UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended: September 30, 2009

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

For the transition period from                      to                     

Commission File Number: 001-33738

MORGANS HOTEL GROUP CO.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		16-1736884 (I.R.S. employer identification no.)
475 Tenth Avenue
New York, New York (Address of principal executive offices)		10018 (Zip Code)

212-277-4100
(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of November 5, 2009 was 29,661,630

 

 

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Morgans Hotel Group Co. Unaudited Consolidated Balance Sheets			4
Morgans Hotel Group Co. Unaudited Consolidated Statements of Operations and Comprehensive Loss			5
Morgans Hotel Group Co. Unaudited Consolidated Statements of Cash Flows			6
Notes to Unaudited Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3. Quantitative and Qualitative Disclosures About Market Risk			53
Item 4. Controls and Procedures			54
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			55
Item 1A. Risk Factors			55
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			55
Item 3. Defaults Upon Senior Securities			55
Item 4. Submission of Matters to a Vote of Security Holders			56
Item 5. Other Information			56
Item 6. Exhibits			56
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

FORWARD LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for “forward-looking statements” made by or on behalf of a company. We may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our stockholders. These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ materially from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important risks and factors that could cause our actual results to differ materially from any forward-looking statements include, but are not limited to, the risks discussed in the Company’s Annual Report on Form 10-K under the section titled “Risk Factors” and in this Quarterly Report on Form 10-Q under the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”; downturns in economic and market conditions, particularly levels of spending in the business, travel and leisure industries; hostilities, including future terrorist attacks, or fear of hostilities that affect travel; risks related to natural disasters, such as earthquakes and hurricanes; risks associated with the acquisition, development and integration of properties; the seasonal nature of the hospitality business; changes in the tastes of our customers; increases in real property tax rates; increases in interest rates and operating costs; the impact of any material litigation; the loss of key members of our senior management; general volatility of the capital markets and our ability to access the capital markets; and changes in the competitive environment in our industry and the markets where we invest.

We are under no duty to update any of the forward-looking statements after the date of this report to conform these statements to actual results.

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

Morgans Hotel Group Co.

		September 30,				December 31,
		2009				2008
						(As Adjusted)
ASSETS
Property and equipment, net		$	529,961			$	555,645
Goodwill			73,698				73,698
Investments in and advances to unconsolidated joint ventures			40,040				56,754
Cash and cash equivalents			34,114				49,150
Restricted cash			18,078				21,484
Accounts receivable, net			6,653				6,673
Related party receivables			13,127				7,900
Prepaid expenses and other assets			10,449				9,192
Deferred tax asset			92,948				61,005
Other, net			17,878				13,963
Total assets		$	836,946			$	855,464
LIABILITIES AND EQUITY
Long-term debt and capital lease obligations, net		$	744,058			$	717,179
Accounts payable and accrued liabilities			29,784				26,711
Distributions and losses in excess of investment in unconsolidated joint ventures			12,430				14,563
Other liabilities			26,667				35,655
Total liabilities			812,939				794,108
Commitments and contingencies
Common stock, $.01 par value; 200,000,000 shares authorized; 36,277,495 shares issued at September 30, 2009 and December 31, 2008, respectively			363				363
Additional paid-in capital			248,623				242,158
Treasury stock, at cost, 6,629,399 and 6,758,303 shares of common stock at September 30, 2009 and December 31, 2008, respectively			(100,191	)			(102,394	)
Comprehensive income			(9,537	)			(13,949	)
Accumulated deficit			(131,213	)			(82,755	)
Total Morgans Hotel Group Co. stockholders’ equity			8,045				43,423
Noncontrolling interest			15,962				17,933
Total equity			24,007				61,356
Total liabilities and equity		$	836,946			$	855,464

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

		Three Months				Three Months				Nine Months				Nine Months
		Ended Sept. 30,				Ended Sept. 30,				Ended Sept. 30,				Ended Sept 30,
		2009				2008				2009				2008
						(As Adjusted)								(As Adjusted)
Revenues:
Rooms		$	32,524			$	45,500			$	92,003			$	138,521
Food and beverage			18,795				23,269				57,664				76,392
Other hotel			2,351				3,133				7,355				9,957
Total hotel revenues			53,670				71,902				157,022				224,870
Management fee-related parties and other income			3,998				5,799				11,311				14,887
Total revenues			57,668				77,701				168,333				239,757
Operating Costs and Expenses:
Rooms			10,770				12,097				31,313				37,162
Food and beverage			14,721				16,817				43,836				54,538
Other departmental			1,562				1,792				4,722				5,801
Hotel selling, general and administrative			12,863				15,003				36,968				45,375
Property taxes, insurance and other			4,683				5,447				13,193				13,229
Total hotel operating expenses			44,599				51,156				130,032				156,105
Corporate expenses, including stock compensation of $3.2 million, $4.8 million, $8.8 million, and $12.1 million, respectively			8,507				12,355				25,295				35,002
Depreciation and amortization			7,528				7,587				23,159				19,696
Restructuring, development and disposal costs			494				2,957				2,037				4,124
Total operating costs and expenses			61,128				74,055				180,523				214,927
Operating (loss) income			(3,460	)			3,646				(12,190	)			24,830
Interest expense, net			13,098				10,791				36,599				32,760
Equity in loss of unconsolidated joint ventures			2,262				7,617				4,700				16,526
Impairment loss on development project			11,914				—				11,914				—
Impairment loss on investment in joint venture			17,220				—				17,220				—
Other non-operating expenses			869				516				1,934				1,816
Loss before income taxes			(48,823	)			(15,278	)			(84,557	)			(26,272	)
Income tax benefit			(20,189	)			(6,336	)			(35,700	)			(11,304	)
Net loss			(28,634	)			(8,942	)			(48,857	)			(14,968	)
Net loss (income) attributable to noncontrolling interest			817				(388	)			399				(2,731	)
Net loss attributable to common stockholders			(27,817	)			(9,330	)			(48,458	)			(17,699	)
Other comprehensive loss:
Unrealized gain on valuation of swap/cap agreements, net of tax			3,887				696				12,303				3,635
Realized loss on settlement of swap/cap agreements, net of tax			(2,382	)			(1,444	)			(7,379	)			(3,247	)
Foreign currency translation (loss) gain			532				(388	)			(512	)			(353	)
Comprehensive loss		$	(25,780	)		$	(10,466	)		$	(44,046	)		$	(17,664	)
Loss per share attributable to common stockholders:
Basic and diluted		$	(0.94	)		$	(0.30	)		$	(1.62	)		$	(0.55	)
Weighted average number of common shares outstanding:
Basic and diluted			29,737				31,231				29,941				31,953

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

		Nine Months				Nine Months
		Ended Sept. 30,				Ended Sept. 30,
		2009				2008
						(As Adjusted)
Cash flows from operating activities:
Net loss		$	(48,857	)		$	(14,968	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation			22,633				19,159
Amortization of other costs			526				537
Amortization of deferred financing costs			2,614				2,106
Amortization of discount on convertible debt			1,707				1,707
Stock-based compensation			8,805				12,130
Accretion of interest on capital lease obligation			1,222				1,114
Equity in losses from unconsolidated joint ventures			4,700				16,526
Impairment loss and loss on disposal of assets			29,113				2,589
Deferred income tax benefit			(36,300	)			(11,304	)
Changes in assets and liabilities:
Accounts receivable, net			20				468
Related party receivables			(5,227	)			(2,428	)
Restricted cash			2,360				(4,616	)
Prepaid expenses and other assets			(1,267	)			849
Accounts payable and accrued liabilities			3,814				(3,536	)
Other liabilities			(56	)			(721	)
Net cash (used in) provided by operating activities			(14,193	)			19,612
Cash flows from investing activities:
Additions to property and equipment			(8,842	)			(55,377	)
(Deposits to) withdrawals from capital improvement escrows, net			1,046				2,449
Distributions and reimbursements from unconsolidated joint ventures			6				30,670
Investment in unconsolidated joint ventures, net			(8,232	)			(23,656	)
Net cash used in investing activities			(16,022	)			(45,914	)
Cash flows from financing activities:
Proceeds from long-term debt			139,789				—
Payments for deferred costs			(7,063	)			—
Payments on long-term debt and capital lease obligations			(115,839	)			(244	)
Cash paid in connection with vesting of stock based awards			(136	)			(84	)
Distributions to holders of noncontrolling interests in consolidated subsidiaries			(1,572	)			(2,692	)
Financing costs			—				(53	)
Repurchase of Company’s common stock			—				(33,654	)
Net cash provided by (used in) financing activities			15,179				(36,727	)
Net decrease in cash and cash equivalents			(15,036	)			(63,029	)
Cash and cash equivalents, beginning of period			49,150				122,712
Cash and cash equivalents, end of period		$	34,114			$	59,683
Supplemental disclosure of cash flow information:
Cash paid for interest		$	30,859			$	26,137
Cash paid for taxes		$	411			$	1,198

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

1. Organization and Formation Transaction

Morgans Hotel Group Co. (the “Company”) was incorporated on October 19, 2005 as a Delaware corporation to complete an initial public offering (“IPO”) that was part of the formation and structuring transactions described below. The Company operates, owns, acquires and redevelops hotel properties.

At the time of the IPO, the Company was comprised of the subsidiaries and ownership interests that were contributed as part of the formation and structuring transactions from Morgans Hotel Group LLC, now known as Residual Hotel Interest LLC (“Former Parent”), to Morgans Group LLC, the Company’s operating company. At the time of the formation and structuring transactions, the Former Parent was owned approximately 85% by NorthStar Hospitality, LLC, a subsidiary of NorthStar Capital Investment Corp., and approximately 15% by RSA Associates, L.P.

In connection with the IPO, the Former Parent contributed the subsidiaries and ownership interests in nine operating hotels in the United States and the United Kingdom to Morgans Group LLC in exchange for membership units. Simultaneously, Morgans Group LLC issued additional membership units to the Company in exchange for cash from the IPO. The Former Parent also contributed all the membership interests in its hotel management business to Morgans Group LLC in return for 1,000,000 membership units in Morgans Group LLC exchangeable for shares of the Company’s common stock. The Company is the managing member of Morgans Group LLC, and has full management control. On April 24, 2008, 45,935 outstanding membership units in Morgans Group LLC were converted into 45,935 shares of the Company’s common stock. As of September 30, 2009, 954,065 membership units in Morgans Group LLC remain outstanding.

On February 17, 2006, the Company completed its IPO. The Company issued 15,000,000 shares of common stock at $20 per share resulting in net proceeds of approximately $272.5 million, after underwriters’ discounts and offering expenses.

These financial statements have been presented on a consolidated basis and reflect the Company’s assets, liabilities and results from operations. The equity method of accounting is utilized to account for investments in joint ventures over which the Company has significant influence, but not control.

The Company has one reportable operating segment; it operates, owns, acquires and redevelops boutique hotels.

Operating Hotels

The Company’s operating hotels as of September 30, 2009 are as follows:

				Number of
Hotel Name		Location		Rooms				Ownership
Delano South Beach		Miami Beach, FL			194				(1	)
Hudson		New York, NY			831				(5	)
Mondrian Los Angeles		Los Angeles, CA			237				(1	)
Morgans		New York, NY			114				(1	)
Royalton		New York, NY			168				(1	)
Sanderson		London, England			150				(2	)
St Martins Lane		London, England			204				(2	)
Shore Club		Miami Beach, FL			309				(3	)
Clift		San Francisco, CA			372				(4	)
Mondrian Scottsdale		Scottsdale, AZ			189				(1	)
Hard Rock Hotel & Casino		Las Vegas, NV			1,136				(6	)
Mondrian South Beach		Miami Beach, FL			328				(2	)

Restaurant Joint Ventures

The food and beverage operations of certain of the hotels are operated under 50/50 joint ventures with a third party restaurant operator.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company consolidates all wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in combination. We have evaluated all subsequent events through November 5, 2009, the date the financial statements were issued.

Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51, as amended (“FIN46R”), which has been subsequently codified in Accounting Standards Codification (“ASC”) 810-10, Consolidation (“ASC 810-10”) requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. Pursuant to ASC 810-10, the Company consolidates five ventures that provide food and beverage services at the Company’s hotels as the Company absorbs a majority of the ventures’ expected losses and residual returns. These services include operating restaurants including room service at five hotels, banquet and catering services at four hotels and a bar at one hotel. No assets of the Company are collateral for the venturers’ obligations and creditors of the venturers’ have no recourse to the Company.

Management has evaluated the applicability of ASC 810-10 to its investments in certain joint ventures and determined that these joint ventures do not meet the requirements of a variable interest entity or the Company is not the primary beneficiary and, therefore, consolidation of these ventures is not required. Accordingly, these investments are accounted for using the equity method.

Derivative Instruments and Hedging Activities

As required by FASB Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No.133”) and SFAS No. 161, Disclosures About Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS No. 161”), which has been subsequently codified in ASC 815-10, Derivatives and Hedging (“ASC 815-10”) the Company records all derivatives on the balance sheet at fair value and provides qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash payments principally related to the Company’s borrowings.

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction.

