approximately $0.7 million, or 4.9%, to approximately $14.3 million compared to food and beverage expense of approximately $13.6 million for the year ended December 31, 2011. The increase in food and beverage expense was generally attributable to the 7.2% increase in food and beverage revenue.

Indirect expenses at our properties for the year ended December 31, 2012 increased approximately $1.1 million, or 3.6%, to approximately $32.9 million compared to indirect expenses of approximately $31.8 million for the year ended December 31, 2011. Sales and marketing costs, franchise fees, utilities, repairs and maintenance, insurance, management fees, real and personal property taxes as well as general and administrative costs at the property level are included in indirect expenses. Most of the increase in indirect expenses related to expenses that increase proportionally with increases in occupancy and/or revenue, including management fees and franchise fees. The overall increase in indirect expenses was offset by a decrease in energy costs, the non-recurrence of costs associated with Hurricane Irene at our property in Hampton, Virginia and the expiration of the sublease at Shell Island on December 31, 2011.

Depreciation and Amortization. Depreciation and amortization for the year ended December 31, 2012 remained constant at approximately $8.7 million compared to depreciation and amortization expense for the year ended December 31, 2011.

Corporate General and Administrative. Corporate general and administrative expenses for the year ended December 31, 2012 increased approximately $0.1 million, or 1.3%, to approximately $4.1 million compared to corporate general and administrative expenses of approximately $4.0 million for the year ended December 31, 2011. The absence in the current year of charges related to our aborted stock offering in 2011 was offset by higher salaries and legal fees.

Interest Expense. Interest expense for the year ended December 31, 2012 increased approximately $1.6 million, or 14.4%, to approximately $12.4 million compared to approximately $10.8 million of interest expense for the year ended December 31, 2011. If not for the write-off of unamortized loan costs in conjunction with the extinguishment of the credit facility in March 2012 of approximately $0.5 million, the premium paid to redeem approximately 11,514 shares of Preferred Stock in June 2012 of approximately $0.8 million and the write-off of unamortized issuance costs related to the redeemed shares of approximately $0.7 million, we would have experienced a reduction in interest expense of approximately $0.4 million.

Equity Income (Loss) in Joint Venture. Equity in the income of the joint venture was approximately $0.2 million for the year ended December 31, 2012 compared to equity in the loss of joint venture of

 

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approximately $0.1 million for the year ended December 31, 2011 and represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. The improvement was attributable to a 12.6% increase in net operating income as well as a curtailment of unrealized losses on hedging activities. For the year ended December 31, 2012, the Crowne Plaza Hollywood Beach Resort reported occupancy of 79.2%, ADR of $147.37 and RevPAR of $116.66. This compares with results reported by the hotel for the year ended December 31, 2011 of occupancy of 79.4%, ADR of $133.29 and RevPAR of $105.82.

Unrealized Loss on Warrant Derivative. The unrealized loss on the Warrant derivative for the year ended December 31, 2012 increased approximately $0.7 million, or 54.8%, to approximately $2.0 million compared to the unrealized loss of approximately $1.3 million for the year ended December 31, 2011. The current year loss was predominantly attributable to the increase in market price of the underlying common stock whereas the prior year loss was predominantly attributable to the modification to the Warrant agreement in December 2011 whereby the exercise price will be adjusted for any and all dividends declared and paid after December 31, 2011.

Income Tax Provision. The income tax provision for the year ended December 31, 2012 increased approximately $0.4 million, or 43.7%, to approximately $1.3 million compared to approximately $0.9 million for the year ended December 31, 2011. The income tax provision is primarily derived from the operations of our TRS Lessee. Our TRS Lessee realized greater operating income for the year ended December 31, 2012 compared to the year ended December 31, 2011.

Net Loss. Net loss for the year ended December 31, 2012 decreased approximately $1.2 million, or 17.7%, to approximately $5.3 million compared to net loss of approximately $6.5 million for the year ended December 31, 2011 as a result of the operating results discussed above.

Sources and Uses of Cash

The following narrative discusses our sources and used of cash for the year ended December 31, 2013.

Operating Activities. Our principal source of cash to meet our operating requirements, including distributions to unit holders of the Operating Partnership and stockholders of the Company as well as debt service (excluding debt maturities), is the operations of our hotels. Cash flow provided by operating activities for the year ended December 31, 2013 was approximately $9.6 million. We expect that cash on hand and the net cash provided by operations will be adequate to fund our operating requirements, monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt) and the payment of dividends (distributions) to the stockholders of the Company (the unitholders of the Operating Partnership) in accordance with federal income tax laws which require us to make annual distributions, as “qualifying distributions”, to the Company’s stockholders of at least 90.0% of its REIT taxable income (determined without regard to the dividends-paid deduction and by excluding its net capital gains, and reduced by certain non-cash items).

Investing Activities. In November 2013, we spent approximately $30.7 million to purchase the Crowne Plaza Houston Downtown. During 2013, we spent approximately $4.9 million on capital expenditures at our properties, of which approximately $2.4 million related to the routine replacement of furniture, fixtures and equipment, and approximately $2.5 million related to renovations of our properties in Philadelphia, Pennsylvania and Jacksonville, Florida. We also contributed approximately $2.2 million in reserves required by the lenders of the Crowne Plaza Hampton Marina, DoubleTree by Hilton Raleigh Brownestone – University, Hilton Wilmington Riverside, Hilton Savannah DeSoto, Hilton Philadelphia Airport and Sheraton Louisville Riverside according to the provisions of the loan agreements. We also received reimbursement from those reserves of approximately $1.7 million for capital expenditures related to those properties.

On December 27, 2013, the joint venture entity that owns the Crowne Plaza Hollywood Beach entered into a credit and security agreement and other loan documents with Bank of America, N.A. to refinance the mortgage

 

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on that property. Subsequent to the refinance, we received a distribution of approximately $5.6 million, bringing the total distributions from the joint venture to approximately $6.6 million for the year ended December 31, 2013.

Financing Activities. On March 26, 2013, the Company used the net proceeds of the mortgage on the DoubleTree by Hilton Raleigh Brownstone-University to redeem 1,902 shares of Preferred Stock for an aggregate redemption price of approximately $2.1 million plus the payment of related accrued and unpaid cash and stock dividends. The redemption resulted in a prepayment fee of approximately $0.2 million.

On June 17, 2013, we provided approximately $0.9 million in cash collateral to the lender for the Crowne Plaza Jacksonville Riverfront in order to comply with the terms of the loan agreement following the property’s failure to meet its debt service coverage test for the period ended March 31, 2013. On September 25, 2013, we received back a portion of the cash collateral of approximately $0.2 million as a result of improvement in the property’s debt service coverage ratio.

On June 28, 2013, we entered into an agreement with TowneBank to extend the maturity of the mortgage on the Crowne Plaza Hampton Marina in Hampton, Virginia. Pursuant to the agreement, we reduced the outstanding indebtedness by approximately $1.1 million.

On August 2, 2013, we used approximately $2.7 million of the net proceeds of a new mortgage on the DoubleTree by Hilton Raleigh Brownstone-University to make a special distribution by the Operating Partnership to the Company to redeem 2,460 shares of Preferred Stock. The remainder of the proceeds were used to pay transaction costs and for working capital.

On September 30, 2013, the Operating Partnership issued 8.0% senior unsecured notes in the aggregate amount of $27.6 million. The proceeds were used to redeem the remaining outstanding shares of Preferred Stock for an aggregate redemption price of approximately $10.7 million, pay accrued and unpaid cash dividends, pay transaction costs and for working capital.

On October 23, 2013 and December 23, 2013, we redeemed the Essex Warrant, in two separate transactions, corresponding to an aggregate of 1,900,000 Issuable Warrant Shares for an aggregate cash redemption price of approximately $7.2 million. Concurrently with the redemptions on October 23, 2013 and December 23, 2013, the Operating Partnership redeemed an aggregate of 1,900,000 Issuable Warrant Units, as defined in the Warrant to Purchase Partnership Units agreement, for an aggregate cash redemption price of $7.2 million.

On November 13, 2013, we borrowed $21.5 million in conjunction with the purchase of the Crowne Plaza Houston Downtown.

On December 30, 2013, we paid approximately $3.5 million and extinguished the balance of the loan with the Carlyle Affiliate Lender.

The following narrative discusses our sources and uses of cash for the year ended December 31, 2012.

Operating Activities. Our principal source of cash to meet our operating requirements, including distributions to unitholders of the Operating Partnership and stockholders of the Company as well as repayments of indebtedness, is the operations of our hotels. Cash flow provided by operating activities for the year ended December 31, 2012 was approximately $9.0 million. We expect that cash on hand and the net cash provided by operations will be adequate to fund our operating requirements, monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt) and the payment of dividends in accordance with federal income tax laws which require us to make annual distributions to the Company’s stockholders of at least 90.0% of the Company’s REIT taxable income, excluding net capital gains.

 

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Investing Activities. Approximately $2.9 million was spent during the year ended December 31, 2012 on capital expenditures, of which, approximately $1.4 million related to the routine replacement of furniture, fixtures and equipment and $1.5 million related to the completion of our renovation of our property in Raleigh, North Carolina as well as renovation of our properties in Philadelphia, Pennsylvania and Jacksonville, Florida. We also contributed approximately $2.0 million during the year ended December 31, 2012 into reserves required by the lenders for the Hilton Wilmington Riverside, Hilton Savannah DeSoto, Hilton Philadelphia Airport, Sheraton Louisville Riverside, Crowne Plaza Jacksonville Riverfront and the Crowne Plaza Hampton Marina according to the provisions of the loan agreements as well as the administrator of the then-existing credit agreement. During the year ended December 31, 2012, we received reimbursements from those reserves of approximately $1.2 million for capital expenditures related to those properties for periods ending on or before September 30, 2012.

Financing Activities. On March 5, 2012, we obtained a mortgage on the Hilton Philadelphia Airport for $30.0 million and used the proceeds to extinguish the credit facility and repay a portion of the outstanding indebtedness on the $10.0 million loan agreement with Essex Equity High Income Joint Investment Vehicle, LLC (the “Essex Note Agreement”).

On June 18, 2012, we obtained a mortgage on the Crowne Plaza Tampa Westshore for $14.0 million and used the proceeds to repay the outstanding indebtedness on the Essex Note Agreement and to make a special distribution by the Operating Partnership to the Company to redeem approximately 11,514 shares of Preferred Stock.

On July 10, 2012, we obtained a $14.3 million mortgage with Fifth Third Bank on the Crowne Plaza Jacksonville Riverfront in Jacksonville, Florida and used the proceeds to repay the outstanding indebtedness on the property and to pay transaction costs.

During the year ended December 31, 2012, we paid approximately $2.5 million of scheduled principal payments toward the mortgages on our properties.

During the year ended December 31, 2012, we also paid approximately $1.1 million in deferred financing costs in relation to the mortgages discussed above.

