SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

FORM 10-K

 

For the Fiscal Year Ended December 31, 2006

 

OR

 

For the Transition Period from            to           

 

Commission File Number: 1-7959

 

STARWOOD HOTELS & RESORTS WORLDWIDE, INC.

(Exact name of Registrant as specified in its charter)

 

Maryland
(State or other jurisdiction
of incorporation or organization)

 

52-1193298
(I.R.S. employer identification no.)

 

1111 Westchester Avenue
White Plains, NY 10604
(Address of principal executive
offices, including zip code)

 

(914) 640-8100
(Registrant’s telephone number,
including area code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

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 þ  No o

 

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 o  No þ

 

Note:  Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

 

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 þ  No o

 

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 the 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. o

 

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.

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No þ

 

As of June 30, 2006, the aggregate market value of the Registrant’s voting and non-voting common equity (for purposes of this Annual Report only, includes all Shares other than those held by the Registrant’s Directors and executive officers) was $13,169,150,513.

 

As of February 16, 2007, the Corporation had outstanding 214,850,249 shares of common stock.

 

For information concerning ownership of Shares, see the Proxy Statement for the Company’s Annual Meeting of Stockholders that is currently scheduled for May 3, 2007 (the “Proxy Statement”), which is incorporated by reference under various Items of this Annual Report.

 

Document Incorporated by Reference:

 

 

 

TABLE OF CONTENTS

 

 

This Annual Report is filed by Starwood Hotels & Resorts Worldwide, Inc., a Maryland corporation (the “Corporation”). Unless the context otherwise requires, all references to the Corporation include those entities owned or controlled by the Corporation, including SLC Operating Limited Partnership, a Delaware limited partnership (the “Operating Partnership”), which prior to April 10, 2006 included Starwood Hotels & Resorts, a Maryland real estate investment trust (the “Trust”), which was sold in the Host Transaction (defined below); all references to the Trust include the Trust and those entities owned or controlled by the Trust, including SLT Realty Limited Partnership, a Delaware limited partnership (the “Realty Partnership”); and all references to “we”, “us”, “our”, “Starwood”, or the “Company” refer to the Corporation, the Trust and its respective subsidiaries, collectively through April 7, 2006. Until April 7, 2006, the shares of common stock, par value $0.01 per share, of the Corporation (“Corporation Shares”) and the Class B shares of beneficial interest, par value $0.01 per share, of the Trust (“Class B Shares”) were attached and traded together and were held or transferred only in units consisting of one Corporation Share and one Class B Share (a “Share”). On April 7, 2006, in connection with a transaction (the “Host Transaction”) with Host Hotels & Resorts, Inc. (“Host”), the Shares were depaired and the Corporation Shares became transferable separately from the Class B Shares. As a result of the depairing, the Corporation Shares trade alone under the symbol “HOT” on the New York Stock Exchange (“NYSE”). As of April 10, 2006, neither Shares nor Class B Shares are listed or traded on the NYSE.

 

This Annual Report contains statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements appear in several places in this Annual Report, including, without limitation, the section of Item 1. Business, captioned “Business Strategy” and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Such forward-looking statements may include statements regarding the intent, belief or current expectations of Starwood, its Directors or its officers with respect to the matters discussed in this Annual Report. All forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements including, without limitation, the risks and uncertainties set forth below. Starwood undertakes no obligation to publicly update or revise any forward-looking statements to reflect current or future events or circumstances.

 

General

 

We are one of the world’s largest hotel and leisure companies. We conduct our hotel and leisure business both directly and through our subsidiaries. Our brand names include the following:

 

St. Regis Hotels & Resorts (luxury full-service hotels, resorts and residences) are for connoisseurs who desire the finest expressions of luxury. They provide flawless and bespoke service to high-end leisure and business travelers. St. Regis hotels are located in the ultimate locations within the world’s most desired destinations, important emerging markets and yet to be discovered paradises, and they typically have individual design characteristics to capture the distinctive personality of each location.

 

The Luxury Collection (luxury full-service hotels and resorts) is a group of unique hotels and resorts offering exceptional service to an elite clientele. From legendary palaces and remote retreats to timeless modern classics, these remarkable hotels and resorts enable the most discerning traveler to collect a world of unique, authentic and enriching experiences that capture the sense of both luxury and place. They are distinguished by magnificent decor, spectacular settings and impeccable service.

 

W Hotels (luxury and upscale full service hotels, retreats and residences) feature world class design, world class restaurants and “on trend” bars and lounges and its signature Whatever\Whenever service standard. It’s a sensory multiplex that not only indulges the senses, it delivers an emotional experience. Whether it’s “behind the

scenes” access at Whappenings, or our cutting edge music, lighting and scent programs, W delivers an experience unmatched in the hotel segment.

 

Westin Hotels & Resorts (luxury and upscale full-service hotels and resorts) is a lifestyle brand competing in the upper upscale sector in nearly 30 countries around the globe. Each hotel offers renewing experiences that inspire guests to be at their best. First impressions at any Westin are fueled by signature sensory experiences of light, music, white tea scent and botanicals. Westin revolutionized the industry with its famous Heavenly Bed^® and Heavenly Bath^® and launched a multi-million dollar retail program featuring these products. Westin is the first global brand to offer in-room spa treatments at every hotel and the first to go smoke-free in North America. Westin guests stay in shape at WestinWORKOUT^® Powered by Reebok^sm.

 

Le Méridien (luxury and upscale full-service hotels, resorts and residences) is a European-inspired brand with a French accent. Each of its hotels, whether city, airport or resort has a distinctive character driven by its individuality and the Le Méridien brand values. With its underlying passion for food, art and style and its classic yet stylish design, Le Méridien offers a unique experience at some of the world’s top travel destinations.

 

Sheraton Hotels & Resorts (luxury and upscale full-service hotels and resorts) is the Company’s largest brand serving the needs of luxury and upscale business and leisure travelers worldwide. We offer the entire spectrum of comfort. From full-service hotels in major cities to luxurious resorts by the water, Sheraton can be found in the most sought-after cities and resort destinations around the world. Every guest at Sheraton hotels and resorts feels a warm and welcoming connection, the feeling you have when you walk into a place and your favorite song is playing — a sense of comfort and belonging. At Sheraton, we help our guests connect to what matters most to them, the office, home and the best spots in town.

 

Four Points by Sheraton (select-service hotels) delights the self-sufficient traveler with a new kind of comfort, approachable style and spirited, can-do service — all at the honest value our guests deserve. Our guests start their day feeling energized and finish up relaxed and free to enjoy little indulgences that make their time away from home special.

 

aloft (select-service hotels), a brand introduced in 2005 with the first hotel expected to open in 2007, is a hotel of new heights, an oasis where you least expect it, a spirited neighborhood outpost, a haven at the side of the road. Bringing a cozy harmony of modern elements to the classic American on-the-road tradition, aloft offers a sassy, refreshing, ultra effortless alternative for both the business and leisure traveler. Fresh, fun, and fulfilling, aloft is an experience to be discovered and rediscovered, destination after destination, as you ease on down the road.

 

Element (extended stay hotels), a brand introduced in 2006 with the first hotel expected to open in 2008, provides a modern, upscale and intuitively designed hotel experience that allows guests to live well and feel in control. Inspired by Westin, Element promotes balance through a thoughtful, upscale environment. Decidedly modern with an emphasis on nature, Element is intuitively constructed with an efficient use of space that encourages guests to stay connected, feel alive, and thrive while they are away. Element is the smart, renewing haven for extended stay travel.

 

Through our brands, we are well represented in most major markets around the world. Our operations are grouped into two business segments, hotels and vacation ownership and residential operations.

 

Our revenue and earnings are derived primarily from hotel operations, which include management and other fees earned from hotels we manage pursuant to management contracts, the receipt of franchise and other fees and the operation of our owned hotels.

 

Our hotel business emphasizes the global operation of hotels and resorts primarily in the luxury and upscale segment of the lodging industry. We seek to acquire interests in, or management or franchise rights with respect to properties in this segment. At December 31, 2006, our hotel portfolio included owned, leased, managed and franchised hotels totaling 871 hotels with approximately 266,000 rooms in approximately 100 countries, and is comprised of 85 hotels that we own or lease or in which we have a majority equity interest, 426 hotels managed by us on behalf of third-party owners (including entities in which we have a minority equity interest) and 360 hotels for which we receive franchise fees.

 

Our revenues and earnings are also derived from the development, ownership and operation of vacation ownership resorts, marketing and selling vacation ownership interests (“VOIs”) in the resorts and providing financing to customers who purchase such interests. Generally these resorts are marketed under the brand names described above. Additionally, our revenues and earnings are derived from the development, marketing and selling of residential units at mixed use hotel projects owned by us as well as fees earned from the marketing and selling of residential units at mixed use hotel projects developed by third-party owners of hotels operated under our brands. At December 31, 2006, we had 25 vacation ownership resorts and residential properties in the United States, Mexico, Aruba and the Bahamas.

 

The Corporation was incorporated in 1980 under the laws of Maryland. Sheraton Hotels & Resorts and Westin Hotels & Resorts, Starwood’s largest brands, have been serving guests for more than 60 years. Starwood Vacation Ownership (and its predecessor, Vistana, Inc.) has been selling VOIs for more than 20 years.

 

Our principal executive offices are located at 1111 Westchester Avenue, White Plains, New York 10604, and our telephone number is (914) 640-8100.

 

For a discussion of our revenues, profits, assets and geographical segments, see the notes to financial statements of this Annual Report. For additional information concerning our business, see Item 2. Properties, of this Annual Report.

 

Competitive Strengths

 

Management believes that the following factors contribute to our position as a leader in the lodging and vacation ownership industry and provide a foundation for the Company’s business strategy:

 

Brand Strength.  We have assumed a leadership position in markets worldwide based on our superior global distribution, coupled with strong brands and brand recognition. Our upscale and luxury brands continue to capture market share from our competitors by aggressively cultivating new customers while maintaining loyalty among the world’s most active travelers. The strength of our brands is evidenced, in part, by the superior ratings received from our hotel guests and from industry publications.

 

Frequent Guest Program.  Our loyalty program, Starwood Preferred Guest^® (“SPG”), made headlines when it launched in 1999 with a breakthrough policy of no blackout dates and no capacity controls, allowing members to redeem free nights anytime, anywhere. Since then, the program has grown to include more than 33 million members and continues to be cited for its hassle-free award redemption, outstanding customer service, dedicated member website and innovative promotions and benefits for elite members. The program yields repeat guest business by uniting a world of distinctive hotels and rewarding customers with the rewards and recognition they want — from points that can be used for free hotel stays, indulgent experiences and airline miles with 32 participating airlines.

 

Significant Presence in Top Markets.  Our luxury and upscale hotel and resort assets are well positioned throughout the world. These assets are primarily located in major cities and resort areas that management believes have historically demonstrated a strong breadth, depth and growing demand for luxury and upscale hotels and resorts, in which the supply of sites suitable for hotel development has been limited and in which development of such sites is relatively expensive.

 

Premier and Distinctive Properties.  We control a distinguished and diversified group of hotel properties throughout the world, including the St. Regis in New York, New York; The Phoenician in Scottsdale, Arizona; the Hotel Gritti Palace in Venice, Italy; and the St. Regis in Beijing, China. These are among the leading hotels in the industry and are at the forefront of providing the highest quality and service. Our properties are consistently recognized as the best of the best by readers of Condé Nast Traveler, who are among the world’s most sophisticated and discerning group of travelers. The January 2007 issue of the Condé Nast Traveler Magazine included 37 Starwood properties among its prestigious Gold List.

 

Scale.  As one of the largest hotel and leisure companies focusing on the luxury and upscale full-service lodging market, we have the scale to support our core marketing and reservation functions. We also believe that our scale will contribute to lower our cost of operations through purchasing economies in areas such as insurance,

energy, telecommunications, technology, employee benefits, food and beverage, furniture, fixtures and equipment and operating supplies.

 

Diversification of Cash Flow and Assets.  Management believes that the diversity of our brands, market segments served, revenue sources and geographic locations provide a broad base from which to enhance revenue and profits and to strengthen our global brands. This diversity limits our exposure to any particular lodging or vacation ownership asset, brand or geographic region.

 

While we focus on the luxury and upscale portion of the full-service lodging, vacation ownership and residential markets, our brands cater to a diverse group of sub-markets within this market. For example, the St. Regis hotels cater to high-end hotel and resort clientele while Four Points by Sheraton hotels deliver extensive amenities and services at more affordable rates. The aloft brand will provide a youthful alternative to the “commodity lodging” of currently existing brands in the select-service market segment, and the Element brand will provide modern, upscale hotels for extended stay travel.

 

We derive our cash flow from multiple sources within our hotel and vacation ownership and residential segments, including owned hotels’ operations, management and franchise fees and the sale of VOIs and residential units. These operations are in geographically diverse locations around the world. The following tables reflect our hotel and vacation ownership and residential properties by type of revenue source and geographical presence by major geographic area as of December 31, 2006:

 

 

 

 

 

Business Segment and Geographical Information

 

Incorporated by reference in Note 24. Business Segment and Geographical Information, in the notes to financial statements set forth in Part II, Item 8. Financial Statements and Supplementary Data.

