================================================================================
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
September 30, 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 November 14, 1997, there were 34,984,863 shares of
Common Stock outstanding.
SUNSTONE HOTEL INVESTORS, INC.
QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 1997
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 September 30, 1997
and December 31, 1996 .............................................. 4
Consolidated Statements of Income for the Three Months and Nine Months
Ended September 30, 1997 and 1996 .................................. 5
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1997 and 1996 ........................................ 6
Notes to Consolidated Financial Statements ............................. 7
Sunstone Hotel Properties, Inc. (the "Lessee")
Statements of Financial Position as of September 30, 1997 and
December 31, 1996 .................................................. 9
Statements of Operations for the Three Months and Nine Months
Ended September 30, 1997 and 1996 .................................. 10
Statements of Cash Flows for the Nine Months ended September 30, 1997
and 1996 ........................................................... 11
Notes to Financial Statements .......................................... 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .............................. 14
PART II -- OTHER INFORMATION
ITEM 5. OTHER INFORMATION -- RISK FACTORS ................................ 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ................................. 34
2
PART I
SUNSTONE HOTEL INVESTORS, INC.
SUNSTONE HOTEL PROPERTIES, INC.
INTRODUCTION TO THE FINANCIAL STATEMENTS
ITEM 1. FINANCIAL STATEMENTS
The interim consolidated financial statements of Sunstone Hotel Investors,
Inc. (the "Company") and the interim financial statements of Sunstone Hotel
Properties, Inc. (the "Lessee") included herein, have been prepared 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 audited consolidated 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
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
September 30, December 31,
1997 1996
-------------- --------------
ASSETS: (Unaudited)
Investment in hotel properties, net $304,548,000 $152,937,000
Mortgage notes receivable 398,000 2,850,000
Cash and cash equivalents 321,000 142,000
Rent receivable-- Lessee 6,891,000 2,360,000
Prepaid expenses and other assets, net 3,959,000 1,790,000
------------ ------------
$316,117,000 $160,079,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Revolving line of credit $ 67,300,000 $ 40,400,000
Mortgage notes payable 22,439,000 19,651,000
Accounts payable and accrued expenses 2,262,000 3,249,000
------------ ------------
92,001,000 63,300,000
------------ ------------
Commitments
Minority interest 26,612,000 15,978,000
------------ ------------
Stockholders' equity:
Common stock, $.01 par value, 50,000,000
authorized; 20,458,820 and 10,936,457 issued
and outstanding as of September 30, 1997 and
December 31, 1996, respectively 204,000 109,000
Preferred stock, $.01 par value, 10,000,000
authorized, no shares issued or outstanding
Additional paid-in capital 197,410,000 80,700,000
Distributions in excess of earnings (110,000) (8,000)
------------ ------------
197,504,000 80,801,000
------------ ------------
$316,117,000 $160,079,000
============ ============
The accompanying notes are an integral part of these financial statements.
4
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1997 1996 1997 1996
------------ ----------- ------------ -----------
REVENUES:
Lease revenue $12,129,000 $4,252,000 $27,476,000 $10,407,000
Interest income 42,000 81,000 363,000 141,000
----------- ---------- ----------- -----------
Total revenues 12,171,000 4,333,000 27,839,000 10,548,000
----------- ---------- ----------- -----------
EXPENSES:
Real estate related depreciation and amortization 2,700,000 1,211,000 6,600,000 3,057,000
Interest expense and amortization of financing costs 1,218,000 218,000 2,775,000 1,279,000
Real estate, personal property taxes and insurance 1,071,000 191,000 2,431,000 757,000
General and administrative 550,000 426,000 1,351,000 457,000
----------- ---------- ----------- -----------
Total expenses 5,539,000 2,046,000 13,157,000 5,550,000
----------- ---------- ----------- -----------
Income before minority interest 6,632,000 2,287,000 14,682,000 4,998,000
Minority interest 759,000 332,000 1,712,000 829,000
----------- ---------- ----------- -----------
NET INCOME $ 5,873,000 $1,955,000 $12,970,000 $ 4,169,000
=========== ========== =========== ===========
NET INCOME PER COMMON SHARE $0.29 $0.23 $0.72 $0.59
Weighted average number of common shares outstanding 20,397,961 8,590,190 18,066,056 7,066,102
The accompanying notes are an integral part of these financial statements
5
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
---------------------------
1997 1996
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,970,000 $ 4,169,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Minority interest 1,712,000 829,000
Real estate related depreciation and
amortization 6,600,000 3,057,000
Amortization of financing costs 331,000 170,000
Changes in assets and liabilities:
Rent receivable-Lessee (4,531,000) (2,262,000)
Prepaid expenses and other assets, net (1,481,000) 6,000
Accounts payable and accrued expenses (986,000) 584,000
------------- ------------
Net cash provided by operating activities 14,615,000 6,553,000
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions, improvements and additions
to hotel properties (129,189,000) (60,566,000)
Payments on mortgage notes receivable 2,452,000
Proceeds from sale and disposition of hotel
properties 1,100,000
------------- ------------
Net cash used in investing activities (126,737,000) (59,466,000)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 119,070,000 42,747,000
Net proceeds from issuance of partnership units 161,000
Payment of deferred financing costs (1,020,000)
Borrowings on revolving line of credit 73,400,000 30,580,000
Principal payments on revolving line of credit (46,500,000) (21,200,000)
Proceeds from issuance of mortgage notes payable 3,025,000
Principal payments on mortgage notes payable (17,741,000) (22,000)
Dividends paid (13,072,000) (4,362,000)
Partnership distributions paid (1,997,000) (1,055,000)
------------- ------------
Net cash provided by financing activities 112,301,000 49,713,000
------------- ------------
Net change in cash and cash equivalents 179,000 (3,200,000)
Cash and cash equivalents, beginning of period 142,000 5,222,000
------------- ------------
Cash and cash equivalents, end of period $ 321,000 $ 2,022,000
============= ============
The accompanying notes are an integral part of these financial statements.
6
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
Organization
Sunstone Hotel Investors, Inc., a Maryland Corporation (the "Company"), is
a real estate investment trust ("REIT") that, through Sunstone Hotel Investors,
L.P. (the "Partnership"), owns upscale and mid-price hotels primarily located
in the Pacific and Mountain regions of the western United States. As of
September 30, 1997, the Company owned an 88.1% combined limited and general
partner interest in the Partnership, through units of partnership interest
("partnership units") of the Partnership.
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
share, resulting in gross proceeds of approximately $59.8 million and net
proceeds (less 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 underwriter's 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 underwriter's discount and offering costs) of approximately $10.6 million.
On May 6, 1997, the Company completed a shelf offering for 4,000,000 shares
of common stock. The offering price of the shares sold 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.
At September 30, 1997, the Company owned 34 hotel properties 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 of the Board 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. Certain prior year amounts have been reclassified to conform
to the current period financial statement presentation.
Newly Issued Accounting Pronouncements:
In 1997, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("SFAS") No. 128 Earnings Per Share
and No. 129 Disclosure of Information about Capital Structure. These statements
are effective for fiscal years ending after December 15, 1997. The FASB also
issued SFAS No. 130 Reporting Comprehensive Income and No. 131 Disclosures about
Segments of an Enterprise and Related Information. These statements are
effective for fiscal years beginning after December 15, 1997.