Capital Expenditures

We anticipate that our need for recurring capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment over the next 12 to 24 months will be at or lower than historical norms for our properties and the industry. Historically, we have aimed to maintain overall capital expenditures, except for those required by our franchisors as a condition to a franchise license or license renewal, at 4.0% of gross revenue. In anticipation of the franchise license renewals at our properties in Philadelphia, Pennsylvania and Jacksonville, Florida, we anticipate capital expenditures this year of approximately $2.5 million. In addition, we anticipate capital expenditures of approximately $1.0 million at our property in Houston, Texas, other than for the recurring replacement of furniture, fixtures and equipment.

Given our desire to proceed with the renovation activities at these properties, we aim to restrict all other capital expenditures to the replacement of broken or damaged furniture and equipment and the acquisition of items mandated by our licensors that are necessary to maintain our brand affiliations. We anticipate that capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment that are not related to these renovation activities to total 2.50% to 3.00% of gross revenues in 2014.

We expect capital expenditures for the recurring replacement or refurbishment of furniture, fixtures and equipment at our properties will be funded by our replacement reserve accounts, other than costs that we incur to make capital improvements required by our franchisors. Reserve accounts are escrowed accounts with funds

 

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deposited monthly and reserved for capital improvements or expenditures with respect to all of our hotels. We currently deposit an amount equal to 4.0% of gross revenue for the Crowne Plaza Hampton Marina, Crowne Plaza Houston Downtown, DoubleTree by Hilton Raleigh Brownestone – University, Hilton Savannah DeSoto, the Hilton Wilmington Riverside, and the Sheraton Louisville Riverside as well as 4.0% of room revenues for the Hilton Philadelphia Airport on a monthly basis.

Liquidity and Capital Resources

As of December 31, 2013, we had cash and cash equivalents of approximately $13.2 million, of which approximately $3.8 million was in restricted reserve accounts as well as real estate tax and insurance escrows. We expect that our cash on hand combined with our cash flow from our hotels should be adequate to fund continuing operations, recurring capital expenditures for the refurbishment and replacement of furniture, fixtures and equipment, and monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt).

On March 22, 2013, we entered into a First Amendment to the Loan Agreement and other amendments to secure additional proceeds on the original $8.0 million mortgage on the DoubleTree by Hilton Brownstone-University with its existing lender. We used the net proceeds to redeem 1,902 shares of Preferred Stock for an aggregate redemption price of approximately $2.1 million. The redemption resulted in a prepayment fee of approximately $0.2 million.

On June 28, 2013, the maturity date of the mortgage on the Crowne Plaza Hampton Marina was extended until June 30, 2014 and we reduced the mortgage balance by approximately $1.1 million and paid an extension fee. Pursuant to certain terms and conditions, we may extend the maturity date of the loan to June 30, 2015.

On August 1, 2013, we obtained a $15.6 million mortgage with CIBC, Inc. on the DoubleTree by Hilton Raleigh Brownstone-University in Raleigh, North Carolina. The maturity date is August 1, 2018. Approximately $0.7 million of the loan proceeds were placed into a restricted reserve – which were disbursed to us in December 2013 upon satisfyfing the financial performance criteria. The remaining proceeds of the mortgage were used to repay the existing mortgage indebtedness, to pay closing costs, to redeem 2,460 shares of the Company’s Preferred Stock for an aggregate redemption price of approximately $2.7 million plus the payment of related accrued and unpaid cash and stock dividends and for working capital. The redemption resulted in a prepayment fee of approximately $0.2 million.

On September 30, 2013, the Operating Partnership issued 8.0% senior unsecured notes in the aggregate amount of $27.6 million. The proceeds were used to redeem the remaining outstanding shares of Preferred Stock for an aggregate redemption price of approximately $10.7 million plus the payment of accrued and unpaid cash and stock dividends and for working capital. The redemption resulted in a prepayment fee of approximately $0.7 million.

On October 23, 2013 and December 23, 2013, we redeemed the Essex Warrant in two separate transactions corresponding to an aggregate of 1,900,000 Issuable Warrant Shares for an aggregate cash redemption price of approximately $7.2 million.

On November 13, 2013, we acquired the Crowne Plaza Houston Downtown by purchasing 100% of the partnership interests of HHA. The purchase was funded through a new first mortgage of $21.5 million, issuance of 32,929 units of limited partnership interests in the Operating Partnership and approximately $9.2 million in cash, net of cash received.

On December 30, 2013, we received a distribution from the joint venture that owns the Crowne Plaza Hollywood Beach of approximately $5.6 million and used approximately $3.5 million to extinguish the remaining balance of our loan from an affiliate of Carlyle related to the joint venture.

 

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On January 13, 2014, we entered into an agreement to acquire an independent full-service hotel in Atlanta, Georgia for the aggregate purchase price of approximately $61.0 million. We anticipate that the purchase will be completed by the end of the first quarter, or shortly thereafter, and will be funded with a first mortgage in the amount of $41.5 million, a $19.0 million loan secured by interests in another asset, and working capital.

In June 2014, the mortgage on the Crowne Plaza Hampton Marina matures. We intend to extend the maturity to June 2015 pursuant to the terms and conditions of the mortgage. Pursuant to those terms, we anticipate that we may be required to reduce the mortgage balance by an amount up to $1.5 million. We intend to draw upon working capital to secure the extension.

In August 2014, the mortgage on the Hilton Philadelphia Airport matures, but we may extend such mortgage until March 2017 pursuant to certain terms and conditions. We intend to extend the mortgage until March 2017 pursuant to the terms and conditions of the mortgage.

We will need to, and plan to, renew, replace or extend our long-term indebtedness prior to their respective maturity dates. We are uncertain whether we will be able to refinance these obligations or if refinancing terms will be favorable. If we are unable to obtain alternative or additional financing arrangements in the future, or if we cannot obtain financing on acceptable terms, we may be forced to dispose of hotel properties on disadvantageous terms. To the extent we cannot repay our outstanding debt, we risk losing some or all of these properties to foreclosure and we could be required to invoke insolvency proceedings including, but not limited to, commencing a voluntary case under the U.S. Bankruptcy Code.

We believe there will be more opportunities to acquire properties in the future that meet our strategic goals and provide attractive long term returns. Given the potential for attractive acquisitions emerging from the recent economic downturn, we intend to pursue the acquisition of wholly-owned properties, additional and permissible joint venture investments as well as equity or debt financing in the future to enable us to take advantage of such opportunities. However, should additional and permissible joint venture transactions and equity or debt financing not be available on acceptable terms, we may not be able to take advantage of such opportunities.

Beyond the funding of any required principal reduction on our existing indebtedness or acquisitions, our medium and long-term capital needs will generally include the repayment of the Notes and the retirement of maturing mortgage debt. We remain committed to maintaining a flexible capital structure. Accordingly, we expect to meet our long-term liquidity needs through a combination of some or all the following:

 

    The issuance of additional shares of preferred stock;

 

    The issuance of additional shares of our common stock;

 

    The issuance of senior, unsecured debt;

 

    The issuance of additional units in the Operating Partnership;

 

    The incurrence by the subsidiaries of the Operating Partnership of mortgage indebtedness in connection with the acquisition or refinancing of hotel properties;

 

    The selective disposition of core or non-core assets;

 

    The sale or contribution of some of our wholly-owned properties, development projects or development land to strategic joint ventures to be formed with unrelated investors, which would have the net effect of generating additional capital through such sale or contribution; or

 

    The issuance by the Operating Partnership and/or subsidiary entities of secured and unsecured debt securities.

 

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Financial Covenants

Mortgage Loans

Our mortgage loan agreements contain various financial covenants. Failure to comply with these financial covenants could result from, among other things, changes in the local competitive environment, general economic conditions and disruption caused by renovation activity or major weather disturbances.

If we violate the financial covenants contained in these agreements, we may attempt to negotiate waivers of the violations or amend the terms of the applicable mortgage loan agreement with the lender; however, we can make no assurance that we would be successful in any such negotiation or that, if successful in obtaining waivers or amendments, such waivers or amendments would be on attractive terms. Some mortgage loan agreements provide alternate cure provisions which may allow us to otherwise comply with the financial covenants by obtaining an appraisal of the hotel, prepaying a portion of the outstanding indebtedness or by providing cash collateral until such time as the financial covenants are met by the collateralized property without consideration of the cash collateral. Alternate cure provisions which include prepaying a portion of the outstanding indebtedness or providing cash collateral may have a material impact on our liquidity.

If we are unable to negotiate a waiver or amendment or satisfy alternate cure provisions, if any, or unable to meet any alternate cure requirements and a default were to occur, we would possibly have to refinance the debt through additional debt financing, private or public offerings of debt securities, or additional equity financing.

Under the terms of our non-recourse secured mortgage loan agreements, failure to comply with the financial covenants in the loan agreement triggers cash flows from the property to be directed to the lender, which may limit our overall liquidity as that cash flow would not be available to us.

At December 31, 2013, we were in compliance with all debt covenants, current on all loan payments and not otherwise in default under any of our mortgage loans with the exception of the debt service coverage requirements under the mortgage on the Crowne Plaza Tampa Westshore for which we received a waiver.

Unsecured Notes

The indenture for the Notes contains certain covenants and restrictions that require us to meet certain financial ratios. We are not permitted to incur any Debt (other than intercompany Debt), as defined in the indenture, if, immediately after giving effect to the incurrence of such Debt and to the application of the proceeds thereof, the ratio of the aggregate principal amount of all outstanding Debt to Adjusted Total Asset Value, as defined in the indenture, would be greater than 0.65 to 1.0. In addition, we are not permitted to incur any Debt if the ratio of Stabilized Consolidated Income Available for Debt Service to Stabilized Consolidated Interest Expense, both as defined in the indenture, on the date on which such additional Debt is to be incurred, on a pro-forma basis, after giving effect to the incurrence of such Debt and to the application of the proceeds thereof, would be less than 1.50 to 1.0.

 

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These financial measures are not calculated in accordance with GAAP and are presented below for the sole purpose of evaluating our compliance with the key financial covenants as they were or would have been applicable at December 31, 2013 and December 31, 2012, respectively.

