<PAGE> 1
This filing is made pursuant
to Rule 424(a) under
the Securities Act of
1933 in connection with
Registration No. 333-34377
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
PROSPECTUS SUPPLEMENT
(TO JOINT PROSPECTUS DATED OCTOBER , 1997)
9,000,000 SHARES
LOGO
COMMON STOCK
Sunstone Hotel Investors, Inc. (the "Company") is a leading
self-administered equity real estate investment trust that currently owns 34
mid-price and upscale hotels located primarily in the Pacific and Mountain
regions of the western United States. The hotels operate under nationally
recognized franchises, including brands affiliated with Holiday Hospitality
Corporation, Marriott International, Inc. and Promus Hotel Corporation. The
Company intends to use a portion of the net proceeds from this Offering (as
defined below) to fund the cash portion of the purchase price for 17 additional
hotels from the shareholders of Kahler Realty Corporation (the "Kahler
Acquisition"). Following the Kahler Acquisition, the Company will own 51 hotels
with an aggregate of 9,545 rooms located primarily in the western United States.
All of the shares of common stock (the "Common Stock") being offered hereby
are being sold by the Company. Of the 9,000,000 shares of Common Stock offered
hereby, 1,800,000 shares are being offered in a concurrent offering outside the
United States and Canada by the International Managers (the "International
Offering" and, together with the U.S. Offering, the "Offering"). The price to
public and underwriting discount per share are identical for the U.S. Offering
and the International Offering. The Common Stock is listed on the New York Stock
Exchange (the "NYSE") under the symbol "SSI." On September 18, 1997, the last
reported sales price of the Common Stock on the NYSE was $16.125 per share.
The Company's Articles of Incorporation limit its consolidated indebtedness
to 50% of the Company's investment in hotel properties, at cost. Upon the
closing of this Offering, after giving effect to the Kahler Acquisition and the
application of the net proceeds from this Offering, the Company's consolidated
indebtedness will be approximately 37% of its investment in hotel properties, at
cost.
Since November 1996, the Company has paid regular quarterly dividends,
representing an annual dividend of $1.00 per share. On September 12, 1997, the
Company declared a dividend payable on November 15, 1997 of $0.275 per share to
holders of record on September 30, 1997, representing an increase in the annual
dividend to $1.10 per share. See "Price Range of Common Stock and Dividend
Distributions."
SEE "ADDITIONAL RISK FACTORS" BEGINNING ON PAGE S-11 AND "RISK FACTORS"
BEGINNING ON PAGE 5 OF THE ACCOMPANYING PROSPECTUS FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C>
=====================================================================================================
PRICE UNDERWRITING PROCEEDS TO
TO PUBLIC DISCOUNT (1) COMPANY(2)
- -----------------------------------------------------------------------------------------------------
Per Share..................... $ $ $
- -----------------------------------------------------------------------------------------------------
Total(3)...................... $ $ $
=====================================================================================================
</TABLE>
(1) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $1,350,000.
(3) The Company has granted the several U.S. Underwriters and the International
Managers (the "Underwriters") options to purchase up to 1,080,000 and
270,000 additional shares, respectively, of Common Stock to cover
over-allotments, if any. See "Underwriting." If such options are exercised
in full, the total Price to Public, Underwriting Discount and Proceeds to
Company will be $ , $ and $ , respectively.
The shares offered hereby are offered by the Underwriters subject to prior
sale, when, as and if delivered to and accepted by them and subject to approval
of certain legal matters by counsel for the Underwriters. The Underwriters
reserve the right to withdraw, cancel or modify such offer and to reject orders
in whole or in part. It is expected that delivery of the shares of Common Stock
will be made in New York, New York on or about October , 1997.
------------------------
MERRILL LYNCH & CO. BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
CREDIT SUISSE FIRST BOSTON
EVEREN SECURITIES, INC.
RAYMOND JAMES & ASSOCIATES, INC.
------------------------
The date of this Prospectus Supplement is September 22, 1997
<PAGE> 2
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Corp. Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates. The Commission also
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission, such as the Company, and the address is http://www.sec.gov. The
Company's Common Stock is listed on the NYSE, and reports, proxy statements and
other information concerning the Company can be inspected at the offices of the
New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-3 under the Securities Act of 1933, as amended (the "Securities Act"), and the
rules and regulations promulgated thereunder, with respect to the Offered
Securities. This Prospectus Supplement, which is part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement and the exhibits. For further information concerning the Company and
the Common Stock offered hereby, reference is made to the Registration Statement
and the exhibits and schedules filed therewith, which may be obtained as
described above.
------------------------
Certain information in this Prospectus Supplement has been obtained from
data published by Smith Travel Research, an industry research organization, and
Coopers & Lybrand L.L.P., a recognized industry expert. Neither Smith Travel
Research nor Coopers & Lybrand L.L.P. have provided any form of consultation,
advice or counsel regarding this Offering and are not associated with the
Company.
------------------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSAC-
TIONS THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON
STOCK. SUCH TRANSACTIONS MAY INCLUDE STABILIZING THE PURCHASE OF COMMON STOCK TO
COVER SYNDICATE SHORT POSITIONS AND THE IMPOSITION OF PENALTY BIDS. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."
S-2
<PAGE> 3
PROSPECTUS SUPPLEMENT SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
herein or incorporated by reference in the accompanying Prospectus to which this
Prospectus Supplement relates. Unless the context otherwise indicates, all
references herein to the "Company" include Sunstone Hotel Investors, Inc. and
Sunstone Hotel Investors, L.P. (the "Partnership"). Except as otherwise noted,
all of the information in this Prospectus Supplement assumes no exercise of the
Underwriters' over-allotment option. This Prospectus Supplement may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. The Company's actual results could
differ materially from those set forth in any such forward-looking statements.
Certain factors that might cause such a difference are discussed in the sections
entitled "Additional Risk Factors" commencing on page S-11 of this Prospectus
Supplement and "Risk Factors" commencing on page 5 of the accompanying
Prospectus. The Company cautions the reader, however, that the factors discussed
in those sections may not be exhaustive.
THE COMPANY
The Company is a leading self-administered equity real estate investment
trust ("REIT") that owns mid-price and upscale 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 most widely recognized in the lodging industry, including brands affiliated
with Holiday Hospitality Corporation, Marriott International, Inc. and Promus
Hotel Corporation. As of August 31, 1997, the Company owned 34 hotels (the
"Current Hotels"), 23 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 Company's growth strategy is to maximize shareholder value by (i)
acquiring underperforming hotels within the Primary Region that are in
attractive locations with significant barriers to entry and (ii) improving such
hotels' financial performance by renovating, redeveloping, repositioning and
rebranding the hotels, and through the implementation of focused sales and
marketing programs.
The Company has entered into an agreement to acquire all of the outstanding
shares of Kahler Realty Corporation ("Kahler") for an estimated aggregate
purchase price of $322 million, the cash portion of which will be funded with a
portion of the net proceeds from this Offering. The Company expects to close the
Kahler Acquisition contemporaneously with or immediately following the closing
of this Offering. Kahler owns and operates 17 hotels with 4,255 rooms (the
"Kahler Hotels," and together with the Current Hotels, the "Hotels"),
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 owned by Kahler are concentrated in Rochester, Minnesota, with
four hotels and 1,329 rooms, three of which are connected by an underground
walkway to the internationally renown Mayo Clinic, and in the Salt Lake City
area of Utah, with six hotels and 1,509 rooms. Nine of the hotels are operated
independently, while the balance are currently operated under Sheraton(R),
Hilton(R), Holiday Inn(R), Residence Inn(R) and other national franchises. The
Company intends to (i) brand or rebrand a number of the hotels and (ii)
undertake an extensive renovation program, both of which the Company expects
will increase its return on investment by increasing the revenues of the hotels.
Following the Kahler Acquisition, the Company will own 51 hotels with an
aggregate of 9,545 rooms in 12 states, including California (14 hotels), Utah
(8), Colorado (6), Arizona (5), Washington (5), Minnesota (4), Idaho (3), Oregon
(2), Montana (1), New Mexico (1), Texas (1) and West Virginia (1). Following the
Kahler Acquisition, 81.2% of the rooms in the Company's hotel portfolio will be
located in the Primary Region.
Since its Initial Public Offering in August 1995, the Company has:
- acquired 23 hotels for an aggregate purchase price of $206.3 million;
- agreed to acquire the 17 Kahler Hotels, bringing the total number of
hotels acquired since the Initial Public Offering to 40, for an aggregate
purchase price of $528.3 million;
S-3
<PAGE> 4
- increased the number of rooms in its hotel portfolio by over six times
through acquisition and development, from 1,328 rooms to 9,545, including
the Kahler Hotels;
- completed $31.0 million in renovation and redevelopment to 15 of the
Current Hotels, and is currently, or will shortly begin, renovating and
redeveloping another 20 of the Hotels for an additional estimated
aggregate cost of $36.3 million;
- increased funds from operations ("FFO") from $8.1 million on a pro forma
basis after giving effect to the Initial Public Offering in 1995 to $11.2
million on an historical basis in 1996, an increase of 38.3%, and
increased FFO per share on the same basis from $1.05 in 1995 to $1.19 in
1996, an increase of 13.3%;
- increased revenue per available room ("REVPAR") for the 11 Current Hotels
that did not undergo renovation during the second quarter of 1996 or 1997
by approximately 11.9% over the comparable period in 1996. According to
Smith Travel Research, the lodging industry as a whole reported a 6.0%
REVPAR increase over the same period;
- increased the annualized quarterly dividend on its Common Stock twice,
for an aggregate increase of approximately 20%, from an initial
annualized quarterly dividend of $0.92 per share to the current
annualized quarterly dividend of $1.10 per share;
- entered into an alliance with Westbrook Partners L.L.C. ("Westbrook
Partners") which includes representation on the Company's Board and an
approximate 11.9% ownership interest (on an as converted basis and after
giving effect to this Offering) in the Company. Westbrook Partners' have
also provided the Company with a right of first refusal to acquire seven
hotels owned by Westbrook Partners in or around Oxnard, California;
- raised approximately $170.4 million of equity capital through the sale of
Common Stock in four follow-on offerings; and
- increased availability under the Company's bank credit facility on three
occasions, from $30.0 million to $200.0 million (assuming that the
increase from $100.0 million to $200.0 million, for which a commitment
letter has been issued, will be in place prior to the closing of this
Offering), and reduced its borrowing cost from an initial rate of LIBOR
plus 2.75% per annum to LIBOR plus 1.80% per annum.
The Company was incorporated as a Maryland corporation in 1995 and is
structured as a REIT. The Company's principal executive offices are located at
115 Calle de Industrias, Suite 201, San Clemente, CA 92672, and its telephone
number is (714) 361-3900.
GROWTH STRATEGY
The Company's principal growth strategy is to maximize shareholder value by
increasing Cash Available for Distribution per share by:
- acquiring underperforming mid-price and upscale hotels located
principally in the Primary Region that are, or can be renovated,
redeveloped and repositioned by branding or rebranding the hotels with
nationally recognized franchises, with an increasing emphasis on
multiple-property acquisitions;
- enhancing the operating performance of hotels owned by the Company
through such renovation, redevelopment, repositioning and rebranding, and
through the implementation of focused management and marketing programs;
and
- selectively developing new mid-price and upscale hotels in markets where
room demand and other competitive factors justify new construction.
S-4
<PAGE> 5
The Company believes that its recently completed and planned future
renovation, redevelopment, repositioning and rebranding activities, as well as
improvements in management and marketing, will continue to fuel REVPAR growth at
its hotels, thereby increasing percentage lease revenue to the Company. In
addition, the Company believes that there will continue to be substantial
acquisition, renovation, redevelopment, repositioning and rebranding
opportunities in the mid-price and upscale hotel markets in the Primary Region.
The Company believes these opportunities will result from the aging of a
significant portion of the nation's hotel supply and the imposition of capital
improvement requirements by certain national hotel franchisors on the owners of
franchised hotels, many of which are small independent hotel companies or
private hotel owners that may be unwilling or unable to satisfy such
requirements.
RECENT DEVELOPMENTS
THE KAHLER ACQUISITION
On August 5, 1997, the Company entered into a Stock Purchase Agreement (the
"Stock Purchase Agreement") to acquire all of the outstanding capital stock of
Kahler from Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate
Co-Investment Partnership I, L.P. (collectively, the "Westbrook Funds"), for an
estimated aggregate purchase price of $322 million. The Kahler Acquisition will
increase the number of hotels owned by the Company by approximately 50%, from 34
hotels to 51 hotels, and will increase the Company's room total by approximately
80%. The Kahler Acquisition is anticipated to close contemporaneously with or
immediately following the closing of this Offering.
Nine of the Kahler Hotels are operated independently -- without a brand
affiliation -- while the balance are currently operated under Best Western(3),
Hilton, Holiday Inn, Quality Inn, Residence Inn and Sheraton franchises. The
Company believes that there are significant opportunities for renovating,
redeveloping 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 also believes that it can increase the revenue
of the hotels and its return on investment by branding a number of the nine
independent Kahler Hotels and "upbranding" 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 the Kahler Hotels located in Texas and 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 Partners 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.
S-5
<PAGE> 6
1997 ACQUISITIONS
The following table sets forth certain information related to the Company's
hotel acquisition activity since January 1, 1997, including the Kahler Hotels to
be acquired contemporaneously with or immediately following the closing of this
Offering:
<TABLE>
<CAPTION>
NUMBER ACQUISITION
OF COST (IN
DATE ACQUIRED BRAND(1) LOCATION ROOMS MILLIONS)
- ------------- ---------------------- ----------------------------- ------ -----------
<S> <C> <C> <C> <C>
January 1997 Holiday Inn San Diego, California 218 $ 9.0
January 1997 Courtyard by Marriott Cypress, California 180 12.0
March 1997 Hawthorn Suites Kent, Washington 152 13.6
March 1997 Holiday Inn Select La Mirada, California 289 18.0
May 1997 Hawthorn Suites(2) Sacramento, California 301 16.8
June 1997 Holiday Inn Hotel & San Diego, California 151 11.8
Suites (3)
July 1997 Holiday Inn(3) Lynnwood, Washington 103 7.4
August 1997 Holiday Inn Mission San Diego, California 174 9.1
Valley
August 1997 Hawthorn Suites(2) Anaheim, California 130 8.7
August 1997 Regency Plaza Hotel Los Angeles, California 178 12.6
----- -------
Subtotal 1,876 $ 119.0
----- -------
October 1997 Kahler Hotels(4) Midwest and Mountain
Regions of the United States 4,255 322.0
----- -------
Total 6,131 $ 441.0
===== =======
</TABLE>
- ---------------
(1) In cases where the Company has obtained approval of a new franchise license,
subject to completion of renovations or improvements, the franchise brand
indicated in this column represents the approved new franchise brand. Many
of the Current Hotels were operated under different brands at the time of
their acquisition or are currently operating under brands that the Company
intends to change.
(2) The Company has received a franchise license to rebrand these hotels as
Hawthorn Suites. The Sacramento hotel will be reconfigured to create 32
two-room suites, which will reduce the room count to 269. The new franchise
licenses are subject to completion of certain renovations and improvements.
The Anaheim and the Sacramento hotels are currently operated independently.
(3) The Company has received franchise licenses to change these hotels to
various Holiday Inn brands, subject to completion of certain renovations and
improvements. The San Diego hotel has been a Holiday Inn, but will become a
Holiday Inn & Suites; the Lynnwood hotel was a Best Western and will become
a Holiday Inn.
(4) Of the 17 Kahler Hotels, nine are independent, three are subject to Best
Western franchise licenses, one is subject to a Hilton franchise license,
one is subject to a Holiday Inn franchise license, one is subject to a
Quality Inn franchise license, one is subject to a Residence Inn by Marriott
franchise license and one is subject to a Sheraton franchise license. The
Company anticipates reflagging certain of these hotels. See "Business and
Properties -- Internal Growth Strategy -- Renovations and Redevelopment."
MARRIOTT HOTELS STRATEGIC RELATIONSHIP
Marriott International, Inc. ("Marriott") recently performed a review of
the Company's and the Lessee's management and operations and has, based on their
standards of operations, approved the Company as a qualified full service
operator. In addition to the fact that three of the Current Hotels are licensed
as Courtyard by Marriott hotels and two of the Current Hotels and one of the
Kahler Hotels are licensed as Residence Inn by Marriott hotels, the Company
expects to brand or rebrand at least three of the Kahler Hotels as full service
Marriott hotels and up to three of the other Kahler Hotels as Courtyard by
Marriott hotels after completion of
S-6
<PAGE> 7
product improvement plans. The Company will consider the Marriott brands when
repositioning future acquired hotels. The Company believes that the preferred
business relationship with Marriott will enhance its opportunities for future
acquisitions and operation of its hotels.
INCREASE IN LINE OF CREDIT
On July 30, 1997, the Company received a commitment from its lenders (led
by Bank One of Arizona, NA, as the agent bank) to increase its unsecured
revolving line of credit facility (the "Credit Facility") to $200.0 million,
which the Company anticipates will be in place prior to the closing of this
Offering. The Credit Facility currently consists of an unsecured $100.0 million
revolving line of credit facility which accrues interest at LIBOR plus 1.80% per
annum (reduced from LIBOR plus 2.75% per annum at the time of the Initial Public
Offering), with provisions for reduced rates. The Credit Facility also requires
that the Company provide collateral if the Company fails to satisfy certain
financial covenants.
SECOND QUARTER 1997 FINANCIAL RESULTS
For the quarter ended June 30, 1997, the Company's FFO increased 195.2% to
$6.2 million, from $2.1 million during the quarter ended June 30, 1996. During
the same period, the Company's FFO per share increased 11.1% to $0.30, from
$0.27 in the corresponding quarter in 1996.
INCREASED DIVIDEND
On September 12, 1997, the Company announced a 10.0% increase in its
regular quarterly dividend, from $0.25 to $0.275 per share, payable on November
15, 1997 to shareholders of record on September 30, 1997.
FUTURE ACQUISITIONS
The Company is in various stages of identifying, evaluating and negotiating
potential hotel portfolio and individual hotel acquisitions. The Company
believes that a large number of attractive acquisition opportunities that meet
the Company's acquisition criteria continue to exist in the Primary Region.
There can be no assurance, however, that any pending or contemplated
acquisitions will be consummated or whether any such acquisitions will be
beneficial to the Company.
S-7
<PAGE> 8
THE OFFERING
All of the shares of Common Stock being sold in this Offering are being
sold by the Company. None of the Company's shareholders are selling any shares
of Common Stock in this Offering.
<TABLE>
<S> <C>
Shares of Common Stock offered by the Company........ 9,000,000 shares.
Shares of Common Stock and Units to be outstanding
after this Offering................................ 34,462,510 shares and Units(1).
Use of Proceeds...................................... To fund the cash portion of the purchase
price of the Kahler Acquisition and to
repay certain indebtedness of Kahler.
NYSE symbol of the Company........................... SSI.
</TABLE>
- ---------------
(1) Includes as of August 31, 1997 (i) 2,764,255 shares of Common Stock issuable
at the option of the Company upon redemption of partnership units (the
"Partnership Units") from limited partners of the Partnership. Also includes
2,284,262 shares of Common Stock to be issued to the Westbrook Funds in
connection with the Kahler Acquisition. Excludes shares of Common Stock
issuable (i) upon exercise of options issued or to be issued pursuant to the
Company's 1994 Stock Incentive Plan (the "Incentive Plan") and the 1994
Directors Plan (the "Directors Plan") and (ii) upon redemption of
Partnership Units which are issuable upon exercise of outstanding warrants
issued to Messrs. Alter, Enever and MYPC Partners ("MYPC"), an affiliate of
Montgomery Securities. Also excludes approximately 1,699,605 shares of
Common Stock initially issuable upon conversion of Preferred Stock to be
issued to the Westbrook Funds in connection with the Kahler Acquisition. See
"Capitalization" and "Underwriting."
S-8
<PAGE> 9
SUMMARY FINANCIAL AND OPERATING INFORMATION
The following table sets forth historical and unaudited pro forma financial
and other information for the Company and Sunstone Hotel Properties, Inc., a
Colorado corporation (the "Lessee"). The following summary financial and
operating information should be read in conjunction with the financial
statements and notes thereto included elsewhere in this Prospectus Supplement
and other financial statements incorporated by reference in the accompanying
Prospectus.
The combined statements of operations data for the year ended December 31,
1996 have been derived from the historical consolidated financial statements of
the Company and the Lessee audited by Coopers & Lybrand L.L.P., independent
auditors, and from the historical consolidated financial statements of Kahler
audited by KPMG Peat Marwick LLP, each of whose reports with respect thereto are
included elsewhere in this Prospectus Supplement.
The summary financial data at June 30, 1997 and for the six months ended
June 30, 1997 are derived from unaudited financial statements. The unaudited
financial information includes all adjustments (consisting of normal recurring
adjustments) that management of the Company considers necessary for a fair
presentation of the combined financial position and results of operations for
these periods. Combined operating results for the six months ended June 30, 1997
are not necessarily indicative of the results to be expected for the entire year
ended December 31, 1997.
Unaudited pro forma operating information for the six months ended June 30,
1997 and the year ended December 31, 1996 are presented as if (i) the
acquisitions of any Current Hotels acquired following the beginning of such
period, (ii) the Kahler Acquisition and (iii) this Offering occurred at January
1, 1997 and 1996, respectively, and, therefore, incorporates certain assumptions
that are described in the notes to the Pro Forma Combined Statements of
Operations included elsewhere in this Prospectus Supplement. The unaudited pro
forma balance sheet data is presented as if the aforementioned transactions had
occurred as of June 30, 1997.
The pro forma information does not purport to represent what the Company's
or the Lessee's financial position or results of operations would actually have
been if these transactions had, in fact, occurred on such date or at the
beginning of the period indicated, or to project the Company's or the Lessee's
financial position or results of operations at any future date or for any future
period.
<TABLE>
<CAPTION>
SUNSTONE HOTEL
INVESTORS, INC. YEAR ENDED
(HISTORICAL) DECEMBER 31, 1996
----------------- SIX MONTHS ENDED ------------------------
SIX JUNE 30, 1997 PRO FORMA(1)
MONTHS YEAR ---------------------------------------------------------------------------------
ENDED ENDED KAHLER OFFERING KAHLER
JUNE 30, DEC. 31, CURRENT ACQUISITION PRO FORMA SUNSTONE HOTEL CURRENT ACQUISITION
1997 1996 HOTELS ADJUSTMENTS ADJUSTMENTS INVESTORS, INC. HOTELS ADJUSTMENTS
------- ------- ----------- ----------- ----------- --------------- ----------- -----------
(PRO FORMA) (PRO FORMA) (PRO FORMA)
(IN THOUSANDS, EXCEPT SHARE, PER SHARE AND ROOM DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
REVENUE:
Lease
revenue(2)...... $15,347 $14,848 $20,151 $21,215 $ -- $41,366 $35,644 $37,379
Interest income... 321 236 321 -- -- 321 236 --
-------- -------- ------- ------- ------- ------- ------- -------
15,668 15,084 20,472 21,215 -- 41,687 35,880 37,379
-------- -------- ------- ------- ------- ------- ------- -------
EXPENSES:
Real estate
related
depreciation.... 3,900 4,514 5,519 4,715 -- 10,234 12,832 9,429
Interest expense
and amortization
of financing
costs........... 1,557 1,558 4,201 13,343 (7,603) 9,941 13,142 23,867
Real estate and
personal
property taxes
and insurance... 1,360 1,273 2,429 2,345 -- 4,774 4,037 4,727
General and
administrative.. 801 1,015 801 125 -- 926 1,015 250
-------- -------- ------- ------- ------- ------- ------- -------
7,618 8,360 12,950 20,528 (7,603) 25,875 31,026 38,273
-------- -------- ------- ------- ------- ------- ------- -------
Income (loss)
before minority
interest........ 8,050 6,724 7,522 687 7,603 15,812 4,854 (894)
Minority
interest........ 953 1,090 953 -- 317 1,270 1,090 --
-------- -------- ------- ------- ------- ------- ------- -------
Net income
(loss).......... 7,097 5,634 6,569 687 7,286 14,542 3,764 (894)
Preferred dividend
requirements.... -- -- -- (988) -- (988) -- (1,975)
-------- -------- ------- ------- ------- ------- ------- -------
Net income (loss)
available to
common
shareholders...... $ 7,097 $ 5,634 $ 6,569 $ (301) $ 7,286 $13,554 $ 3,764 $(2,869)
======== ======== ======= ======= ======= ======= ======= =======
Net income per
common share
outstanding....... $ 0.43
=======
Weighted average
number of shares
of common stock
and common stock
equivalents
outstanding....... 31,859,072
==========
<CAPTION>
OFFERING
PRO FORMA SUNSTONE HOTEL
ADJUSTMENTS INVESTORS, INC.
----------- ---------------
(PRO FORMA)
<S> <C> <C>
OPERATING DATA:
REVENUE:
Lease
revenue(2)...... $ -- $73,023
Interest income... -- 236
------- -------
-- 73,259
------- -------
EXPENSES:
Real estate
related
depreciation.... -- 22,261
Interest expense
and amortization
of financing
costs........... (17,127) 19,882
Real estate and
personal
property taxes
and insurance... -- 8,764
General and
administrative.. -- 1,265
------- -------
(17,127) 52,172
------- -------
Income (loss)
before minority
interest........ 17,127 21,087
Minority
interest........ 603 1,693
------- -------
Net income
(loss).......... 16,524 19,394
Preferred dividend
requirements.... -- (1,975)
------- -------
Net income (loss)
available to
common
shareholders...... $16,524 $17,419
======= =======
Net income per
common share
outstanding....... $ 0.55
=======
Weighted average
number of shares
of common stock
and common stock
equivalents
outstanding....... 31,859,072
==========
</TABLE>
S-9
<PAGE> 10
<TABLE>
<CAPTION>
SUNSTONE HOTEL
INVESTORS, INC.
AND LESSEE PRO FORMA(1)
(HISTORICAL) ---------------------------------------------------------------------------------
----------------- SIX MONTHS ENDED YEAR ENDED
SIX JUNE 30, 1997 DECEMBER 31, 1996
MONTHS YEAR ------------------------------------------------------- ------------------------
ENDED ENDED KAHLER OFFERING SUNSTONE HOTEL KAHLER
JUNE 30, DEC. 31, CURRENT ACQUISITION PRO FORMA INVESTORS, INC. CURRENT ACQUISITION
1997 1996 HOTELS ADJUSTMENTS ADJUSTMENTS AND LESSEE HOTELS ADJUSTMENTS
-------- -------- ----------- ----------- ----------- --------------- ----------- -----------
(PRO FORMA) (PRO FORMA) (PRO FORMA)
(IN THOUSANDS, EXCEPT SHARE, PER SHARE AND ROOM DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER DATA:
Lessee room
revenue........... $34,501 $34,085 $43,934 $38,199 $ 3,110 $ 85,243 $80,544 $69,770
Funds from
operations for
common
shareholders(3)... 11,950 11,238 13,041 4,414 25,058 17,686 6,560
Cash available for
distribution(4)... 10,194 9,100 10,850 1,900 20,229 13,572 1,758
Cash provided by
operating
activities........ 9,206 11,669
Cash used in
investing
activities........ (86,805) (82,757)
Cash provided by
financing
activities........ 78,646 66,008
Occupancy........... 67.4% 64.9% 67.5% 69.5%
ADR................. $ 67.74 $ 62.13 $ 76.98 $ 70.92
REVPAR.............. $ 45.68 $ 40.30 $ 51.93 $ 49.26
<CAPTION>
OFFERING SUNSTONE HOTEL
PRO FORMA INVESTORS, INC.
ADJUSTMENTS AND LESSEE
----------- ---------------
(PRO FORMA)
<S> <C> <C>
OTHER DATA:
Lessee room
revenue........... $ 4,249 $ 154,563
Funds from
operations for
common
shareholders(3)... 41,373
Cash available for
distribution(4)... 32,287
Cash provided by
operating
activities........
Cash used in
investing
activities........
Cash provided by
financing
activities........
Occupancy...........
ADR.................
REVPAR..............
</TABLE>
<TABLE>
<CAPTION>
AT JUNE 30, 1997
---------------------------
PRO FORMA AS
ACTUAL ADJUSTED(1)
-------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Investment in hotels at cost........................................................................ $273,168 $681,631
Total assets........................................................................................ 263,016 674,247
Total long-term debt................................................................................ 41,449 252,191
Minority interest in partnership.................................................................... 24,521 27,680
Total shareholders' equity.......................................................................... 194,811 384,858
</TABLE>
- ---------------
(1) The pro forma information does not purport to represent what the Company's
or the Lessee's financial position or results of operations actually would
have been if the Company had, in fact, owned and leased to the Lessee the
Current Hotels and the Kahler Hotels at the beginning of the periods
indicated, or to project the Company's or the Lessee's financial position or
results of operations at any future date for any future period.
(2) With respect to the pro forma information, rent from the Lessee to the
Company is calculated on a pro forma basis by applying the rent provisions
of the Percentage Leases to the historical revenue of the Hotels as if the
beginning of the periods were the beginning of the lease year and assumes
the Company owned and leased the Current Hotels and the Kahler Hotels
throughout the periods presented.
(3) Management and industry analysts generally consider Funds From Operations
("FFO") 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.
FFO 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),
less preferred dividend requirements. FFO 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. FFO 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.
(4) Cash Available for Distribution is computed by subtracting from FFO the sum
of (i) 4% of room revenues, which the Company is obligated by the Percentage
Leases to make available to the Lessee for the periodic refurbishment and
replacement of furniture, fixture and equipment at the Hotels and (ii)
amounts required to repay principal amortization on long-term debt.
S-10
<PAGE> 11
ADDITIONAL RISK FACTORS
In evaluating the Company's business, prospective investors should
carefully consider the factors set forth in this section in addition to other
information set forth in the accompanying Prospectus before making an investment
decision with respect to the Common Stock being sold in this Offering. This
Prospectus Supplement may contain forward-looking statements which involve risks
and uncertainties, and actual results could differ materially from those
discussed in any such forward-looking statements. Certain of the factors that
could cause actual results to differ materially are discussed below and in the
accompanying Prospectus under the caption "Risk Factors."
RISK THAT KAHLER ACQUISITION WILL NOT CLOSE
The Company intends to close the Kahler Acquisition contemporaneously with
or immediately following the closing of this Offering. The closing of the Kahler
Acquisition is subject to the receipt of certain third party consents and
certain other closing conditions. In addition, the Company intends to distribute
the historical earnings and profits of Kahler and must complete a reorganization
of Kahler prior to closing in order to preserve the Company's status as a REIT.
If the Company does not complete the Kahler Acquisition, for whatever reason,
the Company could be subject to significant penalties and will have incurred
significant costs and expenses which are not recoverable or refundable. In such
event, there can be no assurance that the Company would be able to identify
acquisition candidates that meet the Company's investment criteria and the
Company's Cash Available for Distribution would be materially and adversely
affected. See "Recent Developments -- The Kahler Acquisition," "-- Earnings and
Profits Distribution Risk" below and "Business and Properties -- The Kahler
Acquisition."
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, in August 1997, the
Company announced the Kahler Acquisition which will almost double the Company's
current 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 Current Hotel portfolio. 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 such as the Kahler Acquisition, 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 could be subject to
a 100% tax. See "Business and Properties -- The Kahler Acquisition" and "United
States Federal Income Tax Considerations" in the accompanying Prospectus.
S-11
<PAGE> 12
FAILURE TO INTEGRATE KAHLER SUCCESSFULLY
The acquisition of Kahler 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 Kahler Hotels and the Current
Hotels or that the combined businesses can be operated profitably. The failure
to integrate and operate the Kahler Hotels 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 certain of the Current
Hotels and may, therefore, compete with the Current Hotels. There can be no
assurance that the Kahler Acquisition will not adversely affect the operations,
revenues or prospects of the Company's hotels located in such geographic areas.
See "Recent Developments -- The Kahler Acquisition."
GEOGRAPHIC CONCENTRATION OF KAHLER HOTELS
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 the Kahler Hotels will have a material
adverse effect on the Company's results of operations and Cash Available for
Distribution.
NEW MARKETS
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 the Kahler Hotels located in Rochester, Minnesota. 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.
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 distribution prior to December 31, 1997. It is expected that, prior to
the Kahler Acquisition, a distribution will be made to the Westbrook Funds in
the amount of such earnings and profits, currently estimated to be approximately
$33 million, as certified by Kahler's auditors and auditors for the Company, and
that the Company will receive a corresponding credit against the cash portion of
the purchase price for Kahler. 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.
In addition, the Company intends to apply for a ruling from the IRS that
the expected distribution to the Westbrook Funds will deplete the historical
earnings and profits of Kahler. However, there 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 $30.0 million. The Company will be required to 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
S-12
<PAGE> 13
obligated to make such additional distribution but fails to do so, such failure
may result in the Company being disqualified as a REIT.
DEPENDENCE ON LESSEE
The Company is substantially dependent upon the Lessee's continued ability
to generate sufficient cash flow from the operation of the Hotels to enable the
Lessee to meet its rent obligations under the Percentage Leases. The Lessee had
a negative net book value of approximately $3.6 million as of June 30, 1997, and
had a net operating loss of $3.2 million for the year ended December 31, 1996
and net income of $365,000 for the six months ended June 30, 1997. On a pro
forma basis, after giving effect to acquisitions of Current Hotels during 1996
and thereafter, and the Kahler Acquisition, the Lessee had a net operating loss
of $4.0 million for the year ended December 31, 1996 and net income of $758,000
for the six months ended June 30, 1997. If the Lessee is not able to meet its
obligations under the Percentage Leases, the performance of the Company would be
materially and adversely affected. See "The Lessee -- General" and
"-- Minimizing Conflicts of Interest -- Percentage Leases."
OTHER RISKS
Investors should also carefully consider the matters discussed under "Risk
Factors" which begins on page 5 of the accompanying Prospectus.
USE OF PROCEEDS
The net proceeds to the Company from this Offering, before deducting
expenses, are estimated to be approximately $137.5 million (approximately $158.1
million if the Underwriters' over-allotment option is fully exercised). The
Company intends to use the net proceeds of this Offering, together with
borrowings under the Credit Facility, to fund the cash portion of the purchase
price for the Kahler Acquisition and to repay approximately $144.9 million of
outstanding indebtedness of Kahler. The indebtedness to be repaid consists of
revolving lines of credit of approximately $21.1 million and mortgage and other
notes payable of approximately $123.8 million. The lines of credit bear interest
at the prime rate plus one percent and mature at various dates through June 30,
1998. The mortgage notes payable bear interest at a weighted average rate of
9.6% and mature at various dates through June 10, 2009. See Notes J on page F-6
and K and L on page F-7 to the Unaudited Pro Forma Combined Financial Statements
herein.
Pending the use of proceeds referenced above, the net proceeds from this
Offering will be invested in interest-bearing, short-term investment-grade
securities or money market accounts, which are consistent with the Company's
ability to continue to qualify for taxation as a REIT. Such investments may
include, for example, government and government agent securities, certificates
of deposit and interest-bearing bank deposits.
S-13
<PAGE> 14
PRICE RANGE OF COMMON STOCK AND DIVIDEND DISTRIBUTIONS
The Company's Common Stock commenced trading in the over-the-counter market
on August 16, 1995 and since July 23 1996, has been listed on the NYSE under the
symbol "SSI." The following table sets forth, for the periods indicated, the
high and low closing sales price information for the Common Stock on the Nasdaq
National Market or NYSE, as applicable.
<TABLE>
<CAPTION>
PER SHARE
DISTRIBUTION
HIGH LOW AMOUNT
------- ------- ------------
<S> <C> <C> <C>
1995
Third Quarter (from August 16, 1995).................... $ 9.625 $ 8.875 $0.115(1)
Fourth Quarter.......................................... 10.500 7.875 0.230
1996
First Quarter........................................... $11.500 $ 9.750 $0.230
Second Quarter.......................................... 11.625 9.875 0.230
Third Quarter........................................... 10.875 9.500 0.250
Fourth Quarter.......................................... 13.625 10.000 0.250
1997
First Quarter........................................... $14.000 $12.250 $0.250
Second Quarter.......................................... 14.500 12.625 0.250
Third Quarter (through September 18, 1997).............. 16.250 13.750 0.275(2)
</TABLE>
- ---------------
(1) Represents the pro rata portion (for the period from August 16, 1995 to
September 30, 1995) of a quarterly distribution of $0.230 per share.
(2) Per share dividend to be paid November 15, 1997 to shareholders of record on
September 30, 1997.
As of September 15, 1997, there were approximately 572 record holders of
the Company's Common Stock. On September 18, 1997, the last reported sale price
of the Common Stock on the NYSE was $16.125 per share. In addition, the
Partnership Units (which are exchangeable for Common Stock) were held by 50
entities and/or individuals as of September 15, 1997. In order to comply with
certain requirements related to qualification of the Company as a REIT, the
Company's Articles of Incorporation limits the number of shares of Common Stock
that may be beneficially owned by any single person to 9.8% of the Company's
outstanding Common Stock.
Although the declaration of dividends is within the discretion of the Board
of Directors (the "Board") and depends on the Company's results of operations,
Cash Available for Distribution, the financial condition of the Company, tax
considerations (including those related to REITs) and other factors considered
important by the Board, the Company's policy is to make regular quarterly
distributions to its shareholders. The Company's ability to make distributions
will depend on its receipt of distributions from the Partnership. The
Partnership's primary source of revenue is, and will continue to be, rent
payments under the percentage leases (the "Percentage Leases") for the Hotels.
The Company must rely on the operation of its Hotels to generate sufficient cash
flow to permit the Lessee to meet its rent obligations under the Percentage
Leases. The Lessee had a negative net book value of approximately $3.6 million
as of June 30, 1997, and had a net operating loss of $3.2 million for the year
ended December 31, 1996 and net income of $365,000 for the six months ended June
30, 1997. On a pro forma basis, after giving effect to acquisitions of Current
Hotels during 1996 and thereafter, and the Kahler Acquisition, the Lessee had a
net operating loss of $4.0 million for the year ended December 31, 1996 and net
income of $758,000 for the six months ended June 30, 1997. The Lessee's
obligations under the Percentage Leases are secured by a blanket lien on
substantially all of its assets and a pledge of 481,955 Partnership Units by Mr.
Alter and Mr. Biederman pursuant to the Amended and Restated Third Party Pledge
Agreement. See "Business and Properties -- The Percentage Leases" and "-- The
Lessee."
Under the federal income tax provisions affecting REITs, the Company must
distribute at least 95% of its taxable income in order to avoid taxation as a
regular corporation. Moreover, the Company must distribute at
S-14
<PAGE> 15
least 85% of its ordinary income and 95% of its capital gain net income to avoid
certain excise taxes applicable to REITs. Under certain circumstances, the
Company may be required to make distributions in excess of Cash Available for
Distribution in order to meet such distribution requirements. In such event, the
Company would seek to borrow the amount of the deficiency or sell assets to
obtain the cash necessary to make distributions to retain its qualification as a
REIT for federal income tax purposes. See "United States Federal Income Tax
Considerations -- Taxation of the Company" in the accompanying Prospectus.
CAPITALIZATION
The following table sets forth the pro forma capitalization of the Company
(i) as of June 30, 1997 and (ii) as adjusted to give effect on such date to the
acquisition of any Current Hotels acquired subsequent to June 30, 1997, the
Kahler Acquisition and this Offering and the application of the estimated net
proceeds therefrom as described under "Use of Proceeds."
<TABLE>
<CAPTION>
JUNE 30, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt........................................................ $ 41,449 $ 252,191
-------- ---------
Minority interest..................................................... 24,521 27,680
-------- ---------
Shareholders' equity:
7.9% Class A Cumulative Convertible Preferred Stock, $.01 par value,
10,000,000 shares authorized; no shares issued and outstanding;
250,000 shares issued and outstanding, as adjusted (liquidation
value $100 per share, aggregating $25,000,000 as adjusted)(1).... -- 3
Common Stock, $.01 par value, 50,000,000 shares authorized;
20,368,021 shares issued and outstanding; 31,698,255 shares
issued and outstanding, as adjusted(2)........................... 203 316
Additional paid-in capital.......................................... 195,494 385,425
Retained earnings (deficit)......................................... (886) (886)
-------- ---------
Total shareholders' equity.......................................... 194,811 384,858
-------- ---------
Total capitalization........................................ $260,781 $ 664,729
======== =========
</TABLE>
- ---------------
(1) The Preferred Stock is initially convertible into 1,699,605 shares of Common
Stock and may be redeemed by the Company after five years from the issuance
date.
(2) Excludes 2,764,255 shares issuable upon redemption of Partnership Units
outstanding prior to this Offering and shares of Common Stock issuable upon
exercise of options granted under the Incentive Plan, the Directors Plan and
upon exercise of outstanding warrants.
S-15
<PAGE> 16
BUSINESS AND PROPERTIES
THE LODGING INDUSTRY
The 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. The total asset value of that 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 and
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%, even though room supply
exceeded room demand by 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 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 5.8% for the six months ended June 30, 1997, compared to the six
months ended June 30, 1996. According to Coopers & Lybrand's 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 (including the Kahler Hotels) are
located, grew by 9.4% during the six months ended June 30, 1997, as compared to
5.8% for the industry generally.
Mid-Price and Upscale Segments
The lodging industry as a whole, and the mid-price and upscale segments in
particular, are benefiting from a favorable supply and demand imbalance in the
United States. Based on data provided by Smith Travel Research, demand for
rooms, as measured by annual domestic occupied room nights, increased 3.8% and
2.6% in 1995 and 3.3% and 3.4% in 1996 for the mid-price and upscale segments,
respectively.
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 5.8% in the six months ended June 30, 1997. 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 5.2% during the
six months ended June 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.
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.
S-16
<PAGE> 17
The following graph illustrates REVPAR growth for the six months ended June
30, 1997 over the comparable period for the prior year for hotels in the United
States and in the Pacific Region:
[REVPAR GROWTH CHART]
The following graph illustrates the profitability of the United States
lodging industry between 1982 and 1996, and as projected for 1997, 1998 and
1999:
[PROFITABILITY GRAPH]
S-17
<PAGE> 18
OVERVIEW OF THE COMPANY
The Company is a leading self-administered equity REIT that, through the
Partnership, currently owns 34 mid-price and upscale hotels located principally
in the Primary Region. The Current Hotels operate or will operate under
nationally recognized franchises, including Courtyard by Marriott(R), Residence
Inn(R) by Marriott, Holiday Inn Select(TM), Holiday Inn(R) Hotel & Suites,
Holiday Inn Express(TM), Hampton Inn(R), Hawthorn Suites(R), Doubletree(R) and
Comfort Suites(R). Of the Company's 34 Current Hotels, 23 were acquired and one
was built subsequent to the Initial Public Offering in August 1995. The Company
has entered into an agreement to acquire the 17 Kahler Hotels contemporaneously
with or immediately following the closing of this Offering. Following such
acquisition, the Company will own 51 hotels with an aggregate of 9,545 rooms in
12 states, including California (14 hotels), Utah (8), Colorado (6), Arizona
(5), Washington (5), Minnesota (4), Idaho (3), Oregon (2), Montana (1), New
Mexico (1), Texas (1) and West Virginia (1) and will have increased the number
of hotels in its portfolio by more than 410% and the number of rooms by more
than 610% in the two years since the Initial Public Offering.
The majority (83.1%) of the Company's Hotel room portfolio (including the
Kahler Hotels) consists of full service and upscale extended stay hotels, and
the remainder of the Company's hotel room portfolio consists of mid-price,
limited service hotels located primarily in markets where the Company believes
significant barriers exist for new competitive supply.
The Company believes success in the hospitality industry is measured by
competition in local markets. The Company distinguishes itself when competing in
local hotel markets by providing high levels of service and value to its guests
through its high-quality hotels and superior marketing practices. Based on data
provided by Smith Travel Research, the Company believes that its portfolio of
renovated and rebranded hotels has, upon stabilization, consistently
outperformed the industry's average year-over-year growth in revenues by a
significant margin. For the six months ended June 30, 1997, the Company's
average REVPAR growth for those hotels not under renovation was 12.3%, compared
to 5.8% and 5.2% average REVPAR growth for the mid-price and upscale segments of
the lodging industry, respectively. The Company believes that its recently
completed and future renovation, redevelopment, repositioning and rebranding
activities, as well as improvements in management and marketing by the Lessee
and the Management Company, will continue to fuel REVPAR growth at its hotels,
thereby increasing revenue to the Company.
THE KAHLER ACQUISITION
On August 5, 1997, the Company entered into an agreement to acquire all of
the outstanding capital stock of Kahler from the Westbrook Funds for an
estimated aggregate purchase price of $322 million. Kahler owns and operates 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, and in the Salt Lake City area of Utah, with
six hotels and 1,509 rooms.
The Company believes that the Kahler Hotels are being acquired at a
significant discount to replacement cost. The Company believes that there are
significant opportunities for renovating, redeveloping, repositioning and
rebranding 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 also believes that it can increase its return on investment by
branding a number of the nine independent Kahler Hotels and "upbranding" several
of the other Kahler Hotels. Nine of the hotels are operated independently, while
the balance are operated under Best Western (3), Hilton, Holiday Inn, Quality
Inn, Residence Inn and Sheraton franchises. Thirteen of the Kahler Hotels are
wholly-owned by Kahler, while four hotels are owned by entities in which Kahler
has a partial interest. The Company is currently in discussions with such third
parties to acquire their interests. In addition, the Company may sell or
exchange the Kahler Hotels located in Texas and West Virginia because they are
not consistent with the Company's geographic focus.
In addition to the Kahler Hotels, Kahler owns and operates two industrial
laundry businesses (the "Kahler Laundries"). Kahler also manages four hotels and
two conference centers owned by third parties unaffiliated with Kahler pursuant
to management contracts (the "Kahler Management Contracts"). Kahler
S-18
<PAGE> 19
also has an interest in a utility related to its hotels (the "Utility"). Due to
certain constraints imposed by the rules governing REITs, the Company will only
acquire the real estate and certain equipment (the "Hard Assets") relating to
the Kahler Laundries, but not the operating assets associated with the Kahler
Laundries, or the Utility or the Kahler Management Contracts. Rather, such
assets will be sold by the Company to the Lessee concurrently with the closing
of the Kahler Acquisition. In such event, any transaction with the Lessee will
be subject to the approval of the Independent Directors. In addition, the
Company anticipates leasing the Hard Assets to the Lessee on a short-term basis
at a percentage rent to be agreed upon between the Company and the Lessee.
Kahler also owns partial interests in four of the Kahler Hotels. In order
to comply with the REIT provisions of the Internal Revenue Code upon the
Company's acquisition of the Kahler Hotels, the Company intends to enter into
Percentage Leases for each of the Kahler Hotels (including those wherein Kahler
owns a partial interest), substantially similar to those currently in effect for
the Current Hotels with the Lessee. If the Company is not successful in entering
into Percentage Leases for one or more of such four Kahler Hotels, the Company
may be required to transfer such hotels to a subsidiary of the Partnership. The
accompanying pro forma financial information assumes that the Company will
acquire all of the third party interests in these entities. There can be no
assurance that the Company will, in fact, be successful in acquiring such third
party interests. If the Company is not successful in acquiring any such third
party interest, the amount earned by the Company from such hotel subject to such
third party interest may be different than as set forth in the pro forma
financial information. In addition, one of the parties in the University Park
Hotel and Conference Center has a right of first refusal to increase its
percentage interest in the hotel under certain circumstances. The Company
believes this right is not triggered as a result of the Kahler Acquisition.
The Kahler Acquisition is expected to close contemporaneously with or
immediately following the closing of this Offering. The estimated aggregate
purchase price to be paid to the Westbrook Funds at closing consists of
approximately $95 million in cash, 250,000 shares of newly issued Preferred
Stock and 2,284,262 shares of newly issued Common Stock of the Company, and the
assumption of approximately $170 million in debt, approximately $40 million of
which will be purchased from the Westbrook Funds at closing. The remaining $130
million of debt, which consists almost entirely of mortgage indebtedness on the
Kahler Hotels, will be either kept in place, retired or refinanced concurrently
with the closing. In addition, in April 2000, the Company may be required to
make an additional payment of up to $16.5 million to the Westbrook Funds if the
portion of the Company's earnings attributable to the Kahler Hotels for the year
ended December 31, 1999 exceeds certain thresholds (the "Earn-Out Payment"). The
Earn-Out Payment may be paid at the Company's option in cash or shares of Common
Stock. The acquisition may be terminated by the Company or the Westbrook Funds
if it does not close prior to December 31, 1997. In addition, if the transaction
does not close by October 15, 1997, the Company must pay the Westbrook Funds
interest, of approximately $41,000 per day, on a portion of the purchase
consideration for each day after October 15, 1997 that the closing is delayed.
See "Additional Risk Factors -- Risk That Kahler Acquisition Will Not Close."
The closing of the Kahler Acquisition is subject to the fulfillment of
certain conditions on or prior to the closing, including, without limitation,
receipt of consents from certain local government entities and private parties
to the change in ownership of Kahler and the assignment of certain of Kahler's
contracts to the Company, and certain other closing conditions. In addition, it
is expected that all of the accumulated earnings and profits of Kahler from its
inception in 1917 will be paid to the Westbrook Funds prior to closing in order
to preserve the Company's status as a REIT. The amount of Kahler's accumulated
earnings and profits, currently estimated to be approximately $33 million, will
be credited to the Company against the cash portion of the purchase price for
Kahler. It is currently anticipated that such distribution will be funded by a
bank loan (to be obtained) to Kahler secured by certain Kahler Hotels, which
loan will be paid entirely from net cash generated by the affected hotels'
operations or, if necessary, out of proceeds from the sale of such hotels. No
portion of any such loan will be repaid with cash from the Company's other
operations. Finally, Kahler must be reorganized prior to closing of the Kahler
Acquisition in a manner that will allow the Company to continue Kahler's
operations so as not to violate the rules pertaining to REITs. There can be no
assurance that the conditions precedent to the closing of the Kahler Acquisition
will be fulfilled.
S-19
<PAGE> 20
Pursuant to the Stock Purchase Agreement, the Westbrook Funds have provided
the Company with limited indemnification for breaches of representations and
warranties by the Westbrook Funds and Kahler regarding the Kahler Hotels,
Kahler's historical financial statements, and corporate, labor and certain other
matters. The Westbrook Funds are not obligated to indemnify the Company unless
the breaches of such representations and warranties are material and cause
damages to the Company in excess of $2.5 million in the aggregate. In addition,
the Westbrook Funds are obligated to indemnify the Company only for $5 million
in damages above the $2.5 million threshold. The Westbrook Funds'
indemnification obligation with respect to certain representations and
warranties terminates upon closing of the Kahler Acquisition, and with respect
to the other representations and warranties survives for a maximum of one year
after closing. The consideration to be paid for Kahler is not subject to
adjustment for any adverse matters concerning Kahler or its operations
discovered by the Company prior to closing of the Kahler Acquisition.
The cash consideration to be paid at closing and indebtedness to be
purchased from the Westbrook Funds at closing will be funded with the net
proceeds from this Offering. The shares of Common Stock and Preferred Stock
issued to the Westbrook Funds at closing will be restricted shares which are not
registered under the Securities Act. The rights, preferences and privileges of
the Common Stock and Preferred Stock are described in greater detail in the
accompanying Prospectus under "Description of Common Stock and Preferred
Stock -- Common Stock" and "-- Preferred Stock -- 7.9% Class A Cumulative
Convertible Preferred Stock."
The Westbrook Funds have agreed that, for a period of 12 months after the
closing (the "Initial Lock-Up Period"), they will not sell, transfer or
otherwise dispose of its Common Stock, Preferred Stock or Common Stock issued as
the result of the conversion of the Preferred Stock. In addition, the Westbrook
Funds have agreed that following the expiration of the Initial Lock-Up Period,
they will only sell, transfer or otherwise dispose of such shares in certain
limited amounts during the following year. In addition, following the Initial
Lock-Up Period, the Westbrook Funds will have certain rights to register their
shares of Common Stock received at closing or issued as the result of the
conversion of their Preferred Stock, pursuant to a registration rights agreement
(the "Registration Rights Agreement") to be entered into between the Company and
the Westbrook Funds at the closing of the Kahler Acquisition. Pursuant to the
Registration Rights Agreement, the Westbrook Funds will have the right to
include their shares of Common Stock for registration in certain public
offerings initiated by the Company and will have the right, two times, to
require that the Company initiate a registration of their Common Stock, subject
in each case to certain limitations and the ability of the underwriters of such
offerings to restrict the number of shares of Common Stock so registered.
Upon the closing of the Kahler Acquisition, the Company's Board will elect
a designee of Westbrook Partners to serve on its Board. The Company's Board
recently increased its size to nine members in order to create a vacancy for
this purpose. In the event that the size of the Board is further increased,
Westbrook Partners may be entitled to additional board seats as necessary to
ensure that its board representation is equal to the total number of directors
multiplied by the percentage of Common Stock beneficially owned by the Westbrook
Funds. Subject to certain limitations, the Company must nominate Westbrook
Partners' designee (or designees, if the Westbrook Funds are entitled to more
than one board seat) for election to the Board at the Company's annual meeting
of shareholders.
The Kahler Acquisition may be terminated prior to the scheduled closing in
certain events. In the event the Kahler Acquisition is terminated, generally
neither party shall be liable to the other, unless the termination resulted from
the wilful and material breach of the other party. In addition, in the event the
acquisition is terminated due to the inability of the Company to obtain the
necessary financing, the Company is liable to the Westbrook Funds for all
direct, actual damages incurred by the Westbrook Funds in connection with such
failure, including, without limitation, all expenses incurred by Westbrook
Partners and Kahler in connection with the preparation, negotiation and
execution of the Stock Purchase Agreement.
The description of the terms of the Stock Purchase Agreement contained in
this Prospectus Supplement is qualified in its entirety by reference to the
Stock Purchase Agreement attached as an exhibit to the Company's Current Report
on Form 8-K filed on August 14, 1997, which is incorporated into the Prospectus
by reference.
S-20
<PAGE> 21
GROWTH STRATEGY
External Growth Strategy
The Company's external growth strategy is to (i) acquire underperforming
mid-price and upscale hotels located principally in its Primary Region that are,
or can be renovated or redeveloped and repositioned by branding or rebranding
the hotels with nationally recognized franchises, with an increasing emphasis on
multiple-property acquisitions and (ii) selectively develop new mid-price and
upscale hotels in markets where room demand and other competitive factors
justify new construction.
Acquisitions. The Company intends to acquire hotels located principally in
the Primary Region which meet one or more of the following criteria: (i)
underperforming hotels which have the potential for improved performance through
the implementation of quality management and marketing programs, and/or
association with a national franchisor; (ii) hotels in a deteriorated physical
condition that would benefit significantly from renovation or redevelopment;
(iii) hotels in attractive locations that would benefit significantly by
changing franchises ("upbranding") to a nationally recognized franchise brand
that have a greater potential to produce significant REVPAR growth, such as
Marriott, Courtyard by Marriott, Doubletree Hotel, Hampton Inn, Hilton, Holiday
Inn, Holiday Inn Select, Holiday Inn Hotel & Suites, Holiday Inn Express and
Residence Inn by Marriott; (iv) hotels owned by franchisees who are unable or
unwilling to meet capital improvement requirements of the franchisor; (v) hotels
in markets with favorable room supply and demand fundamentals; and (vi) 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.
Multiple Property Acquisitions. The Company has increased its access to
capital for multiple-property acquisitions by increasing availability under its
Credit Facility from $30.0 million to $100.0 million and has received a
commitment from its lenders to further increase the Credit Facility to $200.0
million. In addition, rather than paying cash, the Company also has the
flexibility of issuing its Common Stock, Preferred Stock or Partnership Units to
acquire hotels, which under certain circumstances allows the sellers to defer
tax liability which would otherwise arise upon a sale for cash. In addition to
its financial resources, the Company's experience in successfully operating
hotels has given it significant knowledge of a variety of markets and the
ability to quickly identify strategic acquisition opportunities. The Company
believes that its increasing profile in the hotel industry and its record of
closing acquisitions will enable it to continue to attract sellers of hotel
portfolios. See "Additional Risk Factors -- New Markets."
The Company believes that Kahler's business fundamentals are complimentary
to the Company's focus on the mid-price and upscale hotel segments.
Additionally, the Company believes that a number of hotels in the Kahler Hotel
portfolio have potential for increased revenue through renovation,
redevelopment, repositioning and rebranding opportunities. The Company also
believes that the Kahler Acquisition, which will result in the Westbrook Funds'
holding a significant equity position in the Company and Westbrook Partners'
representation on the Company's Board, will provide the Company with additional
acquisition opportunities. The Company believes that the Kahler Hotels are being
purchased at a significant discount to replacement cost.
Selective Development of Additional Hotels. The Company may also
selectively develop new upscale hotels which will operate under other national
franchises in markets where room demand and other competitive factors justify
new construction. The Company may develop other hotels itself or may contract
with unaffiliated developers who will build hotels and then sell them to the
Company upon completion on pre-agreed terms. Such arrangements with developers
will enable the Company to minimize risks associated with development. Other
than the Company's construction of a 166-room full-service Marriott hotel
currently under development through an unaffiliated developer in Pueblo,
Colorado at the site of the new Pueblo Convention Center, and the Company's
agreement to acquire from an unaffiliated developer a 93-room Hawthorn Suites at
the Denver Tech Center in Colorado, the Company is not currently involved in any
development projects.
S-21
<PAGE> 22
Internal Growth Strategy
The Company's internal growth strategy is to enhance the operating
performance of hotels owned and acquired by the Company by (i) selectively
renovating the hotels, and when advantageous, redeveloping and rebranding them
under national franchises, (ii) improving the marketing and management of the
hotels, (iii) leasing restaurants in the hotels to national or regional
restaurant companies and (iv) selectively, expanding the number of rooms at
certain hotels where market conditions justify such expansion. The Company
intends to apply its internal growth strategy to enhance the operating
performance of the Kahler Hotels through selective renovation, redevelopment
and, in certain cases, rebranding, improving the marketing and management of the
hotels, leasing restaurants in the hotels to national or regional restaurant
companies, and, in selective cases, expanding the number of rooms at certain of
the hotels where market conditions justify expansion.
Renovations and Redevelopment. The Company upgrades its hotels to meet
competitive conditions and occupancy levels and renovates its hotels when the
Company believes such renovations will increase its return on investment by
increasing revenue to the Company under the Percentage Leases or will otherwise
be in the best interest of the Company. As one method of upgrading its hotels,
the Company will brand or rebrand certain of its hotels with upscale national
brands. For example, under a Master Development Agreement with United States
Franchise Systems ("USFS"), the Company has branded one of its recent
independent acquisitions and expects to brand its hotels in Anaheim and
Sacramento, California as extended-stay Hawthorn Suites hotels. The Company
intends to further increase this brand in its portfolio through the Master
Development Agreement which provides for a right of first offer in several major
urban markets in California, Oregon and Washington. USFS is required to help the
Company identify hotel sites, provide architectural plans and development
oversight and assist in marketing the hotels. See "Risk Factors -- Hawthorn
Suites Development Risks" in the accompanying Prospectus.
In addition, 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. 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 generally
conducts 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. The Company believes that its recently completed and planned future
redevelopment and renovation activities will continue to improve REVPAR growth
at its hotels, thereby increasing its return on investment by increasing revenue
to the Company; however, there can be no assurance that the Company will
continue to experience the same rate of REVPAR growth in the renovated hotels or
as a result of future renovation or redevelopment activities at other hotels.
S-22
<PAGE> 23
The following charts summarize the scope of renovation and redevelopment
activities typically performed by the Company.
