Table of Contents

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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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** **

**FORM 10-Q**

 

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| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For the quarterly period ended June 30,2010**

 

**OR**

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

 

**For the transition period from                to                **

 

**Commission file number 001-32319**

 

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**Sunstone Hotel Investors, Inc.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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| **Maryland**                                                    | ** ** | **20-1296886**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |       | (I.R.S. Employer  Identification Number) |
|                                                            |       |                                     |
| **120 Vantis,  Suite 350  Aliso Viejo, California**        | ** ** | **92656**                                |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                               |

 

Registrant’stelephone number, including area code:**(949)330-4000**

 

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Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes  x  No  o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes  o  No  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

98,529,494****shares ofCommon Stock, $0.01 par value, as of August 1, 2010

 

 

 

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Table of Contents

 

**SUNSTONEHOTEL INVESTORS, INC.**

**QUARTERLY REPORT ON**

**FORM 10-Q**

 

**For theQuarterly Period Ended June 30, 2010**

 

**TABLE OFCONTENTS**

 
| ** ** | ** **                                                                                                            | ** ** | **Page** |
|------------|-----------------------------------------------------------------------------------------------------------------------|------------|----------|
| ** ** | **PART I—FINANCIAL  INFORMATION**                                                                           |       |     |
|       |                                                                                                                  |       |     |
| Item 1.    | Financial Statements:                                                                                                 |       |     |
|       |                                                                                                                  |       |     |
|       | Consolidated Balance Sheets as of June 30, 2010  (unaudited) and December 31, 2009                          |       | 1        |
|       |                                                                                                                  |       |     |
|       | Unaudited Consolidated Statements of Operations for  the Three and Six Months Ended June 30, 2010 and 2009       |       | 2        |
|       |                                                                                                                  |       |     |
|       | Consolidated Statements of Stockholders’ Equity as of  June 30, 2010 (unaudited) and December 31, 2009 |       | 3        |
|       |                                                                                                                  |       |     |
|       | Unaudited Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2010 and 2009                 |       | 4        |
|       |                                                                                                                  |       |     |
|       | Notes to Unaudited Consolidated Financial Statements                                                                  |       | 5        |
|       |                                                                                                                  |       |     |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |       | 23       |
|       |                                                                                                                  |       |     |
| Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk                                                           |       | 44       |
|       |                                                                                                                  |       |     |
| Item 4.    | Controls and  Procedures                                                                                              |       | 44       |
|       |                                                                                                                  |       |     |
| ** ** | **PART II—OTHER  INFORMATION**                                                                              |       |     |
|       |                                                                                                                  |       |     |
| Item 1.    | Legal Proceedings                                                                                                     |       | 45       |
|       |                                                                                                                  |       |     |
| Item 1A.   | Risk Factors                                                                                                          |       | 45       |
|       |                                                                                                                  |       |     |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                          |       | 45       |
|       |                                                                                                                  |       |     |
| Item 3     | Defaults Upon  Senior Securities                                                                                      |       | 45       |
|       |                                                                                                                  |       |     |
| Item 4.    | Removed and Reserved                                                                                                  |       | 45       |
|       |                                                                                                                  |       |     |
| Item 5.    | Other Information                                                                                                     |       | 45       |
|       |                                                                                                                  |       |     |
| Item 6.    | Exhibits                                                                                                              |       | 46       |
|       |                                                                                                                  |       |     |
| SIGNATURES |                                                                                                                  | 47         |

 

i

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Table ofContents

 

**PART I—FINANCIALINFORMATION**

 

**Item 1.****                                   ****Financial Statements**

 

**SUNSTONEHOTEL INVESTORS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

*(In thousands, except share data)*

 
| ** **                                                                                                                                                                                                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                   | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                                                                                                   | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                                                                                                                                       |       |              |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                              |       |              |       |                  |       |
| Cash and cash equivalents (including from VIEs of  $2,195 and $1,471, respectively)                                                                                                                                                                                          |       | $                 | 204,299    |                  | $          | 353,255 |   |
| Restricted cash (including from VIEs of $3,947 and  $4,711, respectively)                                                                                                                                                                                                    |       | 70,237            |       | 36,858                |       |
| Accounts receivable, net (including from VIEs of  $4,121 and $2,758, respectively)                                                                                                                                                                                           |       | 26,484            |       | 22,624                |       |
| Due from affiliates                                                                                                                                                                                                                                                          |       | 34                |       | 62                    |       |
| Inventories (including from VIEs of $93 and $92,  respectively)                                                                                                                                                                                                              |       | 2,282             |       | 2,446                 |       |
| Prepaid expenses                                                                                                                                                                                                                                                             |       | 5,330             |       | 7,423                 |       |
| Investment in hotel property of discontinued  operations, net                                                                                                                                                                                                                |       | —            |       | 16,471                |       |
| Other current assets of discontinued operations,  net                                                                                                                                                                                                                        |       | —            |       | 1,739                 |       |
| Investment in hotel properties of operations held  for non-sale disposition, net                                                                                                                                                                                             |       | 99,527            |       | 102,343               |       |
| Other current assets of operations held for  non-sale disposition, net                                                                                                                                                                                                       |       | 29,443            |       | 14,140                |       |
| Total current assets                                                                                                                                                                                                                                                         |       | 437,636           |       | 557,361               |       |
| Investment in hotel properties, net                                                                                                                                                                                                                                          |       | 1,919,125         |       | 1,923,392             |       |
| Other real estate, net                                                                                                                                                                                                                                                       |       | 12,058            |       | 14,044                |       |
| Investments in unconsolidated joint ventures                                                                                                                                                                                                                                 |       | 543               |       | 542                   |       |
| Deferred financing fees, net                                                                                                                                                                                                                                                 |       | 4,920             |       | 7,300                 |       |
| Goodwill                                                                                                                                                                                                                                                                     |       | 4,673             |       | 4,673                 |       |
| Other assets, net                                                                                                                                                                                                                                                            |       | 9,427             |       | 6,218                 |       |
| Total assets                                                                                                                                                                                                                                                                 |       | $                 | 2,388,382  |                  | $          | 2,513,530 |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                    |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                         |       |              |       |                  |       |
| Accounts payable and accrued expenses (including  from VIEs of $815 and $523, respectively)                                                                                                                                                                                  |       | $                 | 12,673     |                  | $          | 12,425 |   |
| Accrued payroll and employee benefits (including  from VIEs of $1,020 and $1,121, respectively)                                                                                                                                                                              |       | 9,497             |       | 9,092                 |       |
| Due to Third Party Managers                                                                                                                                                                                                                                                  |       | 9,761             |       | 9,817                 |       |
| Dividends payable                                                                                                                                                                                                                                                            |       | 5,137             |       | 5,137                 |       |
| Other current liabilities (including from VIEs of  $1,934 and $1,316, respectively)                                                                                                                                                                                          |       | 21,907            |       | 21,910                |       |
| Current portion of notes payable                                                                                                                                                                                                                                             |       | 93,401            |       | 153,778               |       |
| Note payable of discontinued operations                                                                                                                                                                                                                                      |       | —            |       | 25,499                |       |
| Notes payable of operations held for non-sale  disposition                                                                                                                                                                                                                   |       | 162,972           |       | 184,121               |       |
| Other current liabilities of discontinued  operations, net                                                                                                                                                                                                                   |       | 43,904            |       | 41,449                |       |
| Other current liabilities of operations held for  non-sale disposition                                                                                                                                                                                                       |       | 20,455            |       | 6,364                 |       |
| Total current liabilities                                                                                                                                                                                                                                                    |       | 379,707           |       | 469,592               |       |
| Notes payable, less current portion                                                                                                                                                                                                                                          |       | 1,043,622         |       | 1,050,019             |       |
| Other liabilities (including from VIEs of $3 and  $12, respectively)                                                                                                                                                                                                         |       | 7,692             |       | 7,256                 |       |
| Total liabilities                                                                                                                                                                                                                                                            |       | 1,431,021         |       | 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 June 30, 2010 and  December 31, 2009, liquidation preference of $24.375 per share                      |       | 99,996            |       | 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 June 30, 2010 and  December 31, 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, 97,216,527 shares issued and outstanding at June 30, 2010  and 96,904,075 shares issued and outstanding at December 31, 2009                                                                        |       | 972               |       | 969                   |       |
| Additional paid in capital                                                                                                                                                                                                                                                   |       | 1,120,657         |       | 1,119,005             |       |
| Retained earnings (deficit)                                                                                                                                                                                                                                                  |       | (29,732           | )          | (8,949                | )          |
| Cumulative dividends                                                                                                                                                                                                                                                         |       | (407,801          | )          | (397,527              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                         |       | (2,981            | )          | (2,981                | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                              |       | 857,365           |       | 886,767               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                              |       | $                 | 2,388,382  |                  | $          | 2,513,530 |   |

 

The abbreviation VIEs above means Variable InterestEntities.

 

*See accompanying notes to consolidated financialstatements.*

 

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Table ofContents

 

**SUNSTONE HOTEL INVESTORS, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF OPERATIONS**

*(In thousands, except per share data)*

 
| ** **                                                              | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| REVENUES                                                                |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Room                                                                    |       | $                                                    | 108,323    |                                                 | $          | 101,214                                            |       | $                                                  | 198,701    |   | $ | 197,897 |   |
| Food and beverage                                                       |       | 40,543                                               |       | 40,220                                               |       | 78,751                                             |       | 81,257                                             |       |
| Other operating                                                         |       | 12,008                                               |       | 13,086                                               |       | 24,321                                             |       | 25,412                                             |       |
| Revenues of operations held for non-sale  disposition                   |       | 20,158                                               |       | 21,575                                               |       | 39,992                                             |       | 42,922                                             |       |
| Total revenues                                                          |       | 181,032                                              |       | 176,095                                              |       | 341,765                                            |       | 347,488                                            |       |
| OPERATING EXPENSES                                                      |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Room                                                                    |       | 25,669                                               |       | 24,073                                               |       | 48,961                                             |       | 46,814                                             |       |
| Food and beverage                                                       |       | 29,095                                               |       | 29,046                                               |       | 56,783                                             |       | 58,422                                             |       |
| Other operating                                                         |       | 6,379                                                |       | 6,376                                                |       | 13,117                                             |       | 13,334                                             |       |
| Advertising and promotion                                               |       | 8,903                                                |       | 8,728                                                |       | 17,225                                             |       | 17,903                                             |       |
| Repairs and maintenance                                                 |       | 6,614                                                |       | 6,582                                                |       | 13,077                                             |       | 13,301                                             |       |
| Utilities                                                               |       | 5,530                                                |       | 5,588                                                |       | 11,359                                             |       | 12,148                                             |       |
| Franchise costs                                                         |       | 5,636                                                |       | 5,104                                                |       | 10,151                                             |       | 9,799                                              |       |
| Property tax, ground lease, and insurance                               |       | 10,663                                               |       | 10,096                                               |       | 20,970                                             |       | 20,055                                             |       |
| Property general and administrative                                     |       | 18,876                                               |       | 17,867                                               |       | 36,021                                             |       | 35,896                                             |       |
| Corporate overhead                                                      |       | 5,135                                                |       | 4,785                                                |       | 9,715                                              |       | 10,492                                             |       |
| Depreciation and amortization                                           |       | 23,264                                               |       | 23,765                                               |       | 46,822                                             |       | 47,289                                             |       |
| Operating expenses of operations held for non-sale  disposition         |       | 17,912                                               |       | 20,400                                               |       | 35,950                                             |       | 39,260                                             |       |
| Property and goodwill impairment losses                                 |       | 1,943                                                |       | 27,237                                               |       | 1,943                                              |       | 28,643                                             |       |
| Goodwill impairment losses of operations held for  non-sale disposition |       | —                                               |       | 697                                                  |       | —                                             |       | 3,007                                              |       |
| Total operating expenses                                                |       | 165,619                                              |       | 190,344                                              |       | 322,094                                            |       | 356,363                                            |       |
| Operating income (loss)                                                 |       | 15,413                                               |       | (14,249                                              | )          | 19,671                                             |       | (8,875                                             | )          |
| Equity in earnings (losses) of unconsolidated  joint ventures           |       | 163                                                  |       | (584                                                 | )          | 275                                                |       | (2,101                                             | )          |
| Interest and other income                                               |       | 99                                                   |       | 252                                                  |       | 270                                                |       | 872                                                |       |
| Interest expense                                                        |       | (17,015                                              | )          | (19,498                                              | )          | (37,056                                            | )          | (39,513                                            | )          |
| Interest expense of operations held for non-sale  disposition           |       | (4,986                                               | )          | (2,892                                               | )          | (10,397                                            | )          | (5,787                                             | )          |
| Gain on extinguishment of debt                                          |       | —                                               |       | 26,559                                               |       | —                                             |       | 54,579                                             |       |
| Loss from continuing operations                                         |       | (6,326                                               | )          | (10,412                                              | )          | (27,237                                            | )          | (825                                               | )          |
| Income (loss) from discontinued operations                              |       | 6,634                                                |       | (119,793                                             | )          | 6,454                                              |       | (122,870                                           | )          |
| NET INCOME (LOSS)                                                       |       | 308                                                  |       | (130,205                                             | )          | (20,783                                            | )          | (123,695                                           | )          |
| Dividends paid on unvested restricted stock  compensation               |       | —                                               |       | —                                               |       | —                                             |       | (447                                               | )          |
| Preferred stock dividends and accretion                                 |       | (5,187                                               | )          | (5,188                                               | )          | (10,374                                            | )          | (10,375                                            | )          |
| LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS                                |       | $                                                    | (4,879     | )                                                    | $          | (135,393                                           | )          | $                                                  | (31,157    | ) | $ | (134,517 | ) |
| Basic per share amounts:                                                |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Loss from continuing operations attributable to  common stockholders    |       | $                                                    | (0.12      | )                                                    | $          | (0.26                                              | )          | $                                                  | (0.39      | ) | $ | (0.21 | ) |
| Income (loss) from discontinued operations                              |       | 0.07                                                 |       | (1.97                                                | )          | 0.07                                               |       | (2.17                                              | )          |
| Basic loss attributable to common stockholders per  common share        |       | $                                                    | (0.05      | )                                                    | $          | (2.23                                              | )          | $                                                  | (0.32      | ) | $ | (2.38 | ) |
| Diluted per share amounts:                                              |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Loss from continuing operations attributable to  common stockholders    |       | $                                                    | (0.12      | )                                                    | $          | (0.26                                              | )          | $                                                  | (0.39      | ) | $ | (0.21 | ) |
| Income (loss) from discontinued operations                              |       | 0.07                                                 |       | (1.97                                                | )          | 0.07                                               |       | (2.17                                              | )          |
| Diluted loss attributable to common stockholders  per common share      |       | $                                                    | (0.05      | )                                                    | $          | (2.23                                              | )          | $                                                  | (0.32      | ) | $ | (2.38 | ) |
| Weighted average common shares outstanding:                             |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Basic                                                                   |       | 97,188                                               |       | 60,845                                               |       | 97,118                                             |       | 56,549                                             |       |
| Diluted                                                                 |       | 97,188                                               |       | 60,845                                               |       | 97,118                                             |       | 56,549                                             |       |
| Dividends declared per common share                                     |       | $                                                    | —     |                                                 | $          | —                                             |       | $                                                  | —     |   | $ | — |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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Table ofContents

 

**SUNSTONEHOTEL INVESTORS, INC.**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

*(In thousands, except share data)*

 
| ** **                                                                                       | ** ** | ** **          | ** ** | ** **       | ** ** | ** **         | ** ** | ** ** | ** ** | ** **  | ** ** | ** **                  | ** ** | ** **     | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|--------------------|------------|------------|------------|-------------|------------|-----------------------------|------------|----------------|------------|-------------------|------------|------------|------------|
|                                                                                             |       | **Preferred Stock** |       | **Common Stock** |       | **Additional**     |       |       |       |        |       | **Other**                   |       |           |       |
| ** **                                                                                       | ** ** | **Number of**  | ** ** | ** **       | ** ** | **Number of** | ** ** | ** ** | ** ** | **Paid in** | ** ** | **Retained**                | ** ** | **Cumulative** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                                                                       | ** ** | **Shares**          | ** ** | **Amount**       | ** ** | **Shares**         | ** ** | **Amount** | ** ** | **Capital** | ** ** | **Earnings (Deficit)** | ** ** | **Dividends**  | ** ** | **Loss**          | ** ** | **Total**  | ** ** |
|                                                                                             |       |                |       |             |       |               |       |       |       |        |       |                        |       |           |       |              |       |       |       |
| 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 |   |
| Vesting of restricted common stock (unaudited)                                                   |       |                |       |             |       | 312,452            |       | 3          |       | 1,752       |       |                        |       |           |       |              |       | 1,755      |       |
| Series A preferred dividends and dividends payable  at $1.00 per share year to date (unaudited)  |       |                |       |             |       |               |       |       |       |        |       |                        |       | (7,050         | )          |              |       | (7,050     | )          |
| Series C preferred dividends and dividends payable  at $0.786 per share year to date (unaudited) |       |                |       |             |       |               |       |       |       |        |       |                        |       | (3,224         | )          |              |       | (3,224     | )          |
| Accretion of discount on Series C preferred stock  (unaudited)                                   |       |                |       |             |       |               |       |       |       | (100        | )          |                        |       |           |       |              |       | (100       | )          |
| Net loss and comprehensive loss (unaudited)                                                      |       |                |       |             |       |               |       |       |       |        |       | (20,783                     | )          |           |       |              |       | (20,783    | )          |
| Balance at June 30, 2010 (unaudited)                                                             |       | 7,050,000           |       | $                | 176,250    |               | 97,216,527 |       | $          | 972         |       | $                           | 1,120,657  |           | $          | (29,732           | )          | $          | (407,801   | ) | $ | (2,981 | ) | $ | 857,365 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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Table ofContents

 

**SUNSTONEHOTEL INVESTORS, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(In thousands)*

 
| ** **                                                                                 | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES                                                       |       |                                          |       |                                          |       |
| Net loss                                                                                   |       | $                                             | (20,783    | )                                             | $          | (123,695 | ) |
| Adjustments to reconcile net loss to net cash  (used in) provided by operating activities: |       |                                          |       |                                          |       |
| Bad debt expense (recovery)                                                                |       | (34                                           | )          | 230                                           |       |
| Loss on sale of other assets                                                               |       | —                                        |       | 12,716                                        |       |
| Gain on extinguishment of debt                                                             |       | (6,747                                        | )          | (54,579                                       | )          |
| Depreciation                                                                               |       | 50,048                                        |       | 58,261                                        |       |
| Amortization of franchise fees and other  intangibles                                      |       | 285                                           |       | 215                                           |       |
| Amortization and write-off of deferred financing  fees                                     |       | 2,650                                         |       | 1,204                                         |       |
| Amortization of loan discounts                                                             |       | 491                                           |       | 1,339                                         |       |
| Amortization of deferred stock compensation                                                |       | 1,648                                         |       | 2,348                                         |       |
| Property and goodwill impairment losses                                                    |       | 1,943                                         |       | 135,657                                       |       |
| Equity in (earnings) losses of unconsolidated  joint ventures                              |       | (275                                          | )          | 2,101                                         |       |
| Changes in operating assets and liabilities:                                               |       |                                          |       |                                          |       |
| Restricted cash                                                                            |       | (31,279                                       | )          | (3,641                                        | )          |
| Accounts receivable                                                                        |       | (3,142                                        | )          | 5,337                                         |       |
| Due from affiliates                                                                        |       | 28                                            |       | 17                                            |       |
| Inventories                                                                                |       | 167                                           |       | 455                                           |       |
| Prepaid expenses and other assets                                                          |       | 2,694                                         |       | 2,379                                         |       |
| Accounts payable and other liabilities                                                     |       | 13,887                                        |       | (2,638                                        | )          |
| Accrued payroll and employee benefits                                                      |       | 396                                           |       | (780                                          | )          |
| Due to Interstate SHP                                                                      |       | (72                                           | )          | (1,212                                        | )          |
| Discontinued operations                                                                    |       | 584                                           |       | (743                                          | )          |
| Operations held for non-sale disposition                                                   |       | (14,455                                       | )          | (608                                          | )          |
| Net cash (used in) provided by operating  activities                                       |       | (1,966                                        | )          | 34,363                                        |       |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                       |       |                                          |       |                                          |       |
| Proceeds from sale of hotel properties and other  assets                                   |       | —                                        |       | 56,289                                        |       |
| Cash received from unconsolidated joint ventures                                           |       | 300                                           |       | —                                        |       |
| Restricted cash — replacement reserve                                                 |       | (1,739                                        | )          | (515                                          | )          |
| Acquisitions of notes receivable                                                           |       | (3,700                                        | )          | —                                        |       |
| Renovations and additions to hotel properties and  other real estate                       |       | (17,123                                       | )          | (26,059                                       | )          |
| Net cash (used in) provided by investing  activities                                       |       | (22,262                                       | )          | 29,715                                        |       |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                       |       |                                          |       |                                          |       |
| Proceeds from common stock offering                                                        |       | —                                        |       | 103,500                                       |       |
| Payment of common stock offering costs                                                     |       | —                                        |       | (4,802                                        | )          |
| Proceeds from notes payable                                                                |       | —                                        |       | 60,000                                        |       |
| Payments on notes payable and related costs                                                |       | (114,450                                      | )          | (66,781                                       | )          |
| Payments for repurchases of notes payable and  related costs                               |       | —                                        |       | (117,377                                      | )          |
| Payments of deferred financing costs                                                       |       | (4                                            | )          | (3,104                                        | )          |
| Dividends paid                                                                             |       | (10,274                                       | )          | (17,636                                       | )          |
| Net cash used in financing activities                                                      |       | (124,728                                      | )          | (46,200                                       | )          |
| Net (decrease) increase in cash and cash  equivalents                                      |       | (148,956                                      | )          | 17,878                                        |       |
| Cash and cash equivalents, beginning of period                                             |       | 353,255                                       |       | 176,102                                       |       |
| Cash and cash equivalents, end of period                                                   |       | $                                             | 204,299    |                                          | $          | 193,980 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                          |       |                                          |       |                                          |       |
| Cash paid for interest                                                                     |       | $                                             | 32,734     |                                          | $          | 49,995 |   |
| NONCASH INVESTING ACTIVITY                                                                 |       |                                          |       |                                          |       |
| Deconsolidation of assets of hotel placed into  receivership                               |       | $                                             | 18,374     |                                          | $          | — |   |
| Deconsolidation of liabilities of hotel placed  into receivership                          |       | $                                             | 26,854     |                                          | $          | — |   |
| Amortization of deferred stock compensation —  construction activities                |       | $                                             | 90         |                                          | $          | 124 |   |
| Amortization of deferred stock compensation —  unconsolidated joint venture           |       | $                                             | 17         |                                          | $          | 16 |   |
| NONCASH FINANCING ACTIVITY                                                                 |       |                                          |       |                                          |       |
| Issuance of stock dividend                                                                 |       | $                                             | —     |                                          | $          | 29,056 |   |
| Dividends payable                                                                          |       | $                                             | 5,137      |                                          | $          | 5,138 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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**SUNSTONE HOTEL INVESTORS, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**1. Organization and Description of Business**

 

SunstoneHotel Investors, Inc. (the “Company”) was incorporated in Maryland on June 28,2004 in anticipation of an initial public offering of common stock, which wasconsummated on October 26, 2004. The Company, through its 100% controlling interest in Sunstone HotelPartnership, LLC (the “Operating Partnership”), of which the Company is thesole managing member, and the subsidiaries of the Operating Partnership,including Sunstone Hotel TRS Lessee, Inc. (the “TRS Lessee”) and itssubsidiaries, is currently engaged in acquiring, owning, asset managing andrenovating hotel properties. The Company may also sell certain hotel propertiesfrom time to time. The Company operates as a real estate investment trust (“REIT”)for federal income tax purposes.

 

Asa REIT, certain tax laws limit the amount of “non-qualifying” income theCompany can earn, including income derived directly from the operation ofhotels. As a result, the Company leases all of its hotels to its TRS Lessee,which in turn enters into long-term management agreements with third parties tomanage the operations of the Company’s hotels. As of June 30, 2010, theCompany owned 38 hotels. Pursuant to a secured debt restructuring programinitiated by the Company in 2009 which was aimed at reducing leverage andminimizing risk associated with individual hotels (the “2009 secured debtrestructuring program”), the Company is currently in the process oftransferring ownership and control of eight (the “Mass Mutual eight”) of its 38hotels to a lender in satisfaction of a non-recourse mortgage, leaving 30hotels (the “30 hotels”) currently held for investment. The Company hasreclassified the assets, liabilities and operating results of the Mass Mutualeight to “operations held for non-sale disposition” on its balance sheets,statements of operations and cash flows. Two additional hotels, the W San Diegoand Marriott Ontario Airport, are included in discontinued operations. Thesetwo hotels were transferred to receivers pursuant to the 2009 secured debtrestructuring program. The Renaissance Westchester, which was also transferredto a receiver pursuant to the 2009 secured debt restructuring program, wasreacquired by the Company on June 14, 2010. Operating results for theRenaissance Westchester for 2009, therefore, are included in discontinuedoperations, whereas operating results from June 14, 2010 forward areincluded in the Company’s continuing operations.

 

Asof June 30, 2010, the Company’s third-party managers included SunstoneHotel Properties, Inc., a division of Interstate Hotels & Resorts, Inc.(“Interstate SHP”), manager of 20 of the Company’s 38 hotels; subsidiaries ofMarriott International, Inc. or Marriott Hotel Services, Inc.(collectively, “Marriott”), managers of 13 of the Company’s 38 hotels; andDavidson Hotel Company (“Davidson”), Fairmont Hotels & Resorts (U.S.)(“Fairmont”), Hilton Worldwide (“Hilton”), Hyatt Corporation (“Hyatt”) and SageHospitality Resources (“Sage”), each managers of one of the Company’s 38hotels.  In addition to its wholly ownedhotels, the Company has a 38% equity interest in a joint venture that owns onehotel.

 

**2. Summary of Significant Accounting Policies**

 

**Basis of Presentation**

 

Theaccompanying consolidated financial statements as of June 30, 2010 and December 31,2009, and for the three and six months ended June 30, 2010 and 2009,include the accounts of the Company, the Operating Partnership, the TRS Lesseeand their subsidiaries. All significant intercompany balances and transactionshave been eliminated.