7
SFAS No. 128 specifies the computation, representation and disclosure
requirements for earnings per share. SFAS No. 129 established standards for
disclosing information about an entity's capital structure, such as information
about securities, liquidation preference of preferred stock and redeemable
stock. SFAS No. 130 specifies the presentation and disclosure requirement of
reporting comprehensive income which includes those items which have been
formerly reported as a component of shareholder's equity. SFAS No. 131
establishes the disclosure requirements for reporting segment information.
The management of the Company believes that, when adopted, SFAS Nos. 128,
129, 130 and 131 will not have a significant impact on the Company's financial
statements.
2. Net Income per Common Share and Partnership Units
Net income per common share is based on the weighted average number of
common shares and common share equivalents outstanding during the period.
Outstanding options are included as common share equivalents using the treasury
stock method when the effect is dilutive. The weighted average number of shares
used in determining net income per common share was 20,397,961 and 8,590,190 for
the three months ended September 30, 1997 and 1996, respectively. At September
30, 1997, a total of 23,215,479 Partnership Units were issued and outstanding.
The weighted average number of partnership units outstanding for the three
months ended September 30, 1997 and 1996 was 23,034,454 and 10,048,990,
respectively.
3. Subsequent Events and Significant Acquisitions
On October 15, 1997, the Company completed a secondary offering for
9,000,000 shares of common stock. The offering price of the shares sold was
$17.25 per share, resulting in gross proceeds of approximately $155.3 million
and net proceeds (after deducting the underwriters' discount and offering costs)
of approximately $147.1 million. On November 7, 1997, 490,000 shares of common
stock were issued by the Company upon the partial exercise of the underwriters'
over-allotment option. The offering price of the shares sold was $17.25 per
share, resulting in gross proceeds of approximately $8.5 million and net
proceeds (after deducting the underwriter's discount and offering costs) of
approximately $8.0 million.
On October 10, 1997, the Company increased its unsecured revolving line of
credit facility (the "Credit Facility") from $100 million to $200 million. The
Credit Facility accrues interest at LIBOR plus 1.80% per annum, has a two year
term with a one-year extension option in favor of the Company and provides for a
reduction in the interest rate margin if the Company's debt securities are rated
by a national rating agency. The Credit Facility also requires that the Company
provide collateral if the Company fails to satisfy certain financial covenants.
On October 15, 1997, the Company completed the acquisition of all the
outstanding capital stock of Kahler Realty Corporation ("Kahler") from Westbrook
Real Estate Fund I, L.P. and Westbrook Real Estate Co-Investment Partnership I,
L.P. (collectively, "Westbrook"). The purchase price of this acquisition (the
"Kahler Acquisition") was funded with proceeds from the Company's recently
completed public offering and with borrowings under its $200 million unsecured
line of credit. The purchase price consisted of approximately $63.8 million in
cash, $25.0 million in newly issued preferred stock, $32.0 million of newly
issued common stock, $201.2 million of assumed debt and certain other costs.
Additionally, concurrent with the closing of the Kahler Acquisition, the Company
acquired the third-party ownership interests in three Kahler hotels that were
previously partially owned by Kahler: the 220-room University Park Hotel in Salt
Lake City, Utah (76% third-party ownership interest) and the 114-room Residence
Inn and 333-room Provo park Hotel in Provo, Utah (50% third-party ownership
interest), for a total of $14.3 million in cash.
8
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF FINANCIAL POSITION
September 30, December 31,
1997 1996
-------------- -------------
(Unaudited)
ASSETS:
Cash and cash equivalents $ 2,499,000 $ 1,165,000
Receivables, net 4,584,000 1,217,000
Inventories 1,028,000 514,000
Due from affiliates 1,413,000 66,000
Prepaid expenses and other assets, net 375,000 134,000
----------- -----------
$ 9,899,000 $ 3,096,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT:
Rent payable -- REIT $ 6,891,000 $ 2,360,000
Accounts payable 1,771,000 2,328,000
Advanced deposits 276,000 276,000
Sales taxes payable 1,077,000 224,000
Accrued payroll 643,000 718,000
Accrued vacation 361,000 163,000
Accrued bonuses 411,000 176,000
Due to affiliates 852,000 258,000
Other accrued expenses 912,000 501,000
----------- -----------
13,194,000 7,004,000
----------- -----------
Commitments
Stockholders' Deficit:
Common stock, no par value, 100,000
authorized; 125 issued and outstanding
Accumulated deficit (3,295,000) (3,908,000)
----------- -----------
$ 9,899,000 $ 3,096,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
9
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1997 1996 1997 1996
------------ ------------- ------------ -------------
REVENUES: (As Restated) (As Restated)
Room $24,622,000 $ 9,961,000 $59,123,000 $23,717,000
Food and beverage 1,471,000 845,000 4,215,000 1,503,000
Other 1,926,000 526,000 3,928,000 1,242,000
----------- ----------- ----------- -----------
Total revenue 28,019,000 11,332,000 67,266,000 26,462,000
----------- ----------- ----------- -----------
EXPENSES:
Room 5,159,000 2,358,000 12,894,000 6,061,000
Food and beverage 1,377,000 619,000 3,673,000 1,434,000
Other 705,000 434,000 1,693,000 804,000
Property general and administrative 2,070,000 888,000 5,328,000 1,695,000
Franchise costs 1,709,000 407,000 4,266,000 863,000
Advertising and promotion 1,495,000 1,036,000 3,795,000 2,570,000
Repairs and maintenance 940,000 467,000 2,314,000 1,203,000
Utilities 1,261,000 650,000 3,053,000 1,362,000
Management fees 548,000 256,000 1,307,000 539,000
----------- ----------- ----------- -----------
Total operating expenses 15,264,000 7,115,000 38,323,000 16,531,000
----------- ----------- ----------- -----------
Operating profit 12,755,000 4,217,000 28,943,000 9,931,000
Corporate general and adminstrative 294,000 75,000 769,000 393,000
Rent expense 12,129,000 4,533,000 27,476,000 10,749,000
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ 332,000 $ (391,000) $ 698,000 $(1,211,000)
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
10
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
----------------------------
1997 1996
------------ -------------
(As Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 698,000 $(1,211,000)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Changes in assets and liabilities:
Receivables, net (3,367,000) (681,000)
Inventories 1,000 45,000
Due from affiliates (1,347,000)
Prepaid expenses and other assets, net (221,000) (762,000)
Rent payable -- REIT 4,531,000 2,263,000
Accounts payable (557,000) 398,000
Advanced deposits (130,000)
Sales taxes payable 853,000 87,000
Accrued payroll (75,000) 64,000
Accrued vacation 198,000 18,000
Accrued bonuses 235,000
Due to affiliates 79,000 14,000
Other accrued expenses 411,000 120,000
----------- -----------
Net cash provided by operating
activities 1,439,000 225,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of office furniture, fixtures and
equipment (105,000)
----------- -----------
Net cash used in investing activities (105,000)
----------- -----------
Net change in cash and cash equivalents 1,334,000 225,000
Cash and cash equivalents, beginning of period 1,165,000 800,000
----------- -----------
Cash and cash equivalents end of period $ 2,499,000 $ 1,025,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
11
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
(the "Percentage Leases").
2. Accumulated Deficit:
The Lessee has remained current in its payments to the Company under the
terms of the Percentage Leases. For 1997 and 1998, 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 three and nine months ended September 30, 1997, the Lessee reported
net income of $332,000 and $698,000, respectively. The Lessee reported positive
net cash provided by operating activities of $1.4 million for the nine months
ended September 30, 1997.
