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

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

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)

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 8, 2011 was 30,731,457.

 

 

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MORGANS HOTEL GROUP CO. CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2011 (UNAUDITED) AND DECEMBER 31, 2010			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			35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			60
ITEM 4. CONTROLS AND PROCEDURES			61
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			62
ITEM 1A. RISK FACTORS			62
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			62
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			62
ITEM 4. REMOVED AND RESERVED			62
ITEM 5. OTHER INFORMATION			62
ITEM 6. EXHIBITS			62
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

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 for the fiscal year ended December 31, 2010 and other documents filed by the Company with the Securities and Exchange Commission from time to time; 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, volcanoes 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.

Consolidated Balance Sheets

		September 30,				December 31,
		2011				2010
		(unaudited)
ASSETS
Property and equipment, net		$	283,811			$	291,078
Goodwill			54,057				53,691
Investments in and advances to unconsolidated joint ventures			5,063				20,450
Assets held for sale, net			—				194,964
Investment in property held for non-sale disposition, net			—				9,775
Cash and cash equivalents			12,829				5,250
Restricted cash			7,148				28,783
Accounts receivable, net			8,250				6,018
Related party receivables			5,186				3,830
Prepaid expenses and other assets			7,202				7,007
Deferred tax asset, net			81,421				80,144
Other, net			15,834				13,786
Total assets		$	480,801			$	714,776
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Debt and capital lease obligations		$	433,267			$	558,779
Mortgage debt of property held for non-sale disposition			—				10,500
Accounts payable and accrued liabilities			32,353				23,604
Debt obligation, accounts payable and accrued liabilities of assets held for sale			—				107,161
Accounts payable and accrued liabilities of property held for non-sale disposition			—				1,162
Distributions and losses in excess of investment in unconsolidated joint ventures			272				1,509
Deferred gain on asset sales			77,792				—
Other liabilities			14,291				13,866
Total liabilities			557,975				716,581
Commitments and contingencies
Preferred securities, $.01 par value; liquidation preference $1,000 per share, 75,000 shares authorized and issued at September 30, 2011 and December 31, 2010, respectively			53,319				51,118
Common stock, $.01 par value; 200,000,000 shares authorized; 36,277,495 shares issued at September 30, 2011 and December 31, 2010, respectively			363				363
Additional paid-in capital			289,971				297,554
Treasury stock, at cost, 5,555,654 and 5,985,045 shares of common stock at September 30, 2011 and December 31, 2010, respectively			(89,155	)			(92,688	)
Accumulated comprehensive loss			(3,683	)			(3,194	)
Accumulated deficit			(336,360	)			(265,874	)
Total Morgans Hotel Group Co. stockholders’ deficit			(85,545	)			(12,721	)
Noncontrolling interest			8,371				10,916
Total deficit			(77,174	)			(1,805	)
Total liabilities and stockholders’ deficit		$	480,801			$	714,776

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

Consolidated Statements of Operations and Comprehensive Loss

		Three Months				Three Months				Nine Months				Nine Months
		Ended Sept. 30,				Ended Sept. 30,				Ended Sept. 30,				Ended Sept. 30,
		2011				2010				2011				2010
Revenues:
Rooms		$	26,432			$	35,100			$	90,951			$	99,443
Food and beverage			15,575				16,017				49,216				51,062
Other hotel			1,271				2,077				5,020				6,730
Total hotel revenues			43,278				53,194				145,187				157,235
Management fees and other income			3,408				4,547				10,112				14,079
Total revenues			46,686				57,741				155,299				171,314
Operating Costs and Expenses:
Rooms			8,263				11,061				29,122				31,377
Food and beverage			13,664				14,426				41,901				42,526
Other departmental			870				1,322				3,117				3,834
Hotel selling, general and administrative			9,951				12,275				33,301				35,523
Property taxes, insurance and other			4,247				3,650				12,136				12,461
Total hotel operating expenses			36,995				42,734				119,577				125,721
Corporate expenses, including stock compensation of $1.4 million, $2.3 million, $7.4 million, and $8.9 million, respectively			7,037				8,045				25,920				27,270
Depreciation and amortization			4,833				8,173				17,405				23,529
Restructuring, development and disposal costs			2,125				1,064				10,518				2,930
Impairment loss on receivables from unconsolidated joint venture			—				5,499				—				5,499
Total operating costs and expenses			50,990				65,515				173,420				184,949
Operating loss			(4,304	)			(7,774	)			(18,121	)			(13,635	)
Interest expense, net			8,775				8,319				27,783				33,058
Equity in loss of unconsolidated joint ventures			12,794				1,435				23,187				9,437
Gain on asset sales			(1,101	)			—				(1,721	)			—
Other non-operating expenses			616				20,299				2,885				35,491
Loss before income tax expense			(25,388	)			(37,827	)			(70,255	)			(91,621	)
Income tax expense			230				420				523				994
Net loss from continuing operations			(25,618	)			(38,247	)			(70,778	)			(92,615	)
(Loss) income from discontinued operations, net of taxes			—				(281	)			485				16,474
Net loss			(25,618	)			(38,528	)			(70,293	)			(76,141	)
Net loss attributable to noncontrolling interest			799				1,451				2,007				2,033
Net loss attributable to Morgans Hotel Group			(24,819	)			(37,077	)			(68,286	)			(74,108	)
Preferred stock dividends and accretion			2,285				2,164				6,701				6,357
Net loss attributable to common stockholders			(27,104	)			(39,241	)			(74,987	)			(80,465	)
Other comprehensive loss:
Unrealized (loss) gain on valuation of swap/cap agreements, net of tax			(12	)			1,055				(7	)			11,058
Share of unrealized loss on valuation of swap agreements from unconsolidated joint venture, net of tax			(1,444	)			(1,274	)			(423	)			(1,274	)
Realized loss on settlement of swap/cap agreements, net of tax			—				(830	)			—				(5,971	)
Foreign currency translation gain (loss), net of tax			52				(179	)			(57	)			77
Comprehensive loss		$	(28,508	)		$	(40,469	)		$	(75,474	)		$	(76,575	)
(Loss) income per share:
Basic and diluted continuing operations		$	(0.89	)		$	(1.29	)		$	(2.41	)		$	(3.18	)
Basic and diluted discontinued operations		$	(0.00	)		$	(0.01	)		$	0.02			$	0.54
Basic and diluted attributable to common stockholders		$	(0.89	)		$	(1.30	)		$	(2.39	)		$	(2.64	)
Weighted average number of common shares outstanding:
Basic and diluted			30,617				30,162				31,359				30,470

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

Consolidated Statements of Cash Flows

		Nine Months Ended Sept. 30,
		2011				2010
Cash flows from operating activities:
Net loss		$	(70,293	)		$	(76,141	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities (including discontinued operations):
Depreciation			15,850				21,992
Amortization of other costs			1,555				1,537
Amortization of deferred financing costs			7,784				4,343
Amortization of discount on convertible notes			1,708				1,708
Amortization of deferred gain on asset sales			(1,721	)			—
Stock-based compensation			7,384				8,892
Accretion of interest on capital lease obligation			1,451				3,317
Equity in losses from unconsolidated joint ventures			23,187				9,437
Impairment loss on receivable from unconsolidated joint venture			—				5,499
Gain on disposal of property held for non-sale disposition			—				(17,766	)
Impairment and loss on disposal of assets			1,182				—
Change in value of warrants			—				32,902
Change in value of interest rate caps and swaps, net			35				26
Changes in assets and liabilities:
Accounts receivable, net			33				(2,133	)
Related party receivables			(1,348	)			(289	)
Restricted cash			20,234				(18,718	)
Prepaid expenses and other assets			2,533				2,031
Accounts payable and accrued liabilities			2,430				(330	)
Other liabilities			—				(150	)
Discontinued operations			(843	)			1,053
Net cash provided by (used in) operating activities			11,161				(22,790	)
Cash flows from investing activities:
Additions to property and equipment			(7,861	)			(10,602	)
Deposits to capital improvement escrows, net			1,091				716
Distributions from unconsolidated joint ventures			1,622				206
Proceeds from asset sales, net			267,162				—
Proceeds from sale of joint venture, net			2,500				—
Purchase of interest in food and beverage joint ventures, net of cash acquired			(19,291	)			—
Investments in and settlement related to unconsolidated joint ventures			(9,479	)			(4,340	)
Net cash provided by (used in) investing activities			235,744				(14,020	)
Cash flows from financing activities:
Proceeds from debt			193,992				—
Payments on debt and capital lease obligations			(426,159	)			—
Debt issuance costs			(5,744	)			(167	)
Cash paid in connection with vesting of stock based awards			(588	)			(772	)
Cost of issuance of preferred stock			—				(246	)
Distributions to holders of noncontrolling interests in consolidated subsidiaries			(827	)			(1,019	)
Net cash used in financing activities			(239,326	)			(2,204	)
Net increase (decrease) in cash and cash equivalents			7,579				(39,014	)
Cash and cash equivalents, beginning of period			5,250				68,956
Cash and cash equivalents, end of period		$	12,829			$	29,942
Supplemental disclosure of cash flow information:
Cash paid for interest		$	18,568			$	27,703
Cash paid for taxes		$	784			$	19
Non-cash Investing Activities
Acquisition of interest in unconsolidated joint ventures:
Furniture, fixture and equipment		$	(706	)		$	—
Other assets and liabilities, net			2,999				—
Distributions and losses in excess of investment in unconsolidated joint ventures			(1,587	)			—
Cash included in purchase of interest in food and beverage joint ventures		$	706			$	—

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

Notes to Consolidated Financial Statements

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.

The Morgans Hotel Group Co. predecessor (the “Predecessor”) comprised the subsidiaries and ownership interests that were contributed as part of the formation and structuring transactions from Morgans Hotel Group LLC, now known as Residual Hotel Interest LLC (“Former Parent”), to Morgans Group LLC (“Morgans Group”), the Company’s operating company. 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 in exchange for membership units. Simultaneously, Morgans Group issued additional membership units to the Predecessor in exchange for cash raised by the Company from the IPO. The Former Parent also contributed all the membership interests in its hotel management business to Morgans Group in return for 1,000,000 membership units in Morgans Group exchangeable for shares of the Company’s common stock. The Company is the managing member of Morgans Group, and has full management control. On April 24, 2008, 45,935 outstanding membership units in Morgans Group were exchanged for 45,935 shares of the Company’s common stock. As of September 30, 2011, 954,065 membership units in Morgans Group 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.

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, 2011 are as follows:

				Number of
Hotel Name		Location		Rooms				Ownership
Hudson		New York, NY			834				(1	)
Morgans		New York, NY			114				(2	)
Royalton		New York, NY			168				(2	)
Mondrian SoHo		New York, NY			270				(3	)
Delano South Beach		Miami Beach, FL			194				(4	)
Mondrian South Beach		Miami Beach, FL			328				(5	)
Shore Club		Miami Beach, FL			309				(6	)
Mondrian Los Angeles		Los Angeles, CA			237				(7	)
Clift		San Francisco, CA			372				(8	)
Ames		Boston, MA			114				(9	)
Sanderson		London, England			150				(10	)
St Martins Lane		London, England			204				(10	)
Hotel Las Palapas		Playa del Carmen, Mexico			75				(11	)

Restaurant Joint Venture

Prior to June 20, 2011, the food and beverage operations of certain of the hotels were operated under 50/50 joint ventures with a third party restaurant operator, China Grill Management Inc. (“CGM”). The joint ventures operated, and CGM managed, certain restaurants and bars at Delano South Beach, Mondrian Los Angeles, Mondrian South Beach, Morgans, Sanderson and St Martins Lane. The food and beverage joint ventures at hotels the Company owned were consolidated, as the Company believed that it was the primary beneficiary of these entities. The Company’s partner’s share of the results of operations of these food and beverage joint ventures were recorded as noncontrolling interests in the accompanying consolidated financial statements. The food and beverage joint ventures at hotels in which the Company had a joint venture ownership interest were accounted for using the equity method, as the Company did not believe it exercised control over significant asset decisions such as buying, selling or financing, and the Company was not the primary beneficiary of the entities.

On June 20, 2011, pursuant to an omnibus agreement, subsidiaries of the Company acquired from affiliates of CGM the 50% interests CGM owned in the Company’s food and beverage joint ventures for approximately $20 million (the “CGM Transaction”). CGM has agreed to continue to manage the food and beverage operations at these properties for a transitional period pursuant to short-term cancellable management agreements while the Company reassesses its food and beverage strategy.

As a result of the CGM Transaction, the Company owns 100% of the former food and beverage joint venture entities located at Morgans, Delano South Beach, Sanderson and St Martins Lane, all of which are consolidated in the Company’s consolidated financial statements. Prior to the completion of the CGM Transaction, the Company accounted for the food and beverage entities located at Sanderson and St Martins Lane using the equity method of accounting. See note 4.

The Company’s resulting ownership interests in the remaining two of these food and beverage ventures, covered by the CGM Transaction, relating to the food and beverage operations at Mondrian Los Angeles and Mondrian South Beach, was less than 100%, and were reevaluated in accordance with ASC 810-10, Consolidation (“ASC 810-10”). The Company concluded that these two ventures did not meet the requirements of a variable interest entity and accordingly, these investments in joint ventures were accounted for using the equity method, as the Company does not believe it exercises control over significant asset decisions such as buying, selling or financing. See note 4. Prior to the completion of the CGM Transaction, the Company consolidated the Mondrian Los Angeles food and beverage entity, as it exercised control and was the primary beneficiary of the venture.

