(Mark One)

 

 

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 ☒    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  ☒    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 ☒



As of October 27,  2014, there were 4,692,965 shares of common stock, par value $.01 per share, outstanding.

---

 

SUPERTEL HOSPITALITY, INC. AND SUBSIDIARIES

 

TABLE OF CONTENTS

 

 

 

 

 

 

---

 

     

 

 

 

 

 

---

 

 

 

 

---

 

 

 

 

 

 

 

 

 

 

 

 

 

 

---

 

General

 

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”). The Company owns 59 properties as follows:

 

SHI, through Supertel Hospitality REIT Trust, is the sole general partner in SLP and at September 30, 2014 owned approximately 99% of the partnership interests in SLP.  SLP is the general partner in SBILP.  At September 30,  2014,  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), BMI Alexandria Holdings, Inc. (BAHI) 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,  2014, the Company owned 59 limited service hotels, 47 of which are included in continuing operations.  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”) and Cherry Cove Hospitality Management, LLC (“Cherry Cove”). 

 

HMA manages 17 Company hotels in Arkansas, Louisiana, Kentucky, Indiana, Virginia and Florida.  Strand manages the Company’s five 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 23 Company hotels in seven 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, 2015, 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.

 

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 and employee bonuses, and personal and real property taxes).

 

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 hotel located in Florida, which experiences peak demand in the first and fourth quarters of the year.

 

Consolidated Financial Statements

 

The Company has prepared the condensed consolidated balance sheet as of September 30,  2014, the condensed consolidated statements of operations for the three and nine months ended September 30,  2014 and 2013, and the condensed consolidated statements of cash flows for the nine months ended September 30,  2014 and 2013 without audit, in conformity with U. S. generally accepted accounting principles (GAAP).  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,  2014 and the results of operations and cash flows for all periods presented.  Balance sheet data as of December 31, 2013 has been derived from the audited consolidated financial statements as of that date. The preparation of financial statements in conformity with 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. GAAP, 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 and 10-K/A for the year ended December 31, 2013.  The results of operations for the three and nine months ended September 30,  2014 are not necessarily indicative of the operating results for the full year.

 

Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board  (FASB) issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. The new standard is effective for the Company on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU No. 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

 

In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." The amendments in ASU 2014-08 change the criteria for reporting a discontinued operation and require new disclosures of both discontinued operations and certain other significant disposals that do not meet the definition of a discontinued operation. Only disposals representing a strategic shift in operations that has a major effect on an entity’s operations and financial results should be presented as discontinued operations.  This accounting standard update is effective for annual filings beginning on or after December 15, 2014. Early adoption is permitted only for disposals that have not been previously reported. The Company adopted the pronouncement on October 1, 2014. As a result of the early adoption of ASU Update No. 2014-08, we anticipate that most of our hotel dispositions not already shown as discontinued operations will not be classified as discontinued operations as most will not fit this description.

 

For transactions that have been classified as discontinued operations for periods prior to our adoption of ASU Update No. 2014-08, we will continue to present the operating results as discontinued operations in the

---

 

statements of operations for all applicable periods presented, subject to management’s quarterly review of the criteria for such classifications.

 

Derivative Liabilities 

 

Series C Convertible Preferred Stock and Warrants

 

The conversion feature embedded in the Series C convertible preferred 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 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,  2014 and December 31, 2013. As a result of a subscription rights offering by the Company which concluded on June 6, 2014, the conversion price of the Series C convertible stock, pursuant to its terms, was adjusted to $1.60, the exercise price of the subscription rights for a share of common stock. The antidilution provision continues to be in effect, and treatment of the embedded conversion feature as a derivative liability remains unchanged.

 

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 warrants’ 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,  2014 and December 31, 2013. As a result of a subscription rights offering by the Company which concluded on June 6, 2014, the exercise price of the warrants for a share of common stock was adjusted to $1.92,  equal to 120% of the adjusted conversion price of the Series C convertible preferred stock. The antidilution provision remains in effect, and treatment of the warrants as a derivative liability remains unchanged.

 

Convertible Loan

 

On January 9, 2014, we entered into an unsecured convertible loan agreement with Real Estate Strategies, L.P. (“RES”), for a revolving line of credit of up to $2.0 million with an annual interest rate equal to LIBOR plus 7%. During the first quarter, the Company borrowed the full amount of $2.0 million available under the loan agreement. RES, pursuant to rights under the loan, applied the loan amount to purchase 1,250,000 shares of common stock on June 6, 2014, from the Company in the subscription rights offering at a rate per share of $1.60.

