UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

(Mark One)

For the fiscal year ended December 31, 2014

or

For the transition period from                      to                      

Commission file number: 001-33738

 

Morgans Hotel Group Co.

(Exact name of registrant as specified in its charter)

 

 

(212) 277-4100

(Registrant’s telephone number, including area code)

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

 

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

None

 

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

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

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

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

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

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

 

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

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant was approximately $232,241,755, based on a closing sale price of $7.93 as reported on the NASDAQ Global Market on June 30, 2014.

As of March 12, 2015, the registrant had issued and outstanding 34,426,667 shares of common stock, par value $0.01 per share.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Morgans Hotel Group Co.’s Proxy Statement in connection with its Annual Meeting of Stockholders to be held in 2015 are incorporated by reference into Part III of this report.

 

 

 

 

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INDEX

 

 

 

 

 

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FORWARD-LOOKING STATEMENTS

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

The forward-looking statements contained in this Annual Report on Form 10-K reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ materially from those expressed in any forward-looking statement.  Such forward-looking statements include, without limitation, statements regarding our expectations with respect to:  

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important risks and factors that could cause our actual results to differ materially from those expressed in any forward-looking statements include, but are not limited to economic, business, competitive market and regulatory conditions such as:

 

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Other than as required by applicable law, we are under no duty to update any of the forward-looking statements after the date of this Annual Report on Form 10-K to conform these statements to actual results.

 

 

 

 

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PART I

Overview

Morgans Hotel Group Co. is a fully integrated lifestyle hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations.  

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

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

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

We conduct our operations through Morgans Group LLC, a Delaware limited liability company and our operating company (“Morgans Group”). Morgans Group holds substantially all of our assets. We are the managing member of Morgans Group and held approximately 99.8% of its membership units at December 31, 2014, excluding long-term incentive plan units (“LTIP Units”) convertible into membership units issued as part of our employee compensation plans. We manage all aspects of Morgans Group, including the operation, development, sale and purchase of, and investments in, hotels primarily through subsidiaries, including our management company, Morgans Hotel Group Management LLC (“Morgans Management”), and certain non-U.S. management company affiliates, and the operation and development of various food and beverage venues. As of December 31, 2014, there were 75,446 membership units outstanding, each of which is exchangeable for one share of Morgans Hotel Group Co.’s common stock.

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

Corporate Strategy

Our corporate strategy is to achieve growth as a boutique hotel management and brand company by leveraging our management experience and one-of-a-kind luxury brands for expansion into major gateway markets and key resort destinations in both domestic and international markets. We intend to achieve growth primarily through the pursuit of new long-term management agreements and, in select situations where we believe third-party managers have the experience and resources to satisfy our high branding standards,  through franchise or licensing agreements.

 

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

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

Unlike traditional franchised or large brand-managed hotels, we believe our portfolio of boutique hotel brands provides guests with a distinctive lodging experience. Each of our Morgans Hotel Group branded hotels has a personality specifically tailored to reflect the local market environment and features a modern, sophisticated design that includes critically acclaimed public spaces, popular “destination” bars and restaurants and highly personalized service. We believe that the Morgans Hotel Group brand and each of our individual property brands are synonymous with style, innovation and service, with a distinctive combination of lodging and social experiences.

We also have a portfolio of “Original” brands, which currently include Clift, Sanderson, St Martins Lane, Morgans, Royalton, Shore Club, and 10 Karaköy. Each of these hotel brands is unique, offering an atmosphere filled with designs from an eclectic mix of designers, artists and influencers and our signature personalized service.

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

In addition, consistent with our growing focus on management opportunities, we continue to pursue new management contracts in new and existing markets, with the goal of strengthening our profit margins by maximizing revenue, increasing our market share and managing costs. We base our decisions to enter new markets on a number of criteria, with a focus on markets that attract affluent travelers who value a distinctive and sophisticated atmosphere and outstanding service. Specifically, we target key gateway destinations that attract both domestic and foreign business and leisure travelers, as well as select resort markets. Consistent with our prior expansion activities, we will continue to seek growth primarily in markets with multiple demand drivers and high barriers to entry, including major North American metropolitan markets with vibrant urban locations, select resort locations, key European destinations that we believe offer a similar customer base as our established United States and United Kingdom markets, and select locations in the Middle East, Asia and South America. For example, Mondrian London, a 359-room hotel that we operate under a long-term management agreement, opened on September 30, 2014 on London’s vibrant South Bank.   This is our first Mondrian-branded hotel outside the United States, representing the evolution and expansion of the Mondrian brand, and it is our third managed hotel in the London.

In addition, we may pursue license or franchise opportunities with third-party managers who have the experience and resources to satisfy our high brand standards. We believe we can create substantial value for potential franchisees through connection to our loyal and affluent customer base, creation of unique designs through interaction and direction with our design team, creation of valuable food and beverage destinations through interaction and direction with our food and beverage team, and unique marketing of the hotel through interaction and direction with our brand marketing team. For example, Delano Las Vegas, a 1,117-room hotel at Mandalay Bay, opened in September 2014 and is operated under a 10-year licensing agreement with affiliates of MGM, and includes two five-year extensions at our option, subject to performance thresholds.  Also, in November 2014, 10 Karaköy, a 71-room hotel in Istanbul, opened and is operated pursuant to a 15-year franchise agreement with one five-year extension option.  

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

 

  

 

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There can be no assurances that any or all of our projects listed above will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, in which case we may be unable to recover any previously funded key money, equity investments or debt financing.  For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 5 of our consolidated financial statements.  

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

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

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

Maintain Flexibility for New Opportunities. Although our strategic focus is on long-term management agreements and select franchising opportunities, we intend to be flexible so as to best position ourselves to take advantage of new opportunities. The acquisition and finance markets and the specifics of any particular deal will influence each transaction’s structure. For example, in order to secure management opportunities, we may be required to make equity investments or contribute key money. Additionally, we may also consider pursuing licensing agreements in select markets with the right partners, as we did with MGM which licensed our Delano brand and opened Delano Las Vegas in September 2014.  

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

2014 Key Events and Other Recent Transactions and Developments

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

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

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

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

 

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

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

Repayment of TLG Promissory Notes.  On December 10, 2014, we repaid and retired the outstanding $19.1 million of TLG Promissory Notes, which included the original principal balance plus deferred interest of $1.1 million, held by Messrs. Andrew Sasson and Andy Masi. In connection with our November 2011 acquisition of TLG, we issued $18.0 million in promissory notes convertible into shares of our common stock at $9.50 per share subject to the achievement of certain EBITDA (earnings before interest, tax, depreciation and amortization) targets for the acquired TLG business (the “TLG Promissory Notes”), which were scheduled to mature in November 2015, as fully described in note 7 to our consolidated financial statements.  We elected to retire the TLG Promissory Notes in full prior to the November 2015 maturity due to the increase in the interest rate from 8% to 18% in November 2014.

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

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

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

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

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

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

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

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

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

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

 

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

The Settlement Stipulation provided for the partial settlement and dismissal with prejudice of the action entitled OTK Associates, LLC v. Friedman, et al., C.A. No. 8447-VCL (Del. Ch.) (the “Delaware Shareholder Derivative Action”) and the complete settlement and dismissal with prejudice of the actions entitled Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., et al., Index No. 652294/2013 (NY Sup.) (the “New York Securities Action”); Burkle v. OTK Associates, LLC, et al., Case No. 13-CIV-4557 (S.D.N.Y.) (the “Proxy Action”); and Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., Index No. 653455/2013 (NY Sup.) (the “Board Observer Action”) (the foregoing four actions are collectively referred to as the “Actions”).   As of February 2015, the Actions have been settled or dismissed with respect to all parties.  

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

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

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

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

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

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

Management and Operations of Our Portfolio

Overview of Management

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

 

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

Food and Beverage Operations

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

Our food and beverage team is also fully engaged with all of our development partners in concepting and launching unique food and beverage outlets in all of our development pipeline projects. We believe that we have the food and beverage capability we need to enhance our existing properties and service our growth.

In August 2012, we acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas from an existing tenant. The three food and beverage venues, which continue to be managed by TLG, are being operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which we pay minimum annual lease payments and a percentage rent based on cash flow.

 Sales, Marketing and Public Relations  

Direct sales have been an integral part of our success. We employ a sales force of approximately 130 people with multiple sales managers stationed in each of our markets, deployed by industry focus and geography. Our sales force is divided into a global sales organization and a property-level sales force. Our global sales organization handles the majority of our key accounts and can provide our clients with one point of contact for all brands. The property-level sales force has responsibility for sourcing business for their respective hotels. Our sales efforts are designed to be proactive and direct and are focused on building success in the transient, leisure, corporate business travel, group and consortia markets. We believe these segments are key to our competitiveness in the market. Unlike many hotel companies, our sales force is trained to sell the “experience,” not simply the rate. By branding the “experience,” we showcase the kind of creativity that happens inside our hotels, and we believe that our guests come to us for much more than just a room or a bed. Our objective is to create differentiation by selling an “experience” and brand.

In 2014, we derived approximately 25% of our business from corporate negotiated and group accounts. Our core corporate business comes from the financial services, entertainment, advertising and public relations, technology, and fashion industries.

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

Over the past year we continued to enhance and reinvest in our website, www.morganshotelgroup.com, and our digital marketing efforts. We continue to expand our social media presence and to engage our followers through these platforms and continue to make additional enhancements to our guest communication program with more targeted emails, mobile messaging, and digital partnerships.  We upgraded our reservation system in June 2014.  

 

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Competition

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

Seasonality

The hospitality business is seasonal in nature. Our revenue is generally higher in the second and fourth quarters. However, prevailing economic conditions, including supply, can cause fluctuations which impact seasonality.

Insurance

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

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

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

Employees

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

Government Regulations  

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

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

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

 

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

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

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

Our business is reliant upon technology systems and networks, including systems and networks managed by third parties, to process, transmit and store information and to conduct many of our business activities and transactions with clients, vendors and other third parties. Furthermore, we are required to comply with legal, regulatory and contractual obligations which are designed to protect personally identifiable and other information pertaining to our customers, stockholders and employees. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving and the hospitality industry is under increasing attack by cyber-criminals in the U.S. and other jurisdictions in which we operate. Such information includes but is not limited to large volumes of customer credit and payment card information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of customer, stockholder, employee or our data. Accordingly, significant actual or potential theft, loss, fraudulent use or misuse of customer, stockholder, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy policies with respect to such data may result in fines, damage to our reputation, litigation or regulatory actions against us and transfer of information and otherwise have a material adverse impact on our business, financial condition or results of operations.

We have implemented security measures designed to protect against such breaches of security. Despite these measures, we cannot be sure that our systems and networks will not be subject to breaches or interference. The size and complexity of our information security systems, and those of our third-party vendors and business partners with whom we contract, make such systems potentially vulnerable to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. The frequency of third-party cyber attacks in the hospitality industry have increased in recent years.  Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives and expertise, including organized criminal groups, “hacktivists,” and others.  Furthermore, given the ever-changing tactics used by cyber criminals, there can be no assurance that a compromise of our systems would be discovered promptly. A successful attack or other security breach could result in unauthorized access to or the disclosure or loss of customer, stockholder, employee or other data, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure and damage to our business. We have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to customer data. There can be no assurance that such incidents will not occur again. We have obtained cyber-risk insurance to mitigate this risk, but it is of limited scope and amount, may not cover us against all of the possible damage it would suffer from a significant successful cyber attack.

 

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

Intellectual Property  

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

Our trademarks include, without limitation, Morgans Hotel Group^®, Morgans^®, Clift Hotel^®, Delano^®, Hudson^®, Mondrian^®, Sanderson^®, St Martins™, St Martins Lane Hotel™, Morgans Semi-Automatic^®, Agua^®, Agua Baby™, Agua Bath House™, Agua Home™, Bianca Delano™, Bianca Delano™ (and design), Henry^®, Hudson Common^®, Redwood Room^®, Rose Bar™, The Florida Room Delano (and design)^®, Skybar^®, Mondrian Skybar™, Velvet Room™, and Mister H^®. The majority of these trademarks are registered in the United States and the European community. Certain of these trademarks are also registered in Canada, France, the United Kingdom, Argentina, Mexico, China, Turkey, the United Arab Emirates and Russia, and we are seeking registration of several of our trademarks in Russia, the United Kingdom, India, China, Brazil, the Bahamas, Indonesia, Egypt, Qatar, Turkey and other jurisdictions. Our trademarks are very important to the success of our business and we actively enforce, maintain and protect these marks.   

Materials Available On Our Website

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

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

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

 

 

 

 

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

Risks Related to Our Business

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

We have $450.0 million of mortgage debt on Hudson and Delano South Beach which matures in February 2016, with three one-year extension options to extend the maturity to February 2019 if certain conditions are met.  We also have 75,000 shares of Series A preferred securities for which the dividend rate will increase to 20% in October 2016.

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

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

As of December 31, 2014, we had $605.7 million of outstanding consolidated indebtedness, including capital lease obligations. Our share of indebtedness held by our joint venture entities, which debt is generally nonrecourse to us with the exception of certain standard nonrecourse carve-out guarantees, was approximately $64.7 million as of December 31, 2014.

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

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

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

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

 

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

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

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

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

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

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

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

The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano and the owners of Hudson and Delano and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities (CMBS) loans. For more information on the Hudson/Delano 2014 Mortgage Loan, see Part I, “Item I. Business – 2014 and Other Recent Transactions and Developments – Hudson and Delano South Beach Loan Refinancing.”

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

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

We have provided standard “bad boy” nonrecourse carve-out guarantees in connection with certain mortgages and related mezzanine loans, which are otherwise nonrecourse to us or have agreed to indemnify joint venture partners who have provided such guarantees for our pro rata share of certain liabilities under such guarantees. See, for example, nonrecourse carve-out guarantees and

 

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

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

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

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

 

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

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

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

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

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

 

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

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

 

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

 

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

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

We generally compete in the “boutique” or “lifestyle” hotel segment of the hospitality industry. We believe that this segment is highly competitive. Competition within the boutique hotel segment is also likely to increase in the future. Competitive factors in the hospitality industry include name recognition, quality of service, convenience of location, quality of the property, pricing and range and quality of food and beverage services and amenities offered. We also compete with other operators of full service hotels, including major hospitality chains with well-established and recognized brands.  Most of these major hospitality chains are larger than we are based on the number of properties or rooms they manage, franchise or own or based on the number of geographic locations in which they operate. Our competitors generally also have broader guest loyalty programs which may enable them to attract more customers and more effectively retain such guests. Market perception that we no longer provide innovative property concepts and designs would adversely affect our ability to compete effectively. If we are unable to compete for guests effectively, we would lose market share, which could adversely affect our business and operations.

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

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

The concentration of our hotels in a limited number of cities exposes us to greater risk to local economic, business and other conditions than more geographically diversified hotel companies. Morgans, Royalton, Hudson and Mondrian SoHo, located in Manhattan, represented approximately 41.1% of our total guest rooms for all the hotels we manage and Hudson, our only wholly-owned New York City hotel as of December 31, 2014, represented approximately $85.2 million, or 40.1%, of our consolidated hotel revenues for the year ended December 31, 2014. An economic downturn, a natural disaster, a terrorist attack or similar disaster in New York would likely cause a decline in the Manhattan hotel market and adversely affect occupancy rates, the financial performance of our New York hotels and our overall results of operations. In addition, we operate three hotels in Miami and three hotels in London, making us susceptible to economic slowdowns and other risks in these markets, which could adversely affect our business and results of operations.

 

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

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

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

The threat of terrorism may negatively impact hotel occupancy and average daily rate, due to resulting disruptions in business and leisure travel patterns and concerns about travel safety. Hotels in major metropolitan areas, such as New York and London, which represented approximately 61.6% of our total guest rooms for all the hotels we managed at December 31, 2014, may be particularly adversely affected due to concerns about travel safety. The impact on such major metropolitan areas may be particularly severe because of the importance of transient business travel, which includes the corporate and premium business segments that generally pay the highest average room rates, to those markets. The possibility of future attacks may hamper business and leisure travel patterns and, accordingly, the performance of our business and our operations.

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

Our operations are sensitive to currency exchange risks. Changes in exchange rates between foreign currencies and the U.S. dollar may adversely affect our operating results. For example, all else being equal, a stronger U.S. dollar could harm international tourism in our domestic markets and may increase U.S. travel to our international markets. As foreign currencies depreciate against the U.S. dollar, it becomes more expensive, in terms of those depreciating foreign currencies, to pay for our U.S. hotel services. Conversely, all else being equal, a depreciating U.S. dollar could affect demand for our U.S. hotel services but may decrease U.S. travel to our international markets.

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

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

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

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

 

We may not be successful in identifying or completing hotel projects that are consistent with our strategy. We compete for management agreements based primarily on the value and quality of our management services and reputation, our brand recognition, our ability and willingness to invest key money into projects, the level of our management fees, and the terms of our management agreements.

We compete with hotel operating companies, institutional pension funds, private equity investors, real estate investment trusts, owner-operators of hotels and others who are engaged in hotel operating or real estate investment activities for the operation, development, and acquisition of hotels. We also have experienced challenges in securing new projects in recent years as a result of the occurrence of certain events at our corporate level, including proxy contests, our now settled dispute with Yucaipa, and our strategic review process.  In addition, competition for suitable hotel management, development, investment, and acquisition opportunities is intense and may increase in the future. Some competitors may have substantially greater financial resources than we do, and as such, will be able to invest more or accept greater risk than we can prudently manage. These competitors may limit the number of suitable hotel management, development, investment and acquisition opportunities for us by driving up the price we must pay for such

 

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opportunities. In addition, our potential hotel management or development projects or acquisition targets may find our competitors to be more attractive investors because they may have greater resources, be willing to pay more, have a more compatible operating philosophy, or better relationships with hotel franchisors, sellers or lenders. Furthermore, the terms of our management agreements are influenced by contract terms offered by our competitors, among other things. We cannot assure you that any of our current arrangements will continue or that we will be able to enter into future collaborations, renew agreements, or enter into new agreements in the future on terms that are as favorable to us as those that exist today.

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

 

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

 

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

 

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

 

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

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

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

 

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

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

We have in the past, and may in the future acquire, develop or redevelop hotel properties through joint ventures with third parties, acquiring non-controlling interests in or sharing responsibility for managing the affairs of a property, joint venture or other entity. As of December 31, 2014, we owned our Mondrian South Beach hotel through a 50/50 joint venture and our Mondrian SoHo hotel through a joint venture in which our interest was 20%.

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

 

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

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

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

Our business may be harmed as a result of litigation.

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

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

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

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

In addition, we may be unable to make payments under the leases if we are not able to operate the properties profitably. For example, the Clift lease agreement provides for base annual rent of approximately $6.0 million per year until October 2014. Thereafter, the base rent increases at five-year intervals by a formula tied to increases in the Consumer Price Index, with a maximum increase of 40% and a minimum increase of 20% at October 2014, and a maximum increase of 20% and a minimum increase of 10% at each five-year rent increase date thereafter. As a result of the first such increase, effective October 14, 2014, the annual rent increased to $7.6 million.  The lease is nonrecourse to us. We can provide no assurance that we can operate the property at a profit now or upon future rent increases under the lease.  Morgans Group also provides a limited guaranty, whereby Morgans Group has agreed to guarantee losses of up to $6.0 million suffered by the lessors in the event of certain “bad boy” type acts.  

 

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

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

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

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

The nature of our responsibilities under our management agreements to manage hotels that are not wholly-owned by us may be subject to interpretation and will from time to time give rise to disagreements. To the extent that such conflicts arise, we seek to resolve them by negotiation with the relevant parties. In the event that such resolution cannot be achieved, litigation may result in damages or other remedies against us. Such remedies could in certain circumstances include termination of the right to manage the relevant property.

Additionally, although our hotel management, franchise and license agreements are generally long-term, they may be subject to early termination in specified circumstances, or we may agree to early termination as circumstances require. Certain of our hotel management agreements and franchise or license agreements contain performance tests that stipulate certain minimum levels of operating performance, which could result in early termination of our hotel management, if we fail or elect not to cure. We may disagree with hotel owners on how the performance criteria are calculated or whether they have been met.  

