<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 1996
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
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(Registrant's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
--- ---
As of May 14, 1996, there were 6,322,000 shares of Common Stock outstanding.
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SUNSTONE HOTEL INVESTORS, INC.
MARCH 31, 1996 QUARTERLY REPORT
TABLE OF CONTENTS
PART I -- FINANCIAL INFORMATION
<TABLE>
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
Sunstone Hotel Investors, Inc. and Sunstone Hotels (the "Predecessor")
Sunstone Hotel Investors, Inc. -- Consolidated Balance Sheets as of March 31, 1996
and December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Sunstone Hotel Investors, Inc. -- Consolidated Statement of Income for the three months
Ended March 31, 1996 and Sunstone Hotels (Predecessor) --
Combined Statement of Income for the three months ended March 31, 1995 . . . . . . . . . . 2
Sunstone Hotel Investors, Inc. -- Consolidated Statement of Cash Flows for the three
months ended March 31, 1996, and Sunstone Hotels (Predecessor) --
Combined Statement of Cash Flows for three months ended March 31, 1995 . . . . . . . . . . 3
Notes to Consolidated and Combined Financial Statements . . . . . . . . . . . . . . . . . . . 4
Sunstone Hotel Properties, Inc. (the Lessee)
Balance Sheet as of March 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Statement of Operations for three months ended March 31, 1996 . . . . . . . . . . . . . . . . 7
Statement of Cash Flow for three months ended March 31, 1996 . . . . . . . . . . . . . . . . 8
Notes to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
PART II -- OTHER INFORMATION
ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>
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SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
1996 1995
----------- ------------
<S> <C> <C>
ASSETS:
Investment in hotel properties, net $67,076,000 $49,926,000
Cash 407,000 5,222,000
Rent receivable -- Lessee 2,227,000 646,000
Due from affiliates 128,000 21,000
Prepaid expenses and other assets, net 1,206,000 1,421,000
----------- -----------
$71,044,000 $57,236,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Revolving line of credit $22,000,000 $ 8,400,000
Accounts payable and other accrued expenses 1,690,000 1,346,000
Dividends/distributions payable 1,764,000
----------- -----------
$23,690,000 $11,510,000
----------- -----------
Minority interest 8,722,000 8,231,000
----------- -----------
Stockholders' equity:
Common stock, $.01 par value, 50,000,000
authorized; 6,322,000 issued and outstanding 63,000 63,000
Preferred stock, $.01 par value, 10,000,000
authorized, no shares issued or outstanding
Additional paid-in capital 37,432,000 37,432,000
Retained earnings 1,137,000
----------- -----------
38,632,000 37,495,000
----------- -----------
$71,044,000 $57,236,000
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENT OF INCOME
SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Sunstone Hotel
Investors, Inc. Sunstone Hotels
For the Three Months Ended For the Three Months Ended
March 31, 1996 March 31, 1995
-------------------------- --------------------------
<S> <C> <C>
REVENUES:
Lease revenue $3,190,000
Hotel operating revenue $3,458,000
Interest income 19,000
Other revenue 497,000
---------- ----------
Total Revenues 3,209,000 3,955,000
EXPENSES:
Real estate related depreciation and amortization 849,000 273,000
Interest expense and amortization of financing costs 324,000 585,000
Real estate, personal property taxes and insurance 253,000 87,000
Property operating costs 698,000
General and administrative 153,000 282,000
Food and beverage 358,000
Management fees 167,000
Franchise costs 128,000
Advertising and promotion 269,000
Utilities 170,000
Repairs and maintenance 125,000
Other (5,000)
---------- ----------
Total expenses 1,579,000 3,137,000
---------- ----------
Income before minority interest 1,630,000 818,000
Minority interest 293,000
---------- ----------
NET INCOME $1,337,000 $ 818,000
========== ==========
NET INCOME PER SHARE $ 0.21
Weighted average number of shares 6,322,000
</TABLE>
The accompanying notes are an integral part of these financial statements
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SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENT OF CASH FLOWS
SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Sunstone Hotel
