FXRE FX Real Est And Ent (MM)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

 

Commission File No. 001-33902

 

FX Real Estate and Entertainment Inc.

(Exact name of Registrant as specified in its charter)

 

 

650 Madison Avenue

 

New York, New York 10022

 

(Address of Principal Executive Offices and Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (212) 838-3100

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  o No  þ

 

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

 

Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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  þ No  o

 

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 the 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. þ

 

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

 

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant on June 30, 2008, based on the closing price of such stock on The NASDAQ Global Market on such date, was $22,017,039.

 

As of March 27, 2009, there were 51,992,417 shares of the registrant’s common stock outstanding.

 

Documents Incorporated by Reference:   Portions of the registrant’s definitive proxy statement for its 2009 annual stockholders’ meeting are incorporated by reference in Part III (Items 10-14) of this report. The registrant’s definitive proxy statement will be filed with the Securities and Exchange Commission within 120 days after December 31, 2008.

 

 

FX Real Estate and Entertainment Inc.

 

Annual Report on Form 10-K

 

December 31, 2008

 

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In this Annual Report on Form 10-K, the words “we,” “us,” “our,” “FXRE,” and the “Company” collectively refer to FX Real Estate and Entertainment Inc., and its consolidated subsidiaries, FX Luxury Realty, LLC, BP Parent, LLC, Metroflag BP, LLC and Metroflag Cable, LLC. In August 2008, FX Luxury Realty, LLC changed its name to FX Luxury, LLC, BP Parent, LLC changed its name to FX Luxury Las Vegas Parent, LLC, Metroflag BP, LLC changed its name to FX Luxury Las Vegas I, LLC and Metroflag Cable, LLC changed its name to FX Luxury Las Vegas II, LLC. The words “Metroflag” or “Metroflag entities” refer to FX Luxury Realty and its predecessors, including BP Parent, LLC, Metroflag BP, LLC, Metroflag Cable, LLC, Metroflag Polo, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC and Metroflag Management, LLC, the predecessor entities through which our historical business was conducted prior to September 27, 2007. “Las Vegas subsidiaries” refers to BP Parent, LLC, Metroflag BP, LLC and Metroflag Cable, LLC, each as renamed as indicated above. Some of the descriptive material in this Annual Report on Form 10-K refers to the assets, liabilities, operations, results, activities or other attributes of the historical business conducted by the Metroflag entities.

 

Financial Condition of the Company

 

As disclosed in more detail throughout this Form 10-K, the Company is in severe financial distress and may not be able to continue as a going concern. Our current cash flow and cash on hand as of March 27, 2009 are not sufficient to fund our past due obligations and short-term liquidity needs, including our ordinary course obligations as they come due. Our Las Vegas subsidiaries are currently in default under the $475 million mortgage loan secured by our Las Vegas property, which is substantially our entire business, and neither we nor our subsidiaries are able to repay the obligations with respect thereto. As a result of the ongoing default under the mortgage loan, our lenders may at any time exercise their remedies under the amended and restated credit agreements governing the mortgage loan, which may include foreclosing on the Las Vegas property. Further, we have received an opinion from our auditors expressing substantial doubt as to our ability to continue as a going concern. Investors are encouraged to read the information set forth below in order to better understand the financial condition of, and risks of investing in, the Company.

 

The Company

 

The Las Vegas Property

 

Our business consists of the ownership and operation of the Las Vegas property, which is made up of six contiguous parcels aggregating 17.72 acres of land located on the southeast corner of Las Vegas Boulevard and Harmon Avenue in Las Vegas, Nevada. The property enjoys strong visibility with 1,175 feet of frontage on Las Vegas Boulevard, known as “the Strip”, and 600 feet of frontage on Harmon Avenue. The entire 17.72 acre parcel is zoned H-1, Limited Resort and Apartment District, and allows for casino gaming through its designation as a Gaming Enterprise District, or GED, and can support a variety of development alternatives, including hotels/resorts, entertainment venue(s), a casino, condominiums, hotel-condominiums, residences and retail establishments. The Las Vegas property is currently occupied by a motel and several commercial and retail tenants with a mix of short and long-term leases. The Las Vegas property’s six parcels generated total rental and other revenue of approximately $19.5 million for the fiscal year ended December 31, 2008.

 

As discussed below under “Mortgage Loan Default,” the property is subject to a $475 million loan that is currently in default due to the failure of our Las Vegas subsidiaries to repay the loan at maturity on January 6, 2009. As a result of the failure to make repayment when due, the lenders may at any time exercise their remedies under the amended and restated credit agreements governing the mortgage loan, which may include foreclosing on the Las Vegas property. The loss of the Las Vegas property, which is substantially our entire business, would have a material adverse effect on our business, financial condition, results of operations, prospects and ability to continue as a going concern.

 

Set forth below is a summary of the parcels, including a description of the land, the current tenant(s) and the current term(s) of the existing lease(s).

 

Parcel 1.  Parcel 1 consists of 0.996 acres of land with 115 linear feet of frontage on Las Vegas Boulevard and 150 linear feet of frontage on Harmon Avenue. One tenant currently occupies Parcel 1. The lease for the property is terminable at any time by either party upon 120 days’ prior written notice and without the payment of a termination fee.

 

Parcel 2.  Parcel 2 consists of 5.135 acres of land with 210 linear feet of frontage on Las Vegas Boulevard and 450 linear feet of frontage on Harmon Avenue. The property is currently occupied by a Travelodge motel which we own in fee, as well as several retail, billboard and parking lot tenants. The Travelodge motel is being operated by WW Lodging Limited LLC pursuant to a management agreement. The management agreement is terminable upon 30 days’ prior notice and a payment of a termination fee equal to 4% of the trailing 12 months room revenue multiplied by 200%. The property’s retail, billboard and parking lot leases are month-to-month.

 

Parcel 3.  Parcel 3 consists of 2.356 acres of land, with 275 linear feet of frontage on Las Vegas Boulevard. The property currently hosts the Hawaiian Marketplace, which consists of multiple retail tenants. All but six of the leases on this property are terminable at any time upon 30 days’ (in one instant upon 180 days’) advance written notice and without payment of a termination fee. All six leases not terminable with notice are terminable by us at any time upon the exercise of options to either repurchase, recapture or relocate the premises.

 

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Parcel 4.  Parcel 4 consists of 4.49 acres of land with 270 linear feet of frontage on Las Vegas Boulevard. The property is currently occupied by several tenants. The current leases are month-to-month, except for a lease with a single tenant. Such tenant’s lease term expires in May 2009, which may be extended for an additional five years at the option of the tenant.

 

Parcel 5.  Parcel 5 consists of 3.008 acres of land, with 180 linear feet of frontage on Las Vegas Boulevard. The property accommodates 51,414 square feet of retail space and is currently occupied by several restaurant and retail tenants. One lease term expires in January 2012, but is terminable earlier upon 120 days’ advance written notice and, if terminated after February 2010, payment of a termination fee of $200,000. Another lease term expires in December 2009, with the tenant holding two options to extend the lease for five year periods. A third lease term expires in August 2012, with the tenant holding an option to extend the lease for an additional five years. A fourth lease term expires in May 2059.

 

Parcel 6.  Parcel 6 consists of 1.765 acres of land, with 125 linear feet of frontage on Las Vegas Boulevard. The property accommodates 2,094 square feet of retail space and is currently occupied by a restaurant and several retail tenants. One lease term expires in December 2013, another lease term expires in April 2011 and a third lease term expires in February 2014, with the tenant holding an option to extend the lease term for an additional five years. A fourth lease term expires in May 2045.

 

Mortgage Loan Default

 

The Las Vegas property is subject to a mortgage loan, which, as of December 31, 2008, had $475 million outstanding, made up of a $280 million senior secured first lien loan and a $195 million senior secured second lien loan. As a result of the application of certain escrowed proceeds to the payment of principal under the first lien loan, as more fully described below, there is $454 million outstanding under the mortgage loan as of March 27, 2009. The borrowers under the mortgage loan are the Las Vegas subsidiaries. The mortgage loan is not guaranteed by FX Real Estate and Entertainment nor has FX Real Estate and Entertainment pledged any assets to secure the mortgage loan. The mortgage loan is secured only by first lien and second lien security interests in substantially all of the assets of the Las Vegas subsidiaries, including the Las Vegas property. FX Luxury Realty has provided a guarantee to the lenders only for losses caused under limited circumstances such as fraud or willful misconduct. The mortgage loan includes certain financial and other maintenance covenants on the Las Vegas property including limitations on indebtedness, liens, restricted payments, loan to value ratio, asset sales and related party transactions. The mortgage loan matured on January 6, 2009.

 

The Las Vegas subsidiaries had previously obtained a temporary waiver of noncompliance with certain of the mortgage loan’s loan-to-value ratio covenants, which waiver expired on December 19, 2008 in accordance with its terms. Because the Las Vegas subsidiaries did not regain compliance with the loan-to-value ratio covenants prior to expiration of the temporary waiver, an event of default occurred. On January 5, 2009, the second lien lenders under the mortgage loan delivered a written demand for repayment of all of the obligations owed to them under the loan, including the second lien principal amount of $195 million. The second lien lenders’ written demand, which was delivered prior to the mortgage loan maturity date, cited the continuing covenant default referenced above.

 

On January 6, 2009, following the Las Vegas subsidiaries’ failure to repay the mortgage loan at maturity, the first lien lenders delivered their demand for repayment of all of the obligations owed to them under the loan, including the first lien principal amount of $280 million. On January 30, 2009, the first lien lenders seized the cash collateral reserve accounts established under the mortgage loan from which the Las Vegas subsidiaries had been drawing working capital funds to meet ordinary expenses, including operating the Las Vegas property, and have applied $21 million to the outstanding principal amount of the first lien loan as of March 25, 2009. In addition, the first lien lenders have directed all payments from the existing tenants on the Las Vegas property to be delivered directly to the lenders. The Las Vegas subsidiaries make requests of the first lien lenders on a monthly basis to access the cash generated by the rental activities on the property deemed necessary to meet the operating expenses related to the Las Vegas property. The first lien lenders have sole discretion to approve or reject any such request. Because the Las Vegas subsidiaries have limited cash available, if the lenders fail to honor the draw requests in full or in part or delay the processing, the Las Vegas subsidiaries will not be able to satisfy their obligations and pay for necessary expenses unless the Company is able to fund shortfalls from other sources. As of March 27, 2009, the Company had approximately $3 million of cash available to fund its current operations, including ordinary payables as incurred, to meet its obligations as they come due and to provide any such funding for the Las Vegas subsidiaries. Thus, the Las Vegas subsidiaries may not be able to meet their obligations as they come due.

 

Neither the Company nor the Las Vegas subsidiaries are able to repay the obligations outstanding under the mortgage loan.

 

As a result of the current global recession and financial crisis and based upon a valuation report obtained for the Las Vegas property from an independent appraisal firm combined with certain assumptions made by management, the Company recorded an impairment charge to land of $325.1 million. This charge reduced the carrying value of the Las Vegas property to its estimated fair value of $218.8 million which management believes to be reasonable. The current global financial crisis has had a particularly negative impact on the Las Vegas real estate market, including a significant reduction in the number of visitors and per visitor spending, the abandonment of, and/or loan defaults related to, several major new hotel and casino development projects as well as publicly expressed concerns regarding the financial viability of several of the largest hotel and casino operators in the Las Vegas market. These factors combined with the lack of availability of financing for development has resulted in a near cessation of land sales on the Las Vegas strip. Though the Company

 

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believes the $218.8 million carrying value ascribed to the property is fair and reasonable based on current market conditions, the lack of recent comparable sales and the rapidly changing economic environment means that no assurance can be given that the value ascribed by the Company will prove to be accurate or even within a reasonable range of the actual sales price that would be received in the event the property is sold as a result of the loan default. A sale of the land by the Company or upon foreclosure by the lenders at or near the adjusted carrying value of $218.8 million would be insufficient to fully repay the outstanding mortgage loan and therefore would result in the Company receiving no net cash proceeds.

 

While the Las Vegas subsidiaries have engaged in preliminary discussions with the first lien lenders and the second lien lenders regarding potential solutions to the existing loan defaults, no agreement has yet been reached. To the extent that no consensual arrangement is reached and the lenders pursue their remedies, the Las Vegas subsidiaries may explore possible legal options in connection with trying to maintain their ownership of the Las Vegas property, including bankruptcy or similar filings. Whether or to what extent such action may be effective or viable is unclear.

