10-Q 1 mhgc-10q_20160930.htm FORM 10-Q mhgc-10q_20160930.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

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

For the quarterly period ended: September 30, 2016

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      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      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

 

 

 

 

 

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  

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of November 5, 2016 was 34,981,553.

 

 

 

 

 


 

TABLE OF CONTENTS

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

ITEM 1. FINANCIAL STATEMENTS

 

 

 

MORGANS HOTEL GROUP CO. CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2016 (UNAUDITED) AND DECEMBER 31, 2015

 

5

 

MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS FOR THE PERIODS ENDED SEPTEMBER 30, 2016 and 2015

 

6

 

MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE PERIODS ENDED SEPTEMBER 30, 2016 and 2015

 

7

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

8

 

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

 

25

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

42

 

ITEM 4. CONTROLS AND PROCEDURES

 

43

 

PART II. OTHER INFORMATION

 

 

 

ITEM 1. LEGAL PROCEEDINGS

 

44

 

ITEM 1A. RISK FACTORS

 

45

 

ITEM 6. EXHIBITS

 

45

 

 

 

 

 

 

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:  

 

risks related to the consummation of our pending acquisition by SBEEG Holdings, LLC (“SBE”);

 

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

 

our business operations, including our ability to enter into new management, franchise or licensing agreements and the enhanced the value of existing hotels and management agreements;

 

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

 

the effect of new lodging supply;

 

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

 

the timing of receiving expected hotel management agreement termination fees; and

 

the outcome of litigation to which the Company is a party, including litigation related to our pending acquisition by SBE.

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, 2015, our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2016 and June 30, 2016, 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:

 

risks related to the proposed acquisition of the Company by SBE and the related diversion of management’s attention from the operation of the business;

 

risks related to our ability to successfully execute on an alternative transaction should we be unable to successfully consummate the sale of the Company to SBE;

 

risks we may face from the impact or outcome of pending or future litigation related to our proposed acquisition by SBE;

 

our ability to refinance the Hudson/Delano 2014 Mortgage Loan  or sell one or more of Hudson or Delano South Beach in order to extend the Hudson/Delano 2014 Mortgage Loan (as defined below) in February 2017 in the event the SBE acquisition does not close;

 

a downturn in economic and market conditions, both in the U.S. and internationally, including the impact of new supply in key markets in which we operate, particularly as it impacts demand for travel, hotels, dining and entertainment;

 

our level of debt under our outstanding debt agreements, our obligations under our preferred equity instruments, our ability to restructure or refinance our current outstanding debt and preferred equity instruments, our ability to generate sufficient cash to repay or redeem outstanding debt and preferred equity instruments or make payments on guarantees as they may become due;

 

the impact of any dividend payments or accruals on our Series A preferred equity instruments on our cash flow and the value of our common stock;

 

the impact of restructuring charges on our liquidity;

3


 

 

general volatility of our stock price, the capital markets and our ability to access the capital markets;

 

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

 

our history of losses;

 

our liquidity position;  

 

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 operate;

 

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

 

risks related to natural disasters or outbreaks of contagious diseases (including the recent Zika outbreak in the Miami area), terrorist attacks, the threat of terrorist attacks and similar disasters, including a downturn in travel, hotels, dining and entertainment resulting therefrom;

 

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 owned properties of Morgans Hotel Group and associated brands;

 

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

 

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

 

potential terminations of management agreements and timing of receipt of anticipated termination fees;

 

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; and

 

other risks discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 and in the Quarterly Reports on Form 10-Q for the periods ended March 31, 2016 and June 30, 2016 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)

 

 

 

September 30,

2016

 

 

December 31,

2015

 

 

 

(unaudited)

 

 

 

 

 

ASSETS

 

 

 

 

 

 

 

 

Property and equipment, net

 

$

254,533

 

 

$

265,678

 

Goodwill

 

 

53,691

 

 

 

54,057

 

Investments in and advances to unconsolidated joint ventures

 

 

100

 

 

 

100

 

Cash and cash equivalents

 

 

10,647

 

 

 

45,925

 

Restricted cash

 

 

16,739

 

 

 

12,892

 

Accounts receivable, net

 

 

7,601

 

 

 

8,325

 

Prepaid expenses and other assets

 

 

6,547

 

 

 

8,897

 

Deferred tax asset, net

 

 

129,435

 

 

 

128,645

 

Other assets, net

 

 

30,032

 

 

 

33,516

 

Total assets

 

$

509,325

 

 

$

558,035

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

Debt and capital lease obligations, net of deferred financing costs of $3.0 million and $3.7 million as of September 30, 2016 and December 31, 2015, respectively

 

$

575,724

 

 

$

602,630

 

Accounts payable and accrued liabilities

 

 

41,530

 

 

 

33,599

 

Deferred gain on asset sales

 

 

111,363

 

 

 

117,378

 

Other liabilities

 

 

13,866

 

 

 

13,866

 

Total liabilities

 

 

742,483

 

 

 

767,473

 

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 September 30, 2016 and December 31, 2015,

   respectively

 

 

74,777

 

 

 

71,025

 

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

   at September 30, 2016 and December 31, 2015, respectively

 

 

363

 

 

 

363

 

Additional paid-in capital

 