Investors, Inc. Sunstone Hotels
--------------- ---------------
For the Three Months Ended
---------------------------------
March 31, 1996 March 31, 1995
-------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,337,000 $ 818,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interest 293,000
Depreciation 849,000 273,000
Amortization of financing costs 56,000
Increase in due to affiliates for management fees 70,000
Management fees waived by partner 15,000
Changes in assets and liabilities:
Receivables, net (134,000)
Rent receivable-Lessee (1,581,000)
Due from affiliates (108,000)
Prepaids and other assets, net 158,000 (22,000)
Accounts payable and accrued expenses 344,000 (383,000)
Accrued interest payable and deferred (17,000)
------------ ---------
Net cash provided by operating
activities 1,348,000 620,000
------------ ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition, improvements and additions
to hotel properties (17,999,000) (176,000)
Decrease in restricted cash 49,000
------------ ---------
Net cash used in investing activities (17,999,000) (127,000)
------------ ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings on revolving line of credit 13,600,000
Principal payments on long-term debt (463,000)
Advances from affiliates 9,000
Payments on advances from affiliates (125,000)
Dividends paid (1,454,000)
Partnership distributions paid (310,000) (42,000)
------------ ---------
Net cash provided by (used in)
financing activities 11,836,000 (621,000)
------------ ---------
Net change in cash (4,815,000) (128,000)
Cash, beginning of period 5,222,000 718,000
------------ ---------
Cash, end of period $ 407,000 $ 590,000
============ =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
__________
1. ORGANIZATION AND INITIAL PUBLIC OFFERING
Sunstone Hotel Investors, Inc. (the "Company"), a Maryland corporation,
was formed on September 21, 1994, as a real estate investment trust ("REIT").
The Company completed an initial public offering (the "Offering") of 5,910,000
shares of its common stock on August 16, 1995. An additional 404,500 shares of
common stock were issued by the Company on September 3, 1995 upon a partial
exercise of the underwriters' over-allotment option. The offering price of
all shares sold in the Offering was $9.50 per share, resulting in gross
proceeds of approximately $60.0 million and net proceeds (less the
underwriters' discount and offering expenses) of approximately $53.0 million.
The Company contributed all of the net proceeds of the Offering to
Sunstone Hotel Investors, L.P. (the "Partnership") in exchange for an
approximately 82.5% aggregate equity interest in the Partnership. The Company
conducts all its business through and is the sole general partner of the
Partnership (hereafter referred to as the "Company").
In connection with the Offering, the Company acquired seven hotels (the
"Sunstone Hotels") from seven entities controlled by officers and a director of
the Company and acquired the three additional hotels (the "Acquisition Hotels"
and together, the "Initial Hotels") from unrelated third parties in exchange
for (i) 1,288,500 units ("Units") in the Partnership (representing the
remaining 17.5% of equity interest in the Partnership) which are exchangeable
for a like number of shares of the common stock of the Company and (ii) the
payment of mortgage indebtedness for the Sunstone Hotels of approximately $23.5
million and other obligations relating to the Sunstone Hotels and (iii) payment
of approximately $25.8 million to purchase the Acquisition Hotels.
The Company currently owns 18 hotels (the "Hotels") and leases them to
Sunstone Hotel Properties, Inc. (the "Lessee") under operating leases (the
"Percentage Leases") providing for the payment of base and percentage rent. The
Lessee is owned by Robert A. Alter, Chairman and President of the Company (80%),
and Charles L. Biederman, Director and Executive Vice President of the Company
(20%). The Lessee has entered into a management agreement pursuant to which all
of the Hotels are managed by Sunstone Hotel Management, Inc. (the "Management
Company"), of which Mr. Alter is the sole shareholder.
Basis Of Presentation:
For accounting purposes, the Company exercises unilateral control over
the Partnership; hence, the financial statements of the Company and the
Partnership are consolidated. All significant intercompany transactions and
balances have been eliminated.