SCOPE OF RENOVATION
For those hotels whose franchise affiliation will not be changed, the
Company typically makes renovations following acquisition in order to satisfy
the existing franchisor's capital improvement plan. The Company also performs
periodic routine maintenance to all of its hotels in order to keep them
competitive. Renovations typically consist of many of the following:
<TABLE>
<CAPTION>
GUEST ROOMS PUBLIC AREAS EXTERIOR
- ------------------------------ ------------------------------ ------------------------------
<S> <C> <C>
- - selectively replacing - replacing drapes and - repainting
bedspreads, linens, drapes valances - seal coating parking lot
and valances - refinishing and selectively - adding lighting
- - refinishing and selectively replacing furniture
replacing furniture and - replacing wallpaper and
adding televisions, vinyl wallcovering
telephones with data ports - repainting
and voicemail, clock radios, - recarpeting
coffeemakers, irons and
ironing boards
- - replacing wallpaper and
vinyl wallcovering
- - repainting
- - recarpeting
</TABLE>
SCOPE OF REDEVELOPMENT
Redevelopment is more extensive than renovation and is used to completely
upgrade a hotel so that in certain instances it can be branded or rebranded with
a national franchise that the Company believes will generate higher REVPAR than
that currently being generated. Redevelopment typically involves many of the
following:
<TABLE>
<CAPTION>
GUEST ROOMS PUBLIC AREAS EXTERIOR
- ------------------------------ ------------------------------ ------------------------------
<S> <C> <C>
- - replacing all bedspreads, - replacing drapes and - repainting
linens, drapes and valances valances - installing new window
- - replacing all furniture - replacing wallpaper and treatments and grill work
- - adding televisions, vinyl wallcovering - modifying the facade
telephones with data ports - repainting - constructing port-cochere
and voicemail, clock radios, - recarpeting - repaving or seal coating
coffeemakers, irons and - redecorating parking lot
ironing boards - replacing furniture - adding lighting
- - replacing wallpaper and - rebuilding reception area - re-roofing
vinyl wallcovering - redesigning lobby for
- - repainting improved traffic flow
- - recarpeting - remodeling restaurant to
- - remodeling guestrooms, standards of regional or
including changing room national restaurant operator
layout and modifying closets - installing fire safety
- - remodeling guest bathrooms equipment, including
with new countertops, tile sprinklers and smoke
floors, plumbing fixtures, detectors
lights and valances
- - installing fire safety
equipment, including
sprinklers and smoke
detectors
</TABLE>
S-23
<PAGE> 24
The following table sets forth certain information with respect to the
Company's completed, pending and planned renovation and redevelopment
activities, including planned renovation and redevelopment activities for the
Kahler Hotels. The table includes renovation and redevelopment work on certain
of the Current Hotels completed by affiliates of the Company prior to the
transfer of the initial hotels to the Company in connection with the Initial
Public Offering. The table does not include work completed by any other prior
owners of the hotels. The table also includes completed and pending changes in
franchise affiliations:
CURRENT HOTELS -- RENOVATION OR REDEVELOPMENT
<TABLE>
<CAPTION>
REPLACE/ PUBLIC AREAS
EXPECTED TO BE REFURBISH -------------------
COMPLETED COMPLETED EXTERIOR RESTAURANT LOBBY
--------------- --------------- ---------- ----------- ------
<S> <C> <C> <C> <C> <C>
COURTYARD BY MARRIOTT:
Cypress, California........................................ June 1997 X X X
Fresno, California......................................... February 1994 X X X
Riverside, California...................................... June 1994 X X X
RESIDENCE INN BY MARRIOTT:
Oxnard, California......................................... May 1997 X X X
Highlands Ranch, Colorado.................................. September 1996 NEWLY CONSTRUCTED
HOLIDAY INN SELECT:
La Mirada, California...................................... February 1998 X X X
Renton (Seattle), Washington............................... July 1997 X X X
HOLIDAY INN HOTEL & SUITES:
Mesa, Arizona(1)........................................... October 1997 X X X
San Diego (Old Town), California........................... January 1998 X X X
Craig, Colorado............................................ April 1997 X
Price, Utah................................................ June 1997 X X X
Kent (Seattle), Washington................................. October 1996 X X
HOLIDAY INN:
Flagstaff, Arizona......................................... July 1997 X
San Diego (Harbor), California............................. July 1997 X X X
San Diego (Mission Valley), California..................... January 1998 X X X
Steamboat Springs, Colorado................................ June 1996 X X X
Provo, Utah................................................ June 1994 X X
June 1997 X
Lynnwood, Washington(1).................................... September 1998 X X X
HOLIDAY INN EXPRESS:
Portland, Oregon........................................... October 1996 X X
Poulsbo, Washington........................................ September 1996 X X
HAMPTON INN:
Mesa, Arizona.............................................. October 1997 X
Tucson, Arizona............................................ October 1997 X
Arcadia, California........................................ February 1997
Oakland, California........................................ July 1996 X X
Denver, Colorado........................................... June 1996 X
Pueblo, Colorado........................................... February 1997 X
Silverthorne, Colorado..................................... June 1996 X X
June 1997 X
Clackamas (Portland), Oregon............................... October 1996 X X
HAWTHORN SUITES:
Anaheim, California(1)..................................... December 1997 X
Sacramento, California(1).................................. February 1998 X X X
Kent, Washington........................................... December 1997
DOUBLETREE HOTEL:
Santa Fe, New Mexico....................................... April 1996 X X X
COMFORT SUITES:
South San Francisco, California............................ June 1997 X X
INDEPENDENT (REGENCY PLAZA):
Los Angeles, California.................................... September 1996 NEWLY CONSTRUCTED
<CAPTION>
ADD/UPGRADE GUEST ROOMS PRIOR
MEETING ------------------------------------ FRANCHISE
SPACE SOFT GOODS FURNITURE GUEST BATH AFFILIATION
------------ ----------- ---------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
COURTYARD BY MARRIOTT:
Cypress, California........................................ X X X X Ramada Hotel
Fresno, California......................................... X X X Hampton Inn
Riverside, California...................................... X X X X Days Inn
RESIDENCE INN BY MARRIOTT:
Oxnard, California......................................... X X X X Radisson Suites
Highlands Ranch, Colorado..................................
HOLIDAY INN SELECT:
La Mirada, California...................................... X X X X Holiday Inn
Renton (Seattle), Washington............................... X X X Holiday Inn
HOLIDAY INN HOTEL & SUITES:
Mesa, Arizona(1)........................................... X X X X Holiday Inn
San Diego (Old Town), California........................... X X X Ramada Hotel
Craig, Colorado............................................ X X X
Price, Utah................................................ X X X X Days Inn
Kent (Seattle), Washington................................. X X X X Cypress Inn
HOLIDAY INN:
Flagstaff, Arizona......................................... X X X
San Diego (Harbor), California............................. X X
San Diego (Mission Valley), California..................... X X X X Best Western
Steamboat Springs, Colorado................................ X X
Provo, Utah................................................ X X X X
Lynnwood, Washington(1).................................... X X X X Best Western
HOLIDAY INN EXPRESS:
Portland, Oregon........................................... X X X X Cypress Inn
Poulsbo, Washington........................................ X X X Cypress Inn
HAMPTON INN:
Mesa, Arizona.............................................. X X
Tucson, Arizona............................................ X X X X
Arcadia, California........................................
Oakland, California........................................ X X X
Denver, Colorado........................................... X X
Pueblo, Colorado........................................... X X X
Silverthorne, Colorado..................................... X X
Clackamas (Portland), Oregon............................... X X X X Cypress Inn
HAWTHORN SUITES:
Anaheim, California(1)..................................... X Independent
Sacramento, California(1).................................. X X X X Independent
Kent, Washington........................................... X X Independent
DOUBLETREE HOTEL:
Santa Fe, New Mexico....................................... X X X X Best Western
COMFORT SUITES:
South San Francisco, California............................ X X X
INDEPENDENT (REGENCY PLAZA):
Los Angeles, California....................................
</TABLE>
- ---------------
(1) The Company has obtained a franchise license from the applicable franchisors
to rebrand the hotel with the brand listed in the left-hand column of this
table, subject to the completion of redevelopment or renovation.
S-24
<PAGE> 25
KAHLER HOTELS -- PLANNED RENOVATION OR REDEVELOPMENT(1)
<TABLE>
<CAPTION>
PUBLIC AREAS
-------------------------------
COMPLETED OR REPLACE/ ADD/UPGRADE GUEST ROOMS
EXPECTED TO BE REFURBISH MEETING ----------------------------------
COMPLETED EXTERIOR RESTAURANT LOBBY SPACE SOFT GOODS FURNITURE GUEST BATH
--------------- ---------- ----------- ------ ------------ ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
HILTON:
Salt Lake City, Utah................ February 1998 X X X X X X X
SHERATON:
Chandler, Arizona................... December 1997 X X X
RESIDENCE INN BY MARRIOTT:
Provo, Utah......................... NEWLY CONSTRUCTED
HOLIDAY INN:
Rochester, Minnesota................ June 1998 X X X X X
QUALITY INN:
Pocatello, Idaho.................... June 1998 X X X X X X
BEST WESTERN:
Helena, Montana..................... September 1998 X X X X X X
Ogden, Utah......................... September 1998 X X X X X
Twin Falls, Idaho................... September 1998 X X X X X
INDEPENDENT:
BOISE PARK SUITES HOTEL -
Boise, Idaho...................... September 1998 X X X X X X X
KAHLER INN & SUITES -
Rochester, Minnesota.............. June 1998 X X X X X X X
KAHLER PLAZA HOTEL -
Rochester, Minnesota.............. June 1998 X X X X X
OLYMPIA PARK HOTEL & CONFERENCE
CENTER -
Park City, Utah................... May 1998 X X X X X X
PROVO PARK HOTEL -
Provo, Utah....................... June 1998 X X X X X
THE KAHLER HOTEL -
Rochester, Minnesota.............. November 1997 X X X X
UNIVERSITY PARK HOTEL & CONFERENCE
CENTER -
Salt Lake City, Utah.............. X X X
<CAPTION>
INTENDED
FRANCHISE
AFFILIATION(2)
-------------------------------------------
<S> <C>
HILTON:
Salt Lake City, Utah................ Hilton
SHERATON:
Chandler, Arizona................... Sheraton
RESIDENCE INN BY MARRIOTT:
Provo, Utah......................... Residence Inn by Marriott
HOLIDAY INN:
Rochester, Minnesota................ Holiday Inn
QUALITY INN:
Pocatello, Idaho.................... Courtyard by Marriott or Radisson
BEST WESTERN:
Helena, Montana..................... Courtyard by Marriott,
Holiday Inn or Other
Ogden, Utah......................... Marriott
Twin Falls, Idaho................... Holiday Inn or Courtyard by Marriott
INDEPENDENT:
BOISE PARK SUITES HOTEL -
Boise, Idaho...................... Holiday Inn Hotel & Suites or Radisson
KAHLER INN & SUITES -
Rochester, Minnesota.............. Kahler
KAHLER PLAZA HOTEL -
Rochester, Minnesota.............. Marriott
OLYMPIA PARK HOTEL & CONFERENCE
CENTER -
Park City, Utah................... Courtyard by Marriott or Other
PROVO PARK HOTEL -
Provo, Utah....................... Marriott
THE KAHLER HOTEL -
Rochester, Minnesota.............. Kahler
UNIVERSITY PARK HOTEL & CONFERENCE
CENTER -
Salt Lake City, Utah.............. To be determined
</TABLE>
- ---------------
(1) Does not include the Green Oaks Park Hotel in Texas or the Lakeview Resort
and Conference Center in West Virginia which the Company intends to sell or
exchange.
(2) Franchise applications have been submitted to the applicable franchisor but
are pending approval; however, there can be no assurance that such franchise
applications will be approved, or if approved, the cost or scope of the
renovations and improvements that will be required.
S-25
<PAGE> 26
COMPLETED RENOVATION AND REDEVELOPMENT ACTIVITIES
The following table sets forth certain information for each of the Current
Hotels for which redevelopment and marketing activities were completed through
August 31, 1997, indicating the combined effects of renovation, redevelopment,
repositioning and rebranding:
<TABLE>
<CAPTION>
PERIOD
DATE RENOVATED/ PURCHASE
BRAND ROOMS ACQUIRED REDEVELOPED PRICE
- ------------------------------------------------- ----- ------------- -------------------------- ------------
<S> <C> <C> <C> <C>
COURTYARD BY MARRIOTT:
Cypress, California............................ 180 January 1997 May - June 1997 $ 12,000,000
Fresno, California............................. 116 August 1995 (1) 5,303,000
Riverside, California.......................... 163 April 1996 (1) 4,000,000
RESIDENCE INN BY MARRIOTT:
Oxnard, California............................. 251 December 1996 February -May 1997 15,650,000
Highlands Ranch (Denver), Colorado............. 78 December 1995 Newly Constructed 5,400,000
HOLIDAY INN SELECT:
Renton (Seattle), Washington................... 226 June 1996 January - July 1997 8,150,000
HOLIDAY INN HOTEL & SUITES:
Price, Utah.................................... 151 August 1996 March - June 1997 4,500,000
Kent (Seattle), Washington..................... 125 February 1996 May - October 1996 4,596,000
HOLIDAY INN:
Flagstaff, Arizona............................. 157 October 1996 February - July 1997 7,600,000
San Diego (Harbor), California................. 218 January 1997 March - July 1997 9,000,000
Steamboat Springs, Colorado.................... 82 August 1995 November 1995 - June 1996 4,519,000
Provo, Utah.................................... 78 August 1995 (1)(3) 2,890,000
HOLIDAY INN EXPRESS:
Portland, Oregon............................... 84 February 1996 March - October 1996 2,114,000
Poulsbo, Washington............................ 63 February 1996 March - September 1996 2,416,000
HAMPTON INN:
Oakland, California............................ 152 December 1995 February - July 1996 4,400,000
Clackamas (Portland), Oregon................... 114 February 1996 June - December 1996 2,517,000
DOUBLETREE:
Santa Fe, New Mexico........................... 213 August 1995 January - July 1996 11,600,000
COMFORT SUITES:
South San Francisco, California................ 166 August 1996 February - June 1997 11,200,000
============
-----
Total/Average................................ 2,617 $117,855,000
===== ============
<CAPTION>
RENOVATION/
REDEVELOPMENT PRIOR FRANCHISE
BRAND COST AFFILIATION
- ------------------------------------------------- ------------- ---------------
<S> <C><C> <C>
COURTYARD BY MARRIOTT:
Cypress, California............................ $ 1,997,000 Ramada
Fresno, California............................. (2) Hampton
Riverside, California.......................... (2) Days Inn
RESIDENCE INN BY MARRIOTT:
Oxnard, California............................. 2,249,000 Radisson
Highlands Ranch (Denver), Colorado............. N/A N/A
HOLIDAY INN SELECT:
Renton (Seattle), Washington................... 4,895,000 Holiday Inn
HOLIDAY INN HOTEL & SUITES:
Price, Utah.................................... 1,943,000
Kent (Seattle), Washington..................... 1,650,000 Independent
HOLIDAY INN:
Flagstaff, Arizona............................. 1,306,000 N/A
San Diego (Harbor), California................. 3,238,000 N/A
Steamboat Springs, Colorado.................... 1,670,000 N/A
Provo, Utah.................................... (2) N/A
HOLIDAY INN EXPRESS:
Portland, Oregon............................... 1,400,000 Independent
Poulsbo, Washington............................ 870,000 Independent
HAMPTON INN:
Oakland, California............................ 900,000 Independent
Clackamas (Portland), Oregon................... 1,850,000 N/A
DOUBLETREE:
Santa Fe, New Mexico........................... 2,863,000 Best Western
COMFORT SUITES:
South San Francisco, California................ 2,085,000 N/A
===========
Total/Average................................ $28,916,000
===========
</TABLE>
- ---------------
(1) Renovation completed prior to the Company's Initial Public Offering.
(2) Included in the purchase price.
(3) The Provo Holiday Inn was undergoing additional renovation during the
majority of 1997.
S-26
<PAGE> 27
Comprehensive Marketing and Management Strategies. The hotels acquired by
the Company often lack adequate management and marketing programs. The Lessee
implements a full complement of management and marketing programs at each
acquired hotel designed to maximize sales and operational efficiency. The
Company believes that these marketing activities significantly contributed to
the growth in REVPAR for the Company's acquired Current Hotels during 1996 and
1997. On average, the Company believes that implementation of the required sales
program alone -- before any improvements to the physical condition of the hotel
are made by the Company -- has increased same-unit-sales REVPAR growth 14.4% for
the first three months following acquisition compared to the respective
corresponding periods in the prior year. The Lessee has also developed a sales
program to direct and manage the sales activities of personnel located at each
hotel and a program to ensure that staff is properly trained and that staffing
levels are efficient. As part of the required reporting process, each hotel must
contact every business within a five-mile radius to evaluate possible hotel use
and revenue potential. 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. See "Business and Properties -- The
Percentage Leases."
Restaurant Leases. The Company also subleases restaurant facilities in the
hotels (other than the Courtyard by Marriott Hotels) to regional or national
restaurant companies. The Company believes this strategy is beneficial because
it (i) allows the Lessee to concentrate on increasing room revenue, which
benefits the Company because of the higher percentage rent thresholds (from 60%
to 65%) than the 5% of food and beverage revenue it would otherwise receive, and
(ii) significantly enhances guest satisfaction by providing food service from
experienced national or regional restaurant companies. Fourteen of the Current
Hotels have restaurant facilities, ten of which the Lessee owns and operates and
four of which the Lessee has subleased to unaffiliated restaurant companies
including Old Chicago Bar & Grill, Mitzell American Restaurant, Ruby River Steak
House and Village Inn. The Lessee is actively seeking to sublease restaurants at
three of the Current Hotels that the Company currently operates.
Expansions. In certain cases, the Company may expand the number of rooms at
a hotel where it believes it can achieve a favorable return on the cost of such
expansion, and where occupancy, ADR and other market conditions are otherwise
believed to justify such expansion, and where building permits can be obtained.
The Company owns adjacent land at five of the Current Hotels suitable for
building additional rooms. However, the Company currently has no plans to expand
any of these hotels other than the 39 room expansion of the Residence Inn
(Highlands Ranch) expected to be completed in the fall of 1997.
S-27
<PAGE> 28
PORTFOLIO CHARACTERISTICS
National Franchise Affiliations
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. All of the
Current Hotels are represented by a national or regional franchise system. 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 table summarizes certain information with
respect to the current or anticipated franchise affiliations of the hotels:
FRANCHISE AFFILIATIONS
<TABLE>
<CAPTION>
PRO FORMA LEASE
REVENUES FOR THE
NUMBER OF SIX MONTHS ENDED PERCENTAGE OF PERCENTAGE
FRANCHISE AFFILIATION (1) HOTELS JUNE 30, 1997 LEASE REVENUES ROOMS OF ROOMS
- -------------------------------------- --------- ---------------- -------------- ----- ----------
<S> <C> <C> <C> <C> <C>
Marriott (2).......................... 13 $ 11,145,013 27.0% 2,441 25.7%
Holiday Inn........................... 18 9,011,659 21.8 2,819 29.5
Kahler(3)............................. 2 4,887,661 11.8 965 10.1
Hampton............................... 8 4,673,828 11.3 1,063 11.1
Hawthorn Suites (4)................... 3 2,872,610 6.9 583 6.1
Sheraton.............................. 1 2,754,714 6.7 295 3.1
Hilton................................ 1 2,687,056 6.5 351 3.7
Independent........................... 3 2,117,026 5.1 649 6.8
Doubletree Hotel...................... 1 432,823 1.0 213 2.2
Comfort Suites........................ 1 783,151 1.9 166 1.7
--- ------------ ----- ----- -----
Total....................... 51 $ 41,365,541 100.0% 9,545 100.0%
=== ============ ===== ===== =====
</TABLE>
- ---------------
(1) Several of the other Kahler Hotels will be branded or rebranded following
this Offering, 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 following
closing of the Kahler Acquisition. The Company has obtained approval of
these new franchise licenses, subject to completion of renovations or
improvements.
(3) Includes income from laundry operations.
(4) 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.
Regional Focus
The Company focuses its acquisition efforts principally on the Pacific and
Mountain regions which collectively comprise the western United States where
favorable supply and demand demographic trends currently exist. The western
United States has experienced and is projected to continue to have the highest
population growth of any region in the country. Population growth between 1990
and 1995 was 9.1% in the western region compared to 1.3% in the northeast, 3.6%
in the midwest and 7.5% in the south and is projected to be 9.9% between 1995
and 2000 in the west compared to 0.8%, 3.3% and 5.8% in the northeast, midwest
and south, respectively. In addition, between 2000 and 2005 the population in
the western United States is projected to grow 7.9% while the population growth
in the northeast, midwest and south is projected to grow
S-28
<PAGE> 29
1.1%, 2.1% and 5.3% respectively. The geographic distribution of the hotels,
which are located in 12 states, reflects the Company's belief that a certain
amount of geographic distribution helps to insulate the Company's hotel
portfolio from local market fluctuations that are typical for the hotel
industry. The Company has also sought to increase its geographic distribution by
focusing on major metropolitan areas. The following table summarizes the
Company's presence in each of these 12 markets including the Kahler Hotels:
LOCATION BY REGION
<TABLE>
<CAPTION>
PRO FORMA LEASE
REVENUES FOR THE
NUMBER SIX MONTHS ENDED PERCENTAGE OF PERCENTAGE
REGION OF HOTELS JUNE 30, 1997 LEASE REVENUES ROOMS OF ROOMS
------------------------------- --------- ---------------- -------------- ------ ----------
<S> <C> <C> <C> <C> <C>
Mountain (1)................... 24 $ 19,639,070 47.5% 4,280 44.9%
Pacific (2).................... 21 13,120,742 31.7 3,465 36.3
Minnesota...................... 4 7,159,346 17.3 1,329 13.9
Other(3)....................... 2 1,446,383 3.5 471 4.9
--- ------------ ----- ----- -----
Total................ 51 $ 41,365,541 100.0% 9,545 100.0%
=== ============ ===== ===== =====
</TABLE>
- ---------------
(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.
Description of Current Franchises
Courtyard by Marriott. Three of the Current Hotels are presently licensed
to operate as Courtyard by Marriott hotels. Courtyard by Marriott hotels seek to
offer guests moderately-priced lodging with superior accommodations. Courtyard
by Marriott hotels generally feature in-room coffee makers, a limited-service
restaurant and lounge and a tollfree reservation number. According to Marriott,
the first Courtyard by Marriott hotel was opened in 1983, and, as of June 30,
1997, there were over 317 Courtyard by Marriott hotels operating in the United
States, Mexico and Canada.
Residence Inn by Marriott. Two of the Current Hotels and one of the Kahler
Hotels are presently licensed to operate as Residence Inn by Marriott. Residence
Inn by Marriott is the most successful extended-stay hotel facility in the
industry. All Residence Inns offer suite accommodations and conveniences to
travelers such as fully equipped kitchens with cooking facilities and
appliances, table wares, comfortable living space and a bedroom area. Other
features include a complimentary breakfast buffet and evening social hour, a
weekly manager's dinner, pool, spa, fitness facility, an outdoor sport court,
and on-site laundry facilities. Residence Inn design and philosophy is to offer
guests all the conveniences of home in a suite that is 50% larger than a typical
hotel guest room.
Residence Inn by Marriott targets and has successfully achieved a 60% ratio
of extended stay guests staying five or more consecutive nights. In order to
achieves this high volume of extended stay guests, the brand directs its sales
and marketing efforts to attract training groups, disaster displaced
individuals, family relocations, and temporary assignments. As a hotel brand in
1996, Residence Inn achieved an industry leading 83% occupancy, the highest of
any hotel chain world-wide and also captured an ADR of $87.50. As of August 15,
1997, there were 255 Residence Inns in operation.
Holiday Inn Hotels. Fifteen of the Current Hotels are presently licensed to
operate as various Holiday Inn brand hotels, of which two remain subject to the
completion of certain renovations and improvements. Mr. Alter is a past
President of the International Association of Holiday Inns, the franchisee
association for Holiday Inn hotels, and, through his Affiliates, has been a
Holiday Inn franchisee since 1980. All Holiday Inn brand hotels participate in
the Holiday Inn Priority Club frequent guest program, and all offer a toll-free
S-29
<PAGE> 30
reservation number. As of August 15, 1997, there were 1,792 hotels with Holiday
Inn brands. Each of the Holiday Inn brands is described below.
Holiday Inn Select. Holiday Inn Select specializes in servicing the
business traveler. Each room offers a residential decor with a well lighted work
area including a dataport and voicemail, and an in-room coffee maker. Amenities
offered at the hotel include full business services such as photocopying and
telecopying, meeting capabilities for small to mid-size groups, swimming pool,
exercise facilities, and a full-service restaurant and lounge.
Holiday Inn Hotel & Suites. Holiday Inn Hotel & Suites are designed for
extended stay travelers who desire more room than is offered in a typical hotel
room. In general, at least 15% of a hotel's rooms generally must be suites in
order to qualify for this franchise. Suites generally include a hairdryer,
coffee maker, iron and ironing board, alarm/clock radio, microwave oven,
refrigerator, 25 inch television and a sofa bed. Amenities at the hotel
generally include guest laundry, fitness center, restaurant and lounge, free
continental breakfast, meeting facilities, and swimming pool. Convenience store
items are typically sold at a gift shop or other service area.
Holiday Inn. Holiday Inn hotels offer a full-service restaurant and
lounge, swimming pool, meeting and banquet facilities, optional fitness center,
and electronic locks. In-room amenities include a hairdryer, coffee maker, iron
and ironing board, alarm/clock radio and 25 inch televisions.
Holiday Inn Express. Holiday Inn Express is a limited-service hotel that
offers comfortable guest rooms that include a 25 inch television, alarm/clock
radio, and free local phone calls. A free continental breakfast on the hallmark
"breakfast bar" is also included in the Great Room/Lobby.
Hampton Inn Hotels. Eight of the Current Hotels are presently licensed to
operate as Hampton Inn hotels. Hampton Inn hotels seek to offer guests
consistent quality and value at all locations. Hampton Inn was among the first
hotel companies to offer guests an unconditional 100% satisfaction guarantee.
Most Hampton Inn hotels are limited service hotels that feature complimentary
continental breakfasts, free local telephone and in-room movie channel, a
toll-free reservation number and a special discount program for guests over 50
years of age, but do not generally provide a restaurant or lounge. According to
Hampton Inn, the first Hampton Inn hotel was opened August 1, 1984, and, as of
August 15, 1997, there were over 531 Hampton Inn hotels operating in the United
States, Mexico and Canada. In 1985, Mr. Alter and Mr. Biederman developed and
opened the Hampton Inn hotel in Aurora, Colorado, which was the fourteenth hotel
franchised in the Hampton Inn system.
Hawthorn Suites. One of the Current Hotels is presently licensed to operate
as a Hawthorn Suites hotel. One of the Company's external growth strategies is
to develop extended-stay Hawthorn Suites hotels in several major urban markets
on the west coast pursuant to the Master Development Agreement. See "Business
and Properties -- Growth Strategy -- External Growth Strategy -- Hawthorn Suites
Master Development Agreement." Hawthorn Suites offer travelers spacious suite
accommodations, a free breakfast buffet, swimming and fitness facilities and
other amenities designed to facilitate a more comfortable extended stay. Guest
suites include separate sleeping and living areas (many with fireplaces), fully
equipped kitchens, complimentary newspaper and manager's reception, irons and
ironing boards in every suite, on-site guest laundry facilities with available
valet service, on-site convenience store and grocery shopping services (at some
locations), business services, barbecue grills, airport shuttle service (at some
locations), and meeting facilities with full-service catering at most locations.
Hilton Hotels. One of the Kahler Hotels is presently licensed as a Hilton
Hotel franchise. Hilton is best known for its successful operation of world wide
full-service business, convention and resort hotels. Hilton's vision is to build
on the heritage and strength of a powerful industry name providing superior
facilities, services and amenities to meet the expectations of all guests.
Hilton's commercial hotels are designed primarily for business travelers
attending meetings and conventions in prime urban and suburban locations,
offering recreational and entertainment options that often attract leisure
travelers. Hilton has been long known and marketed as "America's Business
Address" providing a hassle-free hotel experience and with superior levels of
service. All commercial Hilton Hotels offer free premium channel television,
in-room coffee makers, two
S-30
<PAGE> 31
telephones with data ports, electronic voice mail, and world wide reservations.
Many hotels offer business centers, fitness facilities, recreation area and fine
dining restaurants in addition to Concierge level services. Honors continues to
be a rapidly growing and well followed frequent traveler program for Hilton
Hotels.
Sheraton Hotels. One of the Kahler Hotels is presently licensed as a
Sheraton Hotel. Sheraton Hotels targets the convention market and upscale
business and leisure travelers. ITT Sheraton has world-wide hotel locations,
particularly in resort, convention and destination markets. The Sheraton system
promotes a wide variety of services through hotels that encompass extensive
meeting space and upscale accommodations.
Doubletree Hotels. One of the Current Hotels is presently licensed to
operate as a full-service Doubletree hotel. Full-service Doubletree hotels are
targeted at business travelers, group meetings and leisure travelers, and range
in size from 120 to 720 rooms. Full-service Doubletree hotels typically include
a swimming pool, gift shop, meeting and banquet facilities, at least one
restaurant and cocktail lounge, room service, parking facilities and other
services. As of June 30, 1997, there were 101 full-service Doubletree hotels in
the United States and Mexico.
Ramada Inn Hotels. One of the Current Hotels is presently licensed to
operate as a Ramada Plaza Hotel. Ramada Hotels are a licensed division of
Hospitality Franchise Services. The Ramada Plaza brand is positioned in the
upper mid-level price segment, with product quality, services and amenities
designed for corporate travelers and upscale leisure guests. Ramada Plaza Hotels
offer a full line of services available to all guests including meeting room,
restaurant, and lounge facilities. As of August 15, 1997 the Ramada Inn division
had 935 hotels in operation.
Best Western International Hotels. One of the Current Hotels and three of
the Kahler Hotels are presently licensed to operate as Best Western hotels. Best
Western is the largest lodging brand in the world with more than 3,700
independently owned and operated hotel locations as of August 15, 1997. Best
Western embarked upon an image change within the last five years. The Best
Western chain primarily targets the mid-market traveler in both the Leisure and
Corporate market segments. Best Western remains most identifiable as a clean and
affordable lodging brand offered in many second and third tier cities, as well
as airport and primary city locations.
Comfort Suites. One of the Current Hotels is presently licensed to operate
as a Comfort Suites hotel. Comfort Suites have separate living and sleeping
areas, a 60 square foot oversized bath, a sleeper sofa, television, a
mini-refrigerator and microwave. The hotels also generally feature a two-story
vaulted lobby, on-site convenience store, meeting space, fitness center and
guest amenities such as a complimentary newspaper and continental breakfast.
According to Choice Hotels International, owner of the Comfort Suites franchise,
as of August 15, 1997 there were 81 Comfort Suites hotels.
Quality Inn Hotels. One of the Kahler Hotels presently operates pursuant to
a Quality Inn hotel franchise license. Quality Inn Hotels is a division of
Choice Hotels International, designed to meet the specific needs of today's
business traveler. Quality Inns offer well-established mid-priced lodging
facilities with a full range of amenities. The Quality Executive Room features
speakerphones with data ports, in-room coffee makers, oversized desks, upgraded
lighting, easyaccess electrical outlets, upgraded furnishings, and plush towels.
All hotels under the Quality Inn flag offer a 100% satisfaction guarantee. As of
August 15, 1997, there were over 3,200 hotels within the Choice Hotels
International system which includes Inns, Hotels, Suites and Resorts under the
Sleep, Comfort, Quality, Clarion, Econo Lodge, Rodeway and MainStay Suites brand
names.
S-31
<PAGE> 32
HOTELS
The following tables set forth certain information with respect to each
Current Hotel and each Kahler Hotel:
Current Hotels
<TABLE>
<CAPTION>
COMPLETION OF
NUMBER OF YEAR YEAR RENOVATION/
BRAND LOCATION ROOMS OPENED ACQUIRED REDEVELOPMENT
- ------------------------------- ----------------------------------- --------- ------ -------- -------------
<S> <C> <C> <C> <C> <C>
Courtyard by Marriott.......... Cypress, California 180 1990 1997 1997
Courtyard by Marriott.......... Fresno, California 116 1989 1995 1994
Courtyard by Marriott.......... Riverside, California 163 1988 1996 1994
Residence Inn by Marriott...... Oxnard, California 251 1987 1996 1997
Residence Inn by Marriott
(1).......................... Highlands Ranch (Denver), Colorado 78 1996 1995 1996
Holiday Inn Select............. La Mirada, California 289 1984 1997 1998*
Holiday Inn Select............. Renton (Seattle), Washington 226 1968 1996 1997
Holiday Inn Hotel & Suites..... Mesa, Arizona 246 1985 1996 1997*
Holiday Inn Hotel & Suites
(2).......................... San Diego (Old Town), California 151 1986 1997 1998*
Holiday Inn Hotel & Suites..... Craig, Colorado 152 1981 1995 1997
Holiday Inn Hotel & Suites..... Price, Utah 151 1984 1996 1997
Holiday Inn Hotel & Suites..... Kent (Seattle), Washington 125 1986 1996 1996
Holiday Inn.................... Flagstaff, Arizona 157 1987 1996 1997
Holiday Inn--Harbor View....... San Diego, California 218 1968 1997 1997
Holiday Inn--Mission Valley.... San Diego, California 174 1991 1997 1998*
Holiday Inn.................... Steamboat Springs, Colorado 82 1971 1995 1996
Holiday Inn.................... Provo, Utah 78 1968 1995 1994
Holiday Inn (2)................ Lynnwood, Washington 103 1978 1997 1998*
Holiday Inn Express............ Portland, Oregon 84 1986 1996 1996
Holiday Inn Express............ Poulsbo, Washington 63 1986 1996 1996
Hampton Inn.................... Mesa, Arizona 118 1987 1995 1997*
Hampton Inn.................... Tucson, Arizona 126 1986 1996 1997*
Hampton Inn.................... Arcadia, California 129 1989 1995 1997
Hampton Inn.................... Oakland, California 152 1986 1995 1996
Hampton Inn.................... Denver, Colorado 152 1986 1995 1996
Hampton Inn.................... Pueblo, Colorado 112 1986 1995 1997
Hampton Inn.................... Silverthorne, Colorado 160 1976 1995 1997
Hampton Inn.................... Clackamas (Portland), Oregon 114 1986 1996 1996
Hawthorn Suites (2)............ Anaheim, California 130 1992 1997 1997*
Hawthorn Suites (2)............ Sacramento, California 301 1988 1997 1998*
Hawthorn Suites................ Kent, Washington 152 1990 1997 1997*
Doubletree Hotel............... Santa Fe, New Mexico 213 1985 1995 1996
Comfort Suites................. South San Francisco, California 166 1985 1996 1997
Regency Plaza Hotel............ Los Angeles, California 178 1996 1997 1996
-----
Total 5,290
=====
</TABLE>
- ---------------
* Expected year of completion.
(1) The Company acquired the land in December 1995. The hotel opened in
September 1996 and is currently completing a 39 room expansion.
(2) The Company has obtained franchise licenses from the franchisors to rebrand
the hotel with the brands listed in this table, subject to completion of
renovations and improvements. See "Prospectus Supplement Summary -- Recent
Developments -- 1997 Acquisitions."
S-32
<PAGE> 33
The Kahler Hotels
SELECTED KAHLER OCCUPANCY, ADR AND REVPAR DATA
<TABLE>
<CAPTION>
ROOM ADR ($)
REVENUE(2) ----------------------------------
----------- SIX YEAR ENDED
YEAR YEAR MONTHS DECEMBER 31,
# OF OPENED/ ENDED ENDED ------------------------
CURRENT BRAND LOCATION ROOMS REDEVELOPED 12/31/96 6/30/97 1996 1995 1994
- ------------------------------ -------------------- ----- ------------ ----------- ------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Hilton........................ Salt Lake City, Utah 351 1975/1997 $ 8,259,702 86.58 74.67 62.39 57.48
Sheraton...................... Chandler, Arizona 295 1987/1998 7,432,365 108.74 92.83 83.48 80.72
Residence Inn by Marriott..... Provo, Utah 114 1996 /N/A N/A 78.97 N/A N/A N/A
Holiday Inn................... Rochester, Minnesota 170 1969/1998 2,526,855 64.66 62.42 60.33 59.90
Quality Inn................... Pocatello, Idaho 152 1976/1998 1,921,877 49.81 49.62 50.64 51.59
Best Western.................. Helena, Montana 149 1971/1988 1,856,064 61.40 61.84 60.98 58.81
Best Western.................. Ogden, Utah 288 1982/1998 4,108,748 59.19 55.47 54.31 53.38
Best Western.................. Twin Falls, Idaho 112 1974/1998 1,676,294 56.09 54.51 54.51 52.13
Boise Park Suites Hotel....... Boise, Idaho 238 1991/1998 3,105,613 68.17 65.94 63.20 61.30
Green Oaks Park Hotel......... Fort Worth, Texas 284 1964/1998 3,575,424 53.29 51.50 50.96 49.78
Kahler Inn & Suites........... Rochester, Minnesota 266 Various/1998 4,317,880 75.46 73.31 72.94 72.73
Kahler Plaza Hotel............ Rochester, Minnesota 194 1991/1998 6,043,735 122.00 112.84 108.97 104.00
Lakeview Resort & Conference
Center....................... Morgantown, West 187 Various/1998 3,261,781 86.32 87.30 80.73 83.70
Virginia
Olympia Park Hotel and
Conference Center............ Park City, Utah 203 1985/1998 3,630,067 93.76 69.88 70.77 63.72
Provo Park Hotel.............. Provo, Utah 333 1982/1998 4,248,555 76.19 69.84 65.50 57.84
1998
The Kahler Hotel.............. Rochester, Minnesota 699 Various/1998 10,704,492 68.15 66.82 64.29 63.58
University Park Hotel &
Conference Center............ Salt Lake City, Utah 220 1987/1998 4,576,615 82.99 73.16 69.35 65.68
----- ----------- ------ ------ ------ ------
Subtotal/Weighted Average..... 4,255 $71,246,067 76.98 70.92 67.70 65.27
===== =========== ====== ====== ====== ======
<CAPTION>
OCCUPANCY (%) REVPAR ($)
---------------------------- -------------------------------
SIX YEAR ENDED SIX YEAR ENDED
MONTHS DECEMBER 31, MONTHS DECEMBER 31,
ENDED ------------------ ENDED ---------------------
CURRENT BRAND 6/30/97 1996 1995 1994 6/30/97 1996 1995 1994 INTENDED BRAND(1)
- ------------------------------ ------- ---- ---- ---- ------- ----- ----- ----- ---------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Hilton........................ 82.7 86.6 86.5 88.5 71.62 64.65 53.98 50.85 Hilton
Sheraton...................... 79.4 74.6 75.8 69.5 66.36 69.22 63.24 56.08 Sheraton
Residence Inn by Marriott..... 52.2 N/A N/A N/A 41.18 N/A N/A N/A Residence Inn by Marriott
Holiday Inn................... 72.7 65.4 64.2 63.6 47.03 40.83 38.71 38.09 Holiday Inn
Quality Inn................... 67.7 70.0 66.9 72.4 33.73 34.74 33.89 37.35 Courtyard by Marriott or
Radisson
Best Western.................. 74.2 72.4 74.0 73.0 45.54 45.63 44.89 43.03 Courtyard by Marriott,
Holiday Inn or Other
Best Western.................. 69.5 70.7 71.4 71.5 38.19 39.19 38.76 38.19 Marriott
Best Western.................. 69.1 72.0 73.7 N/A 36.78 41.12 40.18 40.26 Holiday Inn or Courtyard by
Marriott
Boise Park Suites Hotel....... 60.6 61.3 79.6 81.0 41.29 40.44 50.33 49.66 Holiday Inn Hotel & Suites
or Radisson
Green Oaks Park Hotel......... 66.4 67.2 63.6 61.0 35.37 34.59 32.40 30.35 To be sold or exchanged
Kahler Inn & Suites........... 57.0 60.6 59.7 60.0 43.02 44.60 43.58 43.62 Kahler
Kahler Plaza Hotel............ 74.2 75.8 76.7 73.5 80.49 85.59 83.60 76.44 Marriott
Lakeview Resort & Conference
Center....................... 53.9 54.8 82.3 57.1 46.53 47.92 50.32 47.83 Scheduled to be sold or
exchanged
Olympia Park Hotel and
Conference Center............ 68.3 70.3 56.6 55.7 64.04 49.13 40.02 35.49 Courtyard by Marriott or
Other
Provo Park Hotel.............. 55.8 72.0 75.0 74.3 42.53 50.31 49.12 42.85 Marriott
The Kahler Hotel.............. 62.4 63.1 59.7 59.4 42.52 42.19 38.40 37.78 Kahler
University Park Hotel &
Conference Center............ 80.5 78.1 75.7 75.9 66.81 57.15 52.49 49.66 To be determined
----- ---- ---- ---- ----- ----- ----- -----
Subtotal/Weighted Average..... 67.5 69.5 68.8 67.9 51.93 49.26 46.61 44.33
===== ==== ==== ==== ===== ===== ===== =====
</TABLE>
- ---------------
(1) Franchise applications have been submitted but are pending approval;
however, there can be no assurance that such franchise applications will be
approved, or if approved, the nature and scope of the renovations and
improvements that will be required.
(2) Room revenue includes all revenue of non-consolidated properties and the
properties managed for others. Under generally accepted accounting
principles, this revenue is not included in revenue of owned operations and
the Company's interest in non-consolidated properties is reflected in the
Consolidated Statements of Operations as equity in earnings of affiliates.
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<PAGE> 34
Operating Performance of the Hotels
The following table sets forth certain summary information regarding
average occupancy, ADR and REVPAR data on a same-unit sales basis for the
Current Hotels and the Kahler Hotels:
SELECTED OCCUPANCY, ADR AND REVPAR DATA
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------ -----------------
1996 1995 1997 1996
------- ------ ------ ------
<S> <C> <C> <C> <C>
ALL CURRENT HOTELS:
Occupancy.................................... 64.90% 66.90% 67.40% 66.70%
ADR.......................................... $ 62.13 $58.04 $67.74 $63.97
REVPAR....................................... $ 40.30 $38.82 $45.68 $42.67
REVPAR Growth................................ 3.80% 7.10%
NON-RENOVATION CURRENT HOTELS(1):............
Occupancy.................................... 66.70% 66.20% 73.10% 68.90%
ADR.......................................... $ 62.01 $57.51 $68.92 $65.15
REVPAR....................................... $ 41.38 $38.08 $50.40 $44.90
REVPAR Growth................................ 8.70% 12.30%
RENOVATION CURRENT HOTELS(2):
Occupancy.................................... 54.50% 66.20% 63.00% 65.00%
ADR.......................................... $ 62.72 $60.17 $66.68 $63.02
REVPAR....................................... $ 34.17 $39.85 $42.00 $40.97
REVPAR Growth................................ (14.30%) 2.50%
KAHLER HOTELS:
Occupancy.................................... 69.50% 68.80% 67.50% 69.60%
ADR.......................................... $ 70.92 $67.70 $76.98 $72.93
REVPAR....................................... $ 49.26 $46.61 $51.93 $50.73
REVPAR Growth................................ 5.70% 2.40%
</TABLE>
- ---------------
(1) Non-Renovation Current Hotels are those Current Hotels that had minor or no
expenditures for renovation during the respective periods of 1995, 1996 and
1997.
(2) Renovation Current Hotels are those Current Hotels that had significant
expenditures for renovation or redevelopment during the respective periods
of 1995, 1996 and 1997 and includes three, eight and eleven Current Hotels,
respectively.
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<PAGE> 35
Description of the Hotels
Franchised Hotels
LOGO
Marriott Hotel and Convention Center -- Pueblo, CO: Construction has
begun on the 168 room Marriott Hotel which is anticipated to open
around July 1998. The hotel will have a corridor connected to a new
55,000 square foot Convention Center that opened in downtown Pueblo
in early 1997. The Marriott Hotel will be the finest hotel facility in the
greater Pueblo area and will provide high quality guest room accommodations with
state-of-the-art features with design and decor appointments of high appeal. A
full-service restaurant and lounge will be provided to all guests along with an
indoor pool, spa, fitness center, and on-site meeting room facilities to 150
people. The hotel will work in tandem with the Convention Center management to
secure large groups and associations to the City of Pueblo. The City has begun
its first phase of a River Walk District that will be lined with restaurant and
entertainment complexes and is expected to be open by the year 2000.
LOGO
Hilton Hotel -- Salt Lake City, UT: This hotel was constructed in
1975 and is currently undergoing an extensive renovation in excess of
$9.5 million targeted for a complete interior and exterior upgrade.
The hotel is located in the center of Salt Lake City with immediate
access to I-15 and I-80, Salt Lake International Airport is 10
minutes away, and seven world class ski resorts are within 45 minutes of the
hotel. This full-service hotel provides 351 guest rooms including 33 suites, an
executive concierge level providing check-in and check-out service a
complimentary continental breakfast and evening social hour. All guest rooms
will provide an electronic key system, coffee makers, two data port telephones,
voice message, iron and ironing board, hair dryers, upscale bathroom toiletries,
and a 25 inch television. Other facilities offered include an outdoor pool,
sauna, spa, fitness center, game room, business center, valet and free parking,
gift and retail shops, ski rentals, three restaurants, lounge, and 21
meeting/banquet rooms with over 34,000 square foot of total meeting and exhibit
space. Complimentary shuttle is provided to Salt Lake International Airport.
LOGO
Sheraton San Marcos Hotel Golf Resort and Conference
Center -- Phoenix (Chandler), AZ: This hotel was originally built in
1913 and then closed from 1979 to 1987. In 1987, there were 250 new
guest rooms added to the 45 rooms that remained from a 1962 addition,
thus bringing the total to 295 guest rooms. Location is a convenient
18 miles from Phoenix International Airport, 12 miles from Arizona
State University and the Phoenix Zoo, and is less than 5 minutes from Compadre
Stadium, home of the Milwaukee Brewers spring training facility. An 18 hole PGA
rated golf course and pro-shop are located on the site with the hotel, creating
a Golf Resort environment. Features of the hotel include two large heated pools
lighted tennis courts, fitness room, jogging trail, grass volleyball, gift shop,
beauty salon, business center, two restaurants, and Mulligan's Clubhouse Lounge.
There are 18 meeting rooms on-site that can accommodate up to a total of 700
people, and there is a 7,200 square foot outdoor pavilion available for special
events.
LOGO
Courtyard by Marriott -- Cypress, CA: This seven story 180 room
interior corridor hotel opened in 1990 and has just completed an
entire remodel and flag change to Courtyard by Marriott. Positioned
in the heart of an upscale business and industrial park, this hotel
has high appeal to many large corporations such as Pacific Health
Care, Mitsubishi Electronics, Mitsubishi Motors, and Yamaha. The hotel is
conveniently located for quick access to four major Los Angeles area Freeway
systems, 15 miles from the Orange County Airport, 30 miles from the Los Angeles
International Airport, one-half a mile from Los Alamitos Race Track, 8 miles
from Knott's Berry Farm, and 10 miles from Disneyland in Anaheim. All guest
rooms offer a variety of standard features such as an electronic key system,
coffee makers, two data port telephones, voice message, iron and ironing board,
hair dryers, and a 25 inch television. The total room count includes 20 two-room
suites with a comfortable living area, bedroom separated by French doors,
microwave, refrigerator, and wet bar. Other hotel features include an outdoor
pool, restaurant, lobby lounge, a full line gift shop, 5,000 square feet of
meeting and breakout facilities. Complimentary shuttle service is provided to
the Orange County Airport, nearby corporate offices and attractions.
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<PAGE> 36
LOGO
Courtyard by Marriott -- Fresno, CA: This hotel was built in 1989 and
is a four story interior corridor hotel with 116 modern guest rooms.
Location is at the entry to Fresno Airport and in close proximity to
Fresno State University, 52 miles from Yosemite National Park and 57
miles from Kings Canyon National Park. Each guest room offers many standard
amenities such as an electronic key system, coffee makers, two data port
telephones, voice message, iron and ironing board, hair dryers, and a 25 inch
television. There is an on-site limited service restaurant and lounge, outdoor
pool and spa, fitness room, and two small conference rooms. Complimentary
shuttle service is provided to the Fresno Airport.
LOGO
Courtyard by Marriott -- Riverside, CA: This six story all interior
corridor hotel opened in 1988. It is located in convenient proximity
to the University of California at Riverside, and is 15 miles from
Ontario International Airport, Ontario Mills Outlet Mall, and the new
California Speedway. The hotel is positioned midway between Los
Angeles and Palm Springs, 50 miles in either direction. Guest rooms offer
amenities such as an electronic key system, coffee makers, two data port
telephones, voice message, iron and ironing board, hair dryers, and a 25 inch
television. Available facilities include a limited service restaurant, lobby
lounge, outdoor heated pool and spa, and meeting facilities accommodating up to
150 people.
LOGO
Residence Inn by Marriott -- Oxnard, CA: The Residence Inn in Oxnard
was built in 1987 in an exterior residential style environment with
32 buildings of eight suites each for total of 251 suite
accommodations. The hotel is adjacent to the 18th fairway of the PGA
rated River Ridge Golf Course and is located one mile from Highway
101. The hotel is a close proximity to Port Hueneme, Point Mugu
military installation, Oxnard Beaches and Marina, 35 miles north of Malibu and
Santa Barbara is 35 miles north. The hotel offers two suite floor plans and all
provide amenities such as a comfortable living area, bedroom area with two data
port telephones, voice message, iron and ironing board, hair dryer, and a 25
inch television. The kitchen area is fully equipped with a stove, refrigerator,
dishwasher, microwave, coffee maker, cookware, and tableware utensils. The
Penthouse Suite provides a second television in the bedroom area and an
additional bathroom. The gate house lobby features the Hearth Room where guests
are provided with a complimentary breakfast buffet, weekday evening social hour,
Wednesday evening Manager's Dinner, a large screen television with comfortable
seating. This hotel provides extensive meeting space with a 5,000 square foot
ballroom and total meeting/banquet space of 12,000 square feet. Other hotel
features include five lighted tennis courts, sports court, two heated outdoor
pools and three spas, guest laundry, fitness center, and guest shopping service.
LOGO
Residence Inn by Marriott -- Denver (Highlands Ranch), CO: The
Residence Inn at Highlands Ranch was opened in September 1996 with 78
suites in a four story, two building all interior structure. The
hotel is conveniently located along Highway C-470 and 15 miles south
of downtown Denver, three miles from the new Fiddlers Green Park
Meadows Mall, Arapahoe Racing Park, and 20 miles to the Factory
Outlet Mall and Roxborough State Park. The ski areas of Summit County are less
than 70 miles from the hotel. A variety of restaurants, a new multi Cinema
facility, and shopping plazas are within walking distance of the hotel. The
hotel offers three suite floor plans and all provide amenities such as a
comfortable living area, bedroom area with two data port dual line telephones,
voice message, iron & ironing board, hair dryer, and a 25 inch television. The
kitchen area is fully equipped with a stove, refrigerator, dishwasher,
microwave, coffee maker, cookware, and tableware utensils. The one and two
bedroom suites offer a second television and a private bedroom area. The gate
house lobby features a complimentary breakfast buffet, weekday evening social
hour, Wednesday evening Manager's Dinner, a large screen television with
comfortable seating, and a meeting facilities that can accommodate up to 75
guests. Other hotel features include a sports court, heated outdoor pool and
spa, guest laundry, fitness center, and guest shopping service.
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<PAGE> 37
LOGO
Residence Inn by Marriott -- Provo, UT: This hotel opened for
business in December 1996 with 114 one and two-bedroom suites in an
all interior corridor four story facility. Located in central Provo,
the hotel is a convenient one mile from Brigham Young University and
three miles from I-15, and is a short drive to the Sundance Ski
Resort, and 45 miles from Salt Lake City. All suites offer a
comfortable living area, bedroom area with two data port dual line telephones,
voice message, iron and ironing board, hair dryer, and a 25 inch television. The
kitchen area is fully equipped with a stove, refrigerator, dishwasher,
microwave, coffee maker, cookware, and tableware utensils. The one bedroom suite
offers a private bedroom area and a second television. The Gate House lobby
features a complimentary breakfast buffet in the Hearth Room, weekday evening
social hour, Manager's weekly dinner gathering, a large screen television with
comfortable seating, and meeting facilities that can accommodate up to 30
people. Other hotel features include a sports court, indoor pool and spa, guest
laundry, fitness center, and guest shopping service. A variety of movie theaters
and restaurants are within a short walk of the hotel.
LOGO
Holiday Inn Select -- La Mirada, CA: This hotel will complete its
proposed $3.5 million renovation and upgrade from a core brand
Holiday Inn to an upscale Holiday Inn Select by February 1998. This
eight story all-interior corridor hotel was built in 1984 and offers
289 well appointed guest rooms including two floors of Executive
Level rooms with a Concierge Lounge. The hotel is immediately
accessible from I-5 at the Valley View exit, a highly traveled area within LA
County. Nearby attractions include Knott's Berry Farm four miles, Disneyland and
the Anaheim Convention Center eight miles, 20 miles to Orange County Airport,
and 30 miles to Los Angeles International Airport. All guest rooms include
upgraded features such as electronic key system, coffee makers, two data port
telephones, voice message system, irons and ironing boards, hair dryers, and a
25 inch television. Other features include an outdoor pool and heated spa,
fitness room, men's and women's saunas, a full line gift shop, guest laundry
facilities, and complimentary shuttle to nearby attractions and corporate
offices. The hotel offers a full service restaurant, lounge, and 13,000 square
feet of flexible meeting space.
LOGO
Holiday Inn Select -- Renton (Seattle), WA: Original construction on
this hotel occurred in 1968 and consists of an all interior corridor
six story tower connected to a three story annex building. In August
1997 an extensive six month exterior and interior refurbishment was
completed. In addition to the remodel of all guest areas, the night
club on the 6th floor was removed and an entire floor of executive
level guest rooms was added, thus raising the room count to 226 rooms from its
previous 188. The hotel is well positioned in the heart of major corporate
centers such as Boeing, five miles from SEATAC International Airport, and a
convenient 12 miles to downtown Seattle. It's prime location at I-405 and
Highway 167 make it an excellent location choice to businesses in Kent, Renton,
Tukwilla, SEA-TAC, and Bellevue area. The hotel now offers 226 deluxe guest
rooms, two floors of Executive Level rooms, Concierge lounge, the Yankee Grill
restaurant, lounge, and meeting facilities to 300 people. All rooms include
large well lighted desk work areas with a fully upholstered swivel desk chair,
electronic key system, coffee makers, two data port telephones, voice message
system, irons and ironing boards, hair dryers, and a 25 inch remote control
television. Many rooms on the Executive Levels offer two-room suites with full
kitchen facilities. The completely refurbished pool and spa area are now an
excellent compliment to the hotel and a modern fitness facility is available on
site. Free airport transportation and 24 hour bellman service are a few
amenities that make this hotel the most desired lodging choice in Renton.
LOGO
Holiday Inn Hotel & Suites -- Mesa, AZ: The first phase of this
hotel, a six floor interior corridor hi-rise was constructed in 1985
and housed 244 guest rooms, including two penthouse suites. A couple
years following the opening a second hi-rise was constructed which
consists of 84 two-room suites. The hotel is in the final stage of a
$3.5 million renovation to fully upgrade the interior and exterior
appearance of the facility. The lobby area has been reconfigured to offer a far
more inviting atmosphere upon arrival. Features of the hotel include a full
service restaurant, lounge, fitness center, an outdoor lushly landscaped pool
and spa area, and 8,000 square feet of meeting and breakout facilities. Each
guest room offers an electronic key system, coffee makers, two data port
telephones, voice message, irons and ironing boards, hair dryers, and 25 inch
televisions. Every suite provides a microwave and refrigerator unit in addition
to the standard guest room amenities. Located adjacent to the Superstition
Freeway, a main east-west transportation corridor makes this hotel extremely
convenient to a number of large corporations such as Motorola and Intel. The
hotel is within 12 miles of Phoenix International Airport, six miles west of
Arizona State University in Tempe, 90 miles Southwest of Tucson, 150 miles South
of the Grand Canyon and 300 miles from the Los Angeles basin. Mesa is also home
to the Chicago Cubs spring training program.
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<PAGE> 38
LOGO
Holiday Inn Hotel & Suites -- San Diego (Old Town), CA: This hotel
currently consists of 151 guest rooms and is located with convenient
access to I-5 and within 3 blocks of the heart of the Old Town
Shopping District, a high visibility tourist attraction. The existing
hotel, a four story all interior corridor building, will undergo an
extensive renovation by the end of 1997 and new construction will
begin on a 27-suite and standard guest room structure that will be designed for
immediate access to the main entry drive and the hotel lobby. The new guest room
building is expected to be completed by August 1998. The hotel also features a
variety of amenities such as Business Class rooms, coffee makers, two data port
telephones, and irons and ironing boards. Additional amenities will be added to
all guest rooms as part of the redevelopment program. Also available to guests
is an on-site restaurant, lounge, meeting facilities for up to 150 people, and
an outdoor pool and spa. The hotel is located across the I-5 Freeway of the
SPA-WARS facility and within three miles of Sea World, downtown San Diego and
Lindbergh Field Airport. The hotel is in a great location that is limited to any
new supply by the extensive barriers to entry centered around the Old Town
District.
LOGO
Holiday Inn Hotel & Suites -- Craig, CO: This all interior corridor
hotel was built in 1981 and consists of 152 guest rooms and two-room
suites. Suites offer two full rooms separated by French doors and are
equipped with cooking facilities for extended stay travelers. The
hotel features a fully enclosed Holidome recreational facility with
an indoor pool, spa, children's play area, fitness center, 3,000
square feet of meeting space and a well appointed Boardroom. All guest rooms are
equipped with an electronic key system, coffee makers, two data port telephones,
voice message, irons and ironing boards, hair dryers, and 25 inch televisions.
The full service restaurant and lounge are well followed by hotel guests and
local patrons. Located in the northwest hills of Colorado the area offers many
outdoor interests such as hiking, hunting, fishing, bicycling, and guided
wilderness tours. The hotel is 45 miles west of the Steamboat Springs Ski Area
and is accessible by automobile or 20 miles from Hayden Regional Airport.
LOGO
Holiday Inn Hotel & Suites -- Price, UT: This hotel which was
constructed in 1984 is a 151 room all interior corridor hotel with a
substantial number of suite accommodations. The economy in Price is
centered around coal mining, agriculture, tourism, camping, trail
rides through the Nine Mile Canyon, Dinosaur Museum, Margi-La Sal
National Forest and the College of Eastern Utah. Located 135 miles
southeast of Salt Lake City, Price is conveniently accessible by plane or
automobile. Each hotel guest room features an electronic key system, coffee
makers, two data port telephones, voice message, irons and ironing boards, hair
dryers, and 25 inch televisions. Meeting facilities and breakout rooms can
accommodate up to 250 people. The on-site lounge is a favorite spot for hotel
guests and local patrons. The new food court facility is sure to be a hit with
leisure and corporate travelers. This hotel is the premier hotel and meeting
facility within a 100 mile radius of Price.
LOGO
Holiday Inn Hotel & Suites -- Kent (Seattle), WA: A convenient
suburban location within 20 miles of downtown Seattle, this 125 room
hotel was built in 1986 and consists of two floors of guest rooms
including 32 two-room suites. The hotel is conveniently located to
Highway 167, and is four miles from Boeing's Space and Defense
Research/Development facility, eight miles from SEA-TAC International
Airport, 10 miles from Auburn Horse Race Course, and 90 miles from Mount Ranier.
The hotel features a Complimentary Deluxe Continental Breakfast every morning in
a comfortable guest library adjacent to lobby. The hotel also offers Mitzel's
American Kitchen for dining or room service pleasure. All guest rooms are fully
refurbished and include amenities such as electronic key system, coffee makers,
two data port telephones, voice message, irons and ironing boards, hair dryers,
and 25 inch televisions. Meeting and breakout facilities accommodate up to 150
people. A large seasonal outdoor pool and heated spa are available to guests
along with a well equipped fitness center.
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<PAGE> 39
LOGO
Holiday Inn -- Flagstaff, AZ: This hotel is located on the east side
of Flagstaff and immediately accessible to Interstate 40. Built in
1987, the hotel consists of 157 guest rooms in a five story all
interior corridor structure. A recent exterior and interior
renovation have well positioned this hotel for future years to
compete in the local market. The primary attraction to the Flagstaff
area is the southern rim of the Grand Canyon only 70 miles north. Northern
Arizona State University is three miles, Flagstaff Airport is six miles, and
Sedona is 25 miles from the hotel. Other nearby attractions include Meteor
Crater, Walnut Canyon, Petrified Forest, and the Painted Desert. Each newly
refurbished guest room offers an electronic key system, coffee makers, two data
port telephones, voice message, irons and ironing boards, hair dryers, and 25
inch televisions. Other features available to guests include an indoor & outdoor
pool facility, restaurant, lounge, game room, and meeting facilities for up to
75 people. Complimentary shuttle service is available to the airport, Amtrak,
and bus terminal.
