Table ofContents

 

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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**x****               QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

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

 

**OR**

 

**o****                  TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from            to           **

 

**Commission file number 001-32319**

 

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**SunstoneHotel 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 90days.    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.

98,512,026 shares of Common Stock, $0.01 par value, as of November 1,2010

 

 

 

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Table of Contents

 

**SUNSTONEHOTEL INVESTORS, INC.**

**QUARTERLY REPORT ON**

**FORM 10-Q**

 

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

 

**TABLE OFCONTENTS**

 
| ** ** | ** **                                                                                                                  | **Page** |
|------------|-----------------------------------------------------------------------------------------------------------------------------|----------|
| ** ** | **PART I—FINANCIAL INFORMATION**                                                                                  |     |
|       |                                                                                                                        |     |
| Item 1.    | Financial Statements:                                                                                                       |     |
|       |                                                                                                                        |     |
|       | Consolidated  Balance Sheets as of September 30, 2010 (unaudited) and  December 31, 2009                          | 1        |
|       |                                                                                                                        |     |
|       | Unaudited  Consolidated Statements of Operations for the Three and Nine Months Ended  September 30, 2010 and 2009      | 2        |
|       |                                                                                                                        |     |
|       | Consolidated  Statements of Stockholders’ Equity as of September 30, 2010 (unaudited)  and December 31, 2009 | 3        |
|       |                                                                                                                        |     |
|       | Unaudited  Consolidated Statements of Cash Flows for the Nine Months Ended  September 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                                 | 25       |
|       |                                                                                                                        |     |
| Item 3.    | Quantitative  and Qualitative Disclosures about Market Risk                                                                 | 46       |
|       |                                                                                                                        |     |
| Item 4.    | Controls and  Procedures                                                                                                    | 46       |
|       |                                                                                                                        |     |
| ** ** | **PART II—OTHER  INFORMATION**                                                                                    |     |
|       |                                                                                                                        |     |
| Item 1.    | Legal Proceedings                                                                                                           | 47       |
|       |                                                                                                                        |     |
| Item 1A.   | Risk Factors                                                                                                                | 47       |
|       |                                                                                                                        |     |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                | 47       |
|       |                                                                                                                        |     |
| Item 3     | Defaults  Upon Senior Securities                                                                                            | 47       |
|       |                                                                                                                        |     |
| Item 4.    | Removed and Reserved                                                                                                        | 47       |
|       |                                                                                                                        |     |
| Item 5.    | Other Information                                                                                                           | 47       |
|       |                                                                                                                        |     |
| Item 6.    | Exhibits                                                                                                                    | 48       |
|       |                                                                                                                        |     |
| SIGNATURES | 49                                                                                                                          |

 

i

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Tableof Contents

 

**PART I—FINANCIALINFORMATION**

 

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

 

**SUNSTONEHOTEL INVESTORS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

*(In thousands, except share data)*
| ** **                                                                                                                                                                                                                                                                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
|                                                                                                                                                                                                                                                                              |       | **2010**               |       | **2009**              |       |
| ** **                                                                                                                                                                                                                                                                        | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                                                                                                                                            |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                                                                                   |       |                   |       |                  |       |
| Cash and cash equivalents ($1,861 and $1,471  related to VIEs)                                                                                                                                                                                                                    |       | $                      | 71,089     |                  | $          | 353,255 |   |
| Restricted cash ($3,974 and $4,711 related to  VIEs)                                                                                                                                                                                                                              |       | 72,388                 |       | 36,858                |       |
| Accounts receivable, net ($2,710 and $2,758  related to VIEs)                                                                                                                                                                                                                     |       | 20,246                 |       | 22,624                |       |
| Due from affiliates                                                                                                                                                                                                                                                               |       | 37                     |       | 62                    |       |
| Inventories ($134 and $92 related to VIEs)                                                                                                                                                                                                                                        |       | 2,412                  |       | 2,446                 |       |
| Prepaid expenses                                                                                                                                                                                                                                                                  |       | 10,035                 |       | 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                                                                                                                                                                                                  |       | 98,239                 |       | 102,343               |       |
| Other current assets of operations held for  non-sale disposition, net                                                                                                                                                                                                            |       | 35,157                 |       | 14,140                |       |
| Total current assets                                                                                                                                                                                                                                                              |       | 309,603                |       | 557,361               |       |
| Investment in hotel properties, net                                                                                                                                                                                                                                               |       | 2,028,082              |       | 1,923,392             |       |
| Other real estate, net                                                                                                                                                                                                                                                            |       | 11,900                 |       | 14,044                |       |
| Investments in unconsolidated joint ventures                                                                                                                                                                                                                                      |       | 449                    |       | 542                   |       |
| Deferred financing fees, net                                                                                                                                                                                                                                                      |       | 4,618                  |       | 7,300                 |       |
| Goodwill                                                                                                                                                                                                                                                                          |       | 4,673                  |       | 4,673                 |       |
| Other assets, net                                                                                                                                                                                                                                                                 |       | 14,137                 |       | 6,218                 |       |
| Total assets                                                                                                                                                                                                                                                                      |       | $                      | 2,373,462  |                  | $          | 2,513,530 |   |
|                                                                                                                                                                                                                                                                              |       |                   |       |                  |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                         |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                                                                                              |       |                   |       |                  |       |
| Accounts payable and accrued expenses ($1,134 and  $523 related to VIEs)                                                                                                                                                                                                          |       | $                      | 17,963     |                  | $          | 12,425 |   |
| Accrued payroll and employee benefits ($933 and  $1,121 related to VIEs)                                                                                                                                                                                                          |       | 10,591                 |       | 9,092                 |       |
| Due to Third Party Managers                                                                                                                                                                                                                                                       |       | 8,742                  |       | 9,817                 |       |
| Dividends payable                                                                                                                                                                                                                                                                 |       | 5,137                  |       | 5,137                 |       |
| Other current liabilities ($1,637 and $1,316  related to VIEs)                                                                                                                                                                                                                    |       | 22,731                 |       | 21,910                |       |
| Current portion of notes payable                                                                                                                                                                                                                                                  |       | 94,810                 |       | 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                                                                                                                                                                                                                        |       | —                 |       | 41,449                |       |
| Other current liabilities of operations held for  non-sale disposition                                                                                                                                                                                                            |       | 26,151                 |       | 6,364                 |       |
| Total current liabilities                                                                                                                                                                                                                                                         |       | 349,097                |       | 469,592               |       |
| Notes payable, less current portion                                                                                                                                                                                                                                               |       | 1,039,757              |       | 1,050,019             |       |
| Other liabilities ($88 and $12 related to VIEs)                                                                                                                                                                                                                                   |       | 7,923                  |       | 7,256                 |       |
| Total liabilities                                                                                                                                                                                                                                                                 |       | 1,396,777              |       | 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 September 30, 2010 and December 31, 2009,  liquidation preference of $24.375 per share                      |       | 100,000                |       | 99,896                |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                        |       |                   |       |                  |       |
| Preferred stock, $0.01 par value, 100,000,000  shares authorized. 8.0% Series A Cumulative Redeemable Preferred Stock,  7,050,000 shares issued and outstanding at September 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, 97,275,660 shares issued and outstanding at September 30,  2010 and 96,904,075 shares issued and outstanding at December 31, 2009                                                                        |       | 973                    |       | 969                   |       |
| Additional paid in capital                                                                                                                                                                                                                                                        |       | 1,121,460              |       | 1,119,005             |       |
| Retained earnings (deficit)                                                                                                                                                                                                                                                       |       | (6,079                 | )          | (8,949                | )          |
| Cumulative dividends                                                                                                                                                                                                                                                              |       | (412,938               | )          | (397,527              | )          |
| Accumulated other comprehensive loss                                                                                                                                                                                                                                              |       | (2,981                 | )          | (2,981                | )          |
| Total stockholders’ equity                                                                                                                                                                                                                                                   |       | 876,685                |       | 886,767               |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                   |       | $                      | 2,373,462  |                  | $          | 2,513,530 |   |

 

The abbreviation VIEs above refers to “VariableInterest Entities.”

 

*See accompanying notes to consolidated financialstatements.*

 

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Tableof Contents

 

**SUNSTONE HOTEL INVESTORS, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF OPERATIONS**

*(In thousands, except per share data)*

 
| ** **                                                                            | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | ** **                                                     | ** ** | ** **                                                     | ** ** | ** **                                                    | ** ** | ** **                                                    | ** ** |
| REVENUES                                                                              |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Room                                                                                  |       | $                                                              | 108,324    |                                                           | $          | 101,754                                                       |       | $                                                             | 307,025    |   | $ | 299,651 |   |
| Food and beverage                                                                     |       | 35,893                                                         |       | 34,664                                                         |       | 114,644                                                       |       | 115,921                                                       |       |
| Other operating                                                                       |       | 12,847                                                         |       | 12,856                                                         |       | 37,168                                                        |       | 38,268                                                        |       |
| Revenues of operations held for non-sale  disposition                                 |       | 20,646                                                         |       | 20,790                                                         |       | 60,638                                                        |       | 63,712                                                        |       |
| Total revenues                                                                        |       | 177,710                                                        |       | 170,064                                                        |       | 519,475                                                       |       | 517,552                                                       |       |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| OPERATING EXPENSES                                                                    |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Room                                                                                  |       | 27,542                                                         |       | 25,873                                                         |       | 78,343                                                        |       | 74,316                                                        |       |
| Food and beverage                                                                     |       | 28,544                                                         |       | 27,215                                                         |       | 85,327                                                        |       | 85,637                                                        |       |
| Other operating                                                                       |       | 6,658                                                          |       | 6,600                                                          |       | 19,775                                                        |       | 19,934                                                        |       |
| Advertising and promotion                                                             |       | 8,012                                                          |       | 7,070                                                          |       | 23,397                                                        |       | 23,344                                                        |       |
| Repairs and maintenance                                                               |       | 6,660                                                          |       | 6,402                                                          |       | 19,737                                                        |       | 19,703                                                        |       |
| Utilities                                                                             |       | 6,793                                                          |       | 6,280                                                          |       | 18,152                                                        |       | 18,428                                                        |       |
| Franchise costs                                                                       |       | 5,727                                                          |       | 5,283                                                          |       | 15,878                                                        |       | 15,082                                                        |       |
| Property tax, ground lease and insurance                                              |       | 11,045                                                         |       | 10,863                                                         |       | 32,015                                                        |       | 30,918                                                        |       |
| Property general and administrative                                                   |       | 18,673                                                         |       | 17,232                                                         |       | 54,694                                                        |       | 53,128                                                        |       |
| Corporate overhead                                                                    |       | 11,596                                                         |       | 4,334                                                          |       | 21,311                                                        |       | 14,826                                                        |       |
| Depreciation and amortization                                                         |       | 23,871                                                         |       | 23,529                                                         |       | 70,693                                                        |       | 70,818                                                        |       |
| Operating expenses of operations held for non-sale  disposition                       |       | 17,787                                                         |       | 19,098                                                         |       | 53,737                                                        |       | 58,358                                                        |       |
| Property and goodwill impairment losses                                               |       | —                                                         |       | 2,209                                                          |       | 1,943                                                         |       | 30,852                                                        |       |
| Goodwill impairment losses of operations held for  non-sale disposition               |       | —                                                         |       | —                                                         |       | —                                                        |       | 3,007                                                         |       |
| Total operating expenses                                                              |       | 172,908                                                        |       | 161,988                                                        |       | 495,002                                                       |       | 518,351                                                       |       |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Operating income (loss)                                                               |       | 4,802                                                          |       | 8,076                                                          |       | 24,473                                                        |       | (799                                                          | )          |
| Equity in earnings (losses) of unconsolidated  joint ventures                         |       | 200                                                            |       | (515                                                           | )          | 475                                                           |       | (2,616                                                        | )          |
| Interest income and other income (loss)                                               |       | (276                                                           | )          | 239                                                            |       | (6                                                            | )          | 1,111                                                         |       |
| Interest expense                                                                      |       | (16,671                                                        | )          | (18,190                                                        | )          | (53,727                                                       | )          | (57,703                                                       | )          |
| Interest expense of operations held for non-sale  disposition                         |       | (4,875                                                         | )          | (2,880                                                         | )          | (15,272                                                       | )          | (8,667                                                        | )          |
| Gain (loss) on extinguishment of debt                                                 |       | —                                                         |       | (20                                                            | )          | —                                                        |       | 54,559                                                        |       |
| Loss from continuing operations                                                       |       | (16,820                                                        | )          | (13,290                                                        | )          | (44,057                                                       | )          | (14,115                                                       | )          |
| Income (loss) from discontinued operations                                            |       | 40,473                                                         |       | (4,658                                                         | )          | 46,927                                                        |       | (127,528                                                      | )          |
| NET INCOME (LOSS)                                                                     |       | 23,653                                                         |       | (17,948                                                        | )          | 2,870                                                         |       | (141,643                                                      | )          |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Dividends paid on unvested restricted stock  compensation                             |       | —                                                         |       | —                                                         |       | —                                                        |       | (447                                                          | )          |
| Preferred stock dividends and accretion                                               |       | (5,141                                                         | )          | (5,187                                                         | )          | (15,515                                                       | )          | (15,562                                                       | )          |
| Undistributed income allocated to unvested  restricted stock compensation             |       | (232                                                           | )          | —                                                         |       | —                                                        |       | —                                                        |       |
| INCOME AVAILABLE (LOSS ATTRIBUTABLE) TO COMMON  STOCKHOLDERS                          |       | $                                                              | 18,280     |                                                           | $          | (23,135                                                       | )          | $                                                             | (12,645    | ) | $ | (157,652 | ) |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Basic per share amounts:                                                              |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Loss from continuing operations attributable to  common stockholders                  |       | $                                                              | (0.23      | )                                                              | $          | (0.25                                                         | )          | $                                                             | (0.61      | ) | $ | (0.48 | ) |
| Income (loss) from discontinued operations                                            |       | 0.42                                                           |       | (0.06                                                          | )          | 0.48                                                          |       | (2.05                                                         | )          |
| Basic income available (loss attributable) to  common stockholders per common share   |       | $                                                              | 0.19       |                                                           | $          | (0.31                                                         | )          | $                                                             | (0.13      | ) | $ | (2.53 | ) |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Diluted per share amounts:                                                            |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Loss from continuing operations attributable to  common stockholders                  |       | $                                                              | (0.23      | )                                                              | $          | (0.25                                                         | )          | $                                                             | (0.61      | ) | $ | (0.48 | ) |
| Income (loss) from discontinued operations                                            |       | 0.42                                                           |       | (0.06                                                          | )          | 0.48                                                          |       | (2.05                                                         | )          |
| Diluted income available (loss attributable) to  common stockholders per common share |       | $                                                              | 0.19       |                                                           | $          | (0.31                                                         | )          | $                                                             | (0.13      | ) | $ | (2.53 | ) |
|                                                                                  |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Weighted average common shares outstanding:                                           |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Basic                                                                                 |       | 97,250                                                         |       | 73,857                                                         |       | 97,163                                                        |       | 62,382                                                        |       |
| Diluted                                                                               |       | 97,612                                                         |       | 73,857                                                         |       | 97,163                                                        |       | 62,382                                                        |       |
| Dividends declared per common share                                                   |       | $                                                              | —     |                                                           | $          | —                                                        |       | $                                                             | —     |   | $ | — |   |

 

*See accompanying notes to consolidated financial statements.*

 

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**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)                                                        |       |                     |       |                  |       | 371,585            |       | 4          |       | 2,559            |       |                        |       |           |       |   |   | 2,563 |   |
| Series A preferred dividends and dividends  payable at $1.50 per share year to date (unaudited)  |       |                     |       |                  |       |               |       |       |       |             |       |                        |       | (10,575        | )          |   |   | (10,575 | ) |
| Series C preferred dividends and dividends  payable at $1.179 per share year to date (unaudited) |       |                     |       |                  |       |               |       |       |       |             |       |                        |       | (4,836         | )          |   |   | (4,836 | ) |
| Accretion of discount on Series C preferred  stock (unaudited)                                   |       |                     |       |                  |       |               |       |       |       | (104             | )          |                        |       |           |       |   |   | (104 | ) |
| Net income and comprehensive income (unaudited)                                                       |       |                     |       |                  |       |               |       |       |       |             |       | 2,870                       |       |           |       |   |   | 2,870 |   |
| Balance at September 30, 2010 (unaudited)                                                        |       | 7,050,000                |       | $                     | 176,250    |               | 97,275,660 |       | $          | 973              |       | $                           | 1,121,460  |           | $          | (6,079 | ) | $ | (412,938 | ) | $ | (2,981 | ) | $ | 876,685 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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**SUNSTONEHOTEL INVESTORS, INC.**

**UNAUDITEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

*(In thousands)*

 
| ** **                                                                                | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES                                                      |       |                                                          |       |                                                          |       |
| Net income (loss)                                                                         |       | $                                                             | 2,870      |                                                          | $          | (141,643 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                                          |       |                                                          |       |
| Bad debt expense                                                                          |       | 78                                                            |       | 236                                                           |       |
| Loss on sale of other assets                                                              |       | 383                                                           |       | 12,698                                                        |       |
| Gain on extinguishment of debt                                                            |       | (47,220                                                       | )          | (54,559                                                       | )          |
| Depreciation                                                                              |       | 75,446                                                        |       | 85,186                                                        |       |
| Amortization of franchise fees and other  intangibles                                     |       | 386                                                           |       | 317                                                           |       |
| Amortization and write-off of deferred financing  fees                                    |       | 3,084                                                         |       | 1,928                                                         |       |
| Amortization of loan discounts                                                            |       | 743                                                           |       | 1,576                                                         |       |
| Amortization of deferred stock compensation                                               |       | 2,405                                                         |       | 3,286                                                         |       |
| Property and goodwill impairment losses                                                   |       | 1,943                                                         |       | 137,866                                                       |       |
| Equity in (earnings) losses of unconsolidated  joint ventures                             |       | (475                                                          | )          | 2,616                                                         |       |
| Changes in operating assets and liabilities:                                              |       |                                                          |       |                                                          |       |
| Restricted cash                                                                           |       | (33,977                                                       | )          | (3,104                                                        | )          |
| Accounts receivable                                                                       |       | 2,846                                                         |       | 10,092                                                        |       |
| Due from affiliates                                                                       |       | 25                                                            |       | 30                                                            |       |
| Inventories                                                                               |       | 43                                                            |       | 423                                                           |       |
| Prepaid expenses and other assets                                                         |       | (7,869                                                        | )          | 581                                                           |       |
| Accounts payable and other liabilities                                                    |       | 22,308                                                        |       | 2,768                                                         |       |
| Accrued payroll and employee benefits                                                     |       | 1,488                                                         |       | 59                                                            |       |
| Due to Third Party Managers                                                               |       | (1,111                                                        | )          | (2,623                                                        | )          |
| Discontinued operations                                                                   |       | 584                                                           |       | (706                                                          | )          |
| Operations held for non-sale disposition                                                  |       | (20,152                                                       | )          | (3,833                                                        | )          |
| Net cash provided by operating activities                                                 |       | 3,828                                                         |       | 53,194                                                        |       |
|                                                                                      |       |                                                          |       |                                                          |       |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                      |       |                                                          |       |                                                          |       |
| Proceeds from sale of hotel properties and other  assets                                  |       | 61                                                            |       | 64,052                                                        |       |
| Cash received from unconsolidated joint ventures                                          |       | 600                                                           |       | 250                                                           |       |
| Restricted cash — replacement reserve                                                |       | (1,335                                                        | )          | (2,376                                                        | )          |
| Acquisitions of notes receivable                                                          |       | (3,700                                                        | )          | —                                                        |       |
| Acquisitions of hotel properties                                                          |       | (117,604                                                      | )          | —                                                        |       |
| Renovations and additions to hotel properties and  other real estate                      |       | (31,443                                                       | )          | (33,487                                                       | )          |
| Net cash (used in) provided by investing  activities                                      |       | (153,421                                                      | )          | 28,439                                                        |       |
|                                                                                      |       |                                                          |       |                                                          |       |
| 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                                               |       | (117,158                                                      | )          | (71,237                                                       | )          |
| Payments for repurchases of notes payable and  related costs                              |       | —                                                        |       | (117,397                                                      | )          |
| Payments of deferred financing costs                                                      |       | (4                                                            | )          | (3,158                                                        | )          |
| Dividends paid                                                                            |       | (15,411                                                       | )          | (22,774                                                       | )          |
| Net cash used in financing activities                                                     |       | (132,573                                                      | )          | (55,868                                                       | )          |
| Net (decrease) increase in cash and cash  equivalents                                     |       | (282,166                                                      | )          | 25,765                                                        |       |
| Cash and cash equivalents, beginning of period                                            |       | 353,255                                                       |       | 176,102                                                       |       |
| Cash and cash equivalents, end of period                                                  |       | $                                                             | 71,089     |                                                          | $          | 201,867 |   |
|                                                                                      |       |                                                          |       |                                                          |       |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                         |       |                                                          |       |                                                          |       |
| Cash paid for interest                                                                    |       | $                                                             | 49,547     |                                                          | $          | 71,682 |   |
|                                                                                      |       |                                                          |       |                                                          |       |
| 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               |       | $                                                             | 137        |                                                          | $          | 157 |   |
| Amortization of deferred stock compensation —  unconsolidated joint venture          |       | $                                                             | 21         |                                                          | $          | 28 |   |
|                                                                                      |       |                                                          |       |                                                          |       |
| NONCASH FINANCING ACTIVITY                                                                |       |                                                          |       |                                                          |       |
| Issuance of stock dividend                                                                |       | $                                                             | —     |                                                          | $          | 29,056 |   |
| Dividends payable                                                                         |       | $                                                             | 5,137      |                                                          | $          | 5,137 |   |

 

*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 September 30, 2010,the Company owned 39 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 39hotels to a lender in satisfaction of a non-recourse mortgage (see Footnote17), leaving 31 hotels (the “31 hotels”) currently held for investment. TheCompany has reclassified the assets, liabilities and operating results of theMass Mutual eight to “operations held for non-sale disposition” on its balancesheets, statements of operations and cash flows. The Renaissance Westchester,which was transferred to a receiver pursuant to the 2009 secured debtrestructuring program, was reacquired by the Company on June 14, 2010.Operating results for the Renaissance Westchester for 2009, therefore, areincluded in discontinued operations, whereas operating results from June 14,2010 forward are included in the Company’s continuing operations.

 

Asof September 30, 2010, the Company’s third party managers includedInterstate Hotels & Reports, Inc. (“IHR”), manager of 13 of theCompany’s 39 hotels, Sunstone Hotel Properties, Inc., a division ofInterstate Hotels & Resorts, Inc. (“Interstate SHP”), manager ofseven of the Company’s 39 hotels; subsidiaries of Marriott International, Inc.or Marriott Hotel Services, Inc. (collectively, “Marriott”), managers of13 of the Company’s 39 hotels; and Davidson Hotel Company (“Davidson”),Fairmont Hotels & Resorts (U.S.) (“Fairmont”), GF Management (“GF”),Hilton Worldwide (“Hilton”), Hyatt Corporation (“Hyatt”) and Sage HospitalityResources (“Sage”), each managers of one of the Company’s 39 hotels.  In addition to its wholly owned hotels, theCompany has a 38% equity interest in a joint venture that owns one hotel.

 

**2. Summary of Significant Accounting Policies**

 

**Basis of Presentation**

 

Theaccompanying consolidated financial statements as of September 30, 2010and December 31, 2009, and for the three and nine months ended September 30,2010 and 2009, include the accounts of the Company, the Operating Partnership,the TRS Lessee and their subsidiaries. All significant intercompany balancesand transactions have 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, includingreclassifications due to the finalization of a restructuring agreement withMass Mutual in April 2010 regarding the Mass Mutual eight hotels alongwith three additional hotels that secured 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 September 30, 2010 and December 31,2009, the carrying amount of certain financial instruments, including cash andcash equivalents, restricted cash, accounts receivable, accounts payable andaccrued expenses 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 $5.0 million split life insurance policy for its formerChief Executive 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 September 30, 2010 and December 31, 2009.These amounts are included in other assets, net in the accompanying balancesheets.

 

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, regardless of the reason for such termination.The Company has valued this agreementusing Level 2 measurements at $1.8 million as of both September 30, 2010and December 31, 2009. These amounts are included in accrued payroll andemployee benefits in the accompanying balance sheets.

 

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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. When indicators of impairment existed in 2009and the undiscounted cash flows were less than the carrying value of the asset,the Company used terminal capitalization rates in its 2009 analyses rangingbetween 8.1% and 9.6%, based on the Company’s weighted average cost of capital,a hurdle rate assigned to each hotel to account for a hotel’s individualcharacteristics including, but not limited to, size, age and market supply, andan estimated average annual growth rate.

 

On an annual basis and periodically when indicatorsof impairment exist, 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 ninemonths ended September 30, 2010, the Company did not identify anyproperties with indicators of goodwill impairment. When indicators of goodwillimpairment existed in 2009 and the discounted cash flows were less than thecarrying value of the reporting unit, the Company used discount rates rangingbetween 13.0% and 13.8% in its 2009 analyses, taking into account each relatedreporting unit’s expected cash flow from operations, holding period andproceeds from the potential disposition of the property. The factors addressedin determining estimated proceeds from disposition include anticipatedoperating cash flow in the year of potential disposition and terminalcapitalization rate. The Company used terminal capitalization rates in its 2009analyses ranging between 8.1% and 9.6%, based on the Company’s weighted averagecost of capital, a hurdle rate assigned to each hotel to account for a hotel’sindividual characteristics including, but not limited to, size, age and marketsupply, and an estimated average annual growth rate. The Company’s judgment isrequired in determining the discount rate applied to estimated cash flows, theterminal capitalization rate, the growth rate of each property’s projectedrevenues and expenses, the need for capital expenditures, as well as specificmarket and economic conditions.

 

As of September 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 debt secured by the Mass Mutual eighthotels, totaled $1.3 billion and $1.4 billion as of September 30, 2010 andDecember 31, 2009, respectively. Using Level 3 measurements, including theCompany’s weighted average cost of capital ranging between 6.0% and 9.6%, theCompany estimates that the fair market value of its debt totaled $1.3 billionand $1.2 billion as of September 30, 2010 and December 31, 2009,respectively.

 

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

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                               | ** ** | **(unaudited)**                                               | ** ** |
| Investment in hotel  properties, net                                       |       | $                                                              | —     |                                                           | $          | —                                                        |       | $                                                             | —     |   | $ | 25,488 |   |
| Investment in hotel  properties of discontinued operations, net            |       | —                                                         |       | —                                                         |       | —                                                        |       | 104,007                                                       |       |
| Other real estate, net                                                     |       | —                                                         |       | —                                                         |       | 1,943                                                         |       | —                                                        |       |
| Goodwill                                                                   |       | —                                                         |       | 2,209                                                          |       | —                                                        |       | 3,948                                                         |       |
| Other current assets of  operations held for non-sale disposition, net (1) |       | —                                                         |       | —                                                         |       | —                                                        |       | 3,007                                                         |       |
| Other assets, net                                                          |       | —                                                         |       | —                                                         |       | —                                                        |       | 1,416                                                         |       |
| Total Level 3 measurement  impairment losses included in earnings          |       | $                                                              | —     |                                                           | $          | 2,209                                                         |       | $                                                             | 1,943      |   | $ | 137,866 |   |

 

----

(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 September 30, 2010 and December 31,2009 (in thousands):

 
| ** **                                                | ** ** | **Total**                        | ** ** | **Fair Value Measurements at Reporting Date** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **September 30, 2010** | ** ** | **Level 1**                                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| ** **                                                | ** ** | **(unaudited)**                  | ** ** | **(unaudited)**                                                        | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| **Assets:**                                               |       |                             |       |                                                                   |       |   |   |   |   |
| Life  insurance policy                                    |       | $                                | 1,796      |                                                                   | $          | — |   | $ | 1,796 |   | $ | — |   |
| Goodwill                                                  |       | 4,673                            |       | —                                                                 |       | — |   | 4,673 |   |
| Goodwill of operations held for non-sale  disposition (1) |       | 1,174                            |       | —                                                                 |       | — |   | 1,174 |   |
| Total  assets                                             |       | $                                | 7,643      |                                                                   | $          | — |   | $ | 1,796 |   | $ | 5,847 |   |
|                                                      |       |                             |       |                                                                   |       |   |   |   |   |
| **Liabilities:**                                          |       |                             |       |                                                                   |       |   |   |   |   |
| Retirement  benefit agreement                             |       | $                                | 1,796      |                                                                   | $          | — |   | $ | 1,796 |   | $ | — |   |
| Total  liabilities                                        |       | $                                | 1,796      |                                                                   | $          | — |   | $ | 1,796 |   | $ | — |   |

 
| ** **                                                                           | ** ** | **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 September 30, 2010 and December 31,2009 includes an allowance for doubtful accounts of $0.1 million, all of whichis included in continuing operations. At September 30, 2010 and December 31,2009, the Company had approximately $0.6 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 September 30, 2010 or December 31, 2009as all 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 zero and $1.6 million forthe three and nine months ended September 30, 2010, respectively. Duringthe first quarter of 2010, the Company wrote-off $1.5 million in deferredfinancing fees related to the termination of its credit facility, and duringthe second quarter of 2010 the Company wrote off $0.1 million in deferredfinancing fees related to the release of three hotels from the Mass Mutualloan. During the three and nine months ended September 30, 2009, theCompany wrote off zero and $0.3 million, respectively, in deferred financingfees associated with the amendment of its credit facility during the secondquarter 2009.

 

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

 
| ** **                                                           | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                               | ** ** | **(unaudited)**                                               | ** ** |
| Operations held for investment:                                      |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Amortization of deferred financing fees                              |       | $                                                              | 303        |                                                           | $          | 582                                                           |       | $                                                             | 1,102      |   | $ | 1,217 |   |
| Write-off of deferred financing fees                                 |       | —                                                         |       | —                                                         |       | 1,585                                                         |       | 284                                                           |       |
| Total deferred financing fees — operations held  for investment |       | 303                                                            |       | 582                                                            |       | 2,687                                                         |       | 1,501                                                         |       |
| Operations held for non-sale disposition:                            |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Amortization of deferred financing fees                              |       | 131                                                            |       | 131                                                            |       | 395                                                           |       | 395                                                           |       |
| Discontinued operations:                                             |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Amortization of deferred financing fees                              |       | —                                                         |       | 11                                                             |       | 2                                                             |       | 32                                                            |       |
| Total amortization and write-off of deferred  financing fees         |       | $                                                              | 434        |                                                           | $          | 724                                                           |       | $                                                             | 3,084      |   | $ | 1,928 |   |

 

**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 September 30, 2010 and 2009,undistributed earnings representing nonforfeitable dividends of $0.2 millionand zero, respectively, were allocated to the participating securities. For thenine months ended September 30, 2010 and 2009, distributed earningsrepresenting 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  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                               | ** ** | **(unaudited)**                                               | ** ** |
| Numerator:                                                                                   |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Net income (loss)                                                                            |       | $                                                              | 23,653     |                                                           | $          | (17,948                                                       | )          | $                                                             | 2,870      |   | $ | (141,643 | ) |
| Less dividends paid on unvested restricted stock  compensation                               |       | —                                                         |       | —                                                         |       | —                                                        |       | (447                                                          | )          |
| Less preferred stock dividends and accretion                                                 |       | (5,141                                                         | )          | (5,187                                                         | )          | (15,515                                                       | )          | (15,562                                                       | )          |
| Less undistributed income allocated to unvested  restricted stock compensation               |       | (232                                                           | )          | —                                                         |       | —                                                        |       | —                                                        |       |
| Numerator for basic and diluted income available  (loss attributable) to common stockholders |       | $                                                              | 18,280     |                                                           | $          | (23,135                                                       | )          | $                                                             | (12,645    | ) | $ | (157,652 | ) |
|                                                                                         |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Denominator:                                                                                 |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Weighted average basic common shares outstanding                                             |       | 97,250                                                         |       | 73,857                                                         |       | 97,163                                                        |       | 62,382                                                        |       |
| Unvested restricted stock awards                                                             |       | 362                                                            |       | —                                                         |       | —                                                        |       | —                                                        |       |
| Weighted average diluted common shares outstanding                                           |       | 97,612                                                         |       | 73,857                                                         |       | 97,163                                                        |       | 62,382                                                        |       |
| Basic income available (loss attributable) to  common stockholders per common share          |       | $                                                              | 0.19       |                                                           | $          | (0.31                                                         | )          | $                                                             | (0.13      | ) | $ | (2.53 | ) |
| Diluted income available (loss attributable) to  common stockholders per common share        |       | $                                                              | 0.19       |                                                           | $          | (0.31                                                         | )          | $                                                             | (0.13      | ) | $ | (2.53 | ) |

 

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Sharesassociated with the Company’s long-term incentive plan have been excluded fromthe above calculation of earnings per share for the three months ended September 30,2009 and the nine months ended September 30, 2010 and 2009 as theirinclusion would have been anti-dilutive. The Company’s shares of Series Cpreferred stock issuable upon conversion and shares associated with commonstock options and unvested restricted stock units have been excluded from theabove calculation of earnings per share for the three and nine months ended September 30,2010 and 2009, 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):

 
| ** **                                | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Land                                      |       | $                            | 274,591    |                        | $          | 233,812 |   |
| Buildings and improvements                |       | 1,958,697                    |       | 1,848,435                   |       |
| Furniture, fixtures and equipment         |       | 254,893                      |       | 243,415                     |       |
| Intangibles                               |       | 34,454                       |       | 34,081                      |       |
| Franchise fees                            |       | 983                          |       | 1,133                       |       |
| Construction in process                   |       | 17,734                       |       | 6,182                       |       |
|                                      |       | 2,541,352                    |       | 2,367,058                   |       |
| Accumulated depreciation and amortization |       | (513,270                     | )          | (443,666                    | )          |
|                                      |       | $                            | 2,028,082  |                        | $          | 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.

 

OnAugust 16, 2010, the Company acquired the Royal Palm hotel in Miami Beach,Florida at a foreclosure auction for a gross purchase price of $126.1 millionexcluding transaction costs. Prior to the auction, the Company purchased aportion of the hotel’s outstanding debt at a discount to par resulting in aneconomic net purchase price of approximately $117.6 million, excludingtransaction costs. On August 27, 2010, title to the hotel was transferredto the Company. The results of operations for the Royal Palm Miami Beach havebeen included in the Company’s statement of operations from the title transferdate of August 27, 2010 through the third quarter ended September 30,2010.

 

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Thefollowing unaudited pro forma results of operations reflect the Company’sresults as if the reacquisition of the Renaissance Westchester and theacquisition of the Royal Palm Miami Beach had occurred on January 1, 2009.In the Company’s opinion, all significant adjustments necessary to reflectthe effects of these transactions have been made (in thousands, except pershare data):

 
| ** **                                                                             | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **(Unaudited)**                                                | ** ** | **(Unaudited)**                                                | ** ** | **(Unaudited)**                                               | ** ** | **(Unaudited)**                                               | ** ** |
|                                                                                   |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Revenues                                                                               |       | $                                                              | 179,790    |                                                           | $          | 177,175                                                       |       | $                                                             | 539,833    |   | $ | 543,281 |   |
| Loss attributable to common stockholders from  continuing operations                   |       | $                                                              | (17,939    | )                                                              | $          | (14,778                                                       | )          | $                                                             | (44,762    | ) | $ | (15,919 | ) |
| Loss per diluted share attributable to common  stockholders from continuing operations |       | $                                                              | (0.23      | )                                                              | $          | (0.27                                                         | )          | $                                                             | (0.62      | ) | $ | (0.52 | ) |

 

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 (see Footnote 17).