The Predecessor:
The predecessor to the Company was Sunstone Hotels (the "Predecessor"),
consisting of the seven entities referred to above. Due to a common ownership
and management of the Predecessor, the historical combined financial statements
have been accounted for as a group of entities under common control. All
significant intercompany transactions and balances have been eliminated in the
combined presentations. The financial statements of the Predecessor do not
include the Acquisition Hotels, the Oakland, California Hampton Inn acquired in
December 1995 or the Cypress Inn properties acquired in February 1996 and are,
therefore, not comparable to the financial statements of the Company.
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2. NET INCOME PER SHARE AND PARTNERSHIP UNITS
Net income per share is based on the weighted average number of common
and equivalent shares outstanding during the period. Outstanding options are
included as common equivalent shares using the treasury stock method when the
effect is dilutive. The weighted average number of shares used in determining
net income per share was 6,322,000 for the quarter ended March 31, 1996. At
March 31, 1996, a total of 7,709,859 partnership units were issued and
outstanding. The weighted average number of units for the same period was
7,709,859.
3. PRO FORMA FINANCIAL INFORMATION:
On February 2, 1996, the Company acquired six Cypress Inns in Oregon and
Washington for approximately $15 million. The Company borrowed $12.6 million on
its line of credit and used $2.4 million from cash on hand previously drawn on
the line of credit as sources of funds used to purchase the properties.
The pro forma financial information set forth below is presented as if
the acquisition of the Hampton Inn in Oakland, California and the acquisition of
the six Cypress Inns, in Oregon and Washington had occurred as of January 1,
1996.
The pro forma financial information is not necessarily indicative of
what actual results of operations of the Company would have been assuming the
Offering and related formation transactions and the acquisition of the Oakland
Hampton Inn and the six Cypress Inns had been consummated as of January 1,
1996, nor does it purport to represent the results of operations for future
periods.
<TABLE>
<CAPTION>
Quarter Ended
March 31, 1996
--------------
(Unaudited)
<S> <C>
Lease revenues $3,406,000
Net income $1,450,000
Net Income per share $ 0.23
</TABLE>
4. RECENTLY ISSUED ACCOUNTING STANDARDS:
In March 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No 121, "Accounting for the Impairment of Long
Lived Assets and for Long Lived Assets to be Disposed Of." This statement
shall be effective for financial statements for fiscal years beginning after
December 5, 1995. Management has elected early adoption of this statement.
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation" which shall be effective for financial statements for fiscal
years beginning after December 15, 1995. Management intends to adopt the
disclosure method and, accordingly, there will be no impact on the Company's
financial position or results of operations.
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SUNSTONE HOTEL PROPERTIES, INC.