 

Business Strategy

 

We have implemented a strategy of reducing our investment in owned real estate and increasing our focus on the management and franchise business. In furtherance of this strategy, during 2006 we sold a total of 43 hotels for approximately $4.5 billion, including 33 properties to Host for approximately $4.1 billion in stock, cash and debt assumption. As a result, our primary business objective is to maximize earnings and cash flow by increasing the number of our hotel management contracts and franchise agreements; acquiring and developing vacation ownership resorts and selling VOIs; and investing in real estate assets where there is a strategic rationale for doing so, which may include selectively acquiring interests in additional assets and disposing of non-core hotels (including hotels where the return on invested capital is not adequate) and “trophy” assets that may be sold at significant premiums. We plan to meet these objectives by leveraging our global assets, broad customer base and other resources and by

taking advantage of our scale to reduce costs. The implementation of our strategy and financial planning are impacted by the uncertainty relating to political and economic environments around the world and their consequent impact on travel in their respective regions and the rest of the world.

 

Growth Opportunities.  Management has identified several growth opportunities with a goal of enhancing our operating performance and profitability, including:

 

 

We intend to explore opportunities to expand and diversify our hotel portfolio through internal development, minority investments and selective acquisitions of properties domestically and internationally that meet some or all of the following criteria:

 

 

 

We may also selectively choose to develop and construct desirable hotels and resorts to help us meet our strategic goals, such as the current construction of a dual hotel campus in Lexington, Massachusetts featuring both an aloft hotel and an Element hotel.

 

Competition

 

The hotel industry is highly competitive. Competition is generally based on quality and consistency of room, restaurant and meeting facilities and services, attractiveness of locations, availability of a global distribution system, price, the ability to earn and redeem loyalty program points and other factors. Management believes that we compete favorably in these areas. Our properties compete with other hotels and resorts in their geographic markets, including facilities owned by local interests and facilities owned by national and international chains. Our principal competitors include other hotel operating companies, ownership companies (including hotel REITs) and national and international hotel brands.

 

We encounter strong competition as a hotel, residential, resort and vacation ownership operator and developer. While some of our competitors are private management firms, several are large national and international chains that own and operate their own hotels, as well as manage hotels for third-party owners and develop and sell VOIs, under a variety of brands that compete directly with our brands. In addition, hotel management contracts are typically long-term arrangements, but most allow the hotel owner to replace the management firm if certain financial or performance criteria are not met. Our timeshare and residential business depends on our ability to obtain land for development of our timeshare and residential products and to utilize land already owned by us but used in hotel operations. Changes in the general availability of suitable land or the cost of acquiring or developing such land could adversely impact the profitability of our timeshare and residential business.

 

Environmental Matters

 

We are subject to certain requirements and potential liabilities under various federal, state and local environmental laws, ordinances and regulations (“Environmental Laws”). For example, a current or previous owner or operator of real property may become liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of hazardous or toxic substances may adversely affect the owner’s ability to sell or rent such real property or to borrow using such real property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic wastes may be liable for the costs of removal or remediation of such wastes at the treatment, storage or disposal facility, regardless of whether such facility is owned or operated by such person. We use certain substances and generate certain wastes that may be deemed hazardous or toxic under applicable Environmental Laws, and we from time to time have incurred, and in the future may incur, costs related to cleaning up contamination resulting from historic uses of certain of our current or former properties or our treatment, storage or disposal of wastes at facilities owned by others. Other Environmental Laws require abatement or removal of certain asbestos-containing materials (“ACMs”) (limited quantities of which are present in various building materials such as spray-on insulation, floor coverings, ceiling coverings, tiles, decorative treatments and piping located at certain of our hotels) in the event of damage or demolition, or certain renovations or remodeling. These laws also govern emissions of and exposure to asbestos fibers in the air. Environmental Laws also regulate polychlorinated biphenyls (“PCBs”), which may be

present in electrical equipment. A number of our hotels have underground storage tanks (“USTs”) and equipment containing chlorofluorocarbons (“CFCs”); the operation and subsequent removal or upgrading of certain USTs and the use of equipment containing CFCs also are regulated by Environmental Laws. In connection with our ownership, operation and management of our properties, we could be held liable for costs of remedial or other action with respect to PCBs, USTs or CFCs.

 

Environmental Laws are not the only source of environmental liability. Under the common law, owners and operators of real property may face liability for personal injury or property damage because of various environmental conditions such as alleged exposure to hazardous or toxic substances (including, but not limited to, ACMs, PCBs and CFCs), poor indoor air quality, radon or poor drinking water quality.

 

Although we have incurred and expect to incur remediation and various environmental-related costs during the ordinary course of operations, management anticipates that such costs will not have a material adverse effect on our operations or financial condition.

 

Seasonality and Diversification

 

The hotel industry is seasonal in nature; however, the periods during which our properties experience higher revenue activities vary from property to property and depend principally upon location. Generally, our revenues and operating income have been lower in the first quarter than in the second, third or fourth quarters.

 

Comparability of Owned Hotel Results

 

We continually update and renovate our owned, leased and consolidated joint venture hotels. While undergoing renovation, these hotels are generally not operating at full capacity and, as such, these renovations can negatively impact our revenues and operating income. Other events, such as the occurrence of natural disasters, may cause a full or partial closure of a hotel, and such events can negatively impact our revenues and operating income.

 

Regulation and Licensing of Gaming Facilities

 

We have an interest in the gaming operations of the Aladdin Resort and Casino in Las Vegas, Nevada and we and certain of our affiliates and officers have obtained from the Nevada Gaming Authorities (herein defined) the various registrations, approvals, permits and licenses required to engage in these gaming activities in Nevada. The casino gaming licenses are not transferable and must be renewed periodically by the payment of various gaming license fees and taxes. The gaming authorities may deny an application for licensing for any cause which they deem reasonable and may find an officer or key employee unsuitable for licensing or unsuitable to continue having a relationship with us in which case all relationships with such person would be required to be severed. In addition, the gaming authorities may require us to terminate the employment of any person who refuses to file the appropriate applications or disclosures.

 

The ownership and/or operation of casino gaming facilities in the United States where permitted are subject to federal, state and local regulations which under federal law, govern, among other things, the ownership, possession, manufacture, distribution and transportation in interstate commerce of gaming devices, and the recording and reporting of currency transactions, respectively. Our Nevada casino gaming operations are subject to the Nevada Gaming Control Act and the regulations promulgated thereunder (the “Nevada Act”), and the licensing and regulatory control of the Nevada Gaming Commission (the “Nevada Commission”) and the Nevada State Gaming Control Board (the “Nevada Board”), as well as certain county government agencies (collectively referred to as the “Nevada Gaming Authorities”).

 

If it were determined that applicable laws or regulations were violated, the gaming licenses, registrations and approvals held by us and our affiliates and officers could be limited, conditioned, suspended or revoked and we and the persons involved could be subject to substantial fines for each separate violation. Furthermore, a supervisor could be appointed by the Nevada Commission to operate the gaming property and, under certain circumstances, earnings generated during the supervisor’s appointment (except for reasonable rental value of the affected gaming property) could be forfeited to the State of Nevada. Any suspension or revocation of the licenses, registrations or

approvals, or the appointment of a supervisor, would not have a material adverse effect on us given the limited nature and extent of the investment by us in casino gaming.

 

We are also required to submit certain financial and operating reports to the Nevada Commission. Further, certain loans, leases, sales of securities and similar financing transactions by us must be reported to or approved by the Nevada Commission. We have a Nevada “shelf” approval for certain public offerings that expires in November 2008.

 

The Nevada Gaming Authorities may investigate and require a finding of suitability of any holder of any class of our voting securities at any time. Nevada law requires any person who acquires more than 5 percent of any class of our voting securities to report the acquisition to the Nevada Commission and such person may be investigated and found suitable or unsuitable. Any person who becomes a beneficial owner of more than 10 percent of any class of our voting securities must apply for finding of suitability by the Nevada Commission within 30 days after the Nevada Board Chairman mails a written notice requiring such filing. The applicant must pay the costs and fees incurred by the Nevada Board in connection with the investigation.

 

Under certain circumstances, an “institutional investor,” as defined by the Nevada Act, that acquires more than 10 percent but no more than 15 percent of our voting securities may apply to the Nevada Commission for a waiver of such finding of shareholder suitability requirements if such institutional investor holds the voting securities for investment purposes only. An institutional investor will not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as a institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of either our Board of Directors, any change in our corporate charter, bylaws, management, policies or operations or any of our casino gaming operations, or any other action which the Nevada Commission finds to be inconsistent with holding our voting securities for investment purposes only. The Nevada Commission also may in its discretion require the holder of any debt security of a registered company to file an application, be investigated and be found suitable to own such debt security.

 

Any beneficial owner of our voting securities who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Commission or by the Chairman of the Nevada Board may be found unsuitable. Any person found unsuitable who holds, directly or indirectly, any beneficial ownership of our debt or equity voting securities beyond such periods or periods of time as may be prescribed by the Nevada Commission may be guilty of a gross misdemeanor. We could be subject to disciplinary action if, without prior approval of the Nevada Commission, and after receipt of notice that a person is unsuitable to be an equity or debt security holder or to have any other relationship with us, either (i) pays to the unsuitable person any dividend, interest or any distribution whatsoever; (ii) recognizes any voting right by such unsuitable person in connection with such securities; (iii) pays the unsuitable person remuneration in any form; (iv) makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction; or, (v) fails to pursue all lawful efforts to require such unsuitable person to relinquish his securities including, if necessary, the immediate purchase of such securities for cash at fair market value.

 

Regulations of the Nevada Commission provide that control of a registered publicly traded corporation cannot be changed through merger, consolidation, acquisition or assets, management or consulting agreements, or any form of takeover without the prior approval of the Nevada Commission. Persons seeking approval to control a registered publicly traded corporation must satisfy the Nevada Commission as to a variety of stringent standards prior to assuming control of such corporation. The failure of a person to obtain such approval prior to assuming control over the registered publicly traded corporation may constitute grounds for finding such person unsuitable.

 

Regulations of the Nevada Commission also prohibit certain repurchases of securities by registered publicly traded corporations without the prior approval of the Nevada Commission. Transactions covered by these regulations are generally aimed at discouraging repurchases of securities at a premium over market price from certain holders of more than 3 percent of the outstanding securities of the registered publicly traded corporation. The regulations of the Nevada Commission also require approval for a “plan of recapitalization.” Generally a plan of recapitalization is a plan proposed by the management of a registered publicly traded corporation that contains recommended action in response to a proposed corporate acquisition opposed by management of the corporation if such acquisition would require the prior approval of the Nevada Commission.

 

Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such persons (collectively “Licensees”), and who proposes to become involved in a gaming operation outside the State of Nevada is required to deposit with the Nevada Board, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation by the Nevada Board of the Licensees’ participation in such foreign gaming. The revolving fund is subject to an increase or decrease in the discretion of the Nevada Commission. Once such revolving fund is established, the Licensees may engage in gaming activities outside the State of Nevada without seeking the approval of the Nevada Commission provided (i) such activities are lawful in the jurisdiction where they are to be conducted; and (ii) the Licensees comply with certain reporting requirements imposed by the Nevada Act. Licensees are subject to disciplinary action by the Nevada Commission if they (i) knowingly violate any laws of the foreign jurisdiction pertaining to the foreign gaming operation; (ii) fail to conduct the foreign gaming operation in accordance with the standards of honesty and integrity required of Nevada gaming operations; (iii) engage in activities that are harmful to the State of Nevada or its ability to collect gaming taxes and fees; or, (iv) employ a person in the foreign operation who has been denied a license or finding of suitability in Nevada on the ground of personal unsuitability. We own and/or operate through various affiliates gaming operations at the Sheraton Lima Hotel and Towers in Lima, Peru, the Sheraton Stockholm Hotel and Towers in Sweden and the Sheraton Cairo Hotel, Towers & Casino in Gaza, Egypt, respectively.

 

Employees

 

At December 31, 2006, we employed approximately 145,000 employees at our corporate offices, owned and managed hotels and vacation ownership resorts, of whom approximately 36% were employed in the United States. At December 31, 2006, approximately 38% of the U.S.-based employees were covered by various collective bargaining agreements providing, generally, for basic pay rates, working hours, other conditions of employment and orderly settlement of labor disputes. Generally, labor relations have been maintained in a normal and satisfactory manner, and management believes that our employee relations are satisfactory.

 

Where you can find more information

 

We file annual, quarterly and special reports, proxy statements and other information with the Securities & Exchange Commission (“SEC”). Our SEC filings are available to the public over the Internet at the SEC’s web site at http://www.sec.gov. Our SEC filings are also available on our website at http://www.starwoodhotels.com/corporate/investor relations.html as soon as reasonably practicable after they are filed with or furnished to the SEC. You may also read and copy any document we file with the SEC at its public reference rooms in Washington, D.C. Please call the SEC at (800) SEC-0330 for further information on the public reference rooms. Our filings with the SEC are also available at the New York Stock Exchange. For more information on obtaining copies of our public filings at the New York Stock Exchange, you should call (212) 656-5060. You may also obtain a copy of our filings free of charge by calling Jason Koval, Vice President, Investor Relations at (914) 640-4429.

