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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
---------------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------------- -----------------
Commission file number 0-26304
SUNSTONE HOTEL INVESTORS, INC.
(Exact name of registrant as specified in its charter)
--------------------
Maryland 52-1891908
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
115 Calle de Industrias, Suite 201, San Clemente, CA 92672
(Address of Principal Executive Offices) (Zip Code)
(714) 361-3900
(Registrant's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
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 X No
--- ---
As of May 13, 1997, there were 20,360,021 shares of Common Stock outstanding.
2
SUNSTONE HOTEL INVESTORS, INC.
MARCH 31, 1997 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Introduction to the Financial Statements.......................................................... 3
Sunstone Hotel Investors, Inc.
Consolidated Statements of Financial Position as of March 31, 1997 and December 31, 1996.......... 4
Consolidated Statements of Income for the Three Months Ended March 31, 1997 and 1996.............. 5
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 1997................... 6
Notes to Consolidated Financial Statements........................................................ 7
Sunstone Hotel Properties, Inc. (the Lessee)
Statements of Financial Position as of March 31, 1997 and December 31, 1996....................... 9
Statements of Operations for the Three Months ended March 31, 1997 and 1996....................... 10
Statements of Cash Flows for the Three Months ended March 31, 1997 and 1996....................... 11
Notes to Financial Statements..................................................................... 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................................................. 13
PART II -- OTHER INFORMATION
ITEM 5. OTHER INFORMATION................................................................................. 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................................................................. 25
2
3
PART I
SUNSTONE HOTEL INVESTORS, INC.
INTRODUCTION TO THE FINANCIAL STATEMENTS
ITEM 1 - FINANCIAL STATEMENTS
The consolidated financial statements included herein have been
prepared by Sunstone Hotel Investors, Inc. (the "Company"), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Disclosures normally included in the notes to the financial statements prepared
in accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. The Company believes that the
disclosures are adequate to make the information presented not misleading when
read in conjunction with the financial statements included in the Company's
Annual Report on Form 10-K.
The financial information presented herein reflects all adjustments,
consisting only of normal recurring accruals, which are, in the opinion of
management, necessary for a fair presentation of the results for the interim
periods presented. The results for interim periods are not necessarily
indicative of the results to be expected for the full year.
3
4
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
March 31, December 31,
1997 1996
------------- -------------
ASSETS:
Investment in hotel properties, net ........... $ 211,148,000 $ 152,937,000
Mortgage notes receivable ..................... 2,850,000 2,850,000
Cash .......................................... 403,000 142,000
Rent receivable-- Lessee ...................... 4,322,000 2,360,000
Prepaid expenses and other assets, net ........ 2,363,000 1,790,000
------------- -------------
$ 221,086,000 $ 160,079,000
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Revolving line of credit ...................... $ 33,300,000 $ 40,400,000
Mortgage notes payable ........................ 22,855,000 19,651,000
Accounts payable and other accrued expenses ... 2,211,000 3,249,000
------------- -------------
58,366,000 63,300,000
------------- -------------
Minority interest ............................. 19,596,000 15,978,000
------------- -------------
Stockholders' equity:
Common stock, $.01 par value, 50,000,000
authorized; 16,250,244 and 10,936,457 issued
and outstanding as of March 31,1997 and
December 31, 1996, respectively ............ 162,000 109,000
Preferred stock, $.01 par value, 10,000,000
authorized, no shares issued or outstanding
Additional paid-in capital .................... 143,444,000 80,700,000
Distribution in excess of earnings ............ (482,000) (8,000)
------------- -------------
143,124,000 80,801,000
------------- -------------
$ 221,086,000 $ 160,079,000
============= =============
The accompanying notes are an integral part of these financial statements.
4
5
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31,
---------------------------
1997 1996
----------- -----------
REVENUES:
Lease revenue ......................................................... $ 7,572,000 $ 3,190,000
Interest income ....................................................... 197,000 19,000
----------- -----------
Total revenues ...................................................... 7,769,000 3,209,000
----------- -----------
EXPENSES:
Real estate related depreciation and amortization ..................... $ 1,800,000 849,000
Interest expense and amortization of financing costs .................. 840,000 324,000
Real estate, personal property taxes and insurance .................... 676,000 253,000
General and administrative ............................................ 532,000 153,000
----------- -----------
Total expenses ................................................. 3,848,000 1,579,000
----------- -----------
Income before minority interest .......................................... 3,921,000 1,630,000
Minority interest ........................................................ 510,000 293,000
----------- -----------
NET INCOME ............................................................... $ 3,411,000 $ 1,337,000
=========== ===========
NET INCOME PER SHARE ..................................................... $ 0.23 $ 0.21
Weighted average number of shares ........................................ 14,834,673 6,322,000
The accompanying notes are an integral part of these financial statements
5
6
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Three Months Ended
March 31,
------------------------------
1997 1996
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net ................................................ $ 3,411,000 $ 1,337,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Minority interest ................................ 510,000 293,000
Depreciation ..................................... 1,800,000 849,000
Amortization of financing costs .................... 50,000 56,000
Changes in assets and liabilities:
Rent receivable-Lessee ...................... (1,962,000) (1,581,000)
Prepaids and other assets, net .............. (599,000) 50,000
Accounts payable and accrued expenses ....... (1,038,000) 344,000
------------ ------------
Net cash provided by operating activities 2,172,000 1,348,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, improvements and additions
to hotel properties ............................ (47,999,000) (17,999,000)
------------ ------------
Net cash used in investing activities ... (47,999,000) (17,999,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock ......... 65,640,000
Borrowings on revolving line of credit ............. 20,375,000 13,600,000
Principal payments on revolving line of credit ..... (27,500,000)
Principal payments on long-term debt ............... (7,913,000)
Dividends paid ..................................... (3,885,000) (1,454,000)
Partnership distributions paid ..................... (629,000) (310,000)
------------ ------------
Net cash provided by financing activities 46,088,000 11,836,000
------------ ------------
Net change in cash ...................... 261,000 (4,815,000)
Cash, beginning of period .......................... 142,000 5,222,000
------------ ------------
Cash, end of period ................................ $ 403,000 $ 407,000
============ ============
The accompanying notes are an integral part of these financial statements.
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7
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
On January 6, 1997, the Company completed a shelf offering for
4,000,000 shares of its common stock. Concurrently, 600,000 shares of common
stock were issued by the Company upon the full exercise of the underwriters'
over-allotment option. The offering price of the shares sold in the offering was
$13.00 per full share, resulting in gross proceeds of approximately $59.8
million and net proceeds (less the underwriters' discount and offering costs) of
approximately $56.8 million.
On March 31, 1997, the Company completed a shelf offering for 700,000
shares of its common stock. On April 28, 1997, 105,000 shares of common stock
were issued by the Company upon the full exercise of the underwriters'
over-allotment option. The offering price of the shares sold was $13.75 per
share, resulting in gross proceeds of approximately $11.1 million and net
proceeds (less the underwriters' discount and offering costs) of approximately
$10.6 million.
At March 31, 1997, the Company owned 28 hotel properties (the
"Hotels"), primarily located in the Western United States, which are leased to
Sunstone Hotel Properties, Inc. (the "Lessee") under operating leases (the
"Percentage Leases") providing for the payment of base and percentage rent. The
Lessee is owned by Robert A. Alter, Chairman and President of the Company (80%),
and Charles L. Biederman, Director and Executive Vice President of the Company
(20%). The Lessee has entered into a management agreement pursuant to which all
of the Hotels are managed by Sunstone Hotel Management, Inc. (the "Management
Company"), of which Mr. Alter is the sole shareholder.
Basis Of Presentation:
For accounting purposes, the Company exercises unilateral control
over the Partnership; hence, the financial statements of the Company and the
Partnership are consolidated. All significant intercompany transactions and
balances have been eliminated.
Newly Issued Accounting Pronouncements:
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards ("FAS No. 128"), Earnings per Share.
FAS No. 128 establishes standards for computing and presenting earnings per
share and is effective for periods ending after December 15, 1997. The impact
of the adoption of FAS No. 128 on the Company's earnings per share is expected
to be immaterial.
