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MHGC > SEC Filings for MHGC > Form 10-Q on 7-Nov-2012All Recent SEC Filings

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Form 10-Q for MORGANS HOTEL GROUP CO.


7-Nov-2012

Quarterly Report


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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. 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 our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Overview

We are a fully integrated lifestyle hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States, Europe and other international locations, and nightclubs, restaurants, bars and other food and beverage venues in many of the hotels we operate, as well as in hotels and casinos operated by MGM Resorts International ("MGM") in Las Vegas. Since 1984, when we opened our first hotel, we have gained experience operating in a variety of market conditions.

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

three hotels that we own and manage ("Owned Hotels"), consisting, as of September 30, 2012, of Hudson in New York, Delano South Beach in Miami Beach, and Clift in San Francisco (which we lease under a long-term lease that is treated as a financing), comprising approximately 1,400 rooms;

our wholly-owned food and beverage operations ("Owned F&B Operations"), consisting, as of September 30, 2012, of certain food and beverage operations located at Hudson in New York, Delano South Beach in Miami Beach, Clift in San Francisco, and Sanderson and St Martins Lane, both in London;

four hotels that we partially own and manage pursuant to long-term management agreements ("Joint Venture Hotels"), consisting, as of September 30, 2012, of Mondrian South Beach in Miami Beach, Shore Club in Miami Beach, Ames in Boston and Mondrian SoHo in New York, comprising approximately 1,015 rooms;

seven hotels that we manage pursuant to long-term management agreements with no ownership interest ("Managed Hotels"), consisting, as of September 30, 2012, of Royalton and Morgans in New York, Mondrian in Los Angeles, Sanderson and St Martins Lane in London, Delano Marrakech in Morocco, and Hotel Las Palapas in Playa del Carmen, Mexico, comprising approximately 1,025 rooms;

our 90% controlling interest in a group of companies known as The Light Group ("TLG"), a leading lifestyle food and beverage management company with a ten-year track record of delivering cutting-edge food and beverage experiences at world class properties. TLG develops, redevelops and operates numerous venues in Las Vegas pursuant to management agreements with MGM, including nightclubs, such as The Bank Nightclub at Bellagio Hotel and Casino and Haze at ARIA Resort and Casino at CityCenter, restaurants, such as Yellowtail Japanese Restaurant & Lounge at Bellagio Hotel and Casino and Diablos Mexican Cantina at Monte Carlo Hotel, pool lounges and bars. TLG also serves as our food and beverage platform, operating or assisting in the development, redevelopment, concepting, design and operations of food and beverage venues in many of the hotels we operate. Additionally, in August 2012, we invested $15.0 million in cash and issued a $10.6 million principal only promissory note to acquire the leasehold interests in three restaurants at Mandalay Bay from the existing tenant. The venues will be reconcepted and managed by TLG and will be operated pursuant to 10-year operating leases with MGM;

our investment in unconsolidated food and beverage operations ("F&B Venture"), consisting, as of September 30, 2012, of certain food and beverage operations located at Mondrian South Beach in Miami Beach;

our investments in hotels under development and other proposed properties; and


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the rights and obligations contributed to Morgans Group, our operating company, in the formation and structuring transactions described in note 1 to our consolidated financial statements, included elsewhere in this report.

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.

Our Joint Venture Hotels as of September 30, 2012 are operated under management agreements which expire as follows:

Shore Club - July 2022;

Mondrian South Beach - August 2026;

Ames - November 2024; and

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

Our Managed Hotels as of September 30, 2012 are operated under management agreements which expire as follows:

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

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

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

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

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

Delano Marrakech - June 2027; and

Hotel Las Palapas in Playa del Carmen, Mexico -December 2014 (with one automatic five-year extension, so long as we are not in default under the management agreement).

We have also signed management agreements to manage various other hotels, including a Mondrian project in Doha, Qatar, a Mondrian project in The Bahamas, a Mondrian project in London, a Mondrian project in Istanbul, Turkey, a Mondrian project in Marrakech, a Delano project on the Aegean Sea in Turkey, a Delano project in Moscow, a Hudson project in London, and a hotel project in the Highline area in New York City. However, financing has not been obtained for some of these hotel projects, and there can be no assurances that all of these projects will be developed as planned.

Additionally, in August 2012, we signed a license agreement with MGM for a Delano at Mandalay Bay in Las Vegas following a renovation and conversion of MGM's THEhotel. Delano Las Vegas will be managed by MGM pursuant to a 10-year licensing agreement, with two 5-year extensions at our option, subject to performance thresholds. Under the license agreement, we will earn a base fee, subject to increase based on our development and brand expansion and we can earn an incentive fee based on Delano Las Vegas' revenue per available room compared with its competitive set.

