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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
-------------------
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended
DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission file number 0-26304
SUNSTONE HOTEL INVESTORS, INC.
(Exact name of registrant as specified in its charter)
--------------------
Maryland 52-1891908
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
903 Calle Amanecer, San Clemente, CA 92673
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (949) 369-4000
- --------------------------------------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, Par Value $.01
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicated by a check mark if disclosure of delinquent fliers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information -- statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
Based on the closing sale price on New York Stock Exchange on March 5,
1999, the aggregate market value of the voting stock held by non-affiliates of
the registrant was $289,345,000.
As of March 5, 1999, there were 37,638,427 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Report incorporates information by reference from the
definitive Proxy Statement for the Annual Meeting of Stockholders, to be held
May 24, 1999.
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The Company hereby amends its Annual Report for the year ended December
31, 1998 on Form 10-K, dated March 5, 1999. The principal changes from the Form
10-K dated March 5, 1999, are as follows:
(1) Page 29, Selected Financial Data - added "CASH FLOW FROM INVESTING
ACTIVITIES" and "CASH FLOW USED IN FINANCING ACTIVITIES" data to the
table.
(2) Page 36, second paragraph, Funds from Operations ("FFO") - the FFO
discussion was revised to include statements that FFO may not be
comparable to FFO reported by other REITs that do not compute FFO in the
same manner as the Company; that FFO should be considered in conjunction
with cash flows from operating, investing and financing activities as
presented in the Company's consolidated financial statements and notes
thereto; and that FFO should not be considered as an alternative to cash
flow from investing or financing activities determined in accordance with
GAAP.
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth (i) selected historical financial
information for the Company as of and for the years ended December 31, 1998,
1997 and 1996 and as of December 31, 1995 and for the period August 16, 1995
(inception) through December 31, 1995, (ii) historical information for the
Lessee for the years ended December 31, 1998, 1997 and 1996 and the period
August 16, 1995 (inception) to December 31, 1995, and (iii) historical
information for the predecessor of the Company ("Sunstone Hotels") for the
period January 1, 1995 through August 15, 1995 and for the year ended December
31, 1994. The following selected historical financial information should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and notes thereto
included in this Annual Report on Form 10-K.
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SUNSTONE HOTEL INVESTORS, INC.
(THE COMPANY)
<TABLE>
<CAPTION>
Inception
August 16,
For the Years Ended December 31, 1995 to
----------------------------------------------- December 31,
1998 1997 1996 1995
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Lease revenue - Lessee $ 98,682,000 $ 44,680,000 $ 14,848,000 $ 3,013,000
Interest and other income 473,000 471,000 236,000 47,000
------------- ------------- ------------- -------------
99,155,000 45,151,000 15,084,000 3,060,000
------------- ------------- ------------- -------------
EXPENSES:
Real estate related depreciation and amortization 35,835,000 14,749,000 4,514,000 968,000
Interest expense and amortization of financing costs 23,734,000 6,365,000 1,558,000 47,000
Real estate and personal property taxes and insurance 11,409,000 4,670,000 1,273,000 312,000
General and administrative 5,344,000 1,890,000 1,015,000 109,000
Cost of withdrawn offerings 1,450,000 -- -- --
------------- ------------- ------------- -------------
Total expenses 77,772,000 27,674,000 8,360,000 1,436,000
------------- ------------- ------------- -------------
Income before losses on dispositions of hotel
properties, minority interest and extraordinary item 21,383,000 17,477,000 6,724,000 1,624,000
Losses on dispositions of hotel properties (3,574,000) -- -- --
Minority interest (851,000) (1,886,000) (1,090,000) (284,000)
------------- ------------- ------------- -------------
Income before extraordinary item 16,958,000 15,591,000 5,634,000 1,340,000
Extraordinary charge for early extinguishment of debt
(net of $34,000 of minority interest) -- -- -- (159,000)
------------- ------------- ------------- -------------
NET INCOME 16,958,000 15,591,000 5,634,000 1,181,000
Distributions on preferred shares (1,975,000) (422,000) -- --
------------- ------------- ------------- -------------
INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 14,983,000 $ 15,169,000 $ 5,634,000 $ 1,181,000
============= ============= ============= =============
EARNINGS PER SHARE - DILUTED $ 0.40 $ 0.71 $ 0.69 $ 0.19
DIVIDENDS DECLARED PER COMMON SHARE $ 1.12 $ 1.05 $ 0.96 $ 0.35
CASH FLOW FROM OPERATING ACTIVITIES $ 63,911,000 $ 24,316,000 $ 11,669,000 $ 2,291,000
CASH FLOW USED IN INVESTING ACTIVITIES $(165,441,000) $(392,546,000) $ (82,757,000) $ (32,899,000)
CASH FLOW FROM FINANCING ACTIVITIES $ 98,805,000 $ 371,672,000 $ 66,008,000 $ 35,824,000
FUNDS FROM OPERATIONS ("FFO") (1) $ 57,218,000 $ 32,226,000 $ 11,238,000 $ 2,592,000
Balance Sheet and Other Data:
Investments in hotel properties, net $ 840,974,000 $ 704,817,000 $ 152,937,000 $ 50,063,000
Total assets 875,636,000 739,577,000 160,079,000 57,226,000
Total debt 398,893,000 307,830,000 63,300,000 11,510,000
Number of properties owned at end of period 57 53 24 11
Number of rooms at end of period 10,215 9,854 3,389 1,477
</TABLE>
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(1) See discussion of Funds From Operations in the "Liquidity and Capital
Resources" section of Management's Discussion and Analysis of Financial
Condition and Results of Operations.
