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		16-1736884
(State or other jurisdiction of		(I.R.S. employer
incorporation or organization)		identification no.)
475 Tenth Avenue
New York, New York		10018
(Address of principal executive offices)		(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 May 6, 2011 was 30,421,363.

 

 

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS			3
MORGANS HOTEL GROUP CO. CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2011 (UNAUDITED) AND DECEMBER 31, 2010			3
MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS			4
MORGANS HOTEL GROUP CO. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS			5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS			6
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			53
ITEM 4. CONTROLS AND PROCEDURES			54
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS			55
ITEM 1A. RISK FACTORS			55
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			56
ITEM 3. DEFAULTS UPON SENIOR SECURITIES			56
ITEM 4. REMOVED AND RESERVED			56
ITEM 5. OTHER INFORMATION			56
ITEM 6. EXHIBITS			56
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 10.5
Exhibit 10.6
Exhibit 10.7
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

FORWARD LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for “forward-looking statements” made by or on behalf of a company. We may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission and in reports to our stockholders. These forward-looking statements reflect our current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ materially from those expressed in any forward-looking statement. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important risks and factors that could cause our actual results to differ materially from any forward-looking statements include, but are not limited to, the risks discussed in the Company’s Annual Report on Form 10-K 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
(in thousands, except per share data)

		March 31,				December 31,
		2011				2010
		(unaudited)
ASSETS
Property and equipment, net		$	286,351			$	291,078
Goodwill			53,691				53,691
Investments in and advances to unconsolidated joint ventures			20,328				20,450
Assets held for sale, net			190,481				194,964
Investment in property held for non-sale disposition, net			—				9,775
Cash and cash equivalents			5,962				5,250
Restricted cash			29,883				28,783
Accounts receivable, net			5,318				6,018
Related party receivables			3,871				3,830
Prepaid expenses and other assets			5,872				7,007
Deferred tax asset, net			79,793				80,144
Other, net			11,210				13,786
Total assets		$	692,760			$	714,776
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Debt and capital lease obligations		$	571,471			$	558,779
Mortgage debt of property held for non-sale disposition			—				10,500
Accounts payable and accrued liabilities			26,572				23,604
Debt obligation, accounts payable and accrued liabilities of assets held for sale			108,297				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			1,728				1,509
Other liabilities			13,866				13,866
Total liabilities			721,934				716,581
Commitments and contingencies
Preferred securities, $.01 par value; liquidation preference $1,000 per share, 75,000 shares authorized and issued at March 31, 2011 and December 31, 2010, respectively			51,806				51,118
Common stock, $.01 par value; 200,000,000 shares authorized; 36,277,495 shares issued at March 31, 2011 and December 31, 2010, respectively			363				363
Additional paid-in capital			301,541				297,554
Treasury stock, at cost, 5,965,992 and 5,985,045 shares of common stock at March 31, 2011 and December 31, 2010, respectively			(92,688	)			(92,688	)
Accumulated comprehensive loss			(1,434	)			(3,194	)
Accumulated deficit			(298,601	)			(265,874	)
Total Morgans Hotel Group Co. stockholders’ deficit			(39,013	)			(12,721	)
Noncontrolling interest			9,839				10,916
Total deficit			(29,174	)			(1,805	)
Total liabilities and stockholders’ deficit		$	692,760			$	714,776

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except per share data)
(unaudited)

		Three Months Ended March 31,
		2011				2010
Revenues:
Rooms		$	31,034			$	29,250
Food and beverage			18,030				17,496
Other hotel			2,016				2,209
Total hotel revenues			51,080				48,955
Management fee-related parties and other income			3,324				4,429
Total revenues			54,404				53,384
Operating Costs and Expenses:
Rooms			11,174				10,025
Food and beverage			15,102				13,916
Other departmental			1,211				1,252
Hotel selling, general and administrative			12,558				11,437
Property taxes, insurance and other			4,185				4,100
Total hotel operating expenses			44,230				40,730
Corporate expenses, including stock compensation of $4.0 million and $3.8 million, respectively			10,834				10,005
Depreciation and amortization			8,373				7,345
Restructuring, development and disposal costs			4,593				677
Total operating costs and expenses			68,030				58,757
Operating loss			(13,626	)			(5,373	)
Interest expense, net			8,994				12,350
Equity in loss of unconsolidated joint ventures			9,483				263
Other non-operating expenses			1,390				15,029
Loss before income tax (benefit) expense			(33,493	)			(33,015	)
Income tax (benefit) expense			(135	)			294
Net loss from continuing operations			(33,358	)			(33,309	)
Income from discontinued operations, net of tax			490				17,202
Net loss			(32,868	)			(16,107	)
Net loss attributable to noncontrolling interest			825				147
Net loss attributable to Morgans Hotel Group			(32,043	)			(15,960	)
Preferred stock dividends and accretion			(2,187	)			(2,078	)
Net loss attributable to common stockholders			(34,230	)			(18,038	)
Other comprehensive loss:
Unrealized gain on valuation of swap/cap agreements, net of tax			—				4,924
Share of unrealized gain on valuation of swap agreements from unconsolidated joint venture, net of tax			1,866				—
Realized loss on settlement of swap/cap agreements, net of tax			—				(2,553	)
Foreign currency translation (loss) gain, net of tax			(106	)			254
Comprehensive loss		$	(32,470	)		$	(15,413	)
Loss per share:
Basic and diluted continuing operations			(1.12	)			(1.18	)
Basic and diluted discontinued operations			0.02				0.58
Basic and diluted attributable to common stockholders			(1.10	)			(0.60	)
Weighted average number of common shares outstanding:
Basic and diluted			31,103				29,849

See accompanying notes to these consolidated financial statements.

Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

		Three Months Ended Mar 31,
		2011				2010
Cash flows from operating activities:
Net loss		$	(32,868	)		$	(16,107	)
Adjustments to reconcile net loss to net cash used in operating activities (including discontinued operations):
Depreciation			7,687				7,181
Amortization of other costs			686				164
Amortization of deferred financing costs			2,298				1,529
Amortization of discount on convertible notes			569				569
Stock-based compensation			3,987				3,798
Accretion of interest on capital lease obligation			473				943
Equity in losses from unconsolidated joint ventures			9,483				263
Gain on disposal of property held for sale			—				(17,944	)
Change in value of warrants			—				14,353
Changes in assets and liabilities:
Accounts receivable, net			940				33
Related party receivables			(67	)			(825	)
Restricted cash			(1,084	)			(5,011	)
Prepaid expenses and other assets			2,066				2,279
Accounts payable and accrued liabilities			4,106				1,274
Other liabilities			—				(203	)
Discontinued operations			(843	)			665
Net cash used in operating activities			(2,567	)			(7,039	)
Cash flows from investing activities:
Additions to property and equipment			(1,074	)			(4,057	)
Deposits to capital improvement escrows, net			(15	)			(632	)
Distributions from unconsolidated joint ventures			2				2
Investments in and settlement related to unconsolidated joint ventures			(7,032	)			(242	)
Net cash used in investing activities			(8,119	)			(4,929	)
Cash flows from financing activities:
Proceeds from debt			11,650				—
Cash paid in connection with vesting of stock based awards			—				(97	)
Cost of issuance of preferred stock			—				(246	)
Distributions to holders of noncontrolling interests in consolidated subsidiaries			(252	)			(387	)
Net cash provided by (used in) financing activities			11,398				(730	)
Net decrease in cash and cash equivalents			712				(12,698	)
Cash and cash equivalents, beginning of period			5,250				68,956
Cash and cash equivalents, end of period		$	5,962			$	56,258
Supplemental disclosure of cash flow information:
Cash paid for interest		$	5,280			$	9,508
Cash paid for taxes		$	149			$	17

See accompanying notes to these consolidated financial statements.

Morgans Hotel Group Co.

Notes to Consolidated Financial Statements
(unaudited)

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 March 31, 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 March 31, 2011 are as follows:

				Number of
Hotel Name		Location		Rooms				Ownership
Hudson		New York, NY			834				(1	)
Morgans (10)		New York, NY			114				(2	)
Royalton (10)		New York, NY			168				(2	)
Mondrian SoHo		New York, NY			270				(3	)
Delano South Beach		Miami Beach, FL			194				(2	)
Mondrian South Beach		Miami Beach, FL			328				(4	)
Shore Club		Miami Beach, FL			309				(5	)
Mondrian Los Angeles (10)		Los Angeles, CA			237				(2	)
Clift		San Francisco, CA			372				(6	)
Ames		Boston, MA			114				(7	)
Sanderson		London, England			150				(4	)
St Martins Lane		London, England			204				(4	)
Water and Beach Club Hotel		San Juan, PR			78				(8	)
Hotel Las Palapas		Playa del Carmen, Mexico			75				(9	)

Restaurant Joint Venture

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

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“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 months ended March 31, 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, Consolidation (“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.

The Company has reevaluated its interest in three ventures that provide food and beverage services in accordance with ASC 810-10. These services include operating restaurants including room service at three hotels, banquet and catering services at three hotels and a bar at one hotel. No assets of the Company are collateral for the ventures’ obligations and creditors of the venture have no recourse to the Company. Based on the evaluation performed, the Company was determined to be the primary beneficiary of these three ventures.

Management has also reevaluated the applicability of ASC 810-10 to its investments in unconsolidated joint ventures and has concluded that most joint ventures do not meet the requirements of a variable interest entity. As of December 31, 2010, Mondrian South Beach and Mondrian SoHo were determined to be variable interest entities, but the Company is not its primary beneficiary and, therefore, consolidations of these joint ventures are not required. Accordingly, all investments in joint ventures (other than the three food and beverage joint ventures discussed above) are accounted for using the equity method. In February 2011, the Mondrian SoHo hotel opened and as such, 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.

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 property or an interest therein. The Company anticipates it will be able to use a portion of these deferred tax assets relating to its tax net operating loss carryforwards in connection with completion of the sale of Royalton, Morgans and Mondrian Los Angeles, as discussed in note 12.

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 months ended March 31, 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 swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

For derivatives designated as cash flow hedges, and 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. 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 March 31, 2011, the estimated fair market value of the Company’s cash flow hedges is immaterial.

Credit-risk-related Contingent Features

The Company has entered into agreements with each of its derivative counterparties in connection with the interest rate swaps and hedging instruments related to the Convertible Notes, 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 March 31, 2011 the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. 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”).

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 March 31, 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 March 31, 2011 and December 31, 2010 was approximately $231.0 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. Compensation expense is recorded ratably over the vesting period, if any. Stock compensation expense recognized for the three months ended March 31, 2011 and 2010 was $4.0 million and $3.8 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 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 $9.5 million and $10.6 million as of March 31, 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, $0.3 million and $0.3 million was recorded as noncontrolling interest as of March 31, 2011 and December 31, 2010, respectively, which represents the Company’s food and beverage joint venture partner’s interest in the restaurant 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.

 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 March 31, 2011, warrants issued to the Investors, unvested restricted stock units, LTIP Units (as defined in note 7), stock options, 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
		March 31, 2011				March 31, 2010
Numerator:
Net loss from continuing operations		$	(33,358	)		$	(33,309	)
Net income from discontinued operations			490				17,202
Net loss			(32,868	)			(16,107	)
Net loss attributable to noncontrolling interest			825				147
Net loss attributable to Morgans Hotel Group Co.			(32,043	)			(15,960	)
Less: preferred stock dividends and accretion			2,187				2,078
Net loss attributable to common shareholders		$	(34,230	)		$	(18,038	)
Denominator, continuing and discontinued operations:
Weighted average basic common shares outstanding			31,103				29,849
Effect of dilutive securities			—				—
Weighted average diluted common shares outstanding			31,103				29,849
Basic and diluted loss from continuing operations per share		$	(1.12	)		$	(1.18	)
Basic and diluted income from discontinued operations per share		$	0.02			$	0.58
Basic and diluted loss available to common stockholders per common share		$	(1.10	)		$	(0.60	)

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
		March 31,				December 31,
Entity		2011				2010
Mondrian South Beach		$	5,318			$	5,817
Morgans Hotel Group Europe Ltd.			2,208				1,366
Mondrian SoHo			—				—
Boston Ames			10,244				10,709
Other			2,558				2,558
Total investments in and advances to unconsolidated joint ventures		$	20,328			$	20,450

		As of				As of
		March 31,				December 31,
Entity		2011				2010
Restaurant Venture — SC London		$	(1,728	)		$	(1,509	)
Hard Rock Hotel & Casino (1)			—				—
Total losses from and distributions in excess of investment in unconsolidated joint ventures		$	(1,728	)		$	(1,509	)

Equity in income (loss) from unconsolidated joint ventures

		Three Months				Three Months
		Ended				Ended
		March 31,				March 31,
		2011				2010
Morgans Hotel Group Europe Ltd.		$	7			$	812
Restaurant Venture — SC London			(220	)			(257	)
Mondrian South Beach			(500	)			(423	)
Mondrian SoHo			(1,932	)			—
Hard Rock Hotel & Casino (1)			(6,376	)			—
Ames			(464	)			(397	)
Other			2				2
Total equity in loss from unconsolidated joint ventures		$	(9,483	)		$	(263	)

Morgans Hotel Group Europe Limited

As of March 31, 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 months ended March 31, 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 March 31, 2011, Morgans Europe had outstanding mortgage debt of £99.6 million, or approximately $160.4 million at the exchange rate of 1.61 US dollars to GBP at March 31, 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.

