76626_Vivo_Cvr 3/20/07 4:50 PM Page 1 DIAMONDROCK HOSPITALITY DIAMONDROCK HOSPITALITY 2 0 0 6 A N N U A L R E P O R T 2 0 0 6 A N N U A L R E P O R T 6903 ROCKLEDGE DRIVE, SUITE 800 BETHESDA, MARYLAND 20817 (240) 744-1150 WWW.DRHC.COM We are a self-advised real estate company committed to maximizing shareholder value through investing in premium full-service hotels. We currently own 21 hotels focused in the gateway markets of New York City, Chicago, Los Angeles, Boston and Atlanta, as well as resort destination markets. [cover] the chicago marriott downtown and conrad chicago are both situated on michigan avenue, the famed shopping district in the heart of downtown chicago known as the “magnificent mile”. [above] the los angeles airport marriott underwent significant renovations during 2005 and 2006, including the guestrooms, ballroom and food outlets. the hotel is located minutes from the los angeles international airport. 76626_Vivo_Cvr 3/20/07 4:50 PM Page 1 DIAMONDROCK HOSPITALITY DIAMONDROCK HOSPITALITY 2 0 0 6 A N N U A L R E P O R T 2 0 0 6 A N N U A L R E P O R T 6903 ROCKLEDGE DRIVE, SUITE 800 BETHESDA, MARYLAND 20817 (240) 744-1150 WWW.DRHC.COM We are a self-advised real estate company committed to maximizing shareholder value through investing in premium full-service hotels. We currently own 21 hotels focused in the gateway markets of New York City, Chicago, Los Angeles, Boston and Atlanta, as well as resort destination markets. [cover] the chicago marriott downtown and conrad chicago are both situated on michigan avenue, the famed shopping district in the heart of downtown chicago known as the “magnificent mile”. [above] the los angeles airport marriott underwent significant renovations during 2005 and 2006, including the guestrooms, ballroom and food outlets. the hotel is located minutes from the los angeles international airport. 76626_Vivo_Cvr 3/20/07 4:51 PM Page 2 t h e DIAMONDROCK p o r t f o l i o business orlando airport marriott, florida renaissance worthington, texas renaissance waverly, georgia bethesda marriott suites, maryland los angeles airport marriott, california westin atlanta north, at perimeter, georgia salt lake city marriott downtown, utah torrance marriott, california chicago marriott downtown magnificent mile, illinois renaissance austin, texas marriott atlanta alpharetta, georgia westin boston waterfront, massachusetts resorts and conference centers frenchman’s reef & morning star marriott beach resort, united states virgin islands marriott griffin gate resort, kentucky the lodge at sonoma, a renaissance resort and spa, california oak brook hills marriott resort, illinois vail marriott mountain resort & spa, colorado urban select service luxury courtyard manhattan/fifth avenue, new york courtyard manhattan/midtown east, new york springhill suites atlanta buckhead, georgia conrad chicago, illinois B OARD OF DIRECTORS William W. McCarten Chairman of the Board and Chief Executive Officer W. Robert Grafton Lead Independent Director Daniel J. Altobello Independent Director Maureen L. McAvey Independent Director and Senior Resident Fellow and ULI/Klingbeil Family Chair, Urban Development at the Urban Land Institute Gilbert T. Ray Independent Director John L. Williams Director and President and Chief Operating Officer EXECUTIVE OFFICERS William W. McCarten Chief Executive Officer John L. Williams President and Chief Operating Officer Mark W. Brugger Executive Vice President, Chief Financial Officer and Treasurer Michael D. Schecter Executive Vice President, General Counsel and Secretary Sean M. Mahoney Chief Accounting Officer and Corporate Controller cor p or ate infor mation CORPORATE HEADQUARTERS DiamondRock Hospitality Company 6903 Rockledge Drive Suite 800 Bethesda, Maryland 20817 (240) 744-1150 FAX (240) 744-1199 INTERNET ACCESS A corporate profile, recent press releases, SEC filings, property locations and other information about DiamondRock Hospitality Company can be found on the World Wide Web at www.drhc.com. ANNUAL MEETING DiamondRock Hospitality Company will hold its annual meeting of share- holders on April 26, 2007, at 11:00 am EST at the Bethesda Marriott Suites, 6711 Democracy Boulevard, Bethesda, Maryland 20817. A formal notice and proxy will be mailed before the meeting to shareholders entitled to vote. REGISTRAR AND STO CK TRANSFER AGENT American Stock Transfer & Trust Company 59 Maiden Lane New York, New York 10038 (212) 936-5100 www.amstock.com INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM KPMG LLP 1660 International Drive McLean, Virginia 22102 OTHER SHAREHOLDER INFORMATION For information about DiamondRock Hospitality Company and its sub- sidiaries, including copies of its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, you may call our corporate headquarters or submit a written request to Investor Relations. Our Chief Executive Officer and Chief Financial Officer have furnished the Sections 302 and 906 certifications required by the U.S. Securities and Exchange Commission in our Annual Report on Form 10-K. In addition, our Chief Executive Officer has certified to the NYSE that he is not aware of any violations by us of NYSE corporate governance standards. propert y lo cat i ons Luxury Hotels Business Hotels Resorts and Conference Centers Select Service Urban Hotels VIRGIN ISLANDS 76626_Vivo_Cvr 3/20/07 4:51 PM Page 2 t h e DIAMONDROCK p o r t f o l i o business orlando airport marriott, florida renaissance worthington, texas renaissance waverly, georgia bethesda marriott suites, maryland los angeles airport marriott, california westin atlanta north, at perimeter, georgia salt lake city marriott downtown, utah torrance marriott, california chicago marriott downtown magnificent mile, illinois renaissance austin, texas marriott atlanta alpharetta, georgia westin boston waterfront, massachusetts resorts and conference centers frenchman’s reef & morning star marriott beach resort, united states virgin islands marriott griffin gate resort, kentucky the lodge at sonoma, a renaissance resort and spa, california oak brook hills marriott resort, illinois vail marriott mountain resort & spa, colorado urban select service luxury courtyard manhattan/fifth avenue, new york courtyard manhattan/midtown east, new york springhill suites atlanta buckhead, georgia conrad chicago, illinois B OARD OF DIRECTORS William W. McCarten Chairman of the Board and Chief Executive Officer W. Robert Grafton Lead Independent Director Daniel J. Altobello Independent Director Maureen L. McAvey Independent Director and Senior Resident Fellow and ULI/Klingbeil Family Chair, Urban Development at the Urban Land Institute Gilbert T. Ray Independent Director John L. Williams Director and President and Chief Operating Officer EXECUTIVE OFFICERS William W. McCarten Chief Executive Officer John L. Williams President and Chief Operating Officer Mark W. Brugger Executive Vice President, Chief Financial Officer and Treasurer Michael D. Schecter Executive Vice President, General Counsel and Secretary Sean M. Mahoney Chief Accounting Officer and Corporate Controller cor p or ate infor mation CORPORATE HEADQUARTERS DiamondRock Hospitality Company 6903 Rockledge Drive Suite 800 Bethesda, Maryland 20817 (240) 744-1150 FAX (240) 744-1199 INTERNET ACCESS A corporate profile, recent press releases, SEC filings, property locations and other information about DiamondRock Hospitality Company can be found on the World Wide Web at www.drhc.com. ANNUAL MEETING DiamondRock Hospitality Company will hold its annual meeting of share- holders on April 26, 2007, at 11:00 am EST at the Bethesda Marriott Suites, 6711 Democracy Boulevard, Bethesda, Maryland 20817. A formal notice and proxy will be mailed before the meeting to shareholders entitled to vote. REGISTRAR AND STO CK TRANSFER AGENT American Stock Transfer & Trust Company 59 Maiden Lane New York, New York 10038 (212) 936-5100 www.amstock.com INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM KPMG LLP 1660 International Drive McLean, Virginia 22102 OTHER SHAREHOLDER INFORMATION For information about DiamondRock Hospitality Company and its sub- sidiaries, including copies of its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, you may call our corporate headquarters or submit a written request to Investor Relations. Our Chief Executive Officer and Chief Financial Officer have furnished the Sections 302 and 906 certifications required by the U.S. Securities and Exchange Commission in our Annual Report on Form 10-K. In addition, our Chief Executive Officer has certified to the NYSE that he is not aware of any violations by us of NYSE corporate governance standards. propert y lo cat i ons Luxury Hotels Business Hotels Resorts and Conference Centers Select Service Urban Hotels VIRGIN ISLANDS 76626_Vivo4pg 3/20/07 4:47 PM Page 1 the westin atlanta north, at perimeter, was acquired in an off-market transaction in 2006. this hotel was our first westin branded hotel. 76626_Vivo4pg 3/20/07 4:47 PM Page 2 to our fe l l ow sha reh ol de rs In 2006, DiamondRock Hospitality Company delivered outstanding results with an industry leading 58% total return to our shareholders. The Company benefited from a strong overall economy and favorable trends in the travel industry. The lodging industry continued to benefit from historically During 2006, we dramatically grew the size and quality of low supply growth and solid demand. With our high quality our hotel portfolio while further strengthening the Company’s portfolio of hotels, prudent acquisi- tions and thoughtful asset manage- ment, we capitalized on the positive environment to deliver very strong operating results and outstanding growth. Highlights of our 2006 financial results are as follows: ◆ Pro forma revenue per available room (“RevPAR”) increased 11.7%. ◆ Hotel adjusted EBITDA margins expanded a robust 300 basis points. ◆ Revenues increased over 114% and Adjusted EBITDA increased 184% compared to 2005 histori- cal results. balance sheet. DiamondRock Hospitality Company completed two successful equity offerings, raising net proceeds of approxi- mately $336 million and acquiring five high quality hotels for total consideration in excess of $700 million. In March, the Company com- pleted the $306 million acquisition of the 1,192-room Chicago Downtown Marriott. The Chicago Downtown Marriott is located on famed Michigan Avenue and is the flagship for Marriott in Chicago. In May, the Company completed the $62 million acquisition of the 369-room Westin Atlanta North, William W. McCarten [right] Chairman & Chief Executive Officer John L. Williams [left] President & Chief Operating Officer ◆ Adjusted FFO per share increased 75% to $1.38. ◆ Our annual dividend of $0.72 per share represented a 4% annual yield based on our year-end stock price. at Perimeter. We believe that the Westin Atlanta North is the best located hotel in the Perimeter Center submarket of Atlanta, which has over 23 million square feet of office space. In November, the Company completed the $118 million We are pleased to report that DiamondRock Hospitality acquisition of the 311-room Chicago Conrad, located one Company ranked as the number one performing REIT in the block from the Chicago Downtown Marriott between Bloomberg lodging REIT index in 2006 based on total share- Michigan Avenue and Rush Street. Conrad is one of Hilton’s holder return. With a total return of 58%, the Company’s luxury brands. The hotel was converted to the Conrad brand return compares very favorably with the 36% total return for in June 2006 and, with Hilton’s powerful presence in the City the Morgan Stanley REIT index or the 17% total return for of Chicago, we expect the hotel to benefit significantly from the Russell 2000. its Hilton affiliation. D I A M O N DR O C K H O S PI TA L I T Y | 2006 A N N UA L R E P O RT 76626_Vivo4pg 3/20/07 4:47 PM Page 3 In December, the Company completed the $238 million capability and flexibility to capitalize on attractive acquisi- acquisition of two hotels: the 521-room Renaissance Waverly tion opportunities generated by our management team or and the 492-room Austin Renaissance. The Renaissance our strategic partners. Waverly has 65,000 square feet of meeting space and is the In January 2007, the Company acquired the six month old regional meeting facility for the Northwest office market 793-room Westin Boston Waterfront for $330 million. The of Atlanta. The Austin Renaissance has over 60,000 square hotel is attached to the recently built convention center in feet of meeting space and is the regional meeting facility Boston and is located in one of the most exciting redevelop- for the technology corridor of Austin. ment areas on the East Coast. In connection with this acquisi- At the end of 2006, DiamondRock Hospitality Company had an enterprise value in excess of $2 billion with a port- folio of 20 premium hotels and resorts concentrated in gateway cities such as New York, Chicago, Atlanta and Los Angeles. We believe that we can create significant value from thoughtful capital reinvestments in our port- folio of hotels. In 2006, we under- took a number of significant capital projects to our portfolio. These investments ranged from full-scale repositioning of hotels such as Oak Brook Hills Marriott Resort, to adding five new rooms at tion, the Company also completed a successful $318 million equity offer- ing. These transactions have enhanced our portfolio quality and increased our financial flexibility. In 2007 and 2008, assuming the general economy continues its current growth, we anticipate that lodging fundamentals will remain favorable as demand will continue to outstrip new supply. With our portfolio of high quality hotels, concentrated in urban and resort locations, combined with our solid balance sheet, we are well posi- tioned to continue our success as prudent stewards of our share- holders’ capital. We intend to the lodge at sonoma, a renaissance resort & spa, is located in the heart of wine country in sonoma valley. the resort experienced impressive profit growth of over 20% during 2006. the Courtyard Manhattan Midtown East. The benefits from consistently deliver a growing dividend and capital appreci- these investments will be realized in our operating perform- ation through diversified investments in premium hotels ance over the next few years. and resorts. We believe that we have one of the strongest balance We are proud of our accomplishments since our incep- sheets among lodging REITs. With year-end net debt to tion in mid-2004 and appreciate the support of our share- enterprise value of only 37% and no outstanding preferred holders, associates and capital and strategic partners. We equity or joint ventures, the Company enters 2007 with the look forward to another outstanding year in 2007. William W. McCarten Chairman & Chief Executive Officer John L. Williams President & Chief Operating Officer D I A M O N DR O C K H O S PI TA L I T Y | 2006 A N N UA L R E P O RT 76626_Vivo4pg 3/20/07 4:47 PM Page 4 the lounge terrace views from the frenchman’s reef & morning star marriott beach resort provide guests with spectacular views of charlotte amalie harbor. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ## ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2006 OR "" TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 001-32514 DIAMONDROCK HOSPITALITY COMPANY (Exact Name of Registrant as Specified in Its Charter) Maryland (State or Other Jurisdiction of Incorporation or Organization) 6903 Rockledge Drive, Suite 800 Bethesda, Maryland (Address of Principal Executive Offices) 20-1180098 (I.R.S. Employer Identification Number) 20817 (Zip Code) Registrant’s telephone number, including area code: (240) 744-1150 Title of Each Class Common Stock, $.01 par value Name of Exchange On Which Registered New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes # No" Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes " No # Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes # No " Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. # Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer # Accelerated filer " Non-accelerated filer " The aggregate market value of the common equity held by non-affiliates of the Registrant (assuming for these purposes, but without conceding, that all executive officers and Directors are “affiliates” of the Registrant) as of June 16, 2006, the last business day of the Registrant’s most recently completed second fiscal quarter, was $949.4 million (based on the closing sale price of the Registrant’s Common Stock on that date as reported on the New York Stock Exchange). Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes " No # As of February 28, 2007 there were 94,534,132 shares of common stock outstanding. Documents Incorporated by Reference Proxy Statement for the registrant’s 2007 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2006, is incorporated by reference in Part III herein. DIAMONDROCK HOSPITALITY COMPANY INDEX PART I Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 1A Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 1B. Unresolved Staff Comments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 2. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 3. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 4. PART II Item 5. Item 6. Item 7. Market for Our Common Stock and Related Stockholder Matters . . . . . . . . . . . . . . . . . . Selected Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Management’s Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 7a. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . . . . . . . Financial Statements and Supplementary Data. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 8. Changes in and Disagreements with Accountants on Accounting and Item 9. Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 9A Controls and Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 9B. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PART III Item 10. Directors, Executive Officers and Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Item 11. Security Ownership of Certain Beneficial Owners and Management and Item 12. Item 13. Item 14. Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal Accounting Fees and Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PART IV Page 3 9 24 25 38 38 39 42 45 63 64 64 64 64 65 65 65 65 65 Item 15. Exhibits and Financial Statement Schedules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2 SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS Certain statements in this report, other than purely historical information, including estimates, projections, statements relating to our business plans, objectives and expected operating results, and the assumptions upon which those statements are based, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements generally are identified by the words “believes,” “project,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in Item 1A “Risk Factors” of this Annual Report on Form 10-K. We undertake no obligation to update or revise publicly any forward- looking statements, whether as a result of new information, future events or otherwise. Item 1. Business Overview PART I We are a lodging focused real estate company that owns, as of February 28, 2007, twenty-one hotels and resorts that contain nearly 10,000 guest rooms. We differentiate ourselves from our competitors because of our adherence to three basic principles: • high quality urban and resort focused real estate; • conservative capital structure; and • thoughtful asset management. High Quality Urban and Resort Focused Real Estate We own and seek to acquire premium hotels and resorts in North America. Since our formation in May 2004, we have acquired 21 properties, with purchase prices aggregating over $2 billion, including five hotels with purchase prices aggregating over $700 million in 2006. These hotels and resorts are all categorized as upper upscale as defined by Smith Travel Research and are generally located in high barrier to entry markets with multiple demand generators. Our properties are concentrated in five key gateway cities (New York City, Los Angeles, Chicago, Boston and Atlanta) and in destination resorts (such as the U.S. Virgin Islands and Vail, Colorado). We believe that these gateway cities and destination resorts are high growth markets because they are attractive business and leisure destinations. We also believe that these locations are better insulated from new supply due to relatively high barriers to entry and expensive construction costs. We believe that the higher quality lodging assets create more dynamic cash flow growth and superior long-term capital appreciation. Conservative Capital Structure We are committed to maintaining a conservative and flexible capital structure with prudent leverage levels. During 2004 through 2006, we have taken advantage of the low interest environment by fixing our debt rates for an extended period of time. Depending on the outlook for interest rates in the future we maintain the flexibility to modify these strategies. 3 As of December 31, 2006, 100% of our debt carried fixed interest rates, with a weighted-average interest rate of 5.69%, and a weighted-average maturity date of 8.8 years. As of December 31, 2006, we had $841.2 million of debt outstanding, representing a net debt-to-enterprise value ratio of 37%, which is calculated as our market capitalization plus net debt. We prefer a relatively simple but efficient capital structure. We have not invested in joint ventures and have not issued any operating partnership units or preferred stock. We endeavor to structure our hotel acquisitions so that they will not overly complicate our capital structure; however, we will consider a more complex transaction if we believe that the projected returns to our stockholders will significantly exceed the returns that would otherwise be available. Thoughtful Asset Management We believe that we are able to create significant value in our portfolio by utilizing our management’s extensive experience and our innovative asset management strategies. Our senior management team has established a broad network of hotel industry contacts and relationships, including relationships with hotel owners, financiers, operators, project managers and contractors and other key industry participants. Our philosophy is to negotiate management agreements that give us the right to exert significant influence over the management of our properties, annual budgets and all capital expenditures, and then to use those rights to continually monitor and improve the performance of our properties. We cooperatively partner with the managers of our hotels in an attempt to increase operating results and long-term asset values at our hotels. In addition to working directly with the personnel at our hotels, our senior management team also has long-standing professional relationships with our hotel managers’ senior executives, and we work directly with these senior executives to improve the performance of our portfolio. We believe we can create significant value in our portfolio through innovative asset management strategies such as rebranding, renovating and repositioning. We are committed to regularly evaluating our portfolio to determine if we can employ these value-added strategies at our hotels. During 2006, we completed a significant amount of capital reinvestment in our hotels—completing projects that ranged from a room renovation (Courtyard Manhattan/Midtown East, Los Angeles Airport Marriott, Bethesda Marriott Suites) to a total renovation and repositioning of the hotel (Torrance Marriott and the Oak Brook Hills Marriott Resort). In connection with our planned renovations and repositionings, our senior management team and our asset managers are individually committed to completing these renovations on time, on budget and with minimum disruption at our hotels. We are optimistic that, when completed, these renovations will enable us to achieve higher rates and greater demand for our hotels. A core of our asset management strategy is to leverage national hotel brands. We strongly believe in the value of powerful national brands because we believe that they are able to produce incremental revenue and profits compared to similar unbranded hotels. Dominant national hotel brands typically have very strong reservation and reward systems and sales organizations, as a result, all of our hotels are operated under a brand owned by one of the top three national brand companies (Marriott, Starwood or Hilton) and all but two of the hotels are operated by the brand company directly. Generally, we are interested in acquiring only those hotels that are operated under a nationally recognized brand or can be converted into a branded hotel. Our Company We commenced operations in July 2004. As of December 31, 2006, we owned 20 hotels that contained over 9,000 hotel rooms, located in the following markets: Atlanta, Georgia (4); Austin, Texas; Chicago, Illinois (2); Fort Worth, Texas; Lexington, Kentucky; Los Angeles, California (2); New York, New York 4 (2); Northern California; Oak Brook, Illinois; Orlando, Florida; Salt Lake City, Utah; Washington D.C.; St. Thomas, U.S. Virgin Islands; and Vail, Colorado. The address of our principal executive office is 6903 Rockledge Drive, Suite 800, Bethesda, Maryland 20817. Our phone number is 240-744-1150. Recent Developments Follow-on offering. We completed a follow-on offering of our common stock on January 17, 2007. We sold 18,342,500 shares of common stock, including the underwriters’ over-allotment of 2,392,500 shares, at an offering price of $18.15 per share. The net proceeds to us, after deduction of offering costs, was $317.6 million. Acquisition of the Westin Boston Waterfront Hotel. Subsequent to year end, we acquired a leasehold interest in the Westin Boston Waterfront Hotel and in the attached 100,000 square feet of potential retail space. We also purchased an option to acquire a leasehold interest in an adjacent parcel of land which could permit us to expand the hotel (or construct a new hotel) by more than 300 rooms. The contractual purchase price for the Westin Boston Waterfront Hotel, the retail space, and the expansion option was $330.3 million. The Westin Boston Waterfront Hotel opened in June 2006 and contains 793 rooms and 32,000 square feet of meeting space. Amended and Restated Credit Facility. We amended and restated our $75 million secured credit facility to expand it into a $200 million unsecured credit facility on February 28, 2007. Our Relationship with Marriott Investment Sourcing Relationship We have an investment sourcing relationship with Marriott, a leading worldwide hotel brand, franchise and management company. Pursuant to this relationship, Marriott regularly provides us with an early opportunity to bid on hotel acquisition and investment opportunities known to Marriott. This relationship has generated a large number of additional acquisition opportunities, with many of the properties being “off-market” transactions, meaning that they are not made generally available to other real estate investment companies. However, we have not entered into a binding agreement or commitment setting forth the terms of this investment sourcing relationship. As a result, we cannot assure you that our investment sourcing relationship with Marriott will continue or not be modified. Our senior management team regularly meets with senior representatives of Marriott to explore how to further our investment sourcing relationship in order to maximize the value of the relationship to both parties. Key Money and Yield Support Marriott has contributed to us certain amounts in exchange for the right to manage hotels we have acquired or the completion of certain brand enhancing capital projects. We refer to these amounts as “key money.” Marriott has provided us with key money of approximately $12 million in the aggregate in connection with our acquisitions of five of our hotels. In addition, Marriott has provided us with operating cash flow guarantees for certain hotels and will fund shortfalls of actual hotel operating income compared to a negotiated target net operating income. We refer to these guarantees as “yield support.” Marriott provided us with yield support for the Oak Brook Hills Marriott Resort for fiscal years 2006 and 2007. The total guarantee obligation of Marriott is capped at $2.5 million. We received $1 million of yield support for the Orlando Airport Marriott for fiscal year 2006 and are not entitled to any further yield support. Finally, the SpringHill Suites Atlanta Buckhead is entitled to a maximum of $200,000 of yield support during 2006 and 2007. During the year ended December 31, 2006 we earned an aggregate of $2.8 million of yield support at the three properties. 5 Investment in DiamondRock In connection with our July 2004 private placement, Marriott purchased 3.0 million shares of common stock at the same purchase price as all other investors in our private placement. In connection with our initial public offering, Marriott purchased 1,428,571 shares of our common stock at the same purchase price as all other investors. As of December 31, 2006, Marriott owned 5.8% of our outstanding common stock. Subsequent to the completion of our follow on offering in January 2007, Marriott owns 4.7% of our outstanding common stock. Our Corporate Structure We conduct our business through a traditional umbrella partnership REIT, or UPREIT, in which our hotels are owned by subsidiaries of our operating partnership, DiamondRock Hospitality Limited Partnership. We are the sole general partner of our operating partnership and currently own, either directly or indirectly, all of the limited partnership units of our operating partnership. In order for the income from our hotel investments to constitute “rents from real properties” for purposes of the gross income test required for REIT qualification, we must lease each of our hotels to a wholly-owned subsidiary of our taxable REIT subsidiary, or TRS, or an unrelated third party. However, we may structure our properties, which are not subject to U.S. federal income tax differently from the structures we use for our U.S. properties. For example, the Frenchman’s Reef & Morning Star Marriott Beach Resort is held by a United States Virgin Islands corporation, which we have elected to be a TRS. The following chart shows our corporate structure as of the date of this report: DiamondRock Hospitality Company 100% (direct and indirect) 100% DiamondRock Hospitality Limited Partnership (our operating partnership) 100% Bloodstone TRS, Inc. (our taxable REIT subsidiary) 100% Subsidiaries Owning Hotels Leases Subsidiaries Leasing Hotels (our TRS Lessees) Management Agreements Hotel Management Companies, including Marriott International, Inc. or one or more wholly owned subsidiaries of Marriott 6 Environmental Matters Under various federal, state and local environmental laws and regulations, a current or previous owner, operator or tenant of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases or threats of releases at such property and may be held liable to a government entity or to third parties for property damage and for investigation, clean-up and monitoring costs incurred by such parties in connection with the actual or threatened contamination. These laws typically impose clean-up responsibility and liability without regard to fault, or whether or not the owner, operator or tenant knew of or caused the presence of the contamination. The liability under these laws may be joint and several for the full amount of the investigation, clean-up and monitoring costs incurred or to be incurred or actions to be undertaken, although a party held jointly and severally liable may obtain contributions from other identified, solvent, responsible parties of their fair share toward these costs. These costs may be substantial and can exceed the value of the property. The presence of contamination, or the failure to properly remediate contamination, on a property may adversely affect the ability of the owner, operator or tenant to sell or rent that property or to borrow funds using such property as collateral and may adversely impact our investment in that property. Federal regulations require building owners and those exercising control over a building’s management to identify and warn, via signs and labels, of potential hazards posed by workplace exposure to installed asbestos-containing materials and potential asbestos-containing materials in their building. The regulations also set forth employee training, record keeping and due diligence requirements pertaining to asbestos-containing materials and potential asbestos-containing materials. Significant fines can be assessed for violation of these regulations. Building owners and those exercising control over a building’s management may be subject to an increased risk of personal injury lawsuits by workers and others exposed to asbestos-containing materials and potential asbestos-containing materials as a result of these regulations. The regulations may affect the value of a building containing asbestos-containing materials and potential asbestos-containing materials in which we have invested. Federal, state and local laws and regulations also govern the removal, encapsulation, disturbance, handling and disposal of asbestos- containing materials and potential asbestos-containing materials when such materials are in poor condition or in the event of construction, remodeling, renovation or demolition of a building. Such laws may impose liability for improper handling or a release to the environment of asbestos-containing materials and potentially asbestos-containing materials and may provide for fines to, and for third parties to seek recovery from, owners or operators of real estate facilities for personal injury or improper work exposure associated with asbestos-containing materials and potential asbestos-containing materials. Prior to closing any property acquisition, we obtain Phase I environmental assessments in order to attempt to identify potential environmental concerns at the properties. These assessments are carried out in accordance with an appropriate level of due diligence and will generally include a physical site inspection, a review of relevant federal, state and local environmental and health agency database records, one or more interviews with appropriate site-related personnel, review of the property’s chain of title and review of historic aerial photographs and other information on past uses of the property. We may also conduct limited subsurface investigations and test for substances of concern where the results of the Phase I environmental assessments or other information indicates possible contamination or where our consultants recommend such procedures. We cannot assure you that these assessments will discover every environmental condition that may be present on a property. Competition The hotel industry is highly competitive and our hotels are subject to competition from other hotels for guests. Competition is based on a number of factors, including convenience of location, brand affiliation, price, range of services, guest amenities, and quality of customer service. Competition is specific to the individual markets in which our properties are located and will include competition from existing 7 and new hotels operated under brands in the full-service, select-service and extended-stay segments. We believe that properties flagged with a Marriott, Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) or Hilton Hotels Corporation (“Hilton”) brands will enjoy the competitive advantages associated with their operations under such brand. These national brands reservation systems and national advertising, marketing and promotional services combined with the strong management expertise they provide enable our properties to perform favorably in terms of both occupancy and room rates. These brands guest loyalty programs generate repeat guest business that might otherwise go to competing hotels. Increased competition may have a material adverse effect on occupancy, ADR and RevPAR or may require us to make capital improvements that we otherwise would not undertake, which may result in decreases in the profitability of our hotels. We face competition for the acquisition of hotels from institutional pension funds, private equity investors, REITs, hotel companies and others who are engaged in the acquisition of hotels. Some of these competitors have substantially greater financial and operational resources than we have and may have greater knowledge of the markets in which we seek to invest. This competition may reduce the number of suitable investment opportunities offered to us and increase the cost of acquiring our targeted hotel investments. Employees We currently employ 17 full-time employees. We believe that our relations with our employees are good. None of our employees is a member of any union; however, the employees working at the Courtyard Manhattan/Fifth Avenue hotel, the Oak Brook Hills Marriott Resort, Frenchman’s Reef & Morning Star Marriott Beach Resort and the Westin Boston Waterfront Hotel are currently represented by labor unions and are subject to collective bargaining agreements. Legal Proceedings We are not involved in any material litigation nor, to our knowledge, is any material litigation pending or threatened against us, other than routine litigation arising out of the ordinary course of business or which is expected to be covered by insurance and not expected to harm our business, financial condition or results of operations. Regulation Our properties must comply with Title III of the Americans with Disabilities Act, or ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. However, noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and to make alterations as appropriate in this respect. Insurance We carry comprehensive liability, fire, extended coverage, earthquake, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket policy. In addition, we carry earthquake and terrorism insurance on our properties in an amount and with deductibles, which we believe are commercially reasonable. We do not carry insurance for generally uninsured losses such as loss from riots, war or acts of God. Certain of the properties in our portfolio are located in areas known to be seismically active or subject to hurricanes and we have appropriate insurance for those risks, although they are subject to higher deductibles than ordinary property insurance. 8 Most of our hotel management agreements generally provide that we are responsible for obtaining and maintaining property insurance, business interruption insurance, flood insurance, earthquake insurance (if the hotel is located in an “earthquake prone zone” as determined by the U.S. Geological Survey) and other customary types of insurance related to hotels and the manager is responsible for obtaining general liability insurance, workers’ compensation and employer’s liability insurance. Securities Exchange Act Reports We maintain an internet website at the following address: www.drhc.com. The information on our website is not incorporated by reference in this annual report on Form 10-K. We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (the “SEC”) in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and Section 16 filings. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC. Item 1A. Risk Factors The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that it may currently deem immaterial also may impair its business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be adversely affected. Risks Related to Our Business and Operations Our business model, especially our concentration in premium full-service hotels, can be highly volatile. We own hotels, a very different asset class from many other REITs. A typical office REIT, for example, has long-term leases with third party tenants, which provides a relatively stable long-term stream of revenue. Our TRS, on the other hand, does not enter into a lease with a hotel manager. Instead, our TRS engages the hotel manager pursuant to a management agreement and pays the manager a fee for managing the hotel. The TRS receives all the operating profit or losses at the hotel. Moreover, virtually all hotel guests stay at the hotel for only a few nights, so the rate and occupancy at each of our hotels changes every day. As a result, we may have highly volatile earnings. In addition to fluctuations related to our business model, our hotels are and will continue to be subject to various long-term operating risks common to the hotel industry, many of which are beyond our control, including: • competition from other hotels that may be located in our markets, some of which may have greater marketing and financial resources than us; • an over-supply or over-building of hotels in our markets, which could adversely affect occupancy rates and revenues at our properties; • dependence on business and commercial travelers and tourism, both of which vary with consumer and business perceptions as to the strength of the general economy; • increases in energy costs and other expenses affecting travel, which may affect travel patterns and reduce the number of business and commercial travelers and tourists; 9 • increases in operating costs due to inflation and other factors that may not be offset by increased room rates; and • changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance. In addition, our hotels are mostly in the premium full-service segment of the hotel business that tends to have the best operating results in a strong economy and the worst results in a weak economy. In periods of weak demand, profitability is negatively affected by the relatively high fixed costs of operating premium full-service hotels when compared to other classes of hotels. The occurrence of any of the foregoing factors could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Our portfolio is highly concentrated in a handful of core markets. We expect that in 2007 more than 75% of our earnings will be derived from our hotels in three destination resorts (Frenchman’s Reef, Vail Marriott, and the Lodge at Sonoma) and five gateway cities (New York City, Boston, Chicago, Los Angeles and Atlanta) and as such, the operations of these hotels will have a material impact on our overall results of operations. As a result, we have a highly concentrated portfolio and this concentration may lead to volatility in our results. In the event of an economic downturn in any of these cities, the unpopularity of any of these destinations resorts, or a manmade or natural disaster or casualty or other damage to one of our key hotels, our overall results of operations may be adversely affected. Our recently built or converted hotels have limited operating history and, as such, the hotels may not achieve the returns that we are expecting, and as a result, our overall returns may be negatively impacted. The Westin Boston Waterfront Hotel opened in June 2006, and has limited operating history. Our ability to accurately forecast future operations is accordingly limited. In addition, the Westin Boston Waterfront Hotel is located in a newly developed submarket of Boston. Should the retail, office and apartment developments of this submarket fail to develop as we currently expect, this submarket may not be an attractive destination to travelers. As a result, there is considerable risk this hotel may not achieve the returns we are expecting and our overall returns may be negatively impacted. The Chicago Conrad converted to the Conrad brand in June 2006, and has limited operating history as a Conrad. Moreover, the Conrad brand does not have the brand recognition of other premium and luxury brands. Our ability to accurately forecast future operations is accordingly limited. As a result, there is considerable risk this hotel may not achieve the returns we are expecting and our overall returns may be negatively impacted. The Oak Brook Hills Marriott Resort was converted to a Marriott hotel in July 2005 and the transition to a Marriott was initially difficult, however, the disruption caused by the transition was minimized by the negotiated yield support that we received from Marriott. That yield support expires at the end of 2007. If the hotel continues to perform below our expectations, there is a risk that after the yield support terminates, that our returns may be negatively impacted. Our hotels are subject to significant competition. Currently, we believe the supply and demand in the markets where our hotels are located is in balance and, with few exceptions, the markets are very competitive. However, historically, a material increase in the supply of new hotel rooms to a market can quickly destabilize that market and existing hotels can experience rapidly decreasing RevPAR and profitability. If such over-building occurs in one or more of our 10 major markets, we may experience a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. In the event of natural disasters, terrorist attacks, significant military actions, outbreaks of contagious diseases or other events for which we may not have adequate insurance, our operations may suffer. One of our major hotels, Frenchman’s Reef & Morning Star Marriott Beach Resort, is located on the side of a cliff facing the ocean in the United States Virgin Islands, which is in the so-called “hurricane belt” in the Caribbean. The hotel was partially destroyed by a hurricane in the mid-1990’s and since then has been damaged by subsequent hurricanes. In addition, three of our hotels, the Los Angeles Airport Marriott, the Torrance Marriott and The Lodge at Sonoma, a Renaissance Resort & Spa, are located in areas that are seismically active. Finally, seven of our hotels are located in metropolitan markets that have been, or may in the future be, targets of actual or threatened terrorist attacks, including New York City, Chicago, Boston and Los Angeles. These hotels are each material to our financial results. Chicago Marriott, Frenchman’s Reef & Morning Star Marriott Beach Resort, Los Angeles Airport Marriott, the Torrance Marriott, Courtyard Manhattan/Midtown East, the Lodge at Sonoma, Courtyard Manhattan/Fifth Avenue and Conrad Chicago constituted 16.5%, 10.6%, 11.1%, 4.5%, 5.3%, 3.7%, 3.2% and 0.7% of our revenues in 2006, respectively. Additionally, even in the absence of direct physical damage to our hotels, the occurrence of any natural disasters, terrorist attacks, significant military actions, outbreaks of contagious diseases, such as SARS or the avian bird flu, or other casualty events affecting the United States, will likely have a material adverse effect on business and commercial travelers and tourists, the economy generally and the hotel and tourism industries in particular. While we cannot predict the impact of the occurrence of any of these events, such impact could result in a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. We have acquired and intend to maintain comprehensive insurance on each of our hotels, including liability, terrorism, fire and extended coverage, of the type and amount we believe are customarily obtained for or by hotel owners. We cannot assure you that such coverage will be available at reasonable rates or with reasonable deductibles. For example, Frenchman’s Reef & Morning Star Marriott Beach Resort has a high deductible if it is damaged due to a wind storm. Various types of catastrophic losses, like earthquakes, floods, losses from foreign terrorist activities such as those on September 11, 2001, or losses from domestic terrorist activities such as the Oklahoma City bombing may not be insurable or are generally not insured because of economic infeasibility, legal restrictions or the policies of insurers. Future lenders may require such insurance and our failure to obtain such insurance could constitute a default under loan agreements. Depending on our access to capital, liquidity and the value of the properties securing the affected loan in relation to the balance of the loan, a default could have a material adverse effect on our results of operations and ability to obtain future financing. In the event of a substantial loss, our insurance coverage may not be sufficient to cover the full current market value or replacement cost of our lost investment. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a hotel, as well as the anticipated future revenue from that particular hotel. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also keep us from using insurance proceeds to replace or renovate a hotel after it has been damaged or destroyed. Under those circumstances, the insurance proceeds we receive might be inadequate to restore our economic position with regard to the damaged or destroyed property. With or without insurance, damage to any of our hotels, or to the hotel industry generally, due to fire, hurricane, earthquake, terrorism, outbreaks such as avian bird flu or other man-made or natural disasters 11 or casualty events could materially and adversely affect our business, financial condition, results of operations and our ability to make distributions to our stockholders. The hotel industry is capital intensive and we are subject to risks associated with our ongoing need for renovations and capital improvements as well as financing for such expenditures. In order to remain competitive, our hotels have an ongoing need for renovations and other capital improvements, including replacements, from time to time, of furniture, fixtures and equipment. These capital improvements may give rise to the following risks: • construction cost overruns and delays; • a possible shortage of available cash to fund capital improvements and the related possibility that financing for these capital improvements may not be available to us on affordable terms; • disruptions in the operations of the hotel as well as in demand for the hotel while capital improvements are underway; and • disputes with franchisors/hotel managers regarding compliance with relevant management/franchise agreements. The costs of these capital improvements could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. In addition, we may not be able to fund capital improvements or acquisitions solely from cash provided from our operating activities because we generally must distribute at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction, each year to maintain our REIT tax status. As a result, our ability to fund capital expenditures, or investments through retained earnings, is very limited. Consequently, we will rely upon the availability of debt or equity capital to fund our investments and capital improvements, but these sources of funds may not be available on favorable terms and conditions. Neither our charter nor our bylaws limits the amount of debt that we can incur; however, we may not be able to obtain additional equity or debt financing on favorable terms, if at all. Our hotel portfolio is not diverse by brand or manager and there are risks associated with using Marriott’s brands on most of our hotels and having Marriott manage most of our hotels. Our success depends in part on the success of Marriott. Eighteen of our current hotels utilize brands owned by Marriott. As a result, our success is dependent in part on the continued success of Marriott and its brands. If market recognition or the positive perception of these Marriott brands is reduced or compromised, the goodwill associated with Marriott branded hotels may be adversely affected and the results of operations of our hotels may be adversely affected. As a result, we could experience a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Our success depends in part on maintaining good relations with Marriott. Due to the differences in how each company earns its money, which company is responsible for operating losses and capital expenditures, and tensions between an individual hotel and the brand standards of a large chain, there are natural conflicts between an owner of a hotel and a brand company, such as Marriott. Over the last several years, Marriott has been involved in contractual and other disputes with owners of the hotels it manages. Although we currently maintain good relations with Marriott, we cannot assure you that disputes between us and Marriott regarding the management of our properties will not arise. Should our relationship with Marriott deteriorate, we believe that two of our competitive advantages (namely our ability to work with senior executives at Marriott to improve the asset 12 management of our hotels and our investment sourcing relationship) could be eliminated, which may have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Our results of operations are highly dependent on the management of our hotel properties by third-party hotel management companies, including Marriott. In order to qualify as a REIT, we cannot operate our hotel properties or participate in the decisions that affect the daily operations of our hotel properties. Our TRS lessees may not operate these hotel properties and, therefore, they must enter into third-party hotel management agreements with one or more eligible independent contractors (including Marriott). Thus, third-party hotel management companies that enter into management contracts with our TRS lessees will control the daily operations of our hotel properties. Under the terms of the hotel management agreements that we have entered into, or that we will enter into in the future, our ability to participate in operating decisions regarding our hotel properties is limited. We currently rely, and will continue to rely, on these hotel management companies to adequately operate our hotel properties under the terms of the hotel management agreements. We do not have the authority to require any hotel property to be operated in a particular manner or to govern any particular aspect of its operations (for instance, setting room rates). Thus, even if we believe our hotel properties are being operated inefficiently or in a manner that does not result in satisfactory occupancy rates, ADRs and operating profits, we may not have sufficient rights under our hotel management agreements to enable us to force the hotel management company to change its method of operation. We can only seek redress if a hotel management company violates the terms of the applicable hotel management agreement with the TRS lessee, and then only to the extent of the remedies provided for under the terms of the hotel management agreement. Our current management agreements are generally non-terminable, subject to certain exceptions for cause, and in the event that we need to replace any of our hotel management companies pursuant to termination for cause, we may experience significant disruptions at the affected properties, which may have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Marriott may encourage us to enter into transactions or hotel management agreements that are not favorable to us. We have pursued and intend to continue to pursue, hotel investment opportunities referred to us by Marriott, and we intend to work with Marriott as our preferred hotel management company. Marriott is paid a fee based on gross revenues at the hotels while we only benefit from operating profits at a hotel. It is possible that Marriott will encourage us to acquire a hotel which generates significant gross revenues, but little or no operating profits. Marriott may also have short-term or long-term goals and objectives that conflict with our own, including the terms of the agreements under which our hotels are managed. These differences may be significant and may include the fees payable to Marriott, the term of any hotel management agreement, trade area restrictions with respect to competition by Marriott or its affiliates or differing policies, procedures or practices. As a result of these potentially differing objectives, Marriott may present to us, and we may invest in, hotel investment opportunities, and enter into management agreements, that are less favorable to us than other alternatives. If we do enter into below market management agreements, our returns on invested capital and operating results will suffer. These differing objectives could result in deterioration in our relationship with Marriott and may adversely affect our ability to execute our business strategies, which in turn, would have a material adverse 13 effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Our ownership of properties through ground leases exposes us to the risk that we may have a difficulty financing such properties, may sell such properties for a lower price or may lose such properties upon breach or termination of the ground leases. We acquired interests in four hotels (Bethesda Marriott Suites, Courtyard Manhattan/Fifth Avenue, the Salt Lake City Marriott Downtown and the Westin Boston Waterfront Hotel), the parking lot associated with another hotel (Renaissance Worthington) and two golf courses associated with two additional hotels (Marriott Griffin Gate Resort and Oak Brook Hills Marriott Resort) by acquiring a leasehold interest in land underlying the property. We may acquire additional hotels in the future through the purchase of hotels subject to ground leases. In the past, from time to time, secured lenders have been unwilling to lend, or otherwise charged higher interest rates, for loans secured by a leasehold mortgage compared to loans secured by a fee simple mortgage. In addition, at any given time, investors may be disinterested in buying properties subject to a ground lease and may pay a lower price for such properties than for a comparable property in fee simple or they may not purchase such properties at any prices, so we may find that we will have a difficult time selling a property subject to a ground lease or may receive less proceeds from such sale. Finally, as lessee under ground leases, we are exposed to the possibility of losing the hotel, or a portion of the hotel, upon termination, or an earlier breach by us, of the ground lease, which could result in a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Due to restrictions in our hotel management agreements, mortgage agreements and ground leases, we may not be able to sell our hotels at the highest possible price (or at all). Our current hotel management agreements are long-term and contain certain restrictions on selling our hotels, which may affect the value of our hotels. The hotel management agreements that we have entered into, and those we expect to enter into in the future, contain provisions restricting our ability to dispose of our hotels which, in turn, may have an adverse affect on the value of our hotels. Our hotel management agreements generally prohibit the sale of a hotel to: • certain competitors of the manager; • purchasers who are insufficiently capitalized; or • purchasers who might jeopardize certain liquor or gaming licenses. In addition, there are rights of first refusal in the hotel management agreement for the Salt Lake City Marriott Downtown and in both the franchise agreement and management agreement for the Vail Marriott Mountain Resort & Spa. These rights of first refusal might discourage certain purchasers from expending resources to conduct due diligence and making an offer to purchase these hotels from us, thus resulting in a lower sales price. Finally, our current hotel management agreements contain initial terms ranging from ten to forty years and certain agreements have renewal periods, exercisable at the option of the property manager, of ten to forty-five years. Because our hotels would have to be sold subject to the applicable hotel management agreement, the term length of a hotel management agreement may deter some potential purchasers and could adversely impact the price realized from any such sale. To the extent we receive less sale proceeds, we could experience a material adverse effect on our business financial conditions, results of operations and our ability to make distributions to stockholders. 14 Our mortgage agreements contain certain provisions that may limit our ability to sell our hotels. In order to assign or transfer our rights and obligations under certain of our mortgage agreements, we generally must: • obtain the consent of the lender; • pay a fee equal to a fixed percentage of the outstanding loan balance; and • pay any costs incurred by the lender in connection with any such assignment or transfer. These provisions of our mortgage agreements may limit our ability to sell our hotels which, in turn, could adversely impact the price realized from any such sale. To the extent we receive less sale proceeds, we could experience a material adverse effect on our business financial conditions, results of operations and our ability to make distributions to stockholders. Our ground leases contain certain provisions that may limit our ability to sell our hotels. Our ground lease agreements with respect to Bethesda Marriott Suites, Salt Lake City Marriott Downtown and the Westin Boston Waterfront require the consent of the lessor for assignment or transfer. These provisions of our ground leases may limit our ability to sell our hotels which, in turn, could adversely impact the price realized from any such sale. In addition, at any given time, investors may be disinterested in buying properties subject to a ground lease and may pay a lower price for such properties than for a comparable property in fee simple or they may not purchase such properties at any price. Accordingly, we may find it difficult to sell a property subject to a ground lease or may receive less proceeds from any such sale. To the extent we receive less sale proceeds, we could experience a material adverse effect on our business financial conditions, results of operations and our ability to make distributions to stockholders. We face competition for the acquisition of hotels and we may not be successful in identifying or completing hotel acquisitions that meet our criteria, which may impede our growth. One component of our business strategy is expansion through acquisitions, and we may not be successful in identifying or completing acquisitions that are consistent with our strategy. We compete with institutional pension funds, private equity investors, REITs, hotel companies and others who are engaged in the acquisition of hotels. This competition for hotel investments may increase the price we pay for hotels and these competitors may succeed in acquiring those hotels that we seek to acquire. Furthermore, our potential acquisition targets may find our competitors to be more attractive suitors because they may have greater financial resources, may be willing to pay more or may have a more compatible operating philosophy. In addition, the number of entities competing for suitable hotels may increase in the future, which would increase demand for these hotels and the prices we must pay to acquire them. If we pay higher prices for hotels, our returns on investment and profitability may be reduced. Also, future acquisitions of hotels or hotel companies may not yield the returns we expect and may result in stockholder dilution. Noncompliance with governmental regulations could adversely affect our operating results. Environmental matters. Our hotels are, and the hotels we acquire in the future will be, subject to various federal, state and local environmental laws. Under these laws, courts and government agencies may have the authority to require us, as owner of a contaminated property, to clean up the property, even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property at the time it became contaminated. In addition to the costs of cleanup, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or 15 to sell the property. Under the environmental laws, courts and government agencies also have the authority to require that a person who sent waste to a waste disposal facility, such as a landfill or an incinerator, pay for the clean-up of that facility if it becomes contaminated and threatens human health or the environment. A person that arranges for the disposal or treatment, or transports for disposal or treatment, a hazardous substance at a property owned by another person may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property. Furthermore, various court decisions have established that third parties may recover damages for injury caused by property contamination. For instance, a person exposed to asbestos while staying in a hotel may seek to recover damages if he or she suffers injury from the asbestos. Lastly, some of these environmental laws restrict the use of a property or place conditions on various activities. For example, certain laws require a business using chemicals (such as swimming pool chemicals at a hotel) to manage them carefully and to notify local officials that the chemicals are being used. We could be responsible for the costs associated with a contaminated property. The costs to clean up a contaminated property, to defend against a claim, or to comply with environmental laws could be material and could adversely affect the funds available for distribution to our stockholders. We cannot assure you that future laws or regulations will not impose material environmental liabilities or that the current environmental condition of our hotels will not be affected by the condition of the properties in the vicinity of our hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to us. We may face liability regardless of: • our knowledge of the contamination; • the timing of the contamination; • the cause of the contamination; or • the party responsible for the contamination of the property. Although we have taken and will take commercially reasonable steps to assess the condition of our properties, there may be unknown environmental problems associated with our properties. If environmental contamination exists on our properties, we could become subject to strict, joint and several liability for the contamination by virtue of our ownership interest. In addition, we are obligated to indemnify our lenders for any liability they may incur in connection with a contaminated property. The presence of hazardous substances or petroleum contamination on a property may adversely affect our ability to sell the property and could cause us to incur substantial remediation costs. The discovery of environmental liabilities attached to our properties could have a material adverse effect on our results of operations and financial condition and our ability to pay dividends to our stockholders. Americans with Disabilities Act and other changes in governmental rules and regulations. Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet various federal requirements related to access and use by disabled persons. Compliance with the ADA’s requirements could require removal of access barriers, and non-compliance could result in the U.S. government imposing fines or private litigants winning damages. If we are required to make substantial modifications to our hotels, whether to comply with the ADA or other changes in governmental rules and regulations, our financial condition, results of operations and ability to make distributions to our stockholders could be adversely affected. 16 Our hotel properties may contain or develop harmful mold, which could lead to liability for adverse health effects and costs of remediating the problem. When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Concern about indoor exposure to mold has been increasing, as exposure to mold may cause a variety of adverse health effects and symptoms, including allergic reactions. As a result, the presence of mold to which our hotel guests or employees could be exposed at any of our properties could require us to undertake a costly remediation program to contain or remove the mold from the affected property, which would reduce our cash available for distribution. In addition, exposure to mold by our guests or employees, management company employees or others could expose us to liability if property damage or adverse health concerns arise. Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition. Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotel properties or investments in our portfolio in response to changing economic, financial and investment conditions may be limited. The real estate market is affected by many factors that are beyond our control, including: • adverse changes in international, national, regional and local economic and market conditions; • changes in interest rates and in the availability, cost and terms of debt financing; • changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances; • the ongoing need for capital improvements, particularly in older structures; • changes in operating expenses; and • civil unrest, acts of God, including earthquakes, floods and other natural disasters and acts of war or terrorism, including the consequences of terrorist acts such as those that occurred on September 11, 2001, which may result in uninsured losses. We may decide to sell our hotel properties in the future. We cannot predict whether we will be able to sell any hotel property or investment for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a hotel property or loan. We may be required to expend funds to correct defects or to make improvements before a hotel property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. In acquiring a hotel property, we may agree to lock-out provisions that materially restrict us from selling that hotel property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that hotel property. These facts and any others that would impede our ability to respond to adverse changes in the performance of our hotel properties could have a material adverse effect on our operating results and financial condition, as well as our ability to make distributions to stockholders. 17 A portion of our revenues may be attributable to operations outside of the United States, which will subject us to different legal, monetary and political risks, as well as currency exchange risks, and may cause unpredictability in a significant source of our cash flows that could adversely affect our ability to make distributions to our stockholders. We may acquire selective hotel properties outside of the United States. International investments and operations generally are subject to various political and other risks that are different from and in addition to risks in U.S. investments, including: • the enactment of laws prohibiting or restricting the foreign ownership of property; • laws restricting us from removing profits earned from activities within the foreign country to the United States, including the payment of distributions, i.e., nationalization of assets located within a country; • variations in the currency exchange rates, mostly arising from revenues made in local currencies; • change in the availability, cost and terms of mortgage funds resulting from varying national economic policies; • changes in real estate and other tax rates and other operating expenses in particular countries; and • more stringent environmental laws or changes in such laws. In addition, currency devaluations and unfavorable changes in international monetary and tax policies could have a material adverse effect on our profitability and financing plans, as could other changes in the international regulatory climate and international economic conditions. Liabilities arising from differing legal, monetary and political risks as well as currency fluctuations could adversely affect our financial condition, operating results and our ability to make distributions to our stockholders. In addition, the requirements for qualifying as a REIT limit our ability to earn gains, as determined for federal income tax purposes, attributable to changes in currency exchange rates. These limitations may significantly limit our ability to invest outside of the United States or impair our ability to qualify as a REIT. Any properties we invest in outside of the United States may be subject to foreign taxes. We may invest in hotel properties located outside the United States. Jurisdictions outside the United States will generally impose taxes on our hotel properties and our operations within their jurisdictions. To the extent possible, we will structure our investments and activities to minimize our foreign tax liability, but we will likely incur foreign taxes with respect to non-U.S. properties. Moreover, the requirements for qualification as a REIT may preclude us from always using the structure that minimizes our foreign tax liability. Furthermore, as a REIT, we and our stockholders will derive little or no benefit from the foreign tax credits arising from the foreign taxes we pay. As a result, foreign taxes we pay will reduce our income and available cash flow from our foreign hotel properties, which, in turn, could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. We are a relatively young company and are subject to all of the risks associated with being at an early stage of development. We commenced operations in July 2004 and, as a result, have a limited operating history. We have experienced rapid growth in our short history and have developed our business strategies based on the expectation of continued rapid growth. We cannot assure you that we will be able to adapt our management, administrative, accounting and operational systems, or hire and retain qualified operational staff to integrate and manage our investment in our hotels. Our failure to successfully integrate and manage acquisitions could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. 