10-K 1 d658368d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

(Mark One)

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

For the fiscal year ended December 31, 2013

or

 

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

For the transition period from                      to                     

Commission file number: 001-33738

 

 

Morgans Hotel Group Co.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   16-1736884

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

475 Tenth Avenue

New York, New York

  10018
(Address of principal executive offices)   (Zip Code)

(212) 277-4100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.01 par value   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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 Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant was approximately $218,452,534, based on a closing sale price of $8.06 as reported on the NASDAQ Global Market (formerly the NASDAQ National Market) on June 28, 2013.

As of March 12, 2014, the registrant had issued and outstanding 33,777,062 shares of common stock, par value $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Morgans Hotel Group Co.’s Proxy Statement in connection with its Annual Meeting of Stockholders to be held in 2014 are incorporated by reference into Part III of this report.

 

 

 


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INDEX

 

     Page  
PART I   

ITEM 1 BUSINESS

     5   

ITEM 1A RISK FACTORS

     16   

ITEM 1B UNRESOLVED STAFF COMMENTS

     37   

ITEM 2 PROPERTIES

     38   

ITEM 3 LEGAL PROCEEDINGS

     45   

ITEM 4 MINE SAFETY DISCLOSURES

     49   
PART II   

ITEM  5 MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     50   

ITEM 6 SELECTED FINANCIAL DATA

     52   

ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     54   

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     88   

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     90   

ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     90   

ITEM 9A CONTROLS AND PROCEDURES

     90   

ITEM 9B OTHER INFORMATION

     93   
PART III   

ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

     94   

ITEM 11 EXECUTIVE COMPENSATION

     94   

ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     94   

ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

     94   

ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES

     94   
PART IV   

ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

     95   

 

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FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things, the operating performance of our investments and financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. References to “we,” “our” and the “Company” refer to Morgans Hotel Group Co. together in each case with our consolidated subsidiaries and any predecessor entities unless the context suggests otherwise.

The forward-looking statements contained in this Annual Report on Form 10-K reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ materially from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important risks and factors that could cause our actual results to differ materially from those expressed in any forward-looking statements include, but are not limited to economic, business, competitive market and regulatory conditions such as:

 

    a sustained downturn in economic and market conditions, both in the U.S. and internationally, particularly as it impacts demand for travel, hotels, dining and entertainment;

 

    our levels of debt, our ability to refinance our current outstanding debt, repay outstanding debt or make payments on guaranties as they may become due, general volatility of the capital markets and our ability to access the capital markets, and the ability of our joint ventures to do the foregoing;

 

    the impact of financial and other covenants in our loan agreements and other debt instruments that limit our ability to borrow and restrict our operations;

 

    our history of losses;

 

    our ability to compete in the “boutique” or “lifestyle” hotel segments of the hospitality industry and changes in the competitive environment in our industry and the markets where we invest;

 

    our ability to protect the value of our name, image and brands and our intellectual property;

 

    risks related to natural disasters, terrorist attacks, the threat of terrorist attacks and similar disasters;

 

    risks related to our international operations, such as global economic conditions, political or economic instability, compliance with foreign regulations and satisfaction of international business and workplace requirements;

 

    our ability to timely fund the renovations and capital improvements necessary to maintain our properties at the quality of the Morgans Hotel Group and associated brands;

 

    risks associated with the acquisition, development and integration of properties and businesses;

 

    the risks of conducting business through joint venture entities over which we may not have full control;

 

    our ability to perform under management agreements and to resolve any disputes with owners of properties that we manage but do not wholly own;

 

    potential terminations of management agreements;

 

    the impact of any material litigation, claims or disputes, including labor disputes;

 

    the seasonal nature of the hospitality business and other aspects of the hospitality industry that are beyond our control;

 

    our ability to comply with complex U.S. and international regulations, including regulations related to the environment, labor, food and beverage operations and data privacy;

 

    ownership of a substantial block of our common stock by a small number of outside investors and the ability of such investors to influence key decisions;

 

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    the impact of any dividend payments or accruals on our preferred securities on our cash flow and the value of our common stock; and

 

    other risks discussed in this Annual Report on Form 10-K in the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Result of Operations.”

We are under no duty to update any of the forward-looking statements after the date of this Annual Report on Form 10-K to conform these statements to actual results.

 

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PART I

 

ITEM 1. BUSINESS

Overview

Morgans Hotel Group Co. is a fully integrated lifestyle hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations, and nightclubs, restaurants, bars and other food and beverage venues in many of the hotels we operate, as well as in hotels and casinos operated by MGM Resorts International (“MGM”) in Las Vegas.

At December 31, 2013, our portfolio of Morgans Hotel Group branded hotel properties and food and beverage operations and entities consisted of:

 

    three hotels that we own and manage (“Owned Hotels”), consisting of Hudson in New York, Delano South Beach in Miami Beach, and Clift in San Francisco (which we lease under a long-term lease that is treated as a financing), comprising approximately 1,400 rooms;

 

    our wholly-owned food and beverage operations (“Owned F&B Operations”), consisting of the food and beverage operations in our Owned Hotels, certain food and beverage operations located at Sanderson and St Martins Lane, both in London, and three food and beverage venues at Mandalay Bay in Las Vegas;

 

    two hotels that we partially own and manage pursuant to long-term management agreements (“Joint Venture Hotels”), consisting of Mondrian South Beach in Miami Beach and Mondrian SoHo in New York, comprising approximately 500 rooms and our investment in certain unconsolidated food and beverage operations at Mondrian South Beach in Miami Beach (“F&B Venture”);

 

    six hotels that we manage pursuant to long-term management agreements with no ownership interest (“Managed Hotels”), consisting of Royalton and Morgans in New York, Shore Club in Miami Beach, Mondrian in Los Angeles, and Sanderson and St Martins Lane in London, comprising approximately 1,200 rooms;

 

    our 90% controlling interest in TLG Acquisition LLC (“TLG Acquisition,” and together with its subsidiaries, collectively The Light Group (“TLG”)), which owns and operates certain locations of our nightclub and food and beverage management business. TLG develops, redevelops and operates numerous venues primarily in Las Vegas pursuant to management agreements with MGM, including nightclubs, restaurants, pool lounges and bars; and

 

    our investments in hotels under development and other proposed properties.

In addition to our current portfolio, we expect to manage, own, acquire, redevelop, and develop new hotel properties that are consistent with our portfolio in major metropolitan cities and select resort markets in North America, Europe and other select international destinations. We currently have signed management agreements to manage four hotels that are financed and under construction, consisting of a Mondrian project in London, a Mondrian project in The Bahamas, a Mondrian project in Doha, Qatar, and a Delano project in Moscow. We also have signed management agreements to manage three other hotels that are in earlier stages of development, and for which financing has not yet been obtained. Additionally, we have a license agreement with MGM for a Delano in Las Vegas following a renovation and conversion of MGM’s THEhotel, which is scheduled to open in the fall of 2014, and a franchise agreement for a Morgans Original in Istanbul, Turkey, which is scheduled to open in late 2014. There can be no assurances that any or all of these projects will be developed as planned.

We conduct our operations through Morgans Group LLC, a Delaware limited liability company and our operating company (“Morgans Group”). Morgans Group holds substantially all of our assets. We are the managing member of Morgans Group and held approximately 99.8% of its membership units at December 31, 2013, excluding long-term incentive plan units (“LTIP Units”) convertible into membership units issued as part of our employee compensation plans. We manage all aspects of Morgans Group, including the operation, development, sale and purchase of, and investments in, hotels primarily through subsidiaries, including our management company, Morgans Hotel Group Management LLC (“Morgans Management”), and certain non-U.S. management company affiliates, and the operation and development of various food and beverage venues. As of December 31, 2013, there were 75,446 remaining membership units in Morgans Group, other than LTIP Units, which are owned by Residual Hotel Interest, LLC or its affiliates and are exchangeable for our common stock.

 

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We were incorporated in Delaware in October 2005 and completed our initial public offering of common stock (“IPO”) on February 17, 2006. Our corporate offices are located at 475 Tenth Avenue, New York, New York 10018. Our telephone number is (212) 277-4100. We maintain a website that contains information about us at www.morganshotelgroup.com.

Corporate Strategy

Our corporate strategy is to achieve growth as a boutique hotel management and brand company by leveraging our management experience and one-of-a-kind luxury brands for expansion into both domestic and international markets. We intend to achieve growth primarily through the pursuit of new long-term management agreements and, in select situations where third-party managers have the experience and resources to satisfy our high branding standards, franchise agreements. We also intend to enhance the value of our existing hotels and management agreements through targeted renovation and expansion projects. We believe that by pursuing this targeted strategy, while remaining open and flexible to unique opportunities, we will strengthen our position as a leader in lifestyle hospitality management.

Cultivate Unique Brands. A key element of our growth strategy is our unique brand portfolio, which we continue to cultivate and develop. Many of our brands, including hotel brands such as Delano, Mondrian and Hudson, may be extended to other hotels, restaurants and bars in existing and new markets, providing a competitive advantage as we seek to secure new management agreements with third parties.

Unlike traditional franchised or large brand-managed hotels, we believe our portfolio of boutique hotel brands provides guests with a distinctive lodging experience. Each of our Morgans Hotel Group branded hotels has a personality specifically tailored to reflect the local market environment and features a modern, sophisticated design that includes critically acclaimed public spaces, popular “destination” bars and restaurants and highly personalized service. Significant media attention has been devoted to our hotels, which we believe is the result of their distinctive nature, renowned design, dynamic and exciting atmosphere, celebrity guests and high-profile events. We believe that the Morgans Hotel Group brand and each of our individual property brands are synonymous with style, innovation and service, and that this distinctive combination of lodging and social experiences, which customers associate with our brands, increases our occupancy levels, pricing power and ability to secure new management agreements.

We also have a portfolio of original brands, which currently include Sanderson, St Martins Lane, Morgans, and Clift. Each of these hotel brands is unique, offering an atmosphere filled with designs from an eclectic mix of designers, artists and influencers and our signature personalized service.

Pursue New Management and Franchise Opportunities. As part of our growth strategy, we shifted towards a more “asset light” business model in 2011 by selling five hotels we had previously owned or partially owned while retaining management pursuant to long-term management agreements. We may engage in further asset sales, depending on market opportunities and other factors.

In addition, consistent with our growing focus on management opportunities, we continue to pursue new management contracts in new and existing markets, with the goal of strengthening our profit margins by maximizing revenue, increasing our market share and managing costs. We base our decisions to enter new markets on a number of criteria, with a focus on markets that attract affluent travelers who value a distinctive and sophisticated atmosphere and outstanding service. Specifically, we target key gateway destinations that attract both domestic and foreign business and leisure travelers, as well as select resort markets. Consistent with our prior expansion activities, we will continue to seek growth primarily in markets with multiple demand drivers and high barriers to entry, including major North American metropolitan markets with vibrant urban locations, select resort locations, key European destinations that we believe offer a similar customer base as our established United States and United Kingdom markets, and select locations in the Middle East, Asia and South America. As part of our pursuit of new management contracts, we may continue to make strategic monetary investments to obtain new management agreements in the form of key money and equity investments.

 

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In July 2013, we entered into a hotel management agreement for an approximately 211-room Delano-branded hotel to be located in Cartagena, Colombia. Upon completion and opening of the hotel, which is expected to include some condominium hotel units for sale, we will operate the hotel pursuant to a 20-year management agreement, with one 10-year extension option. The hotel is scheduled to open in 2016.

In addition, we may pursue license or franchise opportunities with third-party managers who have the experience and resources to satisfy our high brand standards. We believe we can create substantial value for potential franchisees through connection to our loyal and affluent customer base, creation of unique designs through interaction and direction with our design team, creation of valuable food and beverage destinations through interaction and direction with our food and beverage team, and unique marketing of the hotel through interaction and direction with our brand marketing team. For example, in January 2014, we signed a 15-year franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey. The hotel is expected to have 78 rooms and open in late 2014.

As a result of our growth and expansion efforts, we now have signed hotel management agreements for seven hotels and license or franchise agreements for two additional hotels with five of these hotels scheduled to open in the next twelve months. Six of these hotels already have financing for construction or redevelopment, although there can be no assurance that any or all of these hotel projects will be completed as scheduled or at all. Given the lingering effects of the economic disruptions that have occurred in recent years and the potential for future disruptions in the global economic environment, these and other projects may not be able to obtain adequate project financing in a timely manner or at all. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, and to the extent we have previously funded key money, an equity investment or debt financing on a cancelled project, we may be unable to recover the amounts funded.

For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the hotel, in early 2014, we exercised a put option under our Mondrian Istanbul joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We do not currently anticipate that these proceeding will have an impact on our management agreement should the hotel development continue.

The following table summarizes our signed management and franchise agreements by brand as of March 1, 2014:

 

     Expected Room
Count
     Anticipated
Opening
 

Delano:

     

Delano Las Vegas (1)

     1,114         2014   

Delano Moscow

     160         2015   

Delano Cartagena

     211      

Delano Aegean Sea

     150      

Mondrian:

     

Mondrian Doha

     270         2014   

Mondrian London

     360         2014   

Mondrian at Baha Mar

     310         2015   

Mondrian Istanbul

     105      

Originals:

     

Istanbul (1)

     78         2014   

 

(1) Subject to franchise or license agreements.

 

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Enhance Value Through Targeted Renovations and Expansions. We believe that investing in our properties yields long-term results. Together with our third party hotel owners or partners, we will continue to pursue targeted projects throughout our portfolio of hotels that we believe will increase our appeal to potential guests, improve revenue generation potential and enhance the value of our existing properties. While upgrades and repositioning efforts can impact the financial performance of our hotels in the short-term, we believe they are essential to ensure our hotel properties and food and beverage offerings continue to meet the expectations of our guests and the high standards of our brands.

During 2012 and 2013, we focused on upgrading the guestrooms and repositioning our food and beverage offerings at Hudson, our largest fee-owned hotel. We spent most of 2012 renovating all the guestrooms, which we completed in September 2012. We also converted 32 single room dwelling (“SRO”) units into guest rooms. Twenty-six SRO units were converted in 2012 and 6 were converted in January 2013, at an estimated cost of approximately $150,000 per room, bringing the total number of rooms at Hudson to 866 as of January 31, 2013. Additionally, in February 2013, we opened a new restaurant at Hudson, Hudson Commons, which is a modern-day beer hall and burger joint featuring a wide selection of local craft beers, inventive preparations of classic American fare, and soda shop-inspired specialty cocktails. In September 2013, we opened Henry, a seasonal cocktail bar and lounge with an inventive and experimental mixology program. Additionally, in 2014, we plan to convert an additional nine SRO units into 11 new guest rooms. We anticipate these 11 new guestrooms will be completed in the second quarter of 2014 and once completed, will increase the room count at Hudson to 877.

In January 2014, the hotel owner of Mondrian Los Angeles opened Herringbone, a reconcepted and renovated restaurant which evokes a contemporary California vibe. Herringbone, featuring ocean-to-table cuisine, showcases inventive ocean specialties from around the world and a variety of surf and turf dishes. Additionally, in the spring of 2014, Reserve, a bourbon and scotch bar serving light fare, is scheduled to open at Morgans in New York City.

In early 2014, the owners of Sanderson and St Martins Lane will begin major renovations of these hotels’ guestrooms and public spaces, including reconcepting and renovation of the food and beverage offerings at both hotels.

Maintain Flexibility for New Opportunities. Although our strategic focus is on long-term management agreements and select franchising opportunities, we intend to be flexible so as to best position ourselves to take advantage of new opportunities. The acquisition and finance markets and the specifics of any particular deal will influence each transaction’s structure. For example, in order to secure management opportunities, we may be required to make equity investments or contribute key money. Additionally, we may also consider pursuing licensing agreements in select markets with the right partners. For example, in August 2012, we signed a license agreement with MGM for a Delano in Las Vegas following renovation and conversion of MGM’s THEhotel, which is expected to be complete in the Fall of 2014. Delano Las Vegas will be managed by MGM pursuant to a 10-year licensing agreement, with two 5-year extensions at our option, subject to performance thresholds.

In addition, we believe that our ability to remain flexible with respect to the physical configuration of buildings, as compared to many of our competitors who require very particular specifications, allows us greater access to strategically important hotels and other opportunities.

2013 and Other Recent Transactions and Developments

Hotel Las Palapas. In March 2013, we entered into an agreement with the owner of Hotel Las Palapas to terminate our management agreement effective March 31, 2013 in exchange for a termination payment of approximately $0.5 million.

Ames. On April 26, 2013, our Ames joint venture closed on a new loan agreement with the mortgage lenders that provides for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. We did not contribute to the cash paydown and instead entered into an agreement with our joint venture partner pursuant to which, among other things, (1) we assigned our equity interests in the joint venture to our joint venture partner, (2) we agreed to give our joint venture partner the right to terminate our management agreement upon 60 days prior notice in return for an aggregate payment of $1.8 million, and (3) a credit-worthy affiliate of our joint venture partner has assumed all or a portion of our liability with respect to historic tax credit guaranties, with our liability for any tax credit guaranties capped, in any event, at $3.0 million in the aggregate. In May 2013, the hotel owner exercised its right to terminate our management agreement effective July 17, 2013 and on July 17, 2013 the management agreement terminated.

 

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Board of Directors Change. On June 14, 2013, we held our reconvened 2013 Annual Meeting of Stockholders (the “2013 Annual Meeting”), and the following seven individuals were elected as directors for one-year terms expiring at the Company’s 2014 Annual Meeting of Stockholders: John D. Dougherty, Jason T. Kalisman, Mahmood Khimji, Jonathan Langer, Andrea L. Olshan, Michael E. Olshan and Parag Vora.

Delano Cartagena. In July 2013, we entered into a hotel management agreement for an approximately 211-room Delano-branded hotel to be located in Cartagena, Colombia. Upon completion and opening of the hotel, which is expected to have some condominium hotel units for sale, we will operate the hotel pursuant to a 20-year management agreement, with one 10-year extension option. The hotel is scheduled to open in 2016. Through certain cash flow guarantees which stipulate certain minimum levels of operating performance, we may have potential future funding obligations related to Delano Cartagena, once opened. The maximum amount of such future funding obligations under the applicable contract is approximately $5.0 million in the aggregate.

Departure of CEO and Appointment of Interim Chief Executive Officer. On August 30, 2013, Mr. Michael Gross, who served as our Chief Executive Officer since March 2011, stepped down from that role to pursue new opportunities. Jason T. Kalisman, our Chairman of the Board of Directors, was named Chief Executive Officer on an interim basis, effective as of the same date.

On August 30, 2013 (the “Separation Date”), we entered into a separation agreement with Mr. Gross. Pursuant to the Separation Agreement, in lieu of severance benefits payable under Mr. Gross’s employment agreement, dated March 20, 2011, as amended on February 28, 2013 (the “Gross Employment Agreement”), and in addition to the payment of accrued but unpaid base salary, we, among other things, (i) made a lump sum payment of $500,000, (ii) granted 58,334 restricted stock units to Mr. Gross, pursuant to our Amended and Restated 2007 Omnibus Incentive Plan, as amended, which vested immediately on the Separation Date, (iii) granted 25,000 restricted stock units, which will vest on the first anniversary of the Separation Date, or August 30, 2014, and (iv) accelerated the vesting of any unvested long-term incentive plan units and stock options as of the Separation Date, with all stock options exercisable for a period of one year following the Separation Date. All other equity awards that remained unvested as of the Separation Date expired and were forfeited.

Delano Marrakech Termination of Management Agreement. We served the owner of Delano Marrakech with a notice of default in June 2013. In September 2013, we served notice of termination of our management agreement for Delano Marrakech following the failure by the owner of Delano Marrakech to remedy numerous breaches of the agreement. As a result, we discontinued all affiliation with the hotel, including removal of the Delano name, and terminated management of the property, effective November 12, 2013. Pursuant to the management agreement, in the event of an owner default, we have no further obligations under the performance-based cash flow guarantee. The owner of the hotel is disputing the circumstances surrounding termination. Both parties are seeking arbitration of outstanding claims, including our claims for unpaid fees and reimbursements. Arbitration is expected to occur in early 2015.

Morgans Original Franchise Agreement in Istanbul. In January 2014, we signed a 15-year franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey. The hotel, which is currently under development, is being converted from office and retail space, is expected to have 78 rooms and open in late 2014. We have a $0.7 million key money obligation that will be funded upon the hotel opening.

Hudson and Delano South Beach Loan Refinancing. On February 6, 2014, certain of our subsidiaries entered into a new mortgage financing with Citigroup Global Markets Realty Corp. and Bank of America, N.A., as lenders, consisting of nonrecourse mortgage and mezzanine loans in the aggregate principal amount of $450 million, secured by mortgages encumbering Delano South Beach and Hudson and pledges of equity interests in certain of our subsidiaries (collectively, the “Hudson/Delano 2014 Mortgage Loan”).

 

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The Hudson/Delano 2014 Mortgage Loan bears interest at a reserve adjusted blended rate of 30-day LIBOR plus 565 basis points. We will maintain an interest rate cap for the amount of the Hudson/Delano 2014 Mortgage Loan that will cap the LIBOR rate on the debt under the Hudson/Delano 2014 Mortgage Loan at approximately 1.75% through the initial maturity date.

The Hudson/Delano 2014 Mortgage Loan matures on February 9, 2016. We have three, one-year extension options that will permit us to extend the maturity date of the Hudson/Delano 2014 Mortgage Loan to February 9, 2019, if certain conditions are satisfied at the respective extension dates, including delivery by the borrowers of a business plan and budget for the extension term reasonably satisfactory to the lenders and achievement by us of a specified debt yield. The second and third extensions would also require the payment of an extension fee in an amount equal to 0.25% of the then outstanding principal amount under the Hudson/Delano 2014 Mortgage Loan. A minimum unencumbered assets requirement may also be required if certain other indebtedness (as same may be amended, supplemented, modified, refinanced or replaced) becomes due during the extension term. We may prepay the Hudson/Delano 2014 Mortgage Loan in an amount necessary to achieve the specified debt yield.

The Hudson/Delano 2014 Mortgage Loan may be prepaid at any time, in whole or in part, subject to payment of a prepayment premium for any prepayment prior to August 9, 2015. There is no prepayment premium after August 9, 2015.

The Hudson/Delano 2014 Mortgage Loan is assumable under certain conditions, and provides that either one of the encumbered hotels may be sold, subject to prepayment of the Hudson/Delano 2014 Mortgage Loan at a specified release price and satisfaction of certain other conditions.

The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano South Beach and the owners of Hudson and Delano South Beach and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities (CMBS) loans. The Hudson/Delano 2014 Mortgage Loan is nonrecourse to our subsidiaries that are the borrowers under the loan, except pursuant to certain carveouts detailed therein. In addition, we have provided a customary environmental indemnity and nonrecourse carveout guaranty under which we would have liability with respect to the Hudson/Delano 2014 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, changes to the Hudson capital lease without prior written consent of the lender, violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty requires us to maintain minimum unencumbered assets (as defined in the nonrecourse carveout guaranty) until our outstanding Convertible Notes (as defined below) and TLG Promissory Notes (as defined below) are repaid, extended, refinanced or replaced beyond the term of the Hudson/Delano 2014 Mortgage Loan. Further, the nonrecourse carveout guaranty prohibits the payment of dividends on or repurchase of our common stock.

The net proceeds from the Hudson/Delano 2014 Mortgage Loan were applied to (1) repay $180 million of outstanding mortgage debt under the prior mortgage loan secured by Hudson (the “Hudson 2012 Mortgage Loan”), (2) repay $37 million of indebtedness under our $100 million senior secured revolving credit facility secured by Delano South Beach (the “Delano Credit Facility”), (3) provide cash collateral for reimbursement obligations with respect to a $10.0 million letter of credit under the Delano Credit Facility, and (4) fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital, which may include the repayment of other indebtedness, including the Convertible Notes and TLG Promissory Notes, subject to certain minimum unencumbered asset requirements.

The Hudson 2012 Mortgage Loan and the Delano Credit Facility were terminated after repayment of the outstanding debt thereunder.

Yucaipa Settlement. On February 28, 2014, we entered into a binding Memorandum of Understanding (“MOU”) which, among other things, contemplates the settlement of all pending litigations with affiliates of The Yucaipa Companies LLC (“Yucaipa”). See Part I, “Item III. Legal Proceedings” for an update of such pending litigation and explanation of the MOU.

 

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Repurchase of $88.0 Million of Convertible Notes. On February 28, 2014, in connection with the MOU, we repurchased from two Yucaipa affiliates $88.0 million principal amount of outstanding 2.375% Senior Subordinated Convertible Notes (“Convertible Notes”) at par value plus accrued interest thereon (the “Yucaipa Note Repurchase”). These Convertible Notes were retired following the repurchase and, as a result, the outstanding balance of our Convertible Notes as of March 1, 2014 is $84.5 million.

Termination Plan. On March 10, 2014, we implemented a plan of termination (the “Termination Plan”) that is expected to result in a workforce reduction of our corporate office employees. The Termination Plan is part of our previously announced corporate strategy to, among other things, reduce corporate overhead and costs allocated to property owners. The Termination Plan is the result of the Board of Directors’ extensive review of our operations and cost structure. The Termination Plan will streamline our general corporate functions and we anticipate achieving annualized savings of approximately $8.0 million of corporate expenses and approximately $1.6 million of expenses allocated to our Owned Hotels, Joint Venture Hotels and Managed Hotels, based on 2013 incurred costs and targeted compensation levels.

We intend to enter into severance arrangements with the terminated employees, subject to their execution of separation and general release agreements. As a result of the Termination Plan, we anticipate recording a charge of approximately $8.6 million in the first quarter of 2014 related to the cost of one-time termination benefits of which approximately $2.6 million is expected to be paid in cash and approximately $2.2 million is expected to be recognized as non-cash stock compensation expense relating to the severance of former executives mentioned below, and $3.8 million is expected to be paid in cash to other terminated employees.

Pursuant to the Termination Plan, on March 10, 2014, Daniel Flannery, Executive Vice President, Chief Operating Officer, and Yoav Gery, Executive Vice President, Chief Development Officer, were provided notices of termination of their employment with us effective immediately. Messrs. Flannery’s and Gery’s departures will be treated as terminations without cause under their employment agreements and they will be entitled to severance compensation and benefits accordingly.

In connection with the Termination Plan, we also announced the promotion of Joshua Fluhr to Executive Vice President and Chief Operating Officer, effective immediately.

Management and Operations of Our Portfolio

Overview of Management

We manage and operate each of our hotels, which are generally staffed in the United States by our employees and outside of the United States by the employees of the hotel owners, with personnel dedicated to each of the properties or a cluster of properties, including a general manager, director of finance, director of sales and marketing, director of revenue management, director of human resources and other employees. The personnel at each hotel report to the general manager of the hotel. Each general manager reports to a regional general manager who reports to our Chief Operating Officer in the corporate office. The corporate office provides support directly to certain functions at the hotel such as sales, marketing, revenue management, and finance. This organizational structure allows for each property to operate in a responsive and dynamic fashion while ensuring integrity of our guest experience and core values. As we have expanded in our existing markets, we have begun to regionalize certain operational, finance and sales functions.

Our management team is headquartered in New York City and coordinates our management and operations. The management team reviews business contracts, oversees the financial budgeting and forecasting for our hotels, performs internal accounting and audit functions, administers insurance plans and identifies new systems and procedures to employ within our hotels to improve efficiency and profitability. In addition, the management team is responsible for coordinating the sales and marketing activities at each of our hotels, designing sales training programs, tracking future business prospects and identifying, employing and monitoring marketing programs. The management team is also responsible for the design of our hotels and overall product and service quality levels.

Food and Beverage Operations

As a central element of our operating strategy, we focus significant resources on identifying exciting and creative restaurant, bar and nightclub concepts. We are continually looking for ways to re-energize our food and beverage offerings and improve key facilities with a focus on driving higher beverage to food ratios and re-igniting the buzz around our nightlife and lobby scenes.

In November 2011, we acquired a 90% controlling interest in TLG, a leading lifestyle food and beverage management company. We believe the acquisition has helped us in improving the operations and our various restaurant, bars and nightclubs, identifying a talented New York-based food and beverage team, reconcepting certain of our existing restaurants, bars and nightclubs, concepting new food and beverage venues and winning new hotel and food and beverage management contracts. In early 2012, we used TLG to re-concept and re-launch our restaurants, bars and nightclub at Delano South Beach, including opening Bianca, our renovated restaurant focused on offering an inventive Italian menu featuring local, farm-to-table organic ingredients in January 2012, and FDR, our new nightclub, in February 2012.

In August 2012, we acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas from an existing tenant. The venues were reconcepted and renovated and are managed by TLG. The three food and beverage venues are being operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which we pay minimum annual lease payments and a percentage rent based on cash flow. In December 2012, we opened Red Square, a trend-setting dinner, cocktail, and nightlife destination featuring contemporary American favorites, and in February 2013, we opened Citizens Kitchen & Bar, which offers classic American comfort food. In July 2013, we opened Kumi Japanese Restaurant & Bar, with a modern Japanese menu with a Korean American twist.

We also have an internal food and beverage team located in New York City. This in-house team was responsible for launching Hudson Commons and Henry at Hudson during 2013. Our food and beverage team is also fully engaged with all of our development partners in concepting and launching unique food and beverage outlets in all of our development pipeline projects. We believe that we have the food and beverage capability we need to enhance our existing properties and service our growth.

 

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Sales, Marketing and Public Relations

Strong direct sales have been an integral part of our success. We employ a sales force of approximately 120 people with multiple sales managers stationed in each of our markets, deployed by industry focus and geography. Our sales force is divided into a global sales organization and a property-level sales force. Our global sales organization handles the majority of our key accounts and can provide our clients with one point of contact for all brands. The property level sales force has responsibility for sourcing business for their respective hotels. Our sales efforts are designed to be proactive and direct and are focused on building success in the transient, leisure, corporate business travel, group and consortia markets. We believe these segments are key to our competitiveness in the market. Unlike many hotel companies, our sales force is trained to sell the experience, not simply the rate. By branding the “experience,” we showcase the kind of creativity that happens inside our hotels and prove that our guests come to us for much more than just a room or a bed. Our objective is to create differentiation by selling an “experience” and brand.

In 2013, we derived approximately 27.9% of our business from corporate negotiated and group accounts. Our core corporate business comes from the financial services, entertainment, advertising and public relations, technology, and fashion industries.

We place significant emphasis on branded communication strategies that are multi-layered and non-traditional. We believe our public relations and social networking outreach strategy is a highly cost-effective marketing tool for us. Through highly publicized events, prospective guests are more likely to be made aware of our hotels through word-of-mouth or magazine, newspaper articles or social networking entries and high-profile events rather than direct advertising. This publicity is supplemented with focused marketing activities to our existing customers. Our in-house marketing and public relations team coordinates the efforts of third-party public relations firms to promote our properties through travel magazines and various local, national and international newspaper travel sections. We regularly host events that attract celebrity guests and journalists, generating articles in newspapers and magazines around the world. Our marketing efforts also include hosting other special events, which have included events for Art Basel Miami, The Academy Awards, The Grammy’s, film premieres, and Fashion Week in New York and London.

Over the past year we continued to enhance and reinvest in our website, www.morganshotelgroup.com, and our digital marketing efforts. We continue to expand our social media presence and to engage our followers through these platforms and continue to make additional enhancements to our guest communication program with more targeted emails, mobile messaging, and digital partnerships.

Competition

We believe competition in the hospitality industry reflects a highly fragmented group of owners and operators offering a wide range of quality and service levels. Our hotels compete with other hotels in their respective locations that operate in the same segments of the hospitality market. These segments consist of traditional hotels in the luxury sector and boutique hotels in the same local area. Competitive factors include quality of service, convenience of location, quality of the property, pricing and range and quality of food services and amenities offered. We compete by providing a differentiated combination of location, design, amenities and service. We are constantly striving to enhance the experience and service we are providing for our guests and have a continuing focus on improving our customer experience.

Seasonality

The hospitality business is seasonal in nature. For example, our Miami hotels are generally strongest in the first quarter, whereas our New York hotels are generally strongest in the fourth quarter. Our revenue is generally higher in the second and fourth quarters. However, prevailing economic conditions can cause fluctuations which impact seasonality.

 

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Insurance

We bid out our insurance programs to obtain the most competitive coverage and pricing. We believe our programs provide coverage of the insurable risks facing our business that are consistent with or exceed industry standards.

Directors and officers liability insurance has been in place since our initial public offering in February 2006 at limits and retentions that we believe are consistent with public companies in our industry groups. Coverage includes protection for securities claims.

We believe that the premiums we pay and the insurance coverages we maintain are reasonable and consistent with comparable businesses of our size and risk profile. Our insurance policies require annual renewal. Given current trends and events which transpired in 2013, our insurance expense may increase in the foreseeable future.

Employees

We employ approximately 4,400 individuals, approximately 27.6% of whom were represented by labor unions. We believe relations with our employees are positive.

Government Regulation

Our businesses are subject to numerous United States and international laws, including laws governing employees in our hotels in such areas as minimum wage and maximum working hours, overtime, working conditions, hiring and firing employees and work permits. Also, our ability to expand our existing properties may be dependent upon our obtaining necessary building permits or zoning variances from local authorities.

Our properties must comply with various laws and regulations, including Title III of the Americans with Disabilities Act to the extent that such properties are “public accommodations” as defined by the Americans with Disabilities Act and similar laws of the jurisdictions in which our properties are located. The Americans with Disabilities Act requires removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the Americans with Disabilities Act and similar laws of the jurisdictions in which our properties are located; however, noncompliance could result in capital expenditures, the imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and to make alterations as appropriate in this respect.

Our hotel properties expose us to possible environmental liabilities in both the United States and other jurisdictions in which we operate, including liabilities related to activities that predated our acquisition or operation of a property. Under various federal, state, local and international laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up certain hazardous substances released at the property and may be held liable to a governmental entity or to third parties for property damages and for investigation and cleanup costs incurred by such parties in connection with the contamination. Environmental liability can be incurred by a current owner or operator of a property for environmental problems or violations that occurred on a property prior to acquisition or operation. These laws often impose liability whether or not the owner knew of, or was responsible for, the presence of hazardous or toxic substances. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. The presence of contamination or the failure to remediate contamination may adversely affect the owner’s ability to sell or lease real estate or to borrow using the real estate as collateral. The owner or operator of a site may be liable under common law to third parties for damages and injuries resulting from environmental contamination emanating from the site.

The majority of our hotels have been subject to environmental site assessments prepared by independent third-party professionals. These environmental site assessments were intended to evaluate the environmental conditions of these properties and included a site visit, a review of certain records and public information concerning the properties, the preparation of a written report and, in some cases, invasive sampling. We obtained the environmental site assessments before we acquired certain of our hotels to help us identify whether we might be responsible for cleanup costs or other environmental liabilities. We also obtain environmental site assessments prior to undergoing a significant renovation at any of our hotels. The environmental site assessments on our properties did not reveal any environmental conditions that are likely to have a material adverse effect on our business, assets, and results of operations or liquidity. However, environmental site assessments do not always identify all potential problems or environmental liabilities. Consequently, we may have material environmental liabilities of which we are unaware. Moreover, it is possible that future laws, ordinances or regulations could impose material environmental liabilities, or that the current environmental condition of our properties could be adversely affected by third parties or by the condition of land or operations in the vicinity of our properties. We believe that we are currently in compliance with all applicable environmental regulations in all material aspects.

 

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We are also subject to regulations relating to our food and beverage operations, which are numerous and complex. A variety of regulations at various governmental levels relating to the handling, preparation and serving of food, and the cleanliness of food production facilities and the hygiene of food-handling personnel are enforced primarily at the local public health department level. We cannot assure you that we are in full compliance with all applicable laws and regulations at all times or that we will be able to comply with any future laws and regulations. Furthermore, legislation and regulatory attention to food safety is very high. Additional or amended regulations in this area may significantly increase the cost of compliance.

We serve alcoholic beverages at many facilities, and must comply with applicable licensing laws, as well as state and local service laws, commonly called dram shop statutes. Dram shop statutes generally prohibit serving alcoholic beverages to certain persons such as an individual who is intoxicated or a minor. If we violate dram shop laws, we may be liable to the patron and/or third parties for the acts of the patron. Although we sponsor regular training programs designed to minimize the likelihood of such a situation, we cannot guarantee that intoxicated or minor patrons will not be served or that liability for their acts will not be imposed on us. There can be no assurance that additional regulation in this area would not limit our activities in the future or significantly increase the cost of regulatory compliance. We must also obtain and comply with the terms of licenses in order to sell alcoholic beverages in the states in which we serve alcoholic beverages.