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 March 31, 2011, there are remaining payables outstanding to vendors of approximately $1.5 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.

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. On December 24, 2009, the mortgage and mezzanine loans were amended so that the maturity dates were extendable from February 2011 to February 2014, subject to certain conditions.

Since the formation of Hard Rock Hotel Holdings, LLC, additional disproportionate cash contributions had been made 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. The amount due and payable under the Second Mezzanine Loan Agreement as of January 20, 2011 was approximately $96 million. The Second Mezzanine Lender also notified the such subsidiaries that it intended to auction to the public the collateral pledged in connection with the Second Mezzanine Loan Agreement, including all membership interests in certain subsidiaries of Hard Rock Hotel Holding, LLC that indirectly owned the Hard Rock and other related assets.

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, dated as of February 6, 2011. Pursuant to the Standstill and Forbearance Agreement, among other things, until February 28, 2011, the Mortgage Lender, First Mezzanine Lender and the Second Mezzanine Lender agreed not to take any action or assert any right or remedy arising with respect to any of the applicable loan documents or the collateral pledged under such loan documents, including remedies with respect to the Company’s Hard Rock management agreement. In addition, pursuant to the Standstill and Forbearance Agreement, the Second Mezzanine Lender agreed to withdraw its foreclosure notice, and the parties agreed to jointly request a stay of all action on the pending motions that had been filed by various parties to enjoin such foreclosure proceedings.

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, the Company will no longer be subject to Nevada gaming regulations, after completion of certain gaming de-registration procedures.

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 $3.3 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. In addition to new funds being 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 complete the project. The Company’s contribution will be treated as a loan with priority over the equity. The Company has contributed the full amount of this priority loan, as well as additional funds, all of which were considered impaired and recorded as impairment charges through equity in loss of unconsolidated joint ventures during the period funds were contributed. As of March 31, 2011, the Company’s investment balance in the joint venture was zero.

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, consolidations 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 $11.5 million in equity through March 31, 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 amount was outstanding as of March 31, 2011. The project also qualified for federal and state historic rehabilitation tax credits which were sold for approximately $16.9 million.

In October 2010, the mortgage loan secured by Ames matured, and the joint venture did not satisfy the conditions necessary to exercise the first of two remaining one-year extension options available under the loan, which included funding a debt service reserve account, among other things. As a result, the mortgage lender for Ames served the joint venture with a notice of default and acceleration of debt. In February 2011, the joint venture reached an agreement with the lender whereby the lender waived the default, reinstated the loan and extended the loan maturity date until October 9, 2011 with a one-year extension option, subject to certain conditions. In connection with the amendment, the joint venture was required to deposit $1.0 million into a debt service account.

Shore Club

The Company operates Shore Club under a management contract and owned a minority ownership interest of approximately 7% at March 31, 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.

5. Other Liabilities

As of March 31, 2011 and December 31, 2010, the balance of other liabilities consisted of $13.9 million, which is related to 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				Interest rate at
		March 31,				December 31,				March 31,
Description		2011				2010				2011
Notes secured by Hudson (a)		$	201,162			$	201,162			1.29% (LIBOR + 1.03%)
Notes secured by Hudson (a)			26,500				26,500			3.24% (LIBOR + 2.98%)
Clift debt (b)			85,506				85,033				9.60	%
Liability to subsidiary trust (c)			50,100				50,100				8.68	%
Revolving credit (d)			37,658				26,008				(d	)
Convertible Notes, face value of $172.5 million (e)			164,437				163,869				2.38	%
Capital lease obligations (f)			6,107				6,107				(f	)
Debt and capital lease obligation		$	571,471			$	558,779
Mortgage debt secured by assets held for sale — Mondrian Los Angeles (a)			103,496				103,496			1.90% (LIBOR + 1.64%)
Notes secured by property held for non-sale disposition (g)		$	—			$	10,500				11.00	%

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

On October 6, 2006, subsidiaries of the Company, Henry Hudson Holdings LLC (“Hudson Holdings”) and Mondrian Holdings LLC (“Mondrian Holdings”), entered into non-recourse mortgage financings consisting of two separate first mortgage loans secured by Hudson and Mondrian Los Angeles, respectively (collectively, the “Mortgages”), and a mezzanine loan related to Hudson, secured by a pledge of the equity interests in the Company’s subsidiary owning Hudson.

On October 14, 2009, the Company entered into an agreement with the lender that holds, among other loans, the mezzanine loan on Hudson. Under the agreement, the Company paid an aggregate of $11.2 million to (i) reduce the principal balance of the mezzanine loan from $32.5 million to $26.5 million, (ii) acquire interests in $4.5 million of certain debt securities secured by certain of the Company’s other debt obligations, (iii) pay fees, and (iv) obtain a forbearance from the mezzanine lender until October 12, 2013 from exercising any remedies resulting from a maturity default, subject only to maintaining certain interest rate caps and making an additional aggregate payment of $1.3 million to purchase additional interests in certain of the Company’s other debt obligations prior to October 11, 2011. The mezzanine lender also agreed to cooperate with the Company in its efforts to seek an extension of the Hudson mortgage loan and consent to certain refinancings and other modifications of the Hudson mortgage loan.

Until amended as described below, the Hudson Holdings Mortgage bore interest at 30-day LIBOR plus 0.97% and the Mondrian Holdings Mortgage bore interest at 30-day LIBOR plus 1.23%. The Hudson mezzanine loan bears interest at 30-day LIBOR plus 2.98%. The Company had entered into interest rate swaps on the Mortgages and the mezzanine loan on Hudson which effectively fixed the 30-day LIBOR rate at approximately 5.0%. These interest rate swaps expired on July 15, 2010. The Company subsequently entered into short-term interest rate caps on the Mortgages that expired on September 12, 2010.

On October 1, 2010, Hudson Holdings and Mondrian Holdings each entered into a modification agreement of its respective Mortgage, together with promissory notes and other related security agreements, with Bank of America, N.A., as trustee, for the lenders. These modification agreements and related agreements amended and extended the Mortgages (collectively, the “Amended Mortgages”) until October 15, 2011. In connection with the Amended Mortgages, on October 1, 2010, Hudson Holdings and Mondrian Holdings paid down a total of $15.8 million and $17 million, respectively, on their outstanding mortgage loan balances. As of March 31, 2011, there is $331.1 million outstanding under the Amended Mortgages.

The interest rates were also amended to 30-day LIBOR plus 1.03% on the Hudson Holdings Amended Mortgage and 30-day LIBOR plus 1.64% on the Mondrian Holdings Amended Mortgage. The interest rate on the Hudson mezzanine loan continues 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 Mortgages, which effectively cap the 30-day LIBOR rate at 5.3% and 4.25% on the Hudson Holdings Amended Mortgage and Mondrian Holdings Amended Mortgage, respectively, and effectively cap the 30-day LIBOR rate at 7.0% on the Hudson mezzanine loan.

The Amended Mortgages require the Company’s subsidiary borrowers (entities owning Hudson and Mondrian Los Angeles) to fund reserve accounts to cover monthly debt service payments. Those subsidiary borrowers are also required to fund reserves for property, sales and occupancy taxes, insurance premiums, capital expenditures and the operation and maintenance of those hotels. Reserves are deposited into restricted cash accounts and are released as certain conditions are met. Starting in 2009, the Mortgages had fallen below the required debt service coverage and as such, all excess cash, once all other reserve accounts were completed, were funded into curtailment reserve accounts. At September 30, 2010, the balance in the curtailment reserve accounts was $20.3 million, of which $16.5 million was used in October 2010 to reduce the amount of mortgage debt outstanding under the Amended Mortgages, as discussed above. Under the Amended Mortgages, all excess cash will continue to be funded into curtailment reserve accounts regardless of the debt service coverage ratio. The subsidiary borrowers are not permitted to have any liabilities other than certain ordinary trade payables, purchase money indebtedness, capital lease obligations and certain other liabilities.

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

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

As discussed further in note 12, 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 Hotel Trust (“Pebblebrook”), pursuant to a purchase and sale agreement entered into on April 22, 2011. 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.

After the repayment of the Mondrian Holdings Amended Mortgage, the Company is pursuing a number of options to finance the Hudson Holdings Amended Mortgage and Hudson mezzanine loan maturities, including using a portion of the proceeds from other asset sales such as Royalton and Morgans, discussed in note 12, debt financing, and other sources. The Company believes the combination of rising hotel cash flows and improving capital markets should provide sufficient capital to refinance the debt and provide capital for growth.

(b) Clift Debt

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

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, the Company’s subsidiary that leases Clift, 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) 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, and which is referred to as the Amended Revolving Credit Facility.

The Amended Revolving Credit Facility provides for a maximum aggregate amount of the commitments of $125.0 million, divided into two tranches: (i) a revolving credit facility in an amount equal to $90.0 million (the “New York Tranche”), which is secured by a mortgage on Morgans and Royalton (the “New York Properties”) and a mortgage on Delano South Beach (the “Florida Property”); and (ii) a revolving credit facility in an amount equal to $35.0 million (the “Florida Tranche”), which is secured by the mortgage on the Florida Property (but not the New York Properties). The Amended Revolving Credit Facility also provides for a letter of credit facility in the amount of $25.0 million, which is secured by the mortgages on the New York Properties and the Florida Property. At any given time, the amount available for borrowings under the Amended Revolving Credit Facility is contingent upon the borrowing base valuation, which is calculated as the lesser of (i) 60% of appraised value and (ii) the implied debt service coverage value of certain collateral properties securing the Amended Revolving Credit Facility; provided that the portion of the borrowing base attributable to the New York Properties will never be less than 35% of the appraised value of the New York Properties. Following appraisals in March 2010, total availability under the Amended Revolving Credit Facility as of March 31, 2011 was $116.4 million, of which the outstanding principal balance was $37.7 million, and approximately $1.2 million of letters of credit were posted. Of the $37.7 million outstanding, $33.7 million was allocated to the Florida Tranche and $4.0 million was allocated to the New York Tranche.

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

In addition, the Amended Revolving Credit Facility includes the following, among other, provisions:

	•		requirement that the Company maintain a fixed charge coverage ratio (defined generally as the ratio of consolidated EBITDA excluding Mondrian Scottsdale’s EBITDA for the periods ending June 30, 2009 and September 30, 2009 and Clift’s EBITDA for all periods to consolidated interest expense excluding Mondrian Scottsdale’s interest expense for the periods ending June 30, 2009 and September 30, 2009 and Clift’s interest expense for all periods) for each four-quarter period of no less than 0.90 to 1.00. As of March 31, 2011, the Company’s fixed charge coverage ratio under the Amended Revolving Credit Facility was 1.81x;
	•		prohibition on capital expenditures with respect to any hotels owned by the Company, the borrowers, as defined, or subsidiaries, other than maintenance capital expenditures for any hotel not exceeding 4% of the annual gross revenues of such hotel and certain other exceptions;
	•		prohibition on repurchases of the Company’s common equity interests by the Company or Morgans Group; and
	•		certain limits on any secured swap agreements entered into after the effective date of the Amended Revolving Credit Facility.

The commitments under the Amended Revolving Credit Facility terminate on October 5, 2011, at which time all outstanding amounts under the Amended Revolving Credit Facility will be due.

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

(e) 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.

On January 1, 2009, the Company adopted 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. ASC 470-20 required retroactive application to all periods presented. 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.

(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 March 31, 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.

The Company has also entered into capital lease obligations related to equipment at certain of the hotels.

(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 in 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

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.

In connection with the Company’s senior management changes announced in March 2011, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 200,000 LTIP units to the Company’s newly appointed Chief Executive Officer and Executive Chairman under the Amended 2007 Incentive Plan on March 20, 2011. The 125,000 LTIP units granted to the newly appointed Chief Executive Officer vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant. The 75,000 LTIP units granted to the newly appointed Executive Chairman vest pro rata on a monthly basis over the 12 months beginning on the first monthly anniversary of the date of grant, so long as the recipient continues to be an eligible participant. The estimated fair value of each LTIP unit granted was $8.87 at the grant date.

