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SOHO > SEC Filings for SOHO > Form 10-Q on 8-May-2013All Recent SEC Filings

Show all filings for SOTHERLY HOTELS INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SOTHERLY HOTELS INC.


8-May-2013

Quarterly Report


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

Overview

We are a self-managed and self-administered lodging REIT incorporated in Maryland in August 2004 to pursue opportunities primarily in the full-service upper-upscale and upscale segments of the hotel industry located in primary and secondary markets in the Mid-Atlantic and Southern United States. We commenced operations in December 2004 when we completed our initial public offering (the "IPO") and thereafter consummated the acquisition of the initial properties.

Our hotel portfolio currently consists of eight full-service, upper-upscale and upscale hotels and one midscale hotel, collectively with 2,113 rooms which operate under well-known brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn. Substantially all of our assets are held by, and all of our operations are conducted through, our Operating Partnership. We also own a 25.0% indirect noncontrolling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with Carlyle. In total, our hotel portfolio contains 2,424 rooms. As of March 31, 2013, we owned the following hotel properties:

                                          Number
Property                                 of Rooms            Location         Date of Acquisition
Wholly-owned
Crowne Plaza Hampton Marina                    173      Hampton, VA           April 24, 2008
Crowne Plaza Jacksonville Riverfront           292      Jacksonville, FL      July 22, 2005
Crowne Plaza Tampa Westshore                   222      Tampa, FL             October 29, 2007
Doubletree by Hilton
Brownstone-University                          190      Raleigh, NC           December 21, 2004
Hilton Philadelphia Airport                    331      Philadelphia, PA      December 21, 2004
Hilton Savannah DeSoto                         246      Savannah, GA          December 21, 2004
Hilton Wilmington Riverside                    272      Wilmington, NC        December 21, 2004
Holiday Inn Laurel West                        207      Laurel, MD            December 21, 2004
Sheraton Louisville Riverside                  180      Jeffersonville, IN    September 20, 2006

                                             2,113
Joint Venture Property
Crowne Plaza Hollywood Beach Resort            311      Hollywood, FL         August 9, 2007

Total                                        2,424


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We conduct substantially all our business through our Operating Partnership. We are the sole general partner of our Operating Partnership, and we own an approximate 77.9% interest in our Operating Partnership, with the remaining interest being held by the contributors of our initial properties as limited partners.

To qualify as a REIT, we cannot operate hotels. Therefore, our Operating Partnership leases our wholly-owned hotel properties to MHI Hospitality TRS, LLC (our "TRS Lessee"), which then engages a hotel management company to operate the hotels under a management contract. Our TRS Lessee has engaged MHI Hotels Services to manage our hotels. Our TRS Lessee, and its parent, MHI Hospitality TRS Holding, Inc., are consolidated into our financial statements for accounting purposes. The earnings of MHI Hospitality TRS Holding, Inc. are subject to taxation similar to other C corporations.

Key Operating Metrics

In the hotel industry, most categories of operating costs, with the exception of franchise, management, credit card fees and the costs of the food and beverage served, do not vary directly with revenues. This aspect of our operating costs creates operating leverage, whereby changes in sales volume disproportionately impact operating results. Room revenue is the most important category of revenue and drives other revenue categories such as food, beverage and telephone. There are three key performance indicators used in the hotel industry to measure room revenues:

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

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

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

Results of Operations

The following table illustrates the actual key operating metrics for each of the
three months ended March 31, 2013 and 2012 for the properties we wholly-owned
during each respective reporting period.



                           Three months ended        Three months ended
                             March 31, 2013            March 31, 2012
            Occupancy %                   65.6 %                    66.1 %
            ADR           $             114.19      $             109.71
            RevPAR        $              74.93      $              72.52

Comparison of the Three Months Ended March 31, 2013 to the Three Months Ended March 31, 2012

Revenue. Total revenue for the three months ended March 31, 2013 increased approximately $0.2 million or 0.8% to approximately $20.2 million compared to total revenue of approximately $20.0 million for the three months ended March 31, 2012. Each of our properties experienced increases in revenue except our Savannah, Georgia, Jacksonville, Florida, Tampa, Florida and Hampton, Virginia properties.