 

Terminated License Agreements

 

On June 1, 2007, the Company entered into license agreements with Elvis Presley Enterprises, Inc., an 85%-owned subsidiary of CKX, Inc. (“EPE”) [NASDAQ: CKXE], and Muhammad Ali Enterprises LLC, an 80%-owned subsidiary of CKX (“MAE”), which allowed the Company to use the intellectual property and certain other assets associated with Elvis Presley and Muhammad Ali in the development of its real estate and other entertainment attraction-based projects. The Company’s license agreement with Elvis Presley Enterprises granted the Company, among other rights, the right to develop one or more hotels as part of the master plan of Elvis Presley Enterprises, Inc. to redevelop the Graceland property and surrounding areas in Memphis, Tennessee.

 

Under the terms of the license agreements, we were required to pay EPE and MAE a specified percentage of the gross revenue generated at the properties that incorporate the Elvis Presley and Muhammad Ali intellectual property. In addition, the Company was required to pay a guaranteed annual minimum royalty payment (against royalties payable for the year in question) of $10 million in each of 2007, 2008, and 2009, $20 million in each of 2010, 2011, and 2012, $25 million in each of 2013, 2014, 2015 and 2016, and increasing by 5% for each year thereafter. The initial payments (for 2007) under the license agreements, as amended, were paid on April 1, 2008, with proceeds from our March 2008 rights offering. The guaranteed annual minimum royalty payments for 2008 in the aggregate amount of $10 million were due on January 30, 2009.

 

On March 9, 2009, following the Company’s failure to make the $10 million annual guaranteed minimum royalty payments for 2008, the Company entered into a Termination, Settlement and Release agreement with EPE and MAE, pursuant to which the parties agreed to terminate the Elvis Presley and Muhammad Ali license agreements and to release each other from all claims related to or arising from such agreements. In consideration for releasing the Company from any claims related to the license agreements, EPE and MAE will receive 10% of any future net proceeds or fees received by the Company from the sale and/or development of the Las Vegas property, up to a maximum of $10 million. The Company has the right to buy-out this participation right at any time prior to April 9, 2014 for a payment equal to (i) $3.3 million plus interest at 7% per annum, calculated from year 3 until repaid, plus (ii) 10% of any net proceeds received from the sale of some or all of the Las Vegas property during such buy-out period and for six months thereafter, provided that the amount paid under clauses (i) and (ii) shall not exceed $10 million.

 

Formation of the Company

 

FXLR was formed under the laws of the state of Delaware on April 13, 2007. The Company was inactive from inception through May 10, 2007.

 

On May 11, 2007, Flag Luxury Properties, LLC (“Flag”), a real estate development company in which Robert F.X. Sillerman and Paul C. Kanavos each owned an approximate 29% interest, contributed to the Company its 50% ownership interest in the Metroflag entities for all of the membership interests in the Company. The sale of assets by Flag was accounted for at historical cost as FXLR and Flag were entities under common control.

 

On June 1, 2007, Flag Leisure Group, LLC, a company in which Robert F.X. Sillerman and Paul C. Kanavos each beneficially own an approximate 33% interest and which is the managing member of Flag, sold to the Company all of its membership interests in RH1, LLC (“RH1”), which owned an aggregate of 418,294 shares of Riviera Holdings Corporation and 28.5% of the outstanding shares of common stock of Riv Acquisition Holdings, Inc. On such date, Flag also sold to the Company all of its membership interests in Flag Luxury Riv, LLC, which owned an additional 418,294 shares of Riviera Holdings Corporation and 28.5% of the outstanding shares of common stock of Riv Acquisition Holdings. With the purchase of these membership interests, FXLR acquired, through its interests in Riv Acquisitions Holdings, a 50% beneficial ownership interest in an option to acquire an additional 1,147,550 shares of Riviera Holdings Corporation at $23 per share. These options were exercised in September 2007. The total consideration for these transactions was $21.8 million paid in cash, a note for $1.0 million and additional contributed equity of $15.9 million for a total of $38.7 million. As a result of these transactions, as of December 31, 2008, the Company owned 1,410,363 shares of common stock (161,758 of which were put into trust for the benefit of the Company in October 2008) of Riviera Holdings Corporation (the “Riv Shares”).

 

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As of March 27, 2009, the Company had sold all but 115,558 shares of the RIV Shares. The sale of assets by Flag Leisure Group, LLC and Flag was accounted for at historical cost as the Company, Flag Leisure Group, LLC and Flag were entities under common control at the time of the transactions. Historical cost for these acquired interests equals fair values because the assets acquired comprised available for sale securities and a derivative instrument that are required to be reported at fair value in accordance with generally accepted accounting principles.

 

FXRE was formed under the laws of the state of Delaware on June 15, 2007.

 

On September 26, 2007, CKX, together with other holders of common membership interests in FXLR contributed all of their common membership interests in FXLR to FXRE in exchange for shares of common stock of FXRE.

 

This exchange is sometimes referred to herein as the “reorganization.” As a result of the reorganization, FXRE holds 100% of the outstanding common membership interests of FXLR.

 

On November 29, 2007, the Company reclassified its common stock on a basis of 194,515.758 shares of common stock for each share of common stock then outstanding.

 

On January 10, 2008, the Company became a publicly traded company as a result of the completion of the distribution of 19,743,349 shares of common stock to CKX’s stockholders of record as of December 31, 2007. This distribution is referred to herein as the “CKX Distribution.”

 

CKX Investment

 

On June 1, 2007, CKX contributed $100 million in cash to the Company in exchange for 50% of the common membership interests in the Company (the “CKX Investment”). CKX also agreed to permit Flag to retain a $45 million preferred priority distribution right which amount will be payable upon certain defined capital events.

 

As a result of the CKX investment on June 1, 2007 and the determination that Flag and CKX constituted a collaborative group representing 100% of FXLR’s ownership interests, the Company recorded its assets and liabilities at the combined accounting bases of the respective investors. FXLR’s net asset base represents a combination of 50% of the assets and liabilities at historical cost, representing Flag’s predecessor ownership interest, and 50% of the assets and liabilities at fair value, representing CKX’s ownership interest, for which it contributed cash on June 1, 2007. Along with the accounting for the subsequent acquisition of the remaining 50% interest in Metroflag (see below) at fair value, the assets and liabilities were ultimately adjusted to reflect an aggregate 75% fair value.

 

On September 26, 2007, CKX acquired an additional 0.742% of the outstanding capital stock of the Company for a price of $1.5 million. The proceeds of this investment, together with an additional $0.5 million that was invested by Flag, were used by the Company for working capital and general corporate purposes.

 

CKX subsequently distributed 100% of its interest in the Company to CKX’s stockholders through the consummation of the CKX Distribution.

 

Terminated License Agreements

 

On June 1, 2007, the Company entered into a worldwide license agreement with Elvis Presley Enterprises, Inc., a 85%-owned subsidiary of CKX (“EPE”), granting the Company the exclusive right to utilize Elvis Presley-related intellectual property in connection with the development, ownership and operation of Elvis Presley-themed hotels, casinos and certain other real estate-based projects and attractions around the world. The Company also entered into a worldwide license agreement with Muhammad Ali Enterprises LLC, a 80%-owned subsidiary of CKX (“MAE”), granting the company the right to utilize Muhammad Ali-related intellectual property in connection with Muhammad Ali-themed hotels and certain other real estate-based projects and attractions. As described above under “Terminated License Agreements,” these license agreements were terminated on March 9, 2009.

 

Metroflag Acquisition

 

On May 30, 2007, the Company entered into an agreement to acquire the remaining 50% ownership interest in the Metroflag entities that it did not already own. This purchase was completed on July 6, 2007. As a result of this purchase, the Company owns 100% of Metroflag, and therefore the Las Vegas property. The total consideration paid by FXLR for the remaining 50% interest in Metroflag was $180 million, $172.5 million of which was paid in cash at closing and $7.5 million of which was an advance payment made in May 2007 (funded by a $7.5 million loan from Flag). The cash payment at closing was funded from $92.5 million of cash on hand and $105 million in additional borrowings, which was reduced by $21.3 million deposited into a restricted cash account to cover

 

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debt service commitments and $3.7 million in debt issuance costs. The $7.5 million loan from Flag was repaid on July 9, 2007.

 

The Repurchase Agreement and Contingently Redeemable Stock

 

In connection with the CKX Investment, CKX, FXRE, FXLR, Flag, Robert F.X. Sillerman, Paul Kanavos and Brett Torino entered into a Repurchase Agreement dated June 1, 2007, as amended on June 18, 2007 and September 27, 2007. The purpose of the Repurchase Agreement was to provide a measure of valuation protection for the 50%-interest in the Company acquired by CKX (the “Purchased Securities”) for $100 million, under certain limited circumstances. Specifically, if no “Termination Event” was to occur prior to the second anniversary of the CKX Distribution, which were events designed to indicate that the value of the CKX Investment had been confirmed, each of Messrs. Sillerman, Kanavos and Torino would be required to sell back such number of their shares of the Company’s common stock to the Company at a price of $.01 per share as would result in the shares that were received by the CKX stockholders in the CKX Distribution having a value of at least $100 million.

 

The interests held by Messrs. Sillerman, Kanavos and Torino subject to the Repurchase Agreement were recorded as contingently redeemable members’ interest in accordance with FASB Emerging Issues Task Force Topic D-98: Classification and Measurement of Redeemable Securities . This statement requires the issuer to estimate and record value for securities that are mandatorily redeemable when that redemption is not in the control of the issuer. The value for this instrument has been determined based upon the redemption price of par value for the expected 18 million shares of common stock of FXRE subject to the Repurchase Agreement. At December 31, 2007, the value of the interest subject to redemption was recorded at the maximum redemption value of $180,000.

 

In the first quarter of 2008, a “Termination Event” as defined in the Repurchase Agreement was deemed to have occurred as the average closing price of the common stock of FXRE for the consecutive 30-day period following the date of the CKX Distribution (January 10, 2008) exceeded a price per share that attributed an aggregate value to the Purchased Securities of greater than $100 million. As a result of the termination event and resulting termination of the Repurchase Agreement, the shares previously classified as redeemable were no longer redeemable. As of December 31, 2008, the Company has reclassified to stockholders’ equity the contingently redeemable stockholders’ equity included on the consolidated balance sheet as of December 31, 2007.

 

Rights Offering and Related Investment Agreements

 

On March 11, 2008, the Company commenced a registered rights offering pursuant to which it distributed to certain of its stockholders, at no charge, transferable subscription rights to purchase one share of its common stock for every two shares of common stock owned as of March 6, 2008, the record date for the rights offering, at a cash subscription price of $10.00 per share. As of the commencement of the offering, the Company had 39,790,247 shares of common stock outstanding. As part of the transaction that created the Company in June 2007, the Company agreed to undertake the rights offering, and certain stockholders who own, in the aggregate, 20,046,898 shares of common stock, waived their rights to participate in the rights offering. As a result, the rights offering was made only to stockholders who owned, in the aggregate, 19,743,349 shares of common stock as of the record date, resulting in the distribution of rights to purchase up to 9,871,674 shares of common stock in the rights offering. The rights offering expired on April 18, 2008.

 

The rights offering was made to fund certain obligations, including short-term obligations described elsewhere herein. On January 9, 2008, Robert F.X. Sillerman, the Company’s Chairman and Chief Executive Officer, and The Huff Alternative Fund, L.P. and The Huff Alternative Parallel Fund, L.P. (collectively, “Huff”), one of the Company’s principal stockholders, entered into investment agreements with the Company, pursuant to which they agreed to purchase shares that were not otherwise subscribed for in the rights offering, if any, at the same $10.00 per share subscription price. In particular, under Huff’s investment agreement with the Company, as amended, Huff agreed to purchase the first $15 million of shares (1.5 million shares at $10 per share) that were not subscribed for in the rights offering, if any, and 50% of any other unsubscribed shares, up to a total investment of $40 million; provided, however, that the first $15 million was reduced by $11.5 million, representing the aggregate value of the 1,150,000 shares acquired by Huff upon the exercise on April 1, 2008 of its own subscription rights in the offering; and provided further that Huff was not obligated to purchase any shares beyond its initial $15 million investment in the event that Mr. Sillerman did not purchase an equal number of shares at the $10 price per share pursuant to the terms of his investment agreement with the Company. Under his investment agreement with the Company, Mr. Sillerman agreed to subscribe for his full pro rata amount of shares in the rights offering (representing 3,037,265 shares), and agreed to purchase up to 50% of the shares that were not sold in the rights offering after Huff’s initial $15 million investment at the same subscription price per share offered in the offering.