The Company has interest rate caps that are not designated as hedges. These derivatives are not speculative and are used to manage the Company’s exposure to interest rate movements and other identified risks, but the Company has elected not to designate these instruments in hedging relationships based on the provisions in ASC 815-10. The changes in fair value of derivatives not designated in hedging relationships have been recognized in earnings.

A summary of the Company’s derivative and hedging instruments that have been recognized in earnings as of September 30, 2009 and December 31, 2008 is as follows (in thousands):

										Estimated				Estimated
										Fair Market				Fair Market
										Value at				Value at
		Type of		Maturity		Strike				September 30,				December 31,
Notional Amount		Instrument		Date		Rate				2009				2008
$285,000		Sold interest cap		July 9, 2010			4.25	%			(2	)			(15	)
285,000		Interest cap		July 9, 2010			4.25	%			2				17
85,000		Interest cap		July 15, 2010			7.00	%			—				—
85,000		Sold interest cap		July 15, 2010			7.00	%			—				—
Fair value of derivative instruments not designated as hedges										$	—			$	2

As of September 30, 2009 and December 31, 2008, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk (in thousands):

										Estimated				Estimated
										Fair Market				Fair Market
										Value at				Value at
		Type of		Maturity		Strike				September 30,				December 31,
Notional Amount		Instrument		Date		Rate				2009				2008
$285,000		Interest swap		July 9, 2010			5.04	%		$	(10,008	)		$	(16,953	)
85,000		Interest swap		July 15, 2010			4.91	%			(2,966	)			(4,941	)
Fair value of derivative instruments designated as effective hedges										$	(12,974	)		$	(21,894	)
Total fair value of derivative instruments										$	(12,974	)		$	(21,892	)
Total fair value included in other assets										$	3			$	17
Total fair value included in other liabilities										$	(12,977	)		$	(21,909	)

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. It is estimated that approximately $13.3 million included in accumulated other comprehensive income related to derivatives will be reclassified to interest expense over the next 12 months.

Credit-risk-related Contingent Features

The Company has entered into agreements with each of its derivative counterparties in connection with the interest rate swaps and hedging instruments related to the Convertible Notes, discussed in Note 6, providing that in the event the Company either defaults or is capable of being declared in default on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.

Fair Value Measurements

SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which has been subsequently codified in ASC 820-10, Fair Value Measurements and Disclosures (“ASC 820-10”) defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820-10 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

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

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

Currently, the Company uses interest rate caps and interest rate swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. To comply with the provisions of ASC 820-10, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2009, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives.

During the three months ended September 30, 2009, the Company recognized nonrecurring non-cash impairment charges of $29.1 million related to adjustments to property under development and investments in unconsolidated joint ventures, which reflects an other-than-temporary decline in the fair value of its investments resulting from further declines in the real estate markets in 2009. The Company’s estimated fair values relating to these impairment assessments were based upon Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of the assets taking into account the assets expected cash flow, holding period and estimated proceeds from the disposition of assets, as well as specific market and economic conditions.

Impairment of Long-Lived Assets

In accordance with SFAS Statement No. 144, Accounting for the Impairment of Disposal of Long Lived Assets), which has been subsequently codified in ASC 360-10, Property, Plant and Equipment, long-lived assets currently in use are reviewed periodically for possible impairment and will be written down to fair value if considered impaired. Long-lived assets to be disposed of are written down to the lower of cost or fair value less the estimated cost to sell. The Company reviews its portfolio of long-lived assets for impairment at least annually. When events or changes of circumstances indicate that an asset’s carrying value may not be recoverable, the Company tests for impairment by reference to the asset’s estimated future cash flows. As of September 30, 2009, management concluded that the property across the street from Delano South Beach, which the Company planned to develop into a hotel, was impaired. Accordingly, the Company recorded an impairment charge of approximately $11.9 million to reduce the property to its estimated fair value in September 2009. As of September 30, 2009, management concluded that no further reserves for impairment were required on all other long-lived assets.

Investments in and Advances to Unconsolidated Joint Ventures

The Company periodically reviews its investments in unconsolidated joint ventures for other temporary declines in market value. In this analysis of fair value, the Company uses discounted cash flow analysis to estimate the fair value of its investment taking into account expected cash flow from operations, holding period and net proceeds from the dispositions of the property. Any decline that is not expected to be recovered is considered other-than-temporary and an impairment charge is recorded as a reduction in the carrying value of the investment. As of September 30, 2009, management concluded that the Company’s investment in the Echelon Las Vegas joint venture was impaired. These investment costs related primarily to the plans and drawings for the development project. Given the current economic environment, the Company recorded an impairment charge of approximately $17.2 million representing the carrying value of this investment as it does not expect to develop these projects in the next three to five years. As of September 30, 2009, management concluded that no further reserves for impairment were required on all other investments in unconsolidated joint ventures.

Stock-based Compensation

The Company accounts for stock based employee compensation using the fair value method of accounting described in SFAS No. 123R, Accounting for Stock-Based Compensation (as amended by SFAS No. 148 and SFAS No. 123(R), which has subsequently been codified in ASC 718-10, Compensation, Stock Based Compensation. For share grants, total compensation expense is based on the price of the Company’s stock at the grant date. For option grants, the total compensation expense is based on the estimated fair value using the Black-Scholes option-pricing model. Compensation expense is recorded ratably over the vesting period, if any. Stock compensation expense recognized for the three months ended September 30, 2009 and 2008 was $3.2 million and $4.8 million, respectively. Stock compensation expense recognized for the nine months ended September 30, 2009 and 2008 was $8.8 million and $12.1 million, respectively.

Income (Loss) Per Share

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

Noncontrolling Interest

The Company follows SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulleting (ARB) No. 51, which has been subsequently codified in ASC 810-10, when accounting and reporting for noncontrolling interests in a consolidated subsidiary and the deconsolidation of a subsidiary. Under ASC 810-10, the Company now reports noncontrolling interests in subsidiaries as a separate component of equity in the consolidated financial statements and reflects net income attributable to the noncontrolling interests and net income attributable to the common stockholders on the face of the consolidated statement of operations.

The percentage of membership units in Morgans Group LLC, our operating company, owned by the Former Parent is presented as noncontrolling interest in Morgans Group LLC in the consolidated balance sheet and was approximately $14.9 million and $16.6 million as of September 30, 2009 and December 31, 2008, respectively. The noncontrolling interest in Morgans Group LLC is: (i) increased or decreased by the limited members’ pro rata share of Morgans Group LLC’s net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by redemptions of membership units for the Company’s common stock; and (iv) adjusted to equal the net equity of Morgans Group LLC multiplied by the limited members’ ownership percentage immediately after each issuance of units of Morgans Group LLC and/or shares of the Company’s common stock and after each purchase of treasury stock through an adjustment to additional paid-in capital. Net income or net loss allocated to the noncontrolling interest in Morgans Group LLC is based on the weighted-average percentage ownership throughout the period.

Additionally, $1.0 million and $1.4 million was recorded as noncontrolling interest as of September 30, 2009 and December 31, 2008, respectively, which represents our third-party food and beverage joint venture partner’s interest in the restaurant ventures at certain of our hotels.

New Accounting Pronouncements

On February 15, 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which has been subsequently codified in ASC 825-10, Financial Instruments (“ASC 825-10”). ASC 825-10 permits companies to make a one-time election to carry eligible types of financial assets and liabilities at fair value, even if fair value measurement is not required under GAAP. ASC 825-10 must be applied prospectively, and the effect of the first re-measurement to fair value, if any, should be reported as a cumulative effect adjustment to the opening balance of retained earnings. The adoption of ASC 825-10 had no material impact on the Company’s consolidated financial statements as the Company did not elect the fair value measurement option for any of its financial assets or liabilities.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations, which replaces SFAS No. 141 and has subsequently been codified in ASC 805-10, Business Combinations (“ASC 805-10”). ASC 805-10, among other things, establishes principles and requirements for how an acquirer entity recognizes and measures in its financial statements the identifiable assets acquired (including intangibles), the liabilities assumed and any noncontrolling interest in the acquired entity. Additionally, ASC 805-10 requires that all transaction costs of a business acquisition will be expensed as incurred. The adoption of ASC 805-10 in the first quarter of 2009 will only have an impact on the accounting on future business combinations.

In February 2008, the FASB issued Staff Position No. FAS 157-2, which has subsequently been codified in ASC 820-10. ASC 820-10 provided for a one-year deferral of the effective date of ASC 820-10 for non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The adoption of these provisions of ASC 820-10 on January 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, which has subsequently been codified in ASC 815-10, and which requires enhanced disclosures related to derivative and hedging activities and thereby seeks to improve the transparency of financial reporting. Under this statement, entities are required to provide enhanced disclosure related to: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedge items are accounted for under SFAS No.133, and its related interpretations; and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The Company adopted SFAS No. 161 as of January 1, 2009 and the applicable disclosures are detailed above in Derivative Instruments and Hedging Activities.

In May 2008, the FASB issued FASB Staff Position No. APB 14-1 (“FSP APB 14-1”), which has subsequently been codified in ASC 470-20, Debt, Debt with Conversion and Other Options (“ASC 470-20”), and which clarifies the accounting for convertible notes payable. ASC 470-20 requires the proceeds from the sale of convertible notes to be allocated between a liability component and an equity component. The resulting debt discount must be amortized over the period the debt is expected to remain outstanding as additional interest expense. ASC 470-20 requires retroactive application to all periods presented and is effective for fiscal years beginning after December 15, 2008 and became effective for the Company as of January 1, 2009. The Company has adopted ASC 470-20 as of January 1, 2009. See Note 6 (g).

In June 2008, the FASB ratified EITF Issue 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock, which has subsequently been codified in ASC 815-40, Derivatives and Hedging, Contracts in Entity’s Own Equity (“ASC 815-40”). Former guidance from paragraph 11(a) of SFAS No. 133 specified that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of operations would not be considered a derivative financial instrument. ASC 815-40 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the SFAS No. 133 paragraph 11(a) scope exception. ASC 815-40 is effective on January 1, 2009. The adoption of ASC 815-40 did not have a material impact on the Company’s consolidated financial statements.

In October 2008, the FASB issued FASB Staff Position No. FAS 157-3 which clarifies the application of SFAS No. 157, which has subsequently been codified in ASC 820-10. ASC 820-10 provides guidance in determining the fair value of a financial asset when the market for that financial asset is not active.

On April 1, 2009, the FASB issued three FASB Staff Positions intended to provide additional application guidance and enhance disclosures regarding the fair value of measurements and impairments of securities. FASB Staff Position No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides guidelines for making fair value measurements more consistent with the principles presented in SFAS No. 157. FASB Staff Position No. FAS 107-1 and APB No. 28-1, Interim Disclosures about Fair Value of Financial Instruments, enhances consistency in financial reporting by increasing the frequency of fair value disclosures. FASB Staff Position No. FAS 115-2 and No. FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. All three FASB Staff Positions have subsequently been codified in ASC 820-10, ASC 825-10, and ASC 320-10, Investments, Investments — Debt and Equity Securities, respectively. These codifications are effective for reporting periods ending after June 15, 2009 and the adoption of these codifications did not have a material impact on the Company’s consolidated financial statements.

On May 28, 2009, the FASB issued SFAS No. 165, Subsequent Events, which has subsequently been codified in ASC 855-10, Subsequent Events (“ASC 855-10”). The Company adopted ASC 855-10 in the second quarter of 2009. ASC 855-10 establishes the accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, that is, whether that date represents the date the financial statements were issued or were available to be issued. See above, “Basis of Presentation” for the related disclosures. The adoption of ASC 855-10 did not have a material impact on our consolidated financial statements.

On June 12, 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which has subsequently been codified in ASC 810-10. ASC 810-10 amends prior guidance established in FIN 46R and changes the consolidation guidance applicable to a variable interest entity (a “VIE”). It also amends the guidance governing the determination of whether an enterprise is the primary beneficiary of a VIE, and is therefore required to consolidate an entity by requiring a qualitative analysis rather than a quantitative analysis. The qualitative analysis will include, among other things, consideration of who has the power to direct the activities of the entity that most significantly impact the entity’s economic performance, and who has the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. This standard also requires continuous reassessments of whether an enterprise is the primary beneficiary of a VIE. Previously, FIN 46R required reconsideration of whether an enterprise was the primary beneficiary of a VIE only when specific events had occurred. Qualified special purpose entities, which were previously exempt from the application of this standard, will be subject to the provisions of this standard when it becomes effective. ASC 810-10 also requires enhanced disclosures about an enterprise’s involvement with a VIE. ASC 810-10 will be effective as of the beginning of interim and annual reporting periods that begin after November 15, 2009. The Company is currently evaluating the impact that these standards will have on its consolidated financial statements.

Fair Value of Financial Instruments

As mentioned above, the Company adopted SFAS No. 107-1 and APB No. 28-1 during the second quarter of 2009, which have subsequently been codified in ASC 825-10 and ASC 270-10, Presentation, Interim Reporting, respectively. This guidance requires quarterly fair value disclosures for financial instruments rather than annual disclosure. Disclosures about fair value of financial instruments are based on pertinent information available to management as of the valuation date. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented are not necessarily indicative of the amounts at which these instruments could be purchased, sold, or settled. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The Company’s financial instruments include cash and cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, and long-term debt. Substantially all of the Company’s long-term debt accrues interest at a floating rate, which re-prices frequently. Management believes the carrying amount of the aforementioned financial instruments is a reasonable estimate of fair value as of September 30, 2009 and December 31, 2008 due to the short-term maturity of these items or variable interest rate. The fair value of the Company’s fixed rate debt amounted to approximately $226.8 million and $242.0 million as of September 30, 2009 and December 31, 2008, respectively, using market interest rates ranging from 1.4% to 5.8%.