BALANCE SHEET
MARCH 31, 1996
<TABLE>
<S> <C>
ASSETS:
Cash $2,074,000
Receivables, net 710,000
Inventories 69,000
Prepaid expenses and other assets 790,000
----------
$3,643,000
==========
LIABILITIES AND DEFICIT:
Rent payable - REIT $2,227,000
Accounts payable, trade 735,000
Advanced deposits 61,000
Sales taxes payable 222,000
Accrued payroll 220,000
Accrued vacation 89,000
Management and accounting fees payable 308,000
Due to affiliates 367,000
Other accrued expenses 179,000
----------
4,408,000
SHAREHOLDERS' DEFICIT:
Common Stock, no par value, 1,000 shares authorized
100 shares issued and outstanding
Shareholders' deficit (765,000)
----------
$3,643,000
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-6-
<PAGE> 9
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENT OF OPERATIONS AND DEFICIT
FOR THE THREE MONTHS ENDED
MARCH 31, 1996
<TABLE>
<S> <C>
REVENUE:
Room $6,786,000
Food and beverage 232,000
Other 318,000
----------
Total revenue 7,336,000
----------
EXPENSES:
Room 1,697,000
Food and beverage 242,000
Other 193,000
General and administrative 461,000
Franchise costs 192,000
Advertising and promotion 638,000
Utilities 294,000
Repairs and maintenance 316,000
Management fees 132,000
Rent expense 3,190,000
----------
Total expenses 7,355,000
----------
Net loss $ (19,000)
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-7-
<PAGE> 10
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED
MARCH 31, 1996
<TABLE>
<S> <C>
Cash flows from operating activities:
Net loss $ (19,000)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Changes in assets and liabilities:
Receivables, net (244,000)
Inventories 56,000
Prepaid expenses and other assets (320,000)
Rent payable - REIT 1,582,000
Accounts payable, trade 442,000
Advanced deposits (138,000)
Sales taxes payable (3,000)
Accrued payroll (22,000)
Accrued vacation 7,000
Accrued bonus (116,000)
Due to affiliates 263,000
Other accrued expenses 186,000
----------
Net cash provided by operating activities 1,674,000
----------
Cash flows from investing activities:
Capitalized construction costs (400,000)
----------
Net cash used in investing activities (400,000)
----------
Net change in cash 1,274,000
Cash, beginning of period 800,000
----------
Cash, end of period $2,074,000
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-8-
<PAGE> 11
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
__________
1. ORGANIZATION:
Sunstone Hotel Properties, Inc. (the "Company") was incorporated in Colorado
in August 1995 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 Company leases hotel properties
primarily located in the western United States and leases the properties from
the REIT pursuant to long term leases.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following tables set forth (i) historical and pro forma financial
information for the Company for the quarter ended March 31, 1996 and March 31,
1995, respectively, (ii) historical information for the Lessee for the quarter
ended March 31, 1996, and (iii) historical information for the predecessor of
the Company ("Sunstone Hotels") for the quarter ended March 31, 1995.
The pro forma information is presented as if the formation transactions
for the Partnership and the Offering had occurred as of January 1, 1995, and
includes the results of operations from the Oakland and Cypress Inns as of the
date of their acquisitions, December 1995 and February 1996, respectively. The
pro forma information does not purport to represent what the Company's results
of operations would actually have been if the formation transactions and
Offering had, in fact, occurred on such date, or to project the Company's
results of operations at any future date or for any future periods.
The following selected financial information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and notes thereto
included in the Company's Annual Report on Form 10-K, incorporated herein by
reference.
SUNSTONE HOTEL INVESTORS, INC.
STATEMENTS OF OPERATIONS
(THE COMPANY)
<TABLE>
<CAPTION>
For the Quarter Ended
March 31,
1996 1995
Actual Pro Forma
----------- -----------
<S> <C> <C>
REVENUE
Lease revenue $ 3,190,000 $ 2,593,000
Interest income 19,000
----------- -----------
$ 3,209,000 $ 2,593,000
----------- -----------
EXPENSES
Real estate-related depreciation and amortization 849,000 505,000
Interest expense and amortization of financing costs 324,000
Real estate and personal property taxes and insurance 253,000 127,000
General and administrative 153,000 104,000
----------- -----------
1,579,000 736,000
----------- -----------
Income before minority interest 1,630,000 1,857,000
Minority interest 293,000 324,000
----------- -----------
NET INCOME $ 1,337,000 $ 1,533,000
=========== ===========
NET INCOME PER SHARE $ 0.21 $ 0.24
Weighted average number of shares 6,322,000 6,322,000
FUNDS FROM OPERATIONS $ 2,479,000 $ 2,362,000
Weighted average number of units 7,709,859 7,659,500
</TABLE>
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SELECTED FINANCIAL INFORMATION
(THE LESSEE AND ITS PREDECESSOR)
<TABLE>
<CAPTION>
Sunstone Sunstone Hotels
Hotel Properties, Inc. (The Predecessor)
For The Quarter Ended For The Quarter Ended
March 31, 1996 March 31, 1995
---------------------- ---------------------
<S> <C> <C>
Hotel operating revenue $7,336,000 $3,458,000
Hotel operating expense 4,113,000 2,279,000
Operating Profit 3,223,000 1,179,000
Lease rent expense 3,243,000
Net income (loss) (20,000) 818,000
</TABLE>
RESULTS OF OPERATIONS OF THE COMPANY
Comparison of the Quarter ended March 31, 1996 to March 31, 1995 -- Actual and
Pro Forma Net Income
For those hotels not undergoing significant renovation (i.e. all except
Sante Fe, New Mexico and Steamboat Springs, Colorado), same-unit-sales (1,996
rooms) revenue per available room (REVPAR) rose 6.1% from $40.01 to $42.47,
fueled by an average daily rate (ADR) increase of 2.9% from $60.17 to $61.91 and
an occupancy increase of 3.2%, from 66.5% to 68.6%.