 

Theaccompanying interim financial statements have been prepared in accordance withaccounting principles generally accepted in the United States (“GAAP”) and inconformity with the rules and regulations of the Securities and ExchangeCommission. In the Company’s opinion, the interim financial statementspresented herein reflect all adjustments, consisting solely of normal andrecurring adjustments, which are necessary to fairly present the interimfinancial statements. These financial statements should be read in conjunctionwith the financial statements included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 31, 2009, filed with the Securities andExchange Commission on February 23, 2010.

 

Certainprior year amounts have been reclassified in the consolidated financialstatements in order to conform to the current year presentation as a result ofthe transfer of the Marriott Ontario Airport to a receiver in March 2010,and the finalization of a restructuring agreement with Mass Mutual in April 2010regarding the Mass Mutual eight hotels along with three additional hotels thatsecured this non-recourse mortgage.

 

TheCompany has evaluated subsequent events through the date of issuance of thesefinancial statements.

 

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**Use of Estimates**

 

Thepreparation of consolidated financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differmaterially from those estimates.

 

**Reporting Periods**

 

Theresults the Company reports in its consolidated statements of operations arebased on results reported to the Company by its hotel managers.  These hotel managers use different reportingperiods.  Marriott uses a fiscal yearending on the Friday closest to December 31 and reports twelve weeks ofoperations for each of the first three quarters of the year, and sixteen orseventeen weeks of operations for the fourth quarter of the year.  The Company’s other hotel managers reportoperations on a standard monthly calendar. The Company has elected to adopt quarterly close periods of March 31,June 30 and September 30, and an annual year end of December 31.As a result, the Company’s 2010 results of operations for the Marriott-managedhotels include results from January 2 through March 26 for the firstquarter, March 27 through June 18 for the second quarter, June 19through September 10 for the third quarter, and September 11 through December 31for the fourth quarter. The Company’s 2009 results of operations for theMarriott-managed hotels include results from January 3 through March 27for the first quarter, March 28 through June 19 for the secondquarter, June 20 through September 11 for the third quarter, and September 12through January 1 for the fourth quarter.

 

**Fair Value of Financial Instruments**

 

As of June 30, 2010 and December 31, 2009,the carrying amount of certain financial instruments, including cash and cashequivalents, restricted cash, accounts receivable, accounts payable and accruedexpenses were representative of their fair values due to the short-termmaturity of these instruments.

 

TheCompany follows the requirements of the Fair Value Measurements and DisclosureTopic of the Financial Accounting Standards Board (“FASB”) Accounting StandardsCodification (“ASC”), which establishes a framework for measuring fair valueand disclosing fair value measurements by establishing a fair value hierarchythat prioritizes the inputs to valuation techniques used to measure fair value.The hierarchy gives the highest priority to unadjusted quoted prices in activemarkets for identical assets or liabilities (Level 1 measurements) andlowest priority to unobservable inputs (Level 3 measurements). The threelevels of the fair value hierarchy are described below:

 
| Level  1 |   | Observable  inputs that reflect quoted prices (unadjusted) for identical assets or  liabilities in active markets.                                                                                                                                                                                                                                                                |
|----------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                                                                              |
| Level  2 |   | Inputs  reflect quoted prices for identical assets or liabilities in markets that are  not active; quoted prices for similar assets or liabilities in active  markets; inputs other than quoted prices that are observable for the asset or  the liability; or inputs that are derived principally from or corroborated by  observable market data by correlation or other means. |
|     |   |                                                                                                                                                                                                                                                                                                                                                                              |
| Level 3  |   | Unobservable inputs reflecting the Company’s own assumptions  incorporated in valuation techniques used to determine fair value. These  assumptions are required to be consistent with market participant assumptions  that are reasonably available.                                                                                                                        |

 

The Company currently paysthe premiums for a $5,000,000 split life insurance policy for its former ChiefExecutive Officer and current Executive Chairman, Robert A. Alter. Under the terms of the policy, the Companyis entitled to receive the greater of the cash surrender value of the policy orthe premiums paid by the Company following the termination of Mr. Alter’semployment with the Company. Within 60 days following the date of thetermination of the split dollar policy during Mr. Alter’s lifetime, Mr. Altermay obtain a release of such obligation by paying the Company the greater ofthe total amount of the premiums paid by the Company or the then-current cashsurrender value. The Company has valued this policy using Level 2 measurementsat $1.8 million as of both June 30, 2010 and December 31, 2009. Theseamounts are included in other assets, net in the accompanying balance sheets.

 

The Company also has aRetirement Benefit Agreement with Mr. Alter. Pursuant to the RetirementBenefit Agreement, Mr. Alter may defer a portion of his compensation.Mr. Alter may amend the amount of his compensation to be deferred fromtime to time; provided, however, that any such amendment must be in compliancewith Section 409A of the Internal Revenue Code. The Company will match 50%of Mr. Alter’s deferrals for each year, up to a maximum of $1,500 for thatyear. Earnings on Mr. Alter’s deferrals and the Company’s matchingcontributions are an amount equal to the amount which would have been earned onsuch deferrals and matching contributions had they been paid as premiums on thelife insurance policy noted above in accordance with the investmentdesignations made by Mr. Alter. The balance in Mr. Alter’s deferredcompensation account is payable over a period of time following the terminationof his employment with the Company,

 

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regardlessof the reason for such termination. TheCompany has valued this agreement using Level 2 measurements at $1.8 million asof both June 30, 2010 and December 31, 2009. These amounts areincluded in accrued payroll and employee benefits in the accompanying balance sheets.

 

TheCompany has analyzed the carrying values of its hotel properties using Level 3measurements, including a discounted cash flow analysis to estimate the fairvalue of its hotel properties taking into account each property’s expected cashflow from operations, holding period and estimated proceeds from thedisposition of the property. The factors addressed in determining estimatedproceeds from disposition included anticipated operating cash flow in the yearof disposition and terminal capitalization rate. In June 2010, the Companyrecognized a $1.9 million impairment on an office building and land adjacent toone of its hotels based on estimated proceeds expected to be received from thepossible sale of this property during the third or fourth quarter of 2010. Whenindicators of impairment existed in 2009 and the undiscounted cash flows wereless than the carrying value of the asset, the Company used terminalcapitalization rates in its 2009 analyses ranging between 8.1% and 9.6%, basedon the Company’s weighted average cost of capital, a hurdle rate assigned toeach hotel to account for a hotel’s individual characteristics including, butnot limited to, size, age and market supply, and an estimated average annualgrowth rate.

 

The Company has analyzed the carrying value of itsgoodwill using Level 3 measurements including a discounted cash flow analysisto estimate the fair value of its reporting units. For the three and six monthsended June 30, 2010, the Company did not identify any properties withindicators of goodwill impairment. When indicators of goodwill impairmentexisted in 2009 and the discounted cash flows were less than the carrying valueof the reporting unit, the Company used discount rates ranging between 13.0%and 13.8% in its 2009 analyses, taking into account each related reporting unit’sexpected cash flow from operations, holding period and proceeds from thepotential disposition of the property. The factors addressed in determiningestimated proceeds from disposition include anticipated operating cash flow inthe year of potential disposition and terminal capitalization rate. The Companyused terminal capitalization rates in its 2009 analyses ranging between 8.1%and 9.6%, based on the Company’s weighted average cost of capital, a hurdlerate assigned to each hotel to account for a hotel’s individual characteristicsincluding, but not limited to, size, age and market supply, and an estimatedaverage annual growth rate. The Company’s judgment is required in determiningthe discount rate applied to estimated cash flows, the terminal capitalizationrate, the growth rate of each property’s projected revenues and expenses, theneed for capital expenditures, as well as specific market and economicconditions.

 

As of June 30, 2010 and December 31, 2009,all of the Company’s outstanding debt had fixed interest rates. The Company’scarrying value of its debt, including the Mass Mutual eight hotels, totaled$1.3 billion and $1.4 billion as of June 30, 2010 and December 31,2009, respectively. Using Level 3 measurements, including the Company’sweighted average cost of capital ranging between 7.0% and 9.6%, the Companyestimates that the fair market value of its debt as of both June 30, 2010and December 31, 2009 totaled $1.2 billion.

 

Thefollowing table presents the impairment charges recorded as a result ofapplying Level 3 measurements included in earnings for the three and six monthsended June 30, 2010 and 2009 (in thousands):

 
| ** **                                                                 | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                 | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                          | ** ** | **(unaudited)**                          | ** ** |
| Investment in hotel  properties, net                                       |       | $                                          | —     |                                       | $          | 25,371                                   |       | $                                        | —     |   | $ | 25,488 |   |
| Investment in hotel  properties of discontinued operations, net            |       | —                                     |       | 104,007                                    |       | —                                   |       | 104,007                                  |       |
| Other real estate, net                                                     |       | 1,943                                      |       | —                                     |       | 1,943                                    |       | —                                   |       |
| Goodwill                                                                   |       | —                                     |       | 450                                        |       | —                                   |       | 1,739                                    |       |
| Other current assets of  operations held for non-sale disposition, net (1) |       | —                                     |       | 697                                        |       | —                                   |       | 3,007                                    |       |
| Other assets, net                                                          |       | —                                     |       | 1,416                                      |       | —                                   |       | 1,416                                    |       |
| Total Level 3 measurement  impairment losses included in earnings          |       | $                                          | 1,943      |                                       | $          | 131,941                                  |       | $                                        | 1,943      |   | $ | 135,657 |   |

 

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(1)          Includes goodwill impairmentlosses recorded on operations held for non-sale disposition.

 

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Thefollowing tables present our assets and liabilities measured at fair value on arecurring and non-recurring basis at June 30, 2010 and December 31,2009 (in thousands):

 
| ** **                                                | ** ** | **Total**              | ** ** | **Fair Value Measurements at Reporting Date** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|
| ** **                                                | ** ** | **June 30, 2010** | ** ** | **Level 1**                                   | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **                                                | ** ** | **(unaudited)**        | ** ** | **(unaudited)**                               | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| **Assets:**                                               |       |                   |       |                                          |       |   |   |   |   |
| Life insurance policy                                     |       | $                      | 1,807      |                                          | $          | — |   | $ | 1,807 |   | $ | — |   |
| Other real estate, net                                    |       | 2,150                  |       | —                                        |       | — |   | 2,150 |   |
| Goodwill                                                  |       | 4,673                  |       | —                                        |       | — |   | 4,673 |   |
| Goodwill of operations held for non-sale  disposition (1) |       | 1,174                  |       | —                                        |       | — |   | 1,174 |   |
| Total assets                                              |       | $                      | 9,804      |                                          | $          | — |   | $ | 1,807 |   | $ | 7,997 |   |
| **Liabilities:**                                          |       |                   |       |                                          |       |   |   |   |   |
| Retirement benefit agreement                              |       | $                      | 1,807      |                                          | $          | — |   | $ | 1,807 |   | $ | — |   |
| Total liabilities                                         |       | $                      | 1,807      |                                          | $          | — |   | $ | 1,807 |   | $ | — |   |

 
| ** **                                                                           | ** ** | **Total**                        | ** ** | **Fair Value Measurements at Reporting Date** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                           | ** ** | **December  31, 2009** | ** ** | **Level 1**                                   | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets:**                                                                          |       |                             |       |                                          |       |   |   |   |   |
| Investment in hotel properties of operations held  for non-sale disposition, net (2) |       | $                                | 69,272     |                                          | $          | — |   | $ | — |   | $ | 69,272 |   |
| Life insurance policy                                                                |       | 1,814                            |       | —                                        |       | 1,814 |   | — |   |
| Goodwill                                                                             |       | 4,673                            |       | —                                        |       | — |   | 4,673 |   |
| Goodwill of operations held for non-sale  disposition (1)                            |       | 1,174                            |       | —                                        |       | — |   | 1,174 |   |
| Total assets                                                                         |       | $                                | 76,933     |                                          | $          | — |   | $ | 1,814 |   | $ | 75,119 |   |
| **Liabilities:**                                                                     |       |                             |       |                                          |       |   |   |   |   |
| Retirement benefit agreement                                                         |       | $                                | 1,814      |                                          | $          | — |   | $ | 1,814 |   | $ | — |   |
| Total liabilities                                                                    |       | $                                | 1,814      |                                          | $          | — |   | $ | 1,814 |   | $ | — |   |

 

----

(1)      Goodwill of operations heldfor non-sale disposition is included in other current assets of operations heldfor non-sale disposition, net.

(2)      Includes the six hotelproperties that were impaired and recorded at fair value as of December 31,2009.

 

**Accounts Receivable**

 

Accountsreceivable primarily represents receivables from hotel guests who occupy hotelrooms and utilize hotel services. Accounts receivable also includes, amongother things, receivables from customers who utilize the Company’s commerciallaundry facilities in Salt Lake City, Utah, and Rochester, Minnesota, as wellas tenants who lease space in the Company’s hotels. The Company maintains anallowance for doubtful accounts sufficient to cover potential credit losses.The Company’s accounts receivable at both June 30, 2010 and December 31,2009 includes an allowance for doubtful accounts of $0.1 million, all of whichis included in continuing operations. At June 30, 2010 and December 31,2009, the Company had approximately $1.2 million and $2.6 million,respectively, in accounts receivable with one customer who is operating under acontract with the United States government. No amounts have been reserved forthis receivable as of either June 30, 2010 or December 31, 2009 asall amounts have been deemed to be collectible.

 

**Deferred Financing Fees**

 

Deferredfinancing fees consist of loan fees and other financing costs related to theCompany’s outstanding indebtedness and are amortized to interest expense overthe terms of the related debt. Upon repayment or refinancing of the underlyingdebt, any related unamortized deferred financing fee is charged to interestexpense. Upon any loan modification, any related unamortized deferred financingfee is amortized over the remaining terms of the modified loan. Unamortizeddeferred financing fees written off and charged to interest expense due to therepayment or modification of the underlying debt totaled $0.1 million and $1.6million for the three and six months ended June 30, 2010, respectively.During the first quarter of 2010, the Company wrote-off $1.5 million indeferred financing fees related to the termination of its credit facility, andduring the second quarter of 2010 the Company wrote off $0.1 million indeferred financing fees related to the release of three hotels from the MassMutual loan. During the three and six months ended June 30, 2009, theCompany wrote off $0.3 million in deferred financing fees associated with theamendment of its credit facility during the second quarter 2009.

 

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Totalamortization and write-off of deferred financing fees for the three and sixmonths ended June 30, 2010 and 2009 was as follows (in thousands):

 
| ** **                                                           | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                           | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                          | ** ** | **(unaudited)**                          | ** ** |
| Operations held for investment:                                      |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Amortization of deferred financing fees                              |       | $                                          | 306        |                                       | $          | 361                                      |       | $                                        | 799        |   | $ | 635 |   |
| Write-off of deferred financing fees                                 |       | 123                                        |       | 284                                        |       | 1,585                                    |       | 284                                      |       |
| Total deferred financing fees — operations held  for investment |       | 429                                        |       | 645                                        |       | 2,384                                    |       | 919                                      |       |
| Operations held for non-sale disposition:                            |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Amortization of deferred financing fees                              |       | 132                                        |       | 132                                        |       | 264                                      |       | 264                                      |       |
| Discontinued operations:                                             |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Amortization of deferred financing fees                              |       | —                                     |       | 10                                         |       | 2                                        |       | 21                                       |       |
| Total amortization and write-off of deferred  financing fees         |       | $                                          | 561        |                                       | $          | 787                                      |       | $                                        | 2,650      |   | $ | 1,204 |   |

 

**Earnings Per Share**

 

TheCompany applies the two-class method when computing its earnings per share asrequired by the Earnings Per Share Topic of the FASB ASC, which requires thenet income per share for each class of stock (common stock and convertiblepreferred stock) to be calculated assuming 100% of the Company’s net income isdistributed as dividends to each class of stock based on their contractualrights. To the extent the Company has undistributed earnings in any calendarquarter, the Company will follow the two-class method of computing earnings pershare.

 

TheCompany follows the requirements of ASC 260-10, which states that unvestedshare-based payment awards that contain non-forfeitable rights to dividends ordividend equivalents (whether paid or unpaid) are participating securities andshall be included in the computation of earnings per share pursuant to thetwo-class method. For the three months ended June 30, 2010 and 2009, noearnings representing nonforfeitable dividends were allocated to theparticipating securities. For the six months ended June 30, 2010 and 2009,earnings representing nonforfeitable dividends of zero and $0.4 million,respectively, were allocated to the participating securities.

 

Inaccordance with the Earnings Per Share Topic of the FASB ASC, basic earningsavailable (loss attributable) to common stockholders per common share iscomputed based on the weighted average number of shares of common stockoutstanding during each period. Diluted earnings available (loss attributable)to common stockholders per common share is computed based on the weightedaverage number of shares of common stock outstanding during each period, pluspotential common shares considered outstanding during the period, as long asthe inclusion of such awards is not anti-dilutive. Potential common sharesconsist of unvested restricted stock awards (using the treasury stock method),the incremental common shares issuable upon the exercise of stock options(using the treasury stock method) and the conversion of the Company’s Series CCumulative Convertible Redeemable Preferred Stock (“Series C preferredstock”).

 

Thefollowing table sets forth the computation of basic and diluted earnings (loss)per common share (in thousands, except per share data):

 
| ** **                                                                | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)**                                    | ** ** | **(unaudited)**                                    | ** ** |
| Numerator:                                                                |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Net income (loss)                                                         |       | $                                                    | 308        |                                                 | $          | (130,205                                           | )          | $                                                  | (20,783    | ) | $ | (123,695 | ) |
| Less dividends paid on unvested restricted stock  compensation            |       | —                                               |       | —                                               |       | —                                             |       | (447                                               | )          |
| Less preferred stock dividends and accretion                              |       | (5,187                                               | )          | (5,188                                               | )          | (10,374                                            | )          | (10,375                                            | )          |
| Numerator for basic and diluted loss attributable  to common stockholders |       | $                                                    | (4,879     | )                                                    | $          | (135,393                                           | )          | $                                                  | (31,157    | ) | $ | (134,517 | ) |
| Denominator:                                                              |       |                                                 |       |                                                 |       |                                               |       |                                               |       |
| Weighted average basic and diluted common shares  outstanding             |       | 97,188                                               |       | 60,845                                               |       | 97,118                                             |       | 56,549                                             |       |
| Basic loss attributable to common stockholders per  common share          |       | $                                                    | (0.05      | )                                                    | $          | (2.23                                              | )          | $                                                  | (0.32      | ) | $ | (2.38 | ) |
| Diluted loss attributable to common stockholders  per common share        |       | $                                                    | (0.05      | )                                                    | $          | (2.23                                              | )          | $                                                  | (0.32      | ) | $ | (2.38 | ) |

 

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TheCompany’s shares of Series C preferred stock issuable upon conversion andshares associated with common stock options, unvested restricted stock unitsand its long-term incentive plan have been excluded from the above calculationof earnings per share for the three and six months ended June 30, 2010 and2009, as their inclusion would have been anti-dilutive.

 

**Segment Reporting**

 

TheCompany reports its consolidated financial statements in accordance with theSegment Reporting Topic of the FASB ASC. Currently, the Company operates in twosegments, operations held for investment and operations held for non-saledisposition.

 

**3. Investment in Hotel Properties**

 

Investmentin hotel properties, net consisted of the following (in thousands):

 
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                 | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| Land                                       |       | $                 | 239,564    |                  | $          | 233,812 |   |
| Buildings and improvements                 |       | 1,874,199         |       | 1,848,435             |       |
| Furniture, fixtures and  equipment         |       | 251,144           |       | 243,415               |       |
| Intangibles                                |       | 34,081            |       | 34,081                |       |
| Franchise fees                             |       | 942               |       | 1,133                 |       |
| Construction in process                    |       | 8,946             |       | 6,182                 |       |
|                                       |       | 2,408,876         |       | 2,367,058             |       |
| Accumulated depreciation  and amortization |       | (489,751          | )          | (443,666              | )          |
|                                       |       | $                 | 1,919,125  |                  | $          | 1,923,392 |   |

 

InAugust 2009, pursuant to the 2009 secured debt restructuring program, theCompany elected to cease the subsidization of debt service on the $29.2 millionnon-recourse mortgage secured by the 347-room Renaissance Westchester. In December 2009,a stipulation for the appointment of a receiver for the entity that owns theRenaissance Westchester was filed in the New York Superior Court, County ofWestchester, and the Company transferred possession and control of theRenaissance Westchester to a receiver, who was operating the property for thebenefit of the lender of the non-recourse loan. As such, and in conjunctionwith the Consolidation Topic of the FASB ASC, the Company effectivelytransferred control of the asset to the receiver in December 2009, andaccordingly deconsolidated the Renaissance Westchester. The Company had norights to the profit or loss associated with the Renaissance Westchester uponthe hotel’s appointment to the receiver; however since the Company was stillnot released from the non-recourse mortgage, the net liability was stillrecorded on the Company’s balance sheet. On June 14, 2010, the Companyreacquired the Renaissance Westchester for $26.0 million, including relatedcosts. In connection with the repurchase of the Renaissance Westchester, the$29.2 million non-recourse mortgage was cancelled. The Company recorded a $6.7million gain on the extinguishment of this debt, which is included indiscontinued operations. Operating results for the Renaissance Westchester for2009, therefore, are included in discontinued operations, whereas operatingresults from June 14, 2010 forward are included in the Company’scontinuing operations. The Company is in the process of finalizing the purchaseprice allocation for the Renaissance Westchester. The Company has includeddepreciation expense based on this preliminary purchase price allocation.

 

Thefollowing unaudited pro forma results of operations reflect the Company’sresults as if the reacquisition of the Renaissance Westchester had occurred on January 1,2010. In the Company’s opinion, all significant adjustments necessaryto reflect the effects of the reacquisition have been made; however,depreciation expense for the Renaissance Westchester was based on a preliminarypurchase price allocation (in thousands, except per share data):

 
| ** **                                                                             | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2010** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                             | ** ** | **(Unaudited)**                                      | ** ** | **(Unaudited)**                                    | ** ** |
| Revenues                                                                               |       | $                                                    | 185,104    |                                               | $          | 350,050 |   |
| Loss attributable to common stockholders from  continuing operations                   |       | $                                                    | (6,129     | )                                                  | $          | (26,891 | ) |
| Loss per diluted share attributable to common  stockholders from continuing operations |       | $                                                    | (0.12      | )                                                  | $          | (0.38 | ) |

 

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Pursuantto its 2009 secured debt restructuring program, the Company finalized arestructuring agreement in April 2010 with Massachusetts Mutual LifeInsurance Company, or Mass Mutual, the lender’s representative for a $246.0million, 5.95% non-recourse mortgage loan secured by 11 of the Company’s hotelscomprised of 2,587 rooms. As part of this agreement, the Company agreed to paydown $83.0 million of the Mass Mutual loan in exchange for the release of threehotels from the loan. The three hotels include the 179-room Courtyard byMarriott Los Angeles Airport, the 271-room Kahler Inn & SuitesRochester and the 203-room Marriott Rochester. Also pursuant to this agreement,the Company expects to complete the deed back of the Mass Mutual eight hotelsin satisfaction of the remaining $163.0 million loan balance during 2010. TheMass Mutual eight hotels include the following: 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). Pending the completion of the deed back or appointment of areceiver, the Company has reclassified the assets, liabilities and results ofoperations of the Mass Mutual eight to “operations held for non-saledisposition” on its balance sheets, statements of operations and statements ofcash flows. Upon the completion of the deed back or appointment of a receiver,the assets and liabilities associated with the Mass Mutual eight will bedeconsolidated.

 

Asof June 30, 2010 and December 31, 2009, the assets and liabilities ofoperations held for non-sale disposition associated with the Mass Mutual eighthotels consisted of the following (in thousands):

 
| ** **                                                             | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                             | ** ** | **(unaudited)**        | ** ** | ** **                 | ** ** |
| ASSETS                                                                 | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Current assets:                                                        | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Cash and cash equivalents                                              |       | $                      | 20,319     |                       | $          | 5,864 |   |
| Restricted cash                                                        |       | 4,994                  |       | 4,683                      |       |
| Accounts receivable, net                                               |       | 1,594                  |       | 1,137                      |       |
| Inventories                                                            |       | 240                    |       | 245                        |       |
| Prepaid expenses                                                       |       | 371                    |       | 208                        |       |
| Deferred financing fees, net                                           |       | 439                    |       | 702                        |       |
| Goodwill                                                               |       | 1,174                  |       | 1,174                      |       |
| Other assets, net                                                      |       | 312                    |       | 127                        |       |
| Other current assets of operations held for  non-sale disposition, net |       | 29,443                 |       | 14,140                     |       |
| Investment in hotel properties, net                                    |       | 99,527                 |       | 102,343                    |       |
| Total assets                                                           |       | $                      | 128,970    |                       | $          | 116,483 |   |
| LIABILITIES                                                            | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Current liabilities:                                                   | ** ** | ** **             | ** ** | ** **                 | ** ** |
| Accounts payable and accrued expenses                                  |       | $                      | 757        |                       | $          | 989 |   |
| Due to Interstate SHP                                                  |       | 1,345                  |       | 1,148                      |       |
| Other current liabilities                                              |       | 18,309                 |       | 4,192                      |       |
| Other liabilities                                                      |       | 44                     |       | 35                         |       |
| Other current liabilities of operations held for  non-sale disposition |       | 20,455                 |       | 6,364                      |       |
| Notes payable                                                          |       | 162,972                |       | 184,121                    |       |
| Total liabilities                                                      |       | $                      | 183,427    |                       | $          | 190,485 |   |

 

**4. Discontinued Operations**

 

OnJune 14, 2010, the Company reacquired the Renaissance Westchester for$26.0 million, including related costs. In connection with the repurchase ofthe Renaissance Westchester, the $29.2 million non-recourse mortgage secured bythe hotel was cancelled. The Company recorded a $6.7 million gain on the extinguishmentof this debt, which is included in discontinued operations. Operating resultsfor the Renaissance Westchester for 2009, therefore, are included indiscontinued operations, whereas operating results from June 14, 2010forward are included in the Company’s continuing operations.