 

On March 12, 2008, Mr. Sillerman subscribed for his full pro rata amount of shares resulting in his purchase of 3,037,265 shares. On May 13, 2008, pursuant to and in accordance with the terms of the investment agreements described above, Mr. Sillerman and Huff purchased an aggregate of 4,969,112 shares that were not otherwise sold in the offering. The Company generated aggregate gross proceeds of approximately $98.7 million from the rights offering and from sales under the related investment agreements described above. In conjunction with the shares purchased by Huff pursuant to its investment agreement with the Company, Huff purchased one share of the Company’s Non-Voting Designated Preferred Stock (referred to hereafter as the “special preferred stock”) for a purchase

 

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price of $1.00.

 

Under the terms of the special preferred stock, Huff is entitled to appoint a member to the Company’s Board of Directors so long as it continues to beneficially own at least 20% of the 6,611,998 shares of the Company’s common stock it received and/or acquired from the Company, consisting of (i) 2,802,442 shares received by Huff in the CKX Distribution, (ii) 1,150,000 shares acquired by Huff in the rights offering, and (iii) 2,659,556 shares acquired by Huff under the investment agreement described above. Huff appointed Bryan Bloom as a member of the Company’s Board of Directors effective May 13, 2008.

 

In connection with Huff’s purchase of the shares of common stock and the special preferred stock in the second quarter of 2008, the Company paid Huff a commitment fee of $715,000, and the parties entered into a registration rights agreement.

 

Conditional Option Agreement and EPE License Agreement Amendment with 19X

 

On February 28, 2008, the Company entered into an Option Agreement with 19X, Inc. pursuant to which, in consideration for aggregate annual payments totaling $105 million payable over five years in four equal cash installments per year, the Company would have the right (but not the obligation) to acquire an 85% interest in the Elvis Presley business currently owned and operated by CKX through EPE at an escalating price ranging from $650 million to $850 million over the period beginning on the date of the closing of 19X’s acquisition of CKX through 72 months following such date, subject to extension under certain circumstances as described below. The effectiveness of the Option Agreement was conditioned upon the consummation of the then pending merger between 19X and CKX.

 

The Company also entered into an agreement with 19X to amend the EPE license agreement, which was also conditioned upon the closing of 19X’s then pending acquisition of CKX. The amendment to the EPE license agreement provided that, if, by the date that is 7 1/2 years following the closing of 19X’s acquisition of CKX, EPE had not achieved certain financial thresholds, the Company would have been entitled to a reduction of $50 million against 85% of the payment amounts due under the EPE license agreement, with such reduction to occur ratably over the ensuing three year period; provided, however, that if the Company had failed in its obligations to build any hotel to which it had previously committed under the definitive Graceland master redevelopment plan, then this reduction would not have applied.

 

The merger agreement between 19X and CKX was terminated on November 1, 2008. Because 19X would only have owned the EPE business upon consummation of its acquisition of CKX, as a result of the termination of the merger agreement between 19X and CKX, these conditional agreements with 19X were terminated.

 

Private Placement of Units

 

Between July 15, 2008 and July 18, 2008, the Company sold in a private placement to Paul C. Kanavos, the Company’s President, Barry A. Shier, the Company’s Chief Operating Officer, an affiliate of Brett Torino, the Company’s Chairman of the Las Vegas Division, Mitchell J. Nelson, the Company’s Executive Vice President and General Counsel, and an affiliate of Harvey Silverman, a director of the Company, an aggregate of 2,264,289 units at a purchase price of $3.50 per unit. Each unit consisted of one share of the Company’s common stock, a warrant to purchase one share of the Company’s common stock at an exercise price of $4.50 per share and a warrant to purchase one share of the Company’s common stock at an exercise price of $5.50 per share. The warrants to purchase shares of the Company’s common stock for $4.50 per share are exercisable for a period of seven years and the warrants to purchase shares of the Company’s common stock for $5.50 per share are exercisable for a period of ten years. The Company generated aggregate proceeds from the sale of the units of approximately $7.9 million.

 

Intellectual Property

 

We intend to protect our intellectual property rights through a combination of patent, trademark, copyright, rights of publicity, and other laws, as well as licensing agreements and third party nondisclosure and assignment agreements. With respect to applications to register trademarks that have not yet been accepted, we cannot assure you that such applications to register trademarks that have not yet been accepted, we cannot assure you that such applications will be approved. Third parties may oppose the trademark applications, seek to cancel existing registrations or otherwise challenge our use of the trademarks. If they are successful, we could be forced to re-brand our products and services, which could result in loss of brand recognition, and could require us to devote resources to advertising and marketing new brands. Because of the differences in foreign trademark, patent and other laws concerning proprietary rights, our intellectual property rights may not receive the same degree of protection in one country as in another. Our failure to obtain or maintain adequate protection of our intellectual property rights for any reason could have a material adverse effect on our business, financial condition and results of operations.

 

8

Employees

 

As of December 31, 2008, the Company had a total of 24 full-time employees. Management considers its relations with its employees to be good.

 

Company Organization

 

The principal executive office of the Company is located at 650 Madison Avenue, New York, New York 10022 and our telephone number is (212) 838-3100.

 

Available Information

 

The Company is subject to the informational requirements of the Securities Exchange Act and electronically files reports and other information with, and electronically furnishes reports and other information to, the Securities and Exchange Commission. Such reports and other information filed or furnished by the Company may be inspected and copied at the Securities and Exchange Commission’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the Public Reference Room. The Securities and Exchange Commission also maintains an Internet site that contains reports, proxy statements and other information about issuers, like us, who file electronically with the Securities and Exchange Commission. The address of the Securities and Exchange Commission’s website is http://www.sec.gov.

 

In addition, the Company makes available free of charge through its website, www.fxree.com, its Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such documents are electronically filed with, or furnished to, the Securities and Exchange Commission. This reference to our Internet website does not constitute incorporation by reference in this report of the information contained on or hyperlinked from our Internet website and such information should not be considered part of this report.

 

9

 

The risks and uncertainties described below are those that we currently believe are material to our stockholders.

 

Risks Related to Our Business

 

Our Las Vegas subsidiaries are in default under the $475 million mortgage loan secured by the Las Vegas property.

 

Our Las Vegas subsidiaries are in default under the mortgage loan secured by the Las Vegas property, which, as of December 31, 2008, was made up of a $280 million senior secured first lien loan and a $195 million senior secured second lien loan. As a result of the application of certain escrowed proceeds to the payment of principal on the first lien loan, as more fully described below, there is $454 million outstanding under the mortgage loan as of March 27, 2009. The mortgage loan matured on January 6, 2009.

 

As a result of a prior breach of certain maintenance covenants governing the mortgage loan, on January 5, 2009, the second lien lenders under the mortgage loan had delivered a written demand for repayment of all of the obligations owed to them under the loan, including the second lien principal amount of $195 million.

 

On January 6, 2009, following the Las Vegas subsidiaries’ failure to repay the mortgage loan at maturity, the first lien lenders delivered their demand for repayment of all of the obligations owed to them under the loan, including the first lien principal amount of $280 million. On January 30, 2009, the first lien lenders seized the cash collateral reserve accounts established under the mortgage loan from which the Las Vegas subsidiaries had been drawing working capital funds to meet ordinary expenses, including operating the Las Vegas property, and applied $21 million of that amount to the outstanding principal amount of the first lien loan thereby leaving a minimal balance in the reserve accounts. In addition, the first lien lenders have directed all payments from the existing tenants on the Las Vegas property to be delivered directly to the lenders. Each month the Las Vegas subsidiaries may make a request of the lenders to access the cash generated by the tenants that the Las Vegas subsidiaries deem necessary to meet the operating expenses related to the Las Vegas property. The lenders have sole discretion to approve or reject any such request. Because the Las Vegas subsidiaries have limited cash available, if the lenders fail to honor the draw requests in full or in part or delay the processing, the Las Vegas subsidiaries will not be able to satisfy their obligations and pay for necessary expenses unless the Company is able to fund shortfalls from other sources. The Company has limited cash available with which to provide any such funding. Thus, the Las Vegas subsidiaries may not be able to meet their obligations as they come due.

 

Neither the Company nor the Las Vegas subsidiaries are able to repay the obligations outstanding under the mortgage loan.

 

As a result of delivery of the demands for repayment and the loan being past due, the first lien lenders may at any time exercise their remedies under the amended and restated credit agreements governing the mortgage loan, which may include foreclosing on the Las Vegas property.

 

While the Las Vegas subsidiaries have engaged in preliminary discussions with the first lien lenders and the second lien lenders regarding potential solutions to the existing loan defaults, no agreement has yet been reached. To the extent that no consensual arrangement is reached and the lenders pursue their remedies, the Las Vegas subsidiaries may explore possible legal options in connection with trying to maintain their ownership of the Las Vegas property, including bankruptcy or similar filings. Whether or to what extent such action may be effective or viable is unclear.

 

The loss of the Las Vegas property, which is substantially our entire business, would have a material adverse effect on our business, financial condition, results of operations, prospects and ability to continue as a going concern.

 

The Las Vegas property, which is substantially our entire business, is particularly sensitive to reductions in discretionary consumer spending as a result of the financial crisis and global recession.

 

The financial crisis and global recession has resulted in a significant decline in the amount of tourism and discretionary consumer spending in Las Vegas. The tenants on the Las Vegas property are primarily retailers and, as such, are heavily reliant on tourism and discretionary consumer spending in Las Vegas. The Las Vegas property’s commercial leasing activities could be adversely affected because of the failure to maintain high tenant occupancy rates amid these market conditions. In addition, Las Vegas may experience a prolonged decline in the development of new hotels and other entertainment venues, which could adversely affect any potential redevelopment of the Las Vegas property.

 

10

The financial crisis and global recession has adversely affected and may continue to adversely affect our ability to repay, refinance or extend the past due $475 million mortgage loan and fund our short-term liquidity needs.

 

Our current cash flow and cash on hand is not sufficient to repay the past due $475 mortgage loan secured by the Las Vegas property or otherwise fund our short-term liquidity needs, including the payment of executive salaries of approximately $5.0 million during 2009. The ongoing financial crisis and global recession have adversely affected and may continue to adversely affect our ability to repay, refinance or extend the past due $475 million mortgage loan and fund our short-term liquidity needs.

 

Even if we are able to raise additional financing, we might not be able to obtain it on terms that are not unduly expensive or burdensome to us or disadvantageous to our existing stockholders.

 

Even if we are able to raise additional cash or obtain financing through the public or private sale of debt and/or equity securities, funding from joint-venture or strategic partners, debt financing or short-term loans, the terms of such transactions may be unduly expensive or burdensome to us or disadvantageous to our existing stockholders. For example, we may be forced to sell or issue our securities at significant discounts to market, or pursuant to onerous terms and conditions, including the issuance of preferred stock with disadvantageous dividend, voting or veto, board membership, conversion, redemption or liquidation provisions; the issuance of convertible debt with disadvantageous interest rates and conversion features; the issuance of warrants with cashless exercise features; the issuance of securities with anti-dilution provisions; the issuance of high-yield securities and bank debt with restrictive covenants and security packages; and the grant of registration rights with significant penalties for the failure to quickly register. If we raise debt financing, we may be required to secure the financing with all of our business assets, which could be sold or retained by the creditor should we default in our payment obligations.

 

Our independent registered public accounting firm has rendered a report expressing substantial doubt as to our ability to continue as a going concern.

 

Our independent registered public accounting firm has issued an audit report dated March 30, 2009 in connection with the audit of the consolidated financial statements of FX Real Estate and Entertainment Inc. as of and for the period ending December 31, 2008 that includes an explanatory paragraph expressing substantial doubt as to our ability to continue as a going concern due to our need to secure additional capital in order to pay the past due $475 million mortgage loan and other obligations as they become due. If we are not able to obtain additional debt and/or equity financing, we may not be able to continue as a going concern and you could lose all of the value of our common stock.

 

The concentration of ownership of our capital stock with our affiliates will limit your ability to influence corporate matters.

 

Robert F.X. Sillerman, our Chairman and Chief Executive Officer, Paul C. Kanavos, our President, and Brett Torino, our Chairman-Las Vegas Division, beneficially own in the aggregate approximately 63.5% of our outstanding common stock, and our executive officers and directors together beneficially own approximately 69.5% of our outstanding common stock. Our executive officers and directors, including their respective affiliates, therefore have the ability to influence our management and affairs and the outcome of matters submitted to stockholders for approval, including the election and removal of directors, amendments to our charter, approval of any equity-based employee compensation plan and any stock splits or any merger, consolidation or sale of all or substantially all of our assets. As a result of this concentrated control, unaffiliated stockholders of us do not have the ability to meaningfully influence corporate matters and, as a result, we may take actions that our unaffiliated stockholders do not view as beneficial. As a result, the value and/or liquidity of our common stock could be adversely affected.

