10-Q 1 mhgc-10q_20150630.htm 10-Q mhgc-10q_20150630.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

x

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

For the quarterly period ended: June 30, 2015

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)

 

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 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 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. (Check one):

 

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 Exchange Act).    Yes  ¨    No   x

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of August 4, 2015 was 34,627,055.

 

 

 

 


 

TABLE OF CONTENTS

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

 

 

 

MORGANS HOTEL GROUP CO. CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2015 (UNAUDITED) AND DECEMBER 31, 2014

 

5

 

MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS FOR THE PERIODS ENDED JUNE 30, 2015 and 2014

 

6

 

MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE PERIODS ENDED JUNE 30, 2015 and 2014

 

7

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

8

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

28

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

46

 

ITEM 4. CONTROLS AND PROCEDURES

 

47

 

PART II. OTHER INFORMATION

 

 

 

ITEM 1. LEGAL PROCEEDINGS

 

47

 

ITEM 1A. RISK FACTORS

 

49

 

ITEM 6. EXHIBITS

 

49

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2


 

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q 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,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. References to “we,” “our” and the “Company” refer to Morgans Hotel Group Co. together in each case with our consolidated subsidiaries and any predecessor entities unless the context suggests otherwise.

We may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our stockholders. These forward-looking statements 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. Forward-looking statements in this Quarterly Report on Form 10-Q 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;

·

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

·

the status and expectations with respect to the development of new hotels;

·

the effect of new lodging supply;

·

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

·

the outcome of litigation or settlement discussions 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, the risks discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 and other documents we file with the Securities and Exchange Commission from time to time. 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;

 

3


 

·

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

·

potential terminations of management agreements;

·

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

·

the seasonal nature of the hospitality business and other aspects of the hospitality 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, and data privacy;

·

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 our Board of Directors and/or pursued by the Company;

·

the impact of changes in our management team, including the recent resignation of our interim chief executive officer; and  

·

other risks discussed in our 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 report to conform these statements to actual results.

 

 

 

 

4


 

Morgans Hotel Group Co.

Consolidated Balance Sheets

(in thousands, except share data)

 

 

 

June 30,

2015

 

 

December 31,

2014

 

 

 

(unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Property and equipment, net

 

$

269,949

 

 

$

277,825

 

Goodwill

 

 

54,057

 

 

 

54,057

 

Investments in and advances to unconsolidated joint ventures

 

 

6,600

 

 

 

10,492

 

Cash and cash equivalents

 

 

32,994

 

 

 

13,493

 

Restricted cash

 

 

13,391

 

 

 

13,939

 

Accounts receivable, net

 

 

9,470

 

 

 

10,475

 

Related party receivables

 

 

2,735

 

 

 

3,560

 

Prepaid expenses and other assets

 

 

10,822

 

 

 

8,493

 

Deferred tax asset, net

 

 

77,592

 

 

 

77,204

 

Assets held for sale

 

 

 

 

 

34,284

 

Other assets, net

 

 

42,940

 

 

 

47,422

 

Total assets

 

$

520,550

 

 

$

551,244

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

Debt and capital lease obligations

 

$

606,052

 

 

$

605,743

 

Accounts payable and accrued liabilities

 

 

31,076

 

 

 

32,524

 

Accounts payable and accrued liabilities on assets held for sale

 

 

 

 

 

1,128

 

Deferred gain on asset sales

 

 

121,388

 

 

 

125,398

 

Other liabilities

 

 

13,866

 

 

 

13,866

 

Total liabilities

 

 

772,382

 

 

 

778,659

 

Redeemable noncontrolling interest

 

 

 

 

 

5,042

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Preferred stock, $0.01 par value; liquidation preference $1,000 per share, 40,000,000

   shares authorized; 75,000 shares issued at June 30, 2015 and December 31, 2014,

   respectively

 

 

68,742

 

 

 

66,724

 

Common stock, $0.01 par value; 200,000,000 shares authorized; 36,277,495 shares issued

   at June 30, 2015 and December 31, 2014, respectively

 

 

363

 

 

 

363

 

Additional paid-in capital

 

 

237,824

 

 

 

241,001

 

Treasury stock, at cost, 1,678,508 and 1,899,707 shares of common stock at

   June 30, 2015 and December 31, 2014, respectively

 

 

(19,477

)

 

 

(23,279

)

Accumulated other comprehensive loss

 

 

(750

)

 

 

(254

)

Accumulated deficit

 

 

(539,042

)

 

 

(517,561

)

Total Morgans Hotel Group Co. stockholders’ deficit

 

 

(252,340

)

 

 

(233,006

)

Noncontrolling interest

 

 

508

 

 

 

549

 

Total deficit

 

 

(251,832

)

 

 

(232,457

)

Total liabilities, redeemable noncontrolling interest and stockholders’ deficit

 

$

520,550

 

 

$

551,244

 

 

See accompanying notes to these consolidated financial statements.

 

 

 

5


 

Morgans Hotel Group Co.

Consolidated Statements of Comprehensive Loss

(in thousands, except per share data)

 

 

 

Three Months

Ended June 30,

2015

 

 

Three Months

Ended June 30,

2014

 

 

Six Months

Ended June 30,

2015

 

 

Six Months

Ended June 30,

2014

 

Revenues:

 

(unaudited)

 

 

 

 

 

 

 

 

 

Rooms

 

$

30,991

 

 

$

33,118

 

 

$

56,787

 

 

$

60,112

 

Food and beverage

 

 

19,573

 

 

 

21,004

 

 

 

40,990

 

 

 

42,925

 

Other hotel

 

 

2,138

 

 

 

1,308

 

 

 

4,223

 

 

 

2,470

 

Total hotel revenues

 

 

52,702

 

 

 

55,430

 

 

 

102,000

 

 

 

105,507

 

Management fee-related parties and other income

 

 

3,508

 

 

 

5,859

 

 

 

7,516

 

 

 

11,250

 

Total revenues

 

 

56,210

 

 

 

61,289

 

 

 

109,516

 

 

 

116,757

 

Operating Costs and Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rooms

 

 

9,414

 

 

 

9,413

 

 

 

18,298

 

 

 

18,305

 

Food and beverage

 

 

13,822

 

 

 

14,838

 

 

 

28,405

 

 

 

30,149

 

Other departmental

 

 

1,129

 

 

 

797

 

 

 

2,219

 

 

 

1,569

 

Hotel selling, general and administrative

 

 

10,418

 

 

 

10,769

 

 

 

20,570

 

 

 

22,355

 

Property taxes, insurance and other

 

 

4,411

 

 

 

4,157

 

 

 

8,294

 

 

 

7,931

 

Total hotel operating expenses

 

 

39,194

 

 

 

39,974

 

 

 

77,786

 

 

 

80,309

 

Corporate expenses, including stock compensation of

   $0.6 million, $0.8 million, $0.9 million, and $2.7 million,

   respectively

 

 

4,919

 

 

 

6,019

 

 

 

10,947

 

 

 

13,901

 

Depreciation and amortization

 

 

5,563

 

 

 

6,681

 

 

 

11,200

 

 

 

15,083

 

Restructuring and disposal costs

 

 

593

 

 

 

3,981

 

 

 

2,542

 

 

 

11,224

 

Development costs

 

 

457

 

 

 

2,666

 

 

 

605

 

 

 

3,364

 

Loss on receivables from unconsolidated joint venture

 

 

550

 

 

 

 

 

 

550

 

 

 

 

Total operating costs and expenses

 

 

51,276

 

 

 

59,321

 

 

 

103,630

 

 

 

123,881

 

Operating income (loss)

 

 

4,934

 

 

 

1,968

 

 

 

5,886

 

 

 

(7,124

)

Interest expense, net

 

 

11,955

 

 

 

12,935

 

 

 

23,782

 

 

 

28,933

 

Impairment loss and equity in income of investment in

   unconsolidated joint venture

 

 

(2

)

 

 

(2

)

 

 

3,888

 

 

 

(4

)

Gain on asset sales

 

 

(2,086

)

 

 

(2,005

)

 

 

(5,794

)

 

 

(4,010

)

Other non-operating expenses

 

 

1,552

 

 

 

430

 

 

 

3,207

 

 

 

1,126

 

Loss before income tax expense

 

 

(6,485

)

 

 

(9,390

)

 

 

(19,197

)

 

 

(33,169

)

Income tax expense

 

 

169

 

 

 

66

 

 

 

295

 

 

 

229

 

Net loss

 

 

(6,654

)

 

 

(9,456

)

 

 

(19,492

)

 

 

(33,398

)

Net loss (income) attributable to noncontrolling interest

 

 

13

 

 

 

(263

)

 

 

27

 

 

 

(456

)

Net loss attributable to Morgans Hotel Group Co.

 

 

(6,641

)

 

 

(9,719

)

 

 

(19,465

)

 

 

(33,854

)

Preferred stock dividends and accretion

 

 

(4,075

)

 

 

(3,987

)

 

 

(7,985

)

 

 

(8,354

)

Net loss attributable to common stockholders

 

$

(10,716

)

 

$

(13,706

)

 

$

(27,450

)

 

$

(42,208

)

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on valuation of cap agreements, net of tax

 

 

29

 

 

 

103

 

 

 

17

 

 

 

207

 

Foreign currency translation adjustment

 

 

483

 

 

 

 

 

 

(514

)

 

 

 

 

Comprehensive loss

 

$

(10,204

)

 

$

(13,603

)

 

$

(27,947

)

 

$

(42,001

)

Loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted attributable to common stockholders

 

$

(0.31

)

 

$

(0.40

)

 

$

(0.80

)

 

$

(1.24

)

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

34,492

 

 

 

34,184

 

 

 

34,440

 

 

 

33,927

 

 

See accompanying notes to these consolidated financial statements.