LOGO
Holiday Inn Harbor View -- San Diego, CA: This 16 story hi-rise
hotel, built in 1968, has recently completed a $4 million exterior
and interior renovation. The hotel is now well positioned to compete
for its fair share of the downtown San Diego corporate market. With
immediate access to I-5, the hotel is also conveniently located
one-half a mile from the harbor water front, two miles from San
Diego's Lindburgh Field Airport, three miles from the Old Town District, four
miles from Sea World and the San Diego Zoo, 15 miles from the Mexico border, and
90 miles from the greater Los Angeles area. The 218 room facility now offers
completely modern guest room accommodations featuring an electronic key system,
oversized well lighted desk work area with a fully upholstered swivel desk
chair, coffee makers, two data port telephones, voice message, irons and ironing
boards, hair dryers, and a 25 inch television. The top floor was recently
converted into 12 oversized executive level rooms with an panoramic view of the
city. A meeting facility is provided on the top floor for up to 75 people.
Hazelwoods Cafe is located on the first floor and provides sit-down or grab and
go service for all three meal periods. A fitness center and outdoor pool area
are provided year round. Complimentary shuttle service to the Airport, downtown
and most major attractions is available to all guests.
LOGO
Holiday Inn Mission Valley/Stadium -- San Diego, CA: This hotel,
built in 1991, is a four story all interior corridor structure and
provides 174 guest rooms, including 18 two-room suites. The hotel is
positioned with immediate access to I-15, within walking distance of
various eateries, shopping and a business center. Located one and
one-half mile from the hotel is QualComm Stadium, home to the San
Diego Padres, Chargers and the 1998 Super Bowl. Sea World is located five miles
from the hotel and downtown San Diego and Lindbergh Field Airport are eight
miles. All guest rooms include an electronic key system, mini-refrigerators,
coffee makers, irons and ironing boards, and hair dryers. Other features include
an outdoor pool and jacuzzi, fitness room, guest laundry, restaurant, and a
meeting facility and breakout rooms to accommodate up to 250 people.
LOGO
Holiday Inn -- Steamboat Springs, CO: The hotel was built in 1971, is
a two story interior corridor construction and provides 82 deluxe
guest room accommodations. The hotel is conveniently located on the
main highway passing through the City of Steamboat Springs and is
within two miles of the world class Steamboat Ski area and many other
winter activities Steamboat Springs is serviced by and located 20
miles from Hayden Regional Airport. Other seasonal activities nearby include
fishing, mountain climbing, hunting, hot air-ballooning, rafting, and golf. A
$2.5 million renovation was completed in mid 1996 which included all guest
rooms, corridors, lobby, commercial areas, restaurant, pool/spa, and the
building exterior. Each guest room offers amenities such as an electronic key
system, coffee makers, two data port telephones, voice message, irons and
ironing boards, hair dryers, and a 25 inch television. The hotel provides
shuttle service to the ski area and downtown, an outdoor heated pool and large
hot tub, an on-site ski rental shop, meeting facility, the Fireside lounge, and
the Village Inn Restaurant.
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<PAGE> 40
LOGO
Holiday Inn Downtown -- Rochester, MN: The Holiday Inn Rochester was
built in 1969 and is a high-rise structure with 170 guest rooms and
69 private condominiums on the floors above the guest rooms. The
hotel is located in the heart of the downtown cultural and commercial
center and is connected the Mayo Medical Complex and the Mayo Civic
Center by way of the city's climate controlled pedestrian skyway
system. The hotel is less than a 10 minute drive to Rochester International
Airport and the IBM-Rochester facility, and 90 miles south of Minneapolis. Guest
rooms feature a variety of amenities for guest convenience. Features of the
hotel include a lobby atrium area, the Garden Grill Restaurant, the Sports Page
Lounge, and meeting facilities for up to 250 people.
LOGO
Holiday Inn -- Provo, UT: Holiday Inn Provo is located a convenient
45 miles south of Salt Lake City International Airport and
immediately accessible to Interstate 15. The 78 room all interior
corridor facility was constructed in 1968 and has recently finished
an extensive exterior upgrade which now projects a completely new and
modern appearance. The hotel is within one-half a mile of Novell
Software headquarters and East Bay Industrial Park, within three miles of
Brigham Young University, and is a short drive from the Sundance Ski Area. The
city of Provo is currently developing a major regional indoor retail mall
facility with four anchor stores which is directly adjacent to the hotel. All
guest rooms offer an electronic key system, coffee makers, two data port
telephones, voice message, irons and ironing boards, hair dryers, and 25 inch
televisions. All guests receive a complimentary continental breakfast buffet,
and can enjoy the outdoor heated pool. The hotel is home to the extremely
successful Ruby River Steak House and Lounge, a local leased operator. Meeting
and breakout facilities accommodate up to 150 people.
LOGO
Holiday Inn -- Lynnwood, WA: The 103 room all interior corridor hotel
was built in 1978 and consists of five floors of guest rooms.
Location is adjacent to I-5 and is 15 miles north of downtown
Seattle, 30 miles from SEA-TAC International Airport, 12 miles from
the Boeing assembly facility, and is nearby waterfront ferries,
fishing and many other seasonal activities. Skiing and hiking areas
are within 50 miles of the hotel. Features offered by the hotel include deluxe
continental breakfast, indoor heated pool and jacuzzi, exercise facility, free
local phone calls, extensive meeting facilities, and an on-site restaurant with
room service. The hotel is positioned on a six acre land parcel which is
designated for the future sites of a 130 room Courtyard by Marriott and a 95
suite Town Place Suites by Marriott. Both of the new projects are expected to be
completed in late 1998 at which time a renovation will begin on the existing 103
room hotel.
LOGO
Holiday Inn Express -- Portland, OR: This hotel is a three story all
interior corridor facility, was built in 1986 and completed a major
refurbishment in late 1996 and was flagged as a Holiday Inn Express.
The hotel has immediate access to I-205 at Stark Street and is within
two blocks of Mall 205, four miles south of Portland International
Airport, and six miles east of downtown Portland. All guests receive
a complimentary continental breakfast buffet, and have access to the new
oversized indoor spa and fitness facility. Guest room features include an
electronic key system, coffee makers, two data port telephones, voice message,
free local telephone calls, iron and ironing board, hair dryers, and a 25 inch
television. Meeting room facilities are available for up to 50 people.
Complimentary shuttle service is provided to Portland International Airport.
LOGO
Holiday Inn Express -- Poulsbo, WA: This hotel is located across the
Puget Sound on Bainbridge Island, a 30 minute ferry ride to downtown
Seattle or a 70 mile drive around the Sound. This area relies heavily
on the leisure market and government installations for its economic
stability. The hotel is located one mile from Historic Poulsbo and
the Norwegian Marine Science Center, six miles from Keyport Naval
Museum, and 18 miles from the Bremerton Shipyard. The hotel, built in 1986, is a
two story interior corridor structure with 63 guest rooms and was completely
remodeled and flagged as a Holiday Inn Express in late 1996. All guests receive
a complimentary continental breakfast buffet and use of the seasonal outdoor
pool. Each guest room provides an electronic key system, coffee makers, two data
port telephones, voice message, free local telephone calls, iron and ironing
boards, hair dryers, and a 25 inch television.
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LOGO
Hampton Inn -- Mesa, AZ: This hotel is a five story interior corridor
facility that was built in 1987. Located on the east side of Mesa it
has immediate access to the Superstition Freeway, a major east/west
corridor for the greater Phoenix area. The hotel is 14 miles from
Phoenix International Airport, 20 miles from downtown Phoenix, is in
close proximity to the Chicago Cubs spring training baseball park,
and convenient to many local golf courses and business parks. The hotel is
currently in the completion phase of a full interior renovation of all guests
rooms and will offer many amenities such as an electronic key system,
microwave/refrigerator units, coffee makers, two data port telephones, voice
message, iron and ironing board, hair dryers, and a 25 inch television. Other
features provided to guests include a complimentary continental breakfast
buffet, free local telephone calls, an outdoor heated pool and spa for
year-round use, and two meeting rooms accommodating groups of up to 40 people.
LOGO
Hampton Inn -- Tucson (Airport), AZ: This hotel is a four story all
interior corridor facility that was built in 1986 and offers 126
guest rooms in their final phase of full renovation. The hotel is
conveniently located one quarter of a mile from the entry to Tucson
International Airport and is near business and office parks. Access
to I-10 is three miles from the hotel, eight miles from the
University of Arizona and downtown Tucson, and 90 miles south of Phoenix. In
1998, the city will play host to three major league baseball teams for their
spring training camp. Guest room amenities include an electronic key system,
coffee makers, two data port telephones, voice message, iron & ironing board,
hair dryers, and a 25 inch television. Other features provided are a
complimentary continental breakfast buffet, free local telephone calls, an
outdoor heated pool, and meeting facilities accommodating up to 35 guests.
LOGO
Hampton Inn -- Arcadia, CA: This hotel opened in 1988 and is an
attractive four story interior corridor hotel with 129 guest rooms.
The hotel is located near various business centers in Pasadena,
Monrovia, and Irwindale with easy access to the 210 Freeway. The
historic Santa Anita Race Track is one mile from the hotel, and other
nearby attractions include the Rose Bowl 10 miles, and Universal
Studios and the Los Angeles Zoo are within a 25 mile drive. Airport service to
the area is available through Ontario International Airport, Los Angeles
International Airport, and Burbank Airport, all of which are within 30 miles of
the hotel. Standard guest room amenities include an electronic key system,
coffee makers, two data port telephones, voice message, iron and ironing board,
hair dryers, and a 25 inch television. Other guest features include a
complimentary continental breakfast buffet, free local telephone calls, an
outdoor heated pool, a hospitality suite and a meeting room facility to
accommodate up to 25 people. This hotel has received "Excellent" quality ratings
from the Hampton Inn system over the past two years.
LOGO
Hampton Inn -- Oakland (Airport), CA: The Hampton Inn at Oakland
Airport is a three story structure that was built in 1986 and offers
152 recently renovated guest rooms. The hotel is located two miles
from Oakland International Airport, within one quarter of a mile of
the Oakland Coliseum and newly renovated Arena, five miles from
downtown Oakland, 12 miles from the University of California at
Berkley, and 15 miles from downtown San Francisco. This fully renovated hotel
offers many guest room amenities including an electronic key system, coffee
makers, two data port telephones, voice message, iron and ironing board, hair
dryers, and a 25 inch television. Other features provided to guests are a
complimentary continental breakfast buffet, free local telephone calls, a
year-round heated pool and spa, and complimentary shuttle service to Oakland
Airport and the Bay Area Rapid Transit system (BART).
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LOGO
Hampton Inn (S.E./Tech Center) -- Denver, CO: Constructed in 1986,
this hotel is a 152-room five story interior corridor facility. The
prime location on Arapahoe Road in the Tech Center area makes this
facility particularly appealing to many business travelers, and the
recent addition of Fiddlers Green Park Meadows Mall is a large
attraction to leisure travelers. This prime location is also
convenient to downtown Denver 20 miles northwest, and to Denver International
Airport 35 miles northeast. The hotel completed a full interior remodel in late
1997 including an upscale lobby decor and a full upgrade to all guest rooms.
Standard guest room features include an electronic key system, coffee makers,
two data port telephones, voice message, iron and ironing board, hair dryers,
and a 25 inch television. Other hotel features offered are a complimentary
continental breakfast buffet, free local telephone calls, fitness facility,
outdoor heated pool, and two meeting facilities to 25 people each.
LOGO
Hampton Inn -- Pueblo, CO: Hampton Inn Pueblo was built in 1986 and
is a two story exterior corridor hotel offering 112 guest rooms
renovated in early 1997. The hotel is immediately accessible to I-25
and is a convenient drive to the Colorado State Fair and Exposition
Center, University of Southern Colorado, Pueblo Industrial Park, and
35 miles south of Colorado Springs. Attractions near the hotel and
the Pueblo area include the Pueblo Reservoir, Greenway and Nature Center,
Greyhound Racing, the Royal Gorge, golfing, and biking. The hotel offers many
guest room amenities such as an electronic key system, coffee makers, two data
port telephones, voice message, iron and ironing board, hair dryers, and a 25
inch television. Other features provided to guests are a complimentary
continental breakfast buffet, free local telephone calls, a year-round heated
pool and spa, and a 24-hour IHOP restaurant adjacent to the hotel.
LOGO
Hampton Inn -- Silverthorne, CO: The Hampton Inn Silverthorne is a
six story interior corridor hotel that was built in 1976 and
converted to a Hampton Inn in 1993. It has an excellent location 70
miles from Denver and on the west side of the Continental Divide. It
is immediately accessible to I-70 and in a central proximity to six
world class ski areas such as Keystone (8 miles), Copper Mountain (10
miles), Breckenridge (20 miles), and Vail (45 miles). In addition to skiing,
visitors enjoy snowmobiling, fishing, mountain climbing, and many other outdoor
activities. Recently the lobby area received a reconfiguration and renovation to
promote more of a lodge environment. Guest will enjoy many room amenities such
as an electronic key system, coffee makers, two data port telephones, voice
message, iron and ironing board, hair dryers, and a 25 inch television. Other
features include a complimentary continental breakfast buffet, free local
telephone calls, an indoor heated pool, guest laundry, a full line ski rental
and gift shop, Old Chicago Restaurant for dine-in or room-service delivery, and
meeting facilities to accommodate up to 200 people.
LOGO
Hampton Inn -- Clackamas (Portland), OR: This hotel opened in 1988 as
an independent hotel and received a multi-million dollar renovation
and was converted to a Hampton Inn in late 1996. The hotel is located
along I-205 and 11 miles south of Portland International Airport, 15
miles southeast of downtown Portland, in close proximity to Clackamas
Town Center Mall in the heart of nearby business and industrial park,
and 50 miles from Mt. Hood. Hotel guest room amenities offered following the
renovation include an electronic key system, coffee makers, two data port
telephones, voice message, iron and ironing board, hair dryers, and a 25 inch
television. Other hotel features include a complimentary continental breakfast
buffet, free local telephone calls, fitness facility, indoor spa and sauna, and
a meeting facility that accommodates up to 40 people. A variety of restaurants
and convenience stores are within a short walk of the hotel.
LOGO
Hawthorn Suites, LTD -- Anaheim, CA: The Hawthorn Suites, LTD was
built in 1992 and is a five story interior corridor hotel with 130
suites. The hotel is located one half a mile from the 5 Freeway and
within a three block walk or complimentary shuttle ride to the
Disneyland entrance and the Anaheim Convention Center, 1 and one half
miles from the Arrowhead Pond and Anaheim Stadium, seven miles from
Knott's Berry Farm, 15 miles from Orange County Airport and the
Pacific Beaches, and 30 miles from Los Angeles. All suites will provide
amenities such as microwaves, refrigerators, coffee maker, iron and ironing
board, two data port telephones, voice message, hair dryer, and two remote
control televisions. Hotel features include a complimentary breakfast buffet,
outdoor pool, spa, fitness room, game room, guest laundry, and gift shop. A
variety of suites can comfortably accommodate a family of four and the two
bedroom suites can sleep up to eight people.
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LOGO
Hawthorn Suites -- Sacramento, CA: This hotel is configured in a
series of five three-story buildings and was constructed in 1988. The
entire facility will undergo an interior and exterior renovation
during the last quarter of 1997 and will then have 271 modern suite
accommodations including 16 two-room suites. The hotel is located one
mile north of Old Town Sacramento, 1 and one half miles from the
State Capitol and downtown Convention Center. Easily accessible to
the I-5 freeway, the Hawthorn Suites is 10 miles southeast of Sacramento
Airport, and 90 miles from Lake Tahoe, Reno, and the San Francisco Bay Area.
Each suite will offer a variety of amenities including a bedroom area and
comfortable living area with a large well lighted desk work area, two data port
telephones, voice message, iron and ironing board, hair dryer, and a 25 inch
television. Kitchen areas will be equipped with cooking appliances,
refrigerator, microwave, coffee maker, cookware, and tableware. The upcoming
renovation will create the addition of 16 two-bedroom suites with a common
living area. Other features offered will be a daily complimentary continental
breakfast buffet, a full-service restaurant, lobby lounge, outdoor pool and spa,
guest laundry and meeting facilities to accommodate groups of up to 100 people.
LOGO
Hawthorn Suites -- Seattle (Kent), WA: The Hawthorn Suites Kent was
built in 1990 and consists of 19 individually constructed buildings
of eight suites each for a total of 152 suites. Seventy-six are two
bedroom loft suites. This extended stay hotel is ideally located
directly across the street from Boeing Space & Defense, near many
other Boeing offices and facilities, four miles from South Center
Mall, seven miles to SEA-TAC International Airport, 12 miles from Emerald Downs
Race Course and Auburn Super Mall, and 18 miles from downtown Seattle. Each
suite offers a comfortable living area, a bedroom area with two data port
telephones, voice message, iron and ironing board, hair dryer, and a 25 inch
television. The kitchen area is fully equipped with a stove, refrigerator,
dishwasher, microwave, coffee maker, cookware, and tableware utensils. Each
suite has a walk-out private balcony and provides a residential style
environment. The main lobby building features a complimentary hot and cold
breakfast buffet, a daily light dinner social hour, a large screen television
with comfortable seating, a mini-gift shop, and two meeting facilities that can
accommodate up to 75 guests each. Other features include a tennis and sport
court, and an indoor spa and fitness center.
LOGO
Doubletree Hotel -- Santa Fe, NM: The hotel was constructed in 1985
and is a combination interior and exterior corridor hotel with 213
guest rooms and suites. Located in northern New Mexico the hotel has
easy access to I-25 and the downtown Historic Plaza District. Taos
Ski Area is 45 miles from the hotel, and Albuquerque is 55 miles
south. The hotel was completely remodeled in 1996 with a look
reminiscent of Santa Fe and the American Indian cultural influence. Each guest
room offers standard amenities such as an electronic key system, coffee makers,
two data port telephones, voice message, iron and ironing board, hair dryers,
upscale bathroom toiletries, and a 25 inch television. The 17 suites offer a
full living area separate of the bedroom, an additional 25 inch television and
data port telephone, wet bar and refrigerator. On site services include a full
service restaurant, indoor pool, two spas, fitness facility, guest laundry, a
full line gift shop, business center, and conference and breakout facilities to
comfortably accommodate 300 people.
LOGO
Comfort Suites (SFO) -- South San Francisco, CA: This airport hotel
location was constructed in 1985 and consists of 166 suites in a
three story exterior/interior configuration. The hotel finished a
complete exterior and interior refurbishment in June 1997 and offers
an outstanding lodging facility within two miles of San Francisco
International Airport. Other nearby areas and attractions include 13
miles to downtown San Francisco, Fisherman's Wharf, and the famed
Golden Gate Bridge. Positioned on the east side of San Francisco Bay and one
block from Highway 101, the hotel has convenient access to Sunnyvale and San
Jose and is 30 miles from Oakland via the San Mateo Bridge. All suites offer a
comfortable living area, a well lighted large work desk with a swivel fabric
desk chair, mini-refrigerator, microwave, an electronic key system, coffee
makers, two data port telephones, voice message, iron and ironing board, hair
dryers, and a 25 inch television. A complimentary continental breakfast buffet
is provided daily to all guests in the newly expanded lobby and verandah seating
area. The beautifully landscaped courtyard surrounds an outdoor heated pool and
spa. Complimentary shuttle transportation is provided to San Francisco
International Airport and the nearby business park.
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Independent Hotels
Boise Park Suites Hotel -- Boise, ID: The Boise Park Suites hotel was
developed in 1992 with 130 suites in a three story structure, and was expanded
to include an additional 108 suites in 1996. The hotel is located just one mile
from Boise State University, six miles from Boise Airport, 10 minutes from
downtown Boise, and is adjacent to the scenic Boise River Greenbelt. Each suite
offers a variety of amenities such as complimentary continental breakfast and
morning newspaper, two data port telephones, a 25 inch television, a full
kitchen facility with microwave, refrigerator, coffee maker, toaster, china and
flatware. Other hotel features include "Executive Quarters" Suites with a
Concierge lounge, guest laundry facility, outdoor pool, spa, fitness center, a
fully equipped business center, hospitality lounge area, and more than 2,000
square feet of meeting room space. This hotel is currently under consideration
to be flagged as either a Holiday Inn Hotel & Suites or Radisson.
Canyon Springs Park Hotel -- Twin Falls, ID: This two story hotel facility
opened in 1974 and provides 112 guest rooms. Located on U.S. Highway 93 with
convenient access to I-84, the Canyon Springs Park Hotel is near the majestic
Snake River Canyon. Hotel features include an outdoor pool, fitness room, a
full-service restaurant, lounge, coffee shop, and six meeting and banquet rooms
totaling 5,000 square feet. This well maintained facility is currently under
consideration to be flagged as either a Holiday Inn or a Courtyard by Marriott.
Colonial Park Hotel -- Helena, MT: This two story all brick exterior
structure was constructed in 1971 and offers 149 guest room accommodations
including 10 executive rooms. Located near the State Capitol with easy access to
I-15 and I-90, the hotel is also within close proximity to the Helena Airport.
Helena and the Colonial Park Hotel are equidistant between Glacier National Park
and Yellowstone National Park. The hotel offers a variety of guest room
amenities and features such as an indoor and outdoor pool, spa, sauna, gift
shop, beauty salon, guest laundry, and an on-site restaurant. This hotel is
viewed as an excellent convention and meeting facility offering 13
banquet/meeting rooms for a combined total of 15,000 square feet of available
convention space. The Company is currently contemplating reflagging this hotel
as a Courtyard by Marriott, Holiday Inn or other national franchise.
Kahler Inn & Suites Hotel -- Rochester, MN: The Kahler Inn & Suites opened
in 1974 with 50 guest rooms, completed a 90-room expansion in 1979, and
completed its final 128-suite expansion in 1991. This brings the entire room
count of the facility to 268 rooms, the second largest hotel in Rochester. The
Kahler Inn & Suites is also connected to all Mayo Clinic facilities and
Methodist Hospital by way of an underground walkway system. An extensive
renovation will take place in 1998 to enhance customer appeal for this hotel.
The 128 guest suites provide a wet bar, refrigerator, microwave, a separate
living area, well lighted large work desk area, two data port telephones, voice
message, coffee maker, and iron and ironing board. Features of the hotel include
a complimentary breakfast buffet, an indoor pool, spa, sauna, exercise bikes,
guest laundry, a full line convenience store, restaurant, lounge, parking
facility, and meeting rooms that can handle up to 135 persons. A national flag
is being reviewed for this hotel but a final decision has not been made at this
time.
Kahler Plaza Hotel -- Rochester, MN: The Kahler Plaza Hotel was built in
1991 and consists of 194 guest rooms including 16 suites. This hotel is located
directly across the street from the Kahler Hotel and is one block from the Mayo
Clinic and connected to the facility by an underground pedestrian walkway. The
top two floors house the Concierge Club rooms and provide a continental
breakfast and evening social hour, and a variety of upgraded guest room
amenities. This hotel is the premier AAA four-diamond hotel in all of Rochester.
Features of the hotel include a seven story atrium with an indoor pool, spa, and
sauna. In addition there is an on-site fitness room, three restaurants, a lobby
lounge, and a gourmet Coffee Shop. This hotel is also accessible to the 60
retail and gift shops located in the underground pedestrian walkway. Meeting
space can accommodate up to 400 persons in more than 7,500 square feet of total
meeting and banquet space. This hotel is being strongly considered to become a
Marriott Hotel within the next year of operation.
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Ogden Park Hotel -- Ogden, UT: The Ogden Park Hotel was built in 1982 as a
seven story all brick exterior with 288 guest rooms including 18 luxury suites.
Located in the center of downtown Ogden, the hotel is close to the Ogden
Egyptian Center, near Ogden City Mall, a short drive to three major ski resorts,
and 35 miles north of Salt Lake International Airport. Hotel features include
in-room coffee makers, an indoor pool, spa and sun deck, fitness center,
business center, gift shop, guest laundry, a full-service restaurant, sports
bar, and more than 16,000 square feet of meeting space accommodating up to 1,000
people. This hotel is under strong consideration to be flagged as a Marriott
Hotel after undergoing an extensive renovation.
Olympia Park Hotel and Conference Center -- Park City, UT: This hotel
opened in late 1985 with 202 guest rooms. In addition to the guest rooms, there
currently is a management agreement on a fee structure basis on 114 condominium
units. The Olympia Park Hotel is located 45 miles east of Salt Lake
International Airport. Park City is surrounded by the Wasatch Mountains and will
be host to the 2002 Winter Olympic Games. A wide variety of area activities
ranging from horseback riding, to the alpine slide, hot air balloon rides,
tennis, trout fishing, golfing at any of five championship courses, mountain
bike and hiking are within minutes of the hotel. Complimentary public
transportation is provided to the 150 shops and restaurants in nearby Park City.
Hotel services and features include an atrium indoor pool, spa, sauna, fitness
center, concierge services, gift shop, espresso bar, ski rental and an accessory
shop. This hotel promotes Park City's largest meeting complex of 10,000 square
feet including the Grand Ballroom that can accommodate 800 people. The Olympia
Park is under consideration to be flagged as either a Courtyard by Marriott or
other national franchise.
Pocatello Park Quality Inn Hotel -- Pocatello, ID: This hotel was developed
in 1976 and consists of 152 guest rooms in a two story interior corridor
structure. Located within five minutes of Idaho State University, five minutes
of a variety of business and shopping centers, and 10 minutes of Pocatello
Municipal Airport. Features and services include in-room coffee, an indoor pool,
spa, sauna and fitness facility and a full-service business center, restaurant
and lounge. The hotel also features 30 business amenity suites with microwaves,
refrigerators, and data port telephones. There are 15 meeting rooms providing a
total of 7,600 square feet of total conference and banquet space. The Company is
currently contemplating reflagging this hotel as a Courtyard by Marriott or
Radisson.
Provo Park Hotel and Conference Center -- Provo, UT: The Provo Park Hotel,
a 10 story all brick interior corridor hotel, opened for business in 1983 with
232 guest rooms and then added 101 rooms in early March 1997. Located in
downtown Provo, the hotel is a convenient one and one half miles from Brigham
Young University and I-15, 45 miles south of Salt Lake City, and is within
minutes of the Sundance Ski Resort. This full-service four-diamond hotel offers
many features and amenities including an outdoor pool, indoor lap pool, spa,
sauna, fitness center, gift shop, business center, the Park Cafe & Oak Grill,
and a private club. The hotel has 21 meeting rooms for a total of 28,000 square
feet including an 8,000 square foot ballroom and a 102 person tiered seminar
facility. This hotel is currently under strong consideration to be flagged as a
full service Marriott Hotel and Conference Center.
The Kahler Hotel, Rochester, MN: The historic Kahler Hotel was opened in
1921 and offers 699 guest room accommodations, including 45 suites. The hotel
lays claim to being the closest hotel to the well known Mayo Clinic and is
connected by an underground pedestrian walkway system to provide convenience and
protection from winter weather conditions. The "President's Floor" provides VIP
Suites, complimentary continental breakfast, and evening receptions. A variety
of guest room configurations offer clean and comfortable accommodations. A
renovation in excess of $3 million has commenced and will continue into 1998 to
improve the features and furnishings of the hotel. Complimentary shuttle service
to Rochester International Airport, Hospitals, and nearby businesses is
provided. Other hotel features include an enclosed roof top pool, spa, and
sauna, four distinctly different theme restaurant facilities, a lounge, and
16,000 square feet of banquet and meeting facilities including the Heritage
Ballroom that seats 1,000 people. Below the hotel in the underground walkway
system is a variety of retail shops, a pharmacy, travel agent, airline ticket
counter, beauty and barber shops. The hotel lobby entrance is directly across
the street from the new 10-story Mayo Clinic II building that will begin
construction in early 1998 and be completed in 2001.
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The Regency Plaza Hotel at LAX -- Los Angeles, CA: The Regency Plaza at Los
Angeles International Airport is a six floor all interior facility with 178
guest rooms and opened for business in September 1996. This Four-Diamond hotel
is the second closest hotel to the airport terminals at LAX. The hotel is
located within minutes of Marina Del Ray, Santa Monica, The Great Western Forum
and Hollywood Race Course. Other nearby destinations and attractions within 30
minutes of the hotel include Beverly Hills, Hollywood, Universal Studios, and LA
World Port. The Regency Plaza offers a variety of guest room amenities such as
mini-bar, microwaves, large well lighted work desk areas, two data port
telephones, a sofa living area and in-room movies. Features include
complimentary airport shuttle service, full-service restaurant and lobby bar,
well appointed meeting and boardrooms accommodating up to 150 people. An in
depth market review is in process for a national identity upscale or luxury
franchise for this hotel.
University Park Hotel & Suites -- Salt Lake City, UT: The University Park
Hotel & Suites was built in 1987 and consists of 220 deluxe guest rooms and
suites in a seven story brick finish interior corridor hotel. Located within the
University of Utah's Research Park, and five minutes from downtown Salt Lake
City. The hotel provides easy access to I-80 and I-15, and is within 30 miles of
a variety of world class ski resorts. Hotel features include a theme restaurant
and lounge, an indoor pool, spa, fitness center, bike rental, gift shop, and is
adjacent to a tennis center and golf course. Meeting facilities combine for a
total of 11 rooms and can accommodate up to 500 persons. A well designed tiered
seminar room is also available to guests. A national flag is being reviewed for
this hotel but a final decision has not been made at this time.
THE PERCENTAGE LEASES
In order for the Company to qualify as a REIT, neither the Company nor the
Partnership can operate any hotels. The Partnership, therefore, leases hotels to
the Lessee typically for an initial term of ten years pursuant to Percentage
Leases which provide for rent equal to base rent and percentage rent. Each
Percentage Lease contains the provisions generally described below, and the
Company intends that future Percentage Leases with respect to additional hotels
it may acquire will contain substantially similar provisions, although the
Independent Directors may, in their discretion, alter any of these provisions
with respect to any proposed percentage lease, depending on the purchase price
paid, economic conditions and other factors deemed relevant at the time. The
Lessee will not lease or operate any hotel other than those owned by the
Partnership.
Amounts Payable Under the Percentage Leases
During the term of each Percentage Lease, the Lessee is obligated to pay to
the Partnership (i) base rent and percentage rent (which includes a specified
percentage of room revenues -- 20% to 47% in the first tier and 60% to 65% in
the second tier, 5% of the Lessee's food and beverage revenues, 100% of any
sublease and concession rentals and other net revenues described in the
Percentage Leases) and (ii) certain other amounts, including interest accrued on
any late payments or charges. Base rent accrues and is required to be paid
monthly in arrears. Both the base rent and the threshold room revenue amount in
each percentage rent formula is adjusted annually for inflation. The Percentage
Leases also require the Lessee to pay the operating expenses of the Hotel
(including workers' compensation insurance, utility, repairs and maintenance
costs and other charges incurred in the operation of the Hotel) during the terms
of the Percentage Leases. The Percentage Leases also provide for rent reductions
and abatements in the event of damage or destruction.
Maintenance and Modifications
Under the Percentage Leases, the Company is required to pay for capital
improvements at each Hotel. In addition, the Percentage Leases obligate the
Company to make available to the Lessee for the repair, replacement and
refurbishment of furniture, fixtures and equipment in the hotel, when and as
deemed necessary by the Lessee, an amount equal to 4.0% of room revenue per
quarter on a cumulative basis, provided that such amount may be used for capital
expenditures made by the Partnership respecting the Hotel. The Company owns
substantially all of the personal property, including that portion affixed to,
or deemed a part of, the real estate or improvements.
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Events of Default
Each of the Percentage Leases is cross-defaulted so that a default under
one Percentage Lease constitutes a default under all of the Percentage Leases.
If an Event of Default occurs and continues beyond any curative period, the
Partnership will have the option of terminating the Percentage Lease or any or
all other Percentage Leases by giving the Lessee 10 days' written notice of the
date for termination of the Percentage Leases and, unless such Event of Default
is cured prior to the termination date set forth in such notice, the Percentage
Leases shall terminate on the date specified in the Partnership's notice and the
Lessee is required to surrender possession of each affected Hotel.
Subordination of Management Fees
The Lessee is permitted to engage a management company to assist the Lessee
in the operation and maintenance of the Hotels. The Percentage Leases provide
that effective upon written notice by the Lessee of any Event of Default under
the Percentage Leases, and during the continuance thereof, no payments will be
made to any management company (including the Management Company) with respect
to any Hotel. In addition, each management agreement which the Lessee enters
into must provide that the management company will repay to the Company any
payments made to it by the Lessee while any such Event of Default has occurred
and is continuing. This obligation is personally guaranteed by Mr. Alter during
the term of the Management Agreement. See "The Management Company -- The
Management Agreement."
Inventory and Personal Property
All inventory required in the operation of the Hotels will be purchased at
the Lessee's expense and owned by the Lessee. The Partnership will have the
option to purchase all personal property related to such Hotel and owned by the
Lessee at fair market value upon termination of the Percentage Lease for that
Hotel. Any inventory used by Lessee in the operation of the respective Hotel
shall, upon termination of the Percentage Lease, become the property of the
Company.
Security Interest
The Partnership has a blanket lien on substantially all assets of the
Lessee, subject to the rights of any lender financing the purchase of personal
property by the Lessee.
THE MANAGEMENT AGREEMENT
Pursuant to the terms of the Management Agreement, the Management Company
will provide management and administrative services to the Lessee with respect
to the Hotels for a fee equal to 2% of the Current Hotels' gross revenues (to be
1% in the case of the Kahler Hotels) and reimbursement of expenses by the
Lessee. The Lessee anticipates that if additional hotels are acquired, the
Lessee and the Management Company will enter into similar management agreements
with respect to such additional hotels. However, the Lessee is not obligated to
enter into any additional management agreements with the Management Company with
respect to such additional hotels. Neither the Partnership nor the Company have
any contractual or other obligations to the Management Company.
FRANCHISE AGREEMENTS
The Company has existing franchise licenses on all of the Currents Hotels.
The Company anticipates that each of the additional hotels which it
acquires, including many of the Kahler Hotels, will be operated under franchise
licenses with strong national franchisors. The public's perception of quality
associated with a franchisor is an important feature in the operation of a
hotel. Franchisors provide a variety of benefits for franchisees which include
national advertising, publicity and other marketing programs designed to
increase brand awareness, training of personnel, continuous review of quality
standards and centralized reservation systems.
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Franchise licenses generally specify certain management, operational,
recordkeeping, accounting, reporting and marketing standards and procedures with
which the franchisee must comply. The franchise licenses obligate the Lessee to
comply with the franchisors' standards and requirements with respect to training
of operational personnel, safety, maintaining specified insurance, the types of
services and products ancillary to guest room services that may be provided by
the Lessee, display of signage, and the type, quality and age of furniture,
fixtures and equipment included in guest rooms, lobbies and other common areas.
The franchise licenses for the Current Hotels expire at various times
ranging between 2003 and 2017. The franchise licenses provide for termination at
the franchisor's option upon the occurrence of certain events, including the
Lessee's failure to pay royalties and fees or perform its other covenants under
the franchise license, bankruptcy, abandonment of the franchise, commission of a
felony, assignment of the franchise license without the consent of the
franchisor, or failure to comply with applicable law in the operation of the
applicable Hotel. The Lessee will be entitled to terminate the franchise license
(other than the Courtyard by Marriott franchise agreements) only by giving prior
written notice and only by paying significant liquidated damages. The franchise
licenses do not renew automatically upon expiration. The Lessee will be
responsible for making all payments under the franchise licenses to the
franchisors, except that pursuant to a three-party agreement among Marriott, the
Lessee and the Partnership, the Partnership and the Lessee are jointly and
severally liable for the material obligations of the franchisee under the
Courtyard by Marriott franchise licenses. Mr. Alter has executed certain
personal guaranties covering the obligations of the Lessee under the Holiday
Inn, Hampton Inn, Hawthorn Suites, Comfort Suites and Doubletree franchise
licenses. Mr. Alter has also agreed to indemnify the Company for defaults by the
Lessee with respect to unpaid franchise fees and termination fees under all
franchise licenses for so long as the Percentage Leases are in effect.
Holiday Inn, Hampton Inn, Doubletree and Marriott have each agreed that, in
the event of certain events of default by the Lessee under the applicable
franchise licenses or the Partnership's termination of a Percentage Lease, upon
request by the Partnership and the curing of such events of default, the
applicable franchisor will allow that Current Hotel to be operated by a designee
of the Partnership acceptable to such franchisor for a specified period of time.
HOLIDAY INN(R), HOLIDAY INN EXPRESS(TM), HOLIDAY INN SELECT(TM) AND HOLIDAY
INN(R) HOTEL & SUITES ARE REGISTERED TRADEMARKS OF HOLIDAY INNS FRANCHISING,
INC. HAMPTON INN(R) IS A REGISTERED TRADEMARK OF PROMUS HOTELS CORPORATION.
COURTYARD BY MARRIOTT(R) AND RESIDENCE INN(R) ARE REGISTERED TRADEMARKS OF
MARRIOTT INTERNATIONAL, INC. DOUBLETREE(R) IS A REGISTERED TRADEMARK OF
DOUBLETREE HOTELS CORPORATION. COMFORT SUITES(R) IS A REGISTERED TRADEMARK OF
CHOICE HOTELS INTERNATIONAL, INC. HAWTHORN SUITES IS A REGISTERED TRADEMARK OF
U.S. FRANCHISE SYSTEMS, INC. NEITHER HOLIDAY INNS FRANCHISING, INC., PROMUS
HOTELS, INC., DOUBLETREE HOTELS CORPORATION, MARRIOTT INTERNATIONAL, INC.,
CHOICE HOTELS INTERNATIONAL, INC. OR U.S. FRANCHISE SYSTEMS HAS ENDORSED OR
APPROVED THIS OFFERING. A GRANT OF A FRANCHISE LICENSE BY SUCH COMPANIES FOR
CERTAIN OF THE HOTELS IS NOT INTENDED AS, AND SHOULD NOT BE INTERPRETED AS, AN
EXPRESS OR IMPLIED APPROVAL OR ENDORSEMENT BY SUCH COMPANIES (OR ANY OF ITS
AFFILIATES, SUBSIDIARIES OR DIVISIONS) OF THE COMPANY, THE PARTNERSHIP OR THE
COMMON STOCK OFFERED HEREBY.
OPERATING PRACTICES
The Company's management recognizes the need for aggressive, market driven,
creative management in view of the competition in the hospitality industry.
Management of the Company has owned and managed hotels since 1976. Employees of
affiliates of Mr. Alter and Mr. Biederman are employed by the Lessee and by the
Management Company, who manage each of the Current Hotels and will manage the
Kahler Hotels and any other hotels acquired in the foreseeable future. The
Management Company implements management systems developed by affiliates of the
Company. Such affiliates have also developed systems for marketing, ADR
enhancement, expense management, physical facility maintenance, human resources,
accounting and
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<PAGE> 49
internal auditing. The general manager of each hotel reports to lead managers,
who in turn report to the Vice President of Marketing and the Director of Sales
of the Management Company. The Management Company's strategy is to place
responsibility and authority in the hands of the on-site general manager with
supervision by senior staff of the Management Company. See "The Management
Company" for a description of the management systems to be used by the
Management Company at the hotels.
EMPLOYEES
At the time of the Initial Public Offering, Messrs. Alter and Biederman
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 12 other employees, six of whom are
construction personnel. The Lessee employed approximately 1,700 people as of
September 15, 1997 to operate the Current Hotels leased from the Company. The
Lessee has advised the Company that its relationship with its 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. However, employees of certain
of the Kahler Hotels are subject to collective bargaining agreements which will
be binding on the Lessee.
ENVIRONMENTAL MATTERS
Under various federal, state and local laws and regulations, an owner or
operator of real property may be liable for the costs of removal or remediation
of certain hazardous or toxic substances on such property. Such laws often
impose 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, and the Lessee, as the case may be, may be potentially
liable for any such costs.
The Company believes that its 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, or the Lessee. The
Company has not been notified by any government 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.
COMPETITION
Intense competition exists for investment opportunities in mid-priced and
upscale 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 can prudently manage.
Competition may generally reduce the number of suitable hotel investment
opportunities offered to the Company and increase the bargaining power of
property owners seeking to sell. The Company believes that the inclusion of not
only underperforming, but also undercapitalized hotels as well as secondary
markets in its strategy lessens competition for the types of hotels 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
portfolios, 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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<PAGE> 50
LEGAL PROCEEDINGS
Neither the Company nor the Partnership is currently involved in any
material litigation nor, to the Company's knowledge, is any material litigation
currently threatened against the Company or the Partnership or any of the
Current Hotels. The Lessee and the Management Company have each advised the
Company that it currently is not involved in any litigation. Kahler has advised
the Company that there is no material litigation threatened against or affecting
it or the Kahler Hotels.
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<PAGE> 51
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Company's Board currently consists of eight members, five of whom are
Independent Directors. The Board is divided into three classes. Upon the closing
of the Kahler Acquisition, the Board will consist of nine members, including
Paul D. Kazilionis, the designee of Westbrook Partners.
Certain information regarding those individuals who serve as the directors
and executive officers of the Company is set forth below.
<TABLE>
<CAPTION>
NAME AGE POSITION CLASS EXPIRES
- ---------------------------- ---- ----------------------------------- ---------- -------
<S> <C> <C> <C> <C>
Robert A. Alter 46 Chairman of the Board, President Class I 1998
and Secretary
Charles L. Biederman 63 Executive Vice President and Class II 2000
Director
Kenneth J. Biehl 43 Vice President and Chief Financial N/A N/A
Officer
C. Robert Enever 69 Director Class III 1999
H. Raymond Bingham 51 Independent Director Class II 2000
Laurence S. Geller 49 Independent Director Class II 2000
Frederic H. Gould 62 Independent Director Class I 1998
David Lambert 45 Independent Director Class III 1999
Edward H. Sondker 49 Independent Director Class III 1999
Paul D. Kazilionis(1) 40 Director Class I 1998
</TABLE>
- ---------------
(1) Board appointment effective upon the closing of the Kahler Acquisition.
Robert A. Alter has served as Chairman of the Board, President and
Secretary since August 1994. Mr. Alter also served as the Chief Financial
Officer from August 1994 until January 1997. From 1990 until August 1995, Mr.
Alter served as President of the Management Company, which currently manages all
of the Hotels owned by the Company. Mr. Alter also serves as Chairman of the
Board of Directors of both the Management Company and the Lessee. Mr. Alter has
been engaged in the business of hotel ownership, development and management
since 1976. Affiliates of Mr. Alter owned interests in seven of the ten hotels
sold to the Company in the formation transactions consummated at the Initial
Public Offering in August 1995. Mr. Alter is a Certified Hotel Administrator, as
designated by the American Hotel and Motel Association, and is a past President
and a member of the Board of Directors of the International Association of
Holiday Inns, the franchisee association for Holiday Inn hotels. Mr. Alter holds
a Bachelor of Science degree in Hotel Administration from Cornell University.
Charles L. Biederman has served as the Executive Vice President and a
director since September 1994. From 1990 until August 1995, Mr. Biederman served
as Executive Vice President of the Management Company. Mr. Biederman has
previously served as President of Provident Development Group Corporation which
engaged in the design, development and sale of luxury homes in South Florida,
from 1989 until 1992 and as President of Colorado Home Improvements, Inc., which
engaged in general contracting, renovation and related services for existing
homes in the Denver, Colorado area. He is currently the President of Woodstone
Homes, Inc., which is engaged in luxury home construction in the Vail, Colorado
area, and a director of One Liberty Properties, Inc., a real estate investment
trust specializing in the purchase and leasing of single tenant net leased
properties throughout the United States. Mr. Biederman has been engaged in the
real estate development business since 1962. Affiliates of Mr. Biederman owned
interests in five of the ten hotels sold to the Company in the formation
transactions consummated in August 1995. Mr. Biederman holds a Bachelor of Arts
degree from Colgate University, and a Bachelor of Architecture degree and a
Masters in Architecture degree from Columbia University and is a registered
architect.
Kenneth J. Biehl has served as Vice President and Chief Financial Officer
of the Company since January 1997. From February 1996 until January 1997, Mr.
Biehl served as the Chief Financial Officer of the Lessee. Prior to joining the
Lessee, Mr. Biehl served as Vice President and Corporate Controller of Starwood
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<PAGE> 52
Lodging Corporation, the hotel operating company for one of the largest hotel
REIT's in the United States, for three years. Before that, Mr. Biehl served with
E & Y Kenneth Leventhal Real Estate Group, Price Waterhouse and KPMG Peat
Marwick. Mr. Biehl has eleven years of experience in the real estate and
hospitality industry. Mr. Biehl holds a Bachelor of Science degree in Accounting
from Brigham Young University and is a Certified Public Accountant licensed in
the State of California.
C. Robert Enever has served as a director since September 1994. Mr. Enever
is retired but currently manages a portfolio of real estate and securities
investments. From 1971 until his recent retirement, Mr. Enever was engaged in
real estate development management and ownership, through several owned
entities. Before that he had a career in financial analysis, pricing and
international operations with Ford Motor Company. Mr. Enever holds a Bachelor of
Science degree in Economics from the University of London and a Masters in
Business Administration degree (with distinction) in Finance and Accounting from
Northwestern University. Mr. Enever is also a Certified Public Accountant
licensed in the State of Illinois.
Frederic H. Gould has served as a director since August 1995. Mr. Gould has
served for the past [FIVE] years as the General Partner of Gould Investors L.P.,
a master limited partnership engaged in the ownership and operation of various
types of income-producing real property located throughout the United States and
which holds substantial interests in publicly held real estate investment trusts
and savings and commercial banks. Mr. Gould is currently a director of BFS
Bancorp Inc. and Bankers Federal Savings. In addition, Mr. Gould is currently
the Chairman of the Board of Trustees of BRT Realty Trust, a publicly-traded
mortgage real estate investment trust, and Chairman of the Board of Directors of
One Liberty Properties, Inc. Mr. Gould holds a Bachelor of Business
Administration degree from Lehigh University and an L.L.B. degree from New York
University Law School.
H. Raymond Bingham has served as a director since August 1995. Mr. Bingham
has served since 1993 as the Chief Financial Officer and Executive Vice
President of Cadence Design Systems, a publicly traded computer aided design
company. Prior to joining Cadence Design Systems, Mr. Bingham served as
Executive Vice President and Chief Financial Officer of Red Lion Hotels & Inns
for eight years. Mr. Bingham is currently a director of WTD Industries, a wood
products and wood mills company, and IMS, a test equipment and manufacturing
company. Mr. Bingham is the former Chairman of the American Hotel & Motel
Association Industry Real Estate Finance Council and a former Director of the
National Realty Committee. Mr. Bingham holds a Bachelor of Science degree in
Economics from Weber State College and a Masters in Business Administration
degree from Harvard Business School.
Laurence S. Geller has served as a director since November 1996. Since
December 1989 Mr. Geller has been Chairman of Geller & Co., a hotel-industry
consulting firm based in Chicago, Illinois. From 1984 through December 1989, Mr.
Geller served as the Executive Vice President and Chief Operating Officer of
Hyatt Development Corporation, a developer of domestic and international hotels
and resorts, and from 1976 to 1981, as a Senior Vice President of Holiday Inns,
Inc. Mr. Geller serves as a consultant to the Company through Geller & Co.
pursuant to a consulting agreement entered into in July 1996. Mr. Geller is
Chairman and Chief Executive Officer of Sky Games and is a director of Vistana,
Inc. and of Eagle Gaming. Mr. Geller is a graduate of the Ealing Technical
College (U.K.) in Hotel Management and Catering.
David Lambert has served as a director since August 1995. Mr. Lambert has
served as Chief Financial Officer of Preview Travel, Inc., a San Francisco Bay
Area online travel and media production company, since June 1995. Prior to
joining Preview Travel, from 1992 to 1995 Mr. Lambert served as Chief Financial
Officer of Excalibur Technologies Corporation, a publicly traded computer
software company specializing in the indexing and retrieval of information. Mr.
Lambert served as a private consultant from 1991 to 1992, President and Chief
Executive Officer of Grand American Fare, Inc., a restaurant company, from 1985
to 1991, served as Executive Vice President of Colony Hotels and Resorts, a
subsidiary of Radisson Hotels, from 1981 to 1985. Mr. Lambert holds a Bachelor
of Arts degree in Physics and Mathematics from Occidental College and a Masters
in Business Administration degree from the University of California, Los
Angeles, and is a real estate broker licensed in the State of California.
Edward H. Sondker has served as a director since August 1995. Mr. Sondker
is currently President and Chief Executive Officer of Bay View Financial
Corporation, a publicly traded bank-holding company located
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<PAGE> 53
in the San Francisco Bay Area. Prior to joining Bay View Financial, Mr. Sondker
served from 1990 through June 1995 as the President and Chief Executive Officer
of Independence One Bank of California. During the fifteen years prior to such
time, Mr. Sondker has served in senior executive positions with several
independent financial institutions having assets ranging in size from $200
million to over $1 billion. Mr. Sondker holds a Bachelor of Arts degree and a
J.D. degree from Washburn University. Mr. Sondker currently is a director of
SAMCEDA, a public policy forum for business in San Mateo County, California.
Paul D. Kazilionis will become a director of the Company contemporaneously
with the closing of the Kahler Acquisition. From April 1994 until the present,
Mr. Kazilionis has been a Managing Principal of Westbrook Partners, a real
estate investment management company. Prior to co-founding Westbrook Partners,
Mr. Kazilionis spent 12 years at Morgan Stanley and Company serving most
recently as Managing Director and President of the General Partner of the Morgan
Stanley Real Estate Fund, through which Morgan Stanley conducted its principal
real estate investment activities. Mr. Kazilionis received a Bachelor of Arts
degree from Colby college in 1979 and a Masters in Business Administration
degree from the Amos Tuck School of Business Administration at Dartmouth College
in 1982. Mr. Kazilionis is a member of the Dartmouth College real estate
advisory committee.
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<PAGE> 54
THE LESSEE
GENERAL
The Lessee leases and operates the Current Hotels pursuant to the
Percentage Leases and it is anticipated that the Lessee will lease the Kahler
Hotels pursuant to similar percentage leases. The Lessee employs approximately
1,700 people and upon the closing of the Kahler Acquisition will employ
approximately 5,200 people. Under the Percentage Leases, the Lessee generally
will be required to perform all operational functions necessary to operate the
Current Hotels and the acquired Kahler Hotels. See "Additional Risk
Factors -- Risk that Kahler Acquisition Will Not Close" and "Business and
Properties -- The Percentage Leases."
The Lessee is entitled to all gross revenue from the Current Hotels, and
will be entitled to all gross revenues from the Kahler Hotels, after payment of
rent due under the Percentage Leases, payment of a management fee to the
Management Company, and other operating expenses. The Lessee is required to
provide operating information about each of the Current Hotels and will be
required to provide the same information about each of the Kahler Hotels,
quarterly financial statements, annual audited financial statements and any
other information material to the Lessee's continuing ability to perform its
obligations under the Percentage Leases. The Company will include this
information in its periodic reports filed with the Commission under the Exchange
Act.
Management of the Company believes that a single tenant lessee which is
restricted to solely operating the hotels of the Company minimizes conflicts of
interest that may arise in an unrestricted multiple tenant organizational
structure. Additionally, the Company believes that the Lessee is more
experienced with the requirements of operating hotels during extensive
renovations, a critical element of the Company's growth strategy. As a result of
the Lessee's management, the Current Hotels have outperformed the lodging
industry in year-over-year REVPAR growth, averaging 8.7% REVPAR growth, compared
to 5.5% REVPAR growth for the lodging industry generally over the last five
years.
The Partnership must rely on the Lessee to generate sufficient cash flow
from the operation of the Current Hotels (and the Kahler Hotels when acquired)
to enable the Lessee to pay rent necessary for the Company to fund the
distributions to holders of the Common Stock. The Lessee had a negative net book
value of approximately $3.6 million as of June 30, 1997, had a net operating
loss of $3.2 million for the year ended December 31, 1996, and net income of
$365,000 for the six months ended June 30, 1997. On a pro forma basis, after
giving effect to acquisitions of Current Hotels during 1996 and thereafter, and
the Kahler Acquisition, the Lessee had a net operating loss of $4.0 million for
the year ended December 31, 1996 and net income of $758,000 for the six months
ended June 30, 1997. The Lessee's obligations under the Percentage Leases are
secured by a blanket lien on substantially all of its assets and a pledge of
481,955 Partnership Units by Mr. Alter and Mr. Biederman pursuant to the Amended
and Restated Third Party Pledge Agreement. See "Business and Properties -- The
Percentage Leases." The obligations of the Lessee under the Percentage Leases
are secured and cross-defaulted so that a default under one Percentage Lease
constitutes a default under all of the Percentage Leases. Other than working
capital sufficient to operate the Current Hotels, the Lessee currently has only
nominal assets in excess of the value of its rights and benefits under the
Percentage Leases. See "Business and Properties -- The Percentage Leases."
MANAGEMENT
Certain information with respect to key management personnel of the Lessee
is set forth below.
Randy Hulce (age 45) is currently the President of the Lessee and has
served in such position since February 1997. During the five years prior to
joining the Lessee, Mr. Hulce served as a Divisional Vice President of
Operations and Senior Asset Manager for La Quinta Inns, Inc. Prior to joining La
Quinta Inns, Mr. Hulce had spent over 14 years with Holiday Inn World Wide in
executive management positions directing sales, operations and asset management.
Mr. Hulce holds a Bachelor of Science degree from Western Michigan University
and a Master of Business Administration degree from Kellogg Graduate School of
Management, Northwestern University.
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<PAGE> 55
Michael T. George (age 38) will join the Lessee as Chief Operations Officer
on September 29, 1997. Prior to joining the Lessee, since 1994, Mr. George was
the Senior Vice President of Operations at CAPSTAR Hotel Company in Washington,
D.C. From 1989 until 1994, Mr. George served as Chief Operating Officer and Vice
President of Operations of Devar Hotels, LTD. Mr. George holds a Bachelor of
Science degree in Hotel, Restaurant and Institutional Management from Purdue
University.
David R. Kinkade (age 60) is currently the Vice President -- Acquisitions
of the Lessee and has served in such position since December 1995. During the
six years prior to joining the Lessee, Mr. Kinkade served as Director of Systems
Development -- Western Region for Hampton Inns, Director of Development for
Crossroads Hospitality Company and Director of Operations for Oceanside Pier
Restaurant. Mr. Kinkade holds a Bachelor of Business Administration degree from
the University of Oregon and a Master of Business Administration degree in
Hotel, Restaurant and Institutional Management from Michigan State University.
Mr. Kinkade is also a Certified Public Accountant licensed in the State of
California.
Evan Studer (age 45) is currently the Vice President -- Sales and Marketing
of the Lessee and has served in such position since October 1996. Prior to
joining the Lessee, Mr. Studer was the Regional Vice President of Operations and
Sales/Marketing for Vista Host, Inc., a Houston based hotel management company.
Mr. Studer has over 25 years of experience in the hotel and hospitality
industry. Mr. Studer holds a Bachelor of Science degree from Eastern Kentucky
University.
Russ Jussulevich (age 39) is currently the Vice President -- Accounting of
the Lessee and has served in such position since August 1997. Prior to joining
the Lessee, Mr. Jussulevich was Regional Controller of Hotels of Distinction,
Inc. a Palm Beach, Florida, based hotel company. Mr. Jussulevich has over 14
years of experience in the hotel and hospitality industry. Ms. Jussulevich holds
a Bachelor of Science degree in Hospitality Management from Niagara University.
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, Mr. Alter and Mr.
Biederman, as sole owners of the Lessee, have each entered into several
agreements. Their respective employment agreements restrict competitive
activities and the Amended and Restated Third Party Pledge Agreement requires
each of Mr. Alter and Biederman to pledge their Partnership Units to the Company
to secure obligations of the Lessee under the Percentage Leases. In addition,
Messrs. Alter and Biederman entered into a 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 Partnership Units from the Partnership at the
then current price of the 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 the Lessee under any
Percentage Lease, Mr. Alter or Mr. Biederman under the Unit Purchase Agreement
or any other agreement with the Company. Further, Mr. Alter, as owner of 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.
Percentage Leases
In order to qualify as a REIT, the Company has leased each of the Current
Hotels to the Lessee pursuant to the Percentage Leases. Each Percentage Lease
has been approved by a majority of the Independent Directors. The Percentage
Leases are designed to allow the Company to participate in revenue growth by
providing that (i) between approximately 60% to 65% (20% to 47% in the first
tier) 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) 100% of other net revenues described in the Percentage Lease for the
applicable Current Hotel in excess of base rent will be paid to the Partnership
as Percentage Rent. Once the rent under the Percentage Leases, together with all
operating expenses of each Current Hotel is paid by the Lessee, the Lessee will
be entitled to all of the net income from the Current Hotels. Mr. Alter and Mr.
Biederman have
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<PAGE> 56
agreed, however, to use distributions from the Lessee, in excess of their tax
liability from the earnings of the Lessee, to either accumulate reserves for the
Lessee's rental obligations due under the Percentage Leases or purchase from the
Partnership additional Partnership Units at the then current market price of the
Common Stock. As of August 31, 1997, no distributions have been made to Messrs.
Alter and Biederman.
Amended and Restated Third Party Pledge Agreement
Mr. Alter and Mr. Biederman, the stockholders of the Lessee, have through
September 18, 1997 pledged to the Partnership 481,955 Partnership Units with a
value equal to approximately $7.7 million, to secure the Lessee's obligations
under the Percentage Leases. Provided no event of default under any Percentage
Lease exists, the pledged Partnership Units corresponding to a particular
Percentage Lease will be returned to the pledgors on the third anniversary of
such Percentage Lease. At the Board meeting in February 1997, the Independent
Directors approved an amendment to the Third Party Pledge Agreement with Mr.
Alter and Mr. Biederman to limit the total number of Partnership Units that
would be required to be pledged to secure the Lessee's obligations under the
Percentage Leases to four (4) months base rent under each new Percentage Lease,
up to an aggregate of 481,955 Partnership Units. The Independent Directors also
approved the subordination of the Company's lien in the Partnership Units to a
lien proposed in favor of an institutional lender that, as a condition to making
a proposed working capital facility available to the Lessee, has required that
Mr. Alter guarantee the loan and secure it with a first priority lien in his
Partnership Units.
Unit Purchase Agreement
Mr. Alter and Mr. Biederman entered into the Unit Purchase Agreement with
the Company, the Lessee and the Partnership to use distributions from the
Lessee, in excess of their tax liability from earnings of the Lessee, to either
accumulate reserves for the Lessee's rental obligations due under the Percentage
Leases or purchase from the Partnership additional Partnership Units at the then
current market price of the Common Stock. The Unit Purchase Agreement will
remain in effect so long as there is a Percentage Lease in effect.
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<PAGE> 57
THE MANAGEMENT COMPANY
GENERAL
The Management Company owned by Mr. Alter currently provides certain
management services and functions for the Lessee, including finance, accounting,
management information systems and other administrative services. As
consideration for such services, the Management Company receives a management
fee from the Lessee initially equal to 2% of gross revenues for the Current
Hotels (to be 1% for the Kahler Hotels) and future acquisitions. In addition,
the Management Company is reimbursed by the Lessee for all accounting-related
expenses and all out-of-pocket expenses incurred in connection with the
management and administration of the Current Hotels. The Company anticipates
that if additional hotels are acquired and leased to the Lessee, the Lessee and
the Management Company will enter into similar management agreements with
respect to such additional hotels. However, the Lessee is not obligated to enter
into any additional management agreements with the Management Company with
respect to such additional hotels. As required by the Percentage Leases, the
Management Agreement provides, and any such other management agreements must
provide, that the Management Company will repay to the Company any payments made
to it by the Lessee after the Management Company receives notice that an event
of default has occurred and is continuing. This obligation is personally
guaranteed by Mr. Alter. Neither the Partnership nor the Company is a party to
the Management Agreement and, therefore, neither shall have any obligations or
liabilities under the Management Agreement or to the Management Company. See
"The Lessee -- Amended and Restated Third Party Pledge Agreement" and " -- Unit
Purchase Agreement."
Each Current Hotel has an on-site general manager. The on-site general
manager of each Current Hotel will report to lead managers, who in turn report
to the Vice President -- Marketing and the Director of Sales of the Lessee. This
strategy is designed to place responsibility and authority in the hands of the
on-site general manager with supervision by senior staff of the Management
Company and the Lessee. In addition, the Lessee is obligated pursuant to the
Percentage Leases to employ a sales manager for each Hotel, as reasonably
required by the Company. All sales managers work with their on-site general
manager, with supervision by the Vice President -- Marketing of the Management
Company and the Lessee. Each year, the on-site general manager and sales manager
of each Hotel will develop an annual marketing plan with careful attention given
to measurable results. The Company will monitor the results for each quarter as
compared to the plan. The Management Company uses a management by objective
sales program to coordinate, direct and manage the sales activities of personnel
located at the Hotels.