Also in connection with the Company’s senior management changes announced in March 2011, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 900,000 stock options to the Company’s newly appointed Chief Executive Officer and Executive Chairman under the Amended 2007 Incentive Plan on March 20, 2011. The stock options vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipients continue to be eligible participants and expire 10 years after the grant date. The fair value for each such option granted was estimated at the date of grant using the Black-Scholes option-pricing model, an allowable valuation method under ASC 718-10 with the following assumptions: risk-free interest rate of approximately 2.3%, expected option lives of 5.85 years, 50% volatility, no dividend rate and an approximately 10% forfeiture rate. The fair value of each such option was $4.36 at the date of grant.

Additionally, on March 23, 2011, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 200,000 stock options to the Company’s newly appointed Chief Development Officer under the Amended 2007 Incentive Plan. The stock options vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant and expire 10 years after the grant date. The fair value for each such option granted was estimated at the date of grant using the Black-Scholes option-pricing model, an allowable valuation method under ASC 718-10 with the following assumptions: risk-free interest rate of approximately 2.4%, expected option lives of 5.85 years, 50% volatility, no dividend rate and an approximately 10% forfeiture rate. The fair value of each such option was $4.75 at the date of grant.

On April 4, 2011, the Compensation Committee of the Board of Directors of the Company issued an aggregate of 200,000 stock options to the Company’s newly appointed Chief Operations Officer under the Amended 2007 Incentive Plan. The stock options vest one-third of the amount granted on each of the first three anniversaries of the grant date so long as the recipient continues to be an eligible participant and expire 10 years after the grant date. The fair value for each such option granted was estimated at the date of grant using the Black-Scholes option-pricing model, an allowable valuation method under ASC 718-10 with the following assumptions: risk-free interest rate of approximately 2.5%, expected option lives of 5.85 years, 50% volatility, no dividend rate and an approximately 10% forfeiture rate. The fair value of each such option was $4.79 at the date of grant.

In March 2011, the Company also announced changes to its Board of Directors, including the addition of two new directors. As a result, on April 7, 2011 the Company issued an aggregate of 11,000 RSUs to the two newly appointed non-employee directors under the Amended 2007 Incentive Plan, which vested immediately upon grant. The fair value of each such RSU was $9.09 at the grant date.

Pursuant to the separation agreement with the Company’s former president (the “Former President”), the Former President retained his vested and unvested RSUs, LTIP units and stock options. To the extent that these awards were not yet vested, they were fully vested on March 27, 2011. Pursuant to the expiration of the employment agreement with the Company’s former CEO (the “Former CEO”), the Former CEO retained his vested and unvested RSUs, LTIP units and stock options. To the extent that these awards were not yet vested, they were fully vested on March 20, 2011. The accelerated expense for these vested awards was recognized during the three months ended March 31, 2011.

A summary of stock-based incentive awards as of March 31, 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			65,250				200,000				1,100,000
Distributed/exercised during 2011			(37,182	)			—				—
Forfeited during 2011			(28,420	)			—				—
Outstanding as of March 31, 2011			804,982				2,471,437				1,514,872
Vested as of March 31, 2011			166,806				2,184,993				1,267,108

As of March 31, 2011 and December 31, 2010, there were approximately $9.6 million and $6.8 million, respectively, of total unrecognized compensation costs related to unvested share awards. As of March 31, 2011, the weighted-average period over which the unrecognized compensation expense will be recorded is approximately 1.5 years.

Total stock compensation expense, which is included in corporate expenses on the accompanying consolidated statements of operations, was $4.0 million and $3.8 million for the three months ended March 31, 2011 and 2010, respectively.

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 March 31, 2011, the Company had undeclared and unpaid dividends of $8.8 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, 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 March 31, 2011, the value of the Series A Preferred Securities was $51.8 million, which includes accretion of $3.7 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 will be to invest in hotel real estate projects located in North America. The Company will be offered the opportunity to manage the hotels owned by the Fund under long-term management agreements. In connection with the Fund Formation Agreement, the Company issued to the Fund Manager 5,000,000 contingent warrants to purchase the Company’s common stock at an exercise price of $6.00 per share with a 7-1/2 year term. These contingent warrants will only become exercisable if the Fund obtains capital commitments in certain amounts over certain time periods and also meets certain further capital commitment and investment thresholds. The exercise price and number of shares subject to these contingent warrants are both subject to anti-dilution adjustments.

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. The 5,000,000 contingent warrants issued to the Fund Manager will be forfeited in their entirety on October 15, 2011 if a fund with $250 million has not closed by that date. As of March 31, 2011, no contingent warrants have been issued or exercised and no value has been assigned to the warrants, as the Company cannot determine the probability that the Fund will be raised. In the event the Fund is raised and contingent warrants are issued, the Company will determine the value of the contingent warrants in accordance with ASC 505-50, Equity-Based Payments to Non-Employees. The Company cannot provide any assurances that the Fund will be raised.

For so long as the Investors collectively own or have the right to purchase through exercise of the warrants 875,000 shares of the Company’s common stock, the Company has agreed to use its reasonable best efforts to cause its Board of Directors to nominate and recommend to the Company’s stockholders the election of a person nominated by the Investors as a director of the Company and to use its reasonable best efforts to ensure that the Investors’ nominee is elected to the Company’s Board of Directors at each such meeting. If that nominee is not elected by the Company’s stockholders, the Investors have certain observer rights and, in certain circumstances, the dividend rate on the Series A 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 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 months ended March 31, 2011 and 2010 (in thousands):

		Three Months				Three Months
		Ended				Ended
		March 31,				March 31,
		2011				2010
Operating revenues		$	—			$	1,594
Operating expenses			(27	)			(1,770	)
Interest expense			—				(433	)
Depreciation and amortization expense			—				(268	)
Income tax (expense) benefit			(326	)			126
Gain on disposal			843				17,953
Income from discontinued operations		$	490			$	17,202

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 $3.3 million and $4.4 million for the three months ended March 31, 2011 and 2010, respectively.

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

11. Litigation

Potential Litigation

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

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 alleges 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 demands 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 LLC 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. It also requested relevant documents from Petra. 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. Petra also moved to stay discovery pending resolution of its motion. The Company opposed Petra’s motion for summary judgment, and similarly 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. The action has accordingly been dismissed. Petra has appealed the decision, and the appeal was heard on April 28, 2011. The Company will continue to defend this lawsuit vigorously. The Company believes the probability of losses associated with this litigation is remote and cannot reasonably estimate a range of such losses, if any, at this time.

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. Assets Held for Sale

On April 2, 2011, Royalton LLC, a subsidiary of the Company, entered into a purchase and sale agreement to sell 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, entered into a purchase and sale agreement to sell Morgans for $51.8 million to Madison 237 Hotel, L.L.C., an affiliate of FelCor Lodging Trust, Incorporated. The parties have agreed that the Company will continue to operate the hotels under a 15-year management agreement with one 10-year extension option. The transaction is expected to close in the second quarter of 2011 and is subject to satisfaction of customary closing conditions.

On April 22, 2011, Mondrian Holdings entered into a purchase and sale agreement to sell Mondrian Los Angeles for $137.0 million to Pebblebrook. The parties have agreed that the Company will continue to operate the hotel under a 20-year management agreement with one 10-year extension option. The transaction closed on May 3, 2011 and 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, are approximately $40 million.

The Company has reclassified the individual assets and liabilities of Royalton, Morgans and Mondrian Los Angeles to the appropriate assets and liabilities of assets held for sale on its March 31, 2011 and December 31, 2010 balance sheets.

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 three months ended March 31, 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 March 31, 2011, of Morgans, Royalton and Hudson in New York, Delano South Beach in Miami Beach, Mondrian Los Angeles in Los Angeles, and Clift in San Francisco;
	•		our hotels in which we own partial interests, or Joint Venture Hotels, consisting, as of March 31, 2011, of our London hotels (Sanderson and St Martins Lane), Mondrian South Beach and Shore Club in Miami Beach, Ames in Boston, Mondrian SoHo in New York and the San Juan Water and Beach Club in Isla Verde, Puerto Rico;
	•		our investments in hotels under construction, such as Mondrian SoHo prior to its opening in February 2011, and our investment in other proposed properties;
	•		our investment in certain joint venture food and beverage operations at our Owned Hotels and Joint Venture Hotels, discussed further below;
	•		our management company subsidiary, Morgans Hotel Group Management LLC, or MHG Management Company, and certain non-U.S. management company affiliates; 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.

In April 2011, we entered into definitive agreements to sell Royalton, Morgans and Mondrian Los Angeles. We will continue to operate these hotels under long-term management agreements. The sale of Mondrian Los Angeles was completed on May 3, 2011 and the sale of Royalton and Morgans is expected to close in the second quarter of 2011, subject to satisfaction of customary closing conditions.

As of March 31, 2011, we consolidate the results of operations, including food and beverage operations, for all of our Owned Hotels. Certain food and beverage operations at three of our Owned Hotels, are operated under 50/50 joint ventures with restaurateur Jeffrey Chodorow. We consolidate the food and beverage joint ventures as we believe that we are the primary beneficiary of these entities. Our partner’s share of the results of operations of these food and beverage joint ventures are recorded as noncontrolling interests in the accompanying consolidated financial statements.

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

As of March 31, 2011, we operated the following Joint Venture Hotels under management agreements which expire as follows:

	•		Sanderson — June 2018 (with one 10-year extension at our option);
	•		St Martins Lane — June 2018 (with one 10-year extension at our option);
	•		Shore Club — July 2022;
	•		Mondrian South Beach — August 2026;
	•		Ames — November 2024;
	•		Mondrian SoHo — February 2021 (with two 10-year extensions at our option, subject to certain conditions); and
	•		San Juan Water and Beach Club — October 2019 (subject to certain conditions).

In addition to the Joint Venture Hotels, we also manage Hotel Las Palapas in Playa del Carmen, Mexico under a management agreement which expires in December 2014, with one five-year extension, which is automatic so long as we are not in default under the management agreement. We do not have an ownership interest in Hotel Las Palapas.

In February 2011, we opened Mondrian SoHo which we manage under a 10-year management agreement with two 10-year extension options. We have signed management agreements to manage various other hotels that are in development, including a Mondrian Palm Springs project, 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 and a Mondrian project in Doha, Qatar, but we are unsure of the future of the development of some of these hotels as financing has not yet been obtained.

These management agreements may be subject to early termination in specified circumstances. 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.

Until March 1, 2011, we managed and had a partial ownership interest in the Hard Rock Hotel & Casino in Las Vegas (the “Hard Rock”) pursuant to a management agreement that was terminated in connection with the Hard Rock settlement, discussed below in “—Recent Developments.”

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 earned by our 50/50 restaurant joint ventures and is driven by occupancy of our hotels and the popularity of our bars and restaurants with our local customers.
	•		Other hotel revenue. Other hotel revenue, which consists of ancillary revenue such as telephone, parking, spa, entertainment and other guest services, is principally driven by hotel occupancy.
	•		Management fee-related parties revenue and other income. We earn fees under our management agreements. These fees may include management fees as well as reimbursement for allocated chain services.

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 global economic downturn, the impact of seasonality in 2009 and 2010 was not as significant as in prior periods and may remain less pronounced throughout 2011 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.
	•		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 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 quarters ended March 31, 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 losses going forward.
	•		Noncontrolling interest. Noncontrolling interest constitutes our third-party food and beverage joint venture partner’s interest in the profits and losses of the restaurant ventures at certain of our hotels as well as 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.

	•		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 is expected to continue into 2011. We are optimistic as we continue into 2011. However, 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 experienced positive trends in 2010 as we saw improvement in demand in key gateway markets, particularly in New York and London. These markets experienced increasing occupancy in all quarters, accompanied by increases in average daily rate in the second, third and fourth quarters of 2010.

During the first quarter of 2011, we continued to experience an increase in demand in most of our markets, although we witnessed some softness, particularly in New York and London, where RevPAR decreased slightly compared to the prior year. We believe this softness will prove to be temporary in nature and primarily due to the impact of severe winter storms combined with recent new supply additions during a seasonally slow period. Our overall RevPAR performance showed greater increases beginning in March 2011 and this trend continued through April. Overall, however, our operating results are still below pre-recessionary levels.

As demand continues to strengthen in 2011, 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.