 

---

 

The Company analyzed the conversion options for derivative accounting consideration under ASC 815-15 “Derivatives and Hedging” and determined that the conversion feature should be bifurcated from its host instrument and accounted for as a freestanding derivative liability due to there being no explicit limit to the number of shares to be delivered upon settlement of the above conversion options.

 

The initial fair value of the conversion feature was determined to be $150,538 and was recorded as a derivative liability with the offset recorded as a debt discount against the $2.0 million convertible loan. Embedded derivatives are to be recorded at fair value each period with the changes in value recorded to earnings. The $2.0 million loan was converted and used by RES to purchase 1,250,000 shares of common stock from the Company in the subscription rights offering. On June 11, 2014, the effective purchase date, $1,950,000, the fair value of the shares issued, was recorded in equity, and a gain of $88,000 was recorded in other income to reflect the change in fair value from March 31, 2014 to the date of conversion of the convertible loan, amortized debt discount, and the separately accounted for embedded derivative. Amortization of $38,000 of the initial debt discount of $150,538 was determined using the straight line method, which approximates the effective interest method, and was reflected in interest expense.  The amortization expense was calculated through the date of conversion.  In addition $11,267 of loan expense which was shown in the balance sheet as deferred financing was released and reflected in loss on debt extinguishment upon conversion in the statement of earnings.

 

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 hotels, and the disclosure of the fair value of our debt.

 

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability. Level 2 inputs may include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, as well as inputs other than quoted prices that are observable for the asset or liability such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 nonfinancial 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 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.

 

Nonfinancial assets

 

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

 

 

---

 

Financial instruments

 

As of September 30,  2014 and December 31, 2013, the fair value of the Series C convertible embedded derivative and the warrant derivative were 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,  2014 and December 31, 2013 are as follows (in thousands):

 

 

There were no transfers between levels during the nine months ended September 30,  2014 and the twelve months ended December 31, 2013.

 

The following table presents 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 Derivative gain  (loss) for each of the three and nine months ended September 30, 2014 (in thousands):

---

 

 

 

---

 

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,  2014 and December 31, 2013 are presented in the table below (in thousands):

 

 

 

 

Discontinued Operations - Hotel Properties Held for Sale and Sold

 

At December 31, 2013, the Company had 19 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, 2014,  ten of these hotels were sold. We recorded an approximate $2.7 million aggregate net gain on four of the

---

 

hotels sold. The gain consisted of: $0.5 million from the sale of two hotels in the second quarter of 2014; $1.2 million from the sale of a Super 8 in Moberly, Missouri; and $1.0 million from the sale of a Super 8 in Omaha, Nebraska (“M” Street), both in the third quarter of 2014.  We recorded either impairment or impairment recovery on the other six hotels sold as described below in the note “Impairment Losses”. Due to changes in the market during the first quarter, one hotel was reclassified as held for sale, and an additional hotel was reclassified from held for sale to held for use. During the second quarter, three hotels were reclassified as held for sale due to changes in the market. Twelve hotels remain classified as held for sale as of September 30,  2014. 

 

A REIT will incur a 100% tax on the net gain 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.

 

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,  2014 include 12 hotels held for sale and four hotels that were sold in the third quarter of 2014.  The operating results for the three months ended September 30,  2013 include 12 hotels held for sale, ten hotels sold in 2014, and seven hotels sold in the third and fourth quarters of 2013.

 

The operating results for the nine months ended September 30, 2014 include 12 hotels held for sale and ten hotels sold in 2014. The operating results for the nine months ended September 30, 2013 include 12 hotels held for sale, 17 hotels sold in 2013, and ten hotels sold in 2014 (in thousands): 

 

 

 

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 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 derivative liabilities (related to the Series C convertible preferred stock and warrants, and the convertible loan) during the period the convertible securities are dilutive. The computation of basic and diluted earnings per common share is presented below:

 

---

 

 

Potentially dilutive common shares, if any, have been excluded from the denominator if they are antidilutive to earnings (loss) from continuing operations attributable to common shareholders. The number of weighted average shares of common stock for the three and nine months ended September 30, 2014 is significantly higher than the outstanding shares at September 30, 2013  due to the issuance of common stock from the rights offering occurring during the last month of the second quarter of 2014.

