avatar Sunstone Hotel Investors, Inc. Finance, Insurance, And Real Estate

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    SHIFTING FROM DEFENSE TO OFFENSE 2 010 A N N UA L R E P ORT


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    The Doubletree Guest Suites Times Square


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    Sunstone hotel investors, inc. throughout 2010, we remained true to our core strategy of disciplined capital allocation, conservative financial manage- ment and proactive asset management. As a result, we have positioned sunstone for strong performance in 2011 and beyond. today, our portfolio is comprised of 33 institutional- quality, upper-upscale hotels comprised of 12,676 rooms located in some of the most desirable lodging markets across the country, such as new York city, Washington, D.c., Boston, chicago and new orleans. 1


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    2010 A n nuA l r ePort expanding our reach. oregon Marriott Portland valley river inn eugene utah Marriott Park city california courtyard by Marriott los Angeles Airport embassy suites hotel la Jolla Fairmont newport Beach hilton Del Mar–san Diego hyatt regency newport Beach Marriott Del Mar–san Diego renaissance long Beach renaissance los Angeles Airport sheraton cerritos 2


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    sunstone hotel investors, inc. Minnesota Michigan Doubletree Guest suites Minneapolis Marriott troy Kahler Grand rochester Kahler inn & suites Marriott rochester residence inn by Marriott rochester illinois embassy suites hotel chicago Massachusetts Marriott long Wharf–Boston Marriott Quincy–Boston new York Doubletree Guest suites times square hilton times square renaissance Westchester Pennsylvania Marriott Philadelphia MD/ Dc/ vA renaissance Baltimore harborplace renaissance Washington, D.c. Marriott tysons corner louisiana JW Marriott new orleans texas Florida hilton houston–north renaissance orlando at sea World® Marriott houston royal Palm Miami Beach 3


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    In January 2011, Sunstone acquired the 460-suite Doubletree Guest Suites Times Square at an attractive valuation by capitalizing on prior investments in both the debt and equity of this irreplaceable asset.


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    sunstone hotel investors, inc. shifting from defense to offense. During the second half of 2010, lodging demand trends began to recover after a two-year trough. Many of the major metropolitan markets where we have an established presence have seen strong demand growth and are anticipated to have limited supply growth over the coming years. looking ahead, sunstone will remain focused on enhancing the positioning and growth of its portfolio, acquiring high-quality hotels at dis- count valuations, adding key talent to our management team and strengthening our industry relationships. the following pages highlight some of our existing hotels, recent acquisitions and completed renovations. 5


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    The lobby at the Fairmont Newport Beach.


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    © Li DIL PAIRPA NT zu f DIAS DD Le IPOS PEST PS ea mE ERS


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    During 2010, Sunstone renovated the lobby space at the Renaissance Long Beach, including the gastro-bar concept Sip, which transformed the lobby and restaurant into a highly attractive and functional venue for dining, working and socializing.


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    During 2010, Sunstone completed a renovation of the Renaissance Washington, D.C., upgrading the lobby and porte-cochère spaces.


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    The new lobby library at the Renaissance Washington, D.C.


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    2010 A n nuA l r ePort Dear shareholders During 2010 – We strengthened Sunstone’s foundation: • Including our recent acquisitions of the Doubletree Guest Suites Times Square and the JW Marriott New Orleans, we own a high-quality portfolio of 33 hotels located in many of the top lodging markets across the country such as New York City, Boston, Washington D.C., Los Angeles, New Orleans and Chicago. In 2011, we intend to increase the size and quality of our portfolio through intelligent, targeted acquisitions. • We have a world-class asset management team focused on both driving and maintaining property- level efficiencies to achieve superior long-term operating margins. • We have a selective capital investment program aimed at enhancing the value of our portfolio through focused hotel renovations and repositionings. • We have a strong balance sheet, and we will continue to proactively manage our balance sheet to mini- mize our cost of capital and maximize our financial flexibility. We improved the quality of our portfolio in 2010 – We ended 2010 with a high-quality portfolio of well-located, well-branded and well-capitalized hotels. We believe that our portfolio now ranks as one of the highest-quality portfolios amongst our lodging reit peers. As the lodging cycle continues to recover, we intend to increase the size and quality of our portfolio on a measured basis through the acquisition of institutional quality assets that complement our existing portfolio. As of February 2011, we have already executed on the acquisitions of the 460-room Doubletree Guest suites times square and the 494-room JW Marriott new orleans. We enhanced the profitability of our hotels – throughout the recent cyclical downturn, our asset management team worked diligently with our managers to redefine our operating model. the results of these efforts are evident in our margins. As calculated on a same-store basis, our adjusted hotel eBitDA margins were more than 300 basis points higher during the recent cyclical trough as compared to the 2003 trough. As the cycle continues to evolve over the coming years, we expect our new operating model to produce superior hotel eBitDA margins and improved cash flow. 14


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    sunstone hotel investors, inc. We selectively invested in our assets – capital reinvestment continues to be a primary focus for sunstone, as we firmly believe maintaining our hotels in superior condition will enable us to maximize both room and occupancy rates to drive cash flow. We invested $57.0 million across our portfolio in 2010, and as we enter 2011, we will continue to selectively invest and further upgrade our portfolio during the early stages of the lodging industry recovery. We maintain a cycle-appropriate portfolio management program – As we look to grow through acquisitions and selective reinvestment in our existing portfolio, we will also look to opportunistically dispose of certain non-core assets. We believe that a disciplined approach to capital recycling and portfolio management will improve the overall quality and cash flow generation of our asset base. We maintain a strong and flexible balance sheet – During the year, we proactively managed our capital structure. We eliminated $365.7 million in mortgage debt, we entered into a new $150.0 million unsecured revolving credit facility, which as of year-end 2010, remained undrawn, and we raised $190.6 million in new equity capital. We ended 2010 with $333.9 million of cash and cash equivalents, and 100% of our outstanding mortgage debt at year-end was fixed-rate, bearing an average interest rate of 5.5% and a weighted average maturity of approximately 7 years. Going forward, we will continue to follow a measured approach to improving our credit statistics to position the company for continued growth and for solid, risk-adjusted returns for our investors. Looking forward – While 2010 was a transitional year for our industry, the long-term fundamentals are very positive. Demand trends have recovered markedly, and supply trends remain muted in the major metropolitan markets where we have a presence. As the recovery continues, we intend to capitalize on opportunities to further improve the quality of our portfolio. We thank you for your continued interest in sunstone, and we look forward to building momentum and generating meaningful returns for our stockholders in 2011 and beyond. sincerely, Kenneth e. cruse robert A. Alter President executive chairman 15


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    The lobby at the Renaissance Long Beach.


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    SUNSTONE HOTEL INVESTORS, INC. Financial Review Selected Financial Data page 18 Management’s Discussion and Analysis of Financial Condition and Results of Operations page 19 Report of Independent Registered Public Accounting Firm page 44 Consolidated Balance Sheets page 45 Consolidated Statements of Operations page 46 Consolidated Statements of Stockholders’ Equity page 47 Consolidated Statements of Cash Flows page 48 Notes to Consolidated Financial Statements page 50 Report of Independent Registered Public Accounting Firm page 79 Stock Information page 80 Corporate Information inside back cover 17


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    Selected Financial Data The following table sets forth selected financial information for the Company that has been derived from the consolidated financial statements and notes. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this Annual Report. Year Ended Year Ended Year Ended Year Ended Year Ended December 31, December 31, December 31, December 31, December 31, 2010 2009 2008 2007 2006 ($ in thousands) Operating Data: Revenues: Room $ 428,412 $ 408,150 $ 504,104 $ 492,240 $ 380,839 Food and beverage 164,378 161,963 201,952 199,831 156,117 Other operating 50,300 53,744 59,140 53,686 42,284 Total revenues 643,090 623,857 765,196 745,757 579,240 Operating Expenses: Room 109,935 101,780 113,987 109,902 86,922 Food and beverage 120,650 118,629 145,576 144,518 111,204 Other operating 26,871 26,916 29,823 29,755 26,545 Advertising and promotion 33,182 32,295 35,676 34,619 27,576 Repairs and maintenance 28,049 27,360 29,579 27,769 23,372 Utilities 25,232 24,895 28,731 25,840 21,858 Franchise costs 21,474 20,656 24,658 23,770 19,051 Property tax, ground lease and insurance 42,349 43,352 44,993 43,791 39,858 Property general and administrative 77,101 72,823 86,797 86,055 69,395 Corporate overhead 28,803 25,242 21,511 27,849 18,640 Depreciation and amortization 95,500 93,795 93,759 89,925 65,238 Property and goodwill impairment losses 1,943 30,852 57 — — Total operating expenses 611,089 618,595 655,147 643,793 509,659 Operating income 32,001 5,262 110,049 101,964 69,581 Equity in net earnings (losses) of unconsolidated joint ventures 555 (27,801) (1,445) (3,588) 140 Interest and other income 111 1,388 3,639 8,880 4,074 Interest expense (70,830) (76,539) (83,176) (77,463) (54,702) Gain (loss) on extinguishment of debt — 54,506 — (417) (9,976) Income (loss) from continuing operations (38,163) (43,184) 29,067 29,376 9,117 Income (loss) from discontinued operations 76,705 (226,424) 42,171 94,500 44,120 Net income (loss) 38,542 (269,608) 71,238 123,876 53,237 Dividends paid on unvested restricted stock compensation — (447) (814) (1,007) (856) Preferred stock dividends and accretion (20,652) (20,749) (20,884) (20,795) (19,616) Undistributed income allocated to unvested restricted stock compensation (102) — — (222) — Undistributed income allocated to Series C preferred stock — — — (1,397) — Income available (loss attributable) to common stockholders $ 17,788 $ (290,804) $ 49,540 $ 100,455 $ 32,765 Income (loss) from continuing operations available (attributable) to common stockholders per diluted common share $ (0.59) $ (0.92) $ 0.14 $ 0.10 $ (0.20) (1) Cash dividends declared per common share $ 0.00 $ 0.00 $ 1.20 $ 1.31 $ 1.22 Balance Sheet Data: Investment in hotel properties, net $ 2,034,223 $ 1,923,392 $ 2,004,914 $ 2,002,329 $ 1,696,885 Total assets $ 2,436,106 $ 2,513,530 $ 2,805,611 $ 3,049,152 $ 2,760,373 Total debt(2) $ 1,143,303 $ 1,203,797 $ 1,389,783 $ 1,394,904 $ 1,170,778 Total liabilities $ 1,236,807 $ 1,526,867 $ 1,791,103 $ 1,836,894 $ 1,624,583 Equity $ 1,099,299 $ 886,767 $ 914,812 $ 1,112,762 $ 1,036,494 (1) Does not include non-cash common stock dividend of $0.60 per share declared in 2008. (2) Does not include debt which has been reclassified to discontinued operations. 18


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    Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report. Overview Sunstone Hotel Investors, Inc. is a Maryland corporation. We operate as a self-managed and self-administered real estate investment trust, or REIT. A REIT is a legal entity that directly or indirectly owns real estate assets. REITs generally are not subject to federal income taxes at the corporate level as long as they pay stockholder dividends equivalent to 100% of their taxable income. REITs are required to distribute to stockholders at least 90% of their taxable income. We own, directly or indirectly, 100% of the interests of Sunstone Hotel Partnership, LLC (the “Operating Partnership”), which is the entity that directly or indirectly owns our hotel properties. We also own 100% of the interests of our taxable REIT subsidiary, Sunstone Hotel TRS Lessee, Inc., which leases all of our hotels from the Operating Partnership, and engages third parties to manage our hotels. In addition, as of December 31, 2010, we owned 50% of BuyEfficient, LLC (“BuyEfficient”), an electronic pur- chasing platform that allows members to procure food, operating supplies, furniture, fixtures and equipment. In January 2011, we purchased the outside 50% share in BuyEfficient for $8.6 million, and as a result, we are now the sole owner of BuyEfficient. We own primarily upper upscale and upscale hotels in the United States. As of December 31, 2010, we owned 31 hotels (the “31 hotels”). Of the 31 hotels, we classify 29 as upscale or upper upscale, one as luxury and one as upper midscale as defined by Smith Travel Research, Inc. In addition to our wholly owned hotels, as of December 31, 2010, we owned a 38% equity interest in a joint venture that owns the Doubletree Guest Suites Times Square in New York, and we owned other non-hotel investments. In January 2011, we purchased the outside 62% equity interests in the Doubletree Guest Suites Times Square joint venture for approximately $37.5 million. As a result, we are now the sole owner of the entity that owns the 460-room Doubletree Guest Suites Times Square. The majority of our hotels are operated under nationally recognized brands such as Marriott, Fairmont, Hilton and Hyatt, which are among the most respected and widely recognized brands in the lodging industry. While we believe the largest and most stable segment of demand for hotel rooms is represented by travelers who prefer the consistent service and quality associated with nationally recognized brands, we also believe that in certain markets the strongest demand growth may come from travelers who prefer non-branded hotels that focus on highly customized service standards. We seek to own hotels in urban locations that benefit from significant barriers to entry by competitors. Most of our hotels are considered business, convention, or airport hotels, as opposed to resort, leisure or extended-stay hotels. The hotels comprising our 31 hotel portfolio average 378 rooms in size. The demand for lodging generally fluctuates with the overall economy. We refer to these changes in demand as the lodging cycle, and we seek to employ a cycle-appropriate portfolio management strategy. During the recovery and growth phases of the lodging cycle, our strategy emphasizes active investment, both in terms of acquisitions of new hotels and selective renovations of our existing portfolio, while also balancing our liquidity and leverage policies. During the mature phase of the lodging cycle, our strategy emphasizes net hotel dispositions, and during cyclical declines, our strategy emphasizes capital preservation. Through all phases of the lodging cycle, we seek to maximize the value of our portfolio through proactive asset management, which entails working closely with our third party hotel operators to develop plans and actions designed to enhance revenues, minimize operational expenses and maximize the appeal of our hotels to travelers. During 2010, we began to see improving business and consumer sentiment, which may point to an impending economic recovery, and which may lead to a period of positive fundamentals in the lodging industry. Accordingly, we believe we are currently in the early stages of a recovery phase of the lodging cycle. Consistent with our cycle-appropriate strategy, we believe that acquiring hotels now may likely create long-term value, and we expect to deploy a portion of our cash balance in 2011 towards selective hotel acquisitions. During 2010, we selectively deployed a portion of our cash to fund certain trans- actions such as the purchase of two hotel loans for $4.0 million, which had a combined principal amount of $35.0 million, and the acquisition of the Royal Palm Miami Beach for a net purchase price of $117.6 million, excluding transaction costs. Our acquisition program is aimed at generating attractive returns on our investment dollars, and therefore we may target lodging assets outside of the typical branded, urban, upper upscale profile represented by our existing portfolio in order to capitalize on opportunities which may arise. We intend to select the brands and operators for our hotels that we believe will lead to the highest returns. Additionally, the scope of our acquisitions program may include large hotel portfolios or hotel loans. Future acquisitions may be funded by our issuance of additional debt or equity securities, including our common and preferred OP units, or by draws on our $150.0 million senior corporate credit facility entered into in November 2010. 19