Reclassifications and Adoption of New Accounting Pronouncements

Certain prior year financial statement amounts have been reclassified to conform to the current year presentation.

The Company followed the guidance for a change in accounting principle under SFAS No. 154, Accounting Changes and Error Corrections (which has subsequently been codified in ASC 250-10, Accounting Changes and Error Corrections), to reflect the impact of the adoption of FSP APB 14-1, discussed above, which was effective January 1, 2009. As a result of these adoptions, the Company adjusted comparative consolidated financial statements of prior periods in this Quarterly Report on Form 10-Q.

The following consolidated balance sheet for the year ended December 31, 2008 and consolidated statement of operations and consolidated statement of cash flows for the three and nine months ended September 30, 2008 were affected by the changes in accounting principles (in thousands, except per share data):

		December 31, 2008
		As Originally								Effect of
Consolidated Balance Sheet		Reported				As Adjusted				Change
Deferred tax asset		$	66,279			$	61,005			$	(5,274	)
Other, net			14,490				13,963				(527	)
Long term debt and capital lease obligations			730,365				717,179				(13,186	)
Additional paid-in capital			232,022				242,158				10,136
Accumulated deficit			(80,088	)			(82,755	)			(2,667	)
Noncontrolling interest			18,017				17,933				(84	)

		Three Months Ended Sept. 30, 2008												Nine Months Ended Sept. 30, 2008
Consolidated Statement of		As Originally				As				Effect of				As Originally				As				Effect of
Operations		Reported				Adjusted				Change				Reported				Adjusted				Change
Interest expense, net		$	10,222			$	10,791			$	(569	)		$	31,053			$	32,760			$	(1,707	)
Income tax benefit			(6,109	)			(6,336	)			228				(10,621	)			(11,304	)			683
Net loss			(8,600	)			(8,962	)			(342	)			(13,944	)			(14,968	)			(1,024	)
Net income attributable to noncontrolling interest			(399	)			(388	)			(10	)			(2,762	)			(2,731	)			(31	)
Net loss attributable to common stockholders			(8,999	)			(9,330	)			(331	)			(16,706	)			(17,699	)			(993	)
Loss per share attributable to common stockholders:
Basic and diluted			(0.29	)			(0.30	)			(0.01	)			(0.52	)			(0.55	)			(0.03	)

		Nine Months Ended September 30, 2008
		As Originally								Effect of
Consolidated Statement of Cash Flows		Reported				As Adjusted				Change
Net loss		$	(13,944	)		$	(14,968	)		$	(1,024	)
Amortization of discount on convertible debt			—				1,707				1,707
Deferred tax benefit			(10,621	)			(11,304	)			(683	)

3. Income (Loss) Per Share

Basic earnings per share is calculated based on the weighted average number of common stock outstanding during the period. Diluted earnings per share include the effect of potential shares outstanding, including dilutive securities. Potential dilutive securities may include shares and options granted under the Company’s stock incentive plan and membership units in Morgans Group LLC, which may be exchanged for shares of the Company’s common stock under certain circumstances. The 954,065 outstanding Morgans Group LLC membership units (which may be converted to common stock) at September 30, 2009 have been excluded from the diluted net income (loss) per common share calculation, as there would be no effect on reported diluted net income (loss) per common share. All unvested restricted stock units, LTIP Units (as defined in Note 7), stock options and contingent Convertible Notes (as defined in Note 6) have been excluded from loss per share for the three months ended September 30, 2009 and 2008 and the nine months ended September 30, 2009 and 2008 as they are anti-dilutive.

The table below details the components of the basic and diluted loss per share calculations (in thousands, except for per share data):

		Three Months Ended September 30, 2009												Three Months Ended September 30, 2008
						Weighted												Weighted
						Average				EPS								Average				EPS
		Loss				Shares				Amount				Loss				Shares				Amount
Basic and diluted loss per share		$	(27,817	)			29,737			$	(0.94	)		$	(9,330	)			31,231			$	(0.30	)

		Nine Months Ended September 30, 2009												Nine Months Ended September 30, 2008
						Weighted												Weighted
						Average				EPS								Average				EPS
		Loss				Shares				Amount				Loss				Shares				Amount
Basic and diluted loss per share		$	(48,458	)			29,941			$	(1.62	)		$	(17,699	)			31,953			$	(0.55	)

4. Investments in and Advances to Unconsolidated Joint Ventures

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

Investments

		As of				As of
		September 30,				December 31,
Entity		2009				2008
Mondrian South Beach			20,319				24,785
Shore Club			57				57
Echelon Las Vegas			—				17,198
Mondrian SoHo			8,335				7,564
Ames			11,228				7,049
Other			101				101
Total investments in and advances to unconsolidated joint ventures		$	40,040			$	56,754

		As of				As of
		September 30,				December 31,
Entity		2009				2008
Morgans Hotel Group Europe Limited		$	(2,778	)		$	(2,689	)
Restaurant Venture — SC London			(1,458	)			(811	)
Hard Rock Hotel & Casino			(8,194	)			(11,063	)
Total losses from and distributions in excess of investment in unconsolidated joint ventures		$	(12,430	)		$	(14,563	)

Equity in income (loss) from unconsolidated joint ventures

		Three Months Ended				Three Months Ended				Nine Months Ended				Nine Months Ended
Entity		Sept. 30, 2009				Sept. 30, 2008				Sept. 30, 2009				Sept. 30, 2008
Mondrian South Beach		$	(2,580	)		$	(369	)		$	(4,667	)		$	(1,083	)
Shore Club			—				—				—				—
Echelon Las Vegas			(80	)			(124	)			(191	)			(735	)
Morgans Hotel Group Europe Ltd.			625				(2,527	)			798				897
Restaurant Venture — SC London			(230	)			(131	)			(647	)			184
Hard Rock Hotel & Casino			—				(4,468	)			—				(15,796	)
Other			3				2				7				7
Total		$	(2,262	)		$	(7,617	)		$	(4,700	)		$	(16,526	)

Morgans Hotel Group Europe Limited

As of September 30, 2009, the Company owned interests in two hotels in London, England, St Martins Lane, a 204-room hotel, and Sanderson, a 150-room hotel, through a 50/50 joint venture known as Morgans Hotel Group Europe Limited (“Morgans Europe”) with Walton MG London Investors V, L.L.C.

Under a management agreement with Morgans Europe, the Company earns management fees and a reimbursement for allocable chain service and technical service expenses. The Company is also entitled to an incentive management fee and a capital incentive fee. The Company did not earn any incentive fees during the nine months ended September 30, 2009 or 2008.

Morgans Europe has outstanding mortgage debt of £101.0 million, or approximately $160.5 million at the exchange rate of 1.59 US dollars to GBP at September 30, 2009, which matures on November 24, 2010. The joint venture is currently considering various options with respect to the refinancing of this mortgage obligation.

Net income or loss and cash distributions or contributions are allocated to the partners in accordance with ownership interests. The Company accounts for this investment under the equity method of accounting.

Mondrian South Beach

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

The joint venture acquired the existing building and land for a gross purchase price of $110.0 million. An initial equity investment of $15.0 million from each of the Company and Hudson Capital was funded at closing, and subsequently each member also contributed $8.0 million of additional equity. The Company and an affiliate of Hudson Capital provided additional mezzanine financing of approximately $22.5 million in total to the joint venture to fund completion of the construction at Mondrian South Beach in 2008. Additionally, the joint venture initially received mortgage loan financing of approximately $124.0 million at a rate of LIBOR, based on the rate set date, plus 300 basis points. A portion of this mortgage debt was paid down, prior to the amendment discussed below, with proceeds obtained from condominium sales. In April 2008, the Mondrian South Beach joint venture obtained a mezzanine loan of $28.0 million bearing interest at LIBOR, based on the rate set date, plus 600 basis points. The mezzanine loan was also amended in November 2008, as discussed below.

On November 25, 2008, together with its joint venture partner, the Company amended and restated the mortgage loan and mezzanine loan agreements related to the Mondrian South Beach to provide for, among other things, four one-year extension options of the third-party financing, totaling $95.6 million as of September 30, 2009. Under the amended agreements, the initial maturity date of August 1, 2009 can be extended to July 29, 2013, subject to certain conditions including an amortization payment of approximately $17.5 million on August 1, 2009 for the first such annual extension, repayment of the remainder of the A-Note, as defined in the agreements, by August 1, 2010 for the exercise of the second annual extension, achievement of defined debt service coverage ratios for the exercise of the third and fourth annual extensions, and achievement of a loan to value test for the fourth annual extension. The loans matured on August 1, 2009 and were not repaid or extended. The Company is currently operating Mondrian South Beach. The joint venture is in discussions with the lenders to extend the maturity.

A standard non-recourse carve-out guaranty by Morgans Group LLC is in place for the Mondrian South Beach loans. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, the Company and affiliates of its partner may have continuing obligations under a construction completion guaranty. The Company and affiliates of its partner also have an agreement to purchase approximately $14 million each of condominium units under certain conditions, including an event of default. As noted above, the joint venture is in discussions with the lenders to extend the maturity of the loans.

The joint venture is in the process of selling units as condominiums, subject to market conditions, and unit buyers will have the opportunity to place their units into the hotel’s rental program. In addition to hotel management fees, the Company could also realize fees from the sale of condominium units.

Hard Rock Hotel & Casino

Formation and Financing

On February 2, 2007, the Company and Morgans Group LLC (together, the “Morgans Parties”), an affiliate of DLJ Merchant Banking Partners (“DLJMB”), and certain other DLJMB affiliates (such affiliates, together with DLJMB, collectively the “DLJMB Parties”) completed the acquisition of the Hard Rock Hotel & Casino in Las Vegas (“Hard Rock”). The acquisition was completed through a joint venture entity, Hard Rock Hotel Holdings, LLC, funded one-third, or approximately $57.5 million, by the Morgans Parties, and two-thirds, or approximately $115.0 million, by the DLJMB Parties. In connection with the joint venture’s acquisition of the Hard Rock, certain subsidiaries of the joint venture entered into a debt financing in the form of a real estate loan in the commercial mortgage-backed securities market (the “CMBS Facility”) that matures on February 9, 2010, with two one-year extension options, subject to certain conditions. The CMBS Facility provides for a $760.0 million acquisition loan that was used to fund the acquisition and a construction loan of up to $620.0 million for the expansion project at the Hard Rock. As of September 30, 2009, the joint venture had drawn $492.0 million from the construction loan. The Company has entered into standard joint and several guarantees in connection with the CMBS Facility, including construction completion guarantees related to the Hard Rock expansion, which is scheduled to be completed by the end of 2009. In its joint venture agreement with DLJMB, the Company has agreed to be responsible for the first $50.0 million of exposure on the completion guarantees, subject to certain conditions. In August 2009, the joint venture entered into a non-binding term sheet with the lenders under the CMBS Facility to amend the terms of the loan agreements governing the CMBS Facility. There can be no assurance that the joint venture will complete the amendment process with the lenders under the CMBS Facility on a timely basis or at all.

Land Loans

On August 1, 2008, a subsidiary of the Hard Rock joint venture completed an intercompany land purchase with respect to an 11-acre parcel of land located adjacent to the Hard Rock. To finance a portion of the purchase, a subsidiary of the Hard Rock joint venture entered into a $50.0 million loan agreement with Column Financial, Inc. NorthStar Realty Finance Corp. is a participant lender in the loan. The loan had an initial maturity date of August 9, 2009. In connection with the land loan, Morgans Group LLC, together with DLJMB, as guarantors, entered into a non-recourse carve-out guaranty agreement, which is triggered in the event of certain “bad boy” acts, in favor of Column Financial, Inc. Under the joint venture agreement, DLJMB has agreed to be responsible for 100% of any liability under the guaranty, subject to certain conditions.

As part of the intercompany land purchase, the DLJMB Parties contributed an aggregate of approximately $74.0 million to the joint venture to fund the remaining portion of the $110.0 million of proceeds necessary to complete the intercompany land purchase and to pay for related costs and expenses. The proceeds from the financing, together with the equity contribution from the DLJMB Parties, were used to fully satisfy an amortization payment of $110.0 million that was required under the joint venture’s CMBS Facility.

At maturity of the land loan on August 9, 2009, the joint venture’s subsidiary borrower did not repay the loan. On October 23, 2009, the joint venture received a notice of default from the lenders under the land acquisition financing with respect to the subsidiary borrower’s failure to repay the loan in full on the then effective maturity date. However, the lenders under the land acquisition financing have not, to the Company’s knowledge, accelerated the debt or exercised any other remedies. Further, the joint venture has entered into a term sheet with the lenders under the land acquisition financing to amend the loan agreement governing the land acquisition financing to, among other things, extend the maturity date to August 9, 2011 and thereby cure the event of default. There can be no assurance that the joint venture will be able to complete the amendment process with the lenders under the land acquisition financing on a timely basis or at all.