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

 

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Several of our hotels are also subject to mortgage and mezzanine debt, and in some instances our management, franchise or license fee is subordinated to the debt. Some of our management agreements also may be terminated by the lenders on foreclosure or certain other related events. With some of our existing management, franchise and license agreements, and with all of our new management, franchise and license agreements for hotels under development we attempt to negotiate, non-disturbance agreements or similar protections with the mortgage lender, or to require that such agreements be entered into upon securing of financing, in order to protect our agreements in the event of foreclosure. However, we are not always successful in imposing these requirements, and some of our new development projects and existing hotels do not have non-disturbance or similar protections, which may make the related agreements subject to termination by the lenders on foreclosure or certain other related events. Even if we have such non-disturbance protections in place, they may be subject to conditions and may be difficult or costly to enforce in a foreclosure situation.  See, for example Part I, Item 3.“Legal Proceedings — Litigations Regarding Mondrian SoHo.”

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

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

Risks Related to the Hospitality Industry

A number of factors, many of which are common to the lodging industry and beyond our control, could affect our business.

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

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

 

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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

 

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

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

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

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

Our business is reliant upon technology systems and networks, including systems and networks managed by third parties, to process, transmit and store information and to conduct many of our business activities and transactions with clients, vendors and other third parties. Furthermore, we are required to comply with legal, regulatory and contractual obligations which are designed to protect personally identifiable and other information pertaining to our customers, stockholders and employees. The legal, regulatory and contractual environment surrounding information security and privacy is constantly evolving and the hospitality industry is under increasing attack by cyber-criminals in the U.S. and other jurisdictions in which we operate. Such information includes but is not limited to large volumes of customer credit and payment card information. Maintaining the integrity of our systems and networks is critical to the success of our business operations and to the protection of customer, stockholder, employee or our data. Accordingly, significant actual or potential theft, loss, fraudulent use or misuse of customer, stockholder, employee or our data by cybercrime or otherwise, non-compliance with our contractual or other legal obligations regarding such data or a violation of our privacy policies with respect to such data may result in fines, damage to our reputation, litigation or regulatory actions against us and transfer of information and otherwise have a material adverse impact on our business, financial condition or results of operations.

We have implemented security measures designed to protect against such breaches of security. Despite these measures, we cannot be sure that our systems and networks will not be subject to breaches or interference. The size and complexity of our information security systems, and those of our third-party vendors and business partners with whom we contract, make such systems potentially vulnerable to security breaches from inadvertent or intentional actions by our employees or vendors, or from attacks by malicious third parties. The frequency of third party cyber attacks in the hospitality industry have increased in recent years.  Such attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives and expertise, including organized criminal groups, “hacktivists,” and others.  Furthermore, given the ever-changing tactics used by cyber criminals, there can be no assurance that a compromise of our systems would be discovered promptly. A successful attack or other security breach could result in unauthorized access to or the disclosure or loss of customer, stockholder, employee or other data, which in turn may result in legal claims, regulatory scrutiny and liability, reputational damage, the incurrence of costs to eliminate or mitigate further exposure and damage to our business. We have, in the past, been subject to systems, network and data breaches, including breaches that resulted in unauthorized access to customer data. There can be no assurance that such incidents will not occur again. We have obtained cyber-risk insurance to mitigate this risk, but it is of limited scope and amount, may not cover us against all of the possible damage it would suffer from a significant successful cyber attack.

 

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

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

 

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Our business and operations are heavily regulated and a failure to comply with regulatory requirements may result in an adverse effect on our business.

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

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

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

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

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

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

 

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In addition, local jurisdictions in the United States where our hotel properties are located do not allow for insurance to cover damages that are characterized as punitive or similar damages. As a result, any claims or legal proceedings, or settlement of any such claims or legal proceedings that result in damages that are characterized as punitive or similar damages may not be covered by our insurance. If these types of damages are substantial, our financial resources may be adversely affected.

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

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

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

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

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

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

Claims of illness or injury relating to food quality or food handling are common in the food and beverage business, and a number of these claims may exist at any given time. As a result, we could be adversely affected by negative publicity, whether or not accurate, regarding food quality or handling claims at one or more of the restaurants, bars or other food and beverage venues that we operate. In addition to decreasing sales and profitability at these restaurants, bars or other food and beverage venues, adverse publicity could negatively impact our reputation, hindering our ability to renew contracts on favorable terms or to obtain new business.

 

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

 

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

 

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

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

Risks Related to Our Organization and Corporate Structure

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

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

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

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

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

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

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

 

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

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

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

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

For so long as the Yucaipa Investors collectively own or have the right to purchase through exercise of the warrants (assuming a cash exercise of such warrants) 875,000 shares of our common stock, we have agreed to use our reasonable best efforts to cause our Board of Directors to nominate and recommend to our stockholders the election of a person nominated by the Yucaipa Investors as a director of the Company and to use its reasonable best efforts to ensure that the Yucaipa Investors’ nominee is elected to our Board of Directors at each such meeting. If that nominee is not elected as a director at a meeting of stockholders, the Yucaipa Investors have certain Board of Director observer rights. Further, if we do not, within 30 days from the date of such meeting, create an additional seat on the Board of Directors and make available such seat to the nominee, the dividend rate on the Series A preferred securities increases by 4% during any time that a Yucaipa Investors’ nominee is not a member of our Board of Directors.

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

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

On October 15, 2009 we issued 75,000 shares of Series A preferred securities to the Yucaipa Investors. The holders of such Series A preferred securities are entitled to cumulative cash dividends, payable in arrears on every three-month anniversary following the original date of issuance if such dividends are declared by the Board of Directors or an authorized committee thereof, at a rate of 8% until October 2014, 10% per year until October 2016, and 20% per year thereafter. In addition, should the Yucaipa Investors’ nominee fail to be elected to our Board of Directors, the dividend rate would increase by 4% during any time that the Yucaipa Investors’ nominee is not a director.  From July 14, 2013 through May 14, 2014, the dividend rate was 12% as a result of the Yucaipa Investors’ nominee not being elected or appointed to our Board of Directors. On May 14, 2014, at our annual shareholder meeting, a Board of Directors nominee representing the Yucaipa Investors was elected as a director and the dividend rate on the Series A preferred securities returned to the stated rate of 8%. Accordingly, the current dividend rate on the Series A preferred securities is 10%.

We have the option to accrue any and all dividend payments. As of December 31, 2014, we have not declared or paid any dividends. The accrual of these dividends may have a negative impact on the value of our common stock. In addition, the payment of these dividends may limit our ability to grow and compete by reducing our ability to use capital for other business and operational needs.

 

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

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

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

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

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

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

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

 

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

Sales of a substantial number of additional shares of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock. In addition to the possibility that we may sell shares of our common stock in a public offering at any time, we also may issue shares of common stock in connection with the warrants we issued to the Yucaipa Investors and their affiliates, grants of restricted stock or LTIP Units or upon exercise of stock options that we grant to our directors, officers and employees. All of these shares may be available for sale in the public markets from time to time. As of December 31, 2014, there were:

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

Our stock price has been and continues to be volatile.

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

 

 

None.  

 

 

 

 

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Hotel Properties

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

 

 

 

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Owned Operations

Owned Hotels

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

Hudson

Overview

Opened in 2000, Hudson is our largest hotel, with 878 guest rooms and suites as of December 31, 2014, including two ultra-luxurious accommodations — a 3,355 square foot penthouse with a landscaped terrace and an apartment with a 2,500 square foot tented terrace. The hotel, located only a few blocks away from Columbus Circle, Time Warner Center and Central Park, has numerous food and beverage offerings.

We spent most of 2012 renovating all the guest rooms and corridors and converting SRO units into new guest rooms. The renovation was completed in September 2012 and between 2012 and 2014, we added 44 more guest rooms to Hudson by converting SRO units and other space into guest rooms, bringing the total number of guest rooms at Hudson to 878 as of December 31, 2014.  In February 2013, we opened a new restaurant at Hudson, Hudson Commons, which is a modern-day beer hall and burger joint featuring a wide selection of local craft beers, inventive preparations of classic American fare, and soda shop-inspired specialty cocktails. In October 2014, we introduced the Half & Half nightlife concept at Hudson.

 

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We own a fee simple interest in Hudson, which is part of a property that is structured as a condominium, in which Hudson constitutes 96% of the square footage of the entire building. Hudson has a total of 928 rooms, comprised of 878 guest rooms and 60 SROs as of December 31, 2014. Each SRO is for occupancy by a single eligible individual. The unit need not, but may, contain food preparation or sanitary facilities, or both. SROs remain from the prior ownership of the building and we are by statute required to maintain these long-term tenants, unless we get their consent to terminate the lease, as long as they pay us their rent. Over time, we intend to convert the remaining SRO units into new guest rooms.

The hotel is subject to mortgage and mezzanine indebtedness as more fully described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Debt.”

Selected Financial and Operating Information

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

 

 

Delano South Beach

Overview

Opened in 1995, Delano South Beach has 194 guest rooms, suites and lofts and is located in the heart of Miami Beach’s fashionable South Beach Art Deco district. The hotel features an “indoor/outdoor” lobby, the Water Salon and Orchard (which is Delano South Beach’s landscaped orchard and 100-foot long pool) and beach facilities. The hotel’s accommodations also include eight poolside bungalows and a penthouse and apartment. Delano South Beach’s food and beverage offerings include the restaurant, Bianca, which opened in January 2012, Delano Beach Club, a poolside bar and bistro, the Rose Bar, FDR, a nightclub which opened in February 2012, and Umi Sushi & Sake Bar, which also opened in February 2012.  These food and beverage venues at Delano South Beach were managed by TLG from January 2012 until January 15, 2015, on which date we began managing the venues.  The hotel also features Club Essentia Wellness Retreat, a full-service spa facility. Delano South Beach also offers multi-service meeting facilities, consisting of one executive boardroom and other facilities, including a state-of-the-art media room.

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

Selected Financial and Operating Information

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

 

 

 

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Clift

Overview

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

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

Selected Financial and Operating Information

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

 

 

Owned Food and Beverage Operations

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

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

Managed Operations

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

Managed Hotels

Our Joint Venture Hotels as of December 31, 2014 are operated under management agreements which expire as follows:

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

 

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Our Managed Hotels as of December 31, 2014 are operated under management agreements which expire as follows:

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

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

Managed Food and Beverage

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

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

The primary assets of TLG consisted of its management and similar agreements with various MGM affiliates. During the time we owned 90% of TLG, we recognized management fees in accordance with the applicable management agreement which generally provided for base management fees as a percentage of gross sales, and incentive management fees as a percentage of net profits, as calculated pursuant to the management agreements.

Licensed and Franchised Hotels

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

 

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Development Hotels

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

 

 

However, financing and/or governmental approvals have not been obtained for the hotel projects listed under “Other Signed Agreements” above, and there can be no assurances that any or all of our projects listed above will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, in which case we may be unable to recover any previously funded key money, equity investments or debt financing.  For example, due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 5 of the consolidated financial statements.  

 

Corporate Headquarters

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

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

Litigations Regarding Mondrian SoHo

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

On March 11, 2013 we moved to dismiss the lender’s complaint on the grounds that, among other things, our management agreement is not subject to foreclosure. On April 2, 2013, the lender opposed our motion to dismiss and cross-moved for summary judgment. On August 12, 2013, the court heard oral argument on both motions, as well as a third motion brought by the Company to strike an affirmation submitted by lender’s attorney. On January 27, 2014, the court granted Morgans Management’s motion to dismiss on the ground that Morgans Management was not a proper party to the foreclosure action and that a management contract does not constitute an interest in real property subject to foreclosure, and denied lender’s motion for summary judgment as moot. On March 20, 2014 the lender moved for summary judgment against the remaining defendants,  seeking foreclosure on four mortgages secured by Mondrian SoHo. By order dated May 27, 2014, the trial court granted the motion for summary judgment to a limited extent, ordering the appointment of a referee to compute the amount but stating that a motion for summary judgment of foreclosure and sale is premature. By decision entered on July 28, 2014, the court referred the matter to a referee to ascertain and compute the amount due to the lender for principal, interest, and other disbursements and to determine whether the property should be sold in one parcel.  On August 6, 2014, the referee set a hearing on the issues for August 18, 2014, and subsequently issued her report setting the amount due on the loan ($250.5 million, plus interest accruing at a daily rate of approximately $84,000, as of August 18, 2014) and determining the property should be sold as one parcel. On September 15, 2014, the lender filed a motion to confirm the referee’s report and for judgment of foreclosure and sale, along with the Referee’s Report of Amount Due attached as an exhibit, and a

 

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

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

On February 25, 2013, the Sochin JV filed a complaint in the Delaware Court of Chancery against Morgans Management and Morgans Group, seeking, among other things, a declaration that Sochin JV had terminated the management agreement for the hotel. In addition, we, through our equity affiliate, filed a separate action against Sochin JV and its parent in the Delaware Court of Chancery for, among other things, breaching fiduciary duties and their joint venture agreement for failing to obtain consent prior to the termination. That action was subsequently consolidated with the joint venture’s termination action.  On April 30, 2013, Morgans Management filed a lawsuit against Sochin JV and the majority member of Sochin JV’s parent and its affiliate in New York Supreme Court for damages based on the wrongful attempted termination of the management agreement, defamation, and breach of fiduciary and other obligations under the parties’ joint venture agreement.  On September 20, 2013, the Delaware Court of Chancery ruled that Sochin JV properly terminated the hotel management agreement on agency principles, that Morgans Management must vacate the hotel forthwith or on whatever other timetable the hotel owner chooses, and that certain claims by our equity affiliate are dismissed but not its breach of fiduciary duty claim. 

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

Litigations Regarding Delano Marrakech

In June 2013, we served the owner of Delano Marrakech with a notice of default for numerous breaches of the management agreement, including among other things, failure to pay fees and reimbursable expenses and to operate the hotel in accordance with the standards under the management agreement. In September 2013, we served notice of termination of our management agreement for Delano Marrakech following the failure by the owner of Delano Marrakech to remedy the numerous breaches of the agreement. As a result, we discontinued all affiliation with the hotel, including removal of the Delano name, and terminated management of the property, effective November 12, 2013. Pursuant to the management agreement, in the event of an owner default, we have no further obligations under the performance-based cash flow guarantee. In addition, as a result of the breaches by the hotel owner, we have asserted a claim for losses and damages against the owner that is currently estimated at in excess of $30.0 million, including interest. The owner of the hotel is disputing the circumstances surrounding termination and therefore its liability for this amount. The owner is also counterclaiming against us under both the performance-based cash flow guarantee and for loss of profits. The total counterclaim made by the owner is in excess of $119.0 million, excluding interest. We consider the counterclaim made by the owner to be entirely without merit and intend to vigorously defend ourselves while pursuing what we consider to be a strong claim against the owner. Both parties are seeking arbitration of the dispute, which is expected to occur in October 2015.  A preliminary hearing was heard on January 19, 2015 in which the arbitral tribunal rejected entirely the owner’s attempt to have a preliminary issue determined in its favor.

Litigation Regarding TLG Promissory Notes

On August 5, 2013, Andrew Sasson and Andy Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition LLC and Morgans Group LLC relating to the $18.0 million in notes convertible into shares of our common stock at $9.50

 

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per share subject to the achievement of certain EBITDA (earnings before interest, tax, depreciation and amortization) targets for the acquired TLG business (the “TLG Promissory Notes”), which were issued in connection with our November 2011 acquisition of 90% of the equity interests in a group of companies known as The Light Group (the “Light Group Transaction”) . See note 1 and note 7 of our consolidated financial statements regarding the background of the TLG Promissory Notes. The complaint alleged, among other things, a breach of contract and an event of default under the TLG Promissory Notes as a result of our failure to repay the TLG Promissory Notes following an alleged “Change of Control” that purportedly occurred upon the election of our current Board of Directors on June 14, 2013. The complaint sought payment of Mr. Sasson’s $16 million TLG Promissory Note and Mr. Masi’s $2 million TLG Promissory Note, plus interest compounded to principal, as well as default interest, and reasonable costs and expenses incurred in the lawsuit. We believe that a Change of Control, within the meaning of the TLG Promissory Notes, has not occurred and that no prepayments are required under the TLG Promissory Notes. On September 26, 2013, we filed a motion to dismiss the complaint in its entirety. On February 6, 2014, the court granted our motion to dismiss. On March 7, 2014, Messrs. Sasson and Masi filed a Notice of Appeal from this decision with the Appellate Division, First Department, and on July 8, 2014, they filed their initial brief in support of that appeal. Briefing of that appeal is ongoing, and our opposition brief was due August 29, 2014.  The oral argument on the motion occurred on October 29, 2014 and we are awaiting the court’s ruling.   Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit has not been dismissed.  

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

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

The Settlement Stipulation provided for the partial settlement and dismissal with prejudice of most of the defendants from the action entitled OTK Associates, LLC v. Friedman, et al., C.A. No. 8447-VCL (Del. Ch.) and the complete settlement and dismissal with prejudice of the actions entitled Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., et al., Index No. 652294/2013 (NY Sup.); Burkle v. OTK Associates, LLC, et al., Case No. 13-CIV-4557 (S.D.N.Y.); and Yucaipa American Alliance Fund II L.P., et al. v. Morgans Hotel Group Co., Index No. 653455/2013 (NY Sup.),  the foregoing four actions are collectively referred to as the Actions.

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

 

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

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

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

Not Applicable.

 

 

 

 

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PART II

Market Information

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

 

 

On March 12, 2015, the closing sale price for our common stock, as reported on the NASDAQ Global Market, was $7.21. As of March 12, 2015, there were 37 record holders of our common stock, although there is a much larger number of beneficial owners.

Dividend Policy

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

The Series A preferred securities we issued in October 2009 had an 8% dividend rate until October 2014, and have a 10% dividend rate until October 2016, and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. We have the option to accrue any and all dividend payments, and as of December 31, 2014, have not declared any dividends. As of December 31, 2014, we have undeclared dividends of approximately $43.3 million.

 

 

 

 

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Performance Graph  

The following graph below shows the cumulative total stockholder return of our common stock from December 31, 2009 through December 31, 2014 compared to the S&P 500 Stock Index and the S&P 500 Hotels. The graph assumes that the value of the investment in our common stock and each index was $100 at December 31, 2009. We have declared no dividends during this period. The stockholder return on the graph below is not indicative of future performance.

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

and S&P 500 Hotels Index From December 31, 2009 through December 31, 2014

 

 

 

 

 

 

 

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

The following table contains selected consolidated financial data for the years ended December 31, 2014, 2013, 2012, 2011, and 2010, all of which is derived from the Company’s audited consolidated financial statements. The historical results do not necessarily indicate results expected for any future period.

 

 

 

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

Overview

Morgans Hotel Group Co. is a fully integrated lifestyle hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations.  

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

Effective January 23, 2015, we completed the TLG Equity Sale, as discussed in Item 1 of Part I of this report under the heading “2014 Key Events and Other Recent Transactions and Developments.” Also, effective March 6, 2015, we no longer hold any equity interest in Mondrian SoHo.

Our corporate strategy is to achieve growth as a boutique hotel management and brand company by leveraging our management experience and one-of-a-kind luxury brands for expansion into major gateway markets and key resort destinations in both domestic and international markets. We intend to achieve growth primarily through the pursuit of new long-term management agreements and, in select situations where we believe third-party managers have the experience and resources to satisfy our high branding standards, franchise or licensing agreements.

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

Management, Franchise, and License Agreements. Although our hotel management agreements and franchise or license agreements are generally long-term, they may be subject to early termination in specified circumstances, or we may agree to early termination as circumstances require. Certain of our hotel management agreements and franchise or license agreements contain performance tests that stipulate certain minimum levels of operating performance, which could result in early termination of our hotel management, license or franchise agreements, once the performance test period begins, which is generally multiple years after a hotel opens. As of December 31, 2014, we are in compliance with these termination performance tests and are not exercising any contractual cure rights.  We may disagree with hotel owners on how the performance criteria are calculated or whether they have been met. In addition, some courts have applied principles of agency law and related fiduciary standards to managers of third-party hotel

 

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properties (or have interpreted hotel management agreements as “personal services contracts”). This means, among other things, that property owners may assert the right to terminate management agreements even where the agreements provide otherwise, and some courts have upheld such assertions regarding management agreements and may do so in the future.

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

We may also terminate hotel management, franchise or license agreements as circumstances require or as we deem appropriate. For example, in September 2014, we and the hotel owners mutually agreed to terminate the Delano Moscow management agreement and, as a result, we were relieved of our key money and possible cash flow commitment obligations.  Additionally, in June 2014, the Mondrian at Baha Mar management agreement was terminated due to the failure of the hotel owner to obtain a non-disturbance agreement from its lender as required by the management agreement, among other things.   This termination relieved us of a $10.0 million key money obligation.  