 

Asof September 30, 2010 and December 31, 2009, the assets andliabilities of operations held for non-sale disposition associated with theMass Mutual eight hotels consisted of the following (in thousands):

 
| ** **                                                             | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                             | ** ** | **(unaudited)**                  | ** ** | ** **                      | ** ** |
| ASSETS                                                                 | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| Current assets:                                                        | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| Cash and cash equivalents                                              |       | $                                | 26,016     |                            | $          | 5,864 |   |
| Restricted cash                                                        |       | 5,137                            |       | 4,683                           |       |
| Accounts receivable, net                                               |       | 1,732                            |       | 1,137                           |       |
| Inventories                                                            |       | 234                              |       | 245                             |       |
| Prepaid expenses                                                       |       | 265                              |       | 208                             |       |
| Deferred financing fees, net                                           |       | 307                              |       | 702                             |       |
| Goodwill                                                               |       | 1,174                            |       | 1,174                           |       |
| Other assets, net                                                      |       | 292                              |       | 127                             |       |
| Other current assets of operations held for  non-sale disposition, net |       | 35,157                           |       | 14,140                          |       |
| Investment in hotel properties, net                                    |       | 98,239                           |       | 102,343                         |       |
| Total assets                                                           |       | $                                | 133,396    |                            | $          | 116,483 |   |
|                                                                   |       |                             |       |                            |       |
| LIABILITIES                                                            | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| Current liabilities:                                                   | ** ** | ** **                       | ** ** | ** **                      | ** ** |
| Accounts payable and accrued expenses                                  |       | $                                | 986        |                            | $          | 989 |   |
| Due to Third Party Managers                                            |       | 1,325                            |       | 1,148                           |       |
| Other current liabilities                                              |       | 23,801                           |       | 4,192                           |       |
| Other liabilities                                                      |       | 39                               |       | 35                              |       |
| Other current liabilities of operations held for  non-sale disposition |       | 26,151                           |       | 6,364                           |       |
| Notes payable                                                          |       | 162,972                          |       | 184,121                         |       |
| Total liabilities                                                      |       | $                                | 189,123    |                            | $          | 190,485 |   |

 

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**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 theextinguishment of this debt, which is included in discontinued operations.Operating results for the Renaissance Westchester for 2009, therefore, areincluded in discontinued operations, whereas operating results from June 14,2010 forward are included in the Company’s continuing operations.

 

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, whooperated the property for the benefit of the lender of the non-recourse loanuntil the hotel was sold by the receiver in August 2010, and title to thehotel was transferred to the hotel’s new owner. In conjunction with thereceiver’s sale of the hotel, the Company removed the net assets andliabilities from its 2010 balance sheet and recorded a gain on extinguishmentof debt of $5.1 million in the third quarter of 2010. The Company reclassifiedthe Marriott Ontario Airport’s results of operations and cash flows for thethree months ended March 31, 2010, as well as any expenses incurred asowner of the property for the nine months ended September 30, 2010, alongwith the hotel’s results of operations for the three and nine months ended September 30,2009 to discontinued operations on its statements of operations and cash flows.

 

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 operated the property for the benefit of the lender of thenon-recourse loan until the deed back was completed in July 2010, andtitle to the hotel was transferred to the lender. In conjunction with the deedback of the hotel, the Company removed the net assets and liabilities from its2010 balance sheet and recorded a gain on extinguishment of debt of $35.4million in the third quarter 2010. The Company has reclassified the W San Diego’sresults of operations and cash flows for the three and nine months ended September 30,2009 to discontinued operations on its statements of operations and cash flows.

 

Inaddition to the deed backs noted above, the Company sold the Marriott NapaValley and the Marriott Riverside during the second quarter of 2009, and theHyatt Suites Atlanta Northwest during the third quarter of 2009. The followingsets forth the discontinued operations for the three and nine months ended September 30,2010 and 2009, related to the three hotel properties sold during 2009, as wellas the two hotel properties deeded back in 2010 and the Renaissance Westchesterheld in receivership until its reacquisition by the Company in June 2010(in thousands):

 
| ** **                                 | ** ** | **Three Months Ended********September 30, 2010** | ** ** | **Three Months Ended********September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Operating revenues                         |       | $                                                                    | —     |                                                                 | $          | 11,259                                                              |       | $                                                                   | 1,842      |   | $ | 44,889 |   |
| Operating expenses                         |       | —                                                               |       | (10,340                                                              | )          | (1,736                                                              | )          | (40,550                                                             | )          |
| Interest expense                           |       | —                                                               |       | (4,846                                                               | )          | (275                                                                | )          | (8,306                                                              | )          |
| Depreciation and amortization expense      |       | —                                                               |       | (749                                                                 | )          | (124                                                                | )          | (6,502                                                              | )          |
| Property and goodwill impairment losses    |       | —                                                               |       | —                                                               |       | —                                                              |       | (104,007                                                            | )          |
| Gain on extinguishment of debt             |       | 40,473                                                               |       | —                                                               |       | 47,220                                                              |       | —                                                              |       |
| Gain (loss) on sale of hotels              |       | —                                                               |       | 18                                                                   |       | —                                                              |       | (13,052                                                             | )          |
| Income (loss) from discontinued operations |       | $                                                                    | 40,473     |                                                                 | $          | (4,658                                                              | )          | $                                                                   | 46,927     |   | $ | (127,528 | ) |

 

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**5. Other Real Estate**

 

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

 
| ** **                        | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Land                              |       | $                            | 2,768      |                        | $          | 3,824 |   |
| Buildings and improvements        |       | 9,296                        |       | 10,179                      |       |
| Furniture, fixtures and equipment |       | 6,497                        |       | 6,058                       |       |
| Construction in process           |       | —                       |       | 27                          |       |
|                              |       | 18,561                       |       | 20,088                      |       |
| Accumulated depreciation          |       | (6,849                       | )          | (6,232                      | )          |
|                              |       | 11,712                       |       | 13,856                      |       |
| Land held for investment          |       | 188                          |       | 188                         |       |
|                              |       | $                            | 11,900     |                        | $          | 14,044 |   |

 

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.

 

Asof September 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. In April 2010,the Company purchased a $30.0 million, 8.5% mezzanine loan maturing in January 2017for $3.45 million. The mezzanine loan is secured by the equity interests in theCompany’s Doubletree Guest Suites Times Square joint venture, and is includedin other assets, net on the Company’s balance sheets (see Footnote 8).  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 nine months ended September 30,2010 and 2009, all of which was included in equity in earnings (losses) ofunconsolidated joint ventures, as follows (in thousands):

 
| ** **                       | ** ** | **Three Months Ended********September 30, 2010** | ** ** | **Three Months Ended********September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|----------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                       | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Stock-based compensation expense |       | $                                                                    | 7          |                                                                 | $          | 20                                                                  |       | $                                                                   | 33         |   | $ | 44 |   |
|                                  |            |                                                                      |            |                                                                      |            |                                                                     |            |                                                                     |            |  |  |  |  |

 

TheCompany received $0.3 million in distributions from its BuyEfficient jointventure during both the three months ended September 30, 2010 and 2009,and $0.6 million and $0.3 million for the nine months ended September 30,2010 and 2009, respectively.

 

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 value of the Company’s 38% interestin the partnership to zero. Although the Doubletree Guest Suites Times Squarejoint venture earned income of $0.5 million and $0.1 million during the threeand nine months ended September 30, 2010, respectively, the Company didnot recognize any portion of this income as the value of its interest in thepartnership was reduced to zero at December 31, 2009. The Company will notrecognize any future income from this joint venture until its share of suchearnings exceeds its share of cumulative losses in excess of the zero bookvalue of its 38% interest in the joint venture.

 

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 nine months ended September 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 (seeFair 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 September 30, 2010 and December 31, 2009, goodwill consisted ofthe following (in thousands):

 
| ** **                                                      | ** ** | **September 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):

 
| ** **                  | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                  | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| Property and equipment, net |       | $                            | 1,819      |                        | $          | 1,125 |   |
| Deposits                    |       | 2,358                        |       | —                      |       |
| Other receivables           |       | 7,535                        |       | 2,567                       |       |
| Other                       |       | 2,425                        |       | 2,526                       |       |
|                        |       | $                            | 14,137     |                        | $          | 6,218 |   |

 

InSeptember 2010, the Company paid a good faith deposit of $2.4 millionrelated to the expected refinancing of the $81.0 million mortgage on its HiltonTimes Square, which is scheduled to mature in December 2010. Once therefinance has been completed, a portion of this deposit will be refunded to theCompany and a portion will be applied to deferred financing fees and amortizedover the life of the loan (see Footnote 17).

 

Priorto its acquisition of the Royal Palm Miami Beach in August 2010, theCompany purchased a portion of the hotel’s debt with a principal amount of$17.1 million for $3.0 million. In conjunction with the purchase of the hotel,the Company received $5.4 million, net of related costs, as a partial paymentof this debt, and will receive an additional $3.1 million no later than February 2012.The Company has included the additional $3.1 million receivable in otherassets.

 

InApril 2010, the Company purchased two hotel loans for $3.7 million thathave a combined principal amount of $32.5 million. The loans include (i) a$30.0 million, 8.5% mezzanine loan maturing in January 2017 secured by theequity interests in the Company’s Doubletree Guest Suites Times Square jointventure (see Footnote 6), and (ii) a $2.5 million, 8.075% subordinate notematuring in November 2010 secured by the 101-room boutique hotel known asTwelve Atlantic Station in Atlanta, Georgia. The Company purchased themezzanine loan for $3.45 million and the subordinate note for $250,000. None ofthe debt on the Doubletree Guest Suites Times Square is in default, howeverinterest payments on the mezzanine loan are currently being deferred inaccordance with the provisions of the loan. The subordinate note secured by theTwelve Atlantic Station is currently in default. The Company will account forboth loans using the cost recovery method until such time as the expected cashflows from the loans are reasonably probable and estimable. No amounts werereceived for either note during the three and nine months ended September 30, 2010.

 

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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 interest receivableon the note, and any amounts received from the Buyer in the future will beapplied first towards the principal amount of the note. During the three andnine months ended September 30, 2010, the Company received zero and $0.1million, respectively, from the Buyer and applied these receipts towards theprincipal amount of the note as recoveries of bad debt which were included incorporate overhead.

 

**9. Notes Payable**

 

Notespayable consisted of the following (in thousands):

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **September 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 September 30, 2010, and 30 hotel properties and one laundry  facility at December 31, 2009. |       | $                            | 1,237,489  |                        | $          | 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                      |       |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       | 1,299,989                    |       | 1,391,111                   |       |
| Less: discount on Senior Notes                                                                                                                                                                                                                                                                                                                                                                       |       | (2,450                       | )          | (3,193                      | )          |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       | 1,297,539                    |       | 1,387,918                   |       |
| Less: notes payable of operations held for  non-sale disposition                                                                                                                                                                                                                                                                                                                                     |       | (162,972                     | )          | (184,121                    | )          |
| Less: current portion                                                                                                                                                                                                                                                                                                                                                                                |       | (94,810                      | )          | (153,778                    | )          |
|                                                                                                                                                                                                                                                                                                                                                                                                 |       | $                            | 1,039,757  |                        | $          | 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-recourse mortgagedebt. The status of the final four loans included in the 2009 secured debtrestructuring 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 recorded a $35.4 million gain onextinguishment of this debt, which is included in discontinued operations, andthe net assets and liabilities were removed from its 2010 balance sheet.

 

*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*. On August 12, 2010,the Marriott Ontario Airport was sold by the receiver, and title to the hotelwas transferred to the hotel’s new owner. The Company recorded a $5.1 milliongain on extinguishment of this debt, which is included in discontinuedoperations, and the net assets and liabilities were removed from its 2010balance sheet.

 

*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 (see Footnote 17).

 

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

 
| ** **                                | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended   September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Operations held for investment:           |       |                                                           |       |                                                                 |       |                                                                |       |                                                                |       |
| Interest expense                          |       | $                                                              | 16,116     |                                                                 | $          | 17,371                                                              |       | $                                                                   | 49,239     |   | $ | 54,626 |   |
| Interest expense — default rate (1)  |       | —                                                         |       | —                                                               |       | 884                                                                 |       | —                                                              |       |
| Accretion of Senior Notes                 |       | 252                                                            |       | 237                                                                  |       | 743                                                                 |       | 1,576                                                               |       |
| Amortization of deferred financing fees   |       | 303                                                            |       | 582                                                                  |       | 1,102                                                               |       | 1,217                                                               |       |
| Write-off of deferred financing fees      |       | —                                                         |       | —                                                               |       | 1,585                                                               |       | 284                                                                 |       |
| Loan penalties and fees (2)               |       | —                                                         |       | —                                                               |       | 174                                                                 |       | —                                                              |       |
|                                      |       | $                                                              | 16,671     |                                                                 | $          | 18,190                                                              |       | $                                                                   | 53,727     |   | $ | 57,703 |   |
|                                      |       |                                                           |       |                                                                 |       |                                                                |       |                                                                |       |
| Operations held for non-sale disposition: |       |                                                           |       |                                                                 |       |                                                                |       |                                                                |       |
| Interest expense                          |       | $                                                              | 2,424      |                                                                 | $          | 2,749                                                               |       | $                                                                   | 7,606      |   | $ | 8,272 |   |
| Interest expense — default rate (1)  |       | 2,038                                                          |       | —                                                               |       | 6,392                                                               |       | —                                                              |       |
| Amortization of deferred financing fees   |       | 131                                                            |       | 131                                                                  |       | 395                                                                 |       | 395                                                                 |       |
| Loan penalties and fees (2)               |       | 282                                                            |       | —                                                               |       | 879                                                                 |       | —                                                              |       |
|                                      |       | $                                                              | 4,875      |                                                                 | $          | 2,880                                                               |       | $                                                                   | 15,272     |   | $ | 8,667 |   |

 

----

(1) Interest expense — default rate for the three and nine months ended September 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 (see Footnote 17).

 

(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 zero and $135,000 for the three and ninemonths ended September 30, 2010, respectively, and operations held fornon-sale disposition includes loan penalties and fees of $0.3 million and $0.9million for the three and nine months ended September 30, 2010. While theCompany is required to record such loan penalties and fees, as the Mass Mutualloan is non-recourse to the Company, the Company does not expect to actuallyfund such fees. The Company will reverse these accruals and record a gain onthe forgiveness of these penalties and fees once the deed back of the MassMutual eight is completed, and the debt is extinguished (see Footnote 17). Anadditional $39,000 in loan penalties and fees for operations held forinvestment was incurred during the three months ended March 31, 2010 dueto the termination of the Company’s credit facility.

 

**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. As of July 8,2010, the Series C 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 $24.375 per share, plus accrued and unpaid dividends up to andincluding the redemption date. The holders of the Series C preferred stockhave the right to require the Company to redeem the Series C preferredstock in the event of any of the following: (1) a change in control of the Company, if certain conditions arenot met; (2) a REIT termination event; or (3) a termination of theCompany’s listing on either the New York Stock Exchange or NASDAQ. In general,holders of Series C preferred stock vote on an as-converted basis as asingle class with holders of the Company’s common stock. The holders areeligible to receive a participating dividend to the extent the Company’sdividend on its common stock exceeds $0.339 per share per quarter. Thequarterly dividend on the Series C preferred stock is currently $0.393 pershare. If the Company fails to meet certain financial ratios for fourconsecutive quarters, a financial ratio violation 

 

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willoccur with 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 gain theright 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 anytime. As the Series C preferred stockholders may redeem their shares incertain circumstances 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 September 30, 2010 and December 31,2009, the Series C preferred stock carrying value consisted of thefollowing (in thousands):

 
| ** **                                       | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **(unaudited)**                  | ** ** | ** **                      | ** ** |
| Initial fair value, sales price of $99.0 million |       | $                                | 99,000     |                            | $          | 99,000 |   |
| Redemption value accretion                       |       | 1,000                            |       | 896                             |       |
|                                             |       | $                                | 100,000    |                            | $          | 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 September 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 netproceeds of $98.7 million. The Company used the net proceeds from this equityoffering for working capital and other general corporate purposes, includingthe replacement 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.

 

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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, as well as the reacquisition of the Renaissance Westchesterin June 2010 and the acquisition of the Royal Palm Miami Beach in August 2010.

 

**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 nine months ended September 30, 2010 and 2009 wereas follows (in thousands):

 
| ** **                     | ** ** | **Three Months Ended   September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|--------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                     | ** ** | **(unaudited)**                                                      | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Compensation expense           |       | $                                                                    | 1,138      |                                                           | $          | 1,540                                                               |       | $                                                                   | 3,464      |   | $ | 4,736 |   |
| Forfeiture expense adjustments |       | $                                                                    | —     |                                                           | $          | 10                                                                  |       | $                                                                   | 79         |   | $ | 32 |   |

 

**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 current ExecutiveChairman. The Options fully vested in April 2009, and will expire in April 2018.The exercise price of the Options is $17.71 per share.

 

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 31 hotels andtwo commercial laundry facilities. Operations held for non-sale dispositioncurrently includes the Mass Mutual eight hotels.