Our business is reliant upon technology systems and networks, including systems and networks managed by third parties, to process, transmit and store information and to conduct many of our business activities and transactions with clients, vendors and other third parties. Accordingly, we are required to comply with data privacy regulations in both the United States and other jurisdictions in which we operate, which regulations are designed to protect sensitive client information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of our proprietary information and our clients’ personal information. Accordingly, any breaches or interference with such systems or networks by third parties or by our employees may result in fines, damage to our reputation, restrictions on the use and transfer of information and otherwise have a material adverse impact on our business, financial condition or results of operations. We have implemented security measures designed to protect against such breaches of security. Despite these measures, we cannot assure you that our systems and networks will not be subject to breaches or interference. Any such event may result in unauthorized access to or the disclosure or loss of our proprietary information or our clients’ personal information, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure and damage to our business. We cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in our systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology or other security measures protecting the networks and systems used in connection with our business. We have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to client data. There can be no assurance that such incidents will not occur again. In addition, third parties with which we do business may also be sources of systems, network or other technological risks.

Intellectual Property

We operate in a highly competitive industry and our brand names, trademarks, service marks, trade names, and logos are very important to the success of our business. We believe that our brand names and other intellectual property represent an enhanced experience to our customers as a result of our high standards of hotel and design quality, service, and amenities. Accordingly, we register and protect our intellectual property where we deem appropriate and we actively enforce, maintain and protect this property against unauthorized use.

 

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Our trademarks include, without limitation, Morgans Hotel Group®, Morgans®, Clift Hotel®, Delano®, Hudson®, Mondrian®, Sanderson®, St Martins™, St Martins Lane Hotel™, Morgans Semi-Automatic®, Agua™, Agua Baby™, Agua Bath House™, Agua Home™, Bianca Delano™, Bianca Delano™ (and design), Rose Bar™, The Florida Room Delano (and design)®, Skybar®, Mondrian Skybar™, Velvet Room™, Imperial No. Nine®, and Mister H®. The majority of these trademarks are registered in the United States and the European Community. Certain of these trademarks are also registered in Canada, France, the United Kingdom, Argentina, Mexico, China, Turkey, the United Arab Emirates and Russia, and we are seeking registration of several of our trademarks in Russia, the United Kingdom, India, China, Brazil, the Bahamas, Indonesia, Egypt, Qatar, Turkey and other jurisdictions. TLG’s (or its related companies’) trademarks include Skeleton Fish design®, Deuce Gaming Lounge®, Fix®, Quick Fix®, Mist®, Haze Nightclub®, Liquid®, Stack Restaurant and Bar™, The Bank®, The Light Group®, Caramel®, Union®, and Lily Bar & Lounge (and design)®. Apart from Stack Restaurant and Bar™, these trademarks are registered in the United States and Diablo’s Cantina is registered in the United Arab Emirates. TLG uses the trademarks 1Oak™ and Yellowtail™ pursuant to trademark license agreements with the owners of the marks. Our trademarks are very important to the success of our business and we actively enforce, maintain and protect these marks.

Materials Available On Our Website

We file annual, quarterly and periodic reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may obtain and copy any document we file with or furnish to the SEC at the SEC’s public reference room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You may obtain information on the operation of the SEC’s public reference room by calling the SEC at 1-800-SEC-0330. You can request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at its principal office at 100 F Street, N.E., Washington, D.C. 20549. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file or furnish such information electronically with the SEC. Our SEC filings are accessible through the Internet at that website.

Copies of SEC filings including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as well as reports on Forms 3, 4, and 5 regarding officers, directors or 10% beneficial owners of our Company, and our code of ethics, are available for download, free of charge, as soon as reasonably practicable after these reports are filed or furnished with the SEC, at our website at www.morganshotelgroup.com.

The content of our website is not a part of this report. You may request a copy of any of the above documents, at no cost to you, by writing or telephoning us at: Morgans Hotel Group Co., 475 Tenth Avenue, New York, New York 10018, Attention: Investor Relations, telephone (212) 277-4100. We will not send exhibits to these reports, unless the exhibits are specifically requested and you pay a modest fee for duplication and delivery.

 

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ITEM 1A. RISK FACTORS

Set forth below are risks that we believe are material to investors who purchase or own our securities. You should consider carefully the following risks, together with the other information contained in and incorporated by reference in this Annual Report on Form 10-K, and the descriptions included in our consolidated financial statements and accompanying notes.

Risks Related to Our Business

Recovery from the recent global economic crisis has been modest, and demand for travel, hotels, dining and entertainment, has not returned to pre-recession levels. In addition, boutique hotels such as ours remain more susceptible to future economic downturns than other segments of the hospitality industry, which could have a material adverse effect on our business, results of operations and financial condition.

The performance of the hospitality industry has traditionally been closely linked with the general economy. In an economic downturn, boutique hotels may be more susceptible to a decrease in revenues, as compared to hotels in other segments that have lower room rates, because our hotels generally target business and high-end leisure travelers. Business and high-end leisure travelers may seek to reduce travel costs by limiting travel, choosing lower cost hotels or otherwise reducing the costs of their trips. These changes could result in steep declines in average daily room rates or occupancy, or both. Profitability also may be negatively affected by the relatively high fixed costs of operating hotels such as ours, when compared to other segments of the hospitality industry.

While the U.S. economy has improved since the recent crisis, the recovery may stall or conditions may worsen, reducing the amounts people spend on travel, hotels, dining and entertainment. Moreover, global markets and economic conditions remain uncertain and difficult to predict. If economic conditions do not improve as anticipated, or worsen again, they could have a material adverse effect on our business, results of operations, and financial condition. We can also provide no assurance that boutique hotels, such as ours, will fully recover to prior levels or that they will recover at a comparable rate with the rest of the hospitality industry.

We have substantial debt, and we may incur additional indebtedness, which may negatively affect our business and financial results.

As of December 31, 2013, we had $559.9 million of outstanding consolidated indebtedness, including capital lease obligations. As of December 31, 2013, on a pro forma basis as if we had completed the closing of the Hudson/Delano 2014 Mortgage Loan, the repayment of the Hudson 2012 Mortgage Loan and the Delano Credit Facility, and the Yucaipa Note Repurchase in 2013, we had approximately $705.8 million of outstanding indebtedness, including capital lease obligations. See Part I, “Item I. Business – 2013 and Other Recent Transactions and Developments – Hudson and Delano South Beach Loan Refinancing” and “—Repurchase of Convertible Notes.” After repurchase of the $88.0 million Convertible Notes in February 2014, $102.5 million of such amounts is due in 2014.

Our share of indebtedness held by our joint venture entities, which debt is generally nonrecourse to us with the exception of certain standard nonrecourse carve-out guarantees, was approximately $69.7 million as of December 31, 2013.

With respect to our nonrecourse carve-out guarantees, a violation of any of the nonrecourse carve-out guaranty provisions, including fraud, misapplication of funds and other customary nonrecourse carve-out provisions, could cause the debt to become fully recourse to us. Our substantial debt could negatively affect our business and operations in several ways, including:

 

    requiring us to use a substantial portion of our funds from operations to make required payments on principal and interest, which would reduce funds available for operations and capital expenditures, future business opportunities and other purposes;

 

    making us more vulnerable to economic and industry downturns, such as the one that occurred from 2008 through 2011, and reducing our flexibility in responding to changing business and economic conditions;

 

    limiting our ability to borrow more money for operations, capital or to finance development projects or acquisitions in the future; and

 

    requiring us to dispose of properties in order to make required payments of interest and principal.

 

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We also may incur additional debt in connection with any future development projects or acquisitions. We may in some instances borrow funds to finance development projects or acquisitions. In addition, we may incur further mortgage debt by obtaining loans secured by the properties we acquire or our existing portfolio.

Our working capital and liquidity reserves may not be adequate to cover all of our cash needs and we may have to obtain additional debt financing. Sufficient financing may not be available or, if available, may not be available on terms acceptable to us. Additional borrowings for working capital purposes will increase our interest expense, and therefore may harm our business and operations.

Our organizational documents do not limit the amount of indebtedness that we may incur. If we increase our leverage, the resulting increase in debt service could adversely affect our ability to make payments on our indebtedness and harm our business and operations.

We anticipate that we will need to refinance our indebtedness from time to time to repay our debt, and our inability to refinance on favorable terms, or at all, could harm our business and operations.

We have $450.0 million of mortgage debt on Hudson and Delano South Beach which matures in February 2016, with three one-year extension options to extend the maturity to February 2019 if certain conditions are met. We have $84.5 million of Convertible Notes which mature on October 14, 2014, unless earlier repurchased by us or converted in accordance with their terms prior to such date, $18.0 million in notes convertible into shares of our common stock at $9.50 per share subject to the achievement of certain EBITDA (earnings before interest, tax, depreciation and amortization) targets for the acquired TLG business (the “TLG Promissory Notes”), as fully described in note 7 to our consolidated financial statements issued in connection with our November 2011 acquisition of 90% of the equity interests in a group of companies known as The Light Group (the “Light Group Transaction”) which mature in November 2015, a $7.4 million face value promissory note issued in connection with our August 2012 acquisition of leasehold interests in three restaurants at Mandalay Bay in Las Vegas which is payable over seven years with final payment in August 2019, $50.0 million of trust preferred securities which mature in October 2036 and 75,000 shares of Series A preferred securities for which the dividend rate will increase to 20% in October 2016.

Since we anticipate that our internally generated cash will be inadequate to repay our indebtedness prior to maturity, we expect that we will be required to repay debt from time to time through refinancings of our indebtedness, offerings of equity or debt, asset dispositions, joint venture transactions or other financing transactions. The amount of our existing indebtedness and the continued uncertainty in the credit markets may harm our ability to repay our debt through refinancings. In addition, if prevailing interest rates or other factors at the time of any refinancing result in higher interest rates on any refinancing, our interest expense would increase, which could harm our business and operations. If we are unable to refinance our indebtedness on acceptable terms, or at all, we might be forced to sell one or more of our properties on disadvantageous terms, which might result in losses to us, or default on the loan.

We or our joint ventures did not repay the mortgage and mezzanine financing on several of our properties upon maturity, and in the future we or our joint ventures may elect to cease making payments on additional mortgages or sell a property at a loss if it fails to generate cash flow to cover its debt service or if we or our joint ventures are unable to refinance the debt at maturity, which could result in foreclosure proceedings, negative publicity and reduce the number of properties we or our joint ventures own or operate, as well as our revenues, and could negatively affect our ability to obtain loans or raise equity or debt financing in the future.

In the past, we or our joint ventures have not repaid the mortgage and mezzanine financings on several of our properties upon maturity and have been subject to foreclosure and other actions by lenders, including with respect to Shore Club and Mondrian SoHo, among others properties. See Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements – Mondrian SoHo” and “– Shore Club.”

 

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In the future, we or our joint venture entities or other owners of hotels we manage may cease making payments on the mortgages on one or more of our properties if the property fails to generate cash flow to cover its debt service or if we, the joint venture entities or other owners are unable to refinance the mortgage at maturity. To the extent we, our joint venture entities or other owners of hotels we manage, do not meet debt service obligations and we or the joint venture entity or other owners default on a mortgage or other loan, the lender may have the right to exercise various remedies under the loan documents, including foreclosing on the applicable property and, in certain situations, termination of our management agreement. Foreclosures can be expensive and lengthy processes, which could have a substantial negative effect on our operating results. Lenders may assert numerous claims and take various actions against us, including, without limitation, seeking a deficiency judgment or seeking to terminate our management agreement. Foreclosures may also create a negative public perception of us, resulting in a diminution of our brand value, and may negatively impact our ability to obtain loans or raise equity or debt financing in the future. Foreclosure actions may also require a substantial amount of resources and negotiations, which may divert the attention of our executive officers from other activities, adversely affecting our business, financial condition and results of operations.

For a property, a foreclosure may also result in increased tax costs to us if we recognize income upon foreclosure. For tax purposes, a foreclosure on any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure but would not receive any cash proceeds.

In addition, certain mortgage or other loan defaults could result in a default under our corporate debt, or otherwise have an adverse effect on our business, results of operations or financial condition.

Certain of our debt instruments contain covenants that may limit our ability to borrow and restrict our operations, and if we fail to comply with such covenants, such failure could result in a default under one or more of our debt instruments.

Some of our existing indebtedness, and the indebtedness of certain of our joint ventures, contain limitations on the ability to incur additional debt on specific properties, as well as financial and other covenants relating to the performance or operation of those properties. If these covenants restrict us or the applicable joint venture from engaging in activities that we believe would benefit those properties, our growth may be limited. If we or the applicable joint venture fail to comply with these covenants, consents or waivers from compliance with these covenants will need to be obtained, which may take time, cost money, or require prepayment of the debt containing the restrictive covenants.

At December 31, 2013, our then outstanding Delano Credit Facility required the maintenance of a fixed charge coverage ratio. Our ability to borrow under the Delano Credit Facility was subject to compliance with this financial and other covenants. As of December 31, 2013, we were in compliance with the financial covenant set forth in our Delano Credit Facility. As a result of the Hudson/Delano 2014 Mortgage Loan we obtained on February 6, 2014, we repaid the outstanding balance on our Delano Credit Facility. The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano and the owners of Hudson and Delano and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities (CMBS) loans. In addition, pursuant to a nonrecourse carveout guaranty that we have provided, we are required to maintain minimum unencumbered assets (as defined in the nonrecourse carveout guaranty) until our outstanding Convertible Notes and the TLG Promissory Notes are repaid, extended, refinanced or replaced beyond the term of the Hudson/Delano 2014 Mortgage Loan. For more information on the Hudson/Delano 2014 Mortgage Loan, see Part I, “Item I. Business – 2013 and Other Recent Transactions and Developments – Hudson and Delano South Beach Loan Refinancing.”

In addition, our trust preferred securities and our Convertible Notes include limitations on our ability to sell all or substantially all of our assets and engage in mergers, consolidations and certain acquisitions. These covenants may restrict our ability to engage in transactions that we believe would otherwise be in the best interests of our stockholders.

 

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If we were required to make payments under the “bad boy” nonrecourse carve-out guaranties that we have provided in connection with certain mortgages and related mezzanine loans, our business and financial results could be materially adversely affected.

We have provided standard “bad boy” nonrecourse carve-out guaranties in connection with certain mortgages and related mezzanine loans, which are otherwise nonrecourse to us or have agreed to indemnify joint venture partners who have provided such guaranties for our pro rata share of certain liabilities under such guaranties. See, for example, nonrecourse carve-out guaranties and other guaranties or indemnification obligations provided by us in connection with mortgage and mezzanine loans associated with Mondrian South Beach and Mondrian SoHo properties, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources—Other Liquidity Matters.” Although we believe that our “bad boy” carve-out guaranties and related indemnification obligations are not guaranties of payment in the event of foreclosure or other actions of the foreclosing lender that are beyond our control, some lenders in the real estate industry have recently sought to make claims for payment under such guaranties. In the event such a claim were made against us under one of our “bad boy” carve-out guaranties or related indemnification obligations following foreclosure on a related mortgage or mezzanine loan and such claim were successful, our business and financial results could be materially adversely affected.

We have incurred substantial losses and have a significant net deficit and may continue to incur losses in the future.

We reported pre-tax net losses of $43.4 million, $55.7 million, and $87.5 million for the years ended December 31, 2013, 2012, and 2011, respectively. Our net losses primarily reflect decreased revenues due to renovation work at our Owned Hotels, interest expense, depreciation and amortization charges, impairment charges, and losses in equity of unconsolidated joint ventures. Although we sold three of our owned hotels and sold our ownership interest in the entity that owns Sanderson and St Martins Lane in 2011 and have impaired many of our unconsolidated joint ventures, these losses could continue to be significant in future years. Additionally, stock compensation, a non-cash expense, contributed to the net losses recorded during 2013, 2012, and 2011. There can be no assurance that we will attain profitability and generate net income for our stockholders in the near term or at all.

Disruptions in the financial markets could affect our ability and the ability of our joint venture partners, development partners, or other third party owners to obtain capital or financing for development of properties and other purposes on reasonable terms.

As part of our strategy, we focus on management opportunities, which may entail the investment of key money and equity. We also may continue, through joint ventures, to acquire and develop, or redevelop, hotel properties as suitable opportunities arise. These investments could require significant capital expenditures, especially since these properties usually generate little or no cash flow until the project’s completion. To the extent the expenditures are significant, we, our joint venture partners, our development partners or other third party owners, may rely upon the availability of debt or equity capital.

During the most recent global economic recession, U.S. and global markets experienced significant price volatility, severely diminished liquidity and credit availability and other market dislocations. These circumstances materially impacted liquidity in the financial markets, making terms for certain types of capital or financings less attractive, and in some cases resulted in the unavailability of capital or financing. Although the U.S. and global economies have begun improving, the economic recovery continues to be modest, as uncertainty remains as to its sustainability, and the effects of continued weakness in certain areas of global economies, as well as our financial condition or the financial condition of our properties, may prevent or negatively impact our ability to access additional capital or financing for development of properties and other purposes at reasonable terms, which may cause us, or our joint venture partners, to suspend, abandon or delay development and other activities and otherwise negatively affect our business. As a result, we, our joint venture partners, our development partners, or other third party owners, may be forced to seek alternative sources of potentially less attractive capital or financing and adjust business plans accordingly. These events also may make it more difficult or costly for us to raise capital through the issuance of our common stock or preferred stock.

 

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Boutique hotels are a highly competitive segment of the hospitality industry. If we are unable to compete effectively, our business and operations will be adversely affected by declines in our average daily room rates or occupancy, or both.

We generally compete in the “boutique” or “lifestyle” hotel segment of the hospitality industry. We believe that this segment is highly competitive. Competition within the boutique hotel segment is also likely to increase in the future. Competitive factors in the hospitality industry include name recognition, quality of service, convenience of location, quality of the property, pricing and range and quality of food services and amenities offered. Market perception that we no longer provide innovative property concepts and designs would adversely affect our ability to compete effectively. If we are unable to compete effectively, we would lose market share, which could adversely affect our business and operations.

All of our properties are located in areas with numerous competitors, many of whom have substantially greater resources than us. In addition, new hotels may be constructed in the areas in which our properties are located, possibly without corresponding increases in demand for hotel rooms. New or existing competitors could offer significantly lower rates or more convenient locations, services or amenities or significantly expand, improve or introduce new service offerings in markets in which our hotels compete, thereby posing a greater competitive threat than at present. The resulting decrease in our revenues could adversely affect our business and operations.

Our success depends on the value of our name, image and brands, and if the demand for our hotels and their features decreases or the value of our name, image or brands diminishes, our business and operations would be adversely affected.

Our success depends, to a large extent, on our ability to shape and stimulate consumer tastes and demands by producing and maintaining innovative, attractive, and exciting properties and services, as well as our ability to remain competitive in the areas of design and quality. There can be no assurance that we will be successful in this regard or that we will be able to anticipate and react to changing consumer tastes and demands in a timely manner.

Furthermore, a high media profile is an integral part of our ability to shape and stimulate demand for our hotels with our target customers. A key aspect of our marketing strategy is to focus on attracting media coverage. If we fail to attract that media coverage, we may need to substantially increase our advertising and marketing costs, which would adversely affect our results of operations. In addition, other types of marketing tools, such as traditional advertising and marketing, may not be successful in attracting our target customers.

Our business would be adversely affected if our public image, reputation or brands were to be diminished, including as a result of any failure to remain competitive in the areas of design, quality and service. If we do not maintain our hotel properties at a high level, which necessitates, from time to time, capital expenditures and the replacement of furniture, fixtures and equipment, or the owners of the hotels that we manage fail to develop or maintain the properties at standards worthy of the Morgans Hotel Group brands, the value of our name, image or brands would be diminished and our business and operations would be adversely affected.

Any failure to protect our trademarks could have a negative impact on the value of our brand names and adversely affect our business.

We believe that our trademarks are critical to our success. We rely on trademark laws to protect our proprietary rights. The success of our business depends in part upon our continued ability to use our trademarks to increase brand awareness and further develop our brands in both domestic and international markets. Monitoring the unauthorized use of our intellectual property is difficult. Litigation has been and may continue to be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources, may result in counterclaims or other claims against us and could significantly harm our results of operations. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States.

From time to time, we apply to have certain trademarks registered. There is no guarantee that such trademark registrations will be granted. We cannot assure you that all of the steps we have taken to protect our trademarks in the United States and foreign countries will be adequate to prevent imitation of our trademarks by others. The unauthorized reproduction of our trademarks could diminish the value of our brands and their market acceptance, competitive advantages or goodwill, which could adversely affect our business.

 

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We may have disputes with, or be sued by, third parties for infringement or misappropriation of their proprietary rights, which could have a negative impact on our business.

Other parties may assert trademark, copyright or other intellectual property rights that have a negative impact on our business. We cannot assure you that others will not seek to block our use of certain marks or seek monetary damages or other remedies for the prior use of our brand names or other intellectual property or the sale of our products or services as a violation of their trademark, copyright or other proprietary rights. Defending any claims, even claims without merit, could divert our management’s attention, consume significant time, result in costly settlements, litigation or restrictions on our business and damage our reputation.

In addition, there may be prior registrations or use of trademarks in the United States or foreign countries for similar or competing marks or other proprietary rights. In all such countries it may be possible for any third-party owner of a national trademark registration or other proprietary right to enjoin or limit our expansion into those countries or to seek damages for our use of such intellectual property in such countries. In the event a claim against us was successful and we could not obtain a license to the relevant intellectual property or redesign or rename our products or operations to avoid infringement, our business, financial condition or results of operations could be harmed. Securing registrations does not fully insulate us against intellectual property claims, as another party may have rights superior to our registration or our registration may be vulnerable to attack on various grounds.

Our hotels are geographically concentrated in a limited number of cities and, accordingly, we could be disproportionately harmed by an economic downturn in these cities or a disaster, such as a hurricane or earthquake.

The concentration of our hotels in a limited number of cities exposes us to greater risk to local economic, business and other conditions than more geographically diversified hotel companies. Morgans, Royalton, Hudson and Mondrian SoHo, located in Manhattan, represented approximately 45.5% of our total guest rooms for all the hotels we manage and Hudson, our only wholly-owned New York City hotel as of December 31, 2013, represents approximately $81.5 million, or 38.9%, of our consolidated hotel revenues for the year ended December 31, 2013. An economic downturn, a natural disaster, a terrorist attack or similar disaster in New York would likely cause a decline in the Manhattan hotel market and adversely affect occupancy rates, the financial performance of our New York hotels and our overall results of operations. For example, in October 2012, our operations in New York City were impacted by Hurricane Sandy. Although all four of our New York properties were operating during the storm and none of them suffered any significant property damage, we had to close both Morgans and Mondrian SoHo due to a lack of power for several days. In addition, we operate three hotels in Miami, making us susceptible to economic slowdowns and other factors in this market, which could adversely affect our business and results of operations.

In addition, certain of our hotels are located in markets that are more susceptible to natural disasters than others, which could adversely affect those hotels, the local economies, or both. Specifically, the Miami area, where Delano South Beach, Shore Club and Mondrian South Beach are located, is susceptible to hurricanes and California, where Mondrian Los Angeles and Clift are located, is susceptible to earthquakes.

The threat of terrorism may negatively impact the hospitality industry generally and may have a particularly adverse impact on major metropolitan areas.

The threat of terrorism may negatively impact hotel occupancy and average daily rate, due to resulting disruptions in business and leisure travel patterns and concerns about travel safety. Hotels in major metropolitan areas, such as New York and London, which represented approximately 57.0% of our total guest rooms for all the hotels we managed at December 31, 2013, may be particularly adversely affected due to concerns about travel safety. The impact on such major metropolitan areas may be particularly severe because of the importance of transient business travel, which includes the corporate and premium business segments that generally pay the highest average room rates, to those markets. The possibility of future attacks may hamper business and leisure travel patterns and, accordingly, the performance of our business and our operations.

 

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We are exposed to the risks of a global market, which could hinder our ability to maintain and expand our international operations.

We currently have operating hotels in the United States and the United Kingdom and plan to expand to numerous other international markets. The success and profitability of any future international operations are subject to numerous risks and uncertainties, many of which are outside of our control, such as:

 

    global economic conditions, such as economic contraction, economic uncertainty or the perception by our customers of weak or weakening economic conditions;

 

    political or economic instability;

 

    changes in governmental regulation;

 

    trade restrictions;

 

    foreign currency controls;

 

    difficulties and costs of staffing and managing operations in certain foreign countries;

 

    work stoppages or other changes in labor conditions;

 

    taxes;

 

    payments terms; and

 

    seasonal reductions in business activity in some parts of the world.

Furthermore, changes in policies and/or laws of the United States or foreign governments resulting in, among other things, higher taxation, currency conversion limitations or the expropriation of private enterprises could reduce the anticipated benefits of our international operations. Any actions by countries in which we conduct business to reverse policies that encourage foreign trade could adversely affect our business relationships and gross profit. In addition, we may be restricted in moving or repatriating funds attributable to our international properties without the approval of foreign governmental authorities or courts. These limitations could have a material adverse effect on our business and results of operations.

Establishing operations in any foreign country or region presents risks such as those described above, as well as risks specific to the particular country or region. We may not be able to maintain and expand our international operations successfully, and as a result, our business operations could be adversely affected.

The hotel business is capital intensive and requires capital improvements to remain competitive; the failure to timely fund such capital improvements, the rising cost of such improvements and increasing operating expenses could negatively impact our ability to compete, reduce our cash flow and adversely affect our financial performance.

Our hotel properties have an ongoing need for renovations and other capital improvements to remain competitive, including replacement, from time to time, of furniture, fixtures and equipment. To compete effectively, we will need to, or convince our joint venture partners or other third party owners to, make capital expenditures to maintain our innovative property concepts and designs. In addition, we will need to make capital expenditures to comply with applicable laws and regulations.

During 2014 we, our joint venture entities, and owners of our hotels plan to spend approximately $14.5 million for capital improvements to hotels that we manage. To the extent that we, our joint venture entities, or the owners of our hotels decide to begin a larger-scale renovation, the capital spent on renovations to hotels we manage could increase.

If we, our joint venture entities or other owners of our hotels are not able to fund capital improvements solely from cash provided from hotel operations, debt or equity capital may be needed, which may not be available. If we, our joint venture entities or other owners of our hotels cannot access debt or equity capital, capital improvements may need to be postponed or cancelled, which could harm our ability to remain competitive.

 

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In addition, renovations and other capital improvements to our hotels may be expensive and may require us to close all or a portion of the hotels to customers during such renovations, affecting occupancy and average daily rate. These capital improvements may give rise to the following additional risks, among others:

 

    construction cost overruns and delays;

 

    exposure under completion and related guarantees;

 

    uncertainties as to market demand or a loss of market demand after capital improvements have begun;

 

    disruption in service and room availability causing reduced demand, occupancy and rates; and

 

    possible environmental problems.

As a result, capital improvement projects may increase our expenses and reduce our cash flows and our revenues. If capital expenditures exceed our expectations, this excess would have an adverse effect on our available cash.

We have high fixed costs, including property taxes and insurance costs, which we may be unable to adjust in a timely manner in response to a reduction in revenues. In addition, our property taxes have increased in recent years and we expect those increases to continue.

The costs associated with owning and operating hotels are significant, some of which may not be altered in a timely manner in response to changes in demand for services. Failure to adjust our expenses may adversely affect our business and operations. For example, pursuant to the terms of our agreements with the labor unions for our New York City and San Francisco hotels, and TLG operations in Las Vegas, we may not unilaterally reduce the wages of the employees subject to these agreements, and are restricted in the manner in which we may layoff and/or alter the schedule of employees.

Property taxes and insurance costs are a significant part of our operating expenses. In recent years, our real property taxes have increased and we anticipate those increases may continue. Our real property taxes may increase as property tax rates change and as the values of properties are assessed and reassessed by taxing authorities. Our real estate taxes do not depend on our revenues, and generally we cannot reduce them, other than by filing appeals with the applicable tax jurisdictions to reduce our tax assessments.

Insurance premiums for the hospitality industry have increased significantly in recent years, and continued escalation may result in our inability to obtain adequate insurance at acceptable premium rates. A continuation of this trend would appreciably increase the operating expenses of our hotels. Additionally, we anticipate that our directors and officers insurance may increase in future years. If we do not obtain adequate insurance, to the extent that any of the events not covered by an insurance policy materialize, our financial condition may be materially adversely affected.

In the future, our properties may be subject to increases in real estate and other tax rates, utility costs, operating expenses, insurance costs, repairs and maintenance and administrative expenses, as well as reductions in our revenues due to the effects of economic downturns, which could reduce our cash flow and adversely affect our financial performance. If our revenues decline and we are unable to reduce our expenses in a timely manner, our results of operations could be adversely affected.

We may not be able to successfully compete for desirable hotel management, development, acquisition or investment opportunities.

We may not be successful in identifying or completing hotel projects that are consistent with our strategy. We compete with hotel operating companies, institutional pension funds, private equity investors, real estate investment trusts, owner-operators of hotels and others who are engaged in hotel operating or real estate investment activities for the operation, development, and acquisition of hotels. In addition, competition for suitable hotel management, development, investment, and acquisition opportunities is intense and may increase in the future. Some competitors may have substantially greater financial resources than we do, and as such, will be able to invest more or accept greater risk than we can prudently manage. These competitors may limit the number of suitable hotel management, development, investment and acquisition opportunities for us by driving up the price we must pay for such opportunities. In addition, our potential hotel management or development projects or acquisition targets may find our competitors to be more attractive investors because they may have greater resources, be willing to pay more, have a more compatible operating philosophy, or better relationships with hotel franchisors, sellers or lenders. Furthermore, the terms of our management agreements are influenced by contract terms offered by our competitors, among other things. We cannot assure you that any of our current arrangements will continue or that we will be able to enter into future collaborations, renew agreements, or enter into new agreements in the future on terms that are as favorable to us as those that exist today.

 

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Even if we are able to successfully identify and acquire other hotel management or development projects, acquisitions or investments, they may not yield the returns we expect and, if financed using our equity capital, may be dilutive. We also may incur significant costs and divert management attention in connection with evaluating and negotiating potential hotel management or development projects or acquisitions, including ones that we or others are subsequently unable to complete. We may underestimate the costs necessary to bring a hotel management agreement or development project or acquired property up to the standards established for its intended market position or to re-develop it as a Morgans Hotel Group brand hotel or the costs to integrate it with our existing operations. Significant costs of hotel development projects or acquisitions could materially impact our operating results, including costs of uncompleted hotel development projects or acquisitions, as they would generally be expensed in the time period during which they are incurred.

Integration of new hotels or food and beverage operations may be difficult and may adversely affect our business and operations.

The success of any hotel management or development project or acquisition will depend, in part, on our ability to realize the anticipated benefits from integrating new hotels with our existing operations. For instance, we may manage, develop or acquire new hotels in geographic areas in which our management may have little or no operating experience and in which potential customers may not be familiar with our existing hotels, name, image or brands. These hotels may attract fewer customers than our existing hotels, while at the same time, we may incur substantial additional costs with these new hotel properties. As a result, the results of operations at new hotel properties may be inferior to those of our existing hotels. Unanticipated expenses and insufficient demand at a new hotel property, therefore, could adversely affect our business. Our success in realizing anticipated benefits and the timing of this realization depend upon the successful integration of the operations of the new hotel. This integration is a complex, costly and time-consuming process. The difficulties of combining new hotel properties with our existing operations include, among others:

 

    coordinating sales, distribution and marketing functions;

 

    integrating information systems;

 

    preserving the important licensing, distribution, marketing, customer, labor, and other relationships of a new hotel;

 

    costs relating to the opening, operation and promotion of new hotel properties that are substantially greater than those incurred in other geographic areas; and

 

    converting hotels to our brands.

We may not accomplish the integration of new hotels or food and beverage operations smoothly or successfully. The diversion of the attention of our management from our existing operations to integration efforts and any difficulties encountered in combining operations could prevent us from realizing the anticipated benefits from the new addition and could adversely affect our business and operations.

The use of joint ventures or other entities, over which we may not have full control, for hotel development projects or acquisitions could prevent us from achieving our objectives.

We have in the past and may in the future acquire, develop or redevelop hotel properties through joint ventures with third parties, acquiring non-controlling interests in or sharing responsibility for managing the affairs of a property, joint venture or other entity. As of December 31, 2013, we owned our Mondrian South Beach hotel through a 50/50 joint venture and our Mondrian SoHo hotel through a joint venture in which our interest was 20%.

 

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To the extent we own properties through joint ventures or other entities, we may not be in a position to exercise sole decision-making authority regarding the property, joint venture or other entity. Investments in joint ventures or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners might become bankrupt or fail to fund their share of required capital contributions. Likewise, partners may have economic or other business interests or goals which are inconsistent with our business interests or goals and may be in a position to take actions contrary to our policies or objectives. Such investments may also have the potential risk of creating impasses on decisions if neither we nor our partner have full control over the joint venture or other entity. Disputes between us and our partners may result in litigation or arbitration that would increase our expenses and prevent management from focusing their time and effort on our business. Consequently, actions by, or disputes with, our partners might result in subjecting properties owned by the joint venture to additional risk. In addition, we may, in certain circumstances, be liable for the actions of our partners.

We have invested, and may continue to invest in the future, in select properties which have residential components, and this strategy may not yield the returns we expect and may result in disruptions to our business or strain management resources.

As part of our growth strategy, we may seek to leverage awareness of our hotel brands by acquiring, developing and/or managing non-hotel properties, such as condominium developments and other residential projects, including condominiums or apartments. We may invest in these opportunities solely or with joint venture partners. For example, in August 2006, together with a 50/50 joint venture partner, we acquired an apartment building in the South Beach area of Miami Beach, Florida, which we renovated and converted into a hotel and condominium project and re-branded as Mondrian South Beach. This strategy, however, may expose us to additional risks, including the following:

 

    we may be unable to obtain, or face delays in obtaining, necessary zoning, land-use, building, occupancy, and other required governmental permits and authorizations, which could result in increased development or re-development costs and/or lower than expected sales;

 

    local residential real estate market conditions and renewed downturns in such market conditions;

 

    cost overruns, including development or re-development costs that exceed our original estimates, could make completion of the project uneconomical;

 

    land, insurance and development or re-development costs continue to increase and may continue to increase in the future, and we may be unable to attract rents or sales prices that compensate for these increases in costs;

 

    development or re-development of condominium properties usually generate little or no cash flow until the project’s completion and the sale of a significant number of condominium units and may experience operating deficits after the date of completion and until such condominium units are sold;

 

    failure to achieve expected occupancy and/or rent levels at residential apartment properties within the projected time frame, if at all;

 

    failure to attract sufficient participation in the hotel rental program by condominium hotel unit owners may result in a low hotel room inventory making it difficult to run the hotel profitably;

 

    condominium hotel unit owners may attempt to rent their units as hotel units outside of the hotel rental program, which may result in confusion and guest relations issues and reputational damage to our brands; and

 

    we may abandon development or re-development opportunities that we have already begun to explore, and we may fail to recover expenses already incurred in connection with exploring any such opportunities.

Overall project costs may significantly exceed the costs that were estimated when the project was originally undertaken, which will result in reduced returns, or even losses, from our investment.

 

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We may be involved in disputes, from time to time, with the owners of the hotels that we manage.

The nature of our responsibilities under our management agreements to manage hotels that are not wholly-owned by us may be subject to interpretation and will from time to time give rise to disagreements. Such disagreements may be more likely as hotel returns remain below pre-recession levels, despite recent improvements in economic conditions. To the extent that such conflicts arise, we seek to resolve them by negotiation with the relevant parties. In the event that such resolution cannot be achieved, litigation may result in damages or other remedies against us. Such remedies could in certain circumstances include termination of the right to manage the relevant property. For example, in October 2013, the owner of Mondrian Los Angeles initiated arbitration proceedings against us, as hotel operator, alleging that pursuant to our management agreement, our management fee, which is calculated as a percentage of Gross Revenues, as defined in the agreement, should not include the gross sales receipts generated by the hotel’s new food and beverage tenant. A two-day hearing is scheduled to be held on March 31, 2014 and April 1, 2014. It is not possible at this time to predict with reasonable certainty the likely outcome of this arbitration. If the arbitration proceedings result in an unfavorable outcome for us, we believe the impact to our management fee would be immaterial in 2013.