Capital Structure

As a result of additional disproportionate cash contributions made by the DLJMB Parties since the formation of the Hard Rock joint venture, the Company held approximately an 11.3% ownership interest in the joint venture as of September 30, 2009 based on cash contributions, and applying a weighting of 1.75x to such contributions, based on the last agreed weighting for capital contributions beyond the amount initially committed by the DLJMB Parties. Some of these additional contributions by the DLJMB Parties may ultimately receive a greater weighting based on an appraisal process included in the joint venture agreement or as otherwise agreed by the parties, which would further dilute the Company’s ownership interest. As of September 30, 2009, the Company has approximately $8.2 million of letters of credit outstanding toward the expansion, which are expected to be funded in the fourth quarter of 2009. Although the Company has the right to participate in any future capital contributions that may be called by the joint venture’s board of directors, the Company has no obligation to fund such contributions. To the extent the Company decides not to participate in any such contribution, its interest in the joint venture will be diluted.

Management Agreement

Under an amended property management agreement, the Company operates the hotel, retail, food and beverage, entertainment and all other businesses related to the Hard Rock, excluding the casino prior to March 1, 2008, as discussed below. Under the terms of the agreement, the Company receives a management fee and a chain service expense reimbursement of all non-gaming revenue including casino rents and all other rental income. The Company can also earn an incentive management fee based on EBITDA, as defined, above certain levels. The term of the management contract is 20 years with two 10-year renewals. Beginning 12 months following completion of the expansion, the Company’s management agreement is subject to certain performance tests, namely achievement of an EBITDA hurdle, as defined in the amended property management agreement.

Echelon Las Vegas

In January 2006, the Company entered into a 50/50 joint venture with a subsidiary of Boyd Gaming Corporation (“Boyd”), through which the joint venture plans to develop Delano Las Vegas and Mondrian Las Vegas as part of Boyd’s Echelon project.

On August 1, 2008, Boyd announced that it will delay the entire Echelon project due to the current capital markets and economic conditions. On September 23, 2008, the Company and Boyd amended their joint venture agreement to, among other things, extend the deadline by which the joint venture must obtain construction financing for the development of Delano Las Vegas and Mondrian Las Vegas to December 31, 2009. The amended joint venture agreement also provided for the immediate return of the $30.0 million deposit the Company had provided for the project, plus interest, the elimination of the Company’s future funding obligations of approximately $41.0 million and the elimination of any obligation by the Company to provide a construction loan guaranty. Each partner has the right to terminate the joint venture for any reason prior to December 31, 2009. Additionally, the terms of the management agreement, which provide for the Company to operate the joint venture hotels upon their completion, remain unchanged.

Given the current economic environment, in September 2009, the Company recorded a non-cash impairment charge of $17.2 million related to its investment in the Echelon Las Vegas joint venture. The costs related primarily to the plans and drawings for the development project. While the Company has not made any formal decisions regarding the future of the Echelon Las Vegas project, the Company does not expect to develop this project in the next three to five years.

Mondrian SoHo

In June 2007, the Company entered into an agreement for an approximately 20% equity interest in a joint venture with Cape Advisors Inc. to acquire and develop a Mondrian hotel in the SoHo neighborhood of New York City. The Mondrian SoHo is currently expected to have approximately 270 rooms, a restaurant, bar, meeting rooms, exercise facility and a penthouse suite. The Company has contributed approximately $4.8 million in equity and $3.5 million in mezzanine loans to the joint venture through September 30, 2009. The Company has signed a 10-year management contract with two 10-year extension options to operate the hotel upon its completion, which is currently expected to occur in the middle of 2010.

Ames

On June 17, 2008, the Company, Normandy Real Estate Partners, and Ames Hotel Partners entered into a joint venture agreement as part of the development of the Ames hotel in Boston, located near Government Center, Boston Common and Faneuil Hall. The Company has signed a long-term management contract to operate the hotel upon its completion. Ames is expected to open in November 2009 and to have approximately 115 guest rooms, a restaurant, bar and exercise facility.

The Company has contributed approximately $11.2 million in equity through September 30, 2009 for an approximately 35% interest in the joint venture. The project is expected to qualify for federal and state historic rehabilitation tax credits. The joint venture has obtained a development loan for $46.5 million, which amount was outstanding as of September 30, 2009.

Shore Club

The Company operates Shore Club under a management contract and owned a minority ownership interest of approximately 7% at September 30, 2009. On September 15, 2009, the joint venture that owns Shore Club received a notice of default on behalf of the special servicer for the lender on the joint venture’s mortgage loan for failure to make its September monthly payment and for failure to maintain its debt service coverage ratio, as required by the loan documents. On October 7, 2009, the joint venture received a second letter on behalf of the special servicer for the lender accelerating the payment of all outstanding principal, accrued interest, and all other amounts due on the mortgage loan. The lender also demanded that the joint venture transfer all rents and revenues directly to the lender to satisfy the joint venture’s debt. The Company understands that the joint venture and the lender are currently in discussions to address the default.

5. Other Liabilities

Other liabilities consist of the following (in thousands):

		As of				As of
		September 30,				December 31,
		2009				2008
Interest swap liability (Note 2)		$	12,977			$	21,909
Designer fee payable			13,696				13,175
Other			(6	)			571
		$	26,667			$	35,655

Designer Fee Payable

The Former Parent had an exclusive service agreement with a hotel designer, pursuant to which the designer has initiated various claims related to the agreement. Although the Company is not a party to the agreement, it may have certain contractual obligations or liabilities to the Former Parent in connection with the agreement. While defenses and/or counter-claims may be available to the Company or the Former Parent in connection with any claims brought by the designer, a liability amount has been recorded in these consolidated financial statements. According to the agreement, the designer is owed a base fee for each designed hotel, plus 1% of Gross Revenues, as defined in the agreement, for a 10-year period from the opening of each hotel. The estimated costs of the design services were capitalized as a component of the applicable hotel and are being amortized over the five-year estimated life of the related design elements. Interest is accreted each year on the liability and charged to interest expense using a rate of 9%. Changes to the liability recorded in these consolidated financial statements are recorded as an adjustment to the capitalized design fee and amortized prospectively. Adjustments to the liability after the five-year life of the design asset will be charged directly to operations. In addition, the agreement also called for the designer to design a minimum number of projects for which the designer would be paid a minimum fee, which is recorded in the above liability. See further discussion in Note 9.

6. Long-Term Debt and Capital Lease Obligations

Long-term debt and capital lease obligations consists of the following (in thousands):

		As of				As of				Interest rate at
		September 30,				December 31,				September 30,
Description		2009				2008				2009
Notes secured by Hudson and Mondrian(a)		$	370,000			$	370,000			LIBOR + 1.25		%
Clift debt(b)			82,799				81,578				9.6	%
Promissory note(c)			10,500				10,000				11.0	%
Note secured by Mondrian Scottsdale (d)			40,000				40,000			LIBOR + 2.30		%
Liability to subsidiary trust(e)			50,100				50,100				8.68	%
Revolving credit facility(f)			23,508				—					(f)
Convertible Notes — Face Value $172.5 million(g)			161,022				159,314				2.375	%
Capital lease obligations			6,129				6,187			various
Total long-term debt and capital lease obligations		$	744,058			$	717,179

(a) Mortgage Agreement — Notes secured by Hudson and Mondrian Los Angeles

On October 6, 2006, subsidiaries of the Company entered into non-recourse mortgage financings with Wachovia Bank, National Association, as lender, consisting of two separate mortgage loans and a mezzanine loan (collectively, the “Mortgages”). As of September 30, 2009, the Mortgages were comprised of a $217.0 million first mortgage note secured by Hudson, a $32.5 million mezzanine loan secured by a pledge of the equity interests in the Company’s subsidiary owning Hudson, and a $120.5 million first mortgage note secured by Mondrian Los Angeles. As discussed below, the $32.5 million mezzanine loan secured by the equity interests in the Company’s subsidiary owning Hudson was reduced to $26.5 million in October 2009.

The Mortgages bear interest at a blended rate of 30-day LIBOR plus 125 basis points. The Company maintains swaps that effectively fix the LIBOR rate on the debt under the Mortgages at approximately 5.0% through the initial maturity date.

The Mortgages mature on July 12, 2010. The Company has the option of extending the maturity date of the Mortgages to October 15, 2011 provided that certain extension requirements are achieved, including maintaining a debt service coverage ratio, as defined, at the subsidiary owning the relevant hotel for the two fiscal quarters preceding the maturity date of 1.55 to 1.00 or greater. A portion of the Mortgages may need to be repaid in order to meet this covenant, or the Company may consider refinancing these Mortgages.

On October 14, 2009, the Company entered into an agreement with one of its lenders which holds, among other loans, the mezzanine loan on Hudson. Under the agreement, the Company paid an aggregate of $11.2 million to (i) reduce the principal balance of the mezzanine loan from $32.5 million to $26.5 million, (ii) acquire interests in $4.5 million of certain of the Company’s other debt obligations, (iii) pay fees, and (iv) obtain a forbearance from the mezzanine lender until October 12, 2013 from exercising any remedies resulting from a maturity default, subject only to maintaining certain interest rate caps and making an additional aggregate payment of $1.3 million to purchase additional interests in certain of the Company’s other debt obligations prior to October 11, 2011. The Company believes these transactions will have the practical effect of extending the Hudson mezzanine loan by three years and three months beyond its scheduled maturity of July 12, 2010. The mezzanine lender also has agreed to cooperate with the Company in its efforts to seek an extension of the $217 million Hudson mortgage loan, which is also set to mature on July 12, 2010, and to consent to certain refinancings and other modifications of the Hudson mortgage loan.

The prepayment clause in the Mortgages permits the Company to prepay the Mortgages in whole or in part on any business day.

The Mortgages require the Company’s subsidiary borrowers (entities owning Hudson and Mondrian Los Angeles) to fund reserve accounts to cover monthly debt service payments. Those subsidiary borrowers are also required to fund reserves for property, sales and occupancy taxes, insurance premiums, capital expenditures and the operation and maintenance of those hotels. Reserves are deposited into restricted cash accounts and are released as certain conditions are met. The subsidiary borrowers are not permitted to have any liabilities other than certain ordinary trade payables, purchase money indebtedness, capital lease obligations and certain other liabilities.

The Mortgages prohibit the incurrence of additional debt on Hudson and Mondrian Los Angeles. Furthermore, the subsidiary borrowers are not permitted to incur additional mortgage debt or partnership interest debt. In addition, the Mortgages do not permit (1) transfers of more than 49% of the interests in the subsidiary borrowers, Morgans Group LLC or the Company or (2) a change in control of the subsidiary borrowers or in respect of Morgans Group LLC or the Company itself without, in each case, complying with various conditions or obtaining the prior written consent of the lender.

The Mortgages provide for events of default customary in mortgage financings, including, among others, failure to pay principal or interest when due, failure to comply with certain covenants, certain insolvency and receivership events affecting the subsidiary borrowers, Morgans Group LLC or the Company, and breach of the encumbrance and transfer provisions. In the event of a default under the Mortgages, the lender’s recourse is limited to the mortgaged property, unless the event of default results from insolvency, a voluntary bankruptcy filing or a breach of the encumbrance and transfer provisions, in which event the lender may also pursue remedies against Morgans Group LLC.

(b) Clift Debt

In October 2004, Clift Holdings LLC sold the hotel to an unrelated party for $71.0 million and then leased it back for a 99-year lease term. Under this lease, the Company is required to fund operating shortfalls including the lease payments and to fund all capital expenditures. This transaction did not qualify as a sale due to the Company’s continued involvement and therefore is treated as a financing.

The lease payment terms are as follows:

Years 1 and 2		$2.8 million per annum (completed in October 2006)
Years 3 to 10		$6.0 million per annum
Thereafter		Increased at 5-year intervals by a formula tied to increases in the Consumer Price Index. At year 10, the increase has a maximum of 40% and a minimum of 20%. At each payment date thereafter, the maximum increase is 20% and the minimum is 10%.

(c) Promissory Note

The purchase of the property across from the Delano South Beach was partially financed with the issuance of a $10.0 million interest only non-recourse promissory note to the seller. The note matures on January 24, 2010 and currently bears interest at 11.0%, which was required to be prepaid in full at the time the note was extended in November 2008. The obligations under the note are secured by the property. Additionally, in January 2009, an affiliate of the seller financed an additional $0.5 million to pay for costs associated with obtaining necessary permits. This $0.5 million promissory note matures on January 24, 2010 and bears interest at 11%. The obligations under this note are secured with a pledge of the equity interests in the Company’s subsidiary that owns the property.

(d) Mondrian Scottsdale Debt

In May 2006, the Company obtained non-recourse mortgage and mezzanine financing on Mondrian Scottsdale. The $40.0 million mortgage and mezzanine loans accrue interest at LIBOR plus 2.3%. The loans matured on June 1, 2009 and were not repaid. The Company is currently operating Mondrian Scottsdale and is discussing various options with the lenders. The Company does not intend to commit significant monies toward the repayment or restructuring of the loans or the funding of operating deficits.