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

 Factors Affecting Our Results of Operations

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

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

 

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

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

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

In addition to economic conditions, supply is another important factor that can affect revenues. Room rates, occupancy and food and beverage revenues tend to fall when supply increases, unless the supply growth is offset by an equal or greater increase in demand.

Finally, competition within the hospitality industry can affect revenues. Competitive factors in the hospitality industry include name recognition, quality of service, convenience of location, quality of the property or venue, pricing, and range and quality of nightlife, food and beverage services and amenities offered. We also compete with other operators, including major hospitality chains with well-established and recognized brands.  Our competitors generally also have broader guest loyalty programs which may enable them to attract more customers and more effectively retain such guests. In addition, all of our hotels, restaurants, nightclubs, and bars are located in areas where there are numerous competitors, many of whom have substantially greater financial and marketing resources than us. New or existing competitors could offer significantly lower rates and pricing or more convenient locations, services or amenities or significantly expand, improve or introduce new service offerings in markets in which our hotels, restaurants, nightclubs, bars, and other food and beverage venues compete, thereby posing a greater competitive threat than at present. If we are unable to compete effectively, we would lose market share, which could adversely affect our revenues.

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

 

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Other Items. Other expenses we incur include:

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

 

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

Recent Trends and Developments

Recent Trends.   Lodging demand is closely linked to the performance of the general economy and is sensitive to business and personal discretionary spending levels. Declines in consumer demand due to adverse general economic conditions, risks reducing travel patterns, lower consumer confidence and adverse political conditions can lower the revenues and profitability of our Owned Hotels and limit the amount of fee revenues we are able to generate from our Managed Hotels and franchised properties.  

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

We also believe the impact of the strong U.S. dollar and a weak global economy, specifically in Europe, could impact our hotels in New York City and Miami in 2015, where we are particularly dependent on international tourists.  

RevPAR at System-Wide Comparable Hotels, all of which are located in the United States and includes all Morgans Hotel Group branded hotels operated by us, except for hotels added or under major renovation during the current or the prior year, development projects and hotels no longer managed by us, increased by 2.8% in 2014 as compared to 2013, driven by a 1.8% increase in occupancy and 1.0% increase in ADR.  

RevPAR from System-Wide Comparable Hotels in New York decreased 0.2% in 2014 over 2013, due to decreased ADR of 1.4%.  Occupancy at our New York hotels was strong at 89.7% in 2014, an increase of 1.2% as compared to 2013.  RevPAR at Hudson decreased by 1.0% during 2014 as compared to 2013.  Occupancy at Hudson increased by 2.1% to 90.9% year-over-year and ADR at Hudson declined 3.0% during 2014, primarily as a result of an increase in competitive room supply.

RevPAR from System-Wide Comparable Hotels in Miami increased 2.1% in 2014 as compared to 2013.  Delano South Beach experienced a RevPAR increase of 2.1% during 2014 as compared to 2013 primarily due to increased occupancy year-over-year.  

Our System-Wide Comparable Hotels on the West Coast generated 11.5% RevPAR growth in 2014 as compared to 2013, with a 9.7% RevPAR increase at Clift.

Our managed hotels in London, Sanderson, St Martins Lane and Mondrian London, are non-comparable between 2014 and 2013 due to a major renovation of Sanderson and St Martins Lanes’ guestrooms and public spaces, and the opening of Mondrian London on September 30, 2014.

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

 

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 Comparison of Year Ended December 31, 2014 to Year Ended December 31, 2013

The following table presents our operating results for the years ended December 31, 2014 and 2013, including the amount and percentage change in these results between the two periods. The consolidated operating results are as follows:

 

 

Total Hotel Revenues. Total hotel revenues increased 1.2% to $212.2 million for the year ended December 31, 2014 compared to $209.8 million for the year ended December 31, 2013. This increase was primarily due to increased occupancy at our Owned Hotels.

Rooms revenue increased 2.4% to $123.8 million for the year ended December 31, 2014 compared to $120.8 million for the year ended December 31, 2013. This increase was primarily due to increases in occupancy at Delano South Beach and increases in occupancy and ADR at Clift in San Francisco during year ended December 31, 2014 as compared to the same period in 2013.

 

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The components of RevPAR from our Owned Hotels, which consisted, as of December 31, 2014, of Hudson, Delano South Beach and Clift, for the years ended December 31, 2014 and 2013 are summarized as follows:

 

 

Food and beverage revenue decreased 2.2% to $82.2 million for the year ended December 31, 2014 compared to $84.1 million for the year ended December 31, 2013. This decrease was primarily due to a decrease of approximately $10.4 million related to the  transfer of the food and beverage venues at St Martins Lane in London to the hotel owner effective January 1, 2014.  Offsetting this decrease was an increase of approximately $5.9 million from our three leased food and beverage venues at Mandalay Bay in Las Vegas, one of which opened in February 2013 and another restaurant which opened in July 2013. Additionally, we saw an increase in revenues of approximately $2.6 million at the food and beverage venues at Hudson, primarily Hudson Common, which opened in February 2013.

Other hotel revenue increased 28.0% to $6.2 million for the year ended December 31, 2014 compared to $4.9 million for the year ended December 31, 2013. This increase was primarily due to increased internet revenues at Hudson during 2014 as compared to the same period in 2013, which was the result of a change in strategy regarding internet pricing that became effective January 1, 2014, and an urban resort fee implemented at Delano South Beach and Hudson in the latter half of 2014.

Management Fee—Related Parties and Other Income. Management fee—related parties and other income decreased by 14.9% to $22.7 million for the year ended December 31, 2014 compared to $26.7 million for the year ended December 31, 2013. Approximately $2.3 million of this decrease was due to a termination fees related to Hotel Las Palapas and Ames that we received during 2013. Excluding one-time items, management fees primarily decreased as a result of a decrease in fees from TLG primarily due to revisions in the management fee structure with MGM effective January 1, 2014. Additionally, we experienced a decrease in management fees from managed hotels, primarily due to the loss of the Ames management contract, major renovations at Sanderson and St Martins Lane which began during the first quarter of 2014, and lower technical service fees.

 

Operating Costs and Expenses

Rooms expense was relatively flat at $37.3 million for the year ended December 31, 2014 compared to $36.7 million for the year ended December 31, 2013. This slight increase is less than the  percentage increase in rooms revenue, discussed above, due to restructuring initiatives implemented on May 1, 2014 at our hotel properties.

Food and beverage expense decreased 2.1% to $60.4 million for the year ended December 31, 2014 compared to $61.8 million for the year ended December 31, 2013. This decrease is consistent with the decrease in food and beverage revenue, discussed above, and is primarily due to decrease in food and beverage expenses related to the effective transfer of the food and beverage venues at St Martins Lane in London to the hotel owner on January 1, 2014. Offsetting these decreases were increased expenses associated with the three leased food and beverage venues at Mandalay Bay in Las Vegas and at the food and beverage venues at Hudson, primarily Hudson Common.

Other departmental expense was relatively flat at $3.3 million for the years ended December 31, 2014 and December 31, 2013. A slight increase of 1.5% was primarily the result of increased expenses at Hudson related to the change in internet pricing strategy discussed above.  

Hotel selling, general and administrative expense decreased 5.0% to $41.7 million for the year ended December 31, 2014 compared to $43.9 million for the year ended December 31, 2013. This decrease was primarily due to a decrease in advertising and promotional expenses due to cost-control measures taken in 2014.  

Property taxes, insurance and other expense decreased 4.6% to $16.5 million for the year ended December 31, 2014 compared to $17.3 million for the year ended December 31, 2013. This decrease was primarily due to real estate tax refunds received at Delano South Beach during the second quarter of 2014 and Clift during the third quarter of 2014 for which there was no comparable refunds received during the same periods in 2013.    

 

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Corporate expenses, including stock compensation decreased 5.8% to $26.0 million for the year ended December 31, 2014 compared to $27.6 million for the year ended December 31, 2013. This decrease was primarily due to savings resulting from the Termination Plan in March 2014 that resulted in a workforce reduction of our corporate office employees, which was partially offset by a $1.5 million litigation settlement at TLG in 2014.

Depreciation and amortization increased 5.5% to $28.9 million for the year ended December 31, 2014 compared to $27.4 million for the year ended December 31, 2013. This increase was primarily due to the increased depreciation related to the renovation of certain food and beverage outlets at Hudson in 2013 and 2014 and the conversion of SROs into new guest rooms at Hudson in early 2014.

Restructuring and disposal costs increased 26.9% to $14.5 million for the year ended December 31, 2014 compared to $11.5 million for the year ended December 31, 2013. This increase was primarily due to severance and related costs incurred in early 2014 relating to the Termination Plan. Costs incurred during 2013 primarily related to legal and advisory fees incurred in connection with the 2013 Deleveraging Transaction, discussed further in note 7 to our consolidated financial statements.

Development costs increased 57.6% to $4.7 million for the year ended December 31, 2014 compared to $3.0 million for the year ended December 31, 2013. This increase was primarily due to costs incurred in 2014 related to the termination of the management agreement for Mondrian at Baha Mar, including the write-off of capitalized costs, and costs associated with the initiation of foreclosure proceedings related to Mondrian Istanbul, as discussed further in note 5 to our consolidated financial statements.

Impairment loss on receivables and other assets from unconsolidated joint venture and managed hotel was zero for the year ended December 31, 2014 compared to $6.0 million for the year ended December 31, 2013. During 2013, we impaired certain outstanding receivables due from Mondrian SoHo and Delano Marrakech, as management concluded that collection of these receivables was uncertain, and we impaired the balance of our key money investment in Delano Marrakech. There were no comparable impairment charges in 2014.

 Interest expense, net increased 18.1% to $54.3 million for the year ended December 31, 2014 compared to $46.0 million for the year ended December 31, 2013. This increase was primarily due to a $2.2 million exit fee related to the repayment of the Hudson 2012 Mortgage Loan in February 2014, defined below in “--Debt”, and the Hudson/Delano 2014 Mortgage Loan, which closed in February 2014, resulting in a larger debt balance outstanding during 2014 as compared the same period in 2013.

Equity in (income) loss of unconsolidated joint ventures resulted in a slight gain for the year ended December 31, 2014 compared to a loss of $0.8 million for the year ended December 31, 2013. We no longer record our share of equity losses on a majority of our unconsolidated joint ventures, as we have written our investment balances down to zero due to impairments recorded in prior periods.  

Gain on asset sales was flat for the periods presented, resulting in income of $8.0 million for the years ended December 31, 2014 and 2013. This income was related to the recognition of gains we recorded on the sales of Royalton, Morgans and Mondrian Los Angeles and our 50% ownership in the entity that owned Sanderson and St Martins Lane, all occurring in 2011. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement.

Other non-operating expenses increased 37.0% to $3.7 million for the year ended December 31, 2014 as compared to $2.7 million for the year ended December 31, 2013. This increase was primarily due to settlement and litigation related costs incurred in 2014.

Income tax expense increased to $1.5 million for the year ended December 31, 2014 as compared to $0.7 million for the year ended December 31, 2013. This increase was primarily due to recognition of additional valuation allowance against a portion of the deferred tax assets that we believed was more likely than not to be unrealized.  

 

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

The following table presents our operating results for the years ended December 31, 2013 and 2012, including the amount and percentage change in these results between the two periods. The consolidated operating results are as follows:

 

  

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

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

 

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

 

  

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

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

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

Operating Costs and Expenses

Rooms expense increased 17.5% to $36.6 million for the year ended December 31, 2013 compared to $31.2 million for the year ended December 31, 2012. This increase is consistent with the increase in rooms revenue, discussed above, and is primarily a result of rooms out of service during the Hudson renovation work in 2012, which decreased rooms expense recognized during the year ended December 31, 2012.

Food and beverage expense increased 32.2% to $61.8 million for the year ended December 31, 2013 compared to $46.7 million for the year ended December 31, 2012. This is consistent with the increase in food and beverage revenue, discussed above, and is primarily due to the expenses associated with the three leased food and beverage venues at Mandalay Bay in Las Vegas, which opened in late 2012 and the first and third quarter of 2013, respectively, for which there was no comparable expense in the prior year.

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

Hotel selling, general and administrative expense increased 14.7% to $43.9 million for the year ended December 31, 2013 compared to $38.3 million for the year ended December 31, 2012. This increase was primarily due to increased occupancy and more rooms in service at Hudson which resulted in increased heat, light and power and other related costs. Occupancy levels and the number of rooms in service at Hudson during the year ended December 31, 2012 were lower due to the ongoing renovation and out of service rooms.

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

 

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

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

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

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

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

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

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

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

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

 

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Liquidity and Capital Resources

As of December 31, 2014, we had approximately $13.5 million in cash and cash equivalents.  

On January 23, 2015, we completed the TLG Equity Sale.  Net proceeds from the sale were approximately $32.8 million resulting in pro forma cash and cash equivalents of approximately $46.3 million had the TLG Equity Sale been completed on December 31, 2014.

We intend to utilize our liquidity to satisfy our short-term and long-term liquidity requirements, as described in more detail below, and for general corporate purposes. We believe we have sufficient cash to meet these obligations.

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

Liquidity Requirements

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

On January 15, 2015, each of Messrs. Sasson and Masi exercised his right to require the managing member of TLG to purchase his equity interest in TLG pursuant to the Sasson-Masi Put Options.  We currently estimate the total Sasson-Masi Put Options liability to be approximately $5.0 million.  However, pursuant to the TLG Equity Sale, Hakkasan, as the current managing member, is obligated to pay $3.6 million of this amount upon delivery of the 10% equity interest in TLG held by the Minority Holders.  As a result, our net cash outlay is expected to be approximately $1.4 million, which we anticipate paying in 2015.

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

Our obligations under the Hudson/Delano 2014 Mortgage Loan mature on February 9, 2016 unless we exercise certain extension rights. We have three, one-year extension options that will permit us to extend the maturity date of the Hudson/Delano 2014 Mortgage Loan to February 9, 2019, if certain conditions are satisfied at the respective extension dates, including delivery by the borrowers of a business plan and budget for the extension term reasonably satisfactory to the lenders and our achievement of a specified debt yield. We may prepay the Hudson/Delano 2014 Mortgage Loan in an amount necessary to achieve the specified debt yield.  We are currently meeting the necessary extension options without a requirement for a prepayment.

We often commit to contribute capital in various forms toward the development of our new managed and franchised hotels. These contributions may include equity investments, key money and cash flow guarantees to hotel owners. As of December 31, 2014, our short-term key money funding obligation was $0.3 million in key money for 10 Karaköy, a Morgans Original branded hotel in Istanbul, Turkey, that opened in November 2014 and is expected to be funded in 2015.  

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt or lease agreements related to such hotels. These capital expenditures relate primarily to the periodic replacement or refurbishment of furniture, fixtures and equipment. Such agreements typically require us to reserve funds at amounts equal to 4% of the hotel’s revenues and require the funds to be set aside in restricted cash. Furthermore, we may incur additional costs at our Owned Hotels on targeted projects that we believe will enhance the value of our properties.  

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

We are a party to several ongoing material legal proceedings. These proceedings are described below Item 3 of Part I of this report under the heading “Legal Proceedings” and also in note 8 of our consolidated financial statements included in Item 15 of Part IV of this report.   Should an unfavorable outcome occur in some or all of these legal proceedings, we may incur additional costs and expenses relating to the defense or adverse outcome of any future litigation.  

 

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

Our Series A preferred securities had an 8% dividend rate until October 15, 2014, and have a 10% dividend rate until October 15, 2016 and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. On May 14, 2014, at our annual shareholder meeting, a Board of Directors nominee representing the Yucaipa Investors was elected as a director of the Company. Accordingly, the current dividend rate on the Series A preferred securities is 10%.  We have the option to accrue any and all dividend payments, and as of December 31, 2014, have not declared any dividends. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. As of December 31, 2014, we have undeclared dividends of approximately $43.3 million. We have the option to redeem any or all of the Series A preferred securities at any time.

Other long-term liquidity requirements include our obligations in our trust preferred securities, which mature in October 2036 and the Clift lease, each as described under “—Debt.” In the event we were to undertake a transaction that was deemed to constitute a transfer of our properties and assets substantially as an entirety within the meaning of the indenture, we may be required to repay the trust preferred securities prior to their maturity or obtain the trustee’s consent in connection with such transfer.   The TLG Equity Sale was not deemed to constitute a transfer of substantially all of our assets within the meaning of the indenture.  

We are focused on growing our portfolio, primarily with our core brands, in major gateway markets and key resort destinations. In order to obtain long-term management contracts, we have committed to contribute capital in various forms on hotel development projects. These include equity investments, key money and cash flow guarantees to hotel owners. The cash flow guarantees generally have a stated maximum amount of funding and a defined term. The terms of the cash flow guarantees to hotel owners generally require us to fund if the hotels do not attain specified levels of operating profit. See note 8 to our consolidated financial statements included elsewhere in this report for more information. Often, cash flow guarantees to hotel owners may be recoverable as loans repayable to us out of future hotel cash flows and/or proceeds from the sale of hotels. Additionally, as our new managed and franchised hotels are developed, to the extent we have committed to contribute key money, equity or debt, these amounts will generally come due prior to or on the hotel opening. As of December 31, 2014, we did not have any equity or debt financing commitments relating to hotel development projects. As of December 31, 2014, we believe our potential funding under cash flow guarantees at operating hotels and hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum cannot be determined, was $5.0 million. In addition, we have an $8.0 million performance-based cash flow guarantee related to Delano Marrakech, which we believe we are not obligated to fund. As discussed further in Part I, “Item 3. Legal Proceedings,” we are in litigation with the hotel owner surrounding the termination of the Delano Marrakech hotel management agreement, performance-based cash flow guarantee and related matters. Both parties are seeking arbitration of the dispute, which is expected to occur in October 2015.  See note 8 to our consolidated financial statements included elsewhere in this report for more information.

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

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

As of December 31, 2014, we had approximately $391.0 million of remaining Federal tax net operating loss carryforwards to offset future income, including gains on future asset sales. We believe we have significant value available to us in Delano South Beach and Hudson, and that the tax basis of these assets is significantly less than their fair values. As of December 31, 2014, we estimate that the tax basis of Delano South Beach is approximately $54.4 million and the tax basis in Hudson is approximately $136.8 million.  

Other Liquidity Matters

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

 

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Mondrian South Beach Mortgage and Mezzanine Agreements. As of December 31, 2014, the joint venture’s outstanding nonrecourse mortgage debt was $23.1 million and mezzanine debt was $28.0 million. The joint venture also has an additional $28.0 million of mezzanine debt owed to affiliates of the joint venture partners. The lender’s nonrecourse mortgage loan and mezzanine loan related to Mondrian South Beach matured on August 1, 2009. In April 2010, the Mondrian South Beach ownership joint venture amended the nonrecourse financing and mezzanine loan agreements secured by Mondrian South Beach or related equity interests and extended the maturity date for up to seven years through one-year extension options until April 2017, subject to certain conditions. In February 2015, the joint venture exercised its option to extend the outstanding mortgage and mezzanine debt until April 2016.

Morgans Group and affiliates of our joint venture partner have agreed to provide standard nonrecourse carve-out guarantees and provide certain limited indemnifications for the Mondrian South Beach mortgage and mezzanine loans. In the event of a default, the lenders’ recourse is generally limited to the mortgaged property or related equity interests, subject to standard nonrecourse carve-out guarantees for “bad boy” type acts. Morgans Group and affiliates of our joint venture partner also agreed to guaranty the joint venture’s obligation to reimburse certain expenses incurred by the lenders and indemnify the lenders in the event such lenders incur liability in connection with certain third-party actions. Morgans Group and affiliates of our joint venture partner have also guaranteed the joint venture’s liability for the unpaid principal amount of any seller financing note provided for condominium sales if such financing or related mortgage lien is found unenforceable, provided they shall not have any liability if the seller financed unit becomes subject again to the lien of the lender’s mortgage or title to the seller financed unit is otherwise transferred to the lender or if such seller financing note is repurchased by Morgans Group and/or affiliates of our joint venture partner at the full amount of unpaid principal balance of such seller financing note. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, Morgans Group and affiliates of our joint venture partner may have continuing obligations under construction completion guarantees until all outstanding payables due to construction vendors are paid. As of December 31, 2014, there were remaining payables outstanding to vendors of approximately $0.3 million. Pursuant to a letter agreement with the lenders for the Mondrian South Beach loan, the joint venture agreed that these payables, many of which are currently contested or under dispute, will not be paid from operating funds but only from tax abatements and settlements of certain lawsuits. In the event funds from tax abatements and settlements of lawsuits are insufficient to repay these amounts in a timely manner, we and our joint venture partner are required to fund the shortfall amounts.