On August 5, 2011, an affiliate of Pebblebrook Hotel Trust (“Pebblebrook”), the company that purchased Mondrian Los Angeles in May 2011 (as discussed in note 12), exercised its option to purchase the Company’s remaining ownership interest in the food and beverage operations at Mondrian Los Angeles for approximately $2.5 million. As a result of Pebblebrook’s exercise of this purchase option, the Company no longer has any ownership interest in the food and beverage operations at Mondrian Los Angeles.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company consolidates all wholly-owned subsidiaries and variable interest entities in which the Company is determined to be the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation. Entities which the Company does not control through voting interest and entities which are variable interest entities of which the Company is not the primary beneficiary, are accounted for under the equity method, if the Company can exercise significant influence.

The consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The information furnished in the accompanying consolidated financial statements reflects all adjustments that, in the opinion of management, are necessary for a fair presentation of the aforementioned consolidated financial statements for the interim periods.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. For further information, refer to the consolidated financial statements and accompanying footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Effective January 1, 2010, the Financial Accounting Standards Board (“FASB”) amended the guidance in ASC 810-10, for determining whether an entity is a variable interest entity and requiring the performance of a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity. Under this guidance, an entity would be required to consolidate a variable interest entity if it has (i) the power to direct the activities that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the variable interest entity or the right to receive benefits from the variable interest entity that could be significant to the variable interest entity. Adoption of this guidance on January 1, 2010 did not have a material impact on the consolidated financial statements.

Assets Held for Sale

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

The operations of the properties held for sale prior to the sale date are recorded in discontinued operations unless the Company has continuing involvement, such as through a management agreement, after the sale.

Investments in and Advances to Unconsolidated Joint Ventures

The Company accounts for its investments in unconsolidated joint ventures using the equity method as it does not exercise control over significant asset decisions such as buying, selling or financing nor is it the primary beneficiary under ASC 810-10, as discussed above. Under the equity method, the Company increases its investment for its proportionate share of net income and contributions to the joint venture and decreases its investment balance by recording its proportionate share of net loss and distributions. For investments in which there is recourse or unfunded commitments to provide additional equity, distributions and losses in excess of the investment are recorded as a liability.

Income Taxes

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

The Company’s deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Decreases to the valuation allowance are recorded as reductions to the Company’s provision for income taxes and increases to the valuation allowance result in additional provision for income taxes. The realization of the Company’s deferred tax assets, net of the valuation allowance, is primarily dependent on estimated future taxable income. A change in the Company’s estimate of future taxable income may require an addition to or reduction from the valuation allowance. The Company has established a reserve on a portion of its deferred tax assets based on anticipated future taxable income and tax strategies which may include the sale of hotel properties or an interest therein. When the Company sells a wholly-owned hotel subject to a long-term management contract, the pretax gain is deferred and is recognized over the life of the contract. In such instances, the Company establishes a deferred tax asset on the deferred gain and recognizes the related tax benefit through the tax provision. In May 2011, the Company used a portion of its tax net operating loss carryforwards to offset the gains on the sale of Royalton, Morgans and Mondrian Los Angeles.

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

Income taxes for the three and nine months ended September 30, 2011 and 2010, were computed using the Company’s effective tax rate.

Derivative Instruments and Hedging Activities

In accordance with ASC 815-10, Derivatives and Hedging (“ASC 815-10”) the Company records all derivatives on the balance sheet at fair value and provides qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

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 relating to interest payments on the Company’s borrowings. 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 caps as part of its interest rate risk management strategy. Interest rate caps 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 loss (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 as a component of interest expense. 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.

As of September 30, 2011 and December 31, 2010, the estimated fair market value of the Company’s cash flow hedges is immaterial.

In connection with the London Sale Agreement, defined below in footnote 4, on November 2, 2011, Walton, on behalf of itself and the Company, entered into a foreign currency forward contract to effectively fix the currency conversion rate on half of the expected net sales proceeds at an exchange rate of 1.592 US dollars to GBP.

Credit-risk-related Contingent Features

The Company has entered into agreements with each of its derivative counterparties in connection with the interest rate caps and hedging instruments related to the Convertible Notes, as defined and 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.

The Company has entered into warrant agreements with Yucaipa, as discussed in note 8, providing Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P. (collectively, the “Investors”) with 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.

Fair Value Measurements

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

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

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

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

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2011 and December 31, 2010, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. Accordingly, all derivatives have been classified as Level 2 fair value measurements.

In connection with the issuance of 75,000 of the Company’s Series A Preferred Securities to the Investors, as discussed in note 8, the Company also issued warrants to purchase 12,500,000 shares of the Company’s common stock at an exercise price of $6.00 per share to the Investors. Until October 15, 2010, the $6.00 exercise price of the warrants was subject to certain reductions if the Company had issued shares of common stock below $6.00 per share. The exercise price adjustments were not triggered prior to the expiration of such right on October 15, 2010. The fair value for each warrant granted was estimated at the date of grant using the Black-Scholes option pricing model, an allowable valuation method under ASC 718-10, Compensation, Stock Based Compensation (“ASC 718-10”). The estimated fair value per warrant was $1.96 on October 15, 2009.

Although the Company has determined that the majority of the inputs used to value the outstanding warrants fall within Level 1 of the fair value hierarchy, the Black-Scholes model utilizes Level 3 inputs, such as estimates of the Company’s volatility. Accordingly, the warrant liability was classified as a Level 3 fair value measure. On October 15, 2010, this liability was reclassified into equity, per ASC 815-10-15, Derivatives and Hedging, Embedded Derivatives (“ASC 815-10-15”).

In connection with its Outperformance Award Program, as discussed in note 7, the Company issued OPP LTIP Units (as defined in note 7) which were initially fair valued on the date of grant, and on September 30, 2011, utilizing a Monte Carlo simulation to estimate the probability of the performance vesting conditions being satisfied. The Monte Carlo simulation used a statistical formula underlying the Black-Scholes and binomial formulas and such simulation was run approximately 100,000 times. As the Company has the ability to settle the vested OPP LTIP Units with cash, these awards are not considered to be indexed to the Company’s stock price and must be accounted for as liabilities at fair value.

Although the Company has determined that the majority of the inputs used to value the OPP LTIP Units fall within Level 1 of the fair value hierarchy, the Monte Carlo simulation model utilizes Level 3 inputs, such as estimates of the Company’s volatility. Accordingly, the OPP LTIP Unit liability was classified as a Level 3 fair value measure.

During the three and nine months ended September 30, 2011, the Company recognized non-cash impairment charges of $1.6 million and $4.0 million, respectively, related to the Company’s investment in Mondrian SoHo, through equity in loss from joint ventures. The Company’s estimated fair value relating to this impairment assessment was based primarily upon Level 3 measurements, including a discounted cash flow analysis to estimate the fair value of the assets taking into account the assets expected cash flow, holding period and estimated proceeds from the disposition of assets, as well as market and economic conditions.

Fair Value of Financial Instruments

As mentioned below and in accordance with ASC 825-10, Financial Instruments, and ASC 270-10, Presentation, Interim Reporting, the Company provides quarterly fair value disclosures for financial instruments. Disclosures about fair value of financial instruments are based on pertinent information available to management as of the valuation date. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented are not necessarily indicative of the amounts at which these instruments could be purchased, sold, or settled. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The Company’s financial instruments include cash and cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, and fixed and variable rate debt. Management believes the carrying amount of the aforementioned financial instruments, excluding fixed-rate debt, is a reasonable estimate of fair value as of September 30, 2011 and December 31, 2010 due to the short-term maturity of these items or variable market interest rates.

The fair market value of the Company’s $222.6 million of fixed rate debt, excluding capitalized lease obligations and including the Convertible Notes at face value, as of September 30, 2011 and December 31, 2010 was approximately $205.7 million and $248.6 million, respectively, using market interest rates.

Stock-based Compensation

The Company accounts for stock based employee compensation using the fair value method of accounting described in ASC 718-10. For share grants, total compensation expense is based on the price of the Company’s stock at the grant date. For option grants, the total compensation expense is based on the estimated fair value using the Black-Scholes option-pricing model. For awards under the Company’s Outperformance Award Program, discussed in note 7, long-term incentive awards, the total compensation expense is based on the estimated fair value using the Monte Carlo pricing model. Compensation expense is recorded ratably over the vesting period, if any. Stock compensation expense recognized for the three months ended September 30, 2011 and 2010 was $1.4 million and $2.3 million, respectively. Stock compensation expense recognized for the nine months ended September 30, 2011 and 2010 was $7.4 million and $8.9 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 ASC 810-10, when accounting and reporting for noncontrolling interests in a consolidated subsidiary and the deconsolidation of a subsidiary. Under ASC 810-10, the Company reports noncontrolling interests in subsidiaries as a separate component of stockholders’ equity (deficit) in the consolidated financial statements and reflects net income (loss) attributable to the noncontrolling interests and net income (loss) attributable to the common stockholders on the face of the consolidated statements of operations and comprehensive loss.

The membership units in Morgans Group, the Company’s operating company, owned by the Former Parent are presented as noncontrolling interest in Morgans Group in the consolidated balance sheets and were approximately $8.4 million and $10.6 million as of September 30, 2011 and December 31, 2010, respectively. The noncontrolling interest in Morgans Group is: (i) increased or decreased by the limited members’ pro rata share of Morgans Group’s net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by exchanges of membership units for the Company’s common stock; and (iv) adjusted to equal the net equity of Morgans Group multiplied by the limited members’ ownership percentage immediately after each issuance of units of Morgans Group and/or shares of the Company’s common stock and after each purchase of treasury stock through an adjustment to additional paid-in capital. Net income or net loss allocated to the noncontrolling interest in Morgans Group is based on the weighted-average percentage ownership throughout the period.

Additionally, less than $0.3 million was recorded as noncontrolling interest as of December 31, 2010, which represents the Company’s joint venture partner’s interest in food and beverage ventures at certain of the Company’s hotels.

Reclassifications

Certain prior year financial statement amounts have been reclassified to conform to the current year presentation, including discontinued operations, discussed in note 9, and assets held for sale, discussed in note 12.

New Accounting Pronouncements

Accounting Standards Update No. 2011-04 — “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU No. 2011-04”) generally provides a uniform framework for fair value measurements and related disclosures between GAAP and International Financial Reporting Standards (“IFRS”). Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 will be effective for interim and annual periods beginning on or after December 15, 2011. The Company does not believe ASU 2011-04 will have a material impact on its financial statements.

Accounting Standards Update No. 2011-05 — “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (“ASU No. 2011-05”) amends existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement, statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. ASU No. 2011-05 requires retrospective application, and it is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with early adoption permitted. The Company believes the adoption of this update may provide additional detail on the consolidated financial statements when applicable, but will not have any other impact on the Company’s financial statements.

Accounting Standards Update No. 2011-08 — “Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (“ASU No. 2011-08”) amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount. If this is the case, companies will need to perform a more detailed two-step goodwill impairment test which is used to identify potential goodwill impairments and to measure the amount of goodwill impairment losses to be recognized, if any. ASU No. 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company does not believe the adoption of this update will have a material impact on its financial statements.

3. Income (Loss) Per Share

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

Basic earnings (loss) per share is calculated based on the weighted average number of common stock outstanding during the period. Diluted earnings (loss) per share include the effect of potential shares outstanding, including dilutive securities. Potential dilutive securities may include shares and options granted under the Company’s stock incentive plan and membership units in Morgans Group, which may be exchanged for shares of the Company’s common stock under certain circumstances. The 954,065 Morgans Group membership units (which may be converted to cash, or at the Company’s option, common stock) held by third parties at September 30, 2011, warrants issued to the Investors, unvested restricted stock units, LTIP Units (as defined in note 7), stock options, and OPP LTIP Units and shares issuable upon conversion of outstanding Convertible Notes (as defined in note 6) 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.

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

		Three Months				Three Months
		Ended				Ended
		Sept. 30, 2011				Sept. 30, 2010
Numerator:
Net loss from continuing operations		$	(25,618	)		$	(38,247	)
Net loss from discontinued operations			—				(281	)
Net loss			(25,618	)			(38,528	)
Net loss attributable to noncontrolling interest			799				1,451
Net loss attributable to Morgans Hotel Group Co.			(24,819	)			(37,077	)
Less: preferred stock dividends and accretion			2,285				2,164
Net loss attributable to common shareholders		$	(27,104	)		$	(39,241	)
Denominator, continuing and discontinued operations:
Weighted average basic common shares outstanding			30,617				30,162
Effect of dilutive securities			—				—
Weighted average diluted common shares outstanding			30,617				30,162
Basic and diluted loss from continuing operations per share		$	(0.89	)		$	(1.29	)
Basic and diluted loss from discontinued operations per share		$	0.00			$	(0.01	)
Basic and diluted loss available to common stockholders per common share		$	(0.89	)		$	(1.30	)

		Nine Months				Nine Months
		Ended				Ended
		Sept. 30, 2011				Sept. 30, 2010
Numerator:
Net loss from continuing operations		$	(70,778	)		$	(92,615	)
Net income from discontinued operations			485				16,474
Net loss			(70,293	)			(76,141	)
Net loss attributable to noncontrolling interest			2,007				2,033
Net loss attributable to Morgans Hotel Group Co.			(68,286	)			(74,108	)
Less: preferred stock dividends and accretion			6,701				6,357
Net loss attributable to common shareholders		$	(74,987	)		$	(80,465	)
Denominator, continuing and discontinued operations:
Weighted average basic common shares outstanding			31,359				30,470
Effect of dilutive securities			—				—
Weighted average diluted common shares outstanding			31,359				30,470
Basic and diluted loss from continuing operations per share		$	(2.41	)		$	(3.18	)
Basic and diluted income from discontinued operations per share		$	0.02			$	0.54
Basic and diluted loss available to common stockholders per common share		$	(2.39	)		$	(2.64	)

4. Investments in and Advances to Unconsolidated Joint Ventures

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

Investments

		As of				As of
		Sept. 30,				December 31,
Investment		2011				2010
Mondrian South Beach		$	3,313			$	5,817
Morgans Hotel Group Europe Ltd.			—				1,366
Mondrian SoHo			—				—
Ames			—				10,709
Mondrian South Beach food and beverage — MC South Beach (1)			1,592				—
Other			158				2,558
Total investments in and advances to unconsolidated joint ventures		$	5,063			$	20,450

		As of				As of
		Sept. 30,				December 31,
Investment		2011				2010
Restaurant Venture — SC London (2)		$	—			$	(1,509	)
Morgans Hotel Group Europe Ltd.			(272	)			—
Hard Rock Hotel & Casino (3)			—				—
Total losses from and distributions in excess of investment in unconsolidated joint ventures		$	(272	)		$	(1,509	)

Equity in income (loss) of unconsolidated joint ventures

		Three Months Ended				Three Months Ended				Nine Months Ended				Nine Months Ended
Investment		Sept. 30, 2011				Sept. 30, 2010				Sept. 30, 2011				Sept. 30, 2010
Morgans Hotel Group Europe Ltd.		$	499			$	1041			$	1,392			$	2,540
Restaurant Venture — SC London (1)			—				(136	)			(510	)			(584	)
Mondrian South Beach			(1,025	)			(1,576	)			(2,503	)			(1,808	)
Mondrian South Beach food and beverage — MC South Beach (2)			(108	)			—				(108	)			—
Ames			(10,597	)			(86	)			(11,062	)			(577	)
Mondrian SoHo			(1,565	)			(680	)			(4,026	)			(9,015	)
Hard Rock Hotel & Casino (3)			—				—				(6,376	)			—
Other			2				2				6				7
Total equity in loss from unconsolidated joint ventures		$	(12,794	)		$	(1,435	)		$	(23,187	)		$	(9,437	)

Morgans Hotel Group Europe Limited

As of September 30, 2011, 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 (“Walton”).