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<PAGE> 58
PRINCIPAL SHAREHOLDERS
The following table sets forth information, as of August 31, 1997,
regarding the beneficial ownership of Common Stock by (i) each person known to
the Company to be the beneficial owner of more than 5% of its Common Stock, (ii)
each director of the Company, (iii) each executive officer of the Company and
(iv) by all directors and executive officers of the Company as a group. Unless
otherwise indicated, all shares of Common Stock are owned directly and the
indicated person has sole voting and investment power.
<TABLE>
<CAPTION>
PERCENT OF CLASS(2)
NUMBER OF SHARES -------------------------
BENEFICIALLY BEFORE AFTER
NAME OF BENEFICIAL OWNER OWNED(1) OFFERING OFFERING
---------------------------------- ---------------- -------- --------
<S> <C> <C> <C>
FMR Corporation................... 1,995,000 9.78% 6.29%
82 Devonshire Street
Boston, MA 02109
Capital Growth Management......... 1,136,000 5.56 3.58
Limited Partnership
One International Place
Boston, MA 02110
Westbrook Real Estate Fund I,
L.P............................. 3,983,867(3) * 11.93
Westbrook Real Estate
Co-Investment
Partnership I, L.P
c/o Westbrook Partners
599 Lexington Avenue, Suite 3800
New York, NY 10022
Paul D. Kazilionis................ 3,983,867(3)(4) * 11.93
Robert A. Alter................... 606,281(5) 2.88 2.02
Charles L. Biederman.............. 435,727(6) 2.09 1.46
C. Robert Enever.................. 193,706(7) * *
Laurence S. Geller................ 39,250(8) * *
H. Raymond Bingham................ 9,038(9) * *
David Lambert..................... 9,147(10) * *
Edward H. Sondker................. 9,038(11) * *
Frederic H. Gould................. 7,538(12) * *
Kenneth J. Biehl.................. * * *
All Directors and Officers as a
Group (10 persons).............. 1,309,725(13) 6.04% 16.34%
</TABLE>
- ---------------
* Less than 1%.
(1) The Partnership had 23,178,248 Partnership Units outstanding as of
September 15, 1997, of which 20,413,993 were owned by the Company
corresponding to the number of shares of Common Stock outstanding as of
that date, and 2,764,255 by other limited partners. Each of the Partnership
Units is redeemable pursuant to certain redemption rights (the "Redemption
Rights") on a one-for-one basis for shares of Common Stock. The number and
percentages set forth above assumes that all Partnership Units held by the
person are redeemed for shares of Common Stock. The total number of shares
of Common Stock outstanding used in calculating the percentage assumes that
all of the Partnership Units held by other persons are redeemed for shares
of Common Stock.
(2) Calculation of ownership percentages After Offering includes the 2,284,262
shares of Common Stock being issued to the Westbrook Funds in connection
with the Kahler Acquisition as well as the 9,000,000 shares being sold in
this Offering.
(3) All shares of Common Stock will be issued to the Westbrook Funds
concurrently with the closing of the Kahler Acquisition and are not
considered outstanding in calculating ownership percentages Before
Offering. Includes 1,699,605 shares of Common Stock initially issuable to
the Westbrook Funds upon conversion of Preferred Stock, subject to
adjustment in certain events.
S-58
<PAGE> 59
(4) Includes all shares of Common Stock owned by the Westbrook Funds. Mr.
Kazilionis is a Managing Principal of Westbrook Partners, the General
Partner of the Westbrook Funds.
(5) Includes (i) 96,720 shares of Common Stock underlying stock options granted
pursuant to the Incentive Plan which are currently exercisable or which
will become exercisable within 60 days after August 31, 1997 and (ii)
509,561 Partnership Units redeemable pursuant to the Redemptions Rights on
a one-for-one basis for shares of Common Stock, including 65,600
Partnership Units owned by Riverside Hotel Partners of which Mr. Alter has
an 82% interest.
(6) Includes (i) 38,680 shares of Common Stock underlying stock options granted
pursuant to the Incentive Plan which are currently exercisable or which
will become exercisable within 60 days after August 31, 1997 and (ii)
397,047 Partnership Units redeemable pursuant to the Redemption Rights on a
one-for-one basis for shares of Common Stock, including 14,400 Partnership
Units owned by Riverside Hotel Partners of which Mr. Biederman has an 18%
interest.
(7) Includes (i) 4,500 shares of Common Stock underlying stock options granted
pursuant to the Directors Plan which are currently exercisable or which
will become exercisable within 60 days after August 31, 1997, (ii) 60,615
Partnership Units redeemable pursuant to the Redemption Rights on a
one-for-one basis for shares of Common Stock, (iii) 100,254 Partnership
Units owned by Enever Rout Investment Group Ltd. redeemable on a
one-for-one basis for shares of Common Stock and (iv) 20,799 shares of
Common Stock owned by Mr. Enever's spouse.
(8) Includes 34,250 shares of Common Stock underlying stock options which are
currently exercisable or which will become exercisable within 60 days after
September 15, 1997, of which 31,240 were granted in connection with his
consulting agreement with the Company pursuant to the Incentive Plan and
3,000 of which were granted pursuant to the Directors Plan.
(9) Includes 4,500 shares of Common Stock underlying stock options granted
pursuant to the Directors Plan which are currently exercisable or which
will become exercisable within 60 days after September 15, 1997.
(10) Includes 4,500 shares of Common Stock underlying stock options granted
pursuant to the Directors Plan which are currently exercisable or which
will become exercisable within 60 days after September 15, 1997.
(11) Includes 4,500 shares of Common Stock underlying stock options granted
pursuant to the Directors Plan which are currently exercisable or which
will become exercisable within 60 days after September 15, 1997.
(12) Includes 1,500 shares underlying previously granted stock options granted
pursuant to the Directors Plan which are currently exercisable or which
will become exercisable within 60 days after September 15, 1997.
(13) Includes (i) 190,650 shares of Common Stock underlying stock options
granted pursuant to the Incentive Plan and the Directors Plan which are
currently exercisable or which will become exercisable within 60 days after
September 15, 1997 and (ii) 1,088,276 Partnership Units redeemable pursuant
to the Redemption Rights on a one-for-one basis for shares of Common Stock.
The Percent of Class Before Offering excludes, and the Percent of Class
After Offering includes, shares deemed to be beneficially owned by Mr.
Kazilionis.
S-59
<PAGE> 60
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The Company believes it has operated, and the Company intends to continue
to operate, in such a manner as to qualify as a REIT under the Code, but no
assurance can be given that it will at all times so qualify. See "Risk
Factors -- Failure to Maintain REIT Status" and "United States Federal Income
Tax Considerations" in the accompanying Prospectus.
In connection with this Offering, Brobeck, Phleger & Harrison LLP, counsel
to the Company, will render a legal opinion that the Company has qualified as a
REIT under the Code, commencing with the Company's taxable year ended December
31, 1995. Such legal opinion will be filed as an exhibit to the Registration
Statement of which the accompanying Prospectus is a part. Such legal opinion and
any opinions contained in this Prospectus Supplement or the accompanying
Prospectus as to the Company's qualification as a REIT under the Code will be
qualified in their entirety by the assumptions and qualifications contained in
such legal opinion and described in the Prospectus and this Prospectus
Supplement. For a more specific discussion of the federal income tax treatment
of the Company and its shareholders, the various requirements for qualification
as a REIT and the risks of disqualification as a REIT, reference is made to the
section of the accompanying Prospectus entitled "United States Federal Income
Tax Considerations."
The provisions of the Code pertaining to REITs are highly technical and
complex, and neither the Company nor Brobeck, Phleger & Harrison LLP can assure
that the IRS will not successfully contest the Company's qualification as a
REIT. Upon audit, Brobeck, Phleger & Harrison LLP's opinion is not binding on
the IRS. Investors are urged to consult their own tax advisors with respect to
the appropriateness of an investment in the Common Stock offered hereby and with
respect to the tax consequences arising under federal law and the laws of any
state, municipality or other taxing jurisdiction, including tax consequences
resulting from such investor's own tax characteristics. In particular, investors
are urged to consult their own tax advisors with respect to the new rules
contained in the 1997 Act, and foreign investors should consult their own tax
advisors concerning the tax consequences of an investment in the Company,
including the possibility of United States income tax withholding on Company
distributions.
S-60
<PAGE> 61
UNDERWRITING
Subject to the terms and conditions contained in a purchase agreement (the
"U.S. Purchase Agreement"), the Company has agreed to sell to the U.S.
Underwriters named below (the "U.S. Underwriters"), and the U.S. Underwriters,
for whom Merrill Lynch & Co., Bear, Stearns & Co. Inc., Montgomery Securities,
Credit Suisse First Boston Corporation, EVEREN Securities, Inc. and Raymond
James & Associates, Inc. are acting as representatives (the "U.S.
Representatives"), have severally agreed to purchase, the number of shares of
Common Stock set forth opposite their respective names below.
<TABLE>
<CAPTION>
NUMBER OF SHARES
TO BE
UNDERWRITERS PURCHASED
------------------------------------------------------------- ----------------
<S> <C>
Merrill Lynch & Co...........................................
Bear, Stearns & Co. Inc......................................
Montgomery Securities........................................
Credit Suisse First Boston Corporation.......................
EVEREN Securities, Inc.......................................
Raymond James & Associates, Inc..............................
---------
Total.............................................. 7,200,000
=========
</TABLE>
The Company has also entered into a purchase agreement (the "International
Purchase Agreement" and, together with the U.S. Purchase Agreement, the
"Agreements") with certain underwriters outside the United States and Canada
(the "International Managers"), for whom Merrill Lynch International, Bear,
Stearns International Limited, Montgomery Securities, Credit Suisse First Boston
Corporation, EVEREN Securities, Inc. and Raymond James & Associates, Inc. are
acting as lead managers (the "Lead Managers"). Subject to the terms and
conditions set forth in the International Purchase Agreement, the Company has
agreed to sell to the International Managers, and the International Managers
have severally agreed to purchase, an aggregate of 1,800,000 shares of Common
Stock. The public offering price per share and the underwriting discount per
share are identical under the U.S. Purchase Agreement and the International
Purchase Agreement.
In the U.S. Purchase Agreement and the International Purchase Agreement,
the several U.S. Underwriters and the several International Managers
(collectively, the "Underwriters"), respectively, have agreed, subject to the
terms and conditions set forth therein, to purchase all of the shares of Common
Stock being sold pursuant to such Agreements if any of the shares of Common
Stock being sold pursuant to such Agreements are purchased. The U.S. Purchase
Agreement provides that in the event of a default by a U.S. Underwriter, the
purchase commitments of the non-defaulting U.S. Underwriters may in certain
circumstances be increased, and the International Purchase Agreement provides
that, in the event of a default by an International Manager, the purchase
commitments of the non-defaulting International Managers may in certain
circumstances be increased. The closing with respect to the sale of the shares
of Common Stock pursuant to the U.S. Purchase Agreement is a condition to the
closing with respect to the sale of the shares of Common Stock pursuant to the
International Purchase Agreement, and the closing with respect to the sale of
the shares of Common Stock pursuant to the International Purchase Agreement is a
condition to the closing with respect to the sale of the shares of Common Stock
pursuant to the U.S. Purchase Agreement.
The U.S. Underwriters and the International Managers have entered into an
intersyndicate agreement (the "Intersyndicate Agreement") which provides for the
coordination of their activities. Under the terms of the Intersyndicate
Agreement, the U.S. Underwriters and the International Managers are permitted to
sell shares of Common Stock to each other. Pursuant to the Intersyndicate
Agreement, sales may be made between the International Managers and the U.S.
Underwriters of such number of shares of Common Stock as may be mutually agreed.
The price of any shares of Common Stock so sold shall be the public offering
price, less an amount not greater than the selling concession.
Under the terms of the Intersyndicate Agreement, the U.S. Underwriters and
any dealer to whom they sell shares of Common Stock will agree to offer to sell
or sell shares of Common Stock only to persons whom they believe are United
States Persons or Canadian Persons (as defined in the Intersyndicate Agreement)
or
S-61
<PAGE> 62
to persons whom they believe intend to reoffer or resell the same to United
States Persons or Canadian Persons, and the International Managers and any bank,
broker or dealer to whom they sell shares of Common Stock will agree not to
offer to sell or sell shares of Common Stock to persons whom they believe to be
United States Persons or Canadian Persons or to persons whom they believe intend
to reoffer or resell the same to United States Persons or Canadian Persons,
except in each case for transactions pursuant to the Intersyndicate Agreement
which, among other things, permits the Underwriters to purchase from each other
and offer for resale such number of shares of Common Stock as the selling
Underwriter or Underwriters and the purchasing Underwriter or Underwriters may
agree.
The U.S. Representatives have advised the Company that the U.S.
Underwriters propose initially to offer the shares of Common Stock offered
hereby to the public at the public offering price set forth on the cover page of
this Prospectus Supplement, and to certain dealers at such price less a
concession not in excess of $ per share. The U.S. Underwriters may
allow, and such dealers may reallow, a concession not in excess of $
per share to certain other dealers. After this Offering, the public offering
price and the concession may be changed.
The Company has granted to the U.S. Underwriters an option, exercisable for
30 days after the date hereof, to purchase up to 1,080,000 additional shares of
Common Stock and to the International Managers an option, exercisable for 30
days after the date hereof, to purchase up to 270,000 additional shares of
Common Stock, in each case solely to cover over-allotments, if any, at the
public offering price less the underwriting discount. To the extent that the
U.S. Underwriters exercise such option, each of the U.S. Underwriters will be
obligated, subject to certain conditions, to purchase approximately the same
percentage of such shares which the number of shares of Common Stock to be
purchased by it shown in the foregoing table bears to the total number of shares
of Common Stock set forth in such table.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including certain liabilities under the Securities Act.
The Company has agreed that it will not, with certain exceptions, offer,
sell or otherwise dispose of any shares of Common Stock for a period of 90 days
from the date of this Prospectus Supplement without the prior written consent of
Merrill Lynch & Co. This prohibition will not affect shares of Common Stock
issued by the Company in connection with acquisitions, issued or granted by the
Company pursuant to the Incentive Plan and the Directors Plan, any dividend
reinvestment plan or the conversion or exercise of securities convertible or
exercisable for Common Stock. Each of the Company's directors and executive
officers has agreed that, for a period of 90 days from the date of this
Prospectus Supplement, he will not, without the prior written consent of Merrill
Lynch & Co., offer, sell or otherwise voluntarily dispose of any shares of
Common Stock or any securities convertible into or exercisable for Common Stock.
Until the distribution of the Common Stock is completed, rules of the
Commission may limit the ability of the Underwriters and certain selling group
members to bid for and purchase the Common Stock. As an exception to these
rules, the Underwriters are permitted to engage in certain transactions that
stabilize the price of the Common Stock. Such transactions consist of bids or
purchases for the purpose of pegging, fixing or maintaining the price of the
Common Stock.
If the Underwriters create a short position in the Common Stock in
connection with this Offering (i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus Supplement), the U.S.
Representatives and the Lead Managers, respectively, may reduce that short
position by purchasing Common Stock in the open market. The U.S. Representatives
and the Lead Managers, respectively, may also elect to reduce any short position
through the exercise of all or part of the over-allotment option described
above.
The U.S. Representatives and the Lead Managers, respectively, may also
impose a penalty bid on certain Underwriters and selling group members. This
means that if the U.S. Representatives or the Lead Managers purchase shares of
Common Stock in the open market to reduce the Underwriters' short position or to
stabilize the price of the Common Stock, they may reclaim the amount of the
selling concession from the Underwriters and selling group members who sold
those shares as part of this Offering.
S-62
<PAGE> 63
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the U.S.
Representatives or the Lead Managers will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
Certain of the Underwriters engage in transactions with, and, from time to
time, have performed services for, the Company in the ordinary course of
business. All of the U.S. Representatives, other than Merrill Lynch & Co. and
Credit Suisse First Boston Corporation, have either lead or co-managed one or
more public equity offerings of the Company's Common Stock over the last two
years for which they received customary compensation therefor.
In addition, at the Initial Public Offering, MYPC, an affiliate of
Montgomery Securities, acquired 24,500 Partnership Units. Additionally, MYPC
received warrants to purchase 33,946 Partnership Units which are exercisable at
any time between the first and fifth anniversary of the closing of the Initial
Public Offering at an exercise price per share equal to the Initial Public
Offering price of $9.50 per share of Common Stock. At any time at the request of
MYPC, the Partnership Units may be redeemed on a one-for-one basis for shares of
Common Stock (or for cash at the election of the Company). In an April 1997
offering of Common Stock for the Company in which Montgomery Securities was the
lead managing underwriter, Montgomery Securities paid a finder's fee to Triton
Pacific Capital, LLC ("Triton") in connection with certain sales to
institutional investors. In February 1997, the Company entered into an agreement
with Triton whereby Triton will act as a financial advisor to the Company under
certain limited circumstances.
Bear, Stearns & Co. Inc., one of the Underwriters, is affiliated with the
NYSE specialist for the Company's Common Stock. Bear, Stearns & Co. Inc. has in
the past performed, and may continue to perform, investment banking and
financial advisory services for the Company and has received customary
compensation therefore. Bear, Stearns & Co. Inc. is the exclusive financial
advisor to the Company in connection with the Kahler Acquisition and, in
addition, has rendered a fairness opinion in connection therewith, for which it
will receive customary compensation therefor.
Merrill Lynch & Co. has entered into an agreement with the Company to
provide certain underwriting services to the Company in furtherance of the
Kahler Acquisition. To the extent such services are rendered, Merrill Lynch &
Co. will receive customary compensation therefore.
S-63
<PAGE> 64
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Introduction to Unaudited Pro Forma Combined Financial Information................... F-3
SUNSTONE HOTEL INVESTORS, INC. -- Pro Forma Combined Financial Information
Unaudited Pro Forma Combined Balance Sheet as of June 30, 1997..................... F-4
Notes to Unaudited Pro Forma Combined Balance Sheet................................ F-5
Unaudited Pro Forma Combined Statement of Income for the Six Months Ended
June 30, 1997................................................................... F-8
Unaudited Pro Forma Combined Statement of Income for the Year Ended
December 31, 1996............................................................... F-9
Notes to Unaudited Pro Forma Combined Statements of Income......................... F-10
SUNSTONE HOTEL PROPERTIES, INC. ("LESSEE") -- Pro Forma Combined Statements of
Operations
Unaudited Pro Forma Combined Statement of Operations for the Six Months Ended
June 30, 1997................................................................... F-12
Unaudited Pro Forma Combined Statement of Operations for the Year Ended
December 31, 1996............................................................... F-13
Notes to Unaudited Pro Forma Combined Statements of Operations..................... F-14
SUNSTONE HOTEL INVESTORS, INC.
Report of Independent Accountants.................................................. F-15
Sunstone Hotel Investors, Inc. -- Consolidated Balance Sheets as of June 30, 1997
(unaudited) and December 31, 1996 and 1995...................................... F-16
Sunstone Hotel Investors, Inc. -- Consolidated Statements of Income for the Six
Months Ended June 30, 1997 (unaudited) and 1996 (unaudited) and for the Year
Ended December 31, 1996 and for the Period August 16, 1995 to December 31, 1995
and Sunstone Hotels (Predecessor) -- Combined Statements of Income for the
Period January 1, 1995 to August 15, 1995 and for the Year Ended December 31,
1994............................................................................ F-17
Sunstone Hotel Investors, Inc. -- Consolidated Statements of Equity for the Year
Ended December 31, 1996 and for the Period August 16, 1995 to December 31, 1995
and Sunstone Hotels (Predecessor) -- Combined Statements of Deficit for the
Period January 1, 1995 to August 15, 1995 and the Year Ended December 31,
1994............................................................................ F-18
Sunstone Hotel Investors, Inc. -- Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1997 (unaudited) and 1996 (unaudited) and for the Year
Ended December 31, 1996 and for the Period August 16, 1995 to December 31, 1995
and Sunstone Hotels (Predecessor) -- Combined Statements of Cash Flows for the
Period January 1, 1995 to August 15, 1995 and for the Year Ended December 31,
1994............................................................................ F-19
Notes to Consolidated and Combined Financial Statements............................ F-20
SUNSTONE HOTEL PROPERTIES, INC. ("LESSEE")
Report of Independent Accountants.................................................. F-31
Balance Sheets as of June 30, 1997 (unaudited) and December 31, 1996 and 1995...... F-32
Statements of Operations and Stockholders' Equity for the Six Months Ended June 30,
1997 (unaudited) and 1996 (unaudited) and for the Year Ended December 31, 1996
and for the Period August 16, 1995 to December 31, 1995......................... F-33
</TABLE>
F-1
<PAGE> 65
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Statements of Cash Flows for the Six Months Ended June 30, 1997 (unaudited) and
1996 (unaudited) and for the Year Ended December 31, 1996 and for the Period
August 16, 1995 to December 31, 1995............................................ F-34
Notes to Combined Financial Statements............................................. F-35
KAHLER REALTY CORPORATION AND SUBSIDIARIES
Independent Auditors' Report....................................................... F-38
Consolidated Statements of Operations for the Six Months Ended June 29, 1997
(Unaudited) and June 30, 1996 (Unaudited) and for the Period from August 13,
1996 to December 29, 1996 (Successor Period) and the Period from January 1, 1996
to August 12, 1996 (Predecessor Period)......................................... F-39
Consolidated Balance Sheets as of June 29, 1997 (Unaudited) and December 29,
1996............................................................................ F-40
Consolidated Statements of Stockholders' Equity for Six Months Ended June 29, 1997
(Unaudited) and for the Period from January 1, 1996 to August 12, 1996
(Predecessor Period) and the Period from August 13, 1996 to December 29, 1996
(Successor Period).............................................................. F-41
Consolidated Statements of Cash Flows for the Six Months Ended June 29, 1997
(Unaudited) and for the Period from August 13, 1996 to December 29, 1996
(Successor Period) and the Period from January 1, 1996 to August 12, 1996
(Predecessor Period)............................................................ F-42
Notes to Consolidated Financial Statements......................................... F-43
Independent Auditor's Report....................................................... F-55
Consolidated Statements of Operations for the Years Ended December 31, 1995
and January 1, 1995............................................................. F-56
Consolidated Balance Sheets as of December 31, 1995 and January 1, 1995............ F-57
Consolidated Statements of Stockholders' Equity for the Years Ended December 31,
1995
and January 1, 1995............................................................. F-59
Consolidated Statements of Cash Flows for the Years Ended December 31, 1995
and January 1, 1995............................................................. F-60
Notes to Consolidated Financial Statements......................................... F-61
</TABLE>
F-2
<PAGE> 66
SUNSTONE HOTEL INVESTORS, INC.
SUNSTONE HOTEL PROPERTIES, INC.
INTRODUCTION TO UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION
The unaudited pro forma combined balance sheet of Sunstone Hotel Investors,
Inc. (the "Company") as of June 30, 1997 is presented as if the acquisitions of
the Current Hotels, the Kahler Acquisition and the Offering and related
financings all had occurred by June 30, 1997.
The Company's and Sunstone Hotel Properties, Inc.'s (the "Lessee")
unaudited pro forma combined statements of operations for the six months ended
June 30, 1997 and year ended December 31, 1996 are presented as if the
acquisitions of the Current Hotels, the Kahler Acquisition and the Offering and
related financings had all occurred as of the beginning of the period presented.
In management's opinion, all adjustments necessary to reflect the effects of
these transactions have been made. No pro forma revenues or expenses related to
the Regency Plaza Hotel in Los Angeles (acquired August 28, 1997) have been
included in the pro forma statements of operations for the year ended December
31, 1996 because the hotel was not operational during the majority of that year.
The pro forma financial information assumes that the Company will acquire, as a
result of the Kahler Acquisition, the outside interests in certain Kahler
Hotels.
The unaudited pro forma combined financial information is not necessarily
indicative of what the Company's or Lessee's financial position or results of
operations would have been assuming consummation of the acquisitions of the
Current Hotels, the Kahler Acquisition and the Offering and related financings
on such date or at the beginning of the period indicated, nor do they purport to
project the Company's or Lessee's financial position or results of operations at
any future date or for any future period.
F-3
<PAGE> 67
SUNSTONE HOTEL INVESTORS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF JUNE 30, 1997
<TABLE>
<CAPTION>
PRO FORMA
SUNSTONE HOTEL KAHLER OFFERING SUNSTONE HOTEL
INVESTORS, PRO FORMA CURRENT ACQUISITION PRO FORMA INVESTORS,
INC. ADJUSTMENTS HOTELS ADJUSTMENTS ADJUSTMENTS INC.
--------------- ----------- ------------ ------------ -------------- --------------
(HISTORICAL) (PRO FORMA)
(A) (B) (C) (I)
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Investment in hotel
properties, net.......... $ 252,349,000 $37,458,000 $289,807,000 $371,005,000(D) $ -- $660,812,000
Mortgage notes
receivable............... 2,850,000 -- 2,850,000 910,000 -- 3,760,000
Cash....................... 1,189,000 -- 1,189,000 -- --(J) 1,189,000
Rent receivable - Lessee... 3,904,000 -- 3,904,000 -- -- 3,904,000
Prepaid expenses and other
assets, net.............. 2,724,000 -- 2,724,000 1,858,000 -- 4,582,000
------------- ----------- ------------ ------------ -------------- ------------
$ 263,016,000 $37,458,000 $300,474,000 $373,773,000 $ -- $674,247,000
============= =========== ============ ============ ============== ============
LIABILITIES AND
STOCKHOLDERS' EQUITY:
Revolving lines of
credit................... $ 18,800,000 $34,355,000 $53,155,000 $103,599,000(E) $ (9,256,000)(K) $147,498,000
Mortgage and other notes
payable.................. 22,649,000 -- 22,649,000 205,835,000(F) (123,791,000)(L) 104,693,000
Accounts payable and other
accrued expenses......... 2,235,000 -- 2,235,000 7,283,000 -- 9,518,000
------------- ----------- ------------ ------------ -------------- ------------
43,684,000 34,355,000 78,039,000 316,717,000 (133,047,000) 261,709,000
------------- ----------- ------------ ------------ -------------- ------------
Minority interest.......... 24,521,000 3,103,000 27,624,000 56,000(G) -- 27,680,000
------------- ----------- ------------ ------------ -------------- ------------
Stockholders' equity:
7.9% Class A Cumulative,
Convertible Preferred
Stock, $.01 par value,
10,000,000 shares
authorized; no shares
issued or outstanding
250,000 shares issued and
outstanding pro forma
(liquidation value $100,
per share aggregating
$25,000,000 pro forma)... -- -- -- 3,000(H) -- 3,000
Common stock, $.01 par
value, 50,000,000
authorized; 20,368,001
shares outstanding;
31,698,255 pro forma..... 203,000 -- 203,000 23,000(H) 90,000(M) 316,000
Additional paid-in
capital.................. 195,494,000 -- 195,494,000 56,974,000(H) 132,957,000(M) 385,425,000
Distributions in excess of
earnings................. (886,000) -- (886,000) -- -- (886,000)
------------- ----------- ------------ ------------ -------------- ------------
194,811,000 -- 194,811,000 57,000,000 133,047,000 384,858,000
------------- ----------- ------------ ------------ -------------- ------------
$ 263,016,000 $37,458,000 $300,474,000 $373,773,000 $ -- $674,247,000
============= =========== ============ ============ ============== ============
</TABLE>
The accompanying notes are an integral part of the pro forma balance sheets.
F-4
<PAGE> 68
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF JUNE 30, 1997
(A) Reflects the Company's historical consolidated balance sheet as of June 30,
1997.
(B) Represents pro forma adjustments to reflect the assets, liabilities and
equity related to the Current Hotels acquired subsequent to June 30, 1997 as
follows:
<TABLE>
<CAPTION>
FINANCED
FINANCED WITH TOTAL
WITH LINE PARTNERSHIP ACQUISITION
HOTEL OF CREDIT UNITS(1) COST
--------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Best Western Landmark Inn.............. $ 7,200,000 $ -- $ 7,200,000
Holiday Inn Mission Valley Stadium..... 9,037,000 -- 9,037,000
Best Western Crystal Suites............ 8,636,000 -- 8,636,000
Regency Plaza Hotel.................... 9,482,000 3,103,000 12,585,000
----------- ----------- -----------
$34,355,000 $ 3,103,000 $37,458,000
=========== =========== ===========
</TABLE>
- ---------------
(1) Represents 216,695 Partnership units at $14.32 per unit.
(C) Represents pro forma adjustments to reflect the assets, liabilities and
equity from the purchase of all of the outstanding stock and outside
interests of Kahler Realty Corporation, including estimated closing costs.
(D) Represents the following proposed transactions in connection with the Kahler
Acquisition:
<TABLE>
<S> <C>
Cash portion of purchase price for Kahler stock................ $ 94,680,000
Kahler notes payable at June 30, 1997.......................... 178,389,000
Issuance of 2,284,262 shares of unregistered Common Stock at
$14.01 per share............................................. 32,000,000
Issuance of 250,000 shares of unregistered 7.9% Class A
Cumulative Convertible Preferred Stock at $100 per share..... 25,000,000
------------
Subtotal.................................................. 330,069,000(1)
Reduction of cash portion of purchase price by amount of
estimated accumulated earnings and profits................... (33,000,000)
Cash paid to buy-out outside interests in Provo Park Hotel and
Residence Inn................................................ 7,500,000
Cash paid to buy-out outside interests in University Park Hotel
and Conference Center........................................ 3,800,000
Payment of transaction related costs........................... 9,500,000
Additional Kahler debt assumed (excludes lines of credit)...... 42,515,000
Kahler lines of credit assumed (See E)......................... 6,050,000
Issuance of 3,500 Partnership units at $16.125 per unit to
acquire the minority interest share of Best Western, Ogden,
Utah......................................................... 56,000
Other net liabilities assumed.................................. 4,515,000
------------
Investment in hotel properties................................. $371,005,000
============
</TABLE>
(1) Amount does not include any adjustments related to earnings or
gains/losses from the sales of assets subsequent to June 30, 1997.
F-5
<PAGE> 69
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET (CONTINUED)
AS OF JUNE 30, 1997
(E) Represents the following proposed transactions in connection with the Kahler
Acquisition:
<TABLE>
<S> <C>
Cash portion of purchase price................................. $ 94,680,000
Reduction of cash portion of purchase price for accumulated
earnings and profits......................................... (33,000,000)
Kahler lines of credit assumed (June 30, 1997 balances)........ 6,050,000
Additional assumed Kahler line of credit financing subsequent
to June 30, 1997............................................. 15,069,000
Cash paid to buy-out outside interests in Provo Park Hotel and
Residence Inn................................................ 7,500,000
Cash paid to buy-out outside interest in University Park Hotel
and Conference Center........................................ 3,800,000
Payment of transaction related costs........................... 9,500,000
------------
$103,599,000
============
</TABLE>
(F) Represents the following proposed transactions in connection with the Kahler
Acquisition:
<TABLE>
<S> <C>
Kahler assumed debt at June 30, 1997 (excluding lines of
credit) to be repaid......................................... $123,791,000
Kahler assumed debt at June 30, 1997 to remain
outstanding(1)............................................... 48,548,000
Kahler affiliate debt assumed (previously not
consolidated)(2)............................................. 15,565,000
Additional assumed Kahler mortgage financing subsequent to June
30, 1997..................................................... 17,931,000
------------
$205,835,000
============
</TABLE>
(1) Includes $15,069,000 in debt to be refinanced prior to the closing.
(2) Represents the historical mortgage debt related to Provo Park Hotel and
Residence Inn, both in Provo, Utah. These hotels were historically
accounted for using the equity method; however, pro forma adjustments
have been recorded to combine the hotels' accounts because the Company
intends to acquire a 100% interest in these hotels in the near future.
(G) Represents the issuance of 3,500 Partnership units at $16.125 per unit in
connection with the proposed buyout of the minority interest share of the
Best Western, Ogden, Utah.
(H) Represents the following proposed transactions in connection with the Kahler
Acquisition:
<TABLE>
<S> <C>
Issuance of unregistered Common Stock (2,284,262 shares at
$14.01 per share)............................................. $32,000,000
Issuance of unregistered 7.9% Class A Cumulative Convertible
Preferred Stock (250,000 shares at $100 per share)............ 25,000,000
-----------
$57,000,000
===========
</TABLE>
The 7.9% Class A Cumulative Convertible Preferred Stock is currently
convertible into 1,699,605 shares of Common Stock and may be redeemed by the
Company after five years from the issuance date.
(I) To record the Offering and related financing based upon the assumed issuance
of 9,000,000 Common shares, at $16.125 per share.
F-6
<PAGE> 70
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET (CONTINUED)
AS OF JUNE 30, 1997
(J) To reflect the following:
<TABLE>
<S> <C>
Gross proceeds from the assumed sale of 9,000,000 Common
shares; $0.01 par value at $16.125 per share................ $ 145,125,000
Transaction, registration, issuance and other costs........... (12,078,000)
-------------
Net proceeds............................................. 133,047,000
Additional draw on line of credit balance..................... 11,863,000
Anticipated repayment of assumed Kahler debt.................. (123,791,000)
Anticipated repayment of assumed Kahler lines of credit....... (21,119,000)
-------------
Net change in cash....................................... $ --
=============
</TABLE>
(K) To reflect the following:
<TABLE>
<S> <C>
Anticipated repayment of Kahler lines of credit.............. $(21,119,000)
Additional draws on Company line of credit to repay Kahler
lines of credit............................................ 11,863,000
------------
Net offering proceeds used to repay Kahler lines of credit... $ (9,256,000)
============
</TABLE>
(L) To reflect mortgage and other debt (excluding lines of credit) anticipated
to be repaid from the net proceeds of the Offering ($133,047,000). The
maturity dates, interest rates and balances of the debt anticipated to be
repaid, as of June 30, 1997 are listed below. The actual amounts repaid will
be different to the extent of any amortization of loan balances which occurs
prior to the actual date of repayment.
<TABLE>
<CAPTION>
MATURITY DATE INTEREST RATE
------------------------------ ------------------------------
<S> <C> <C>
December 1, 2003.............. 12% $ 2,740,000
November 1, 1997.............. 10% plus 2% of room sales 15,035,000
May 1, 2000................... 9.75% plus 2% of room sales 14,139,000
December 10, 2000............. Prime plus 1% 3,837,000
October 22, 2000.............. Prime plus 1.5% 453,000
June 10, 2004................. Prime 543,000
June 1, 2013.................. 9.875% 9,199,000
August 31, 1999............... Prime plus 0.5% 4,800,000
April 30, 2001................ 8.19% 8,492,000
April 1, 2014................. Prime plus 1.5% 3,475,000
April 1, 2001................. 8.06% 4,403,000
December 1, 1997.............. Prime plus 1% 1,500,000
June 30, 2000................. 9.50% 560,000
June 1, 2003.................. Prime plus 0.5% 11,475,000
April 21, 1998................ Prime plus 1% 500,000
June 10, 2009................. Prime 1,850,000
August 12, 2003............... 10% 40,000,000
Various through June 1998..... 6.5%-13% 790,000
------------
Total assumed Kahler mortgage
and other debt to be
repaid...................... $123,791,000
============
</TABLE>
The pro forma income statements do not reflect additional costs of
extinguishing any of Kahler's debt (e.g., prepayment penalties). Any gain or
loss related to the extinguishment of debt will be treated as an extraordinary
item in the Company's post-acquisition income statement. At June 30, 1997, the
weighted average interest rate of debt to be repaid is 9.6%.
(M) To reflect the following:
<TABLE>
<S> <C>
Gross proceeds from the assumed sale of 9,000,000 Common
shares, $0.01 par value at $16.125 per share................. $145,125,000
Transaction, registration, issuance and other costs............ (12,078,000)
------------
Net proceeds.............................................. $133,047,000
============
</TABLE>
F-7
<PAGE> 71
SUNSTONE HOTEL INVESTORS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
KAHLER OFFERING SUNSTONE HOTEL
SUNSTONE HOTEL PRO FORMA CURRENT ACQUISITION PRO FORMA INVESTORS,
INVESTORS, INC. ADJUSTMENTS HOTELS ADJUSTMENTS ADJUSTMENTS INC.
--------------- ----------- ----------- ----------- ----------- --------------
(HISTORICAL) (PRO FORMA) (PRO FORMA)
(A) (B) (G) (I)
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue................. $15,347,000 $4,804,000 (C) $20,151,000 $21,215,000 (C) $ -- $ 41,366,000
Interest income............... 321,000 -- 321,000 -- -- 321,000
----------- ---------- ----------- ----------- ----------- ------------
15,668,000 4,804,000 20,472,000 21,215,000 -- 41,687,000
----------- ---------- ----------- ----------- ----------- ------------
EXPENSES:
Real estate related
depreciation and
amortization................ 3,900,000 1,619,000 (D) 5,519,000 4,715,000 (D) -- 10,234,000
Interest expense and
amortization of financing
costs....................... 1,557,000 2,644,000 (E) 4,201,000 13,343,000 (E) (7,603,000)(J) 9,941,000
Real estate, personal property
taxes and insurance......... 1,360,000 1,069,000 (F) 2,429,000 2,345,000 (F) -- 4,774,000
General and administrative.... 801,000 -- 801,000 125,000 (H) -- 926,000
----------- ---------- ----------- ----------- ----------- ------------
Total expenses.............. 7,618,000 5,332,000 12,950,000 20,528,000 (7,603,000) 25,875,000
----------- ---------- ----------- ----------- ----------- ------------
Income (loss) before
minority interest......... 8,050,000 (528,000) 7,522,000 687,000 7,603,000 15,812,000
Minority interest............. 953,000 -- 953,000 -- 317,000 (K) 1,270,000
----------- ---------- ----------- ----------- ----------- ------------
Net income (loss)........... 7,097,000 (528,000) 6,569,000 687,000 7,286,000 14,542,000
Preferred dividend
requirements.............. -- -- -- (988,000) -- (988,000)
----------- ---------- ----------- ----------- ----------- ------------
Net income (loss) available
to common stockholders.... $ 7,097,000 $ (528,000) $ 6,569,000 $ (301,000) $ 7,286,000 $ 13,554,000
=========== ========== =========== =========== =========== ============
Net income per Common Share
outstanding................. $ 0.43
============
Weighted average number of
shares of Common Stock and
Common Stock equivalents
outstanding(L).............. 31,859,072
============
</TABLE>
F-8
<PAGE> 72
SUNSTONE HOTEL INVESTORS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
SUNSTONE HOTEL KELLER OFFERING SUNSTONE HOTEL
INVESTORS, PRO FORMA CURRENT ACQUISITION PRO FORMA INVESTORS,
INC. ADJUSTMENTS HOTELS ADJUSTMENTS ADJUSTMENTS INC.
-------------- ----------- ----------- ----------- ------------ --------------
(HISTORICAL) (PRO FORMA) (PRO FORMA)
(A) (B) (G) (I)
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue................. $14,848,000 $20,796,000(C) $35,644,000 $37,379,000(C) $ -- $73,023,000
Interest income............... 236,000 -- 236,000 -- -- 236,000
----------- ----------- ----------- ----------- ------------ -----------
15,084,000 20,796,000 35,880,000 37,379,000 -- 73,259,000
----------- ----------- ----------- ----------- ------------ -----------
EXPENSES:
Real estate related
depreciation and
amortization................ 4,514,000 8,318,000 (D) 12,832,000 9,429,000 (D) -- 22,261,000
Interest expense and
amortization of financing
costs....................... 1,558,000 11,584,000 (E) 13,142,000 23,867,000 (E) (17,127,000)(J) 19,882,000
Real estate, personal property
taxes and insurance......... 1,273,000 2,764,000 (F) 4,037,000 4,727,000 (F) -- 8,764,000
General and administrative.... 1,015,000 -- 1,015,000 250,000 (H) -- 1,265,000
----------- ----------- ----------- ----------- ------------ -----------
Total expenses.............. 8,360,000 22,666,000 31,026,000 38,273,000 (17,127,000) 52,172,000
----------- ----------- ----------- ----------- ------------ -----------
Income (loss) before
minority interest......... 6,724,000 (1,870,000) 4,854,000 (894,000) 17,127,000 21,087,000
Minority interest............. 1,090,000 -- 1,090,000 -- 603,000 (K) 1,693,000
----------- ----------- ----------- ----------- ------------ -----------
Net income (loss)........... 5,634,000 (1,870,000) 3,764,000 (894,000) 16,524,000 19,394,000
Preferred dividend
requirements.............. -- -- -- (1,975,000) -- (1,975,000)
----------- ----------- ----------- ----------- ------------ -----------
Net income (loss) available
to common stockholders.... $ 5,634,000 $(1,870,000) $ 3,764,000 $(2,869,000) $ 16,524,000 $17,419,000
=========== =========== =========== =========== ============ ===========
Net income per Common Share
outstanding................. $ 0.55
===========
Weighted average number of
shares of Common Stock and
Common Stock equivalents
outstanding(L).............. 31,859,072
===========
</TABLE>
F-9
<PAGE> 73
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND
FOR THE YEAR ENDED DECEMBER 31, 1996
(A) Represents the Company's historical results of operations for the period.
(B) Represents pro forma adjustments to the Company's results of operations
assuming the acquisitions of the Current Hotels had occurred at the
beginning of the period presented. No pro forma revenues or expenses related
to the Regency Plaza Hotel in Los Angeles (acquired August 28, 1997) have
been included in the pro forma combined statement of income for the year
ended December 31, 1996 because the hotel was not operational during the
majority of that year.
The following hotels are included in the six months ended June 30, 1997 and
the year ended December 31, 1996 pro forma adjustments:
<TABLE>
<CAPTION>
ACQUIRED HOTEL DATE ACQUIRED
- ----------------------------------------------------------- ------------------
<S> <C>
Holiday Inn Harbor View, San Diego, California January 17, 1997
Ramada Hotel, Cypress, California January 17, 1997
Hawthorn Suites, Kent, Washington March 11, 1997
Holiday Inn, La Mirada, California March 31, 1997
Fountain Suites, Sacramento, California May 17, 1997
Ramada Plaza Hotel, San Diego, California June 11, 1997
Best Western Landmark Inn, Lynnwood, Washington July 17, 1997
Holiday Inn Mission Valley Stadium, San Diego, California August 7, 1997
Best Western Crystal Suites, Anaheim, California August 7, 1997
Regency Plaza Hotel, Los Angeles, California August 28, 1997
</TABLE>
The following additional hotels are included in the year ended December 31,
1996 pro forma adjustments (these hotels are already included in the
Company's historical amounts for the six months ended June 30, 1997):
<TABLE>
<CAPTION>
ACQUIRED HOTEL DATE ACQUIRED
- ----------------------------------------------------------- ------------------
<S> <C>
Holiday Inn & Suites, Kent, Washington February 2, 1996
Holiday Inn Express, Poulsbo, Washington February 2, 1996
Holiday Inn Express, Portland, Oregon February 2, 1996
Hampton Inn, Clackamas, Oregon February 2, 1996
Courtyard by Marriott, Riverside, California April 1, 1996
Holiday Inn Select, Renton, Washington June 28, 1996
Comfort Suites, South San Francisco, California August 13, 1996
Holiday Inn Hotel & Suites, Price, Utah August 13, 1996
Holiday Inn, Mesa, Arizona October 29, 1996
Holiday Inn, Flagstaff, Arizona October 29, 1996
Hampton Inn, Tucson, Arizona October 29, 1996
Residence Inn, Oxnard, California December 19, 1996
</TABLE>
F-10
<PAGE> 74
(C) Represents lease payments from the Lessee to the Company calculated on a pro
forma basis by applying the provisions of the Percentage Leases to the
historical revenue of the Current Hotels and Kahler Hotels acquired assuming
the beginning of the period was the start of the lease term.
The Kahler Hotel lease terms are as follows:
<TABLE>
<CAPTION>
ANNUAL
PERCENTAGE
LEASE
-------------- ROOM
FIRST SECOND REVENUE
BRAND LOCATION TIER TIER BREAKPOINT
--------------------------------------- ------------------- ----- ------ -----------
<S> <C> <C> <C> <C>
Quality Inn Pocatello Park............. Pocatello, ID 23.1% 62% $ 1,686,000
Best Western Colonial Park............. Helena, MT 42.7% 62% 2,237,000
Olympia Park........................... Park City, UT 24.4% 62% 3,793,000
Kahler Plaza Hotel..................... Rochester, MN 42.3% 62% 6,861,000
Best Western Ogden Park................ Ogden, UT 25.0% 62% 4,115,000
Provo Park............................. Provo, UT 37.2% 62% 5,490,000
Residence Inn by Marriott.............. Provo, UT 34.6% 62% 1,936,000
Best Western Canyon Springs............ Twin Falls, ID 40.3% 62% 1,501,000
Holiday Inn............................ Rochester, MN 9.2% 62% 2,655,000
Boise Park Suites...................... Boise, ID 37.5% 62% 3,275,000
Hilton................................. Salt Lake City, UT 50.2% 62% 7,659,000
The Kahler Hotel....................... Rochester, MN 35.2% 62% 11,720,000
Sheraton............................... Chandler, AZ 34.7% 62% 8,316,000
Kahler Inn & Suites.................... Rochester, MN 47.3% 62% 3,635,000
Green Oaks Park Hotel.................. Fort Worth, TX 23.8% 62% 2,466,000
University Park Hotel & Conference
Center............................... Salt Lake City, UT 44.9% 62% 4,258,000
Lakeview Resort & Conference Center.... Morgantown, WV 22.7% 62% 4,586,000
</TABLE>
(D) Represents depreciation on the hotels and other assets acquired.
Depreciation is computed using the straight-line method and is based upon
the estimated useful lives of 3 to 40 years for buildings and improvements,
2 to 10 years for furniture and equipment and 10 to 20 years for franchise
fees.
(E) Represents interest expense and amortization of financing costs which would
have been incurred on the net borrowings under the line of credit which was
used to purchase hotel properties and other assets.
(F) Represents real estate and personal property taxes, ground leases and
insurance expense that would have been incurred by the Company based on
historical amounts of property taxes and ground lease expense and estimated
insurance premiums based upon the Company's existing insurance policies
(estimated at 1% of total revenue).
(G) Represents adjustments to the Company's results of operations assuming the
Kahler acquisition had occurred at the beginning of the period presented.
(H) Represents the incremental corporate expenses that will be incurred as a
result of the Kahler Acquisition.
(I) Represents adjustments to the Company's results of operations assuming the
Offering and related financings had occurred at the beginning of the period
presented.
(J) Represents the elimination of interest expense incurred on the portion of
borrowings which are to be repaid with proceeds from the Offering.
(K) Calculated as a percentage of income before minority interest. Pro forma
adjustment required to reflect the percentage of the Partnership owned by
parties other than the Company (8.03%).
(L) The weighted average number of common stock and common stock equivalents
outstanding does not assume the conversion of Partnership units into common
shares.
F-11
<PAGE> 75
SUNSTONE HOTEL PROPERTIES, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
SUNSTONE HOTEL SUNSTONE HOTEL
PROPERTIES, PRO FORMA CURRENT KAHLER PRO FORMA KAHLER PROPERTIES,
INC. ADJUSTMENTS HOTELS ACQUISITION ADJUSTMENTS ACQUISITION INC.
-------------- ----------- ----------- ----------- ----------- ----------- --------------
(HISTORICAL) (PRO FORMA) (HISTORICAL) (PRO FORMA) (PRO FORMA)
(A) (B) (D)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Room................. $ 34,501,000 $ 9,433,000 $43,934,000 $38,199,000 $ 3,110,000(E) $41,309,000 $ 85,243,000
Food and beverage.... 2,744,000 816,000 3,560,000 18,942,000 1,271,000(E) 20,213,000 23,773,000
Other................ 2,002,000 659,000 2,661,000 9,571,000 362,000(E) 9,933,000 12,594,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
39,247,000 10,908,000 50,155,000 66,712,000 4,743,000 71,455,000 121,610,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
OPERATING EXPENSES:
Room................. 7,735,000 2,534,000 10,269,000 9,036,000 792,000(E) 9,828,000 20,097,000
Food and beverage.... 2,296,000 716,000 3,012,000 14,361,000 978,000(E) 15,339,000 18,351,000
Laundry.............. -- -- -- 1,904,000 -- 1,904,000 1,904,000
Telephone............ -- 111,000 111,000 -- 78,000(E) 78,000 189,000
Amusement park
tickets............ -- 144,000 144,000 -- -- -- 144,000
Other................ 988,000 106,000 1,094,000 19,762,000 104,000(E) 19,866,000 20,960,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
11,019,000 3,611,000 14,630,000 45,063,000 1,952,000 47,015,000 61,645,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
Departmental
profit........... 28,228,000 7,297,000 35,525,000 21,649,000 2,791,000 24,440,000 59,965,000
General and
administrative..... 3,734,000 1,098,000 4,832,000 -- 454,000(E) 454,000 5,286,000
Sales and
marketing.......... 2,300,000 929,000 3,229,000 -- 442,000(E) 442,000 3,671,000
Repairs and
maintenance........ 1,374,000 579,000 1,953,000 -- 156,000(E) 156,000 2,109,000
Utilities and other
operating costs.... 1,792,000 466,000 2,258,000 -- 193,000(E) 193,000 2,451,000
Management fees...... 759,000 218,000(C) 977,000 -- 715,000(F) 715,000 1,692,000
Franchise fees....... 2,557,000 50,000 2,607,000 -- -- -- 2,607,000
Real estate, personal
property taxes and
insurance.......... -- -- -- 2,517,000 (2,517,000)(G) -- --
Corporate expenses... -- -- -- 1,475,000 (1,475,000)(H) -- --
Non-recurring
expenses........... -- -- -- 2,102,000 (2,102,000)(I) -- --
------------ ----------- ----------- ----------- ----------- ----------- ------------
Gross operating
profit........... 15,712,000 3,957,000 19,669,000 15,555,000 6,925,000 22,480,000 42,149,000
Capital lease
expense............ -- 15,000 15,000 -- 10,000 10,000 25,000
Real estate related
depreciation and
amortization....... -- -- -- 5,277,000 (5,277,000)(J) -- --
Interest expense and
amortization of
financing costs.... -- -- -- 8,420,000 (8,420,000)(K) -- --
Rent expense......... 15,347,000 4,804,000(L) 20,151,000 -- 21,215,000(L) 21,215,000 41,366,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
Net income(loss)... $ 365,000 $ (862,000) $ (497,000) $ 1,858,000 $ (603,000) $ 1,255,000 $ 758,000
============ =========== =========== =========== =========== =========== ============
</TABLE>
F-12
<PAGE> 76
SUNSTONE HOTEL PROPERTIES, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
SUNSTONE HOTEL SUNSTONE HOTEL
PROPERTIES, PRO FORMA CURRENT KAHLER PRO FORMA KAHLER PROPERTIES,
INC. ADJUSTMENTS HOTELS ACQUISITION ADJUSTMENTS ACQUISITION INC.
-------------- ----------- ----------- ----------- ----------- ----------- --------------
(HISTORICAL) (PRO FORMA) (HISTORICAL) (PRO FORMA) (PRO FORMA)
(A) (B) (D)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Room................ $ 34,085,000 $46,459,000 $80,544,000 $69,770,000 $ 4,249,000(E) $74,019,000 $154,563,000
Food and beverage... 2,576,000 6,189,000 8,765,000 35,358,000 2,229,000(E) 37,587,000 46,352,000
Other............... 1,932,000 3,227,000 5,159,000 19,526,000 506,000(E) 20,032,000 25,191,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
38,593,000 55,875,000 94,468,000 124,654,000 6,984,000 131,638,000 226,106,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
OPERATING EXPENSES:
Room................ 9,041,000 11,863,000 20,904,000 17,010,000 958,000(E) 17,968,000 38,872,000
Food and beverage... 2,436,000 5,429,000 7,865,000 27,365,000 1,690,000(E) 29,055,000 36,920,000
Laundry............. -- -- -- 5,163,000 -- 5,163,000 5,163,000
Telephone........... -- 590,000 590,000 -- 125,000(E) 125,000 715,000
Amusement park
tickets........... -- 687,000 687,000 -- -- -- 687,000
Other............... 1,265,000 603,000 1,868,000 37,572,000 188,000(E) 37,760,000 39,628,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
12,742,000 19,172,000 31,914,000 87,110,000 2,961,000 90,071,000 121,985,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
Departmental
profit............ 25,851,000 36,703,000 62,554,000 37,544,000 4,023,000 41,567,000 104,121,000
General and
administrative.... 4,098,000 5,849,000 9,947,000 -- 738,000(E) 738,000 10,685,000
Sales and
marketing......... 3,895,000 4,665,000 8,560,000 542,000(E) 542,000 9,102,000
Repairs and
maintenance....... 1,829,000 2,950,000 4,779,000 -- 224,000(E) 224,000 5,003,000
Utilities and other
operating costs... 2,034,000 2,906,000 4,940,000 -- 269,000(E) 269,000 5,209,000
Management fees..... 983,000 1,118,000(C) 2,101,000 -- 1,316,000(F) 1,316,000 3,417,000
Franchise fees...... 1,326,000 309,000 1,635,000 -- -- -- 1,635,000
Real estate,
personal property
taxes and
insurance......... -- -- -- 5,418,000 (5,418,000)(G) -- --
Corporate
expenses.......... -- -- -- 4,192,000 (4,192,000)(H) -- --
Non-recurring
expenses.......... -- -- -- 3,465,000 (3,465,000)(I) -- --
------------ ----------- ----------- ----------- ----------- ----------- ------------
Gross operating
profit............ 11,686,000 18,906,000 30,592,000 24,469,000 14,009,000 38,478,000 69,070,000
Capital lease
expense........... -- 7,000 7,000 -- -- -- 7,000
Real estate related
depreciation and
amortization...... -- -- -- 9,113,000 (9,113,000)(J) -- --
Interest expense and
amortization of
financing costs... -- -- -- 13,958,000 (13,958,000)(K) -- --
Rent expense........ 14,848,000 20,796,000(L) 35,644,000 -- 37,379,000(L) 37,379,000 73,023,000
------------ ----------- ----------- ----------- ----------- ----------- ------------
Net
income(loss).... $ (3,162,000) $(1,897,000) $(5,059,000) $ 1,398,000 $ (299,000) $ 1,099,000 $ (3,960,000)
============ =========== =========== =========== =========== =========== ============
</TABLE>
F-13
<PAGE> 77
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND FOR THE YEAR ENDED DECEMBER 31, 1996
(A) Represents the historical results of operations of Sunstone Hotel
Properties, Inc. (the "Lessee").
(B) Represents pro forma adjustments to the Company's results of operations
assuming the acquisitions of the Current Hotels had occurred at the
beginning of the period presented. No pro forma revenues or expenses related
to the Regency Plaza Hotel in Los Angeles (acquired August 28, 1997) have
been included in the pro forma statement of operations for the year ended
December 31, 1996 because the hotel was not operational during the majority
of that year.
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, 1997 DECEMBER 31, 1996
------------- -----------------
<S> <C> <C> <C>
(C) Represents the following:
Management fees incurred.................................. $ 152,000 $ 1,551,000
Adjustment to reflect fees at 2% of total revenue......... 66,000 (433,000)
--------- -----------
$ 218,000 $ 1,118,000
========= ===========
</TABLE>
(D) Represents the historical results of operations of Kahler Realty Corporation
and subsidiaries.
(E) Represents the consolidation of Provo Park Hotel and Residence Inn by
Marriott, both in Provo, Utah. These hotels were historically accounted for
using the equity method; however, pro forma adjustments have been recorded
to consolidate the hotels' operations because the Company intends to acquire
a 100% interest in these hotels in the near future.
(F) Represents the adjustment to reflect management fees at 1% of total revenue.
(G) Represents the elimination of property taxes, ground lease payments and
insurance which would be a cost incurred by the Company.
(H) Represents the elimination of corporate expenses which would be a cost of
the Company.
(I) Represents the elimination of non-recurring and other expenses which would
not be incurred by the Lessee.
(J) Represents the elimination of depreciation and amortization expense which
would be a cost incurred by the Company.
(K) Represents the elimination of interest and amortization expense which would
be a cost incurred by the Company.
(L) Represents rent expense calculated on a pro forma basis by applying the rent
provisions of the Percentage Leases to the historical revenues of the
Current Hotels and the Kahler Hotels acquired assuming the beginning of the
period was the start of the lease term.
F-14
<PAGE> 78
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Sunstone Hotel Investors, Inc.
We have audited the accompanying consolidated balance sheets of Sunstone Hotel
Investors, Inc. (the "Company") as of December 31, 1996 and 1995 and the related
consolidated statements of operations, equity and cash flows for the year ended
December 31, 1996 and for the period August 16, 1995 to December 31, 1995 and
the combined statements of operations, deficit and cash flows of Sunstone Hotels
(the "Predecessor") for the period January 1, 1995 to August 15, 1995, and for
the year ended December 31, 1994. Our audit also included the accompanying
financial statement schedule as of December 31, 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated and combined financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of Sunstone Hotel Investors, Inc. as of December 31, 1996 and 1995, and
the consolidated results of their operations and cash flows for the year ended
December 31, 1996 and for the period August 16, 1995 to December 31, 1995 and
the combined results of operations and cash flows of the Predecessor for the
period January 1, 1995 to August 15, 1995, and for the year ended December 31,
1994, in conformity with generally accepted accounting principles. In addition,
in our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
San Francisco, California
February 28, 1997
F-15
<PAGE> 79
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
A S S E T S
<TABLE>
<CAPTION>
DECEMBER 31,
JUNE 30, ---------------------------
1997 1996 1995
------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Investment in hotel properties, net......... $252,349,000 $152,937,000 $50,063,000
Mortgage notes receivable................... 2,850,000 2,850,000
Cash and cash equivalents................... 1,189,000 142,000 5,222,000
Rent receivable -- Lessee................... 3,904,000 2,360,000 646,000
Prepaid expenses and other assets, net of
accumulated amortization of $426,000,
$253,000 and $32,000, respectively........ 2,724,000 1,790,000 1,305,000
------------ ------------ -----------
$263,016,000 $160,079,000 $57,236,000
============ ============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Revolving line of credit.................... $ 18,800,000 $ 40,400,000 $ 8,400,000
Mortgage loans payable...................... 22,649,000 19,651,000
Accounts payable and other accrued
expenses.................................. 2,235,000 3,249,000 1,346,000
Distributions payable....................... 1,764,000
------------ ------------ -----------
43,684,000 63,300,000 11,510,000
------------ ------------ -----------
Commitments and contingencies
Minority interest........................... 24,521,000 15,978,000 8,231,000
------------ ------------ -----------
Stockholders' equity:
Common stock, $.01 par value, 50,000,000
authorized; 20,368,001, 10,936,457 and
6,322,000 issued and outstanding as of
June 30, 1997, December 31, 1996 and 1995,
respectively.............................. 203,000 109,000 63,000
Preferred stock, $.01 par value, 10,000,000
authorized, no shares issued or
outstanding
Additional paid-in capital.................. 195,494,000 80,700,000 37,432,000
Distributions in excess of earnings......... (886,000) (8,000)
------------ ------------ -----------
$194,811,000 80,801,000 37,495,000
------------ ------------ -----------
$263,016,000 $160,079,000 $57,236,000
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-16
<PAGE> 80
SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENTS OF INCOME
SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SUNSTONE HOTEL INVESTORS, INC.