We are also actively managing costs at each of our properties and our corporate office. Through our multi-phased contingency plan, we reduced hotel operating expenses and corporate expenses during 2008 and 2009. We continue to focus on containing operating costs without affecting the guest experience. We believe that these cost reduction plans have resulted and will continue to result in significant savings, although market conditions may require increases in certain areas.

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.

In 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 during 2011, although we believe there will continue to be less credit available and on less favorable terms than were obtainable in prior years. Given the current state of the credit markets, some of our 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.

Settlement of Debt on Property Across from Delano in South Beach. In January 2011, our indirect subsidiary transferred its interests in the property across the street from Delano in South Beach to SU Gale Properties, LLC. As a result of this transaction, we were released from $10.5 million of non-recourse mortgage and mezzanine indebtedness previously consolidated on our balance sheet. The property across the street from Delano in South Beach was a development property with no operations and generated no earnings before interest tax, depreciation and amortization during 2010 or the first three months of 2011.

New Management Contracts. In February 2011, we announced a new hotel management agreement for a 114 key Delano on the beach at the tip of the Baja Peninsula in Cabo San Lucas, Mexico, overlooking the Sea of Cortez. The hotel is currently under construction and is expected to open early in 2013. We also announced a management agreement for a 200 key Delano on the Aegean Sea in Turkey, an exclusive, high-end resort destination easily accessible from Istanbul and other key European locations, which is expected to open in 2013. Further, we announced a new management agreement for a 175 key hotel in New York City in the Highline area. The hotel will be branded with one of our existing brands and is expected to open in 2014. Finally, also in February 2011, we announced a new hotel management agreement for a Mondrian hotel in Doha, Qatar that is currently under construction and is expected to open in early 2013. We will operate the hotel pursuant to a 30-year management contract with extension options.

Hard Rock Settlement Agreement. On March 1, 2011, Hard Rock Hotel Holdings, LLC, a joint venture through which we held a minority interest in the Hard Rock Hotel & Casino in Las Vegas, Vegas HR Private Limited (the “Mortgage Lender”), Brookfield Financial, LLC — Series B (the “First Mezzanine Lender”), NRFC HRH Holdings, LLC (the “Second Mezzanine Lender”), Morgans Group, the Company and certain affiliates of DLJ Merchant Banking Partners (“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 Hard Rock settlement agreement provided, among other things, for the following:

	•		release of the non-recourse carve-out guaranties provided by us 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 we managed the Hard Rock;
	•		the transfer by Hard Rock Hotel Holdings, LLC and its subsidiary Hard Rock Hotel Inc. 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 us. Our net payment was approximately $3.7 million.

As a result of the settlement, we will no longer be subject to Nevada gaming regulations, after completion of certain gaming de-registration procedures. See “Off-Balance Sheet Arrangements” for additional information.

Board of Director and Management Changes. In March 2011, we announced the following Board of Directors (“Board”) and senior management changes:

	•		David Hamamoto, Chairman of the Board and one of our largest stockholders, was appointed Executive Chairman, effective March 20, 2011;
	•		Michael Gross, a member of the Board who previously served on the Corporate Governance and Nominating Committee, was appointed Chief Executive Officer, effective March 20, 2011;
	•		Daniel Flannery, who previously served with Marriott International, Inc., was appointed Chief Operating Officer, effective April 4, 2011;
	•		Yoav Gery, who previously served with Marriott International, Inc., was appointed Chief Development Officer, effective March 23, 2011;
	•		Ron Burkle, Managing Partner at The Yucaipa Companies, LLC, joined the Board, effective March 20, 2011, as the nominee appointed by Yucaipa, which is our largest stakeholder; and
	•		Jason Taubman Kalisman, a founding member of our largest stockholder, OTK Associates, joined the Board, effective March 22, 2011.

Also in March 2011, we announced that Fred Kleisner stepped down as Chief Executive Officer and resigned from the Board effective March 20, 2011 and that the Company’s President, Marc Gordon, was leaving the Company to pursue other interests and resigned from the Board effective March 22, 2011. In connection with Mr. Gordon’s departure, we entered into a separation agreement and release (the “Separation Agreement”) on March 20, 2011. Pursuant to the Separation Agreement, we agreed to pay Mr. Gordon (1) a lump sum severance payment of $2,069,000, (2) monthly consulting payments of $66,666 per month through December 2011, and (3) a lump sum payment of $300,000 in January 2012. We also agreed that all of Mr. Gordon’s equity awards would vest and that he will be eligible to elect continuation coverage under COBRA. In consideration of the monthly consulting payments, Mr. Gordon agreed to make himself available to provide consulting services to us through December 2011. In addition, Mr. Gordon agreed to certain non-competition and standstill provisions that are effective for nine months following the date of the Separation Agreement and certain non-solicitation provisions that are effective through March 31, 2012.

Agreement to sell Royalton and Morgans. On April 2, 2011, we entered into purchase and sale agreements to sell Royalton for $88.2 million and Morgans for $51.8 million to affiliates of FelCor Lodging Trust, Incorporated. The parties have agreed that we will continue to operate the hotels following the sales under 15-year management agreements with one 10-year extension option. The transactions are expected to close in the second quarter of 2011 and are subject to satisfaction of customary closing conditions.

We intend to use a portion of the proceeds of the sales to retire approximately $37.7 million outstanding debt under our amended revolving credit facility as of March 31, 2011. The hotels, along with Delano, are collateral for our amended revolving credit facility, which terminates upon the sale of any of the properties securing the facility. Upon termination of the facility, Delano will be unencumbered.

We received a $7 million security deposit, which is non-refundable except in the event of a default by us.

Sale of Mondrian Los Angeles. On May 3, 2011, our subsidiary Mondrian Holdings LLC (“Mondrian Holdings”) completed the sale of Mondrian Los Angeles for $137.0 million to Wolverines Owner LLC, an affiliate of Pebblebrook Hotel Trust (“Pebblebrook”), pursuant to a purchase and sale agreement entered into on April 22, 2011. We 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, defined below in “—Debt.” Net proceeds, after the repayment of debt and closing costs, were approximately $40 million. We will continue to operate the hotel under a 20-year management agreement with one 10-year extension option.

Operating Results

Comparison of Three Months Ended March 31, 2011 to Three Months Ended March 31, 2010

The following table presents our operating results for the three months ended March 31, 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 March 31, is comparable to the consolidated operating results for the three months ended March 31, 2010, with the exception of the Hard Rock, which we managed until March 1, 2011 and Mondrian SoHo, which opened in February 2011. The consolidated operating results are as follows:

		Three Months Ended
		March 31,				March 31,
		2011				2010				Changes ($)				Changes (%)
		(Dollars in thousands)
Revenues:
Rooms		$	31,034			$	29,250			$	1,784				6.1	%
Food and beverage			18,030				17,496				534				3.1
Other hotel			2,016				2,209				(193	)			(8.7	)
Total hotel revenues			51,080				48,955				2,125				4.3
Management fee-related parties and other income			3,324				4,429				(1,105	)			(24.9	)
Total revenues			54,404				53,384				1,020				1.9
Operating Costs and Expenses:
Rooms			11,174				10,025				1,149				11.5
Food and beverage			15,102				13,916				1,186				8.5
Other departmental			1,211				1,252				(41	)			(3.3	)
Hotel selling, general and administrative			12,558				11,437				1,121				9.8
Property taxes, insurance and other			4,185				4,100				85				2.1
Total hotel operating expenses			44,230				40,730				3,500				8.6
Corporate expenses, including stock compensation			10,834				10,005				829				8.3
Depreciation and amortization			8,373				7,345				1,028				14.0
Restructuring, development and disposal costs			4,593				677				3,916				(1	)
Total operating costs and expenses			68,030				58,757				9,273				15.8
Operating loss			(13,626	)			(5,373	)			(8,253	)			(1	)
Interest expense, net			8,994				12,350				(3,356	)			(27.2	)
Equity in loss of unconsolidated joint venture			9,483				263				9,220				(1	)
Other non-operating expenses			1,390				15,029				(13,639	)			(90.8	)
Loss before income tax (benefit) expense			(33,493	)			(33,015	)			(478	)			1.4
Income tax (benefit) expense			(135	)			294				(429	)			(1	)
Net loss from continuing operations			(33,358	)			(33,309	)			(49	)			0.1
Income from discontinued operations, net of tax			490				17,202				(16,712	)			(97.2	)
Net loss			(32,868	)			(16,107	)			(16,761	)			(1	)
Net loss attributable to non controlling interest			825				147				678				(1	)
Net loss attributable to Morgans Hotel Group Co.			(32,043	)			(15,960	)			(16,083	)			(1	)
Preferred stock dividends and accretion			(2,187	)			(2,078	)			(109	)			5.2
Net loss attributable to common stockholders		$	(34,230	)		$	(18,038	)		$	(16,192	)			89.8	%

Total Hotel Revenues. Total hotel revenues increased 1.9% to $54.4 million for the three months ended March 31, 2011 compared to $53.4 million for the three months ended March 31, 2010. The components of RevPAR from our Owned Hotels for the three months ended March 31, 2011 and 2010 are summarized as follows:

		Three Months Ended
		March 31,				March 31,
		2011				2010				Change ($)				Change (%)
Occupancy			75.4	%			72.0	%			—				4.7	%
ADR		$	238			$	236			$	2				1.2	%
RevPAR		$	180			$	170			$	10				6.0	%

RevPAR from our Owned Hotels increased 6.0% to $180 for the three months ended March 31, 2011 compared to $170 for the three months ended March 31, 2010.

Rooms revenue increased 6.1% to $31.0 million for the three months ended March 31, 2011 compared to $29.3 million for the three months ended March 31, 2010, which is directly attributable to the increase in occupancy and ADR shown above.

Food and beverage revenue increased 3.1% to $18.0 million for the three months ended March 31, 2011 compared to $17.5 million for the three months ended March 31, 2010. The increase was primarily attributable to Hudson, which was being re-concepted and was under renovation during the three months ended March 31, 2010.

Other hotel revenue decreased 8.7% to $2.0 million for the three months ended March 31, 2011 compared to $2.2 million for the three months ended March 31, 2010. The overall decrease is primarily due to decreased revenues related to ancillary services, such as our spas at Delano, as guests are still spending conservatively in light of the uncertain economic recovery. Slightly offsetting this decrease, newly installed wireless infrastructures at certain of our Owned Hotels have contributed to an increase in internet revenues.

Management Fee — Related Parties and Other Income. Management fee — related parties and other income decreased by 24.9% to $3.3 million for the three months ended March 31, 2011 compared to $4.4 million for the three months ended March 31, 2010. This decrease is primarily attributable to the decrease in management fees earned at Hard Rock as a result of the termination of our management agreement effective March 1, 2011 in connection with the Hard Rock settlement.

Operating Costs and Expenses

Rooms expense increased 11.5% to $11.1 million for the three months ended March 31, 2011 compared to $10.0 million for the three months ended March 31, 2010. This increase is a result of the increase in rooms revenue attributable to increased occupancy along with the timing of operating supply purchases.

Food and beverage expense increased 8.5% to $15.1 million for the three months ended March 31, 2011 compared to $13.9 million for the three months ended March 31, 2010. This increase is primarily due to an increase in food and beverage expenses at Hudson in the first quarter of 2011 compared to the first quarter of 2010 as a result of the primary restaurant being closed from January 2010 to May 2010 during its re-concepting and renovation, and opened in the first quarter of 2011.

Other departmental expense decreased 3.3% to $1.2 million for the three months ended March 31, 2011 compared to $1.3 million for the three months ended March 31, 2010. This slight decrease is a direct result of the decrease in other hotel revenue noted above.

Hotel selling, general and administrative expense increased 9.8% to $12.6 million for the three months ended March 31, 2011 compared to $11.4 million for the three months ended March 31, 2010. This increase was primarily due to increased selling and marketing initiatives implemented across our hotel portfolio including the addition of a global sales team.

Property taxes, insurance and other expense increased 2.1% to $4.2 million for the three months ended March 31, 2011 compared to $4.1 million for the three months ended March 31, 2010. This slight increase was primarily due to tax refunds received during the three months ended March 31, 2010.

Corporate expenses, including stock compensation increased 8.3% to $10.8 million for the three months ended March 31, 2011 compared to $10.0 million for the three months ended March 31, 2010. This increase is primarily due to an increase in stock compensation expense due to the acceleration of vesting of unvested equity awards granted to our former Chief Executive Officer and President in connection with their separation from the Company in March 2011 and incentive compensation that was restored to more normalized levels than in prior years.