 

233,007

 

 

 

236,730

 

Treasury stock, at cost, 1,297,687 and 1,541,381 shares of common stock at

   September 30, 2016 and December 31, 2015, respectively

 

 

(13,064

)

 

 

(17,257

)

Accumulated other comprehensive loss

 

 

(2,231

)

 

 

(1,131

)

Accumulated deficit

 

 

(526,559

)

 

 

(499,765

)

Total Morgans Hotel Group Co. stockholders’ deficit

 

 

(233,707

)

 

 

(210,035

)

Noncontrolling interest

 

 

549

 

 

 

597

 

Total deficit

 

 

(233,158

)

 

 

(209,438

)

Total liabilities and stockholders’ deficit

 

$

509,325

 

 

$

558,035

 

 

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 September 30, 2016

 

 

Three Months

Ended September 30, 2015

 

 

Nine Months

Ended September 30,

2016

 

 

Nine Months

Ended September 30,

2015

 

Revenues:

 

(unaudited)

 

Rooms

 

$

28,740

 

 

$

30,352

 

 

$

83,913

 

 

$

87,139

 

Food and beverage

 

 

14,219

 

 

 

17,697

 

 

 

52,195

 

 

 

58,942

 

Other hotel

 

 

2,592

 

 

 

1,953

 

 

 

7,205

 

 

 

5,921

 

Total hotel revenues

 

 

45,551

 

 

 

50,002

 

 

 

143,313

 

 

 

152,002

 

Management fee-related parties and other income

 

 

2,893

 

 

 

3,204

 

 

 

9,015

 

 

 

10,720

 

Total revenues

 

 

48,444

 

 

 

53,206

 

 

 

152,328

 

 

 

162,722

 

Operating Costs and Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rooms

 

 

9,770

 

 

 

9,579

 

 

 

29,077

 

 

 

27,877

 

Food and beverage

 

 

11,265

 

 

 

13,293

 

 

 

37,692

 

 

 

41,853

 

Other departmental

 

 

1,049

 

 

 

1,079

 

 

 

3,312

 

 

 

3,143

 

Hotel selling, general and administrative

 

 

9,407

 

 

 

9,980

 

 

 

28,937

 

 

 

30,550

 

Property taxes, insurance and other

 

 

4,389

 

 

 

4,061

 

 

 

13,040

 

 

 

12,355

 

Total hotel operating expenses

 

 

35,880

 

 

 

37,992

 

 

 

112,058

 

 

 

115,778

 

Corporate expenses, including stock compensation of

   $0.2 million,  $0.5 million, $0.5 million, and $1.4 million, respectively

 

 

3,822

 

 

 

5,247

 

 

 

12,870

 

 

 

16,194

 

Depreciation and amortization

 

 

5,716

 

 

 

5,586

 

 

 

16,945

 

 

 

16,786

 

Restructuring and development costs

 

 

2,482

 

 

 

1,764

 

 

 

5,776

 

 

 

4,911

 

Loss on receivables from unconsolidated joint venture

 

 

 

 

 

 

 

 

 

 

 

550

 

Total operating costs and expenses

 

 

47,900

 

 

 

50,589

 

 

 

147,649

 

 

 

154,219

 

Operating income

 

 

544

 

 

 

2,617

 

 

 

4,679

 

 

 

8,503

 

Interest expense, net

 

 

10,464

 

 

 

12,090

 

 

 

31,886

 

 

 

35,872

 

Impairment loss and equity in income of investment in

   unconsolidated joint venture

 

 

(3

)

 

 

(2

)

 

 

(7

)

 

 

3,886

 

Impairment loss on intangible asset

 

 

 

 

 

 

 

 

366

 

 

 

 

Gain on asset sales

 

 

(2,005

)

 

 

(2,005

)

 

 

(6,015

)

 

 

(7,799

)

Other non-operating expenses (income)

 

 

319

 

 

 

(112

)

 

 

1,163

 

 

 

3,095

 

Loss before income tax expense

 

 

(8,231

)

 

 

(7,354

)

 

 

(22,714

)

 

 

(26,551

)

Income tax expense

 

 

117

 

 

 

156

 

 

 

378

 

 

 

451

 

Net loss

 

 

(8,348

)

 

 

(7,510

)

 

 

(23,092

)

 

 

(27,002

)

Net loss attributable to noncontrolling interest

 

 

18

 

 

 

15

 

 

 

48

 

 

 

42

 

Net loss attributable to Morgans Hotel Group Co.

 

 

(8,330

)

 

 

(7,495

)

 

 

(23,044

)

 

 

(26,960

)

Preferred stock dividends and accretion

 

 

(4,835

)

 

 

(4,263

)

 

 

(13,961

)

 

 

(12,248

)

Net loss attributable to common stockholders

 

$

(13,165

)

 

$

(11,758

)

 

$

(37,005

)

 

$

(39,208

)

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

   of tax

 

 

202

 

 

 

59

 

 

 

(44

)

 

 

76

 

Foreign currency translation adjustment

 

 

(213

)

 

 

(279

)

 

 

(1,056

)

 

 

(793

)

Comprehensive loss

 

$

(13,176

)

 

$

(11,978

)

 

$

(38,105

)

 

$

(39,925

)

Loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted attributable to common stockholders

 

$

(0.38

)

 

$

(0.34

)

 

$

(1.06

)

 

$

(1.14

)

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted

 

 

34,884

 

 

 

34,618

 

 

 

34,812

 

 

 

34,500

 

 

See accompanying notes to these consolidated financial statements.