Room revenue increased approximately $0.3 million or 2.2% to approximately $14.2 million for the three months ended March 31, 2013 compared to room revenue of approximately $13.9 million for the three months ended March 31, 2012. The increase in room revenue for the three months ended March 31, 2013 resulted from a 4.1% increase in ADR which was offset by a 0.7% decrease in occupancy as compared to the same period in 2012. Our property in Raleigh, North Carolina continues to experience a significant increase as a result of the rebranding to a DoubleTree by Hilton.

Food and beverage revenues decreased approximately $0.1 million or 2.9% to approximately $4.9 million for the three months ended March 31, 2013 compared to food and beverage revenues of approximately $5.0 million for the three months ended March 31, 2012. Decreases in food and beverage revenue at our properties in Tampa, Florida and Philadelphia, Pennsylvania were offset by increases in banqueting revenue at our property in Raleigh, North Carolina.

Revenue from other operating departments remained at approximately $1.1 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Hotel Operating Expenses. Hotel operating expenses, which consist of room expenses, food and beverage expenses, other direct expenses, indirect expenses and management fees, were approximately $15.2 million, a decrease of approximately $0.2 million or 1.6% for the three months ended March 31, 2013 compared to total hotel operating expenses of approximately $15.4 million for the three months ended March 31, 2012.

Rooms expense for the three months ended March 31, 2013 remained at approximately $4.0 million compared to rooms expense for the three months ended March 31, 2012. Cost control measures were responsible for limiting any increase for the period.

Food and beverage expenses for the three months ended March 31, 2013 decreased approximately $0.2 million or 5.1% to approximately $3.2 million compared to food and beverage expenses of approximately $3.4 million for the three months ended March 31,


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2012. Most of the decrease in food and beverage expense was directly related to the decrease in food and beverage revenues. Despite the decrease in food and beverage revenue, cost control measures enabled us to increase food and beverage margins from 32.0% to 33.5%.

Indirect expenses at our wholly-owned properties for the three months ended March 31, 2013 decreased approximately $0.1 million or 1.5% to approximately $7.8 million compared to indirect expenses of approximately $7.9 million for the three months ended March 31, 2012. While franchise fees increased directly in proportion to the increase in revenue, decreased energy and utility expenses due to lower energy prices and cost control measures contributed to the overall decrease in indirect expenses. Repairs and maintenance, insurance, real and personal property taxes as well as general and administrative costs at the property level are also included in indirect expenses.

Depreciation and Amortization. Depreciation and amortization expense for the three months ended March 31, 2013 decreased approximately $0.1 million or 5.8% to $2.1 million compared to depreciation and amortization of approximately $2.2 million for the three months ended March 31, 2012.

Corporate General and Administrative. Corporate general and administrative expenses for the three months ended March 31, 2013 remained constant at approximately $1.1 million compared to the three months ended March 31, 2012.

Interest Expense. Interest expense for the three months ended March 31, 2013 decreased approximately $0.6 million or 18.5% to approximately $2.7 million compared to interest expense of approximately $3.3 million for the three months ended March 31, 2012. Most of the decrease related to a lower effective interest rate on our outstanding debt due in substantial part to the retirement of approximately 45% of the outstanding Preferred Stock during the second quarter 2012. However, if not for the premium paid to redeem 1,902 shares of Preferred Stock in March 2013 of approximately $0.2 million and the write-off of unamortized issuance costs related to the redeemed shares of approximately $0.1 million and the write-off of unamortized loan costs in conjunction with the extinguishment of the credit facility in March 2012 of approximately $0.5 million, we would have experienced a reduction in interest expense of approximately $0.5 million.

Equity Income in Joint Venture. Equity income in joint venture for the three months ended March 31, 2013 represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. For the three months ended March 31, 2013, our 25.0% share of the net income of the hotel increased approximately $0.2 million or 76.7% to approximately $0.5 million compared to net income of approximately $0.3 million for the three months ended March 31, 2012. For the three months ended March 31, 2013, the hotel reported occupancy of 88.6%, ADR of $207.01 and RevPAR of $183.47. This compares with results reported by the hotel for the three months ended March 31, 2012 of occupancy of 87.5%, ADR of $178.52 and RevPAR of $156.25.

Unrealized Loss on Warrant Derivative. The Company recognized an unrealized loss of approximately $2.8 million on the value of the warrant derivative issued in April 2011 to the purchasers of Preferred Stock for the three months ended March 31, 2013 compared to an unrealized loss of approximately $1.2 million for the three months ended March 31, 2012. The unrealized losses are mostly attributable to the change in the market price of our common stock.