 

     December 31,
2013
    December 31,
2012
 

Ratio of Stabilized Consolidated Income Available for Debt Service to Stabilized Consolidated Interest Expense

    

Net income (loss)

   $ (4,435,185   $ (5,327,711

Interest expense

     11,647,141        12,382,146   

Provision for taxes

     1,521,182        1,301,229   

Equity in (income) loss of joint venture

     (453,700     (172,172

Realized and unrealized loss on warrant derivative

     2,205,248        2,026,677   

Impairment of investment in hotel properties, net

     611,000        —     

Impairment of note receivable

     —          110,871   

Depreciation and amortization

     8,467,228        8,661,769   

Corporate general and administrative expenses

     4,360,583        4,078,826   
  

 

 

   

 

 

 

Consolidated Income Available for Debt Service

     23,923,497        23,061,635   

Less: Income of Non-Stabilized Assets(1)

     (223,541     —     
  

 

 

   

 

 

 

Stabilized Consolidated Income Available for Debt Service

   $ 23,699,956      $ 23,061,635   
  

 

 

   

 

 

 

Interest expense

   $ 11,647,141      $ 12,382,146   

Distributions on Preferred Interest(2)

     (2,230,806     (3,106,981

Amortization of issuance costs(2)

     (1,518,556     (1,971,796
  

 

 

   

 

 

 

Consolidated Interest Expense

     7,897,779        7,303,369   

Less: Interest expense of Non-Stabilized Assets(1)

     (131,410     —     
  

 

 

   

 

 

 

Stabilized Consolidated Income Available for Debt Service

   $ 7,766,369      $ 7,303,369   
  

 

 

   

 

 

 

Ratio of Stabilized Consolidated Income Available for Debt Service to Stabilized Consolidated Interest Expense

     3.05        3.16   

Ratio of Debt to Adjusted Total Asset Value:

    

Mortgage loans

   $ 160,363,549      $ 135,674,432   

Loans payable

     —          4,025,220   

Unsecured notes

     27,600,000        —     
  

 

 

   

 

 

 

Total debt

   $ 187,963,549      $ 139,699,652   
  

 

 

   

 

 

 

Stabilized Consolidated Income Available for Debt Service

   $ 23,699,956      $ 23,061,635   

Capitalization Rate

     7.5     7.5
  

 

 

   

 

 

 
     315,999,415        307,488,467   

Non-Stabilized Assets(1)

     35,000,000        —     

Cash and cash equivalents, total

     13,172,769        10,255,610   
  

 

 

   

 

 

 

Adjusted Total Asset Value

   $ 364,172,184      $ 317,744,077   
  

 

 

   

 

 

 

Ratio of Debt to Adjusted Total Asset Value

     0.52        0.44   

 

(1) As permitted by the indenture, the Crowne Plaza Houston Downtown is considered a non-stabilized asset for purposes of the financial covenants.
(2) Includes prepayment fee and write-off of unamortized issuance costs associated with the redemption of Preferred Stock and Preferred Interest redeemed during the period.

 

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Mortgage Debt

As of December 31, 2013, we had approximately $160.4 million of outstanding mortgage debt. The following table sets forth our mortgage debt outstanding as of December 31, 2013.

 

Property

  December 31,
2013
    Prepayment
Penalties
  Maturity
Date
    Amortization
Provisions
    Interest Rate  

Crowne Plaza Hampton Marina

  $ 5,903,500      None     06/30/2014 (1)    $ 16,000 (2)      LIBOR plus 4.55 %(3) 

Crowne Plaza Houston Downtown

    21,428,258      Yes(4)     04/12/2016 (5)      25 years        4.50

Crowne Plaza Jacksonville Riverfront

    13,756,209      None     07/10/2015 (6)      25 years       
 
LIBOR plus
3.00
  

Crowne Plaza Tampa Westshore

    13,602,701      None     06/18/2017        25 years        5.60

DoubleTree by Hilton Brownstone – University

    15,525,626      (7)     08/01/2018        30 years        4.78

Hilton Philadelphia Airport

    28,731,151      None     08/30/2014 (8)      25 years       
 
LIBOR plus
3.00
  
%(9) 

Hilton Savannah DeSoto

    21,546,423      Yes(10)     08/01/2017        25 years        6.06

Hilton Wilmington Riverside

    20,919,030      Yes(10)     04/01/2017        25 years        6.21

Holiday Inn Laurel West

    7,141,845      Yes(11)     08/05/2021        25 years        5.25 %(12) 

Sheraton Louisville Riverside

    11,808,806      (7)     01/06/2017        25 years        6.24
 

 

 

         

Total

  $ 160,363,549           
 

 

 

         

 

(1) The note provides that the mortgage can be extended until June 2015 if certain conditions have been satisfied.
(2) The Operating Partnership is required to make monthly principal payments of $16,000.
(3) The note bears a minimum interest rate of 5.00%.
(4) The note may not be prepaid during the first two years of the term.
(5) The note provides that the mortgage can be extended until November 2018 if certain conditions have been satisfied.
(6) The note provides that the mortgage can be extended until July 2016 if certain conditions have been satisfied.
(7) With limited exception, the note may not be prepaid until two months before maturity.
(8) The note provides that the mortgage can be extended until March 2017 if certain conditions have been satisfied.
(9) The note bears a minimum interest rate of 3.50%.
(10) The notes may not be prepaid during the first six years of the terms. Prepayment can be made with penalty thereafter until 90 days before maturity.
(11) Pre-payment can be made with penalty until 180 days before the fifth anniversary of the commencement date of the loan or from such date until 180 days before the maturity.
(12) The note provides that after five years, the rate of interest will adjust to a rate of 3.00% per annum plus the then-current five-year U.S. Treasury rate of interest, with a floor of 5.25%.

Contractual Obligations

The following table outlines our contractual obligations as of December 31, 2013, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands).

 

     Payments due by period (in thousands)  

Contractual Obligations

   Total      Less than
1 year
     1-3 years      3-5 years      More than
5 years
 

Mortgage loans, including interest

   $ 183,729       $ 44,835       $ 50,141       $ 81,702       $ 7,051   

Unsecured notes, including interest

     38,088         2,208         4,416         31,464         —     

Ground, building, office and equipment leases

     1,208         413         639         156         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 223,025       $ 47,456       $ 55,196       $ 113,322       $ 7,051   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

In connection with the acquisition of our six initial hotel properties, we entered into tax indemnity agreements that require us to indemnify the contributors of our initial properties against tax liabilities in the event we sell those properties in a taxable transaction during a 10-year period. As of December 31, 2013, such

 

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indemnification obligations could result in aggregate payments of approximately $4.6 million. Our obligations under the tax indemnity agreements may effectively preclude us from selling or disposing of certain of the initial hotels in taxable transactions or reducing our consolidated indebtedness below approximately $11.0 million.

Off Balance Sheet Arrangements. Through a joint venture with a Carlyle subsidiary, we own a 25.0% indirect, noncontrolling interest in an entity (the “JV Owner”) that acquired the 311-room Crowne Plaza Hollywood Beach Resort in Hollywood, Florida. We have the right to receive a pro rata share of operating surpluses and we have an obligation to fund our pro rata share of operating shortfalls. We also have the opportunity to earn an incentive participation in the net proceeds realized from the sale of the hotel based upon the achievement of certain overall investment returns, in addition to our pro rata share of net sale proceeds. The Crowne Plaza Hollywood Beach Resort is leased to another entity (the “Joint Venture Lessee”) in which we also own a 25.0% indirect, noncontrolling interest.

On December 27, 2013, the joint venture secured a $57.0 million non-recourse mortgage with Bank of America, N.A. The mortgage requires monthly payments of interest at a rate of LIBOR plus additional interest of 3.95%. The proceeds from the loan were used to repay the existing first mortgage, to extinguish the interest-rate swap, to pay closing costs, and to make a distribution to the joint venture partners. The Crowne Plaza Hollywood Beach Resort property secures the mortgage.

Carlyle owns a 75.0% controlling interest in the JV Owner and Joint Venture Lessee. Carlyle may elect to dispose of the Crowne Plaza Hollywood Beach without our consent. We account for our noncontrolling 25.0% interest in all of these entities under the equity method of accounting.

Distributions to Common Stockholders and Holders of Units in the Operating Partnership. The Company has elected to be taxed as a REIT commencing with our taxable year ending December 31, 2004. To maintain qualification as a REIT, the Company is required to make annual distributions to its stockholders of at least 90.0% of our REIT taxable income, (excluding net capital gain, which does not necessarily equal net income as calculated in accordance with generally accepted accounting principles). The Company’s ability to pay distributions to its stockholders will depend, in part, upon its receipt of distributions from the Operating Partnership which may depend upon receipt of lease payments with respect to our properties from our TRS Lessee, and in turn, upon the management of our properties by our hotel manager. Distributions to the Company’s stockholders will generally be taxable to the Company’s stockholders as ordinary income; however, because a portion of our investments will be equity ownership interests in hotels, which will result in depreciation and non-cash charges against our income, a portion of our distributions may constitute a non-taxable return of capital. To the extent not inconsistent with maintaining the Company’s REIT status, our TRS Lessee may retain any after-tax earnings.

The amount, timing and frequency of distributions will be authorized by the Company’s board of directors and declared by the Company based upon a variety of factors deemed relevant by its directors, and no assurance can be given that the distribution policy will not change in the future.

Inflation

We generate revenues primarily from lease payments from our TRS Lessee and net income from the operations of our TRS Lessee. Therefore, we rely primarily on the performance of the individual properties and the ability of the management company to increase revenues and to keep pace with inflation. Operators of hotels, in general, possess the ability to adjust room rates daily to keep pace with inflation. However, competitive pressures at some or all of our hotels may limit the ability of the management company to raise room rates.

Our expenses, including hotel operating expenses, administrative expenses, real estate taxes and property and casualty insurance are subject to inflation. These expenses are expected to grow with the general rate of inflation, except for energy, liability insurance, property and casualty insurance, property tax rates, employee benefits, and some wages, which are expected to increase at rates higher than inflation.

 

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Geographic Concentration and Seasonality

Our hotels are located in Florida, Georgia, Indiana, Maryland, North Carolina, Pennsylvania, Texas and Virginia. As a result, we are particularly susceptible to adverse market conditions in these geographic areas, including industry downturns, relocation of businesses and any oversupply of hotel rooms or a reduction in lodging demand. Adverse economic developments in the markets in which we have a concentration of hotels, or in any of the other markets in which we operate, or any increase in hotel supply or decrease in lodging demand resulting from the local, regional or national business climate, could materially and adversely affect us.

The operations of our hotel properties have historically been seasonal. The months of April and May are traditionally strong, as is October. The periods from mid-November through mid-February are traditionally slow with the exception of hotels located in markets, namely Florida and Texas, that experience significant room demand during this period.

Competition

The hotel industry is highly competitive with various participants competing on the basis of price, level of service and geographic location. Each of our hotels is located in a developed area that includes other hotel properties. The number of competitive hotel properties in a particular area could have a material adverse effect on occupancy, ADR and RevPAR of our hotels or at hotel properties acquired in the future. We believe that brand recognition, location, the quality of the hotel, consistency of services provided, and price, are the principal competitive factors affecting our hotels.

Critical Accounting Policies

The critical accounting policies are described below. We consider these policies critical because they involve difficult management judgments and assumptions, are subject to material change from external factors or are pervasive, and are significant to fully understand and evaluate our reported financial results.

Investment in Hotel Properties. Hotel properties are stated at cost, net of any impairment charges, and are depreciated using the straight-line method over an estimated useful life of 7-39 years for buildings and improvements and 3-10 years for furniture and equipment. In accordance with generally accepted accounting principles, the controlling interests in hotels comprising our accounting predecessor, MHI Hotels Services Group, and noncontrolling interests held by the controlling holders of our accounting predecessor in hotels, which were acquired from third parties contributed to us in connection with the Company’s initial public offering, are recorded at historical cost basis. Noncontrolling interests in those entities that comprise our accounting predecessor and the interests in hotels, other than those held by the controlling members of our accounting predecessor, acquired from third parties are recorded at fair value at the time of acquisition.