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    Consistent with our cycle-appropriate strategy, during 2010, we issued 19,500,000 shares of our common stock. Net proceeds from this offering of approximately $190.6 million were contributed to our subsidiary, Sunstone Hotel Partnership LLC, which will use the proceeds for growth capital expenditures, future acquisitions and other general corporate purposes, including working capital. As of December 31, 2010, the weighted average term to maturity of our debt is approximately 7 years, and 100% of our debt is fixed rate with a weighted average interest rate of 5.5%. Of our total debt, approximately $98.3 million matures over the next four years (none in 2011, $33.3 million in 2012, $65.0 million in 2013, assuming we repay our Senior Notes remaining balance of $62.5 million at the first put date in 2013 and none in 2014). The $98.3 million does not include $14.8 million of scheduled loan amortization payments due in 2011, $17.0 million due in 2012, $18.1 million due in 2013, or $19.1 million due in 2014. In January 2011, we purchased the outside 62% equity interests in our Doubletree Guest Suites Times Square joint venture for approximately $37.5 million and, as a result, became the sole owner of the entity that owns the 460-room Doubletree Guest Suites Times Square hotel in New York City. The hotel is encumbered by approximately $270.0 million of non-recourse senior mortgage and mezzanine debt that matures in January 2012 and bears a blended interest rate of LIBOR + 115 basis points. We expect to refinance this debt during 2011 and intend to fund any refinancing shortfalls with existing cash. Operating Activities Operating Performance Indicators. The following performance indicators are commonly used in the hotel industry: ❈ Occupancy; ❈ Average daily room rate, or ADR; ❈ Revenue per available room, or RevPAR, which is the product of occupancy and ADR, and does not include food and beverage revenue, or other operating revenue; ❈ Comparable RevPAR, which we define as the RevPAR generated by hotels we owned as of the end of the reporting period, but excluding those hotels that experienced material and prolonged business interruption due to renovations, re-branding or property damage during either the most recent calendar year presented or the calendar year immediately preceding it. For hotels that were not owned for the entirety of the comparison periods, comparable RevPAR is calculated using RevPAR generated during periods of prior ownership. We refer to this subset of our hotels used to calculate comparable RevPAR as our “Comparable Portfolio.” Currently our Comparable Portfolio includes all 31 hotels except the Royal Palm Miami Beach, which is undergoing renovation and repositioning that began in 2010. Our Comparable Portfolio also includes operating results for the Renaissance Westchester for all periods presented, including the period in 2010 while it was held in receivership; ❈ RevPAR index, which is the quotient of a hotel’s RevPAR divided by the average RevPAR of its competitors, multiplied by 100. A RevPAR index in excess of 100 indicates a hotel is achieving higher RevPAR than its competitors. In addition to absolute RevPAR index, we monitor changes in RevPAR index; ❈ EBITDA, which is income available (loss attributable) to common stockholders excluding: preferred stock dividends; interest expense (including prepayment penalties, if any); provision for income taxes, including income taxes applicable to sale of assets; and depreciation and amortization; ❈ Adjusted EBITDA, which includes EBITDA but excludes: amortization of deferred stock compensation; the impact of any gain or loss from asset sales; impairment charges; and any other identified adjustments; ❈ Funds from operations, or FFO, which includes income available (loss attributable) to common stockholders, excluding gains and losses from sales of property, plus real estate-related depreciation and amortization (excluding amortization of deferred financing costs), and after adjustment for unconsolidated partnerships and joint ventures; and ❈ Adjusted FFO, which includes FFO but excludes prepayment penalties, written-off deferred financing costs, impairment losses and other identified adjustments. Revenues. Substantially all of our revenues are derived from the operation of our hotels. Specifically, our revenues consist of the following: ❈ Room revenue, which is the product of the number of rooms sold and the ADR; ❈ Food and beverage revenue, which is comprised of revenue realized in the hotel food and beverage outlets as well as banquet and catering events; and 20


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    ❈ Other operating revenue, which includes ancillary hotel revenue such as performance guaranties, if any, and other items primarily driven by occupancy such as telephone, transportation, parking, spa, entertainment and other guest services. Additionally, this category includes, among other things, operating revenue from our two commercial laundry facilities located in Rochester, Minnesota and Salt Lake City, Utah, as well as hotel space leased by third parties. Expenses. Our expenses consist of the following: ❈ Room expense, which is primarily driven by occupancy and, therefore, has a significant correlation with room revenues; ❈ Food and beverage expense, which is primarily driven by food and beverage sales and banquet and catering bookings and, therefore, has a significant correlation with food and beverage revenues; ❈ Other operating expense, which includes the corresponding expense of other operating revenue, advertising and promotion, repairs and maintenance, utilities, and franchise costs; ❈ Property tax, ground lease and insurance expense, which includes the expenses associated with property tax, ground lease and insurance payments, each of which is primarily a fixed expense, but property tax is subject to regular revaluations based on the specific tax regulations and practices of each municipality; ❈ Property general and administrative expense, which includes our property-level general and administrative expenses, such as payroll and related costs, professional fees, travel expenses, and management fees; ❈ Corporate overhead expense, which includes our corporate-level expenses, such as payroll and related costs, amortization of deferred stock compensation, severance expense, acquisition and due diligence costs, professional fees, travel expenses and office rent; ❈ Depreciation and amortization expense, which includes depreciation on our hotel buildings, improvements, furniture, fixtures and equipment, along with amortization on our franchise fees and intangibles; and ❈ Property and goodwill impairment losses expense, which includes the charges we have recognized to reduce the carrying value of assets on our balance sheets to their fair value and to write-off goodwill in association with our impairment evaluations. Other Revenue and Expense. Other revenue and expense consists of the following: ❈ Equity in net earnings (losses) of unconsolidated joint ventures, which includes our portion of net earnings or losses from our joint ventures; ❈ Interest and other income, which includes interest we have earned on our restricted and unrestricted cash accounts, as well as any gains or losses we have recognized on sales of assets other than hotels; ❈ Interest expense, which includes interest expense incurred on our outstanding debt, accretion of the Senior Notes, amor- tization of deferred financing fees, any write-offs of deferred financing fees, and any loan penalties and fees incurred on our debt; ❈ Gain on extinguishment of debt, which includes the gain we recognized on the repurchase and cancellation of the Senior Notes; ❈ Dividends paid on unvested restricted stock compensation, which includes dividends earned on our unvested restricted stock awards; and, ❈ Preferred stock dividends and accretion, which includes dividends earned on our 8.0% Series A Cumulative Redeemable Preferred Stock (“Series A preferred stock”) and Series C Cumulative Convertible Redeemable Preferred Stock (“Series C preferred stock”) and redemption value accretion on our Series C preferred stock. Factors Affecting Our Operating Results. The primary factors affecting our operating results include overall demand for hotel rooms, the pace of new hotel development, or supply, and the relative performance of our operators in increasing revenue and controlling hotel operating expenses. ❈ Demand. The demand for lodging generally fluctuates with the overall economy. In 2010, following a two-year cyclical trough, we began to see signs of improving demand trends, and Comparable Portfolio RevPAR increased 2.6% as compared to 2009. Consistent with prior trends, we anticipate that lodging demand will continue to improve as the U.S. economy continues to strengthen. Historically, cyclical troughs are followed by extended periods of relatively strong demand, resulting in a cyclical lodging growth phase. We expect hotel demand to strengthen in 2011. 21


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    ❈ Supply. The addition of new competitive hotels affects the ability of existing hotels to drive RevPAR and profits. The devel- opment of new hotels is largely driven by construction costs and expected performance of existing hotels. The recession and credit crisis which occurred in 2008 and 2009 served to restrict credit and tighten lending standards, which resulted in a meaningful curtailment of funding for new hotel construction projects. Moreover, with demand still meaningfully below peak levels, new supply in many markets is difficult to justify economically. Accordingly, we believe hotel development will be constrained until operating trends of existing hotels improve to levels where developer return targets can be achieved, and until the construction financing markets recover. Given the one to three year timeline needed to construct a typical hotel, we expect a window of at least two to four years during which hotel supply, as indicated by the number of new hotel openings, will be below historical levels. ❈ Revenues and expenses. We believe that marginal improvements in RevPAR index, even in the face of declining revenues, are a good indicator of the relative quality and appeal of our hotels, and our operators’ effectiveness in maximizing revenues. Similarly, we also evaluate our operators’ effectiveness in minimizing incremental operating expenses in the context of increasing revenues or, conversely, in reducing operating expenses in the context of declining revenues. With respect to improving RevPAR index, we continue to work with our hotel operators to optimize revenue management ini- tiatives while taking into consideration market demand trends and the pricing strategies of competitor hotels in our markets. We also develop capital investment programs designed to ensure each of our hotels is well renovated and positioned to appeal to groups and individual travelers fitting target guest profiles. Our revenue management initiatives are generally oriented towards maximizing ADR even if the result may be lower occupancy than may be achieved through lower ADR, as increases in RevPAR attributable to increases in ADR may be accompanied by minimal additional expenses, while increases in RevPAR attributable to higher occupancy may result in higher variable expenses such as housekeeping, labor and utilities expense. Thus, increases in RevPAR associated with higher ADR may result in higher hotel EBITDA margins. Increases in RevPAR associated with higher occupancy may result in less EBITDA margin improvement. With respect to maximizing operational flow through, we continue to work with our operators to identify operational effi- ciencies designed to reduce expenses while minimally affecting guest experience. Key asset management initiatives include reducing hotel staffing levels, increasing the efficiency of the hotels, such as installing energy efficient management and inventory control systems, and selectively combining certain food and beverage outlets. Our operational efficiency initiatives may be difficult to implement, as most categories of variable operating expenses, such as utilities and certain labor costs, such as housekeeping, fluctuate with changes in occupancy. Furthermore, our hotels operate with significant fixed costs, such as general and administrative expense, insurance, property taxes, and other expenses associated with owning hotels, over which our operators may have little control. We have experienced increases in hourly wages, employee benefits (especially health insurance) and utility costs, which have negatively affected our operating margins. Moreover, there are limits to how far our operators can reduce expenses without adversely affecting the competitiveness of our hotels. Operating Results. The following table presents our operating results for our total portfolio for 2010 and 2009, including the amount and percentage change in the results between the two periods. The table presents the results of operations included in the consolidated statements of operations, and includes the 31 hotels (11,722 rooms) as of December 31, 2010 and 29 hotels (10,966 rooms) as of December 31, 2009. Income from discontinued operations for 2010 includes: the results of operations and the gain on extinguishment of debt for the eight hotels which secured the non-recourse mortgage with Massachusetts Mutual Life Insurance Company (the “Mass Mutual eight” hotels: Renaissance Atlanta Concourse; Hilton Huntington; Residence Inn by Marriott Manhattan Beach; Marriott Provo; Courtyard by Marriott San Diego (Old Town); Holiday Inn Downtown San Diego; Holiday Inn Express San Diego (Old Town); and Marriott Salt Lake City (University Park)), which were deeded back to the lender in November 2010 pursuant to our 2009 secured debt restructuring program; the results of 22