 

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InSeptember 2009, pursuant to the 2009 secured debt restructuring program,the Company elected to cease the subsidization of debt service on the $25.5million non-recourse mortgage secured by the 299-room Marriott Ontario Airport.In March 2010, a stipulation for the appointment of a receiver for theentity that owns the Marriott Ontario Airport was filed in the CaliforniaSuperior Court, County of San Bernardino, and the Company transferredpossession and control of the Marriott Ontario Airport to the receiver, who isoperating the property for the benefit of the lender of the non-recourse loan.As such, and in conjunction with the Consolidation Topic of the FASB ASC, theCompany effectively transferred control of the asset to a receiver in March 2010,and accordingly has deconsolidated the Marriott Ontario Airport. The Companyhas reclassified the net assets and the net liabilities, including the hotel’s$25.5 million mortgage indebtedness to other current liabilities ofdiscontinued operations, net on the Company’s June 30, 2010 balance sheet.The Company reclassified the individual assets and liabilities, including thehotel’s $25.5 million mortgage indebtedness to the appropriate discontinuedoperations line items on its December 31, 2009 balance sheet.Additionally, the Company reclassified the Marriott Ontario Airport’s resultsof operations and cash flows for the three months ended March 31, 2010, aswell as any expenses incurred as owner of the property for the three monthsended June 30, 2010, along with the hotel’s results of operations for thethree and six months ended June 30, 2009 to discontinued operations on itsstatements of operations and cash flows. Although the entity that owns theMarriott Ontario Airport has been deconsolidated, the Company will remain theowner of the hotel until the deed back is completed. Accordingly, the Companyhas deferred recording a gain on extinguishment of debt until the deed back iscompleted and the non-recourse mortgage is extinguished.

 

InJune 2009, pursuant to the 2009 secured debt restructuring program, theCompany elected to cease the subsidization of debt service on the $65.0 millionnon-recourse mortgage secured by the 258-room W San Diego. In September 2009,a stipulation for the appointment of a receiver for the entity that owns the WSan Diego was filed in the California Superior Court, County of San Diego, andthe Company transferred possession and control of the W San Diego to thereceiver, who is operating the property for the benefit of the lender of thenon-recourse loan. As such, and in conjunction with the Consolidation Topic ofthe FASB ASC, the Company effectively transferred control of the asset to a receiverin September 2009, and accordingly deconsolidated the W San Diego. TheCompany has reclassified the net assets and the net liabilities, including thehotel’s $65.0 million mortgage indebtedness to other current liabilities ofdiscontinued operations, net on the Company’s June 30, 2010 and December 31,2009 balance sheets. Additionally, the Company reclassified the W San Diego’sresults of operations and cash flows for the three and six months ended June 30,2009, as well as any expenses incurred as owner of the property for the threeand six months ended June 30, 2010, to discontinued operations on theCompany’s statements of operations and cash flows. On July 2, 2010, the Companycompleted its previously announced deed back of the W San Diego, and title tothe hotel was transferred to the lender. The Company will record a gain onextinguishment of debt to discontinued operations in the third quarter of 2010,and the net assets and liabilities will be removed from its balance sheets.

 

Inaddition to the deconsolidations noted above, the Company sold the MarriottNapa Valley and the Marriott Riverside during the second quarter of 2009, andthe Hyatt Suites Atlanta Northwest during the third quarter of 2009. Thefollowing sets forth the discontinued operations for the three and six monthsended June 30, 2010 and 2009, related to the three hotel properties soldduring 2009, as well as the two hotel properties held in receivership at June 30,2010 and the Renaissance Westchester held in receivership until itsreacquisition by the Company on June 14, 2010 (in thousands):

 
| ** **                                 | ** ** | **Three Months Ended********June 30, 2010** | ** ** | **Three Months Ended********June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended********June 30, 2009** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                 | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)**                          | ** ** | **(unaudited)**                                | ** ** |
| Operating revenues                         |       | $                                                | —     |                                             | $          | 16,405                                   |       | $                                              | 1,842      |   | $ | 33,630 |   |
| Operating expenses                         |       | (113                                             | )          | (14,614                                          | )          | (1,736                                   | )          | (30,210                                        | )          |
| Interest expense                           |       | —                                           |       | (1,737                                           | )          | (275                                     | )          | (3,460                                         | )          |
| Depreciation and amortization expense      |       | —                                           |       | (2,770                                           | )          | (124                                     | )          | (5,753                                         | )          |
| Property and goodwill impairment losses    |       | —                                           |       | (104,007                                         | )          | —                                   |       | (104,007                                       | )          |
| Gain on extinguishment of debt             |       | 6,747                                            |       | —                                           |       | 6,747                                    |       | —                                         |       |
| Loss on sale of hotels                     |       | —                                           |       | (13,070                                          | )          | —                                   |       | (13,070                                        | )          |
|                                       |       |                                             |       |                                             |       |                                     |       |                                           |       |
| Income (loss) from discontinued operations |       | $                                                | 6,634      |                                             | $          | (119,793                                 | )          | $                                              | 6,454      |   | $ | (122,870 | ) |

 

**5. Other Real Estate**

 

Otherreal estate, net consisted of the following (in thousands):

 
| ** **                        | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Land                              |       | $                       | 2,768      |                        | $          | 3,824 |   |
| Buildings and improvements        |       | 9,297                   |       | 10,179                      |       |
| Furniture, fixtures and equipment |       | 6,420                   |       | 6,058                       |       |
| Construction in process           |       | 43                      |       | 27                          |       |
|                              |       | 18,528                  |       | 20,088                      |       |
| Accumulated depreciation          |       | (6,658                  | )          | (6,232                      | )          |
|                              |       | 11,870                  |       | 13,856                      |       |
| Land held for investment          |       | 188                     |       | 188                         |       |
|                              |       | $                       | 12,058     |                        | $          | 14,044 |   |

 

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InJune 2010, the Company recorded an impairment loss of $1.9 million on anoffice building and land adjacent to one of its hotels in anticipation of apossible sale during the third or fourth quarter of 2010.

 

Asof June 30, 2010, other real estate, net included the Company’s twocommercial laundry facilities, an office building and one vacant parcel ofland.

 

**6. Investments in Unconsolidated Joint Ventures**

 

InDecember 2007, the Company entered into a joint venture agreement withStrategic Hotels & Resorts, Inc. (“Strategic”) to own and operateBuyEfficient, LLC (“BuyEfficient”), an electronic purchasing platform thatallows members to procure food, operating supplies, furniture, fixtures andequipment. Under the terms of the agreement, Strategic acquired a 50% interestin BuyEfficient from the Company. In December 2006, the Company enteredinto a joint venture agreement to obtain a 38% interest in the 460-roomDoubletree Guest Suites Times Square in New York City, New York.  The Company accounts for both of theseownership interests using the equity method. The Company’s accounting policiesare consistent with those of the unconsolidated joint ventures.

 

Aspart of the Company’s agreement with Strategic, the cost of BuyEfficient’sparticipation in the Company’s Long-Term Incentive Plan continues to be bornesolely by the Company. In accordance with the Investments — Equity Method andJoint Ventures Topic of the FASB ASC, the Company expenses the cost ofstock-based compensation granted to employees of BuyEfficient as incurred tothe extent the Company’s claim on BuyEfficient’s book value has not beenincreased. The Company recognizes this stock-based compensation expense basedon fair value in accordance with the Compensation — Stock Compensation Topicand the Equity Topic of the FASB ASC. The Company recognized stock-basedcompensation expense for BuyEfficient for the three and six months ended June 30,2010 and 2009, all of which was included in equity in earnings (losses) ofunconsolidated joint ventures, as follows (in thousands):

 
| ** **                       | ** ** | **Three Months Ended********June 30, 2010** | ** ** | **Three Months Ended********June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                       | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)**                                  | ** ** | **(unaudited)**                          | ** ** | **(unaudited)**                          | ** ** |
| Stock-based compensation expense |       | $                                                | 11         |                                             | $          | 17                                       |       | $                                        | 26         |   | $ | 24 |   |
|                                  |            |                                                  |            |                                                  |            |                                          |            |                                          |            |  |  |  |  |

 

InApril 2010, the Company received a $0.3 million distribution from itsBuyEfficient joint venture. No distributions were received for either the threeor six months ended June 30, 2009.

 

Duringthe fourth quarter of 2009, the Doubletree Guest Suites Times Square recordedan impairment loss in accordance with the Property, Plant and Equipment Topicof the FASB ASC, reducing the members’ equity in the joint venture to adeficit.  The Company has no guaranteed obligations to fund any losses ofthe partnership; therefore, in accordance with the Investments — Equity Methodand Joint Ventures Topic of the FASB ASC, the Company’s impairment loss waslimited to its remaining $26.0 million investment in the partnership. Theimpairment charge effectively reduced the Company’s investment in thepartnership to zero. Although the Doubletree Guest Suites Times Square jointventure earned income of $0.5 million during the three months ended June 30,2010, and incurred a loss of $0.4 million during the six months ended June 30,2010, the Company did not recognize any portion of this income or loss as itsinterest in the partnership was reduced to zero at December 31, 2009. TheCompany will not recognize any future income from this joint venture until itsshare of such earnings exceeds its share of cumulative losses in excess of itszero book value in the investment.

 

Annualdividends on the Company’s equity investment in the Doubletree Guest SuitesTimes Square are senior to the returns on equity to other investors in thisjoint venture.  The annual dividendaccrual rates, which are calculated as a percentage of the Company’s original$40.0 million investment, were initially 8.0%, are currently 8.5%, and willincrease to 9.25% over a nine-year period. In addition, the Company’s equityinvestment is entitled to receive a pro-rata share of any excess equitydistributions made by the joint venture. The Company received no distributionsduring either the three or six months ended June 30, 2010 or 2009.

 

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**7. Goodwill**

 

TheCompany follows the requirements of the Intangibles — Goodwill and Other Topicof the FASB ASC, which states that goodwill and intangible assets deemed tohave indefinite lives are subject to annual impairment tests. As a result, thecarrying value of goodwill allocated to the hotel properties and other realestate is reviewed at least annually for impairment. In addition, when factsand circumstances suggest that the Company’s goodwill may be impaired, aninterim evaluation of goodwill is prepared. Such review entails comparing thecarrying value of the individual hotel property (the reporting unit) includingthe allocated goodwill to the fair value determined for that hotel property(see Fair Value of Financial Instruments for detail on the Company’s valuationmethodology). If the aggregate carrying value of the hotel property exceeds thefair value, the goodwill of the hotel property is impaired to the extent of thedifference between the fair value and the aggregate carrying value, not toexceed the carrying amount of the allocated goodwill. The Company’s annualimpairment evaluation is performed each year as of December 31.

 

Asof June 30, 2010 and December 31, 2009, goodwill consisted of thefollowing (in thousands):

 
| ** **                                                      | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                      | ** ** | **(unaudited)**        | ** ** | ** **                 | ** ** |
| Beginning balance                                               |       | $                      | 4,673      |                       | $          | 8,621 |   |
| Goodwill impairment loss — operations held for  investment |       | —                 |       | (3,948                     | )          |
| Ending balance                                                  |       | $                      | 4,673      |                       | $          | 4,673 |   |

 

**8.Other Assets**

 

Otherassets, net consisted of the following (in thousands):

 
| ** **                  | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                  | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Property and equipment, net |       | $                       | 2,205      |                        | $          | 1,125 |   |
| Other receivables           |       | 4,710                   |       | 2,567                       |       |
| Other                       |       | 2,512                   |       | 2,526                       |       |
|                        |       | $                       | 9,427      |                        | $          | 6,218 |   |

 

InApril 2010, the Company purchased two hotel loans for $3.7 million thathave a combined principal amount of $32.5 million plus accrued interest ofapproximately $800,000. The loans include (i) a $30.0 million, 8.5%mezzanine loan maturing in January 2017 secured by the equity interests inthe Company’s Doubletree Guest Suites Times Square joint venture, and (ii) a$2.5 million, 8.075% subordinate note maturing in November 2010 secured bythe 101-room boutique hotel known as Twelve Atlantic Station in Atlanta,Georgia. The Company purchased the mezzanine loan for $3.45 million and thesubordinate note for $250,000. None of the debt on the Doubletree Guest SuitesTimes Square is in default, however interest payments on the mezzanine loan arecurrently being deferred in accordance with the provisions of the loan. Thesubordinate note secured by the Twelve Atlantic Station is currently indefault. The Company will account for both loans using the cost recovery methoduntil such time as the expected cash flows from the loans are reasonablyprobable and estimable. No amounts were received for either note during the threeand six months ended June 30, 2010.

 

In2006, the Company sold 13 hotels for gross proceeds of $144.1 million. As acondition of the transaction, the Company currently holds a promissory notefrom the buyer of the 13 hotels (the “Buyer”) for $5.6 million, with interestaccruing at 8% per annum. The note is interest only and is secured by an equitypledge in the Buyer’s legal investment entity. In December 2009, the Company receivednotice that the Buyer requested a loan modification from the Senior NoteLender, indicating that the Company’s $5.6 million mezzanine loan along withthe accrued interest may not be collectible. As such, the Company recorded anallowance for bad debt of $5.6 million to other assets, net in December 2009,which reserved both the discounted note and the related interest receivable infull at December 31, 2009. The Company suspended recording interestreceivable on the note, and any amounts received from the Buyer in the futurewill be applied first towards the principal amount of the note. During thethree and six months ended June 30, 2010, the Company received zero and$0.1 million, respectively, from the Buyer and applied these receipts towardsthe principal amount of the note as recoveries of bad debt which were includedin corporate overhead.

 

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**9. Notes Payable**

 

Notespayable consisted of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                      | ** ** | **(unaudited)**         | ** ** | ** **                  | ** ** |
| Notes payable requiring payments of interest and  principal, with fixed rates ranging from 4.98% to 9.88%; maturing at dates  ranging from December 2010 through May 2021. The notes are  collateralized by first deeds of trust on 27 hotel properties and one laundry  facility at June 30, 2010, and 30 hotel properties and one laundry  facility at December 31, 2009. |       | $                       | 1,240,198  |                        | $          | 1,328,611 |   |
|                                                                                                                                                                                                                                                                                                                                                                                            |       |                    |       |                        |       |   |   |
| Senior Notes, with a fixed interest rate of 4.60%,  maturing in July 2027. The notes are guaranteed by the Company and  certain of its subsidiaries.                                                                                                                                                                                                                                       |       | 62,500                  |       | 62,500                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                            |       | 1,302,698               |       | 1,391,111                   |       |
| Less: discount on Senior Notes                                                                                                                                                                                                                                                                                                                                                                  |       | (2,703                  | )          | (3,193                      | )          |
|                                                                                                                                                                                                                                                                                                                                                                                            |       | 1,299,995               |       | 1,387,918                   |       |
| Less: notes payable of operations held for  non-sale disposition                                                                                                                                                                                                                                                                                                                                |       | (162,972                | )          | (184,121                    | )          |
| Less: current portion                                                                                                                                                                                                                                                                                                                                                                           |       | (93,401                 | )          | (153,778                    | )          |
|                                                                                                                                                                                                                                                                                                                                                                                            |       | $                       | 1,043,622  |                        | $          | 1,050,019 |   |

 

TheCompany’s 2009 secured debt restructuring program was initiated to address cashflow and value deficits among certain of its hotels securing non-recoursemortgage debt. The status of the final four loans included in the 2009 secureddebt restructuring program is discussed further below.

 

*W San Diego*. On July 2, 2010, the Company completed itspreviously announced deed back of the W San Diego, and title to the hotel wastransferred to the lender. The Company will record a gain on extinguishment ofdebt to discontinued operations in accordance with the Debt Topic of the FASBASC in the third quarter of 2010, and the net assets and liabilities will beremoved from its balance sheets.

 

*Renaissance Westchester*. On June 14,2010, the Company reacquired the Renaissance Westchester for $26.0 million,including related costs. In connection with the repurchase of the RenaissanceWestchester, the $29.2 million non-recourse mortgage secured by the hotel wascancelled. The Company recorded a $6.7 million gain on the extinguishment ofthis debt, which is included in discontinued operations. Operating results forthe Renaissance Westchester for 2009, therefore, are included in discontinuedoperations, whereas operating results from June 14, 2010 forward areincluded in the Company’s continuing operations.

 

*Marriott Ontario Airport*. Effective March 1,2010, possession and control of the 299-room Marriott Ontario Airport wastransferred to a court-appointed receiver. In connection with this transfer,the Company deconsolidated this hotel and reclassified the assets andliabilities, including the hotel’s $25.5 million 5.34% non-recourse mortgage,to discontinued operations on its balance sheets. Additionally, the Companyreclassified the Marriott Ontario Airport’s results of operations and cashflows to discontinued operations on its statements of operations and cashflows. Once title to the hotel is transferred, the Company will record a gainon extinguishment of debt in accordance with the Debt Topic of the FASB ASC,and the net assets and liabilities will be removed from the Company’s balancesheets.

 

*Massachusetts Mutual Life Insurance Company.*In April 2010,the Company finalized an agreement with Massachusetts Mutual Life InsuranceCompany, or Mass Mutual, the lender’s representative for a $246.0 million,5.95% non-recourse mortgage loan secured by 11 of the Company’s hotelscomprised of 2,587 rooms. As part of the agreement, the Company agreed to paydown $83.0 million of the Mass Mutual loan in exchange for the release of threehotels from the loan. Also pursuant to this agreement, the Company expects tocomplete the deed back of the Mass Mutual eight hotels in satisfaction of theremaining $163.0 million loan balance during 2010. Pending the completion ofthe deed back or appointment of a receiver, the Company has reclassified theassets, liabilities and results of operations of the Mass Mutual eight to “operationsheld for non-sale disposition” on its balance sheets, statements of operationsand statements of cash flows. Upon completion of the deed back or appointmentof a receiver, the assets and liabilities associated with the Mass Mutual eightwill be deconsolidated.

 

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Totalinterest incurred and expensed on the notes payable was as follows (inthousands):

 
| ** **                                | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                          | ** ** | **(unaudited)**                          | ** ** |
| Operations held for investment:           |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Interest expense                          |       | $                                          | 16,185     |                                       | $          | 18,198                                   |       | $                                        | 33,123     |   | $ | 37,255 |   |
| Interest expense — default rate (1)  |       | 120                                        |       | —                                     |       | 884                                      |       | —                                   |       |
| Accretion of Senior Notes                 |       | 245                                        |       | 655                                        |       | 491                                      |       | 1,339                                    |       |
| Amortization of deferred financing fees   |       | 306                                        |       | 361                                        |       | 799                                      |       | 635                                      |       |
| Write-off of deferred financing fees      |       | 123                                        |       | 284                                        |       | 1,585                                    |       | 284                                      |       |
| Loan penalties and fees (2)               |       | 36                                         |       | —                                     |       | 174                                      |       | —                                   |       |
|                                      |       | $                                          | 17,015     |                                       | $          | 19,498                                   |       | $                                        | 37,056     |   | $ | 39,513 |   |
|                                      |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Operations held for non-sale disposition: |       |                                       |       |                                       |       |                                     |       |                                     |       |
| Interest expense                          |       | $                                          | 2,473      |                                       | $          | 2,760                                    |       | $                                        | 5,182      |   | $ | 5,523 |   |
| Interest expense — default rate (1)  |       | 2,078                                      |       | —                                     |       | 4,354                                    |       | —                                   |       |
| Amortization of deferred financing fees   |       | 132                                        |       | 132                                        |       | 264                                      |       | 264                                      |       |
| Loan penalties and fees (2)               |       | 303                                        |       | —                                     |       | 597                                      |       | —                                   |       |
|                                      |       | $                                          | 4,986      |                                       | $          | 2,892                                    |       | $                                        | 10,397     |   | $ | 5,787 |   |

 

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(1) Interest expense — default rate for the three and six months ended June 30,2010 was incurred due to the Company’s elective default on the Mass Mutualloan, pursuant to its 2009 secured debt restructuring program. While theCompany is required to record such interest, as the Mass Mutual loan isnon-recourse to the Company, the Company does not expect to actually fund suchinterest. The Company will reverse this accrual and record a gain on theforgiveness of this interest once the deed back of the Mass Mutual eight iscomplete, and the debt is extinguished.

 

(2) Due to the Company’s elective default on the Mass Mutual loan pursuant to its2009 secured debt restructuring program, operations held for investmentincludes loan penalties and fees of $36,000 and $135,000 for the three and sixmonths ended June 30, 2010, respectively, and operations held for non-saledisposition includes loan penalties and fees of $303,000 and $597,000 for thethree and six months ended June 30, 2010. While the Company is required torecord such loan penalties and fees, as the Mass Mutual loan is non-recourse tothe Company, the Company does not expect to actually fund such fees. TheCompany will reverse these accruals and record a gain on the forgiveness ofthese penalties and fees once the deed back of the Mass Mutual eight iscompleted, and the debt is extinguished. An additional $39,000 in loan penaltiesand fees for operations held for investment was incurred during the threemonths ended March 31, 2010 due to the termination of the Company’s creditfacility.

 

**10. Series CCumulative Convertible Redeemable Preferred Stock**

 

InJuly 2005, the Company sold 4,102,564 shares of Series C preferredstock with a liquidation preference of $24.375 per share to Security CapitalPreferred Growth, Incorporated, an investment vehicle advised by SecurityCapital Research & Management Incorporated, for gross proceeds of$99.0 million, or $24.13 per share, which included a 1% discount to theconversion price/liquidation preference. Other costs of the offering totaled$130,000. Net proceeds of $99.0 million were contributed to the OperatingPartnership in exchange for preferred membership units with economic termssubstantially identical to the Series C preferred stock. The net proceedswere used to partially finance the Company’s acquisition of six Renaissancehotels. As a result of the Company’s stock dividend paid in January 2009,the Series C conversion price was adjusted to $22.23 per share. Each shareof Series C preferred stock is convertible into 1.096 shares of theCompany’s common stock at the option of the holder, subject to customaryantidilution provisions, including stock splits, stock dividends, non-cashdistributions and above-market issuer self-tender or exchange offers. On orafter July 8, 2010, the Series C preferred stock will be redeemableat the Company’s option, in whole or in part, at any time or from time to time,for cash at a redemption price of $24.375 per share, plus accrued and unpaiddividends up to and including the redemption date. The holders of the Series Cpreferred stock have the right to require the Company to redeem the Series Cpreferred stock in the event of any of the following:  (1) a change in control of the Company,if certain conditions are not met; (2) a REIT termination event; or (3) atermination of the Company’s listing on either the New York Stock Exchange orNASDAQ. In general, holders of Series C preferred stock vote on anas-converted basis as a single class with holders of the Company’s commonstock. The holders are eligible to receive a participating dividend to theextent the Company’s dividend on its common stock exceeds $0.339 per share perquarter. The quarterly dividend on the Series C preferred stock iscurrently $0.393 per share. If the Company fails to meet certain financialratios for four consecutive quarters, a financial ratio violation will occurwith respect to the Company’s Series C preferred stock. During thecontinuation of a financial ratio violation, among other things, the Companywould be restricted from paying dividends on its common stock, and may incur a50 basis point per quarter dividend increase on the Series C preferredstock. Additionally, the Series C preferred stockholders would 

 

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gainthe right to appoint one board member. The Company does not currently expect toincur a financial ratio violation. Should operations deteriorate from currentlevels, however, the Company may fail to meet its financial ratios with respectto its Series C preferred stock for four consecutive quarters, which wouldcause the Company to incur a financial ratio violation. The Series Cpreferred stock has no maturity date and, except as set forth above, theCompany is not required to redeem the Series C preferred stock at any time.As the Series C preferred stockholders may redeem their shares in certaincircumstances outside of the control of the Company, the Series Cpreferred stock has not been classified as permanent equity.

 

Theinitial carrying value of the Series C preferred stock was recorded at itssales price less costs to issue on the date of issuance.  This carrying value is periodically adjustedso that the carrying value will equal the redemption value on the redemptiondate, which is the earliest date available for the Company to redeem the Series Cpreferred stock. The carrying value will also be periodically adjusted for anyaccrued and unpaid dividends. At June 30, 2010 and December 31, 2009,the Series C preferred stock carrying value consisted of the following (inthousands):

 
| ** **                                       | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**        | ** ** | ** **                 | ** ** |
| Initial fair value, sales price of $99.0 million |       | $                      | 99,000     |                       | $          | 99,000 |   |
| Redemption value accretion                       |       | 996                    |       | 896                        |       |
|                                             |       | $                      | 99,996     |                       | $          | 99,896 |   |

 

**11. Stockholders’ Equity**

 

**Series A Cumulative Redeemable Preferred Stock**

 

InMarch 2005, the Company sold an aggregate of 4,850,000 shares of 8.0% Series Aand B Cumulative Redeemable Preferred Stock (“Series A preferred stock”and “Series B preferred stock,” respectively) with a liquidationpreference of $25.00 per share for gross proceeds of $121.3 million.Underwriting and other costs of the offering totaled $3.8 million. Net proceedsof $117.5 million were contributed to the Operating Partnership in exchange forpreferred membership units with economic terms substantially identical to the Series Aand B preferred stock. Subsequent to this offering, the shares of Series Bpreferred stock were exchanged for an equivalent number of shares of Series Apreferred stock. The net proceeds were used to reduce borrowings under theCompany’s credit facility in existence at the time and for acquisitions. As of March 17,2010, the Series A preferred stock is redeemable at the Company’s option,in whole or in part, at any time or from time to time, for cash at a redemptionprice of $25.00 per share, plus accrued and unpaid dividends up to andincluding the redemption date. Holders of Series A preferred stockgenerally have no voting rights. However, if the Company is in arrears ondividends on the Series A preferred stock for six or more quarterlyperiods, whether or not consecutive, holders of the Series A preferredstock will be entitled to vote at its next annual meeting and each subsequentannual meeting of stockholders for the election of two additional directors toserve on the Company’s board of directors until all unpaid dividends and thedividend for the then-current period with respect to the Series Apreferred stock have been paid or declared and a sum sufficient for the paymentthereof set aside for payment. As of June 30, 2010, the Company is incompliance with the dividend requirements for the Series A preferredstock. The Series A preferred stock has no maturity date and the Companyis not required to redeem the Series A preferred stock at any time.

 

InApril 2006, the Company sold an additional 2,200,000 shares of Series Apreferred stock with a liquidation preference of $25.00 per share for grossproceeds of $55.0 million. The proceeds to the Company, net of offering costs,were $54.2 million, and were used together with proceeds of certain debtrefinancings to repay the Company’s term loan facility.