Under the joint venture agreement with Walton, the Company owns indirectly a 50% equity interest in Morgans Europe and has an equal representation on the Morgans Europe board of directors. In the event the parties cannot agree on certain specified decisions, such as approving hotel budgets or acquiring a new hotel property, or beginning any time after February 9, 2010, either party has the right to buy all the shares of the other party in the joint venture or, if its offer is rejected, require the other party to buy all of its shares at the same offered price per share in cash.

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 three and nine months ended September 30, 2011 and 2010.

On July 15, 2010, the joint venture refinanced in full its then outstanding £99.3 million mortgage debt with a new £100 million loan maturing in July 2015 that is non-recourse to the Company and is secured by Sanderson and St Martins Lane. The joint venture also entered into a swap agreement that effectively fixes the interest rate at 5.22% for the term of the loan, a reduction in interest rate of approximately 105 basis points, as compared to the previous mortgage loan. As of September 30, 2011, Morgans Europe had outstanding mortgage debt of £99.3 million, or approximately $154.8 million at the exchange rate of 1.56 US dollars to GBP at September 30, 2011.

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.

On October 7, 2011, subsidiaries of the Company and Walton entered into an agreement (the “London Sale Agreement”) to sell their respective equity interests in the joint venture for an aggregate of £192 million (or approximately $300.0 million at the exchange rate of 1.56 US dollars to GBP at September 30, 2011) to Capital Hills Hotels Limited. On closing of the transaction, the Company will continue to operate the hotels under long-term management agreements that, including extension options, extend the term of the existing management agreements to 2041 from 2027. The transaction is expected to close in the fourth quarter of 2011 and is subject to satisfaction of customary closing conditions. The Company expects to receive net proceeds of approximately $70 million, depending on foreign currency exchange rates and working capital adjustments, after the joint venture applies a portion of the proceeds from the sale to retire the £99.5 million of outstanding mortgage debt secured by the hotels and after payment of closing costs. The joint venture partners have received a £10 million security deposit, which is non-refundable except in the event of a default by the seller.

On November 2, 2011, Walton, on behalf of itself and the Company, entered into a foreign currency forward contract to effectively fix the currency conversion rate on half of the expected net sales proceeds at an exchange rate of 1.592 US dollars to GBP.

Mondrian South Beach

On August 8, 2006, the Company entered into a 50/50 joint venture to renovate and convert an apartment building on Biscayne Bay in 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 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 50/50 joint venture partners was funded at closing, and subsequently each member also contributed $8.0 million of additional equity. The Company and an affiliate of its joint venture partner provided additional mezzanine financing of approximately $22.5 million in total to the joint venture to fund completion of the construction in 2008. Additionally, the joint venture initially received non-recourse mortgage loan financing of approximately $124.0 million at a rate of LIBOR plus 300 basis points. A portion of this mortgage debt was paid down, prior to the amendments discussed below, with proceeds obtained from condominium sales. In April 2008, the Mondrian South Beach joint venture obtained a mezzanine loan from the mortgage lenders of $28.0 million bearing interest at LIBOR, based on the rate set date, plus 600 basis points. The $28.0 million mezzanine loan provided by the lender and the $22.5 million mezzanine loan provided by the joint venture partners were both amended when the loan matured in April 2010, as discussed below.

In April 2010, the joint venture amended the non-recourse financing secured by the property and extended the maturity date for up to seven years through extension options until April 2017, subject to certain conditions. Among other things, the amendment allows the joint venture to accrue all interest for a period of two years and a portion thereafter and provides the joint venture the ability to provide seller financing to qualified condominium buyers with up to 80% of the condominium purchase price. Each of the joint venture partners provided an additional $2.75 million to the joint venture resulting in total mezzanine financing provided by the partners of $28.0 million. The amendment also provides that this $28.0 million mezzanine financing invested in the property be elevated in the capital structure to become, in effect, on par with the lender’s mezzanine debt so that the joint venture receives at least 50% of all returns in excess of the first mortgage.

Morgans Group and affiliates of its joint venture partner have agreed to provide standard non-recourse carve-out guaranties and provide certain limited indemnifications for the Mondrian South Beach mortgage and mezzanine loans. In the event of a default, the lenders’ recourse is generally limited to the mortgaged property or related equity interests, subject to standard non-recourse carve-out guaranties for “bad boy” type acts. Morgans Group and affiliates of its joint venture partner also agreed to guaranty the joint venture’s obligation to reimburse certain expenses incurred by the lenders and indemnify the lenders in the event such lenders incur liability as a result of any third-party actions brought against Mondrian South Beach. Morgans Group and affiliates of its joint venture partner have also guaranteed the joint venture’s liability for the unpaid principal amount of any seller financing note provided for condominium sales if such financing or related mortgage lien is found unenforceable, provided they shall not have any liability if the seller financed unit becomes subject again to the lien of the lender’s mortgage or title to the seller financed unit is otherwise transferred to the lender or if such seller financing note is repurchased by Morgans Group and/or affiliates of its joint venture at the full amount of unpaid principal balance of such seller financing note. In addition, although construction is complete and Mondrian South Beach opened on December 1, 2008, Morgans Group and affiliates of its joint venture partner may have continuing obligations under construction completion guaranties until all outstanding payables due to construction vendors are paid. As of September 30, 2011, there are remaining payables outstanding to vendors of approximately $1.1 million. The Company believes that payment under these guaranties is not probable and the fair value of the guarantee is not material.

The Company and affiliates of its joint venture partner also have an agreement to purchase approximately $14 million each of condominium units under certain conditions, including an event of default. In the event of a default under the mortgage or mezzanine loan, the joint venture partners are obligated to purchase selected condominium units, at agreed-upon sales prices, having aggregate sales prices equal to 1/2 of the lesser of $28.0 million, which is the face amount outstanding on the mezzanine loan, or the then outstanding principal balance of the mezzanine loan. The joint venture is not currently in an event of default under the mortgage or mezzanine loan. The Company has not recognized a liability related to the construction completion or the condominium purchase guarantees.

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.

The Mondrian South Beach joint venture was determined to be a variable interest entity as during the process of refinancing the venture’s mortgage in April 2010, its equity investment at risk was considered insufficient to permit the entity to finance its own activities. Management determined that the Company is not the primary beneficiary of this variable interest entity as the Company does not have a controlling financial interest in the entity. The Company’s maximum exposure to losses as a result of its involvement in the Mondrian South Beach variable interest entity is limited to its current investment, outstanding management fee receivable and advances in the form of mezzanine financing. The Company is not committed to providing financial support to this variable interest entity, other than as contractually required and all future funding is expected to be provided by the joint venture partners in accordance with their respective percentage interests in the form of capital contributions or mezzanine financing, or by third parties.

Mondrian SoHo

In June 2007, the Company entered into a joint venture with Cape Advisors Inc. to acquire and develop a Mondrian hotel in the SoHo neighborhood of New York City. The Company initially contributed $5.0 million for a 20% equity interest in the joint venture and subsequently loaned an additional $4.3 million to the venture. The joint venture obtained a loan of $195.2 million to acquire and develop the hotel, which matured in June 2010.

Based on the decline in market conditions following the inception of the joint venture and more recently, the need for additional funding to complete the hotel, the Company wrote down its investment in Mondrian SoHo to zero in June 2010 and recorded an impairment charge through equity in loss of unconsolidated joint ventures.

On July 31, 2010, the lender amended the debt financing on the property to provide for, among other things, extensions of the maturity date of the mortgage loan secured by the hotel to November 2011 with extension options through 2015, subject to certain conditions including a minimum debt service coverage test calculated, as defined, based on ratios of net operating income to debt service for the three months ended September 30, 2011 of 1:1 or greater.

In addition to new funds provided by the lender, Cape Advisors Inc. made cash and other contributions to the joint venture, and the Company agreed to provide up to $3.2 million of additional funds to be treated as a loan with priority over the equity, to complete the project. The Company has contributed the full amount of this priority loan, as well as additional funds of $1.1, all of which were considered impaired and recorded as impairment charges through equity in loss of unconsolidated joint ventures during the periods funds were contributed. As of September 30, 2011, the Company’s investment balance in the joint venture was zero.

The joint venture believes the hotel has achieved the required 1:1 coverage ratio as of September 30, 2011 and subject to other customary conditions, the maturity of this debt can be extended to November 2012. The joint venture has additional extension options available in 2012 subject to similar conditions, including a minimum debt service coverage test calculated, as defined, based on ratios of net operating income to debt service for the twelve months ended September 30, 2012 of 1.1:1.0 or greater.

Certain affiliates of the Company’s joint venture partner have agreed to provide a standard non-recourse carve-out guaranty for “bad boy” type acts and a completion guaranty to the lenders for the Mondrian SoHo loan, for which Morgans Group has agreed to indemnify the joint venture partner and its affiliates up to 20% of such entities’ guaranty obligations, provided that each party is fully responsible for any losses incurred as a result of its own gross negligence or willful misconduct.

The Mondrian SoHo opened in February 2011 and has 270 guest rooms, a restaurant, bar and other facilities. The Company has a 10-year management contract with two 10-year extension options to operate the hotel.

As of December 31, 2010, the Mondrian SoHo joint venture was determined to be a variable interest entity, but the Company was not its primary beneficiary and, therefore, consolidation of this joint venture is not required. In February 2011, when Mondrian SoHo opened, the Company determined that the joint venture was an operating business. The Company continues to account for its investment in Mondrian SoHo using the equity method of accounting.

Ames

On June 17, 2008, the Company, Normandy Real Estate Partners, and Ames Hotel Partners entered into a joint venture agreement as part of the development of the Ames hotel in Boston. Ames opened on November 19, 2009 and has 114 guest rooms, a restaurant, bar and other facilities. The Company manages Ames under a 15-year management contract.

The Company has contributed approximately $11.8 million in equity through September 30, 2011 for an approximately 31% interest in the joint venture. The joint venture obtained a loan for $46.5 million secured by the hotel, which was outstanding as of September 30, 2011. The project also qualified for federal and state historic rehabilitation tax credits which were sold for approximately $16.9 million.

In September 2011, the joint venture partners funded their pro rata shares of the debt service reserve account, of which the Company’s contribution was $0.3 million, and exercised the one remaining extension option available on the mortgage debt. As a result, the mortgage debt secured by Ames will mature on October 9, 2012.

Based on current economic conditions and the upcoming mortgage debt maturity, the joint venture concluded that the hotel was impaired as of September 30, 2011, and recorded a $49.9 million impairment charge. The Company wrote down its investment in Ames to zero and recorded an impairment charge through equity in loss of unconsolidated joint ventures of $10.6 million.

Shore Club

The Company operates Shore Club under a management contract and owned a minority ownership interest of approximately 7% at September 30, 2011. 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. In March 2010, the lender for the Shore Club mortgage initiated foreclosure proceedings against the property in U.S. federal district court. In October 2010, the federal court dismissed the case for lack of jurisdiction. In November 2010, the lender initiated foreclosure proceedings in state court. The Company continues to operate the hotel pursuant to the management agreement during these proceedings. However, there can be no assurances the Company will continue to operate the hotel once foreclosure proceedings are complete.

MC South Beach and SC Sunset

On June 20, 2011, the Company completed the CGM Transaction, pursuant to which subsidiaries of the Company acquired from affiliates of CGM the 50% interests CGM owned in the Company’s food and beverage joint ventures for approximately $20.0 million. CGM has agreed to continue to manage the food and beverage operations at these properties for a transitional period pursuant to short-term cancellable management agreements while the Company reassess its food and beverage strategy.

The Company’s ownership interest in one of the food and beverage ventures covered by the CGM Transaction, MC South Beach LLC (“MC South Beach”) at Mondrian South Beach, is less than 100%, and was reevaluated in accordance with ASC 810-10. The Company concluded that this venture did not meet the requirements of a variable interest entity and accordingly, this investment in the joint venture is accounted for using the equity method, as the Company does not believe it exercises control over significant asset decisions such as buying, selling or financing.