 

 

6


 

Morgans Hotel Group Co.

Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Six Months Ended June 30,

 

 

 

2015

 

 

2014

 

Cash flows from operating activities:

 

(unaudited)

 

Net loss

 

$

(19,492

)

 

$

(33,398

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation

 

 

9,612

 

 

 

9,946

 

Amortization of other costs

 

 

1,588

 

 

 

5,137

 

Amortization and write off of deferred financing costs

 

 

3,274

 

 

 

3,986

 

Amortization of discount on convertible notes

 

 

 

 

 

751

 

Amortization of deferred gain on asset sales

 

 

(4,010

)

 

 

(4,010

)

Stock-based compensation

 

 

922

 

 

 

2,748

 

Accretion of interest

 

 

1,042

 

 

 

1,578

 

Impairment loss and equity in income of investment in unconsolidated joint venture

 

 

3,888

 

 

 

(4

)

Loss on receivables from unconsolidated joint venture

 

 

550

 

 

 

 

Gain on sale and disposal of assets

 

 

(1,790

)

 

 

(289

)

Change in fair value of TLG Promissory Notes

 

 

 

 

 

5

 

Change in value of interest rate caps

 

 

77

 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

454

 

 

 

(2,210

)

Related party receivables

 

 

275

 

 

 

(221

)

Restricted cash

 

 

1,638

 

 

 

7,208

 

Prepaid expenses and other assets

 

 

(2,079

)

 

 

1,016

 

Accounts payable and accrued liabilities

 

 

(3,151

)

 

 

4,262

 

Net cash used in operating activities

 

 

(7,202

)

 

 

(3,495

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(1,725

)

 

 

(2,131

)

Deposits into capital improvement escrows, net

 

 

(1,090

)

 

 

(1,225

)

Distributions from unconsolidated joint ventures

 

 

4

 

 

 

4

 

Proceeds from asset sale, net

 

 

30,806

 

 

 

 

Development hotel funding

 

 

(250

)

 

 

 

Net cash provided by (used in) investing activities

 

 

27,745

 

 

 

(3,352

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from debt

 

 

 

 

 

450,000

 

Payments on debt and capital lease obligations

 

 

(732

)

 

 

(305,735

)

Debt issuance costs

 

 

 

 

 

(13,271

)

Cash paid in connection with vesting of stock based awards

 

 

(310

)

 

 

(769

)

Distributions to holders of noncontrolling interests in consolidated subsidiaries

 

 

 

 

 

(430

)

Net cash (used in) provided by financing activities

 

 

(1,042

)

 

 

129,795

 

Net increase in cash and cash equivalents

 

 

19,501

 

 

 

122,948

 

Cash and cash equivalents, beginning of year

 

 

13,493

 

 

 

10,025

 

Cash and cash equivalents, end of year

 

$

32,994

 

 

$

132,973

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

20,508

 

 

$

24,075

 

Cash paid for income taxes

 

$

1

 

 

$

552

 

Non cash financing activities are as follows:

 

 

 

 

 

 

 

 

Write off of discount on convertible debt

 

$

 

 

$

726

 

 

See accompanying notes to these consolidated financial statements.

 

 

 

7


 

Morgans Hotel Group Co.

Notes to Consolidated Financial Statements

 

 

1. Organization and Formation Transaction

Morgans Hotel Group Co., a Delaware corporation (the “Company”), was incorporated on October 19, 2005. The Company 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.  

In addition, the Company owns leasehold interests in certain food and beverage venues.  Prior to the TLG Equity Sale, discussed below, completed on January 23, 2015, the Company, through TLG Acquisition LLC (“TLG Acquisition” and, together with its subsidiaries, The Light Group, or “TLG”), operated nightclubs, restaurants, pool lounges, bars and other food and beverage venues primarily in  hotels operated by MGM Resorts International (“MGM”) in Las Vegas.  

The Morgans Hotel Group Co. predecessor comprised the subsidiaries and ownership interests that were contributed as part of the formation and structuring transactions from Morgans Hotel Group LLC, now known as Residual Hotel Interest LLC (“Former Parent”), to Morgans Group LLC (“Morgans Group”), the Company’s operating company. The Former Parent also contributed all the membership interests in its hotel management business to Morgans Group in return for 1,000,000 membership units in Morgans Group exchangeable for shares of the Company’s common stock.

The Company has one reportable operating segment.  During the six months ended June 30, 2015 and 2014, the Company derived 6.3% and 5.3% of its total revenues from international locations, respectively. The assets at these international locations were not significant during the periods presented.

Hotels

The Company’s hotels as of June 30, 2015 were as follows:

 

Hotel Name

 

Location

 

Number of

Rooms

 

 

Ownership

 

Hudson

 

New York, NY

 

 

878

 

 

 

(1

)

Morgans

 

New York, NY

 

 

117

 

 

 

(2

)

Royalton

 

New York, NY

 

 

168

 

 

 

(2

)

Delano South Beach

 

Miami Beach, FL

 

 

194

 

 

 

(3

)

Mondrian South Beach

 

Miami Beach, FL

 

 

218

 

 

 

(4

)

Shore Club

 

Miami Beach, FL

 

 

308

 

 

 

(5

)

Mondrian Los Angeles

 

Los Angeles, CA

 

 

236

 

 

 

(2

)

Clift

 

San Francisco, CA

 

 

372

 

 

 

(6

)

Sanderson

 

London, England

 

 

150

 

 

 

(2

)

St Martins Lane

 

London, England

 

 

204

 

 

 

(2

)

Mondrian London at Sea Containers

 

London, England

 

 

359

 

 

 

(2

)

Delano Las Vegas

 

Las Vegas, Nevada

 

 

1,117

 

 

 

(7

)

10 Karakoy

 

Istanbul, Turkey

 

 

71

 

 

 

(8

)

 

(1)

The Company owns 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 June 30, 2015, Hudson had 878 guest rooms and 60 single room dwelling units (“SROs”).

(2)

Operated under a management contract.

(3)

Wholly-owned hotel.

(4)

Operated as a condominium hotel under a management contract and owned through a 50/50 unconsolidated joint venture. As of June 30, 2015, 274 hotel residences had been sold, of which 157 are in the hotel rental pool and are included in the hotel room count, and 61 hotel residences remain to be sold. See note 4.

(5)

Operated under a management contract. As of June 30, 2015, the Company had an immaterial contingent profit participation equity interest. See note 4.

(6)

The hotel is operated under a long-term lease which is accounted for as a financing. See note 6.

(7)

A licensed hotel managed by MGM.  

(8)

A franchised hotel.  

 

8


 

 Food and Beverage Operations

The Company leases and manages all but one of the Sanderson food and beverage venues.  The Company also owns three food and beverage venues subject to leasehold agreements at Mandalay Bay in Las Vegas, which are managed by TLG.  These food and beverage venues are included in the Company’s consolidated financial statements.

Effective January 1, 2014, the Company transferred all of its ownership interest in the food and beverage venues at St Martins Lane to the hotel owner. The Company will continue to manage the transferred food and beverage venues. Prior to January 1, 2014, the Company leased and managed all of the St Martins Lane food and beverage venues, which were included in the Company’s consolidated financial statements.

The Light Group

On November 30, 2011, certain of the Company’s subsidiaries completed the acquisition of 90% of the equity interests in TLG Acquisition LLC for a purchase price of $28.5 million in cash and up to $18.0 million in notes (the “TLG Promissory Notes”) (“The Light Group Purchase”).  

In December 2014, the Company used cash on hand to repay and retire $19.1 million of the outstanding TLG Promissory Notes, which included the original principal balance of $18.0 million plus deferred interest of $1.1 million.

The primary assets of TLG consisted of its management and similar agreements primarily with various MGM affiliates. During the time the Company owned 90% of TLG, it 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.

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

The Company has certain indemnification obligations, which generally survive for 18 months following the closing of the TLG Equity Sale; however, no amounts are held in escrow for the satisfaction of such claims.  As of June 30, 2015, the Company has accrued approximately $0.3 million related to these indemnification obligations.

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. The Minority Holders maintained the right to put their equity interests to TLG’s managing member for amounts determined pursuant to the Amended and Restated Limited Liability Company of TLG. Hakkasan, as the current managing member, was obligated to pay $3.6 million of this amount upon delivery of the 10% equity interest in TLG held by the Minority Holders with the Company responsible for any amounts in excess of $3.6 million, as discussed below in “—Sasson-Masi Put Options.”

In addition, for the 18 months following the closing of the TLG Equity Sale, the Company has the right to purchase 49% of the equity of TLG from Hakkasan (the “Option Right”).   