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

Mondrian SoHo. As of December 31, 2014, the Mondrian SoHo joint venture’s outstanding mortgage debt secured by the hotel was $196.0 million.  The joint venture did not satisfy the extension conditions in 2012 and the loan matured on November 15, 2012. In January 2013, the lender initiated foreclosure proceedings.  A foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was completed on March 6, 2015, as discussed further in Part I, “Item 3. Legal Proceedings.”  

Additionally, there have been and, due to the fact that the lender controls all of the cash flow, may continue to be cash shortfalls from the operations of the hotel from time to time which have required additional fundings by us and our joint venture partner.

Certain affiliates of our joint venture partner provided a standard nonrecourse carve-out guaranty for “bad boy” type acts and a completion guaranty to the lenders for the Mondrian SoHo loan, for which Morgans Group has agreed to indemnify the joint venture partner and its affiliates up to 20% of such entities’ guaranty obligations, provided that each party is fully responsible for any losses incurred as a result of its respective gross negligence or willful misconduct. As of December 31, 2014, we believe that there has been no triggering event that would require us to accrue any potential liability related to the above mentioned guarantees.  

Ames. On April 26, 2013, the joint venture closed on a new loan agreement with the mortgage lenders that provides for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. We did not contribute to the cash paydown and instead entered into an agreement with our joint venture partner pursuant to which, among other things, (1) we assigned our equity interests in the joint venture to our joint venture partner, (2) we agreed to give our joint venture partner the right to terminate our management agreement upon 60 days’ prior notice in return for an aggregate payment of $1.8 million, and (3) a creditworthy affiliate of our joint venture partner has assumed all or a portion of our liability with respect to historic tax credit guarantees, with our liability for any tax credit guarantees capped, in any event, at $3.0 million in the aggregate. The potential liability for historic tax credit guarantees relates to approximately $16.9 million of federal and state historic rehabilitation tax credits that Ames qualified for at the time of its development. As of December 31, 2014, there has been no triggering event that would require us to accrue any potential liability related to the historic tax credit guarantee. Effective July 17, 2013, we no longer manage Ames.

 

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Mondrian Istanbul. Due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We initiated foreclosure proceedings on March 11, 2014. Our joint venture partner, and through such joint venture partner, the joint venture itself, have objected to the foreclosure proceeding, as a result of which, the foreclosure proceeding is currently stayed.  A case for the annulment of such objection to the foreclosure proceeding was initiated on October 31, 2014 and is currently pending. Additionally, in June 2014, the joint venture purported to notify us that it had terminated the hotel management agreement. We have objected to such purported notices and intend to vigorously defend against any lawsuit that may result. In addition, we have initiated proceedings in an English court seeking payment of the put option amount against the individual shareholders behind the joint venture partner.  The parties are also seeking various other judicial remedies in Turkey. 

Potential Litigation. We may have potential liability in connection with certain claims by a designer for which we have accrued $13.9 million as of December 31, 2014, as discussed in note 6 of our consolidated financial statements.  

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

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

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

Comparison of Cash Flows for the Year Ended December 31, 2014 to December 31, 2013

Operating Activities. Net cash used in operating activities was $3.9 million for the year ended December 31, 2014 as compared to net cash used in operating activities of $3.1 million for the year ended December 31, 2013. This increase in cash used related primarily to payments made related to the Termination Plan in 2014.

Investing Activities. Net cash used in investing activities amounted to $18.9 million for the year ended December 31, 2014 as compared to net cash used in investing activities of $7.4 million for the year ended December 31, 2013. The increase in cash used was primarily related to the October 2014 funding of our $15.3 million Mondrian London key money obligation which was slightly offset by the return of $3.0 million of previously funded key money, plus reimbursables, related to the Delano Moscow management agreement which was terminated in September 2014, as discussed further in note 8 of our consolidated financial statements.  

Financing Activities. Net cash provided by financing activities amounted to $26.2 million for the year ended December 31, 2014 as compared to $14.7 million for the year ended December 31, 2013. This increase in cash provided was primarily due to net proceeds received from the Hudson/Delano 2014 Mortgage Loan in February 2014, discussed below in “—Debt”, offset by the repayment of our Hudson 2012 Mortgage Loan, Delano Credit Facility, Convertible Notes and TLG Promissory Notes in 2014.  

Debt

Hudson/Delano 2014 Mortgage Loan. On February 6, 2014, certain of our subsidiaries entered into a new mortgage financing with Citigroup Global Markets Realty Corp. and Bank of America, N.A., as lenders, consisting of nonrecourse mortgage and mezzanine loans in the aggregate principal amount of $450.0 million, secured by mortgages encumbering Delano South Beach and Hudson and pledges of equity interests in certain of our subsidiaries (collectively, the “Hudson/Delano 2014 Mortgage Loan”). The net proceeds from the Hudson/Delano 2014 Mortgage Loan were applied to (1) repay $180 million of outstanding mortgage debt under the prior mortgage loan secured by Hudson (the “Hudson 2012 Mortgage Loan”), (2) repay $37 million of indebtedness under our $100.0 million senior secured revolving credit facility secured by Delano South Beach (the “Delano Credit Facility”), (3) provide cash collateral for reimbursement obligations with respect to a $10.0 million letter of credit under the Delano Credit Facility which was returned to the Company in June 2014, and (4) fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital, including repayment of the Convertible Notes and TLG Promissory Notes.

 

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

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

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

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

The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano South Beach and the owners of Hudson and Delano South Beach and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities loans. The Hudson/Delano 2014 Mortgage Loan is nonrecourse to our subsidiaries that are the borrowers under the loan, except pursuant to certain carveouts detailed therein. In addition, we have provided a customary environmental indemnity and nonrecourse carveout guaranty under which we would have liability with respect to the Hudson/Delano 2014 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, changes to the Hudson capital lease without prior written consent of the lender, violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty prohibits the payment of dividends on or repurchase of our common stock. As of December 31, 2014, we were in compliance with these covenants.

On April 8, 2014, the Hudson/Delano 2014 Mortgage Loan was amended to reallocate the principal amount and interest rate spread of the $300.0 million nonrecourse mortgage notes. This technical amendment had no impact on the outstanding principal amount of the nonrecourse mortgage notes or the blended interest rate of the Hudson/Delano 2014 Mortgage Loan.

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

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

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

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

The Delano Credit Facility provided commitments for a $100 million revolving credit facility and included a $15 million letter of credit sub-facility. The interest rate applicable to loans under the Delano Credit Facility was a floating rate of interest per annum, at the Borrowers’ election, of either LIBOR (subject to a LIBOR floor of 1.00%) plus 4.00%, or a base rate, as set forth in the agreement, plus 3.00%. In addition, a commitment fee of 0.50% applied to the unused portion of the commitments under the Delano Credit Facility.

 

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

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

Clift. We lease Clift under a 99-year nonrecourse lease agreement expiring in 2103. The lease is accounted for as a capital lease with a liability balance of $93.8 million at December 31, 2014.

The lease agreement provides for base annual rent of approximately $6.0 million per year until October 2014. As a result of the first such increase, effective October 14, 2014, the annual rent increased to $7.6 million.  Thereafter, the base rent increases at five-year intervals by a formula tied to increases in the Consumer Price Index, with a maximum increase of 20% and a minimum increase of 10% at each five-year rent increase date thereafter. The lease is nonrecourse to us. Morgans Group also entered into a limited guaranty, whereby Morgans Group agreed to guarantee losses of up to $6 million suffered by the lessors in the event of certain “bad boy” type acts. As of December 31, 2014, there has been no triggering event that would require us to accrue any potential liability related to this guarantee.

Convertible Notes. On October 17, 2007, we completed an offering of $172.5 million aggregate principal amount of our 2.375% Convertible Notes in a private offering.  

From April 21, 2010 to July 21, 2010, the Yucaipa Investors purchased $88.0 million of the Convertible Notes from third parties. On February 28, 2014, we entered into a Note Repurchase Agreement with the Yucaipa Investors, pursuant to which we repurchased the $88.0 million of Convertible Notes owned by them for an amount equal to their principal balance plus accrued interest. We used cash on hand, including proceeds of the Hudson/Delano 2014 Mortgage Loan, for this repurchase.

During the third quarter of 2014, we used cash on hand to repurchase an aggregate of $35.4 million of outstanding Convertible Notes at a discount of approximately $0.1 million plus accrued interest. On the maturity date, October 15, 2014, we repaid the remaining outstanding balance of Convertible Notes of $49.1 million.  All Convertible Notes were retired upon repurchase.

TLG Promissory Notes. On November 30, 2011, pursuant to purchase agreements entered into on November 17, 2011, certain of our subsidiaries completed the acquisition of 90% of the equity interests in TLG for a purchase price of $28.5 million in cash and up to $18.0 million in TLG Promissory Notes convertible into shares of our common stock at $9.50 per share subject to the achievement of certain EBITDA targets for the acquired business. The EBITDA targets were achieved in November 2014.  

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

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

As discussed further in Part I, “Item 3. Legal Proceedings,” on August 5, 2013, Messrs. Sasson and Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition and Morgans Group alleging, among other things, breach of contract and an event of default under the TLG Promissory Notes.  The oral argument on the motion occurred on October 29, 2014 and we are awaiting the court’s ruling.  Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit has not been dismissed.  

Hudson Capital Leases. We lease two condominium units at Hudson which are reflected as capital leases with balances of $6.1 million at December 31, 2014. Currently annual lease payments total approximately $1.0 million and are subject to increases in line with inflation. The leases expire in 2096 and 2098.

 

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

The Restaurant Lease Note does not bear interest except in the event of default, as defined in the agreement. In accordance with ASC 470, Debt, we imputed interest on the Restaurant Lease Note, which was recorded at its fair value of $7.5 million as of the date of issuance. At December 31, 2014, the recorded balance outstanding on the Restaurant Lease Note is $5.7 million.

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

Contractual Obligations

We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also enter into other purchase commitments and other executory contracts that are not recognized as liabilities until services are performed or goods are received. The following table summarizes our contractual obligations and other commitments as of December 31, 2014, excluding debt obligations at our Joint Venture Hotels:

 

 

The table above excludes our $0.3 million key money obligation for 10 Karaköy and potential funding under cash flow guarantees at operating hotels and hotels under development, as described in “—Off Balance Sheet Arrangements - Other Development Stage Hotels” below.  Financing has not been obtained for certain of these hotel projects, and there can be no assurances that any or all of our hotel projects will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, in which case we may be unable to recover any previously funded key money, equity investments or debt financing.  

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

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

 

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Our Series A preferred securities had an 8% dividend rate until October 15, 2014 and have a 10% dividend rate until October 15, 2016 and a 20% dividend rate thereafter, with a 4% increase in the dividend rate during certain periods in which the Yucaipa Investors’ nominee to our Board of Directors has not been elected as a director or subsequently appointed as a director by our Board of Directors. On May 14, 2014, at our annual shareholder meeting, a Board of Directors nominee representing the Yucaipa Investors was elected as a director of the Company. Accordingly, the current dividend rate on the Series A preferred securities is 10%.  We have the option to accrue any and all dividend payments, and as of December 31, 2014, have not declared any dividends. The cumulative unpaid dividends also have a dividend rate equal to the then applicable dividend rate on the Series A preferred securities. As of December 31, 2014, we have undeclared dividends of approximately $43.3 million, which amount is not included in the table above. We have the option to redeem any or all of the Series A preferred securities at any time.

Seasonality

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

To help demonstrate seasonality, the table below provides room revenues by quarter for the years ended December 31, 2014 and 2013 for Hudson and Delano South Beach, both of which are our fee-owned hotels included in our Owned Hotels as of December 31, 2014.

 

  

Due to the recent global economic downturn, the impact of seasonality in 2014 and 2013 was not as significant as in pre-recessionary periods and may continue to be less pronounced in 2015 depending on the timing and strength of the economic recovery.

Capital Expenditures and Reserve Funds

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt or lease agreements related to such hotels. As of December 31, 2014, approximately $1.9 million was available in restricted cash reserves for future capital expenditures under these obligations related to our Owned Hotels.

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

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

During 2014, we converted eight additional SROs, together with other space, into 12 new guest rooms.  The total cost of these 12 new guest rooms was approximately $2.0 million. As of December 31, 2014, we have 60 SROs remaining at Hudson, which we intend to convert into guest rooms in the future. In addition, we may incur additional costs at our Owned Hotels on targeted projects that we believe will enhance the value of our properties.  

We anticipate Clift, a leased hotel, will need to be renovated in the next few years.

 

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 Derivative Financial Instruments

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

As of December 31, 2014, we had three interest rate caps outstanding related to the Hudson/Delano 2014 Mortgage Loan, the fair value of which was immaterial.

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

Off-Balance Sheet Arrangements

As of December 31, 2014, we had unconsolidated joint ventures that we account for using the equity method of accounting, most of which have mortgage or related debt, as described in “—Other Liquidity Matters” above. In some cases, we provide nonrecourse carve-out guarantees of joint venture debt, which guarantees are only triggered in the event of certain “bad boy” acts, and other limited liquidity or credit support, as described in “—Other Liquidity Matters” above.

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

Mondrian South Beach. We own a 50% interest in Mondrian South Beach, an apartment building which was converted into a condominium and hotel. Mondrian South Beach opened in December 2008, at which time we began operating the property under a 20-year management contract. We also own a 50% interest in a mezzanine financing joint venture with an affiliate of our Mondrian South Beach joint venture partner through which a total of $28.0 million in mezzanine financing was provided to the Mondrian South Beach joint venture. As of December 31, 2014, the Mondrian South Beach joint venture’s outstanding nonrecourse mortgage debt secured by the hotel was $23.1 million and mezzanine debt secured by related equity interests was $28.0 million. In addition, as of December 31, 2014 the outstanding mezzanine debt owed to the affiliates of joint venture partners was $28.0 million. In February 2015, the Mondrian South Beach joint venture exercised its option to extend the outstanding mortgage and mezzanine debt for another year until April 2016.

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

We accounted for this investment under the equity method of accounting through December 31, 2012, until our recording of losses was suspended due to our investment balance reaching zero. At December 31, 2014, our investment in Mondrian South Beach was zero.

Mondrian SoHo. In June 2007, we contributed approximately $5.0 million for a 20% equity interest in a joint venture with Cape Advisors Inc. to develop a Mondrian hotel in the SoHo neighborhood of New York. The joint venture obtained a loan of $195.2 million to acquire and develop the hotel, which matured in June 2010. On July 31, 2010, the mortgage loan secured by the hotel was amended to, among other things, provide for extensions of the maturity date to November 2011 with extension options through 2015, subject to certain conditions including a minimum debt service coverage test calculated, based on ratios of net operating income to debt service for specified periods ended September 30^th of each year. The joint venture did not satisfy the extension conditions in 2012 and the loan matured on November 15, 2012. In January 2013, the lender initiated foreclosure proceedings.  A foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was completed on March 6, 2015, as discussed further in Part I, “Item 3. Legal Proceedings.”  Effective March 6, 2015, we no longer hold any equity interest in Mondrian SoHo.

 

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

Based on the decline in market conditions following the inception of the joint venture and the need for additional funding to complete the hotel, we wrote down our investment in Mondrian SoHo to zero in June 2010. We have recorded all additional fundings as impairment charges through equity in loss of unconsolidated joint ventures during the periods the funds were contributed. As of December 31, 2014, our financial statements reflect no value for our investment in the Mondrian SoHo joint venture.

Shore Club. On December 30, 2013, Shore Club was sold to HFZ Capital Group. Phillips International, an affiliate of Shore Club’s former owner, retains an ownership stake. The new owner has publicly stated that it may convert a substantial part of the hotel to condominiums, and we could be replaced as hotel manager. To date, we have received no notice of termination of our management agreement, and intend to continue to operate the hotel pursuant to that agreement. However, no assurance can be provided that we will continue to do so in the future. As of December 31, 2014, we had only an immaterial contingent profit participation equity interest in Shore Club.

Mondrian Istanbul. In December 2011, we entered into a new 20-year hotel management agreement, with a 10-year extension option, for an approximately 114-room Mondrian-branded hotel to be located in the Old City area of Istanbul, Turkey. As of December 31, 2014, we have contributed a total of $10.4 million in the form of equity and key money and have a 20% ownership interest in the venture owning the hotel.

Due to our joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, we exercised our put option under the joint venture agreement that requires our joint venture partner to buy back our equity interests in the Mondrian Istanbul joint venture. Our rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, we issued a notice of default to our joint venture partner, as they failed to buy back our equity interests by the contractual deadline, and further notified our joint venture partner that we plan to begin foreclosure proceedings as a result of the event of default. We initiated foreclosure proceedings on March 11, 2014. Our joint venture partner, and through such joint venture partner, the joint venture itself, have objected to the foreclosure proceeding, as a result of which, the foreclosure proceeding is currently stayed.  A case for the annulment of such objection to the foreclosure proceeding was initiated on October 31, 2014 and is currently pending.  Additionally, in June 2014, the joint venture purported to notify us that it had terminated the hotel management agreement. We have objected to such purported notices and intend to vigorously defend against any lawsuit that may result. In addition, we have initiated proceedings in an English court seeking payment of the put option amount against the individual shareholders behind the joint venture partner.  The parties are also seeking various other judicial remedies in Turkey. 

Food and Beverage Venture at Mondrian South Beach. In June 2011, we acquired the ownership interest in the food and beverage venture at Mondrian South Beach from our former joint venture partner. Our ownership interest in the food and beverage venture at Mondrian South Beach is less than 100%, and was re-evaluated in accordance with ASC 810-10. We concluded that this venture did not meet the requirements of a variable interest entity and accordingly, this investment in the joint venture is accounted for using the equity method, as we do not believe we exercise control over significant asset decisions such as buying, selling or financing.

We accounted for this investment under the equity method of accounting through December 31, 2013, until our recording of losses were suspended due to the investment in this food and beverage venture being reduced to zero. At December 31, 2014, our investment in food and beverage venture at Mondrian South Beach was zero. Our equity in loss of the food and beverage venture was $0.6 million and $0.8 million for the years ended December 31, 2013 and 2012, respectively.

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

As of December 31, 2014, our key money funding obligations were $0.3 million related to 10 Karaköy, which opened in November 2014.  As of December 31, 2014, our potential funding obligations under cash flow guarantees at operating hotels and hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum cannot be determined, were $13.0 million, which includes an $8.0 million performance cash flow guarantee related to Delano Marrakech, which we believe we are not obligated to fund.   As of December 31, 2014, we had no equity or debt-related funding obligations related to hotels under development.

 

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Recent Accounting Pronouncements

See note 2 to our consolidated financial statements for information related to our adoption of new accounting standards in 2014 and for information on our anticipated adoption of recently issued accounting standards.  

Critical Accounting Policies

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

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

 

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

 

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Interest Rate Risk

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Some of our outstanding debt has a variable interest rate. As described in “Management’s Discussion and Analysis of Financial Results of Operations — Derivative Financial Instruments” above, we use derivative financial instruments, primarily interest rate caps, to manage our exposure to interest rate risks related to our floating rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors.

As of December 31, 2014, our total outstanding consolidated debt, including capital lease obligations, was approximately $605.7 million, of which approximately $450.0 million, or 74.3%, was variable rate debt. At December 31, 2014, the one month LIBOR rate was 0.17%.

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

As of December 31, 2014, our fixed rate debt, excluding our Hudson capital lease obligation, of $149.6 million consisted of the trust notes underlying our trust preferred securities, the Clift lease, and the Restaurant Lease Note. The fair value of some of these debts is greater than the book value. As such, if interest rates increase by 1.0%, or 100 basis points, the fair value of our fixed rate debt at December 31, 2014, would decrease by approximately $17.3 million. If market rates of interest decrease by 1.0%, the fair value of our fixed rate debt at December 31, 2014 would increase by $22.0 million.

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

 

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Currency Exchange Risk

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

Generally, we do not enter into forward or option contracts to manage our exposure applicable to day-to-day net operating cash flows. We do not foresee any significant changes in either our exposure to fluctuations in foreign exchange rates or how such exposure is managed in the future.