 

Risks Relating to Hotel, Resort, Vacation Ownership and Residential Operations

 

We Are Subject to All the Operating Risks Common to the Hotel and Vacation Ownership and Residential Industries.  Operating risks common to the hotel and vacation ownership industries include:

 

 

 

We are also impacted by our relationships with owners and franchisees. Our hotel management contracts are typically long-term arrangements, but most allow the hotel owner to replace us if certain financial or performance criteria are not met and in certain cases, upon a sale of the property. Our ability to meet these financial and performance criteria is subject to, among other things, the risks described in this section. Additionally, our operating results would be adversely affected if we could not maintain existing management, franchise or representation agreements or obtain new agreements on as favorable terms as the existing agreements.

 

We utilize our brands in connection with the residential portions of certain properties that we develop and license our brands to third parties to use in a similar manner for a fee. Residential properties using our brands could become less attractive due to changes in mortgage rates, market absorption or oversupply in a particular market. As a result, we and our third party licensees may not be able to sell these residences for a profit or at the prices that we or they have anticipated.

 

General Economic Conditions May Negatively Impact Our Results.  While the lodging and travel industries have generally recovered from events occurring in the first half of the decade, the duration, pace and full extent of the current growth environment remains unclear. Moderate or severe economic downturns or adverse conditions may negatively affect our operations. These conditions may be widespread or isolated to one or more geographic regions. A tightening of the labor markets in one or more geographic regions may result in fewer and/or less qualified applicants for job openings in our facilities. Higher wages, related labor costs and the increasing cost trends in the insurance markets may negatively impact our results as wages, related labor costs and insurance premiums increase.

 

We Must Compete for Customers.  The hotel, vacation ownership and residential industries are highly competitive. Our properties compete for customers with other hotel and resort properties, and, with respect to our vacation ownership resorts and residential projects, with owners reselling their VOIs, including fractional ownership, or apartments. Some of our competitors may have substantially greater marketing and financial resources than we do, and they may improve their facilities, reduce their prices or expand or improve their marketing programs in ways that adversely affect our operating results.

 

We Must Compete for Management and Franchise Agreements.  We compete with other hotel companies for management and franchise agreements. As a result, the terms of such agreements may not be as favorable as our current agreements. In connection with entering into management or franchise agreements, we may be required to make investments in or guarantee the obligations of third parties or guarantee minimum income to third parties.

 

Any Failure to Protect our Trademarks Could Have a Negative Impact on the Value of our Brand Names and Adversely Affect our Business.  We believe our trademarks are an important component of our business. We rely on trademark laws to protect our proprietary rights. The success of our business depends in part upon our continued ability to use our trademarks to increase brand awareness and further develop our brand in both domestic and international markets. Monitoring the unauthorized use of our intellectual property is difficult. Litigation has been and may continue to be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources, may result in counterclaims or other claims against us and could significantly harm our results of operations. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. From time to time, we apply to have certain trademarks registered. There is no guarantee that such trademark registrations will be granted. We cannot assure you that all of the steps we have taken to protect our trademarks in the United States and foreign countries will be adequate to prevent imitation of our trademarks by others. The unauthorized reproduction of our trademarks could diminish the value of our brand and its market acceptance, competitive advantages or goodwill, which could adversely affect our business.

 

Significant Owners of Our Properties May Concentrate Risks.  Generally there has not been a concentration of ownership of hotels operated under our brands by any single owner. Following the acquisition of the Le Méridien brand business and the Host Transaction, single ownership groups own significant numbers of hotels operated by us. While the risks associated with such ownership are no different than exist generally (i.e., the financial position of the

owner, the overall state of the relationship with the owner and their participation in optional programs and the impact on cost efficiencies if they choose not to participate), they are more concentrated.

 

The Hotel Industry Is Seasonal in Nature.  The hotel industry is seasonal in nature; however, the periods during which we experience higher revenue vary from property to property and depend principally upon location. Our revenue historically has been lower in the first quarter than in the second, third or fourth quarters.

 

Third Party Internet Reservation Channels May Negatively Impact our Bookings.  Some of our hotel rooms are booked through third party internet travel intermediaries such as Travelocity.com^®, Expedia.com^® and Priceline.com^®. As the percentage of internet bookings increases, these intermediaries may be able to obtain higher commissions, reduced room rates or other significant contract concessions from us. Moreover, some of these internet travel intermediaries are attempting to commoditize hotel rooms by increasing the importance of price and general indicators of quality (such as “three-star downtown hotel”) at the expense of brand identification. These agencies hope that consumers will eventually develop brand loyalties to their reservations system rather than to our lodging brands. Although we expect to derive most of our business from traditional channels and our websites, if the amount of sales made through internet intermediaries increases significantly, our business and profitability may be significantly harmed.

 

We Place Significant Reliance on Technology.  The hospitality industry continues to demand the use of sophisticated technology and systems including technology utilized for property management, procurement, reservation systems, operation of our customer loyalty program, distribution and guest amenities. These technologies can be expected to require refinements and there is the risk that advanced new technologies will be introduced. Further, the development and maintenance of these technologies may require significant capital. There can be no assurance that as various systems and technologies become outdated or new technology is required we will be able to replace or introduce them as quickly as our competition or within budgeted costs and timeframes for such technology. Further, there can be no assurance that we will achieve the benefits that may have been anticipated from any new technology or system.

 

Our Businesses Are Capital Intensive.  For our owned, managed and franchised properties to remain attractive and competitive, the property owners and we have to spend money periodically to keep the properties well maintained, modernized and refurbished. This creates an ongoing need for cash and, to the extent the property owners and we cannot fund expenditures from cash generated by operations, funds must be borrowed or otherwise

obtained. In addition, to continue growing our vacation ownership business and residential projects, we need to spend money to develop new units. Accordingly, our financial results may be sensitive to the cost and availability of funds and the carrying cost of VOI and residential inventory.

 

Real Estate Investments Are Subject to Numerous Risks.  We are subject to the risks that generally relate to investments in real property because we own and lease hotels and resorts. The investment returns available from equity investments in real estate depend in large part on the amount of income earned and capital appreciation generated by the related properties, and the expenses incurred. In addition, a variety of other factors affect income from properties and real estate values, including governmental regulations, real estate, insurance, zoning, tax and eminent domain laws, interest rate levels and the availability of financing. For example, new or existing real estate zoning or tax laws can make it more expensive and/or time-consuming to develop real property or expand, modify or renovate hotels. When interest rates increase, the cost of acquiring, developing, expanding or renovating real property increases and real property values may decrease as the number of potential buyers decreases. Similarly, as financing becomes less available, it becomes more difficult both to acquire and to sell real property. Finally, under eminent domain laws, governments can take real property. Sometimes this taking is for less compensation than the owner believes the property is worth. Any of these factors could have a material adverse impact on our results of operations or financial condition. In addition, equity real estate investments are difficult to sell quickly and we may not be able to adjust our portfolio of owned properties quickly in response to economic or other conditions. If our properties do not generate revenue sufficient to meet operating expenses, including debt service and capital expenditures, our income will be adversely affected.

 

Hotel and Resort Development Is Subject to Timing, Budgeting and Other Risks.  We intend to develop hotel and resort properties, including VOIs and residential components of hotel properties, as suitable opportunities arise, taking into consideration the general economic climate. New project development has a number of risks, including risks associated with:

 

 

We cannot assure you that any development project will be completed on time or within budget.

 

Environmental Regulations.  Environmental laws, ordinances and regulations of various federal, state, local and foreign governments regulate our properties and could make us liable for the costs of removing or cleaning up hazardous or toxic substances on, under, or in property we currently own or operate or that we previously owned or operated. These laws could impose liability without regard to whether we knew of, or were responsible for, the presence of hazardous or toxic substances. The presence of hazardous or toxic substances, or the failure to properly clean up such substances when present, could jeopardize our ability to develop, use, sell or rent the real property or to borrow using the real property as collateral. If we arrange for the disposal or treatment of hazardous or toxic wastes, we could be liable for the costs of removing or cleaning up wastes at the disposal or treatment facility, even if we never owned or operated that facility. Other laws, ordinances and regulations could require us to manage, abate or remove lead or asbestos containing materials. Similarly, the operation and closure of storage tanks are often regulated by federal, state, local and foreign laws. Certain laws, ordinances and regulations, particularly those governing the management or preservation of wetlands, coastal zones and threatened or endangered species, could limit our ability to develop, use, sell or rent our real property.

 

International Operations Are Subject to Special Political and Monetary Risks.  We have significant international operations which as of December 31, 2006 included 264 owned, managed or franchised properties

in Europe, Africa and the Middle East (including 21 properties with majority ownership); 55 owned, managed or franchised properties in Latin America (including 9 properties with majority ownership); and 124 owned, managed or franchised properties in the Asia Pacific region (including 4 properties with majority ownership). International operations generally are subject to various political, geopolitical, and other risks that are not present in U.S. operations. These risks include the risk of war, terrorism, civil unrest, expropriation and nationalization as well as the impact in cases in which there are inconsistencies between U.S. law and the laws of an international jurisdiction. In addition, some international jurisdictions restrict the repatriation of non-U.S. earnings. Various other international jurisdictions have laws limiting the ability of non-U.S. entities to pay dividends and remit earnings to affiliated companies unless specified conditions have been met. In addition, sales in international jurisdictions typically are made in local currencies, which subject us to risks associated with currency fluctuations. 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. Other than Italy, where our risks are heightened due to the 9 properties we owned as of December 31, 2006, our international properties are geographically diversified and are not concentrated in any particular region.

 

Risks Relating to Operations in Syria

 

During fiscal 2006, Starwood subsidiaries generated approximately $2 million of revenue from management and other fees from hotels located in Syria, a country that the United States has identified as a state sponsor of terrorism. This amount constitutes significantly less than 1% of our worldwide annual revenues. The United States does not prohibit U.S. investments in, or the exportation of services to, Syria, and our activities in that country are in full compliance with U.S. and local law. However, the United States has imposed limited sanctions as a result of Syria’s support for terrorist groups and its interference with Lebanon’s sovereignty, including a prohibition on the exportation of U.S.-origin goods to Syria and the operation of government-owned Syrian air carriers in the United States except in limited circumstances. The United States may impose further sanctions against Syria at any time for foreign policy reasons. If so, our activities in Syria may be adversely affected, depending on the nature of any further sanctions that might be imposed. In addition, our activities in Syria may reduce demand for our stock among certain investors.

 

Debt Financing

 

As a result of our debt obligations, we are subject to: (i) the risk that cash flow from operations will be insufficient to meet required payments of principal and interest and (ii) interest rate risk. Although we anticipate that we will be able to repay or refinance our existing indebtedness and any other indebtedness when it matures, there can be no assurance that we will be able to do so or that the terms of such refinancings will be favorable. Our leverage may have important consequences including the following: (i) our ability to obtain additional financing for acquisitions, working capital, capital expenditures or other purposes, if necessary, may be impaired or such financing may not be available on terms favorable to us and (ii) a substantial decrease in operating cash flow or a substantial increase in our expenses could make it difficult for us to meet our debt service requirements and force us to sell assets and/or modify our operations.

 

Risks Relating to So-Called Acts of God, Terrorist Activity and War

 

Our financial and operating performance may be adversely affected by so-called acts of God, such as natural disasters, in locations where we own and/or operate significant properties and areas of the world from which we draw a large number of customers. Similarly, wars (including the potential for war), terrorist activity (including threats of terrorist activity), political unrest and other forms of civil strife and geopolitical uncertainty have caused in the past, and may cause in the future, our results to differ materially from anticipated results.

 

Some Potential Losses are Not Covered by Insurance

 

We carry insurance coverage for general liability, property, business interruption and other risks with respect to our owned and leased properties and we make available insurance programs for owners of properties we manage. These policies offer coverage terms and conditions that we believe are usual and customary for our industry.

Generally, our “all-risk” property policies provide that coverage is available on a per occurrence basis and that, for each occurrence, there is a limit as well as various sub-limits on the amount of insurance proceeds we will receive in excess of applicable deductibles. In addition, there may be overall limits under the policies. Sub-limits exist for certain types of claims such as service interruption, debris removal, expediting costs or landscaping replacement, and the dollar amounts of these sub-limits are significantly lower than the dollar amounts of the overall coverage limit. Our property policies also provide that for the coverage of critical earthquake (California and Mexico), hurricane and flood, all of the claims from each of our properties resulting from a particular insurable event must be combined together for purposes of evaluating whether the annual aggregate limits and sub-limits contained in our policies have been exceeded and any such claims will also be combined with the claims of owners of managed hotels that participate in our insurance program for the same purpose. Therefore, if insurable events occur that affect more than one of our owned hotels and/or managed hotels owned by third parties that participate in our insurance program, the claims from each affected hotel will be added together to determine whether the per occurrence limit, annual aggregate limit or sub-limits, depending on the type of claim, have been reached and if the limits or sub-limits are exceeded each affected hotel will only receive a proportional share of the amount of insurance proceeds provided for under the policy. In addition, under those circumstances, claims by third party owners will reduce the coverage available for our owned and leased properties.