------------------------------------------------------------ SUNSTONE HOTELS
FOR THE FOR THE -------------------------------
SIX MONTHS SIX MONTHS FOR THE YEAR FOR THE PERIOD FOR THE PERIOD FOR THE
ENDED ENDED ENDED AUGUST 16, 1995 JANUARY 1, 1995 YEAR ENDED
JUNE 30, JUNE 30, DECEMBER 31, TO DECEMBER 31, TO AUGUST 15, DECEMBER 31,
1997 1996 1996 1995 1995 1994
------------ ------------ ------------ --------------- ---------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
REVENUES:
Lease revenue............. $15,347,000 $6,155,000 $14,848,000 $ 3,013,000
Hotel operating revenue... $9,675,000 $13,863,000
Interest income........... 321,000 60,000 236,000 47,000
----------- ---------- ----------- ----------- ---------- -----------
15,668,000 6,215,000 15,084,000 3,060,000 9,675,000 13,863,000
----------- ---------- ----------- ----------- ---------- -----------
EXPENSES:
Real estate related
depreciation and
amortization............ 3,900,000 1,846,000 4,514,000 968,000 696,000 1,248,000
Interest expense and
amortization of
financing costs......... 1,557,000 811,000 1,558,000 47,000 1,270,000 2,360,000
Real estate, personal
property taxes and
insurance............... 1,360,000 566,000 1,273,000 312,000 356,000 689,000
Property operating
costs................... 3,550,000 5,801,000
General and
administrative.......... 801,000 281,000 1,015,000 109,000 721,000 1,067,000
Management fees........... 409,000 620,000
Franchise costs........... 323,000 624,000
Advertising and
promotion............... 676,000 1,056,000
----------- ---------- ----------- ----------- ---------- -----------
Total expenses..... 7,618,000 3,504,000 8,360,000 1,436,000 8,001,000 13,465,000
----------- ---------- ----------- ----------- ---------- -----------
Income before minority
interest and
extraordinary items..... 8,050,000 2,711,000 6,724,000 1,624,000 1,674,000 398,000
Minority interest......... 953,000 497,000 1,090,000 284,000
----------- ---------- ----------- ----------- ---------- -----------
Income before
extraordinary
item............. 7,097,000 2,214,000 5,634,000 1,340,000 1,674,000 398,000
Extraordinary charge for
early extinguishment of
debt (net of $34,000 of
minority interest)...... 159,000
----------- ---------- ----------- ----------- ---------- -----------
NET INCOME.................. $ 7,097,000 $2,214,000 $ 5,634,000 $ 1,181,000 $1,674,000 $ 398,000
=========== ========== =========== =========== ========== ===========
Per common share:
Income before
extraordinary item...... $ 0.43 $ 0.35 $ 0.71 $ 0.21
Extraordinary item (net of
minority interest)...... (0.02)
----------- ---------- ----------- -----------
NET INCOME.............. $ 0.43 $ 0.35 $ 0.71 $ 0.19
=========== ========== =========== ===========
Weighted average number of
shares.................... 16,505,000 6,322,000 8,050,990 6,322,000
=========== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-17
<PAGE> 81
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL DISTRIBUTIONS
--------------------- PAID-IN IN EXCESS OF
TOTAL SHARES $ CAPITAL EARNINGS
----------- ---------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance at August 15, 1995................... $ 490,000 $ 490,000
Reorganization and issuance of common
stock.................................... 53,306,000 6,322,000 $ 63,000 53,243,000
Predecessor deficit........................ (6,627,000) (6,627,000)
Issuance of common stock to directors...... 71,000 71,000
Dividends/distributions declared........... (2,695,000) (1,514,000) $ (1,181,000)
Net income................................. 1,181,000 1,181,000
Minority interest.......................... (8,231,000) (8,231,000)
----------- ---------- -------- ----------- ------------
Balance at December 31, 1995................. 37,495,000 6,322,000 63,000 37,432,000
Issuance of common stock, net.............. 43,151,000 4,614,457 46,000 43,105,000
Distributions declared..................... (5,642,000) (5,642,000)
Net income................................. 5,634,000 5,634,000
Reallocation of minority interest.......... 163,000 163,000
----------- ---------- -------- ----------- ------------
Balance at December 31, 1996................. $80,801,000 10,936,457 $109,000 $80,700,000 $ (8,000)
=========== ========== ======== =========== ============
</TABLE>
SUNSTONE HOTELS (PREDECESSOR)
COMBINED STATEMENTS OF DEFICIT
<TABLE>
<CAPTION>
PARTNERS'
DEFICIT
-----------
<S> <C>
Balance at January 1, 1994...................................................... $(8,781,000)
Net income.................................................................... 398,000
Capital contributions......................................................... 159,000
Distributions................................................................. (50,000)
-----------
Balance at December 31, 1994.................................................... (8,274,000)
Net income.................................................................... 1,674,000
Capital contributions......................................................... 15,000
Distributions................................................................. (42,000)
-----------
Balance at August 15, 1995...................................................... $(6,627,000)
===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-18
<PAGE> 82
SUNSTONE HOTEL INVESTORS, INC. -- CONSOLIDATED STATEMENTS OF CASH FLOWS
SUNSTONE HOTELS (PREDECESSOR) -- COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SUNSTONE HOTEL INVESTORS, INC.
------------------------------------------------------------------ SUNSTONE HOTELS
FOR THE FOR THE ------------------------------
SIX MONTHS SIX MONTHS FOR THE YEAR FOR THE PERIOD FOR THE PERIOD FOR THE
ENDED ENDED ENDED AUGUST 16, 1995 JANUARY 1, 1995 YEAR ENDED
JUNE 30, JUNE 30, DECEMBER 31, TO DECEMBER 31, TO AUGUST 15, DECEMBER 31,
1997 1996 1996 1995 1995 1994
--------------- --------------- ------------ --------------- --------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income................ $ 7,097,000 $ 2,214,000 $ 5,634,000 $ 1,181,000 $1,674,000 $ 398,000
Extraordinary item due to
early extinguishment of
debt.................... 159,000
Adjustments to reconcile
net income to net cash
provided by operating
activities:
Minority interest....... 953,000 497,000 1,090,000 284,000
Depreciation............ 3,900,000 1,846,000 4,514,000 968,000 696,000 1,248,000
Amortization of
financing costs....... 173,000 114,000 221,000 35,000
Loss on disposal of
assets................ 108,000
Increase in due to
affiliates for
management fees....... 70,000 73,000
Management fees waived
by partner............ 15,000 160,000
Interest expense added
to principal balance
for revenue
participation
clause................ 51,000
Changes in assets and
liabilities:
Receivables, net........ 255,000 33,000
Rent
receivable-Lessee..... (1,544,000) (1,314,000) (1,714,000) (646,000)
Prepaid and other
assets, net........... (359,000) 493,000 21,000 (900,000) 79,000 97,000
Accounts payable and
accrued expenses...... (1,014,000) (1,225,000) 1,903,000 1,210,000 (1,595,000) 429,000
------------- ------------- ------------ ------------- ----------- -----------
Net cash provided by
operating
activities........ 9,206,000 2,625,000 11,669,000 2,291,000 1,194,000 2,597,000
------------- ------------- ------------ ------------- ----------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Acquisition, improvements
and additions to hotel
properties.............. (86,805,000) (35,577,000) (83,857,000) (32,899,000) (463,000) (1,081,000)
Mortgage notes
receivables............. (2,850,000)
Proceeds from sale of
hotel properties........ 3,950,000 1,100,000
Decrease in restricted
cash.................... 104,000 263,000
------------- ------------- ------------ ------------- ----------- -----------
Net cash used in
investing
activities........ (86,805,000) (34,477,000) (82,757,000) (32,899,000) (359,000) (818,000)
------------- ------------- ------------ ------------- ----------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net proceeds from issuance
of common stock......... 118,282,000 43,151,000 52,982,000
Payments to noncontinuing
equity investors of
Predecessor............. (832,000)
Payment of deferred
financing costs......... (748,000) (308,000) (425,000)
Borrowings on revolving
line of credit.......... 24,900,000 28,656,000 53,200,000 8,400,000
Principal payments on
revolving line of
credit.................. (46,500,000) (1,100,000) (21,200,000)
Principal payments on
long-term debt.......... (8,119,000) (411,000) (23,420,000) (846,000) (1,055,000)
Proceeds from issuance of
long-term debt.......... 3,018,000 200,000
Advances from
affiliates.............. 40,000
Payments on advances from
affiliates.............. (418,000) (460,000)
Distributions paid........ (7,975,000) (2,908,000) (7,096,000) (727,000)
Partnership distributions
paid.................... (1,194,000) (719,000) (1,328,000) (154,000) (42,000) (50,000)
------------- ------------- ------------ ------------- ----------- -----------
Net cash provided by
(used in)
financing
activities........ 78,646,000 26,947,000 66,008,000 35,824,000 (1,306,000) (1,325,000)
------------- ------------- ------------ ------------- ----------- -----------
Net change in
cash.............. 1,047,000 (4,905,000) (5,080,000) 5,216,000 (471,000) 454,000
Cash, beginning of period... 142,000 5,222,000 5,222,000 6,000 718,000 264,000
------------- ------------- ------------ ------------- ----------- -----------
Cash, end of period......... $ 1,189,000 $ 317,000 $ 142,000 $ 5,222,000 $ 247,000 $ 718,000
============= ============= ============ ============= =========== ===========
Supplemental Disclosure:
Cash paid for interest,
net of amounts
capitalized............. $ 2,016,000 $ 1,242,000 $ 1,337,000 $ 11,000 $ 1,750,000 $ 2,193,000
============= ============= ============ ============= =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE> 83
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, 1995, 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 (inception). 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 $53.3 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 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, (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.
On August 7, 1996, the Company completed a secondary offering for 4,000,000
shares of its common stock. On September 10, 1996, 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 was $10.00 per
share, resulting in gross proceeds of approximately $46 million and net proceeds
(less the underwriters' discount and offering expenses) of approximately $43.1
million.
At December 31, 1996, the Company owned 24 hotel properties, primarily
located in the Western United States, which are leased to Sunstone Hotel
Properties, Inc. (the "Lessee") under operating leases (the "Percentage Leases")
providing for the payment of base and percentage rent. The Lessee is owned by
Robert A. Alter, Chairman and President of the Company (80%), and Charles L.
Biederman, Director and Executive Vice President of the Company (20%). The
Lessee has entered into a management agreement pursuant to which all of the
Hotels are managed by Sunstone Hotel Management, Inc. (the "Management
Company"), of which Mr. Alter is the sole shareholder.
Basis Of Presentation
For accounting purposes, the Company exercises unilateral control over the
Partnership; hence, the financial statements of the Company and the Partnership
are consolidated. All significant intercompany transactions and balances have
been eliminated.
The Predecessor
The predecessor to the Company was Sunstone Hotels (the "Predecessor"),
consisting of the seven entities referred to above. Due to 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 or other hotel properties
F-20
<PAGE> 84
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
acquired subsequent to the Offering and are, therefore, not comparable to the
financial statements of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Investment In Hotel Properties
The Sunstone Hotels are recorded at the historical cost of the Predecessor
including accumulated depreciation and do not reflect the Company's cost to
acquire the Sunstone Hotels. All other hotel properties are recorded at cost,
less accumulated depreciation. During periods of construction, interest
attributable to rooms not in service is capitalized until such rooms are
available for their intended use under a specific identification method. Hotel
properties are stated at the lower of cost or the amounts described below and
are depreciated using the straight-line method over estimated useful lives
ranging from five to thirty-five years for buildings and improvements and three
to ten years for furniture, fixtures and equipment. A gain or loss is recorded
to the extent the amounts ultimately received upon disposition differ from the
book values of the hotel assets. Franchise fees are recorded at cost and
amortized using the straight-line method over the lives of the franchise
agreements ranging from 10 to 20 years.
In 1996, the Company applied Statement of Financial Accounting Standards
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of", which requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the estimated undiscounted cash flows to be generated by those assets are
less than the carrying amount of the assets.
Management estimates that the sum of the expected future undiscounted cash
flows, excluding interest charges, for each hotel asset is greater than the
carrying amount of each hotel property and, accordingly, hotel properties are
stated at cost less accumulated depreciation.
Cash And Cash Equivalents
Cash and cash equivalents are defined as cash on hand and in banks plus all
short-term investments with an original maturity of three months or less.
Other Assets
Other assets consist primarily of deferred offering costs, deferred loan
fees, deposits and due from affiliates. Amortization of deferred loan costs is
computed using the straight-line method over the life of the loan based upon the
terms of the loan agreements. Deferred offering costs are offset against equity
when the related proceeds are received.
Minority Interest
Minority interest carried on the balance sheet is adjusted periodically
upon issuance of either common stock of the Company or Units based on the number
of Units outstanding divided by the sum of shares of common stock and units
outstanding at the measurement date. Such adjustments are recorded as
adjustments to additional paid-in capital.
Concentrations Of Credit Risk
At December 31, 1996 and 1995, the Company had amounts in banks that were
in excess of federally insured amounts.
F-21
<PAGE> 85
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
Revenue Recognition
The Company recognizes lease revenue on an accrual basis over the terms of
the respective Percentage Leases.
Income Taxes
The Company expects to qualify as a REIT under the Internal Revenue Code of
1986, as amended. A REIT will generally not be subject to federal income
taxation to the extent that it distributes at least 95% of its taxable income to
its stockholders and complies with other requirements. The Company is subject to
state income and franchise taxes in certain states in which it operates.
Stock-Based Compensation
The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations, in accounting for
its Stock Incentive Plan and its Directors Plan.
Net Income Per Share and Partnership Units
Net income per share is based on the weighted average number of common and
common equivalent shares outstanding during the year. 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 8,050,990 and 6,322,000 for the year ended December 31,
1996 and for the period August 16, 1995 to December 31, 1995, respectively. At
December 31, 1996 and 1995, 2,162,147 and 1,387,859 partnership units, which are
exchangeable for a like number of common shares of the Company, were issued and
outstanding, respectively. The weighted average number of partnership units
outstanding for the year ended December 31, 1996 and for the period August 16,
1995 to December 31, 1995 was 1,563,947 and 1,340,121, respectively. Partnership
units are not deemed to be common stock equivalents for purposes of calculating
net income per share.
Fair Value Of Financial Instruments
Management has estimated the fair value of its financial instruments.
Considerable judgment is required in interpreting market data in order to
develop estimates of the fair value of the Company's financial instruments.
Accordingly, the estimated values are not necessarily indicative of the amounts
that could be realized in current market exchanges. For those financial
instruments for which it is practical to estimate value, management believes
that the carrying amounts of the Company's financial instruments reasonably
approximate their fair value at December 31, 1996 and 1995.
Use Of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
F-22
<PAGE> 86
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT IN HOTEL PROPERTIES
Investment in hotel properties as of December 31, 1996 and 1995 consists of
the following:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Land............................................ $ 25,774,000 $ 11,597,000
Building and improvements....................... 121,550,000 40,552,000
Furniture and equipment......................... 19,681,000 8,239,000
Construction in process......................... 2,851,000 2,280,000
------------ ------------
169,856,000 62,668,000
Accumulated depreciation and amortization....... (16,919,000) (12,605,000)
------------ ------------
Net investment in hotel properties.............. $152,937,000 $ 50,063,000
============ ============
</TABLE>
In December 1995, the Company acquired one hotel in exchange for 50,537
Units and the assumption of $4 million of debt.
During 1996, the Company acquired 12 hotel properties for aggregate
consideration of $85,884,000, including transaction costs, comprised of
$57,942,000 in cash, $20,062,000 in assumed mortgage notes payable and the
issuance of 786,347 Units, which are exchangeable for a like number of shares of
common stock of the Company. During 1996, the Company completed, or was in the
process of completing, substantial renovations at ten of the hotel properties,
and in connection with such renovations, incurred costs of approximately
$9,600,000. In addition, during 1996, the Company completed development and
construction of one hotel property and incurred related costs in 1996 of
$5,189,000. In connection with the renovations and construction activity during
the year ended December 31, 1996, the Company capitalized $1,131,000 of
interest.
In May 1996, the Company sold two hotel properties acquired in February
1996 for aggregate consideration of $3,950,000, comprised of $1,100,000 in cash
and mortgage notes receivable aggregating $2,850,000. The Company did not
recognize any gain or loss in connection with the sale of the assets.
4. MORTGAGE NOTES RECEIVABLE
At December 31, 1996, mortgage notes receivable consisted of the following:
<TABLE>
<S> <C>
Note receivable dated May 17, 1996; monthly payments of interest
only at 9.1% until maturity on May 17, 1997; collateralized by
a deed of trust, assignment of rents and fixtures.............. $1,250,000
Note receivable dated May 17, 1996; monthly payments of interest
only at 9.1% until maturity on May 17, 1997; collateralized by
a deed of trust, assignment of rents and fixtures.............. 1,600,000
----------
$2,850,000
==========
</TABLE>
Related interest income for the year ended December 31, 1996 was $167,000.
5. REVOLVING LINE OF CREDIT
In October 1995, the Company obtained a three-year commitment for a $30
million credit facility maturing in 1998, which was increased to $50 million in
December 1996. Borrowings outstanding at maturity may, at the option of the
Company, be converted to a three-year term note. Initially, variable interest
was payable monthly at the London Interbank Offered Rate ("LIBOR") plus 2.75%.
The spread over LIBOR was reduced to 2.25% in June 1996 and 1.90% in August
1996. In January 1997, the spread over LIBOR was reduced to 1.75%. The credit
facility may be used for acquisitions, capital improvements, working capital and
F-23
<PAGE> 87
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
general corporate purposes and requires the Company to pay a 0.25% fee on the
unused portion. As of December 31, 1996 and 1995, additional borrowings
available under the credit facility were $9.6 million and $21.6 million,
respectively. For the year ended December 31, 1996 and for the period August 16,
1995 to December 31, 1995, related interest expense was $1,044,000 and $11,000,
respectively, and the weighted average interest rates on outstanding borrowings
at December 31, 1996 and 1995 was 7.53% and 8.13%, respectively.
The line of credit is collateralized by the hotel properties. In addition,
the line of credit is guaranteed by certain directors of the Company.
The line of credit requires the Company to maintain a specified debt to net
worth ratio, a coverage ratio of EBITDA to debt service and a debt service
coverage ratio. In addition, the Company is restricted in the amount of
distributions to share and unit holders and must maintain a specified liquidity.
Further, the Company is required to maintain national franchises at each of its
properties and maintain its REIT status. At December 31, 1996 and 1995, the
Company was in compliance with such covenants.
6. MORTGAGE NOTES PAYABLE
At December 31, 1996, mortgage notes payable consisted of the following:
<TABLE>
<S> <C>
$2,100,000 note payable dated June 9, 1994; monthly payments of
principal and interest at 9.76%; maturing in 2004;
collateralized by a first deed of trust, assignment of rents
and fixtures.................................................. $ 2,025,000
$1,000,000 note payable dated October 12, 1994; monthly payments
of principal and interest at 8.73%; maturing in 2014;
collateralized by a second deed of trust, assignment of rents
and fixtures.................................................. 955,000
$9,000,000 note payable dated September 26, 1995; monthly
payments of principal and interest at 9.95%; maturing in 1999;
collateralized by a deed of trust, assignment of rents and
fixtures...................................................... 8,018,000
$9,500,000 note payable dated December 28, 1993; monthly
payments of principal and interest at 9.67%; maturing in 1999;
collateralized by a deed of trust, assignment of rents and
fixtures...................................................... 8,653,000
-----------
$19,651,000
===========
</TABLE>
Interest expense on these mortgage notes payable was $506,000 for the year
ended December 31, 1996.
Future principal maturities after December 31, 1996, are as follows:
<TABLE>
<S> <C>
1997............................................................ $ 767,000
1998............................................................ 847,000
1999............................................................ 15,276,000
2000............................................................ 88,000
2001............................................................ 97,000
Thereafter...................................................... 2,576,000
-----------
$19,651,000
===========
</TABLE>
No mortgage notes payable were outstanding as of, or for the period ended,
December 31, 1995.
For the period January 1, 1995 to August 15, 1995, and for the year ended
December 31, 1994, the Predecessor had approximately $23.5 million of long-term
indebtedness outstanding. Such obligations were repaid in connection with the
Offering.
F-24
<PAGE> 88
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
7. COMMITMENTS
In 1996, the Company entered into a contract to acquire a 166-room
full-service convention hotel located in Pueblo, Colorado for $8.4 million from
an unaffiliated developer upon completion of construction, which is expected to
occur in the second quarter of 1998.
8. DISTRIBUTIONS
As described in Note 2, the Company qualifies for federal income tax
purposes as a REIT. The following summarizes the tax components of common
distributions declared during the year ended December 31, 1996 and for the
period August 16, 1995 to December 31, 1995:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Per common share:
Ordinary income.............................................. 100% 85%
Return of capital............................................ 15%
--- ---
Total..................................................... 100% 100%
=== ===
</TABLE>
9. PREFERRED STOCK
The Company has the authority to issue 10,000,000 shares of preferred
stock, par value $0.01 per share, undesignated as to class, series or terms. No
shares of preferred stock have been issued.
10. PERCENTAGE LEASE AGREEMENTS
Future minimum rentals (base rents) to be received by the Company from the
Lessee under the Percentage Leases after December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997........................................................... $ 11,329,000
1998........................................................... 11,329,000
1999........................................................... 11,329,000
2000........................................................... 11,329,000
2001........................................................... 11,329,000
Thereafter..................................................... 47,069,000
------------
$103,714,000
============
</TABLE>
The term of each lease is ten years. The Percentage Leases contain various
covenants and are cross-defaulted. The rent due under each lease is the greater
of base rent (subject to annual adjustments based on increases in the United
States Consumer Price Index) or percentage rent. Percentage rent is calculated
as 20% to 37% of room revenues, up to a certain baseline revenue, then 60% to
65% of room revenues in excess of the baseline revenues. Generally, percentage
rent includes 5% of food and beverage revenue and 100% of net other revenues.
Rental income pursuant to the leases for the year ended December 31, 1996 and
for the period August 16, 1995 through December 31, 1995 was $14,848,000 and
$3,013,000, respectively, of which $6,807,000 and $1,328,000, respectively, was
in excess of base rents. All rents have been assigned as collateral under the
line of credit. The stockholders of the Lessee have pledged 375,315 Units as
collateral for the lease payments.
Pursuant to the Percentage Leases, the Company is required to make
available to the Lessee for the repair, replacement and refurbishment of
furniture, fixtures and equipment in the Initial Hotels, when and as deemed
necessary by the Lessee, an amount equal to 4.0% of room revenue per quarter on
a cumulative basis.
F-25
<PAGE> 89
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
To the extent the amount is not fully utilized by the Lessee in any year, the
Company may use the amount to fund certain capital expenditures.
11. STOCK INCENTIVE PLAN AND DIRECTORS PLAN
Under the Stock Incentive Plan adopted by the Board of Directors in 1994,
executive officers and other key employees of the Company may be granted share
options, restricted share awards or performance share awards. Restricted share
awards are subject to restrictions determined by the Company's Compensation
Committee. The Compensation Committee, comprised of independent Directors,
determines compensation for the Company's executive officers, and administers
awards under the Stock Incentive Plan. No restricted shares have been issued as
of December 31, 1996. At December 31, 1996, 94,600 shares were available for
future grant of options or awards under the Stock Incentive Plan.
Under the Directors Plan adopted by the Board of Directors in 1994,
non-employee members of the Board of Directors of the Company are granted
options to purchase common shares, which vest immediately, or direct issuances
of common stock at periodic intervals over their period of board service. No
direct issuances of common stock have been issued as of December 31, 1996. At
December 31, 1996, 135,000 shares were available for future grant of options or
awards under the Directors Plan.
During the year ended December 31, 1996, the Company granted options to
purchase 180,400 shares at exercise prices ranging from $9.75 to $10.50 per
share. During the period August 16, 1995 to December 31, 1995, the Company
granted options to purchase 240,000 shares at an exercise price of $9.50 per
share. Such options, which were granted at fair market value on the date of
grant, vest over 5 years and expire in ten years from date of grant. As of
December 31, 1996, no options have been exercised.
The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting for its
plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation plans. Had compensation cost for the Company's stock
options plans been determined based upon the fair value at the grant date for
awards under these plans consistent with the methodology prescribed under
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per share would have been
reduced by approximately $67,000 or $0.01 per share for the year ended December
31, 1996, and approximately $16,000 and $0.01 per share for the year ended
December 31, 1995. The average fair value of the options granted during 1996 is
estimated as $0.96 per share on the date of grant using the Black-Scholes option
pricing model with the following assumptions: dividend yield of 7.11%,
volatility of 27.9, risk-free interest rates of 6.48% to 6.85%, actual
forfeitures, and an expected life of approximately 10 years. The average fair
value of the options granted during 1995 is estimated as $0.88 per share on the
date of grant using the Black-Scholes option pricing model with the following
assumptions: dividend yield of 7.11%, volatility of 27.9%, risk-free interest
rates of 6.5%, actual forfeitures, and an expected life or approximately 10
years.
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized quarterly financial data for the year ended December 31, 1996
and for the period August 16, 1995 to December 31, 1995 is as follows:
<TABLE>
<CAPTION>
1996
-------------------------------------------------------------
QUARTER ENDED QUARTER ENDED QUARTER ENDED QUARTER ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Lease revenues..................... $ 3,190,000 $ 2,965,000 $ 4,252,000 $ 4,441,000
Net income......................... 1,337,000 877,000 1,955,000 1,465,000
Net income per share............... 0.21 0.14 0.23 0.13
</TABLE>
F-26
<PAGE> 90
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
1995
-------------------------------
PERIOD ENDED QUARTER ENDED
SEPTEMBER 30, DECEMBER 31,
------------- -------------
<S> <C> <C>
Lease revenues............................................ $ 1,145,000 $ 1,868,000
Net income before extraordinary item...................... 629,000 711,000
Extraordinary charge...................................... 159,000
Net income per share before extraordinary item............ 0.10 0.11
Net income................................................ 470,000 711,000
Net income per share...................................... 0.08 0.11
</TABLE>
13. RELATED PARTY TRANSACTIONS
The Management Company provides certain accounting and management services
for the Company. The Company expensed $60,000 and $11,000 for these services for
the year ended December 31, 1996 and for the period August 16, 1995 to December
31, 1995, respectively, and are included in general and administrative services
in the statement of operations.
At December 31, 1995, prepaid expenses and other assets includes $21,000
representing interest expense incurred by the Company that was reimbursed by
affiliates in 1996. Certain interest incurred by the Company is reimbursable
pursuant to an understanding whereby, among other provisions, the Company has
agreed to maintain debt of at least $8.4 million in order to avoid triggering a
taxable event to certain affiliates. Such affiliates, in return, have agreed to
cover the negative interest spread under this arrangement. During periods in
which outstanding debt exceeds $8.4 million, no amounts are payable by the
affiliates. To date, the affiliates have paid $66,000 under this arrangement. In
connection with a hotel acquisition completed subsequent to December 31, 1996,
the outstanding debt threshold under this arrangement was increased to $13.6
million.
In April 1996, the Company acquired a hotel property from an affiliate for
$4.0 million, comprised of $3.2 million of an assumed mortgage note payable and
the issuance of 80,000 Units.
Certain Lessee employee salaries and identifiable employee expenses
incurred in connection with acquisition and construction services are reimbursed
by the REIT. During the year ended December 31, 1996 and for the period August
16, 1995 to December 31, 1995, $200,000 and $13,000 was paid to the Lessee for
such services, respectively.
14. PRO FORMA FINANCIAL INFORMATION (UNAUDITED)
The unaudited pro forma financial information set forth below is presented
as if: (i) the Offering and related formation transactions, (ii) the
acquisition, development and disposition of the other hotel properties, and
(iii) the secondary equity offering completed in 1996, had occurred on January
1, 1995.
F-27
<PAGE> 91
SUNSTONE HOTEL INVESTORS, INC.
AND SUNSTONE HOTELS -- PREDECESSOR
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS (CONTINUED)
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, development and
disposition of the other hotel properties, and the secondary equity offering
completed in 1996 had occurred on January 1, 1996, nor does it purport to
represent the results of operations for future periods.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
(UNAUDITED)
<S> <C> <C>
Lease revenues.................................... $22,653,000 $20,754,000
Net income........................................ 6,865,000 5,631,000
Net income per share.............................. 0.63 0.51
</TABLE>
15. SUBSEQUENT EVENTS
The Company completed a shelf offering for 4,000,000 shares of its common
stock on January 6, 1997. Concurrently, 600,000 shares of common stock were
issued by the Company upon the 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 the underwriters' discount and offering expenses) of
approximately $56.3 million.
Subsequent to December 31, 1996, the Company acquired two hotel properties
for $21.0 million.
Subsequent to December 31, 1996, the Company declared a dividend of $0.25
per common share which was paid February 15, 1997.
F-28
<PAGE> 92
SUNSTONE HOTELS
SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
COST CAPITALIZED
SUBSEQUENT TO GROSS AMOUNT AT WHICH
INITIAL COST TO COMPANY ACQUISITION CARRIED AT CLOSE OF PERIOD
-------------------------- ----------------------- --------------------------
BUILDINGS AND BUILDINGS AND BUILDINGS AND
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENT LAND IMPROVEMENT LAND IMPROVEMENT
- ---------------------------- ------------ ----------- ------------- -------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Hampton Inn -- Pueblo....... (c) $ 607,183 $ 1,745,054 $ 435,241 $ 607,183 $ 2,180,295
Hampton Inn -- Denver....... (c) 1,250,462 2,597,505 879,429 1,250,462 3,476,934
Holiday Inn -- Craig........ (c) 70,000 915,024 $207,098 697,390 277,098 1,612,414
Hampton Inn -- Mesa......... (c) 900,000 2,117,321 229,573 900,000 2,346,894
Courtyard by
Marriott -- Fresno........ (c) 800,000 2,936,460 150,000 792,129 950,000 3,728,589
Holiday Inn -- Provo........ (c) 850,000 1,116,708 68,687 850,000 1,185,395
Best Western -- Santa Fe.... (c) 2,296,000 8,610,000 1,627,014 2,296,000 10,237,014
Hampton Inn -- Arcadia...... (c) 1,660,500 6,226,875 3,507 1,660,500 6,230,382
Hampton
Inn -- Silverthorne....... (c) 1,337,625 5,016,094 463,067 1,337,625 5,479,161
Hampton Inn -- Oakland...... (c) 1,223,045 3,109,435 437,861 1,223,045 3,547,296
Holiday Inn -- Steamboat
Springs................... 400,000 2,959,000 1,000 2,161,795 401,000 5,120,795
Holiday Inn -- Kent......... (c) 1,166,955 2,963,452 21,996 1,826,105 1,188,951 4,789,557
Holiday Inn
Express -- Poulsbo........ (c) 613,485 1,558,033 21,996 989,547 635,481 2,547,580
Hampton Inn -- Clackamas.... (c) 2,261,998 2,048,440 4,310,438
Holiday Inn
Express -- Stark.......... (c) 376,254 1,643,824 27,211 1,219,554 403,465 2,863,378
Residence Inn -- Highlands
Ranch..................... (c) 809,159 4,151,567 155,226 208,503 964,385 4,360,070
Holiday Inn -- Price........ (c) 240,167 4,034,833 123,364 240,167 4,158,197
Comfort Suites -- S. San
Francisco................. (c) 1,731,368 8,935,209 73,345 1,731,368 9,008,554
Holiday Inn -- Renton....... (c) 2,119,815 5,622,685 216,484 2,119,815 5,839,169
Hampton Inn -- Mesa CC...... $16,671,000 (d) 1,800,000 11,025,000 175,040 1,800,000 11,200,040
Hampton Inn -- Tucson....... (d) 500,000 5,817,500 94,955 500,000 5,912,455
Holiday Inn -- Flagstaff.... (d) 1,148,000 6,072,000 120,324 1,148,000 6,192,324
Radisson Suites -- Oxnard... (c) 2,894,000 11,996,825 66,619 2,894,000 12,063,444
Courtyard -- Riverside...... 2,980,000 (c) 395,323 3,098,797 60,593 395,323 3,159,390
----------- ----------- ------------- -------- ----------- ----------- -------------
$19,651,000 $25,189,341 $ 106,531,199 $584,527 $15,018,566 $25,773,868 $ 121,549,765
=========== =========== ============= ======== =========== =========== =============
<CAPTION>
LIFE ON
WHICH
DEPRECIATION
IN LATEST
INCOME
ACCUMULATED DATE OF DATE STATEMENT IS
DESCRIPTION TOTALS(A) DEPRECIATION(B) CONSTRUCTION ACQUIRED CONDUCTED
- ---------------------------- ------------ --------------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C>
Hampton Inn -- Pueblo....... $ 2,787,478 $ 1,079,089 1985 5-35
Hampton Inn -- Denver....... 4,727,396 1,745,762 1985 5-35
Holiday Inn -- Craig........ 1,889,512 397,496 1991 5-35
Hampton Inn -- Mesa......... 3,246,894 663,519 1987 5-35
Courtyard by
Marriott -- Fresno........ 4,678,589 803,387 1989 5-35
Holiday Inn -- Provo........ 2,035,395 109,136 1993 5-35
Best Western -- Santa Fe.... 12,533,014 780,270 1995 5-35
Hampton Inn -- Arcadia...... 7,890,882 418,459 1995 5-35
Hampton
Inn -- Silverthorne....... 6,816,786 290,283 1995 5-35
Hampton Inn -- Oakland...... 4,770,341 104,465 1995 5-35
Holiday Inn -- Steamboat
Springs................... 5,521,795 2,180,201 1995
Holiday Inn -- Kent......... 5,978,508 119,033 1996 5-35
Holiday Inn
Express -- Poulsbo........ 3,183,061 68,145 1996 5-35
Hampton Inn -- Clackamas.... 4,310,438 90,903 1996 5-35
Holiday Inn
Express -- Stark.......... 3,266,843 64,357 1996 5-35
Residence Inn -- Highlands
Ranch..................... 5,324,455 39,242 1996 5-35
Holiday Inn -- Price........ 4,398,364 64,185 1996 5-35
Comfort Suites -- S. San
Francisco................. 10,739,922 141,537 1996 5-35
Holiday Inn -- Renton....... 7,958,984 121,039 1996
Hampton Inn -- Mesa CC...... 13,000,040 77,641 1996 5-35
Hampton Inn -- Tucson....... 6,412,455 41,075 1996 5-35
Holiday Inn -- Flagstaff.... 7,340,324 42,854 1996 5-35
Radisson Suites -- Oxnard... 14,957,444 18,001 1996 5-35
Courtyard -- Riverside...... 3,554,713 98,138 1996 5-35
------------ -----------
$147,323,633(a) $ 9,558,217(b)
============ ===========
</TABLE>
F-29
<PAGE> 93
- ---------------
<TABLE>
<CAPTION>
1996 1995
------------ -----------
<S> <C> <C>
(a) Reconciliation of Land and Buildings and Improvements:
Balance at beginning of year....................................................... $ 52,012,431 $22,148,798
Additions during year:
Acquisitions..................................................................... 88,198,970 29,499,740
Improvements..................................................................... 11,062,230 363,893
Disposals during the year........................................................ (3,949,998)
------------ -----------
Balance at end of year period...................................................... $147,323,633 $52,012,431
============ ===========
(b) Reconciliation of Accumulated Depreciation:
Balance at beginning of year....................................................... 6,735,996 5,661,851
Depreciation for the year.......................................................... 2,861,351 1,074,145
Retirement......................................................................... (39,130)
------------ -----------
Balance at end of year period...................................................... $ 9,558,217 $ 6,735,996
============ ===========
</TABLE>
(c) Property is pledged as collateral under the line of credit. At December 31,
1996, $40,400,000 was outstanding under the line of credit.
(d) The $16,671,000 of encumbrances are cross-collateralized by the Mesa Hampton
Inn, the Tucson Hampton Inn, and the Flagstaff Holiday Inn. Properties are
also pledged as collateral under the line of credit.
F-30
<PAGE> 94
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Sunstone Hotel Investors, Inc.
We have audited the accompanying balance sheets of Sunstone Hotel
Properties, Inc. (the "Lessee") as of December 31, 1996 and 1995, and the
related statements of operations, stockholders' equity, and cash flows for the
year ended December 31, 1996 and for the period August 16, 1995 (inception) to
December 31, 1995. These financial statements are the responsibility of the
Lessee's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Sunstone Hotel Properties,
Inc. as of December 31, 1996 and 1995, and the results of its operations and
cash flows for the year ended December 31, 1996 and for the period August 16,
1995 to December 31, 1995, in conformity with generally accepted accounting
principles.
COOPERS & LYBRAND L.L.P.
San Francisco, California
February 28, 1997
F-31
<PAGE> 95
SUNSTONE HOTEL PROPERTIES, INC.
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31
JUNE 30, --------------------------
1997 1996 1995
----------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents............................ $ 891,000 $ 1,165,000 $ 800,000
Receivables, net of allowance for doubtful accounts
of $99,000 and $6,000, at December 31, 1996 and
1995 respectively.................................. 3,159,000 1,217,000 466,000
Due from affiliates, net............................. 66,000
Inventories.......................................... 815,000 514,000 125,000
Prepaid expenses and other assets, net............... 313,000 134,000 70,000
----------- ----------- ----------
$ 5,178,000 $ 3,096,000 $1,461,000
=========== =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Rent payable -- Sunstone Hotel Investors, Inc........ $ 3,904,000 $ 2,360,000 $ 645,000
Accounts payable..................................... 1,727,000 2,328,000 294,000
Customer deposits.................................... 152,000 276,000 199,000
Sales taxes payable.................................. 757,000 224,000 225,000
Accrued payroll...................................... 239,000 718,000 242,000
Accrued vacation..................................... 273,000 163,000 82,000
Accrued bonuses...................................... 409,000 176,000 115,000
Due to affiliates.................................... 680,000 104,000
Other accrued expenses............................... 664,000 759,000 301,000
----------- ----------- ----------
8,805,000 7,004,000 2,207,000
----------- ----------- ----------
Commitments
Stockholders' equity:
Common stock, no par value, 100,000 shares
authorized, 125 issued and outstanding
Accumulated deficit (Note 3)......................... (3,627,000) (3,908,000) (746,000)
----------- ----------- ----------
$ 5,178,000 $ 3,096,000 $1,461,000
=========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-32
<PAGE> 96
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF OPERATIONS AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE
FOR THE FOR THE PERIOD FROM
SIX MONTHS SIX MONTHS FOR THE AUGUST 16,
ENDED ENDED YEAR ENDED 1995 TO
JUNE 30, JUNE 30, DECEMBER 31, DECEMBER 31,
1997 1996 1996 1995
----------- ----------- ------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Room................................... $34,501,000 $13,756,000 $34,085,000 $7,060,000
Food and beverage...................... 2,744,000 658,000 2,576,000 572,000
Other.................................. 2,002,000 716,000 1,932,000 293,000
----------- ----------- ----------- ----------
Total revenue.................. 39,247,000 15,130,000 38,593,000 7,925,000
----------- ----------- ----------- ----------
Expenses:
Room................................... 7,735,000 3,450,000 9,041,000 2,487,000
Food and beverage...................... 2,296,000 678,000 2,436,000 531,000
Other.................................. 988,000 339,000 1,265,000 131,000
General and administrative............. 3,734,000 1,067,000 4,098,000 726,000
Franchise costs........................ 2,557,000 456,000 1,326,000 285,000
Advertising and promotion.............. 2,300,000 1,400,000 3,895,000 602,000
Utilities.............................. 1,792,000 638,000 2,034,000 363,000
Repairs and maintenance................ 1,374,000 696,000 1,829,000 376,000
Management fees........................ 759,000 273,000 983,000 157,000
Rent expense (Note 5).................. 15,347,000 6,155,000 14,848,000 3,013,000
----------- ----------- ----------- ----------
Total expenses................. 38,882,000 15,152,000 41,755,000 8,671,000
----------- ----------- ----------- ----------
Net income (loss).............. $ 365,000 $ (22,000) (3,162,000) (746,000)
=========== ===========
Stockholders' equity:
Accumulated deficit, beginning of
period............................ (746,000)
----------- ----------
Accumulated deficit, end of
period............................ $(3,908,000) $ (746,000)
=========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-33
<PAGE> 97
SUNSTONE HOTEL PROPERTIES, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE
PERIOD FROM
FOR THE SIX MONTHS ENDED FOR THE AUGUST 16,
JUNE 30, YEAR ENDED 1995 TO
-------------------------- DECEMBER 31, DECEMBER 31,
1997 1996 1996 1995
----------- ----------- ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................... $ 365,000 $ (22,000) $ (3,162,000) $ (746,000)
Adjustments to reconcile net loss to
net cash provided by operating
activities:
Changes in assets and liabilities:
Receivables, net.................. (1,137,000) (362,000) (751,000) (466,000)
Inventories....................... (301,000) 63,000 (389,000) (125,000)
Prepaid expenses and other
assets......................... (179,000) (510,000) (45,000) (70,000)
Rent payable -- Sunstone Hotel
Investors, Inc................. 1,544,000 1,315,000 1,715,000 645,000
Accounts payable, trade........... (601,000) 473,000 2,034,000 294,000
Customer deposits................. (124,000) (140,000) 77,000 199,000
Sales taxes payable............... 533,000 5,000 (1,000) 225,000
Accrued payroll................... (479,000) (223,000) 476,000 242,000
Accrued vacation.................. 110,000 18,000 81,000 82,000
Accrued bonuses................... 233,000 61,000 115,000
Management and accounting fees
payable........................ (143,000) (104,000)
Due from/to affiliates, net....... (170,000) 104,000
Other accrued expenses............ (24,000) 613,000 458,000 301,000
----------- ----------- ------------ ----------
Net cash (used in) provided by
operating activities......... (203,000) 1,126,000 384,000 800,000
----------- ----------- ------------ ----------
Cash flows used in investing activities:
Purchase of office furniture and
equipment........................... (71,000) (863,000) (19,000)
----------- ----------- ------------ ----------
Net cash used in investing
activities................... (71,000) (863,000) (19,000)
----------- ----------- ------------ ----------
Net change in cash............. (274,000) 263,000 365,000 800,000
Cash and cash equivalents, beginning of
period................................. 1,165,000 800,000 800,000
----------- ----------- ------------ ----------
Cash and cash equivalents, end of
period................................. $ 891,000 $ 1,063,000 $ 1,165,000 $ 800,000
=========== =========== ============ ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-34
<PAGE> 98
SUNSTONE HOTEL PROPERTIES
NOTES TO COMBINED FINANCIAL STATEMENTS
1. ORGANIZATION:
Sunstone Hotel Properties, Inc. (the "Lessee") was incorporated in Colorado
in August 1996 and commenced operations effective with the completion of an
initial public stock offering by Sunstone Hotel Investors, Inc. (the Company) on
August 16, 1996. The Lessee leases hotel properties, which are primarily located
in the Western United States, from the Company pursuant to long-term leases (the
"Percentage Leases"). 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%). At December 31, 1996, 24 hotel properties
were leased from the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash And Cash Equivalents:
Cash and cash equivalents are defined as cash on hand and in banks plus all
short-term investments with an original maturity of three months or less.
Inventories:
Inventories are stated at the lower of cost or market with cost determined
on a first-in, first-out basis.
Concentrations Of Credit Risk:
At December 31, 1995, the Lessee had amounts in banks that were in excess
of federally-insured amounts.
Revenue Recognition:
Revenue is recognized as earned which is generally defined as the date upon
which a guest occupies a room and utilizes the hotel's services. Ongoing credit
evaluations are performed and potential credit losses are expensed at the time
the account receivable is estimated to be uncollectible. Historically, credit
losses have not been material to the hotels' results of operations.
Fair Value of Financial Instruments:
The carrying amounts of cash and cash equivalents, accounts receivable,
prepaid and other assets, accounts payable and accrued expenses are deemed to
represent their fair value at December 31, 1996 and 1995.
Use of Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Income Taxes:
The Lessee has elected to be treated as an S Corporation under Subchapter S
of the Internal Revenue Code. As a Subchapter S Corporation, the tax attributes
of the Lessee will pass through to its stockholders, who will then owe any
related taxes. Accordingly, the accompanying statements of operations and
stockholders' equity do not include income tax expense.
F-35
<PAGE> 99
SUNSTONE HOTEL PROPERTIES
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
3. ACCUMULATED DEFICIT:
From inception, the Lessee has incurred cumulative losses of $3.9 million.
Of the current year loss of $3.2 million, 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 operating 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. Additional losses not related to renovation are primarily
attributable to the transition to new management at acquired hotels, seasonal
operations as determined by the timing of acquisitions, the operating leverage
of certain Percentage Leases and market conditions in certain markets.
The Lessee has remained current in its payments to the Company under the
terms of the Percentage Leases, and during 1997, management anticipates
generating net income and substantial positive operating cash flow, however,
there can be no assurance that improved operating expectations will be met.
4. COMMITMENTS:
Franchise costs represent the expense for franchise royalties under the
terms of hotel franchise agreements, generally ranging from 10 to 20 years. Fees
are computed based upon percentages of gross room revenue.
Advertising and promotion costs represent the expense for franchise
advertising and reservation systems under the terms of the hotel franchise
agreements and general and administrative expenses that are directly
attributable to advertising and promotions. Fees are computed based upon
percentages of room revenue.
5. PERCENTAGE LEASE AGREEMENTS:
Future minimum rentals (base rents) payable under the Percentage Leases
with the Company subsequent to December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997................................................... $ 11,329,000
1998................................................... 11,329,000
1999................................................... 11,329,000
2000................................................... 11,329,000
2001................................................... 11,329,000
Thereafter............................................. 47,069,000
------------
$103,714,000
============
</TABLE>
The term of each lease is ten years. The Percentage Leases contain various
covenants and are cross-defaulted. The rent payable under each lease is the
greater of base rent (subject to annual adjustments based on increases in the
United States Consumer Price Index) or percentage rent. Percentage rent is
calculated as 20% to 37% of room revenues, up to a certain baseline revenue,
then 60% to 65% of room revenues in excess of the baseline revenues. Generally,
percentage rent includes 5% of food and beverage revenue and 100% of net other
revenues. Rent expense for the year ended December 31, 1996 and for the period
August 16, 1995 to December 31, 1995 was $14,848,000 and $3,013,000,
respectively, of which $6,807,000 and $1,328,000, respectively, was in excess of
base rent. The stockholders of the Lessee have collateralized the lease payments
F-36
<PAGE> 100
SUNSTONE HOTEL PROPERTIES
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
by pledging 375,315 units owned in Sunstone Hotel Investors, L.P., a
majority-owned partnership of the Company.
6. RELATED PARTY TRANSACTIONS:
Sunstone Hotel Management, Inc. (the "Management Company"), a company
wholly owned by Robert A. Alter, Chairman and President of the Company, provided
management services to the Lessee. The cost of these services is classified as
management fees in the statements of operations.
Certain Lessee employee salaries and identifiable employee expenses
incurred in connection with acquisition and construction services are reimbursed
by the Company. During the year ended December 31, 1996 and for the period
August 16, 1995 to December 31, 1995, $200,000 and $13,000 was reimbursed to the
Lessee for such services, respectively.
F-37
<PAGE> 101
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Kahler Realty Corporation:
We have audited the accompanying consolidated balance sheet of Kahler
Realty Corporation and subsidiaries as of December 29, 1996, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the period from August 13, 1996 to December 29, 1996 (Successor Period), and the
period from January 1, 1996, to August 12, 1996 (Predecessor Period). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Kahler Realty Corporation and subsidiaries as of December 29, 1996, and the
results of their operations and their cash flows for the Successor and
Predecessor Periods in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, effective
August 13, 1996, an investor group as described in Note 1, acquired all of the
outstanding stock of Kahler Realty Corporation in a business combination
accounted for as a purchase. As a result of the acquisition, the consolidated
financial information for the periods after the acquisition is presented on a
different cost basis than that for the periods before the acquisition and,
therefore, is not comparable.
/s/ KPMG PEAT MARWICK LLP
--------------------------------------
KPMG Peat Marwick LLP
Chicago, Illinois
August 15, 1997
F-38
<PAGE> 102
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED (NOTE 1) (NOTE 1)
--------------------- SUCCESSOR PREDECESSOR YEAR ENDED
JUNE 29, JUNE 30, 8/13/96 TO 1/1/96 TO DECEMBER 29,
1997 1996 12/29/96 8/12/96 1996
-------- --------- ---------- ------------ -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES
Revenue of owned operations.......... $ 66,712 $ 62,363 $ 47,794 $ 76,860 $ 124,654
Other properties managed and/or
partially owned................... 8,715 9,526 7,096 12,017 19,113
-------- -------- --------- -------- ---------
Total revenues............... $ 75,427 $ 71,889 $ 54,890 $ 88,877 $ 143,767
======== ======== ========= ======== =========
REVENUE OF OWNED OPERATIONS
Lodging -- rooms..................... $ 38,199 $ 35,260 $ 26,603 $ 43,167 $ 69,770
-- food and beverage........ 18,942 17,393 14,505 20,853 35,358
-- other.................... 6,227 5,978 3,867 8,262 12,129
Laundry & other...................... 3,206 3,568 2,715 4,388 7,103
Interest income...................... 138 164 104 190 294
-------- -------- --------- -------- ---------
Total revenue of owned
operations................. 66,712 62,363 47,794 76,860 124,654
-------- -------- --------- -------- ---------
OPERATING COSTS AND EXPENSES
Lodging -- rooms..................... 9,036 8,427 6,446 10,564 17,010
-- food and beverage........ 14,361 13,640 10,835 16,530 27,365
-- other.................... 22,279 21,041 16,643 26,347 42,990
Laundry & other...................... 1,904 2,708 1,899 3,264 5,163
Corporate expenses................... 1,475 1,946 1,505 2,687 4,192
Depreciation and amortization........ 5,277 4,329 3,823 5,290 9,113
Non-recurring expenses (Note 8)...... 998 542 -- 3,050 3,050
-------- -------- --------- -------- ---------
Total operating costs and
expenses................... 55,330 52,633 41,151 67,732 108,883
-------- -------- --------- -------- ---------
GROSS OPERATING PROFIT................. 11,382 9,730 6,643 9,128 15,771
Interest expense..................... (8,420) (6,205) (6,146) (7,812) (13,958)
Equity in earnings (loss) of
affiliates (Note 4)............... 138 244 157 (112) 45
Gain (Loss) on sale of assets........ (2) 1 (1) 10 9
-------- -------- --------- -------- ---------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES.................. 3,098 3,770 653 1,214 1,867
Provision for income taxes (Note
9)................................ 1,240 1,171 263 486 749
-------- -------- --------- -------- ---------
INCOME FROM CONTINUING OPERATIONS...... 1,858 2,599 390 728 1,118
DISCONTINUED OPERATIONS (NOTE 8)
Income from operations of Anderson's
Formal Wear (net of income tax of
$168, $15, $183, $129 and zero,
respectively)..................... -- 286 27 253 280
-------- -------- --------- -------- ---------
NET INCOME............................. $ 1,858 $ 2,885 $ 417 $ 981 $ 1,398
======== ======== ========= ======== =========
</TABLE>
See Notes to Consolidated Financial Statements
F-39
<PAGE> 103
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
JUNE 29, DECEMBER 29,
1997 1996
----------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents........................................................ $ 2,633 $ 1,623
Receivables:
Trade, less allowance for doubtful accounts of $323 and $234, respectively..... 6,356 7,633
Current portion of notes receivable............................................ 450 470
Inventories...................................................................... 2,217 2,380
Prepaid expenses................................................................. 684 1,209
--------- --------
Total current assets...................................................... 12,340 13,315
--------- --------
OTHER ASSETS
Notes receivable, less allowance for doubtful accounts of $219 and $219,
respectively (Note 2).......................................................... 460 485
Investments in affiliates (Note 4)............................................... 8,467 8,581
Debt service escrow accounts (Note 6)............................................ -- 3,304
Intangibles...................................................................... 22 25
Other............................................................................ 336 321
--------- --------
Total other assets........................................................ 9,285 12,716
--------- --------
PROPERTY AND EQUIPMENT
Land and improvements............................................................ 37,919 38,581
Buildings........................................................................ 189,067 191,094
Equipment........................................................................ 30,958 29,655
Formal wear apparel (Note 8)..................................................... 1,019 755
--------- --------
Total..................................................................... 258,963 260,085
Less accumulated depreciation............................................. (9,278) (3,924)
--------- --------
Total property and equipment.............................................. 249,685 256,161
--------- --------
TOTAL ASSETS.............................................................. $ 271,310 $282,192
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable:
Trade (Note 8)................................................................. $ 5,226 $ 6,767
Bank overdraft................................................................. 3,471 4,152
Due to affiliates (Note 4)..................................................... 1,134 850
Accrued liabilities:
Payroll and payroll related.................................................... 3,138 3,046
Real estate taxes.............................................................. 2,951 2,784
Other taxes.................................................................... 1,368 1,560
Pension liability (Note 7)..................................................... 1,279 1,284
Notes payable (Note 5)........................................................... 7,550 8,200
Current portion of long-term debt (Note 5)....................................... 19,373 19,404
Current portion of subordinated debt (Note 5).................................... 500 500
--------- --------
Total current liabilities................................................. 45,990 48,547
--------- --------
LONG-TERM DEBT (NOTE 5)
Obligations of Kahler Realty Corporation......................................... 87,592 89,275
Obligations of Subsidiaries -- Non-Recourse to Kahler Realty Corporation......... 23,374 25,501
Obligations to Westbrook (Note 10)............................................... 40,000 40,000
--------- --------
Total long-term debt...................................................... 150,966 154,776
--------- --------
OTHER LIABILITIES
Deferred income taxes (Note 9)................................................... 30,607 30,607
Minority interest (Note 3)....................................................... 196 2,548
Deferred revenue................................................................. 80 106
Other (Note 6)................................................................... 560 4,055
--------- --------
Total other liabilities................................................... 31,443 37,316
--------- --------
SUBORDINATED DEBT (NOTE 5)......................................................... -- 500
--------- --------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY
Common stock, par value $1.00 Authorized -- 1,000 shares; Issued and
outstanding -- 100 shares...................................................... -- --
Additional paid-in capital....................................................... 40,636 40,636
Retained earnings................................................................ 2,275 417
--------- --------
Total stockholders' equity................................................ 42,911 41,053
--------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................ $ 271,310 $282,192
========= ========
</TABLE>
See Notes to Consolidated Financial Statements
F-40
<PAGE> 104
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK MINIMUM
------------------- ADDITIONAL PENSION
FOR THE YEAR ENDED NUMBER PAID-IN RETAINED LIABILITY
DECEMBER 29, 1996 OF SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT TOTAL
- ---------------------------------- ---------- ------ ---------- --------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, December 31, 1995....... 4,293,473 $ 429 $ 13,846 $ 10,414 $ (516) $ 24,173
Predecessor:
Net income................... -- -- -- 981 -- 981
Dividends paid to common
stockholders ($0.08 per
share)..................... -- -- -- (348) -- (348)
Unrecognized gain on defined
benefit pension plan....... -- -- -- -- 7 7
Common stock issued from
exercise of employee stock
options.................... 105,393 11 645 -- -- 656
Tax benefit from exercise of
employee stock options..... -- -- 147 -- -- 147
Successor:
Common stock issued.......... 100 -- 40,636 -- -- 40,636
Acquisition and retirement of
Predecessor common stock... (4,398,866) (440) (14,638) (11,047) 509 (25,616)
Net income................... -- -- 417 417
---------- ----- --------- --------- ------ --------
BALANCES, December 29, 1996....... 100 -- 40,636 417 -- 41,053
Net income (unaudited)....... -- -- -- 1,858 -- 1,858
---------- ----- --------- --------- ------ --------
BALANCES, June 29, 1997
(unaudited)..................... 100 $ -- $ 40,636 $ 2,275 $ -- $ 42,911
========== ===== ========= ========= ====== ========
</TABLE>
See Notes to Consolidated Financial Statements.
F-41
<PAGE> 105
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS (NOTE 1) (NOTE 1)
ENDED SUCCESSOR PREDECESSOR YEAR ENDED
JUNE 29, 8/13/96 TO 1/1/96 TO DECEMBER 29,
1997 12/29/96 8/12/96 1996
---------- ---------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATIONS:
Net income............................................... $ 1,858 $ 417 $ 981 $ 1,398
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Depreciation........................................... 5,277 3,823 5,290 9,113
Depreciation on discontinued operations................ -- 115 851 966
Equity in (earnings) loss of affiliates................ (138) (157) 112 (45)
Tax benefit from exercise of employee stock options.... -- -- 147 147
Common stock issued under employee benefit plans....... -- -- 207 207
Unrecognized gain on defined benefit pension plan...... -- -- 7 7
Loss (Gain) on sale of assets.......................... 2 1 (10) (9)
Change in current assets and liabilities:
Receivables............................................ 1,277 (1,698) (660) (2,358)
Inventories............................................ 163 229 (11) 218
Prepaid expenses....................................... 525 (581) (305) (886)
Accounts payable....................................... (1,938) (1,640) 2,561 921
Accrued liabilities.................................... 62 (2,626) 4,055 1,429
-------- -------- --------- --------
Net cash provided (used) by operating
activities...................................... 7,088 (2,117) 13,225 11,108
-------- -------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for:
Property and equipment................................. (1,307) (6,543) (14,550) (21,093)
Advances to affiliates................................. (28) (50) (167) (217)
Intangible assets...................................... -- (25) (23) (48)
Other assets........................................... (295) (649) (656) (1,305)
Proceeds from:
Sales of property and equipment........................ 2,507 2 99 101
Intangible assets...................................... -- -- 33 33
Sale of retail laundry customer list................... -- 810 -- 810
Payments received on notes receivable.................. 45 205 115 320
Distributions from affiliates.......................... 280 562 187 749
Other assets........................................... 280 354 -- 354
-------- -------- --------- --------
Net cash provided (used) by investing
activities...................................... 1,482 (5,334) (14,962) (20,296)
-------- -------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock................... -- -- 449 449
Dividends paid to common shareholders.................... -- -- (348) (348)
Payments on subordinated debt............................ (500) -- (500) (500)
Proceeds from long-term debt............................. -- -- 8,836 8,836
Debt service escrow accounts............................. 3,304 (52) (54) (106)
Principal payments on long-term debt..................... (3,841) (958) (3,452) (4,410)
Net proceeds (payments) from notes payable and lines of
credit................................................. (650) 1,725 1,775 3,500
Other liabilities........................................ (5,873) (209) 942 733
Proceeds from issuance of Successor common stock......... -- 40,636 -- 40,636
Acquisition of Predecessor common stock.................. -- (74,781) -- (74,781)
Proceeds from long-term debt to affiliate................ -- 40,000 -- 40,000
Payment of merger costs.................................. -- (4,121) -- (4,121)
-------- -------- --------- --------
Net cash provided (used) by financing
activities...................................... (7,560) 2,240 7,648 9,888
-------- -------- --------- --------
INCREASE (DECREASE) IN CASH................................ 1,010 (5,211) 5,911 700
CASH AT BEGINNING OF THE PERIOD............................ 1,623 6,834 923 923
-------- -------- --------- --------
CASH AT END OF THE PERIOD.................................. $ 2,633 $ 1,623 $ 6,834 $ 1,623
======== ======== ========= ========
</TABLE>
See Notes to Consolidated Financial Statements
F-42
<PAGE> 106
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
NOTE 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business
The primary business of Kahler Realty Corporation and Subsidiaries (the
Company) is the operation and management of hotel properties in 11 states,
primarily Minnesota, Utah and Idaho. As an adjunct to its hotels, the Company
operates commercial laundries in Rochester and Salt Lake City which provide
services to the Company's hotels and other third parties in their respective
locations. The Company's other business activities also included operating a
wholesale and retail formal wear business. (See Note 8)
Organization
On August 13, 1996, Tiger Real Estate Acquisition Corporation, a wholly
owned subsidiary of Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate
Co-Investment Partnership I, L.P. (Westbrook) purchased the outstanding stock of
the Company and simultaneously merged with and into the Company, with the
Company continuing as the surviving corporation. The aggregate purchase price of
the Company's stock was approximately $80,636, including acquisition costs,
which was financed in part by the issuance of a promissory note (Note 5). The
purchase price has been allocated to the accounts of the Company based on the
relative fair values of the assets acquired and liabilities assumed.
Basis of Accounting
The Company is referred to as "Predecessor" prior to the August 13, 1996
acquisition and is referred to as "Successor" thereafter. The transaction has
been accounted for under the purchase method of accounting. Successor has
recorded the assets and liabilities of the Predecessor at estimated fair market
values at the date of purchase. Because of these adjustments, the accompanying
consolidated financial statements of Successor are not directly comparable to
those of the Predecessor. The "Purchase Adjustments" column below represents the
adjustments made at August 13, 1996 to record the Company's assets, liabilities
and equity at fair market value.