Income Taxes. The income tax provision for the three months ended March 31, 2013 increased approximately $0.2 million or 151.5% to approximately $0.3 million compared to an income tax provision of approximately $0.1 million for the three months ended March 31, 2012. The income tax provision is primarily derived from the operations of our TRS Lessee. Our TRS Lessee realized greater operating income for the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Net Loss Attributable to the Company. The net loss attributable to the Company for the three months ended March 31, 2013 increased approximately $0.3 million or 13.1% to approximately $2.6 million as compared to a net loss of approximately $2.3 million for the three months ended March 31, 2012 as a result of the operating results discussed above.

Funds From Operations

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


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Management believes that the use of FFO, combined with the required GAAP presentations, has improved the understanding of the operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be a useful measure of adjusted net income for reviewing comparative operating and financial performance. Management believes FFO is most directly comparable to net income (loss), which remains the primary measure of performance, because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO assists in comparing the operating performance of a company's real estate between periods or as compared to different companies. Although FFO is intended to be a REIT industry standard, other companies may not calculate FFO in the same manner as we do, and investors should not assume that FFO as reported by us is comparable to FFO as reported by other REITs.

The following table reconciles net loss to FFO for each of the three months ended March 31, 2013 and 2012 (unaudited):

                                              Three months ended             Three months ended
                                                March 31, 2013                 March 31, 2012
Net loss                                     $         (3,355,766 )         $         (2,980,344 )
Add depreciation and amortization                       2,052,821                      2,179,963
Add equity in depreciation of joint
venture                                                   135,101                        137,815

FFO                                          $         (1,167,844 )         $           (662,566 )

Weighted average shares outstanding                    10,080,375                      9,983,105
Weighted average units outstanding                      2,955,617                      2,984,839

Weighted average shares and units                      13,035,992                     12,967,944

FFO per share and unit                       $              (0.09 )         $              (0.05 )

Sources and Uses of Cash

Operating Activities. Our principal source of cash to meet our operating requirements, including distributions to unitholders and stockholders as well as debt service (excluding debt maturities), is the operations of our hotels. Cash flow provided by operating activities for the three months ended March 31, 2013 was approximately $2.2 million. We expect that the net cash provided by operations will be adequate to fund our continuing operations, monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt) and the payment of dividends in accordance with federal income tax laws which require us to make annual distributions to our stockholders of at least 90% of our REIT taxable income, excluding net capital gains.

Investing Activities. Approximately $1.1 million was spent during the three months ended March 31, 2013 on capital improvements and the replacement of furniture, fixtures and equipment.

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

Capital Expenditures

We anticipate that our need for recurring capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment over the next 12 to 24 months will approximate historical norms for our properties and the industry. Historically, we have aimed to maintain overall capital expenditures, except for those required by our franchisors as a condition to a franchise license or license renewal, at 4.0% of gross revenue.

We expect capital expenditures for the replacement or refurbishment of furniture, fixtures and equipment at our properties will be funded by our replacement reserve accounts, other than costs that we incur to make capital improvements required by our franchisors. Reserve accounts are escrowed accounts with funds deposited monthly and reserved for capital improvements or expenditures with respect to all of our hotels. We currently deposit an amount equal to 4.0% of gross revenue for the Hilton Savannah DeSoto, the Hilton Wilmington Riverside, the Crowne Plaza Hampton Marina and the Sheraton Louisville Riverside as well as 4.0% of room revenues for the Hilton Philadelphia Airport on a monthly basis.


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Liquidity and Capital Resources

As of March 31, 2013, we had cash and cash equivalents of approximately $10.3 million, of which approximately $3.1 million was in restricted reserve accounts and real estate tax escrows. We expect that our cash on hand combined with our cash flow from our hotels should be adequate to fund continuing operations, recurring capital expenditures for the refurbishment and replacement of furniture, fixtures and equipment, monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of a debt) and dividends on the Preferred Stock.

In March 2013, we entered into a First Amendment to the Loan Agreement and other amendments to secure additional proceeds on the original $8.0 million mortgage on the Doubletree by Hilton Brownstone-University hotel property with its existing lender. We used the net proceeds to redeem 1,902 shares of Preferred Stock for an aggregate redemption price of approximately $2.1 million plus the payment of related accrued and unpaid cash and stock dividends.