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    operations and the gain on extinguishment of debt for the Marriott Ontario Airport, which was sold by the receiver in August 2010 pursuant to our 2009 secured debt restructuring program; the gain on extinguishment of debt for the W San Diego, which was deeded back to the lender in July 2010 pursuant to our 2009 secured debt restructuring program; and the gain on extinguishment of debt for the Renaissance Westchester, which we reacquired in June 2010. Loss from discontinued opera- tions for 2009 includes the results of operations for the Marriott Napa Valley, Marriott Riverside, and Hyatt Suites Atlanta Northwest which were sold in 2009, as well as the Mass Mutual eight hotels, Marriott Ontario Airport, W San Diego, and Renaissance Westchester which have been deconsolidated from our operations due to the deed backs and title transfers noted above. These amounts can be found in our consolidated financial statements and related notes included elsewhere in this Annual Report. 2010 2009 Change $ Change % (dollars in thousands, except statistical data) Revenues Room $428,412 $ 408,150 $ 20,262 5.0% Food and beverage 164,378 161,963 2,415 1.5% Other operating 50,300 53,744 (3,444) (6.4)% Total revenues 643,090 623,857 19,233 3.1% Operating expenses Hotel operating 407,742 395,883 11,859 3.0% Property general and administrative 77,101 72,823 4,278 5.9% Corporate overhead 28,803 25,242 3,561 14.1% Depreciation and amortization 95,500 93,795 1,705 1.8% Property and goodwill impairment losses 1,943 30,852 (28,909) (93.7)% Total operating expenses 611,089 618,595 (7,506) (1.2)% Operating income 32,001 5,262 26,739 508.2% Equity in net earnings (losses) of unconsolidated joint ventures 555 (27,801) 28,356 102.0% Interest and other income 111 1,388 (1,277) (92.0)% Interest expense (70,830) (76,539) 5,709 7.5% Gain on extinguishment of debt — 54,506 (54,506) (100.0)% Loss from continuing operations (38,163) (43,184) 5,021 11.6% Income (loss) from discontinued operations 76,705 (226,424) 303,129 133.9% Net income (loss) 38,542 (269,608) 308,150 114.3% Dividends paid on unvested restricted stock compensation — (447) 447 100.0% Preferred stock dividends and accretion (20,652) (20,749) 97 0.5% Undistributed income allocated to unvested restricted stock compensation (102) — (102) (100.0)% Income available (loss attributable) to common stockholders $ 17,788 $(290,804) $308,592 106.1% The following table presents our operating results for our total portfolio for 2009 and 2008, including the amount and per- centage change in the results between the two periods. The table presents the results of operations included in the consoli- dated statements of operations, and includes the 29 hotels (10,966 rooms) as of December 31, 2009 and 2008. Loss from discontinued operations for 2009 includes the results of operations for the Marriott Napa Valley, Marriott Riverside, and Hyatt Suites Atlanta Northwest which were sold in 2009, as well as the Mass Mutual eight hotels deeded back to the lender in November 2010, Marriott Ontario Airport sold by the receiver in August 2010, W San Diego deeded back to the lender in July 2010, and Renaissance Westchester reacquired by the Company in June 2010. Income from discontinued operations for 2008 includes the results of operations for the Hyatt Regency Century Plaza and Crowne Plaza Grand Rapids which were sold in 2008, the results of operations for the Marriott Napa Valley, Marriott Riverside and Hyatt Suites Atlanta Northwest 23


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    which were sold in 2009, as well as the Mass Mutual eight hotels, Marriott Ontario Airport, W San Diego, and Renaissance Westchester which have been deconsolidated from our operations due to the deed backs and title transfers noted above. These amounts can be found in our consolidated financial statements and related notes included elsewhere in this Annual Report. 2009 2008 Change $ Change % (dollars in thousands, except statistical data) Revenues Room $ 408,150 $504,104 $ (95,954) (19.0)% Food and beverage 161,963 201,952 (39,989) (19.8)% Other operating 53,744 59,140 (5,396) (9.1)% Total revenues 623,857 765,196 (141,339) (18.5)% Operating expenses Hotel operating 395,883 453,023 (57,140) (12.6)% Property general and administrative 72,823 86,797 (13,974) (16.1)% Corporate overhead 25,242 21,511 3,731 17.3% Depreciation and amortization 93,795 93,759 36 0.0% Property and goodwill impairment losses 30,852 57 30,795 54,026.3% Total operating expenses 618,595 655,147 (36,552) (5.6)% Operating income 5,262 110,049 (104,787) (95.2)% Equity in net losses of unconsolidated joint ventures (27,801) (1,445) (26,356) (1,823.9)% Interest and other income 1,388 3,639 (2,251) (61.9)% Interest expense (76,539) (83,176) 6,637 8.0% Gain on extinguishment of debt 54,506 — 54,506 100.0% Income (loss) from continuing operations (43,184) 29,067 (72,251) (248.6)% Income (loss) from discontinued operations (226,424) 42,171 (268,595) (636.9)% Net income (loss) (269,608) 71,238 (340,846) (478.5)% Dividends paid on unvested restricted stock compensation (447) (814) 367 45.1% Preferred stock dividends and accretion (20,749) (20,884) 135 0.6% Income available (loss attributable) to common stockholders $(290,804) $ 49,540 $(340,344) (687.0)% Operating Statistics. Included in the following tables are comparisons of the key operating metrics for our hotel portfolio for the years ended December 31, 2010, 2009 and 2008. The comparisons do not include the results of operations for the three hotels sold in 2009 and the two hotels sold in 2008. The comparisons also do not include the W San Diego and the Mass Mutual eight hotels which were deeded back to their respective lenders in 2010, or the Marriott Ontario Airport which was sold by the receiver in 2010. 2010 2009 Change Occ% ADR RevPAR Occ% ADR RevPAR Occ% ADR RevPAR (1) Total Portfolio (31 hotels) 69.6% $149.11 $103.78 68.9% $147.09 $101.35 70 bps 1.4% 2.4% Comparable Portfolio (30 hotels)(2) 70.0% $148.83 $104.18 69.0% $147.19 $101.56 100 bps 1.1% 2.6% 2009 2008 Change Occ% ADR RevPAR Occ% ADR RevPAR Occ% ADR RevPAR Total Portfolio (31 hotels)(1) 68.9% $147.09 $101.35 74.1% $168.12 $124.58 (520) bps (12.5)% (18.6)% Comparable Portfolio (30 hotels)(2) 69.0% $147.19 $101.56 74.2% $167.68 $124.42 (520) bps (12.2)% (18.4)% (1) Includes results for the 31 hotels owned by the Company as of December 31, 2010, including the Renaissance Westchester, reacquired by the Company in June 2010, and the Royal Palm Miami Beach, acquired by the Company in August 2010, for all periods presented. (2) Includes the Company’s total portfolio noted above, but excludes the Royal Palm Miami Beach which is undergoing renovation and repositioning beginning in 2010. 24


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    Non-GAAP Financial Measures. The following table reconciles income available (loss attributable) to common stockholders to EBITDA and Adjusted EBITDA for our hotel portfolio for the years ended December 31, 2010, 2009 and 2008. We believe EBITDA and Adjusted EBITDA are useful to investors in evaluating our operating performance because these measures help investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest expense and preferred stock dividends) and our asset base (primarily depreciation and amortiza- tion) from our operating results. We also use EBITDA and Adjusted EBITDA as measures in determining the value of hotel acquisitions and dispositions. We caution investors that amounts presented in accordance with our definitions of EBITDA and Adjusted EBITDA may not be comparable to similar measures disclosed by other companies, because not all companies calculate these non-GAAP measures in the same manner. EBITDA and Adjusted EBITDA should not be considered as an alternative measure of our net income (loss), operating performance, cash flow or liquidity. EBITDA and Adjusted EBITDA may include funds that may not be available for our discretionary use to fund interest expense, capital expenditures or general corporate purposes. Although we believe that EBITDA and Adjusted EBITDA can enhance an investor’s understanding of our results of operations, these non-GAAP financial measures, when viewed individually, are not necessarily a better indica- tor of any trend as compared to GAAP measures such as net income (loss) or cash flow from operations. In addition, you should be aware that adverse economic and market conditions may harm our cash flow. 2010 2009 2008 Income available (loss attributable) to common stockholders $ 17,788 $(290,804) $ 49,540 Dividends paid on unvested restricted stock compensation — 447 814 Series A and C preferred stock dividends 20,652 20,749 20,884 Undistributed income allocated to unvested restricted stock compensation 102 — — Operations held for investment: Depreciation and amortization 95,500 93,795 93,759 Amortization of lease intangibles 281 — — Interest expense 65,457 71,940 78,538 Interest expense—default rate 884 472 — Amortization of deferred financing fees 1,597 1,823 1,133 Write-off of deferred financing fees 1,585 284 — Loan penalties and fees 311 207 — Non-cash interest related to discount on Senior Notes 996 1,813 3,505 Unconsolidated joint ventures: Depreciation and amortization 52 5,131 5,000 Interest expense — 2,614 5,168 Amortization of deferred financing fees — 192 1,547 Discontinued operations: Depreciation and amortization 5,432 17,265 25,655 Interest expense 8,639 16,941 18,049 Interest expense—default rate 7,071 1,407 — Amortization of deferred financing fees 441 566 569 Loan penalties and fees 1,021 3,784 — 25


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    2010 2009 2008 EBITDA $227,809 $ (51,374) $304,161 Operations held for investment: Amortization of deferred stock compensation 3,942 4,055 3,975 (Gain) loss on sale of other assets 382 (375) — Gain on extinguishment of debt — (54,506) — Impairment loss 1,943 30,852 57 Closing costs—Royal Palm Miami Beach acquisition 6,796 — — Due diligence costs—abandoned project 959 — — Costs associated with CEO severance 2,242 — — Bad debt expense on corporate note receivable — 5,557 — Unconsolidated joint ventures: Amortization of deferred stock compensation 32 47 47 Impairment loss — 26,007 — Discontinued operations: Gain on extinguishment of debt (86,235) — — (Gain) loss on sale of hotel properties — 13,052 (26,013) Impairment loss — 195,293 2,847 (69,939) 219,982 (19,087) Adjusted EBITDA $157,870 $ 168,608 $285,074 Adjusted EBITDA was $157.9 million in 2010 as compared to $168.6 million in 2009 and $285.1 million in 2008. Adjusted EBITDA decreased in 2010 as compared to 2009 primarily due to decreased operating income from discontinued operations combined with increased costs incurred during 2010 to transition our hotels to new management companies. Adjusted EBITDA decreased in 2009 as compared to 2008 primarily due to decreased earnings at our hotels. The following table reconciles income available (loss attributable) to common stockholders to FFO and Adjusted FFO for our hotel portfolio for the years ended December 31, 2010, 2009 and 2008. We believe that the presentation of FFO and Adjusted FFO provide useful information to investors regarding our operating performance because they are measures of our operations without regard to specified non-cash items such as real estate depreciation and amortization, gain or loss on sale of assets and certain other items which we believe are not indicative of the performance of our underlying hotel properties. We believe that these items are more representative of our asset base and our acquisition and disposition activities than our ongoing operations. We also use FFO as one measure in determining our results after taking into account the impact of our capital structure. We caution investors that amounts presented in accordance with our definitions of FFO and Adjusted FFO may not be comparable to similar measures disclosed by other companies, because not all companies calculate these non-GAAP measures in the same manner. FFO and Adjusted FFO should not be considered as an alternative measure of our net income (loss), operating performance, cash flow or liquidity. FFO and Adjusted FFO may include funds that may not be available for our discretionary use to fund interest expense, capital expenditures or general corporate purposes. Although we believe that FFO and Adjusted FFO can enhance an investor’s understanding of our results of operations, these non- GAAP financial measures, when viewed individually, are not necessarily a better indicator of any trend as compared to GAAP measures such as net income (loss) or cash flow from operations. In addition, you should be aware that adverse economic and market conditions may harm our cash flow. 26


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    2010 2009 2008 Income available (loss attributable) to common stockholders $ 17,788 $(290,804) $ 49,540 Dividends paid on unvested restricted stock compensation — 447 814 Series C preferred stock dividends (1) — — 6,784 Undistributed income allocated to unvested restricted stock compensation 102 — — Operations held for investment: Real estate depreciation and amortization 94,950 93,248 92,953 Amortization of lease intangibles 281 — — (Gain) loss on sale of other assets 382 (375) — Unconsolidated joint ventures: Real estate depreciation and amortization — 5,060 4,949 Discontinued operations: Real estate depreciation and amortization 5,432 17,265 25,655 (Gain) loss on sale of hotel properties — 13,052 (26,013) FFO 118,935 (162,107) 154,682 Operations held for investment: Interest expense—default rate 884 472 — Write-off of deferred financing fees 1,585 284 — Loan penalties and fees 311 207 — Gain on extinguishment of debt — (54,506) — Impairment loss 1,943 30,852 57 Closing costs—Royal Palm Miami Beach acquisition 6,796 — — Due diligence costs—abandoned project 959 — — Costs associated with CEO severance 2,242 — — Amortization of deferred stock compensation associated with CEO severance 1,074 — — Bad debt expense on corporate note receivable — 5,557 — Unconsolidated joint ventures: Impairment loss — 26,007 — Discontinued operations: Interest expense—default rate 7,071 1,407 — Loan penalties and fees 1,021 3,784 — Gain on extinguishment of debt (86,235) — — Impairment loss — 195,293 2,847 (62,349) 209,357 2,904 Adjusted FFO $ 56,586 $ 47,250 $157,586 (1) Our Series C preferred stock has been excluded from the calculation of FFO and Adjusted FFO for the years ended December 31, 2010 and 2009 as their inclusion would have been anti-dilutive. Adjusted FFO was $56.6 million in 2010 as compared to $47.3 million in 2009 and $157.6 million in 2008. Adjusted FFO increased in 2010 as compared to 2009 primarily due to lower interest expense, partially offset by decreased operating income from discontinued operations combined with increased costs incurred during 2010 to transition our hotels to new management companies. Adjusted FFO decreased in 2009 as compared to 2008 primarily due to decreased earnings at our hotels, partially offset by lower interest expense. 27