<TABLE>
<CAPTION>
PURCHASE
PREDECESSOR ADJUSTMENTS SUCCESSOR
----------- ------------ ----------
<S> <C> <C> <C>
ASSETS
Cash, receivables, inventories and prepaid
expenses..................................... $ 11,885 $ 5,855 $ 17,740
Notes receivable............................... 1,378 (218) 1,160
Investment in affiliates....................... 4,963 3,973 8,936
Intangibles.................................... 608 202 810
Debt service escrow fund....................... 3,252 -- 3,252
Other assets................................... 2,676 (2,636) 40
Land and improvements.......................... 18,742 11,747 30,489
Buildings...................................... 153,751 36,186 189,937
Equipment...................................... 54,054 (26,983) 27,071
Formal wear apparel............................ 5,530 (4,830) 700
Accumulated depreciation....................... (66,933) 66,933 --
--------- -------- ---------
$ 189,906 $ 90,229 $ 280,135
========= ======== =========
</TABLE>
F-43
<PAGE> 107
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
<TABLE>
<CAPTION>
PURCHASE
PREDECESSOR ADJUSTMENTS SUCCESSOR
--------- -------- ---------
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................... $ 9,288 $ 4,121 $ 13,409
Accrued liabilities............................ 10,669 631 11,300
Notes payable, current and long-term debt and
subordinated debt............................ 142,613 -- 142,613
Obligations to Westbrook....................... -- 40,000 40,000
Other deferred liabilities..................... 1,720 1,813 3,533
Deferred taxes................................. -- 28,644 28,644
Stockholders' equity........................... 25,616 15,020 40,636
--------- -------- ---------
$ 189,906 $ 90,229 $ 280,135
========= ======== =========
</TABLE>
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and subsidiaries in which it has a controlling interest. Investments in owned
affiliates in which the Company possesses significant influence are accounted
for under the equity method. The Company owns 24% of a partnership which owns
the University Park Hotel (the Hotel) and a $4,620, 9% mortgage note with an
option to convert the note into an additional equity interest in the partnership
which owns the Hotel in 1998. Should the Company exercise its option, the
Company would own 69.6% of the Hotel. The Company consolidates the assets and
liabilities of the Hotel which approximated $15,772 and $9,085 at December 29,
1996. All material intercompany amounts have been eliminated in consolidation.
Revenues
Revenues of the Company are classified into two components. The Company
uses this presentation to show the total scope of the Company's operations. The
components of revenue are:
- Revenue of owned operations include revenues from lodging properties in
which the Company consolidates its ownership interest, management fees
generated from non-consolidated properties and properties owned by
others. Also included are revenues from Textile Care Services and
interest income.
- Other properties managed and/or partially owned includes all revenue of
non-consolidated properties and the properties managed for others. Under
generally accepted accounting principles, this revenue is not included in
revenue of owned operations and the Company's interest in
non-consolidated properties is reflected in the Consolidated Statements
of Operations as equity in earnings of affiliates.
Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
includes the current portion of debt service escrow accounts in cash and cash
equivalents. The balance in this account at December 29, 1996 was $701, and will
be used to pay accrued interest on certain of the hotel mortgages.
Inventories
Inventories are stated primarily at the lower of average cost or market.
F-44
<PAGE> 108
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
Notes receivable
Notes receivable are carried at their unpaid balance less an allowance for
doubtful accounts and net of unamortized contract discounts. The Company
evaluates the collectibility of its notes receivable (including accrued
interest) by estimating the probability of loss utilizing projections of loan
and property performance, factors related to the borrower, terms of the notes,
other supply and demand factors and overall economic conditions.
Fair value of financial instruments
Management has determined that fair values of the Company's financial
instruments approximates the carrying values of those instruments except for
notes receivable and long-term debt as discussed in Notes 2 and 5, respectively.
Property and equipment
Property and equipment was recorded at cost in the Predecessor period.
Property and equipment are recorded at their allocated purchase price in the
Successor period. Depreciation of property and equipment is computed on the
straight-line method over their estimated useful lives. The estimated useful
lives are:
<TABLE>
<S> <C>
Land improvements..................................... 5 to 25 years
Buildings............................................. 20 to 50 years
Equipment............................................. 5 to 20 years
</TABLE>
The Company records a provision for impairment of the carrying value of its
real estate investments whenever the estimated future cash flows from a
property's operations and projected sale are less than the property's net
carrying value. Management believes that the estimates and assumptions used are
appropriate in evaluating the carrying value of the Company's properties
presented currently in the consolidated balance sheet, however, changes in
market conditions and circumstances could occur in the near term which could
cause these estimates to change.
Measurement of impairment losses on long-lived assets are based on the
estimated fair value of the assets. Properties held for sale under SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets To Be
Disposed Of", (SFAS 121), will be reflected at the lower of historical cost or
estimated fair value less anticipated selling costs. No adjustment of the
carrying values of the Company's long-lived assets was required at December 29,
1996 pursuant to the provisions of SFAS 121.
Income taxes
The Company accounts for income taxes in accordance with SFAS 109,
"Accounting for Income Taxes", which, among other things, requires an asset and
liability approach in accounting for deferred income taxes. (See Note 9)
F-45
<PAGE> 109
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
Intangibles
Intangibles represent franchise rights and organization costs. The cost of
these intangible assets are as follows:
<TABLE>
<CAPTION>
DECEMBER 29,
1996 EXPECTED LIFE
------------ -------------
<S> <C> <C>
Organization costs.............................. $ 15 5 years
Franchise rights................................ 10 10 years
----
$ 25
====
</TABLE>
Use of estimates
Preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that may affect the reported amounts of certain assets and
liabilities and the disclosure of contingent liabilities at the balance sheet
date and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
FISCAL YEAR
The Company's fiscal year ends on the Sunday closest to December 31.
The balance sheet as of June 29, 1997 and the statements of operations,
changes in stockholders' equity and cash flows for the six-month period then
ended are unaudited. However, in the opinion of management, these financial
statements include all adjustments, which consist only of normal recurring
adjustments, necessary for fair presentation of the Company's financial
position. The results and operations for the unaudited six-month period ended
June 29, 1997 are not necessarily indicative of the results which may be
expected for the entire year.
NOTE 2. NOTES RECEIVABLE
Notes receivable consist of contracts for deeds and first mortgages bearing
interest at rates ranging from 8% to 10%. Two loans aggregating $535 at December
29, 1996 are considered impaired under the provisions of SFAS 114, "Accounting
For By Creditors of Impairment of a Loan". Accordingly, no interest income has
been recognized on these loans during the period from January 1, 1996 to
December 29, 1996. The Company has determined an allowance for doubtful accounts
of $219 was necessary for one of the notes receivable at December 29, 1996.
The fair values of the non-current portion of notes receivable at December
29, 1996 approximated their carrying value. The fair value of the non-current
portion of notes receivable is determined by discounting the scheduled loan
payments to maturity using current market rates commensurate with the risks and
terms to maturity of those instruments.
Total maturities of notes receivable for each of the next five years are
approximately $520, $125, $125, $111 and $50, respectively.
NOTE 3. ACQUISITION
The Company acquired 64% of the outstanding shares of GMX Corporation (GMX)
on November 1, 1996 for $4,496. This acquisition has been accounted for using
the purchase method of accounting. GMX's
F-46
<PAGE> 110
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
principal asset is the land under the Company's Salt Lake Hilton Hotel. The
Company consolidated the assets and liabilities of GMX in its December 29, 1996
consolidated balance sheet and the results of its operations for the period from
November 1, 1996 to December 29, 1996. All material intercompany transactions
have been eliminated in consolidation. This amount has been recorded as a
minority interest in the December 29, 1996 consolidated balance sheet. During
the first half of 1997 the Company acquired an additional 33.4% of the
outstanding shares of GMX Corporation for $2,352. The Company intends to acquire
the remaining 2.8% of GMX in the second half of 1997 for $196.
On April 1, 1996, the Company acquired the 149 room full service Colonial
Park Hotel in Helena, Montana. The purchase was financed with a first mortgage
of $4.5 million, a note payable to the seller of $1.0 million and $3.7 million
from available cash and lines of credit.
NOTE 4. INVESTMENTS IN AFFILIATES
As of December 29, 1996 the Company's investment in affiliates, accounted
for under the equity method of accounting, is as follows:
<TABLE>
<CAPTION>
OWNERSHIP DEC. 29,
INTEREST 1996
--------- --------
<S> <C> <C>
Provo Park Hotel and Residence Inn, Provo, UT......... 50.0% $8,581
Kahler Park Hotel, Hibbing, MN........................ 25.0% --
Quality Hotel Plaza One, Rock Island, IL.............. 26.6% --
------
$8,581
======
</TABLE>
The Company or its subsidiaries typically have an interest in an affiliated
partnership or limited liability company and operate the hotels under long-term
management contracts. The Company also held a note receivable (Note 2) from an
affiliate of $274 at December 29, 1996.
The Provo Park Hotel and Residence Inn, using funds from a $16,000
non-recourse loan commitment and a $1,000 federal grant, is constructing a 96
suite expansion and 17,000 square foot conference center and has constructed a
114 suite Residence Inn by Marriott in Provo, Utah. The Residence Inn was
completed in December 1996 and the expansion of the Provo Park Hotel was
completed in early 1997.
The Company's income from affiliates before taxes is as follows:
<TABLE>
<S> <C>
Management fees............................................... $584
Equity in earnings............................................ 45
----
$629
====
</TABLE>
Combined summarized balance sheet information for the Company's affiliates
is as follows:
<TABLE>
<CAPTION>
DECEMBER 29,
1996
------------
<S> <C>
Current assets................................................................ $ 1,508
Noncurrent assets............................................................. 27,375
Current liabilities........................................................... 3,007
Long-term debt, principally mortgages......................................... 19,099
Other long-term liabilities................................................... 1,352
Owners' equity................................................................ 5,425
</TABLE>
F-47
<PAGE> 111
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
Combined summarized operating results reported by these affiliates are as
follows:
<TABLE>
<S> <C>
Revenues................................................... $14,798
Net income................................................. 358
</TABLE>
NOTE 5. FINANCING
Notes payable consist of $4,300 drawn on various lines of credit with a
maximum available of $8,000 at December 29, 1996 and short-term notes of $3,900.
The lines of credit and notes payable carry an interest rate of prime plus 1%,
mature at various dates throughout 1997 and are secured by property and
equipment, inventory and accounts receivable. The Company anticipates the
extension of all its lines of credit. The prime rate at December 29, 1996 was
8.25%.
Outstanding long-term debt, which is secured by substantially all property
and equipment, is summarized as follows:
OBLIGATIONS OF KAHLER REALTY CORPORATION
<TABLE>
<CAPTION>
SECURITY/SECURED DEC. 29,
PROPERTY INTEREST RATE MATURITY 1996
- --------------------------- ------------------------------ ------------- --------
<S> <C> <C> <C>
Mortgages
Kahler Plaza Hotel 10.0% plus 2.0% of room sales Nov 1997 $ 15,130
Clinic View Inn 9.75% plus 2.0% of room sales May 2000 14,307
San Marcos Tax-exempt variable rate
of 6.75% Dec 2015 13,120
Kahler Hotel Prime plus 1.0% Dec 2003 11,608
Mortgages under
$10 million -- secured
by ten hotel properties
and a commercial Ranging from Ranging from
laundry prime to 12.0% 2000 to 2014 52,614
Notes payable Prime On demand 408
Capitalized leases 12.2% to 12.93% June 2000 710
--------
Subtotal 107,897
Less current maturities 18,622
--------
$ 89,275
========
</TABLE>
F-48
<PAGE> 112
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
OBLIGATIONS OF SUBSIDIARIES -- NONRECOURSE TO KAHLER REALTY CORPORATION
<TABLE>
<CAPTION>
SECURITY/SECURED DEC. 29,
PROPERTY INTEREST RATE MATURITY 1996
- --------------------------- ------------------------------ ------------- --------
<S> <C> <C> <C>
Mortgages under Tax-exempt variable
$10 million -- secured rate of 5.5% to Ranging from
by six hotel prime plus 0.5% 2009 to 2015 $ 26,169
properties
Special assessments 7.5% to 12.0% December 1997 59
Capitalized leases 12.2% to 12.54% April 1997
to June 1998 55
--------
Subtotal 26,283
Less current maturities 782
--------
25,501
Obligation to Westbrook, 10%, matures August 2003 40,000
--------
Total indebtedness 174,180
Less current
maturities 19,404
--------
$154,776
========
</TABLE>
Under certain financial debt covenants, the Company is required to maintain
certain levels of net worth, debt to equity, cash flow and other ratios. The
Company obtained a waiver for one of its debt covenants at December 29, 1996
which expires December 31, 1997.
The fair value of long-term debt at December 29, 1996 was approximately
$153,684 as compared to a carrying value of $154,776. The fair values of
long-term debt were determined by discounting the scheduled loan payments to
maturity using borrowing rates currently available to the Company for bank loans
of similar term and maturity.
Total maturities of long-term debt, excluding capital lease obligations, in
each of the next five years are approximately $19,404, $3,964, $8,493, $20,564
and $15,705, respectively.
At December 29, 1996 the Company has arranged for the issuance of a letter
of credit aggregating $1,000 as additional collateral for one of the nonrecourse
obligations listed above.
The laundry facility in Rochester Minnesota was financed with a $10,000
loan. In the event of default by the Company on this loan the lender can require
a non-affiliate to purchase the loan at its outstanding balance.
The subordinated note requires annual principal payments of $500, matures
in 1998 and carries an interest rate of prime plus 1%. As of December 29, 1996
the balance was $1,000. The Company made its $500 scheduled payment in April,
1997. The Company has the right to repay the note in cash or with common stock
equal to 120% of the subordinated note at any time.
The Company intends to refinance the mortgage secured by the Kahler Plaza
Hotel upon its maturity in November, 1997. In July, 1997 the Company refinanced
the mortgage secured by the San Marcos property which reduced the interest rate
by 1%.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company had recorded an estimate of a loss that could have resulted
from the unfavorable resolution of a lawsuit regarding the proper interpretation
of the calculation of added interest on one of its mortgages
F-49
<PAGE> 113
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
prior to December 29, 1996. While the Company believed it had a meritorious case
in appeal, the ultimate resolution of the matter, could have resulted in a loss
greater or less than what was accrued. A trustee held $3,038 in escrow accounts
at December 29, 1996, pending resolution of the litigation which is included in
debt service escrow accounts in the accompanying consolidated balance sheets. In
June 1997 the Company settled this litigation for $3,250, which had no material
impact on the Company's 1997 consolidated statement of operations.
Additionally, the Company is involved in various litigation in the normal
course of business. The Company does not expect the outcome of these matters to
have a material adverse effect on the Company's consolidated financial
statements.
Operating leases
The Company leases warehouse and retail store facilities for its formal
wear operations and land for two of its hotels under various operating lease
agreements which call for minimum lease payments and contingent rents based upon
percentages of revenues. Rent expense under these leases was $1,312, including
contingent rentals of $195, for the year ended December 29, 1996.
Future minimum lease payments under operating leases total $4,859 with
annual payments of $996, $685, $476, $312 and $224 due in each of the next five
years, respectively.
Telephone service agreements
In March, 1990 the Company sold all telephone switches and related
equipment at ten of its hotels to a telecommunications company. Each of these
hotels subsequently entered into telephone service agreements with the same
telecommunications company which call for contingent payments based upon
telephone usage. These agreements expire in June, 2000. Expenses incurred
pursuant to these service agreements was $2,475 for 1996.
NOTE 7. RETIREMENT PLANS
The Company has a defined benefit plan (the Plan) covering union employees
at properties located in Rochester, Minnesota. Pension contributions and
expenses for this plan are determined based on the actuarial cost of current
service.
Net periodic pension cost for the Plan included the following components
for the year ended December 29, 1996:
<TABLE>
<S> <C>
Service costs-benefits earned during the period.............. $ 124
Interest cost on projected benefit obligation................ 229
Return on assets-actual...................................... (227)
Net amortization and deferral................................ 112
-----
Net periodic pension cost.................................... $ 238
=====
</TABLE>
F-50
<PAGE> 114
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
The following table sets forth the Plan's funded status at December 29,
1996:
<TABLE>
<CAPTION>
DECEMBER 29,
1996
------------
<S> <C>
Actuarial present value of vested benefit obligation............ $3,219
======
Accumulated benefit obligation.................................. $3,304
======
Projected benefit obligation.................................... $3,304
Fair market value of plan assets*............................... 2,164
------
Unfunded projected benefit obligation........................... 1,140
Unrecognized net gain........................................... 144
------
Unfunded pension liability...................................... $1,284
======
</TABLE>
- ---------------
* Plan assets consist primarily of equity and fixed income securities.
The Company has recognized a liability as the accumulated benefit
obligation exceeded the fair value of the plan assets.
The weighted-average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.25%. The expected
long-term rate of return on assets was 8%.
The Company has a defined contribution plan covering substantially all
other employees.
Total expense for both plans was $682 for 1996.
The Company provides postretirement health benefits to a fixed number of
retired employees relating to service provided prior to 1992. At December 29,
1996 the estimated liability was $150.
The Company has employment agreements with certain key executives. In 1997
three executives resigned.
NOTE 8. SEGMENTS
The Company's principal business activity is the operation and management
of hotel properties. Fees from managed properties are primarily based on a
percent of revenues of the managed property. The Company's other business
activities include institutional laundries. Intersegment transactions including
laundry revenues of $2,045 for the period ended December 29, 1996 have been
eliminated from the table below. Operating income represents revenues less
operating expenses, excluding general corporate expenses. Identifiable assets
are those used in the operation of each segment. Corporate and other assets
consist primarily of cash, notes and other investments.
F-51
<PAGE> 115
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
(continued)
The following table summarizes the Company's segment information:
<TABLE>
<S> <C>
REVENUE OF OWNED OPERATIONS
Lodging........................................................ $ 117,257
Laundry........................................................ 6,332
Other.......................................................... 771
Interest income................................................ 294
---------
$ 124,654
=========
OPERATING INCOME
Lodging........................................................ $ 21,650
Laundry........................................................ 1,042
Other.......................................................... 113
Non-recurring charges.......................................... (3,050)
Corporate expenses............................................. (4,278)
Interest income................................................ 294
---------
GROSS OPERATING PROFIT........................................... 15,771
Interest expense............................................... (13,958)
Equity in earnings of affiliates............................... 45
Gain(Loss) on sale of assets................................... 9
---------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES............ $ 1,867
=========
IDENTIFIABLE ASSETS
Lodging........................................................ $ 243,470
Laundry........................................................ 14,798
Formal Wear.................................................... 2,286
Corporate and other............................................ 21,638
---------
$ 282,192
=========
CAPITAL EXPENDITURES
Lodging........................................................ $ 19,462
Laundry........................................................ 156
Formal Wear.................................................... 1,394
Corporate and other............................................ 81
---------
$ 21,093
=========
DEPRECIATION AND AMORTIZATION
Lodging........................................................ $ 8,242
Laundry........................................................ 772
Corporate and other............................................ 99
---------
$ 9,113
=========
</TABLE>
On June 30, 1997 the Company completed the sale of its formal wear
operations. The Company received cash of approximately $2.1 million and a note
receivable of $230,000 with an annual interest rate of 12%. All operating
activity for the first half of 1997 reverted to the purchaser in accordance with
the sales agreement. All operating activity for prior periods has been reclassed
as income from discontinued operations.
The non-recurring charges incurred during 1996 relate to noncapitalizable
costs incurred in the merger described in Note 1.
F-52
<PAGE> 116
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
NOTE 9. PROVISION FOR INCOME TAXES
Provision for income taxes consists of the following:
<TABLE>
<S> <C>
Federal tax, paid or currently payable...................... $789
State tax, paid or currently payable........................ 147
Net deferred credits (prepaid charges)...................... (4)
----
Tax provision............................................... $932
====
</TABLE>
The difference between the federal statutory rate and the effective tax
rate is as follows for the year ended December 29, 1996:
<TABLE>
<S> <C>
Statutory tax rate............................................ 34.0%
Generation of general business credits........................ (.2)
Other permanent differences................................... 2.0
State taxes, before valuation allowance and net of federal
income tax benefit.......................................... 4.2
----
Effective tax rate.................................. 40.0%
====
</TABLE>
Deferred tax assets and liabilities are classified as current and
noncurrent on the basis of the classification of the related asset or liability
for financial reporting. Prepaid and deferred taxes are recorded for temporary
differences between the book value of assets and liabilities for financial
reporting purposes and tax purposes.
Temporary differences comprising the net deferred tax liability on the
Consolidated Balance Sheet at December 29, 1996 are as follows:
<TABLE>
<CAPTION>
DECEMBER 29, 1996
-------------------------------------
TEMPORARY DIFFERENCES ASSETS LIABILITIES TOTAL
---------------------------------------------------- ------- ------------ --------
<S> <C> <C> <C>
Allowance for doubtful accounts..................... $ 95 $ -- $ 95
Accrued employee benefits........................... 554 -- 554
Other............................................... -- (3) (3)
------- ---------- --------
Current................................... 649 (3) 646
------- ---------- --------
Depreciation and amortization....................... 710 (34,900) (34,190)
Deferred revenues................................... 1,581 (89) 1,492
Installment gains................................... -- (289) (289)
Property valuation allowances....................... 412 -- 412
Joint ventures...................................... 2,015 (1,559) 456
Accrued employee benefits........................... 634 -- 634
Interest............................................ 528 -- 528
------- ---------- --------
Noncurrent................................ 5,880 (36,837) (30,957)
------- ---------- --------
Other Components
Alternative minimum tax credits..................... 1,656 -- 1,656
General business credits............................ 243 -- 243
Valuation allowance................................. (2,195) -- (2,195)
------- ---------- --------
(296) -- (296)
------- ---------- --------
Net deferred tax liability.......................... $ 6,233 $ (36,840) $(30,607)
======= ========== ========
</TABLE>
F-53
<PAGE> 117
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 29, 1996
The total valuation allowance at December 29, 1996 is $2,195. There was no
net change in the total valuation allowance for the year ended December 29,
1996. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the net
deferred tax assets will not be realized. Also, management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. In order to fully realize
the net deferred tax asset, the Company will need to generate future regular
tax. Based upon the levels of historical taxable income and projections for
future taxable income, management believes it is more likely than not the
Company will realize the benefits of the net deferred tax asset, net of the
existing valuation allowance at December 29, 1996. The amount of the deferred
tax asset considered realizable, however, could be reduced in the near term if
estimates of taxable income during future periods are reduced.
NOTE 10. RELATED PARTY TRANSACTIONS
Westbrook is owed $40,000 under an unsecured promissory note due August,
2003 (Note 5). Interest expense on the promissory note was $1,556 for 1996.
NOTE 11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH
INVESTING ACTIVITIES
<TABLE>
<CAPTION>
1996
-------
<S> <C>
Interest paid............................................ $13,874
Interest received........................................ (393)
Income taxes............................................. (24)
</TABLE>
The GMX acquisition increased property and equipment, minority interest and
deferred income taxes by $5,348, $2,548 and $2,800, respectively.
NOTE 12. SUBSEQUENT EVENTS
On August 4, 1997 Westbrook entered into an agreement to sell 100% of the
outstanding common stock of the Company to Sunstone Hotel Investors, Inc.
("Sunstone"). Westbrook will receive from Sunstone a combination of cash, common
stock, and convertible preferred stock. The transaction is subject to third
party approvals and other customary conditions.
F-54
<PAGE> 118
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Kahler Realty Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Kahler Realty
Corporation and Subsidiaries as of December 31, 1995 and January 1, 1995, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the years in the two-year period ended December 31, 1995.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Kahler
Realty Corporation and Subsidiaries as of December 31, 1995 and January 1, 1995,
and the results of their operations and their cash flows for each of the years
in the two-year period ended December 31, 1995 in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
--------------------------------------
KPMG Peat Marwick LLP
Chicago, Illinois
February 16, 1996
F-55
<PAGE> 119
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
REVENUES
Revenue of owned operations.......................................... $121,772 $109,910
Other properties managed and/or partially owned...................... 18,113 17,490
-------- --------
Total revenues............................................... $139,885 $127,400
======== ========
REVENUE OF OWNED OPERATIONS
Lodging -- rooms..................................................... $ 61,249 $ 54,108
-- food and beverage........................................ 32,554 29,339
-- other.................................................... 11,553 9,796
Formal wear, laundry and other....................................... 15,912 15,894
Interest income...................................................... 504 773
-------- --------
Total revenue of owned operations............................ 121,772 109,910
-------- --------
OPERATING COSTS AND EXPENSES
Lodging -- rooms..................................................... 15,180 13,523
-- food and beverage........................................ 25,697 23,221
-- other.................................................... 38,441 34,053
Formal wear, laundry & other......................................... 12,801 13,487
Corporate expenses................................................... 3,901 3,257
Depreciation and amortization (Note 9)............................... 8,919 8,477
Non-recurring charges (Note 9)....................................... 526 1,811
-------- --------
Total operating costs and expenses........................... 105,465 97,829
-------- --------
GROSS OPERATING PROFIT................................................. 16,307 12,081
Interest expense..................................................... (13,115) (11,207)
Equity in earnings of affiliates (Note 4)............................ 533 193
Gain (Loss) on sale of assets........................................ (11) 20
-------- --------
INCOME FROM OPERATIONS BEFORE INCOME TAXES............................. 3,714 1,087
Provision for income taxes........................................... 697 323
-------- --------
NET INCOME............................................................. $ 3,017 $ 764
======== ========
PER COMMON SHARE DATA
Primary income per common share...................................... $ .70 $ .14
======== ========
Fully diluted income per common share................................ $ .69 $ .14
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-56
<PAGE> 120
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31, 1995 AND JANUARY 1, 1995
ASSETS
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents............................................ $ 923 $ 1,110
Receivables:
Trade, less allowance for doubtful accounts of $251 and $252,
respectively..................................................... 5,275 5,333
Current portion of notes receivable............................... 132 150
Inventories.......................................................... 2,598 2,498
Prepaid expenses..................................................... 323 265
-------- --------
Total current assets......................................... 9,251 9,356
-------- --------
OTHER ASSETS
Notes receivable (Notes 2 and 4)..................................... 1,361 1,423
Investments in affiliates (Note 4)................................... 5,095 3,279
Debt service escrow accounts (Notes 5 and 7)......................... 3,198 1,650
Intangibles.......................................................... 654 791
Other................................................................ 2,224 1,823
-------- --------
Total other assets........................................... 12,532 8,966
-------- --------
PROPERTY AND EQUIPMENT
Land and improvements................................................ 17,065 16,349
Buildings............................................................ 141,965 136,967
Equipment............................................................ 50,660 46,977
Formal wear apparel.................................................. 4,381 4,735
-------- --------
Total........................................................ 214,071 205,028
Less accumulated depreciation................................ 61,118 54,281
-------- --------
152,953 150,747
Construction in progress (Note 5).................................... 3,631 --
-------- --------
Total property and equipment................................. 156,584 150,747
-------- --------
TOTAL ASSETS................................................. $178,367 $169,069
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-57
<PAGE> 121
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, 1995 AND JANUARY 1, 1995
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable (Notes 7 and 9)..................................... $ 10,110 $ 8,392
Due to affiliates (Note 4)........................................... 738 167
Accrued liabilities:
Payroll and payroll related....................................... 3,131 2,473
Real estate taxes................................................. 1,954 1,996
Other taxes....................................................... 520 806
Notes payable (Note 5)............................................... 4,700 5,300
Current portion of long-term debt (Note 5)........................... 3,739 2,767
Current portion of subordinated debt to affiliate (Note 6)........... 500 500
-------- --------
Total current liabilities.................................... 25,392 22,401
-------- --------
LONG-TERM DEBT (Note 5)
Obligations of Kahler Realty Corporation............................. 99,754 95,842
Obligations of Subsidiaries -- Nonrecourse to Kahler Realty
Corporation....................................................... 26,261 26,517
-------- --------
Total long-term debt......................................... 126,015 122,359
-------- --------
OTHER LIABILITIES
Pension liability (Note 8)........................................... 1,009 734
Deferred revenue..................................................... 160 137
Other................................................................ 618 667
-------- --------
Total other liabilities...................................... 1,787 1,538
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 7)
SUBORDINATED DEBT TO AFFILIATE (Note 6)................................ 1,000 1,500
-------- --------
STOCKHOLDERS' EQUITY (Note 6) Common stock, par value $.10
Authorized -- 70,000,000 shares; Issued and outstanding -- 4,293,473
and 4,167,598 shares, respectively................................... 429 417
Additional paid-in capital........................................... 13,846 13,030
Retained earnings.................................................... 10,414 7,991
Minimum pension liability adjustment (Note 8)........................ (516) (167)
-------- --------
Total stockholders' equity................................... 24,173 21,271
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................... $178,367 $169,069
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-58
<PAGE> 122
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
<TABLE>
<CAPTION>
COMMON STOCK MINIMUM
------------------ ADDITIONAL PENSION
NUMBER PAID-IN RETAINED LIABILITY
OF SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT TOTAL
---------- ------ ---------- --------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
BALANCES, January 2, 1994............. 3,425,798 $343 $ 8,450 $ 7,800 $ (227) $16,366
Net income.......................... 764 764
Dividends paid to preferred
stockholders..................... (224) (224)
Dividends paid to common
stockholders ($0.09 per share)... (349) (349)
Unrecognized gain on defined benefit
pension plan..................... 60 60
Common stock issued................. 741,800 74 4,580 4,654
--------- ---- -------- -------- ------ -------
BALANCES, January 1, 1995............. 4,167,598 417 13,030 7,991 (167) 21,271
Net income.......................... 3,017 3,017
Dividends paid to common
stockholders ($0.14 per share)... (594) (594)
Unrecognized loss on defined benefit
pension plan..................... (349) (349)
Common stock issued (Note 6)........ 125,875 12 816 828
--------- ---- -------- -------- ------ -------
BALANCES, December 31, 1995........... 4,293,473 $429 $ 13,846 $ 10,414 $ (516) $24,173
========= ==== ======== ======== ====== =======
</TABLE>
See Notes to Consolidated Financial Statements
F-59
<PAGE> 123
KAHLER REALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
OPERATIONS:
Net income............................................................. $ 3,017 $ 764
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization....................................... 8,919 8,477
Common stock issued under employee benefit plans.................... 303 6
Unrecognized gain (loss) on defined benefit pension plan............ (349) 60
Equity in earnings of affiliates.................................... (533) (193)
(Gain) Loss on sale of assets....................................... 11 (20)
Change in current assets and liabilities:
Receivables......................................................... 58 (962)
Inventories......................................................... (100) (144)
Prepaid expenses.................................................... (58) (32)
Accounts payable.................................................... 1,673 1,493
Accrued liabilities................................................. 330 (15)
------- -------
Net cash provided by operating activities...................... 13,271 9,434
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Payments for property and equipment.................................... (14,540) (13,523)
Proceeds from sale of property and equipment........................... 34 125
Payments received on notes receivable.................................. 79 250
Investment in affiliates (Note 4)...................................... (1,856) --
Distributions received from affiliates................................. 574 374
Decrease (Increase) in intangible assets............................... 40 (374)
Increase in other assets............................................... (565) (108)
------- -------
Net cash used by investing activities.......................... (16,234) (13,256)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock................................. 525 1,352
Purchase of common stock............................................... -- --
Dividends paid to common shareholders.................................. (594) (349)
Dividends paid to preferred shareholders............................... -- (224)
Payments on subordinated debt due to affiliate......................... (500) --
Construction payables.................................................. 616 --
Increase in debt service escrow accounts............................... (1,548) (900)
Proceeds from long-term debt and notes payable......................... 6,943 3,833
Principal payments on long-term debt................................... (2,315) (2,692)
Net borrowings (payments) on lines of credit and notes payable......... (600) 2,850
Increase (Decrease) in other liabilities............................... 249 78
------- -------
Net cash provided by financing activities...................... 2,776 3,948
------- -------
INCREASE (DECREASE) IN CASH.............................................. (187) 126
CASH AT BEGINNING OF THE PERIOD.......................................... 1,110 984
------- -------
CASH AT END OF THE PERIOD................................................ $ 923 $ 1,110
======= =======
</TABLE>
See Notes to Consolidated Financial Statements
F-60
<PAGE> 124
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business
The primary business of Kahler Realty Corporation (the Company) is the
operation and management of hotel properties in 11 states, primarily Minnesota,
Utah and Idaho. As an adjunct to its hotels, the Company operates commercial
laundries in Rochester and Salt Lake City which provide services to the
Company's hotels and other third parties in their respective locations. The
Company's other business activities include operating a wholesale and retail
formal wear business.
Principles of consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. Investments of 50% or less in owned
affiliates in which the Company possesses significant influence are accounted
for under the equity method. The Company owns 24% of a partnership which owns
the University Park Hotel and a $4,620, 9% mortgage note with an option to
convert the note into additional equity interest in the hotel in 1998. Should
the Company exercise its option to convert, the Company would own 69.6% of the
hotel. The Company consolidates the assets and liabilities of the hotel which
approximated $10,391 and $9,412 at December 31, 1995, and $10,714 and $9,463 at
January 1, 1995, respectively. All material intercompany transactions and
balances have been eliminated.
Reclassifications
The consolidated financial statements for prior years reflect certain
reclassifications to conform with classifications adopted in 1995. These
reclassifications have no effect on net income or stockholders' equity as
previously reported.
Revenues
Revenues of the Company are classified into two components. The Company
uses this presentation to show the total scope of the Company's operations. The
components of revenue are:
Revenue of owned operations include revenues from lodging properties
in which the Company has an interest greater than 50%, management fees
generated from properties partially-owned (50% or less) and properties
owned by others. Also included are revenues from Anderson's Formal Wear,
Textile Care Services and interest income.
Other properties managed and/or partially-owned includes all revenue
of properties partially-owned (50% or less) by the Company and the
properties managed for others. Under generally accepted accounting
principles, this revenue is not included in revenue of owned operations and
the Company's interest in partially-owned properties is reflected in the
Consolidated Statements of Operations as equity in earnings of affiliates.
Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents. The Company
includes the current portion of debt service escrow accounts in cash and cash
equivalents. Amounts in these accounts were $336 and $416 at December 31, 1995
and January 1, 1995, respectively, and will be used to pay accrued interest on
certain of the hotel mortgages.
F-61
<PAGE> 125
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
Inventories
Inventories are stated primarily at the lower of average cost or market.
Notes receivable
Notes receivable are carried at their unpaid balance net of unamortized
contract discounts. The Company evaluates the collectibility of its notes
receivable (including accrued interest) by estimating the probability of loss
utilizing projections of loan and property performance, factors related to the
borrower, terms of the notes, other supply and demand factors and overall
economic conditions.
On January 2, 1995 the Company adopted the provisions of Statement of
Financial Accounting Standards (SFAS) 114, "Accounting by Creditors for
Impairment of a Loan". The Company also adopted the provisions of SFAS 118,
"Accounting by Creditors for Impairment of a Loan -- Income Recognition and
Disclosures". The adoption of SFAS 114 and 118 had no effect on the Company's
financial position or results of operations as of or for the year ended December
31, 1995.
Fair value of financial instruments
On December 31, 1995 the Company adopted the provisions of SFAS 107
"Disclosures about Fair Value of Financial Instruments". Management has
determined that fair values of the Company's financial instruments approximate
the carrying values of those instruments except for notes receivable and
long-term debt as discussed in Notes 2 and 5, respectively.
Property and equipment
Property and equipment are recorded at cost. Depreciation of property,
equipment and formal wear apparel is computed on the straight-line method over
their estimated useful lives. Depreciation expense was $8,658 and $8,197 for the
years 1995 and 1994, respectively. Interest of $76 related to certain hotels
under construction has been capitalized and is included in property and
equipment at December 31, 1995. The estimated useful lives are:
<TABLE>
<S> <C>
Land improvements..................................... 5 to 25 years
Buildings............................................. 20 to 50 years
Equipment............................................. 5 to 20 years
Formal wear apparel................................... 4 years
</TABLE>
The Company records a provision for impairment of the carrying value of its
real estate investments whenever the estimated future cash flows from a
property's operations and projected sale are less than the property's net
carrying value. Management believes that the estimates and assumptions used are
appropriate in evaluating the carrying value of the Company's properties
presented currently in the balance sheet, however, changes in market conditions
and circumstances could occur in the near term which will cause these estimates
to change.
On January 1, 1996, the Company adopted the provisions of SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of". Measurement of impairment losses on long-lived assets are based
on the estimated fair value of the assets. Properties held for sale under SFAS
121 will continue to be reflected at the lower of historical cost or estimated
fair value less anticipated selling costs. No adjustment of the carrying values
of the Company's long-lived assets was required at January 1, 1996 as a result
of adopting the provisions of SFAS 121.
F-62
<PAGE> 126
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
Deferred financing costs
Deferred financing costs were $1,425 and $1,309, net of accumulated
amortization, at December 31, 1995 and January 1, 1995, respectively. These
amounts are included in other assets and amortized over the life of the
respective loans.
Income taxes
The Company accounts for income taxes in accordance with SFAS 109,
"Accounting for Income Taxes", which, among other things, requires an asset and
liability approach in accounting for deferred income taxes. (See Note 10)
Intangibles
Intangibles represent pre-opening costs, organization costs, franchise
rights and an intangible pension asset relating to the Company's defined benefit
plan. Pre-opening costs include certain costs incurred during the property's
break-in period which consist of marketing, employee training and the excess of
expenses over revenues. The cost of these intangible assets are as follows:
<TABLE>
<CAPTION>
1995 1994 EXPECTED LIFE
----- ----- -------------
<S> <C> <C> <C>
Pre-opening costs................................ $ 57 $ 163 3 years
Organization costs............................... 145 132 5 years
Franchise rights................................. 125 139 8 to 20 years
----- -----
327 434
----- -----
Accumulated amortization......................... (166) (210)
----- -----
161 224
Intangible pension asset......................... 493 567
----- -----
$ 654 $ 791
===== =====
</TABLE>
Income per common share
For 1995 and 1994, income per share is computed on a primary share basis
using the weighted average number of outstanding common shares and equivalents
(arising from employee stock plans, deferred stock compensation and a warrant)
aggregating 4,329,000 and 3,956,000, respectively.
Income per share is computed on a fully diluted basis using the weighted
average number of outstanding common shares plus stock equivalents aggregating
4,355,000 for 1995. In 1994 the effect is the same as on a primary share basis.
Use of estimates
Preparation of the Consolidated Financial Statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of certain assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Fiscal year
The Company's fiscal year ends on the Sunday closest to December 31.
F-63
<PAGE> 127
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 2. NOTES RECEIVABLE
Notes receivable consist of contracts for deeds and first mortgages bearing
interest at rates ranging from 8% to 10%. One loan aggregating $454 is
considered impaired under provisions of SFAS 118 at December 31, 1995.
Accordingly, no interest income has been recognized on this loan during 1995.
The Company has determined no reserve for impairment is necessary for its notes
receivable at December 31, 1995 under provisions of SFAS 114.
The fair value of the non-current portion of notes receivable at December
31, 1995 approximated carrying value. The fair value of the non-current portion
of notes receivable is determined by discounting the scheduled loan payments to
maturity using current market rates commensurate with the risks and terms to
maturity of those instruments.
Total maturities of notes receivable for each of the next five years are
approximately $132, $467, $385, $31 and $478, respectively.
NOTE 3. ACQUISITIONS
On August 1, 1995 the Company acquired the Best Western Canyon Springs Park
Hotel, a 112 room full-service property in Twin Falls, Idaho, for $5,750. The
purchase was financed with new long-term debt of $3,750, a note payable to the
seller of $400 and $1,600 from available cash and lines of credit.
On July 1, 1995 the Company paid $600 for a 32.9% equity interest in the
150 room full-service Best Western Copper King Park Hotel in Butte, Montana. The
Company, which accounts for this investment under the equity method of
accounting, used internally generated funds to make this investment. The Company
subsequently entered into a management contract with the property.
On December 31, 1994 the Company acquired the Green Oaks Inn and Conference
Center, a 284 room hotel property in Fort Worth, Texas which it has managed
since 1990 and had owned prior to that year. At the time of acquisition the
Company held a mortgage receivable of $2,783 net of deferred revenue of $522.
The Company purchased this property for $438 in cash, the cancellation of the
mortgage receivable and related accrued interest receivable of $136 and the
assumption of negative working capital and a capital lease.
In March 1994, the Company acquired the Quality Inn Pocatello Park, a
152-room full service hotel property in Pocatello, Idaho for $5,224. This
purchase was financed with new long-term debt of $3,700. The Company's lines of
credit and internally generated funds were utilized to finance the balance of
the purchase price.
The pro forma results listed below are unaudited and reflect the impact of
the purchase price accounting adjustments on the Company's Consolidated
Statements of Operations assuming the aforementioned acquisitions occurred at
the beginning of each year presented.
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
Revenue of owned operations............................ $123,628 $118,077
Net income............................................. 3,277 1,196
Income per common share:
Primary.............................................. .76 .25
Fully diluted........................................ .75 .25
</TABLE>
F-64
<PAGE> 128
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 4. INVESTMENT IN AFFILIATES
As of December 31, 1995 and January 1, 1995 the Company's investment in
affiliates, accounted for under the equity method of accounting, are as follows:
<TABLE>
<CAPTION>
OWNERSHIP
INTEREST 1995 1994
--------- ------- -------
<S> <C> <C> <C>
Provo Park Hotel, Provo, UT............................ 50.0% $ 4,450 $ 3,165
Best Western Copper King Park Hotel, Butte, MT (Note 32.9% 560 --
3)...................................................
Kahler Park Hotel, Hibbing, MN......................... 25.0% 85 114
Quality Hotel Plaza One, Rock Island, IL............... 26.6% -- --
------- -------
$ 5,095 $ 3,279
======= =======
</TABLE>
The Company or its subsidiaries typically have an interest in an affiliated
partnership or limited liability company and operate the hotels under long-term
management contracts. The Company also held notes receivable from affiliates of
$572 and $574 at December 31, 1995 and January 1, 1995, respectively.
The Company contributed $1,200 to the Provo Park Hotel during 1995, which
along with funds from a $16,000 non-recourse loan commitment and a $1,000
federal grant will be used to construct a 96 suite expansion and 17,000 square
foot conference center as well as a 114 suite Residence Inn by Marriott in
Provo, Utah. The Company's partner in this venture contributed land and cash
valued at $1,200. Construction of the Residence Inn and the expansion of the
Provo Park Hotel is scheduled to be completed in late 1996 and early 1997,
respectively.
The Company's income from affiliates before taxes is as follows:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Management fees.......................................... $ 540 $ 381
Equity in earnings....................................... 533 193
------- -------
$ 1,073 $ 574
======= =======
</TABLE>
Combined summarized balance sheet information for the Company's affiliates
is as follows:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Current assets........................................... $ 1,431 $ 654
Noncurrent assets........................................ 20,710 15,629
Current liabilities...................................... 2,194 1,595
Long-term debt, principally mortgages.................... 12,076 9,162
Other long-term liabilities.............................. 1,663 1,273
Owners' equity........................................... 6,208 4,253
</TABLE>
Combined summarized operating results reported by these affiliates are as
follows:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Revenues................................................. $13,782 $11,099
Net income (loss)........................................ 422 (87)
</TABLE>
NOTE 5. FINANCING
Notes payable consist of $4,100 drawn on various lines of credit with a
maximum available of $5,000 at December 31, 1995 and a short-term note payable
of $600. The lines of credit and note payable carry an
F-65
<PAGE> 129
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
interest rate of prime plus 1%, mature at various dates throughout 1996 and are
secured by property and equipment, inventory and accounts receivable. The
Company anticipates the extension of all its lines of credit. The prime rate at
December 31, 1995 and January 1, 1995 was 8.75% and 8.5%, respectively.
Outstanding long-term debt, which is secured by substantially all property
and equipment, is summarized as follows:
OBLIGATIONS OF KAHLER REALTY CORPORATION
<TABLE>
<CAPTION>
SECURITY/SECURED
PROPERTY
MORTGAGES INTEREST RATE MATURITY 1995 1994
- --------------------------------------- ---------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Kahler Plaza Hotel 10.0% plus 2.0%
of room sales Nov 1997 $ 15,300 $ 15,455
Clinic View Inn 9.75% plus 2.0%
of room sales May 2000 14,531 14,654
San Marcos 7.5% plus added
interest* Dec 2000 13,600 13,600
Kahler Hotel Prime plus 1.0% Dec 2003 12,038 12,421
Mortgages under $10 million -- secured
by ten hotel properties and a Ranging from Ranging from
commercial laundry prime to 12.0% 1996 to 2014 46,937 41,441
Notes payable Various dates
through Sept
Prime to 11.0% 1997 291 290
Capitalized leases 12.2% to 12.93% May 1997 26 46
-------- --------
Subtotal 102,723 97,907
Less current maturities 2,969 2,065
-------- --------
$ 99,754 $ 95,842
======== ========
</TABLE>
OBLIGATIONS OF SUBSIDIARIES -- NONRECOURSE TO KAHLER REALTY CORPORATION
<TABLE>
<CAPTION>
SECURITY/SECURED
PROPERTY
MORTGAGES INTEREST RATE MATURITY 1995 1994
- --------------------------------------- ---------------- ------------- -------- --------
<S> <C> <C> <C> <C>
Mortgages under $10 million -- secured Ranging from
by six hotel properties Tax-exempt vari-
able rate of
3.55% to prime
plus 0.5% 2003 to 2015 $ 26,813 $ 26,908
Special assessments 7.5% to 12.0% Dec 1997 111 158
August 1994
Capitalized leases 0.0% to 14.3% to June 1998 107 153
-------- --------
Subtotal 27,031 27,219
Less current maturities 770 702
-------- --------
26,261 26,517
-------- --------
Total indebtedness 129,754 125,126
Less current maturities 3,739 2,767
-------- --------
$126,015 $122,359
======== ========
</TABLE>
- ---------------
* Added interest is defined as approximately 67% of Excess Cash Flow as
defined. (See Note 7)
F-66
<PAGE> 130
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
The fair value of long-term debt at December 31, 1995 was approximately
$122,744 as compared to a carrying value of $126,015. The fair values of
long-term debt were determined by discounting the scheduled loan payments to
maturity using borrowing rates currently available to the Company for bank loans
of similar term and maturity.
Total maturities of long-term debt, excluding capital lease obligations, in
each of the next five years are approximately $3,668, $18,619, $3,808, $8,325
and $20,512, respectively.
At December 31, 1995 the Company has arranged for the issuance of a letter
of credit aggregating $1,000 as additional collateral for one of the nonrecourse
obligations listed above.
Under certain financial debt covenants, the Company is required to maintain
certain levels of net worth, debt to equity, cash flow and other ratios. Waivers
of certain covenants have been obtained as of December 31, 1995 and January 1,
1995.
The laundry facility in Rochester, Minnesota was financed with a $10,000
loan. In the event of default by the Company on this loan the lender can require
the Company's largest shareholder to purchase the loan at its outstanding
balance.
On January 19, 1996, the Company refinanced the San Marcos mortgage in the
amount of $13,600. The initial variable tax-exempt interest rate, including a
credit enhancement fee, was approximately 6.0%. To facilitate this refinancing,
the Company placed $1,548 in escrow with the trustee of the present mortgage in
November, 1995. These funds will be held by the trustee pending resolution of
the litigation discussed in Note 7.
NOTE 6. STOCKHOLDERS' EQUITY
Preferred stock
The Company has 10,000,000 shares authorized and no shares outstanding as
of December 31, 1995 and January 1, 1995. The Board of Directors is authorized
to determine the series and number of preferred shares to be issued and any
related designations, powers, preferences, rights, qualifications, limitations
or restrictions.
Common stock
Common stock has been issued under deferred compensation, incentive stock
option, employee retirement and stock purchase plans and upon conversion of
preferred stock, and a common stock warrant.
Stock option plans
Under certain stock option plans, incentive stock options may be granted to
key employees or non-employee directors at not less than 100% of the fair market
value of the Company's stock on the date of grant and options not qualifying as
incentive stock options may be granted to non-employees providing valuable
services to the Company at not less than 50% of the fair market value of the
Company's stock on the date of grant. None of these shares have been granted at
less than market value. Total number of shares authorized under these plans are
931,350. Key employee options expire five years after the date of grant and vest
25% per
F-67
<PAGE> 131
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
year commencing one year after the date of grant. Non-employee director options
expire ten years after the date of grant and vest after one year. Activity under
the plans is summarized below:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF SHARES PER SHARE
--------- ----------------
<S> <C> <C>
Balance, January 2, 1994........................... 495,300 $ 2.88 -- $7.50
Granted.......................................... 113,700 8.50 -- 11.75
Exercised........................................ (186,075) 2.88 -- 7.50
Canceled......................................... (5,000) 3.00 -- 7.50
--------
Balance, January 1, 1995........................... 417,925 2.88 -- 11.75
Granted.......................................... 125,000 7.88 -- 12.88
Exercised........................................ (105,500) 2.88 -- 11.75
Canceled......................................... (5,875) 3.00 -- 11.75
-------- ----------------
Balance, December 31, 1995......................... 431,550 $ 3.00 -- $12.88
======== ================
</TABLE>
At December 31, 1995 178,744 options were exercisable and 499,800 shares
were available for grant.
Subordinated debt to affiliate
In January 1992, the Company issued a $2,000 subordinated note to the
Company's largest shareholder. The subordinated note requires annual principal
payments of $500 per year each April 21, matures in 1998 and carries an interest
rate of prime plus 1%. As of December 31, 1995 the balance was $1,500. The
Company has the right to repay the note in cash or with common stock equal to
120% of the subordinated note at any time.
NOTE 7. COMMITMENTS AND CONTINGENCIES
The Company believes it is in the final stages of negotiating a settlement
with a telecommunications company related to disputed unremitted telephone
revenue and fees at ten of its hotels (the Hotels). Proposed terms of this
settlement provide for the lease by the Company of $1,500 of new telephone
switches and equipment from the telecommunications company over the remaining
term of the amended existing telephone service agreements. The Company would
have the option to acquire all telephone switches and equipment in the Hotels at
the end of the telephone service agreement term. However, while this settlement
has been agreed to in principle by the parties, it has not yet been executed. If
completed, this settlement is not expected to have a material adverse impact on
the Company's Consolidated Financial Statements.
In December 1994, the Company received notice of default relating to bond
indebtedness on one of it's wholly-owned hotels. In January 1995, the Company
brought suit against the bondholders. The Company is seeking declaratory
judgment regarding the proper interpretation of the calculation of added
interest. In January, 1996 the Superior Court of Arizona (the Court) ruled
against the Company. The Company plans to vigorously appeal the Court's
decision. The appellate court will hear the Company's suit in its entirety and
is not restricted in any way by the Court's decision. If the bondholders are
found judicially correct, the Company would owe $267, $618 and $884 for 1993,
1994 and 1995, respectively, and certain other costs as determined by the Court.
The Company has recorded an estimate of the loss that could result from the
unfavorable resolution of this uncertainty. While the Company believes it has a
meritorious case in appeal, the ultimate resolution of the matter, which is
expected to take longer than one year, could result in a loss greater or less
than what is presently accrued. The Company refinanced this mortgage in January,
1996 as discussed in Note 5.
F-68
<PAGE> 132
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
Additionally, the Company is involved in various litigation in the normal
course of business. The Company does not expect the outcome of the matters
described above to have a material adverse effect on the Company's consolidated
financial statements.
Operating leases
The Company leases warehouse and retail store facilities for its formal
wear operations and land for three of its hotels under various operating lease
agreements which call for minimum lease payments and contingent rents based upon
percentages of revenues. Operating lease expense was $1,629 and $1,550,
including contingent rentals of $516 and $486 for 1995 and 1994, respectively.
Future minimum lease payments under operating leases total $6,651 with
annual payments of $997, $681, $409, $234 and $190 due in each of the next five
years, respectively.
Capital leases
The Company leases furniture and equipment under capital leases. Future
minimum lease payments under these capital leases total $171 with annual
payments of $100, $54, $17, $0 and $0 due in each of the next five years,
respectively. Of the $171 of total minimum lease payments, $38 represents
interest.
The following is an analysis of property under capital leases:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Furniture & equipment....................................... $ 465 $ 465
Less accumulated amortization............................... (239) (164)
----- -----
$ 226 $ 301
===== =====
</TABLE>
Amortization of leased equipment is classified with depreciation expense.
Telephone service agreements
In March, 1990 the Company sold all telephone switches and related
equipment at the Hotels to a telecommunications company. Each of the Hotels
subsequently entered into telephone service agreements with the same
telecommunications company which call for contingent payments based upon
telephone usage. Expenses incurred pursuant to these service agreements were
$2,316 and $1,766 in 1995 and 1994, respectively. These agreements expire in
February, 2000.
Other
The Company plans on opening a 108 suite expansion to its hotel in Boise,
Idaho, in early 1996. At December 31, 1995, the Company had a $2,455 loan
commitment which is expected to fund a substantial portion of the remaining
expansion costs to be paid.
In January, 1996 the Company entered into an agreement to purchase the 149
room full service Colonial Inn Hotel in Helena, Montana at a cost of $9,200.
This acquisition will be financed through a mortgage note payable to a bank, a
note payable to the seller and internally generated funds.
F-69
<PAGE> 133
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 8. RETIREMENT PLANS
The Company has a defined benefit plan covering union employees at
properties located in Rochester, Minnesota. Pension contributions and expenses
for this plan are determined based on the actuarial cost of current service and
amortization of prior service costs over a 20 year period.
Net periodic pension cost for the defined benefit plan included the
following components:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Service costs-benefits earned during the period............... $ 97 $ 80
Interest cost on projected benefit obligation................. 219 179
Return on assets-actual....................................... (122) 8
Net amortization and deferral................................. 53 (102)
----- -----
Net periodic pension cost........................... $ 247 $ 165
===== =====
</TABLE>
The following table sets forth the Plan's funded status at December 31,
1995 and January 1, 1995:
<TABLE>
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Actuarial present value of vested benefit obligation....... $3,124 $2,503
====== ======
Accumulated benefit obligation............................. $3,200 $2,564
====== ======
Projected benefit obligation............................... $3,200 $2,564
Fair market value of plan assets*.......................... 1,795 1,498
------ ------
Unfunded projected benefit obligation...................... 1,405 1,066
Unrecognized net liability at date of initial
application.............................................. (34) (40)
Unrecognized prior service cost............................ (459) (527)
Unrecognized net loss...................................... (516) (167)
Adjustment to recognize minimum liability.................. 1,009 734
------ ------
Pension liability................................ $1,405 $1,066
====== ======
</TABLE>
- ---------------
* Plan assets consist primarily of equity and fixed income securities.
The Company has recognized an additional liability as the accumulated
benefit obligation exceeded the fair value of the plan assets. An intangible
asset was recognized up to the amount of unrecognized prior service cost. As of
December 31, 1995 the additional liability exceeded the unrecognized prior
service cost and the unrecognized transition liability by $516. This amount has
been recorded as a reduction of stockholders' equity.
The weighted-average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.25% and 8.5% in 1995 and
1994, respectively. The expected long-term rate of return on assets was 8%.
The Company has a defined contribution plan covering substantially all
other employees. The funding of the defined contribution plan is determined by
the Board of Directors.
Total expense for both plans was $497 and $215 for 1995 and 1994,
respectively.
The Company provides postretirement benefits to a fixed number of retired
employees relating to service provided prior to 1992. At December 31, 1995 and
1994 the estimated liability was $175 and $200, respectively.
F-70
<PAGE> 134
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 9. SEGMENTS
The Company's principal business activity is the operation and management
of hotel properties. Fees from managed properties are primarily based on a
percent of revenues of the managed property. The Company's other business
activities include a wholesale and retail formal wear business and institutional
laundries. Intersegment transactions including laundry revenues of $2,050 and
$1,857 in 1995 and 1994, respectively, have been eliminated from the table
below. Operating income represents revenue less operating expenses, excluding
general corporate expenses. Identifiable assets are those used in the operation
of each segment. Capital expenditures include non-cash lodging acquisitions of
$2,783 in 1994. General corporate assets consist primarily of cash, notes and
other investments.
The following tables summarize the Company's segment information:
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
REVENUE OF OWNED OPERATIONS
Lodging...................................................... $105,356 $ 93,243
Laundry...................................................... 5,890 6,304
Formal Wear.................................................. 9,373 8,924
Other........................................................ 649 666
Interest income.............................................. 504 773
-------- --------
$121,772 $109,910
======== ========
OPERATING INCOME
Lodging...................................................... $ 19,316 $ 16,304
Laundry...................................................... 584 (389)
Formal Wear.................................................. 363 539
Other........................................................ 12 11
Non-recurring charges........................................ (526) (1,811)
Corporate expenses........................................... (3,946) (3,346)
Interest income.............................................. 504 773
-------- --------
GROSS OPERATING PROFIT......................................... 16,307 12,081
Interest expense............................................... (13,115) (11,207)
Equity in earnings of affiliates............................... 533 193
Gain (Loss) on sale of assets.................................. (11) 20
-------- --------
INCOME FROM OPERATIONS BEFORE INCOME TAXES..................... $ 3,714 $ 1,087
======== ========
IDENTIFIABLE ASSETS
Lodging...................................................... $155,479 $145 602
Laundry...................................................... 14,155 14,703
Formal Wear.................................................. 3,872 4,024
Other........................................................ 1,613 1,634
Corporate.................................................... 3,248 3,106
-------- --------
$178,367 $169,069
======== ========
</TABLE>
F-71
<PAGE> 135
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
CAPITAL EXPENDITURES
Lodging...................................................... $ 13,024 $ 13,859
Laundry...................................................... 140 846
Formal Wear.................................................. 1,265 1,464
Other........................................................ 38 74
Corporate.................................................... 73 63
-------- --------
$ 14,540 $ 16,306
======== ========
DEPRECIATION AND AMORTIZATION
Lodging...................................................... $ 6,722 $ 6,142
Laundry...................................................... 759 736
Formal Wear.................................................. 1,326 1,411
Other........................................................ 67 99
Corporate.................................................... 45 89
-------- --------
$ 8,919 $ 8,477
======== ========
</TABLE>
During the fourth quarters of 1995 and 1994, the Company recorded
non-recurring charges of $526 and $1,811 related to expenses incurred in
connection with planned secondary offerings and conversion of the Company into a
real estate investment trust. Neither offering was completed as a result of
general market conditions.
The Company regularly furnishes laundry, hospitality and food services to
the Company's largest shareholder, the Mayo Foundation (Mayo), and its
affiliates at competitive prices. The Company purchases, at competitive prices,
steam, electricity, water and related utility services from a Mayo affiliate.
These activities are summarized below.
<TABLE>
<CAPTION>
1995 1994
------ ------
<S> <C> <C>
Revenue
Laundry sales............................................ $3,576 $3,333
Food services............................................ 1,001 951
Operating costs and expenses
Utilities.................................................. $1,497 $1,870
Interest................................................... 153 162
</TABLE>
The consolidated balance sheet includes receivables and payables to Mayo
summarized as follows:
<TABLE>
<CAPTION>
1995 1994
---- ----
<S> <C> <C>
Receivables................................................... $521 $424
Payables (including accrued interest)......................... 182 209
</TABLE>
F-72
<PAGE> 136
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
NOTE 10. PROVISION FOR INCOME TAXES
Provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Federal tax, paid or currently payable...................... $ 622 $ 350
State tax, paid or currently payable........................ 110 93
Net deferred credits (prepaid charges)...................... (174) (120)
Tax benefit of stock options................................ 139 --
----- -----
Tax provision............................................... $ 697 $ 323
===== =====
</TABLE>
The difference between the U.S. Federal Statutory rate and the effective
tax rate is as follows:
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Statutory tax rate........................................... 34.0% 34.0%
Changes in the valuation allowance........................... (12.4) (15.0)
Generation of general business credits....................... (3.7) --
Other permanent differences.................................. (0.8) 5.4
State taxes, before valuation allowance and net of federal
income tax................................................. 1.7 5.3
----- -----
Effective tax rate................................. 18.8% 29.7%
===== =====
</TABLE>
Deferred tax assets and liabilities are classified as current and
noncurrent on the basis of the classification of the related asset or liability
for financial reporting. Prepaid and deferred taxes are recorded for temporary
differences between the book value of assets and liabilities for financial
reporting purposes and tax purposes.