Management of the Company believes that while the 6.1% increase in REVPAR
may exceed the national average, the substance of the 3.2% increase in
occupancy, which is more than triple the national average, may indicate the
potential capacity for long-term growth.
The Company attributed this growth to continuing demand for mid-priced
hotel rooms and the ongoing success of Sunstone's programs to acquire,
refurbish, reposition and remarket hotels.
During the first quarter, the company completed its renovation and
conversion of the Best Western High Mesa Inn in Santa Fe, New Mexico to a
Doubletree Hotel and the renovation of the Holiday Inn in Steamboat Springs,
Colorado. REVPAR for these hotels decreased 36.7% for the quarter, when
compared to the corresponding period in 1995. Both hotels are expected to have
an incremental positive impact on FFO beginning in the second quarter of 1996.
For the first quarter ended March 31, 1996, net income decreased
$196,000, or by 12.8% to $1.3 million from $1.5 million, while revenues
increased $616,000 or by 23.8%, to $3.2 million from $2.6 million, as compared
to the first quarter of 1995.
The decrease in net income was primarily due to increases of noncash
depreciation expense of $344,000 and interest expense of $324,000.
Internal Growth
The following tables summarize average occupancy, ADR and REVPAR on a
same-unit-sales (1,996 rooms) basis for the Hotels for the quarter ended March
31, 1996.
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SUNSTONE HOTEL INVESTORS, INC.
SUMMARY COMPARISON TABLE
<TABLE>
<CAPTION>
For the First Quarter
Ended March 31,
----------------------------
1996 1995
Actual Pro Forma
---------- -----------
<S> <C> <C>
Revenue $3,209,000 $2,593,000
Funds from operations (FFO) $2,479,000 $2,362,000
Net Income $1,337,000 $1,533,000
Net income per share $ 0.21 $ 0.24
All Hotels:
Occupancy 63.7% 67.8%
ADR $ 63.51 $ 60.72
REVPAR $ 40.46 $ 41.17
REVPAR growth (1.7)%
Non-renovation Hotels:
Occupancy 68.6% 66.5%
ADR $ 61.91 $ 60.17
REVPAR $ 42.47 $ 40.01
REVPAR growth 6.1%
Renovation Hotels:
Occupancy 35.4% 57.4%
ADR $ 72.41 $ 70.54
REVPAR $ 25.63 $ 40.49
REVPAR growth (36.7)%
Dividend $1,773,268
FFO Payout ratio 71.5%
FAD Payout ratio 75.5%
Weighted average shares outstanding 6,322,000 6,322,000
Weighted average units outstanding 7,709,859 7,659,500
</TABLE>
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<PAGE> 15
Management believes that the increases in REVPAR for Hotels other than
the Renovation Hotels resulted primarily from increases in demand due to more
favorable economic conditions and demographic changes which have created
increased business and leisure travel throughout the western United States,
while the supply of hotel rooms in that market has not increased as rapidly.
