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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-26304
SUNSTONE HOTEL INVESTORS, INC.
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(Exact name of registrant as specified in its charter)
MARYLAND 52-1891908
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
115 CALLE DE INDUSTRIAS, SUITE 201, SAN CLEMENTE, CA 92672
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (714) 361-3900
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01
(Title of Class)
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 # No
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Indicated by a check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
Based on the closing sale price on Nasdaq National Market on March 15,
1996, the aggregate market value of the voting stock held by non-affiliates of
the registrant was $65,611,000.
As of March 15, 1996, there were 6,322,000 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Report incorporates information by reference from the
definitive Proxy Statement for the Annual Meeting of Stockholders, to be held
May 17, 1996.
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SUNSTONE HOTEL INVESTORS, INC.
1995 FORM 10-K/A ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . . -1-
Note: The only change to the originally filed Form 10-K which is
being made in this Form 10-K/A is to add the section entitled
"Risk Factors" to the end of ITEM 1. None of the text of
ITEM 1 which precedes the Risk Factors section has been
changed. However, the text in ITEM 1 which precedes Risk
Factors is restated herein in order to comply with Exchange
Act Rule 12b-15 which states that amendments set forth the
complete text of each item as amended.
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PART I
ITEM 1. BUSINESS.
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 $60.1 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
certain directors 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
Initial Hotels together with the Hampton Inn in Oakland, California
(together, the "Hotels") acquired by the Company in December 1995
comprise all of the investments of the Company at December 31, 1995.
The Company owns 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.
THE COMPANY AND ITS AFFILIATES
The Company has been formed to operate as a self-advised REIT under
the Internal Revenue Code of 1986 (the "Code"). Through the Partnership,
the Company invests in equity interests in hotels that meet the Company's
investment criteria. In order to qualify as a REIT, neither the Company
nor the Partnership can operate hotels. Accordingly, the Partnership
leases each of the Hotels to the Lessee pursuant to the Percentage
Leases. The Percentage Leases are designed to allow the Company to
participate in revenue growth by providing that (i) between approximately
60% to 65% of room revenues in excess of specified amounts, (ii) 5% of
the Lessee's food and beverage revenues, (iii) 100% of any sublease and
concession rentals and (iv) other net revenues described in the
Percentage Leases for the applicable Hotel in excess of the base rent
will be paid to the Partnership as percentage rent. The Partnership is
responsible for real estate and personal property taxes, insurance
premiums, the cost of certain furniture, fixtures and equipment and
capital improvements. The Lessee is responsible for the operations of
the Hotels, including the cost of repair and maintenance.
The Lessee has entered into a management agreement with the
Management Company for each of the Hotels for a fee equal to 2% of such
Hotels' gross revenues plus reimbursement of certain direct expenses
incurred by the Management Company for the Lessee. It is anticipated
that additional hotels acquired by the
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Company will be leased to the Lessee upon similar terms and managed by
the Management Company also upon similar terms.
MINIMIZING THE RISKS OF POTENTIAL CONFLICTS OF INTEREST
In order to minimize conflicts of interest inherent in the legal
structure required to maintain the Company's status as a REIT, Messrs.
Alter and Biederman each have entered into several agreements Their
respective employment agreements restrict competitive activities and the
third party pledge agreements requires each of Messrs. Alter and
Biederman to pledge Units to the Company to secure obligations of the
Lessee under the Percentage Leases with a value equal to four months
initial base rent for the Hotels (approximately $ 1.6 million at December
31, 1995). In addition, Messrs. Alter and Biederman entered into a unit
purchase agreement (the "Unit Purchase Agreement") with the Company and
the Lessee requiring that the Lessee's income (net of shareholder tax
liability) be used to either accumulate reserves to pay rent under the
Percentage Leases or to purchase Units from the Partnership at the then
current price of the Company's common stock. The Percentage Leases also
contain cross-default provisions permitting the Company to terminate the
Percentage Leases, subject to certain conditions, upon a default by
Messrs. Alter or Biederman under the Unit Purchase Agreement or any other
agreement with the Company. Further, the Management Company has agreed
not to collect any payments from the Lessee after receiving notice of an
event of default under a Percentage Lease. Mr. Alter has personally
guaranteed the Lessee's obligation to return any amounts received by the
Management Company in violation of this agreement. Messrs. Alter and
Biederman also granted the Company an option and right of first refusal
to acquire (i) the Residence Inn by Marriott Hotel to be built in
Highlands Ranch, Colorado by an affiliate of Messrs. Alter and Biederman,
(ii) a Courtyard by Marriott Hotel in Riverside, California, owned by
another affiliate of Messrs. Alter and Biederman, and (iii) any hotel
that may be exchanged for the interests of another affiliate of Messrs.