 

Non-segment operations include corporate overhead,earnings (losses) on unconsolidated joint ventures, interest income and otherincome (loss) and discontinued operations. Non-segment assets primarily consistof corporate assets, including cash, restricted cash, due from affiliates,prepaid expenses, investment in unconsolidated joint ventures, deferred financingcosts and office 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  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                               | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                               | ** ** | **(unaudited)**                                               | ** ** |
| Revenues:                                                |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Operations held for  investment                          |       | $                                                              | 157,064    |                                                           | $          | 149,274                                                       |       | $                                                             | 458,837    |   | $ | 453,840 |   |
| Operations held for non-sale  disposition                |       | 20,646                                                         |       | 20,790                                                         |       | 60,638                                                        |       | 63,712                                                        |       |
| Total revenues                                           |       | $                                                              | 177,710    |                                                           | $          | 170,064                                                       |       | $                                                             | 519,475    |   | $ | 517,552 |   |
|                                                     |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Property and goodwill  impairment losses:                |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Operations held for  investment                          |       | $                                                              | —     |                                                           | $          | 2,209                                                         |       | $                                                             | 1,943      |   | $ | 30,852 |   |
| Operations held for  non-sale disposition                |       | —                                                         |       | —                                                         |       | —                                                        |       | 3,007                                                         |       |
| Non-segment                                              |       | —                                                         |       | —                                                         |       | —                                                        |       | 104,007                                                       |       |
| Total property and  goodwill impairment losses           |       | $                                                              | —     |                                                           | $          | 2,209                                                         |       | $                                                             | 1,943      |   | $ | 137,866 |   |
|                                                     |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Adjusted EBITDA: (1)                                     |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Operations held for  investment                          |       | $                                                              | 37,410     |                                                           | $          | 36,456                                                        |       | $                                                             | 111,519    |   | $ | 113,350 |   |
| Operations held for  non-sale disposition                |       | 4,415                                                          |       | 4,440                                                          |       | 11,694                                                        |       | 13,536                                                        |       |
| Non-segment                                              |       | (2,886                                                         | )          | (751                                                           | )          | (9,953                                                        | )          | (3,048                                                        | )          |
| Adjusted EBITDA                                          |       | $                                                              | 38,939     |                                                           | $          | 40,145                                                        |       | $                                                             | 113,260    |   | $ | 123,838 |   |
|                                                     |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Reconciliation of  Adjusted EBITDA to Net Income (Loss): |       |                                                           |       |                                                           |       |                                                          |       |                                                          |       |
| Adjusted EBITDA                                          |       | $                                                              | 38,939     |                                                           | $          | 40,145                                                        |       | $                                                             | 113,260    |   | $ | 123,838 |   |
| Depreciation and  amortization                           |       | (25,436                                                        | )          | (28,333                                                        | )          | (75,646                                                       | )          | (89,363                                                       | )          |
| Amortization of lease  intangibles                       |       | (76                                                            | )          | —                                                         |       | (226                                                          | )          | —                                                        |       |
| Interest expense                                         |       | (18,540                                                        | )          | (22,500                                                        | )          | (57,070                                                       | )          | (70,065                                                       | )          |
| Interest expense —  default rate                    |       | (2,038                                                         | )          | —                                                         |       | (7,276                                                        | )          | —                                                        |       |
| Amortization of deferred  financing fees                 |       | (434                                                           | )          | (769                                                           | )          | (1,499                                                        | )          | (1,781                                                        | )          |
| Write-off of deferred  financing fees                    |       | —                                                         |       | —                                                         |       | (1,585                                                        | )          | (284                                                          | )          |
| Loan penalties and fees                                  |       | (282                                                           | )          | (3,093                                                         | )          | (1,101                                                        | )          | (3,093                                                        | )          |
| Non-cash interest  related to discount on Senior Notes   |       | (252                                                           | )          | (237                                                           | )          | (743                                                          | )          | (1,576                                                        | )          |
| Amortization of deferred  stock compensation             |       | (761                                                           | )          | (950                                                           | )          | (2,426                                                        | )          | (3,314                                                        | )          |
| Gain (loss) on sale of  assets                           |       | (383                                                           | )          | 18                                                             |       | (383                                                          | )          | (12,698                                                       | )          |
| Gain (loss) on extinguishment  of debt                   |       | 40,473                                                         |       | (20                                                            | )          | 47,220                                                        |       | 54,559                                                        |       |
| Property and goodwill  impairment losses                 |       | —                                                         |       | (2,209                                                         | )          | (1,943                                                        | )          | (137,866                                                      | )          |
| Closing costs — Royal  Palm Miami Beach acquisition |       | (6,619                                                         | )          | —                                                         |       | (6,774                                                        | )          | —                                                        |       |
| Due diligence costs —  abandoned project            |       | (938                                                           | )          | —                                                         |       | (938                                                          | )          | —                                                        |       |
| Net income (loss)                                        |       | $                                                              | 23,653     |                                                           | $          | (17,948                                                       | )          | $                                                             | 2,870      |   | $ | (141,643 | ) |

 
| ** **                                | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **(unaudited)**                  | ** ** | ** **                      | ** ** |
| Assets:                                   |       |                             |       |                            |       |
| Operations held for  investment           |       | $                                | 2,145,454  |                            | $          | 2,023,561 |   |
| Operations held for  non-sale disposition |       | 133,396                          |       | 116,483                         |       |
| Non-segment                               |       | 94,612                           |       | 373,486                         |       |
| Total assets                              |       | $                                | 2,373,462  |                            | $          | 2,513,530 |   |

 

----

(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, amortization of lease intangibles, interest expense, amortizationof deferred financing fees, any write-offs of deferred financing fees, loanpenalties and fees, amortization of deferred stock compensation, gain (loss) onsale of assets or extinguishment of debt, property and goodwill impairmentlosses and any other identified adjustments. Non-segment Adjusted EBITDA isdefined by the Company as net income (loss) excluding adjustments for itsunconsolidated joint ventures and discontinued operations related todepreciation and amortization, interest expense, amortization of deferredfinancing fees, loan penalties and fees, amortization of deferred stockcompensation, gain (loss) on sale of assets or extinguishment of debt, andproperty and goodwill impairment losses. The Company believes Adjusted EBITDA isuseful to investors in evaluating its operating performance because thesemeasures help investors evaluate and compare the results of its operations fromperiod to period by removing the impact of the Company’s capital structure(primarily interest expense) and the Company’s asset base (primarilydepreciation and amortization) from its operating results. The Company alsouses Adjusted EBITDA as a measure in determining the value of hotelacquisitions and dispositions. The Company cautions investors that amountspresented in accordance with its definition of Adjusted EBITDA may not becomparable to similar measures disclosed by other companies, because not allcompanies calculate non-GAAP measures in the 

 

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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 nine months ended September 30, 2010 and2009 were included in the Company’s statements of operations as follows (inthousands):

 
| ** **                                                                         | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Operations  held for investment — property general and administrative expense |       | $                                                              | 3,886      |                                                           | $          | 3,666                                                               |       | $                                                                   | 11,405     |   | $ | 11,265 |   |
| Operating  expenses of operations held for non-sale disposition                    |       | 461                                                            |       | 462                                                            |       | 1,365                                                               |       | 1,435                                                               |       |
| Discontinued  operations                                                           |       | —                                                         |       | 321                                                            |       | 37                                                                  |       | 1,204                                                               |       |
|                                                                               |       | $                                                              | 4,347      |                                                           | $          | 4,449                                                               |       | $                                                                   | 12,807     |   | $ | 13,904 |   |

 

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 $0.7 million and $0.6 million for the three months ended September 30,2010 and 2009, respectively, all of which were included in property general andadministrative expense. Total incentive management fees incurred by the Companywere $2.0 million for both the nine months ended September 30, 2010 and2009, 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 both the three months ended September 30, 2010 and 2009were $7.2 million, of which royalties totaled $2.6 million for both the threemonths ended September 30, 2010 and 2009. For the nine months ended September 30,2010 and 2009, total license and franchise costs incurred by the Company were$20.1 million and $21.5 million, respectively, of which royalties totaled $7.3million and $8.1 million, respectively. The remaining costs includedadvertising, reservation and frequent guest program assessments. Total license and franchise costs incurred bythe Company during the three and nine months ended September 30, 2010 and2009 were included in the Company’s statements of operations as follows (inthousands):

 
| ** **                                                      | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Operations  held for investment — franchise costs          |       | $                                                              | 5,727      |                                                           | $          | 5,283                                                               |       | $                                                                   | 15,878     |   | $ | 15,082 |   |
| Operating  expenses of operations held for non-sale disposition |       | 1,465                                                          |       | 1,457                                                          |       | 4,069                                                               |       | 4,167                                                               |       |
| Discontinued  operations                                        |       | —                                                         |       | 479                                                            |       | 130                                                                 |       | 2,289                                                               |       |
|                                                            |       | $                                                              | 7,192      |                                                           | $          | 7,219                                                               |       | $                                                                   | 20,077     |   | $ | 21,538 |   |

 

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Severalof the Company’s franchise agreements contain corporate guaranties. In theevent of a default under any of these franchise agreements, the Company may beliable for termination fees. During the third quarter of 2010, the Company paid$3.4 million in franchise termination fees for the Marriott Ontario Airport asthis hotel’s franchise agreement was terminated in connection with the receiver’ssale of the hotel. The $3.4 million is included in discontinued operations inthe Company’s statement of operations. Currently, seven of the hotels includedin the Mass Mutual eight may be in default under their respective franchiseagreements as a result of the Company’s 2009 secured debt restructuringprogram. If the franchise agreements on the seven hotels were to be terminateddue to franchisee default(s) thereunder, the Company may be liable for upto $21.5 million in termination fees.

 

**Renovation and Construction Commitments**

 

AtSeptember 30, 2010, the Company had various contracts outstanding withthird parties in connection with the renovation of certain of its hotels aimedat maintaining the appearance and quality of its hotels. The remainingcommitments under these contracts at September 30, 2010 totaled $28.4million.

 

**Ground and Operating Leases**

 

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

 
| ** **                                                                          | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                | ** ** | **(unaudited)**                                                     | ** ** | **(unaudited)**                                                     | ** ** |
| Operations  held for investment — property tax, ground lease and insurance (1) |       | $                                                              | 1,481      |                                                           | $          | 1,193                                                               |       | $                                                                   | 3,966      |   | $ | 3,481 |   |
| Operating  expenses of operations held for non-sale disposition (2)                 |       | 142                                                            |       | 158                                                            |       | 432                                                                 |       | 485                                                                 |       |
|                                                                                |       | $                                                              | 1,623      |                                                           | $          | 1,351                                                               |       | $                                                                   | 4,398      |   | $ | 3,966 |   |

 

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(1) Operations held for investment includes ground leases for six of the Company’shotels currently held for investment. Beginning in 2010, ground lease expensealso includes amortization of lease intangibles on the easements at two of theCompany’s hotels currently held for investment.

 

(2) Operations held for non-sale disposition includes ground leases for two hotelsincluded in the Mass Mutual eight hotels.

 

Rentexpense incurred pursuant to the lease on the corporate facility totaled$32,000 and $0.1 million for the three months ended September 30, 2010 and2009, respectively, and $0.3 million for both the nine months ended September 30,2010 and 2009, and was included in corporate overhead expense.

 

**Concentration of Risk**

 

Asof September 30, 2010, nine of the 31 hotels were located in California,the largest concentration of the Company’s hotels in any state, representingapproximately 25% of the Company’s rooms and approximately 26% of the revenuegenerated by the Company’s 31 hotels during the nine months ended September 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.

 

AtSeptember 30, 2010, the Company had $2.4 million of outstandingirrevocable letters of credit to guaranty the Company’s financial obligationsrelated to workers’ compensation insurance programs from prior policy years.The beneficiaries of these letters of credit may draw upon these letters ofcredit in the event of a contractual default by the Company relating to eachrespective obligation.  No draws havebeen made through September 30, 2010.

 

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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 September 30, 2010 and December 31,2009, amounts owed to the Company by its affiliates amounted to $37,000 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 $0.5 millionfor the three and nine months ended September 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 events hadoccurred. The topic also requires additional disclosures about an enterprise’sinvolvement 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.

 

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**17. Subsequent Events**

 

OnNovember 1, 2010, the Company completed its previously announced deed backof the Mass Mutual eight hotels and titles to the hotels were transferred tothe lender. In connection with such transfer, Mass Mutual delivered to theCompany a covenant and agreement pursuant to which Mass Mutual agreed to notsue the Company for any matter or claim which Mass Mutual may ever haverelating to the hotels, the loan or the loan documents.  There are certain customary carveouts fromthis covenant not to sue, including fraud, a breach of the deed in lieuagreement itself and the environmental indemnity agreement delivered at thetime the loan was originated.  Additionally,the Company made certain customary representations and warranties, all of whichsurvive the closing for a period of six (6) months; the maximum aggregateliability for the Company in connection with a breach of any representations orwarranties is $500,000.  Additionally,seven of the Mass Mutual hotels are subject to franchise agreements whichcontain corporate guaranties.  If thefranchise agreements on the seven hotels were to be terminated, the Company maybe liable for up to $21.5 million in termination fees.  The Company will record a gain onextinguishment of debt to discontinued operations in the fourth quarter of2010. A portion of this gain will be deferred until all significantcontingencies are resolved, and the net remaining assets and liabilities willbe removed from its balance sheet.

 

OnNovember 1, 2010, the Company entered into a new $150.0 million seniorcorporate credit facility. The interest rate for the facility ranges from 325to 425 basis points over LIBOR, depending on the overall leverage of theCompany. The initial term of the facility is three years with an option toextend for an additional one year. Subject to approval by the lender group, thefacility may be increased to up to $250.0 million.  The facility contains customary events ofdefault relating to payments and breaches of representations and warranties.  The Company expects to have full fundsavailability upon the delivery of certain post closing items during the fourthquarter, 2010.

 

OnNovember 1, 2010, the Company entered into a new $92.5 million non-recoursemortgage (“Mortgage”) on its Hilton Times Square. The Mortgage matures in 2020and bears a fixed interest rate of 4.97%, with scheduled monthly principal andinterest amounts based on a thirty-year amortization. The proceeds from theMortgage were used in part to repay the maturing $81.0 million mortgage, whichbore an interest rate of 5.915%. Excess proceeds were retained for generalcorporate purposes. The Mortgage contains customary events of default relatingto payments and breaches of representations and warranties.

 

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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 31 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; 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.**

 

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**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.

 

Weown primarily upper upscale hotels in the United States. As of September 30,2010, we owned 31 hotels held for investment (the “31 hotels”), and we  owned eight additional hotels until they weredeeded back to the lender on November 1, 2010 pursuant to our 2009 secureddebt restructuring program. These eight hotels are included in operations heldfor non-sale disposition. The eight hotels secured the non-recourse mortgagewith Massachusetts Mutual Life Insurance Company (the “Mass Mutual eight”), andinclude: Renaissance Atlanta Concourse; Hilton Huntington; Residence Inn byMarriott Manhattan Beach; Marriott Provo; Courtyard by Marriott San Diego (OldTown); Holiday Inn Downtown San Diego; Holiday Inn Express San Diego (OldTown); and Marriott Salt Lake City (University Park). Three additional hotelswhich previously secured the Mass Mutual loan (Courtyard by Marriott LosAngeles Airport, Kahler Inn & Suites Rochester and Marriott Rochester)were released in April 2010 following our payment of an $83.0 millionrelease price. In addition, the Renaissance Westchester was included in our2009 secured debt restructuring program and held in receivership until wereacquired the hotel for $26.0 million, including related costs, in June 2010.Operating results for the Renaissance Westchester for 2009, therefore, areincluded in discontinued operations as possession and control of the hotel washeld by a court-appointed receiver; whereas operating results from the date wereacquired the hotel, June 14, 2010, forward are included in continuingoperations. The Renaissance Westchester, along with the three hotels releasedfrom the Mass Mutual loan, are included in the 31 hotels. Of the 31 hotels, weclassify 29 as upscale or upper upscale, one as luxury and one as mid-scale asdefined by Smith Travel Research, Inc. In addition to our wholly ownedhotels, we own a 38% equity interest in a joint venture that owns one hotel,and we own certain other non-hotel investments. The majority of our hotels areoperated under nationally recognized brands such as Marriott, Fairmont, Hiltonand Hyatt, which are among the most respected and widely recognized brands inthe lodging industry. While we believe the largest and most stable segment ofdemand for hotel rooms is represented by travelers who prefer the consistentservice and quality associated with nationally recognized brands, we alsobelieve that in certain markets the strongest demand growth may come fromtravelers who prefer non-branded hotels that focus on highly customized servicestandards.

 

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 31 hotel portfolio average 378 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, while also balancing our liquidity and leverage policies. During themature phase of the lodging cycle, our strategy emphasizes net hoteldispositions, and during periods of cyclical declines, our strategy emphasizescapital 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 nine months of 2010, we began to see positive signs in terms ofimproving business and consumer sentiment, which may point to an impendingeconomic recovery, setting the stage for a prolonged period of positivefundamentals in the lodging industry. Accordingly, we believe we are currently inthe early stages of a recovery phase of the lodging cycle. Consistent with ourcycle-appropriate strategy, we believe that acquiring hotels now may likelycreate long-term value, and we expect to deploy a portion of our cash balancein 2010 towards selective hotel acquisitions, including our acquisition of theRoyal Palm Miami Beach in August 2010. Our acquisition program is aimed atgenerating attractive returns on our investment dollars, and therefore we maytarget lodging assets outside of the typical branded, urban, upper upscaleprofile represented by our existing portfolio in order to capitalize onopportunities which may arise. We intend to select the brands and operators forour hotels that we believe will lead to the highest returns, which depending onasset and market characteristics may result in our utilization of nationallyrecognized brands, or more focused, but lesser-known boutique brands.Additionally, the scope of our acquisitions program may include large hotelportfolios or hotel loans. Future acquisitions may be funded by our issuance ofadditional debt or equity securities, including our common and preferred OPunits, or by draws on our new $150.0 million senior corporate credit facilityentered into on November 1, 2010.