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SELECTED FINANCIAL INFORMATION
(THE LESSEE AND THE PREDECESSOR)
<TABLE>
<CAPTION>
Sunstone Hotel Properties Inc. Sunstone Hotels (Predecessor)
------------------------------------------------ ---------------------------------------------------
From For the Period For the Year
For the Years Ended December 31, August 16, January 1, 1995 Ended
------------------------------------------------ 1995 (Inception) to to August 15, December 31,
1998 1997 1996 December 31, 1995 1995 1994
------------ ------------ ----------- ----------------- ---------------- -----------
<S> <C> <C> <C> <C> <C> <C>
Hotel operating revenue $273,596,000 $118,153,000 $38,593,000 $7,925,000 $9,675,000 $13,863,000
Hotel operating expense 179,297,000 75,604,000 26,907,000 5,658,000 5,679,000 9,168,000
Operating Profit 94,299,000 42,549,000 11,686,000 2,267,000 3,996,000 4,695,000
Lease rent expense 98,682,000 44,680,000 14,848,000 3,013,000 -- --
Net income (loss) (4,383,000) (2,131,000) (3,162,000) (746,000) 1,674,000 398,000
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998 AND 1997
During 1998, the Company:
o acquired 10 hotels for an aggregate purchase price of $134.2
million;
o sold six non-core hotel properties located in tertiary markets
for an aggregate sales price of $47.2 million;
o invested $68.2 million in renovation and redevelopment to 20
hotels;
o raised approximately $69.4 million of equity capital through the
sale of common stock in a shelf offering; and
o increased the commitment under Company's unsecured line of credit
facility from $200.0 million at December 31, 1997 to $350.0
million by December 31, 1998.
For the year ended December 31, 1998, lease revenue increased $54.0
million, to $98.7 million from $44.7 million for the corresponding period of
1997. The 120.8% increase is attributable to the net increase in hotels owned
during 1998, ten hotels acquired and six hotels sold, the full year effect of
hotels acquired during 1997 and net REVPAR increases for continuously owned
hotels.
The Company experienced strong revenue growth of its hotels during
1998. Total room revenue generated by the Company's hotels increased 115.0% to
$204.5 million for 1998 from $95.1 million for 1997, primarily due to the
increase in hotels owned during 1998 and 1997. On a same-unit-sales basis for
the entire portfolio, the Company achieved a 5.0% increase in REVPAR for the
year ended December 31, 1998 as compared to 1997.
The 5.0% REVPAR growth for the year ended December 31, 1998 over 1997
was a result of both the performance of the recently repositioned hotels and the
internal revenue growth from continuously owned and operated hotels. For
comparative purposes, for the year ended December 31, 1998, the nationwide
lodging industry REVPAR growth for the luxury, upscale and mid-price hotel
segments, the segments most representative of the Company's hotels, were 3.2%,
2.9% and 3.5%, respectively. The 5.0% increase was driven by a 10.0% increase in
ADR, from $75.02 in 1997 to $82.50 in 1998, while occupancy decreased three
percentage points.
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REVPAR for 1998 for the non-renovation hotels increased by 7.9% over
1997, from $53.92 to $58.16. Non-renovation hotels represent the Company's
portfolio of hotels during periods of stabilized operations (pre- and
post-renovation) in both 1998 and 1997. The 7.9% increase in REVPAR for
non-renovation hotels was driven by a 9.1% increase in ADR, from $76.06 to
$82.96, while occupancy decreased less than one percentage point. REVPAR for
1998 for the hotels that were undergoing renovation during certain months of
1998 or 1997, decreased 1.1% over the corresponding periods of 1997.
During 1998, the Company invested $68.2 million redeveloping and
renovating 20 hotels as compared to $48.8 million invested redeveloping and
renovating 19 hotels during 1997. In conjunction with the current year
redevelopment and renovation activities, the Company rebranded and upgraded nine
hotels with new and existing franchises including four full-service Marriotts.