 

---

 

The following table summarizes the weighted average 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,  2014 is as follows (dollars in thousands):

 

---

 

 

 

On January 9, 2014, the Company entered into an unsecured convertible loan agreement with RES, whereby the Company may borrow up to $2.0 million from time to time in revolving loans, subject to the conditions therein. During the first quarter, the Company borrowed the full amount of $2.0 million available under the loan agreement.  On June 11, 2014, the effective purchase date, the loan was converted and used to purchase 1,250,000 shares of common stock in a subscription rights offering by the Company.  See “Convertible Loan” above.    Per the loan agreement the annual interest rate increased from variable at LIBOR plus 700 basis points to a 12.5% fixed rate back to the origination date of the loan because the subscription rights offering was not completed by April 15, 2014.

 

On March 10, 2014 the Company sold a Super 8 in Shawano, Wisconsin (55 rooms) for gross sale proceeds of $1.1 million. Net proceeds were used to pay off the associated loan and reduce the balance of the revolving credit facility with Great Western Bank.

 

On March 14, 2014, the Company received a waiver from GE Franchise Finance Commercial LLC (“GE”) for non-compliance with covenants, as formulated at that time, with respect to our before dividend fixed charge coverage ratio (FCCR) covenant with respect to our GE-encumbered properties (actual of 1.25:1 versus requirement of 1.30:1), our before dividend consolidated FCCR covenant (actual of 0.98:1 versus requirement of 1.20:1), and our after dividend consolidated FCCR covenant (actual of 0.84:1 versus requirement of 1.00:1) in each case, as of March 31, 2014.

 

The financial covenants under our loan facilities with GE require that, through the term of the loans, we maintain: (a) a minimum before dividend FCCR with respect to our GE-encumbered properties (based on a rolling 12-month period) of 1.15:1 as of September 30, 2014, which requirement increases to 1.20:1 as of December 31, 2014; (b) a maximum loan to value ratio with respect to our GE-encumbered properties of 70% as of September 30, 2014, which requirement decreases to 60% as of December 31, 2014; (c) a minimum before dividend consolidated FCCR (based on a rolling 12-month period) of 0.75:1 as of September 30, 2014, which requirement increases to 1.00:1 as of December 31, 2014; and (d) a minimum after dividend consolidated FCCR (based on a rolling 12-month period) of 0.70:1 as of September 30, 2014, which requirement increases to 1.00:1 as of December 31, 2014.

 

The consolidated FCCRs are not required to be tested as of the end of any fiscal quarter if the loan to value ratio with respect to our GE-encumbered properties is 60% or less. The required payment of a  $380,000 modification fee for amendments to our loan facilities with GE in connection with the waiver we received on March 14, 2014 was paid on June 27, 2014.

 

On April 24, 2014, the Company sold a Baymont Inn in Brooks, Kentucky (65 rooms) for gross sale proceeds of $1.7 million.  Net proceeds were used to pay down debt with GE.

 

On May 6, 2014, the Company sold a Super 8 in Omaha, Nebraska (West Dodge) (101 rooms) for gross sale proceeds of $1.6 million.  Net proceeds were used to pay down the associated term loan with Great Western Bank.

 

On June 4, 2014, the Company sold a Super 8 in Boise, Idaho  (108 rooms) for gross sale proceeds of $2.8 million.  Net proceeds were used to pay down the associated debt with GE.

 

On June 11, 2014, the Company sold a Super 8 in Clarinda, Iowa (40 rooms) for gross sale proceeds of $1.7 million.  Net proceeds were used to pay down the associated debt with Great Western Bank.

 

On June 23, 2014, the Company sold a Super 8 in Norfolk, Nebraska (64 rooms) for gross sale proceeds of $1.4 million.  Net proceeds were used to pay down the associated debt with First State Bank.

---

 

 

On July 15, 2014, the Company sold a Savannah Suites in Jonesboro, Georgia (172 rooms) for gross sale proceeds of $1.4 million. Net proceeds were used to pay down debt with GE.

 

On August 1, 2014, our credit facilities with Great Western Bank were amended to, among other things, extend the maturity date of the revolving credit facility from August 30, 2014 to June 30, 2015, reduce the interest rate on the revolving credit facility from 4.95% to 4.50% and provide for the application of net proceeds of certain hotels to the loans under the credit facilities.

