10-K 1 mhgc-10k_20141231.htm 10-K

 

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, 2014

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 $232,241,755, based on a closing sale price of $7.93 as reported on the NASDAQ Global Market on June 30, 2014.

As of March 12, 2015, the registrant had issued and outstanding 34,426,667 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 2015 are incorporated by reference into Part III of this report.

 

 

 

 


 

INDEX

 

 

 

Page

PART I

 

 

 

 

 

ITEM 1 BUSINESS

 

5

 

 

 

ITEM 1A RISK FACTORS

 

14

 

 

 

ITEM 1B UNRESOLVED STAFF COMMENTS

 

32

 

 

 

ITEM 2 PROPERTIES

 

33

 

 

 

ITEM 3 LEGAL PROCEEDINGS

 

38

 

 

 

ITEM 4 MINE SAFETY DISCLOSURES

 

41

 

 

 

PART II

 

 

 

 

 

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

 

42

 

 

 

ITEM 6 SELECTED FINANCIAL DATA

 

44

 

 

 

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

 

46

 

 

 

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

69

 

 

 

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

70

 

 

 

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

 

70

 

 

 

ITEM 9A CONTROLS AND PROCEDURES

 

70

 

 

 

ITEM 9B OTHER INFORMATION

 

72

 

 

 

PART III

 

 

 

 

 

ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

73

 

 

 

ITEM 11 EXECUTIVE COMPENSATION

 

73

 

 

 

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

 

73

 

 

 

ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

73

 

 

 

ITEM 14 PRINCIPAL ACCOUNTING FEES AND SERVICES

 

73

 

 

 

PART IV

 

 

 

 

 

ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

74

 

 

 


 

2


 

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. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “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.  Such forward-looking statements include, without limitation, statements regarding our expectations with respect to:  

·

our future financial performance, including selling, general and administrative expenses, capital expenditures, income taxes and our expected available cash and use of cash and net operating loss carryforwards;

·

the use of our available cash;

·

the future impact of the reductions in our workforce effected in 2014;

·

our business operations, including entering into new management, franchise or licensing agreements and enhancing the value of existing hotels and management agreements;

·

the effect of new lodging supply;

·

the impact of the strong U.S. dollar and a weak global economy; and

·

the outcome of litigation to which the Company is a party.

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 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 guarantees 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 sustain the quality of the properties of 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;

 

3


 

·

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

·

our ability to maintain state of the art information technology systems and protect such systems from cyber-attacks;

·

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

·

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

·

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

·

the impact of any strategic alternatives considered by the special transaction committee of our Board of Directors and/or pursued by the Company; 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.”

Other than as required by applicable law, 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.

 

 

 

 

4


 

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.  

At December 31, 2014 our portfolio of Morgans Hotel Group branded hotel properties and food and beverage operations and entities consisted of:

·

our three 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 1,450 rooms, and the food and beverage operations located at these hotels (collectively, our “Owned Hotels”);

·

our owned food and beverage operations, consisting of leasehold interests in the food and beverage operations located at Sanderson, in London, and Mandalay Bay in Las Vegas (collectively, our “Owned F&B Operations”);

·

our two joint venture hotels, consisting of Mondrian South Beach in Miami Beach and Mondrian SoHo in New York, (together, our “Joint Venture Hotels”) comprising approximately 500 rooms and our investment in the food and beverage venture at Mondrian South Beach in Miami Beach (the “F&B Venture”);

·

our seven managed hotels, consisting of Royalton and Morgans in New York, Shore Club in Miami Beach, Mondrian in Los Angeles, Sanderson, St Martins Lane, and Mondrian London in London (collectively, our “Managed Hotels”), comprising approximately 1,550 rooms;

·

our licensed hotel, Delano Las Vegas, comprising 1,117 rooms and our franchised hotel, 10 Karaköy, in Istanbul, comprising 71 rooms;

·

our 90% controlling interest in TLG Acquisition LLC (“TLG Acquisition,” and together with its subsidiaries, “TLG”), which operates numerous food and beverage and nightclub venues primarily in Las Vegas pursuant to management agreements with MGM Resorts International (“MGM”); and

·

our investments in certain hotels under development and other proposed properties.

Effective January 23, 2015, we sold our equity interests in TLG, as discussed further below in “2014 Key Events and Other Recent Transactions and Developments.”  Also, effective March 6, 2015, we no longer hold any equity interest in Mondrian SoHo.  

We have one reportable operating segment, as discussed further in note 1 to our consolidated financial statements.

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, 2014, 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, 2014, there were 75,446 membership units outstanding, each of which is exchangeable for one share of Morgans Hotel Group Co.’s common stock.

We were incorporated in Delaware in October 2005 and completed our initial public offering of common stock 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 major gateway markets and key resort destinations in 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 we believe third-party managers have the experience and resources to satisfy our high branding standards,  through franchise or licensing agreements.

 

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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.

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 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. We believe that the Morgans Hotel Group brand and each of our individual property brands are synonymous with style, innovation and service, with a distinctive combination of lodging and social experiences.

We also have a portfolio of “Original” brands, which currently include Clift, Sanderson, St Martins Lane, Morgans, Royalton, Shore Club, and 10 Karaköy. 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. In connection with our strategy to reduce reliance on owned real estate, 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. For example, Mondrian London, a 359-room hotel that we operate under a long-term management agreement, opened on September 30, 2014 on London’s vibrant South Bank.   This is our first Mondrian-branded hotel outside the United States, representing the evolution and expansion of the Mondrian brand, and it is our third managed hotel in the London.

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, Delano Las Vegas, a 1,117-room hotel at Mandalay Bay, opened in September 2014 and is operated under a 10-year licensing agreement with affiliates of MGM, and includes two five-year extensions at our option, subject to performance thresholds.  Also, in November 2014, 10 Karaköy, a 71-room hotel in Istanbul, opened and is operated pursuant to a 15-year franchise agreement with one five-year extension option.  

We have signed management agreements for new hotels which are in various stages of development. As of December 31, 2014, these included the following:

 

 

 

Expected

Room Count

 

 

Anticipated

Opening

 

Initial

Term

Hotels Currently Under Construction or Renovation:

 

 

 

 

 

 

 

 

Mondrian Doha

 

 

270

 

 

2015

 

30 years

Other Signed Agreements:

 

 

 

 

 

 

 

 

Mondrian Istanbul

 

 

114

 

 

 

 

20 years

Delano Aegean Sea

 

 

150

 

 

 

 

20 years

Delano Cartagena

 

 

211

 

 

 

 

20 years

  

 

6


 

There can be no assurances that any or all of our projects listed above 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, in which case we may be unable to recover any previously funded key money, equity investments or debt financing.  For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 5 of our consolidated financial statements.  

 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.

For example, we increased the room count at Hudson by 12 rooms to 878 during 2014 by converting eight single room dwelling (“SRO”) units and other space into guest rooms.  The total cost of the 12 new guest rooms was approximately $2.0 million. As of December 31, 2014, we had 60 SROs remaining at Hudson, which we intend to convert into guest rooms in the future as they become available.

In early 2014, the owners of Sanderson and St Martins Lane began major renovations of these hotels’ guest rooms. The majority of the guest room renovations at Sanderson are complete, with the exception of a few suites that are expected to be renovated in early 2016.  Renovation on the remaining St Martins Lane guest rooms and public spaces, and reconcepting and renovation of its food and beverage offerings, is expected to be completed in mid-2015.  The owners expect to renovate Sanderson’s public space, including food and beverage venues, in 2016.

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, as we did with MGM which licensed our Delano brand and opened Delano Las Vegas in September 2014.  

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.

2014 Key Events and Other Recent Transactions and Developments

Restructured Debt.  Throughout 2014, we restructured our debt by refinancing Hudson and Delano South Beach, repaying our 2.375% Senior Subordinated Convertible Notes (“Convertible Notes”) and repaying the TLG Promissory Notes (as defined below).  

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 $450.0 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”), as discussed further in “—Debt.”