 

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Theweighted average term to maturity of our debt, excluding debt on the MassMutual eight hotels, is approximately 6.4 years, and 100% of our debt is fixedrate with an average interest rate of 5.6%. Of our total debt, approximately$179.6 million matures over the next four years ($81.0 million in 2010, none in2011, $33.4 million in 2012 and $65.2 million in 2013, assuming we repay ourremaining Senior Notes balance of $62.5 million at the first put date in 2013).The $179.6 million does not include scheduled amortization payments, whichtotal $2.4 million for the remainder of 2010, $13.5 million in 2011, $15.6million in 2012, and $16.6 million in 2013. In addition, in April 2010, wemade a partial payment of $83.0 million on the Mass Mutual mortgage loan tosecure the release of three of the 11 hotels securing the loan, and in June 2010,we reacquired 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 secured by the hotel was cancelled. Werecognized a gain of $6.7 million on the extinguishment of this debt, which isincluded in discontinued operations. In light of improving secured debt marketsand our desire to maintain flexibility in our level of indebtedness, on November 1,2010, we refinanced the $81.0 million mortgage due in December 2010,rather than use excess cash to repay the loan in full. The new $92.5 millionnon-recourse mortgage matures in 2020 and bears a fixed interest rate of 4.97%,with scheduled monthly principal and interest amounts based on a thirty-yearamortization. The proceeds from the new mortgage were used in part to repay thematuring $81.0 million mortgage, which bore an interest rate of 5.915%. Weretained the excess proceeds for general corporate purposes. The new mortgagecontains customary events of default relating to payments and breaches of representationsand warranties.

 

**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.”Currently our Comparable Portfolio includes all 31 hotels held for investmentat September 30, 2010 except the Royal Palm Miami Beach which is beingrepositioned beginning in 2010. Our Comparable Portfolio also includesoperating results for the Renaissance Westchester for all of 2009, as well asthe period in 2010 while it was held in receivership;

 

·                  *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.

 

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***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

 

·                  *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 have reclassified the assets, liabilities and results ofoperations of the Mass Mutual eight hotels to “operations held for non-saledisposition” on our balance sheets, statements of operations and statements ofcash flows. On November 1, 2010, we conveyed the Mass Mutual eight hotelsto the lender in lieu of repayment of the debt. We will record a gain on extinguishmentof debt to discontinued operations in the fourth quarter of 2010; however aportion of this gain will be deferred until all significant contingencies areresolved.

 

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

 

·                  *Room expense*, which isprimarily driven by occupancy and, therefore, has a significant correlation withroom 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,acquisition and due diligence costs, professional fees, travel expenses andoffice 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 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 impairment evaluations for those hotels which we intend to dispose ofother than by sale. Currently, this category includes the Mass Mutual eighthotels.

 

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***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;

 

·                  *Interestincome and other income (loss),* which includes interest wehave earned on our restricted and unrestricted cash accounts, as well as anygains or losses we have 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;

 

·                  *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;

 

·                  *Gain(loss) on extinguishment of debt,* which includes the gain orloss we recognized 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 Comparable PortfolioRevPAR 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 andComparable Portfolio RevPAR increased by 6.8% in the second quarter of 2010 and3.3% in the third quarter of 2010 as compared to the same periods in 2009.Consistent with prior trends, we anticipate that lodging demand will continueto improve as liquidity is restored in the credit markets and the U.S. economybegins to strengthen. Historically, periods of declining demand are followed byextended periods of relatively strong demand, resulting in a cyclical lodginggrowth phase. Assuming the current U.S. recession ended in the later part of2009, we expect hotel demand to begin to show year-over-year increasesbeginning in 2010 and 2011.

 

·                  *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 higher hotelEBITDA margins. Increases in RevPAR associated with higher occupancy may resultless EBITDA margin improvement.

 

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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 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 margins. Moreover, there are limits to how far our operatorscan reduce expenses without affecting the competitiveness of our hotels.

 

***Operating Results.***The following table presentsthe unaudited operating results for our total portfolio for the three monthsended September 30, 2010 and 2009, including the amount and percentagechange in the results between the two periods. The table presents the resultsof operations included in the consolidated statements of operations, andincludes the 31 hotels (11,722 rooms) as of September 30, 2010 and 29hotels (10,966 rooms) as of September 30, 2009. In addition, operatingresults for operations held for non-sale disposition for both the three monthsended September 30, 2010 and 2009 includes the Mass Mutual eight hotels.Income (loss) from discontinued operations for the three months ended September 30,2010 includes the gain on extinguishment of debt for the W San Diego andMarriott Ontario Airport which were deeded back and sold, respectively,pursuant to our 2009 secured debt restructuring program. Income (loss) fromdiscontinued operations for the three months ended September 30, 2009includes the results of operations for the Hyatt Suites Atlanta Northwest whichwas sold during the third quarter of 2009, as well as the W San Diego, MarriottOntario Airport and Renaissance Westchester which have been deconsolidated fromour operations.

 
| ** **                                                                | ** ** | **Three Months Ended September 30,**                                     | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **2010**                                                                                     | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                                | ** ** | **(unaudited, dollars in thousands, except statistical data)** | ** ** |
| ** **                                                                | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| REVENUES                                                                  |       |                                                                                         |       |   |   |   |   |   |   |
| Room                                                                      |       | $                                                                                            | 108,324    |   | $ | 101,754 |   | $ | 6,570 |   | 6.5 | % |
| Food and beverage                                                         |       | 35,893                                                                                       |       | 34,664 |   | 1,229 |   | 3.5 | % |
| Other operating                                                           |       | 12,847                                                                                       |       | 12,856 |   | (9 | ) | (0.1 | )% |
| Revenues of operations held for non-sale  disposition                     |       | 20,646                                                                                       |       | 20,790 |   | (144 | ) | (0.7 | )% |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Total revenues                                                            |       | 177,710                                                                                      |       | 170,064 |   | 7,646 |   | 4.5 | % |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| OPERATING EXPENSES                                                        |       |                                                                                         |       |   |   |   |   |   |   |
| Hotel operating                                                           |       | 100,981                                                                                      |       | 95,586 |   | 5,395 |   | 5.6 | % |
| Property general and administrative                                       |       | 18,673                                                                                       |       | 17,232 |   | 1,441 |   | 8.4 | % |
| Corporate overhead                                                        |       | 11,596                                                                                       |       | 4,334 |   | 7,262 |   | 167.6 | % |
| Depreciation and amortization                                             |       | 23,871                                                                                       |       | 23,529 |   | 342 |   | 1.5 | % |
| Operating expenses of operations held for non-sale  disposition           |       | 17,787                                                                                       |       | 19,098 |   | (1,311 | ) | (6.9 | )% |
| Property and goodwill impairment losses                                   |       | —                                                                                       |       | 2,209 |   | (2,209 | ) | (100.0 | )% |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Total operating expenses                                                  |       | 172,908                                                                                      |       | 161,988 |   | 10,920 |   | 6.7 | % |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Operating income                                                          |       | 4,802                                                                                        |       | 8,076 |   | (3,274 | ) | (40.5 | )% |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Equity in earnings (losses) of unconsolidated  joint ventures             |       | 200                                                                                          |       | (515 | ) | 715 |   | 138.8 | % |
| Interest income and other income (loss)                                   |       | (276                                                                                         | )          | 239 |   | (515 | ) | (215.5 | )% |
| Interest expense                                                          |       | (16,671                                                                                      | )          | (18,190 | ) | 1,519 |   | 8.4 | % |
| Interest expense of operations held for non-sale  disposition             |       | (4,875                                                                                       | )          | (2,880 | ) | (1,995 | ) | (69.3 | )% |
| Loss on extinguishment of debt                                            |       | —                                                                                       |       | (20 | ) | 20 |   | 100.0 | % |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Loss from continuing operations                                           |       | (16,820                                                                                      | )          | (13,290 | ) | (3,530 | ) | (26.6 | )% |
| Income (loss) from discontinued operations                                |       | 40,473                                                                                       |       | (4,658 | ) | 45,131 |   | 968.9 | % |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Net income (loss)                                                         |       | 23,653                                                                                       |       | (17,948 | ) | 41,601 |   | 231.8 | % |
| Preferred stock dividends and accretion                                   |       | (5,141                                                                                       | )          | (5,187 | ) | 46 |   | 0.9 | % |
| Undistributed income allocated to unvested  restricted stock compensation |       | (232                                                                                         | )          | — |   | (232 | ) | (100.0 | )% |
|                                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Income available (loss attributable) to common  stockholders              |       | $                                                                                            | 18,280     |   | $ | (23,135 | ) | $ | 41,415 |   | 179.0 | % |

 

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Thefollowing table presents the unaudited operating results for our totalportfolio for the nine months ended September 30, 2010 and 2009, includingthe amount and percentage change in the results between the two periods. Thetable presents the results of operations included in the consolidatedstatements of operations, and includes the 31 hotels (11,722 rooms) as of September 30,2010 and 29 hotels (10,966 rooms) as of September 30, 2009. In addition,operating results for operations held for non-sale disposition for both thenine months ended September 30, 2010 and 2009 includes the Mass Mutualeight hotels. Income (loss) from discontinued operations for the nine monthsended September 30, 2010 includes: the results of operations and the gainon extinguishment of debt for the Marriott Ontario Airport, which was sold by thereceiver pursuant to our 2009 secured debt restructuring program; the gain onextinguishment of debt for the W San Diego, which was deeded back pursuant toour 2009 secured debt restructuring program; and the gain on extinguishment ofdebt for the Renaissance Westchester, which we reacquired on June 14, 2010.Income (loss) from discontinued operations for the nine months ended September 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, Marriott Ontario Airport and Renaissance Westchester whichhave been deconsolidated from our operations.

 
| ** **                                                              | ** ** | **Nine Months Ended September 30,**                                      | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                              | ** ** | **2010**                                                                                     | ** ** | **2009** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                              | ** ** | **(unaudited, dollars in thousands, except statistical data)** | ** ** |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| REVENUES                                                                |       |                                                                                         |       |   |   |   |   |   |   |
| Room                                                                    |       | $                                                                                            | 307,025    |   | $ | 299,651 |   | $ | 7,374 |   | 2.5 | % |
| Food and beverage                                                       |       | 114,644                                                                                      |       | 115,921 |   | (1,277 | ) | (1.1 | )% |
| Other operating                                                         |       | 37,168                                                                                       |       | 38,268 |   | (1,100 | ) | (2.9 | )% |
| Revenues of operations held for non-sale  disposition                   |       | 60,638                                                                                       |       | 63,712 |   | (3,074 | ) | (4.8 | )% |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Total revenues                                                          |       | 519,475                                                                                      |       | 517,552 |   | 1,923 |   | 0.4 | % |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| OPERATING EXPENSES                                                      |       |                                                                                         |       |   |   |   |   |   |   |
| Hotel operating                                                         |       | 292,624                                                                                      |       | 287,362 |   | 5,262 |   | 1.8 | % |
| Property general and administrative                                     |       | 54,694                                                                                       |       | 53,128 |   | 1,566 |   | 2.9 | % |
| Corporate overhead                                                      |       | 21,311                                                                                       |       | 14,826 |   | 6,485 |   | 43.7 | % |
| Depreciation and amortization                                           |       | 70,693                                                                                       |       | 70,818 |   | (125 | ) | (0.2 | )% |
| Operating expenses of operations held for non-sale  disposition         |       | 53,737                                                                                       |       | 58,358 |   | (4,621 | ) | (7.9 | )% |
| Property and goodwill impairment losses                                 |       | 1,943                                                                                        |       | 30,852 |   | (28,909 | ) | (93.7 | )% |
| Goodwill impairment losses of operations held for  non-sale disposition |       | —                                                                                       |       | 3,007 |   | (3,007 | ) | (100.0 | )% |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Total operating expenses                                                |       | 495,002                                                                                      |       | 518,351 |   | (23,349 | ) | (4.5 | )% |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Operating income (loss)                                                 |       | 24,473                                                                                       |       | (799 | ) | 25,272 |   | 3,163.0 | % |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Equity in earnings (losses) of unconsolidated  joint ventures           |       | 475                                                                                          |       | (2,616 | ) | 3,091 |   | 118.2 | % |
| Interest income and other income (loss)                                 |       | (6                                                                                           | )          | 1,111 |   | (1,117 | ) | (100.5 | )% |
| Interest expense                                                        |       | (53,727                                                                                      | )          | (57,703 | ) | 3,976 |   | 6.9 | % |
| Interest expense of operations held for non-sale  disposition           |       | (15,272                                                                                      | )          | (8,667 | ) | (6,605 | ) | (76.2 | )% |
| Gain on extinguishment of debt                                          |       | —                                                                                       |       | 54,559 |   | (54,559 | ) | (100.0 | )% |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Loss from continuing operations                                         |       | (44,057                                                                                      | )          | (14,115 | ) | (29,942 | ) | (212.1 | )% |
| Income (loss) from discontinued operations                              |       | 46,927                                                                                       |       | (127,528 | ) | 174,455 |   | 136.8 | % |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Net income (loss)                                                       |       | 2,870                                                                                        |       | (141,643 | ) | 144,513 |   | 102.0 | % |
| Dividends paid on unvested restricted stock  compensation               |       | —                                                                                       |       | (447 | ) | 447 |   | 100.0 | % |
| Preferred stock dividends and accretion                                 |       | (15,515                                                                                      | )          | (15,562 | ) | 47 |   | 0.3 | % |
|                                                                    |       |                                                                                         |       |   |   |   |   |   |   |
| Loss attributable to common stockholders                                |       | $                                                                                            | (12,645    | ) | $ | (157,652 | ) | $ | 145,007 |   | 92.0 | % |

 

*Operating Statistics.*Included in the followingtables are comparisons of the key operating metrics for our hotel portfolio forthe three and nine months ended September 30, 2010 and 2009. Thecomparisons do not include the results of operations for the three hotels soldin 2009, the W San Diego deeded back to the lender in 2010, the MarriottOntario Airport sold by the receiver in 2010, or the Mass Mutual eight hotelsheld for non-sale disposition.

 

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| ** **                            | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Change** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------|------------|
| ** **                            | ** ** | **Occ%**                                                       | ** ** | **ADR**                                                        | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** |
| Total  Portfolio (31 Hotels) (1)      |       | 73.1                                                           | %          | $                                                              | 146.74     |       | $          | 107.27 |   | 74.9 | % | $ | 140.53 |   | $ | 105.26 |   | (180) bps |   | 4.4 | % | 1.9 | % |
| Comparable  Portfolio (30 hotels) (2) |       | 73.5                                                           | %          | $                                                              | 147.04     |       | $          | 108.07 |   | 74.5 | % | $ | 140.37 |   | $ | 104.58 |   | (100) bps |   | 4.8 | % | 3.3 | % |

 
| ** **                            | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** | **Change** | ** ** |
|---------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|------------|------------|
| ** **                            | ** ** | **Occ%**                                                      | ** ** | **ADR**                                                       | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** | **Occ%** | ** ** | **ADR** | ** ** | **RevPAR** | ** ** |
| Total  Portfolio (31 Hotels) (1)      |       | 71.4                                                          | %          | $                                                             | 146.80     |       | $          | 104.82 |   | 70.4 | % | $ | 147.61 |   | $ | 103.92 |   | 100 bps |   | (0.5 | )% | 0.9 | % |
| Comparable  Portfolio (30 hotels) (2) |       | 71.4                                                          | %          | $                                                             | 146.79     |       | $          | 104.81 |   | 70.1 | % | $ | 147.46 |   | $ | 103.37 |   | 130 bps |   | (0.5 | )% | 1.4 | % |

 

----

(1)         Includes the Company’s ownership results for the 31 hotels held forinvestment as of September 30, 2010.

 

(2)             Includes the Company’s total portfolio noted above, plus results forthe Renaissance Westchester for all periods presented. Excludes the Royal PalmMiami Beach which is being repositioned beginning in 2010.