18 Our success depends on senior executive officers whose continued service is not guaranteed. We depend on the efforts and expertise of our senior executive officers to manage our day-to-day operations and strategic business direction. The loss of any of their services could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. Seasonality of the hotel business can be expected to cause quarterly fluctuations in our earnings. The hotel industry is seasonal in nature. Generally, our earnings are higher in the second and fourth quarters. As a result, we may have to enter into short-term borrowings in our first and third quarters in order to offset these fluctuations in earnings and to make distributions to our stockholders. We cannot assure you that we will remain qualified as a REIT. Risks Related to Our Status as a REIT We believe we are qualified to be taxed as a REIT for our taxable year ended December 31, 2006, and we expect to continue to qualify as a REIT for future taxable years, but we cannot assure you that we have qualified, or will remain qualified, as a REIT. The REIT qualification requirements are extremely complex and official interpretations of the federal income tax laws governing qualification as a REIT are limited. Certain aspects of our REIT qualification are beyond our control. For example, we will fail to qualify as a REIT if one of our hotel managers acquires directly or constructively more than 35% of our stock. Accordingly, we cannot be certain that we will be successful in operating so that we can remain qualified as a REIT. At any time, new laws, interpretations, or court decisions may change the federal tax laws or the federal income tax consequences of our qualification as a REIT. Moreover, our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we fail to qualify as a REIT and do not qualify for certain statutory relief provisions, or otherwise cease to be a REIT, we will be subject to federal income tax on our taxable income. We might need to borrow money or sell assets in order to pay any such tax. Unless we were entitled to relief under certain federal income tax laws, we could not re-elect REIT status until the fifth calendar year after the year in which we failed to qualify as a REIT. Maintaining our REIT qualification contains certain restrictions and drawbacks. Complying with REIT requirements may cause us to forego otherwise attractive opportunities. To remain qualified as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. In order to meet these tests, we may be required to forego attractive business or investment opportunities. For example, we may not lease to our TRS any hotel which contains gaming. Thus, compliance with the REIT requirements may hinder our ability to operate solely to maximize profits. Failure to make required distributions would subject us to tax. In order to remain qualified as a REIT, we generally are required to distribute at least 90% of our REIT taxable income, determined without regard to the dividends paid deduction, each year to our stockholders. To the extent that we satisfy this distribution requirement, but distribute less than 100% of 19 our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount specified under federal tax laws. As a result, for example, of differences between cash flow and the accrual of income and expenses for tax purposes, or of nondeductible expenditures, our REIT taxable income in any given year could exceed our cash available for distribution. Accordingly, we may be required to borrow money or sell assets to make distributions sufficient to enable us to pay out enough of our taxable income to satisfy the distribution requirement and to avoid federal corporate income tax and the 4% nondeductible excise tax in a particular year. The formation of our TRSs and TRS lessees increases our overall tax liability. Bloodstone TRS, Inc. and any other of our domestic TRSs are subject to federal and state income tax on their taxable income. The taxable income of our TRS lessees is included in the taxable income of Bloodstone TRS, Inc. and currently consists and generally will continue to consist of revenues from the hotels leased by our TRS lessees plus, in certain cases, Key Money payments (amounts paid to us by a hotel management company in exchange for the right to manage a hotel we acquire), net of the operating expenses for such properties and rent payments to us. Such taxes could be substantial. Our non-U.S. TRSs also may be subject to tax in jurisdictions where they operate. We incur a 100% excise tax on transactions with our TRSs that are not conducted on an arms-length basis. For example, to the extent that the rent paid by one of our TRS lessees exceeds an arms-length rental amount, such amount potentially is subject to the excise tax. While we believe we structure all of our leases on an arms-length basis, upon an audit, the IRS might disagree with our conclusion. You may be restricted from transferring our common stock. In order to maintain our REIT qualification, among other requirements, no more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws to include various kinds of entities) during the last half of any taxable year (other than the first year for which a REIT election is made). In addition, the REIT rules generally prohibit a manager of one of our hotels from owning, directly or indirectly, more than 35% of our stock and a person who holds 35% or more of our stock from also holding, directly or indirectly, more than 35% of any such hotel management company. To qualify for and preserve REIT status, our charter contains an aggregate share ownership limit and a common share ownership limit. Generally, any shares of our stock owned by affiliated owners will be added together for purposes of the aggregate share ownership limit, and any shares of common stock owned by affiliated owners will be added together for purposes of the common share ownership limit. If anyone transfers or owns shares in a way that would violate the aggregate share ownership limit or the common share ownership limit (unless such ownership limits have been waived by our board of directors), or prevent us from continuing to qualify as a REIT under the federal income tax laws, those shares instead will be transferred to a trust for the benefit of a charitable beneficiary and will be either redeemed by us or sold to a person whose ownership of the shares will not violate the aggregate share ownership limit or the common share ownership limit. If this transfer to a trust fails to prevent such a violation or our continued qualification as a REIT, then we will consider the initial intended transfer or ownership to be null and void from the outset. The intended transferee or owner of those shares will be deemed never to have owned the shares. Anyone who acquires or owns shares in violation of the aggregate share ownership limit, the common share ownership limit (unless such ownership limits have been waived by our board of directors) or the other restrictions on transfer or ownership in our charter bears the risk of a financial loss when the shares are redeemed or sold if the market price of our stock falls between the date of purchase and the date of redemption or sale. 20 Risks Related to Our Organization and Structure Provisions of our charter may limit the ability of a third party to acquire control of our company. Our charter provides that no person may beneficially own more than 9.8% of our common stock or of the value of the aggregate outstanding shares of our capital stock, except certain “look-through entities,” such as mutual funds, which may beneficially own up to 15% of our common stock or of the value of the aggregate outstanding shares of our capital stock. Our board of directors has waived this ownership limitation for Marriott Hotel Services, Inc. and certain institutional investors in the past. Our bylaws waive this ownership limitation for certain other classes of investors. These ownership limitations may prevent an acquisition of control of our company by a third party without our board of directors’ approval, even if our stockholders believe the change of control is in their best interests. Our charter also authorizes our board of directors to issue up to 200,000,000 shares of common stock and up to 10,000,000 shares of preferred stock, to classify or reclassify any unissued shares of common stock or preferred stock and to set the preferences, rights and other terms of the classified or reclassified shares. Furthermore, our board of directors may, without any action by the stockholders, amend our charter from time to time to increase or decrease the aggregate number of shares of stock of any class or series that we have authority to issue. Issuances of additional shares of stock may have the effect of delaying, deferring or preventing a transaction or a change in control of our company that might involve a premium to the market price of our common stock or otherwise be in our stockholders’ best interests. Certain advance notice provisions of our bylaws may limit the ability of a third party to acquire control of our company. Our bylaws provide that (a) with respect to an annual meeting of stockholders, nominations of persons for election to our board of directors and the proposal of business to be considered by stockholders may be made only (i) pursuant to our notice of the meeting, (ii) by the board of directors or (iii) by a stockholder who is entitled to vote at the meeting and has complied with the advance notice procedures set forth in the bylaws and (b) with respect to special meetings of stockholders, only the business specified in our notice of meeting may be brought before the meeting of stockholders and nominations of persons for election to the board of directors may be made only (i) pursuant to our notice of the meeting, (ii) by the board of directors or (iii) provided that the board of directors has determined that directors shall be elected at such meeting, by a stockholder who is entitled to vote at the meeting and has complied with the advance notice provisions set forth in the bylaws. These advance notice provisions may have the effect of delaying, deferring or preventing a transaction or a change in control of our company that might involve a premium to the market price of our common stock or otherwise be in our stockholders’ best interests. Provisions of Maryland law may limit the ability of a third party to acquire control of our company. The Maryland General Corporation Law, or the MGCL, has certain restrictions on a “business combination” and “control share acquisition” which we have opted out of. If an affirmative majority of votes cast by a majority of stockholders entitled to vote approve it, our board of directors may opt in to such provisions of the MGCL. If we opt in, and the shareholders approve it, these provisions may have the effect of delaying, deferring or preventing a transaction or a change in control of our company that might involve a premium price for holders of our common stock or otherwise be in their best interests. Additionally, Title 3, Subtitle 8 of the MGCL permits our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to take certain actions that may have the effect of delaying, deferring or preventing a transaction or a change in control of our company that might involve a premium to the market price of our common stock or otherwise be in our stockholders’ best interests. 21 We have entered into an agreement with each of our senior executive officers that provides each of them benefits in the event his employment is terminated by us without cause, by him for good reason, or under certain circumstances following a change of control of our company. We have entered into an agreement with each of our senior executive officers that provides each of them with severance benefits if his employment is terminated under certain circumstances following a change of control of our company. Certain of these benefits and the related tax indemnity could prevent or deter a change of control of our company that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders. Risk of future dilution. As hotel acquisition opportunities arise from time to time, we may issue additional shares of common stock or preferred stock to raise the capital necessary to finance the hotel acquisitions or may issue common stock or preferred stock or partnership units, which are redeemable on a one-to-one basis for our common stock, to acquire hotels. Such issuances could result in dilution of shareholders’ equity. Future offerings of debt securities or preferred stock, which would be senior to our common stock upon liquidation and for the purpose of distributions, may cause the market price of our common stock to decline. In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. We will be able to issue additional shares of common stock or preferred stock without stockholder approval, unless stockholder approval is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Preferred stock and debt, if issued, could have a preference on liquidating distributions or a preference on dividend or interest payments that could limit our ability to make a distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interest. Risks Related to Our Debt and Financing Our existing indebtedness contains financial covenants that could limit our operations and our ability to make distributions to our stockholders. Our existing indebtedness contains financial and operating covenants, such as net worth requirements, fixed charge coverage, debt ratios and other limitations which will restrict our ability to make distributions or other payments to our stockholders, sell all or substantially all of our assets and engage in mergers, consolidations and certain acquisitions. In addition, our existing indebtedness contains restrictions (including cash management provisions) that may under circumstances specified in the loan agreements prohibit our subsidiaries that own our hotels from making distributions or paying dividends, repaying loans to us or other subsidiaries or transferring any of their assets to us or another subsidiary. Failure to meet our financial covenants could result from, among other things, changes in our results of operations, the incurrence of debt or changes in general economic conditions. These covenants may restrict our ability to engage in transactions that we believe would otherwise be in the best interests of our stockholders. This 22 could cause one or more of our lenders to accelerate the timing of payments and could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. There is refinancing risk associated with our debt. Our typical debt contains limited principal amortization, therefore the vast majority of the principal must be repaid at the maturity of the loan in a so-called “balloon payment.” At the maturity of these loans, assuming we do not have sufficient funds to repay the debt, we will need to refinance this debt. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancings, increases in interest expense will adversely affect our cash flow, and, consequently, our cash available for distribution to our stockholders. If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of our hotels on disadvantageous terms, potentially resulting in losses that could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our stockholders. If we default on our secured debt in the future, the lenders may foreclose on our hotels. All of our indebtedness for borrowed money, except our amended and restated unsecured senior credit facility, is secured by single property first mortgages on the applicable property. Should we default on any of the loans, the lender will be able to foreclose on the property pledged to the relevant lender under that loan. In addition to losing the property, a foreclosure may result in recognition of taxable income. Under the Internal Revenue Code, a foreclosure would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure even though we did not receive any cash proceeds. As a result, we may be required to identify and utilize other sources of cash for distributions to our stockholders. If this occurs, our financial condition, cash flow and ability to satisfy our other debt obligations or ability to pay distributions may be adversely affected. Future debt service obligations may adversely affect our operating results, require us to liquidate our properties, jeopardize our tax status as a REIT and limit our ability to make distributions to our stockholders. In the future, we and our subsidiaries may be able to incur substantial additional debt, including secured debt. Incurring such debt could subject us to many risks, including the risks that: • our cash flow from operations will be insufficient to make required payments of principal and interest; • we may be more vulnerable to adverse economic and industry conditions; • we may be required to dedicate a substantial portion of our cash flow from operations to the repayment of our debt, thereby reducing the cash available for distribution to our stockholders, funds available for operations and capital expenditures, future investment opportunities or other purposes; • the terms of any refinancing may not be as favorable as the terms of the debt being refinanced; and • the use of leverage could adversely affect our stock price and the ability to make distributions to our stockholders. 23 If we violate covenants in our future indebtedness agreements, we could be required to repay all or a portion of our indebtedness before maturity at a time when we might be unable to arrange financing for such repayment on favorable terms, if at all. If we obtain debt in the future and do not have sufficient funds to repay our debt at maturity, it may be necessary to refinance this debt through additional debt financing, private or public offerings of debt securities, or additional equity financings. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancings, increases in interest expense could adversely affect our cash flow, and, consequently, our cash available for distribution to our stockholders. If we are unable to refinance our debt on acceptable terms, we may be forced to dispose of our hotel properties on disadvantageous terms, potentially resulting in losses adversely affecting cash flow from operating activities. In addition, we may place mortgages on our hotel properties to secure our line of credit or other debt. To the extent we cannot meet these debt service obligations, we risk losing some or all of those properties to foreclosure. Additionally, our debt covenants could impair our planned strategies and, if violated, result in a default of our debt obligations. Higher interest rates could increase debt service requirements on our floating rate debt and could reduce the amounts available for distribution to our stockholders, as well as reduce funds available for our operations, future investment opportunities or other purposes. We may obtain in the future one or more forms of interest rate protection—in the form of swap agreements, interest rate cap contracts or similar agreements—to “hedge” against the possible negative effects of interest rate fluctuations. However, we cannot assure you that any hedging will adequately mitigate the adverse effects of interest rate increases or that counterparties under these agreements will honor their obligations. In addition, we may be subject to risks of default by hedging counter-parties. Adverse economic conditions could also cause the terms on which we borrow to be unfavorable. Item 1B. Unresolved Staff Comments None. 24 Item 2. Our Properties Overview The following table sets forth certain operating information for each of our hotels as of and for the year ended December 31, 2006. Property Chicago Marriott . . . . . . . . . . . . . . Los Angeles Airport Marriott. . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel . . . . . . Salt Lake City Marriott Downtown. Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . Renaissance Worthington. . . . . . . . Renaissance Austin Hotel. . . . . . . . Torrance Marriott. . . . . . . . . . . . . . Orlando Airport Marriott . . . . . . . . Marriott Griffin Gate Resort . . . . . Oak Brook Hills Marriott Resort . . Westin Atlanta North Location Chicago, Illinois Los Angeles, California Atlanta, Georgia Salt Lake City, Utah St. Thomas, U.S. Virgin Islands Fort Worth, Texas Austin, Texas Los Angeles County, California Orlando, Florida Lexington, Kentucky Oak Brook, Illinois at Perimeter . . . . . . . . . . . . . . . . Atlanta, Georgia Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . . . . Marriott Atlanta Alpharetta . . . . . . Courtyard Manhattan/Midtown East New York, New York Conrad Chicago . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . SpringHill Suites Atlanta Chicago, Illinois Bethesda, Maryland Vail, Colorado Atlanta, Georgia Buckhead . . . . . . . . . . . . . . . . . . Atlanta, Georgia Courtyard Manhattan/ Fifth Avenue . . . . . . . . . . . . . . . . New York, New York The Lodge at Sonoma, a Renaissance Resort & Spa . . . . . Sonoma, California TOTAL/WEIGHTED AVERAGE. . . . . . . . . . . . . . . . . Number of Rooms 1,192 1,004 521 510 504 504 492 487 486 408 384 369 346 318 312 311 272 220 185 182 Average Occupancy (%) ADR ($) RevPAR ($) 81.9% $ 210.08 $ 172.10 % Change from 2005 RevPAR(1) 16.0% 74.7 41.0 68.8 79.9 75.6 50.4 78.2 72.2 60.9 57.2 65.4 63.8 64.5 84.1 57.4 73.3 67.0 89.6 70.4 114.87 138.52 130.16 219.78 166.52 131.85 112.06 112.70 131.98 129.28 85.83 56.77 89.54 175.59 125.89 66.43 87.58 81.35 80.36 73.93 9.3 (23.6) 5.6 11.8 8.1 16.8 9.4 1.4 3.0 19.0 139.69 91.42 12.4 213.78 140.99 264.28 254.72 176.08 136.34 90.97 222.14 146.20 129.03 21.0 13.1 9.7 23.7 3.9 114.21 76.55 12.7 256.95 230.17 37.4 219.04 154.20 7.3 9,007 72.8% $ 165.27 $ 120.26 11.7% (1) The % change from 2005 RevPAR for our 2006 acquisitions compares the 2005 RevPAR of the comparable period in 2005 to our 2006 ownership period. 25 The following table sets forth information regarding our investment in each of our hotels: Property Chicago Marriott . . . . . . . . . . . . . . . . . . . Chicago, IL Los Angeles Airport Marriott . . . . . . . . . . Los Angeles, CA Renaissance Waverly Hotel . . . . . . . . . . . Atlanta, GA Salt Lake City Marriott Downtown. . . . . . Frenchman’s Reef & Morning Star Salt Lake City, UT Location Marriott Beach Resort . . . . . . . . . . . . . St. Thomas, USVI Renaissance Worthington. . . . . . . . . . . . . Fort Worth, TX Renaissance Austin Hotel. . . . . . . . . . . . . Austin, TX Torrance Marriott. . . . . . . . . . . . . . . . . . . Los Angeles County, CA Orlando Airport Marriott . . . . . . . . . . . . . Orlando, FL Marriott Griffin Gate Resort . . . . . . . . . . Lexington, KY Oak Brook Hills Marriott Resort . . . . . . . Oak Brook, IL Westin Atlanta North at Perimeter. . . . . . Atlanta, GA Vail Marriott Mountain Resort & Spa . . . Vail, CO Marriott Atlanta Alpharetta . . . . . . . . . . . Atlanta, GA Courtyard Manhattan/Midtown East . . . . New York, NY Conrad Chicago . . . . . . . . . . . . . . . . . . . . Chicago, IL Bethesda Marriott Suites . . . . . . . . . . . . . Bethesda, MD SpringHill Suites Atlanta Buckhead . . . . . Atlanta, GA Courtyard Manhattan/Fifth Avenue . . . . . New York, NY The Lodge at Sonoma, a Renaissance Resort & Spa. . . . . . . . . . . . . . . . . . . . . Sonoma, CA Total/Weighted Average (1) As of December 31, 2006. Our Hotels Bethesda Marriott Suites Year Opened 1978 1973 1983 1981 Number of Rooms(1) 1,192 1,004 521 510 Total Investment(1) (in thousands) $ 309,860 127,665 128,720 53,054 Total Investment Per Room(1) $ 259,950 127,156 247,063 104,027 1973/1984 1981 1986 1985 1983 1981 1987 1987 1983/2002 2000 1998 2001 1990 2005 1990 504 504 492 487 486 408 384 369 346 318 312 311 272 220 185 82,919 82,823 107,406 71,979 78,557 51,294 74,359 61,795 67,781 39,099 78,352 117,397 46,949 34,381 43,986 164,522 164,331 218,305 147,801 161,640 125,721 193,643 167,466 195,899 122,953 251,128 377,482 172,607 156,277 237,762 2001 182 9,007 32,890 $ 1,691,266 180,714 $ 187,772 Bethesda Marriott Suites is located in the Rock Spring Corporate Office Park near downtown Bethesda, Maryland, with convenient access to Washington, D.C.’s Beltway (I-495) and the I-270 Technology Corridor. Rock Spring Corporate Office Park contains several million feet of office space and includes companies such as Marriott and Lockheed Martin Corp., as well as the National Institute of Health. The hotel contains 272 guestrooms, all of which are suites, and 5,000 square feet of total meeting space. The hotel was built in 1990. We completed the refurbishment of guestrooms during 2006. We hold a ground lease interest in the property. The current term of the ground lease will expire in 2087. Chicago Marriott The Chicago Marriott opened in 1978 and contains 1,192 rooms, 60,000 square-feet of meeting space, and three food and beverage outlets. The 46-story hotel sits amid the world-famous shops and restaurants on Michigan Avenue, in the heart of downtown Chicago. We own a fee simple interest in the hotel. Conrad Chicago The Conrad Chicago opened in 2001 as a Le Meridien and contains 311 rooms, 33 of which are suites, and 13,000 square-feet of meeting space. The property is located on several floors within the 17-story 26 former McGraw-Hill Building, amid Chicago’s Magnificent Mile. The Conrad Chicago rises above the Westfield North Bridge Shopping Centre and the Nordstrom department store on North Michigan Avenue. The property is approximately one half block away from our Chicago Marriott. The Conrad Chicago changed management to Hilton in November 2005 and had its official “Conrad launch” in June 2006. Conrad Hotels has approximately 20 luxury properties worldwide, but currently just four are open in the United States. Conrad Hotels are to be Hilton’s equivalent of Marriott’s Ritz-Carlton brand or Starwood’s St. Regis brand, and is expected to grow significantly both domestically and overseas now that Hilton and Hilton International have combined. We own a fee simple interest in the hotel. Courtyard Manhattan/Fifth Avenue The Courtyard Manhattan/Fifth Avenue is located on 40th Street, just off of Fifth Avenue in Midtown Manhattan, across the street from the New York Public Library. The hotel is situated in a convenient tourist and business location. It is within walking distance from Times Square, Broadway theaters, Grand Central Station, Rockefeller Center and the Empire State Building. The hotel includes 185 guestrooms. We completed significant capital improvements in 2005 and 2006 in connection with our re-branding, renovation and repositioning plan. The capital improvement plan included a complete soft goods renovation of the guestrooms, purchasing new furniture and bedding for the guestrooms, renovation of the bathrooms with granite vanity tops, installation of a new exercise facility, construction of a boardroom meeting space and modifications to make the hotel more accommodating to persons with disabilities. We hold a ground lease interest in the hotel. The term of the ground lease expires in 2085, inclusive of one 49-year extension. Courtyard Manhattan/Midtown East The Courtyard Manhattan/Midtown East is located in Manhattan’s East Side, on Third Avenue between 52nd and 53rd Streets. The hotel has 312 guestrooms and 1,500 square feet of meeting space. Prior to 1998, the building was used as an office building, but then was completely renovated and opened in 1998 as a Courtyard by Marriott. We completed a complete guestroom and public space renovation during 2006. We hold a fee simple interest in a commercial condominium unit, which includes a 47.725% undivided interest in the common elements in the 866 Third Avenue Condominium; the rest of the condominium is owned predominately (48.2%) by the building’s other major occupant, Memorial Sloan-Kettering. The hotel occupies the lobby area on the 1st floor, all of the 12th-30th floors and its pro rata share of the condominium’s common elements. Frenchman’s Reef & Morning Star Marriott Beach Resort The Frenchman’s Reef & Morning Star Marriott Beach Resort is a 17-acre resort hotel located in St. Thomas, U.S. Virgin Islands. The hotel is located on a cliff overlooking Charlotte Amalie Harbor and the Caribbean Sea. The hotel has 504 guestrooms, including 27 suites, and approximately 60,000 square feet of meeting space. The hotel caters primarily to tourists, but also attracts group business travelers. The Frenchman’s Reef section of the resort was built in 1973 and the Morning Star section of the resort was built in 1984. Following severe damage from a hurricane, the entire resort was substantially rebuilt in 1996 as part of a $60 million capital improvement. We own a fee simple interest in the hotel. 27 Los Angeles Airport Marriott The Los Angeles Airport Marriott was built in 1973 and has 1,004 guestrooms, including 19 suites, and approximately 55,000 square feet of meeting space. The hotel underwent a significant renovation in 2006. The hotel attracts both business and leisure travelers due to its convenient location minutes from Los Angeles International Airport (LAX), the fourth busiest airport in the world. The property attracts large groups due to its significant amount of meeting space, guestrooms and parking spaces. We own a fee simple interest in the hotel. Marriott Atlanta Alpharetta The Marriott Atlanta Alpharetta is located in the city of Alpharetta, Georgia, approximately 22 miles north of Atlanta. Alpharetta is located in North Fulton County, a rapidly growing, very affluent county, which is characterized by being the national or regional headquarters of a number of large corporations, and it contains a large network of small and mid-sized companies supporting these corporations. The hotel is located in the Windward Office Park near several major corporations, including ADP, AT&T, McKesson, Siemens, Nortel and IBM. The hotel provides all of the amenities that are desired by business guests and is one of the few full-service hotels in a market predominately characterized by chain-affiliated select-service hotels. The hotel opened in 2000. The hotel includes 318 guestrooms and 9,000 square feet of meeting space. We own a fee simple interest in the hotel. Marriott Griffin Gate Resort Marriott Griffin Gate Resort is a 163-acre regional resort located north of downtown Lexington, Kentucky. The resort has 408 guestrooms, including 21 suites, as well as 13,000 square feet of meeting space. The resort contains three distinct components: the seven story main hotel and public areas, the Griffin Gate Golf Club, with a Rees Jones-designed 18-hole golf course, and The Mansion (which was originally constructed in 1854 and was Lexington’s first AAA 4-Diamond restaurant). The hotel is near all the area’s major corporate office parks and regional facilities of a number of major companies such as IBM, Toyota, Lexel Corporation and Lexmark International. The hotel also is located in proximity to downtown Lexington, the University of Kentucky, the historic Keeneland Horse Track and the Kentucky Horse Park. The hotel originally opened in 1981. In 2003, the prior owner, Marriott International, initiated a major renovation and repositioning of the resort, with an approximate $10 million capital improvement plan. We completed the renovation plan in 2005. The renovation included a complete guestroom and guestroom corridor renovation, as well as a renovation of the exterior façade. We also significantly renovated the public space at the hotel. We own a fee simple interest in the hotel, The Mansion, and most of the Griffin Gate Golf Club. However, there is a ground lease interest under approximately 54 acres of the golf course. The ground lease runs through 2033 (inclusive of four five-year renewal options), and contains a buyout right beginning at the end of the term in 2013 and at the end of each five-year renewal term thereafter. We are the sub- sublessee under another minor ground lease of land adjacent to the golf course, with a term expiring in 2020. Oak Brook Hills Marriott Resort In July 2005, we acquired the Oak Brook Hills Resort & Conference Center, replaced the existing manager with an affiliate of Marriott and re-branded the hotel as the Oak Brook Hills Marriott Resort. 28 The hotel underwent a significant renovation in 2006 and early 2007. The resort was built in 1987 and has 384 guestrooms, including 37 suites. The hotel markets itself to national and regional conferences by providing over 40,000 square feet of meeting space at a hotel with a championship golf course that is convenient to both O’Hare and Chicago Midway airports and is near downtown Chicago. The resort is located in Oak Brook, Illinois. The hotel is located on approximately 18 acres that we own in fee simple. The hotel is adjacent to an 18-hole, approximately 110-acre, championship golf course that we lease pursuant to a ground lease, which has approximately 40 years remaining, including renewal terms. Rent for the entire initial term of the ground lease has been paid in full. Orlando Airport Marriott The Orlando Airport Marriott was built in 1983 and has 486 guestrooms, including 14 suites, and approximately 26,000 square feet of meeting space. The hotel underwent a significant renovation in 2006. The hotel has a resort-like setting yet is well-located in a successful commercial office park five minutes from the Orlando International Airport. The hotel serves predominantly business transient guests as well as small and mid-size groups that enjoy the hotel’s amenities as well as its proximity to the airport. We own a fee simple interest in the hotel. Renaissance Austin Hotel The Renaissance Austin opened in 1986 and includes 492 rooms (14 of which were added in 2006), 60,000 square feet of meeting space, a restaurant, lounge and delicatessen. The hotel is situated in the heart of Austin’s Arboretum area, near the major technology firms located in Austin, including Dell, Motorola, IBM, Samsung and National Instruments. In close proximity are office complexes, high-end shopping and upscale restaurants. The hotel is 12 miles from downtown Austin, home of the 6th Avenue Historic District, the State Capitol, and the University of Texas. We own a fee simple interest in the hotel. Renaissance Waverly Hotel The Renaissance Waverly opened in 1983 and includes 521 rooms, 65,000 square feet of meeting space, and multiple food and beverage outlets. The Renaissance Waverly consists of a 13-story rectangular tower with an impressive atrium rising to the top floor. The Renaissance Waverly is connected to the Galleria shopping complex and the 320,000 square-foot Cobb Galleria Centre convention facility. The Galleria office complex is within Atlanta’s 2nd largest office sub-market and in close proximity to Home Depot’s world headquarters, as well as offices for IBM, Lockheed Martin and Coca-Cola. Within walking distance of the property are the Cumberland Mall, which is undergoing an $80 million renovation, and the new $145 million, 2,750-seat, Cobb Energy Performing Arts Center, which is scheduled to open in 2007. We own a fee simple interest in the hotel. Renaissance Worthington The Renaissance Worthington is Fort Worth’s only AAA Four Diamond hotel. It has 504 guestrooms, including 30 suites, and approximately 57,000 total square feet of meeting space. The hotel is located in downtown Fort Worth in Sundance Square, a sixteen-block retail area. It is also near Fort Worth’s Convention Center, which hosts a wide range of events, including conventions, conferences, sporting events, concerts and trade and consumer shows. The hotel was opened in 1981 and underwent $4 million in renovations in 2002 and 2003. 29 While the hotel does not currently face significant competition from its competitors, the City of Fort Worth has announced that it will heavily subsidize the construction of a new hotel to be managed by Omni to be built next to the convention center. We expect that hotel to become the Renaissance Worthington’s primary competitor in the market. The Omni is scheduled to open in 2009. We acquired a fee simple interest in the hotel. A portion of the land under the parking garage (consisting of 0.28 acres of the entire 3.46 acre site) is subject to three co-terminous ground leases. Each of the ground leases extends to July 31, 2022 and provides for three successive renewal options of 15 years each. The ground leases provide for adjustments to the fixed ground rent payments every ten years during the term. Salt Lake City Marriott Downtown The Salt Lake City Marriott Downtown has 510 guestrooms, including 6 suites, and approximately 22,300 square feet of meeting space. The hotel is located in downtown Salt Lake City across from the Salt Palace Convention Center near Temple Square. Demand for the hotel is generated primarily by the Convention Center, the Church of Jesus Christ of Latter-Day Saints, the University of Utah, government offices and nearby ski destinations. The hotel is connected to Crossroads Plaza Mall, which is currently completing a major reconstruction as part of a redevelopment that is expected to include the construction of up to 900 residential units. The hotel was built in 1981 and, immediately prior to the 2002 Salt Lake Olympic games, the prior owner made significant capital improvements, including the replacement of soft goods in the guestrooms and a refurbishment of the lobby, ballroom and public space. We hold ground lease interests in the hotel and the extension that connects the hotel to Crossroads Plaza Mall. The term of the ground lease for the hotel runs through 2056, inclusive of five ten-year renewal options. The term of the ground lease for the extension of the hotel (containing approximately 1,078 square feet) runs through 2017, inclusive of the one remaining ten-year renewal option. SpringHill Suites Atlanta Buckhead The SpringHill Suites Atlanta Buckhead is located in the heart of the Buckhead submarket of Atlanta, Georgia. Buckhead is one of the country’s largest urban mixed-use development areas, combining major office, retail, hotel, restaurant/entertainment and high-rise residential development within its commercial core area. The hotel is recently constructed and first opened for business in July 2005. We purchased the hotel upon opening from the developer of the hotel. We own a fee simple interest in this 220-room all-suite hotel. The hotel also has 2,000 square feet of meeting space. The Lodge at Sonoma, a Renaissance Resort & Spa The Lodge at Sonoma, a Renaissance Resort & Spa, was built in 2000 and is located in the heart of the Sonoma Valley wine country, 45 miles from San Francisco, in the town of Sonoma, California. Numerous wineries are located within a short driving distance from the resort. The area is served by the Sacramento, Oakland and San Francisco airports. The resort is readily accessible by a variety of local, county, and state highways, including Highway 101. Leisure demand is generated by Sonoma Valley and Napa Valley wine country attractions. Group and business demand is primarily generated from companies located in San Francisco and the surrounding Bay Area, and some ancillary demand is generated from the local wine industry. 30 We own a fee simple interest in the hotel, which is comprised of the main two-story Lodge building, including 76 guestrooms and 18 separate cottage buildings, containing the remaining 102 guestrooms and 4 suites. The Raindance Spa is located in a separate two-story building at the rear of the cottages. The hotel also has 22,000 square feet of meeting and banquet space. Torrance Marriott The Torrance Marriott was built in 1985 and has 487 guestrooms, including 11 suites, and approximately 23,000 square feet of indoor and outdoor meeting space. The hotel underwent a significant renovation in 2006. The hotel is located in Los Angeles County in Torrance, California, a major automotive center. Three major Japanese automobile manufacturers, Honda, Nissan and Toyota, have their U.S. headquarters in the Torrance area and generate significant demand for the hotel. It is also adjacent to the Del Amo Fashion Center mall, one of the largest malls in America. We own a fee simple interest in the hotel. Westin Atlanta North at Perimeter In May 2006, we acquired the Westin Atlanta North at Perimeter. The 20-story hotel opened in 1987 and contains 369 rooms and 20,000 square-feet of meeting space. The property is located within the Perimeter Center sub-market of Atlanta, Georgia. Comprising over 23 million square-feet of office space, Perimeter Center is one of the largest office markets in the southeast, representing substantial levels of corporate demand including: UPS, Hewlett Packard, Microsoft, Newell Rubbermaid and GE. We own a fee simple interest in the hotel. Westin Boston Waterfront Hotel In January 2007, we acquired the Westin Boston Waterfront Hotel. The hotel opened in June 2006 and contains 793 rooms and 32,000 square feet of meeting space. The Boston Westin Hotel is attached to the recently built 1.6 million square foot Boston Convention and Exhibition Center, or BCEC, and is located in the Seaport District. The Westin Boston Waterfront Hotel includes a full service restaurant, a lobby lounge, a Starbucks licensed café, a 400-car underground parking facility, a fitness center, an indoor swimming pool, a business center, a gift shop and retail space. The retail space is a separate three-floor, 100,000 square foot unfinished building attached to the Westin Boston Waterfront Hotel. When the retail space is leased to third-party tenants, we or the tenants will complete the necessary tenant improvements. We also acquired a leasehold interest in a parcel of land with development rights to build a 320 to 350 room hotel. The expansion hotel, should we decide to build it, will be located on a 1 ½ acre parcel of developable land that is immediately adjacent to the Westin Boston Waterfront Hotel. We are still investigating the cost to construct and the potential returns associated with, an expansion hotel and have not concluded whether or not to pursue this portion of the project. Vail Marriott Mountain Resort & Spa The Vail Marriott Mountain Resort & Spa is located at the base of Vail Mountain in Vail, Colorado. The hotel has 346 guestrooms, including 61 suites, and approximately 21,000 square feet of meeting space. 31 The hotel is approximately 150 yards from the Eagle Bahn Express Gondola, which transports guests to the top of Vail Mountain, the largest single ski mountain in North America, with over 5,289 acres of skiable terrain. The hotel is located in Lions Head Village, the center of which is currently undergoing a massive renovation to create a new European-inspired plaza which will include luxury condominiums and a small 36 room hotel, as well as equipment rentals, ski storage, lockers, ski and snowboard school, shopping and an après ski restaurant and bar; dining and shopping opportunities; and a winter ice-skating plaza and entertainment venues. Vail Resorts is scheduling the renovation to be completed before the 2007-2008 season. The hotel opened in 1983 and underwent a luxurious renovation of the public space, guest rooms and corridors in 2002. We completed the renovation of certain meeting space and pre-function space during 2006. We own a fee simple interest in the hotel. Our Hotel Management Agreements We are a party to hotel management agreements with Marriott for seventeen of the twenty-one properties. The Vail Marriott Mountain Resort & Spa is managed by an affiliate of Vail Resorts and is under a long-term franchise agreement with Marriott; the Westin Atlanta North at Perimeter is managed by Noble Investment Group; the Conrad Chicago is managed by Conrad Hotels USA, Inc., a subsidiary of Hilton; and the Westin Boston Waterfront Hotel is managed by Starwood. Each hotel manager is responsible for (i) the hiring of certain executive level employees, subject to certain veto rights, (ii) training and supervising the managers and employees required to operate the properties and (iii) purchasing supplies, for which we generally will reimburse the manager. The manager provides centralized reservation systems, national advertising, marketing and promotional services, as well as various accounting and data processing services. Each manager also prepares and implements annual operations budgets subject to our review and approval. Each of our management agreements limit our ability to sell, lease or otherwise transfer the hotels unless the transferee (i) is not a competitor of the manager, (ii) assumes the related management agreements and (iii) meets specified other conditions. 