Depreciation and amortization increased 14.0% to $8.4 million for the three months ended March 31, 2011 compared to $7.3 million for the three months ended March 31, 2010. This increase is primarily the result of depreciation on capital improvements required to maintain our existing hotels incurred during 2010 and increased depreciation expense related to the recent lower level expansion at Hudson, Good Units, and the restaurant re-concepting, Hudson Hall, both of which occurred during the first half of 2010.

Restructuring, development and disposal costs increased to $4.6 million for the three months ended March 31, 2011 compared to $0.7 million for the three months ended March 31, 2010. The increase in expense is primarily due to severance costs related to our executive restructurings during March 2011, for which there was no comparable costs incurred during the three months ended March 31, 2010.

Interest expense, net decreased 27.2% to $9.0 million for the three months ended March 31, 2011 compared to $12.4 million for the three months ended March 31, 2010. This decrease is primarily due to decreased interest expense recognized as a result of the expiration in July 2010 of the interest rate swaps related to the loans secured by the Hudson and Mondrian Los Angeles hotels which had fixed our interest expense on those loans at a much higher rate than the current LIBOR rates.

Equity in loss of unconsolidated joint ventures resulted in a loss of $9.5 million for the three months ended March 31, 2011 compared to a loss of $0.3 million for the three months ended March 31, 2010. This change was primarily a result of charges recognized related to the Hard Rock settlement, discussed above, and an impairment loss recognized on Mondrian SoHo, which opened in February 2011.

The components of RevPAR from our comparable Joint Venture Hotels for the three months ended March 31, 2011 and 2010, which includes Sanderson, St Martins Lane, Shore Club, and Mondrian South Beach, 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 is a non-Morgans Hotel Group branded hotel, are summarized as follows (in constant dollars):

		Three Months Ended
		March 31,				March 31,
		2011				2010				Change ($)				Change (%)
Occupancy			67.0	%			63.5	%			—				5.5	%
ADR		$	326			$	334			$	(8	)			(2.2	)%
RevPAR		$	219			$	212			$	7				3.1	%

Other non-operating expense was $1.4 million for the three months ended March 31, 2011 as compared to $15.0 million for the three months ended March 31, 2010. The change was primarily the result of the loss on change in fair market value of the warrants issued to the Investors, defined below in “—Derivative Financial Instruments”, in connection with the Series A preferred securities during 2010. For further discussion, see notes 2 and 8 of our consolidated financial statements.

Income tax expense (benefit) resulted in a benefit of $0.1 million for the three months ended March 31, 2011 as compared to an expense of $0.3 million for the three months ended March 31, 2010. The slight change was primarily due to overall operating performance of the quarters.

Income from discontinued operations, net of tax resulted in a gain of $0.5 million for the three months ended March 31, 2011 compared to a gain of $17.2 million for the three months ended March 31, 2010. This change was primarily a result of the gain on disposal of Mondrian Scottsdale in March 2010 as compared to a slight gain on the disposal of the property across the street from Delano South Beach in January 2011.

Liquidity and Capital Resources

As of March 31, 2011, we had approximately $6.0 million in cash and cash equivalents. The maximum amount of borrowings available under our amended revolving credit facility was $116.5 million, of which $37.7 million of borrowings were outstanding and $1.2 million of letters of credit were posted.

We have both short-term and long-term liquidity requirements as described in more detail below.

Liquidity Requirements

Short-Term Liquidity Requirements. We generally consider our short-term liquidity requirements to consist of those items that are expected to be incurred by us or our consolidated subsidiaries within the next 12 months and believe those requirements currently consist primarily of funds necessary to pay operating expenses and other expenditures directly associated with our properties, including the funding of our reserve accounts, capital commitments associated with certain of our development projects, and payment of scheduled debt maturities, unless otherwise extended or refinanced.

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt or lease agreements related to such hotels, with the exception of Delano South Beach, Royalton and Morgans. Our Joint Venture Hotels and Hotel Las Palapas, which we manage, generally are subject to similar obligations under debt agreements related to such hotels, or under our management agreements. These capital expenditures relate primarily to the periodic replacement or refurbishment of furniture, fixtures and equipment. Such agreements typically require us to reserve funds at amounts equal to 4% of the hotel’s revenues and require the funds to be set aside in restricted cash. In addition, our restaurant joint ventures require the ventures to set aside restricted cash of between 2% to 4% of gross revenues of the restaurant. Our Owned Hotels that were not subject to these reserve funding obligations — Delano South Beach, Royalton, and Morgans — underwent significant room and common area renovations during 2006, 2007 and 2008, and as such, are not expected to require a substantial amount of capital spending during 2011.

In addition to reserve funds for capital expenditures, our debt and lease agreements also require us to deposit cash into escrow accounts for taxes, insurance and debt service payments. As of March 31, 2011, total restricted cash was $29.9 million.

As of March 31, 2011, there was approximately $10.8 million in curtailment reserve accounts related to Hudson and Mondrian Los Angeles loans. These loans previously required that all excess cash be deposited into these accounts until such time as the debt service coverage ratio improved above the required ratio of 1:05 to 1:00 for two consecutive quarters. On October 1, 2010, our subsidiaries Hudson Holdings LLC (“Hudson Holdings”) and Mondrian Holdings LLC (“Mondrian Holdings”) each entered into a modification agreement of its respective mortgage, together with promissory notes and other related security agreements, with Bank of America, N.A., as trustee, for the lenders. These modification agreements and related agreements amended and extended the mortgages (collectively, the “Amended Mortgages”) until October 15, 2011. Under the Amended Mortgages all excess cash will continue to be deposited into curtailment reserve accounts regardless of the debt service coverage ratio.

In May 2011, we completed the sale of Mondrian Los Angeles for $137.0 million. We utilized a portion of the net proceeds along with cash held in escrow accounts to retire the $103.5 million of debt scheduled to mature in October 2011.

In October 2011, both our amended revolving credit facility, with an outstanding balance of $37.7 million as of March 31, 2011, and the Amended Mortgage on Hudson, with an outstanding aggregate balance of $201.2 million as of March 31, 2011, will mature. In addition, the mezzanine debt of $26.5 million at Hudson may not be extended if the underlying mortgage debt is not extended.

As we implement our strategy to shift towards a more “asset light” business model, which includes selling hotel assets, we announced in April 2011 that we entered into purchase and sale agreements to sell Royalton for $88.2 million, Morgans for $51.8 million, and Mondrian Los Angeles for $137.0 million. The sale of Royalton and Morgans is expected to close in the second quarter of 2011 and is subject to satisfaction of customary closing conditions. The sale of Mondrian Los Angeles closed on May 3, 2011.

We intend to use a portion of the proceeds from the sale of Royalton and Morgans to repay the approximately $37.7 million outstanding debt under our amended revolving credit facility secured by Delano, Royalton and Morgans, with the remainder available for the Hudson debt refinancing and for growth. Upon the closing of the sale, the facility will terminate and Delano will be unencumbered.

We have a number of options to finance the outstanding maturity on Hudson, including debt financing opportunities, and sales of additional hotels and other sources. We believe that the combination of rising hotel cash flows and improving capital markets should provide access to sufficient capital to retire or refinance this debt and provide capital for growth.

Historically, we have satisfied our liquidity requirements through various sources of capital, including borrowings under our revolving credit facility, our existing working capital, cash provided by operations, equity and debt offerings, and long-term mortgages on our properties. Other sources may include cash generated through asset dispositions and joint venture transactions. Additionally, we may secure other financing opportunities. Given the uncertain economic environment and continuing difficult conditions in the credit markets, however, we may not be able to obtain such financings, or succeed in selling any assets, on terms acceptable to us or at all. We may require additional borrowings to satisfy these liquidity requirements. See also “—Other Liquidity Matters” below for additional liquidity that may be required in the short-term, depending on market and other circumstances, including our ability to refinance or extend existing debt.

Long-Term Liquidity Requirements. We generally consider our long-term liquidity requirements to consist of those items that are expected to be incurred by us or our consolidated subsidiaries beyond the next 12 months and believe these requirements consist primarily of funds necessary to pay scheduled debt maturities, renovations and other non-recurring capital expenditures that need to be made periodically to our properties and the costs associated with acquisitions and development of properties under contract and new acquisitions and development projects that we may pursue.

Our Series A preferred securities have an 8% dividend rate for the first five years, a 10% dividend rate for years six and seven, and a 20% dividend rate thereafter. We have the option to accrue any and all dividend payments, and as of March 31, 2011, have not declared any dividends. We have the option to redeem any or all of the Series A preferred securities at any time. While we do not anticipate redeeming any or all of the Series A preferred securities in the near-term, we may want to redeem them prior to the escalation in dividend rate to 20% in 2017.

Other long-term liquidity requirements include our obligations under our Hudson mezzanine loan, obligations under our Convertible Notes, defined below, our obligations under our trust preferred securities, and our obligations under the Clift lease, each as described under “—Debt.” Historically, we have satisfied our long-term liquidity requirements through various sources of capital, including our existing working capital, cash provided by operations, equity and debt offerings, and long-term mortgages on our properties. Other sources may include cash generated through asset dispositions and joint venture transactions. Additionally, we may secure other financing opportunities. Given the uncertain economic environment and continuing challenging conditions in the credit markets, however, we may not be able to obtain such financings on terms acceptable to us or at all. We may require additional borrowings to satisfy our long-term liquidity requirements.

Additionally, we anticipate we will need to renovate Hudson, Clift, Sanderson and St Martins Lane in the next few years, which will require capital and will most likely be funded by owner equity contributions, debt financing, possible asset sales, future operating cash flows or a combination of these sources.

Although the credit and equity markets remain challenging, we believe that these sources of capital will become available to us in the future to fund our long-term liquidity requirements. However, our ability to incur additional debt is dependent upon a number of factors, including our degree of leverage, borrowing restrictions imposed by existing lenders and general market conditions. We will continue to analyze which source of capital is most advantageous to us at any particular point in time.

Other Liquidity Matters

In addition to our expected short-term and long-term liquidity requirements, our liquidity could also be affected by potential liquidity matters at our Owned Hotels or Joint Venture Hotels, as discussed below.

Mondrian South Beach Mortgage and Mezzanine Agreements. The non-recourse mortgage loan and mezzanine loan agreements related to Mondrian South Beach matured on August 1, 2009. In April 2010, the Mondrian South Beach joint venture amended the non-recourse financing and mezzanine loan agreements secured by Mondrian South Beach and extended the maturity date for up to seven years through extension options until April 2017, subject to certain conditions.

Morgans Group and affiliates of our 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 our 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 our 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 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 our 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 our joint venture partner may have continuing obligations under construction completion guaranties until all outstanding payables due to construction vendors are paid. As of March 31, 2011, there are remaining payables outstanding to vendors of approximately $1.5 million. We believe that payment under these guaranties is not probable and the fair value of the guarantee is not material.

We and affiliates of our 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. We have not recognized a liability related to the construction completion or the condominium purchase guarantees.

Mondrian SoHo. The mortgage loan on the Mondrian SoHo property matured in June 2010. 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.

Certain affiliates of our 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 respective gross negligence or willful misconduct.

Mondrian SoHo opened in February 2011, and we are operating the hotel under a 10-year management contract with two 10-year extension options. We anticipate there may be cash shortfalls from the operations of the hotel and there may not be enough operating cash flow to cover debt service payments in all months going forward, which could require additional contributions by the joint venture partners.

Ames in Boston. As of March 31, 2011, the ownership joint venture’s outstanding mortgage debt secured by the hotel was $46.5 million. In October 2010, the mortgage loan matured, and the joint venture did not satisfy the conditions necessary to exercise the first of two remaining one-year extension options available under the loan, which included funding a debt service reserve account, among other things. As a result, the mortgage lender for Ames served the joint venture with a notice of default and acceleration of debt. In February 2011, the joint venture reached an agreement with the lender whereby the lender waived the default, reinstated the loan and extended the loan maturity date until October 9, 2011. The mortgage debt has one remaining extension option, subject to certain conditions, which if exercised would extend the maturity date for one year to October 9, 2012.

Potential Litigation. We may have potential liability in connection with certain claims by a designer for which we have accrued $13.9 million as of March 31, 2011, as discussed in note 5 of our consolidated financial statements. We believe the probability of losses associated with this claim in excess of the liability that is accrued of $13.9 million is remote and we cannot reasonably estimate of range of such additional losses, if any, at this time.

Other Possible Uses of Capital. We have a number of development projects signed or under consideration, some of which may require equity investments, key money or credit support from us.