 

6


 

Morgans Hotel Group Co.

Consolidated Statements of Cash Flows

(in thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2016

 

 

2015

 

Cash flows from operating activities:

 

(unaudited)

 

Net loss

 

$

(23,092

)

 

$

(27,002

)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

 

Depreciation

 

 

14,594

 

 

 

14,399

 

Amortization of other costs

 

 

2,351

 

 

 

2,387

 

Amortization and write off of deferred financing costs

 

 

839

 

 

 

4,912

 

Gain on asset sales

 

 

(6,015

)

 

 

(7,799

)

Stock-based compensation

 

 

493

 

 

 

1,430

 

Accretion of interest

 

 

1,606

 

 

 

1,566

 

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

 

 

(7

)

 

 

3,886

 

Impairment loss on intangible asset

 

 

366

 

 

 

-

 

Loss on receivables from unconsolidated joint venture

 

 

 

 

 

550

 

Gain on transfer and disposal of assets

 

 

(647

)

 

 

(6

)

Change in value of interest rate caps

 

 

848

 

 

 

183

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, net

 

 

307

 

 

 

454

 

Restricted cash

 

 

(2,600

)

 

 

(803

)

Prepaid expenses and other assets

 

 

2,234

 

 

 

1,085

 

Accounts payable and accrued liabilities

 

 

8,989

 

 

 

86

 

Net cash provided by (used in) operating activities

 

 

266

 

 

 

(4,672

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Additions to property and equipment

 

 

(3,530

)

 

 

(4,636

)

Deposits into capital improvement escrows, net

 

 

(1,247

)

 

 

(1,071

)

Distributions from unconsolidated joint ventures

 

 

6

 

 

 

6,506

 

Proceeds from asset sale, net

 

 

 

 

 

30,806

 

Development hotel funding

 

 

 

 

 

(250

)

Net cash (used in) provided by investing activities

 

 

(4,771

)

 

 

31,355

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Payments on debt and capital lease obligations

 

 

(29,296

)

 

 

(1,098

)

Other debt costs

 

 

(1,456

)

 

 

 

Cash paid in connection with vesting of stock based awards

 

 

(21

)

 

 

(309

)

Net cash used in financing activities

 

 

(30,773

)

 

 

(1,407

)

Net (decrease) increase in cash and cash equivalents

 

 

(35,278

)

 

 

25,276

 

Cash and cash equivalents, beginning of year

 

 

45,925

 

 

 

13,493

 

Cash and cash equivalents, end of year

 

$

10,647

 

 

$

38,769

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

30,381

 

 

$

30,859

 

Cash paid for income taxes

 

$

470

 

 

$

564

 

 

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, and develops 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.

As further discussed in note 13, on May 9, 2016, the Company entered into a definitive agreement under which the Company will be acquired by SBEEG Holdings, LLC (“SBE”), a leading global lifestyle hospitality company.  Under the terms of the merger agreement, SBE will acquire all of the outstanding shares of the Company’s common stock for $2.25 per share in cash.  As of the date of this filing, November 9, 2016, the merger has not yet closed. On November 8, 2016, the parties to the merger agreement agreed to extend the outside date to November 30, 2016.  The parties are continuing to work towards closing the merger as promptly as practicable.  

The Company’s current cash balance and future cash flows may be insufficient to meet its near term obligations. Unforeseen expenses, a further downturn in operating results, the acquisition of the Company by SBE not closing, or any combination of the foregoing would further increase the Company’s cash flow concerns.  The Company is actively managing its cash flow to meet its obligations, however there can be no assurance that it will be successful. Furthermore, cash flow has historically been negative in January, the Company’s operationally slowest month of the year.

The Company has one reportable operating segment.  During the nine months ended September 30, 2016 and 2015, the Company derived 4.8% and 6.4% 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 September 30, 2016 were as follows:

 

Hotel Name

 

Location

 

Number of

Rooms

 

 

Interest

 

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

 

 

215

 

 

 

(6

)

Shore Club

 

Miami Beach, FL

 

 

308

 

 

 

(4

)

Mondrian Los Angeles

 

Los Angeles, CA

 

 

236

 

 

 

(2

)

Clift

 

San Francisco, CA

 

 

372

 

 

 

(5

)

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

 

 

 

(6

)

10 Karakoy

 

Istanbul, Turkey

 

 

71

 

 

 

(7

)

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 September 30, 2016, Hudson had 878 guest rooms and 60 single room dwelling units (“SROs”).

(2)

Operated under a management contract.

(3)

Wholly-owned hotel.

(4)

Operated under a management contract.  The Company currently expects to no longer manage Shore Club during the first quarter of 2017.    

(5)

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

(6)

A licensed hotel.  

(7)

A franchised hotel.  

