UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 Washington,  D.C. 20549

 

FORM 10‑Q  

(Mark One)  

xQuarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September  30, 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: 001-34087

 

SUPERTEL HOSPITALITY, INC.

(Exact name of registrant as specified in its charter)

 

 

1800 W. Pasewalk Ave., Ste. 200, Norfolk, NE 68701

 (Address of principal executive offices)

 

Telephone number: (402) 371-2520

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

YES     x   NO 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES   x   NO 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

 



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

YES    NO x

As of October 31, 2013, there were 2,897,539 shares of common stock, par value $.01 per share, outstanding.

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SUPERTEL HOSPITALITY, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

 

 

 

 

 

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General

 

Adjustments to Previously Filed Financial Statements

 

On August 14, 2013, the Company effected a one-for-eight reverse split of the Company’s common stock. Amounts for the Company’s outstanding common stock, common stock options and other equity awards and to the Company’s equity compensation plans, and the voting rights and conversion price of the Company’s 6.25% Series C Cumulative Convertible Preferred Stock and the exercise price and number of outstanding Company warrants exercisable for the purchase of common stock and the outstanding limited partnership units of the Company’s operating partnership have been retroactively adjusted herein to reflect the one-for-eight reverse split. The reverse split had no effect on the Company’s reported net income or loss, net income or loss applicable to common shareholders, or funds from operations.

 

Supertel Hospitality, Inc. (SHI) was incorporated in Virginia on August 23, 1994.  SHI is a self-administered real estate investment trust (REIT) for federal income tax purposes.     

 

SHI, through its wholly owned subsidiaries, Supertel Hospitality REIT Trust and E&P REIT Trust (collectively, the “Company”) owns a controlling interest in Supertel Limited Partnership (“SLP”) and E&P Financing Limited Partnership (“E&P LP”).  All of the Company’s interests in 61 properties with the exception of furniture, fixtures and equipment on 49 properties held by TRS Leasing, Inc. and its subsidiaries are held directly or indirectly by E&P LP, SLP or Solomon’s Beacon Inn Limited Partnership (SBILP) (collectively, the “Partnerships”). The Company’s interests in 10 properties are held directly by either SPPR-Hotels, LLC (SHLLC), SPPR-South Bend, LLC (SSBLLC), SPPR-BMI, LLC (SBMILLC) or SPPR-Dowell, LLC (SDLLC). SHI, through Supertel Hospitality REIT Trust, is the sole general partner in SLP and at September 30, 2013 owned approximately 99% of the partnership interests in SLP.  SLP owns 100% of Solomons GP, LLC, and Solomons GP, LLC is the general partner in SBILP.  At September 30,  2013,  SLP and SHI owned 99% and 1% interests in SBILP, respectively, and SHI owned 100% of Supertel Hospitality Management, Inc, SPPR Holdings, Inc. (SPPRHI), SPPR-BMI Holdings, Inc. (SBMIHI) and SPPR-Dowell Holdings, Inc. (SDHI).  SLP and SBMIHI owned 99% and 1% of SBMILLC, respectively, SLP and SPPRHI owned 99% and 1% of SHLLC, respectively, SLP owned 100% of SSBLLC and SLP and SDHI owned 99% and 1% of SDLLC, respectively.  References to “we”, “our”, and “us”, herein refer to Supertel Hospitality, Inc., including as the context requires, its direct and indirect subsidiaries.

 

As of September 30, 2013, the Company owned 71 limited service hotels.  All of the hotels are leased to our wholly owned taxable REIT subsidiary, TRS Leasing, Inc. (“TRS”), and its wholly owned subsidiaries (collectively “TRS Lessee”), and are managed by eligible independent contractors: Hospitality Management Advisors, Inc. (“HMA”), Strand Development Company, LLC (“Strand”), Kinseth Hotel Corporation (“Kinseth”), Cherry Cove Hospitality Management, LLC (“Cherry Cove”) and HLC Hotels Inc. (“HLC”).

 

HMA manages 18 Company hotels in Arkansas, Louisiana, Kentucky, Indiana, Virginia and Florida. Strand manages the Company’s seven economy extended-stay hotels in Georgia and South Carolina as well as 13 additional Company hotels located in Georgia, Maryland, North Carolina, Pennsylvania, Tennessee, Virginia, and West Virginia. Kinseth manages 31 Company hotels in eight states primarily in the Midwest. Cherry Cove manages one Company hotel in Maryland.  Each of the management agreements with HMA, Strand and Kinseth expires on May 31, 2014, and the management agreement with Cherry Cove expires on May 24, 2015. The management agreements renew for additional terms of one year unless either party to the agreement gives the other party written notice of termination at least 90 days before the end of a term.

 

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Each of HMA, Strand, Kinseth, and Cherry Cove receives a monthly management fee with respect to the hotels they manage equal to 3.5% of the gross hotel revenue and 2.25% of hotel net operating income (“NOI”).  NOI is equal to gross hotel income less operating expenses (exclusive of management fees, certain insurance premiums, employee bonuses, and personal and real property taxes).