2. NET INCOME PER SHARE AND PARTNERSHIP UNITS
Net income per share is based on the weighted average number of
common and common equivalent shares outstanding during the period. Outstanding
options are included as common equivalent shares using the treasury stock method
when the effect is dilutive. The weighted average number of shares used in
determining net income per share was 14,834,673 and 6,322,000 for the three
months ended March 31, 1997 and 1996, respectively. At March 31, 1997, a total
of 18,475,177 partnership units were issued and outstanding. The weighted
average number of units outstanding for the three months ended March 31, 1997
was 17,051,892.
3. SUBSEQUENT EVENTS AND SIGNIFICANT ACQUISITIONS
On May 6, 1997, the Company acquired the 300-room Fountain Suites
Hotel in Sacramento, California for a purchase price of approximately $16.8
million in cash.
On May 6, 1997, the Company completed a shelf offering for 4,000,000
shares of its common stock. The offering price of the shares sold in the
offering was $13.375 per share, resulting in gross proceeds of approximately
$53.5 million and net proceeds (less underwriters' discount and offering costs)
of approximately $51.4 million. The underwriters' have a 30-day option to
purchase an additional 600,000 shares of common stock at a price of $13.375 per
share.
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8
On May 7, 1997, the Company entered into an agreement with a
syndicate of national banks for an unsecured $100 million revolving line of
credit with interest at LIBOR plus 1.80% per annum to replace its $50 million
secured line of credit. The credit facility will have a two year term with a
one-year extension option in favor of the Company and will provide for a
reduction in the interest rate margin if the Company's debt securities are rated
by a national rating agency. The credit facility will also require that the
Company provide collateral if the Company fails to satisfy certain financial
covenants.
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9
SUNSTONE HOTEL PROPERTIES, INC
STATEMENTS OF FINANCIAL POSITION
March 31, December 31,
1997 1996
----------- -----------
ASSETS:
Cash ................................................. $ 991,000 $ 1,165,000
Receivables, net ..................................... 2,518,000 1,283,000
Inventories .......................................... 493,000 514,000
Prepaid expenses and other assets .................... 205,000 134,000
----------- -----------
$ 4,207,000 $ 3,096,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT:
Rent payable - REIT .................................. $ 4,322,000 $ 2,360,000
Accounts payable, trade .............................. 846,000 2,328,000
Advanced deposits .................................... 178,000 276,000
Sales taxes payable .................................. 585,000 224,000
Accrued payroll ...................................... 432,000 718,000
Accrued vacation ..................................... 246,000 163,000
Accrued bonuses ...................................... 227,000 176,000
Due to affiliate ..................................... 657,000 258,000
Other accrued expenses ............................... 661,000 501,000
----------- -----------
8,154,000 7,004,000
----------- -----------
Shareholders' Deficit:
Common stock, no par value, 100,000 shares authorized;
125 shares issued and outstanding
Shareholders' deficit ................................ (3,947,000) (3,908,000)
----------- -----------
$ 4,207,000 $ 3,096,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
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10
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF OPERATIONS
Three Months Ended
March 31,
---------------------------
1997 1996
----------- -----------
REVENUES:
Room ..................... $16,566,000 $ 6,786,000
Food and beverage ........ 1,275,000 232,000
Other .................... 1,003,000 318,000
----------- -----------
Total revenues ....... 18,844,000 7,336,000
----------- -----------
EXPENSES:
Room ..................... 3,632,000 1,697,000
Food and beverage ........ 1,034,000 242,000
Other .................... 521,000 193,000
General and administrative 1,831,000 461,000
Franchise costs .......... 1,232,000 192,000
Advertising and promotion 1,075,000 638,000
Repairs and maintenance .. 655,000 316,000
Utilities ................ 891,000 294,000
Management fees .......... 356,000 132,000
Rent expense ............. 7,572,000 3,190,000
----------- -----------
Total expenses ....... 18,799,000 7,355,000
----------- -----------
NET INCOME (LOSS) ............ $ 45,000 $ (19,000)
=========== ===========
The accompanying notes are an integral part of these financial statements.
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11
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF CASH FLOWS
For The Three Months Ended
March 31,
----------------------------
1997 1996
----------- -----------
Cash flows from operating activities:
Net income .................................... $ 45,000 $ (19,000)
Adjustments to reconcile net loss to net cash
used in operating activities:
Changes in assets and liabilities:
Receivables, net ....................... (912,000) (244,000)
Inventories ............................ 21,000 56,000
Prepaid expenses and other assets ...... (72,000) (320,000)
Rent payable - REIT .................... 1,962,000 1,582,000
Accounts payable, trade ................ (1,482,000) 442,000
Advanced deposits ...................... (98,000) (138,000)
Sales taxes payable .................... 361,000 (3,000)
Accrued payroll ........................ (286,000) (22,000)
Accrued vacation ....................... 83,000 7,000
Accrued bonuses ........................ 51,000 (116,000)
Management and accounting fees payable . 251,000 263,000
Other accrued expenses ................. (93,000) 186,000
----------- -----------
Cash used in operating activities (169,000) 1,674,000
----------- -----------
Cash flows from investing activities:
Purchase of office furniture and equipment .... (5,000) (400,000)
----------- -----------
Cash used in investing activities (5,000) (400,000)
----------- -----------
Net change in cash ............................ (174,000) 1,274,000
Cash, beginning of period ......................... 1,165,000 800,000
----------- -----------
Cash, end of period ............................... $ 991,000 $ 2,074,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
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SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO FINANCIAL STATEMENTS
----------------
1. ORGANIZATION:
Sunstone Hotel Properties, Inc. (the "Lessee") was incorporated in
Colorado in October 1994 and commenced operations effective with the completion
of an initial public stock offering (the "Offering") by Sunstone Hotel
Investors, Inc. (the "REIT") on August 16, 1995. The Lessee leases hotel
properties primarily located in the Western United States from the REIT pursuant
to long term leases.
2. ACCUMULATED DEFICIT:
From inception, the Lessee has incurred cumulative losses of $3.9
million. Of this amount, approximately $1.5 million of the loss is attributable
to seven hotels that underwent substantial renovations during 1996. Such
renovations were made in conjunction with the Company's strategy of acquiring
hotels that can benefit from extensive improvements, reflagging and
repositioning resulting in higher potential revenue. In accordance with the
terms of the Percentage Leases, the Lessee is required to pay the full lease
payment even though a portion of the rooms are under renovation and not
available for rent to guests. During periods of renovation, the hotels generally
do not generate sufficient revenue to meet operating expenses, including lease
payments. Accordingly, the Lessee incurred substantial losses primarily due to
the terms of the Percentage Leases. Management believes that the related losses
represent costs that have a reasonable assurance of future economic benefit that
will be derived from improved operating performance of the renovated hotels
throughout the remaining periods of the respective leases. Additional losses not
related to renovation are primarily attributable to the transition to new
management at acquired hotels, seasonal operations as determined by the timing
of acquisitions, the operating leverage of certain Percentage Leases and market
conditions in certain markets.
The Lessee has remained current in its payments to the Company under
the terms of the Percentage Leases, and during 1997, management anticipates
generating net income and substantial positive operating cash flow, however,
there can be no assurance that improved operating expectations will be met.
During the first quarter of 1997, the Lessee reported net income of $45,000.
12
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Forward-Looking Statements
When used throughout this report, the words "believes", "anticipates"
and "expects" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to the many risks and uncertainties
which affect the Company's business, and actual results could differ materially
from those projected and forecasted. These uncertainties, which include
competition within the lodging industry, the balance between supply and demand
for the hotel rooms, the Company's continued ability to execute acquisitions and
renovations, the effect of economic conditions, and the availability of capital
to finance planned growth, are described but are not limited to those disclosed
in this report. These and other factors which could cause actual results to
differ materially from those in the forward-looking statements are discussed
under the heading "Risk Factors". Given these uncertainties, readers are
cautioned not to place undue reliance on such statements. The Company also
undertakes no obligation to publicly release the result of any revisions to
these forward-looking statements that may be made to reflect any future events
or circumstances.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
Sunstone Hotel Investors, Inc. ("Sunstone" or the "Company") is a
REIT with an acquisition, renovation and repositioning strategy that currently
focuses its acquisition strategy primarily in the Western United States. The
Company brands its hotels with strong national franchises that are among the
most respected and widely recognized brand names in the lodging industry. The
majority of the Company's hotel portfolio consists of full service and upscale
extended stay properties (71% as of May 13, 1997) with the remainder of the
Company's portfolio consisting of mid-price limited service properties located
primarily in markets where significant barriers exist for new competitive
supply.