The following table summarizes average occupancy, ADR and REVPAR on a
same-unit-sales basis for the hotels for the years ended December 31, 1998, 1997
and 1996:
<TABLE>
<CAPTION>
For the Years Ended For the Years Ended
December 31 December 31
------------------------- -----------------------
1998 1997(1) 1997 1996(1)
------- ------- ------- -------
<S> <C> <C> <C> <C>
SAME-UNIT SALES ANALYSIS
Number of Hotels 57 57 53 53
Number of Rooms 10,215 10,215 9,854 9,854
ALL HOTELS:
Occupancy 65.9% 69.0% 65.4% 65.9%
ADR $ 82.50 $ 75.02 $ 70.75 $ 64.65
REVPAR $ 54.38 $ 51.79 $ 46.24 $ 42.57
REVPAR growth 5.0% 8.6%
NON-RENOVATION HOTELS:
Occupancy 70.1% 70.9% 67.9% 63.9%
ADR $ 82.96 $ 76.06 $ 71.46 $ 64.35
REVPAR $ 58.16 $ 53.92 $ 48.51 $ 41.10
REVPAR growth 7.9% 18.0%
RENOVATION HOTELS:
Occupancy 58.1% 65.6% 61.1% 68.4%
ADR $ 81.46 $ 72.94 $ 67.90 $ 63.11
REVPAR $ 47.36 $ 47.87 $ 41.50 $ 43.19
REVPAR growth (1.1%) (3.9)%
</TABLE>
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(1) The Company did not own certain hotels for the entire period presented.
The Company invested $217.8 million in the acquisition, renovation and
development of hotel properties and other real estate assets during 1998. As a
result of such investments, interest expense and amortization of financing costs
increased to $23.7 million from $6.4 million, and real estate and personal
property taxes and insurance increased to $11.4 million from $4.7 million, for
the year ended December 31, 1998 in comparison to the prior year. Additionally,
real estate related depreciation and amortization increased $21.1 million in
1998 over 1997.
For the year ended December 31, 1998, general and administrative
expenses increased $3.4 million, to $5.3 million from $1.9 million for the prior
year. The increase in general and administrative expenses was primarily due to
the acquisition of Kahler in October 1997, significant growth in the Company's
hotel portfolio and additional personnel added to the staff of the Company.
Additionally, the Company incurred increased recurring expenses for legal,
accounting and tax services during 1998 due to the significant acquisition and
hotel portfolio growth. Also, the
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Company incurred $553,000 of costs related to the termination of a significant
hotel portfolio acquisition that was under consideration. Increases in other
general and administrative expenses were also incurred commensurate with the
growth of the Company's hotel portfolio during 1998 and 1997.
During 1998, the Company disposed of six non-core hotels, that were
included in the acquisition of Kahler, for $47.2 million and recognized losses
of $3.6 million. Additionally, the Company incurred $1.5 million in costs
related to debt and equity offerings that were withdrawn due to market
conditions. Accordingly, these costs were expensed in 1998.
As a result of the above factors, net income available to common
stockholders decreased $200,000 to $15.0 million in 1998 from $15.2 million.
Earnings per share for 1998 were impacted by the 5.3 million and 21.3 million
common shares that were issued during 1998 and 1997, respectively, and on a
diluted basis was $0.40 per share as compared to $0.71 per share for 1997. (See
discussion of Funds From Operations in "Liquidity and Capital Resources.")
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1997 AND 1996
For the year ended December 31, 1997, lease revenues increased $29.9
million, to $44.7 million from $14.8 million for the corresponding period of
1996. The 202.0% increase is primarily due to the 27 hotels acquired during
1997, the full year effect of hotels acquired during 1996 and net REVPAR
increases for continuously owned hotels.
The Company experienced strong revenue growth of its hotels during
1997. Total room revenue from the Company's hotels increased 178.9% from $34.1
million to $95.1 million over 1996, primarily due to the completion of $521.8
million of hotel acquisitions during the preceding twelve months. On a same
unit-sales basis for the entire portfolio, the Company achieved an 8.6% increase
in REVPAR during 1997 compared to 1996.
The 8.6% REVPAR growth for the year ended December 31, 1997 over 1996
was a result of both the performance of the recently repositioned hotels and the
internal revenue growth from continuously owned and operated hotels. For
comparative purposes, for the year ended December 31, 1997, the nationwide
lodging industry, REVPAR growth for the luxury, upscale and mid-price hotel
segments, the segments most representative of the Company's hotels, were 5.9%,
4.8% and 4.6%, respectively. The 8.6% increase was driven by a 9.4% increase in
ADR from $64.65 in 1996 to $70.75 in 1997.