 

In addition, there are also other risks including but not limited to war, certain forms of terrorism such as nuclear, biological or chemical terrorism, political risks, some environmental hazards and/or acts of God that may be deemed to fall completely outside the general coverage limits of our policies or may be uninsurable or may be too expensive to justify insuring against.

 

We may also encounter challenges with an insurance provider regarding whether it will pay a particular claim that we believe to be covered under our policy. 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 or resort, as well as the anticipated future revenue from the hotel or resort. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property.

 

Acquisitions/Dispositions and New Brands

 

We intend to make acquisitions and investments that complement our business. There can be no assurance, however, that we will be able to identify acquisition or investment candidates or complete transactions on commercially reasonable terms or at all. If transactions are consummated, there can be no assurance that any anticipated benefits will actually be realized. Similarly, there can be no assurance that we will be able to obtain additional financing for acquisitions or investments, or that the ability to obtain such financing will not be restricted by the terms of our debt agreements.

 

We periodically review our business to identify properties or other assets that we believe either are non-core, no longer complement our business, are in markets which may not benefit us as much as other markets during an economic recovery or could be sold at significant premiums. We are focused on restructuring and enhancing real estate returns and monetizing investments and from time to time, may attempt to sell these identified properties and assets. There can be no assurance, however, that we will be able to complete dispositions on commercially reasonable terms or at all or that any anticipated benefits will actually be received.

 

We have developed and launched two new hotel brands, aloft and Element, and may develop and launch additional brands in the future. There can be no assurance regarding the level of acceptance of these brands in the development and consumer marketplaces, that the cost incurred in developing the brands will be recovered or that the anticipated benefits from these new brands will be realized.

 

Investing Through Partnerships or Joint Ventures Decreases Our Ability to Manage Risk

 

In addition to acquiring or developing hotels and resorts or acquiring companies that complement our business directly, we have from time to time invested, and expect to continue to invest, as a co-venturer. Joint venturers often have shared control over the operation of the joint venture assets. Therefore, joint venture investments may involve risks such as the possibility that the co-venturer in an investment might become bankrupt or not have the financial resources to meet its obligations, or have economic or business interests or goals that are inconsistent with our

business interests or goals, or be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives. Consequently, actions by a co-venturer might subject hotels and resorts owned by the joint venture to additional risk. Further, we may be unable to take action without the approval of our joint venture partners. Alternatively, our joint venture partners could take actions binding on the joint venture without our consent. Additionally, should a joint venture partner become bankrupt, we could become liable for our partner’s share of joint venture liabilities.

 

Our Vacation Ownership Business is Subject to Extensive Regulation and Risk of Default

 

We market and sell VOIs, which typically entitle the buyer to ownership of a fully-furnished resort unit for a one-week period (or in the case of fractional ownership interests, generally for three or more weeks) on either an annual or an alternate-year basis. We also acquire, develop and operate vacation ownership resorts, and provide financing to purchasers of VOIs. These activities are all subject to extensive regulation by the federal government and the states in which vacation ownership resorts are located and in which VOIs are marketed and sold including regulation of our telemarketing activities under state and federal “Do Not Call” laws. In addition, the laws of most states in which we sell VOIs grant the purchaser the right to rescind the purchase contract at any time within a statutory rescission period. Although we believe that we are in material compliance with all applicable federal, state, local and foreign laws and regulations to which vacation ownership marketing, sales and operations are currently subject, changes in these requirements or a determination by a regulatory authority that we were not in compliance, could adversely affect us. In particular, increased regulations of telemarketing activities could adversely impact the marketing of our VOIs.

 

We bear the risk of defaults under purchaser mortgages on VOIs. If a VOI purchaser defaults on the mortgage during the early part of the loan amortization period, we will not have recovered the marketing, selling (other than commissions in certain events), and general and administrative costs associated with such VOI, and such costs will be incurred again in connection with the resale of the repossessed VOI. Accordingly, there is no assurance that the sales price will be fully or partially recovered from a defaulting purchaser or, in the event of such defaults, that our allowance for losses will be adequate.

 

Recent Privacy Initiatives

 

We collect information relating to our guests for various business purposes, including marketing and promotional purposes. The collection and use of personal data are governed by privacy laws and regulations enacted in the United States and other jurisdictions around the world. Privacy regulations continue to evolve and on occasion may be inconsistent from one jurisdiction to another. Compliance with applicable privacy regulations may increase our operating costs and/or adversely impact our ability to market our products, properties and services to our guests. In addition, non-compliance with applicable privacy regulations by us (or in some circumstances non-compliance by third parties engaged by us) may result in fines or restrictions on our use or transfer of data.

 

Ability to Manage Growth

 

Our future success and our ability to manage future growth depend in large part upon the efforts of our senior management and our ability to attract and retain key officers and other highly qualified personnel. Competition for such personnel is intense. Since January 2004, we have experienced significant changes in our senior management, including executive officers (See Item 10. “Directors, Executive Officers and Corporate Governance” of this Annual Report). There can be no assurance that we will continue to be successful in attracting and retaining qualified personnel. Accordingly, there can be no assurance that our senior management will be able to successfully execute and implement our growth and operating strategies. In addition, we recently announced a strategy of reducing our investment in owned real estate and increasing our focus on the management and franchise business, and there can be no assurance that our new strategy will be successful.

 

Tax Risks

 

Failure of the Trust to Qualify as a REIT Would Increase Our Tax Liability.  Qualifying as a real estate investment trust (a “REIT”) requires compliance with highly technical and complex tax provisions that courts and

administrative agencies have interpreted only to a limited degree. Due to the complexities of our ownership, structure and operations, the Trust is more likely than are other REITs to face interpretative issues for which there are no clear answers. Also, facts and circumstances that we do not control may affect the Trust’s ability to qualify as a REIT. The Trust believes that for the taxable years ended December 31, 1995 through April 10, 2006, the date which Host acquired the Trust, it has qualified as a REIT under the Internal Revenue Code of 1986, as amended. If the Trust fails to qualify as a REIT for any prior tax year, we would be liable to pay a significant amount of taxes for those years. Subsequent to the Host Transaction, the Trust is no longer owned by us and we are not subject to this risk for actions following the transaction.

 

Evolving government regulation could impose taxes or other burdens on our business.  We rely upon generally available interpretations of tax laws and other types of laws and regulations in the countries and locales in which we operate. We cannot be sure that these interpretations are accurate or that the responsible taxing or other governmental authority is in agreement with our views. The imposition of additional taxes or causing us to change the way we conduct our business could cause us to have to pay taxes that we currently do not collect or pay or increase the costs of our services or increase our costs of operations.

 

Our current business practice with our internet reservation channels is that the intermediary collects hotel occupancy tax from its customer based on the price that the intermediary paid us for the hotel room. We then remit these taxes to the various tax authorities. Several jurisdictions have stated that they may take the position that the tax is also applicable to the intermediaries’ gross profit on these hotel transactions. If jurisdictions take this position, they should seek the additional tax payments from the intermediary; however, it is possible that they may seek to collect the additional tax payment from us and we would not be able to collect these taxes from the customers. To the extent that any tax authority succeeds in asserting that the hotel occupancy tax applies to the gross profit on these transactions, we believe that any additional tax would be the responsibility of the intermediary. However, it is possible that we might have additional tax exposure. In such event, such actions could have a material adverse effect on our business, results of operations and financial condition.

 

Risks Relating to Ownership of Our Shares

 

No Person or Group May Own More Than 8% of Our Shares.  Our current governing documents provide (subject to certain exceptions) that no one person or group may own or be deemed to own more than 8% of our outstanding stock or Shares of beneficial interest, whether measured by vote, value or number of Shares. There is an exception for shareholders who owned more than 8% as of February 1, 1995, who may not own or be deemed to own more than the lesser of 9.9% or the percentage of Shares they held on that date, provided, that if the percentage of Shares beneficially owned by such a holder decreases after February 1, 1995, such a holder may not own or be deemed to own more than the greater of 8% or the percentage owned after giving effect to the decrease but we have the right to waive this limitation. This ownership limit may have the effect of precluding a change in control of us by a third party without the consent of our Board of Directors, even if such change in control would otherwise give the holders of Shares or other of our equity securities the opportunity to realize a premium over then-prevailing market prices.

 

Our Board of Directors May Issue Preferred Stock and Establish the Preferences and Rights of Such Preferred Stock.  Our charter provides that the total number of shares of stock of all classes which the Corporation has authority to issue is 1,350,000,000, initially consisting of one billion shares of common stock, 50 million shares of excess common stock, 200 million shares of preferred stock and 100 million shares of excess preferred stock. Our Board of Directors has the authority, without a vote of shareholders, to establish the preferences and rights of any preferred or other class or series of shares to be issued and to issue such shares. The issuance of preferred shares or other shares having special preferences or rights could delay or prevent a change in control even if a change in control would be in the interests of our shareholders. Since our Board of Directors has the power to establish the preferences and rights of additional classes or series of shares without a shareholder vote, our Board of Directors may give the holders of any class or series preferences, powers and rights, including voting rights, senior to the rights of holders of our shares.

 

Our Board of Directors May Implement Anti-Takeover Devices and our Charter and By-Laws Contain Provisions which May Prevent Takeovers.  Certain provisions of Maryland law permit our Board of Directors,

without stockholder approval, to implement possible takeover defenses that are not currently in place, such as a classified board. In addition, our charter contains provisions relating to restrictions on transferability of the Corporation Shares, which provisions may be amended only by the affirmative vote of our shareholders holding two-thirds of the votes entitled to be cast on the matter. As permitted under the Maryland General Corporation Law, our Bylaws provide that directors have the exclusive right to amend our Bylaws.

 

Our Shareholder Rights Plan Would Cause Substantial Dilution to Any Shareholder That Attempts to Acquire Us on Terms Not Approved by Our Board of Directors.  We adopted a shareholder rights plan which provides, among other things, that when specified events occur, our shareholders will be entitled to purchase from us a newly created series of junior preferred stock, subject to the ownership limit described above. The preferred stock purchase rights are triggered by the earlier to occur of (i) ten days after the date of a public announcement that a person or group acting in concert has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of our outstanding Corporation Shares or (ii) ten business days after the commencement of or announcement of an intention to make a tender offer or exchange offer, the consummation of which would result in the acquiring person becoming the beneficial owner of 15% or more of our outstanding Corporation Shares. The preferred stock purchase rights would cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors.

 

We are one of the largest hotel and leisure companies in the world, with operations in approximately 100 countries. We consider our hotels and resorts, including vacation ownership resorts (together “Resorts”), generally to be premier establishments with respect to desirability of location, size, facilities, physical condition, quality and variety of services offered in the markets in which they are located. Although obsolescence arising from age and condition of facilities can adversely affect our Resorts, Starwood and third-party owners of managed and franchised Resorts expend substantial funds to renovate and maintain their facilities in order to remain competitive. For further information see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources in this Annual Report.

 

Our hotel business included 871 owned, managed or franchised hotels with approximately 266,000 rooms and our vacation ownership business included 25 vacation ownership resorts and residential properties at December 31, 2006, predominantly under seven brands. All brands (other than the Four Points by Sheraton and the newly announced aloft and Element brands) represent full-service properties that range in amenities from luxury hotels and resorts to more moderately priced hotels. We also lease three stand-alone Bliss Spas, two in New York, New York and one in London, England and have opened five Bliss Spas in W Hotels. In addition, we have opened three Remède Spas in St. Regis hotels.

 

The following table reflects our hotel and vacation ownership properties, by brand as of December 31, 2006:

 

 

Hotel Business

 

Owned, Leased and Consolidated Joint Venture Hotels.  Historically, we have derived the majority of our revenues and operating income from our owned, leased and consolidated joint venture hotels and a significant

portion of these results are driven by these hotels in North America. However, in 2005 and 2006 we have sold 56 wholly owned hotels which has substantially reduced our revenues and operating income from owned, leased and consolidated joint venture hotels. The majority of these hotels were sold subject to long-term management or franchise contracts. Total revenues generated from our owned, leased and consolidated joint venture hotels worldwide for the years ending December 31, 2006 and 2005 were $2.692 billion and $3.517 billion, respectively (total revenues from our owned, leased and consolidated joint venture hotels in North America were $1.881 billion and $2.571 billion for 2006 and 2005, respectively). The following represents our top ten markets in the United States by metropolitan area as a percentage of our total owned, leased and consolidated joint venture revenues for the year ended December 31, 2006 (with comparable data for 2005):

 

 

The following represents our top ten international markets by country as a percentage of our total owned, leased and consolidated joint venture revenues for the year ended December 31, 2006 (with comparable data for 2005):

 

 

 

 

Following the sale of a significant number of our hotels, we currently own or lease 85 hotels. Our owned, leased and consolidated joint venture hotel revenues and operating income is generated substantially from the following hotels:

 

An indicator of the performance of our owned, leased and consolidated joint venture hotels is revenue per available room (“REVPAR”)⁽¹⁾, as it measures the period-over-period growth in rooms revenue for comparable properties. This is particularly the case in the United States where there is no impact on this measure from foreign exchange rates.