Alter and Biederman in a Hampton Inn Hotel in Aurora, Colorado.
GROWTH STRATEGY
The Company's growth strategy is to enhance stockholder value by
increasing cash available for distribution through (i) external growth
and the acquisition of additional hotels in the mid-scale and upper
economy market segments located in the western United States that meet
the Company's investment criteria, (ii) internal growth and the
renovation, reflagging and improved management of the Company's Hotels,
and (iii) the development of additional hotels. The Company's growth
strategy is designed to capitalize on improving occupancy rates and
average daily rates ("ADRs") prevailing in the U.S. lodging industry.
External Growth
The Company intends to consider investments which meet one or more
of the following criteria:
o Poorly managed hotels which have the potential for increased
performance after the implementation of quality management and/or
association with a national franchisor;
o Hotels in a deteriorated physical condition which could benefit
significantly from substantial renovation or other capital
improvements;
o Hotels in attractive locations that would benefit significantly by
changing franchises to a brand that can increase penetration in a
particular market, such as Courtyard by Marriott, Residence Inn by
Marriott, Doubletree, Hampton Inn, Holiday Inn and Holiday Inn
Express;
o Hotels owned by franchisees who are unable or unwilling to meet
capital improvement requirements of the franchisor;
o Nationally franchised hotels in locations with relatively high
demand for rooms and relatively low supply of competing hotels; and
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o Hotels in markets where there are significant barriers to entry,
such as limited opportunities to change existing franchises at
competitive hotels, scarcity of suitable hotel sites or zoning
restrictions.
Internal Growth
The Company's internal growth strategy is to enhance stockholder
value primarily by increasing cash available for distribution resulting
from increased revenue generated by the Lessee's sales program through
effective sales management policies and procedures at the Hotels and by
renovating certain of its Hotels when the Company believes such
renovations will provide incremental returns on investment and increased
revenue.
Lessee Marketing. The Management Company uses a
management-by-objective sales program to coordinate, direct and manage
the sales activities of personnel located at each hotel. The Lessee is
required under the applicable Percentage Lease to implement this sales
program. Under each Percentage Lease, the Lessee is also obligated to
have a sales manager at each Hotel, as reasonably required by the
Company, to coordinate, direct and manage the sales activities of
personnel located at that Hotel in order to maximize revenue.
Renovations. The Percentage Leases require the Lessee to maintain
and repair the Hotels in a condition that complies with the standards of
the respective franchise agreements, among other requirements. In
addition, the Company may upgrade the Hotels as needed to meet
competitive conditions and occupancy levels and to renovate Hotels when
the Company believes such renovations will increase revenue to the
Company under the Percentage Leases or will otherwise be in the best
interest of the Company. This strategy is designed to enhance the
revenue growth and economic performance of each hotel and to maintain or
increase each hotel's market share. Management intends to conduct
renovation work during off-peak periods and in a manner least disruptive
to hotel operations; however, there can be no assurance that, due to
possible construction delays, environmental problems or other reasons,
management will be successful in its efforts to minimize disruptions to
hotel operations.