REVPAR for 1997 for the non-renovation hotels increased by 18.0% over
1996, from $41.10 to $48.51. Non-renovation hotels represent the Company's
portfolio of hotels during periods of stabilized operations (pre- and
post-renovation) in both 1997 and 1996. The 18.0% increase in REVPAR for
non-renovation hotels was driven by a 11.0% increase in average daily rate from
$64.35 to $71.46, while occupancy increase four percentage points. REVPAR for
1997, for the hotels which were undergoing renovation during certain months of
1996 or 1997, decreased 3.9% over the corresponding periods of 1996.
Interest expense and amortization of financing costs increased to $6.4
million from $1.6 million, and real estate and personal property taxes and
insurance increased to $4.7 million from $1.3 million for the year ended
December 31, 1997 in comparison to the prior year. Additionally, real estate
related depreciation and amortization increased $10.2 million in 1997. These
increases are attributable to the growth of the Company's hotel portfolio to 53
hotels during 1997 compared to 24 hotels owned during 1996. Acquisitions are
typically initially financed with debt contributing to the increase in interest
expense and amortization of financing costs.
During 1997, the Company recorded increased general and administrative
expenses relating to due diligence for hotels not acquired and other general and
administrative costs incurred due to the growth of the Company's hotel
portfolio. Additionally, effective January 1, 1997, the Company increased the
compensation of the President and added a chief financial officer, corporate
controller, cash manager and other administrative staff necessitated by the
Company's growth. As a result, general and administrative expenses increased to
$1.9 million from $1.0 million for the year ended December 31, 1997 in
comparison to the prior year.
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As a result of the above factors, net income available to common
stockholders increased $9.6 million, to $15.2 million in 1997 from $5.6 million
in 1996. Earnings per share on a diluted basis for 1997 was $0.71 per share as
compared to $0.69 per share for 1996. (See discussion of Funds from Operations
in "Liquidity and Capital Resources.")
NATIONAL FRANCHISE AFFILIATIONS
The Company generally believes that franchise affiliations provide
advantages to its hotels. Such advantages include brand recognition, access to
national reservation systems, national direct sales efforts and national volume
purchasing agreements, and technical and business assistance. The use of
multiple franchise systems provides the Company with further diversification,
less dependence on the continued popularity of one brand and less vulnerability
to new requirements of any individual franchise affiliation. The Company expects
to focus its franchise affiliations on nationally recognized luxury upscale
hotel chains. The following table summarizes certain information with respect to
the current or anticipated franchise affiliations of the hotels.
FRANCHISE AFFILIATIONS
(As of and for the Year Ended December 31, 1998)
<TABLE>
<CAPTION>
Percentage of
Number of Percentage of Lease Lease
Franchise Affiliation Hotels Rooms Rooms Revenues Revenues
- ------------------------------- --------------- ------------------ ------------------ ------------------ ---------------
<S> <C> <C> <C> <C> <C>
Marriott - Full-Service,
Courtyard and
Residence Inn(1) 20 3,520 34.5% $34,555,000 35.0%
Holiday Inns (1) 16 2,534 24.8 19,949,000 20.2
Kahler 2 965 9.4 11,198,000 11.3
Hampton Inns 9 1,193 11.7 9,797,000 9.9
Hilton 2 572 5.6 6,008,000 6.1
Hawthorn Suites 3 583 5.7 5,025,000 5.1
Sheraton 1 295 2.9 2,969,000 3.0
Comfort Suites 1 166 1.6 2,144,000 2.2
Ramada 1 124 1.2 1,340,000 1.4
Best Western 1 103 1.0 649,000 0.7
Radisson (1) 1 160 1.6 740,000 0.7
Other (2) - - - 4,308,000 4.4
--------------- ------------------ ------------------ ------------------ ---------------
57 10,215 100.0% $98,682,000 100.0%
=============== ================== ================== ================== ===============
</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 represents the approved new franchise brand.
(2) Represents six non-core hotel properties sold during the third quarter of
1998.
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SEASONALITY AND REGIONAL FOCUS
The Company focuses its current acquisition efforts principally on the
Pacific region where supply and demand demographic trends are more favorable.
The geographic distribution of the hotels, which are located in eight 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 also has sought to increase
its geographic distributions by focusing on major metropolitan areas. The
following table summarizes the Company's presence in each of these eight
markets:
GEOGRAPHIC DIVERSIFICATION
(As of and for the Year Ended December 31, 1998)
<TABLE>
<CAPTION>
Percentage
Number of Percentage of Lease of Lease
Region Hotels Rooms Rooms Revenues Revenues
- ---------------------------------------- ---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Pacific (1)......................... 32 5,054 49.5% $46,423,000 47.0%
Mountain (2)........................ 21 3,832 37.5 30,854,000 31.3
Minnesota........................... 4 1,329 13.0 17,097,000 17.3
Other (3)........................... - - - 4,308,000 4.4
---------------------------------------------------------------------------
Total.......................... 57 10,215 100% $98,682,000 100%
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</TABLE>
(1) Includes California, Oregon and Washington
(2) Includes Arizona, Colorado, New Mexico and Utah.