 

**Common Stock**

 

InMay 2009, the Company issued 20,700,000 shares of its common stock,including the underwriters’ over-allotment of 2,700,000 shares, for net proceedsof $98.7 million. The Company used the net proceeds from this equity offeringfor working capital and other general corporate purposes, including thereplacement of cash used in the repurchase of the Senior Notes and therepayment of $60.0 million outstanding on its credit facility in existence atthe time.

 

InOctober 2009, the Company issued 23,000,000 shares of its common stock,including the underwriters’ over-allotment of 3,000,000 shares, for netproceeds of approximately $158.4 million. The Company used a portion of the netproceeds from this equity offering for working capital and other generalcorporate purposes, and may use the remaining proceeds for the acquisition ofadditional hotel properties.

 

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**12. Long-Term Incentive Plan**

 

**Stock Grants**

 

Restrictedshares and restricted share units granted pursuant to the Company’s Long-TermIncentive Plan generally vest over periods from one to five years from the dateof grant. The value of shares granted has been calculated based on the shareprice on the date of grant and is being amortized as compensation expense inaccordance with the Company’s policy on a straight-line basis over the vestingperiods for the entire award. The Company’s compensation expense and forfeitureexpense adjustments related to these restricted shares and restricted shareunits for the three and six months ended June 30, 2010 and 2009 were asfollows (in thousands):

 
| ** **                     | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended********June 30, 2010** | ** ** | **Six Months Ended********June 30, 2009** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                     | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                                | ** ** | **(unaudited)**                                | ** ** |
| Compensation expense           |       | $                                          | 1,022      |                                       | $          | 1,677                                          |       | $                                              | 2,326      |   | $ | 3,196 |   |
|                           |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Forfeiture expense adjustments |       | $                                          | 5          |                                       | $          | 2                                              |       | $                                              | 79         |   | $ | 22 |   |

 

**StockOptions**

 

InApril 2008, the Compensation Committee of the Company’s board of directorsapproved a grant of 200,000 non-qualified stock options (the “Options”) toRobert A. Alter, the Company’s former Chief Executive Officer and currentExecutive Chairman. The Options fully vested in April 2009, and willexpire in April 2018. The exercise price of the Options is $17.71 pershare.

 

Theinitial fair value of the Options was $0.7 million, and was estimated using abinomial option pricing model with the following assumptions:

 
| Expected dividend yield  |   | 7.90  | %      |
|--------------------------|--------|-------|--------|
| Risk-free interest rate  |   | 3.29  | %      |
| Expected volatility      |   | 26.90 | %      |
| Expected life (in years) |   | 5.5   |   |

 

The expected life was calculated using thesimplified method as outlined in the Securities and Exchange Commission’s StaffAccounting Bulletin No. 107.

 

**13. Segment Reporting**

 

The Company’s operations are organized into twosegments, operations held for investment and operations held for non-saledisposition. Operations held for investment currently includes 30 hotels andtwo commercial laundry facilities. Operations held for non-sale dispositioncurrently includes the Mass Mutual eight hotels.

 

Non-segment assets primarily consist of corporateassets, including cash, restricted cash, due from affiliates, prepaid expenses,investment in unconsolidated joint ventures, deferred financing costs andoffice equipment, which is included in other assets, net.

 

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Summary information for the Company’s reportablesegments is as follows (in thousands):

 
| ** **                                              | ** ** | **Three Months Ended June 30, 2010** | ** ** | **Three Months Ended June 30, 2009** | ** ** | **Six Months Ended********June 30, 2010** | ** ** | **Six Months Ended********June 30, 2009** | ** ** |
|---------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                              | ** ** | **(unaudited)**                           | ** ** | **(unaudited)**                           | ** ** | **(unaudited)**                                | ** ** | **(unaudited)**                                | ** ** |
| Revenues:                                               |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Operations held for  investment                         |       | $                                         | 160,874    |                                      | $          | 154,520                                        |       | $                                              | 301,773    |   | $ | 304,566 |   |
| Operations held for  non-sale disposition               |       | 20,158                                    |       | 21,575                                    |       | 39,992                                         |       | 42,922                                         |       |
| Total revenues                                          |       | $                                         | 181,032    |                                      | $          | 176,095                                        |       | $                                              | 341,765    |   | $ | 347,488 |   |
|                                                    |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Property and goodwill  impairment losses:               |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Operations held for  investment                         |       | $                                         | 1,943      |                                      | $          | 27,237                                         |       | $                                              | 1,943      |   | $ | 28,643 |   |
| Operations held for  non-sale disposition               |       | —                                    |       | 697                                       |       | —                                         |       | 3,007                                          |       |
| Non-segment                                             |       | —                                    |       | 104,007                                   |       | —                                         |       | 104,007                                        |       |
| Total property and  goodwill impairment losses          |       | $                                         | 1,943      |                                      | $          | 131,941                                        |       | $                                              | 1,943      |   | $ | 135,657 |   |
|                                                    |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Adjusted EBITDA: (1)                                    |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Operations held for  investment                         |       | $                                         | 43,509     |                                      | $          | 41,060                                         |       | $                                              | 74,109     |   | $ | 76,894 |   |
| Operations held for  non-sale disposition               |       | 3,790                                     |       | 3,902                                     |       | 7,279                                          |       | 9,097                                          |       |
| Non-segment                                             |       | (4,130                                    | )          | (139                                      | )          | (7,222                                         | )          | (2,298                                         | )          |
| Adjusted EBITDA                                         |       | $                                         | 43,169     |                                      | $          | 44,823                                         |       | $                                              | 74,166     |   | $ | 83,693 |   |
|                                                    |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Reconciliation of  Adjusted EBITDA to Net Income (Loss) |       |                                      |       |                                      |       |                                           |       |                                           |       |
| Adjusted EBITDA                                         |       | $                                         | 43,169     |                                      | $          | 44,823                                         |       | $                                              | 74,166     |   | $ | 83,693 |   |
| Depreciation and  amortization                          |       | (24,821                                   | )          | (30,544                                   | )          | (50,210                                        | )          | (61,030                                        | )          |
| Amortization of lease  intangibles                      |       | (150                                      | )          | —                                    |       | (150                                           | )          | —                                         |       |
| Interest expense                                        |       | (18,658                                   | )          | (23,348                                   | )          | (38,530                                        | )          | (47,565                                        | )          |
| Interest expense —  default rate                   |       | (2,198                                    | )          | —                                    |       | (5,238                                         | )          | —                                         |       |
| Amortization of deferred  financing fees                |       | (438                                      | )          | (549                                      | )          | (1,065                                         | )          | (1,012                                         | )          |
| Write-off of deferred  financing fees                   |       | (123                                      | )          | (284                                      | )          | (1,585                                         | )          | (284                                           | )          |
| Loan penalties and fees                                 |       | (339                                      | )          | —                                    |       | (819                                           | )          | —                                         |       |
| Non-cash interest  related to discount on Senior Notes  |       | (245                                      | )          | (655                                      | )          | (491                                           | )          | (1,339                                         | )          |
| Amortization of deferred  stock compensation            |       | (693                                      | )          | (1,231                                    | )          | (1,665                                         | )          | (2,364                                         | )          |
| Loss on sale of assets                                  |       | —                                    |       | (13,035                                   | )          | —                                         |       | (12,716                                        | )          |
| Gain on extinguishment  of debt                         |       | 6,747                                     |       | 26,559                                    |       | 6,747                                          |       | 54,579                                         |       |
| Property and goodwill  impairment losses                |       | (1,943                                    | )          | (131,941                                  | )          | (1,943                                         | )          | (135,657                                       | )          |
| Net income (loss)                                       |       | $                                         | 308        |                                      | $          | (130,205                                       | )          | $                                              | (20,783    | ) | $ | (123,695 | ) |

 
| ** **                                | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **(unaudited)**        | ** ** | ** **                 | ** ** |
| Assets:                                   |       |                   |       |                       |       |
| Operations held for investment            |       | $                      | 2,031,237  |                       | $          | 2,023,561 |   |
| Operations held for  non-sale disposition |       | 128,970                |       | 116,483                    |       |
| Non-segment                               |       | 228,175                |       | 373,486                    |       |
| Total assets                              |       | $                      | 2,388,382  |                       | $          | 2,513,530 |   |

 

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(1)          Adjusted EBITDA is a non-GAAP financial measure used to evaluate theoperating performance of the Company’s segments. The Company defines AdjustedEBITDA for both of its segments as net income (loss) excluding depreciation andamortization, property and goodwill impairment losses and interest expense.Non-segment Adjusted EBITDA is defined by the Company as net income (loss)excluding depreciation and amortization, interest expense, amortization ofdeferred financing fees, any write-offs of deferred financing fees or loanpenalties and fees, amortization of deferred stock compensation, gain on saleof assets or extinguishment of debt, and property and goodwill impairmentlosses. The Company believes Adjusted EBITDA is useful to investors inevaluating its operating performance because these measures help investorsevaluate and compare the results of its operations from period to period byremoving the impact of the Company’s capital structure (primarily interestexpense) and the Company’s asset base (primarily depreciation and amortization)from its operating results. The Company also uses Adjusted EBITDA as a measurein determining the value of hotel acquisitions and dispositions. The Companycautions

 

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investors that amounts presented in accordance with its definition ofAdjusted EBITDA may not be comparable to similar measures disclosed by othercompanies, because not all companies calculate non-GAAP measures in the samemanner. Adjusted EBITDA should not be considered as an alternative measure ofthe Company’s net income (loss), operating performance, cash flow or liquidity.Adjusted EBITDA may include funds that may not be available for the Company’sdiscretionary use to fund interest expense, capital expenditures or generalcorporate purposes. Although the Company believes that Adjusted EBITDA canenhance an investor’s understanding of the Company’s results of operations,this non-GAAP financial measure, when viewed individually, is not necessarily abetter 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 thatadverse economic and market conditions may harm the Company’s cash flow.

 

**14. Commitments and Contingencies**

 

**Management Agreements**

 

Management agreements withthe Company’s third-party hotel managers require the Company to pay between 1%and 3.5% of total revenue of the managed hotels to the third-party managerseach month as a basic management fee. Total basic management fees incurred bythe Company during the three and six months ended June 30, 2010 and 2009were included in the Company’s statements of operations as follows (inthousands):

 
| ** **                                                                         | ** ** | **Three  Months Ended June 30, 2010** | ** ** | **Three  Months Ended June 30, 2009** | ** ** | **Six Months  Ended********June 30, 2010** | ** ** | **Six Months  Ended********June 30, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                         | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                                 | ** ** | **(unaudited)**                                 | ** ** |
| Operations  held for investment — property general and administrative expense |       | $                                          | 4,012      |                                       | $          | 3,855                                           |       | $                                               | 7,519      |   | $ | 7,599 |   |
| Operating  expenses of operations held for non-sale disposition                    |       | 452                                        |       | 486                                        |       | 904                                             |       | 973                                             |       |
| Discontinued  operations                                                           |       | —                                     |       | 437                                        |       | 37                                              |       | 883                                             |       |
|                                                                               |       | $                                          | 4,464      |                                       | $          | 4,778                                           |       | $                                               | 8,460      |   | $ | 9,455 |   |

 

In addition to basicmanagement fees, provided that certain operating thresholds are met, theCompany may also be required to pay certain of its third-party managersincentive management fees. Total incentive management fees incurred by theCompany were $0.8 million and $0.7 million for the three months ended June 30,2010 and 2009, respectively, all of which were included in property general andadministrative expense. Total incentive management fees incurred by the Companywere $1.3 million and $1.4 million for the six months ended June 30, 2010and 2009, respectively, all of which were included in property general andadministrative expense.

 

**License and Franchise Agreements**

 

TheCompany has entered into license and franchise agreements related to certain ofits hotel properties. The license and franchise agreements require the Companyto, among other things, pay monthly fees that are calculated based on specifiedpercentages of certain revenues. The license and franchise agreements generallycontain specific standards for, and restrictions and limitations on, theoperation and maintenance of the hotels which are established by thefranchisors to maintain uniformity in the system created by each suchfranchisor. Such standards generally regulate the appearance of the hotel,quality and type of goods and services offered, signage and protection oftrademarks. Compliance with such standards may from time to time require theCompany to make significant expenditures for capital improvements.

 

Total license and franchise costs incurred by theCompany during the three months ended June 30, 2010 and 2009 were $7.0million and $7.4 million, respectively, of which royalties totaled $2.4 millionand $2.7 million, for the three months ended June 30, 2010 and 2009,respectively. For the six months ended June 30, 2010 and 2009, totallicense and franchise costs incurred by the Company were $12.9 million and$14.3 million, respectively, of which royalties totaled $4.7 million and $5.5million, respectively. The remaining costs included advertising, reservationand frequent guest program assessments. Totallicense and franchise costs incurred by the Company during the three and sixmonths ended June 30, 2010 and 2009 were included in the Company’sstatements of operations as follows (in thousands):

 

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| ** **                                                      | ** ** | **Three  Months Ended June 30, 2010** | ** ** | **Three  Months Ended June 30, 2009** | ** ** | **Six Months  Ended********June 30, 2010** | ** ** | **Six Months  Ended********June 30, 2009** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                      | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                                 | ** ** | **(unaudited)**                                 | ** ** |
| Operations  held for investment — franchise costs          |       | $                                          | 5,636      |                                       | $          | 5,104                                           |       | $                                               | 10,151     |   | $ | 9,799 |   |
| Operating  expenses of operations held for non-sale disposition |       | 1,361                                      |       | 1,384                                      |       | 2,604                                           |       | 2,710                                           |       |
| Discontinued  operations                                        |       | —                                     |       | 874                                        |       | 130                                             |       | 1,810                                           |       |
|                                                            |       | $                                          | 6,997      |                                       | $          | 7,362                                           |       | $                                               | 12,885     |   | $ | 14,319 |   |

 

**Renovation and Construction Commitments**

 

TheCompany believes that the appeal of its portfolio to travelers may be enhancedthrough a capital renovation program aimed at maintaining the appearance andquality of its hotels. At June 30, 2010, the Company had various contractsoutstanding with third parties in connection with the renovation of certain ofits hotels. The remaining commitments under these contracts at June 30,2010 totaled $14.3 million.

 

**Ground and Operating Leases**

 

Totalrent expense incurred pursuant to ground lease agreements for the three and sixmonths ended June 30, 2010 and 2009 was included in the Company’sstatements of operations as follows (in thousands):

 
| ** **                                                                           | ** ** | **Three  Months Ended June 30, 2010** | ** ** | **Three  Months Ended June 30, 2009** | ** ** | **Six Months  Ended********June 30, 2010** | ** ** | **Six Months  Ended********June 30, 2009** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                           | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                            | ** ** | **(unaudited)**                                 | ** ** | **(unaudited)**                                 | ** ** |
| Operations  held for investment — property tax, ground lease, and insurance (1) |       | $                                          | 1,331      |                                       | $          | 1,147                                           |       | $                                               | 2,485      |   | $ | 2,288 |   |
| Operating  expenses of operations held for non-sale disposition (2)                  |       | 179                                        |       | 174                                        |       | 290                                             |       | 327                                             |       |
|                                                                                 |       | $                                          | 1,510      |                                       | $          | 1,321                                           |       | $                                               | 2,775      |   | $ | 2,615 |   |

 

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(1) Operations held for investment includes ground leases for six of the Company’shotels currently held for investment.

 

(2)  Operations heldfor non-sale disposition includes ground leases for two hotels included in theMass Mutual eight hotels.

 

Rentexpense incurred pursuant to the lease on the corporate facility totaled $0.1million for both the three months ended June 30, 2010 and 2009, and $0.2million for both the six months ended June 30, 2010 and 2009, and wasincluded in corporate overhead expense.

 

**Concentration of Risk**

 

Asof June 30, 2010, nine of the 30 hotels were located in California, thelargest concentration of the Company’s hotels in any state, representingapproximately 26% of the Company’s rooms and approximately 25% of the revenuegenerated by the Company’s 30 hotels during the six months ended June 30,2010. The concentration of the Company’s hotels in California exposes theCompany’s business to economic conditions, competition and real and personalproperty tax rates unique to California.

 

**Other**

 

TheCompany has provided unsecured environmental indemnities to certain lenders.The Company has performed due diligence on the potential environmental risks,including obtaining an independent environmental review from outsideenvironmental consultants. These indemnities obligate the Company to reimbursethe indemnified parties for damages related to certain environmental matters.There is no term or damage limitation on these indemnities; however, if anenvironmental matter arises, the Company could have recourse against otherprevious owners or a claim against its environmental insurance policies.

 

AtJune 30, 2010, the Company had $7.8 million of outstanding irrevocableletters of credit to guaranty the Company’s financial obligations related toworkers’ compensation insurance programs from prior policy years, as well asfuture pension plan funding obligations and working capital requirementspursuant to certain management agreements. The beneficiaries of these lettersof credit may draw upon these letters of credit in the event of a contractualdefault by the Company relating to each respective obligation.  No draws have been made through June 30,2010.

 

Severalof the Company’s franchise agreements contain corporate guaranties. Should anyof the hotels included in these franchise agreements default on the agreements,the Company may be liable for any termination fees. Currently, the MarriottOntario Airport and seven of the hotels included in the Mass Mutual eight arein default as a result of the Company’s 2009 secured debt restructuringprogram. If the franchise agreements on all eight of these hotels were to beterminated, the Company may be liable for up to $26.7 million in terminationfees.

 

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**15. Transactions With Affiliates**

 

**Other Reimbursements**

 

Fromtime to time, the Company pays for certain expenses such as payroll, insuranceand other costs on behalf of certain affiliates. The affiliates generallyreimburse such amounts on a monthly basis. At June 30, 2010 and December 31,2009, amounts owed to the Company by its affiliates amounted to $34,000 and$62,000, respectively, and are included in due from affiliates in theaccompanying balance sheets.

 

**Transactions With Others**

 

TheCompany purchases telecommunications equipment from Gemini TelemanagementSystems (“GTS”), a telecommunications equipment provider based in Redwood City,California. The Company’s former Chief Executive Officer and current ExecutiveChairman, Robert A. Alter, was a 5.2% stockholder in GTS, and his brother,Richard Alter, was the majority stockholder in GTS, until they both divestedtheir interests in April 2009. Richard Alter remains an employee with GTS.The Company paid GTS nominal amounts in 2010 and $0.1 million and $0.4 millionfor the three and six months ended June 30, 2009, respectively.

 

**16. Variable Interest Entities**

 

The Company adopted Accounting Standards Update (“ASU”)No. 2009-17 codified in the Consolidation Topic of the FASB ASC on January 1,2010, which changes the consolidation guidance applicable to variable interestentities (“VIEs”). It also amends the guidance governing the determination ofwhether an enterprise is the primary beneficiary of a VIE, and is, therefore,required to consolidate an entity, by requiring a qualitative analysis ratherthan a quantitative analysis. The qualitative analysis includes, among otherthings, consideration of who has the power to direct the activities of theentity that most significantly impact the entity’s economic performance and whohas the obligation to absorb losses or the right to receive benefits of the VIEthat could potentially be significant to the VIE. This topic also requirescontinuous reassessments of whether an enterprise is the primary beneficiary ofa VIE. Previously, the applicable standard required reconsideration of whetheran enterprise was the primary beneficiary of a VIE only when specific eventshad occurred. The topic also requires additional disclosures about anenterprise’s involvement with a VIE.

 

Upon adoption of ASU No. 2009-17,the Company evaluated its variable interests, including the managementagreements it has with its third-party hotel managers and its interest in theDoubletree Guest Suites Times Square joint venture, to determine whether or notthese variable interests are VIEs. The Company’s analysis included bothquantitative and qualitative reviews. In arriving at the VIE determination forits third-party management agreements, the Company followed the guidance in ASC810-10-55-37, “*Fees Paid to Decision Makers or ServiceProviders*,” which states that fees paid to a legal entity’s decisionmakers or service providers are not variable interests if six conditions aremet: 1) the fees are compensation for services provided and are commensuratewith the level of effort required to provide those services; 2) substantiallyall of the fees are at or above the same level of seniority as other operatingliabilities of the VIE that arise in the normal course of the VIE’s activities,such as trade payables; 3) the decision maker or service provider does not holdother interests in the VIE that individually, or in the aggregate, would absorbmore than an insignificant amount of the VIE’s expected losses or receive morethan an insignificant amount of the VIE’s expected residual returns; 4) theservice arrangement includes only terms, conditions, or amounts that arecustomarily present in arrangements for similar services negotiated at arm’slength; 5) the total amount of anticipated fees are insignificant relative tothe total amount of the VIE’s anticipated economic performance; and 6) theanticipated fees are expected to absorb an insignificant amount of thevariability associated with the VIE’s anticipated economic performance, whichincludes any carried interests, promotes or incentive fees. Based on the sixconditions stated in ASC 810-10-55-37, the Company has determined that themanagement agreements for all but three of its hotels are not variable interestentities. The three hotels do not meet conditions (5) and (6) as eachof the three hotel’s incentive management fees are significant relative to thetotal amount of each hotel’s economic performance, and these fees are expectedto absorb a significant amount of the variability associated with each hotel’santicipated economic performance. The Company has determined that it is theprimary beneficiary of these three VIEs because it has the power to direct theactivities that most significantly impact the hotels’ economic performance,such as developing budgets and renovation programs as well as making thedecision to sell the hotels, and it is obligated to absorb the losses or toreceive the benefits from the hotels that could potentially be significant tothe hotels. The Company has, therefore, consolidated these three VIEs.

 

Though the Companyconcluded its interest in the Doubletree Guest Suites Times Square jointventure is a VIE, the Company has determined that it is not the primarybeneficiary because it does not have the power to direct the activities thatmost significantly impact the economic performance of the Doubletree GuestSuites Times Square. The Company, therefore, will continue to account for thisinvestment using the equity method.

 

**17. Subsequent Events**

 

On July 2, 2010, the Company completed its previouslyannounced deed back of the W San Diego and title to the hotel was transferredto the lender. The Company will record a gain on extinguishment of debt todiscontinued operations in the third quarter of 2010, and the net assets andliabilities will be removed from its balance sheets.

 

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**CautionaryStatement**

 

**This report contains forward-looking statements thathave been made pursuant to the provisions of the Private Securities LitigationReform Act of 1995. These statements relate to future events or our futurefinancial performance. In some cases, you can identify forward-lookingstatements by terminology such as “anticipate,” “believe,” “continue,” “could,”“estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “should,” “will”or the negative of such terms and other comparable terminology. Thesestatements are only predictions. Actual events or results may differ materiallyfrom those expressed or implied by these forward-looking statements. Inevaluating these statements, you should specifically consider the risksoutlined in detail in our Annual Report on Form 10-K, filed with theSecurities and Exchange Commission on February 23, 2010, under the caption“Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q,including but not limited to the following factors:**

 

·**                 ****general economic and business conditions affecting the lodging and travelindustry, both nationally and locally, including a prolonged U.S. recession;**

 

·**                 ****our need to operate as a REIT and comply with other applicable laws andregulations;**

 

·**                 ****rising operating expenses;**

 

·**                 ****relationships with and requirements of franchisors and hotel brands;**

 

·**                 ****relationships with and the performance of the managers of our hotels;**

 

·**                 ****the ground or air leases for six of our 30 hotels;**

 

·**                 ****our ability to complete acquisitions and dispositions;**

 

·**                 ****competition for the acquisition of hotels;**

 

·**                 ****performance of hotels after they are acquired;**

 

·**                 ****competition from hotels not owned by us;**

 

·**                 ****the need for renovations of and other capital expenditures for ourhotels;**

 

·**                 ****the impact of renovations on hotel operations and delays in renovationsor other developments;**

 

·**                 ****changes in our business strategy or acquisition or disposition plans;**

 

·**                 ****our level of debt, including secured, unsecured, fixed and variable ratedebt;**

 

·**                 ****financial and other covenants in our debt and preferred stock;**

 

·**                 ****impairments to our hotels and goodwill;**

 

·**                 ****potential adverse consequences related to our 2009 secured debtrestructuring program, including potential increases to our marginal borrowingrate and increased difficulty of raising equity or debt capital or increases inthe costs of such capital;**

 

·**                 ****volatility in the capital markets and the effect on lodging demand or ourability to obtain capital on favorable terms or at all;**

 

·**                 ****our ability to complete the 2009 secured debt restructuring program; and**

 

·**                 ****other events beyond our control.**

 

**These factors may cause our actual events to differmaterially from the expectations expressed or implied by any forward-lookingstatement. We do not undertake to update any forward-looking statement.**

 

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

 

**Overview**

 

SunstoneHotel Investors, Inc. (the “Company,” “we” or “us”) is a Marylandcorporation. We operate as a self-managed and self-administered real estateinvestment trust (“REIT”). A REIT is a legal entity that directly or indirectlyowns real estate assets. REITs generally are not subject to federal incometaxes at the corporate level as long as they pay stockholder dividendsequivalent to 100% of their taxable income. REITs are required to distribute tostockholders at least 90% of their taxable income. We own, directly orindirectly, 100% of the interests of Sunstone Hotel Partnership, LLC (the “OperatingPartnership”), which is the entity that directly or indirectly owns our hotelproperties. We also own 100% of the interests of our taxable REIT subsidiary,Sunstone Hotel TRS Lessee, Inc., which leases all of our hotels from theOperating Partnership, and engages third parties to manage our hotels.

 

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Weown primarily upper upscale hotels in the United States. As of June 30,2010, we owned 30 hotels held for investment (the “30 hotels”). We continue toown 10 additional hotels which are in the process of being deeded back tocertain lenders pursuant to our 2009 secured debt restructuring program. These10 hotels include the W San Diego and Marriott Ontario Airport, which are heldin receivership and included in discontinued operations, and eight additionalhotels which we are currently in the process of deeding back to a lender, andwhich are included in operations held for non-sale disposition. The eighthotels secure the non-recourse mortgage with Massachusetts Mutual LifeInsurance Company (the “Mass Mutual eight”), and include: Renaissance AtlantaConcourse; Hilton Huntington; Residence Inn by Marriott Manhattan Beach;Marriott Provo; Courtyard by Marriott San Diego (Old Town); Holiday InnDowntown San Diego; Holiday Inn Express San Diego (Old Town); and Marriott SaltLake City (University Park). Three additional hotels which previously securedthe Mass Mutual loan (Courtyard by Marriott Los Angeles Airport, Kahler Inn &Suites Rochester and Marriott Rochester) were released in April 2010following our payment of an $83.0 million release price. In addition, theRenaissance Westchester was included in our 2009 secured debt restructuringprogram and held in receivership until we reacquired the hotel for $26.0million, including related costs, in June 2010. The results of operationsfor the Renaissance Westchester are included in continuing operations from thedate we reacquired the hotel, June 14, 2010 forward. Prior to June 14,2010, the results of operations for the Renaissance Westchester are included indiscontinued operations as possession and control of the hotel was held by acourt-appointed receiver. The Renaissance Westchester, along with the threehotels released from the Mass Mutual loan, are included in the 30 hotels. Ofthe 30 hotels, we classify 28 as upscale or upper upscale, one as luxury andone as mid-scale as defined by Smith Travel Research, Inc. In addition toour wholly owned hotels, we own a 38% equity interest in a joint venture thatowns one hotel, and we own certain other non-hotel investments. The majority ofour hotels are operated under nationally recognized brands such as Marriott,Fairmont, Hilton and Hyatt, which are among the most respected and widelyrecognized brands in the lodging industry. We believe the largest and moststable segment of demand for hotel rooms is represented by travelers who preferthe consistent service and quality associated with nationally recognizedbrands.