The consolidated financial statements of Morgans Hotel Group Co. and the notes related to the foregoing financial statements, together with the independent registered public accounting firm’s reports thereon, are set forth on pages F-1 through F-43 of this report. Additionally, the consolidated financial statements of our significant subsidiary are incorporated by reference in this Annual Report on Form 10-K.

None.

Evaluation of Disclosure Controls and Procedure

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

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15) that occurred during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

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

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

In connection with the preparation of the Company’s annual financial statements, management has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014. The assessment was based upon the framework described in “Internal Control-Integrated Framework (2013 Framework)” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management’s assessment included an evaluation of the design of internal control over financial reporting and testing of the operational effectiveness of internal control over financial reporting. We have reviewed the results of the assessment with the Audit Committee of our Board of Directors.  

Based on our assessment under the criteria set forth in COSO, management has concluded that, as of December 31, 2014, the Company maintained effective internal control over financial reporting.

BDO USA, LLP, an independent registered public accounting firm, that audited our consolidated financial statements included in this Annual Report has issued an attestation report on our internal control over financial reporting as of December 31, 2014, which appears in Item 9A, below.

 

 

 

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

Board of Directors and Stockholders

Morgans Hotel Group Co.

New York, NY

We have audited Morgans Hotel Group Co.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Morgans Hotel Group Co.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

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

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

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

In our opinion, Morgans Hotel Group Co. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014 based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Morgans Hotel Group Co. as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2014, and our report dated March 13, 2015 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP                        

New York, New York

March 13, 2015

 

 

 

 

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None.

 

 

 

 

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PART III

The information required by this item regarding directors, executive officers and corporate governance is hereby incorporated by reference to the material appearing in the Proxy Statement for the Annual Stockholders Meeting to be held in 2015 (the “Proxy Statement”) under the captions “Board of Directors and Corporate Governance,” and “Executive Officer Biographies.” The information required by this item regarding compliance with Section 16(a) of the Exchange Act, is hereby incorporated by reference to the material appearing in the Proxy Statement under the caption “Voting Securities of Certain Beneficial Owners and Management — Section 16(a) Beneficial Ownership Reporting Compliance.” The information required by this item with respect to the availability of our code of ethics is provided in Item 1 of this Annual Report on Form 10-K. See “Item 1 — Materials Available on Our Website.”

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

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

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

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

 

 

 

 

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PART IV

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

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

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

(b) Exhibits

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

 

 

 

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

 

F-1

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Morgans Hotel Group Co.

New York, NY

We have audited the accompanying consolidated balance sheets of Morgans Hotel Group Co. (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive loss, stockholders’ deficit, and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Morgans Hotel Group Co. at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Morgans Hotel Group Co.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 13, 2015 expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

New York, New York

March 13, 2015

 

 

 

 

F-2

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Morgans Hotel Group Co.

Consolidated Balance Sheets

(in thousands, except per share data)

 

See accompanying notes to these consolidated financial statements.

 

 

 

 

F-3

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Morgans Hotel Group Co.

Consolidated Statements of Comprehensive Loss

(in thousands, except per share data)

 

 

See accompanying notes to these consolidated financial statements.

 

 

 

 

F-4

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Morgans Hotel Group Co.

Consolidated Statements of Stockholders’ Deficit

(in thousands)

  

 

See accompanying notes to these consolidated financial statements.

 

 

 

F-5

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Morgans Hotel Group Co.

Consolidated Statements of Cash Flows

(in thousands)

 

  

See accompanying notes to these consolidated financial statements.

 

 

 

F-6

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Morgans Hotel Group Co.

Notes to Consolidated Financial Statements

 

1. Organization and Formation Transaction

Morgans Hotel Group Co., a Delaware corporation (the “Company”), was incorporated on October 19, 2005. The Company operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations.  

In addition, the Company owns leasehold interests in certain food and beverage venues.  Prior to the TLG Equity Sale, defined below, completed on January 23, 2015, the Company  operated nightclubs, restaurants, pool lounges, bars and other food and beverage venues primarily in  hotels operated by MGM Resorts International (“MGM”) in Las Vegas.  

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

The Company has one reportable operating segment; it operates, owns, acquires, develops and redevelops boutique hotels, nightclubs, restaurants, bars and other food and beverage venues in many of the hotels it operates.  Prior to the TLG Equity Sale completed on January 23, 2015, defined and discussed below, the Company, through its ownership of The Light Group (“TLG”), owned and operated nightclubs, restaurants, pool lounges, bars and other food and beverage venues in hotels and casinos operated by MGM in Las Vegas and at Delano Las Vegas.  During the years ended December 31, 2014, 2013 and 2012, the Company derived 5.8%, 10.7%, and 12.6% 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 December 31, 2014 were as follows:

 

 

 

F-7

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 Food and Beverage Operations

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

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

The Light Group

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

On November 30, 2011, pursuant to purchase agreements entered into on November 17, 2011, certain of the Company’s subsidiaries completed the acquisition of 90% of the equity interests in TLG Acquisition LLC (“TLG Acquisition,” and together with its subsidiaries, “TLG”), for a purchase price of $28.5 million in cash and up to $18.0 million in notes (the “TLG Promissory Notes”), which were convertible into shares of the Company’s common stock at $9.50 per share subject to the achievement of certain earnings before interest, tax, depreciation and amortization (“EBITDA”) targets for the acquired business (“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 7.

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.

In 2013, TLG failed performance tests at certain MGM venues, and as a result, TLG agreed with MGM to amend the calculation of base and incentive management fees for all of TLG’s management agreements with MGM effective January 1, 2014 and agreed to a termination effective April 1, 2014 of TLG’s management agreement for Brand Steakhouse.

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

The Company has certain indemnification obligations, which generally survive for 18 months; however, no amounts will be held in escrow for the satisfaction of such claims.  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, is 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 paying any amounts in excess of this amount, as discussed below in “—Sasson-Masi Put Options.”

 

F-8

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In addition, for the 18 months following the closing of the TLG Equity Sale, the Company has the right to purchase 49% of the equity of TLG from Hakkasan (the “Option Right”).   The Option Right does not currently trigger any accounting impact on the Company’s consolidated financial statements.

Sasson-Masi Put Options.  On January 15, 2015, each of Messrs. Sasson and Masi exercised his right to require Morgans Group to purchase his equity interest in TLG at a purchase price equal to his percentage equity ownership interest multiplied by the product of seven times the EBITDA from non-Morgans business (“Non-Morgans EBITDA”) for the preceding 12 months, subject to certain adjustments (the “Sasson-Masi Put Options”). The Company initially accounted for the redeemable noncontrolling interest at fair value in accordance with Accounting Standard Codification (“ASC”) 805, Business Combinations. Due to the redemption feature associated with the Sasson-Masi Put Options, the Company classified the noncontrolling interest in temporary equity in accordance with the Securities and Exchange Commission’s guidance as codified in ASC 480-10, Distinguishing Liabilities from Equity. Subsequently, the Company accreted the redeemable noncontrolling interest to its current redemption value, which approximates fair value, each period. The change in the redemption value did not impact the Company’s earnings or earnings per share.   The estimated aggregate purchase price for the Sasson-Masi Put Options was approximately $5.0 million based on the contractual formula applied as of December 31, 2014 and to an option exercise date of January 15, 2015.  However, pursuant to the TLG Equity Sale, Hakkasan, as the current managing member, is obligated to pay $3.6 million of this amount upon delivery of the 10% equity interest in TLG held by the Minority Holders.  As a result, the Company’s net cash outlay is expected to be approximately $1.4 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 (“GAAP”). The Company consolidates all wholly-owned subsidiaries and variable interest entities in which the Company is determined to be the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation. Entities which the Company does not control through voting interest and entities which are variable interest entities of which the Company is not the primary beneficiary, are accounted for under the equity method.

 

Use of Estimates

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

 

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid investments with maturities of three months or less from the date of purchase.

 

Restricted Cash

As required by certain debt and lease agreements, restricted cash consists of cash held in escrow accounts for taxes, ground rent, insurance premiums, and debt service or lease payments.

The Hudson/Delano 2014 Mortgage Loan, defined and discussed below in note 7, provides that, in the event the debt yield ratio falls below certain defined thresholds, all cash flows from Hudson and Delano South Beach are deposited into accounts controlled by the lenders from which debt service and operating expenses, including management fees, are paid and from which other reserve accounts may be funded. Any excess amounts will be retained by the lenders until the debt yield ratio exceeds the required thresholds for two consecutive calendar quarters. As of December 31, 2014, the debt yield ratio exceeded the required threshold.  

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.

As of December 31, 2014, restricted cash also consisted of cash held in escrow for insurance programs.

 

F-9

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Accounts Receivable

Accounts receivable are carried at their estimated recoverable amount, net of allowances. Management provides for the allowances based on a percentage of aged receivables and assesses accounts receivable on a periodic basis to determine if any additional amounts will potentially be uncollectible. After all attempts to collect accounts receivable are exhausted, the uncollectible balances are written off against the allowance. The allowance for doubtful accounts is immaterial for all periods presented.

 

Property and Equipment

Building and building improvements are depreciated on a straight-line method over their estimated useful life of 39.5 years. Furniture, fixtures and equipment are depreciated on a straight-line method using five years. Building and equipment under capital leases and leasehold improvements are amortized on a straight-line method over the shorter of the lease term or estimated useful life of the asset.

Costs of significant improvements, including real estate taxes, insurance, and interest during the construction periods are capitalized. There was no such capitalized real estate taxes, insurance and interest for the years ended December 31, 2014 and 2013.

 

Goodwill

Goodwill represents the excess purchase price over the fair value of net assets attributable to business acquisitions and combinations. The Company tests for impairment of goodwill at least annually at year end. The Company will test for impairment more frequently if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. In accordance with ASU No. 2011-08, management assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If this is the case, management will perform a more detailed two-step goodwill impairment test which is used to identify potential goodwill impairments and to measure the amount of goodwill impairment losses to be recognized, if any. In applying the detailed two-step process, management identifies potential impairments in goodwill by comparing the fair value of the reporting unit with its book value. If the fair value of the reporting unit exceeds the carrying amount, including goodwill, the asset is not impaired. Any excess of carrying value over the estimated fair value of goodwill would be recognized as an impairment loss in continuing operations.

 The Company has one reportable operating segment, which is its reporting unit under ASC 350-20; therefore management aggregates goodwill associated to all owned hotels as well as the goodwill recorded in connection with the acquisition of TLG and the Company’s owned food and beverage venues when analyzing potential impairment.

As of December 31, 2014 and 2013, management concluded that no goodwill impairment existed as qualitative factors did not indicate that the fair value of the Company’s reporting unit was less than its carrying value. Further, management also performed a quantitative analysis comparing the Company’s carrying values to market values, as provided by third-party appraisals prepared in January 2014 and other market data available, and concluded that the fair value of the Company’s reporting unit was significantly greater than its carrying value. Management does not believe it is reasonably likely that goodwill will become impaired in future periods, but will test goodwill before the 2015 year end if events or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.

In connection with the TLG Equity Sale, the Company will write off the appropriate amount of goodwill associated with TLG during the first quarter of 2015.  

 

Impairment of Long-Lived Assets

In accordance with ASC 360-10, Property, Plant and Equipment (“ASC 360-10”) long-lived assets currently in use are reviewed periodically for possible impairment and will be written down to fair value if considered impaired. Long-lived assets to be disposed of are written down to the lower of cost or fair value less the estimated cost to sell. The Company reviews its portfolio of long-lived assets for impairment at least annually or when specific triggering events occur, as required by ASC 360-10. Recoverability of such assets is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset as determined by analyzing the operating forecasts for future periods. When events or changes of circumstances indicate that an asset’s carrying value may not be recoverable, the Company tests for impairment by estimating each property’s fair value using a discounted cash flow method taking into account each property’s expected cash flow from operations, holding period and net proceeds from the dispositions of the property. The factors the Company addresses in determining estimated net proceeds from disposition include anticipated operating cash flow in the year of disposition, terminal cash flow capitalization rate and selling price per room. For the years ended December 31, 2014 and 2013, management concluded that all long-lived assets were not impaired.

 

F-10

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Assets Held for Sale

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

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

In December 2014, the Company’s Board of Directors approved the TLG Equity Sale, as discussed in note 1.  For the year ended December 31, 2014, the Company has classified the assets and liabilities related to TLG as assets held for sale, as discussed further in note 17.  The Company’s assets related to TLG include its investment in the TLG management contracts, which were amortized using the straight line method, over the life of each applicable management contract prior to the Company’s reclassification of these assets to held for sale, goodwill, and some intangible assets.  The Company’s liabilities related to TLG are payables which are incurred in the normal course of running the food and beverage management company.  The Company has also reclassified its December 31, 2013 consolidated balance sheet to present the assets and liabilities related to TLG as assets held for sale.

 

Business Combinations

The Company recognizes identifiable assets acquired, liabilities (both specific and contingent) assumed, and non-controlling interests in a business combination at their fair values at the acquisition date based on the exit price (i.e. the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date). Furthermore, acquisition-related costs, such as due diligence, legal and accounting fees, are expensed as incurred. In certain situations, a deferred tax asset or liability is created due to the difference between the fair value and the tax basis of the acquired asset and assumed liabilities at the acquisition date, which also may result in a goodwill asset being recorded.

 

 Investments in and Advances to Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures using the equity method as it does not exercise control over significant business decisions such as buying, selling or financing nor is it the primary beneficiary under ASC 810-10, as discussed above. Under the equity method, the Company increases its investment for its proportionate share of net income and contributions to the joint venture and decreases its investment balance by recording its proportionate share of net loss and distributions. Once the Company’s investment balance in an unconsolidated joint venture is zero, the Company suspends recording additional losses. For investments in which there is recourse or unfunded commitments to provide additional equity, distributions and losses in excess of the investment are recorded as a liability. As of December 31, 2014 and 2013, there were no liabilities required to be recorded related to these investments.

The Company periodically reviews its investments in unconsolidated joint ventures for other-than-temporary declines in market value. In this analysis of fair value, the Company uses a discounted cash flow analysis to estimate the fair value of its investment taking into account expected cash flow from operations, holding period and net proceeds from the dispositions of the property. Any decline that is not expected to be recovered is considered other-than-temporary and an impairment charge is recorded as a reduction in the carrying value of the investment.

In 2013 and 2012, based on various factors, but primarily current economic conditions and certain upcoming mortgage debt maturities, the Company recognized, through its equity in loss from unconsolidated joint ventures, impairment charges totaling $0.2 million and $1.6 million, respectively, related to its unconsolidated joint ventures in Ames, Mondrian SoHo and Mondrian South Beach. As a result of these impairments and the recording of the Company’s equity in loss at each respective joint venture, the Company’s investment in Mondrian SoHo and Mondrian South Beach is zero as of December 31, 2014. Effective April 26, 2013, the Company no longer had any ownership interest in Ames.

 

 

F-11

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Other Assets

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

In August 2012, the Company entered into a 10-year licensing agreement with MGM, with two five-year extensions at the Company’s option subject to performance thresholds, to convert THEhotel to Delano Las Vegas. Delano Las Vegas opened in September 2014.  In addition, the Company acquired the leasehold interests in three food and beverage venues at Mandalay Bay in Las Vegas from an existing tenant for $15.0 million in cash at closing and a deferred, principal-only $10.6 million promissory note (“Restaurant Lease Note”) to be paid over seven years, which the Company recorded at fair value as of the date of issuance at $7.5 million, as discussed in note 7. The food and beverage venues, which have been reconcepted and renovated, were and continue to be managed by TLG. The three food and beverage venues are operated pursuant to 10-year operating leases with an MGM affiliate, pursuant to which the Company pays minimum annual lease payments and a percentage rent based on cash flow. The Company 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, using the straight line method, over the 10-year life of the license agreement, and the fair value of the restaurant leasehold interests, using the straight line method, over the 10-year life of the operating leases.

Further, as of December 31, 2014, other assets primarily consist of deferred financing costs which are being amortized, using the straight line method, which approximates the effective interest rate method, over the terms of the related debt agreements.

 

 Foreign Currency Translation

As we have international operations at hotels that we manage in London and hotels operated pursuant to franchise agreements in Turkey, currency exchange risks between the U.S. dollar and the British pound and U.S dollar and Turkish Lira arise as a normal part of our business. We reduce these risks by transacting these businesses primarily in their local currency. As a result, the translation of transactions with these hotels has resulted in foreign currency transaction gains and losses, which have been reflected in the results of operations based on exchange rates in effect at the date of the transactions. Such transactions do not have a material effect on the Company’s earnings.

 

Revenue Recognition

The Company’s revenues are derived from lodging, food and beverage and related services provided to hotel customers such as telephone, minibar and rental income from tenants. Revenue is recognized when the amounts are earned and can reasonably be estimated. These revenues are recorded net of taxes collected from customers and remitted to government authorities and are recognized as the related services are delivered. Rental revenue is recorded on a straight-line basis over the term of the related lease agreement.

The Company recognizes base and incentive management fees and chain service expense reimbursements related to the management of operating hotels in which the Company does not have an ownership interest, or in operating hotels that are unconsolidated joint ventures. These amounts are recognized as revenue when earned in accordance with the applicable management agreement. Under its management agreements, the Company generally recognizes base management and chain service expense reimbursements as a percentage of gross revenue and incentive management fees as a percentage of net operating income or Net Capital or Refinancing Proceeds, as defined in the applicable management agreement. The chain service expense reimbursements represent reimbursements of costs incurred by the Company from its managed hotels. The Company recognizes termination fees as income when received.  In 2013, the Company received and recorded income of $2.3 million of termination fees which was recorded in management fee-related parties other income on the consolidated statements of comprehensive loss.

Additionally, the Company recognizes license and franchise fees related to operating hotels that are subject to license or franchise agreements and managed by third parties.  These fees are recognized as revenue when earned in accordance with the applicable agreement. Under its license and franchise agreements, the Company generally recognizes base license or franchise fees as a percentage of gross sales, and incentive management fees as a percentage of net profits, as calculated pursuant to the applicable management agreement.  

Prior to completion of the TLG Equity Sale, the Company, through its ownership of TLG, also recognized management fees from the management of nightclubs, restaurants, pool lounges, and bar venues. These fees were recognized as revenue when earned in accordance with the applicable management agreement. Under its food and beverage management agreements, the Company generally recognizes base management fees as a percentage of gross sales, and incentive management fees as a percentage of net profits, as calculated pursuant to the applicable management agreement.

 

F-12

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Concentration of Credit Risk

The Company places its temporary cash investments in high credit financial institutions. However, a portion of temporary cash investments may exceed FDIC insured levels from time to time. The Company has never experienced any losses related to these balances.

 

Advertising and Promotion Costs

Advertising and promotion costs are expensed as incurred and are included in hotel selling, general and administrative expenses on the accompanying consolidated statements of comprehensive loss. These costs amounted to approximately $0.8 million, $0.8 million, and $1.1 million, for the years ended December 31, 2014, 2013, and 2012, respectively.

 

Repairs and Maintenance Costs

Repairs and maintenance costs are expensed as incurred and are included in hotel selling, general and administrative expenses on the accompanying consolidated statements of comprehensive loss.

 

Income Taxes

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

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

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

Income taxes for the years ended December 31, 2014, 2013, and 2012, were computed using the Company’s effective tax rate.

 

Derivative Instruments and Hedging Activities

As of December 31, 2014 and 2013, the Company had cash flow hedges in the form of interest rate caps whose estimated fair market values were immaterial.  In accordance with ASC 815-10, Derivatives and Hedging (“ASC 815-10”) the Company records all derivatives on the balance sheet at fair value and provides qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

 

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 11, to purchase a total of 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share (the “Yucaipa Warrants”). In addition, subject to the terms of the Securities Purchase Agreement, the Yucaipa Investors have certain consent rights over certain transactions for so long as they collectively own or have the right to purchase through exercise of the Yucaipa Warrants 6,250,000 shares of the Company’s common stock. The Yucaipa Warrants are exercisable utilizing a cashless exercise method only, resulting in a net share issuance.

 

 

F-13

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Fair Value Measurements

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

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

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

Currently, the Company uses interest rate caps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. To comply with the provisions of ASC 820-10, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2014 and 2013, 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 December 31, 2014, the Company had three interest rate caps outstanding and the fair value of these interest rate caps was less than $0.1 million.