Comparison of Cash Flows for the Three Months Ended March 31, 2011 to the Three Months ended March 31, 2010

Operating Activities. Net cash used in operating activities was $2.6 million for the three months ended March 31, 2011 as compared to $7.0 million for the three months ended March 31, 2010. The decrease in cash used in operating activities is primarily due to a reduction in deposits of excess cash flow from Hudson into a curtailment reserve escrow account as a result of the decline in operating results at Hudson during the three months ended March 31, 2011. During the three months ended March 31, 2010, the deposit of funds into the reserve account was greater than during the three months ended March 31, 2011.

Investing Activities. Net cash used in investing activities amounted to $8.1 million for the three months ended March 31, 2011 as compared to $4.9 million for the three months ended March 31, 2010. The increase in cash used in investing activities primarily relates to an increase in contributions made to our investments in unconsolidated joint ventures in 2011 compared to 2010, primarily related to the Hard Rock settlement.

Financing Activities. Net cash provided by financing activities amounted to $11.4 million for the three months ended March 31, 2011 as compared to net cash used by financing activities of $0.7 million for the three months ended March 31, 2010. During the three months ended March 31, 2011, we drew $11.7 million on our amended revolving credit facility for which there were no comparable proceeds in 2010.

Debt

Amended Revolving Credit Facility. On October 6, 2006, we and certain of our subsidiaries entered into a revolving credit facility with Wachovia Bank, National Association, as Administrative Agent, and the lenders thereto, which was amended on August 5, 2009, and which we refer to as our amended revolving credit facility.

The amended revolving credit facility provides for a maximum aggregate amount of commitments of $125.0 million, divided into two tranches: (i) a revolving credit facility in an amount equal to $90.0 million (the “New York Tranche”), which is secured by a mortgage on Morgans and Royalton and a mortgage on Delano South Beach and (ii) a revolving credit facility in an amount equal to $35.0 million (the “Florida Tranche”), which is secured by the mortgage on the Florida Property (but not the Morgans and Royalton). Our amended revolving credit facility also provides for a letter of credit facility in the amount of $25.0 million, which is secured by the mortgages on the Morgans and Royalton and the Delano South Beach. At any given time, the amount available for borrowings under the amended revolving credit facility is contingent upon the borrowing base valuation, which is calculated as the lesser of (i) 60% of appraised value and (ii) the implied debt service coverage value of certain collateral properties securing the amended revolving credit facility; provided that the portion of the borrowing base attributable to the Morgans and Royalton will never be less than 35% of the appraised value of the Morgans and Royalton. Following appraisals in March 2010, total availability under our amended revolving credit facility as of March 31, 2011 was $116.5 million, of which $37.7 million of borrowings were outstanding, and approximately $1.2 million of letters of credit were posted. Of the outstanding $37.7 million, $33.7 million was allocated to the Florida Tranche and $4.0 million was allocated to the New York Tranche.

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

In addition, the amended revolving credit facility includes the following, among other provisions:

	•		requirement that we maintain a fixed charge coverage ratio (defined generally as the ratio of consolidated EBITDA excluding Mondrian Scottsdale’s EBITDA for the periods ending June 30, 2009 and September 30, 2009 and Clift’s EBITDA for all periods to consolidated interest expense excluding Mondrian Scottsdale’s interest expense for the periods ending June 30, 2009 and September 30, 2009 and Clift’s interest expense for all periods) for each four-quarter period of no less than 0.90 to 1.00. As of March 31, 2011, our fixed charge coverage ratio was 1.81x;
	•		prohibition on capital expenditures with respect to any hotels owned by us, the borrowers, or our subsidiaries, other than maintenance capital expenditures for any hotel not exceeding 4% of the annual gross revenues of such hotel and certain other exceptions;
	•		prohibition on repurchase of our common equity interests by us or Morgans Group; and
	•		certain limits on any secured swap agreements entered into after the effective date of the amended revolving credit facility.

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

As of March 31, 2011, the principal balance of the amended revolving credit facility was $37.7 million, and approximately $1.2 million in letters of credit were outstanding. The commitments under the amended revolving credit facility terminate on October 5, 2011, at which time all outstanding amounts under the amended revolving credit facility will be due.

In connection with our proposed sale of Royalton and Morgans, we intend to use a portion of the proceeds to retire the approximately $37.7 million outstanding debt under the amended revolving credit facility as of March 31, 2011. These hotels, along with Delano, are collateral for the amended revolving credit facility, which terminates upon the sale of any of the properties securing the facility. Upon termination of the facility, Delano will be unencumbered.

Mortgages and Hudson Mezzanine Loan. On October 6, 2006, our subsidiaries, Hudson Holdings and Mondrian Holdings, entered into non-recourse mortgage financings consisting of two separate first mortgage loans secured by Hudson and Mondrian Los Angeles, respectively (collectively, the “Mortgages”), and a mezzanine loan related to Hudson, secured by a pledge of our equity interests in the subsidiary owning Hudson.

On October 14, 2009, we entered into an agreement with the lender that holds, among other loans, the mezzanine loan on Hudson. Under the agreement, we paid an aggregate of $11.2 million to (i) reduce the principal balance of the mezzanine loan from $32.5 million to $26.5 million, (ii) acquire interests in $4.5 million of debt securities secured by certain of our other debt obligations, (iii) pay fees, and (iv) obtain a forbearance from the mezzanine lender until October 12, 2013 from exercising any remedies resulting from a maturity default, subject only to maintaining certain interest rate caps and making an additional aggregate payment of $1.3 million to purchase additional interests in certain of our other debt obligations prior to October 11, 2011. The mezzanine lender also agreed to cooperate with us in our efforts to seek an extension of the Hudson mortgage loan and to consent to certain refinancings and other modifications of the Hudson mortgage loan.

Until amended as described below, the Hudson Holdings Mortgage bore interest at 30-day LIBOR plus 0.97%, and the Mondrian Holdings Mortgage bore interest at 30-day LIBOR plus 1.23%. We had entered into interest rate swaps on the Mortgages and the mezzanine loan on Hudson, which effectively fixed the 30-day LIBOR rate at approximately 5.0%. These interest rate swaps expired on July 15, 2010. We subsequently entered into short-term interest rate caps on the Mortgages that expired on September 12, 2010.

On October 1, 2010, Hudson Holdings and Mondrian Holdings each entered into a modification agreement of its respective Mortgage, together with promissory notes and other related security agreements, with Bank of America, N.A., as trustee, for the lenders. These modification agreements and related agreements extended the Mortgages until October 15, 2011. In connection with the Amended Mortgages, on October 1, 2010, Hudson Holdings and Mondrian Holdings paid down a total of $16 million and $17 million, respectively, on their outstanding loan balances. The Hudson Holdings Amended Mortgage bears interest at 30-day LIBOR plus 1.03% and the Mondrian Holdings Amended Mortgage bears interest at 30-day LIBOR plus 1.64%.

The interest rate on the Hudson mezzanine loan continues to bear interest at 30-day LIBOR plus 2.98%. We entered into interest rate caps expiring October 15, 2011 in connection with the Amended Mortgages, which effectively cap the 30-day LIBOR rate at 5.3% and 4.25% on the Hudson Holdings Amended Mortgage and Mondrian Holdings Amended Mortgage, respectively, and effectively cap the 30-day LIBOR rate at 7.0% on the Hudson mezzanine loan.

The Amended Mortgages require our subsidiary borrowers to fund reserve accounts to cover monthly debt service payments. Those subsidiary borrowers are also required to fund reserves for property, sales and occupancy taxes, insurance premiums, capital expenditures and the operation and maintenance of those hotels. Reserves are deposited into restricted cash accounts and are released as certain conditions are met. Starting in 2009, the Mortgages had fallen below the required debt service coverage and as such, all excess cash, once all other reserve accounts were completed, were funded into curtailment reserve accounts. At the time the modification agreements were entered into, the balance in the curtailment reserve accounts was $20.3 million, of which $16.5 million was used to reduce the amount of debt outstanding under the Amended Mortgages, as discussed above. Under the Amended Mortgages, all excess cash will continue to be funded into curtailment reserve accounts regardless of our debt service coverage ratio. The subsidiary borrowers are not permitted to have any liabilities other than certain ordinary trade payables, purchase money indebtedness, capital lease obligations and certain other liabilities.

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

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

As of March 31, 2011 the balance outstanding on the Hudson Holdings Amended Mortgage was $201.2 million and on the Mondrian Holdings Amended Mortgage was $103.5 million. As of March 31, 2011, the balance outstanding on the Hudson mezzanine loan was $26.5 million.

On May 3, 2011, we completed the sale of Mondrian Los Angeles for $137.0 million to an affiliate of Pebblebrook, pursuant to a purchase and sale agreement entered into on April 22, 2011. We 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.

We are pursuing a number of alternatives to finance the Hudson Holdings Amended Mortgage and Hudson mezzanine loan maturities, including using a portion of the proceeds from asset sales such as Royalton and Morgans, debt financing, and other sources. The Company believes the combination of rising hotel cash flows and improving capital markets should provide sufficient capital to refinance the debt and provide capital for growth.

Notes to a Subsidiary Trust Issuing Preferred Securities. In August 2006, we formed a trust, MHG Capital Trust I (the “Trust”), to issue $50.0 million of trust preferred securities in a private placement. The sole assets of the Trust consist of the trust notes due October 30, 2036 issued by Morgans Group and guaranteed by Morgans Hotel Group Co. The trust notes have a 30-year term, ending October 30, 2036, and bear interest at a fixed rate of 8.68% for the first 10 years, ending October 2016, and thereafter will bear interest at a floating rate based on the three-month LIBOR plus 3.25%. These securities are redeemable by the Trust at par beginning on October 30, 2011.

Clift. We lease Clift under a 99-year non-recourse lease agreement expiring in 2103. The lease is accounted for as a financing with a liability balance of $85.5 million at March 31, 2011.

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

On September 17, 2010, we and our subsidiaries entered into a settlement and release agreement with the lessors under the Clift ground lease, which 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 the lessors for the period March 1, 2010 through 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 us. Morgans Group also entered into a limited guaranty, 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.

Hudson Capital Leases. We lease two condominium units at Hudson which are reflected as capital leases with balances of $6.1 million at March 31, 2011. Currently annual lease payments total approximately $900,000 and are subject to increases in line with inflation. The leases expire in 2096 and 2098.

Promissory Notes. The purchase of the property across from the Delano South Beach was partially financed with the issuance of a $10.0 million interest only non-recourse promissory note to the seller with a scheduled maturity of January 24, 2009 and an interest rate of 10.0%. In November 2008, we extended the maturity of the note until January 24, 2010 and agreed to pay 11.0% interest for the extension year which we were required to prepay in full at the time of extension. Effective January 24, 2010, we further extended the maturity of the note until January 24, 2011. The note bore interest at 11.0%, but we are permitted to defer half of each monthly interest payment until the maturity date. The obligations under the note were secured by the property. Additionally, in January 2009, an affiliate of the seller financed an additional $0.5 million to pay for costs associated with obtaining necessary permits. This $0.5 million promissory note had a scheduled maturity date on January 24, 2010, which we extended to January 24, 2011, and bore interest at 11%. The obligations under this note were secured with a pledge of the equity interests in our subsidiary that owned the property.

In January 2011, our indirect subsidiary transferred its interest in the property to SU Gales Properties, LLC. As a result of this transaction, we were released from this aggregate $10.5 million non-recourse debt.

Convertible Notes. On October 17, 2007, we completed an offering of $172.5 million aggregate principal amount of 2.375% Senior Subordinated Convertible Notes (“Convertible Notes”), in a private offering, which included an additional issuance of $22.5 million in aggregate principal amount of Convertible Notes as a result of the initial purchasers’ exercise in full of their overallotment option. The Convertible Notes are senior subordinated unsecured obligations of the Company and are guaranteed on a senior subordinated basis by our operating company, Morgans Group. The Convertible Notes are convertible into shares of our common stock under certain circumstances and upon the occurrence of specified events. The Convertible Notes mature on October 15, 2014, unless repurchased by us or converted in accordance with their terms prior to such date.

In connection with the private offering, we entered into certain Convertible Note hedge and warrant transactions. These transactions are intended to reduce the potential dilution to the holders of our common stock upon conversion of the Convertible Notes and will generally have the effect of increasing the conversion price of the Convertible Notes to approximately $40.00 per share, representing a 82.23% premium based on the closing sale price of our common stock of $21.95 per share on October 11, 2007. The net proceeds to us from the sale of the Convertible Notes were approximately $166.8 million (of which approximately $24.1 million was used to fund the Convertible Note call options and warrant transactions).

