Sotherly Hotels Inc. - Quarter Report: 2014 June (Form 10-Q)

Large Accelerated Filer

Accelerated Filer

Non-accelerated Filer

Smaller Reporting Company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2014

SOTHERLY HOTELS INC.

(Exact name of registrant as specified in its charter)

MARYLAND

001-32379

20-1531029

(State or Other Jurisdiction of

Incorporation or Organization)

(Commission

File Number)

(I.R.S. Employer

Identification No.)

SOTHERLY HOTELS LP

(Exact name of registrant as specified in its charter)

DELAWARE

001-36091

20-1965427

(State or Other Jurisdiction of

Incorporation or Organization)

(Commission

File Number)

(I.R.S. Employer

Identification No.)

410 West Francis Street

Williamsburg, Virginia 23185

(757) 229-5648

(Address and Telephone Number of Principal Executive Offices)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 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.)

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

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

Sotherly Hotels Inc.

Sotherly Hotels LP

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

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

As of August 6, 2014, there were 10,353,677 shares of Sotherly Hotels Inc.’s common stock issued and outstanding.

EXPLANATORY NOTE

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

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

This report combines the Quarterly Reports on Form 10-Q for the period ended June 30, 2014 of the Company and the Operating Partnership. We believe combining the quarterly reports into this single report results in the following benefits:

•

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

•

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

•

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

•

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

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

•

Consolidated Financial Statements;

•

the following Notes to Consolidated Financial Statements:

•

Note 8 – Equity; and

•

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

•

Item 4 - Controls and Procedures; and

•

Item 6 - Certifications of CEO and CFO Pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act.

SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

INDEX


		Page
PART I
Item 1.	Financial Statements		4
	Sotherly Hotels Inc.		4
	Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013		4
	Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2014 and 2013		5
	Consolidated Statement of Changes in Equity (unaudited) for the Six Months Ended June 30, 2014		6
	Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2014 and 2013		7
	Sotherly Hotels LP		8
	Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013		8
	Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2014 and 2013		9
	Consolidated Statement of Changes in Partners’ Capital (unaudited) for the Six Months Ended June 30, 2014		10
	Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2014 and 2013		11
	Notes to Consolidated Financial Statements		12
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		40
Item 4.	Controls and Procedures		41

PART II
Item 1.	Legal Proceedings		42
Item 1A.	Risk Factors		42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		42
Item 3.	Defaults Upon Senior Securities		42
Item 4.	Mine Safety Disclosures		42
Item 5.	Other Information		42
Item 6.	Exhibits		42

PART I

Item 1.

Financial Statements

SOTHERLY HOTELS INC.

CONSOLIDATED BALANCE SHEETS


	*June 30, 2014*			*December 31, 2013*
	*(unaudited)*
*ASSETS*
Investment in hotel properties, net	$	261,179,261		$	202,645,633
Investment in joint venture		2,101,007			2,446,039
Cash and cash equivalents		17,925,684			9,376,628
Restricted cash		6,363,682			3,796,141
Accounts receivable, net		4,221,989			1,982,091
Accounts receivable-affiliate		87,868			101,439
Prepaid expenses, inventory and other assets		3,258,668			2,444,975
Shell Island sublease, net		120,098			240,196
Deferred income taxes		1,493,367			1,186,122
Deferred financing costs, net		4,645,543			3,820,838

*TOTAL ASSETS*	$	*301,397,167*		$	*228,040,102*

*LIABILITIES*
Mortgage loans	$	204,751,451		$	160,363,549
Bridge loan		19,000,000			—
Unsecured notes		27,600,000			27,600,000
Accounts payable and accrued liabilities		13,903,321			7,650,219
Advance deposits		1,570,393			666,758
Dividends and distributions payable		655,390			588,197

*TOTAL LIABILITIES*		267,480,555			196,868,723
Commitments and contingencies (see Note 7)
*EQUITY*
Sotherly Hotels Inc. stockholders’ equity
Preferred stock, par value $0.01, 1,000,000 shares authorized, 0 shares issued and outstanding		—			—
Common stock, par value $0.01, 49,000,000 shares authorized, 10,353,677 shares and 10,206,927 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively		103,537			102,069
Additional paid in capital		58,025,483			57,534,113
Distributions in excess of retained earnings		(30,239,875	)		(32,210,917	)

Total Sotherly Hotels Inc. stockholders’ equity		27,889,145			25,425,265
Noncontrolling interest		6,027,467			5,746,114

*TOTAL EQUITY*		33,916,612			31,171,379

*TOTAL LIABILITIES AND EQUITY*	$	*301,397,167*		$	*228,040,102*

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

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

REVENUE

Rooms department

25,416,248

18,152,020

42,869,437

32,401,979

Food and beverage department

9,020,055

5,974,795

15,271,738

10,826,366

Other operating departments

1,903,398

1,123,828

3,208,915

2,212,109

Total revenue

36,339,701

25,250,643

61,350,090

45,440,454

EXPENSES

Hotel operating expenses

Rooms department

6,278,583

4,563,463

11,030,109

8,577,196

Food and beverage department

5,936,451

3,690,911

10,006,821

6,915,391

Other operating departments

335,502

119,350

537,008

226,025

Indirect

12,189,910

8,756,559

21,673,784

16,571,618

Total hotel operating expenses

24,740,446

17,130,283

43,247,722

32,290,230

Depreciation and amortization

2,988,968

2,031,050

5,423,296

4,083,871

Corporate general and administrative

1,391,206

1,123,684

2,698,997

2,217,471

Total operating expenses

29,120,620

20,285,017

51,370,015

38,591,572

NET OPERATING INCOME

7,219,081

4,965,626

9,980,075

6,848,882

Other income (expense)

Interest expense

(3,925,428

)

(2,332,644

)

(6,808,867

)

(5,013,191

)

Interest income

5,267

3,654

7,156

7,559

Equity income in joint venture

17,417

87,377

404,968

557,116

Unrealized gain (loss) on warrant derivative

—

88,855

—

(2,680,210

)

Net income (loss) before income taxes

3,316,337

2,812,868

3,583,332

(279,844

)

Income tax benefit (provision)

(563,782

)

(1,111,818

)

171,537

(1,374,873

)

Net income (loss)

2,752,555

1,701,050

3,754,869

(1,654,717

)

Add: Net (income) loss attributable to the noncontrolling interest

(585,866

)

(390,458

)

(805,178

)

370,392

NET INCOME (LOSS) ATTRIBUTABLE TO THE COMPANY

2,166,689

1,310,592

2,949,691

(1,284,325

)

Net income (loss) per share attributable to the Company

Basic

0.21

0.13

0.29

(0.13

)

Diluted

0.21

0.12

0.29

(0.13

)

Weighted average number of shares outstanding

Basic

10,353,677

10,156,927

10,290,047

10,118,862

Diluted

10,353,677

11,132,542

10,290,047

10,118,862

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

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(unaudited)

Common Stock

Additional
Paid-
In Capital

Distributions
in Excess of
Retained Earnings

Noncontrolling
Interest

Total

Shares

Par Value

Balances at December 31, 2013

10,206,927

102,069

57,534,113

(32,210,917

)

5,746,114

31,171,379

Issuance of unrestricted common stock awards

24,750

248

147,112

—

147,360

Issuance of restricted common stock awards

12,000

120

78,165

—

78,285

Conversion of units into common stock

110,000

1,100

256,133

—

(257,233

)

—

Amortization of restricted stock award

—

9,960

—

9,960

Dividends and distributions declared

—

(978,649

)

(266,592

)

(1,245,241

)

Net income

—

2,949,691

805,178

3,754,869

Balances at June 30, 2014

10,353,677

103,537

58,025,483

(30,239,875

)

6,027,467

33,916,612

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

SOTHERLY HOTELS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	*Six months ended* *June 30, 2014*			Six months ended June 30, 2013
*Cash flows from operating activities:*
Net income (loss)	$	3,754,869		$	(1,654,717	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		5,423,296			4,083,871
Equity income in joint venture		(404,968	)		(557,116	)
Unrealized loss on warrant derivative		—			2,680,210
Amortization of deferred financing costs		613,279			430,396
Paid-in-kind interest		—			131,449
Charges related to equity-based compensation		235,605			166,480
Changes in assets and liabilities:
Restricted cash		(1,018,062	)		(126,397	)
Accounts receivable		(1,774,611	)		(679,141	)
Prepaid expenses, inventory and other assets		(1,063,887	)		(642,708	)
Deferred income taxes		(307,245	)		1,317,752
Accounts payable and other accrued liabilities		6,455,198			1,564,135
Advance deposits		438,763			255,370
Accounts receivable - affiliate		13,571			(2,008	)

Net cash provided by operating activities		*12,365,808*			*6,967,576*

*Cash flows from investing activities:*
Acquisition of hotel properties		(61,106,085	)		—
Improvements and additions to hotel properties		(2,559,086	)		(3,167,840	)
Distributions from joint venture		750,000			750,000
Funding of restricted cash reserves		(1,652,014	)		(972,570	)
Proceeds of restricted cash reserves		1,727,194			814,713

Net cash used in investing activities		*(62,839,991*	)		*(2,575,697*	)

*Cash flows from financing activities:*
Proceeds of mortgage debt		45,600,000			2,225,613
Proceeds of loans		19,000,000			—
Redemption of redeemable preferred stock		—			(1,901,547	)
Dividends and distributions paid		(1,178,049	)		(845,863	)
Pledge of cash collateral		—			(892,890	)
Redemption of units in operating partnership		—			(32,900	)
Payment of deferred financing costs		(1,686,615	)		(176,867	)
Payments on mortgage debt and loans		(2,712,097	)		(3,381,357	)

Net cash provided by (used in) financing activities		*59,023,239*			*(5,005,811*	)

Net increase (decrease) in cash and cash equivalents		8,549,056			(613,932	)
Cash and cash equivalents at the beginning of the period		9,376,628			7,175,716

*Cash and cash equivalents at the end of the period*	$	*17,925,684*		$	*6,561,784*

*Supplemental disclosures:*
Cash paid during the period for interest	$	*5,515,200*		$	*4,528,329*

Cash paid during the period for income taxes	$	*221,157*		$	*108,147*

*Non-cash investing and financing activities:*
Proceeds of mortgage debt contributed to restricted cash reserves	$	*1,500,000*		$	—

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

SOTHERLY HOTELS LP

CONSOLIDATED BALANCE SHEETS


	*June 30, 2014*		*December 31, 2013*
	*(unaudited)*
*ASSETS*
Investment in hotel properties, net	$	261,179,261	$	202,645,633
Investment in joint venture		2,101,007		2,446,039
Cash and cash equivalents		17,925,684		9,376,628
Restricted cash		6,363,682		3,796,141
Accounts receivable, net		4,221,989		1,982,091
Accounts receivable-affiliate		87,868		101,439
Prepaid expenses, inventory and other assets		3,258,668		2,444,975
Shell Island sublease, net		120,098		240,196
Deferred income taxes		1,493,367		1,186,122
Deferred financing costs, net		4,645,543		3,820,838

*TOTAL ASSETS*	$	*301,397,167*	$	*228,040,102*

*LIABILITIES*
Mortgage loans	$	204,751,451	$	160,363,549
Bridge loan		19,000,000		—
Unsecured notes		27,600,000		27,600,000
Accounts payable and other accrued liabilities		13,903,321		7,650,219
Advance deposits		1,570,393		666,758
Dividends and distributions payable		655,390		588,197

*TOTAL LIABILITIES*		267,480,555		196,868,723


Commitments and contingencies (see Note 7)

*PARTNERS’ CAPITAL*
General Partner: 131,079 and 130,711 units issued and outstanding as of June 30, 2014 and December 31, 2013, respectively		584,935		557,479
Limited Partners: 12,976,725 and 12,940,343 units issued and outstanding as of June 30, 2014 and December 31, 2013, respectively		33,331,677		30,613,900

*TOTAL PARTNERS’ CAPITAL*		33,916,612		31,171,379

*TOTAL LIABILITIES AND PARTNERS’ CAPITAL*	$	*301,397,167*	$	*228,040,102*

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

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

REVENUE

Rooms department

25,416,248

18,152,020

42,869,437

32,401,979

Food and beverage department

9,020,055

5,974,795

15,271,738

10,826,366

Other operating departments

1,903,398

1,123,828

3,208,915

2,212,109

Total revenue

36,339,701

25,250,643

61,350,090

45,440,454

EXPENSES

Hotel operating expenses

Rooms department

6,278,583

4,563,463

11,030,109

8,577,196

Food and beverage department

5,936,451

3,690,911

10,006,821

6,915,391

Other operating departments

335,502

119,350

537,008

226,025

Indirect

12,189,910

8,756,559

21,673,784

16,571,618

Total hotel operating expenses

24,740,446

17,130,283

43,247,722

32,290,230

Depreciation and amortization

2,988,968

2,031,050

5,423,296

4,083,871

Corporate general and administrative

1,391,206

1,123,684

2,698,997

2,217,471

Total operating expenses

29,120,620

20,285,017

51,370,015

38,591,572

NET OPERATING INCOME

7,219,081

4,965,626

9,980,075

6,848,882

Other income (expense)

Interest expense

(3,925,428

)

(2,332,644

)

(6,808,867

)

(5,013,191

)

Interest income

5,267

3,654

7,156

7,559

Equity income (loss) in joint venture

17,417

87,377

404,968

557,116

Unrealized gain (loss) on warrant derivative

—

88,855

—

(2,680,210

)

Net income (loss) before income taxes

3,316,337

2,812,868

3,583,332

(279,844

)

Income tax benefit (provision)

(563,782

)

(1,111,818

)

171,537

(1,374,873

)

Net income (loss)

2,752,555

1,701,050

3,754,869

(1,654,717

)

Net income (loss) per unit

Basic

0.21

0.13

0.29

(0.13

)

Diluted

0.21

0.12

0.29

(0.13

)

Weighted average number of units outstanding

Basic

13,107,804

13,038,125

13,098,870

13,037,064

Diluted

13,107,804

14,013,740

13,098,870

13,037,064

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

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS’ CAPITAL

(unaudited)

General Partner

Limited Partners

Total

Units

Amount

Units

Amount

Balances at December 31, 2013

130,711

557,479

12,940,343

30,613,900

31,171,379

Issuance of partnership units

368

2,360

36,382

223,385

225,645

Amortization of restricted award

—

100

—

9,860

9,960

Distributions declared

—

(12,453

)