Development Strategy
As a secondary strategy, the Company will develop and construct
hotels in markets where a particular franchise brand or hotel product
type is absent. Other than as discussed in "Recent Developments" below,
however, the Company presently has no plans to commence any such
development or construction and, in the absence of a strategic
opportunity consistent with its growth strategies, intends to focus on
the implementation of its acquisition and internal growth strategies for
the foreseeable future.
1995 ACTIVITY
External Growth
Acquisitions. On December 13, 1995, the Company acquired the
149-room Hampton Inn in Oakland, California for 50,539 Units valued at
$8.11 per Unit and the assumption of $4.0 million of debt. Management
immediately improved upon the under-performing hotel by revising the
property's marketing plan and increasing revenue per available room
("REVPAR") by 28.1%, from $32.53 to $41.67, in the first two months of
operations over the same period in the prior year. The property is
currently undergoing an approximately $1 million renovation, which
management believes will be conducted in a fashion to minimize occupancy
decreases. The renovation is expected to be completed in July of 1996;
however, there can be no assurance that, due to possible construction
delays, environmental problems or other reasons, management will be
successful in its efforts to minimize disruptions to hotel operations or
complete such renovation by such time.
Internal Growth
Renovations. In 1995, the Company's renovation strategy focused
primarily upon renovating the Holiday Inn in Steamboat Springs, Colorado
and the Best Western in Santa Fe, New Mexico and upon
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implementing the Lessee's marketing program at each of the three
Acquisition Hotels. Management anticipates that the renovations will
improve average occupancy rate, ADR and REVPAR at these renovation Hotels
starting in the second quarter of 1996. The Company experienced delays
and increased costs during the renovation of these two Hotels. During
the renovation of the Steamboat Springs Hotel, the Company entered into a
lease for a Village Inn restaurant which required the Company to
completely renovate the existing restaurant. This additional work cost
approximately $650,000 and was not included in either the original
construction schedule or budget for the renovations. In addition, the
Company upgraded its franchise for the Santa Fe Hotel from the limited
service Club Hotel by Doubletree to a full service Doubletree Hotel. The
Company's need to comply with the franchisor's higher product improvement
standards for the full service hotel added to the cost and time to
complete the renovation. The Company expects, however, that the
restaurant lease at the Steamboat Springs Hotel will increase the
Company's revenues and the upgrade of the Santa Fe Hotel to a Doubletree
Hotel will increase ADR over that of a Club Hotel.
Lessee Marketing. The implementation of the Lessee's marketing
program, which focuses on increasing occupancy and ADR, at the two
Acquisition Hotels not renovated (the Hampton Inns in Arcadia, California
and in Silverthorne, Colorado) resulted in increased REVPAR of 9.9% for
the fourth quarter of 1995 over the fourth quarter 1994. The Company
also aligned its food and beverage operations consistent with the
Company's strategy to increase lease revenue by leasing the restaurants
in the Hampton Inn Hotel in Silverthorne, Colorado and the Holiday Inn
Hotel in Steamboat Springs, Colorado. The lease for the Steamboat
Springs Hotel for a Village Inn restaurant provides a $5,000 month base
rent, percentage rent of 6% of food sales and 10% of liquor sales and a
seven-year initial term with three five-year options. The lease for the
Silverthorne Hotel for an Old Chicago restaurant provides for a $3,500
month base rent, percentage rent of between 4% to 6% of food and beverage
sales and a term of 10 years.
Development. While not its primary focus, the Company exercised an
option, in December, 1995, to acquire a hotel development site from an
affiliate of Messrs. Alter and Biederman in Highlands Ranch, Colorado,
and is currently developing at the site a 78-room Residence Inn by
Marriott. The Hotel is expected to open in the fourth quarter of 1996.
However, because of the inherent risks of construction and development,
there can be no assurance that this project will open by such time.
TAX STATUS
The Company will elect to be taxed as a REIT under Section 856 of
the Code, commencing with its taxable year ending December 31, 1995. If
the Company qualifies for taxation as a REIT, then under current federal
income tax laws the Company generally will not be taxed at the corporate
level to the extent it currently distributes at least 95% of its net
taxable income to its stockholders. Even if the Company qualifies for
taxation as a REIT, the Company may be subject to certain federal, state
and local taxes on its income and property and to federal income and
excise tax on its undistributed income.
