Drive Shack Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

EQUITY AND EARNINGS PER SHARE

EQUITY AND EARNINGS PER SHARE

12 Months Ended

Dec. 31, 2018

Earnings per Share

The Company is required to present both basic and diluted earnings per share (“EPS”). The following table shows the amounts used in computing basic and diluted EPS:



	For Year Ended December 31,
	2018			2017			2016
Numerator for basic and diluted earnings per share:
(Loss) income from continuing operations after preferred dividends and noncontrolling interest	$	(44,263	)	$	(47,781	)	$	71,499
(Loss) Income Applicable to Common Stockholders	$	(44,263	)	$	(47,781	)	$	71,499

Denominator:
Denominator for basic earnings per share - weighted average shares	66,993,543			66,903,457			66,709,925
Effect of dilutive securities
Options	—			—			2,078,515
RSUs	—			—			—
Denominator for diluted earnings per share - adjusted weighted average shares	66,993,543			66,903,457			68,788,440

Basic earnings per share:
(Loss) income from continuing operations per share of common stock, after preferred dividends and noncontrolling interest	$	(0.66	)	$	(0.71	)	$	1.07
(Loss) Income Applicable to Common Stock, per share	$	(0.66	)	$	(0.71	)	$	1.07

Diluted earnings per share:
(Loss) income from continuing operations per share of common stock, after preferred dividends and noncontrolling interest	$	(0.66	)	$	(0.71	)	$	1.04
(Loss) Income Applicable to Common Stock, per share	$	(0.66	)	$	(0.71	)	$	1.04

Basic EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of dilutive securities during each period. The Company’s dilutive securities are its options and RSUs. During 2018 and 2017, based on the treasury stock method, the Company had 2,718,704 and 1,749,596, potentially dilutive securities, respectively, which were excluded due to the Company's loss position. During 2016, based on the treasury stock method, the Company had 2,078,515 dilutive securities resulting from its outstanding options. During 2018, 2017 and 2016, the Company had: 88,023; 201,430; and 309,024 antidilutive options, respectively. Net income (loss) applicable to common stockholders is equal to net income (loss) less preferred dividends.

Common Stock Issuances

In May 2016 and July 2016, the Company issued a total of 57,740 and 21,798 shares, respectively, of its common stock to its independent directors as a component of their annual compensation.

In January 2017, May 2017, October 2017 and December 2017, the Company issued a total of 18,074; 90,366; 30,822 and 13,538 shares, respectively, of its common stock to its independent directors as a component of their annual compensation.

In September 2018, the Company issued a total of 50,000 shares of its common stock to an independent director as part of the Director Stock Program described below.

Option Plans

On April 11, 2018, our board of directors adopted the Drive Shack Inc. 2018 Omnibus Incentive Plan (the "2018 Plan") which was approved by our shareholders. The 2018 Plan provides for the issuance of equity-based awards in various forms to eligible participants. The 2018 Plan allows for 6,697,710 shares of common stock to be available for grants of equity awards, subject to an annual limitation of 1,339,542 (with any shares not issued or granted in a specific year being added to such number in the subsequent year). As of December 31, 2018, the 2018 Plan has 1,146,422 shares available for grant through May 2019.

All outstanding options granted under prior option plans will continue to be subject to the terms and conditions set forth in the agreements evidencing such options and the terms of respective option plan. Upon exercise, all options will be settled in an amount of cash equal to the excess of the fair market value of a share of common stock on the date of exercise over the strike price per share, unless advance approval is made to settle the option in shares of common stock.

As detailed in the 2018 Plan, the board of directors may permit a first time non-employee director to make a one-time election to participate in a stock purchase and matching grant program (the "Director Stock Program") which provides that if the non-employee director purchases shares of the Company's common stock at fair value within 30 days following the date the individual becomes a non-employee director, then the Company will issue a matching grant of fully vested shares of common stock equal to 20% of the aggregate fair value of the purchased shares. In September 2018, a non-employee director purchased 41,667 shares and the Company issued 8,333 shares representing the matching grant.