Geographically, 59% of the Company's portfolio is located in the
Pacific Coast states of California, Oregon and Washington, where California's
much-improved economic fundamentals have given a boost to the hotel industry and
have caused domestic outmigration to subside. The balance of the Company's
portfolio is in the Mountain states, which according to the U.S. Census Bureau,
posted the fastest population growth in the country in 1995 and 1996.
Sunstone is a self-administered REIT whose hotel operating strategy
emphasizes a commitment to increase market share at each of its hotels. The
Company is able to achieve this increase in market share through an expansion of
a strong base of direct sales and marketing with emphasis on repeat customers.
The Company is able to increase its customer base by providing a high level of
guest satisfaction, high-quality facilities and quality food and beverage
services through its program of subleasing its food and beverage operations to
national and regional restaurant chains.
While national in scope, success in the hospitality industry is
measured by competition in local markets and is a street-corner-by-street-corner
business. The Company distinguishes itself from its competition in local hotel
markets by providing high levels of service and value to its guests, with
high-quality hotels combined with superior marketing practices. Based on data
provided by Smith Travel Research, the Company believes that its portfolio of
renovated and rebranded hotels consistently outperforms the industry's average
year-over-year growth in revenues by a significant margin.
The lodging industry as a whole, and the mid-price and upscale
segments in particular, are benefiting from a favorable supply and demand
imbalance in the United States. Based on data provided by Smith Travel Research,
the Company believes that demand for rooms, as measured by annual domestic
occupied room nights, increased 3.3% and 3.4% in 1996 for the mid-price and
upscale segments, respectively. Future demand growth for these two segments is
forecasted by Smith Travel Research to be 2.2% per year through 1999 and revenue
growth for the entire hotel industry is forecasted to be 5.4%, 5.1% and 4.9% for
the years 1997, 1998 and 1999.
Management believes that recent demand increases have resulted
primarily from an improved economic environment in the Company's markets and a
corresponding increase in business travel, as well as favorable demographic
factors. However, in spite of increased demand for rooms, the room supply growth
rate has generally not kept pace with the growth in demand in the markets in
which the Company owns hotels. This supply and demand imbalance is significantly
greater in the Pacific Coast states. Management believes that this lag in the
supply growth
13
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rate is attributable to many factors including the limited availability of
attractive building sites for hotels in the markets in which the Company
operates, more disciplined financing for new hotel construction and the
availability of existing properties for sale at a discount to their replacement
cost. The Company expects this supply and demand imbalance, particularly in the
Western United States, to continue which should, if current trends continue,
result in improved Revenue per Available Room ("REVPAR") for its hotels, and
consequently, lease revenue to the Company in the near term.
The Company's operating strategy is to increase REVPAR by emphasizing
increases in average daily rate ("ADR") and occupancy. This strategy has been
implemented by replacing certain discounted group business with higher-rate
group and transient business and by selectively increasing room rates. The
Company has been successful in this strategy because of (1) the relatively high
occupancy rates at certain of its hotels, (2) the success of the Company's
superior marketing strategy implemented at each recently acquired hotel, and (3)
the effects of repositioning recently acquired hotels as high-quality properties
through the Company's redevelopment and rebranding program. As a result of the
Company's operating strategy, on a comparable basis, REVPAR for the 22 hotels
owned by the Company which did not undergo renovation during the first quarter
of 1997 increased approximately 20.0% over the corresponding quarter of 1996.
The lodging industry as a whole reported 6.5% REVPAR increase for the same
period.
RESULTS OF OPERATIONS OF THE COMPANY
Comparison of the Quarter Ended March 31, 1997 and 1996
For the first quarter ended March 31, 1997, net income increased
155.1% to $3,411,000 from $1,337,000 for the corresponding quarter of 1996, and
on a per-share basis increased 9.5% to $0.23 per share from $0.21 per share for
the corresponding quarter of 1996. Revenues increased 142.1% to $7,769,000 from
$3,209,000 for the first quarter of 1997. The increase in revenues is
substantially attributable to the execution of the Company's external growth
strategy, as well as increases in REVPAR, of both continuously owned and
recently acquired hotels.
External Growth. During the first quarter of 1997, the Company
acquired four hotels comprising 823 rooms for purchase prices aggregating $52.6
million. These acquisitions, combined with the eight hotels and 1,444 rooms for
purchase prices aggregating $71.8 million acquired during 1996 after the first
quarter, contributed $3.5 million of the $4.6 million increase in revenues for
the first quarter of 1997 over the corresponding quarter of 1996. The Company's
portfolio now contains a total of 29 hotels in the Western United States.
Through these acquisitions, as well as the development of a 78-room Residence
Inn in Highlands Ranch (Denver), Colorado, the Company has increased the number
of rooms in its portfolio since its IPO in August of 1995 by 239% to 4,512 to
date.
During the first quarter of 1997, the Company expended $4.0 million
of a budgeted $25.0 million to complete, during 1997, the redevelopment and
renovation of twelve recently acquired hotels. As the Company places these
newly-renovated, high-quality products in the marketplace, the Company continues
to receive the support of major franchisors. As part of its redevelopment and
renovation strategy, the Company rebranded the 262-suite Oxnard, California
hotel as a Residence Inn during the first quarter of 1997, bringing the number
of rebrandings to a total of nine hotels since its IPO, under such leading
brands as Courtyard by Marriott, Doubletree Hotel, Hampton Inn, Holiday Inn and
Residence Inn by Marriott. As the $2.5 million budgeted redevelopment and
renovation of the hotels are completed, the Company anticipates rebranding
additional hotels. The Company believes that the rebranding of these hotels with
strong national franchises will result in increased REVPAR in the near term and
an improved competitive position for these hotels in their local markets during
periods of both economic growth and decline.
REVPAR for the nine renovation hotels, six and three of which were
under renovation during the first quarter of 1997 and 1996, respectively,
increased 6.7% to $46.93 for the first quarter of 1997 from $43.97 for the
corresponding quarter of 1996.
14
15
Internal Growth. The Company reported strong revenue growth for the
first quarter of 1997. Overall, the Company posted an 11.2% REVPAR increase for
the entire portfolio for the first quarter of 1997 compared to the corresponding
quarter of 1996. Moreover, on a same-unit-sales basis, REVPAR for the
non-renovation hotels significantly increased by 20.0% over the first quarter of
1996, from $39.71 to $47.67. (During the first quarter of 1997, the nationwide
lodging industry REVPAR growth for the mid-price and upscale hotel segments, the
segments which are most representative of the Company's hotels, were 10.5% and
6.9%, respectively, according to Smith Travel Research.) This 20.0% increase in
REVPAR was driven by a 15.4% increase in occupancy, from 60.3% to 69.6%, and a
3.9% increase in ADR, from $65.91 to $68.45. The strong performance of the
Company's hotel portfolio in the first quarter of 1997 was not only due to the
results of the Company's recently redeveloped hotels, but also due to the
internal growth of a number of continuously owned hotels as indicated in the
following table.
The Company's Leading REVPAR Performers for First Quarter of 1997
REVPAR
------------------------------------------
Hotel Rooms 1996 1997 % Change
----- ----- ---- ---- --------
Courtyard by Marriott - Riverside, California 163 $28.18 $36.37 29.1%
Holiday Inn & Suites - Kent, Washington 122 28.35 42.57 50.2
Hampton Inn - Clackamas (Portland) Oregon 114 21.68 42.51 96.1
Hampton Inn - Arcadia, California 131 39.27 55.02 40.1
Holiday Inn Express - Poulsbo, Washington 63 25.98 29.89 15.1
Holiday Inn Express - Portland, Oregon 85 30.87 35.05 13.5
15
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The following tables summarize average occupancy rate, ADR and REVPAR
on a same-unit-sales basis for the Company's entire hotel portfolio of hotels
owned during the three months ended March 31, 1997.