COMPETITION
Intense competition exists for investment opportunities in
mid-scale and upper-economy hotels from entities organized for purposes
substantially similar to the Company's objectives as well as from other
purchasers of hotels. The Company competes 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. The Company believes that the inclusion of
secondary and tertiary markets in its strategy lessens competition for
the types of properties targeted by the Company.
There are a number of companies which develop, construct and
renovate hotels. Some of these companies perform these services only for
their own account, while others actively pursue contracts for these
services with third party owners. The Company believes that it can
develop, construct and renovate hotels at costs which are competitive.
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There is significant operational competition in the mid-market
hotel industry. There are numerous hotel chains that operate on a
national or regional basis, as well as other hotels, motor inns and other
independent lodging establishments throughout the western United States.
Competition is primarily in the areas of price, location, quality and
services. Many of the Company's competitors have recognized trade names,
greater resources and longer operating histories than the Company.
However, the Company believes that its management is sufficiently
experienced, and the markets which the Company targets for acquisitions
and operations have historically had less competition than in other
larger markets, enabling the Company to compete successfully. There can
be no assurances, however, that competitors will not develop or renovate
hotels in the secondary and tertiary markets in which the Company has
historically operated. Increased competition may have a negative impact
on the Company's operating results and consequently cash available for
distribution.
FRANCHISE LICENSING
The Hotels operated and managed by the Company are part of a
national or regional franchise system, such as Courtyard by Marriott,
Doubletree Hotels, Hampton Inns or Holiday Inns. Franchises in certain
locations are important in maintaining occupancy levels, which is
accomplished through the franchise's national reservation systems as well
as through brand name recognition. The importance of national franchises
is amplified for highway locations. The typical term of a franchise
agreement is twenty years for newly developed and constructed hotels and
ten years for the conversion of an existing hotel. The Company believes
that the loss of any one of its franchise agreements would not have a
material adverse effect on the Company.
SEASONALITY
The hotel industry is seasonal in nature and this seasonality is
typically geographically and market specific. The effects of seasonality
may be expected to cause significant quarterly fluctuations in the
Company's Percentage Lease revenues. Effects of this seasonality on the
Company's operating results may change depending upon the locations and
markets of additional hotels the Company acquires.
ENVIRONMENTAL MATTERS
Under various federal, state and local laws and regulations, an
owner or operator of real estate may be liable for the costs of removal
or remediation of certain hazardous or toxic substances on such property.
Such laws often impose such liability without regard to whether the owner
or operator knew of, or was responsible for, the presence of hazardous or
toxic substances on the property. The costs of removal or remediation of
such substances may be substantial, and the presence of such substances,
or the failure to promptly remediate such substances, may adversely
affect the owner's ability to fully utilize such property without
restriction, to sell such property or to borrow using such property as
collateral. In connection with the ownership and operation of the
Hotels, the Company, the Partnership and the Lessee, as the case may be,
may be potentially liable for any such costs.
The Company believes that the Hotels are in compliance, in all
material respects, with all federal, state and local ordinances and
regulations regarding hazardous or toxic substances and other
environmental matters, the violation of which could have a material
adverse effect on the Company, the Partnership or the Lessee. The
Company has not been notified by any governmental authority of any
material noncompliance, liability or claim relating to hazardous or toxic
substances or other environmental matters in connection with any of its
present or former properties.
EMPLOYEES
Messrs. Alter and Biederman have each entered into employment
agreements with the Company for one-year terms which renew automatically
until terminated. While Mr. Alter is required to devote substantially
all of his time to the business of the Company, Mr. Biederman is not.