External Growth
During the first quarter of 1996, the Company acquired six Cypress Inns
in Washington and Oregon for approximately $15 million. Additionally, pursuant
to an option that had previously been granted by Messrs. Alter and Biederman,
the Company acquired a building site for a 78-room Residence Inn Marriott in
Highlands Ranch, Colorado and acquired in April 1996, the recently renovated
163-room Courtyard by Marriott in Riverside, California. Management believes
that the results of operations from these acquisition hotels will have a
positive effect on FFO. Since the Company's Offering in August 1995, the
Company has acquired a total of eight new properties for $23 million
representing a 62.6% growth in the number of rooms from 1,328 to a total of
2,159 rooms.
Acquisitions.
On February 2, 1996, the Company acquired six Cypress Inn Hotels in the
Portland, Oregon and Seattle, Washington metropolitan areas. The six hotels,
with a total of 519 guest rooms, were purchased for $15 million from an
affiliate of a major international financial institution. The purchase price
represents an approximate per-room price of $28,900 and includes the
acquisition of the 120-room Cypress Inn in Kent, Washington, which opened in
1987; the 70-room Cypress Inn in Everett, Washington, which opened in 1989; the
63-room Cypress Inn in Poulsbo, Washington, which opened in 1986; the 105-room
Cypress Inn in South Portland (Clackamas), Oregon, which opened in 1986; the
78-room Cypress Inn on Stark Street in Portland, Oregon, which opened in 1986
with an addition in 1988; and the 83-room Cypress Inn on King Street in
Portland, Oregon consisting of two buildings, a 5-story facility which opened
in 1960 and a 2-story facility across the street, which opened in 1961. The
Company intends to sell the Cypress Inns in Everett, Washington and on King
Street, Portland, Oregon, in the second quarter of 1996.
Pursuant to an option granted by Messrs. Alter and Biederman in
connection with the Offering, the Company acquired, in April 1996, the 163-room
Courtyard by Marriott in Riverside, California, in consideration for an amount
equal to an 11% capitalization rate on the operating income for the twelve
months ended March 31, 1996, the assumption of approximately $3.0 million in
existing mortgage debt and the issuance of Units representing the net equity in
the property.
Franchise Conversions
The Company has received the approval from Holiday Inn and Promus Hotels
for the issuance of franchises for each of the four Cypress Inn Hotels being
retained by the Company. The Cypress Inn Hotels in East Portland and in
Poulsbo, Washington have each been approved for conversion to Holiday Inn
Express Hotels and the Cypress Inn Hotel in Kent, Washington, has been approved
for conversion to a Holiday Inn and Suites Hotel. The Cypress Inn Hotel in
Clackamas, Oregon, has been approved for conversion to a Hampton Inn. The
Company has begun architectural and design work necessary for the renovation
and conversion required by the franchisors. The Company currently anticipates
completing the conversions by the end of the third quarter of 1996.
Renovations and Repositioning Hotels
As previously discussed, the Company completed an estimated $2.3 million
renovation and conversion of the Santa Fe property to a Doubletree Hotel in the
first quarter of 1996. Additionally, the Company completed an estimated $1.6
million renovation of the Steamboat Springs Hotel and restaurant. The Company
has also commenced an approximately $1 million renovation for the Hampton Inn
in Oakland, California. Planned renovations for the four Cypress Inn hotels
being retained by the Company will include exterior facelifting, public
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<PAGE> 16
area redesign, room and bath revisions and redecorating of guest rooms.
Management believes that the effect of these renovations and repositioning will
have a positive impact on FFO.
THE LESSEE
For a discussion of the Lessee's operations and a comparison of the
quarter ended March 31, 1996, please see "Pro Forma Results of Operations" of
the Company. For the first quarter of 1996, the Lessee incurred a loss of
$19,000. The loss was primarily a result of the seasonality of the Company's
Portfolio and due to the effects of renovation activity during the quarter. The
terms of each Percentage Lease allow for annualizing the percentage rent payable
to compensate for the effects of seasonality when base rents may be required
during periods of low occupancy which would otherwise be offset during peak
seasons.