SELECTED FINANCIAL INFORMATION
Three Months Ended
March 31,
------------------
1997 1996
------ ------
ALL HOTELS:
Occupancy ................ 68.3% 63.8%
ADR ...................... $69.76 $67.18
REVPAR ................... $47.66 $42.85
REVPAR Growth ............ 11.2%
NON-RENOVATION HOTELS (1):
Occupancy ................ 69.6% 60.3%
ADR ...................... $68.45 $65.91
REVPAR ................... $47.67 $39.71
REVPAR Growth ............ 20.0%
RENOVATION HOTELS (2):
Occupancy ................ 65.8% 65.7%
ADR ...................... $71.31 $66.91
REVPAR ................... $46.93 $42.97
REVPAR Growth ............ 6.7%
- ---------------
(1) Non-renovation hotels are those hotels that had minor or no expenditures for
renovation during the respective periods of 1996 and 1997 and included 21 of
the Company's portfolio of 28 hotels in 1997 and 12 of the Company's
portfolio of 15 hotels in 1997.
(2) Renovation hotels are those hotels that had significant expenditures for
renovation or redevelopment during the respective periods of 1996 and 1997
and included six of the Company's portfolio of 28 hotels during the first
quarter of 1997 and three of the Company's portfolio of 15 hotels during
the first quarter of 1996.
Interest expense and amortization of financing costs increased to
$840,000 from $324,000, and real estate and personal property taxes and
insurance increased to $636,000 from $253,000, for the first quarter of 1997
compared to the corresponding quarter of 1996. These increases are attributable
to the growth of the Company's hotel portfolio to 28 hotels in the first quarter
of 1997 compared to 15 hotels in the corresponding quarter of 1996. This growth
of the Company was initially financed with debt contributing to the increase in
interest expense. During the first quarter of 1997, the Company recorded
increased general and administrative expenses relating to due diligence for
hotels not acquired, annual report, and annual shareholders' meeting costs
(which were not incurred until the second quarter of 1996) and other general and
administrative costs. Additionally, effective January 1, 1997, the Company
increased the compensation of the President and added a chief financial officer,
corporate controller, cash manager and other administrative staff. As a result,
general and administrative expenses increased to $572,000 from $153,000 for the
first quarter of 1997 and 1996, respectively.
SEASONALITY AND DIVERSIFICATION
The hotel industry is seasonal in nature and this seasonality is
typically geographically and market specific. The effects of seasonality may be
expected to cause significant quarterly fluctuations in the Company's Percentage
Lease revenues. Effects of this seasonality on the Company's operating results
may change depending upon the locations and markets of additional hotels the
Company acquires.
The Company has implemented a business strategy of franchise and
geographic diversification. The following tables summarize certain information
for the Company's hotels with respect to franchise affiliations and distribution
of hotels throughout the Western United States for the three months ended March
31,1997.
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FRANCHISE AFFILIATIONS
(As of March 31,1997)
Percentage Percentage of
Franchise System Rooms Of Rooms Gross Revenues Gross Revenues
- ---------------- ----- -------- -------------- --------------
Comfort Suites ..... 165 3.9 923,000 4.9
Hampton Inns ....... 1,064 25.3 6,951,000 36.9
Hawthorn Suites .... 152 3.6 250,000 1.3
Holiday Inns (1) ... 1,831 43.5 6,052,000 32.1
Marriott - Courtyard
and Residence Inn 787 18.7 3,967,000 21.1
Doubletree Hotels .. 213 5.0 701,000 3.7
----- ----- ----------- -----
4,212 100.0% $18,844,000 100.0%
===== ===== =========== =====
- ---------------
(1) Includes the Price, Utah hotel which will be rebranded as a Holiday Inn
and Suites upon completion of renovation which is expected to occur in the
second quarter of 1997.
GEOGRAPHIC DIVERSIFICATION
(As of March 31, 1997)
Percentage Percentage of
State Rooms Of Rooms Gross Revenues Revenues
- ----- ----- ---------- -------------- ------------
Arizona 645 15.3% 3,988,000 21.2%
California 1,648 39.1 6,620,000 35.1
Colorado 753 17.9 4,241,000 22.5
New Mexico 213 5.1 701,000 3.7
Oregon 199 4.7 728,000 3.9
Utah 229 5.4 833,000 4.4
Washington 525 12.5 1,733,000 9.2
----- ----- ----------- -----
Total 4,212 100.0% $18,844,000 100.0%
===== ===== =========== =====
GEOGRAPHIC DIVERSIFICATION
(As of May 13, 1997)
Percentage
State Rooms Of Rooms
- ----- ----- --------
Arizona 645 14.3%
California 1,948 43.2
Colorado 753 16.7
New Mexico 213 4.7
Oregon 199 4.4
Utah 229 5.1
Washington 525 11.6
----- -----
Total 4,512 100.0%
===== =====
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LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Provided by Operating Activities.
The Company's operating activities provide the principal source of
cash to fund the Company's operating expenses, interest expense, recurring
capital expenditures and dividend payments. The Company anticipates that its
cash flow provided by leasing the hotels to the Lessee will provide the
necessary funds on a short and long term basis to meet its operating cash
requirements. In the first quarter of 1997, the Company paid dividends and
distributions totaling $4.4 million representing $0.25 per share, or per
Partnership Unit, on a quarterly basis.
Cash Flows from Investing and Financing Activities
The Company believes a regular program of capital improvements,
including replacement and refurbishment of furniture, fixtures and equipment at
its hotels, as well as the periodic renovation and redevelopment of certain of
its hotels, is essential to maintaining the competitiveness of the hotels and
maximizing revenue growth. The Company is also required under the Percentage
Leases to make available to the Lessee for the repair, replacement and
refurbishment of furniture, fixtures and equipment an amount equal to 4% of the
room revenue per quarter on a cumulative basis, provided that such amount may be
used for capital expenditures made by the Company with respect to the hotels.
The Company expects that this amount will be adequate to fund the required
repairs, replacements and refurbishment and to maintain its hotels in a
competitive condition.
During the first quarter of 1997, the Company issued $20.4 million in
debt through its line of credit, raised $65.6 million through issuance of equity
securities and issued 68,936 Partnership Units to finance the acquisition of
additional hotel properties, hotel renovations and non-recurring capital
improvements. As of March 31, 1997, the Company had $16.7 million of unused
credit on the $50 million line of credit facility (the "Facility"). Interest on
advances under the Facility accrued at a rate equal to the three-month LIBOR
plus 1.90%.
On May 7, 1997, the Company entered into an agreement with a
syndicate of national banks (including Bank One) for an unsecured $100 million
revolving line of credit facility (the "$100 Million Facility") with interest at
LIBOR plus 1.80% per annum with provisions for reduced rates. The $100 Million
Facility also requires that the Company provide collateral if the Company fails
to satisfy certain financial covenants. Immediately after the Company's May 6,
1997 shelf offering, the Company had $85.7 million of unused credit on the $100
Million Facility.
The $100 Million Facility may be retired in whole or in part from the
proceeds of public or private issuances of equity or debt securities by the
Company. However, because Messrs. Alter and Biederman and limited partners
would suffer adverse tax consequences if the Company's indebtedness were reduced
below $14.3 million, the Company does not anticipate reducing its indebtedness
under the $100 Million Facility below this amount.
As part of its investment strategy, the Company plans to acquire
additional hotels. Future acquisitions are expected to be funded through use of
the $100 Million Facility or other borrowings and the issuance of additional
equity or debt securities. The Company's Articles of Incorporation limits
consolidated indebtedness to 50% of the Company's investment in hotel
properties, at cost on a consolidated basis, after giving effect to the
Company's use of proceeds from any indebtedness. Management believes that it
will have access to capital resources sufficient to satisfy the Company's cash
requirements and to expand and develop its business in accordance with its
strategy for future growth.
The Company is currently engaged or has planned for the redevelopment
and renovation of 12 of its more recently acquired hotels for an aggregate
budgeted amount of approximately $25.0 million. Management believes the
renovations should result in incremental increases in REVPAR at these renovation
hotels and increased leases revenue for the Company. The Company may acquire
additional hotels and invest additional cash for renovations during 1997.