The Company has no other employees. The Lessee employed approximately
450 people as of December 31, 1995 to operate the Hotels leased from the
Company. The Lessee has advised the Company that its relationship with
its
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employees is good. None of the employees of the Company or the Lessee is
a party to any collective bargaining agreement or other similar
agreement.
RECENT DEVELOPMENTS -- FIRST QUARTER OF 1996
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 will acquire, 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 fourth quarter of 1996 and
intends to actively supervise the general contractor and use a fixed
price construction contract. However, because of the inherent risks of
construction, there can be no assurance that such renovations and
conversions will be completed during such period or within budget.
RISK FACTORS
In evaluating the Company's business, prospective investors should
carefully consider the factors set forth in this section (some of which
have been discussed above) in addition to other information set forth in
this Report before making investment decisions with respect to the shares
of the Company's Common Stock. This Report contains forward-looking
statements which involve risks and uncertainties, and actual results
could differ materially from those discussed in the forward-looking
statements. Certain of the factors that could cause actual results to
differ materially are discussed below.
Impediments to Growth and Increasing Cash Available for Distribution
The Company's ability to increase cash available for distribution
on its Common Stock ("Cash Available for Distribution") will depend
significantly on the Company's ability to acquire or develop additional
hotels at attractive prices. Risks associated with this growth strategy
include:
Acquisition Risks. There is significant competition for investment
opportunities in mid-scale and upper economy hotels for entities
organized for purposes similar to the Company's. Such entities may have
substantially greater financial resources than the Company or better
relationships with franchisors, sellers or lenders. They may also
generally be able to accept more risk than the Company can.
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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 code or other legal
requirements, the discovery of structural or other latent problems with a
property once construction has commenced and other risks inherent in the
construction process. Delays or cost overruns in connection with
renovations or redevelopments could have a material adverse effect on
Cash Available for Distribution.
Development Risks. A component of the Company's growth strategy is
to develop new hotels in markets where room supply and other competitive
factors justify new construction or to purchase such hotels from
unaffiliated developers after they have been completed. New project
development will increase the Company's indebtedness and is subject to a
number of other risks, including risks of construction delays or cost
overruns, and the risk that required zoning, occupancy and other
governmental permits might not be obtained and the risk that projects
might not be completed. Additional risks of development projects include
the risks associated with effectively marketing a hotel in order to
ramp-up occupancy at projected room rates after the hotel has been
opened. Any failure to complete a development project in a timely manner
and within budget or to ramp-up occupancy after completion of the project
could have a material adverse effect on Cash Available for Distribution.
Total Dependence on the Lessee and Payments Under the Percentage Leases
Certain tax rules relating to the qualification of a REIT prohibit
the Company from operating hotels. Therefore, the Company enters into
Percentage Leases with the Lessee, and the Lessee operates the hotels and
pays rent to the Company based, in large part, on the revenues from the
hotels. Consequently, the Company relies entirely on the Lessee to
effectively operate the Company's hotels in a manner which generates
sufficient cash flow to enable the Lessee to timely make the rent
payments under the applicable Percentage Leases. Ineffective operation
of the hotels may result in the Lessee 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. The Lessee controls the daily operations of the hotels under
the Percentage Leases, which have non-cancelable initial terms of ten
years. The Company selected the Lessee without consideration of other
lessees because it believes that Mr. Alter and Mr. Biederman, who own the
Lessee, owned and were involved in the management of a number of the
hotels contributed to the Company in connection with its IPO and because
Mr. Alter and Mr. Biederman own significant Units in the Partnership and
options to acquire Common Stock of the Company, and therefore have an
incentive to cause the Lessee to maximize rents. Except as set forth in
the Percentage Leases, neither the Company nor the Partnership has the
authority to require the Lessee to operate the hotels in a manner that
results in a maximization of rent to the Company. Other than working
capital to operate the 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.