Sasson-Masi Put Options.  On January 15, 2015, each of Messrs. Sasson and Masi exercised his right to require Morgans Group to purchase his equity interest in TLG at a purchase price calculated in accordance with the Amended and Restated Limited Liability Company of TLG (the “Sasson-Masi Put Options”). The Company initially accounted for the redeemable noncontrolling interest at fair value in accordance with Accounting Standard Codification (“ASC”) 805, Business Combinations. Due to the redemption feature associated with the Sasson-Masi Put Options, the Company classified the noncontrolling interest in temporary equity in accordance with the Securities and Exchange Commission’s guidance as codified in ASC 480-10, Distinguishing Liabilities from Equity. Subsequently, the Company accreted the redeemable noncontrolling interest to its current redemption value, which approximates fair value, each period. The change in the redemption value did not impact the Company’s earnings or earnings per share.  

The estimated aggregate purchase price for the Sasson-Masi Put Options was approximately $5.0 million based on the contractual formula applied to an option exercise date of January 15, 2015.    Pursuant to the TLG Equity Sale, Hakkasan was obligated to pay $3.6 million of the purchase price for the Sasson-Masi Put Options upon their execution and settlement, which occurred on May 27, 2015.  As a result, the Company paid approximately $1.4 million.  

 

 

 

9


 

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company consolidates all wholly-owned subsidiaries and variable interest entities in which the Company is determined to be the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation. Entities which the Company does not control through voting interest and entities which are variable interest entities of which the Company is not the primary beneficiary, are accounted for under the equity method.

The consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information furnished in the accompanying consolidated financial statements reflects all adjustments that, in the opinion of management, are necessary for a fair presentation of the aforementioned consolidated financial statements for the interim periods.

Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Restricted Cash

As required by certain debt and lease agreements, restricted cash consists of cash held in escrow accounts for taxes, ground rent, insurance programs, and debt service or lease payments. As further required by the debt and lease agreements related to hotels owned by the Company or one of its subsidiaries, the Company must set aside 4% of the hotels’ revenues in restricted escrow accounts for the future periodic replacement or refurbishment of furniture, fixtures and equipment. As replacements occur, the Company or its subsidiary is eligible for reimbursement from these escrow accounts.

The Hudson/Delano 2014 Mortgage Loan, defined and discussed below in note 6, provides that, in the event the debt yield ratio falls below certain defined thresholds, all cash flows from Hudson and Delano South Beach are deposited into accounts controlled by the lenders from which debt service and operating expenses, including management fees, are paid and from which other reserve accounts may be funded. Any excess amounts will be retained by the lenders until the debt yield ratio exceeds the required thresholds for two consecutive calendar quarters. As of June 30, 2015, the debt yield ratio exceeded the required threshold.  

Assets Held for Sale

The Company considers properties to be assets held for sale when management approves and commits to a formal plan to actively market a property or a group of properties for sale and the sale is probable. Upon designation as an asset held for sale, the Company records the carrying value of each property or group of properties at the lower of its carrying value, which includes allocable goodwill, or its estimated fair value, less estimated costs to sell, and the Company stops recording depreciation expense. Any gain realized in connection with the sale of the properties for which the Company has significant continuing involvement, such as through a long-term management agreement, is deferred and recognized over the initial term of the related management agreement.

The Company adopted Accounting Standards Update (“ASU”) No. 2014-08 (“ASU 2014-08”), “Presentation of Financial Statements and Property, Plant and Equipment; Reporting Discontinued Operations and Disclosures of Components of an Entity” in 2014, and as a result, it evaluates properties or assets to be held for sale under this accounting standard.  If, under the guidance of ASU 2014-08, a property or asset meets the requirements to be classified as a discontinued operation, the operations of the properties held for sale prior to the sale date are recorded in discontinued operations.  Otherwise, management looks to ASC 360-10-45 for guidance on presentation of properties or assets presented as assets held for sale.  

 

10


 

In December 2014, the Company’s Board of Directors approved the TLG Equity Sale, as discussed in note 1.  For the year ended December 31, 2014, the Company classified the assets and liabilities related to TLG as assets held for sale.  The Company’s assets related to TLG included its investment in the TLG management contracts, which were amortized using the straight line method, over the life of each applicable management contract prior to the Company’s reclassification of these assets to held for sale, goodwill, and some intangible assets.  The Company’s liabilities related to TLG were payables which were incurred in the normal course of its operation.  

 Investments in and Advances to Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures using the equity method as it does not exercise control over significant business decisions such as buying, selling or financing nor is it the primary beneficiary under ASC 810-10, as discussed above. Under the equity method, the Company increases its investment for its proportionate share of net income and contributions to the joint venture and decreases its investment balance by recording its proportionate share of net loss and distributions. Once the Company’s investment balance in an unconsolidated joint venture is zero, the Company suspends recording additional losses. For investments in which there is recourse or unfunded commitments to provide additional equity, distributions and losses in excess of the investment are recorded as a liability. As of June 30, 2015, there were no liabilities required to be recorded related to these investments.

Other Assets

In October 2014, the Company funded an approximately $15.3 million key money obligation related to Mondrian London, which is included in Other Assets and is being amortized over the term of the hotel management agreement.

In August 2012, the Company entered into a 10-year licensing agreement with MGM, with two five-year extensions at the Company’s option subject to performance thresholds, to convert THEhotel to Delano Las Vegas. Delano Las Vegas opened in September 2014.  In addition, the Company acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas from an existing tenant for $15.0 million in cash at closing and a deferred, principal-only $10.6 million promissory note (“Restaurant Lease Note”) to be paid over seven years, which the Company recorded at fair value as of the date of issuance at $7.5 million, as discussed in note 6. The food and beverage venues were, and continue to be, managed by TLG. The three food and beverage venues are operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which the Company pays minimum annual lease payments and a percentage rent based on cash flow. The Company amortizes the fair value of the license agreement and restaurant leasehold interests, using the straight line method, over the 10-year life of the agreements.

Further, as of June 30, 2015, other assets also include deferred financing costs which are being amortized, using the straight line method, which approximates the effective interest rate method, over the terms of the related debt agreements.

Income Taxes

The Company accounts for income taxes in accordance with ASC 740-10, Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the tax and financial reporting basis of assets and liabilities and for loss and credit carry forwards. Valuation allowances are provided when it is more likely than not that the recovery of deferred tax assets will not be realized.

The Company’s deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Decreases to the valuation allowance are recorded as reductions to the Company’s provision for income taxes and increases to the valuation allowance result in additional provision for income taxes. The realization of the Company’s deferred tax assets, net of the valuation allowance, is primarily dependent on estimated future taxable income. A change in the Company’s estimate of future taxable income may require an addition to or reduction from the valuation allowance. The Company has established a reserve on its deferred tax assets based on anticipated future taxable income and tax strategies which may include the sale of property or an interest therein.

All of the Company’s foreign subsidiaries are subject to local jurisdiction corporate income taxes. Income tax expense is reported at the applicable rate for the periods presented.

Income taxes for the three and six months ended June 30, 2015 and 2014, were computed using the Company’s effective tax rate.

 

11


 

Credit-risk-related Contingent Features

The Company has entered into warrant agreements with Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P., (collectively, the “Yucaipa Investors”), as discussed in note 9, to purchase a total of 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share (the “Yucaipa Warrants”). In addition, subject to the terms of the Securities Purchase Agreement, the Yucaipa Investors have certain consent rights over certain transactions for so long as they collectively own or have the right to purchase through exercise of the Yucaipa Warrants 6,250,000 shares of the Company’s common stock. The Yucaipa Warrants are exercisable utilizing a cashless exercise method only, resulting in a net share issuance.

Fair Value Measurements

ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”) defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820-10 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

ASC 820-10 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820-10 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Currently, the Company uses interest rate caps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. To comply with the provisions of ASC 820-10, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2015 and December 31, 2014, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. Accordingly, all derivatives have been classified as Level 2 fair value measurements. As of June 30, 2015, the Company had three interest rate caps outstanding and the fair value of these interest rate caps was immaterial.

In connection with the three restaurant leases in Las Vegas, the Company issued the Restaurant Lease Note to be paid over seven years. The Restaurant Lease Note does not bear interest except in the event of default, as defined by the agreement. In accordance with ASC 470, Debt, the Company imputed interest on the Restaurant Lease Note, which is recorded at fair value on the accompanying consolidated balance sheets. On the date of grant, the Company determined the fair value of the Restaurant Lease Note to be $7.5 million imputing an interest rate of 10%. The Company has determined that the majority of the inputs used to value the Restaurant Lease Note fall within Level 2 of the fair value hierarchy, which accordingly has been classified as Level 2 fair value measurements.

 

12


 

During the six months ended June 30, 2015, the Company recognized non-cash impairment charges of $3.9 million related to the Company’s investment in Mondrian Istanbul, which was recorded in impairment loss and equity in income of investment in unconsolidated joint venture, and a loss of $0.6 million on receivables from an unconsolidated joint venture. The Company’s estimated fair value relating to these impairment assessments was based primarily upon Level 3 measurements, including the assets expected cash flow, market conditions, and, as it pertained to Mondrian Istanbul, settlement discussions with the Company’s joint venture partner.

Fair Value of Financial Instruments

Disclosures about fair value of financial instruments are based on pertinent information available to management as of the valuation date. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented are not necessarily indicative of the amounts at which these instruments could be purchased, sold, or settled. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The Company’s financial instruments include cash and cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, and fixed and variable rate debt. Management believes the carrying amount of the aforementioned financial instruments, excluding fixed-rate debt, is a reasonable estimate of fair value as of June 30, 2015 and December 31, 2014 due to the short-term maturity of these items or variable market interest rates.