During 1995 and 1996, the Lessee incurred cumulative losses of $3.9
million. As of September 30, 1997, the accumulated stockholder's deficit was
$3.3 million, improved by $698,000 of net income for the nine months ended
September 30, 1997. Of the losses incurred through December 31, 1996,
approximately $1.5 million of the loss was 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 in prior periods 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 terms of certain Percentage Leases and market conditions in
certain markets.
Effective July 1, 1997, the Company and the Lessee amended certain
Percentage Leases to abate rent related to rooms under major renovation which
were not available for rent to guests. New Percentage Leases between the Company
and the Lessee reflect similar rent abatement provisions during periods of major
renovation.
12
3. Restatement
The interim financial statements as of and for the three months and nine
months ended September 30, 1996 have been restated. Certain amounts have been
restated to give effect to the expensing of costs related to renovation activity
at various hotels that were previously capitalized. The effects of the
restatement are as follows:
September 30, 1996
--------------------------
As Reported As Restated
----------- -----------
Total assets $ 4,298,000 $ 3,084,000
Accumulated deficit (767,000) (1,981,000)
For the Three Months Ended For the Nine Months Ended
September 30, 1996 September 30, 1996
-------------------------- -------------------------
As Reported As Restated As Reported As Restated
----------- ----------- ----------- -----------
Total revenue $11,332,000 $11,332,000 $26,462,000 $26,462,000
Total operating expenses 6,980,000 7,115,000 15,659,000 16,531,000
Rent expense 4,252,000 4,533,000 10,407,000 10,749,000
Net income (loss) 25,000 (391,000) 3,000 (1,211,000)
The effects of the above restatement have been reflected in the Lessee's
previously reported financial statements as of and for the year ended December
31, 1996.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
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 risks and 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 risks and
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.
General
The Lodging Industry. The business fundamentals of the lodging industry in
the United States have improved significantly in each year since 1990. The
industry as a whole generated record earnings in 1996, with industry-wide pre-
tax profits of approximately $12.5 billion. This amount represented an increase
of 47.1%, from $8.5 billion in pre-tax profits in 1995, and represented the
industry's fourth consecutive year of profitability. Coopers & Lybrand L.L.P.
projects that industry profits will reach $19.4 billion in 1999.
The REIT vehicle has become increasingly important within the lodging
industry. Total asset value of the portion of the lodging industry that is
controlled by equity REITs has grown from $872.9 million in 1994 to $8.5 billion
at June 30, 1997, as measured by the aggregate book value of total assets.
The industry's profitability has been fueled by five consecutive years in
which the growth in demand for hotel rooms has exceeded the growth in room
supply. Industry-wide growth in total room demand exceeded the growth in total
room supply by 2.7%, 3.0%, 3.3%, 1.4% and 0.8% in 1992, 1993, 1994, 1995, 1996,
respectively. The trend continued in the Pacific Region (California, Oregon and
Washington) during the six months ended June 30, 1997, with total room demand
exceeding total room supply by 1.2%, compared to 0.7% for the country as a whole
during the same period.
This favorable relationship between demand growth and supply growth has
enabled the industry to increase revenue per available room ("REVPAR") every
year since 1991. Based on data from Smith Travel Research, REVPAR for the
industry as a whole grew 3.9%, 4.8%, 7.5%, 5.2% and 7.7% in 1992, 1993, 1994,
1995, and 1996, respectively, and increased 5.3% for the nine months ended
September 30, 1997, compared in each case to the prior year. According to
Coopers & Lybrands Hospitality Directions, REVPAR for the industry is expected
- -----------------------------------------
to increase by 5.3% and 5.2% in 1998 and 1999, respectively. REVPAR for hotels
in the Pacific Region, where approximately 36% of the Company's hotel rooms are
located, grew by 8.9% during the nine months ended September 30, 1997, as
compared to 5.3% for the industry generally.
Upscale and Mid-Price Segments. The lodging industry as a whole, and the
upscale and mid-price segments in particular, the segments in which the Company
owns hotel assets, continue to benefit from a favorable supply and demand
imbalance in the United States. Based on data provided by Smith Travel
Research, for the upscale and mid-price segments, respectively, demand for
rooms, as measured by annual domestic occupied room nights, increased 2.6% and
3.8% in 1995 and 3.4% and 3.3% in 1996.
The upscale segment of the industry, which represents a growing number of
the Company's hotels, is expected to achieve strong results due to limited
growth in the supply of new upscale rooms. REVPAR at upscale hotels throughout
the United States grew an average of 5.6% in 1995 and 5.4% in 1996, and grew an
average of 4.5% during
14
the nine months ended September 30, 1997, compared in each case to the prior
year. The Company believes supply growth will be limited in the upscale segment
due to (i) the continued availability of hotel acquisition opportunities in most
markets at prices below replacement cost, (ii) the high relative cost of
construction for hotels in this segment and (iii) the long construction lead
times in this segment.
REVPAR at mid-price hotels throughout the United States grew an average of
6.2% in 1995 and 6.7% in 1996, compared in each case to the prior year, and grew
an average of 4.9% in the nine months ended September 30, 1997.
As used herein, according to Smith Travel Research in its industry reports,
the terms "upscale" and "mid-price" generally mean the segments of the lodging
industry that consist of hotels with average daily room rates (total revenues
divided by the total number of rooms occupied) between the 70th and 85th
percentile and the 40th and 70th percentile, respectively, of the average daily
room rates of all hotels in the markets in which the hotels operate.
15
The following graph illustrates REVPAR growth for the nine months ended
September 30, 1997 over the comparable period for the prior year for hotels in
the United States, in the Pacific Region and for the Company:
(For the nine months ended September 30, 1997)
[REVPAR GROWTH GRAPH APPEARS HERE]
TOTAL U.S. PACIFIC REGION SUNSTONE (1)
---------- -------------- ------------
5.3% 8.9% 14.0%
Source: Smith Travel Research and the Company
- --------
(1) Non-renovation hotels
The following graph illustrates the profitability of the United States
lodging industry between 1982 and 1996, and as projected for 1997, 1998 and
1999:
Lodging Industry Profitability 1982-1999P
[LODGING INDUSTRY PROFITABILITY GRAPH APPEARS HERE]
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997P 1998P 1999P
- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----- ----- -----
2.5 1.9 1.7 0.1 -0.9 -1.1 -1.3 -2.1 -5.7 -2.8 0.0 2.4 5.5 8.5 12.5 13.7 16.4 19.4
Source: Smith Travel Research; Coopers & Lybrand L.L.P.
16
The Company. Sunstone Hotel Investors, Inc. ("Sunstone" or the "Company")
is a leading self-administered equity real estate investment trust ("REIT") that
owns upscale and mid-price hotels located primarily in the Pacific and Mountain
regions of the western United States (the "Primary Region"). The hotels operate
primarily under national franchises that are among the best respected and most
widely recognized in the lodging industry, including brands affiliated with
Holiday Hospital Corporation, Marriott International, Inc. and Promus Hotel
Corporation. As of November 7, 1997, the Company owned 51 hotels, 40 of which
were acquired and one of which was developed subsequent to the Company's initial
public offering (the "Initial Public Offering") in August 1995. The majority of
the Company's hotel portfolio consists of full service and upscale extended stay
properties (approximately 83%) 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, 36% 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
where population growth currently exceeds all other regions of the United
States. Additionally, 45% 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 though 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.