Premature termination of our management agreements could hurt our financial performance.

Although our hotel management agreements are long-term, they may be subject to early termination in specified circumstances, or we may agree to early termination as circumstances require. See, for example, Part I, “Item I. Business – 2013 and Other Recent Transactions and Developments – Ames.” Certain of our management agreements allow the hotel owner to replace us if certain financial or performance criteria are not met and in certain cases, upon a sale of the property. We may disagree with hotel owners on how the performance criteria are calculated and whether they have been met. We can provide no assurances that we will satisfy these financial or performance tests in our management agreements, many of which may be beyond our control, or that our management agreements will not be subject to early termination.

In addition, some courts have applied principles of agency law and related fiduciary standards to managers of third-party hotel properties (or have interpreted hotel management agreements as “personal services contracts”). This means, among other things, that property owners may assert the right to terminate management agreements even where the agreements provide otherwise, and some courts have upheld such assertions regarding management agreements and may do so in the future. In the event of any such termination, we may need to enforce our right to damages for breach of contract and related claims, which may cause us to incur significant legal fees and expenses. Any damages we ultimately collect could be less than the projected future value of the fees and other amounts we would have otherwise collected under the management agreement.

Several of our hotels are also subject to mortgage and mezzanine debt, and in some instances our management fee is subordinated to the debt. Some of our management agreements also may be terminated by the lenders on foreclosure or certain other related events. With all of our new management agreements for hotels under development, we attempt to negotiate non-disturbance agreements or similar protections with the mortgage lender, or to require that such agreements be entered into upon securing of financing, in order to protect our management agreements in the event of foreclosure. However, we are not always successful in imposing these requirements, and some of our new development projects and existing hotels do not have non-disturbance or similar protections, which may make the related management agreements subject to termination by the lenders on foreclosure or certain other related events. Even if we have such non-disturbance protections in place, they may be subject to conditions and may be difficult or costly to enforce in a foreclosure situation. See, for example, Part II, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Off-Balance Sheet Arrangements – Mondrian SoHo.”

We may also terminate hotel management agreements as circumstances require or as we deem appropriate. See, for example, Part I, “Item I. Business – 2013 and Other Recent Transactions and Developments – Delano Marrakech Termination of Management Agreement.”

TLG’s management agreements may be subject to early termination in specified circumstances. For example, the management agreements generally contain, among other covenants, a performance test that stipulates a minimum level of operating performance, and restrictions or requirements related to suitability, capacity, financial stability and compliance with laws and material terms. For example, in 2013, we failed performance tests at certain venues, and as a result, we agreed with MGM to a change in the calculation of base and incentive management fees at all MGM venues effective January 1, 2014. Many of the management agreements also require that certain named representatives, including Andy Masi, whose employment contract expires December 2014, must remain employed by or under contract to TLG. We can provide no assurance that we will satisfy these conditions.

 

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Our business may be harmed as a result of litigation.

We are a party to several ongoing material legal proceedings. These proceedings are described below in Item 3 of Part I of this report under the heading “Legal Proceedings” and also in note 8 of our consolidated financial statements included in Item 15 of Part IV of this report. Should an unfavorable outcome occur in some or all of our current legal proceedings, or if successful claims and other actions are brought against us in the future, our business, results of operations and financial condition could be seriously harmed. In addition, litigation may divert the attention of our management from other activities, adversely affecting our business, financial condition and results of operations.

Our operations are sensitive to currency exchange risks, and we cannot predict the impact of future exchange-rate fluctuations on our business and operating results.

Our operations are sensitive to currency exchange risks. Changes in exchange rates between foreign currencies and the U.S. dollar may adversely affect our operating results. For example, all else being equal, a weaker U.S. dollar will tend to promote international tourism in our domestic markets but may reduce U.S. travel to our international markets. As foreign currencies appreciate against the U.S. dollar, it becomes less expensive, in terms of those appreciating foreign currencies, to pay for our U.S. hotel services. Conversely, all else being equal, an appreciating U.S. dollar could affect demand for our U.S. hotel services but may increase U.S. travel to our international markets. We cannot predict the impact of future exchange-rate fluctuations on our business and operations.

If we fail to maintain effective internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act, it may have an adverse effect on our business and stock price.

We are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, and the applicable SEC rules and regulations that require our management to conduct an annual assessment and to report on the effectiveness of our internal controls over financial reporting. In addition, our independent registered public accounting firm must issue an attestation report addressing the operating effectiveness of our internal controls over financial reporting. While our internal controls over financial reporting currently meet all of the standards required by Sarbanes-Oxley Act of 2002, failure to maintain an effective internal control environment could have a material adverse effect on our business, financial condition and results of operations and the price of our common stock. We cannot be certain as to our ability to continue to comply with the requirements of Sarbanes-Oxley Act of 2002. If we are not able to continue to comply with the requirements of Sarbanes-Oxley Act of 2002 in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or Financial Industry Regulatory Authority. In addition, should we identify a material weakness, there can be no assurance that we would be able to remediate such material weakness in a timely manner in future periods. Moreover, if we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, and incur significant expenses to restructure our internal controls over financial reporting, which may have a material adverse effect on our business and operations.

 

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Because Clift is leased pursuant to a 99-year lease and a portion of Hudson is the lease of a condominium interest, we are subject to the risk that these leases could be terminated or that we could default on payments under the lease, either of which would cause us to lose the ability to operate all or a portion of these hotels.

Our rights to operate Clift in San Francisco are based upon our interest under a 99-year lease. In addition, a portion of Hudson in New York is a condominium interest that is leased to us under a 99-year lease. Pursuant to the terms of the leases for these hotels, we are required to pay all rent due and comply with all other lessee obligations under the leases. Any transfer, including a pledge, of our interest in a lease may require the consent of the applicable lessor and its lenders. As a result, we may not be able to sell, assign, transfer or convey our lessee’s interest in any hotel subject to a lease in the future absent consent of such third parties even if such transactions may be in the best interest of our stockholders.

The lessor may require us, at the expiration or termination of the lease to surrender or remove any improvements, alterations or additions to the land or hotel at our own expense. The leases also generally require us to restore the premises following a casualty or taking and to apply in a specified manner any proceeds received in connection therewith. We may have to restore the premises if a material casualty, such as a fire or an act of God, occurs, the cost of which may exceed any available insurance proceeds. The termination of any of these leases could cause us to lose the ability to continue operating all or a portion of these hotels, which would materially affect our business and results of operations.

In addition, we may be unable to make payments under the leases if we are not able to operate the properties profitably. Due to the amount of the lease payments, our subsidiary that leases Clift is not always able to operate Clift at a profit and Morgans Group may fund cash shortfalls sustained at Clift in order to enable our subsidiary to make lease payments from time to time. In 2010, we discontinued subsidizing the lease payments and our subsidiary stopped making the scheduled monthly payments, resulting in litigation and a subsequent settlement and release agreement with the lessors. The Clift lease agreement currently provides for base annual rent of approximately $6.0 million per year through October 2014. Thereafter, the base rent increases at 5-year intervals by a formula tied to increases in the Consumer Price Index, with a maximum increase of 40% and a minimum increase of 20% at October 2014, and a maximum increase of 20% and a minimum increase of 10% at each 5-year rent increase date thereafter. The lease is nonrecourse to us. We can provide no assurance that we can operate the property at a profit now or upon increase of payments under the lease. As part of the settlement, Morgans Group also entered into a limited guaranty, dated September 17, 2010, whereby Morgans Group agreed to guarantee losses of up to $6 million suffered by the lessors in the event of certain “bad boy” type acts.

We are party to numerous contracts and operating agreements, certain of which limit our activities through restrictive covenants or consent rights. Violation of those covenants or failure to receive consents could lead to termination of those contracts or operating agreements.

We are party to numerous contracts and operating agreements, many of which are integral to our business operations. Certain of those contracts and operating agreements, including our joint venture agreements, generally require that we obtain the consent of the other party or parties before taking certain actions and/or contain restrictive covenants that could affect the manner in which we conduct our business. Our failure to comply with restrictive covenants or failure to obtain consents could provide the beneficiaries of those covenants or consents with the right to terminate the relevant contract or operating agreement or seek damages against us. If those claims relate to agreements that are integral to our operations, any termination could have a material adverse effect on our results of operations or financial condition.

Risks Related to the Hospitality Industry

A number of factors, many of which are common to the lodging industry and beyond our control, could affect our business, including those described elsewhere in this section as well as the following:

 

    competition from other hotels in the markets in which we operate;

 

    over-building of hotels in the markets in which we operate which results in increased supply and would likely adversely affect occupancy and revenues at our hotels;

 

    dependence on business, commercial and leisure travelers and tourism;

 

    dependence on group and meeting/conference business;

 

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    increases in energy costs, property taxes or insurance costs;

 

    requirements for periodic capital reinvestment to repair and upgrade hotels;

 

    increases in operating costs due to inflation and other factors that may not be offset by increased room rates;

 

    changes in interest rates;

 

    changes in the availability, cost and terms of financing;

 

    adverse effects of international, national, regional and local economic and market conditions;

 

    unforeseen events beyond our control, such as terrorist attacks, travel-related health concerns and other factors that may affect travel patterns and reduce the number of business and commercial travelers and tourists;

 

    adverse effects of worsening conditions in the lodging industry;

 

    changes in laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances; and

 

    risks generally associated with the ownership of hotel properties and real estate.

These factors could have an adverse effect on our financial condition and results of operations.

Seasonal variations in revenue at our hotels can be expected to cause quarterly fluctuations in our revenues.

The hospitality industry is seasonal in nature. This seasonality can be expected to cause quarterly fluctuations in our revenues. Our revenue is generally highest in the second and fourth quarters. Our quarterly earnings may also be adversely affected by factors outside our control, including weather conditions and poor economic conditions. As a result, we may have to enter into short-term borrowings in certain quarters in order to offset these fluctuations in revenues.

The industries in which we operate are heavily regulated and a failure to comply with regulatory requirements may result in an adverse effect on our business.

Any failure to comply with regulatory requirements may result in an adverse effect on our business. Our various properties are subject to numerous laws, including those relating to the preparation and sale of food and beverages, including alcohol. The failure to comply with such laws could subject us to a number of adverse consequences, including fines or even suspension or revocation of liquor licenses. We are also subject to laws governing our relationship with our employees in such areas as minimum wage and maximum working hours, overtime, working conditions, hiring and firing employees and work permits. Also, our ability to remodel, refurbish or add to our existing properties may be dependent upon our obtaining necessary building permits from local authorities. The failure to obtain any of these permits could adversely affect our ability to increase revenues and net income through capital improvements of our properties. In addition, we are subject to the numerous rules and regulations relating to state and federal taxation. Compliance with these rules and regulations requires significant management attention. Any failure to comply with all such rules and regulations could subject us to fines or audits by the applicable taxation authority.

In addition, our business is reliant upon technology systems and networks, including systems and networks managed by third parties, to process, transmit and store information and to conduct many of our business activities and transactions with clients, vendors and other third parties. Accordingly, we are required to comply with data privacy regulations in both the United States and other jurisdictions in which we operate, which regulations are designed to protect sensitive client information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of our proprietary information and our clients’ personal information. Accordingly, any breaches or interference with such systems or networks by third parties or by our employees may result in fines, damage to our reputation, restrictions on the use and transfer of information and otherwise have a material adverse impact on our business, financial condition or results of operations. We have implemented security measures designed to protect against such breaches of security. Despite these measures, we cannot assure you that our systems and networks will not be subject to breaches or interference. Any such event may result in unauthorized access to or the disclosure or loss of our proprietary information or our clients’ personal information, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure and damage to our business. We cannot be certain that advances in criminal capabilities, discovery of new vulnerabilities, attempts to exploit vulnerabilities in our systems, data thefts, physical system or network break-ins or inappropriate access, or other developments will not compromise or breach the technology or other security measures protecting the networks and systems used in connection with our business. We have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to client data. There can be no assurance that such incidents will not occur again. In addition, third parties with which we do business may also be sources of systems, network or other technological risks.

 

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The illiquidity of real estate investments and the lack of alternative uses of hotel properties could significantly limit our ability to respond to adverse changes in the performance of our properties and harm our financial condition.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more of our properties in response to changing economic, financial and investment conditions is limited. We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property.

Although we evaluate alternative uses throughout our portfolio, including residential conversion and other opportunities, hotel properties may not readily be converted to alternative uses. The conversion of a hotel to alternative uses would also generally require substantial capital expenditures and may not provide a more profitable return than the use of the hotel property prior to that conversion.

We may be required to expend funds to correct defects or to make improvements before a property can be sold. We may not have funds available to correct those defects or to make those improvements and as a result our ability to sell the property would be limited. In acquiring a hotel, we may agree to lock-out provisions that materially restrict us from selling that hotel for a period of time or impose other restrictions on us. These factors and any others that would impede our ability to respond to adverse changes in the performance of our properties could significantly harm our financial condition and results of operations.

Uninsured and underinsured losses could adversely affect our financial condition and results of operations.

We are responsible for insuring our hotel properties as well as obtaining the appropriate insurance coverage to reasonably protect our interests in the ordinary course of business except in connection with some of our hotels where insurance is provided for by the respective property owners. Additionally, each of our leases and loans typically specifies that comprehensive insurance be maintained on each of our hotel properties, including liability, fire and extended coverage. There are certain types of losses, generally of a catastrophic nature, such as earthquakes and floods or terrorist acts, which may be uninsurable or not economically insurable, or may be subject to insurance coverage limitations, such as large deductibles or co-payments. We will use our discretion in determining amounts, coverage limits, deductibility provisions of insurance and the appropriateness of self-insuring, with a view to maintaining appropriate insurance coverage on our investments at a reasonable cost and on suitable terms. Uninsured and underinsured losses could harm our financial condition and results of operations. We could incur liabilities resulting from loss or injury to our hotels or to persons at our hotels. Claims, whether or not they have merit, could harm the reputation of a hotel or cause us to incur expenses to the extent of insurance deductibles or losses in excess of policy limitations, which could harm our results of operations.

In the event of a catastrophic loss, our insurance coverage may not be sufficient to cover the full current market value or replacement cost of our lost investment. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. In the event of a significant loss, our deductible may be high and we may be required to pay for all such repairs and, as a consequence, it could materially adversely affect our financial condition. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position on the damaged or destroyed property.

 

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Since September 11, 2001, it has generally become more difficult and expensive to obtain property and casualty insurance, including coverage for terrorism. When our current insurance policies expire, we may encounter difficulty in obtaining or renewing property or casualty insurance on our properties at the same levels of coverage and under similar terms. Such insurance may be more limited and for some catastrophic risks (e.g., earthquake, hurricane, flood and terrorism) may not be generally available at current levels. Even if we are able to renew our policies or to obtain new policies at levels and with limitations consistent with our current policies, we cannot be sure that we will be able to obtain such insurance at premium rates that are commercially reasonable. If we were unable to obtain adequate insurance on our properties for certain risks, it could cause us to be in default under specific covenants on certain of our indebtedness or other contractual commitments that require us to maintain adequate insurance on our properties to protect against the risk of loss. If this were to occur, or if we were unable to obtain adequate insurance and our properties experienced damage which would otherwise have been covered by insurance, it could materially adversely affect our financial condition and the operations of our properties.

In addition, insurance coverage for our hotel properties and for casualty losses does not customarily cover damages that are characterized as punitive or similar damages. As a result, any claims or legal proceedings, or settlement of any such claims or legal proceedings that result in damages that are characterized as punitive or similar damages may not be covered by our insurance. If these types of damages are substantial, our financial resources may be adversely affected.

Environmental and other governmental laws and regulations could increase our compliance costs and liabilities and adversely affect our financial condition and results of operations.

Our hotel properties are subject to various federal, state and local laws relating to the environment, fire and safety and access and use by disabled persons. Under these laws, courts and government agencies have the authority to require us, if we are the owner of a contaminated property, to clean up the property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property at the time it became contaminated. In addition to the costs of clean-up, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. Under such environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such as a landfill or an incinerator, to pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment.

Furthermore, various court decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person exposed to asbestos while staying in or working at a hotel may seek to recover damages for injuries suffered. Additionally, some of these environmental laws restrict the use of a property or place conditions on various activities. For example, some laws require a business using chemicals (such as swimming pool chemicals at a hotel) to manage them carefully and to notify local officials that the chemicals are being used.

We could be responsible for the types of costs discussed above. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material. Future laws or regulations may impose material environmental liabilities on us, or the current environmental condition of our hotel properties may be affected by the condition of the properties in the vicinity of our hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to us.

Our hotel properties are also subject to the Americans with Disabilities Act. Under the Americans with Disabilities Act, all public accommodations must meet various federal requirements related to access and use by disabled persons. Compliance with the requirements of the Americans with Disabilities Act could require removal of access barriers and non-compliance could result in the U.S. government imposing fines or in private litigants’ winning damages. If we are required to make substantial modifications to our hotels, whether to comply with the Americans with Disabilities Act or other changes in governmental rules and regulations, our financial condition and results of operations could be harmed. In addition, we are required to operate our hotel properties and laundry facilities in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and become applicable to our properties.

 

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Claims of illness or injury associated with the service of food and beverage to the public could adversely affect us.

Claims of illness or injury relating to food quality or food handling are common in the food and beverage business, and a number of these claims may exist at any given time. As a result, we could be adversely affected by negative publicity resulting from food quality or handling claims at one or more of the restaurants, bars or other food and beverage venues that we operate. In addition to decreasing sales and profitability at these restaurants, bars or other food and beverage venues, adverse publicity could negatively impact our reputation, hindering our ability to renew contracts on favorable terms or to obtain new business.

Our hotels may be faced with labor disputes or, upon expiration of a collective bargaining agreement, a strike, which would adversely affect the operation of our hotels.

We rely heavily on our employees to provide high-quality personal service at our hotels and any labor dispute or stoppage caused by poor relations with a labor union or the hotels’ employees could adversely affect our ability to provide those services, which could reduce occupancy and room revenue, tarnish our reputation and hurt our results of operations. Most of our employees who work at Morgans, Royalton, Hudson, Mondrian SoHo and Clift are members of local labor unions. Additionally, a majority of our employees employed through TLG are members of local labor unions. Our relationship with our employees or the union could deteriorate due to disputes relating to, among other things, wage or benefit levels or management responses to various economic and industry conditions. The collective bargaining agreement governing the terms of employment for employees working in our New York City hotels expires on June 30, 2019. Labor agreements with unions representing the majority of our TLG employees expire in May 2018. The collective bargaining agreement with the unions representing the majority of the Clift employees expired in August 2013 and we continue to follow the terms of the existing contract while negotiations with the respective labor unions continue.

Risks Related to Our Organization and Corporate Structure

Morgans Hotel Group Co. is a holding company with no operations.

Morgans Hotel Group Co. is a holding company and we conduct all of our operations through our subsidiaries. Morgans Hotel Group Co. does not have, apart from its ownership of Morgans Group, any independent operations. As a result and although we have no current plan to do so, we would rely on dividends and other payments or distributions from Morgans Group and our other subsidiaries to pay dividends on our common stock. We also rely on dividends and other payments or distributions from Morgans Group and our other subsidiaries to meet our debt service and other obligations, including our obligations in respect of our trust preferred notes, Convertible Notes and Series A preferred securities. The ability of Morgans Group and our other subsidiaries to pay dividends or make other payments or distributions to us will depend on Morgans Group’s operating results.

In addition, because Morgans Hotel Group Co. is a holding company, claims of our stockholders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our subsidiaries will be able to satisfy the claims of our stockholders only after all of our and our subsidiaries’ liabilities and obligations have been paid in full.

Substantially all of our businesses are held through our direct subsidiary, Morgans Group. Other than with respect to 75,446 membership units held by affiliates of NorthStar Capital Investment Corp. and LTIP Units convertible into membership units issued as part of our employee compensation plans, we own all of the outstanding membership units of Morgans Group. We may, in connection with acquisitions or otherwise, issue additional membership units of Morgans Group in the future. Such issuances would reduce our ownership of Morgans Group. Because our stockholders do not directly own Morgans Group units, they do not have any voting rights with respect to any such issuances or other corporate level activities of Morgans Group.

 

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Provisions in our charter documents, Delaware law and our rights plan could discourage potential acquisition proposals, could delay, deter or prevent a change in control and could limit the price certain investors might be willing to pay for our stock.

Certain provisions of our certificate of incorporation and bylaws may inhibit changes in control of our Company not approved by our Board of Directors or changes in the composition of our Board of Directors, which could result in the entrenchment of current management. These provisions include:

 

    a prohibition on stockholder action through written consents;

 

    a requirement that special meetings of stockholders be called by the Board of Directors;

 

    advance notice requirements for stockholder proposals and director nominations;

 

    limitations on the ability of stockholders to amend, alter or repeal the bylaws; and

 

    the authority of the Board of Directors to issue, without stockholder approval, preferred stock with such terms as the Board of Directors may determine and additional shares of our common stock.

We are also afforded the protections of Section 203 of the Delaware General Corporation Law, which prevents us from engaging in a business combination with a person who becomes a 15% or greater stockholder for a period of three years from the date such person acquires such status unless certain Board of Directors or stockholder approvals are obtained. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock.

In addition, our Board of Directors has adopted a stockholder protection rights plan which may deter certain takeover tactics.

The Yucaipa Investors, who own our Series A preferred securities and warrants to purchase our common stock, may have interests that are not aligned with yours and will have substantial influence over the vote on key matters requiring stockholder approval.

As of March 1, 2014, the Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P., (collectively, the “Yucaipa Investors”), held 12,500,000 warrants to purchase shares of our common stock and 75,000 shares of our Series A preferred securities.

In addition, the Yucaipa Investors have consent rights over certain transactions for so long as they collectively own or have the right to purchase through exercise of the warrants 6,250,000 shares of our common stock, including, subject to certain exceptions and limitations:

 

    the sale of all or substantially all of our assets to a third party;

 

    the acquisition (including by merger, consolidation or other business combination) by us of a third party where the equity investment by us is $100 million or greater;

 

    our acquisition by a third party; or

 

    any change in the size of our Board of Directors to a number below 7 or above 9.

For so long as the Yucaipa Investors collectively own at least a majority of the outstanding Series A preferred securities, they also have consent rights, subject to certain exceptions and limitations, over the sale of all or substantially all of our assets and certain other transactions where a vote of the holders of the Series A preferred securities is required by law or our certificate of incorporation.

For so long as the Yucaipa Investors collectively own or have the right to purchase through exercise of the warrants (assuming a cash exercise of such warrants) 875,000 shares of our common stock, we have agreed to use our reasonable best efforts to cause our Board of Directors to nominate and recommend to our stockholders the election of a person nominated by the Yucaipa Investors as a director and to use our reasonable best efforts to ensure that the Yucaipa Investors’ nominee is elected to our Board of Directors at each such meeting. If that nominee is not elected as a director at a meeting of stockholders, the Yucaipa Investors have certain Board of Director observer rights. Further, if we do not, within 30 days from the date of such meeting, create an additional seat on the Board of Directors and make available such seat to the nominee, the dividend rate on the Series A preferred securities increases by 4% during any time that a Yucaipa Investors’ nominee is not a member of our Board of Directors. At the 2013 Annual Meeting, Ron Burkle, the Yucaipa Investors’ nominee was not re-elected to the Board of Directors, and as of December 31, 2013, had not been offered a seat on our Board of Directors. Accordingly, the dividend rate on the Series A preferred securities increased by 4% to 12% as of July 14, 2013. The Yucaipa Investors contend that the 4% dividend rate increase was effective June 14, 2013.

 

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Accordingly, the Yucaipa Investors have substantial control rights over our business and may be able to decide the outcome of key corporate decisions. The interests of the Yucaipa Investors may differ from the interests of our other stockholders, and they may cause us to take or not take certain actions with which you may disagree. Third parties may be discouraged from making a tender offer or bid to acquire us because of this concentration of ownership, and we may have more difficulty raising equity or debt financing due to the Yucaipa Investors’ significant ownership and ability to influence certain decisions.

On November 1, 2013, we issued a press release stating that we received a letter from The Yucaipa Companies, LLC containing an unsolicited and conditional proposal to acquire the Company for $8.00 per share. See our Current Report on Form 8-K, filed on November 4, 2013, for additional details.

Payment of dividends on our Series A preferred securities and any redemptions of warrants may negatively impact our cash flow and the value of our common stock.

On October 15, 2009 we issued 75,000 shares of Series A preferred securities to the Yucaipa Investors. The holders of such Series A preferred securities are entitled to cumulative cash dividends, payable in arrears on every three-month anniversary following the original date of issuance if such dividends are declared by the Board of Directors or an authorized committee thereof, at a rate of 8% until October 2014, 10% per year until October 2016, and 20% per year thereafter. In addition, should the Yucaipa Investors’ nominee fail to be elected to our Board of Directors, the dividend rate would increase by 4% during any time that the Yucaipa Investors’ nominee is not a director. At the 2013 Annual Meeting, Ron Burkle, the Yucaipa Investors’ nominee was not re-elected to the Board of Directors, and as of December 31, 2013, had not been offered a seat on our Board of Directors. Accordingly, the dividend rate on the Series A preferred securities increased by 4% to 12% as of July 14, 2013. The Yucaipa Investors contend that the 4% dividend rate increase was effective June 14, 2013.

We have the option to accrue any and all dividend payments. As of December 31, 2013, we have not declared or paid any dividends. The accrual of these dividends may have a negative impact on the value of our common stock. In addition, the payment of these dividends may limit our ability to grow and compete by reducing our ability to use capital for other business and operational needs.

We have the option to redeem any or all of the Series A preferred securities at any time. Our working capital and liquidity reserves may not be adequate to cover these redemption payments should we elect to redeem these securities, which would place pressure on us to find outside sources of financing that may or may not be available.

Our basis in our Owned Hotels is generally substantially less than their fair market value which will decrease the amount of our depreciation deductions and increase the amount of recognized gain upon sale.

Some of the hotels which were part of our formation and structuring transactions at the time of our IPO in 2006 were contributed to us in tax-free transactions. Accordingly, our tax basis in the assets contributed was not adjusted in connection with our IPO and is generally substantially less than the fair market value of the contributed hotels as of the date of our IPO. We also intend to generally use the “traditional” method for making allocations under Section 704(c) of the Internal Revenue Code of 1986, as amended, as opposed to the “curative” or “remedial” method for making such allocations. Consequently, (i) our depreciation deductions with respect to our hotels will likely be substantially less than the depreciation deductions that would have been available to us had our tax basis been equal to the fair market value of the hotels as of the date of our IPO, (ii) we may recognize gain upon the sale of an asset that is attributable to appreciation in the value of the asset that accrued prior to the date of our IPO, and (iii) we may utilize available net operating losses against the potential gain from the sale of an asset.

 

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The change of control rules under Section 382 of the Internal Revenue Code may limit our ability to use net operating loss carryforwards to reduce future taxable income.

We have net operating loss (“NOL”) carryforwards for federal and state income tax purposes. Generally, NOL carryforwards can be used to reduce future taxable income. Our use of our NOL carryforwards will be limited, however, under Section 382 of the Internal Revenue Code (the “Code”) if we undergo a change in ownership of more than 50% of our capital stock over a three-year period as measured under Section 382 of the Code. These complex change of ownership rules generally focus on ownership changes involving stockholders owning directly or indirectly 5% or more of our stock, including certain public “groups” of stockholders as set forth under Section 382 of the Code, including those arising from new stock issuances and other equity transactions. We believe we experienced an ownership change for these purposes in April 2008, but that the resulting annual limit on our NOL carryforwards did not affect our ability to use the NOL carryforwards that we had at the time of that ownership change. Our stock is actively traded and it is possible that we will experience another ownership change within the meaning of Section 382 of the Code, measured for this purpose by including transfers and issuances of stock that took place after the ownership change that we believe occurred in April 2008. If we experienced another ownership change, the resulting annual limit on the use of our NOL carryforwards (which would equal the product of the applicable federal long-term tax-exempt rate, multiplied by the value of our capital stock immediately before the ownership change, then increased by certain existing gains recognized within 5 years after the ownership change if we have a net built-in gain in our assets at the time of the ownership change) could result in a meaningful increase in our federal and state income tax liability in future years. Whether an ownership change occurs by reason of public trading in our stock is not within our control and the determination of whether an ownership change has occurred is complex. No assurance can be given that we have not already undergone, or that we will not in the future undergo, another ownership change that would have a significant adverse effect on the value of our stock. In addition, the possibility of causing an ownership change may reduce our willingness to issue new stock to raise capital.

Non-U.S. holders owning more than 5% of our common stock may be subject to U.S. federal income tax on gain recognized on the disposition of our common stock.

Because of our significant U.S. real estate holdings, we believe that we are a “United States real property holding corporation” as defined under Section 897 of the Internal Revenue Code. As a result, any “non-U.S. holder” (as defined in the applicable tax provisions) will be subject to U.S. federal income tax on gain recognized on a disposition of our common stock if such non-U.S. holder has held, directly or indirectly, 5% of our common stock at any time during the five-year period ending on the date of the disposition and such non-U.S. holder is not eligible for any treaty exemption.

Changes in market conditions or sales of our common stock could adversely affect the market price of our common stock.

Sales of a substantial number of additional shares of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock. In addition to the possibility that we may sell shares of our common stock in a public offering at any time, we also may issue shares of common stock in connection with the warrants we issued to the Yucaipa Investors and their affiliates, our Convertible Notes, grants of restricted stock or LTIP Units or upon exercise of stock options that we grant to our directors, officers and employees. All of these shares may be available for sale in the public markets from time to time. As of December 31, 2013, there were:

 

    up to 12,500,000 shares of common stock issuable upon exercise of the warrants we issued to the Yucaipa Investors at an exercise price of $6.00 per share. The closing stock price at December 31, 2013 was $8.13;

 

    7,858,755 shares of common stock issuable upon conversion of the Convertible Notes assuming a conversion rate of 45.5580 shares per $1,000 principal amount of the Convertible Notes, representing a conversion price of approximately $21.95 per share of common stock, which is substantially higher than the closing price of $8.13 per share of our common stock as of December 31, 2013. As a result of the Yucaipa Note Repurchase in February 2014, this amount was reduced to 3,849,651 shares of common stock issuable assuming the same conversion rate as above;

 

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    1,424,740 shares of our common stock issuable upon exercise of outstanding options, of which options to purchase 1,291,406 shares were exercisable, at a weighted average exercise price of $14.19 per share. As of December 31, 2013, all of these options had exercise prices exceeding our stock price;

 

    1,101,276 LTIP Units outstanding exercisable for a total of 1,101,276 shares of our common stock;

 

    888,461 restricted stock units and 33,334 LTIP Units outstanding and subject to vesting requirements for a total of 921,795 shares of our common stock. As a result of the Termination Plan, 262,015 of these restricted stock units vested on March 10, 2014; and

 

    up to 3,740,198 shares of our common stock available for future grants under our equity incentive plans.

In addition, outperformance long-term incentive units (“OPP LTIP Units”) have been issued to our named executive officer and former named executive officers. The OPP LTIP Units are a new series of long-term incentive units (membership interests) in Morgans Group and are subject to vesting on the third anniversary of the grant date, which is March 20, 2011 (or earlier in the event of a change of control) and the achievement of certain performance targets (based on stock price appreciation plus dividends). See note 10 to our consolidated financial statements included elsewhere in this report for more information.

Most of the outstanding shares of our common stock are eligible for resale in the public market and certain holders of our shares have the right to require us to file a registration statement for purposes of registering their shares for resale. A significant portion of these shares is held by a small number of stockholders. If our stockholders sell substantial amounts of our common stock, the market price of our common stock could decline, which may make it more difficult for us to sell equity or equity related securities in the future at a time and price that we deem appropriate. We are unable to predict the effect that sales of our common stock may have on the prevailing market price of our common stock.

Transactions relating to our convertible note hedge and warrant transactions may affect the trading price of our common stock.

In connection with the issuance of the Convertible Notes, we have entered into convertible note hedge and warrant transactions with affiliates of certain of the initial purchasers, which we refer to as the counterparties. Pursuant to the convertible note hedge, we have purchased from the counterparties a call option on our common stock, and pursuant to the warrant transaction, we have sold to the counterparties a warrant for the purchase of shares of our common stock. The warrant has an exercise price that is 82.2% higher than the closing price of our common stock on the date of the pricing of the Convertible Notes. Together, the convertible note hedge and warrant transactions are expected to provide us with some protection against increases in our stock price over the conversion price per share and, accordingly, reduce our exposure to potential dilution upon the conversion of the Convertible Notes. We used an aggregate of approximately $21.0 million of the net proceeds of the offering of the Convertible Notes to fund the net cost of these hedging transactions. In connection with these transactions, the counterparties to these transactions:

 

    entered into various over-the-counter derivative transactions or purchased or sold our common stock in secondary market transactions at or about the time of the pricing of the Convertible Notes; and

 

    may enter into, or may unwind, various over-the-counter derivatives or purchase or sell our common stock in secondary market transactions following the pricing of the Convertible Notes, including during any conversion reference period with respect to a conversion of Convertible Notes.

These activities may have the effect of increasing, or preventing a decline in, the market price of our common stock. In addition, any hedging transactions by the counterparties following the pricing of the Convertible Notes, including during any conversion reference period, may have an adverse impact on the trading price of our common stock. The counterparties are likely to modify their hedge positions from time to time prior to conversion or maturity of the Convertible Notes by purchasing and selling shares of our common stock or other instruments, including over-the-counter derivative instruments, that they may wish to use in connection with such hedging. In particular, such hedging modifications may occur during a conversion reference period. In addition, we intend to exercise our purchased call option whenever Convertible Notes are converted, although we are not required to do so. In order to unwind any hedge positions with respect to our exercise of the purchased call option, the counterparties would expect to sell shares of common stock in secondary market transactions or unwind various over-the-counter derivative transactions with respect to the common stock during the conversion reference period for the converted Convertible Notes.

 

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The effect, if any, of any of these transactions and activities on the market price of our common stock will depend in part on current market conditions and therefore cannot be ascertained at this time. However, any of these activities could adversely affect the trading price of our common stock.

Our stock price has been and continues to be volatile.

The stock markets have, in the past, experienced extreme price fluctuations. These fluctuations have not always been related to the operating performance of the specific companies whose stock is traded. During the recent global economic downturn and thereafter, our stock price has been extremely volatile. Our stock price may continue to fluctuate as a result of various factors, such as:

 

    general industry and economic conditions, such as the lingering effects of the recent global economic downturn;

 

    general stock market volatility unrelated to our operating performance;

 

    announcements relating to significant corporate transactions;

 

    fluctuations in our quarterly and annual financial results;

 

    operating and stock price performance of companies that investors deem comparable to us;

 

    changes in government regulation or proposals relating thereto; and

 

    sales or the expectation of sales of a substantial number of shares of our common stock in the public market.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

Our Hotel Properties

Set forth below is a summary of certain information related to our Morgans Hotel Group hotel properties as of December 31, 2013:

 

Hotel

   City    Year
Opened
     Interest
Owned
    Number
of
Rooms
    Twelve Months
Ended December 31, 2013
 
             ADR(1)      Occupancy(2)     RevPAR(3)  

Owned Hotels:

                 

Hudson

   New York      2000         100 %(4)      866 (4)        

Delano South Beach

   Miami      1995         100     194          

Clift

   San Francisco      2001         (5     372          

Operating Statistics for Owned Comparable Hotels (6)

             $ 327         80.5   $ 263   

Joint Venture Hotels:

                 

Mondrian South Beach

   Miami      2008         50 %(7)      225 (7)        

Mondrian SoHo

   New York      2011         20 %(8)      263          

Operating Statistics for Joint Venture Comparable Hotels (10)

             $ 306         81.8   $ 250   

Managed Hotels:

                 

Shore Club

   Miami      2001         —   (9)      309          

Morgans

   New York      1984         —   (11)      114          

Royalton

   New York      1988         —   (11)      168          

Mondrian Los Angeles

   Los Angeles      1996         —   (11)      237          

St Martins Lane

   London      1999         —   (12)      204          

Sanderson

   London      2000         —   (12)      150          

Operating Statistics for Managed Comparable Hotels (13)

             $ 323         79.8   $ 258   

System-wide Comparable (14)

             $ 320         80.4   $ 258   

Hotel Operating Statistics by Region:

                 

Northeast Comparable Hotels (15)

             $ 323         87.9   $ 284   

West Coast Comparable Hotels (16)

             $ 258         84.9   $ 219   

Miami Comparable Hotels (17)

             $ 347         70.7   $ 246   

United States Comparable Hotels (18)

             $ 309         80.3   $ 248   

International Comparable Hotels (19)

             $ 381         80.7   $ 308   

 

(1) Average daily rate (“ADR”)
(2) Average daily occupancy
(3) Revenue per available room (“RevPAR”) is the product of ADR and average daily occupancy. RevPAR does not include food and beverage revenues or other hotel operations revenues such as telephone, parking and other guest services.
(4) We own 100% of Hudson through its subsidiary, Henry Hudson Holdings LLC, which is part of a property that is structured as a condominium, in which Hudson constitutes 96% of the square footage of the entire building. As of December 31, 2013, Hudson has 866 guest rooms and 67 SROs. Each SRO is for occupancy by a single eligible individual. The unit need not, but may, contain food preparation or sanitary facilities, or both. SROs remain from the prior ownership of the building and we are by statute required to maintain these long-term tenants, unless we get their consent, as long as they pay us their rent. Certain of our subsidiaries, including Henry Hudson Holdings LLC, Hudson Leaseco LLC, the lessee of our Hudson hotel, and certain related entities and lessees are required by the terms of the non-recourse indebtedness related to Hudson to maintain their status as “single purpose entities.” As such, their assets, which are included in our consolidated financial statements, are not available to satisfy the indebtedness or other obligations of our other subsidiaries.