Stock Options and Restricted Stock Units (RSUs)

The following is a summary of the changes in the Company's outstanding options for the year ended December 31, 2018.



	Number of Options	Weighted Average Strike Price		Weighted Average Life Remaining (in years)
Balance at December 31, 2017	5,010,576	$	2.55
Granted	3,426,355	5.44
Balance at December 31, 2018 (A)	8,436,931	$	3.72	7.72 years

Exercisable at December 31, 2018	2,705,586	$	2.64	4.64 years

The Company's outstanding options were summarized as follows:



	Year Ended December 31,
	2018	2017
Held by the former Manager	2,705,253	3,857,748
Issued to the former Manager and subsequently transferred to certain Manager’s employees (B)	2,304,990	1,152,495
Issued to the independent directors	333	333
Issued to Drive Shack employees (C)	3,426,355	—
Total (A)	8,436,931	5,010,576


(A)	The total at December 31, 2018 excludes 54,641 RSUs granted to certain non-employee directors as part of the annual compensation.

(B)

The Company and the former Manager agreed that options held by certain employees formerly employed by the Manager will not terminate or be forfeited as a result of the Termination and Cooperation Agreement, and the vesting of such options will relate to the relevant holder’s employment with the Company and its affiliates following January 1, 2018. In both February 2017 and April 2018, the former Manager issued 1,152,495 options to certain employees formerly employed by the Manager as part of their compensation. The options fully vest and are exercisable one year prior to the option expiration date, beginning March 2020 through January 2024.


(C)	On November 12, 2018, the Company issued options to certain employees as provided in their employment agreements. The options fully vest and are exercisable as follows: 3,351,355 options vest in equal annual installments on each of the first three anniversaries of the grant date; and 75,000 options fully vest on the third anniversary of the grant date.

The valuation of the employee options has been determined using the Black-Scholes option valuation model. The Black-Scholes option valuation model uses assumptions of expected volatility, expected dividend yield of the Company’s stock, expected term of the awards and the risk-free interest rate. The fair value of the options was determined using the following assumptions:



Option Valuation Date	January 1, 2018			April 10, 2018			November 12, 2018
Expected Volatility	39.73		%	35.66		%	35.4 - 35.8%
Expected Dividend Yield	0.00		%	0.00		%	0.00		%
Expected Remaining Term	3.0 - 6.6 years			2.7 - 6.3 years			6.0 - 6.5 years
Risk-Free Rate	2.16 - 2.29%			2.68 - 2.82%			3.09 - 3.11%
Fair Value at Valuation Date	$	4,272		$	3,558		$	7,478

Stock-based compensation expense is recognized on a straight-line basis through the vesting date of the options. Stock-based compensation expense related to the employee options was $2.2 million during the year ended December 31, 2018 and was recorded in general and administrative expense on the Consolidated Statements of Operations. The unrecognized stock-based compensation expense related to the unvested options was $13.1 million as of December 31, 2018 and will be expensed over a weighted average of 2.3 years.

The following table summarizes the Company’s outstanding options at December 31, 2018. Note that the last sales price on the New York Stock Exchange for the Company’s common stock in the year ended December 31, 2018 was $3.92 per share.