 

HLC manages the Company’s one Masters Inn hotel.  The management agreement, as amended, provides for HLC to operate and manage the hotel through December 31, 2013 and receive management fees equal to 5.0% of the gross revenues derived from the operation of the hotel and incentive fees equal to 10% of the annual operating income of the hotel in excess of 10.5% of the Company’s investment in the hotel.

The management agreements generally require TRS Lessee to fund debt service, working capital needs, capital expenditures and third-party operating expenses for the management companies excluding those expenses not related to the operation of the hotels. TRS Lessee is responsible for obtaining and maintaining insurance policies with respect to the hotels.

The hotel industry is seasonal in nature. Generally, occupancy rates, revenues and operating results for hotels operating in the geographic areas in which we operate are greater in the second and third quarters of the calendar year than in the first and fourth quarters, with the exception of our hotels located in Florida, which experience peak demand in the first and fourth quarters of the year.

 

Consolidated Financial Statements

 

The Company has prepared the unaudited condensed consolidated balance sheet as of September 30,  2013, the unaudited condensed consolidated statements of operations for the three and nine months ended September 30,  2013 and 2012, and the unaudited condensed consolidated statements of cash flows for the nine months ended September  30,  2013 and 2012, in conformity with U. S. generally accepted accounting principles. In the opinion of management, all necessary adjustments (which include only normal recurring adjustments) have been made to present fairly the financial position as of September 30,  2013 and the results of operations and cash flows for all periods presented.  Balance sheet data as of December 31, 2012 has been derived from the audited consolidated financial statements as of that date. The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period.  Actual results could differ from those estimates.

 

Certain information and footnote disclosures, normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles, have been condensed or omitted, although management believes that the disclosures are adequate to make the information presented not misleading.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 and the Current Report on Form 8-K filed August 29, 2013.  The results of operations for the three and nine months ended September 30,  2013 are not necessarily indicative of the operating results for the full year. 

 

Derivative Liabilities

 

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.  However, fair value accounting requires bifurcation of certain embedded derivative instruments such as conversion features in convertible debt or equity instruments, and measurement at their fair value for accounting purposes.  The conversion feature embedded in the Series C convertible preferred

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stock was evaluated, and it was determined that the conversion feature should be bifurcated from its host instrument and accounted for as a freestanding derivative.  In addition the common stock warrants issued with the Series C convertible preferred stock were also determined to be freestanding derivatives. The following table summarizes our derivative liabilities at September 30, 2013 and December 31, 2012 (dollars in thousands):

 

 

The amendment to the Company’s articles of incorporation,  setting forth the terms of the Series C convertible preferred stock, the host instrument, includes an antidilution provision that requires an adjustment in the common stock conversion ratio should subsequent issuances of the Company’s common stock be issued below the instruments’ original conversion price of $8.00 per share.  Accordingly we bifurcated the embedded conversion feature which is shown as a derivative liability recorded at fair value on the accompanying consolidated balance sheets as of September 30, 2013 and December 31, 2012. 

 

The agreement setting forth the terms of the common stock warrants issued to the holders of the Series C convertible preferred stock also includes an antidilution provision that requires a reduction in the warrant’s exercise price of $9.60 should the conversion ratio of the Series C convertible preferred stock be adjusted due to antidilution provisions. Accordingly, the warrants do not qualify for equity classification, and, as a result, the fair value of the derivative is shown as a derivative liability on the accompanying consolidated balance sheets as of September 30, 2013 and December 31, 2012.

 

Fair Value Measurements

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value measurements are utilized to determine the value of certain liabilities, to perform impairment assessments, and for disclosure purposes.  In February 2012, the Company issued financial instruments with features that were determined to be derivative liabilities, and as a result must be measured at fair value on a recurring basis under Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) 820-10 Fair Value Measurements and Disclosures – Overall.  In addition we apply the fair value provisions of ASC 820-10-35 Fair Value Measurements and Disclosures – Overall – Subsequent Measurement, for our nonfinancial assets which include our held for sale and impaired held for use hotels and the disclosure of the fair value of our debt.

 

Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date.

 

Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

 

Level 3 non-financial asset valuations use unobservable inputs that reflect our assumptions about the assumptions that market participants would use in pricing the asset or liability.  We develop

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these inputs based on the best information available, including our own data. Financial asset and liability valuation inputs include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the liability; this includes pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

 

Non financial assets

 

Nonfinancial asset fair value measurements are discussed below in the note “Impairment Losses.”

 

 Financial instruments

 

As of September 30,  2013 and December 31, 2012, the fair value of the derivative liabilities was determined by 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 minimizes standard error.

 

The fair value of the Company’s financial liabilities carried at fair value and measured on a recurring basis as of September 30,  2013 and December 31, 2012 are as follows (dollars in thousands):

 

 

 

 

There were no transfers between levels during the three and nine months ended September 30, 2013 and 2012.