In connection with The Light Group Transaction, the Company provided Messrs. Sasson and Masi with the Sasson-Masi Put Options, which were exercised in January 2015, as discussed further in note 1.  Due to the redemption feature associated with the Sasson-Masi Put Options, the Company classified the noncontrolling interest in temporary equity. Subsequently, the Company accreted the redeemable noncontrolling interest to its current redemption value, which approximates fair value, each period. The Company has determined that the majority of the inputs used to value the Sasson-Masi Put Options fall within Level 3 of the fair value hierarchy. Accordingly, the Sasson-Masi Put Options were classified as Level 3 fair value measurements.

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

 

F-14

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 During the year ended December 31, 2013, the Company recognized non-cash impairment charges related to the Company’s receivables due from and other assets related to Mondrian SoHo and Delano Marrakech, which was recorded as an impairment loss on receivables and other assets from unconsolidated joint venture and managed hotel. Also during the years ended December 31, 2013 and 2012, the Company recognized non-cash impairment charges related to the Company’s investments in unconsolidated joint ventures, through equity in loss from unconsolidated joint ventures. The Company’s estimated fair value relating to these impairment assessments was based primarily upon Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of the assets taking into account the assets expected cash flow, holding period and estimated proceeds from the disposition of assets, as well as market and economic conditions.

The following table presents charges recorded as a result of applying Level 3 non-recurring measurements included in net loss for the years ended December 31, 2013 and 2012 (in thousands):

 

 

 

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 December 31, 2014 and 2013 due to the short-term maturity of these items or variable market interest rates.

The fair market value of the Company’s $55.8 million of fixed rate debt, which includes the Company’s trust preferred securities and Restaurant Lease Note, discussed above, and excludes capital leases, as of December 31, 2014 was approximately $64.4 million, using market rates.  The fair market value of the Company’s $247.1 million of fixed rate debt, which includes the Company’s trust preferred securities, the then outstanding TLG Promissory Notes at fair value, and Restaurant Lease Note, and then outstanding 2.375% Senior Subordinated Convertible Notes (the “Convertible Notes”) at face value, as discussed in note 7, as of December 31, 2013 was approximately $217.7 million, using market rates.

Although the Company has determined that the majority of the inputs used to value its fixed rate debt fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its fixed rate debt utilize Level 3 inputs, such as estimates of current credit spreads. However, as of December 31, 2014 and 2013, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its fixed rate debt and determined that the credit valuation adjustments are not significant to the overall valuation of its fixed rate debt. Accordingly, all derivatives have been classified as Level 2 fair value measurements.

 

Stock-based Compensation

The Company accounts for stock based employee compensation using the fair value method of accounting described in ASC 718-10. For share grants, total compensation expense is based on the price of the Company’s stock at the grant date. For option grants, the total compensation expense is based on the estimated fair value using the Black-Scholes option-pricing model. For awards under the Company’s Outperformance Award Program, discussed in note 10, long-term incentive awards, the total compensation expense was based on the estimated fair value using the Monte Carlo pricing model. Compensation expense is recorded ratably over the vesting period.

 

 

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 Income (Loss) Per Share

Basic net income (loss) per common share is calculated by dividing net income (loss) available to common stockholders, less any dividends on unvested restricted common stock, by the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per common share is calculated by dividing net income (loss) available to common stockholders, less dividends on unvested restricted common stock, by the weighted-average number of shares of common stock outstanding during the period, plus other potentially dilutive securities, such as unvested shares of restricted common stock and warrants.

 

Redeemable Noncontrolling Interest

Due to the redemption feature associated with the Sasson-Masi Put Options, the Company initially classified the noncontrolling interest in temporary equity in accordance with the Securities and Exchange Commission’s guidance as codified in ASC 480-10, Distinguishing Liabilities from Equity. Subsequently, the Company accreted the redeemable noncontrolling interest to its current redemption value, which approximates fair value, each period. The change in the redemption value does not impact the Company’s earnings or earnings per share.  The Sasson-Masi Put Options were exercised on January 15, 2015, as discussed further in note 1.  

 

Noncontrolling Interest

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

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 $0.4 million and $0.5 million as of December 31, 2014 and 2013, 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 December 31, 2014, there were 75,446 membership units outstanding, each of which is exchangeable for a share of the Company’s common stock.

 

Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2014-08 (“ASU 2014-08”), “Presentation of Financial Statements and Property, Plant and Equipment; Reporting Discontinued Operations and Disclosures of Components of an Entity.” ASU 2014-08 modifies the requirements for reporting discontinued operations. Under the amendments in ASU 2014-08, the definition of discontinued operation has been modified to only include those disposals of an entity that represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results, the operations and cash flows of the component have been, or will be, eliminated from the ongoing operations of the entity as a result of the disposal transaction and the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. ASU 2014-08 shall be applied prospectively for periods beginning on or after December 15, 2014, with early adoption permitted. The Company adopted ASU 2014-08 in early 2014 and as a result of this adoption, no changes were made to the accompanying consolidated financial statements.   The Company applied ASU 2014-08 to its assessment of the appropriate financial statement presentation in connection with the TLG Equity Sale and concluded that TLG did not meet the definition of a discontinued operation.  Therefore, the Company has presented the assets and liabilities of TLG as held for sale on its consolidated balance sheets.  

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), “Revenue from Contracts with Customers,” which supersedes all existing revenue recognition guidance as well as most industry-specific guidance, and significantly enhances comparability of revenue recognition practices across entities and industries by providing a principles-based, comprehensive framework for addressing revenue recognition issues. Under ASU 2014-09, the reporting entity must recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled to those good and services. ASU 2014-09 defines a five step process to achieve this principle and it also specifies the accounting for some costs to obtain or fulfill a contract with a customer and provides enhanced disclosure requirements. ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods therein, which for the

 

F-16

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Company will be its 2017 first quarter. The Company is permitted to use the retrospective or modified retrospective method when adopting ASU No. 2014-09. The Company is currently evaluating the impact of the adoption of ASU 2014-09 will have on its consolidated financial statements.

 In June 2014, the FASB issued Accounting Standards Update No. 2014-12 (“ASU 2014-12”), “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” ASU 2014-12 requires that a performance target included in a share-based payment award that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and therefore, such performance condition should not be reflected in estimating the grant-date fair value of the award. ASU 2014-12 will be effective for financial statements issued for the first interim period within annual reporting periods beginning after December 15, 2015, with early adoption permitted. The Company is currently evaluating the impact that ASU 2014-12 will have on its consolidated financial statements.

In November 2014, the FASB issued Accounting Standards Update No. 2014-16 (“ASU 2014-16”), “Derivatives and Hedging - Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity.”   ASU 2014-16 applies to any entity that is an issuer of, or invests in, hybrid financial instruments that are issued in the form of a share. The amendments in ASU 2014-16 clarify that an entity must take into account all relevant terms and features when reviewing the nature of the host contract. Additionally, the amendments state that no one term or feature would define the host contract’s economic characteristics and risks. Instead, the economic characteristics and risks of the hybrid financial instrument as a whole would determine the nature of the host contract. ASU 2014-16 will be effective for public business entities for fiscal years, and interim periods within, starting after December 15, 2015. The Company is currently evaluating the impact that ASU 2014-12 will have on its consolidated financial statements.

In February 2015, the FASB issued Accounting Standards Update No. 2015-02 (“ASU 2015-02”), “Consolidation – Amendments to the Consolidation Analysis.”   ASU 2015-02 applies to reporting entities that are required to evaluate whether they should consolidate certain legal entities.  Specifically, the amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities.  Additionally, the amendments eliminate the presumption that a general partner should consolidate a limited partnership.  The amendments in ASU 2015-02 affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships.   ASU 2015-02 will be effective for public business entities for fiscal years, and interim periods within, beginning after December 15, 2015. The Company is currently evaluating the impact that ASU 2015-02 will have on its consolidated financial statements.

 

Reclassifications

Certain prior year financial statement amounts have been reclassified to conform to the current year presentation, including the presentation of TLG as an asset held for sale, discussed in note 1.

 

 

3. Income (Loss) Per Share

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

Basic earnings (loss) per share is calculated based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings (loss) per share include the effect of potential shares outstanding, including dilutive securities. Potential dilutive securities may include shares and options granted under the Company’s stock incentive plan and membership units in Morgans Group, which may be exchanged for shares of the Company’s common stock under certain circumstances. The 75,446 Morgans Group membership units (which may be converted to cash, or at the Company’s option, common stock) held by third parties at December 31, 2014, Yucaipa Warrants issued to the Yucaipa Investors, unvested restricted stock units, LTIP Units (as defined in note 10), and stock options have been excluded from the diluted net income (loss) per common share calculation, as there would be no effect on reported diluted net income (loss) per common share.

 

F-17

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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.

 

  

 

4. Property and Equipment

Property and equipment consist of the following (in thousands):

 

  

Property subject to capital lease, such as Clift and two condominium units at Hudson, both discussed in note 7, are included under “Building” in the above table. Fully depreciated assets totaling approximately $10.4 million and $0.9 million were retired during the years ended December 31, 2014 and 2013, respectively.  Depreciation on property and equipment was $19.9 million, $20.3 million, and $17.6 million, for the years ended December 31, 2014, 2013, and 2012, respectively. Depreciation on property subject to capital leases was $0.1 million, for each of the years ended December 31, 2014, 2013 and 2012.

 

 

5. Investments in and Advances to Unconsolidated Joint Ventures

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

Investments

 

 

F-18

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Equity in income (losses) from unconsolidated joint ventures

 

  

Mondrian South Beach

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

The Mondrian South Beach joint venture acquired the existing building and land for a gross purchase price of $110.0 million. An initial equity investment of $15.0 million from each of the 50/50 joint venture partners was funded at closing, and subsequently each member also contributed $8.0 million of additional equity. The Company and an affiliate of its joint venture partner provided additional mezzanine financing of approximately $22.5 million in total to the joint venture through a new 50/50 mezzanine financing joint venture to fund completion of the construction in 2008. Additionally, the Mondrian South Beach joint venture initially received nonrecourse mortgage loan financing of approximately $124.0 million at a rate of LIBOR plus 3.0%. A portion of this mortgage debt was paid down, prior to the amendments discussed below, with proceeds obtained from condominium sales. In April 2008, the Mondrian South Beach joint venture obtained a mezzanine loan from the mortgage lenders of $28.0 million bearing interest at LIBOR plus 6.0%.

In April 2010, the Mondrian South Beach ownership joint venture amended the nonrecourse mortgage financing and mezzanine loan agreements secured by Mondrian South Beach or related equity interests and extended the maturity date for up to seven years through one-year extension options until April 2017, subject to certain conditions. Among other things, the amendment allowed the joint venture to accrue all interest through April 2012, accrue a portion of the interest thereafter, extend the mezzanine loan to April 2027 if the mortgage loan is retired, and provide the ability to provide seller financing to qualified condominium buyers with up to 80% of the condominium purchase price. The Company and an affiliate of its joint venture partner each provided an additional $2.75 million to the joint venture through the mezzanine financing joint venture resulting in total mezzanine financing provided by the mezzanine financing joint venture of $28.0 million. After the repayment of the mortgage debt, the mezzanine financing joint venture receives the first $5.5 million of net cash flow, the lender mezzanine financing receives the next $5.5 million, and the remaining proceeds are distributed equally between the joint venture mezzanine loan and the lender mezzanine loan.  

In February 2015, the joint venture exercised its option to extend the outstanding mortgage and mezzanine debt until April 2016. As of December 31, 2014, the joint venture’s outstanding nonrecourse mortgage loan was $23.1 million, with interest accruing at LIBOR plus 3.8% and paid at LIBOR plus 1.5%.  The outstanding mezzanine loan was $28.0 million, with interest accruing at 4.35%. In addition, the outstanding mezzanine debt owed to affiliates of the joint venture partners was $28.0 million.

The joint venture is in the process of selling units as condominiums, subject to market conditions, and unit buyers will have the opportunity to place their units into the hotel’s rental program. As of December 31, 2014, 263 hotel residences had been sold, of which 150 are in the hotel rental pool and are included in the hotel room count, and 72 hotel residences remain to be sold. In addition to hotel management fees, the Company could also realize fees from the sale of condominium units, although there can be no assurances of any sales in the future.

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

 

F-19

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Because the Company has written its investment value in the joint venture to zero, for financial reporting purposes, the Company believes its maximum exposure to losses as a result of its involvement in the Mondrian South Beach variable interest entity is limited to its outstanding management fees and related receivables and $14.0 million of advances in the form of mezzanine financing, excluding guarantees and other contractual commitments.

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

Morgans Group and affiliates of its joint venture partner have provided certain guarantees and indemnifications to the Mondrian South Beach lenders. See note 8.

Summarized balance sheet information of Mondrian South Beach is as follows (in thousands):  

 

  

Summarized income statement information of Mondrian South Beach is as follows (in thousands):  

 

  

 

F-20

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Mondrian SoHo

In June 2007, the Company entered into a joint venture with Cape Advisors Inc. to acquire and develop a Mondrian hotel in the SoHo neighborhood of New York City. The Company initially contributed $5.0 million for a 20% equity interest in the joint venture. Mondrian SoHo opened in February 2011 and has 263 guest rooms, a restaurant, bar and other facilities. Under the terms of the hotel management agreement executed between the Company and the joint venture in June 2007, the Company has a contract to manage the hotel for a 10-year term beginning on the date the hotel opened for business, which was in February 2011, with two 10-year extension options.

The joint venture obtained a loan of $195.2 million to acquire and develop the hotel, which matured in June 2010. On July 31, 2010, the mortgage loan secured by the hotel was amended to, among other things, provide for extensions of the maturity date to November 2011 with extension options through 2015, subject to certain conditions including a minimum debt service coverage test calculated, based on ratios of net operating income to debt service for specified periods ended September 30th of each year. The joint venture satisfied the extension conditions in 2011, but did not satisfy the conditions in November 2012. In January 2013, the lender initiated foreclosure proceedings and litigation is ongoing, although a court appointed referee issued a report in August 2014 setting the amount due on the loan ($250.5 million as of August 18, 2014, plus interest accruing at a daily rate of approximately $84,000, as of August 18, 2014) and determining the property should be sold as one parcel.  On September 15, 2014, the lender filed a motion to confirm the referee’s report in the foreclosure action and for proposed judgment of foreclosure and sale.  The foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was held on January 7, 2015, at which GACC was the winning and only bidder. GACC had an agreement to assign its bid to an affiliate of the Sapir Organization (“Sapir”), a New York-based real estate development and management organization; and in connection with that contract, GACC and Sapir have agreed to terminate the Company as manager of Mondrian SoHo.  That sale to Sapir closed on March 6, 2015.  As a result, effective March 6, 2015, the Company no longer holds any equity interest in Mondrian SoHo. Refer to note 8 for further discussion related to ongoing Mondrian SoHo legal proceedings.

As of December 31, 2014, the Mondrian SoHo joint venture’s outstanding mortgage debt secured by the hotel was $196.0 million.  In addition, as of August 18, 2014, the court appointed referee calculated deferred interest through the date of default of $20.8 million and default interest of $33.4 million.   As a result of the completion of the foreclosure sale of Mondrian SoHo, the joint venture will not pay these outstanding amounts.  

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

Certain affiliates of the Company’s joint venture partner have provided certain guarantees and indemnifications to the Mondrian SoHo lenders for which Morgans Group has agreed to indemnify the joint venture partner and its affiliates in certain circumstances. See note 8.

 

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Summarized balance sheet information of Mondrian SoHo, excluding the default interest as discussed above, which was eliminated as an obligation of the joint venture upon completion of the foreclosure sale on March 6, 2015, is as follows (in thousands):

 

  

Summarized income statement information of Mondrian SoHo is as follows (in thousands):

 

  

Food and Beverage Venture at Mondrian South Beach

In June 2011, the Company acquired its former joint venture partner’s ownership interest in the food and beverage venture at Mondrian South Beach.  As a result, the Company owns 50% of the venture.  The other 50% is owned by the Mondrian South Beach hotel joint venture, in which the Company has a 50% interest. The Company concluded that this venture did not meet the requirements of a variable interest entity and accordingly, this investment in the joint venture is accounted for using the equity method, as the Company does not believe it exercises control over significant asset decisions such as buying, selling or financing.

The Company accounted for this investment under the equity method of accounting through December 31, 2013, until its recording of losses was suspended. As of December 31, 2014, the Company’s investment in this food and beverage venture was zero. Because the Company has written its investment value in the joint venture to zero, for financial reporting purposes, the Company believes its maximum exposure to losses as a result of its involvement in the food and beverage venture at Mondrian South Beach is limited to any outstanding receivables, which was immaterial as of December 31, 2014.

Ames

On June 17, 2008, the Company, Normandy Real Estate Partners, and Ames Hotel Partners entered into a joint venture agreement as part of the development of the Ames hotel in Boston. Ames opened on November 19, 2009.

The Company contributed a total of approximately $12.1 million in equity for an approximately 31% interest in the ownership joint venture. The joint venture obtained a loan for $46.5 million secured by the hotel, which matured on October 9, 2012 and the mortgage lender served the joint venture with a notice of event of default stating that the nonrecourse mortgage refinancing on the property was not repaid when it matured.

 

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On April 26, 2013, the joint venture closed on a new loan agreement with the mortgage lenders that provided for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. The Company did not contribute to the cash paydown and instead entered into an agreement with its joint venture partner, as discussed further in note 8.

In May 2013, the hotel owner exercised its right to terminate the Company’s management agreement effective July 17, 2013, and on July 17, 2013 the management agreement terminated. As a result, the Company recorded $1.8 million in termination fee income during 2013.  

Prior to the Company assigning its equity interests in the joint venture to its joint venture partner, net income or loss and cash distributions or contributions were allocated to the partners in accordance with their respective ownership interests. The Company accounted for this investment under the equity method of accounting.

The Company had no ownership interest in Ames as of December 31, 2014 or 2013.  Summarized income statement information of Ames is as follows (in thousands). Information presented in 2013 is from January 1, 2013 through April 26, 2013, the date the Company no longer had an ownership interest in Ames:

 

  

Shore Club

On December 30, 2013, Shore Club was sold to HFZ Capital Group. Phillips International, an affiliate of Shore Club’s former owner, retains an ownership stake. The new owner has publicly stated that it may convert a substantial part of the hotel to condominiums, and the Company could be replaced as hotel manager. To date, the Company has received no notice of termination of its management agreement, and intends to continue to operate the hotel pursuant to that agreement. However, no assurance can be provided that the Company will continue to do so in the future. As of December 31, 2014, the Company had only an immaterial contingent profit participation equity interest in Shore Club.

Mondrian Istanbul

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

Due to the Company’s joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, the Company exercised its put option under the joint venture agreement that requires the Company’s joint venture partner to buy back the Company’s equity interests in the Mondrian Istanbul joint venture. The Company’s rights under that joint venture agreement are secured by, among other things, a mortgage on the property. In February 2014, the Company issued a notice of default to its joint venture partner, as they failed to buy back the Company’s equity interests by the contractual deadline, and further notified its joint venture partner that the Company plans to begin foreclosure proceedings as a result of the event of default. The Company initiated foreclosure proceedings on March 11, 2014. The Company’s joint venture partner, and through such joint venture partner, the joint venture itself, have objected to the foreclosure proceeding, as a result of which, the foreclosure proceeding is currently stayed.  A case for the annulment of such objection to the foreclosure proceeding was initiated on October 31, 2014 and is currently pending.  Additionally, in June 2014, the joint venture purported to notify the Company that it had terminated the hotel management agreement. The Company has objected to such purported notices and intends to vigorously defend against any lawsuit that may result. In addition, the Company has initiated proceedings in an English court seeking payment of the put option amount against the individual shareholders behind the joint venture partner.  The parties are also seeking various other judicial remedies in Turkey. 

 

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6. Other Liabilities

Other liabilities consist of the following (in thousands):  

 

 

Designer Fee Claim

As of December 31, 2014 and 2013, other liabilities consist of $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.

 

 

7. Debt and Capital Lease Obligations

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

 

 

(a) Mortgage Agreements

Hudson/Delano 2014 Mortgage Loan

On February 6, 2014, subsidiaries of the Company entered into a new 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 (1) repay $180.0 million of outstanding mortgage debt under the prior mortgage loan secured by Hudson (the “Hudson 2012 Mortgage Loan”), (2) repay $37.0 million of indebtedness under the Company’s $100.0 million senior secured revolving credit facility secured by Delano South Beach (the “Delano Credit Facility”), (3) provide cash collateral for reimbursement obligations with respect to a $10.0 million letter of credit

 

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under the Delano Credit Facility which was returned to the Company in June 2014, as discussed in note 8, and (4) fund reserves required under the Hudson/Delano 2014 Mortgage Loan, with the remainder available for general corporate purposes and working capital, including repayment of the Convertible Notes and TLG Promissory Notes.