Our hotel management agreements may be subject to early termination in specified circumstances. For example, our hotel management agreements for Royalton and Morgans contain performance tests that stipulate certain minimum levels of operating performance. These performance test provisions related to Royalton and Morgans provide us the option to fund a shortfall in operating performance limited to our earned base fees. If we choose not to fund the shortfall, the hotel owner has the option to terminate the management agreement. As of September 30, 2012, approximately $0.7 million was recorded in accrued expenses and as a reduction to management fees related to these Royalton and Morgans performance test provisions.

TLG's management agreements may be subject to early termination in specified circumstances. For example, all of the management agreements contain, among other covenants, a performance test that stipulates a minimum level of operating performance, and restrictions as to certain requirements of suitability, capacity, compliance with laws and material terms, financial stability, and that certain named representatives must remain employed by or under contract to TLG.


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Several of our hotels are also subject to mortgage and mezzanine debt, and in some instances our management fee is subordinated to the debt, and our management agreements may be terminated by the lenders on foreclosure or certain other related events. For example , the outstanding mortgage debt at Ames matured in October 2012 and the mortgage debt at Mondrian SoHo matures in November 2012, as discussed further below. We do not intend to commit significant monies toward the repayment of the Mondrian SoHo or Ames joint venture loans or the funding of operating deficits. We have subordination and non-disturbance agreements pertaining to our management agreements at Mondrian SoHo and Ames and intend to defend our rights under these agreements in the event of any challenge by the lender, although we can provide no assurances that we will be successful.

In March 2010, the lender for the Shore Club mortgage initiated foreclosure proceedings against the property in U.S. federal district court. In October 2010, the federal court dismissed the case for lack of jurisdiction. In November 2010, the lender initiated foreclosure proceedings in state court and a bench trial took place in June 2012 during which the trial court granted a default ruling of foreclosure. Entry of a foreclosure judgment has been delayed pending, among other things, resolution of a motion to disqualify the presiding trial court judge and corresponding relinquishment of jurisdiction from the Florida appeals court to the trial court. We have operated and expect to continue to operate the hotel pursuant to the management agreement during the pendency of these proceedings, which may continue for some additional period of time in the event of post-judgment proceedings, which may include an appeal. However, there can be no assurances as to when a foreclosure sale may take place, or whether we will continue to operate the hotel once foreclosure proceedings are complete.

Factors Affecting Our Results of Operations

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

Occupancy;

Average daily room rate ("ADR"); and

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

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

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

Food and beverage revenue. Most of our food and beverage revenue is driven by occupancy of our hotels and the popularity of our bars and restaurants with our local customers. In June 2011, we acquired from affiliates of China Grill Management ("CGM") the 50% interests CGM owned in our prior food and beverage joint ventures at Delano South Beach, Mondrian South Beach, Mondrian Los Angeles, Morgans, Sanderson and St Martins Lane for $20.0 million (the "CGM Transaction"). As a result of the CGM Transaction, we record 100% of the food and beverage revenue, and related expenses, for our Owned F&B Operations.

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


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Management fee revenue and other income. We earn hotel management fees under our hotel management agreements. These fees may include management fees as well as reimbursement for allocated chain services. Additionally, we own a 90% controlling investment in TLG, a leading lifestyle food and beverage management company, which operates numerous venues in Las Vegas pursuant to management agreements with MGM. The primary assets of TLG consist of its management and similar agreements with various MGM affiliates. Each of TLG's venues is managed by an affiliate of TLG, which receives revenue based on a revenue sharing arrangement. Through our ownership of TLG, we recognize management fees in accordance with the applicable management agreement, which generally provides for base management fees as a percentage of gross sales, as defined in the agreement, and incentive management fees as a percentage of net profits, as defined in the agreement. Under TLG's management agreements, all costs associated with the construction, build-out, FF&E, operating supplies, equipment and daily operational expenses are borne by each respective MGM affiliate.

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

Renovations at our hotels can have a significant impact on our revenues. For example, our guestroom and corridor renovations at Hudson, which began in the fourth quarter of 2011 and were substantially complete by the end of the third quarter, has had a material impact on our operating results during the nine months ended September 30, 2012, as discussed further below.

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, given the recent global economic downturn, the impact of seasonality in 2010 and 2011 was not as significant as in prior periods and may remain less pronounced in 2012 depending on the timing and strength of the economic recovery.

In addition to economic conditions, supply is another important factor that can affect revenues. Room rates, occupancy and food and beverage revenues tend to fall when supply increases, unless the supply growth is offset by an equal or greater increase in demand. One reason why we focus on boutique hotels in key gateway cities is because these markets have significant barriers to entry for new competitive supply, including scarcity of available land for new development and extensive regulatory requirements resulting in a longer development lead time and additional expense for new competitors. Additionally, through our strategic relationship with MGM, we believe that the impact of competitive new supply on our food and beverage operations in Las Vegas may be minimized, as we offer nightlife and food and beverage venues at highly-visible and visited locations on the Las Vegas Strip.

