NOTE 6: FAIR VALUE MEASUREMENTS AND DERIVATIVE INSTRUMENTS

Our determination of fair value measurements is based on the assumptions that market participants would use in pricing the asset or liability. At June 30, 2016, the Company’s convertible debt (see Note 5) and certain derivative instruments were the only financial instruments measured in the financial statements at fair value on a recurring basis. Nonrecurring fair value measurements were utilized in the accounting for the Company’s equity transactions that occurred in March 2016 (see Note 8) and in the valuation of impaired hotels during the three and six months ended June 30, 2016 and 2015.

Derivative Instruments

Currently, the Company uses derivatives, such as interest rate swaps and caps, to manage its interest rate risk. The fair value of interest rate positions is determined using the standard market methodology of netting discounted expected future cash receipts and payments. Variable interest rates used in the calculation of projected receipts and payments on the positions are based on expectations of future interest rates derived from observable market interest rate curves and volatilities. Derivatives expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the agreements. The Company believes it minimizes this credit risk by transacting with major creditworthy financial institutions. These interest rate positions at June 30, 2016 are as follows:


Associated debt	Type	Terms	Effective date	Maturity date		Notional amount at June 30, 2016
Huntington	Swap	Swaps 30-day LIBOR + 2.25% for fixed rate of	11/2015	11/2020	$	9,865 (1)
		4.13 % cancellable at Company option anytime
		after 11/01/2018 without penalty
Latitude	Cap	Caps 30-day LIBOR at 1.00%	03/2016	06/2017	$	11,196 (1)

(1)

Notional amounts amortize consistently with the principal amortization of the associated loans

Additionally, prior to the execution of the Exchange Agreement (see Note 8) on March 16, 2016 which extinguished the instrument, the Company was required to bifurcate and include on the balance sheet at fair value the embedded conversion option in the Series C Preferred Stock due to the presence of an antidilution provision that required an adjustment in the common stock conversion ratio should subsequent issuances of the Company’s common stock be issued below the instrument’s original conversion price of $8.00 per share.

Similarly, at December 31, 2015, prior to the execution of the Exchange Agreement, the terms of the common stock warrants issued to the holders of the Series C Preferred Stock (see Note 8) also included an antidilution provision that required a reduction in the warrant’s exercise price of $9.60 should the conversion ratio of the Series C Preferred Stock be adjusted due to its antidilution provisions. Accordingly, the warrants did not qualify for equity classification, and, as a result, the fair value of the warrants was shown as a derivative liability on the consolidated balance sheet. With the execution of the Exchange Agreement, this provision of these warrants was effectively eliminated and the conversion price was locked permanently at its current amount on the date of the extinguishment of the Series C Preferred Stock ($1.92). Following this modification of terms, the warrants qualify for equity classification and were reclassified to additional paid in capital at their fair value of $611 on the date of the modification.

The fair value of the derivative liabilities recognized in connection with the Series C Preferred Stock was determined using the Monte Carlo simulation method. The Monte Carlo simulation method is a generally accepted statistical method used to generate a defined number of stock price paths in order to develop a reasonable estimate of the range of future expected stock prices of the Company and its peer group and minimize standard error.

All derivatives recognized by the Company are reported as derivative liabilities on the consolidated balance sheets and are adjusted to their fair value at each reporting date. All gains and losses on derivative instruments are included in net gain (loss) on derivatives and convertible debt and with the exception of realized gains and losses related to the interest rate instruments, which are included in interest expense on the consolidated statements of operations. Net loss of $46 and $4,710 were recognized related to derivative instruments for the three months ended June 30, 2016 and 2015, respectively. Net gains of $6,458 and $113 were recognized related to derivative instruments for the six months ended June 30, 2016 and 2015, respectively.

Recurring Fair Value Measurements

The following tables provide the fair value of the Company’s financial liabilities carried at fair value and measured on a recurring basis:


	Fair value at
	June 30, 2016		Level 1		Level 2		Level 3
Interest rate derivatives	$	260	$	-	$	260	$	-
Convertible debt		1,191		-		-		1,191
Total	$	1,451	$	-	$	260	$	1,191


	Fair value at
	December 31, 2015		Level 1		Level 2		Level 3
Series C Preferred embedded derivative	$	6,271	$	-	$	-	$	6,271
RES warrant derivative		2,411		-		-		2,411
Interest rate derivatives		77		-		77		-
Total	$	8,759	$	-	$	77	$	8,682

There were no transfers between levels during the three or six months ended June 30, 2016 or 2015.