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    Room revenue. Room revenue increased $20.3 million, or 5.0%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The results of operations for the Renaissance Westchester are included in continuing operations from the date we reacquired the hotel (June 2010) forward. The 2009 results of operations for the Renaissance Westchester are included in discontinued operations as possession and control of the hotel was held by a court-appointed receiver. In addi- tion, we acquired the Royal Palm Miami Beach hotel in August 2010. Room revenue generated by the Renaissance Westchester and included in continuing operations as well as room revenue generated by the Royal Palm Miami Beach (the “new hotels”) for 2010 was $10.3 million. Room revenue generated by the 29 hotels we acquired prior to January 1, 2008 (our “existing portfolio”) increased $10.0 million in 2010 as compared to 2009 due to an increase in occupancy ($5.3 million) combined with an increase in ADR ($4.7 million). Room revenue decreased $96.0 million, or 19.0%, for the year ended December 31, 2009 as compared to the year ended December 31, 2008. Room revenue generated by our existing portfolio decreased in 2009 as compared to 2008 due to a decrease in occupancy ($26.2 million) combined with a decrease in ADR ($69.8 million). Food and beverage revenue. Food and beverage revenue increased $2.4 million, or 1.5%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Food and beverage revenue generated by the new hotels in 2010 was $3.8 million. Food and beverage revenue generated from our existing portfolio decreased $1.4 million in 2010 as compared to 2009. This decrease is primarily due to lower revenues generated in 2010 by our Washington D.C. area hotels, which bene- fited from the 2009 presidential inauguration. Food and beverage revenue also decreased in 2010 as compared to 2009 due to a reduction in business at our Houston, Texas hotels with one customer who is operating under a contract with the United States government. Additionally, many of our hotels began to consolidate food and beverage outlets during 2009 in order to maximize profitability, which continued into 2010. Food and beverage revenue decreased $40.0 million, or 19.8%, for the year ended December 31, 2009 as compared to the year ended December 31, 2008. Food and beverage revenue generated from our existing portfolio decreased in 2009 as compared to 2008 primarily due to declines in occupancy, as well as to a reduction in city-wide conventions and meetings held at our hotels, which caused decreases in banquet, catering, restaurant and room service revenue. Restaurant revenue also decreased in 2009 as compared to 2008 as many of our hotels closed their restaurants during slow periods of the day in order to save costs. Other operating revenue. Other operating revenue decreased $3.4 million, or 6.4%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Other operating revenue generated by the new hotels in 2010 was $0.9 million. Other operating revenue generated by our existing portfolio decreased $4.3 million in 2010 compared to 2009. A substantial portion of our other operating revenue in 2009 resulted from a performance guaranty provided by the manager of the Fairmont Newport Beach. We recognized $2.5 million of the $6.0 million performance guaranty during 2009, and zero during 2010. As of December 31, 2009, we had fully utilized the entire $6.0 million performance guaranty. Other operating revenue also decreased in 2010 as compared to 2009 due to decreased cancellation, attrition, telephone and guest movie reve- nue in our existing portfolio slightly offset by increased parking and spa revenue in our existing portfolio and increased revenue at our two commercial laundry facilities. Other operating revenue decreased $5.4 million, or 9.1%, for the year ended December 31, 2009 as compared to the year ended December 31, 2008. A substantial portion of our other operating revenue in both 2009 and 2008 resulted from a per- formance guaranty provided by the manager of the Fairmont Newport Beach. We recognized $2.5 million of the $6.0 million performance guaranty during the year ended December 31, 2009, and recognized $3.5 million of the performance guaranty during the year ended December 31, 2008. Other revenue generated from our existing portfolio also decreased during 2009 as compared to 2008 primarily due to decreases in telephone, retail, business center and guest movie revenue, resulting from the decrease in occupancy at our hotels and to the fact that discretionary spending by our hotel guests decreased in 2009 as a result of the recession, combined with decreased cancellation and attrition revenue. These decreases were partially offset by increases in parking revenue due to new contracts at several of our hotels. 28


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    Hotel operating expenses. Hotel operating expenses, which are comprised of room, food and beverage, advertising and pro- motion, repairs and maintenance, utilities, franchise costs, property tax, ground lease and insurance, and other hotel operating expenses increased $11.9 million, or 3.0%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Hotel operating expenses generated by the new hotels in 2010 totaled $10.7 million. Hotel operating expenses for our existing portfolio increased $1.2 million during 2010 as compared to 2009. This increase in hotel operating expenses is primarily related to the increase in related room revenue. In addition, hotel operating expenses increased in 2010 as compared to 2009 due to costs incurred of $0.2 million during 2010 related to our management company transitions, increased franchise fees and assessments due to higher revenue, and increased ground lease expense due to higher costs at several of our hotels. These increases were partially offset by decreases in the following expenses: food and beverage expense and other operating expense due to the decline in related revenue; departmental payroll due to staff reductions and cost cutting initiatives imple- mented throughout 2009; repairs and maintenance as the hotels continued to cancel or delay unnecessary expenditures; utilities due to reductions in gas rates and usage at several of our hotels; and property taxes due to reassessments on several of our hotels. Hotel operating expenses decreased $57.1 million, or 12.6%, for the year ended December 31, 2009 as compared to the year ended December 31, 2008. This decrease in hotel operating expenses is the result of cost cutting initiatives, as well as lower occupancy rates at our hotels. Hotel operating expenses declined during 2009 as compared to 2008 due to decreases in the following expenses: departmental payroll due to staff reductions and cost cutting initiatives; advertising and repairs and maintenance as the hotels developed more efficient operating models; utilities due to the decline in occupancy and to reduc- tions in gas rates at several of our hotels; franchise fees and assessments due to the decreased revenue; and ground lease due to the elimination of expense at our Renaissance Orlando at SeaWorld® as we purchased the land underlying the hotel in September 2008. These decreases were slightly offset by increased property taxes due to increased tax rates at several of our hotels combined with $0.2 million in supplemental prior year taxes assessed on several of our hotels in 2009, slightly offset by $0.8 million in property tax credits received at several of our hotels in 2009 and by $0.2 million in prior year tax reim- bursements collected from the buyer upon our second quarter 2009 sale of land adjacent to one of our hotels. Property general and administrative expense. Property general and administrative expense increased $4.3 million, or 5.9%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Property general and administra- tive expense generated by the new hotels in 2010 totaled $2.3 million. Hotel operating expenses for our existing portfolio increased $2.0 million during 2010 as compared to 2009. Management fees and credit and collection expenses increased in our existing portfolio due to the increase in revenue. In addition, property general and administrative expense in our existing portfolio increased due to increased payroll, employee recruitment, relocation and training. These increases were partially offset by decreased legal and sales tax audit expenses. Property general and administrative expense decreased $14.0 million, or 16.1%, for the year ended December 31, 2009 as compared to the year ended December 31, 2008, primarily due to decreased management fees and credit and collection expenses due to the decline in revenue, combined with decreased payroll and related costs, employee recruitment, employee relations, employee relocation, training, legal and travel due to staff reductions and cost control initiatives as our hotels worked to control costs during the recession. These decreases were slightly offset by an increase in sales tax audit expense due to audits at several of our hotels. Corporate overhead expense. Corporate overhead expense increased $3.6 million, or 14.1%, during the year ended December 31, 2010 as compared to the year ended December 31, 2009 primarily due to increased due diligence costs. During 2010 we incurred due diligence costs of $6.8 million related to our acquisition of the Royal Palm Miami Beach, which primarily related to costs specific with the foreclosure auction process as well as the acquisition of a portion of the hotel’s outstanding debt at a discount. Previously, these due diligence costs would have been capitalized as part of the acquisition; however, under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) revised business combinations guidance, these costs are expensed for acquisitions on or after January 1, 2009. We incurred an additional $1.3 million in due diligence costs during 2010 related to acquisition projects that were abandoned, as compared to $0.2 million in 29


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    due diligence costs incurred in 2009. In addition, corporate overhead expense increased in 2010 as compared to 2009 due to $3.3 million in CEO severance expenses, increased legal expenses and by $0.5 million in retention bonuses accrued during 2010 to incentivize certain hotel-level employees to stay through the management company transitions. These increases were partially offset by decreased bad debt expense. In December 2009, we determined that a $5.6 million note received from the buyer of 13 hotels we sold in 2006, along with the related interest accrued on the note may be uncollectible. As such, we recorded bad debt expense of $5.6 million to corporate overhead in 2009 to reserve against both the discounted note and the related interest receivable. Corporate overhead expenses also decreased in 2010 as compared to 2009 due to decreased sales tax expense, office rent, and relocation expense. Corporate overhead expense increased $3.7 million, or 17.3%, during the year ended December 31, 2009 as compared to the year ended December 31, 2008 due in part to $5.6 million in bad debt expense recorded in 2009, along with $0.8 million in corporate severance due to our corporate reorganization in the second quarter of 2009 and $0.1 million in relocation expense. In December 2009, we determined that a $5.6 million note received from the buyer of 13 hotels we sold in 2006, along with the related interest accrued on the note may be uncollectible. As such, we recorded bad debt expense of $5.6 million to cor- porate overhead to reserve against both the discounted note and the related interest receivable. These increases were partially offset by decreases in salaries, wages and deferred stock compensation in 2009 as compared to 2008. During the second quarter of 2009, we made certain changes to our organizational structure, and as a result, our corporate workforce was reduced by approximately 40%, resulting in decreases in salaries, wages and deferred stock compensation. In addition, corporate overhead decreased due to reductions in sales tax expenses, audit and legal fees, recruitment, entity level state franchise and minimum tax payments, conferences and meetings, and travel. Depreciation and amortization expense. Depreciation and amortization expense increased $1.7 million, or 1.8%, for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Depreciation and amortization expense generated by the new hotels in 2010 totaled $2.5 million. Depreciation and amortization in our existing portfolio decreased $0.8 million during 2010 as compared to 2009 primarily due to the fact that we reduced the depreciable assets of our existing portfolio by $25.4 million during the second quarter of 2009, as well as due to reduced renovations and purchases of furniture, fixtures and equipment for our hotel properties. Depreciation and amortization expense remained relatively flat for the year ended December 31, 2009 as compared to the year ended December 31, 2008. Additional depreciation recognized on hotel renovations and purchases of furniture, fixtures and equipment for our hotel properties was offset due to the fact that we reduced the depreciable assets of our existing portfolio by $25.4 million during 2009 due to impairment charges. Property and goodwill impairment losses. Property and goodwill impairment losses totaled $1.9 million for the year ended December 31, 2010, $30.9 million for the year ended December 31, 2009, and $0.1 million for the year ended December 31, 2008. During 2010, we recognized a property impairment loss of $1.9 million on an office building and land adjacent to one of our hotels in anticipation of its possible sale. In conjunction with our quarterly impairment evaluations performed during 2009, we recognized a $25.4 million impairment loss on the Marriott Del Mar to reduce the carrying value of this hotel to its fair value. In addition, during 2009 we recognized a $1.4 million impairment loss related to costs associated with a potential timeshare development, and recognized a $0.1 million impairment loss on a parcel of land adjacent to one of our hotels which we sold in June 2009. We also wrote off $1.3 million of goodwill associated with the Marriott Park City and $2.6 million of goodwill associated with the Marriott Rochester. In 2008 we recognized a $0.1 million impairment loss on a vacant parcel of land which was sold in January 2009. Equity in net earnings (losses) of unconsolidated joint ventures. Equity in net earnings (losses) of unconsolidated joint ven- tures totaled earnings of $0.6 million for the year ended December 31, 2010, a net loss of $27.8 million for the year ended December 31, 2009, and a net loss of $1.4 million for the year ended December 31, 2008. In 2010, we recognized income of $0.6 million on our BuyEfficient joint venture, and zero on our Doubletree Guest Suites Times Square joint venture. Though the Doubletree Guest Suites Times Square joint venture recognized earnings during 2010, we did not recognize any portion of these earnings due to the fact that the joint venture had cumulative losses in excess of our investment, and we reduced our interest in this partnership to zero at December 31, 2009. The excess cumulative losses resulted primarily from the hotel’s fourth quarter 2009 impairment charge. In 2009, we recognized a $28.3 million loss on our Doubletree Guest Suites Times Square joint venture. This $28.3 million loss was comprised of a $2.3 million operating loss and a $26.0 million impairment loss. Also during 2009, we recognized income of $0.5 million on our BuyEfficient joint venture. In 2008, we recognized a $1.6 million loss on our Doubletree Guest Suites Times Square joint venture, and income of $0.2 million on our BuyEfficient joint venture. 30