We review our hotel properties for impairment whenever events or changes in circumstances indicate the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause us to perform our review include, but are not limited to, adverse changes in the demand for lodging at our properties due to declining national or local economic conditions and/or new hotel construction in markets where our hotels are located. When such conditions exist, management performs a recoverability analysis to determine if the estimated undiscounted future cash flows from operating activities and the estimated proceeds from the ultimate disposition of a hotel property exceed its carrying value. If the estimated undiscounted future cash flows are found to be less than the carrying amount of the hotel property, an adjustment to reduce the carrying value to the related hotel property’s estimated fair market value would be recorded and an impairment loss recognized.

Our review of possible impairment at one of our hotel properties revealed an excess of current carrying cost over the estimated undiscounted future cash flows of $611,000, as of December 31, 2013. There were no charges for impairment of hotel properties recorded in 2012 or 2011.

 

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In performing the recoverability analysis, we project future operating cash flows based upon significant assumptions regarding growth rates, occupancy, room rates, economic trends, property-specific operating costs and future capital expenditures required to maintain the hotel in its current operating condition. We also project cash flows from the eventual disposition of the hotel based upon various factors including property-specific capitalization rates, ratio of selling price to gross hotel revenues and the selling price per room.

Revenue Recognition. Hotel revenues, including room, food, beverage and other hotel revenues, are recognized as the related services are delivered. We generally consider accounts receivable to be fully collectible; accordingly, no allowance for doubtful accounts is required. If we determine that amounts are uncollectible, which would generally be the result of a customer’s bankruptcy or other economic downturn, such amounts will be charged against operations when that determination is made.

Income Taxes. We record a valuation allowance to reduce deferred tax assets to an amount that we believe is more likely than not to be realized. Because of expected future taxable income of our TRS Lessee, we have not recorded a valuation allowance to reduce our net deferred tax asset as of December 31, 2013. Should our estimate of future taxable income be less than expected, we would record an adjustment to the net deferred tax asset in the period such determination was made.

Recent Accounting Pronouncements

For a summary of recently adopted and newly issued accounting pronouncements, please refer to the Recent Accounting Pronouncements section of Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.

Non-GAAP Financial Measures

We consider FFO, Adjusted FFO and Hotel EBITDA, all of which are non-GAAP financial measures, to be key supplemental measures of our performance and could be considered along with, not alternatives to, net income (loss) as a measure of our performance. These measures do not represent cash generated from operating activities determined by generally accepted accounting principles (“GAAP”) or amounts available for our discretionary use and should not be considered alternative measures of net income, cash flows from operations or any other operating performance measure prescribed by GAAP.

FFO and Adjusted FFO. Industry analysts and investors use FFO as a supplemental operating performance measure of an equity REIT. FFO is calculated in accordance with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). FFO, as defined by NAREIT, represents net income or loss determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after adjustment for any noncontrolling interest from unconsolidated partnerships and joint ventures. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by itself.

We consider FFO to be a useful measure of adjusted net income (loss) for reviewing comparative operating and financial performance. We believe FFO is most directly comparable to net income (loss), which remains the primary measure of performance, because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs.

 

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We further adjust FFO for certain additional items that are not in NAREIT’s definition of FFO, including any unrealized gain (loss) on its hedging instruments or warrant derivative, loan impairment losses, investment in hotel property impairment, losses on early extinguishment of debt, aborted offering costs, costs associated with the departure of executive officers and acquisition transaction costs. We exclude these items as we believe it allows for meaningful comparisons between periods and among other REITs and is more indicative of the on-going performance of our business and assets. Our calculation of Adjusted FFO may be different from similar measures calculated by other REITs.

The following is a reconciliation of net loss to FFO and Adjusted FFO for the years ended December 31, 2013, 2012 and 2011.

 

     Year Ended
December 31,
2013
    Year Ended
December 31,
2012
    Year Ended
December 31,
2011
 

Net Loss

   $ (4,435,185   $ (5,327,711   $ (6,475,243

Depreciation and Amortization

     8,467,228        8,661,769        8,702,880   

Equity in Depreciation on Joint Venture

     545,667        590,675        567,803   

(Gain)/ Loss on Asset Disposal

     —           —           128,099   
  

 

 

   

 

 

   

 

 

 

Funds From Operations

   $ 4,577,710      $ 3,924,733      $ 2,923,539   

Realized and Unrealized (Gain)/Loss on Hedging Activities(A)

     (89,998     13,752        77,152   

Realized and Unrealized Loss on Warrant Derivative

     2,205,248        2,026,677        1,309,075   

(Increase)/Decrease in Deferred Income Taxes

     1,463,160        1,412,467        685,189   

Impairment of Investment in Hotel Properties, Net

     611,000        —          —     

Impairment of Note Receivable

     —           110,871        —      

Aborted Offering Costs

     —           —           582,850   

Acquisition Costs

     89,743        —           —      

Loss on Early Extinguishment of Debt(A)(B)

     2,040,662        1,982,184        —      
  

 

 

   

 

 

   

 

 

 

Adjusted FFO

   $ 10,897,525      $ 9,470,684      $ 5,577,805   
  

 

 

   

 

 

   

 

 

 

 

(A) Includes equity in unrealized (gain)/loss on hedging activities and loss on early extinguishment of debt of joint venture.
(B) Except for the portion representing equity in loss on early extinguishment of debt of joint ventures, amounts are reflected in interest expense for the periods presented above.

Hotel EBITDA. We define Hotel EBITDA as net income or loss excluding: (1) interest expense, (2) interest income, (3) equity in the income or loss of equity investees, (4) unrealized gains and losses on derivative instruments not included in other comprehensive income, (5) gains and losses on disposal of assets, (6) realized gains and losses on investments, (7) impairment of long-lived assets or investments, (8) corporate general and administrative expense; (9) depreciation and amortization; and (10) other operating revenue not related to our wholly-owned portfolio. We believe this provides a more complete understanding of the operating results over which our wholly-owned hotels and its operators have direct control. We believe Hotel EBITDA provides investors with supplemental information on the on-going operational performance of our hotels and the effectiveness of third-party management companies operating our business on a property-level basis.

Our calculation of Hotel EBITDA may be different from similar measures calculated by other REITs.

 

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The following is a reconciliation of net loss to Hotel EBITDA for the years ended December 31, 2013, 2012 and 2011.

 

     Year Ended
December 31,
2013
    Year Ended
December 31,
2012
    Year Ended
December 31,
2011
 

Net Loss

   $ (4,435,185   $ (5,327,711   $ (6,475,243

Interest Expense

     11,647,141        12,382,146        10,821,815   

Interest Income

     (17,914     (16,158     (14,808

Income Tax Provision (Benefit)

     1,521,182        1,301,229        905,455   

Depreciation and Amortization

     8,467,228        8,661,769        8,702,880   

Equity in (Earnings)/Loss of Joint Venture

     (453,700     (172,172     60,094   

(Gain)/ Loss on Asset Disposal

     —           —           128,099   

Unrealized (Gain)/Loss on Hedging Activities

     —           —           (72,649

Realized and Unrealized (Gain)/Loss on Warrant Derivative

     2,205,248        2,026,677        1,309,075   

Impairment of Investment in Hotel Properties, Net

     611,000        —          —     

Impairment of Note Receivable

     —           110,871        —      

Corporate General and Administrative Expenses

     4,360,583        4,078,826        4,025,794   

Net Lease Rental Income

     (350,000     (350,000     (447,000

Other Fee Income

     (275,775     (255,707     (235,493
  

 

 

   

 

 

   

 

 

 

Hotel EBITDA

   $ 23,279,808      $ 22,439,770      $ 18,708,019   
  

 

 

   

 

 

   

 

 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The effects of potential changes in interest rates are discussed below. Our market risk discussion includes “forward-looking statements” and represents an estimate of possible changes in fair value or future earnings that could occur assuming hypothetical future movements in interest rates. These disclosures are not precise indicators of expected future losses, but only indicators of reasonably possible losses. As a result, actual future results may differ materially from those presented. The analysis below presents the sensitivity of the market value of our financial instruments to selected changes in market interest rates.

To meet in part our long-term liquidity requirements, we will borrow funds at a combination of fixed and variable rates. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. From time to time we may enter into interest rate hedge contracts such as collars and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not intend to hold or issue derivative contracts for trading or speculative purposes.

As of December 31, 2013, we had approximately $139.6 million of fixed-rate debt and approximately $48.4 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 6.01%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt, but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the change in 30-day LIBOR. However, to the extent that 30-day LIBOR does not exceed the 30-day LIBOR floors on the mortgages on the Crowne Plaza Hampton Marina and the Hilton Philadelphia Airport of 0.45% and 0.50%, respectively, a portion of our variable-rate debt would not be exposed to changes in interest rates. Assuming that the amount outstanding on our mortgage on the Crowne Plaza Hampton Marina, the

 

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mortgage on the Hilton Philadelphia Airport and the mortgage on the Crowne Plaza Jacksonville Riverfront remain at approximately $48.4 million, the balance at December 31, 2013, the impact on our annual interest incurred and cash flows of a one percent increase in 30-day LIBOR would be approximately $372,000.

As of December 31, 2012, we had approximately $98.7 million of fixed-rate debt and approximately $55.2 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 6.78%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt, but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the change in 30-day LIBOR. However, to the extent that 30-day LIBOR does not exceed the 30-day LIBOR floors on the mortgages on the Crowne Plaza Hampton Marina and the Hilton Philadelphia Airport of 0.45% and 0.50%, respectively, a portion of our variable-rate debt would not be exposed to changes in interest rates. Assuming that the amount outstanding on our mortgage on the Crowne Plaza Hampton Marina, the mortgage on the Hilton Philadelphia Airport, the mortgage on the Crowne Plaza Jacksonville Riverfront and the loan from the Carlyle Affiliate Lender remained at approximately $55.2 million, the balance at December 31, 2012, the impact on our annual interest incurred and cash flows of a one percent increase in 30-day LIBOR would be approximately $467,000.

Item 8. Financial Statements and Supplementary Data

See Index to Financial Statements and Financial Statement Schedules on page F-1.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Sotherly Hotels Inc.

Disclosure Controls and Procedures

The Company’s management, under the supervision and participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act), as of December 31, 2013. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2013, its disclosure controls and procedures were effective and designed to ensure that (i) information required to be disclosed in its reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported with the time periods specified in the SEC’s rules and instructions, and (ii) information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Company’s management, including its Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures or its internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of the controls can provide absolute assurance that all control issues and instances of fraud, if any, within Sotherly Hotels Inc. have been detected.

 

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Management’s Report on Internal Control over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). The Company’s management assessed the effectiveness over internal control over financial reporting as of December 31, 2013. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. The Company’s management has concluded that, as of December 31, 2013, its internal control over financial reporting is effective based on these criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the exemption provided to issuers that are not “large accelerated filers” or “accelerated filers” under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Changes in Internal Control over Financial Reporting

There was no change in Sotherly Hotels Inc.’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotels Inc.’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels Inc.’s internal control over financial reporting.

Sotherly Hotels LP

Disclosure Controls and Procedures

The Operating Partnership’s management, under the supervision and participation of the Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc., as general partner, has evaluated the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act), as of December 31, 2013. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2013, the disclosure controls and procedures were effective and designed to ensure that (i) information required to be disclosed in the reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported with the time periods specified in the SEC’s rules and instructions, and (ii) information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Operating Partnership’s management, including the Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc., as general partner, does not expect that the disclosure controls and procedures or the internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of the controls can provide absolute assurance that all control issues and instances of fraud, if any, within Sotherly Hotels LP have been detected.