(3) Includes the six non-core hotel properties sold during the third quarter
of 1998. Such hotels are located in Idaho, Montana, Texas and West
Virginia.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Provided by Operating Activities. The Company's operating
activities provide the principal source of cash to fund the Company's operating
expenses, interest expense, recurring capital expenditures and distribution
payments. The Company anticipates that its cash flow provided by leasing the
hotels to the Lessee will provide the necessary funds on a short- and long-term
basis to meet its operating cash requirements. (See discussion of the Lessee's
stockholders' deficit in the following section, "The Lessee.") In 1998, the
Company paid distributions totaling $44.7 million. Beginning with the third
quarter of 1998, the Company increased its regular quarterly dividend 3.64% to
$0.285 per share.
The Company believes a regular program of capital improvements,
including replacement and refurbishment of furniture, fixtures and equipment at
its hotels, as well as the periodic renovation and redevelopment of certain of
its hotels, is essential to maintaining the competitiveness of the hotels and
maximizing revenue growth. The Company is required under the Percentage Leases
to make available to the Lessee for the repair, replacement and refurbishment of
furniture, fixtures and equipment an amount equal to 4% of the room revenue per
quarter on a cumulative basis, provided that such amount may be used for capital
expenditures made by the Company with respect to the hotels. The Company expects
that this amount will be adequate to fund the required repairs, replacements and
refurbishments and to maintain its hotels in a competitive condition.
Cash Flows from Investing and Financing Activities. The Company intends
to finance the acquisition of additional hotel properties, hotel renovations and
non-recurring capital improvements principally through its $350 million
unsecured revolving line of credit facility (the "Credit Facility") from its
lenders (led by Bank One of Arizona, N.A., as the agent bank), proceeds from the
disposition of certain non-core hotel assets and, when market conditions
warrant, proceeds from the issuance of additional equity or debt securities.
During 1998, the Company borrowed $182.2 million on the Credit Facility, raised
$47.2 million through the disposition of non-core hotel assets and $69.9 million
through issuance of common stock. As of December 31, 1998, approximately $163.2
million was available
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<PAGE> 9
under the Company's shelf registration statement and the Company had $75.5
million of unused commitment on the Credit Facility. The Credit Facility
contains financial covenants that require the Company to maintain certain
specified financial ratios. Under the most restrictive of these provisions, the
Company's maximum additional indebtedness that could be incurred for the
acquisition and renovation of hotel properties would have been between $23.7
million and $47.4 million at December 31, 1998, depending upon the use of the
funds.
On July 23, 1998, the Company amended the Credit Facility to (i)
increase total commitment to $350.0 million, (ii) increase the total amount
available under the Credit Facility from 45% to 50% of the aggregate value of
the Company's eligible hotels, as defined, (iii) increase amount available for
working capital purposes from $15.0 million to $30.0 million, and (iv) extend
the term from June 30, 1999 to June 30, 2000.
Borrowings under the Credit Facility accrue interest at LIBOR plus
1.40% per annum, to LIBOR plus 2.00% per annum, based upon the leverage of the
Company. At December 31, 1998, the Company's actual borrowing rate was LIBOR
plus 1.75%. The Credit Facility may be retired in whole or in part from the
proceeds of public or private issuances of equity or debt securities by the
Company and may be refinanced in whole or in part with fixed-rate financing. The
Company may seek to obtain such financing if market conditions are appropriate
in management's view.
During 1998, the Company disposed of six non-core hotel assets that
were included in the $372 million acquisition of Kahler Realty Corporation for
$47.2 million in cash. These dispositions were structured as non-taxable
exchange transactions. Additionally, on February 2, 1999, the Company sold the
129-room limited service Hampton Inn located in Arcadia, California for $8.5
million in cash. The Company continues to consider certain non-core hotel assets
for disposition and has identified five additional hotels for disposition,
primarily limited service hotels.
As part of its investment strategy, the Company plans to acquire
additional hotels. Future acquisitions are expected to be funded through the use
of the Credit Facility or other borrowings, proceeds from the disposition of
non-core hotel assets and the issuance of additional equity or debt securities.
The Company's Articles of Incorporation limits consolidated indebtedness to 50%
of the Company's investment in hotel properties, at cost on a consolidated
basis, after giving effect to the Company's use of proceeds from any
indebtedness. Management believes that it will have access to capital resources
sufficient to satisfy the Company's cash requirements and to expand and develop
its business in accordance with its current strategy for growth. During 1998,
the Company used cash in the amount of $217.8 million as well as debt and the
issuance of Units to acquire hotel properties and other real estate investments,
including redevelopment and recurring capital expenditures.