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    In January 2011, we increased our ownership in both the BuyEfficient and Doubletree Guest Suites Times Square joint ven- tures, and will present both of these investments in 2011 on a consolidated basis. We purchased the outside 50% share in the BuyEfficient joint venture for $8.6 million, and the outside 62% equity interests in the Doubletree Guest Suites Times Square joint venture for approximately $37.5 million. As a result, we are now the sole owner of both BuyEfficient and the 460-room Doubletree Guest Suites Times Square. Interest and other income. Interest and other income totaled $0.1 million for the year ended December 31, 2010, $1.4 million for the year ended December 31, 2009 and $3.6 million for the year ended December 31, 2008. In 2010, we recognized $0.3 million in interest income and $0.1 million in other miscellaneous income, partially offset by a loss of $0.3 million on sales and dispositions of surplus furniture, fixtures and equipment (“FF&E”) located in several of our hotels and in our corporate office. In 2009, we recognized $0.9 million in interest income, $0.4 million on the sale of surplus FF&E located in two of our hotels and $0.1 million in other miscellaneous income. In 2008, we recognized $3.4 million in interest income and $0.2 million in other miscellaneous income. Interest expense. Interest expense is as follows (in thousands): Year Ended Year Ended Year Ended December 31, December 31, December 31, 2010 2009 2008 Interest expense $65,457 $71,940 $78,538 Interest expense—default rate 884 472 — Accretion of Senior Notes 996 1,813 3,505 Amortization of deferred financing fees 1,597 1,823 1,133 Write-off of deferred financing fees 1,585 284 — Loan penalties and fees 311 207 — $70,830 $76,539 $83,176 Interest expense decreased $5.7 million, or 7.5%, during the year ended December 31, 2010 as compared to the year ended December 31, 2009. Interest expense decreased $6.5 million during 2010 as compared to 2009 as a result of decreases in our loan balances combined with our repurchase of $64.0 million in aggregate principal amount of the Senior Notes in the first quarter of 2009 and an additional $123.5 million in the second quarter of 2009, as well as the repayment of $83.0 million in April 2010 to release three hotels from the Mass Mutual loan. In addition, interest expense due to the accretion of the Senior Notes decreased $0.8 million during 2010 as compared to 2009 due to the repurchases of the Senior Notes in 2009. Interest expense also decreased $0.2 million during 2010 as compared to 2009 due to a decrease in amortization of deferred financing fees related to the repayment of the $83.0 million noted above, as well as the termination of our credit facility in February 2010, partially offset by an increase in fees associated with our new credit facility entered into in November 2010, combined with our repurchase of the Senior Notes and the amendment of our loan on the Renaissance Baltimore during the third quarter of 2009. These decreases were partially offset by an increase of $1.3 million in interest expense due to the write-off of deferred financing fees. During 2010, we wrote-off $1.5 million in deferred financing fees related to the termination of our credit facility in February 2010, and $0.1 million in deferred financing fees related to the release of the three hotels from the Mass Mutual loan in April 2010. During 2009, we wrote off $0.3 million in deferred financing fees associated with the amendment of our credit facility. Interest expense also increased during 2010 as compared to 2009 due to our elective defaults pursuant to our 2009 secured debt restructuring program as one of the lenders increased our interest rate by 5.0% causing an additional $0.4 million in default interest and an additional $0.1 million in penalties and fees. Interest expense decreased $6.6 million, or 8.0%, during the year ended December 31, 2009 as compared to the year ended December 31, 2008. Interest expense decreased $6.6 million as a result of decreases in our loan balances combined with our repurchase of $64.0 million in aggregate principal amount of the Senior Notes in the first quarter of 2009 and an additional $123.5 million repurchased in May 2009. In addition, during the first quarter of 2009, we adopted FASB ASC 470-20, “Debt with Conversion and Other Options (“ASC 470-20”). As part of this adoption, we recorded an additional $1.8 million in interest expense for the year ended December 31, 2009, and we retrospectively adjusted interest expense by an additional $3.5 million for the year ended December 31, 2008. Interest expense due to the accretion of the Senior Notes decreased by $1.7 million during 2009 as compared to 2008 due to the repurchase of $64.0 million in aggregate principal amount of Senior Notes in the first quarter of 2009 combined with an additional $123.5 million repurchased in May 2009. Partially offsetting these decreases, interest expense increased in 2009 as compared to 2008 due to an increase in amortization of deferred 31


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    financing fees of $0.7 million related to an increase in fees associated with our repurchase of the Senior Notes, the amend- ment of our credit facility during the second quarter of 2009 and the amendment of our loan on the Renaissance Baltimore during the third quarter of 2009. In addition, interest expense increased in 2009 as compared to 2008 due to $0.3 million recognized in 2009 related to the write-off of deferred financing fees associated with the amendment of our credit facility, as well as $0.5 million in default interest and $0.2 million in loan penalties and fees recognized in 2009 due to our elective defaults pursuant to our 2009 secured debt restructuring program. Our weighted average interest rate per annum was approximately 5.5% at both December 31, 2010 and 2008, and 5.6% at December 31, 2009. At December 31, 2010, all of our outstanding notes payable had fixed interest rates. Gain on extinguishment of debt. Gain on extinguishment of debt totaled zero for the year ended December 31, 2010, $54.5 million for the year ended December 31, 2009 and zero for the year ended December 31, 2008. During 2009, we recognized a gain of $54.5 million due to the repurchase and cancellation of $187.5 million in aggregate principal amount of the Senior Notes. Income (loss) from discontinued operations. Income (loss) from discontinued operations is as follows (in thousands): Year Ended Year Ended Year Ended December 31, December 31, December 31, 2010 2009 2008 Operating revenues $ 71,105 $ 136,777 $ 250,584 Operating expenses (58,031) (114,893) (187,306) Interest expense (17,172) (22,698) (18,618) Depreciation and amortization expense (5,432) (17,265) (25,655) Property and goodwill impairment losses — (195,293) (2,847) Gain on extinguishment of debt 86,235 — — Gain (loss) on sale of hotels — (13,052) 26,013 Income (loss) from discontinued operations $ 76,705 $(226,424) $ 42,171 As described under “—Investing Activities—Dispositions,” we sold three hotels during 2009 and two hotels during 2008. In addition, pursuant to our 2009 secured debt restructuring program we reclassified the operating results of 11 hotels to dis- continued operations: W San Diego, transferred to a receiver in September 2009 and deeded back to the lender in July 2010; Renaissance Westchester, transferred to a receiver in December 2009 and reacquired by the Company in June 2010; Marriott Ontario Airport, transferred to a receiver in March 2010 and sold by the receiver in August 2010; and the Mass Mutual eight hotels, deeded back to the lender in November 2010. As a result of these deed backs and title transfers, we have disposed of all assets and liabilities from our operations held for non-sale disposition segment. Accordingly, all assets, liabilities and the operations from our non-sale disposition segment have been reclassified to discontinued operations. Consistent with the Property, Plant and Equipment Topic of the FASB ASC, we have reclassified the results of operations for all of these hotels, along with any impairments recognized, the gains or losses on the hotel sales and the gains on extinguishment of debt for the W San Diego, Renaissance Westchester, Marriott Ontario Airport and Mass Mutual eight hotels to discontinued operations. Dividends paid on unvested restricted stock compensation. Common stock dividends earned on our unvested restricted stock awards were zero for the year ended December 31, 2010, $0.4 million for the year ended December 31, 2009 and $0.8 million for the year ended December 31, 2008. 32


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    Preferred stock dividends and accretion. Preferred stock dividends and accretion decreased $0.1 million, or 0.5% during the year ended December 31, 2010 as compared to the year ended December 31, 2009. Though the dividend rate for our Series A preferred stock and Series C preferred stock remained at $2.00 and $1.572, respectively, per share for 2010 and 2009, pre- ferred stock dividends and accretion decreased in 2010 due to the fact that the initial carrying value of our Series C preferred stock was fully accreted to its redemption value during the third quarter of 2010. Preferred stock dividends and accretion decreased $0.1 million, or 0.6%, during the year ended December 31, 2009 as compared to the year ended December 31, 2008 due to a decrease in the dividend rate for our Series C preferred stock to $1.572 per share during 2009 from $1.605 per share during 2008. Undistributed income allocated to unvested restricted stock compensation. In accordance with ASC 260-10, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. As such, undistributed income of $0.1 million for 2010 and zero for both 2009 and 2008 were allocated to the participating securities. Investing Activities Acquisitions. In light of the recent cyclical downturn, we did not acquire any hotel properties during either 2009 or 2008. Our only material real estate acquisition during 2008 was made in September, when we acquired 32.6 acres of land underlying our Renaissance Orlando at SeaWorld® hotel using available cash on hand for $30.7 million, including costs of the acquisition. Prior to our acquisition, the land had been leased from a third party. As a result of this acquisition, property tax, ground lease and insurance expense has been reduced by $2.1 million, $2.0 million and $0.7 million for the years ended December 31, 2010, 2009 and 2008, respectively. With better market clarity and in anticipation of an economic recovery, public REIT valuations improved significantly during the course of 2009. While hotel sale transactions were relatively limited in number during 2009, the hotel sale transactions that were consummated during 2010 indicate that hotel trading values have not recovered commensurately with public REIT valuations. Consistent with our cycle-appropriate strategy, we shifted our focus at the end of 2009 towards the pursuit of selective hotel acquisitions. Our acquisitions program is aimed at generating attractive returns on our investment dollars, and therefore we may target lodging assets outside of the typical branded, urban, upper upscale profile represented by our existing portfolio in order to capitalize on opportunities which may arise. Additionally, the scope of our acquisitions program may include large hotel portfolios or hotel loans. In April 2010, we purchased two hotel loans with a combined principal amount of $32.5 million for a total purchase price of $3.7 million. The loans included (i) a $30.0 million, 8.5% mezzanine loan maturing in January 2017 secured by the equity interests in our Doubletree Guest Suites Times Square joint venture, and (ii) one-half of a $5.0 million, 8.075% subordinate note maturing in November 2010 secured by the 101-room boutique hotel known as Twelve Atlantic Station in Atlanta, Georgia. We purchased the mezzanine loan for $3.45 million and the subordinate note for $250,000. In November 2010, we purchased the remaining half of the Twelve Atlantic Station subordinate note for an additional $250,000. In November 2010, the subordinate note was modified to provide for monthly interest only payments of 3.5%, with the remaining interest due at maturity, and the maturity date was extended to November 2012. As the subordinate note was in default, the borrower was required to bring the subordinate note current. As of December 31, 2010, the subordinate note secured by the Twelve Atlantic Station was not in default, however, we are accounting for the Twelve Atlantic Station loan using the cost recovery method until such time as the expected cash flows from the loan are reasonably probable and estimable. As of December 31, 2010, the debt on the Doubletree Guest Suites Times Square was not in default, however interest on the mezzanine loan was deferred in accordance with the provisions of the loan, and we accounted for the loan using the cost recovery method. In January 2011, we purchased the outside 62% equity interests in our Doubletree Guest Suites Times Square joint venture for approximately $37.5 million and, as a result, became the sole owner of the entity that owns the 460-room Doubletree Guest Suites Times Square hotel in New York City. After our acquisition of the remaining interests in the hotel, the mezzanine loan will remain in effect for tax purposes, but will be eliminated in consolidation on our financial statements. 33


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    In June 2010, we reacquired the 347-room Renaissance Westchester in White Plains, New York. In 2009, we transferred possession and control of the hotel to a court-appointed receiver pursuant to our 2009 secured debt restructuring program. In connection with this transfer, we deconsolidated this hotel and reclassified the assets and liabilities, including the $25.2 million hotel net asset and the hotel’s $29.2 million 4.98% non-recourse mortgage, to discontinued operations on our balance sheets. Additionally, we reclassified the Renaissance Westchester’s results of operations and cash flows to discontinued oper- ations on our statements of operations and cash flows. We reacquired the Renaissance Westchester in June 2010 for $26.0 million, including $1.2 million of restricted cash and related costs for a net purchase price of $24.8 million. In connection with the repurchase of the Renaissance Westchester, the $29.2 million non-recourse mortgage was cancelled. We recorded a $6.7 million gain on extinguishment of debt to discontinued operations in June 2010. In August 2010, we used available cash on hand to acquire the Royal Palm hotel in Miami Beach, Florida at a foreclosure auction for a gross purchase price of $126.1 million excluding transaction costs. Prior to the auction, we purchased a portion of the hotel’s outstanding debt at a discount to par resulting in a net purchase price of approximately $117.6 million. The following table sets forth the hotels we have acquired and reacquired since January 1, 2008: Hotels Rooms Acquisition Date 2010: Royal Palm Miami Beach, Miami Beach, Florida 409 August 27, 2010 Renaissance Westchester, White Plains, New York(1) 347 June 14, 2010 2009: No hotel acquisitions — 2008: No hotel acquisitions — Total January 1, 2008 to December 31, 2010 756 (1) Hotel deeded back to the lender and reacquired by the Company on June 14, 2010. The cost for the two hotel acquisitions was approximately $142.4 million, or $188,000 per room. Dispositions. We did not sell any hotels during 2010. During the second quarter of 2010, we disposed of the Renaissance Westchester, and subsequently reacquired the hotel from the lender in June 2010. During the third quarter of 2010, we com- pleted our previously announced deed back of the W San Diego and the Marriott Ontario Airport which was sold by the receiver. Titles to the W San Diego and Marriott Ontario Airport were transferred to the lender and third party purchaser, respectively. During the fourth quarter of 2010, we completed our previously announced deed back of the Mass Mutual eight hotels, and titles to the hotels were transferred to the lender. Consistent with our cycle-appropriate strategy, we were a net seller of hotels in 2009 and 2008. In May 2009, we sold the Marriott Napa Valley for net proceeds of $34.8 million, and a net loss of $13.7 million. In June 2009, we sold the Marriott Riverside for net proceeds of $18.7 million and a net gain of $2.9 million. In July 2009 we sold the Hyatt Suites Atlanta Northwest for net proceeds of $7.8 million and a net gain of $18,000, after having recorded an impairment loss in June 2009 of $4.9 million in order to reduce the carrying value of this hotel on our balance sheet to its fair value. We retained the net proceeds from these three sales in cash. In May 2008, we sold the Hyatt Regency Century Plaza for net proceeds of $358.8 million, and a net gain of $42.1 million. In July 2008, we used a portion of the net proceeds to repay amounts outstanding under our credit facility, which had been used to fund the repurchase of 7,374,179 shares of our common stock for $129.0 million (excluding fees and costs). In December 2008, we sold the Crowne Plaza Grand Rapids for net proceeds of $3.6 million, including a $2.0 million note receivable that we collected in January 2009, and a net loss of $16.1 million. 34