On January 1, 2009, we adopted Accounting Standard Codification (“ASC”) 470-20, Debt with Conversion and other Options (“ASC 470-20”). ASC 470-20 requires the proceeds from the sale of the Convertible Notes to be allocated between a liability component and an equity component. The resulting debt discount is amortized over the period the debt is expected to remain outstanding as additional interest expense. ASC 470-20 required retroactive application to all periods presented. The equity component, recorded as additional paid-in capital, was $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.

Joint Venture Debt. See “—Off-Balance Sheet Arrangements” for descriptions of joint venture debt.

Seasonality

The hospitality business is seasonal in nature. For example, our Miami hotels are generally strongest in the first quarter, whereas our New York hotels are generally strongest in the fourth quarter. Quarterly revenues also may be adversely affected by events beyond our control, such as the current recession, extreme weather conditions, terrorist attacks or alerts, natural disasters, airline strikes, and other considerations affecting travel. Given the recent global economic downturn, the impact of seasonality in 2010 and the first quarter of 2011 was not as significant as in prior periods and may remain less pronounced throughout 2011 depending on the timing and strength of the economic recovery.

To the extent that cash flows from operations are insufficient during any quarter, due to temporary or seasonal fluctuations in revenues, we may have to enter into additional short-term borrowings or increase our borrowings, if available, to meet cash requirements.

Capital Expenditures and Reserve Funds

We are obligated to maintain reserve funds for capital expenditures at our Owned Hotels as determined pursuant to our debt and lease agreements related to such hotels, with the exception of Delano South Beach, Royalton and Morgans. Our Joint Venture Hotels and Hotel Las Palapas, which we manage, generally are subject to similar obligations under debt agreements related to such hotels, or under our management agreements. These capital expenditures relate primarily to the periodic replacement or refurbishment of furniture, fixtures and equipment. Such agreements typically require us to reserve funds at amounts equal to 4% of the hotel’s revenues and require the funds to be set aside in restricted cash. In addition, our restaurant joint ventures require the ventures to set aside restricted cash of between 2% to 4% of gross revenues of the restaurant. As of March 31, 2011, approximately $3.0 million was available in restricted cash reserves for future capital expenditures under these obligations related to our Owned Hotels.

Additionally, we anticipate we will need to renovate Hudson, Clift, Sanderson and St Martins Lane in the next few years which will require capital and will most likely be funded by owner equity contributions, debt financing, possible asset sales, future operating cash flows or a combination of these sources.

The lenders under the Amended Mortgages require our subsidiary borrowers to fund reserve accounts to cover monthly debt service payments. Those subsidiary borrowers are also required to fund reserves for property, sales and occupancy taxes, insurance premiums, capital expenditures and the operation and maintenance of those hotels. Reserves are deposited into restricted cash accounts and are released as certain conditions are met. In 2009, the Mortgages had fallen below the required debt service coverage and as such, all excess cash, once all other reserve accounts are completed, was funded into curtailment reserve accounts. In October 2010, $16.5 million from these curtailment reserve accounts was used to reduce the amount of mortgage debt outstanding under the Amended Mortgages. Under the Amended Mortgages, all excess cash will continue to be funded into curtailment reserve accounts. As of March 31, 2011, the balance in these curtailment reserve accounts was $10.8 million. Our subsidiary borrowers are not permitted to have any liabilities other than certain ordinary trade payables, purchase money indebtedness, capital lease obligations, and certain other liabilities. As a result of the sale of Mondrian Los Angeles and repayment of the Mondrian Holdings Amended Mortgage on May 3, 2011, approximately $9.2 million held in escrow related to this debt was applied to the repayment of the Mondrian Holdings Amended Mortgage.

During 2006, 2007 and 2008, our Owned Hotels that were not subject to these reserve funding obligations — Delano South Beach, Royalton, and Morgans — underwent significant room and common area renovations, and as such, are not expected to require a substantial amount of capital during 2011. Management will evaluate the capital spent at these properties on an individual basis and ensure that such decisions do not impact the overall quality of our hotels or our guests’ experience.

Under our amended revolving credit facility, we are generally prohibited from funding capital expenditures with respect to any hotels owned by us other than maintenance capital expenditures for any hotel not exceeding 4% of the annual gross revenues of such hotel and certain other exceptions.

Derivative Financial Instruments

We use derivative financial instruments to manage our exposure to the interest rate risks related to our variable rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We determine the fair value of our derivative financial instruments using models which incorporate standard market conventions and techniques such as discounted cash flow and option pricing models to determine fair value. We believe these methods of estimating fair value result in general approximation of value, and such value may or may not be realized.

On February 22, 2006, we entered into an interest rate forward starting swap that effectively fixed the interest rate on $285.0 million of mortgage debt at approximately 5.04% on Mondrian Los Angeles and Hudson with an effective date of July 9, 2007 and a maturity date of July 9, 2010. This derivative qualified for hedge accounting treatment per ASC 815-10, Derivatives and Hedging (“ASC 815-10”) and accordingly, the change in fair value of this instrument was recognized in accumulated other comprehensive loss. In connection with the Mortgages, we also entered into an $85.0 million interest rate swap that effectively fixed the LIBOR rate on $85.0 million of the debt at approximately 5.0% with an effective date of July 9, 2007 and a maturity date of July 15, 2010. This derivative qualified for hedge accounting treatment per ASC 815-10 and accordingly, the change in fair value of this instrument was recognized in accumulated other comprehensive loss.

The foregoing swaps expired in July 2010, when the underlying debt was scheduled to mature. In connection with forbearance agreements we entered into in July and September 2010 with the mortgage lenders on Hudson and Mondrian Los Angeles, we entered into short-term interest rate caps. These interest rate caps were entered into in August and matured in September of 2010. In September 2010, in connection with the Amended Mortgages, we entered into interest rate caps which qualify for hedge accounting treatment per ASC 815-10 and accordingly, the change in fair value of this instrument is recognized in accumulated other comprehensive loss. Additionally, in August 2010, we entered into an interest rate cap on the Hudson mezzanine loan which does not qualify for hedge accounting treatment per ASC 815-10 and accordingly, the change in fair value of this instrument is recognized in interest expense. The fair value of all of these interest rate caps was insignificant as of March 31, 2011.

In connection with the sale of the Convertible Notes, we entered into call options which are exercisable solely in connection with any conversion of the Convertible Notes and pursuant to which we will receive shares of our common stock from counterparties equal to the number of shares of our common stock, or other property, deliverable by us to the holders of the Convertible Notes upon conversion of the Convertible Notes, in excess of an amount of shares or other property with a value, at then current prices, equal to the principal amount of the converted Convertible Notes. Simultaneously, we also entered into warrant transactions, whereby we sold warrants to purchase in the aggregate 6,415,327 shares of our common stock, subject to customary anti-dilution adjustments, at an exercise price of approximately $40.00 per share of common stock. The warrants may be exercised over a 90-day trading period commencing January 15, 2015. The call options and the warrants are separate contracts and are not part of the terms of the Convertible Notes and will not affect the holders’ rights under the Convertible Notes. The call options are intended to offset potential dilution upon conversion of the Convertible Notes in the event that the market value per share of the common stock at the time of exercise is greater than the exercise price of the call options, which is equal to the initial conversion price of the Convertible Notes and is subject to certain customary adjustments.

On October 15, 2009, we entered into a securities purchase agreement with Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P., which we refer to collectively as the Investors. Under the securities purchase agreement, we issued and sold to the Investors (i) 75,000 shares of the our Series A preferred securities, $1,000 liquidation preference per share, 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 warrants have a 7-1/2 year term and are exercisable utilizing a cashless exercise method only, resulting in a net share issuance. The exercise price and number of shares subject to the warrant are both subject to anti-dilution adjustments.

We and Yucaipa American Alliance Fund II, LLC, an affiliate of the Investors, as the fund manager, also entered into a real estate fund formation agreement on October 15, 2009 pursuant to which we and the fund manager agreed to use good faith efforts to endeavor to raise a private investment fund. In connection with the agreement, we issued to the fund manager 5,000,000 contingent warrants to purchase our common stock at an exercise price of $6.00 per share with a 7-1/2 year term. These contingent warrants will only become exercisable if the Fund obtains capital commitments in certain amounts over certain time periods and also meets certain further capital commitment and investment thresholds. The exercise price and number of shares subject to these contingent warrants are both subject to anti-dilution adjustments.

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. The 5,000,000 contingent warrants issued to the fund manager will be forfeited in their entirety on October 15, 2011 if a fund with $250 million has not closed by that date.

Off-Balance Sheet Arrangements

As of March 31, 2011, we have unconsolidated joint ventures that we account for using the equity method of accounting, most of which have mortgage or related debt, as described below. In some cases, we provide non-recourse carve-out guaranties of joint venture debt, which guaranty is only triggered in the event of certain “bad boy” acts, and other limited liquidity or credit support, as described below.

Morgans Europe. We own interests in two hotels through a 50/50 joint venture known as Morgans Europe. Morgans Europe owns two hotels located in London, England, St Martins Lane, a 204-room hotel, and Sanderson, a 150-room hotel. Under a management agreement with Morgans Europe, we earn management fees and a reimbursement for allocable chain service and technical service expenses.

On July 15, 2010, Morgans Europe 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 us and is secured by Sanderson and St Martins Lane. As of March 31, 2011, Morgans Europe had outstanding mortgage debt of £99.6 million, or approximately $160.4 million at the exchange rate of 1.61 US dollars to GBP at March 31, 2011.

Morgans Europe’s net income or loss and cash distributions or contributions are allocated to the partners in accordance with ownership interests. At March 31, 2011, we had an investment in Morgans Europe of $2.2 million. We account for this investment under the equity method of accounting. Our equity in income of the joint venture amounted to income of $0.1 million and income of $0.9 million for the three months ended March 31, 2011 and 2010, respectively.

Mondrian South Beach. We own a 50% interest in Mondrian South Beach, a recently renovated apartment building which was converted into a condominium and hotel. Mondrian South Beach opened in December 2008, at which time we began operating the property under a long-term management contract.

In April 2010, the Mondrian South Beach joint venture amended its 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. In April 2010, in connection with the loan amendment, 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. As of March 31, 2011, the joint venture’s outstanding mortgage and mezzanine debt was $91.6 million, which does not include the $28.0 million mezzanine loan provided by the joint venture partners, which in effect is on par with the lender’s mezzanine debt.

Morgans Group and affiliates of our 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 our 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 our 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 our 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 our joint venture partner may have continuing obligations under construction completion guaranties until all outstanding payables due to construction vendors are paid. As of March 31, 2011, there are remaining payables outstanding to vendors of approximately $1.5 million. We believe that payment under these guaranties is not probable and the fair value of the guarantee is not material. For further discussion, see note 4 of our consolidated financial statements.

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. In April 2010, each of the joint venture partners provided an additional $2.75 million of mezzanine financing to the joint venture in order to complete a refinancing of the outstanding mortgage debt of the venture. We determined that we are not the primary beneficiary of this variable interest entity as we do not have a controlling financial interest in the entity. Our maximum exposure to losses as result of our involvement in the Mondrian South Beach variable interest entity is limited to our current investment, outstanding management fee receivable and advances in the form of mezzanine financing. We have 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 ownership interests in the form of capital contributions or mezzanine financing, or by third parties.

We account for this investment under the equity method of accounting. At March 31, 2011, our investment in Mondrian South Beach was $5.3 million. Our equity in loss of Mondrian South Beach was $0.5 million and $0.4 million for the three months ended March 31, 2011 and 2010, respectively.

Ames in Boston. On June 17, 2008, we, Normandy Real Estate Partners, and Ames Hotel Partners, entered into a joint venture to develop the Ames hotel in Boston. Upon the hotel’s completion in November 2009, we began operating Ames under a 20-year management contract.

As of March 31, 2011, we had an approximately 31% economic interest in the joint venture and our investment in the Ames joint venture was $10.2 million. Our equity in loss for the three months ended March 31, 2011 and 2010 was $0.5 million and $0.4 million, respectively.

As of March 31, 2011, the joint venture’s outstanding mortgage debt secured by the hotel was $46.5 million. In October 2010, the mortgage loan secured by Ames matured, and the joint venture did not satisfy the conditions necessary to exercise the first of two remaining one-year extension options available under the loan, which included funding a debt service reserve account, among other things. As a result, the mortgage lender for Ames served the joint venture with a notice of default and acceleration of debt. In February 2011, the joint venture reached an agreement with the lender whereby the lender waived the default, reinstated the loan and extended the loan maturity date until October 9, 2011 with a one-year extension option, subject to certain conditions. In connection with the amendment, the joint venture was required to deposit $1 million into a debt service account. The mortgage debt has one remaining extension option, subject to certain conditions, which if exercised would extend the maturity date for one year to October 9, 2012.