Management’s Report on Internal Control over Financial Reporting

The Operating Partnership’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management assessed the effectiveness over internal control over financial reporting as of December 31, 2013. In making this assessment,

 

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management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Management has concluded that, as of December 31, 2013, the Operating Partnership’s internal control over financial reporting is effective based on these criteria.

This annual report does not include an attestation report of the Operating Partnership’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Operating Partnership’s independent registered public accounting firm pursuant to the exemption provided to issuers that are not “large accelerated filers” or “accelerated filers” under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Changes in Internal Control over Financial Reporting

There was no change in Sotherly Hotels LP’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotels LP’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels LP’s internal control over financial reporting.

Item 9B. Other Information

None.

 

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PART III

The information required by Items 10-14 is incorporated by reference to the Company’s proxy statement for the 2014 annual meeting of stockholders (to be filed with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this report).

Item 10. Directors, Executive Officers and Corporate Governance

The Company has adopted a code of business conduct and ethics, including a conflicts of interest policy that applies to its principal executive officer, principal financial officer, principal accounting officer or controller performing similar functions. We intend to maintain the highest standards of ethical business practices and compliance with all laws and regulations applicable to our business. A copy of the Company’s Code of Business Conduct is posted on the Company’s external website at www.sotherlyhotels.com. The Company and the Operating Partnership intend to post to its website any amendments to or waivers of its code. The Operating Partnership is managed by the Company, its sole general partner and parent company. Consequently, the Operating Partnership does not have its own separate directors or executive officers.

Information on the Company’s directors is incorporated by reference to the sections captioned “Proposal I – Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” contained in the Company’s 2014 Proxy Statement.

Item 11. Executive Compensation

The information required by this item is incorporated by reference to the section captioned “Director and Executive Compensation” contained in the Company’s 2014 Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS

Information required by this item is incorporated herein by reference to the section captioned “Principal Holders” of the Company’s 2014 Proxy Statement.

(b) SECURITY OWNERSHIP OF MANAGEMENT

Information required by this item is incorporated herein by reference to the section captioned “Principal Holders” of the Company’s 2014 Proxy Statement.

(c) CHANGES IN CONTROL

Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.

(d) SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

Information required by this item is incorporated herein by reference to the section captioned “Director and Executive Compensation” of the Company’s 2014 Proxy Statement.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item is incorporated by reference to the sections captioned “Certain Relationships and Related Transactions” and “Proposal I – Election of Directors” in the Company’s 2014 Proxy Statement.

 

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Item 14. Principal Accountant Fees and Services

The information required by this item is incorporated by reference to the section captioned “Proposal II – Ratification of Appointment of Accountants” in the Company’s 2014 Proxy Statement.

 

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PART IV

Item 15. Exhibits and Financial Statement Schedules

 

1.   Financial Statements

  

       Index to Financial Statements and Financial Statement Schedules

     F-1   

Sotherly Hotels Inc.

  
  Report of Independent Registered Public Accounting Firm, PBMares, LLP      F-2   
  Report of Independent Registered Public Accounting Firm, Witt Mares, PLC      F-3   
  Consolidated Balance Sheets for Sotherly Hotels Inc. as of December 31, 2013 and 2012      F-4   
  Consolidated Statements of Operations for Sotherly Hotels Inc. for the years ended December 31, 2013, 2012 and 2011      F-5   
  Consolidated Statements of Changes in Equity for Sotherly Hotels Inc. for the years ended December 31, 2013, 2012 and 2011      F-6   
  Consolidated Statements of Cash Flows for Sotherly Hotels Inc. for the years ended December 31, 2013, 2012 and 2011      F-7   

Sotherly Hotels LP

  
  Report of Independent Registered Public Accounting Firm, PBMares, LLP      F-8   
  Consolidated Balance Sheets for Sotherly Hotels LP as of December 31, 2013 and 2012      F-9   
  Consolidated Statements of Operations for Sotherly Hotels LP for the years ended December 31, 2013, 2012 and 2011      F-10   
  Consolidated Statements of Changes in Partners’ Capital for Sotherly Hotels LP for the years ended December 31, 2013, 2012 and 2011      F-11   
  Consolidated Statements of Cash Flows for Sotherly Hotels LP for the years ended December 31, 2013, 2012 and 2011      F-12   

Notes to Consolidated Financial Statements

     F-13   

2.   Financial Statement Schedules

  

         Schedule III – Real Estate and Accumulated Depreciation as of December 31, 2013

     F-38   

All other schedules for which provision is made in Regulation S-X are either not required to be included herein under the related instructions or are inapplicable or the related information is included in the footnotes to the applicable financial statement and, therefore, have been omitted.

The following exhibits are filed as part of this Form 10-K:

 

Exhibits

    
  3.1    Articles of Amendment and Restatement of Sotherly Hotels Inc.(1)
  3.3    Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.(2)
  3.4    Articles Supplementary of Sotherly Hotels Inc.(3)
  3.5    Amended and Restated Bylaws of Sotherly Hotels Inc.(3)
  3.6    Amendment No. 1 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.(3)
  3.7    Articles of Amendment to the Articles of Amendment and Restatement of the Company, effective as of April 16, 2013.(34)
  3.8    Second Amended and Restated Bylaws of the Company, effective as of April 16, 2013.(34)
  3.9    Amendment No. 2 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.(35)
  4.    Form of Common Stock Certificate.(2)

 

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Exhibits

    
  4.2    Warrant, dated as of April 18, 2011, by and between the Company, Essex Illiquid, LLC and Richmond Hill Capital Partners, LP(3)
  4.3    Amendment, dated December 21, 2011, to Warrant, dated as of April 18, 2011, by and among the Company, Essex Illiquid, LLC and Richmond Hill Capital Partners, LP (4)
  4.4    Amendment No. 2, dated July 10, 2012, to Warrant, dated as of April 18, 2011, by and among the Company, Essex Illiquid, LLC and Richmond Hill Capital Partners, LP (5)
  4.5    Amendment No. 3 to Warrant, dated October 23, 2013, by and among Sotherly Hotels Inc., Essex Illiquid, LLC and Richmond Hill Capital Partners, LP.(36)
  4.6    Senior Unsecured Note issued by Sotherly Hotels LP.(37)
  4.7    Indenture by and among Sotherly Hotels LP and Wilmington Trust, National Association, as trustee.(37)
10.1    Sotherly Hotels Inc. 2004 Long-Term Incentive Plan.(2)*
10.1A    Form of Restricted Stock Award Agreement between Sotherly Hotels Inc. and Participant(6)*
10.2A    Executive Employment Agreement between Sotherly Hotels Inc. and Andrew M. Sims.(7)*
10.2B    First Amendment, dated as of January 1, 2011, to Executive Employment Agreement between Sotherly Hotels Inc. and Andrew M. Sims.(8)*
10.2C    Executive Employment Agreement between Sotherly Hotels Inc. and Anthony E. Domalski.(33)*
10.3    Executive Employment Agreement between Sotherly Hotels Inc. and William J. Zaiser.(7)*
10.3A    Consulting Agreement between Sotherly Hotels Inc. and WJZ Consulting LLC.(33)*
10.4    Strategic Alliance Agreement between Sotherly Hotels Inc., Sotherly Hotels LP and MHI Hotels Services, LLC.(31)
10.5    Master Management Agreement by and between MHI Hospitality TRS, LLC and MHI Hotels Services, LLC.(31)
10.5A    Amendment Number 2, dated January 14, 2008 to the Master Management Agreement, dated December 21, 2004, as amended, by and between MHI Hospitality TRS, LLC and MHI Hotels Services, LLC.(9)
10.6    Contribution Agreement dated August 23, 2004 by and between the owners of Capitol Hotel Associates L.P., L.L.P. and Sotherly Hotels LP(10)
10.7    Contribution Agreement dated August 23, 2004 by and between the owners of Savannah Hotel Associates LLC and Sotherly Hotels LP(10)
10.8    Contribution Agreement dated August 23, 2004 by and between KDCA Partnership, MAVAS LLC, and Sotherly Hotels LP(2)
10.9    Contribution Agreement dated September 8, 2004 by and between Elpizo Limited Partnership, Phileo Land Corporation and Sotherly Hotels LP(2)
10.10    Asset Purchase Agreement dated August 19, 2004 by and between Accord LLC, West Laurel Corporation and MHI Hotels Services, LLC.(2)
10.11    Agreement to Assign and Sublease Common Space Lease and Form of Sublease by and between MHI Hospitality L.P. and MHI Hotels, LLC.(31)
10.12    Agreement to Assign and Sublease Commercial Space Lease and Form of Sublease by and between MHI Hospitality L.P. and MHI Hotels Two, Inc.(31)

 

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Exhibits

    
10.13    Lease Agreement by and between Philadelphia Hotel Associates, LP and MHI Hospitality TRS, LLC (with a schedule of eight additional agreements that are substantially identical in all material respects to the Lease agreement, except as identified in such schedule, and are not being filed herewith per Instruction 2 to Item 601 of Regulation S-K.(31)
10.14    Management Restructuring Agreement by and between MHI Hospitality TRS, LLC, MHI Hotels Services, LLC and Sotherly Hotels LP(11)
10.15    Contribution Agreement by and between MHI Hotels Services, LLC, MHI Hotels, LLC and MHI Hotels Two, Inc.(31)
10.16    Loan Agreement dated as of July 22, 2005, by and between MHI Jacksonville LLC and Mercantile Safe Deposit and Trust Company.(12)
10.17    Promissory Note dated as of July 22, 2005, made by MHI Jacksonville LLC to Mercantile Safe Deposit and Trust Company.(12)
10.18    Purchase, Sale and Contribution Agreement by and between BIT Holdings Seventeen, Inc, Sotherly Hotels LP, and MHI Hotels, LLC.(13)
10.19    Purchase Agreement by and between MCZ/Centrum Florida VI and MHI Hollywood LLC.(14)
10.19A    Third Amendment to Purchase Agreement by and between MCZ/Centrum Florida XIX, LLC and MHI Hollywood, LLC.(15)
10.19B    Fourth Amendment to Purchase Agreement by and between MCZ/Centrum Florida XIX, LLC and MHI Hollywood, LLC, dated September 1, 2006.(15)
10.19C    Fifth Amendment to Purchase Agreement by and between MCZ/Centrum Florida XIX, LLC and MHI Hollywood, LLC.(16)
10.20    Employment Agreement, dated as of January 1, 2011, between Sotherly Hotels Inc. and David R. Folsom.(8)*
10.21    Credit Agreement dated as of May 8, 2006, among Sotherly Hotels Inc., Sotherly Hotels LP, MHI Hospitality TRS Holding, Inc. as Borrowers and the Initial Guarantors Listed Herein and the Lenders Listed Herein: KeyBank National Association, as Syndication Agent, Regions Bank as Co Documentation Agent, Manufacturers and Traders Trust Company as Co Documentation Agent and Branch Banking and Trust Company.(17)
10.21A    First Amendment to Credit Agreement, dated August 1, 2007.(19)
10.21B    Second Amendment to Credit Agreement, dated April 15, 2008.(20)
10.21C    Third Amendment to Credit Agreement, dated February 18, 2009.(21)
10.21D    Fourth Amendment to Credit Agreement, dated May 18, 2009.(22)
10.21E    Fifth Amendment to Credit Agreement, dated June 4, 2010.(23)
10.21F    Sixth Amendment to Credit Agreement, dated April 18, 2011.(3)
10.22A    First Amendment to the Purchase Agreement dated as of June 15, 2006, by and between Jay Ganesh, Inc., Hiren Patel, and Capitol Hotel Associates, LP, dated as of July 25, 2006.(24)
10.22B    Second Amendment to the Purchase Agreement dated as of June 15, 2006, by and between Jay Ganesh, Inc., Hiren Patel, and Capitol Hotel Associates, LP, dated as of August 4, 2006.(24)
10.23    Purchase Agreement dated July 6, 2006, between Riverfront Inn, LLC and Sotherly Hotels Inc..(25)

