The following discussion and analysis is based primarily on the consolidated financial statements of Strategic Hotels & Resorts, Inc. (SHR) and its subsidiaries for the years presented and should be read together with the notes thereto contained in this annual report on Form 10-K. Terms employed herein as defined terms, but without definition, have meanings set forth in the notes to the financial statements (see "Item 8. Financial Statements and Supplementary Data").
Overview
We were incorporated in Maryland in January 2004 to acquire and asset-manage upper upscale and luxury hotels (as defined by Smith Travel Research). Our accounting predecessor, Strategic Hotel Capital, L.L.C. (SHC LLC), was founded in 1997. We made an election to be taxed as a real estate investment trust (REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the Tax Code). On June 29, 2004, we completed our initial public offering (IPO) of our common stock. Prior to the IPO, 21 hotel interests were owned by SHC LLC. Concurrent with and as part of the transactions relating to the IPO, a reverse spin-off distribution to shareholders separated SHC LLC into two companies, a new, privately-held SHC LLC, with interests, at that time, in seven hotels and SHR, a public entity with interests, at that time, in 14 hotels. See "Item 8. Financial Statements and Supplementary Data-1. General" for the hotel interests owned or leased by us as of December 31, 2012. We operate as a self-administered and self-managed REIT, which means that we are managed by our board of directors and executive officers. A REIT is a legal entity that holds real estate interests and, through payments of dividends to stockholders, is permitted to reduce or avoid federal income taxes at the corporate level. To continue to qualify as a REIT, we cannot operate hotels; instead we employ internationally known hotel management companies to operate our hotels under management contracts. We conduct our operations through our direct and indirect subsidiaries including our operating partnership, Strategic Hotel Funding, L.L.C. (SH Funding), which currently holds substantially all of our assets. We are the managing member of SH Funding and hold approximately 99% of its membership units as of December 31, 2012. We manage all business aspects of SH Funding, including the sale and purchase of hotels, the investment in such hotels and the financing of SH Funding and its assets.
Throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section, references to "we", "our", "us", and "the Company" are references to SHR together, except as the context otherwise requires, with its consolidated subsidiaries, including SH Funding.
When presenting the U.S. dollar equivalent amount for any amounts expressed in a foreign currency, the U.S. dollar equivalent amount has been computed based on the exchange rate on the date of the transaction or the exchange rate prevailing on December 31, 2012, as applicable, unless otherwise noted. Key Indicators of Operating Performance
We evaluate the operating performance of our business using a variety of operating and other information that includes financial information prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) such as total revenues, operating income (loss), net income
(loss), and earnings per share, as well as non-GAAP financial information. 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. Key indicators that we evaluate include average daily occupancy, average daily rate (ADR), revenue per available room (RevPAR), and Total RevPAR, which are more fully discussed under "-Factors Affecting Our Results of Operations-Revenues." We also evaluate Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), Comparable EBITDA, Funds from Operations (FFO), FFO-Fully Diluted, and Comparable FFO as supplemental non-GAAP measures to GAAP performance measures. We provide a more detailed discussion of the non-GAAP financial measures under "-Non-GAAP Financial Measures." Outlook The lodging industry began its recovery in the first quarter of 2010, after one of the worst downturns in its history. Luxury demand, in which our portfolio has the highest concentration of assets, has experienced positive RevPAR growth beginning with the week of February 20, 2010, following 96 consecutive weeks of negative RevPAR growth. RevPAR and occupancy gains continued in the fourth quarter of 2012, primarily driven by improved demand in transient business and increases in average room rates.