32 Term The following table sets forth the agreement date, initial term and number of renewal terms under the respective hotel management agreements for each of our hotels. Generally, the term of the hotel management agreements generally renew automatically for a negotiated number of consecutive periods upon the expiration of the initial term unless the property manager gives notice to us of its election not to renew the hotel management agreement. Austin Renaissance Hotel . . . . . . . . . . . . . . . . . . . . . Atlanta Alpharetta Marriott. . . . . . . . . . . . . . . . . . . . Atlanta Westin North at Perimeter. . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . Boston Westin Waterfront . . . . . . . . . . . . . . . . . . . . . Chicago Marriott Downtown . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . . Courtyard Manhattan/Midtown East . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waverly Renaissance Hotel . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . Date of Agreement 6/2005 9/2000 5/2006 12/2004 5/2004 3/2006 11/2005 01/2005 11/2004 9/2000 9/2000 12/2004 7/2005 11/2005 9/2000 12/2001 7/2005 10/2004 1/2005 6/2005 6/2005 Intitial Term 20 years 30 years 10 years 21 years 20 years 32 years 10 years 30 years 30 years Number of Renewal Terms Three ten-year periods Two ten-year periods Two five-year periods Two ten-year periods Four ten-year periods Two ten-year periods Two five-year periods None Two ten-year periods Two ten-year periods Two ten-year periods One ten-year period None None Two ten-year periods 30 years 30 years 20 years 30 years 30 years 30 years 30 years Three fifteen-year periods 30 years Two ten-year periods 20 years 40 years 20 years 15 ½ years One ten-year period None Three ten-year periods None Amounts Payable under our Hotel Management Agreements Under our current hotel management agreements, the property manager receives a base management fee and, if certain financial thresholds are met or exceeded, an incentive management fee. The base management fee is generally payable as a percentage of gross hotel revenues for each fiscal year. The incentive management fee is generally based on hotel operating profits and is typically equal to between 20% and 25% of hotel operating profits, but the fee only applies to that portion of hotel operating profits above a negotiated return on our invested capital. We refer to this excess of operating profits over a return on our invested capital as “available cash flow.” 33 The following table sets forth the base management fee and incentive management fee, generally due and payable each fiscal year, for each of our properties: Austin Renaissance Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Atlanta Alpharetta Marriott. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Atlanta North at Perimeter Westin. . . . . . . . . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Boston Westin Waterfront . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chicago Marriott Downtown . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Midtown East . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa. . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Waverly Renaissance Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . (1) As a percentage of gross revenues. Base Management Fee(1) 3% 3% 3%(5) 3% 2.5% 3% 2%(10) 5%(12) 5% 3% 3% 3% 3% 3% 3% 3% 5%(22) 3% 3% 3% 3% Incentive Management Fee(2) 20%(3) 25%(4) 10%(6) 50%(7) 20%(8) 20%(9) 15%(11) 25%(13) 25%(14) 25%(15) 25%(16) 20%(17) 20% or 30%(18) 20% or 25%(19) 25%(20) Not more than 20%(21) 25%(23) 20%(24) 20%(25) 20%(26) 20%(27) (2) Based on a percentage of hotel operating profits above a negotiated return on our investment capital as more fully described in the following footnotes. (3) Calculated as a percentage of operating profits in excess of the sum of (i) $6.0 million and (ii) 10.75% of certain capital expenditures. (4) Calculated as a percentage of operating profits in excess of the sum of (i) $4.1 million and (ii) 10.75% of certain capital expenditures. (5) The base management fee will be equal to 3% of gross revenues for fiscal years 2006 through 2008, with up to 1% of gross revenues forfeited from 2006 to 2008 if DiamondRock does not achieve an 8.5% unlevered yield in 2006, 9.5% unlevered yield in 2007, or 10.75% unlevered yield in 2008. (6) Calculated as a percentage of operating profits in excess of 10.75% of certain capital expenditures. (7) Calculated as a percentage of operating profits in excess of the sum of (i) the payment of certain loan procurement costs, (ii) 10.75% of certain capital expenditures, (iii) an agreed-upon return on certain expenditures and (iv) the value of certain amounts paid into a reserve account established for the replacement, renewal and addition of certain hotel goods. The owners priority expires in 2023. (8) Calculated as a percentage of operating profits in excess of the sum of (i) actual debt service and (ii) 15% of cumulative and compounding return on equity, which results with each sale. (9) Calculated as 20% of net operating income before base management fees. There is no owner’s priority. (10) The base management fee will be equal to 2.5% of gross revenues for fiscal years 2008 and 2009 and 3% for fiscal years thereafter. (11) Calculated as a percentage of operating profits after a pre-set dollar amount of owner’s priority. Beginning in fiscal year 2011, the incentive management fee will be 103% of the prior year cash flow. 34 (12) The base management fee will be equal to 5.5% of gross revenues for fiscal years 2010 through 2014 and 6% for fiscal year 2015 and thereafter until the expiration of the agreement. Also, beginning in 2007, the base management fee may increase to 5.5% at the beginning of the next fiscal year if operating profits equal or exceed $4.7 million, and beginning in 2011, the base management fee may increase to 6.0% at the beginning of the next fiscal year if operating profits equal or exceed $5.0 million. (13) Calculated as a percentage of operating profits in excess of 12% of the sum of (i) $38.8 million and (ii) the amount of certain capital expenditures, less 5% of the total real estate tax bill (for as long as the hotel is leased to a party other than the manager). (14) Calculated as a percentage of operating profits in excess of 10.75% of the sum of (i) $73.7 million and (ii) the amount of certain capital expenditures. (15) Calculated as a percentage of operating profits in excess of the sum of (i) $8.4 million and (ii) 10.75% of certain capital expenditures. (16) Calculated as a percentage of operating profits in excess of the sum of (i) $9.4 million and (ii) 10.75% of certain capital expenditures. (17) Calculated as a percentage of operating profits in excess of the sum of (i) $5.5 million and (ii) 10.75% of certain capital expenditures. (18) Calculated as a percentage of operating profits in excess of the sum of (i) $8.1 million and (ii) 10.75% of certain capital expenditures. The percentage of operating profits is 20% except from 2011 through 2025 when it is 30%. (19) Calculated as a percentage of operating profits in excess of 10.75% of our acquisition costs plus certain capital expenditures. We estimate that the threshold will be approximately $9 million. The percentage of operating profits is 20% except from 2011 through 2025 when it is 25%. (20) Calculated as a percentage of operating profits in excess of the sum of (i) $7.6 million and (ii) 10.75% of certain capital expenditures. (21) The incentive management fee is equal to the available cash flow for each fiscal year, subject to a cap of 20% of operating profit for such fiscal year. Commencing with the fiscal year 2002, the operating profit with respect to each fiscal year is reduced by an amount equal to 10.75% of all material capital expenditures funded by the TRS lessee; provided that the material capital expenditures are included in the calculation of the incentive management fee with respect to the fiscal year or fiscal years during which such expenditures occurred (on a pro rata basis). (22) The base management fee will be equal to 6% of gross revenues for fiscal years 2008 through 2016 and 6.5% of gross revenues thereafter. In the event that the property’s operating profit is below certain thresholds in 2006 and 2007, the base management fee may be reduced by up to $100,000 per year. In addition, in the event that the hotel’s operating profit is above certain thresholds starting in 2008, the base management fee will be increased to 6.5% and if the hotel’s operating profit is above an additional threshold starting in 2012, the base management fee will be increased to 7.0% (23) Calculated as a percentage of operating profits in excess of the sum of (i) $4.1 million and (ii) 12% of certain capital expenditures and pre-conversion expenses. (24) Calculated as a percentage of operating profits in excess of the sum of (i) $3.6 million and (ii) 10.75% of capital expenditures. (25) Calculated as a percentage of operating profits in excess of the sum of (i) $7.5 million and (ii) 10.75% of certain capital expenditures. (26) Calculated as a percentage of operating profits in excess of the sum of (i) $10.3 million and (ii) 10.75% of certain capital expenditures. (27) Calculated as a percentage of operating profits in excess of 11% of our invested capital. The incentive management fee rises to 25% if the hotel achieves operating profits in excess of 15% of our invested capital. We recorded $19.7 million and $7.9 million of management fees to Marriott during the year ended December 31, 2006 and December 31, 2005, respectively. The management fees for the year ended December 31, 2006 consisted of $8.4 million of incentive management fees and $11.3 million of base management fees. The management fees for the year ended December 31, 2005 consisted of $0.6 million of incentive management fees and $7.3 million of base management fees. 35 Our Ground Lease Agreements Four of our hotels are subject to ground lease agreements that cover all of the land underlying the respective hotel: • The Bethesda Marriott Suites hotel is subject to a ground lease that runs until 2087. There are no renewal options. • The Courtyard Manhattan/Fifth Avenue is subject to a ground lease that runs until 2085, inclusive of one 49-year renewal option. • The Salt Lake City Marriott Downtown is subject to two ground leases: one ground lease covers the land under the hotel and the other ground lease covers the portion of the hotel that extends into the Crossroads Plaza Mall. The term of the ground lease covering the land under the hotel runs through 2056, inclusive of our renewal options, and the term of the ground lease covering the extension runs through 2017, inclusive of the remaining ten-year renewal option. • The Westin Boston Waterfront is subject to a ground lease that runs until 2099. There are no renewal options. In addition, part of one of the parking garages adjacent to one of our hotels is subject to a ground lease agreement: • A portion of the parking garage relating to the Renaissance Worthington is subject to three ground leases that cover, contiguously with each other, approximately one-fourth of the land on which the parking garage is constructed. Each of the ground leases has a term that runs through July 2067, inclusive of the three 15-year renewal options. Finally, two of the golf courses adjacent to two of our hotels are subject to ground lease agreements: • The golf course that is part of the Marriott Griffin Gate Resort is subject to a ground lease covering approximately 54 acres. The ground lease runs through 2033, inclusive of our renewal options. We have the right, beginning in 2013 and upon the expiration of any 5-year renewal term, to purchase the property covered by such ground lease for an amount ranging from $27,500 to $37,500 per acre, depending on which renewal term has expired. The ground lease also grants us the right to purchase the leased property upon a third party offer to purchase such property on the same terms and conditions as the third party offer. We are also the sub-sublessee under another minor ground lease of land adjacent to the golf course, with a term expiring in 2020. • The golf course that is part of the Oak Brook Hills Marriott Resort is subject to a ground lease covering approximately 110 acres. The ground lease runs through 2045 including renewal options. These ground leases generally require us to make rental payments (including a percentage of gross receipts as percentage rent with respect to the Courtyard Manhattan/Fifth Avenue ground lease) and payments for all, or in the case of the ground leases covering the Salt Lake City Marriott Downtown extension and a portion of the Marriott Griffin Gate Resort golf course, our tenant’s share of, charges, costs, expenses, assessments and liabilities, including real property taxes and utilities. Furthermore, these ground leases generally require us to obtain and maintain insurance covering the subject property. 36 The following table reflects the annual base rents of our ground leases: Property Ground leases under hotels Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue(3)(4). . . . . . . . . . Salt Lake City Marriott Downtown Term(1) Annual Rent Through 10/87 10/97 – 9/07 10/07 – 9/17 10/17 – 9/27 10/27 – 9/37 10/37 – 9/47 10/47 – 9/57 10/57 – 9/67 10/67 – 9/77 10/77 – 9/85 $411,466(2) 800,000 906,000 1,132,812 1,416,015 1,770,019 2,212,524 2,765,655 3,457,069 4,321,336 (Ground Lease for Hotel) . . . . . . . . . . . . . . . . . . . . . Through 12/56 (Ground Lease for Extension) . . . . . . . . . . . . . . . . . . . . Westin Boston Waterfront Hotel (6) (Base Rent) . . . Westin Boston Waterfront Hotel (Percentage Rent) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ground leases under parking garage Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . Ground leases under golf course Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . Through 12/07 1/08 – 12/12 1/13 – 12/17 Through 6/11 7/11 – 6/15 7/15 – 6/20 7/20 – 6/25 7/25 – 6/30 7/30 – 6/35 7/35 – 6/99 Greater of $132,000 or 2.6% of annual gross room sales $9,343 10,277 11,305 $0 500,000 750,000 1,000,000 1,500,000 1,750,000 No base rent Through 6/16 7/16 – 6/26 7/26 – 6/36 7/36 – 6/46 7/46 – 6/56 7/56 – 6/66 7/66 – 6/99 0% of annual gross revenue 1.0% of annual gross revenue 1.5% of annual gross revenue 2.75% of annual gross revenue 3.0% of annual gross revenue 3.25% of annual gross revenue 3.5% of annual gross revenue Through 7/12 8/12 – 7/22 8/22 – 7/37 8/37 – 7/52 8/52 – 7/67 9/03 – 8/08 9/08 – 8/13 9/13-8/18 9/18-8/23 9/23-8/28 9/28-8/33 10/85-9/25 $36,613 40,400 46,081 51,764 57,444 $90,750 99,825 109,800 120,750 132,750 147,000 1(5) (1) These terms assume our exercise of all renewal options. (2) Represents rent for the year ended December 31, 2006. Rent will increase annually by 5.5%. 37 (3) The ground lease term is 49 years. We have the right to renew the ground lease for an additional 49 year term on the same terms then applicable to the ground lease. (4) The total annual rent includes the fixed rent noted in the table plus a percentage rent equal to 5% of gross receipts for each lease year, but only to the extent that 5% of gross receipts exceeds the minimum fixed rent in such lease year. (5) We have the right to extend the term of this lease for two consecutive renewal terms of ten years each with rent at then market value. (6) Total annual rent under the ground lease is capped at 2.5% of hotel gross revenues during the initial 30 years of the ground lease. Subject to certain limitations, an assignment of the ground leases covering the Courtyard Manhattan/Fifth Avenue, a portion of the Marriott Griffin Gate Resort golf course and the Oak Brook Hills Marriott Resort golf course do not require the consent of the ground lessor. With respect to the ground leases covering the Salt Lake City Marriott Downtown hotel and extension, Bethesda Marriott Suites and Westin Boston Waterfront, any proposed assignment of our leasehold interest as ground lessee under the ground lease requires the consent of the applicable ground lessor. As a result, we may not be able to sell, assign, transfer or convey our ground lessee’s interest in any such property in the future absent the consent of the ground lessor, even if such transaction may be in the best interests of our stockholders. Mortgage Debt As of December 31, 2006, we had approximately $841.2 million of outstanding mortgage debt. The following table sets forth our mortgage debt obligations on our hotels. Property Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . Courtyard Manhattan/Midtown East . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . Austin Renaissance Hotel . . . . . . . . . . . . . . . . . . . . Waverly Renaissance Hotel . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal Balance (in thousands) $ 18,742 62,500 29,806 82,600 51,000 43,215 59,000 36,888 57,400 220,000 83,000 97,000 $841,151 Interest Rate 7.69% Maturity Date 2/23 Amortization Provisions 25 years 5.44% 5.11% 5.30% 6.48% 5.195% 5.68% 5.50% 5.40% 5.975% 5.507% 5.503% 8/15 1/10 7/15 6/16 12/09 12/15 1/15 7/15 4/16 12/16 12/16 30 years(1) 25 years Interest Only Interest Only 25 years 30 years (2) 20 years(3) 30 years(4) 30 years(5) Interest Only Interest Only (1) The debt has a three-year interest only period that commenced in July 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (2) The debt has a five-year interest only period that commenced in December 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (3) There is an accelerated amortization provision based on a predetermined formula of available cash flow. (4) The debt has a four-year interest only period that commenced in June 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (5) The debt has a 3.5 year interest only period that commenced in April 2006. After the expiration of that period, the debt will amortize based on a thirty-year schedule. Item 3. Legal Proceedings We are not involved in any material litigation nor, to our knowledge, is any material litigation threatened against us. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of our stockholders during the fourth quarter of the fiscal year ended December 31, 2006. 38 Item 5. Market for our common stock and related stockholder matters Market Information PART II Our common stock trades on the New York Stock Exchange, or NYSE, under the symbol “DRH”. The following table sets forth, for the indicated period, the high and low closing prices for the common stock, as reported on the NYSE: Year Ended December 31, 2005 First Quarter(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second Quarter(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third Quarter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 First Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Second Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Third Quarter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fourth Quarter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2007 Price Range High Low N/A $ 11.73 $ 12.62 $ 12.00 $ 13.52 $ 15.66 $ 16.85 $ 18.13 N/A $ 10.50 $ 11.14 $ 10.84 $ 11.63 $ 12.95 $ 13.90 $ 16.16 First Quarter (as of February 28, 2007). . . . . . . . . . . . . . . . . . . . . . . $19.28 $18.00 (1) Our common stock commenced trading on the NYSE on May 26, 2005. The closing price of our common stock on the NYSE on February 28, 2007 was $18.09 per share. In order to maintain our qualification as a REIT, we must make distributions to our stockholders each year in an amount equal to at least: • 90% of our REIT taxable income determined without regard to the dividends paid deduction, plus; • 90% of the excess of our net income from foreclosure property over the tax imposed on such income by the U.S. Internal Revenue Code of 1986, as amended (the “Code”), minus; • Any excess non-cash income. The following graph provides a comparison of cumulative total stockholder return for the period from May 25, 2005 (the date of our initial public offering) through December 31, 2006, among DiamondRock Hospitality Company, the Standard & Poor’s 500 Index (the “S&P 500 Total Return”) and Morgan Stanley REIT Index (the “RMZ Total Return”). 39 The total return values were calculated assuming a $100 investment on May 25, 2005 with reinvestment of all dividends in (i) our common stock, (ii) the S&P 500 Total Return, and (iii) the RMZ Total Return. The total return values do not include any dividends declared, but not paid, during the period. 195.00 185.00 175.00 165.00 155.00 145.00 135.00 125.00 115.00 105.00 95.00 5/25/2005 12/31/2005 12/31/2006 DiamondRock Hospitality Company Total Return RMZ Total Return S&P 500 Total Return DiamondRock Hospitality Company Total Return . . . . RMZ Total Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . S&P 500 Total Return. . . . . . . . . . . . . . . . . . . . . . . . . . . . . May 25, 2005 $100.00 $100.00 $100.00 December 31, 2005 December 31, 2006 117.58 111.73 106.07 $185.72 $151.85 $122.82 During the first fiscal quarter of 2006, the Company’s board of directors declared a cash dividend of $0.18 per share of our common stock. The dividend was paid on April 11, 2006, to all stockholders of record as of March 24, 2006. During the second fiscal quarter of 2006, our board of directors declared a cash dividend of $0.18 per share of our common stock. The dividend was paid on June 22, 2006 to stockholders of record as of June 16, 2006. During the third fiscal quarter of 2006, our board of directors declared a cash dividend of $0.18 per share of our common stock. The dividend was paid on September 19, 2006 to stockholders of record as of September 8, 2006. During the fourth fiscal quarter of 2006, our board of directors declared a cash divided of $0.18 per share of our common stock. The dividend was paid on January 4, 2007 to stockholders on record as of December 21, 2006. As of February 28, 2007, there were 18 record holders of our common stock. In order to comply with certain requirements related to our qualification as a REIT, our charter, subject to certain exceptions, limits the number of common shares that may be owned by any single person or affiliated group to 9.8% of the outstanding common shares. Distribution Information In order to maintain our qualification as a REIT, we must make annual distributions to our stockholders of at least 90% of our taxable income (excluding net capital gains). For federal income tax purposes, distributions that we make may consist of ordinary income, capital gains, nontaxable return of capital or a combination of those items. Distributions that exceed our current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend, which reduces a stockholder’s basis in the shares of common stock and will not be taxable to the extent that the distribution equals or is less than the stockholder’s basis in the stock. To the extent that a distribution 40 exceeds both current and accumulated earnings and profits and the stockholder’s basis in the stock, that distribution will be treated as a gain from the sale or exchange of that stockholder’s shares. Every year, we notify stockholders of the taxable composition of distributions paid during the preceding year. The Company made distributions per common share for the 2006 tax year of $0.684521, of which 82.438% ($0.564303 per common share) is taxable as ordinary income and 17.562% ($0.120218 per common share) is taxable as qualified dividends. The Company made distributions per common share for the 2005 tax year of $0.295723, of which 84.976% ($0.251293 per common share) was taxable as ordinary income and 15.024% ($0.044430 per common share) was taxable as qualified dividends. Equity compensation plan information. The following table sets forth information regarding securities authorized for issuance under our equity compensation plan, the 2004 Stock Option and Incentive Plan, as of December 31, 2006. Under our 2004 Stock Option and Incentive Plan, we have only issued shares of restricted stock and deferred stock units. We have not issued any options to purchase shares of the Company’s common stock and do not intend to issue any such options in 2007. See Note 5 to the accompanying consolidated financial statements for a complete description of the 2004 Stock Option and Incentive Plan. Equity Compensation Plan Information Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) Weighted-average exercise price of outstanding options, warrants and rights (b) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c) Plan category Equity compensation plans approved by security holders . . . . . . . . . . . . . . . . 1,206,763 Equity compensation plans not approved by security holders . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 1,206,763 N/A N/A N/A 793,237 — 793,237 41 Item 6. Selected Financial Data The selected historical financial information as of and for the years ended December 31, 2006 and 2005 and as of December 31, 2004 and the period from May 6, 2004 to December 31, 2004, has been derived from our audited historical financial statements. The selected historical financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements as of and for the years ended December 31, 2006 and 2005 and as of December 31, 2004 and the period from May 6, 2004 to December 31, 2004, and the related notes contained elsewhere in this Form 10-K. We present the following two non-GAAP financial measures that we believe are useful to investors as key measures of our operating performance: (1) EBITDA; and (2) FFO. We caution investors that amounts presented in accordance with our definitions of EBITDA and FFO may not be comparable to similar measures disclosed by other companies, since not all companies calculate these non-GAAP measures in the same manner. EBITDA and FFO should not be considered as an alternative measure of our net income (loss), operating performance, cash flow or liquidity. EBITDA and FFO may include funds that may not be available for our discretionary use due to functional requirements to conserve funds for capital expenditures and property acquisitions and other commitments and uncertainties. Although we believe that EBITDA and FFO can enhance your understanding of our results of operations, these non- GAAP financial measures, when viewed individually, are not necessarily better indicators of any trend as compared to GAAP measures such as net income (loss) or cash flow from operations. In addition, you should be aware that adverse economic and market conditions may harm our cash flow. Under this section, as required, we include a quantitative reconciliation of EBITDA and FFO to the most directly comparable GAAP financial performance measure, which is net income (loss). 42 Historical (in thousands, except per share data) Year Ended December 31, 2006 Year Ended December 31, 2005 Period from May 6, 2004 to December 31, 2004 Statement of operations data: Revenues: Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage. . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 322,198 143,493 26,199 491,890 Operating costs and expenses: Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage. . . . . . . . . . . . . . . . . . . . . . . . . . Other hotel expenses and management fees . . . . Corporate expenses . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) before income taxes . . . . . . . . . . . . . . Income tax (expense) benefit . . . . . . . . . . . . . . . . . . . Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) per share—basic . . . . . . . . . . . . . . . . . Income (loss) per share—diluted . . . . . . . . . . . . . . . Cash dividends declared per common share . . . . . . 74,521 96,145 185,588 12,403 52,362 421,019 70,871 (4,657) 36,934 38,594 (3,383) $ 35,211 0.51 $ 0.51 $ 0.72 $ FFO(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 87,573 EBITDA(2). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $127,890 $ 151,756 63,261 14,433 229,450 37,433 47,281 96,555 13,462 27,590 222,321 7,129 (1,549) 17,367 (8,689) 1,353 $ (7,336) (0.19) $ (0.19) $ 0.38 $ $ 20,254 $ 36,268 $ 5,137 1,508 429 7,074 1,455 1,267 3,445 4,114 1,053 11,334 (4,260) (1,333) 773 (3,700) 1,582 $ (2,118) $ (0.12) $ (0.12) $ — $ (1,065) $ (1,874) As of December 31, 2006 As of December 31, 2005 As of December 31, 2004 Balance sheet data (in thousands): Property and equipment, net . . . . . . . . . . . . . . . . . . . Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,686,426 19,691 1,818,965 843,771 190,266 784,928 $ 870,562 9,432 966,011 431,177 71,446 463,388 $ 285,642 76,983 391,691 180,772 15,332 195,587 (1) FFO, as defined by the National Association of Real Estate Investment Trusts (“NAREIT’), is net income (loss) determined in accordance with GAAP, excluding gains (losses) from sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures (which are calculated to reflect FFO on the same basis). The calculation of FFO may vary from entity to entity, thus our presentation of FFO may not be comparable to other similarly titled measures of other reporting companies. FFO is not intended to represent cash flows for the period. FFO has not been presented as an alternative to operating income, but as an indicator of operating performance, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. FFO is a supplemental industry-wide measure of REIT operating performance, the definition of which was first proposed by NAREIT in 1991 (and clarified in 1995, 1999 and 2002). Since the introduction of the definition by NAREIT, the term has come to be widely used by REITs. Historical GAAP cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market 43 conditions, many industry investors have considered presentations of operating results for real estate companies that use historical GAAP cost accounting to be insufficient by themselves. Accordingly, we believe FFO (combined with our primary GAAP presentations) help improve our stockholders’ ability to understand our operating performance. We only use FFO as a supplemental measure of operating performance. The following is a reconciliation between net income (loss) and FFO (in thousands): Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . . . Real estate related depreciation and amortization FFO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 $ 35,211 52,362 $ 87,573 Year Ended December 31, 2005 $ (7,336) 27,590 $ 20,254 Period from May 6, 2004 to December 31, 2004 $ (2,118) 1,053 $ (1,065) (2) EBITDA is defined as net income (loss) before interest, taxes, depreciation and amortization. We believe it is a useful financial performance measure for us and for our stockholders and is a complement to net income and other financial performance measures provided in accordance with GAAP. We use EBITDA to measure the financial performance of our operating hotels because it excludes expenses such as depreciation and amortization, taxes and interest expense, which are not indicative of operating performance. By excluding interest expense, EBITDA measures our financial performance irrespective of our capital structure or how we finance our properties and operations. By excluding depreciation and amortization expense, which can vary from hotel to hotel based on a variety of factors unrelated to the hotels’ financial performance, we can more accurately assess the financial performance of our hotels. Under GAAP, hotels are recorded at historical cost at the time of acquisition and are depreciated on a straight-line basis. By excluding depreciation and amortization, we believe EBITDA provides a basis for measuring the financial performance of hotels unrelated to historical cost. However, because EBITDA excludes depreciation and amortization, it does not measure the capital we require to maintain or preserve our fixed assets. In addition, because EBITDA does not reflect interest expense, it does not take into account the total amount of interest we pay on outstanding debt nor does it show trends in interest costs due to changes in our borrowings or changes in interest rates. EBITDA, as calculated by us, may not be comparable to EBITDA reported by other companies that do not define EBITDA exactly as we define the term. Because we use EBITDA to evaluate our financial performance, we reconcile it to net income (loss) which is the most comparable financial measure calculated and presented in accordance with GAAP. EBITDA does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to operating income or net income determined in accordance with GAAP as an indicator of performance or as an alternative to cash flows from operating activities as an indicator of liquidity. The following is a reconciliation between net income (loss) and EBITDA (in thousands): Net income (loss). . . . . . . . . . . . . . . . . . . . . . . . Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense (benefit). . . . . . . . . . . . . . . Real estate related depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . . . EBITDA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 $ 35,211 36,934 3,383 Year Ended December 31, 2005 $ (7,336) 17,367 (1,353) Period from May 6, 2004 to December 31, 2004 $ (2,118) 773 (1,582) 52,362 $ 127,890 27,590 $ 36,268 1,053 $ (1,874 ) 44 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements about our business. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in “Forward-Looking Statements” and “Risk Factors” contained in our SEC filings. Overview We are a lodging focused real estate company that owns, as of February 28, 2007, twenty-one hotels and resorts that contain nearly 10,000 guest rooms. We differentiate ourselves from our competitors because of our adherence to three basic principles: • high quality urban and resort focused real estate; • conservative capital structure; and • thoughtful asset management. High Quality and Resort Focused Real Estate We own and seek to acquire premium hotels and resorts in North America. Since our formation in May 2004, we have acquired 21 properties, with purchase prices aggregating over $2 billion, including five hotels with purchase prices aggregating over $700 million in 2006. These hotels and resorts are all categorized as upper upscale as defined by Smith Travel Research and are generally located in high barrier to entry markets with multiple demand generators. Our properties are concentrated in five key gateway cities (New York City, Los Angeles, Chicago, Boston and Atlanta) and in destination resorts (such as the U.S. Virgin Islands and Vail, Colorado). We believe that these gateway cities and destination resorts are high growth markets because they are attractive business and leisure destinations. We also believe that these locations are better insulated from new supply due to relatively high barriers to entry and expensive construction costs. We believe that the higher quality lodging assets create more dynamic cash flow growth and superior long-term capital appreciation. Conservative Capital Structure We are committed to maintaining a conservative and flexible capital structure with prudent leverage levels. During 2004 through 2006, we have taken advantage of the low interest environment by fixing our debt rates for an extended period of time. Depending on the outlook for interest rates in the future we maintain the flexibility to modify these strategies. As of December 31, 2006, 100% of our debt carried fixed interest rates, with a weighted-average interest rate of 5.69%, and a weighted-average maturity date of 8.8 years. As of December 31, 2006, we had $841.2 million of debt outstanding, representing a net debt-to-enterprise value ratio of 37%, which is calculated as our market capitalization plus net debt. We prefer a relatively simple but efficient capital structure. We have not invested in joint ventures and have not issued any operating partnership units or preferred stock. We endeavor to structure our hotel acquisitions so that they will not overly complicate our capital structure; however, we will consider a more complex transaction if we believe that the projected returns to our stockholders will significantly exceed the returns that would otherwise be available. 