F-73
<PAGE> 137
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
Temporary differences comprising the net prepaid taxes included in other
assets on the Consolidated Balance Sheet at December 31, 1995 and January 1,
1995 are as follows:
1995
<TABLE>
<CAPTION>
TEMPORARY DIFFERENCES ASSETS LIABILITIES TOTAL
------------------------------------------------------ ------- ----------- -------
<S> <C> <C> <C>
Allowance for doubtful accounts....................... $ 81 $ -- $ 81
Accrued employee benefits............................. 504 -- 504
Other................................................. -- (180) (180)
------- ------- -------
Current..................................... 585 (180) 405
------- ------- -------
Depreciation and amortization......................... 6 (1,910) (1,904)
Deferred revenues..................................... 1,658 (105) 1,553
Installment gains..................................... -- (399) (399)
Property valuation allowances......................... -- (70) (70)
Joint ventures........................................ 1,003 (142) 861
Accrued employee benefits............................. 242 -- 242
------- ------- -------
Noncurrent.................................. 2,909 (2,626) 283
------- ------- -------
Other Components:
Alternative minimum tax credits....................... 1,563 -- 1,563
General business credits.............................. 631 -- 631
Valuation allowance................................... (2,195) -- (2,195)
------- ------- -------
(1) -- (1)
------- ------- -------
Net prepaid tax asset................................. $ 3,493 $(2,806) $ 687
======= ======= =======
</TABLE>
1994
<TABLE>
<CAPTION>
TEMPORARY DIFFERENCES ASSETS LIABILITIES TOTAL
------------------------------------------------------ ------- ----------- -------
<S> <C> <C> <C>
Allowance for doubtful accounts....................... $ 75 $ -- $ 75
Accrued employee benefits............................. 360 -- 360
Other................................................. 13 (129) (116)
------- ------- -------
Current..................................... 448 (129) 319
------- ------- -------
Depreciation and amortization......................... -- (775) (775)
Deferred revenues..................................... 1,596 (108) 1,488
Installment gains..................................... 8 (427) (419)
Property valuation allowances......................... -- (90) (90)
Joint ventures........................................ 589 (81) 508
Accrued employee benefits............................. 264 -- 264
------- ------- -------
2,457 (1,481) $ 976
------- ------- -------
Noncurrent
Other Components
Alternative minimum tax credits....................... 1,068 -- 1,068
General business credits.............................. 587 -- 587
NOL carryforwards..................................... 218 -- 218
Valuation allowance................................... (2,655) -- (2,655)
------- ----------- -------
(782) -- (782)
------- ----------- -------
Net prepaid tax asset................................. $ 2,123 $(1,610) $ 513
======= ======= =======
</TABLE>
F-74
<PAGE> 138
KAHLER REALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, 1995 AND JANUARY 1, 1995
The Company has based the value of the net prepaid tax asset primarily on
the alternative minimum tax credits which, under current law, have no expiration
dates. The ultimate realization of the net prepaid tax asset is dependent upon
the offset of these credits against future federal tax payments if future
taxable income exceeded the alternative minimum tax levels.
The total valuation allowance at the end of 1995 was $2,195. The net change
in the total valuation allowance for the years ended 1995 and 1994 was a
decrease of $460 and an increase of $398, respectively. In assessing the
realizability of prepaid tax assets, management considers whether it is more
likely than not that some portion or all of the net prepaid tax assets will not
be realized. Also, management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making this assessment. In order to fully realize the net prepaid tax asset, the
Company will need to generate future regular tax. Taxable income for the years
ended 1995 (estimated) and 1994 was approximately $273 and $937, respectively.
Based upon the levels of historical taxable income and projections for future
taxable income, management believes it is more likely than not the Company will
realize the benefits of the net prepaid tax asset, net of the existing valuation
allowance at December 31, 1995. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of taxable
income during future periods are reduced.
NOTE 11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH FINANCING
AND INVESTING ACTIVITIES
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Interest paid, net of amounts capitalized.............. $12,354 $10,968
Interest received...................................... (444) (753)
Income taxes paid...................................... 1,083 520
</TABLE>
The Company acquired certain hotel interests in 1995 and 1994 as described
in Note 3.
NOTE 12. OTHER MATTERS
On November 24, 1995 the Company retained Montgomery Securities as
financial advisor to assist the Company's Board of Directors in exploring the
strategic alternatives available to enhance shareholder value. As one
alternative, the Company is presently considering a public sale of its shares
simultaneously with its conversion to a real estate investment trust. As other
possible alternatives, the Company with Montgomery's assistance, will also
explore a possible sale of part or all of its assets as well as the continued
operation of the Company in its present corporate form.
F-75
<PAGE> 139
======================================================
NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES, OR AN OFFER OR SOLICITATION
WITH RESPECT TO THOSE SECURITIES TO WHICH IT RELATES TO ANY PERSONS IN ANY
JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. THE DELIVERY OF
THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT
THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE HEREIN AT ITS DATE IS
CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Available Information................. S-2
Prospectus Supplement Summary......... S-3
Additional Risk Factors............... S-11
Use of Proceeds....................... S-13
Price Range of Common Stock and
Dividend Distributions.............. S-14
Capitalization........................ S-15
Business and Properties............... S-16
Management............................ S-51
The Lessee............................ S-54
The Management Company................ S-57
Principal Shareholders................ S-58
United States Federal Income Tax
Considerations...................... S-60
Underwriting.......................... S-61
Index to Financial Statements......... F-1
PROSPECTUS
Available Information................. 2
Incorporation of Certain Information
by Reference........................ 2
The Company........................... 3
Use of Proceeds....................... 4
Risk Factors.......................... 5
Description of Common Stock and
Preferred Stock..................... 12
Description of Warrants............... 17
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws............ 18
United States Federal Income Tax
Considerations...................... 21
Plan of Distribution.................. 33
Legal Matters......................... 34
Experts............................... 34
Change in Accountants................. 35
</TABLE>
======================================================
======================================================
9,000,000 SHARES
SUNSTONE HOTEL INVESTORS, INC.
LOGO
COMMON STOCK
-----------------------------------
PROSPECTUS SUPPLEMENT
-----------------------------------
MERRILL LYNCH & CO.
BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
CREDIT SUISSE FIRST BOSTON
EVEREN SECURITIES, INC.
RAYMOND JAMES & ASSOCIATES, INC.
SEPTEMBER , 1997
======================================================
<PAGE> 140
PROSPECTUS
$525,000,000*
LOGO
COMMON STOCK
PREFERRED STOCK
WARRANTS
------------------------
Sunstone Hotel Investors, Inc. ("Sunstone" or the "Company") may from time
to time offer in one or more series or classes (i) shares of its common stock,
par value $0.01 per share (the "Common Stock"), (ii) shares of its preferred
stock, par value $0.01 per share (the "Preferred Stock"), and/or (iii) warrants
to purchase Preferred Stock or Common Stock (the "Warrants") in amounts, at
prices and on terms to be determined at the time of offering, with an aggregate
public offering price of up to $525,000,000. The Common Stock, Preferred Stock,
and Warrants (collectively, the "Offered Securities") may be offered, separately
or together, in separate series or classes, in amounts, at prices and on terms
to be set forth in one or more supplements to the Prospectus (each a "Prospectus
Supplement").
The specific terms of the Offered Securities in respect to which this
Prospectus is being delivered will be set forth in a future Prospectus
Supplement and will include (i) in the case of Common Stock, the specific title
and stated value, any voting, dividend and other rights, and public offering
price, (ii) in the case of Preferred Stock, the specific title and stated value,
any dividend, liquidation, redemption, conversion, voting and other rights,
share and price adjustment mechanisms, and public offering price, and (iii) in
the case of Warrants, the term, exercise price, share and price adjustment
mechanisms, voting and other rights, detachability, and public offering price.
In addition, such specific terms may include limitations on direct or beneficial
ownership and restrictions on transfer of the Offered Securities, in each case
as may be appropriate to preserve the status of the Company as a real estate
investment trust ("REIT") for United States federal income tax purposes.
Each Prospectus Supplement will also contain information, where applicable,
about United States federal income tax considerations relating specifically to,
and any listing on a securities exchange of, the Offered Securities covered by
such Prospectus Supplement.
The Offered Securities may be offered directly, through agents designated
from time to time by the Company, or to or through underwriters or dealers. If
any agents or underwriters are involved in the sale of any of the Offered
Securities, their names, and any applicable purchase price, fee, commission or
discount arrangement between or among them, will be set forth, or will be
calculable from the information set forth, in the applicable Prospectus
Supplement. See "Plan of Distribution." No Offered Securities may be sold
without delivery of the applicable Prospectus Supplement describing the method
and terms of the offering of such series or class of Offered Securities.
SEE "RISK FACTORS" BEGINNING ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE OFFERED SECURITIES
OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
------------------------
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF OFFERED SECURITIES UNLESS
ACCOMPANIED BY A PROSPECTUS SUPPLEMENT. THE DELIVERY IN ANY JURISDICTION OF THIS
PROSPECTUS, TOGETHER WITH A PROSPECTUS SUPPLEMENT RELATING TO SPECIFIC OFFERED
SECURITIES, SHALL NOT CONSTITUTE AN OFFER IN SUCH JURISDICTION OF ANY OTHER
OFFERED SECURITIES COVERED BY THIS PROSPECTUS BUT NOT DESCRIBED IN SUCH
PROSPECTUS SUPPLEMENT.
------------------------
THE DATE OF THIS PROSPECTUS IS OCTOBER , 1997.
- ---------------
* Includes amounts registered under two registration statements, of which
approximately $124.4 million has previously been sold. This Prospectus
constitutes the "Base" Prospectus for both registration statements.
<PAGE> 141
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Corp. Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such material can be
obtained by mail from the Public Reference Section of the Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549 at prescribed rates.
The Company files information electronically with the Commission, and the
Commission maintains a Web Site that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the Commission, such as the Company, and the address is http://www.sec.gov.
The Company's Common Stock is listed on the New York Stock Exchange (the
"NYSE"), and reports, proxy statements and other information concerning the
Company can be inspected at the offices of the New York Stock Exchange, Inc., 20
Broad Street, New York, New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-3 under the Securities Act of 1933, as amended (the "Securities Act"), and the
rules and regulations promulgated thereunder, with respect to the Offered
Securities. This Prospectus, which is part of the Registration Statement, does
not contain all of the information set forth in the Registration Statement and
the exhibits. For further information concerning the Company and the Offered
Securities, reference is made to the Registration Statement and the exhibits and
schedules filed therewith, which may be obtained as described above.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The following documents, which have been filed with the Commission, are
hereby incorporated by reference:
1. Annual Report (i) on Form 10-K of the Company for the fiscal year ended
December 31, 1996; and (ii) on Form 10-K/A filed with the Commission on
March 24, 1997;
2. Quarterly Reports (i) on Form 10-Q for the quarters ended March 31, 1997
and June 30, 1997 and (ii) on Form 10-Q/A filed with the Commission on
August 26, 1997;
3. Current Reports (i) on Form 8-K filed with the Commission on January 9,
1997, March 26, 1997, May 1, 1997, June 26, 1997, July 17, 1997 and
August 14, 1997; and (ii) on Form 8-K/A filed with the Commission on
January 7, 1997 and August 22, 1997;
4. The description of the Common Stock of the Company included in the
Company's Registration Statement on Form 8-A, filed with the Commission
on June 26, 1995; and on Form 8-A/A, filed with the Commission on July
19, 1996.
In addition, all reports and other documents subsequently filed by the
Company with the Commission pursuant to Section 13, 14 or 15(d) of the Exchange
Act after the date of this Prospectus and prior to the termination of the
offering shall be deemed to be incorporated by reference in this Prospectus and
to be a part hereof from the date of the filing of such documents (such
documents, and the documents enumerated above, being herein referred to as
"Incorporated Documents;" provided however, that the documents enumerated above
or subsequently filed by the Company pursuant to Section 13, 14 or 15(d) of the
Exchange Act prior to the filing of the Company's next Annual Report on Form
10-K with the Commission shall not be Incorporated Documents or be incorporated
by reference in this Prospectus or be a part hereof from and after any such
filing of an Annual Report on Form 10-K). Any statement contained in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained herein (or in any other subsequently filed document which
also is or is deemed to be incorporated by reference herein) modifies or
supersedes such statement. Any statements so modified or superseded shall not be
deemed to constitute a part of this Prospectus, except as so modified or
superseded.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon written or oral request of such person, a copy of
any or all of the documents referred to above which have been or may be
incorporated by reference in this Prospectus (other than certain exhibits to
such documents). Requests for such documents should be directed to Sunstone
Hotel Investors, Inc., 115 Calle de Industrias, Suite 201, San Clemente,
California 92672, Attention: Secretary (telephone: (714) 361-3900).
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THE COMPANY
The Company, a Maryland corporation, is a self-administered REIT that owns
mid-priced and upscale hotels in the mid and western United States through
Sunstone Hotel Investors, L.P., a Delaware limited partnership (the
"Partnership"), of which the Company is the sole general partner. The hotels
operate under nationally recognized franchises, including Courtyard by
Marriott(R), Doubletree(R) Hotel, Hampton Inn(R), Holiday Inn(R), Holiday Inn(R)
Hotel & Suites, Holiday Inn Express(TM), Holiday Inn Select(TM), Comfort
Suites(R), Residence Inn(R) by Marriott and Hawthorn Suites. As of August 31,
1997, the Company, through the Partnership, owned 34 hotels, with an aggregate
of 5,290 rooms in seven states, including Arizona (4 hotels), California (14),
Colorado (6), New Mexico (1), Oregon (2), Utah (2), and Washington (5).
In order for the Company to qualify as a REIT for United States federal
income tax purposes, neither the Company nor the Partnership can operate hotels.
Therefore, the Partnership leases the hotels to Sunstone Hotel Properties, Inc.,
a Colorado corporation (the "Lessee") pursuant to percentage leases with an
initial term of ten years (the "Percentage Leases"), which provide for rent
payments based principally on a percentage of room revenues at the hotels. The
Lessee pays the franchise fees, management fees and certain other operating
expenses of the hotels. The Lessee is owned by Robert A. Alter, Chairman and
President of the Company, and Charles L. Biederman, director and Executive Vice
President of the Company. The hotels are managed by Sunstone Hotel Management,
Inc., a Colorado corporation (the "Management Company") pursuant to a management
agreement between the Lessee and the Management Company for a fee equal to 2% of
gross revenues of the hotels (plus reimbursement of accounting costs). The
Management Company is wholly-owned by Mr. Alter.
On August 5, 1997, the Company entered into a Stock Purchase Agreement with
affiliates of Westbrook Partners L.L.C., a real estate investment firm, to
acquire all of the outstanding capital stock of Kahler Realty Corporation, a
Minnesota corporation ("Kahler") from Westbrook Real Estate Fund I, L.P. and
Westbrook Real Estate Co-Investment Partnership I, L.P. (collectively, the
"Westbrook Funds") for an estimated purchase price of approximately $322 million
(the "Kahler Acquisition"). Kahler owns and operates 17 hotels (the "Kahler
Hotels") with 4,255 rooms, principally in two markets, the intermountain region
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 and in the Salt Lake City area of Utah, with
six hotels and 1,509 rooms. Nine of the hotels are operated independently, while
the balance is operated under Sheraton, Hilton, Holiday Inn, Best Western and
Quality Inn franchises. The acquisition of Kahler will almost double the number
of hotel rooms currently owned or operated by the Company.
The consideration to be paid for Kahler consists of approximately $95
million cash, $25 million of newly issued Preferred Stock and $32 million of
newly issued Common Stock of the Company and the assumption of approximately
$170 million in debt, approximately $40 million of which will be repaid to the
Westbrook Funds at the closing. The remaining debt may be kept in place, retired
or replaced following the closing. The purchase price may be increased by as
much as $16.5 million following the closing pursuant to a formula based on the
1999 earnings of the Kahler assets. Any additional purchase price may be paid at
the Company's option in cash or shares of Common Stock. The transaction is
expected to close during the fourth quarter of 1997; however, there can be no
assurance that the Kahler Acquisition will close in the anticipated time frame
or at all. Any delay in closing the Kahler Acquisition following October 15,
1997 will adversely effect the Company's cash flow.
The Company's principal executive office is located at 115 Calle de
Industrias, Suite 201, San Clemente, California 92672; telephone number (714)
361-3900.
The Company's Common Stock is listed on the NYSE under the symbol "SSI."
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USE OF PROCEEDS
The Company intends to invest the net proceeds from any sale of the Offered
Securities in the Partnership in exchange for an additional ownership interest
in the Partnership. Unless otherwise indicated in a future Prospectus
Supplement, the Partnership intends to use the net proceeds from any sale of
Offered Securities for general corporate purposes, including, without
limitation, the acquisition and development of additional hotels, the
maintenance and renovation of currently owned hotels, and the repayment of debt.
For instance, the net proceeds from any sale of the Offered Securities may be
used to acquire Kahler. Should this occur, the Kahler assets will be contributed
to the Partnership in exchange for additional ownership interest in the
Partnership. Pending application of the net proceeds, such net proceeds may be
invested in interest-bearing accounts and short-term, interest-bearing
securities, in a manner consistent with the Company's ability to qualify for
taxation as a REIT. Such investments may include, for example, government and
government agency securities, certificates of deposit, interest-bearing bank
deposits and mortgage loan participations.
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RISK FACTORS
In evaluating the Company's business, prospective investors should
carefully consider the factors set forth in this section in addition to other
information set forth in the accompanying Prospectus Supplement before making an
investment decision with respect to the Offered Securities. This Prospectus may
contain forward-looking statements which involve risks and uncertainties, and
actual results could differ materially from those discussed in any such
forwardlooking 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:
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 code or other
legal requirements, the discovery of structural or other latent defects 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 government 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 and the Partnership from operating hotels. Therefore, the Partnership
enters into Percentage Leases with the Lessee, and the Lessee operates the
hotels and pays rent to the Partnership 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 shareholders because payment of base rent alone
is insufficient for such purposes. In the event that all or a portion of such
higher
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tier rent is not received by the Partnership, the Company may not be able to
make such distributions to its shareholders. There can be no assurance that the
Company will receive such higher tier rent from the Lessee or that the Lessee
will even be able to pay base rent. The Lessee controls the daily operations of
the hotels under the Percentage Leases, which have non-cancelable initial terms
of ten years. The Company selected the Lessee without consideration of other
lessees because Mr. Alter and Mr. Biederman, who own the Lessee, owned and were
involved in the management of a number of the hotels contributed to the Company
in connection with its initial public offering in 1995 (the "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 only has
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 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. The Lessee
had a net operating loss of $3.2 million for the year ended December 31, 1996
and net income of $365,000 for the six months ended June 30, 1997. The Lessee
was able to meet its rent obligations under the Percentage Leases during these
periods.
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, in August 1997, the
Company announced the Kahler Acquisition which, if consummated, will almost
double the Company's current 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. 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
portfolio acquisition that does not close are generally greater than for an
individual hotel acquisition that does not close. If the Company fails to close
multiple hotel acquisitions, its ability to increase Cash Available for
Distribution will be limited. See "-- Dependence on Acquisitions to Increase
Cash Available for Distribution." Another risk associated with multiple-hotel
acquisitions is that a seller may require that a group of hotels be purchased as
a package, even though one or more of the hotels in the package does not meet
the Company's investment criteria. In such cases, the Company may purchase the
group of hotels with the intent to re-sell or exchange those which do not meet
its criteria. This occurred in the first quarter of 1996 with the acquisition of
the six Cypress Inn Hotels in Oregon and Washington, two of which were re-sold
by the Company within three months of the acquisition. It is anticipated that
any hotel acquired in the Kahler Acquisition that does not fit the geographic or
operating parameters of the Company will likewise be sold or exchanged. In such
circumstances, however, there can be no assurance as to how quickly the Company
could sell or exchange such hotels or the price at 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 would be subject to a 100% tax.
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The Company may finance multiple-hotel acquisitions by issuing shares of
Common Stock or Partnership Units which are convertible into Common Stock. Such
issuances may have an adverse effect on the market price of the Common Stock.
See "-- Adverse Effect of Shares Available for Future Issuance and Sale on
Market Price of Common Stock."
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 IPO and any other subsequently acquired
hotels into its existing operations. Since the closing of the IPO, 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 acquisition of Kahler 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
businesses 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
the Company's hotels. There can be no assurance that the Kahler Acquisition will
not adversely affect the operations, revenues or prospects of the Company's
hotels located in such geographic areas.
GEOGRAPHIC CONCENTRATION OF KAHLER
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.
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, the Management
Company and the Company in the leasing, acquisition, disposition, operation and
management of the Company's hotels. Accordingly, the interests of shareholders
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
contributed to the Company in connection with its IPO is specially allocated to
Mr. Alter and Mr. Biederman and any sale of such hotels by the Partnership may
cause adverse tax consequences to them. In addition, the reduction of mortgage
indebtedness by the Partnership at any time below certain levels would create
adverse tax consequences to Mr. Alter and Mr. Biederman. These conflicts may
result in decisions relating to the sale of certain hotels and/or the incurrence
or repayment of indebtedness which do not reflect solely the interests of the
Company and the shareholders. 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
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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 shareholders.
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, average daily rate ("ADR") and revenue
per available room ("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. Under the
terms of the Percentage Leases, the
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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 entered into a five-year master development agreement with U.S.
Franchise Systems, Inc. and Hawthorn Suites Franchising, Inc. on March 10, 1997
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 overcommit to building 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
Thirty-one 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 revenues under the Percentage Leases and Cash
Available for Distribution to its shareholders.
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.
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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 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.
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.
See "United States Federal Income Tax Considerations" for a discussion of
the material tax consequences and risks of an investment in the Company.
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 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.
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
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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 shareholders
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.
ADVERSE EFFECT OF SHARES AVAILABLE FOR FUTURE ISSUANCE AND SALE ON MARKET PRICE
OF COMMON STOCK
The Company's Articles of Incorporation authorize the Board of Directors to
issue up to 60,000,000 shares of capital stock, consisting of 50,000,000 shares
of Common Stock and 10,000,000 shares of Preferred Stock. As of August 15, 1997,
the Board of Directors was able to reclassify and issue an aggregate of
approximately 24,700,000 unissued or unreserved shares of Common Stock and to
classify and issue all 10,000,000 unissued shares of Preferred Stock, of which
250,000 will be classified and issued in connection with the Kahler Acquisition.
The Company's acquisition strategy depends in part on access to additional
capital through sales and issuances of equity securities. The market price of
the Common Stock may be adversely affected by the availability for future sale
and issuance of such unissued and unreserved shares of Common Stock and
Preferred Stock and the consequent dilutive effect of such issuances.
In addition, the market price of the Common Stock may also be adversely
affected by the availability for future sale and issuance of shares of Common
Stock that could be issued upon the redemption of Units of the Partnership. The
Company may at any time file a Registration Statement on Form S-3 to give the
limited partners of the Partnership the ability to sell shares of Common Stock
issued upon redemption of Units. In addition, Westbrook will be granted certain
registration rights in connection with the shares being issued to them in the
Kahler Acquisition.
RISK OF DILUTION
As hotel acquisition opportunities arise from time to time, the Company may
issue additional shares of Common Stock or Preferred Stock to raise the capital
necessary to finance the hotel acquisitions or may issue Common Stock or
Preferred Stock (as is proposed in the Kahler Acquisition) or Partnership Units
which are redeemable on a one-to-one basis for Common Stock to acquire hotels.
Such issuances could result in dilution of shareholders' equity.
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DESCRIPTION OF COMMON STOCK AND PREFERRED STOCK
The following summary description of Common Stock and Preferred Stock of
the Company is subject to and qualified in its entirety by reference to Maryland
law described herein, and to the Articles of Incorporation and Bylaws of the
Company (and any amendments or supplements thereto) which are filed as exhibits
to, or incorporated by reference in, the Registration Statement of which this
Prospectus is a part.
GENERAL
The Articles of Incorporation of the Company provide that the Company may
issue up to 60,000,000 shares of capital stock, consisting of 50,000,000 shares
of Common Stock, $0.01 par value per share, and 10,000,000 shares of Preferred
Stock, $0.01 par value per share. As of August 15, 1997, (i) 20,390,830 shares
of Common Stock were issued and outstanding, (ii) 1,000,000 shares of Common
Stock were reserved for issuance under the Company's Dividend Reinvestment and
Stock Purchase Plan, (iii) 1,200,000 shares of Common Stock were reserved for
issuance under the Company's 1994 Stock Incentive Plan, (iv) 150,000 shares of
Common Stock were reserved for issuance under the 1994 Directors Plan, and (v)
2,562,560 shares of Common Stock were reserved for issuance upon the conversion
of units of Partnership interest ("Units") into Common Stock (each Unit is
convertible into one share of Common Stock at the Unitholder's election). As of
August 15, 1997, no shares of Preferred Stock were issued and outstanding.
The following description sets forth certain general terms and provisions
of the Common Stock to which any Prospectus Supplement may relate, including a
Prospectus Supplement providing that Common Stock will be issuable upon
conversion of Preferred Stock or upon the exercise of Warrants issued by the
Company. The Common Stock is listed on the NYSE under the symbol "SSI."
ChaseMellon Shareholder Services LLC is the Company's registrar and transfer
agent for the Common Stock and Partnership Units.
COMMON STOCK
All shares of Common Stock offered hereby will, when issued, be duly
authorized, fully paid and nonassessable. Subject to the preferential rights of
any other shares, series or class of shares of capital stock that may from time
to time cone into existence, and to the provisions of the Company's Articles of
Incorporation regarding owning shares in excess of the Ownership Limitation,
holders of Common Stock will be entitled to receive dividends on such Common
Stock if, as and when authorized and declared by the Board of Directors of the
Company out of assets legally available therefor and to share ratably in the
assets of the Company legally available for distribution to its shareholders in
the event of its liquidation, dissolution or winding-up after payment of, or
adequate provision for, all known debts and liabilities of the Company. The
Company intends to continue its practice of paying regular quarterly dividends
to the holders of its Common Stock.
Holders of the Company's Common Stock can elect to participate in the
Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") and have
all or part of their dividends reinvested in additional shares of Common Stock.
Participants in the Plan can also purchase additional shares of Common Stock
with cash (subject to certain limitations). The terms of the Plan are described
in a separate prospectus which may be obtained by calling the Plan
administrator, Mellon Bank, N.A., at (888) 261-6776.
Subject to the provisions of the Articles of Incorporation regarding owning
shares in excess of the Ownership Limitation, each outstanding share of Common
Stock entitles the holder to one vote on all matters submitted to a vote of
shareholders, including the election of directors, and, except as otherwise
required by law or except as provided with respect to any other class or series
of shares of stock, the holders of such shares of Common Stock will possess the
exclusive voting power. There is no cumulative voting in the election of
directors, which means that the holders of a majority of the outstanding shares
of Common Stock can elect all of the directors then standing for election and
the holders of the remaining shares, if any, will not be able to elect any
directors.
Holders of Common Stock have no conversion, sinking fund, redemption rights
or any preemptive rights to subscribe for any securities of the Company, nor do
they have any preference, appraisal or exchange rights.
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PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to issue, from
the 10,000,000 authorized but unissued shares of capital stock of the Company,
Preferred Stock in such classes or series as the Board of Directors may
determine and to establish from time to time the number of shares of Preferred
Stock to be included in any such class or series and to fix the designation and
any preferences, conversion and other rights, voting powers, restrictions,
limitations as to dividends, qualifications and terms and conditions of
redemption of the shares of any such class or series, and such other subjects or
matters as may be fixed by resolution of the Board of Directors. As of the date
of this Prospectus, no shares of Preferred Stock are outstanding; however, it is
anticipated that an aggregate of 250,000 shares of Class A Preferred Stock will
be issued in connection with the Kahler Acquisition. The issuance of Preferred
Stock may have the effect of delaying, deferring or preventing a change in
control of the Company or other transaction in which holders of shares of Common
Stock might receive a premium for such shares over the market price.
7.9% Class A Cumulative Convertible Preferred Stock
In connection with the Kahler Acquisition the Company will issue 250,000
shares of its newly designated 7.9% Class A Cumulative Convertible Preferred
Stock (the "Class A Shares"). The holders of the Class A Shares are entitled to
one vote for each share of Common Stock into which such holder's Class A Shares
could then be converted, and with respect to such vote, such holder shall have
full voting rights and powers equal to the voting rights and powers of the
holders of Common Stock. The holders of Class A Shares shall be entitled to
vote, together with holders of Common Stock as a single class. Subject to
preferences that may be applicable to any future class of Preferred Stock, the
holders of Class A Shares are entitled to receive, ratably, a dividend equal to
the greater of (i) 7.9% per share per annum or (ii) the percentage dividend that
would be paid on the Common Stock into which the Preferred Stock is convertible.
In the event of a liquidation, dissolution or winding up of the Company, subject
to the rights of future classes of Preferred Stock, the holders of Class A
Shares are entitled to receive, prior and in preference to the holders of Common
Stock, an amount per share equal to $100.00 for each outstanding Class A Share,
plus accrued and unpaid dividends. The Class A Shares have no preemptive rights.
Each Class A Share is convertible at the option of the holder at any time
into a number of shares of Common Stock that is equal to the quotient obtained
by dividing $100 by $14.7093, subject to adjustment for stock splits, stock
dividends, recapitalizations and the like. On or at any time after the fifth
anniversary of issuance of the Class A Shares, the Company may, at its option,
redeem the Class A Shares in whole or in part by paying an amount equal to the
redemption percentage of $100.00 per share then in effect (as adjusted for any
stock dividends, combinations or splits), plus all accrued but unpaid dividends
on such shares. The redemption percentage declines one percent per year, from
105% to par commencing in 2002. There are no sinking fund provisions applicable
to the Class A Shares. All outstanding Class A Shares will, upon issuance, be
fully paid and non-assessable.
Terms of Future Classes of Preferred Stock
Preferred Stock, upon issuance against full payment of the purchase price
therefor, will be fully paid and nonassessable. The specific terms of a
particular class or series of Preferred Stock to be offered hereby will be
described in the Prospectus Supplement relating to that class or series,
including a Prospectus Supplement providing that Preferred Stock may be issuable
upon the exercise of Warrants issued by the Company. In addition, the terms of
any class or series of Preferred Stock which may be issued will be set forth in
Articles Supplementary to the Company's Articles of Incorporation which will be
filed with the Maryland Department of Assessments and Taxation and as an exhibit
to (or incorporated by reference in) the Registration Statement of which this
Prospectus is a part. The description of Preferred Stock set forth below and the
description of the terms of a particular class or series of Preferred Stock set
forth in a Prospectus Supplement do not purport to be complete and are qualified
in their entirety by reference to the articles supplementary relating to that
class or series.
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The preferences and other terms of the Preferred Stock of each class or
series will be fixed by the Articles Supplementary relating to such class or
series. A Prospectus Supplement, relating to each class or series, will specify
the terms of the Preferred Stock as follows:
(1) The title and stated value of such Preferred Stock;
(2) The number of shares of such Preferred Stock offered, the liquidation
preference per share and the offering price of such Preferred Stock;
(3) The dividend rate(s), period(s), and/or payment date(s) or method(s)
of calculation thereof applicable to such Preferred Stock;
(4) Whether dividends payable on such Preferred Stock is cumulative or not
and, if cumulative, the date from which dividends on such Preferred
Stock shall accumulate;
(5) The provision for a sinking fund, if any, for such Preferred Stock;
(6) The provision for redemption, if applicable, of such Preferred Stock;
(7) Any listing of such Preferred Stock on any securities exchange;
(8) The terms and conditions, if applicable, upon which such Preferred
Stock will be converted into Common Stock of the Company, including
the conversion price (or manner of calculation thereof);
(9) A discussion of any material United States federal income tax
considerations applicable to such Preferred Stock (in addition to
those discussed herein);
(10) Any limitations on direct or beneficial ownership and restrictions on
transfer, in each case as may be appropriate to preserve the status of
the Company as a REIT;
(11) The relative ranking and preferences of such Preferred Stock as to
dividend rights and rights upon liquidation, dissolution or winding up
of the affairs of the Company;
(12) Any limitations on issuance of any class or series of preferred stock
ranking senior to or on parity with such class or series of Preferred
Stock as to dividend rights and rights upon liquidation, dissolution
or winding up of the affairs of the Company;
(13) Any voting rights of such Preferred Stock; and
(14) Any other specific terms, preferences, rights, limitations or
restrictions of such Preferred Stock.
Registrar and Transfer Agent
The registrar and transfer agent for any class or series of the Preferred
Stock offered hereby will be set forth in the applicable Prospectus Supplement.
CLASSIFICATION OR RECLASSIFICATION OF COMMON STOCK OR PREFERRED STOCK
Subject to limitations prescribed by Maryland law and the Company's
Articles of Incorporation, the Board of Directors is authorized to classify and
reclassify any unissued portion of the authorized shares of capital stock to
provide for the issuance of shares in other classes or series, including other
classes or series of Common Stock or Preferred Stock, to establish the number of
shares in each class or series and to fix the designation and any preferences,
conversion and other rights, voting powers, restrictions, limitations as to
dividends, qualifications and terms and conditions of redemption of such class
or series. The rights, preferences, privileges and restrictions of such class or
series will be fixed by Articles Supplementary to the Company's Articles of
Incorporation relating to such class or series. A Prospectus Supplement will
specify the terms of any such class or series offered hereby.
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RESTRICTIONS ON OWNERSHIP OF COMMON STOCK OR PREFERRED STOCK
The following is a description of the restrictions on ownership of the
Common Stock and Preferred Stock. There may be additional provisions that
further restrict ownership and transfer, which will be described in any
applicable Prospectus Supplement. Such description is, and will be, qualified in
its entirety by any supplements to the Articles of Incorporation or Bylaws filed
as exhibits to, or incorporated by reference in, the Registration Statement of
which this Prospectus is a part.
For the Company to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding shares of capital
stock. Specifically, not more than 50% in value of the Company's outstanding
shares may be owned, directly or indirectly, by five or fewer individuals (as
defined in the Code to include certain entities) during the last half of a
taxable year, and the Company must be beneficially owned by 100 or more persons
during at least 335 days of a taxable year of 12 months or during a
proportionate part of a shorter taxable year. See "United States Federal Income
Tax Considerations -- Requirements for Qualification." In addition, the Company
must meet certain requirements regarding the nature of its gross income in order
to qualify as a REIT. One such requirement is that at least 75% of the Company's
gross income for each year must consist of rents from real property and income
from certain other real property investments. The rents received by the
Partnership from the Lessee would not qualify as rents from real property, which
would result in loss of REIT status for the Company, if the Company were at any
time to own, directly or constructively, 10% or more of the ownership interests
in the Lessee within the meaning of Section 856(d)(2)(B) of the Code. See
"United States Federal Income Tax Considerations -- Requirements for
Qualification -- Income Tests."
Because the Board of Directors believes it is essential for the Company to
qualify as a REIT, the Articles of Incorporation, subject to certain exceptions
described below, provides that no person may own, or be deemed to own by virtue
of the constructive ownership provisions of the Code, more than 9.8% of the
lesser in value of the total number or value of the outstanding shares of Common
Stock or the outstanding shares of Preferred Stock (the "Ownership Limitation").
The constructive ownership rules of the Code are complex and may cause shares
owned actually or constructively by two or more related individuals and/or
entities to be constructively owned by one individual or entity. As a result,
the acquisition of less than 9.8% of the outstanding shares of Common Stock or
9.8% of the shares of Preferred Stock (or the acquisition of an interest in an
entity which owns the shares) by an individual or entity could cause that
individual or entity (or another individual or entity) to own constructively in
excess of 9.8% of the outstanding shares of Common Stock or 9.8% of the
outstanding shares of Preferred Stock, and thus subject such shares to the
Ownership Limitation provisions of the Articles of Incorporation. The Ownership
Limitation also prohibits any transfer of Common Stock or Preferred Stock that
would (i) result in the Common Stock and Preferred Stock being owned by fewer
than 100 persons (determined without reference to any rules of attribution),
(ii) result in the Company being "closely held" within the meaning of Section
856(h) of the Code, or (iii) cause the Company to own, directly or
constructively, 10% or more of the ownership interests in a tenant of the
Company's real property, within the meaning of Section 856(d)(2)(B) of the Code.
Except as otherwise provided below, any such acquisition or transfer of the
Company's capital stock (including any constructive acquisition or transfer of
ownership) shall be null and void, and the intended transferee or owner will
acquire no rights to, or economic interests in, the shares.
Subject to certain exceptions described below, any purported transfer of
Common Stock or Preferred Stock that would (i) result in any person owning,
directly or indirectly, Common Stock or Preferred Stock in excess of the
Ownership Limitation, (ii) result in the Common Stock and Preferred Stock being
owned by fewer than 100 persons (determined without reference to any rules of
attribution), (iii) result in the Company being "closely held" within the
meaning of Section 856(h) the Code, or (iv) cause the Company to own, directly
or constructively, 10.0% or more of the ownership interests in a tenant of the
Company's or the Partnership's real property, within the meaning of Section
856(d)(2)(B) of 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 Stock or Preferred Stock. The
record holder of the Common Stock or Preferred Stock that are designated as
Shares-in-Trust (the "Prohibited Owner") will be required to submit such number
of shares of Common Stock or Preferred Stock to the Share Trust for designation
in the name of
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a trustee to be designated by the Company (the "Share Trustee"). The beneficiary
of the Share Trust (the "Beneficiary") will be one or more charitable
organizations that are named by the Company.
Shares-in-Trust will remain issued and outstanding Common Stock or
Preferred Stock and will be entitled to the same rights and privileges as all
other shares of the same class or series. The Share Trust will receive all
dividends and distributions on the Shares-in-Trust and will hold such dividends
or distributions in trust for the benefit of the Beneficiary. The Share Trustee
will vote all Shares-in-Trust. The Share Trustee will designate a permitted
transferee of the Shares-in-Trust, provided that the permitted transferee (i)
purchases such Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Share Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required to
repay to the Share Trust the amount of any dividends or distributions received
by the Prohibited Owner (i) that are attributable to any Shares-in-Trust and
(ii) for which the record date was on or after the date that such shares became
Shares-in-Trust. The Prohibited Owner generally will receive from the Share
Trustee the lesser of (i) the price per share such Prohibited Owner paid for the
Common Stock or Preferred Stock that were designated as Shares-in-Trust (or, in
the case of a gift or devise, the market price (based on a five day trading
average) per share on the date of such transfer) and (ii) the price per share
received by the Share Trustee from the sale or other disposition of such
Shares-in-Trust. Any amounts received by the Share Trustee in excess of the
amounts to be paid to the Prohibited Owner will be distributed to the
Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the market price per share on the date of such
transfer) or (ii) the market price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept such
offer for a period of ninety days after the later of (i) the date of the
purported transfer which resulted in such Shares-in-Trust and (ii) the date the
Company determines in good faith that a transfer resulting in such
Shares-in-Trust occurred.
Any person who acquires or attempts to acquire Common Stock or Preferred
Stock in violation of the foregoing restrictions, or any person who owned shares
of Common Stock or Preferred Stock that were transferred to a Share Trust, will
be required (i) to give immediately written notice to the Company of such event
and (ii) to provide to the Company such other information as the Company may
request in order to determine the effect, if any, of such transfer on the
Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such lower
percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must within 30 days after
January 1 of each year, provide to the Company a written statement or affidavit
stating the name and address of such direct or indirect owner, the number of
shares of Common Stock and Preferred Stock owned directly or indirectly, and a
description of how such shares are held. In addition, each direct or indirect
shareholder shall provide to the Company such additional information as the
Company may request in order to determine the effect, if any, of such ownership
on the Company's status as a REIT and to ensure compliance with the Ownership
Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates in
a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the Internal Revenue Service or an opinion of counsel
and upon such other conditions as the Board of Directors may direct, may exempt
a person from the Ownership Limitation under certain circumstances. The
foregoing restrictions will continue to apply until the Board of Directors, with
the approval of the holders of at least two-thirds of the outstanding shares of
all votes entitled to vote on such matter at a regular or special meeting of the
shareholders of the Company, determines to terminate its status as a REIT.
The Ownership Limitation will not be automatically removed even if the REIT
provisions of the Code are changed so as to remove any ownership concentration
limitation. Any change of the Ownership Limitation would require an amendment to
the Articles of Incorporation. Such amendment requires the affirmative vote
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of holders holding at least two-thirds of the outstanding shares entitled to
vote on the matter. In addition to preserving the Company's status as a REIT,
the Ownership Limitation may have the effect of delaying, deferring,
discouraging or preventing a transaction or a change in control of the Company
without the approval of the Board of Directors.
Any certificates representing shares of Common Stock or Preferred Stock
will bear a legend referring to the restrictions described above.
DESCRIPTION OF WARRANTS
The Company has no Warrants outstanding. The Company may issue Warrants for
the purchase of Preferred Stock or Common Stock. Warrants may be issued
independently or together with any other Offered Securities offered by any
Prospectus Supplement and may be attached to or separate from such Offered
Securities. Each series of Warrants will be issued under a separate warrant
agreement (each, a "Warrant Agreement") to be entered into between the Company
and a warrant agent specified in the applicable Prospectus Supplement (the
"Warrant Agent"). The Warrant Agent will act solely as an agent of the Company
in connection with the Warrants of such series and will not assume any
obligation or relationship of agency or trust for or with any provisions of the
Warrants offered hereby. Further terms of the Warrants and the applicable
Warrant Agreements will be set forth in the applicable Prospectus Supplement.
The applicable Prospectus Supplement will describe the terms of the
Warrants in respect of which this Prospectus is being delivered, including,
where applicable, the following:
(1) The title of such Warrants;
(2) The aggregate number of such Warrants;
(3) The price or prices at which such Warrants will be issued;
(4) The designation, terms and number of shares of Preferred Stock or
Common Stock purchasable upon exercise of such Warrants;
(5) The designation and terms of the Common Stock or Preferred Stock, if
any, with which such Warrants are issued and the number of such
Warrants issued with the Common Stock or Preferred Stock;
(6) The date, if any, on and after which such Warrants and the related
Preferred Stock or Common Stock will be separately transferable;
(7) The price at which each share of Preferred Stock or Common Stock
issuable upon exercise of such Warrants may be purchased;
(8) The date on which the right to exercise such Warrants shall commence
and the date on which such right shall expire;
(9) The minimum or maximum amount of such Warrants which may be exercised
at any one time;
(10) Information with respect to book-entry procedures, if any;
(11) A discussion of certain Federal income tax considerations specifically
related to such Warrants; and
(12) Any other terms of such Warrants, including terms, procedures and
limitations relating to the exchange and exercise of such Warrants.
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CERTAIN PROVISIONS OF MARYLAND LAW AND
OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Maryland law and of the
Articles of Incorporation and Bylaws of the Company does not purport to be
complete and is qualified in its entirety by reference to Maryland law and the
Articles of Incorporation and Bylaws of the Company (and any amendments and
supplements thereto) which are filed as exhibits to, or incorporated by
reference in, the Registration Statement of which this Prospectus is a part.
ANTI-TAKEOVER EFFECT OF CERTAIN PROVISIONS OF MARYLAND LAW AND OF THE COMPANY'S
ARTICLES OF INCORPORATION AND BYLAWS
The provisions in the Articles of Incorporation regarding the Ownership
Limitation and the classification of the Board of Directors, the business
combination provisions of the Maryland General Corporation Law ("MGCL"), the
control shares acquisition provisions of the MGCL, and the advance notice
provisions of the Bylaws could have the effect of delaying, deferring,
discouraging or preventing a transaction or a change in control of the Company
in which holders of some, or a majority, of the capital stock of the Company
might receive a premium for their shares over the then prevailing market price
or which such holders might believe to be otherwise in their best interest.
Certain significant provisions which might have this effect are described below.
CLASSIFICATION OF THE BOARD OF DIRECTORS
The Bylaws provide that the number of directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. The directors may increase the number of directors by a vote of a
least 80% of the members of the Board of Directors, provided that the number of
directors shall never be less than the number required by Maryland law and that
the tenure of office of a director shall not be affected by any decrease in the
number of directors. Any vacancy will be filled, including a vacancy created by
an increase in the number of directors, at any regular meeting or at any special
meeting called for that purpose, by a majority of the remaining directors,
except that a vacancy resulting from an increase in the number of directors must
be filled by a majority of the entire Board of Directors.
Pursuant to the Articles of Incorporation the Board of Directors will be
divided into three classes of directors. As the term of each class expires,
directors in that class will be elected by the shareholders of the Company for a
term of three years and until their successors are duly elected and qualify.
Classification of the Board of Directors is intended to assure the continuity
and stability of the Company's business strategies and policies as determined by
the Board of Directors. Shareholders will have no right to cumulative voting in
the election of directors. Consequently, at each annual meeting of shareholders,
the holders of a majority of the shares of Common Stock present in person or by
proxy at such meeting will be able to elect all of the successors of the class
of directors whose terms expire at that meeting.
The classified board provision could have the effect of making the
replacement of incumbent directors more time consuming and difficult, which
could delay, defer, discourage or prevent an attempt by a third party to obtain
control of the Company or other transaction, even though such an attempt or
other transaction might be beneficial to the Company and its shareholders. At
least two annual meetings of shareholders, instead of one, will generally be
required to effect a change in a majority of the Board of Directors. Thus, the
classified board provision could increase the likelihood that incumbent
directors will retain their positions.
REMOVAL OF DIRECTORS
The Articles of Incorporation provide that a director may be removed with
or without cause by the affirmative vote of at least two-thirds of the votes
entitled to be cast in the election of directors. This provision when coupled
with the provision in the Bylaws authorizing the Board of Directors to fill
vacant directorships, could preclude shareholders from removing incumbent
directors except upon the existence of a substantial affirmative vote and by
filling the vacancies created by such removal with their own nominees upon the
affirmative vote of a majority of the votes entitled to be cast in the election
of directors.
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LIMITATION OF LIABILITY AND INDEMNIFICATION
The Articles of Incorporation and Bylaws limit the liability of the
Company's directors and officers for money damages to the Company and its
shareholders to the fullest extent permitted from time to time by Maryland law.
Maryland law presently permits the liability of directors and officers to a
corporation or its shareholders for monetary damages to be limited, except (i)
to the extent that it is proved that the director or officer actually received
an improper benefit or profit, or (ii) to the extent that a judgment or other
final adjudication is entered in a proceeding based on a finding that the
director's or officer's action, or failure to act, was the result of active and
deliberate dishonesty and was material to the cause of action, as adjudicated in
the proceeding. This provision does not limit the ability of the Company or its
shareholders to obtain other relief, such as an injunction or rescission.
The Articles of Incorporation and Bylaws require the Company to indemnify
its directors and officers to the fullest extent permitted from time to time by
Maryland law. The Company's Articles of Incorporation and Bylaws also permit the
Company to indemnify employees, agents and other persons acting on behalf of or
at the request of the Company. The MGCL generally permits a corporation to
indemnify its directors, officers and certain other parties against judgments,
penalties, fines, settlements and reasonable expenses actually incurred by them
in connection with any proceeding to which they may be made a party by reason of
their service to or at the request of the Company. Indemnification under the
provisions of the MGCL is not deemed exclusive to any other rights, by
indemnification or otherwise, to which an officer or director may be entitled
under the Articles of Incorporation or Bylaws, or under resolutions of
shareholders or directors, contract or otherwise. It is the position of the
Commission that indemnification of directors and officers for liabilities
arising under the Securities Act is against public policy and is unenforceable
pursuant to Section 14 of the Securities Act.
BUSINESS COMBINATIONS
Under the MGCL, certain "business combinations" (including a merger,
consolidation, share exchange or, in certain circumstances, an asset transfer or
issuance or reclassification of equity securities) between a Maryland
corporation and any person who beneficially owns ten percent or more of the
voting power of such corporation's shares or an affiliate of such corporation
who, at any time within the two-year period prior to the date in question, was
the beneficial owner of ten percent or more of the voting power of the
then-outstanding voting shares of such corporation (an "Interested Shareholder")
or an affiliate thereof are prohibited for five years after the most recent date
on which the Interested Shareholder became an Interested Shareholder.
Thereafter, any such business combination must be recommended by the board of
directors of such corporation and approved by the affirmative vote of at least
(a) 80% of the votes entitled to be cast by holders of outstanding voting shares
of such corporation and (b) two-thirds of the votes entitled to be cast by
holders of voting shares of such corporation other than shares held by the
Interested Shareholder with whom (or with whose affiliate) the business
combination is to be effected, unless, among other things, such corporation's
shareholders receive a minimum price (as defined in the MGCL) for their shares
and the consideration is received in cash or in the same form as previously paid
by the Interested Shareholder for its shares. These provisions of Maryland law
do not apply, however, to business combinations that are approved or exempted by
the board of directors of a corporation prior to the time that the Interested
Shareholder becomes an Interested Shareholder. The Board of Directors has
exempted from these provisions of the MGCL any business combination with certain
officers and directors of the Company, and all present or future affiliates or
associates of, or any other person acting in concert or as a group with, any of
the foregoing persons and any other business combination which may arise in
connection with the Company formation transactions generally.
CONTROL SHARE ACQUISITIONS
The MGCL provides that "control shares" of a Maryland corporation acquired
in a "control share acquisition" have no voting rights except to the extent
approved by a vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares owned by the acquiror, by officers or by directors who are
employees of a corporation. "Control Shares" are voting shares which, if
aggregated with all other such shares previously acquired by the acquiror, or in
respect of which the acquiror is able to exercise or direct the exercise of
voting
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power (except solely by virtue of a revocable proxy), would entitle the acquiror
to exercise voting power in electing directors within one of the following
ranges of voting power: (i) one-fifth or more but less than one-third (ii)
one-third or more but less than a majority, or (iii) a majority or more of all
voting power. Control Shares do not include shares the acquiring person is then
entitled to vote as a result of having previously obtained shareholder approval.
A "control share acquisition" means the acquisition of control shares, subject
to certain exceptions.
A person who has made or proposes to make a control share acquisition, upon
satisfaction of certain conditions (including an undertaking to pay expenses),
may compel the board of directors of a corporation to call a special meeting of
shareholders to be held within 50 days of demand to consider the voting rights
of the shares. If no request for a meeting is made, the corporation may itself
present the question at any shareholders meeting.
If voting rights are not approved at the meeting or if the acquiring person
does not deliver an acquiring person statement as required by the statute, then,
subject to certain conditions and limitations, a corporation may redeem any or
all of the control shares (except those for which voting rights have previously
been approved) for fair value determined, without regard to the absence of
voting rights for the control shares, as of the date of the last control share
acquisition by the acquiror or of any meeting of shareholders at which the
voting rights of such shares are considered and not approved. If voting rights
for control shares are approved at a shareholders meeting and the acquiror
becomes entitled to vote a majority of the shares entitled to vote, all other
shareholders may exercise appraisal rights. The fair value of the shares as
determined for purposes of such appraisal rights may not be less than the
highest price per share paid by the acquiror in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a control share acquisition.
The control share acquisition statute does not apply to shares acquired in
a merger, consolidation or share exchange, if the corporation is a party to the
transaction, or to acquisitions approved or exempted by the articles of
incorporation or bylaws of a corporation.
The Bylaws of the Company contain a provision exempting from the control
share acquisition statute any and all acquisitions by any person of the
Company's Common Stock or Preferred Stock. There can be no assurance that such
provision will not be amended or eliminated in the future.
AMENDMENTS TO THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The Articles of Incorporation may only be amended by the affirmative vote
of the holders of not less than a majority of the votes entitled to be cast on
the matter, except that any proposal (i) to permit cumulative voting in the
election of directors, (ii) to alter provisions of the Articles of Incorporation
requiring a majority of the directors to be independent directors or provisions
of the Articles of Incorporation relative to the classification of the Company's
Board of Directors into three classes, removal of directors, preemptive rights,
indemnification of corporate agents and limitation of liability of officers and
directors, or (iii) that would terminate the Company's status as a REIT for tax
purposes, may not be amended, altered, changed or repealed without the
affirmative vote of at least two-thirds of all of the votes entitled to be cast
on the matter. Subject to the right of the Company's shareholders to adopt,
alter or repeal the Bylaws, the Bylaws may be amended by the Board of Directors,
except for provisions of the Bylaws relating to the sale of certain hotels and
transactions involving the Company in which an advisor, director or officer has
an interest, which may be altered or repealed only upon the vote of shareholders
holding at least two-thirds of the outstanding shares of stock entitled to vote
generally in the election of directors.
DISSOLUTION OF THE COMPANY
Pursuant to the Articles of Incorporation, the dissolution of the Company
must be approved and advised by the Board of Directors and approved by the
affirmative vote of the holders of a majority of all of the votes entitled to be
cast on the matter.
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OPERATIONS
The Company is generally prohibited from engaging in certain activities,
including incurring consolidated indebtedness, in the aggregate, in excess of
50% of the Company's investment in hotels at cost, and acquiring or holding
property or engaging in any activity that would cause the Company to fail to
qualify as a REIT.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax considerations
that may be relevant to a prospective holder of the Common Stock or Preferred
Stock. The discussion contained herein does not address all aspects of taxation
that may be relevant to particular holders of the Common Stock or Preferred
Stock in light of their personal investment or tax circumstances, or to certain
types of holders (including insurance companies, tax-exempt organizations,
financial institutions or broker-dealers, foreign corporations, and persons who
are not citizens or residents of the United States) subject to special treatment
under the federal income tax laws.
This discussion as to tax consequences is based on current provisions of
the Code, existing, temporary, and currently proposed Treasury Regulations
promulgated under the Code, the legislative history of the Code, existing
administrative rulings and practices of the Service, and judicial decisions. No
assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus with respect to the transactions
entered into or contemplated prior to the effective date of such changes.
EACH PROSPECTIVE PURCHASER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR
REGARDING THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP, AND
SALE OF THE COMMON STOCK OR PREFERRED STOCK AND OF THE COMPANY'S ELECTION TO BE
TAXED AS A REIT, INCLUDING THE FEDERAL, STATE, LOCAL, FOREIGN, AND OTHER TAX
CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP, SALE, AND ELECTION, AND OF POTENTIAL
CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF THE COMPANY
The Company has elected to be taxed as a REIT under Sections 856 through
860 of the Code, effective for its taxable year ended on December 31, 1995. The
Company will receive an opinion of its counsel, Brobeck, Phleger & Harrison LLP,
that, commencing with the inception of the Company's taxable year ended December
31, 1995, the Company has been organized and operated in conformity with the
requirements for qualification as a REIT under the Code, and that its
organization and contemplated method of operation as of the date of such opinion
will enable it to continue to meet the requirements for qualification and
taxation as a REIT under the Code for 1997 and subsequent taxable years. The
Company may, in connection with a particular offering of the Offered Securities,
receive an opinion of counsel that as of the time of such offering the Company
continues to qualify as a REIT under the Code. Investors should be aware,
however, that Brobeck, Phleger & Harrison LLP's opinion and any subsequent
opinions of counsel are not binding upon the Service or any court. It must be
emphasized that Brobeck, Phleger & Harrison LLP's opinions have been, and any
subsequent opinion of counsel will be, based on various assumptions and have
been and will be conditioned upon the accuracy of various representations and
assumptions as to factual matters, including representations regarding the
nature of the Company's properties and income during 1995 and subsequently and
the future conduct of its business. Moreover, qualification and taxation as a
REIT depends upon the Company's ability to meet on a continuing basis, the
various qualification tests imposed under the Code discussed below. Counsel will
not review the Company's compliance with those tests on a continuing basis.
Accordingly, no assurance can be given that the actual results of the Company's
operation will satisfy all of the requirements for qualification as a REIT.
The sections of the Code relating to qualification and operation as a REIT
are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its shareholders. The discussion is qualified in its
entirety by the
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applicable Code provisions, Treasury Regulations promulgated thereunder, and
administrative and judicial interpretations thereof, all of which are subject to
change prospectively or retrospectively.
Assuming the Company qualifies for taxation as a REIT, it generally will
not be subject to federal corporate income tax on its net income that is
distributed currently to its shareholders. That treatment substantially
eliminates the "double taxation" (i.e., taxation at both the corporate and
shareholder levels) that generally results from investment in a corporation.
However, the Company will be subject to federal income tax in the following
circumstances. First, the Company will be taxed at regular corporate rates on
any undistributed REIT taxable income, including undistributed net capital
gains. Furthermore, under certain circumstances, the Company may be subject to
the "alternative minimum tax" on its items of tax preference. Third, if the
Company has (i) net income from the sale or other disposition of "foreclosure
property" that is held primarily for sale to customers in the ordinary course of
business or (ii) other nonqualifying income from foreclosure property, it will
be subject to tax at the highest corporate rate on such income. Fourth, if the
Company has net income from prohibited transactions (which are, in general,
certain sales or other dispositions of property (other than foreclosure
property) held primarily for sale to customers in the ordinary course of
business), such income will be subject to a 100% tax. Fifth, if the Company
should fail to satisfy the 75% gross income test or the 95% gross income test
(as discussed below), and has nonetheless maintained its qualification as a REIT
because certain other requirements have been met, it will be subject to a 100%
tax on the net income attributable to the greater of the amount by which the
Company fails the 75% or 95% gross income test. Sixth, if the Company should
fail to distribute during each calendar year at least the sum of (i) 85% of its
REIT ordinary income for such year, (ii) 95% of its REIT capital gain net income
for such year, and (iii) any undistributed taxable income from prior periods,
the Company would be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. Seventh, if the Company
acquires any asset from a C corporation (i.e., a corporation generally subject
to full corporate-level tax) in a transaction in which the basis of the asset in
the Company's hands is determined by reference to the basis of the asset (or any
other asset) in the hands of the C corporation and the Company recognizes gain
on the disposition of such asset during the 10-year period beginning on the date
on which such asset was acquired by the Company, then the Company would be
taxable to the extent of such asset's "built-in-gain." Such taxation of the
Company on "built-in gains" will be applicable to gain on the disposition of
assets received by the Company upon the liquidation of Kahler and its
subsidiaries.
REQUIREMENTS FOR QUALIFICATION
Earnings and Profits
In order to maintain its REIT status, any earnings and profits that the
Company acquires as a result of the Kahler Acquisition must be distributed on or
before December 31, 1997. The Company has received a certification from the
auditors for Kahler that, subject to certain assumptions set forth therein, the
pre-acquisition earnings and profits of Kahler is $33 million, and the Company's
auditors have reviewed and approved this certification and the workpapers of
Kahler's auditors. The opinion of Brobeck, Phleger & Harrison LLP assumes this
certification is correct, a factual question upon which counsel expresses no
opinion. However, the certification is not binding on the IRS, and there can be
no assurance that it will not be successfully challenged.
In addition, the Company intends to apply to the IRS for a private letter
ruling confirming that Kahler's pre-acquisition cash distribution will be
treated as a "dividend" for tax purposes, and thus will eliminate Kahler's
pre-acquisition earnings and profits. Based on a pre-submission conference held
with the IRS, the Company anticipates the receipt of a favorable private letter
ruling from the IRS prior to December 31, 1997. The Company has committed to
make an extraordinary distribution to its shareholders by December 31, 1997, in
an amount intended to eliminate Kahler's pre-acquisition earnings and profits,
if a favorable ruling is not received prior to that date.
Based on the foregoing, the Company anticipates that it will have no
non-REIT earnings and profits as of the end of its 1997 taxable year. In the
event, however, that the Company has such non-REIT earnings and profits, it
would be disqualified as a REIT in 1997 and thereafter.
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Other Requirements
The Code defines a REIT as a corporation, trust or association (i) that is
managed by one or more trustees or directors; (ii) the beneficial ownership of
which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) not
more than 50% in value of the outstanding shares of which is owned, directly or
indirectly, by five or fewer individuals (as defined in the Code to include
certain entities) during the last half of each taxable year (the "5/50 Rule");
(vii) that makes an election to be a REIT (or has made such election for a
previous taxable year) and satisfies all relevant filing and other
administrative requirements established by the Service that must be met in order
to elect and to maintain REIT status; (viii) that uses a calendar year for
federal income tax purposes and complies with the recordkeeping requirements of
the Code and Treasury Regulations promulgated thereunder; and (ix) that meets
certain other tests, described below, regarding the nature of its income and
assets. The Company's Articles of Incorporation provide for restrictions
regarding transfer of the Company's stock that are intended to assist the
Company in continuing to satisfy the share ownership requirements described in
(v) and (vi) above. See "Description of Common Stock and Preferred Stock --
Restrictions on Ownership of Common Stock or Preferred Stock."
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT as in the partnership for purposes of Section 856 of the Code,
including satisfying the gross income and asset tests, described below. Thus,
assuming the Partnership is classified as a partnership rather than as a
corporation for tax purposes, the Company's proportionate share of the assets,
liabilities and items of income of the Partnership will be treated as assets and
gross income of the Company for purposes of applying the requirements described
herein.
Income Tests
In order for the Company to maintain its qualification as a REIT, there are
three requirements relating to the Company's gross income that must be satisfied
annually. First, at least 75% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must consist of
defined types of income derived directly or indirectly from investments relating
to real property or mortgages on real property (including "rents from real
property" and, in certain circumstances, interest) or temporary investment
income. Second, at least 95% of the Company's gross income (excluding gross
income from prohibited transactions) for each taxable year must be derived from
such real property or temporary investments, and from dividends, other types of
interest, and gain from the sale or disposition of stock or securities, or from
any combination of the foregoing. Third, not more that 30% of the Company's
gross income (including gross income from prohibited transactions) for each
taxable year may be gain from the sale or other disposition of (i) stock or
securities held for less than one year, (ii) dealer property that is not
foreclosure property, and (iii) certain real property held for less than four
years (apart from involuntary conversions and sales of foreclosure property).
The 30% test will not apply in taxable years after 1997. The specific
application of these tests to the Company is discussed below.