(e) Liability to Subsidiary Trust Issuing Preferred Securities

On August 4, 2006, a newly established trust formed by the Company, MHG Capital Trust I (the “Trust”), issued $50.0 million in trust preferred securities (the “Trust Securities”) in a private placement. The Company owns all of the $0.1 million of outstanding common stock of the Trust. The Trust used the proceeds of these transactions to purchase $50.1 million of junior subordinated notes issued by the Company’s operating company and guaranteed by the Company (the “Trust Notes”) which mature on October 30, 2036. The sole assets of the Trust consist of the Trust Notes. The terms of the Trust Notes are substantially the same as the Trust Securities. The Trust Notes and the Trust Securities have a fixed interest rate of 8.68% per annum during the first 10 years, after which the interest rate will float and reset quarterly at the three-month LIBOR rate plus 3.25% per annum. The Trust Notes are redeemable by the Trust, at the Company’s option, after five years at par. To the extent the Company redeems the Trust Notes, the Trust is required to redeem a corresponding amount of Trust Securities.

Prior to the amendment described below, the Trust Notes agreement required that the Company not fall below a fixed charge coverage ratio, defined generally as Consolidated EBITDA, excluding Clift’s EBITDA, over consolidated interest expense, excluding Clift’s interest expense, of 1.4 to 1.0 for four consecutive quarters. On November 2, 2009, the Company amended the Trust Notes agreement to permanently eliminate this financial covenant. The Company paid a one-time fee of $2.0 million in exchange for the permanent removal of the covenant.

The Company has identified that the Trust is a variable interest entity under ASC 810-10 (former guidance: FIN 46R). Based on management’s analysis, the Company is not the primary beneficiary since it does not absorb a majority of the expected losses, nor is it entitled to a majority of the expected residual returns. Accordingly, the Trust is not consolidated into the Company’s financial statements. The Company accounts for the investment in the common stock of the Trust under the equity method of accounting.

(f) Revolving Credit Facility

On October 6, 2006, the Company and certain of its subsidiaries entered into a revolving credit facility in the initial commitment amount of $225.0 million, which included a $50.0 million letter of credit sub-facility and a $25.0 million swingline sub-facility (collectively, the “Revolving Credit Facility”) with Wachovia Bank, National Association, as Administrative Agent, and the other lenders party thereto. In early 2009, the Company received notice that one of the lenders on the Revolving Credit Facility was taken over by the Federal Deposit Insurance Corporation. As such, the total initial commitment amount on the Revolving Credit Facility was reduced to approximately $220.0 million.

On August 5, 2009, the Company and certain of its subsidiaries entered into an amendment to the Revolving Credit Facility (the “Amended Revolving Credit Facility”).

Among other things, the Amended Revolving Credit Facility:

•

deleted the financial covenant requiring the Company to maintain certain leverage ratios;

•

revised the fixed charge coverage ratio (defined generally as the ratio of consolidated EBITDA excluding Mondrian Scottsdale’s EBITDA for the periods ending June 30, 2009 and September 30, 2009 and Clift’s EBITDA for all periods to consolidated interest expense excluding Mondrian Scottsdale’s interest expense for the periods ending June 30, 2009 and September 30, 2009 and Clift’s interest expense for all periods) that the Company is required to maintain for each four-quarter period to no less than 0.90 to 1.00 from the previous fixed charge coverage ratio of no less than 1.75 to 1.00. As of September 30, 2009, the Company’s fixed charge coverage ratio under the Amended Revolving Credit Facility was 1.63x;

•

limits defaults relating to bankruptcy and judgments to certain events involving the Company, Morgans Group LLC and subsidiaries that are parties to the Amended Revolving Credit Facility;

•

prohibits capital expenditures with respect to any hotels owned by the Company, the borrowers, as defined, or subsidiaries, other than maintenance capital expenditures for any hotel not exceeding 4% of the annual gross revenues of such hotel and certain other exceptions;

•

revised certain provisions related to permitted indebtedness, including, among other things, deleting certain provisions permitting unsecured indebtedness and indebtedness for the acquisition or expansion of hotels;

•

prohibits repurchases of the Company’s common equity interests by the Company or Morgans Group LLC;

•

imposes certain limits on any secured swap agreements entered into after the effective date of the Amended Revolving Credit Facility; and

•

provided for a waiver of any default or event of default, to the extent that a default or event of default existed for failure to comply with any financial covenant under the existing Revolving Credit Facility as of June 30, 2009 and/or for the four fiscal quarters ended June 30, 2009.

In addition to the provisions above, the Amended Revolving Credit Facility reduced the maximum aggregate amount of the commitments from $220.0 million to $125.0 million, which amount is available under two tranches: (i) a revolving credit facility in an amount equal to $90.0 million (the “New York Tranche”), which is secured by a mortgage on Morgans Hotel and Royalton Hotel (the “New York Properties”) and a mortgage on the Delano Hotel (the “Florida Property”); and (ii) a revolving credit facility in an amount equal to $35.0 million (the “Florida Tranche”), which is secured by the mortgage on the Florida Property (but not the New York Properties). The Amended Revolving Credit Facility also provides for a letter of credit facility in the amount of $25.0 million, which is secured by the mortgages on the New York Properties and the Florida Property. At any given time, the amount available for borrowings under the Amended Revolving Credit Facility is contingent upon the borrowing base valuation, which is calculated as the lesser of (i) 60% of appraised value and (ii) the implied debt service coverage value of certain collateral properties securing the Amended Revolving Credit Facility; provided that the portion of the borrowing base attributable to the New York Properties will never be less than 35% of the appraised value of the New York Properties. Total availability under the Amended Revolving Credit Facility as of September 30, 2009 was $123.2 million, of which the outstanding principal balance was $23.5 million, and approximately $9.8 million of letters of credit were posted, all allocated to the Florida Tranche.

The Amended Revolving Credit Facility bears interest at a fluctuating rate measured by reference to, at the Company’s election, either LIBOR (subject to a LIBOR floor of 1%) or a base rate, plus a borrowing margin. LIBOR loans have a borrowing margin of 3.75% per annum and base rate loans have a borrowing margin of 2.75% per annum. The Amended Revolving Credit Facility also provides for the payment of a quarterly unused facility fee equal to the average daily unused amount for each quarter multiplied by 0.5%.

The owners of the New York Properties, wholly-owned subsidiaries of the Company, have paid all mortgage recording and other taxes required for the mortgage on the New York Properties to secure in full the amount available under the New York Tranche. The commitments under the Amended Revolving Credit Facility terminate on October 5, 2011, at which time all outstanding amounts under the Amended Revolving Credit Facility will be due.

The Amended Revolving Credit Facility provides for customary events of default, including: failure to pay principal or interest when due; failure to comply with covenants; any representation proving to be incorrect; defaults relating to acceleration of, or defaults on, certain other indebtedness of at least $10.0 million in the aggregate; certain insolvency and bankruptcy events affecting the Company, Morgans Group LLC or certain subsidiaries of the Company that are party to the Amended Revolving Credit Facility; judgments in excess of $5.0 million in the aggregate affecting the Company, Morgans Group LLC and certain subsidiaries of the Company that are party to the Amended Revolving Credit Facility; the acquisition by any person of 40% or more of any outstanding class of capital stock having ordinary voting power in the election of directors of the Company; and the incurrence of certain ERISA liabilities in excess of $5.0 million in the aggregate.

(g) October 2007 Convertible Notes Offering

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

The Convertible Notes are senior subordinated unsecured obligations of the Company and are guaranteed on a senior subordinated basis by the Company’s operating company, Morgans Group LLC. The Convertible Notes are convertible into shares of the Company’s common stock under certain circumstances and upon the occurrence of specified events.

Interest on the Convertible Notes is payable semi-annually in arrears on April 15 and October 15 of each year, beginning on April 15, 2008, and the Convertible Notes mature on October 15, 2014, unless previously repurchased by the Company or converted in accordance with their terms prior to such date. The initial conversion rate for each $1,000 principal amount of Convertible Notes is 37.1903 shares of the Company’s common stock, representing an initial conversion price of approximately $26.89 per share of common stock. The initial conversion rate is subject to adjustment under certain circumstances.

On January 1, 2009, the Company adopted ASC 470-20 (former literature: FSP APB 14-1), which clarifies the accounting for convertible notes payable. ASC 470-20 requires the proceeds from the issuance of convertible notes to be allocated between a debt component and an equity component. The debt component is measured based on the fair value of similar debt without an equity conversion feature, and the equity component is determined as the residual of the fair value of the debt deducted from the original proceeds received. The resulting discount on the debt component is amortized over the period the debt is expected to be outstanding as additional interest expense. ASC 470-20 required retroactive application to all periods presented. The equity component, recorded as additional paid-in capital, was $10.1 million, which represents the difference between the proceeds from issuance of the Convertible Notes and the fair value of the liability, net of deferred taxes of $5.3 million as of the date of issuance of the Convertible Notes.

In connection with the issuance of the Convertible Notes, the Company entered into convertible note hedge transactions with respect to the Company’s common stock (the “Call Options”) with Merrill Lynch Financial Markets, Inc. and Citibank, N.A. (collectively, the “Hedge Providers”). The Call Options are exercisable solely in connection with any conversion of the Convertible Notes and pursuant to which the Company will receive shares of the Company’s common stock from the Hedge Providers equal to the number of shares issuable to the holders of the Convertible Notes upon conversion. The Company paid approximately $58.2 million for the Call Options.

In connection with the sale of the Convertible Notes, the Company also entered into separate warrant transactions with Merrill Lynch Financial Markets, Inc. and Citibank, N.A., whereby the Company issued warrants (the “Warrants”) to purchase 6,415,327 shares of common stock, subject to customary anti-dilution adjustments, at an exercise price of approximately $40.00 per share of common stock. The Company received approximately $34.1 million from the issuance of the Warrants.

The Company recorded the purchase of the Call Options, net of the related tax benefit of approximately $20.3 million, as a reduction of additional paid-in capital and the proceeds from the Warrants as an addition to additional paid-in capital in accordance with EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company’s Own Stock, which has been subsequently codified in ASC 815-30, Derivatives and Hedging, Cash Flow Hedges.

In February 2008, the Company filed a registration statement with the Securities and Exchange Commission to cover the resale of shares of the Company’s common stock that may be issued from time to time upon the conversion of the Convertible Notes.

7. Omnibus Stock Incentive Plan

On February 9, 2006, the Board of Directors of the Company adopted the Morgans Hotel Group Co. 2006 Omnibus Stock Incentive Plan (the “2006 Stock Incentive Plan”). The 2006 Stock Incentive Plan provided for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock units (“RSUs”) and other equity-based awards, including membership units in Morgans Group LLC which are structured as profits interests (“LTIP Units”), or any combination of the foregoing. The eligible participants in the 2006 Stock Incentive Plan included directors, officers and employees of the Company. An aggregate of 3,500,000 shares of common stock of the Company were reserved and authorized for issuance under the 2006 Stock Incentive Plan, subject to equitable adjustment upon the occurrence of certain corporate events. On April 23, 2007, the Board of Directors of the Company adopted, and at the annual meeting of stockholders on May 22, 2007, the stockholders approved, the Company’s 2007 Omnibus Incentive Plan (the “2007 Incentive Plan”), which amended and restated the 2006 Stock Incentive Plan and increased the number of shares reserved for issuance under the plan by up to 3,250,000 shares to a total of 6,750,000 shares. Awards other than options and stock appreciation rights reduce the shares available for grant by 1.7 shares for each share subject to such an award. On April 10, 2008, the Board of Directors of the Company adopted, and at the annual meeting of stockholders on May 20, 2008, the stockholders approved, an Amended and Restated 2007 Omnibus Incentive Plan (the “Amended 2007 Incentive Plan”) which, among other things, increased the number of shares reserved for issuance under the plan by 1,860,000 shares from 6,750,000 shares to 8,610,000 shares.

In August 2009, the Board of Directors of the Company issued an aggregate of 580,000 RSUs to one executive officer, other senior executives and employees under the Amended 2007 Incentive Plan. All grants vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant. The fair value of each such RSU granted was between $4.96 and $5.09 at the grant date.

Also in August 2009, the Company issued an aggregate of 80,640 RSUs to the Company’s non-employee directors under the Amended 2007 Incentive Plan, which vested immediately upon grant. The fair value of each such RSU was $4.96 at the grant date.

A summary of stock-based incentive awards as of September 30, 2009 is as follows (in units, or shares, as applicable):

		Restricted Stock
		Units				LTIP Units				Stock Options
Outstanding as of January 1, 2009			873,553				1,560,788				2,082,943
Granted during 2009			660,640				465,232				—
Distributed/exercised during 2009			(166,128	)			—				—
Forfeited during 2009			(79,659	)			—				(410,797	)
Outstanding as of September 30, 2009			1,288,406				2,026,020				1,672,146
Vested as of September 30, 2009			123,040				1,097,813				1,066,393

As of September 30, 2009 and December 31, 2008, there were approximately $16.3 million and $21.8 million, respectively, of total unrecognized compensation costs related to unvested share awards. As of September 30, 2009, the weighted-average period over which the unrecognized compensation expense will be recorded is approximately one year.

Total stock compensation expense, which is included in corporate expenses on the accompanying consolidated financial statements, was $3.2 million and $4.8 million for the three months ended September 30, 2009 and September 30, 2008, respectively, and $8.8 million and $12.1 million for the nine months ended September 30, 2009 and September 30, 2008.