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 most of the
markets in which the Company owns hotels. This supply and demand imbalance is
significantly greater in the Pacific Coast states where the Company currently
emphasizes its acquisition focus. Management believes that this lag in the
supply growth 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 stringent requirements for obtaining financing for new
hotel construction and the availability of existing properties for sale at a
significant discount to their replacement cost. The Company expects this supply
and demand imbalance, particularly in the Pacific Coast, to continue, which
should result in improved 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 increasing
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 (i) the relatively high occupancy rates
at certain of its hotels, (ii) the success of the Company's superior marketing
strategy implemented at each acquired hotel, and (iii) the effects of
repositioning recently acquired hotels as high-quality properties with strong
national franchises through the Company's redevelopment and rebranding program.
As a result of the Company's operating strategy, on a comparable basis, REVPAR
for the 25 hotels owned by the Company that did not undergo renovation during
the third quarter of 1997 increased approximately 10.1% over the corresponding
quarter of 1996.
17
The Kahler Acquisition. On October 15, 1997, the Company completed the
acquisition of all the outstanding capital stock of Kahler Realty Corporation
("Kahler") from Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate Co-
Investment Partnership I, L.P. (collectively, "Westbrook"). The purchase price
of this acquisition (the "Kahler Acquisition") was funded with proceeds from the
Company's recently completed public offering and with borrowings under its $200
million unsecured line of credit. The purchase price consisted of approximately
$63.8 million in cash, $25.0 million in newly issued preferred stock, $32.0
million of newly issued common stock, $201.2 million of assumed debt and certain
other costs. Additionally, concurrent with the closing of the Kahler
Acquisition, the Company acquired the third-party ownership interests in three
Kahler hotels that were previously partially owned by Kahler: the 220-room
University Park Hotel in Salt Lake City, Utah (76% third-party ownership
interest) and the 114-room Residence Inn and 333-room Provo park Hotel in Provo,
Utah (50% third-party ownership interest), for a total of $14.3 million in cash.
Prior to the acquisition, Kahler owned and operated 17 hotels with an aggregate
of 4,255 rooms.
Nine of the Kahler Hotels are operated independently without a brand
affiliation while the balance are currently operated under Hilton, Holiday Inn,
Residence Inn, Sheraton franchises and other national franchises. The Company
believes that there are significant opportunities for renovating, redeveloping,
branding, rebranding and repositioning several of the Kahler Hotels that will
provide an attractive return on investment, and has budgeted approximately $33.2
million for such activities. The Company believes that it can increase the
revenue of the hotels and its return on investment by branding the nine
independent Kahler Hotels and rebranding several of the other Kahler Hotels.
The Kahler Hotel portfolio includes 17 hotels with 4,255 rooms, principally
in two markets, the Mountain Region states of Utah, Idaho, Montana and Arizona
(11 hotels) and Rochester, Minnesota (four hotels). The largest number of rooms
are concentrated in Rochester, Minnesota, with four hotels and 1,329 rooms,
three of which are connected by an underground walkway to the headquarters of
the internationally renown Mayo Clinic, and in the Salt Lake City area of Utah,
host of the 2002 Winter Olympic Games, with six hotels and 1,509 rooms. The
Company may sell or exchange two of the Kahler Hotels, one in Texas and one in
West Virginia, as they are inconsistent with the Company's geographic focus.
The Kahler Acquisition is consistent with the Company's growth strategy of
acquiring hotels with upside potential in its Primary Region within the western
United States. The Company believes that the Kahler Acquisition is attractive
because the Kahler Hotel portfolio (i) contains primarily underperforming full
service hotels with significant opportunities for renovation, redevelopment,
repositioning and rebranding, (ii) includes the largest number of rooms under
common management in Rochester, Minnesota, and a significant concentration of
hotel rooms in the Salt Lake City area of Utah, which the Company believes will
enable it to be a leader in pricing and to achieve economies of scale in its
operations, (iii) includes the Rochester, Minnesota, hotels that service the
Mayo Clinic, which recently announced an 850,000 square foot expansion, (iv)
creates an alliance with Westbrook through its equity ownership and Board
representation in the Company, which the Company believes will result in
additional hotel acquisition opportunities and (v) is being purchased at a
significant discount to replacement cost.
Results of Operations of the Company
Comparison of the Quarter Ended September 30, 1997 and 1996
For the third quarter ended September 30, 1997, net income increased 195%
to $5.9 million from $2.0 million, and on a per-share basis increased 26.1% to
$0.29 per share from $0.23 per share for the corresponding quarter of 1996.
Revenues increased $7.9 million, or 184%, to $12.2 million from $4.3 million for
the third 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 third quarter of 1997, the Company acquired
four hotels comprising 585 rooms for purchase prices aggregating approximately
$37.8 million resulting in $119.0 million of hotel acquisitions for the nine
months ended September 30, 1997. For the last twelve months ended September 30,
1997, the Company acquired 14 hotels with 2,656 rooms for purchase prices
aggregating approximately $124.6 million, which contributed $5.2
18
million of the $7.9 million increase in revenues. On October 15, 1997, the
Company completed the Kahler Acquisition, which included 17 hotels with an
aggregate of 4,255 rooms.
Internal Growth. On a same-unit-sales basis, overall, the Company posted
a 10.4% REVPAR increase for the entire portfolio for the third quarter of 1997
as compared to the corresponding quarter of 1996. REVPAR for the non-renovation
hotels increased by 10.1% over the third quarter of 1996, from $50.96 to $56.13.
For comparative purposes, for the nine months ended September 30, 1997, the
nationwide lodging industry REVPAR growth for the upscale and mid-price hotel
segments, the segments which are most representative of the Company's hotels,
were 4.5% and 4.9%, respectively, according to Smith Travel Research. The 10.1%
increase in REVPAR was driven by a 8.6% increase in ADR, from $67.55 to $73.37,
and an approximately one percentage point increase in occupancy, to 76.5%. The
strong performance of the Company's hotel portfolio in the third 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 Third Quarter of 1997
REVPAR
---------------------------
Hotel Rooms 1996 1997 % Change
----- ----- ------- ------- ---------
Courtyard by Marriott -- Fresno, California 116 $42.28 $51.84 22.6%
Doubletree Hotel -- Santa Fe, New Mexico 213 46.97 60.15 28.1
Holiday Inn -- La Mirada, California 289 35.74 44.22 23.7
Hampton Inn -- Oakland, California 152 47.41 59.17 24.8
Hampton Inn -- Silverthorne, Colorado 160 35.95 44.14 22.8
REVPAR for the third quarter of 1997 for the four 1996-renovation hotels
(which were undergoing renovation during the third quarter of 1996) increased
74.9% over the corresponding quarter of 1996.
REVPAR for the third quarter of 1997 for the five 1997-renovation hotels
(which were undergoing renovation during the third quarter of 1997) decreased
12.5% over the corresponding quarter of 1996, a period during which these hotels
were not undergoing renovation. The net effect of renovations on room revenues
for these nine hotels was an increase in REVPAR of 11.1% over the prior year.
19
The following table summarizes average occupancy rate, ADR and REVPAR, on a
same-unit-sales basis, for the Company's hotels owned during the three and nine
months ended September 30, 1997.