 

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(5) Clift is operated under a long-term lease, which is accounted for as a financing.
(6) Owned Comparable Hotels includes all hotels that we owned and operate, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. Owned Comparable Hotels for the year ended December 31, 2013 includes Delano South Beach and Clift. Hudson is non-comparable during the period presented, as beginning in the fourth quarter of 2011 and continuing into 2012, this owned hotel was under renovation.
(7) Operated as a condominium hotel under a management contract and owned through a 50/50 unconsolidated joint venture. As of December 31, 2013, 235 hotel residences have been sold, of which 125 are in the hotel rental pool and are included in the hotel room count, and 100 hotel residences remain to be sold.
(8) Operated under a management contract and owned through an unconsolidated joint venture in which we held a minority ownership interest of approximately 20% at December 31, 2013.
(9) Operated under a management contract. Until December 30, 2013, we held a minority ownership interest of approximately 7% and accounted for the hotel as an unconsolidated joint venture. As of December 31, 2013, we have an immaterial contingent profit participation equity interest in Shore Club.
(10) Joint Venture Comparable Hotels include all hotels that we operate in which we have a non-controlling ownership interest except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. Joint Venture Comparable Hotels for the year ended December 31, 2013 includes Mondrian South Beach and Mondrian SoHo.
(11) Operated under a management contract.
(12) Operated under a management contract. The currency translation is based on an exchange rate of 1 British pound = 1.56 U.S. dollars, which is an average monthly exchange rate provided by www.oanda.com for the last twelve months ended December 31, 2013.
(13) Managed Comparable Hotels include all Morgans Hotel Group hotels that we operate in which we have no ownership interest, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. Managed Comparable Hotels for the year ended December 31, 2013 includes Morgans, Royalton, Shore Club, Mondrian Los Angeles, St Martins Lane, and Sanderson. The currency translation is based on an exchange rate of 1 British pound = 1.56 U.S. dollars, which is an average monthly exchange rate provided by www.oanda.com for the last twelve months ended December 31, 2013.
(14) System-Wide Comparable Hotels includes all Morgans Hotel Group hotels that we operate except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. System-Wide Comparable Hotels for the year ended December 31, 2013 excludes Hudson, which was undergoing renovation beginning in the fourth quarter of 2011 and continuing into 2012. The currency translation is based on an exchange rate of 1 British pound = 1.56 U.S. dollars, which is an average monthly exchange rate provided by www.oanda.com for the last twelve months ended December 31, 2013.
(15) Northeast Comparable Hotels includes all hotels that we operate in the Northeastern United States, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. Northeast Comparable Hotels for the year ended December 31, 2013 includes Morgans, Royalton, and Mondrian SoHo. Hudson is non-comparable during the period presented, as Hudson was under major renovation beginning the fourth quarter of 2011 and continuing throughout 2012.
(16) West Coast Comparable Hotels includes all hotels that we operate on the Western coast of the United States except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. West Coast Comparable Hotels for the year ended December 31, 2013 includes Mondrian Los Angeles and Clift.
(17) Miami Comparable Hotels includes all hotels that we operate in the Miami area of Florida, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. Miami Comparable Hotels for the year ended December 31, 2013 includes Delano South Beach, Shore Club and Mondrian South Beach.
(18) United States Comparable Hotels includes all hotels that we operate in the United States, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. United States Comparable Hotels for the year ended December 31, 2013 includes Morgans, Royalton, Mondrian SoHo, Mondrian Los Angeles, Clift, Delano South Beach, Mondrian South Beach and Shore Club. Hudson is non-comparable during the period presented, as Hudson was under major renovations beginning the fourth quarter of 2011 and continuing throughout 2012.

 

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(19) International Comparable Hotels includes hotels that we operate in international locations outside of the United States, except for hotels added or under major renovation during the current or the prior year, development projects and discontinued operations. International Comparable Hotels for the year ended December 31, 2013 includes St Martins Lane and Sanderson. The currency translation is based on an exchange rate of 1 British pound = 1.56 U.S. dollars, which is an average monthly exchange rate provided by www.oanda.com for the last twelve months ended December 31, 2013.

Owned Operations

Owned Hotels

The tables below reflect the results of operations of our Owned Hotel properties.

Hudson

Overview

Opened in 2000, Hudson is our largest New York City hotel, with 866 guest rooms and suites, as of December 31, 2013, including two ultra-luxurious accommodations — a 3,355 square foot penthouse with a landscaped terrace and an apartment with a 2,500 square foot tented terrace. The hotel, located only a few blocks away from Columbus Circle, Time Warner Center and Central Park, has numerous food and beverage offerings including Hudson Common, Henry, Tequila Park, Hudson Lodge, Library Bar and Sky Terrace.

We spent most of 2012 renovating all the guest rooms and corridors and converting SRO units into new guest rooms. The renovation was completed in September 2012 and the conversion of 32 SRO units into guest rooms was completed in January 2013, bringing the total number of guest rooms at Hudson to 866 as of December 31, 2013. In November 2012, we launched Hudson Lodge, a winter pop-up venue at the hotel’s private park. Additionally, in February 2013, we opened a new restaurant at Hudson, Hudson Commons, which is a modern-day beer hall and burger joint featuring a wide selection of local craft beers, inventive preparations of classic American fare, and soda shop-inspired specialty cocktails. The primary bar, Henry, opened in September 2013 after reconcepting and renovation. Henry is a cocktail bar and lounge featuring an inventive and experimental mixology program at Hudson.

We own 100% of Hudson, which is part of a property that is structured as a condominium, in which Hudson constitutes 96% of the square footage of the entire building. Hudson has a total of 928 rooms, comprised of 866 guest rooms and 67 SROs as of December 31, 2013. SROs are single room dwelling units. In 2014, we plan to convert an additional nine SRO units into 11 new guest rooms. We anticipate these 11 new guestrooms will be completed in the second quarter of 2014 and once completed, will increase the room count at Hudson to 877. As part of the Hudson/Delano 2014 Mortgage Loan, we are required to convert a minimum number of SRO units into ten guestrooms by September 30, 2014.

Each SRO is for occupancy by a single eligible individual. The unit need not, but may, contain food preparation or sanitary facilities, or both. SROs remain from the prior ownership of the building and we are by statute required to maintain these long-term tenants, unless we get their consent to terminate the lease, as long as they pay us their rent. Over time, we intend to develop new guest rooms from the remaining rooms that were formerly SRO units. We own a fee simple interest in Hudson. The hotel is subject to mortgage and mezzanine indebtedness as more fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt.”

Selected Financial and Operating Information

The following table shows selected financial and operating information for Hudson:

 

     Year Ended December 31,  
     2013     2012     2011     2010     2009  

Selected Operating Information:

          

Occupancy

     89.0     74.9     88.0     88.6     83.8

ADR

   $ 236      $ 234      $ 220      $ 213      $ 200   

RevPAR

   $ 210      $ 175      $ 194      $ 189      $ 168   

Selected Financial Information (in thousands):

          

Room Revenue (1)

   $ 66,505      $ 53,463      $ 58,993      $ 57,360      $ 49,853   

Total Revenue (1)

     81,534        62,279        73,112        72,804        65,663   

Depreciation (1)

     11,461        8,472        8,223        7,869        6,813   

Operating Income (1)

     9,391        2,520        5,919        9,564        6,329   

 

(1) Hudson was under major renovations beginning in late 2011, throughout 2012, and was concluded in 2013.

 

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Delano South Beach

Overview

Opened in 1995, Delano South Beach has 194 guest rooms, suites and lofts and is located in the heart of Miami Beach’s fashionable South Beach Art Deco district. The hotel features an “indoor/outdoor” lobby, the Water Salon and Orchard (which is Delano South Beach’s landscaped orchard and 100-foot long pool) and beach facilities. The hotel’s accommodations also include eight poolside bungalows and a penthouse and apartment. Delano South Beach’s food and beverage offerings were renovated and reconcepted in 2011 and include the restaurant, Bianca, which opened in January 2012, Delano Beach Club, a poolside bar and bistro, the Rose Bar, FDR, a nightclub which opened in February 2012, and Umi Sushi & Sake Bar, which also opened in February 2012. The hotel also features Club Essentia Wellness Retreat, a full-service spa facility providing preventative aging procedures focusing on the augmentation and restoration of one’s energy, vitality and vigor. Delano South Beach also offers multi-service meeting facilities, consisting of one executive boardroom and other facilities including a state-of-the-art media room.

In late 2011 and in early 2012, we spent approximately $13.0 million on projects at Delano South Beach to upgrade the exclusive bungalows and suites, improve public areas, including the pool, restaurant and bar space, and create additional meeting space. This work was begun in the third quarter of 2011 and was completed in the first quarter of 2012.

We own a fee simple interest in Delano South Beach. The hotel is subject to mortgage and mezzanine indebtedness as more fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt.”

Selected Financial and Operating Information

The following table shows selected financial and operating information for Delano South Beach:

 

     Year Ended December 31,  
     2013     2012     2011     2010     2009  

Selected Operating Information:

          

Occupancy

     68.6     67.6     64.1     61.1     62.3

ADR

   $ 525      $ 494      $ 499      $ 480      $ 488   

RevPAR

   $ 360      $ 334      $ 320      $ 293      $ 304   

Selected Financial Information (in thousands):

          

Room Revenue

   $ 25,485      $ 23,722      $ 22,612      $ 20,780      $ 21,539   

Total Revenue

     47,504        45,511        44,697        43,628        44,814   

Depreciation

     4,568        4,604        4,649        4,868        4,646   

Operating Income

     11,855        9,240        9,052        9,542        11,024   

Clift

Overview

Acquired in 1999 and reopened after an extensive renovation in 2001, Clift has 372 guestrooms and suites and is located in the heart of San Francisco’s Union Square district. The hotel features a restaurant, The Velvet Room, the Redwood Room Bar and the Living Room, which is available for private events. Clift also offers multi-service meeting facilities, consisting of two executive boardrooms, one suite and other facilities. Clift was last renovated in 2001 and the property may need to be renovated in the future.

 

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Our rights to operate Clift in San Francisco are based upon our interest under a 99-year lease. The lease is accounted for as a financing as more fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt.”

Selected Financial and Operating Information

The following table shows selected financial and operating information for Clift:

 

     Year Ended December 31,  
     2013     2012     2011     2010     2009  

Selected Operating Information:

          

Occupancy

     86.7     77.7     79.5     76.9     65.5

ADR

   $ 245      $ 240      $ 220      $ 187      $ 201   

RevPAR

   $ 212      $ 186      $ 175      $ 144      $ 131   

Selected Financial Information (in thousands):

          

Room Revenue

   $ 28,833      $ 25,361      $ 23,732      $ 19,547      $ 17,700   

Total Revenue

     42,102        37,543        36,379        31,861        30,702   

Depreciation

     2,947        3,077        3,133        3,128        3,028   

Operating (loss) income

     4,063        2,705        2,130        (1,284     (2,712

Owned Food and Beverage Operations

As of December 31, 2013, our Owned F&B Operations consisted of certain food and beverage operations located at our Owned Hotels and Sanderson and St Martins Lane, both in London, and three restaurants at Mandalay Bay in Las Vegas for which we acquired the leasehold interests in August 2012. We operate all of our Owned F&B Operations, with the exception of the Owned F&B Operations at St Martins Lane, which are managed by affiliates of China Grill Management Inc. (“CGM”) pursuant to a short-term management agreement.

In August 2012, we acquired the leasehold interests in three restaurants at Mandalay Bay from an existing tenant for $15.0 million in cash at closing and a $10.6 million principal only promissory note to be paid over seven years. The restaurants were renovated and reconcepted following the transaction. In December 2012, we opened Red Square, a premier dinner, cocktail, and nightlife destination, in January 2013, we opened Citizens Kitchen & Bar, which offers classic American comfort food, and in July 2013, we opened Kumi Japanese Restaurant & Bar, with a modern Japanese menu with a Korean American twist. The venues are managed by TLG and operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which we pay minimum annual lease payments of $0.2 million a year and a percentage rent based on cash flow.

Managed Operations

We manage hotels and food and beverage venues, pursuant to management agreements of varying terms.

Managed Hotels

Our Joint Venture Hotels as of December 31, 2013 are operated under management agreements which expire as follows:

 

    Mondrian South Beach — August 2026; and

 

    Mondrian SoHo — February 2021 (with two 10-year extensions at our option, subject to certain conditions).

 

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We are subject to ongoing litigation with our joint venture partner and the lender at Mondrian SoHo, as fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity.” As a result, no assurance can be provided that we will retain the management agreement for Mondrian SoHo.

Our Managed Hotels as of December 31, 2013 are operated under management agreements which expire as follows:

 

    Shore Club — July 2022;

 

    Mondrian Los Angeles — May 2031 (with one 10-year extension at our option);

 

    Royalton — May 2026 (with one 10-year extension at our option, subject to certain conditions);

 

    Morgans — May 2026 (with one 10-year extension at our option, subject to certain conditions);

 

    Sanderson — June 2018 (with one 10-year extension at our option); and

 

    St Martins Lane — June 2018 (with one 10-year extension at our option).

On December 30, 2013, Shore Club was sold to HFZ Capital Group. The new owner has publicly stated that it may convert a substantial part of the hotel to condos, and we could be replaced as hotel manager. To date, we have received no notice of termination of our management agreement, and intend to continue to operate the hotel pursuant to that agreement. However, no assurance can be provided that we will continue to do so in the future, as discussed further in note 5 of the consolidated financial statements.

We have also signed management, license or franchise agreements for various other hotels. As of December 31, 2013, these development stage hotels included the following:

 

     Expected Room
Count
     Anticipated
Opening
     Initial
Term
 

Hotels Currently Under Construction or Renovation:

        

Mondrian London

     360         2014         25 years   

Delano Las Vegas (1)

     1,114         2014         10 years   

Morgans Original, Istanbul (1)

     78         2014         15 years   

Mondrian Doha

     270         2014         30 years   

Mondrian at Baha Mar

     310         2015         20 years   

Delano Moscow

     160         2015         20 years   

Other Signed Agreements:

        

Mondrian Istanbul

     105            20 years   

Delano Aegean Sea

     150            20 years   

Delano Cartagena

     211            20 years   

 

(1) License or franchise agreements.

However, financing has not been obtained for the hotel projects listed under “Other Signed Agreements” above, and there can be no assurances that any or all of our development stage hotel projects will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, and to the extent we have previously funded key money, an equity investment or debt financing on a cancelled project, we may be unable to recover the amounts funded. For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the hotel, in early 2014, we exercised a put option under our Mondrian Istanbul joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We do not currently anticipate that these proceeding will have an impact on our management agreement should the hotel development continue.

 

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Our hotel management agreements may be subject to early termination in specified circumstances. For example, certain of our hotel management agreements contain performance tests that stipulate certain minimum levels of operating performance. In addition, some courts have applied principles of agency law and related fiduciary standards to managers of third-party hotel properties (or have interpreted hotel management agreements as “personal services contracts”). This means, among other things, that property owners may assert the right to terminate management agreements even where the agreements provide otherwise, and some courts have upheld such assertions regarding management agreements and may do so in the future. Several of our hotels are also subject to mortgage and mezzanine debt, and in some instances our management fee is subordinated to the debt. With all of our new management agreements for hotels under development, we attempt to negotiate non-disturbance agreements or similar protections with the mortgage lender, or to require that such agreements be entered into upon securing of financing, in order to protect our management agreements in the event of foreclosure. However, we are not always successful in imposing these requirements and some of our new development projects and existing hotels do not have non-disturbance or similar protections, which may make the related management agreements subject to termination by the lenders on foreclosure or certain other related events. Even if we have such non-disturbance protections in place, they may be subject to conditions and may be difficult or costly to enforce in a foreclosure situation. See, for example “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Off-Balance Sheet Arrangements – Mondrian SoHo and – Shore Club.”

Managed Food and Beverage

We own a 90% controlling investment in TLG, a leading lifestyle food and beverage management company, which primarily operates numerous venues in Las Vegas pursuant to management agreements with various MGM affiliates. Additionally, TLG manages the food and beverage operations at Delano South Beach, including Bianca, a restaurant serving Italian cuisine, FDR, the nightclub, and Delano Beach Club, the poolside bistro and bar.

The primary assets of TLG consist of its management and similar agreements with various MGM affiliates. Each of TLG’s venues is managed by an affiliate of TLG. Through our ownership of TLG, we recognize management fees in accordance with the applicable management agreement which generally provide for base management fees as a percentage of gross sales, and incentive management fees as a percentage of net profits, as calculated pursuant to the management agreements.

TLG owns the trade name, service mark and other intellectual property rights associated with the name of most of its nightclubs, lounges, restaurants and pools.

TLG’s management agreements with various MGM affiliates are typically structured as 10-year initial term contracts (effective the opening date of each respective venue) with two five-year renewal options, subject to certain conditions. As of December 31, 2013, TLG manages the following venues pursuant to management agreements with various MGM affiliates:

 

     Location    Initial
Term
     Exp. Date (before
extension options)
 

Nightclubs:

        

The Bank

   Bellagio      10 years         12/31/2017   

Haze

   Aria      10 years         12/31/2019   

1Oak

   Mirage      10 years         12/31/2020   

Light

   Mandalay Bay      10 years         8/31/2022   

Lounges:

        

Lily Bar & Lounge

   Bellagio      10 years         2/28/2022   

The Deuce Lounge

   Aria      10 years         12/31/2019   

Gold Boutique Nightclub and Lounge

   Aria      10 years         12/31/2019   

Revolution Lounge

   Mirage      10 years         1/31/2019   

Restaurants:

        

Brand Steakhouse (1)

   Monte Carlo      10 years         5/31/2018   

Diablo’s Cantina

   Monte Carlo      10 years         9/30/2017   

FIX Restaurant & Bar

   Bellagio      10 years         6/30/2014   

Stack Restaurant

   Mirage      10 years         12/31/2015   

Yellowtail Japanese Restaurant & Lounge

   Bellagio      10 years         7/31/2018   

Red Square Restaurant & Bar

   Mandalay Bay      10 years         12/31/2022   

Citizens Kitchen and Bar

   Mandalay Bay      10 years         1/31/2023   

Kumi Japanese Restaurant + Bar

   Mandalay Bay      10 years         3/31/2023   

Pool Lounges:

        

Bare

   Mirage      10 years         12/31/2016   

Liquid

   Aria      10 years         3/31/2020   

 

(1) TLG’s management agreement will terminate on April 1, 2014, as discussed below.

 

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Under TLG’s management agreements with various affiliates of MGM, all costs associated with the construction, build-out, FF&E, operating supplies, equipment and daily operational expenses are generally borne by the owner or the lessor of the venue.

These management agreements may be subject to early termination in specified circumstances. For example, the management agreements generally contain, among other covenants, a performance test that stipulates a minimum level of operating performance, and restrictions as to certain requirements of suitability, capacity, compliance with laws and material terms, financial stability, and certain of the management agreements require that certain named representatives, including Andy Masi, must remain employed by or under contract to TLG. We were recently engaged in a lawsuit with Mr. Masi, as fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity.” Additionally, in 2013, we failed performance tests at certain venues, and as a result, we agreed with MGM to a change in the calculation of base and incentive management fees for all of TLG’s management agreements with MGM effective January 1, 2014, and agreed to a termination effective April 1, 2014 of TLG’s management agreement for Brand Steakhouse.

In August 2012, we acquired the leasehold interests in three restaurants at Mandalay Bay from an existing tenant for $15.0 million in cash at closing and a $10.6 million principal only promissory note to be paid over seven years. The restaurants were renovated and reconcepted following the transaction. In December 2012, we opened Red Square, in January 2013, we opened Citizens Kitchen & Bar, and in July 2013, we opened Kumi Japanese Restaurant & Bar. The venues are managed by TLG and operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which we pay minimum annual lease payments of $0.2 million a year and a percentage rent based on cash flow.

 

ITEM 3. LEGAL PROCEEDINGS

We are involved in various lawsuits and administrative actions in the normal course of business, as well as other litigations as noted below.

Litigations Regarding Mondrian SoHo

On January 16, 2013, German American Capital Corporation, the lender for the mortgage loans on Mondrian SoHo (“GACC” or the “lender”), filed a complaint in the Supreme Court of the State of New York, County of New York against Sochin Downtown Realty, LLC, the joint venture that owns Mondrian SoHo (“Sochin JV”), Morgans Management, Morgans Group, Happy Bar LLC and MGMT LLC, seeking foreclosure including, among other things, the sale of the mortgaged property free and clear of the management agreement, entered into on June 27, 2007, as amended on July 30, 2010, between Sochin JV and Morgans Management. According to the complaint, Sochin JV defaulted by failing to repay the approximately $217 million outstanding on the loans when they became due on November 15, 2012. Cape Advisors Inc. indirectly owns 80% of the equity interest in Sochin JV and Morgans Group indirectly owns the remaining 20% equity interest.

On March 11, 2013 we moved to dismiss the lender’s complaint on the grounds that, among other things, our management agreement is not terminable upon a foreclosure. On April 2, 2013, the lender opposed our motion to dismiss and cross-moved for summary judgment. On August 12, 2013, the court heard oral argument on both motions, as well as a third motion brought by the Company to strike an affirmation submitted by lender’s attorney. On January 27, 2014, the court granted Morgans Management’s motion to dismiss on the ground that a management contract does not constitute an interest subject to foreclosure, and denied lender’s motion for summary judgment as moot. On February 27, 2014, the court held a status conference where a schedule was set for further proceedings including a further summary judgment motion to be filed by the lender within 30 days as to the remaining defendants.

 

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On February 25, 2013, Sochin JV filed a complaint in the Delaware Chancery Court against Morgans Management and Morgans Group, seeking, among other things, a declaration that plaintiff properly terminated the management agreement for the hotel, injunctive relief, and an award of damages in an amount to be determined, but alleged to exceed $10 million, plus interest. The management agreement has an initial term of 10 years, with two 10-year renewals, subject to certain conditions. The complaint alleges, among other things, mismanagement of the hotel and breach of the management agreement by Morgans Management. The plaintiff also purports to terminate the management agreement under alleged agency principles. The suit was initiated on behalf of Sochin JV by Cape Soho Holdings, LLC, our joint venture partner. In addition, we, through our equity affiliate, filed a separate action against the owner and its parent in the Delaware Chancery Court for, among other things, breaching fiduciary duties and their joint venture agreement for failing to obtain consent prior to the termination. That action was subsequently consolidated with the termination action. On September 17, 2013, the Delaware Chancery Court heard oral argument on various motions to dismiss and for partial summary judgment in the consolidated actions, following which the court entered orders, on September 20, 2013, ruling that Sochin JV terminated the hotel management agreement on agency grounds, that Morgans must vacate the hotel forthwith or on whatever other timetable the hotel owner chooses, and that two claims by our equity affiliate are dismissed but not its breach of fiduciary duty claim. On September 30, 2013, we filed a motion for reconsideration and to stay execution of the judgment pending appeal. That motion is still pending, and no final order has as yet been issued. By joint stipulation of the parties, granted on February 21, 2014, Sochin JV will file its opposition to the motion for reconsideration and to stay by March 24, 2014, following which the court will issue its ruling. The parties have also stipulated to move, answer or otherwise respond to the operative complaints, by March 24, 2014. Should we not prevail on our motion for reconsideration and to stay, we intend to vigorously pursue our rights on appeal, but no assurance can be provided that we will prevail or otherwise retain management of the hotel.

On April 30, 2013, we filed a lawsuit against Cape Soho Holdings, LLC and Cape Advisors Inc. in New York Supreme Court for damages based on the wrongful attempted termination of the management agreement, defamation, and breach of fiduciary and other obligations under the parties’ joint venture agreement. On August 23, 2013, the owner moved to dismiss that complaint. As of January 13, 2014, that motion has been fully briefed, and oral argument has been set for April 10, 2014. It is not possible to predict with reasonable certainty the outcome of this action, nor the amount of damages we are likely to recover should we ultimately prevail on one or more of our claims.

Litigation Regarding TLG Promissory Notes

On August 5, 2013, Messrs. Andrew Sasson and Andy Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition LLC and Morgans Group LLC relating to the $18.0 million TLG Promissory Notes. See note 1 and note 7 of our consolidated financial statements regarding the background of the TLG Promissory Notes. The complaint alleged, among other things, a breach of contract and an event of default under the TLG Promissory Notes as a result of our failure to repay the TLG Promissory Notes following an alleged “Change of Control” that purportedly occurred upon the election of our current Board of Directors on June 14, 2013. The complaint sought payment of Mr. Sasson’s $16 million TLG Promissory Note and Mr. Masi’s $2 million TLG Promissory Note, plus interest compounded to principal, as well as default interest, and reasonable costs and expenses incurred in the lawsuit. We believe that a Change of Control, within the meaning of the TLG Promissory Notes, has not occurred and that no prepayments are required under the TLG Promissory Notes. On September 26, 2013, we filed a motion to dismiss the complaint. On February 6, 2014, the court granted our motion to dismiss.

Litigation Regarding 2013 Deleveraging Transaction, Proxy Litigation Between Mr. Burkle and OTK, and Litigation Regarding Yucaipa Board Observer Rights

On February 28, 2014, we entered into a binding Memorandum of Understanding (“MOU”) which contemplates the partial settlement and dismissal with prejudice of the action entitled OTK Associates, LLC v. Friedman, et al., C.A. No. 8447-VCL (Del. Ch.) (the “Delaware Action”) and the complete settlement and dismissal with prejudice of the actions entitled Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., et al., Index No. 652294/2013 (NY Sup.) (the “Securities Action”); Burkle v. OTK Associates, LLC, et al., Case No. 13-CIV-4557 (S.D.N.Y.) (the “Proxy Action”); and Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group, Index No. 653455/2013 (NY Sup.) (the “Observer Action”) (the foregoing four actions are collectively referred to as the “Actions”). An overview of the Actions and terms of the MOU follows.

 

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The Delaware Action

On April 1, 2013, director Jason Kalisman filed in the Delaware Chancery Court the “Delaware Action,” a purported derivative action on our behalf against former directors Robert Friedman, Thomas L. Harrison, Michael D. Malone, Jeffrey Gault and Andrew Sasson (collectively, the “Former Director Defendants”), Michael J. Gross, a former director and chief executive officer, and Ronald W. Burkle, another former director, and the following companies with which he is affiliated: Yucaipa American Alliance Fund II, L.P., Yucaipa American Alliance (Parallel) Fund II, L.P., Yucaipa Aggregator Holdings, LLC and The Yucaipa Companies LLC (collectively, the “Yucaipa Defendants”). The action arose from a proposed deleveraging transaction between us and the Yucaipa Defendants (the “2013 Deleveraging Transaction”), which a majority of the Board of Directors voted to approve on March 30, 2013. On April 4, 2013, OTK Associates, LLC (“OTK”), a stockholder of ours, filed a motion to intervene as a plaintiff in the Delaware Action.

On May 14, 2013, the court issued a preliminary injunction (a) prohibiting us from taking any steps to consummate the 2013 Deleveraging Transaction until the earlier of a trial or the taking of certain action by the Board of Directors and one of its committees; and (b) requiring us to hold our 2013 Annual Meeting on the date originally scheduled, using the originally scheduled record date. The court further determined that all claims asserted by plaintiffs, including those resolved on a preliminary basis by the court in its May 14, 2013 Order, were subject to final resolution following trial.

On July 9, 2013, the court granted plaintiff OTK’s motion to file a Second Amended and Supplemental Complaint (the “Second Amended Complaint”). The Second Amended Complaint excludes Mr. Kalisman as a plaintiff but continues to assert claims, both directly and derivatively on our behalf, against all persons and entities previously named as defendants in the Amended Complaint, except that no claims are now made against us.

On July 17, 2013, counsel for Mr. Kalisman and OTK filed in the Delaware Action a motion for the award of approximately $2.7 million in attorneys’ fees and expenses related to their prosecution of the Delaware Action through the date of the motion. On October 31, 2013, the court, after directing that notice of the application be given to our stockholders and having not received any objections, issued an order granting the award. Our directors and officers liability insurance paid this award in late 2013.

On August 22, 2013, we filed our answer to the Second Amended Complaint. The defendants in the action chose either to answer the Second Amended Complaint or moved to dismiss or stay the action. On January 21, 2014, the court granted an unopposed motion to dismiss without prejudice all claims asserted against Mr. Gross in the Delaware Action. On February 5, 2014, the court issued an opinion denying, in most part, all the defendants’ motions to dismiss or stay the Delaware Action.

The Securities Action

On June 27, 2013, Yucaipa American Alliance Fund II, L.P., Yucaipa American Alliance (Parallel) Fund II, L.P., Yucaipa Aggregator Holdings, LLC and Vintage Deco Hospitality LLC (collectively the “Yucaipa Securities Action Plaintiffs”) filed a complaint against us and Morgans Group in the Supreme Court of the State of New York alleging, among other things, that we and Morgans Group had refused to use commercially reasonable best efforts to close the various putative agreements comprising the 2013 Deleveraging Transaction, and that there has “effectively” been a withdrawal or adverse modification of the approval of the 2013 Deleveraging Transaction by the Board of Directors. Alternatively, the Yucaipa Securities Action Plaintiffs contend that we and Morgans Group breached certain representations and warranties under the putative contracts comprising the 2013 Deleveraging Transaction. The Yucaipa Securities Action Plaintiffs have asserted various claims and seek, among other things, an award of damages equal to a termination fee of $9 million, as well as payment of out-of-pocket costs, indemnification in excess of $1 million, pre-judgment interest and attorney’s fees.

 

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On July 22, 2013, we and Morgans Group filed a motion in the Securities Action to stay (or alternatively to dismiss) that action pending the disposition of the Delaware Action. On January 29, 2014, the court in the Securities Action denied on a “without prejudice” basis, that motion. On February 26, 2014, we and Morgans Group served an answer to the complaint in the Securities Action.

The Proxy Action

On July 1, 2013, Mr. Burkle filed a complaint in the U.S. District Court for the Southern District of New York against OTK and the seven current members of our Board of Directors. The complaint purports to assert a claim against all defendants arising under Section 14(a) of the Securities Exchange Act of 1934, as amended, for allegedly using false and materially misleading proxy solicitation materials during the 2013 annual election of directors. The complaint seeks, among other things, an injunction requiring defendants to cause us to hold a new election of our Board of Directors. On August 30, 2013, Mr. Burkle filed a motion for preliminary injunction requesting that defendants be ordered to call a stockholders’ meeting and to schedule a new board of directors election. On that same date, defendants filed a motion to dismiss Mr. Burkle’s complaint. On November 13, 2013, the court issued a decision denying Mr. Burkle’s preliminary injunction motion and on February 25, 2014, the court converted the dismissal motion to one for summary judgment and gave the parties 30 days to submit any additional relevant material. We are not party to the Proxy Action.

The Observer Action

On October 4, 2013, Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II L.P. filed a complaint against us in the Supreme Court of the State of New York. The plaintiffs assert in the complaint, among other things, that we have breached the terms of a Securities Purchase Agreement, dated as of October 15, 2009, we entered with the plaintiffs by not providing plaintiffs with the “observer” rights to our Board of Directors meetings that plaintiffs contend they are entitled to under the Securities Purchase Agreement. In addition to attorneys’ fees and other unspecified relief, the complaint seeks preliminary and permanent injunctions ordering us to “honor fully” plaintiffs’ alleged observer rights by, among other things, refraining from holding informal board meetings, from failing to provide notice, and from improperly delegating board duties to a committee of the Board of Directors. On January 27, 2014, we filed an answer, denying material allegations of the complaint, and we served demands for discovery.

The MOU

The MOU is subject to execution of a Stipulation of Settlement acceptable to us (the “Settlement Stipulation”), which must be submitted to the Delaware Court of Chancery in the Delaware Action for review and approval and will not become effective, under the terms of the MOU, until such approval is given and is no longer subject to further court review (the “Effective Date”).

The MOU provides, among other things, for the following:

 

    We will pay to the Yucaipa Securities Action Plaintiffs in the Securities Action an amount equal to $3 million less the aggregate amount of any reasonable and necessary attorneys’ fees and expenses incurred by Mr. Burkle in his defense of the Delaware Action that are paid to him by our insurers prior to the Effective Date (the “Securities Action Payment”).

 

    Mr. Burkle will pay to us the amount of all insurance proceeds he recovers from our insurers after the Effective Date for the reasonable and necessary attorneys’ fees and expenses that he incurred in defense of the Delaware Action and assign to us any claims he may have against our insurers relating to any such reasonable and necessary attorneys’ fees and expenses that our insurers may fail to pay Mr. Burkle.

 

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    To the extent not paid by our insurers, we will pay the amount of any reasonable and necessary attorneys’ fees and expenses incurred by Messrs. Friedman, Gault and Sasson (collectively, the “Settling Former Directors”) in defending the Delaware Action, subject to the Settling Former Directors’ assignment to us of any claims they have against our insurers relating to any such unpaid amounts.

 

    The Settling Former Directors will pay to us a portion of the Securities Action Payment (based on a formula whose elements cannot presently be quantified) unless our insurers pay such amounts to us or the Settling Former Directors assign to us any claims they have against our insurers relating to any such amounts that our insurers fail to pay.

 

    Counsel for OTK and current director Jason T. Kalisman will apply to the Delaware Court of Chancery for an award of payment from us of the reasonable and necessary fees and expenses they incurred in connection with the Delaware Action, excluding those fees and expenses encompassed in the court’s October 31, 2013 order in the Delaware Action. Any such award may be subject to recovery by us from our insurers.

 

    Plaintiffs and defendants in each of the Actions, apart from former director defendants Messrs. Harrison and Malone who chose not to participate in the MOU and against whom the Delaware Action continues (collectively, the “Non-Settling Former Directors”), will exchange customary releases which release the parties and certain of their affiliates from claims arising from the subject matters of each of the Actions.

 

    Each of the Actions will be dismissed with prejudice and on the merits with each party bearing its own costs, except as to the Non-Settling Former Directors against whom the Delaware Action continues or as specified in the MOU.

We cannot currently predict the amount of any funds we might be required to pay under the MOU; whether our insurers will pay some or all of the amounts that we would otherwise be obligated to pay under the MOU; whether we would be successful in asserting against our insurers any claims that will or may be assigned to us under the terms of the MOU or that we might assert on our own behalf, or what the amount of any such recovery might be. Furthermore, we cannot predict whether the Delaware Court of Chancery will approve the Settlement Stipulation or whether the court’s decision will be challenged on appeal and, if so challenged, affirmed. Notwithstanding the foregoing, we do not expect that the net amount of all payments we might ultimately be required to make, after recovery of all insurance proceeds, under the terms of the MOU and the Stipulation of Settlement, if approved, will be material to our financial position.

The foregoing description of the MOU does not purport to be complete and is qualified in its entirety by reference to the MOU, which is filed as Exhibit 10.40 hereto and is incorporated into this report by reference.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock has been listed on the Nasdaq Global Market under the symbol “MHGC” since the completion of our IPO in February 2006. The following table sets forth the high and low sales prices for our common stock, as reported on the Nasdaq Global Market, for each of the periods listed. No dividends were declared or paid during the periods listed.