Mondrian SoHo. In June 2007, we contributed approximately $5.0 million for a 20% equity interest in a joint venture with Cape Advisors Inc. to develop a Mondrian hotel in the SoHo neighborhood of New York. The joint venture obtained a loan of $195.2 million to acquire and develop the hotel. We subsequently loaned an additional $3.3 million to the joint venture. As a result of the decline in general market conditions and real estate values since the inception of the joint venture, and more recently, the need for additional funding to complete the hotel, in June 2010, we wrote down our investment in Mondrian SoHo to zero. All of our subsequent fundings in 2010 and 2011, all of which are in the form of loans, have been impaired, and as of March 31, 2011, our investment balance in Mondrian SoHo is zero.

The mortgage loan on the property matured in June 2010. On July 31, 2010, the loan was amended to, among other things, provide for 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.

Certain affiliates of our 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 respective gross negligence or willful misconduct.

In July 2010, the joint venture partners each agreed to provide additional funding to the joint venture in proportionate to their equity interest in order to complete the project. At that time, the Mondrian SoHo joint venture was determined to be a variable interest entity as its equity investment at risk was considered insufficient to permit the entity to finance its own activities. Further, we determined that we were not the primary beneficiary of this variable interest entity as we do not have a controlling financial interest in the entity. In February 2011, the hotel opened and as such, we determined that the joint venture was an operating business. We continue to account for our investment in Mondrian SoHo using the equity method of accounting.

Mondrian SoHo opened in February 2011, and we are operating the hotel under a 10-year management contract with two 10-year extension options.

Shore Club. As of March 31, 2011, we owned approximately 7% of the joint venture that owns Shore Club. On September 15, 2009, the joint venture 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. 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.

For further information regarding our off balance sheet arrangements, see note 4 to our consolidated financial statements.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

We consider properties to be assets held for sale when management approves and commits to a formal plan to actively market a property or group of properties for sale and the sale is probable. Upon designation as an asset held for sale, we record 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 we stop recording depreciation expense. Any gain realized in connection with the sale of the properties for which we 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 we have continuing involvement, such as through a management agreement, after the sale.

We evaluate our estimates on an ongoing basis. We base our estimates on historical experience, information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. No material changes to our critical accounting policies have occurred since December 31, 2010.

ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Quantitative and Qualitative Disclosures About Market Risk

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Some of our outstanding debt has a variable interest rate. As described in “Management’s Discussion and Analysis of Financial Results of Operations — Derivative Financial Instruments” above, we use some derivative financial instruments, primarily interest rate swaps, to manage our exposure to interest rate risks related to our floating rate debt. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. As of March 31, 2011, our total outstanding consolidated debt, including capital lease obligations, was approximately $675.0 million, of which approximately $368.8 million, or 54.6%, was variable rate debt. At March 31, 2011, the one month LIBOR rate was 0.24%.

As of March 31, 2011, the $368.8 million of variable rate debt consists of our outstanding balances on the Amended Mortgages and our amended revolving credit facility. In connection with the Amended Mortgages, interest rate caps for 5.3% and 4.25%, in the amounts of approximately $201.2 million and $103.5 million, respectively, were entered into in September 2010, and were outstanding as of March 31, 2011. These interest rate caps mature on October 15, 2011. If market rates of interest on this $368.8 million variable rate debt increase by 1.0%, or 100 basis points, the increase in interest expense would reduce future pre-tax earnings and cash flows by approximately $3.7 million annually and the maximum annual amount the interest expense would increase on this variable rate debt is $16.2 million due to our interest rate cap agreements, which would reduce future pre-tax earnings and cash flows by the same amount annually. If market rates of interest on this $368.8 million variable rate decrease by 1.0%, or 100 basis points, the decrease in interest expense would increase pre-tax earnings and cash flow by approximately $3.7 million annually.

As of March 31, 2011, our fixed rate debt of $306.2 million consisted of the trust notes underlying our trust preferred securities, the Convertible Notes, and the Clift lease. The fair value of some of this debt is greater than the book value. As such, if market rates of interest increase by 1.0%, or approximately 100 basis points, the fair value of our fixed rate debt at March 31, 2011 would decrease by approximately $30.2 million. If market rates of interest decrease by 1.0%, or 100 basis points, the fair value of our fixed rate debt at March 31, 2011 would increase by $36.7 million.

Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments and future cash flows. These analyses do not consider the effect of a reduced level of overall economic activity. If overall economic activity is significantly reduced, we may take actions to further mitigate our exposure. However, because we cannot determine the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

We have entered into agreements with each of our derivative counterparties in connection with our interest rate swaps and hedging instruments related to the Convertible Notes, providing that in the event we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations.

Currency Exchange Risk

As we have international operations with our two London hotels and the hotel we manage in Mexico, currency exchange risks between the U.S. dollar and the British pound and the U.S. dollar and Mexican peso, respectively, arise as a normal part of our business. We reduce these risks by transacting these businesses in their local currency. As we have a 50% ownership in Morgans Europe, a change in prevailing rates would have an impact on the value of our equity in Morgans Europe. The U.S. dollar/British pound and U.S. dollar/Mexican peso currency exchanges are currently the only currency exchange rates to which we are directly exposed. Generally, we do not enter into forward or option contracts to manage our exposure applicable to net operating cash flows. We do not foresee any significant changes in either our exposure to fluctuations in foreign exchange rates or how such exposure is managed in the future.

ITEM 4.		CONTROLS AND PROCEDURES.

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rule 13a-15 of the rules promulgated under the Securities and Exchange Act of 1934, as amended. Based on this evaluation, our chief executive officer and the chief financial officer concluded that the design and operation of these disclosure controls and procedures were effective as of the end of the period covered by this report.

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15) that occurred during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1.		LEGAL PROCEEDINGS.

Litigation

Potential Litigation

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

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 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 us. In connection with the mezzanine loan, Morgans Group 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 alleges 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 pursuant to the guaranty. Petra demands damages of approximately $15.9 million plus costs and expenses.

We believe 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, we 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. Petra also moved to stay discovery pending resolution of its motion. We opposed Petra’s motion for summary judgment, and similarly moved for summary judgment in favor of us on grounds that the guaranty was not triggered by a foreclosure resulting from a payment default. On December 20, 2010, the court granted our motion for summary judgment dismissing the complaint, and denied the plaintiff’s motion for summary judgment. The action has accordingly been dismissed. Petra has appealed the decision, and the appeal was heard on April 28, 2011. We will continue to defend this lawsuit vigorously. However, it is not possible to predict the outcome of the lawsuit.

Other Litigation

We are 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.

ITEM 1A.		RISK FACTORS.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010. These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results and future prospects.

ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None

ITEM 3.		DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4.		REMOVED AND RESERVED.

ITEM 5.		OTHER INFORMATION.

None.

ITEM 6.		EXHIBITS.

The exhibits listed in the accompanying Exhibit Index are filed as part of this report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

May 9, 2011

EXHIBIT INDEX

Exhibit
Number				Description
	2.1			Agreement and Plan of Merger, dated May 11, 2006, by and among Morgans Hotel Group Co., MHG HR Acquisition Corp., Hard Rock Hotel, Inc. and Peter Morton (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on May 17, 2006)
	2.2			First Amendment to Agreement and Plan of Merger, dated as of January 31, 2007, by and between Morgans Hotel Group Co., MHG HR Acquisition Corp., Hard Rock Hotel, Inc., (solely with respect to Section 1.6 and Section 1.8 thereof) 510 Development Corporation and (solely with respect to Section 1.7 thereof) Peter A. Morton (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on February 6, 2007)
	3.1			Amended and Restated Certificate of Incorporation of Morgans Hotel Group Co.(incorporated by reference to Exhibit 3.1 to Amendment No. 5 to the Company’s Registration Statement on Form S-1 (File No. 333-129277) filed on February 6, 2006)
	3.2			Amended and Restated By-laws of Morgans Hotel Group Co. (incorporated by reference to Exhibit 3.2 to Amendment No. 5 to the Company’s Registration Statement on Form S-1 (File No. 333-129277) filed on February 6, 2006)
	3.3			Certificate of Designations for Series A Preferred Securities (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 16, 2009)
	4.1			Specimen Certificate of Common Stock of Morgans Hotel Group Co. (incorporated by reference to Exhibit 4.1 to Amendment No. 3 to the Company’s Registration Statement on Form S-1 (File No. 333-129277) filed on January 17, 2006)
	4.2			Junior Subordinated Indenture, dated as of August 4, 2006, between Morgans Hotel Group Co., Morgans Group LLC and JPMorgan Chase Bank, National Association (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 11, 2006)
	4.3			Amended and Restated Trust Agreement of MHG Capital Trust I, dated as of August 4, 2006, among Morgans Group LLC, JPMorgan Chase Bank, National Association, Chase Bank USA, National Association, and the Administrative Trustees Named Therein (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on August 11, 2006)
	4.4			Amended and Restated Stockholder Protection Rights Agreement, dated as of October 1, 2009, between Morgans Hotel Group Co. and Mellon Investor Services LLC, as Rights Agent (including Forms of Rights Certificate and Assignment and of Election to Exercise as Exhibit A thereto and Form of Certificate of Designation and Terms of Participating Preferred Stock as Exhibit B thereto) (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed on October 2, 2009)
	4.5			Amendment No. 1, dated as of October 15, 2009, to Amended and Restated Stockholder Protection Rights Agreement, dated as of October 1, 2009, between Morgans Hotel Group Co. and Mellon Investor Services LLC, as Rights Agent (incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on October 16, 2009)
	4.6			Amendment No. 2, dated as of April 21, 2010, to Amended and Restated Stockholder Protection Rights Agreement, dated as of October 1, 2009, between Morgans Hotel Group Co. and Mellon Investor Services LLC, as Rights Agent (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on April 22, 2010)
	4.7			Indenture related to the Senior Subordinated Convertible Notes due 2014, dated as of October 17, 2007, by and among Morgans Hotel Group Co., Morgans Group LLC and The Bank of New York, as trustee (including form of 2.375% Senior Subordinated Convertible Note due 2014) (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed on October 17, 2007)

Exhibit
Number				Description
	4.8			Supplemental Indenture, dated as of November 2, 2009, by and among Morgans Group LLC, the Company and The Bank of New York Mellon Trust Company, National Association (as successor to JPMorgan Chase Bank, National Association), as Trustee (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on November 4, 2009)
	4.9			Registration Rights Agreement, dated as of October 17, 2007, between Morgans Hotel Group Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated (incorporated by reference to Exhibit 4.2 of the Company’s Current Report on Form 8-K filed on October 17, 2007)
	4.10			Form of Warrant for Warrants issued under Securities Purchase Agreement to Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P. (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 16, 2009)
	4.11			Warrant, dated October 15, 2009, issued to Yucaipa American Alliance Fund II, LLC (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on October 16, 2009)
	4.12			Warrant, dated October 15, 2009, issued to Yucaipa American Alliance Fund II, LLC (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on October 16, 2009)
	4.13			Form of Amended Common Stock Purchase Warrants issued under Securities Purchase Agreement to Yucaipa American Alliance Fund II, L.P. and Yucaipa American Alliance (Parallel) Fund II, L.P. (incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on December 14, 2009)
	4.14			Amendment No. 1 to Common Stock Purchase Warrant issued under the Real Estate Fund Formation Agreement to Yucaipa American Alliance Fund II, LLC, dated as of December 11, 2009 (incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on December 14, 2009)
	4.15			Amendment No. 1 to Common Stock Purchase Warrant issued under the Real Estate Fund Formation Agreement to Yucaipa American Alliance Fund II, LLC, dated as of December 11, 2009 (incorporated by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K filed on December 14, 2009)
	10.1	*		Separation Agreement and Release, dated as of March 20, 2011, between Marc Gordon and Morgans Hotel Group, Inc.
	10.2	*		Employment Agreement, effective as of March 20, 2011, between Morgans Hotel Group Co. and David Hamamoto
	10.3	*		Employment Agreement, effective as of March 20, 2011, between Morgans Hotel Group Co. and Michael Gross
	10.4	*		Employment Agreement, effective as of March 23, 2011, between Morgans Hotel Group Co. and Yoav Gery
	10.5	*		Employment Agreement, effective as of April 4, 2011, between Morgans Hotel Group Co. and Daniel Flannery
	10.6	*		Form of Morgans Hotel Group Co. 2011 Outperformance Plan Award Agreement
	10.7	*		Form of Morgans Hotel Group Co. 2011 Executive Promoted Interest Bonus Pool Award Agreement
	31.1	*		Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	*		Certification by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	*		Certification by the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	*		Certification by the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002