Conflicts of Interest Between the Company and Certain Officers and
Directors
Because of Mr. Alter's and Mr. Biederman's ownership in and
positions with the Company and the Lessee and Mr. Alter's ownership of
the Management Company, there are inherent conflicts of interest between
the Lessee and the Company in the leasing, acquisition, disposition,
operation and management of the Company's hotels. Accordingly, the
interests of stockholders may not have been, and in the future may not
be, reflected fully in all decisions made or actions taken by the
officers and directors of the Company. In the event revenues from the
Company's hotels increase significantly over prior periods and operating
expenses with respect thereto are less than historical or projected
operating expenses, the Lessee could disproportionately benefit. In
addition, there may be conflicts of interest in connection with the sale
of certain hotels. Unrealized gain from the sale to the Company of
certain hotels in connection with its IPO is specially allocated to Mr.
Alter and Mr. Biederman and any sale of such hotels by the Partnership
may cause adverse tax consequences to them. In addition, the reduction
of mortgage indebtedness by the Partnership at any time below certain
levels would create adverse tax consequences to Mr. Alter and Mr.
Biederman. These conflicts may result in decisions relating to the sale
of certain hotels and/or the incurrence or repayment of
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indebtedness which do not reflect solely the interests of the
stockholders. In addition, the Company will generally be required under
the Percentage Leases to pay a lease termination fee to the Lessee if the
Company elects to sell a hotel and not replace it with another hotel.
The payment of a termination fee to the Lessee, which is owned by Mr.
Alter and Mr. Biederman, may result in decisions regarding the sale of a
hotel which do not reflect solely the interests of the Company.
Substantial Reliance on Mr. Alter
The Company places substantial reliance on the hotel industry
knowledge and experience and the continued services of Robert A. Alter,
the Company's Chairman of the Board of Directors, President, Chief
Financial Officer and Secretary. The Company's future success and its
ability to manage future growth depends in large part upon the efforts of
Mr. Alter and on the Company's ability to attract and retain other highly
qualified personnel. Competition for such personnel is intense and there
can be no assurance that the Company will be successful in attracting and
retaining such personnel. The loss of Mr. Alter's services or the
Company's inability to attract and retain highly qualified personnel may
adversely affect the operations of the Company and the Cash Available for
Distribution.
Hotel Industry Risks
Operating Risks and Competition. Many of the Company's competitors
have substantially greater marketing and financial resources than the
Company and the Lessee. In addition, the Company's hotels are subject to
all operating risks common to the hotel industry. The hotel industry has
experienced volatility in the past, as have the Company's hotels. Hotel
industry risks include, among other things, competition from other
hotels; over-building in the hotel industry which has adversely affected
occupancy, ADR and REVPAR; increases in operating costs due to inflation
and other factors, which may not necessarily be offset by increased room
rates; dependence on business and commercial travelers and tourism;
strikes and other labor disturbances of hotel employees for hotels owned
by the Company; increases in energy costs and other expenses of travel;
and adverse effects of general and local economic conditions. These
factors could decrease room revenues of the hotels and adversely affect
the Lessee's ability to make payments of Rent under the Percentage Leases
to the Company, and therefore reduce Cash Available for Distribution.
Seasonality of Hotel Business and the Company's Hotels. The hotel
industry is seasonal in nature. 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,
therefore, may be insufficient to provide all of the Cash Available for
Distribution necessary to pay dividends in a given quarter.
Risks of Increases in Operating Costs and Capital Expenditures;
Franchise Agreements
Hotels in general, including the Company's hotels, have an ongoing
need for renovations and other capital improvements, including periodic
replacement of furniture, fixtures and equipment. In addition, the
franchise agreements under which the Company's hotels are operated impose
specified operating standards and may permit the franchisor to condition
the continuation of a franchise agreement on the completion of capital
improvements. Under the terms of the Percentage Leases, the Company is
obligated to pay the cost of certain capital expenditures at its hotels
and to pay for furniture, fixtures and equipment. The ability of the
Company to fund these and other capital expenditures and periodic
replacement of furniture, fixtures and equipment will depend in part on
the financial performance of the Lessee and the hotels. If these
expenses exceed the Company's estimate, the additional expenses could
have an adverse effect on Cash Available for Distribution. Any inability
or failure to fund these expenditures could have a material adverse
effect on occupancy rates, ADRs and REVPAR and may constitute a breach
under the franchise agreements.