 

*Non-GAAP Financial Measures*. The followingtable reconciles income available (loss attributable) to common stockholders toEBITDA and Adjusted EBITDA for our hotel portfolio for the three and ninemonths ended September 30, 2010 and 2009. We believe EBITDA and AdjustedEBITDA are useful to investors in evaluating our operating performance becausethese 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  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                             | ** ** | **(in thousands)**                                             | ** ** |
| Income available (loss attributable) to common  stockholders              |       | $                                                              | 18,280     |                                                           | $          | (23,135                                                             | )          | $                                                                   | (12,645    | ) | $ | (157,652 | ) |
| Dividends paid on unvested restricted stock  compensation                 |       | —                                                         |       | —                                                         |       | —                                                              |       | 447                                                                 |       |
| Series A and C preferred stock dividends                             |       | 5,141                                                          |       | 5,187                                                          |       | 15,515                                                              |       | 15,562                                                              |       |
| Undistributed income allocated to unvested  restricted stock compensation |       | 232                                                            |       | —                                                         |       | —                                                              |       | —                                                              |       |
| Operations held for investment:                                           |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Depreciation and amortization                                             |       | 23,871                                                         |       | 23,529                                                         |       | 70,693                                                              |       | 70,818                                                              |       |
| Amortization of lease intangibles                                         |       | 76                                                             |       | —                                                         |       | 226                                                                 |       | —                                                              |       |
| Interest expense                                                          |       | 16,116                                                         |       | 17,371                                                         |       | 49,239                                                              |       | 54,626                                                              |       |
| Interest expense — default rate                                      |       | —                                                         |       | —                                                         |       | 884                                                                 |       | —                                                              |       |
| Amortization of deferred financing fees                                   |       | 303                                                            |       | 582                                                            |       | 1,102                                                               |       | 1,217                                                               |       |
| Write-off of deferred financing fees                                      |       | —                                                         |       | —                                                         |       | 1,585                                                               |       | 284                                                                 |       |
| Loan penalties and fees                                                   |       | —                                                         |       | —                                                         |       | 174                                                                 |       | —                                                              |       |
| Non-cash interest related to discount on Senior  Notes                    |       | 252                                                            |       | 237                                                            |       | 743                                                                 |       | 1,576                                                               |       |
| Unconsolidated joint ventures:                                            |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Depreciation and amortization                                             |       | 13                                                             |       | 1,306                                                          |       | 40                                                                  |       | 3,860                                                               |       |
| Interest expense                                                          |       | —                                                         |       | 638                                                            |       | —                                                              |       | 1,986                                                               |       |
| Amortization of deferred financing fees                                   |       | —                                                         |       | 45                                                             |       | —                                                              |       | 137                                                                 |       |
|                                                                           |            |                                                                |            |                                                                |            |                                                                     |            |                                                                     |            |  |  |  |  |

 

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| ** **                                              | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| Operations held for non-sale disposition:               |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Depreciation and amortization                           |       | 1,552                                                          |       | 2,749                                                          |       | 4,789                                                               |       | 8,183                                                               |       |
| Interest expense                                        |       | 2,424                                                          |       | 2,749                                                          |       | 7,606                                                               |       | 8,272                                                               |       |
| Interest expense — default rate                    |       | 2,038                                                          |       | —                                                         |       | 6,392                                                               |       | —                                                              |       |
| Amortization of deferred financing fees                 |       | 131                                                            |       | 131                                                            |       | 395                                                                 |       | 395                                                                 |       |
| Loan penalties and fees                                 |       | 282                                                            |       | —                                                         |       | 879                                                                 |       | —                                                              |       |
| Discontinued operations:                                |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Depreciation and amortization                           |       | —                                                         |       | 749                                                            |       | 124                                                                 |       | 6,502                                                               |       |
| Interest expense                                        |       | —                                                         |       | 1,742                                                          |       | 225                                                                 |       | 5,181                                                               |       |
| Amortization of deferred financing fees                 |       | —                                                         |       | 11                                                             |       | 2                                                                   |       | 32                                                                  |       |
| Loan penalties and fees                                 |       | —                                                         |       | 3,093                                                          |       | 48                                                                  |       | 3,093                                                               |       |
| EBITDA                                                  |       | 70,711                                                         |       | 36,984                                                         |       | 148,016                                                             |       | 24,519                                                              |       |
|                                                    |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Operations held for investment:                         |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Amortization of deferred stock compensation             |       | 757                                                            |       | 938                                                            |       | 2,405                                                               |       | 3,286                                                               |       |
| (Gain) loss on sale of assets                           |       | 383                                                            |       | —                                                         |       | 383                                                                 |       | (354                                                                | )          |
| (Gain) loss on extinguishment of debt                   |       | —                                                         |       | 20                                                             |       | —                                                              |       | (54,559                                                             | )          |
| Impairment loss                                         |       | —                                                         |       | 2,209                                                          |       | 1,943                                                               |       | 30,852                                                              |       |
| Closing costs — Royal Palm Miami Beach acquisition |       | 6,619                                                          |       | —                                                         |       | 6,774                                                               |       | —                                                              |       |
| Due diligence costs — abandoned project            |       | 938                                                            |       | —                                                         |       | 938                                                                 |       | —                                                              |       |
| Unconsolidated joint ventures:                          |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Amortization of deferred stock compensation             |       | 4                                                              |       | 12                                                             |       | 21                                                                  |       | 28                                                                  |       |
| Operations held for non-sale disposition:               |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Impairment loss                                         |       | —                                                         |       | —                                                         |       | —                                                              |       | 3,007                                                               |       |
| Discontinued operations:                                |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| (Gain) loss on sale of assets                           |       | —                                                         |       | (18                                                            | )          | —                                                              |       | 13,052                                                              |       |
| Gain on extinguishment of debt                          |       | (40,473                                                        | )          | —                                                         |       | (47,220                                                             | )          | —                                                              |       |
| Impairment loss                                         |       | —                                                         |       | —                                                         |       | —                                                              |       | 104,007                                                             |       |
|                                                    |       | (31,772                                                        | )          | 3,161                                                          |       | (34,756                                                             | )          | 99,319                                                              |       |
| Adjusted EBITDA                                         |       | $                                                              | 38,939     |                                                           | $          | 40,145                                                              |       | $                                                                   | 113,260    |   | $ | 123,838 |   |
|                                                         |            |                                                                |            |                                                                |            |                                                                     |            |                                                                     |            |  |  |  |  |

 

AdjustedEBITDA was $38.9 million and $40.1 million for the three months ended September 30,2010 and 2009, respectively, and $113.3 million and $123.8 million for the ninemonths ended September 30, 2010 and 2009, respectively. Adjusted EBITDAdecreased for the three months ended September 30, 2010 as compared to thesame period in 2009 as increased operating income at the 31 hotels and the MassMutual eight hotels was offset by the fact that Adjusted EBITDA for the thirdquarter of 2009 also includes operating income from hotels included indiscontinued operations, combined with increased costs incurred during thethird quarter of 2010 to transition our hotels to new management companies.Adjusted EBITDA decreased for the nine months ended September 30, 2010 ascompared to the same period in 2009 as decreased operating income at the 31hotels and the Mass Mutual eight hotels combined with decreased operatingincome from discontinued operations as well as increased costs incurred during2010 to transition our hotels to new management companies.

 

Thefollowing table reconciles income available (loss attributable) to commonstockholders to FFO and Adjusted FFO for our hotel portfolio for the three andnine months ended September 30, 2010 and 2009. We believe that thepresentation of FFO and Adjusted FFO provide useful information to investorsregarding our operating performance because they are measures of our operationswithout regard 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 hotel properties.We believe that these items are more representative of our asset base and ouracquisition and disposition activities than our ongoing operations. We also useFFO as one measure in determining our results after taking into account theimpact of our capital structure. We caution investors that amounts presented inaccordance with our definitions of FFO and Adjusted FFO may not be comparableto similar measures disclosed by other companies, because not all companiescalculate these non-GAAP measures in the same manner. FFO and Adjusted FFOshould not be considered as an alternative measure of our net income (loss),operating performance, cash flow or liquidity. FFO and Adjusted FFO may includefunds that may not be available for our discretionary use to fund interestexpense, capital expenditures or general corporate purposes. Although webelieve that FFO and Adjusted FFO can enhance an investor’s understanding ofour results of operations, these non-GAAP financial measures, when viewedindividually, are not necessarily a better indicator of any trend as comparedto GAAP measures such as net income (loss) or cash flow from operations. Inaddition, you should be aware that adverse economic and market conditions mayharm our cash flow.

 

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| ** **                                                                | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                        | ** ** | **(in thousands)**                                             | ** ** | **(in thousands)**                                             | ** ** |
| Income available (loss attributable) to common  stockholders              |       | $                                                              | 18,280     |                                                           | $          | (23,135                                                             | )          | $                                                                   | (12,645    | ) | $ | (157,652 | ) |
| Dividends paid on unvested restricted stock  compensation                 |       | —                                                         |       | —                                                         |       | —                                                              |       | 447                                                                 |       |
| Undistributed income allocated to unvested  restricted stock compensation |       | 232                                                            |       | —                                                         |       | —                                                              |       | —                                                              |       |
| Operations held for investment:                                           |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Real estate depreciation and amortization                                 |       | 23,734                                                         |       | 23,385                                                         |       | 70,287                                                              |       | 70,357                                                              |       |
| Amortization of lease intangibles                                         |       | 76                                                             |       | —                                                         |       | 226                                                                 |       | —                                                              |       |
| (Gain) loss on sale of assets                                             |       | 383                                                            |       | —                                                         |       | 383                                                                 |       | (354                                                                | )          |
| Unconsolidated joint ventures:                                            |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Real estate depreciation and amortization                                 |       | —                                                         |       | 1,288                                                          |       | —                                                              |       | 3,806                                                               |       |
| Operations held for non-sale disposition:                                 |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Real estate depreciation and amortization                                 |       | 1,552                                                          |       | 2,749                                                          |       | 4,789                                                               |       | 8,183                                                               |       |
| Discontinued operations:                                                  |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Real estate depreciation and amortization                                 |       | —                                                         |       | 749                                                            |       | 124                                                                 |       | 6,502                                                               |       |
| (Gain) loss on sale of assets                                             |       | —                                                         |       | (18                                                            | )          | —                                                              |       | 13,052                                                              |       |
| FFO                                                                       |       | 44,257                                                         |       | 5,018                                                          |       | 63,164                                                              |       | (55,659                                                             | )          |
| Operations held for investment:                                           |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Interest expense — default rate                                      |       | —                                                         |       | —                                                         |       | 884                                                                 |       | —                                                              |       |
| Write-off of deferred financing fees                                      |       | —                                                         |       | —                                                         |       | 1,585                                                               |       | 284                                                                 |       |
| Loan penalties and fees                                                   |       | —                                                         |       | —                                                         |       | 174                                                                 |       | —                                                              |       |
| (Gain) loss on extinguishment of debt                                     |       | —                                                         |       | 20                                                             |       | —                                                              |       | (54,559                                                             | )          |
| Impairment loss                                                           |       | —                                                         |       | 2,209                                                          |       | 1,943                                                               |       | 30,852                                                              |       |
| Closing costs — Royal Palm Miami Beach acquisition                   |       | 6,619                                                          |       | —                                                         |       | 6,774                                                               |       | —                                                              |       |
| Due diligence costs — abandoned project                              |       | 938                                                            |       | —                                                         |       | 938                                                                 |       | —                                                              |       |
| Operations held for non-sale disposition:                                 |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Interest expense — default rate                                      |       | 2,038                                                          |       | —                                                         |       | 6,392                                                               |       | —                                                              |       |
| Loan penalties and fees                                                   |       | 282                                                            |       | —                                                         |       | 879                                                                 |       | —                                                              |       |
| Impairment loss                                                           |       | —                                                         |       | —                                                         |       | —                                                              |       | 3,007                                                               |       |
| Discontinued operations:                                                  |       |                                                           |       |                                                           |       |                                                                |       |                                                                |       |
| Loan penalties and fees                                                   |       | —                                                         |       | 3,093                                                          |       | 48                                                                  |       | 3,093                                                               |       |
| Gain on extinguishment of debt                                            |       | (40,473                                                        | )          | —                                                         |       | (47,220                                                             | )          | —                                                              |       |
| Impairment loss                                                           |       | —                                                         |       | —                                                         |       | —                                                              |       | 104,007                                                             |       |
|                                                                      |       | (30,596                                                        | )          | 5,322                                                          |       | (27,603                                                             | )          | 86,684                                                              |       |
| Adjusted FFO                                                              |       | $                                                              | 13,661     |                                                           | $          | 10,340                                                              |       | $                                                                   | 35,561     |   | $ | 31,025 |   |

 

AdjustedFFO was $13.7 million and $10.3 million for the three months ended September 30,2010 and 2009, respectively, and $35.6 million and $31.0 million for the ninemonths ended September 30, 2010 and 2009, respectively. Adjusted FFOincreased for the three months ended September 30, 2010 as compared to thesame period in 2009 primarily due to the reasons noted above in the discussionregarding Adjusted EBITDA combined with decreased interest expense. AdjustedFFO increased for the nine months ended September 30, 2010 as compared tothe same period in 2009 primarily due to the reasons noted above in thediscussion regarding Adjusted EBITDA combined with lower interest expense.

 

*Room revenue*. Room revenueincreased $6.6 million, or 6.5%, for the three months ended September 30, 2010 as compared to the threemonths ended September 30, 2009. The results of operations for theRenaissance Westchester are included in continuing operations from the date wereacquired the hotel (June 14, 2010) forward. The 2009 results ofoperations for the Renaissance Westchester are included in discontinuedoperations as possession and control of the hotel was held by a court-appointedreceiver. In addition, we acquired the Royal Palm Miami Beach hotel in August 2010.Room revenue generated by the Renaissance Westchester and included incontinuing operations as well as room revenue generated by the Royal Palm MiamiBeach (the “new hotels”) for the third quarter of 2010 was $3.3 million. Room revenuegenerated by the 29 hotels held for investment during all periods presented(our “existing portfolio”) increased $3.3 million in the third quarter of 2010as compared to the same period in 2009 due to an increase in ADR of $4.8million partially offset by a decrease in occupancy of $1.5 million.

 

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Room revenueincreased $7.4 million, or 2.5%, for the nine months ended September 30,2010 as compared to the nine months ended September 30, 2009. Room revenuegenerated by the new hotels for the first nine months of 2010 was $3.4 million.Room revenue generated by our existing portfolio increased $4.0 million inthe first nine months of 2010 as compared to the same period in 2009 due to anincrease in occupancy of $5.1 million partially offset by a decrease in ADR of$1.1 million.

 

*Food and beverage revenue.* Food and beveragerevenue increased $1.2 million, or 3.5%, for the three months ended September 30,2010 as compared to the three months ended September 30, 2009. Food andbeverage revenue generated by the new hotels for the third quarter of 2010 was$1.3 million. Food and beverage revenue generated by our existing portfoliodecreased $0.1 million in the third quarter 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, combined with decreased outlet revenue as several of our hotels arein the process of remodeling and re-concepting their restaurants. Thesedecreases were partially offset by increased banquet revenue at several of ourhotels.

 

Foodand beverage revenue decreased $1.3 million, or 1.1%, for the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009. Food and beverage revenue generated by the new hotels for the first ninemonths of 2010 was $1.5 million. Food and beverage revenue generated by ourexisting portfolio decreased $2.8 million for the first nine months of 2010 ascompared to the same period in 2009. This decrease is primarily due to lowerrevenues generated in 2010 by our Washington D.C. area hotels, which benefitedfrom the 2009 presidential inauguration. Food and beverage revenue alsodecreased in the first nine months of 2010 as compared to the same period in2009 due to a reduction in business at our Houston Texas hotels with onecustomer who is operating under a contract with the United States government.Additionally, many of our hotels that began to close their restaurants duringthe second quarter and second half of 2009 in order to save costs continued tokeep their restaurants closed during the first nine months of 2010 either tosave costs or due to remodeling and re-concepting projects.

 

*Other operating revenue*. Otheroperating revenue decreased $9,000, or 0.1%, for the three months ended September 30,2010 as compared to the three months ended September 30, 2009. Otheroperating revenue generated by the new hotels for the third quarter of 2010 was$0.2 million. Other operating revenue generated by our existing portfoliodecreased $0.3 million in the third quarter as compared to the same period in2009, primarily due to decreased cancellation, attrition, telephone and guestmovie revenue in our existing portfolio slightly offset by increased revenue atour two commercial laundry facilities.

 

Otheroperating revenue decreased $1.1 million, or 2.9%, for the nine months ended September 30,2010 as compared to the nine months ended September 30, 2009. Otheroperating revenue generated by the new hotels for the first nine months of 2010was $0.2 million. Other operating revenue generated by our existing portfoliodecreased $1.3 million in the first nine months of 2010 as compared to the sameperiod in 2009, primarily due to the same reasons described above in thediscussion regarding the third quarter.

 

*Revenues of operations held for non-sale disposition.*Revenues of operations held for non-sale disposition associated withthe Mass Mutual eight hotels decreased $0.1 million, or 0.7%, for the threemonths ended September 30, 2010 as compared to the same period in 2009.This decrease was primarily the result of decreased food and beverage revenueof $0.2 million as occupancy decreased 140 basis points, partially offset byincreased room revenue of $0.1 million as the occupancy decrease was partiallyoffset by a 2.8% increase in ADR.

 

Revenuesof operations held for non-sale disposition associated with the Mass Mutualeight hotels decreased $3.1 million, or 4.8%, for the nine months ended September 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 2.7% decreasein ADR, causing room revenue to decrease $2.2 million. In addition, food andbeverage revenue decreased $0.6 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 $5.4million, or 5.6%, during the three months ended September 30, 2010 ascompared to the three months ended September 30, 2009. Hotel operatingexpenses generated by the new hotels for the third quarter of 2010 totaled $3.9million. Hotel operating expenses for our existing portfolio increased $1.5million during the third quarter of 2010 as compared to the same period in2009. This increase in hotel operating expenses is primarily related to theincrease in related room revenue. In addition, hotel operating expensesincreased during the third quarter of 2010 as compared to the same period in2009 due to costs incurred of $0.2 million during the third quarter of 2010related to our management company transitions, and to increases in thefollowing expenses: advertising and promotion as the hotels began to increasetheir spending in response to the recovering economy; franchise fees andassessments due to the increased revenue; and ground lease expense due toincreased costs at several of our hotels. These increases were partially offsetby decreases in property taxes as several of our hotels were assessed withlower taxes in 2010, combined with decreases in departmental payroll due tostaff reductions and cost cutting initiatives implemented throughout 2009.

 

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Hoteloperating expenses increased $5.3 million, or 1.8%, during the nine monthsended September 30, 2010 as compared to the nine months ended September 30,2009. Hotel operating expenses generated by the new hotels for the first ninemonths of 2010 totaled $4.1 million. Hotel operating expenses for our existingportfolio increased $1.2 million during the first nine months of 2010 ascompared to the same period in 2009. This increase in hotel operating expensesis primarily related to the increase in related room revenue. In addition,hotel operating expenses increased in the first nine months of 2010 as comparedto the same period in 2009 due to costs incurred of $0.3 million during thefirst nine months of 2010 related to our management company transitions, and toincreases in the following expenses: franchise fees and assessments due to theincreased revenue; ground lease expense due to increased costs at several ofour hotels; and property taxes due to prior year refunds received by several ofour hotels which were recorded during the first nine months of 2009, and by$0.2 million in prior year tax reimbursements collected from the buyer upon oursecond quarter 2009 sale of land adjacent to one of our hotels. These increaseswere partially offset by decreases in the following expenses: food and beverageexpense and other operating expense due to the decline in related revenue;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.