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, including repayment of the Convertible Notes and TLG Promissory Notes.

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

 

7


 

Repurchase and Retirement of Convertible Notes. On February 28, 2014, in connection with signing a binding Memorandum of Understanding with affiliates of The Yucaipa Companies LLC (“Yucaipa”), we repurchased from two Yucaipa affiliates $88.0 million principal amount of outstanding Convertible Notes at par value plus accrued interest thereon (the “Yucaipa Note Repurchase”). These Convertible Notes were retired following the repurchase.  

Additionally, during the third quarter of 2014, we used cash on hand to repurchase an aggregate of $35.4 million of outstanding Convertible Notes prior to maturity at a discount of approximately $0.1 million plus accrued interest. The repurchased Convertible Notes were retired upon repurchase. In October 2014, we used cash on hand to repay the remaining $49.1 million outstanding Convertible Notes, which matured on October 15, 2014.

Repayment of TLG Promissory Notes.  On December 10, 2014, we repaid and retired the outstanding $19.1 million of TLG Promissory Notes, which included the original principal balance plus deferred interest of $1.1 million, held by Messrs. Andrew Sasson and Andy Masi. In connection with our November 2011 acquisition of TLG, we issued $18.0 million in promissory 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”), which were scheduled to mature in November 2015, as fully described in note 7 to our consolidated financial statements.  We elected to retire the TLG Promissory Notes in full prior to the November 2015 maturity due to the increase in the interest rate from 8% to 18% in November 2014.

Reduction of Corporate Cost Structure.  In early 2014, we initiated a significant reduction in overhead expenses, at both the corporate office and property level, in order to optimize the organizational structure and lay the ground work for additional growth.  

Termination Plan. On March 10, 2014, we implemented a plan of termination (the “Termination Plan”) that resulted in a workforce reduction of our corporate office employees. The Termination Plan was part of our previously announced corporate strategy to, among other things, reduce corporate overhead and costs allocated to property owners. The Termination Plan streamlined our general corporate functions and reduce corporate expenses and expenses allocated to our Owned Hotels, Joint Venture Hotels and Managed Hotels.

 We entered into severance arrangements with the terminated employees, including certain former named executive officers. As a result of the Termination Plan, we recorded a charge of approximately $7.1 million in the first quarter of 2014 related to the cost of one-time termination benefits which have been paid in cash. We also recorded a charge of approximately $1.8 million for accelerated non-cash stock compensation expense relating to the severance of former executives.

Property Level Restructuring. On May 1, 2014, we implemented a restructuring plan at our Owned, Joint Venture and Managed Hotels. As a result, we anticipate achieving savings at our Owned, Joint Venture and Managed Hotels.

Growth of Hotel Portfolio.   In 2014, we expanded our portfolio of hotels with the opening of three new properties, while strategically making decisions to terminate certain hotel management agreements, discussed below.  

Delano Las Vegas.  Delano Las Vegas, a 1,117-room hotel at Mandalay Bay, opened in September 2014. Delano Las Vegas is managed by MGM pursuant to a 10-year licensing agreement, with two five-year extensions at our option, subject to performance thresholds.

Mondrian London.  Mondrian London, a 359-room hotel operated under a long-term management agreement, opened on September 30, 2014.  This is the first Mondrian-branded hotel outside the United States, representing the evolution and expansion of the Mondrian brand. 

10 Karaköy. In January 2014, we entered into a franchise agreement for 10 Karaköy, a 71-room Morgans Original in Istanbul, Turkey, which opened in November 2014.  

Termination of Management Agreements.  In September 2014, we and the hotel owner mutually agreed to terminate the Delano Moscow management agreement.  As a result, we were relieved of a $10.0 million key money obligation, of which $3.0 million had already been funded and was refunded back to us in September 2014.  We were also relieved of our $8.0 million potential cash flow guarantee.  Additionally, in June 2014, the Mondrian at Baha Mar management agreement was terminated due to the failure of the hotel owner to obtain a non-disturbance agreement from its lender as required by the management agreement, among other things.   This termination relieved us of a $10.0 million key money obligation.  

Settlement of Lawsuits.  As further discussed in detail in Part I, “Item III. Legal Proceedings,” in 2014, we settled our litigation with Yucaipa.

 

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On May 5, 2014, we and affiliates of Yucaipa, among other litigants, executed and submitted to the Delaware Court of Chancery the Stipulation of Settlement, which contemplated the partial settlement and dismissal of the Delaware Shareholder Derivative Action and the complete settlement and dismissal of the New York Securities Action, the Proxy Action and the Board Observer Action, all defined below. On July 23, 2014, the Delaware Court of Chancery approved the Settlement Stipulation, which pursuant to its terms, became effective on August 25, 2014 (the “Effective Date”).

The Settlement Stipulation provided for 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 Shareholder Derivative 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 “New York 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 Co., Index No. 653455/2013 (NY Sup.) (the “Board Observer Action”) (the foregoing four actions are collectively referred to as the “Actions”).   As of February 2015, the Actions have been settled or dismissed with respect to all parties.  

Our insurers have paid a majority of the costs that we were obligated to pay under the settlement and we do not expect that the net amount of any remaining payments we will make under the terms of the settlement or any other settlement with the former directors who have not settled will be material to our financial position.

Sale of TLG. On January 23, 2015, we closed the sale of our 90% equity interest in TLG to Hakkasan Holdings LLC (“Hakkasan”) (the “TLG Equity Sale”) for $32.8 million, net of closing costs.  The TLG Equity Sale was approved  by our Board of Directors as part of its ongoing review of strategic alternatives to maximize value for stockholders.  

TEJ Management, LLC, an entity controlled by Andrew Sasson, and Galts Gulch Holding Company LLC, an entity controlled by Andy Masi (together, the “Minority Holders”) did not exercise their right to participate in the TLG Equity Sale.  Rather, the Minority Holders maintained the right to put their equity interests to TLG’s managing member and on January 15, 2015, each of Messrs. Sasson and Masi exercised his right to require the managing member of TLG to purchase his equity interest in TLG at a purchase price equal to his percentage equity ownership interest multiplied by the product of seven times the EBITDA from non-Morgans business (“Non-Morgans EBITDA”) for the preceding 12 months, subject to certain adjustments (the “Sasson-Masi Put Options”).  We currently estimate the total Sasson-Masi Put Options liability to be approximately $5.0 million.  However, pursuant to the TLG Equity Sale, Hakkasan, as the current managing member, is obligated to pay $3.6 million of this amount upon delivery of the 10% equity interest in TLG held by the Minority Holders.  As a result, our net cash outlay is expected to be approximately $1.4 million, which we anticipate paying in 2015.  

We also have certain indemnification obligations related to the TLG Equity Sale, which generally survive for 18 months; however, no amounts will be held in escrow for the satisfaction of such claims. 

In addition, for the 18 months following the closing of the TLG Equity Sale, we have the right to purchase 49% of the equity of TLG from Hakkasan.   

In connection with the TLG Equity Sale, on January 15, 2015, we transferred the operations of the food and beverage venues at Delano South Beach from TLG back to one of our wholly-owned subsidiaries.  Additionally, we continue to own three food and beverage venues subject to leasehold agreements at Mandalay Bay in Las Vegas, which continue to be managed by TLG subsequent to the TLG Equity Sale.  

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 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, graphic design services, food and beverage services, 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.  

 

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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, maintains and upgrades technology platforms, 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. Our food and beverage team, located in our corporate office, is 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.

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.

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 three food and beverage venues, which continue to be managed by TLG, 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.