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
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<PAGE> 11
present or future environmental legislation and compliance with
environmental laws, the ongoing need for capital improvements, changes in
real estate tax rates and other operating expenses, changes in
governmental rules (such as those requiring upgrades for disabled
persons) and fiscal policies, civil unrest, acts of God, including
earthquakes, hurricanes and other natural disasters (which may result in
uninsured losses), acts of war, changes in zoning laws, and other factors
which are beyond the control of the Company. In addition, real estate
investments are relatively illiquid, and the ability of the Company to
vary its portfolio in response to changes in economic and other
conditions will be limited.
Distribution of Substantially All of Cash Available for Distribution;
Distributions Include Return of Capital
Consistent with the Company's practice of acquiring properties in
need of renovation or redevelopment, the Company's annual distributions
to stockholders have constituted a high percentage of the Company's Cash
Available for Distribution. If this continues, the Company will retain
little or no cash from the rent payments under the Percentage Leases, and
expenditures for additional acquisitions or future capital improvements
would have to be funded from borrowings, or from proceeds from the sale
of assets (including the hotels) or equity securities. In addition, a
percentage of the estimated annual distribution has constituted a return
of capital rather than a distribution of retained earnings.
Consequently, there is a risk that the distribution rate has been set too
high and may not be sustainable.
Tax Risks
The Company intends to operate so as to be taxed as a REIT under
Sections 856-860 of the 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 shareholders. 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
shareholders 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.
Ownership Limitation
In order for the Company to maintain its qualification as a REIT,
not more than 50% in value of its outstanding stock may be owned,
directly or indirectly, by five or fewer individuals (as defined in the
Code to include certain entities). Furthermore, if any shareholder or
group of shareholders of the Lessee owns, actually or constructively, 10%
or more of the stock of the Company, the Lessee could become a related
party tenant of the Partnership, which likely would result in loss of
REIT status for the Company. For the purpose of preserving the Company's
REIT qualification, the Company's Articles of Incorporation prohibit
direct or indirect ownership of more than 9.8% of the outstanding shares
of any class of the Company's stock by any person or group (the
"Ownership Limitation"). Generally, the capital stock owned by
affiliated owners will be aggregated for purposes of the Ownership
Limitation. Subject to certain exceptions, any transfer of Common or
Preferred Stock that would prevent the Company from continuing to qualify
as a REIT under the Code will be designated as "Shares-in-Trust" and
transferred automatically to a trust (the "Share Trust") effective on the
day before the purported transfer of such Common or Preferred Stock. The
record holder of the Common or Preferred Stock that are designated as
Shares-in-Trust will be required to submit such number of Common or
Preferred Stock to the Share Trust and the beneficiary of the Share Trust
will be one or more charitable organizations that are named by the
Company.
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<PAGE> 12
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1 to
Report on Form 10-K/A to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of San Clemente, State of California, on October
4, 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
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Amendment No. 1 to Report on Form 10-K/A has been signed below by the
following persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ ROBERT A. ALTER President, Chief Financial October 4, 1996
- ------------------------------- Officer, Secretary and Chairman
Robert A. Alter of the Board of Directors
(Principal Executive, Financial
and Accounting Officer)
* Executive Vice President and Director October 4, 1996
- -------------------------------
Charles L. Biederman
* Director October 4, 1996
- -------------------------------
C. Robert Enever
* Director October 4, 1996
- -------------------------------
David Lambert
* Director October 4, 1996
- -------------------------------
H. Raymond Bingham
* Director October 4, 1996
- -------------------------------
Fredric H. Gould
* Director October 4, 1996
- -------------------------------
Edward H. Sondker
*By: /s/ ROBERT A. ALTER
-------------------------
Robert A. Alter
Attorney-in-Fact
</TABLE>
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