 

*Property general and administrative expense.*Property**general andadministrative expense increased $1.4 million, or 8.4%, during the three monthsended September 30, 2010 as compared to the three months ended September 30,2009. Property general and administrative expense generated by the new hotelsfor the third quarter of 2010 totaled $0.7 million. Hotel operating expensesfor our existing portfolio increased $0.7 million during the third quarter of2010 as compared to the same period in 2009. Management fees and credit andcollection expenses increased in our existing portfolio due to the increase inrevenue. In addition, property general and administrative expense in ourexisting portfolio increased due to increased payroll, employee recruitment andrelocation. These increases were partially offset by decreased legal and salestax audit expenses.

 

Property**general andadministrative expense increased $1.6 million, or 2.9%, during the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009. Property general and administrative expenses generated by the new hotelsfor the first nine months of 2010 totaled $0.8 million. Property general andadministrative expenses for our existing portfolio increased $0.8 millionduring the first nine months of 2010 as compared to the same period in 2009,primarily due to increased expenses in our existing portfolio due to the samereasons described above in the discussion regarding the third quarter.Management fees, however, decreased in our existing portfolio for the ninemonths ended September 30, 2010 as compared to the same period in 2009 dueto the 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 $7.3 million, or 167.6%, during the three monthsended September 30, 2010 as compared to the three months ended September 30,2009, primarily due to increased due diligence costs. During the third quarterof 2010 we incurred due diligence costs of $6.6 million related to ouracquisition of the Royal Palm Miami Beach, which primarily related to costsspecific with the foreclosure auction process as well as the acquisition of aportion of the hotel’s outstanding debt at a discount. Previously, these duediligence costs would have been capitalized as part of the acquisition;however, under the Financial Accounting Standards Board (“FASB”) AccountingStandards Codification (“ASC”) revised business combinations guidance, thesecosts are expensed. We incurred an additional $1.0 million in due diligencecosts during the third quarter of 2010 related to acquisition projects thatwere abandoned, as compared to $12,000 in due diligence costs incurred in thethird quarter of 2009. This increase was slightly offset by decreased sales taxexpense, office rent, legal expense and relocation expense.

 

Corporateoverhead expense increased $6.5 million, or 43.7%, during the nine months endedSeptember 30, 2010 as compared to the nine months ended September 30,2009, primarily due to a $7.8 million increase in due diligence costs. Duringthe first nine months of 2010 we incurred due diligence costs of $6.8 million relatedto our acquisition of the Royal Palm Miami Beach, which primarily related tocosts specific with the foreclosure auction process as well as the acquisitionof a portion of the hotel’s outstanding debt at a discount. Previously, thesedue diligence costs would have been capitalized as part of the acquisition;however, under the FASB ASC revised business combinations guidance, these costsare expensed. We incurred an additional $1.2 million in due diligence costsduring the first nine months of 2010 related to acquisition projects that wereabandoned, as compared to $0.2 million in due diligence costs incurred in thesame period in 2009. In addition, corporate overhead expense increased in thefirst nine months of 2010 as compared to the same period in 2009 due toincreased legal expenses and by $0.4 million in retention bonuses accruedduring the second quarter of 2010 to incentivize certain hotel-level employeesto stay through the management company transitions. These increases werepartially offset by decreases in total payroll related costs and deferred stockcompensation expense as a result of our corporate reorganization in the secondquarter of 2009, combined with decreases in sales tax expense and contract andprofessional fees.

 

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*Depreciation and amortization expense.*Depreciationand amortization expense increased $0.3 million, or 1.5%, during the threemonths ended September 30, 2010 as compared to the three months ended September 30,2009. Depreciation and amortization expense generated by the new hotels for thethird quarter of 2010 totaled $0.8 million. Depreciation and amortization inour existing portfolio decreased $0.5 million in the third quarter of 2010 ascompared to the same period in 2009 due to reduced renovations and purchases offurniture, fixtures and equipment for our hotel properties.

 

Depreciationand amortization expense decreased $0.1 million, or 0.2%, during the ninemonths ended September 30, 2010 as compared to the nine months ended September 30,2009. Depreciation and amortization expense generated by the new hotels for thefirst nine months of 2010 totaled $0.9 million. Depreciation and amortizationin our existing portfolio decreased $1.0 million during the first nine monthsof 2010 as compared to the same period in 2009 primarily due to the fact thatwe reduced the depreciable assets of our existing portfolio by $25.4 million duringthe second quarter of 2009, as well as due to reduced renovations and purchasesof furniture, fixtures and equipment for our hotel properties.

 

*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 $17.8 million for the threemonths ended September 30, 2010 as compared to $19.1 million for the threemonths ended September 30, 2009. During the three months ended September 30,2010, we recognized $16.2 million in operating expenses and $1.6 million indepreciation and amortization. During the three months ended September 30,2009, we recognized $16.4 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 food and beverage expense due to the reductionin related revenue. The decrease in depreciation in the third quarter of 2010as compared to the same period in 2009 is primarily due to $88.2 million inimpairment charges recorded in 2009, which reduced the depreciable assets foroperations held for non-sale disposition.

 

Operatingexpenses of operations held for non-sale disposition associated with the MassMutual eight hotels totaled $53.7 million for the nine months ended September 30,2010 as compared to $58.4 million for the nine months ended September 30,2009. During the nine months ended September 30, 2010, we recognized $48.9million in operating expenses and $4.8 million in depreciation andamortization. During the nine months ended September 30, 2009, werecognized $50.2 million in operating expenses and $8.2 million in depreciationand amortization. The decrease in operating expenses of operations held fornon-sale disposition associated with the Mass Mutual eight hotels is primarilyrelated to decreased property taxes due to supplemental prior year taxesassessed on two of the hotels in 2009, as well as to decreased food andbeverage expense related to the reduction in related revenue. The decrease indepreciation and amortization expense of operations held for non-saledisposition associated with the Mass Mutual eight hotels is primarily due to$88.2 million in impairment charges recorded in 2009, which reduced thedepreciable assets for operations held for non-sale disposition.

 

*Property and goodwill impairment losses.*Property and goodwill impairment losses totaled zero for the threemonths ended September 30, 2010 compared to $2.2 million for the threemonths ended September 30, 2009. During the third quarter of 2009, wewrote off $2.2 million in goodwill associated with the Marriott Rochester inconjunction with our impairment evaluation.

 

Property and goodwill losses totaled $1.9 millionfor the nine months ended September 30, 2010 compared to $30.9 million forthe nine months ended September 30, 2009. During the first nine months of2010, we recognized a property impairment loss of $1.9 million on an officebuilding and land adjacent to one of our hotels in anticipation of its possiblesale. During the first nine months of 2009, we recognized a $25.4 millionproperty impairment loss on the Marriott Del Mar to reduce the carrying valueof the hotel on our balance sheet to its fair value. In addition, we recognizeda $0.1 million property impairment loss on a parcel of land adjacent toone of our hotels which we sold in September 2009. During the first nine 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 impairment evaluations performed during thefirst nine months of 2009, we wrote off $1.3 million and $2.6 million ofgoodwill 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 both the three months ended September 30,2010 and 2009.  For the nine months endedSeptember 30, 2010 and 2009, goodwill impairment losses of operations heldfor non-sale disposition associated with the Mass Mutual eight hotels totaledzero and $3.0 million, respectively. In conjunction with our impairmentevaluations performed during the first nine 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.

 

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*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 September 30,2010, and a loss of $0.5 million for the three months ended September 30,2009. In the third 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 third quarter of 2010, we did notrecognize any portion of these earnings due to the fact that we reduced our interestin this partnership to zero at December 31, 2009 as a result of the hotel’sfourth quarter 2009 impairment charge. In the third quarter of 2009, werecognized a loss of $0.6 million on our interest in the Doubletree GuestSuites Times Square joint venture, and income of $0.1 million on ourBuyEfficient joint venture.

 

Equityin earnings (losses) of unconsolidated joint ventures totaled earnings of $0.5million for nine months ended September 30, 2010, and a loss of $2.6million for the nine months ended September 30, 2009. In the first ninemonths of 2010, we recognized income of $0.5 million on our BuyEfficient jointventure, and zero on our Doubletree Guest Suites Times Square joint venture.Though the Doubletree Guest Suites Times Square joint venture recognizedearnings during the first nine months of 2010, we did not recognize any portionof these earnings due to the fact that we reduced our interest in thispartnership to zero at December 31, 2009 as a result of the hotel’s fourthquarter 2009 impairment charge. In the first nine months of 2009, we recognizeda loss of $2.8 million on our interest in the Doubletree Guest Suites TimesSquare joint venture, and income of $0.2 million on our BuyEfficient jointventure.

 

*Interest income and other income (loss).*Interest incomeand other income (loss) totaled a loss of $0.3 million for the three monthsended September 30, 2010 and income of $0.2 million for the same period in2009. In the third quarter of 2010, we recognized a loss of $0.4 million on salesand dispositions of surplus furniture, fixtures and equipment (“FF&E”)located in two of our hotels and in our corporate office, as well as $0.1million in interest income. In the third quarter of 2009, we recognized $0.2million in interest income.

 

Interestincome and other income (loss) totaled a loss of $6,000 for the nine monthsended September 30, 2010 and income of $1.1 million for the same period in2009. In the first nine months of 2010, we recognized a loss of $0.3 million onsales and dispositions of surplus FF&E located in several of our hotels andin our corporate office, $0.2 million in interest income and $0.1 million inother miscellaneous income. In the first nine months of 2009, we recognized$0.7 million in interest income, and $0.4 million on the sale of surplusFF&E located in two of our hotels.

 

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

 
| ** **                              | ** ** | **Three Months Ended  September 30, 2010** | ** ** | **Three Months Ended  September 30, 2009** | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Interest expense                        |       | $                                                              | 16,116     |                                                           | $          | 17,371                                                        |       | $                                                             | 49,239     |   | $ | 54,626 |   |
| Interest expense — default rate    |       | —                                                         |       | —                                                         |       | 884                                                           |       | —                                                        |       |
| Accretion of Senior Notes               |       | 252                                                            |       | 237                                                            |       | 743                                                           |       | 1,576                                                         |       |
| Amortization of deferred financing fees |       | 303                                                            |       | 582                                                            |       | 1,102                                                         |       | 1,217                                                         |       |
| Write-off of deferred financing fees    |       | —                                                         |       | —                                                         |       | 1,585                                                         |       | 284                                                           |       |
| Loan penalties and fees                 |       | —                                                         |       | —                                                         |       | 174                                                           |       | —                                                        |       |
|                                    |       | $                                                              | 16,671     |                                                           | $          | 18,190                                                        |       | $                                                             | 53,727     |   | $ | 57,703 |   |

 

Interestexpense decreased $1.5 million, or 8.4%, during the three months ended September 30,2010 as compared to the same period during 2009. Interest expense decreased$1.3 million during the third quarter of 2010 as compared to the same period in2009 as a result of decreases in our loan balances combined with our repurchaseof $64.0 million in aggregate principal amount of the Senior Notes in the firstquarter of 2009 and an additional $123.5 million in the second quarter of 2009,as well as the repayment of $83.0 million in April 2010 to release threehotels from the Mass Mutual loan. In addition, interest expense decreased inthe third quarter of 2010 as compared to the third quarter of 2009 due to a$0.3 million decrease in amortization of deferred financing fees related to therepayment of the $83.0 million noted above, as well as the termination of our creditfacility in February 2010.

 

Interestexpense decreased $4.0 million, or 6.9%, during the nine months ended September 30,2010 as compared to the same period during 2009. Interest expense decreased$5.4 million during the first nine months of 2010 as compared to the sameperiod in 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 second quarterof 2009, as well as the repayment of $83.0 million in April 2010 torelease three hotels from the Mass Mutual loan. In addition, interest expensedue to the accretion of the Senior Notes decreased $0.8 million during thefirst nine months of 2010 as compared to the same period in 2009 due to therepurchases of the Senior Notes in 2009. Interest expense also decreased $0.1million during the first nine months of 2010 as compared to the same period in2009 due to a decrease in amortization of

 

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deferredfinancing fees related to the repayment of the $83.0 million noted above, aswell as the termination of our credit facility, partially offset by an increasein fees associated with our repurchase of the Senior Notes and the amendment ofour loan on the Renaissance Baltimore during the third quarter of 2009. Thesedecreases were partially offset by an increase of $1.3 million in interestexpense due to the write-off of deferred financing fees. During the first ninemonths of 2010, we wrote-off $1.5 million in deferred financing fees related tothe termination of our credit facility in February 2010, and $0.1 millionin deferred financing fees related to the release of the three hotels from theMass Mutual loan in April 2010. During the first nine months of 2009, wewrote off $0.3 million in deferred financing fees associated with the amendmentof our credit facility. Interest expense also increased during the first ninemonths of 2010 as compared to the same period in 2009 due to our electivedefaults pursuant to our 2009 secured debt restructuring program as one of thelenders increased our interest rate by 5.0% causing an additional $0.9 millionin default interest and $0.2 million in penalties and fees.

 

Ourweighted average interest rate per annum was approximately 5.6% at both September 30,2010 and 2009. At September 30, 2010, all of our outstanding notes payablehad fixed 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** | ** ** | **Three  Months Ended**      | ** ** | **Nine  Months Ended**      | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
|                                    |       | **September 30, 2010** |       | ** September 30, 2009** |       | **September 30, 2010** |       | **September 30, 2009** |       |
| Interest expense                        |       | $                                | 2,424      |                              | $          | 2,749                            |       | $                           | 7,606      |   | $ | 8,272 |   |
| Interest expense — default rate    |       | 2,038                            |       | —                            |       | 6,392                            |       | —                      |       |
| Amortization of deferred financing fees |       | 131                              |       | 131                               |       | 395                              |       | 395                         |       |
| Loan penalties and fees                 |       | 282                              |       | —                            |       | 879                              |       | —                      |       |
|                                    |       | $                                | 4,875      |                              | $          | 2,880                            |       | $                           | 15,272     |   | $ | 8,667 |   |

 

Interestexpense of operations held for non-sale disposition increased $2.0 million, or69.3%, during the three months ended September 30, 2010 as compared to thesame period in 2009 primarily due to our elective default of the non-recourseloan secured by the Mass Mutual eight hotels pursuant to our 2009 secured debtrestructuring program. Interest expense of operations held for non-saledisposition includes an additional $2.0 million in the third quarter of 2010 ascompared to the same period in 2009 as the lender increased our interest rateby 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 third quarter of 2010as compared to the same period in 2009 due to $0.3 million in loan penaltiesand fees recorded in 2010 related to our elective default of the non-recourseloan secured by the Mass Mutual eight hotels. While we are required to recordsuch loan penalties and fees, as this loan is non-recourse to us, we do notintend to actually fund such fees, and consequently, we expect to record a gainon the forgiveness of these expenses upon completion of the deed backs of thesehotels. These increases were slightly offset by a decrease in interest expenseof $0.3 million in the third quarter of 2010 as compared to the same period in2009 due to decreased loan balances.

 

Interestexpense of operations held for non-sale disposition increased $6.6 million, or76.2%, during the nine months ended September 30, 2010 as compared to thesame period in 2009 primarily due to our elective default of the non-recourseloan secured by the Mass Mutual eight hotels pursuant to our 2009 secured debtrestructuring program. Interest expense of operations held for non-saledisposition includes an additional $6.4 million in the first nine 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 nine months of2010 as compared to the same period in 2009 due to $0.9 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 the deedbacks of these hotels. These increases were slightly offset by a decrease ininterest expense of $0.7 million in the first nine months of 2010 as comparedto the same period in 2009 due to decreased loan balances.

 

*Gain (loss) on extinguishment of debt.* Gain (loss) onextinguishment of debt totaled zero for the three months ended September 30,2010, and a loss of $20,000 for the three months ended September 30, 2009.During the third quarter of 2009, we recognized additional expenses of $20,000related to our second quarter 2009 repurchase and cancellation of $123.5million in aggregate principal amount of the Senior Notes.

 

Gain(loss) on extinguishment of debt totaled zero for the nine months ended September 30,2010, and a gain of $54.6 million for the nine months ended September 30,2009. During the first nine months of 2009, we recognized a gain of $54.6million due to the repurchase and cancellation of $187.5 million in aggregateprincipal amount of the Senior Notes.

 

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*Income (loss) from discontinued operations.* Income (loss)from discontinued operations is as follows:

 
| ** **                                 | ** ** | **Three Months Ended********September 30, 2010** | ** ** | **Three Months Ended********September 30, 2009** | ** ** | **Nine Months Ended********September 30, 2010** | ** ** | **Nine Months Ended********September 30, 2009** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| Operating revenues                         |       | $                                                                    | —     |                                                                 | $          | 11,259                                                              |       | $                                                                   | 1,842      |   | $ | 44,889 |   |
| Operating expenses                         |       | —                                                               |       | (10,340                                                              | )          | (1,736                                                              | )          | (40,550                                                             | )          |
| Interest expense                           |       | —                                                               |       | (4,846                                                               | )          | (275                                                                | )          | (8,306                                                              | )          |
| Depreciation and amortization expense      |       | —                                                               |       | (749                                                                 | )          | (124                                                                | )          | (6,502                                                              | )          |
| Property and goodwill impairment losses    |       | —                                                               |       | —                                                               |       | —                                                              |       | (104,007                                                            | )          |
| Gain on extinguishment of debt             |       | 40,473                                                               |       | —                                                               |       | 47,220                                                              |       | —                                                              |       |
| Gain (loss) on sale of hotels              |       | —                                                               |       | 18                                                                   |       | —                                                              |       | (13,052                                                             | )          |
| Income (loss) from discontinued operations |       | $                                                                    | 40,473     |                                                                 | $          | (4,658                                                              | )          | $                                                                   | 46,927     |   | $ | (127,528 | ) |

 

Asdescribed under “—Investing Activities—Dispositions,” no hotels were soldduring the first nine months of 2010 and three hotels were sold during 2009. Inaddition, pursuant to our 2009 secured debt restructuring program we deededback the W San Diego to the lender and the Marriott Ontario Airport was sold bythe receiver during the third quarter of 2010. Also pursuant to our 2009secured debt restructuring program, we deconsolidated the RenaissanceWestchester during 2009 due to the transfer of possession and control of thehotel to a court-appointed receiver. On June 14, 2010, we reacquired theRenaissance Westchester for $26.0 million, including related costs. Operatingresults, therefore, for the Renaissance Westchester for all of 2009 as well asthe gain on extinguishment of debt recorded in June 2010, are included indiscontinued operations, whereas operating results from June 14, 2010forward are included in continuing operations. Consistent with the Property,Plant and Equipment Topic of the FASB ASC, we have reclassified the results ofoperations for all of these hotels, along with any impairments recognized, thegains or losses on the hotel sales and the gains on extinguishment of debt onthe W San Diego, Marriott Ontario Airport and Renaissance Westchester, todiscontinued operations.