 

The following table summarizes REVPAR, average daily rates (“ADR”) and average occupancy rates on a year-to-year basis for our 74 owned, leased and consolidated joint venture hotels (excluding 56 hotels sold or closed and 11 hotels undergoing significant repositionings or without comparable results in 2006 and 2005) (“Same-Store Owned Hotels”) for the years ended December 31, 2006 and 2005:

 

 

 

 

During the years ended December 31, 2006 and 2005, we invested approximately $245 million and $318 million, respectively, for capital improvements at owned hotels, excluding the inventory expenditures at the St. Regis Museum Tower in San Francisco, California, discussed below. These capital expenditures included the renovation of the Sheraton Centre Toronto Hotel in Toronto, Canada, the Westin Resort & Spa in Cancun, Mexico and the Sheraton Kauai Resort in Kauai, Hawaii.

 

Managed and Franchised Hotels.  Hotel and resort properties in the United States are often owned by entities that do not manage hotels or own a brand name. Hotel owners typically enter into management contracts with hotel management companies to operate their hotels. When a management company does not offer a brand affiliation, the hotel owner often chooses to pay separate franchise fees to secure the benefits of brand marketing, centralized reservations and other centralized administrative functions, particularly in the sales and marketing area. Management believes that companies, such as Starwood, that offer both hotel management services and well-established worldwide brand names appeal to hotel owners by providing the full range of management, marketing and reservation services.

 

Managed Hotels.  We manage hotels worldwide, usually under a long-term agreement with the hotel owner (including entities in which we have a minority equity interest). Our responsibilities under hotel management contracts typically include hiring, training and supervising the managers and employees that operate these facilities. For additional fees, we provide centralized reservation services and coordinate national advertising and certain marketing and promotional services. We prepare and implement annual budgets for the hotels we manage and are responsible for allocating property-owner funds for periodic maintenance and repair of buildings and furnishings. In addition to our owned and leased hotels, at December 31, 2006, we managed 426 hotels with approximately

142,000 rooms worldwide. During the year ended December 31, 2006, we generated management fees by geographic area as follows:

 

 

Management contracts typically provide for base fees tied to gross revenue and incentive fees tied to profits as well as fees for other services, including centralized reservations, sales and marketing, public relations and national and international media advertising. In our experience, owners seek hotel managers that can provide attractively priced base, incentive, marketing and franchise fees combined with demonstrated sales and marketing expertise and operations-focused management designed to enhance profitability. Some of our management contracts permit the hotel owner to terminate the agreement when the hotel is sold or otherwise transferred to a third party, as well as if we fail to meet established performance criteria. In addition, many hotel owners seek equity, debt or other investments from us to help finance hotel renovations or conversions to a Starwood brand so as to align the interests of the owner and the Company. Our ability or willingness to make such investments may determine, in part, whether we will be offered, will accept, or will retain a particular management contract. In addition to the management contracts we retained in connection with the sale of hotels discussed earlier, during the year ended December 31, 2006, we opened 29 managed hotels with approximately 7,000 rooms, and 13 hotels with approximately 3,000 rooms left the system. In addition, during 2006, we signed management agreements for 68 hotels with approximately 18,000 rooms, a portion of which opened in 2006 and a portion of which will open in the future.

 

Brand Franchising and Licensing.  We franchise our Sheraton, Westin, Four Points by Sheraton, Luxury Collection, Le Méridien, aloft and Element brand names and generally derive licensing and other fees from franchisees based on a fixed percentage of the franchised hotel’s room revenue, as well as fees for other services, including centralized reservations, sales and marketing, public relations and national and international media advertising. In addition, a franchisee may also purchase hotel supplies, including brand-specific products, from certain Starwood-approved vendors. We approve certain plans for, and the location of, franchised hotels and review their design. At December 31, 2006, there were 360 franchised properties with approximately 96,000 rooms operating under the Sheraton, Westin, Four Points by Sheraton, Luxury Collection and Le Méridien brands. During the year ended December 31, 2006, we generated franchise fees by geographic area as follows:

 

 

In addition to the franchise contracts we retained in connection with the sale of hotels discussed earlier, during the year ended December 31, 2006, we opened 27 franchised hotels with approximately 7,000 rooms, and 17 hotels with approximately 4,000 rooms left the system. In addition, during 2006, we signed franchise agreements for 88 hotels with approximately 18,000 rooms, a portion of which opened in 2006 and a portion of which will open in the future.

 

Vacation Ownership and Residential Business

 

We develop, own and operate vacation ownership resorts, market and sell the VOIs in the resorts and, in many cases, provide financing to customers who purchase such ownership interests. Owners of VOIs can trade their interval for intervals at other Starwood vacation ownership resorts, for intervals at certain vacation ownership resorts not otherwise sponsored by Starwood through an exchange company, or for hotel stays at Starwood properties. From time to time, we securitize or sell the receivables generated from our sale of VOIs.

 

We have also entered into arrangements with several owners for mixed use hotel projects that will include a residential component. We have entered into licensing agreements for the use of certain of our brands to allow the owners to offer branded condominiums to prospective purchasers. In consideration, we typically receive a licensing fee equal to a percentage of the gross sales revenue of the units sold. The licensing arrangement generally terminates upon the earlier of sell-out of the units or a specified length of time.

 

At December 31, 2006, we had 25 residential and vacation ownership resorts and sites in our portfolio with 15 actively selling VOIs and residences, 6 expected to start construction in 2007 or 2008 and 4 that have sold all existing inventory. During 2006 and 2005, we invested approximately $411 million and $231 million, respectively, for vacation ownership capital expenditures, including VOI construction at Westin Ka’anapali Ocean Resort Villas North in Maui, Hawaii, and the Westin Princeville Resort in Kauai, Hawaii and the purchase of land in Aruba where we plan to build a 154-unit Westin-branded vacation ownership resort.

 

In late 2004, we began selling residential units at the St. Regis Museum Tower in San Francisco, California which opened in November 2005. We recognized revenues of approximately $53 million and $183 million in 2006 and 2005, respectively, related to the sale of these residential units which were sold out in the first half of 2006. In 2006 we began selling residential units at the St. Regis Hotel in New York, New York and recognized revenues of approximately $41 million. During 2006 and 2005, we invested approximately $23 million and $65 million, respectively, for residential inventory.

 

Incorporated by reference to the description of legal proceedings in Note 23. Commitments and Contingencies, in the notes to financial statements set forth in Part II, Item 8. Financial Statements and Supplementary Data.

 

Not applicable.

 

 

See Part III, Item 10. of this Annual Report for information regarding the executive officers of the Registrants, which information is incorporated herein by reference.

 

Market Information

 

The Corporation Shares are traded on the New York Stock Exchange (the “NYSE”) under the symbol “HOT.”

 

The following table sets forth, for the fiscal periods indicated, the high and low sale prices per Corporation Share (and Share until April 7, 2006) on the NYSE Composite Tape(a).

 

 

 

 

Holders

 

As of February 16, 2007, there were approximately 18,000 holders of record of Corporation Shares.

 

Distributions and Dividends Made/Declared

 

The following table sets forth the frequency and amount of distributions made by the Trust and dividends made by the Corporation to holders of Corporation Shares (and Shares until April 7, 2006) for the years ended December 31, 2006 and 2005:

 

 

 

 

Conversion of Securities; Sale of Unregistered Securities

 

In 2006, we completed the redemption of the remaining 25,000 outstanding shares of Class B Exchangeable Preferred Shares (“Class B EPS”) for approximately $1 million in cash. Also in 2006, in connection with the Host Transaction, we redeemed all of the Class A Exchangeable Preferred Shares (“Class A EPS”) (approximately 562,000 shares) and Realty Partnership units (approximately 40,000 units) for approximately $34 million in cash. SLC Operating Limited Partnership units are convertible into Shares at the unit holder’s option, provided that the Company has the option to settle conversion requests in cash or Shares. In 2006, we redeemed approximately 926,000 SLC Operating Limited Partnership units for approximately $56 million in cash, and there were approximately 179,000 of these units outstanding at December 31, 2006.

 

Issuer Purchases of Equity Securities

 

Pursuant to the Share Repurchase Program, Starwood repurchased 21.7 million Shares and Corporation Shares in the open market for an aggregate cost of $1.263 billion during 2006. The Company repurchased the following Corporation Shares during the three months ended December 31, 2006:

 

 

Information relating to securities authorized for issuance under equity compensation plans is provided under Item 12 of this Annual Report and is incorporated herein by reference.

STOCKHOLDER RETURN PERFORMANCE

 

Set forth below is a line graph comparing the cumulative total stockholder return on the Corporation Shares (and Shares until April 7, 2006) against the cumulative total return on the S&P 500 and the S&P 500 Hotel Index (the “S&P 500 Hotel”) for the five fiscal years beginning December 31, 2001 and ending December 31, 2006. The graph assumes that the value of the investments was 100 on December 31, 2001 and that all dividends and other distributions were reinvested. In addition, the Share prices for the periods prior to the Host Transaction on April 10, 2006 have been adjusted based on the value shareholders received for their Class B shares. The comparisons are provided in response to SEC disclosure requirements and are not intended to forecast or be indicative of future performance.

 

 

Item 6.  Selected Financial Data.

 

The following financial and operating data should be read in conjunction with the information set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes thereto appearing elsewhere in this Annual Report and incorporated herein by reference.

 

 

 

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and costs and expenses during the reporting periods. On an ongoing basis, management evaluates its estimates and judgments, including those relating to revenue recognition, bad debts, inventories, investments, plant, property and equipment, goodwill and intangible assets, income taxes, financing operations, frequent guest program liability, self-insurance claims payable, restructuring costs, retirement benefits and contingencies and litigation.

 

Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions and conditions.

CRITICAL ACCOUNTING POLICIES

 

We believe the following to be our critical accounting policies:

 

Revenue Recognition.  Our revenues are primarily derived from the following sources: (1) hotel and resort revenues at our owned, leased and consolidated joint venture properties; (2) vacation ownership and residential revenues; (3) management and franchise revenues; (4) revenues from managed and franchised properties; and (5) other revenues which are ancillary to our operations. Generally, revenues are recognized when the services have been rendered. The following is a description of the composition of our revenues:

 

 

Frequent Guest Program.  SPG is our frequent guest incentive marketing program. SPG members earn points based on spending at our properties, as incentives to first time buyers of VOIs and residences and through participation in affiliated programs. Points can be redeemed at substantially all of our owned, leased, managed and

franchised properties as well as through other redemption opportunities with third parties, such as conversion to airline miles. Properties are charged based on hotel guests’ qualifying expenditures. Revenue is recognized by participating hotels and resorts when points are redeemed for hotel stays.

 

We, through the services of third-party actuarial analysts, determine the fair value of the future redemption obligation based on statistical formulas which project the timing of future point redemption based on historical experience, including an estimate of the “breakage” for points that will never be redeemed, and an estimate of the points that will eventually be redeemed as well as the cost of reimbursing hotels and other third parties in respect of other redemption opportunities for point redemptions. Actual expenditures for SPG may differ from the actuarially determined liability. The total actuarially determined liability as of December 31, 2006 and 2005 is $409 million and $314 million, respectively. A 10% reduction in the “breakage” of points would result in an estimated increase of $59 million to the liability at December 31, 2006.

 

Long-Lived Assets.  We evaluate the carrying value of our long-lived assets for impairment by comparing the expected undiscounted future cash flows of the assets to the net book value of the assets if certain trigger events occur. If the expected undiscounted future cash flows are less than the net book value of the assets, the excess of the net book value over the estimated fair value is charged to current earnings. Fair value is based upon discounted cash flows of the assets at a rate deemed reasonable for the type of asset and prevailing market conditions, appraisals and, if appropriate, current estimated net sales proceeds from pending offers. We evaluate the carrying value of our long-lived assets based on our plans, at the time, for such assets and such qualitative factors as future development in the surrounding area, status of expected local competition and projected incremental income from renovations. Changes to our plans, including a decision to dispose of or change the intended use of an asset, can have a material impact on the carrying value of the asset.

 

Assets Held for Sale.  We consider properties to be assets held for sale when management approves and commits to a formal plan to actively market a property or group of properties for sale and a signed sales contract and significant non-refundable deposit or contract break-up fee exist. Upon designation as an asset held for sale, we record the carrying value of each property or group of properties at the lower of its carrying value which includes allocable segment goodwill or its estimated fair value, less estimated costs to sell, and we stop recording depreciation expense. Any gain realized in connection with the sale of a property for which we have significant continuing involvement (such as through a long-term management agreement) is deferred and recognized over the initial term of the related agreement. The operations of the properties held for sale prior to the sale date are recorded in discontinued operations unless we will have continuing involvement (such as through a management or franchise agreement) after the sale.