At the closing of the CGM Transaction, the Company’s ownership interest in another food and beverage venture covered by the CGM Transaction, Sunset Restaurant LLC (“SC Sunset”) at Mondrian Los Angeles, was also less than 100%, and was reevaluated at the time in accordance with ASC 810-10. The Company initially concluded that this venture did not meet the requirements of a variable interest entity and accordingly, this investment in joint venture was accounted for using the equity method. Subsequently, on August 5, 2011, an affiliate of Pebblebrook, the company that purchased Mondrian Los Angeles in May 2011 (as discussed in note 12), exercised its option to purchase the Company’s remaining ownership interest in the food and beverage operations at Mondrian Los Angeles for approximately $2.5 million. As a result of Pebblebrook’s exercise of this purchase option, the Company no longer has any ownership interest in the food and beverage operations at Mondrian Los Angeles.

Hard Rock Hotel & Casino

Formation and Hard Rock Credit Facility

On February 2, 2007, the Company and Morgans Group (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 (“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 comprised of a senior mortgage loan and three mezzanine loans, which provided for a $760.0 million acquisition loan that was used to fund the acquisition, of which $110.0 million was subsequently repaid according to the terms of the loan, and a construction loan of up to $620.0 million, which was fully drawn for the expansion project at the Hard Rock. Morgans Group provided a standard non-recourse, carve-out guaranty for each of the mortgage and mezzanine loans.

Following the formation of Hard Rock Hotel Holdings, LLC, additional cash contributions were made by both the DLJMB Parties and the Morgans Parties, including disproportionate cash contributions by the DLJMB Parties. Prior to the Hard Rock settlement, discussed below, the DLJMB Parties had contributed an aggregate of $424.8 million in cash and the Morgans Parties had contributed an aggregate of $75.8 million in cash. In 2009, the Company wrote down the Company’s investment in Hard Rock to zero.

Hard Rock Settlement Agreement

On January 28, 2011, subsidiaries of Hard Rock Hotel Holdings, LLC received a notice of acceleration from the NRFC HRH Holdings, LLC (the “Second Mezzanine Lender”) pursuant to the First Amended and Restated Second Mezzanine Loan Agreement, dated as of December 24, 2009 (the “Second Mezzanine Loan Agreement”), between such subsidiaries and the Second Mezzanine Lender, declaring all unpaid principal and accrued interest under the Second Mezzanine Loan Agreement immediately due and payable.

On February 6, 2011, subsidiaries of Hard Rock Hotel Holdings, LLC, Vegas HR Private Limited (the “Mortgage Lender”), Brookfield Financial, LLC-Series B (the “First Mezzanine Lender), the Second Mezzanine Lender, Morgans Group, certain affiliates of DLJMB, and certain other related parties entered into a Standstill and Forbearance Agreement.

On March 1, 2011, Hard Rock Hotel Holdings, LLC, the Mortgage Lender, the First Mezzanine Lender, the Second Mezzanine Lender, the Morgans Parties and certain affiliates of DLJMB, as well as Hard Rock Mezz Holdings LLC (the “Third Mezzanine Lender”) and other interested parties entered into a comprehensive settlement to resolve the disputes among them and all matters relating to the Hard Rock and related loans and guaranties. The settlement provided, among other things, for the following:

•

release of the non-recourse carve-out guaranties provided by the Company with respect to the loans made by the Mortgage Lender, the First Mezzanine Lender, the Second Mezzanine Lender and the Third Mezzanine Lender to the direct and indirect owners of the Hard Rock;

•

termination of the management agreement pursuant to which the Company’s subsidiary managed the Hard Rock;

•

the transfer by Hard Rock Hotel Holdings, LLC to an affiliate of the First Mezzanine Lender of 100% of the indirect equity interests in the Hard Rock; and

•

certain payments to or for the benefit of the Mortgage Lender, the First Mezzanine Lender, the Second Mezzanine Lender, the Third Mezzanine Lender and the Company. The Company’s net payment was approximately $3.7 million.

As a result of the settlement and completion of certain gaming de-registration procedures, the Company is no longer subject to Nevada gaming regulations.

5. Other Liabilities

Other liabilities consist of the following (in thousands):

		As of				As of
		Sept. 30,				December 31,
		2011				2010
OPP Liability (note 7)		$	425			$	—
Designer fee payable			13,866				13,866
		$	14,291			$	13,866

OPP Liability

As discussed further in note 7, the estimated fair value of the OPP LTIP Units liability was approximately $0.4 million at September 30, 2011.

Designer Fee Payable

As of September 30, 2011 and December 31, 2010, included in other liabilities was $13.9 million, which is related to a potential claim for a fee payable to a designer. 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. According to the agreement, the designer was owed a base fee for each designed hotel, plus 1% of Gross Revenues, as defined in the agreement, for a 10-year period from the opening of each hotel. In addition, the agreement also called for the designer to design a minimum number of projects for which the designer would be paid a minimum fee. A liability amount has been estimated and recorded in these consolidated financial statements before considering any defenses and/or counter-claims that may be available to the Company or the Former Parent in connection with any claim brought by the designer. The Company believes the probability of losses associated with this claim in excess of the liability that is accrued of $13.9 million is remote and cannot reasonably estimate of range of such additional losses, if any, at this time. The estimated costs of the design services were capitalized as a component of the applicable hotel and amortized over the five-year estimated life of the related design elements.

6. Debt and Capital Lease Obligations

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

		As of				As of
		Sept. 30,				December 31,				Interest rate at
Description		2011				2010				September 30, 2011
Notes secured by Hudson (a)		$	115,000			$	201,162			5.00% (LIBOR + 4.00%, LIBOR floor of 1.00%)
Notes secured by equity interests in Henry Hudson Holdings (a)			—				26,500			(a)
Clift debt (b)			86,484				85,033			9.60%
Liability to subsidiary trust (c)			50,100				50,100			8.68%
Convertible Notes, face value of $172.5 million (d)			165,576				163,869			2.38%
Revolving credit facility (e)			10,000				26,008			5.00% (LIBOR + 4.00%, LIBOR floor of 1.00%)
Capital lease obligations (f)			6,107				6,107			(f)
Debt and capital lease obligation		$	433,267			$	558,779
Mortgage debt secured by assets held for sale — Mondrian Los Angeles (a)		$	—			$	103,496
Notes secured by property held for non-sale disposition (g)		$	—			$	10,500

(a) Mortgage Agreements

Hudson Mortgage and Mezzanine Loan

On October 6, 2006, a subsidiary of the Company, Henry Hudson Holdings LLC (“Hudson Holdings”), entered into a non-recourse mortgage financing secured by Hudson (the “Hudson Mortgage”), and another subsidiary entered into a mezzanine loan related to Hudson, secured by a pledge of the Company’s equity interests in Hudson Holdings.

Until amended as described below, the Hudson Mortgage bore interest at 30-day LIBOR plus 0.97%. The Company had entered into an interest rate swap on the Hudson Mortgage and the mezzanine loan on Hudson which effectively fixed the 30-day LIBOR rate at approximately 5.0%. This interest rate swap expired on July 15, 2010. The Company subsequently entered into a short-term interest rate cap on the Hudson Mortgage that expired on September 12, 2010.

On October 1, 2010, Hudson Holdings entered into a modification agreement of the Hudson Mortgage, together with promissory notes and other related security agreements, with Bank of America, N.A., as trustee, for the lenders (the “Amended Hudson Mortgage”). This modification agreement and related agreements extended the Hudson Mortgage until October 15, 2011. In connection with the Amended Hudson Mortgage, on October 1, 2010, Hudson Holdings paid down a total of $16 million on its outstanding loan balances.

The interest rate on the Amended Hudson Mortgage was also amended to 30-day LIBOR plus 1.03%. The interest rate on the Hudson mezzanine loan continued to bear interest at 30-day LIBOR plus 2.98%. The Company entered into interest rate caps expiring October 15, 2011 in connection with the Amended Hudson Mortgage, which effectively capped the 30-day LIBOR rate at 5.3% on the Amended Hudson Mortgage and effectively capped the 30-day LIBOR rate at 7.0% on the Hudson mezzanine loan.

The Amended Hudson Mortgage required the Company’s subsidiary borrower to fund reserve accounts to cover monthly debt service payments. The subsidiary borrower was also required to fund reserves for property, sales and occupancy taxes, insurance premiums, capital expenditures and the operation and maintenance of Hudson. Reserves were deposited into restricted cash accounts and released as certain conditions were met. In addition, all excess cash was required to be funded into a curtailment reserve account. The subsidiary borrower was not permitted to have any liabilities other than certain ordinary trade payables, purchase money indebtedness, capital lease obligations and certain other liabilities.

On August 12, 2011, certain of the Company’s subsidiaries entered into a new mortgage financing with Deutsche Bank Trust Company Americas and the other institutions party thereto from time to time, as lenders, consisting of two mortgage loans, each secured by Hudson and treated as a single loan once disbursed, in the following amounts: (1) a $115.0 million mortgage loan that was funded at closing, and (2) a $20.0 million delayed draw term loan, which will be available to be drawn over a 15-month period, subject to achieving a debt yield ratio of at least 9.5% (based on net operating income for the prior 12 months) after giving effect to each additional draw (collectively, the “ Hudson 2011 Mortgage Loan”).

Proceeds from the Hudson 2011 Mortgage Loan, cash on hand and cash held in escrow were applied to repay $201.2 million of outstanding mortgage debt under the Amended Hudson Mortgage, repay $26.5 million of outstanding indebtedness under the Hudson mezzanine loan, and pay fees and expenses in connection with the financing.

The Hudson 2011 Mortgage Loan bears interest at a reserve adjusted blended rate of 30-day LIBOR (with a minimum of 1.0%) plus 400 basis points. The Company maintains an interest rate cap for the amount of the Hudson 2011 Mortgage Loan that will cap the LIBOR rate on the debt under the Hudson 2011 Mortgage Loan at approximately 3.0% through the maturity date of the loan.

The Hudson 2011 Mortgage Loan matures on August 12, 2013. The Company has three one-year extension options that will permit it to extend the maturity date of the Hudson 2011 Mortgage Loan to August 12, 2016 if certain conditions are satisfied at each respective extension date. The first two extension options require, among other things, the borrowers to maintain a debt service coverage ratio of at least 1-to-1 for the 12 months prior to the applicable extension dates. The third extension option requires, among other things, the borrowers to achieve a debt yield ratio of at least 13.0% (based on net operating income for the prior 12 months).

The Hudson 2011 Mortgage Loan provides that, in the event the debt yield ratio falls below certain defined thresholds, all cash from the property is deposited into accounts controlled by the lenders from which debt service, operating expenses and management fees are paid and from which other reserve accounts may be funded. Any excess amounts are retained by the lenders until the debt yield ratio exceeds the required thresholds for two consecutive calendar quarters. Furthermore, if the Hudson manager is not reserving sufficient funds for property tax, ground rent, insurance premiums, and capital expenditures in accordance with the hotel management agreement, then the Company’s subsidiary borrowers would be required to fund the reserve account for such purposes. The Company’s subsidiary borrowers are not permitted to have any indebtedness other than certain permitted indebtedness customary in such transactions, including ordinary trade payables, purchase money indebtedness and capital lease obligations, subject to limits.

The Hudson 2011 Mortgage Loan may be prepaid, in whole or in part, subject to payment of a prepayment penalty for any prepayment prior to August 12, 2013. There is no prepayment premium after August 12, 2013.

The Hudson 2011 Mortgage Loan contains restrictions on the ability of the borrowers to incur additional debt or liens on their assets and on the transfer of direct or indirect interests in Hudson and the owner of Hudson and other affirmative and negative covenants and events of default customary for single asset mortgage loans. The Hudson 2011 Mortgage Loan is fully recourse to our subsidiaries that are the borrowers under the loan. The loan is nonrecourse to us, Morgans Group and our other subsidiaries, except for certain standard nonrecourse carveouts. Morgans Group has provided a customary environmental indemnity and nonrecourse carveout guaranty under which it would have liability with respect to the Hudson 2011 Mortgage Loan if certain events occur with respect to the borrowers, including voluntary bankruptcy filings, collusive involuntary bankruptcy filings, and violations of the restrictions on transfers, incurrence of additional debt, or encumbrances of the property of the borrowers. The nonrecourse carveout guaranty requires Morgans Group to maintain a net worth of at least $100 million (based on the estimated market value of our net assets) and liquidity of at least $20 million.

Mondrian Los Angeles Mortgage

On October 6, 2006, a subsidiary of the Company, Mondrian Holdings LLC (“Mondrian Holdings”), entered into a non-recourse mortgage financing secured by Mondrian Los Angeles (the “Mondrian Mortgage”).

On October 1, 2010, Mondrian Holdings entered into a modification agreement of its Mondrian Mortgage, together with promissory notes and other related security agreements, with Bank of America, N.A., as trustee, for the lenders. This modification agreement and related agreements amended and extended the Mondrian Mortgage (the “Amended Mondrian Mortgage”) until October 15, 2011. In connection with the Amended Mondrian Mortgage, on October 1, 2010, Mondrian Holdings paid down a total of $17 million on its outstanding mortgage loan balance.

The interest rate on the Amended Mondrian Mortgage was also amended to 30-day LIBOR plus 1.64%. The Company entered into an interest rate cap which expired on October 15, 2011 in connection with the Amended Mondrian Mortgage which effectively capped the 30-day LIBOR rate at 4.25%.

On May 3, 2011, the Company completed the sale of Mondrian Los Angeles for $137.0 million to Wolverines Owner LLC, an affiliate of Pebblebrook. The Company applied a portion of the proceeds from the sale, along with approximately $9.2 million of cash in escrow, to retire the $103.5 million Mondrian Holdings Amended Mortgage.

(b) Clift Debt

In October 2004, Clift Holdings LLC (“Clift Holdings”), a subsidiary of the Company, sold the Clift hotel to an unrelated party for $71.0 million and then leased it back for a 99-year lease term. Under this lease, 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.