—

(1,232,788

)

(1,245,241

)

Net income

—

37,549

—

3,717,320

3,754,869

Balances at June 30, 2014

131,079

584,935

12,976,725

33,331,677

33,916,612

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

SOTHERLY HOTELS LP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	*Six months ended* *June 30, 2014*			Six months ended June 30, 2013
*Cash flows from operating activities:*
Net income (loss)	$	3,754,869		$	(1,654,717	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		5,423,296			4,083,871
Equity income in joint venture		(404,968	)		(557,116	)
Unrealized loss on warrant derivative		—			2,680,210
Amortization of deferred financing costs		613,279			430,396
Paid-in-kind interest		—			131,449
Charges related to equity-based compensation		235,605			166,480
Changes in assets and liabilities:
Restricted cash		(1,018,062	)		(126,397	)
Accounts receivable		(1,774,611	)		(679,141	)
Prepaid expenses, inventory and other assets		(1,063,887	)		(642,708	)
Deferred income taxes		(307,245	)		1,317,752
Accounts payable and other accrued liabilities		6,455,198			1,564,135
Advance deposits		438,763			255,370
Accounts receivable - affiliate		13,571			(2,008	)

Net cash provided by operating activities		*12,365,808*			*6,967,576*

*Cash flows from investing activities:*
Acquisition of hotel properties		(61,106,085	)		—
Improvements and additions to hotel properties		(2,559,086	)		(3,167,840	)
Distributions from joint venture		750,000			750,000
Funding of restricted cash reserves		(1,652,014	)		(972,570	)
Proceeds of restricted cash reserves		1,727,194			814,713

Net cash used in investing activities		*(62,839,991*	)		*(2,575,697*	)

*Cash flows from financing activities:*
Proceeds of mortgage debt		45,600,000			2,225,613
Proceeds of loans		19,000,000			—
Redemption of Series A Preferred Interest		—			(1,901,547	)
Dividends and distributions paid		(1,178,049	)		(845,863	)
Pledge of cash collateral		—			(892,890	)
Redemption of units in operating partnership		—			(32,900	)
Payment of deferred financing costs		(1,686,615	)		(176,867	)
Payments on mortgage debt and loans		(2,712,097	)		(3,381,357	)

Net cash provided by (used in) financing activities		*59,023,239*			*(5,005,811*	)

Net increase in cash and cash equivalents		8,549,056			(613,932	)
Cash and cash equivalents at the beginning of the period		9,376,628			7,175,716

*Cash and cash equivalents at the end of the period*	$	*17,925,684*		$	*6,561,784*

*Supplemental disclosures:*
Cash paid during the period for interest	$	*5,515,200*		$	*4,528,329*

Cash paid during the period for income taxes	$	*221,157*		$	*108,147*

*Non-cash investing and financing activities:*
Proceeds of mortgage debt contributed to restricted cash reserves	$	*1,500,000*		$	—

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

SOTHERLY HOTELS INC.

SOTHERLY HOTELS LP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Description of Business

Sotherly Hotels Inc., formerly MHI Hospitality Corporation (the “Company”), is a self-managed and self-administered lodging real estate investment trust (“REIT”) that was incorporated in Maryland on August 20, 2004 to own full-service, primarily upscale and upper-upscale hotels located in primary and secondary markets in the Mid-Atlantic and Southern United States. Many of the hotels operate under well-known national hotel brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn.

The Company commenced operations on December 21, 2004 when it completed its initial public offering and thereafter consummated the acquisition of six hotel properties (the “initial properties”). Substantially all of the Company’s assets are held by, and all of its operations are conducted through, Sotherly Hotels LP, formerly MHI Hospitality, L.P. (the “Operating Partnership”). The Company and the Operating Partnership also own a 25.0% noncontrolling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with CRP/MHI Holdings, LLC, an affiliate of both Carlyle Realty Partners V, L.P. and The Carlyle Group (“Carlyle”).

Pursuant to the terms of the Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”) of the Operating Partnership, the Company, as general partner, is not entitled to compensation for its services to the Operating Partnership. The Company, as general partner, conducts substantially all of its operations through the Operating Partnership and the Company’s administrative expenses are the obligations of the Operating Partnership. Additionally, the Company is entitled to reimbursement for any expenditure incurred by it on the Operating Partnership’s behalf.

For the Company to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership, which, at June 30, 2014, was approximately 79.0% owned by the Company, and its subsidiaries, lease the hotels to a subsidiary of MHI Hospitality TRS Holding Inc., MHI Hospitality TRS, LLC, (collectively, “MHI TRS”), a wholly-owned subsidiary of the Operating Partnership. MHI TRS then engages an eligible independent hotel management company, MHI Hotels Services, LLC (“MHI Hotels Services”), to operate the hotels under a management contract. MHI TRS is treated as a taxable REIT subsidiary for federal income tax purposes.

All references in this report to “we”, “us” and “our” refer to the Company, its Operating Partnership and its subsidiaries and predecessors, collectively, unless the context otherwise requires or where otherwise indicated.

Significant transactions occurring during the current and prior fiscal year include the following:

On March 22, 2013, we entered into a First Amendment to the Loan Agreement and other amendments to secure additional proceeds on the original $8.0 million mortgage on the DoubleTree by Hilton Brownstone-University hotel property with our existing lender, Premier Bank, Inc. Pursuant to the amended loan documents, the mortgage loan’s principal amount was increased to $10.0 million, the prepayment penalty was removed and the interest rate was fixed at 5.25%; if the mortgage loan is extended, it will adjust to a rate of 3.00% plus the current 5-year U.S. Treasury bill rate of interest, with an interest rate floor of 5.25%. The remaining original terms of the agreement remained the same.

On March 26, 2013, we used the net proceeds of the mortgage on the DoubleTree by Hilton Brownstone-University to make a special distribution by the Operating Partnership to the Company to redeem 1,902 shares of the Company’s Series A Cumulative Redeemable Preferred Stock (the “Preferred Stock”) for an aggregate redemption price of approximately $2.1 million plus the payment of accrued and unpaid cash and stock dividends.

On June 28, 2013, we entered into an agreement with TowneBank to extend the maturity of the mortgage on the Crowne Plaza Hampton Marina in Hampton, Virginia, until June 30, 2014. Under the terms of the extension, we made a principal payment of approximately $1.1 million to reduce the principal balance on the loan to approximately $6.0 million and are required to continue to make monthly principal payments of $16,000. Interest payable monthly pursuant to the mortgage will remain at a rate of LIBOR plus additional interest of 4.55% and a minimum total rate of interest of 5.00% per annum. Pursuant to certain terms and conditions, we may extend the maturity date of the loan to June 30, 2015.

On August 1, 2013, we obtained a $15.6 million mortgage with CIBC, Inc. on the DoubleTree by Hilton Raleigh Brownstone – University in Raleigh, North Carolina. The mortgage bears interest at a rate of 4.78% and provides for level payments of principal and interest on a monthly basis under a 30-year amortization schedule. The maturity date is August 1, 2018. Approximately $0.7 million of the loan proceeds were placed into a restricted reserve which can be disbursed to us upon satisfaction of certain financial

performance criteria. The remaining proceeds of the mortgage were used to repay the existing indebtedness, to pay closing costs, to make a special distribution by the Operating Partnership to the Company to redeem 2,460 shares of Preferred Stock for an aggregate redemption price of approximately $2.7 million plus the payment of accrued and unpaid cash and stock dividends and for working capital. The redemption resulted in a prepayment fee of approximately $0.2 million.

On September 30, 2013, the Operating Partnership issued 8.0% senior unsecured notes (the “Notes”) in the aggregate amount of $27.6 million. The indenture requires quarterly payments of interest and matures on September 30, 2018. The proceeds were used to make a special distribution to the Company to redeem the remaining outstanding shares of Preferred Stock for an aggregate redemption price of approximately $10.7 million plus the payment of accrued and unpaid cash and stock dividends. The redemption resulted in a prepayment fee of approximately $0.7 million.

On October 23, 2013, the Company redeemed a portion of a warrant to purchase 1,900,000 shares of the Company’s common stock (the “Essex Warrant”) from Essex Illiquid, LLC and Richmond Hill Capital Partners, LP (collectively, the “Investors” or “Initial Holders”) corresponding to an aggregate of 900,000 Issuable Warrant Shares (the “First Tranche of Redeemed Warrant Shares”) for an aggregate cash redemption price of $3.2 million. The First Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant are terminated and extinguished.

Concurrently with the redemption of the 900,000 Issuable Warrant Shares, the Operating Partnership redeemed a portion of a warrant to purchase 1,900,000 units of the Operating Partnership (the “Operating Partnership Warrant”) corresponding to an aggregate of 900,000 Issuable Warrant Units, as defined in the Operating Partnership Warrant, for an aggregate cash redemption price of $3.2 million.

On November 13, 2013, we acquired 100% of the partnership interests of Houston Hotel Associates Limited Partnership, L.L.P., a Virginia limited liability partnership (“HHA”), for aggregate consideration of approximately $30.9 million in cash, the issuance to MHI Hotels, L.L.C., a Virginia limited liability company (“MHI Hotels”), of 32,929 units of limited partnership interests in the Operating Partnership, plus an additional amount for HHA’s working capital as of the closing date. HHA is the sole owner of the entity that indirectly owns the Crowne Plaza Houston Downtown.

On December 23, 2013, the Company redeemed the remaining portion of the Essex Warrant corresponding to an aggregate of 1,000,000 Issuable Warrant Shares (the “Final Tranche of Redeemed Warrant Shares”) for an aggregate cash redemption price of approximately $4.0 million. The Final Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant are terminated and extinguished.

Concurrently with the redemption of the 1,000,000 Issuable Warrant Shares, the Operating Partnership redeemed a portion of the Operating Partnership Warrant corresponding to an aggregate of 1,000,000 Issuable Warrant Units from the Company for an aggregate cash redemption price of approximately $4.0 million.

On December 27, 2013, through our joint venture with Carlyle, we entered into a credit and security agreement and other loan documents to secure a $57.0 million non-recourse mortgage on the Crowne Plaza Hollywood Beach Resort in Hollywood, Florida with Bank of America, N.A. The proceeds from the loan were used to repay the existing first mortgage, to pay closing costs, and to make a distribution to the joint venture partners. We used approximately $3.5 million of the distribution proceeds to repay an existing loan with Carlyle, and the remainder for general corporate purposes.

On March 26, 2014, we entered into a Note Agreement, Guaranty, and Pledge Agreement to secure a $19.0 million secured loan (the “Bridge Loan”) with Richmond Hill Capital Partners, LP (“Richmond Hill”) and Essex Equity Joint Investment Vehicle, LLC (collectively with Richmond Hill, the “Bridge Lenders”). The Bridge Loan bears interest at the rate of 10.0% per annum and matures on March 26, 2015. The loan also requires mandatory prepayment upon certain events, is subject to a prepayment premium if the loan is prepaid in full or in part prior to maturity and contains limited financial covenants. The loan is secured by a lien on our interest in our subsidiary that owns the Hilton Philadelphia Airport.

On March 27, 2014, we acquired the Georgian Terrace, a 326-room hotel in Atlanta, Georgia for the aggregate purchase price of approximately $61.1 million. Also included in the acquisition was a 698-space parking structure; all personal property and equipment located in or at the hotel; and a separate 0.6 acre development parcel with related development rights and improvements located thereon. In conjunction with the acquisition, we obtained a $41.5 million first mortgage from Bank of the Ozarks, of which $1.5 million of the proceeds was placed in a restricted cash reserve. The mortgage bears a floating rate of interest equal to LIBOR plus 3.75%, with a 4.00% floor and requires monthly payments of principal and interest on a 25-year amortization schedule following a 12-month interest-only period. The mortgage matures on March 27, 2017, but may be extended for two additional 1-year period subject to certain terms and conditions.

On March 31, 2014, we entered into a First Amendment and other amended loan documents to extend the maturity date and secure additional proceeds of approximately $5.6 million on the original $30.0 million mortgage on the Hilton Philadelphia Airport hotel with its existing lender, TD Bank, N.A. Pursuant to the First Amendment and other amended loan documents, the mortgage continues to bear interest at a rate of LIBOR plus 3.0% with a 3.50% floor, requires monthly payments of principal and interest on an amortization schedule over the remainder of the 25-year period that began with the commencement of the loan in March 2012, and extends the maturity date to April 1, 2019.

As a condition to obtaining the First Amendment to the mortgage on the Hilton Philadelphia Airport hotel, we were required to enter into a license agreement with a national hotel franchise through at least the term of the amended mortgage loan. As such, we entered into a 10-year franchise agreement with Hilton Worldwide and plan to rebrand the Hilton Philadelphia Airport hotel as a DoubleTree by Hilton in November 2014, subject to the completion of certain product improvement requirements.

On June 27, 2014, we entered into an agreement with TowneBank to extend the maturity of the mortgage on the Crowne Plaza Hampton Marina in Hampton, Virginia, until June 30, 2016. Under the terms of the extension, we made a principal payment of $0.8 million and are required to make monthly principal payments of $83,000 and interest payments at a rate of 5.0% per annum.

2. Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements of the Company presented herein include all of the accounts of Sotherly Hotels Inc., the Operating Partnership, MHI TRS and subsidiaries. All significant inter-company balances and transactions have been eliminated. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The consolidated financial statements of the Operating Partnership presented herein include all of the accounts of Sotherly Hotels LP, MHI TRS and subsidiaries. All significant inter-company balances and transactions have been eliminated. Additionally, all administrative expenses of the Company and those expenditures made by the Company on behalf of the Operating Partnership are reflected as the administrative expenses, expenditures and obligations thereto of the Operating Partnership, pursuant to the terms of the Partnership Agreement.

Investment in Hotel Properties – Investments in hotel properties include investments in operating properties which are recorded at acquisition cost and allocated to land, property and equipment and identifiable intangible assets. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation are removed from our accounts and any resulting gain or loss is included in the statements of operations. Expenditures under a renovation project, which constitute additions or improvements that extend the life of the property, are capitalized.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 7 to 39 years for buildings and building improvements and 3 to 10 years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets.