The Company had fixed rate debt of $55.4 million and $55.8 million as of June 30, 2015 and December 31, 2014, respectively, which included the Company’s trust preferred securities and Restaurant Lease Note, discussed above, and excludes capital leases.  This fixed rate debt had a fair market value at June 30, 2015 and December 31, 2014 of approximately $58.3 million and $63.0 million, respectively, using market rates.

Although the Company has determined that the majority of the inputs used to value its fixed rate debt fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its fixed rate debt utilize Level 3 inputs, such as estimates of current credit spreads. However, as of June 30, 2015 and December 31, 2014, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its fixed rate debt and determined that the credit valuation adjustments are not significant to the overall valuation of its fixed rate debt. Accordingly, all derivatives have been classified as Level 2 fair value measurements.

Stock-based Compensation

The Company accounts for stock based employee compensation using the fair value method of accounting described in ASC 718-10. For share grants, total compensation expense is based on the price of the Company’s stock at the grant date. For option grants, the total compensation expense is based on the estimated fair value using the Black-Scholes option-pricing model. Compensation expense is recorded ratably over the vesting period.

 

Redeemable Noncontrolling Interest

Due to the redemption feature associated with the Sasson-Masi Put Options, the Company initially classified the noncontrolling interest in temporary equity in accordance with the Securities and Exchange Commission’s guidance as codified in ASC 480-10, Distinguishing Liabilities from Equity. Subsequently, the Company accreted the redeemable noncontrolling interest to its current redemption value, which approximates fair value, each period. The change in the redemption value does not impact the Company’s earnings or earnings per share.  The Sasson-Masi Put Options were settled on May 27, 2015, as discussed further in note 1.  

Noncontrolling Interest

The Company follows ASC 810-10, when accounting and reporting for noncontrolling interests in a consolidated subsidiary and the deconsolidation of a subsidiary. Under ASC 810-10, the Company reports noncontrolling interests in subsidiaries as a separate component of stockholders’ equity (deficit) in the consolidated financial statements and reflects net income (loss) attributable to the noncontrolling interests and net income (loss) attributable to the common stockholders on the face of the consolidated statements of comprehensive loss.

 

13


 

The membership units in Morgans Group, the Company’s operating company, owned by the Former Parent are presented as a noncontrolling interest in Morgans Group in the consolidated balance sheets and were approximately $0.5 million and $0.5 million as of June 30, 2015 and December 31, 2014, respectively. The noncontrolling interest in Morgans Group is: (i) increased or decreased by the holders of membership interests’ pro rata share of Morgans Group’s net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by exchanges of membership units for the Company’s common stock; and (iv) adjusted to equal the net equity of Morgans Group multiplied by the holders of membership interests’ ownership percentage immediately after each issuance of units of Morgans Group and/or shares of the Company’s common stock and after each purchase of treasury stock through an adjustment to additional paid-in capital. Net income or net loss allocated to the noncontrolling interest in Morgans Group is based on the weighted-average percentage ownership throughout the period. As of June 30, 2015, there were 75,446 membership units outstanding, each of which is exchangeable for a share of the Company’s common stock.

Recent Accounting Pronouncements

In April 2015, the FASB issued ASU No. 2015-03 (“ASU 2015-03”), “Interest – Imputation of Interest.”   ASU 2015-03 is intended to simplify the presentation of debt issuance costs under GAAP.  Under the new standard, debt issuance costs will be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, rather than as an asset.  ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those years.  Additionally, ASU 2015-03 must be applied on a retroactive basis and upon transition, an entity is required to comply with the applicable disclosures for a change in accounting principle.  The Company will adopt ASU 2015-03 and change its presentation of debt issuance costs effective the first quarter of fiscal year 2016.  

Reclassifications

Certain prior period financial statement amounts have been reclassified to conform to the current period presentation.

 

 

3. Income (Loss) Per Share

The Company applies the two-class method as required by ASC 260-10, Earnings per Share (“ASC 260-10”). ASC 260-10 requires the net income per share for each class of stock (common stock and preferred stock) to be calculated assuming 100% of the Company’s net income is distributed as dividends to each class of stock based on their contractual rights. To the extent the Company has undistributed earnings in any calendar quarter, the Company will follow the two-class method of computing earnings per share.

Basic earnings (loss) per share is calculated based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share include the effect of potential shares outstanding, including dilutive securities. Potential dilutive securities may include shares and options granted under the Company’s stock incentive plan and membership units in Morgans Group, which may be exchanged for shares of the Company’s common stock under certain circumstances. The 75,446 Morgans Group membership units (which may be converted to cash, or at the Company’s option, common stock) held by third parties at June 30, 2015, the Yucaipa Warrants issued to the Yucaipa Investors, unvested restricted stock units, LTIP Units (as defined in note 10) and stock options have been excluded from the diluted net income (loss) per common share calculation, as there would be no effect on reported diluted net income (loss) per common share.

 

14


 

The table below details the components of the basic and diluted loss per share calculations (in thousands, except for per share data). The Company has not had any undistributed earnings in any calendar quarter presented. Therefore, the Company does not present earnings per share following the two-class method.

 

 

 

Three Months

Ended

June 30, 2015

 

 

Three Months

Ended

June 30, 2014

 

 

Six Months

Ended

June 30, 2015

 

 

Six Months

Ended

June 30, 2014

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(6,654

)

 

$

(9,456

)

 

$

(19,492

)

 

$

(33,398

)

Net loss (income) attributable to noncontrolling interest

 

 

13

 

 

 

(263

)

 

 

27

 

 

 

(456

)

Net loss attributable to Morgans Hotel Group Co.

 

 

(6,641

)

 

 

(9,719

)

 

 

(19,465

)

 

 

(33,854

)

Less: preferred stock dividends and accretion

 

 

4,075

 

 

 

3,987

 

 

 

7,985

 

 

 

8,354

 

Net loss attributable to common stockholders

 

$

(10,716

)

 

$

(13,706

)

 

$

(27,450

)

 

$

(42,208

)

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic common shares outstanding

 

 

34,492

 

 

 

34,184

 

 

 

34,440

 

 

 

33,927

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average diluted common shares outstanding

 

 

34,492

 

 

 

34,184

 

 

 

34,440

 

 

 

33,927

 

Basic and diluted loss available to common stockholders

   per common share

 

$

(0.31

)

 

$

(0.40

)

 

$

(0.80

)

 

$

(1.24

)

 

 

4. Investments in and Advances to Unconsolidated Joint Ventures

The Company’s investments in and advances to unconsolidated joint ventures and its equity in losses of unconsolidated joint ventures are summarized as follows (in thousands):

Investments

 

Entity

 

As of

June 30,

2015

 

 

As of

December 31,

2014

 

Mondrian Istanbul

 

$

6,500

 

 

$

10,392

 

Other

 

 

100

 

 

 

100

 

Total investments in and advances to unconsolidated joint

   ventures

 

$

6,600

 

 

$

10,492

 

 

The Company’s income from unconsolidated joint ventures was immaterial for the three and six months ended June 30, 2015 and 2014. The Company recorded a $3.9 million impairment charge related to its investment in Mondrian Istanbul during the six months ended June 30, 2015, discussed below.       

Mondrian South Beach

On August 8, 2006, the Company entered into a 50/50 joint venture to renovate and convert an apartment building on Biscayne Bay in Miami Beach into a condominium hotel, Mondrian South Beach, which opened in December 2008. The Company operates Mondrian South Beach under a long-term management contract.

The Mondrian South Beach joint venture initially received nonrecourse mortgage loan financing of approximately $124.0 million at a rate of LIBOR plus 3.0%. A portion of this mortgage debt was paid down, prior to the amendments discussed below, with proceeds obtained from condominium sales. In April 2008, the Mondrian South Beach joint venture obtained a mezzanine loan from the mortgage lenders of $28.0 million bearing interest at LIBOR plus 6.0%. Additionally, the Company and an affiliate of its joint venture partner provided additional mezzanine financing of $28.0 million in total to the joint venture through a 50/50 mezzanine financing joint venture.  

 

15


 

In April 2010, the Mondrian South Beach ownership joint venture amended the nonrecourse mortgage financing and mezzanine loan agreements secured by Mondrian South Beach or related equity interests and extended the maturity date for up to seven years through one-year extension options until April 2017, subject to certain conditions. Among other things, the amendment allowed the joint venture to accrue all interest through April 2012, accrue a portion of the interest thereafter, extend the mezzanine loan to April 2027 if the mortgage loan is retired, and provide the ability to provide seller financing to qualified condominium buyers with up to 80% of the condominium purchase price. After the repayment of the mortgage debt, the mezzanine financing joint venture receives the first $5.5 million of net cash flow, the lender mezzanine financing receives the next $5.5 million, and the remaining proceeds are distributed equally between the joint venture mezzanine loan and the lender mezzanine loan.  

In February 2015, the joint venture exercised its option to extend the outstanding mortgage and mezzanine debt until April 2016. As of June 30, 2015, the joint venture’s outstanding nonrecourse mortgage loan was $19.4 million, with interest accruing at LIBOR plus 3.8% and paid at LIBOR plus 1.5%.  The outstanding mezzanine loan was $28.0 million, with interest accruing at 4.26%. In addition, the outstanding mezzanine debt owed to affiliates of the joint venture partners was $28.0 million.