 

The following tables present a reconciliation of the beginning and ending balances of items measured at fair value on a recurring basis in the table above that used significant unobservable inputs (Level 3), and the realized and unrealized gains (losses) recorded in the Consolidated Statement of Operations in other income (expenses) for each of the quarter and nine months ending September 30, 2013  (dollars in thousands): 

 

 

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The Company estimates the fair value of its fixed rate debt and the credit spreads over variable market rates on its variable rate debt by discounting the future cash flows of each instrument at estimated market rates or credit spreads consistent with the maturity of the debt obligation with similar credit 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 hierarchy. The carrying value and estimated fair value of the Company’s debt as of September 30, 2013 and December 31, 2012 are presented in the table below  (dollars in thousands):

 

 

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Discontinued Operations - Hotel Properties Held for Sale and Sold

 

At December 31, 2012, the Company had 22 hotels identified that it intends to sell and that met the Company’s criteria to be classified as held for sale (the “Sale Hotels”).  During the nine months ended September 30, 2013, 15 hotels were sold, with an approximate aggregate net gain of $1.7 million. The gain consisted of: $0.4 million from the sale of a Super 8 in Fort Madison, Iowa; $0.3 million from the sale of a Super 8 in Pella, Iowa; $0.6 million from the sale of a Super 8 in Columbus, Nebraska,  approximately $24,000 from the sale of a Quality Inn in Minocqua, Wisconsin; and $0.4 million from the sale of a Super 8 in Jefferson City, Missouri. There was no gain on the sale of the other ten hotels sold. Two were sold in the first quarter of 2013, eight were sold in the second quarter of 2013, and five were sold in the third quarter of 2013. A REIT will incur a 100% tax on the net income derived from any sale or other disposition of property that the REIT holds primarily for sale to customers in the ordinary course of a trade or business. We do not believe any of our hotels were held primarily for sale in the ordinary course of our trade or business. However, if the Internal Revenue Service would successfully assert that we held such hotels primarily for sale in the ordinary course of our business, the gain from such sales could be subject to a 100% prohibited transaction tax.  Due to changes in the market during the second quarter, seven hotels were reclassified as held for sale. This brings the total number of hotels classified as held for sale to 14 as of September 30, 2013.

 

In accordance with FASB ASC 205-20 Presentation of Financial Statements – Discontinued Operations, gains, losses and impairment losses on hotel properties sold or classified as held for sale are presented in discontinued operations.    The operating results of the hotels held for sale and sold are included in discontinued operations and are summarized below. The operating results for the three months ended September 30, 2013 include 14 hotels held for sale and five hotels that were sold in the third quarter of 2013.  The operating results for the three months ended September 30, 2012 include 14 hotels held for sale, 15 hotels that were sold in 2013 and 9 hotels that were sold in 2012.

 

The operating results for the nine months ended September 2013 included 14 hotels held for sale and 15 hotels that were sold in 2013. The operating results for the nine months ended September 2012 included 14 hotels held for sale, 15 hotels that were sold in 2013, and 15 hotels sold in 2012 (dollars in thousands):     

 

 

 

 

 

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Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing earnings available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS is computed after adjusting the numerator and denominator of the basic EPS computation for the effects of any dilutive potential common shares outstanding during the period, if any. The effects include adjustments to the numerator for any change in fair market value attributed to the derivatives liabilities (related to the Series C convertible preferred stock and warrants) during the period the convertible securities are dilutive. The computation of basic and diluted earnings per common share is presented below: 

 

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The net earnings (loss) attributable to noncontrolling interest is allocated between continuing and discontinued operations.  Additionally, unvested stock awards, outstanding stock options, the Series C convertible preferred stock and warrants, and the preferred operating units, if any, have been omitted from the denominator for the purpose of computing diluted earnings per share when the effects of including these awards in the denominator would be antidilutive due to the loss from continuing operations applicable to common shareholders.  The following table summarizes the weighted average of common stock equivalence of potentially dilutive securities that have been excluded from the denominator for the purpose of computing diluted earnings per share:

 

 

 

Debt Financing

 

A summary of the Company’s long term debt as of September 30, 2013 is as follows (dollars in thousands):

 

 

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On January 10, 2013, the Company obtained a $2.4 million loan from First State Bank in Fremont, Nebraska.  The loan was secured by four hotels, two of which were subsequently sold, bears interest at 5.5%, and matures on September 1, 2016. Proceeds of the loan were used for general corporate purposes.

 

On February 13, 2013, the Company sold a Guesthouse Inn in Ellenton, Florida (63 rooms) for $1.26 million, and a Days Inn in Fredericksburg, Virginia (North)  (120 rooms) for $2.05 million. Proceeds from the sales of the two properties were used to pay off the associated debt. 

 

On February 21, 2013, the rate on the $2.9 million balance owed to Elkhorn Valley Bank was lowered from 6.25% to 5.50%. 

 

On March 26, 2013, the Company amended its credit facilities with Great Western Bank to (a) extend the maturity date of the revolving credit facility from June 30, 2013 to June 30, 2014 and decrease the interest rate from 5.95% to 4.95% and (b) extend the maturity date of the term loans from June 30, 2013 to June 30, 2015 and decrease the interest rate from 6.00% to 5.00%.

 

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On March 28, 2013, the Company paid $5.3 million on a loan with GE Franchise Finance Commercial LLC, using funds from the revolving credit facility with Great Western Bank, in exchange for the release of three Masters Inn properties, two of which  were subsequently sold. 

 

On April 18, 2013, the Company sold a Super 8 in Fort Madison, Iowa (40 rooms) for $1.1 million. Proceeds were used to pay off the associated debt.