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

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

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

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


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

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

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

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

Depreciation and amortization expense. Hotel properties are depreciated using the straight-line method over estimated useful lives of 39.5 years for buildings and five years for furniture, fixtures and equipment.

Restructuring, development and disposal costs include costs incurred related to losses on asset disposals as part of major renovation projects, the write-off of abandoned development projects resulting primarily from events generally outside management's control such as the recent tightness of the credit markets, our restructuring initiatives and severance costs related to our restructuring initiatives. These items do not relate to the ongoing operating performance of our assets.

Other Items

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

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

Gain on asset sales. We recorded deferred gains of approximately $11.2 million, $12.5 million and $55.6 million, respectively, related to the sales of Royalton, Morgans and Mondrian Los Angeles, and a deferred gain of approximately $73.1 million related to the sale of our ownership interest in the entity that owned 50% of Sanderson and St Martins Lane, as discussed in note 11 of our consolidated financial statements. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement.

Other non-operating expenses include costs associated with executive terminations not related to restructuring initiatives, costs of financings, litigation and settlement costs and other items that relate to the financing and investing activities associated with our assets and not to the ongoing operating performance of our assets, both consolidated and unconsolidated.

Income tax expense (benefit). All of our foreign subsidiaries are subject to local jurisdiction corporate income taxes. Income tax expense is reported at the applicable rate for the periods presented. We are subject to Federal and state income taxes. Income taxes for the three and nine months ended September 30, 2012 and 2011 were computed using our calculated effective tax rate. We also recorded net deferred taxes related to cumulative differences in the basis recorded for certain assets and liabilities. We established a reserve on the deferred tax assets based on the ability to utilize net operating loss carryforwards.


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

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

Preferred stock dividends and accretion. Dividends attributable to our outstanding preferred stock and the accretion of the fair value discount on the issuance of the preferred stock are reflected as adjustments to our net loss to arrive at net loss attributable to common stockholders, as discussed in note 8 of our consolidated financial statements.

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

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

Recent Trends and Developments

Recent Trends. Starting in the fourth quarter of 2008 and continuing throughout 2009, the weakened U.S. and global economies resulted in considerable negative pressure on both consumer and business spending. As a result, lodging demand and revenues, which are primarily driven by growth in GDP, business investment and employment growth weakened substantially during this period as compared to the lodging demand and revenues we experienced prior to the fourth quarter of 2008. After this extremely difficult recessionary period, the outlook for the U.S. and global economies began improving in 2010 and that improvement has continued through 2012. However, as a result of the current European economic crisis and slow domestic growth, the outlook for the global economy remains uncertain. To date, the economic recovery has not been particularly robust, as spending by businesses and consumers remains restrained, and there are still several trends which make our performance difficult to forecast, including shorter booking lead times at our hotels.

The pace of new lodging supply has increased over the past several years as many projects initiated before the economic downturn came to fruition. For example, we witnessed new competitive luxury and boutique properties opening between 2008 and 2012 in some of our markets, particularly in New York, which have impacted our performance in these markets and may continue to do so. However, we believe the timing of additional new development projects may be affected by ongoing uncertain economic conditions, which may slow down the pace of new supply development, including our own, in the next few years.

Our operating results for the third quarter of 2012 reflected performance that varied by region and were further impacted by renovation work at Hudson. RevPAR at our System-Wide Comparable Hotels, which excludes Delano, Hudson, Mondrian SoHo and Hotel Las Palapas, as well as hotels no longer operated by us, increased by 8.0% in constant dollars (7.4% in actual dollars) in the third quarter of 2012 from the comparable period in 2011. In the Northeastern United States, RevPAR from the System-Wide Comparable Hotels in the region, which consist of Morgans, Royalton and Ames, increased by 4.6%. Additionally, despite the renovation work at Hudson, ADR increased by 4.0% for the three months ended September 30, 2012 as compared to the same period in 2011. Mondrian SoHo, which opened in February 2011, generated an 8.9% RevPAR increase during the third quarter of 2012 as compared to the same period in 2011, driven by 6.4% occupancy growth. Our London hotels benefited from the Olympics during August 2012, which resulted in an increase in RevPAR of 16.9% in constant dollars (14.5 % in actual dollars) during the third quarter of 2012 as compared to the same period in 2011, primarily driven by increased rates. Revenues in Miami during the third quarter were relatively flat with a 0.6% increase in RevPAR during the third quarter of 2012 as compared to the same period in 2011. Our San Francisco hotel experienced a RevPAR increase of 11.0%.


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Subsequent to the third quarter, our results have been and may continue to be impacted by Hurricane Sandy. Though all four of our New York properties were operating during the storm and none of them appear to have suffered any significant property damage, we had to close both Morgans and Mondrian SoHo due to a lack of power for several days. Both hotels have since reopened. Given the widespread devastation Hurricane Sandy caused to the Northeastern United States, we are unable to assess the impact of the storm on our results at this time, . . .

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