8. Related Party Transactions

The Company earned management fees, chain services fees and fees for certain technical services and has receivables from hotels it owns through investments in unconsolidated joint ventures. These fees totaled approximately $3.9 million and $5.8 million for the three months ended September 30, 2009 and September 30, 2008, respectively, and $11.3 million and $14.9 million for the nine months ended September 30, 2009 and 2008, respectively.

As of September 30, 2009 and December 31, 2008, the Company had receivables from these affiliates of approximately $13.1 million and $7.9 million, respectively, which are included in receivables from related parties on the accompanying consolidated balance sheets.

9. Litigation

Hard Rock Financial Advisory Agreement

In July 2008, the Company received an invoice from Credit Suisse Securities (USA) LLC (“Credit Suisse”) for $9.4 million related to the Financial Advisory Agreement the Company entered into with Credit Suisse in July 2006. Under the terms of the financial advisory agreement, Credit Suisse received a transaction fee for placing DLJMB, an affiliate of Credit Suisse, in the Hard Rock joint venture. The transaction fee, which was paid by the Hard Rock joint venture at the closing of the acquisition of the Hard Rock and related assets on February 2007, was based upon an agreed upon percentage of the initial equity contribution made by DLJMB in entering into the joint venture. The invoice received in July 2008 alleges that as a result of events subsequent to the closing of the Hard Rock acquisition transactions, Credit Suisse is due additional transaction fees. The Company believes this invoice is invalid, and would otherwise be a Hard Rock joint venture liability.

Potential Litigation

The Company understands that Mr. Philippe Starck has attempted to initiate arbitration proceedings in the London Court of International Arbitration regarding an exclusive service agreement that he entered into with Residual Hotel Interest LLC (formerly known as Morgans Hotel Group LLC) in February 1998 regarding the design of certain hotels now owned by the Company. The Company is not a party to these proceedings at this time. See Note 5 of the consolidated financial statements.

Other Litigation

The Company is involved in various lawsuits and administrative actions in the normal course of business. In management’s opinion, disposition of these lawsuits is not expected to have a material adverse effect on the Company’s financial positions, results of operations or liquidity.

10. Preferred Securities

On October 15, 2009, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P. (collectively, the “Investors”). Under the Securities Purchase Agreement, the Company issued and sold to the Investors (i) 75,000 of the Company’s Series A Preferred Securities, $1,000 liquidation preference per share (the “Series A Preferred Securities”), and (ii) warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share.

The Series A Preferred Securities have an 8% dividend rate for the first five years, a 10% dividend rate for years six and seven, and a 20% dividend rate thereafter. The Company has the option to redeem any or all of the Series A Preferred Securities at par at any time. The Series A Preferred Securities have limited voting rights and only vote on the authorization to issue senior preferred, amendments to their certificate of designations, amendments to the Company’s charter that adversely affect the Series A Preferred Securities and certain change in control transactions.

The warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share have a 7-1/2 year term and are exercisable utilizing a cashless exercise method only, resulting in a net share issuance. The exercise of the warrants is subject to approval by the Company’s stockholders of the issuance of the shares of common stock issuable upon exercise. The exercise of the warrants is also subject to an exercise cap which effectively limits the Investors’ beneficial ownership of the Company’s common stock to 9.9% at any one time. The exercise price and number of shares subject to the warrants are both subject to anti-dilution adjustments. Under the Securities Purchase Agreement, the Investors have consent rights over certain transactions for so long as they collectively own or have the right to purchase through exercise of the warrants 6,250,000 shares of the Company’s common stock, including (subject to certain exceptions and limitations):

•

the sale of substantially all of the Company’s assets to a third party;

•

the acquisition by the Company of a third party where the equity investment by the Company is $100 million or greater;

•

the acquisition of the Company by a third party; or

•

any change in the size of the Company’s Board of Directors to a number below 7 or above 9.

Subject to certain exceptions, the Investors may not transfer any Series A Preferred Securities, warrants or common stock until October 15, 2012. The Investors are also subject to certain standstill arrangements as long as they beneficially own over 15% of the Company’s common stock. Until October 15, 2010, the Investors have certain rights to purchase their pro rata share of any equity or debt securities offered or sold by the Company.

In connection with the investment by the Investors, the Company paid to the Investors a commitment fee of $2.4 million and reimbursed the Investors for $600,000 of expenses.

The Company and Yucaipa American Alliance Fund II, LLC, an affiliate of the Investors (the “Fund Manager”), also entered into a Real Estate Fund Formation Agreement (the “Fund Formation Agreement”), on October 15, 2009, pursuant to which the Company and the Fund Manager have agreed to use their good faith efforts to endeavor to raise a private investment fund (the “Fund”). The purpose of the Fund will be to invest in hotel real estate projects located in North America. The Company will be offered the opportunity to manage the hotels owned by the Fund under long-term management agreements. In connection with the Fund Formation Agreement, the Company issued to the Fund Manager 5,000,000 contingent warrants to purchase the Company’s common stock at an exercise price of $6.00 per share with a 7-1/2 year term. These contingent warrants will only become exercisable if the Fund obtains capital commitments in certain amounts over certain time periods and also meets certain further capital commitment and investment thresholds. The exercise of these contingent warrants is subject to the approval of the issuance of the shares of common stock issuable upon exercise by the Company’s stockholders. The exercise of these contingent warrants is also subject to an exercise cap which effectively limits the Fund Manager’s beneficial ownership (which is considered jointly with the Investors’ beneficial ownership) of the Company’s common stock to 9.9% at any one time. The exercise price and number of shares subject to these contingent warrants are both subject to anti-dilution adjustments.

For so long the Investors collectively own or have the right to purchase through exercise of the warrants 875,000 shares of the Company’s common stock, the Company has agreed to use its reasonable best efforts to cause its board of directors to nominate and recommend to the Company’s stockholders the election of a person nominated by the Investors as a director of the Company and to use its reasonable best efforts to ensure that the Investors’ nominee is elected to the Company’s board of directors at each such meeting. If that nominee is not elected by the Company’s stockholders, the Investors have certain observer rights and, in certain circumstances, the dividend rate on the Series A Preference Securities increases by 4% during any time that the Investors’ nominee is not a member of the Company’s board of directors. Effective October 15, 2009, the Investors nominated and the Company’s board of directors elected Michael Gross as a member of the Company’s board of directors. Mr. Gross was also named to the Company’s corporate governance and nominating committee. Deepak Chopra and David Moore have resigned from their positions on the Company’s board of directors effective October 15, 2009.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q for the nine months ended September 30, 2009. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to, those set forth under “Risk Factors” and elsewhere in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

Overview

We are a fully integrated hospitality company that operates, owns, acquires, develops and redevelops boutique hotels, primarily in gateway cities and select resort markets in the United States and Europe. Over our 25-year history, we have gained experience operating in a variety of market conditions.

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

•

our Owned Hotels, consisting of Morgans, Royalton and Hudson in New York, Delano South Beach in Miami, Mondrian Los Angeles in Los Angeles, Clift in San Francisco, and Mondrian Scottsdale in Scottsdale;

•

our Joint Venture Hotels, consisting of our London hotels (Sanderson and St Martins Lane), Shore Club, Hard Rock, and Mondrian South Beach;

•

our investments in hotels under construction, such as Mondrian SoHo and Ames, and our investment in other proposed properties;

•

our investment in certain joint venture food and beverage operations at our Owned Hotels and Joint Venture Hotels, discussed further below;

•

our management company subsidiary, Morgans Hotel Group Management LLC; and

•

the rights and obligations contributed to Morgans Group LLC in the formation and structuring transactions described in Note 1 to the consolidated financial statements, included elsewhere in this report.

We consolidate the results of operations for all of our Owned Hotels and certain food and beverage operations at five of our Owned Hotels, which are operated under 50/50 joint ventures with restaurateur Jeffrey Chodorow. We consolidate the food and beverage joint ventures as we believe that we are the primary beneficiary of these entities. Our partner’s share of the results of operations of these food and beverage joint ventures is recorded as a noncontrolling interest in the accompanying consolidated financial statements. This noncontrolling interest is based upon 50% of the income of the applicable entity after giving effect to rent and other administrative charges payable to the hotel. The Asia de Cuba restaurant at Mondrian Scottsdale is operated under license and management agreements with China Grill Management, a company controlled by Jeffrey Chodorow.

We own partial interests in the Joint Venture Hotels and certain food and beverage operations at three of the Joint Venture Hotels, Sanderson, St Martins Lane and Mondrian South Beach. We account for these investments using the equity method as we believe we do not exercise control over significant asset decisions such as buying, selling or financing nor are we the primary beneficiary of the entities. Under the equity method, we increase our investment in unconsolidated joint ventures for our proportionate share of net income and contributions and decrease our investment balance for our proportionate share of net losses and distributions.

On February 2, 2007, we began managing the hotel operations at the Hard Rock. We also have signed agreements to manage Mondrian SoHo and Ames in Boston once development is complete. We have signed agreements to manage Mondrian Las Vegas, Delano Las Vegas, Delano Dubai and Mondrian Palm Springs, but we are unsure of the future of the development of these hotels as financing has not yet been obtained.

As of September 30, 2009, we operated the following Joint Venture Hotels under management agreements which expire as follows:

	•		Sanderson — June 2018 (with one 10-year extension at our option);
	•		St Martins Lane — June 2018 (with one 10-year extension at our option);
	•		Shore Club — July 2022;
	•		Hard Rock — February 2027 (with two 10-year extensions); and
	•		Mondrian South Beach — August 2026.

These agreements are subject to early termination in specified circumstances. For instance, beginning 12 months following completion of the expansion of the Hard Rock, our Hard Rock management agreement may be terminated if the Hard Rock fails to achieve an EBITDA hurdle, as defined in the management agreement. There can be no assurances that we will satisfy this or other performance tests in our management agreements, many of which may be beyond our control, or that our management agreements will not be subject to early termination. Several of our hotels are also subject to substantial mortgage and mezzanine debt, and in some instances our management fee is subordinated to the debt and our management agreements may be terminated by the lenders on foreclosure.

Factors Affecting Our Results of Operations

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

	•		occupancy;
	•		Average daily rate (“ADR”); and

•

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

Substantially all of our revenue is derived from the operation of our hotels. Specifically, our revenue consists of:

•

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

•

Food and beverage revenue. Most of our food and beverage revenue is earned by our 50/50 restaurant joint ventures and is driven by occupancy of our hotels and the popularity of our bars and restaurants with our local customers.

•

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

•

Management fee — related parties revenue and other income. We earn fees under our management agreements. These fees may include management fees as well as reimbursement for allocated chain services. Additionally, we earn branding fees related to the use of our Delano brand in connection with sales by our joint venture partner in our Delano Dubai development project of condominium units associated with the project.

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

The seasonal nature of the hospitality business can also impact revenues. For example, our Miami hotels are generally strongest in the first quarter, whereas our New York hotels are generally strongest in the fourth quarter. However, given the current economic environment, the impact of seasonality in 2009 may not be as significant as in prior periods.

In addition to economic conditions, supply is another important factor that can affect revenues. Room rates and occupancy tend to fall when supply increases, unless the supply growth is offset by an equal or greater increase in demand. One reason why we focus on boutique hotels in key gateway cities is because these markets have significant barriers to entry for new competitive supply, including scarcity of available land for new development and extensive regulatory requirements resulting in a longer development lead time and additional expense for new competitors.

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

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

Restructuring, development and disposal costs include costs incurred related to our restructuring initiatives implemented in 2008 and 2009, charges associated with disposals of assets as part of major renovation projects and the write-off of abandoned development projects resulting primarily from events generally outside management’s control such as the tightening of the credit markets. These items do not relate to the ongoing operating performance of our assets.

Other Items

•

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

•

Equity in (income) loss of unconsolidated joint ventures. Equity in (income) loss of unconsolidated joint ventures constitutes our share of the net profits and losses of our Joint Venture Hotels and our investments in hotels under development.

•

Impairment loss on development project and investment in joint venture. When certain triggering events occur, we periodically review each property, asset and investment for possible impairment. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated discounted future cash flows of the assets to estimate the fair value of the asset taking into account each property’s expected cash flow from operations, holding period and net proceeds from the dispositions of the property. For the three and nine months ended September 30, 2009, management concluded that our investment in the Echelon Las Vegas joint venture and the property across the street from Delano South Beach, were impaired. Impairment charges of $17.2 million and $11.9 million on these investments, respectively, are reflected in our consolidated financial statements for the three and nine months ended September 30, 2009.

•

Other non-operating (income) expenses include costs associated with financings, litigation and settlement costs and other items that relate to the financing and investing activities associated with our assets and not to the on-going operating performance of our assets, both consolidated and unconsolidated.

•

Income tax (benefit) expense. One of our foreign subsidiaries is subject to United Kingdom corporate income taxes. Income tax expense is reported at the applicable rate for the periods presented. We are subject to Federal and state income taxes. Income taxes for the three and nine months ended September 30, 2009 and 2008 were computed using our calculated effective tax rate. We also recorded net deferred taxes related to cumulative differences in the basis recorded for certain assets and liabilities.