 

Weseek to own hotels in urban locations that benefit from significant barriers toentry by competitors. Most of our hotels are considered business, convention,or airport hotels, as opposed to resort, leisure or extended-stay hotels. Thehotels comprising our 30 hotel portfolio average 377 rooms in size.

 

Thedemand for lodging generally fluctuates with the overall economy. We refer tothese changes in demand as the lodging cycle, and we seek to employ acycle-appropriate portfolio management strategy. During the recovery and growthphases of the lodging cycle, our strategy emphasizes active investment, both interms of acquisitions of new hotels and selective renovations of our existingportfolio. During the mature phase of the lodging cycle, our strategyemphasizes net hotel dispositions, and during periods of cyclical declines, ourstrategy emphasizes capital preservation.

 

Throughall phases of the lodging cycle, we seek to maximize the value of our portfoliothrough proactive asset management, which entails working closely with ourthird-party hotel operators to develop plans and actions designed to enhancerevenues, minimize operational expenses and maximize the appeal of our hotelsto travelers.

 

Duringthe first six months of 2010, we began to see increasingly positive signs interms of improving business and consumer sentiment, which may point to animpending economic recovery, setting the stage for a prolonged period ofpositive fundamentals in the lodging industry. Accordingly, we believe we arecurrently in the early stages of a recovery phase of the lodging cycle.Consistent with our cycle-appropriate strategy, we believe that acquiringhotels now may likely create long-term value, and we expect to deploy a portionof our cash balance in 2010 towards selective hotel acquisitions. Ouracquisition program is aimed at generating attractive returns on our investmentdollars, and therefore we may target lodging assets outside of the typicalbranded, urban, upper upscale profile represented by our existing portfolio inorder to capitalize on opportunities which may arise, but we do not expectthese atypical lodging assets to comprise a major component of our portfolio.Additionally, the scope of our acquisitions program may include large hotel portfoliosor hotel loans. Future acquisitions may be funded by our issuance of additionaldebt or equity securities, including our common and preferred OP units.

 

Theweighted average term to maturity of our debt is approximately 6.7 years, and100% of our debt is fixed rate with an average interest rate of 5.6%. Of ourtotal debt, approximately $180.0 million matures over the next four years($81.0 million in 2010, none in 2011, $33.6 million in 2012 and $65.4 millionin 2013, assuming we repay our remaining Senior Notes balance of $62.5 millionat the first put date in 2013). The $180.0 million does not include scheduledamortization payments, which total $4.7 million for the remainder of 2010,$13.5 million in 2011, $15.6 million in 2012, and $16.6 million in 2013. Inaddition, in April 2010, we made a partial payment of $83.0 million on theMass Mutual mortgage loan to secure the release of three of the 11 hotelssecuring the loan, and in June 2010, we reacquired the RenaissanceWestchester for $26.0 million, including related costs. In connection with therepurchase of the Renaissance Westchester, the $29.2 million non-recoursemortgage secured by the hotel was cancelled. We recognized a gain of $6.7million on the extinguishment of this debt, which is included in discontinuedoperations.

 

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**Operating Activities**

 

***Operating Performance Indicators*****.** The following performance indicators are commonly used in the hotelindustry:

 

·                  *occupancy;*

 

·                  *averagedaily room rate,* or ADR;

 

·                  *revenueper available room,* or RevPAR, which is the product of occupancy andADR, and does not include food and beverage revenue, or other operatingrevenue;

 

·                  *comparableRevPAR,* which we define as the RevPAR generated by hotels we owned as of theend of the reporting period, but excluding those hotels that experiencedmaterial and prolonged business interruption due to renovations, re-branding orproperty damage during either the most recent calendar year presented or thecalendar year immediately preceding it. For hotels that were not owned for theentirety of the comparison periods, comparable RevPAR is calculated usingRevPAR generated during periods of prior ownership. We refer to this subset ofour hotels used to calculate comparable RevPAR as our “Comparable Portfolio;”

 

·                  *RevPARindex,* which is the quotient of a hotel’s RevPAR divided by the averageRevPAR of its competitors, multiplied by 100. A RevPAR index in excess of 100indicates a hotel is achieving higher RevPAR than its competitors. In additionto absolute RevPAR index, we monitor changes in RevPAR index;

 

·                  *EBITDA*, which isincome available (loss attributable) to common stockholders excluding:preferred stock dividends; interest expense (including prepayment penalties, ifany); provision for income taxes, including income taxes applicable to sale ofassets; and depreciation and amortization;

 

·                  *AdjustedEBITDA*, which includes EBITDA but excludes: amortization of deferred stockcompensation; the impact of any gain or loss from asset sales; impairmentcharges; and any other identified adjustments;

 

·                  *AdjustedHotel EBITDA**,* which is calculated ashotel revenues less hotel expenses excluding corporate-level expenses, such aspreferred stock dividends, interest expense (including prepayment penalties, ifany), provision for income taxes, including income taxes applicable to sale ofassets, depreciation and amortization, impairment charges, and any otheridentified adjustments;

 

·                  *HotelEBITDA Margin**,* which is the quotient ofadjusted hotel EBITDA divided by hotel revenues;

 

·                  *operatingflow through,* which is the quotient of incremental operatingincome (Adjusted hotel EBITDA) divided by incremental revenues;

 

·                  *Fundsfrom operations*, or FFO, which includes income available (lossattributable) to common stockholders, excluding gains and losses from sales ofproperty, plus real estate-related depreciation and amortization (excludingamortization of deferred financing costs), and after adjustment forunconsolidated partnerships and joint ventures; and

 

·                  *AdjustedFFO*, which includes FFO but excludes prepayment penalties, written-offdeferred financing costs, impairment losses and other identified adjustments.

 

***Revenues.*** Substantiallyall of our revenues are derived from the operation of our hotels. Specifically,our revenues consist of the following:

 

·                  *Room revenues*, which is theproduct of the number of rooms sold and the ADR;

 

·                  *Foodand beverage revenues*, which is comprised of revenues realized inthe hotel food and beverage outlets as well as banquet and catering events;

 

·                  *Otheroperating revenues*, which include ancillary hotel revenue such asperformance guaranties, if any, and other items primarily driven by occupancysuch as telephone, transportation, parking, spa, entertainment and other guestservices. Additionally, this category includes, among other things, operatingrevenue from our two commercial laundry facilities located in Rochester,Minnesota and Salt Lake City, Utah, as well as hotel space leased by thirdparties; and

 

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·                  *Revenuesof operations held for non-sale disposition*, which includes roomrevenues, food and beverage revenues, and other operating revenues for thosehotels which we intend to dispose of other than by sale. Currently, thiscategory includes the Mass Mutual eight hotels. In November 2009, weelected to cease the subsidization of debt service on the Mass Mutualnon-recourse mortgage, as we believed that the values of the 11 hotels thatsecured this loan were, on a collective basis, significantly less than theprincipal amount of the mortgage. Prior to electing this default, we workedwith the loan’s lender representative to amend the repayment terms, but we wereunable to reach mutually acceptable amendment terms. Other than as noted abovewith respect to the partial release of three of the hotels securing the MassMutual loan, we do not expect further negotiations with the lenderrepresentative, and we are working to convey the Mass Mutual eight hotels tothe lender in lieu of repayment of the debt. We have reclassified the assets,liabilities and results of operations of the Mass Mutual eight hotels to “operationsheld for non-sale disposition” on our balance sheets, statements of operationsand statements of cash flows.

 

***Expenses.*** Our expensesconsist of the following:

 

·                  *Room expense*, which isprimarily driven by occupancy and, therefore, has a significant correlationwith room revenues;

 

·                  *Foodand beverage expense*, which is primarily driven by food and beveragesales and banquet and catering bookings and, therefore, has a significantcorrelation with food and beverage revenues;

 

·                  *Otheroperating expense*, which includes the corresponding expense of otheroperating revenue, advertising and promotion, repairs and maintenance,utilities, and franchise costs;

 

·                  *Propertytax, ground lease and insurance expense*, which includes theexpenses associated with property tax, ground lease and insurance payments,each of which is primarily a fixed expense;

 

·                  *Propertygeneral and administrative expense*, which includes ourproperty-level general and administrative expenses, such as payroll and relatedcosts, professional fees, travel expenses, and management fees;

 

·                  *Corporateoverhead expense,* which includes our corporate-level expenses, suchas payroll and related costs, amortization of deferred stock compensation,professional fees, travel expenses and office rent;

 

·                  *Depreciationand amortization expense*, which includes depreciation on our hotelbuildings, improvements, furniture, fixtures and equipment, along withamortization on our franchise fees and intangibles;

 

·                  *Operatingexpenses of operations held for non-sale disposition*, whichincludes room expense, food and beverage expense, other operating expenses,advertising and promotion, repairs and maintenance, utilities, franchise costs,property tax, ground lease and insurance expense, property general andadministrative expense, and depreciation and amortization expense for thosehotels which we intend to dispose of other than by sale. Currently, thiscategory includes the Mass Mutual eight hotels;

 

·                  *Propertyand g**oodwill impairment losses expense*, whichincludes the charges we have recognized to reduce the carrying value of assetson our balance sheets to their fair value and to write-off goodwill inassociation with our quarterly impairment evaluations; and

 

·                  *G**oodwillimpairment losses of operations held for non-sale disposition*, whichincludes the charges we have recognized to write-off goodwill in associationwith our quarterly impairment evaluations for those hotels which we intend todispose of other than by sale. Currently, this category includes the MassMutual eight hotels.

 

***Other Revenue and Expense.*** Other revenueand expense consists of the following:

 

·                  *Equityin earnings (losses) of unconsolidated joint ventures*, whichincludes our portion of earnings or losses from our joint ventures;

 

·                  *Interestand other income,* which includes interest we have earned on ourrestricted and unrestricted cash accounts, as well as any gains or losses wehave recognized on sales of assets other than hotels;

 

·                  *Interestexpense,* which includes interest expense incurred on ouroutstanding debt, accretion of the Senior Notes, amortization of deferredfinancing fees, any write-offs of deferred financing fees, and any loanpenalties and fees incurred on our debt;

 

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·                  *Interestexpense of operations held for non-sale disposition*, whichincludes interest expense, amortization of deferred financing fees and any loanpenalties and fees incurred on our debt for those hotels which we intend todispose of other than by sale. Currently, this category includes the MassMutual eight hotels;

 

·                  *Gainon extinguishment of debt,* which includes the gain werecognized on the repurchase and cancellation of the Senior Notes;

 

·                  *Dividendspaid on unvested restricted stock compensation,* which includes dividendsearned on our unvested restricted stock awards; and

 

·                  *Preferredstock dividends and accretion,* which includes dividendsearned on our 8.0% Series A Cumulative Redeemable Preferred Stock (“Series Apreferred stock”) and Series C Cumulative Convertible Redeemable PreferredStock (“Series C preferred stock”) and redemption value accretion on our Series Cpreferred stock.

 

***Factors Affecting Our OperatingResults.***The primary factors affecting our operating resultsinclude overall demand for hotel rooms, the pace of new hotel development, orsupply, and the relative performance of our operators in increasing revenue andcontrolling hotel operating expenses.

 

·                  *Demand.*The demand for lodging generally fluctuates with the overall economy.As a result of the U.S. recession and the deterioration of the credit markets,the lodging cycle entered a decline phase in 2008. While total RevPAR for the30 hotels declined by 6.3% in the first quarter of 2010 as compared to the sameperiod in 2009, we are seeing positive signs of improving demand trends andRevPAR for the 30 hotels increased by 6.8% in the second quarter of 2010 ascompared to the same period in 2009. Consistent with prior trends, weanticipate that lodging demand will continue to improve as liquidity isrestored in the credit markets and the U.S. economy begins to strengthen.Historically, periods of declining demand are followed by extended periods ofrelatively strong demand, resulting in a cyclical lodging growth phase.Assuming the current U.S. recession ended in the later part of 2009, we expecthotel demand to begin to show year-over-year increases beginning in 2010 and2011.

 

·                  *Supply*. The additionof new competitive hotels affects the ability of existing hotels to driveRevPAR and profits. The development of new hotels is largely driven byconstruction costs and expected performance of existing hotels. We believe thelodging industry will benefit from the recent recession and credit crisis asrestricted credit and tighter lending standards have made it difficult tofinance new hotel construction projects. We believe hotel development will beconstrained until operating trends of existing hotels improve to levels wheredeveloper return targets can be achieved, and until the construction financingmarkets recover. Given the one to three year timeline needed to construct atypical hotel, we expect a window of at least two to four years beginning in2010 during which hotel supply, as indicated by the number of new hotelopenings, will be below historical levels.

 

·                  *Revenuesand expenses*. We believe that marginal improvements in RevPARindex, even in the face of declining revenues, are a good indicator of therelative quality and appeal of our hotels, and our operators’ effectiveness inmaximizing revenues. Similarly, we believe that strong operating flow throughis a good indicator of our operators’ effectiveness in minimizing incrementaloperating expenses in the context of increasing revenues or, conversely, inreducing operating expenses in the context of declining revenues.

 

Withrespect to improving RevPAR index, we continue to work with our hotel operatorsto optimize revenue management initiatives while taking into considerationmarket demand trends and the pricing strategies of competitor hotels in ourmarkets. We also develop capital investment programs designed to ensure each ofour hotels is well renovated and positioned to appeal to groups and individualtravelers fitting target guest profiles. Our revenue management initiatives aregenerally oriented towards maximizing ADR even if the result may be loweroccupancy than may be achieved through lower ADR, as increases in RevPARattributable to increases in ADR may be accompanied by minimal additionalexpenses, while increases in RevPAR attributable to higher occupancy may resultin higher variable expenses such as housekeeping, labor and utilities expense.Thus, increases in RevPAR associated with higher ADR may result in better flowthrough, and as a result, higher hotel EBITDA margins. Increases in RevPAR associatedwith higher occupancy may result in worse flow through and, as a result, EBITDAmargin improvement may be muted.

 

Withrespect to maximizing operating flow through, we continue to work with ouroperators to identify operational efficiencies designed to reduce expenseswhile minimally affecting guest experience. Key asset management initiativesinclude reducing hotel staffing levels, capitalizing on relaxed brandstandards, such as reducing complimentary amenities, and selectively closingcertain food and beverage outlets. Our operational efficiency initiatives maybe difficult to implement, as most categories of variable operating expenses,such as utilities and certain labor costs, such as housekeeping, fluctuate 

 

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withchanges in occupancy. Furthermore, our hotels operate with significant fixedcosts, such as general and administrative expense, insurance, property taxes,and other expenses associated with owning hotels, over which our operators mayhave little control. We have experienced increases in hourly wages, employeebenefits (especially health insurance) and utility costs, which have negativelyaffected our hotel EBITDA margins. Moreover, there are limits to how far ouroperators can reduce expenses without affecting the competitiveness of ourhotels.

 

***Operating Results.***The following table presentsthe unaudited operating results for our total portfolio for the three monthsended June 30, 2010 and 2009, including the amount and percentage changein the results between the two periods. The table presents the results ofoperations included in the consolidated statements of operations, and includesthe 30 hotels (11,313 rooms) as of June 30, 2010 and 29 hotels (10,966rooms) as of June 30, 2009. In addition, operating results for operationsheld for non-sale disposition for both the three months ended June 30,2010 and 2009 includes the Mass Mutual eight hotels. Income (loss) fromdiscontinued operations for the three months ended June 30, 2010 includesthe results of operations for the W San Diego and Marriott Ontario Airportwhich have been deconsolidated from our operations as a result of the transferof possession and control of these properties to receivers, and the RenaissanceWestchester prior to our reacquisition of the hotel on June 14, 2010.Income (loss) from discontinued operations for the three months ended June 30,2009 includes the results of operations for the Marriott Napa Valley, MarriottRiverside, and Hyatt Suites Atlanta Northwest which were sold in 2009, as wellas the W San Diego, Renaissance Westchester and Marriott Ontario Airport whichhave been deconsolidated from our operations.

 
| ** **                                                              | ** ** | **Three Months Ended June 30,**                           | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                                                       | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                              | ** ** | **(unaudited, dollars in thousands, except statistical data)** | ** ** |
| REVENUES                                                                |       |                                                           |       |   |   |   |   |   |   |
| Room                                                                    |       | $                                                              | 108,323    |   | $ | 101,214 |   | $ | 7,109 |   | 7.0 | % |
| Food and beverage                                                       |       | 40,543                                                         |       | 40,220 |   | 323 |   | 0.8 | % |
| Other operating                                                         |       | 12,008                                                         |       | 13,086 |   | (1,078 | ) | (8.2 | )% |
| Revenues of operations held for non-sale  disposition                   |       | 20,158                                                         |       | 21,575 |   | (1,417 | ) | (6.6 | )% |
| Total revenues                                                          |       | 181,032                                                        |       | 176,095 |   | 4,937 |   | 2.8 | % |
| OPERATING EXPENSES                                                      |       |                                                           |       |   |   |   |   |   |   |
| Hotel operating                                                         |       | 98,489                                                         |       | 95,593 |   | 2,896 |   | 3.0 | % |
| Property general and administrative                                     |       | 18,876                                                         |       | 17,867 |   | 1,009 |   | 5.6 | % |
| Corporate overhead                                                      |       | 5,135                                                          |       | 4,785 |   | 350 |   | 7.3 | % |
| Depreciation and amortization                                           |       | 23,264                                                         |       | 23,765 |   | (501 | ) | (2.1 | )% |
| Operating expenses of operations held for non-sale  disposition         |       | 17,912                                                         |       | 20,400 |   | (2,488 | ) | (12.2 | )% |
| Property and goodwill impairment losses                                 |       | 1,943                                                          |       | 27,237 |   | (25,294 | ) | (92.9 | )% |
| Goodwill impairment losses of operations held for  non-sale disposition |       | —                                                         |       | 697 |   | (697 | ) | (100.0 | )% |
| Total operating expenses                                                |       | 165,619                                                        |       | 190,344 |   | (24,725 | ) | (13.0 | )% |
| Operating income (loss)                                                 |       | 15,413                                                         |       | (14,249 | ) | 29,662 |   | 208.2 | % |
| Equity in earnings (losses) of unconsolidated  joint ventures           |       | 163                                                            |       | (584 | ) | 747 |   | 127.9 | % |
| Interest and other income                                               |       | 99                                                             |       | 252 |   | (153 | ) | (60.7 | )% |
| Interest expense                                                        |       | (17,015                                                        | )          | (19,498 | ) | 2,483 |   | 12.7 | % |
| Interest expense of operations held for non-sale  disposition           |       | (4,986                                                         | )          | (2,892 | ) | (2,094 | ) | (72.4 | )% |
| Gain on extinguishment of debt                                          |       | —                                                         |       | 26,559 |   | (26,559 | ) | (100.0 | )% |
| Loss from continuing operations                                         |       | (6,326                                                         | )          | (10,412 | ) | 4,086 |   | 39.2 | % |
| Income (loss) from discontinued operations                              |       | 6,634                                                          |       | (119,793 | ) | 126,427 |   | 105.5 | % |
| Net income (loss)                                                       |       | 308                                                            |       | (130,205 | ) | 130,513 |   | 100.2 | % |
| Preferred stock dividends and accretion                                 |       | (5,187                                                         | )          | (5,188 | ) | 1 |   | 0.0 | % |
| Loss attributable to common stockholders                                |       | $                                                              | (4,879     | ) | $ | (135,393 | ) | $ | 130,514 |   | 96.4 | % |

 

Thefollowing table presents the unaudited operating results for our totalportfolio for the six months ended June 30, 2010 and 2009, including theamount and percentage change in the results between the two periods. The tablepresents the results of operations included in the consolidated statements ofoperations, and includes the 30 hotels (11,313 rooms) as of June 30, 2010and 29 hotels (10,966 rooms) as of June 30, 2009. In addition, operatingresults for operations held for non-sale disposition for both the six monthsended June 30, 2010 and 2009 includes the Mass Mutual eight hotels. Income(loss) from discontinued operations for the six months ended June 30, 2010includes the results of operations for the W San Diego and Marriott OntarioAirport which have been deconsolidated from our operations as a result of thetransfer of possession and control of these properties to receivers, and theRenaissance Westchester prior to our reacquisition of the hotel on June 14,2010. Income (loss) from discontinued operations for the

 

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sixmonths ended June 30, 2009 includes the results of operations for theMarriott Napa Valley, Marriott Riverside, and Hyatt Suites Atlanta Northwestwhich were sold in 2009, as well as the W San Diego, Renaissance Westchesterand Marriott Ontario Airport which have been deconsolidated from ouroperations.

 
| ** **                                                              | ** ** | **Six Months Ended June 30,**                             | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                                                       | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                              | ** ** | **(unaudited, dollars in thousands, except statistical data)** | ** ** |
| REVENUES                                                                |       |                                                           |       |   |   |   |   |   |   |
| Room                                                                    |       | $                                                              | 198,701    |   | $ | 197,897 |   | $ | 804 |   | 0.4 | % |
| Food and beverage                                                       |       | 78,751                                                         |       | 81,257 |   | (2,506 | ) | (3.1 | )% |
| Other operating                                                         |       | 24,321                                                         |       | 25,412 |   | (1,091 | ) | (4.3 | )% |
| Revenues of operations held for non-sale  disposition                   |       | 39,992                                                         |       | 42,922 |   | (2,930 | ) | (6.8 | )% |
| Total revenues                                                          |       | 341,765                                                        |       | 347,488 |   | (5,723 | ) | (1.6 | )% |
| OPERATING EXPENSES                                                      |       |                                                           |       |   |   |   |   |   |   |
| Hotel operating                                                         |       | 191,643                                                        |       | 191,776 |   | (133 | ) | (0.1 | )% |
| Property general and administrative                                     |       | 36,021                                                         |       | 35,896 |   | 125 |   | 0.3 | % |
| Corporate overhead                                                      |       | 9,715                                                          |       | 10,492 |   | (777 | ) | (7.4 | )% |
| Depreciation and amortization                                           |       | 46,822                                                         |       | 47,289 |   | (467 | ) | (1.0 | )% |
| Operating expenses of operations held for non-sale  disposition         |       | 35,950                                                         |       | 39,260 |   | (3,310 | ) | (8.4 | )% |
| Property and goodwill impairment losses                                 |       | 1,943                                                          |       | 28,643 |   | (26,700 | ) | (93.2 | )% |
| Goodwill impairment losses of operations held for  non-sale disposition |       | —                                                         |       | 3,007 |   | (3,007 | ) | (100.0 | )% |
| Total operating expenses                                                |       | 322,094                                                        |       | 356,363 |   | (34,269 | ) | (9.6 | )% |
| Operating income (loss)                                                 |       | 19,671                                                         |       | (8,875 | ) | 28,546 |   | 321.6 | % |
| Equity in earnings (losses) of unconsolidated  joint ventures           |       | 275                                                            |       | (2,101 | ) | 2,376 |   | 113.1 | % |
| Interest and other income                                               |       | 270                                                            |       | 872 |   | (602 | ) | (69.0 | )% |
| Interest expense                                                        |       | (37,056                                                        | )          | (39,513 | ) | 2,457 |   | 6.2 | % |
| Interest expense of operations held for non-sale  disposition           |       | (10,397                                                        | )          | (5,787 | ) | (4,610 | ) | (79.7 | )% |
| Gain on extinguishment of debt                                          |       | —                                                         |       | 54,579 |   | (54,579 | ) | (100.0 | )% |
| Loss from continuing operations                                         |       | (27,237                                                        | )          | (825 | ) | (26,412 | ) | (3,201.5 | )% |
| Income (loss) from discontinued operations                              |       | 6,454                                                          |       | (122,870 | ) | 129,324 |   | 105.3 | % |
| Net loss                                                                |       | (20,783                                                        | )          | (123,695 | ) | 102,912 |   | 83.2 | % |
| Dividends paid on unvested restricted stock  compensation               |       | —                                                         |       | (447 | ) | 447 |   | 100.0 | % |
| Preferred stock dividends and accretion                                 |       | (10,374                                                        | )          | (10,375 | ) | 1 |   | 0.0 | % |
| Loss attributable to common stockholders                                |       | $                                                              | (31,157    | ) | $ | (134,517 | ) | $ | 103,360 |   | 76.8 | % |

 

*Operating Statistics.*Included in the followingtables are comparisons of the key operating metrics for our hotel portfolio forthe three and six months ended June 30, 2010 and 2009. The comparisons donot include the results of operations for the three hotels sold in 2009, thetwo hotels held in receivership, or the Mass Mutual eight hotels held fornon-sale disposition. The comparisons do include the results of operations forthe Renaissance Westchester during the period the hotel was held inreceivership in 2010 as well as all of 2009.

 
| ** **                        | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------|------------|
| ** **                        | ** ** | **Occ%**                                   | ** ** | **ADR**                                    | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** |
| Total Hotel Portfolio (30 hotels) |       | 73.9                                       | %          | $                                          | 151.43     |       | $          | 111.91 |   | 70.5 | % | $ | 148.69 |   | $ | 104.83 |   | 340 bps |   | 1.8 | % | 6.8 | % |
|                                   |            |                                            |            |                                            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                        | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|------------|------------|
| ** **                        | ** ** | **Occ%**                                 | ** ** | **ADR**                                  | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** |
| Total Hotel Portfolio (30 hotels) |       | 70.3                                     | %          | $                                        | 146.65     |       | $          | 103.09 |   | 67.9 | % | $ | 151.39 |   | $ | 102.79 |   | 240 bps |   | (3.1 | )% | 0.3 | % |
|                                   |            |                                          |            |                                          |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

For the three months ended June 30, 2010,RevPAR for the 30 hotel portfolio increased 6.8% to $111.91 from the sameperiod in 2009. Occupancy increased 340 basis points to 73.9%, while ADRincreased 1.8% to $151.43.