Selected Financial Information
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
1997 1996 1997 1996
-------- -------- -------- --------
Same-unit-sales Analysis
ALL HOTELS:
Occupancy 73.5% 72.8% 70.8% 69.9%
ADR $72.10 $65.88 $69.08 $64.43
REVPAR $52.97 $47.97 $48.92 $45.02
REVPAR Growth 10.4% 8.7%
NON-RENOVATION HOTELS (1):
Occupancy 76.5% 75.4% 75.2% 72.9%
ADR $73.37 $67.55 $70.22 $65.55
REVPAR $56.13 $50.96 $52.82 $47.81
REVPAR Growth 10.1% 10.5%
RENOVATION HOTELS (2):
Occupancy 64.2% 62.7% 63.4% 64.5%
ADR $62.92 $58.01 $65.68 $61.97
REVPAR $40.40 $36.36 $41.65 $39.98
REVPAR Growth 11.1% 4.2%
________________________________________________________________________________
(1) Non-renovation hotels are those hotels that had minor or no expenditures
for renovation during the respective periods of 1997 and 1996.
(2) Includes the five hotels undergoing renovation in the third quarter of 1997
and the four hotels undergoing renovation in the third quarter of 1996.
Interest expense and amortization of financing costs increased to
$1,218,000 from $218,000, and real estate and personal property taxes and
insurance increased to $1,071,000 from $191,000, for the third quarter of 1997
compared to the corresponding quarter of 1996. These increases are attributable
to the growth of the Company's hotel portfolio to 34 hotels in the third quarter
of 1997 compared to 20 hotels in the corresponding quarter of 1996. Acquisitions
are typically initially financed with debt contributing to the increase in
interest expense.
Renovations, Rebranding and Upgrades. Sunstone continued to implement its
strategy of renovating, rebranding and repositioning its recently acquired hotel
assets and, during the third quarter of 1997, completed three franchise
conversions and upgrades bringing the total number of franchise conversions and
upgrades to 20.
Holiday Inn Select--Renton, Washington. Upon the July 1997 completion of
a $5.9 million extensive renovation of the exterior, restaurant , lobby meeting
space and guest rooms, the Company upgraded the Renton Holiday Inn to a Holiday
Inn Select, a brand primarily used by corporate business travelers. As part of
the renovation, Sunstone added 38 rooms to the hotel. Because of strong demand
in the local market and because of the significant improvement in product
quality, management was able to immediately increase ADR by 42.0%, to $95.65
from the $67.38 1996 ADR.
20
Holiday Inn & Suites--Price, Utah. Also in July 1997, the Company
completed a $3.6 million renovation of the exterior, restaurant, lobby meeting
space and guest rooms and rebranded the hotel in Price, Utah to a Holiday Inn &
Suites from an economy-level franchise. Due to the renovation and the
implementation of a focused sales and marketing program, management was able to
immediately increase ADR by 25.7%, to $51.41 from the $40.89 1996 ADR.
Holiday Inn Harbor View--San Diego, California. In August 1997, the $4.2
million extensive renovation of the exterior, lobby meeting space and guest
rooms as well as the relocation of the restaurant and the addition of 16 rooms
enabled Sunstone to immediately increase ADR by 9.2%, to $65.61 from the $60.10
1996 ADR. Additionally, after the expiration of certain group business
contracts in December of 1997, management expects to increase ADR an additional
$10, for an expected total ADR increase of 25.8%. The hotel is experiencing
strong market demand and the improved product quality has enabled management to
capitalize on revenue growth opportunities.
Results from renovations completed in June 1997 have also been strong and have
positively affected third quarter results. REVPAR for the Courtyard by Marriott
in Cypress, California (formerly a Ramada Inn), which underwent a $1.8 million
renovation, was up 14.1% in August and September. REVPAR for the Comfort Suites
in South San Francisco, California, which underwent a $2.5 million renovation,
was up 15.3% in the third quarter over the corresponding period in the prior
year.
Consistent with Sunstone's plan of a regular program of capital improvement,
which the Company believes is essential to maintaining the competitiveness of
its hotels and maximizing revenue growth, the Hampton Inn in Silverthorne,
Colorado, underwent a $646,000 lobby renovation in June of 1997. REVPAR for the
hotel was up 22.8% in the third quarter over the corresponding period in the
prior year.
Sunstone continues to invest in future internal revenue growth and during the
third quarter of 1997 was in the process of a $2.9 million major renovation of
the exterior, restaurant, lobby meeting space and guest rooms to the Holiday Inn
in Mesa, Arizona. During the third quarter, the Hampton Inn in Tucson, Arizona
was also in the process of a $668,000 renovation of the lobby, meeting space and
guest rooms and the Company was in the process of a competitive refurbishment of
the Hampton Inn in Mesa, Arizona. These renovations will be completed in the
fourth quarter of 1997.
Management believes that its internal growth strategy of improving each hotel's
revenue performance by renovating, rebranding, and repositioning the asset not
only has an immediate impact on financial performance, but also will create long
term value and growth as well.
Franchise Diversification and Seasonality. The Company has implemented a
business strategy of franchise and geographic diversification. The Company
generally believes that franchise affiliations provide advantages to certain
hotels. Such advantages include brand recognition, access to national
reservation systems, national direct sales efforts and national volume
purchasing agreements, and technical and business assistance. The use of
multiple franchise systems provides the Company with further diversification,
less dependence on the continued popularity of one brand and less vulnerability
to new requirements of any individual franchise affiliation. The Company
expects to focus its franchise affiliations on nationally recognized upscale
hotel chains. 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 as of and for the periods indicated.
21
FRANCHISE AFFILIATIONS
(As of and For the Nine months Ended September 30, 1997)
Number of Lease Percentage of Percentage
Franchise Affiliation Hotels Revenues Lease Revenues Rooms Of Rooms
- --------------------- --------- ----------- -------------- ----- ----------
Holiday Inns 13 $ 9,519,000 34.6% 2,045 38.7%
Hampton Inns 8 6,919,000 25.2 1,063 20.1
Marriott - Courtyard
and Residence Inn 6 5,279,000 19.2 891 16.8
Hawthorn Suites (1) 2 2,339,000 8.5 453 8.6
Comfort Suites 1 1,404,000 5.1 166 3.1
Doubletree Hotels 1 1,008,000 3.7 213 4.0
Independent 3 1,008,000 3.7 459 8.7
-- ----------- ----- ----- -----
34 $27,476,000 100.0% 5,290 100.0%
== =========== ===== ===== =====
________________________________________________________________________________
(1) Includes the Sacramento, California, hotel which will be rebranded as a
Hawthorn Suites upon completion of renovation which is expected to occur in
the fourth quarter of 1997.
FRANCHISE AFFILIATIONS
As of November 7, 1997
Franchise Affiliation /(1)/ Number of Hotels Rooms Percentage of Rooms
- --------------------------- ---------------- ----- -------------------
Holiday Inn 18 2,819 29.5%
Marriott (2) 13 2,441 25.7%
Kahler (3) 2 965 10.1%
Hampton 8 1,063 11.1%
Hawthorn Suites (3) 3 583 6.1%
Sheraton 1 295 3.1%
Hilton 1 351 3.7%
Independent 3 649 6.8%
Comfort Suites 1 166 1.7%
Doubletree Hotel 1 213 2.2%
-- ----- -----
Total 51 9,545 100.0%
== ===== =====
________________________________________________________________________________
(1) Several of the other Kahler Hotels will likely be branded or rebranded,
under either Marriott, Courtyard by Marriott, Holiday Inn Hotel & Suites or
Holiday Inn brands. Certain of the Company's planned changes in franchise
affiliations are included in this table. There can be no assurance that
the Company will receive final approval from the applicable franchisor.