 

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Exhibits

    
10.24    Strategic Alliance Agreement dated September 8, 2006 by and among Sotherly Hotels LP, Sotherly Hotels Inc. and Coakley & Williams Hotel Management Company.(26)
10.25    Promissory Note dated March 29, 2007, made by Capitol Hotel Associates, L.P., L.L.P. and MONY Life Insurance Company.(27)
10.26A    Limited Liability Company Agreement of MHI/Carlyle Hotel Investment Program I, L.L.C. dated April 26, 2007.(28)
10.26B    Limited Liability Company Agreement of MHI/Carlyle Hotel Lessee Program I, L.L.C. dated April 26, 2007.(28)
10.26C    Program Agreement for MHI/Carlyle Hotel Investment Program I, L.L.C. and MHI/Carlyle Hotel Lessee Program I, L.L.C. dated April 26, 2007.(28)
10.27    Agreement to Purchase Hotel dated May 25, 2007 between MCZ/Centrum Florida VI Owner, L.L.C. and MHI Hollywood LLC.(16)
10.28    Purchase Agreement between Sotherly Hotels Inc. and VanTampa Plaza Hotel, Inc. dated July 16, 2007.(18)
10.29    Promissory Note dated August 2, 2007 made by Savannah Hotel Associates L.L.C., to the order of MONY Life Insurance Company.(19)
10.30    Assumption and Consent Agreement by and among Hampton Hotel Associates LLC, US Bank National Association and Hampton Redevelopment and Housing Authority dated April 24, 2008.(29)
10.31    Loan Agreement between Hampton Redevelopment and Housing Authority and Olde Hampton Hotel Associates dated December 1, 1998.(29)
10.32    $7,430,000 Hampton Redevelopment and Housing Authority First Mortgage Revenue Refunding Bonds (Olde Hampton Hotel Associates Project) Series 1998A.(29)
10.33    Indenture of Trust between Hampton Redevelopment and Housing Authority and Crestar Bank dated December 1, 1998.(29)
10.34    Promissory Note by MHI Hotel Investments Holdings, LLC, dated February 9, 2009.(30)
10.35    Guaranty by Sotherly Hotels Inc., dated February 9, 2009.(30)
10.36    Securities Purchase Agreement, dated as of April 18, 2011, by and between the Company, Essex Illiquid, LLC and Richmond Hill Capital Partners, LP.(3)
10.37    Registration Rights Agreement, dated April 18, 2011, by and between the Company, Essex Illiquid, LLC and Richmond Hill Capital Partners, LP.(3)
10.38    Note Agreement, dated as of April 18, 2011, by and between the Company and Essex High Income Joint Investment Vehicle, LLC.(3)
10.39    Amendment No. 1, dated December 21, 2011, to Note Agreement, dated April 18, 2011, by and among the Company and Essex Equity High Income Joint Investment Vehicle, LLC.(4)
10.40    Amendment No. 2, dated June 15, 2012, to Note Agreement, dated April 18, 2011, by and between the Company and Essex Equity High Income Joint Investment Vehicle, LLC. (32)
10.41    Agreement, Waiver and Consent by Preferred Stockholders, dated June 15, 2012, by and among the Company, Essex Illiquid, LLC, and Richmond Hill Capital Partners, LP. (32)
10.42    Sotherly Hotels Inc. 2013 Long-Term Incentive Plan.(38)*

 

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Exhibits

    
  10.43    Warrant Redemption Agreement, dated October 23, 2013, by and among Sotherly Hotels Inc., Essex Illiquid, LLC, and Richmond Hill Capital Partners, LP.(36)
  10.44    General Partnership Interest Sale and Purchase Agreement between Boston Resources Limited and Sotherly-Houston GP LLC, dated as of November 13, 2013.(39)
  10.45    Exchange Agreement between MHI Hotels, L.L.C. and Sotherly Hotels LP, dated as of November 13, 2013.(39)
  10.46    Warrant Redemption Agreement, dated December 23, 2013, by and among Sotherly Hotels Inc., Essex Illiquid, LLC, and Richmond Hill Capital Partners, LP.(40)
  16.1    Letter from PBMares, LLP, dated November 27, 2013.(41)
  21.1    List of Subsidiaries of Sotherly Hotels Inc.
  21.2    List of Subsidiaries of Sotherly Hotels LP.
  23.1    Consent of PBMares, LLP.
  23.2    Consent of Witt Mares, PLC.
  23.3    Consent of PBMares, LLP.
  31.1    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13(a)-14 and 15(d)-14, as adopted, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.3    Certification of Chief Executive Officer pursuant to Exchange Act Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.4    Certification of Chief Financial Officer pursuant to Exchange Act Rule 13(a)-14 and 15(d)-14, as adopted, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 of the Sarbanes-Oxley Act of 2002.
  32.3    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 of the Sarbanes-Oxley Act of 2002.
  32.4    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB    XBRL Taxonomy Extension Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

(1) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Pre-Effective Amendment No. 1 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on October 20, 2004. (333-118873)

 

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(2) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Pre-Effective Amendment No. 5 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on December 13, 2004. (333-118873)
(3) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 18, 2011.
(4) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 22, 2011.
(5) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 13, 2012.
(6) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on March 25, 2009.
(7) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2010.
(8) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 19, 2011.
(9) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2008.
(10) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Pre-Effective Amendment No. 6 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on December 15, 2004. (333-118873)
(11) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Pre-Effective Amendment No. 3 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on November 15, 2004. (333-118873)
(12) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 28, 2005.
(13) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, filed with the Securities and Exchange Commission on August 11, 2005.
(14) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005, filed with the Securities and Exchange Commission on November 10, 2005.
(15) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 28, 2006.
(16) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 1, 2007.
(17) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2006, filed with the Securities and Exchange Commission on May 11, 2006.
(18) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 18, 2007.
(19) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 3, 2007.
(20) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 17, 2008.
(21) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 25, 2009.
(22) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 20, 2009.
(23) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 7, 2010.

 

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(24) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, filed with the Securities and Exchange Commission on August 8, 2006.
(25) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 26, 2006.
(26) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, filed with the Securities and Exchange Commission on March 22, 2007.
(27) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 2, 2007.
(28) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 2, 2007.
(29) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008, filed with the Securities and Exchange Commission on May 7, 2008.
(30) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 13, 2009.
(31) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2011, filed with the Securities and Exchange Commission on November 9, 2011.
(32) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 20, 2012
(33) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 3, 2013.
(34) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 16, 2013.
(35) Incorporated by reference to the document previously filed as Exhibit 3.3 to the Operating Partnership’s Pre-Effective Amendment No. 1 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on August 9, 2013 (333-189821).
(36) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on October 24, 2013.
(37) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2013, filed with the Securities and Exchange Commission on November 7, 2013.
(38) Incorporated by reference to Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A, filed with the Securities and Exchange Commission on March 20, 2013.
(39) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2013.
(40) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on December 27, 2013.
(41) Incorporated by reference to the corresponding exhibit previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on November 27, 2013.
* Denotes management contract and/or compensatory plan/arrangement.

 

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SIGNATURES

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

Date: March 25, 2014

 

SOTHERLY HOTELS INC.
By:   /s/    ANDREW M. SIMS        
 

Andrew M. Sims

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

 

Date

/s/    ANDREW M. SIMS

Andrew M. Sims

  

Chief Executive Officer and Chairman of the Board of Directors

  March 25, 2014

/s/    DAVID R. FOLSOM

David R. Folsom

  

President, Chief Operating Officer and Director

  March 25, 2014

/s/    ANTHONY E. DOMALSKI

Anthony E. Domalski

  

Chief Financial Officer

  March 25, 2014

/s/    J. PAUL CAREY

J. Paul Carey

  

Director

  March 25, 2014

/s/    JAMES. P. O’HANLON

James P. O’Hanlon

  

Director

  March 25, 2014

/s/    DAVID J. BEATTY

David J. Beatty

  

Director

  March 25, 2014

/s/    KIM E. SIMS

Kim E. Sims

  

Director

  March 25, 2014

/s/    EDWARD S. STEIN

Edward S. Stein

  

Director

  March 25, 2014

/s/    ANTHONY C. ZINNI

Anthony C. Zinni

  

Director

  March 25, 2014

 

77


Table of Contents

SIGNATURES

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

Date: March 25, 2014

 

SOTHERLY HOTELS LP,

            by its General Partner,

            SOTHERLY HOTELS INC.

            By:   /s/    ANDREW M. SIMS        
 

Andrew M. Sims

Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

 

Date

/s/    ANDREW M. SIMS

Andrew M. Sims

  

Chief Executive Officer and Chairman of the Board of Directors

  March 25, 2014

/s/    DAVID R. FOLSOM

David R. Folsom

  

President, Chief Operating Officer and Director

  March 25, 2014

/s/    ANTHONY E. DOMALSKI

Anthony E. Domalski

  

Chief Financial Officer

  March 25, 2014

/s/    J. PAUL CAREY

J. Paul Carey

  

Director

  March 25, 2014

/s/    JAMES. P. O’HANLON

James P. O’Hanlon

  

Director

  March 25, 2014

/s/    DAVID J. BEATTY

David J. Beatty

  

Director

  March 25, 2014

/s/    KIM E. SIMS

Kim E. Sims

  

Director

  March 25, 2014

/s/    EDWARD S. STEIN

Edward S. Stein

  

Director

  March 25, 2014

/s/    ANTHONY C. ZINNI

Anthony C. Zinni

  

Director

  March 25, 2014

 

78


Table of Contents

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

 

Sotherly Hotels Inc.