 Food and Beverage Operations

As of September 30, 2016, the Company 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 June 1, 2016, the Company transferred all of its ownership interest in the food and beverage venues at Sanderson to the hotel owner.  The Company will continue to manage Sanderson’s food and beverage venues.  Prior to June 1, 2016, the Company leased and managed the Sanderson food and beverage venues, which were included in the Company’s consolidated financial statements.  As a result of this transfer, the Company impaired approximately $0.4 million of goodwill related to its ownership interest of the Sanderson food and beverage venues and recorded an approximately $0.7 million gain on the transfer during the nine months ended September 30, 2016.  

The Light Group

Acquisition.  On November 30, 2011, certain of the Company’s subsidiaries completed the acquisition of 90% of the equity interests in TLG Acquisition 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 Transaction”).  

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, as discussed further in note 6.  

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 Company has certain indemnification obligations, which generally survive for 18 months following the close of the TLG Equity Sale; however, no amounts are held in escrow for the satisfaction of such claims.  As of September 30, 2016, the Company has accrued approximately $0.3 million in liabilities 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.

 

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 (“U.S. GAAP”).  The Company consolidates all wholly-owned subsidiaries and variable

9


 

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 U.S. 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 U.S. 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 nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. 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, 2015.

Use of Estimates

The preparation of financial statements in conformity with U.S. 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 debt service or lease payments, insurance programs, and taxes, among others.  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 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.  In the event the debt yield ratio falls below 6.75%, any excess amounts will be retained by the lenders until the debt yield ratio exceeds 7.00% for two consecutive calendar quarters.  During the second quarter of 2016, the Company’s debt yield ratio fell below the defined threshold to 6.68%.   As a result, the lenders began retaining the excess cash flow of Hudson and Delano South Beach.  The Company’s debt yield ratio as of September 30, 2016 of 6.35% remained below the required threshold.  Such excess amounts will be retained by the lenders until the debt yield ratio exceeds 7.00% for two consecutive calendar quarters.     

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 whereby a signed sales contract and significant non-refundable deposit or contract break-up fee exist.  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.

 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 Account Standard Codification (“ASC”) 810-10, Consolidation.  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.  

10


 

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 an existing hotel 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 three food and beverage venues are managed by TLG and 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 allocated the total consideration paid, or to be paid, to the license agreement and the restaurant leasehold asset based on their respective fair values.  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 respective agreement.

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.

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 nine months ended September 30, 2016 and 2015 were computed using the Company’s effective tax rate.

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, as discussed further in note 9.  The Yucaipa Warrants are exercisable utilizing a cashless exercise method only, resulting in a net share issuance.  See note 13 for additional information about the Yucaipa Warrants.

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

11


 

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.  As of September 30, 2016 and December 31, 2015, 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 September 30, 2016, the Company had three interest rate caps outstanding and the fair value of these interest rate caps was $0.5 million.  

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 September 30, 2016 and December 31, 2015 due to the short-term maturity of these items or variable market interest rates.

The Company had outstanding fixed rate debt principal of $54.1 million and $54.9 million as of September 30, 2016 and December 31, 2015, 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 September 30, 2016 and December 31, 2015 of approximately $60.7 million and $60.6 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.  As of September 30, 2016 and December 31, 2015, 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.

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

12


 

noncontrolling interests and net income (loss) attributable to the common stockholders on the face of the consolidated statements of comprehensive loss.

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 $0.6 million as of September 30, 2016 and December 31, 2015, 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 September 30, 2016, 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 May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”, and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, as well as most industry-specific guidance.  The new standard sets forth five prescribed steps to determine the timing and amount of revenue to be recognized to appropriately depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  In March 2016, the FASB issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations”, which further clarifies the application of the standard depending on whether the entity is a principal or an agent. In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”, which deferred the effectiveness of ASU No. 2014-09 to reporting periods beginning after December 15, 2017.  The Company is currently evaluating the impact the new standard will have on its consolidated financial statements.  

In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230)”, which is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. This standard will be effective for the first annual reporting period beginning after December 15, 2017. The Company is currently evaluating the effect that ASU No. 2016-15 will have on its consolidated financial statements.

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 net income (loss) per common share is calculated by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period.  Vested LTIP Units (as defined in note 8) are considered participating securities and are included in the computation of basic earnings per common share pursuant to the two-class method.  Diluted net income (loss) per common share is calculated by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period, plus other potentially 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.  In periods when the Company has net loss attributable to Morgans Hotel Group Co., the Yucaipa Warrants issued to the Yucaipa Investors, unvested restricted stock units, LTIP Units (as defined in note 8), and stock options are excluded from the diluted net loss per common share calculation, as there would be no effect on reported diluted net loss per common share, however in periods when the Company has net income attributable to Morgans Hotel Group Co., these same securities are included in the diluted net income per common share calculation to the extent they are considered dilutive.  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 September 30, 2016 and December 31, 2015, are not reflected in the computation of basic and diluted earnings per share, as the income allocable to such membership units is allocated and reflected as noncontrolling interests in the accompanying consolidated financial statements.

13


 

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

September 30, 2016

 

 

Three Months

Ended

September 30, 2015

 

 

Nine Months

Ended

September 30, 2016

 

 

Nine Months

Ended

September 30, 2015

 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(8,348

)

 

$

(7,510

)

 

$

(23,092

)

 

$

(27,002

)

Net loss attributable to noncontrolling

   interest

 

 

18

 

 

 

15

 

 

 

48

 

 

 

42

 

Net loss attributable to Morgans Hotel

   Group Co.