(2) Includes six hotels from the Kahler Acquisition with 1,390 rooms which the
Company anticipates converting to various Marriott franchises. The Company
has obtained approval of these new franchise licenses, subject to
completion of renovations or improvements.
(3) Includes the Anaheim and Sacramento, California hotels which will be
rebranded as Hawthorn Suites hotels upon completion of renovation and
improvements which are expected to be completed in the fourth quarter of
1997.
22
GEOGRAPHIC DIVERSIFICATION
(As of and For the Nine Months Ended September 30, 1997)
Percentage of Percentage
State Lease Revenues Lease Revenues Rooms Of Rooms
- ------------- -------------- -------------- ----- ----------
Arizona $ 3,258,000 11.9% 647 12.2%
California 11,674,000 42.5 2,598 49.1
Colorado 5,267,000 19.2 736 13.9
New Mexico 1,008,000 3.7 213 4.0
Oregon 1,025,000 3.7 198 3.8
Utah 1,418,000 5.1 229 4.3
Washington 3,826,000 13.9 669 12.7
----------- ----- ----- -----
Total $27,476,000 100.0% 5,290 100.0%
=========== ===== ===== =====
GEOGRAPHIC DIVERSIFICATION
(As of November 7, 1997)
Percentage
Region Rooms Of Rooms
--------------- ----- ----------
Mountain (1) 4,280 44.9%
Pacific (2) 3,465 36.3
Minnesota 1,329 13.9
Other (3) 471 4.9
----- -----
Total 9,545 100.0%
===== =====
________________________________________________________________________________
(1) Includes Arizona, Colorado, Idaho, Montana, New Mexico and Utah.
(2) Includes California, Oregon and Washington.
(3) The Company is considering the sale or exchange of the two Kahler Hotels
located in Texas and West Virginia.
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 and may change depending upon the locations and markets of additional
hotels the Company acquires.
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 operating
activities to the Lessee will provide the necessary funds on a short and long
term basis to meet such operating cash requirements. For the nine months ended
September 30, 1997, the Company paid dividends and distributions totaling $15.1
million representing $0.25 per share, or per Partnership Unit, on a quarterly
basis. On September 12, 1997, the Company declared a dividend payable on
November 15, 1997 of $0.275 per share (or per Partnership Unit), representing an
increase in the annual dividend to $1.10 per share (or per Unit), from $1.00
previously.
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
23
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.
The Company is currently engaged or has planned for the redevelopment and
renovation of 20 of its recently acquired hotels (including the Kahler hotels)
for an aggregate budgeted amount of approximately $48.2 million. Management
believes the renovations should result in incremental increases in REVPAR at
these renovation hotels and increased lease revenue for the Company. The Company
may acquire additional hotels and invest additional cash for renovations during
1997.
Debt Financing. During the nine months ended September 30, 1997, the
Company borrowed $73.4 million through its unsecured line of credit facility to
finance the acquisition of additional hotel properties, hotel renovations and
non-recurring capital improvements.
On October 15, 1997, the Company increased its unsecured revolving line of
credit facility (the "Credit Facility") from $100 million to $200 million. The
Credit Facility continues to accrue interest at LIBOR plus 1.80% per annum, has
a two year term with a one-year extension option in favor of the Company and
provides for a reduction in the interest rate margin if the Company's debt
securities are rated by a national rating agency. The Credit Facility also
requires that the Company provide collateral if the Company fails to satisfy
certain financial covenants.
The Credit 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 certain other limited partners
of the Partnership would suffer adverse tax consequences if the Company's
indebtedness were reduced below $18.6 million, the Company does not anticipate
reducing its indebtedness under the Credit Facility below this amount. As of
September 30, 1997, the Company had $32.7 million of unused credit on the $100
million revolving line of credit facility. As of November 7, 1997, the Company
had $60.7 million of unused credit on its $200 million Credit Facility.
Equity Financing. During the nine months ended Septembver 30, 1997, the
Company raised $119.1 million in four follow-on, public equity offerings. In
connection with the Kahler transaction, the Company raised an additional $155.1
million of public equity funds (net of underwriters' discount) in October and
November of 1997. The Company has increased its hotel asset acquisition rate to
approximately $441.0 million to date in 1997 compared to $82.9 million for all
of 1996. Management believes that there will continue to be attractive
acquisition opportunities for at least the next twelve months. Currently, the
Company has $238.4 million remaining on its $525 million shelf registration.
Management of the Company believes that its access to public equity funds will
continue to be a viable source of funding its external growth strategy through
1998.
During the nine months ended September 30, 1997, the Company issued
approximately 217,000 Partnership Units for an aggregate value of $3.1 million
in conjunction with the acquisition of hotel properties. The Company expects
that the issuance of Partnership Units will continue to facilitate the
acquisition of hotel properties.
As part of its investment strategy, the Company plans to acquire additional
hotels. Future acquisitions are expected to be funded through use of the Credit
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.
24
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 third quarter of 1997 grew by 166%
to $9.3 million from $3.5 million, as indicated in the following table:
Three Months Ended
September 30,
-------------------------
1997 1996
----------- -----------
Income before minority interest $ 6,632,000 $ 2,287,000
Real estate related depreciation 2,700,000 1,211,000
----------- -----------
Funds from operations $ 9,332,000 $ 3,498,000
=========== ===========
Weighted average number of partnership
units outstanding 23,034,454 10,048,990
________________________________________________________________________________
(1) 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 Operations 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 third quarter of 1997, the Lessee reported
net income of $332,000. As of September 30, 1997, the Lessee had a net working
capital deficit of $3.3 million improved from a $3.9 million deficit as of
December 31, 1996. The Lessee has $1.5 million of availability on its working
capital line of credit. No amounts have been drawn on the line of credit. The
Lessee anticipates that cash provided by operations will be an adequate source
of liquidity for the foreseeable future.
25
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:
Competition For Future 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
prudently can 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.
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, 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 Partnership, 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
26
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 Initial
Public Offering 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 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 of Mr. Alter's and
Mr. Biederman's 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 has been amended, however, to limit the total number of Units that Mr.
Alter or Mr. Biederman must pledge to the current number Mr. Alter owns. This
may limit the Company's ability to recover in full for any claims it may have
against the Lessee for defaults under the Percentage Leases. The amendment to
the Third Party Pledge Agreement also subordinated the Company's lien on the
majority of Mr. Alter's Units to the lien in favor of an institutional lender
providing a working capital line to the Lessee guaranteed by Mr. Alter and
secured by a pledge of a significant portion 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.
Multiple-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 expenses per hotel and enable the Company to more rapidly
expand its hotel portfolio. Consistent with this emphasis, on October 15, 1997,
the Company closed the Kahler Acquisition which almost doubled the Company's
room total. Multiple-hotel acquisitions, such as the Kahler Acquisition, 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.
Such portfolio acquisitions, whether by stock or asset purchase, may also
result in the Company owning hotels in geographically dispersed markets. For
instance, several of the Kahler Hotels are located in areas geographically
removed from the Company's Primary Region. This geographic diversity will place
significant additional demands on the Company's ability to manage such
operations. In addition, the Company's costs for a hotel portfolio acquisition
that does not close are generally greater than for an individual hotel
acquisition which does not close. If the Company fails to close multiple-hotel
acquisitions, its ability to increase Cash Available for Distribution will be
limited. 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. It is anticipated that
any hotel acquired in the Kahler Acquisition that does not fit geographic or
operating parameters of the Company may be sold or exchanged, including the
Kahler Hotels located in Texas and West Virginia. In such circumstances,
however, there can be no assurance as to how quickly the Company could sell or
exchange such hotels or the terms on which they could be sold or exchanged.