 

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

 

*Preferred stock dividends and accretion.*Preferred stockdividends and accretion totaled $5.1 million and $5.2 million for the threemonths ended September 30, 2010 and 2009, respectively, and $15.5 millionand $15.6 million for the nine months ended September 30, 2010 and 2009,respectively. Though the dividend rate for our Series A preferred stockand Series C preferred stock remained consistent at $0.50 and $0.393,respectively, per share for all periods presented, preferred stock dividendsand accretion decreased in 2010 due to the fact that the initial carrying valueof our Series C preferred stock was fully accreted to its redemption valueduring the third quarter of 2010.

 

**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 were consummated during the first half of 2010 indicatethat hotel trading values had not recovered commensurately with public REITvaluations. Consistent with our cycle-appropriate strategy, we shifted ourfocus at the end of 2009 towards the pursuit of selective hotel acquisitions.Our acquisitions program is aimed at generating attractive returns on ourinvestment dollars, and therefore we may target lodging assets outside of thetypical branded, urban, upper upscale profile represented by our existingportfolio in order to capitalize on opportunities which may arise.Additionally, the scope of our acquisitions program may include large hotelportfolios or hotel loans.

 

OnApril 30, 2010, we purchased two hotel loans with a combined principalamount of $32.5 for a total purchase price of $3.7 million. The loans include (i) a$30.0 million, 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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OnAugust 16, 2010, we used available cash on hand to acquire the Royal Palmhotel in Miami Beach, Florida at a foreclosure auction for a gross purchaseprice of $126.1 million excluding transaction costs. Prior to the auction, wepurchased a portion of the hotel’s outstanding debt at a discount to parresulting in an economic gross purchase price of approximately $117.6 million.On August 27, 2010, we obtained title to the hotel.

 

***Dispositions***. We did not sellany hotels during the nine months ended September 30, 2010. During thethird quarter of 2010, we completed our previously announced deed back of the WSan Diego and the Marriott Ontario Airport was sold by the receiver. Titles tothe W San Diego and Marriott Ontario Airport were transferred to the lender andthird party purchaser, respectively. Consistent with our cycle-appropriatestrategy, we were a net seller of hotels in 2009. In May 2009, we sold theMarriott Napa Valley for net proceeds of $34.8 million, and a net loss of $13.7million. In June 2009, we sold the Marriott Riverside for net proceeds of$18.7 million and a net gain of $2.9 million. In July 2009, we sold theHyatt Suites Atlanta Northwest for net proceeds of $7.8 million and a net gainof $18,000, after having recorded an impairment loss in June 2009 of $4.9million in order to reduce the carrying value of this hotel on our balancesheet 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,acquisitions of hotel properties, purchases of notes receivable and dividendson our common and preferred stock. We cannot be certain that traditionalsources of funds will be available in the future.

 

***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 provided by operating activities was $3.8 million for the nine monthsended September 30, 2010 as compared to $53.2 million for the nine monthsended September 30, 2009. This decrease was primarily due to an increasein our restricted cash, partially offset by an increase in accounts payable andother liabilities during the nine months ended September 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 nine months of 2010 compared to net cashprovided by investing activities during the first nine months of 2009 was asfollows (in thousands):

 
| ** **                                                           | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Proceeds from sale of hotel properties and other  assets             |       | $                                                             | 61         |                                                          | $          | 64,052 |   |
| Cash received from unconsolidated joint ventures                     |       | 600                                                           |       | 250                                                           |       |
| Restricted cash — replacement reserve                           |       | (1,335                                                        | )          | (2,376                                                        | )          |
| Acquisitions of notes receivable                                     |       | (3,700                                                        | )          | —                                                        |       |
| Acquisitions of hotel properties                                     |       | (117,604                                                      | )          | —                                                        |       |
| Renovations and additions to hotel properties and  other real estate |       | (31,443                                                       | )          | (33,487                                                       | )          |
| Net cash (used in) provided by investing  activities                 |       | $                                                             | (153,421   | )                                                             | $          | 28,439 |   |

 

Netcash used in investing activities was $153.4 million during the first ninemonths of 2010 compared to net cash provided of $28.4 million for the ninemonths ended September 30, 2009. During the nine months ended September 30,2010, we received proceeds of $0.1 million from the sale of surplus FF&E atseveral of our hotels and our corporate office and distributions of $0.6million from one of our unconsolidated joint ventures. In addition, weincreased the balance in our restricted cash replacement reserve accounts by$1.3 million, and we paid $117.6 million to acquire a hotel, $3.7 million forthe purchase of two notes receivable and $31.4 million for renovations to ourhotels. During the nine months ended September 30, 2009, we received $64.1million from the sale of hotel properties and other assets, which included$61.3 million from the sale of three hotels, a $2.0 million payment on a notereceivable from the buyer of a hotel we sold in December 2008, $0.4million from the sale of surplus FF&E located in two of our hotels, and$0.4 million from the sales of two vacant parcels of land. In addition, wereceived $0.3 million from one of our unconsolidated joint ventures, increasedthe balance in our restricted cash replacement reserve accounts by $2.4million, and paid cash of $33.5 million for renovations to our hotels.

 

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***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 $132.6 million forthe nine months ended September 30, 2010 compared to $55.9 million for thenine months ended September 30, 2009. Net cash used in financingactivities for the nine months ended September 30, 2010 consistedprimarily of $117.2 million of principal payments on our notes payable andrelated costs, including $83.0 million paid to release three hotels from theMass Mutual loan, $26.0 million paid to reacquire control of the RenaissanceWestchester and to extinguish the loan, and $8.2 million of principalamortization. In addition, net cash used in financing activities for the ninemonths ended September 30, 2010 includes $15.4 million of dividends paidto our stockholders. Net cash used in financing activities for the nine monthsended September 30, 2009 consisted primarily of $117.4 million torepurchase a portion of our Senior Notes including related costs, $71.2 millionof principal payments on our credit facility and notes payable, $22.8 millionof dividends paid to our stockholders, $4.8 million in costs associated withthe issuance of our common stock, and $3.2 million in deferred financing feespaid in connection with amendments to our Senior Notes indenture and our creditfacility. These cash outlays were partially offset by $103.5 million inproceeds received from the issuance of common stock and $60.0 million inproceeds received from our credit facility.

 

***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, ouraccess to capital markets and our unencumbered properties will provide us withsufficient liquidity to meet our current operating expenses and other expensesdirectly associated with our business (including payment of dividends on ourcapital stock, if declared) for the foreseeable future, and in any event for atleast 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 eliminated approximately$0.6 million in fees and associated costs per annum.****OnNovember 1, 2010, we entered into a new $150.0 million senior corporatecredit facility (the “new facility”). The interest rate for the new facilityranges from 325 to 425 basis points over LIBOR, depending on our overallleverage. The initial term of the new facility is three years with an option toextend for an additional one year. Subject to approval by the lender group, thenew facility may be increased to up to $250.0 million.  We expect to have full funds availabilityupon the delivery of certain post closing items during the fourth quarter,2010. The new facility contains customary events of default relating topayments and breaches of representations and warranties.

 

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, and, on November 1, 2010, we finalized the remaining deed back ofcertain hotels associated with loans which entered the program in 2009. Loanssubject to our secured debt restructuring program generally met two criteria:(1) the hotel, or hotels as a group, was not generating sufficient cashflow to cover debt service, and under the current terms of the mortgage, thehotel was not expected to generate sufficient cash flow for the foreseeablefuture, 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 ofthe W San Diego, and title to the hotel was transferred to the lender. Werecorded a $35.4 million gain on extinguishment of debt, which is included indiscontinued operations in the third quarter of 2010, and removed the netassets and liabilities from our 2010 balance sheet.

 

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*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 mortgage, to discontinued operations on our balance sheets.Additionally, we reclassified the Marriott Ontario Airport’s results ofoperations and cash flows to discontinued operations on our statements ofoperations and cash flows. On August 12, 2010, the Marriott OntarioAirport was sold by the receiver, and title to the hotel was transferred to thehotel’s new owner. We recorded a $5.1 million gain on extinguishment of debt,and removed the net assets and liabilities from our 2010 balance sheet.

 

*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, on November 1, 2010, we completedthe deed back of the Mass Mutual eight hotels and titles to the hotels weretransferred to the lender. In connection with such transfer, Mass Mutualdelivered to the Company a covenant and agreement pursuant to which Mass Mutualagreed to not sue the Company for any matter or claim which Mass Mutual mayever have relating to the hotels, the loan or the loan documents.  There are certain customary carveouts fromthis covenant not to sue, including fraud, a breach of the deed in lieuagreement itself and the environmental indemnity agreement delivered at thetime the loan was originated. Additionally, we made certain customary representations and warranties,all of which survive the closing for a period of six (6) months; themaximum aggregate liability for the Company in connection with a breach of anyrepresentations or warranties is $500,000. Additionally, seven of the Mass Mutual hotels are subject to franchiseagreements which contain corporate guaranties. If the franchise agreements on the seven hotels were to be terminated,we may be liable for up to $21.5 million in termination fees.  We will record a gain on extinguishment ofdebt to discontinued operations in the fourth quarter of 2010. A portion ofthis gain will be deferred until all significant contingencies are resolved,and the net remaining assets and liabilities will be removed from our balancesheet.  Pending the completion of thedeed back, we reclassified the assets, liabilities and results of operations ofthe Mass Mutual eight to “operations held for non-sale disposition” on ourbalance sheets, statements of operations and statements of cash flows.

 

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 September 30,2010.

 

As of September 30,2010, we had $1.1 billion of debt ($1.3 billion including the mortgage for theMass Mutual eight), $143.5 million of cash and cash equivalents, includingrestricted cash, and total assets of $2.4 billion. We believe that bycontrolling debt levels, staggering maturity dates and maintaining a highlyflexible capital structure, we can maintain lower capital costs than morehighly leveraged companies, or companies with limited flexibility due torestrictive corporate-level financial covenants.

 

Asof September 30, 2010, all of our outstanding debt had fixed interestrates. The majority of our mortgage debt is in the form of single asset loans.We believe this structure is appropriate for the operating characteristics ofour business and provides flexibility for assets to be sold subject to theexisting debt, and as evidenced by our 2009 secured debt restructuring program,in instances where asset values have declined to levels below the principalamount of the associated mortgage, non-recourse single asset mortgages maylimit the degradation in value experienced by our stockholders by shifting aportion of asset risk to our secured lenders.

 

Theweighted average term to maturity of our debt is 6.4 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, on November 1, 2010, werefinanced the $81.0 million mortgage due in December 2010, rather thanuse excess cash to repay the loan in full. The new $92.5 million non-recoursemortgage matures in 2020 and bears a fixed interest rate of 4.97%, withscheduled monthly principal and interest amounts based on a thirty-yearamortization. The proceeds from the new mortgage were used in part to repay thematuring $81.0 million mortgage, which bore an interest rate of 5.915%. Weretained the excess proceeds for general corporate purposes. The new mortgagecontains customary events of default relating to payments and breaches ofrepresentations and warranties.

 

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***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 November 4,2010, none of the maturity dates have been accelerated for any of ourindebtedness.

 

Additionally,we believe we may be successful in obtaining mortgages on, or pledge to asecured facility, one or all of our 12 unencumbered hotels at September 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, Royal Palm MiamiBeach and Sheraton Cerritos. These 12 hotels had an aggregate of 3,760 rooms asof September 30, 2010, and generated $135.6 million in revenue during thefirst nine months of 2010.

 

***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, includingour acquisition of the Royal Palm Miami Beach in August 2010. 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 tocapitalize on opportunities which may arise. Additionally, the scope of ouracquisitions program may include large hotel portfolios or hotel loans.

 

**Contractual Obligations**

 

Thefollowing table summarizes our payment obligations and commitments as of September 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                                                                          |       | $                          | 1,137,017  |   | $ | 94,810 |   | $ | 66,275 |   | $ | 236,889 |   | $ | 739,043 |   |
| Notes payable on operations held for non-sale  disposition (1)                         |       | 162,972                    |       | 162,972 |   | — |   | — |   | — |   |
| Interest obligations  on notes payable                                                 |       | 393,363                    |       | 59,493 |   | 112,738 |   | 103,657 |   | 117,475 |   |
| Interest obligations on notes payable on  operations held for non-sale disposition (2) |       | 19,074                     |       | 19,074 |   | — |   | — |   | — |   |
| Operating lease obligations                                                            |       | 309,990                    |       | 4,413 |   | 8,945 |   | 9,113 |   | 287,519 |   |
| Operating lease obligations on operations held for  non-sale disposition (3)           |       | 5,181                      |       | 221 |   | 442 |   | 442 |   | 4,076 |   |
| Construction commitments                                                               |       | 28,436                     |       | 28,436 |   | — |   | — |   | — |   |
| Employment obligations                                                                 |       | 4,056                      |       | 1,611 |   | 2,445 |   | — |   | — |   |
| Total                                                                                  |       | $                          | 2,060,089  |   | $ | 371,030 |   | $ | 190,845 |   | $ | 350,101 |   | $ | 1,148,113 |   |

 

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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 September 30, 2010.

(2)                   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 September 30, 2010.

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

 

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**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 $31.4 million in ourhotels during the first nine months of 2010. Our renovation budget for 2010includes $28.4 million of contractual construction commitments. If we acquire,renovate or develop additional hotels in the future, our capital expenditureswill increase.

 

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 FF&E reserveaccount for future planned and emergency-related capital expenditures at thesehotels. The amount funded into each of these reserve accounts is determinedpursuant to the management, franchise and loan agreements for each of therespective hotels, ranging between 4.0% and 5.0% of the respective hotel’stotal annual revenue. As of September 30, 2010, $24.4 million was held inFF&E reserve accounts for future capital expenditures at the 31 hotels.According to the respective loan agreements, the reserve funds are to be heldby the lenders or managers in restricted cash accounts. We generally are notrequired to spend the entire amount in the FF&E reserve accounts each year.

 

**Off-Balance Sheet Arrangements**

 

Our off-balance sheet arrangements consist of ourownership interests in two joint ventures. For further discussion of our twojoint ventures and their effect on our financial condition, results ofoperations and cash flows, see Note 6 to the consolidated financial 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 ourcontrol, such as extreme weather conditions, terrorist attacks or alerts,public health concerns, airline strikes or reduced airline capacity, economicfactors and other considerations affecting travel. Revenues for our ComparablePortfolio by quarter for 2008, 2009 and 2010 were as follows (dollars inthousands):

 
| ** **                                | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|-----------|------------|
| **Revenues**                              |       |               |       |                |       |               |       |                |       |      |       |
| 2008 Comparable Portfolio (30 hotels) (1) |       | $                  | 174,713    |                | $          | 200,634            |       | $                   | 187,763    |      | $          | 206,501 |   | $ | 769,611 |   |
| 2008 Revenues as a percentage of total    |       | 22.7               | %          | 26.1                | %          | 24.4               | %          | 26.8                | %          | 100.0     | %          |
|                                      |       |               |       |                |       |               |       |                |       |      |       |
| 2009 Comparable Portfolio (30 hotels) (1) |       | $                  | 149,705    |                | $          | 154,883            |       | $                   | 148,919    |      | $          | 169,126 |   | $ | 622,633 |   |
| 2009 Revenues as a percentage of total    |       | 24.0               | %          | 24.9                | %          | 23.9               | %          | 27.2                | %          | 100.0     | %          |
|                                      |       |               |       |                |       |               |       |                |       |      |       |
| 2010 Comparable Portfolio (30 hotels) (1) |       | $                  | 141,158    |                | $          | 161,088            |       | $                   | 152,153    |      |       |   |   |   |

 

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(1)                       Includes the Company’s hotels held for investment as of September 30,2010, less the Royal Palm Miami Beach which is being repositioned beginning in2010. Also includes operating results for the Renaissance Westchester for allperiods presented.

 

**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 other assumptionsthat we believe are reasonable under the circumstances. Actual results maydiffer from these estimates under different assumptions or conditions. Webelieve the following critical accounting policies affect the most significantjudgments and estimates used in the preparation of our consolidated financialstatements.

 

·                  ***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 September 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 overfinancial reporting.

 

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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** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1, 2010 —  July 31, 2010           |       | —                                           |       | —                                           |       | —                                                                                                                           |       | —                                                                                                                                                                            |       |
| August 1, 2010 —  August 31, 2010       |       | 13,002                                           | (1)        | $                                                | 8.64       |                                                                                                                             | —     |                                                                                                                                                                              | —     |   |
| September 1, 2010 —  September 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**

 

None.

 

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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). |
|                |       |                                                                                                                                                                                                                  |
| 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: November 4, 2010 | By:                                 | /s/    Kenneth  E. Cruse |
|                        |                                | **Kenneth  E. Cruse  (Principal Financial Officer and Duly Authorized Officer)** |

 

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