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    The following table sets forth the hotels we have sold or disposed of since January 1, 2008: Hotels Rooms Disposition Date 2010: Courtyard by Marriott, San Diego (Old Town), California (1) 176 November 1, 2010 Hilton, Huntington, New York(1) 302 November 1, 2010 Holiday Inn Downtown, San Diego, California (1) 220 November 1, 2010 Holiday Inn Express, San Diego (Old Town), California (1) 125 November 1, 2010 Marriott, Provo, Utah (1) 330 November 1, 2010 Marriott, Salt Lake City (University Park), Utah (1) 218 November 1, 2010 Renaissance Atlanta Concourse, Atlanta, Georgia (1) 387 November 1, 2010 Residence Inn by Marriott, Manhattan Beach, California (1) 176 November 1, 2010 Marriott, Ontario Airport, California (1) 299 August 12, 2010 W Hotel, San Diego, California (1) 258 July 2, 2010 Renaissance Westchester, White Plains, New York(1)(2) 347 June 14, 2010 2009: Hyatt Suites Atlanta Northwest, Marietta, Georgia 202 July 31, 2009 Marriott, Riverside, California 292 June 18, 2009 Marriott, Napa, California 274 May 20, 2009 2008: Crowne Plaza, Grand Rapids, Michigan 320 December 10, 2008 Hyatt Regency, Los Angeles (Century City), California 726 May 30, 2008 Total January 1, 2008 to December 31, 2010 4,652 (1) Hotels deeded back to the lenders, or sold by the receiver, pursuant to our 2009 secured debt restructuring program. (2) Hotel reacquired by the Company on June 14, 2010. The 11 hotels disposed of in 2010 pursuant to our secured debt restructuring program eliminated $282.7 million of debt from our balance sheet. The aggregate net sale proceeds for the five hotels sold in 2008 and 2009 was $423.7 million, or $234,000 per room. The results of operations of all of the hotels identified above and the gains or losses on dispositions and extinguish- ments of debt through December 31, 2010 are included in discontinued operations for all periods presented through the time of sale. The proceeds from the sales are included in our cash flows from investing activities for the respective periods. The following table summarizes our portfolio and room data from January 1, 2008 through December 31, 2010, adjusted for the hotels acquired, reacquired, disposed through non-sale disposition and sold during the respective periods. 2010 2009 2008 Portfolio Data—Hotels Number of hotels—beginning of period 40 43 45 Add: Acquisitions 1 — — Add: Re-acquisitions 1 — — Less: Dispositions — (3) (2) Less: Non-sale dispositions (11) — — Number of hotels—end of period 31 40 43 Portfolio Data—Rooms Number of rooms—beginning of period 13,804 14,569 15,625 Add: Acquisitions 409 — — Add: Re-acquisitions 347 — — Add: Room expansions — 3 — Less: Dispositions — (768) (1,046) Less: Non-sale dispositions (2,838) — — Less: Rooms converted to other usage — — (10) Number of rooms—end of period 11,722 13,804 14,569 Average rooms per hotel—end of period 378 345 339 35


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    Renovations. During 2010, we invested $57.0 million in capital improvements to our hotel and other real estate portfolio. Consistent with our cycle-appropriate strategy, this investment in capital improvements to our portfolio was $12.9 million more than the amount we invested in 2009 and $37.7 million less than the amount we invested in 2008. Liquidity and Capital Resources Historical. During the periods presented, our sources of cash included our operating activities, working capital, sales of hotel properties and other assets, distributions received from our unconsolidated joint ventures, proceeds from notes payable including our Operating Partnership’s debt securities and our credit facility, and proceeds from our offerings of common stock. Our primary uses of cash were for acquisitions of hotel properties, capital expenditures for hotels, operating expenses, purchases of notes receivable, repayment of notes payable (including repurchases of Senior Notes), repurchases of our com- mon stock, and dividends on our common and preferred stock. We cannot be certain that traditional sources of funds will be available in the future. Operating activities. Our cash provided by or used in operating activities fluctuates primarily as a result of changes in RevPAR and operating margins of our hotels. Our net cash provided by or used in operating activities may also be affected by changes in our portfolio resulting from hotel acquisitions, dispositions or renovations. Net cash provided by operating activities was $45.4 million for 2010 compared to $64.7 million for 2009, and $160.0 million for 2008. The decrease in 2010 as compared to 2009 was primarily due to an increase in restricted cash during 2010. The decrease in 2009 as compared to 2008 was primar- ily due to decreased earnings at our hotels during 2009, combined with a decrease in accounts payable and other liabilities. Investing activities. Our cash provided by or used in investing activities fluctuates primarily as a result of acquisitions, dispositions and renovations of hotels. Net cash provided by or used in investing activities in 2010, 2009 and 2008 was as follows (in thousands): Year Ended Year Ended Year Ended December 31, December 31, December 31, 2010 2009 2008 Proceeds from sale of hotel properties and other assets $ 63 $ 64,073 $360,395 Cash received from unconsolidated joint ventures 900 500 5,675 Restricted cash—replacement reserve (931) (1,823) 5,136 Acquisitions of notes receivable (3,950) — — Acquisitions of hotel properties and land (142,410) — (30,695) Renovations and additions to hotel properties and other real estate (56,984) (44,105) (94,697) Net cash provided by (used in) investing activities $(203,312) $ 18,645 $245,814 Pursuant to our cycle-appropriate strategy, we acquired one hotel and reacquired one hotel in 2010, and did not acquire any hotels in either 2009 or 2008. Net cash used in investing activities was $203.3 million in 2010 as compared to net cash pro- vided of $18.6 million in 2009, and net cash provided of $245.8 million in 2008. During 2010, we paid $117.6 million to acquire the Royal Palm Miami Beach and $24.8 million to reacquire the Renaissance Westchester, for a total cash outlay of $142.4 million. In addition, we increased the balance in our restricted cash replacement reserve accounts by $0.9 million, and we paid $4.0 million for the purchase of two notes receivable and $57.0 million for renovations and additions to our portfolio. These cash outflows were partially offset by $0.1 million of proceeds received from the sale of surplus FF&E at several of our hotels and our corporate office and distributions of $0.9 million received from one of our unconsolidated joint ventures. During 2009, we received $64.1 million from the sale of hotel properties and other assets, which included $61.3 million from the sale of three hotels, a $2.0 million payment on a note receivable from the buyer of a hotel we sold in December 2008, $0.4 million from the sale of certain excess FF&E located in two of our hotels, and $0.4 million from the sales of two vacant parcels of land. In addition, we received $0.5 million from one of our unconsolidated joint ventures, increased the balance in our restricted cash replacement reserve accounts by $1.8 million, and paid cash of $44.1 million for renovations and additions to our portfolio. 36


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    During 2008, we received net proceeds of $360.4 million from the sale of the two hotels, decreased the balance in our restricted cash replacement reserve accounts by $5.1 million, and received $5.7 million from one of our unconsolidated joint ventures. During 2008, we also acquired the land underlying one of our hotels for $30.7 million, paid an additional $14,000 for two hotels acquired in 2007, and received a $35,000 deposit paid in 2007 for a total cash outlay of $30.7 million. In addi- tion, we paid cash of $94.7 million for renovations and additions to our portfolio. Financing activities. Our cash provided by or used in financing activities fluctuates primarily as a result of our issuance and repayment of notes payable, including the repurchase of Senior Notes, repayments on our credit facility and the issuance and repurchase of other forms of capital, including preferred equity and common stock. Net cash provided by financing activities was $82.6 million in 2010 as compared to net cash provided of $93.8 million in 2009, and net cash used of $293.7 million in 2008. Net cash provided by financing activities for 2010 consisted primarily of $199.9 million in proceeds received from the issuance of common stock and $92.5 million in proceeds received from the new loan on the Hilton Times Square. These cash inflows were partially offset by $175.2 million of principal payments on our notes payable and related costs, including $83.0 million paid to release three hotels from the Mass Mutual loan, $81.0 million to pay off the loan on the Hilton Times Square in connection with the refinance of the loan and $11.2 million of principal amortization. In addition, net cash provided by financing activities for 2010 includes $20.5 million of dividends paid to our stockholders, $9.2 million in costs associated with the issuance of our common stock, and $4.8 million in deferred financing costs paid in connection with our new credit facility and the refinancing of the Hilton Times Square loan. Net cash provided by financing activities in 2009 consisted primarily of $269.1 million in proceeds received from the issuance of common stock and $60.0 million in proceeds received from our credit facility. These cash inflows were partially offset by $117.5 million used to repurchase a portion of our Senior Notes including related costs, $74.4 million of principal payments on our credit facility and notes payable, $27.9 million of dividends paid to our stockholders, $12.0 million in costs associated with the issuance of our common stock, and $3.5 million in deferred financing fees paid in connection with amendments to our Senior Notes indenture, our credit facility and our loan secured by the Renaissance Baltimore. Net cash used in financing activities in 2008 consisted primarily of $190.4 million of principal payments on our credit facility and notes payable, $184.5 million used to repurchase shares of our common stock, $99.8 million of dividends paid to our stockholders, and $0.1 million in deferred financing costs partially offset by $181.0 million in proceeds received from draws on our credit facility. Future. We expect our primary uses of cash to be for acquisitions of hotels, including possibly for hotel portfolios, capital investments in our hotels, operating expenses, repayment of principal on our notes payable and credit facility, interest expense and dividends. We expect our primary sources of cash will continue to be our operating activities, working capital, notes payable, sales of hotel properties, and proceeds from public and private offerings of debt securities and common and preferred stock. Our ability to incur additional debt depends on a number of factors, including our leverage, the value of our unencum- bered assets and borrowing restrictions imposed by lenders under our existing notes payable, as well as other factors affecting the general willingness or ability of lenders to provide loans. Our ability to raise funds through the issuance of equity secu- rities depends on, among other things, general market conditions for hotel companies and REITs and market perceptions about us. We will continue to analyze alternate sources of capital in an effort to minimize our capital costs and maximize our financial flexibility. However, when needed, the capital markets may not be available to us on favorable terms or at all. We believe that our current cash balance, our cash flow from operations, our access to capital markets and our unencumbered properties will provide us with sufficient liquidity to meet our current operating expenses and other expenses directly associ- ated with our business (including payment of dividends on our capital stock, if declared) for the foreseeable future, and in any event for at least the next 12 months. 37


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    Debt. In February 2010, we elected to terminate our existing $80.0 million credit facility, and we wrote off $1.5 million in related deferred financing costs. The termination of the facility eliminated approximately $0.6 million in fees and associated costs per annum. In November 2010, we entered into a new $150.0 million senior corporate credit facility (the “new credit facility”). The interest rate for the new credit facility ranges from 325 to 425 basis points over LIBOR, depending on our overall leverage. The initial term of the new credit facility is three years with an option to extend for an additional one year. Subject to approval by the lender group, the new credit facility may be increased to $250.0 million. The new credit facility contains customary events of default relating to payments and breaches of representations and warranties, and is pledged by 12 of our unencumbered hotels (Courtyard by Marriott Los Angeles Airport, Fairmont Newport Beach, Hyatt Regency Newport Beach, Kahler Inn & Suites Rochester, Marriott Quincy, Marriott Portland, Marriott Rochester, Renaissance Los Angeles Airport, Renaissance Westchester, Residence Inn by Marriott Rochester, Royal Palm Miami Beach and Sheraton Cerritos). In November 2010, we entered into a new $92.5 million non-recourse mortgage on our Hilton Times Square. The new mort- gage matures in 2020 and bears a fixed interest rate of 4.97%, with scheduled monthly principal and interest amounts based on a thirty-year amortization. The proceeds from the new mortgage were used in part to repay the maturing $81.0 million mortgage on our Hilton Times Square, which bore an interest rate of 5.915%. Excess proceeds were retained for general cor- porate purposes. The new mortgage contains customary events of default relating to payments and breaches of representations and warranties. In January 2011, we purchased the outside 62% equity interests in our Doubletree Guest Suites Times Square joint venture for approximately $37.5 million and, as a result, became the sole owner of the entity that owns the 460-room Doubletree Guest Suites Times Square hotel in New York City. The hotel is encumbered by approximately $270.0 million of non-recourse senior mortgage and mezzanine debt that matures in January 2012 and bears a blended interest rate of LIBOR + 115 basis points. We expect to refinance this debt during 2011 and intend to fund any refinancing shortfall with existing cash. Consistent with our cycle-appropriate strategy, we initiated the 2009 secured debt restructuring program aimed at addressing cash flow and value deficits among certain of our hotels securing non-recourse mortgage debt. We concluded the program in the fourth quarter of 2009, and, in November 2010, we finalized the remaining deed back of certain hotels associated with loans which entered the program in 2009. Loans subject to our secured debt restructuring program generally met two criteria: (1) the hotel, or hotels as a group, was not generating sufficient cash flow to cover debt service, and under the current terms of the mortgage, the hotel was not expected to generate sufficient cash flow for the foreseeable future, and (2) the present value of the hotel, or hotels as a group, was significantly less than the principal amount of the applicable loan. The loans secured by such hotels, subject to customary exceptions, were non-recourse to us. The primary goal of the 2009 secured debt restructuring program was to amend the terms of mortgage debt to eliminate situations where hotel cash flow and asset values fell short of debt service and loan amounts, respectively. In certain cases, however, where acceptable restructuring terms could not be reached, rather than employing corporate resources to subsidize debt service, we elected to deed back the col- lateral hotels in satisfaction of the associated debt. The resolution of the final four loans included in our 2009 secured debt restructuring program is discussed further below. W San Diego. In July 2010, we completed our previously announced deed back of the W San Diego, and title to the hotel was transferred to the lender. We recorded a gain on extinguishment of debt of $35.4 million to discontinued operations in July 2010, and the net assets and liabilities were removed from our 2010 balance sheet. Renaissance Westchester. In June 2010, we reacquired the Renaissance Westchester for $26.0 million, including $1.2 million of restricted cash and related costs for a net purchase price of $24.8 million. In connection with the repurchase of the Renaissance Westchester, the $29.2 million non-recourse mortgage was cancelled. We recorded a $6.7 million gain on extin- guishment of debt to discontinued operations in June 2010. Marriott Ontario Airport. In March 2010, possession and control of the Marriott Ontario Airport was transferred to a court- appointed receiver, and we deconsolidated the hotel. In August 2010, the Marriott Ontario Airport was sold by the receiver, and title to the hotel was transferred to the hotel’s new owner. We recorded a $5.1 million gain on extinguishment of debt to discontinued operations in August 2010, and removed the net assets and liabilities from our 2010 balance sheet. 38