The fourth quarter of 2012 represented the twelfth consecutive quarter of demand growth and eleventh consecutive quarter of RevPAR growth and profit margin expansion for our Same Store North American portfolio. Same Store Assets (see "- Total Portfolio and Same Store Assets Definitions" below) located in North America, which excludes hotels owned through unconsolidated affiliates and those owned for less than five quarters, gained 1.5 percentage points in occupancy, driven by a 6.6% increase in transient room nights, partially offset by a 3.3% decrease in group room nights compared to the quarter ended December 31, 2011. ADR at our North American Same Store Assets increased 2.9% in the fourth quarter of 2012 as a result of a 2.9% increase in transient rate and a 1.6% increase in group rate, compared to the fourth quarter of 2011. For the quarter ended December 31, 2012, RevPAR in this portfolio increased 5.2% and Total RevPAR increased 3.2%, compared to the quarter ended December 31, 2011. Our total United States portfolio of 14 hotels includes our unconsolidated affiliates at the Hotel del Coronado and Fairmont Scottsdale Princess hotel and excludes the JW Marriott Essex House Hotel, which we acquired on September 14, 2012. We believe that providing the operating results on this portfolio, as well as the results of our Same Store Assets, is a better reflection of the operating trends of our business. For the year ended December 31, 2012, RevPAR for our total United States portfolio increased 7.0%, driven by a 4.9% increase in ADR and a 1.4 percentage point increase in occupancy, compared to the year ended December 31, 2011.
The performance of our asset in Mexico, the Four Seasons Punta Mita Resort, has lagged the recovery of the rest of our portfolio as the hotel continues to be impacted by broad based security concerns in Mexico. For the year ended December 31, 2012, occupancy at the Four Seasons Punta Mita Resort declined by 3.3 percentage points, leading to a 6.8% decline in RevPAR, compared to the year ended December 31, 2011.
As we assess lodging supply and demand dynamics looking forward, we are optimistic about the long-term prospects for a robust and sustained recovery, particularly in the product niche and markets in which we own assets. However, in the near-term we remain cautious given the current backdrop of global macroeconomic uncertainty. Group bookings pace remains our best forward indicator of demand. For our total North American portfolio of hotels, which includes the 14 hotels in our total United States portfolio and the Four Seasons Punta Mita Resort, definite group room nights for 2013 as of January 31, 2013 are up 6.6% compared to the same time last year and are booked at 3.9% higher rates. New supply in the luxury and upper upscale segments remains very well contained in our markets and the current significant gap between hotel trading values and replacement costs bodes favorably for very limited supply growth into the future.
During the lodging downturn we implemented hotel specific contingency plans designed to reduce costs and maximize efficiency at each hotel. These include, but are not limited to, adjusting variable labor, eliminating certain fixed labor, and reducing the hours of room service operations and other food and beverage outlets. We believe the cost structures of our hotels have been fundamentally redesigned to sustain many of the cost reductions, even during periods of rising lodging demand. Therefore, we are optimistic that improving lodging demand will lead to increases in ADR and drive significant profit margin expansion throughout our portfolio.
Balance Sheet Restructuring
Since the beginning of 2010, we have been in the process of restructuring our balance sheet to decrease our leverage, improve both our short-term and long-term liquidity, and address our near-term debt maturities. This restructuring has been multifaceted and has included asset sales, equity issuances, and recapitalization and refinancing transactions on many of our assets as summarized below:
• We issued an aggregate of 128.3 million shares of common stock in a private offering, two public offerings and in connection with the purchase of assets, raising $657.9 million of new equity.

• We tendered for and retired our 3.50% Exchangeable Senior Notes (Exchangeable Notes) totaling $180.0 million.

• We tendered for and purchased approximately 3.2 million shares of preferred stock totaling $86.1 million.

• We sold our interests in the InterContinental Prague, the Paris Marriott Champs Elysees (Paris Marriott), and BuyEfficient, L.L.C. (BuyEfficient) generating net proceeds of $72.6 million.

• We recapitalized our investments in the Hotel del Coronado and the Fairmont Scottsdale Princess hotels and restructured the debt on those properties, reducing our pro-rata share of the debt on these assets from $463.5 million to $212.3 million.

• We first extended and then replaced our bank credit facility with a new $300.0 million credit facility (which also includes a $100.00 million accordion feature) with an initial maturity date of June 30, 2014, with an option to extend for an additional year, subject to certain conditions.

• We refinanced $847.0 million of property level mortgage debt scheduled to mature in 2011 and 2012 with new mortgage debt of $877.8 million, with initial maturity dates ranging from 2014 to 2021 (and 2016 to 2021 assuming extension options are exercised).