On May 1, 2013, the Company sold a Masters Inn in Tuscaloosa, Alabama (151 rooms) for $1.7 million. Proceeds were used to reduce the balance of the revolving credit facility with Great Western Bank.

 

On May 20, 2013, the Company sold a Masters Inn in Savannah, Georgia (128 rooms) for $1.5 million.  Proceeds were used to reduce the balance of the revolving credit facility with Great Western Bank.

 

On May 23, 2013, the Company sold a Super 8 in Pella, Iowa (40 rooms) for $0.7 million.  Proceeds were used to pay off the associated debt.

 

On June 21, 2013, the Company sold a Masters Inn in Charleston, South Carolina (North) (150 rooms) for $1.2 million. Proceeds were used to pay off the associated debt.

 

On June 24, 2013, the Company sold a Super 8 in Columbus, Nebraska (63 rooms) for $1.2 million. Proceeds were used to pay off the associated debt.

 

On June 24, 2013, the Company sold a Masters Inn in Columbia, South Carolina  (112 rooms) for $1.2 million. Proceeds were used to pay off the associated debt.

 

On June 24, 2013, the Company paid down the loan facility from GE Franchise Finance Commercial LLC by $5.3 million.

 

On June 27, 2013, the Company sold a Days Inn in Fredericksburg, Virginia (South) (156 rooms) for $1.8 million. Proceeds were used to pay off the associated debt.

 

On July 10, 2013, the Company sold a Masters Inn in Tampa, Florida (East) (117 rooms) for $0.8 million. Proceeds were applied to the line of credit with Great Western Bank.

 

On July 18, 2013, the Company sold a Quality Inn in Minocqua, Wisconsin (51 rooms) for $1.3 million.  Proceeds were used to pay off the associated debt.

 

Our loan facilities with GE Franchise Finance Commercial LLC require us to maintain a minimum after dividend consolidated fixed charge coverage ratio (FCCR) (as defined in the loan agreement). As of June 30, 2013, our after dividend consolidated FCCR (as defined in the loan agreement) was 0.88:1 (versus the requirement of 0.95:1).  On August 13, 2013, the Company received a waiver for non-compliance with this covenant as of June 30, 2013 in return for payment of $107,500. In connection with the waiver, our loan facilities with GE were also amended to increase the before dividend FCCR with respect to our GE-encumbered properties from 1.05:1 to 1.20:1, commencing on September 30, 2013.

 

On August 22, 2013, the Company sold a Comfort Suites (69 rooms) and a Sleep Inn (63 rooms) in Louisville, Kentucky for a total of $4.0 million. Proceeds were used to reduce the balance of two loan facilities with GE.

 

On September 12, 2013, the Company sold a Super 8 in Jefferson City, Missouri (77 rooms) for $1.275 million. Proceeds were used to pay off the associated debt.

 

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At September 30, 2013, the Company had long-term debt of $93.2 million associated with assets held for use, consisting of notes and mortgages payable, with a weighted average term to maturity of 3.3 years and a weighted average interest rate of 5.6%. The weighted average fixed rate was 5.8%, and the weighted average variable rate was 3.9%. Debt is classified as held for use if the properties collateralizing it are included in continuing operations. Debt is classified as held for sale if the properties collateralizing it are included in discontinued operations. Debt associated with assets held for sale is classified as a short-term liability due within the next year irrespective of whether the notes and mortgages evidencing such debt mature within the next year. Aggregate annual principal payments on debt associated with assets held for use for the remainder of 2013 and thereafter, and debt associated with assets held for sale, are as follows (dollars in thousands):

 

At September 30,  2013, the Company had $0.8 million of principal due in 2013.  This amount consists entirely of principal amortization on mortgage loans.

 

We are required to comply with certain financial covenants for some of our lenders.  As of September 30, 2013, we were either in compliance with our financial covenants or obtained waivers for noncompliance (as discussed below).  As a result, we are not in default of any of our loans. 

 

Our loan facilities with GE Franchise Finance Commercial LLC require us to maintain a minimum before dividend consolidated fixed charge coverage ratio (FCCR) (as defined in the loan agreement) and a minimum after dividend consolidated FCCR (as defined in the loan agreement). As of September 30, 2013, our before dividend consolidated FCCR (as defined in the loan agreement) was 1.09:1 (versus the requirement of 1.10:1) and our after dividend consolidated FCCR (as defined in the loan agreement) was 0.84:1 (versus the requirement of 0.95:1). On November 13, 2013, the Company received a waiver for non-compliance with these covenants as of September 30, 2013 in return for payment of $190,000. In connection with the waiver, our loan facilities with GE were also amended to increase the minimum before dividend FCCR with respect to our GE-encumbered properties from 1.20:1 to 1.30:1, commencing on December 31, 2013, and decrease the maximum loan to value ratio with respect to our GE-encumbered properties from 75% to 72.2%, commencing on December 31, 2013.    The covenant calculation currently stands at 72.2% as of September 30, 2013. The Company did not amend the covenant requirement related to the after dividend consolidated FCCR of 1.00:1 as of December 31, 2013. The Company does not currently project that it will be able to satisfy the after dividend FCCR requirement under the covenant and anticipates that it will not be compliant with this covenant as of December 31, 2013.