 

On August 21, 2014, the Company sold a Savannah Suites in Stone Mountain, Georgia (140 rooms) for gross sale proceeds of $1.5 million. Net proceeds were used to pay down debt with GE.

 

On September 19, 2014, the Company sold a Super 8 in Moberly, Missouri (60 rooms) for $1.7 million.  Net proceeds were used to pay down the associated debt with Great Western Bank.

 

On September 30, 2014, the Company sold a Super 8 in Omaha, Nebraska (“M” Street) (116 rooms) for gross sale proceeds of $1.9 million. Net proceeds were used to pay down the associated debt with Great Western Bank.

 

At September 30, 2014, the Company had long-term debt of $81.0 million associated with assets held for use, consisting of notes and mortgages payable, with a weighted average term to maturity of 2.2 years and a weighted average interest rate of 6.4%. The weighted average fixed rate was 6.5%, and the weighted average variable rate was 3.7%. 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 in the table below as 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 2014 and thereafter, and debt associated with assets held for sale, are as follows (in thousands):

 

At September 30, 2014, the Company had $16.9 million of principal due in 2014; of that amount, $16.2 million is related to the debt associated with assets held for sale. Included in the $16.2 million is the $14.2 million of GE debt maturing in December of 2014. The approximate $0.7 million classified as held for use in the table above is the principal amortization on mortgage loans for the remainder of 2014.

 

On October 18, 2014, the Company agreed to sell four hotels which collateralize borrowings from GE for a total purchase price of $15.15 million.  All of the GE loans are cross collateralized and the 17 assets securing the loans outstanding at September 30, 2014 are treated as a pool. If the four assets currently under contract are sold, the Company believes that the net proceeds from the sale of these hotels will be sufficient to satisfy the debt with GE that matures in December 2014. The sale is subject to the completion of a contingency period for inspections and

---

 

investigations of the hotels.  If the hotels are not sold, the Company will attempt to extend or refinance this debt with GE or some other lender. If we are unable to extend or refinance this GE debt, we may be forced to sell the hotels on disadvantageous terms, or we could be compelled to file for reorganization.

 

We are required to comply with certain financial covenants for some of our lenders.  As of September 30,  2014, we were either in compliance with our financial covenants or obtained waivers for non-compliance (as discussed below). As a result, we are not in default of any of our loans.    

 

Our credit facilities with Great Western Bank require us to maintain a consolidated leverage ratio (as defined in the loan agreement) of 4.25:1 or less. As of September 30, 2014, our consolidated leverage ratio (as defined in the loan agreement) was 4.30:1. On November 12, 2014, the Company received a waiver for non-compliance with this covenant as of September 30, 2014.  The Company currently anticipates that it will not be compliant with respect to this covenant as of December 31, 2014. In the event the Company is not in compliance with this covenant, the Company will seek a waiver from the lender. Although the Company has received waivers from lenders in the past with respect to covenants, there is no assurance that the Company would be successful in obtaining waivers in the future.

 

Stock-Based Compensation

 

Non Vested Share Awards

 

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 2,084 and 3,125 unvested awards as of September 30, 2014 and 2013, respectively. 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

 

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 quarterly 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 number of shares issued to the committee members for the three months ended September 30, 2014 and 2013 were 2,988 and 747, respectively. A total of 6,723 and 1,494 shares were issued to the committee members for the first three quarters of 2014 and 2013, respectively.  

 

Share-Based Compensation Expense

 

The expense recognized in the condensed consolidated financial statements for the three months ended September 30,  2014 and 2013 for share-based compensation related to employees and directors was approximately $6,000 and $12,000, respectively. The expense recognized for the nine months ended September 30, 2014 and 2013 was approximately $25,000 and $35,000, 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 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:

 

 

During the three and nine months ended September 30, 2014, no trigger events as described in ASC 360-10-35 occurred for any of our held for use hotels. The Company did record $0.1 million of recovery of previously recorded impairment loss on one hotel that was moved from held for sale to held for use at the end of the first quarter of 2014.    

 

 During the three and nine months ended September 30, 2013, impairment of $0.2 million was recorded on one hotel reclassified as held for use in the fourth quarter of 2013. No trigger events as described in ASC 360-10-35 occurred for any of our held for use hotels. 