During 1998, the Company invested approximately $68.2 million in major
renovations and conversions of 20 of its hotels. During the quarters ended March
31, 1998, June 30, 1998, September 30, 1998 and December 31, 1998, there were
twelve, eleven, four and nine hotels under renovation, respectively. Certain of
these hotels were under renovation for more than one quarter. The Company
estimates it will invest an additional $34.0 million to complete the renovation
of those hotels currently under renovation and certain other recently acquired
hotels. Management believes the renovations should result in incremental
increases in REVPAR after a ramp-up period at these renovation hotels and
increased lease revenue for the Company.
The Company selectively develops luxury and upscale hotels in markets
where management believes room demand and other competitive factors justify new
construction. On August 12, 1998, the Company completed its acquisition and
development of the newly-built Pueblo Marriott in Pueblo, Colorado, for a cost
of approximately $12.0 million that was funded with the Credit Facility.
Additionally, the Company is in the construction phases of developing three
additional hotels, which are expected to open in 1999. The Company estimates it
will invest approximately $35.3 million to complete the development of these
hotels. This development will be funded by approximately $21.0 million in loan
proceeds from the existing construction lender for two of the hotels which are
being built by third parties, proceeds from the February 1999 sale of the
Hampton Inn located in Arcadia, California and the Credit facility. In
conjunction with the on-going development activity, the Company has various
contracts and commitments outstanding with third parties. The Company plans to
fund remaining commitments under these agreements through the use of the Credit
Facility, and proceeds from the disposition of certain non-core hotel assets. In
addition, the Company may acquire additional hotels and invest additional cash
for renovations during 1999.
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<PAGE> 10
The Company historically has financed hotel acquisitions through
advances on the Credit Facility and the issuance of equity securities. The
Company intends to finance future acquisitions of hotel properties, hotel
renovations and non-recurring capital improvements principally through the
Credit Facility, proceeds from the disposition of non-core hotel assets and,
when market conditions warrant, by issuing additional equity or debt securities.
There can be no assurance that the Company will have access to capital on
favorable terms. If the Company's access to capital is restricted, its ability
to acquire additional hotel properties or to complete development projects or
major renovation projects may be adversely affected. A decline in the Company's
acquisition pace relative to historical periods may result in a decline in
earnings growth.
Funds From Operations ("FFO"). Management believes that FFO is one
measure of financial performance of an equity REIT, such as the Company. FFO (as
defined at footnote below) grew by 78% to $57.2 in 1998 from $32.2 million in
1997.
<TABLE>
<CAPTION>
1998 1997 1996
Actual Actual Actual
----------- ----------- -----------
<S> <C> <C> <C>
Net Income $16,958,000 $15,591,000 $ 5,634,000
Add back:
Real estate related
depreciation and
amortization 35,835,000 14,749,000 4,514,000
Losses on dispositions of
hotel properties 3,574,000 -- --
Minority interest 851,000 1,886,000 1,090,000
----------- ----------- -----------
FFO assuming conversion of
preferred shares $57,218,000 $32,226,000 $11,238,000
=========== =========== ===========
</TABLE>
- -------------------
Management and industry analysts generally consider Funds From Operations to be
an appropriate measure of the performance of an equity REIT. The White Paper on
Funds From Operations approved by the Board of Governors of the National
Association of Real Estate Investment Trusts ("NAREIT") defines Funds From
Operations as net income or loss (computed in accordance with GAAP), excluding
gains or losses from debt restructuring and sales of property, plus real estate
related depreciation and amortization, and after adjustments for unconsolidated
partnerships and joint ventures. The Company computes Funds From Operations in
accordance with standards established by NAREIT, adjusted for minority interest,
which may not be comparable to Funds From Operations reported by other REITs
that do not define the term in accordance with the current NAREIT definition or
that interpret the current NAREIT definition differently than the Company.
Funds From Operations should be considered in conjunction with net income and
cash flows from operating, investing and financing activities as presented in
the Company's consolidated financial statements and notes thereto. Funds From
Operations should not be considered as an alternative to net income (determined
in accordance with GAAP) as an indication of the Company's financial performance
or to cash flow from operating, investing or financing activities (determined in
accordance with GAAP) as a measure of the Company's liquidity, nor is it
indicative of funds available to fund the Company's cash needs, including its
ability to make cash distributions. Funds From Operations may include funds that
may not be available for management's discretionary use due to the requirements
to conserve funds for capital expenditures and property acquisitions and other
commitments.
YEAR 2000 ISSUE
The term "Year 2000 issue" is a general term used to describe the
complications that may be caused by existing computer hardware and software that
were designed by the respective manufacturers without consideration of the
upcoming change in the century. Many computer systems recognize calendar years
by the last two digits in the date code field. Beginning in the year 2000, these
date code fields will need to accept four digit entries to distinguish
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<PAGE> 11
twenty-first century dates from twentieth century dates. If not corrected,
computer systems may fail or create erroneous results causing disruptions of
operations.