 

Our credit facilities with Great Western Bank require us to maintain a loan-specific debt service coverage ratio of 1.20:1 or more. In the event the ratio is below the requirement on any measurement date, the loan agreement provides for an automatic decrease in the availability of the revolving credit facility in an amount sufficient to meet the required ratio. On September 30, 2013, the loan-specific debt service coverage ratio was 1.28:1 (based upon full availability); accordingly, the availability of our revolving credit

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facility was $12.5 million. The availability of our revolving credit facility is adjusted monthly, subject to maximum availability of $12.5 million.

 

Stock-Based Compensation

 

Non Vested Share Awards

 

On May 22, 2012, share awards totaling 5,625 shares were made to two executive officers of the Company in accordance with the 2006 Stock Plan at a grant date price of $7.20.  The shares vest based on continued employment of the executives, and the restrictions lapse in 50% increments on each of the first and second anniversary of issuance. There were 2,813 and 5,625 unvested stock awards as of September 30, 2013 and 2012, respectively.

 

On July 15, 2013, the Company granted share awards and stock options to an executive officer of the Company outside of the 2006 Stock Plan as an inducement material to the executive’s acceptance of employment. The share awards total 3,125 authorized but previously unissued shares of the Company’s common stock with a grant date price of $7.28. The shares vest based on continued employment of the executive, and the restrictions lapse in 33.3% increments on each of the first, second and third anniversaries of issuance. There were 3,125 unvested awards as of September 30, 2013. The stock options entitle the executive to purchase 3,125 authorized but previously unissued shares of the Company’s common stock at an exercise price of $8.08 per share.  The stock options have a four-year term and vest in equal one-third increments on each of the first, second and third anniversaries of issuance provided that the executive is employed by the Company on each such vesting date.  The stock options and share awards will become fully vested in the event of a change of control of the company or upon the executive’s death or disability.

 

Investment Committee Share Compensation

 

In March 2012 the Board of Directors approved the recommendation by the Compensation Committee that the independent directors serving as members of the Investment Committee receive their monthly Investment Committee fees in the form of shares of the Company’s Common Stock issued under the 2006 Stock Plan, priced as the average of the closing price of the stock for the first 20 trading days for the calendar year.  The shares issued to the independent directors of the Investment Committee for the three months ended September 30, 2013 and 2012 were 747 and 1,090, respectively. An aggregate of 1,494 and 2,725 shares were issued for the nine months ended September 30, 2013 and 2012, respectively. 

 

Share-Based Compensation Expense

 

The expense recognized in the condensed consolidated financial statements for the three months ended September 30, 2013 and 2012 for share-based compensation related to employees and directors was approximately $12,200 and $14,200, respectively, and the expense recognized for the nine months ended September 30, 2013 and 2012 was approximately $43,900 and $27,600, respectively.

 

Impairment Losses

 

Held for use

 

In accordance with FASB ASC 360-10-35 Property Plant and Equipment – Overall – Subsequent Measurement, the Company analyzes its assets for impairment when events or circumstances occur that indicate the carrying amount may not be recoverable. As part of this process, the Company utilizes a two-step analysis to determine whether a trigger event (within the meaning of ASC 360-10-35) has occurred with respect to cash flow of, or a significant adverse change in business climate for, its hotel properties. Quarterly and annually the Company reviews all of its held for use hotels to determine any property whose

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cash flow or operating performance significantly underperformed from budget or prior year, which the Company has set as a shortfall against budget or prior year as 15% or greater.

 

Each quarter we apply a second analysis on those properties identified in the 15% change analysis or which have had a trigger event. The analysis estimates the expected future cash flows to identify any property whose carrying amount potentially exceeded the recoverable value. In performing this analysis, the Company makes the following assumptions:

 

 

If the analysis results in the carrying value of the hotel exceeding the sum of the undiscounted cash flows expected over its remaining anticipated holding period and from its disposition, the property is then tested in accordance with FASB ASC 360-10-35 35-29 Property Plant and Equipment – Overall – Subsequent Measurement, Estimates of Future Cash Flows Used to Test a Long-Lived Asset for Recoverability. The Company uses estimates of future cash flows associated with the individual properties over their expected holding period and eventual disposition.  In estimating these future cash flows, the Company incorporates its own assumptions about its use of the hotel property and expected hotel performance.  Assumptions used for the individual hotels are determined by management, based on discussions with our asset management group and our third party management companies. The properties are then subjected to a probability – weighted cash flow analysis as described in FASB ASC 360-10-55 Property Plant and Equipment – Overall – Implementation. In this analysis, the Company completes a detailed review of the hotels’ market conditions and future prospects, which incorporates specific detailed cash flow and revenue multiplier assumptions over the remaining expected holding periods, including the probability that the property will be sold. To determine the amount of impairment on the hotel properties identified in this analysis, the Company calculates the excess of the carrying value of the properties in comparison to their fair market value.

 

During the three months ended March 31, 2013, June 30, 2013, and September 30, 2013, no trigger events as described in ASC 360-10-35 occurred for any of our held for use hotels. 