 

Held for sale

 

During the three months ended September 30, 2014, Level 3 inputs were used to determine non-cash impairment losses of $1.0 million on six hotels held for sale. Negligible recovery of previously recorded impairment loss was taken on two hotels at the time of sale. During the nine months ended September 30, 2014, Level 3 inputs were used to determine non-cash impairment losses of $2.0 million on six hotels held for sale. The Company recorded $0.4 million of recovery on previously recorded impairment on one hotel held for sale. Impairment of $0.3 million was taken on three properties sold, and recovery of previously recorded impairment of $0.4 million was taken on three properties sold.

 

During the three months ended September 30, 2013, impairment of $0.2 million was taken on a hotel held for sale. There was negligible impairment of one property sold and recovery of $0.1 million on four properties sold.  During the nine months ended September 30, 2013, Level 3 inputs were used to determine non-cash impairment losses of $0.7 million on one property held for sale and $1.0 million on eight properties sold. Recovery of $0.2 million was taken on five properties sold.

 

---

 

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

We have provided a full valuation allowance against our deferred tax asset at September 30, 2014 and 2013, that results in no net deferred tax asset at September 30, 2014 and 2013 due to the uncertainty of realization (because of historical operating losses). The TRS Lessee has estimated its income tax benefit using a combined federal and state rate of approximately 38%.  The TRS net operating loss carryforward from September 30, 2014 as determined for federal income tax purposes was approximately $19.8 million. The availability of such loss carryforward will begin to expire in 2022.

The Company is currently evaluating the impact, if any, of its recently completed subscription rights offering to potentially limit its ability to fully utilize all of the net operating loss carryforwards.

 

Noncontrolling Interest of Common Units in SLP

 

As of September 30, 2014 and 2013, the limited partners of SLP held 97,008 common operating units, representing approximately 1.0% of the partnership interest in SLP.

 

Equity Reconciliation of Parent and Noncontrolling Interest

 

 

 

 

Subscription Rights Offering

 

The Company concluded a subscription rights offering on June 6, 2014.  Each subscription right entitled its holder to purchase one share of common stock of the Company for $1.60 per share.  Subscription rights to purchase 

---

 

1,787,204 shares of common stock were exercised for $2,859,526, of which $2,000,000 was paid by conversion of a loan owed by the Company to RES.  The Company incurred issuance costs of $217,852.

 

Series B Redeemable Preferred Stock

 

At September 30,  2014 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. Commencing with dividends due on December 31, 2013, the Company suspended payment of dividends on its Series B preferred stock to preserve capital and improve liquidity. Accrued but unpaid dividends on the Series B preferred stock will not bear interest. Accumulated but undeclared dividends are $831,232, or $2.50 per share as of September 30, 2014. Holders of the Series B preferred stock generally have no voting rights. However, if the dividends on the Series B preferred stock are in arrears for six or more quarterly periods (whether or not consecutive), holders of the Series B preferred stock, voting together as a single class with all series of preferred stock for which like voting rights are exercisable, will be entitled to elect two directors. The terms of such directors will end up to twelve months after all dividend arrearages have been paid. 

 

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 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,  2014, 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,  2014, 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 or from time to time for cash at a redemption price of $10.00 per share, plus all accrued and unpaid dividends. Commencing with dividends due on December 31, 2013, the Company suspended payment of dividends on its Series A preferred stock to preserve capital and improve liquidity. Unpaid dividends will accumulate and bear additional dividends at 8%, compounded monthly. Accumulated but undeclared dividends are $551,874, or $0.687 per share, as of September 30, 2014. Holders of the Series A preferred stock generally have no voting rights. However, if dividends on the Series A preferred stock are in arrears for six consecutive months or nine months (whether or not consecutive) in any twelve-month period, holders of the Series A preferred stock, voting together as a single class with all series of preferred stock for which like voting rights are exercisable, will be entitled to elect two directors. The terms of such directors will end up to twelve months after all dividend arrearages have been paid. 

 

The Series A preferred stock with respect to dividend rights and rights upon the Company’s liquidation, dissolution or winding up, ranks senior to all classes or series of the Company’s common stock, senior or on parity with all other classes or series of preferred stock and junior to all of the Company’s existing and future indebtedness. Upon liquidation all Series A preferred stock will be entitled to $10.00 per share plus accumulated but undeclared dividends. The Company will not pay any distribution, 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 outstanding preferred shares do not have any maturity date, and are not subject to mandatory redemption.

 

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 A preferred stock has no stated maturity and is not subject to any sinking fund or mandatory redemption.

 

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 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, shares of common stock of Supertel which may be issued upon conversion of the Series C convertible preferred stock, and warrants to purchase additional 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 shares of common stock. 