Due to the amount of the payments stated in the lease, which increase periodically, and the economic environment in which the hotel operates, Clift Holdings, had not been operating Clift at a profit and Morgans Group had been funding cash shortfalls sustained at Clift in order to enable Clift Holdings to make lease payments from time to time. On March 1, 2010, however, the Company discontinued subsidizing the lease payments and Clift Holdings stopped making the scheduled monthly payments. On May 4, 2010, the owners filed a lawsuit against Clift Holdings, which the court dismissed on June 1, 2010. On June 8, 2010, the owners filed a new lawsuit and on June 17, 2010, the Company and Clift Holdings filed an affirmative lawsuit against the owners.

On September 17, 2010, the Company, Clift Holdings and another subsidiary of the Company, 495 Geary, LLC, entered into a settlement and release agreement with Hasina, LLC, Tarstone Hotels, LLC, Kalpana, LLC, Rigg Hotel, LLC, and JRIA, LLC (collectively, the “Lessors”), and Tarsadia Hotels (the “Settlement and Release Agreement”). The Settlement and Release Agreement, among other things, effectively provided for the settlement of all outstanding litigation claims and disputes among the parties relating to defaulted lease payments due with respect to the ground lease for the Clift and reduced the lease payments due to Lessors for the period March 1, 2010 through February 29, 2012. Clift Holdings and the Lessors also entered into an amendment to the lease, dated September 17, 2010 (“Lease Amendment”), to memorialize, among other things, the reduced annual lease payments of $4.97 million from March 1, 2010 to February 29, 2012. Effective March 1, 2012, the annual rent will be as stated in the lease agreement, which currently provides for base annual rent of approximately $6.0 million per year through October 2014 increasing thereafter, at 5-year intervals by a formula tied to increases in the Consumer Price Index, with a maximum increase of 40% and a minimum of 20% at October 2014, and at each payment date thereafter, the maximum increase is 20% and the minimum is 10%. The lease is non-recourse to the Company.

Morgans Group also entered into an agreement, dated September 17, 2010 (the “Limited Guaranty,” together with the Settlement and Release Agreement and Lease Amendment, the “Clift Settlement Agreements”), whereby Morgans Group agreed to guarantee losses of up to $6 million suffered by the Lessors in the event of certain “bad boy” type acts.

(c) Liability to Subsidiary Trust Issuing Preferred Securities

On August 4, 2006, a newly established trust formed by the Company, MHG Capital Trust I (the “Trust”), issued $50.0 million in trust preferred securities in a private placement. The Company owns all of the $0.1 million of outstanding common stock of the Trust. The Trust used the proceeds of these transactions to purchase $50.1 million of junior subordinated notes issued by the Company’s operating company and guaranteed by the Company (the “Trust Notes”) which mature on October 30, 2036. The sole assets of the Trust consist of the Trust Notes. The terms of the Trust Notes are substantially the same as preferred securities issued by the Trust. The Trust Notes and the preferred securities have a fixed interest rate of 8.68% 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 preferred 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 earnings before interest, taxes, depreciation and amortization (“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. Based on management’s analysis, the Company is not the primary beneficiary under the trust. Accordingly, the Trust is not consolidated into the Company’s financial statements. The Company accounts for the investment in the common stock of the Trust under the equity method of accounting.

(d) 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. 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. The maximum conversion rate for each $1,000 principal amount of Convertible Notes is 45.5580 shares of the Company’s common stock representing a maximum conversion price of approximately $21.95 per share of common stock.

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

(e) Revolving Credit Facility

On October 6, 2006, the Company and certain of its subsidiaries entered into a revolving credit facility with Wachovia Bank, National Association, as Administrative Agent, and the other lenders party thereto, which was amended on August 5, 2009, (the “Amended Revolving Credit Facility”).

The Amended Revolving Credit Facility provided for a maximum aggregate amount of commitments of $125.0 million, divided into two tranches, which were secured by the mortgages on Morgans, Royalton and Delano South Beach.

The Amended Revolving Credit Facility bore 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 had a borrowing margin of 3.75% per annum and base rate loans have a borrowing margin of 2.75% per annum.

On May 23, 2011, in connection with the sale of Royalton and Morgans, the Company used a portion of the sales proceeds to retire all outstanding debt under the Amended Revolving Credit Facility. These hotels, along with Delano South Beach, were collateral for the Amended Revolving Credit Facility, which terminated with the sale of the properties securing the facility.

On July 28, 2011, the Company and certain of its subsidiaries (collectively, the “Borrowers”), including Beach Hotel Associates LLC (the “Florida Borrower”), entered into a secured Credit Agreement (the “Delano Credit Agreement”), with Deutsche Bank Securities Inc. as sole lead arranger, Deutsche Bank Trust Company Americas, as agent (the “Agent”), and the lenders party thereto (the “Lenders”).

The Delano Credit Agreement provides commitments for a $100.0 million revolving credit facility and includes a $15 million letter of credit sub-facility. The maximum amount of such commitments available at any time for borrowings and letters of credit is determined according to a borrowing base valuation equal to the lesser of (i) 55% of the appraised value of Delano (the “Florida Property”) and (ii) the adjusted net operating income for the Florida Property divided by 11%. Extensions of credit under the Delano Credit Agreement are available for general corporate purposes. The commitments under the Delano Credit Agreement may be increased by up to an additional $10 million during the first two years of the facility, subject to certain conditions, including obtaining commitments from any one or more lenders to provide such additional commitments. The commitments under the Delano Credit Agreement terminate on July 28, 2014, at which time all outstanding amounts under the Delano Credit Agreement will be due and payable.

As of September 30, 2011, the Company had $10.0 million outstanding under the Delano Credit Agreement and an additional $10.0 million letter of credit outstanding related to the Company’s key money investment in the 310-room Mondrian-branded hotel, to be the lifestyle hotel destination in the 1,000 acre destination resort metropolis, Baha Mar Resort, in Nassau, The Bahamas. In August 2011, the Company entered into a hotel management and residential licensing agreement related to this project.

The obligations of the Borrowers under the Delano Credit Agreement are guaranteed by the Company and a subsidiary of the Company. Such obligations are also secured by a mortgage on the Florida Property and all associated assets of the Florida Borrower, as well as a pledge of all equity interests in the Florida Borrower.

The interest rate applicable to loans under the Delano Credit Agreement is a floating rate of interest per annum, at the Borrowers’ election, of either LIBOR (subject to a LIBOR floor of 1.00%) plus 4.00%, or a base rate plus 3.00%. In addition, a commitment fee of 0.50% applies to the unused portion of the commitments under the Delano Credit Agreement.

The Borrowers’ ability to borrow under the Delano Credit Agreement is subject to ongoing compliance by the Company and the Borrowers with various customary affirmative and negative covenants, including limitations on liens, indebtedness, issuance of certain types of equity, affiliated transactions, investments, distributions, mergers and asset sales. In addition, the Delano Credit Agreement requires that the Company and the Borrowers maintain a fixed charge coverage ratio (consolidated EBITDA to consolidated fixed charges) of no less than (i) 1.05 to 1.00 at all times on or prior to June 30, 2012 and (ii) 1.10 to 1.00 at all times thereafter. As of September 30, 2011, the Company’s fixed charge coverage ratio under the Delano Credit Agreement was 1.59x.

The Delano Credit Agreement also includes customary events of default, the occurrence of which, following any applicable cure period, would permit the Lenders to, among other things, declare the principal, accrued interest and other obligations of the Borrowers under the Delano Credit Agreement to be immediately due and payable.

(f) Capital Lease Obligations

The Company has leased two condominium units at Hudson from unrelated third-parties, which are reflected as capital leases. One of the leases requires the Company to make annual payments, currently $582,180 (subject to increases due to increases in the Consumer Price Index) from acquisition through November 2096. This lease also allows the Company to purchase the unit at fair market value after November 2015.

The second lease requires the Company to make annual payments, currently $328,128 (subject to increases due to increases in the Consumer Price Index) through December 2098. The Company has allocated both of the leases’ payments between the land and building based on their estimated fair values. The portion of the payments allocated to building has been capitalized at the present value of the future minimum lease payments. The portion of the payments allocable to land is treated as operating lease payments. The imputed interest rate on both of these leases is 8%, which is based on the Company’s incremental borrowing rate at the time the lease agreement was executed. The capital lease obligations related to the units amounted to approximately $6.1 million as of September 30, 2011 and December 31, 2010. Substantially all of the principal payments on the capital lease obligations are due at the end of the lease agreements.

(g) Notes secured by property held for non sale disposition

An indirect subsidiary of the Company had issued a $10.0 million interest only non-recourse promissory note to the seller of the property across from the Delano South Beach which was due on January 24, 2011 and secured by the property. Additionally, a separate indirect subsidiary of the Company had issued a $0.5 million interest only non-recourse promissory note to an affiliate of the seller which was also due on January 24, 2011 and secured with a pledge of the equity interests in the Company’s subsidiary that owned the property. In January 2011, the Company’s indirect subsidiary transferred its interests in the property across the street from Delano South Beach to SU Gale Properties, LLC (the “Gale Transaction”). As a result of the Gale Transaction, the Company was released from the $10.5 million of non-recourse mortgage and mezzanine indebtedness.

7. Omnibus Stock Incentive Plan

RSUs, LTIPs and Stock Options

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”). 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. 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 “Restated 2007 Incentive Plan”) which, among other things, increased the number of shares reserved for issuance under the plan by up to 1,860,000 shares to a total of 8,610,000 shares. On November 30, 2009, the Board of Directors of the Company adopted, and at a special meeting of stockholders of the Company held on January 28, 2010, the Company’s stockholders approved, an amendment to the Restated 2007 Incentive Plan (the “Amended 2007 Incentive Plan”) to increase the number of shares reserved for issuance under the plan by 3,000,000 shares to 11,610,000 shares.

The Amended 2007 Incentive Plan provides for the issuance of stock-based incentive awards, including incentive stock options, non-qualified stock options, stock appreciation rights, shares of common stock of the Company, including restricted stock units (“RSUs”) and other equity-based awards, including membership units in Morgans Group which are structured as profits interests (“LTIP Units”), or any combination of the foregoing. The eligible participants in the Amended 2007 Incentive Plan included directors, officers and employees of the Company. Awards other than options and stock appreciation rights reduce the shares available for grant by 1.7 shares for each share subject to such an award.

During the third quarter of 2011, the Company granted newly hired employees an aggregate of 42,360 RSUs. A summary of stock-based incentive awards as of September 30, 2011 is as follows (in units, or shares, as applicable):

		Restricted Stock
		Units				LTIP Units				Stock Options
Outstanding as of January 1, 2011			805,334				2,271,437				1,506,337
Granted during 2011			379,280				300,000				1,300,000
Distributed/exercised during 2011			(286,309	)			(219,053	)			—
Forfeited during 2011			(168,142	)			—				(481,597	)
Outstanding as of September 30, 2011			730,163				2,352,384				2,324,470
Vested as of September 30, 2011			221,029				2,043,532				1,024,740

As of September 30, 2011 and December 31, 2010, there were approximately $10.3 million and $6.8 million, respectively, of total unrecognized compensation costs related to unvested RSUs, LTIP Units and options. As of September 30, 2011, the weighted-average period over which this unrecognized compensation expense will be recorded is approximately 1.3 years.

Total stock compensation expense related to RSUs, LTIPs and options, which is included in corporate expenses on the accompanying consolidated statements of operations and comprehensive loss, was $1.3 million and $2.3 million for the three months ended September 30, 2011 and 2010, respectively, and $7.0 million and $8.9 million for the nine months ended September 30, 2011 and 2010, respectively.

Outperformance Award Program

In connection with the Company’s senior management changes announced in March 2011, the Compensation Committee of the Board of Directors of the Company implemented an Outperformance Award Program, which is a long-term incentive plan intended to provide the Company’s senior management with the ability to earn cash or equity awards based on the Company’s level of return to shareholders over a three-year period.

Pursuant to the Outperformance Award Program, each of the Company’s newly hired senior managers, Messrs. Hamamoto, Gross, Flannery and Gery, will receive, an award (an “Award”), in each case reflecting the participant’s right to receive a participating percentage (the “Participating Percentage”) in an outperformance pool if the Company’s total return to shareholders (including stock price appreciation plus dividends) increases by more than 30% (representing a compounded annual growth rate of approximately 9% per annum) over a three-year period from March 20, 2011 to March 20, 2014 (or a prorated hurdle rate over a shorter period in the case of certain changes of control), of a new series of outperformance long-term incentive units (the “OPP LTIP Units,” as described below), subject to vesting and the achievement of certain performance targets.

The total return to shareholders will be calculated based on the average closing price of the Company’s common shares on the 30 trading days ending on the Final Valuation Date (as defined below). The baseline value of the Company’s common shares for purposes of determining the total return to shareholders will be $8.87, the closing price of the Company’s common shares on March 18, 2011. The Participation Percentages granted to Messrs. Hamamoto, Gross, Flannery and Gery are 35%, 35%, 10% and 10%, respectively.

Each of the current participants’ Awards vests on March 20, 2014 (or earlier in the event of certain changes of control) (the “Final Valuation Date”), contingent upon each participant’s continued employment, except for certain accelerated vesting events described below.

The aggregate dollar amount available to all participants is equal to 10% of the amount by which the Company’s March 20, 2014 valuation exceeds 130% (subject to proration in the case of certain changes of control) of the Company’s March 20, 2011 valuation (the “Total Outperformance Pool”) and the dollar amount payable to each participant (the “Participation Amount”) is equal to such participant’s Participating Percentage in the Total Outperformance Pool. Following the Final Valuation Date, the participant will either forfeit existing OPP LTIP Units or receive additional OPP LTIP Units so that the value of the vested OPP LTIP Units of the participant are equivalent to the participant’s Participation Amount.