 

During the three months ended September 30, 2012, no trigger events as described in ASC 360-10-35 occurred for any of our held for use hotels. However, during the three months ended June 30, 2012, a trigger event as described in ASC 360-10-35 occurred for two of our held for use hotels. We recorded impairment on one hotel subsequently placed into held for sale from held for use in the amount of $1.4 million, and $2.7 million was recorded on one hotel classified as held for use. For the three months ended March 31, 2012, recovery of $0.3 million was recorded on one hotel classified as held for use.

 

Held for sale

 

During the three months ended September 30, 2013, Level 3 inputs were used to determine impairment losses totaling $0.4 million on two held for sale hotels and one hotel subsequently sold, and recovery totaling $0.1 million on two held for sale and two hotels at the time of sale. During the three months ended June 30, 2013, Level 3 inputs were used to determine impairment losses of $0.7 million on three held for sale hotels, $0.4 million on four hotels at the time of sale, and recovery of $0.1 million of impairment on three hotels at the time of sale.  During the three months ended March 31, 2013, Level 3 inputs were used to determine non-cash impairment losses of $0.1 million on four held for sale hotels, and

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$0.4 million on eight hotels subsequently sold.  The Company also recorded negligible recovery of impairment on one hotel at the time of sale.

 

During the three months ended September 30, 2012, Level 3 inputs were used to determine impairment losses of $0.1 million on one held for sale hotel and $2.6 million on nine hotels subsequently sold. During the three months ended June 30, 2012, Level 3 inputs were used to determine impairment losses of $1.4 million on two held for sale hotels. The Company also recorded recovery of $0.1 million of impairment on three hotels subsequently sold and recorded impairment losses of $0.1 million on seven hotels subsequently sold. During the three months ending March 31, 2012, Level 3 inputs were used to determine non-cash impairment losses of $0.2 million on one held for sale hotel, a loss of $1.6 million on nine hotels subsequently sold, and recovery of $0.1 million of previously recorded impairment loss on one hotel at the time of sale. 

 

The fair value of an asset held for sale is based on the estimated selling price less estimated selling costs.  We engage independent real estate brokers to assist us in determining the estimated selling price using a market approach. The estimated selling costs are based on our experience with similar asset sales.  We record impairment charges and write down the carrying value of an asset if the carrying value exceeds the estimated selling price less costs to sell.

 

Income Taxes

The TRS Lessee income tax expense from continuing operations for the three months ended September 30,  2013 and 2012 was $0 and $0.3 million, respectively.  The TRS Lessee income tax expense from continuing operations for the nine months ended September 30, 2013 and 2012 was $0 and $0.4 million respectively. The TRS Lessee has estimated its income tax benefit using a combined federal and state rate of approximately 38%.  We have provided a full valuation allowance against our deferred tax asset at September 30, 2013, due to the uncertainty of realization (because of historical operating losses) and as a result no income tax expense or benefit was recorded for the three months and nine months ended September 30, 2013. The TRS net operating loss carryforward from September 30, 2013 as determined for federal income tax purposes was approximately $18.9 million. The availability of such loss carryforward will begin to expire in 2022.  

 

Noncontrolling Interest of Common and Redeemable Preferred Units in SLP

 

At September 30, 2013 and 2012, 0 and 11,424, respectively, of SLP’s preferred operating partnership units (“Preferred OP Units”) were outstanding. The Preferred OP Units received a preferred dividend distribution of $1.10 per preferred unit annually, payable on a monthly basis and did not participate in the allocations of profits and losses of SLP. All holders elected to have their Preferred OP units redeemed on October 24, 2012, and the 11,424 units were redeemed at $10 per unit.

 

As of September 30, 2013 and 2012, 97,008 Common OP Units were outstanding.

 

Equity Reconciliation of Parent and Noncontrolling Interest

 

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Series B Redeemable Preferred Stock

 

At September 30,  2013, there were 332,500 shares of 10.0% Series B preferred stock outstanding.  The shares were sold on June 3, 2008 for $25.00 per share and bear a liquidation preference of $25.00 per share.

 

Dividends on the Series B preferred stock are cumulative and are payable quarterly in arrears on each March 31, June 30, September 30 and December 31, or, if not a business day, the next succeeding business day, at the annual rate of 10.0% of the $25.00 liquidation preference per share, equivalent to a fixed annual amount of $2.50 per share.  Dividends on the Series B preferred stock accrue whether or not the Company has earnings, whether or not there are funds legally available for the payment of such dividends, whether or not such dividends are declared and whether or not such dividends are prohibited by agreement. Accrued but unpaid dividends on the Series B preferred stock will not bear interest.

 

The Series B preferred stock will, with respect to dividend rights and rights upon the Company’s liquidation, dissolution or winding up, rank: (a) senior to the Company’s common stock, (b) senior to all classes or series of preferred stock issued by the Company and ranking junior to the Series B preferred stock with respect to dividend rights or rights upon the Company’s liquidation, dissolution or winding up, (c) on a parity with the Company’s Series A preferred stock and Series C convertible preferred stock and with all classes or series of preferred stock issued by the Company and ranking on a parity with the Series B preferred stock with respect to dividend rights or rights upon the Company’s liquidation, dissolution or winding up and (d)  junior to all of the Company’s existing and future indebtedness.