 Sales, Marketing and Public Relations  

Direct sales have been an integral part of our success. We employ a sales force of approximately 130 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 we believe 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 2014, we derived approximately 25% 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 integrated approach that includes utilizing multiple channels such as public relations, social media, partnerships, digital content creation and distribution, and branded experiences reinforces an authentic message in a highly cost-effective manner. Through highly publicized events or high profile partnerships, prospective guests are more likely to be made aware of our hotels through word-of-mouth or from media coverage rather than direct advertising. This publicity is supplemented with focused marketing activities to our existing customers, primarily through digital campaigns, keeping them informed and engaged with our properties and brands. Our in-house marketing and digital team coordinates with the efforts of third-party public relations and marketing firms to promote our properties through various local, national and international travel, entertainment, and food and beverage print media. We host events that attract celebrity guests, cultural leaders, and journalists, generating articles in well recognized media outlets around the world. Our marketing efforts also include hosting special events, which include annual happenings during iconic events such as Art Basel Miami, The Academy Awards, The Grammy’s, film premieres, and Fashion Week in New York and London.  We have also been able to establish ongoing partnerships with some of the most sought after companies in media, technology, entertainment, and travel. 

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.  We upgraded our reservation system in June 2014.  

 

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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 name recognition, quality of service, convenience of location, quality of the property, pricing and range and quality of food services and amenities offered.  Our competitors generally also have broader guest loyalty programs which may enable them to attract more customers and more effectively retain such guests.  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. Our revenue is generally higher in the second and fourth quarters. However, prevailing economic conditions, including supply, can cause fluctuations which impact seasonality.

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, our insurance expense may increase in the foreseeable future.  

Employees

We currently employ approximately 2,600 individuals, approximately 15.5% of whom were represented by labor unions. We believe relations with our employees are positive.

Government Regulations  

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.

 

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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.

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 properties, 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. Furthermore, we are required to comply with legal, regulatory and contractual obligations which are designed to protect personally identifiable and other information pertaining to our customers, stockholders and employees. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving and the hospitality industry is under increasing attack by cyber-criminals in the U.S. and other jurisdictions in which we operate. Such information includes but is not limited to large volumes of customer credit and payment card information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of customer, stockholder, employee or our data. Accordingly, significant actual or potential theft, loss, fraudulent use or misuse of customer, stockholder, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy policies with respect to such data may result in fines, damage to our reputation, litigation or regulatory actions against us 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 be sure that our systems and networks will not be subject to breaches or interference. The size and complexity of our information security systems, and those of our third-party vendors and business partners with whom we contract, make such systems potentially vulnerable to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. The frequency of third-party cyber attacks in the hospitality industry have increased in recent years.  Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives and expertise, including organized criminal groups, “hacktivists,” and others.  Furthermore, given the ever-changing tactics used by cyber criminals, there can be no assurance that a compromise of our systems would be discovered promptly. A successful attack or other security breach could result in unauthorized access to or the disclosure or loss of customer, stockholder, employee or other data, 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 have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to customer data. There can be no assurance that such incidents will not occur again. We have obtained cyber-risk insurance to mitigate this risk, but it is of limited scope and amount, may not cover us against all of the possible damage it would suffer from a significant successful cyber attack.

 

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We are also subject to restrictions imposed by the U.S. Foreign Corrupt Practices Act and anti-corruption laws and regulations of other countries applicable to our operations, such as the UK Bribery Act. Anti-corruption laws and regulations generally prohibit companies and their intermediaries from making improper payments to government officials or other persons in order to receive or retain business. The compliance programs, internal controls and policies we maintain and enforce to promote compliance with applicable anti-bribery and anti-corruption laws may not prevent our associates, contractors or agents from acting in ways prohibited by these laws and regulations. We are also subject to trade sanctions administered by the Office of Foreign Assets Control and the U.S. Department of Commerce. Our compliance programs and internal controls also may not prevent conduct that is prohibited under these rules. The United States may impose additional sanctions at any time against any country in which or with whom we do business. Depending on the nature of the sanctions imposed, our operations in the relevant country could be restricted or otherwise adversely affected. Any violations of anti-corruption laws and regulations or trade sanctions could result in significant civil and criminal penalties, reduce our profits, disrupt our business or damage our reputation. In addition, an imposition of further restrictions in these areas could increase our cost of operations, reduce our profits or cause us to forgo development opportunities that would otherwise support growth.

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.

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), Henry®, Hudson Common®, Redwood Room®Rose Bar™, The Florida Room Delano (and design)®, Skybar®, Mondrian Skybar™, Velvet Room™, 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. 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 common stock. 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

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 also have 75,000 shares of Series A preferred securities for which the dividend rate will increase to 20% in October 2016.

Our internally generated cash may be inadequate to repay our indebtedness prior to maturity, and we may 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. 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 indebtedness.

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

As of December 31, 2014, we had $605.7 million of outstanding consolidated indebtedness, including capital lease obligations. 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 $64.7 million as of December 31, 2014.

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:

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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;

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making us more vulnerable to economic and industry downturns and reducing our flexibility in responding to changing business and economic conditions;

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

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

 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 in 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.

 

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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 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.”

 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 a taxable gain 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.

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. For more information on the Hudson/Delano 2014 Mortgage Loan, see Part I, “Item I. Business – 2014 and Other Recent Transactions and Developments – Hudson and Delano South Beach Loan Refinancing.”

In addition, our trust preferred securities 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.

 If we were required to make payments under the “bad boy” nonrecourse carve-out guarantees 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 guarantees 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 guarantees for our pro rata share of certain liabilities under such guarantees. See, for example, nonrecourse carve-out guarantees and

 

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other guarantees 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 guarantees and related indemnification obligations are not guarantees 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 sought to make claims for payment under such guarantees. In the event such a claim were made against us under one of our “bad boy” carve-out guarantees 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.

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/or 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 markets 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, our joint venture partners, or other third-party owners, 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 and therefore could materially adversely affect our growth strategy.

 

Recovery from the most 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 and is sensitive to personal discretionary spending levels. 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 most recent economic 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.

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.

 

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Furthermore, a high media profile, including new digital platforms, 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 or as a result of negative social media content. 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 our standards, the value of our name, image or brands would be diminished and our business and operations would be adversely affected.

 

Negative publicity concerning our properties or our business could harm our brands and reputation as well as increase our costs and reduce our revenues.

 

Our brands and our reputation regarding the quality of our hotels and services are key to attracting guests to our properties.   An incident involving the potential safety or security of our associates or our guests, or adverse publicity relating to the geographic areas in which any of our properties are located, or the hotel or travel industry generally may harm our brands and reputation, cause a loss of consumer confidence in the industry, and negatively impact our results of operations. The continued expansion in the use of social media and multiple digital platforms over recent years could increase our exposure to negative publicity that could damage our reputation and materially adversely affect our financial position.

 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 and beverage services and amenities offered. We also compete with other operators of full service hotels, including major hospitality chains with well-established and recognized brands.  Most of these major hospitality chains are larger than we are based on the number of properties or rooms they manage, franchise or own or based on the number of geographic locations in which they operate. Our competitors generally also have broader guest loyalty programs which may enable them to attract more customers and more effectively retain such guests. 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 for guests 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 financial and marketing 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 hotels are geographically concentrated in a limited number of cities and, accordingly, we could be disproportionately harmed by an economic downturn or other financial pressures in these cities or a natural 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 41.1% 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, 2014, represented approximately $85.2 million, or 40.1%, of our consolidated hotel revenues for the year ended December 31, 2014. 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. In addition, we operate three hotels in Miami and three hotels in London, making us susceptible to economic slowdowns and other risks in these markets, which could adversely affect our business and results of operations.

 

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Additionally, the pace of new lodging supply, especially in New York City and Miami, has increased over the past several years as many projects initiated before the economic downturn came to fruition and new projects commenced as the economy recovered. In New York City and South Beach, new lodging supply impacted our hotels’ occupancy and constrained rate growth, and we expect that these trends will continue through 2015 as the new supply in these markets is absorbed.  

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 61.6% of our total guest rooms for all the hotels we managed at December 31, 2014, 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.

 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 stronger U.S. dollar could harm international tourism in our domestic markets and may increase U.S. travel to our international markets. As foreign currencies depreciate against the U.S. dollar, it becomes more expensive, in terms of those depreciating foreign currencies, to pay for our U.S. hotel services. Conversely, all else being equal, a depreciating U.S. dollar could affect demand for our U.S. hotel services but may decrease U.S. travel to our international markets.