 

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For the six months ended June 30, 2010, RevPARfor the 30 hotel portfolio increased 0.3% to $103.09 from the same period in2009. Occupancy increased 240 basis points to 70.3%, while ADR decreased 3.1%to $146.65.

 

*Non-GAAP Financial Measures*. The followingtable reconciles net income available (loss attributable) to commonstockholders to EBITDA and Adjusted EBITDA for our hotel portfolio for thethree and six months ended June 30, 2010 and 2009. We believe EBITDA andAdjusted EBITDA are useful to investors in evaluating our operating performancebecause these measures help investors evaluate and compare the results of ouroperations from period to period by removing the impact of our capitalstructure (primarily interest expense and preferred stock dividends) and ourasset base (primarily depreciation and amortization) from our operatingresults. We also use EBITDA and Adjusted EBITDA as measures in determining thevalue of hotel acquisitions and dispositions. We caution investors that amountspresented in accordance with our definitions of EBITDA and Adjusted EBITDA maynot be comparable to similar measures disclosed by other companies, because notall companies calculate these non-GAAP measures in the same manner. EBITDA andAdjusted EBITDA should not be considered as an alternative measure of our netincome (loss), operating performance, cash flow or liquidity. EBITDA andAdjusted EBITDA may include funds that may not be available for ourdiscretionary use to fund interest expense, capital expenditures or generalcorporate purposes. Although we believe that EBITDA and Adjusted EBITDA canenhance an investor’s understanding of our results of operations, thesenon-GAAP financial measures, when viewed individually, are not necessarily abetter 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 thatadverse economic and market conditions may harm our cash flow.

 
| ** **                                                | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                | ** ** | **(in thousands)**                                   | ** ** | **(in thousands)**                                   | ** ** | **(in thousands)**                                 | ** ** | **(in thousands)**                                 | ** ** |
| Loss attributable to common stockholders                  |       | $                                                         | (4,879     | )                                                         | $          | (135,393                                                | )          | $                                                       | (31,157    | ) | $ | (134,517 | ) |
| Dividends paid on unvested restricted stock  compensation |       | —                                                    |       | —                                                    |       | —                                                  |       | 447                                                     |       |
| Series A and C preferred stock dividends             |       | 5,187                                                     |       | 5,188                                                     |       | 10,374                                                  |       | 10,375                                                  |       |
| Operations held for investment:                           |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Depreciation and amortization                             |       | 23,264                                                    |       | 23,765                                                    |       | 46,822                                                  |       | 47,289                                                  |       |
| Amortization of lease intangibles                         |       | 150                                                       |       | —                                                    |       | 150                                                     |       | —                                                  |       |
| Interest expense                                          |       | 16,185                                                    |       | 18,198                                                    |       | 33,123                                                  |       | 37,255                                                  |       |
| Interest expense — default rate                      |       | 120                                                       |       | —                                                    |       | 884                                                     |       | —                                                  |       |
| Amortization of deferred financing fees                   |       | 306                                                       |       | 361                                                       |       | 799                                                     |       | 635                                                     |       |
| Write-off of deferred financing fees                      |       | 123                                                       |       | 284                                                       |       | 1,585                                                   |       | 284                                                     |       |
| Loan penalties and fees                                   |       | 36                                                        |       | —                                                    |       | 174                                                     |       | —                                                  |       |
| Non-cash interest related to discount on Senior  Notes    |       | 245                                                       |       | 655                                                       |       | 491                                                     |       | 1,339                                                   |       |
| Unconsolidated joint ventures:                            |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Depreciation and amortization                             |       | 13                                                        |       | 1,282                                                     |       | 27                                                      |       | 2,554                                                   |       |
| Interest expense                                          |       | —                                                    |       | 663                                                       |       | —                                                  |       | 1,348                                                   |       |
| Amortization of deferred financing fees                   |       | —                                                    |       | 46                                                        |       | —                                                  |       | 92                                                      |       |
| Operations held for non-sale disposition:                 |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Depreciation and amortization                             |       | 1,544                                                     |       | 2,727                                                     |       | 3,237                                                   |       | 5,434                                                   |       |
| Interest expense                                          |       | 2,473                                                     |       | 2,760                                                     |       | 5,182                                                   |       | 5,523                                                   |       |
| Interest expense — default rate                      |       | 2,078                                                     |       | —                                                    |       | 4,354                                                   |       | —                                                  |       |
| Amortization of deferred financing fees                   |       | 132                                                       |       | 132                                                       |       | 264                                                     |       | 264                                                     |       |
| Loan penalties and fees                                   |       | 303                                                       |       | —                                                    |       | 597                                                     |       | —                                                  |       |
| Discontinued operations:                                  |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Depreciation and amortization                             |       | —                                                    |       | 2,770                                                     |       | 124                                                     |       | 5,753                                                   |       |
| Interest expense                                          |       | —                                                    |       | 1,727                                                     |       | 225                                                     |       | 3,439                                                   |       |
| Amortization of deferred financing fees                   |       | —                                                    |       | 10                                                        |       | 2                                                       |       | 21                                                      |       |
| Loan penalties and fees                                   |       | —                                                    |       | —                                                    |       | 48                                                      |       | —                                                  |       |
| EBITDA                                                    |       | 47,280                                                    |       | (74,825                                                   | )          | 77,305                                                  |       | (12,465                                                 | )          |
| Operations held for investment:                           |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Amortization of deferred stock compensation               |       | 686                                                       |       | 1,220                                                     |       | 1,648                                                   |       | 2,348                                                   |       |
| Gain on sale of assets                                    |       | —                                                    |       | (35                                                       | )          | —                                                  |       | (354                                                    | )          |
| Gain on extinguishment of debt                            |       | —                                                    |       | (26,559                                                   | )          | —                                                  |       | (54,579                                                 | )          |
| Impairment loss                                           |       | 1,943                                                     |       | 27,237                                                    |       | 1,943                                                   |       | 28,643                                                  |       |
| Unconsolidated joint ventures:                            |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Amortization of deferred stock compensation               |       | 7                                                         |       | 11                                                        |       | 17                                                      |       | 16                                                      |       |
| Operations held for non-sale disposition:                 |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Impairment loss                                           |       | —                                                    |       | 697                                                       |       | —                                                  |       | 3,007                                                   |       |
| Discontinued operations:                                  |       |                                                      |       |                                                      |       |                                                    |       |                                                    |       |
| Loss on sale of assets                                    |       | —                                                    |       | 13,070                                                    |       | —                                                  |       | 13,070                                                  |       |
| Gain on extinguishment of debt                            |       | (6,747                                                    | )          | —                                                    |       | (6,747                                                  | )          | —                                                  |       |
| Impairment loss                                           |       | —                                                    |       | 104,007                                                   |       | —                                                  |       | 104,007                                                 |       |
|                                                      |       | (4,111                                                    | )          | 119,648                                                   |       | (3,139                                                  | )          | 96,158                                                  |       |
| Adjusted EBITDA                                           |       | $                                                         | 43,169     |                                                      | $          | 44,823                                                  |       | $                                                       | 74,166     |   | $ | 83,693 |   |

 

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AdjustedEBITDA was $43.2 million and $44.8 million for the three months ended June 30,2010 and 2009, respectively, and $74.2 million and $83.7 million for the sixmonths ended June 30, 2010 and 2009, respectively. Adjusted EBITDAdecreased for the three months ended June 30, 2010 as compared to the sameperiod in 2009 as increased earnings at our hotels were partially offset bytransition costs incurred as a result of our management company changes.Adjusted EBITDA decreased for the six months ended June 30, 2010 ascompared to the same period in 2009 primarily due to decreased earnings at ourhotels, combined with transition costs incurred as a result of our managementcompany changes.

 

Thefollowing table reconciles net income available (loss attributable) to commonstockholders to FFO and Adjusted FFO for our hotel portfolio for the three andsix months ended June 30, 2010 and 2009. We believe that the presentationof FFO and Adjusted FFO provide useful information to investors regarding ouroperating performance because they are measures of our operations withoutregard to specified non-cash items such as real estate depreciation andamortization, gain or loss on sale of assets and certain other items which webelieve are not indicative of the performance of our underlying hotelproperties. We believe that these items are more representative of our assetbase and our acquisition and disposition activities than our ongoingoperations. We also use FFO as one measure in determining our results aftertaking into account the impact of our capital structure. We caution investorsthat amounts presented in accordance with our definitions of FFO and AdjustedFFO 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 ournet income (loss), operating performance, cash flow or liquidity. FFO andAdjusted FFO may include funds that may not be available for our discretionaryuse to fund interest expense, capital expenditures or general corporatepurposes. Although we believe that FFO and Adjusted FFO can enhance an investor’sunderstanding of our results of operations, these non-GAAP financial measures,when viewed individually, are not necessarily a better indicator of any trendas compared to GAAP measures such as net income (loss) or cash flow fromoperations. In addition, you should be aware that adverse economic and marketconditions may harm our cash flow.

 

 
| ** **                                                | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended********June 30, 2010** | ** ** | **Six Months Ended********June 30, 2009** | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                | ** ** | **(in thousands)**                         | ** ** | **(in thousands)**                         | ** ** | **(in thousands)**                             | ** ** | **(in thousands)**                             | ** ** |
| Loss attributable to common stockholders                  |       | $                                          | (4,879     | )                                          | $          | (135,393                                       | )          | $                                              | (31,157    | ) | $ | (134,517 | ) |
| Dividends paid on unvested restricted stock  compensation |       | —                                     |       | —                                     |       | —                                         |       | 447                                            |       |
| Operations held for investment:                           |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Real estate depreciation and amortization                 |       | 23,133                                     |       | 23,611                                     |       | 46,553                                         |       | 46,972                                         |       |
| Amortization of lease intangibles                         |       | 150                                        |       | —                                     |       | 150                                            |       | —                                         |       |
| Gain on sale of assets                                    |       | —                                     |       | (35                                        | )          | —                                         |       | (354                                           | )          |
| Unconsolidated joint ventures:                            |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Real estate depreciation and amortization                 |       | —                                     |       | 1,264                                      |       | —                                         |       | 2,518                                          |       |
| Operations held for non-sale disposition:                 |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Real estate depreciation and amortization                 |       | 1,544                                      |       | 2,727                                      |       | 3,237                                          |       | 5,434                                          |       |
| Discontinued operations:                                  |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Real estate depreciation and amortization                 |       | —                                     |       | 2,770                                      |       | 124                                            |       | 5,753                                          |       |
| Loss on sale of assets                                    |       | —                                     |       | 13,070                                     |       | —                                         |       | 13,070                                         |       |
| FFO                                                       |       | 19,948                                     |       | (91,986                                    | )          | 18,907                                         |       | (60,677                                        | )          |
| Operations held for investment:                           |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Interest expense — default rate                      |       | 120                                        |       | —                                     |       | 884                                            |       | —                                         |       |
| Write-off of deferred financing fees                      |       | 123                                        |       | 284                                        |       | 1,585                                          |       | 284                                            |       |
| Loan penalties and fees                                   |       | 36                                         |       | —                                     |       | 174                                            |       | —                                         |       |
| Gain on extinguishment of debt                            |       | —                                     |       | (26,559                                    | )          | —                                         |       | (54,579                                        | )          |
| Impairment loss                                           |       | 1,943                                      |       | 27,237                                     |       | 1,943                                          |       | 28,643                                         |       |
| Operations held for non-sale disposition:                 |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Interest expense — default rate                      |       | 2,078                                      |       | —                                     |       | 4,354                                          |       | —                                         |       |
| Loan penalties and fees                                   |       | 303                                        |       | —                                     |       | 597                                            |       | —                                         |       |
| Impairment loss                                           |       | —                                     |       | 697                                        |       | —                                         |       | 3,007                                          |       |
| Discontinued operations:                                  |       |                                       |       |                                       |       |                                           |       |                                           |       |
| Loan penalties and fees                                   |       | —                                     |       | —                                     |       | 48                                             |       | —                                         |       |
| Gain on extinguishment of debt                            |       | (6,747                                     | )          | —                                     |       | (6,747                                         | )          | —                                         |       |
| Impairment loss                                           |       | —                                     |       | 104,007                                    |       | —                                         |       | 104,007                                        |       |
|                                                      |       | (2,144                                     | )          | 105,666                                    |       | 2,838                                          |       | 81,362                                         |       |
| Adjusted FFO                                              |       | $                                          | 17,804     |                                       | $          | 13,680                                         |       | $                                              | 21,745     |   | $ | 20,685 |   |

 

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AdjustedFFO was $17.8 million and $13.7 million for the three months ended June 30,2010 and 2009, respectively, and $21.7 million and $20.7 million for the six monthsended June 30, 2010 and 2009, respectively. Adjusted FFO increased for thethree months ended June 30, 2010 as compared to the same period in 2009primarily due to increased earnings at our hotels combined with decreasedinterest expense, partially offset by transition costs incurred as a result ofour management company changes. Adjusted FFO increased for the six months endedJune 30, 2010 as compared to the same period in 2009 primarily due tolower interest expense, partially offset by decreased earnings at our hotelsand by transition costs incurred as a result of our management company changes.

 

*Room revenue*. Room revenueincreased $7.1 million, or 7.0%, for the three months ended June 30, 2010as compared to the three months ended June 30, 2009. The results ofoperations for the Renaissance Westchester are included in continuingoperations from the date we reacquired the hotel (June 14, 2010) forward.Prior to June 14, 2010, the results of operations for the RenaissanceWestchester are included in discontinued operations as possession and controlof the hotel was held by a court-appointed receiver. Room revenuegenerated by the Renaissance Westchester and included in continuing operationsfor the second quarter of 2010 was $0.2 million. Room revenue generated bythe 29 hotels held for investment during all periods presented (our “existingportfolio”) increased $6.9 million in the second quarter of 2010 as compared tothe same period in 2009 due to an increase in occupancy of $3.4 millioncombined with an increase in ADR of $3.5 million.

 

Room revenueincreased $0.8 million, or 0.4%, for the six months ended June 30, 2010 ascompared to the six months ended June 30, 2009. Room revenuegenerated by the Renaissance Westchester and included in continuing operationsfor the first six months of 2010 was $0.2 million. Room revenue generatedby our existing portfolio increased $0.6 million in the first six months of2010 as compared to the same period in 2009 due to an increase in occupancy of$4.7 million partially offset by a decrease in ADR of $4.1 million.

 

*Food and beverage revenue.* Food andbeverage revenue increased $0.3 million, or 0.8%, for the three months ended June 30,2010 as compared to the three months ended June 30, 2009. Food andbeverage revenue generated by the Renaissance Westchester and included incontinuing operations for the second quarter of 2010 was $0.1 million. Food andbeverage revenue generated by our existing portfolio increased $0.2 million inthe second quarter of 2010 as compared to the same period in 2009 due toincreased banquet, room service and other revenue due to increased occupancy atseveral of our hotels and to an increase in conventions and meetings held atour hotels. These increases were partially offset by decreased outlet revenueprimarily due to the fact that several of our hotels are in the process ofremodeling and re-concepting their restaurants.

 

Foodand beverage revenue decreased $2.5 million, or 3.1%, for the six months ended June 30,2010 as compared to the six months ended June 30, 2009. Food and beveragerevenue generated by the Renaissance Westchester and included in continuingoperations for the first six months of 2010 was $0.1 million. Food and beveragerevenue generated by our existing portfolio decreased $2.6 million for the sixmonths of 2010 as compared to the same period in 2009. This decrease isprimarily due to lower revenues generated in 2010 by our Washington D.C. areahotels, which benefited from the 2009 presidential inauguration. Food and beveragerevenue also decreased in the first six months of 2010 as compared to the sameperiod in 2009 due to a reduction in business at our Houston Texas hotels withone customer who is operating under a contract with the United Statesgovernment. Additionally, many of our hotels that began to close theirrestaurants during the second quarter and second half of 2009 in order to savecosts continued to keep their restaurants closed during the first six months of2010 either to save costs or due to remodeling and re-concepting projects.

 

*Other operating revenue*. Otheroperating revenue decreased $1.1 million, or 8.2%, for the three months ended June 30,2010 as compared to the three months ended June 30, 2009, primarily due todecreased cancellation and attrition revenue in our existing portfolio slightlyoffset by increased revenue at our two commercial laundry facilities.

 

Otheroperating revenue decreased $1.1 million, or 4.3%, for the six months ended June 30,2010 as compared to the six months ended June 30, 2009, primarily due tothe same reasons described above in the discussion regarding the secondquarter.

 

*Revenues of operations held for non-sale disposition.*Revenues of operations held for non-sale disposition associated withthe Mass Mutual eight hotels decreased $1.4 million, or 6.6%, for the threemonths ended June 30, 2010 as compared to the same period in 2009. Thisdecrease was primarily the result of a 310 basis point decrease in occupancycombined with a 4.3% decrease in ADR, causing room revenue to decrease $1.2million. In addition, food and beverage revenue decreased $0.1 million, andother operating revenue decreased $0.1 million.

 

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Revenuesof operations held for non-sale disposition associated with the Mass Mutualeight hotels decreased $2.9 million, or 6.8%, for the six months ended June 30,2010 as compared to the same period in 2009. This decrease was primarily theresult of a 170 basis point decrease in occupancy combined with a 5.5% decreasein ADR, causing room revenue to decrease $2.3 million. In addition, food andbeverage revenue decreased $0.3 million, and other operating revenue decreased$0.3 million.

 

*Hotel operating expenses.*Hotel operatingexpenses, which are comprised of room, food and beverage, advertising andpromotion, repairs and maintenance, utilities, franchise costs, property tax,ground lease and insurance, and other hotel operating expenses increased $2.9million, or 3.0%, during the three months ended June 30, 2010 as comparedto the three months ended June 30, 2009. Hotel operating expensesgenerated by the Renaissance Westchester and included in continuing operationsfor the second quarter of 2010 totaled $0.2 million. Hotel operating expensesfor our existing portfolio increased $2.7 million during the second quarter of2010 as compared to the same period in 2009. This increase in hotel operatingexpenses is primarily related to the increase in related room revenue. Inaddition, hotel operating expenses increased during the second quarter of 2010as compared to the same period in 2009 due to increases in the followingexpenses: advertising and promotion as the hotels began to increase theirspending in response to the recovering economy; franchise fees and assessmentsdue to the increased revenue; and property taxes due to $0.4 million inproperty tax credits received at one of our hotels during the second quarter of2009, and by $0.2 million in prior year tax reimbursements collected from thebuyer upon our second quarter 2009 sale of land adjacent to one of our hotels.These increases were partially offset by decreases in departmental payroll dueto staff reductions and cost cutting initiatives implemented throughout 2009,and utilities due to reductions in gas rates and usage at several of ourhotels.

 

Hoteloperating expenses decreased $0.1 million, or 0.1%, during the six months endedJune 30, 2010 as compared to the six months ended June 30, 2009.Hotel operating expenses generated by the Renaissance Westchester and includedin continuing operations for the first six months of 2010 totaled $0.2 million.Hotel operating expenses for our existing portfolio decreased $0.3 millionduring the first six months of 2010 as compared to the same period in 2009.This decrease in hotel operating expenses is primarily related to the decreasesin related food and beverage and other operating revenue. In addition, hoteloperating expenses declined during the first six months of 2010 as compared tothe same period in 2009 due to decreases in the following expenses:departmental payroll due to staff reductions and cost cutting initiativesimplemented throughout 2009; advertising and repairs and maintenance as thehotels continued to cancel or delay unnecessary expenditures; and utilities dueto reductions in gas rates and usage at several of our hotels. These decreaseswere partially offset by increases in franchise assessments at several of ourhotels and property taxes due to prior year refunds received by several of ourhotels which were recorded during the first six months of 2009, and by $0.2million in prior year tax reimbursements collected from the buyer upon oursecond quarter 2009 sale of land adjacent to one of our hotels.

 

*Property general and administrative expense.*Property**general andadministrative expense increased $1.0 million, or 5.6%, during the three monthsended June 30, 2010 as compared to the three months ended June 30,2009, primarily due to increased expenses in our existing portfolio. Managementfees and credit and collection expenses increased in our existing portfolio dueto the increase in revenue. In addition, property general and administrativeexpense in our existing portfolio increased due to increased payroll, employeerelations, recruitment and relocation combined with increased licenses andpermits. These increases were slightly offset by decreased training and travel.

 

Property**general andadministrative expense increased $0.1 million, or 0.3%, during the six monthsended June 30, 2010 as compared to the six months ended June 30,2009, primarily due to increased expenses in our existing portfolio due to thesame reasons described above in the discussion regarding the second quarter.Management fees, however, decreased in our existing portfolio for the sixmonths ended June 30, 2010 as compared to the same period in 2009 due tothe decline in revenue generated in 2010 by our Washington D.C. area hotels,which benefited from the 2009 presidential inauguration.

 

*Corporate overhead expense.*Corporateoverhead expense increased $0.4 million, or 7.3%, during the three months endedJune 30, 2010 as compared to the three months ended June 30, 2009,primarily due to $0.4 million in stay-put bonuses accrued during the secondquarter of 2010 to incentivize certain hotel-level employees to stay throughthe management company transitions. Additional increases in due diligence,licenses and permits, and legal costs and expenses during the three monthsended June 2010 as compared to the same period in 2009 were offset bydecreased sales tax expenses.

 

Corporateoverhead expense decreased $0.8 million, or 7.4%, during the six months ended June 30,2010 as compared to the six months ended June 30, 2009, primarily due todecreases in total payroll related costs and deferred stock compensationexpense as a result of our corporate reorganization in the second quarter of2009, combined with decreases in contract and professional fees and sales taxexpense. These decreases were partially offset by $0.4 million in stay-putbonuses accrued during the second quarter of 2010 to incentivize certainhotel-level employees to stay through the management company transitions,combined with increases in due diligence, licenses and permits, and legal costsand expenses.

 

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*Depreciation and amortization expense.*Depreciationand amortization expense decreased $0.5 million, or 2.1%, during the threemonths ended June 30, 2010 as compared to the three months ended June 30,2009. Depreciation and amortization expense generated by the RenaissanceWestchester and included in continuing operations for the second quarter of2010 totaled $0.1 million. Depreciation and amortization in our existingportfolio decreased $0.6 million due to the fact that we reduced thedepreciable assets of our existing portfolio by $25.4 million during the secondquarter of 2009 due to impairment charges.

 

Depreciationand amortization expense decreased $0.5 million, or 1.0%, during the six monthsended June 30, 2010 as compared to the six months ended June 30,2009, primarily due to the same reasons described above in the discussionregarding the second quarter.

 

*Operating expenses of operations held for non-saledisposition*. Operating expenses of operations held for non-saledisposition associated with the Mass Mutual eight hotels, which are comprisedof room, food and beverage, other operating expenses, advertising andpromotion, repairs and maintenance, utilities, franchise costs, property tax,ground lease and insurance expense, property general and administrativeexpense, depreciation and amortization, totaled $17.9 million for the threemonths ended June 30, 2010 as compared to $20.4 million for the threemonths ended June 30, 2009. During the three months ended June 30,2010, we recognized $16.4 million in operating expenses and $1.5 million indepreciation and amortization. During the three months ended June 30,2009, we recognized $17.7 million in operating expenses and $2.7 million indepreciation and amortization. The decrease in operating expenses of operationsheld for non-sale disposition associated with the Mass Mutual eight hotels isprimarily related to decreased property taxes due to supplemental prior yeartaxes assessed on two of the hotels in 2009. The decrease in depreciation inthe second quarter of 2010 as compared to the same period in 2009 is primarilydue to $88.2 million in impairment charges recorded in 2009, which reduced thedepreciable assets for operations held for non-sale disposition.

 

Operatingexpenses of operations held for non-sale disposition associated with the MassMutual eight hotels totaled $36.0 million for the six months ended June 30,2010 as compared to $39.3 million for the six months ended June 30, 2009.During the six months ended June 30, 2010, we recognized $32.7 million inoperating expenses and $3.3 million in depreciation and amortization. Duringthe six months ended June 30, 2009, we recognized $33.8 million inoperating expenses and $5.5 million in depreciation and amortization. Thedecrease in operating expenses and depreciation and amortization expense ofoperations held for non-sale disposition associated with the Mass Mutual eighthotels is primarily due to the same reasons described above in the discussionregarding the second quarter.

 

*Property and goodwill impairment losses.*Property and goodwill impairment losses totaled $1.9 million for thethree months ended June 30, 2010 compared to $27.2 million for the threemonths ended June 30, 2009. During the second quarter of 2010, werecognized a property impairment loss of $1.9 million on an office building andland adjacent to one of our hotels in anticipation of its possible sale during the third or fourth quarter of2010. During the second quarter of 2009, we recognized a $25.4 million propertyimpairment loss on the Marriott Del Mar to reduce the carrying value of thehotel on our balance sheet to its fair value. In addition, during the secondquarter of 2009, we recognized a $1.4 million property impairment loss relatedto the write-off of costs associated with a potential timeshare development inNewport Beach, California, and we wrote off $0.4 million in goodwill associatedwith the Marriott Rochester in conjunction with a quarterly impairmentevaluation.

 

Property and goodwill losses totaled $1.9 millionfor the six months ended June 30, 2010 compared to $28.6 million for thesix months ended June 30, 2009. During the first six months of 2010, werecognized a property impairment loss of $1.9 million on an office building andland adjacent to one of our hotels in anticipation of its possible sale duringthe third or fourth quarter of 2010. During the first six months of 2009, werecognized a $25.4 million property impairment loss on the Marriott Del Mar toreduce the carrying value of the hotel on our balance sheet to its fair value.In addition, we recognized a $0.1 million property impairment loss on a parcel of landadjacent to one of our hotels which we sold in June 2009. During the first six months of 2009, we alsorecognized a $1.4 million property impairment loss related to the write-off ofcosts associated with a potential timeshare development in Newport Beach,California. In conjunction with our quarterly impairment evaluations performedduring the first six months of 2009, we wrote off $1.3 million and $0.4 millionof goodwill associated with the Marriott Park City and the Marriott Rochester,respectively.