 

The Company will not pay any distributions, or set aside any funds for the payment of distributions, on its common shares, unless it has also paid (or set aside for payment) the full cumulative distributions on the preferred shares for the current and all past dividend periods. The Series B preferred stock has no stated maturity and is not subject to any sinking fund or mandatory redemption (except as described below).  

 

The Series B preferred stock was not redeemable prior to June 3, 2013, except in certain limited circumstances relating to the maintenance of the Company’s ability to qualify as a REIT as provided in the Company’s articles of incorporation or a change of control (as defined in the Company’s amendment to its articles of incorporation establishing the Series B preferred stock).  The Company may redeem the Series B

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preferred stock, in whole or in part, at any time or from time to time on or after June 3, 2013 for cash at a redemption price of $25.00 per share, plus all accrued and unpaid dividends. Also, upon a change of control, each outstanding share of the Company’s Series B preferred stock will be redeemed for cash at a redemption price of $25.00 per share, plus all accrued and unpaid dividends. At September 30,  2013, no events have occurred that would lead the Company to believe redemption of the preferred stock, due to a change of control or failure to maintain its REIT qualification, is probable.    

 

Series A Preferred Stock

 

On December 30, 2005,  the Company offered and sold 1,521,258 shares of 8% Series A preferred stock.  At September 30,  2013, 803,270 shares of Series A preferred stock remained outstanding.  Dividends on the Series A preferred stock are cumulative and are payable monthly in arrears on the last day of each month, at the annual rate of 8% of the $10.00 liquidation preference per share, equivalent to a fixed annual amount of $.80 per share. The Company may redeem the Series A preferred stock, in whole or in part, at any time and from time to time for cash at a redemption price of $10.00 per share, plus all accrued and unpaid dividends.

 

Series C Convertible Preferred Stock and Warrants

 

The Company entered into a Purchase Agreement dated November 16, 2011 for the issuance and sale of Supertel’s Series C convertible preferred stock and warrants under a private transaction to Real Estate Strategies, L.P. (“RES”). On January 31, 2012 at a special meeting, the shareholders of Supertel, by the requisite vote, approved the issuance and sale of up to 3,000,000 shares of the Series C convertible preferred stock of Supertel, up to 30,000,000 shares of common stock of Supertel which may be issued upon conversion of the Series C convertible preferred stock, and warrants to purchase up to an additional 30,000,000 shares of common stock, to RES pursuant to the Purchase Agreement. In two closings on February 1, 2012 and February 15, 2012, the Company completed the sale to RES of 3,000,000 shares of Series C convertible preferred stock and warrants to purchase 30,000,000 shares of common stock at an exercise price of $1.20 per common share. In connection with the one-for-eight reverse split, the aggregate number of shares of common stock issuable upon the exercise of the warrants was decreased from 30,000,000 to 3,750,000 shares. The exercise price of the warrants was increased from $1.20 per share of common stock to $9.60 per share. 

 

Each share of Series C convertible preferred stock is entitled to a dividend of $0.625 per year payable in equal quarterly dividends. Each share of Series C convertible preferred stock has a liquidation preference of $10.00 per share, in cash, plus an amount equal to any accrued and unpaid dividends.  With respect to dividend rights and rights upon the Company’s liquidation, dissolution or winding up, the Series C convertible preferred stock ranks: (a) on  a parity with the Series A preferred stock and Series B preferred stock and other future series of preferred stock designated to rank on  a parity, and (b) senior to the common stock and other future series of preferred stock designated to rank junior, and (c) junior to the Company’s existing and future indebtedness.

 

The Series C convertible preferred stock, at the option of the holder, is convertible at any time into common stock at a conversion price of $8.00 for each share of common stock, which is equal to the rate of 1.25 shares of common stock for each share of Series C convertible preferred stock. A holder of Series C convertible preferred stock will not have conversion rights to the extent the conversion would cause the holder and its affiliates to beneficially own more than 34% of voting stock (the “Beneficial Ownership Limitation”). “Voting stock” means capital stock having the power to vote generally for the election of directors of the Company. A holder of warrants would similarly not have exercise rights to the extent the exercise of a warrant would cause the holder and its affiliates to own capital stock in an amount exceeding the Beneficial Ownership Limitation.

 

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The Series C convertible preferred stock will vote with the common stock as one class, subject to certain voting limitations. For any vote, the voting power of the Series C convertible preferred stock will be equal to the lesser of: (a) 0.78625 vote per share (which will be reduced as described below) or (b) an amount of votes per share such that the vote of all shares of Series C convertible preferred stock in the aggregate equal 34% of the combined voting power of all the Company voting stock, minus an amount equal to the number of votes represented by the other shares of voting stock beneficially owned by RES and its affiliates (the “Voting Limitation”).

 

As long as RES has the right to designate two or more directors to the Company Board of Directors pursuant to the Directors Designation Agreement, the following requires the approval of RES and IRSA Inversiones y Representaciones Sociedad Anonima (“IRSA”):  

•  the merger,  consolidation, liquidation or sale of substantially all of the assets of the Company;

•  the sale by the Company of common stock or securities convertible into common stock equal to 20% or more of the outstanding common stock or voting stock; or

•  any Company transaction of more than $120,000 in which any of its directors or executive officers or any member of their immediate family will have a material interest, exclusive of employment compensation and interests arising solely from the ownership of the Company equity securities if all holders of that class of equity securities receive the same benefit on a pro rata basis.