•

Noncontrolling interest. Noncontrolling interest constitutes the third-party food and beverage joint venture partner’s interest in the profits of the restaurant ventures at certain of our hotels as well as the percentage of membership units in Morgans Group LLC, our operating company, owned by Residual Hotel Interest LLC, our Former Parent, as discussed in Note 2 of the consolidated financial statements.

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

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

Recent Trends and Developments

Recent Trends. Starting in the fourth quarter of 2008 and continuing throughout 2009, the weakened U.S. and global economies have resulted in considerable negative pressure on both consumer and business spending. As a result, lodging revenues, which are primarily driven by growth in GDP, business investment and employment growth, has weakened substantially, as compared to the lodging demand we experience prior to the fourth quarter of 2008. We believe these trends will continue through the remainder of 2009 and into 2010, although not to the magnitude we have experienced during the last four quarters. Recently, the rate of decline in the lodging sector has slowed and we are beginning to see indications of return in demand in key gateway markets, most notably in the form of increasing occupancy in those markets. However, while the outlook for the U.S. and global economies have somewhat improved, we anticipate that lodging demand will not improve significantly during early 2010, as spending by businesses and consumers remains cautious.

To help mitigate the effects of these trends, we are actively managing costs, and each of our properties and our corporate office has implemented certain cost reduction plans. Through our multi-phased contingency plan, we reduced hotel operating expenses and corporate expenses during 2008 and 2009. We will continue to carefully monitor our costs with the objective of achieving all possible efficiencies throughout the remainder of 2009 and into 2010. We believe that these cost reduction plans have resulted and will continue to result in significant savings in future quarters and that our experienced management team and dedicated employees have allowed us to implement these cost cuts without impacting the overall quality of our guest experience.

In addition, as occupancy levels begin to rise in some of our markets, we are focusing on revenue enhancement by actively managing rates and availability. As modest demand begins to return, as evidenced by the increase in occupancy, the ability to increase pricing will be a critical component in driving profitability. Through these challenging times, our strategy and focus continues to be to preserve profit margins by maximizing revenue, increasing our market share and managing costs.

Although the pace of new lodging supply in various phases of development has increased over the past several quarters, we believe the timing of some of these projects may be affected by the ongoing economic recession and the reduced availability of financing. These factors may dampen the pace of new supply development, including our own, during the fourth quarter of 2009 and into 2010. Nevertheless, we did witness new competitive luxury and boutique properties opening in 2008 and 2009 in some of our markets, particularly in Los Angeles, Scottsdale and Miami Beach, which have impacted our performance in these markets and may continue to do so.

For the remainder of 2009 and into early 2010, we believe that if various economic forecasts citing modest expansion are accurate, this may lend to a gradual and modest increase in lodging demand for both leisure and business travel, but with continued pressure on rates, as leisure and business travelers alike continue to focus on cost containment. As such, there can be no assurances that any increases in hotel revenues or earnings at our properties will occur or that any losses will not increase for these or any other reasons.

We believe that the global credit market conditions will gradually improve during 2010, although we believe there will continue to be less credit available and on less favorable terms than were obtainable in prior years. Given the current state of the credit markets, some of our joint venture projects, such as Mondrian Palm Springs and Delano Dubai, may not be able to obtain adequate project financing in a timely manner or at all. If adequate project financing is not obtained, the joint ventures or developers, as applicable, may seek additional equity investors to raise capital, limit the scope of the project, defer the project or cancel the project altogether.

Recent Developments.

Amendment to the Revolving Credit Facility On August 5, 2009, we and certain of our subsidiaries amended the Revolving Credit Facility (the “Amended Revolving Credit Facility”) with Wells Fargo Securities, LLC (successor in interest to Wachovia Capital Markets, LLC) and Citigroup Global Markets Inc. For further discussion of the Amended Revolving Credit Facility, see Note 6 to our consolidated financial statements.

Stockholder Protection Rights Agreement. On October 1, 2009, we amended and restated our Stockholder Protection Rights Agreement (the “Rights Agreement”), which was scheduled to expire on October 9, 2009. In connection with the amendment, the expiration date was extended to October 9, 2012 (assuming there is no earlier redemption or exchange of the rights, or a consolidation, merger or statutory share exchange which does not trigger the rights, or any subsequent extension by our board of directors pursuant to the terms of the Rights Agreement) and certain technical changes were made to facilitate the implementation of the rights if exercised. The Rights Agreement was not extended in response to any specific effort to obtain control of the Company but rather to continue to deter abusive takeover tactics that otherwise could be used to deprive stockholders of the full value of their investment.

In connection with the issuance of preferred securities and warrants discussed below, on October 15, 2009, the Rights Agreement was further amended to revise the definition of “Acquiring Person” and to add the definition of “Exempt Person” to exempt the Investors, defined below, the Fund Manager, defined below, and their affiliates from the definition of Acquiring Person in the Rights Agreement.

Management Agreement — San Juan Water and Beach Club. On October 1, 2009, the Company announced a long-term management agreement for the San Juan Water and Beach Club Hotel, a 78-room beachfront hotel in Isla Verde, Puerto Rico. The owners of the San Juan Water and Beach Club intend to obtain development rights to build a Morgans Hotel Group branded hotel including a casino. The ownership group includes Hotel Development Corp., a subsidiary of the Puerto Rico Tourism Company. We assumed management of the property as of October 18, 2009, under a 10-year management agreement. San Juan Water and Beach Club Hotel will remain open and operating as an independent hotel until it ultimately becomes a Morgans Hotel Group branded property.

Issuance of Preferred Securities and Real Estate Opportunity Fund. On October 15, 2009, we entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P. (collectively, the “Investors”). Under the Securities Purchase Agreement, we issued and sold to the Investors (i) 75,000 of our Series A Preferred Securities, $1,000 liquidation preference per share (the “Series A Preferred Securities”), and (ii) warrants to purchase 12,500,000 shares of our common stock at an exercise price of $6.00 per share.

The Series A Preferred Securities have an 8% dividend rate for the first five years, a 10% dividend rate for years six and seven, and a 20% dividend rate thereafter. We have the option to redeem any or all of the Series A Preferred Securities at par at any time. The Series A Preferred Securities have limited voting rights and only vote on the authorization to issue senior preferred, amendments to their certificate of designations, amendments to our charter that adversely affect the Series A Preferred Securities and certain change in control transactions.

The warrants to purchase 12,500,000 shares of our common stock at an exercise price of $6.00 per share have a 7-1/2 year term and are exercisable utilizing a cashless exercise method only, resulting in a net share issuance. The exercise of the warrants is subject to approval by our shareholders of the issuance of the shares of common stock issuable upon exercise. The exercise of the warrants is also subject to an exercise cap which effectively limits the Investors’ beneficial ownership of our common stock to 9.9% at any one time. The exercise price and number of shares subject to the warrants are both subject to anti-dilution adjustments.

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

•

the sale of substantially all of our assets to a third party;

•

the acquisition by us of a third party where the equity investment by us is $100 million or greater;

•

the acquisition of us by a third party; or

•

any change in the size of our board of directors to a number below 7 or above 9.

Subject to certain exceptions, the Investors may not transfer any Series A Preferred Securities, warrants or common stock until October 15, 2012. The Investors are also subject to certain standstill arrangements as long as they beneficially own over 15% of our common stock. Until October 15, 2010, the Investors have certain rights to purchase their pro rata share of any equity or debt securities offered or sold by us.

In connection with the investment by the Investors, we paid to the Investors a commitment fee of $2.4 million and reimbursed the Investors for $600,000 of expenses.

We also entered into a Real Estate Fund Formation Agreement (the “Fund Formation Agreement”) with Yucaipa American Alliance Fund II, LLC, an affiliate of the Investors (the “Fund Manager”) on October 15, 2009 pursuant to which we and the Fund Manager have agreed to use our good faith efforts to endeavor to raise a private investment fund (the “Fund”). The purpose of the Fund will be to invest in hotel real estate projects located in North America. We will be offered the opportunity to manage the hotels owned by the Fund under long-term management agreements. In connection with the Fund Formation Agreement, we issued to the Fund Manager 5,000,000 contingent warrants to purchase our common stock at an exercise price of $6.00 per share with a 7-1/2 year term. These contingent warrants will only become exercisable if the Fund obtains capital commitments in certain amounts over certain time periods and also meets certain further capital commitment and investment thresholds. The exercise of these contingent warrants is subject to the approval of the issuance of the shares of common stock issuable upon exercise by our stockholders. The exercise of these contingent warrants is also subject to an exercise cap which effectively limits the Fund Manager’s beneficial ownership (which is considered jointly with the Investors’ beneficial ownership) of our common stock to 9.9% at any one time. The exercise price and number of shares subject to these contingent warrants are both subject to anti-dilution adjustments.

For so long the Investors collectively own or have the right to purchase through exercise of the warrants 875,000 shares of our common stock, we have agreed to use its reasonable best efforts to cause its board of directors to nominate and recommend to our stockholders the election of a person nominated by the Investors as a director and to use our reasonable best efforts to ensure that the Investors’ nominee is elected to our board of directors at each such meeting. If that nominee is not elected by our stockholders, the Investors have certain observer rights and, in certain circumstances, the dividend rate on the Series A Preference Securities increases by 4% during any time that the Investors’ nominee is not a member of our board of directors. Effective October 15, 2009, the Investors nominated and our board of directors elected Michael Gross as a member of our board of directors. Mr. Gross was also named to the corporate governance and nominating committee. Deepak Chopra and David Moore have resigned from their positions on our board of directors effective October 15, 2009.

Amendment to Hudson Mezzanine Loan. On October 14, 2009, we entered into an agreement with one of our lenders which holds, among other loans, the mezzanine loan on Hudson. Under the agreement, we paid an aggregate of $11.2 million to (i) reduce the principal balance of the mezzanine loan from $32.5 million to $26.5 million, (ii) acquire interests in $4.5 million of certain of our other debt obligations, (iii) pay fees, and (iv) obtain a forbearance from the mezzanine lender until October 12, 2013 from exercising any remedies resulting from a maturity default, subject only to maintaining certain interest rate caps and making an additional aggregate payment of $1.3 million to purchase additional interests in certain of our other debt obligations prior to October 11, 2011. We believe these transactions will have the practical effect of extending the Hudson mezzanine loan by three years and three months beyond its scheduled maturity of July 12, 2010. The mezzanine lender also has agreed to cooperate with us in our efforts to seek an extension of the $217 million Hudson mortgage loan, which is also set to mature on July 12, 2010, and to consent to certain refinancings and other modifications of the Hudson mortgage loan.

Operating Results

Comparison of Three Months Ended September 30, 2009 to Three Months Ended September 30, 2008

The following table presents our operating results for the three months ended September 30, 2009 and the three months ended September 30, 2008, including the amount and percentage change in these results between the two periods. The consolidated operating results for the three months ended September 30, 2009 is comparable to the consolidated operating results for the three months ended September 30, 2008, with the exception of Mondrian Los Angeles and Morgans, both of which were under renovation during 2008, the investment in the Hard Rock, which has been under renovation and expansion during 2008 and 2009, and the investment in Mondrian South Beach, which opened in December 2008. The consolidated operating results are as follows:

		Three Months Ended
		Sept. 30,				Sept. 30,
		2009				2008				Change ($)				Change (%)
						As adjusted(2)
		(in thousands, except percentages)
Revenues:
Rooms		$	32,524			$	45,500			$	(12,976	)			(28.5	)%
Food and beverage			18,795				23,269				(4,474	)			(19.2	)%
Other hotel			2,351				3,133				(782	)			(25.0	)%
Total hotel revenues			53,670				71,902				(18,232	)			(25.4	)%
Management fee—related parties and other income			3,998				5,799				(1,801	)			(31.1	)%
Total revenues			57,668				77,701				(20,033	)			(25.8	)%
Operating Costs and Expenses:
Rooms			10,770				12,097				(1,327	)			(11.0	)%
Food and beverage			14,721				16,817				(2,096	)			(12.5	)%
Other departmental			1,562				1,792				(230	)			(12.8	)%
Hotel selling, general and administrative			12,863				15,003				(2,140	)			(14.3	)%
Property taxes, insurance and other			4,683				5,447				(764	)			(14.0	)%
Total hotel operating expenses			44,599				51,156				(6,557	)			(12.8	)%
Corporate expenses, including stock compensation			8,507				12,355				(3,848	)			(31.1	)%
Depreciation and amortization			7,528				7,587				(59	)			(1.0	)%
Restructuring, development and disposal costs			494				2,957				(2,463	)			(83.3	)%
Total operating costs and expenses			61,128				74,055				(12,927	)			(17.5	)%
Operating (loss) income			(3,460	)			3,646				(7,106	)			(1	)
Interest expense, net			13,098				10,791				2,307				21.4	%
Equity in loss of unconsolidated joint ventures			2,262				7,617				(5,355	)			(70.3	)%
Impairment loss on development project and investment in joint venture			29,134				—				(29,134	)			(1	)
Other non-operating expense			869				516				353				68.4	%
Loss before income taxes			(48,823	)			(15,278	)			(33,545	)			(1	)
Income tax benefit			(20,189	)			(6,336	)			(13,853	)			(1	)
Net loss income			(28,634	)			(8,942	)			(19,692	)			(1	)
Net loss (income) attributable to noncontrolling interest			817				(388	)			1,205				(1	)
Net loss attributable to Morgans Hotel Group Co.			(27,817	)			(9,330	)			(18,487	)			(1	)
Other comprehensive income (loss):
Unrealized gain on valuation of swap/cap agreements, net of tax			3,887				696				3,191				(1	)
Realized loss on settlement of swap/cap agreements, net of tax			(2,382	)			(1,444	)			(938	)			(65.0	)%
Foreign currency translation (loss) gain			532				(388	)			920				(1	)
Comprehensive loss		$	(25,780	)		$	(10,466	)		$	(15,314	)			(1	)

Total Hotel Revenues. Total hotel revenues decreased 25.4% to $53.7 million for the three months ended September 30, 2009 compared to $71.9 million for the three months ended September 30, 2008. The components of RevPAR from our comparable Owned Hotels for the three months ended September 30, 2009 and 2008, which includes Hudson, Delano, Clift, Mondrian Scottsdale, and Royalton, and excludes Mondrian Los Angeles and Morgans, which were under renovation during 2008, are summarized as follows:

		Three Months Ended
		Sept. 30,				Sept. 30,
		2009				2008				Change ($)				Change (%)
Occupancy			77.9	%			85.4	%			—				(8.8	)%
ADR		$	210			$	291			$	(81	)			(27.8	)%
RevPAR		$	164			$	249			$	(85	)			(34.2	)%

RevPAR from our comparable Owned Hotels decreased 34.2% to $164 for the three months ended September 30, 2009 compared to $249 for the three months ended September 30, 2008.