 

 

(8,330

)

 

 

(7,495

)

 

 

(23,044

)

 

 

(26,960

)

Less: preferred stock dividends and accretion

 

 

4,835

 

 

 

4,263

 

 

 

13,961

 

 

 

12,248

 

Net loss attributable to common stockholders

 

$

(13,165

)

 

$

(11,758

)

 

$

(37,005

)

 

$

(39,208

)

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average basic common shares

   outstanding

 

 

34,884

 

 

 

34,618

 

 

 

34,812

 

 

 

34,500

 

Basic and diluted loss attributable to common

   stockholders per common share

 

$

(0.38

)

 

$

(0.34

)

 

$

(1.06

)

 

$

(1.14

)

 

 

4. Investments in and Advances to Unconsolidated Joint Ventures

 

The Company’s investments in and advances to unconsolidated joint ventures was $0.1 million and $0.1 million as of September 30, 2016 and December 31, 2015, respectively.  The Company’s income from unconsolidated joint ventures was immaterial for the three and nine months ended September 30, 2016 and 2015.   The Company recorded a $3.9 million impairment charge related to its investment in Mondrian Istanbul during the nine months ended September 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 operated Mondrian South Beach under a long-term management contract until June 8, 2016, discussed further below.   The Company accounted for its investment in Mondrian South Beach using the equity method of accounting.

On June 8, 2016, the Mondrian South Beach joint venture entered into a purchase and sale agreement to sell its interest in Mondrian South Beach.  Pursuant to the terms and conditions of the purchase and sale agreement, the buyer paid the joint venture a cash purchase price sufficient for the joint venture to extinguish its outstanding mortgage and mezzanine loans, plus accrued interest, in full at a negotiated discount, and the buyer assumed certain liabilities of Mondrian South Beach.  As a result of the debt extinguishment, the Company was released from the condominium purchase guarantee of up to $14.0 million and the construction completion guarantee. 

As part of this transaction, on June 8, 2016, the Company and the Mondrian South Beach joint venture mutually terminated their existing management agreement for Mondrian South Beach and the Company entered into a license agreement with the buyer to allow the hotel to remain under the Mondrian brand.  The license agreement grants the buyer a limited, non-exclusive right to use the Mondrian brand and other specified intellectual property of the Company, subject to certain termination rights, in exchange for a license fee that varies with Mondrian South Beach’s monthly gross revenue for the term of the license agreement but is subject to a minimum annual fee payable to the Company.  

As a result of the sale of Mondrian South Beach, effective June 8, 2016, the Company no longer held any ownership interest in the Mondrian South Beach real estate.   The joint venture has been funded with retained cash to fund known liabilities relating to the joint venture.  As of September 30, 2016, the Company is not aware of any events that would require the Company to recognize a liability related to the wind down of the Mondrian South Beach joint venture.

14


 

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 Company accounted for its investment in Mondrian SoHo using the equity method of accounting.  

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.  In 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.  

Mondrian Istanbul

In December 2011, the Company entered into a hotel management agreement for a 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 had a 20% ownership interest in the joint venture owning the hotel.

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 would have required the Company’s joint venture partner to buy back the Company’s equity interests in the Mondrian Istanbul joint venture.   In early 2015, as a result of settlement discussions, the Company determined that this investment was other-than-temporarily impaired and recorded a $3.9 million impairment charge for the three months ended March 31, 2015.   Subsequently, on June 26, 2015, the Company and its Mondrian Istanbul joint venture partner (and related parties) entered into a settlement agreement, which terminated all legal proceedings between the parties.  Pursuant to the settlement agreement, in September 2015, the Company received $6.5 million in exchange for the Company’s equity interest in the joint venture.  

 

 

5. Other Liabilities

As of September 30, 2016 and December 31, 2015, 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.

 

15


 

 

6. Debt and Capital Lease Obligations

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

 

Description

 

Principal as of

September 30, 2016

 

 

Unamortized Debt Issuance Costs as of

September 30, 2016

 

 

Net Debt as of

September 30, 2016

 

 

Interest rate at

September 30, 2016

Hudson/Delano Mortgage (a)

 

$

421,803

 

 

$

(20

)

 

$

421,783

 

 

5.94% (LIBOR cap + 5.65%)

Clift debt (b)

 

 

96,654

 

 

 

(46

)

 

 

96,608

 

 

9.60%

Liability to subsidiary trust (c)

 

 

50,100

 

 

 

(2,894

)

 

 

47,206

 

 

8.68%

Restaurant Lease Note (d)

 

 

4,023

 

 

 

-

 

 

 

4,023

 

 

(d)

Capital lease obligations (e)

 

 

6,104

 

 

 

-

 

 

 

6,104

 

 

(e)

Debt and capital lease obligation

 

$

578,684

 

 

$

(2,960

)

 

$

575,724

 

 

 

Deferred financing costs are amortized, using the straight line method, which approximates the effective interest rate method, over the terms of the related debt agreements.