As a result of these transactions, our total consolidated debt decreased from $1.6 billion at December 31, 2009 to $1.3 billion as of December 31, 2012. As of December 31, 2012, we had approximately $11.3 million of available corporate level cash, not including restricted cash and cash currently held by the hotels, and we had $146.0 million outstanding borrowings on our $300.0 million bank credit facility and $18.5 million in letters of credit outstanding. European Strategy
We previously announced our intention to exit our assets in Europe in an orderly process designed to maximize proceeds. Since that time, we sold the Renaissance Paris Hotel LeParc Trocadero (Renaissance Paris), the InterContinental Prague and our leasehold interest in the Paris Marriott. Our remaining European assets are the Marriott London Grosvenor Square hotel and our leasehold interest in the Marriott Hamburg hotel. We continue to opportunistically explore options to exit these investments and still intend to be North American-centric with respect to any new acquisitions.
Four Seasons Jackson Hole Hotel
In the third quarter of 2012, we hired a hotel brokerage firm to advise us on the marketing and sale of the Four Seasons Jackson Hole hotel. The formal process to sell this hotel has been suspended while we evaluate other disposition alternatives.
Factors Affecting Our Results of Operations The table below summarizes the changes to our consolidated hotel properties and rooms as of December 31, 2012, 2011 and 2010:

                                     2012     2011      2010
Hotels
Number of hotels, beginning of year    15       15        16
Acquisitions                            1        2         -
Dispositions                            -       (1 )      (1 )
Recapitalization of property(a)         -       (1 )       -
Number of hotels, end of year          16       15        15
Rooms
Number of rooms, beginning of year  6,356    6,873     7,245
Acquisitions                          509      324         -
Dispositions                            -     (192 )    (372 )
Recapitalization of property(a)         -     (649 )       -
Number of rooms, end of year        6,865    6,356     6,873

(a) On June 9, 2011, we completed a recapitalization transaction that changed our ownership interest in the Fairmont Scottsdale Princess hotel. See"-Off-Balance Sheet Arrangements-Fairmont Scottsdale Princess Venture" for further description of this transaction.

Acquisition of Interests in Consolidated Properties. During the years ended December 31, 2012 and 2011, we acquired interests in the following consolidated properties and paid net purchase prices, including proration adjustments related to assets and liabilities of the hotels, as shown below:

                                                                  Net Purchase Price
Hotel                                         Date Acquired          (in millions)
JW Marriott Essex House Hotel(a)            September 14, 2012   $             350.3
Four Seasons Silicon Valley and Four
Seasons Jackson Hole(b)                         March 11, 2011   $              92.4
InterContinental Chicago(c)                      June 24, 2011   $              90.2

(a) In connection with the closing of the hotel acquisition, we entered into joint venture agreements with affiliates of KSL Capital Partners, LLC (Essex House Hotel Venture) to fund the equity portion of the purchase price. We have a 51% controlling interest in the Essex House Hotel Venture and serve as managing member and asset manager.
(b) We acquired the Four Seasons Silicon Valley and the Four Seasons Jackson Hole hotels in exchange for an aggregate of 15.2 million shares of our common stock at a price of $6.08 per share based on our March 11, 2011 common share closing price.
(c) We acquired the remaining 49.0% interest in the InterContinental Chicago hotel, previously owned by our partner in the consolidated affiliate, giving us 100% ownership of the InterContinental Chicago hotel. As part of the transaction, we also acquired an additional 2.5% ownership interest in the Hyatt Regency La Jolla hotel, increasing our controlling interest in the hotel to 53.5%. Total consideration included the issuance of approximately 10.8 million shares of our common stock at a price of $6.51 per share based on the June 24, 2011 common share closing price, $19.4 million of cash, which includes working capital, and post-closing adjustments of $0.5 million.
Sale of Interests in Consolidated Properties. During the years ended December 31, 2012, 2011, and 2010, we sold our interests in the following consolidated properties and received net sales proceeds, after proration adjustments related to assets and liabilities of the hotels and closing costs, as shown below:

                                                Net Sales Proceeds
Hotel                          Date Sold           (in millions)
Paris Marriott(a)              April 6, 2011   $               60.0

(a) We sold our leasehold interest in the Paris Marriott hotel for consideration of €29.2 million ($41.6 million). As part of the transaction, we received an additional €13.5 million ($18.9 million) related to the release of the security deposit and other closing adjustments, of which €1.6 million ($2.0 million) was received in the second quarter of 2012.

(b) Approximate consideration received of €106.1 million ($141.4 million) included the assignment of the hotel's third party debt and the interest rate swap liability related to the third party indebtedness.