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

Assets Held For Sale – The Company records assets as held for sale when management has committed to a plan to sell the assets, actively seeks a buyer for the assets, and the consummation of the sale is considered probable and is expected within one year.

Investment in Joint Venture – Investment in joint venture represents our noncontrolling indirect 25.0% equity interest in (i) the entity that owns the Crowne Plaza Hollywood Beach Resort and (ii) the entity that leases the hotel and has engaged MHI Hotels Services to operate the hotel under a management contract. Carlyle owns a 75.0% controlling indirect interest in these entities. We account for our investment in the joint venture under the equity method of accounting and are entitled to receive our pro rata share of operating cash flow. We also have the opportunity to earn an incentive participation in the net sale proceeds based upon the achievement of certain overall investment returns, in addition to our pro rata share of net sale proceeds.

Cash and Cash Equivalents – We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Concentration of Credit Risk – We hold cash accounts at several institutions in excess of the Federal Deposit Insurance Corporation (the “FDIC”) protection limits of $250,000. Our exposure to credit loss in the event of the failure of these institutions is represented by the difference between the FDIC protection limit and the total amounts on deposit. Management monitors, on a regular basis, the financial condition of the financial institutions along with the balances there on deposit to minimize our potential risk.

Restricted Cash – Restricted cash includes real estate tax escrows, insurance escrows and reserves for replacements of furniture, fixtures and equipment pursuant to certain requirements in our various mortgage agreements.

Accounts Receivable – Accounts receivable consists primarily of hotel guest and banqueting receivables. Ongoing evaluations of collectability are performed and an allowance for potential credit losses is provided against the portion of accounts receivable that is estimated to be uncollectible.

Inventories – Inventories, consisting primarily of food and beverages, are stated at the lower of cost or market, with cost determined on a method that approximates first-in, first-out basis.

Franchise License Fees – Fees expended to obtain or renew a franchise license are amortized over the life of the license or renewal. The un-amortized franchise fees as of June 30, 2014 and December 31, 2013 were $175,239 and $196,989, respectively. Amortization expense for each of the three month periods ended June 30, 2014 and 2013 totaled $10,875 and for each of the six month periods ended June 30, 2014 and 2013 totaled $21,750.

Deferred Financing Costs – Deferred financing costs are recorded at cost and consist of loan fees and other costs incurred in issuing debt. Amortization of deferred financing costs is computed using a method that approximates the effective interest method over the term of the related debt and is included in interest expense in the consolidated statements of operations.

Derivative Instruments – Our derivative instruments are reflected as assets or liabilities on the balance sheet and measured at fair value. Derivative instruments used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as an interest rate risk, are considered fair value hedges. Derivative instruments used to hedge exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. For a derivative instrument designated as a cash flow hedge, the change in fair value each period is reported in accumulated other comprehensive income in stockholders’ equity and partners’ capital to the extent the hedge is effective. For a derivative instrument designated as a fair value hedge, the change in fair value each period is reported in earnings along with the change in fair value of the hedged item attributable to the risk being hedged. For a derivative instrument that does not qualify for hedge accounting or is not designated as a hedge, the change in fair value each period is reported in earnings.

We use derivative instruments to add stability to interest expense and to manage our exposure to interest-rate movements. To accomplish this objective, we primarily used an interest-rate swap, which was required under the then-existing credit agreement and acted as a cash flow hedge involving the receipts of variable-rate amounts from a counterparty in exchange for us making fixed-rate payments without exchange of the underlying principal amount. We valued the interest-rate swap at fair value, which we define 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 (exit price). We also use derivative instruments in the Company’s stock to obtain more favorable terms on our financing. We do not enter into contracts to purchase or sell derivative instruments for speculative trading purposes.

Fair Value Measurements –

We classify the inputs used to measure fair value into the following hierarchy:


Level 1		Unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2		Unadjusted quoted prices in active markets for similar assets or liabilities, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.

Level 3		Unobservable inputs for the asset or liability.

We endeavor to utilize the best available information in measuring fair value. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table represents our debt instruments measured at fair value and the basis for that measurement:

Level 1

Level 2

Level 3

December 31, 2013

Mortgage loans⁽¹⁾

—

(162,841,165

)

—

Unsecured notes⁽²⁾

(28,770,240

)

—

June 30, 2014

Mortgage loans⁽¹⁾

—

(206,949,159

)

—

Unsecured notes⁽²⁾

(30,387,061

)

—

(1)	Mortgage loans are reflected at carrying value on our Consolidated Balance Sheet as of June 30, 2014 and December 31, 2013.

(2)	Unsecured notes are recorded at historical cost on our Consolidated Balance Sheet as of June 30, 2014 and December 31, 2013.

Noncontrolling Interest in Operating Partnership – Certain hotel properties have been acquired, in part, by the Operating Partnership through the issuance of limited partnership units of the Operating Partnership. The noncontrolling interest in the Operating Partnership is: (i) increased or decreased by the limited partners’ pro-rata share of the Operating Partnership’s net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by redemption of partnership units for the Company’s common stock; and (iv) adjusted to equal the net equity of the Operating Partnership multiplied by the limited partners’ ownership percentage immediately after each issuance of units of the Operating Partnership and/or the Company’s common stock through an adjustment to additional paid-in capital. Net income or net loss is allocated to the noncontrolling interest in the Operating Partnership based on the weighted average percentage ownership throughout the period.

Revenue Recognition – Revenues from operations of the hotels are recognized when the services are provided. Revenues consist of room sales, food and beverage sales, and other hotel department revenues, such as telephone, parking, gift shop sales and rentals from restaurant tenants, rooftop leases and gift shop operators. Revenues are reported net of occupancy and other taxes collected from customers and remitted to governmental authorities.

Income Taxes – The Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As a REIT, the Company generally will not be subject to federal income tax. MHI TRS, our wholly owned taxable REIT subsidiary which leases our hotels from subsidiaries of the Operating Partnership, is subject to federal and state income taxes.

We account for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. As of June 30, 2014, we had no uncertain tax positions. Our policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2014, the tax years that remain subject to examination by the major tax jurisdictions to which the Company is subject generally include the calendar years 2010 through 2013. In addition, as of June 30, 2014, the tax years that remain subject to examination by the major tax jurisdictions to which MHI TRS is subject generally include the calendar years 2004 through 2009.

The Operating Partnership is generally not subject to federal and state income taxes as the unit holders of the Partnership are subject to tax on their respective shares of the Partnership’s taxable income.

Stock-based Compensation – The Company’s 2004 Long Term Incentive Plan (the “2004 Plan”) and its 2013 Long-Term Incentive Plan (the “2013 Plan”), which the Company’s stockholders approved in April 2013, permit the grant of stock options, restricted stock and performance share compensation awards to its employees for up to 350,000 and 750,000 shares of common stock, respectively. The Company believes that such awards better align the interests of its employees with those of its stockholders.

Under the 2004 Plan, the Company has made restricted stock and deferred stock awards totaling 337,438 shares including 255,938 shares issued to certain executives and employees and 81,500 restricted shares issued to its independent directors. Of the 255,938 shares issued to certain of our executives and employees, all have vested except for 24,000 shares which were issued to the Chief Financial Officer upon execution of his employment contract. These shares are to vest pro rata on each of the next four anniversaries of the effective date of his employment agreement. All of the 81,500 restricted shares issued to the Company’s independent directors have vested.

Under the 2013 Plan, the Company has made issuances totaling 36,750 shares, consisting of 24,000 non-restricted shares issued to certain executives and 12,000 restricted shares and 750 non-restricted shares issued to its independent directors. All of the restricted shares will vest at the end of 2014.

The value of the awards is charged to compensation expense on a straight-line basis over the vesting or service period based on the Company’s stock price on the date of grant or issuance. Previously, under the 2004 Plan, and currently, under the 2013 Plan, the Company may issue a variety of performance-based stock awards, including nonqualified stock options. As of June 30, 2014, no performance-based stock awards have been granted. Consequently, stock-based compensation as determined under the fair-value method would be the same under the intrinsic-value method. Total compensation cost recognized under the 2004 Plan and 2013 Plan totaled $24,551 and $49,103, respectively for the three months and six months ended June 30, 2014 and $21,069 and $43,026, respectively, for the three months and six months ended June 30, 2013.

Comprehensive Income (Loss) – Comprehensive income (loss) includes all changes in equity (net assets) during a period from non-owner sources. We do not have any items of comprehensive income (loss) other than net income (loss).

Segment Information – We have determined that our business is conducted in one reportable segment: hotel ownership.

Use of Estimates – The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America 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 reporting period. Actual results could differ from those estimates.

Reclassifications – Certain reclassifications have been made to the prior period balances to conform to the current period presentation.

New Accounting Pronouncements – There are no recent accounting pronouncements which we believe will have a material impact on our consolidated financial statements.

3. Acquisition of Hotel Properties

Georgian Terrace Acquisition. On March 27, 2014, we acquired the 326-room Georgian Terrace in Atlanta, Georgia, for approximately $61.1 million. The preliminary allocation of the purchase price based on fair values is as follows:


	Georgian Terrace
Land and land improvements	$	10,127,687
Buildings and improvements		45,385,939
Furniture, fixtures and equipment		5,163,135

Investment in hotel properties		60,676,761
Restricted cash		124,658
Accounts receivable		465,287
Prepaid expenses, inventory and other assets		430,997
Accounts payable and accrued liabilities		(591,618	)

Net cash	$	61,106,085

The results of operations of the hotel are included in our consolidated financial statements from the date of acquisition. The total revenue and net income related to the acquisition for the period March 27, 2014 to June 30, 2014 are approximately $5.8 million and $0.7 million, respectively. The following pro forma financial information presents the results of operations of the Company and the Operating Partnership for the three and six months ended June 30, 2014 and 2013 as if the acquisitions of the Georgian Terrace and the Crowne Plaza Houston Downtown had taken place on January 1, 2013. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which would have actually occurred had the transaction taken place on January 1, 2013, or of future results of operations:


	Three months ended				Six months ended
	June 30, 2014		June 30, 2013		June 30, 2014		June 30, 2013
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Pro forma revenues	$	36,339,701	$	33,934,540	$	66,120,754	$	62,390,570
Pro forma operating expenses		29,120,620		27,542,225		58,222,109		52,926,026
Pro forma operating income		7,219,081		6,392,314		7,898,645		9,464,544
Pro forma net income (loss)		2,166,689		1,534,115		615,372		(1,015,041	)
Pro forma earnings (loss) per basic share and unit		0.21		0.15		0.06		(0.10	)
Pro forma earnings (loss) per diluted share and unit		0.21		0.14		0.06		(0.10	)
Pro forma basic common shares		10,353,677		10,156,927		10,290,047		10,118,862
Pro forma diluted common shares		10,353,677		11,132,542		10,290,047		10,118,862

4. Investment in Hotel Properties

Investment in hotel properties as of June 30, 2014 and December 31, 2013 consisted of the following:


	June 30, 2014			*December 31, 2013*
	*(unaudited)*
Land and land improvements	$	37,083,998		$	26,956,311
Buildings and improvements		253,070,121			206,101,663
Furniture, fixtures and equipment		35,958,398			29,829,908

		326,112,517			262,887,882
Less: accumulated depreciation and impairment		(64,933,256	)		(60,242,249	)

	$	261,179,261		$	202,645,633

5. Debt

Mortgage Debt. As of June 30, 2014 and December 31, 2013, we had approximately $204.8 million and approximately $160.4 million of outstanding mortgage debt, respectively. The following table sets forth our mortgage debt obligations on our hotels.


	Balance Outstanding as of
Property	June 30, 2014		December 31, 2013		Prepayment Penalties	Maturity Date	Amortization Provisions			Interest Rate
Crowne Plaza Hampton Marina	$	5,007,500	$	5,903,500	None	06/30/2016⁽¹⁾	$	83,000	⁽²⁾		5.00	%⁽³⁾
Crowne Plaza Houston Downtown		21,193,019		21,428,258	Yes⁽⁴⁾	04/12/2016⁽⁵⁾		25 years			4.50	%
Crowne Plaza Jacksonville Riverfront		13,558,460		13,756,209	None	07/10/2015⁽⁶⁾		25 years			LIBOR plus 3.00	%
Crowne Plaza Tampa Westshore		13,461,137		13,602,701	None	06/18/2017		25 years			5.60	%
DoubleTree by Hilton Brownstone – University		15,409,693		15,525,626	⁽⁷⁾	08/01/2018		30 years			4.78	%
Georgian Terrace		41,500,000		—	Yes⁽⁸⁾	03/27/2017⁽¹⁴⁾		25 years			LIBOR plus 3.75	%⁽¹³⁾
Hilton Philadelphia Airport		33,863,890		28,731,151	None	04/01/2019		25 years			LIBOR plus 3.00	%⁽⁹⁾
Hilton Savannah DeSoto		21,343,258		21,546,423	Yes⁽¹⁰⁾	08/01/2017		25 years			6.06	%
Hilton Wilmington Riverside		20,658,279		20,919,030	Yes⁽¹⁰⁾	04/01/2017		25 years			6.21	%
Holiday Inn Laurel West		7,058,741		7,141,845	Yes⁽¹¹⁾	08/05/2021		25 years			5.25	%⁽¹²⁾
Sheraton Louisville Riverside		11,697,474		11,808,806	⁽⁷⁾	01/06/2017		25 years			6.24	%

Total	$	204,751,451	$	160,363,549

(1)	The amended note provides that the mortgage has been extended until June 2016.

(2)	The Operating Partnership is required to make monthly principal payments of $83,000.

(3)	The note rate was changed to a fixed rate of 5% effective June 27, 2014.

(4)	The note may not be prepaid during the first two years of the term.

(5)	The note provides that the mortgage can be extended until November 2018 if certain conditions have been satisfied.

(6)	The note provides that the mortgage can be extended until July 2016 if certain conditions have been satisfied.

(7)	With limited exception, the note may not be prepaid until two months before maturity.

(8)	The note is subject to a prepayment penalty if the loan is prepaid in full or in part prior to March 26, 2015.

(9)	The note bears a minimum interest rate of 3.50%.

(10)	The notes may not be prepaid during the first six years of the terms. Prepayment can be made with penalty thereafter until 90 days before maturity.

(11)	Pre-payment can be made with penalty until 180 days before the fifth anniversary of the commencement date of the loan or from such date until 180 days before the maturity.