In June 2013, the mortgage on the Crowne Plaza Hampton Marina matures. We may be required to reduce the mortgage balance by an amount up to $1.0 million in order to secure an extension or to refinance the existing mortgage indebtedness with a different lender. Prior to May 31, 2013, when our ability to borrow under the Bridge Financing ends, we intend to draw upon the Bridge Financing as well as working capital to secure the extension or refinance.

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

We believe the recovering economy will provide opportunities to acquire properties at attractive prices. However, with the constraints of the covenants in our Preferred Stock instrument and Note Agreement, we have limited ability to incur additional debt in order to take advantage of such opportunities. Given the potential for attractive acquisitions emerging from the recent economic downturn, we intend to pursue additional and permissible joint venture transactions and equity or debt financing in the future to enable us to take advantage of such opportunities. However, should additional and permissible joint venture transactions and equity or debt financing not be available on acceptable terms, we may not be able to take advantage of such opportunities.

Beyond the funding of any required principal reduction on our existing indebtedness or acquisitions in the near-term, our medium and long-term capital needs will generally include the retirement of maturing mortgage debt, redemption of the Preferred Stock, repayment of draws under the Bridge Financing, if any, and obligations under our tax indemnity agreements, if any. We remain committed to maintaining a flexible capital structure. Accordingly, we expect to meet our long-term liquidity needs through a combination of some or all the following:

The issuance of additional shares of preferred stock;

The issuance of additional shares of our common stock;

The issuance of senior, unsecured debt;

The issuance of additional units in the Operating Partnership;

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

The selective disposition of core or non-core assets;

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

The issuance by the Operating Partnership and/or subsidiary entities of secured and unsecured debt securities to the extent permitted by our Preferred Stock instrument and Note Agreement.

Dividend Policy

In December 2008, in the interest of capital preservation and based on the expectation that the U.S. economy, and in particular the lodging industry, would continue to face declining operating trends through 2010, we amended our dividend policy and reduced the level of our cash dividend payments. Reducing and suspending our dividend during 2009 and 2010 did not jeopardize our REIT status as our 2009 distributions exceeded the minimum annual distribution requirement and operating losses in 2010 eliminated any distribution requirement for 2010.


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In July 2011, in part due to improving operating trends, we reevaluated our quarterly dividend policy and reinstated our quarterly common stock dividend (distribution). On July 18, 2011, we authorized the first payment of a quarterly dividend (distribution) of $0.02 per common share (and unit) to our stockholders (and unitholders of MHI Hospitality, L.P.) of record as of September 15, 2011 which was paid on October 11, 2011. Dividends (distributions) have been declared in each subsequent quarterly period. In July 2012, we authorized an increase in the quarterly dividend (distribution) to $0.03 per common share (and unit). In January 2013, we authorized another increase in the quarterly dividend (distribution) to $0.035 per common share (and unit).

Our ability to make common stock distributions is constrained by the terms of the Preferred Stock instrument and the Note Agreement. The Preferred Stock instrument and the Note Agreement permit us to pay a dividend on our common stock subject to certain requirements, including liquidity thresholds. At present, we meet and exceed these requirements to pay a dividend on our common stock in an amount minimally necessary in order to maintain our status as a REIT. The Preferred Stock instrument requires a minimum liquidity position of $7.5 million as a condition to payment of a dividend on common stock. The Note Agreement further provides that we may make additional dividend distributions if we have, and will have after giving effect to such distributions, at least $10.0 million in total cash or cash equivalents. Up to $5.0 million in undrawn commitments under the Note Agreement may be included in calculating the liquidity requirements under the Preferred Stock instrument and the Note Agreement.

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

The holders of the Preferred Stock have a right to payment of a cumulative dividend payable quarterly (i) in cash at an annual rate of 10.0% of the liquidation preference per share and (ii) in additional shares of the preferred stock at an annual rate of 2.0% of the $1,000 liquidation preference per share.

Off-Balance Sheet Arrangements

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

The property is currently encumbered by a $32.6 million mortgage which matures in August 2014, requires monthly payments of interest at a rate of LIBOR plus additional interest of 1.94% and requires annual principal payments of $0.5 million. In conjunction with the loan, the joint venture executed an interest-rate swap with a notional amount and maturity tied to the projected outstanding balance and maturity date of the loan. The Crowne Plaza Hollywood Beach Resort secures the mortgage.

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

Inflation

We generate revenues primarily from lease payments from our TRS Lessee and net income from the operations of our TRS Lessee. Therefore, we rely primarily on the performance of the individual properties and the ability of the management . . .

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