The following tables presents a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis that use significant unobservable inputs (Level 3) and the related gains and losses recorded in the consolidated statements of operations during the period:


	Three months ended June 30,
	2016			2015
	Convertible debt		Series C Preferred embedded derivative		RES warrant derivative		Total
Fair value, beginning of period	$	1,399	$	10,921	$	4,593	$	15,514
Net (gains) losses recognized in earnings		(208)		3,288		1,422		4,710
Purchase and issuances		-		-		-		-
Sales and settlements		-		-		-		-
Gross transfers into Level 3		-		-		-		-
Gross transfers out of Level 3		-		-		-		-
Fair value, end of period	$	1,191	$	14,209	$	6,015	$	20,224

Total unrealized (gains) losses during the period included in earnings related to instruments held at end of period	$	(208)	$	3,288	$	1,422	$	4,710


	Six months ended June 30,
		2016								2015
	Series C Preferred embedded derivative		RES warrant derivative		Convertible debt		Total		Series C Preferred embedded derivative		RES warrant derivative		Total
Fair value, beginning of period	$	6,271	$	2,411	$	-	$	8,682	$	13,804	$	6,533	$	20,337
Net (gains) losses recognized in earnings		(4,848)		(1,800)		179		(6,469)		405		(518)		(113)
Purchase and issuances		-		-		1,012		1,012		-		-		-
Sales and settlements		(1,423)		-		-		(1,423)		-		-		-
Gross transfers into Level 3		-		-		-		-		-		-		-
Gross transfers out of Level 3		-		(611) (1)		-		(611)		-		-		-
Fair value, end of period	$	-	$	-	$	1,191	$	1,191	$	14,209	$	6,015	$	20,224

Total unrealized (gains) losses during the period included in earnings related to instruments held at end of period	$	-	$	-	$	179	$	-	$	405	$	(518)	$	(113)

(1)

RES warrants were permanently reclassified to additional paid in capital as discussed above

Fair Value of Long-Term Debt

The Company estimates the fair value of its fixed rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of debt obligations with similar credit policies. Credit spreads take into consideration general market conditions and maturity. The inputs utilized in estimating the fair value of debt are classified in Level 2 of the fair value hierarchy. The carrying value and estimated fair value of the Company’s long-term debt is presented in the table below:


	Carrying value as of				Estimated fair value as of
	June 30, 2016		December 31, 2015		June 30, 2016		December 31, 2015
Held for use	$	52,922	$	54,105	$	54,138	$	55,753
Held for sale		16,319		31,906		16,932		33,526
Total	$	69,241	$	86,011	$	71,070	$	89,279

Impaired Hotel Properties

In the performance of impairment analysis for both held for sale and held for use properties, fair value is determined with the assistance of independent real estate brokers and through the use of revenue multiples based on the Company’s experience with hotel sales as well as available industry information. For held for sale properties, estimated selling costs are based on our experience with similar asset sales. These are considered Level 3 inputs. The amount of impairment and recovery of previously recorded impairment recognized in the three and six months ended June 30, 2016 and 2015 is shown in the tables below:


	Three months ended June 30,
	2016			2015
	Number of hotels		Impairment (loss) recovery	Number of hotels		Impairment (loss) recovery
Continuing Operations:
Held for sale hotels:
Impairment loss	2	$	(121)	2	$	(1,989)
Sold hotels:
Impairment loss	-		-	3		(1,064)
Net impairment loss reported in continuing operations	2	$	(121)	5	$	(3,053)

Discontinued Operations:
Sold hotels:
Recovery of impairment	-		-	2		75
Total net impairment:	2	$	(121)	7	$	(2,978)


	Six months ended June 30,
	2016			2015
	Number of hotels		Impairment (loss) recovery	Number of hotels		Impairment (loss) recovery
Continuing Operations:
Held for sale hotels:
Impairment loss	3	$	(914)	2	$	(1,989)
Sold hotels:
Impairment loss	-		-	3		(1,926)
Recovery of impairment	-		-	1		85
Subtotal sold hotels	-		-	4		(1,841)
Net impairment loss reported in continuing operations	3	$	(914)	6	$	(3,830)

Discontinued Operations:
Sold hotels:
Impairment loss	-	$	-	1	$	(117)
Recovery of impairment	-		-	3		237
Net impairment recovery reported in discontinued operations	-	$	-	4	$	120
Total net impairment:	3	$	(914)	10	$	(3,710)