Due to the concentration of our hotels in global cities, such as New York and Miami, frequently visited by guests from other countries, we could be impacted by the change in the value of foreign currencies as compared to the U.S. dollar.  For example, if the value of the U.S. dollar continues to strengthen against the value of the Euro, guests from Europe may not travel to New York or Miami during 2015 as frequently, and/or room rates we are able to charge international guests may be driven down, which could have a significant impact on our operating results.  

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 $48.6 million, $43.4 million, and $55.7 million for the years ended December 31, 2014, 2013, and 2012, respectively. Our net losses primarily reflected losses related to restructuring and disposal costs, development costs, impairment charges and non-operating costs, decreased revenues due to renovation work at our Owned Hotels,  losses in equity of unconsolidated joint ventures, interest expense and depreciation and amortization charges.

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 for management agreements based primarily on the value and quality of our management services and reputation, our brand recognition, our ability and willingness to invest key money into projects, the level of our management fees, and the terms of our management agreements.

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. We also have experienced challenges in securing new projects in recent years as a result of the occurrence of certain events at our corporate level, including proxy contests, our now settled dispute with Yucaipa, and our strategic review process.  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

 

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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.

 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.

 

If we are unable to maintain good relationships with third-party property owners and/or if we terminate agreements with defaulting third-party property owners, our revenues could decrease and we may be unable to maintain or expand our presence.

 

We earn fees for managing and franchising/licensing hotels and, since our shift in 2011 to an “asset light” strategy, we are dependent on maintaining and developing positive relationships with third-party owners and joint venture partners. Third-party developers and owners and joint venture partners are focused on maximizing the value of their investment and working with a management company that can help them maximize profitability and return on investment. The effectiveness of our management, the value of our brands, and the rapport that we maintain with our third-party owners and joint venture partners impact renewals of existing agreements and are also important factors for existing or new third-party owners or joint venture partners considering doing additional business with us in the future. If we are unable to maintain these relationships, we may be unable to maintain existing agreements or effectively grow our portfolio, which may have a material adverse effect on our financial position and results of operations.

 

Some of our existing and future development pipeline may not be developed into new hotels, which could materially adversely affect our growth prospects.

 

The commitments of owners and developers under our pipeline hotel management agreements and letters of intent are subject to numerous conditions.   The eventual development and construction of our pipeline not currently under construction or in the initial stages of construction, or the signing of a management agreement in the case of letters of intent, is subject to numerous risks, including, in certain cases, obtaining governmental and regulatory approvals and adequate financing. As a result, we cannot assure you that our development pipeline will be completed and developed into new hotels.

Integration of new hotels 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.

 

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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, 2014, 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%.

 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.  

For example, in the first half of 2014, we and our Mondrian SoHo joint venture partner litigated over our Mondrian SoHo hotel management agreement, among other things, as detailed further in “Item 3. Legal Proceedings – Litigations Regarding Mondrian SoHo.”  Additionally, due to our Mondrian Istanbul joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. In addition, we have initiated proceedings in an English court seeking payment of the put option amount against the individual shareholders behind the joint venture partner.  The parties are also seeking various other judicial remedies in Turkey. These actions have resulted in significant management distraction and the incurrence of significant legal fees.  

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

We currently manage hotels in the United States and the United Kingdom and have a franchise hotel in Turkey and currently plan to expand to 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;

·

war, civil unrests, or threats and heighted travel security measures;

·

work stoppages or other changes in labor conditions;

·

taxes;

·

payments terms; and

·

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

 

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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.

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, 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 union employees.

Property taxes and insurance costs are a significant part of our operating expenses. In recent years, our real property taxes have increased and 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.

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 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 these legal proceedings or any litigation for which we have indemnified Hakkasan in connection with the TLG Equity Sale, 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.

 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. For example, the Clift lease agreement provides for base annual rent of approximately $6.0 million per year until October 2014. Thereafter, the base rent increases at five-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 five-year rent increase date thereafter. As a result of the first such increase, effective October 14, 2014, the annual rent increased to $7.6 million.  The lease is nonrecourse to us. We can provide no assurance that we can operate the property at a profit now or upon future rent increases under the lease.  Morgans Group also provides a limited guaranty, whereby Morgans Group has agreed to guarantee losses of up to $6.0 million suffered by the lessors in the event of certain “bad boy” type acts.  

 

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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.

 We may be involved in disputes, from time to time, with the owners of the hotels that we manage and premature termination of our management agreements could hurt our financial performance.

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. 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.

Additionally, although our hotel management, franchise and 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. Certain of our hotel management agreements and franchise or license agreements contain performance tests that stipulate certain minimum levels of operating performance, which could result in early termination of our hotel management, if we fail or elect not to cure. We may disagree with hotel owners on how the performance criteria are calculated or 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. 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.  

 

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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 agreements also may be terminated by the lenders on foreclosure or certain other related events. With some of our existing management, franchise and license agreements, and 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 Part I, Item 3.“Legal Proceedings — Litigations Regarding Mondrian SoHo.”

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.

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:

·

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;

·

changes in the desirability of particular locations or travel patterns of guests;

·

dependence on business, commercial and leisure travelers and tourism;

·

decreased airline capacity and routes;

·

travel-related accidents;

·

fear of outbreaks or outbreaks of pandemic or contagious diseases;

·

dependence on group and meeting/conference business and the impact of decreased corporate budgets and spending;

·

increases in energy costs, property taxes or insurance costs;

·

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 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;

·

changes in taxes and regulations that impact wages (including minimum wage increases) and benefits; and

·

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

These factors and the resulting reputational harm could have an adverse effect on individual properties and our financial condition and results of operations as a whole.

 

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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.

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.

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.

 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.

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 borrowing arrangements in certain quarters in order to offset these fluctuations in revenues.

 

Information technology system failures, delays in the operation of our information technology systems or system enhancement failures could reduce our revenues and profits and harm the reputation of our brands and our business.

 

Our success depends on the efficient and uninterrupted operation of our information technology systems. For example, we depend on our central reservation system, which allows bookings by hotels directly, via telephone through our call centers, by travel

 

25


 

agents, online through our website www.morganshotelgroup.com, and through our online reservations partners. In addition, we depend on information technology to run our day-to-day operations, including, among others, hotel services and amenities such as guest check-in and check-out, housekeeping and room service and systems for tracking and reporting our financial results and the financial results of our hotels.

Our information technology systems are vulnerable to damage or interruption from fire, floods, hurricanes, power loss, telecommunications failures, computer viruses, hackers and similar events. The occurrence of any of these natural disasters or unanticipated problems at any information technology facilities we manage or subscribe to, or any of our call centers could cause interruptions or delays in our business or loss of data, or render us unable to process reservations.

In addition, if our information technology systems are unable to provide the communications capacity that we need, or if our information technology systems suffer problems caused by installing system enhancements, we could experience failures or interruptions. If our information technology systems fail and our redundant systems or disaster recovery plans are not adequate to address such failures, or if our property and business interruption insurance does not sufficiently compensate us for any losses that we may incur, our revenues and profits could be reduced and the reputation of our brands and our business could be harmed.

Cyber risk and the failure to maintain the integrity of internal or customer data could result in faulty business decisions, harm to our reputation, or subject us to fines, costs, or lawsuits.

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. Furthermore, we are required to comply with legal, regulatory and contractual obligations which are designed to protect personally identifiable and other information pertaining to our customers, stockholders and employees. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving and the hospitality industry is under increasing attack by cyber-criminals in the U.S. and other jurisdictions in which we operate. Such information includes but is not limited to large volumes of customer credit and payment card information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of customer, stockholder, employee or our data. Accordingly, significant actual or potential theft, loss, fraudulent use or misuse of customer, stockholder, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy policies with respect to such data may result in fines, damage to our reputation, litigation or regulatory actions against us 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 be sure that our systems and networks will not be subject to breaches or interference. The size and complexity of our information security systems, and those of our third-party vendors and business partners with whom we contract, make such systems potentially vulnerable to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. The frequency of third party cyber attacks in the hospitality industry have increased in recent years.  Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives and expertise, including organized criminal groups, “hacktivists,” and others.  Furthermore, given the ever-changing tactics used by cyber criminals, there can be no assurance that a compromise of our systems would be discovered promptly. A successful attack or other security breach could result in unauthorized access to or the disclosure or loss of customer, stockholder, employee or other data, 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 have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to customer data. There can be no assurance that such incidents will not occur again. We have obtained cyber-risk insurance to mitigate this risk, but it is of limited scope and amount, may not cover us against all of the possible damage it would suffer from a significant successful cyber attack.