Participants will forfeit any unvested Awards upon termination of employment; provided, however, that in the event a participant’s employment terminates because of death or disability, or employment is terminated by the Company without Cause or by the participant for Good Reason, as such terms are defined in the participant’s employment agreements, the participant will not forfeit the Award and will receive, following the Final Valuation Date, a Participation Amount reflecting his partial service. If the Final Valuation Date is accelerated by reason of certain change of control transactions, each participant whose Award has not previously been forfeited will receive a Participation Amount upon the change of control reflecting the amount of time since the effective date of the program, which was March 20, 2011.

OPP LTIP Units represent a special class of membership interest in the operating company, Morgans Group, which are structured as profits interests for federal income tax purposes. Conditioned upon minimum allocations to the capital accounts of the OPP LTIP Units for federal income tax purposes, each vested OPP LTIP Unit may be converted, at the election of the holder, into one Class A Unit in Morgans Group upon the receipt of shareholder approval for the shares of common stock underlying the OPP LTIP Units.

During the six-month period following the Final Valuation Date, Morgans Group may redeem some or all of the vested OPP LTIP Units (or Class A Units into which they were converted) at a price equal to the common share price (based on a 30-day average) on the Final Valuation Date. From and after the one-year anniversary of the Final Valuation Date, for a period of six months, participants will have the right to cause Morgans Group to redeem some or all of the vested OPP LTIP Units at a price equal to the greater of the common share price at the Final Valuation Date (determined as described above) or the then current common share price (calculated as determined in Morgans Group’s limited liability company agreement). Thereafter, beginning 18 months after the Final Valuation Date, each of these OPP LTIP Units (or Class A Units into which they were converted) is redeemable at the election of the holder for: (1) cash equal to the then fair market value of one share of the Company’s common stock, or (2) at the option of the Company, one share of common stock, in the event the Company then has shares available for that purpose under its shareholder-approved equity incentive plans. Participants are entitled to receive distributions on their vested OPP LTIP Units if any distributions are paid on the Company’s common stock following the Final Valuation Date.

The OPP LTIP Units were valued at approximately $7.3 million on the date of grant utilizing a Monte Carlo simulation to estimate the probability of the performance vesting conditions being satisfied. The Monte Carlo simulation used a statistical formula underlying the Black-Scholes and binomial formulas and such simulation was run approximately 100,000 times. For each simulation, the payoff is calculated at the settlement date, which is then discounted to the award date at a risk-free interest rate. The average of the values over all simulations is the expected value of the unit on the award date. Assumptions used in the valuations included factors associated with the underlying performance of the Company’s stock price and total shareholder return over the term of the performance awards including total stock return volatility and risk-free interest.

As the Company has the ability to settle the vested OPP LTIP Units with cash, these Awards are not considered to be indexed to the Company’s stock price and must be accounted for as liabilities at fair value. As of September 30, 2011, the fair value of the OPP LTIP Units were approximately $2.4 million and compensation expense relating to these OPP LTIP Units is being recorded over the vesting period. The fair value of the OPP LTIP Units were estimated on the date of grant using the following assumptions in the Monte-Carlo valuation: expected price volatility for the Company’s stock of 50%; a risk free rate of 1.46%; and no dividend payments over the measurement period. The fair value of the OPP LTIP Units were estimated on September 30, 2011 using the following assumptions in the Monte-Carlo valuation: expected price volatility for the Company’s stock of 50%; a risk free rate of 0.69%; and no dividend payments over the measurement period.

Total stock compensation expense related to the OPP LTIP Units, which is included in corporate expenses on the accompanying consolidated statements of operations and comprehensive loss, was less than $0.1 million for the three months ended September 30, 2011 and $0.4 million for the nine months ended September 30, 2011.

8. Preferred Securities and Warrants

On October 15, 2009, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with the Investors. Under the Securities Purchase Agreement, the Company issued and sold to the Investors (i) 75,000 shares 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 accrue any and all dividend payments, and as of September 30, 2011, the Company had undeclared and unpaid dividends of $12.8 million. The Company has the option to redeem any or all of the Series A Preferred Securities at par at any time. The Series A Preferred Securities have limited voting rights and only vote on the authorization to issue senior preferred securities, amendments to their certificate of designations, amendments to the Company’s charter that adversely affect the Series A Preferred Securities and certain change in control transactions.

As discussed in note 2, 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. Until October 15, 2010, the Investors had certain rights to purchase their pro rata share of any equity or debt securities offered or sold by the Company. In addition, the $6.00 exercise price of the warrants was subject to certain reductions if, any time prior to October 15, 2010, the Company issued shares of common stock below $6.00 per share. Per ASC 815-40-15, as the strike price was adjustable until the first anniversary of issuance, the warrants were not considered indexed to the Company’s stock until that date. Therefore, through October 15, 2010, the Company accounted for the warrants as liabilities at fair value. On October 15, 2010, the Investors rights under this warrant exercise price adjustment expired, at which time the warrants met the scope exception in ASC 815-10-15 and are accounted for as equity instruments indexed to the Company’s stock. At October 15, 2010, the warrants were reclassified to equity and will no longer be adjusted periodically to fair value.

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.

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 calculated the fair value of the Series A Preferred Securities at its net present value by discounting dividend payments expected to be paid on the shares over a 7-year period using a 17.3% rate. The Company determined that the market discount rate of 17.3% was reasonable based on the Company’s best estimate of what similar securities would most likely yield when issued by entities comparable to the Company.

The initial carrying value of the Series A Preferred Securities was recorded at its net present value less costs to issue on the date of issuance. The carrying value will be periodically adjusted for accretion of the discount. As of September 30, 2011, the value of the Series A Preferred Securities was $53.3 million, which includes accretion of $5.3 million.

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

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 agreed to use their good faith efforts to endeavor to raise a private investment fund (the “Fund”). The purpose of the Fund was to invest in hotel real estate projects located in North America. The Company was to 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.

The Fund Formation Agreement terminated by its terms on January 30, 2011 due to the failure to close a fund with $100 million of aggregate capital commitments by that date, and the 5,000,000 contingent warrants issued to the Fund Manager were forfeited in their entirety on October 15, 2011 due to the failure to close a fund with $250 million of aggregate capital commitments by that date.

For so long as the Investors collectively own or have the right to purchase through exercise of the warrants (assuming a cash rather than a cashless exercise) 875,000 shares of the Company’s common stock, the Company has agreed to use its reasonable best efforts to cause its Board of Directors to nominate and recommend to the Company’s stockholders the election of a person nominated by the 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 Preferred Securities increases by 4% during any time that an 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. Effective March 20, 2011 when Mr. Gross was appointed Chief Executive Officer of the Company, the Investors’ nominated, and the Company’s Board of Directors elected, Ron Burkle as a member of the Company’s Board of Directors.

On April 21, 2010, the Company entered into a Waiver Agreement (the “Waiver Agreement”) with the Investors. The Waiver Agreement allowed the purchase by the Investors of up to $88 million in aggregate principal amount of the Convertible Notes within six months of April 21, 2010 and subject to the limitations and conditions set forth therein. From April 21, 2010 to July 21, 2010, the Investors purchased $88 million of the Convertible Notes. Pursuant to the Waiver Agreement, in the event an Investor proposes to sell the Convertible Notes at a time when the market price of a share of the Company’s common stock exceeds the then effective conversion price of the Convertible Notes, the Company is granted certain rights of first refusal for the purchase of the same from the Investors. In the event an Investor proposes to sell the Convertible Notes at a time when the market price of a share of the Company’s common stock is equal to or less than the then effective conversion price of the Convertible Notes, the Company is granted certain rights of first offer to purchase the same from the Investors.

9. Discontinued Operations

In May 2006, the Company obtained a $40.0 million non-recourse mortgage and mezzanine financing on Mondrian Scottsdale, which accrued interest at LIBOR plus 2.3%, and for which Morgans Group had provided a standard non-recourse carve-out guaranty. In June 2009, the non-recourse mortgage and mezzanine loans matured and the Company discontinued subsidizing the debt service. The lender foreclosed on the property and terminated the Company’s management agreement related to the property with an effective termination date of March 16, 2010.

The Company has reclassified the individual assets and liabilities to the appropriate discontinued operations line items on its December 31, 2010 balance sheet. Additionally, the Company reclassified the hotels results of operations and cash flows to discontinued operations on the Company’s statements of operations and comprehensive loss and cash flows.

Additionally, in January 2011, an indirect subsidiary of the Company transferred its interests in the property across the street from Delano South Beach to SU Gale Properties, LLC. As a result of this transaction, the Company was released from $10.5 million of non-recourse mortgage and mezzanine indebtedness previously consolidated on the Company’s balance sheet. The property across the street from Delano South Beach was a development property.

The following sets forth the discontinued operations of Mondrian Scottsdale and the property across the street from Delano South Beach for the three and nine months ended September 30, 2011 and 2010 (in thousands):

		Three Months				Three Months				Nine Months				Nine Months
		Ended				Ended				Ended				Ended
		Sept. 30, 2011				Sept. 30, 2010				Sept. 30, 2011				Sept. 30, 2010
Operating revenues		$	—			$	—			$	—			$	1,594
Operating expenses			—				(175	)			(35	)			(2,105	)
Interest expense			—				(291	)			—				(1,026	)
Depreciation and amortization expense			—				—				—				(268	)
Income tax benefit (expense)			—				185				(323	)			459
Gain on disposal			—				—				843				17,820
(Loss) income from discontinued operations		$	—			$	(281	)		$	485			$	16,474

10. 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 $3.4 million and $4.5 million for the three months ended September 30, 2011 and 2010, respectively, and $10.1 million and $14.1 million for the nine months ended September 30, 2011 and 2010, respectively.

As of September 30, 2011 and December 31, 2010, the Company had receivables from these affiliates of approximately $5.2 million and $3.8 million, respectively, which are included in related party receivables on the accompanying consolidated balance sheets.

11. Litigation

Petra Litigation Regarding Scottsdale Mezzanine Loan

On April 7, 2010, Petra CRE CDO 2007-1, LTD, a Cayman Islands Exempt Company (“Petra”), filed a complaint against Morgans Group LLC in the Supreme Court of the State of New York County of New York in connection with an approximately $14.0 million non-recourse mezzanine loan made on December 1, 2006 by Greenwich Capital Financial Products Company LLC (the “Original Lender”) to Mondrian Scottsdale Mezz Holding Company LLC, a wholly-owned subsidiary of Morgans Group LLC. The mezzanine loan relates to the Scottsdale, Arizona property previously owned by the Company. In connection with the mezzanine loan, Morgans Group LLC entered into a so-called “bad boy” guaranty providing for recourse liability under the mezzanine loan in certain limited circumstances. Pursuant to an assignment by the Original Lender, Petra is the holder of an interest in the mezzanine loan. The complaint alleged that the foreclosure of the Scottsdale property by a senior lender on March 16, 2010 constitutes an impermissible transfer of the property that triggered recourse liability of Morgans Group LLC pursuant to the guaranty. Petra demanded damages of approximately $15.9 million plus costs and expenses.

The Company believes that a foreclosure based on a payment default does not create one of the limited circumstances under which Morgans Group would have recourse liability under the guaranty. On May 27, 2010, the Company answered Petra’s complaint, denying any obligation to make payment under the guaranty. On July 9, 2010, Petra moved for summary judgment on the ground that the loan documents unambiguously establish Morgans Group’s obligation under the guaranty. The Company opposed Petra’s motion for summary judgment, and cross-moved for summary judgment in favor of the Company on grounds that the guaranty was not triggered by a foreclosure resulting from a payment default. On December 20, 2010, the court granted the Company’s motion for summary judgment dismissing the complaint, and denied the plaintiff’s motion for summary judgment. Petra thereafter appealed the decision. On May 19, 2011, the appellate court unanimously affirmed the trial courts’ grant of summary judgment in the Company’s favor and the dismissal of Petra’s complaint. Petra then petitioned the New York Court of Appeals for permission to appeal further and the Company opposed that petition. On September 22, 2011, the Court of Appeals denied Petra’s request for leave to appeal.

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 our financial position, results of operations or liquidity.

Environmental

As a holder of real estate, the Company is subject to various environmental laws of federal and local governments. Compliance by the Company with existing laws has not had an adverse effect on the Company and management does not believe that it will have a material adverse impact in the future. However, the Company cannot predict the impact of new or changed laws or regulations on its current investment or on investments that may be made in the future.

12. Deferred Gain on Assets Sold

On May 3, 2011, pursuant to a purchase and sale agreement, Mondrian Holdings sold Mondrian Los Angeles for $137.0 million to Pebblebrook. The Company applied a portion of the proceeds from the sale, along with approximately $9.2 million of cash in escrow, to retire the $103.5 million Mondrian Holdings Amended Mortgage. Net proceeds, after the repayment of debt and closing costs, were approximately $40 million. The Company continues to operate the hotel under a 20-year management agreement with one 10-year extension option.

On May 23, 2011, pursuant to purchase and sale agreements, Royalton LLC, a subsidiary of the Company, sold Royalton for $88.2 million to Royalton 44 Hotel, L.L.C., an affiliate of FelCor Lodging Trust, Incorporated, and Morgans Holdings LLC, a subsidiary of the Company, sold Morgans for $51.8 million to Madison 237 Hotel, L.L.C., an affiliate of FelCor Lodging Trust, Incorporated. The Company applied a portion of the proceeds from the sale to retire the outstanding balance on the Amended Revolving Credit Facility. Net proceeds, after the repayment of debt and closing costs, were approximately $93 million. The Company continues to operate the hotels under a 15-year management agreement with one 10-year extension option.