Seasonality and Diversification
Demand is affected by normally recurring seasonal patterns. Generally,
the Company's portfolio of hotels as a whole has performed better in the first
and third quarters due to the positive and negative effects of the winter
season. Future acquisitions may further affect the seasonality of the
Company's current portfolio.
The Company has implemented a business strategy of franchise and
geographic diversification. The following tables summarize certain information
for the Company's Hotels with respect to franchise affiliations and to the
distribution of hotels throughout the western United States.
Management believes that the renovation and reflagging of the Best
Western in Santa Fe, New Mexico as a full service, Doubletree Hotel and the
renovation of the Holiday Inn in Steamboat Springs, Colorado, will improve the
Lessee's results of operation from the first quarter in 1996.
FRANCHISE AFFILIATIONS
(As of March 31, 1996)
<TABLE>
<CAPTION>
Number of First Quarter 1996 Percentage of
Franchise System Rooms Gross Revenues Gross Revenues
---------------- ----- ------------------ --------------
<S> <C> <C> <C>
Courtyard by Marriott 116 $ 529,000 7.2%
Cypress Inns 519 974,000 13.3
Hampton Inns 822 4,311,000 58.8
Holiday Inns 329 1,260,000 17.1
Doubletree Hotels 210 262,000 3.6
----- ---------- -----
1,996 $7,336,000 100.0%
===== ========== =====
</TABLE>
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<PAGE> 17
GEOGRAPHIC DIVERSIFICATION
(As of March 31, 1996)
<TABLE>
<CAPTION>
Revenues
Percentage For the Quarter Ended Percentage of
State Rooms Of Rooms March 31, 1995 Revenues
- ----- ----- ---------- --------------------- -------------
<S> <C> <C> <C> <C>
Arizona 118 5.9% $ 917,000 12.5%
California 396 19.9 1,603,000 21.9
Colorado 675 33.8 3,270,000 44.6
New Mexico 210 10.5 262,000 3.6
Oregon 266 13.3 516,000 7.0
Utah 78 3.9 310,000 4.2
Washington 253 12.7 458,000 6.2
----- ----- ---------- -----
Total 1,996 100.0% $7,336,000 100.0%
===== ====== ========== =====
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Provided by Operating Activities. The Company's operating
activities provide the principal source of cash to fund the Company's operating
expenses, interest expense, recurring capital expenditures and dividend
payments. The Company anticipates that its cash flow provided by leasing the
Hotels to the Lessee will provide the necessary funds on a short and long term
basis to meet its operating cash requirements. In 1996, the Company expects to
pay dividends of approximately $0.23 per share on a quarterly basis.
Additionally, the Company is required under the Percentage Leases to make
available to the Lessee for the repair, replacement and refurbishment of
furniture, fixtures and equipment an amount equal to 4% of the room revenue per
quarter on a cumulative basis, provided that such amount may be used for
capital expenditures made by the Company with respect to the Hotels. The
Company expects that this amount will be adequate to fund such periodic
repairs, replacements and refurbishments after consideration of its renovation
program.
Cash flows from Investing and Financing Activities. The Company intends
to finance the acquisition of additional hotel properties, hotel renovations
and non-recurring capital improvements principally through a loan facility of
Bank One of Arizona, N.A. and, when market conditions warrant, to issue
additional equity or debt securities. As of March 31, 1996, the Company had $8
million of unused credit on the $30 million line of credit facility from Bank
One (the "Facility"). The Company expects to be able to increase the Facility
to $45 million in May 1996. Interest accrues on advances under the Facility at
a rate equal to the three-month LIBOR plus 2.75%. Up to $3 million of the
Facility may be used for working capital purposes. The Facility has an initial
term of two years (currently ending October, 1997), at which time the
outstanding balance at the end of that period is convertible, at the option of
the Company, into a 3-year term loan. The Facility is secured by first
mortgages on each of its Hotels. However, the Company has the option of owning
hotels not subject to the lien securing the Facility so long as no proceeds
under the Facility are used with respect to such hotel and any other lender
loaning against such hotel limits its liens to only that hotel. This feature
of the Facility gives the Company the ability to separately finance on a
long-term basis certain of its Hotels. The Company may seek to obtain such a
stand-alone mortgage facility if market conditions are appropriate in
management's view. The 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 and may be refinanced in whole or in part with fixed-rate financing.