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Funds From Operations (FFO)
Management believes that FFO is one measure of financial performance
of an equity REIT such as the Company. FFO (as defined by the National
Association of Real Estate Investment Trusts) (1) for the first quarter of 1997
grew by 128.0% from $2.5 million to $5.7 million, as indicated in the following
table:
Three Months Ended
March 31,
----------------------------
1997 1996
---------- ----------
Income before minority interest .... $3,921,000 $1,630,000
Real estate related depreciation ... 1,800,000 849,000
---------- ----------
Funds from operations ........ $5,721,000 $2,479,000
========== ==========
Weighted average number of units 17,051,892 7,709,859
========== ==========
- ---------------------
(1) With respect to the presentation of FFO, management elected early
adoption of the "new definition" as recommended in the March 1995 NAREIT
White Paper on Funds From Operations beginning January 1, 1995.
Management and industry analysts generally consider funds from operations
to be one measure of the financial performance of an equity REIT that
provides a relevant basis for comparison among REITS and it is presented
to assist investors in analyzing the performance of the Company. Funds
From Operations is defined as income before minority interest (computed
in accordance with generally accepted accounting principles), excluding
gains (losses) from debt restructuring and sales of property and real
estate related depreciation and amortization (excluding amortization of
financing costs). Funds From Operations does not represent cash generated
from operating activities in accordance with generally accepted
accounting principles and is not necessarily indicative of cash available
to fund cash needs. Funds From Operating should not be considered an
alternative to net income as an indication of the Company's financial
performance or as an alternative to cash flows from operating activities
as a measure of liquidity.
The Lessee
For a discussion of the Lessee's revenue operations, see "Results of
Operations of the Company." For the first quarter of 1997, the Lessee reported
net income of $45,000. As of December 31, 1996, the Lessee had a net working
capital deficit of $3.9 million. The Lessee has received credit approval from a
financial institution for a $1.5 million working capital line of credit. The
Lessee anticipates that cash provided by operations will be an adequate source
of liquidity for the foreseeable future.
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PART II
ITEM 5. OTHER INFORMATION.
RISK FACTORS
IMPEDIMENTS TO GROWTH AND INCREASING CASH AVAILABLE FOR DISTRIBUTION
The Company's ability to increase cash available for distribution on
its Common Stock ("Cash Available for Distribution") will depend significantly
on the Company's ability to acquire or develop additional hotels at attractive
prices. Risks associated with this growth strategy include:
Acquisition Risks. There is significant competition for investment
opportunities in mid-price and upscale economy hotels for entities organized for
purposes similar to the Company's. Such entities may have substantially greater
financial resources than the Company or better relationships with franchisors,
sellers or lenders. They may also generally be able to accept more risk than the
Company can.
Renovation and Redevelopment Risks. The Company faces risks arising
from its strategy of acquiring hotels in need of substantial renovation or
redevelopment, particularly the risk that the cost or time to complete the
renovation or redevelopment will exceed the budgeted amount. Such delays or cost
overruns may arise from shortages of materials or skilled labor, a change in the
scope of the original project, the need to comply with building codes or other
legal requirements, the discovery of structural or other latent problems with a
hotel once construction has commenced and other risks inherent in the
construction process. In particular, renovation and redevelopment must comply
with the Americans with Disabilities Act of 1990 (the "ADA"), which provides
that all public accommodations meet certain federal requirements related to
access and use by disabled persons. The Company may be required to make
substantial modifications at the hotels to comply with the ADA. Delays or cost
overruns in connection with renovations or redevelopments could have a material
adverse effect on Cash Available for Distribution.
Development Risks. A component of the Company's growth strategy is to
develop new hotels in markets where room supply and other competitive factors
justify new construction or to purchase such hotels from unaffiliated developers
after they have been completed. New project development will increase the
Company's indebtedness and is subject to a number of other risks, including
risks of construction delays or cost overruns, and the risk that required
zoning, occupancy and other governmental permits might not be obtained and the
risk that projects might not be completed. Additional risks of development
projects include the risks associated with effectively marketing a hotel in
order to ramp up occupancy at projected room rates after the hotel has been
opened. Any failure to complete a development project in a timely manner and
within budget or to ramp up occupancy after completion of the project could have
a material adverse effect on Cash Available for Distribution.
TOTAL DEPENDENCE ON THE LESSEE AND PAYMENTS UNDER THE PERCENTAGE LEASES
Certain tax rules relating to the qualification of a REIT prohibit
the Company from operating hotels. Therefore, the Company enters into Percentage
Leases with the Lessee, and the Lessee operates the hotels and pays rent to the
Company based, in large part, on the revenues from the hotels. Consequently, the
Company relies entirely on the Lessee to effectively operate the Company's
hotels in a manner which generates sufficient cash flow to enable the Lessee to
timely make the rent payments under the applicable Percentage Leases.
Ineffective operation of the hotels may result in the Lessee's being unable to
pay rent at the higher tier level necessary for the Company to fund
distributions to stockholders because payment of base rent alone is insufficient
for such purposes. In the event that all or a portion of such higher tier rent
is not received by the Company, the Company may not be able to make such
distributions to its stockholders. There can be no assurance that the Company
will receive such higher tier rent from the Lessee or that the Lessee will even
be able to pay base rent. The Lessee controls the daily operations of the hotels
under the Percentage Leases, which have non-cancelable initial terms of ten
years. The Company selected the Lessee without consideration of other lessees
because Mr. Alter and Mr. Biederman, who own the Lessee, owned and were involved
in the management of a number of the hotels contributed to the Company in
connection with its IPO and because Mr. Alter and Mr. Biederman own significant
Units in the Partnership and options to acquire Common Stock of the Company, and
therefore have an incentive to cause the Lessee to maximize rents. Except as set
forth in the Percentage Leases, neither the Company nor the Partnership has the
authority to require the Lessee to operate the hotels in a manner that results
in a maximization of rent to the Company. Other than working capital to operate
the
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hotels, the Lessee will have only nominal assets, which will likely be
insufficient to satisfy any claims the Company may have if the Lessee defaults
under the Percentage Leases. Mr. Alter and Mr. Biederman have entered into an
agreement (the "Third Party Pledge Agreement") whereby the obligations of the
Lessee under the Percentage Leases are secured with a pledge by Mr. Alter and
Mr. Biederman of Units in the Partnership equal in value to four months of
initial base rent for each hotel. The Third Party Pledge Agreement will be
amended, however, to limit the total number of Units that Mr. Alter or Mr.
Biederman must pledge to the current number owned. The Third Party Pledge
Agreement may also be amended to subordinate the Company's lien on these Units
to the lien in favor of an institutional lender which may be providing a working
capital line to the Lessee guaranteed by Mr. Alter and secured by a pledge of
Mr. Alter's Units. The obligations of the Lessee under the Percentage Leases are
not secured by any additional security deposits or guarantees by third parties.
CONFLICTS OF INTEREST BETWEEN THE COMPANY AND CERTAIN OFFICERS AND DIRECTORS
Because of Mr. Alter's and Mr. Biederman's ownership in and positions
with the Company and the Lessee and Mr. Alter's ownership of the Management
Company, there are inherent conflicts of interest between the Lessee and the
Company in the leasing, acquisition, disposition, operation and management of
the Company's hotels. Accordingly, the interests of stockholders may not have
been, and in the future may not be, reflected fully in all decisions made or
actions taken by the officers and directors of the Company. In the event
revenues from the Company's hotels increase significantly over prior periods and
operating expenses with respect thereto are less than historical or projected
operating expenses, the Lessee could disproportionately benefit. In addition,
there may be conflicts of interest in connection with the sale of certain
hotels. Unrealized gain from the sale to the Company of certain hotels in
connection with its IPO is specially allocated to Mr. Alter and Mr. Biederman
and any sale of such hotels by the Partnership may cause adverse tax
consequences to them. In addition, the reduction of mortgage indebtedness by the
Partnership at any time below certain levels would create adverse tax
consequences to Mr. Alter and Mr. Biederman. These conflicts may result in
decisions relating to the sale of certain hotels and/or the incurrence or
repayment of indebtedness which do not reflect solely the interests of the
stockholders. In addition, the Company will generally be required under the
Percentage Leases to pay a lease termination fee to the Lessee if the Company
elects to sell a hotel and not replace it with another hotel. The payment of a
termination fee to the Lessee, which is owned by Mr. Alter and Mr. Biederman,
may result in decisions regarding the sale of a hotel which do not reflect
solely the interests of the Company.