The Company has reclassified the individual assets and liabilities of Mondrian Los Angeles, Royalton and Morgans to assets held for sale on its December 31, 2010 balance sheet.

The Company recorded deferred gains of approximately $11.3 million, $12.6 million and $56.1 million, respectively, related to the sales of Royalton, Morgans and Mondrian Los Angeles. As the Company has significant continuing involvement through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement. For the three months ended September 30, 2011, the Company recorded a gain of $1.1 million. For the nine months ended September 30, 2011, the Company recorded a gain of $1.7 million.

The Company’s hotel management agreements for Royalton and Morgans contain performance tests that stipulate certain minimum levels of operating performance. These performance test provisions give the Company the option to fund a shortfall in operating performance. If the Company chooses not to fund the shortfall, the hotel owner has the option to terminate the management agreement. As of September 30, 2011, an insignificant amount was recorded in accrued expenses related to these performance test provisions.

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, 2011. 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, 2010.

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, Europe and other international locations. Over our 27-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 wholly-owned hotels, or Owned Hotels, consisting, as of September 30, 2011, of Hudson in New York, Delano South Beach in Miami Beach, and Clift in San Francisco;

•

our wholly-owned food and beverage operations, or Owned F&B Operations, consisting, as of September 30, 2011, of certain food and beverage operations located at Royalton, Morgans and Hudson in New York, Delano South Beach in Miami Beach, Clift in San Francisco, and Sanderson and St Martins Lane, both in London;

•

our hotels in which we own partial interests, or Joint Venture Hotels, consisting, as of September 30, 2011, of our London hotels (Sanderson and St Martins Lane), Mondrian South Beach and Shore Club in Miami Beach, Ames in Boston and Mondrian SoHo in New York;

•

our management company subsidiary, Morgans Hotel Group Management LLC, or MHG Management Company, and certain non-U.S. management company affiliates, through which we manage our portfolio of hotels that we manage with no ownership interest, or Managed Hotels, consisting of Royalton and Morgans in New York, Mondrian in Los Angeles and Hotel Las Palapas in Playa del Carmen, Mexico;

•

our investment in unconsolidated food and beverage operations, or F&B Ventures, consisting, as of September 30, 2011, of certain food and beverage operations located at Mondrian South Beach in Miami Beach;

•

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

•

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

Our Joint Venture Hotels as of September 30, 2011 are operated 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;

•

Mondrian South Beach — August 2026;

	•		Ames — November 2024; and
	•		Mondrian SoHo — February 2021 (with two 10-year extensions at our option, subject to certain conditions).

Our Managed Hotels as of September 30, 2011 are operated under management agreements which expire as follows:

•

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

•

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

•

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

•

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

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

Our management agreements may be subject to early termination in specified circumstances. For example, our hotel management agreements for Royalton and Morgans contain performance tests that stipulate certain minimum levels of operating performance. These performance test provisions provide us the option to fund a shortfall in operating performance. If we choose not to fund the shortfall, the hotel owner has the option to terminate the management agreement. As of September 30, 2011, an insignificant amount was recorded in accrued expenses related to these performance test provisions. 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 or certain other related events.

In March 2010, the lender for the Shore Club mortgage initiated foreclosure proceedings against the property in U.S. federal district court. In October 2010, the federal court dismissed the case for lack of jurisdiction. In November 2010, the lender initiated foreclosure proceedings in state court. We continue to operate the hotel pursuant to the management agreement during these proceedings. However, there can be no assurances we will continue to operate the hotel once foreclosure proceedings are complete.

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 room rate (“ADR”); and

•

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

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 driven by occupancy of our hotels and the popularity of our bars and restaurants with our local customers. In June 2011, we acquired from affiliates of China Grill Management Inc. (“CGM”) the 50% interests CGM owned in our food and beverage joint ventures for $20.0 million (the “CGM Transaction”). As a result of the CGM Transaction, we have begun to record 100% of the food and beverage revenue, and related expenses, for our Owned F&B Operations.

•

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

•

Management fee 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.

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

In addition to economic conditions, supply is another important factor that can affect revenues. Room rates 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 losses on asset disposals as part of major renovation projects, the write-off of abandoned development projects resulting primarily from events generally outside management’s control such as the recent tightness of the credit markets, our restructuring initiatives and severance costs related to our restructuring initiatives. These items do not relate to the ongoing operating performance of our assets.

Other Items

•

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

•

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

•

Gain on asset sales. We recorded deferred gains of approximately $11.3 million, $12.6 million and $56.1 million, respectively, related to the sales of Royalton, Morgans and Mondrian Los Angeles, as discussed in note 12 of our consolidated financial statements. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement.

•

Other non-operating (income) expenses include costs associated with executive terminations not related to restructuring initiatives, costs of financings, litigation and settlement costs and other items that relate to the financing and investing activities associated with our assets and not to the ongoing operating performance of our assets, both consolidated and unconsolidated, as well as the change in fair market value during 2010 of our warrants issued in connection with the Yucaipa transaction.

•

Income tax expense (benefit). All of our foreign subsidiaries are subject to local jurisdiction corporate income taxes. Income tax expense is reported at the applicable rate for the periods presented. We are subject to Federal and state income taxes. Income taxes for the periods ended September 30, 2011 and 2010 were computed using our calculated effective tax rate. We also recorded net deferred taxes related to cumulative differences in the basis recorded for certain assets and liabilities. We established a reserve on the deferred tax assets based on the ability to utilize net operating loss carryforwards.

•

Noncontrolling interest. Noncontrolling interest constitutes the percentage of membership units in Morgans Group, our operating company, owned by Residual Hotel Interest LLC, our former parent, as discussed in note 1 of our consolidated financial statements, as well as our third-party food and beverage joint venture partner’s interest in the profits and losses of our F&B Ventures.

•

Income (loss) from discontinued operations, net of tax. In March 2010, the mortgage lender foreclosed on Mondrian Scottsdale and we were terminated as the property’s manager. As such, we have recorded the income or loss earned from Mondrian Scottsdale in the income (loss) from discontinued operations, net of tax, on the accompanying consolidated financial statements. In January 2011, we recognized income from the transfer of the property across the street from Delano South Beach.

•

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

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

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

Recent Trends and Developments

Recent Trends. Starting in the fourth quarter of 2008 and continuing throughout 2009, the weakened U.S. and global economies resulted in considerable negative pressure on both consumer and business spending. As a result, lodging demand and revenues, which are primarily driven by growth in GDP, business investment and employment growth weakened substantially during this period as compared to the lodging demand and revenues we experienced prior to the fourth quarter of 2008. After this extremely difficult recessionary period, the outlook for the U.S. and global economies improved in 2010 and that improvement has continued into 2011. However, to date, the recovery has not been particularly robust, as spending by businesses and consumers remains restrained, and there are still several trends which make our lodging performance difficult to forecast, including shorter booking lead times at our hotels.

We have experienced positive business trends in 2011, with improvement in demand and average daily rate compared to the prior year in most of our major markets. These trends continued during the third quarter of 2011, with increased occupancies accompanied by increases in average daily rate resulting in strong increases in RevPAR performance in most of our hotels for the third quarter compared to the same period in 2010. However, we experienced some market-specific softening in demand during the third quarter of 2011 in New York and London and overall our operating results are still below pre-recessionary levels.

As demand has strengthened, we are focusing on revenue enhancement by actively managing rates and availability. With increased demand, the ability to increase pricing will be a critical component in driving profitability. Through these uncertain times, our strategy and focus continues to be to preserve profit margins by maximizing revenue, increasing our market share and managing costs. Our strategy includes re-energizing our food and beverage offerings by taking action to improve key facilities with a focus on driving higher beverage to food ratios and re-igniting the buzz around our nightlife and lobby scenes.

The pace of new lodging supply has increased over the past two years as many projects initiated before the economic downturn came to fruition. For example, we witnessed new competitive luxury and boutique properties opening in 2008, 2009 and 2010 in some of our markets, particularly in Los Angeles, Miami Beach and New York, which have impacted our performance in these markets and may continue to do so. However, we believe the timing of new development projects may be affected by the severe recession, ongoing uncertain economic conditions and reduced availability of financing compared to pre-recession periods. These factors may dampen the pace of new supply development, including our own, in the next few years.

For 2011, we believe that if various economic forecasts projecting continued modest expansion are accurate, this may lead to a gradual and modest increase in lodging demand for both leisure and business travel, although we expect there to be 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 be sustained, or that any losses will not increase for these or any other reasons.

We believe that the global credit market conditions will also gradually improve, although we believe there will continue to be less credit available and on less favorable terms than were obtainable in pre-recessionary periods. Given the current state of the credit markets, some of our development projects 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.

Delano Credit Facility. On July 28, 2011, we entered into a new $100 million senior secured revolving credit facility with borrowing capacity of up to $110 million, secured by Delano South Beach (the “Delano Credit Facility”). Borrowings under the Delano Credit Facility are subject to a borrowing base test and upon closing, our availability was $100.0 million. The interest rate is LIBOR plus 4.0%, subject to a LIBOR floor of 1.0%. The Delano Credit Facility matures in three years and contains standard financial covenants, including a minimum fixed charge coverage ratio of 1.05x in the first year and 1.10x thereafter.

Baha Mar Development Deal. In August 2011, we entered into a hotel management and residential licensing agreement for a 310-room Mondrian-branded hotel, to be the lifestyle hotel destination in the 1,000 acre destination resort metropolis, Baha Mar Resort, in Nassau, The Bahamas. This hotel is expected to represent the fifth Mondrian hotel in the expansion of our iconic brand. Upon completion and opening of the hotel, we will operate Mondrian at Baha Mar pursuant to a 20-year management agreement. The hotel is scheduled to open in late 2014. We are required to fund approximately $10 million of key money just prior to and at opening of the hotel. At signing, this amount was funded into escrow and was subsequently replaced with a $10 million standby letter of credit for up to 48 months, which is outstanding as of September 30, 2011.

Mondrian Los Angeles Food and Beverage Sale. On August 5, 2011, an affiliate of Pebblebrook Hotel Trust (“Pebblebrook”), the company that purchased Mondrian Los Angeles in May 2011, exercised its option to purchase our remaining ownership interest in the food and beverage operations at Mondrian Los Angeles for approximately $2.5 million. As a result of Pebblebrook’s exercise of this purchase option, we no longer have any ownership interest in the food and beverage operations at Mondrian Los Angeles.

Hudson Mortgage Loan. On August 12, 2011, certain of our subsidiaries entered into a new mortgage financing with Deutsche Bank Trust Company Americas and the other institutions party thereto from time to time, as lenders, consisting of two mortgage loans, each secured by Hudson and treated as a single loan once disbursed, in the following amounts: (1) a $115.0 million mortgage loan that was funded at closing, and (2) a $20.0 million delayed draw term loan, which will be available to be drawn over a 15-month period, subject to achieving a debt yield ratio of at least 9.5% (based on net operating income for the prior 12 months) after giving effect to each additional draw (collectively, the “Hudson 2011 Mortgage Loan”).

Proceeds from the Hudson 2011 Mortgage Loan, cash on hand and cash held in escrow were applied to repay $201.2 million of outstanding mortgage debt under the Hudson Holdings Amended Mortgage (as defined in “—Debt”) prior first mortgage loan (the “2006 Hudson Mortgage Loan”) secured by Hudsonandand andnn repay $26.5 million of outstanding indebtedness under the Hudson mezzanine loan, and pay fees and expenses in connection with the financing.

London hotels sales. On October 7, 2011, our subsidiary, Royalton Europe Holdings LLC (“Royalton Europe”), and Walton MG London Hotels Investors V, L.L.C. (“Walton MG London”), each of which owns a 50% equity interest in the joint venture that owns the Sanderson and St Martins Lane hotels, entered into an agreement (the “London Sale Agreement”) to sell their respective equity interests in the joint venture for an aggregate of £192 million (or approximately $300 million at the exchange rate of 1.56 US dollars to GBP at September 30, 2011) to Capital Hills Hotels Limited, a Middle Eastern investor with other global hotel holdings. Also parties to the London Sale Agreement were Morgans Group LLC, as guarantor for Royalton Europe, and Walton Street Real Estate Fund V, L.P., as guarantor for Walton MG London. On closing of the transaction, we will continue to operate the hotels under long-term management agreements that, including extension options, extend the term of the existing management agreements to 2041 from 2027. The transaction is expected to close in the fourth quarter of 2011 and is subject to satisfaction of customary closing conditions.

We expect to receive net proceeds of approximately $70 million, depending on foreign currency exchange rates and working capital adjustments, after the joint venture applies a portion of the proceeds from the sale to retire the £99.5 million of outstanding mortgage debt secured by the hotels and after payment of closing costs. The joint venture partners have received a £10 million security deposit, which is non-refundable except in the event of a default by a seller.

On November 2, 2011, Walton MG London, on behalf of itself and us, entered into a foreign currency forward contract to effectively fix the currency conversion rate on half of the expected net sales proceeds at an exchange rate of 1.592 US dollars to GBP.