 

Each of the 3,000,000 shares of Series C convertible preferred stock is convertible, in whole or in part, at RES’s option, at any time, but subject to RES’s beneficial ownership limitation, into the number of shares of common stock equal to the $10.00 per share liquidation preference, divided by the conversion price then in effect.  As a result of the subscription rights offering concluded on June 6, 2014, the conversion price was adjusted downward from $8.00 to $1.60, equal to the public offering price of our common stock in the subscription rights offering. Pursuant to the terms of warrants held by RES to purchase up to 3,750,000 shares of common stock, the exercise price of the warrants was adjusted downward from $9.60 to $1.92 per share, equal to 120% of the adjusted conversion price of the Series C convertible preferred stock.    

 

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. Commencing with dividends due on December 31, 2013, the Company suspended payment of dividends on its Series C cumulative preferred stock to preserve capital and improve liquidity. Unpaid dividends will accumulate and bear additional dividends at 6.25%, compounded quarterly. Accumulated but undeclared dividends are $1,919,405, or $0.64 per share, as of September 30, 2014.

 

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 $1.60 for each share of common stock, which is equal to the rate of 6.25 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.

 

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 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. 

 

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”):  

 

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.

 

A lawsuit has been filed against the Company in Muscogee County Superior Court in Columbus, Georgia by a plaintiff on October 22, 2013. The plaintiff is alleging injury from an altercation with an employee at the Columbus, Georgia Super 8.  The plaintiff is seeking to recover for damages arising out of physical and mental injury, lost wages, pain and suffering, past and future medical expenses and punitive or exemplary damages.

---

 

 

On October 21, 2014, the Company reached an agreement to settle the claim. The settlement was made with authorization from the insurers, and the Company has recorded a liability for the amount of the unpaid claim and a receivable reflecting recoverability of the claim from the insurers.

 

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, including those discussed in the following paragraph, 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 a covenant related to its credit facilities with Great Western Bank as of September 30, 2014. The Company received a waiver for non-compliance as of September 30, 2014. The Company currently anticipates that it will not be compliant with respect to this covenant as of December 31, 2014. In the event the Company is not in compliance with this covenant, the Company will seek a waiver from the lender. Although the Company has received waivers from lenders in the past with respect to covenants, there is no assurance that the Company would be successful in obtaining waivers in the future.

 

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 facilities with Great Western Bank 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

 

On October 15, 2014, we sold a Days Inn in Sioux Falls, South Dakota (Empire) (79 rooms) for gross sale proceeds of $2.4 million. Net proceeds were used to reduce debt with GE.

 

On October 17, 2014, we sold an unencumbered Days Inn in Shreveport, Louisiana (148 rooms) for gross sale proceeds of $1.3 million. Net proceeds were used to reduce the balance of the revolving credit facility with Great Western Bank.

 

On October 18, 2014, the Company agreed to sell four hotels which collateralize borrowings from GE for a total purchase price of $15.15 million.  All of the GE loans are cross collateralized and the 17 assets securing the loans outstanding at September 30, 2014 are treated as a pool. If the four assets currently under contract are sold, the Company believes that the net proceeds from the sale of these hotels will be sufficient to satisfy the debt with GE

---

 

that matures in December 2014. The sale is subject to the completion of a contingency period for inspections and investigations of the hotels.  If the hotels are not sold, the Company will attempt to extend or refinance this debt with GE or some other lender. If we are unable to extend or refinance this GE debt, we may be forced to sell the hotels on disadvantageous terms, or we could be compelled to file for reorganization.

 

On November 6, 2014, we sold a Super 8 in Terre Haute, Indiana (117 rooms) for gross sale proceeds of $1.9 million. Net proceeds were used to reduce the debt with GE.

 

Our credit facilities with Great Western Bank require us to maintain a consolidated leverage ratio (as defined in the loan agreement) of 4.25:1 or less. As of September 30, 2014, our consolidated leverage ratio (as defined in the loan agreement) was 4.30:1. On November 12, 2014, the Company received a waiver for non-compliance with this covenant as of September 30, 2014. The Company currently anticipates that it will not be compliant with respect to this covenant as of December 31, 2014.  In the event the Company is not in compliance with this covenant, the Company will seek a waiver from the lender.  Although the Company has received waivers from lenders in the past with respect to covenants, there is no assurance that the Company would be successful in obtaining waivers in the future.