Rooms revenue decreased 28.5% to $32.5 million for the three months ended September 30, 2009 compared to $45.5 million for the three months ended September 30, 2008. The overall decrease was primarily attributable to the significant adverse impact on lodging demand and pricing as a result of the global economic downturn. All of our comparable Owned Hotels experienced a decline in rooms revenue in excess of 25% during the three months ended September 30, 2009 as compared to the same period in 2008.

Food and beverage revenue decreased 19.2% to $18.8 million for the three months ended September 30, 2009 compared to $23.3 million for the three months ended September 30, 2008. The overall decrease was primarily attributable to the economic downturn which has had a significant adverse impact on lodging demand and local spending, which negatively impacts the ancillary venues at our hotels, such as the bar and restaurant revenue. All of our comparable Owned Hotels experienced a decline in food and beverage revenue in excess of 15% during the three months ended September 30, 2009 as compared to the same period in 2008.

Other hotel revenue decreased 25.0% to $2.4 million for the three months ended September 30, 2009 compared to $3.1 million for the three months ended September 30, 2008. The overall decrease was primarily attributable to the significant adverse impact on lodging demand, which negatively impacts the ancillary revenues at our hotels, as a result of the global economic downturn.

Management Fee — Related Parties and Other Income decreased by 31.1% to $4.0 million for the three months ended September 30, 2009 compared to $5.8 million for the three months ended September 30, 2008. This decrease is primarily attributable to a branding fee earned in September 2008 relating to the use of the Delano brand for the sale of branded residences to be constructed in connection with the Delano Dubai project for which there was no comparable fee earning during 2009, and the significant adverse impact on lodging demand as a result of the global economic downturn, especially at our London joint venture hotels and Shore Club. Slightly offsetting these decreases are management fees earned at Mondrian South Beach, which opened in December 2008, and an increase in management fees earned at Hard Rock due to the opening of the new 490-room south tower in July 2009.

Operating Costs and Expenses

Rooms expense decreased 11.0% to $10.8 million for the three months ended September 30, 2009 compared to $12.1 million for the three months ended September 30, 2008. This decrease is a direct result of the decrease in rooms revenue. While we have implemented cost cutting initiatives at our hotels in 2008 and early 2009, our occupancy did not decrease as significantly as our ADR. Therefore certain variable expenses, such as housekeeping payroll costs, did not decrease in proportion to the decrease in rooms revenue noted above.

Food and beverage expense decreased 12.5% to $14.7 million for the three months ended September 30, 2009 compared to $16.8 million for the three months ended September 30, 2008. All of our comparable Owned Hotels experienced a decline in food and beverage expense in excess of 7% during the three months ended September 30, 2009 as compared to the same period in 2008.

Other departmental expense decreased 12.8% to $1.6 million for the three months ended September 30, 2009 compared to $1.8 million for the three months ended September 30, 2008. This decrease is a direct result of the decrease in other hotel revenue. While we have implemented cost cutting initiatives at our hotels in 2008 and early 2009, our occupancy did not decrease as significantly as our ADR. Therefore certain variable expenses did not decrease in proportion to the decrease in revenue noted above.

Hotel selling, general and administrative expense decreased 14.3% to $12.9 million for the three months ended September 30, 2009 compared to $15.0 million for the three months ended September 30, 2008. This decrease was primarily due to the impact of cost cutting initiatives across all hotel properties, which were implemented in 2008 and in early 2009, resulting in decreased administrative and general costs and advertising and promotion expenses.

Property taxes, insurance and other expense decreased 14.0% to $4.7 million for the three months ended September 30, 2009 compared to $5.4 million for the three months ended September 30, 2008. This decrease was primarily due to pre-opening expenses recorded at Mondrian Los Angeles and Morgans during the three months ended September 30, 2008 as a result of their re-launch after renovation. Slightly offsetting this decrease is an increase related to Morgans which was closed for renovation for the three months ended September 30, 2008.

Corporate expenses, including stock compensation decreased by 31.1% to $8.5 million for the three months ended September 30, 2009 compared to $12.4 million for the three months ended September 30, 2008. This decrease is due primarily to the impact of cost cutting initiatives at the corporate office which were implemented in late 2008 and early 2009.

Depreciation and amortization decreased 1.0% to $7.5 million for the three months ended September 30, 2009 compared to $7.6 million for the three months ended September 30, 2008. This decrease is primarily the result of an impairment charge on Mondrian Scottsdale we recognized in December 2008 which reduced the basis of the asset being depreciated for the three months ended September 30, 2009 as compared to the same period in 2008. Slightly offsetting this decrease was an increase in depreciation expense resulting from the increased depreciation due to hotel renovations at Mondrian Los Angeles and Morgans during 2008.

Restructuring, development and disposal costs decreased 83.3% to $0.5 million for the three months ended September 30, 2009 as compared to $3.0 million for the three months ended September 30, 2008. The decrease in the expense is primarily related to the write-off of assets at Mondrian Los Angeles and Morgans during the three months ended September 2008 when both hotels were nearing completion of large-scale renovation projects. There was no comparable asset write-off during the three months ended September 30, 2009.

Interest expense, net increased 21.4% to $13.1 million for the three months ended September 30, 2009 compared to $10.8 million for the three months ended September 30, 2008. The increase in this expense is primarily due to lower interest income earned on our cash balances for the three months ended September 30, 2009, which nets down interest expense, and interest incurred on the outstanding balance on the revolving credit facility during the three months ended September 30, 2009 for which there was no comparable amount in 2008.

Equity in loss of unconsolidated joint ventures decreased 70.3% to $2.3 million for the three months ended September 30, 2009 compared to $7.6 million for the three months ended September 30, 2008. This decrease is primarily due to a reduction in our share of losses from the Hard Rock. We did not record our proportionate share of loss from our investment in the Hard Rock for the three months ended September 30, 2009 as losses have been recognized to the extent of our capital investment and commitments to fund. Additionally, the decrease is due to the recognition of our share of earnings of our London hotels during the three months ended September 30, 2009 as compared to equity in loss of our London hotels which we recorded for the three months ended September 30, 2008. Slightly offsetting this decrease was our share of losses from Mondrian South Beach, which opened in December 2008.

The components of RevPAR from our comparable Joint Venture Hotels for the three months ended September 30, 2009 and 2008, which includes Sanderson, St Martins Lane and Shore Club, but excludes the Hard Rock, which has been under renovation and expansion during 2008 and 2009, and Mondrian South Beach, which opened in December 2008, are summarized as follows (in constant dollars):

		Three Months Ended
		Sept. 30,				Sept. 30,
		2009				2008				Change ($)				Change (%)
Occupancy			61.5	%			68.0	%			—				(9.5	)%
ADR		$	302			$	344			$	(42	)			(12.3	)%
RevPAR		$	186			$	234			$	(48	)			(20.6	)%

The components of RevPAR from the Hard Rock for the three months ended September 30, 2009 and the three months ended September 30, 2008 are summarized as follows:

		Three Months Ended
		Sept. 30,				Sept. 30,
		2009				2008				Change ($)				Change (%)
Occupancy			89.0	%			92.4	%			—				(3.8	)%
ADR		$	133			$	190			$	(57	)			(29.8	)%
RevPAR		$	119			$	176			$	(57	)			(32.4	)%

As is customary for companies in the gaming industry, the Hard Rock presents average occupancy rate and average daily rate including rooms provided on a complimentary basis. Like most operators of hotels in the non-gaming lodging industry, we do not follow this practice at our other hotels, where we present average occupancy rate and average daily rate net of rooms provided on a complimentary basis.

Impairment loss of development project and investment in joint venture of $29.1 million was recognized during the three months ended September 30, 2009 related to the write-down in the carrying value of our investment in Echelon Las Vegas and the property across the street from Delano South Beach. No such impairment loss was recognized in 2008.

Other non-operating expense increased 68.4% to $0.9 million for the three months ended September 30, 2009 as compared to $0.5 million for the three months ended September 30, 2008. The increase in the expense is primarily related to costs associated with advisory services incurred during the three months ended September 30, 2009 in connection with our financing efforts.

Income tax benefit was $20.2 million for the three months ended September 30, 2009 compared to $6.3 million for the three months ended September 30, 2008. The income tax benefit was due primarily to the recording of deferred tax assets from the net operating loss.

Comparison of Nine Months Ended September 30, 2009 to Nine Months Ended September 30, 2008

The following table presents our operating results for the nine months ended September 30, 2009 and the nine months ended September 30, 2008, including the amount and percentage change in these results between the two periods. The consolidated operating results for the nine months ended September 30, 2009 is comparable to the consolidated operating results for the nine months ended September 30, 2008, with the exception of Mondrian Los Angeles and Morgans, both of which were under renovation during 2008, the investment in the Hard Rock, which has been under renovation and expansion during 2008 and 2009, and the investment in Mondrian South Beach, which opened in December 2008. The consolidated operating results are as follows:

		Nine Months Ended
		Sept. 30,				Sept. 30,
		2009				2008				Change ($)				Change (%)
						As adjusted(2)
		(in thousands, except percentages)
Revenues:
Rooms		$	92,003			$	138,521			$	(46,518	)			(33.6	)%
Food and beverage			57,664				76,392				(18,728	)			(24.5	)%
Other hotel			7,355				9,957				(2,602	)			(26.1	)%
Total hotel revenues			157,022				224,870				(67,848	)			(30.2	)%
Management fee—related parties and other income			11,311				14,887				(3,576	)			(24.0	)%
Total revenues			168,333				239,757				(71,424	)			(29.8	)%
Operating Costs and Expenses:
Rooms			31,313				37,162				(5,849	)			(15.7	)%
Food and beverage			43,836				54,538				(10,702	)			(19.6	)%
Other departmental			4,722				5,801				(1,079	)			(18.6	)%
Hotel selling, general and administrative			36,968				45,375				(8,407	)			(18.5	)%
Property taxes, insurance and other			13,193				13,229				(36	)			(0.3	)%
Total hotel operating expenses			130,032				156,105				(26,073	)			(16.7	)%
Corporate expenses, including stock compensation			25,295				35,002				(9,707	)			(27.7	)%
Depreciation and amortization			23,159				19,696				3,463				17.6	%
Restructuring, development and disposal costs			2,037				4,124				(2,087	)			(50.6	)%
Total operating costs and expenses			180,523				214,927				(34,404	)			(16.0	)%
Operating (loss) income			(12,190	)			24,830				(37,020	)			(1	)
Interest expense, net			36,599				32,760				3,839				11.7	%
Equity in loss of unconsolidated joint ventures			4,700				16,526				(11,826	)			(71.6	)%
Impairment loss on development project and investment in joint venture			29,134				—				29,134				(1	)
Other non-operating expense			1,934				1,816				118				6.5	%
Loss before income taxes			(84,557	)			(26,272	)			(58,285	)			(1	)
Income tax benefit			(35,700	)			(11,304	)			(24,396	)			(1	)
Net loss			(48,857	)			(14,968	)			(33,889	)			(1	)
Net loss (income) attributable to noncontrolling interest			399				(2,731	)			3,130				(114.6	)%
Net loss attributable to Morgans Hotel Group Co.			(48,458	)			(17,699	)			(30,759	)			(1	)
Other comprehensive income:
Unrealized gain on valuation of swap/cap agreements, net of tax			12,303				3,635				8,668				(1	)
Realized loss on settlement of swap/cap agreements, net of tax			(7,379	)			(3,247	)			(4,132	)			(1	)
Foreign currency translation (loss) gain			(512	)			(353	)			(159	)			45.0	%
Comprehensive loss		$	(44,046	)		$	(17,664	)		$	(26,382	)			(1	)