 

*Goodwill impairment losses of operations held fornon-sale disposition.*Goodwillimpairment losses of operations held for non-sale disposition associated withthe Mass Mutual eight hotels totaled zero for the three months ended June 30,2010 as compared to $0.7 million for the same period in 2009. In conjunctionwith our quarterly impairment evaluation performed as of June 30, 2009, wewrote off $0.7 million in goodwill associated with two of the Mass Mutual eighthotels: Marriott Salt Lake City (University Park) $0.5 million and Holiday InnExpress San Diego $0.2 million.

 

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Goodwill impairment losses of operations heldfor non-sale disposition associated with the Mass Mutual eight hotels totaledzero for the six months ended June 30, 2010 as compared to $3.0 millionfor the same period in 2009. In conjunction with our quarterly impairmentevaluations performed during the first six months of 2009, we wrote off $3.0million in goodwill associated with four of the Mass Mutual eight hotels:Holiday Inn Downtown San Diego $1.4 million; Marriott Provo $0.7 million;Marriott Salt Lake City (University Park) $0.7 million; and Holiday Inn ExpressSan Diego $0.2 million.

 

*Equity in earnings (losses) of unconsolidated jointventures.* Equity in earnings (losses) of unconsolidated jointventures totaled earnings of $0.2 million for the three months ended June 30,2010, and a loss of $0.6 million for the three months ended June 30, 2009.In the second quarter of 2010, we recognized income of $0.2 million on ourBuyEfficient joint venture, and zero on our Doubletree Guest Suites TimesSquare joint venture. Though the Doubletree Guest Suites Times Square jointventure recognized earnings during the second quarter of 2010, we did notrecognize any portion of these earnings due to the fact that we reduced ourinterest in this partnership to zero at December 31, 2009 as a result ofthe hotel’s fourth quarter 2009 impairment charge. In the second quarter of2009, we recognized a loss of $0.7 million on our interest in the DoubletreeGuest Suites Times Square joint venture, and income of $0.1 million on ourBuyEfficient joint venture.

 

Equityin earnings (losses) of unconsolidated joint ventures totaled earnings of $0.3million for six months ended June 30, 2010, and a loss of $2.1 million forthe six months ended June 30, 2009. In the first six months of 2010, werecognized income of $0.3 million on our BuyEfficient joint venture, and zeroon our Doubletree Guest Suites Times Square joint venture. Though theDoubletree Guest Suites Times Square joint venture incurred a loss during thefirst half of 2010, we did not recognize any portion of this loss due to thefact that we reduced our interest in this partnership to zero at December 31,2009 as a result of the hotel’s fourth quarter 2009 impairment charge. In thefirst six months of 2009, we recognized a loss of $2.2 million on our interestin the Doubletree Guest Suites Times Square joint venture, and income of $0.1million on our BuyEfficient joint venture.

 

*Interest and other income.*Interest andother income totaled $0.1 million for the three months ended June 30, 2010and $0.3 million for the same period in 2009. In the second quarter of 2010, werecognized $0.1 million in interest income. In the second quarter of 2009, werecognized $0.2 million in interest income, and $0.1 million on the sale ofsurplus furniture, fixtures and equipment (“FF&E”) located in two of ourhotels.

 

Interestand other income totaled $0.3 million for the six months ended June 30,2010 and $0.9 million for the same period in 2009. In the first six months of2010, we recognized $0.2 million in interest income and $0.1 million in othermiscellaneous income. In the first six months of 2009, we recognized $0.5million in interest income, and $0.4 million on the sale of surplus furniture,fixtures and equipment (“FF&E”) located in two of our hotels.

 

*Interest expense.*Weincurred interest expense as follows (in thousands):

 
| ** **                              | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| Interest expense                        |       | $                                               | 16,185     |                                            | $          | 18,198                                        |       | $                                             | 33,123     |   | $ | 37,255 |   |
| Interest expense — default rate    |       | 120                                             |       | —                                          |       | 884                                           |       | —                                        |       |
| Accretion of Senior Notes               |       | 245                                             |       | 655                                             |       | 491                                           |       | 1,339                                         |       |
| Amortization of deferred financing fees |       | 306                                             |       | 361                                             |       | 799                                           |       | 635                                           |       |
| Write-off of deferred financing fees    |       | 123                                             |       | 284                                             |       | 1,585                                         |       | 284                                           |       |
| Loan penalties and fees                 |       | 36                                              |       | —                                          |       | 174                                           |       | —                                        |       |
|                                    |       | $                                               | 17,015     |                                            | $          | 19,498                                        |       | $                                             | 37,056     |   | $ | 39,513 |   |

 

Interestexpense decreased $2.5 million, or 12.7%, during the three months ended June 30,2010 as compared to the same period during 2009. Interest expense decreased$2.0 million during the second quarter of 2010 as compared to the same periodin 2009 as a result of decreases in our loan balances combined with ourrepurchase of $64.0 million in aggregate principal amount of the Senior Notesin the first quarter of 2009 and an additional $123.5 million in the secondquarter of 2009, as well as the repayment of $83.0 million in April 2010to release three hotels from the Mass Mutual loan. In addition, interestexpense due to the accretion of the Senior Notes decreased by $0.4 millionduring the three months ended June 30, 2010 as compared to the same periodin 2009 due to the repurchases of the Senior Notes in 2009. Interest expensealso decreased in the second quarter of 2010 as compared to the same period in2009 due to a $0.2 million decrease in write-off of deferred financing fees.During the second quarter of 2010, we wrote off $0.1 million in deferredfinancing fees related to the release of the three hotels from the Mass Mutual loan,and during the second quarter of 2009, we wrote off $0.3 million in deferredfinancing fees associated with the amendment of our credit facility. Interestexpense also decreased in the second quarter of 2010 as compared to the secondquarter of 2009 due to a $0.1 million decrease in amortization of deferredfinancing fees related to the repayment of the loans noted above, as well asthe termination of our credit facility. These decreases were slightly offset byan increase in interest expense for the second quarter of 2010 as compared tothe same period in 2009 due to our elective defaults pursuant to our 2009secured debt restructuring program as one of the lenders increased our interestrate by 5.0% causing an additional $0.2 million in default interest, penaltiesand fees.

 

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Interestexpense decreased $2.5 million, or 6.2%, during the six months ended June 30,2010 as compared to the same period during 2009. Interest expense decreased$4.1 million during the first six months of 2010 as compared to the same periodin 2009 as a result of decreases in our loan balances combined with ourrepurchase of $64.0 million in aggregate principal amount of the Senior Notesin the first quarter of 2009 and an additional $123.5 million in the secondquarter of 2009, as well as the repayment of $83.0 million in April 2010to release three hotels from the Mass Mutual loan. In addition, interestexpense due to the accretion of the Senior Notes decreased by $0.8 millionduring the first six months of 2010 as compared to the same period in 2009 dueto the repurchases of the Senior Notes in 2009. These decreases were partiallyoffset by an increase of $1.3 million in interest expense due to the write-offof deferred financing fees. During the first half of 2010, we wrote-off $1.5million in deferred financing fees related to the termination of our creditfacility in February 2010, and $0.1 million in deferred financing feesrelated to the release of the three hotels from the Mass Mutual loan in April 2010.During the first six months of 2009, we wrote off $0.3 million in deferredfinancing fees associated with the amendment of our credit facility. Inaddition, interest expense increased $0.2 million during the first six monthsof 2010 as compared to the same period in 2009 due to an increase inamortization of deferred financing fees related to an increase in feesassociated with our repurchase of the Senior Notes and the amendment of ourloan on the Renaissance Baltimore during the third quarter of 2009, partiallyoffset by a decrease in fees related to the repayment of the loans noted above,as well as the termination of our credit facility. Interest expense alsoincreased during the first six months of 2010 as compared to the same period in2009 due to our elective defaults pursuant to our 2009 secured debtrestructuring program as one of the lenders increased our interest rate by 5.0%causing an additional $0.9 million in interest and $0.2 million in defaultpenalties and fees.

 

Ourweighted average interest rate per annum was approximately 5.6% at both June 30,2010 and 2009. At June 30, 2010, all of our outstanding notes payable hadfixed interest rates.

 

*Interest expense of operations held for non-saledisposition*. Interest expense of operations held for non-saledisposition associated with the Mass Mutual eight hotels is as follows (inthousands):

 

 

 
| ** **                              | ** ** | **Three Months Ended  June 30, 2010** | ** ** | **Three Months Ended  June 30, 2009** | ** ** | **Six Months Ended********June 30, 2010** | ** ** | **Six Months Ended********June 30, 2009** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
| Interest expense                        |       | $                                               | 2,473      |                                            | $          | 2,760                                               |       | $                                                   | 5,182      |   | $ | 5,523 |   |
| Interest expense — default rate    |       | 2,078                                           |       | —                                          |       | 4,354                                               |       | —                                              |       |
| Amortization of deferred financing fees |       | 132                                             |       | 132                                             |       | 264                                                 |       | 264                                                 |       |
| Loan penalties and fees                 |       | 303                                             |       | —                                          |       | 597                                                 |       | —                                              |       |
|                                    |       | $                                               | 4,986      |                                            | $          | 2,892                                               |       | $                                                   | 10,397     |   | $ | 5,787 |   |

 

Interestexpense of operations held for non-sale disposition increased $2.1 million, or72.4%, during the three months ended June 30, 2010 as compared to the sameperiod in 2009 primarily due to our elective default of the non-recourse loansecured by the Mass Mutual eight hotels pursuant to our 2009 secured debtrestructuring program. Interest expense of operations held for non-saledisposition includes an additional $2.1 million in the second quarter of 2010as compared to the same period in 2009 as the lender increased our interestrate by 5.0% in conjunction with our elective default of the non-recourse loansecured by the Mass Mutual eight hotels. In addition, interest expense ofoperations held for non-sale disposition increased in the second quarter of2010 as compared to the same period in 2009 due to $0.3 million in loanpenalties and fees recorded in 2010 related to our elective default of thenon-recourse loan secured by the Mass Mutual eight hotels. While we arerequired to record such loan penalties and fees, as this loan is non-recourseto us, we do not intend to actually fund such fees, and consequently, we expectto record a gain on the forgiveness of these expenses upon completion of thedeed backs of these hotels. These increases were slightly offset by a decreasein interest expense of $0.3 million in the second quarter of 2010 as comparedto the same period in 2009 due to decreased loan balances.

 

Interestexpense of operations held for non-sale disposition increased $4.6 million, or79.7%, during the six months ended June 30, 2010 as compared to the sameperiod in 2009 primarily due to our elective default of the non-recourse loansecured by the Mass Mutual eight hotels pursuant to our 2009 secured debtrestructuring program. Interest expense of operations held for non-saledisposition includes an additional $4.4 million in the first six months of 2010as compared to the same period in 2009 as the lender increased our interestrate by 5.0% in conjunction with our elective default of the non-recourse loansecured by the Mass Mutual eight hotels. In addition, interest expense ofoperations held for non-sale disposition increased in the first six months of2010 as compared to the same period in 2009 due to $0.6 million in loanpenalties and fees recorded in 2010 related to our elective default of thenon-recourse loan secured by the Mass Mutual eight hotels. While we arerequired to record such loan penalties and fees, as this loan is non-recourseto us, we do not intend to actually fund such fees, and consequently, we expectto record a gain on the forgiveness of these expenses upon completion of thedeed backs of these hotels. These increases were slightly offset by a decreasein interest expense of $0.4 million in the first six months of 2010 as comparedto the same period in 2009 due to decreased loan balances.

 

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*Gain on extinguishment of debt.* Gain onextinguishment of debt totaled zero for the three months ended June 30,2010, and $26.6 million for the three months ended June 30, 2009. Duringthe second quarter of 2009, we recognized a gain of $26.6 million due to therepurchase and cancellation of $123.5 million in aggregate principal amount ofthe Senior Notes.

 

Gainon extinguishment of debt totaled zero for the six months ended June 30,2010, and $54.6 million for the six months ended June 30, 2009. During thefirst six months of 2009, we recognized a gain of $54.6 million due to therepurchase and cancellation of $187.5 million in aggregate principal amount ofthe Senior Notes.

 

*Income (loss) from discontinued operations.* Income (loss)from discontinued operations totaled income of $6.6 million and a loss of$119.8 million, respectively, for the three months ended June 30, 2010 and2009, and income of $6.5 million a loss of $122.9 million, respectively, forthe six months ended June 30, 2010 and 2009. As described under “—InvestingActivities—Dispositions,” no hotels were sold during either the first or secondquarters of 2010 and three hotels were sold during 2009. In addition, wedeconsolidated the Marriott Ontario Airport during the first quarter of 2010,and the W San Diego and the Renaissance Westchester during 2009. Upondeconsolidation, we reclassified each hotel’s results of operations todiscontinued operations due to the transfer of possession and control of eachhotel to a court-appointed receiver. On June 14, 2010, we reacquired theRenaissance Westchester for $26.0 million, including related costs. Inconnection with the repurchase of the Renaissance Westchester, the $29.2million non-recourse mortgage secured by the hotel was cancelled. We recorded a$6.7 million gain on the extinguishment of this debt, which is included indiscontinued operations. Operating results for the Renaissance Westchester for2009, therefore, are included in discontinued operations, whereas operatingresults from June 14, 2010 forward are included in our continuingoperations. Consistent with the Property, Plant and Equipment Topic of the FASBASC, we have reclassified the results of operations for all of these hotels,along with any impairments recognized, the gains or losses on the hotel salesand the gain on extinguishment of the Renaissance Westchester debt, todiscontinued operations.

 

*Dividends paid on unvested restricted stock compensation*. Common stockdividends earned on our unvested restricted stock awards were zero for both thethree and six months ended June 30, 2010 as compared to zero and $0.4million, respectively, for the three and six months ended June 30, 2009.

 

*Preferred stock dividends and accretion.*Preferred stockdividends and accretion remained constant at $5.2 million for both the threemonths ended June 30, 2010 and 2009 and $10.4 million for both the sixmonths ended June 30, 2010 and 2009, as the dividend rate for our Series Apreferred stock and Series C preferred stock was $0.50 and $0.393,respectively, per share for both the first and second quarters of 2010 and2009.

 

**Investing Activities**

 

***Acquisitions***. In light ofthe recent cyclical downturn, we did not acquire any hotel properties during2009. With better market clarity and in anticipation of an economic recovery,public REIT valuations improved significantly during the course of 2009. Whilehotel sale transactions were relatively limited in number during 2009, thehotel sale transactions that have recently been consummated indicate that hoteltrading values have not recovered commensurately with public REIT valuations.The pressure on single asset values is primarily caused by the significantamount of distressed CMBS debt associated with hotel assets. Consistent withour cycle-appropriate strategy, we shifted our focus at the end of 2009 towardsthe pursuit of selective hotel acquisitions. Our acquisitions program is aimedat generating attractive returns on our investment dollars, and therefore wemay target lodging assets outside of the typical branded, urban, upper upscaleprofile represented by our existing portfolio in order to capitalize onopportunities which may arise, but we do not expect these atypical lodgingassets to comprise a major component of our portfolio. Additionally, the scopeof our acquisitions program may include large hotel portfolios or hotel loans.

 

OnApril 30, 2010, we purchased two hotel loans with a combined principalamount of $32.5 million plus accrued interest of approximately $800,000, for atotal purchase price of $3.7 million. The loans include (i) a $30.0million, 8.5% mezzanine loan maturing in January 2017 secured by theequity interests in our Doubletree Guest Suites Times Square joint venture, and(ii) a $2.5 million, 8.075% subordinate note maturing in November 2010secured by the 101-room boutique hotel known as Twelve Atlantic Station inAtlanta, Georgia. We purchased the mezzanine loan for $3.45 million and thesubordinate note for $250,000. None of the debt on the Doubletree Guest SuitesTimes Square is in default, however interest on the mezzanine loan is currentlybeing deferred in accordance with the provisions of the loan. The subordinatenote secured by the Twelve Atlantic Station is currently in default. We areaccounting for both loans using the cost recovery method until such time as theexpected cash flows from the loans are reasonably probable and estimable.

 

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***Dispositions***. We did notsell any hotels during the six months ended June 30, 2010. Consistent withour cycle-appropriate strategy, we were a net seller of hotels in 2009. In May 2009,we sold the Marriott Napa Valley for net proceeds of $34.8 million, and a netloss of $13.7 million. In June 2009, we sold the Marriott Riverside fornet 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 anda net gain of $18,000, after having recorded an impairment loss in June 2009of $4.9 million in order to reduce the carrying value of this hotel on ourbalance sheet to its fair value.

 

**Liquidity and Capital Resources**

 

***Historical.*** During theperiods presented, our sources of cash included our operating activities,working capital, sales of hotel properties and other assets, distributionsreceived from our unconsolidated joint ventures, proceeds from our offerings ofcommon stock, and proceeds from our credit facility. Our primary uses of cashwere for capital expenditures for hotels, operating expenses, repayment ofnotes payable (including repurchases of Senior Notes) and our credit facility,purchases of notes receivable and dividends on our common and preferred stock.We cannot be certain that traditional sources of funds will be available in thefuture.

 

***Operating activities****.* Our cashprovided by or used in operating activities fluctuates primarily as a result ofchanges in RevPAR and operating flow through of our hotels. Our net cashprovided by or used in operating activities may also be affected by changes inour portfolio resulting from hotel acquisitions, dispositions or renovations.Net cash used in operating activities was $2.0 million for the six months endedJune 30, 2010 as compared to net cash provided of $34.4 million for thesix months ended June 30, 2009. This decrease was primarily due to anincrease in our restricted cash, partially offset by an increase in accountspayable and other liabilities during the six months ended June 30, 2010 ascompared to the same period in 2009.

 

***Investing activities***. Our cash usedin or provided by investing activities fluctuates primarily as a result ofacquisitions, dispositions and renovations of hotels. Net cash used ininvesting activities during the first six months of 2010 compared to net cashprovided by investing activities during the first six months of 2009 was asfollows (in thousands):

 
| ** **                                                           | ** ** | **Six Months Ended  June 30, 2010** | ** ** | **Six Months Ended  June 30, 2009** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| Proceeds from sale of hotel properties and other  assets             |       | $                                        | —     |                                     | $          | 56,289 |   |
| Cash received from unconsolidated joint ventures                     |       | 300                                      |       | —                                   |       |
| Restricted cash — replacement reserve                           |       | (1,739                                   | )          | (515                                     | )          |
| Acquisitions of notes receivable                                     |       | (3,700                                   | )          | —                                   |       |
| Renovations and additions to hotel properties and  other real estate |       | (17,123                                  | )          | (26,059                                  | )          |
| Net cash (used in) provided by investing  activities                 |       | $                                        | (22,262    | )                                        | $          | 29,715 |   |

 

Netcash used in investing activities was $22.3 million during the first six monthsof 2010 compared to net cash provided of $29.7 million for the six months endedJune 30, 2009. During the six months ended June 30, 2010, we receiveda distribution of $0.3 million from one of our unconsolidated joint ventures,increased the balance in our restricted cash replacement reserve accounts by$1.7 million, paid $3.7 million for the purchase of two notes receivable andpaid cash of $17.1 million for renovations to our hotels. During the six monthsended June 30, 2009, we received $56.3 million from the sale of hotelproperties and other assets, which included $53.5 million from the sale of twohotels, a $2.0 million payment on a note receivable from the buyer of a hotelwe sold in December 2008, $0.4 million from the sale of surplus FF&Elocated in two of our hotels, and $0.4 million from the sales of two vacantparcels of land. In addition, we increased the balance in our restricted cashreplacement reserve accounts by $0.5 million, and paid cash of $26.1 millionfor renovations to our hotels.

 

***Financing activities***. Our cash usedin financing activities fluctuates primarily as a result of our issuance andrepayment of notes payable, including the repurchase of Senior Notes, and theissuance and repurchase of other forms of capital, including preferred equityand common stock. Net cash used in financing activities was $124.7 million forthe six months ended June 30, 2010 compared to $46.2 million for the sixmonths ended June 30, 2009. Net cash used in financing activities for thesix months ended June 30, 2010 consisted primarily of $114.5 million ofprincipal payments on our notes payable and related costs, including $83.0million paid to release three hotels from the Mass Mutual loan, $26.0 millionpaid to reacquire control of the Renaissance Westchester and to extinguish theloan, and $5.5 million of principal amortization. In addition, net cash used infinancing activities for the six months ended June 30, 2010 includes $10.3million of dividends paid to our stockholders. Net cash used in financingactivities for the six months ended June 30, 2009 consisted primarily of$117.4 million to repurchase a portion of our Senior Notes including relatedcosts, $66.8 million of principal payments on our credit facility and notespayable, $17.6 million of dividends paid to our stockholders, $4.8 million incosts associated with the issuance of our common stock, and $3.1 million indeferred financing fees paid in connection with amendments to our Senior Notesindenture and our credit facility. These cash outlays were partially offset by$103.5 million in proceeds received from the issuance of common stock and $60.0million in proceeds received from our credit facility.

 

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***Future.***We expect ourprimary uses of cash to be for acquisitions of hotels, including possibly hotelportfolios, capital expenditures for hotels, operating expenses, repayment ofprincipal on our notes payable, interest expense and dividends. We expect ourprimary sources of cash will continue to be our operating activities, workingcapital, notes payable, sales of hotel properties, and proceeds from public andprivate offerings of debt securities and common and preferred stock. Ourability to incur additional debt depends on a number of factors, including ourleverage, the value of our unencumbered assets and borrowing restrictionsimposed by lenders under our existing notes payable, as well as other factorsaffecting the general willingness or ability of lenders to provide loans.  Our ability to raise funds through theissuance of equity securities depends on, among other things, general marketconditions for hotel companies and REITs and market perceptions about us. Wewill continue to analyze alternate sources of capital in an effort to minimizeour 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.

 

Webelieve that our current cash balance, our cash flow from operations and ourunencumbered properties will provide us with sufficient liquidity to meet ourcurrent operating expenses and other expenses directly associated with our business(including payment of dividends on our capital stock, if declared) for theforeseeable future, and in any event for at least the next 12 months.

 

***Debt.*** In February 2010, we elected to terminateour credit facility, and we wrote off $1.5 million in related deferredfinancing costs. In view of our strong liquidity position and the restrictiveterms of the credit facility, our business plan did not anticipate accessingthe facility in 2010. The termination of the facility eliminates approximately$0.6 million in fees and associated costs per annum. We expect to enter into anew credit facility in the second half of 2010.

 

Consistentwith our cycle-appropriate strategy, during 2009 we initiated a secured debtrestructuring program aimed at addressing cash flow and value deficits amongcertain of our hotels securing non-recourse mortgage debt (the “2009 secureddebt restructuring program”). We concluded the program in the fourth quarter of2009, however we continue to work to finalize the deed back of certain hotelsassociated with loans which entered the program in 2009. Loans subject to oursecured debt restructuring program generally met two criteria: (1) thehotel, or hotels as a group, was not generating sufficient cash flow to coverdebt service, and under the current terms of the mortgage, the hotel was notexpected to generate sufficient cash flow for the foreseeable future, and(2) the present value of the hotel, or hotels as a group, wassignificantly less than the principal amount of the applicable loan. The loanssecured by such hotels, subject to customary exceptions, are non-recourse tous. The primary goal of the 2009 secured debt restructuring program was toamend the terms of mortgage debt to eliminate situations where hotel cash flowand asset values fell short of debt service and loan amounts respectively. Incertain cases, however, where acceptable restructuring terms could not bereached, rather than employing corporate resources to subsidize debt service,we elected to deed back the collateral hotels in satisfaction of the associateddebt. The status of the final four loans included in our 2009 secured debtrestructuring program is discussed further below.

 

*W San Diego.* EffectiveSeptember 30, 2009, possession and control of the 258-room W San Diego wastransferred to a court-appointed receiver. In connection with this transfer, wedeconsolidated this hotel and reclassified the assets and liabilities,including the $29.0 million hotel net asset and the hotel’s $65.0 million 6.14%non-recourse mortgage, to discontinued operations on our balance sheets.Additionally, we reclassified the W San Diego’s results of operations and cashflows to discontinued operations on our statements of operations and cashflows. On July 2, 2010, we completed our previously announced deed back of theW San Diego, and title to the hotel was transferred to the lender. We willrecord a gain on extinguishment of debt to discontinued operations in the thirdquarter of 2010, and the net assets and liabilities will be removed from ourbalance sheets.

 

*Renaissance Westchester*. EffectiveDecember 28, 2009, possession and control of the 347-room RenaissanceWestchester was transferred to a court-appointed receiver. In connection withthis transfer, we deconsolidated this hotel and reclassified the assets andliabilities, including the $25.2 million hotel net asset and the hotel’s $29.2million 4.98% non-recourse mortgage, to discontinued operations on our balancesheets. Additionally, we reclassified the Renaissance Westchester’s results ofoperations and cash flows to discontinued operations on our statements ofoperations and cash flows. On June 14, 2010, we reacquired the RenaissanceWestchester for $26.0 million, including related costs. In connection with therepurchase of the Renaissance Westchester, the $29.2 million non-recoursemortgage was cancelled. We recorded a $6.7 million gain on the extinguishmentof this debt, which is included in discontinued operations. Operating resultsfor the Renaissance Westchester for 2009, therefore, are included indiscontinued operations, whereas operating results from June 14, 2010forward are included in our continuing operations.

 

*Marriott Ontario Airport.*Effective March 1,2010, possession and control of the 299-room Marriott Ontario Airport wastransferred to a court-appointed receiver. In connection with this transfer, wedeconsolidated this hotel and reclassified the assets and liabilities,including the $16.3 million hotel net asset and the hotel’s $25.5 million 5.34%non-recourse 

 

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mortgage,to discontinued operations on our balance sheets. Additionally, we reclassifiedthe Marriott Ontario Airport’s results of operations and cash flows todiscontinued operations on our statements of operations and cash flows. Oncetitle to the hotel is transferred, we will record a gain on extinguishment ofdebt, and the net assets and liabilities will be removed from our balancesheets.