 

If we fail to maintain pace with developments in technology necessary for our business, our operations and competitive position could be harmed.

Sophisticated information technology and other systems are critical for the hospitality industry, including systems used for our central reservations, revenue management, and property management, as well as technology systems that we make available to our guests. These information technology and other systems must be refined, updated, and/or replaced with more advanced systems on a regular basis. Developing and maintaining these systems may require significant capital. If we are unable to replace or introduce information technology and other systems as quickly as our competitors or within budgeted costs or schedules when these systems become outdated or need replacing, or if we are unable to achieve the intended benefits of any new information technology or other systems, our operations could be harmed and our ability to compete effectively could be diminished.

 

26


 

Our business and operations 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.

We are subject to restrictions imposed by the U.S. Foreign Corrupt Practices Act and anti-corruption laws and regulations of other countries applicable to our operations, such as the UK Bribery Act. Anti-corruption laws and regulations generally prohibit companies and their intermediaries from making improper payments to government officials or other persons in order to receive or retain business. The compliance programs, internal controls and policies we maintain and enforce to promote compliance with applicable anti-bribery and anti-corruption laws may not prevent our associates, contractors or agents from acting in ways prohibited by these laws and regulations. We are also subject to trade sanctions administered by the Office of Foreign Assets Control and the U.S. Department of Commerce. Our compliance programs and internal controls also may not prevent conduct that is prohibited under these rules. The United States may impose additional sanctions at any time against any country in which or with whom we do business. Depending on the nature of the sanctions imposed, our operations in the relevant country could be restricted or otherwise adversely affected. Any violations of anti-corruption laws and regulations or trade sanctions could result in significant civil and criminal penalties, reduce our profits, disrupt our business or damage our reputation. In addition, an imposition of further restrictions in these areas could increase our cost of operations, reduce our profits or cause us to forgo development opportunities that would otherwise support growth.

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 general liability, cyber 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.

 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.

 

27


 

In addition, local jurisdictions in the United States where our hotel properties are located do not allow for insurance to 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.

 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, whether or not accurate, regarding 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.

 

Labor shortages could restrict our ability to operate our properties or grow our business or result in increased labor costs that could reduce our profits.

 

Our success depends in large part on our ability to attract, retain, train, manage and engage our employees. Our properties are staffed 24 hours a day, seven days a week by thousands of employees. If we are unable to attract, retain, train and engage skilled workers, our ability to manage and staff our properties adequately could be impaired, which could harm our reputation. Staffing shortages could also hinder our ability to grow and expand our business. Because payroll costs are a major component of the operating expenses at our properties, a shortage of skilled labor could also require higher wages that would increase our labor costs, which could reduce our profits and the profits of our third-party owners.

 

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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. 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. The collective bargaining agreement with the unions representing the majority of the Clift employees expires in August 2018.

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, although our current debt agreements restrict Morgans Hotel Group Co. from paying dividends. 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 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.

 Provisions in our charter documents and Delaware law 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.

 

29


 

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 December 31, 2014, the Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P., (collectively, the “Yucaipa Investors”), held warrants to purchase 12,500,000 shares of our common stock and 75,000 shares of our Series A preferred securities.

For so long as the Yucaipa Investors own a majority of the outstanding Series A preferred securities, they also have consent rights, subject to certain exceptions and limitations, over transactions involving the acquisition of the Company by any third party, pursuant to which the Series A preferred securities are converted or otherwise reclassified into or exchanged for securities of another entity, 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.  

In addition, subject to the terms of the Securities Purchase Agreement, the Yucaipa Investors have consent rights over certain transactions for so long as they collectively own or have the right to purchase through the cashless exercise of the warrants to purchase 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 $100.0 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 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 of the Company and to use its 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.

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.

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.  From July 14, 2013 through May 14, 2014, the dividend rate was 12% as a result of the Yucaipa Investors’ nominee not being elected or appointed to our Board of Directors. On May 14, 2014, at our annual shareholder meeting, a Board of Directors nominee representing the Yucaipa Investors was elected as a director and the dividend rate on the Series A preferred securities returned to the stated rate of 8%. Accordingly, the current dividend rate on the Series A preferred securities is 10%.

We have the option to accrue any and all dividend payments. As of December 31, 2014, 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.

 

30


 

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 initial public offering 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 initial public offering and is generally substantially less than the fair market value of the contributed hotels as of the date of our initial public offering. 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 initial public offering, (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 initial public offering, and (iii) we may utilize available net operating losses against the potential gain from the sale of an asset.

 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.

 

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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, 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, 2014, 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, utilizing a cashless exercise method only, resulting in a net share issuance;

·

1,124,740 shares of our common stock issuable upon exercise of outstanding options, all of which were exercisable at a weighted average exercise price of $15.07 per share;

·

941,157 LTIP Units outstanding exercisable for a total of 941,157 shares of our common stock;

·

333,402 restricted stock units outstanding and subject to vesting requirements for a total of 333,402 shares of our common stock; and

·

up to 3,771,343 shares of our common stock available for future grants under our equity incentive plans.

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.

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

Hotel Properties

Set forth below is a summary of certain information related to hotel properties operated by Morgans Hotel Group as of December 31, 2014.  The table below does not include information related to hotels we franchise or license:

 

 

 

 

 

 

 

 

 

 

 

Number

 

 

Twelve Months

 

 

 

 

 

Year

 

Interest

 

 

of

 

 

Ended December 31, 2014

 

Hotel

 

City

 

Opened

 

Owned

 

 

Rooms

 

 

ADR(1)

 

 

Occupancy(2)

 

 

RevPAR(3)

 

Owned Hotels:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hudson

 

New York

 

2000

 

 

100

%

(4)

 

878

 

(4)

 

 

 

 

 

 

 

 

 

 

 

Delano South Beach

 

Miami

 

1995

 

 

100

%

 

 

194

 

 

 

 

 

 

 

 

 

 

 

 

 

Clift

 

San Francisco

 

2001

 

 

 

 

(5)

 

372

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Statistics for Owned Comparable

   Hotels (6)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

268

 

 

 

88.2

%

 

$

236

 

Joint Venture  Hotels:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mondrian South Beach

 

Miami

 

2008

 

 

50

%

(7)

 

222

 

(7)

 

 

 

 

 

 

 

 

 

 

 

Mondrian SoHo

 

New York

 

2011

 

 

20

%

(8)

 

263

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Statistics for Joint Venture

   Comparable Hotels (10)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

318

 

 

 

81.5

%

 

$

259

 

Managed Hotels:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shore Club

 

Miami

 

2001

 

 

 

(9)

 

308

 

 

 

 

 

 

 

 

 

 

 

 

 

Morgans

 

New York

 

1984

 

 

 

(11)

 

117

 

 

 

 

 

 

 

 

 

 

 

 

 

Royalton

 

New York

 

1988

 

 

 

(11)

 

168

 

 

 

 

 

 

 

 

 

 

 

 

 

Mondrian Los Angeles

 

Los Angeles

 

1996

 

 

 

(11)

 

236

 

 

 

 

 

 

 

 

 

 

 

 

 

St Martins Lane

 

London

 

1999

 

 

 

(12)

 

204

 

 

 

 

 

 

 

 

 

 

 

 

 

Sanderson

 

London

 

2000

 

 

 

(12)

 

150

 

 

 

 

 

 

 

 

 

 

 

 

 

Mondrian London

 

London

 

2014

 

 

 

(12)

 

359

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Statistics for Managed Comparable

   Hotels (13)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

317

 

 

 

78.5

%

 

$

249

 

System-wide Comparable (14)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

287

 

 

 

84.6

%

 

$

243

 

Hotel Operating Statistics by Region:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Northeast Comparable Hotels (15)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

266

 

 

 

89.7

%

 

$

239

 

West Coast Comparable Hotels (16)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

273

 

 

 

89.3

%

 

$

244

 

Miami Comparable Hotels (17)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

357

 

 

 

70.2

%

 

$

251

 

United States Comparable Hotels (18)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

287

 

 

 

84.6

%

 

$

243

 

 

 

(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, 2014, Hudson has 878 guest rooms and 60 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.