45 Thoughtful Asset Management We believe that we are able to create significant value in our portfolio by utilizing our management’s extensive experience and our innovative asset management strategies. Our senior management team has established a broad network of hotel industry contacts and relationships, including relationships with hotel owners, financiers, operators, project managers and contractors and other key industry participants. Our philosophy is to negotiate management agreements that give us the right to exert significant influence over the management of our properties, annual budgets and all capital expenditures, and then to use those rights to continually monitor and improve the performance of our properties. We cooperatively partner with the managers of our hotels in an attempt to increase operating results and long-term asset values at our hotels. In addition to working directly with the personnel at our hotels, our senior management team also has long-standing professional relationships with our hotel managers’ senior executives and we work directly with these senior executives to improve the performance of our portfolio. We believe we can create significant value in our portfolio through innovative asset management strategies such as rebranding, renovating and repositioning. We are committed to regularly evaluating our portfolio to determine if we can employ these value-added strategies at our hotels. During 2006 we completed a significant amount of capital reinvestment in our hotels—completing projects that ranged from a room renovation (Courtyard Manhattan/Midtown East, Los Angeles Airport Marriott, Bethesda Marriott Suites) to a total renovation and repositioning of the hotel (Torrance Marriott and the Oak Brook Hills Marriott Resort). In connection with our planned renovations and repositionings, our senior management team and our asset managers are individually committed to completing these renovations on time, on budget and with minimum disruption at our hotels. We are optimistic that, when completed, these renovations will enable us to achieve higher rates and greater demand for our hotels. A core of our asset management strategy is to leverage national hotel brands. We strongly believe in the value of powerful national brands because we believe that they are able to produce incremental revenue and profits compared to similar unbranded hotels. Dominant national hotel brands typically have very strong reservation and reward systems and sales organizations, as a result, all of our hotels are operated under a brand owned by one of the top three national brand companies (Marriott, Starwood or Hilton) and all but two of the hotels are operated by the brand company directly. Generally, we are interested in acquiring only those hotels that are operated under a nationally recognized brand or can be converted into a branded hotel. Key Indicators of Financial Condition and Operating Performance We use a variety of operating and other information to evaluate the financial condition and operating performance of our business. These key indicators include financial information that is prepared in accordance with GAAP, as well as other financial information that is not prepared in accordance with GAAP. In addition, we use other information that may not be financial in nature, including statistical information and comparative data. We use this information to measure the performance of individual hotels, groups of hotels and/or our business as a whole. We periodically compare historical information to our internal budgets as well as industry-wide information. These key indicators include: • Occupancy percentage; • ADR; • RevPAR; • EBITDA; and • FFO. 46 Occupancy, ADR and RevPAR are commonly used measures within the hotel industry to evaluate operating performance. RevPAR, which is calculated as the product of ADR and occupancy percentage, is an important statistic for monitoring operating performance at the individual hotel level and across our business as a whole. We evaluate individual hotel RevPAR performance on an absolute basis with comparisons to budget and prior periods, as well as on a company-wide and regional basis. ADR and RevPAR include only room revenue. Room revenue comprised approximately 66% of our total revenues for each of the years ended December 31, 2006 and 2005, respectively, and is dictated by demand, as measured by occupancy percentage, pricing, as measured by ADR, and our available supply of hotel rooms. Our ADR, occupancy percentage and RevPAR performance may be impacted by macroeconomic factors such as regional and local employment growth, personal income and corporate earnings, office vacancy rates and business relocation decisions, airport and other business and leisure travel, new hotel construction and the pricing strategies of competitors. In addition, our ADR, occupancy percentage and RevPAR performance is dependent on the continued success of Marriott and its brands. We also use EBITDA and FFO as measures of the financial performance of our business. See “Non- GAAP Financial Matters.” Our Hotels As of December 31, 2006, we owned the following hotels: Location Chicago, Illinois Los Angeles, California Atlanta, Georgia Salt Lake City, Utah St. Thomas, U.S. Virgin Islands Fort Worth, Texas Austin, Texas Los Angeles County, California Property Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Orlando, Florida Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . Oak Brook, Illinois Westin Atlanta North at Perimeter. . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . Marriott Atlanta Alpharetta. . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Midtown East . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa. . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Atlanta, Georgia Vail, Colorado Atlanta, Georgia New York, New York Chicago, Illinois Bethesda, Maryland Atlanta, Georgia New York, New York Sonoma, California Lexington, Kentucky Number of Rooms 1,192 1,004 521 510 504 504 492 487 486 408 384 369 346 318 312 311 272 220 185 182 9,007 Recent Developments Follow-on offering. We completed a follow-on offering of our common stock on January 17, 2007. We sold 18,342,500 shares of common stock, including the underwriters’ over-allotment of 2,392,500 shares, at 47 an offering price of $18.15 per share. The net proceeds to us, after deduction of offering costs, were $317.6 million. Acquisition of the Westin Boston Waterfront Hotel. Subsequent to year end, we acquired a leasehold interest in the Westin Boston Waterfront Hotel and in the attached 100,000 square feet of potential retail space. We also purchased an option to acquire a leasehold interest in an adjacent parcel of land which could permit us to expand the hotel (or construct a new hotel) by more than 300 rooms. The contractual purchase price for the Westin Boston Waterfront Hotel, the retail space, and the expansion option was $330.3 million. The Westin Boston Waterfront Hotel opened in June 2006 and contains 793 rooms and 32,000 square feet of meeting space. Amended and Restated Credit Facility. We amended and restated our $75 million secured credit facility to expand it into a $200 million unsecured credit facility on February 28, 2007. 2006 Highlights Significant highlights for the year ended December 31, 2006 are as follows: • Acquisitions. We acquired five full-service hotels in 2006 for aggregate purchase prices in excess of $700 million (including working capital and cash escrowed for future renovations). The five hotels that we acquired are: the Chicago Marriott (March 24, 2006); the Westin Atlanta North at Perimeter (May 2, 2006); Conrad Chicago (November 8, 2006); and a portfolio of two full-service hotels: Renaissance Waverly Hotel and Renaissance Austin Hotel (December 8, 2006). • Follow-on Offerings. We completed a follow-on offering of our common stock on April 4, 2006. We sold 19,320,000 shares of common stock, including 2,520,000 shares of common stock exercised in the underwriters’ over-allotment, at an offering price of $13.00 per share. The net proceeds to us, after deduction of offering costs, were $237.8 million. On September 20, 2006, the Company completed another follow-on offering of our common stock, where we sold 5,750,000 shares of common stock at an offering price of $16.90 per share. The net proceeds to us, after deduction of offering costs, were $97.2 million. • Dividends. We paid shareholders on record as of March 24, 2006 a cash dividend of $0.18 per share on April 11, 2006; we paid shareholders of record on June 16, 2006 a cash dividend of $0.18 per share on June 22, 2006; we paid shareholders of record on September 8, 2006 a cash dividend of $0.18 per share on September 19, 2006; and we paid shareholders of record on December 21, 2006 a cash dividend of $0.18 per share on January 4, 2007. • Refinancing of the Courtyard Fifth Avenue. On May 9, 2006, we refinanced the $23 million variable-rate mortgage debt on the Courtyard Manhattan/Fifth Avenue with a $51 million fixed-rate loan bearing interest at 6.48% and a term of 10 years. The loan is interest only for five years, after which, the principal will amortize using a 30-year amortization schedule. The new loan is a limited recourse loan secured by a mortgage on the property. Results of Operations Year Ended December 31, 2006 As of December 31, 2006, we owned twenty hotels. Our total assets were $1.8 billion as of December 31, 2006. Total liabilities were $1.0 billion as of December 31, 2006, including $843.8 million of debt. Shareholders’ equity was approximately $784.9 million as of December 31, 2006. Our net income for the year ended December 31, 2006 was $35.2 million. We acquired five of our twenty hotels during the year ended December 31, 2006. Accordingly, the current period results are not comparable to the results for the corresponding period in 2005. 48 Revenue. Our revenues totaled $491.9 million for the year ended December 31, 2006. Revenue consisted primarily of the room, food and beverage and other revenues from our hotels. Revenues for the year ended December 31, 2006 consisted of the following (in thousands): Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $322,198 143,493 26,199 $491,890 Individual hotel revenues for the year ended December 31, 2006 consisted of the following (in millions): Property Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . . . . . . . Renaissance Worthington . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan / Midtown East. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa . . . . . . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Atlanta Alpharetta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan / Fifth Avenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Westin Atlanta North at Perimeter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Revenues $ 81.3 54.4 52.0 38.7 26.1 25.5 25.4 25.0 24.6 22.7 22.1 18.3 17.1 16.0 15.8 12.9 6.9 3.4 1.9 1.8 $491.9 The following pro forma key hotel operating statistics for the years ended December 31, 2006 and 2005 presented below include the prior year operating statistics for the comparable period in 2005 to our 2006 ownership period. Same-store RevPAR for the full year 2006 increased 11.7 percent from $107.62 to $120.26 as compared to the same period in 2005, driven by an 11.1 percent increase in the average daily rate and a 0.4 percentage point increase in occupancy (from 72.4 percent to 72.8 percent). Year Ended 72.4% December 31, 2005 % Change 0.4% 11.1 % 11.7 % 148.71 107.62 Occupancy % . . . . . . . . . . . . . . . . . . . . ADR . . . . . . . . . . . . . . . . . . . . . . . . . . . RevPAR . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 72.8% $165.27 $120.26 49 The pro forma hotel operating statistics presented below include the prior year operating statistics for the comparable period in 2005 to our 2006 ownership period. Individual hotel RevPAR for the years ended December 31, 2006 and 2005 is as follows: Property Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan / Midtown East . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/ Fifth Avenue . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Atlanta Alpharetta. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa. . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . Westin Atlanta North at Perimeter. . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 $ 129.03 172.10 146.20 222.14 230.17 175.59 85.83 90.97 80.36 73.93 81.35 66.43 56.77 125.89 89.54 76.55 154.20 87.58 136.34 91.42 $ 120.26 Year Ended December 31, 2005 $ 124.13 148.33 118.17 202.52 167.46 157.06 78.52 80.42 78.00 62.13 80.19 56.87 74.31 116.45 84.76 67.92 143.65 80.07 112.66 81.33 $ 107.62 % Change from 2005 (1) 3.9% 16.0 23.7 9.7 37.4 11.8 9.3 13.1 3.0 19.0 1.4 16.8 (23.6) 8.1 5.6 12.7 7.3 9.4 21.0 12.4 11.7% (1) The percentage change from 2005 RevPAR for our 2006 acquisitions compares the 2005 RevPAR of the comparable period in 2005 to our 2006 ownership period. Hotel operating expenses. Our hotel operating expenses totaled $356.3 million for the year ended December 31, 2006. Hotel operating expenses consisted primarily of operating expenses of our hotels, including approximately $7.4 million of non-cash ground rent expense. The operating expenses for the year ended December 31, 2006 consisted of the following (in millions): Rooms departmental expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage departmental expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other hotel expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Yield support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Incentive management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ground rent—Contractual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ground rent—Non-cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 74.5 96.1 141.9 12.5 (2.8 ) 8.4 16.5 1.8 7.4 $356.3 Depreciation and amortization. Our depreciation and amortization expense totaled $52.4 million for the year ended December 31, 2006. Depreciation and amortization is recorded on our hotel buildings over 40 years for the periods subsequent to acquisition. Depreciable lives of hotel furniture, fixtures and 50 equipment are estimated as the time period between the acquisition date and the date that the hotel furniture, fixtures and equipment will be replaced. Corporate expenses. Our corporate expenses totaled $12.4 million for the year ended December 31, 2006. Corporate expenses principally consisted of employee related costs, including base payroll, bonus and restricted stock. Corporate expenses also included corporate operating costs, professional fees and directors’ fees. Corporate expenses decreased in 2006 due to the recording in 2005 of approximately $3.7 million of our commitment to issue, on the fifth anniversary of the initial public offering, 382,500 shares of common stock to our executive officers. Interest expense. Our interest expense totaled $36.9 million for the year ended December 31, 2006. This interest expense is related to mortgage debt incurred (or in one case assumed) in connection with our acquisition of our hotels ($35.2 million), amortization and write-off of deferred financing costs ($0.9 million) and interest and unused facility fees on our credit facility ($0.8 million). As of December 31, 2006, we have property-specific mortgage debt outstanding on twelve of our hotels. On all of the hotels, we have fixed-rate secured debt, which bears interest at rates ranging from 5.11% to 7.69% per year. Our weighted- average interest rate as of December 31, 2006 was 5.69%. Interest income. We recorded interest income of $4.7 million for the year ended December 31, 2006. Interest income increased from the comparable period in 2005 as a result of interest earned on cash received from our follow-on offerings during 2006. Income taxes. We recorded an expense for income taxes of $3.4 million for the year ended December 31, 2006 based primarily on the $8.6 million pre-tax income of our TRS for the year ended December 31, 2006. Year Ended December 31, 2005 As of December 31, 2005, our total assets were $966 million. Total liabilities were $502.6 million as of December 31, 2005, including $431.2 million of debt. Shareholders’ equity was approximately $463.4 million as of December 31, 2005. Our net loss for the year ended December 31, 2005 was $7.3 million. Revenue. We had total revenues of $229.5 million for the year ended December 31, 2005. Revenue consisted primarily of the room, food and beverage and other revenues from our hotels. Revenues for the year ended December 31, 2005 consisted of the following (in thousands): Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $151,756 63,261 14,433 $229,450 51 Hotel operating expenses. Our hotel operating expenses totaled $181.3 million for the year ended December 31, 2005. Hotel operating expenses consist primarily of operating expenses of our hotels, including approximately $7.1 million of non-cash ground rent expense. The operating expenses for the year ended December 31, 2005 consist of the following (in millions): Rooms departmental expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage departmental expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other hotel expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Incentive management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ground rent—Contractual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ground rent—Non-cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 37.4 47.3 73.2 7.5 0.6 6.5 1.7 7.1 $181.3 Depreciation and amortization expense. Our depreciation and amortization expense totaled $27.6 million for the year ended December 31, 2005. Depreciation and amortization is recorded on our hotel buildings over 40 years for the periods subsequent to acquisition. Depreciable lives of hotel furniture, fixtures and equipment are estimated as the time period between the acquisition date and the date that the hotel furniture, fixtures and equipment will be replaced. We have assigned shorter depreciable lives of 1-2 years for the furniture, fixtures and equipment of the Courtyard Manhattan/Midtown East, the Courtyard Manhattan/Fifth Avenue, the Bethesda Marriott Suites, the Marriott Atlanta Alpharetta, the Frenchman’s Reef & Morning Star Marriott Beach Resort, the Los Angeles Airport Marriott, the Oak Brook Hills Marriott Resort and the Orlando Airport Marriott since these hotels will undergo, and/or have undergone, significant renovations within two years of acquisition. Corporate expenses. Our corporate expenses totaled $13.5 million for the year ended December 31, 2005. Corporate expenses principally consist of employee related costs, including base payroll, bonus and restricted stock. Corporate expenses also include organizational costs, professional fees and directors’ fees. We recorded an expense of approximately $3.7 million during the year as a result of our commitment to issue, on the fifth anniversary of the initial public offering, 382,500 shares of common stock to our executive officers. Interest expense. Our interest expense totaled $17.4 million for the year ended December 31, 2005. Interest expense relates to the mortgage debt incurred (or in one case assumed) in connection with our acquisition of hotels ($15.8 million), amortization and write-off of deferred financing costs ($1.3 million) and interest and unused facility fees on our credit facility ($0.3 million). Interest income. We recorded interest income of $1.5 million for the year ended December 31, 2005. Income tax benefit. We recorded an income tax benefit for income taxes of $1.4 million for the year ended December 31, 2005. We recorded an income statement charge of $1.4 million in the first quarter to reverse a portion of the deferred tax assets recorded in 2004 in connections with our REIT election. This charge was offset by an income tax benefit of $2.8 million recorded on the $7 million pre-tax loss of our TRS for the year ended December 31, 2005. May 6, 2004 (inception) through December 31, 2004 We were formed on May 6, 2004, began operations in July 2004 and acquired our first hotel in October 2004. We competed our private placement of common stock in July 2004 and received proceeds, net of offering costs and fees, of approximately $196.3 million. Stockholders’ equity at December 31, 2004 52 was approximately $195.6 million. Our GAAP loss before income taxes, for the period from inception (May 6, 2004) through December 31, 2004, was $3.7 million. Revenue. We had total revenues of $7.1 million for the period from May 6, 2004 to December 31, 2004. Revenue consists primarily of the room, food and beverage and other revenues from The Lodge at Sonoma, a Renaissance Resort & Spa, and the Courtyard Manhattan/Midtown East for the periods subsequent to our acquisition dates of October 27, 2004 and November 19, 2004, respectively. Revenues are also included for the post acquisition period for our other four acquisitions, completed during the last two weeks of 2004. The average occupancy of our hotels was 67.9% for the periods subsequent to acquisition. The hotels collectively achieved an ADR of $184.22 and RevPAR of $125.02, respectively, for the periods subsequent to acquisition. Hotel operating expenses. Our hotel operating expenses totaled $6.2 million for the period from May 6, 2004 to December 31, 2004. Hotel operating expenses consist primarily of operating expenses of The Lodge at Sonoma, a Renaissance Resort & Spa, and the Courtyard Manhattan/Midtown East for the periods subsequent to our acquisition dates of October 27, 2004 and November 19, 2004, respectively. Operating expenses are also included for the post acquisition period of our other four 2004 acquisitions, which were completed during the last two weeks of 2004. Depreciation and amortization expense. Our depreciation and amortization expense totaled $1.1 million for the period from May 6, 2004 to December 31, 2004. Depreciation and amortization is recorded on our hotels for the periods subsequent to acquisition. Depreciable lives of hotel furniture, fixtures and equipment are estimated as the time period between the acquisition date and the date that the hotel furniture, fixtures and equipment will be replaced. The furniture, fixtures and equipment depreciable lives are less than one year for the Courtyard Manhattan/Midtown East, the Courtyard Manhattan/Fifth Avenue and the Bethesda Marriott Suites since these hotels were scheduled to undergo significant renovations in 2005 and 2006. Corporate expenses. Our corporate expenses totaled $4.1 million for the period from May 6, 2004 to December 31, 2004. Corporate expenses principally consist of employee related costs, including base salary, bonus and restricted stock. Corporate expenses also include organizational costs, professional fees and directors’ fees. Interest expense. Our interest expense totaled $0.8 million for the period from May 6, 2004 to December 31, 2004. Interest expense relates to the mortgage debt incurred in connection with our acquisitions. Our mortgage debt on two of our hotels bore interest at variable rates based on LIBOR. The interest rates as of December 31, 2004 on these two mortgage loans were 4.74% and 5.04%, respectively. The mortgage debt on our other four hotels bears interest at fixed rates ranging from 5.11% to 7.69% per annum. Interest income. We recorded interest income of $1.3 million for the period from May 6, 2004 to December 31, 2004. Income tax benefit. We recorded an income tax benefit of $1.6 million for the period from May 6, 2004 to December 31, 2004. The 2004 current tax liability of $0.9 million is the result of temporary differences primarily resulting from deferred key money, capitalized pre-opening costs, restricted stock expense, straight-line ground rent, depreciation and other items that will result in future taxable income. A significant portion of the deferred tax assets recorded in 2004 was expensed in the first quarter of 2005 in connection with our REIT election. Liquidity and Capital Resources Our short-term liquidity requirements consist primarily of funds necessary to fund future distributions to our stockholders to maintain our REIT status as well as to pay for operating expenses and other 53 expenditures directly associated with our hotels, including capital expenditures as well as payments of interest and principal. We currently expect that our operating cash flows will be sufficient to meet our short-term liquidity requirements generally through net cash provided by operations, existing cash balances and, if necessary, short-term borrowings under our credit facility. Our long-term liquidity requirements consist primarily of funds necessary to pay for the costs of acquiring additional hotels, renovations, expansions and other capital expenditures that need to be made periodically to our hotels, scheduled debt payments and making distributions to our stockholders. We expect to meet our long-term liquidity requirements through various sources of capital, cash provided by operations and borrowings, as well as through the issuances of additional equity or debt securities. Our ability to incur additional debt is dependent upon a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions imposed by existing lenders. Our ability to raise funds through the issuance of debt and equity securities is dependent upon, among other things, general market conditions for REITs and market perceptions about us. Our Financing Strategy We are committed to maintaining a conservative capital structure with prudent aggregate leverage primarily comprised of long-term fixed-rate debt. However, we maintain the flexibility to modify these strategies if we believe fundamental changes have occurred in the capital markets. As of December 31, 2006, 100% of our debt carried fixed interest rates, with a weighted-average interest rate of 5.69%, and a weighted-average maturity date of 8.8 years. Moreover, as of December 31, 2006, we had $841.2 million of debt outstanding, representing a debt-to-enterprise value ratio of 37% which is calculated as our market capitalization plus net debt. In the current market, we have a strong bias for fixed-rate long-term limited recourse single property specific debt and when possible and desirable, we will seek to replace short-term sources of capital with long-term financing. In addition to property specific debt and our credit facility, we intend to use other financing methods as necessary, including obtaining from banks, institutional investors or other lenders, bridge loans, letters of credit, and other arrangements, any of which may be unsecured or may be secured by mortgages or other interests in our investments. In addition, we may issue publicly or privately placed debt instruments. We prefer a relatively simple but efficient capital structure. We have not invested in joint ventures and have not issued any operating partnership units or preferred stock. We endeavor to structure our hotel acquisitions so that they will not overly complicate our capital structure; however, we will consider a more complex transaction if we believe that the projected returns to our shareholders will significantly exceed the returns that would otherwise be available. Our Former Senior Secured Revolving Credit Facility We were party to a $75 million senior secured revolving credit facility with Wachovia Bank, National Association, as administrative agent under the credit facility. Citicorp North America, Inc. and Bank of America, N.A. were co-syndication agents under the credit facility. 54 Interest was paid on the periodic advances under the credit facility at varying rates, based upon either LIBOR or the applicable prime rate, plus an agreed upon additional margin amount. The interest rate depended upon our level of outstanding indebtedness in relation to the value of our assets from time to time, as follows: Prime rate margin . . . . . . . . . . . . . . . . . . . . . LIBOR margin. . . . . . . . . . . . . . . . . . . . . . . . 70% or greater 1.25% 2.00% Leverage Ratio 65% to 70% 1.00% 1.75% less than 65% 0.75% 1.45% In addition to the interest payable on amounts outstanding under the credit facility, we were required to pay an amount equal to 0.35% of the unused portion of the credit facility. As of December 31, 2006, we did not have an outstanding balance under the credit facility. Our senior secured credit facility contained various financial covenants. We complied with all of these covenants as of December 31, 2006. A summary of the most restrictive covenants, along with our corresponding value for each covenant, as of December 31, 2006, is as follows: Maximum leverage ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Minimum fixed charge coverage ratio . . . . . . . . . . . . . . . . . . . . Unhedged floating rate debt as a percentage of total Value at December 31, 2006 50.2% 2.88 x Covenant 75% 1.5x indebtedness. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50% 0% Minimum implied debt service ratio for the borrowing base assets for the trailing twelve months . . . . . . . . . . . . . . . . . . . Limitation on our distributions to stockholders . . . . . . . . . . . . 1.40x 100% N/A 54.9% 2006 Mortgage Financings On March 24, 2006, in connection with our acquisition of the Chicago Marriott Downtown Magnificent Mile, the Company assumed $220 million of floating-rate debt. The Company refinanced the $220 million floating-rate loan with a fixed-rate loan bearing interest at 5.98% and a term of 10 years. The loan is interest only for 3.5 years, after which, the principal will amortize using a 30-year amortization schedule. The new loan is a limited recourse loan secured by a mortgage on the property. The remainder of the purchase price, after the application of the Company’s $10 million deposit, was financed by a $79.5 million short-term floating-rate loan made by Wachovia Investment Holdings, LLC, which was repaid with a portion of the net proceeds of our follow-on offering of common stock, which closed on April 4, 2006. On May 9, 2006, we refinanced the $23 million variable-rate mortgage debt on the Courtyard Manhattan/Fifth Avenue with a $51 million fixed-rate loan bearing interest at 6.48% and a term of 10 years. The loan is interest only for five years, after which, the principal will amortize using a 30-year amortization schedule. The new loan is a limited recourse loan secured by a mortgage on the property. On December 8, 2006, we entered into mortgage debt in connection with the acquisitions of the Renaissance Austin Hotel and the Renaissance Waverly Hotel. The Renaissance Austin Hotel mortgage debt has a principal balance of $83 million, a term of 10 years, bears interest at 5.507%, and is interest only for the entire term of the loan. The Renaissance Waverly Hotel mortgage debt has a principal balance of $97 million, a term of 10 years, bears interest at 5.503%, and is interest only for the entire term of the loan. The loans are limited recourse loans secured by the mortgages on the properties. 55 New Senior Unsecured Credit Facility We amended and restated our $75 million secured credit facility to expand it into a $200 million unsecured credit facility on February 28, 2007 (“the New Facility”). As of February 28, 2007 there was $21.5 million outstanding on the New Facility. Wachovia Bank, National Association is the sole lead arranger and book manager of the New Facility. Our operating partnership is the borrower under the New Facility and certain of our material subsidiaries guarantees obligations under the New Facility. The New Facility has a term of 48 months. We may extend the maturity date of the New Facility for an additional year upon the payment of applicable fees and the satisfaction of certain standard conditions. We also have the right to increase the amount of the New Facility to $500.0 million with the lenders’ approval. Interest is paid on the periodic advances under the New Facility at varying rates, based upon either LIBOR or the alternate base rate, plus an agreed upon additional margin amount. The interest rate depends upon our level of outstanding indebtedness in relation to the value of our assets from time to time, as follows: Alternate base rate margin . . . LIBOR margin. . . . . . . . . . . . . . 60% or greater 0.65% 1.55% Leverage Ratio 55% to 60% 0.45% 1.45% 50% to 55% 0.25% 1.25% less than 50% 0.00% 0.95% In addition to the interest payable on amounts outstanding under the New Facility, we are required to pay an amount equal to 0.20% of the unused portion of the New Facility if the unused portion of the New Facility is greater than 50% and 0.125 if the unused portion of the New Facility is less than 50%. Our New Facility contains various corporate financial covenants. A summary of the most restrictive covenants is as follows: Maximum leverage ratio. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Minimum fixed charge coverage ratio . . . . . . . . . . . . . . . . . . . . . . . . . . Minimum tangible net worth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unhedged floating rate debt as a percentage of total in 65% 1.6x $738.4 million debtedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35% Our New Facility requires that the Company maintain a specific pool of unencumbered borrowing base properties. The unencumbered borrowing base assets are subject to the following limitations and covenants: • A minimum of four properties with an unencumbered borrowing base value, as defined, of not less than $150 million. • No single borrowing base asset shall contribute more than 40% of the adjusted net operating income, as defined, of the unencumbered borrowing base. • Not more than 40% of the adjusted net operating income, as defined, of the unencumbered borrowing base shall be located in one MSA. • The minimum implied debt service ratio of the unencumbered borrowing base assets shall be greater than 1.50x. • Total unsecured indebtedness shall not exceed 65% of the unencumbered borrowing base asset value, as defined. 56 Sources and Uses of Cash Our principal sources of cash are cash from operations, borrowing under mortgage financings, draws on our senior secured credit facility and the proceeds from offerings of our common stock. Our principal uses of cash are debt service, asset acquisitions, capital expenditures, operating costs, corporate expenses and dividends. Cash Provided by Operations. Our cash provided by operations was $92.8 million for the year ended December 31, 2006, which is the result of our net income, adjusted for the impact of several non-cash charges, including $52.5 million of real estate and corporate depreciation, $7.4 million of non-cash straight line ground rent, $0.9 million of amortization of deferred financing costs and loan repayment losses, $2.1 million non-cash deferred income tax expense and $3.0 million of stock grants, offset by negative working capital changes of $4.7 million, $0.3 million of key money amortization, $1.5 million amortization of unfavorable contract liabilities. Our cash used in operations was $19.8 million for the year ended December 31, 2005, which is the result of our $7.3 million net loss, adjusted for the impact of several non- cash charges, including $27.6 million of depreciation, $7.1 million of non-cash straight line ground rent, $1.3 million of amortization of deferred financing costs and loan repayment losses, and $6.3 million of stock grants, offset by working capital changes of $13.0 million and a $1.8 million non-cash income tax benefit. Our cash used in operations was $0.8 million for the period from May 6, 2004 to December 31, 2004, which is the result of our $2.1 million net loss, adjusted for the impact of several non-cash charges, including $1.1 million of depreciation, $1.4 million of stock grants and working capital changes of $0.3 million, offset by a $1.5 million of depreciation, $1.4 million of stock grants and working capital changes of $1.3 million, offset by a $2.5 million non-cash income tax benefit. Cash Used In Investing Activities. Our cash used in investing activities was $561.8 million and $619.9 million for the years ended December 31, 2006 and 2005, respectively. During the year ended December 31, 2006, we utilized $500.7 million of cash for the acquisition of the following hotels (in millions): Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Westin Atlanta North at Perimeter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 85.9 59.6 117.4 107.7 130.1 $500.7 During the year ended December 31, 2005, we utilized 611.6 million of cash for the acquisition of the following hotels (in millions): Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital Hotel Investments Portfolio (Los Angeles Airport Marriott, $ 61.5 Frenchman’s Reef & Morning Star Marriott Beach Resort, Marriott Atlanta Alpharetta, and Renaissance Worthington). . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315.2 63.7 65.7 34.1 71.4 $611.6 57 During the year ended December 31, 2006, we also incurred normal recurring capital expenditures at our other hotels of $64.3 million. In addition, we received $1.5 million of key money related to the Los Angles Marriott Renovation. During the year ended December 31, 2005 our cash used in investing activities was $619.9 million. During the year ended December 31, 2005 we utilized $611.6 million to acquire nine hotels. In addition, we received $8 million of key money related to the Torrance Marriott ($3 million), the Courtyard Manhattan/Fifth Avenue ($1 million), the Oak Brook Hills Marriott Resort ($2.5 million), the SpringHill Suites Atlanta Buckhead ($0.5 million) and the Orlando Airport Marriott ($1 million). During the period from May 6, 2004 to December 31, 2004, we also received $2.5 million of key money related to the Courtyard Manhattan/Midtown East and paid $3.3 million for pre-acquisition costs related to the acquisition of the Torrance Marriott. Cash Provided by Financing Activities. Approximately $479.2 million of cash was provided by financing activities for the year ended December 31, 2006. The cash provided by financing activities for the year ended December 31, 2006 primarily consists of $79.5 million of proceeds from a short-term loan incurred in conjunction with the acquisition of the Chicago Marriott, $451 million of proceeds from the mortgage debt of the Chicago Marriott ($220 million), the Courtyard Manhattan/Fifth Avenue ($51 million), the Renaissance Austin Hotel ($83 million) and the Renaissance Waverly Hotel ($97 million) and $336.4 million of net proceeds from sales of our common stock. The cash provided by financing activities for the year ended December 31, 2006 was offset by the $322.5 million repayment of mortgage debt, including the $220 million variable-rate mortgage assumed in the acquisition of the Chicago Marriott, the $23 million variable-rate mortgage debt on the Courtyard Manhattan/Fifth Avenue and the $79.5 million short-term loan incurred in conjunction with the acquisition of the Chicago Marriott, the $12 million net repayment of the Company’s senior secured credit facility, $3.2 million of scheduled debt principal payments, $1.8 million payment of financing costs, $3.1 of employee taxes on issued shares, $1.4 million of issuance costs, and $43.7 million of dividend payments. Approximately $532.5 million of cash was provided by financing activities for the year ended December 31, 2005. The cash provided by financing activities for the year ended December 31, 2005 primarily consists of $291.8 million of proceeds from the sale of 29.8 million shares of common stock in our initial public offering, offset by the $3.4 million of offering costs, $305.5 million of proceeds from mortgage debt of the Torrance Marriott ($44 million), the Los Angeles Marriott ($82.6 million), the Renaissance Worthington ($57.4 million), the Frenchman’s Reef Marriott & Morning Star Resort ($62.5 million), and the Orlando Airport Marriott ($59 million) and net proceeds from $12 million of draws under the senior secured credit facility. The cash provided by financing activities for the year ended December 31, 2005 was offset by the $56.9 million repayment of the secured debt incurred at the Lodge at Sonoma, a Renaissance Resort & Spa and the Torrance Marriott in June 2005, $2.8 million of financing costs paid during the year, $2.9 million of scheduled debt principal payments and $10.7 million of dividends. The $352.9 million of cash provided by financing activities for the period from May 6, 2004 to December 31, 2004 primarily consists of $197.4 million of proceeds from the sale of 21 million shares of common stock in a private placement offering, offset by the $1 million of offering costs, $158 million of proceeds from mortgage debt of the Lodge at Sonoma, a Renaissance Resort & Spa ($20 million), the Marriott Griffin Gate Resort ($31 million), the Salt Lake City Marriott Downtown ($39 million), the Courtyard Manhattan/Fifth Avenue ($23 million) and the Courtyard Manhattan/Midtown East ($45 million). The cash provided by financing activities for the period from May 6, 2004 to December 31, 2004 was offset by $1.4 million of financing costs paid during the period and $0.1 million cash paid for interest rate caps. 58 The following table summarizes our significant financing activities since the beginning of 2006: Description of Transaction Payment of fourth quarter dividends Transaction Date January 25, 2006 . . . . . . . . . . . . . . . Draw under senior secured credit facility January 27, 2006 . . . . . . . . . . . . . . . February 28, 2006. . . . . . . . . . . . . . Draw under senior secured credit facility March 9, 2006 . . . . . . . . . . . . . . . . . Draw under senior secured credit facility March 13, 2006 . . . . . . . . . . . . . . . . Draw under senior secured credit facility March 24, 2006 . . . . . . . . . . . . . . . . Repayment of senior secured credit facility March 24, 2006 . . . . . . . . . . . . . . . . April 4, 2006 . . . . . . . . . . . . . . . . . . April 5, 2006 . . . . . . . . . . . . . . . . . . Repayment of senior secured credit facility April 5, 2006 . . . . . . . . . . . . . . . . . . Repayment of Wachovia short-term loan April 11, 2006 . . . . . . . . . . . . . . . . . May 9, 2006 . . . . . . . . . . . . . . . . . . . Net proceeds from Courtyard Manhattan/ Proceeds from Wachovia short-term loan Proceeds from our follow on offering Payment of first quarter dividends Fifth Avenue refinancing Payment of second quarter dividends Payment of third quarter dividends Proceeds from follow on offering Proceeds from Renaissance Austin mortgage debt Proceeds from Renaissance Waverly mortgage debt June 22, 2006. . . . . . . . . . . . . . . . . . September 19, 2006 . . . . . . . . . . . . September 26, 2006 . . . . . . . . . . . . December 8, 2006. . . . . . . . . . . . . . December 8, 2006. . . . . . . . . . . . . . January 3, 2007 . . . . . . . . . . . . . . . . Draw under senior secured credit facility January 4, 2007 . . . . . . . . . . . . . . . . January 9, 2007 . . . . . . . . . . . . . . . . Draw under senior secured credit facility January 23, 2007 . . . . . . . . . . . . . . . February 28, 2007. . . . . . . . . . . . . . Repayment of senior secured credit facility February 28, 2007. . . . . . . . . . . . . . Draw under New Facility Payment of fourth quarter dividends Proceeds from follow-on offering Amount $ 11.0 million (8.9 million) 5.0 million 5.0 million 3.0 million (3.0 million) 79.5 million 239.2 million (33.0 million) (79.5 million) (9.3 million) 27.3 million (12.8 million) (12.8 million) 97.2 million 83.0 million 97.0 million 5.0 million (13.8 million) 15.0 million 317.9 million (20.0 million) 21.5 million Dividend Policy Generally, we intend to continue to distribute to our stockholders each year on a regular quarterly basis sufficient amounts of our REIT taxable income so as to avoid paying corporate income tax and excise tax on our earnings (other than the earnings of our TRS and TRS lessees, which are all subject to tax at regular corporate rates) and to qualify for the tax benefits afforded to REITs under the Code. In order to qualify as a REIT under the Code, we generally must make distributions to our stockholders each year in an amount equal to at least: • 90% of our REIT taxable income determined without regard to the dividends paid deduction, plus • 90% of the excess of our net income from foreclosure property over the tax imposed on such income by the Code, minus • any excess non-cash income. During the first fiscal quarter of 2006, the Company’s board of directors declared a cash divided of $0.18 per share of our common stock. The divided was paid on April 11, 2006 to all stockholders of record as of March 24, 2006. During the second fiscal quarter of 2006, the Company’s board of directors declared a cash divided of $0.18 per share of our common stock. The divided was paid on June 22, 2006 to all stockholders of record as of June 16, 2006. During the third fiscal quarter of 2006, the Company’s board of directors declared a cash divided of $0.18 per share of our common stock. The divided was paid on September 19, 2006 to all stockholders of record as of September 8, 2006. During the fourth fiscal quarter of 2006, the Company’s board of directors declared a cash divided of $0.18 per share of our common stock. The divided was paid on January 4, 2007 to all stockholders of record as of December 21, 2006. 