RELIANCE ON MR. ALTER
The Company places substantial reliance on the hotel industry
knowledge and experience and the continued services of Robert A. Alter, the
Company's Chairman and President. The Company's future success and its ability
to manage future growth depends in large part upon the efforts of Mr. Alter and
on the Company's ability to attract and retain other highly qualified personnel.
Competition for such personnel is intense and there can be no assurance that the
Company will be successful in attracting and retaining such personnel. The loss
of Mr. Alter's services or the Company's inability to attract and retain highly
qualified personnel may adversely affect the operations of the Company and the
Cash Available for Distribution.
HOTEL INDUSTRY RISKS
Operating Risks and Competition. Many of the Company's competitors
have substantially greater marketing and financial resources than the Company
and the Lessee. In addition, the Company's hotels are subject to all operating
risks common to the hotel industry. The hotel industry has experienced
volatility in the past, as have the Company's hotels. Hotel industry risks
include, among other things, competition from other hotels; over-building in the
hotel industry which has adversely affected occupancy ADR and REVPAR increases
in operating costs due to inflation and other factors, which may not necessarily
be offset by increased room rates; dependence on business and commercial
travelers and tourism; strikes and other labor disturbances of hotel employees
for hotels owned by the Company; increases in energy costs and other expenses of
travel and adverse effects of general and local economic conditions. These
factors could decrease room revenues of the hotels and adversely affect the
Lessee's ability to make payments of rent under the Percentage Leases to the
Company, and therefore reduce Cash Available for Distribution.
Seasonality of Hotel Business and the Company's Hotels. The hotel
industry is seasonal in nature. This seasonality can be expected to cause
quarterly fluctuations in the Company's Percentage Lease revenues, which,
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therefore, may be insufficient to provide all of the Cash Available for
Distribution necessary to pay dividends in a given quarter.
Increased Competition Resulting From Overbuilding. The hotel industry
has historically experienced cycles of overbuilding in certain geographic
markets and product segments. Such overbuilding increases competition for hotel
guests, resulting in lower occupancies and lower average daily rates, thereby
reducing the profitability of the hotels affected by the increased competition.
While the Company's investment strategy is to acquire underperforming hotels or
hotels where there are significant barriers to entry, there can be no assurance
that the current hotel development activities, particularly in the limited
service segment, will not create additional significant competition for the
Company's hotels. Such increased competition would reduce the revenue generated
by the Lessee, thus reducing percentage rent paid to the Company and Cash
Available for Distribution.
RISKS OF INCREASES IN OPERATING COSTS AND CAPITAL EXPENDITURES; FRANCHISE
AGREEMENTS
Hotels in general, including the Company's hotels, have an ongoing
need for renovations and other capital improvements, including periodic
replacement of furniture, fixtures and equipment. In addition, the franchise
agreements under which the Company's hotels are operated impose specified
operating standards and may permit the franchisor to condition the continuation
of a franchise agreement on the completion of capital improvements. Under the
terms of the Percentage Leases, the Company is obligated to pay the cost of
certain capital expenditures at its hotels and to pay for furniture, fixtures
and equipment. The ability of the Company to fund these and other capital
expenditures and periodic replacement of furniture, fixtures and equipment will
depend in part on the financial performance of the Lessee and the hotels. If
these expenses exceed the Company's estimate, the additional expenses could have
an adverse effect on Cash Available for Distribution. Any inability or failure
to fund these expenditures could have a material adverse effect on occupancy
rates, ADRs and REVPAR and may constitute a breach under the franchise
agreements.
MULTI-HOTEL ACQUISITION RISKS
The Company has increasingly emphasized and intends to continue to
emphasize acquisitions of multiple hotels in a single transaction in order to
reduce acquisition expense-per hotel and enable the Company to more rapidly
expand its hotel portfolio. Multiple-hotel acquisitions are, however, more
complex than single-hotel acquisitions and the risk that a multiple-hotel
acquisition will not close may be greater than in a single-hotel acquisition. In
addition, the Company's costs for a portfolio acquisition that does not close
are generally greater than for an individual hotel acquisition. If the Company
fails to close hotel acquisitions, its ability to increase Cash Available for
Distribution will be limited. See "Risk Factors--Dependence on Acquisitions to
Increase Cash Available for Distribution." Another risk associated with
multiple-hotel acquisitions is that a seller may require that a group of hotels
be purchased as a package, even though one or more of the hotels in the package
does not meet the Company's investment criteria. In such cases, the Company may
purchase the group of hotels with the intent to re-sell those which do not meet
its criteria. This occurred in the first quarter of 1996 with the acquisition of
the six Cypress Inn Hotels in Oregon and Washington, two of which were re-sold
by the Company within three months of the acquisition. In such circumstances,
however, there is no assurance as to how quickly the Company could sell such
hotels or the price at which they could be sold. Such hotels might reduce Cash
Available for Distribution if they operate at a loss during the time the Company
holds them for sale or if the Company sells them at a loss. In addition, any
gains on the sale of such hotels within four years of the date of acquisition
may be subject to a 100% tax. The Company may finance multi-hotel acquisitions
by issuing shares of Common Stock or Units in the Partnership which are
convertible into Common Stock. Such issuances may have an adverse effect on the
market price of the Common Stock.
HAWTHORN SUITES DEVELOPMENT RISKS
The Company has entered into a five-year master development agreement
with U.S. Franchise Systems, Inc. and Hawthorn Suites Franchising, Inc. to
permit the Company to franchise properties operated under the Hawthorn Suites
brand. Pursuant to the agreement, the Company will have the right to obtain
franchise licenses in several major urban markets on the West Coast. Under the
agreement, certain development rights may terminate if the Company does not
establish a certain minimum number of licenses for Hawthorn Suites during each
year. This timetable may cause the Company to over commit to developing and
owning Hawthorn Suites at the expense of other
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growth opportunities. As a franchise with a limited number of hotels currently
operating, the Company's focus on this brand subjects it to greater risks than a
more diversified approach.
COMPETITION FOR ACQUISITIONS
There will be competition for investment opportunities in mid-price
and upscale hotels from entities organized for purposes substantially similar to
the Company's objectives as well as other purchasers of hotels. The Company is
competing for such hotel investment opportunities with entities which have
substantially greater financial resources than the Company or better
relationships with franchisors, sellers or lenders. These entities may also
generally be able to accept more risk than the Company can prudently manage.
Competition may generally reduce the number of suitable hotel investment
opportunities offered to the Company and increase the bargaining power of
property owners seeking to sell.
DEPENDENCE ON ACQUISITIONS TO INCREASE CASH AVAILABLE FOR DISTRIBUTION
The Company's success in implementing its growth plan will depend
significantly on the Company's ability to acquire additional hotels at
attractive prices. After the ramp-up of certain of the hotels which were
recently redeveloped or renovated and repositioned or which are expected to be
redeveloped or renovated and repositioned in the near future, internal growth in
ADR and occupancy for the hotels is not expected to provide as much growth in
Cash Available for Distribution as will acquisition of additional hotels.
However, since the Company intends to borrow funds to purchase, redevelop or
renovate and reposition hotels, the Company will be subject to the risks
associated with increased indebtedness, such as paying debt service even if cash
flow from such additional hotels is not sufficient to pay it or cost overruns in
redeveloping or renovating such additional hotels.
REAL ESTATE INVESTMENT RISKS IN GENERAL
The Company's hotels will be subject to varying degrees of risk
generally incident to the ownership of real property. Income from the hotels may
be adversely affected by changes in national and local economic conditions,
changes in interest rates and in the availability, cost and terms of mortgage
funds, the impact of present or future environmental legislation and compliance
with environmental laws, the ongoing need for capital improvements, changes in
real estate tax rates and other operating expenses, changes in governmental
rules (such as those requiring upgrades for disabled persons) and fiscal
policies, civil unrest, acts of God, including earthquakes, hurricanes and other
natural disasters (which may result in uninsured losses), acts of war, changes
in zoning laws, and other factors which are beyond the control of the Company.