 

There are conflicts of interest in our relationship with Flag Luxury Properties and its affiliates, which could result in decisions that are not in the best interests of our stockholders.

 

There are conflicts of interest in our current and ongoing relationship with Flag Luxury Properties and its affiliates. These conflicts include:

 

 

11

 

Because of the leverage that Flag Luxury Properties has in negotiating with us, these agreements may not be as beneficial to our stockholders as they would be if they were negotiated at arms’ length and we cannot guarantee that future arrangements with Flag Luxury Properties will be negotiated at arms’ length. For additional information concerning these agreements, please see generally the Notes to our Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.

 

We have potential business conflicts with certain of our executive officers because of their relationships with CKX and/or Flag Luxury Properties and their ability to pursue business activities for themselves and others that may compete with our business activities.

 

Potential business conflicts exist between us and certain of our executive officers, including Messrs. Sillerman and Kanavos, in a number of areas relating to our past and ongoing relationships, including:

 

 

We may not be able to resolve any potential conflicts with these executive officers. Even if we do so, however, because of their ownership interest in us, these executive officers will have leverage with negotiations over their performance that may result in a resolution of such conflicts that may be less favorable to us than if we were dealing with another third party.

 

We have entered into a number of related party transactions with CKX and Flag Luxury Properties and their affiliates on terms that some stockholders may consider not to be in their best interests.

 

We are a party to a shared services agreement with CKX, pursuant to which employees for each company, including management level employees, provide services for the other company. In addition, certain of our employees, including Mr. Kanavos, our President, and Mitchell J. Nelson, our General Counsel, are permitted to devote a portion of their time providing services for or on behalf of Flag Luxury Properties.

 

CKX, as a company subject to the rules of The NASDAQ Global Market, is subject to certain rules regarding “affiliated” transactions, including the requirement that all affiliated transactions be approved by a majority of the independent members of the board of directors. Based on Mr. Sillerman’s ownership interests in Flag Luxury Properties, the June 2007 transactions between CKX, Flag Luxury Properties and our company were deemed “affiliated” and therefore subject to the procedural requirements related to such transactions. Because we were a private company at the time we entered into these transactions, and Flag Luxury Properties remains a private company, and not subject to affiliated and related party transaction restrictions, neither Flag Luxury Properties nor our company was represented by a special committee or any independent financial advisor in the negotiation and review of the transactions with CKX. As such, the fairness of the transactions between CKX, Flag Luxury Properties and FX Luxury Realty, from the point of view of Flag Luxury Properties and our company, was determined by management of Flag Luxury Properties, including Messrs. Sillerman and Kanavos, each of whom has numerous conflicting interests relating to their cross-ownership and managerial roles in the various entities. Based on these conflicting interests, some stockholders may not consider these transactions to have been in the best interest of our stockholders.

 

12

We may lose the services of our key personnel, including certain senior executives, if we are not able to satisfy our payment obligations under their agreements.

 

Our performance is dependent on the continued efforts of our executive officers with whom we have employment agreements. Due to our current financial situation, there can be no guarantee that we will be able to continue to make required payments under the executive employment agreements, which amounts total $5.0 million for 2009. A failure to make a payment under an executive employment agreement when due could result in a Termination without Cause under such agreement, which could lead to the departure of the executive in question as well as the acceleration of the obligation to make significant additional payments to the executive in question. The loss of the services of any of our executive officers or other key employees could adversely affect our business.

 

Terrorism and the uncertainty of war, as well as other factors affecting discretionary consumer spending, may harm our future operating results.

 

The strength and profitability of our business will depend on consumer demand for hotel casino resorts in general. Changes in consumer preferences or discretionary consumer spending could harm our business. The terrorist attacks of September 11, 2001, and ongoing terrorist and war activities in the United States and elsewhere, had a negative impact on travel and leisure expenditures, including lodging, gaming and tourism. We cannot predict the extent to which terrorist and anti-terrorist activities may affect us, directly or indirectly, in the future. An extended period of reduced discretionary spending and/or disruptions or declines in airline travel and business conventions could significantly harm our operations. In particular, because we expect that our business will rely heavily upon customers traveling by air to Las Vegas, both domestically and internationally, factors resulting in a decreased propensity to travel by air, like the terrorist attacks of September 11, 2001, could have a negative impact on our future operations.

 

In addition to fears of war and future acts of terrorism, other factors affecting discretionary consumer spending, including general economic conditions, disposable consumer income, fears of recession and consumer confidence in the economy, may negatively impact our business. Negative changes in factors affecting discretionary spending could reduce customer demand for the products and services we will offer, thus imposing practical limits on pricing and harming our operations.

 

We are subject to environmental regulation, which creates uncertainty regarding future environmental expenditures and liabilities.

 

We may be required to incur significant costs and expend significant funds to comply with environmental laws and regulations, including those relating to discharges to air, water and land, the handling and disposal of solid and hazardous waste, exposure to asbestos or other hazardous materials, and the cleanup of properties affected by hazardous substances. Violation of these laws and regulations could lead to substantial fines and penalties. Under these and other environmental requirements, we, as an owner and/or operator of property, may be required to investigate and clean up hazardous or toxic substances or chemical releases at that property. As an owner or operator, we could also potentially be held responsible to a governmental entity or third parties for property damage, personal injury and investigation and cleanup costs incurred by them in connection with any contamination.

 

These laws and regulations often impose cleanup responsibility and liability whether or not the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances. The liability under environmental laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of the responsibility. The costs of investigation, remediation or removal of contaminants may be substantial, and the presence of contaminants, or the failure to remediate a property properly, may impair our ability to rent or otherwise use our property.

 

We continue to need to enhance our internal controls and financial reporting systems to comply with the Sarbanes-Oxley Act of 2002.

 

We are subject to reporting and other obligations under the Securities and Exchange Act of 1934, as amended, and Section 404 of the Sarbanes-Oxley Act of 2002. As of December 31, 2008, Section 404 requires us to assess and attest to the effectiveness of our internal control over financial reporting. As of December 31, 2009, Section 404 requires our independent registered public accounting firm to opine as to the effectiveness of our internal controls over financial reporting.

 

13

Risks Related to Our Common Stock

 

Substantial amounts of our common stock and other equity securities could be sold in the near future, which could depress our stock price.

 

We cannot predict the effect, if any, that market sales of shares of common stock or the availability of shares of common stock for sale will have on the market price of our common stock prevailing from time to time.

 

All of the outstanding shares of common stock belonging to officers, directors and other affiliates are currently “restricted securities” under the Securities Act. Approximately 41 million shares of these restricted securities are eligible for sale in the public market at prescribed times pursuant to Rule 144 under the Securities Act, or otherwise. Sales of a significant number of these shares of common stock in the public market or the appearance of such sales could reduce the market price of our common stock and could negatively impact our ability to sell equity in the market to fund our business plans. In addition, we expect that we will be required to issue a large amount of additional common stock and other equity securities as part of our efforts to raise capital to fund our development plans. The issuance of these securities could negatively effect the value of our stock.

 

We do not anticipate paying cash dividends on our common stock in the foreseeable future, and the lack of dividends may have a negative effect on our stock price.

 

We currently intend to retain any future earnings to support operations and to finance expansion and therefore do not anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, the terms of our credit facilities prohibit, and the terms of any future debt agreements we may enter into are likely to prohibit or restrict, the payment of cash dividends on our common stock.

 

Our issuance of additional shares of our common stock, or options or warrants to purchase those shares, would dilute proportionate ownership and voting rights.

 

Our issuance of shares of preferred stock, or options or warrants to purchase those shares, could negatively impact the value of a stockholder’s shares of common stock as the result of preferential voting rights or veto powers, dividend rights, disproportionate rights to appoint directors to our board, conversion rights, redemption rights and liquidation provisions granted to preferred stockholders, including the grant of rights that could discourage or prevent the distribution of dividends to stockholders, or prevent the sale of our assets or a potential takeover of our company that might otherwise result in stockholders receiving a distribution or a premium over the market price for their common stock.

 

We are entitled, under our certificate of incorporation to issue up to 300 million common and 75 million “blank check” preferred shares. After taking into consideration our outstanding common and preferred shares as of March 27, 2009, we will be entitled to issue up to 248,007,583 additional common shares and 74,999,999 preferred shares. Our board may generally issue those common and preferred shares, or options or warrants to purchase those shares, without further approval by our stockholders based upon such factors as our board of directors may deem relevant at that time. Any preferred shares we may issue shall have such rights, preferences, privileges and restrictions as may be designated from time-to-time by our board, including preferential dividend rights, voting rights, conversion rights, redemption rights and liquidation provisions.

 

We cannot give you any assurance that we will not issue additional common or preferred shares, or options or warrants to purchase those shares, under circumstances we may deem appropriate at the time.

 

We may not be able to maintain our NASDAQ Global Market listing.

 

Our common stock is listed on The NASDAQ Global Market. Companies listed on The NASDAQ Global Market are required, among other things, to maintain a minimum closing bid price of $1.00 per share. If the closing bid price of a security remains below the $1.00 minimum closing bid price requirement for 30 consecutive business days, companies have a period of 180 calendar days to demonstrate compliance by maintaining a closing bid price of $1.00 or more for 10 consecutive business days. In light of the economic downturn’s broad effects on the stock prices of its listed companies, NASDAQ announced in December 2008 the suspension of the rules requiring a minimum $1.00 closing bid price per share and minimum market value of publicly held shares. That suspension is currently schedule to expire on July 20, 2009.

 

Since October 2, 2008, our closing price on The NASDAQ Global Market has been less than $1.00 per share. If the closing bid price of our common stock remains below $1.00 per share for a period of 30 consecutive business days beginning after July 20, 2009 and we are unable to regain compliance within the following 180 calendar days, or we are unable to continue to meet any of

 

14

NASDAQ’s listing maintenance standards for any other reason, our common stock could be delisted from The NASDAQ Global Market. If our common stock is delisted, we would be forced to list our common stock on the OTC Bulletin Board or some other quotation medium. Selling our common stock would be more difficult because smaller quantities of shares would likely be bought and sold and transactions could be delayed. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of our common stock. If this happens, we will have greater difficulty accessing the capital markets to raise any additional necessary capital.

 

Certain provisions of Delaware law and our charter documents could discourage a takeover that stockholders may consider favorable.

 

Certain provisions of Delaware law and our certificate of incorporation and by-laws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

 

As a Delaware corporation, by an express provision in our certificate of incorporation, we have elected to “opt out” of the restrictions under Section 203 of the Delaware General Corporation Law regulating corporate takeovers. In general, Section 203 prohibits a publicly-held Delaware corporation from engaging, under certain circumstances, in a business combination with an interested stockholder for a period of three years following the date the person became an interested stockholder.

 

15

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

ITEM 2. PROPERTIES

 

The following table sets forth certain information with respect to the Company’s principal locations as of December 31, 2008. These properties were leased or owned by the Company for use in its operations. We believe that our facilities will be suitable for the purposes for which they are employed, are adequately maintained and will be adequate for current requirements and projected growth.

 

 

 

ITEM 3. LEGAL PROCEEDINGS

 

The Company is involved in litigation on a number of matters and is subject to certain claims which arose in the normal course of business, none of which, in the opinion of management, is expected to have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

 

On February 3, 2009, the Las Vegas subsidiaries completed the previously announced settlement with Hard Carbon, LLC, an affiliate of Marriott International, Inc. for claims relating to the construction of a parking garage and reimbursement for road widening work performed by Marriott on and adjacent to the Company’s property off of Harmon Avenue in Las Vegas. The Las Vegas Subsidiaries paid $4.3 million in full settlement of the claims, which amount was funded from a reserve fund that had been established in that amount and for this purpose with the lenders under the mortgage loan on the Company’s Las Vegas property.

 

We are subject to certain claims and litigation in the ordinary course of business. It is the opinion of management that the outcome of such matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of security holders during the three months ended December 31, 2008

 

16

 

 

Market Information

 

Since January 10, 2008, our common stock, par value $.01 per share (the “Common Stock”) has been listed and traded on The NASDAQ Global Market (R) under the ticker symbol “FXRE.” Prior to January 10, 2008 there was no established public trading market for our Common Stock. The following table sets forth the high and low closing sales prices for our Common Stock for the quarterly periods for the year ended December 31, 2008.