Operating Results

Comparison of Three Months Ended September 30, 2011 to Three Months Ended September 30, 2010

The following table presents our operating results for the three months ended September 30, 2011 and 2010, including the amount and percentage change in these results between the two periods. The consolidated operating results for the three months ended September 30, 2011 is comparable to the consolidated operating results for the three months ended September 30, 2010, with the exception of Mondrian Los Angeles, which we owned until May 3, 2011, Royalton and Morgans, which we owned until May 23, 2011, the Hard Rock Hotel & Casino in Las Vegas (“Hard Rock”), which we managed until March 1, 2011, Mondrian SoHo, which opened in February 2011, the completion of the CGM Transaction in June 2011, resulting in our full ownership of certain food and beverage operations previously owned through a 50/50 joint venture, and the management of the San Juan Water and Beach Club, which terminated effective July 13, 2011. The consolidated operating results are as follows:

		Three Months Ended
		Sept. 30,				Sept. 30,				Changes				Changes
		2011				2010				($)				(%)
		(Dollars in thousands)
Revenues:
Rooms		$	26,432			$	35,100			$	(8,668	)			(24.7	)%
Food and beverage			15,575				16,017				(442	)			(2.8	)
Other hotel			1,271				2,077				(806	)			(38.8	)
Total hotel revenues			43,278				53,194				(9,916	)			(18.6	)
Management fee and other income			3,408				4,547				(1,139	)			(25.0	)
Total revenues			46,686				57,741				(11,055	)			(19.1	)
Operating Costs and Expenses:
Rooms			8,263				11,061				(2,798	)			(25.3	)
Food and beverage			13,664				14,426				(762	)			(5.3	)
Other departmental			870				1,322				(452	)			(34.2	)
Hotel selling, general and administrative			9,951				12,275				(2,324	)			(18.9	)
Property taxes, insurance and other			4,247				3,650				597				16.4
Total hotel operating expenses			36,995				42,734				(5,739	)			(13.4	)
Corporate expenses, including stock compensation			7,037				8,045				(1,008	)			(12.5	)
Depreciation and amortization			4,833				8,173				(3,340	)			(40.9	)
Restructuring, development and disposal costs			2,125				1,064				1,061				99.7
Impairment loss on receivables from unconsolidated joint venture			—				5,499				(5,499	)			(1	)
Total operating costs and expenses			50,990				65,515				(14,525	)			(22.2	)
Operating loss			(4,304	)			(7,774	)			3,470				(44.6	)
Interest expense, net			8,775				8,319				456				5.5
Equity in loss of unconsolidated joint venture			12,794				1,435				11,359				(1	)
Gain on asset sales			(1,101	)			—				(1,101	)			(1	)
Other non-operating expenses			616				20,299				(19,683	)			(97.0	)
Loss before income tax expense			(25,388	)			(37,827	)			12,439				(32.9	)
Income tax expense			230				420				(190	)			(45.2	)
Net loss from continuing operations			(25,618	)			(38,247	)			12,629				(33.0	)
Loss from discontinued operations, net of tax			—				(281	)			281				(1	)
Net loss			(25,618	)			(38,528	)			12,910				(33.5	)
Net loss attributable to non controlling interest			799				1,451				(652	)			(44.9	)
Net loss attributable to Morgans Hotel Group Co.			(24,819	)			(37,077	)			12,258				(33.1	)
Preferred stock dividends and accretion			2,285				2,164				121				5.6
Net loss attributable to common stockholders		$	(27,104	)		$	(39,241	)		$	12,137				(30.9	)%

Total Hotel Revenues. Total hotel revenues decreased 18.6% to $43.3 million for the three months ended September 30, 2011 compared to $53.2 million for the three months ended September 30, 2010. The components of RevPAR from our Owned Hotels, which consisted of Hudson, Delano South Beach and Clift for the three months ended September 30, 2011 and 2010, are summarized as follows:

		Three Months Ended
		Sept. 30,				Sept. 30,				Change				Change
		2011				2010				($)				(%)
Occupancy			87.2	%			87.0	%			—				0.2	%
ADR		$	235			$	219			$	16				7.4	%
RevPAR		$	205			$	191			$	14				7.7	%

RevPAR from our Owned Hotels increased 7.7.% to $205 for the three months ended September 30, 2011 compared to $191 for the three months ended September 30, 2010.

Rooms revenue decreased 24.7% to $26.4 million for the three months ended September 30, 2011 compared to $35.1 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels rooms revenue increased 7.8%, which was directly attributable to the increase in RevPAR presented above.

Food and beverage revenue decreased 2.8% to $15.6 million for the three months ended September 30, 2011 compared to $16.0 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Partially offsetting this decrease was an increase related to the CGM Transaction and the consolidation of previously unconsolidated food and beverage operations at our London hotels.

Other hotel revenue decreased 38.8% to $1.3 million for the three months ended September 30, 2011 compared to $2.1 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels’ other hotel revenue decreased 5.3% primarily due to decreased telephone revenues at Hudson as a result of a policy change in June 2011 to no longer charge for internet connectivity and a slight decrease in revenues related to our ancillary services, such as our spa at Delano South Beach, as guests are still spending conservatively in light of the uncertain economic recovery.

Management Fee and Other Income. Management fee and other income decreased by 25.0% to $3.4 million for the three months ended September 30, 2011 compared to $4.5 million for the three months ended September 30, 2010. This decrease was primarily attributable to the termination of our management agreement at Hard Rock effective March 1, 2011 in connection with the Hard Rock settlement, as discussed further in note 4 to the consolidated financial statements.

Operating Costs and Expenses

Rooms expense decreased 25.3% to $8.3 million for the three months ended September 30, 2011 compared to $11.1 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels rooms expense increased 8.5% as a result of the increase in rooms revenue attributable to increased occupancy and increased costs at Hudson primarily due to a rooms’ renewal project that we undertook during the quarter which resulted in increased labor and rooms supply expenses.

Food and beverage expense decreased 5.3% to $13.7 million for the three months ended September 30, 2011 compared to $14.4 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned, as well as a decrease in food and beverage expenses at Hudson as a result of the primary restaurant being closed for lunch during the third quarter of 2011. Partially offsetting this decrease was an increase related to the CGM Transaction and the consolidation of previously unconsolidated food and beverage operations at our London hotels.

Other departmental expense decreased 34.2% to $0.9 million for the three months ended September 30, 2011 compared to $1.3 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels experienced a decrease of 14.5% as a direct result of the decrease in other hotel revenue noted above.

Hotel selling, general and administrative expense decreased 18.9% to $10.0 million for the three months ended September 30, 2011 compared to $12.3 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these hotels during all periods presented, our Owned Hotels selling, general and administrative expense increased 2.3%.

Property taxes, insurance and other expense increased 16.4% to $4.2 million for the three months ended September 30, 2011 compared to $3.7 million for the three months ended September 30, 2010. This increase was primarily due to an increase in property tax assessments at Hudson during the three months ended September 30, 2011 as compared to the same period in 2010.

Corporate expenses, including stock compensation decreased 12.5% to $7.0 million for the three months ended September 30, 2011 compared to $8.0 million for the three months ended September 30, 2010. This decrease was primarily due to a decrease in stock compensation expense recognized during the three months ended September 30, 2011 as a result of the accelerated vesting of unvested equity awards granted to our former Chief Executive Officer and our former President in connection with their separation from the Company in March 2011, which would have normally vested throughout the year.

Depreciation and amortization decreased 40.9% to $4.8 million for the three months ended September 30, 2011 compared to $8.2 million for the three months ended September 30, 2010. This decrease was primarily due to the impact of the sale in May 2011 of three hotels we previously owned. Excluding the operating results of these three hotels during all periods presented, our Owned Hotels depreciation and amortization increased 7.1% as a result of depreciation on renovation and capital improvements at Hudson and Delano South Beach, which were incurred during 2010 and 2011.

Restructuring, development and disposal costs increased to $2.1 million for the three months ended September 30, 2011 compared to $1.1 million for the three months ended September 30, 2010. The increase in expense was primarily due to severance costs related to employee and executive restructurings incurred during the three months ended September 30, 2011, for which there was no comparable costs incurred during the three months ended September 30, 2010.

Impairment loss on receivables from unconsolidated joint venture decreased to zero for the three months ended September 30, 2011 compared to $5.5 million for the three months ended September 30, 2010. During 2010, we recorded an impairment charge on uncollectible receivables for which there was no comparable charge during the three months ended September 30, 2011.

Interest expense, net increased 5.5% to $8.8 million for the three months ended September 30, 2011 compared to $8.3 million for the three months ended September 30, 2010. This increase was primarily due to financing fees associated with the repayment and refinancing of the loan secured by Hudson in August 2011.

Equity in loss of unconsolidated joint ventures increased to $12.8 million for the three months ended September 30, 2011 compared to $1.4 million for the three months ended September 30, 2010. This change was primarily a result of our recognition in September 2011 of a $10.6 million impairment charge on our investment in Ames for which there was no comparable impairment charge in 2010. Based on current economic conditions and the October 2012 mortgage debt maturity, the joint venture concluded that Ames was impaired as of September 30, 2011, and recorded a $49.9 million impairment charge. We wrote down our investment in Ames to zero.

The components of RevPAR from our comparable Joint Venture Hotels for the three months ended September 30, 2011 and 2010, which includes Sanderson, St Martins Lane, Shore Club, Mondrian South Beach and Ames, but excludes the Hard Rock, which we managed until March 1, 2011, Mondrian SoHo, which opened in February 2011, and San Juan Water and Beach Club in Isla Verde, Puerto Rico, which we managed until July 13, 2011, are summarized as follows (in constant dollars):

		Three Months Ended
		Sept. 30,				Sept. 30,				Change				Change
		2011				2010				($)				(%)
Occupancy			68.9	%			63.4	%			—				8.6	%
ADR		$	290			$	290			$	—				(0.1	)%
RevPAR		$	200			$	184			$	16				8.5	%

Gain on asset sales resulted in income of $1.1 million for the three months ended September 30, 2011. This income was related to the recognition of gains we recorded on the sales of Royalton, Morgans and Mondrian Los Angeles in 2011. As we have significant continuing involvement with these hotels through long-term management agreements, the gains on sales are deferred and recognized over the initial term of the related management agreement. There were no comparable asset sales in 2010.

Other non-operating expense decreased to $0.6 million for the three months ended September 30, 2011 as compared to $20.3 million for the three months ended September 30, 2010. The decrease was primarily due to a change in accounting for the warrants issued to the Investors, as defined below in “—Derivative Financial Instruments,” in connection with our Series A preferred securities. During the three months ended September 30, 2010, we recorded $19.1 million in expenses related to these warrants for which there was no similar expense recorded during the three months ended September 30, 2011. For further discussion, see notes 2 and 8 of our consolidated financial statements.

Income tax expense decreased 45.2% to $0.2 million for the three months ended September 30, 2011 as compared to $0.4 million for the three months ended September 30, 2010. The change was primarily due to lower state and local taxes during the three months ended September 30, 2011 as compared to the same period in 2010.

Loss from discontinued operations, net of tax was $0.3 million for the three months ended September 30, 2010. There were no discontinued operations during the three months ended September 30, 2011.

Operating Results

Comparison of Nine Months Ended September 30, 2011 to Nine Months Ended September 30, 2010

The following table presents our operating results for the nine months ended September 30, 2011 and 2010, including the amount and percentage change in these results between the two periods. The consolidated operating results for the nine months ended September 30, 2011 is comparable to the consolidated operating results for the nine months ended September 30, 2010, with the exception of Mondrian Los Angeles, which we owned until May 3, 2011, Royalton and Morgans, which we owned until May 23, 2011, Hard Rock, which we managed until March 1, 2011, Mondrian SoHo, which opened in February 2011, the completion of the CGM Transaction in June 2011, resulting in our full ownership of certain food and beverage operations previously owned through a 50/50 joint venture, and the management of the San Juan Water and Beach Club, which terminated effective July 13, 2011. The consolidated operating results are as follows:

		Nine Months Ended
		Sept. 30,				Sept. 30,				Changes				Changes
		2011				2010				($)				(%)
		(Dollars in thousands)
Revenues:
Rooms		$	90,951			$	99,443			$	(8,492	)			(8.5	)%
Food and beverage			49,216				51,062				(1,846	)			(3.6	)
Other hotel			5,020				6,730				(1,710	)			(25.4	)
Total hotel revenues			145,187				157,235				(12,048	)			(7.7	)
Management fee and other income			10,112				14,079				(3,967	)			(28.2	)
Total revenues			155,299				171,314				(16,015	)			(9.3	)
Operating Costs and Expenses:
Rooms			29,122				31,377				(2,255	)			(7.2	)
Food and beverage			41,901				42,526				(625	)			(1.5	)
Other departmental			3,117				3,834				(717	)			(18.7	)
Hotel selling, general and administrative			33,301				35,523				(2,222	)			(6.3	)
Property taxes, insurance and other			12,136				12,461				(325	)			(2.6	)
Total hotel operating expenses			119,577				125,721				(6,144	)			(4.9	)
Corporate expenses, including stock compensation			25,920				27,270				(1,350	)			(5.0	)
Depreciation and amortization			17,405				23,529				(6,124	)			(26.0	)
Restructuring, development and disposal costs			10,518				2,930				7,588				(1	)
Impairment loss on receivables from unconsolidated joint ventures			—				5,499				(5,499	)			(1	)
Total operating costs and expenses			173,420				184,949				(11,529	)			(6.2	)
Operating loss			(18,121	)			(13,635	)			(4,486	)			32.9
Interest expense, net			27,783				33,058				(5,275	)			(16.0	)
Equity in loss of unconsolidated joint venture			23,187				9,437				13,750				(1	)
Gain on asset sales			(1,721	)			—				(1,721	)			(1	)
Other non-operating expenses			2,885				35,491				(32,606	)			(91.9	)
Loss before income tax expense			(70,255	)			(91,621	)			21,366				(23.3	)
Income tax expense			523				994				(471	)			(47.4	)
Net loss from continuing operations			(70,778	)			(92,615	)			21,837				(23.6	)
Income from discontinued operations, net of tax			485				16,474				(15,989	)			(97.1	)
Net loss			(70,293	)			(76,141	)			5,848				(7.7	)
Net loss attributable to non controlling interest			2,007				2,033				(26	)			(1.3	)
Net loss attributable to Morgans Hotel Group Co.			(68,286	)			(74,108	)			5,822				(7.9	)
Preferred stock dividends and accretion			(6,701	)			(6,357	)			(344	)			(5.4	)
Net loss attributable to common stockholders		$	(74,987	)		$	(80,465	)		$	5,478				(6.8	)%