However, because Messrs. Alter and Biederman and certain affiliates would
suffer adverse tax consequences if the Company's mortgage indebtedness were
reduced below $8.4 million, the Company does not anticipate reducing its
mortgage indebtedness below this amount.
The Company has completed an approximately $2.3 million major renovation
and conversion of the Best Western Santa Fe, New Mexico Hotel to a full
service, Doubletree Hotel and a $1.6 million renovation
-15-
<PAGE> 18
of the Holiday Inn Steamboat Springs, Colorado Hotel and restaurant. The
Company is currently engaged in a renovation of the Hampton Inn in Oakland,
California for approximately $1 million and is planning a major renovation for
each of the four Cypress Inns it intends to retain in Oregon and Washington for
approximately $2.4 million. Management believes the renovations should result
in incremental increases in REVPAR at these renovation hotels and increased FFO
for the Company. In addition, the Company is building the 78 room Residence
Inn in Highlands Ranch, Colorado for approximately $5.2 million. Sources of
capital for new construction, major building renovations and expansions are
expected to be excess FFO and additional debt financing under the Facility.
From the date of the Offering through March 1996, the Company has
acquired over $19 million in hotel assets ($15 million in the first quarter of
1996). As part of its investment strategy, the Company plans to acquire
additional hotels. Future acquisitions are expected to be funded through use
of the 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.
Funds From Operations (FFO). Management believes that FFO is one measure
of financial performance of an equity REIT such as the Company. On a pro forma
basis, FFO (as defined by the National Association of Real Estate Investment
Trusts)(1) for the first quarter of 1996 grew by 4.2% to $2.5 million from $2.4
million. The following table shows the calculations of FFO:
<TABLE>
<CAPTION>
Quarter Ended
March 31,
--------------------------
1996 1995
Actual Pro Forma
---------- ----------
<S> <C> <C>
Income before minority interest $1,630,000 $1,857,000
Real estate related depreciation 849,000 505,000
---------- ----------
Funds from operations $2,479,000 $2,362,000
========== ==========
</TABLE>
- --------------------
(1) With respect to the presentation of FFO, management elected early
adoption of the "new definition" as recommended in the March 1995 NAREIT
White Paper on Funds From Operations beginning January 1, 1995.
Management and industry analysts generally consider funds from operations
to be one measure of the financial performance of an equity REIT that
provides a relevant basis for comparison among REITs and it is presented
to assist investors in analyzing the performance of the Company. Funds
From Operations is defined as income before minority interest (computed
in accordance with generally accepted accounting principles), excluding
gains (losses) from debt restructuring and sales of property and real
estate related depreciation and amortization (excluding amortization of
financing costs). Funds From Operations does not represent cash
generated from operating activities in accordance with generally accepted
accounting principles and is not necessarily indicative of cash available
to fund cash needs. Funds From Operating should not be considered an
alternative to net income as an indication of the Company's financial
performance or as an alternative to cash flows from operating activities
as a measure of liquidity.
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<PAGE> 19
ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K:
A Current Report on Form 8-K (the "8-K" and, as amended, the 8KA)
dated February 2, 1996, was filed in the quarter ended March 31, 1996, with
disclosure under Items 2 and 7.
-17-
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of San
Clemente, State of California, on May 14, 1996.
SUNSTONE HOTEL INVESTORS, INC.
By: /s/ ROBERT A. ALTER
---------------------------------------
Robert A. Alter
President, Chief Financial Officer,
Secretary and Chairman of the Board of
Directors
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</TABLE>