(a) Hudson/Delano 2014 Mortgage Loan

On February 6, 2014, subsidiaries of the Company entered into a mortgage financing 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 repay the outstanding mortgage debt under the prior mortgage loan secured by Hudson, repay outstanding indebtedness under the Company’s senior secured revolving credit facility secured by Delano South Beach (the “Delano Credit Facility”), and fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital.  

The Hudson/Delano 2014 Mortgage Loan was scheduled to mature on February 9, 2016.  On that date, the Company paid $28.2 million to reduce the principal balance by the same amount and extend the maturity of this debt until February 9, 2017.  Following the extension, the Company has two additional 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 achievement by the Company of a trailing twelve month debt yield of no less than 7.75% for the first extension and no less than 8.00% for the second extension.  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 equal to 0.25% of the then outstanding principal amount under the Hudson/Delano 2014 Mortgage Loan.  Based on the Company’s trailing 12 month cash flow through September 30, 2016, the Company estimates that it would be required to prepay approximately $76.2 million of outstanding debt under the Hudson/Delano 2014 Mortgage Loan by February 9, 2017 and pay an approximately $1.0 million extension fee in order to extend the maturity date of the debt outstanding under the Hudson/Delano 2014 Mortgage Loan to February 9, 2018.  Because of this prepayment requirement, if the proposed acquisition by SBE is not consummated, the Company will need to explore a refinancing of the Hudson/Delano 2014 Mortgage Loan from external sources or seek to sell one or more of the Hudson and Delano South Beach.  There can be no assurance that the Company will be able to effect an asset sale or obtain external financing on favorable terms, if at all.  

 

The Hudson/Delano 2014 Mortgage Loan bears interest at a blended rate of 30-day LIBOR plus 565 basis points.  The Company maintained interest rate caps for the $450.0 million principal amount of the Hudson/Delano 2014 Mortgage Loan that capped the LIBOR rate on the debt under the Hudson/Delano 2014 Mortgage Loan at approximately 1.75% through the February 9, 2016.  In connection with the extension in February 2016, the Company purchased three interest rate caps with an aggregate notional value of $421.8 million that cap LIBOR at 0.29% through the next maturity date of the loan.  

The Hudson/Delano 2014 Mortgage Loan provides that 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.  In the event the debt yield ratio falls below 6.75%, any excess amounts will be retained by the lenders until the debt yield ratio exceeds 7.00% for two consecutive calendar quarters.  During the second quarter of 2016, the Company’s debt yield ratio fell below the required threshold to 6.68%.  As a result, the lenders began retaining the excess cash flow of Hudson and Delano South Beach.  The Company’s debt yield ratio as of September 30, 2016 of 6.35% remained below the required

16


 

threshold.  Such excess amounts will be retained by the lenders until the debt yield ratio exceeds 7.00% for two consecutive calendar quarters.   

The Hudson/Delano 2014 Mortgage Loan may be prepaid at any time, in whole or in part.  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 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 September 30, 2016, 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 shortfalls 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.

The lease agreement provided for base annual rent of approximately $6.0 million per year until October 2014.  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. As a result of the first contractual rate increase, effective October 14, 2014, the annual rent increased to $7.6 million.  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 September 30, 2016, 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 newly established 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 Preferred Notes”) which mature on October 30, 2036.  The sole assets of the Trust consist of the Trust Preferred Notes.  The terms of the Trust Preferred Notes are substantially the same as preferred securities issued by the Trust.  The Trust Preferred Notes and the preferred securities had a fixed interest rate of 8.68% until October 2016, after which the interest rate floats and reset quarterly at the three-month LIBOR rate plus 3.25% per annum.  The Trust Preferred Notes are redeemable by the Trust, at the Company’s option, at par, and the Company has not redeemed any Trust Preferred Notes.  To the extent the Company redeems the Trust Preferred 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 Preferred 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

17


 

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 September 30, 2016, the carrying amount of the Restaurant Lease Note was $4.0 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 September 30, 2016 and December 31, 2015, respectively. Substantially all of the principal payments on the capital lease obligations are due at the end of the lease agreements.  

 

 

7. Commitments and Contingencies

Hotel Development Related Commitments

In order to obtain 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.  As of September 30, 2016, 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, which relates to Delano Cartagena where construction has not yet begun.    

The Company has signed management, license or franchise agreements for new hotels which are in various stages of development. As of September 30, 2016, these included the following:

 

 

 

Expected

Room

Count

 

Anticipated

Opening

 

Initial

Term

Hotels Currently Under Construction or Renovation:

 

 

 

 

 

 

Mondrian Doha

 

270

 

2017

 

30 years

Delano Dubai

 

110

 

2017

 

20 years

Mondrian Dubai

 

235

 

2018

 

15 years

Other Signed Agreements:

 

 

 

 

 

 

Delano Aegean Sea

 

150

 

 

 

20 years

Delano Cartagena

 

211

 

 

 

20 years

 

There can be no assurance 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.  