The joint venture is in the process of selling units as condominiums, subject to market conditions, and unit buyers will have the opportunity to place their units into the hotel’s rental program. As of June 30, 2015, 274 hotel residences had been sold, of which 157 are in the hotel rental pool and are included in the hotel room count, and 61 hotel residences remain to be sold. In addition to hotel management fees, the Company could also realize fees from the sale of condominium units, although there can be no assurances of any sales in the future.

The Mondrian South Beach joint venture was determined to be a variable interest entity as during the process of refinancing the venture’s mortgage in April 2010, its equity investment at risk was considered insufficient to permit the entity to finance its own activities. Management determined that the Company is not the primary beneficiary of this variable interest entity.

Because the Company has written its investment value in the joint venture to zero, for financial reporting purposes, the Company believes its maximum exposure to losses as a result of its involvement in Mondrian South Beach is limited to its outstanding management fees and related receivables, excluding guarantees and other contractual commitments.

The Company is not committed to providing financial support to this variable interest entity, other than as contractually required, and all future funding is expected to be provided by the joint venture partners in accordance with their respective percentage interests in the form of capital contributions or loans, or by third parties.

Morgans Group and affiliates of its joint venture partner have provided certain guarantees and indemnifications to the Mondrian South Beach lenders. See note 7.

Mondrian SoHo

In June 2007, the Company entered into a joint venture with Cape Advisors Inc. to acquire property and develop a Mondrian hotel on that property in the SoHo neighborhood of New York City. The Company had a 20% equity interest in the joint venture. Under the terms of the hotel management agreement executed between the Company and the joint venture in June 2007, the Company had a contract to manage the hotel for a 10-year term beginning on the date the hotel opened for business, which was in February 2011, with two 10-year extension options.

The joint venture obtained a loan to acquire the hotel property and develop the hotel, which matured in June 2010 and was extended several times.  On November 2012, the joint venture did not meet the necessary extension options and a foreclosure judgment was issued on November 25, 2014.  The foreclosure sale was held on January 7, 2015, at which German American Capital Corporation (“GACC”), the lender, was the sole and winning bidder. GACC assigned its bid to 9 Crosby LLC, an affiliate of The Sapir Organization (“Sapir”), a New York-based real estate development and management organization.  The sale of the hotel property to Sapir closed on March 6, 2015.  As a result, effective March 6, 2015, the Company no longer held any equity interest in Mondrian SoHo. Effective April 27, 2015, the Company no longer managed Mondrian SoHo.  See note 7 for further discussion related to ongoing legal proceedings related to Mondrian SoHo.

Mondrian Istanbul

In December 2011, the Company entered into a hotel management agreement for an approximately 114-room Mondrian-branded hotel to be located in the Old City area of Istanbul, Turkey. In December 2011 and January 2012, the Company contributed an aggregate of $10.3 million in the form of equity and key money and has a 20% ownership interest in the joint venture owning the hotel. The Company has no additional funding commitments in connection with this project.  

 

16


 

Due to the Company’s joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, the Company exercised its put option under the joint venture agreement that requires the Company’s joint venture partner to buy back the Company’s equity interests in the Mondrian Istanbul joint venture. The Company’s rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, the Company issued a notice of default to its joint venture partner, as they failed to buy back the Company’s equity interests by the contractual deadline, and further notified its joint venture partner that the Company plans to begin foreclosure proceedings as a result of the event of default. The Company initiated foreclosure proceedings on March 11, 2014. The Company’s joint venture partner, and through such joint venture partner, the joint venture itself, have objected to the foreclosure proceeding, as a result of which, the foreclosure proceeding is currently stayed.  A case for the annulment of such objection to the foreclosure proceeding was initiated on October 31, 2014 and is currently pending.  Additionally, in June 2014, the joint venture purported to notify the Company that it had terminated the hotel management agreement. The Company has objected to such purported notices and intends to vigorously defend against any lawsuit that may result. In addition, the Company has initiated proceedings in an English court seeking payment of the put option amount against the individual shareholders behind the joint venture partner.  There are also two cases between the Company and the joint venture partner pending before Turkish courts relating to the representation and management of the joint venture.  On June 26, 2015, the Company and its Mondrian Istanbul joint venture partner (and related parties) entered into a settlement agreement which, subject to the joint venture partner securing financing, would result in a payment of $6.5 million to the Company in exchange for the sale of the Company’s equity interest in the joint venture no later than October 1, 2015.  Under the settlement agreement, the Company is also entitled to an additional amount equal to 20% of the excess proceeds over $6.5 million if the land or 50% or more equity interests are subject to agreement to be sold by the joint venture partner to a third party within one year from the closing of the settlement.  The parties intend to sign a share purchase agreement as contemplated by the settlement.  The settlement will terminate all legal proceedings in Turkey and the United Kingdom between the parties and the Company will thereafter no longer have any rights in the Mondrian Istanbul project, including the hotel management agreement, other than as set forth in the settlement agreement.  

Based on the settlement discussions, the Company determined that this investment was other-than-temporarily impaired and recorded a $3.9 million impairment charge during the six months ended June 30, 2015.  

 

 

5. Other Liabilities

As of June 30, 2015 and December 31, 2014, other liabilities included $13.9 million related to a designer fee claim. The Former Parent had an exclusive service agreement with a hotel designer, pursuant to which the designer has made various claims related to the agreement. Although the Company is not a party to the agreement, it may have certain contractual obligations or liabilities to the Former Parent in connection with the agreement. According to the agreement, the designer was owed a base fee for each designed hotel, plus 1% of gross revenues, as defined in the agreement, for a 10-year period from the opening of each hotel. In addition, the agreement also called for the designer to design a minimum number of projects for which the designer would be paid a minimum fee. A liability amount has been estimated and recorded in these consolidated financial statements before considering any defenses and/or counter-claims that may be available to the Company or the Former Parent in connection with any claim brought by the designer. The estimated costs of the design services were capitalized as a component of the applicable hotel and amortized over the five-year estimated life of the related design elements.

 

 

6. Debt and Capital Lease Obligations

Debt and capital lease obligations consists of the following (in thousands):

 

Description

 

As of

June 30,

2015

 

 

As of

December 31,

2014

 

 

Interest rate at

June 30,

2015

Hudson/Delano Mortgage (a)

 

$

450,000

 

 

$

450,000

 

 

5.84% (LIBOR + 5.65%)

Clift debt (b)

 

 

94,590

 

 

 

93,829

 

 

9.60%

Liability to subsidiary trust (c)

 

 

50,100

 

 

 

50,100

 

 

8.68%

Restaurant Lease Note (d)

 

 

5,257

 

 

 

5,709

 

 

(d)

Capital lease obligations (e)

 

 

6,105

 

 

 

6,105

 

 

(e)

Debt and capital lease obligation

 

$

606,052

 

 

$

605,743

 

 

 

 

 

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(a) Mortgage Agreements

Hudson/Delano 2014 Mortgage Loan

On February 6, 2014, subsidiaries of the Company entered into a financing arrangement with Citigroup Global Markets Realty Corp. and Bank of America, N.A., as lenders, consisting of $300.0 million nonrecourse mortgage notes and $150.0 million mezzanine loans resulting in an aggregate principal amount of $450.0 million, secured by mortgages encumbering Delano South Beach and Hudson and pledges of equity interests in certain subsidiaries of the Company (collectively, the “Hudson/Delano 2014 Mortgage Loan”).

The net proceeds from the Hudson/Delano 2014 Mortgage Loan were applied to (1) repay $180.0 million of outstanding mortgage debt under the prior mortgage loan secured by Hudson (the “Hudson 2012 Mortgage Loan”), (2) repay $37.0 million of indebtedness under the Company’s $100.0 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 which was returned to the Company in June 2014, 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 Company’s 2.375% Senior Subordinated Convertible Notes (the “Convertible Notes”) that matured and were repaid in full in October 2014 and TLG Promissory Notes.

The Hudson/Delano 2014 Mortgage Loan bears interest at a blended rate of 30-day LIBOR plus 565 basis points. The Company maintains interest rate caps for the principal amount of the Hudson/Delano 2014 Mortgage Loan that caps the LIBOR rate on the debt under the Hudson/Delano 2014 Mortgage Loan at approximately 1.75% through the initial maturity date.

The Hudson/Delano 2014 Mortgage Loan matures on February 9, 2016. The Company has three, one-year extension options that will permit the Company to extend the maturity date of the Hudson/Delano 2014 Mortgage Loan to February 9, 2019, if certain conditions are satisfied at the respective extension dates, including delivery by the borrowers of a business plan and budget for the extension term reasonably satisfactory to the lenders and achievement by the Company of a specified debt yield. The Company may prepay the Hudson/Delano 2014 Mortgage Loan in an amount necessary to achieve the specified debt yield.  The second and third extensions would also require the payment of an extension fee in an amount equal to 0.25% of the then outstanding principal amount under the Hudson/Delano 2014 Mortgage Loan.