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

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

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

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

The Hudson/Delano 2014 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson or Delano South Beach and the owners of Hudson and Delano South Beach and other affirmative and negative covenants and events of default customary for multiple asset commercial mortgage-backed securities loans. The Hudson/Delano 2014 Mortgage Loan is nonrecourse to the Company’s subsidiaries that are the borrowers under the loan, except pursuant to certain carveouts detailed therein. In addition, the Company has provided a customary environmental indemnity and nonrecourse carveout guaranty under which it would have liability with respect to the Hudson/Delano 2014 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, changes to the Hudson capital lease without prior written consent of the lender, violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty prohibits the payment of dividends on or repurchase of the Company’s common stock. As of December 31, 2014, the Company was in compliance with these covenants.

On April 8, 2014, the Hudson/Delano 2014 Mortgage Loan was amended to reallocate the principal amount and interest rate spread of the $300.0 million nonrecourse mortgage notes. This technical amendment had no impact on the total outstanding principal amount of the nonrecourse mortgage notes or the blended interest rate of the Hudson/Delano 2014 Mortgage Loan.

Hudson Mortgage and Mezzanine Loan

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

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

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

 

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

Morgans Group also entered into an agreement, dated September 17, 2010, whereby Morgans Group agreed to guarantee losses of up to $6.0 million suffered by the lessors in the event of certain “bad boy” type acts. As of December 31, 2014, 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 Notes”) which mature on October 30, 2036. The sole assets of the Trust consist of the Trust Notes. The terms of the Trust Notes are substantially the same as preferred securities issued by the Trust. The Trust Notes and the preferred securities have a fixed interest rate of 8.68% until October 2016, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum. The Trust Notes are redeemable by the Trust, at the Company’s option, at par, and the Company has not redeemed any Trust Notes. To the extent the Company redeems the Trust Notes, the Trust is required to redeem a corresponding amount of preferred securities.

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

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

(d) Convertible Notes

On October 17, 2007, the Company issued $172.5 million aggregate principal amount of 2.375% Senior Subordinated Convertible Notes in a private offering. Net proceeds from the offering were approximately $166.8 million.

In 2010, the Yucaipa Investors purchased $88.0 million of the Convertible Notes from third parties. On February 28, 2014, the Company entered into a Note Repurchase Agreement with the Yucaipa Investors, pursuant to which it repurchased the Convertible Notes owned by them for an amount equal to their principal balance plus accrued interest. The Company used cash on hand, including proceeds of the Hudson/Delano 2014 Mortgage Loan, for this repurchase. Additionally, during the third quarter of 2014, the Company used cash on hand to repurchase an aggregate of $35.4 million of outstanding Convertible Notes at an aggregate discount of approximately $0.1 million plus accrued interest. The repurchased Convertible Notes were retired upon repurchase.

On October 15, 2014, the Convertible Notes matured and the Company repaid the outstanding principal amount of $49.1 million with cash on hand. The Convertible Notes were retired upon repayment.

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

 

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(e) Restaurant Lease Note

As discussed in note 2, in August 2012, the Company acquired the leasehold interests in three food and beverage venues at Mandalay Bay from an existing tenant for $15.0 million in cash at closing and the issuance of a principal-only $10.6 million Restaurant Lease Note to be paid over seven years. The Restaurant Lease Note does not bear interest except in the event of default, as defined in the agreement. In accordance with ASC 470, Debt, the Company imputed interest on the Restaurant Lease Note, which was recorded at its fair value of $7.5 million as of the date of issuance. At December 31, 2014, the balance outstanding recorded on the Restaurant Lease Note was $5.7 million.

(f) 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 December 31, 2014 and 2013, respectively. Substantially all of the principal payments on the capital lease obligations are due at the end of the lease agreements.

(g) Delano Credit Facility

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

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

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

(h) TLG Promissory Notes  

On November 30, 2011, pursuant to purchase agreements entered into on November 17, 2011, certain of the Company’s subsidiaries completed the acquisition of 90% of the equity interests in TLG for a purchase price of $28.5 million in cash and up to $18.0 million of TLG Promissory Notes, which are convertible into shares of the Company’s common stock at $9.50 per share.  The TLG Promissory Notes were allocated $16.0 million to Mr. Sasson and $2.0 million to Mr. Masi.  

The payment of $18.0 million was based on TLG achieving EBITDA of at least $18.0 million from Non-Morgans EBITDA during the period starting on January 1, 2012 and ending on March 31, 2014, with ratable reduction of the payment if less than $18.0 million of EBITDA was earned. The fair value of the TLG Promissory Notes was estimated each quarter utilizing a Monte Carlo simulation to estimate the probability of the performance conditions being satisfied.

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

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

 

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As discussed further in note 8, on August 5, 2013, Messrs. Sasson and Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition and Morgans Group alleging, among other things, breach of contract and an event of default under the TLG Promissory Notes The oral argument on the motion occurred on October 29, 2014 and the Company is awaiting the court’s ruling. Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit has not been dismissed.

Principal Maturities

The following is a schedule, by year, of principal payments on notes payable (including capital lease obligations) as of December 31, 2014 (in thousands):

 

 

The weighted average interest rate on all of the Company’s debt as of December 31, 2014, 2013, and 2012 was 6.1%, 6.0%, and 6.1%, respectively.

 

 

8. Commitments and Contingencies

Hotel Development Related Commitments

In order to obtain long-term management, franchise and license contracts, the Company may commit to contribute capital in various forms on hotel development projects. These include equity investments, key money, and cash flow guarantees to hotel owners. The cash flow guarantees generally have a stated maximum amount of funding and a defined term. The terms of the cash flow guarantees to hotel owners generally require the Company to fund if the hotels do not attain specified levels of operating profit. Oftentimes, 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.

The following table details, as of December 31, 2014, the Company’s key money, equity investment and debt financing commitments for hotels under development as well as potential funding obligations under cash flow guarantees at operating hotels and hotels under development at the maximum amount under the applicable contracts, but excluding contracts where the maximum amount cannot be determined (in thousands):

 

  

 

 

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On September 30, 2014, Mondrian London opened.  As a result, the Company funded its £9.4 million key money obligation (or approximately $15.3 million at the exchange rate as of the payment date) in October 2014 with cash on hand.  

In September 2012, the Company opened Delano Marrakech, a 71-room hotel in Marrakech, Morocco. The management agreement included certain cash flow guarantees by the Company which stipulate certain minimum levels of operating performance and could result in potential future funding obligations related to Delano Marrakech, which are in dispute and disclosed in the hotel commitments and guarantees table above. As discussed further below, the Company and the hotel owner are in litigation surrounding the termination of the hotel management agreement, performance-based cash flow guarantee and related matters. Both parties are seeking arbitration of the dispute, which is expected to occur in October 2015.  

In January 2014, the Company signed a franchise agreement for 10 Karaköy, a Morgans Original branded hotel in Istanbul, Turkey. The hotel, which opened in November 2014, was converted from office and retail space and has 71 rooms. The Company expects to fund a $0.3 million key money obligation in 2015 related to 10 Karaköy.

The Company has signed management, license or franchise agreements for new hotels which are in various stages of development. As of December 31, 2014, these included the following:

 

 

There can be no assurances that any or all of the Company’s projects listed above will be developed as planned. If adequate project financing is not obtained, these projects may need to be limited in scope, deferred or cancelled altogether, in which case the Company may be unable to recover any previously funded key money, equity investments or debt financing.  

For example, due to the Company’s joint venture partner’s failure to achieve certain agreed milestones in the development of the Mondrian Istanbul hotel, in early 2014, the Company exercised its put option under the joint venture agreement and initiated foreclosure proceedings, as discussed further in note 5.    

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. For the years ended December 31, 2014, 2013 and 2012, the Company has funded the shortfall and as of December 31, 2014, approximately $1.1 million was accrued as a reduction to management fees related to these performance test provisions.  Until 2016 and so long as the Company funds the shortfalls, the hotel owners do not have the right to terminate the Company as hotel manager. The Company’s maximum potential amount of future fundings related to the Royalton and Morgans performance guarantee cannot be determined as of December 31, 2014, but under the hotel management agreements is limited to the Company’s base fees earned.

Additionally, the Company is currently subject to performance tests under certain other of its hotel management agreements, which could result in early termination of the Company’s hotel management agreements.  As of December 31, 2014, 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.  

 

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Operating Joint Venture Hotels Commitments and Guarantees

The following details obligations the Company has or may have related to its operating joint venture hotels as of December 31, 2014.

Mondrian South Beach Mortgage and Mezzanine Agreements. Morgans Group and affiliates of its joint venture partner have agreed to provide standard nonrecourse carve-out guarantees and provide certain limited indemnifications for the Mondrian South Beach mortgage and mezzanine loans. In the event of a default, the lenders’ recourse is generally limited to the mortgaged property or related equity interests, subject to standard nonrecourse carve-out guarantees for “bad boy” type acts. Morgans Group and affiliates of its joint venture partner also agreed to guarantee the joint venture’s obligation to reimburse certain expenses incurred by the lenders and indemnify the lenders in the event such lenders incur liability in connection with certain third-party actions. Morgans Group and affiliates of its joint venture partner have also guaranteed the joint venture’s liability for the unpaid principal amount of any seller financing note provided for condominium sales if such financing or related mortgage lien is found unenforceable, provided they shall not have any liability if the seller financed unit becomes subject to the lien of the lender’s mortgage or title to the seller financed unit is otherwise transferred to the lender or if such seller financing note is repurchased by Morgans Group and/or affiliates of its joint venture at the full amount of unpaid principal balance of such seller financing note. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, Morgans Group and affiliates of its joint venture partner may have continuing obligations under construction completion guarantees until all outstanding payables due to construction vendors are paid. As of December 31, 2014, there were remaining payables outstanding to vendors of approximately $0.3 million. Pursuant to a letter agreement with the lenders for the Mondrian South Beach loan, the joint venture agreed that these payables, many of which are currently contested or under dispute, will not be paid from operating funds but only from tax abatements and settlements of certain lawsuits. In the event funds from tax abatements and settlements of lawsuits are insufficient to repay these amounts in a timely manner, the Company and its joint venture partner are required to fund the shortfall amounts.  

The Company and affiliates of its joint venture partner also have each agreed to purchase approximately $14.0 million of condominium units under certain conditions, including an event of default. In the event of a default under the lender’s mortgage or mezzanine loan, the joint venture partners are each obligated to purchase selected condominium units, at agreed-upon sales prices, having aggregate sales prices equal to 1/2 of the lesser of $28.0 million, which is the face amount outstanding on the lender’s mezzanine loan, or the then outstanding principal balance of the lender’s mezzanine loan. The joint venture is not currently in an event of default under the mortgage or mezzanine loan. As of December 31, 2014, there had been no triggering event that would require the Company to recognize a liability related to the construction completion or the condominium purchase guarantees.

Mondrian SoHo. Certain affiliates of the Company’s joint venture partner have agreed to provide a standard nonrecourse carve-out guaranty for “bad boy” type acts and a completion guaranty to the lenders for the Mondrian SoHo loan, for which Morgans Group has agreed to indemnify the joint venture partner and its affiliates up to 20% of such entities’ guaranty obligations, provided that each party is fully responsible for any losses incurred as a result of its own gross negligence or willful misconduct. As of December 31, 2014, there had been no triggering event that would require the Company to recognize a liability related to this indemnity.

Ames. On April 26, 2013, the joint venture closed on a new loan agreement with the mortgage lenders that provided for a reduction of the mortgage debt and an extension of maturity in return for a cash paydown. The Company did not contribute to the cash paydown and instead entered into an agreement with its joint venture partner pursuant to which, among other things, (1) the Company assigned its equity interests in the joint venture to its joint venture partner, (2) the Company agreed to give its joint venture partner the right to terminate its management agreement upon 60 days’ prior notice in return for an aggregate payment of $1.8 million, and (3) a creditworthy affiliate of the Company’s joint venture partner has assumed all or a portion of the Company’s potential liability with respect to historic tax credit guarantees, with the Company’s liability for any tax credit guarantees capped, in any event, at $3.0 million in the aggregate. The potential liability for historic tax credit guarantees relates to approximately $16.9 million of federal and state historic rehabilitation tax credits that Ames qualified for at the time of its development. As of December 31, 2014, there had been no triggering event that would require the Company to accrue any potential liability related to the historic tax credit guarantee.

Guaranteed Loans and Commitments

The Company has made guarantees to lenders and lessors of its owned and leased hotels, namely related to the Hudson/Delano 2014 Mortgage Loan and Clift lease payments, as discussed further in note 7.

 

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Additionally, the Company is obligated to make future minimum lease payments for noncancelable leases, which the Company accounts for as operating leases. These operating leases include amounts related to the portion of the Hudson capital lease which are allocable to land, lease payments related to our Owned F&B Operations, and our corporate office lease. Future minimum lease payments related to these operating leases in effect as of December 31, 2014 are as follows (in thousands):

 

 

 

Future minimum lease payments do not include amounts for renewal periods or amounts that may need to be paid to landlords for real estate taxes, electricity and operating costs.

Multi-employer Retirement Plan

As of December 31, 2014, approximately 17.8% of the Company’s employees were subject to collective bargaining agreements.  As a result of the TLG Equity Sale, the Company has approximately 15.5% of its employees subject to collective bargaining agreements.  The Company is a participant, through these collective bargaining agreements, in multi-employer defined contribution retirement plans in New York and multi-employer defined benefit retirement plans in California covering union employees.

The Company’s participation in these plans is outlined in the table below (in thousands):  

 

 

Eligible employees at the Company’s owned and managed hotels in New York City participate in the New York Hotel Trades Council and Hotel Association of New York City, Inc. Pension Fund. The Company contributions are based on a percentage of all union employee wages as dictated by the collective bargaining agreement that expires on June 30, 2019. The Company’s contributions did not exceed 5% of the total contributions to the pension fund in 2014, 2013, or 2012. The pension fund has implemented a funding improvement plan and the Company has not paid a surcharge.  

Under the Employee Retirement Income Security Act of 1974, as amended by the Multiemployer Pension Plan Amendments Act of 1980, an employer is liable upon withdrawal from or termination of a multiemployer plan for its proportionate share of the plan’s unfunded vested benefits liability. Based on information provided by the administrators of the majority of these multiemployer plans, the Company does not believe there is any significant amount of unfunded vested liability under these plans.

 

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Litigations Regarding Mondrian SoHo

On January 16, 2013, German American Capital Corporation (“GACC” or the “lender”), the lender for the mortgage loans on Mondrian SoHo, filed a complaint in the Supreme Court of the State of New York, County of New York against Sochin Downtown Realty, LLC, the joint venture that owns Mondrian SoHo (“Sochin JV”), Morgans Management, the manager for the hotel, Morgans Group, Happy Bar LLC and MGMT LLC, seeking foreclosure including, among other things, the sale of the mortgaged property free and clear of the management agreement, entered into between Sochin JV and Morgans Management on June 27, 2007, as amended on July 30, 2010. According to the complaint, Sochin JV defaulted by failing to repay the approximately $217.0 million outstanding on the loans when they became due on November 15, 2012. Cape Advisors Inc. indirectly owns 80% of the equity interest in Sochin JV and Morgans Group indirectly owns the remaining 20% equity interest.

On March 11, 2013, the Company moved to dismiss the lender’s complaint on the grounds that, among other things, the Company’s management agreement is not subject to foreclosure. On April 2, 2013, the lender opposed the Company’s motion to dismiss and cross-moved for summary judgment. On August 12, 2013, the court heard oral argument on both motions, as well as a third motion brought by the Company to strike an affirmation submitted by lender’s attorney. On January 27, 2014, the court granted Morgans Management’s motion to dismiss on the ground that Morgans Management was not a proper party to the foreclosure action and that a management contract does not constitute an interest in real property subject to foreclosure, and denied lender’s motion for summary judgment as moot. On March 20, 2014, the lender moved for summary judgment against the remaining defendants, seeking foreclosure on four mortgages secured by Mondrian SoHo. By order dated May 27, 2014, the trial court granted the motion for summary judgment to a limited extent, ordering the appointment of a referee to compute the amount but stating that a motion for summary judgment of foreclosure and sale is premature. By decision entered on July 28, 2014, the court referred the matter to a referee to ascertain and compute the amount due to the lender for principal, interest, and other disbursements and to determine whether the property should be sold in one parcel.  On August 6, 2014, the Referee set a hearing on the issues for August 18, 2014, and subsequently issued her report setting the amount due on the loan ($250.5 million, plus interest accruing at a daily rate of approximately $84,000, as of August 18, 2014) and determining the property should be sold as one parcel. On September 15, 2014, the lender filed a motion to confirm the Referee’s report and for judgment of foreclosure and sale, along with the referee’s Report of Amount Due attached as an exhibit, and a proposed judgment of foreclosure and sale.  The foreclosure judgment was issued on November 25, 2014 and the foreclosure sale was held on January 7, 2015, at which GACC was the winning and only bidder. GACC had an agreement to assign its bid to an affiliate of the Sapir Organization (“Sapir”), a New York-based real estate development and management organization; and in connection with that contract, GACC and Sapir have agreed to terminate the Company as manager of Mondrian SoHo.  That sale to Sapir closed on March 6, 2015.  

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

Litigation Regarding Delano Marrakech  

In June 2013, the Company served the owner of Delano Marrakech with a notice of default for numerous breaches of the management agreement, including, among other things, failure to pay fees and reimbursable expenses and to operate the hotel in accordance with the standards under the management agreement. In September 2013, the Company served notice of termination of its management agreement for Delano Marrakech following the failure by the owner of Delano Marrakech to remedy the numerous breaches of the agreement. As a result, the Company discontinued all affiliation with the hotel, including removal of the Delano name, and terminated management of the property, effective November 12, 2013. Pursuant to the management agreement, in the event of an owner default, the Company has no further obligations under the performance-based cash flow guarantee. In addition, as a result of the breaches by the hotel owner, the Company has asserted a claim for losses and damages against the owner that is currently estimated at in excess of $30.0 million, including interest. The owner of the hotel is disputing the circumstances surrounding termination and therefore its liability for this amount. On April 17, 2014, the owner submitted a counterclaim against the Company under both the performance-based cash flow guarantee and for loss of profits. The total counterclaim made by the owner is in excess of $119.0 million, excluding interest. The Company considers the counterclaim made by the owner to be entirely without merit and intends to vigorously defend itself. Both parties are seeking arbitration of the dispute, which is expected to occur in October 2015.  A preliminary hearing was heard on January 19, 2015 in which the arbitral tribunal rejected entirely the owner’s attempt to have a preliminary issue determined in its favor.

 

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Litigation Regarding TLG Promissory Notes

On August 5, 2013, Messrs. Andrew Sasson and Andy Masi filed a lawsuit in the Supreme Court of the State of New York against TLG Acquisition LLC and Morgans Group LLC relating to the $18.0 million TLG Promissory Notes. See note 1 and note 7 regarding the background of the TLG Promissory Notes. The complaint 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 current Board of Directors on June 14, 2013. The complaint sought payment of Mr. Sasson’s $16.0 million TLG Promissory Note and Mr. Masi’s $2.0 million TLG Promissory Note, plus interest compounded to principal, as well as default interest, and reasonable costs and expenses incurred in the lawsuit. On September 26, 2013, the Company filed a motion to dismiss the complaint in its entirety. On February 6, 2014, the court granted the Company’s motion to dismiss. On March 7, 2014, Messrs. Sasson and Masi filed a Notice of Appeal from this decision with the Appellate Division, First Department, and on July 8, 2014, they filed their initial brief in support of that appeal. Briefing of that appeal is ongoing, and the Company’s opposition brief was due August 29, 2014.  The oral argument on the motion occurred on October 29, 2014 and the Company is awaiting the court’s ruling.  Although the TLG Promissory Notes were repaid and retired in December 2014, this lawsuit has not been dismissed.  

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

On May 5, 2014, the Company and affiliates of Yucaipa, among other litigants, executed and submitted to the Delaware Court of Chancery a Stipulation of Settlement (the “Settlement Stipulation”) which contemplates the partial settlement and dismissal of most of the defendants from the Delaware Shareholder Derivative Action and the complete settlement and dismissal of the New York Securities Action, the Proxy Action and the Board Observer Action, all discussed further in Part I, “Item 3. Legal Proceedings.”  On July 23, 2014, the Delaware Court of Chancery approved the settlement as set forth in the Settlement Stipulation, which, pursuant to its terms, became effective on August 25, 2014 (the “Effective Date”).