  

Report of Independent Registered Public Accounting Firm, PBMares, LLP

     F-2   

Report of Independent Registered Public Accounting Firm, Witt Mares, PLC

     F-3   

Consolidated Balance Sheets for Sotherly Hotels Inc. as of December 31, 2013 and 2012

     F-4   

Consolidated Statements of Operations for Sotherly Hotels Inc. for the years ended December  31, 2013, 2012 and 2011

     F-5   

Consolidated Statements of Changes in Equity for Sotherly Hotels Inc. for the years ended December  31, 2013, 2012 and 2011

     F-6   

Consolidated Statements of Cash Flows for Sotherly Hotels Inc. for the years ended December  31, 2013, 2012 and 2011

     F-7   

Sotherly Hotels LP

  

Report of Independent Registered Public Accounting Firm, PBMares, LLP

     F-8   

Consolidated Balance Sheets for Sotherly Hotels LP as of December 31, 2013 and 2012

     F-9   

Consolidated Statements of Operations for Sotherly Hotels LP for the years ended December  31, 2013, 2012 and 2011

     F-10   

Consolidated Statements of Changes in Partners’ Capital for Sotherly Hotels LP for the years ended December 31, 2013, 2012 and 2011

     F-11   

Consolidated Statements of Cash Flows for Sotherly Hotels LP for the years ended December  31, 2013, 2012 and 2011

     F-12   

Notes to Consolidated Financial Statements

     F-13   

Schedule III – Real Estate and Accumulated Depreciation as of December 31, 2013

     F-38   

 

F-1


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Sotherly Hotels Inc. (formerly MHI Hospitality Corporation)

Williamsburg, Virginia 23185

We have audited the accompanying consolidated balance sheets of Sotherly Hotels Inc. (formerly MHI Hospitality Corporation) and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, changes in equity, and cash flows for each of the years in the two-year period ended December 31, 2013. In connection with our audit of the consolidated financial statements, we have also audited the financial statement schedule of real estate and accumulated depreciation as of December 31, 2013. Sotherly Hotels Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sotherly Hotels Inc. (formerly MHI Hospitality Corporation) and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ PBMares, LLP

Norfolk, Virginia

March 25, 2014

 

F-2


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Sotherly Hotels Inc. (formerly MHI Hospitality Corporation)

Williamsburg, Virginia 23185

We have audited the accompanying consolidated statements of operations, changes in equity, and cash flows of Sotherly Hotels Inc. (formerly MHI Hospitality Corporation) and subsidiaries (the “Company”) for the year ended December 31, 2011. Sotherly Hotels Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, Sotherly Hotels Inc. (formerly MHI Hospitality Corporation) and subsidiaries’ results of operations and cash flows for the year ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.

/s/ Witt Mares, PLC

Norfolk, Virginia

March 16, 2012

 

F-3


Table of Contents

SOTHERLY HOTELS INC.

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2013 AND 2012

 

     2013     2012  

ASSETS

    

Investment in hotel properties, net

   $ 202,645,633      $ 176,427,904   

Investment in joint venture

     2,446,039        8,638,967   

Cash and cash equivalents

     9,376,628        7,175,716   

Restricted cash

     3,796,141        3,079,894   

Accounts receivable, net

     1,982,091        1,478,923   

Accounts receivable-affiliate

     101,439        8,657   

Prepaid expenses, inventory and other assets

     2,444,975        1,684,951   

Shell Island sublease, net

     240,196        480,392   

Deferred income taxes

     1,186,122        2,649,282   

Deferred financing costs, net

     3,820,838        2,406,183   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 228,040,102      $ 204,030,869   
  

 

 

   

 

 

 

LIABILITIES

    

Mortgage loans

   $ 160,363,549      $ 135,674,432   

Loans payable

     —          4,025,220   

Unsecured notes

     27,600,000        —     

Series A Cumulative Redeemable Preferred Stock , par value $0.01, 27,650 shares authorized, 0 and 14,228 shares issued and outstanding at December 31, 2013 and 2012, respectively

     —          14,227,650   

Accounts payable and accrued liabilities

     7,650,219        6,786,684   

Advance deposits

     666,758        625,822   

Dividends and distributions payable

     588,197        389,179   

Warrant derivative liability

     —          4,969,752   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     196,868,723        166,698,739   

Commitments and contingencies (see Note 7)

    

EQUITY

    

Sotherly Hotels Inc. stockholders’ equity

    

Preferred stock, par value $0.01, 972,350 shares authorized, 0 shares issued and outstanding

     —          —     

Common stock, par value $0.01, 49,000,000 shares authorized, 10,206,927 shares and 9,999,786 shares issued and outstanding at December 31, 2013 and 2012, respectively

     102,069        99,998   

Additional paid in capital

     57,534,113        57,020,979   

Distributions in excess of retained earnings

     (32,210,917     (27,179,392
  

 

 

   

 

 

 

Total Sotherly Hotels Inc. stockholders’ equity

     25,425,265        29,941,585   

Noncontrolling interest

     5,746,114        7,390,545   
  

 

 

   

 

 

 

TOTAL EQUITY

     31,171,379        37,332,130   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND EQUITY

   $ 228,040,102      $ 204,030,869   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

F-4


Table of Contents

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

     2013     2012     2011  

REVENUE

      

Rooms department

   $ 62,837,422      $ 60,824,016      $ 56,187,231   

Food and beverage department

     22,054,209        21,961,328        20,482,457   

Other operating departments

     4,482,896        4,557,876        4,502,816   
  

 

 

   

 

 

   

 

 

 

Total revenue

     89,374,527        87,343,220        81,172,504   

EXPENSES

      

Hotel operating expenses

      

Rooms department

     17,210,445        16,613,769        15,841,985   

Food and beverage department

     14,066,145        14,284,057        13,617,847   

Other operating departments

     508,868        480,307        537,969   

Indirect

     33,683,486        32,919,610        31,784,191   
  

 

 

   

 

 

   

 

 

 

Total hotel operating expenses

     65,468,944        64,297,743        61,781,992   

Depreciation and amortization

     8,467,228        8,661,769        8,702,880   

Corporate general and administrative

     4,360,583        4,078,826        4,025,794   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     78,296,755        77,038,338        74,510,666   
  

 

 

   

 

 

   

 

 

 

NET OPERATING INCOME

     11,077,772        10,304,882        6,661,838   

Other income (expense)

      

Interest expense

     (11,647,141     (12,382,146     (10,821,815

Interest income

     17,914        16,158        14,808   

Equity income (loss) in joint venture

     453,700        172,172        (60,094

Realized and unrealized loss on warrant derivative

     (2,205,248     (2,026,677     (1,309,075

Unrealized gain on hedging activities

     —          —          72,649   

Impairment of investment in hotel properties, net

     (611,000     —          —     

Impairment of note receivable

     —          (110,871     —     

Loss on disposal of assets

     —          —          (128,099
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (2,914,003     (4,026,482     (5,569,788

Income tax (provision) benefit

     (1,521,182     (1,301,229     (905,455
  

 

 

   

 

 

   

 

 

 

Net loss

     (4,435,185     (5,327,711     (6,475,243

Add: Net loss attributable to the noncontrolling interest

     981,126        1,223,036        1,630,797   
  

 

 

   

 

 

   

 

 

 

Net loss attributable to the Company

   $ (3,454,059   $ (4,104,675   $ (4,844,446
  

 

 

   

 

 

   

 

 

 

Net loss per share attributable to the Company

      

Basic and diluted

   $ (0.34   $ (0.41   $ (0.50

Weighted average number of shares outstanding

      

Basic and diluted

     10,156,955        9,995,638        9,676,846   

The accompanying notes are an integral part of these financial statements.

 

F-5


Table of Contents

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

    Common Stock     Additional
Paid-In
Capital
    Distributions in
Excess of
Retained
Earnings
    Noncontrolling
Interest
    Total  
    Shares     Par Value          

Balances at December 31, 2010

    9,541,286      $ 95,413      $ 55,682,976      $ (16,837,182   $ 11,867,096      $ 50,808,303   

Net loss

    —          —          —          (4,844,446     (1,630,797     (6,475,243

Conversion of units in Operating Partnership to shares of common stock

    367,000        3,670        1,153,588        —          (1,157,258     —     

Redemption of units in Operating Partnership

    —          —          —          —          (7,150     (7,150

Issuance of restricted common stock awards

    45,500        455        74,475        —          —          74,930   

Dividends and distributions declared

    —          —          —          (393,111     (124,486     (517,597
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2011

    9,953,786      $ 99,538      $ 56,911,039      $ (22,074,739   $ 8,947,405      $ 43,883,243   

Net loss

    —          —          —          (4,104,675     (1,223,036     (5,327,711

Redemption of units in Operating Partnership

    —          —          —          —          (36,180     (36,180

Issuance of restricted common stock awards

    46,000        460        109,940        —          —          110,400   

Dividends and distributions declared

    —          —          —          (999,978     (297,644     (1,297,622
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2012

    9,999,786      $ 99,998      $ 57,020,979      $ (27,179,392   $ 7,390,545      $ 37,332,130   

Net loss

    —          —          —          (3,454,059     (981,126     (4,435,185

Conversion of units in Operating Partnership to shares of common stock

    131,641        1,316        337,449        —          (338,765     —     

Redemption of units in Operating Partnership

    —          —          —          —          (32,900     (32,900

Issuance of units for Houston purchase

    —          —          —          —          153,636        153,636   

Issuance of restricted and unrestricted common stock awards

    75,500        755        175,685        —          —          176,440   

Dividends and distributions declared

    —          —          —          (1,577,466     (445,276     (2,022,742
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2013

    10,206,927      $ 102,069      $ 57,534,113      $ (32,210,917   $ 5,746,114      $ 31,171,379   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

F-6


Table of Contents

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

    2013        2012        2011   

Cash flows from operating activities:

     

Net loss

  $ (4,435,185   $ (5,327,711   $ (6,475,243

Adjustments to reconcile net loss to net cash provided by operating activities:

     

Depreciation and amortization

    8,467,228        8,661,769        8,702,880   

Equity in (income) loss of joint venture

    (453,700     (172,172     60,094   

Loss on disposal of assets

    —          —          128,099   

Impairment of investment in hotel properties, net

    611,000        —          —     

Impairment of note receivable

    —          110,871        —     

Unrealized gain on hedging activities

    —          —          (72,649

Realized and unrealized loss on warrant derivative

    2,205,248        2,026,677        1,309,075   

Amortization of deferred financing costs

    1,518,556        1,971,796        1,106,279   

Paid-in-kind interest

    186,293        387,554        353,698   

Charges related to equity-based compensation

    176,440        110,400        74,930   

Changes in assets and liabilities:

     

Restricted cash

    (173,990     377,908        129,976   

Accounts receivable

    (111,698     212,822        165,764   

Inventory, prepaid expenses and other assets

    16,536        122,645        380,260   

Deferred income taxes

    1,463,160        1,412,467        685,189   

Accounts payable and accrued liabilities

    178,784        (1,072,036     1,074,323   

Advance deposits

    (33,233     172,745        (102,825

Due from affiliates

    (20,688     16,222        30,292   
 

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

    9,594,751        9,011,957        7,550,142   
 

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

     

Acquisition of hotel property

    (30,725,959     —          —     

Improvements and additions to hotel properties

    (4,906,000     (2,908,114     (5,979,832

Distributions from joint venture

    6,646,627        500,000        437,500   

Funding of restricted cash reserves

    (2,195,658     (1,983,383     (2,347,877

Proceeds from restricted cash reserves

    1,653,401        1,215,972        1,733,231   

Proceeds from sale of assets

    —          19,404        26,705   
 

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

    (29,527,589     (3,156,121     (6,130,273
 

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

     