Recipient	Date of Grant/Exercise	Number of Options		Options Exercisable at December 31, 2018	Weighted Average Strike Price		Fair Value At Grant Date (millions) (A)		Intrinsic Value at December 31, 2018 (millions)
Directors	Various	3,666		333	$	—	Not Material		—
Manager ^(B)	2002 - 2008	587,277		—	$	0.00	$	6.4	—
Manager ^(B)	Mar-11	311,853		82,141	$	1.00	$	7.0	$	0.6
Manager ^(B)	Sep-11	524,212		166,582	$	1.00	$	5.6	$	1.1
Manager ^(B)	Apr-12	348,352		140,112	$	1.00	$	5.6	$	0.8
Manager ^(B)	May-12	396,316		158,345	$	1.00	$	7.6	$	0.9
Manager ^(B)	Jul-12	437,991		178,478	$	1.00	$	8.3	$	1.0
Manager ^(B)	Jan-13	958,331		489,196	$	2.32	$	18.0	$	1.4
Manager ^(B)	Feb-13	383,331		195,679	$	2.95	$	8.4	$	0.3
Manager ^(B)	Jun-13	670,829		342,438	$	3.23	$	3.8	$	0.4
Manager ^(B)	Nov-13	965,847		493,032	$	3.57	$	6.0	$	0.3
Manager ^(B)	Aug-14	765,416		459,250	$	4.01	$	1.7	$	—
Employees	Nov-18	3,426,355		—	$	5.44	$	7.5	$	—
Exercised ^(C)	Prior to 2008	(173,853	)	N/A	$	14.09	N/A		N/A
Exercised ^(D)	Oct-12	(15,972	)	N/A	$	1.48	N/A		N/A
Exercised ^(E)	Sep-13	(51,306	)	N/A	$	1.67	N/A		N/A
Exercised ^(F)	2014	(216,186	)	N/A	$	1.46	N/A		N/A
Exercised ^(G)	2015	(202,446	)	N/A	1.00		N/A		N/A
Exercised ^(H)	2016	(266,657	)	N/A	3.01		N/A		N/A
Expired unexercised	2002-2008	(416,425	)	N/A	N/A		N/A		N/A
Outstanding		8,436,931		2,705,586

(A)

The fair value of the options was estimated using an option valuation model. Since the option plans have characteristics significantly different from those of traded options, and since the assumptions used in such model, particularly the volatility assumption, are subject to significant judgment and variability, the actual value of the options could vary materially from management’s estimate. The volatility assumption for these options was estimated based primarily on the historical volatility of the Company’s common stock and management’s expectations regarding future volatility. The expected life assumption for options issued prior to 2011 was estimated based on the simplified term method. This simplified method was used because the Company did not have sufficient historical data to conclude on the appropriate expected life of its options and because historical data to date was consistent with the simplified term method. The expected life assumption for options issued in 2011 and thereafter was estimated based primarily on the historical expected life of applicable previously issued options.


(B)	The former Manager assigned certain of its options to Fortress’s employees as follows:



Date of Grant	Strike Prices	Total Unexercised Inception to Date
Mar-11	$1.00	124,740
Sep-11	$1.00	209,686
Apr-12	$1.00	139,340
May-12	$1.00	158,526
Jul-12	$1.00	175,196
Jan-13	$2.32	383,332
Feb-13	$2.95	153,332
Jun-13	$3.23	268,332
Nov-13	$3.57	386,340
Aug-14	$4.01	306,166
	Total	2,304,990


(C)	111,770 of the total options exercised were by the former Manager. 61,417 of the total options exercised were by employees of Fortress subsequent to their assignment. 666 of the total options exercised were by directors.


(D)	Exercised by employees of Fortress subsequent to their assignment. The options exercised had an intrinsic value of $0.2 million.


(E)	Exercised by employees of Fortress subsequent to their assignment. The options exercised had an intrinsic value of $0.9 million.


(F)	215,853 options were exercised by employees of Fortress subsequent to their assignment with an intrinsic value of $4.1 million. 333 options were exercised by directors with a minimal intrinsic value.


(G)	Exercised by employees of Fortress subsequent to their assignment. The options exercised had an intrinsic value of $0.8 million.


(H)	Exercised by employees of Fortress subsequent to their assignment. The options exercised had an intrinsic value of $0.4 million. As a result of his resignation, the Company's former CEO forfeited 16,748 options and were transferred back to the former Manager.