 

Owned Hotel Commitments

The Company may have long-term commitments that are expected to be incurred by the Company or its consolidated consisting of targeted renovations at the Company’s Owned Hotels and other non-recurring capital expenditures that need to be made periodically with respect to its properties, including a renovation of the façade of Hudson and Clift.  As required by applicable law, at Hudson, the Company must complete a renovation of the façade by April 2018, costing an estimated $6.0 million.   Additionally, beginning in 2017 and into 2018, we anticipate a renovation of the façade of Clift and we are currently in the process of receiving

18


 

estimates for the work, which we expect could be material.   The Company intends to fund both of these projects during 2017 and 2018 through amounts in restricted cash and additional funds to be provided by the Company, however there can be no assurances that the Company will be able to access the additional funds necessary.

 

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 September 30, 2016, approximately $0.6 million was accrued as a reduction to management fees related to these performance test provisions.  Until the end of 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 September 30, 2016, but under the hotel management agreements is limited to the Company’s base fees earned.  On January 28, 2016, the Company entered into amendments to each of the hotel management agreements relating to Royalton and Morgans, both owned by the same hotel owner.  In connection with owner’s potential sale of each of those hotels, the Company agreed to allow the owner to sell the hotels unencumbered by the current hotel management agreements.  Under each of the amendments, the owner has the right to terminate the hotel management agreements at any time upon at least 30 days’ prior written notice in exchange for paying us $3.5 million for each of the hotels upon a termination of each agreement.  The Company expects to continue to manage the hotels until they are sold.

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 September 30, 2016, 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.  

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 regarding the background of the TLG Promissory Notes.  The complaint alleges, 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 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.  On August 27, 2015, Messrs.  Sasson and Masi filed a motion for partial summary judgment with the trial court and the Company filed its opposition to that motion on October 12, 2015.  In February 2016, the plaintiff’s partial summary judgment motion was granted and the judge signed the order in March 2016.  

On July 6, 2016, a judgment was entered in the Supreme Court of the State of New York.  At that time, the Company posted a bond in the amount of approximately $3.0 million, thereby staying enforcement of the judgment pending the Company’s appeal. Plaintiffs also have a claim for attorneys’ fees, which they have recently estimated to total approximately $1.0 million, which the Company intends to dispute and oppose.  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.  

Litigation Regarding Pending Acquisition of Company by SBEEG Holdings LLC

 

19


 

Following the announcement of the execution of the definitive agreement under which the Company would be acquired by SBE, as discussed further in footnote 13, four putative class action lawsuits were filed by purported stockholders of the Company challenging the merger and the merger agreement.

 

The first complaint was filed in the Supreme Court of New York, New York County on May 27, 2016 (theNew York Action”).  On June 15, 2016, the plaintiff in the New York Action filed a notice of voluntary discontinuance without prejudice, thereby voluntarily discontinuing the New York Action.

 

The other three complaints were filed in the Court of Chancery of the State of Delaware.  On June 29, 2016, the Court of Chancery of the State of Delaware entered an order, among other things, consolidating the three actions filed in Delaware (the “Consolidated Action) and appointing co-lead counsel and Delaware counsel in the Consolidated Action.

 

On June 30, 2016, plaintiffs in the Consolidated Action filed a Verified Consolidated Amended Class Action Complaint (the “Complaint”).  The Complaint names as defendants the individual members of our Board of Directors, SBE, Merger Sub, Ronald W. Burkle, The Yucaipa Companies, LLC, Yucaipa American Alliance Fund II, L.P., Yucaipa American Alliance (Parallel) Fund II, L.P., Yucaipa American Alliance Fund II, LLC, Yucaipa American Funds, LLC, and Yucaipa American Management, LLC.  The Complaint alleges, among other things, that the members of the Company’s Board of Directors breached their fiduciary duties to the Company’s stockholders by approving the merger and authorizing the Company to enter into the merger agreement, that Mr. Burkle and the Yucaipa entities are controlling stockholders of the Company and breached their purported fiduciary duties, and that SBE and Merger Sub aided and abetted these alleged fiduciary breaches.  The Complaint further alleges that, among other things, Mr. Burkle and the Yucaipa entities pressured the Company into entering into the merger agreement and approving the merger and frustrated the Company’s efforts to explore other potential strategic alternatives; that the merger consideration is financially inadequate; that the sales process leading up to the merger and the merger agreement was flawed; and that the deal-protection provisions in the merger agreement are unduly preclusive and therefore prevent a potential topping bidder or topping bidders from making a superior proposal.  The Complaint seeks, among other things, certification of the proposed class, preliminary and permanent injunctive relief (including enjoining or rescinding the merger), unspecified damages, and an award of other unspecified attorneys’ and other fees and costs.

 

The Company believes that the claims asserted in the Complaint are without merit and intend to defend against them. However, a

negative outcome in these lawsuits, or any follow-on lawsuit, could have a significant impact on the Company if they result in preliminary or permanent injunctive relief or damages.  The Company is not currently able to predict the outcome of the litigation or any follow-up lawsuit with any certainty.

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.  The Company has recorded the necessary accrual for contingent liabilities related to outstanding litigations.

Environmental

As a holder of real estate, the Company is subject to various environmental laws of federal, state and local governments. 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.

 

 

8. Omnibus Stock Incentive Plan

On May 22, 2007, the Company adopted the Morgans Hotel Group Co. 2007 Omnibus Stock Incentive Plan.  Subsequently and on several occasions, the Company’s Board of Directors adopted, and stockholders approved, amendments to the 2007 Omnibus Stock Incentive Plan (the “Stock Plan”), to namely increase the number of shares reserved for issuance under the plan.  As of September 30, 2016, 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.