(12)	The note provides that after five years, the rate of interest will adjust to a rate of 3.00% per annum plus the then-current five-year U.S. Treasury rate of interest, with a floor of 5.25%.

(13)	The note bears a minimum interest rate of 4.00%.

(14)	The note provides that the mortgage can be extended through the fourth and fifth anniversary of the commencement date of the loan, or March 27, 2018 and March 27, 2019, respectively, subject to certain conditions.

We were in compliance with all debt covenants, current on all loan payments and not otherwise in default under any of our mortgage loans, as of June 30, 2014.

Total future mortgage debt maturities, without respect to any extension of loan maturity, as of June 30, 2014 were as follows:


The remaining six month period ending December 31, 2014	$	2,470,611
December 31, 2015		18,402,295
December 31, 2016		27,870,508
December 31, 2017		104,797,895
December 31, 2018		15,846,237
December 31, 2019 and thereafter		35,363,905

Total future maturities	$	204,751,451

Unsecured Notes. On September 30, 2013, the Operating Partnership issued 8.0% senior unsecured notes in the aggregate amount of $27.6 million. The indenture requires quarterly payments of interest and matures on September 30, 2018. The Notes are callable after September 30, 2016 at 101% of face value.

Bridge Financing. On March 26, 2014, we entered into a Note Agreement, Guaranty, and Pledge Agreement to secure a $19.0 million secured Bridge Loan with the Bridge Lenders. The Bridge Loan has a maturity date of March 26, 2015; carries a fixed interest rate of 10.0% per annum; is subject to a prepayment premium if the loan is prepaid in full or in part prior to March 26, 2015; requires mandatory prepayment upon certain events; contains limited financial covenants; and is secured by a lien on 100% of the limited partnership interests in the subsidiary that owns the Hilton Philadelphia Airport hotel. The outstanding balance on the Bridge Loan at June 30, 2014 and December 31, 2013 was $19.0 million and $0.0 million, respectively.

6. Preferred Stock, Preferred Interest and Warrants

Preferred Stock and Preferred Interest. On April 18, 2011, the Company completed a private placement to the Investors pursuant to the Securities Purchase Agreement for gross proceeds of $25.0 million. The Company issued 25,000 shares of Preferred Stock and the Essex Warrant to purchase 1,900,000 shares of the Company’s common stock, par value $0.01 per share.

The Company designated a class of preferred stock, the Preferred Stock, consisting of 27,650 shares with $0.01 par value per share, having a liquidation preference of $1,000.00 per share pursuant to Articles Supplementary (the “Articles Supplementary”), which sets forth the preferences, rights and restrictions for the Preferred Stock. The Preferred Stock is non-voting and non-convertible. The holders of the Preferred Stock had 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 Preferred Stock at an annual rate of 2.0% of the liquidation preference per share. As set forth in the Articles Supplementary, the holder(s) of the Company’s Preferred Stock had the exclusive right, voting separately as a single class, to elect one (1) member of the Company’s board of directors. In addition, under certain circumstances as set forth in the Articles Supplementary, the holder(s) of the Company’s Preferred Stock were entitled to appoint a majority of the members of the Company’s board of directors. The holder(s) of the Company’s Preferred Stock were entitled to require that the Company redeem the Preferred Stock under certain circumstances, but no later than April 18, 2016, and on such terms and at such price as is set forth in the Articles Supplementary.

Concurrently with the issuance of the Preferred Stock, the Operating Partnership issued the Preferred Interest to the Company in an amount equivalent to the proceeds of the Preferred Stock received by the general partner pursuant to the terms of the Partnership Agreement. The Partnership Agreement also authorizes the general partner to make special distributions to the Company related to its Preferred Interest for the sole purpose of fulfilling the Company’s obligations with respect to the Preferred Stock. In addition, the Operating Partnership issued the Operating Partnership Warrant to purchase 1,900,000 partnership units at an amount equal to the consideration received by the Company upon exercise of the Essex Warrant, as amended.

On March 26, 2013, we used the net proceeds of an expansion of the mortgage on the DoubleTree by Hilton Brownstone-University to make a special distribution by the Operating Partnership to the Company to redeem 1,902 shares of Preferred Stock for an aggregate redemption price of approximately $2.1 million plus the payment of related accrued and unpaid cash and stock dividends. The redemption resulted in a prepayment fee of approximately $0.2 million. In addition, approximately $0.1 million in unamortized issuance costs related to the redeemed shares were written off.

On August 1, 2013, we used the net proceeds of a new mortgage on the DoubleTree by Hilton Brownstone-University to make a special distribution by the Operating Partnership to the Company to redeem 2,460 shares of Preferred Stock for an aggregate redemption price of approximately $2.7 million plus the payment of related accrued and unpaid cash and stock dividends. The redemption resulted in a prepayment fee of approximately $0.2 million. In addition, approximately $0.1 million in unamortized issuance costs related to the redeemed shares were written off.

On September 30, 2013, we used a portion of the proceeds of the Notes offering to make a special distribution by the Operating Partnership to the Company to redeem the remaining outstanding shares of Preferred Stock for an aggregate redemption price of approximately $10.7 million plus the payment of related accrued and unpaid cash and stock dividends. The redemption resulted in a prepayment fee of approximately $0.7 million. In addition, approximately $0.4 million in unamortized issuance costs related to the redeemed shares were written off.

As of June 30, 2014 and December 31, 2013, there were no shares of the Preferred Stock issued and outstanding.

As of June 30, 2014 and December 31, 2013, there was no redemption value in the Preferred Interest.

Warrants. The Essex Warrant, as modified, entitled the holder(s) to purchase up to 1,900,000 shares of the Company’s common stock at an exercise price of $2.25 per share. Pursuant to an amendment to the Essex Warrant, the exercise price per share of common stock covered by the Essex Warrant could have adjusted from time to time in the event of payment of cash dividends to holders of common stock by deducting from such exercise price the per-share amount of such cash dividends. Such adjustment could not take into account dividends declared prior to January 1, 2012.

Concurrently with the issuance of the Essex Warrant, the Operating Partnership issued the Operating Partnership Warrant to the Company. Under the terms of the Operating Partnership Warrant, the Company was obligated to exercise the Operating Partnership Warrant immediately and concurrently if at any time the Essex Warrant was exercised by its holders. In that event, the Operating Partnership would have issued an equivalent number of partnership units and would have been entitled to receive the proceeds received by the Company upon exercise of the Essex Warrant.

On October 23, 2013, the Company redeemed the First Tranche of Redeemed Warrant Shares for an aggregate cash redemption price of $3.2 million. The First Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant are terminated and extinguished.

Concurrently with the redemption of the 900,000 Issuable Warrant Shares, the Operating Partnership redeemed 900,000 Issuable Warrant Units, as defined in the Operating Partnership Warrant, for an aggregate cash redemption price of $3.2 million.

On December 23, 2013, the Company redeemed the Final Tranche of Redeemed Warrant Shares for an aggregate cash redemption price of approximately $4.0 million. The Final Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant are terminated and extinguished.

Concurrently with the redemption of the 1,000,000 Issuable Warrant Shares, the Operating Partnership redeemed 1,000,000 Issuable Warrant Units, as defined in the Operating Partnership Warrant, for an aggregate cash redemption price of approximately $4.0 million. The redeemed warrant units are no longer Issuable Warrant Units under the Operating Partnership Warrant, and all rights under the Operating Partnership Warrant are terminated and extinguished.

On the date of issuance, we determined the fair market value of the Essex Warrant was approximately $1.6 million using the Black-Scholes option pricing model assuming an exercise price of $2.25 per share of common stock, a risk-free interest rate of 2.26%, a dividend yield of 5.00%, expected volatility of 60.0%, and an expected term of 5.5 years. The fair market value is included in deferred financing costs. The deferred cost was amortized to interest expense in the accompanying consolidated statement of operations over the period of issuance to the mandatory redemption date of the Preferred Stock.

7. Commitments and Contingencies

Ground, Building and Submerged Land Leases – We lease 2,086 square feet of commercial space next to the Savannah hotel property for use as an office, retail or conference space, or for any related or ancillary purposes for the hotel and/or atrium space. In December 2007, we signed an amendment to the lease to include rights to the outdoor esplanade adjacent to the leased commercial space. The areas are leased under a six-year operating lease, which expired October 31, 2006 and has been renewed for the second of three optional five-year renewal periods expiring October 31, 2011, October 31, 2016 and October 31, 2021, respectively. Rent expense for the three months and six months ended June 30, 2014 totaled $15,867 and $31,734, respectively, and totaled $15,867 and $32,623 for the three months and six months ended June 30, 2013, respectively, for this operating lease.

We lease, as landlord, the entire fourteenth floor of the Hilton Savannah DeSoto to The Chatham Club, Inc. under a ninety-nine year lease expiring July 31, 2086. This lease was assumed upon the purchase of the building under the terms and conditions agreed to by the previous owner of the property. No rental income is recognized under the terms of this lease as the original lump sum rent payment of $990 was received by the previous owner and not prorated over the life of the lease.

We lease a parking lot adjacent to the DoubleTree by Hilton Brownstone-University in Raleigh, North Carolina. The land is leased under a second amendment, dated April 28, 1998, to a ground lease originally dated May 25, 1966. The original lease is a 50-year operating lease, which expires August 31, 2016. We exercised a renewal option for the first of three additional ten-year periods expiring August 31, 2026, August 31, 2036, and August 31, 2046, respectively. We hold an exclusive and irrevocable option to purchase the leased land at fair market value at the end of the original lease term, subject to the payment of an annual fee of $9,000, and other conditions. Rent expense for the three months and six months ended June 30, 2014 totaled $23,871 and $47,741, respectively, and totaled $23,871 and $47,741 for the three months and six months ended June 30, 2013, respectively

We lease land adjacent to the Crowne Plaza Tampa Westshore for use as parking under a five-year agreement with the Florida Department of Transportation that commenced in July 2009 and expires in July 2019. The agreement requires annual payments of

$2,432, plus tax, and may be renewed for an additional five years. Rent expense totaled $651 and $1,084 for the three months and six months ended June 30, 2014, respectively, and totaled $651 and $1,301 for the three months and six months ended June 30, 2013, respectively.

We lease certain submerged land in the Saint Johns River in front of the Crowne Plaza Jacksonville Riverfront from the Board of Trustees of the Internal Improvement Trust Fund of the State of Florida. The submerged land was leased under a five-year operating lease requiring annual payments of $4,961, which expired September 18, 2012. A new operating lease was executed requiring annual payments of $6,020 and expires September 18, 2017. Rent expense totaled $1,505 and $3,010 for the three months and six months ended June 30, 2014, respectively, and totaled $1,505 and $3,010 for the three months and six months ended June 30, 2013, respectively.

We lease 4,836 square feet of commercial office space in Williamsburg, Virginia under an agreement, as amended, that commenced September 1, 2009 and expires August 31, 2018. Rent expense totaled $20,398 and $40,796 for the three months and six months ended June 30, 2014, respectively, and totaled $13,750 and $27,500 for the three months and six months ended June 30, 2013, respectively.

We lease 1,632 square feet of commercial office space in Rockville, Maryland under an agreement that commenced December 14, 2009 and expires February 28, 2017. The agreement required monthly payments at an annual rate of $22,848 for the first year of the lease term and monthly payments at an annual rate of $45,696 for the second year of the lease term, increasing 2.75% per year for the remainder of the lease term. Rent expense totaled $11,046 and $22,091 for the three months and six months ended June 30, 2014, respectively, and totaled $10,963 and $22,071 for the three months and six months ended June 30, 2013, respectively.

We also lease certain furniture and equipment under financing arrangements expiring between February 2014 and March 2017.

A schedule of minimum future lease payments for the following twelve-month periods is as follows:


The remaining six month period ending December 31, 2014	$	206,707
December 31, 2015		363,586
December 31, 2016		327,228
December 31, 2017		198,941
December 31, 2018		161,226
December 31, 2019 and thereafter		735,987

Total	$	1,993,675

Management Agreements – At June 30, 2014, each of our wholly-owned operating hotels, except for the Crowne Plaza Tampa Westshore, the Crowne Plaza Houston Downtown and the Georgian Terrace, are operated under a master management agreement with MHI Hotels Services that expires between December 2014 and April 2018. We entered into separate management agreements with MHI Hotels Services for the management of the Crowne Plaza Tampa Westshore that expires in March 2019 and for management of the Georgian Terrace that expires in March 2024. We also assumed the existing agreement for management of the Crowne Plaza Houston Downtown upon purchase of the hotel in November 2013, which expires in April 2016 (see Note 9).

Franchise Agreements – As of June 30, 2014, many of our hotels operate under franchise licenses from national hotel companies. Under the franchise agreements, we are required to pay a franchise fee generally between 2.5% and 5.0% of room revenues, plus additional fees for marketing, central reservation systems, and other franchisor programs and services that amount to between 2.5% and 6.0% of room revenues from the hotels. The franchise agreements currently expire between October 2014 and April 2023.

Restricted Cash Reserves – Each month, we are required to escrow with the lenders on the Hilton Wilmington Riverside, the Hilton Savannah DeSoto, the DoubleTree by Hilton Brownstone-University, the Sheraton Louisville Riverside and the Georgian Terrace an amount equal to¹/₁₂ of the annual real estate taxes due for the properties. We are also required by several of our lenders to establish individual property improvement funds to cover the cost of replacing capital assets at our properties. Each month, those contributions equal 4.0% of gross revenues for the Hilton Savannah DeSoto, the Hilton Wilmington Riverside, the Sheraton Louisville Riverside, DoubleTree by Hilton Raleigh Brownstone–University, Crowne Plaza Houston Downtown, the Crowne Plaza Hampton Marina and the Georgian Terrace and equal 4.0% of room revenues for the Hilton Philadelphia Airport.

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

8. Equity

Preferred Stock – The Company has authorized 1,000,000 shares of preferred stock, of which 27,650 shares were issued as Series A Cumulative Redeemable Preferred Stock, as described above, and subsequently redeemed in 2013. None of the remaining authorized shares have been issued.

Common Stock – The Company is authorized to issue up to 49,000,000 shares of common stock, $0.01 par value per share. Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Holders of the Company’s common stock are entitled to receive distributions when authorized by the Company’s board of directors out of assets legally available for the payment of distributions.