The Company's in-house computer systems environment is limited to
software and hardware developed by third parties. All of the Company's computer
systems, consisting of financial reporting and accounting systems only, were
installed in the last two years and management believes such systems are Year
2000 compliant. However, the Company's business is heavily dependent upon the
efforts of the Lessee and third parties with whom the Lessee conducts
significant business.
The Lessee relies on information technology ("IT") systems and other
systems and facilities such as PBX switches, elevators, heating, ventilation and
air conditioning, security, fire and life safety and other environmental systems
("embedded systems") to conduct its business. Both the IT and the embedded
systems are subject to the Year 2000 Issue which, if not remedied in time, could
have an impact on the operations of the Lessee. The Lessee may also be exposed
to risk from third parties with whom the Lessee interacts who fail to adequately
address their own Year 2000 issues. Such third parties include franchisors,
vendors, suppliers and significant customers.
To mitigate and minimize the number and seriousness of any disruptions
caused by the Year 2000 Issue, the Company and the Lessee have developed and
adopted a Year 2000 Compliance Program (the "Compliance Program") which involves
the following four phases: assessment, which includes development of an action
plan and inventorying of hotel systems, remediation, testing and implementation.
With the assistance of outside consultants, site surveys are being performed and
all hotel systems will be identified and inventoried and will include
information such as the manufacturer or vendor who performed the installation,
currently services or maintains each system. The Lessee has begun contacting
these vendors to obtain certification relating to their Year 2000 compliance
testing. In addition, all parties for building systems that service leased
premises, or a facility within leased premises are located and are operated and
controlled by or interact with a software program will be identified and
contacted. It should be noted that due to the complexity of some of the systems,
in many cases, the only way to determine the potential impact of the systems
would be to verify the Year 2000 effect with the particular vendor. The
assessment phase was completed in February 1999.
Status of Progress in Becoming Year 2000 Compliant, Including Timetable for
Completion of Each Remaining Phase - Hotel and Lessee Systems:
Based on the results of the site assessments, the identified IT and
embedded systems will be replaced or upgraded. The system upgrades will be
prioritized according to their critical importance. Life safety systems and
emergency services will take priority in accordance with the steps laid out in
the Compliance Program. The various vendors associated with any system
replacements or upgrades will be contacted to determine their readiness to deal
with these system enhancements. Performance of certain testing by the vendors
may be required in several cases to ensure Year 2000 compliance. All vendors,
manufacturers, service personnel, consultants, contractors, lessees and lessors
will be requested to prepare a letter certifying and warranting that all
systems, utilities and services containing time and date-related coding and
internal programs, shall continue without interruption beyond December 31, 1999.
The implementation will be monitored and managed on a real-time basis to ensure
a smooth upgrade of the systems. Completion of the implementation and testing
phases for all significant systems is expected by June 30, 1999, with all
remediated systems fully tested and implemented by September 30, 1999, with 100%
completion targeted for October 31, 1999.
Nature and Level of Importance of Third Party Systems and Their Exposure to the
Year 2000:
The Lessee is in the process of surveying its vendors and service
providers that are critical to the Lessee's business to determine whether they
are Year 2000 compliant. The Lessee expects that these surveys will be completed
by the end of the second quarter of 1999, but cannot guarantee that all vendors
or service providers will respond to the survey, and therefore the Lessee may
not be able to determine Year 2000 compliance of those vendors or service
providers. By the end of the second quarter of 1999, the Lessee will determine
the extent to which the Lessee will be able to replace those vendors not in
compliance. There may be instances in which the Lessee will have no alternative
but to remain with non-compliant vendors or service providers. The inability of
vendors to complete their Year 2000
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<PAGE> 12
resolution process in a timely fashion could materially impact the Company and
the Lessee. The effect of compliance by vendors is not determinable.
Cost of Addressing Year 2000 Issues:
The Company estimates that total cost for the Year 2000 compliance
review, evaluation, assessment and remediation efforts should not exceed $1.0
million and will be funded by the Company through its operating cash flows. To
date, the costs incurred to address the Year 2000 issue consist primarily of
services provided by outside consultants for onsite system surveys and total
$163,000 which was expensed by the Company in 1999. The remaining balance is
also anticipated to be expended in 1999.
Risks Presented by Year 2000 Issues:
Management of the Company and the Lessee believe they have an effective
plan in place to resolve the Year 2000 Issue in a timely manner. As noted above,
the Lessee has not yet completed all necessary phases of the Year 2000 program.