(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, 2014 includes Hudson, Delano South Beach, and Clift.

(7)

Operated as a condominium hotel under a management contract and owned through a 50/50 unconsolidated joint venture. As of December 31, 2014, 263 hotel residences have been sold, of which 150 are in the hotel rental pool and are included in the hotel room count, and 72 hotel residences remain to be sold.

 

33


 

(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, 2014.   Effective March 6, 2015, we no longer hold any equity interest in Mondrian SoHo.  

(9)

Operated under a management contract. As of December 31, 2014, 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 hotels we no longer manage or have an ownership interest in. Joint Venture Comparable Hotels for the year ended December 31, 2014 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 = 1.65 U.S. dollars, which is an average monthly exchange rate provided by www.oanda.com for the last twelve months ended December 31, 2014.

(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 hotels we no longer manage. Managed Comparable Hotels for the year ended December 31, 2014 includes Morgans, Royalton, Shore Club, and Mondrian Los Angeles.  Managed Comparable Hotels for the year ended December 31, 2014 excludes Sanderson and St Martins Lane, which were both under renovation beginning in 2014, and Mondrian London, which opened on September 30, 2014.  

(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 hotels we no longer manage. System-Wide Comparable Hotels for the year ended December 31, 2014 excludes Sanderson and St Martins Lane, which were both under renovation beginning in 2014, and Mondrian London, which opened on September 30, 2014.  

(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 hotels we no longer manage. Northeast Comparable Hotels for the year ended December 31, 2014 includes Hudson, Morgans, Royalton, and Mondrian SoHo.

(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 hotels we no longer manage. West Coast Comparable Hotels for the year ended December 31, 2014 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 hotels we no longer manage. Miami Comparable Hotels for the year ended December 31, 2014 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 hotels we no longer manage. United States Comparable Hotels for the year ended December 31, 2014 includes Hudson, Morgans, Royalton, Mondrian SoHo, Mondrian Los Angeles, Clift, Delano South Beach, Mondrian South Beach and Shore Club.

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 hotel, with 878 guest rooms and suites as of December 31, 2014, 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.

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 between 2012 and 2014, we added 44 more guest rooms to Hudson by converting SRO units and other space into guest rooms, bringing the total number of guest rooms at Hudson to 878 as of December 31, 2014.  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 October 2014, we introduced the Half & Half nightlife concept at Hudson.

 

34


 

We own a fee simple interest in 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 878 guest rooms and 60 SROs as of December 31, 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 convert the remaining SRO units into new guest rooms.

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,

 

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

2010

 

Selected Operating Information:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Occupancy

 

 

90.9

%

 

 

89.0

%

 

 

74.9

%

 

 

88.0

%

 

 

88.6

%

ADR

 

$

229

 

 

$

236

 

 

$

234

 

 

$

220

 

 

$

213

 

RevPAR

 

$

208

 

 

$

210

 

 

$

175

 

 

$

194

 

 

$

189

 

Selected Financial Information (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Room Revenue (1)

 

$

66,144

 

 

$

66,505

 

 

$

53,463

 

 

$

58,993

 

 

$

57,360

 

Total Revenue (1)

 

 

85,177

 

 

 

81,534

 

 

 

62,279

 

 

 

73,112

 

 

 

72,804

 

Depreciation (1)

 

 

11,443

 

 

 

11,461

 

 

 

8,472

 

 

 

8,223

 

 

 

7,869

 

Operating Income (1)

 

 

10,345

 

 

 

9,391

 

 

 

2,520

 

 

 

5,919

 

 

 

9,564

 

 

 

(1)

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

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 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.  These food and beverage venues at Delano South Beach were managed by TLG from January 2012 until January 15, 2015, on which date we began managing the venues.  The hotel also features Club Essentia Wellness Retreat, a full-service spa facility. 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.

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,

 

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

2010

 

Selected Operating Information:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Occupancy

 

 

70.6

%

 

 

68.6

%

 

 

67.6

%

 

 

64.1

%

 

 

61.1

%

ADR

 

$

520

 

 

$

525

 

 

$

494

 

 

$

499

 

 

$

480

 

RevPAR

 

$

367

 

 

$

360

 

 

$

334

 

 

$

320

 

 

$

293

 

Selected Financial Information (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Room Revenue

 

$

26,019

 

 

$

25,485

 

 

$

23,722

 

 

$

22,612

 

 

$

20,780

 

Total Revenue

 

 

48,840

 

 

 

47,504

 

 

 

45,511

 

 

 

44,697

 

 

 

43,628

 

Depreciation

 

 

4,544

 

 

 

4,568

 

 

 

4,604

 

 

 

4,649

 

 

 

4,868

 

Operating Income

 

 

14,882

 

 

 

11,855

 

 

 

9,240

 

 

 

9,052

 

 

 

9,542

 

 

 

35


 

Clift

Overview

Acquired in 1999 and reopened after an extensive renovation in 2001, Clift has 372 guest rooms 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.

 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,

 

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

2010

 

Selected Operating Information:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Occupancy

 

 

91.1

%

 

 

86.7

%

 

 

77.7

%

 

 

79.5

%

 

 

76.9

%

ADR

 

$

256

 

 

$

245

 

 

$

240

 

 

$

220

 

 

$

187

 

RevPAR

 

$

233

 

 

$

212

 

 

$

186

 

 

$

175

 

 

$

144

 

Selected Financial Information (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Room Revenue

 

$

31,618

 

 

$

28,833

 

 

$

25,361

 

 

$

23,732

 

 

$

19,547

 

Total Revenue

 

 

44,061

 

 

 

42,102

 

 

 

37,543

 

 

 

36,379

 

 

 

31,861

 

Depreciation

 

 

2,590

 

 

 

2,947

 

 

 

3,077

 

 

 

3,133

 

 

 

3,128

 

Operating (loss) income

 

 

5,144

 

 

 

4,063

 

 

 

2,705

 

 

 

2,130

 

 

 

(1,284

)

 

Owned Food and Beverage Operations

The Company leases and manages all but one of the Sanderson food and beverage venues.   Effective January 1, 2014, we transferred all of our ownership interest in the food and beverage venues at St Martins Lane to the hotel owner. We continue to manage the transferred food and beverage venues. Prior to January 1, 2014, we leased and managed all of the St Martins Lane food and beverage venues.

We also own three food and beverage venues subject to leasehold agreements at Mandalay Bay in Las Vegas, which we acquired in August 2012 from the former tenant. Following the TLG Equity Sale, the venues continue to be managed by TLG and operated pursuant to the 10-year operating leases our subsidiary has entered into with an MGM affiliate.

Managed Operations

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

Managed Hotels

Our Joint Venture Hotels as of December 31, 2014 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).

 We are subject to ongoing litigation with the lender and the new owner of Mondrian SoHo, as fully described under “Legal Proceedings—Litigations Regarding Mondrian SoHo” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity.” As a result, while we believe we have the right to continue to manage the hotel following the foreclosure, no assurance can be provided that we will retain the management agreement for Mondrian SoHo. The new owner of the hotel property has indicated its intention to remove Morgans as manager of the hotel.  The sale of the hotel to the new owner was completed on March 6, 2015, and as a result, effective this date we no longer hold any equity interest in Mondrian SoHo .  