 

 

From January 1, 2009 through March 27, 2009, the high closing sales price for our Common Stock was $0.48, the low closing sales price was $0.05 and the last closing sales price on March 27, 2009 was $0.27. As of March 27, 2009, there were 596 holders of record of our Common Stock.

 

Dividend Policy

 

We have not paid and have no present intentions to pay cash dividends on our Common Stock. In addition, the terms of mortgage loan, as described elsewhere herein, and the terms of any future debt agreements we may enter into are likely to prohibit or restrict, the payment of cash dividends on our Common Stock.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The table below shows information with respect to our equity compensation plans and individual compensation arrangements as of December 31, 2008.

 

 

For a description of our 2007 Executive Equity Incentive Plan and 2007 Long-Term Incentive Compensation Plan, see Note 13 to our audited Consolidated Financial Statements included in this Annual Report on Form 10-K.

 

17

Performance Graph

 

The graph below compares the cumulative 1-year total return to holders of FX Real Estate & Entertainment Inc.’s common stock with the cumulative total returns of the NASDAQ Composite index and the DJ Wilshire Real Estate Holding & Development index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from January 10, 2008 to December 31, 2008.

 

COMPARISON OF 1 YEAR CUMULATIVE TOTAL RETURN*

Among FX Real Estate & Entertainment Inc., The NASDAQ Composite Index

And The DJ Wilshire Real Estate Holding & Development Index

 

 

*$100 invested on 1/10/08 in stock or 12/31/07 in index, including reinvestment of dividends.

Fiscal year ending December 31.

 

Copyright ^© 2009 Dow Jones & Co. All rights reserved.

 

 

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

18

 

Prior to May 10, 2007, FXRE was a company with no operations. As a result Metroflag is considered to be the predecessor company (the “Predecessor”). To assist in the understanding of the results of operations and balance sheet data of the Company, we have presented the historical results of the Predecessor. The selected consolidated financial data was derived from the audited consolidated financial statements of the Company as of and for the year ended December 31, 2008. The data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes thereto included elsewhere herein.

 

The selected historical financial data for each of the three years ended December 31, 2006 and as of December 31, 2006, 2005 and 2004 is represented by that of Metroflag (as Predecessor) which have been derived from the Metroflag’s audited Combined Financial Statements and Notes thereto, as of December 31, 2006, 2005 and 2004, and for each of the three years ended December 31, 2006. The selected statement of operations data for the period January 1, 2007—May 10, 2007 represents the pre-acquisition operating results of Metroflag (as Predecessor) in 2007.

 

Our selected statement of operations data for the period from May 11, 2007 through December 31, 2007 includes the results of Metroflag accounted for under the equity method through July 5, 2007 and consolidated thereafter. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for discussion of the conditions that affect the comparability of the information included in the selected historical financial data.

 

 

 

 

19

 

 

FORWARD LOOKING STATEMENTS

 

In addition to historical information, this Annual Report on Form 10-K (this “Annual Report”) contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. All statements in this Annual Report regarding our future strategy, future operations, projected financial position, estimated future revenue, projected costs, future prospects, and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Important risks that might cause our actual results to differ materially from the results contemplated by the forward-looking statements are contained in “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report and in our subsequent filings with the Securities and Exchange Commission (“SEC”). Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this Annual Report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our stockholders.

 

20

 

The following management’s discussion and analysis of financial condition and results of operations of the Company (and its predecessor) should be read in conjunction with the historical audited consolidated financial statements and footnotes of Metroflag and the Company’s historical audited consolidated financial statements and notes thereto included elsewhere in this Annual Report. Our future results of operations may change materially from the historical results of operations reflected in our historical audited consolidated financial statements.

 

FX Real Estate and Entertainment Inc. was organized as a Delaware corporation in preparation for the CKX Distribution. On September 26, 2007, holders of common membership interests in FX Luxury Realty, LLC, a Delaware limited liability company, exchanged all of their common membership interests for shares of our common stock. Following this reorganization, FX Real Estate and Entertainment owns 100% of the outstanding common membership interests of FX Luxury Realty. We hold our assets and conduct our operations through our subsidiary FX Luxury Realty and its subsidiaries. All references to FX Real Estate and Entertainment for the periods prior to the date of the reorganization shall refer to FX Luxury Realty and its consolidated subsidiaries. For all periods as of and subsequent to the date of the reorganization, all references to FX Real Estate and Entertainment shall refer to FX Real Estate and Entertainment and its consolidated subsidiaries, including FX Luxury Realty.

 

FX Luxury Realty was formed on April 13, 2007. On May 11, 2007, Flag Luxury Properties, a privately owned real estate development company, contributed to FX Luxury Realty its 50% ownership interest in the Metroflag entities in exchange for all of the membership interests of FX Luxury Realty. On June 1, 2007, FX Luxury Realty acquired 100% of the outstanding membership interests of RH1, LLC and Flag Luxury Riv, LLC, which together own shares of common stock of Riviera Holdings Corporation, a publicly traded company which owns and operates the Riviera Hotel and Casino in Las Vegas, Nevada, and the Blackhawk Casino in Blackhawk, Colorado. On June 1, 2007, CKX contributed $100 million in cash to FX Luxury Realty in exchange for a 50% common membership interest therein. As a result of CKX’s contribution, each of CKX and Flag Luxury Properties owned 50% of the common membership interests in FX Luxury Realty, while Flag Luxury Properties retained a $45 million preferred priority distribution in FX Luxury Realty.

 

On May 30, 2007, FX Luxury Realty entered into an agreement to acquire the remaining 50% ownership interest in the Metroflag entities from an unaffiliated third party for total consideration of $180 million in cash, $172.5 million of which was paid in cash at closing and $7.5 million of which was an advance payment made in May 2007 (funded by a $7.5 million loan from Flag Luxury Properties). The cash payment at closing on July 6, 2007 was funded from $92.5 million cash on hand and $105.0 million in additional borrowings under the Mortgage Loan, which amount was reduced by $21.3 million deposited into a restricted cash account to cover debt service commitments and $3.7 million in debt issuance costs. The $7.5 million loan from Flag Luxury Properties was repaid on July 9, 2007. As a result of this purchase, FX Luxury Realty owns 100% of Metroflag, and therefore has consolidated the operations of Metroflag since July 6, 2007.

 

The following management’s discussion and analysis of financial condition and results of operations is based on the historical financial condition and results of operations of Metroflag, as predecessor, rather than those of FX Luxury Realty, for the period prior to May 11, 2007.

 

The historical financial statements of Metroflag and related management’s discussion and analysis of financial condition and results of operations reflect Metroflag’s ownership of 100% of the Las Vegas property. Therefore, these financial statements are not directly comparable to FX Luxury Realty’s financial statements prior to July 6, 2007 which account for FX Luxury Realty’s 50% ownership of Metroflag under the equity method of accounting. As a result of the acquisition of the remaining 50% interest in Metroflag on July 6, 2007, we have made changes to the historical capital and financial structure of our company, which are noted below under “— Liquidity and Capital Resources.”

 

Management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the historical financial statements and notes thereto for Metroflag and “Selected Historical Financial Information” included elsewhere herein. However, this Management’s Discussion and Analysis of Financial Condition and Results of Operations and such historical financial statements and information should not be relied upon by you to evaluate our business and financial condition going forward because they are not necessarily representative of our planned business going forward or indicative of our future operating and financial results. For example, as described below and in the historical financial statements, our predecessor Metroflag derived revenue primarily from commercial leasing activities on the properties comprising the Las Vegas property. As a result of the 2008 disruption in the capital markets and the 2008 economic downturn in the United States, and Las Vegas in particular, in the third quarter of 2008, we determined not to proceed with our originally proposed plan for the redevelopment plan of the Las Vegas property and intended to consider alternative plans with respect to the development of the property. Since then, however, the Las Vegas subsidiaries have defaulted on the $475 million mortgage loan on the Las Vegas property. As a result, we intend to continue the property’s current commercial leasing activities, subject to our continued ability to conduct such activities unless prevented by the

 

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lenders as a result of the mortgage loan default. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

 

FX Real Estate and Entertainment Operating Results

 

Our results for the year ended December 31, 2008 reflected revenue of $6.0 million and operating expenses of $364.6 million. These operating expenses include the license fees for the year ended December 31, 2008 of $10.0 million, representing the guaranteed annual minimum royalty payments under the license agreements with Elvis Presley Enterprises and Muhammad Ali Enterprises, which were not paid because of the termination of the license agreements on March 9, 2009. The Company incurred corporate overhead expenses of $9.0 million for the year ended December 31, 2008. Included in corporate overhead expenses for the year ended December 31, 2008 are $2.8 million in non-cash compensation and $1.9 million in shared services charges and professional fees, including legal and accounting costs. Our operating expenses for the year ended December 31, 2008 also included an impairment charge on land of $325.1 million (see below) and a charge of $10.7 million related to the write-off of capitalized development costs as a result of the Company’s determination in the third quarter of 2008 not to proceed with our originally proposed plan for the redevelopment plan of the Las Vegas property as a result of the disruption in the capital markets and the economic downturn in the United States in general and Las Vegas in particular. We intend to continue the property’s current commercial leasing activities, subject to our continued ability to conduct such activities unless prevented by the lenders as a result of the mortgage loan default.

 

As a result of the current global recession and financial crisis and based upon a valuation report obtained for the Las Vegas property from an independent appraisal firm combined with certain assumptions made by management, the Company recorded an impairment charge to land of $325.1 million. This charge reduced the carrying value of the Las Vegas property to its estimated fair value of $218.8 million which management believes to be reasonable. The current global financial crisis has had a particularly negative impact on the Las Vegas real estate market, including a significant reduction in the number of visitors and per visitor spending, the abandonment of, and/or loan defaults related to, several major new hotel and casino development projects as well as publicly expressed concerns regarding the financial viability of several of the largest hotel and casino operators in the Las Vegas market. These factors combined with the lack of availability of financing for development has resulted in a near cessation of land sales on the Las Vegas strip. Though the Company believes the $218.8 million carrying value ascribed to the property is fair and reasonable based on current market conditions, the lack of recent comparable sales and the rapidly changing economic environment means that no assurance can be given that the value ascribed by the Company will prove to be accurate or even within a reasonable range of the actual sales price that would be received in the event the property is sold as a result of the loan default. A sale of the land by the Company or upon foreclosure by the lenders at or near the adjusted carrying value of $218.8 million would be insufficient to fully repay the outstanding mortgage loan and therefore would result in the Company receiving no net cash proceeds.

 

As of December 31, 2008, the Company owned 1,410,363 shares of common stock of Riviera Holdings Corporation (the “Riv Shares”), and 161,758 shares were held in a trust for the benefit of the Company. For the year ended December 31, 2008, the Company recorded to other expense other than temporary impairments of $41.7 million, related to the Riv Shares due to the decline in the stock price of Riviera Holdings Corporation. The Company has determined that the losses are other than temporary due to the Company’s evaluation of the underlying reasons for the decline in stock price, including weakening conditions in the Las Vegas market where Riviera Holdings Corporation operates, and the Company’s uncertain ability to hold the Riv Shares for a reasonable amount of time sufficient for an expected recovery of fair value. Prior to the impairment recorded as of June 30, 2008, the Company did not consider the losses to be other than temporary and reported unrealized gains and losses in other comprehensive income as a separate component of stockholders’ equity. As of March 27, 2009, the Company had sold all but 115,558 shares of the RIV Shares.

 

For the year ended December 31, 2008, we had net interest expense of $48.7 million.

 

For the year ended December 31, 2008, the Company did not record a provision for income taxes because the Company has incurred taxable losses since its formation in 2007. As it has no history of generating taxable income, the Company reduces any deferred tax assets by a full valuation allowance.

 

Our results for the period from inception (May 11, 2007) to December 31, 2007 reflects our accounting for our investment in Metroflag as an equity method investment from May 11, 2007 through July 5, 2007 because we did not maintain control, and on a consolidated basis from July 6, 2007 through December 31, 2007 due to the acquisition of the remaining 50% of Metroflag that we did not already own on July 6, 2007.

 

On September 26, 2007, we exercised the Riviera option, acquiring 573,775 shares in Riviera for $13.2 million. We recorded a $6.4 million loss on the exercise, reflecting a decline in the price of Riviera’s common stock from the date the option was acquired. The loss was recorded in other expense in the consolidated statements of operations.