Proceeds of redeemable preferred stock

    —          —          25,000,000   

Proceeds of unsecured notes

    27,600,000        —          —     

Redemption of redeemable preferred stock

    (14,413,943     (11,513,602     —     

Dividends and distributions paid

    (1,823,723     (1,167,216     (258,825

Proceeds of loans

    —          —          5,000,000   

Payments on line of credit

    —          (25,537,290     (49,660,569

Proceeds of mortgage debt

    29,367,287        58,300,000        27,700,000   

Payments on mortgage debt and loans

    (8,703,390     (22,033,393     (5,953,178

Redemption of warrants

    (7,175,000     —          —     

Redemption of units in Operating Partnership

    (32,900     (36,180     (7,150

Payment of deferred financing costs

    (2,684,581     (1,102,398     (1,823,076
 

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

    22,133,750        (3,090,079     (2,798
 

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

    2,200,912        2,765,757        1,417,071   

Cash and cash equivalents at the beginning of the year

    7,175,716        4,409,959        2,992,888   
 

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at the end of the year

  $ 9,376,628      $ 7,175,716      $ 4,409,959   
 

 

 

   

 

 

   

 

 

 

Supplemental disclosures:

     

Cash paid during the year for interest

  $ 10,423,150      $ 10,412,434      $ 8,705,123   
 

 

 

   

 

 

   

 

 

 

Cash paid during the year for income taxes

  $ 143,848      $ 117,447      $ 48,351   
 

 

 

   

 

 

   

 

 

 

Non-cash investing and financing activities:

     

Issuance of units in Operating Partnership for acquisition of hotel property

  $ 153,636      $ —        $ —     
 

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

F-7


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors of the General Partner of

Sotherly Hotels LP (formerly MHI Hospitality, L.P.)

Williamsburg, Virginia 23185

We have audited the accompanying consolidated balance sheets of Sotherly Hotels LP (formerly MHI Hospitality, L.P.) and subsidiaries (the “Partnership”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, changes in partners’ capital, and cash flows for each of the years in the three-year period ended December 31, 2013. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule of real estate and accumulated depreciation as of December 31, 2013. Sotherly Hotels LP’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Partnership is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Partnership’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sotherly Hotels LP (formerly MHI Hospitality, L.P.) and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ PBMares, LLP

Norfolk, Virginia

March 25, 2014

 

F-8


Table of Contents

SOTHERLY HOTELS LP

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2013 AND 2012

 

     2013      2012  

ASSETS

     

Investment in hotel properties, net

   $ 202,645,633       $ 176,427,904   

Investment in joint venture

     2,446,039         8,638,967   

Cash and cash equivalents

     9,376,628         7,175,716   

Restricted cash

     3,796,141         3,079,894   

Accounts receivable, net

     1,982,091         1,478,923   

Accounts receivable-affiliate

     101,439         8,657   

Prepaid expenses, inventory and other assets

     2,444,975         1,684,951   

Shell Island sublease, net

     240,196         480,392   

Deferred income taxes

     1,186,122         2,649,282   

Deferred financing costs, net

     3,820,838         2,406,183   
  

 

 

    

 

 

 

TOTAL ASSETS

   $ 228,040,102       $ 204,030,869   
  

 

 

    

 

 

 

LIABILITIES

     

Mortgage loans

   $ 160,363,549       $ 135,674,432   

Loans payable

     —           4,025,220   

Unsecured notes

     27,600,000         —     

Series A Preferred Interest

     —           14,227,650   

Accounts payable and accrued liabilities

     7,650,219         6,786,684   

Advance deposits

     666,758         625,822   

Distributions payable

     588,197         389,179   

Warrant derivative liability

     —           4,969,752   
  

 

 

    

 

 

 

TOTAL LIABILITIES

     196,868,723         166,698,739   

Commitments and contingencies (see Note 7)

     

PARTNERS’ CAPITAL

     

General Partner: 130,711 and 129,727 units issued and outstanding as of December 31, 2013 and 2012, respectively

     557,479         617,909   

Limited Partners: 12,940,343 and 12,842,898 units issued and outstanding as of December 31, 2013 and 2012, respectively

     30,613,900         36,714,221   
  

 

 

    

 

 

 

TOTAL PARTNERS’ CAPITAL

     31,171,379         37,332,130   
  

 

 

    

 

 

 

TOTAL LIABILITIES AND PARTNERS’ CAPITAL

   $ 228,040,102       $ 204,030,869   
  

 

 

    

 

 

 

The accompanying notes are an integral part of these financial statements.

 

F-9


Table of Contents

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

     2013     2012     2011  

REVENUE

      

Rooms department

   $ 62,837,422      $ 60,824,016      $ 56,187,231   

Food and beverage department

     22,054,209        21,961,328        20,482,457   

Other operating departments

     4,482,896        4,557,876        4,502,816   
  

 

 

   

 

 

   

 

 

 

Total revenue

     89,374,527        87,343,220        81,172,504   

EXPENSES

      

Hotel operating expenses

      

Rooms department

     17,210,445        16,613,769        15,841,985   

Food and beverage department

     14,066,145        14,284,057        13,617,847   

Other operating departments

     508,868        480,307        537,969   

Indirect

     33,683,486        32,919,610        31,784,191   
  

 

 

   

 

 

   

 

 

 

Total hotel operating expenses

     65,468,944        64,297,743        61,781,992   

Depreciation and amortization

     8,467,228        8,661,769        8,702,880   

Corporate general and administrative

     4,360,583        4,078,826        4,025,794   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     78,296,755        77,038,338        74,510,666   
  

 

 

   

 

 

   

 

 

 

NET OPERATING INCOME

     11,077,772        10,304,882        6,661,838   

Other income (expense)

      

Interest expense

     (11,647,141     (12,382,146     (10,821,815

Interest income

     17,914        16,158        14,808   

Equity income (loss) in joint venture

     453,700        172,172        (60,094

Realized and unrealized loss on warrant derivative

     (2,205,248     (2,026,677     (1,309,075

Unrealized gain on hedging activities

     —          —          72,649   

Impairment of investment in hotel properties, net

     (611,000     —          —     

Impairment of note receivable

     —          (110,871     —     

Loss on disposal of assets

     —          —          (128,099
  

 

 

   

 

 

   

 

 

 

Net loss before income taxes

     (2,914,003     (4,026,482     (5,569,788

Income tax (provision) benefit

     (1,521,182     (1,301,229     (905,455
  

 

 

   

 

 

   

 

 

 

Net loss

   $ (4,435,185   $ (5,327,711   $ (6,475,243
  

 

 

   

 

 

   

 

 

 

Net loss per unit

      

Basic and diluted

   $ (0.34   $ (0.41   $ (0.50

Weighted average number of units outstanding

      

Basic and diluted

     13,042,020        12,973,953        12,934,325   

The accompanying notes are an integral part of these financial statements.

 

F-10


Table of Contents

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS’ CAPITAL

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

     General Partner     Limited Partners     Total  
     Units     Amount     Units     Amount    

Balances at December 31, 2010

     128,957      $ 753,017        12,766,768      $ 50,055,286      $ 50,808,303   

Issuance of partnership units

     455        749        45,045        74,181        74,930   

Distributions declared

     —          (5,176     —          (512,421     (517,597

Redemption of limited partnership units

     (25     (146     (2,575     (7,004     (7,150

Net loss

     —          (64,753     —          (6,410,490     (6,475,243
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2011

     129,387      $ 683,691        12,809,238      $ 43,199,552      $ 43,883,243   

Issuance of partnership units

     460        1,104        45,540        109,296        110,400   

Distributions declared

     —          (12,976     —          (1,284,646     (1,297,622

Redemption of limited partnership units

     (120     (633     (11,880     (35,547     (36,180

Net loss

     —          (53,277     —          (5,274,434     (5,327,711
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2012

     129,727      $ 617,909        12,842,898      $ 36,714,221      $ 37,332,130   

Issuance of partnership units

     1,084        4,625        107,345        325,451        330,076   

Distributions declared

     —          (20,227     —          (2,002,515     (2,022,742

Redemption of limited partnership units

     (100     (476     (9,900     (32,424     (32,900

Net loss

     —          (44,352     —          (4,390,833     (4,435,185
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balances at December 31, 2013

     130,711      $ 557,479        12,940,343      $ 30,613,900      $ 31,171,379   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these financial statements.

 

F-11


Table of Contents

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

     2013     2012     2011  

Cash flows from operating activities:

      

Net loss

   $ (4,435,185   $ (5,327,711   $ (6,475,243

Adjustments to reconcile net loss to net cash provided by operating activities:

      

Depreciation and amortization

     8,467,228        8,661,769        8,702,880   

Equity in (income) loss of joint venture

     (453,700     (172,172     60,094   

Loss on disposal of assets

     —          —          128,099   

Impairment of investment in hotel properties, net

     611,000        —          —     

Impairment of note receivable

     —          110,871        —     

Unrealized gain on hedging activities

     —          —          (72,649

Realized and unrealized loss on warrant derivative

     2,205,248        2,026,677        1,309,075   

Amortization of deferred financing costs

     1,518,556        1,971,796        1,106,279   

Paid-in-kind interest

     186,293        387,554        353,698   

Charges related to equity-based compensation

     176,440        110,400        74,930   

Changes in assets and liabilities:

      

Restricted cash

     (173,990     377,908        129,976   

Accounts receivable

     (111,698     212,822        165,764   

Inventory, prepaid expenses and other assets

     16,536        122,645        380,260   

Deferred income taxes

     1,463,160        1,412,467        685,189   

Accounts payable and accrued liabilities

     178,784        (1,072,036     1,074,323   

Advance deposits

     (33,233     172,745        (102,825

Due from affiliates

     (20,688     16,222        30,292   
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     9,594,751        9,011,957        7,550,142   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Acquisition of hotel property

     (30,725,959     —          —     

Improvements and additions to hotel properties

     (4,906,000     (2,908,114     (5,979,832

Distributions from joint venture

     6,646,627        500,000        437,500   

Funding of restricted cash reserves

     (2,195,658     (1,983,383     (2,347,877

Proceeds from restricted cash reserves

     1,653,401        1,215,972        1,733,231   

Proceeds from sale of assets

     —          19,404        26,705   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (29,527,589     (3,156,121     (6,130,273
  

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

      

Proceeds of Series A Preferred Interest

     —          —          25,000,000   

Proceeds of unsecured notes

     27,600,000        —          —     

Redemption of Series A Preferred Interest

     (14,413,943     (11,513,602     —     

Distributions paid

     (1,823,723     (1,167,216     (258,825

Proceeds of loans

     —          —          5,000,000   

Payments on line of credit

     —          (25,537,290     (49,660,569

Proceeds of mortgage debt

     29,367,287        58,300,000        27,700,000   

Payments on mortgage debt and loans

     (8,703,390     (22,033,393     (5,953,178

Redemption of the warrant

     (7,175,000     —          —     

Redemption of units in Operating Partnership

     (32,900     (36,180     (7,150

Payment of deferred financing costs

     (2,684,581