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

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

The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano South Beach and the owners of Hudson and Delano South Beach and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities loans. The Hudson/Delano 2014 Mortgage Loan is nonrecourse to the Company’s subsidiaries that are the borrowers under the loan, except pursuant to certain carveouts detailed therein. In addition, the Company has provided a customary environmental indemnity and nonrecourse carveout guaranty under which it would have liability with respect to the Hudson/Delano 2014 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, changes to the Hudson capital lease without prior written consent of the lender, violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty prohibits the payment of dividends on or repurchase of the Company’s common stock. As of June 30, 2015, the Company was in compliance with these covenants.

(b) Clift Debt

In October 2004, Clift Holdings LLC (“Clift Holdings”), a subsidiary of the Company, sold the Clift hotel to an unrelated party for $71.0 million and then leased it back for a 99-year lease term. Under this lease, Clift Holdings is required to fund operating expenditures including the lease payments and to fund all capital expenditures. This transaction did not qualify as a sale due to the Company’s continued involvement and therefore is treated as a financing.

 

18


 

The lease agreement provides for base annual rent of approximately $6.0 million per year until October 2014 with increases each five years thereafter. As a result of the first such increase, effective October 14, 2014, the annual rent increased to $7.6 million.  Base rent increases by a formula tied to increases in the Consumer Price Index, with a maximum increase of 20% and a minimum increase of 10% at each five-year rent increase date thereafter. The lease is nonrecourse to the Company.

Morgans Group also entered into an agreement, dated September 17, 2010, whereby Morgans Group agreed to guarantee losses of up to $6.0 million suffered by the lessors in the event of certain “bad boy” type acts. As of June 30, 2015, there had been no triggering event that would require the Company to recognize a liability related to this guarantee.

(c) Liability to Subsidiary Trust Issuing Preferred Securities

On August 4, 2006, a trust formed by the Company, MHG Capital Trust I (the “Trust”), issued $50.0 million in trust preferred securities in a private placement. The Company owns all of the $0.1 million of outstanding common stock of the Trust. The Trust used the proceeds of these transactions to purchase $50.1 million of junior subordinated notes issued by the Company’s operating company and guaranteed by the Company (the “Trust Notes”) which mature on October 30, 2036. The sole assets of the Trust consist of the Trust Notes. The terms of the Trust Notes are substantially the same as preferred securities issued by the Trust. The Trust Notes and the preferred securities have a fixed interest rate of 8.68% until October 2016, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum. The Trust Notes are redeemable by the Trust, at the Company’s option, at par, and the Company has not redeemed any Trust Notes. To the extent the Company redeems the Trust Notes, the Trust is required to redeem a corresponding amount of preferred securities.

The Company has identified that the Trust is a variable interest entity under ASC 810-10. Based on management’s analysis, the Company is not the primary beneficiary of the trust. Accordingly, the Trust is not consolidated into the Company’s financial statements. The Company accounts for the investment in the common stock of the Trust under the equity method of accounting.

In the event the Company were to undertake a transaction that was deemed to constitute a transfer of its properties and assets substantially as an entirety within the meaning of the indenture, the Company may be required to repay the Trust Notes prior to their maturity or obtain the trustee’s consent in connection with such transfer.

(d) Restaurant Lease Note

As discussed in note 2, in August 2012, the Company acquired the leasehold interests in three food and beverage venues at Mandalay Bay from an existing tenant for $15.0 million in cash at closing and the issuance of a principal-only $10.6 million Restaurant Lease Note to be paid over seven years. The Restaurant Lease Note does not bear interest except in the event of default, as defined in the agreement. In accordance with ASC 470, Debt, the Company imputed interest on the Restaurant Lease Note, which was recorded at its fair value of $7.5 million as of the date of issuance. At June 30, 2015, the carrying amount of the Restaurant Lease Note was $5.3 million.

(e) Capital Lease Obligations

The Company has leased two condominium units at Hudson from unrelated third-parties, which are reflected as capital leases. One of the leases requires the Company to make annual payments, currently $649,728 (subject to increases due to increases in the Consumer Price Index), through November 2096. This lease also allows the Company to purchase, at its option, the unit at fair market value after November 2015. The second lease requires the Company to make annual payments, currently $365,490 (subject to increases due to increases in the Consumer Price Index), through December 2098.

The Company has allocated both lease payments between the land and building based on their estimated fair values. The portion of the payments allocated to the building has been capitalized at the present value of the future minimum lease payments. The portion of the payments allocable to the land is treated as operating lease payments. The imputed interest rate on both of these leases is 8%, which is based on the Company’s incremental borrowing rate at the time the lease agreement was executed. The capital lease obligations related to the units amounted to approximately $6.1 million as of June 30, 2015 and December 31, 2014, respectively. Substantially all of the principal payments on the capital lease obligations are due at the end of the lease agreements.

(f) Repaid and Retired Debt

Hudson Mortgage and Mezzanine Loan.  On November 14, 2012, certain of the Company’s subsidiaries entered into the Hudson 2012 Mortgage Loan, a mortgage financing with UBS Real Estate Securities Inc., as lender, consisting of a $180.0 million nonrecourse mortgage loan, secured by Hudson, which was fully-funded at closing.

 

19


 

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

In connection with the Hudson/Delano 2014 Mortgage Loan, the Hudson 2012 Mortgage Loan was terminated after repayment of the outstanding debt thereunder in February 2014.

TLG Promissory Notes.  The TLG Promissory Notes were scheduled to mature in November 2015 and could have been voluntarily prepaid, in full or in part, at any time.  The TLG Promissory Notes earned interest at an annual rate of 8%, provided that if the notes were not paid or converted on or before November 30, 2014, the interest rate increased to 18%. The TLG Promissory Notes also provided that 75% of the accrued interest was payable quarterly in cash and the remaining 25% accrued and was included in the principal balance which is payable at maturity.

In December 2014, the Company used cash on hand to repay and retire $19.1 million of outstanding TLG Promissory Notes, which included the original principal balance of $18.0 million plus deferred interest of $1.1 million.  

As discussed further in note 8, on August 5, 2013, Messrs. Sasson and Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition and Morgans Group alleging, among other things, breach of contract and an event of default under the TLG Promissory Notes.  Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit remains pending in connection with issues related primarily to the interest rates applicable to the TLG Promissory Notes.  

Convertible Notes. On October 17, 2007, the Company issued $172.5 million aggregate principal amount of 2.375% Senior Subordinated Convertible Notes in a private offering. Net proceeds from the offering were approximately $166.8 million. Throughout 2014, the Company repurchased an aggregate of $123.4 million of outstanding Convertible Notes for an amount equal to their principal balance plus accrued interest.  On October 15, 2014, the Convertible Notes matured and the Company repaid the outstanding principal amount of $49.1 million with cash on hand. All Convertible Notes were retired upon repayment.

The Company followed ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), which clarifies the accounting for convertible notes payable. ASC 470-20 requires the proceeds from the issuance of convertible notes to be allocated between a debt component and an equity component. The debt component is measured based on the fair value of similar debt without an equity conversion feature, and the equity component is determined as the residual of the fair value of the debt deducted from the original proceeds received. The resulting discount on the debt component is amortized over the period the debt is expected to be outstanding as additional interest expense. The debt component of the Convertible Notes was fully amortized as of the maturity date.  The equity component, recorded as additional paid-in capital, was determined to be $9.0 million, which represented the difference between the proceeds from issuance of the Convertible Notes and the fair value of the liability, net of deferred taxes of $6.4 million as of the date of issuance of the Convertible Notes.    

Delano Credit Facility.  On July 28, 2011, the Company and certain of its subsidiaries (collectively, the “Borrowers”), entered into a secured credit agreement with Deutsche Bank Securities Inc. as sole lead arranger, Deutsche Bank Trust Company Americas, as agent, and the lenders party thereto.

The credit agreement provided commitments for the Delano Credit Facility, a $100.0 million revolving credit facility and included a $15.0 million letter of credit sub-facility. The interest rate applicable to loans outstanding on the Delano Credit Facility was a floating rate of interest per annum, at the Borrowers’ election, of either LIBOR (subject to a LIBOR floor of 1.00%) plus 4.00%, or a base rate, as defined in the agreement, plus 3.00%. In addition, a commitment fee of 0.50% applied to the unused portion of the commitments under the Delano Credit Facility.

In connection with the closing of the Hudson/Delano 2014 Mortgage Loan, described above, the Delano Credit Facility was terminated after repayment of the outstanding debt thereunder in February 2014.

 

 

7. Commitments and Contingencies

Hotel Development Related Commitments

In order to obtain long-term management, franchise and license contracts, the Company may commit to contribute capital in various forms on hotel development projects. These include equity investments, key money, and cash flow guarantees to hotel owners. The cash flow guarantees generally have a stated maximum amount of funding and a defined term. The terms of the cash flow guarantees to hotel owners generally require the Company to fund if the hotels do not attain specified levels of operating profit. Cash flow guarantees to hotel owners may be recoverable as loans repayable to the Company out of future hotel cash flows and/or proceeds from the sale of hotels.

 

20


 

As of June 30, 2015, pro forma for the Delano Marrakech settlement discussed below, the Company’s potential funding obligations under cash flow guarantees at hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum amount cannot be determined, was $5.0 million.    