 

*Massachusetts Mutual Life Insurance Company.*In April 2010,we finalized an agreement with Massachusetts Mutual Life Insurance Company, orMass Mutual, the lender’s representative for a $246.0 million, 5.95%non-recourse mortgage loan secured by 11 of our hotels comprised of 2,587rooms. As part of this agreement, we paid down $83.0 million of the Mass Mutualloan in exchange for the release of three hotels from the loan. The threehotels are the 179-room Courtyard by Marriott Los Angeles Airport, the 271-roomKahler Inn & Suites Rochester and the 203-room Marriott Rochester. Inconjunction with this pay down, we wrote off $0.1 million in deferred financingfees. Also pursuant to this agreement, we expect to complete the deed back ofthe Mass Mutual eight hotels in satisfaction of the remaining $163.0 millionloan balance during 2010.  Pending thecompletion of the deed back or appointment of a receiver, we have reclassifiedthe assets, liabilities and results of operations of the Mass Mutual eight to “operationsheld for non-sale disposition” on our balance sheets, statements of operationsand statements of cash flows. Upon the completion of the deed back orappointment of a receiver, the assets and liabilities associated with the MassMutual eight will be deconsolidated.

 

Our2009 secured debt restructuring program, including our elections to initiatethe process to deed back the W San Diego, Marriott Ontario Airport, and theMass Mutual eight hotels were precipitated by a number of unique, market andhotel-specific factors, and were made after our efforts to amend the loans wereunsuccessful. In the future, other factors may lead us to pursue similaroptions with certain of our other hotels securing non-recourse mortgages. Webelieve such cases, if any, would be limited in number. We were not in defaultof the loan covenants on any other of our notes payable at June 30, 2010.

 

As of June 30, 2010,we had $1.1 billion of debt ($1.4 billion including the mortgages for the W SanDiego, Marriott Ontario Airport and Mass Mutual eight hotels), $274.5 millionof cash and cash equivalents, including restricted cash, and total assets of$2.4 billion. We believe that by controlling debt levels, staggering maturitydates and maintaining a highly flexible capital structure, we can maintainlower capital costs than more highly leveraged companies, or companies withlimited flexibility due to restrictive corporate-level financial covenants.

 

Asof June 30, 2010, all of our outstanding debt had fixed interest rates.The majority of our mortgage debt is in the form of single asset loans. Webelieve this structure is appropriate for the operating characteristics of ourbusiness and provides flexibility for assets to be sold subject to the existingdebt, and as evidenced by our 2009 secured debt restructuring program, ininstances where asset values have declined to levels below the principal amountof the associated mortgage, non-recourse single asset mortgages may limit thedegradation in value experienced by our stockholders by shifting a portion ofasset risk to our secured lenders.

 

Theweighted average term to maturity of our debt is 6.7 years, and the weightedaverage interest rate on our debt is 5.6%. Our first loan maturity, the $81.0million mortgage on the Hilton Times Square New York, is in December 2010.In light of improving secured debt markets and our desire to maintainflexibility in our level of indebtedness, we are currently evaluatingopportunities to refinance this loan at maturity in December 2010, ratherthan use excess cash to repay the loan in full.

 

***Financial Covenants.***We are subjectto compliance with various covenants under the Series C preferred stockand the Senior Notes. With respect to our Series C preferred stock, if wefail to meet certain financial ratios for four consecutive quarters, afinancial ratio violation will occur. During the continuation of a financial ratio violation, among otherthings, we would be restricted from paying dividends on our common stock, andmay incur a 50 basis point per quarter dividend increase on the Series Cpreferred stock. Additionally, the Series C preferred stockholders wouldgain the right to appoint one board member. We do not currently expect to incura financial ratio violation. Should operations deteriorate from current levels,however, we may fail to meet our financial ratios with respect to our Series Cpreferred stock for four consecutive quarters, which would cause us to incur afinancial ratio violation.

 

Withrespect to our Senior Notes, if the maturity dates of more than $300.0 millionof 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 ofthe outstanding Senior Notes would have the right to declare the Senior Notesand any unpaid interest immediately due and payable. As of August 6, 2010,none of the maturity dates have been accelerated for any of our indebtedness.

 

Additionally,we believe we may be successful in obtaining mortgages on, or pledge to asecured facility, one or all of our 11 unencumbered hotels at June 30,2010: Courtyard by Marriott Los Angeles Airport, Fairmont Newport Beach, HyattRegency Newport Beach, Kahler Inn & Suites Rochester, Marriott Quincy,Marriott Portland, Marriott Rochester, Renaissance Los Angeles Airport,Renaissance Westchester, Residence Inn by Marriott Rochester, and SheratonCerritos. These 11 hotels had an aggregate of 3,351 rooms as of June 30,2010, and generated $79.3 million in revenue during the first six months of2010.

 

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***Cash Balance.*** During the recent economic downturn, wemaintained higher than historical cash balances. By minimizing our need toaccess external capital by maintaining higher than typical cash balances, ourfinancial security and flexibility were meaningfully enhanced. As we believethe lodging cycle may have entered a recovery phase, we expect to deploy aportion of our cash balance in 2010 towards selective acquisitions. Our acquisitionprogram 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 capitalizeon opportunities which may arise, but we do not expect these atypical lodgingassets to comprise a major component of our portfolio. Additionally, the scopeof our acquisitions program may include large hotel portfolios or hotel loans.

 

**Contractual Obligations**

 

Thefollowing table summarizes our payment obligations and commitments as of June 30,2010 (in thousands):

 
| ** **                                                                             | ** ** | **Payment due by period** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------|------------|
| **Contractual obligations**                                                            | ** ** | **Total**                 | ** ** | **Less than  1 year** | ** ** | **1 to 3  years** | ** ** | **3 to 5  years** | ** ** | **More than  5 years** | ** ** |
| Notes payable                                                                          |       | $                         | 1,139,726  |   | $ | 93,401 |   | $ | 66,267 |   | $ | 238,152 |   | $ | 741,906 |   |
| Notes payable on operations held for non-sale  disposition (1)                         |       | 162,972                   |       | 162,972 |   | — |   | — |   | — |   |
| Notes payable on hotel properties held in  receivership (2)                            |       | 90,499                    |       | 90,499 |   | — |   | — |   | — |   |
| Interest obligations  on notes payable                                                 |       | 410,575                   |       | 61,305 |   | 113,646 |   | 106,914 |   | 128,710 |   |
| Interest obligations on notes payable on  operations held for non-sale disposition (3) |       | 14,613                    |       | 14,613 |   | — |   | — |   | — |   |
| Interest obligations on notes payable on hotel  properties held in receivership (4)    |       | 5,072                     |       | 5,072 |   | — |   | — |   | — |   |
| Operating lease obligations                                                            |       | 306,556                   |       | 4,359 |   | 8,833 |   | 8,994 |   | 284,370 |   |
| Operating lease obligations on operations held for  non-sale disposition (5)           |       | 5,237                     |       | 221 |   | 442 |   | 442 |   | 4,132 |   |
| Construction commitments                                                               |       | 14,272                    |       | 14,272 |   | — |   | — |   | — |   |
| Employment obligations                                                                 |       | 2,012                     |       | 712 |   | 1,300 |   | — |   | — |   |
| Total                                                                                  |       | $                         | 2,151,534  |   | $ | 447,426 |   | $ | 190,488 |   | $ | 354,502 |   | $ | 1,159,118 |   |

 

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(1)                  Notes payable on operations held for non-saledisposition currently includes the Mass Mutual eight hotels. Due to ourelective default on the non-recourse mortgage secured by the Mass Mutual eighthotels, this mortgage has been classified in its entirety as a currentobligation as of June 30, 2010.

(2)                  Notes payable on hotel properties held inreceivership currently includes the W San Diego and Marriott Ontario Airport.Due to our elective defaults on the non-recourse mortgages secured by the W SanDiego and Marriott Ontario Airport, and the subsequent transfers of these twohotels to court-appointed receivers effective September 30, 2009 and March 1,2010, respectively, we deconsolidated these hotels. As of June 30, 2010,the $65.0 million non-recourse mortgage for the W San Diego, along with the$25.5 million non-recourse mortgage for the Marriott Ontario Airport have beenclassified in their entirety as current obligations, and are included in “othercurrent liabilities of discontinued operations, net” on our balance sheets.

(3)                  Due to our elective default on the mortgagesecured by the Mass Mutual eight hotels, interest obligations on notes payableon operations held for non-sale disposition includes interest obligations onlythrough June 30, 2010.

(4)                  Due to our elective defaults on the mortgagessecured by the W San Diego and Marriott Ontario Airport, interest obligationson notes payable on hotel properties held in receivership includes interestobligations only through June 30, 2010.

(5)                  Operating lease obligations on operationsheld for non-sale disposition includes the operating lease obligations on twohotels included in the Mass Mutual eight hotels.

 

**Capital Expenditures and Reserve Funds**

 

Webelieve we maintain each of our hotels in good repair and condition and ingeneral conformity with applicable franchise and management agreements, groundand air leases, laws and regulations. Our capital expenditures primarily relateto the ongoing maintenance of our hotels and are budgeted in the reserveaccounts described in the following paragraph. We also incur capitalexpenditures for renovation and development. We invested $17.1 million in ourhotels during the first six months of 2010. Our renovation budget for 2010includes $14.3 million of contractual construction commitments. If we acquire,renovate or develop additional hotels in the future, our capital expenditureswill increase.

 

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Withrespect to our hotels that are operated under management or franchiseagreements with major national hotel brands and for all of our hotels subjectto first mortgage liens, we are obligated to maintain a furniture, fixtures andequipment (“FF&E”) reserve account for future planned and emergency-relatedcapital expenditures at these hotels. The amount funded into each of thesereserve accounts is determined pursuant to the management, franchise and loanagreements for each of the respective hotels, ranging between 4.0% and 5.0% ofthe respective hotel’s total annual revenue. As of June 30, 2010, $22.5 millionwas held in FF&E reserve accounts for future capital expenditures at the 30hotels. According to the respective loan agreements, the reserve funds are tobe held by the lenders or managers in restricted cash accounts. We generallyare not required to spend the entire amount in the FF&E reserve accountseach year.

 

**Off-Balance Sheet Arrangements**

 

Our off-balance sheet arrangements consist of ourownership interests in the W San Diego, Marriott Ontario Airport and in twojoint ventures. For further discussion of the W San Diego, Marriott OntarioAirport and our two joint ventures and their effect on our financial condition,results of operations and cash flows, see Notes 4 and 6 to the consolidatedfinancial statements.

 

**Seasonality and Volatility**

 

Asis typical of the lodging industry, we experience some seasonality in ourbusiness as indicated in the table below. Revenue for certain of our hotels isgenerally affected by seasonal business patterns (*e.g*.,the first quarter is strong in Orlando, the second quarter is strong for theMid-Atlantic business hotels, and the fourth quarter is strong for New YorkCity). Quarterly revenue also may be adversely affected by renovations, ourmanagers’ effectiveness in generating business and by events beyond our control,such as extreme weather conditions, terrorist attacks or alerts, public healthconcerns, airline strikes or reduced airline capacity, economic factors andother considerations affecting travel. Revenues for our 30 hotel portfolio byquarter for 2008, 2009 and 2010 were as follows (dollars in thousands):

 
| ** **                                                               | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|-----------|------------|
| **Revenues**                                                             |       |               |       |                |       |               |       |                |       |      |       |
| 2008 Total hotel portfolio held for investment (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 Total hotel portfolio held for investment (30  hotels) (1)          |       | $                  | 149,705    |                | $          | 154,883            |       | $                   | 148,924    |      | $          | 169,126 |   | $ | 622,638 |   |
| 2009 Revenues as a percentage of total                                   |       | 24.0               | %          | 24.9                | %          | 23.9               | %          | 27.2                | %          | 100.0     | %          |
|                                                                     |       |               |       |                |       |               |       |                |       |      |       |
| 2010 Total hotel portfolio held for investment (30  hotels) (1) (2) |       | $                  | 141,158    |                | $          | 161,084            |       |                |       |      |       |   |   |

 

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(1)                      Includes allhotel properties owned on June 30, 2010, excluding the W San Diego andMarriott Ontario Airport held in receivership and included in discontinuedoperations, and the Mass Mutual eight hotels held for non-sale disposition.

(2)                      Revenues for2010 include revenue earned by the Renaissance Westchester during the period inwhich the hotel was held in receivership.

 

**Inflation**

 

Inflationmay affect our expenses, including, without limitation, by increasing suchcosts as labor, food, taxes, property and casualty insurance and utilities.

 

**Critical Accounting Policies**

 

Ourdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States (“GAAP”).The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenue andexpenses and related disclosure of contingent assets and liabilities.

 

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Weevaluate our estimates on an ongoing basis. We base our estimates on historicalexperience, information that is currently available to us and on various otherassumptions that we believe are reasonable under the circumstances. Actualresults may differ from these estimates under different assumptions orconditions. We believe the following critical accounting policies affect themost significant judgments and estimates used in the preparation of ourconsolidated financial statements.

 

 

·                  ***Impairment of long-lived assets and goodwill***. Weperiodically review each property and any related goodwill for possibleimpairment. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future undiscounted net cashflows expected to be generated by the asset. If such assets are considered tobe impaired, the impairment recognized is measured by the amount by which thecarrying 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 flowanalysis to estimate the fair value of our properties taking into account eachproperty’s expected cash flow from operations, holding period and proceeds fromthe disposition of the property. The factors addressed in determining estimatedproceeds from disposition include anticipated operating cash flow in the yearof disposition and terminal capitalization rate. Our judgment is required indetermining the discount rate applied to estimated cash flows, growth rate ofthe properties, operating income of the properties, the need for capitalexpenditures, as well as specific market and economic conditions.

 

We account for goodwill in accordance with theIntangibles — Goodwill and Other Topic of the FASB ASC, which states thatgoodwill has an indefinite useful life that should not be amortized but shouldbe reviewed annually for impairment, or more frequently if events or changes incircumstances indicate that goodwill might be impaired, as well as the FairValue Measurements and Disclosures Topic of the FASB ASC for financial andnonfinancial assets and liabilities, which establishes a framework formeasuring fair value and expands disclosures about fair value measurements byestablishing a fair value hierarchy that prioritizes the inputs to valuationtechniques used to measure fair value. The review of any potential goodwillimpairment requires estimates of fair value for our properties that havegoodwill arising from unallocated acquisition costs. These estimates of fairvalue are prepared using Level 3 measurements.

 

·                  ***Depreciation and amortization expense.*** Depreciationexpense is based on the estimated useful life of our assets. The life of theassets is based on a number of assumptions, including the cost and timing ofcapital expenditures to maintain and refurbish our hotels, as well as specificmarket and economic conditions. Hotel properties and other completed realestate investments are depreciated using the straight-line method overestimated useful lives ranging from five to 35 years for buildings and improvementsand three to 12 years for furniture, fixtures and equipment. While managementbelieves its estimates are reasonable, a change in the estimated lives couldaffect depreciation expense and net income or the gain or loss on the sale ofany of our hotels. We have not changed the estimated useful lives of any of ourassets during the periods discussed.

 

**New Accounting Standards and Accounting Changes**

 

InJune 2009, the FASB issued a pronouncement which amends GAAP to requiremore information about transfers of financial assets, eliminates the qualifyingspecial purpose entity (QSPE) concept, changes the requirements forderecognizing financial assets and requires additional disclosures. TheFASB issued a second pronouncement in June 2009, which amends GAAP regardingcertain guidance for determining whether an entity is a variable interestentity and modifies the methods allowed for determining the primary beneficiaryof a variable interest entity. This second pronouncement requires ongoingreassessments of whether an enterprise is the primary beneficiary of a variableinterest entity and enhanced disclosures related to an enterprise’s involvementin a variable interest entity. Both of these pronouncements are effectivefor the first annual reporting period that begins after November 15, 2009.The adoption of these two pronouncements did not materially impact the Company.

 

InJanuary 2010, the FASB issued a pronouncement to further update the fairvalue measurement guidance to improve fair value measurement disclosures. Thisupdate requires new disclosures related to transfers in and out of Level 1 andLevel 2, as well as activity in Level 3 fair value measurements, and providesclarification to existing disclosures. This standard is effective for interimperiods and annual periods beginning after December 15, 2009, except fordisclosures about purchases, sales, issuances, and settlements in therollforward of activity in Level 3 fair value measurements as these disclosuresare effective for fiscal years beginning after December 15, 2010, and forinterim periods within those fiscal years. Our adoption of the guidance relatedto new disclosures and clarifications on January 1, 2010 did not have anyeffect on our consolidated financial condition, results of operations or cashflows. Our adoption of the guidance related to disclosures about purchases,sales, issuances, and settlements in the rollforward of activity in Level 3fair value measurements will occur during the first quarter of 2011. We do notanticipate that the adoption of this part of the pronouncement will materiallyimpact the Company.

 

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InFebruary 2010, the FASB issued a pronouncement to amend the subsequentevents guidance. The amendment states that SEC filers are no longer required todisclose the date through which subsequent events have been evaluated inoriginally issued and revised financial statements. This standard is effectiveimmediately. The adoption of this pronouncement did not materially impact theCompany.

 

**Item 3.****                                  ****Quantitative and Qualitative Disclosures About Market Risk**

 

Tothe extent that we incur debt with variable interest rates, our future income,cash flows and fair values relevant to financial instruments are dependent uponprevailing market interest rates. Market risk refers to the risk of loss fromadverse changes in market prices and interest rates. At June 30, 2010,none of our outstanding debt was subject to variable interest rates.

 

**Item 4.****                              ****Controls and Procedures**

 

***Evaluation of Disclosure Controlsand Procedures*****.** Based upon anevaluation of the effectiveness of disclosure controls and procedures, ourChief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) haveconcluded that as of the end of the period covered by this Quarterly Report on Form 10-Qour disclosure controls and procedures (as defined in Rules 13a-15(e) or15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) were effective to provide reasonable assurance that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified by the rules and forms ofthe Securities and Exchange Commission and is accumulated and communicated tomanagement, including the CEO and CFO, as appropriate to allow timely decisionsregarding required disclosure.

 

***Changes in Internal Control overFinancial Reporting.*** During our fiscal quarter to which thisQuarterly Report on Form 10-Q relates, there has not occurred any changein our internal control over financial reporting that has materially affected,or is reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II—OTHERINFORMATION**

 

**Item 1.****                                 ****Legal Proceedings**

 

None.

 

**Item 1A.****                        ****Risk Factors**

 

Therehave been no material changes from risk factors as previously disclosed in the “RiskFactors” section of our Annual Report on Form 10-K for the period ended December 31,2009, filed with the Securities and Exchange Commission on February 23,2010.

 

**Item 2.****                                 ****Unregistered Sales of Equity Securities and Use of Proceeds**

 

(c)                        IssuerPurchases of Equity Securities

 
| **Period**                                     | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number  (or Appropriate  Dollar Value) of  Shares that May Yet  Be Purchased Under  the Plans or Programs** | ** ** |
|------------------------------------------------|------------|----------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| April 1, 2010 –  April 30, 2010 |       | —                                 |       | —                            |       | —                                                                                        |       | —                                                                                                                     |       |
| May 1, 2010 –  May 31, 2010     |       | 3,949                                  | (1)        | $                                 | 10.07      |                                                                                          | —     |                                                                                                                       | —     |   |
| June 1, 2010 –  June 30, 2010   |       | —                                 |       | —                            |       | —                                                                                        |       | —                                                                                                                     |       |
|                                                |            |                                        |            |                                   |            |                                                                                               |            |                                                                                                                            |            |  |

 

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(1)                       Reflects sharesof restricted common stock withheld and used for purposes of remittingwithholding and payroll taxes in connection with the release of restrictedcommon shares to plan participants. The average price paid reflects the averagemarket value of shares withheld for tax purposes.

 

**Item 3.****                                  ****Defaults Upon Senior Securities**

 

None.

 

**Item 4.****                                  ****Removed and Reserved**

 

**Item 5.****                                 ****Other Information**

 

On August 4, 2010,Sunstone Hotel Investors, Inc. (the “Company”) entered into employmentagreements with Kenneth E. Cruse, the Executive Vice President and ChiefFinancial Officer of the Company and Sunstone Hotel Partnership, LLC, theCompany’s operating partnership (the “Operating Partnership”), and Marc A.Hoffman, the Executive Vice President and Chief Operating Officer of theCompany and the Operating Partnership (together, the “Executives” andindividually, an “Executive”). The material provisions in each Executive’semployment agreement are substantially identical. The agreements have aninitial term of three years, commencing on August 4, 2010, and will beautomatically extended for additional three-year periods, unless terminated byeither party upon ninety days’ notice prior to the renewal date. The agreementsprovide for an initial annual base salary of $350,000, which may be increasedfrom time to time in the Company’s sole discretion.

 

The Executives will beeligible to receive an annual cash performance bonus based on the attainment ofperformance goals determined by the Company with a threshold level equal to 50%of base salary, a target level equal to 75% of base salary, a high level equalto 125% of base salary and a superior level equal to 150% of base salary, withno guaranteed minimum.  The Executiveswill also be eligible to earn annual equity awards with a threshold level equalto 100% of base salary, a target level equal to 150% of base salary, a highlevel equal to 200% of base salary and a superior level equal to 250% of basesalary, with no guaranteed minimum. Furthermore, the Executives will beeligible to participate in welfare and fringe benefit plans, incentive plansand savings/retirement plans generally available to senior executives of theCompany.

 

If the Company terminateseither of the Executives without cause or either Executive terminates hisemployment for good reason, (i) the Executive will receive, in two lumpsum payments, all of the amounts set forth in (A) and (B) below, (ii) alloutstanding equity awards granted to the Executive shall vest as set forth in(C) below, and (iii) the Executive will receive continued healthinsurance coverage as set forth in (D) below: (A) (1) salary andaccrued vacation through the date of termination, (2) any vested amountsdue under any plan, program or policy of the Company, (3) unpaid bonus owedfor any completed fiscal year before the date of termination, and (4) anamount equal to a pro rata share of the target annual cash bonus determined bymultiplying the target annual cash bonus by a fraction the numerator of whichis the number of days elapsed in the year through the date of termination andthe denominator of which is 365 ((A)(1) — (4) are collectivelyreferred to as “Accrued Obligations”); (B) a severance payment equal totwo  times the sum of (x) theExecutive’s base salary in effect on the date of termination (but not less than$350,000), plus (y) a bonus severance amount (which will be thegreater of the Executive’s target annual cash performance bonus and the actualbonus paid to the Executive in respect of the last full calendar year immediatelypreceding the date of termination); (C) all outstanding stock options,restricted stock units and other equity awards granted to the Executive underany of the Company’s equity incentive plans shall become immediately vestedand, as applicable, exercisable in full; and (D) eighteen months ofCompany-paid continued health insurance coverage for the Executive and theExecutive’s eligible family members. The Company’s obligation to make orprovide the payments and benefits set forth in items (B), (C) and (D) isconditioned upon the Executive’s execution of a general release of claims.

 

If either of the Executive’semployment is terminated by reason of death or disability, the Executive or, asappropriate, the Executive’s estate or beneficiaries shall be paid the AccruedObligations and an amount equal to100% of the Executive’s annual base salarythen in effect, all outstanding equity awards shall continue to vest (but onlyto the extent such outstanding awards were scheduled to vest within the twelve-monthperiod immediately following the date of termination) and the Executive and theExecutive’s eligible family members shall receive eighteen months ofCompany-paid continued health insurance coverage.

 

                                                In conjunctionwith the employment agreements, each Executive entered into an indemnificationagreement with the Company providing that the Company will indemnify andadvance expenses to each Executive in the case of certain claims made againsthim by virtue of his position with the Company.

 

Furthermore, in connectionwith entering into the employment agreements mentioned above, the Change inControl Agreement dated February 15, 2007 by and between the Company andMr. Cruse was terminated effective August 4, 2010. Likewise, theEmployment Offer Letter dated April 19, 2006 by and between the Companyand Mr. Hoffman was terminated effective August 4, 2010.

 

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**Item 6.****                                  ****Exhibits**

 

Thefollowing Exhibits are filed as a part of this report:

 
| **Exhibit  Number** | ** ** | **Description** |
|---------------------|------------|-----------------|
| 3.1                 |       |            | Articles  of Amendment and Restatement of Sunstone Hotel Investors, Inc.  (incorporated by reference to Exhibit 3.1 to the registration statement  on Form S-11 (File No. 333-117141) filed by the Company). |
|                |       |            |   |
| 3.2                 |       |            | Amended  and Restated Bylaws of Sunstone Hotel Investors, Inc. (incorporated by  reference to Exhibit 3.1 to Form 10-Q, filed by the Company on  August 5, 2008). |
|                |       |            |   |
| 3.3                 |       |            | Articles  Supplementary for Series A preferred stock (incorporated by reference to  Exhibit 3.3 to Form 10-K filed by the Company on February 12,  2009). |
|                |       |            |   |
| 3.4                 |       |            | Form of  Articles Supplementary for Series C preferred stock (incorporated by  reference to Exhibit 3 to Form 8-K filed by the Company on  July 13, 2005). |
|                |       |            |   |
| 3.5                 |       |            | Articles  Supplementary increasing the authorized number of shares of Series A  preferred stock (incorporated by reference to Exhibit 3.2 to the Current  Report on Form 8-K filed by the Company on April 11, 2006). |
|                |       |            |   |
| 10.1                |       |            | Second  amendment to the Sunstone Hotel Investors, Inc. 2004 Long-Term Incentive  Plan (incorporated by reference to Form 8-K filed by the Company on May 7,  2010). |
|                |       |            |   |
| 10.2                |       |            | Employment  Agreement (including the Indemnification Agreement), dated as of August 4,  2010, by and between Sunstone Hotel Investors, Inc., Sunstone Hotel  Partnership, LLC and Kenneth E. Cruse. |
|                |       |            |   |
| 10.3                |       |            | Employment  Agreement (including the Indemnification Agreement), dated as of August 4,  2010, by and between Sunstone Hotel Investors, Inc., Sunstone Hotel  Partnership, LLC and Marc A. Hoffman. |
|                |       |            |   |
| 31.1                |       |            | Certification  of CEO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|                |       |            |   |
| 31.2                |       |            | Certification  of CFO Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as  Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|                |       |            |   |
| 32.1                |       |            | Certification  of CEO and CFO Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                       | Sunstone  Hotel Investors, Inc. |
|----------------------------|--------------------------------------|
|                       |                                 |   |
| Date:  August 6, 2010 | By:                                  | /s/ Kenneth E. Cruse |
|                       |                                 | **Kenneth E. Cruse  (Principal Financial Officer and Duly Authorized Officer)** |

 

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