Unconsolidated Affiliates. On February 4, 2011, we completed a recapitalization transaction that changed our ownership interest in the Hotel del Coronado. See "-Off-Balance Sheet Arrangements - Hotel and North Beach Ventures and Hotel del Coronado Venture" for further description of this transaction. On December 17, 2012, we increased our ownership interest in the Hotel del Coronado to 36.4%. On June 9, 2011, we completed a recapitalization transaction that changed our ownership interest in the Fairmont Scottsdale Princess hotel. See"-Off-Balance Sheet Arrangements - Fairmont Scottsdale Princess Venture" for further description of this transaction.
On January 21, 2011, we sold our 50.0% interest in BuyEfficient for $9.0 million and recognized a gain of $2.6 million.
Total Portfolio and Same Store Asset Definitions. We define our Total Portfolio as properties that we wholly or partially own or lease and whose operations are included in our consolidated operating results. The Total Portfolio excludes all sold properties and assets held for sale, if any, included in discontinued operations.
We present certain information about our hotel operating results on a comparable hotel basis, which we refer to as our Same Store analysis. We define our Same Store Assets as those hotels (a) that are owned or leased by us, and whose operations are included in our consolidated operating results and (b) for which we reported operating results throughout the entire reporting periods presented. Our Same Store Assets for purposes of the comparison of the years ended December 31, 2012 and 2011 exclude the JW Marriott Essex House Hotel, the Four Seasons Silicon Valley hotel, the Four Seasons Jackson Hole hotel, unconsolidated affiliates, and all sold properties and assets held for sale, if any, included in discontinued operations. Our Same Store Assets for purposes of the comparison of the years ended December 31, 2011 and 2010 exclude the Four Seasons Silicon Valley hotel, the Four Seasons Jackson Hole hotel, unconsolidated affiliates, and all sold properties and assets held for sale, if any, included in discontinued operations.
We present these results of Same Store Assets because we believe that doing so provides useful information for evaluating the period-to-period performance of our hotels and facilitates comparisons with other hotel REITs and hotel owners.

In particular, these measures assist in distinguishing whether increases or decreases in revenues and/or expenses are due to operations of the Same Store Assets or from acquisition or disposition activity.
Revenues. Substantially all of our revenue is derived from the operation of our hotels. Specifically, our revenue for the years ended December 31, 2012, 2011 and 2010 consisted of:

                                    Total Portfolio             Same Store Assets
                                  % of Total Revenues         %  of Total Revenues
                               2012      2011      2010        2012           2011
Revenues:
Rooms                          55.3 %    53.7 %    52.8 %       55.3 %         54.5 %
Food and beverage              33.9 %    35.0 %    34.8 %       34.6 %         34.9 %
Other hotel operating revenue  10.2 %    10.6 %    11.7 %        9.4 %          9.8 %
Lease revenue                   0.6 %     0.7 %     0.7 %        0.7 %          0.8 %
Total revenues                100.0 %   100.0 %   100.0 %      100.0 %        100.0 %

• Rooms revenue. Occupancy and ADR are the major drivers of rooms revenue.

• Food and beverage revenue. Occupancy, local catering and banquet events are the major drivers of food and beverage revenue.

• Other hotel operating revenue. Other hotel operating revenue consists primarily of cancellation fees, spa, telephone, parking, golf course, Internet access, space rentals, retail and other guest services and is also driven by occupancy.

• Lease revenue. We sublease our interest in the Marriott Hamburg to a third party and earn annual base rent plus additional rent contingent on the hotel meeting performance thresholds.

Changes in our revenues are most easily explained by performance indicators that are used in the hotel real estate industry:
• average daily occupancy;

• ADR, which stands for average daily rate, is equal to rooms revenue divided by the number of occupied rooms;

• RevPAR, which stands for revenue per available room, is equal to rooms revenue divided by the number of rooms available; and

• Total RevPAR, which stands for total revenue per available room, is equal to the sum of rooms revenue, food and beverage revenue and other hotel operating revenue, divided by the number of rooms available.

We generate a significant portion of our revenue from two broad categories of customers, transient and group.
Our transient customers include individual or group business and leisure travelers that occupy fewer than 10 rooms per night. Transient customers accounted for approximately 60.4%, 57.5% and 57.2% of the rooms sold during the years ended December 31, 2012, 2011 and 2010, respectively. We divide our transient customers into the following subcategories:
• Transient Leisure-This category generates the highest room rates and includes travelers that receive published rates offered to the general public that do not have access to negotiated or discounted rates.