Rents received by the Company will qualify as "rents from real property" in
satisfying the gross income requirements for a REIT described above only if
several conditions are met. First, the amount of rent must not be based in whole
or in part on the income or profits of any person. However, an amount received
or accrued generally will not be excluded from the term "rents from real
property" solely by reason of being based on a fixed percentage or percentages
of receipts or sales. Second, rents received from a tenant will not qualify as
"rents from real property" in satisfying the gross income tests if the Company,
or an owner of 10% or more of the Company, directly or constructively owns 10%
or more of such tenant (a "Related Party Tenant"). Third, if rent attributable
to personal property leased in connection with a lease of real property is
greater than 15% of the total rent received under the lease, then the portion of
rent attributable to such personal property will not qualify as "rents from real
property." Finally, for rents received to qualify as "rents from real property,"
the
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Company generally must not operate or manage the property or furnish or render
services to the tenants of such property, other than through an "independent
contractor" who is adequately compensated and from whom the Company derives no
revenue. The "independent contractor" requirement, however, does not apply to
the extent the services provided by the Company are "usually or customarily
rendered" in connection with the rental of space for occupancy only and are not
otherwise considered "rendered to the occupant."
Pursuant to percentage leases (the "Percentage Leases"), Sunstone Hotel
Properties, Inc., a Colorado corporation (the "Lessee") has leased from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the hotels for a 10-year period. The Percentage Leases provide that
the Lessee is obligated to pay to the Partnership (i) the greater of base rent
("Base Rent") or percentage rent ("Percentage Rent," and with Base Rent,
collectively, the "Rents") and (ii) certain other additional charges (the
"Additional Charges"). The Percentage Rent is calculated by multiplying fixed
percentages by the room revenues for each of the hotels in excess of certain
levels. Both the Base Rent and the threshold room revenue amount in each
Percentage Rent formula will be adjusted for inflation. The adjustment will be
calculated at the beginning of each calendar year based on the change in the CPI
during the prior calendar year. The Base Rent accrues and is required to be paid
monthly and the Percentage Rent (if any) accrues and is required to be paid
quarterly. In order for the Base Rent, the Percentage Rent and the Additional
Charges to constitute "rents from real property," the Percentage Leases must be
respected as true leases for federal income tax purposes and not treated as
service contracts, joint ventures or some other type of arrangement.
Brobeck, Phleger & Harrison LLP will render an opinion that the current
Percentage Leases and the Percentage Leases with respect to the Kahler Hotels
will be treated as true leases for federal income tax purposes. Such opinion
will be based, in part, on the following facts and representations of the
Company described below: (i) the Partnership and the Lessee intend for their
relationship to be that of a lessor and lessee and such relationship will be
documented by lease agreements, (ii) the Lessee will have the right to exclusive
possession and use and quiet enjoyment of the hotels during the term of the
Percentage Leases, (iii) the Lessee will bear the cost of, and be responsible
for, day-to-day maintenance and repair of the hotels, other than the cost of
certain capital expenditures and will dictate how the hotels are operated,
maintained and improved, (iv) the Lessee will bear all of the costs and expenses
of operating the hotels (including the cost of any inventory used in their
operation) during the term of the Percentage Leases (other than real and
personal property taxes, insurance (other than workers' compensation insurance)
and the cost of repairing, replacing or refurbishing furniture, fixtures and
equipment, to the extent such costs do not exceed the amounts to be made
available to the Lessee for such costs by the Partnership under each Percentage
Lease), (v) the Lessee will benefit from any savings in the costs of operating
the hotels during the term of the Percentage Leases, (vi) in the event of damage
or destruction to a hotel, the Lessee will be at economic risk because it will
be obligated either (A) to restore the property to its prior condition, in which
event it will bear all costs of such restoration in excess of any insurance
proceeds or (B) to purchase the hotel for an amount generally equal to the fair
market value of the Property, less any insurance proceeds, (vii) the Lessee will
indemnify the Partnership against all liabilities imposed on the Partnership
during the term of the Percentage Leases by reason of (A) injury to persons or
damage to property occurring at the hotels or (B) the Lessee's use, management,
maintenance or repair of the hotels, and (viii) the Lessee will be obligated to
pay substantial fixed rent for the period of use of the hotels and (ix) the
Lessee stands to incur substantial losses (or reap substantial gains) depending
on how successfully it operates the hotels.
Investors should be aware that there are no controlling Treasury
Regulations, published rulings, or judicial decisions involving leases with
terms substantially the same as the Percentage Leases that discuss whether such
leases constitute true leases for federal income tax purposes. Counsel's opinion
regarding the Percentage Leases is not binding on the Service or the courts.
Thus, counsel can provide no assurance that the Service will not assert
successfully a contrary position. If the Percentage Leases are recharacterized
as service contracts or partnership agreements, rather than true leases, part or
all of the payments that the Partnership receives from the Lessee would not be
considered rent or would not otherwise satisfy the various requirements for
qualification as "rents from real property." In that case, the Company would not
be able to satisfy either the 75% or 95% gross income tests and, as a result,
would lose its REIT status.
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As stated above, in order for the Rents to constitute "rents from real
property," the Rents attributable to personal property leased in connection with
the lease of the real properties comprising a hotel must not be greater than 15%
of the Rents received under the Percentage Lease. The portion of the Rents
attributable to the personal property in a hotel is the amount that bears the
same ratio to total Rent for the taxable year as the average of the adjusted
bases of the personal property in the hotel at the beginning and at the end of
the taxable year bears to the average of the aggregate adjusted bases of both
the real and personal property comprising the hotel at the beginning and at the
end of such taxable year (the "Adjusted Basis Ratio"). With respect to each
hotel, the Company has determined and represented to counsel that the adjusted
tax bases of the personal property in such hotel has, at all times while the
Partnership has owned such hotel, been less than 15% of the adjusted tax bases
of both the real and personal property comprising such hotel. In addition, Ernst
& Young, LLP has provided an analysis confirming compliance with the 15% test.
Furthermore, the Partnership has represented that in no event will it acquire
additional personal property for any hotel to the extent that such acquisition
would cause the adjusted tax bases of such personal property to exceed 15% of
the total adjusted tax bases of the real and personal property comprising such
hotel. There can be no firm assurance, however, that the Company will not fail
the 15% adjusted basis ratio test described above as to one or more of the
Percentage Leases, which in turn potentially could cause it to fail to satisfy
the 95% or 75% gross income test and thus lose its REIT status.
Another requirement for qualification of the Rents as "rents from real
property" is that the Percentage Rent must not be based in whole or in part on
the income or profits of any person. The Percentage Rent, however, will qualify
as "rents from real property" if it is based on percentages of receipts or sales
and the percentages (i) are fixed at the time the Percentage Leases are entered
into, (ii) are not renegotiated during the term of the Percentage Leases in a
manner that has the effect of basing Percentage Rent on income or profits, and
(iii) conform with normal business practice. More generally, the Percentage Rent
will not qualify as "rents from real property" if, considering the Percentage
Leases and all the surrounding circumstances, the arrangement does not conform
with normal business practice, but is in reality used as a means of basing the
Percentage Rent on income or profits. Counsel's opinion assumes, based on
representations of the Company, that (i) the Percentage Rent will be based at
all times revenues from the hotels that are established in the Percentage
Leases, (ii) the Percentage Rent has not and will not be renegotiated during the
terms of the Percentage Leases in a manner that has the effect of basing the
Percentage Rent on income or profits and (ii) the Percentage Leases and the
Percentage Rent conform with normal business practice. Furthermore, the Company
has represented that, with respect to other hotels that it acquires in the
future, it will not charge rent for any property that is based in whole or in
part on the income or profits of any person (except by reason of being based on
a fixed percentage of gross revenues, as described above). In the event that any
of the foregoing representations of the Company is or has been inaccurate, the
Company could fail or cease to qualify as a REIT.
A third requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, directly or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide that, if
10% or more in value of the shares of the Company are owned, directly or
indirectly, by or for any person, the Company is considered as owning the shares
of the Lessee owned, directly or indirectly, by or for such person. The Company
has represented that it has not and will not at any time directly or indirectly
own any stock of the Lessee. However, because Mr. Alter and Mr. Biederman each
owns more than 10% of the stock of the Lessee, the Company would be deemed to
own all of the stock of the Lessee if either Mr. Alter or Mr. Biederman at any
time owns, directly, indirectly or constructively, 10% or more in value of the
shares of the Company's stock. The Partnership Agreement provides that a
redeeming Limited Partner will receive cash, rather than shares of Common Stock,
at the election of the Company or if the acquisition of shares of Common Stock
by such partner would result in such partner or any other person owning,
directly or constructively, more than 9.8% of the Company for purposes of the
related party tenant rule. Thus, neither Mr. Alter nor Mr. Biederman will ever
be entitled to acquire a 10% interest in the Company, and the Company should
never own, directly or constructively, 10% of more of the Lessee. Furthermore,
the Company has represented that, with respect to other hotels that it acquires
in the future, it will not rent any property to a related party tenant.
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A fourth requirement for qualification of the Rents as "rents from real
property" is that the Company cannot furnish or render noncustomary services to
the Lessee (or tenants of the hotels), or manage or operate the hotels or any
leased properties, other than through an independent contractor who is
adequately compensated and from whom the Company itself does not derive or
receive any income. Provided that the Percentage Leases are respected as true
leases, the Company should satisfy that requirement because neither the Company
nor the Partnership will be performing any services other than customary ones
for the Lessee. The Company has also represented that, with respect to other
hotels that it acquires in the future, it will not perform noncustomary services
with respect to the tenant of the property and will not be managing or operating
the hotels or such other hotels. As described above, if the Percentage Leases
are recharacterized as service contracts or partnership agreements, the Rents
likely would be disqualified as "rents from real property" because the Company
would be considered to furnish or render nonqualifying services to the occupants
of the hotels and to manage or operate the hotels other than through an
independent contractor who is adequately compensated and from whom the Company
derives or receives no income.
If the Rents do not qualify as "rents from real property" because the rents
attributable to personal property exceed 15% of the total Rents for a taxable
year, the portion of the Rents that is attributable to personal property will
not be qualifying income for purposes of either the 75% or 95% gross income
tests. The Company would lose its REIT status in this event only if the Rents
attributable to personal property (plus any other nonqualifying income) during a
taxable year exceed 5% of the Company's gross income during the year. If,
however, the Rents do not qualify as "rents from real property" because either
(i) the Percentage Rent is considered based on income or profits of the Lessee,
(ii) the Company owns, directly or constructively, 10% or more of the Lessee, or
(iii) the Company furnishes noncustomary services to the Lessee or tenants of
the hotels, or manages or operates the hotels other than through a qualifying
independent contractor, none of the Rents would qualify as "rents from real
property." In that case, the Company would lose its REIT status because it would
be unable to satisfy either the 75% or 95% gross income tests.
In addition to the Rents, the Lessee is required to pay to the Partnership
the Additional Charges. To the extent that the Additional Charges represent
either (i) reimbursements of amounts paid by the Partnership to third parties
that the Lessee is obligated to bear or (ii) penalties for nonpayment or late
payment of such amounts, the Additional Charges should qualify as "rents from
real property." To the extent, however, that the Additional Charges represent
interest that is accrued on the late payment of the Rents or the Additional
Charges, the Additional Charges should not qualify as "rents from real
property," but instead should be treated as interest that qualifies for the 95%
gross income test.
Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT for
taxable years through 1997. In addition, the net income from that transaction is
subject to a 100% tax. The term "prohibited transaction" generally includes a
sale or other disposition of property (other than foreclosure property) that is
held primarily for sale to customers in the ordinary course of a trade or
business. The Company and the Partnership believe that no asset owned by the
Company or the Partnership has or will be held for sale to customers in the
ordinary course of business of the Company or the Partnership. Whether property
is held "primarily for sale to customers in the ordinary course of a trade or
business" will depend, however, on the facts and circumstances from time to
time. The Company and the Partnership will attempt to comply with the terms of
safe-harbor provisions in the Code prescribing when asset sales will not be
characterized as prohibited transactions. Complete assurance cannot be given,
however, that the Company or the Partnership can comply with the safe-harbor
provisions of the Code or avoid owning property that may be characterized as
property held "primarily for sale to customers in the ordinary course of a trade
or business."
If the Lessee defaults on its obligations under a Percentage Lease for a
hotel, the Company terminates the Lessee's leasehold interest, and the Company
is unable to find a qualifying replacement lessee for such hotel within 90 days
of such termination, gross income from hotel operations conducted by the Company
from such hotel would cease to qualify for the 75% and 95% gross income tests.
In such event, the Company likely would be unable to satisfy the 75% and 95%
gross income tests and, thus, would fail to qualify as a REIT.
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If the Company fails to satisfy one or both of the 75% or 95% gross income
tests for any taxable year, it may nevertheless qualify as a REIT for such year
if it is entitled to relief under certain provisions of the Code. Those relief
provisions will be generally available if the Company's failure to meet such
tests is due to reasonable cause and not due to willful neglect, the Company
attaches a schedule of the sources of its income to its return, and any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Company would be entitled to the benefit of these relief provisions. As
discussed above in "-- Taxation of the Company," even if those relief provisions
apply, a 100% tax would be imposed with respect to the amount by which it fails
the 75% or 95% gross income tests. No such relief is available for violations of
the 30% income test, which is applicable for taxable years through 1997.
Asset Tests
The Company, at the close of each quarter of its taxable year, also must
satisfy two tests relating to the nature of its assets. First, at least 75% of
the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock or
debt instruments during the one-year period following the Company's receipt of
such capital. The term "real estate assets" includes interests in real property,
interests in mortgages on real property to the extent the mortgage balance does
not exceed the value of the associated real property, and shares of other REITs.
For purposes of the 75% asset test, the term "interest in real property"
includes an interest in land and improvements thereon, such as buildings or
other inherently permanent structures (including items that are structural
components of such buildings or structures), a leasehold in real property, and
an option to acquire real property (or a leasehold in real property). Second, of
the investments not included in the 75% asset class, the value of any one
issuer's securities owned by the Company may not exceed 5% of the value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities (except for its ownership interest in the
stock of a qualified REIT subsidiary).
For purposes of the asset requirements, the Company will be deemed to own
its proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership, assuming that the Partnership is
treated as a partnership and not as a corporation for tax purposes. The Company
has represented that at all times since the commencement of its taxable year
ended December 31, 1995, (i) at least 75% of the value of its total assets were
represented by assets qualifying under the 75% asset test, and (ii) it has not
owned any securities that do not satisfy the 75% asset test. The Company has
represented that it has not and will not acquire or dispose, or cause the
Partnership to acquire or dispose, of assets during 1995, 1996, 1997 or in later
years in a way that would cause it to violate the asset tests for REIT status.
Distribution Requirements
The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (i) the sum of (A) 95% of its "REIT taxable income"(computed
without regard to the dividends paid deduction and its net capital gain) and (B)
95% of the net income (after tax), if any, from foreclosure property, minus (ii)
the sum of certain items of noncash income. Such distributions must be paid in
the taxable year to which they relate, or in the following taxable year if
declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after such declaration. To
the extent that the Company does not distribute all of its net capital gain or
distributes at least 95%, but less than 100%, of its "REIT taxable income," as
adjusted, it will be subject to tax thereon at regular ordinary and capital
gains corporate tax rates. Furthermore, if the Company should fail to distribute
during each calendar year at least the sum of (i) 85% of its REIT ordinary
income for such year, (ii) 95% of its REIT capital gain income for such year,
and (iii) any undistributed taxable income from prior periods, the Company would
be subject to a 4% nondeductible excise tax on the excess of such required
distribution over the amounts actually distributed. For its taxable years ended
December 31, 1995 and 1996, the Company made distributions sufficient to satisfy
the foregoing distribution requirements. The Company intends in the future to
make timely distributions sufficient to satisfy all annual
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distribution requirements. However, there can be no assurance that the Company
will at all times have sufficient available cash to satisfy such distribution
requirements.
Recordkeeping Requirement
Pursuant to applicable Treasury Regulations, in order to qualify as a REIT,
the Company must maintain certain records and request on an annual basis certain
information from its shareholders designed to disclose the actual ownership of
its outstanding shares. The Company has represented that it complied with these
requirements on a timely basis for its taxable years ended December 31, 1995 and
1996 and intends to comply with such requirements in the future. Counsel will
not monitor such compliance by the Company. For taxable years through 1997, the
penalty for failure to obtain information as to actual ownership is
disqualification as a REIT for 1998 and thereafter, monetary penalties of up to
$50,000 apply.
Anti-Abuse Regulations
The United States Treasury Department recently issued Treasury Regulations
that authorize the Service, in certain "abusive" transactions involving
partnerships, to disregard the form of the transaction and recast it for federal
tax purposes as the Service deems appropriate (the "Anti-Abuse Regulations").
The Anti-Abuse Regulations would apply where a partnership is formed or utilized
in connection with a transaction (or series of related transactions) with a
principal purpose of substantially reducing the present value of the partners'
aggregate federal tax liability in a manner inconsistent with the intent of the
partnership provisions of the Code. Counsel believes that the Anti-Abuse
Regulations will not have any adverse impact on the Company's ability to qualify
as a REIT. However, because the Anti-Abuse Regulations are extremely broad in
scope and would be applied based on an analysis of all of the facts and
circumstances, counsel can give no assurance that the Service will not
successfully apply the Anti-Abuse Regulations to the Company.
FAILURE TO QUALIFY
If the Company fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the shareholders in any year in which
the Company fails to qualify will not be deductible by the Company nor will they
be required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to shareholders will be taxable as
ordinary income and, subject to certain limitations of the Code, corporate
distributees may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company also will be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT. It is not possible to
state whether in all circumstances the Company would be entitled to such
statutory relief.
TAXATION OF TAXABLE SHAREHOLDERS
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such shareholders as ordinary income and will not be eligible for the
dividends received deduction generally available to corporations. Distributions
that are designated as capital gain dividends will be taxed as long-term capital
gains (to the extent they do not exceed the Company's actual net capital gain
for the taxable year) without regard to the period for which the shareholder has
held his shares of Common Stock or Preferred Stock. However, corporate
shareholders may be required to treat up to 20% of certain capital gain
dividends as ordinary income. Distributions in excess of current and accumulated
earnings and profits will not be taxable to a shareholder to the extent that
they do not exceed the adjusted basis of the shareholder's Common Stock or
Preferred Stock, but rather will reduce the adjusted basis of such shares. To
the extent that distributions in excess of current and accumulated earnings and
profits exceed the adjusted basis of a shareholder's Common Stock or Preferred
Stock, such distributions will be included in income as capital gain assuming
the shares of Common Stock or Preferred Stock are capital assets in the hands of
the shareholder. In addition, any distribution declared by the Company in
October, November, or December of any year and
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payable to a shareholder of record on a specified date in any such month shall
be treated as both paid by the Company and received by the shareholder on
December 31 of such year, provided that the distribution is actually paid by the
Company during January of the following calendar year.
For a taxable year of the Company commencing in 1998 and thereafter, a
Company shareholder at the close of the taxable year must include, in computing
his or her long-term capital gains for his or her taxable year in which the last
day of the Company's taxable year falls, the amount (if any) of undistributed
net capital gains of the Company that the Company designates by written notice
to the shareholder ("Designated Retained Capital Gains"). The shareholder will
be deemed to have paid his or her share of the taxes paid by the Company on the
Designated Retained Capital Gains. The shareholder's basis in the Company's
shares will be increased by the amount of the Designated Retained Capital Gains
in excess of the taxes deemed paid by the shareholder.
Shareholders may not include in their individual income tax returns any net
operating losses or capital losses of the Company. Instead, such losses would be
carried over by the Company for potential offset against its future income
(subject to certain limitations). Taxable distributions from the Company and
gain from the disposition of the Common Stock or Preferred Stock will not be
treated as passive activity income and, therefore, shareholders generally will
not be able to apply any "passive activity losses" (such as losses from certain
types of limited partnerships in which the shareholder is a limited partner)
against such income. In addition, taxable distributions from the Company and
gain from the disposition of shares of Common Stock or Preferred Stock generally
will be treated as investment income for purposes of the investment interest
limitations. The Company will notify shareholders after the close of the
Company's taxable year as to the portions of the distributions attributable to
that year that constitute ordinary income, return of capital, and capital gain.
TAXATION OF SHAREHOLDERS ON THE DISPOSITION OF THE COMMON STOCK OR PREFERRED
STOCK
In general, any gain or loss realized upon a taxable disposition of the
Common Stock or Preferred Stock by a shareholder who is not a dealer in
securities will be treated as capital gain or loss. In the case of individuals,
the maximum rate of federal income tax applicable to capital gains is 28% in the
case of assets held for more than one year but 18 months or less and 20% in the
case of assets held for more than 18 months. No preferential rate of capital
gains tax applies in the case of corporations. However, any loss upon a sale or
exchange of shares of Common Stock or Preferred Stock by a shareholder who has
held such shares for six months or less (after applying certain holding period
rules), will be treated as a long-term capital loss to the extent of
distributions from the Company and Designated Retained Capital Gains required to
be treated by such shareholder as long-term capital gain. All or a portion of
any loss realized upon a taxable disposition of the shares of Common Stock or
Preferred Stock may be disallowed if the shares of Common Stock or Preferred
Stock are purchased within 30 days before or after the disposition.
INFORMATION REPORTING REQUIREMENTS AND BACKUP WITHHOLDING
The Company will generally report to its shareholders and the Service the
amount of distributions paid during each calendar year, and the amount of tax
withheld, if any. Under the backup withholding rules, a shareholder may be
subject to backup withholding at the rate of 31% with respect to distributions
paid unless such holder (i) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with the applicable requirements of the
backup withholding rules. A shareholder who does not provide the Company with
his correct taxpayer identification number also may be subject to penalties
imposed by the Service. Any amount paid as backup withholding will be creditable
against the shareholder's income tax liability. In addition, the Company may be
required to withhold a portion of capital gain distributions to any shareholders
who fail to certify their nonforeign status to the Company.
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TAXATION OF TAX-EXEMPT SHAREHOLDERS
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts ("Exempt Organizations"),
generally are exempt from federal income taxation. However, they are subject to
taxation on their unrelated business taxable income ("UBTI"). While many
investments in real estate generate UBTI, the Service has issued a published
ruling that dividend distributions by a REIT to an exempt employee pension trust
do not constitute UBTI, provided that the shares of the REIT are not otherwise
used in an unrelated trade or business of the exempt employee pension trust.
Thus, amounts distributed by the Company to Exempt Organizations generally
should not constitute UBTI. However, if an Exempt Organization finances its
acquisition of the Common Stock with debt, a portion of its income from the
Company will constitute UBTI pursuant to the "debt-financed property" rules.
Furthermore, social clubs, voluntary employee benefit associations, supplemental
unemployment benefit trusts, and qualified group legal services plans that are
exempt from taxation under paragraphs (7), (9), (17), and (20), respectively, of
Code Section 501(c) are subject to different UBTI rules, which generally will
require them to characterize distributions from the Company as UBTI. In
addition, in certain circumstances a pension trust that owns more than 10% of
the Company's shares is required to treat a percentage of the dividends from the
Company as UBTI (the "UBTI Percentage"). The UBTI Percentage is the gross income
derived from an unrelated trade or business (determined as if the Company were a
pension trust) divided by the gross income of the Company for the year in which
the dividends are paid. The UBTI rule applies only if (i) the UBTI Percentage is
at least 5%, (ii) the Company qualifies as a REIT by reason of the modification
of the 5/50 Rule that allows the beneficiaries of the pension trust to be
treated as holding shares of the Company in proportion to their actuarial
interests in the pension trust, and (iii) either (A) one pension trust owns more
than 25% of the value of the Company's shares or (B) a group of pension trusts
individually holding more than 10% of the value of the Company's shares
collectively own more than 50% of the value of the Company's shares.
While an investment in the Company by an Exempt Organization generally is
not expected to result in UBTI except in the circumstances described in the
preceding paragraph, any UBTI that does arise from such an investment will be
combined with all other UBTI of the Exempt Organization for a taxable year. Any
net UBTI will be subject to tax. If the gross income taken into account in
computing UBTI exceeds $1,000, the Exempt Organization is obligated to file a
tax return for such year on IRS Form 990-T. Neither the Company, the Board of
Directors, nor any of their Affiliates expects to undertake the preparation or
filing of IRS Form 990-T for any Exempt Organization in connection with an
investment by such Exempt Organization in the Offered Securities.
OTHER TAX CONSEQUENCES
State or Local Taxes
The Company, the Partnership, or the Company's shareholders may be subject
to state or local taxation in various state or local jurisdictions, including
those in which it or they own property, transact business, or reside. The state
and local tax treatment of the Company and its shareholders may not conform to
the federal income tax consequences discussed above. CONSEQUENTLY, PROSPECTIVE
SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE EFFECT OF STATE
AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.
Dividend Reinvestment Program
Under the Company's Dividend Reinvestment and Stock Purchase Plan,
shareholders participating in the program will be deemed to have received the
gross amount of any cash distributions which would have been paid by the Company
to such shareholders had they not elected to participate. These deemed
distributions will be treated as actual distributions from the Company to the
participating shareholders and will retain the character and tax effect
applicable to distributions from the Company generally. See "-- Taxation of
Shareholders." Shares of Common Stock received under the program will have a
holding period beginning with the day after purchase, and a tax basis equal to
the gross amount of the deemed distribution.
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TAX ASPECTS OF THE PARTNERSHIP
Classification as a Partnership
The Company will be entitled to include in its income its distributive
share of the Partnership's income and to deduct its distributive share of the
Partnership's losses only if the Partnership is classified for federal income
tax purposes as a partnership rather than as association taxable as a
corporation. The Company has received an opinion of its counsel, Brobeck,
Phleger & Harrison LLP, that the Partnership will be treated as a partnership
for Federal income tax purposes. This opinion was based on the provisions of the
Partnership Agreement and certain factual representations of the Company and the
Partnership. No assurance can be given that the Service will not challenge the
status of the Partnership as a partnership for federal income tax purposes. If
such challenge were sustained by a court, the Partnership would be treated as a
corporation for federal income tax purposes.
Under Section 7704 of the Code, a partnership is treated as a corporation
for federal income tax purposes if it is a "publicly traded partnership" (except
in situations in which 90% or more of the partnership's gross income is of a
specified type). A partnership is deemed to be publicly traded if its interests
are either (i) traded on an established securities market, or (ii) readily
tradable on a secondary market (or the substantial equivalent thereof). While
the Partnership Units will not be traded on an established securities market,
they could possibly be deemed to be traded on a secondary market or its
equivalent due to the redemption rights enabling the partners to dispose of
their Units.
The Treasury Department has issued regulations (the "PTP Regulations")
governing the classification of partnerships under Section 7704. These
regulations provide that the classification of partnerships is generally based
on a facts and circumstances analysis. However, the regulations also provide
limited "safe harbors" which preclude publicly traded partnership status.
Pursuant to one of those safe harbors, interests in a partnership will not be
treated as readily tradable on a secondary market or the substantial equivalent
thereof if (i) all interests in the partnership were issued in a transaction (or
transactions) that was not required to be registered under the Securities Act,
and (ii) the partnership does not have more than 100 partners at any time during
the partnership's taxable year. In determining the number of partners in a
partnership for this purpose, a person owning an interest in a flowthrough
entity (i.e., a partnership, grantor trust, or S corporation) that owns an
interest in the partnership is treated as a partner in such partnership only if
(x) substantially all of the value of the person's interest in the flow-through
entity is attributable to the flow-through entity's interest (direct or
indirect) in the partnership and (y) a principal purpose of the use of the
tiered arrangement is to permit the partnership to satisfy the 100-partner
limitation. Furthermore, pursuant to Notice 88-75 issued by the Internal Revenue
Service, through the year 2005, an existing partnership may qualify for
non-publicly traded status if it has less than 500 partners (looking through to
the ultimate owners in the case of flow-through entities), does not issue any
Units registered under the Securities Act and does not enter into a substantial
new line of business.
The Partnership currently has less than 100 actual partners and less than
500 partners calculated on a "lookthrough" basis. The Partnership has not issued
any Units required to be registered under the Securities Act. Thus, the
Partnership presently qualifies for the safe harbors provided in Notice 88-75
and the PTP Regulations. However, there is no assurance that the Partnership
will at all times in the future be able to avoid treatment as a publicly traded
partnership.
Even if the Partnership were ever to be classified as a publicly traded
partnership, it would nevertheless be treated as a partnership for federal
income tax purposes (rather than an association taxable as a corporation) if at
least 90% of its gross income in each taxable year (commencing with the year in
which it is treated as a publicly traded partnership) consists of "qualifying
income" within the meaning of Section 7704(c)(2) of the Code (including
interest, dividends, "real property rents" and gains from the disposition of
real property). The Partnership has represented that, if in any taxable year the
Partnership falls outside of an applicable safe harbor from publicly traded
partnership status, it will satisfy the gross income test set forth in Section
7704(c)(2) of the Code in that taxable year and each subsequent taxable year.
Among other things, this will require that the President of the Company, Mr.
Robert A. Alter (or any other shareholder of the Lessee who owns at least 10% of
the stock of the Lessee) own less than a 5% interest in the Partnership in the
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particular taxable year. Counsel's opinion as to the classification of the
Partnership is based on an assumption that the Partnership will either (i)
continue to fall within a safe harbor from publicly traded partnership status,
or (ii) if the Partnership is ever treated as a publicly traded partnership, it
will satisfy the qualifying income test of Section 7704(c)(2) of the Code in the
taxable year in which such treatment commences and all years thereafter.
If for any reason the Partnership were taxable as a corporation, rather
than as a partnership, for federal income tax purposes, the Company would not be
able to satisfy the income and asset requirements for REIT status. Thus the
Company would be subject to tax as a regular corporation and would not receive a
deduction for dividends paid to its shareholders. See "-- Requirements for
Qualification -- Income Tests" and "-- Requirements for Qualification -- Asset
Tests." In addition, any change in the Partnership's status for tax purposes
might be treated as a taxable event, in which case the Company might incur a tax
liability without any related cash distribution. Further, items of income and
deduction of the Partnership would not pass through to its partners, and its
partners would be treated as shareholders for tax purposes. Consequently, the
Partnership would be required to pay income tax at corporate tax rates on its
net income, and distributions to its partners would constitute dividends that
would not be deductible in computing the Partnership's taxable income.
The following discussion assumes that the Partnership will be treated as a
partnership for federal income tax purposes.
Income Taxation of the Partnership and Its Partners
Partners, Not the Partnership, Subject to Tax. A partnership is not a
taxable entity for federal income tax purposes. Rather, the Company will be
required to take into account its allocable share of the Partnership's income,
gains, losses, deductions, and credits for any taxable year of the Partnership
ending within or with the taxable year of the Company, without regard to whether
the Company has received or will receive any distribution from the Partnership.
Partnership Allocations. Although a partnership agreement generally will
determine the allocation of income and losses among partners, such allocations
will be disregarded for tax purposes under Section 704(b) of the Code if they do
not comply with the provisions of Section 704(b) of the Code and the Treasury
Regulations promulgated thereunder. If an allocation is not recognized for
federal income tax purposes, the item subject to the allocation will be
reallocated in accordance with the partners' interests in the partnership, which
will be determined by taking into account all of the facts and circumstances
relating to the economic arrangement of the partners with respect to such item.
Brobeck Phleger & Harrison is of the opinion that the allocations of taxable
income and loss set forth in the Partnership Agreement comply with the
requirements of Section 704(b) of the Code and the Treasury Regulations
promulgated thereunder.
Tax Allocations With Respect to Contributed Properties. Pursuant to Section
704(c) of the Code, income, gain, loss, and deduction attributable to
appreciated or depreciated property that is contributed to a partnership in
exchange for an interest in the partnership must be allocated for federal income
tax purposes in a manner such that the contributor is charged with, or benefits
from, the unrealized gain or unrealized loss associated with the property at the
time of the contribution. The amount of such unrealized gain or unrealized loss
is generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution. The Treasury Department has issued
regulations requiring partnerships to use a "reasonable method" for allocating
items affected by Section 704(c) of the Code and outlining certain reasonable
allocation methods.
Under the Partnership Agreement, depreciation or amortization deductions of
the Partnership generally will be allocated among the partners in accordance
with their respective interests in the Partnership, except to the extent that
the Partnership is required under Code Section 704(c) to use a method for
allocating tax depreciation deductions attributable to contributed properties
that results in the Company receiving a disproportionately large share of such
deductions. In addition, gain on sale of a hotel will be specially allocated to
the Limited Partners (other than the Company as a Limited Partner) to the extent
of any "built-in" gain with respect to such hotel for federal income tax
purposes.
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Basis in Partnership Interest. The Company's adjusted tax basis in its
Partnership interest in the Partnership generally will be equal to (i) the
amount of cash and the basis of any other property contributed to the
Partnership by the Company, (ii) increased by (A) its allocable share of the
Partnership's income and (B) its allocable share of indebtedness of the
Partnership, and (iii) reduced, but not below zero, by (A) the Company's
allocable share of the Partnership's loss and (B) the amount of cash distributed
to the Company (including deemed distributions as a result of reductions in the
Company's allocable share of indebtedness of the Partnership).
Treatment of Partnership Distributions. Partnership distributions to the
Company will not generally constitute taxable distributions. However, to the
extent that partnership distributions, or any decrease in the Company's share of
the indebtedness of the Partnership (such decrease being considered a
constructive cash distribution to the partners), exceeds the Company's adjusted
tax basis in its Partnership interest, such distributions (including such
constructive distributions) would constitute taxable income to the Company. Such
distributions and constructive distributions normally would be characterized as
capital gain.
Sale of the Partnership's Property. Generally, any taxable gain realized by
the Partnership on the sale of property by the Partnership held for more than
one year will be long-term capital gain, except for any portion of such gain
that is treated as depreciation or cost recovery recapture. Any taxable gain
recognized by the Partnership on the disposition of any other hotels originally
contributed to the Partnership by the Limited Partners other than the Company
will be allocated first to the Limited Partners (other than the Company as a
Limited Partner) under Section 704(c) of the Code to the extent of their
"built-in gain" on those hotels for federal income tax purposes. The Limited
Partners' "built-in gain" on such hotels sold will equal the excess of the
Limited Partners' proportionate share of the book value of those hotels over the
Limited Partners' tax basis allocable to those hotels at the time of the sale.
Any remaining taxable gain recognized by the Partnership on the disposition of
the hotels will generally be allocated among the partners in accordance with
their respective percentage interests in the Partnership.
The Company's share of any gain realized by the Partnership on the sale of
any property held by the Partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the Partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. Such prohibited transaction income also may
have an adverse effect upon the Company's ability to satisfy the income tests
for REIT status. The Company, however, does not presently intend to allow the
Partnership to acquire or hold any property that represents inventory or other
property held primarily for sale to customers in the ordinary course of the
Company's or the Partnership's trade or business. See "-- Requirements for
Qualification -- Income Tests."
PLAN OF DISTRIBUTION
The Company may sell the Offered Securities to one or more underwriters for
public offering and sale by them or may sell the Offered Securities to investors
directly or through agents, which agents may be affiliated with the Company.
Any such underwriter or agent involved in the offer and sale of the Offered
Securities will be named in any applicable Prospectus Supplement.
Sales of Offered Securities offered pursuant to any applicable Prospectus
Supplement may be effected from time to time in one or more transactions at a
fixed price or prices which may be changed, at prices related to the prevailing
market prices at the time of sale, or at negotiated prices. The Company also
may, from time to time, authorize underwriters acting as the Company's agents to
offer and sell the Offered Securities upon the terms and conditions set forth in
the applicable Prospectus Supplement. In connection with the sale of Offered
Securities, underwriters may be deemed to have received compensation from the
Company in the form of underwriting discounts or commissions and may also
receive commissions from purchasers of Offered Securities for whom they may act
as agent. Underwriters may sell Offered Securities to or through dealers, and
such dealers may receive compensation in the form of discounts, concessions or
commissions from the underwriters and/or commissions from the purchasers for
whom they may act as agent.
33
<PAGE> 173
Any underwriting compensation paid by the Company to underwriters or agents
in connection with the offering of Offered Securities, and any discounts,
concessions or commissions allowed by underwriters to participating dealers,
will be set forth in any applicable Prospectus Supplement. Underwriters, dealers
and agents participating in the distribution of the Offered Securities may be
deemed to be underwriters, and any discounts and commissions received by them
and any profit realized by them on resale of the Offered Securities may be
deemed to be underwriting discounts and commissions under the Securities Act.
Underwriters, dealers and agents may be entitled, under agreements entered into
with the Company and the Partnership, to indemnification against and
contribution toward certain civil liabilities, including liabilities under the
Securities Act. Any such indemnification agreements will be described in any
applicable Prospectus Supplement.
Unless otherwise specified in any related Prospectus Supplement, each
series of Offered Securities will be a new issue with no established trading
market, other than the Common Stock which is listed on the NYSE. Any shares of
Common Stock sold pursuant to a Prospectus Supplement will be listed on such
exchange, subject to official notice of issuance. The Company may elect to list
any class or series of Preferred Stock and any series of Warrants on any
exchange, but neither is obligated to do so. It is possible that one or more
underwriters may make a market in a series of Offered Securities, but will not
be obligated to do so and may discontinue any market making at any time without
notice. Therefore, no assurance can be given as to the liquidity of the trading
market for the Offered Securities.
If so indicated in the applicable Prospectus Supplement, the Company may
authorize dealers acting as the Company's agents to solicit offers by certain
institutions to purchase Offered Securities from the Company at the public
offering price set forth in such Prospectus Supplement pursuant to Delayed
Delivery Contracts ("Contracts") providing for payment and delivery on the date
or dates stated in such Prospectus Supplement. Each Contract will be for an
amount not less than, and the aggregate principal amount of Offered Securities
sold pursuant to Contracts shall be not less nor more than, the respective
amounts stated in the applicable Prospectus Supplement. Institutions with whom
Contracts, when authorized, may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions, and other institutions but will in all cases be subject
to the approval of the Company, as the case may be. Contracts will not be
subject to any conditions except (i) the purchase by an institution of the
Offered Securities covered by its Contracts shall not at the time of delivery be
prohibited under the laws of any jurisdiction in the United States to which such
institution is subject, and (ii) if the Offered Securities are being sold to
underwriters, the Company, as the case may be, shall have sold to such
underwriters the total principal amount of the Offered Securities less the
principal amount thereof covered by Contracts.
Certain of the underwriters and their affiliates may be customers of,
engage in transactions with and perform services for, the Company or the
Partnership in the ordinary course of business.
LEGAL MATTERS
The validity of the Offered Securities will be passed upon for the Company
by Brobeck, Phleger & Harrison LLP, Newport Beach, California. In rendering its
opinions, Brobeck, Phleger & Harrison LLP will rely on the opinion of Ballard
Spahr Andrews & Ingersoll, Baltimore, Maryland, as to certain matters of
Maryland law. Roger Cohen, a partner at Brobeck, Phleger & Harrison LLP, is
Assistant Secretary of the Company and owns 2,576 shares of Common Stock and has
been granted options to purchase 3,000 shares of Common Stock. In addition, the
description of federal income tax consequences contained in the section of this
Prospectus entitled "United States Federal Income Tax Considerations" and
certain federal income tax matters pertaining to the Company's status as a REIT
will be based on the opinion of the Company's tax advisor.
EXPERTS
The following financial statements have been audited by Coopers & Lybrand
L.L.P., independent auditors, as set forth in their reports thereon included
therein and incorporated herein by reference: (1) the
34
<PAGE> 174
consolidated financial statements of Sunstone Hotel Investors, Inc. as of
December 31, 1996 and 1995, and for the year ended December 31, 1996, and the
period August 16, 1995 (inception) through December 31, 1995, and the combined
financial statements of Sunstone Initial Hotels (Predecessor) for the period
January 1, 1995 through August 15, 1995, and for the year ended December 31,
1994, the financial statements of Sunstone Hotel Properties, Inc. (the Lessee)
as of December 31, 1996 and 1995, and for the year ended December 31, 1996 and
the period August 16, 1995 (inception) through December 31, 1995, all appearing
in the Company's Annual Report (Form 10-K) for the year ended December 31, 1996;
(2) the financial statements of Markland Hotel, Inc. as of May 31, 1997 and for
the year then ended, the financial statements of the Gateway Center Group, as of
December 31, 1996 and for the year then ended, the financial statements of the
Holiday Inn Mission Valley Stadium Hotel, as of May 31, 1997 and for the period
from June 12, 1996 (date of acquisition) to May 31, 1997, and the financial
statements of TSB Crystal Partnership, as of December 31, 1996 and for the year
then ended, which reports appear in the Company's Current Report on Form 8-K/A
filed August 22, 1997; and, (3) the financial statements of Ventura Hospitality
Partners L.P. as of December 31, 1995 and July 31, 1996, and for the period from
July 22, 1995 (inception) to December 31, 1995, and the seven months ended July
31, 1996, appearing in the Company's Current Report on Form 8-K/A filed January
7, 1997. Such financial statements are incorporated herein by reference in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing.
The financial statements of Kent Hospitality Partners, L.P. as of and for
the year ended October 31, 1996 have been audited by Arthur Andersen LLP,
independent public accountants, as set forth in their report with respect
thereto and incorporated herein by reference. Such financial statements are
incorporated by reference in reliance upon the authority of said firm as experts
in giving said report.
The consolidated financial statements of Kahler Realty Corporation and
subsidiaries as of December 31, 1996, December 31, 1995, and January 1, 1995 and
for the years then ended have been included in the Registration Statement of
Sunstone Hotel Investors, Inc. dated as of August 25, 1997, in reliance upon the
reports of KPMG Peat Marwick LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
CHANGE IN ACCOUNTANTS
The Company selected Ernst & Young LLP on July 11, 1997 for engagement as
the Company's independent accountants to report on the Company's consolidated
balance sheet as of December 31, 1997, and the related consolidated statements
of income, shareholders' equity and cash flows for the year ended December 31,
1997. The decision to select Ernst & Young LLP was approved by the Standing
Audit Committee (the "Audit Committee") of the Company's Board of Directors,
which Audit Committee consists of four of the Company's independent directors.
The change in accountants was made in accordance with the Company's policy to
periodically solicit bids for the engagement of independent public accountants.
Coopers & Lybrand L.L.P. had acted as the Company's independent accountants
prior to July 11, 1997, and was dismissed on that date by the decision of the
Audit Committee. None of Coopers & Lybrand L.L.P.'s reports on the Company's
financial statements for any of the years on which Coopers & Lybrand L.L.P.
reported contained an adverse opinion or disclaimer of opinion, nor were the
opinions modified as to uncertainty, audit scope or accounting principles, nor
were there any events of the type requiring disclosure under Item 304(a)(1)(v)
of Regulation S-K under the Securities Act. There were no disagreements with
Coopers & Lybrand L.L.P., resolved or unresolved, on any matter of accounting
principles, which, if not resolved to Coopers & Lybrand L.L.P.'s satisfaction,
would have caused it to make reference to the subject matter of the disagreement
in connection with its reports.
35
<PAGE> 175
======================================================
NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED IN THIS PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO
SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THOSE TO
WHICH IT RELATES, OR AN OFFER OR SOLICITATION WITH RESPECT TO THOSE SECURITIES
TO WHICH IT RELATES TO ANY PERSONS IN ANY JURISDICTION WHERE SUCH OFFER OR
SOLICITATION WOULD BE UNLAWFUL. THE DELIVERY OF THIS PROSPECTUS AT ANY TIME DOES
NOT IMPLY THAT THE INFORMATION CONTAINED OR INCORPORATED HEREIN AT ITS DATE IS
CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................... 2
Incorporation of Certain Information by
Reference............................. 2
The Company............................. 3
Use of Proceeds......................... 4
Risk Factors............................ 5
Description of Common Stock and
Preferred Stock....................... 12
Description of Warrants................. 17
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws.............. 18
United States Federal Income Tax
Considerations........................ 21
Plan of Distribution.................... 33
Legal Matters........................... 34
Experts................................. 34
Change in Accountants................... 35
</TABLE>
======================================================
======================================================
SUNSTONE HOTEL INVESTORS, INC.
LOGO
COMMON STOCK
PREFERRED STOCK
WARRANTS
---------------------
PROSPECTUS
---------------------
SEPTEMBER , 1997
======================================================
<PAGE> 176
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
PROSPECTUS SUPPLEMENT
(TO JOINT PROSPECTUS DATED OCTOBER , 1997)
9,000,000 SHARES
LOGO
COMMON STOCK
Sunstone Hotel Investors, Inc. (the "Company") is a leading
self-administered equity real estate investment trust that currently owns 34
mid-price and upscale hotels located primarily in the Pacific and Mountain
regions of the western United States. The hotels operate under nationally
recognized franchises, including brands affiliated with Holiday Hospitality
Corporation, Marriott International and Promus Hotel Corporation. The Company
intends to use a portion of the net proceeds from this Offering (as defined
below) to fund the cash portion of the purchase price for 17 additional hotels
from the shareholders of Kahler Realty Corporation (the "Kahler Acquisition").
Following the Kahler Acquisition, the Company will own 51 hotels with an
aggregate of 9,545 rooms located primarily in the western United States.
All of the shares of common stock (the "Common Stock") being offered hereby
are being sold by the Company. Of the 9,000,000 shares of Common Stock offered
hereby, 7,200,000 shares are being offered in a concurrent offering in the
United States and Canada by the U.S. Underwriters (the "U.S. Offering" and,
together with the International Offering, the "Offering"). The price to public
and underwriting discount per share are identical for the International Offering
and the U.S. Offering. The Common Stock is listed on the New York Stock Exchange
(the "NYSE") under the symbol "SSI." On September 18, 1997, the last reported
sales price of the Common Stock on the NYSE was $16.125 per share.
The Company's Articles of Incorporation limit its consolidated indebtedness
to 50% of the Company's investment in hotel properties, at cost. Upon the
closing of this Offering, after giving effect to the Kahler Acquisition and the
application of the net proceeds from this Offering, the Company's consolidated
indebtedness will be approximately 37% of its investment in hotel properties, at
cost.
Since November 1996, the Company has paid regular quarterly dividends,
representing an annual dividend of $1.00 per share. On September 12, 1997, the
Company declared a dividend payable on November 15, 1997 of $0.275 per share to
holders of record on September 30, 1997, representing an increase in the annual
dividend to $1.10 per share. See "Price Range of Common Stock and Dividend
Distributions."
SEE "ADDITIONAL RISK FACTORS" BEGINNING ON PAGE S-11 AND "RISK FACTORS"
BEGINNING ON PAGE 5 OF THE ACCOMPANYING PROSPECTUS FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<TABLE>
<S> <C> <C> <C>
=====================================================================================================
PRICE UNDERWRITING PROCEEDS TO
TO PUBLIC DISCOUNT (1) COMPANY(2)
- -----------------------------------------------------------------------------------------------------
Per Share..................... $ $ $
- -----------------------------------------------------------------------------------------------------
Total(3)...................... $ $ $
=====================================================================================================
</TABLE>
(1) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including certain liabilities under the Securities Act of 1933,
as amended. See "Underwriting."
(2) Before deducting expenses payable by the Company estimated at $1,350,000.
(3) The Company has granted the several International Managers and U.S.
Underwriters (the "Underwriters") options to purchase up to 270,000 and
1,080,000 additional shares, respectively, of Common Stock to cover
over-allotments, if any. See "Underwriting." If such options are exercised
in full, the total Price to Public, Underwriting Discount and Proceeds to
Company will be $ , $ and $ , respectively.
The shares offered hereby are offered by the several Underwriters, subject
to prior sale, when, as and if delivered to and accepted by them and subject to
approval of certain legal matters by counsel for the Underwriters. The
Underwriters reserve the right to withdraw, cancel or modify such offer and to
reject orders in whole or in part. It is expected that delivery of the shares of
Common Stock will be made in New York, New York on or about October , 1997.
------------------------
MERRILL LYNCH INTERNATIONAL BEAR, STEARNS INTERNATIONAL LIMITED
MONTGOMERY SECURITIES
CREDIT SUISSE FIRST BOSTON
EVEREN SECURITIES, INC.
RAYMOND JAMES & ASSOCIATES, INC.
------------------------
The date of this Prospectus Supplement is September 22, 1997
<PAGE> 177
UNDERWRITING
Subject to the terms and conditions in the international purchase agreement
(the "International Purchase Agreement"), the Company has agreed to sell to the
International Managers named below (the "International Managers"), and the
International Managers, for whom Merrill Lynch International, Bear, Stearns
International Limited, Montgomery Securities, Credit Suisse First Boston
Corporation, EVEREN Securities, Inc. and Raymond James & Associates, Inc. are
acting as lead managers (the "Lead Managers"), have severally agreed to
purchase, the number of shares of Common Stock set forth opposite their
respective names below.
<TABLE>
<CAPTION>
NUMBER OF SHARES
TO BE
UNDERWRITERS PURCHASED
------------------------------------------------------------- ----------------
<S> <C>
Merrill Lynch International..................................
Bear, Stearns International Limited..........................
Montgomery Securities........................................
Credit Suisse First Boston Corporation.......................
EVEREN Securities, Inc.......................................
Raymond James & Associates, Inc..............................
---------
Total.............................................. 1,800,000
=========
</TABLE>
The Company has also entered into a purchase agreement (the "U.S. Purchase
Agreement" and, together with the International Purchase Agreement, the
"Agreements") with certain underwriters in the United States and Canada (the
"U.S. Underwriters") for whom Merrill Lynch & Co., Bear, Stearns & Co. Inc.,
Montgomery Securities, Credit Suisse First Boston Corporation, EVEREN
Securities, Inc. and Raymond James & Associates, Inc. are acting as
representatives (the "U.S. Representatives"). Subject to the terms and
conditions set forth in the U.S. Purchase Agreement, the Company has agreed to
sell to the U.S. Underwriters, and the U.S. Underwriters have severally agreed
to purchase, an aggregate of 7,200,000 shares of Common Stock. The public
offering price per share and the underwriting discount per share are identical
under the International Purchase Agreement and the U.S. Purchase Agreement.
In the International Purchase Agreement and the U.S. Purchase Agreement,
the several International Managers and the several U.S. Underwriters
(collectively, the "Underwriters"), respectively, have agreed, subject to the
terms and conditions set forth therein, to purchase all of the shares of Common
Stock being sold pursuant to such Agreements if any of the shares of Common
Stock being sold pursuant to such Agreements are purchased. The International
Purchase Agreement provides that, in the event of a default by an International
Manager, the purchase commitments of the non-defaulting International Managers
may in certain circumstances be increased, and the U.S. Purchase Agreement
provides that in the event of a default by a U.S. Underwriter, the purchase
commitments of the non-defaulting U.S. Underwriters may in certain circumstances
be increased. The closing with respect to the sale of the shares of Common Stock
pursuant to the International Purchase Agreement is a condition to the closing
with respect to the sale of the shares of Common Stock pursuant to the U.S.
Purchase Agreement, and the closing with respect to the sale of the shares of
Common Stock pursuant to the U.S. Purchase Agreement is a condition to the
closing with respect to the sale of the shares of Common Stock pursuant to the
International Purchase Agreement.
The International Managers and the U.S. Underwriters have entered into an
intersyndicate agreement (the "Intersyndicate Agreement") which provides for the
coordination of their activities. Under the terms of the Intersyndicate
Agreement, the International Managers and the U.S. Underwriters are permitted to
sell shares of Common Stock to each other. Pursuant to the Intersyndicate
Agreement, sales may be made between the U.S. Underwriters and the International
Managers of such number of shares of Common Stock as may be mutually agreed. The
price of any shares of Common Stock so sold shall be the public offering price,
less an amount not greater than the selling concession.
Under the terms of the Intersyndicate Agreement, the International Managers
and any bank, broker or dealer to whom they sell shares of Common Stock will
agree not to offer to sell or sell shares of Common Stock to persons whom they
believe to be United States Persons or Canadian Persons (as defined in the
Intersyndicate Agreement) or to persons whom they believe intend to reoffer or
resell the same to United States Persons or Canadian Persons, and the U.S.
Underwriters and any dealer to whom they sell shares of
S-61
<PAGE> 178
Common Stock will agree to offer to sell or sell shares of Common Stock only to
persons whom they believe are United States Persons or Canadian Persons or to
persons whom they believe intend to reoffer or resell the same to United States
Persons or Canadian Persons, except in each case for transactions pursuant to
the Intersyndicate Agreement which, among other things, permits the Underwriters
to purchase from each other and offer for resale such number of shares of Common
Stock as the selling Underwriter or Underwriters and the purchasing Underwriter
or Underwriters may agree.
The Lead Managers have advised the Company that the International Managers
propose initially to offer the shares of Common Stock offered hereby to the
public at the public offering price set forth on the cover page of this
Prospectus Supplement, and to certain dealers at such price less a concession
not in excess of $ per share. The International Managers may allow, and
such dealers may reallow, a concession not in excess of $ per share to
certain other dealers. After this Offering, the public offering price and the
concession may be changed.
The Company has granted to the International Managers an option,
exercisable for 30 days after the date hereof, to purchase up to 270,000
additional shares of Common Stock and to the U.S. Underwriters an option,
exercisable for 30 days after the date hereof, to purchase up to 1,080,000
additional shares of Common Stock, in each case solely to cover over-allotments,
if any, at the public offering price less the underwriting discount. To the
extent that the International Managers exercise such option, each of the
International Managers will be obligated, subject to certain conditions, to
purchase approximately the same percentage of such shares which the number of
shares of Common Stock to be purchased by it shown in the foregoing table bears
to the total number of shares of Common Stock set forth in such table.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including certain liabilities under the Securities Act.
The Company has agreed that it will not, with certain exceptions, offer,
sell or otherwise dispose of any shares of Common Stock for a period of 90 days
from the date of this Prospectus Supplement without the prior written consent of
Merrill Lynch International. This prohibition will not affect shares of Common
Stock issued by the Company in connection with acquisitions, issued or granted
by the Company pursuant to the Incentive Plan and the Directors Plan any
dividend reinvestment plan or the conversion or exercise of securities
convertible or exercisable for Common Stock. Each of the Company's directors and
executive officers has agreed that, for a period of 90 days from the date of
this Prospectus Supplement, he will not, without the prior written consent of
Merrill Lynch International, offer, sell or otherwise voluntarily dispose of any
shares of Common Stock or any securities convertible into or exercisable for
Common Stock.
Each of the Company and the International Managers has represented and
agreed that (a) it has not offered or sold, and prior to the date six months
after the date of this Prospectus Supplement will not offer or sell any shares
of Common Stock to persons in the United Kingdom except to persons whose
ordinary activities involve them in acquiring, holding, managing or disposing of
investments (as principal or agent) for the purchase of their businesses or
otherwise in circumstances which do not constitute an offer to the public in the
United Kingdom for the purposes of the Public Offers of Securities Regulations
1995, (b) it has complied and will comply with all applicable provisions of the
Financial Services Act 1986 with respect to any thing done by it in relation to
the shares of Common Stock, from or otherwise the United Kingdom and (c) it has
only issued or passed on and will only issue or pass on in the United Kingdom
any document received by it in connection with the issue or sale of the shares
of Common Stock to a person who is of a kind described in Article II(3) of the
Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order 1996
or is a person to whom the document may otherwise lawfully be issued or passed
on.
Until the distribution of the shares of Common Stock is completed, rules of
the Commission may limit the ability of the Underwriters and certain selling
group members to bid for and purchase the shares of Common Stock. As an
exception to these rules, the Underwriters are permitted to engage in certain
transactions that stabilize the price of the shares of Common Stock. Such
transactions consist of bids or purchases for the purpose of pegging, fixing or
maintaining the price of the shares of Common Stock.
If the Underwriters create a short position in the shares of Common Stock
in connection with this Offering, i.e., if they sell more shares of Common Stock
than are set forth on the cover page of this Prospectus Supplement, the U.S.
Representatives and the Lead Managers, respectively, may reduce that short
position by
S-62
<PAGE> 179
purchasing shares of Common Stock in the open market. The U.S. Representatives
and the Lead Managers, respectively, may also elect to reduce any short position
by exercising all or part of the over-allotment option described above.
The U.S. Representatives and the Lead Managers, respectively, may also
impose a penalty bid on certain Underwriters and selling group members. This
means that if the U.S. Representatives or the Lead Managers purchase shares of
Common Stock in the open market to reduce the Underwriters' short position or to
stabilize the price of the shares of Common Stock, they may reclaim the amount
of the selling concession from the Underwriters and selling group members who
sold those shares as part of this Offering.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the U.S.
Representatives or the Lead Managers will engage in such transactions or that
such transactions, once commenced, will not be discontinued without notice.
Certain of the Underwriters engage in transactions with, and, from time to
time, have performed services for, the Company and its subsidiaries in the
ordinary course of business. All of the U.S. Representatives, other than Merrill
Lynch & Co. and Credit Suisse First Boston Corporation, have either lead or
co-managed one or more public equity offerings of the Company's Common Stock
over the last two years for which they received customary compensation
therefore.
In addition, at the Initial Public Offering, MYPC, an affiliate of
Montgomery Securities, acquired 24,500 Partnership Units. Additionally, MYPC
received warrants to purchase 33,946 Partnership Units which are exercisable at
any time between the first and fifth anniversary of the closing of the Initial
Public Offering at an exercise price per share equal to the Initial Public
Offering price of $9.50 per share of Common Stock. At any time at the request of
MYPC, the Partnership Units may be redeemed on a one-for-one basis for shares of
Common Stock (or for cash at the election of the Company). In an April 1997
offering of Common Stock for the Company in which Montgomery Securities was the
lead managing underwriter, Montgomery Securities paid a finder's fee to Triton
Pacific Capital, LLC ("Triton") in connection with certain sales to
institutional investors. In February 1997, the Company entered into an agreement
with Triton whereby Triton will act as a financial advisor to the Company under
certain limited circumstances.
Bear, Stearns & Co. Inc., one of the Underwriters, is affiliated with the
NYSE specialist for the Company's Common Stock. Bear, Stearns & Co. Inc. has in
the past performed, and may continue to perform, investment banking and
financial advisory services for the Company and has received customary
compensation therefore. Bear, Stearns & Co. Inc. is the exclusive financial
advisor to the Company in connection with the Kahler Acquisition and, in
addition, has rendered a fairness opinion in connection therewith, for which it
will receive customary compensation therefore.
Merrill Lynch & Co. has entered into an agreement with the Company to
provide certain underwriting services to the Company in furtherance of the
Kahler Acquisition. To the extent such services are rendered, Merrill Lynch &
Co. will receive customary compensation therefore.
S-63
<PAGE> 180
======================================================
NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO
NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITIES OTHER THAN THOSE TO WHICH IT RELATES, OR AN OFFER OR SOLICITATION
WITH RESPECT TO THOSE SECURITIES TO WHICH IT RELATES TO ANY PERSONS IN ANY
JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL. THE DELIVERY OF
THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS AT ANY TIME DOES NOT IMPLY THAT
THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE HEREIN AT ITS DATE IS
CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Available Information................. S-2
Prospectus Supplement Summary......... S-3
Additional Risk Factors............... S-11
Use of Proceeds....................... S-13
Price Range of Common Stock and
Dividend Distributions.............. S-14
Capitalization........................ S-15
Business and Properties............... S-16
Management............................ S-51
The Lessee............................ S-54
The Management Company................ S-57
Principal Shareholders................ S-58
United States Federal Income Tax
Considerations...................... S-60
Underwriting.......................... S-61
Index to Financial Statements......... F-1
PROSPECTUS
Available Information................. 2
Incorporation of Certain Information
by Reference........................ 2
The Company........................... 3
Use of Proceeds....................... 4
Risk Factors.......................... 5
Description of Common Stock and
Preferred Stock..................... 12
Description of Warrants............... 17
Certain Provisions of Maryland Law and
of the Company's Articles of
Incorporation and Bylaws............ 18
United States Federal Income Tax
Considerations...................... 21
Plan of Distribution.................. 33
Legal Matters......................... 34
Experts............................... 34
Change in Accountants................. 35
</TABLE>
======================================================
======================================================
9,000,000 SHARES
SUNSTONE HOTEL INVESTORS, INC.
LOGO
COMMON STOCK
-----------------------------------
PROSPECTUS SUPPLEMENT
-----------------------------------
MERRILL LYNCH INTERNATIONAL
BEAR, STEARNS INTERNATIONAL LIMITED
MONTGOMERY SECURITIES
CREDIT SUISSE FIRST BOSTON
EVEREN SECURITIES, INC.
RAYMOND JAMES & ASSOCIATES, INC.
SEPTEMBER , 1997
======================================================