20


 

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 September 30, 2016 is as follows (in units, or shares, as applicable):  

 

 

 

Restricted Stock

Units

 

 

LTIP Units

 

 

Stock Options

 

Outstanding as of January 1, 2016

 

 

220,799

 

 

 

913,423

 

 

 

248,315

 

Granted during 2016

 

 

330,183

 

 

 

 

 

 

 

Distributed/exercised during 2016

 

 

(152,283

)

 

 

(104,885

)

 

 

 

Forfeited or cancelled during 2016

 

 

(62,757

)

 

 

 

 

 

(133,921

)

Outstanding as of September 30, 2016

 

 

335,942

 

 

 

808,538

 

 

 

114,394

 

Vested as of September 30, 2016

 

 

1,745

 

 

 

808,538

 

 

 

202,715

 

 

Total stock compensation expense, which is included in corporate expenses on the accompanying consolidated statements of comprehensive loss, was $0.2 million, $0.5 million, $0.5 million, and $1.4 million, for the three and nine months ended September 30, 2016 and 2015, respectively.

As of September 30, 2016 and December 31, 2015, there were approximately $0.5 million and $0.7 million, respectively, of total unrecognized compensation costs related to unvested share awards. As of September 30, 2016, the weighted-average period over which the unrecognized compensation expense will be recorded is approximately less than one year.

 

 

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 a 10% dividend rate through October 15, 2016.  Effective October 16, 2016 and thereafter, the dividend rate on the Series A preferred securities is 20%.  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 September 30, 2016, the Company had undeclared and unpaid dividends of approximately $66.0 million.  The Company has the option to redeem any or all of the Series A preferred securities at par, plus cumulative unpaid dividends, 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 under the terms of the certificate of designations governing the Series A preferred securities, they also have certain consent rights, subject to certain exceptions and limitations, over certain transactions involving the acquisition of the Company by any third party, other than as the result of the disposition of our real estate assets where we continue to engage in the business of managing hotel properties and other real estate, 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.  

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.

21


 

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.  A Yucaipa Investors’ nominee currently sits on the Company’s Board of Directors.      

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, other than as the result of the disposition of our real estate assets where the Company continues to engage in the business of managing hotel properties and other real property assets; 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 September 30, 2016, the value of the preferred securities was $73.7 million, which includes cumulative accretion of $26.7 million.

See note 13 for additional information pertaining to the Series A preferred securities and the Yucaipa Warrants.

 

 

10. Related Party Transactions

The Company earned management fees, chain services reimbursements and fees for certain technical services and has receivables from hotels it owns through investments in unconsolidated joint ventures.  These fees totaled approximately $0.4 million for the three months ended September 30, 2015 and $0.9 million and $1.9 million for the nine months ended September 30, 2016 and 2015, respectively.  The Company recognized no fees from its investments in unconsolidated joint ventures during the three months ended September 30, 2016.

As of December 31, 2015, the Company had receivables from these affiliates of approximately $0.4 million, which is included in related party receivables on the accompanying consolidated balance sheet.  The Company’s receivables from affiliates as of September 30, 2016 were immaterial.  

 

 

 

 

 

22


 

 

11. Other Expenses

Restructuring and development costs

Restructuring expenses primarily relate to costs incurred related to the Company’s corporate restructuring initiatives, such as professional fees, litigation and settlement costs, executive terminations and severance costs related to such restructuring initiatives, the Board of Directors’ strategic alterative review process costs, proxy contests, and gains and losses on asset disposals as part of major renovation projects.  Development expenses primarily relate to transaction costs related to the acquisition or termination of projects, internal development payroll and other costs and pre-opening expenses incurred related to new concepts at existing hotel and the development of new hotels, and the write-off of abandoned development projects previously capitalized. Restructuring and development costs consist of the following (in thousands):

 

 

 

Three Months

Ended

September 30, 2016

 

 

Three Months

Ended

September 30, 2015

 

 

Nine Months

Ended

September 30,

2016

 

 

Nine Months

Ended

September 30,

2015

 

Restructuring costs

 

$

2,273

 

 

$

1,427

 

 

$

5,979

 

 

$

1,932

 

Severance costs

 

 

47

 

 

 

(120

)

 

 

123

 

 

 

1,923

 

Development

 

 

148

 

 

 

457

 

 

 

321

 

 

 

1,062

 

Other

 

 

14

 

 

 

-

 

 

 

(647

)

 

 

(6

)

 

 

$

2,482

 

 

$

1,764

 

 

$

5,776

 

 

$

4,911

 

 

Other non-operating expenses

Other non-operating expenses primarily relate to costs associated with discontinued operations and previously owned hotels, both consolidated and unconsolidated, miscellaneous litigation and settlement costs and other expenses that relate to the financing and investing activities of the Company.  Other non-operating expenses consist of the following (in thousands):

 

 

 

Three Months

Ended

September 30, 2016

 

 

Three Months

Ended

September 30, 2015

 

 

Nine Months

Ended

September 30,

2016

 

 

Nine Months

Ended

September 30,

2015

 

Litigation costs