• Transient Negotiated-This category includes travelers, who are typically associated with companies and organizations that generate high volumes of business, that receive negotiated rates that are lower than the published rates offered to the general public.

Our group customers include groups of 10 or more individuals that occupy 10 or more rooms per night. Group customers accounted for approximately 39.6%, 42.5% and 42.8% of the rooms sold during the years ended December 31, 2012, 2011 and 2010, respectively. We divide our group customers into the following subcategories:
• Group Association-This category includes group bookings related to national and regional association meetings and conventions.

• Group Corporate-This category includes group bookings related to corporate business.

• Group Other-This category generally includes group bookings related to social, military, education, religious, fraternal and youth and amateur sports teams.

Fluctuations in revenues, which, for our domestic hotels, historically have been correlated with changes in the United States gross domestic product (U.S. GDP), are driven largely by general economic and local market conditions, which in turn affect levels of business and leisure travel. Guest demographics also affect our revenues. During 2011 and 2012, demand at our hotels increased significantly, despite tepid U.S. GDP growth, which we believe reflects the relative strength of our primary customer demographics, particularly U.S. based corporations and affluent transient travelers. While hotel demand has improved, occupancy and ADR metrics for our hotels remain below prior peak periods. In addition to economic conditions, supply is another important factor that can affect revenues. Room rates and occupancy tend to fall when supply increases unless the supply growth is offset by an equal or greater increase in demand. One reason we target upper upscale and luxury hotels in select urban and resort markets, including major business centers and leisure destinations, is because they tend to be in locations that have greater supply constraints such as lack of available land, high development costs, long development and entitlement lead times, and brand trade area restrictions that prevent the addition of a certain brand or brands in close proximity. Nevertheless, our hotels are not insulated from competitive pressures and our hotel operators will lower room rates to compete more aggressively for guests in periods when occupancy declines. For purposes of calculating our Total Portfolio RevPAR for the years ended December 31, 2012, 2011 and 2010, we exclude unconsolidated affiliates, discontinued operations, and the Marriott Hamburg because we sublease the operations of the hotel and only record lease revenue. Same Store Assets RevPAR is calculated in the same manner as Total Portfolio RevPAR but also excludes the Four Seasons Silicon Valley and the Four Seasons Jackson Hole hotels for the years ended December 31, 2012 and 2011 and excludes the JW Marriott Essex House Hotel for the year ended December 31, 2012. These methods for calculating RevPAR each period are consistently applied through the remainder of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and should be taken into consideration wherever RevPAR results are disclosed. Hotel Operating Expenses. Our hotel operating expenses for the years ended December 31, 2012, 2011 and 2010 consisted of the costs and expenses to provide hotel services, including:

                                                                                                      Same Store Assets
                                                                                                      % of Total Hotel
                                     Total Portfolio % of Total Hotel Operating Expenses             Operating Expenses
                                       2012                  2011                 2010              2012               2011
Hotel Operating Expenses:
Rooms                                     20.2 %                19.3 %                19.2 %       20.4 %               19.8 %
Food and beverage                         32.3 %                32.4 %                31.3 %       32.6 %               32.9 %
Other departmental expenses               34.3 %                35.0 %                36.4 %       34.2 %               34.4 %
Management fees                            4.0 %                 4.2 %                 4.2 %        4.1 %                4.1 %
Other hotel expenses                       9.2 %                 9.1 %                 8.9 %        8.7 %                8.8 %

• Rooms expense. Occupancy is a major driver of rooms expense, which has a significant correlation with rooms revenue.

• Food and beverage expense. Occupancy, local catering and banquet events are the major drivers of food and beverage expense, which has a significant correlation with food and beverage revenue.

• Other departmental expenses. Other departmental expenses consist of general and administrative, marketing, repairs and maintenance, utilities and expenses related to earning other operating revenue.

• Management fees. We pay base and incentive management fees to our hotel operators. Base management fees are computed as a percentage of revenue. Incentive management fees are incurred when operating profits exceed levels prescribed in our management agreements.

• Other hotel expenses. Other hotel expenses consist primarily of insurance costs and property taxes.

. . .