 

36


 

Our Managed Hotels as of December 31, 2014 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);

·

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

·

Mondrian London — June 2039 (with two 10-year extensions at our option, subject to certain conditions).

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 condominiums, 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 are currently subject to performance tests under certain of our hotel management agreements, which could result in early termination of certain of our hotel management agreements.  As of December 31, 2014, we are in compliance with these termination performance tests and are not exercising any contractual cure rights.  Generally, the performance tests are two part tests based on achievement of budget or cash flow and revenue per available room indices.  In addition, once the performance test period begins, which is generally multiple years after a hotel opens, each of these performance tests must fail for two or more consecutive years and we have the right to cure any performance failures, subject to certain limitations.  

Managed Food and Beverage

As of December 31, 2014, we owned a 90% controlling investment in TLG, a food and beverage management company, which operates numerous restaurant, bar and nightlife venues in Las Vegas pursuant to management agreements with various MGM affiliates. Additionally, until January 14, 2015, TLG managed the food and beverage operations at Delano South Beach.  

On January 23, 2015, pursuant to the TLG Equity Sale, we sold our 90% controlling interest in TLG to Hakkasan.   We have an option to buy back a minority interest in TLG for a period of up to 18 months post-closing.

The primary assets of TLG consisted of its management and similar agreements with various MGM affiliates. During the time we owned 90% of TLG, we recognized management fees in accordance with the applicable management agreement which generally provided 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.

Licensed and Franchised Hotels

Consistent with our growth strategy and expansion of our hotel brands, we have entered into license and franchise agreements.  Delano Las Vegas, a 1,117-room hotel at Mandalay Bay, opened in early September and is operated under a license agreement with MGM.  This all-suite hotel features a unique sand-meets-water design and blends signature elements of Delano South Beach with the energy of the Las Vegas Strip. Additionally, 10 Karaköy, a 71-room Morgans Original in Istanbul, Turkey which is subject to a franchise agreement, opened in November 2014.  

 

37


 

Development Hotels

We have also signed management agreements for various other hotels. As of December 31, 2014, these hotels, which are in various stages of development, included the following:

 

 

 

Expected

Room

Count

 

 

Anticipated

Opening

 

Initial

Term

Hotels Currently Under Construction or Renovation:

 

 

 

 

 

 

 

 

Mondrian Doha

 

 

270

 

 

2015

 

30 years

Other Signed Agreements:

 

 

 

 

 

 

 

 

Mondrian Istanbul

 

 

114

 

 

 

 

20 years

Delano Aegean Sea

 

 

150

 

 

 

 

20 years

Delano Cartagena

 

 

211

 

 

 

 

20 years

 

However, financing and/or governmental approvals have 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 projects listed above 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, in which case we may be unable to recover any previously funded key money, equity investments or debt financing.  For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 5 of the consolidated financial statements.  

 

Corporate Headquarters

Our corporate headquarters are located at 475 10th Avenue, New York, New York, 10018. These offices consist of approximately 18,500 square feet of leased space. The lease for this property expires on October 31, 2018. We believe that our existing office properties are in good condition and are sufficient and suitable for the conduct of our business.  

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 (“GACC” or the “lender”), the lender for the mortgage loans on Mondrian SoHo, 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 between Sochin JV and Morgans Management on June 27, 2007, as amended on July 30, 2010. 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 subject to 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 Morgans Management was not a proper party to the foreclosure action and that a management contract does not constitute an interest in real property subject to foreclosure, and denied lender’s motion for summary judgment as moot. On March 20, 2014 the lender moved for summary judgment against the remaining defendants,  seeking foreclosure on four mortgages secured by Mondrian SoHo. By order dated May 27, 2014, the trial court granted the motion for summary judgment to a limited extent, ordering the appointment of a referee to compute the amount but stating that a motion for summary judgment of foreclosure and sale is premature. By decision entered on July 28, 2014, the court referred the matter to a referee to ascertain and compute the amount due to the lender for principal, interest, and other disbursements and to determine whether the property should be sold in one parcel.  On August 6, 2014, the referee set a hearing on the issues for August 18, 2014, and subsequently issued her report setting the amount due on the loan ($250.5 million, plus interest accruing at a daily rate of approximately $84,000, as of August 18, 2014) and determining the property should be sold as one parcel. On September 15, 2014, the lender filed a motion to confirm the referee’s report and for judgment of foreclosure and sale, along with the Referee’s Report of Amount Due attached as an exhibit, and a

 

38


 

proposed judgment of foreclosure and sale.  The foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was held on January 7, 2015, at which GACC was the winning and only bidder. GACC had an agreement to assign its bid to an affiliate of the Sapir Organization (“Sapir”), a New York-based real estate development and management organization; and in connection with that contract, GACC and Sapir have agreed to terminate Morgans as manager of Mondrian SoHo.  That sale to Sapir closed on March 6, 2015.

On October 24, 2014, we filed suit in the Supreme Court of the State of New York seeking a declaration that the mortgage lenders to the Mondrian SoHo debt cannot remove us as hotel manager following the conclusion of the foreclosure proceedings.  The action seeks to protect and enforce our long-term hotel management contract for Mondrian SoHo, regardless of the outcome of the current foreclosure proceedings.  We also seek damages against the lenders and ultimate buyer of the property should we be terminated.  The lawsuit does not affect the foreclosure proceedings, and we do not oppose the lenders’ efforts to foreclose on the Mondrian SoHo property. On February 9, 2015, the court heard our motion for a preliminary injunction preventing the mortgage lender and/or the ultimate buyer from removing Morgans as manager of Mondrian SoHo pending resolution of the lawsuit; that motion was denied in an oral ruling that same day.  While the court did not grant the injunction, it did recognize the underlying merits of our case.  On February 27, 2015, we filed an appeal of the denial of our motion for a preliminary injunction in the Supreme Court of New York, Appellate Division, First Department.  That appeal is currently pending.  

On February 25, 2013, the Sochin JV filed a complaint in the Delaware Court of Chancery against Morgans Management and Morgans Group, seeking, among other things, a declaration that Sochin JV had terminated the management agreement for the hotel. In addition, we, through our equity affiliate, filed a separate action against Sochin JV and its parent in the Delaware Court of Chancery 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 joint venture’s termination action.  On April 30, 2013, Morgans Management filed a lawsuit against Sochin JV and the majority member of Sochin JV’s parent and its affiliate 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 September 20, 2013, the Delaware Court of Chancery ruled that Sochin JV properly terminated the hotel management agreement on agency principles, that Morgans Management must vacate the hotel forthwith or on whatever other timetable the hotel owner chooses, and that certain claims by our equity affiliate are dismissed but not its breach of fiduciary duty claim. 

On May 9, 2014, both of the above-referenced actions in Delaware and the above-referenced action in New York were dismissed with prejudice by agreement among the parties.  Under the terms of the settlement, if the joint venture does not seek to remove us as manager of Mondrian SoHo prior to December 31, 2020, then we will be deemed to have released all claims against the joint venture under the Management Agreement.  Under the terms of the settlement, the joint venture may demand that Morgans vacate Mondrian SoHo on 90 days’ prior notice; in the event the joint venture provides notice of its intention to remove us as manager of Mondrian SoHo, all of our claims against the joint venture (including for breach of the hotel management agreement) would be revived. The joint venture’s rights under the settlement are not assignable without our written consent.  In light of the sale of Mondrian SoHo to Sapir and the related litigation regarding Morgans’ management of the hotel, as discussed above, we do not believe that the settlement agreement with the joint venture is relevant to our right or ability to continue to manage Mondrian SoHo.