 

Equity Distribution Agreement

 

On March 29, 2011, the Company entered into an equity distribution agreement with JMP Securities LLC (“JMP”) pursuant to which the Company may offer and sell up to 250,000 shares of common stock from time to time through JMP. Sales of shares of the Company common stock, if any, under the agreement may be made in negotiated transactions or other transactions that are deemed to be “at the market” offerings, including sales made directly on the Nasdaq Global Market or sales made to or through a market maker other than on an exchange. The common stock will be sold pursuant to the Company’s registration statement on Form S-3 (333-170756). During the three and nine months ended September 30,  2013 or 2012, no shares were issued. 

 

Commitments and Contingencies

Litigation

 

Various claims and legal proceedings arise in the ordinary course of business and may be pending against the Company and its properties. Based upon the information available, the Company believes that the resolution of any of these claims and legal proceedings should not have a material adverse affect on its consolidated financial position, results of operations or cash flows.

 

Terminated Dispositions

 

On September 26, 2013 SLP entered into a purchase and sale agreement with Westmont USA Development, Inc. (the “Purchaser”) to sell all seven of the SLP’s Savannah Suites hotels for a purchase price of $22,500,000 in cash.  These seven properties are classified as held for sale. On November 8, 2013, the Purchaser terminated the agreement in accordance with its terms. $250,000 deposited in escrow as an earnest money deposit against the purchase price was returned to the purchaser. 

 

Acquisition Terminations

 

As previously reported, SLP entered into:

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On September 26, 2013, the Company announced that it was withdrawing its proposed public offering of common stock, the proceeds of which would have been used to consummate the acquisition of these hotels.  On September 26, 2013 the Company notified the sellers of the hotels that it was terminating the purchase agreements pursuant to the terms of the agreements.  The Company received the return of $850,000 of escrowed funds in connection with the purchase terminations.

 

 

Liquidity

 

On September 26, 2013, based on market conditions, pricing expectations, and after discussions with the underwriters, the Company withdrew and terminated its previously announced proposed public offering of 16,700,000 shares of Common Stock.

 

The costs of this offering and its failure to be completed have had a severe impact on the Company’s liquidity.  The Company is exploring other methods to satisfy its liquidity needs, but to date has not been able to complete a transaction that will provide sufficient liquidity to satisfy its operating and capital needs for the next twelve months.  There can be no assurance that the Company will be able to obtain sufficient liquidity to continue to operate as it has in the past. Failure to obtain adequate liquidity may cause the Company to dispose of assets at unfavorable prices, delay or default in paying its obligations, seek legal protection while attempting to reorganize or cease operations entirely.  These conditions raise significant uncertainty about our ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 

As further disclosed in the Debt Financing footnote, the Company was not in compliance with certain covenants related to its loan facilities with GE Franchise Finance Commercial LLC. The Company received a waiver for non-compliance as of September 30, 2013. The Company does not currently project that it will be able to satisfy the after dividend FCCR requirement under the covenant and anticipates that it will not be compliant with respect to this covenant as of December 31, 2013. Further, if we fail to pay our indebtedness when due, fail to comply with covenants or otherwise default on our loans, unless waived, we could incur higher interest rates during the period of such loan defaults, be required to immediately pay our indebtedness and ultimately lose our hotels through lender foreclosure if we are unable to obtain alternative sources of financing with acceptable terms. Our loan facilities with Great Western and GE contain cross-default provisions which would allow Great Western Bank and GE to declare a default and accelerate our indebtedness to them if we default on our other loans, and such default would permit that lender to accelerate our indebtedness under any such loan.

 

Subsequent Events 

 

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Our loan facilities with GE Franchise Finance Commercial LLC require us to maintain a minimum before dividend consolidated fixed charge coverage ratio (FCCR) (as defined in the loan agreement) and a minimum after dividend consolidated FCCR (as defined in the loan agreement). As of September 30, 2013, our before dividend consolidated FCCR (as defined in the loan agreement) was 1.09:1 (versus the requirement of 1.10:1) and our after dividend consolidated FCCR (as defined in the loan agreement) was 0.84:1 (versus the requirement of 0.95:1). On November 13,  2013, the Company received a waiver for non-compliance with these covenants as of September 30, 2013 in return for payment of $190,000. In connection with the waiver, our loan facilities with GE were also amended to increase the minimum before dividend FCCR with respect to our GE-encumbered properties from 1.20:1 to 1.30:1, commencing on December 31, 2013, and decrease the maximum loan to value ratio with respect to our GE-encumbered properties from 75% to 72.2%, commencing on December 31, 2013. The covenant calculation currently stands at 72.2% as of September 30, 2013. The Company did not amend the covenant requirement related to the after dividend consolidated FCCR of 1.00:1 as of December 31, 2013. The Company does not currently project that it will be able to satisfy the after dividend FCCR requirement under the covenant and anticipates that it will not be compliant with this covenant as of December 31, 2013.