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    Massachusetts Mutual Life Insurance Company. During the first quarter of 2010, we reached an agreement in principle with Mass Mutual to secure the release of the three remaining hotels comprising the collateral pool for the Mass Mutual loan (Courtyard by Marriott Los Angeles, Kahler Inn & Suites Rochester and Marriott Rochester). Also pursuant to this agreement, in November 2010, we completed the deed back of the Mass Mutual eight hotels and titles to the hotels were transferred to the lender. In connection with such transfer, Mass Mutual delivered to the Company a covenant and agreement pursuant to which Mass Mutual agreed to not sue the Company for any matter or claim which Mass Mutual may ever have relating to the hotels, the loan or the loan documents. There are certain customary carveouts from this covenant not to sue, including fraud, a breach of the deed in lieu agreement itself and the environmental indemnity agreement delivered at the time the loan was originated. Additionally, we made certain customary representations and warranties, all of which survive the closing for a period of six months. Five of the Mass Mutual eight hotels remain subject to franchise agreements which contain corporate guaranties. If the franchise agreements on these five hotels were to be terminated, we may be liable for up to $19.6 million in termination fees. We recorded a gain on extinguishment of debt of $39.0 million to discontinued operations in the fourth quarter of 2010, and the net assets and liabilities were removed from our 2010 balance sheet. Additional gain of $19.6 million will be deferred until all significant contingencies are resolved. Our 2009 secured debt restructuring program, including our elections to initiate the process to deed back the W San Diego, Marriott Ontario Airport, and the Mass Mutual eight hotels, were precipitated by a number of unique, market and hotel-specific factors, and were made after our efforts to amend the loans were unsuccessful. In the future, other factors may lead us to pursue similar options with certain of our other hotels securing non-recourse mortgages. We believe such cases, if any, would be limited in number. We were not in default of the loan covenants on any other of our notes payable at December 31, 2010. As of December 31, 2010, we had $1.1 billion of debt, $333.9 million of cash and cash equivalents, including restricted cash, and total assets of $2.4 billion. We believe that by controlling debt levels, staggering maturity dates and maintaining a highly flexible capital structure, we can maintain lower capital costs than more highly leveraged companies, or companies with limited flexibility due to restrictive corporate-level financial covenants. As of December 31, 2010, all of our outstanding debt had fixed interest rates. The majority of our mortgage debt is in the form of single asset loans. We believe this structure is appropriate for the operating characteristics of our business and provides flexibility for assets to be sold subject to the existing debt, and as evidenced by our 2009 secured debt restructuring program, in instances where asset values have declined to levels below the principal amount of the associated mortgage, non-recourse single asset mortgages may limit the degradation in value experienced by our stockholders by shifting a portion of asset risk to our secured lenders. As of December 31, 2010, the weighted average term to maturity of our debt is approximately 7 years, and the weighted average interest rate on our debt is 5.5%. With our purchase of the remaining interests in the Doubletree Guest Suites Times Square joint venture in January 2011, our first loan maturity, the $270.0 million mortgage on the Doubletree Guest Suites Times Square, is in January 2012. We expect to refinance this debt during 2011 and intend to fund any refinancing shortfalls with existing cash. Financial Covenants. We are subject to compliance with various covenants under the Series C preferred stock and the Senior Notes. With respect to our Series C preferred stock, if we fail to meet certain financial ratios for four consecutive quarters, a financial ratio violation will occur. During the continuation of a financial ratio violation, among other things, we would be restricted from paying dividends on our common stock, and may incur a 50 basis point per quarter dividend increase on the Series C preferred stock. Additionally, the Series C preferred stockholders would gain the right to appoint one board member. We do not currently expect to incur a financial ratio violation. Should operations deteriorate from current levels, however, we may fail to meet our financial ratios with respect to our Series C preferred stock for four consecutive quarters, which would cause us to incur a financial ratio violation. With respect to our Senior Notes, if the maturity dates of more than $300.0 million of our indebtedness were to be accelerated as the result of uncured defaults, either the trustee or the holders of not less than 25% in principal amount of the outstanding Senior Notes would have the right to declare the Senior Notes and any unpaid interest immediately due and payable. As of February 17, 2011, none of the maturity dates have been accelerated for any of our indebtedness. 39


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    Additionally, we believe we may be successful in obtaining mortgages on one or all of our 12 unencumbered hotels which are currently pledged to our new credit facility at December 31, 2010: Courtyard by Marriott Los Angeles Airport, Fairmont Newport Beach, Hyatt Regency Newport Beach, Kahler Inn & Suites Rochester, Marriott Quincy, Marriott Portland, Marriott Rochester, Renaissance Los Angeles Airport, Renaissance Westchester, Residence Inn by Marriott Rochester, Royal Palm Miami Beach and Sheraton Cerritos. These 12 hotels had an aggregate of 3,760 rooms as of December 31, 2010, and generated $184.1 million in revenue during 2010. Cash Balance. During the recent economic downturn, we maintained higher than historical cash balances. By minimizing our need to access external capital by maintaining higher than typical cash balances, our financial security and flexibility were meaningfully enhanced. As we believe the lodging cycle has now entered a recovery phase, we expect to deploy a portion of our excess cash balance in 2011 towards selective acquisitions and capital investments in our portfolio. Our acquisition pro- gram is aimed at generating attractive returns on our investment dollars, and therefore we may target lodging assets outside of the typical branded, urban, upper upscale profile represented by our existing portfolio in order to capitalize on opportunities which may arise. Additionally, the scope of our acquisitions program may include large hotel portfolios or hotel loans. Contractual Obligations The following table summarizes our payment obligations and commitments as of December 31, 2010 (in thousands): Payment Due By Period Less Than More Than Total 1 Year 1 to 3 Years 3 to 5 Years 5 Years (in thousands) Notes payable $ 1,145,500 $ 16,486 $131,592 $238,706 $ 758,716 Interest obligations on notes payable 420,281 62,344 120,899 109,197 127,841 Operating lease obligations 308,952 4,423 8,968 9,137 286,424 Construction commitments 32,965 32,965 — — — Employment obligations 2,047 938 1,109 — — Total $ 1,909,745 $117,156 $262,568 $357,040 $ 1,172,981 Capital Expenditures and Reserve Funds We believe we maintain each of our hotels in good repair and condition and in general conformity with applicable franchise and management agreements, ground and air leases, laws and regulations. Our capital expenditures primarily relate to the ongoing maintenance of our hotels and are budgeted in the reserve accounts described in the following paragraph. We also incur capital expenditures for renovation and development. We invested $57.0 million in our portfolio during 2010. Our reno- vation budget for 2011 includes $33.0 million of contractual construction commitments. If we acquire, renovate or develop additional hotels in the future, our capital expenditures will increase. With respect to our hotels that are operated under management or franchise agreements with major national hotel brands and for all of our hotels subject to first mortgage liens, we are obligated to maintain a FF&E reserve account for future planned and emergency-related capital expenditures at these hotels. The amount funded into each of these reserve accounts is deter- mined pursuant to the management, franchise and loan agreements for each of the respective hotels, ranging between 4.0% and 5.0% of the respective hotel’s total annual revenue. As of December 31, 2010, $28.3 million was held in FF&E reserve accounts for future capital expenditures at the 31 hotels. According to the respective loan agreements, the reserve funds are to be held by the lenders or managers in restricted cash accounts. We generally are not required to spend the entire amount in the FF&E reserve accounts each year. 40


  • Page 43

    Off-Balance Sheet Arrangements As of December 31, 2010, our off-balance sheet arrangements consist of our ownership interests in two joint ventures. For further discussion of our two joint ventures and their effect on our financial condition, results of operations and cash flows, see Note 6 to the consolidated financial statements. Seasonality and Volatility As is typical of the lodging industry, we experience some seasonality in our business as indicated in the table below. Revenue for certain of our hotels is generally affected by seasonal business patterns (e.g., the first quarter is strong in Orlando, the second quarter is strong for the Mid-Atlantic business hotels, and the fourth quarter is strong for New York City). Quarterly revenue also may be adversely affected by renovations, our managers’ effectiveness in generating business and by events beyond our control, such as extreme weather conditions, terrorist attacks or alerts, public health concerns, airline strikes or reduced airline capacity, economic factors and other considerations affecting travel. Revenues for our Comparable Portfolio by quarter for 2008, 2009 and 2010 were as follows (dollars in thousands): First Second Third Fourth Quarter Quarter Quarter Quarter Total Revenues 2008 Comparable Portfolio (30 Hotels)(1) $174,713 $200,634 $187,763 $206,501 $769,611 2008 Revenues as a percentage of total 22.7% 26.1% 24.4% 26.8% 100.0% 2009 Comparable Portfolio (30 Hotels)(1) $149,705 $154,883 $148,919 $169,126 $622,633 2009 Revenues as a percentage of total 24.0% 24.9% 23.9% 27.2% 100.0% 2010 Comparable Portfolio(30 Hotels) (1) $141,158 $161,088 $152,153 $176,283 $630,682 2010 Revenues as a percentage of total 22.4% 25.5% 24.1% 28.0% 100.0% (1) Includes all hotels owned by the Company as of December 31, 2010, less the Royal Palm Miami Beach which is being renovated and repositioned beginning in 2010. Also includes operating results for the Renaissance Westchester for all periods presented. Inflation Inflation may affect our expenses, including, without limitation, by increasing such costs as labor, food, taxes, property and casualty insurance and utilities. 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 (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. 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. We believe the following critical accounting policies affect the most significant judgments and estimates used in the preparation of our consolidated financial statements. ❈ Impairment of long-lived assets and goodwill. We periodically review each property and any related goodwill for possible impairment. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. We perform a Level 3 analysis of fair value, using a discounted cash flow analysis to estimate the fair value of our properties taking into account each property’s expected cash flow from operations, holding period and proceeds from the disposition of the property. The factors addressed in determining estimated proceeds from disposition include anticipated operating cash flow in the year of disposition and terminal capitalization rate. Our judgment is required in determining the discount rate applied to estimated cash flows, growth rate of the properties, operating income of the prop- erties, the need for capital expenditures, as well as specific market and economic conditions. In June 2010, we recorded an impairment loss of $1.9 million on an office building and land adjacent to one of our hotels in anticipation of a possible sale. 41