Such hotels might reduce Cash Available for Distribution if they operate at a
loss during the time the Company owns them, 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 multiple-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.
27
Failure to Manage Rapid Growth; Failure to Successfully Integrate Kahler
To successfully implement its acquisition strategy, the Company must
integrate the hotels acquired since the Initial Public Offering and any other
subsequently acquired hotels into its existing operations. Since the closing of
the Initial Public Offering, the Company's portfolio of hotel properties has
increased dramatically. During such period, the Company also entered geographic
markets where it previously did not have any properties. As a result, the
consolidation of functions and integration of departments, systems and
procedures of acquired properties with the Company's existing operations
presents a significant management challenge, and the failure to integrate such
properties into the Company's management and operating structures could have a
material adverse effect on the results of operations and financial condition of
the Company.
The Kahler acquisition will place significant demands on the Company's
management and other resources. There can be no assurances that the Kahler
Hotels and other business operations can be integrated successfully, that there
will be any operating efficiencies between the hotels or that the combined
business can be operated profitably. The failure to integrate and operate
Kahler successfully could have a material adverse effect on the Company's
business and future prospects. Also, certain of the Kahler Hotels are in the
same geographic regions as those of the Company and may, therefore, compete with
hotels of the Company. There can be no assurance that the Kahler Acquisition
will not adversely affect the operations, revenues or prospects of the Company's
other hotels located in such geographic areas.
Geographic Concentration of Kahler; New Markets
The concentration of four Kahler Hotels with 1,329 rooms in Rochester,
Minnesota and six Kahler Hotels with 1,509 rooms in and around the Salt Lake
City area of Utah, makes Kahler dependent on factors such as the local economy,
local competition, increases in local real and personal property tax rates and
local catastrophes. The results of operations of the Kahler Hotels in
Rochester, Minnesota, are also dependent on the level of demand generated by the
Mayo Clinic for hotel accommodations by patients and by medical conferences
organized by the Mayo Clinic. Significant disruption in these local markets that
result in decreased operating performance of these hotels will have a material
adverse effect on the Company's results of operations and Cash Available for
Distribution.
In connection with the Kahler Acquisition, the Company will expand its
operations beyond the Primary Region into Minnesota, Texas and West Virginia.
The Company may make other selective acquisitions in markets outside of the
Primary Region from time to time should the appropriate opportunities arise.
The Company's historical experience is in the Primary region, and it is possible
that the Company's expertise in the Primary Region may not assist it in
operating either the Kahler Hotels located in Rochester, Minnesota or any other
hotels that the Company operates or may operate in the future outside of the
Primary Region. In such event, the Company may be exposed to, among others,
risks associated with (i) a lack of market knowledge and understanding of the
local economy, (ii) an inability to access land and property acquisition
opportunities, (iii) an inability to obtain construction tradespeople and (iv)
an unfamiliarity with local governmental procedures.
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 Initial Public
Offering 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
28
do not reflect solely the interests of the Company and 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 also result in
decisions regarding the sale of a hotel which do not reflect solely the
interests of the Company and its stockholders.
Reliance on Mr. Alter and Other Key Personnel
The Company's future success and its ability to manage future growth
depends in large part upon the efforts of its senior management and its ability
to attract and retain key executive officers and other highly qualified
personnel. In particular, 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. Competition for such personnel is intense
and there can be no assurance that the Company will be successful in attracting
and retaining such personnel. Accordingly, there can be no assurance that the
Company's senior management will be able to successfully execute or implement
the Company's growth and operating strategies. In addition, 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 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. Generally, revenues for the Company's hotels are greater
in the first and third quarters than in the second and fourth quarters. This
seasonality can be expected to cause quarterly fluctuations in the Company's
Percentage Lease revenues which 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 ADRs, 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 Company's 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.
Impact of Increased Operating Costs and Capital Expenditures
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 this regard, the Company may spend
significant dollars renovating, repositioning or rebranding a number of the
Kahler Hotels to maximize financial performance; however, the Company is unable
to estimate the amounts to be expended at this time. 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.
29
Under the terms of the Percentage Leases, the Company is also 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. Furthermore,
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.
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 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.
Franchise Risks
Forty Company's hotels are operated pursuant to franchise or license
agreements and additional hotels may be, including seven of the Kahler Hotels,
or become subject to franchise arrangements. The Lessee will hold the franchise
or license agreements for the hotels and will be responsible for complying with
the terms of these agreements. Such franchise or license arrangements are often
helpful in providing marketing services and room reservations to hotels, but
these arrangements also impose financial obligations on hotels generally related
to maintaining the condition of hotels and the payment of franchise fees.
Continuation of such franchises is subject to specified operating standards and
other terms and conditions. Franchisors periodically inspect franchised hotels
to confirm compliance. In addition, franchisors may require the Company to fund
significant capital improvements to the hotels in the future to maintain such
franchises. The failure of a franchisee to maintain standards or adhere to
terms and conditions imposed by the franchisor may result in the loss of a
license or termination of the franchise or damages as a result of the breach.
It is possible that a franchisor could condition the continuation of a franchise
on the completion of capital improvements or replacements of furniture, fixtures
and equipment which the Board of Directors determines are too expensive or
otherwise unwarranted in light of general economic conditions or operating
results or prospects of the affected hotel. The loss of a franchise could have a
material adverse effect upon the operation, financing or value of the hotel
subject to the franchise because of the loss of associated name recognition,
marketing support and centralized reservation systems. There can be no
assurance that an alternative franchise arrangement can be obtained or that
significant expenditures might not be imposed as a condition to obtaining a new
franchise. The loss of a franchise for one or more of the hotels could have a
material adverse effect on the Company's revenue under the Percentage Leases and
Cash Available for Distribution to its stockholders.
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 cover such costs.
30
Failure to Maintain REIT Status
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
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 Resulting in Loss of REIT Status
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.
Earnings and Profits Distribution Risk
In order to preserve the Company's status as a REIT, the accumulated
earnings and profits of Kahler from its inception in 1917 must be eliminated by
way of a distribtuion prior to December 31, 1997. Prior to the Kahler
Acquisiton, Kahler made a distribution to the West rook Funds in the amount of
such earnings and profits, approximately $28.5 million, as certified by Kahler's
auditors and reviewed by the auditors for the Company. The certification of the
earnings and profits is based on certain assumptions and is not binding on the
Internal Revenue Service (the "IRS"). There can be no assurance that the IRS
will not successfully assert that the earnings and profits of Kahler exceeded
the amount so certified, which may in turn result in the Company being
disqualified as a REIT.
The Company has applied for a ruling from the IRS that the above-described
distribution to the Westbrook Funds depleted the historical earnings and profits
of Kahler. However, the can be no assurance that a favorable ruling will be
issued or that such ruling will be issued during 1997. If a favorable ruling is
not issued prior to December 31, 1997, the Company will, on or before December
31, 1997, make an additional distribution to its shareholders sufficient to
eliminate such earnings and profits, which could be as much as $28.5 million.
The Company would be required to
31
incur debt or issue additional stock in order to fund any such distribution,
which in either event will have a material adverse effect on the per-share
financial performance of the Company, incapable of quantification at this time.