 

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Our results for the period from May 11, 2007 to December 31, 2007 reflected $3.1 million in revenue and $30.1 million in operating expenses. Included in operating expenses is $10.0 million in license fees, representing the 2007 guaranteed annual minimum royalty payments under the license agreements with Elvis Presley Enterprises and Muhammad Ali Enterprises. Our operating expenses in 2007 include an impairment charge related to the write-off of approximately $12.7 million of capitalized development costs as a result of a change in development plans for the Las Vegas property.

 

For the period from May 11, 2007 to December 31, 2007, we had $30.7 million in net interest expense, including $30.5 million for Metroflag which was included in our consolidated results commencing July 6, 2007.

 

We are subject to federal, state and city income taxation. Our operations predominantly occur in Nevada, and Nevada does not impose a state income tax. As such, we should incur minimal state income taxes.

 

We have calculated our income tax liability based upon a short taxable year as we were initially formed on June 15, 2007. While we are considered the successor of FX Luxury Realty and the Metroflag Entities for purposes of U.S. generally accepted accounting principles (“GAAP”), it should not be considered as a successor for purposes of U.S. income tax. Thus, we should not have inherited any tax obligations or positions from these other entities.

 

We expect to generate net operating losses in the foreseeable future and, therefore, have established a valuation allowance against the deferred tax asset.

 

Metroflag Operating Results

 

The Las Vegas property is occupied by a motel and several retail and commercial tenants with a mix of short and long-term leases. The historical business of Metroflag was to acquire the parcels and to engage in commercial leasing activities. All revenues are derived from these commercial leasing activities and include minimum rentals, percentage rentals and common area maintenance on the retail space.

 

In 2007, we adopted formal redevelopment plans covering certain of the parcels comprising the Las Vegas property which resulted in the operations related to these properties being reclassified as incidental operations in accordance with SFAS No. 67. In late September 2008, the Company determined not to proceed with its originally proposed plan for the redevelopment of the Las Vegas property and to continue the site’s current commercial leasing activities until such time as an alternative development plan, if any, is adopted. As a result, effective October 1, 2008, the Company no longer classifies these operations of Metroflag as incidental operations. Therefore, all operations beginning in the fourth quarter of 2008 are included as part of income (loss) from operations.

 

Given the significance of the Metroflag’s operations to our current and future results of operations and financial condition, we believe that an understanding of Metroflag’s reported results, trends and performance is enhanced by presenting its results of operations on a stand-alone basis for the years ended December 31, 2008 and 2007. This stand-alone financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place as of January 1, 2007.

 

Metroflag Results for the Year Ended December 31, 2008 and 2007

 

 

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Revenue

 

Revenue decreased $0.1 million, or 1.4%, in 2008 as compared to 2007 due primarily to the classification of the operations of an additional property as incidental operations for the first nine months of 2008 and a decrease in minimum rent due to various rent concessions and a decrease in tenants, offset by Metroflag reporting all operations as part of income (loss) from operations for the fourth quarter of 2008.

 

Operating Expenses

 

Operating expenses increased $4.0 million, or 27.2% in 2008 primarily due to Metroflag reporting all operations as part of income (loss) from operations for the fourth quarter of 2008 and increased payroll costs, including an allocation of corporate-funded costs of $0.5 million, offset by an impairment charge of $10.7 million related to the write-off of capitalized development costs as a result of the Company’s determination not to continue the redevelopment plan for the Las Vegas property as originally proposed in 2008, down from a $12.7 million write-off of capitalized development costs in 2007.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense increased $0.2 million, or 71.6%, in 2008 as compared to 2007 due primarily to Metroflag reporting all operations as part of income (loss) from operations for the fourth quarter of 2008, offset by a decrease due to the revised longer useful lives used for buildings and improvements for the fourth quarter of 2008.

 

Impairment of Land

 

As noted above, the Company recorded an impairment charge to land of $325.1 million for the year ended December 31, 2008. This charge reduces the carrying value of the Company’s total investment in real estate to $218.8 million. There is no tax benefit recorded associated with this charge because the Company has generated losses since its formation in 2007 and has no history of generating taxable income.

 

Interest Income/Expense

 

Interest expense, net, decreased $4.1 million, or 8.0%, in 2008 as compared to 2007 due to a decrease in amortization related to deferred financing costs and lower interest rates in the 2008 period.

 

Loss from Incidental Operations

 

Loss from incidental operations decreased $7.3 million, or 36.1%, in 2008 as compared to 2007 primarily due to the Company reporting all operations as part of income (loss) from operations for the fourth quarter of 2008, offset in part by an additional property being classified as incidental operations for the first nine months of 2008 as compared to 2007.

 

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Metroflag Results for the Years Ended December 31, 2007 and 2006

 

 

Revenue

 

Revenue increased $0.5 million, or 9.1%, to $6.1 million in 2007 as compared to 2006 due to a change in lease term necessary to straight-line rental revenue. Without this, there would have been a $0.4 million decrease in revenue in 2007 as compared to 2006 due to the classification of additional operations as incidental operations.

 

Operating Expenses

 

Overall operating expenses increased $13.3 million in 2007 from 2006 due to an impairment charge related to the write-off of approximately $12.7 million of capitalized development costs as a result of a change in development plans. Other operating expenses, primarily maintenance, real estate taxes and general and administrative costs increased $0.6 million, or 45.7%, to $1.9 million in 2007 as compared to 2006 primarily due to an increase in general and administrative expenses related to the $0.8 million settlement of the Robinson Group LLC litigation and legal fees associated with the litigation.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense declined by $0.1 million, or 16.5%, to $0.3 million in 2007 as compared to 2006.

 

Interest Income/Expense

 

Interest expense, net increased $25.5 million, or 96.9%, to $51.7 million in 2007 as compared to 2006 due to additional mortgage loans used to acquire the remaining 50% ownership interest in the Metroflag entities and the full year impact of these incremental borrowings as well as the amortization of the incremental deferred financing costs.

 

Loss from Early Retirement of Debt

 

Metroflag expensed $3.5 million in costs associated with the retirement of prior debt financing in 2007.

 

Loss from Incidental Operations

 

Loss from incidental operations increased $2.4 million, or 13.8%, to $20.2 million in 2007 as compared to 2006 primarily due to the classification of additional operations as incidental operations.

 

Liquidity and Capital Resources

 

Introduction  — The historical financial statements and financial information of our predecessor, the Metroflag entities, included in this annual report are not necessarily representative of our planned business going forward or indicative of our future operating and financial results.

 

As a result of the 2008 disruption in the capital markets and the 2008 economic downturn in the United States, and Las Vegas in particular, in the third quarter of 2008, we determined not to proceed with our originally proposed plan for the redevelopment plan of the Las Vegas property and intended to consider alternative plans with respect to the development of the property. Since then, however, as described below, the Las Vegas subsidiaries have defaulted on the $475 million mortgage loan on the Las Vegas property. As a result, we intend to continue the property’s current commercial leasing activities, subject to our continued ability to conduct such

 

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activities unless prevented by the lenders as a result of the mortgage loan default.

 

Our current cash flow and cash on hand is not sufficient to repay the past due amount on the mortgage loan or otherwise fund our short-term liquidity needs, including the payment of executive salaries of approximately $5.0 million during 2009. The financial crisis and global rescission has and may continue to adversely affect our ability to repay, refinance or extend the past due amount under the mortgage loan and fund our short-term liquidity needs. If we are unable to secure additional financing, we may not be able to retain our senior management or satisfy terms of existing employment agreements. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

 

As of December 31, 2008, the Las Vegas subsidiaries were in default under the $475 million mortgage loan secured by the Las Vegas property by reason of being out of compliance with the loan-to-value value ratio covenant set forth in the governing amended and restated credit agreements. On November 25, 2008, the Las Vegas subsidiaries, which are the borrowers under the mortgage loan, obtained from their lenders a temporary waiver of noncompliance with the loan-to-value ratio covenants. The waiver was effective through December 19, 2008 (the “Waiver Period”). The Las Vegas subsidiaries failed to regain compliance with the aforementioned covenants prior to the expiration of the Waiver Period, resulting in a default under the Mortgage Loan. On January 5, 2009, the second lien lenders under the mortgage loan delivered a written demand for repayment of all of the obligations owed to them under the loan, including the second lien principal amount of $195 million. The second lien lenders’ written demand, which was delivered prior to the mortgage loan maturity date, cited the continuing covenant default referenced above.

 

The mortgage loan matured on January 6, 2009. On January 6, 2009, following the Las Vegas subsidiaries’ failure to repay the mortgage loan at maturity, the first lien lenders delivered their demand for repayment of all of the obligations owed to them under the loan, including the first lien principal amount of $280 million. Since the mortgage loan went into default, the interest rate being charged on the $280 million first lien loan is prime plus 0.5% plus a 2% default rate on the first tranche of $250 million and prime plus 3% plus the 2% default rate on the second tranche of $30 million. No interest is currently being paid on the $195 million second lien loan though interest being charged is prime plus 8% plus the 2% default rate.

 

On January 30, 2009, the first lien lenders seized the cash collateral reserve accounts established under the mortgage loan from which the Las Vegas subsidiaries had been drawing working capital funds to meet ordinary expenses, including operating the Las Vegas property, and have applied $21 million of that amount to the outstanding principal amount of the first lien loan, thereby reducing the amount outstanding under the mortgage loan to $454 million as of March 27, 2009. In addition, the first lien lenders have directed all payments from the existing tenants on the Las Vegas property to be delivered directly to the lenders. Each month the Las Vegas subsidiaries may make a request of the lenders to access that amount of the cash generated by the current rental operations that the Las Vegas subsidiaries deem necessary to meet the operating expenses related to the Las Vegas property. The lenders have sole discretion to approve or reject any such requests. Because the Las Vegas subsidiaries have limited cash available, if the lenders fail to honor the draw requests in full or in part or delay the processing the Las Vegas subsidiaries will not be able to satisfy their obligations and pay for necessary expenses unless the Company is able to fund shortfalls from other sources. As of March 27, 2009, the Company had approximately $3 million of cash available to fund its current operations, including ordinary payables as incurred, to meet its obligations as they come due and to provide any such funding for the Las Vegas subsidiaries.

 

Neither the Company nor the Las Vegas subsidiaries are able to repay the obligations outstanding under the mortgage loan.

 

As a result of delivery of the demands for repayment and the loan being past due, the first lien lenders may at any time exercise their remedies under the amended and restated credit agreements governing the mortgage loan, which may include foreclosing on the Las Vegas property. After the first lien lenders seized control of the cash collateral accounts, in accordance with the terms of the Intercreditor Agreement amongst the lenders, we ceased making payment of interest and other fees and expenses to the second lien lenders. As a result of the Intercreditor Agreement, the second lien lenders are not entitled to commence an action or pursue any remedy until 120 days after the first lien lenders have received from the second lien lenders notice of acceleration and then only under certain circumstances, as set forth in the such agreement. For example, if the first lien lenders pursue their remedies, then the second lien lenders’ remedies are stayed.

 

While the Las Vegas subsidiaries have engaged in preliminary discussions with the first lien lenders and the second lien lenders regarding potential solutions to the existing loan defaults, no agreement has yet been reached. To the extent that no consensual arrangement is reached and the lenders pursue their remedies, the Las Vegas subsidiaries may explore possible legal options in connection with trying to maintain their ownership of the Las Vegas property, including bankruptcy or similar filings. Whether or to what extent such action may be effective or viable is unclear.

 

The loss of the Las Vegas property, which is substantially our entire business, would have a material adverse effect on our business, financial condition, results of operations, prospects and ability to continue as a going concern.

 

Our independent registered public accounting firm’s report dated March 30, 2009 to our consolidated financial statements for the year ended December 31, 2008 includes an explanatory paragraph indicating substantial doubt as to our ability to continue as a going

 

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concern due to our need to secure additional capital in order to repay the past due amount under the mortgage loan and other obligations as they become due.