The following is a schedule of issuances, since January 1, 2013, of the Company’s common stock:

On April 1, 2014, two holders of units in the Operating Partnership redeemed 110,000 units for an equivalent number of shares of the Company’s common stock.

On February 14, 2014, the Company was issued 36,750 units in the Operating Partnership and awarded an aggregate of 24,000 shares of unrestricted stock to certain executives as well as 12,000 shares of restricted stock and 750 share of unrestricted stock to certain of its independent directors.

On August 14, 2013, one holder of units in the Operating Partnership redeemed 50,000 units for an equivalent number of shares of the Company’s common stock.

On April 1, 2013, one holder of units in the Operating Partnership redeemed 31,641 units for an equivalent number of shares of the Company’s common stock.

On March 1, 2013, one holder of units in the Operating Partnership redeemed 50,000 units for an equivalent number of shares of the Company’s common stock.

On January 25, 2013, the Company was issued 45,500 units in the Operating Partnership and awarded an aggregate of 30,500 shares of unrestricted stock to certain executives and employees as well as 15,000 shares of restricted stock to certain of its independent directors.

On January 1, 2013, the Company was issued 30,000 units in the Operating Partnership and granted 30,000 restricted shares to its Chief Financial Officer in accordance with the terms of his employment contract.

As of June 30, 2014 and December 31, 2013, the Company had 10,353,677 and 10,206,927 shares of common stock outstanding, respectively.

Operating Partnership Units – Holders of Operating Partnership units, other than the Company as general partner, have certain redemption rights, which enable them to cause the Operating Partnership to redeem their units in exchange for shares of the Company’s common stock on a one-for-one basis or, at the option of the Company, cash per unit equal to the average of the market price of the Company’s common stock for the 10 trading days immediately preceding the notice date of such redemption. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or the stockholders of the Company.

The following is a schedule of issuances and redemptions, since January 1, 2013, of units in the Operating Partnership in addition to the issuances of units in the Operating Partnership to the Company described above:

On November 13, 2013, the Operating Partnership issued 32,929 limited partnership units in conjunction with the purchase of the partnership interests in HHA, which is the sole owner of the Crowne Plaza Houston Downtown.

On April 1, 2013, the Company redeemed 10,000 units in the Operating Partnership held by a trust controlled by two members of the Company’s board of directors for a total of $32,900 pursuant to the terms of the partnership agreement.

As of June 30, 2014 and December 31, 2013, the total number of Operating Partnership units outstanding was 13,107,804 and 13,071,054, respectively.

As of each June 30, 2014 and December 31, 2013, the total number of outstanding Operating Partnership units not owned by the Company was 2,754,127 and 2,864,127, respectively, with a fair market value of approximately $21.6 million and approximately $17.0 million, respectively, based on the price per share of the common stock on such respective dates.

9. Related Party Transactions

MHI Hotels Services. As of June 30, 2014, the members of MHI Hotels Services (a company that is majority-owned and controlled by the Company’s chief executive officer, its former chief financial officer as well as a current member of its board of directors and a former member of its board of directors) owned approximately 10.5% of the Company’s outstanding common stock and 1,752,958 Operating Partnership units. The following is a summary of the transactions with MHI Hotels Services:

Accounts Receivable – We were due $87,868 and $101,439 from MHI Hotels Services at June 30, 2014 and December 31, 2013, respectively.

Shell Island Sublease – We have a sublease arrangement with MHI Hotels Services on its expired leasehold interests in the Shell Island Resort in Wrightsville Beach, North Carolina. Leasehold revenue was $87,500 for each of the three month periods ended June 30, 2014 and 2013 and was $175,000 for each of the six month periods ended June 30, 2014 and 2013. The underlying leases at Shell Island expired on December 31, 2011.

Strategic Alliance Agreement – On December 21, 2004, we entered into a ten-year strategic alliance agreement with MHI Hotels Services that provides in part for the referral of acquisition opportunities to us and the management of our hotels by MHI Hotels Services.

Management Agreements – Each of the operating hotels that we wholly-owned at June 30, 2014 and December 31, 2013, except for the Crowne Plaza Tampa Westshore, the Crowne Plaza Houston Downtown and the Georgian Terrace, are operated by MHI Hotels Services under a master management agreement that expires between December 2014 and April 2018. We entered into separate management agreements with MHI Hotels Services for the management of the Crowne Plaza Tampa Westshore that expires in March 2019 and for the management of the Georgian Terrace that expires in March 2024. We assumed an existing management agreement for the Crowne Plaza Houston Downtown when we acquired the property in November 2013, which expires in April 2016. Pursuant to the sale of the Holiday Inn Downtown in Williamsburg, Virginia, one of the hotels initially contributed to the Company and the Operating Partnership upon their formation, MHI Hotels Services has agreed that the property in Jeffersonville, Indiana shall be substituted for the Williamsburg property under the master management agreement.

Under the master management agreement as well as the management agreement for the Crowne Plaza Tampa Westshore, MHI Hotels Services receives a base management fee. The base management fee for any hotel is 2.0% of gross revenues for the first full fiscal year and partial fiscal year from the commencement date through December 31 of that year, 2.5% of gross revenues the second full fiscal year, and 3.0% of gross revenues for every year thereafter. Under the management agreements for the Crowne Plaza Houston and the Georgian Terrace, MHI Hotels Services receives a base management fee of 2.0% of gross revenues.

The incentive management fee under the master management agreement is due annually in arrears within 90 days of the end of the fiscal year and will be equal to 10.0% of the amount by which the gross operating profit of the hotels, on an aggregate basis, for a given year exceeds the gross operating profit for the same hotels, on an aggregate basis, for the prior year. The incentive management fee may not exceed 0.25% of gross revenues of all of the hotels included in the incentive fee calculation. The management agreements for the Crowne Plaza Tampa Westshore and the Georgian Terrace include a similar provision for the payment of an incentive management fee on a stand-alone basis.

The management agreement for the Georgian Terrace also provides for an administrative fee of $30,000 per year for as long as the adjacent parking garage is managed by a third party.

Base management and administrative fees earned by MHI Hotels Services totaled $1,086,379 and $1,781,212 for the three months and six months ended June 30, 2014, respectively, and $752,698 and $1,353,313 for the three months and six months ended June 30, 2013, respectively. In addition, estimated incentive management fees of $92,621 and $99,893 were accrued for the three months and six months ended June 30, 2014, respectively, and estimated incentive management fees of $27,533 and $62,126 were accrued for the three months and six months ended June 30, 2013, respectively. We are in the process of renegotiating our management agreements with MHI Hotels Services.

Employee Medical Benefits – We purchase employee medical benefits through Maryland Hospitality, Inc. (d/b/a MHI Health), an affiliate of MHI Hotels Services, for our employees, as well as those employees that are employed by MHI Hotels

Services that work exclusively for our hotel properties. Gross premiums for employee medical benefits paid by the Company (before offset of employee co-payments) were $996,746 and $1,811,547 for the three months and six months ended June 30, 2014, respectively and $643,724 and $1,294,724 for the three months and six months ended June 30, 2013, respectively.

Redemption of Units in Operating Partnership. During 2013, 2012 and 2011, the Company redeemed a total of 24,600 units in the Operating Partnership held by a trust controlled by two current members and one former member of the Company’s board of directors for a total of $76,230 pursuant to the terms of the Partnership Agreement.

Issuance of Units in Operating Partnership. In connection with the acquisition of the Crowne Plaza Houston Downtown Hotel in November 2013, we purchased from MHI Hotels its 1.0% limited partnership interest in HHA, the entity that owns the property, in exchange for 32,929 units of limited partnership interests in the Company’s operating partnership valued at $153,636 pursuant to an exchange agreement entered into between the Operating Partnership and MHI Hotels. The indirect equity owners of MHI Hotels include the Company’s chief executive officer, Andrew M. Sims, and a member of the Company’s board of directors, Kim E. Sims.

Holders of the Preferred Stock and Essex Warrant. As set forth in the Articles Supplementary, the holders of Preferred Stock, Essex Illiquid, LLC and Richmond Hill Capital Partners, LLC, were entitled to elect one (1) member of the Company’s board of directors. The member of the board of directors elected by the holders of Preferred Stock holds executive positions in Essex Equity Capital Management, LLC, an affiliate of Essex Illiquid, LLC, as well as Richmond Hill Capital Partners, LLC.

Essex Warrant Redemptions. On October 23, 2013, the Company entered into an agreement to redeem the First Tranche of Redeemed Warrant Shares for an aggregate cash redemption price of $3.2 million. The First Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant were terminated and extinguished.

On December 23, 2013, the Company entered into an agreement to redeem the Final Tranche of Redeemed Warrant Shares for an aggregate cash redemption price of approximately $4.0 million. The Final Tranche of Redeemed Warrant Shares are no longer Issuable Warrant Shares under the Essex Warrant, and all exercise and other rights of the Initial Holders in respect of the Redeemed Warrant Shares under the Essex Warrant were terminated and extinguished.

Bridge Lenders. A former member of the Company’s board of directors holds executive positions in Essex Equity Capital Management, LLC, an affiliate of Essex Equity joint Investment Vehicle, LLC as well as Richmond Hill Capital Partners, LP. On March 26, 2014, we entered into a Note Agreement, Guaranty, and Pledge Agreement to secure a $19.0 million secured Bridge Loan with the Richmond Hill Capital Partners, LP and Essex Equity Joint Investment Vehicle, LLC. The Bridge Loan has a maturity date of March 26, 2015; carries a fixed interest rate of 10.0% per annum; is subject to a prepayment premium if the loan is prepaid in full or in part prior to March 26, 2015; requires mandatory prepayment upon certain events; contains limited financial covenants; and is secured by a lien on 100% of the limited partnership interests in the subsidiary that owns the Hilton Philadelphia Airport hotel.

Others. In June 2013, we hired Ashley S. Kirkland, the daughter of our Chief Executive Officer as a legal analyst and Robert E. Kirkland IV, her husband, as our compliance officer. Compensation for the three and six months ended June 30, 2014 totaled $33,287 and $65,617, respectively, and for the three and six months ended June 30, 2013 totaled $2,500, respectively, for both individuals.

10. Retirement Plan

We maintain a 401(k) plan for qualified employees which is subject to “safe harbor” provisions and which requires that we match 100.0% of the first 3.0% of employee contributions and 50.0% of the next 2.0% of employee contributions. All employer matching funds vest immediately in accordance with the “safe harbor” provision. Contributions to the plan totaled $17,106 and $31,553 for the three months and six months ended June 30, 2014, respectively, and $26,771 and $36,179 for the three months and six months ended June 30, 2013, respectively.

11. Unconsolidated Joint Venture

We own a 25.0% indirect interest in (i) the entity that owns the Crowne Plaza Hollywood Beach Resort and (ii) the entity that leases the hotel and has engaged MHI Hotels Services to operate the hotel under a management contract. Carlyle owns a 75.0% indirect controlling interest in all these entities. The joint venture purchased the property on August 8, 2007 and began operations on September 18, 2007. Summarized financial information for this investment, which is accounted for under the equity method, is as follows:


	*June 30, 2014*		*December 31, 2013*
*ASSETS*
Investment in hotel property, net	$	63,443,701	$	64,449,892
Cash and cash equivalents		1,881,881		2,896,841
Restricted cash		715,456		—
Accounts receivable, net		221,787		251,587
Prepaid expenses, inventory and other assets		1,827,342		1,335,472

*TOTAL ASSETS*	$	68,090,167	$	68,933,792

*LIABILITIES*
Mortgage loan, net	$	57,000,000	$	57,000,000
Accounts payable and other accrued liabilities		2,258,467		1,869,476
Advance deposits		394,323		280,339

*TOTAL LIABILITIES*		59,652,790		59,149,815

*TOTAL MEMBERS’ EQUITY*		8,437,377		9,783,977

*TOTAL LIABILITIES AND MEMBERS’ EQUITY*	$	68,090,167	$	68,933,792

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

Revenue

Rooms department

3,524,406

3,363,111

8,732,252

8,498,298

Food and beverage department

725,125

641,213

1,603,337

1,392,985

Other operating departments

359,121

384,740

702,368

785,964

Total revenue

4,608,652

4,389,064

11,037,957

10,677,247

Expenses

Hotel operating expenses

Rooms department

814,657

758,573

1,682,480

1,624,736

Food and beverage department

547,570

503,093

1,179,587

1,041,169

Other operating departments

163,879

149,145

326,446

289,890

Indirect

1,727,825

1,712,374

3,606,910

3,675,768

Total hotel operating expenses

3,253,931

3,123,185

6,795,423

6,631,563

Depreciation and amortization

555,272

533,550

1,110,008

1,073,955

General and administrative

96,884

20,382

233,596

57,843

Total operating expenses

3,906,087

3,677,117

8,139,027

7,763,361

Net operating income

702,565

711,947

2,898,930

2,913,886

Interest expense

(649,687

)

(435,448

)

(1,295,850

)

(867,723

)

Unrealized gain (loss) on hedging activities

—

73,008

—

182,302

Net income

52,878

349,507

1,603,080

2,228,465

12. Indirect Hotel Operating Expenses

Indirect hotel operating expenses consists of the following expenses incurred by the hotels:

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

General and administrative

2,772,076

1,904,382

4,793,073

3,559,576

Sales and marketing

2,648,968

1,976,735

4,740,190

3,713,767

Repairs and maintenance

1,647,141

1,160,057

2,975,656

2,251,966

Utilities

1,493,491

1,038,182

2,694,508

2,026,216

Franchise fees

1,105,391

900,948

1,989,697

1,594,353

Management fees, including incentive

1,086,379

780,231

1,781,212

1,415,440

Insurance

490,986

355,095

960,175

716,395

Property taxes

893,202

571,080

1,634,547

1,168,410

Other

52,276

69,849

104,726

125,495

Total indirect hotel operating expenses

12,189,910

8,756,559

21,673,784

16,571,618

13. Income Taxes

The components of the income tax (benefit) provision for the three and six months ended June 30, 2014 and 2013 are as follows:

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

Current:

Federal

—

17,400

23,000

50,501

State

115,489

55,762

115,489

56,575

115,489

73,162

138,489

107,076

Deferred:

Federal

497,327

880,363

(257,862

)

1,006,149

State

(49,034

)

158,293

(52,164

)

261,648

448,293

1,038,656

(310,026

)

1,267,797

563,782

1,111,818

(171,537

)

1,374,873

A reconciliation of the statutory federal income tax (benefit) provision to the Company’s income tax provision is as follows:

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

Statutory federal income tax expense (benefit)

1,127,555

956,375

1,218,333

(95,147

)

Effect of non-taxable REIT (income) loss

(630,228

)

(58,612

)

(1,453,195

)

1,151,797

State income tax expense (benefit)

66,455

214,055

63,325

318,223

563,782

1,111,818

(171,537

)

1,374,873

As of June 30, 2014 and December 31, 2013, we had a net deferred tax asset of approximately $1.5 million and $1.2 million, respectively, of which, approximately $1.1 million and $0.7 million, respectively, are due to accumulated net operating losses. These loss carryforwards will begin to expire in 2028 if not utilized by such time. As of each June 30, 2014 and December 31, 2013, approximately $0.3 million of the net deferred tax asset is attributable to our share of start-up expenses related to the Crowne Plaza Hollywood Beach Resort, start-up expenses related to the opening of the Sheraton Louisville Riverside and the Crowne Plaza Tampa Westshore that were not deductible in the year incurred, but are being amortized over 15 years. The remainder of the net deferred tax asset is attributable to year-to-year timing differences including accrued, but not deductible, employee performance awards, vacation and sick pay, bad debt allowance and depreciation. We believe that it is more likely than not that the deferred tax asset will be realized and that no valuation allowance is required.