In addition, if the Company becomes obligated to make such additional
distribution but fails to do so, such failure may result in the Company being
disqualified as a REIT.
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.
Possible Liability Relating to Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, 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, or the failure to properly remediate such substances when present,
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 disposal or treatment facility,
regardless of whether such facility is owned or operated by such person. Other
federal, state and local laws, ordinances and regulations require abatement or
removal of certain asbestos containing materials in the event of demolition or
certain renovations or remodeling and govern emissions of and exposure to
asbestos fibers in the air. The operation and subsequent removal of certain
underground storage tanks also are regulated by federal and state laws.
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
debt 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.
32
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 November 14, 1997.
SUNSTONE HOTEL INVESTORS, INC.
By: /s/ Robert A. Alter
---------------------------
Robert A. Alter
President, Secretary and
Chairman of the Board of Directors
33
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
EXHIBIT
NO. DESCRIPTION
--- -----------
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, filed as Exhibit 3.4 to the Company's Current Report on
Form 10-Q for the quarter ended March 31, 1997 and incorporated
herein by this reference.
3.5 Articles of Amendment of the Company, as filed with the State
Department of Assessments and Taxation of Maryland on May 2,
1997, filed as Exhibit 3.5 to the Company's Current Report on
Form 10-Q/A for the quarter ended June 30, 1997 and incorporated
herein by this reference.
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, filed as
Exhibit 10.1.8 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1996 (the "1996 10-K") and
incorporated herein by this reference.
10.1.9 Ninth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of December 31, 1996, filed as
Exhibit 10.1.9 to the 1996 10-K and incorporated herein by this
reference.
10.1.10 Tenth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of January 17, 1997, filed as
Exhibit 10.1.10 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by
this reference.
10.1.11 Eleventh Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of January 31, 1997, filed as
Exhibit 10.1.11 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by
this reference.
10.1.12 Twelfth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of December 31, 1996, filed as
Exhibit 10.1.12 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by
this reference.
10.1.13 Thirteenth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of May 28, 1997, filed as Exhibit
10.1.13 to the Company's Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 1997 and incorporated herein by this
reference.
10.1.14* Fourteenth Amendment to First Amended and Restated Agreement of
Limited Partnership dated as of August 28, 1997.
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.
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 Quarterly
Quarter 1996 10-Q for the quarter ended March 31, 1996 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 Quarterly
Report on Form 10-Q for the quarter ended March 31, 1996 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 Quarterly
Report on Form 10-Q for the quarter ended March 31, 1996 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 Quarterly
Report on Form 10-Q for the quarter ended March 31, 1996 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.
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 as Exhibit 10.2.21 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
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.
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 as Exhibit 10.2.22 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.23 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.24 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.25 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.26 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.27 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997 and incorporated herein by this reference.
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. 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 as Exhibit 10.2.28 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1997 and incorporated herein by this reference.
10.2.29 Lease Agreement dated May 6, 1997 by and between Sunstone Hotel
Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc.,
as lessee, for the Fountain Suites located in Sacramento,
California. 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 as Exhibit 10.2.29 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
10.2.30 Lease Agreement dated June 11, 1997 by and between Sunstone Hotel
Investors, L.P., as lessor, and Sunstone Hotel Properties, Inc.,
as lessee, for the Ramada Plaza Hotel located in Old Town, San
Diego, California. 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 as Exhibit 10.2.30 to
the Company's Quarterly Report on Form 10-Q/A for the quarter
ended June 30, 1997 and incorporated herein by this reference.
10.2.31* Lease Agreement dated July 17, 1997, by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Best Western located in Lynnwood,
Washington. 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 herewith.
10.2.32* Lease Agreement dated August 7, 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. 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 herewith.
10.2.33* Lease Agreement dated August 7, 1997, by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Crystal Suites located in Anaheim,
California. 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 herewith.
10.2.34* Lease Agreement dated August 28, 1997, by and between Sunstone
Hotel Investors, L.P., as lessor, and Sunstone Hotel Properties,
Inc., as lessee, for the Regency Plaza located in Los Angeles.
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 herewith.
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 Have been omitted
Through
10.29
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, filed as Exhibit 10.30.6 to the Company's
Quarterly Report on Form 10-Q/A for the quarter ended June 30,
1997 and incorporated herein by this reference.
10.30.7 Amendment Number Seven to Third Party Agreement effective as of
October 29, 1996, filed as Exhibit 10.30.7 to the 1996 10-K and
incorporated herein by this reference.
10.30.8 Amendment Number Eight to Third Party Agreement effective as of
December 19, 1996, filed as Exhibit 10.30.8 to the 1996 10-K and
incorporated herein by this reference.
10.30.9 Amendment Number Nine To Third Party Pledge Agreement effective
as of January 17, 1997, filed as Exhibit 10.30.9 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
1997 and incorporated herein by this reference.
10.30.10 Amendment Number Ten To Third Party Pledge Agreement effective as
of March 10, 1997, filed as Exhibit 10.30.10 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
1997 and incorporated herein by this reference.
10.30.11 Amendment Number Eleven To Third Party Pledge Agreement effective
as of March 31, 1997, filed as Exhibit 10.30.11 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
1997 and incorporated herein by this reference.
10.30.12 Amendment Number Twelve to Third Party Pledge Agreement effective
as of May 6, 1997, filed as Exhibit 10.30.12 to the Company's
Quarterly Report on Form 10-Q/A for the quarter ended June 30,
1997 and incorporated herein by this reference.
10.30.13 Amendment Number Thirteen to Third Party Pledge Agreement
effective as of June 11, 1997, filed as Exhibit 10.30.13 to the
Company's Quarterly Report on Form 10-Q/A for the quarter ended
June 30, 1997 and incorporated herein by this reference.
10.30.14* Amendment Number Fourteen to Third Party Pledge Agreement
effective as of July 17, 1997.
10.30.15* Amendment Number Fifteen to Third Party Pledge Agreement effective
as of August 7, 1997.
10.30.16* Amendment Number Sixteen to Third Party Pledge Agreement
effective as of August 7, 1997.
10.30.17* Amendment Number Seventeen to Third Party Pledge Agreement
effective as of August 28, 1997.
10.31 Revolving Credit Agreement dated as of May 1, 1997 among Sunstone
Hotel Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New
York Branch and Wells Fargo Bank, National Association, filed as
Exhibit 10.31 to the Company's Current Report on Form 10-Q/A for
the quarter ended June 30, 1997 and incorporated herein by this
reference.
10.32 Stock Purchase Agreement among the Company, Westbrook Real Estate
Fund I, L.P., Westbrook Real Estate Co-Investment Partnership I,
L.P. and Kahler Realty Corporation dated as of August 5, 1997,
filed on August 14, 1997 as Exhibit 10.1 to the Company's Current
Report on Form 8-K and incorporated herein by this reference.
27* Financial Data Schedule
- ---------------
* Filed herewith.
(b) Reports on Form 8-K.
Current Report on Form 8-K dated July 7, 1997 with disclosure under Item 4
regarding a change in the Company's certifying accountants.
Current Report on Form 8-K dated August 13, 1997 with disclosure under Item 5
regarding the Company's acquisition of Kahler Realty Corporation.
Current Report on Form 8-K/A dated August 22, 1997 with disclosure under Item 5
regarding recent acquisitions by the Company and financial statements of the
Company and the businesses acquired for various periods during 1996 and 1997.