 

Period

   High      Low  

First Quarter 2012

   $ 6.40       $ 4.90   

Second Quarter 2012

   $ 5.17       $ 3.74   

Third Quarter 2012

   $ 6.44       $ 4.40   

Fourth Quarter 2012

   $ 6.76       $ 5.10   

First Quarter 2013

   $ 6.05       $ 4.66   

Second Quarter 2013

   $ 8.12       $ 5.95   

Third Quarter 2013

   $ 8.15       $ 6.45   

Fourth Quarter 2013

   $ 8.49       $ 6.25   

On March 12, 2014, the closing sale price for our common stock, as reported on the Nasdaq Global Market, was $8.03. As of March 12, 2014, there were 38 record holders of our common stock, although there is a much larger number of beneficial owners.

Dividend Policy

We have never declared or paid any cash dividends on our common stock and we do not currently intend to pay any cash dividends on our common stock. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our common stock will be, subject to applicable law, at the discretion of our Board of Directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements and contractual restrictions. Our Hudson/Delano 2014 Mortgage Loan prohibits us from paying cash dividends on our common stock. In addition, so long as any Series A preferred securities are outstanding, we are prohibited from paying dividends on our common stock, unless all accumulated and unpaid dividends on all outstanding Series A preferred securities have been declared and paid in full.

The Series A preferred securities we issued in October 2009 have an 8% dividend rate until October 2014, then a 10% dividend rate until October 2016, and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. At the 2013 Annual Meeting, Ron Burkle, the Yucaipa Investors’ nominee to the Board of Directors, was not re-elected to the Board of Directors, and as of July 14, 2013, had not been offered a seat on the Board of Directors. Accordingly, the dividend rate on the Series A preferred securities increased by 4% to 12% as of July 14, 2013. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. We have the option to accrue any and all dividend payments, and as of December 31, 2013, have not declared any dividends. As of December 31, 2013, we have undeclared dividends of approximately $32.2 million.

 

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Performance Graph

The following graph below shows the cumulative total stockholder return of our common stock from December 31, 2008 through December 31, 2013 compared to the S&P 500 Stock Index and the S&P 500 Hotels. The graph assumes that the value of the investment in our common stock and each index was $100 at December 31, 2008. We have declared no dividends during this period. The stockholder return on the graph below is not indicative of future performance.

Comparison of Cumulative Total Return of the Company, S&P 500 Stock Index

and S&P 500 Hotels Index From December 31, 2008 through December 31, 2013

 

LOGO

 

     12/31/2008      12/31/2009      12/31/2010      12/31/2011      12/31/2012      12/31/2013  

Morgans Hotel Group Co.

   $ 100.00       $ 98.07       $ 194.64       $ 126.61       $ 118.88       $ 174.46   

S&P 500 Stock Index

     100.00         123.45         139.23         139.23         157.90         204.63   

S&P 500 Hotels Index

     100.00         155.25         235.68         186.76         228.61         289.00   

 

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ITEM 6. SELECTED FINANCIAL DATA

The following selected historical financial and operating data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K.

The following table contains selected consolidated financial data for the years ended December 31, 2013, 2012, 2011, 2010, and 2009, all of which is derived from the Company’s audited consolidated financial statements. The historical results do not necessarily indicate results expected for any future period.

 

     Year Ended December 31,  
     2013     2012     2011     2010     2009  
     (In thousands, except operating and per share data)  

Statement of Operations Data(1), (2):

          

Total hotel revenues

   $ 209,771      $ 165,261      $ 193,044      $ 218,032      $ 209,978   

Total revenues

     236,486        189,919        207,332        236,370        225,051   

Total hotel operating expense

     162,929        135,608        157,265        170,600        169,557   

Corporate expenses, including stock compensation

     27,626        32,062        34,563        34,538        33,514   

Depreciation and amortization

     27,374        23,977        22,219        32,158        29,623   

Total operating costs and expenses

     238,396        204,281        228,338        246,761        238,777   

Operating loss

     (1,910     (14,362     (21,006     (10,391     (13,726

Interest expense, net

     45,990        38,998        35,514        41,346        48,557   

Net loss from continuing operations

     (44,150     (56,491     (88,442     (99,916     (81,361

Income (loss) from discontinued operations (1), (2)

     —         —         485        16,268        (20,244

Net loss

     (44,150     (56,491     (87,957     (83,648     (101,605

Net (income) loss attributable to noncontrolling interest

     (5     804        2,554        2,239        1,881   

Net loss attributable to Morgans Hotel Group Co.

     (44,155     (55,687     (85,403     (81,409     (99,724

Preferred stock dividends and accretion

     (14,316     (11,124     (9,938     (8,554     (1,746

Net loss attributable to common stockholders

     (58,471     (66,811     (95,341     (89,963     (101,470

Net loss per share attributable to common stockholders, basic and diluted

     (1.78     (2.13     (3.03     (2.94     (3.38

Weighted average common shares outstanding

     32,867        31,437        31,454        30,563        30,017   

Cash Flow Data:

          

Net cash (used in) provided by:

          

Operating activities

   $ (3,147   $ (39,464   $ 9,750      $ (7,252   $ (20,305

Investing activities

     (7,389     (61,119     264,295        (19,015     (35,004

Financing activities

     14,714        77,575        (250,440     (37,439     75,622   

 

 

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     As of December 31,  
     2013     2012     2011(1)     2010     2009  
     (In thousands)  

Balance Sheet Data (2), (3), (4):

          

Cash and cash equivalents

   $ 10,025      $ 5,847      $ 28,855      $ 5,250      $ 68,956   

Restricted cash

     22,144        21,226        9,938        28,783        21,109   

Property and equipment, net

     292,629        303,689        289,169        291,078        300,060   

Assets held for sale, net (4)

     —         —         —         194,964        203,154   

Investment in hotel property of discontinued operations, net (2)

     —         —         —         —         23,977   

Assets of property held for non-sale disposition, net (3)

     —         —         —         9,775        10,113   

Total assets

     571,207        591,155        555,444        714,776        838,238   

Mortgage notes payable

     180,000        180,000        115,000        227,662        243,500   

Mortgage debt of assets held for sale (4)

     —         —         —         103,496        120,500   

Mortgage debt of discontinued operations

     —         —         —         —         40,000   

Promissory notes payable of property held for non-sale disposition, net

     —         —         —         10,500        10,500   

Financing and capital lease obligations

     379,939        358,143        324,905        331,117        325,013   

Debt and capital lease obligations

     559,939        538,143        439,905        672,775        739,013   

Redeemable noncontrolling interest

     4,953        6,053        5,448        —         —    

Preferred stock

     62,004        57,755        54,143        51,118        48,564   

Total MHGC stockholders’ (deficit) equity

     (183,924     (149,436     (97,463     (12,721     9,020   

Total (deficit) equity

     (183,434     (143,370     (89,639     (1,805     23,411   

 

(1) Financial statement data as of December 31, 2011 has been adjusted to present the impact of the final purchase price allocation of our acquisition of TLG, as discussed further in note 1 to the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K. The impact of the final purchase price allocation on our previously filed consolidated statement of comprehensive loss was immaterial.
(2) Financial statement data for 2010 and 2009 has been adjusted to present our former Mondrian Scottsdale hotel as a discontinued operation. The lender foreclosed on the property and terminated our management agreement related to the property with an effective termination date of March 16, 2010.
(3) Financial statement data for 2010 and 2009 has been adjusted to present the property across from Delano South Beach as property held for non-sale disposition separately from our other assets and liabilities and a discontinued investment. In January 2011, our indirect subsidiary transferred its interests in the property to SU Gales Properties, LLC, and as a result of this transfer we were released from the $10.5 million non-recourse mortgage and mezzanine indebtedness. For further discussion and information on this property held for non-sale disposition, see the consolidated balance sheets in the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
(4) Balance sheet data for 2010 and 2009 has been adjusted to present Mondrian Los Angeles, Royalton and Morgans as assets held for sale separately from our other assets and liabilities. In May 2011, we sold our ownership interests in these hotels to unrelated third parties. For further discussion and information on these hotels held for sale, see the consolidated balance sheets in the consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.

 

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ITEM  7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Historical Financial and Operating Data” and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Overview

We are a fully integrated lifestyle hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations, and nightclubs, restaurants, bars and other food and beverage venues in many of the hotels we operate, as well as in hotels and casinos operated by MGM in Las Vegas.

The historical financial data presented herein is the historical financial data for:

 

    our three Owned Hotels, consisting, as of December 31, 2013, of Hudson in New York, Delano South Beach in Miami Beach, and Clift in San Francisco (which we lease under a long-term lease that is treated as a financing), comprising approximately 1,400 rooms;

 

    our Owned F&B Operations, consisting, as of December 31, 2013, of the food and beverage operations located at our Owned Hotels, certain food and beverage operations located at Sanderson and St Martins Lane, both in London, and food and beverage venues at Mandalay Bay in Las Vegas;

 

    our two Joint Venture Hotels, consisting, as of December 31, 2013, of Mondrian South Beach in Miami Beach and Mondrian SoHo in New York, comprising approximately 500 rooms and our investment in the F&B Venture at Mondrian South Beach in Miami Beach;

 

    our six Managed Hotels, consisting, as of December 31, 2013, of Royalton and Morgans in New York, Shore Club in Miami Beach, Mondrian in Los Angeles, Sanderson and St Martins Lane in London, comprising approximately 1,200 rooms;

 

    our 90% controlling interest in TLG Acquisition, which owns and operates certain locations of our nightclub and food and beverage management business. TLG develops, redevelops and operates numerous venues primarily in Las Vegas pursuant to management agreements with MGM, including nightclubs, restaurants, pool lounges and bars;

 

    our investments in hotels under development and other proposed properties.

Our corporate strategy is to achieve growth as a boutique hotel management and brand company by leveraging our management experience and one-of-a-kind luxury brands for expansion into both domestic and international markets. We intend to achieve growth primarily through the pursuit of new long-term management agreements and, in select situations where third-party managers have the experience and resources to satisfy our high branding standards, franchise agreements. For example, in January 2014, we signed a 15-year franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey. The hotel is expected to have 78 rooms and open in late 2014.

Additionally, we also intend to enhance the value of our existing hotels and management agreements through targeted renovation and expansion projects. We believe that by pursuing this targeted strategy, while remaining open and flexible to unique opportunities, we will strengthen our position as a leader in lifestyle hospitality management.

 

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Management and Franchise Agreements. Although our hotel management agreements and franchise or license agreements are generally long-term, they may be subject to early termination in specified circumstances, or we may agree to early termination as circumstances require. See, for example, Part I, “Item 1. Business – 2013 and Other Recent Transactions and Developments – Ames.” Certain of our hotel management agreements and franchise or license agreements contain performance tests that stipulate certain minimum levels of operating performance. We may disagree with hotel owners on how the performance criteria are calculated and whether they have been met. In addition, some courts have applied principles of agency law and related fiduciary standards to managers of third-party hotel properties (or have interpreted hotel management agreements as “personal services contracts”). This means, among other things, that property owners may assert the right to terminate management agreements even where the agreements provide otherwise, and some courts have upheld such assertions regarding management agreements and may do so in the future.

Several of our hotels are also subject to mortgage and mezzanine debt, and in some instances our management, franchise or license fee is subordinated to the debt. Some of our management, franchise or license agreements also may be terminated by the lenders on foreclosure or certain other related events. With all of our new management, franchise and license agreements for hotels under development, we attempt to negotiate non-disturbance agreements or similar protections with the mortgage lender, or to require that such agreements be entered into upon securing of financing, in order to protect our agreements in the event of foreclosure. However, we are not always successful in imposing these requirements, and some of our new development projects and existing hotels do not have non-disturbance or similar protections, which may make the related agreements subject to termination by the lenders on foreclosure or certain other related events. Even if we have such non-disturbance protections in place, they may be subject to conditions and may be difficult or costly to enforce in a foreclosure situation. See, for example, “Off-Balance Sheet Arrangements – Mondrian SoHo” and “Off-Balance Sheet Arrangements – Shore Club.”

We may also terminate hotel management, franchise or license agreements as circumstances require or as we deem appropriate. See, for example, Part I, “Item 1. Business – 2013 and Other Recent Transactions and Developments – Delano Marrakech Termination of Management Agreement.”

TLG’s management agreements may be subject to early termination in specified circumstances. For example, the management agreements generally contain, among other covenants, a performance test that stipulates a minimum level of operating performance, and restrictions or requirements related to suitability, capacity, financial stability and compliance with laws and material terms. In 2013, we failed performance tests at certain venues, and as a result, we agreed with MGM to a change in the calculation of base and incentive management fees for all of TLG’s management agreements with MGM effective January 1, 2014, and agreed to a termination effective April 1, 2014 of TLG’s management agreement for Brand Steakhouse. Many of the management agreements also require that certain named representatives, including Andy Masi, whose employment contract expires December 2014, must remain employed by or under contract to TLG. We can provide no assurance that we will satisfy these conditions.

Joint Ventures and Non-Wholly Owned Entities. We own partial interests in the Joint Venture Hotels and the F&B Venture. We account for these investments using the equity method as we believe we do not exercise control over significant asset decisions such as buying, selling or financing nor are we the primary beneficiary of the entities. Under the equity method, we increase our investment in unconsolidated joint ventures for our proportionate share of net income and contributions and decrease our investment balance for our proportionate share of net losses and distributions.

Due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the hotel, in early 2014, we exercised a put option under our Mondrian Istanbul joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We do not currently anticipate that these proceeding will have an impact on our management agreement should the hotel development continue.

 

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Factors Affecting Our Results of Operations

Revenues. Changes in our hotel revenues are most easily explained by three performance indicators that are commonly used in the hospitality industry:

 

    Occupancy;

 

    ADR; and

 

    RevPAR, which is the product of ADR and average daily occupancy, but does not include food and beverage revenue, other hotel operating revenue such as telephone, parking and other guest services, or management fee revenue.

Our revenues are derived from the operation of hotels, as well as the operation of nightclub, restaurant and bar venues. Specifically, our revenue consists of:

 

    Rooms revenue. Occupancy and ADR are the major drivers of rooms revenue.

 

    Food and beverage revenue. Most of our food and beverage revenue is driven by occupancy of our hotels and the popularity of our bars and restaurants with our local customers. In June 2011, we acquired from affiliates of CGM the 50% interests CGM owned in our prior food and beverage joint ventures at Delano South Beach, Mondrian South Beach, Mondrian Los Angeles, Morgans, Sanderson and St Martins Lane (the “CGM Transaction”). As a result of the CGM Transaction, we began recording 100% of the food and beverage revenue and related expenses at these hotels, with the exception of Mondrian South Beach which is accounted for using the equity method of accounting, as discussed in note 1 to our consolidated financial statements. In August 2011, we sold our ownership interest in Mondrian Los Angeles’ food and beverage operations to the hotel owner. Effective February 1, 2012, we transferred our ownership interest in Morgans food and beverage operations to the hotel owner by terminating our operating lease for the restaurant space. Additionally, we record revenue and related expenses at the three food and beverage venues at Mandalay Bay in Las Vegas for which we acquired the leasehold interest in August 2012. The first of these restaurants opened in late December 2012, the second restaurant opened in February 2013 and the third restaurant opened in July 2013.

 

    Other hotel revenue. Other hotel revenue, which consists of ancillary revenue such as telephone, parking, spa, entertainment and other guest services, is principally driven by hotel occupancy.

 

    Management fee revenue and other income. We earn hotel management fees under our hotel management agreements. These fees may include management fees as well as reimbursement for allocated chain services. Additionally, we own a 90% controlling investment in TLG, which operates numerous venues primarily in Las Vegas pursuant to management agreements with various MGM affiliates. Each of TLG’s venues is managed by an affiliate of TLG, which receives fees under a management agreement for the venue. Through our ownership of TLG, we recognize management fees in accordance with the applicable management agreement, which generally provide for base management fees as a percentage of gross sales, and incentive management fees as a percentage of net profits, as calculated pursuant to the management agreements.

Fluctuations in revenues, which tend to correlate with changes in gross domestic product, are driven largely by general economic and local market conditions but can also be impacted by major events, such as terrorist attacks or natural disasters, which in turn affect levels of business and leisure travel.

Renovations at our hotels can have a significant impact on our revenues. For example, our guestroom and corridor renovations at Hudson, which began in the fourth quarter of 2011 and were completed in late 2012, had a material impact on our operating results during the year ended December 31, 2012.

The seasonal nature of the hospitality business can also impact revenues. For example, our Miami hotels are generally strongest in the first quarter, whereas our New York hotels are generally strongest in the fourth quarter. However, prevailing economic conditions can cause fluctuations which impact seasonality.

In addition to economic conditions, supply is another important factor that can affect revenues. Room rates, occupancy and food and beverage revenues tend to fall when supply increases, unless the supply growth is offset by an equal or greater increase in demand. One reason why we focus on boutique hotels in key gateway cities is because these markets typically have significant barriers to entry for new competitive supply, including scarcity of available land for new development and extensive regulatory requirements resulting in a longer development lead time and additional expense for new competitors.

 

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Finally, competition within the hospitality industry, which includes our hotels and our restaurants, nightclubs, bars and other food and beverage venues, can affect revenues. Competitive factors in the hospitality industry include name recognition, quality of service, convenience of location, quality of the property or venue, pricing, and range and quality of nightlife, food and beverage services and amenities offered. In addition, all of our hotels, restaurants, nightclubs and bars are located in areas where there are numerous competitors, many of whom have substantially greater resources than us. New or existing competitors could offer significantly lower rates and pricing or more convenient locations, services or amenities or significantly expand, improve or introduce new service offerings in markets in which our hotels, restaurants, nightclubs, bars, and other food and beverage venues compete, thereby posing a greater competitive threat than at present. If we are unable to compete effectively, we would lose market share, which could adversely affect our revenues.

Operating Costs and Expenses. Our operating costs and expenses consist of the costs to provide hotel and food and beverage services, costs to operate our hotel and food and beverage management companies, and costs associated with the ownership of our assets, including:

 

    Rooms expense. Rooms expense includes the payroll and benefits for the front office, housekeeping, concierge and reservations departments and related expenses, such as laundry, rooms supplies, travel agent commissions and reservation expense. Like rooms revenue, occupancy is a major driver of rooms expense, which has a significant correlation with rooms revenue.

 

    Food and beverage expense. Similar to food and beverage revenue, occupancy of the hotels in which we operate food and beverage venues, and the popularity of our restaurants, nightclubs, bars and other food and beverage venues, are the major drivers of food and beverage expense, which has a significant correlation with food and beverage revenue.

 

    Other departmental expense. Occupancy is the major driver of other departmental expense, which includes telephone and other expenses related to the generation of other hotel revenue.

 

    Hotel selling, general and administrative expense. Hotel selling, general and administrative expense consist of administrative and general expenses, such as payroll and related costs, travel expenses and office rent, advertising and promotion expenses, comprising the payroll of the hotel sales teams, the global sales team and advertising, marketing and promotion expenses for our hotel properties, utility expense and repairs and maintenance expenses, comprising the ongoing costs to repair and maintain our hotel properties.

 

    Property taxes, insurance and other. Property taxes, insurance and other consist primarily of insurance costs and property taxes.

 

    Corporate expenses, including stock compensation. Corporate expenses consist of the cost of our corporate offices, including the corporate office of our 90% owned subsidiary, TLG, net of any cost reimbursements, which consists primarily of payroll and related costs, stock-based compensation expenses, office rent and legal and professional fees and costs associated with being a public company.

 

    Depreciation and amortization expense. Hotel properties are depreciated using the straight-line method over estimated useful lives of 39.5 years for buildings and five years for furniture, fixtures and equipment. We also record amortization expense related to our other assets, such as the TLG management contracts we acquired as part of our acquisition of TLG in November 2011 and the three restaurant leases in Las Vegas that we purchased in August 2012.

 

    Restructuring and disposal costs include costs incurred related to our corporate restructuring initiatives, such as professional fees, litigation and settlement costs, executive terminations and severance costs related to such restructuring initiatives, and losses on asset disposals as part of major renovation projects.

 

    Development costs include development transaction costs, internal development payroll, costs and pre-opening expenses incurred related to new concepts at existing hotel and the development of new hotels, and the write-off of abandoned development projects previously capitalized.

 

    Impairment loss on receivables and other assets from managed hotel and unconsolidated joint venture includes impairment costs incurred related to receivables deemed uncollectible from unconsolidated joint ventures and managed hotels and other assets related to managed hotels which have been deemed to have no value.

 

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Other Items

 

    Interest expense, net. Interest expense, net includes interest on our debt and amortization of financing costs and is presented net of interest income and interest capitalized.

 

    Equity in (income) loss of unconsolidated joint ventures. Equity in (income) loss of unconsolidated joint ventures constitutes our share of the net profits and losses of our Joint Venture Hotels, our F&B Venture and our investments in hotels under development in which we have an equity interest. Further, we and our joint venture partners review our Joint Venture Hotels and F&B Venture for other-than-temporary declines in market value. In this analysis of fair value, we use discounted cash flow analysis to estimate the fair value of our investment taking into account expected cash flow from operations, holding period and net proceeds from the dispositions of the property. Any decline that is not expected to be recovered is considered other-than-temporary and an impairment charge is recorded as a reduction in the carrying value of the investment.

 

    Gain on asset sales. We recorded deferred gains related to the sales of Royalton, Morgans, Mondrian Los Angeles, and our ownership interests in Sanderson and St Martins Lane, as discussed in note 17 of our consolidated financial statements. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement.

 

    Other non-operating expenses include costs associated with discontinued operations and previously owned hotels, both consolidated and unconsolidated, transaction costs related to business acquisitions, changes in the fair value of debt and equity instruments, miscellaneous litigation and settlement costs and other expenses that relate to our financing and investing activities.

 

    Income tax expense (benefit). All of our foreign subsidiaries are subject to local jurisdiction corporate income taxes. Income tax expense is reported at the applicable rate for the periods presented. We are subject to Federal and state income taxes. Income taxes for the years ended December 31, 2013, 2012 and 2011 were computed using our calculated effective tax rate. We also recorded net deferred taxes related to cumulative differences in the basis recorded for certain assets and liabilities. We established a reserve on the deferred tax assets based on the ability to utilize net operating loss carryforwards.

 

    Noncontrolling interest income (loss). Noncontrolling interest is the income (loss) attributable to the holders of membership units in Morgans Group, our operating company, owned by Residual Hotel Interest LLC, our former parent, as discussed in note 1 of our consolidated financial statements, our third-party food and beverage joint venture partner’s interest in the profits and losses of our F&B Venture, and the 10% ownership interest in TLG that is held by certain prior owners of TLG.

 

    Income (loss) from discontinued operations, net of tax. In January 2011, we recognized income from the transfer of a property across the street from Delano South Beach that we previously owned. As such, we have recorded the income or loss related to this transfer in income (loss) from discontinued operations, net of tax, on the accompanying consolidated statements of comprehensive loss.

 

    Preferred stock dividends and accretion. Dividends attributable to our outstanding preferred stock and the accretion of the fair value discount on the issuance of the preferred stock are reflected as adjustments to our net loss to arrive at net loss attributable to common stockholders, as discussed in note 11 of our consolidated financial statements.

Most categories of variable operating expenses, such as operating supplies, and certain labor, such as housekeeping, fluctuate with changes in occupancy. Increases in RevPAR attributable to increases in occupancy are accompanied by increases in most categories of variable operating costs and expenses. Increases in RevPAR attributable to improvements in ADR typically only result in increases in limited categories of operating costs and expenses, primarily credit card and travel agent commissions. Thus, improvements in ADR have a more significant impact on improving our operating margins than occupancy.

 

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Notwithstanding our efforts to reduce variable costs, there are limits to how much we can accomplish because we have significant costs that are relatively fixed costs, such as depreciation and amortization, labor costs and employee benefits, insurance, real estate taxes, interest and other expenses associated with owning hotels that do not necessarily decrease when circumstances such as market factors cause a reduction in our hotel revenues.

Recent Trends and Developments

Recent Trends. Lodging demand and revenues are primarily driven by growth in GDP, business investment and employment growth. Beginning in 2010, the U.S. and global economies began improving from the recent recessionary period, and that improvement continued in 2013 as businesses and consumers regained confidence. However, the economic recovery continues to be modest, as uncertainty remains as to its sustainability and the effects of continued weakness in certain areas of global economies.

The pace of new lodging supply has increased over the past several years as many projects initiated before the economic downturn came to fruition and new projects were commenced as the economy recovered. For example, we witnessed new competitive luxury and boutique properties opening between 2008 and 2013 in some of our markets, particularly in New York, Miami, and London which have impacted our performance in these markets and may continue to do so.

RevPAR at our System-Wide Comparable Hotels which includes all Morgans Hotel Group branded hotels with the exception of Hudson, which was under renovation during 2012, Ames, which as of July 17, 2013 we no longer managed, and Delano Marrakech, which opened in September 2012 and we no longer manage effective November 12, 2013, increased by 9.1% in constant dollars, or 8.9% in actual dollars, for the year ended December 31, 2013 as compared to the same period in 2012.

RevPAR for System-Wide Comparable Hotels located in the United States increased 10.8% for the year ended December 31, 2013 as compared to the same period in 2012.

RevPAR from System-Wide Comparable Hotels in the Northeastern United States increased by 11.4% for the year ended December 31, 2013, as compared to the same period in 2012, with an increase in occupancy of 7.7% and an increase in ADR of 3.4% for the year ended December 31, 2013. The RevPAR increases were led by a 16.9% increase at Mondrian SoHo, and a 12.0% increase at Morgans, both primarily due to gains in market share at these hotels. Room revenues at Hudson, a non-comparable hotel in New York City, increased 24.4% for the year ended December 31, 2013, as compared to the same period in 2012, primarily due to occupancy gains, the addition of 32 new rooms, and a full inventory of guestrooms in service after completion of the hotel’s renovation in late 2012. RevPAR at Hudson increased 20.3% during the year ended 2013, which was driven primarily by increased occupancy in 2013 as compared to the same period in 2012, when the hotel was under renovation.

RevPAR from System-Wide Comparable Hotels in Miami increased 9.5% for the year ended December 31, 2013, as compared to the same period in 2012. The RevPAR increase was led by Delano South Beach which experienced a RevPAR increase of 7.7% for the year ended December 31, 2013, as compared to the same period in 2012, primarily as a result of increased ADR.

Our System-Wide Comparable Hotels on the West Coast generated 11.6% RevPAR growth for the year ended December 31, 2013, as compared to the same period in 2012, led by Clift where RevPAR increased 13.2% in 2013.

In London, RevPAR increased 2.1% in constant dollars, or 0.8% in actual dollars, during the year ended December 31, 2013, as compared to the same period in 2012.

Recent Developments. In addition to the recent trends described above, we expect that a number of recent events will cause our future results of operations to differ from our historical performance. For a discussion of these recent events, see Part I, “Item 1. “Business – 2013 and Other Recent Transactions and Developments.”

 

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Comparison of Year Ended December 31, 2013 to Year Ended December 31, 2012

The following table presents our operating results for the years ended December 31, 2013 and 2012, including the amount and percentage change in these results between the two periods. The consolidated operating results for the year ended December 31, 2013 are comparable to the consolidated operating results for the year ended December 31, 2012, with the exception of the transfer of our ownership interest in Ames in April 2013, the termination of our management agreement at Ames in July 2013, the termination of our management agreement at Las Palapas in March 2013, the opening of Delano Marrakech in September 2012, and the termination of our management agreement for Delano Marrakech effective November 12, 2013. The consolidated operating results are as follows:

 

     2013     2012     Changes
($)
    Changes
(%)
 
     (Dollars in thousands)  

Revenues:

        

Rooms

   $ 120,823      $ 102,546      $ 18,277        17.8

Food and beverage

     84,085        57,669        26,416        45.8   

Other hotel

     4,863        5,046        (183     (3.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hotel revenues

     209,771        165,261        44,510        26.9   

Management fee-related parties and other income

     26,715        24,658        2,057        8.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     236,486        189,919        46,567        24.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Costs and Expenses:

        

Rooms

     37,347        31,973        5,374        16.8   

Food and beverage

     62,419        47,166        15,253        32.3   

Other departmental

     3,261        3,595        (334     (9.3

Hotel selling, general and administrative

     42,563        37,055        5,508        14.9   

Property taxes, insurance and other

     17,339        15,819        1,520        9.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hotel operating expenses

     162,929        135,608        27,321        20.1   

Corporate expenses, including stock compensation

     27,626        32,062        (4,591     (13.8

Depreciation and amortization

     27,374        23,977        3,397        14.2   

Restructuring and disposal costs

     11,451        6,851        4,600        67.1   

Development costs

     2,987        5,783        (2,796     (48.3

Impairment loss on receivables and other assets from managed hotel and unconsolidated joint venture

     6,029        —          6,029        100.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     238,396        204,281        34,115        16.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (1,910     (14,362     12,452        (86.7

Interest expense, net

     45,990        38,998        6,992        17.9   

Equity in loss of unconsolidated joint ventures

     828        6,436        (5,608     (87.1

Gain on asset sales

     (8,020     (7,989     (31     0.4   

Other non-operating expenses

     2,726        3,908        (1,182     (30.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expense

     (43,434     (55,715     12,281        (22.0

Income tax expense

     716        776        (60     (7.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (44,150     (56,491     12,341        (21.8

Net (income) loss attributable to non controlling interest

     (5     804        (809     (100.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Morgans Hotel Group Co.

     (44,155     (55,687     11,532        (20.7

Preferred stock dividends and accretion

     (14,316     (11,124     (3,192     28.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (58,471   $ (66,811   $ 8,340        (12.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Total Hotel Revenues. Total hotel revenues increased 26.9% to $209.8 million for the year ended December 31, 2013 compared to $165.3 million for the year ended December 31, 2012. This increase was primarily due to the impact of renovations at Delano South Beach and Hudson during 2012. Delano South Beach was under renovation during the first quarter of 2012, and Hudson was under significant renovation for the entire year of 2012, which negatively impacted the operating results at these hotels in the prior year.

The components of RevPAR from our Owned Hotels, which consisted, as of December 31, 2013, of Hudson, Delano South Beach and Clift, for the years ended December 31, 2013 and 2012 are summarized as follows:

 

     Year Ended               
     December 31,
2013
    December 31,
2012
    Change
($)
     Change
(%)
 

Occupancy

     85.6     74.6     —          14.8

ADR

   $ 270      $ 268      $ 2         0.7

RevPAR

   $ 231      $ 200      $ 31         15.6

RevPAR from our Owned Hotels increased 15.6% to $231 for the year ended December 31, 2013 compared to $200 for the year ended December 31, 2012, primarily due to increases in occupancy at our Owned Hotels.

Rooms revenue increased 17.8% to $120.8 million for the year ended December 31, 2013 compared to $102.5 million for the year ended December 31, 2012. This increase was primarily due to the impact in 2012 of renovations at Delano South Beach and Hudson, discussed above, and strong operating trends in New York and San Francisco resulting in increases in occupancy and strong operating trends in Miami South Beach resulting in higher ADR in 2013.

Food and beverage revenue increased 45.8% to $84.1 million for the year ended December 31, 2013 compared to $57.7 million for the year ended December 31, 2012. This increase was primarily due to an increase of approximately $18.7 million from our three leased food and beverage venues at Mandalay Bay in Las Vegas, which opened in late 2012 and the first and third quarter of 2013, respectively, for which there was no comparable revenue in the prior period. Additionally, the increase was also due to increases in revenues of approximately $5.8 million at Hudson due to Hudson Common, the new restaurant at Hudson which opened during the first quarter of 2013, and Henry, the new bar at Hudson which opened during the third quarter of 2013.

Other hotel revenue decreased 3.6% to $4.9 million for the year ended December 31, 2013 compared to $5.0 million for the year ended December 31, 2012. This slight decrease was primarily due to the elimination of an internet connectivity fee charged to guests at Delano, effective February 2012. Slightly offsetting this decrease was increased telephone and parking revenues and movie rental at Hudson during 2013 due to increased occupancy.

Management Fee—Related Parties and Other Income. Management fee—related parties and other income increased by 8.3% to $26.7 million for the year ended December 31, 2013 compared to $24.7 million for the year ended December 31, 2012. Approximately $2.3 million of this increase was due to a $1.8 million fee related to the termination of the Ames management agreement and the assignment of our equity interests in the Ames joint venture to our joint venture partner, and a $0.5 million termination fee related to Hotel Las Palapas. Excluding one-time items, management fees were relatively flat. We experienced a slight increase attributable to fees associated with the management of our Comparable Managed Hotels, defined below, whose performance improved during the year ended December 31, 2013 as compared to the same period in 2012, as demonstrated by a 5.5% RevPAR increase. Partially offsetting this increase in management fee—related parties and other income was a decrease of 4.0% in fees from TLG due to lower nightclub revenues as a result of increased competition from new supply and newly reconcepted competitive nightclubs.

 

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The components of RevPAR from such Comparable Managed Hotels, which includes Morgans, Royalton, Shore Club, Mondrian Los Angeles, Sanderson and St Martins Lane, for the years ended December 31, 2013 and 2012 are summarized as follows (in actual dollars):

 

     Year Ended              
     December 31,
2013
    December 31,
2012
    Change
($)
    Change
(%)
 

Occupancy

     79.8     75.0     —         6.3

ADR

   $ 323      $ 326      $ (3     (0.8 )% 

RevPAR

   $ 258      $ 245      $ 13        5.5

Operating Costs and Expenses

Rooms expense increased 16.8% to $37.3 million for the year ended December 31, 2013 compared to $32.0 million for the year ended December 31, 2012. This increase is consistent with the increase in rooms revenue, discussed above, and is primarily a result of rooms out of service during the Hudson renovation work in 2012, which decreased rooms expense recognized during the year ended December 31, 2012.

Food and beverage expense increased 32.3% to $62.4 million for the year ended December 31, 2013 compared to $47.2 million for the year ended December 31, 2012. This is consistent with the increase in food and beverage revenue, discussed above, and is primarily due to the expenses associated with the three leased food and beverage venues at Mandalay Bay in Las Vegas, which opened in late 2012 and the first and third quarter of 2013, respectively, for which there was no comparable expense in the prior year.

Other departmental expense decreased 9.3% to $3.3 million for the year ended December 31, 2013 compared to $3.6 million for the year ended December 31, 2012. This decrease was primarily the result of the decrease in other hotel revenue noted above.

Hotel selling, general and administrative expense increased 14.9% to $42.6 million for the year ended December 31, 2013 compared to $37.1 million for the year ended December 31, 2012. This increase was primarily due to increased occupancy and more rooms in service at Hudson which resulted in increased heat, light and power and other related costs. Occupancy levels and the number of rooms in service at Hudson during the year ended December 31, 2012 were lower due to the ongoing renovation and out of service rooms.

Property taxes, insurance and other expense increased 9.6% to $17.3 million for the year ended December 31, 2013 compared to $15.8 million for the year ended December 31, 2012. This increase is primarily due to an increased real estate tax assessment at Hudson in 2013, as compared to the same period in 2012. Additionally, we received a real estate tax refund in 2012 as result of a Hudson tax appeal, for which there was no comparable refund received during the year ended December 31, 2013.

Corporate expenses, including stock compensation decreased 13.8% to $27.6 million for the year ended December 31, 2013 compared to $32.1 million for the year ended December 31, 2012. This decrease was primarily due to our ongoing efforts to reduce general overhead costs, including a reduction in bonus and stock compensation expense, and reduced Board of Directors fees.

Depreciation and amortization increased 14.2% to $27.4 million for the year ended December 31, 2013 compared to $24.0 million for the year ended December 31, 2012. This increase was primarily due to the increased depreciation in 2013 related to the renovations which were completed at Delano South Beach during 2012 and Hudson during 2013, as well as the conversion of SRO units into new guestrooms at Hudson in late 2012 and early 2013.

Restructuring and disposal costs increased 67.1% to $11.5 million for the year ended December 31, 2013 compared to $6.9 million for the year ended December 31, 2012. This increase was primarily due to legal and advisory fees incurred during the year ended December 31, 2013 related to the 2013 Deleveraging Transaction and proxy contest.

Development costs decreased 48.3% to $3.0 million for the year ended December 31, 2013 compared to $5.8 million for the year ended December 31, 2012. This decrease was primarily due to pre-opening expenses incurred during early 2012 related to the re-launch of the renovated food and beverage venues at Delano South Beach, for which there was no comparable expense in 2013, as well as a slower pace of development activity during the year ended December 31, 2013.