 

Legal Contingencies.  We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” requires that an estimated loss from a loss contingency should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. We evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our financial position or our results of operations.

 

Income Taxes.  We provide for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our financial statements or tax returns.

 

RESULTS OF OPERATIONS

 

The following discussion presents an analysis of results of our operations for the years ended December 31, 2006, 2005 and 2004.

 

Year Ended December 31, 2006 Compared with Year Ended December 31, 2005

 

Continuing Operations

 

Revenues.  Total revenues, including other revenues from managed and franchised properties, were $5.979 billion, an increase of $2 million when compared to 2005 levels. Revenues reflected a 23.5% decrease in revenues from our owned, leased and consolidated joint venture hotels to $2.692 billion for the year ended December 31, 2006 when compared to $3.517 billion in the corresponding period of 2005, a 39.1% increase in management fees, franchise fees and other income to $697 million for the year ended December 31, 2006 when compared to $501 million in the corresponding period of 2005, a 13.0% increase in vacation ownership and residential revenues to $1.005 billion for the year ended December 31, 2006 when compared to $889 million in the corresponding period of 2005, and an increase of $515 million in other revenues from managed and franchised properties to $1.585 billion for the year ended December 31, 2006 when compared to $1.070 billion in the corresponding period of 2005.

 

The decrease in revenues from owned, leased and consolidated joint venture hotels of $825 million was primarily due to lost revenues from 45 wholly owned hotels sold or closed during 2006. These hotels had revenues of $384 million in the year ended December 31, 2006 compared to $1.299 billion in the corresponding period of 2005. The decrease in revenues from sold hotels was partially offset by business interruption insurance proceeds received in 2006 of approximately $33 million, primarily related to Hurricane Katrina and Hurricane Wilma in 2005, and by improved results at our remaining owned, leased and consolidated joint venture hotels. Revenues at our Same-Store Owned Hotels (74 hotels for the years ended December 31, 2006 and 2005, excluding 56 hotels sold or closed and 11 hotels undergoing significant repositionings or without comparable results in 2006 and 2005) increased 8.8%, or $157 million, to $1.942 billion for the year ended December 31, 2006 when compared to $1.785 billion in the same period of 2005 due primarily to an increase in REVPAR. REVPAR at our Same-Store Owned Hotels increased 10.1% to $136.33 for the year ended December 31, 2006 when compared to the corresponding 2005 period. The increase in REVPAR at these Same-Store Owned Hotels was attributed to increases in occupancy rates to 71.2% in the year ended December 31, 2006 when compared to 69.9% in the same period in 2005, and an 8.2% increase in ADR to $191.56 for the year ended December 31, 2006 compared to $177.04 for the corresponding 2005 period. REVPAR at Same-Store Owned Hotels in North America increased 10.2% for the year ended December 31, 2006 when compared to the same period of 2005. REVPAR growth was particularly strong at our owned hotels in Chicago, Illinois, Boston, Massachusetts, and Seattle, Washington. REVPAR at our international Same-Store Owned Hotels increased by 10.0% for the year ended December 31, 2006 when compared to the same period of 2005. REVPAR for Same-Store Owned Hotels internationally increased 9.5% excluding the favorable effects of foreign currency translation.

 

The increase in management fees, franchise fees and other income of $196 million was primarily a result of a $202 million increase in management and franchise revenue to $564 million for the year ended December 31, 2006 due to the addition of new managed and franchised hotels. The increase included approximately $44 million of management and franchise fees from the 33 hotels sold to Host, as well as approximately $34 million of revenues from the amortization of the deferred gain associated with the Host Transaction. The increase was also due to $58 million of management and franchise fees from the Le Méridien hotels in 2006 as compared to $5 million in 2005. We acquired the Le Méridien brand and related management and franchise business in November 2005 (the “Le Méridien Acquisition”). Additionally, improved operating results at the underlying managed and franchised hotels, increased revenue from our Bliss spas and from the sale of Bliss products and income associated with the settlement of a dispute related to an agreement to manage a hotel contributed to the increase in 2006. These increases were partially offset by lost fees from contracts that were terminated in the last 12 months and by lost income on the Le Méridien debt participation which was used to fund a portion of the Le Méridien Acquisition.

 

The increase in vacation ownership and residential sales and services of $116 million was primarily due to increased sales at ongoing projects in Hawaii and Orlando as well as sales of $41 million at a new project in New

York City. In addition, we recorded a gain of $17 million on the sale of approximately $133 million of vacation ownership receivables in 2006. The gain on the sale of VOI notes receivable in 2005, prior to our adoption of SFAS No. 152, “Accounting for Real Estate Time-Sharing Transactions,” of $25 million was reflected in a separate line in the consolidated statement of income, below operating income. Contract sales of VOI inventory, which represents vacation ownership revenues before adjustments for percentage of completion accounting and rescission, increased 19.2% in the year ended December 31, 2006 when compared to the same period in 2005. These increases were offset by a decrease in residential sales associated with the residences at the St. Regis Museum Tower in San Francisco which sold out in the first half of 2006.

 

Other revenues and expenses from managed and franchised properties increased to $1.585 billion from $1.070 billion for the year ended December 31, 2006 and 2005, respectively. These revenues represent reimbursements of costs incurred on behalf of managed hotel properties and franchisees and relate primarily to payroll costs at managed properties where we are the employer. Since the reimbursements were made based upon the costs incurred with no added margin, these revenues and corresponding expenses had no effect on our operating income and our net income.

 

Selling, General, Administrative and Other.  Selling, general, administrative and other expenses, which includes costs and expenses from our Bliss spas and from the sale of Bliss products, was $470 million in the year ended December 31, 2006 when compared to $370 million in 2005. The increase was primarily due to the impact of stock-based compensation, including stock option expense of $47 million. The remaining increase includes investments in our global development capability and costs associated with the launch of our new brands, aloft and Element, as well as the addition of the Le Méridien business.

 

Operating Income.  Our total operating income was $839 million in the year ended December 31, 2006 compared to $822 million in 2005. Excluding depreciation and amortization of $306 million and $407 million for the years ended December 31, 2006 and 2005, respectively, operating income decreased 6.8% or $84 million to $1.145 billion for the year ended December 31, 2006 when compared to $1.229 billion in the same period in 2005, primarily due to the lost income from the 45 wholly owned hotels sold or closed during 2006 and approximately $47 million of stock option expense recorded in 2006 as a result of the implementation of SFAS No. 123(R), “Share-Based Payment, a revision of the FASB Statement No. 123, Accounting for Stock-Based Compensation,” on January 1, 2006. These items were offset, in part, by the increase in management fees, franchise fees and other income discussed above.

 

Restructuring and Other Special Charges (Credits), Net.  During the twelve months ended December 31, 2006, we recorded $20 million in net restructuring and other special charges primarily related to transition costs associated with the Le Méridien Acquisition in November 2005 and severance costs primarily related to certain executives in connection with the continued corporate restructuring that began at the end of 2005. These charges were offset, in part, by the reversal of accruals for a lease we assumed as part of the merger with Sheraton Holding Corporation (“Sheraton Holding”) and its subsidiaries (formerly ITT Corporation) in 1998 as the lease matured at the end of 2006 and the accruals exceeded our maximum remaining obligation under the lease.

 

During the twelve months ended December 31, 2005, we recorded $13 million in restructuring and other special charges primarily related to severance costs in connection with our corporate restructuring as a result of our planned disposition of significant real estate assets and transition costs associated with the Le Méridien Acquisition.

 

Depreciation and Amortization.  Depreciation expense decreased $107 million to $280 million during the year ended December 31, 2006 compared to $387 million in the corresponding period of 2005 primarily because, beginning in November 2005, we ceased depreciation on the hotels included in the Host Transaction, partially offset by additional depreciation expense resulting from capital expenditures at our owned, leased and consolidated joint venture hotels in the past 12 months. Amortization expense increased to $26 million in the year ended December 31, 2006 compared to $20 million in the corresponding period of 2005 primarily due to amortization of intangible assets that we acquired in connection with the Le Méridien Acquisition in November 2005.

 

Gain on Sale of VOI Notes Receivable.  Gain on sale of VOI receivable was $25 million in 2005, primarily due to the sale of approximately $221 million of vacation ownership receivables during the year ended December 31, 2005. In 2006 we recorded a $17 million gain on sale of VOI notes receivable related to the sale of

approximately $133 million of vacation ownership receivables during 2006. However, as discussed above, the gain is now included in vacation ownership and residential sales and services revenue.

 

Equity Earnings and Gains and Losses from Unconsolidated Ventures, Net. Equity earnings and gains and losses from unconsolidated joint ventures decreased to $61 million for the year ended December 31, 2006 from $64 million in the same period of 2005.

 

Net Interest Expense.  Net interest expense decreased to $215 million for the year ended December 31, 2006 as compared to $239 million in the same period of 2005, primarily due to interest savings from the reduction of our debt with proceeds from the asset sales discussed earlier offset in part by increased interest rates. In addition, we recorded interest income in 2006 of approximately $13 million in association with the full payment of principal and interest on a loan receivable which was previously reserved. The decrease was partially offset by $37 million of expenses related to the early extinguishment of debt in connection with two transactions completed in the first quarter of 2006 whereby we defeased and were released from certain debt obligations that allowed us to sell certain hotels that previously served as collateral for such debt. These transactions also resulted in the release of other owned hotels as collateral, providing us with flexibility to sell or reposition those hotels. Our weighted average interest rate was 6.97% at December 31, 2006 versus 6.27% at December 31, 2005.

 

Loss on Asset Dispositions and Impairments, Net.  During 2006, we recorded a net loss of $3 million primarily related to several offsetting gains and losses, including the sale of ten wholly-owned hotels, which were sold unencumbered by management agreements, impairment charges related to various properties, including the Sheraton Cancun which was damaged by Hurricane Wilma in 2005, and an adjustment to reduce the previously recorded gain on the sale of a hotel consummated in 2004 as certain contingencies associated with the sale became probable in 2006. These losses were primarily offset by a gain of $29 million on the sale of our interests in two joint ventures and a $13 million gain as a result of insurance proceeds received as reimbursement for property damage caused by Hurricane Wilma.

 

During 2005, we recorded a net loss of $30 million primarily related to the impairment of a hotel and impairment charges associated with the Sheraton Cancun in Cancun, Mexico which was demolished in order to build vacation ownership units. These losses were offset by net gains recorded on the sale of several hotels in 2005.

 

Income Tax Expense.  We recorded an income tax benefit from continuing operations of $434 million for the year ended December 31, 2006 compared to an expense of $219 million in the corresponding period of 2005. The 2006 tax benefit includes a one-time benefit of approximately $524 million realized in connection with the Host Transaction, a $59 million benefit due primarily to the completion of various state and federal income tax audits of prior years, a $34 million benefit associated with Company’s election to claim U.S. foreign tax credits in 2006 and 2005 and a $32 million benefit associated with the Trust prior to its acquisition by Host. The 2005 income tax expense for the year ended December 31, 2005 included the recognition of $47 million of tax expense as a result of the adoption of a plan to repatriate foreign earnings in accordance with the American Jobs Creation Act and the recording of an additional provision of $52 million related to our 1998 disposition of ITT World Directories. The income tax expense for the year ended December 31, 2005 also included a net tax credit of $15 million related to the deferred gain on the sale of the Hotel Danieli in Venice, Italy, an $8 million benefit related to tax refunds for tax years prior to the 1995 split-up of ITT Corporation, and a $64 million benefit associated with the Trust. Our effective income tax rate is determined by the level and composition of pre-tax income subject to varying foreign, state and local taxes.

 

Discontinued Operations

 

For the year ended December 31, 2006, the loss on disposition represented a $2 million tax assessment associated with the disposition of our gaming business in 1999. For the year ended December 31, 2005, the loss from operations represented a $2 million sales and use tax assessment related to periods prior to our disposal of our gaming business, offset by a $1 million income tax benefit related to this business.

 

Cumulative Effect of Accounting Change, Net of Tax

 

On January 1, 2006, we adopted SFAS No. 152 and recorded a charge of $70 million, net of a $46 million tax benefit, in cumulative effect of accounting change.

 

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004

 

Continuing Operations

 

Revenues.  Total revenues, including other revenues from managed and franchised properties, were $5.977 billion, an increase of $609 million when compared to 2004 levels. Revenues reflected a 5.7% increase in revenues from our owned, leased and consolidated joint venture hotels to $3.517 billion for the year ended December 31, 2005 when compared to $3.326 billion in the corresponding period of 2004, a 38.9% increase in vacation ownership and residential revenues to $889 million for the year ended December 31, 2005 when compared to $640 million in the corresponding period of 2004, a 19.6% increase in management fees, franchise fees and other income to $501 million for the year ended December 31, 2005 when compared to $419 million in the corresponding period of 2004 and an increase of $87 million in other revenues from managed and franchised properties to $1.070 billion for the year ended December 31, 2005 when compared to $983 million in the corresponding period of 2004.