In addition, real estate investments are relatively illiquid, and the ability of
the Company to vary its portfolio in response to changes in economic and other
conditions will be limited.
DISTRIBUTION OF SUBSTANTIALLY ALL OF CASH AVAILABLE FOR DISTRIBUTION;
DISTRIBUTIONS INCLUDE RETURN OF CAPITAL
Consistent with the Company's practice of acquiring properties in
need of renovation or redevelopment, the Company's annual distributions to
stockholders have constituted a high percentage of the Company's Cash Available
for Distribution. If this continues, the Company will retain little or no cash
from the rent payments under the Percentage Leases, and expenditures for
additional acquisitions or future capital improvements would have to be funded
from borrowings, or from proceeds from the sale of assets (including the hotels)
or equity securities. In addition, a percentage of the estimated annual
distribution has constituted a return of capital rather than a distribution of
retained earnings. Consequently, there is a risk that the distribution rate has
been set too high and may not be sustainable.
TAX RISKS
The Company intends to operate so as to be taxed as a REIT under
Sections 856-860 of the Internal Revenue Code of 1986 as amended (the "Code").
As long as the Company qualifies for taxation as a REIT, with certain
exceptions, the Company will not be taxed at the corporate level on its taxable
income that is distributed to its stockholders. A REIT is subject to a number of
organizational and operational requirements, including requirements as to the
nature of its income and assets, distribution requirements, diversity of stock
ownership
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requirements and record-keeping requirements. While the Company intends to
satisfy all of these requirements for treatment as a REIT, it is possible that
the Company may in the future fail to satisfy one or more of these requirements.
Failure to qualify as a REIT would render the Company subject to tax (including
any applicable minimum tax) on its taxable income at regular corporate rates and
distributions to the stockholders in any such year would not be deductible by
the Company. Unless entitled to relief under certain Code provisions, the
Company also would be disqualified from treatment as a REIT for the four taxable
years following the year during which qualification was lost. Even if the
Company qualifies for taxation as a REIT, the Company may be subject to certain
state and local taxes on its income and property.
In order for the Company to be taxed as a REIT, the Partnership must
be classified as a partnership for federal income tax purposes. If the
Partnership were to be taxable as a corporation, because the Company's ownership
interest in the Partnership constitutes more than 10% of the Partnership's
voting securities and exceeds 5% of the value of the Company's assets, the
Company would cease to qualify as a REIT. The imposition of corporate income tax
on the Company and the Partnership would substantially reduce the amount of Cash
Available for Distribution.
Ownership Limitation
In order for the Company to maintain its qualification as a REIT, not
more than 50% in value of its outstanding stock may be owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities). Furthermore, if any stockholder or group of stockholders of
the Lessee owns, actually or constructively, 10% or more of the stock of the
Company, the Lessee could become a related party tenant of the Partnership,
which likely would result in loss of REIT status for the Company. For the
purpose of preserving the Company's REIT qualification, the Company's Articles
of Incorporation prohibit direct or indirect ownership of more than 9.8% of the
outstanding shares of any class of the Company's stock by any person or group
(the "Ownership Limitation"). Generally, the capital stock owned by affiliated
owners will be aggregated for purposes of the Ownership Limitation. Subject to
certain exceptions, any transfer of Common or Preferred Stock that would prevent
the Company from continuing to qualify as a REIT under the Code will be
designated as "Shares-in-Trust" and transferred automatically to a trust (the
"Share Trust") effective on the day before the purported transfer of such Common
or Preferred Stock. The record holder of the Common or Preferred Stock that are
designated as Shares-in-Trust will be required to submit such number of Common
or Preferred Stock to the Share Trust and the beneficiary of the Share Trust
will be one or more charitable organizations that are named by the Company.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K:
A Current Report on Form 8-K dated January 7, 1997, was filed in
the quarter ended March 31, 1997, with disclosure under Item 7.
A Current Report on Form 8-K dated January 9, 1997, was filed in
the quarter ended March 31, 1997, with disclosure under Item 7.
A Current Report on Form 8-K dated March 26, 1997, was filed in the
quarter ended March 31, 1997, with disclosure under Item 7.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of San
Clemente, State of California, on May 15, 1997.
SUNSTONE HOTEL INVESTORS, INC.
By: /s/ ROBERT A. ALTER
-----------------------------------
Robert A. Alter
President, Chief Financial Officer,
Secretary and Chairman of the Board
of Directors
26
27
PART IV
ITEM EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT
NO. DESCRIPTION
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3.1 Amended Articles of Incorporation of the Company, as further
amended by the Articles of Amendment of the Company, as filed
with the State Department of Assessments and Taxation of Maryland
on November 9, 1994, filed as Exhibit 3.1 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
3.2 Bylaws of the Company, as currently in effect, filed as Exhibit
3.2 to the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
3.3 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on June 19,
1995, filed as Exhibit 3.3 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this reference.
3.4* Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on August 14,
1995.
10.1 Form of First Amended and Restated Agreement of Limited
Partnership of the Partnership, filed as Exhibit 10.1 to the
Company's Registration Statement No. 33-84346 and incorporated
herein by this reference.
10.1.1 First Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of December 12, 1995, filed as
Exhibit 10.36 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 (the "1995 10-K") and incorporated
herein by this reference.
10.1.2 Second Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of December 28, 1995, filed as
Exhibit 10.1.2 to the Company's 1995 10-K and incorporated herein
by this reference.
10.1.3 Third Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of March 17, 1996, filed as Exhibit
10.1.3 to the Company's Registration Statement No. 333-07685 and
incorporated herein by this reference.
10.1.4 Fourth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of March 28, 1996, filed as Exhibit
10.1.4 to the Company's Registration Statement No. 333-07685 and
incorporated herein by this reference.
10.1.5 Fifth Amendment to First Amended and Restated Agreement and
Limited Partnership dated as of July 31, 1996, filed as Exhibit
10.1.5 to the Company's Registration Statement No. 333-07685 and
incorporated herein by this reference.
10.1.6 Sixth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of August 10, 1996, filed as Exhibit
10.1.6 to the Company's Registration Statement No. 333-07685 and
incorporated herein by this reference.
10.1.7 Seventh Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of September 10, 1996, filed as
Exhibit 10.1.7 to the Company's Registration Statement No.
333-07685 and incorporated herein by this reference.
10.1.8 Eighth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of October 29, 1996.
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10.1.9 Ninth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of December 31, 1996.
10.1.10* Tenth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of January 17, 1997.
10.1.11* Eleventh Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of January 31, 1997.
10.1.12* Twelfth Amendment to First Amended and Restated Agreement of Limited
Partnership dated as of December 31, 1996.
10.2 Form of Percentage Lease, filed as Exhibit 10.2 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
10.2.1 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Denver S.E., Colorado, filed as Exhibit 10.2.1 to the Company's
1995 10-K and incorporated herein by this reference.
10.2.2 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Pueblo, Colorado, filed as Exhibit 10.2.2 to the Company's 1995
10-K and incorporated herein by this reference.
10.2.3 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Courtyard By Marriott Hotel
located in Fresno, California, filed as Exhibit 10.2.3 to the
Company's 1995 10-K and incorporated herein by this reference.
10.2.4 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Courtyard By Marriott Hotel
located in Fresno, California, filed As Exhibit 10.2.4 to the
Company's 1995 10-K and incorporated herein by this reference.
10.2.5 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Steamboat Springs, Colorado, filed as Exhibit 10.2.5 to the
Company's 1995 10-K and incorporated herein by this reference.
10.2.6 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Craig, Colorado, filed as Exhibit 10.2.6 to the Company's 1995
10-K and incorporated herein by this reference.
10.2.7 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Provo, Utah, filed as Exhibit 10.2.7 to the Company's 1995 10-K
and incorporated herein by this reference.
10.2.8 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P. as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Silverthorne, Colorado, filed as Exhibit 10.2.7 to the Company's
1995 10-K and incorporated herein by this reference.
10.2.9 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Doubletree Hotel located in
Santa Fe, New Mexico, filed as Exhibit 10.2.9 to the Company's
1995 10-K and incorporated herein by this reference.