 

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Interest expense, net increased 17.9% to $46.0 million for the year ended December 31, 2013 compared to $39.0 million for the year ended December 31, 2012. This increase was primarily due to the refinancing of the Hudson mortgage debt in November 2012, which resulted in an increase in interest expense, and a higher average balance outstanding on our revolving credit facility during the year ended December 31, 2013, which resulted in higher interest expense during that period.

Equity in loss of unconsolidated joint ventures resulted in a loss of $0.8 million for the year ended December 31, 2013 compared to a loss of $6.4 million for the year ended December 31, 2012. We no longer record our share of equity in earnings or losses on a majority of our unconsolidated joint ventures, as we have written our investment balances down to zero due to impairments recorded in prior periods.

The components of RevPAR from our comparable Joint Venture Hotels for the year ended December 31, 2013 and 2012, which includes Mondrian South Beach and Mondrian SoHo and excludes Ames, in which we no longer owned any equity interests effective April 26, 2013, and Shore Club, in which we have only an immaterial contingent profit participation equity interest as of December 30, 2013, are summarized as follows:

 

     Year Ended               
     December 31,
2013
    December 31,
2012
    Change
($)
     Change
(%)
 

Occupancy

     81.8     74.2     —          10.2

ADR

   $ 306      $ 294      $ 12         3.9

RevPAR

   $ 250      $ 219      $ 31         14.5

Gain on asset sales was flat for the periods presented, resulting in income of $8.0 million for the year ended December 31, 2013 compared to $8.0 million for the year ended December 31, 2012. This income was related to the recognition of gains we recorded on the sales of Royalton, Morgans and Mondrian Los Angeles and our 50% ownership in the entity that owned Sanderson and St Martins Lane, all occurring in 2011. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement.

Other non-operating expenses decreased 30.2% to $2.7 million for the year ended December 31, 2013 as compared to $3.9 million for the year ended December 31, 2012. During the year ended December 31, 2012, we recorded an increase in the fair value of the TLG Promissory Notes, discussed in note 7 of our consolidated financial statements, for which the change in fair value was not as material during the year ended December 31, 2013.

Income tax expense was relatively flat for the year ended December 31, 2013 as compared to the year ended December 31, 2012.

 

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Comparison of Year Ended December 31, 2012 to Year Ended December 31, 2011

The following table presents our operating results for the years ended December 31, 2012 and 2011, including the amount and percentage change in these results between the two periods. The consolidated operating results for the year ended December 31, 2012 are comparable to the consolidated operating results for the year ended December 31, 2011, with the exception of the sales of Mondrian Los Angeles on May 3, 2011, and Royalton and Morgans, on May 23, 2011, the transfer of our ownership interest in the Hard Rock Hotel & Casino in Las Vegas and termination of our management on March 1, 2011, the opening of Mondrian SoHo in February 2011, the completion of the CGM Transaction in June 2011 resulting in our full ownership of certain food and beverage operations previously owned through a 50/50 joint venture, termination of our management of the San Juan Water and Beach Club effective July 13, 2011, the sale of our 50% ownership interest in Sanderson and St Martins Lane in November 2011, the acquisition of TLG in November 2011, and the opening of Delano Marrakech in September 2012. The consolidated operating results are as follows:

 

     2012     2011     Changes
($)
    Changes
(%)
 
     (Dollars in thousands)  

Revenues:

        

Rooms

   $ 102,546      $ 120,351      $ (17,805     (14.8 )% 

Food and beverage

     57,669        66,253        (8,584     (13.0

Other hotel

     5,046        6,440        (1,394     (21.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hotel revenues

     165,261        193,044        (27,783     (14.4

Management fee-related parties and other income

     24,658        14,288        10,370        72.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     189,919        207,332        (17,413     (8.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Costs and Expenses:

        

Rooms

     31,973        37,626        (5,653     (15.0

Food and beverage

     47,166        55,466        (8,300     (15.0

Other departmental

     3,595        4,069        (474     (11.6

Hotel selling, general and administrative

     37,055        43,629        (6,574     (15.1

Property taxes, insurance and other

     15,819        16,475        (656     (4.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total hotel operating expenses

     135,608        157,265        (21,657     (13.8

Corporate expenses, including stock compensation

     32,062        34,563        (2,501     (7.2

Depreciation and amortization

     23,977        22,219        1,758        7.9   

Restructuring and disposal costs

     6,851        8,575        (1,724     (20.1

Development costs

     5,783        5,716        67        1.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     204,281        228,338        (24,057     (10.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (14,362     (21,006     6,644        (31.6

Interest expense, net

     38,998        35,514        3,484        9.8   

Equity in loss of unconsolidated joint venture

     6,436        29,539        (23,103     (78.2

Gain on asset sales

     (7,989     (3,178     (4,811     (1 ) 

Other non-operating expenses

     3,908        4,632        (724     (15.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income tax expense

     (55,715     (87,513     31,798        (36.3

Income tax expense

     776        929        (153     (16.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (56,491     (88,442     31,951        (36.1

Income from discontinued operations, net of tax

            485        (485     (100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

     (56,491     (87,957     31,466        (35.8

Net loss attributable to non controlling interest

     804        2,554        (1,750     (68.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to Morgans Hotel Group Co.

     (55,687     (85,403     29,716        (34.8

Preferred stock dividends and accretion

     (11,124     (9,938     (1,186     11.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (66,811   $ (95,341   $ 28,530        (29.9 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)  Not meaningful.

 

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Total Hotel Revenues. Total hotel revenues decreased 14.4% to $165.3 million for the year ended December 31, 2012 compared to $193.0 million for the year ended December 31, 2011. This decrease was primarily due to the sale in May 2011 of three hotels we previously owned and the impact of renovations at Hudson and Delano South Beach, discussed further below.

The components of RevPAR from our Owned Hotels, which consisted, as of December 31, 2012, of Hudson, Delano South Beach and Clift, for the years ended December 31, 2012 and 2011 are summarized as follows:

 

     Year Ended              
     December 31,
2012
    December 31,
2011
    Change
($)
    Change
(%)
 

Occupancy

     74.6     82.4     —         (9.5 )% 

ADR

   $ 268      $ 250      $ 18        7.2

RevPAR

   $ 200      $ 206      $ (6     (3.0 )% 

RevPAR from our Owned Hotels decreased 3.0% to $200 for the year ended December 31, 2012 compared to $206 for the year ended December 31, 2011. During the year ended December 31, 2012, Delano South Beach was under renovation for the first two months of the year, and Hudson was under a significant renovation for the entire year, which negatively impacted the operating results at these hotels.

Rooms revenue decreased 14.8% to $102.5 million for the year ended December 31, 2012 compared to $120.4 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels rooms revenue decreased 2.6%, consistent with the decrease in RevPAR which was primarily attributable to the renovations at Delano South Beach and Hudson.

Food and beverage revenue decreased 13.0% to $57.7 million for the year ended December 31, 2012 compared to $66.3 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned and the corresponding loss of food and beverage revenue from certain of the food and beverage venues at those hotels, as well as the closure of the restaurant and primary bar at Hudson in July 2012 for a reconcepting and renovation. The new restaurant at Hudson, Hudson Commons, opened in February 2013. Additionally, the decrease in food and beverage revenue was due to the transfer of ownership of the restaurant at Mondrian Los Angeles and Morgans to the respective hotel owners in August 2011 and February 2012, respectively. Slightly offsetting this decrease were increases following the CGM Transaction, in which we purchased the remaining 50% interest from our joint venture partner in certain food and beverage operations at several of our hotels, and the consolidation of previously unconsolidated food and beverage operations at our London hotels.

Other hotel revenue decreased 21.6% to $5.0 million for the year ended December 31, 2012 compared to $6.4 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results for these three hotels during all periods presented, our Owned Hotels other hotel revenue decreased 6.9%. This trend is consistent with the decrease in rooms revenue noted above, although the decrease in other hotel revenue was further impacted by the elimination, effective January 2012, of minibars at Hudson and the elimination of an internet connectivity fee charged to guests at Delano, effective February 2012.

Management Fee—Related Parties and Other Income. Management fee—related parties and other income increased by 72.6% to $24.7 million for the year ended December 31, 2012 compared to $14.3 million for the year ended December 31, 2011. This increase was primarily due to management fees earned through our contracts with various MGM affiliates acquired as part of our acquisition of TLG in November 2011.

Operating Costs and Expenses

Rooms expense decreased 15.0% to $32.0 million for the year ended December 31, 2012 compared to $37.6 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels rooms expense decreased 0.6% primarily as a result of rooms out of service during the Hudson renovation work in 2012.

 

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Food and beverage expense decreased 15.0% to $47.2 million for the year ended December 31, 2012 compared to $55.5 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned and the closure of the restaurant and primary bar at Hudson in July 2012 for reconcepting and renovation. Partially offsetting this decrease were increases following the CGM Transaction and the consolidation of previously unconsolidated food and beverage operations at our London hotels.

Other departmental expense decreased 11.6% to $3.6 million for the year ended December 31, 2012 compared to $4.1 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results for these three hotels during all periods presented, other departmental expense at our Owned Hotels decreased 0.8%.

Hotel selling, general and administrative expense decreased 15.1% to $37.1 million for the year ended December 31, 2012 compared to $43.6 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these hotels during all periods presented, our Owned Hotels selling, general and administrative expense decreased by 2.5% primarily as a result of the Hudson renovation which experienced decreased heat, light and power and credit card commissions as a result of decreased occupancy due to rooms being closed during renovation.

Property taxes, insurance and other expense decreased 4.0% to $15.8 million for the year ended December 31, 2012 compared to $16.4 million for the year ended December 31, 2011. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these hotels during all periods presented, our Owned Hotels property taxes, insurance and other expense increased by 7.0% primarily as a result of the scheduled reduction in incentive tax credits at Hudson, which expired June 30, 2012, impacting the year ended December 31, 2012.

Corporate expenses, including stock compensation decreased 7.2% to $32.1 million for the year ended December 31, 2012 compared to $34.6 million for the year ended December 31, 2011. This decrease was primarily due to increased stock compensation expense recognized during the year ended December 31, 2011 due to the accelerated vesting of unvested equity awards granted to our former Chief Executive Officer and our former President in connection with their separation from us in March 2011.

Depreciation and amortization increased 7.9% to $24.0 million for the year ended December 31, 2012 compared to $22.2 million for the year ended December 31, 2011. This increase was primarily due to the depreciation related to the completed renovations at Delano South Beach and Hudson. The increase was offset by a decrease in depreciation and amortization due to the impact of the sale in May 2011 of three hotels we previously owned.

Restructuring and disposal costs decreased 20.1% to $6.9 million for the year ended December 31, 2012 compared to $8.6 million for the year ended December 31, 2011. This decrease was primarily due to severance costs incurred during the year ended December 31, 2011, as we made changes to our senior management team, and other executives and key employees.

Development costs increased 1.2% to $5.8 million for the year ended December 31, 2012 compared to $5.7 million for the year ended December 31, 2011. This slight increase was primarily due to increased pre-opening expenses incurred during 2012 related to the re-launch of the renovated food and beverage venues at Delano South Beach and the guestrooms at Hudson.

Interest expense, net increased 9.8% to $39.0 million for the year ended December 31, 2012 compared to $35.5 million for the year ended December 31, 2011. This increase was primarily due to the refinancing of the Hudson mortgage debt in November 2012, which resulted in a prepayment fee, and an increase in interest expense related to the TLG promissory notes, which were issued in November 2011.

 

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Equity in loss of unconsolidated joint ventures resulted in a loss of $6.4 million for the year ended December 31, 2012 compared to a loss of $29.5 million for the year ended December 31, 2011. During March 2011 we recognized $6.4 million in expenses related to the Hard Rock settlement, described in note 5 to our consolidated financial statements, for which there was no comparable loss recorded during the same period in 2012. Additionally, in September 2011, we recorded an impairment loss of $10.6 million on our investment in Ames. We no longer record our share of equity in earnings or losses on a majority of our unconsolidated joint ventures, as we have written our investment balances down to zero due to impairment.

Gain on asset sales resulted in income of $8.0 million for the year ended December 31, 2012 compared to $3.2 million for the year ended December 31, 2011. This income was related to the recognition of gains we recorded on the sales of Royalton, Morgans and Mondrian Los Angeles, all of which occurred in May 2011, and our 50% ownership in the entity that owned Sanderson and St Martins Lane, which occurred in November 2011. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreements.

Other non-operating expenses decreased 15.6% to $3.9 million for the year ended December 31, 2012 as compared to $4.6 million for the year ended December 31, 2011. This decrease was primarily the result of decreased litigation and settlement costs slightly offset by an increase in fair value of the TLG Promissory Notes, discussed in note 7 to our consolidated financial statements.

Income tax expense was relatively flat for the year ended December 31, 2012 as compared to the year ended December 31, 2011.

Income from discontinued operations, net of tax resulted in income of $0.5 million for the year ended December 31, 2011, for which there was no comparable income recorded during the year ended December 31, 2012. The income recorded in 2011 relates to the transfer of our ownership interests in January 2011 of a property we previously owned across the street from Delano South Beach to a third party.

 

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Liquidity and Capital Resources

As of December 31, 2013, we had approximately $10.0 million in cash and cash equivalents.

In February 2014, we completed the Hudson/Delano 2014 Mortgage Loan financing, discussed further under “—Debt.” The net proceeds from the Hudson/Delano 2014 Mortgage Loan were applied to (1) repay $180 million of outstanding mortgage debt under the Hudson 2012 Mortgage Loan, (2) repay $37 million of indebtedness under the Delano Credit Facility, (3) provide cash collateral for reimbursement obligations with respect to a $10.0 million letter of credit under the Delano Credit Facility, and (4) fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital, which may include the repayment of other indebtedness, including the Convertible Notes and TLG Promissory Notes, subject to certain minimum unencumbered asset requirements. Following the use of the proceeds described above, net proceeds to us were approximately $214.0 million.

On February 28, 2014, in connection with the Yucaipa Note Repurchase, we repurchased $88.0 million of outstanding Convertible Notes for an amount equal to their principal balance plus accrued interest. We used cash on hand, including proceeds of the Hudson/Delano 2014 Mortgage Loan for this repurchase.

We believe we have sufficient cash to meet our scheduled near-term debt maturities consisting of the remaining $84.5 million of obligations due on our outstanding Convertible Notes, scheduled development commitments, operating expenses and other expenditures directly associated with our properties, as well as our obligations under the TLG Promissory Notes which we may elect to prepay on or prior to November 30, 2014 due to their interest rate increase on that date, all discussed further below. However, we can provide no assurance that pending litigations will not result in negative outcomes or that other unexpected contingencies will not occur. Negative litigation outcomes and unexpected contingencies can necessitate the need for additional short-term liquidity.

We intend to utilize our liquidity to repay outstanding debt, to redeem our outstanding preferred securities, to fund growth and development efforts, to fund renovations from time to time at existing Owned Hotels and Owned F&B Operations, to fund infrastructure improvements, and for general corporate purposes. We have both short-term and long-term liquidity requirements as described in more detail below.

Liquidity Requirements

Short-Term Liquidity Requirements. We generally consider our short-term liquidity requirements to consist of those items that are expected to be incurred by us or our consolidated subsidiaries within the next 12 months and believe those requirements currently consist primarily of funds necessary to pay scheduled debt maturities and operating expenses and other expenditures directly associated with our properties, including the funding of our reserve accounts, and capital commitments associated with certain of our development projects and existing hotels.

Our obligations under the Delano Credit Facility were due in July 2014, as described under “—Debt.” As of December 31, 2013, the Delano Credit Facility had $37.0 million of outstanding borrowings and $10.0 million of posted letters of credit. In addition, the Hudson 2012 Mortgage Loan, as defined and described under “—Debt,” was due on February 9, 2014, with extension options. On February 6, 2014, we entered into the Hudson/Delano 2014 Mortgage Loan, which is secured by Delano South Beach and Hudson, as discussed more fully under “—Debt,” and used a portion of the proceeds to repay the outstanding principal amounts under the Delano Credit Facility and Hudson 2012 Mortgage Loan.

Our remaining outstanding Convertible Notes, as described under “—Debt”, with a face value of $84.5 million, mature on October 15, 2014 unless repurchased by us or converted in accordance with their terms prior to such date. We intend to utilize the proceeds from the Hudson/Delano 2014 Mortgage Loan to retire the Convertible Notes.

 

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Additionally, the TLG Promissory Notes, which are obligations related to our acquisition of TLG, mature in November 2015, although we may consider retiring the TLG Promissory Notes prior to the November 2015 maturity due to the increase in the interest rate from 8% to 18% in November 2014. The maximum payment of $18.0 million is based on TLG achieving EBITDA of at least $18 million from non-Morgans business (the “Non-Morgans EBITDA”) during the 27-month period starting on January 1, 2012, with ratable reduction of the payment if less than $18 million of Non-Morgans EBITDA is earned. We currently believe that TLG will achieve this EBITDA target. At December 31, 2013, the balance of the TLG Promissory Notes was $18.8 million, which includes the original principal balance plus deferred interest of $0.8 million.

Also as part of our acquisition of TLG, each of Messrs. Sasson and Masi received the right to require Morgans Group to purchase his 5% equity interest in TLG at any time after November 30, 2014 at a purchase price equal to his percentage equity ownership interest multiplied by the product of seven times the Non-Morgans EBITDA for the preceding 12 months, subject to certain adjustments (the “Sasson-Masi Put Options”). The estimated aggregate purchase price for the Sasson-Masi Put Options, which become exercisable in December 2014, is approximately $5.8 million based on the contractual formula applied as of December 31, 2013.

We are focused on growing our portfolio, primarily with our core brands, in major gateway markets and key resort destinations. In order to obtain long term management contracts, we have committed to contribute capital in various forms on hotel development projects. These include equity investments, key money and cash flow guarantees to hotel owners. The cash flow guarantees generally have a stated maximum amount of funding and a defined term. The terms of the cash flow guarantees to hotel owners generally require us to fund if the hotels do not attain specified levels of operating profit. See note 8 to our consolidated financial statements included elsewhere in this report for more information. Often, cash flow guarantees to hotel owners may be recoverable as loans repayable to us out of future hotel cash flows and/or proceeds from the sale of hotels. As of December 31, 2013, our short-term key money funding obligations were $25.5 million, which represents £9.4 million (or approximately $15.5 million as of December 31, 2013) in key money for Mondrian London, which is expected to open in the summer of 2014, and $10.0 million in key money for Mondrian at Baha Mar, which is secured by a related letter of credit originally issued under the Delano Credit Facility and subsequently cash collateralized in February 2014 with a portion of the proceeds from the Hudson/Delano 2014 Mortgage Loan. In addition, in January 2014, we signed a franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey, which has a $0.7 million key money obligation that will be funded upon the hotel opening in late 2014.

On February 28, 2014, we entered into a binding MOU with affiliates of Yucaipa, among other litigants, which contemplates the partial settlement and dismissal of the Delaware Action and the complete settlement and dismissal of the Securities Action, the Proxy Action and the Observer Action. See Part I, “Item III. Legal Proceedings.” The MOU is subject to execution of a Settlement Stipulation acceptable to us and to approval by the Court of Chancery in the Delaware Action and will not become effective, under the terms of the MOU, until such approval is given and is no longer subject to further court review. The MOU provides, among other things, for us to pay the Yucaipa Securities Action Plaintiffs in the Securities Action an amount equal to $3 million less the aggregate amount of any reasonable and necessary attorneys’ fees and expenses incurred by Mr. Burkle in his defense of the Delaware Action that are paid to him by our insurers prior to the Effective Date and Mr. Burkle will pay to us the amount of all insurance proceeds he recovers from our insurers after the Effective Date for the reasonable and necessary attorneys’ fees and expenses that he incurred in defense of the Delaware Action and assign to us his claims against our insurers for any reasonable and necessary attorneys’ fees and expenses that Mr. Burkle incurred but that our insurers may fail to pay. Additionally, to the extent not paid by our insurers, we will pay the amount of any reasonable and necessary attorneys’ fees and expenses incurred by the Settling Former Directors in defending the Delaware Action, subject to the Settling Former Directors’ assignment to us of any claims they have against our insurers relating to any such unpaid amounts. In addition, the Settling Former Directors will pay to us a portion of the Securities Action Payment (based on a formula whose elements cannot presently be quantified) unless our insurers pay such amounts to us or the Settling Former Directors assign to us any claims they have against our insurers relating to any such amounts that our insurers fail to pay. Counsel for OTK and current director Jason T. Kalisman will apply to the Delaware Court of Chancery for an award of payment from us of the reasonable and necessary fees and expenses they incurred in connection with the Delaware Action, excluding those fees and expenses encompassed in the court’s October 31, 2013 order in the Delaware Action. Any such award may be subject to recovery by us from our insurers. Former directors Thomas L. Harrison and Michael D. Malone chose not to participate in the MOU and the Delaware Action continues against them and we may incur fees and expenses in that continuing litigation which may be subject to recovery from our insurers.

 

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We cannot currently predict the amount of any funds we might be required to pay under the MOU; whether our insurers will pay some or all of the amounts that we would otherwise be obligated to pay under the MOU; whether we would be successful in asserting against our insurers any claims that will or may be assigned to us under the terms of the MOU or that we might assert on our own behalf, or what the amount of any such recovery might be. Furthermore, we cannot predict whether the Delaware Court of Chancery will approve the Settlement Stipulation or whether the court’s decision will be challenged on appeal and, if so challenged, affirmed. Notwithstanding the foregoing, we do not expect that the net amount of all payments we might ultimately be required to make, after recovery of all insurance proceeds, under the terms of the MOU and the Stipulation of Settlement, if approved, will be material to our financial position.

The Termination Plan, which we implemented on March 10, 2014, is part of our previously announced corporate strategy to, among other things, reduce corporate overhead and costs allocated to property owners. The Termination Plan will streamline our general corporate functions and we anticipate achieving annualized savings of approximately $8.0 million of corporate expenses and approximately $1.6 million of expenses allocated to our Owned Hotels, Joint Venture Hotels and Managed Hotels, based on 2013 incurred costs and targeted compensation levels. As a result of the Termination Plan, we anticipate recording a charge of approximately $8.6 million in the first quarter of 2014 related to the cost of one-time termination benefits of which approximately $6.4 million is expected to be paid in cash and approximately $2.2 million is expected to be recognized as non-cash stock compensation expense. See further discussion of the Termination Plan in Part I, “Item 1. “Business – 2013 and Other Recent Transactions and Developments – Termination Plan.”

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt or lease agreements related to such hotels. Our Joint Venture Hotels and our Managed Hotels generally are subject to similar obligations under our management agreements or under debt agreements related to such hotels. These capital expenditures relate primarily to the periodic replacement or refurbishment of furniture, fixtures and equipment. Such agreements typically require us to reserve funds at amounts equal to 4% of the hotel’s revenues and require the funds to be set aside in restricted cash.

In addition to reserve funds for capital expenditures, our Owned Hotels debt and lease agreements also require us to deposit cash into escrow accounts for taxes, insurance and debt service or lease payments, among other things.

Long-Term Liquidity Requirements. We generally consider our long-term liquidity requirements to consist of those items that are expected to be incurred by us or our consolidated subsidiaries beyond the next 12 months and believe these requirements consist primarily of funds necessary to pay scheduled debt maturities, obligations under preferred securities, renovations at our Owned Hotels and Owned F&B Operations and other non-recurring capital expenditures that need to be made periodically with respect to our properties, the costs associated with acquisitions and development of properties under contract, and new acquisitions and development projects that we may pursue.

Our Series A preferred securities have an 8% dividend rate until October 15, 2014, a 10% dividend rate from October 15, 2014 to October 15, 2016, and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. At the 2013 Annual Meeting, Ron Burkle, the Yucaipa Investors’ nominee to the Board of Directors, was not re-elected to the Board of Directors, and as of July 14, 2013, had not been offered a seat on the Company’s Board of Directors. Accordingly, the dividend rate on the Series A preferred securities increased by 4% to 12% as of July 14, 2013. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. We have the option to accrue any and all dividend payments, and as of December 31, 2013, have not declared any dividends. As of December 31, 2013, we have undeclared dividends of approximately $32.2 million. We have the option to redeem any or all of the Series A preferred securities at any time.

Other long-term liquidity requirements include our obligations under our trust preferred securities, which mature in October 2036 and the Clift lease, each as described under “—Debt.” In the event we were to undertake a transaction that was deemed to constitute a transfer of our properties and assets substantially as an entirety within the meaning of the indenture, we may be required to repay the trust preferred securities prior to their maturity or obtain the trustee’s consent in connection with such transfer.

Additionally, as our new managed hotels are developed, to the extent we have committed to contribute key money, equity or debt, these amounts will generally come due prior to or on the hotel opening. As of December 31, 2013, we did not have any equity or debt financing commitments relating to hotel development projects. As of December 31, 2013, our long-term key money commitments were approximately $7.0 million and our potential funding under cash flow guarantees at operating hotels and hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum cannot be determined, was $21.0 million, which includes an $8.0 million performance-based cash flow guarantee related to Delano Marrakech, which we believe we are not obligated to fund. See note 8 to our consolidated financial statements included elsewhere in this report for more information. In September 2013, we served notice of termination of our management agreement for Delano Marrakech following the failure by the owner of Delano Marrakech to remedy numerous breaches of the agreement. As a result, we have discontinued all affiliation with the hotel, including removal of the Delano name, and terminated management of the property, effective November 12, 2013. Pursuant to the management agreement, in the event of an owner default, we have no further obligations under the performance-based cash flow guarantee. The owner of the hotel is disputing the circumstances surrounding termination. Both parties are seeking arbitration of outstanding claims, including our claims for unpaid fees and reimbursements. Arbitration is expected to occur in early 2015.

 

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Financing has not been obtained for some of our hotel development projects, and there can be no assurances that any or all of our development stage hotel projects will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, and to the extent we have previously funded key money, an equity investment or debt financing on a cancelled project, we may be unable to recover the amounts funded.

Sources of Liquidity. Historically, we have satisfied our short-term and long-term liquidity requirements through various sources of capital, including our existing working capital, cash provided by operations, equity and debt offerings, credit facilities, long-term mortgages and mezzanine loans on our properties, and cash generated through asset dispositions.

On February 6, 2014, we closed on the Hudson/Delano 2014 Mortgage Loan, as discussed more fully under “—Debt.” In the future, we may require additional asset sales, debt or equity financings to satisfy both our short-term and long-term liquidity requirements. These sources may include joint venture transactions and new financing opportunities, which may involve the restructuring of our outstanding debt or preferred securities, the disposition of assets and businesses, and the repurchase from time to time of our outstanding debt securities in open market transactions or otherwise.

As of December 31, 2013, we had approximately $352.4 million of remaining Federal tax net operating loss carryforwards to offset future income, including gains on future asset sales. We believe we have significant value available to us in Delano South Beach and Hudson, and that the tax basis of these assets is significantly less than their fair values. As of December 31, 2013, we estimate that the tax basis of Delano South Beach is approximately $60 million and that the tax basis in Hudson is approximately $140 million.

Although the credit and equity markets remain challenging globally, we believe that these sources of capital will become available to us in the future to fund our short- and long-term liquidity requirements. However, there can be no assurances that we will be able to access any of these sources on terms acceptable to us or at all. For example, our ability to obtain additional debt is dependent upon a number of factors, including our degree of leverage, borrowing restrictions imposed by existing lenders and general market conditions. We will continue to explore various options from time to time as necessary for our liquidity requirements or advantageous in pursuing our business strategy.

Other Liquidity Matters

In addition to our expected short-term and long-term liquidity requirements, our liquidity could also be affected by certain other potential liquidity matters, including at our Joint Venture Hotels, as discussed below.

Mondrian South Beach Mortgage and Mezzanine Agreements. As of December 31, 2013, the joint venture’s outstanding nonrecourse mortgage debt was $33.0 million and mezzanine debt was $28.0 million. The joint venture also has an additional $28.0 million of mezzanine debt owed to affiliates of the joint venture partners. The lender’s nonrecourse mortgage loan and mezzanine loan related to Mondrian South Beach matured on August 1, 2009. In April 2010, the Mondrian South Beach ownership joint venture amended the nonrecourse financing and mezzanine loan agreements secured by Mondrian South Beach or related equity interests and extended the maturity date for up to seven years through one-year extension options until April 2017, subject to certain conditions. In March 2014, the joint venture exercised its option to extend the outstanding mortgage and mezzanine debt for another year until April 2015.

 

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Morgans Group and affiliates of our joint venture partner have agreed to provide standard nonrecourse carve-out guaranties and provide certain limited indemnifications for the Mondrian South Beach mortgage and mezzanine loans. In the event of a default, the lenders’ recourse is generally limited to the mortgaged property or related equity interests, subject to standard nonrecourse carve-out guaranties for “bad boy” type acts. Morgans Group and affiliates of our joint venture partner also agreed to guaranty the joint venture’s obligation to reimburse certain expenses incurred by the lenders and indemnify the lenders in the event such lenders incur liability in connection with certain third-party actions. Morgans Group and affiliates of our joint venture partner have also guaranteed the joint venture’s liability for the unpaid principal amount of any seller financing note provided for condominium sales if such financing or related mortgage lien is found unenforceable, provided they shall not have any liability if the seller financed unit becomes subject again to the lien of the lender’s mortgage or title to the seller financed unit is otherwise transferred to the lender or if such seller financing note is repurchased by Morgans Group and/or affiliates of our joint venture partner at the full amount of unpaid principal balance of such seller financing note. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, Morgans Group and affiliates of our joint venture partner may have continuing obligations under construction completion guaranties until all outstanding payables due to construction vendors are paid. As of December 31, 2013, there were remaining payables outstanding to vendors of approximately $0.4 million. Pursuant to a letter agreement with the lenders for the Mondrian South Beach loan, the joint venture agreed that these payables, many of which are currently contested or under dispute, will not be paid from operating funds but only from tax abatements and settlements of certain lawsuits. In the event funds from tax abatements and settlements of lawsuits are insufficient to repay these amounts in a timely manner, we and our joint venture partner are required to fund the shortfall amounts.

We and affiliates of our joint venture partner also have each agreed to purchase approximately $14.0 million of condominium units under certain conditions, including an event of default. In the event of a default under the lender’s mortgage or mezzanine loan, the joint venture partners are each obligated to purchase selected condominium units, at agreed-upon sales prices, having aggregate sales prices equal to 1/2 of the lesser of $28.0 million, which is the face amount outstanding on the lender’s mezzanine loan, or the then outstanding principal balance of the lender’s mezzanine loan. The joint venture is not currently in an event of default under the mortgage or mezzanine loan. We have not recognized a liability related to the construction completion or the condominium purchase guarantees as no triggering event has occurred.

Mondrian SoHo. As of December 31, 2013, the Mondrian SoHo joint venture’s outstanding mortgage debt secured by the hotel was $196.0 million, excluding $27.2 million of deferred interest. The loan matured on November 15, 2012. In January 2013, the lender initiated foreclosure proceedings seeking, among other things, the ability to sell the property free and clear of our management agreement. We moved to dismiss the lender’s complaint on the grounds that, among other things, our management agreement is not terminable upon a foreclosure. On April 2, 2013, the lender opposed our motion to dismiss and cross-moved for summary judgment. On August 12, 2013, the court heard oral argument on both motions, as well as a third motion brought by us to strike an affirmation submitted by lender’s attorney. On January 27, 2014, the court granted Morgans Management’s motion to dismiss on the ground that a management contract does not constitute an interest subject to foreclosure, and denied lender’s motion for summary judgment as moot. On February 27, 2014, the court held a status conference where a schedule was set for further proceedings including a further summary judgment motion to be filed by the lender within 30 days as to the remaining defendants.

In February 2013, the owner of Mondrian SoHo, a joint venture in which Morgans Group owns a 20% equity interest, gave notice purporting to terminate Morgans Management as manager of the hotel. It also filed a lawsuit against us seeking termination of the management agreement on the same grounds. In addition, we, through our equity affiliate, filed a separate action against the owner and its parent in the Delaware Chancery Court for, among other things, breaching fiduciary duties and their joint venture agreement for failing to obtain consent prior to the termination. That action was subsequently consolidated with the termination action. On September 20, 2013, the Delaware Chancery Court ruled that the joint venture owning Mondrian SoHo terminated the hotel management agreement on agency grounds, that we must vacate the hotel forthwith or on whatever other timetable the hotel owner chooses, and that two claims by our equity affiliate are dismissed but not its breach of fiduciary duty claim. On September 30, 2013, we filed a motion for reconsideration and to stay execution of the judgment pending appeal. That motion is still pending, and no final order has as yet been issued. By joint stipulation of the parties, granted on February 21, 2014, Sochin JV will file its opposition to the motion for reconsideration and to stay by March 24, 2014, following which the court will issue its ruling. The parties have also stipulated to move, answer or otherwise respond to the operative complaints, by March 24, 2014. Should we not prevail on our motion for reconsideration and to stay, we intend to vigorously pursue our rights on appeal, but no assurance can be provided that we will prevail or otherwise retain management of the hotel.

 

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On April 30, 2013, we filed a lawsuit against Cape Soho Holdings, LLC and Cape Advisors Inc. in New York Supreme Court for damages based on the wrongful attempted termination of the management agreement, defamation, and breach of fiduciary and other obligations under the parties’ joint venture agreement. On August 23, 2013, the owner moved to dismiss that complaint. As of January 13, 2014, that motion has been fully briefed, and oral argument has been set for April 10, 2014. It is not possible to predict with reasonable certainty the outcome of this action, nor the amount of damages we are likely to recover should we ultimately prevail on one or more of our claims.

Additionally, there have been and, due to the fact that the lender controls all of the cash flow, may continue to be cash shortfalls from the operations of the hotel from time to time which have required additional fundings by us and our joint venture partner. For example, in 2012, we funded approximately $1.0 million in cash shortfalls at Mondrian SoHo, which were treated in part as additional capital contributions and in part as loans from Morgans Management. We subsequently deemed such amounts uncollectible in 2012 and recorded an impairment charge through equity in loss of unconsolidated joint ventures.

Certain affiliates of our joint venture partner provided a standard nonrecourse carve-out guaranty for “bad boy” type acts and a completion guaranty to the lenders for the Mondrian SoHo loan, for which Morgans Group has agreed to indemnify the joint venture partner and its affiliates up to 20% of such entities’ guaranty obligations, provided that each party is fully responsible for any losses incurred as a result of its respective gross negligence or willful misconduct.

Ames. On April 26, 2013, the joint venture closed on a new loan agreement with the mortgage lenders that provides for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. We did not contribute to the cash paydown and instead entered into an agreement with our joint venture partner pursuant to which, among other things, (1) we assigned our equity interests in the joint venture to our joint venture partner, (2) we agreed to give our joint venture partner the right to terminate our management agreement upon 60 days prior notice in return for an aggregate payment of $1.8 million, and (3) a creditworthy affiliate of our joint venture partner has assumed all or a portion of our liability with respect to historic tax credit guaranties, with our liability for any tax credit guaranties capped, in any event, at $3.0 million in the aggregate. The potential liability for historic tax credit guaranties relates to approximately $16.9 million of federal and state historic rehabilitation tax credits that Ames qualified for at the time of its development. As of December 31, 2013, there has been no triggering event that would require us to accrue any potential liability related to the historic tax credit guarantee. Effective July 17, 2013, we no longer manage Ames.

Mondrian Istanbul. Additionally, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the hotel, in early 2014, we exercised a put option under our Mondrian Istanbul joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We do not currently anticipate that these proceeding will have an impact on our management agreement should the hotel development continue.

Potential Litigation. We may have potential liability in connection with certain claims by a designer for which we have accrued $13.9 million as of December 31, 2013, as discussed in note 6 of our consolidated financial statements.

We are also defendants to lawsuits in which plaintiffs have made claims for monetary damages against us. See Part I, “Item 3. Legal Proceedings.”

Other Possible Uses of Capital. As we pursue our growth strategy, we may continue to invest in new management, franchise and license agreements through key money, equity or debt investments. To fund any such future investments, we may from time to time pursue various potential financing opportunities available to us.

 

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We have a number of additional development projects signed or under consideration, some of which may require equity investments, key money or credit support from us. In addition, through certain cash flow guarantees, we may have potential future fundings for operating hotels and hotels under development, as discussed in note 8 of our consolidated financial statements.

Comparison of Cash Flows for the Year Ended December 31, 2013 to December 31, 2012

Operating Activities. Net cash used in operating activities was $3.1 million for the year ended December 31, 2013 as compared to net cash used in operating activities of $39.5 million for the year ended December 31, 2012. This decrease in cash used was primarily due to improved operating results at our Owned Hotels.