Litigations Regarding Delano Marrakech

In June 2013, we served the owner of Delano Marrakech with a notice of default for numerous breaches of the management agreement, including among other things, failure to pay fees and reimbursable expenses and to operate the hotel in accordance with the standards under the management agreement. 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 the 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. In addition, as a result of the breaches by the hotel owner, we have asserted a claim for losses and damages against the owner that is currently estimated at in excess of $30.0 million, including interest. The owner of the hotel is disputing the circumstances surrounding termination and therefore its liability for this amount. The owner is also counterclaiming against us under both the performance-based cash flow guarantee and for loss of profits. The total counterclaim made by the owner is in excess of $119.0 million, excluding interest. We consider the counterclaim made by the owner to be entirely without merit and intend to vigorously defend ourselves while pursuing what we consider to be a strong claim against the owner. Both parties are seeking arbitration of the dispute, which is expected to occur in October 2015.  A preliminary hearing was heard on January 19, 2015 in which the arbitral tribunal rejected entirely the owner’s attempt to have a preliminary issue determined in its favor.

Litigation Regarding TLG Promissory Notes

On August 5, 2013, 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 in notes convertible into shares of our common stock at $9.50

 

39


 

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”), which were 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”) . 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 in its entirety. On February 6, 2014, the court granted our motion to dismiss. On March 7, 2014, Messrs. Sasson and Masi filed a Notice of Appeal from this decision with the Appellate Division, First Department, and on July 8, 2014, they filed their initial brief in support of that appeal. Briefing of that appeal is ongoing, and our opposition brief was due August 29, 2014.  The oral argument on the motion occurred on October 29, 2014 and we are awaiting the court’s ruling.   Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit has not been dismissed.  

Litigation Regarding 2013 Deleveraging Transaction, Proxy Litigation Between Mr. Burkle and OTK and Certain of Our Current Directors, and Litigation Regarding Yucaipa Board Observer Rights

On May 5, 2014, we and affiliates of Yucaipa, among other litigants, executed and submitted to the Delaware Court of Chancery the Stipulation of Settlement, which contemplated the partial settlement and dismissal of most of the defendants from the Delaware Shareholder Derivative Action and the complete settlement and dismissal of the New York Securities Action, the Proxy Action and the Board Observer Action. On July 23, 2014, the Delaware Court of Chancery approved the settlement as set forth in the Settlement Stipulation, which pursuant to its terms, became effective on August 25, 2014, the Effective Date.

The Settlement Stipulation provided for the partial settlement and dismissal with prejudice of most of the defendants from the action entitled OTK Associates, LLC v. Friedman, et al., C.A. No. 8447-VCL (Del. Ch.) 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.); Burkle v. OTK Associates, LLC, et al., Case No. 13-CIV-4557 (S.D.N.Y.); and Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., Index No. 653455/2013 (NY Sup.),  the foregoing four actions are collectively referred to as the Actions.

The Settlement Stipulation provided, among other things, for the following:

·

We paid the Yucaipa parties in the New York Securities Action an amount equal to $3.0 million (which was previously escrowed) for attorneys’ fees and expenses incurred by Mr. Burkle in his defense of the Delaware Shareholder Derivative Action (the “Securities Action Payment”).

·

We paid the reasonable and necessary attorneys’ fees and expenses incurred by Messrs. Friedman, Gault and Sasson (collectively, the “Settling Former Directors”) in defending the Delaware Shareholder Derivative Action.  The Settling Former Directors’ assigned to us any claims they have against our insurers relating to any such unpaid amounts. Our insurers covered these attorneys’ fees and expenses.

·

OTK Associates LLC (“OTK”) and current director Jason T. Kalisman applied to the Delaware Court of Chancery for an award of payment from us of the reasonable and necessary fees and expenses incurred by their counsel in connection with the Delaware Shareholder Derivative Action, excluding those fees and expenses encompassed in the court’s October 31, 2013 order in the Delaware Shareholder Derivative Action. In its July 23, 2014 order approving the Settlement Stipulation, the Delaware Court of Chancery awarded an aggregate amount of approximately $6.5 million (to be reduced by the prior interim award of approximately $2.7 million) to OTK and current director Jason T. Kalisman for their counsel fees and expenses incurred in connection with the Delaware Shareholder Derivative Action which was paid by us with insurance proceeds.

·

Plaintiffs and defendants in each of the Actions, apart from the former directors who chose not to participate in Settlement Stipulation and against whom the Delaware Shareholder Derivative Action continues, exchanged 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 was dismissed with prejudice and on the merits with each party bearing its own costs, except as to the former directors who have not settled, against whom the Delaware Shareholder Derivative Action continues or as specified in the Settlement Stipulation.

 

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On October 3, 2014, we entered into a Memorandum of Understanding with OTK and Thomas L. Harrison (the “Harrison Settlement”) to settle the claims against Mr. Harrison in the Delaware Shareholder Derivative Action and also to settle claims Mr. Harrison has asserted against us in Harrison v. Morgans Hotel Group Co., C. A. No. 10100-VCL (Del. Ch.) (the “Harrison Advancement Action”), in which Mr. Harrison seeks an order requiring us to advance his expenses (including attorneys’ fees) incurred in connection with the Delaware Shareholder Derivative Action and further seeks indemnification of the expenses (including attorneys’ fees) Mr. Harrison incurred in connection with his efforts to enforce his claims to advancement.  The Harrison Settlement is subject to approval by the Delaware Court of Chancery.  Pursuant to the Harrison Settlement, in October 2014, we advanced to Mr. Harrison a portion of the fees and expenses for which he has sought advancement and paid a portion of the amounts for which Mr. Harrison seeks indemnification related to the Harrison Advancement Action.  As part of the consideration for the release of the claims against Mr. Harrison in the Delaware Shareholder Derivative Action, if the Harrison Settlement is approved by the Court of Chancery, Mr. Harrison would waive his claims to recover the remaining amounts for which he has sought advancement and indemnification in the Harrison Advancement Action.  On November 7, 2014, OTK, Morgans, and Mr. Harrison entered into a Stipulation of Settlement setting forth the terms of the settlement. The settlement hearing before the Delaware Court of Chancery was held on February 9, 2015, and the Court of Chancery approved the Harrison Settlement.  As a result, both the Harrison Advancement Action and the claims against Mr. Harrison in the Delaware Shareholder Derivative Action were dismissed with prejudice and the parties to the settlement exchanged customary releases.  

In connection with the Harrison Settlement, OTK and Morgans informed the Delaware Court of Chancery that if the Harrison Settlement were approved, OTK intended to seek dismissal of the claims against the only remaining defendant in the Delaware Shareholder Derivative Action, Michael D. Malone, a former director of the Company.  On February 17, 2015, the remaining parties to the litigation filed a stipulation and proposed form of order to dismiss the claims against Mr. Malone without prejudice, and the Court entered the dismissal order on February 18, 2015.  The Delaware Shareholder Derivative Action is now concluded.

Our insurers have paid a majority of the costs that we were obligated to pay under the Settlement Stipulation.  We do not expect that the net amount of any remaining payments we will make under the terms of the Settlement Stipulation or in connection with the Harrison Settlement or the Malone dismissal will be material to our financial position.

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 initial public offering 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 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

 

First Quarter 2014

 

$

8.37

 

 

$

7.28

 

Second Quarter 2014

 

$

8.30

 

 

$

7.19

 

Third Quarter 2014

 

$

8.49

 

 

$

7.15

 

Fourth Quarter 2014

 

$

8.25

 

 

$

7.30

 

 

On March 12, 2015, the closing sale price for our common stock, as reported on the NASDAQ Global Market, was $7.21. As of March 12, 2015, there were 37 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 had an 8% dividend rate until October 2014, and have 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. 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, 2014, have not declared any dividends. As of December 31, 2014, we have undeclared dividends of approximately $43.3 million.

 

 

 

 

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Performance Graph  

The following graph below shows the cumulative total stockholder return of our common stock from December 31, 2009 through December 31, 2014 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, 2009. 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, 2009 through December 31, 2014

 

 

 

 

 

12/31/2009

 

 

12/31/2010

 

 

12/31/2011

 

 

12/31/2012

 

 

12/31/2013

 

 

12/31/2014

 

Morgans Hotel Group Co.

 

$

100.00

 

 

$

198.47

 

 

$

129.10

 

 

$

121.23

 

 

$

177.90