 

During 2008 and until the mortgage loan default, we were able fund our business activities and obligations as they became due with the following sources of capital:

 

Rights Offering — We generated aggregate gross proceeds of approximately $98.7 million from the rights offering and from sales under the related investment agreements, as amended, between us and Robert F.X. Sillerman, our Chairman and Chief Executive Officer, and The Huff Alternative Fund, L.P. and The Huff Alternative Parallel Fund, L.P. (collectively “Huff”). On March 13, 2008, we used $23 million of the proceeds from the rights offering to repay our $23 million Riv loan (as more fully described below). On April 1, 2008, we paid the guaranteed annual minimum royalty payments of $10 million (plus accrued interest of $0.35 million) for 2007 under the license agreements, as amended, with Elvis Presley Enterprises, Inc. and Muhammad Ali Enterprises, LLC, out of proceeds from the rights offering. On April 17, 2008, we used $7 million of the proceeds from the rights offering to repay in full and retire the Flag promissory note for $1.0 million principal amount and the CKX loan for $6.0 million principal amount (as more fully described below). On May 13, 2008, we used approximately $31 million of proceeds from sales under the investment agreements referenced above to pay Flag $30 million plus accrued return of approximately $1.0 million through the date of payment as partial satisfaction of its $45 million preferred priority distribution right (as described below). We used the remainder of the proceeds from the rights offering and the sales under the related investment agreements to satisfy certain capital requirements associated with extending the maturity of the Mortgage Loan on July 6, 2008.

 

Shier Stock Purchase — In connection with and pursuant to the terms of his employment agreement, on January 3, 2008, Barry Shier, our Chief Operating Officer, purchased 500,000 shares of common stock at a price of $5.14 per share, for aggregate consideration of $2.57 million.

 

Private Placement of Units — Between July 15, 2008 and July 18, 2008, we sold in a private placement to Paul C. Kanavos, our President, Barry A. Shier, our Chief Operating Officer, an affiliate of Brett Torino, our Chairman of the Las Vegas Division, Mitchell J. Nelson, our Executive Vice President and General Counsel, and an affiliate of Harvey Silverman, a director of our company, an aggregate of 2,264,289 units at a purchase price of $3.50 per unit. Each unit consisted of one share of our common stock, a warrant to purchase one share of our common stock at an exercise price of $4.50 per share and a warrant to purchase one share of our common stock at an exercise price of $5.50 per share. The warrants to purchase shares of our common stock for $4.50 per share are exercisable for a period of seven years, and the warrants to purchase shares of our common stock for $5.50 per share are exercisable for a period of ten years. The Company generated aggregate proceeds from the sale of the units of approximately $7.9 million

 

Riv Loan  — On June 1, 2007, FX Luxury Realty entered into a $23 million loan with an affiliate of Credit Suisse. Proceeds from this loan were used for: (i) the purchase of the membership interests in RH1, LLC for $12.5 million from an affiliate of Flag Luxury Properties; (ii) payment of $8.1 million of the purchase price for the membership interests in Flag Luxury Riv, LLC; and (iii) repayment of $1.2 million to Flag Luxury Properties for funds advanced for the purchase of the 50% economic interest in the option to purchase an additional 1,147,550 shares of Riviera Holdings Corporation at a price of $23 per share. The Riv loan was personally guaranteed by Robert F.X. Sillerman. The Riv loan, as amended on September 24, 2007, December 6, 2007 and February 27, 2008, was due and payable on March 15, 2008. We were also required to make mandatory pre-payments under the Riv loan out of certain proceeds from equity transactions as defined in the loan documents. The Riv loan bore interest at a rate of LIBOR plus 250 basis points. The interest rate on the Riv loan at March 13, 2008, the date of repayment, was 5.4%. Pursuant to the terms of the Riv loan, FX Luxury Realty was required to establish a segregated interest reserve account at closing. At March 13, 2008, the date of repayment, FX Luxury Realty had $0.1 million on deposit in this interest reserve fund which had been classified as restricted cash on the accompanying consolidated balance sheet as of December 31, 2007. As described above, on March 13, 2008, we repaid in full and retired the Riv loan with proceeds from the rights offering.

 

CKX Line of Credit  — On September 26, 2007, CKX entered into a Line of Credit Agreement with us pursuant to which CKX agreed to loan up to $7.0 million to us, $6.0 million of which was drawn down on September 26, 2007 and was evidenced by a promissory note dated September 26, 2007. We used $5.5 million of the proceeds of the loan, together with proceeds from additional borrowings, to exercise our option to acquire an additional 573,775 shares of Riviera Holdings Corporation’s common stock at a price of $23 per share. The loan bore interest at LIBOR plus 600 basis points and was payable upon the earlier of (i) two years and (ii) our consummation of an equity raise at or above $90.0 million. As described above, on April 17, 2008, we repaid this loan in full and retired the line of credit with proceeds from the rights offering.

 

On June 1, 2007, FX Luxury Realty signed a promissory note with Flag Luxury Properties for $1.0 million, representing amounts owed to Flag Luxury Properties related to funding for the purchase of the shares of Flag Luxury Riv. The note, included in related party debt on the accompanying audited consolidated balance sheet, accrued interest at 5% per annum through December 31, 2007 and 10% from January 1, 2008 through maturity. The Company discounted the note to fair value and recorded interest expense accordingly. As described above, on April 17, 2008, we repaid in full and retired this note with proceeds from the rights offering.

 

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Bear Stearns Margin Loan  — On September 26, 2007, we entered into a $7.7 million margin loan from Bear Stearns. We used the proceeds of the loan, together with the proceeds from the CKX line of credit, to exercise the option to acquire an additional 573,775 shares of Riviera Holdings Corporation’s common stock at a price of $23 per share. In total, 992,069 of the Company’s shares of Riviera Holdings Corporation common stock were pledged as collateral for the margin loan with Bear Stearns. The loan originally required maintenance margin equity of 40% of the shares’ market value and bears interest at LIBOR plus 100 basis points. As of December 31, 2008, the Company made payments of approximately $7.3 million to pay down the margin loan in conjunction with these loan requirements. On December 30, 2008, the effective interest rate on this loan was 2.33% and the amount outstanding, including accrued interest of $0.3 million, was $0.7 million. On November 3, 2008, the Company was advised that the margin requirement was raised to 50% and would be further raised to 75% on November 17, 2008, provided that if the price of a share of Riviera Holdings Corporation common stock fell below $3.00, the loan would need to be repaid. On November 11, 2008, the closing price of Riviera Holdings Corporation’s common stock fell below $3.00 per share, resulting in the requirement that the Company repay all amounts outstanding under the loan. From January 8, 2009 until January 23, 2009, we sold 268,136 Riviera common shares and repaid all amounts outstanding under the margin loan. As of March 27, 2009, we had sold all but 115,558 of our Riviera shares.

 

Preferred Priority Distribution  — In connection with CKX’s $100 million investment in FXLR on June 1, 2007, CKX agreed to permit Flag Luxury Properties to retain a $45 million preferred priority distribution right which amount will be payable from the proceeds of certain pre-defined capital transactions, including the payment of $30 million from the proceeds of the rights offering and sales under the related investment agreements described elsewhere herein. From and after November 1, 2007, Flag Luxury Properties is entitled to an annual return on the preferred priority distribution equal to the Citibank N.A. prime rate as reported from time to time in the Wall Street Journal. Robert F.X. Sillerman, our Chairman and Chief Executive Officer, Paul Kanavos, our President, and Brett Torino, Chairman of our Las Vegas Division, each own directly and indirectly an approximate 30.5% interest in Flag Luxury Properties and each will receive his pro rata share of the priority distribution. As described above, on May 13, 2008, we paid to Flag with proceeds from sales under the related investment agreements $30 million plus return of approximately $1.0 million through the date of payment as partial satisfaction of its $45 million preferred priority distribution right. As of December 31, 2008, $15 million of the preferred priority distribution right in FLXR remains to be paid to Flag. In connection with the private placement of units by the Company in July 2008, as described above, Flag agreed to defer its right to receive additional payments towards satisfaction of the preferred priority distribution right from the proceeds of this private placement of units.

 

Cash Flow for the Year Ended December 31, 2008

 

Operating Activities

 

Cash used in operating activities of $58.7 million for the year ended December 31, 2008 consisted primarily of the net loss for the period of $461.8 million, which includes the non-cash impairment of available-for-sale securities of $41.7 million, depreciation and amortization costs of $16.4 million, deferred financing cost amortization of $8.3 million, the impairment of capitalized development costs of $10.7 million, share-based payments of $3.2 million and the impairment charge to land of $325.1 million for the decline in value of the Las Vegas property. There were changes in working capital levels during the period of $1.9 million for the year ended December 31, 2008.

 

Investing Activities

 

Cash provided by investing activities of $36.1 million for the year ended December 31, 2008 primarily reflects $9.0 million of development costs capitalized during the period, offset by $45.4 million of restricted cash used.

 

Financing Activities

 

Cash provided by financing activities of $22.7 million for the year ended December 31, 2008 reflects net proceeds from the rights offering and the related investment agreements of $96.6 million, other issuances of stock of $2.6 million and the private placement of units of $7.9 million, offset by the preferred distribution to Flag of $31.0 million, Mortgage Loan extension costs of $15.0 million, repayment of notes of $30.3 million, and repayment of the Flag promissory note of $1.0 million principal amount and the CKX line of credit of $6.0 million principal amount.

 

Cash Flows for the period from May 11, 2007 to December 31, 2007

 

Operating Activities

 

Cash used in operating activities of $23.5 million from inception (May 11, 2007) through December 31, 2007 consisted primarily of the net loss for the period of $77.7 million which includes depreciation and amortization costs of $11.0 million, deferred financing cost amortization of $6.8 million, the impairment of capitalized development costs of $12.7 million, the loss on the exercise of the

 

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Riviera option of $6.4 million, equity in loss of Metroflag for the period May 11, 2007 to July 5, 2007 of $5.0 million and changes in working capital levels of $13.1 million, which includes $10.0 million accrual for the Elvis Presley Enterprises and Muhammad Ali Enterprises license agreements.

 

Investing Activities

 

Cash used in investing activities during the period of $207.8 million, reflects cash used in the purchase of the additional 50% interest in Metroflag of $172.5 million, the cash used for the exercise of the Riv option of $13.2 million, cash used to purchase the Riviera interests of $21.8 million and $1.2 million of development costs capitalized during the period, offset by $0.9 million of restricted cash used.

 

Financing Activities

 

Cash provided by financing activities during the period of $233.9 million reflects the $100.0 million investment from CKX, $105.0 million of additional borrowings under the mortgage loan, $23.0 million of proceeds from the Riv loan, $1.0 million of borrowings under the Flag loan, the $6.0 million loan from CKX and $7.7 million margin loan from Bear Stearns used to fund the exercise of the Riv option and the $2.0 million of additional equity sold to CKX and Flag, partially offset by the repayment of members’ loans of $7.6 million and debt issuance costs paid of $3.7 million.

 

Metroflag — Historical Cash Flow for the year ended December 31, 2006

 

Operating Activities

 

Net cash used in operating activities was $12.0 million in 2006.

 

Investing Activities

 

Acquisitions of real estate totaled $92.4 million in 2006. The net deposits applied to land purchases were $4.8 million in 2006.

 

Net deposits into restricted cash accounts required under various lending agreements were $9.8 million in 2006.

 

Capitalized development costs of $5.2 million in 2006 relate to the redevelopment of the Las Vegas property.

 

Financing Activities

 

Net cash provided by financing activities was $112.8 million in 2006.

 

In 2006, proceeds from mortgage loans of $100.9 million were used to fund acquisitions of real estate. The proceeds from members’ loans of $12.1 million were used to fund redevelopment working capital and to purchase the Travelodge property. Members’ distributions exceeded members’ contributions by $0.1 million.

 

Uses of Capital

 

At December 31, 2008, we had $475.4 million of debt outstanding and $2.7 million in cash and cash equivalents. Our current cash on hand is not sufficient to fund our current operations including payments of interest and principal due on our outstanding debt. Most of our assets are encumbered by our debt obligations. In total, we generated aggregate gross proceeds of approximately $98.7 million from the rights offering and from sales under the related investment agreements. The Company utilized the proceeds to repay the $23 million Riv loan, pay the guaranteed annual minimum royalty payments of $10 million for 2007 under the license agreements, repay in full and retire the Flag promissory note of $1 million and the CKX loan of $6 million principal amount, pay Flag $31 million as partial satisfaction of its $45 million preferred priority distribution right and to satisfy certain capital requirements associated with extending the mortgage loan on July 6, 2008. The aggregate proceeds from the sale of 2,264,289 units pursuant to the subscription agreements entered into on July 15, 2008 were approximately $7.9 million. The Company utilized the proceeds to fund working capital requirements and for general corporate purposes.