Investing Activities. Net cash used in investing activities amounted to $7.4 million for the year ended December 31, 2013 as compared to net cash used in investing activities of $61.1 million for the year ended December 31, 2012. The decrease was primarily related to renovation costs incurred during the year ended December 31, 2012 at Delano South Beach and Hudson, two of our Owned Hotels which were under renovation during the period. Additionally, during the year ended December 31, 2012, we acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas in connection with our Delano Las Vegas project and related agreements with MGM for $15.0 million in cash and funded key money investments in Delano Moscow and Delano Marrakech.

Financing Activities. Net cash provided by financing activities amounted to $14.7 million for the year ended December 31, 2013 as compared to net cash provided by financing activities of $77.6 million for the year ended December 31, 2012. This decrease in cash provided was primarily due to the Hudson mortgage refinancing which occurred in November 2012, discussed below in “—Debt” as well as decreased net funds being borrowed against the Delano Credit Facility during the year ended December 31, 2013 as compared to the same period in 2012.

Debt

Hudson/Delano 2014 Mortgage Loan. On February 6, 2014, certain of our subsidiaries entered into a new mortgage financing with Citigroup Global Markets Realty Corp. and Bank of America, N.A., as lenders, consisting of nonrecourse mortgage and mezzanine loans in the aggregate principal amount of $450 million, secured by mortgages encumbering Delano South Beach and Hudson and pledges of equity interests in certain of our subsidiaries.

The Hudson/Delano 2014 Mortgage Loan bears interest at a reserve adjusted blended rate of 30-day LIBOR plus 565 basis points. We will maintain an interest rate cap for the amount of the Hudson/Delano 2014 Mortgage Loan that will cap the LIBOR rate on the debt under the Hudson/Delano 2014 Mortgage Loan at approximately 1.75% through the initial maturity date.

The Hudson/Delano 2014 Mortgage Loan matures on February 9, 2016. We have three, one-year extension options that will permit us to extend the maturity date of the Hudson/Delano 2014 Mortgage Loan to February 9, 2019, if certain conditions are satisfied at the respective extension dates, including delivery by the borrowers of a business plan and budget for the extension term reasonably satisfactory to the lenders and achievement by us of a specified debt yield. The second and third extensions would also require the payment of an extension fee in an amount equal to 0.25% of the then outstanding principal amount under the Hudson/Delano 2014 Mortgage Loan. A minimum unencumbered assets requirement may also be required if certain other indebtedness (as same may be amended, supplemented, modified, refinanced or replaced) becomes due during the extension term. We may prepay the Hudson/Delano 2014 Mortgage Loan in an amount necessary to achieve the specified debt yield.

The Hudson/Delano 2014 Mortgage Loan may be prepaid at any time, in whole or in part, subject to payment of a prepayment premium for any prepayment prior to August 9, 2015. There is no prepayment premium after August 9, 2015.

The Hudson/Delano 2014 Mortgage Loan is assumable under certain conditions, and provides that either one of the encumbered hotels may be sold, subject to prepayment of the Hudson/Delano 2014 Mortgage Loan at a specified release price and satisfaction of certain other conditions.

 

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The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano South Beach and the owners of Hudson and Delano South Beach and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities (CMBS) loans. The Hudson/Delano 2014 Mortgage Loan is nonrecourse to our subsidiaries that are the borrowers under the loan, except pursuant to certain carveouts detailed therein. In addition, we have provided a customary environmental indemnity and nonrecourse carveout guaranty under which we would have liability with respect to the Hudson/Delano 2014 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, changes to the Hudson capital lease without prior written consent of the lender, violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty requires us to maintain minimum unencumbered assets (as defined in the nonrecourse carveout guaranty) until the Convertible Notes and TLG Promissory Notes are repaid, extended, refinanced or replaced beyond the term of the Hudson/Delano 2014 Mortgage Loan. Further, the nonrecourse carveout guaranty prohibits the payment of dividends on or repurchase of our common stock.

The net proceeds from the Hudson/Delano 2014 Mortgage Loan were applied to (1) repay $180 million of outstanding mortgage debt under the Hudson 2012 Mortgage Loan, defined below, (2) repay $37 million of indebtedness under the Delano Credit Facility, (3) provide cash collateral for reimbursement obligations with respect to a $10.0 million letter of credit under the Delano Credit Facility, and (4) fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital, which may include the repayment of other indebtedness, including the Convertible Notes and TLG Promissory Notes, subject to certain minimum unencumbered asset requirements. On February 28, 2014, we used cash on hand, including proceeds of the Hudson/Delano 2014 Mortgage Loan, to repurchase $88.0 million of our Convertible Notes in connection with the Yucaipa Note Repurchase.

Hudson 2012 Mortgage Loan. On November 14, 2012, certain of our subsidiaries which own Hudson entered into a new mortgage financing with UBS Real Estate Securities Inc., as lender, consisting of a $180.0 million nonrecourse mortgage loan, secured by Hudson, that was fully-funded at closing (the “Hudson 2012 Mortgage Loan”). The net proceeds from the Hudson 2012 Mortgage Loan were applied to (1) repay $115 million of outstanding mortgage debt under the previous Hudson mortgage loan and related fees, (2) repay $36.0 million of indebtedness under our revolving credit facility, and (3) fund reserves required under the Hudson 2012 Mortgage Loan, with the remainder available for general corporate purposes.

The Hudson 2012 Mortgage Loan bore interest at a reserve adjusted blended rate of 30-day LIBOR (with a minimum of 0.50%) plus 840 basis points. We maintained an interest rate cap for the amount of the Hudson 2012 Mortgage Loan that capped the LIBOR rate on the debt under the Hudson 2012 Mortgage Loan at approximately 2.5% through the maturity date.

The Hudson 2012 Mortgage Loan was scheduled to mature on February 9, 2014, with extension options that would have permitted us to extend the maturity date of the Hudson 2012 Mortgage Loan to February 9, 2015, if certain conditions were satisfied at the extension date. There was no prepayment premium to prepay the Hudson 2012 Mortgage Loan after November 9, 2013. In connection with the closing of Hudson/Delano 2014 Mortgage Loan, described more fully below, the Hudson 2012 Mortgage Loan was prepaid and terminated on February 6, 2014.

Delano Credit Facility. On July 28, 2011, we and certain of our subsidiaries (collectively, the “Borrowers”), including Beach Hotel Associates LLC (the “Florida Borrower”), entered into the Delano Credit Facility with Deutsche Bank Securities Inc. as sole lead arranger, Deutsche Bank Trust Company Americas, as agent, and the lenders party thereto.

The Delano Credit Facility provided commitments for a $100 million revolving credit facility and included a $15 million letter of credit sub-facility. The maximum amount of such commitments available at any time for borrowings and letters of credit was determined according to a borrowing base valuation equal to the lesser of (i) 55% of the appraised value of Delano South Beach (the “Florida Property”) and (ii) the adjusted net operating income for the Florida Property divided by 11%. Extensions of credit under the Delano Credit Facility were available for general corporate purposes. The commitments under the Delano Credit Facility would have terminated on July 28, 2014, at which time all outstanding amounts under the Delano Credit Facility would have been due and payable. As of December 31, 2013, our maximum availability under the Delano Credit Facility was $100.0 million, of which $37.0 million of borrowings were outstanding and $10.0 million of letters of credit were posted.

 

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The obligations of the Borrowers under the Delano Credit Facility were guaranteed by us. Such obligations were also secured by a mortgage on the Florida Property and all associated assets of the Florida Borrower, as well as a pledge of all equity interests in the Florida Borrower.

The interest rate applicable to loans under the Delano Credit Facility was a floating rate of interest per annum, at the Borrowers’ election, of either LIBOR (subject to a LIBOR floor of 1.00%) plus 4.00%, or a base rate, as set forth in the agreement, plus 3.00%. In addition, a commitment fee of 0.50% applied to the unused portion of the commitments under the Delano Credit Facility.

The Borrowers’ ability to borrow under the Delano Credit Facility was subject to ongoing compliance by us and the Borrowers with various customary affirmative and negative covenants, including limitations on liens, indebtedness, issuance of certain types of equity, affiliated transactions, investments, distributions, mergers and asset sales. In addition, the Delano Credit Facility required that we and the Borrowers maintain a fixed charge coverage ratio (consolidated EBITDA to consolidated fixed charges) of no less than (i) 1.05 to 1.00 at all times on or prior to June 30, 2012 and (ii) 1.10 to 1.00 at all times thereafter. As of December 31, 2013, we were in compliance with the fixed charge coverage ratio under the Delano Credit Facility and the fixed charge coverage ratio was 1.55x.

In connection with the closing of the Hudson/Delano 2014 Mortgage Loan, described more fully below, the Delano Credit Facility was terminated on February 6, 2014 after repayment of the outstanding debt thereunder.

Notes to a Subsidiary Trust Issuing Preferred Securities. In August 2006, we formed a trust, MHG Capital Trust I (the “Trust”), to issue $50.0 million of trust preferred securities in a private placement. The sole assets of the Trust consist of the trust notes due October 30, 2036 issued by Morgans Group and guaranteed by Morgans Hotel Group Co. The trust notes have a 30-year term, ending October 30, 2036, and bear interest at a fixed rate of 8.68% until October 2016, and thereafter will bear interest at a floating rate based on the three-month LIBOR plus 3.25%. These securities are redeemable by the Trust at par. In the event we were to undertake a transaction that was deemed to constitute a transfer of our properties and assets substantially as an entirety within the meaning of the indenture, we may be required to repay the trust notes prior to their maturity or obtain the trustee’s consent in connection with such transfer.

Clift. We lease Clift under a 99-year nonrecourse lease agreement expiring in 2103. The lease is accounted for as a financing with a liability balance of $91.5 million at December 31, 2013.

Due to the amount of the payments stated in the lease, which increase periodically, and the economic environment in which the hotel operates, our subsidiary that leases Clift is not always able to operate Clift at a profit and Morgans Group may fund cash shortfalls sustained at Clift in order to enable our subsidiary to make lease payments from time to time. Our subsidiary that leases Clift was not able to make certain lease payments in 2010 and Morgans Group elected not to fund the cash shortfalls. Litigation ensued, and on September 17, 2010, we and our subsidiaries entered into a settlement and release agreement with the lessors under the Clift ground lease which, among other things, reduced the lease payments due to the lessors for the period March 1, 2010 through February 29, 2012. Effective March 1, 2012, the annual rent reverted to the rent stated in the lease agreement, which provides for base annual rent of approximately $6.0 million per year through October 2014. Thereafter, the base rent increases at 5-year intervals by a formula tied to increases in the Consumer Price Index, with a maximum increase of 40% and a minimum increase of 20% at October 2014, and a maximum increase of 20% and a minimum increase of 10% at each 5-year rent increase date thereafter. The lease is nonrecourse to us. Morgans Group also entered into a limited guaranty, whereby Morgans Group agreed to guarantee losses of up to $6 million suffered by the lessors in the event of certain “bad boy” type acts.

Convertible Notes. On October 17, 2007, we completed an offering of $172.5 million aggregate principal amount of our 2.375% Convertible Notes in a private offering. The Convertible Notes are senior subordinated unsecured obligations of Morgans Hotel Group Co. and are guaranteed on a senior subordinated basis by our operating company, Morgans Group. The Convertible Notes are convertible into shares of our common stock under certain circumstances and upon the occurrence of specified events. The Convertible Notes mature on October 15, 2014, unless repurchased by us or converted in accordance with their terms prior to such date.

 

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In connection with the private offering, we entered into certain Convertible Note hedge and warrant transactions. These transactions are intended to reduce the potential dilution to the holders of our common stock upon conversion of the Convertible Notes and generally have the effect of increasing the conversion price of the Convertible Notes to approximately $40.00 per share, representing a 82.23% premium based on the closing sale price of our common stock of $21.95 per share on October 11, 2007. The net proceeds to us from the sale of the Convertible Notes were approximately $166.8 million (of which approximately $24.1 million was used to fund the Convertible Note call options and warrant transactions).

We follow Accounting Standard Codification (“ASC”) 470-20, Debt with Conversion and other Options (“ASC 470-20”). ASC 470-20 requires the proceeds from the sale of the Convertible Notes to be allocated between a liability component and an equity component. The resulting debt discount is amortized over the period the debt is expected to remain outstanding as additional interest expense. The equity component, recorded as additional paid-in capital, was $9.0 million, which represents the difference between the proceeds from issuance of the Convertible Notes and the fair value of the liability, net of deferred taxes of $6.4 million, as of the date of issuance of the Convertible Notes.

From April 21, 2010 to July 21, 2010, the Yucaipa Investors purchased $88 million of the Convertible Notes from third parties. On February 28, 2014, we entered into a Note Repurchase Agreement with the Yucaipa Investors, pursuant to which we repurchased the $88 million of Convertible Notes owned by them for an amount equal to their principal balance plus accrued interest. We used cash on hand, including proceeds of the Hudson/Delano 2014 Mortgage Loan, for this repurchase. Following the closing under the Note Repurchase Agreement, the principal amount of the outstanding Convertible Notes has been reduced to $84.5 million.

The Indenture governing our Convertible Notes provides that upon the occurrence of a Change of Control, as defined in the indenture agreement, in certain circumstances, the holders of the Convertible Notes have the right to require the Company to purchase their Convertible Notes at a price and during the period specified in the indenture agreement. Prior to the 2013 Annual Meeting, a majority of the Continuing Directors (as defined in the indenture agreement) adopted a resolution approving the nomination of the OTK Associates, LLC (“OTK”) nominees for election to the Board of Directors at the 2013 Annual Meeting for the purpose of assuring that OTK’s nominees constitute Continuing Directors under the indenture agreement. Such action was taken to ensure that the election of OTK’s nominees at the 2013 Annual Meeting did not constitute a Change of Control. In the event we were to undertake, among other things, a transaction that was deemed to constitute a transfer of all or substantially all of our assets within the meaning of the indenture, we may be required to repay the Convertible Notes prior to their maturity or obtain the trustee’s consent in connection with such transfer.

TLG Promissory Notes. On November 30, 2011 pursuant to purchase agreements entered into on November 17, 2011, certain of our subsidiaries completed the acquisition of 90% of the equity interests in TLG for a purchase price of $28.5 million in cash and up to $18 million in TLG Promissory Notes convertible into shares of our common stock at $9.50 per share subject to the achievement of certain EBITDA targets for the acquired business. The TLG Promissory Notes were allocated $16.0 million to Mr. Sasson and $2.0 million to Mr. Masi.

The maximum payment of $18.0 million under the TLG Promissory Notes is based on TLG achieving Non-Morgans EBITDA of at least $18 million during the 27-month period starting on January 1, 2012, with ratable reduction of the payment if less than $18 million of Non-Morgans EBITDA is earned. The TLG Promissory Notes mature November 30, 2015 and may be voluntarily prepaid at any time. At either Messrs. Sasson’s or Masi’s options, the TLG Promissory Notes are payable in cash or in our common stock valued at $9.50 per share. Each of the TLG Promissory Notes earns interest at an annual rate of 8%, provided that if the notes are not paid or converted on or before November 30, 2014, the interest rate increases to 18%. The TLG Promissory Notes provide that 75% of the accrued interest is payable quarterly in cash and the remaining 25% accrues and is payable at maturity. Morgans Group has guaranteed payment of the TLG Promissory Notes and interest.

 

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As of the issue date, the fair value of the TLG Promissory Notes was estimated at approximately $15.5 million utilizing a Monte Carlo simulation to estimate the probability of the performance conditions being satisfied. The fair value of the TLG Promissory Notes was $18.0 million as of December 31, 2013 and was estimated using the following assumptions in the Monte-Carlo simulation: expected price volatility for the Company’s stock of 15%; a risk free rate of 0.1%; and no dividend payments over the measurement period.

On June 17, 2013 and thereafter, we received Notices from each of Andrew Sasson and Andy Masi pursuant to the $18.0 million TLG Promissory Notes issued to Messrs. Sasson and Masi. The Notices claimed that a total of $18 million of outstanding principal balances under the TLG Promissory Notes, plus any accrued and unpaid interest, was immediately due and payable to Messrs. Sasson and Masi as the result of a “Change of Control” in connection with the election of directors at our 2013 Annual Meeting. On August 1, 2013, we received a purported notice of Event of Default, acceleration and default interest under the TLG Promissory Notes. On August 5, 2013, Messrs. Sasson and Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition and Morgans Group alleging, among other things, breach of contract and an event of default under the TLG Promissory Notes as a result of our failure to repay the TLG Promissory Notes following the alleged “Change of Control”. The complaint sought payment of Mr. Sasson’s $16 million TLG Promissory Note and Mr. Masi’s $2 million TLG Promissory Note, plus interest compounded to principal, as well as default interest, and reasonable costs and expenses incurred in the lawsuit. We believe that a Change of Control, within the meaning of the TLG Promissory Notes, has not occurred and that no prepayments are required under the TLG Promissory Notes. On September 26, 2013, we filed a motion to dismiss the complaint. On February 6, 2014, the court granted our motion to dismiss.

Hudson Capital Leases. We lease two condominium units at Hudson which are reflected as capital leases with balances of $6.1 million at December 31, 2013. Currently annual lease payments total approximately $900,000 and are subject to increases in line with inflation. The leases expire in 2096 and 2098.

Restaurant Lease Note. In August 2012, we entered into an agreement with MGM to convert THEhotel to Delano Las Vegas, which will be managed by MGM pursuant to a 10-year licensing agreement, with two 5-year extensions at our option, subject to performance thresholds. In addition, we acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas from an existing tenant for $15.0 million in cash at closing and a principal-only $10.6 million note (the “Restaurant Lease Note”) to be paid over seven years.

The Restaurant Lease Note does not bear interest except in the event of default, as defined in the agreement. In accordance with ASC 470, Debt, we imputed interest on the Restaurant Lease Note, which was recorded at its fair value of $7.5 million as of the date of issuance. At December 31, 2013, the recorded balance outstanding on the Restaurant Lease Note is $6.6 million.

Joint Venture Debt. See “— Other Liquidity Matters” and “— Off-Balance Sheet Arrangements” for descriptions of joint venture debt.

Contractual Obligations

We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also enter into other purchase commitments and other executory contracts that are not recognized as liabilities until services are performed or goods are received. The following table summarizes our contractual obligations and other commitments as of December 31, 2013, excluding interest, except as indicated, and debt obligations at our Joint Venture Hotels:

 

     Payments Due by Period  

Contractual Obligations

   Total      Less Than 1
Year
     1 to 3 Years      3 to 5 Years      More Than
5 Years
 
     (In thousands)  

Hudson 2012 Mortgage Loan(1)

   $ 180,000       $ 180,000      $ —         $ —        $ —    

Delano Credit Facility (1)

     37,000         37,000         —           —          —    

Liability to subsidiary trust

     50,100         —          —          —          50,100   

Convertible Notes

     172,500         172,500         —          —          —    

Interest on mortgage, notes payable and liability to subsidiary trust (2)

     103,327         12,005         8,697         8,697         73,928   

TLG Promissory Note (3)

     18,000         18,000         —           —          —    

Restaurant Lease Note

     8,785         1,464         4,393         2,928         —    

Redeemable noncontrolling interest (4)

     4,953         4,953         —          —          —    

Capitalized lease obligations including amounts representing interest (5)

     133,473         491         977         977         131,028   

Operating lease obligations (6)

     48,010         4,673         9,432         9,371         24,534   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 756,148       $ 431,086       $ 23,499       $ 21,973       $ 279,590   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table summarizes our contractual obligations and other commitments as of December 31, 2013 on a pro forma basis as if we had completed the closing of the Hudson/Delano 2014 Mortgage Loan, the repayment of the Hudson 2012 Mortgage Loan and Delano Credit Facility, and the repurchase of $88.0 million of Convertible Notes pursuant to the Yucaipa Note Repurchase in 2013, excluding interest, except as indicated, and debt obligations at our Joint Venture Hotels:

 

     Payments Due by Period  

Pro Forma Contractual Obligations

   Total      Less Than 1
Year
     1 to 3 Years      3 to 5 Years      More Than
5 Years
 
     (In thousands)  

Hudson / Delano 2014 Mortgage Loan

   $ 450,000       $ —         $ 450,000       $ —        $ —    

Liability to subsidiary trust

     50,100         —          —          —          50,100   

Convertible Notes

     84,500         84,500         —          —          —    

Interest on mortgage, notes payable and liability to subsidiary trust (7)

     153,834         33,680         37,529         8,697         73,928   

TLG Promissory Note (3)

     18,000         18,000         —           —          —    

Restaurant Lease Note

     8,785         1,464         4,393         2,928         —    

Redeemable noncontrolling interest (4)

     4,953         4,953         —          —          —    

Capitalized lease obligations including amounts representing interest (5)

     133,473         491         977         977         131,028   

Operating lease obligations (6)

     48,010         4,673         9,432         9,371         24,534   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 951,655       $ 147,761       $ 502,331       $ 21,973       $ 279,590   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amount was repaid on February 6, 2014 in connection with the Hudson/Delano 2014 Mortgage Loan, as discussed under “—Debt.”
(2) Includes interest on the Hudson 2012 Mortgage Loan, which was repaid on February 6, 2014 in connection with the Hudson/Delano 2014 Mortgage Loan, Convertible Notes, of which $88.0 million were repurchased on February 28, 2014 pursuant to the Yucaipa Note Repurchase, TLG Promissory Note, Restaurant Lease Note, and liability to subsidiary trust.
(3) The TLG Promissory Notes mature on November 30, 2015, although we may elect to prepay them on or prior to November 30, 2014 when the interest rate increases to 18%.
(4) Represents a calculation of amounts due related to the Sasson-Masi Put Options as of December 31, 2013.
(5) Includes amounts related to the Clift lease, Hudson capital leases, and other capital leases, which are immaterial to our consolidated financial statements, related to equipment at certain of the hotels.
(6) Includes amounts related to the portion of the Hudson capital lease payments, which are allocable to land and treated as operating lease payments, lease payments to hotel owners related to certain of our Owned F&B Operations, minimum lease payments related to our three restaurants at Mandalay Bay, and our corporate office lease.
(7) Includes interest on the Hudson/Delano 2014 Mortgage Loan, remaining $84.5 million of outstanding Convertible Notes, TLG Promissory Note, Restaurant Lease Note, and liability to subsidiary trust.

 

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The tables above exclude our $32.5 million key money obligations and $21.0 million cash flow guarantees related to our hotel development projects, discussed further in note 8 to our consolidated financial statements. The tables above also exclude the $10 million letter of credit outstanding related to our investment in Mondrian Baha Mar. We escrowed the $10.0 million in a collateral account in February 2014 with proceeds from the Hudson/Delano 2014 Mortgage Loan. Additionally, the tables exclude the $0.7 million key money obligation related to the franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey, which was signed in January 2014. Financing has not been obtained for certain of these hotel projects, and there can be no assurances that any or all of our development stage hotel projects will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, and to the extent we have previously funded key money or an equity or debt investment on a cancelled project, we may be unable to recover the amounts funded.

The tables above include certain of our Owned F&B Operations, which lease space from hotels in which we do not have an ownership interest. We may be obligated to make lease payments at these venues if the food and beverage operations do not cover the lease obligations.

As described in “—Derivative Financial Instruments” below, we use some derivative financial instruments, primarily interest rate caps, to manage our exposure to interest rate risks related to our floating rate debt. As such, the interest rate on our debt is fixed for the majority of our outstanding debt, which is reflected in the interest obligations reported in the tables above.

On October 15, 2009, we issued 75,000 shares of Series A preferred securities to the Yucaipa Investors. The holders of such Series A preferred securities are entitled to cumulative cash dividends, payable in arrears on every three-month anniversary following the original date of issuance if such dividends are declared by the Board of Directors or an authorized committee thereof. Our Series A preferred securities have an 8% dividend rate until October 15, 2014, a 10% dividend rate from October 15, 2014 to October 15, 2016, and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. At the 2013 Annual Meeting, Ron Burkle, the Yucaipa Investors’ nominee to the Board of Directors, was not re-elected to the Board of Directors, and as of July 14, 2013, had not been offered a seat on the Company’s Board of Directors. Accordingly, the dividend rate on the Series A preferred securities increased by 4% to 12% as of July 14, 2013. The Yucaipa Investors contend that the 4% dividend rate increase was effective June 14, 2013. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. We have the option to accrue any and all dividend payments, and as of December 31, 2013, have not declared any dividends. As of December 31, 2013, we have undeclared dividends of approximately $32.2 million, which amount is not included in the tables above. We have the option to redeem any or all of the Series A preferred securities at any time.

The tables above also exclude our approximately $6.4 million cash obligation related to the Termination Plan which we expect to pay in early 2014. See further discussion of the Termination Plan in Part I, “Business—2013 and Other Recent Transactions and Developments—Termination Plan.”

Seasonality

The hospitality business is seasonal in nature. For example, our Miami hotels are generally strongest in the first quarter, whereas our New York hotels are generally strongest in the fourth quarter. Quarterly revenues also may be adversely affected by events beyond our control, such as the recent global recession, extreme weather conditions, terrorist attacks or alerts, natural disasters, airline strikes, and other considerations affecting travel.

To help demonstrate seasonality, the table below provides room revenues by quarter for the years ended December 31, 2013 and 2012 for Hudson and Delano South Beach, both of which are our fee-owned hotels included in our Owned Hotels as of December 31, 2013.

 

     First
Quarter
     Second
Quarter
     Third
Quarter
     Fourth
Quarter
 
     (in millions)  

Hudson Room Revenues

           

2013

   $ 10.8       $ 18.8       $ 17.4       $ 19.5   

2012

   $ 7.6       $ 13.9       $ 13.1       $ 18.8   

Delano South Beach Room Revenues

           

2013

   $ 8.8       $ 5.4       $ 4.3       $ 7.0   

2012

   $ 7.4       $ 5.9       $ 3.9       $ 6.6   

 

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Given the guestroom and corridor renovations at Hudson, which began in the fourth quarter of 2011 and were completed in late 2012, the impact of seasonality in 2012 and 2013 was not as significant as in prior periods. Further, due to the recent global economic downturn, the impact of seasonality in 2012 and 2013 was not as significant as in pre-recessionary periods and may continue to be less pronounced in 2014 depending on the timing and strength of the economic recovery.

To the extent that cash flows from operations are insufficient during any quarter, due to temporary or seasonal fluctuations in revenues, we may have to enter into additional short-term borrowings to meet cash requirements.

Capital Expenditures and Reserve Funds

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt or lease agreements related to such hotels. As of December 31, 2013, approximately $0.7 million was available in restricted cash reserves for future capital expenditures under these obligations related to our Owned Hotels.

Our Joint Venture Hotels and our Managed Hotels generally are subject to similar obligations under our management agreements or under debt agreements related to such hotels. These capital expenditures relate primarily to the periodic replacement or refurbishment of furniture, fixtures and equipment. Such agreements typically require the hotel owner to reserve funds at amounts equal to 4% of the hotel’s revenues and require the funds to be set aside in restricted cash.

In addition to reserve funds for capital expenditures, our Owned Hotels debt and lease agreements also require us to deposit cash into escrow accounts for taxes, insurance and debt service or lease payments, among other things.

On March 1, 2012, we completed a $10.8 million renovation at Delano South Beach which began in the third quarter of 2011. The renovations included the re-opening of a newly concepted restaurant, Bianca, improved public areas, such as the Rose Bar and pool and beach bars, a new nightclub, FDR, upgraded exclusive bungalows and suites, and 1,200 square feet of additional meeting space.

At Hudson, we spent most of 2012 renovating all the guest rooms and corridors and converting SRO units into new guest rooms. The renovation was completed in September 2012 and the conversion of 32 SRO units into guest rooms was completed in January 2013. The total number of guest rooms at Hudson was 866 as of December 31, 2013. In November 2012, we launched Hudson Lodge, a winter pop-up venue at the hotel’s private park. Additionally, in February 2013, we opened a new restaurant at Hudson, Hudson Commons, which is a modern-day beer hall and burger joint featuring a wide selection of local craft beers, inventive preparations of classic American fare, and soda shop-inspired specialty cocktails. The primary bar, Henry, opened in September 2013 after reconcepting and renovation. Henry is a cocktail bar and lounge featuring an inventive and experimental mixology program at Hudson. Additionally, in 2014, we plan to convert an additional nine SRO units into 11 new guest rooms. We anticipate these 11 new guestrooms will be completed in the second quarter of 2014 and once completed, will increase the room count at Hudson to 877.

We anticipate Clift will need to be renovated in the next few years, which may require significant capital.

The Hudson 2012 Mortgage Loan provided that, in the event the debt yield ratio fell below certain defined thresholds, all cash from the property was to be deposited into accounts controlled by the lenders from which debt service and operating expenses, including management fees, were paid and from which other reserve accounts were funded. Any excess amounts were retained by the lenders until the debt yield ratio exceeds the required thresholds for three consecutive months. As of December 31, 2013, $11.2 million was held by the lenders in this reserve account, which was released to us at the closing of the Hudson/Delano 2014 Mortgage Loan in February 2014.

 

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Derivative Financial Instruments

We use derivative financial instruments to manage our exposure to the interest rate risks related to our variable rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We determine the fair value of our derivative financial instruments using models which incorporate standard market conventions and techniques such as discounted cash flow and option pricing models to determine fair value. We believe these methods of estimating fair value result in general approximation of value, and such value may or may not be realized.

As of December 31, 2013, we had one interest rate cap outstanding and the fair value of this interest rate cap was insignificant.

In connection with the sale of the Convertible Notes, we entered into call options which are exercisable solely in connection with any conversion of the Convertible Notes and pursuant to which we will receive shares of our common stock from counterparties equal to the number of shares of our common stock, or other property, deliverable by us to the holders of the Convertible Notes upon conversion of the Convertible Notes, in excess of an amount of shares or other property with a value, at then current prices, equal to the principal amount of the converted Convertible Notes. Simultaneously, we also entered into warrant transactions, whereby we sold warrants to purchase in the aggregate 6,415,327 shares of our common stock, subject to customary anti-dilution adjustments, at an exercise price of approximately $40.00 per share of common stock. These Convertible Notes warrants may be exercised over a 90-day trading period commencing January 15, 2015. The call options and the Convertible Notes warrants are separate contracts and are not part of the terms of the Convertible Notes and will not affect the holders’ rights under the Convertible Notes. The call options are intended to offset potential dilution upon conversion of the Convertible Notes in the event that the market value per share of the common stock at the time of exercise is greater than the exercise price of the call options, which is equal to the initial conversion price of the Convertible Notes and is subject to certain customary adjustments.

On October 15, 2009, we entered into a securities purchase agreement with the Yucaipa Investors. Under the securities purchase agreement, we issued and sold to the Yucaipa Investors (i) $75.0 million of preferred stock comprised of 75,000 shares of the our Series A preferred securities, $1,000 liquidation preference per share, and (ii) the Yucaipa Warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share. The Yucaipa Warrants have a 7-1/2 year term and are exercisable utilizing a cashless exercise method only, resulting in a net share issuance. The exercise price and number of shares subject to the warrant are both subject to certain anti-dilution adjustments.

Off-Balance Sheet Arrangements

As of December 31, 2013, we had unconsolidated joint ventures that we account for using the equity method of accounting, most of which have mortgage or related debt, as described in “—Other Liquidity Matters” above. In some cases, we provide nonrecourse carve-out guaranties of joint venture debt, which guaranties are only triggered in the event of certain “bad boy” acts, and other limited liquidity or credit support, as described in “—Other Liquidity Matters” above.

Mondrian South Beach. We own a 50% interest in Mondrian South Beach, an apartment building which was converted into a condominium and hotel. Mondrian South Beach opened in December 2008, at which time we began operating the property under a 20-year management contract. We also own a 50% interest in a mezzanine financing joint venture with an affiliate of our Mondrian South Beach joint venture partner through which a total of $28.0 million in mezzanine financing was provided to the Mondrian South Beach joint venture. As of December 31, 2013, the Mondrian South Beach joint venture’s outstanding nonrecourse mortgage debt secured by the hotel was $33.0 million and mezzanine debt secured by related equity interests was $28.0 million, and the outstanding mezzanine debt owed to the mezzanine financing joint venture was $28.0 million. In March 2014, the Mondrian South Beach joint venture exercised its option to extend the outstanding mortgage and mezzanine debt for another year until April 2015.

 

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In April 2010, the Mondrian South Beach joint venture amended the nonrecourse financing and mezzanine loan agreements secured by Mondrian South Beach or related equity interests and extended the maturity date for up to seven years through one-year extension options until April 2017, subject to certain conditions. Among other things, the amendment allowed the joint venture to accrue all interest through April 2012, allows the joint venture to accrue a portion of the interest thereafter and provides the joint venture the ability to provide seller financing to qualified condominium buyers with up to 80% of the condominium purchase price. The amendment also provides that the $28.0 million mezzanine financing invested in the property by the mezzanine financing joint venture be elevated in the capital structure to become, in effect, on par with the lender’s mezzanine debt so that the mezzanine financing joint venture receives at least 50% of all returns in excess of the first mortgage.

The Mondrian South Beach joint venture was determined to be a variable interest entity as during the process of refinancing the venture’s mortgage in April 2010, its equity investment at risk was considered insufficient to permit the entity to finance its own activities. We determined that we are not the primary beneficiary of this variable interest entity as we do not have a controlling financial interest in the entity. Because we have written our investment value in the joint venture to zero, for financial reporting purposes, we believe our maximum exposure to losses as a result of our involvement in the Mondrian South Beach variable interest entity is limited to our outstanding management fees and related receivables and advances in the form of mezzanine financing, excluding guarantees and other contractual commitments. We have not committed to providing financial support to this variable interest entity, other than as contractually required, and all future funding is expected to be provided by the joint venture partners in accordance with their respective ownership interests in the form of capital contributions or loans, or by third parties.

We accounted for this investment under the equity method of accounting through December 31, 2012, until our recording of losses was suspended due to our investment balance reaching zero. At December 31, 2013, our investment in Mondrian South Beach was reduced to zero as a result of our allocated share of Mondrian South Beach’s equity in loss. Our equity in loss of Mondrian South Beach was $4.0 million and $1.8 million for the years ended December 31, 2012, and 2011 respectively. We recorded no equity in loss during the year ended December 31, 2013.

Mondrian SoHo. In June 2007, we contributed approximately $5.0 million for a 20% equity interest in a joint venture with Cape Advisors Inc. to develop a Mondrian hotel in the SoHo neighborhood of New York. The joint venture obtained a loan of $195.2 million to acquire and develop the hotel. Subsequent to the initial fundings, in 2008 and 2009, the lender and Cape Advisors Inc. made cash and other contributions to the joint venture, and we provided $3.2 million of additional funds which were treated as loans with priority over the equity, to complete the project. During 2010 and 2011, we subsequently funded an aggregate of $5.5 million, all of which were treated as loans. Additionally, as a result of cash shortfalls at Mondrian SoHo, we funded an additional $1.0 million in 2012, which has been treated in part as additional capital contributions and in part as loans from our management company subsidiary. Management subsequently deemed such amounts uncollectible during 2012 and recorded an impairment charge through equity in loss of unconsolidated joint ventures.

Based on the decline in market conditions following the inception of the joint venture and the need for additional funding to complete the hotel, we wrote down our investment in Mondrian SoHo to zero in June 2010 and recorded an impairment charge of $10.7 million through equity in loss of unconsolidated joint ventures for the year ended December 31, 2010. We have recorded all additional fundings as impairment charges through equity in loss of unconsolidated joint ventures during the periods the funds were contributed. As of December 31, 2013, our financial statements reflect no value for our investment in the Mondrian SoHo joint venture. During the year December 31, 2013, we recorded a non-cash impairment charge of $1.5 million related to certain outstanding receivables due from Mondrian SoHo through impairment loss on receivables and other assets from managed hotel and unconsolidated joint venture.

In December 2011, the Mondrian SoHo joint venture was determined to be a variable interest entity as a result of the November 2012 debt maturity and cash shortfalls, and because its equity was considered insufficient to permit the entity to finance its own activities. However, we determined that we are not its primary beneficiary and, therefore, consolidation of this joint venture is not required. We continue to account for our investment in Mondrian SoHo using the equity method of accounting. Because we have written our investment value in the joint venture to zero, for financial reporting purposes, we believe our maximum exposure to losses as a result of our involvement in the Mondrian SoHo variable interest entity is limited to our outstanding management fees and related receivables and advances in the form of equity or loans, excluding guarantees and other contractual commitments.