The Settlement Stipulation provided, among other things, for the Company to pay certain agreed upon amounts to parties involved in the actions mentioned above.  The Company’s insurers have paid a majority of the costs that the Company was obligated to pay under the Settlement Stipulation.  

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

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

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

 

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The Company does not expect that the net amount of any remaining payments it will make under the terms of the Settlement Stipulation or in connection with the Harrison Settlement or the Malone dismissal will be material to the financial position of the Company, and as of December 31, 2014, the Company believes its accruals are adequate to cover its contingencies relating to these matters.  

Environmental

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

Other Litigation

The Company is involved in various lawsuits and administrative actions in the normal course of business, as well as other litigations as noted above.

 

 

9. Income Taxes  

The provision for income taxes on income from operations is comprised of the following for the years ended December 31, 2014, 2013, and 2012 (in thousands):

 

 

 

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Net deferred tax asset consists of the following (in thousands):

 

 

The Company has federal, state and local net operating loss carryforwards (“NOL Carryforwards”). The Company’s federal NOL Carryforwards were approximately $391.0 million at December 31, 2014. These federal NOL Carryforwards are available to offset future federal taxable income, and will expire at various dates from 2029 through  2033. The Company has state and local NOL Carryforwards of approximately $499.2 million in aggregate at December 31, 2014. These state and local NOL Carryforwards are available to offset future taxable income in a number of states and localities and will expire at various dates from 2029 and 2033.

As of December 31, 2014, the Company also accumulated available foreign tax credits of $3.7 million, HIRE tax credit of $0.5 million and FICA tax credit of $1.5 million. These credits can be used to offset any federal taxes due in the future.

As of each reporting date, the Company performs an analysis on whether to increase or decrease its valuation allowance against deferred taxes by considering new evidence, both positive and negative, that could impact the Company’s view with regard to future realization of deferred tax assets. On the basis of this evaluation, the Company determined that sufficient positive evidence exists as of December 31, 2014, to conclude that future taxable income, including estimated gains on potential asset sales, will be generated to use a portion of the deferred tax assets.  Additional valuation allowance has been recorded to reflect only the portion of the deferred tax assets that is more likely than not to be realized.   The total reserve on the deferred tax assets for December 31, 2014 and 2013 was $186.4 million and $146.4 million, respectively.

A reconciliation of the statutory United States federal tax rate to the Company’s effective income tax rate is as follows:

 

 

The Company has not identified any uncertain tax positions in accordance with ASC 740-10 (formerly FIN 48) and does not believe it will have any unrecognized tax positions over the next 12 months. Therefore, the Company has not accrued any interest or penalties associated with any unrecognized tax positions. The Company’s tax returns for the years 2013, 2012 and 2011 are subject to review by the Internal Revenue Service (“IRS”). The Company calculated its deferred tax asset true-up from the tax provision to the actual tax return filed with the IRS. The change in valuation allowance in the rate reconciliation table above includes net true-ups and changes to state tax rates.

 

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10. Omnibus Stock Incentive Plan

On February 9, 2006, the Board of Directors of the Company adopted the Morgans Hotel Group Co. 2006 Omnibus Stock Incentive Plan. Subsequently and on several occasions, the Company’s Board of Directors adopted, and stockholders approved, amendments to the Omnibus Stock Incentive Plan (the “Stock Plan”), to namely increase the number of shares reserved for issuance under the plan. As of December 31, 2014, 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.

Total stock compensation expense, which is included in corporate expenses on the accompanying consolidated statements of comprehensive loss, was $3.4 million, $4.1 million, and $4.5 million for the years ended December 31, 2014, 2013, and 2012, respectively.

As of December 31, 2014 and 2013, there were approximately $5.9 million and $3.3 million, respectively, of total unrecognized compensation costs related to unvested share awards. As of December 31, 2014, the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 1 year.

Restricted Stock Units

On August 14, 2014, the Company issued an aggregate of 77,922 RSUs to the Company’s non-employee directors under the Stock Plan. These grants vest in full on May 14, 2015, provided that upon a non-employee director’s resignation from the Board of Directors, other than as a consequence of the director’s bad acts, the vesting of any RSUs will be on a pro rated basis as of the resignation date. The estimated fair value of each such RSU granted was based on the closing price of the Company’s common stock on the grant date.

On May 5, 2014, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 127,867 RSUs to certain of the Company’s executive officers and senior management under the Stock Plan. The majority of these grants vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant. The estimated fair value of each such RSU granted was based on the closing price of the Company’s common stock on the grant date. In addition, the Company has granted, or may grant, RSUs to certain executives, employees or non-employee directors as part of future annual equity grants or to newly hired or promoted employees from time to time.

Additionally, on May 28, 2014, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 65,912 RSUs, which vested immediately, to Jonathan A. Langer, a member of the Company’s Board of Directors, pursuant to terms of a consulting agreement the Company and Mr. Langer entered into on February 9, 2014, as discussed further in note 12. The estimated fair value of the RSUs granted, which was $495,000, was based on the closing price of the Company’s common stock on the grant date.

Annually, in 2013 and 2012, the Compensation Committee of the Board of Directors of the Company issued RSUs to employees under the Stock Plan. All grants vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant. The estimated fair value of each such RSU granted was based on the closing price of the Company’s common stock on the grant date.

Additionally, in 2012, the Company issued RSUs to the Company’s non-employee directors under the Stock Plan which vested immediately upon grant. The fair value of each such RSU granted was based on the closing price of the Company’s common stock on the grant date.

 

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On August 30, 2013 (the “Separation Date”), the Company entered into a separation agreement with Michael Gross, the Company’s then Chief Executive Officer. In connection with the separation agreement, the Company (i) granted 58,334 RSUs to Mr. Gross, pursuant to the Second Amended 2007 Incentive Plan, which vested immediately on the Separation Date, (ii) granted 25,000 RSUs, which vested on the first anniversary of the Separation Date, or August 30, 2014, and (iii) accelerated the vesting of any unvested LTIP Units and stock options as of the Separation Date, with all stock options exercisable for a period of one year following the Separation Date, discussed further below. All other equity awards that remained unvested as of the Separation Date expired and were forfeited, including 291,242 RSUs that were granted to Mr. Gross on February 28, 2013.

In addition to the above grants of RSUs, 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 the status of the Company’s nonvested RSUs granted as of December 31, 2014 and 2013 and changes during the years ended December 31, 2014 and 2013, are presented below:

 

 

For the years ended December 31, 2014, 2013, and 2012, the Company expensed $3.2 million, $2.5 million, and $1.9 million, respectively, related to granted RSUs. As of December 31, 2014, there were 335,672 RSUs outstanding. At December 31, 2014, the Company has yet to expense approximately $1.1 million related to nonvested RSUs which is expected to be recognized over the remaining vesting period of the outstanding awards, as discussed above.

LTIP Units

As part of annual grants from time to time, or as determined appropriate, the Compensation Committee of the Board of Directors of the Company has issued LTIP Units to executives and non-employee directors under the Stock Plan. The estimated fair value of each such LTIP Unit granted was based on the closing price of the Company’s common stock on the grant date.

On February 22, 2012 and in connection with the Executive Chairman’s employment agreement, the Compensation Committee of the Board of Directors of the Company issued 121,402 LTIP units to the Company’s Executive Chairman, which vested pro rata on a monthly basis over the 12 months beginning on April 20, 2012, so long as the recipient continued to be an eligible participant. The estimated fair value of each LTIP unit granted was based on the closing price of the Company’s common stock on the grant date.

In November 2012, Mr. Hamamoto, Executive Chairman of the Board, tendered his resignation from the Board of Directors and from his position as Executive Chairman, effective November 20, 2012. As such, all unvested LTIP Units issued to him were forfeited.

Pursuant to Mr. Gross’ separation agreement, discussed above, on the Separation Date, the Company accelerated the vesting of any unvested LTIP Units as of the Separation Date.

 

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In addition to the above grants of LTIP Units, the Company has granted, or may grant, LTIP Units to certain executives or non-employee directors as part of future annual equity grants or to certain newly hired or promoted executives from time to time. A summary of the status of the Company’s nonvested LTIP Units granted as of December 31, 2014 and 2013 and changes during the years ended December 31, 2014 and 2013, are presented below:

 

 

For the years ended December 31, 2014, 2013, and 2012, the Company expensed $0.1 million, $0.8 million, and $1.4 million, respectively, related to granted LTIP Units. As of December 31, 2014, there were 941,157 LTIP Units outstanding. At December 31, 2014, the Company has no outstanding expense related to nonvested LTIP Units to be recognized.

Stock Options

 In connection with Mr. Hamamoto’s resignation from the Board of Directors and from his position as Executive Chairman, effective November 20, 2012, his outstanding unvested stock options were forfeited. At his resignation, Mr. Hamamoto held a material amount of unvested stock options. As such, management applied an actual forfeiture rate to Mr. Hamamoto’s outstanding unvested stock option grants at the time of resignation. Due to the fact that only three named executive officers and Mr. Hamamoto held unvested stock, the Company believes this change in methodology is reasonable in order to appropriately state stock compensation expense for the outstanding unvested stock options held by three named executive officers subsequent to Mr. Hamamoto’s resignation.

Pursuant to Mr. Gross’ separation agreement, discussed above, on the Separation Date, the Company accelerated the vesting of any unvested stock options as of the Separation Date, with all stock options exercisable for a period of one year following the Separation Date.  Mr. Gross’ stock options were forfeited on August 30, 2014.

 

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In addition to the above grants of options to purchase common stock of the Company, the Company has granted, or may grant, options to purchase common stock to certain executives, employees or non-employee directors as part of future annual equity grants or to certain newly hired or promoted executives or employees from time to time. A summary of the Company’s outstanding and exercisable stock options granted as of December 31, 2014 and 2013 and changes during the years ended December 31, 2014 and 2013, are presented below:

 

 

For the years ended December 31, 2014, 2013, and 2012, the Company expensed $0.2 million, $1.2 million, and $1.3 million, respectively, related to granted stock options. At December 31, 2014, the Company has no outstanding expense related to outstanding stock options to be recognized.  

Outperformance Award Program

In March 2011, the Compensation Committee of the Board of Directors of the Company implemented an Outperformance Award Program, which was a long-term incentive plan intended to provide the Company’s senior management with the ability to earn cash or equity awards based on the Company’s level of return to stockholders over a three-year period, the Company issued a new series of outperformance long-term incentive units (the “OPP LTIP Units”).

Pursuant to the Outperformance Award Program, each of the senior managers then employed by the Company had the right to receive, an award (an “Award”), in each case reflecting the participant’s right to receive a participating percentage (the “Participating Percentage”) in an outperformance pool if the Company’s total return to stockholders (including stock price appreciation plus dividends) increased by more than 30% (representing a compounded annual growth rate of approximately 9% per annum) over a three-year period from March 20, 2011 to March 20, 2014, of a new series of outperformance long-term incentive units as described below, subject to vesting and the achievement of certain performance targets.

The total return to stockholders was calculated based on the average closing price of the Company’s common shares on the 30 trading days ending on the Final Valuation Date (as defined below). The baseline value of the Company’s common shares for purposes of determining the total return to stockholders was $8.87, the closing price of the Company’s common shares on March 18, 2011.

The Company determined, as of March 20, 2014, that the total outperformance pool had no value, as the valuation on that day did not exceed $11.53, therefore all existing Awards of OPP LTIP Units were forfeited.

As the Company had the ability to settle the vested OPP LTIP Units with cash, these Awards were not considered to be indexed to the Company’s stock price and were accounted for as liabilities at fair value prior to their forfeiture on March 20, 2014.

 

 

 

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11. Preferred Securities and Warrants

Preferred Securities and Warrants Held by Yucaipa Investors

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

The Series A preferred securities had an 8% dividend rate through October 15, 2014 and have a 10% dividend rate until October 15, 2016 and a 20% dividend rate thereafter. The Company has the option to accrue any and all dividend payments. The cumulative unpaid dividends have a dividend rate equal to the dividend rate on the Series A preferred securities. As of December 31, 2014, the Company had undeclared and unpaid dividends of approximately $43.3 million. The Company has the option to redeem any or all of the Series A preferred securities at par at any time. The Series A preferred securities have limited voting rights and only vote on the authorization to issue senior preferred securities, amendments to their certificate of designations and amendments to the Company’s charter that adversely affect the Series A preferred securities.

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

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

For so long as the Yucaipa Investors collectively own or have the right to purchase through exercise of the Yucaipa Warrants (assuming a cash rather than a cashless exercise) 875,000 shares of the Company’s common stock, the Company has agreed to use its reasonable best efforts to cause its Board of Directors to nominate and recommend to the Company’s stockholders the election of a person nominated by the Yucaipa Investors as a director of the Company and to use its reasonable best efforts to ensure that the Yucaipa Investors’ nominee is elected to the Company’s Board of Directors at each such meeting. If that nominee is not elected as a director at a meeting of stockholders, the Yucaipa Investors have certain Board of Director observer rights. Further, if the Company does not, within 30 days from the date of such meeting, create an additional seat on the Board of Directors and make available such seat to the nominee, the dividend rate on the Series A preferred securities increases by 4% during any time that a Yucaipa Investors’ nominee is not a member of the Company’s Board of Directors. From July 14, 2013 through May 14, 2014, the dividend rate was 12% as a result of the Yucaipa Investors’ nominee not being elected or appointed to the Company’s Board of Directors.

On May 14, 2014, at the Company’s annual shareholder meeting, a Board of Directors nominee representing the Yucaipa Investors was elected as a director of the Company and the dividend rate on the Series A preferred securities returned to the stated rate of 8%. Accordingly, the current dividend rate on the Series A preferred securities is 10%.

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

 

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The Company calculated the fair value of the Series A preferred securities at its net present value by discounting dividend payments expected to be paid on the shares over a seven-year period using a 17.3% rate. The Company determined that the market discount rate of 17.3% was reasonable based on the Company’s best estimate of what similar securities would most likely yield when issued by entities comparable to the Company at that time.

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 December 31, 2014, the value of the preferred securities was $66.7 million, which includes cumulative accretion of $18.6 million.

The Company calculated the estimated fair value of the Yucaipa Warrants using the Black-Scholes valuation model, as discussed in note 2.

 

 

12. 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 $4.6 million, $9.0 million, and $7.2 million for the years ended December 31, 2014, 2013, and 2012, respectively.

As of December 31, 2014 and 2013, the Company had receivables from these affiliates of approximately $3.6 million and $3.7 million, respectively, which are included in related party receivables on the accompanying consolidated balance sheets.

On February 9, 2014, the Company entered into a Consulting Agreement with Jonathan A. Langer, a member of the Company’s Board of Directors. Under the terms of the Consulting Agreement, Mr. Langer provided services to the Company in connection with various strategic and financial opportunities through December 31, 2014. Pursuant to the Consulting Agreement, in consideration of Mr. Langer’s efforts in connection with the Hudson/Delano 2014 Mortgage Loan, including negotiating with the lenders and overseeing the transaction on the Company’s behalf, Mr. Langer was entitled to a payment of $495,000 (or 0.11% of the aggregate proceeds from the Hudson/Delano 2014 Mortgage Loan), payable in cash or stock, at the Company’s election. In May 2014, the Company issued stock to Mr. Langer as compensation for this fee, as discussed in note 10. Additionally, under the terms of the Consulting Agreement, Mr. Langer was also eligible to be compensated for the successful negotiation of a revised hotel management or new franchise agreement with one of the Company’s existing hotels in an amount equal to 2.0% of the projected management, incentive and franchise fees to be earned by the Company during the duration of the management or franchise agreement, plus certain other potential fees not to exceed $250,000.  Mr. Langer’s Consulting Agreement expired on December 31, 2014 and no fees were earned related to the negotiation of a revised hotel management or new franchise agreement prior to expiration.

As of December 31, 2013, the TLG Promissory Notes due to Messrs. Sasson and Masi had aggregate fair values of approximately $18.0 million, as discussed in note 7, which was included in debt and capital lease obligations on the accompanying consolidated balance sheet. The TLG Promissory Notes were repaid and retired in December 2014.  During the years ended December 31, 2014, 2013, and 2012, the Company recorded $1.5 million, $1.4 million, and $1.5 million, respectively, of interest expense related to the TLG Promissory Notes.

 

 

13. Other Expenses

Restructuring and disposal costs

These 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, including the plan of termination implemented in March 2014 (the “Termination Plan”) that resulted in a workforce reduction of the Company’s corporate office employees, Committee costs, proxy contests, and gains and losses on asset disposals as part of major renovation projects. Restructuring and disposal costs consist of the following (in thousands):

 

  

 

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As a result of the Termination Plan, which constituted a plan of termination under ASC 420, Exit or Disposal Cost Obligations, the Company recorded a charge of approximately $7.1 million in the first quarter of 2014 related to the cost of one-time termination benefits which have been paid in cash, and are included in ‘Severance Costs’ for the year ended December 31, 2014 in the above table.

Development costs

These 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. Certain prior year amounts have been reclassified to conform to the current year presentation. Development costs consist of the following (in thousands):

 

  

 

14. Other Non-Operating Expenses

Other non-operating expenses primarily relate to costs associated with discontinued operations and previously owned hotels, both consolidated and unconsolidated, changes in the fair value of debt and equity instruments, 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):

 

 

 

15. Quarterly Financial Information (Unaudited)

The tables below reflect the Company’s selected quarterly information for the Company for the years ended December 31, 2014 and 2013 (in thousands, except per share data):

 

 

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16. Deferred Gain on Asset Sales

In 2011, the Company sold Mondrian Los Angeles, Royalton, Morgans, and its 50% equity interest in the joint venture that owned Sanderson and St Martins Lane. The Company continues to operate all of these hotels under long-term management agreements.

In accordance with ASC 360-20, Property, Plant and Equipment, Real Estate Sales. the Company evaluated its accounting for the gain on sales of these assets, noting that the Company continues to have significant continuing involvement in the hotels as a result of long-term management agreements and shares in risks and rewards of ownership. Accordingly, the Company recorded deferred gains of approximately $152.4 million related to the sales of Royalton, Morgans, Mondrian Los Angeles, and the Company’s equity interests in Sanderson and St Martins Lane, which are deferred and recognized as a gain on asset sales over the initial term of the related management agreements. Gain on asset sales for the years ended December 31, 2014, 2013 and 2012 were $8.0 million, $8.0 million, and $8.0 million, respectively.

 

 

17. Assets Held for Sale

In December 2014, the Company’s Board of Directors approved the TLG Equity Sale which included the sale of the Company’s ownership interests in TLG to Hakkasan, as discussed in note 1.

As discussed in note 2, the Company adopted ASU 2014-08 in 2014, and as a result, it evaluated the TLG Equity Sale under this new accounting literature. The Company concluded that TLG did not meet the requirements to be classified as a discontinued operation under ASU 2014-08. Therefore, the Company referred to ASC 360-10-45 and concluded that TLG should be classified as an asset held for sale. Therefore, the Company has reclassified the individual assets and liabilities of TLG to the appropriate asset and liability held for sale line items on its December 31, 2014 and 2013 balance sheets.   The Company’s assets related to TLG include its investment in the TLG management contracts, which represent the value of the TLG management contracts, the goodwill associated with TLG, and some intangible assets.  The Company’s liabilities related to TLG are payables which are incurred in the normal course of running the food and beverage management company.  

The following sets forth TLGs operations for the three years ended December 31, 2014, 2013 and 2012 (in thousands):  

 

 

 

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 13, 2015.

 

Date: March 13, 2015

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jason T. Kalisman and Richard Szymanski and each of them severally, his true and lawful attorney-in-fact with power of substitution and resubstitution to sign in his name, place and stead, in any and all capacities, to do any and all things and execute and all instruments that such attorney may deem necessary or advisable under the Securities Exchange Act of 1934 and any rules, regulations and requirements of the United States Securities and Exchange Commission in connection with this Annual Report on Form 10-K and any and all amendments hereto, as fully for all intents and purposes as he might or could do in person, and hereby ratifies and confirms all said attorneys-in-fact and agents, each acting alone, and his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below on behalf of the Registrant in the capacities and on the dates indicated.

 

 

 

 

 

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Exhibit Index  

 

 

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*    Filed herewith.

†    Denotes a management contract or compensatory plan, contract or arrangement.