 

The increase in revenues from owned, leased and consolidated joint venture hotels was due primarily to strong results at our owned hotels in New York, New York, the Hawaiian Islands, Los Angeles, California, San Diego California, Atlanta, Georgia, Seattle, Washington and Houston, Texas, partially offset by the loss of business due to Hurricanes Dennis, Katrina, Rita and Wilma at our two owned hotels and one joint venture hotel in New Orleans, two owned hotels in Florida and two owned hotels in Cancun, Mexico. Revenues at our Same-Store Owned Hotels (119 hotels for the years ended December 31, 2005 and 2004, excluding 12 hotels sold or closed and 11 hotels undergoing significant repositionings or without comparable results in 2005 and 2004) increased 8.2%, or $240 million, to $3.183 billion for the year ended December 31, 2005 when compared to $2.943 billion in the same period of 2004 due primarily to an increase in REVPAR. REVPAR at our Same-Store Owned Hotels increased 10.9% to $123.14 for the year ended December 31, 2005 when compared to the corresponding 2004 period. The increase in REVPAR at these Same-Store Owned Hotels was attributed to increases in occupancy rates to 70.5% in the year ended December 31, 2005 when compared to 68.3% in the same period in 2004, and a 7.5% increase in ADR to $174.70 for the year ended December 31, 2005 compared to $162.50 for the corresponding 2004 period. REVPAR at Same-Store Owned Hotels in North America increased 11.7% for the year ended December 31, 2005 when compared to the same period of 2004 due to increased transient and group travel business for the period, primarily at our large owned hotels in the major United States cities and destinations discussed above. REVPAR at our international Same-Store Owned Hotels increased by 8.8% for the year ended December 31, 2005 when compared to the same period of 2004, with Europe, where we have our biggest concentration of international owned hotels, increasing 7.8%. REVPAR for Same-Store Owned Hotels internationally increased 6.8% for the year ended December 31, 2005 excluding the favorable effects of foreign currency translation. REVPAR for Same-Store Owned Hotels in Europe increased 6.5% excluding the favorable effects of foreign currency translation.

 

The increase in vacation ownership and residential sales and services of $249 million was primarily due to sales of residential units at the St. Regis Museum Tower in San Francisco, California, which did not begin until the fourth quarter of 2004. In the year ended December 31, 2005, we recognized approximately $183 million of revenues from the San Francisco project compared to sales of $15 million in 2004. The St. Regis Museum Tower opened in November 2005 with 260 hotel rooms and 102 condominium units. The increase in vacation ownership and residential sales and services in 2005 was also due to an increase in the sales of VOIs of 11.3% to $591 million in 2005 compared to $531 million in 2004. These increases represented increased sales volume as well as the revenue recognition from progressing and completed projects accounted for under the percentage of completion accounting methodology as required by generally accepted accounting principles primarily at the Westin Ka’anapali Ocean Resort Villas in Maui, Hawaii, the Westin Kierland Resort and Spa in Scottsdale, Arizona, and the Sheraton Vistana Villages in Orlando, Florida, partially offset by reduced revenues at the Westin Mission Hills Resort in Rancho Mirage, California where substantially all of the available inventory was sold. Contract sales of VOI inventory, which represents vacation ownership revenues before adjustments for percentage of completion

accounting and rescission and excluding fractional sales at the St. Regis Aspen, increased 14.7% in the year ended December 31, 2005 when compared to the same period in 2004.

 

The increase in management fees, franchise fees and other income of $82 million was primarily a result of increased management and franchise fees of $59 million to $362 million for the year ended December 31, 2005 due to improved operating results at the underlying hotels, the addition of new managed and franchised hotels, including approximately $5 million of fees earned on the Le Méridien hotels for the six week period that we managed and franchised these hotels in 2005, and certain termination fees offset by lost fees from contracts that were terminated during 2005. The increase in other income was also due to increased revenues from our Bliss and Remede spas and from the sales of Bliss and Remede products.

 

Other revenues and expenses from managed and franchised properties increased to $1.070 billion from $983 million for the year ended December 31, 2005 and 2004, respectively. These revenues represent reimbursements of costs incurred on behalf of managed hotel properties and franchisees and relate primarily to payroll costs at managed properties where we are the employer. Since the reimbursements are made based upon the costs incurred with no added margin, these revenues and corresponding expenses have no effect on our operating income and our net income.

 

Operating Income.  Our total operating income was $822 million in the year ended December 31, 2005 compared to $653 million in 2004. Excluding depreciation and amortization of $407 million and $431 million for the years ended December 31, 2005 and 2004, respectively, operating income increased 13.4% or $145 million to $1.229 billion for the year ended December 31, 2005 when compared to $1.084 billion in the same period in 2004, primarily due to the improved owned hotel performance and vacation ownership and residential sales discussed above.

 

Restructuring and Other Special Charges (Credits), Net.  During the twelve months ended December 31, 2005, we recorded $13 million in restructuring and other special charges primarily related to severance costs in connection with our corporate restructuring as a result of our planned disposition of significant real estate assets and transition costs associated with the Le Méridien Acquisition. During the twelve months ended December 31, 2004, we reversed a $37 million reserve previously recorded through restructuring and other special charges due to a favorable judgment in a litigation matter.

 

Depreciation and Amortization.  Depreciation expense decreased $26 million to $387 million during the year ended December 31, 2005 compared to $413 million in the corresponding period of 2004 primarily due to reduced depreciation from assets sold during 2005 and due to the fact that we ceased depreciation in November and December 2005 on the hotels classified as held for sale at December 31, 2005, partially offset by additional depreciation expense resulting from capital expenditures at our owned, leased and consolidated joint venture hotels in the past 12 months. Amortization expense increased to $20 million in the year ended December 31, 2005 compared to $18 million in the corresponding period of 2004.

 

Gain on Sale of VOI Notes Receivable.  Gains from the sale of VOI receivables of $25 million and $14 million in 2005 and 2004, respectively, were primarily due to the sale of approximately $221 million and $113 million of vacation ownership receivables during the years ended December 31, 2005 and 2004, respectively.

 

Equity Earnings and Gains and Losses from Unconsolidated Ventures, Net.  Equity earnings and gains and losses from unconsolidated joint ventures increased to $64 million for the year ended December 31, 2005 from $32 million in the same period of 2004 primarily due to our share of gains on the sale of several hotels in unconsolidated joint ventures in 2005.

 

Net Interest Expense.  Net interest expense decreased to $239 million from $254 million for the years ended December 31, 2005 and 2004, respectively, due to a reduction in our level of debt as well as interest income earned from significant cash on hand in 2005. Our weighted average interest rate was 6.27% at December 31, 2005 versus 5.81% at December 31, 2004.

 

Gain (Loss) on Asset Dispositions and Impairments, Net.  During 2005, we recorded a net loss of $30 million primarily related to the impairment of a hotel and impairment charges associated with our owned Sheraton hotel in

Cancun, Mexico that is being partially demolished to build vacation ownership units. These losses were offset by net gains recorded on the sale of several hotels in 2005.

 

During 2004, we recorded a net loss of $33 million primarily related to the sale of two hotels in 2004, the sale of one hotel in January 2005, and three investments deemed impaired in 2004.

 

Income Tax Expense.  The effective income tax rate for continuing operations for the year ended December 31, 2005 was 34.1% compared to 10.5% in 2004. The increase was primarily due to $47 million of tax expense on the adoption of a plan to repatriate foreign earnings in accordance with the American Jobs Creation Act of 2004 and $52 million of additional tax expense related to our 1998 disposition of ITT World Directories recorded in 2005. The effective tax rate for the year ended December 31, 2005 also included a net tax credit of $15 million related to the deferred gain on the sale of the Hotel Danieli in Venice, Italy and an $8 million benefit related to tax refunds for tax years prior to the 1995 split-up of ITT Corporation. Our effective income tax rate is determined by the level and composition of pre-tax income subject to varying foreign, state and local taxes and other items. The effective tax rate for the year ended December 31, 2004 included a $28 million benefit primarily related to the reversal of tax reserves as a result of the resolution of certain tax matters during the year.

 

Discontinued Operations

 

For the year ended December 31, 2005, the loss from operations represented a $2 million sales and use tax assessment related to periods prior to our disposal of our gaming business, which was disposed of in 1999, offset by a $1 million income tax benefit related to this business.

 

For the year ended December 31, 2004, the net gain on dispositions included $16 million related to the favorable resolution of certain tax matters and $10 million primarily related to the reversal of reserves, both of which related to our former gaming business. The reserves were reversed as the related contingencies were resolved.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash From Operating Activities

 

Cash flow from operating activities is generated primarily from operating income from our owned hotels, sales of VOIs and residential units and management and franchise revenues. It is the principal source of cash used to fund our operating expenses, interest payments on debt, capital expenditures, distribution payments and share repurchases. We believe that existing borrowing availability together with capacity for additional borrowings and cash from operations will be adequate to meet all funding requirements for our operating expenses, principal and interest payments on debt, capital expenditures, dividend payments and share repurchases in the foreseeable future.

 

State and local regulations governing sales of VOIs allow the purchaser of such a VOI to rescind the sale subsequent to its completion for a pre-specified number of days or until a certificate of occupancy is obtained. As such, cash collected from such sales during the rescission period is classified as restricted cash in our consolidated balance sheets. At December 31, 2006 and 2005, we had short-term restricted cash balances of $329 million and $295 million, respectively, primarily consisting of such restricted cash.

 

Cash From Investing Activities

 

In limited cases, we have made loans to owners of or partners in hotel or resort ventures for which we have a management or franchise agreement. Loans outstanding under this program, excluding the Westin Boston, Seaport Hotel discussed below, totaled $55 million at December 31, 2006. We evaluate these loans for impairment, and at December 31, 2006, believe these loans are collectible. Unfunded loan commitments aggregating $29 million were outstanding at December 31, 2006, of which $1 million are expected to be funded in 2007 and $11 million are expected to be funded in total. These loans typically are secured by pledges of project ownership interests and/or mortgages on the projects. We also have $105 million of equity and other potential contributions associated with managed or joint venture properties, $23 million of which is expected to be funded in 2007.

 

During 2004, we entered into a long-term management contract to manage the Westin Boston, Seaport Hotel in Boston, Massachusetts, which opened in June 2006. In connection with this project, we agreed to provide up to $28 million in mezzanine loans and other investments (all of which has been funded) as well as various guarantees, including a principal repayment guarantee for the term of the senior debt which was capped at $40 million, a debt service guarantee during the term of the senior debt, which was limited to the interest expense on the amounts drawn under such debt and principal amortization and a completion guarantee for this project. The fair value of these guarantees of $3 million is reflected in other liabilities in the accompanying consolidated balance sheets at December 31, 2006 and 2005. In January 2007, this hotel was sold and the senior debt was repaid in full. As such, we do not expect to fund under these guarantees. In addition, the $28 million in mezzanine loans and other investments, together with accrued interest, was repaid in full.

 

Surety bonds issued on our behalf at December 31, 2006 totaled $122 million, the majority of which were required by state or local governments relating to our vacation ownership operations and by our insurers to secure large deductible insurance programs.

 

To secure management contracts, we may provide performance guarantees to third-party owners. Most of these performance guarantees allow us to terminate the contract rather than fund shortfalls if certain performance levels are not met. In limited cases, we are obliged to fund shortfalls in performance levels through the issuance of loans. At December 31, 2006, excluding the Le Méridien management agreement mentioned below, we had six management contracts with performance guarantees with possible cash outlays of up to $75 million, $50 million of which, if required, would be funded over several years and would be largely offset by management fees received under these contracts. Many of the performance tests are multi-year tests, are tied to the results of a competitive set of hotels, and have exclusions for force majeure and acts of war and terrorism. We do not anticipate any significant funding under these performance guarantees in 2007. In connection with the Le Méridien Acquisition, we assumed the obligation to guarantee certain performance levels at one Le Méridien managed hotel for the periods 2007 through 2013. This guarantee is uncapped. However, we have estimated the exposure under this guarantee and do not anticipate that payments made under the guarantee will be significant in any single year. The estimated fair value of this guarantee of $6 million is reflected in other liabilities in the accompanying consolidated balance sheet at December 31, 2006. We do not anticipate losing a significant number of management or franchise contracts in 2007.

 

In November 2005, we completed the Le Méridien Acquisition for a purchase price of approximately $252 million. The purchase price was funded from available cash and the return of the original Le Méridien investment. In connection with the Le Méridien Acquisition, we were indemnified for certain of Le Méridien’s historical liabilities by the entity that bought Le Méridien’s owned and leased hotel portfolio. The indemnity is limited to the financial resources of that entity. However, at this time, we believe that it is unlikely that we will have to fund any of these liabilities.

 

In connection with the sale of 33 hotels to Host in 2006, we agreed to indemnify Host for certain liabilities, including operations and tax liabilities. At this time, we believe that we will not have to make any material payments under such indemnities.