14. Income (Loss) Per Share and Per Unit

Income (Loss) per Share. The limited partners’ outstanding limited partnership units in the Operating Partnership (which may be redeemed for common stock upon notice from the limited partners and following our election to redeem the units for stock rather than cash) have been excluded from the diluted earnings per share calculation as there would be no effect on the amounts since the limited partners’ share of income would also be added back to net income (loss). The computation of basic and diluted earnings per share is presented below.

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

Numerator

Net income (loss) attributable to the Company for basic computation

2,166,689

1,310,592

2,949,691

(1,284,325

)

Effect of the issuance of dilutive shares on the net loss attributable to the noncontrolling interest

—

40,725

—

Net income (loss) attributable to the Company for dilutive computation

2,166,689

1,351,317

2,949,691

(1,284,325

)

Denominator

Weighted average number of common shares outstanding for basic computation

10,353,677

10,156,927

10,290,047

10,118,862

Dilutive effect of warrants

—

975,615

—

Weighted average number common shares outstanding for dilutive computation

10,353,677

11,132,542

10,290,047

10,118,862

Basic net income (loss) per share

0.21

0.13

0.29

(0.13

)

Diluted net income (loss) per share

0.21

0.12

0.29

(0.13

)

Income (Loss) Per Unit – The computation of basic and diluted loss per unit is presented below.

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

(unaudited)

Numerator

Net income (loss)

2,752,555

1,701,050

3,754,869

(1,654,717

)

Effect of the issuance of dilutive warrants

—

19,401

—

Net income

2,752,555

1,720,451

3,754,869

(1,654,717

)

Denominator

Weighted average number of units outstanding

13,107,804

13,038,125

13,098,870

13,037,064

Dilutive effect of warrants

—

975,615

—

Weighted average number units outstanding for dilutive computation

13,107,804

14,013,740

13,098,870

13,037,064

Basic net income (loss) per unit

0.21

0.13

0.29

(0.13

)

Diluted net income (loss) per unit

0.21

0.12

0.29

(0.13

)

15. Subsequent Events

On July 11, 2014, we paid a quarterly dividend (distribution) of $0.050 per common share (and unit) to those stockholders (and unitholders of the Operating Partnership) of record on June 13, 2014.

On July 22, 2014, we authorized payment of a quarterly dividend (distribution) of $0.065 per common share (and unit) to the stockholders (and unitholders of the Operating Partnership) of record as of October 2, 2014. The dividend (distribution) is to be paid on October 15, 2014.

Item 2.

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

Overview

Sotherly Hotels Inc. is a self-managed and self-administered lodging REIT incorporated in Maryland in August 2004 to pursue opportunities in the full-service, primarily upscale and upper-upscale segments of the hotel industry located in primary and secondary markets in the Mid-Atlantic and Southern United States. Substantially all of the assets of Sotherly Hotels Inc. are held by, and all of its operations are conducted through, Sotherly Hotels LP, formerly MHI Hospitality, L. P. We commenced operations in December 2004 when we completed our initial public offering and thereafter consummated the acquisition of the initial properties.

Our hotel portfolio currently consists of twelve full-service, primarily upscale and upper-upscale hotels, with 3,009 rooms which primarily operate under well-known brands such as Hilton, Crowne Plaza, Sheraton and Holiday Inn. Eleven of these hotels, totaling 2,698 rooms, are 100% owned by subsidiaries of the Operating Partnership. We also own a 25.0% indirect noncontrolling interest in the Crowne Plaza Hollywood Beach Resort through a joint venture with Carlyle. As of June 30, 2014, we owned the following hotel properties:


Property	Number of Rooms		Location	Date of Acquisition	Chain Designation
Wholly-owned
Crowne Plaza Hampton Marina		173	Hampton, VA	April 24, 2008	Upscale
Crowne Plaza Houston Downtown		259	Houston, TX	November 13, 2013	Upscale
Crowne Plaza Jacksonville Riverfront		292	Jacksonville, FL	July 22, 2005	Upscale
Crowne Plaza Tampa Westshore		222	Tampa, FL	October 29, 2007	Upscale
DoubleTree by Hilton Brownstone-University		190	Raleigh, NC	December 21, 2004	Upscale
Georgian Terrace		326	Atlanta, GA	March 27, 2014	Independent
Hilton Philadelphia Airport		331	Philadelphia, PA	December 21, 2004	Upper Upscale
Hilton Savannah DeSoto		246	Savannah, GA	December 21, 2004	Upper Upscale
Hilton Wilmington Riverside		272	Wilmington, NC	December 21, 2004	Upper Upscale
Holiday Inn Laurel West		207	Laurel, MD	December 21, 2004	Upper Mid-Scale
Sheraton Louisville Riverside		180	Jeffersonville, IN	September 20, 2006	Upper Upscale

		2,698
Joint Venture Property
Crowne Plaza Hollywood Beach Resort⁽¹⁾		311	Hollywood, FL	August 9, 2007	Upscale

Total		3,009

(1)	We own this hotel through a joint venture in which we have a 25.0% interest.

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 79.0% interest in our Operating Partnership, with the remaining interest being held by limited partners who were the contributors of our initial properties and related assets.

To qualify as a REIT, we cannot operate hotels. Therefore, our wholly-owned hotel properties are leased to MHI Hospitality TRS, LLC (our “TRS Lessee”), which then engages an eligible independent hotel management company to operate the hotels under a management contract. Our TRS Lessee has engaged MHI Hotels Services to manage our wholly-owned 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, room revenue is considered the most important category of revenue and drives other revenue categories such as food, beverage, catering, parking, and telephone. There are three key performance indicators used in the hotel industry to measure room revenues:

•

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

•

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

•

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

RevPAR changes that are primarily driven by changes in occupancy have different implications for overall revenues and profitability than changes that are driven primarily by changes in ADR. For example, an increase in occupancy at a hotel would lead to additional variable operating costs (such as housekeeping services, laundry, utilities and room supplies), but could also result in increased non-room revenue from the hotel’s restaurant, banquet or parking facilities. Changes in RevPAR that are primarily driven by changes in ADR typically have a greater impact on operating margins and profitability as they do not generate all of the additional variable operating costs associated with higher occupancy.

Results of Operations

The following tables illustrate the key operating metrics for each of the three and six months ended June 30, 2014 and 2013 for our wholly-owned properties during each respective reporting period (“actual” properties) as well as the key operating metrics for the nine wholly-owned properties that were under our control during all of 2013 and the three months ended June 30, 2014 (“same-store” properties). Accordingly, the same-store data does not reflect the performance of the Crowne Plaza Houston Downtown, which was acquired in November 2013, or the Georgian Terrace, which was acquired in March 2014. Each table excludes performance data for the Crowne Plaza Hollywood Beach Resort, which was acquired through a joint venture and in which we have a 25.0% indirect interest.

Three months ended
June 30, 2014

Three months ended
June 30, 2013

Six months ended
June 30, 2014

Six months ended
June 30, 2013

Actual Portfolio Metrics

Occupancy %

77.1

73.7

72.5

69.7

ADR

134.24

128.02

128.33

121.54

RevPAR

103.52

94.40

93.07

84.72

Same Store Portfolio Metrics

Occupancy %

76.1

73.7

70.9

69.7

ADR

133.37

128.02

125.80

121.54

RevPAR

101.47

94.40

89.21

84.72

Comparison of the Three Months Ended June 30, 2014 to the Three Months Ended June 30, 2013

Revenue. Total revenue for the three months ended June 30, 2014 increased approximately $11.0 million, or 43.9%, to approximately $36.3 million compared to total revenue of approximately $25.3 million for the three months ended June 30, 2013. Increases in revenue at our properties in Savannah, Georgia; Raleigh, North Carolina; Jacksonville, Florida; Jeffersonville, Indiana; Tampa, Florida, Hampton, Virginia; plus the newly acquired properties in Houston, Texas and Atlanta, Georgia, were offset by decreases in revenue at the three remaining wholly-owned properties.

Room revenue increased approximately $7.2 million, or 40.0%, to approximately $25.4 million for the three months ended June 30, 2014 compared to room revenue of approximately $18.2 million for the three months ended June 30, 2013. The increase in room revenue for the three months ended June 30, 2014 resulted mainly from the acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $5.9 million for the period. In addition, favorable results from our same-store properties reflected a 3.2% increase in occupancy, a 4.2% increase in ADR and a 7.5% increase in RevPAR, as compared to the same period in 2013. Our property in Raleigh, North Carolina continues to experience a significant increase as a result of the rebranding to a DoubleTree by Hilton. Our properties in Savannah, Georgia; Jacksonville, Florida; Jeffersonville, Indiana; and Tampa, Florida also experienced significant increases in room revenue, offset by decreases at our properties in Philadelphia, Pennsylvania, Wilmington, North Carolina and Laurel, Maryland.

Food and beverage revenues increased approximately $3.0 million, or 51.0%, to approximately $9.0 million for the three months ended June 30, 2014 compared to food and beverage revenues of approximately $6.0 million for the three months ended June 30, 2013. The increase in food and beverage revenues for the three months ended June 30, 2014 resulted principally from our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $2.7 million for the period. Additional increases in food and beverage revenue at our properties in Savannah, Georgia; Tampa, Florida; Hampton, Virginia and Jacksonville, Florida were offset by decreases in banqueting revenue at our other properties.

Revenue from other operating departments increased approximately $0.8 million, or 69.4%, to approximately $1.9 million for the three months ended June 30, 2014 compared to revenue from other operating departments of approximately $1.1 million for the three months ended June 30, 2013.

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 $24.7 million for the three months ended June 30, 2014, an increase of approximately $7.6 million, or 44.4%, compared to total hotel operating expenses of approximately $17.1 million for the three months ended June 30, 2013. The increase in hotel operating expenses for the three months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $6.7 million in expenses for the three months ended June 30, 2014, coupled by an increase in hotel operating expenses at our same-store properties of approximately $0.9 million compared to the three months ended June 30, 2013.

Rooms expense for the three months ended June 30, 2014 increased approximately $1.7 million, or 37.6%, to approximately $6.3 million compared to rooms expense for the three months ended June 30, 2013 of approximately $4.6 million. The increase in rooms expense for the three months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for approximately $1.6 million of the increase.

Food and beverage expenses for the three months ended June 30, 2014 increased approximately $2.2 million, or 60.8%, to approximately $5.9 million compared to food and beverage expenses of approximately $3.7 million for the three months ended June 30, 2013. The increase in food and beverage expenses for the three months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, which accounted for approximately $2.0 million of the increase.

Indirect expenses at our wholly-owned properties for the three months ended June 30, 2014 increased approximately $3.4 million, or 39.2%, to approximately $12.2 million compared to indirect expenses of approximately $8.8 million for the three months ended June 30, 2013. The increase in indirect expenses for the three months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $2.8 million in indirect expenses for the three months ended June 30, 2014.

Depreciation and Amortization. Depreciation and amortization expense for the three months ended June 30, 2014 increased approximately $1.0 million, or 47.2%, to $3.0 million compared to depreciation and amortization of approximately $2.0 million for the three months ended June 30, 2013. The increase was mostly attributable to depreciation and amortization related to our properties in Houston, Texas and Atlanta, Georgia, which we acquired in November 2013 and March 2014, respectively.

Corporate General and Administrative. Corporate general and administrative expenses for the three months ended June 30, 2014 increased approximately $0.3 million, or 23.8%, to approximately $1.4 million compared to general and administrative expenses of approximately $1.1 million for the three months ended June 30, 2013. The increase primarily relates to additional legal and accounting fees.

Interest Expense. Interest expense for the three months ended June 30, 2014 increased approximately $1.6 million, or 68.3%, to approximately $3.9 million compared to interest expense of approximately $2.3 million for the three months ended June 30, 2013. The increase in interest expense for the three months ended June 30, 2014 was substantially related to the interest on the mortgage debt related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, as well as the unsecured notes we issued in September 2013 offset by the interest on the cumulative redeemable preferred stock which was fully redeemed in September 2013.

Equity Income in Joint Venture. Equity income in joint venture for the three months ended June 30, 2014 represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. For the three months ended June 30, 2014, we realized net income of approximately $0.0 million related to our 25.0% interest compared to net income of approximately $0.1 million for the three months ended June 30, 2013. For the three months ended June 30, 2014, the hotel reported occupancy of 83.1%, ADR of $149.90 and RevPAR of $124.53. This compares with results reported by the hotel for the three months ended June 30, 2013 of occupancy of 85.8%, ADR of $138.54 and RevPAR of $118.83.

Income Taxes. The income tax provision for the three months ended June 30, 2014 decreased approximately $0.5 million, or 49.3%, to approximately $0.6 million compared to an income tax provision of approximately $1.1 million for the three months ended June 30, 2013. The income tax provision is primarily derived from the operations of our TRS Lessee. Our TRS Lessee realized lower operating income for the three months ended June 30, 2014 compared to the three months ended June 30, 2013.