10.2.10 Lease Agreement dated as of August 16, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Arcadia, California, filed as Exhibit 10.2.10 to the Company's
1995 10-K and incorporated herein by this reference.
10.2.11 Lease Agreement dated as of December 13, 1995 by and between
Sunstone Hotel Investors, L.P., as lessor, and Sunstone Hotel
Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Oakland, California, filed as Exhibit 10.2.11 to the Company's
1995 10-K and incorporated herein by this reference.
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10.2.12 Lease Agreement dated February 2, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Cypress Inn hotel located in Clackamas,
Oregon, filed as Exhibit 10.2.12 to the Company's First Quarter
1996 10-Q/A and incorporated herein by this reference.
10.2.13 Lease Agreement dated February 2, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Cypress Inn hotel located in Kent,
Washington, filed as Exhibit 10.2.13 to the Company's First
Quarter 1996 10-Q/A and incorporated herein by this reference.
10.2.14 Lease Agreement dated February 2, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Cypress Inn hotel located in Poulsbo,
Washington, filed as Exhibit 10.2.14 to the Company's First
Quarter 1996 10-Q/A and incorporated herein by this reference.
10.2.15 Lease Agreement dated February 2, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Cypress Inn hotel located in Portland,
Oregon, filed as Exhibit 10.2.15 to the Company's First Quarter
1996 10-Q/A and incorporated herein by this reference.
10.2.16 Lease Agreement dated March 28, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Courtyard by Marriott Hotel located in
Riverside, California, filed as Exhibit 10.2.16 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.2.17 Lease Agreement dated June 28, 1996 by and between Sunstone Hotel
Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc.,
as lessee, for the Holiday Inn Hotel located in Renton,
Washington, filed as Exhibit 10.2.17 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.2.18 Lease Agreement dated August 13, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Days Inn Hotel located in Price, Utah,
filed as Exhibit 10.2.18 to the Company's Registration Statement
No. 333-07685 and incorporated herein by this reference.
10.2.19 Lease Agreement dated September 20, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Residence Inn Hotel located in Highlands
Ranch, Colorado, filed as Exhibit 10.2.18 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.2.20 Lease Agreement dated August 13, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Comfort Suites Hotel located in South
San Francisco, California, filed as Exhibit 10.2.20 to the
Company's Registration Statement No. 333-07685 and incorporated
herein by this reference.
10.2.21** Lease Agreement dated October 29, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Hampton Inn located in Tucson, Arizona.
10.2.22** Lease Agreement dated October 29, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Holiday Inn located in Mesa, Arizona.
10.2.23** Lease Agreement dated October 29, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Holiday Inn located in Flagstaff,
Arizona.
10.2.24** Lease Agreement dated December 19, 1996 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Radisson Suites located in Oxnard,
California.
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10.2.25** Lease Agreement dated January 17, 1997 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Holiday Inn located in San Diego,
California.
10.2.26** Lease Agreement dated January 17, 1997 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Ramada Hotel located in Cypress,
California.
10.2.27** Lease Agreement dated March 10, 1997 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Hawthorne Suites Hotel located in Kent,
Washington.
10.2.28** Lease Agreement dated March 31, 1997 by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Holiday Inn located in La Mirada,
California.
10.3 Form of Right of First Refusal and Option to Purchase, filed as
Exhibit 10.3 to the Company's Registration Statement No. 33-84346
and incorporated herein by this reference.
10.4 Form of Alter Employment Agreement, filed as Exhibit 10.4 to the
Company's Registration Statement No. 33-84346 and incorporated
herein by this reference.
10.5 Form of Biederman Employment Agreement, filed as Exhibit 10.5 to
the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
10.6 Form of Indemnification Agreement to be entered into with
officers and directors of the Company, filed as Exhibit 10.6 to
the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
10.7 1994 Stock Incentive Plan, filed as Exhibit 10.7 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
10.7.1 Amendment to the 1994 Stock Incentive Plan filed on March 17,
1997 as Appendix A with the Company's 1997 Proxy Statement and
incorporated herein by this reference.
10.8 Form of Notice of Grant of Stock Option and Form of Stock Option
Agreement (and Addendum thereto) to be generally used in
connection with the Discretionary Option Grant Program of the
1994 Stock Incentive Plan, filed as Exhibit 10.8 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
10.9 Form of Stock Purchase Agreement to be generally used in
connection with the Discretionary Option Grant Program of the
1994 Stock Incentive Plan, filed as Exhibit 10.9 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
10.10 1994 Directors Plan, filed as Exhibit 10.10 to the Company's
Registration Statement No. 33-84346 and incorporated herein by
this reference.
10.10.1 Amendment to the 1994 Directors Plan filed on March 17, 1997 as
Appendix B with the Company's 1997 Proxy Statement and
incorporated herein by this reference.
10.11 Form of Notice of Grant of Automatic Stock Option, Automatic
Stock Option Agreement, Stock Purchase Agreement and Automatic
Direct Stock Issuance Agreement to be generally used in
connection with the 1994 Directors Plan, filed as Exhibit 10.11
to the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
10.12 Deleted
10.13 Deleted
10.14 Deleted
10.15 Deleted
10.16 Deleted
10.17 Deleted
10.18 Deleted
10.19 Deleted
10.20 Deleted
10.21 Deleted
10.22 Deleted
10.23 Deleted
10.24 Deleted
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10.30 Form of Third Party Pledge Agreement among the Partnership,
Robert A. Alter and Charles Biederman, filed as Exhibit 10.30 to
the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
10.30.1 Amendment Number One to Third Party Pledge Agreement effective as
of December 13, 1995, filed as Exhibit 10.34 to the Company's
1995 10-K and incorporated herein by this reference.
10.30.2 Amendment Number Two to Third Party Pledge Agreement effective as
of February 2, 1996, filed as Exhibit 10.30.2 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.30.3 Amendment Number Three to Third Party Pledge Agreement effective
as of May 30, 1996, filed as Exhibit 10.30.3 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.30.4 Amendment Number Four to Third Party Pledge Agreement effective
as of June 28, 1996, filed as Exhibit 10.30.4 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference.
10.30.5 Amendment Number Five to Third Party Pledge Agreement effective
as of August 13, 1996, filed as Exhibit 10.30.5 to the Company's
Registration Statement No. 333-07685 and incorporated herein by
this reference
10.30.6 Amendment Number Six to Third Party Pledge Agreement effective
as of August 10, 1996.
10.30.7 Amendment Number Seven to Third Party Agreement effective as of
October 29, 1996.
10.30.8 Amendment Number Eight to Third Party Agreement effective as of
December 19, 1996.
10.30.9* Amendment Number Nine To Third Party Pledge Agreement effective
as of January 17, 1997.
10.30.10* Amendment Number Ten To Third Party Pledge Agreement effective as
of March 10, 1997.
10.30.11* Amendment Number Eleven To Third Party Pledge Agreement effective
as of March 31, 1997.
10.31 Deleted
10.32 Deleted
10.33 Deleted
10.34 Deleted
10.35 Loan Agreement by and between the Company and Bank One, Arizona,
N.A. dated as of October 25, 1995, filed as Exhibit 10.38 to the
Company's 1995 10-K and incorporated herein by this reference.
10.35.1** Amended and Restated Loan Agreement by and between the Company
and Bank One, Arizona, N.A. dated as of June 21, 1996.
10.36 Deleted
10.37 Deleted
10.38 Deleted
10.39 Deleted
10.40 Deleted
27* Financial Data Schedule
* Filed herewith; all other exhibits previously filed.
** Substantially identical to Exhibit 10.2; full text omitted pursuant to
Instruction 2 to Item 601 of Regulation S-K. The material differences
between this Exhibit and Exhibit 10.2 are set forth in the schedule filed
under this Exhibit.
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(b) Reports on Form 8-K:
A Current Report on Form 8-K dated January 7, 1997, was filed in the
quarter ended March 31, 1997, with disclosure under Item 7.
A Current Report on Form 8-K dated January 9, 1997 was filed in the
quarter ended March 31, 1997, with disclosure under Item 7.
A Current Report on Form 8-K dated March 26, 1997 was filed in the
quarter ended March 31, 1997, with disclosure under Item 7.
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