In the event that the Lessee does not complete any additional phases, the Lessee
may encounter system failures associated with third-party vendors such as
disruptions in passenger transportation or transportation systems generally,
loss of utility and telecommunications services, the loss or disruption of hotel
reservations made on centralized reservation systems and errors or failures in
financial transactions or payment processing systems such as credit cards. These
disruptions could adversely affect the Company and the Lessee, their businesses
and their financial conditions. The Company and the Lessee cannot predict the
actual effects of the Year 2000 Issue on their businesses, such effects depend
on numerous uncertainties such as whether significant third parties have
properly and timely addressed the Year 2000 Issue, and whether broad-based or
systemic economic failures may occur. Due to the general uncertainty inherent in
the Year 2000 Issue and the Company's and Lessee's dependence on third parties,
Management is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact.
Contingency Plan:
The Lessee is in the process of developing its contingency plan for the
systems operated an maintained by the Lessee and the hotels. This is necessary
in order to provide for the most likely worst case scenarios regarding Year 2000
compliance. The contingency plan is expected to be completed in 1999.
IMPACT OF INFLATION
The Company's business is affected by general economic conditions,
including the impact of inflation and interest rates. Substantially all of the
Company's Percentage Leases allow, on an annual basis, for adjustments in the
rent payable thereunder, and thus may enable the Company to seek increases in
base rents, which generally serves to minimize the risk to the Company of the
adverse effects of inflation. For construction, the Company has entered into
various contracts for the developmental and construction of new hotel
properties. These are fixed-fee contracts and thus partially insulate the
Company from inflationary risk.
THE LESSEE
For a discussion of the Lessee's revenue operations and a comparison of
the year ended December 31, 1998 to 1997, see "Results of Operations" of the
Company. Additionally, the Lessee has incurred significant losses from its
inception in 1995. At December 31, 1998, the Lessee's stockholders' deficit
amounted to $10.5 million. At December 31, 1998, the Lessee's rent payable to
the Company amounted to $7.5 million. Also at December 31, 1998, the Lessee's
current liabilities exceeded its current assets by $9.8 million. The ability of
the Lessee to fund its daily operations and continue to remain current on its
substantial rent obligation to the Company is a result of the original terms
under the Percentage Leases, for the payment of rent to the Company, which allow
monthly base rent to be paid in arrears and monthly percentage rent to be paid
within 45 days after the respective month-end.
The Lessee's losses from inception are primarily attributable to the
substantial renovations to the Company's hotels which the Lessee operates and
the original terms of the Percentage Leases. During 1998, 1997 and 1996, a
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<PAGE> 13
significant portion of the Company's hotel portfolio underwent renovation and
redevelopment, 20, 19 and 8 hotels, respectively.
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. There can be no assurance,
however, that the Lessee's operating results will improve because of various
factors described under "Risk Factors." During periods of significant
renovation, the hotels generally do not generate sufficient revenue to meet
operating expenses, including lease payments.
During 1998, the Lessee entered into a $1.5 million line of credit that
expires on December 29, 1999 with its primary stockholder, Mr. Alter. The line
of credit is to be used exclusively for general short-term working capital
needs. As of December 31, 1998, $650,000 was outstanding on the line of credit.
Through March 5, 1999, an additional $800,000 was drawn on the line of credit
and $644,000 was repaid.
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<PAGE> 14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of San Clemente, State of California, on July 6, 1999.
SUNSTONE HOTEL INVESTORS, INC.
By: /s/ ROBERT A. ALTER
------------------------------------
Robert A. Alter
President, Secretary and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K/A has been signed below by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ ROBERT A. ALTER President, Secretary and Chairman July 6, 1999
- ---------------------------------- of the Board of Directors (Principal Executive
Robert A. Alter Officer)
/s/ CHARLES L. BIEDERMAN Vice Chairman of the Board of Directors July 6, 1999
- ----------------------------------
Charles L. Biederman
/s/ R. TERRENCE CROWLEY Chief Operating Officer (Principal Financial July 6, 1999
- ---------------------------------- and Accounting Officer)
R. Terrence Crowley
/s/ C. ROBERT ENEVER Director July 6, 1999
- ----------------------------------
C. Robert Enever
/s/ LAURENCE GELLER Director July 6, 1999
- ----------------------------------
Laurence Geller
/s/ DAVID E. LAMBERT Director July 6, 1999
- ----------------------------------
David E. Lambert
/s/ H. RAYMOND BINGHAM Director July 6, 1999
- ----------------------------------
H. Raymond Bingham
/s/ FREDRIC H. GOULD Director July 6, 1999
- ----------------------------------
Fredric H. Gould
- ---------------------------------- Director July 6, 1999
Paul D. Kazilionis
/s/ EDWARD H. SONDKER Director July 6, 1999
- ----------------------------------
Edward H. Sondker
</TABLE>
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