59 Capital Expenditures The management agreements for each of our hotels provide for the establishment of separate property improvement funds to cover, among other things, the cost of replacing and repairing furniture and fixtures at the hotel. Contributions to the property improvement fund are calculated as a percentage of hotel sales. In addition, we may be required to pay for the cost of certain additional improvements that are not permitted to be funded from the property improvement fund under the applicable management agreement. As of December 31, 2006, we had set aside $28.6 million for capital projects in property improvement funds ($25.2 million) and lender held restricted cash ($3.4 million). Funds held in property improvement funds for one hotel are typically not permitted to be applied to any other property. We undertook several significant capital projects during 2006. A description of the current status of significant capital projects is as follows: • Bethesda Marriott Suites: We completed all of the planned guest room renovations in the first quarter of 2006. • Courtyard Manhattan Fifth Avenue: We completed the guestroom and corridor renovation during 2005. The renovation of the lobby and other public spaces was completed in the second quarter of 2006. • Courtyard Manhattan Midtown East: During the first quarter of 2006, we completed the renovation of guestrooms, lobby, restaurant and meeting space. • Frenchman’s Reef & Morning Star Marriott Beach Resort: We completed the replacement of case goods in select rooms and the renovation of guestrooms, restaurants and certain meeting space in the fourth quarter of 2006. • Los Angeles Airport Marriott: We recently completed a complete room renovation. The project consisted of the renovation of the hotel guestrooms and bathrooms and was funded, in part, by a $1.5 million non-recoverable contribution from Marriott. • Oak Brook Hills Marriott Resort: We began a significant renovation in the fourth quarter of 2006. The renovation will include the hotel guestrooms and bathrooms, the hotel main ballroom and meeting rooms and the hotel lobby. • Orlando Airport Marriott: We completed a significant renovation in 2006 and early 2007. The renovation included the hotel guestrooms and bathrooms, the hotel meeting rooms and the hotel lobby. The renovation began in the third quarter of 2006 and was competed in January 2007. • Torrance Marriott: We completed the renovation of the hotel lobby and the conversion of a food and beverage outlet to meeting space in the first quarter of 2007. • Vail Marriott: We are currently designing a major renovation of the hotel ballrooms. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Non-GAAP Financial Measures We use the following two non-GAAP financial measures that we believe are useful to investors as key measures of our operating performance: (1) EBITDA and (2) FFO. These measures should not be considered in isolation or as a substitute for measures of performance in accordance with GAAP. 60 EBITDA represents net income (loss) excluding: (1) interest expense; (2) provision for income taxes, including income taxes applicable to sale of assets; and (3) depreciation and amortization. We believe EBITDA is useful to an investor in evaluating our operating performance because it helps investors evaluate and compare the results of our operations from period to period by removing the impact of our capital structure (primarily interest expense) and our asset base (primarily depreciation and amortization) from our operating results. In addition, covenants included in our indebtedness use EBITDA as a measure of financial compliance. We also use EBITDA as one measure in determining the value of hotel acquisitions and dispositions. Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax expense (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate related depreciation and amortization . . . . . . . . . . EBITDA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 $ 35,211 36,934 3,383 52,362 $ 127,890 Year Ended December 31, 2005 (in thousands) $ (7,336) 17,367 (1,353) 27,590 $36,268 Period from May 6, 2004 to December 31, 2004 $(2,118) 773 (1,582) 1,053 $(1,874) We compute FFO in accordance with standards established by NAREIT, which defines FFO as net income (loss) (determined in accordance with GAAP), excluding gains (losses) from sales of property, plus depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures (which are calculated to reflect FFO on the same basis). We believe that the presentation of FFO provides useful information to investors regarding our operating performance because it is a measure of our operations without regard to specified non-cash items, such as real estate depreciation and amortization and gain or loss on sale of assets. We also use FFO as one measure in determining our results after taking into account the impact of our capital structure. Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Real estate related depreciation and amortization . . . . . . . . . . FFO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,211 52,362 $ 87,573 Year Ended December 31, 2006 Year Ended December 31, 2005 (in thousands) $ (7,336) 27,590 $ 20,254 Period from May 6, 2004 to December 31, 2004 $ (2,118) 1,053 $ (1,065) Critical Accounting Policies Our consolidated financial statements include the accounts of the Company and all consolidated subsidiaries. The preparation of financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of our financial statements and the reported amounts of revenues and expenses during the reporting period. While we do not believe the reported amounts would be materially different, application of these policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results could differ materially from these estimates. We evaluate our estimates and judgments, including those related to the impairment of long- lived assets, on an ongoing basis. We base our estimates on experience and on various other assumptions that are believed to be reasonable under the circumstances. All of our significant accounting policies are disclosed in the notes to our consolidated financial statements. The following represent certain critical accounting policies that require us to exercise our business judgment or make significant estimates: 61 Investment in Hotels. Investments in hotels, land improvements, building and furniture, fixtures and equipment and identifiable intangible assets are recorded at fair value in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations. Property and equipment, including current buildings, improvements, furniture, fixtures and equipment are recorded at fair value. Property and equipment are depreciated using the straight-line method over an estimated useful life of 15 to 40 years for buildings and land improvements and one to ten years for furniture and equipment. Identifiable intangible assets are typically related to contracts, including ground lease agreements and hotel management agreements, which are recorded at fair value. Above-market and below-market contract values are based on the present value of the difference between contractual amounts to be paid pursuant to the contracts acquired and our estimate of the fair market contract rates for corresponding contracts. Contracts acquired that are at market do not have significant value. We typically enter into a new hotel management agreement based on market terms at the time of acquisition. Intangible assets are amortized using the straight-line method over the remaining non-cancelable term of the related agreements. In making estimates of fair values for purposes of allocating purchase price, we may utilize a number of sources that may be obtained in connection with the acquisition or financing of a property and other market data. Management also considers information obtained about each property as a result of its pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired. We review our investments in hotels for impairment whenever events or changes in circumstances indicate that the carrying value of the investments in hotels may not be recoverable. Events or circumstances that may cause us to perform a review include, but are not limited to, adverse changes in the demand for lodging at our properties due to declining national or local economic conditions and/or new hotel construction in markets where our hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of an investment in a hotel exceed the hotel’s carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying value to the estimated fair market value is recorded and an impairment loss recognized. Revenue Recognition. Hotel revenues, including room, golf, food and beverage, and other hotel revenues, are recognized as the related services are provided. Stock-based Compensation. The Company accounts for stock-based employee compensation using the fair value based method of accounting described in Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), Share-Based Payment. The Company records the cost of awards with service conditions based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. No awards with performance-based or market-based conditions have been issued. Accounting for Key Money. Marriott has contributed to us certain amounts, which we refer to as “key money”, in exchange for the right to manage certain of our hotels. We defer key money received from a hotel manager in conjunction with entering into a long-term hotel management agreement and amortize the amount received against management fees over the term of the management agreement. Accounting for Yield Support. Marriott has provided us with operating cash flow guarantees for certain hotels will fund shortfalls of actual hotel operating income, which is net of management fees, compared to a negotiated target net operating income. We refer to these guarantees as “yield support”. Yield support received is recognized over the period earned if the yield support is not refundable and there is reasonable uncertainty of receipt at inception of the management agreement. Yield support is recorded as an offset to base management fees. 62 Inflation Operators of hotels, in general, possess the ability to adjust room rates daily to reflect the effects of inflation. However, competitive pressures may limit the ability of our management companies to raise room rates. Seasonality The operations of hotels historically have been seasonal depending on location, and accordingly, we expect some seasonality in our business. Historically, we have experienced approximately two-thirds of our annual income in the second and fourth quarters. New Accounting Pronouncements FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). We will adopt the provisions of FIN 48 for fiscal years beginning after December 15, 2006. We do not expect FIN 48 to have a material impact on our results of operations, financial position, or cash flows. Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. We will adopt the provisions of SFAS 157 effective January 1, 2008. We do not expect SFAS 157 to have a material impact on our results of operations, financial position or cash flows. Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), provides companies with an option to report selected financial assets and liabilities at fair value. The Standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. We will adopt the provisions of SFAS 159 effective January 1, 2008. We do not expect SFAS 159 to have a material impact on our results of operations, financial position or cash flows. Contractual Obligations The following table outlines the timing of payment requirements related to the consolidated mortgage debt and other commitments of our operating partnership as of December 31, 2006. Payments due by period (in thousands) 1 to 3 Less than years 1 year 4 to 5 years After 5 years Total Long-Term Debt Obligations including interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,286,450 $51,898 $173,303 $ 132,520 $ 928,729 Operating Lease Obligations—Ground Leasesand Office Space . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 609,787 $1,896,237 $ 1,881 $53,779 $ 3,679 $176,982 $ 3,357 $ 135,877 $ 600,870 $1,529,599 Item 7a. Quantitative and Qualitative Disclosures About Market Risk and Risk Factors Quantitative and Qualitative Disclosures about Market Risk Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. In pursuing our business strategies, the primary market risk to which we are currently exposed, and, which we expect to be exposed in the future, is interest rate risk. The face amount of our outstanding debt at December 31, 2006 was approximately $841.2 million, none of which was variable rate debt. If market rates 63 of interest were to increase by 1.0%, or approximately 100 basis points, the decrease in the fair value of our fixed-rate debt would be $49.2 million. On the other hand, if market rates of interest were to decrease by one percentage point, or approximately 100 basis points, the increase in the fair value of our fixed-rate debt would be $49.2 million. As of December 31, 2006, the fair value of the $841.2 million of fixed-rate debt was approximately $848.1 million. Item 8. Financial Statements and Supplementary Data See Index to the Financial Statements on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures The Company’s management has evaluated, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended the “Exchange Act”), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act, and have concluded that as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to give reasonable assurances that information we disclose in reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time periods specified in the SEC’s (the “SEC”) rules and forms. There was no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during the Company’s most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. See Management’s Report on Internal Control Over Financial Reporting on page F-2. Item 9B. Other Information None. 64 PART III Certain information called for by Items 10-14 is incorporated by reference from the Company’s 2007 Annual Meeting of Stockholders Notice and Proxy Statement (to be filed pursuant to Regulation 14A not later than 120 days after the close of our fiscal year). Item 10. Directors, Executive Officers and Corporate Governance The information required by this item with respect to directors is incorporated by reference to the section of DiamondRock’s definitive Proxy Statement for its 2007 Annual Meeting of Stockholders entitled “Proposal No. 1: Election of Directors.” The information required by this item with respect to compliance with Section 16(a) of the Exchange Act is incorporated by reference to the section of DiamondRock’s definitive Proxy Statement for its 2007 Annual Meeting of Stockholders entitled “Section 16(a) Beneficial Ownership Reporting Compliance.” The information required by this item with respect to DiamondRock’s Audit Committee and Audit Committee Financial Experts is incorporated by reference to the section of DiamondRock’s definitive Proxy Statement for the Company’s 2007 Annual Meeting of Stockholders entitled “The Board of Directors and Its Committees.” There have been no material changes to the procedures by which stockholders may recommend nominees to the Board of Directors since the Company’s last annual report. The Company has adopted a Code of Business Conduct and Ethics that applies to all employees. The Code is available at the Corporate Governance section of the Company’s website at www.drhc.com. A copy of the Code is available in print, free of charge, to stockholders upon request to the Company at the address set forth in Item 1, Attn: Corporate Secretary. The Company intends to satisfy the disclosure requirements under the Securities and Exchange Act of 1934, as amended, regarding an amendment to or waiver from the Company’s Code of Business Conduct and Ethics by posting such information on the Company’s web site. Item 11. Executive Compensation The information required by this item is incorporated by reference to the sections of DiamondRock’s definitive Proxy Statement for the Company’s 2007 Annual Meeting of Stockholders entitled: “Compensation Discussion and Analysis,” “Executive Compensation” and “Director Compensation .” Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The Information required by this item is incorporated by reference to the sections of DiamondRock’s definitive Proxy Statement for the Company’s 2007 Annual Meeting of Stockholders entitled: “Principal and Management Stockholders.” Item 13. Certain Relationships and Related Transactions The Information required by this item is incorporated by reference to the section of DiamondRock’s definitive Proxy Statement for the Company’s 2007 Annual Meeting of Stockholders entitled “Certain Relationships and Related Transactions.” Item 14. Principal Accounting Fees and Services The information required by this item is incorporated by reference to the section of DiamondRock’s definitive Proxy Statement for the Company’s 2007 Annual Meeting of Stockholders entitled “Information About our Independent Accountants.” 65 PART IV Item 15. Exhibits and Financial Statement Schedules 1. Financial Statements Included herein at pages F-1 through F-30. 2. Financial Statement Schedules The following financial statement schedule is included herein at pages F-31 and F-32: Schedule III—Real Estate and Accumulated Depreciation All other schedules for which provision is made in Regulation S-X are either not required to be included herein under the related instructions or are inapplicable or the related information is included in the footnotes to the applicable financial statement and, therefore, have been omitted. 3. Exhibits The following exhibits are filed as part of this Form 10-K: Exhibit Number Description of Exhibit 3.1.1 Articles of Amendment and Restatement of the Articles of Incorporation of DiamondRock Hospitality Company (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 3.1.2 Amendment to the Articles of Amendment and Restatement of the Articles of Incorporation of DiamondRock Hospitality Company (incorporated by reference to the Registrant’s Current Report on Form 8-K dated January 9, 2007) 3.2.1 Second Amended and Restated Bylaws of DiamondRock Hospitality Company (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 3.2.1 Amendment No. 1 to Second Amended and Restated Bylaws of DiamondRock Hospitality Company (incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 7, 2006) 4.1 Form of Certificate for Common Stock for DiamondRock Hospitality Company (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.1 Agreement of Limited Partnership of DiamondRock Hospitality Limited Partnership, dated as of June 4, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.2 Form of Hotel Management Agreement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.3 Form of TRS Lease (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.4* 2004 Stock Option and Incentive Plan (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.5* Form of Restricted Stock Award Agreement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 66 Exhibit Number Description of Exhibit 10.6* Form of Incentive Stock Option Agreement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.7* Form of Non-Qualified Stock Option Agreement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.8* Form of Deferred Stock Award Agreement (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123809) 10.9* Form of Indemnification Agreement between DiamondRock Hospitality Company and its directors and officers (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.10* Employment Agreement between DiamondRock Hospitality Company and William W. McCarten, dated as of June 4, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.11* Employment Agreement between DiamondRock Hospitality Company and John L. Williams, dated as of June 4, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.12* Employment Agreement between DiamondRock Hospitality Company and Mark W. Brugger, dated as of June 4, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.13* Employment Agreement between DiamondRock Hospitality Company and Michael D. Schecter, dated as of June 4, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.14* Employment Agreement between DiamondRock Hospitality Company and Sean M. Mahoney, dated as of June 30, 2004 (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (File no. 333-123065)) 10.15 Credit Agreement dated as of July 8, 2005 by and among DiamondRock Hospitality Limited Partnership, a limited partnership formed under the laws of the State of Delaware, as Borrower, DiamondRock Hospitality Company, a corporation formed under the laws of the State of Maryland , each of the financial institutions initially a signatory hereto together with their assignees pursuant to Section 13.5.(d), Wachovia Bank, National Association, as Agent, Wachovia Capital Markets, LLC, Citigroup Global Markets Inc. and Banc of America Securities LLC, as Tri-Lead Arrangers and as Tri-Bookrunners, and each of Citicorp North America, Inc. and Bank of America, N.A., as Syndication Agents and as Documentation Agents (incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 14, 2005) 10.16 Purchase Agreement, dated September 20, 2006, among DiamondRock Hospitality Company, DiamondRock Hospitality Limited Partnership, Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Citigroup Global Markets Inc. (incorporated by reference to the Registrant’s Current Report of Form 8-K filed with the Securities and Exchange Commission on September 26, 2006) 67 Exhibit Number Description of Exhibit 10.17 Purchase Agreement, dated as of November 13, 2006, by and among WSRH Austin, L.P., WSRH Atlanta Waverly, L.L.C. and DiamondRock Hospitality Limited Partnership (incorporated by reference to the Registrant’s Current Report of Form 8-K filed with the Securities and Exchange Commission on November 20, 2006) 12.1 Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends 21.1 DiamondRock Hospitality Company Subsidiaries 23.1 Consent of KPMG LLP 31.1 Certification of Chief Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. 31.2 Certification of Chief Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended. 32.1 Certification of Chief Executive Officer and Chief Financial Officer Required by Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended. * Exhibit is a management contract or compensatory plan or arrangement. 68 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 28, 2007. SIGNATURES DIAMONDROCK HOSPITALITY COMPANY By: /s/ Michael D. Schecter Name: Michael D. Schecter Title: Executive Vice President, General Counsel and Corporate Secretary Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: By: By: By: By: By: /s/ William W. McCarten Name: William W. McCarten Title: Chairman of the Board and Chief Executive Officer February 28, 2007 Date: /s/ John L. Williams Name: Title: John L. Williams President and Chief Operating Officer and Director February 28, 2007 Date: /s/ Mark W. Brugger Name: Mark W. Brugger Title: Executive Vice President, Chief Financial Officer and Treasurer February 28, 2007 Date: /s/ Sean M. Mahoney Name: Title: Sean M. Mahoney Chief Accounting Officer and Corporate Controller February 28, 2007 Date: /s/ Daniel J. Altobello Name: Daniel J. Altobello Title: Director Date: February 28, 2007 /s/ W. Robert Grafton Name: W. Robert Grafton Title: Date: Lead Director February 28, 2007 69 By: By: /s/ Maureen L. McAvey Name: Maureen L. McAvey Title: Director Date: February 28, 2007 /s/ Gilbert T. Ray Name: Gilbert T. Ray Title: Director Date: February 28, 2007 70 DIAMONDROCK HOSPITALITY COMPANY INDEX TO FINANCIAL STATEMENTS Management’s Report on Internal Control Over Financial Reporting . . . . . . . . . . . . . . . . . . . . . . . . Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Balance Sheets as of December 31, 2006 and 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Consolidated Statements of Operations for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Page F-2 F-3 F-5 F-6 Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-7 Consolidated Statements of Cash Flows for the years ended December 31, 2006 and 2005 and the period form May 6, 2004 to December 31, 2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes to Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-8 F-9 Schedule III—Real Estate and Accumulated Depreciation as of December 31, 2006 . . . . . . . . . . . F-31 F-1 Management’s Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting for the company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that: (1) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission to evaluate the effectiveness of the company’s internal control over financial reporting. Management has concluded that the company’s internal control over financial reporting was effective as of December 31, 2006. KPMG LLP has issued an attestation report on management’s assessment of the company’s internal control over financial reporting. /s/ William W. McCarten Chairman of the Board and Chief Executive Officer /s/ Mark W. Brugger Executive Vice President, Chief Financial Officer and Treasurer February 28, 2007 F-2 Report of Independent Registered Public Accounting Firm The Board of Directors DiamondRock Hospitality Company: We have audited the consolidated financial statements of DiamondRock Hospitality Company and subsidiaries (the “Company”) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of DiamondRock Hospitality Company and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of DiamondRock Hospitality Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2007, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP McLean, Virginia February 28, 2007 F-3 Report of Independent Registered Public Accounting Firm The Board of Directors of DiamondRock Hospitality Company: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that DiamondRock Hospitality Company (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the COSO. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2006 and 2005 and the related consolidated statements of operations, shareholders’ equity and cash flows for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004, and our report dated February 28, 2007, expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP McLean, Virginia February 28, 2007 F-4 DIAMONDROCK HOSPITALITY COMPANY CONSOLIDATED BALANCE SHEETS (in thousands, except share amounts) ASSETS Property and equipment, at cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: accumulated depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due from hotel managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Favorable lease asset, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid and other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred financing costs, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities: Debt, at face amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Debt premium. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income related to key money, net . . . . . . . . . . . . . . . . . . . . . . Unfavorable contract liabilities, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Due to hotel managers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dividends declared and unpaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable and accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . Total other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Shareholders’ Equity: December 31, 2006 December 31, 2005 $1,761,748 (75,322) 1,686,426 28,595 57,753 10,060 12,676 19,691 3,764 $ 1,818,965 $ 841,151 2,620 843,771 11,495 87,843 34,545 13,871 42,512 190,266 $899,310 (28,748) 870,562 23,109 38,965 10,601 10,496 9,432 2,846 $ 966,011 $428,395 2,782 431,177 10,311 5,384 22,791 8,896 24,064 71,446 Preferred stock, $.01 par value; 10,000,000 shares authorized; no shares issued and outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — Common stock, $.01 par value; 100,000,000 shares authorized; 76,191,632 and 50,819,864 shares issued and outstanding at December 31, 2006 and 2005, respectively . . . . . . . . . . . . . . . . . . . . . Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total shareholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 762 826,918 (42,752) 784,928 508 491,951 (29,071) 463,388 Total liabilities and shareholders’ equity . . . . . . . . . . . . . . . . . . . $ 1,818,965 $ 966,011 The accompanying notes are an integral part of these consolidated financial statements. F-5 DIAMONDROCK HOSPITALITY COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except share and per share amounts) Year Ended December 31, 2006 Year Ended December 31, 2005 Period from May 6, 2004 to December 31, 2004 Revenues: Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage. . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating Expenses: Rooms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Food and beverage. . . . . . . . . . . . . . . . . . . . . . . . . . . . Management fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other hotel expenses . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . Corporate expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . Operating income (loss) . . . . . . . . . . . . . . . . . . . . . . . Interest income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total other expenses (income). . . . . . . . . . . . . . . . . . Income (loss) before income taxes . . . . . . . . . . . . . . Income tax (expense) benefit . . . . . . . . . . . . . . . . . . . Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) per share: Basic and diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . Weighted-average number of common shares outstanding: Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ 322,198 143,493 26,199 491,890 74,521 96,145 20,914 164,674 52,362 12,403 421,019 70,871 (4,657) 36,934 32,277 38,594 (3,383) 35,211 0.51 $ $ $ $ 151,756 63,261 14,433 229,450 37,433 47,281 8,108 88,447 27,590 13,462 222,321 7,129 (1,549) 17,367 15,818 (8,689 ) 1,353 (7,336) (0.19) 67,534,851 39,145,789 Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67,715,661 39,145,789 $ $ $ 5,137 1,508 429 7,074 1,455 1,267 261 3,184 1,053 4,114 11,334 (4,260) (1,333) 773 (560) (3,700) 1,582 (2,118) (0.12) 18,162,916 18,162,916 The accompanying notes are an integral part of these consolidated financial statements. F-6 DIAMONDROCK HOSPITALITY COMPANY CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY Years Ended December 31, 2006 and 2005 and Period from May 6, 2004 to December 31, 2004 (in thousands except common stock) Common Stock Additional Shares 100 Par Value Paid-In Capital $ $ — 1 Accumulated Deficit Total $ — $ 1 21,000,000 210 197,166 — 197,376 Formation transactions on May 6, 2004 . . . . . Sale of common stock in private placement offering, less placement fees and expenses of $12,624 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance costs incurred related to private placement . . . . . . . . . . . . . . . . . . . . . . . . . . . . Issuance and amortization of stock grants . . . Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2004. . . . . . . . . . . . . Sale of common stock in initial public — 20,000 — 21,020,100 offering, less placement fees and expenses of $3,354 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,785,764 — 14,000 — 50,819,864 Dividends of $0.38 per common share . . . . . . Issuance and amortization of stock grants . . . Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2005. . . . . . . . . . . . . Sales of common stock in secondary offerings, less placement fees and expenses of $1,361 . . . . . . . . . . . . . . . . . . . . . 25,070,000 — 301,768 — 76,191,632 Dividends of $0.72 per common share . . . . . . Issuance and vesting of common stock grants Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2006. . . . . . . . . . . . . — — — 210 298 — — — 508 (1,029) 1,357 — 197,495 288,148 — 6,308 — 491,951 — — (2,118 ) (2,118 ) (1,029) 1,357 (2,118) 195,587 — (19,617 ) — (7,336 ) (29,071 ) 288,446 (19,617) 6,308 (7,336) 463,388 251 — 3 — $ 762 334,792 216 (41) — $826,918 — (48,892 ) — 35,211 335,043 (48,676) (38) 35,211 $(42,752 ) $ 784,928 The accompanying notes are an integral part of these consolidated financial statements. F-7 DIAMONDROCK HOSPITALITY COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Cash flows from operating activities: Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of deferred financing costs as interest . . . . . . . . . Non-cash straight-line ground rent . . . . . . . . . . . . . . . . . . . . . . Market value adjustment to interest rate caps . . . . . . . . . . . . . . Amortization of debt premium and unfavorable contract liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of deferred income and corporate depreciation . Non-cash yield support . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock-based compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred income tax expense (benefit) . . . . . . . . . . . . . . . . . . . Changes in assets and liabilities: Prepaid expenses and other assets . . . . . . . . . . . . . . . . . . . . . . . Due to/from hotel managers . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in restricted cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable and accrued expenses . . . . . . . . . . . . . . . . . . Net cash provided by (used in) operating activities . . . . . . . . . . . . Cash flows from investing activities: Hotel acquisitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Receipt of key money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hotel capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Change in restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Purchase deposits and pre-acquisition costs . . . . . . . . . . . . . . . . . . Net cash used in investing activities. . . . . . . . . . . . . . . . . . . . . . . . Cash flows from financing activities: Proceeds from debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repayments of mortgage debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net proceeds (repayments) of senior secured credit facility. . . . . . Scheduled mortgage debt principal payments . . . . . . . . . . . . . . . . Payment of financing costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash paid for interest rate caps . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from sale of common stock . . . . . . . . . . . . . . . . . . . . . . . Payment of costs related to sale of common stock . . . . . . . . . . . . . Repurchase of shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net cash provided by financing activities . . . . . . . . . . . . . . . . . . . . Net increase (decrease) in cash and cash equivalents . . . . . . . . . . . . . Cash and cash equivalents, beginning of period . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 Year Ended December 31, 2005 Period from May 6, 2004 to December 31, 2004 $ 35,211 $ (7,336) $ (2,118) 52,362 874 7,403 16 (1,516) (151) (1,804) 3,037 2,084 799 (5,231) (1,007) 723 92,800 (500,736) 1,500 (64,260) 1,724 — (561,772) 530,500 (322,500) (12,000) (3,244) (1,791) — 336,405 (1,361) (3,077) (43,701) 479,231 10,259 9,432 27,590 1,344 7,120 (8) (302) (115) — 6,308 (1,842) (833) (15,915) — 3,815 19,826 (611,604) 8,009 (18,008) 1,727 — (619,876) 305,500 (56,949) 12,000 (2,933) (2,846) — 291,800 (3,354) — (10,719) 532,499 (67,551) 76,983 1,053 29 — 25 (11) 22 — 1,357 (2,462) (581) (2,626) — 4,486 (826) (273,828) 2,500 — (481) (3,272) (275,081) 158,000 — — — (1,373) (85) 197,377 (1,029) — — 352,890 76,983 — Cash and cash equivalents, end of period . . . . . . . . . . . . . . . . . . . . . . $ 19,691 $ 9,432 $ 76,983 Supplemental Disclosure of Cash Flow Information: Cash paid for interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 34,863 $ 15,601 Capitalized interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash paid for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Non-cash Investing and Financing Activities: Repayment of mortgage debt with restricted cash held in escrow. . . . $ $ $ 604 2,384 — Assumption of mortgage debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 220,000 $ $ $ $ 128 1,006 7,051 — $ $ $ $ $ 351 — — — — The accompanying notes are an integral part of these consolidated financial statements. F-8 DIAMONDROCK HOSPITALITY COMPANY NOTES TO FINANCIAL STATEMENTS December 31, 2006 and 2005 1. Organization DiamondRock Hospitality Company (the “Company”) is a lodging focused real estate company that owns, as of February 28, 2007, twenty-one hotels and resorts that contain nearly 10,000 guest rooms. The Company differentiates ourselves from our competitors because of our adherence to three basic principles: • high quality urban and resort focused real estate; • conservative capital structure; and • thoughtful asset management. As of December 31, 2006, the Company owned twenty hotels, comprising 9,007 rooms, located in the following markets: Atlanta, Georgia (4); Austin, Texas; Chicago, Illinois (2); Fort Worth, Texas; Lexington, Kentucky; Los Angeles, California (2 hotels); New York, New York (2 hotels); Northern California; Oak Brook, Illinois; Orlando, Florida; Salt Lake City, Utah; Washington D.C.; St. Thomas, U.S. Virgin Islands; and Vail, Colorado. The Company conducts its business through a traditional umbrella partnership REIT, or UPREIT, in which the Company’s hotel properties are owned by its operating partnership, DiamondRock Hospitality Limited Partnership, or subsidiaries of the Company’s operating partnership. The Company is the sole general partner of the Company’s operating partnership and currently own, either directly or indirectly, all of the limited partnership units of the Company’s operating partnership. 2. Summary of Significant Accounting Policies Basis of Presentation The Company’s financial statements include all of the accounts of the Company and its subsidiaries in accordance with United States generally accepted accounting principles. All intercompany accounts and transactions have been eliminated in consolidation. Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Fair Value of Financial Instruments The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts payable, accrued expenses and due to/from hotel manager. Due to their short maturities, the carrying amounts of cash and cash equivalents and accounts payable and accrued expenses reasonably approximate fair value. See Note 13 for disclosures on fair values of debt and interest rate caps. Property and Equipment Investments in hotel properties, land, land improvements, building and furniture, fixtures and equipment and identifiable intangible assets are recorded at fair value in accordance with Statement of F-9 Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. Property and equipment purchased after the hotel acquisition date is recorded at cost. Replacements and improvements are capitalized, while repairs and maintenance are expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation will be removed from the Company’s accounts and any resulting gain or loss will be included in the statements of operations. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 15 to 40 years for buildings, land improvements, and building improvements and one to ten years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets. The Company reviews its investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of the hotel properties may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the properties due to declining national or local economic conditions and/or new hotel construction in markets where the hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition of a hotel exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related hotel’s estimated fair market value is recorded and an impairment loss recognized. The Company will classify a hotel as held for sale in the period that the Company has made the decision to dispose of the hotel, a binding agreement to purchase the property has been signed under which the buyer has committed a significant amount of nonrefundable cash and no significant financing contingencies exist which could cause the transaction to not be completed in a timely manner. If these criteria are met, the Company will record an impairment loss if the fair value less costs to sell is lower than the carrying amount of the hotel and will cease recording depreciation expense. The Company will classify the loss, together with the related operating results, as discontinued operations on the statements of operations and classify the assets and related liabilities as held for sale on the balance sheets. Goodwill Goodwill represents the excess of the Company’s cost to acquire a business over the net amounts assigned to assets acquired and liabilities assumed. Goodwill is not amortized, but is evaluated for impairment annually or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company’s goodwill is classified within other assets in the accompanying consolidated balance sheets. Revenue Recognition Revenues from operations of the hotels are recognized when the services are provided. Revenues consist of room sales, golf sales, food and beverage sales, and other hotel department revenues, such as telephone and gift shop sales. Income Taxes The Company accounts for income taxes using the asset and liability method prescribed in SFAS 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted. F-10 The Company has elected, effective January 1, 2005, to be treated as a REIT under the provisions of the Internal Revenue Code provided that the Company distributes all taxable income annually to the Company’s shareholders and complies with certain other requirements. In addition to paying federal and state taxes on any retained income, the Company may be subject to taxes on “built in gains” on sales of certain assets. The Company’s taxable REIT subsidiaries will generally be subject to federal and state income taxes. In order for the income from our hotel property investments to constitute “rents from real properties” for purposes of the gross income test required for REIT qualification, the income we earn cannot be derived from the operation of any of our hotels. Therefore, we lease each of our hotel properties to a wholly owned subsidiary of Bloodstone TRS, Inc., our existing taxable REIT subsidiary, or TRS, except for the Frenchman’s Reef & Morning Star Marriott Beach Resort, which is owned by a Virgin Islands corporation, for which we have elected to be treated as a TRS. Earnings (Loss) Per Share Basic earnings (loss) per share is calculated by dividing net income (loss), adjusted for dividends on unvested stock grants, by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income (loss), adjusted for dividends on unvested stock grants, by the weighted-average number of common shares outstanding during the period plus other potentially dilutive securities such as stock grants or shares issuable in the event of conversion of operating partnership units. No adjustment is made for shares that are anti-dilutive during a period. Stock-based Compensation The Company accounts for stock-based employee compensation using the fair value based method of accounting described in Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123R”), Share-Based Payment. The Company records the cost of awards with service conditions based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. No awards with performance- based or market-based conditions have been issued. Comprehensive Income (Loss) Comprehensive income includes net income (loss) as currently reported by the Company on the consolidated statement of operations adjusted for other comprehensive income items. The Company does not have any items of comprehensive income (loss) other than the net income (loss). Segment Information SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”), requires public entities to report certain information about operating segments. See Note 14. Restricted Cash Restricted cash primarily consists of reserves for replacement of furniture and fixtures held by our hotel managers and cash held in escrow pursuant to lender requirements. Deferred Financing Costs Financing costs are recorded at cost and consist of loan fees and other costs incurred in connection with the issuance of debt. Amortization of deferred financing costs is computed using a method, which F-11 approximates the effective interest method over the remaining life of the debt, and is included in interest expense in the accompanying statements of operations. Hotel Working Capital The due from hotel managers consists of hotel level accounts receivable, periodic hotel operating distributions due to owner and prepaid and other assets held by the hotel managers on the Company’s behalf. The liabilities incurred by the hotel managers are comprised of liabilities incurred on behalf of the Company in conjunction with the operation of the hotels which are legal obligations of the Company. Key Money Key money received in conjunction with entering into hotel management agreements is deferred and amortized over the term of the hotel management agreement. Deferred key money is classified as deferred income in the accompanying consolidated balance sheets and amortized against management fees on the accompanying consolidated statements of operations. Debt Premiums Debt premiums are recorded to adjust the stated value of assumed debt to fair value at the acquisition date of a hotel. Debt premiums are amortized over the remaining life of the debt to interest expense on the accompanying consolidated statements of operations. Derivative Instruments The Company may be party to interest rate swaps in the future, which are considered derivative instruments. The fair value of the interest rate swaps and interest rate caps are recorded on the Company’s consolidated balance sheets and gains or losses from the changes in the market value of the contracts are recorded in other income or expense. See Note 13 for disclosures on fair values of the interest rate caps. Straight-Line Rent The Company records rent expense on leases that provide for minimum rental payments that increase in pre-established amounts over the remaining term of the lease on a straight-line basis. Use of Estimates The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Concentration of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents. We maintain cash and cash equivalents with various high credit-quality financial institutions. We perform periodic evaluations of the relative credit standing of these financial institutions and limit the amount of credit exposure with any one institution. Yield Support Marriott has provided the Company with operating cash flow guarantees for certain hotels to fund shortfalls of actual hotel operating income compared to a negotiated target net operating income. We F-12 refer to these guarantees as “Yield Support.” Yield Support received is recognized over the period earned if the Yield Support is not refundable and there is reasonable uncertainty of receipt at inception of the management agreement. Yield Support is recorded as an offset to base management fees. Recent Accounting Pronouncements FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). We will adopt the provisions of FIN 48 for fiscal years beginning after December 15, 2006. The Company does not expect FIN 48 to have a material impact on our results of operations, financial position, or cash flows. Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. The Company will adopt the provisions of SFAS 157 effective January 1, 2008. The Company does not expect SFAS 157 to have a material impact on the Company’s results of operations, financial position, or cash flows. Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), provides companies with an option to report selected financial assets and liabilities at fair value. The Standard’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The Company will adopt the provisions of SFAS 159 effective January 1, 2008. The Company does not expect SFAS 159 to have a material impact on the Company’s results of operations, financial position or cash flows. Reclassifications Certain prior year financial statement amounts have been reclassified to conform to the current year presentation. 3. Property and Equipment Property and equipment as of December 31, 2006 and 2005 consists of the following (in thousands): Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Land improvements . . . . . . . . . . . . . . . . . . . . . . . . . Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures and equipment . . . . . . . . . . . . . Corporate office equipment and construction in progress. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: accumulated depreciation . . . . . . . . . . . . . . . December 31, 2006 $ 223,490 5,594 1,375,143 149,842 December 31, 2005 $125,466 5,594 689,789 73,864 7,679 1,761,748 (75,322) $ 1,686,426 4,597 899,310 (28,748) $870,562 4. Capital Stock Common Shares As of December 31, 2006, the Company was authorized to issue up to 100,000,000 shares of common stock, $.01 par value per share. During 2007, the Company increased the authorized number of shares of common stock to 200,000,000 shares, $.01 par value per share. Each outstanding share of common stock entitles the holder to one vote on all matters submitted to a vote of stockholders. Holders of the F-13 Company’s common stock are entitled to receive dividends when authorized by the Company’s board of directors out of assets legally available for the payment of dividends. On June 1, 2005, the Company consummated its initial public offering of common stock, selling 29,785,764 shares (including the underwriters’ subsequent purchase of the over-allotment option of 3,698,764 shares) at a price of $10.50 per share. The Company received net proceeds (after deducting offering expenses) of approximately $288.4 million. On April 4, 2006 the Company completed a secondary offing of our common stock, where the Company sold 19,320,000 shares of common stock at an offering price of $13.00 per share, yielding net proceeds to the Company of $237.8 million. On September 20, 2006, the Company completed another secondary offing of the Company’s common stock, where the Company sold 5,750,000 shares of common stock at an offering price of $16.90 per share. The net proceeds to the Company, after deduction of offering costs, were $97.2 million. As of December 31, 2006, the Company had 76,191,632 shares of common stock outstanding. On January 17, 2007, the Company completed another secondary offering of the Company’s common stock, where the Company sold 18,342,500 shares of common stock, including the underwriters’ over- allotment of 2,392,500 shares, at an offering price of $18.15 per share. The net proceeds to the Company, after the deduction of offering costs, were $317.6 million. Preferred Shares The Company is authorized to issue up to 10,000,000 shares of preferred stock, $.01 par value per share. The Company’s board of directors is required to set for each class or series of preferred stock the terms, preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption. As of December 31, 2006 and 2005, respectively, there were no shares of preferred stock outstanding. Operating Partnership Units Holders of Operating Partnership units have certain redemption rights, which enable them to cause the Operating Partnership to redeem their units in exchange for cash per unit equal to the market price of the Company’s common stock, at the time of redemption, or, at the option of the Company for shares of the Company’s common stock on a one-for-one basis. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or the stockholders of the Company. As of December 31, 2006 and 2005, respectively, there were no Operating Partnership units held by unaffiliated third parties. 5. Stock Incentive Plan Effective January 1, 2006, the Company adopted the provisions of SFAS 123R. There was no financial statement impact of this adoption. As of December 31, 2006, the Company has issued or committed to issue 1,206,763 shares of its common stock under its 2004 Stock Option and Incentive Plan, including 461,527 shares of unvested restricted common stock and a commitment to issue 409,468 units of deferred common stock. As of December 31, 2006, the Company’s officers and employees have been awarded 944,360 shares of restricted common stock. The aggregate fair value of these awards on the respective grants dates was $10.6 million. The weighted- average grant date fair value of these awards was $11.27 per share. As of December 31, 2006, 482,833 of these awards have vested. The remaining share awards will vest as follows: F-14 314,787 shares during 2007, 80,953 shares during 2008 and 65,787 shares during 2009. None of the recipients were required to pay for such shares of common stock. As of December 31, 2006, the Company’s directors have been awarded 40,288 shares of common stock. Shares issued to our directors were fully vested upon issuance. Shares issued to our officers and employees vest over a three-year period from the date of the grant. As of December 31, 2006, the unrecognized compensation cost related to the share awards was $4.2 million and the weighted- average period over which the unrecognized compensation expense will be recorded is approximately 12 months. At the time of the Company’s initial public offering, the Company made a commitment to issue 382,500 shares of deferred stock units to the Company’s senior executive officers. These deferred stock units are fully vested and represent the promise of the Company to issue a number of shares of the Company’s common stock to each senior executive officer upon the earlier of (i) a change of control or (ii) five years after the date of grant, which was the initial public offering completion date (the “Deferral Period”). However, if an executive’s service with the Company is terminated for “cause” prior to the expiration of the Deferral Period, all deferred stock unit awards will be forfeited. The executive officers are restricted from transferring these shares until the fifth anniversary of the initial public offering completion date. As of December 31, 2006, the Company has a commitment to issue 409,468 shares under this plan. The share commitment increased from 382,500 to 409,468 since the Company’s initial public offering because current dividends are not paid out but instead are effectively reinvested at the dividend payment date’s closing price of our common stock. No expense has been recognized during the year ended December 31, 2006 for these awards. During 2005, the Company recorded $3,736,250 of stock based compensation expense related to these awards. In total, for each of the years ended December 31, 2006 and 2005, and the period from May 6, 2004 to December 31, 2004, the Company recorded $3.0 million, $6.3 million and $1.4 million, respectively, of stock-based compensation expense related to these awards, which is included in corporate expenses in the accompanying consolidated statements of operations. 6. Earnings Per Share Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted-average number of common shares outstanding. Diluted earnings per share is calculated by dividing net income available to common shareholders, that has been adjusted for dilutive securities, by the weighted-average number of common shares outstanding including dilutive securities. No effect is shown for securities that are anti-dilutive. F-15 The following is a reconciliation of the calculation of basic and diluted earnings per share (in thousands, except share and per share data): Basic Earnings per Share Calculation: Numerator: Net income (loss) Dividends on unvested restricted common stock Net income (loss) after dividends on unvested restricted common stock Weighted-average number of common shares outstanding—basic Basic income (loss) per share Diluted Earnings per Share Calculation: Numerator: Net income (loss) Dividends on unvested restricted common stock Net income (loss) after dividends on unvested restricted common stock Weighted-average number of common shares outstanding—basic Unvested restricted common stock Weighted-average number of common shares outstanding—diluted Diluted income (loss) per share 7. Debt Year Ended December 31, 2006 Year Ended December 31, 2005 Period from May 6, 2004 to December 31, 2004 $ $ $ $ $ 35,211 (481) 34,730 67,534,851 0.51 35,211 (481) 34,730 $ $ $ $ $ (7,336) (280) (7,616) $ $ (2,118) — (2,118) 39,145,789 (0.19 ) 18,162,916 (0.12) $ (7,336) (280) (7,616) $ $ (2,118) — (2,118) 67,534,851 180,810 39,145,789 — 18,162,916 — 67,715,661 39,145,789 $ 0.51 $ (0.19 ) 18,162,916 (0.12) $ The Company has incurred property specific mortgage debt in conjunction with the acquisition of certain of the Company’s hotels. The mortgage debt is recourse solely to specific assets, except for fraud, misapplication of funds and other customary recourse provisions. As of December 31, 2006, twelve of the Company’s twenty hotel properties were secured by mortgage debt. The Company’s mortgage debt contains certain property specific covenants and restrictions, including minimum debt service coverage ratios as well as restrictions to incur additional debt without lender consent. F-16 As of December 31, 2006, the Company had approximately $841.2 million of outstanding mortgage debt. The following table sets forth the Company’s mortgage debt obligations on its hotels. Property Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . Courtyard Manhattan/Midtown East . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . Austin Renaissance Hotel . . . . . . . . . . . . . . . . . . Waverly Renaissance Hotel . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Principal Balance (in thousands) $ 18,742 Interest Rate 7.69% Maturity Date 2/23 Amortization Provisions 25 years 62,500 29,806 82,600 51,000 43,215 59,000 36,888 57,400 220,000 83,000 97,000 $841,151 5.44% 5.11% 5.30% 6.48% 5.195% 5.68% 5.50% 5.40% 5.975% 5.507% 5.503% 8/15 1/10 7/15 6/16 12/09 12/15 1/15 7/15 4/16 12/16 12/16 30 years(1) 25 years Interest Only Interest Only 25 years 30 years (2) 20 years(3) 30 years(4) 30 years(5) Interest Only Interest Only (1) The debt has a three-year interest only period that commenced in July 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (2) The debt has a five-year interest only period that commenced in December 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (3) There is an accelerated amortization provision based on a predetermined formula of available cash flow. (4) The debt has a four-year interest only period that commenced in June 2005. After the expiration of that period, the debt will amortize based on a thirty-year schedule. (5) The debt has a 3.5 year interest only period that commenced in April 2006. After the expiration of that period, the debt will amortize based on a thirty-year schedule. Credit Facilities On July 8, 2005, the Company entered into a three-year, $75.0 million senior secured revolving credit facility from Wachovia Bank, National Association, as administrative agent under the credit facility, and Citicorp North America, Inc. and Bank of America, N.A., as co-syndication agents under the credit facility (the “Former Facility”). The Former Facility was guaranteed by a number of our material subsidiaries and is secured by first mortgages on certain of our qualifying properties, which make up the “borrowing base.” The Torrance Marriott and the Vail Marriott Mountain Resort & Spa were the two hotel properties that comprised the borrowing base. The Company amended and restated the Former Facility to expand it into a $200 million unsecured credit facility on February 28, 2007 (the “New Facility”). Interest was paid on the periodic advances under the Former Facility at varying rates, based upon either LIBOR or the applicable prime rate, plus an agreed upon additional margin amount. The interest rate depends upon our level of outstanding indebtedness in relation to the value of our assets from time to time, as follows: Prime rate margin . . . . . . . . . . . . . . . . . . . . . LIBOR margin. . . . . . . . . . . . . . . . . . . . . . . . 70% or greater 1.25% 2.00% Leverage Ratio 65% to 70% 1.00% 1.75% less than 65% 0.75% 1.45% F-17 In addition to the interest payable on amounts outstanding under the Former Facility, the Company is required to pay an annual amount equal to 0.35% of the unused portion of the Former Facility. The Company incurred interest and unused credit facility fees of $801,500 and $254,237 during the years ended December 31, 2006 and 2005, respectively, on the Former Facility. The Company had no outstanding borrowing on the Former Facility as of December 31, 2006. As of December 31, 2005, the Company had $12 million outstanding on the Former Facility. The New Facility has a term of 48 months. The Company may extend the maturity date of the New Facility for an additional year upon the payment of applicable fees and the satisfaction of certain other customary conditions. The Company also has the right to increase the amount of the New Facility to $500.0 million with the lenders’ approval. Interest is paid on the periodic advances under the New Facility at varying rates, based upon either LIBOR or the alternate base rate, plus an agreed upon additional margin amount. The interest rate depends upon our level of outstanding indebtedness in relation to the value of our assets from time to time, as follows: Alternate base rate margin . . . LIBOR margin. . . . . . . . . . . . . . 60% or greater 0.65% 1.55% Leverage Ratio 55% to 60% 0.45% 1.45% 50% to 55% 0.25% 1.25% less than 50% 0.00% 0.95% In addition to the interest payable on amounts outstanding under the New Facility, the Company is required to pay an amount equal to 0.20% of the unused portion of the New Facility if the unused portion of the New facility is greater than 50% and 0.125 if the unused portion of the new Facility is less than 50%. As of February 28, 2007, the Company had $21.5 million outstanding on the New Facility. Mortgage Debt On March 24, 2006, in connection with the Company’s acquisition of the Chicago Marriott Downtown Magnificent Mile, the Company assumed $220 million of floating-rate debt. The Company refinanced the $220 million floating-rate loan on April 7, 2006 with a 10-year fixed-rate loan bearing interest at 5.98%. The loan is interest-only for 3.5 years, after which the principal will amortize using a 30-year amortization schedule. The new loan is a limited recourse loan secured by a mortgage on the property. The remainder of the purchase price, after the application of the Company’s $10 million deposit, was financed by a $79.5 million short-term floating-rate loan made by Wachovia Investment Holdings, LLC, which was repaid on April 5, 2006. On May 9, 2006, the Company refinanced the $23 million variable-rate mortgage debt on the Courtyard Manhattan/Fifth Avenue with a $51 million fixed-rate loan bearing interest at 6.48% and a term of 10 years. In conjunction with this refinancing, the Company wrote off $162,000 of unamortized deferred financing costs which is classified as interest expense in the accompanying condensed consolidated statements of operations. The loan is interest-only for five years, after which, the principal will amortize using a 30-year amortization schedule. The new loan is a limited recourse loan secured by a mortgage on the property. On December 8, 2006, the Company entered into mortgage debt in connection with the acquisitions of the Renaissance Austin Hotel and the Renaissance Waverly Hotel. The Renaissance Austin Hotel mortgage debt has a principal balance of $83 million, a term of 10 years, bears interest at 5.507%, and is interest only for the entire term of the debt. The Renaissance Waverly Hotel mortgage debt has a principal balance of $97 million, a term of 10 years, bears interest at 5.503%, and is interest only for the entire term of the debt. The loans are limited recourse loans secured by the mortgages on the properties. F-18 The aggregate debt maturities as of December 31, 2006 are as follows (in thousands): 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,436 3,624 44,984 33,997 6,986 748,124 $841,151 8. Acquisitions 2005 Acquisitions On January 5, 2005, the Company acquired the Torrance Marriott, a 487-room hotel located in Torrance, California, for total consideration of approximately $72 million (including working capital and $10 million pre-funded for future capital expenditures). The hotel is currently managed by a subsidiary of Marriott. In early 2005, Marriott paid the Company’s taxable REIT subsidiary $3.0 million of Key Money in exchange for the right to manage the hotel pursuant to the management agreement. The Key Money was deferred and will be recognized over the term of the management agreement. The Company entered into $44 million of mortgage debt on the Torrance Marriott which was repaid on June 2, 2005. On June 23, 2005, the Company acquired a portfolio of four hotels (Renaissance Worthington, Marriott Atlanta Alpharetta, Frenchman’s Reef & Morning Star Marriott Beach Resort and Los Angeles Airport Marriott) from affiliates of Capital Hotel Investments, LLC (“CHI”) for approximately $314.9 million (including working capital). In connection with the purchase, the Company assumed the existing Marriott management agreements, which all expire in 2031 and provide for two 10-year extensions at Marriott’s option. These agreements provide for a base management fee of 3% of the applicable hotel’s gross revenues, and an incentive management fee of 25% of available cash flow (after payment of a 10.75% priority return on the prior owner’s investment). The terms of the assumed management contract were consistent with current market terms. In conjunction with this acquisition, the Company entered into an $82.6 million mortgage loan on the Los Angeles Airport Marriott and a $57.4 million mortgage loan on the Renaissance Worthington. On June 24, 2005, the Company acquired the Vail Marriott Mountain Resort & Spa from Vail Resorts, Inc. for approximately $64.9 million (including working capital). A subsidiary of Vail Resorts, Inc. currently manages the hotel under a management agreement that commenced on the date of acquisition. The management agreement expires in 2020. The agreement provides for a base management fee of 3% of the hotel’s gross revenues, and an incentive management fee of (i) 20%, if the hotel achieves operating profits above an 11% return on our invested capital or (ii) 25%, if the hotel achieves operating profits above a 15% return of invested capital, as defined. On July 22, 2005, the Company acquired the SpringHill Suites Atlanta Buckhead for approximately $34.1 million (including working capital). A subsidiary of Marriott International, Inc. manages the hotel under a management agreement that commenced on the date of acquisition. Marriott paid the Company’s taxable REIT subsidiary $0.5 million of Key Money as an incentive to enter into the management agreement. The Key Money was deferred and will be recognized over the term of the management agreement. The management agreement expires in 2035 and has two 10 year renewal options. The agreement provides for a base management fee that will range between 5% - 6.5% of the hotel’s gross revenues, and an incentive management fee of 25% of hotel operating profits above a 12% return on our invested capital. In addition, Marriott provided the Company with a cash flow guaranty for each of fiscal years 2006 and 2007 operating cash flow. The guarantee provides that Marriott will reduce its base F-19 management fee should the actual hotel operating income be less than a prescribed amount during fiscal years 2006 and 2007. The annual guarantee obligation of Marriott is capped at $0.1 million for each of 2006 and 2007, respectively. On July 29, 2005, the Company acquired the Oak Brook Hills Resort & Conference Center for approximately $65.7 million (including working capital). The hotel was converted to the Oak Brook Hills Marriott Resort on July 29, 2005 and is managed by a subsidiary of Marriott International, Inc. under a management agreement that commenced on the date of acquisition. The Company leases the land underlying the golf course adjacent to the Oak Brook Hills Marriott Resort pursuant to a ground lease that provides for ground lease payments of $1 per year through the date of the first extension option in 2025, at which time, if extended, the lease payments will be adjusted to market. The Company reviewed the terms of the ground lease in conjunction with the hotel purchase accounting and concluded that the terms of the ground lease were below current market and recorded a $10.8 million favorable lease asset at the acquisition date. Marriott paid the Company’s taxable REIT subsidiary $2.5 million of Key Money in exchange for the right to manage the hotel pursuant to the management agreement. The Key Money was deferred and will be recognized over the term of the management agreement. The management agreement expires in 2035. The agreement provides for a base management fee of 3% of the hotel’s gross revenues, and an incentive management fee of 20% of hotel operating profits above a 10.75% return on our invested capital. In addition, Marriott provided the Company with a cash flow guarantee for the fiscal years 2006 and 2007 operating cash flow. The guarantee provides that Marriott will fund the deficit of actual hotel operating income from a prescribed amount during each of fiscal years 2006 and 2007. The total guarantee obligation of Marriott is capped at $2.5 million. On December 16, 2005 the Company acquired the Orlando Airport Marriott for approximately $71.6 million (including working capital). A subsidiary of Marriott currently manages the hotel under a management agreement that commenced on the date of acquisition. Marriott paid the Company’s taxable REIT subsidiary $1.0 million of Key Money as an incentive to enter into the management agreement. The Key Money was deferred and will be recognized over the term of the management agreement. The management agreement expires in 2035. The agreement provides for a base management fee of 3% of the hotel’s gross revenues, and an incentive management fee of 20% - 25% of hotel operating profits above a 10.75% return on our invested capital. In addition, Marriott provided the Company with a cash flow guaranty for the fiscal year 2006 operating cash flow. The guarantee provides that Marriott will reduce its base management fee should the actual hotel operating income be less than a prescribed amount during fiscal year 2006. The 2006 guarantee obligation of Marriott is capped at $1.0 million. 2006 Acquisitions On March 24, 2006, the Company acquired the 1,192 room Chicago Marriott Downtown Magnificent Mile for a purchase price of $295 million plus approximately $11 million of net consideration in the form of an assumed property tax liability and other adjustments. A subsidiary of Marriott manages the hotel under a management agreement. The agreement provides for a base management fee of 3% of the hotel’s gross revenues, and an incentive management fee of 20% of hotel operating profits. The calculation of incentive management fee is based on 20% of net house profit without an owner’s priority. In addition, base management fees are not deducted from net house profit in the incentive management fee calculation. The Company reviewed the terms of the management agreement in conjunction with the hotel purchase accounting and concluded that the terms of the management agreement are more favorable to the manager than a typical current market management agreement and recorded an $83.8 million unfavorable contract liability at the acquisition date. The terms of the management agreement were built into the Company’s underwriting economics of the acquisition. On May 2, 2006, the Company acquired the 369-room Westin Atlanta North at Perimeter Center in Atlanta, Georgia, for total contractual consideration of $61.5 million. The hotel remains a Westin-branded F-20 property under a franchise agreement and is managed by Noble Management Group, LLC under a ten- year management agreement. We own 100% of the fee interest in the hotel. The management agreement provides for a base management fee of 3% of the hotel’s gross revenues and an incentive management fee of 10% of hotel operating profits above an owner’s priority defined in the management agreement. On November 8, 2006, the Company acquired the 311-room Conrad Chicago Hotel. The hotel was acquired for a contractual purchase price of $117.5 million. The hotel remains a Conrad-branded property under a franchise agreement and continues to be managed by Conrad Hotels USA, Inc., a subsidiary of Hilton Hotels Corporation, under a ten-year management agreement. The management agreement provides for a base management fee of 2% of the hotel’s gross revenues and an incentive management fee of 15% of hotel operating profits above an owner’s priority defined in the management agreement. On December 8, 2006, the Company acquired the Renaissance Waverly, a 521-room hotel located in Atlanta, Georgia and the Renaissance Austin, a 492-room hotel located in Austin, Texas for contractual consideration of $130.0 million and $107.5 million, respectively. The hotels continue to be managed by a subsidiary of Marriott under the existing 20 year management agreements. The management agreements provide for a base management fee of 3% of each hotel’s gross revenues and an incentive management fee of 20% of each hotel’s operating profits above an owner’s priority defined in the management agreements. The acquisition allocations, some of which may be adjusted if any of the assumptions underlying the purchase accounting change, of the purchase prices of the hotels to the acquired assets and liabilities are as follows (in thousands): Land . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures and equipment . Total property and equipment . . . . . Favorable lease asset . . . . . . . . . . . . . FF&E escrow and restricted cash . . Net deferred tax liability . . . . . . . . . . Hotel working capital accrued 2005 Acquisitions Vail $ 5,800 52,463 5,000 63,263 — — Torrance $ 7,241 48,232 3,409 58,882 — 2,949 Buckhead $ 3,900 28,179 2,310 34,389 — — Oak Brook $ 9,500 39,128 4,800 53,428 10,830 — Orlando $ 9,769 57,803 2,916 70,488 — — CHI Portfolio $ 60,936 230,705 11,113 302,754 — 11,456 (3,896) liabilities and other assets, net . . . Purchase price. . . . . . . . . . . . . . . . . . . 4,891 $ 315,205 412 $ 63,675 (313) $ 61,518 (306) $ 34,083 1,489 $ 65,747 889 $71,377 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Furniture, fixtures and equipment . . . . . . . Total property and equipment . . . . . . . . . . . Unfavorable contract liability. . . . . . . . . . . . FF&E escrow and restricted cash . . . . . . . . Accrued liabilities and other assets, net . . . Purchase Price . . . . . . . . . . . . . . . . . . . . . . . . Chicago Marriott $ 36,900 347,921 7,152 391,973 (83,812) 2,217 (4,462) $ 305,916 2006 Acquisitions Westin Atlanta $ 7,490 51,124 3,400 62,014 — — (2,364) $59,650 Conrad Chicago $ 31,650 76,961 8,168 116,779 — 1,742 (1,135) $ 117,386 Renaissance Waverly $ 12,701 110,461 5,559 128,721 — 1,740 (353) $ 130,108 Renaissance Austin $ 9,283 93,815 4,305 107,403 — 504 (232) $ 107,675 The acquired properties are included in our results of operations from the respective dates of acquisition. The following unaudited pro forma results of operations reflect these transactions as if each had occurred on the first day of the fiscal year presented. In our opinion, all significant adjustments necessary to reflect the effects of the acquisitions have been made; however, a preliminary allocation (for F-21 2006 acquisitions) of the purchase price to land and buildings was made, and we will finalize the allocation after all information is obtained. Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 (in thousands, except per share data) $ 598,031 33,873 Year Ended December 31, 2005 (in thousands, except per share data) $ 539,322 4,533 Earnings per share—basic and diluted . . . . . . $ 0.50 $ 0.07 2007 Acquisition On January 31, 2007 the Company acquired a leasehold interest in the 793 room Westin Boston Waterfront Hotel. In addition to the Westin Boston Waterfront Hotel, the acquisition included a leasehold interest in 100,000 square feet of retail space, which closed on February 8, 2007, and an option to acquire a leasehold interest in a parcel of land with development rights to build a 320 to 350 room hotel. The contractual purchase price for the Westin Boston Waterfront Hotel, the leasehold interest in the retail space and the option to acquire a leasehold interest in a parcel of land was $330.3 million. 9. Dividends During the first fiscal quarter of 2006 the Company’s Board of Directors declared a cash dividend of $0.18 per share of the Company’s common stock. The dividend was paid on April 11, 2006 to stockholders on record as of Mach 24, 2006. During the second fiscal quarter of 2006 the Company’s Board of Directors declared a cash dividend of $0.18 per share of the Company’s common stock. The dividend was paid on June 22, 2006 to stockholders of record as of June 16, 2006. During the third fiscal quarter of 2006 the Company’s Board of Directors declared a cash dividend of $0.18 per share of the Company’s common stock. The dividend was paid on September 19, 2006 to stockholders of record as of September 8, 2006. During the fourth fiscal quarter of 2006 the Company’s Board of Directors declared a cash dividend of $0.18 per share of the Company’s common stock. The dividend was paid on January 4, 2007 to stockholders of record as of December 21, 2006. 10. Income Taxes The Company elected REIT status effective January 1, 2005. As a REIT, the Company generally will not be subject to federal income tax on that portion of its ordinary income or net capital gain that it currently distributes to its stockholders. Bloodstone TRS, Inc., the Company’s taxable REIT subsidiary, will continue to be subject to federal and state income taxes. The Company recorded a charge of $1.4 million to reverse the deferred tax assets that are not realizable by the Company in the first quarter of 2005 as a result of its REIT election. The deferred tax assets related to Bloodstone TRS, Inc. were not reversed. In addition, the Company distributed $2.3 million through dividends during 2005 to eliminate 2004 non- REIT earnings and profits, regardless of the Company’s 2005 REIT taxable income. F-22 The Company’s (provision) benefit for income taxes consists of the following (in thousands): Current—Federal. . . . . . . . . . . . . . . . . . . . . . . . . . . . State. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . Year Ended December 31, 2006 $ (978) (86) (235) (1,299) Year Ended December 31, 2005 $ (355) (134) — (489) Period from May 6, 2004 to December 31, 2004 $ (617) (263) — (880) Deferred—Federal . . . . . . . . . . . . . . . . . . . . . . . . . . State. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax (provision) benefit. . . . . . . . . . . . . . . (2,040) (387) 343 (2,084) $ (3,383) 1,347 448 47 1,842 $ 1,353 1,729 733 — 2,462 $ 1,582 A reconciliation of the statutory Federal tax provision (benefit) to our income tax provision (benefit) is as follows (in thousands): Statutory Federal tax provision (benefit) (@35%) State income tax provision (benefit), net of Federal tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . REIT election deferred tax asset write off. . . . . . . Foreign income taxes. . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income tax provision (benefit). . . . . . . . . . . . . . . Year Ended December 31, 2006 $3,018 Year Ended December 31, 2005 $ (2,435) Period from May 6, 2004 to December 31, 2004 $(1,295) 417 — (108) 56 $ 3,383 (378) 1,404 — 56 $ (1,353) (306) — — 19 $ (1,582) The Company is required to pay franchise taxes in certain jurisdictions. The Company accrued approximately $158,000 and $130,000 of franchise taxes during the years ended December 31, 2006 and 2005, respectively, which are classified as corporate expenses in the accompanying consolidated statements of operations. F-23 Deferred income taxes are recognized for temporary differences between the financial reporting bases of assets and liabilities and their respective tax bases and for operating loss and tax credit carryforwards based on enacted tax rates expected to be in effect when such amounts are paid. However, deferred tax assets are recognized only to the extent that it is more likely than not that they will be realizable based on consideration of available evidence, including future reversals of existing taxable temporary differences, projected future taxable income and tax planning strategies. The total deferred tax assets and liabilities are as follows (in thousands): Deferred income related to key money . . . . . . . . . . . . . . . . . Net operating loss carryforwards . . . . . . . . . . . . . . . . . . . . . . Building and FF&E basis differences . . . . . . . . . . . . . . . . . . Alternative minimum tax credit carryforwards. . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . December 31, 2006 $ 4,580 2,245 766 1,345 8 December 31, 2005 $ 4,170 1,060 365 354 — Deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,944 5,949 Land basis difference recorded in purchase accounting . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax (liability) asset, net . . . . . . . . . . . . . . . . . . . . (4,260) (5,415) (9,675) $ (731) (4,260 ) (1,332 ) (5,592 ) $ 357 The Company believes that it will have sufficient future taxable income, including future reversals of existing taxable temporary differences, projected future taxable income and tax planning strategies to realize existing deferred tax assets. The Frenchman’s Reef & Morning Star Marriott Beach Resort is owned by a subsidiary that has elected to be treated as a taxable REIT subsidiary, and is subject to USVI income taxes. The Company is party to a tax agreement with the USVI that reduces the income tax rate to approximately 4%. This arrangement expires on December 31, 2009. If the arrangement is not extended the Company will be subject to an income tax rate of 37.4%. The Company believes that this agreement will be extended. In addition, the Company recorded a $1 million deferred tax asset and corresponding adjustment to goodwill in 2006 to recognize the net operating loss carry forwards acquired in 2005. 11. Related Party Transactions Marriott Investment Sourcing Relationship As of December 31, 2006, Marriott International Inc. (“Marriott”) owned approximately 5.8% of our common stock. While there is no contractual relationship binding upon the Company and Marriott, the Company considers Marriott to be the Company’s preferred hotel management company. Our Hotel Management Agreements We are a party to hotel management agreements with Marriott for seventeen of the twenty properties owned as of December 31, 2006. The Vail Marriott Mountain Resort & Spa, is managed by an affiliate of Vail Resorts and is under a long-term franchise agreement with Marriott, the Westin Atlanta North at Perimeter is managed by Noble Investment Group and the Conrad Chicago is managed by Conrad Hotels USA, Inc., a subsidiary of Hilton Hotels Corporation. F-24 The following table sets forth the effective date, initial term and the number of renewal terms at the option of the manager under the respective management agreements for each of the Company’s hotel properties: The Lodge at Sonoma, a Renaissance Resort & Spa. Courtyard Manhattan/Midtown East . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Marriott Atlanta Alpharetta. . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . . . Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Westin Atlanta North at Perimeter. . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin Hotel . . . . . . . . . . . . . . . . . . . . . . . Date of Agreement 10/2004 11/2004 12/2001 01/2005 12/2004 12/2004 1/2005 9/2000 9/2000 9/2000 9/2000 6/2005 7/2005 7/2005 11/2005 3/2006 5/2006 11/2005 6/2005 6/2005 Initial Term 20 years 30 years 30 years 30 years 20 years 21 years 40 years 30 years 30 years 30 years 30 years 15 ½ years 30 years 30 years 30 years 32 years 10 years 10 years 20 years 20 years Number of Renewal Terms One ten-year period Two ten-year periods Three fifteen-year periods None One ten-year period Two ten-year periods None Two ten-year periods Two ten-year periods Two ten-year periods Two ten-year periods None Two ten-year periods None None Two ten-year periods Two five-year periods Two five-year periods Three ten-year periods Three ten-year periods The following table sets forth the base management fee and incentive management fee, generally due and payable each fiscal year, for each of our properties: Courtyard Manhattan/Midtown East . . . . . . . . . . . . . . . . . . . . . . . Torrance Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Salt Lake City Marriott Downtown. . . . . . . . . . . . . . . . . . . . . . . . . Marriott Griffin Gate Resort . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bethesda Marriott Suites . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Courtyard Manhattan/Fifth Avenue . . . . . . . . . . . . . . . . . . . . . . . . The Lodge at Sonoma, a Renaissance Resort & Spa. . . . . . . . . . Marriott Atlanta Alpharetta. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Frenchman’s Reef & Morning Star Marriott Beach Resort . . . . Los Angeles Airport Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Worthington. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Vail Marriott Mountain Resort & Spa . . . . . . . . . . . . . . . . . . . . . . SpringHill Suites Atlanta Buckhead . . . . . . . . . . . . . . . . . . . . . . . . Oak Brook Hills Marriott Resort . . . . . . . . . . . . . . . . . . . . . . . . . . Orlando Airport Marriott. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Chicago Marriott . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Westin Atlanta North at Perimeter. . . . . . . . . . . . . . . . . . . . . . . . . Conrad Chicago . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Waverly Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Renaissance Austin Hotel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Base Management Fee(1) 5% 3% 3% 3% 3% 5% (8) 3% 3% 3% 3% 3% 3% 5% (11) 3% 3% 3% 3%(21) 2%(23) 3% 3% Incentive Management Fee(2) 25%(3) 20%(4) Not more than 20%(5) 20%(6) 50%(7) 25%(9) 20%(10) 25%(12) 25%(13) 25%(14) 25%(15) 20%(16) 25%(17) 20% or 30%(18) 20% or 25%(19) 20%(20) 10%(22) 15%(24) 20%(25) 20%(26) F-25 (1) As a percentage of gross revenues. (2) Based on a percentage of hotel operating profits above a negotiated return on our investment capital as more fully described in the following footnotes. (3) Calculated as a percentage of operating profits in excess of 10.75% of the sum of (i) $73.7 million and (ii) the amount of certain capital expenditures. (4) Calculated as a percentage of operating profits in excess of the sum of (i) $7.5 million and (ii) 10.75% of certain capital expenditures. (5) The incentive management fee is equal to the available cash flow for each fiscal year, subject to a cap of 20% of operating profit for such fiscal year. Commencing with the fiscal year 2002, the operating profit with respect to each fiscal year is reduced by an amount equal to 10.75% of all material capital expenditures funded by the TRS lessee; provided that the material capital expenditures are included in the calculation of the incentive management fee with respect to the fiscal year or fiscal years during which such expenditures occurred (on a pro rata basis). (6) Calculated as a percentage of operating profits in excess of the sum of (i) $5.5 million and (ii) 10.75% of certain capital expenditures. (7) Calculated as a percentage of operating profits in excess of the sum of (i) the payment of certain loan procurement costs, (ii) 10.75% of certain capital expenditures, (iii) an agreed-upon return on certain expenditures and (iv) the value of certain amounts paid into a reserve account established for the replacement, renewal and addition of certain hotel goods. The owners priority expires in 2023. (8) The base management fee will be equal to 5.5% of gross revenues for fiscal years 2010 through 2014 and 6% for fiscal year 2015 and thereafter until the expiration of the agreement. Also, beginning in 2007, the base management fee may increase to 5.5% at the beginning of the next fiscal year if operating profits equal or exceed $4.7 million, and beginning in 2011, the base management fee may increase to 6.0% at the beginning of the next fiscal year if operating profits equal or exceed $5.0 million. (9) Calculated as a percentage of operating profits in excess of 12% of the sum of (i) $38.8 million and (ii) the amount of certain capital expenditures, less 5% of the total real estate tax bill (for as long as the hotel is leased to a party other than the manager). (10) Calculated as a percentage of operating profits in excess of the sum of (i) $3.6 million and (ii) 10.75% of capital expenditures. (11) The base management fee will be equal to 6% of gross revenues for fiscal years 2008 through 2016 and 6.5% of gross revenues thereafter. In the event that the property’s operating profit is below certain thresholds in 2006 and 2007, the base management fee may be reduced by up to $100,000 per year. In addition, in the event that the hotel’s operating profit is above certain thresholds starting in 2008, the base management fee will be increased to 6.5% and if the hotel’s operating profit is above an additional threshold starting in 2012, the base management fee will be increased to 7.0% (12) Calculated as a percentage of operating profits in excess of the sum of (i) $4.1 million and (ii) 10.75% of certain capital expenditures. (13) Calculated as a percentage of operating profits in excess of the sum of (i) $8.4 million and (ii) 10.75% of certain capital expenditures. (14) Calculated as a percentage of operating profits in excess of the sum of (i) $9.4 million and (ii) 10.75% of certain capital expenditures. (15) Calculated as a percentage of operating profits in excess of the sum of (i) $7.6 million and (ii) 10.75% of certain capital expenditures. (16) Calculated as a percentage of operating profits in excess of 11% of our invested capital. The incentive management fee rises to 25% if the hotel achieves operating profits in excess of 15% of our invested capital. (17) Calculated as a percentage of operating profits in excess of the sum of (i) $4.1 million and (ii) 12% of certain capital expenditures and pre-conversion expenses. (18) Calculated as a percentage of operating profits in excess of the sum of (i) $8.1 million and (ii) 10.75% of certain capital expenditures. The percentage of operating profits is 20% except from 2011 through 2025 when it is 30%. (19) Calculated as a percentage of operating profits in excess of 10.75% of our acquisition costs plus certain capital expenditures. We estimate that the threshold will be approximately $9 million. The percentage of operating profits is 20% except from 2011 through 2025 when it is 25%. (20) Calculated as 20% of net operating income before base management fees. There is no owner’s priority. F-26 (21) The base management fee will be equal to 3% of gross revenues for fiscal years 2006 through 2008, with up to 1% of gross revenues forfeited from 2006 to 2008 if DiamondRock does not achieve an 8.5% unlevered yield in 2006, 9.5% unlevered yield in 2007, or 10.75% unlevered yield in 2008. (22) Calculated as a percentage of operating profits in excess of 10.75% of certain capital expenditures. (23) The base management fee will be equal to 2.5% of gross revenues for fiscal years 2008 and 2009 and 3% for fiscal years thereafter. (24) Calculated as a percentage of operating profits after a pre-set dollar amount of owner’s priority. Beginning in fiscal year 2011, the incentive management fee will be 103% of the prior year cash flow. (25) Calculated as a percentage of operating profits in excess of the sum of (i) $10.3 million and (ii) 10.75% of certain capital expenditures. (26) Calculated as a percentage of operating profits in excess of the sum of (i) $6.0 million and (ii) 10.75% of certain capital expenditures. The Company recorded $19.7 million, $7.9 million and $0.2 million of management fees to Marriott during the years ended December 31, 2006 and December 31, 2005 and the period from May 6, 2004 to December 31, 2004, respectively. The management fees for the year ended December 31, 2006 consisted of $8.4 million of incentive management fees and $11.3 million of base management fees. The management fees for the year ended December 31, 2005 consisted of $0.6 million of incentive management fees and $7.3 million of base management fees. All management fees earned during the period from May 6, 2004 to December 31, 2004 related to base management fees. Other Business Relationships with Marriott The Company is party to the following arrangements with Marriott: • The Company was party to a one-year lease agreement that terminated on August 31, 2005 for approximately 4,000 square feet of office space at Marriott’s headquarters for the Company’s corporate offices for approximately $190,000 per year. In addition, the Company reimbursed Marriott for approximately $45,000 of leasehold improvement costs for the leased space. The Company moved from Marriott’s headquarters in September 2005. • The Company was party to a shared services agreement with Marriott that terminated on August 31, 2005. The shared services agreement provided the Company with access to certain information technology and telephone and Internet systems as long as the Company continues to lease its corporate offices from Marriott. The Company moved from Marriott’s headquarters in September 2005. The cost of these services was approximately $73,000 and $249,000 for the period from May 6, 2004 to December 31, 2004 and the year ended December 31, 2005, respectively. As of December 31, 2006 and 2005, the liabilities incurred by the hotel managers are comprised of liabilities incurred by the Company’s hotel managers in conjunction with the operation of the hotels which are legal obligations of the Company. As of December 31, 2006 and 2005, the due from managers is primarily comprised of hotel level accounts receivable, periodic hotel operating distributions due to owner and prepaid and other assets held by the hotel managers on the Company’s behalf. Yield Support Marriott has provided the Company with operating cash flow guarantees for certain hotels and will reimburse an amount of the management fee if actual hotel operating income is less than a negotiated target net operating income. We refer to these guarantees as “Yield Support”, or reimbursement of management fees otherwise payable. Yield Support is recognized over the period earned if the Yield Support is not refundable and there is reasonable uncertainty of receipt at inception of the management agreement. Yield Support is recorded as an offset to base management fees on the accompanying consolidated statement of operations. There was $2.8 million of Yield Support earned during the year F-27 ended December 31, 2006. There was no Yield Support earned during the year ended December 31, 2005 or the period from May 6, 2004 to December 31, 2004. Franchise Agreement With respect to the Vail Marriott Mountain Resort & Spa, the Company’s taxable REIT subsidiary lessee entered into a franchise agreement with Marriott International, Inc. which expires on December 17, 2021. The franchise agreement is generally non-terminable by us or by Marriott except upon an event of default or in the case of certain events of casualty or condemnation. In connection with the franchise agreement, the Company’s taxable REIT subsidiary lessee pays Marriott a franchise fee equal to 6% of gross room sales and 3% of gross food and beverage sales. In addition, our TRS lessee pays Marriott an amount equal to 1% of gross room and 1% of gross room sales for use in chain-wide advertising, promotions and sales. 12. Commitments and Contingencies Litigation The Company is not involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Company. Ground Leases Three of the Company’s hotels are subject to ground lease agreements that cover all of the land underlying the respective hotel: • The Bethesda Marriott Suites is subject to a ground lease that runs until 2087. There are no renewal options. • The Courtyard Manhattan/Fifth Avenue is subject to a ground lease that runs until 2085, inclusive of one 49-year renewal option. • The Salt Lake City Marriott Downtown is subject to two ground leases: one ground lease covers the land under the hotel and the other ground lease covers the portion of the hotel that extends into the Crossroads Plaza Mall. The term of the ground lease covering the land under the hotel runs through 2056, inclusive of our renewal options, and the term of the ground lease covering the extension runs through 2017, inclusive of the remaining ten-year renewal option. In addition, part of one of the parking garages adjacent to one of the Company’s hotels is subject to a ground lease agreement: • A portion of the parking garage relating to the Renaissance Worthington is subject to three ground leases that cover, contiguously with each other, approximately one-fourth of the land on which the parking garage is constructed. Each of the ground leases has a term that runs through July 2067, inclusive of the three 15 year renewal options contained in each ground lease. Finally, two of the golf courses adjacent to two of the Company’s hotels are subject to a ground lease agreement: • The golf course which is part of the Marriott Griffin Gate Resort is subject to a ground lease covering approximately 54 acres. The ground lease runs through 2033, inclusive of our renewal options. We have the right, beginning in 2013 and upon the expiration of any 5-year renewal term, to purchase the property covered by such ground lease for an amount ranging from $27,500 to $37,500 per acre, depending on which renewal term has expired. The ground lease also grants us the right to purchase the leased property upon a third party offer to purchase such property on the F-28 same terms and conditions as the third party offer. We are also the sub-sublessee under another minor ground lease of land adjacent to the golf course, with a term expiring in 2020. • The golf course which is part of the Oak Brook Hills Marriott Resort is subject to a ground lease covering approximately 110 acres. The ground lease runs through 2045 including renewal options. These ground leases generally require the Company to make rental payments (including a percentage of gross receipts as percentage rent with respect to the Courtyard Manhattan/Fifth Avenue ground lease) and payments for all, or in the case of the ground leases covering the Salt Lake City Marriott Downtown extension and a portion of the Marriott Griffin Gate Resort golf course, the Company’s share of, charges, costs, expenses, assessments and liabilities, including real property taxes and utilities. Furthermore, these ground leases generally require the Company to obtain and maintain insurance covering the subject property. The Company records ground rent payments on a straight-line basis as required by U.S. generally accepted accounting principles. Ground rent expense was $9.2 million, $8.8 million and $0.4 million for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004, respectively. Cash paid for ground rent was $1.8 million, $1.7 million and $0.1 million for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004, respectively. Future minimum annual rental commitments under non-cancelable operating leases as of December 31, 2006 are as follows (in thousands): 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2011 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Thereafter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,493 2,907 2,779 2,489 2,152 600,985 $ 614,805 13. Fair Value of Financial Instruments The fair value of certain financial assets and liabilities and other financial instruments as of December 31, 2006 and 2005 are as follows: Mortgage debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest rate cap agreements . . . . . . . . . . . . . . . . . . . . . . . . . As of December 31, 2006 (in thousands) As of December 31, 200 (in thousands) Carrying Amount $841,151 — Fair Value $ 848,135 — Carrying Amount $416,395 16 Fair Value $411,667 16 The fair value of all other financial assets and liabilities are equal to their carrying amounts. F-29 14. Segment Information The Company has one reportable operating segment. However, the Company aggregates these operating segments into one reportable segment using the criteria established by SFAS 131, including the similarities of our product offering, types of customers and method of providing service. The following table sets forth revenues and investment in hotel assets represented by the following geographical areas as of December 31, 2006, 2005 and 2004 and for the years ended December 31, 2006 and 2005 and the period from May 6, 2004 to December 31, 2004. Revenues (in thousands) Investment (in thousands) Chicago . . . . . . . . . . . . . . . . . . . . . . . Los Angeles. . . . . . . . . . . . . . . . . . . . US Virgin Islands . . . . . . . . . . . . . . . New York . . . . . . . . . . . . . . . . . . . . . Atlanta . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . Total . . . . . . . . . . . . . . . . . . . . . . . . . . 2006 $ 84,762 76,532 52,049 41,881 37,611 199,055 $491,890 15. Quarterly Operating Results (Unaudited) 2005 2004 $ — $ — — — 3,244 — 3,830 $ 7,074 46,495 19,708 35,339 10,051 117,857 $229,450 2006 $ 427,257 199,644 82,919 122,248 264,175 595,023 $ 1,691,266 2005 $ — 173,731 73,368 111,913 73,174 435,632 $ 867,818 2004 $ — — — 106,025 — 179,617 $285,642 Total revenue . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . Operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income per share: 2006 Quarter Ended (in thousands, except per share data) December 31 March 24 $ 168,902 $83,122 146,240 73,162 $ 22,662 $ 9,960 $ 10,478 $ 4,366 September 8 $ 114,899 100,493 $ 14,406 6,471 $ June 16 $ 124,967 101,124 $ 23,843 $ 13,897 Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ $ 0.08 0.08 $ $ 0.20 0.20 $ $ 0.09 0.09 $ $ 0.14 0.14 Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . Operating (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income (loss) per share: 2005 Quarter Ended (in thousands, except per share data) December 31 March 25 $104,179 $ 26,349 96,461 28,953 7,718 $ (2,604) 1,554 $ (5,262) September 9 $ 65,407 61,393 $ 4,014 $ 2,196 June 17 $ 33,516 35,515 $ (1,999) $ (5,825) $ $ Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.25) $ (0.25) $ (0.20) $ (0.20) $ $ 0.04 0.04 $ $ 0.03 0.03 F-30 y n a p m o C y t i l a t i p s o H k c o R d n o m a i D n o i t a i c e r p e D d e t a l u m u c c A d n a e t a t s E l a e R — I I I e l u d e h c S 6 0 0 2 , 1 3 r e b m e c e D f o s A 0 2 7 , 5 6 5 , 1 $ ) 7 0 5 , 8 3 ( $ 7 2 2 , 4 0 6 1 $ , 7 3 7 , 0 8 3 , 1 $ 0 9 4 , 3 2 2 $ 5 0 9 , 6 $ 2 3 8 , 3 7 3 , 1 $ 0 9 4 , 3 2 2 $ ) 1 5 1 , 1 4 8 ( $ n o i t a i c e r p e D f o r a e Y e f i L n o i t i s i u q c A k o o B t e N e u l a V d e t a l u m u c c A n o i t a i c e r p e D l a t o T d n a g n i d l i u B s t n e m e v o r p m I s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 s r a e Y 0 4 4 0 0 2 4 0 0 2 4 0 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1 5 ( ) 6 0 8 , 9 2 ( ) 2 4 7 , 8 1 ( — — ) 0 0 5 , 2 6 ( ) 0 0 6 , 2 8 ( ) 0 0 4 , 7 5 ( — — — ) 0 0 0 , 9 5 ( ) 0 0 0 , 0 2 2 ( — — ) 0 0 0 , 7 9 ( ) 0 0 0 , 3 8 ( . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . t s a E n a t t a h n a M n w o t d i M d r a y t r u o C . . . . . . . n w o t n w o D y t i C e k a L t l a S t t o i r r a M / e u n e v A h t f i F n a t t a h n a M d r a y t r u o C . . . . . . . . . . . . . . . . . . . . t r o s e R e t a G n i f f i r G t t o i r r a M . . . . . . s e t i u S a d s e h t e B t t o i r r a M . . . . . t t o i r r a M e c n a r r o T . a t t e r a h p A a t n a l t l A t t o i r r a M h c a e B t t o i r r a M r a t S g n i n r o M & f e e R s ’ n a m h c n e r F . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . t r o s e R t t o i r r a M t r o p r i A s e l e g n A s o L . . . n o t g n i h t r o W e c n a s s i a n e R . t r o s e R n i a t n u o M t t o i r r a M l i a V d a e h k c u B a t n a l t A s e t i u S l l i H g n i r p S . . . . . . . . . . . t r o s e R t t o i r r a M s l l i H k o o r B k a O . . . . . . . . . . . t t o i r r a M t r o p r i A o d n a l r O . . . . . . . t t o i r r a M o g a c i h C r e t e m i r e P t a h t r o N a t n a l t A n i t s e W . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . o g a c i h C d a r n o C e c n a s s i a n e R y l r e v a W . . . . . . . . . l a t o T e c n a s s i a n e R n i t s u A F-31 o t t n e u q e s b u S d n a g n i d l i u B s t s o C d e z i l a t i p a C t s o C l a i t i n I n o i t i s i u q c A s t n e m e v o r p m I d n a L s e c n a r b m u c n E n o i t p i r c s e D $ 1 5 9 , 3 $ — $ a p S d n a t r o s e R e c n a s s i a n e R a , a m o n o S t a e g d o L e h T DiamondRock Hospitality Company Schedule III - Real Estate and Accumulated Depreciation (continued) As of December 31, 2006 (in thousands) Notes: A) The change in total cost of properties for the fiscal years ended December 31, 2006 and 2005 and the period from May 9, 2004 to December 31, 2004 is as follows (in thousands): Balance at May 9, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions: $ — Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductions: Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions: Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to purchase accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductions: Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions: Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjustments to purchase accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductions: 265,215 — — 265,215 555,071 110 453 — 820,849 778,684 4,843 (149) Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — Balance at December 31, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,604,227 B) The change in accumulated depreciation of real estate assets for the fiscal years ended December 31, 2006 and 2005 and the period from May 9, 2004 to December 31, 2004 is as follows: Balance at May 9, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ Balance at December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance at December 31, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Dispositions and other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 468 — 468 12,044 — 12,512 25,995 — Balance at December 31, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 38,507 C) The aggregate cost of properties for Federal income tax purposes is approximately $1,594,851 as of December 31, 2006. F-32 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, William W. McCarten, certify that: Exhibit 31.1 1. I have reviewed this Annual Report on Form 10-K of DiamondRock Hospitality Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statement for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: February 28, 2007 /s/ William W. McCarten William W. McCarten Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 I, Mark W. Brugger, certify that: Exhibit 31.2 1. I have reviewed this Annual Report on Form 10-K of DiamondRock Hospitality Company; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statement for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: February 28, 2007 /s/ Mark W. Brugger Mark W. Brugger Executive Vice President and Chief Financial Officer (Principal Financial Officer) Exhibit 32 Certification Pursuant to Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350(a) and (b)) The undersigned officers, who are the Chief Executive Officer and Chief Financial Officer of DiamondRock Hospitality Company (the “Company”), each hereby certifies to the best of his knowledge, that the Company’s Annual Report on Form 10-K to which this certification is attached (the “Report”), as filed with the Securities and Exchange Commission on the date hereof, fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended, and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ William W. McCarten William W. McCarten Chairman of the Board and Chief Executive Officer February 28, 2007 /s/ Mark W. Brugger Mark W. Brugger Executive Vice President, Chief Financial Officer and Treasurer February 28, 2007 76626_Vivo_Cvr 3/20/07 4:51 PM Page 2 t h e DIAMONDROCK p o r t f o l i o business orlando airport marriott, florida renaissance worthington, texas renaissance waverly, georgia bethesda marriott suites, maryland los angeles airport marriott, california westin atlanta north, at perimeter, georgia salt lake city marriott downtown, utah torrance marriott, california chicago marriott downtown magnificent mile, illinois renaissance austin, texas marriott atlanta alpharetta, georgia westin boston waterfront, massachusetts resorts and conference centers frenchman’s reef & morning star marriott beach resort, united states virgin islands marriott griffin gate resort, kentucky the lodge at sonoma, a renaissance resort and spa, california oak brook hills marriott resort, illinois vail marriott mountain resort & spa, colorado urban select service luxury courtyard manhattan/fifth avenue, new york courtyard manhattan/midtown east, new york springhill suites atlanta buckhead, georgia conrad chicago, illinois B OARD OF DIRECTORS William W. McCarten Chairman of the Board and Chief Executive Officer W. Robert Grafton Lead Independent Director Daniel J. Altobello Independent Director Maureen L. McAvey Independent Director and Senior Resident Fellow and ULI/Klingbeil Family Chair, Urban Development at the Urban Land Institute Gilbert T. Ray Independent Director John L. Williams Director and President and Chief Operating Officer EXECUTIVE OFFICERS William W. McCarten Chief Executive Officer John L. Williams President and Chief Operating Officer Mark W. Brugger Executive Vice President, Chief Financial Officer and Treasurer Michael D. Schecter Executive Vice President, General Counsel and Secretary Sean M. Mahoney Chief Accounting Officer and Corporate Controller cor p or ate infor mation CORPORATE HEADQUARTERS DiamondRock Hospitality Company 6903 Rockledge Drive Suite 800 Bethesda, Maryland 20817 (240) 744-1150 FAX (240) 744-1199 INTERNET ACCESS A corporate profile, recent press releases, SEC filings, property locations and other information about DiamondRock Hospitality Company can be found on the World Wide Web at www.drhc.com. ANNUAL MEETING DiamondRock Hospitality Company will hold its annual meeting of share- holders on April 26, 2007, at 11:00 am EST at the Bethesda Marriott Suites, 6711 Democracy Boulevard, Bethesda, Maryland 20817. A formal notice and proxy will be mailed before the meeting to shareholders entitled to vote. REGISTRAR AND STO CK TRANSFER AGENT American Stock Transfer & Trust Company 59 Maiden Lane New York, New York 10038 (212) 936-5100 www.amstock.com INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM KPMG LLP 1660 International Drive McLean, Virginia 22102 OTHER SHAREHOLDER INFORMATION For information about DiamondRock Hospitality Company and its sub- sidiaries, including copies of its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, you may call our corporate headquarters or submit a written request to Investor Relations. Our Chief Executive Officer and Chief Financial Officer have furnished the Sections 302 and 906 certifications required by the U.S. Securities and Exchange Commission in our Annual Report on Form 10-K. In addition, our Chief Executive Officer has certified to the NYSE that he is not aware of any violations by us of NYSE corporate governance standards. propert y lo cat i ons Luxury Hotels Business Hotels Resorts and Conference Centers Select Service Urban Hotels VIRGIN ISLANDS 76626_Vivo_Cvr 3/20/07 4:50 PM Page 1 DIAMONDROCK HOSPITALITY DIAMONDROCK HOSPITALITY 2 0 0 6 A N N U A L R E P O R T 2 0 0 6 A N N U A L R E P O R T 6903 ROCKLEDGE DRIVE, SUITE 800 BETHESDA, MARYLAND 20817 (240) 744-1150 WWW.DRHC.COM We are a self-advised real estate company committed to maximizing shareholder value through investing in premium full-service hotels. We currently own 21 hotels focused in the gateway markets of New York City, Chicago, Los Angeles, Boston and Atlanta, as well as resort destination markets. [cover] the chicago marriott downtown and conrad chicago are both situated on michigan avenue, the famed shopping district in the heart of downtown chicago known as the “magnificent mile”. [above] the los angeles airport marriott underwent significant renovations during 2005 and 2006, including the guestrooms, ballroom and food outlets. the hotel is located minutes from the los angeles international airport.