The Company's non-employee directors were granted 54,641 RSUs during 2018 with a weighted average grant date fair value of $5.02, as part of the annual compensation.

The RSUs are subject to a one year vesting period. Stock-based compensation expense is recognized on a straight-line basis through the vesting date of the RSUs. Stock-based compensation expense related to the RSUs was $0.1 million during the year ended December 31, 2018, and was recorded in general and administrative expense on the Consolidated Statements of Operations. The unrecognized stock-based compensation expense related to the unvested RSUs was $0.2 million as of December 31, 2018 and will be recognized over a weighted average of 0.7 years.

Tax Benefits Preservation Plan

On December 5, 2018, our board of directors adopted a Tax Benefits Preservation Plan (the “2018 Tax Plan”) with American Stock Transfer and Trust Company, LLC as rights agent, and the disinterested members of the board of directors declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record at the close of business on December 15, 2018. Each right is governed by the terms of the 2018 Tax Plan and entitles the registered holder to purchase from us a unit consisting of one one-thousandth of a share of Series E Junior Participating Preferred Stock, par value $0.01 per share at a purchase price of $28.00 per unit, subject to adjustment. The Plan is intended to help protect our ability to use our tax net operating losses and certain other tax assets by deterring an “ownership change” as defined under the Code.

In connection with the adoption of the Tax Benefit Preservation Plan in 2016, our board of directors approved the Articles Supplementary of Series E Junior Participating Preferred Stock, which was filed with the State Department of Assessments and Taxation of Maryland on December 8, 2016.

Preferred Stock

In March 2003, the Company issued 2.5 million shares ($62.5 million face amount) of its 9.75% Series B Cumulative Redeemable Preferred Stock (the “Series B Preferred”). In October 2005, the Company issued 1.6 million shares ($40.0 million face amount) of its 8.05% Series C Cumulative Redeemable Preferred Stock (the “Series C Preferred”). In March 2007, the Company issued 2.0 million shares ($50.0 million face amount) of its 8.375% Series D Cumulative Redeemable Preferred Stock (the “Series D Preferred”). The Series B Preferred, Series C Preferred and Series D Preferred are non-voting, have a $25 per share liquidation preference, no maturity date and no mandatory redemption. The Company has the option to redeem the Series B Preferred, the Series C Preferred and the Series D Preferred, at their liquidation preference. If the Series C Preferred or Series D Preferred cease to be listed on the NYSE or the AMEX, or quoted on the NASDAQ, and the Company is not subject to the reporting requirements of the Exchange Act, the Company has the option to redeem the Series C Preferred or Series D Preferred, as applicable, at their liquidation preference and, during such time any shares of Series C Preferred or Series D Preferred are outstanding, the dividend will increase to 9.05% or 9.375% per annum, respectively.

In connection with the issuance of the Series B Preferred, Series C Preferred and Series D Preferred, the Company incurred approximately $2.4 million, $1.5 million, and $1.8 million of costs, respectively, which were netted against the proceeds of such offerings. If any series of preferred stock were redeemed, the related costs would be recorded as an adjustment to income available for common stockholders at that time.

In March 2010, the Company settled its offer to exchange (the “Exchange Offer”) shares of its common stock and cash for shares of its preferred stock. After settlement of the Exchange Offer, 1,347,321 shares of Series B Preferred Stock, 496,000 shares of Series C Preferred Stock and 620,000 shares of Series D Preferred Stock remain outstanding for trading on the New York Stock Exchange.

As of January 31, 2019, Drive Shack Inc. had paid all current and accrued dividends on its preferred stock.

Noncontrolling Interest

The Company’s noncontrolling interest in 2017 and 2018 is related to our Traditional Golf business, a portion of which the Company does not own. In October 2016, the Company exited certain golf properties in which the Company had a noncontrolling interest. The noncontrolling interest associated with the remaining golf property has a carrying value of zero.