Net Income (Loss). We realized net income for the three months ended June 30, 2014 of approximately $2.8 million compared to total a net income of approximately $1.7 million for the three months ended June 30, 2013 as a result of the operating results discussed above.

Comparison of the Six Months Ended June 30, 2014 to the Six Months Ended June 30, 2013

Revenue. Total revenue for the six months ended June 30, 2014 increased approximately $16.0 million, or 35.0%, to approximately $61.4 million compared to total revenue of approximately $45.4 million for the six months ended June 30, 2013. Increases in revenue at our properties in Savannah, Georgia; Raleigh, North Carolina; Jacksonville, Florida; Jeffersonville, Indiana; Tampa, Florida and Hampton, Virginia; plus the newly acquired properties in Houston, Texas and Atlanta, Georgia, were offset by decreases in revenue at the three remaining wholly-owned properties.

Room revenue increased approximately $10.5 million, or 32.3%, to approximately $42.9 million for the six months ended June 30, 2014 compared to room revenue of approximately $32.4 million for the six months ended June 30, 2013 The increase in room revenue for the six months ended June 30, 2014 resulted mainly from the acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $8.8 million for the period. In addition, favorable results from our same-store properties reflected a 1.7% increase in occupancy, a 3.5% increase in ADR, and a 5.3% increase in RevPAR as compared to the same period in 2013. Our property in Raleigh, North Carolina continues to experience a significant increase as a result of the rebranding to a DoubleTree by Hilton. Our properties in Savannah, Georgia; Jacksonville, Florida; and Tampa, Florida also experienced a significant increase in room revenue, offset by decreases at our properties in Wilmington, North Carolina; Philadelphia, Pennsylvania; and Laurel, Maryland.

Food and beverage revenues increased approximately $4.5 million, or 41.1%, to approximately $15.3 million for the six months ended June 30, 2014 compared to food and beverage revenues of approximately $10.8 million for the six months ended June 30, 2013.

The increase in food and beverage revenues for the six months ended June 30, 2014 resulted principally from our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $3.9 million for the period. Additional increases in food and beverage revenue at our properties in; Savannah, Georgia; Tampa, Florida; Hampton, Virginia and Jacksonville, Florida were offset by decreases in banqueting revenue at our other properties.

Revenue from other operating departments increased approximately $1.0 million, or 45.1%, to approximately $3.2 million for the six months ended June 30, 2014 compared to revenue from other operating departments of approximately $2.2 million for the six months ended June 30, 2013.

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 $43.2 million for the six months ended June 30, 2014, an increase of approximately $10.9 million, or 33.9%, compared to total hotel operating expenses of approximately $32.3 million for the six months ended June 30, 2013. The increase in hotel operating expenses for the six months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $9.7 million in expenses for the six months ended June 30, 2014, coupled by an increase in hotel operating expenses at our same-store properties of approximately $1.2 million compared to the six months ended June 30, 2013.

Rooms expense for the six months ended June 30, 2014 increased approximately $2.4 million, or 28.6%, to approximately $11.0 million compared to rooms expense of approximately $8.6 million for the six months ended June 30, 2013. The increase in rooms expense for the six months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for approximately $2.3 million of the increase.

Food and beverage expenses for the six months ended June 30, 2014 increased approximately $3.1 million, or 44.7%, to approximately $10.0 million compared to food and beverage expenses of approximately $6.9 million for the six months ended June 30, 2013. The increase in food and beverage expenses for the six months ended June 30, 2014 was substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, which accounted for approximately $2.8 million of the increase.

Indirect expenses at our wholly-owned properties were approximately $21.7 million for the six months ended June 30, 2014, an increase of approximately $5.1 million, or 30.8%, compared to indirect expenses of approximately $16.6 million for the six months ended June 30, 2013. The increase in indirect expenses for the six months ended June 30, 2014 were substantially related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, accounting for an increase of approximately $4.3 million in indirect expenses for the six months ended June 30, 2014, coupled by an increase in indirect expenses at our same-store properties of approximately $0.8 million compared to the six months ended June 30, 2013.

Depreciation and Amortization. Depreciation and amortization expense for the six months ended June 30, 2014 increased approximately $1.3 million, or 32.8%, to $5.4 million compared to depreciation and amortization of approximately $4.1 million for the six months ended June 30, 2013. The increase was mostly attributable to depreciation and amortization related to our properties in Houston, Texas and Atlanta, Georgia, which we acquired in November 2013 and March 2014, respectively.

Corporate General and Administrative. Corporate general and administrative expenses for the six months ended June 30, 2014 increased approximately $0.5 million, or 21.7%, to approximately $2.7 million compared to corporate and general administrative expenses of approximately $2.2 million the six months ended June 30, 2013. The increase primarily relates to additional legal and accounting fees as well as costs associated with the acquisition of the Georgian Terrace.

Interest Expense. Interest expense for the six months ended June 30, 2014 increased approximately $1.8 million, or 35.8%, to approximately $6.8 million compared to interest expense of approximately $5.0 million for the six months ended June 30, 2013. The increase in interest expense for the six months ended June 30, 2014 was substantially related to the interest on the mortgage debt related to our recently acquired properties in Houston, Texas and Atlanta, Georgia, as well as the unsecured notes we issued in September 2013 offset by the interest on the cumulative redeemable preferred stock which was fully redeemed in September 2013.

Equity Income in Joint Venture. Equity income in joint venture for the six months ended June 30, 2014 represents our 25.0% share of the net income of the Crowne Plaza Hollywood Beach Resort. For the six months ended June 30, 2014, our 25.0% share of the net income of the hotel decreased approximately $0.2 million, or 27.3%, to approximately $0.4 million compared to net income of approximately $0.6 million for the six months ended June 30, 2013. The decrease primarily relates to higher mortgage interest expense within the joint venture related to the refinance of the mortgage in December 2013. For the six months ended June 30, 2014, the hotel reported occupancy of 86.3%, ADR of $179.69 and RevPAR of $155.13. This compares with results reported by the hotel for the six months ended June 30, 2013 of occupancy of 87.2%, ADR of $173.14 and RevPAR of $150.97.

Unrealized Loss on Warrant Derivative. There was no warrant derivative for the six months ended June 30, 2014 compared to an unrealized loss of approximately $2.7 million for the six months ended June 30, 2013.

Income Taxes. We had an income tax benefit of approximately $0.2 million for the six months ended June 30, 2014 compared to an income tax provision of approximately $1.4 million for the six months ended June 30, 2013. The income tax benefit (provision) is primarily derived from the operations of our TRS Lessee. Our TRS Lessee realized a taxable operating loss for the six months ended June 30, 2014 compared to taxable income for the six months ended June 30, 2013.

Net Income (Loss). We realized net income of approximately $3.8 million for the six months ended June 30, 2014 compared to a net loss of approximately $1.7 million for the six months ended June 30, 2013, as a result of the operating results discussed above.

Non-GAAP Financial Measures

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

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

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

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

The following is a reconciliation of net income (loss) to FFO and Adjusted FFO for the three and six months ended June 30, 2014 and 2013:

Three Months Ended
June 30, 2014

Three Months Ended
June 30, 2013

Six Months Ended
June 30, 2014

Six Months Ended
June 30, 2013

Net income (loss)

2,752,555

1,701,050

3,754,869

(1,654,717

)

Depreciation and amortization

2,988,968

2,031,050

5,423,296

4,083,871

Equity in depreciation and amortization of joint venture

138,818

133,387

277,502

268,489

FFO

5,880,341

3,865,487

9,455,667

2,697,643

Unrealized gain on hedging activities⁽¹⁾

—

(18,252

)

—

)

(45,575

)

Unrealized (gain)/loss on warrant derivative

—

(88,855

)

—

)

2,680,210

(Increase)/decrease in deferred income taxes

428,074

1,056,056

(307,245

)

1,317,752

Acquisition costs

—

155,187

—

Loss on early extinguishment of debt⁽²⁾

—

337,136

Adjusted FFO

6,308,415

4,814,436

9,303,609

6,987,166

(1)	Includes equity in unrealized loss on hedging activities of joint venture.

(2)	Reflected in interest expense for the periods presented above.

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

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

The following is a reconciliation of net loss to Hotel EBITDA for the three and six months ended June 30, 2014 and 2013:

Three Months Ended
June 30, 2014

Three Months Ended
June 30, 2013

Six Months Ended
June 30, 2014

Six Months Ended
June 30, 2013

Net income (loss)

2,752,555

1,701,050

3,754,869

(1,654,717

)

Interest expense

3,925,428

2,332,644

6,808,867

5,013,191

Interest income

(5,267

)

(3,654

)

(7,156

)

(7,559

)

Income tax provision (benefit)

563,782

1,111,818

(171,537

)

1,374,873

Depreciation and amortization

2,988,968

2,031,050

5,423,296

4,083,871

Equity in (earnings)/loss of joint venture

(17,417

)

(87,377

)

(404,968

)

(557,116

)

Unrealized (gain)/loss on warrant derivative

—

(88,855

)

—

2,680,210

Corporate general and administrative

1,391,206

1,123,684

2,698,997

2,217,471

Net lease rental income

(87,500

)

(87,500

)

(175,000

)

(175,000

)

Other fee income

(69,129

)

(65,835

)

(165,569

)

(160,159

)

Hotel EBITDA

11,442,626

7,967,025

17,761,799

12,815,065

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 six months ended June 30, 2014 was approximately $12.4 million. We expect that cash on hand and 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 (distributions) to the Company’s stockholders (and unitholders of the Operating Partnership) in accordance with federal income tax laws which require us to make annual distributions to the Company’s stockholders of at least 90% of its REIT taxable income (determined without regard to the dividends-paid deduction and by excluding its net capital gains, and reduced by certain non-cash items).

Investing Activities. In March 2014, we spent approximately $61.1 million to acquire the Georgian Terrace. We also spent approximately $2.6 million during the six months ended June 30, 2014 on capital expenditures, of which, approximately $1.0 million related to the routine replacement of furniture, fixtures and equipment and approximately $1.6 million related to renovation of our properties in Philadelphia, Pennsylvania and Jacksonville, Florida. We also contributed approximately $1.7 million during the six months ended June 30, 2014 into reserves required by the lenders for seven of our hotels according to the provisions of their respective loan agreements. During the six months ended June 30, 2014, we received reimbursements from those reserves of approximately $1.7 million for capital expenditures related to those properties for periods ending on or before December 31, 2013.

Financing Activities. On March 26, 2014, we borrowed $19.0 million from Richmond Hill Capital Partners, LP and Essex Equity Joint Investment Vehicle, LLC and used the net proceeds to fund a portion of the acquisition of the Georgian Terrace.

On March 27, 2014, we borrowed $41.5 million in conjunction with the purchase of the Georgian Terrace, of which $1.5 million was contributed to a restricted reserve.

On March 31, 2014, we entered into a First Amendment and other amended loan documents to secure additional proceeds in conjunction with a $5.6 million expansion of the existing mortgage on the Hilton Philadelphia Airport.

On June 27, 2014, we entered into an agreement with TowneBank to extend the maturity of the mortgage on the Crowne Plaza Hampton Marina in Hampton, Virginia, until June 30, 2016. Pursuant to those terms, we reduced the mortgage balance by $0.8 million.

Capital Expenditures

We anticipate that our need for recurring capital expenditures for the replacement and refurbishment of furniture, fixtures and equipment over the next 12 to 24 months will be at or lower than historical norms for our properties and the industry. Historically, we have aimed to maintain overall capital expenditures, except for those required by our franchisors as a condition to a franchise license or license renewal, at 4.0% of gross revenue. We expect capital expenditures of $3.2 million for 2014 related to the anticipated relicensing in October 2014 of the Hilton Philadelphia Airport as a DoubleTree by Hilton as well as an anticipated relicensing of the Crowne Plaza Jacksonville no later than April 2016. We also anticipate capital expenditures of approximately $1.0 million in 2014, at our property in Houston, Texas other than for the recurring replacement of furniture, fixtures and equipment. Lastly, we also anticipate capital expenditures of approximately $2.0 million in 2014, for our property in Atlanta, Georgia, other than for the recurring replacement of furniture, fixtures and equipment, the funds for which were contributed into a restricted reserve out of the proceeds of the mortgage.

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

We expect capital expenditures for the recurring replacement or refurbishment of furniture, fixtures and equipment at our properties will be funded by our replacement reserve accounts, other than costs that we incur to make capital improvements required by our franchisors. Reserve accounts are escrowed accounts with funds 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, the DoubleTree by Hilton Raleigh Brownstone-University, the Sheraton Louisville Riverside, the Crowne Plaza Houston Downtown and the Georgian Terrace as well as 4.0% of room revenues for the Hilton Philadelphia Airport on a monthly basis.

Liquidity and Capital Resources

As of June 30, 2014, we had total cash of approximately $24.3 million, of which approximately $17.9 million was in cash and cash equivalents and approximately $6.4 million was restricted for real estate taxes, insurance, capital improvement and certain other expenses, or otherwise restricted. We expect that our cash on hand combined with our cash flow from the operations of our hotels should be adequate to fund continuing operations, recurring capital expenditures for the refurbishment and replacement of furniture, fixtures and equipment, and monthly and quarterly scheduled payments of principal and interest (excluding any balloon payments due upon maturity of the Bridge Loan, the indenture or mortgage debt).

On March 31, 2014, we entered into a First Amendment and other amended loan documents to extend the maturity date and secure additional proceeds on the original $30.0 million mortgage on the Hilton Philadelphia Airport with its existing lender, TD Bank, N.A. Pursuant to the First Amendment and other amended loan documents, the principal balance of the mortgage was increased by $5.6 million to approximately $34.1 million and the maturity extended to April 1, 2019, with no prepayment penalty.

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

We believe there will be more opportunities to acquire properties in the future that meet our strategic goals and provide attractive long term returns. Given the potential for attractive acquisitions emerging from the recent economic downturn, we intend to pursue the acquisition of wholly-owned properties, additional and permissible joint venture investments as well as equity or debt

financing in the future to enable us to take advantage of such opportunities. However, should additional and permissible joint venture transactions and equity or debt financing not be available on acceptable terms, we may not be able to take advantage of such opportunities.