 

Capital Expenditures

 

In connection with and as a condition to the Mortgage Loan, we had funded a segregated escrow account for the purpose of funding pre-development costs in connection with redevelopment of the Las Vegas property. The balance in the pre-development escrow account at December 31, 2008 and 2007 was $20.1 million and $25.9 million, respectively, which is included in restricted cash

 

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on our balance sheet. On January 30, 2009, the first lien lenders seized the amount then remaining in the escrow account and applied it to the principal amount outstanding under the loan.

 

Dividends

 

We have no intention of paying any cash dividends on our common stock for the foreseeable future. In addition, the terms of the mortgage loan restrict, and the terms of any future debt agreements we may enter into are likely to prohibit or restrict, the payment of cash dividends on our common stock.

 

Commitments and Contingencies

 

There are various lawsuits and claims pending against us and which we have initiated against others. We believe that any ultimate liability resulting from these actions or claims will not have a material adverse effect on our results of operations, financial condition or liquidity.

 

Contractual Obligations

 

The following table summarizes our contractual obligations and commitments as of December 31, 2008:

 

 

 

 

Inflation

 

Inflation has affected the historical performances of the business primarily in terms of higher rents we receive from tenants upon lease renewals and higher operating costs for real estate taxes, salaries and other administrative expenses. Although the exact impact of future inflation is indeterminable, we believe that our future costs to develop hotels and casinos will be impacted by inflation in construction costs.

 

Application of Critical Accounting Policies

 

Marketable Securities

 

Marketable securities at December 31, 2008 and December 31, 2007 consist of the Riv Shares owned by FXRE. These securities are classified as available for sale in accordance with the provision of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and accordingly are carried at fair value. Based on the Company’s evaluation of the underlying reasons for the decline in value associated with the Riv Shares, including weakening conditions in the Las Vegas market where Riviera Holdings Corporation operates, and its uncertain ability to hold the securities for a reasonable amount of time sufficient for an expected recovery of fair value, the Company determined that the losses were other than temporary as of December 31, 2008 and recognized impairment loss of $41.7 million that is included in other expense in the accompanying statements of operations for the year ended December 31, 2008. Prior to June 30, 2008, the Company did not consider the losses to be other than temporary and reported unrealized gains and losses in other comprehensive income as a separate component of stockholders’ equity. As of March 27, 2009, the Company had sold all but 115,588 of our Riviera shares.

 

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Financial Instruments

 

We have a policy and also are required by our lenders to use derivatives to partially offset the market exposure to fluctuations in interest rates. In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , we recognize these derivatives on the balance sheet at fair value and adjust them on a quarterly basis. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. The Company does not enter into derivatives for speculative or trading purposes.

 

The carrying value of our accounts payable and accrued liabilities approximates fair value due to the short-term maturities of these instruments. The carrying value of our variable-rate note payable is considered to be at fair value since the interest rate on such instrument re-prices monthly based on current market conditions.

 

Real Estate Investments

 

Land, buildings and improvements are recorded at cost. All specifically identifiable costs related to development activities are capitalized into capitalized development costs on the consolidated balance sheet. The capitalized costs represent pre-development costs essential to the development of the property and include designing, engineering, legal, consulting, obtaining permits, construction, financing, and travel costs incurred during the period of development. We assess capitalized development costs for recoverability periodically and when changes in our development plans occur. In the fourth quarter of 2007, the Company recorded an impairment charge related to a write-off of approximately $12.7 million for capitalized costs that were deemed to be not recoverable based on changes made to the Company’s development plans. In the third quarter of 2008, the Company recorded an impairment charge of $10.7 million related to the write-off of capitalized development costs as a result of the Company’s determination not to proceed with its originally proposed plan for the redevelopment as a result of the disruption in the capital markets and the economic downturn in the United States in general and Las Vegas in particular.

 

We follow the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). In accordance with SFAS 144, we review our real estate portfolio for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable based upon expected undiscounted cash flows from the property. We determine impairment by comparing the property’s carrying value to an estimate of fair value. In the event that the carrying amount of a property is not recoverable and exceeds its fair value, we will write down the asset to fair value. As a result of an impairment test in 2008, the Company recorded an impairment charge of $325.1 million.

 

The fair value of the land was determined based upon the valuation report obtained from an independent appraisal firm as well as applying certain assumptions for significant unobservable inputs. This is largely due to the severity of deterioration of the market conditions in Las Vegas, lack of recent comparable sales, uncertainty as to the timing of any recovery, inability to project meaningful cash flows for market participants given the current state and use of the properties, lack of available financing for large scale developmental projects and rapidly changing environment. A description of the significant unobservable inputs are as follows:

 

 

Incidental Operations

 

We follow the provisions of Statement of Financial Accounting Standards No. 67, Accounting for Costs and Initial Operations of Real Estate Projects (“SFAS 67”) to account for certain operations. In accordance with SFAS 67, these operations are considered “incidental,” and as such, for each entity, when the incremental revenues exceed the incremental costs, such excess is accounted for as a reduction of capitalized costs of the redevelopment project.

 

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The preparation of our financial statements in accordance with US GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Management considers an accounting estimate to be critical if it requires assumptions to be made about matters that were highly uncertain at the time the estimate was made and changes in the estimate or different estimates could have a material effect on the Company’s results of operations. On an ongoing basis, we evaluate our estimates and assumptions, including those related to income taxes and share-based payments. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The result of these evaluations forms the basis for making judgments about the carrying values of assets and liabilities and the reported amount of revenues and expenses that are not readily available from other sources. Actual results may differ from these estimates under different assumptions. We have discussed the development, selection, and disclosure of our critical accounting policies with the Audit Committee of the Company’s Board of Directors.

 

The Company continuously monitors its estimates and assumptions to ensure any business or economic changes impacting these estimates and assumptions are reflected in the Company’s financial statements on a timely basis, including the sensitivity to change the Company’s critical accounting policies.

 

The following accounting policies require significant management judgments and estimates:

 

Income Taxes

 

We adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of SFAS No. 109, Accounting for Income Taxes (“SFAS 109”) upon formation of FXRE on June 15, 2007. We have no uncertain tax positions under the standards of FIN 48.

 

We account for income taxes in accordance with SFAS 109, which requires that deferred tax assets and liabilities be recognized, using enacted tax rates, for the effect of temporary differences between the book and tax basis of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the future tax consequences of events that have been recognized in our financial statements or tax returns, judgment is required. In determining the need for a valuation allowance, the historical and projected financial performance of the operation that is recording a net deferred tax asset is considered along with any other pertinent information.

 

Share-Based Payments

 

In accordance with SFAS 123R, Share-Based Payment , the fair value of stock options is estimated as of the grant date based on a Black-Scholes option pricing model. Judgment is required in determining certain of the inputs to the model, specifically the expected life of options and volatility. As a result of the Company’s short operating history, no reliable historical data is available for expected lives and forfeitures. The Company estimates the expected life of its stock option grants at the midpoint between the vesting dates and the end of the contractual term. This methodology is known as the simplified method and is used because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. We estimated forfeitures based on management’s experience. The expected volatility is based on an analysis of comparable public companies operating in our industry.

 

Impact of Recently Issued Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157 , Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the Company beginning January 1, 2008 for financial assets and liabilities and January 1, 2009 for non-financial assets and liabilities. The Company has adopted SFAS 157 for its marketable securities (see note 2, Formation of the Company ). The Company’s marketable securities qualify as level one financial assets in accordance with SFAS 157 as they are traded on an active exchange market and are fair valued by obtaining quoted prices. The Company does not have any level two financial assets or liabilities that require significant other observable or unobservable inputs in order to calculate fair value. The Company’s interest rate cap agreement (see note 9) qualifies as a level three financial asset in accordance with SFAS 157 as of December 31, 2008; however, the balance as of December 31, 2008 and changes in the period ended December 31, 2008 did not have a material effect on the Company’s financial position or operations. The Company does not have any other level three financial assets or liabilities.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), providing companies with an option to report selected financial assets and liabilities at fair value. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Effective January 1, 2008 the Company elected not to report any additional assets and liabilities at fair value.

 

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On December 4, 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS 141(R)”) and Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements , an amendment of ARB No. 51 (“SFAS 160”). These new standards will significantly change the accounting for and reporting of business combination transactions and noncontrolling (minority) interests in consolidated financial statements. SFAS 141(R) and SFAS 160 are required to be adopted simultaneously and are effective for the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of SFAS 141(R) will change the Company’s accounting treatment for business combinations on a prospective basis beginning January 1, 2009. The Company has completed its assessment of the impact of SFAS 160 on its consolidated financial statements and has concluded that the statement will not have a significant impact on the Company’s consolidated financial statements.

 

Off Balance Sheet Arrangements

 

We do not have any off balance sheet arrangements.

 

Seasonality

 

We do not consider our business to be seasonal.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to market risk arising from changes in market rates and prices, interest rates and the market price of our common stock. To mitigate these risks, we may utilize derivative financial instruments, among other strategies. We do not use derivative financial instruments for speculative purposes.

 

Interest Rate Risk

 

The $475 million mortgage loan pays interest at variable rates ranging from 5.75% to 13.25% at December 31, 2008. We entered into an interest rate agreement with a major financial institution which capped the maximum Eurodollar base rate payable under the loan at 5.5%. The interest rate cap agreement expired on July 23, 2008. A new rate cap agreement to protect the one-month LIBOR rate at a maximum of 3.5% was purchased in conjunction with the extension of the Mortgage Loan effective July 6, 2008. This rate cap agreement lapsed on January 6, 2009 in conjunction with the maturity of the loan.

 

Foreign Exchange Risk

 

We presently have no operations outside the United States. As a result, we do not believe that our financial results have been or will be materially impacted by changes in foreign currency exchange rates.

 

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Table of Contents to Financial Statements

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of FX Real Estate and Entertainment Inc.:

 

We have audited the accompanying consolidated balance sheets of FX Real Estate and Entertainment Inc. (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the year ended December 31, 2008 and for the period from May 11, 2007 to December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of FX Real Estate and Entertainment Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and cash flows for the year ended December 31, 2008 and the period from May 11, 2007 to December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

The accompanying financial statements have been prepared assuming FX Real Estate and Entertainment Inc. will continue as a going concern. As more fully discussed in Note 3 to the consolidated financial statements, the Company is in default under the mortgage loan, has limited available cash, has a working capital deficiency and will need to secure new financing or additional capital in order to pay its obligations. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan as to these matters is also described in Note 3. These financial statements do not include adjustments that might result from the outcome of this uncertainty.

 

 

New York, New York

March 30, 2009

 

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Report of Independent Registered Public Accounting Firm

 

To the Members of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC, and Metroflag Management, LLC:

 

We have audited the accompanying combined statements of operations, members’ equity, and cash flows for the period from January 1, 2007 through May 10, 2007 of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC, and Metroflag Management, LLC (collectively, “Metroflag”). These financial statements are the responsibility of Metroflag’s management. Our responsibility is to express an opinion on these financial statements 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 the financial statements are free of material misstatement. We were not engaged to perform an audit of Metroflag’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Metroflag’s internal control over financial reporting. Accordingly, we express no such opinion. 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the combined results of operations, members’ equity and cash flows of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC, and Metroflag Management, LLC for the period from January 1, 2007 through May 10, 2007 in conformity with U.S. generally accepted accounting principles.

 

 

Las Vegas, Nevada

August 23, 2007

 

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Report of Independent Registered Public Accounting Firm

 

To the Members of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC and Metroflag Management, LLC:

 

We have audited the accompanying combined statements of operations, members’ equity and cash flows of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC, and Metroflag Management, LLC (collectively, “Metroflag”) for the year ended December 31, 2006. These financial statements are the responsibility of Metroflag management. Our responsibility is to express an opinion on these financial statements 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 the financial statements are free of material misstatement. We were not engaged to perform an audit of Metroflag’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Metroflag’s internal control over financial reporting. Accordingly, we express no such opinion. 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, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Metroflag BP, LLC, Metroflag Polo, LLC, Metroflag Cable, LLC, CAP/TOR, LLC, Metroflag SW, LLC, Metroflag HD, LLC, and Metroflag Management, LLC at December 31, 2006 and the combined results of its operations and its cash flows for the year ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

 

 

Las Vegas, Nevada

August 13, 2007

 

37

 

FX Real Estate and Entertainment Inc.

 

CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

 

 

See accompanying notes to consolidated and combined financial statements

 

38

FX Real Estate and Entertainment Inc.

 

STATEMENTS OF OPERATIONS

(amounts in thousands, except share and per share data)

 

 

See accompanying notes to consolidated and combined financial statements

 

39

FX Real Estate and Entertainment Inc.
STATEMENTS OF CASH FLOWS
(amounts in thousands)