The Company has signed management, license or franchise agreements for new hotels which are in various stages of development. As of June 30, 2015, these included the following:

 

 

 

Expected

Room

Count

 

Anticipated

Opening

 

Initial

Term

Hotels Currently Under Construction or Renovation:

 

 

 

 

 

 

Mondrian Doha

 

270

 

2015

 

30 years

Delano Dubai

 

110

 

2017

 

20 years

Other Signed Agreements:

 

 

 

 

 

 

Mondrian Dubai

 

235

 

 

 

15 years

Mondrian Istanbul

 

114

 

 

 

20 years

Delano Aegean Sea

 

150

 

 

 

20 years

Delano Cartagena

 

211

 

 

 

20 years

 

There can be no assurances that any or all of the Company’s 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 the Company may be unable to recover any previously funded key money, equity investments or debt financing.  

Due to the Company’s joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, the Company exercised its put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 4.  While the Company has entered into a settlement agreement with its Mondrian Istanbul joint venture partner, until the Company receives the settlement payment, it continues to maintain its rights in the property.

Other Guarantees to Hotel Owners

As discussed above, the Company has provided certain cash flow guarantees to hotel owners in order to secure management contracts.

The Company’s hotel management agreements for Royalton and Morgans contain cash flow guarantee performance tests that stipulate certain minimum levels of operating performance. These performance test provisions give the Company the option to fund a shortfall in operating performance limited to the Company’s earned base fees. If the Company chooses not to fund the shortfall, the hotel owner has the option to terminate the management agreement. Historically, the Company has funded the shortfall and as of June 30, 2015, approximately $0.4 million was accrued as a reduction to management fees related to these performance test provisions.  Until 2016 and so long as the Company funds the shortfalls, the hotel owners do not have the right to terminate the Company as hotel manager. The Company’s maximum potential amount of future fundings related to the Royalton and Morgans performance guarantee cannot be determined as of June 30, 2015, but under the hotel management agreements is limited to the Company’s base fees earned.

Additionally, the Company is currently subject to performance tests under certain other of its hotel management agreements, which could result in early termination of the Company’s hotel management agreements.  As of June 30, 2015, the Company is in compliance with these termination performance tests and is 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 the Company has the right to cure any performance failures, subject to certain limitations.  

Operating Joint Venture Hotels Commitments and Guarantees

The following details obligations the Company has or may have related to its operating and former joint venture hotels as of June 30, 2015.

Mondrian South Beach Mortgage and Mezzanine Agreements. Morgans Group and affiliates of its joint venture partner have agreed to provide standard nonrecourse carve-out guarantees and provide certain limited indemnifications for the Mondrian South Beach mortgage and mezzanine loans. In the event of a default, the lenders’ recourse is generally limited to the mortgaged property or related equity interests, subject to standard nonrecourse carve-out guarantees for “bad boy” type acts. Morgans Group and affiliates of its joint venture partner also agreed to guarantee the joint venture’s obligation to reimburse certain expenses incurred by the lenders

 

21


 

and indemnify the lenders in the event such lenders incur liability in connection with certain third-party actions. Morgans Group and affiliates of its joint venture partner have also guaranteed the joint venture’s liability for the unpaid principal amount of any seller financing note provided for condominium sales if such financing or related mortgage lien is found unenforceable, provided they shall not have any liability if the seller financed unit becomes subject to the lien of the lender’s mortgage or title to the seller financed unit is otherwise transferred to the lender or if such seller financing note is repurchased by Morgans Group and/or affiliates of its joint venture at the full amount of unpaid principal balance of such seller financing note. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, Morgans Group and affiliates of its joint venture partner may have continuing obligations under construction completion guarantees until all outstanding payables due to construction vendors are paid. As of June 30, 2015, there were remaining payables outstanding to vendors of approximately $0.3 million. Pursuant to a letter agreement with the lenders for the Mondrian South Beach loan, the joint venture agreed that these payables, many of which are currently contested or under dispute, will not be paid from operating funds but only from tax abatements and settlements of certain lawsuits. In the event funds from tax abatements and settlements of lawsuits are insufficient to repay these amounts in a timely manner, the Company and its joint venture partner are required to fund the shortfall amounts.

The Company and affiliates of its joint venture partner also have each agreed to purchase approximately $14.0 million of condominium units under certain conditions, including an event of default. In the event of a default under the lender’s mortgage or mezzanine loan, the joint venture partners are each obligated to purchase selected condominium units, at agreed-upon sales prices, having aggregate sales prices equal to 1/2 of the lesser of $28.0 million, which is the face amount outstanding on the lender’s mezzanine loan, or the then outstanding principal balance of the lender’s mezzanine loan. The joint venture is not currently in an event of default under the mortgage or mezzanine loan. As of June 30, 2015, there had been no triggering event that would require the Company to recognize a liability related to the construction completion or the condominium purchase guarantees.

Ames. On April 26, 2013, the joint venture closed on a new loan agreement with the mortgage lenders that provided for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. The Company did not contribute to the cash paydown and instead entered into an agreement with its joint venture partner pursuant to which, among other things, (1) the Company assigned its equity interests in the joint venture to its joint venture partner, (2) the Company agreed to give its joint venture partner the right to terminate its management agreement upon 60 days’ prior notice in return for an aggregate payment of $1.8 million, and (3) a creditworthy affiliate of the Company’s joint venture partner has assumed all or a portion of the Company’s potential liability with respect to historic tax credit guarantees, with the Company’s liability for any tax credit guarantees capped, in any event, at $3.0 million in the aggregate. The potential liability for historic tax credit guarantees relates to approximately $16.9 million of federal and state historic rehabilitation tax credits that Ames qualified for at the time of its development. As of June 30, 2015, there had been no triggering event that would require the Company to accrue any potential liability related to the historic tax credit guarantee.

Litigation Regarding Mondrian SoHo

On January 16, 2013, German American Capital Corporation (“GACC” or the “lender”), the lender for the mortgage loans on the Mondrian SoHo property, 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 then owned Mondrian SoHo (“Sochin JV”), Morgans Management, the then manager for the hotel, 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 $217.0 million outstanding on the loans when they became due on November 15, 2012. Cape Advisors Inc. indirectly owned 80% of the equity interest in Sochin JV and Morgans Group indirectly owned the remaining 20% equity interest.

A foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was held on January 7, 2015, at which GACC was the sole and winning bidder. GACC had an agreement to assign its bid to 9 Crosby LLC, an affiliate of Sapir, a New York-based real estate development and management organization.  In connection with that contract, GACC and Sapir agreed to terminate the Company as manager of Mondrian SoHo.  The sale of the Mondrian SoHo hotel property to Sapir closed on March 6, 2015.  

On October 24, 2014, the Company filed suit in the Supreme Court of the State of New York seeking a declaration that the mortgage lenders to the Mondrian SoHo debt or Sapir could not remove it as hotel manager following the conclusion of the foreclosure proceedings.   On February 9, 2015, the court heard the Company’s motion for a preliminary injunction preventing the mortgage lender and/or the ultimate buyer from removing it as manager of Mondrian SoHo pending resolution of the lawsuit; that motion was denied in an oral ruling that same day.  On February 27, 2015, the Company filed an appeal of the denial of its motion for a preliminary injunction in the Supreme Court of New York, Appellate Division, First Department. That appeal is currently pending.

 

22


 

On April 24, 2015, the court ordered Morgans to vacate the premises on or before April 27, 2015.  Consistent with that order, Morgans ceased to manage Mondrian SoHo on April 27, 2015.  The parties have submitted a stipulation permitting the Company to file a second amended complaint asserting claims for damages against the lenders, Sapir, and affiliates of Sapir for breach of the hotel management agreement and related subordination agreement, as well as for tortious interference with those contracts.  Upon formal approval of the court the second amended complaint will be filed and served.  The case is currently in the discovery phase.  

Litigation Regarding Delano Marrakech  

In June 2013, the Company 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. On September 12, 2013, the Company commenced arbitration with the owner pursuant to the management agreement to recover losses and damages suffered by the Company.  The Company and the hotel owner recently entered into a settlement agreement, pursuant to which the Company will receive $2.5 million, with $1.3 million being paid at signing and $1.2 million paid over a three-year period in quarterly payments of $0.1 million. Additionally, as stipulated by the settlement agreement, the Company is no longer obligated to fund cash flow guarantees.  As a result of entry into the settlement agreement, the arbitration will be concluded upon receipt of the final order of the tribunal.

Litigation Regarding TLG Promissory Notes

On August 5, 2013, Messrs. Andrew Sasson and Andy Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition LLC and Morgans Group LLC relating to the $18.0 million TLG Promissory Notes. See note 1 and note 7 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 the Company’s failure to repay the TLG Promissory Notes following an alleged “Change of Control” that purportedly occurred upon the election of the Company’s current Board of Directors on June 14, 2013. The complaint sought payment of Mr. Sasson’s $16.0 million TLG Promissory Note and Mr. Masi’s $2.0 million TLG Promissory Note, plus interest compounded to principal, as well as default interest, and reasonable costs and expenses incurred in the lawsuit. On September 26, 2013, the Company filed a motion to dismiss the complaint in its entirety. On February 6, 2014, the court granted the Company’s 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.  On April 9, 2015, the Appellate Division, First Department, reversed the trial court’s decision, denying the motion to dismiss and remanding to the trial court for further proceedings.  The Company filed a motion for reconsideration at the appellate court, which was denied on July 7, 2015.  The Company filed its answer to the complaint with the trial court on May 11, 2015.  Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit remains pending in connection with issues related primarily to the interest rates applicable to the TLG Promissory Notes.  