  • Page 44

    We account for goodwill in accordance with the Intangibles—Goodwill and Other Topic of the FASB ASC, which states that goodwill has an indefinite useful life that should not be amortized but should be reviewed annually for impairment, or more frequently if events or changes in circumstances indicate that goodwill might be impaired, as well as the Fair Value Measurements and Disclosures Topic of the FASB ASC for financial and nonfinancial assets and liabilities, which estab- lishes a framework for measuring fair value and expands disclosures about fair value measurements by establishing a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The review of any potential goodwill impairment requires estimates of fair value for our properties that have goodwill arising from unallocated acqui- sition costs. These estimates of fair value are prepared using Level 3 measurements. ❈ Depreciation and amortization expense. Depreciation expense is based on the estimated useful life of our assets. The life of the assets is based on a number of assumptions, including the cost and timing of capital expenditures to maintain and refurbish our hotels, as well as specific market and economic conditions. Hotel properties and other completed real estate investments are depreciated using the straight-line method over estimated useful lives ranging from five to 35 years for buildings and improvements and three to 12 years for furniture, fixtures and equipment. While management believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income or the gain or loss on the sale of any of our hotels. We have not changed the estimated useful lives of any of our assets during the periods discussed. New Accounting Standards and Accounting Changes In June 2009, the FASB issued a pronouncement which amends GAAP to require more information about transfers of finan- cial assets, eliminates the qualifying special purpose entity (QSPE) concept, changes the requirements for derecognizing financial assets and requires additional disclosures. The FASB issued a second pronouncement in June 2009, which amends GAAP regarding certain guidance for determining whether an entity is a variable interest entity and modifies the methods allowed for determining the primary beneficiary of a variable interest entity. This second pronouncement requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and enhanced disclosures related to an enterprise’s involvement in a variable interest entity. Both of these pronouncements are effective for the first annual reporting period that begins after November 15, 2009. The adoption of these two pronouncements did not materially impact the Company. In January 2010, the FASB issued a pronouncement to further update the fair value measurement guidance to improve fair value measurement disclosures. This update requires new disclosures related to transfers in and out of Level 1 and Level 2, as well as activity in Level 3 fair value measurements, and provides clarification to existing disclosures. This standard is effec- tive for interim periods and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements as these disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Our adoption of the guidance related to new disclosures and clarifications on January 1, 2010 did not have any effect on our consolidated finan- cial condition, results of operations or cash flows. Our adoption of the guidance related to disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements will occur during the first quarter of 2011. We do not anticipate that the adoption of this part of the pronouncement will materially impact the Company. In February 2010, the FASB issued a pronouncement to amend the subsequent events guidance. The amendment states that SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This standard is effective immediately. The adoption of this pronouncement did not materially impact the Company. 42


  • Page 45

    Quantitative and Qualitative Disclosures About Market Risk To the extent that we incur debt with variable interest rates, 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. At December 31, 2010, none of our outstanding debt was subject to variable interest rates. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures Based upon an evaluation of the effectiveness of disclosure controls and procedures, our Principal Executive Officer and Chief Financial Officer (CFO) has concluded that as of the end of the period covered by this Annual Report our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) were effective to provide rea- sonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the SEC and is accumulated and communicated to management, including the Principal Executive Officer and CFO, as appropriate to allow timely decisions regarding required disclosure. (b) Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projec- tions of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Under the supervision and with the participation of our management, including our Principal Executive Officer and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010. Ernst & Young LLP, an independent registered public accounting firm, has audited the Consolidated Financial Statements included in this Annual Report and, as part of its audit, has issued its report, included herein at page 44, on the effectiveness of our internal control over financial reporting. (c) Changes in Internal Control over Financial Reporting There was no change in our internal control over financial reporting that occurred during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 43


  • Page 46

    Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Sunstone Hotel Investors, Inc. We have audited Sunstone Hotel Investors, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Sunstone Hotel Investors, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understand- ing of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Sunstone Hotel Investors, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sunstone Hotel Investors, Inc. as of December 31, 2010 and 2009, and the related consoli- dated statements of operations, stockholders’ equity, and cash flows for each of the years in the period ended December 31, 2010 of Sunstone Hotel Investors, Inc. and our report dated February 17, 2011 expressed an unqualified opinion thereon. Irvine, California February 17, 2011 44


  • Page 47

    Consolidated Balance Sheets December 31, December 31, 2010 2009 (in thousands, except share data) ASSETS Current assets: Cash and cash equivalents ($1,365 and $1,471 related to VIEs) $ 277,976 $ 353,255 Restricted cash ($3,581 and $4,711 related to VIEs) 55,972 36,858 Accounts receivable, net ($1,885 and $2,758 related to VIEs) 18,498 22,624 Due from affiliates 44 62 Inventories ($159 and $92 related to VIEs) 2,614 2,446 Prepaid expenses 8,126 7,423 Investment in hotel properties of discontinued operations, net — 118,814 Other current assets of discontinued operations, net — 15,879 Total current assets 363,230 557,361 Investment in hotel properties, net 2,034,223 1,923,392 Other real estate, net 12,012 14,044 Investments in unconsolidated joint ventures 246 542 Deferred financing costs, net 8,907 7,300 Goodwill 4,673 4,673 Other assets, net ($3 and $0 related to VIEs) 12,815 6,218 Total assets $ 2,436,106 $ 2,513,530 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued expenses ($713 and $523 related to VIEs) $ 21,530 $ 12,425 Accrued payroll and employee benefits ($1,123 and $1,121 related to VIEs) 12,938 9,092 Due to Third Party Managers 7,852 9,817 Dividends payable 5,137 5,137 Other current liabilities ($1,439 and $1,316 related to VIEs) 17,692 21,910 Current portion of notes payable 16,486 153,778 Notes payable of discontinued operations — 209,620 Other current liabilities of discontinued operations, net 19,613 47,813 Total current liabilities 101,248 469,592 Notes payable, less current portion 1,126,817 1,050,019 Other liabilities ($30 and $12 related to VIEs) 8,742 7,256 Total liabilities 1,236,807 1,526,867 Commitments and contingencies (Note 14) — — Preferred stock, Series C Cumulative Convertible Redeemable Preferred Stock, $0.01 par value, 4,102,564 shares authorized, issued and outstanding at December 31, 2010 and 2009, liquidation preference of $24.375 per share 100,000 99,896 Stockholders’ equity: Preferred stock, $0.01 par value, 100,000,000 shares authorized. 8.0% Series A Cumulative Redeemable Preferred Stock, 7,050,000 shares issued and outstanding at December 31, 2010 and 2009, stated at liquidation preference of $25.00 per share 176,250 176,250 Common stock, $0.01 par value, 500,000,000 shares authorized, 116,950,504 shares issued and outstanding at December 31, 2010 and 96,904,075 shares issued and outstanding at December 31, 2009 1,170 969 Additional paid in capital 1,313,498 1,119,005 Retained earnings (deficit) 29,593 (8,949) Cumulative dividends (418,075) (397,527) Accumulated other comprehensive loss (3,137) (2,981) Total stockholders’ equity 1,099,299 886,767 Total liabilities and stockholders’ equity $ 2,436,106 $ 2,513,530 The abbreviation VIEs above refers to “Variable Interest Entities.” See accompanying notes to consolidated financial statements. 45


  • Page 48

    Consolidated Statements of Operations Year Ended Year Ended Year Ended December 31, December 31, December 31, 2010 2009 2008 (in thousands, except per share data) REVENUES Room $428,412 $ 408,150 $504,104 Food and beverage 164,378 161,963 201,952 Other operating 50,300 53,744 59,140 Total revenues 643,090 623,857 765,196 OPERATING EXPENSES Room 109,935 101,780 113,987 Food and beverage 120,650 118,629 145,576 Other operating 26,871 26,916 29,823 Advertising and promotion 33,182 32,295 35,676 Repairs and maintenance 28,049 27,360 29,579 Utilities 25,232 24,895 28,731 Franchise costs 21,474 20,656 24,658 Property tax, ground lease and insurance 42,349 43,352 44,993 Property general and administrative 77,101 72,823 86,797 Corporate overhead 28,803 25,242 21,511 Depreciation and amortization 95,500 93,795 93,759 Property and goodwill impairment losses 1,943 30,852 57 Total operating expenses 611,089 618,595 655,147 Operating income 32,001 5,262 110,049 Equity in net earnings (losses) of unconsolidated joint ventures 555 (27,801) (1,445) Interest and other income 111 1,388 3,639 Interest expense (70,830) (76,539) (83,176) Gain on extinguishment of debt — 54,506 — Income (loss) from continuing operations (38,163) (43,184) 29,067 Income (loss) from discontinued operations 76,705 (226,424) 42,171 NET INCOME (LOSS) 38,542 (269,608) 71,238 Dividends paid on unvested restricted stock compensation — (447) (814) Preferred stock dividends and accretion (20,652) (20,749) (20,884) Undistributed income allocated to unvested restricted stock compensation (102) — — INCOME AVAILABLE (LOSS ATTRIBUTABLE) TO COMMON STOCKHOLDERS $ 17,788 $(290,804) $ 49,540 Basic per share amounts: Income (loss) from continuing operations available (attributable) to common stockholders $ (0.59) $ (0.92) $ 0.14 Income (loss) from discontinued operations 0.77 (3.25) 0.78 Basic income available (loss attributable) to common stockholders per common share $ 0.18 $ (4.17) $ 0.92 Diluted per share amounts: Income (loss) from continuing operations available (attributable) to common stockholders $ (0.59) $ (0.92) $ 0.14 Income (loss) from discontinued operations 0.77 (3.25) 0.78 Diluted income available (loss attributable) to common stockholders per common share $ 0.18 $ (4.17) $ 0.92 Weighted average common shares outstanding: Basic 99,709 69,820 53,633 Diluted 99,709 69,820 53,662 See accompanying notes to consolidated financial statements. 46


  • Page 49

    Consolidated Statements of Stockholders’ Equity Accumulated Preferred Stock Common Stock Additional Retained Other Number Number Paid in Earnings Cumulative Comprehensive of Shares Amount of Shares Amount Capital (Deficit) Dividends Loss Total (in thousands, except per share data) Balance at December 31, 2007 7,050,000 $176,250 58,815,271 $ 588 $1,009,353 $ 189,421 $ (261,665) $(1,185) $1,112,762 Vesting of restricted common stock — — 157,869 2 4,477 — — — 4,479 Repurchase of outstanding common stock — — (11,108,486) (111) (184,356) — — — (184,467) Common dividends and dividends payable at $1.20 per share — — — — — — (65,573) — (65,573) Series A preferred dividends and dividends payable at $2.00 per share — — — — — — (14,100) — (14,100) Series C preferred dividends and dividends payable at $1.605 per share — — — — — — (6,584) — (6,584) Accretion of discount on Series C preferred stock — — — — (200) — — — (200) Net income — — — — — 71,238 — — 71,238 Pension liability adjustment — — — — — — — (2,743) (2,743) Comprehensive income — — — — — — — — 68,495 Balance at December 31, 2008 7,050,000 176,250 47,864,654 479 829,274 260,659 (347,922) (3,928) 914,812 Net proceeds from sale of common stock — — 43,700,000 437 256,638 — — — 257,075 Vesting of restricted common stock — — 290,264 3 4,287 — — — 4,290 Common dividends at $0.60 per share — — 5,049,157 50 29,006 — (29,056) — — Series A preferred dividends and dividends payable at $2.00 per share — — — — — — (14,100) — (14,100) Series C preferred dividends and dividends payable at $1.572 per share — — — — — — (6,449) — (6,449) Accretion of discount on Series C preferred stock — — — — (200) — — — (200) Net loss — — — — — (269,608) — — (269,608) Pension liability adjustment — — — — — — — 947 947 Comprehensive loss — — — — — — — — (268,661) Balance at December 31, 2009 7,050,000 176,250 96,904,075 969 1,119,005 (8,949) (397,527) (2,981) 886,767 Net proceeds from sale of common stock — — 19,500,000 195 190,447 — — — 190,642 Vesting of restricted common stock — — 546,429 6 4,150 — — — 4,156 Series A preferred dividends and dividends payable at $2.00 per share — — — — — — (14,100) — (14,100) Series C preferred dividends and dividends payable at $1.572 per share — — — — — — (6,448) — (6,448) Accretion of discount on Series C preferred stock — — — — (104) — — — (104) Net income — — — — — 38,542 — — 38,542 Pension liability adjustment — — — — — — — (156) (156) Comprehensive income — — — — — — — — 38,386 Balance at December 31, 2010 7,050,000 $176,250 116,950,504 $1,170 $1,313,498 $ 29,593 $ (418,075) $(3,137) $1,099,299 See accompanying notes to consolidated financial statements. 47


  • Page 50

    Consolidated Statements of Cash Flows Year Ended Year Ended Year Ended December 31, December 31, December 31, 2010 2009 2008 (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 38,542 $(269,608) $ 71,238 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Bad debt expense 89 5,976 671 (Gain) loss on sales of hotel properties and other assets, net 382 12,677 (26,013) Gain on extinguishment of debt (86,235) (54,506) — Depreciation 100,670 110,642 117,137 Amortization of franchise fees and other intangibles 543 418 2,277 Amortization and write-off of deferred financing fees 3,623 2,673 1,702 Amortization of loan discounts 996 1,813 3,505 Amortization of deferred stock compensation 3,942 4,055 3,975 Property and goodwill impairment losses 1,943 226,145 2,904 Equity in net (earnings) losses of unconsolidated joint ventures (555) 27,801 1,445 Changes in operating assets and liabilities: Restricted cash (19,234) (879) 372 Accounts receivable 4,269 9,903 604 Due from affiliates 18 47 823 Inventories (163) 290 7 Prepaid expenses and other assets (4,494) 2,008 1,555 Accounts payable and other liabilities (1,301) (4,537) (12,249) Accrued payroll and employee benefits 3,829 712 (9,281) Due to Third Party Managers (2,449) (3,942) (2,891) Discontinued operations 987 (6,948) 2,221 Net cash provided by operating activities 45,402 64,740 160,002 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of hotel properties and other assets 63 64,073 360,395 Cash received from unconsolidated joint ventures 900 500 5,675 Restricted cash—replacement reserve (931) (1,823) 5,136 Acquisitions of notes receivable (3,950) — — Acquisitions of hotel properties and land (142,410) — (30,695) Renovations and additions to hotel properties and other real estate (56,984) (44,105) (94,697) Net cash provided by (used in) investing activities (203,312) 18,645 245,814 (continued) 48

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