 

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As of December 31, 2013, the Mondrian SoHo joint venture’s outstanding mortgage debt secured by the hotel was $196.0 million, excluding $27.2 million of deferred interest. The loan matured on November 15, 2012. In January 2013, the lender initiated foreclosure proceedings seeking, among other things, the ability to sell the property free and clear of our management agreement. We moved to dismiss the lender’s complaint on the grounds that, among other things, our management agreement is not terminable upon a foreclosure. On April 2, 2013, the lender opposed our motion to dismiss and cross-moved for summary judgment. On August 12, 2013, the court heard oral argument on both motions, as well as a third motion brought by us to strike an affirmation submitted by lender’s attorney. On January 27, 2014, the court granted Morgans Management’s motion to dismiss on the ground that a management contract does not constitute an interest subject to foreclosure, and denied lender’s motion for summary judgment as moot. On February 27, 2014, the court held a status conference where a schedule was set for further proceedings including a further summary judgment motion to be filed by the lender within 30 days as to the remaining defendants.

In February 2013, the owner of Mondrian SoHo, a joint venture in which Morgans Group owns a 20% equity interest, gave notice purporting to terminate Morgans Management as manager of the hotel. It also filed a lawsuit against us seeking termination of the management agreement on the same grounds. In addition, we, through our equity affiliate, filed a separate action against the owner and its parent in the Delaware Chancery Court for, among other things, breaching fiduciary duties and their joint venture agreement for failing to obtain consent prior to the termination. That action was subsequently consolidated with the termination action. On September 20, 2013, the Delaware Chancery Court ruled that the owner of Mondrian SoHo terminated the hotel management agreement on agency grounds, that we must vacate the hotel forthwith or on whatever timetable the hotel owner chooses, and that two claims by our equity affiliate are dismissed but not its breach of fiduciary duty claim. On September 30, 2013, we filed a motion for reconsideration and to stay execution of the judgment pending appeal. That motion is still pending, and no final order has as yet been issued. By joint stipulation of the parties, granted on February 21, 2014, Sochin JV will file its opposition to the motion for reconsideration and to stay by March 24, 2014, following which the court will issue its ruling. The parties have also stipulated to move, answer or otherwise respond to the operative complaints, by March 24, 2014. Should we not prevail on our motion for reconsideration and to stay, we intend to vigorously pursue our rights on appeal, but no assurance can be provided that we will prevail or otherwise retain management of the hotel.

On April 30, 2013, we filed a lawsuit against Cape Soho Holdings, LLC and Cape Advisors Inc. in New York Supreme Court for damages based on the wrongful attempted termination of the management agreement, defamation, and breach of fiduciary and other obligations under the parties’ joint venture agreement. On August 23, 2013, the owner moved to dismiss that complaint. As of January 13, 2014, that motion has been fully briefed, and oral argument has been set for April 10, 2014. It is not possible to predict with reasonable certainty the outcome of this action, nor the amount of damages we are likely to recover should we ultimately prevail on one or more of our claims.

Shore Club. In May 2013, a Florida trial court entered a final judgment of foreclosure in favor of the lender on the Shore Club mortgage that allegedly went into default in September 2009, and set a June 25, 2013 foreclosure sale. On June 24, 2013, the joint venture that owned the Shore Club at that time agreed to a six-month refinancing with Fortress Investment Group LLC, a new lender, which expired on December 24, 2013. Pursuant to the refinancing, the foreclosure judgment was satisfied by the joint venture, and a notice of that satisfaction was filed with the court on July 9, 2013, resolving the foreclosure judgment and absolving the need for a judicial sale. The previous owner has appealed the foreclosure judgment to the Florida Court of Appeals, which appeal is still pending.

Subsequent to the expiration of the refinancing term, the hotel was sold on December 30, 2013 to HFZ Capital Group for $172.5 million. Phillips International, an affiliate of Shore Club’s former owner, will retain an ownership stake. The new owner has publicly stated that it may convert a substantial part of the hotel to condos, and we could be replaced as hotel manager. To date, we have received no notice of termination of our management agreement, and intend to continue to operate the hotel pursuant to that agreement. However, no assurance can be provided that we will continue to do so in the future. As of December 31, 2013, we had only an immaterial contingent profit participation equity interest in Shore Club.

 

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Mondrian Istanbul. In December 2011, we announced a new hotel management agreement for an approximately 105 room Mondrian-branded hotel to be located in the Old City area of Istanbul, Turkey. Upon completion and opening of the hotel, we will operate the hotel pursuant to a 20-year management agreement, with a 10-year extension option. As of December 31, 2013, we have contributed a total of $10.4 million in the form of equity and key money and have a 20% ownership interest in the venture owning the hotel.

Due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the hotel, in early 2014, we exercised a put option under our Mondrian Istanbul joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We do not currently anticipate that these proceeding will have an impact on our management agreement should the hotel development continue.

Food and Beverage Venture at Mondrian South Beach. On June 20, 2011, we acquired from affiliates of CGM the 50% interests CGM owned in our food and beverage joint ventures for approximately $20.0 million, including the food and beverage joint venture at Mondrian South Beach.

Our ownership interest in the food and beverage venture at Mondrian South Beach is less than 100%, and was re-evaluated in accordance with ASC 810-10. We concluded that this venture did not meet the requirements of a variable interest entity and accordingly, this investment in the joint venture is accounted for using the equity method, as we do not believe we exercise control over significant asset decisions such as buying, selling or financing.

We accounted for this investment under the equity method of accounting through December 31, 2013, until our recording of losses were suspended due to the investment in this food and beverage venture being reduced to zero. Our equity in loss of the food and beverage venture was $0.6 million, $0.8 million, and $0.2 million for the years ended December 31, 2013, 2012, and 2011, respectively.

Other Development Stage Hotels. We have a number of additional development projects signed or under consideration, some of which may require equity or debt investments, key money or credit support from us. In addition, through certain cash flow guarantees, we may have potential future funding obligations for hotels under development.

As of December 31, 2013, our key money commitments, which are discussed further in note 8 to our consolidated financial statements, were approximately $32.5 million and our potential funding obligations under cash flow guarantees at operating hotels and hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum cannot be determined, were $21.0 million, which includes an $8.0 million performance cash flow guarantee related to Delano Marrakech, which we believe we are not obligated to fund. In September 2013, we served notice of termination of our management agreement for Delano Marrakech following the failure by the owner of Delano Marrakech to remedy numerous breaches of the agreement. As a result, we discontinued all affiliation with the hotel, including removal of the Delano name, and terminated management of the property, effective November 12, 2013. Pursuant to the management agreement, in the event of an owner default, we have no further obligations under the performance-based cash flow guarantee. The owner of the hotel is disputing the circumstances surrounding termination. Both parties are seeking arbitration of outstanding claims, including our claims for unpaid fees and reimbursements. Arbitration is expected to occur in early 2015. Additionally, in January 2014, we signed a 15-year franchise agreement for a Morgans Original branded hotel in Istanbul, Turkey. The hotel is expected to have 78 rooms and open in late 2014. We have a $0.7 million key money obligation that will be funded upon the hotels opening, which is not included in the amounts above.

For further information regarding our off balance sheet arrangements, see note 5 to our consolidated financial statements.

Recent Accounting Pronouncements

There were no new pronouncements adopted in 2013.

 

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Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

We evaluate our estimates on an ongoing basis. We base our estimates on historical experience, information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our consolidated financial statements.

 

    Impairment of long-lived assets. When triggering events occur, we periodically review each property for possible impairment. Recoverability of such assets is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset, as determined by applying our operating budgets for future periods. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value. We estimated each property’s fair value using a discounted cash flow method taking into account each property’s expected cash flow from operations, holding period and net proceeds from the dispositions of the property. The factors we address in determining estimated net proceeds from disposition include anticipated operating cash flow in the year of disposition, terminal cash flow capitalization rate and selling price per room. Our judgment is required in determining the discount rate applied to estimated cash flows, the growth rate of the property revenues, and the need for capital expenditures, as well as specific market and economic conditions. Additionally, the classification of these assets as held-for-sale requires the recording of these assets at our estimate of their fair value less estimated selling costs which can affect the amount of impairment recorded. As of December 31, 2013 and 2012, management concluded that its long-lived assets were not impaired.

 

    Impairment of goodwill. Goodwill represents the excess purchase price over the fair value of net assets attributable to business acquisitions and combinations. We test for impairment of goodwill at least annually and at year end. We will test for impairment more frequently if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. In accordance with Accounting Standards Update (“ASU”) No. 2011-08, Intangibles – Goodwill and Other, management assesses qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If this is the case, management will perform a more detailed two-step goodwill impairment test which is used to identify potential goodwill impairments and to measure the amount of goodwill impairment losses to be recognized, if any. In applying the detailed two-step process, management identifies potential impairments in goodwill by comparing the fair value of the reporting unit with its book value. If the fair value of the reporting unit exceeds the carrying amount, including goodwill, the asset is not impaired. Any excess of carrying value over the estimated fair value of goodwill would be recognized as an impairment loss in continuing operations. Management applies a discounted cash flow method to perform its annual goodwill fair value impairment test taking into account approved operating budgets with appropriate growth assumptions, holding period and proceeds from disposing of the property. In addition to the discounted cash flow analysis, management also considers external independent appraisals to estimate fair value. The analysis and appraisals used by management are consistent with those used by a market participant. Judgment is required in determining the discount rate applied to estimated cash flows, growth rate of the property revenues, and the need for capital expenditures, as well as specific market and economic conditions. The discount rate and the terminal cash flow capitalization rate were based on applicable public hotel studies and market indices. Given the current economic environment, management believes that the growth assumptions applied are reasonable. We have one reportable operating segment, which is its reporting unit under Accounting Standards Codification (“ASC”) 350-20, Intangibles – Goodwill and Other; therefore management aggregates goodwill associated to all owned hotels and owned food and beverage venues when analyzing potential impairment. As of December 31, 2013 and 2012, management concluded that no goodwill impairment existed as qualitative factors did not indicate that the fair value of our reporting unit was less than its carrying value. Management does not believe it is reasonably likely that goodwill will become impaired in future periods, but will test goodwill before the 2014 year end if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.

 

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    Depreciation and amortization expense. Depreciation expense is based on the estimated useful life of our assets. The respective lives of the assets are based on a number of assumptions made by us, including the cost and timing of capital expenditures to maintain and refurbish our hotels, as well as specific market and economic conditions. Hotel properties and other completed real estate investments are depreciated using the straight-line method over estimated useful lives of 39.5 years for buildings and generally five years for furniture, fixtures and equipment. While our management believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of our hotels or other assets. We have not changed the estimated useful lives of any of our assets during the periods discussed and believe that the future useful lives of our assets will be consistent with historical trends and experience.

 

    Consolidation Policy. Variable interest entities are accounted for within the scope of ASC 810-10, Consolidation (“ASC 810-10”), and are required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is the enterprise that has the power to direct the activities that most significantly impact the variable interest entity’s economic performance and obligation to absorb losses or the right to receive benefits of the variable interest entity that could be potentially significant to the variable interest entity. We evaluate our interests in accordance with ASC 810-10, to determine if they are variable interests in variable interest entities. Significant judgments and assumptions are made by us to determine whether an entity is a variable interest entity such as those regarding the sufficiency of an entity’s equity at risk and whether the entity’s equity holders have the power through voting or similar rights to direct the activities of the entity that most significantly impact its economic performance. We have evaluated the applicability of ASC 810-10 to our investments in our Joint Venture Hotels and F&B Venture. We have determined that most of these joint ventures do not meet the requirements of a variable interest entity and some of the ventures meet the requirements of a variable interest entity of which we are not the primary beneficiary and therefore, consolidation of these ventures is not required. We account for these investments using the equity method as we believe we do not exercise control over significant asset decisions such as buying, selling or financing nor are we the primary beneficiary of the entities. Under the equity method, we increase our investment in unconsolidated joint ventures for our proportionate share of net income and contributions and decrease our investment balance for our proportionate share of net loss and distributions.

 

    Assets Held for Sale. In accordance with ASC 360-10-45, Property, Plant, and Equipment, Other Presentation Matters, we consider properties to be assets held for sale when management approves and commits to a formal plan to actively market a property or a group of properties for sale and the sale is probable. Upon designation as an asset held for sale, we record the carrying value of each property or group of properties at the lower of its carrying value, which includes allocable goodwill, or its estimated fair value, less estimated costs to sell, and we stop recording depreciation expense. Any gain realized in connection with the sale of the properties for which we have significant continuing involvement, such as through a long-term management agreement, is deferred and recognized over the initial term of the related management agreement.

The operations of the properties held for sale prior to the sale date are recorded in discontinued operations unless we have continuing involvement, such as through a management agreement, after the sale.

 

    Business Combinations. In accordance with ASC 805-10, Business Combinations, we recognize identifiable assets acquired, liabilities (both specific and contingent) assumed, and non-controlling interests in a business combination at their fair values at the acquisition date based on the exit price (i.e. the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date). Furthermore, acquisition-related costs, such as due diligence, legal and accounting fees, are expensed as incurred and are not applied in determining the fair value of the acquired assets. In certain situations, a deferred tax liability is created due to the difference between the fair value and the tax basis of the acquired asset at the acquisition date, which also may result in a goodwill asset being recorded.

 

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    Stock-based Compensation. We have adopted the fair value method of accounting prescribed in ASC 718-10, Compensation, Stock Based Compensation (“ASC 718-10”) for equity-based compensation awards. ASC 718-10 requires an estimate of the fair value of the equity award at the time of grant rather than the intrinsic value method. For all fixed equity-based awards to employees and directors, which have no vesting conditions other than time of service, the fair value of the equity award at the grant date will be amortized to compensation expense over the award’s vesting period on a straight-line basis. For performance-based compensation plans, we recognize compensation expense at such time when the performance hurdle is anticipated to be achieved over the performance period based upon the fair value at the date of grant. The fair value is determined based on the value of our common stock on the grant date of the award, in the case of stock option awards, the Black-Scholes option pricing model, or in the case of outperformance long-term incentive units, or OPP LTIP Units, the Monte Carlo simulation method. Management’s assumptions when applying the Black-Scholes model are derived based upon the risk profile and volatility of our common stock and our peer group. The Monte Carlo simulation uses a statistical formula underlying the Black-Scholes and binomial formulas and such simulation is run approximately 100,000 times. For each simulation, the payoff is calculated at the settlement date, which is then discounted to the award date at a risk-free interest rate. The average of the values over all simulations is the expected value of the unit on the award date. Assumptions used in the valuations include factors associated with the underlying performance of our stock price and total shareholder return over the term of the performance awards including total stock return volatility and risk-free interest. We believe that the assumptions that we have applied to stock-based compensation are reasonable and we will continue to review such assumptions quarterly and revise them as market conditions change and management deems necessary.

 

    Deferred income taxes and valuation allowance. We account for deferred taxes by recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance will be provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Such valuation allowance will be estimated by management based on our projected future taxable income. The estimate of future taxable income is highly subjective. We have a net operating losses for the tax years 2013 and 2012 and anticipate that all or a major portion of the net operating losses will be utilized to offset any future gains on sale of assets. However, these assumptions may prove to be inaccurate, and unanticipated events and circumstances may occur in the future. To the extent actual results differ from these estimates; our future results of operations may be affected. At December 31, 2013 and 2012, we had a $146.4 million and $125.0 valuation allowance against our deferred tax assets, respectively.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Some of our outstanding debt has a variable interest rate. As described in “Management’s Discussion and Analysis of Financial Results of Operations — Derivative Financial Instruments” above, we use derivative financial instruments, primarily interest rate caps, to manage our exposure to interest rate risks related to our floating rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. As of December 31, 2013, our total outstanding consolidated debt, including capital lease obligations, was approximately $559.9 million, of which approximately $217.0 million, or 38.8%, was variable rate debt. At December 31, 2013, the one month LIBOR rate was 0.17%. As of December 31, 2013, our total outstanding consolidated debt, including capital lease obligations, on a pro forma basis as if we had closed on the Hudson/Delano 2014 Mortgage Loan, repaid the Hudson 2012 Mortgage Loan and the Delano Credit Facility, and repurchased $88.0 million of Convertible Notes pursuant to the Yucaipa Note Repurchase, was approximately $705.8 million, of which approximately $450.0 million, or 63.8%, was variable rate debt.

 

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As of December 31, 2013, the $217.0 million of variable rate debt consisted of an outstanding balance of $180.0 million on the Hudson 2012 Mortgage Loan and our $37.0 million of borrowings outstanding under our Delano Credit Facility. In connection with the Hudson 2012 Mortgage Loan, an interest rate cap for 2.5% in the full amount of $180.0 million was outstanding as of December 31, 2013. This interest rate cap matured in February 2014. The outstanding borrowings of $37.0 million on our Delano Credit Facility as of December 31, 2013 are not subject to an interest rate hedge. If interest rates on this $217.0 million variable rate debt increase by 1.0%, or 100 basis points, the increase in interest expense would reduce future pre-tax earnings and cash flows by approximately $2.2 million annually. The maximum annual amount the interest expense would increase on the $180.0 million of variable rate debt outstanding as of December 31, 2013 under the Hudson 2012 Mortgage Loan is $4.2 million due to our interest rate cap agreement, which would reduce future pre-tax earnings and cash flows by the same amount annually. If interest rates on this $217.0 million variable rate debt decrease by 1.0%, the decrease in interest expense would increase pre-tax earnings and cash flow by approximately $2.2 million annually.

As of December 31, 2013, on a pro forma basis as if we had closed on the Hudson/Delano 2014 Mortgage Loan and repaid the Hudson 2012 Mortgage Loan and Delano Credit Facility in 2013, the $450.0 million of variable rate debt consisted of an outstanding balance of $450.0 million on the Hudson/Delano 2014 Mortgage Loan. In connection with the Hudson/Delano 2014 Mortgage Loan, we maintain an interest rate cap that will cap the LIBOR rate on the debt outstanding under the Hudson/Delano 2014 Mortgage Loan at approximately 1.75% through the initial maturity date. This interest rate cap matures in February 2016. If interest rates on this $450.0 million variable rate debt increase by 1.0%, or 100 basis points, the increase in interest expense would reduce future pre-tax earnings and cash flows by approximately $4.5 million annually. The maximum annual amount the interest expense would increase on the pro forma $450.0 million of variable rate debt outstanding as of December 31, 2013 under the Hudson/Delano 2014 Mortgage Loan is $7.1 million due to our interest rate cap agreement, which would reduce future pre-tax earnings and cash flows by the same amount annually. If interest rates on this $450.0 million variable rate debt decrease by 1.0%, the decrease in interest expense would increase pre-tax earnings and cash flow by approximately $4.5 million annually.

As of December 31, 2013, our fixed rate debt, excluding our Hudson capital lease obligation, of $336.8 million consisted of the trust notes underlying our trust preferred securities, the Convertible Notes, the Clift lease, the TLG Promissory Notes, and the Restaurant Lease Note. The fair value of some of these debts is greater than the book value. As such, if interest rates increase by 1.0%, or approximately 100 basis points, the fair value of our fixed rate debt at December 31, 2013, would decrease by approximately $26.4 million. If market rates of interest decrease by 1.0%, the fair value of our fixed rate debt at December 31, 2013 would increase by $31.5 million.

As of December 31, 2013, on a pro forma basis as if we had repurchased $88.0 million of outstanding Convertible Notes pursuant to the Yucaipa Note Repurchase in 2013, our fixed rate debt, excluding our Hudson capital lease obligation, of $249.7 million consisted of the trust notes underlying our trust preferred securities, the remaining $84.5 million of outstanding Convertible Notes, the Clift lease, the TLG Promissory Notes, and the Restaurant Lease Note. The fair value of some of these debts is greater than the book value. As such, if interest rates increase by 1.0%, or approximately 100 basis points, the fair value of our fixed rate debt at December 31, 2013, would decrease by approximately $21.8 million. If market rates of interest decrease by 1.0%, the fair value of our fixed rate debt at December 31, 2013 would increase by $26.6 million.

Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments and future cash flows. These analyses do not consider the effect of a reduced level of overall economic activity. If overall economic activity is significantly reduced, we may take actions to further mitigate our exposure. However, because we cannot determine the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

We have entered into agreements with each of our derivative counterparties in connection with our interest rate caps and hedging instruments related to the Convertible Notes, providing that in the event we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations.

Currency Exchange Risk

As we have international operations at hotels that we manage in London, currency exchange risks between the U.S. dollar and the British pound arise as a normal part of our business. We reduce these risks by transacting these businesses primarily in their local currency.

 

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Generally, we do not enter into forward or option contracts to manage our exposure applicable to day-to-day net operating cash flows. We do not foresee any significant changes in either our exposure to fluctuations in foreign exchange rates or how such exposure is managed in the future, with the exception of the sale of our interests in our two London hotels, in connection with which we entered into a foreign currency forward contract due to the material nature of the transaction.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of Morgans Hotel Group Co. and the notes related to the foregoing financial statements, together with the independent registered public accounting firm’s reports thereon, are set forth on pages F-1 through F-64 of this report. Additionally, the consolidated financial statements of our significant subsidiary are incorporated by reference in this Annual Report on Form 10-K.

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedure

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including the interim chief executive officer and the chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15 of the rules promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, our interim chief executive officer and the chief financial officer concluded that the design and operation of these disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15) that occurred during the quarter ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In connection with the preparation of the Company’s annual financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. The assessment was based upon the framework described in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management’s assessment included an evaluation of the design of internal control over financial reporting and testing of the operational effectiveness of internal control over financial reporting. We have reviewed the results of the assessment with the Audit Committee of our Board of Directors.

 

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Based on our assessment under the criteria set forth in COSO, management has concluded that, as of December 31, 2013, the Company maintained effective internal control over financial reporting.

BDO USA, LLP, an independent registered public accounting firm, that audited our consolidated financial statements included in this Annual Report has issued an attestation report on our internal control over financial reporting as of December 31, 2013, which appears in Item 9A, below.

 

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Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

Board of Directors and Stockholders

Morgans Hotel Group Co.

New York, NY

We have audited Morgans Hotel Group Co.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Morgans Hotel Group Co.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Morgans Hotel Group Co. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013 based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Morgans Hotel Group Co. as of December 31, 2013 and 2012, and the related consolidated statements of comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2013, and our report dated March 12, 2014 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP                        

New York, New York

March 12, 2014

 

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ITEM 9B. OTHER INFORMATION

None.

 

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PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item regarding directors, executive officers and corporate governance is hereby incorporated by reference to the material appearing in the Proxy Statement for the Annual Stockholders Meeting to be held in 2014 (the “Proxy Statement”) under the captions “Board of Directors and Corporate Governance,” and “Executive Officer Biographies.” The information required by this item regarding compliance with Section 16(a) of the Exchange Act, is hereby incorporated by reference to the material appearing in the Proxy Statement under the caption “Voting Securities of Certain Beneficial Owners and Management — Section 16(a) Beneficial Ownership Reporting Compliance.” The information required by this item with respect to the availability of our code of ethics is provided in Item 1 of this Annual Report on Form 10-K. See “Item 1 — Materials Available on Our Website.”

 

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is hereby incorporated by reference to the material appearing in the Proxy Statement under the captions “Compensation Discussion and Analysis” and “Compensation of Directors and Executive Officers.”

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information regarding security ownership of certain beneficial owners and management required by this item is hereby incorporated by reference to the material appearing in the Proxy Statement under the caption “Voting Securities of Certain Beneficial Owners and Management” and “Compensation of Directors and Executive Officers — Equity Compensation Plan Information.”

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is hereby incorporated by reference to the material appearing in the Proxy Statement under the captions “Certain Relationships and Related Transactions” and “Board of Directors and Corporate Governance — Corporate Governance Information — Director Independence.”

 

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this item is hereby incorporated by reference to the material appearing in the Proxy Statement under the caption “Audit Related Matters.”

 

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PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) and (c) Financial Statements and Schedules.

Reference is made to the “Index to the Financial Statements” on page F-1 of this report.

All other financial statement schedules are not required under the related instructions, or they have been omitted either because they are not significant, the required information has been disclosed in the consolidated financial statements and the notes related thereto.

(b) Exhibits

We hereby file as part of this Annual Report on Form 10-K the exhibits listed in the Index to Exhibits.

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

Consolidated Financial Statements:

  

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheets as of December 31, 2013 and 2012

     F-3   

Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012, and 2011

     F-4   

Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2013, 2012, and 2011

     F-5   

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012, and 2011

     F-7   

Notes to Consolidated Financial Statements

     F-9 – F-64   

 

F-1


Table of Contents

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Morgans Hotel Group Co.

New York, NY

We have audited the accompanying consolidated balance sheets of Morgans Hotel Group Co. (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Morgans Hotel Group Co. at December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Morgans Hotel Group Co.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 12, 2014 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

New York, New York

March 12, 2014

 

F-2


Table of Contents

Morgans Hotel Group Co.

Consolidated Balance Sheets

(in thousands, except per share data)

 

     As of December 31,  
     2013     2012  
ASSETS     

Property and equipment, net

   $ 292,629      $ 303,689   

Goodwill

     66,572        66,572   

Investments in and advances to unconsolidated joint ventures

     10,492        11,178   

Cash and cash equivalents

     10,025        5,847   

Restricted cash

     22,144        21,226   

Accounts receivable, net

     18,384        16,592   

Related party receivables

     3,694        5,754   

Prepaid expenses and other assets

     10,409        8,691   

Deferred tax asset, net

     78,758        78,758   

Investment in TLG management contracts, net

     23,702        29,469   

Other assets, net

     34,398        43,379   
  

 

 

   

 

 

 

Total assets

   $ 571,207      $ 591,155   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ DEFICIT     

Debt and capital lease obligations

   $ 559,939      $ 538,143   

Accounts payable and accrued liabilities

     42,439        34,627   

Deferred gain on asset sales

     133,419        141,401   

Other liabilities

     13,891        14,301   
  

 

 

   

 

 

 

Total liabilities

     749,688        728,472   

Redeemable noncontrolling interest

     4,953        6,053   

Commitments and contingencies

    

Preferred stock, $.01 par value; liquidation preference $1,000 per share, 75,000 shares authorized and issued at December 31, 2013 and 2012, respectively

     62,004        57,755   

Common stock, $.01 par value; 200,000,000 shares authorized; 36,277,495 shares issued at December 31, 2013 and 2012, respectively

     363        363   

Additional paid-in capital

     252,810        265,014   

Treasury stock, at cost, 2,703,181 and 3,977,988 shares of common stock at December 31, 2013 and 2012, respectively

     (37,086     (58,917

Accumulated other comprehensive loss

     (10     (50

Accumulated deficit

     (462,005     (413,601
  

 

 

   

 

 

 

Total Morgans Hotel Group Co. stockholders’ deficit

     (183,924     (149,436

Noncontrolling interest

     490        6,066   
  

 

 

   

 

 

 

Total deficit

     (183,434     (143,370
  

 

 

   

 

 

 

Total liabilities, redeemable noncontrolling interest and stockholders’ deficit

   $ 571,207      $ 591,155   
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

Morgans Hotel Group Co.

Consolidated Statements of Comprehensive Loss

(in thousands, except per share data)

 

     Year Ended December 31,  
     2013     2012     2011  

Revenues:

      

Rooms

   $ 120,823      $ 102,546      $ 120,351   

Food and beverage

     84,085        57,669        66,253   

Other hotel

     4,863        5,046        6,440   
  

 

 

   

 

 

   

 

 

 

Total hotel revenues

     209,771        165,261        193,044   

Management fee-related parties and other income

     26,715        24,658        14,288   
  

 

 

   

 

 

   

 

 

 

Total revenues

     236,486        189,919        207,332   

Operating Costs and Expenses:

      

Rooms

     37,347        31,973        37,626   

Food and beverage

     62,419        47,166        55,466   

Other departmental

     3,261        3,595        4,069   

Hotel selling, general and administrative

     42,563        37,055        43,629   

Property taxes, insurance and other

     17,339        15,819        16,475   
  

 

 

   

 

 

   

 

 

 

Total hotel operating expenses

     162,929        135,608        157,265   

Corporate expenses, including stock compensation of $4.1 million, $4.5 million, and $9.1 million, respectively

     27,626        32,062        34,563   

Depreciation and amortization

     27,374        23,977        22,219   

Restructuring and disposal costs

     11,451        6,851        8,575   

Development costs

     2,987        5,783        5,716   

Impairment loss on receivables and other assets from managed hotel and unconsolidated joint venture

     6,029       —          —     
  

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     238,396        204,281        228,338   
  

 

 

   

 

 

   

 

 

 

Operating loss

     (1,910     (14,362     (21,006

Interest expense, net

     45,990        38,998        35,514   

Equity in loss of unconsolidated joint ventures

     828        6,436        29,539   

Gain on asset sales

     (8,020     (7,989     (3,178

Other non-operating expenses

     2,726        3,908        4,632   
  

 

 

   

 

 

   

 

 

 

Loss before income tax expense

     (43,434     (55,715     (87,513

Income tax expense

     716        776        929   
  

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (44,150     (56,491     (88,442

Income from discontinued operations, net of tax

     —          —          485   
  

 

 

   

 

 

   

 

 

 

Net loss

     (44,150     (56,491     (87,957

Net (income) loss attributable to noncontrolling interest

     (5     804        2,554   
  

 

 

   

 

 

   

 

 

 

Net loss attributable to Morgans Hotel Group Co.

     (44,155     (55,687     (85,403

Preferred stock dividends and accretion

     (14,316     (11,124     (9,938
  

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

   $ (58,471   $ (66,811   $ (95,341
  

 

 

   

 

 

   

 

 

 

Other comprehensive loss:

      

Unrealized gain (loss) on valuation of swap/cap agreements, net of tax

     40        (12     (7

Share of unrealized gain on valuation of swap agreements from unconsolidated joint venture, net of tax

     —          —          1,456   

Foreign currency translation gain, net of tax

     —          —          1,707   
  

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (58,431   $ (66,823   $ (92,185
  

 

 

   

 

 

   

 

 

 

(Loss) Income per share:

      

Basic and diluted continuing operations

   $ (1.78   $ (2.13   $ (3.05

Basic and diluted discontinued operations

     —          —          0.02   

Basic and diluted attributable to common stockholders

   $ (1.78   $ (2.13   $ (3.03

Weighted average number of common shares outstanding:

      

Basic and diluted

     32,867        31,437        31,454   

See accompanying notes to these consolidated financial statements.

 

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Table of Contents

Morgans Hotel Group Co.

Consolidated Statements of Stockholders’ Deficit

(in thousands)

 

    Shares                 Additional           Accumulated
Other
          Total
Morgans
Hotel Group
Co.
       
    Common
Shares
    Preferred
Shares
    Common
Stock
    Preferred
Stock
    Paid-in
Capital
    Treasury
Stock
    Comprehensive
Loss
    Accumulated
Deficit
    Stockholders’
Deficit
    Non controlling
Interest
    Total
Deficit
 

January 1, 2011

    30,293        75      $ 363      $ 51,118      $ 297,554      $ (92,688   $ (3,194   $ (265,874   $ (12,721   $ 10,916      $ (1,805
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    —          —        $ —        $ —        $ —        $ —        $ —        $ (85,403   $ (85,403   $ (2,554   $ (87,957

Accretion of discount on preferred stock

    —          —          —          3,025        —          —          —          (3,025     —          —          —     

Purchase of CGM joint venture ownership interests

    —          —          —          —          (10,421     —          —          —          (10,421     289        (10,132

Foreign currency translation

    —          —          —          —          —          —          1,707        —          1,707        —          1,707   

Unrealized loss on valuation of swap/cap agreements, net of tax

    —          —          —          —          —          —          (7     —          (7     —          (7

Share of unrealized gain on valuation of swap agreements from unconsolidated joint venture, net of tax

    —          —          —          —          —          —          1,456        —          1,456        —          1,456   

Stock-based compensation awards

    —          —          —          —          8,554        —          —          —          8,554        —          8,554   

Issuance of stock-based awards

    497        —          —          —          (8,773     8,145        —          —          (628     —          (628

Noncontrolling interest distribution

    —          —          —          —          —          —          —          —          —          (827     (827
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

    30,790        75      $ 363      $ 54,143      $ 286,914      $ (84,543   $ (38   $ (354,302   $ (97,463   $ 7,824      $ (89,639
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    —          —        $ —        $ —        $ —        $ —        $ —        $ (55,687   $ (55,687   $ (1,758   $ (57,445

Accretion of discount on preferred stock

    —          —          —          3,612        —          —          —          (3,612     —          —          —     

Change in fair market value of redeemable noncontrolling interest

    —          —          —          —          (474     —          —          —          (474      —          (474

Unrealized loss on valuation of swap/cap agreements, net of tax

    —          —          —          —          —          —          (12     —          (12     —          (12

Stock-based compensation awards

    —          —          —          —          4,606        —          —          —          4,606        —          4,606   

Issuance of stock-based awards

    1,510        —          —          —          (26,032     25,626        —          —          (406     —          (406
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2012

    32,300        75      $ 363      $ 57,755      $ 265,014      $ (58,917   $ (50   $ (413,601   $ (149,436   $ 6,066      $ (143,370
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

F-5


Table of Contents
    Shares                 Additional           Accumulated
Other
          Total
Morgans
Hotel Group
Co.
       
    Common
Shares
    Preferred
Shares
    Common
Stock
    Preferred
Stock
    Paid-in
Capital
    Treasury
Stock
    Comprehensive
Loss
    Accumulated
Deficit
    Stockholders’
Deficit
    Non controlling
Interest
    Total
Deficit
 

Net loss

    —          —        $ —        $ —        $ —        $ —        $ —        $ (44,155   $ (44,155   $ (988   $ (45,143

Accretion of discount on preferred stock

    —          —          —          4,249        —          —          —          (4,249     —          —          —     

Shares of membership units converted into common stock

    879       —          —          —          (10,510     15,098       —          —          4,588       (4,588     —     

Change in fair market value of redeemable noncontrolling interest

    —          —          —          —          1,116        —          —          —          1,116       —          1,116   

Unrealized gain on valuation of swap/cap agreements, net of tax

    —          —          —          —          —          —          40        —          40        —          40   

Stock-based compensation awards

    —          —          —          —          4,487        —          —          —          4,487        —          4,487   

Issuance of stock-based awards

    395        —          —          —          (7,297     6,733        —          —          (564     —          (564

Noncontrolling interest distribution

    —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2013

    33,574        75      $ 363      $ 62,004      $ 252,810      $ (37,086   $ (10   $ (462,005   $ (183,924   $ 490      $ (183,434
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements.

 

F-6


Table of Contents

Morgans Hotel Group Co.

Consolidated Statements of Cash Flows

(in thousands)

 

     Year Ended December 31,  
     2013     2012     2011  

Cash flows from operating activities:

      

Net loss

   $ (44,150   $ (56,491   $ (87,957

Adjustments to reconcile net loss to net cash (used in) provided by operating activities (including discontinued operations):

      

Depreciation

     20,302        17,648        20,042   

Amortization of other costs

     7,072        6,328        2,177   

Amortization of deferred financing costs

     6,084        5,776        8,659   

Amortization of discount on convertible notes

     2,277        2,277        2,277   

Amortization of deferred gain on asset sales

     (8,020     (7,989     (3,178

Stock-based compensation

     4,077        4,513        9,082   

Accretion of interest

     2,937        2,021        1,958   

Equity in losses from unconsolidated joint ventures

     828        6,436        29,539   

Impairment loss on receivables and other assets from managed hotels and unconsolidated joint venture

     6,029        —          —     

Impairment loss and loss on disposal of assets

     288        403        1,764   

Gain on disposal of property held for non-sale disposition

     —          —          (843

Change in fair value of TLG Promissory Notes

     65        2,420        —     

Change in value of interest rate caps and swaps, net

     42        35        36   

Changes in assets and liabilities:

      

Accounts receivable, net

     (3,935     (5,765     840   

Related party receivables

     601        (2,606     (304

Restricted cash

     (3,732     (9,754     17,530   

Prepaid expenses and other assets

     (1,758     (3,398     4,479   

Accounts payable and accrued liabilities

     7,846        (1,318     3,649   
  

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (3,147     (39,464     9,750   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

      

Additions to property and equipment

     (9,467     (32,571     (17,842

Deposits into (withdrawals from) capital improvement escrows, net

     2,814        (1,534     1,005   

Distributions from unconsolidated joint ventures

     9        8        1,624