Beyond the funding of any required principal reduction on our existing indebtedness or acquisitions, our medium and long-term needs will generally include the repayment of the Notes (which are callable after September 30, 2016) and the retirement of maturing mortgage debt. In addition, we will be required to repay the Bridge Financing which matures in March 2015. We remain committed to a flexible capital structure. Accordingly, we expect to meet these needs through a combination of some or all of 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.

Financial Covenants

Mortgage Loans

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

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

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

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

As of June 30, 2014, we were in compliance with all debt covenants, current on all loan payments and not otherwise in default under any of our mortgage loans.

Unsecured Notes

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

These financial measures are not calculated in accordance with GAAP and are presented below for the sole purpose of evaluating our compliance with the key financial covenants as they were applicable at June 30, 2014 and December 31, 2013, respectively.


	June 30, 2014			December 31, 2013
Ratio of Stabilized Consolidated Income Available for Debt Service to Stabilized Consolidated Interest Expense
Net income (loss)⁽¹⁾	$	974,400		$	(4,435,185	)
Interest expense⁽¹⁾		13,442,816			11,647,141
Income tax (benefit) provision ⁽¹⁾		(25,228	)		1,521,182
Equity in (income) loss of joint venture⁽¹⁾		(301,552	)		(453,700	)
Realized and unrealized (gain) loss on warrant derivative⁽¹⁾		(474,962	)		2,205,248
Impairment of investment in hotel properties, net⁽¹⁾		611,000			611,000
Depreciation and amortization⁽¹⁾		9,806,654			8,467,228
Corporate general and administrative expenses⁽¹⁾		4,842,108			4,360,583

Consolidated Income Available for Debt Service⁽¹⁾	$	28,875,236		$	23,923,497
Less: Income of Non-Stabilized Assets ⁽¹⁾⁽²⁾		(4,041,524	)		(223,541	)

Stabilized Consolidated Income Available for Debt Service ⁽¹⁾	$	24,833,712		$	23,699,956

Interest expense⁽¹⁾		13,442,816			11,647,141
Distributions on Preferred Interest⁽¹⁾⁽³⁾		(1,199,531	)		(2,230,806	)
Amortization of issuance costs⁽¹⁾⁽³⁾		(1,779,862	)		(1,518,556	)

Consolidated Interest Expense⁽¹⁾	$	10,463,423		$	7,897,779
Less: Interest expense of Non-Stabilized Assets⁽¹⁾⁽²⁾		(924,561	)		(131,410	)

Stabilized Consolidated Interest Expense⁽¹⁾	$	9,538,862		$	7,766,369

Ratio of Stabilized Consolidated Income Available for Debt Service to Stabilized Consolidated Interest Expense		2.60			3.05

Ratio of Debt to Adjusted Total Asset Value:
Mortgage loans	$	204,751,451		$	160,363,549
Loans payable		19,000,000			—
Unsecured notes		27,600,000			27,600,000

Total debt	$	251,351,451			187,963,549

Stabilized Consolidated Income Available for Debt Service⁽¹⁾⁽²⁾	$	24,833,712		$	23,699,956
Capitalization Rate		7.5	%		7.5	%

		331,116,160			315,999,415
Non-Stabilized Assets		100,040,000			35,000,000
Total cash		24,289,366			13,172,769

Adjusted Total Asset Value	$	455,445,526		$	364,172,184

Ratio of Debt to Adjusted Total Asset Value		0.55			0.52

(1)	Represents the four preceding calendar quarters.

(2)	As permitted by the indenture, the Crowne Plaza Houston Downtown and the Georgian Terrace are considered non-stabilized assets for purposes of the financial covenants.

(3)	Includes prepayment fee and write-off of unamortized issuance costs associated with the redemptions of Preferred Stock and Preferred Interest during the period.

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. In July 2011, in part due to improving operating trends, we reevaluated our quarterly dividend policy and reinstated our quarterly common stock dividend (distribution).

In April 2014, we increased the quarterly dividend (distribution) to $0.050 per common share (and unit).

In July 2014, we increased the quarterly dividend (distribution) to $0.065 per common share (and unit).

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

Off-Balance Sheet Arrangements

Through a joint venture with Carlyle, 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 $57.0 million mortgage which matures in December 2016, requires monthly payments of interest at a rate of LIBOR plus additional interest of 3.95%. The Crowne Plaza Hollywood Beach Resort secures the mortgage.

Carlyle owns a 75.0% controlling interest in the JV Owner and the Joint Venture Lessee. 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 company to increase revenues and to keep pace with inflation. Operators of hotels, in general, possess the ability to adjust room rates daily to keep pace with inflation. However, competitive pressures at some or all of our hotels may limit the ability of the management company to raise room rates.

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

Geographic Concentration and Seasonality

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

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

Critical Accounting Policies

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

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

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

There were no charges for impairment of hotel properties recorded for the six months ended June 30, 2014.

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

Revenue Recognition. Hotel Revenues, including room, food, beverage and other revenues, are recognized as the related services are delivered. We generally expect to collect all receivables from customers to whom we have extended credit. If we determine that amounts due on certain accounts are uncollectible, such amounts are written off in the period such determination is made.

Income Taxes. We record a valuation allowance to reduce deferred tax assets to an amount that we believe is more likely than not to be realized. Because of expected future taxable income of our TRS Lessee, we have not recorded a valuation allowance to reduce our net deferred tax asset as of June 30, 2014. Should our estimate of future taxable income be less than expected, we would record an adjustment to the net deferred tax asset in the period such determination was made.

Recent Accounting Pronouncements

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

Forward Looking Statements

Information included and incorporated by reference in this Form 10-Q may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and as such may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe our current strategies, expectations, and future plans are generally identified by our use of words, such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,”

“anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity,” and similar expressions, whether in the negative or affirmative, but the absence of these words does not necessarily mean that a statement is not forward-looking. All statements regarding our expected financial position, business and financing plans are forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

•

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

•

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

•

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

•

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

•

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

•

management and performance of our hotels;

•

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

•

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

•

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

•

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

•

our ability to successfully expand into new markets;

•

legislative/regulatory changes, including changes to laws governing taxation of REITs;

•

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

•

our ability to maintain adequate insurance coverage.

Additional factors that could cause actual results to vary from our forward-looking statements are set forth under the section titled “Risk Factors” in our Annual Report on Form 10-K and subsequent reports filed with the Securities and Exchange Commission.

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

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

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

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

As of June 30, 2014, we had approximately $162.4 million of fixed-rate debt and approximately $88.9 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 6.45%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt, but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the changes in 1-month and 3-month LIBOR. However, to the extent that 1-month LIBOR does not exceed the 1-month LIBOR floors on the mortgage on the Hilton Philadelphia Airport of 0.50% and to the extent that 3-month LIBOR does not exceed the 3-month LIBOR floor on the mortgage on the Georgian Terrace of 0.25%, a portion of our

variable-rate debt would not be exposed to changes in interest rates. Assuming that the aggregate amount outstanding on the mortgage on the Hilton Philadelphia Airport, the mortgage on the Crowne Plaza Jacksonville Riverfront and the mortgage on the Georgian Terrace remains at approximately $88.9 million, the balance at June 30, 2014, the impact on our annual interest incurred and cash flows of a one percent increase in 1-month LIBOR and 3-month LIBOR would be approximately $772,000.

As of December 31, 2013, we had approximately $139.6 million of fixed-rate debt and approximately $48.4 million of variable-rate debt. The weighted-average interest rate on the fixed-rate debt was 6.01%. A change in market interest rates on the fixed portion of our debt would impact the fair value of the debt, but have no impact on interest incurred or cash flows. Our variable-rate debt is exposed to changes in interest rates, specifically the change in 1-month LIBOR. However, to the extent that 1-month LIBOR does not exceed the 1-month LIBOR floors on the mortgages on the Crowne Plaza Hampton Marina and the Hilton Philadelphia Airport of 0.45% and 0.50%, respectively, a portion of our variable-rate debt would not be exposed to changes in interest rates. Assuming that the aggregate amount outstanding on the mortgage on the Crowne Plaza Hampton Marina, the mortgage on the Hilton Philadelphia Airport and the mortgage on the Crowne Plaza Jacksonville Riverfront remains at approximately $48.4 million, the balance at December 31, 2013, the impact on our annual interest incurred and cash flows of a one percent increase in 1-monthy LIBOR would be approximately $372,000.

Item 4.

Controls and Procedures

Sotherly Hotels Inc.

The Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc. have evaluated the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act, and have concluded that as of the end of the period covered by this report, the disclosure controls and procedures of the Company were effective.

As of June 30, 2014, there was no change in either the internal control over financial reporting of Sotherly Hotels Inc. identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotel Inc.’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels Inc.’s internal control over financial reporting.

Sotherly Hotels LP

The Chief Executive Officer and Chief Financial Officer of Sotherly Hotels Inc., as general partner of Sotherly Hotels LP, have evaluated the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act, and have concluded that as of the end of the period covered by this report, the disclosure controls and procedures of the Operating Partnership were effective.

As of June 30, 2014, there was no change in either the internal control over financial reporting of Sotherly Hotels LP identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Sotherly Hotel LP’s last fiscal quarter that materially affected, or is reasonably likely to materially affect, Sotherly Hotels LP’s internal control over financial reporting.

PART II

Item 1.

Legal Proceedings

We are not involved in any legal proceedings other than routine legal proceedings occurring in the ordinary course of business. We believe that these routine legal proceedings, in the aggregate, are not material to our financial condition and results of operations.

Item 1A.

Risk Factors

There have been no material changes in our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2013.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

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

Item 3.

Defaults Upon Senior Securities

Not applicable.

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits

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


Exhibit Number		Description of Exhibit

3.1		Articles of Amendment and Restatement of the Company.⁽¹⁾

3.3		Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽²⁾

3.4		Articles Supplementary of the Company.⁽³⁾

3.6		Amendment No. 1 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽³⁾

3.7		Articles of Amendment to the Articles of Amendment and Restatement of the Company, effective as of April 16, 2013.⁽⁴⁾

3.8		Second Amended and Restated Bylaws of the Company, effective as of April 16, 2013.⁽⁴⁾

3.9		Amendment No. 2 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽⁵⁾

4.6		Senior Unsecured Note issued by Sotherly Hotels LP.⁽⁶⁾

4.7		Indenture by and among Sotherly Hotels LP and Wilmington Trust, National Association, as trustee.⁽⁶⁾


Exhibit Number		Description of Exhibit

10.51		Sales Agency Agreement, dated July 9, 2014, among Sotherly Hotels Inc., Sotherly Hotels LP and Sandler O’Neill & Partners, L.P.⁽⁷⁾

31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.3		Certification of Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

31.4		Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.3		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.4		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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

(2)	Incorporated by reference to the document previously filed as an exhibit to Sotherly’s Pre-Effective Amendment No. 5 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on December 13, 2004. (333-118873)

(3)	Incorporated by reference to the document previously filed as an exhibit to Sotherly’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 18, 2011.

(4)	Incorporated by reference to the document previously filed as an exhibit to the Sotherly’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 16, 2013.

(5)	Incorporated by reference to the document previously filed as an exhibit to the Operating Partnership’s Pre-Effective Amendment No. 1 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on August 9, 2013. (333-189821).

(6)	Incorporated by reference to the document previously filed as an exhibit to our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 7, 2013.

(7)	Incorporated by reference to the document previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 9, 2014.

SIGNATURES

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


	SOTHERLY HOTELS INC.

Date: August 6, 2014	By:	/s/ Andrew M. Sims
		Andrew M. Sims
		Chief Executive Officer

	By:	/s/ Anthony E. Domalski
		Anthony E. Domalski
		Chief Financial Officer

SIGNATURES


	SOTHERLY HOTELS LP

	By:	SOTHERLY HOTELS INC. Its General Partner

Date: August 6, 2014	By:	/s/ Andrew M. Sims
		Andrew M. Sims
		Chief Executive Officer

	By:	/s/ Anthony E. Domalski
		Anthony E. Domalski
		Chief Financial Officer

EXHIBIT INDEX


Exhibit Number		Description of Exhibit

3.1		Articles of Amendment and Restatement of the Company.⁽¹⁾

3.3		Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽²⁾

3.4		Articles Supplementary of the Company.⁽³⁾

3.6		Amendment No. 1 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽³⁾

3.7		Articles of Amendment to the Articles of Amendment and Restatement of the Company, effective as of April 16, 2013.⁽⁴⁾

3.8		Second Amended and Restated Bylaws of the Company, effective as of April 16, 2013.⁽⁴⁾

3.9		Amendment No. 2 to the Amended and Restated Agreement of Limited Partnership of Sotherly Hotels LP.⁽⁵⁾

4.6		Senior Unsecured Note issued by Sotherly Hotels LP.⁽⁶⁾

4.7		Indenture by and among Sotherly Hotels LP and Wilmington Trust, National Association, as trustee.⁽⁶⁾

10.51		Sales Agency Agreement, dated July 9, 2014, among Sotherly Hotels Inc., Sotherly Hotels LP and Sandler O’Neill & Partners, L.P.⁽⁷⁾

31.1		Certification of Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Company.

31.3		Certification of Chief Executive Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

31.4		Certification of Chief Financial Officer pursuant to Exchange Act Rules Rule 13(a)-14 and 15(d)-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Company.

32.3		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.

32.4		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for the Operating Partnership.


Exhibit Number		Description of Exhibit

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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

(2)	Incorporated by reference to the document previously filed as an exhibit to Sotherly’s Pre-Effective Amendment No. 5 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on December 13, 2004. (333-118873)

(3)	Incorporated by reference to the document previously filed as an exhibit to Sotherly’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 18, 2011.

(4)	Incorporated by reference to the document previously filed as an exhibit to the Sotherly’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 16, 2013.

(5)	Incorporated by reference to the document previously filed as an exhibit to the Operating Partnership’s Pre-Effective Amendment No. 1 to its Registration Statement on Form S-11 filed with the Securities and Exchange Commission on August 9, 2013. (333-189821).

(6)	Incorporated by reference to the document previously filed as an exhibit to our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 7, 2013.

(7)	Incorporated by reference to the document previously filed as an exhibit to our Current Report on Form 8-K filed with the Securities and Exchange Commission on July 9, 2014.