Environmental

As a holder of real estate, the Company is subject to various federal, state and local environmental laws. Compliance by the Company with existing laws has not had an adverse effect on the Company and management does not believe that it will have a material adverse impact in the future. However, the Company cannot predict the impact of new or changed laws or regulations.

Other Litigation

The Company is involved in various lawsuits and administrative actions in the normal course of business, in addition to the other litigation noted above.

 

 

8. Omnibus Stock Incentive Plan

On February 9, 2006, the Board of Directors of the Company adopted the Morgans Hotel Group Co. 2006 Omnibus Stock Incentive Plan. Subsequently and on several occasions, the Company’s Board of Directors adopted, and stockholders approved, amendments to the Omnibus Stock Incentive Plan (the “Stock Plan”), to namely increase the number of shares reserved for issuance under the plan. As of June 30, 2015, the Stock Plan had 14,610,000 shares reserved for issuance.

The Stock Plan provides for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock options, stock appreciation rights, shares of common stock of the Company, including restricted stock units (“RSUs”) and other equity-based awards, including membership units in Morgans Group which are structured as profits interests (“LTIP Units”), or any combination of the foregoing. The eligible participants in the Stock Plan include directors, officers and employees of the Company. Awards other than options and stock appreciation rights reduce the shares available for grant by 1.7 shares for each share subject to such an award.

 

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On May 13, 2015, the Company issued an aggregate of 37,936 RSUs, which vested immediately, to Jonathan A. Langer, pursuant to terms of a consulting agreement between the Company and Mr. Langer, discussed further in note 10.  The estimated fair value of the RSUs granted was based on the closing price of the Company’s common stock on the grant date.

On May 19, 2015, the Company issued an aggregate of 120,656 RSUs to eight non-employee directors under the Stock Plan for their annual retainer for the 2015-2016 Board of Directors term. These grants become 100% vested on May 13, 2016, provided that upon a non-employee director’s resignation from the Board of Directors, other than as a consequence of the director’s bad acts, the vesting of any RSUs will be on a pro rated basis as of the resignation date. The estimated fair value of each such RSU granted was based on the closing price of the Company’s common stock on the grant date.

In addition, the Company has granted, or may grant, RSUs to certain executives, employees or non-employee directors as part of future annual equity grants or to newly hired or promoted employees from time to time.

A summary of stock-based incentive awards as of June 30, 2015 is as follows (in units, or shares, as applicable):

 

 

 

Restricted Stock

Units

 

 

LTIP Units

 

 

Stock Options

 

Outstanding as of January 1, 2015

 

 

335,672

 

 

 

941,157

 

 

 

1,124,740

 

Granted during 2015

 

 

163,018

 

 

 

 

 

 

 

Distributed/exercised during 2015

 

 

(234,986

)

 

 

(27,734

)

 

 

 

Forfeited or cancelled during 2015

 

 

(25,815

)

 

 

 

 

 

(876,425

)

Outstanding as of June 30, 2015

 

 

237,889

 

 

 

913,423

 

 

 

248,315

 

Vested as of June 30, 2015

 

 

 

 

 

913,423

 

 

 

248,315

 

 

Total stock compensation expense, which is included in corporate expenses on the accompanying consolidated statements of comprehensive loss, was $0.6 million, $0.8 million, $0.9 million, and $2.7 million for the three and six months ended June 30, 2015 and 2014, respectively.

As of June 30, 2015 and December 31, 2014, there were approximately $4.6 million and $5.9 million, respectively, of total unrecognized compensation costs related to unvested share awards. As of June 30, 2015, the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 0.8 years.

 

 

9. Preferred Securities and Warrants

Preferred Securities and Warrants Held by Yucaipa Investors

On October 15, 2009, the Company entered into a Securities Purchase Agreement with the Yucaipa Investors. Under the agreement, the Company issued and sold to the Yucaipa Investors (i) $75.0 million of preferred stock comprised of 75,000 shares of the Company’s Series A preferred securities, $1,000 liquidation preference per share, and (ii) warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share, or the Yucaipa Warrants, which are exercisable utilizing a cashless exercise method only, resulting in a net share issuance.

The Series A preferred securities had an 8% dividend rate through October 15, 2014 and have a 10% dividend rate until October 15, 2016 and a 20% dividend rate thereafter. The Company has the option to accrue any and all dividend payments. The cumulative unpaid dividends have a dividend rate equal to the dividend rate on the Series A preferred securities. As of June 30, 2015, the Company had undeclared and unpaid dividends of approximately $49.2 million. The Company has the option to redeem any or all of the Series A preferred securities at par at any time. The Series A preferred securities have limited voting rights and only vote on the authorization to issue senior preferred securities, amendments to their certificate of designations and amendments to the Company’s charter that adversely affect the 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 the Company’s certificate of incorporation.  

 

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As discussed in note 2, the Yucaipa Warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share have a 7-1/2 year term and are exercisable utilizing a cashless exercise method only, resulting in a net share issuance. In accordance with ASC 815-10-15, the Yucaipa Warrants are accounted for as equity instruments indexed to the Company’s stock. The Yucaipa Investors’ right to exercise the Yucaipa Warrants to purchase 12,500,000 shares of the Company’s common stock expires in April 2017. The exercise price and number of shares subject to the Yucaipa Warrants are both subject to anti-dilution adjustments.

For so long as the Yucaipa Investors collectively own or have the right to purchase through exercise of the Yucaipa Warrants (assuming a cash rather than a cashless exercise) 875,000 shares of the Company’s common stock, the Company has agreed to use its reasonable best efforts to cause its Board of Directors to nominate and recommend to the Company’s 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 the Company’s 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 the Company does 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 the Company’s Board of Directors. 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 the Company’s Board of Directors. On April 3, 2015, a Yucaipa Investors’ nominee was appointed to the Company’s Board of Directors, and was re-elected by shareholders at the Company’s annual meeting on May 13, 2015.  

Under 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, assuming cashless exercise of the Yucaipa Warrants, 6,250,000 shares of the Company’s common stock, including (subject to certain exceptions and limitations):

·

the sale of substantially all of the Company’s assets to a third party;

·

the acquisition by the Company of a third party where the equity investment by the Company is $100.0 million or greater;

·

the acquisition of the Company by a third party; or

·

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

The Yucaipa Investors are subject to certain standstill arrangements as long as they beneficially own over 15% of the Company’s common stock.

The initial carrying value of the Series A preferred securities was recorded at its net present value less costs to issue on the date of issuance. The carrying value will be periodically adjusted for accretion of the discount. As of June 30, 2015, the value of the preferred securities was $68.7 million, which includes cumulative accretion of $20.7 million.

 

 

10. Related Party Transactions

The Company earned management fees, chain services reimbursements and fees for certain technical services and has receivables from hotels owned by unconsolidated joint ventures. These fees totaled approximately $0.5 million and $1.2 million for the three months ended June 30, 2015 and 2014, respectively, and $1.3 million and $2.4 million for the six months ended June 30, 2015 and 2014, respectively.

As of June 30, 2015 and December 31, 2014, the Company had receivables from these affiliates of approximately $2.7 million and $3.6 million, respectively, which are included in related party receivables on the accompanying consolidated balance sheets.

On May 7, 2015, the Company entered into a Consulting Agreement with Jonathan Langer, then a member of the Company’s Board of Directors, pursuant to which Mr. Langer will provide consulting services to the Company, at the direction of the Board of Directors, in connection with the Company’s previously announced strategic alternatives process, as well as on-going financial and operating consulting services to the Company. The Company’s Board of Directors believes that Mr. Langer is uniquely suited to provide financial and strategic advisory services to the Company because of his extensive experience both in the financial sector and hospitality industry, as well as his tenure as a director and chairman of the Board of Directors’ special transaction committee.  Effective immediately upon the entering of the Consulting Agreement, Mr. Langer resigned from the Board of Directors.  

Under the terms of the Consulting Agreement, to advance the strategic alternatives process and in consideration of the services Mr. Langer provided to the Company over the course of the prior year beyond his duties as a director, the Company paid Mr. Langer a one-time fee of $500,000, of which $250,000 was paid in cash and $250,000 was paid in common stock of the Company under the Stock Plan, which fully vested on the date of grant.   Additionally, the Company will pay Mr. Langer a consulting fee of $375,000 per

 

25


 

quarter (beginning with the fiscal quarter starting April 1, 2015), payable within ten business days following the end of each quarter and prorated for any partial quarter.   Any quarterly consulting fee will be payable by the Company up to 50% in cash and the balance in fully-vested common stock of the Company granted under the Plan.  In the event the Consulting Agreement is terminated without cause or a Corporate Transaction (as defined win the Stock Plan) occurs within one year following the effective date of the Consulting Agreement, Mr. Langer will be entitled to a special payment equal to (x) $500,000 less (y)(i) $125,000 multiplied by (ii) the number of quarterly payments previously paid to Mr. Langer, payable in cash or stock at the Company’s option. The Consulting Agreement is terminable at will by either party upon written notice of no less than 20 business days.  

The members of the Audit Committee, together with a majority of the Board of Directors (excluding Mr. Langer), voted to approve the Consulting Agreement pursuant to the Company’s Related Persons Transaction Policy and Procedures.