 

We had the following contractual obligations outstanding as of December 31, 2006 (in millions):

 

 

 

 

We had the following commercial commitments outstanding as of December 31, 2006 (in millions):

 

 

 

 

In December 2006, we completed a transaction to, among other things, purchase real assets from Club Regina Resorts (“CRR”) in Mexico. These assets included land and fixed assets adjacent to The Westin Resort & Spa in Los Cabos, Mexico and terminated CRR’s rights to solicit guests at three Westin properties in Mexico. In addition to the purchase of these assets, the transaction included the settlement of all pending and threatened legal claims between the parties and the exchange of a new issue of CRR notes with a lower principal amount for the principal amount of existing CRR notes that had been previously fully reserved. Total consideration of approximately $41 million was paid by us for these items.

 

In May 2006, we partnered with Chef Jean-Georges Vongerichten and a private equity firm to create a joint venture that will develop, own, operate, manage and license world-class restaurant concepts created by Jean-Georges Vongerichten, including operating the existing Spice Market restaurant located in New York City. The concepts owned by the venture will be available for Starwood’s upper-upscale and luxury hotel brands including W, Westin, Le Méridien and St. Regis. Additionally, the venture may own and operate freestanding restaurants outside of Starwood’s hotels. We invested approximately $22 million in this venture.

 

In January 2004, we acquired a 95% interest in Bliss World LLC which at that time operated three stand alone spas (two in New York, New York and one in London, England) and a beauty products business with distribution through its own internet site and catalogue as well as through third party retail stores. The purchase price for the acquired interest was approximately $25 million, and was funded from available cash. In 2005, we acquired the remaining 5% interest for approximately $1 million.

 

We intend to finance the acquisition of additional hotel properties (including equity investments), hotel renovations, VOI and residential construction, capital improvements, technology spend and other core and ancillary business acquisitions and investments and provide for general corporate purposes (including dividend payments) through our credit facilities described below, through the net proceeds from dispositions, through the assumption of debt, through the issuance of additional equity or debt securities and from cash generated from operations.

 

We periodically review our business to identify properties or other assets that we believe either are non-core (including hotels where the return on invested capital is not adequate), no longer complement our business, are in markets which may not benefit us as much as other markets during an economic recovery or could be sold at significant premiums. We are focused on enhancing real estate returns and monetizing investments. In the second quarter of 2006, in connection with the Host Transaction, we completed the sale of 33 hotels and the stock of certain controlled subsidiaries to Host for consideration valued at $4.1 billion which consisted of approximately $2.8 billion in the form of Host common stock and cash paid directly to our shareholders and $1.3 billion of consideration paid to Starwood, including $1.2 billion in cash, $77 million in debt assumption and $61 million in Host common stock. During the year ended December 31, 2006, we sold ten additional owned hotels and interests in nine unconsolidated joint ventures for gross proceeds of approximately $588 million in cash. There can be no assurance, however, that we will be able to complete future dispositions on commercially reasonable terms or at all.

 

Cash Used for Financing Activities

 

The following is a summary of our debt portfolio (including capital leases) as of December 31, 2006:

 

 

 

 

Fiscal 2006 Developments.  On March 15, 2006, we completed the redemption of the remaining 25,000 outstanding Class B EPS for approximately $1 million in cash. On April 10, 2006, in connection with the Host Transaction, we redeemed all of the Class A EPS and Realty Partnership units for approximately $34 million in cash. In the year ended December 31, 2006, we redeemed approximately 926,000 SLC Operating Limited Partnership units for approximately $56 million in cash.

 

In February 2006, we closed a new, five-year $1.5 billion Senior Credit Facility (“2006 Facility”). The 2006 Facility replaced the previous $1.45 billion Revolving and Term Loan Credit Agreement (“Existing Facility”) which would have matured in October 2006. Approximately $240 million of the Term Loan balance under the Existing Facility was paid down with cash and the remainder was refinanced with the 2006 Facility. The 2006 Facility is expected to be used for general corporate purposes. The 2006 Facility matures February 10, 2011 and has a current interest rate of LIBOR + 0.475%. We currently expect to be in compliance with all covenants of the 2006 Facility.

 

During March 2006, we gave notice to receive additional commitments totaling $300 million under our 2006 Facility (“2006 Facility Add-On”) on a short-term basis to facilitate the close of the Host Transaction and for general working capital purposes. In June 2006, we amended the 2006 Facility such that the 2006 Facility Add-On will not mature until June 30, 2007.

 

In the first quarter of 2006 in two separate transactions we defeased approximately $510 million of debt secured in part by several hotels that were part of the Host Transaction. In one transaction, in order to accomplish this, we purchased Treasury securities sufficient to make the monthly debt service payments and the balloon payment due under the loan agreement. The Treasury securities were then substituted for the real estate and hotels that originally served as collateral for the loan. As part of the defeasance, the Treasury securities and the debt were transferred to a third party successor borrower that is responsible for all remaining obligations under this debt. In the

second transaction, we deposited Treasury securities in an escrow account to cover the debt service payments. As such, neither debt is reflected on our consolidated balance sheet as of December 31, 2006. In connection with the defeasance, we incurred early extinguishment of debt costs of approximately $37 million which was recorded in interest expense in our consolidated statement of income.

 

In the second quarter of 2006, we gave notice to redeem the $360 million of 3.5% convertible notes, originally issued in May 2003. Under the terms of the convertible indenture, prior to the redemption date of June 5, 2006, the note holders had the right to convert their notes into Shares at the stated conversion rate. Under the terms of the indenture, we settled the conversions by paying the principal portion of the notes in cash and the excess amount by issuing approximately 3 million Corporation Shares. The notes that were not converted prior to the redemption date were redeemed at the price of par plus accrued interest, effective June 5, 2006.

 

In connection with the Host Transaction, a total of $600 million of notes issued by Sheraton Holding were assumed by the Corporation. On June 2, 2006, we redeemed $150 million in principal amount of these notes which had a coupon of 7.75% and a maturity in 2025. The stated redemption price for these notes was 103.186%. We borrowed under the 2006 Facility and used existing unrestricted cash balances to fund the cash portions of these transactions.

 

Fiscal 2005 Developments.  On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act created a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. In order to repatriate funds in accordance with the Act, in October 2005 we increased several existing bank credit lines available to our wholly owned subsidiary, Starwood Italia, from 129 million euros to 399 million euros, approximately 350 million euros of which was borrowed at that time. These credit lines had interest rates ranging from Euribor + 0.50% to Euribor + 0.85% and maturities ranging from April 1, 2006 to May 8, 2007. These proceeds, along with approximately 100 million euros which Starwood Italia borrowed from our Corporate Credit Line (total borrowings of 450 million euros) were used to temporarily finance the repatriation of approximately $550 million pursuant to the Act. The majority of these temporary borrowings were repaid in 2006. In connection with the repatriation, we recorded a tax liability of approximately $47 million in the third quarter of 2005, when our Board of Directors adopted the repatriation plan. In accordance with the Act, the repatriated funds were reinvested pursuant to the terms of a domestic reinvestment plan which was approved by our Board of Directors.

 

Other.  We have approximately $805 million of outstanding debt maturing in 2007. Based upon the current level of operations, management believes that our cash flow from operations and asset sales, together with our significant cash balances (approximately $519 million at December 31, 2006, including $336 million of short-term and long-term restricted cash), available borrowing capacity under the 2006 Facility (approximately $1.218 billion at December 31, 2006), available borrowing capacity from international revolving lines of credit (approximately $131 million at December 31, 2006), and capacity for additional borrowings will be adequate to meet anticipated requirements for scheduled maturities, dividends, working capital, capital expenditures, marketing and advertising program expenditures, other discretionary investments, interest and scheduled principal payments for the foreseeable future. However, there can be no assurance that we will be able to refinance our indebtedness as it becomes due and, if refinanced, on favorable terms. In addition, there can be no assurance that our continuing business will generate cash flow at or above historical levels, that currently anticipated results will be achieved, or that we will be able to complete dispositions on commercially reasonable terms or at all.

 

We maintain non-U.S.-dollar-denominated debt, which provides a hedge of our international net assets and operations but also exposes our debt balance to fluctuations in foreign currency exchange rates. During the year ended December 31, 2006, the effect of changes in foreign currency exchange rates was a net increase in debt of approximately $32 million compared to a net decrease in debt in 2005 of approximately $23 million. Our debt balance is also affected by changes in interest rates as a result of our interest rate swap agreements under which we pay floating rates and receive fixed rates of interest (the “Fair Value Swaps”). The fair market value of the Fair Value Swaps is recorded as an asset or liability and as the Fair Value Swaps are deemed to be effective, an adjustment is recorded against the corresponding debt. At December 31, 2006, our debt included a decrease of approximately $17 million related to the unamortized gains on terminated Fair Value Swaps and the fair market value of current

Fair Value Swap liabilities. At December 31, 2005 our debt included a decrease of approximately $3 million related to the unamortized gains on terminated Fair Value Swaps and the fair market value of current Fair Value Swap assets.

 

If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to sell additional assets, reduce capital expenditures, refinance all or a portion of our existing debt or obtain additional financing. Our ability to make scheduled principal payments, to pay interest on or to refinance our indebtedness depends on our future performance and financial results, which, to a certain extent, are subject to general conditions in or affecting the hotel and vacation ownership industries and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.

 

On July 26, 2006, Standard & Poor’s upgraded our rating to BBB− from BB+ and revised their outlook from positive to stable.

 

On August 28, 2006, Moody’s Investors Service upgraded our rating to Baa3 from Ba1 and revised their outlook from positive to stable.

 

On October 24, 2006, Fitch’s Investors Service upgraded our rating to BBB− from BB+ and revised their outlook from positive to stable.

 

A distribution of $0.84 per Share was paid in January 2006 and January 2005 to shareholders of record as of December 31, 2005 and 2004, respectively. In connection with the Host Transaction, on February 17, 2006, the Trust declared a distribution of $0.21 per Share to shareholders of record on February 28, 2006, which was paid on March 10, 2006. In addition, on March 15, 2006, the Trust declared a distribution of $0.21 per Share to shareholders of record on March 27, 2006, which was paid on April 7, 2006. In December 2006 the Corporation declared a dividend of $0.42 per Corporation Share to shareholders of record on December 31, 2006, which was paid in January 2007.

 

Stock Sales and Repurchases

 

On March 15, 2006 we completed the redemption of the remaining 25,000 shares of Class B EPS for approximately $1 million in cash. In April 2006, in connection with the Host Transaction, we redeemed all of the Class A EPS (approximately 562,000 shares) and Realty Partnership units (approximately 40,000 units) for approximately $34 million in cash. SLC Operating Limited Partnership units are convertible into Shares at the unit holder’s option, provided that we have the option to settle conversion requests in cash or Shares. In the year ended December 31, 2006, we redeemed approximately 926,000 SLC Operating Limited Partnership units for approximately $56 million in cash. At December 31, 2006, we had outstanding approximately 213 million Corporation Shares and 179,000 SLC Operating Limited Partnership units.

 

In May 2006, the Board of Directors of the Company authorized the repurchase of up to an additional $600 million of Corporation Shares under our existing Corporation Share repurchase authorization (the “Share Repurchase Authorization”). Pursuant to the Share Repurchase Authorization, we repurchased 21.7 million Shares and Corporation Shares in the open market for an aggregate cost of $1.263 billion during 2006. Approximately $380 million remains available under the Share Repurchase Authorization.

 

Off-Balance Sheet Arrangements

 

Our off-balance sheet arrangements include retained interests in securitizations of $51 million, third-party loan guarantees of $51 million, letters of credit of $148 million, unconditional purchase obligations of $184 million and surety bonds of $122 million. These items are more fully discussed earlier in this section and in the Notes to Financial Statements and Item 8 of Part II of this report.

 

In limited instances, we seek to reduce earnings and cash flow volatility associated with changes in interest rates and foreign currency exchange rates by entering into financial arrangements intended to provide a hedge

against a portion of the risks associated with such volatility. We continue to have exposure to such risks to the extent they are not hedged.

 

Interest rate swap agreements are the primary instruments used to manage interest rate risk. At December 31, 2006, we had two outstanding long-term interest rate swap agreements under which we pay variable interest rates and receive fixed interest rates. At December 31, 2006, we had no interest rate swap agreements under which we pay a fixed rate and receive a variable rate.

 

We enter into a derivative financial arrangement to the extent it meets the objectives described above, and we do not engage in such transactions for trading or speculative purposes.

 

See Note 21. Derivative Financial Instruments in the notes to financial statements filed as part of this Annual Report and incorporated herein by reference for further description of derivative financial instruments.

 

The following table sets forth the scheduled maturities and the total fair value of our debt portfolio:

 

 

The financial statements and supplementary data required by this Item are included in Item 15 of this Annual Report and are incorporated herein by reference.

 

Not applicable.

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management conducted an evaluation, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2006. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in alerting them in a timely manner to material information required to be included in the Company’s SEC reports.

 

Management’s Report on Internal Control over Financial Reporting

 

Management of Starwood Hotels & Resorts Worldwide Inc. and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) or 15(d)-15(f). Those rules define internal control over financial reporting as 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 (“GAAP”) and includes those policies and procedures that: