<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
___________________
(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 filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Based on the closing sale price on 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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<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
ANNUAL REPORT ON FORM 10-K
DECEMBER 31, 1998
TABLE OF CONTENTS
PART I
Page
----
ITEMS 1. & 2. BUSINESS AND PROPERTIES............................... 1
ITEM 3. LEGAL PROCEEDINGS..................................... 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS... 26
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS................................... 27
ITEM 6. SELECTED FINANCIAL DATA............................... 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS................... 30
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK........................................... 39
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........... 39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................... 39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.... 40
ITEM 11. EXECUTIVE COMPENSATION................................ 40
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT............................................ 40
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........ 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K............................................ 41
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PART I
Forward-Looking Statements
When used throughout this Annual Report, the words "believes",
"anticipates" and "expects" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to the many risks and
uncertainties which affect the Company's business, and actual results could
differ materially from those projected and forecasted. These uncertainties,
which include competition within the lodging industry, the balance between
supply and demand for hotel rooms, the Company's continued ability to execute
acquisitions and renovations, the effect of economic conditions, the
availability of capital to finance planned growth, the Year 2000 Issue, and
the liquidity of the Lessee, are described but are not limited to those
disclosed in this Annual Report. These and other factors which could cause
actual results to differ materially from those in the forward-looking statements
are discussed under the heading "Risk Factors". Given these uncertainties,
readers are cautioned not to place undue reliance on such statements. The
Company also undertakes no obligation to publicly release the result of any
revisions to these forward-looking statements that may be made to reflect any
future events or circumstances.
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
GENERAL
Sunstone Hotel Investors, Inc. (the "Company") is a self-administered,
equity real estate investment trust ("REIT") that through its 94.7% ownership
interest in Sunstone Hotel Investors, LP (the "Operating Partnership") owns and
leases luxury, upscale and mid-price hotels located primarily in the Pacific and
Mountain regions of the western United States. The hotels operate primarily
under national franchises that are among the most respected and widely
recognized in the lodging industry, including brands affiliated with Marriott
International, Inc., Bass Hotels and Resorts, Hilton Hotels Corporation and
Promus Hotel Corporation. As of March 5, 1999, the Company's portfolio
consisted of 56 hotels with a total of 10,086 rooms. The majority of the
Company's hotel portfolio consists of luxury, upscale and mid-price full-service
hotels and upscale extended-stay properties (approximately 84.5%) with the
remainder of the Company's portfolio consisting of mid-price limited service
properties.
The Company's growth strategy is to maximize shareholder value by (i)
acquiring underperforming and undercapitalized hotels that are in strong market
locations with significant barriers to entry and (ii) improving such hotels'
financial performance by renovating, redeveloping, rebranding and repositioning
the hotels and through the implementation of focused sales and marketing
programs.
The Company's business strategy is to seek to increase market share at its
hotels through an expansion of a strong base of direct sales and marketing with
an emphasis on repeat customers. The Company's goal is to increase each hotel's
customer base by providing a high level of guest satisfaction, high-quality
hotels and quality food and beverage services.
The Company's business strategy is to increase revenue per available room
("REVPAR") by increasing average daily rate ("ADR") and occupancy. This
strategy is typically implemented by replacing certain discontinued group
business with higher-rate group and transient business and by selectively
increasing room rates. The Company's success with this strategy has been
achieved primarily because of (i) the relatively high occupancy rates at certain
of its hotels, (ii) the success of a superior marketing strategy implemented at
each acquired hotel, and (iii) the effects of repositioning recently acquired
hotels as high-quality properties with strong national franchises through the
Company's redevelopment and rebranding program.
The Company invests in one business segment, that of owning, developing and
leasing hotel properties primarily in the western United States. See the
consolidated financial statements and notes thereto included in Item 8 of this
Annual Report on Form 10-K for financial information about the industry segment.
-1-
<PAGE>
GROWTH STRATEGY
The Company's principal growth strategy is to maximize shareholder value by
increasing cash available for distribution on its Common Stock ("Cash Available
for Distribution") per share by:
. enhancing the operating performance of hotels owned by the Company
through renovation, redevelopment, rebranding and repositioning, and
through the implementation of focused management and marketing programs;
. selectively developing new luxury, upscale and mid-price hotels in
markets where room demand and other competitive factors justify new
construction; and
. when market conditions are appropriate, acquiring or investing in
underperforming and undercapitalized luxury, upscale and mid-price
hotels located principally in the western United States that are, or can
be renovated, redeveloped and repositioned by branding or rebranding
with nationally recognized franchises.
The Company believes that its recently completed and planned future
renovation, redevelopment, rebranding and repositioning 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, rebranding and repositioning
opportunities in the luxury, upscale and mid-price hotel markets in the western
United States. 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.
External Growth Strategy
The Company's external growth strategy is to (i) acquire underperforming
luxury, upscale and mid-price hotels located principally in the western United
States 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; (ii) selectively develop
new luxury, upscale and mid-price hotels in markets where room demand and other
competitive factors justify new construction; and (iii) dispose of non-core
hotel assets that are inconsistent with the Company's external growth strategy.
Acquisitions. When market conditions are appropriate, the Company intends
to acquire hotels located principally in the western United States 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 to nationally
recognized franchise brands that have a greater potential to produce significant
REVPAR growth such as Marriott, Courtyard by Marriott, Residence Inn by
Marriott, Holiday Inn Select, Holiday Inn Hotel & Suites and Hilton; (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's ability to close multiple-
property acquisitions is dependent upon access to public equity, increased
availability under the Company's unsecured revolving line of credit facility
(the "Credit Facility") and other sources of equity and debt. In the past, the
Company has successfully accessed the public equity markets on six different
occasions and raised over $407.9 million. Additionally, the Company has
increased the commitment under the Credit Facility from $30.0 million at the
time of the Company's initial public offering ("IPO") on August 15, 1995, to
$350.0 million. Furthermore, rather than paying cash, the Company also has the
flexibility of issuing its common stock, preferred stock or units in the
Operating Partnership ("Units") to
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<PAGE>
acquire hotels, which under certain circumstances allows the sellers to defer
tax liability which would otherwise arise upon a sale for cash. There can be no
assurances that the Company will continue to have access to sources of equity
and debt. The Company has significant knowledge of a variety of markets and the
ability to quickly identify strategic acquisition opportunities.
Integration of Kahler. On October 15, 1997, the Company completed the
acquisition of all the outstanding capital stock of Kahler Realty Corporation
("Kahler") from Westbrook Real Estate Fund I, L.P. and Westbrook Real Estate Co-
Investment Partnership I, L.P. (collectively, "Westbrook"). Concurrently, the
Company acquired the third-party ownership interests in three hotels that
were previously partially owned by Kahler: the 220-room University Park Hotel
in Salt Lake City, Utah (76% third-party ownership interest), and the 114-room
Residence Inn and 333-room Provo Park Hotel in Provo, Utah (each a 50% third-
party ownership interest). The aggregate purchase price of these acquisitions
(the "Kahler Acquisition") was $372.3 million and was funded with the net
proceeds from the Company's public offering in October 1997, the assumption of
Kahler debt, the issuance of common and preferred stock to Westbrook and with
borrowings from its then $200.0 million unsecured revolving line of credit.
The Kahler portfolio purchased by the Company consisted of 17 hotels with
4,255 rooms (the "Kahler 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 were
concentrated in Rochester, Minnesota, with four hotels and 1,329 rooms, three of
which are connected by an underground walkway to the internationally renowned
Mayo Clinic, and in the Salt Lake City area of Utah, with six hotels and 1,509
rooms. Originally, nine of the hotels were operated independently, with the
balance operated under Sheraton, Hilton, Holiday Inn, Residence Inn and other
national franchises.
From the date of the Kahler Acquisition through 1998, the Company executed
an extensive renovation program that included branding four of the previously
independently operated hotels as full-service Marriott hotels and significant
improvements to the two hotels operated under the Hilton and Sheraton
franchises. The Company anticipates completing the renovation program for the
Kahler Hotels during 1999 with one additional hotel branded as a full-service
Marriott hotel and significant improvements made to two of the hotels connected
to the Mayo Clinic which will continue to operate under the Kahler name.
During 1998, the Company sold six of the Kahler Hotels because the location
and size of these hotels were inconsistent with the Company's strategy of
renovating and rebranding luxury, upscale and mid-price hotels in large
metropolitan areas, as well as downtown and airport hotel markets. The six
hotels sold with a total of 1,122 rooms, included the Boise Park Suite Hotel in
Boise, Idaho; the Pocatello Park Quality Inn in Pocatello, Idaho; the Best
Western Canyon Springs Park Hotel in Twin Falls, Idaho; the Best Western
Colonial Inn in Helena, Montana; the Lakeview Resort and Conference Center in
Morgantown, West Virginia and the Green Oaks Park Hotel in Fort Worth, Texas.
The Kahler Acquisition was consistent with the Company's growth strategy of
acquiring hotels with upside potential within the Pacific and Mountain regions
of the western United States. The Company believes that the Kahler acquisition
was attractive because the Kahler Hotel portfolio (i) contained primarily
underperforming full service hotels with significant opportunities for
renovation, redevelopment, rebranding and repositioning, (ii) included 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, and (iii) included the Rochester,
Minnesota hotels that service the Mayo Clinic.
-3-
<PAGE>
Acquisitions and Investments. The following table sets forth certain
information related to the Company's hotel acquisition and investment activity
since January 1, 1997:
<TABLE>
<CAPTION>
Acquisition
Acquisition Number of Cost
Date Brand Location Rooms (in Millions)
- ------------- ---------------------------- -------------------------- --------- -------------
1997
<S> <C> <C> <C> <C>
January Holiday Inn San Diego, California 218 $ 9.0
January Courtyard by Marriott Cypress, California 180 12.0
March Hawthorn Suites Kent, Washington 152 13.6
March Holiday Inn Select La Mirada, California 289 18.0
May Hawthorn Suites Sacramento, California 301 16.8
June Holiday Inn Hotel & Suites San Diego, California 151 11.8
July Best Western Lynnwood, Washington 103 7.4
August Holiday Inn Mission Valley San Diego, California 174 9.1
August Hawthorn Suites Anaheim, California 130 8.7
August Courtyard by Marriott Los Angeles, California 178 12.6
October Kahler Hotels (1)(2)(3) Midwest and Mountain
Regions of the United States 3,133 322.2
December Residence Inn Sacramento, California 126 13.0
December Residence Inn San Diego, California 144 17.5
---------- -------------
5,279 471.7
---------- -------------
1998
January Ramada San Diego, California 124 $ 11.5
January Residence Inn Santa Clarita, California 90 11.3
January Fairfield Inn Santa Clarita, California 66 5.2
February Hilton Hotel Carson, California 221 12.5
April Radisson (1) Oxnard, California 160 9.3
April Hampton Inn Santa Clarita, California 130 8.7
May Marriott Napa, California 192 21.4
May Holiday Inn (1) Santa Clara, California 168 20.3
August Marriott Pueblo, Colorado 164 12.0
September Marriott (1) Santa Monica, California 168 22.0
---------- -------------
1,483 134.2
---------- -------------
Total 6,762 $605.9
========== =============
</TABLE>
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(1) In cases where the Company has obtained approval of a new franchise license,
subject to completion of certain renovations or improvements, the franchise
brand indicated represents the approved new franchise brand.
(2) Of the eleven Kahler Hotels currently owned by the Company, six are subject
to Marriott franchise licenses, one is subject to a Hilton franchise
license, one is subject to a Holiday Inn franchise license, one is subject
to a Sheraton franchise license with the two remaining operated
independently.
(3) Excludes the six Kahler Hotels, with a total of 1,122 rooms and an aggregate
acquisition cost of $50.1 million, which were sold during 1998.
Selective Development of Additional Hotels
The Company may also selectively develop new luxury, upscale and mid-price
hotels which will operate under national franchises in markets where the Company
believes room demand and other competitive factors justify new construction.
The Company may develop 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.
-4-
<PAGE>
The following table shows the Company's completed and in process
developments:
<TABLE>
<CAPTION>
Completed/
Expected
Number of Completion
Hotel Location Rooms Date
- ------------------------------- ---------------------- ----------- --------------
<S> <C> <C> <C>
Residence Inn by Marriott Highlands Ranch, CO 78 1996
Residence Inn (Room Addition) Highlands Ranch, CO 39 1997
Marriott Pueblo, CO 164 1998
Residence Inn by Marriott San Diego, CA 120 1999
Courtyard by Marriott Lynnwood, WA 141 1999
Hilton Garden Inn Sacramento, CA 153 1999
</TABLE>
Disposition of Non-Core Hotel Assets
The Company intends to dispose of hotels from time to time to redeploy its
capital to acquire hotels that fit more strategically with its growth strategy.
During 1998, the Company sold six hotels that were included in the October 1997
17-hotel Kahler Acquisition. The size and locations of these hotels were
inconsistent with the Company's external growth strategy. Additionally, on
February 2, 1999, the Company sold the 129-room limited service Hampton Inn
located in Arcadia, California for $8.5 million. The Company continues to
consider certain non-core hotel assets for disposition.
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 and redeveloping the hotels, and when advantageous rebranding them
under national franchises, (ii) improving the marketing and management of the
hotels, (iii) the Lessee subleasing 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.
Redevelopment and Renovation
In conjunction with the Company's strategy of acquiring hotels that can
benefit from extensive improvements, branding and repositioning, the Company's
principal internal growth strategy is to redevelop or extensively renovate such
hotels and brand them with a national franchise that the Company believes will
generate higher REVPAR than that currently being generated. In addition to the
redevelopment strategy, the Company periodically renovates its hotels, not only
to satisfy requirements of the franchise agreements, but also to maintain or
increase its market share. The Company has and intends, to the extent
practicable, to continue to keep hotels operational while conducting renovation
and redevelopment work.
During 1998, the Company expended $68.2 million redeveloping and renovating
20 hotels. During 1997, the Company expended $48.8 million redeveloping and
renovating 19 hotels. During 1999, the Company estimates it will expend
approximately $34.0 million redeveloping and renovating seven of its recently
acquired hotels, as well as, completing the renovation and redevelopment of
certain hotels which were under renovation during the fourth quarter of 1998.
The actual cost of redevelopment and renovation may exceed budgeted amounts for
the reasons described under "Risk Factors - Risks Related To Development And
Renovation Of Hotels."
Scope of Renovation and Redevelopment. For those hotels whose franchise
affiliation will not be changed, the Company typically makes renovations after
acquisition not only to satisfy the existing franchisor's capital improvement
plan, but more importantly to ensure a high level of guest satisfaction and
consequently, increase market share and revenue. The Company also performs
periodic routine maintenance to all of its hotels in order to keep them
competitive.
-5-
<PAGE>
Renovations typically consist of many of the following activities:
<TABLE>
<CAPTION>
Guest Rooms Public Areas Exterior
- -------------------------------------------- -------------------------------------- ------------------------------
<S> <C> <C>
. selectively replacing bedspreads, . replacing drapes and valances . repainting
linens, drapes and valances . refinishing and selectively . seal coating parking lot
. refinishing and selectively replacing replacing furniture . adding light
furniture and televisions, and adding . replacing wallpaper and vinyl
telephones with data ports and wallcovering
voicemail, clock radios, coffeemakers, . repainting
irons and ironing boards . recarpeting
. replacing wallpaper and vinyl
wallcovering
. repainting
. recarpeting
</TABLE>
Redevelopments are expanded in scope and typically include many of the
following activities:
<TABLE>
<CAPTION>
Guest Rooms Public Areas Exterior
- -------------------------------------------- ---------------------------------- ------------------------------
<S> <C> <C>
. replacing all bedspreads, linens, . replacing drapes and valances . repainting
drapes and valances . replacing wallpaper and vinyl . installing new window
. replacing all furniture wallcovering treatments and grill work
. replacing televisions, adding . repainting . modifying the facade
telephones with data ports and . recarpeting . constructing
voicemail, clock radios, coffeemakers, . redecorating port-cochere
irons and ironing boards . replacing furniture . repaving or seal
. replacing wallpaper and vinyl . rebuilding reception area coating parking lot
wallcovering . redesigning lobby for improved . adding lighting
. repainting traffic flow . re-roofing
. recarpeting . remodeling restaurant to
. remodeling guestrooms, including standards of regional or national
changing room layout and modifying restaurant operator
closets . installing fire safety
. remodeling guest bathrooms with new equipment, including sprinklers
countertops, tile floors, plumbing and smoke detectors
fixtures, lights and valances
. installing fire safety equipment,
including sprinklers and smoke detectors
</TABLE>
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<PAGE>
The following table sets forth certain information with respect to the
Company's completed, pending and planned renovation and redevelopment activities
and completed and pending changes in franchise affiliations. The table includes
renovation and redevelopment work on certain 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.
Completed, Pending and Planned Renovation and Redevelopment
<TABLE>
<CAPTION>
Public Areas Guest Rooms
------------------------ ---------------------
Add/
Expected Replace/ Upgrade Prior
to be Refurbish Meeting Soft Guest Franchise
Completed Completed Exterior Restaurant Lobby Space Goods Furniture Bath Affiliation
--------- --------- --------- ---------- ----- ------- ----- --------- ----- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Marriott
Ogden, Utah.................. July 1998 x x x x x Best Western
Park City, Utah.............. June 1999 x x x x x x Independent
Provo, Utah.................. April 1998 x x x x x Independent
Pueblo, Colorado............. August NEWLY CONSTRUCTED
1998
Rochester, Minnesota......... March 1998 x x x x x Kahler
Salt Lake City, Utah ` May 1998 x x x Independent
Santa Monica, California (1). April 2000 x x x x x x x Independent
Courtyard by Marriott:
Cypress, California.......... June 1997 x x x x x x x Ramada Hotel
Fresno, California........... February x x x x x x x Hampton Inn
1994
Los Angeles, California...... June 1998 x x x x x x
Riverside, California........ April 1999 x x x x x x x Days Inn
Santa Fe, New Mexico (1)..... March 1999 x x x x x x x Doubletree Hotel
Residence Inn by Marriott:
Highlands Ranch, Colorado.... September NEWLY CONSTRUCTED
1996
Oxnard, California........... May 1997 x x x x x x x Radisson Suites
Sacramento, California....... December x x x x x x
1998
San Diego, California........ March 1999 x x x x x x
Hilton
Carson, California........... March 1999 x x x x x x x
Salt Lake City, Utah......... August x x x x x x x
1998
Sheraton
Chandler, Arizona............ December x x x
1998
Holiday Inn Select:
La Mirada, California........ August x x x x x x x Holiday Inn
1998
Renton (Seattle), Washington. July 1997 x x x x x x x Holiday Inn
Holiday Inn Hotel & Suites:
Craig, Colorado.............. March 1999 x x x x
Kent (Seattle), Washington... October x x x x x x Cypress Inn
1996
Mesa, Arizona................ November x x x x x x x Holiday Inn
1997
Price, Utah.................. June 1997 x x x x x x x Days Inn
San Diego (Old Town), January x x x x x x Ramada Hotel
California.................. 1998
Holiday Inn:
Flagstaff, Arizona........... July 1997 x x x x
Provo, Utah.................. June x x x x x x
1994/
June 1997 x
Rochester, Minnesota......... March 1999 x x x x x
San Diego (Harbor), July 1997 x x x x x
California..................
San Diego (Mission Valley), February x x x x x x x
California.................. 1998
Santa Clara, California (1).. May 1999 x x x x x x Days Inn
Steamboat Springs, Colorado.. June 1996 x x x x x Best Western
Holiday Inn Express:
Portland, Oregon............. October x x x x x x Cypress Inn
1996
Poulsbo, Washington.......... September x x x x x Cypress Inn
1996
</TABLE>
-7-
<PAGE>
Completed, Pending and Planned Renovation and Redevelopment, continued
<TABLE>
<CAPTION>
Public Areas Guest Rooms
------------------------ ---------------------
Add/
Expected Replace/ Upgrade Prior
to be Refurbish Meeting Soft Guest Franchise
Completed Completed Exterior Restaurant Lobby Space Goods Furniture Bath Affiliation
--------- --------- --------- ---------- ----- ------- ----- --------- ----- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Hampton Inn:
Clackamas (Portland), Oregon. October x x x x x x Cypress Inn
1996
Denver, Colorado............. June 1996 x x x
Mesa, Arizona................ October x x x
1997
Oakland, California.......... July 1996 x x x x x
Pueblo, Colorado............. February x x x x x x
1997
Santa Clarita, California.... February x x x x x x
1999
Silverthorne, Colorado....... June 1996/ x x x x
June 1997
Tucson, Arizona.............. October x x x x x
1997
Hawthorn Suites:
Anaheim, California.......... March 1999 x x Independent
Kent, Washington............. September x x Independent
1998
Sacramento, California....... November x x x x x x x Independent
1998
Radisson:
Oxnard, California (1)....... April 1999 x x x x x x x Hilton
Best Western:
Lynnwood, Washington......... September x x x x x x x
1998
Comfort Suites:
South San Francisco, June 1997 x x x x x
California..................
Ramada Limited:
San Diego, California........ February x x x x x Independent
1999
Independent
Kahler Inn & Suites -
Rochester, Minnesota........ May 1999 x x x x x x x
The Kahler Hotel -
Rochester, Minnesota........ March 1999 x x x x x x x
</TABLE>
__________
(1) In cases where the Company has obtained approval of a new franchise license,
subject to completion of certain renovations or improvements, the franchise
brand indicated represents the approved new franchise brand.
-8-
<PAGE>
Franchise Rebranding. The Company believes that franchise affiliations can
provide substantial advantages to certain hotels. Such advantages include brand
recognition, access to national reservation systems, national direct sales
efforts and national volume purchasing agreements, frequent stayer programs and
technical and business assistance. The use of multiple franchise systems
provides the Company with further diversification, less dependence on 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 and upscale hotel chains. During 1998, the Company
rebranded and upgraded nine hotels with new and existing franchises.
Franchise Awards. During 1998, the Company branded four Kahler Hotels as
full-service Marriotts. In recognition of such achievements, the Company was
named Developer of the Year by Marriott Hotels, Resorts and Suites at Marriott's
1998 National Franchise Conference. During 1999, the Company anticipates adding
a Residence Inn, a Courtyard by Marriott and two additional full-service
Marriott hotels to its portfolio. The two full-service Marriotts will be
located in Santa Monica, California and Park City, Utah.
In September 1998, at the annual Bass Hotels Worldwide Conference the
Company demonstrated its leadership in quality and service excellence in the
Holiday Inn brand segment by winning seven awards for hotels acquired and
renovated in 1997. The hotels and their respective awards are as follows:
<TABLE>
<CAPTION>
Hotel Location Award
- ----------------------- --------------------- ------------------------
<S> <C> <C>
Holiday Inn Express Poulsbo, Washington Quality Excellence Award
Holiday Inn Select Renton, Washington Modernization Award
Holiday Inn Harbor View San Diego, California Modernization Award
Holiday Inn & Suites Mesa, Arizona Modernization Award
Holiday Inn & Suites San Diego, California Newcomer of the Year
Holiday Inn & Suites Price, Utah Newcomer of the Year
Holiday Inn Provo, Utah Torchbearer Award
</TABLE>
The following table summarizes certain information with respect to the
franchise affiliations of the hotels.
Franchise Affiliations
<TABLE>
<CAPTION>
Number Percentage
Franchise Affiliations of Hotels Rooms of Rooms
---------------------- --------- ----- ----------
<S> <C> <C> <C>
Marriott............................................................ 20 3,520 34.9%
Holiday Inn......................................................... 16 2,534 25.1
Hampton Inn......................................................... 8 1,064 10.6
Kahler.............................................................. 2 965 9.6
Hawthorn Suites..................................................... 3 583 5.8
Hilton.............................................................. 2 572 5.7
Sheraton............................................................ 1 295 2.9
Comfort Suites...................................................... 1 166 1.6
Radisson (1)........................................................ 1 160 1.6
Ramada.............................................................. 1 124 1.2
Best Western........................................................ 1 103 1.0
-- ------ -----
Total............................................................. 56 10,086 100.0%
== ====== =====
</TABLE>
___________
(1) Includes Oxnard, California hotel which will be rebranded as a Radisson
upon completion of renovation and improvements which are expected to be
completed in the second quarter of 1999.
-9-
<PAGE>
The typical term of a franchise agreement is 20 years for newly developed
and constructed hotels and ten years for conversions of existing hotels. The
Company believes that the loss of any one of its franchise agreements would not
have a material adverse effect on the Company.
Repositioning - Combining Renovations, Redevelopments and Rebranding with
Comprehensive Marketing and Management Strategies
The hotels acquired by the Company often lack adequate management and
marketing programs. The operator of the hotels, Sunstone Hotel Properties, Inc.,
(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 management and marketing activities contribute
to the growth in REVPAR for the Company's acquired hotels.
The Lessee also has developed a sales program to direct and manage the
sales activities of personnel located at each hotel and a program to ensure that
sales staff are properly trained and that staffing levels are adequate. As part
of the required reporting process, the sales staff at each hotel must contact
every business within a five-mile radius to evaluate possible hotel demand and
revenue potential. 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.
The combined efforts to reposition each of the Company's hotels have
resulted in same-unit-sales, year-over-year revenue increases. The following
table summarizes average occupancy, ADR and REVPAR on a same-unit-sales basis
for the hotels during periods of stabilized operations (pre- and post-
renovation) during the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
For the Years Ended For the Years Ended For the Years Ended
December 31, December 31, December 31,
------------------------------ -------------------------------- --------------------------------
1998 1997 (1) 1997 1996 (1) 1996 1995 (1)
----------- -------------- ------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Number of hotels 57 57 53 53 24 24
Number of rooms 10,215 10,215 9,854 9,854 3,389 3,389
Occupancy rate 70.1% 70.9% 67.9% 63.9% 66.7% 66.2%
ADR $ 82.96 $ 76.06 $71.46 $ 64.35 $62.01 $ 57.51
REVPAR $ 58.16 $ 53.92 $48.51 $ 41.10 $41.38 $ 38.08
REVPAR % change 7.9% 18.0% 8.7%
</TABLE>
________________
(1) The Company did not own certain hotels for the entire period presented.
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.
During 1997, the Company completed the 39-room expansion of the Residence Inn
Highlands Ranch (Denver), Colorado. During 1999, the Company anticipates
completing a 24-room expansion of the Holiday Inn and Suites located in San
Diego (Old Town), California.
In order for the Company to qualify as a REIT under Federal income tax law,
neither the Company nor the Operating Partnership can operate hotels. Therefore,
the Company leases its hotels to the Lessee pursuant to percentage leases (the
"Percentage Leases") with initial terms of ten years, which provide for rent
payments based principally on a percentage of room revenues of the hotels. The
Lessee is a Colorado corporation owned by Robert A. Alter, Chairman and
President of the Company, and Charles L. Biederman, Vice Chairman and Executive
Vice President of the Company. Certain management functions for the hotels
including all finance and accounting responsibilities are provided by Sunstone
Hotel Management, Inc., a Colorado corporation (the "Management Company"),
pursuant to a management agreement between the Lessee and the Management Company
-10-
<PAGE>
for a fee equal to 1% to 2% of gross revenues of the hotels plus reimbursement
of accounting costs. The Management Company is wholly-owned by Mr. Alter.
Hotel Properties
Geographically, 48.8% and 38.0% of the Company's portfolio is located in
the Pacific and Mountain regions, respectively, which collectively comprise the
western United States. The western United States has experienced some of the
fastest growth in population in the 1990's and, according to the Bureau of
Census, is expected to continue to grow at a faster rate than the national
average well into the next century. 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 1.1%,
2.1% and 5.3%, respectively.
While the Company's hotel portfolio is located primarily in the western
United States, it is nevertheless diverse. 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 distribution
by focusing on major metropolitan areas. The following table summarizes the
Company's presence in each of these eight markets:
Location by Region
<TABLE>
<CAPTION>
Number of Percentage
Region Hotels Rooms of Rooms
- ------------------------ --------- ----- ----------
<S> <C> <C> <C>
Pacific (1)............. 31 4,925 48.8%
Mountain (2)............ 21 3,832 38.0
Minnesota............... 4 1,329 13.2
-- ------ ------
Total................... 56 10,086 100.0%
== ====== ======
</TABLE>
- ----------
(1) Includes California, Oregon and Washington.
(2) Includes Arizona, Colorado, New Mexico and Utah.
The hotels consist of the following price segments:
Price Segment
<TABLE>
<CAPTION>
Number of Number of Percentage
Segment Hotels Suites/Rooms of Rooms
- ------------------------------- --------- ------------ ----------
<S> <C> <C> <C>
Luxury......................... 9 2,751 27.3%
Upscale........................ 28 4,762 47.2
Mid-Price...................... 19 2,573 25.5
-- ------ -----
Total.......................... 56 10,086 100.0%
== ====== =====
</TABLE>
-11-
<PAGE>
The hotels consist of the following service categories:
Service Category
<TABLE>
<CAPTION>
Number of Number of Percentage
Category Hotels Suites/Rooms of Rooms
- ---------------------------------------------------------- --------- ------------ ----------
<S> <C> <C> <C>
Full-Service.............................................. 34 7,094 70.3%
Extended-Stay............................................. 9 1,425 14.1
Limited Service........................................... 13 1,567 15.6
-- ------ ------
Total................................................ 56 10,086 100.0%
== ====== =====
</TABLE>
The following table sets forth additional information with respect to the
Company's hotel portfolio as of March, 5, 1999:
<TABLE>
<CAPTION>
Last
Type of Service/ No. of Date Year Opened/ Renovated
Hotel Segment (1) Product Rooms Acquired Redeveloped In
----- ------------ ---------------- ------ -------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Marriott Hotel:
Ogden, Utah Luxury Full 288 10/15/97 1982 1998
Park City, Utah (2) Luxury Full 203 10/15/97 1985 1999 *
Provo, Utah Luxury Full 333 10/15/97 1982 1998
Rochester, Minnesota Luxury Full 194 10/15/97 1991 1998
Salt Lake City, Utah Luxury Full 220 10/15/97 1987 1998
Santa Monica, California (2) Luxury Full 168 9/3/98 1967 2000 *
Hilton:
Salt Lake City, Utah Luxury Full 351 10/15/97 1975 1998
Sheraton:
Chandler, Arizona Luxury Full 295 10/15/97 1987 1999 *
The Kahler Hotel:
Rochester, Minnesota Luxury Full 699 10/15/97 Various 1999 *
Marriott Hotel:
Napa, California Upscale Full 192 5/5/98 1979 1997
Pueblo, Colorado Upscale Full 164 8/11/98 1998 N/A
Courtyard by Marriott:
Cypress, California Upscale Full 180 1/17/97 1990 1997
Fresno, California Upscale Full 116 8/16/95 1989 1994
Los Angeles, California Upscale Full 178 8/28/97 1996 1998
Riverside, California Upscale Full 163 4/1/96 1988 1994
Santa Fe, New Mexico (2) Upscale Full 213 8/16/95 1985 1999 *
Hilton:
Carson, California Upscale Full 221 2/19/98 1989 1998
Holiday Inn:
Craig, Colorado Upscale Full 152 8/16/95 1981 1997
Flagstaff, Arizona Upscale Full 157 10/29/96 1987 1997
La Mirada, California Upscale Full 289 3/31/97 1984 1998
Mesa, Arizona Upscale Full 246 10/29/96 1985 1997
Price, Utah Upscale Full 151 8/12/96 1984 1997
Provo, Utah Upscale Full 78 8/16/95 1968 1994
Steamboat Springs, Colorado Upscale Full 82 8/16/95 1971 1996
Renton (Seattle), Washington Upscale Full 226 6/28/96 1968 1997
San Diego, California Upscale Full 218 1/17/97 1968 1997
San Diego, California (Old Town) Upscale Full 151 6/11/97 1986 1998
</TABLE>
-12-
<PAGE>
<TABLE>
<CAPTION>
Last
Type of Service/ No. of Date Year Opened/ Renovated
Hotel Segment (1) Product Rooms Acquired Redeveloped In
- ---------------------------------- ------------ ---------------- ------ -------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Radisson:
Oxnard, California (2) Upscale Full 160 4/9/98 1987 1996
Hawthorn Suites:
Anaheim, California Upscale Extended-Stay 130 8/7/97 1992 1997
Kent, Washington Upscale Extended-Stay 152 3/11/97 1990 1997
Sacramento, California Upscale Extended-Stay 301 5/17/97 1988 1998
Residence Inn:
Highlands Ranch (Denver), Colorado Upscale Extended-Stay 117 12/22/95 1996 N/A
Oxnard, California Upscale Extended-Stay 251 12/19/96 1987 1997
Provo, Utah Upscale Extended-Stay 114 10/15/97 1996 N/A
Sacramento, California Upscale Extended-Stay 126 12/30/97 1992 1998
San Diego, California Upscale Extended-Stay 144 12/30/97 1989 1998
Santa Clarita, California Upscale Extended-Stay 90 1/27/98 1997 N/A
Holiday Inn:
Kent (Seattle), Washington Mid-Price Full 125 2/2/96 1986 1996
Rochester, Minnesota Mid-Price Full 170 10/15/97 1969 1998
San Diego, California (Stadium) Mid-Price Full 174 8/7/97 1991 1998
Santa Clara, California (2) Mid-Price Full 168 5/13/98 1985 1988
Kahler Hotel:
Rochester, Minnesota Mid-Price Full 266 10/15/97 Various 1999 *
Best Western:
Lynnwood, Washington Mid-Price Full 103 7/17/97 1978 1999 *
Comfort Suites:
San Francisco, California Mid-Price Limited 166 8/13/96 1985 1997
Fairfield Inn:
Santa Clarita, California Mid-Price Limited 66 1/27/98 1997 N/A
Hampton Inn:
Clackamas, Oregon Mid-Price Limited 114 2/2/96 1986 1996
Denver, Colorado Mid-Price Limited 152 8/16/95 1986 1996
Mesa, Arizona Mid-Price Limited 118 8/16/95 1987 1997
Oakland, California Mid-Price Limited 152 12/18/95 1986 1996
Pueblo, Colorado Mid-Price Limited 112 8/16/95 1986 1997
Santa Clarita, California Mid-Price Limited 130 4/30/98
Silverthorne, Colorado Mid-Price Limited 160 8/16/95 1976 1997
Tucson, Arizona Mid-Price Limited 126 10/29/96 1986 1997
Holiday Inn:
Portland, Oregon Mid-Price Limited 84 2/2/96 1986 1996
Poulsbo, Washington Mid-Price Limited 63 2/2/96 1986 1996
Ramada:
San Diego, California Mid-Price Limited 124 1/23/98 1987 1998
</TABLE>
- ------------
* Expected year of completion
(1) Per F.W. Dodge segmentation criteria.
(2) In cases when the Company has obtained approval of a new franchise license,
subject to completion of certain renovations or improvements, the franchise
brand indicated represents the approved new franchise brand.
-13-
<PAGE>
The Percentage Leases
In order for the Company to qualify as a REIT, neither the Company nor the
Operating Partnership can operate any hotels. The Company, therefore, leases
hotels to the Lessee typically for a 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 Company
without consent.
Percentage Lease Terms. The Percentage Leases typically have a
noncancelable term of ten years, subject to earlier termination upon the
occurrence of defaults thereunder and certain other events (including provisions
for damage to the hotels, condemnation of the hotels and termination of
Percentage Leases on disposition of the hotels).
Amounts Payable Under the Percentage Leases. During the term of each
Percentage Lease, the Lessee is obligated to pay to the Company (i) base rent,
(ii) percentage rent (which includes a specified percentage of room revenues, 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 (iii)
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 adjustment will be calculated
at the beginning of each calendar year based upon the change in the CPI during
the prior calendar year. Percentage rent, if any, is due monthly within 45 days
after the end of each calendar month and is reconciled on a quarterly basis.
In 1997, the Company and the Lessee amended the Percentage Leases for
hotels then currently under renovation and for any future hotels to allow for
the abatement of base rent related to rooms taken out of service during periods
of major renovations.
The following table sets forth the annual base rent and percentage rent
formulas under the Percentage Leases for the hotels:
<TABLE>
<CAPTION>
Annual
1998 Percentage Lease
Annual --------------------------------- Room
Base First Second Revenue
Rent (1)(2) Tier Tier Threshold (1)
-------------- ----------- ---------- -------------
<S> <C> <C> <C> <C>
Hotels:
Marriott:
Napa, California $ 1,455,000 34.0% 60.0% $ 4,275,000
Ogden, Utah 1,035,000 25.0% 62.0% 4,136,000
Park City, Utah 931,000 24.4% 62.0% 3,812,000
Provo, Utah 2,050,000 37.2% 62.0% 5,518,000
Pueblo, Colorado 756,000 26.0% 62.0% 2,910,000
Rochester, Minnesota 2,914,000 42.3% 62.0% 6,896,000
Salt Lake City, Utah 2,112,000 46.0% 62.0% 4,589,000
Santa Monica, California (3) 1,452,000 47.8% 62.0% 3,038,000
Courtyard by Marriott:
Cypress, California 1,030,000 37.3% 62.0% 2,760,000
Fresno, California 433,000 30.0% 63.0% 1,444,000
Los Angeles, California (LAX) 972,000 46.8% 60.0% 2,075,000
Riverside, California 447,000 30.0% 60.0% 1,489,000
Santa Fe, New Mexico (3) 706,000 30.0% 63.0% 2,353,000
</TABLE>
-14-
<PAGE>
<TABLE>
<CAPTION>
Annual
1998 Percentage Lease
Annual --------------------------------- Room
Base First Second Revenue
Rent (1)(2) Tier Tier Threshold (1)
-------------- ----------- ---------- -------------
<S> <C> <C> <C> <C>
Residence Inn by Marriott:
Highlands Ranch (Denver), Colorado 537,000 39.0% 63.0% 1,376,000
Oxnard, California 1,118,000 32.0% 61.0% 3,492,000
Provo, Utah 673,000 34.6% 62.0% 1,946,000
Sacramento, California 983,000 43.2% 60.0% 2,276,000
San Diego, California 1,393,000 45.8% 60.0% 3,043,000
Santa Clarita, California 775,000 40.6% 60.0% 1,911,000
Fairfield Inn:
Santa Clarita, California 370,000 36.5% 60.0% 1,015,000
Hilton:
Salt Lake City, Utah 3,862,000 50.2% 62.0% 7,698,000
Carson, California 932,000 37.1% 60.0% 2,509,000
Holiday Inn Select:
La Mirada, California 1,533,000 39.3% 60.0% 3,905,000
Renton (Seattle), Washington 843,000 30.0% 62.0% 2,810,000
Holiday Inn Hotel & Suites:
Craig, Colorado 456,000 30.0% 60.0% 1,519,000
Kent (Seattle), Washington 598,000 36.0% 63.0% 1,660,000
Mesa, Arizona 830,000 31.0% 60.5% 2,677,000
Price, Utah 280,000 24.6% 60.0% 1,140,000
San Diego (Old Town), California 1,176,000 45.7% 60.0% 2,575,000
Holiday Inn:
Flagstaff, Arizona 311,000 30.0% 61.5% 1,035,000
Provo, Utah 171,000 20.0% 65.0% 856,000
Rochester, Minnesota 246,000 9.2% 62.0% 2,668,000
San Diego, California 887,000 25.9% 62.0% 3,424,000
San Diego (Stadium), California 737,000 36.8% 60.0% 2,001,000
Santa Clara, California (3) 1,574,000 47.0% 60.0% 3,124,000
Steamboat Springs, Colorado 401,000 30.0% 60.0% 1,337,000
Holiday Inn Express:
Portland, Oregon 383,000 32.3% 63.0% 1,186,000
Poulsbo, Washington 341,000 35.0% 63.0% 975,000
Hampton Inn:
Clackamas (Portland), Oregon 461,000 38.0% 63.0% 1,212,000
Denver, Colorado 606,000 37.5% 63.0% 1,615,000
Mesa, Arizona 509,000 34.0% 63.0% 1,497,000
Oakland, California 442,000 22.0% 63.0% 2,010,000
Pueblo, Colorado 481,000 36.0% 63.0% 1,337,000
Santa Clarita, California 634,000 33.8% 60.0% 1,877,000
Silverthorne, Colorado 517,000 30.0% 63.0% 1,722,000
Tucson, Arizona 355,000 30.0% 62.0% 1,184,000
</TABLE>
-15-
<PAGE>
<TABLE>
<CAPTION>
Annual
1998 Percentage Lease
Annual --------------------------------- Room
Base First Second Revenue
Rent (1)(2) Tier Tier Threshold (1)
-------------- ----------- ---------- -------------
<S> <C> <C> <C> <C>
Hawthorn Suites:
Anaheim, California 833,000 39.4% 60.0% 2,115,000
Kent, Washington 1,124,000 40.2% 68.0% 2,796,000
Sacramento, California 1,610,000 35.5% 60.0% 4,530,000
Sheraton:
Chandler, Arizona 2,904,000 34.7% 62.0% 8,358,000
Best Western:
Lynnwood, Washington 580,000 45.5% 60.0% 1,274,000
Comfort Suites:
South San Francisco, California 746,000 30.0% 60.0% 2,488,000
Ramada:
San Diego, California 891,000 43.6% 60.0% 2,043,000
Radisson:
Oxnard, California (3) 617,000 24.0% 62.0% 2,576,000
Kahler:
Kahler Inn & Suites
Rochester, Minnesota 1,730,000 47.4% 62.0% 3,653,000
The Kahler Hotel
Rochester, Minnesota 4,147,000 35.2% 62.0% 11,779,000
-----------
$56,890,000
===========
</TABLE>
__________
(1) Effective January 1, 1996, 1997 and 1998, base rent payable and the room
revenue thresholds under the Percentage Leases were adjusted based upon the
change in the CPI for those hotels acquired in 1995, 1996 and 1997. The
lease terms for Hampton Inn located in Arcadia, California which was sold
subsequent to December 31, 1998 have been excluded.
(2) Annual base rent amounts presented have not been prorated for those hotels
acquired during 1998 and do not reflect 1998 rent abatement of $668,000.
(3) 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.
Other than real estate and personal property taxes, ground lease rent,
where applicable, the cost of certain furniture, fixtures and equipment, capital
expenditures and insurance (other than workers' compensation insurance), which
are obligations of the Company, the Percentage Leases require the Lessee to pay
base rent, percentage rent, other additional charges and 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 or
during major renovation.
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 Company with respect to the hotels.
The annual amount is
-16-
<PAGE>
carried forward to the extent that the Lessee or the Company has not expended
such amount, and any unexpended amounts will remain with the Company upon
termination of the Percentage Leases. Otherwise, the Lessee will be required, at
its expense, to maintain the hotel in good order and to repair and to pay for
all operating expenses of the hotel. The Company owns substantially all personal
property including that portion affixed to, or deemed a part of, the real estate
or improvements.
Property Taxes and Insurance. The Company is responsible for paying real
estate and personal property taxes on the hotels (except for taxes on personal
property owned by the Lessee) and for paying all premiums for property,
casualty, comprehensive general public liability (naming the Lessee as an
additional named insured) and other insurance appropriate and customary for
properties similar to the hotel, as determined by the Company. The Lessee is
required to pay for workers' compensation insurance. The Company believes that
the coverages specified in the Percentage Leases are of the type and amount
customarily obtained by owners of hotels similar to the Company's hotels.
Tax Status
The Company has elected to be taxed as a REIT under Section 856 of the
Code, commencing with its taxable year ending December 31, 1995. If the Company
qualifies for taxation as a REIT, then under current federal income tax laws the
Company generally will not be taxed at the corporate level to the extent it
currently distributes at least 95% of its net taxable income to its
stockholders. Even if the Company qualifies for taxation as a REIT, the Company
may be subject to certain federal, state and local taxes on its income and
property and to federal income and excise tax on its undistributed income.
Competition
Intense competition exists for investment opportunities in luxury, upscale
and mid-priced 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 properties as well as secondary
markets in its strategy lessens competition for the types of properties targeted
by the Company.
There are a number of companies which develop, construct and renovate
hotels. Some of these companies perform these services only for their own
portfolios, while others actively pursue contracts for these services with third
party owners.
There is a significant operational competition in the hotel industry.
There are numerous hotel chains that operate on a national or regional basis, as
well as other hotels, motor inns and other independent lodging establishments
throughout the western United States. Competition is primarily in the areas of
price, location, quality and services. Many of the Company's competitors have
recognized trade names, greater resources and longer operating histories than
the Company. However, the Company brands its hotels with strong national
franchises and believes that its management and that of the Lessee is
sufficiently experienced to efficiently manage its hotels, enabling the Company
and Lessee to compete successfully. There can be no assurances, however, that
competitors will not develop or renovate hotels in the markets in which the
Company has historically operated. Increased competition may have a negative
impact on the Company's operating results and consequently cash available for
distribution.
Seasonality
The hotel industry is seasonal in nature and this seasonality is typically
geographically and market specific. The effects of seasonality may be expected
to cause significant quarterly fluctuations in the Company's Percentage
-17-
<PAGE>
Lease revenues. Effects of this seasonality on the Company's operating results
may change depending upon the locations and markets of additional hotels the
Company acquires or develops.
Environmental Matters
Under various federal, state and local laws and regulations, an owner or
operator of real estate may be liable for the costs of removal or remediation of
certain hazardous or toxic substances on such property. Such laws often impose
such liability without regard to whether the owner or operator knew of, or was
responsible for, the presence of hazardous or toxic substances on the property.
The costs of removal or remediation of such substances may be substantial, and
the presence of such substances, or the failure to promptly remediate such
substances, may adversely affect the owner's ability to fully utilize such
property without restriction, to sell such property or to borrow using such
property as collateral. In connection with the ownership and operation of the
hotels, the Company, 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 governmental authority of any material
noncompliance, liability or claim relating to hazardous or toxic substances or
other environmental matters in connection with any of its present or former
properties.
Employees
Messrs. Alter and Biederman have each entered into employment agreements
with the Company for one-year terms which renew automatically until terminated.
While Mr. Alter is required to devote substantially all of his time to the
business of the Company; Mr. Biederman is not. The Company has 28 other
employees. The Lessee employed 4,948 people as of December 31, 1998 to operate
the hotels leased from the Company. The Lessee has advised the Company that its
relationship with its employees is good. The Lessee is subject to collective
bargaining agreements at certain hotels it operates. At December 31, 1998, the
percentage of employees covered by such collective bargaining agreements
represent 11% of the total number of employees of the Lessee. None of the
employees of the Company is a party to any collective bargaining agreement or
other similar agreement.
Minimizing the Risks of Potential Conflicts of Interest
In order to minimize conflicts of interest inherent in the legal structure
required to maintain the Company's status as a REIT, Messrs. Alter and Biederman
each have entered into several agreements. Their respective employment
agreements restrict competitive activities. Additionally, third party pledge
agreements require each of Messrs. Alter and Biederman to pledge Units to the
Company to secure obligations of the Lessee under the Percentage Leases limited
to the total number of Units that Mr. Alter or Mr. Biederman must pledge to the
current number owned of 481,955 shares representing a market value of $3.7
million at March 5, 1999. The Third Party Pledge Agreement subordinates the
Company's lien on these Units to the lien in favor of an institutional lender
providing a working capital line to the primary stockholder of the Lessee, Mr.
Alter. The working capital line is to be used exclusively for the Lessee's
general short-term working capital needs and is secured by a pledge of Mr.
Alter's Units.
In addition, Messrs. Alter and Biederman entered into a unit purchase
agreement (the "Unit Purchase Agreement") with the Company and the Lessee
requiring that the Lessee's income (net of shareholder tax liability) be used to
either accumulate reserves to pay rent under the Percentage Leases or to
purchase Units from the Operating Partnership at the then current price of the
Company's common stock.
The Percentage Leases also contain cross-default provisions permitting the
Company to terminate the Percentage Leases, subject to certain conditions, upon
a default by Messrs. Alter or Biederman under the Unit Purchase Agreement or any
other agreement with the Company. Further, the Management Company has agreed
not to collect any payments from the Lessee after receiving notice of an event
of default under a Percentage Lease. Mr. Alter has personally guaranteed the
Lessee's obligation to return any amounts received by the Management Company in
violation of this agreement.
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RISK FACTORS
Distribution Of Substantially All Cash Available For Distribution
Our hotels generate cash flow in the form of rent we receive from the
Lessee, the entity that leases and operates our hotels. The Lessee's rent is
tied to hotel operating performance and consists of base rent and rent that is a
percentage of certain hotel revenues. In addition, we also have cash available
from a bank line of credit with a maximum commitment of $350.0 million with the
actual availability based on our assets and financial performance. We also have
been able to raise cash by issuing equity securities in the public markets. We
use these three sources of cash, from hotel operations, from borrowings and from
sales of stock to fund our acquisition of hotels, renovation of hotels,
recurring capital expenditures, operating expenses and the payment of dividends
to our shareholders. Because of the recent conditions in the capital markets, it
is currently difficult for many companies, especially REITs, to raise capital by
issuing debt or equity securities. Therefore, we are more dependent on our cash
flows from hotel operations and from our line of credit to fund our obligations.
During 1998, we paid out approximately $44.7 million in distributions to our
stockholders and minority interests which was approximately 78% of our $57.2
million of Funds From Operations. If our operating cash flows decreased or our
availability under the line of credit were reduced, it will be necessary for us
to reduce future acquisitions, defer or reduce the scope of renovations or
capital expenditures, sell assets (including hotels) or to reduce our dividends
paid to shareholders.
Total Dependence On The Lessee And Payments Under The Percentage Leases
Because of our status as a REIT, we are prohibited from operating hotels
and must lease them to the Lessee or other third parties. Our ability to pay
dividends to our shareholders depends on our Lessee's ability to generate
sufficient revenue to pay percentage rent required under the Percentage Leases.
We chose the Lessee because Messrs. Alter and Biederman, who own the Lessee,
were involved in the management of certain hotels contributed as part of our
initial public offering ("IPO") in 1995, and are motivated to maximize
percentage rent paid under the Percentage Leases through their financial and
ownership interests in us.
The Lessee has incurred significant losses since 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.
According to the Lessee, the losses are due to several factors, including:
. the substantial number of renovations we undertook adversely affected
occupancy rates and revenues at the hotels;
. renovations caused greater revenue losses than expected; and
. poorer performance at certain hotels than expected.
There can be no assurance that the Lessee will generate adequate operating
cash flows to meet its obligations. Other than its cash flow generated by
operating the hotels, the Lessee has no financial resources or other assets to
pay its operating obligations or its rent under the Percentage Leases. Messrs.
Alter and Biederman have pledged 481,955 Units to secure the Lessee's
obligations under the Percentage Leases. However, if the Lessee defaults under
the Percentage Leases, the value of these Units and other assets of the Lessee
will be insufficient to satisfy our claims against the Lessee.
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Risks Related To Development And Renovation Of Hotels
Subject to obtaining adequate capital resources, we intend to continue our
growth strategy of acquiring hotels needing substantial renovation or
redevelopment. This strategy creates significant risks including the following:
. We may continue to incur significant renovation and construction cost
overruns and time delays due to:
- labor shortages;
- changes in the scope of a project;
- requirements imposed by local building inspectors;
- discovery of defects in the building once renovation has begun; and
- compliance with the Americans with Disabilities Act of 1990, which
may require expensive modifications to existing hotels to bring them
into compliance.
. We may purchase a hotel or contract to acquire a hotel (after a third
party completes construction) when market conditions are favorable but
then face deteriorated local demand for hotel rooms when the hotel is
available for occupancy resulting in revenues that are less than
projected;
. We may complete our renovation after significant delays reducing the
amount of revenues expected to be received during the delay period; and
. We may spend more than budgeted for a renovation project reducing our
anticipated return on the investment. Conflicts Of Interest Between The
Company and Certain Officers And Directors
The relationship among Mr. Alter and Mr. Biederman, the Lessee, the
Management Company and us creates several inherent conflicts of interest that
may result in decisions being made by our management that are not in the best
interests of our stockholders. The most significant conflicts of interest
include the following:
. As the owners of the Lessee, Mr. Alter and Mr. Biederman will benefit
from any profits the Lessee may generate from the operation of the
hotels and retain for itself, even though under the Unit Purchase
Agreement, Messrs. Alter and Biederman have agreed to reinvest the
Lessee's profits (net of tax liabilities) in additional units or retain
the profits as security for future rent payments.
. As the owner of the Management Company, Mr. Alter is entitled to the
profits of the Management Company, which receives from the Lessee
management fees (1% to 2% of gross revenues of the hotels) and
reimbursements for certain accounting expenses. Because of the Lessee's
current financial condition, the Management Company has agreed to abate
payment of management fees and reimbursements, up to a maximum of $3.5
million during 1998. Through December 31, 1998, management fees
amounting to $3.3 million have been abated. No such agreement is in
effect for 1999 .
. The Percentage Leases generally require us to pay a termination fee to
the Lessee if we elect to sell a hotel and not replace it with a
Percentage Lease for another hotel. As a result, our decisions about
which hotels to sell may be influenced by the conflict of interest of
Messrs. Alter and Biederman who, as owners of the Lessee, would benefit
from the termination fee.
. In connection with our IPO, Messrs. Alter and Biederman contributed tax
free certain hotels that had a tax basis less than their fair market
value. Significant taxable gains that would arise if we were to sell
these hotels would be specifically allocated to Messrs. Alter and
Biederman. Further, in order to prevent
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adverse tax consequences to Messrs. Alter and Biederman, we must
maintain mortgage debt at certain minimum levels. Because of these
conflicts, our decisions concerning whether to sell certain hotels or to
incur or repay debt will be influenced by the tax consequences for
Messrs. Alter and Biederman.
. We did not negotiate the Percentage Leases on an arm's length basis with
the Lessee. The base rent, percentage rent and the economic terms of
each Percentage Lease are determined by us and approved by the Lessee
based on historical financial data and projected operating and financial
data for each hotel. See "Total Dependence on the Lessee and Payments
under the Percentage Leases."
Reliance On Mr. Alter And Other Key Personnel
Our success depends in large part upon our ability to attract and retain
highly qualified personnel. Further, because our sole source of operating
revenue is base and percentage rent paid by the Lessee, our success is also
dependent on the Lessee's management's ability to effectively operate the
hotels. Competition for qualified employees for us and the Lessee is extremely
intense and there is no assurance that we or the Lessee can attract and retain
qualified employees. In particular, we substantially rely on the hotel and real
estate knowledge and experience and continuing services of Mr. Robert Alter, our
Chairman, Chief Executive Officer and President. Our inability (or the
Lessee's) to attract and retain qualified employees could negatively affect our
ability to generate revenues and pay distributions to our shareholders.
Investment Concentration In Single Industry
Our investment strategy is to focus exclusively on acquiring and owning
hotels. This strategy concentrates all our investment in a single industry and
therefore does not diversify our sources of revenues. As a result, a downturn
in the hotel industry will have a greater impact on our revenues and funds from
operations than if we had a diversified portfolio of properties. In addition,
because we have focused on the western United States and in the luxury, upscale
and mid-price segments of the hotel industry, economic or other conditions that
affect this geographic region or these segments may disproportionately impact
us.
Failure To Realize Benefits Of Recent Acquisitions
We have grown rapidly since our IPO. This growth has required us, and, to
a greater extent, the Lessee to develop scaleable operating systems, develop
construction management procedures and systems and other procedures and systems
to operate our multi-state hotel portfolio. If we, or the Lessee, fail to
effectively integrate the acquired hotels into our operating systems, then we
will not achieve the expected benefits of the acquisition.
The revenues generated by the hotels we acquire are used to pay the debt
service on the funds we borrow to fund these acquisitions. If the acquired
hotels do not generate sufficient cash flow to fund debt service on the money
borrowed to purchase those hotels, we will be required to service the debt with
cash flows from other hotels which might adversely affect our cash available for
other purposes, including distributions to our shareholders.
Failure To Maintain REIT Status
We intend to operate so as to be taxed as a REIT under the Internal Revenue
Code of 1986, as amended. As long as we qualify for taxation as a REIT, with
certain exceptions, we will not be taxed at the corporate level on our taxable
income that is distributed to our 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. We intend to satisfy
all of these requirements for treatment as a REIT. It is possible that we may
fail to satisfy one or more of these requirements. Failure to qualify as a REIT
would render us subject to tax on our income at regular corporate rates and we
could not deduct distributions to our shareholders. Unless entitled to relief
under certain Internal Revenue Code provisions, we also would be disqualified
from treatment as a REIT for the four taxable years following the year during
which qualification was lost. Even if we qualify for taxation as a REIT, we may
be subject to certain state and local taxes on our income and property.
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In order for us 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 our ownership interest in the Partnership
constitutes more than 10% of the Partnership's voting securities and exceeds 5%
of the value of our assets, we would cease to qualify as a REIT. The imposition
of corporate income tax on us and the Partnership would substantially reduce the
amount of cash available for distribution to our shareholders.
Ownership Limitation
In order for us to maintain our qualification as a REIT, not more than 50%
in value of our outstanding stock may be owned, directly or indirectly, by five
or fewer individuals (which includes certain entities). Furthermore, if any
shareholder or group of shareholders of the Lessee owns, actually or
constructively, 10% or more of our stock we would likely lose our REIT status.
To protect our REIT qualification, our Articles of Incorporation prohibit direct
or indirect ownership of more than 9.8% of the outstanding shares of our stock
by any person or group. Generally, the capital stock owned by affiliated owners
will be aggregated for purposes of this ownership limitation. Subject to certain
exceptions, any stock subject to a purported transfer that would prevent us from
continuing to qualify as a REIT will be designated as "Shares-in-Trust" and
transferred automatically to a trust effective on the day before the purported
transfer of such 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
shares of stock to the trust and the beneficiary of the trust will be one or
more charitable organizations that are named by us.
Inability To Retain Earnings
In order to qualify as a REIT, we generally are required each year to
distribute to our shareholders at least 95% of our net taxable income (excluding
any net capital gain). In addition, we are subject to a 4% nondeductible excise
tax on the amount, if any, by which certain distributions paid by us with
respect to any calendar year are less than the sum of (i) 85% of our ordinary
income, (ii) 95% of our capital gain net income for that year, and (iii) any
undistributed taxable income from prior periods. We intend to continue to make
distributions to our shareholders to comply with the 95% distribution
requirement and to avoid the nondeductible excise tax. Differences in timing
between taxable income and cash available for distribution to our shareholders
due to the seasonality of the hospitality industry could require us to borrow
funds on a short-term basis to meet the 95% distribution requirement and to
avoid the nondeductible excise tax.
The Company May Not Be Able To Continue Its External Growth Rate
Our growth strategy has been to acquire underperforming and
undercapitalized hotels located in strong markets where we believe significant
barriers to entry exist. We then seek to improve the hotels' financial
performance by renovating, redeveloping, and repositioning the hotels and
requiring the Lessee to implement a focused sales and marketing program. The
current conditions in the equity and debt capital markets limit our ability to
access new capital on favorable terms. Without additional capital to fund
acquisitions we will not be able to continue to acquire additional hotels. We
anticipate that our acquisition activity will diminish significantly for the
remainder of 1999. Accordingly, we cannot assure you that our external growth
rate will equal or exceed our recent historical external growth rate.
Environmental Risks
Various federal, state and local laws subject property owners or operators
to liability for the costs of removal or remediation of certain hazardous
substances released on property. These laws often impose liability without
regard to whether the owner or operator knew of, or was responsible for, the
release of the hazardous substances. The presence of or the failure to properly
remediate hazardous substances may adversely affect occupancy of a contaminated
hotel property, the ability to operate hotels, and our ability to sell or borrow
against contaminated properties. In addition to the costs associated with
investigation and remediation actions brought by governmental agencies, the
presence of hazardous waste on a property could result in personal injury or
similar claims or lawsuits.
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Various laws also impose, on persons who arrange for the disposal or
treatment of hazardous or toxic substances, liability for the cost of removal or
remediation of hazardous or toxic substances at the disposal or treatment
facility. These laws often impose liability whether or not the person arranging
for the disposal ever owned or operated the disposal facility. The obligation
to pay for these costs or our inability to pay for such costs, could adversely
affect our operating costs and the value of our properties.
Phase I environmental site assessments have been obtained on all of our
owned properties. The purpose of Phase I environmental site assessments is to
identify potential sources of contamination for which an owner may be
responsible and to assess the status of environmental regulatory compliance.
None of the environmental site assessments revealed any environmental condition,
liability or compliance concern that we believe would have a material adverse
affect on our business, assets or results of operations. Nor are we aware of
any such condition, liability or concern by any other means. However, it is
possible that the environmental site assessments relating to any one of the
properties did not reveal all environmental conditions, liabilities or
compliance concerns that arose at a property before or after the related review
was completed.
Real Estate Investment Risks In General
Each of our hotels are subject to a variety of risks associated with real
estate ownership. Some of these risks include:
. Changes in national and local economic conditions;
. Changes in interest rates;
. Changes in costs of, or terms of, loans from lenders;
. Changes in environmental laws;
. The ongoing requirement to make capital improvements, repairs or
maintenance;
. Changes in the tax rates or laws;
. The continuing requirement to pay operating expenses;
. Changes in governmental requirements or zoning laws;
. Occurrences beyond the control of an owner, such as natural disasters
like earthquakes and weather, civil unrest or so-called "acts of God;"
. The possibility of unexpected, uninsured or under-insured losses; and
. Condemnation by a government agency seeking to use a property for a
public purpose.
Risks such as those listed above, and other risks which may occur from time
to time, may adversely affect our profit from the property because they cause
increased costs, expenses, liabilities, restrictions and operational delays.
Such risks may also affect the price we may obtain on a sale of a property or
whether the property can be sold at all.
Uninsured And Under-Insured Losses
We carry comprehensive policies of insurance for our hotels which include
liability for personal injury, property damage, fire and extended coverage. We
believe the coverage we carry is typical and customary for owners of hotels such
as ours. Even though we carry the insurance referenced above, certain losses
may be uninsurable by virtue of the type or amount of loss. Losses which result
from catastrophes, such as hurricanes, tornadoes, earthquakes, floods or so-
called "acts of God," may fall within that category. More than half of our
hotels are located in California
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and the Pacific northwest, an area which is subject to a high degree of seismic
activity and risk. Although we carry earthquake insurance for our hotels, there
is no assurance that such insurance will be available in the future under terms
and amounts which are sufficient to provide adequate protection. It also could
be possible that the current insurance coverage we carry would not be sufficient
to pay the full market value or replacement cost of an affected hotel with a
resulting loss of our entire investment. Therefore, a possibility does exist for
substantial uninsured or under-insured losses as a result of an earthquake.
Other factors also affect whether a loss is uninsured or under-insured and
may include inflation, changes in law or environmental contamination. Such
factors may affect whether insurance proceeds received by us are adequate to
restore our entire investment in the property. Factors such as these may also
make it impractical to use insurance proceeds to replace or repair our property
after it has been damaged or destroyed.
Because Real Estate Investments Are Illiquid, We May Not Be Able To Sell
Properties When Appropriate
Real estate investments generally cannot be sold quickly. We may not be
able to vary our portfolio promptly in response to economic or other conditions.
This inability to respond promptly to changes in the performance of our
investments could adversely affect our financial condition and ability to
service debt and make distributions to our shareholders.
Our Earnings And Cash Distributions Will Affect The Market Price Of Our Publicly
Traded Securities
We believe that the market value of a REIT's equity securities is based
primarily upon the market's perception of the REIT's growth potential and its
current and potential future cash distributions, and is secondarily based upon
the real estate market value of the underlying assets. For that reason, REIT
shares may trade at prices that are higher or lower than the net asset value per
share. To the extent we retain operating cash flow for investment purposes,
working capital reserves or other purposes, these retained funds, while
increasing the value of our underlying assets, may not correspondingly increase
the market price of our shares. Our failure to meet the market's expectations
with regard to future earnings and cash distributions would likely adversely
affect the market price of our publicly traded securities.
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
twenty-first century dates from twentieth century dates. If not corrected,
computer systems may fail or create erroneous results which could have
significant negative operational and financial consequences. We have adopted a
Year 2000 Compliance Program (the "Compliance Program") to minimize disruptions
to our business which could be caused by computer system error or failure. These
computerized systems include information and non-information technology systems
and applications, as well as, financial and operational reporting systems. For
discussion of the Company's efforts to address the Year 2000 issue and the
related Compliance Program see "Management's Discussion and Analysis of
Financial Condition and Results of Operations, Year 2000 Issue."
There can be no assurances that our Compliance Program will be properly and
timely completed, and failure to do so could have a material adverse effect our
business operations and financial condition. We cannot predict the actual
effects of the Year 2000 issue on our business operations and financial
condition. The actual effects may be impacted by: (i) whether significant
third parties properly and timely address the Year 2000 issue; and (ii) whether
broad-based or systemic economic failures may occur. We are also unable to
predict the severity and duration of any such failures, which could include
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. Due
to the general uncertainty inherent in the Year 2000 issue and our dependence on
third parties, we are unable to determine at this time whether the consequences
of Year 2000 failures will have a material impact on us. Our Compliance Program
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is expected to significantly reduce the level of uncertainty about the Year 2000
issue and we believe that the possibility of significant interruptions of normal
operations should be reduced.
Market Interest Rates May Have An Effect On The Value Of Our Publicly Traded
Securities
One of the factors that investors consider important in deciding whether to
buy or sell shares of a REIT is the distribution rate on such shares (as a
percentage of the price of such shares) relative to market interest rates. If
market interest rates go up, prospective purchasers of REIT shares may expect a
higher distribution rate. Higher interest rates would not, however, result in
more funds for us to distribute and, in fact, would likely increase our
borrowing costs and potentially decrease funds available for distribution.
Thus, the higher market interest rates could cause the market price of our
publicly traded securities to go down.
Hotel Industry Risks
Operating Risks. In addition to the investment risks associated with
investing all of our resources in the hotel industry, we face operating risks
associated with hotels. These risks include, among others, the following:
. Competition for customers at our hotels from other hotels, many of which
are owned by competitors who have significantly greater financial
resources and marketing power and therefore compete with our hotels;
. The risk of loss of market share in areas in which overbuilding occurs
and adversely affects occupancy, ADR and REVPAR;
. Erosion of operating margins arising from an increase in operating costs
due to inflation or other factors that may exceed increases in REVPAR;
. Dependence on demand for our accommodations from both business
travelers, commercial travelers and tourism, each of which may be
affected in different markets by different economic factors;
. Strikes and other labor disturbances by the Lessee's employees which
would seriously disrupt the Lessee's ability to provide services to
hotel guests;
. The deterioration of economic conditions either generally or in
particular markets in which our hotels are located causing a reduction
in demand for our accommodations.
The Lessee's operating results at our hotels are directly affected by the
factors described above and a significant decrease in operating revenues by the
Lessee will adversely affect the Lessee's ability to make payments of rent under
the percentage leases. Any reduction in such rent will reduce our cash and
could adversely affect our ability to make distributions to our stockholders.
Seasonality of Hotel Business and Our Hotels. The hotel industry in
general is seasonal with certain periods generating greater revenues than
others. In particular, our revenues are greater in the second and the third
quarters than in the first and the fourth quarters. In addition, winter weather
in the markets in which our hotels operate can severely impact the operating
results of particular hotels, such as occurred in 1998 in Arizona due to the
effects of El Nino. The Lessee's revenues can vary significantly from quarter
to quarter. It is possible that the significant fluctuation of revenues in a
particular quarter due to weather or other factors could cause us to earn less
percentage rent than we had originally anticipated which could have an adverse
effect on our ability to make distributions to our shareholders.
Increased Competition from Overbuilding. The hotel industry has
historically experienced cycles of overbuilding in certain geographic markets
and product segments. This overbuilding increases competition for hotel guests,
resulting in lower occupancies and lower ADRs thereby reducing revenues of the
hotels effected by the increased competition. While our investment strategy is
to acquire underperforming hotels in markets where we believe there are
significant barriers to entry, we can give no assurance that the current hotel
development activities, particularly in the limited service segment, will not
create additional significant competition for our hotels. This
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increased competition would reduce the revenues generated by the Lessee at the
effected hotel, thus reducing percentage rent we receive and therefore
potentially adversely effecting our distributions to our shareholders.
Impact of Increased Operating Costs and Capital Expenditures. Our hotels
need to be periodically renovated and furniture, fixtures and equipment replaced
in order to remain competitive in their markets and to comply with the terms of
franchise agreements under which our hotels are operated. Under our Percentage
Leases, we are obligated to make available to the Lessee for periodic
refurbishment of furniture, fixtures and equipment an amount equal to four
percent (4%) of the room revenues of each hotel. Our ability to fund these and
other capital expenditures including periodic replacement of furniture, fixtures
and equipment will depend in part on the financial performance of the Lessee and
our hotels. If these expenditures exceed our estimates, then the increased
costs would adversely effect the cash available for other purposes such as
making distributions to our stockholders. Alternatively, if we fail to make
these expenditures, we may adversely effect the competitive position of the
hotels and have an adverse effect on occupancy rates, ADRs and REVPAR. In
certain instances, our failure to make certain capital expenditures may
constitute a default under the applicable franchise agreement.
Risks Of Operating Under Franchise Agreements.
Of our 56 hotels, 54 are operated under franchise agreements with national
franchisors. The Lessee is the franchisee and is responsible for complying with
the franchise agreements. Under these arrangements, a franchisor provides
marketing service and room reservations and certain other operating assistance,
but requires the Lessee to pay significant fees as well as maintain the hotel in
a certain required condition. If the Lessee fails to maintain these required
standards or we fail to make required capital expenditures (or to fund the
Lessee's expenditures) then there may be a termination of the franchise
agreement and possible liability for damages. If the Lessee were to lose a
franchise on a particular hotel, it could have a material adverse effect upon
the operation, financing or value of that hotel due to the loss of the franchise
name, marketing support and centralized reservation system. In addition,
adverse publicity affecting a franchisor could reduce the revenues we receive
from the hotels subject to such franchise. Any loss of revenues by the Lessee
at a hotel because of loss of the franchise agreement would adversely effect the
Lessee's ability to pay rent and could effect our ability to make distributions
to our stockholders.
Our Degree Of Leverage Could Limit Our Ability to Obtain Additional Financing
Our Articles of Incorporation limits consolidated indebtedness to 50% of
our investment in hotel properties, at cost on a consolidated basis, after
giving effect to our use of proceeds from the indebtedness. As of December 31,
1998, our ratio of debt to total investment in hotel properties and other real
estate investments was approximately 41%. The degree of leverage could have
important consequences to our stockholders, including, effecting our ability to
obtain additional financing in the future for working capital, capital
expenditures, acquisitions, development or other general corporate purposes
including the payment of distributions and could make us more vulnerable to a
downturn in business or the economy.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Operating 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 Operating Partnership
or any of the hotels. The Lessee and the Management Company have each advised
the Company that it is currently is not involved in any material litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
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PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
The Company's Common Stock is traded on the New York Stock Exchange under
the ticker symbol "SSI". The following table sets forth the high and low stock
prices for the last two fiscal years:
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
1997 Quarter Ended
March 31....................... $14.000 $12.250
June 30........................ 14.500 12.625
September 30................... 18.125 13.750
December 31.................... 18.125 15.500
1998 Quarter Ended
March 31....................... $17.375 $14.875
June 30........................ 16.500 12.500
September 30................... 13.750 8.313
December 31.................... 11.000 6.500
</TABLE>
Stockholder Information
As of March 5, 1999, there were approximately 868 record holders of the
Company's Common Stock. On March 5, 1999, the last reported sale price of the
Common Stock on the NYSE was $7.6875 per share. In addition, the Units (which
are exchangeable for Common Stock) were held by 48 entities and/or individuals
as of March 5, 1999. 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.
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Dividends
The Company has adopted a policy of paying regular quarterly dividends on
its common stock, and cash distributions have been paid on the Company's common
stock with respect to each quarter since the Company's inception in 1995. The
following table sets forth information regarding the declaration and payment of
distributions by the Company for 1997 and 1998:
<TABLE>
<CAPTION>
Per Share
Quarter to Which Distribution Distribution Distribution
Distribution Relates Record Date Payment Date Amount
- ------------------------ ------------ ------------ ------------
<S> <C> <C> <C>
1997 Quarter Ended
March 31 4/29/97 5/15/97 $ 0.25
June 30 7/31/97 8/15/97 $ 0.25
September 30 9/30/97 11/14/97 $0.275
December 31 1/31/98 2/15/98 $0.275
1998 Quarter Ended
March 31 5/1/98 5/13/98 $0.275
June 30 7/31/98 8/12/98 $0.275
September 30 10/30/98 11/10/98 $0.285
December 31 2/1/99 2/15/99 $0.285
</TABLE>
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.
-28-
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
(The Company)
<TABLE>
<CAPTION>
Inception August
16, 1995 to
For the Years Ended December 31, 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
FUNDS FROM OPERATIONS ("FFO") (1) $ 57,218,000 $ 32,226,000 $ 11,238,000 $ 2,592,000
CASH FLOW FROM OPERATING ACTIVITIES $ 63,911,000 $ 24,316,000 $ 11,669,000 $ 2,291,000
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>
________________
(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.
-29-
<PAGE>
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, Ended
------------------------------------------ 1995 (Inception) to 1995 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:
. acquired 10 hotels for an aggregate purchase price of $134.2 million;
. sold six non-core hotel properties located in tertiary markets for an
aggregate sales price of $47.2 million;
. invested $68.2 million in renovation and redevelopment to 20 hotels;
. raised approximately $69.4 million of equity capital through the sale of
common stock in a shelf offering; and
. 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.
-30-
<PAGE>
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>
- -------------------
(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
-31-
<PAGE>
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.
-32-
<PAGE>
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.
-33-
<PAGE>
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%
== ====== ==== =========== ====
</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>
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>
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
one measure of the financial performance of an equity REIT that provides a
relevant basis for comparison among REITs and it is presented to assist
investors in analyzing the performance of the Company. Funds From Operations is
defined as net income (computed in accordance with generally accepted accounting
principles), excluding gains (losses) from debt restructuring and sales of
property plus real estate related depreciation and amortization (excluding
amortization of financing costs). FFO should be considered in conjunction with
net income as presented in the Company's consolidated financial statements and
Notes thereto. Funds From Operations does not represent cash generated from
operating activities in accordance with generally accepted accounting principles
and is not necessarily indicative of cash available to fund cash needs. Funds
From Operations should not be considered an alternative to net income as an
indication of the Company's financial performance or as an alternative to cash
flows from operating activities as a measure of liquidity.
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
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.
-36-
<PAGE>
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 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
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<PAGE>
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
significant portion of the Company's hotel portfolio underwent renovation and
redevelopment, 20, 19 and 8 hotels, respectively.
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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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's current and future debt obligations. The Company is
vulnerable, however, to significant fluctuations of interest rates on its
floating rate debt, repricing on its fixed rate debt at various points in the
future and future debt.
The following table provides information about the Company's financial
instruments that are sensitive to changes in interest rates. For debt
obligations, the table presents principal cash flows and related weighted-
average interest rates by expected maturity dates.
<TABLE>
<CAPTION>
Fair Value
1999 2000 2001 2002 2003 Thereafter Total 12/31/98
-----------------------------------------------------------------------------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities
Tax-exempt mortgage bond financings... $ 740 $ 792 $ 857 $ 926 $ 1,009 $ 24,366 $28,690 $28,690
Average interest rate (1)...........
Unsecured line of credit.............. 274,500 274,500 274,500
Average interest rate............... LIBOR + 1.75%
Fixed mortgage notes payable.......... 7,661 1,196 1,272 30,596 598 12,356 53,679 55,457
Average interest rate............... 9.57% 8.70% 8.57% 7.99% 9.53% 9.42%
Variable mortgage notes payable....... 22,600 22,600 22,600
Average interest rate............... LIBOR + 2.25%
</TABLE>
__________
(1) The average interest rates are variable tax-exempt rates and are adjusted on
a weekly or monthly basis. The weighted average interest rate as of
December 31, 1998 was 3.75%.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Regulation S-X
are included in this Annual Report on Form 10-K commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Information with respect to changes in accountants has been previously
filed on Current Report on Form 8-K dated July 7, 1997 with disclosure under
Item 4 regarding a change in the Company's certifying accountants and is
incorporated herein by reference.
There were no disagreements with accountants on accounting and financial
disclosure.
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<PAGE>
PART III
--------
Certain information required by Part III is omitted from this Report in
that the Company has filed a definitive proxy statement pursuant to Regulation
14A (the "Proxy Statement") for its Annual Meeting of Stockholders to be held
May 24, 1999 and the information included therein is incorporated herein by
reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors of the Company is incorporated by
reference from the information under the caption "Election of Director-Nominees"
in the Company's Proxy Statement. Information with respect to executive
officers of the Company is incorporated by reference from the information under
the caption "Executive Officers" in the Company's Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation and Other
Information" in the Company's Proxy Statement is Incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Stock Ownership of Management and
Principal Stockholders" in the Company's Proxy Statement is Incorporated by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Transactions" in the Company's
Proxy Statement is Incorporated by reference.
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<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
1. Financial Statements See Index to Financial Statements on page F-1.
2. Financial Statement Schedule See Index to Financial Statements on
page F-1.
3. Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Amended Articles of Incorporation of the Company, as further amended by the Articles of Amendment
of the Company, as filed with the State Department of Assessments and Taxation of Maryland on
November 9, 1994, filed as Exhibit 3.1 to the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
3.2 Amended and Restated Bylaws of the Company, as currently in effect filed as Exhibit 3.2 to the
Company's Registration Statement No. 333-65037 and incorporated herein by this reference.
3.3 Articles of Amendment of the Company, as filed with the State Department of Assessments and
Taxation of Maryland on June 19, 1995, filed as Exhibit 3.3 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this reference.
3.4 Articles of Amendment of the Company, as filed with the State Department of Assessments and
Taxation of Maryland on August 14, 1995, filed as Exhibit 3.4 to the Company's Current Report on
Form 10-Q for the quarter ended March 31, 1997 and incorporated herein by this reference
3.5 Articles of Amendment of the Company, as filed with the State Department of Assessments and
Taxation of Maryland on May 2, 1997, filed as Exhibit 3.5 to the Company's Current Report on Form
10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference.
3.5.1 Articles of Amendment of the Company, as filed with the State Department of Assessments and
Taxation of Maryland on April 21, 1998, filed as Exhibit 3.5 to the Company's Registration
Statement No. 333-65037 and incorporated herein by this reference.
3.6 Articles Supplementary Classifying Shares of 7.9% Class A Cumulative Convertible Preferred Stock,
as filed with the State Department of Assessments and Taxation of Maryland on October 14, 1997,
filed as Exhibit 3.6 to the Company's Annual Report on Form 10-K for the year ended December 31,
1997 and incorporated herein by this reference.
10.1 thru Omitted
10.1.14
10.1.15 Second Amended and Restated Agreement of Limited Partnership dated as of October 4, 1997, filed as
Exhibit 10.1.15 to the Company's 1997 Annual Report on Form 10-K and incorporated herein by this
reference.
10.1.16* Counterpart Second Amended and Restated Agreement of Limited Partnership for Admission of
Additional Limited Partner to Sunstone Hotel Investors, dated April 30, 1998.
10.2 Form of Percentage Lease, filed as Exhibit 10.2 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
10.2.1 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Denver S.E., Colorado, filed as Exhibit 10.2.1 to the Company's 1995 10-K and incorporated herein
by this reference.
10.2.2 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Pueblo, Colorado, filed as Exhibit 10.2.2 to the Company's 1995 10-K and incorporated herein by
this reference.
10.2.3 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Courtyard By Marriott Hotel
located in Fresno, California, filed as Exhibit 10.2.3 to the Company's 1995 10-K and incorporated
herein by this reference.
10.2.4 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Courtyard By Marriott Hotel
located in Fresno, California, filed As Exhibit 10.2.4 to the Company's 1995 10-K and incorporated
herein by this reference.
10.2.5 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Steamboat Springs, Colorado, filed as Exhibit 10.2.5 to the Company's 1995 10-K and incorporated
herein by this reference.
10.2.6 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Craig, Colorado, filed as Exhibit 10.2.6 to the Company's 1995 10-K and incorporated herein by
this reference.
10.2.7 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in
Provo, Utah, filed as Exhibit 10.2.7 to the Company's 1995 10-K and incorporated herein by this
reference.
10.2.8 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P. as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Silverthorne, Colorado, filed as Exhibit 10.2.7 to the Company's 1995 10-K and incorporated herein
by this reference.
10.2.9 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Doubletree Hotel located in Santa
Fe, New Mexico, filed as Exhibit 10.2.9 to the Company's 1995 10-K and incorporated herein by this
reference.
10.2.10 Lease Agreement dated as of August 16, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Arcadia, California, filed as Exhibit 10.2.10 to the Company's 1995 10-K and incorporated herein
by this reference.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
10.2.11 Lease Agreement dated as of December 13, 1995 by and between Sunstone Hotel Investors, L.P., as
lessor, and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn Hotel located in
Oakland, California, filed as Exhibit 10.2.11 to the Company's 1995 10-K and incorporated herein
by this reference.
10.2.12 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Clackamas,
Oregon, filed as Exhibit 10.2.12 to the Company's Quarterly Quarter 1996 10-Q for the quarter
ended March 31, 1996 and incorporated herein by this reference.
10.2.13 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Kent,
Washington, filed as Exhibit 10.2.13 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1996 and incorporated herein by this reference.
10.2.14 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Poulsbo,
Washington, filed as Exhibit 10.2.14 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1996 and incorporated herein by this reference.
10.2.15 Lease Agreement dated February 2, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Cypress Inn Hotel located in Portland,
Oregon, filed as Exhibit 10.2.15 to the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1996 and incorporated herein by this reference.
10.2.16 Lease Agreement dated March 28, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Courtyard by Marriott Hotel located in
Riverside, California, filed as Exhibit 10.2.16 to the Company's Registration Statement No.
333-07685 and incorporated herein by this reference.
10.2.17 Lease Agreement dated June 28, 1996 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn Hotel located in Renton,
Washington, filed as Exhibit 10.2.17 to the Company's Registration Statement No. 333-07685 and
incorporated herein by this reference.
10.2.18 Lease Agreement dated August 13, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Days Inn Hotel located in Price, Utah,
filed as Exhibit 10.2.18 to the Company's Registration Statement No. 333-07685 and incorporated
herein by this reference.
10.2.19 Lease Agreement dated September 20, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Residence Inn Hotel located in Highlands
Ranch, Colorado, filed as Exhibit 10.2.18 to the Company's Registration Statement No. 333-07685
and incorporated herein by this reference.
10.2.20 Lease Agreement dated August 13, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Comfort Suites Hotel located in South San
Francisco, California, filed as Exhibit 10.2.20 to the Company's Registration Statement No.
333-07685 and incorporated herein by this reference.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
10.2.21 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Hampton Inn located in Tucson, Arizona.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in
the schedule filed as Exhibit 10.2.21 to the Company's Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 1997 and incorporated herein by this reference.
10.2.22 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in Mesa, Arizona.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth in
the schedule filed as Exhibit 10.2.22 to the Company's Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 1997 and incorporated herein by this reference.
10.2.23 Lease Agreement dated October 29, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in Flagstaff, Arizona.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth
in the schedule filed as Exhibit 10.2.23 to the Company's Quarterly Report on Form 10-Q/A for the
quarter ended June 30, 1997 and incorporated herein by this reference.
10.2.24 Lease Agreement dated December 19, 1996 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Radisson Suites located in Oxnard,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.24 to the Company's Quarterly Report on Form
10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference.
10.2.25 Lease Agreement dated January 17, 1997 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in San Diego,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.25 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by this reference.
10.2.26 Lease Agreement dated January 17, 1997 by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Ramada Hotel located in Cypress,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.26 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by this reference.
10.2.27 Lease Agreement dated March 10, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Hawthorne Suites Hotel located in Kent,
Washington. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.27 to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1997 and incorporated herein by this reference.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
10.2.28 Lease Agreement dated March 31, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in La Mirada, California.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth
in the schedule filed as Exhibit 10.2.28 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997 and incorporated herein by this reference.
10.2.29 Lease Agreement dated May 6, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Fountain Suites located in Sacramento,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.29 to the Company's Quarterly Report on Form
10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this reference.
10.2.30 Lease Agreement dated June 11, 1997 by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Ramada Plaza Hotel located in Old Town, San
Diego, California. Substantially identical to Exhibit 10.2; full text omitted pursuant to
Instruction 2 to Item 601 of Regulation S-K. The material differences between this Exhibit and
Exhibit 10.2 are set forth in the schedule filed as Exhibit 10.2.30 to the Company's Quarterly
Report on Form 10-Q/A for the quarter ended June 30, 1997 and incorporated herein by this
reference.
10.2.31 Lease Agreement dated July 17, 1997, by and between Sunstone Hotel Investors, L.P., as lessor, and
Sunstone Hotel Properties, Inc., as lessee, for the Best Western located in Lynnwood, Washington.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth
in the schedule filed as Exhibit 10.2.31 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997 and incorporated herein by this reference.
10.2.32 Lease Agreement dated August 7, 1997, by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Holiday Inn located in San Diego,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.32 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997 and incorporated herein by this reference.
10.2.33 Lease Agreement dated August 7, 1997, by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Crystal Suites located in Anaheim,
California. Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2
to Item 601 of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are
set forth in the schedule filed as Exhibit 10.2.33 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997 and incorporated herein by this reference.
10.2.34 Lease Agreement dated August 28, 1997, by and between Sunstone Hotel Investors, L.P., as lessor,
and Sunstone Hotel Properties, Inc., as lessee, for the Regency Plaza located in Los Angeles.
Substantially identical to Exhibit 10.2; full text omitted pursuant to Instruction 2 to Item 601
of Regulation S-K. The material differences between this Exhibit and Exhibit 10.2 are set forth
in the schedule filed as Exhibit 10.2.34 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1997 and incorporated herein by this reference.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
Lease Agreement by and between Sunstone Hotel Investors, L.P. or its subsidiaries as lessor, and
Sunstone Hotel Properties, Inc., as lessee, substantially identical to Exhibit 10.2; full text
omitted pursuant to Instruction 2 to Item 601 of Regulation S-K and incorporated herein by this
reference.
10.2.36* Lease Agreements entered into in 1998 by and between Sunstone Hotel Investors, L.P. or its
subsidiaries as lessor, and Sunstone Hotel Properties, Inc., as lessee for various hotel
properties. Full text of leases omitted pursuant to Instruction 2 to Item 601 of Regulation S-K.
The hotel properties subject to the leases, the dates of the leases and the material differences
between the leases and the lease filed as Exhibit 10.2 are set forth in the Schedule of Material
Differences Among Percentage Leases for 1998.
10.3 Form of Right of First Refusal and Option to Purchase, filed as Exhibit 10.3 to the Company's
Registration Statement No. 33-84346 and incorporated herein by this reference.
10.4 Form of Alter Employment Agreement, filed as Exhibit 10.4 to the Company's Registration Statement
No. 33-84346 and incorporated herein by this reference.
10.5 Form of Biederman Employment Agreement, filed as Exhibit 10.5 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this reference.
10.6 Form of Indemnification Agreement to be entered into with officers and directors of the Company,
filed as Exhibit 10.6 to the Company's Registration Statement No. 33-84346 and incorporated herein
by this reference.
10.7 1994 Stock Incentive Plan, filed as Exhibit 10.7 to the Company's Registration Statement No.
33-84346 and incorporated herein by this reference.
10.7.1 Amendment to the 1994 Stock Incentive Plan filed on March 17, 1997 as Appendix A to the Company's
1997 Proxy Statement and incorporated herein by this reference.
10.7.2 Amendment to the 1994 Stock Incentive Plan filed on February 27, 1999 as Appendix A to the
Company's 1998 Preliminary Proxy Statement and incorporated herein by this reference.
10.8 Form of Notice of Grant of Stock Option and Form of Stock Option Agreement (and Addendum thereto)
to be generally used in connection with the Discretionary Option Grant Program of the 1994 Stock
Incentive Plan, filed as Exhibit 10.8 to the Company's Registration Statement No. 33-84346 and
incorporated herein by this reference.
10.9 Form of Stock Purchase Agreement to be generally used in connection with the Discretionary Option
Grant Program of the 1994 Stock Incentive Plan, filed as Exhibit 10.9 to the Company's
Registration Statement No. 33-84346 and incorporated herein by this reference.
10.10 1994 Directors Plan, filed as Exhibit 10.10 to the Company's Registration Statement No. 33-84346
and incorporated herein by this reference.
10.10.1 Amendment to the 1994 Directors Plan filed on March 17, 1997 as Appendix B with the Company's 1997
Proxy Statement and incorporated herein by this reference.
</TABLE>
-46-
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- -----------------------------------------------------------------------------------------------------------------
<C> <S>
10.11 Form of Notice of Grant of Automatic Stock Option, Automatic Stock Option Agreement, Stock
Purchase Agreement and Automatic Direct Stock Issuance Agreement to be generally used in
connection with the 1994 Directors Plan, filed as Exhibit 10.11 to the Company's Registration
Statement No. 33-84346 and incorporated herein by this reference.
10.12 thru Omitted
10.20
10-22 thru Omitted
10.30.17
10.30.18 Amended and Restated Third Party Pledge Agreement among the Partnership, Robert A. Alter and
Charles Biederman, effective August 28, 1997 filed as Exhibit 10.30.18 to the Company's 1997
Annual Report on Form 10-K and incorporated herein by this reference.
10.31 Omitted
10.31.1 Amended and Restated Revolving Credit Agreement dated as of October 10, 1997, among Sunstone Hotel
Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New York Branch, Wells Fargo Bank, National
Association, filed as Exhibit 10.31.1 to the Company's 1997 Annual Report on Form 10-K/A filed on
October 16, 1998 and incorporated herein by this reference.
10.31.2 First Amendment to Amended and Restated Revolving Credit Agreement, dated January 26, 1998, among
Sunstone Hotel Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New York Branch, Wells Fargo
Bank, National Association, filed as Exhibit 10.31.1 to the Company's 1998 Annual Report on Form
10-K and incorporated herein by this reference.
10.31.3* Second Amendment to Amended and Restated Revolving Credit Agreement, dated July 22, 1998, among
Sunstone Hotel Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New York Branch, Wells Fargo
Bank, National Association.
10.31.4* Third Amendment to Amended and Restated Revolving Credit Agreement, dated August 28, 1998, among
Sunstone Hotel Investors, L.P., Bank One Arizona, NA, Credit Lyonnais New York Branch, Wells Fargo
Bank, National Association.
10.32 Stock Purchase Agreement among the Company, Westbrook Real Estate Fund I, L.P., Westbrook Real
Estate Co-Investment Partnership I, L.P. and Kahler Realty Corporation dated as of August 5, 1997,
filed on August 14, 1997 as Exhibit 10.1 to the Company's Current Report on Form 8-K and
incorporated herein by this reference.
10.33 Registration Rights Agreement among the Company, Westbrook Real Estate Fund I, L.P., Westbrook
Real Estate Co-Investment Partnership I, L.P. dated as of October 15, 1997 and filed as Exhibit
10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
10.34 Asset Purchase Agreement by and between Sunstone Hotels, LLC and Sunstone Hotel Properties, Inc.,
dated October 14, 1997 and filed as Exhibit 10.34 to the Company's Annual Report on Form 10-K/A on
March 30, 1998 and incorporated herein by this reference.
10.35 First Amendment to Asset Purchase Agreement dated December 19, 1997 and filed as Exhibit 10.24.1
to the Company's Annual Report on Form 10-K/A on March 30, 1998 and incorporated herein by this
reference.
</TABLE>
-47-
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
<C> <S>
21 List of Subsidiaries of the Registrant.
23.1* Consent of Ernst & Young LLP
23.2* Consent of PricewaterhouseCoopers LLP
27* Financial Data Schedule
</TABLE>
_______________________
* Filed herewith.
(b) Reports on Form 8-K; all other exhibits previously filed.
No reports on Form 8-K were filed during the fourth quarter of 1998.
-48-
<PAGE>
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 to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of San Clemente, State of California, on March 5, 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 10K has been signed below by the following persons in the
capacities and on the dates indicated:
Signature Title Date
- ------------------------- ---------------------------------- -------------
/s/ ROBERT A. ALTER President, Secretary and Chairman March 5, 1999
- ------------------------- of the Board of Directors
Robert A. Alter (Principal Executive Officer)
/s/ CHARLES L. BIEDERMAN Vice Chairman of the Board of March 5, 1999
- ------------------------- Directors
Charles L. Biederman
/s/ R. TERRENCE CROWLEY Chief Operating Officer (Principal March 5, 1999
- ------------------------- Financial and Accounting Officer)
R. Terrence Crowley
Director
- -------------------------
C. Robert Enever
/s/ LAURENCE GELLER Director March 5, 1999
- -------------------------
Laurence Geller
/s/ DAVID E. LAMBERT Director March 5, 1999
- -------------------------
David E. Lambert
/s/ H. RAYMOND BINGHAM Director March 5, 1999
- -------------------------
H. Raymond Bingham
/s/ FREDRIC H. GOULD Director March 5, 1999
- -------------------------
Fredric H. Gould
Director
- -------------------------
Paul D. Kazilionis
/s/ EDWARD H. SONDKER Director March 5, 1999
- -------------------------
Edward H. Sondker
-49-
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
SUNSTONE HOTEL INVESTORS, INC.
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997............ F-3
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996.................................................... F-4
Consolidated Statements of Equity for the Years Ended December 31, 1998,
1997 and 1996.......................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996.................................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
Schedule III--Real Estate and Accumulated Depreciation as of December
31, 1998............................................................... F-27
Report of Predecessor Accountants....................................... F-29
SUNSTONE HOTEL PROPERTIES, INC. (THE "LESSEE")
Report of Independent Auditors.......................................... F-30
Consolidated Balance Sheets as of December 31, 1998 and 1997............ F-31
Consolidated Statements of Operations for the Years Ended December 31,
1998, 1997 and 1996.................................................... F-32
Consolidated Statements of Changes in Stockholders' Deficit for the
Years Ended December 31, 1998, 1997 and 1996........................... F-33
Consolidated Statements of Cash Flows for the Years Ended December 31,
1998, 1997 and 1996.................................................... F-34
Notes to Consolidated Financial Statements.............................. F-35
Report of Predecessor Accountants....................................... F-46
</TABLE>
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore
have been omitted.
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
Sunstone Hotel Investors, Inc.
We have audited the accompanying consolidated balance sheets of Sunstone
Hotel Investors, Inc. (the "Company") as of December 31, 1998 and 1997 and the
related consolidated statements of operations, equity and cash flows for the
years then ended. Our audits also included the financial statement schedule
listed in the Index to Financial Statements. These consolidated financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and schedule 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 Sunstone Hotel Investors, Inc. as of December 31, 1998 and 1997 and the
consolidated results of its operations and its cash flows for the years then
ended, in conformity with generally accepted accounting principles. Also, in
our opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ ERNST & YOUNG LLP
Newport Beach, California
February 19, 1999
F-2
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS:
Investments in hotel properties, net $840,974,000 $704,817,000
Other real estate investment properties, net 17,027,000 11,459,000
Cash and cash equivalents 859,000 3,584,000
Restricted cash 2,853,000 2,421,000
Rent receivable--Lessee 7,498,000 7,641,000
Other assets, net 6,425,000 9,655,000
------------ ------------
$875,636,000 $739,577,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Revolving line of credit $274,500,000 $179,800,000
Notes payable 104,969,000 116,671,000
Accounts payable and other accrued expenses 18,921,000 10,937,000
Dividends payable to preferred shareholders 503,000 422,000
------------ ------------
398,893,000 307,830,000
------------ ------------
Commitments and contingencies (Note 10)
Minority interest 25,493,000 33,860,000
Stockholders' equity:
7.9% Class A Cumulative Convertible Preferred
Stock, $.01 par value, 10,000,000 authorized;
250,000 issued and outstanding as of December
31, 1998 and 1997 (liquidation preference $100
per share aggregating $25,000,000) 3,000 3,000
Common stock, $.01 par value, 150,000,000
authorized; 37,572,263 and 32,284,103 issued and
outstanding as of December 31, 1998 and 1997,
respectively 376,000 323,000
Additional paid-in capital 479,848,000 401,098,000
Distributions in excess of earnings (28,977,000) (3,537,000)
------------ ------------
451,250,000 397,887,000
------------ ------------
$875,636,000 $739,577,000
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Lease revenue--Lessee $98,682,000 $44,680,000 $14,848,000
Interest and other income 473,000 471,000 236,000
----------- ----------- -----------
99,155,000 45,151,000 15,084,000
----------- ----------- -----------
EXPENSES:
Real estate related depreciation and
amortization 35,835,000 14,749,000 4,514,000
Interest expense and amortization of
financing costs 23,734,000 6,365,000 1,558,000
Real estate and personal property taxes
and insurance 11,409,000 4,670,000 1,273,000
General and administrative 5,344,000 1,890,000 1,015,000
Cost of withdrawn offerings 1,450,000 -- --
----------- ----------- -----------
Total expenses 77,772,000 27,674,000 8,360,000
----------- ----------- -----------
Income before losses on dispositions of
hotel properties and minority interest 21,383,000 17,477,000 6,724,000
Losses on dispositions of hotel
properties (3,574,000) -- --
Minority interest (851,000) (1,886,000) (1,090,000)
----------- ----------- -----------
NET INCOME 16,958,000 15,591,000 5,634,000
Distributions on preferred shares (1,975,000) (422,000) --
----------- ----------- -----------
INCOME AVAILABLE TO COMMON STOCKHOLDERS $14,983,000 $15,169,000 $ 5,634,000
=========== =========== ===========
EARNINGS PER SHARE (Note 9)
Basic $ 0.40 $ 0.72 $ 0.70
=========== =========== ===========
Diluted $ 0.40 $ 0.71 $ 0.69
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
<TABLE>
<CAPTION>
Preferred
Common Stock Stock Additional Distributions
-------------------- --------------- Paid-In in Excess of
Total Shares $ Shares $ Capital Earnings
------------ ---------- -------- ------- ------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
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
Redeemed Operating
Partnership Units in
excess of book value (7,000) -- -- -- -- (7,000) --
Reallocation of minority
interest 170,000 -- -- -- -- 170,000 --
------------ ---------- -------- ------- ------ ------------ ------------
Balance at December 31,
1996 80,801,000 10,936,457 109,000 -- -- 80,700,000 (8,000)
Issuance of common
stock, net 306,067,000 21,347,646 214,000 -- -- 305,853,000 --
Issuance of preferred
stock 25,000,000 -- -- 250,000 3,000 24,997,000 --
Distributions declared (18,698,000) -- -- -- -- -- (18,698,000)
Income available to
common stockholders 15,169,000 -- -- -- -- -- 15,169,000
Redeemed Operating
Partnership Units in
excess of book value (184,000) -- -- -- -- (184,000) --
Reallocation of minority
interest (10,268,000) -- -- -- -- (10,268,000) --
------------ ---------- -------- ------- ------ ------------ ------------
Balance at December 31,
1997 397,887,000 32,284,103 323,000 250,000 3,000 401,098,000 (3,537,000)
Issuance of common
stock, net 77,857,000 5,288,160 53,000 -- -- 77,804,000 --
Distributions declared (40,423,000) -- -- -- -- -- (40,423,000)
Income available to
common stockholders 14,983,000 -- -- -- -- -- 14,983,000
Redeemed Operating
Partnership Units in
excess of book value (32,000) -- -- -- -- (32,000) --
Reallocation of minority
interest 978,000 -- -- -- -- 978,000 --
------------ ---------- -------- ------- ------ ------------ ------------
Balance at December 31,
1998 $451,250,000 37,572,263 $376,000 250,000 $3,000 $479,848,000 $(28,977,000)
============ ========== ======== ======= ====== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------
1998 1997 1996
------------- ------------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 16,958,000 $ 15,591,000 $ 5,634,000
Adjustments to reconcile net
income to net cash provided by
operating activities:
Minority interest 851,000 1,886,000 1,090,000
Depreciation and amortization 35,835,000 14,849,000 4,514,000
Amortization of financing costs 2,222,000 637,000 221,000
Losses on dispositions of hotel
properties 3,574,000 -- --
Changes in operating assets and
liabilities:
Rent receivable--Lessee 143,000 (5,281,000) (1,714,000)
Other assets, net 50,000 (996,000) 21,000
Accounts payable and other
accrued expenses 4,278,000 (2,370,000) 1,903,000
------------- ------------- ------------
Net cash provided by operating
activities 63,911,000 24,316,000 11,669,000
------------- ------------- ------------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Acquisition, improvements and
additions to hotel properties (212,689,000) (378,019,000) (83,857,000)
Acquisition, improvements and
additions to other real estate
investments (5,092,000) (11,558,000) --
Proceeds from sale of hotel
properties 47,238,000 -- 1,100,000
Restricted cash (432,000) 44,000 --
Issuance of notes receivable -- (5,474,000) --
Payments received on notes
receivable 5,534,000 2,461,000 --
------------- ------------- ------------
Net cash used in investing
activities (165,441,000) (392,546,000) (82,757,000)
------------- ------------- ------------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Net proceeds from issuance of
common stock 69,854,000 273,317,000 43,151,000
Contributions from minority
interests -- 483,000 --
Payment of deferred financing
costs (3,144,000) (1,720,000) (308,000)
Borrowings on revolving line of
credit 182,200,000 185,900,000 53,200,000
Principal payments on revolving
line of credit (87,500,000) (46,500,000) (21,200,000)
Principal payments on notes
payable (17,881,000) (18,233,000) (411,000)
Distributions to common
stockholders (40,423,000) (18,698,000) (7,096,000)
Distributions to minority
interests (2,407,000) (2,877,000) (1,328,000)
Distributions to preferred
stockholders (1,894,000) -- --
------------- ------------- ------------
Net cash provided by financing
activities 98,805,000 371,672,000 66,008,000
------------- ------------- ------------
Net change in cash and cash
equivalents (2,725,000) 3,442,000 (5,080,000)
Cash and cash equivalents,
beginning of year 3,584,000 142,000 5,222,000
------------- ------------- ------------
Cash and cash equivalents, end of
year $ 859,000 $ 3,584,000 $ 142,000
============= ============= ============
SUPPLEMENTAL DISCLOSURE:
Cash paid for interest, net of
amounts capitalized $ 22,238,000 $ 4,942,000 $ 1,337,000
============= ============= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
1. Organization, Relationship with Lessee and Basis of Presentation
Organization:
Sunstone Hotel Investors, Inc., a Maryland corporation (the "Company"), was
formed in September 1994 and commenced operations as a real estate investment
trust ("REIT") on August 15, 1995. At December 31, 1998, the Company had a
94.7% interest in Sunstone Hotel Investors, L.P. (the "Operating Partnership")
which also commenced operations in August 1995. The Company conducts all of
its business through and is the sole general partner of the Operating
Partnership.
At December 31, 1998, the Company's portfolio included 57 hotel properties,
primarily located in the western United States, all of which are leased to
Sunstone Hotel Properties, Inc. (the "Lessee") under operating leases (the
"Percentage Leases") that provide 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, Vice Chairman 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.
Relationship with Lessee:
The Company must rely solely on the Lessee to generate sufficient cash flow
from the operation of the hotels to enable the Lessee to meet its substantial
rent obligation to the Company under the Percentage Leases. The Lessee has
incurred significant losses from its inception in 1995. At December 31, 1998,
the Lessee's stockholder's 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 Company's management will continue to evaluate the
financial condition of the Lessee and continue to evaluate other factors
regarding the relationship between the Company and the Lessee.
Basis Of Presentation:
The consolidated financial statements include the accounts of the Company
and its subsidiaries, including the Operating Partnership. All significant
intercompany transactions and balances have been eliminated.
2. Summary of Significant Accounting Policies
Investments In Hotel Properties and Other Real Estate:
Hotel properties and other real estate assets are recorded at cost, less
accumulated depreciation. During periods of construction or major renovation,
interest attributable to hotel rooms under construction or major renovation
and not in service is capitalized until such rooms are available for their
intended use under a specific identification method. Interest related to other
real estate is capitalized to the real estate project while under development
until the project is ready for its intended use. Hotel properties and other
completed real estate investments are depreciated using the straight-line
method over estimated useful lives ranging from five to
F-7
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, (continued)
Investments In Hotel Properties and Other Real Estate, continued:
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.
The Company recognizes impairment losses on long-lived assets 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. Long-lived assets held for sale are reported at the lower of their
carrying amount or fair value less selling costs. At December 31, 1998,
management believes that the sum of the expected future undiscounted cash
flows excluding interest charges, for each hotel property and other real
estate assets is greater than assets' respective carrying amount. Accordingly,
no such impairment losses have been recognized by the Company on its hotel
properties and other real estate assets.
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.
Restricted Cash:
Restricted cash is comprised of reserve accounts for capital replacements,
property taxes and debt service. These restricted funds are subject to
supervision and approval by the respective lenders.
Rent Receivable Lessee:
At December 31, 1998, all rent payments due from the Lessee are current.
Under the terms of the Percentage Leases, monthly base rent is due from the
Lessee in arrears and percentage rent is due 45 days after the end of each
respective month. As of December 31, 1998, the $7.5 million due from the
Lessee consists of percentage rent for the months of November and December
1998 and base rent for the month of December 1998.
Other Assets:
Other assets consist primarily of notes receivable, deferred financing costs,
liquor license costs and prepaid expenses. Amortization of deferred financing
costs is computed using the straight-line method over the life of the related
loan based upon the terms of the loan agreements.
Offering Costs:
Specific incremental costs incurred in connection with securities offerings
are deferred and charged against the gross proceeds of the related offerings.
Deferred costs related to aborted offerings are expensed in the period the
offering is aborted.
F-8
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
Minority Interest:
Minority interest carried on the balance sheet is adjusted periodically upon
issuance of either common stock of the Company or Operating Partnership units.
Minority interest is based on the number of Operating Partnership units
outstanding held by affiliates and unrelated parties divided by the sum of
total Operating Partnership units outstanding at the measurement date (Note
8). Minority interest adjustments are recorded as adjustments to additional
paid-in capital.
Concentrations:
The Company must rely solely on the Lessee to generate sufficient cash flow
from the operation of the hotels to enable the Lessee to meet rent obligations
under the Percentage Leases. In 1998, 1997 and 1996, the Company earned rents
of $98.7 million, $44.7 million and $14.8 million, respectively, representing
99.5%, 99.0% and 98.4%, respectively, of the Company's total revenue, all of
which was earned from the Percentage Leases with the Lessee (Note 11). See the
Lessee's consolidated financial statements included elsewhere herein.
The Company currently invests primarily in hotel properties. The hotel
industry is highly competitive and the Company's hotel investments are subject
to competition from other hotels for guests. Each of the Company's hotels
competes for guests primarily with other similar hotels in its immediate
vicinity and other similar hotels in its geographic market. The Company
believes that brand recognition, location, the quality of the hotel and
services provided, and price are the principal competitive factors affecting
its hotel investments.
At December 31, 1998 and 1997, the Company had cash amounts in banks that
were in excess of federally insured amounts.
Lease Revenue Recognition:
All of the Company's operating hotel properties are leased to the Lessee
under Percentage Leases (Note 11). The Company recognizes lease revenue when
earned over the terms of the respective Percentage Leases.
Start-Up Costs and Advertising Expense:
Start-up costs and advertising and promotion costs are expensed when
incurred.
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 Plans and its Directors Plan.
F-9
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
Earnings Per Share:
Basic and diluted earnings per share is calculated in accordance with FASB
Statement No. 128, Earnings per Share ("Statement No. 128"). All earnings per
share amounts for all periods have been presented and where appropriate,
restated to conform to the requirements of Statement No. 128 (Note 9).
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 fair value,
management believes that the carrying amounts of the Company's financial
instruments reasonably approximate their fair value at December 31, 1998 and
1997.
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 periods. Actual results could differ materially
from those estimates in the near term.
Significant estimates made in preparing the consolidated financial
statements include recoverability of long-lived assets and the outcome of any
claims and litigation that may arise in the ordinary course of business.
Seasonality:
The hotel industry is seasonal in nature. Seasonal variations in revenues at
the Company's hotels may cause quarterly fluctuations in the Company's lease
revenues.
Reclassifications:
Certain prior year balances have been reclassified to conform to the current
year presentation.
New Accounting Standards:
During 1998, the Company adopted the Financial Accounting Standards Board's
Statement of Financial Accounting Standards No. 131, Disclosures About
Segments of an Enterprise and Related Information ("Statement No. 131").
Statement No. 131 superseded FASB Statement No. 14, Financial Reporting for
Segments of A Business Enterprise. Statement No. 131 establishes standards for
the way that public business enterprises report information regarding
reportable operating segments. The adoption of Statement No. 131 did not
affect the results of operations or financial position of the Company. The
Company's hotel properties generated lease revenues from a single lessee
though its Percentage Leases. The Company separately evaluates the performance
of each of its hotels. However, because each of the hotels have similar
economic characteristics, facilities and services, the hotel properties have
been aggregated into a single dominant segment. The Company evaluates
performance and allocates resources primarily based on revenue per available
room, average daily rate and the occupancy rates of individual hotels.
F-10
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
New Accounting Standard, continued:
In 1998, the Company adopted the Emerging Issues Task Force of the Financial
Accounting Standards Board's consensus on Issue No. 97-11 ("EITF 97-11"),
Accounting for Internal Costs Relating to Real Estate Property Acquisitions.
EITF 97-11 requires internal preacquisition costs related to the purchase of
an operating property be expensed as incurred. As a result of the adoption of
EITF 97-11 for the year ended December 31, 1998, the Company expensed $252,000
in internal acquisition costs.
3. Investments In Hotel Properties
Investments in hotel properties consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Land $116,531,000 $ 93,456,000
Buildings and improvements 657,066,000 549,770,000
Fixtures, furniture and equipment 113,121,000 77,247,000
Construction in process 19,710,000 15,991,000
------------ ------------
906,428,000 736,464,000
Accumulated depreciation and amortization (65,454,000) (31,647,000)
------------ ------------
Investments in hotel properties, net $840,974,000 $704,817,000
============ ============
</TABLE>
1998 Investments:
During 1998, the Company acquired ten hotel properties for aggregate
consideration of $134.2 million, including transaction costs, comprised of
$126.1 million in cash, $6.2 million in an assumed note payable and the
issuance of 118,409 units valued at $1.9 million which are exchangeable for a
like number of shares of common stock of the Company. Also during 1998, the
Company completed, or was in the process of completing, substantial
renovations at 20 of the hotel properties, and in connection with such
renovation, the Company incurred costs of approximately $68.2 million.
1998 Disposition of Non-Core Assets:
During 1998, the Company disposed of six non-core hotel assets, that were
included in the acquisition of Kahler Realty Corporation, for $47.2 million
and recognized losses of $3.6 million.
1997 Kahler Acquisition:
On October 15, 1997, the Company completed the acquisition of all the
outstanding capital stock of Kahler Realty Corporation ("Kahler") from
Westbrook Real Estate Fund I, L.P. and Westbrook Real EstateCo-Investment
Partnership I, L.P. (collectively, "Westbrook") for aggregate consideration of
$372.3 million (the "Kahler Acquisition"), including the concurrent buyout of
minority interests in certain hotels that were partially owned by Kahler. In
addition, the Company may be required to pay up to $16.0 million in additional
consideration, based upon specified future operating results of the acquired
hotels. Any unpaid adjustment to the purchase price will be treated as
additional consideration and capitalized to the hotel properties. The Kahler
Acquisition was funded with the net proceeds from the Company's public
offering in October 1997, the assumption of Kahler debt, the issuance of
common and preferred stock to Westbrook and with borrowings from the Company's
unsecured revolving line of credit. The Kahler portfolio purchased by the
Company consisted of 17 hotels with 4,255 rooms (the "Kahler Hotels"),
principally in two markets, the Mountain region states of Utah, Idaho, Montana
and Arizona (11 hotels) and Rochester, Minnesota (four hotels).
F-11
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investments In Hotel Properties, continued
Other 1997 Investments:
During 1997, the Company acquired or invested in 12 hotel properties,
excluding the Kahler Acquisition, for aggregate consideration of $150.4
million, including transaction costs, comprised of $121.4 million in cash,
$20.5 million in assumed notes payable and the issuance of 624,740 Units
valued at $8.5 million, which are exchangeable for a like number of shares of
common stock of the Company. During 1997, the Company completed, or was in the
process of completing, substantial renovations at 19 of the hotel properties,
and in connection with such renovations, incurred costs of approximately $48.8
million.
The Kahler Acquisition and all of the other hotels properties acquired in
1998 and 1997 have been accounted for as purchase transactions and,
accordingly, the results of operations of the acquisitions have been included
in the Company's consolidated results of operations from the respective dates
of acquisition.
4. Other Real Estate Investments
Other real estate investments consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Laundry facilities
Land $ 2,867,000 $ 2,867,000
Buildings and improvements 6,857,000 6,857,000
Fixtures, furniture and equipment 1,911,000 1,834,000
----------- -----------
11,635,000 11,558,000
Accumulated depreciation (502,000) (99,000)
----------- -----------
11,133,000 11,459,000
Land held for future development or sale 1,497,000 --
Office building under development Land 650,000 --
Construction in progress 3,747,000 --
----------- -----------
4,397,000 --
----------- -----------
$17,027,000 $11,459,000
=========== ===========
</TABLE>
Upon completion, a portion of the office building will be used by the
Company as its corporate facility, a portion will be leased to the Lessee as
its corporate facility and the remaining space will be leased to third
parties.
5. Other Assets
Other assets consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Notes receivable $1,724,000 $6,085,000
Deferred financing costs, net of accumulated
amortization of $3,061,000 in 1998 and $839,000 in
1997 2,661,000 1,739,000
Prepaid expenses and other 2,040,000 1,831,000
---------- ----------
$6,425,000 $9,655,000
========== ==========
</TABLE>
F-12
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Revolving Line Of Credit
On July 23, 1998, the Company amended its revolving line of credit (the
"Credit Facility") to (i) increase the total commitment to $350.0 million;
(ii) increase total borrowings under the Credit Facility from 45% to 50% of
the aggregate value of the Company's eligible hotels, as defined; (iii)
increase the amount available for working capital purposes to $30.0 million;
and (iv) extend the term 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. The Credit Facility may be
used for acquisition, capital improvements, working capital and general
corporate purposes and requires the Company to pay an annual fee of 0.25% on
the unused portion.
As of December 31, 1998 and 1997, the undrawn commitment under the Credit
Facility was $66.1 million and $11.1 million (net of $9.4 million and $10.1
million reserved as collateral for other indebtedness and development of a
hotel), respectively. 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. At December 31, 1998,
the Company was in compliance with all Credit Facility financial covenants.
The weighted average interest rates on outstanding borrowings at December 31,
1998 and 1997 were 7.52% and 7.73%, respectively.
Interest incurred under the Company's revolving line of credit, during
1998, 1997 and 1996, totaled $18.2 million, $4.4 million and $2.0 million,
respectively, of which $4.3 million, $2.3 million and $1.1 million was
capitalized for the years ended December 31, 1998, 1997 and 1996,
respectively.
7. Notes Payable
Notes payable consist of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <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 $ 1,930,000 $ 1,978,000
$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 905,000 930,000
$9,000,000 note payable dated September 26, 1995;
monthly payments of principal and interest at
9.95%; maturing in 1999; collateralized by a first
deed of trust, assignment of rents and fixtures
(repaid in January 1998) -- 7,622,000
$9,500,000 note payable dated December 28, 1993;
monthly payments of principal and interest at
9.67%; maturing in 1999; collateralized by a first
deed of trust, assignment of rents and fixtures
(repaid in January 1998) -- 8,343,000
$3,420,000 note payable dated May 27, 1994; monthly
payments of principal and interest at 8.25%;
maturing in 2004; collateralized by a first deed
of trust, assignment of rents and fixtures 3,301,000 3,350,000
</TABLE>
F-13
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Notes Payable, continued
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
$10,000,000 note payable dated September 1, 1992;
monthly payments of principal and interest at
9.88%; maturing in 2013; collateralized by a first
deed of trust, assignment of rents and fixtures 8,793,000 9,059,000
$33,000,000 note payable dated October 10, 1997;
monthly payments of principal and interest at
7.96%; maturing in 2002; collateralized by a first
deed of trust, assignment of rents and fixtures 32,221,000 32,944,000
$22,600,000 note payable dated October 14, 1997;
monthly payments of interest only at LIBOR plus
2.25%; maturing in 2000; collateralized by a first
deed of trust, assignment of rents and fixtures 22,600,000 22,600,000
$13,120,000 industrial development bonds dated July
9, 1997; monthly payments of principal and
interest at a variable rate ranging from 2.8% to
4.4% during 1998 with principal amounts deposited
into a restricted cash account; maturing in 2015;
collateralized by a first deed of trust,
assignment of rents and fixtures 12,870,000 13,060,000
$6,400,000 note payable dated February 27, 1989;
monthly payments of principal and interest at
10.375%; maturing in 1999; collateralized by a
first deed of trust, assignment of rents and
fixtures 6,139,000 --
$9,500,000 industrial development bonds dated
December 1, 1985; monthly payments of principal
and interest at a variable rate ranging from 3.5%
to 4.0% during 1998 with principal amounts
deposited into a restricted cash account; maturing
in 2015; collateralized by a first deed of trust,
assignment of rents and fixtures and irrevocable
letter of credit for $8,935,000 and expires on
July 25, 2000 8,320,000 8,495,000
$9,700,000 industrial development bonds dated
October 10, 1986; monthly payments of principal
and interest at a variable rate of 4.4% during
1998 with principal amounts deposited into a
restricted cash account; maturing in 2013;
collateralized by a first deed of trust,
assignment of rents and fixtures and irrevocable
letter of credit for $7,600,000 and expires on
September 15, 1999 7,500,000 7,900,000
$390,000 note payable dated December 19, 1997; with
no interest if paid in full on the maturity date
of January 5, 1999; collateralized by a first deed
of trust, assignment of rents and fixtures (repaid
in January 1999) 390,000 390,000
------------ ------------
$104,969,000 $116,671,000
============ ============
</TABLE>
Notes payable are secured by hotel properties carried at $256.3 million at
December 31, 1998. Interest incurred on mortgage notes payable was $7.6
million, $3.6 million and $506,000 for the years ended December 31, 1998, 1997
and 1996, respectively.
F-14
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Notes Payable, continued
Future principal maturities of notes payable at December 31, 1998, are as
follows:
<TABLE>
<S> <C>
1999 $ 8,401,000
2000 24,588,000
2001 2,129,000
2002 31,522,000
2003 1,607,000
Thereafter 36,722,000
------------
$104,969,000
============
</TABLE>
8. Equity
1996 Stock Offerings:
On August 7, 1996, the Company completed an 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 $46.0 million and net proceeds
(after deducting the underwriters' discount and offering costs) of
approximately $43.1 million.
1997 Stock Offerings:
On January 6, 1997, the Company completed an offering for 4,000,000 shares
of its common stock. Concurrently, 600,000 shares of common stock were issued
by the Company upon the full exercise of the underwriters' over-allotment
option. The offering price of the shares sold in the offering was $13.00 per
share, resulting in gross proceeds of approximately $59.8 million and net
proceeds (after deducting the underwriters' discount and offering costs) of
approximately $56.8 million.
On March 31, 1997, the Company completed an offering for 700,000 shares of
its common stock. On April 28, 1997, 105,000 shares of common stock were
issued by the Company upon the full exercise of the underwriter's over-
allotment option. The offering price of the shares sold was $13.75 per share,
resulting in gross proceeds of approximately $11.1 million and net proceeds
(after deducting the underwriter's discount and offering costs) of
approximately $10.6 million.
On May 6, 1997, the Company completed an offering for 4,000,000 shares of
common stock. The offering price of the shares sold was $13.375 per share,
resulting in gross proceeds of approximately $53.5 million and net proceeds
(after deducting the underwriters' discount and offering costs) of
approximately $51.4 million.
On October 15, 1997, in connection with the closing of the Kahler
Acquisition, the Company completed an offering for 9,000,000 shares of common
stock. The offering price of the shares sold was $17.25 per share, resulting
in gross proceeds of approximately $155.3 million and net proceeds (after
deducting the underwriters' discount and offering costs) of approximately
$147.1 million. On November 7, 1997, 490,000 shares of common stock were
issued by the Company upon the partial exercise of the underwriter's over-
allotment option. The offering price of the shares sold was $17.25 per share,
resulting in gross proceeds of approximately $8.5 million and net proceeds
(after deducting the underwriter's discount and offering costs) of
approximately $8.0 million. Additionally, the Company issued 2,284,262 shares
of common stock at a price of $14.01 per share, for a total of $32,000,000 and
250,000 shares of 7.9% Class A Cumulative Convertible Preferred Stock at $100
per share for a total of $25,000,000, to Westbrook.
F-15
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Equity, continued
1997 Stock Offerings, continued:
In October 1997, the Company filed a shelf registration statement with the
Securities and Exchange Commission providing for the issuance of up to $325
million of common stock, preferred stock and warrants to purchase common stock
and preferred stock. This registration statement was in addition to the
registration statement providing for the issuance of up to $200 million in
securities, which was filed in 1996. The Company intends to use the proceeds
raised from any securities issued under its shelf registration statement for
general corporate purposes, including the acquisition and development of
additional hotels, the renovation of currently owned hotels, and the repayment
of debt.
1998 Stock Offerings:
On February 11, 1998, the Company completed a shelf offering for 4,500,000
shares of its common stock. The offering price of the shares sold was $16.375
per share, resulting in gross proceeds of approximately $73.7 million and net
proceeds (after deducting the underwriters' discount and offering costs) of
approximately $69.4 million. The Company used the net proceeds of the offering
to finance the acquisition of additional hotels and to repay outstanding
indebtedness under the Credit Facility. Availability under the Company's shelf
registration statement was $163.2 million at December 31, 1998.
Subject to certain limitations, 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.
In connection with the Kahler Acquisition on October 15, 1997, the Company
issued 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.
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.
F-16
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Equity, continued
Distributions:
The Company has adopted a policy of paying regular quarterly distributions
on its common stock. Cash distributions have been paid on the Company's common
stock with respect to each quarter since its inception. The following table
sets forth information regarding the Company's distributions for 1997 and
1998:
<TABLE>
<CAPTION>
Per Share
Quarter to Which Distribution Distribution Distribution
Distribution Relates Record Date Payment Date Amount
-------------------- ------------ ------------ ------------
<S> <C> <C> <C>
1997
1st Quarter 4/29/97 5/15/97 $0.25
2nd Quarter 7/31/97 8/15/97 $0.25
3rd Quarter 9/30/97 11/14/97 $0.275
4th Quarter 1/31/98 2/16/98 $0.275
1998
1st Quarter 5/1/98 5/13/98 $0.275
2nd Quarter 7/31/98 8/12/98 $0.275
3rd Quarter 10/30/98 11/10/98 $0.285
4th Quarter 2/1/99 2/15/99 $0.285
</TABLE>
Reconciliation of Operating Partnership Units Outstanding:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 Year Ended December 31, 1997
--------------------------------------------- ---------------------------------------------
Company Affiliates Other Total Company Affiliates Other Total
---------- ---------- --------- ---------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of
year 32,284,103 1,416,240 1,331,087 35,031,430 10,936,457 1,455,799 706,347 13,098,603
Stock options exercised 3,000 3,000 41,860 41,860
Stock awards issued 20,984 20,984 13,766 13,766
Warrants exercised 50,850 50,850
Operating Partnership
units
redeemed/exchanged 735,911 (16,355) (727,256) (7,700) 58,446 (90,409) (31,963)
Dividend reinvestment
plan and additional
cash investment plan 28,265 28,265 54,312 54,312
Common stock offerings 4,500,000 4,500,000 21,179,262 21,179,262
Contributions of hotel
properties 118,892 118,892 624,740 624,740
---------- --------- --------- ---------- ---------- --------- --------- ----------
Balance at end of year 37,572,263 1,399,885 722,723 39,694,871 32,284,103 1,416,240 1,331,087 35,031,430
---------- --------- --------- ---------- ---------- --------- --------- ----------
Ownership interest at
end of year 94.7% 3.5% 1.8% 100.0% 92.2% 4.0% 3.8% 100.0%
========== ========= ========= ========== ========== ========= ========= ==========
</TABLE>
At December 31, 1998, the Company has reserved 7.5 million shares of common
stock for its various stock plans, for redemptions and conversions of
Operating Partnership units and for public offerings.
F-17
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
<CAPTION>
For the Year Ended December 31,
------------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Numerator:
Net income $16,958,000 $15,591,000 $5,634,000
Distributions on preferred shares (1,975,000) (422,000) --
----------- ----------- ----------
Numerator for basic and diluted earnings
per share
Income available to common shareholders
after effect of dilutive securities $14,983,000 $15,169,000 $5,634,000
=========== =========== ==========
Denominator:
Denominator for basic earnings per
share--
weighted average shares outstanding 37,023,109 21,089,971 8,041,805
Effect of dilutive securities:
Stock options 83,889 158,160 82,133
----------- ----------- ----------
Denominator for diluted earnings per
share--
adjusted weighted average shares and
assumed conversions 37,106,998 21,248,131 8,123,938
=========== =========== ==========
Basic earnings per share $ 0.40 $ 0.72 $ 0.70
=========== =========== ==========
Diluted earnings per share $ 0.40 $ 0.71 $ 0.69
=========== =========== ==========
</TABLE>
The computation of diluted earnings per share did not assume the conversion
of the 7.9% Class A Preferred Shares because their inclusion would have been
anti-dilutive.
10. Commitments and Contingencies
Development Agreements:
In July 1997, the Company entered into a purchase agreement to acquire a to
be developed hotel property located in Denver, Colorado. The guaranteed
maximum purchase price to the Company was $7.6 million. In order to secure its
obligation to perform under the purchase agreement, the Company was required
to provide a limited repayment guarantee of the construction loan. Such
repayment guarantee was not to exceed 25% of the revised project cost budget.
At December 31, 1998, the Company was negotiating a settlement agreement with
the seller whereby it will be released from its obligation to acquire the
hotel. The tentative terms of the settlement agreement include, among other
things (i) a release of the Company from its partial guarantee of the seller's
construction loan; (ii) a requirement for the Company to provide a $500,000
letter of credit as security on the seller's construction loan; and (iii) the
Company's option (but not obligation) to take over the lender's position if
the seller is in default of its debt to the lender and the Company pays off
the unpaid principal and interest due the lender. Additionally, the Company
will sell approximately $1.3 million in furniture fixtures and equipment it
purchased for the hotel to the seller for an amount which approximates the
Company's cost.
F-18
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Commitments and Contingencies, continued
Development Agreements, continued:
In November 1997, the Company entered into a purchase agreement to acquire a
to be developed hotel property located in Sacramento, California. The
guaranteed maximum purchase price to the Company is $13.3 million. The seller
is required to pay for all project costs and is at risk for any project cost
overruns. Construction of the hotel is to be satisfactory to the Company and
completed within a specified period after commencement of construction,
subject to certain extensions. During 1997 and 1998, the Company advanced the
seller approximately $3.3 million of project financing. Such amounts were
secured by a deed of trust and included in notes receivable. In July 1998 all
amounts secured by the deed of trust and accrued interest owed, totaling
approximately $3.5 million, were repaid. The Company has not recognized
interest income on the amounts advanced to the seller.
In December 1997, the Company entered into a purchase agreement to acquire a
to be developed hotel property located in San Diego, California. The
guaranteed maximum purchase price to the Company is $14.5 million. The seller
is required to pay for all project costs and is at risk for any project cost
overruns. Construction of the hotel is to be satisfactory to the Company and
completed within a specified period after commencement of construction,
subject to certain extensions. During 1997 and 1998, the Company advanced the
seller approximately $3.0 million of project financing. Such amounts were
secured by a deed of trust and included in notes receivable. In September
1998, all amounts secured by the deed of trust and accrued interest owed,
totaling approximately $3.2 million, were repaid. The Company has not
recognized interest income on the amounts advanced to the seller.
At December 31, 1998, the Company has various contracts outstanding with
third parties in connection with the renovation of the Company's hotel
properties. The Company's remaining commitments under these contracts at
December 31, 1998 and 1997 totaled approximately $37.5 million and $25.4
million, respectively.
Litigation:
The Company is involved from time to time in various claims and legal
actions in the ordinary course of business. Management does not believe that
the impact of such matters will have a material adverse effect on the
Company's financial position or results of operations when resolved.
Ground Leases:
Through December 31, 1998, the Company was obligated under the terms of
seven ground leases. Future minimum payments due under the terms of the ground
leases in effect at December 31, 1998 are as follows:
<TABLE>
<S> <C>
1999 $ 1,619,000
2000 1,619,000
2001 1,619,000
2002 1,158,000
2003 419,000
Thereafter 16,330,000
-----------
$22,764,000
-----------
</TABLE>
Rent expense incurred pursuant to these ground lease agreements totaled
$1,635,000, $633,000 and $90,000 in 1998, 1997 and 1996, respectively.
F-19
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Commitments and Contingencies, continued
Capital Leases:
Furniture, fixtures and equipment includes $285,000 for telephone equipment
that is being leased and has been capitalized at December 31, 1998.
Future minimum payments under the capital lease at December 31, 1998 are as
follows:
<TABLE>
<S> <C>
1999 $ 92,000
2000 209,000
2001 123,000
--------
424,000
Amounts representing interest (58,000)
--------
$366,000
========
</TABLE>
Franchise Agreements:
The Company has guaranteed the Lessee's obligations under the terms of
certain franchise agreements. These agreements require the Lessee to, among
other things, pay monthly fees that are calculated based on specified hotel
revenues.
Additionally, these franchise agreements generally contain specific
standards for, and restrictions and limitations on, the operation and
maintenance of the hotels which are established by the franchisors to maintain
uniformity in the system created by each such franchisor. Such standards
generally regulate the appearance of the hotel, quality and type of goods and
services offered, signage, and protection of marks. Compliance with such
standards may from time to time require significant expenditures for capital
improvements which are borne by the Company.
11. Percentage Lease Agreements
As of December 31, 1998, the Company had 57 Percentage Leases with the
Lessee. Future minimum rentals (base rents) to be received by the Company from
the Lessee under the Percentage Leases in effect at December 31, 1998 are as
follows:
<TABLE>
<S> <C>
1999 $ 57,524,000
2000 57,524,000
2001 57,524,000
2002 57,524,000
2003 57,524,000
Thereafter 198,908,000
------------
$486,528,000
============
</TABLE>
The term of each lease is ten years. The Percentage Leases contain various
covenants and are cross-defaulted. The minimum 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 9% to 50% of room revenues, up to a certain baseline revenue
(the base rent component) then 60% to 68% 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
Percentage Leases in 1998, 1997 and 1996 was
F-20
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Percentage Lease Agreements, continued
$98.7 million, $44.7 million and $14.8 million, respectively, of which $40.2
million, $19.8 million and $6.8 million, respectively, was in excess of base
rents. The stockholders of the Lessee have pledged a subordinated interest in
481,955 Operating Partnership Units as collateral for the lease payments.
In 1997, the Lessor and Lessee amended the Percentage Leases for hotels then
currently under renovation and for any future hotels to allow for the
abatement of base rent related to rooms taken out of service during major
renovations. For the year ended December 31, 1998, rent abatement related to
major renovations totaled $668,000. No rent was abated in prior years.
Upon the sale of a hotel, the respective Percentage Lease terminates. As
provided for in the Percentage Leases and as compensation for the early
termination, the Company is required to (i) pay the Lessee a termination fee
of an amount equal to the net profit earned by the Lessee with respect to the
hotel sold for the 12-month period preceding the sale or, (ii) offer to lease
the Lessee one or more substitute hotel facilities pursuant to a similar
lease. During 1998, the Company sold six hotels and terminated the related
Percentage Leases. Such terminated leases were replaced with new leases in
1998 and no termination fee was due the Lessee. During February 1999, the
Company sold one hotel and terminated the related Percentage Lease. The
Company anticipates offering the Lessee a substitute hotel facility within the
180 days allowed under the Percentage Lease.
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 hotels, when and as deemed necessary by the
Lessee, an amount equal to 4% of room revenue per quarter on a cumulative
basis. 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. The
Company is responsible for payment of (i) real estate and personal property
taxes on its hotel properties (except to the extent that personal property
associated with the hotels is owned by the Lessee), (ii) casualty insurance on
the hotels, (iii) business interruption insurance on the hotels, and (iv)
general liability insurance. The Lessee is required to pay for workers'
compensation and other insurance appropriate and customary for properties
similar to the Company's hotels with the Company as an additional named
insured.
12. Stock Plans
The Company accounts for stock option and warrant grants to employees in
accordance with Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees ("APB 25"), and related Interpretations in
accounting for its employee stock options because the Company believes the
alternative fair value accounting provided for under Statements of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation
("Statement No. 123"), requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, if the
stock options are granted at the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. These pro forma effects are not likely to be representative of the
effects on reported pro forma net income for future years because options vest
over several years and additional awards are generally made each year. The
fair value for these options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted average assumptions
for 1998, 1997 and 1996, respectively: risk-free interest rates from 5.88% to
7.88%, from 5.89% to 6.75% and from 6.48% to 6.85%; dividend yields from 6.47%
to 13.41%, from 6.38% to 8.54% and 7.10%; volatility factors of the expected
market price of the Company's common stock of 0.332, 0.330 and 0.279; and a
weighted average expected life of the option of seven and ten years.
F-21
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Stock Plans, continued
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information follows:
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------
1998 1997 1996
----------- ----------- ----------
<S> <C> <C> <C>
Pro forma net income available to common
stockholders $14,434,000 $15,006,000 $5,559,000
Pro forma net income available to common
stockholders per share:
Basic $ 0.39 $ 0.71 $ 0.69
Diluted 0.39 0.71 0.68
</TABLE>
The weighted average remaining contracted life of all employee stock options
outstanding at December 31, 1998 is eight years. The weighted average grant
date fair value of stock options with stock prices equal to their exercise
prices issued during 1998, 1997 and 1996 is $3.40, $3.29 and $0.96,
respectively. The weighted average grant date fair value of stock options with
stock prices in excess of their exercise prices issued during 1997 is $4.21.
1994 Stock Incentive Plan:
Under the 1994 Stock Incentive Plan, as amended, officers, nonemployee
members of the Board of Directors and key employees and consultants of the
Company are eligible to be granted options and warrants to purchase common
stock of the Company. Through December 31, 1998, the Company's Board of
Directors have set aside 2,400,000 shares of common stock to be issued
pursuant to the 1994 Stock Incentive Plan. The 1994 Stock Incentive Plan is
being administered by a committee established by the Company's Board of
Directors. All options granted have exercise prices equal to their quoted
market prices on the dates granted, have ten year terms and vest and become
fully exercisable over five years. Effective September 25, 1998, the Company
agreed to issue two of its officers an aggregate of 454,500 transferable
warrants to purchase 454,500 shares of the Company's common stock in exchange
for the officers surrendering to the Company for cancellation 454,500 options
previously issued to them under the 1994 Stock Incentive Plan. The warrants
have exercise prices ranging from $9.50 to $16.63. The exercise price of each
warrant issued is identical to each stock option being surrendered. The
warrant exercise prices were equal to or in excess of the quoted market price
of the Company's common stock on September 25, 1998. The warrants will become
exercisable 13 months after September 25, 1998 and can be exercised anytime
prior to September 24, 2003. A summary of the Company's 1994 Stock Incentive
Plan activity and related information, excluding the issuance of 454,500
warrants and cancellation of 454,500 options effective September 25, 1998, as
previously discussed, for the years ended December 31, 1998, 1997 and 1996
follows:
F-22
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Stock Plans, continued
<TABLE>
<CAPTION>
Number of Weighted
Available for Options and Exercise Price Average
Future Grant Warrants Per Share Exercise Price
------------- ----------- --------------- --------------
<S> <C> <C> <C> <C>
Outstanding at December
31, 1995 260,000 240,000 $ 9.50 $ 9.50
Granted (247,900) 247,900 9.88 to 10.50 10.42
--------- ---------
Outstanding at December
31, 1996 12,100 487,900 9.50 to 10.50 9.97
Additional options and
warrants authorized 700,000 -- -- --
Granted (355,000) 355,000 12.88 to 17.25 16.95
Exercised -- (38,680) 9.50 to 10.50 9.83
--------- ---------
Outstanding at December
31, 1997 357,100 804,220 9.50 to 17.25 13.06
Additional options and
warrants authorized 1,200,000 -- -- --
Granted (244,100) 244,100 10.50 to 17.25 16.48
Forfeited 35,000 (35,000) 12.88 to 17.00 16.41
--------- ---------
Outstanding at December
31, 1998 1,348,000 1,013,320 9.50 to 17.25 13.75
========= =========
</TABLE>
Options exercisable and their weighted average exercise prices at December
31:
<TABLE>
<S> <C> <C>
1996 48,000 $ 9.50
1997 106,900 9.81
1998 274,720 11.70
</TABLE>
1994 Directors Plan:
In September 1994, the Company adopted the 1994 Directors Plan (the
"Directors Plan"), as amended, under which nonemployee members of the Board of
Directors of the Company are eligible to be granted options to purchase common
stock of the Company. Through December 31, 1998, the Company's Board of
Directors have set aside 150,000 shares of common stock to be issued pursuant
to the Directors Plan. All options granted through December 31, 1998 had
exercise prices equal to their quoted market prices on the dates granted, have
ten year terms and vest immediately. A summary of the Company's Directors
Plan, activity and related information for the years ended December 31, 1998,
1997 and 1996 follows:
<TABLE>
<CAPTION>
Weighted
Available for Number of Exercise Price Average
Future Grant Options Per Share Exercise Price
------------- --------- --------------- --------------
<S> <C> <C> <C> <C>
Outstanding at December
31, 1995 150,000 -- $ -- $ --
Granted (15,000) 15,000 9.75 to 10.13 9.94
Exercised -- (1,500) 9.75 9.75
------- ------
Outstanding at December
31, 1996 135,000 13,500 9.75 to 10.13 9.96
Granted (9,000) 9,000 12.88 to 14.50 14.23
Exercised -- (3,000) 9.75 to 10.13 9.94
------- ------
Outstanding at December
31, 1997 126,000 19,500 9.75 to 14.50 11.93
Granted (18,000) 18,000 8.50 to 17.00 11.73
Exercised -- (3,000) 10.13 to 14.50 12.31
------- ------
Outstanding at December
31, 1998 108,000 34,500 8.50 to 17.00 11.79
======= ======
</TABLE>
F-23
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Stock Plans, continued
1997 Supplemental Stock Option Plan:
In October 1997, the Company adopted the 1997 Supplemental Stock Option Plan
(the "Supplemental Plan"), as amended under which employees, who are neither
officers nor members of the Board of Directors of the Company are eligible to
be granted options to purchase common stock of the Company. Through
December 31, 1998, the Company's Board of Directors have set aside 20,000
shares of common stock to be issued pursuant to the Supplemental Plan. All
options granted through December 31, 1998 had exercise prices less than their
quoted market prices on the dates granted, have ten-year terms and vest over
five years. A summary of the Company's Supplemental Plan activity and related
information for the years ended December 31, 1998 and 1997 follows:
<TABLE>
<CAPTION>
Weighted
Available for Number of Exercise Price Average
Future Grant Options Per Share Exercise Price
------------- --------- -------------- --------------
<S> <C> <C> <C> <C>
Outstanding at December
31, 1996 -- -- $ -- $ --
Authorized, October 10,
1997 20,000 -- -- --
Granted (15,300) 15,300 14.01 14.01
Forfeited 3,000 (3,000) 14.01 14.01
------- ------
Outstanding at December
31, 1997 7,700 12,300 14.01 14.01
Forfeited 3,000 (3,000) 14.01 14.01
------- ------
Outstanding at December
31, 1998 10,700 9,300 14.01 14.01
======= ======
</TABLE>
At December 31, 1998, options exercisable and their weighted average
exercise price were 1,860 and $14.01, respectively. No options were
exercisable at December 31, 1997 and 1996.
13. Quarterly Financial Information (Unaudited)
Summarized quarterly financial data for the year ended December 31, 1998 and
for the year ended December 31, 1997, which have been restated to comply with
Statement No. 128 and to reflect the allocation of a fourth quarter
depreciation expense adjustment to the first three quarters, is as follows:
<TABLE>
<CAPTION>
For the Quarter Ended
-----------------------------------------------
March 31, June 30, September December
1998 1998 30, 1998 31, 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Lease revenues $23,687,000 $24,775,000 $28,907,000 $21,313,000
Net income (loss) 6,597,000 6,274,000 4,585,000 (498,000)
Basic earnings (loss) per
share 0.17 0.15 0.11 (0.03)
Diluted earnings (loss)
per share 0.17 0.15 0.11 (0.03)
<CAPTION>
For the Quarter Ended
-----------------------------------------------
March 31, June 30, September December
1997 1997 30, 1997 31, 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Lease revenues $ 7,572,000 $ 7,775,000 $12,129,000 $17,204,000
Net income 3,276,000 3,295,000 5,569,000 3,029,000
Basic earnings per share 0.22 0.18 0.27 0.10
Diluted earnings per share 0.22 0.17 0.27 0.10
</TABLE>
F-24
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Related Party Transactions
The Management Company provides certain accounting and management services
for the Company. The Company expensed $171,000, $142,000 and $60,000 for these
services for the years ended December 31, 1998, 1997 and 1996, respectively,
and such costs are included in general and administrative expenses in the
statements of and operations.
Additionally, certain Management Company employee salaries, identifiable
employee expenses and other costs incurred in connection with acquisition and
construction and renovation services are reimbursed by the Company. During the
years ended December 31, 1998 and 1997, $18,000 and $341,000, respectively,
was incurred for such costs. No reimbursements were made to the Management
Company in 1996.
Certain Lessee employee salaries and identifiable employee expenses incurred
in connection with acquisition and construction services are reimbursed by the
Company. During the years ended December 31, 1998, 1997 and 1996, $962,000,
$634,000 and $200,000 was paid to the Lessee for such services, respectively.
The Company reimburses the Lessee for capitalizable costs that the Lessee
incurs on behalf of the Company during periods of major renovation of the
hotel properties and capitalizes such costs to the related hotel properties.
The total costs reimbursable to the Lessee during 1998 and 1997 totaled $1.6
million and $1.8 million, respectively. No reimbursements were made to the
Lessee in 1996.
In addition, the Company reimburses the Lessee for general and
administrative expenses incurred by the Lessee on behalf of the Company. The
total costs reimbursable to the Lessee during 1998 and 1997 totaled $167,000
and $80,000, respectively.
During 1998, the Lessee reconveyed to the Company certain hotel telephone
equipment that was being leased pursuant to a capital lease agreement. The
equipment carried at $404,000 and related capital lease obligation of $421,000
were previously assigned to the Lessee by the Company and originally recorded
at the Company's costs. The Company agreed to assume the capital lease
obligation and to reimburse the Lessee for all lease payments made by the
Lessee since the equipment was assigned to the Lessee in October 1997.
During 1998, the Lessee reconveyed to the Company approximately $2.2 million
in china, glass, silver and linen that was previously assigned to the Lessee
by the Company and originally recorded by the Lessee at the Company's cost.
15. Pro Forma Financial Information (Unaudited)
The unaudited pro forma financial information set forth below is presented
as if: (i) the acquisition, development and disposition of hotel properties,
and (ii) the equity offerings completed in 1998 and 1997, had occurred on
January 1, 1997.
The pro forma financial information is not necessarily indicative of what
actual results of operations of the Company would have been assuming the
acquisition, development and disposition of the hotel properties, and the
equity offerings completed in 1998 and 1997 had occurred on January 1, 1997,
nor does it purport to represent the results of operations for future periods.
F-25
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Pro Forma Financial Information (Unaudited), continued
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------
1998 1997
--------------- ---------------
(Unaudited)
<S> <C> <C>
Lease revenues $97,561,000 $92,710,000
Net income 16,332,000 26,749,000
Basic earnings per share 0.38 0.66
Diluted earnings per share 0.38 0.66
</TABLE>
16. Subsequent Events
Subsequent to December 31, 1998, the Company declared a dividend of $0.285
per common share which was paid February 15, 1999.
On February 2, 1999, the Company sold the 129-room Hampton Inn located in
Arcadia, California for $8.5 million.
In February 1999, the Company completed the development of an office
building located in San Clemente, California. A portion of the building is
used by the Company as its corporate facility and a portion is leased to the
Lessee as its corporate facility. The remaining space will be leased to third
parties. The office building was financed with a $5.5 million note payable
dated February 5, 1999 collateralized by a first deed of trust with monthly
interest payments at LIBOR plus 2.25% and maturing August 5, 2000. The Company
has the option to extend the maturity date for up to three years.
F-26
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION
as of December 31, 1998
<TABLE>
<CAPTION>
Cost Capitalized
Initial Subsequent to Gross Amount at
Cost to Company Acquisition Close of Period
---------------------- --------------------- ----------------------
Buildings Buildings Buildings
and and and
Description Encumbrances Land Improvements Land Improvements Land Improvements Totals(a)
- ----------- ------------ --------- ------------ -------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Courtyard by Marriott -
Fresno $ $ 800,000 $2,936,460 $150,000 $ 805,585 $ 950,000 $3,742,045 $4,692,045
Doubletree - Santa Fe 2,296,000 8,610,000 -- 1,925,778 2,296,000 10,535,778 12,831,778
Hampton Inn - Arcadia 1,660,500 6,226,875 -- 229,979 1,660,500 6,456,854 8,117,354
Hampton Inn - Denver 1,250,462 2,597,505 -- 1,128,775 1,250,462 3,726,280 4,976,742
Hampton Inn - Mesa 900,000 2,117,321 -- 830,611 900,000 2,947,932 3,847,932
Hampton Inn - Oakland 1,223,045 3,109,435 542 505,554 1,223,587 3,614,989 4,838,576
Hampton Inn - Pueblo 607,183 1,745,054 335,438 562,288 942,621 2,307,342 3,249,963
Hampton Inn - Silverthorne 1,337,625 5,016,094 1,925 1,317,849 1,339,550 6,333,943 7,673,493
Holiday Inn - Steamboat Springs 400,000 2,959,000 56,157 2,431,108 456,157 5,390,108 5,846,265
Holiday Inn Hotel & Suites - Craig 70,000 915,024 207,098 1,608,186 277,098 2,523,210 2,800,308
Holiday Inn Select - Renton 2,119,815 5,622,685 71 6,590,826 2,119,886 12,213,511 14,333,397
Residence Inn - Highlands Ranch 809,159 4,151,567 155,226 3,142,845 964,385 7,294,412 8,258,797
Comfort Suites - S. San Francisco 1,731,368 8,935,209 -- 1,670,516 1,731,368 10,605,725 12,337,093
Courtyard by Marriott - Riverside 2,835,218 395,323 3,098,797 -- 92,242 395,323 3,191,039 3,586,362
Holiday Inn - Price 240,167 4,034,833 235,459 3,238,786 475,626 7,273,619 7,749,245
Hampton Inn - Clackamas -- 2,261,998 3,322 2,388,215 3,322 4,650,213 4,653,535
Hampton Inn - Tucson 500,000 5,817,500 -- 753,399 500,000 6,570,899 7,070,899
Holiday Inn - Flagstaff 1,148,000 6,072,000 -- 1,466,892 1,148,000 7,538,892 8,686,892
Holiday Inn - Provo 850,000 1,116,708 5,266 1,273,985 855,266 2,390,693 3,245,959
Holiday Inn Express - Portland (Stark) 376,254 1,643,824 27,211 1,845,029 403,465 3,488,853 3,892,318
Holiday Inn Express - Poulsbo 613,485 1,558,033 21,996 1,088,776 635,481 2,646,809 3,282,290
Holiday Inn Hotel & Suites - Kent 1,166,955 2,963,452 21,996 1,966,519 1,188,951 4,929,971 6,118,922
Holiday Inn Hotel & Suites - Mesa CC 1,800,000 11,025,000 -- 4,714,690 1,800,000 15,739,690 17,539,690
Residence Inn - Oxnard 2,894,000 11,996,825 -- 1,715,799 2,894,000 13,712,624 16,606,624
Best Western - Lynnwood 2,952,000 4,090,985 -- 887,744 2,952,000 4,978,729 7,930,729
Best Western - Ogden 7,500,000 1,481,911 11,460,688 -- 4,242,386 1,481,911 15,703,074 17,184,985
Clinic View Inn & Suites - Rochester 1,666,170 16,703,101 -- 63,314 1,666,170 16,766,415 18,432,585
Courtyard by Marriott - Cypress 1,216,537 10,340,564 -- 1,255,013 1,216,537 11,595,577 12,812,114
Crystal Suites - Anaheim -- 6,167,984 -- 1,021,243 -- 7,189,227 7,189,227
Hawthorn Suites - Kent 3,301,165 1,744,000 11,607,036 -- 1,075,544 1,744,000 12,682,580 14,426,580
Hawthorn Suites - Sacramento 3,517,000 11,619,998 -- 4,504,695 3,517,000 16,124,693 19,641,693
Hilton - Salt Lake City 22,600,000 8,926,272 33,785,121 -- 9,869,417 8,926,272 43,654,538 52,580,810
Holiday Inn - La Mirada 3,001,000 13,541,158 -- 4,129,065 3,001,000 17,670,223 20,671,223
Holiday Inn - Rochester 1,099,890 6,691,023 -- 164,616 1,099,890 6,855,639 7,955,529
Holiday Inn - San Diego 875,062 7,438,037 -- 4,812,050 875,062 12,250,087 13,125,149
Holiday Inn - San Diego (Stadium) -- 9,943,238 -- 304,701 -- 10,247,939 10,247,939
Marriott - Rochester 1,851,300 36,162,150 -- 2,218,810 1,851,300 38,380,960 40,232,260
Marriott - Park City (c) 2,259,675 15,909,442 -- 340,485 2,259,675 16,249,927 18,509,602
Marriott - Provo 1,117,314 22,120,724 -- 3,620,537 1,117,314 25,741,261 26,858,575
Ramada Plaza - San Diego (Old Town) 1,188,000 10,258,897 380,814 3,428,080 1,568,814 13,686,977 15,255,791
Regency Plaza - LAX -- 11,120,680 -- 812,639 -- 11,933,319 11,933,319
Residence Inn - Provo 893,851 5,603,726 -- 44,213 893,851 5,647,939 6,541,790
Residence Inn - Sacramento 2,020,000 9,590,182 -- 704,154 2,020,000 10,294,336 12,314,336
<CAPTION>
Life on Which
Depreciation
In Latest
Statement of
Financial
Accumulated Date of Date Position is
Description Depreciation(b) Construction Acquired Conducted
- ----------- -------------- ------------ -------- -------------
<S> <C> <C> <C> <C>
Courtyard by Marriott - Fresno $1,040,447 1989 1995 5-35
Doubletree - Santa Fe 2,026,753 1985 1995 5-35
Hampton Inn - Arcadia 1,018,761 1989 1995 5-35
Hampton Inn - Denver 1,988,610 1986 1995 5-35
Hampton Inn - Mesa 846,575 1987 1995 5-35
Hampton Inn - Oakland 337,544 1986 1995 5-35
Hampton Inn - Pueblo 1,232,418 1986 1995 5-35
Hampton Inn - Silverthorne 769,525 1976 1995 5-35
Holiday Inn - Steamboat Springs 2,764,140 1971 1995 5-35
Holiday Inn Hotel & Suites - Craig 560,040 1981 1995 5-35
Holiday Inn Select - Renton 884,726 1968 1995 5-35
Residence Inn - Highlands Ranch 496,556 1996 1995 5-35
Comfort Suites - S. San Francisco 885,253 1985 1996 5-35
Courtyard by Marriott - Riverside 365,216 1988 1996 5-35
Holiday Inn - Price 512,761 1984 1996 5-35
Hampton Inn - Clackamas 422,944 1986 1996 5-35
Hampton Inn - Tucson 496,762 1986 1996 5-35
Holiday Inn - Flagstaff 561,671 1987 1996 5-35
Holiday Inn - Provo 231,224 1968 1996 5-35
Holiday Inn Express - Portland (Stark) 311,010 1986 1996 5-35
Holiday Inn Express - Poulsbo 260,356 1986 1996 5-35
Holiday Inn Hotel & Suites - Kent 478,439 1986 1996 5-35
Holiday Inn Hotel & Suites - Mesa CC 1,051,861 1985 1996 5-35
Residence Inn - Oxnard 990,158 1987 1996 5-35
Best Western - Lynnwood 209,752 1978 1997 5-35
Best Western - Ogden 587,755 1982 1997 5-35
Clinic View Inn & Suites - Rochester 762,423 Various 1997 5-35
Courtyard by Marriott - Cypress 721,262 1990 1997 5-35
Crystal Suites - Anaheim 305,760 1992 1997 5-35
Hawthorn Suites - Kent 774,378 1990 1997 5-35
Hawthorn Suites - Sacramento 724,543 1988 1997 5-35
Hilton - Salt Lake City 1,786,645 1975 1997 5-35
Holiday Inn - La Mirada 964,833 1984 1997 5-35
Holiday Inn - Rochester 315,248 1969 1997 5-35
Holiday Inn - San Diego 594,714 1968 1997 5-35
Holiday Inn - San Diego (Stadium) 468,546 1991 1997 5-35
Marriott - Rochester 1,694,705 1991 1997 5-35
Marriott - Park City 729,906 1985 1997 5-35
Marriott - Provo 1,082,601 1982 1997 5-35
Ramada Plaza - San Diego (Old Town) 657,817 1986 1997 5-35
Regency Plaza - LAX 520,786 1996 1997 5-35
Residence Inn - Provo 258,919 1996 1997 5-35
Residence Inn - Sacramento 361,523 1992 1997 5-35
</TABLE>
F-27
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION (continued)
as of December 31, 1998
<TABLE>
<CAPTION>
Cost Capitalized
Initial Subsequent to
Cost to Company Acquisition
------------------------- -----------------------
Buildings Buildings
and and
Description Encumbrances Land Improvements Land Improvements
- ----------- ------------ ------------ ------------ ---------- ------------
<S> <C> <C> <C> <C> <C>
Residence Inn - San Diego 3,130,000 12,798,740 -- 852,005
Sheraton - Chandler 13,260,000 18,752,580 23,712,592 1,241,439 2,395,024
The Kahler Hotel - Rochester 32,221,493(c) 3,410,748 43,097,136 -- 1,121,988
Marriott (University) - Salt Lake City 8,320,000 -- 25,238,738 -- 2,650,919
Days Inn - Santa Clara 7,291,944 11,880,357 -- 128,469
Fairfield Inn - Santa Clarita 1,606,752 3,229,381 -- 127,340
Hampton Inn - Santa Clarita 6,138,659 2,142,565 5,406,343 -- 261,890
Hilton - Carson 1,830,000 9,403,847 -- 1,084,313
Marriott - Napa 8,624,880 11,265,026 -- 17,426
Marriott - Pueblo -- 9,430,049 -- 261,781
Pacific Shores - Santa Monica -- 21,006,510 -- 91,947
Radisson - Oxnard 1,637,220 6,793,478 -- 202,573
Residence Inn - Santa Clarita 2,191,026 8,198,217 -- 109,063
Vacation Inn - San Diego 2,070,000 8,521,100 -- 300,624
----------- ------------ ------------ ---------- -----------
$96,176,535 $113,687,038 $560,667,447 $2,843,960 $96,398,300
=========== ============ ============ ========== ===========
Investments in Other Real Estate Properties
- -------------------------------------------
TCS - Rochester $ 8,792,939 $ 2,867,301 $ 5,256,717 $ -- $ --
TCS - Salt Lake City -- -- 1,600,686 -- --
Land held for future development or sale -- 1,496,556 -- -- --
Land under development -- 649,819 -- -- --
----------- ------------ ------------ ---------- -----------
$ 8,792,939 $ 5,013,676 $ 6,857,403 $ -- $ --
=========== ============ ============ ========== ===========
<CAPTION>
Life on Which
Gross Amount at Depreciation
Close of Period In Latest
------------------------- Statement of
Buildings Financial
and Accumulated Date of Date Position is
Description Land Improvements Totals(a) Depreciation(b) Construction Acquired Conducted
- ----------- ------------ ------------ ------------ --------------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Residence Inn - San Diego 3,130,000 13,650,745 16,780,745 482,815 1989 1997 5-35
Sheraton - Chandler 19,994,019 26,107,616 46,101,635 1,115,579 1987 1997 5-35
The Kahler Hotel - Rochester 3,410,748 44,219,124 47,629,872 1,983,715 Various 1997 5-35
Marriott (University) - Salt
Lake City -- 27,889,657 27,889,657 1,204,137 1987 1997 5-35
Days Inn - Santa Clara 7,291,944 12,008,826 19,300,770 291,614 1985 1998 5-35
Fairfield Inn - Santa Clarita 1,606,752 3,356,721 4,963,473 109,520 1997 1998 5-35
Hampton Inn - Santa Clarita 2,142,565 5,668,233 7,810,798 134,855 1988 1998 5-35
Hilton - Carson 1,830,000 10,488,160 12,318,160 327,440 1990 1998 5-35
Marriott - Napa 8,624,880 11,282,452 19,907,332 274,219 1979 1998 5-35
Marriott - Pueblo -- 9,691,830 9,691,830 146,077 1998 1998 5-35
Pacific Shores - Santa Monica -- 21,098,457 21,098,457 256,562 1967 1998 5-35
Radisson - Oxnard 1,637,220 6,996,051 8,633,271 189,776 1987 1998 5-35
Residence Inn - Santa Clarita 2,191,026 8,307,280 10,498,306 275,589 1997 1998 5-35
Vacation Inn - San Diego 2,070,000 8,821,724 10,891,724 291,081 1988 1998 5-35
------------ ------------ ------------ ------------
$116,530,998 $657,065,747 $773,596,745 $41,138,845
============ ============ ============ ============
Investments in Other Real Estate Properties
- -------------------------------------------
TCS - Rochester $ 2,867,301 $ 5,256,717 $ 8,124,018 $ 113,346 1993 1997 5-35
TCS - Salt Lake City -- 1,600,686 1,600,686 389,058 1980 1997 5-35
Land held for future
development or sale 1,496,556 -- 1,496,556 --
Land under development 649,819 -- 649,819 --
------------ ------------ ------------ ------------
$ 5,013,676 $ 6,857,403 $ 11,871,079 $ 502,404
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Hotel Properties Other Real Estate Investments
---------------------------------------- -----------------------------------
1996 1997 1998 1996 1997 1998
------------ ------------ ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
(a) Reconciliation of Land and Buildings and Improvements:
Balance at the
beginning of the year $ 52,012,431 $147,323,633 $643,225,814 -- -- $ 9,724,705
Additions during year:
Acquisitions 88,198,970 467,135,296 122,528,695 -- 9,724,705 --
Improvements 11,062,230 28,766,885 54,903,283 -- -- 2,146,374
Disposals during the
year (3,949,998) -- (47,061,047) -- -- --
------------ ------------ ------------ ----------- ----------- -----------
Balance at end of year $147,323,633 $643,225,814 $773,596,745 $ -- $ 9,724,705 $11,871,079
============ ============ ============ =========== =========== ===========
(b) Reconciliation of Accumulated Depreciation:
Balance at beginning of
year $ 6,735,996 $ 9,558,217 $ 19,223,317 $ -- $ -- $ 99,000
Depreciation for the
year 2,861,351 9,665,100 23,216,159 -- 99,000 403,404
Retirement (39,130) -- (1,300,631) -- -- --
------------ ------------ ------------ ----------- ----------- -----------
Balance at end of year $ 9,558,217 $ 19,223,317 $ 41,138,845 $ -- $ 99,000 $ 502,404
============ ============ ============ =========== =========== ===========
(c) The $32,221,493 encumbrance is cross-collateralized by Park City Marriott and the Kahler Hotel.
</TABLE>
F-28
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Sunstone Hotel Investors, Inc.
We have audited the accompanying consolidated statements of operations,
equity and cash flows of Sunstone Hotel Investors, Inc. and its subsidiaries
(the "Company") for the year ended 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of operations
and cash flows of Sunstone Hotel Investors, Inc. and its subsidiaries for the
year ended December 31, 1996, in conformity with generally accepted accounting
principles.
/s/ COOPERS & LYBRAND LLP
San Francisco, California
February 28, 1997
F-29
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Sunstone Hotel Properties, Inc.
We have audited the accompanying consolidated balance sheets of Sunstone
Hotel Properties, Inc. (the "Lessee") as of December 31, 1998 and 1997, and
the related consolidated statements of operations, changes in stockholders'
deficit and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Lessee's management. Our
responsibility is to express an opinion on these consolidated 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 Sunstone Hotel Properties, Inc. at December 31, 1998 and 1997, and the
consolidated results of its operations and its cash flows for the years then
ended, in conformity with generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
Newport Beach, California
February 19, 1999
F-30
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-------------------------
<S> <C> <C>
1998 1997
------------ -----------
ASSETS
Current assets:
Cash and cash equivalents $ 3,639,000 $ 4,352,000
Receivables, net of allowance for doubtful
accounts of $388,000 in 1998 and $267,000 in 1997 10,771,000 10,037,000
Due from affiliates, net 164,000 321,000
Inventories 1,824,000 1,798,000
Prepaid expenses and other current assets 640,000 306,000
------------ -----------
17,038,000 16,814,000
Management agreements, net 366,000 752,000
Property and equipment, net 154,000 3,116,000
Other assets 420,000 204,000
------------ -----------
$ 17,978,000 $20,886,000
============ ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities
Rent payable--Sunstone Hotel Investors, Inc. $ 7,498,000 $ 7,641,000
Accounts payable 8,811,000 8,836,000
Accrued payroll and employee benefits 6,697,000 5,461,000
Sales taxes payable 1,915,000 1,640,000
Stockholder line of credit 650,000 --
Other liabilities 1,295,000 1,845,000
------------ -----------
26,866,000 25,423,000
Long-term liabilities
Capital lease obligation -- 366,000
Accrued pension liability 1,603,000 1,017,000
------------ -----------
28,469,000 26,806,000
------------ -----------
Commitments and contingencies (Notes 5 and 6)
Minority interest -- 119,000
Stockholders' deficit
Common stock, no par value, 100,000 shares
authorized; 125 shares issued and outstanding 498,000 --
Accumulated deficit (Note 3) (10,422,000) (6,039,000)
Accumulated other comprehensive loss (567,000) --
------------ -----------
(10,491,000) (6,039,000)
------------ -----------
$ 17,978,000 $20,886,000
============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-31
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
REVENUES:
Room $204,492,000 $95,106,000 $34,085,000
Food and beverage 41,857,000 14,159,000 2,576,000
Other 27,247,000 8,888,000 1,932,000
------------ ----------- -----------
Total revenues 273,596,000 118,153,000 38,593,000
------------ ----------- -----------
EXPENSES:
Room 47,585,000 22,073,000 9,041,000
Food and beverage 34,474,000 11,978,000 2,436,000
Other 17,382,000 5,154,000 1,265,000
Advertising and promotion 20,719,000 9,574,000 3,895,000
Repairs and maintenance 11,314,000 4,719,000 1,829,000
Utilities 10,960,000 5,013,000 2,034,000
Franchise costs 7,229,000 3,428,000 1,326,000
Management fees to related party 937,000 1,776,000 983,000
Rent expense--Sunstone Hotel
Investors, Inc. 98,682,000 44,680,000 14,848,000
General and administrative 28,697,000 11,889,000 4,098,000
------------ ----------- -----------
Total expenses 277,979,000 120,284,000 41,755,000
------------ ----------- -----------
NET LOSS $ (4,383,000) $(2,131,000) $(3,162,000)
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-32
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Common Stock, no par Other Total
-------------------- Accumulated Comprehensive Stockholders'
Shares Amount Deficit Loss Deficit
---------------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31,
1995 125 $ -- $ (746,000) $ -- $ (746,000)
Net loss -- -- (3,162,000) -- (3,162,000)
------- ------------ ------------ --------- ------------
Balance at December 31,
1996 125 -- (3,908,000) -- (3,908,000)
Net loss -- -- (2,131,000) -- (2,131,000)
------- ------------ ------------ --------- ------------
Balance at December 31,
1997 125 -- (6,039,000) -- (6,039,000)
Contributions -- 498,000 -- -- 498,000
Net loss -- -- (4,383,000) -- (4,383,000)
Minimum pension
liability adjustment -- -- -- (567,000) (567,000)
------- ------------ ------------ --------- ------------
Balance at December 31,
1998 125 $ 498,000 $(10,422,000) $(567,000) $(10,491,000)
======= ============ ============ ========= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-33
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,383,000) $(2,131,000) $(3,162,000)
Adjustments to reconcile net loss to
net cash (used in) provided by
operating activities:
Gain on sale of assets (266,000) -- --
Bad debt expense 382,000 267,000 --
Depreciation 67,000 53,000 --
Amortization 386,000 94,000 --
Deferred compensation expense 309,000 -- --
Changes in operating assets and
liabilities:
Receivables (692,000) (2,011,000) (751,000)
Inventories -- (140,000) (389,000)
Prepaid expenses and other current
assets (116,000) 91,000 (45,000)
Other assets (222,000) -- --
Rent payable--Sunstone Hotel
Investors, Inc. (143,000) 5,281,000 1,715,000
Accounts payable (25,000) (1,060,000) 2,034,000
Accrued payroll and employee
benefits 1,236,000 3,250,000 618,000
Sales taxes payable 275,000 1,416,000 (1,000)
Due from affiliates, net 2,050,000 (1,852,000) (170,000)
Accrued pension liability 19,000 (180,000) --
Other liabilities (683,000) (976,000) 535,000
----------- ----------- -----------
Net cash (used in) provided by
operating activities (1,806,000) 2,102,000 384,000
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (95,000) (174,000) (19,000)
Net proceeds from sale of assets 525,000 -- --
Proceeds from Lessor upon execution of
certain leases 13,000 1,269,000 --
----------- ----------- -----------
Net cash provided by (used in)
investing activities 443,000 1,095,000 (19,000)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from stockholder line of
credit 650,000 -- --
Payments on capital lease obligation -- (10,000) --
----------- ----------- -----------
Net cash provided by (used in)
financing activities 650,000 (10,000) --
----------- ----------- -----------
Net (decrease) increase in cash and
cash equivalents (713,000) 3,187,000 365,000
Cash and cash equivalents, beginning
of year 4,352,000 1,165,000 800,000
----------- ----------- -----------
Cash and cash equivalents, end of year $ 3,639,000 $ 4,352,000 $ 1,165,000
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-34
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
Sunstone Hotel Properties, Inc. (the "Lessee") was incorporated in Colorado
in August 1995 and commenced operations effective with the completion of an
initial public stock offering by Sunstone Hotel Investors, Inc. (the "Lessor")
on August 16, 1995. The Lessee leases hotel properties, which are primarily
located in the western United States, from the Lessor pursuant to long-term
leases (the "Percentage Leases"). The Lessee operates 100% of the hotel
properties owned by the Lessor. The Lessee is owned by Robert A. Alter,
Chairman and President of the Lessor (80%), and Charles L. Biederman, Director
and Executive Vice President of the Lessor (20%). At December 31, 1998, 57
hotel properties were leased from the Lessor.
2. Summary of Significant Accounting Policies
Consolidation:
The accompanying financial statements include the accounts of the Lessee and
its subsidiaries in which it has controlling interests. All significant
intercompany transactions have been eliminated in consolidation.
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.
Receivables:
Accounts receivable primarily represents receivables from hotel guests who
occupy hotel rooms and utilize the hotel services. Accounts receivable also
includes receivables from customers who utilize the Lessee's laundry
facilities in Salt Lake City, Utah, and Rochester, Minnesota. The Lessee
maintains an allowance for doubtful accounts at a level which the Lessee's
management believes is sufficient to cover potential credit losses.
Inventories:
Inventories, consisting primarily of food and beverages are stated at the
lower of cost or market, with cost determined on a method that approximates
first-in, first-out basis.
Management Agreements:
Management agreements are carried at the Lessor's allocated cost of such
agreements prior to the agreements being assigned to the Lessee. The allocated
costs were based upon the estimated fair value of the management agreements in
connection with the Lessor's acquisition of the stock of Kahler Realty
Corporation in October 1997. The management agreements are amortized over the
estimated term of the related agreements ranging from one to ten years.
Accumulated amortization totaled $480,000 and $94,000 at December 31, 1998 and
1997, respectively.
Property and Equipment:
Property and equipment is stated on the basis of cost and includes computer
equipment and other hotel equipment. Property and equipment is depreciated on
a straight-line basis over the estimated useful lives ranging from 3 to 25
years.
F-35
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
During 1998, the Lessee reconveyed to the Lessor certain hotel telephone
equipment that was being leased pursuant to a capital lease agreement. The
equipment carried at $404,000 and related capital lease obligation of $421,000
were previously assigned to the Lessee by the Lessor and originally recorded
by the Lessee at the Lessor's costs. The Lessor agreed to assume the capital
lease obligation and to reimburse the Lessee for all lease payments made by
the Lessee since the equipment was assigned to the Lessee in October 1997. The
transaction was recorded by the Lessee as a reduction of the applicable asset,
the related accumulated depreciation and a reduction of the capital lease
obligation.
During 1998, the Lessee reconveyed to the Lessor approximately $2.2 million
in china, glass, silver and linen that was previously assigned to the Lessee
by the Lessor and originally recorded by the Lessee at the Lessor's cost. The
transaction was recorded by the Lessee as a reduction of the applicable asset
accounts and a reduction of the amount due to the Lessor, with no gain or loss
being recognized.
During 1998, the sewage treatment plant and related assets were sold to a
third party for net proceeds of $650,000, of which $125,000 of the proceeds
were received by the Lessor and recorded by the Lessee as a receivable from
the Lessor. A gain of $266,000 was recognized in connection with the sale of
these assets.
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
-------- ----------
<S> <C> <C>
Land $ -- $ 26,000
Sewage treatment plant and equipment -- 521,000
-------- ----------
-- 547,000
Hotel and computer equipment 233,000 2,622,000
-------- ----------
233,000 3,169,000
Accumulated depreciation (79,000) (53,000)
-------- ----------
$154,000 $3,116,000
======== ==========
</TABLE>
Depreciation expense for 1998, 1997 and 1996 totaled $67,000, $53,000 and
$0, respectively.
Revenue Recognition:
Revenue is recognized as earned, which is generally defined as the date upon
which a guest occupies a room or utilizes the hotel's services.
Other Revenues:
Other revenues consist of revenues derived from incidental hotel services
such as concession, movie, golf, retail, fitness services and sublease
revenues relating to the restaurants and retail shops. Revenues from
incidental hotel services are recognized in the period the related services
are provided. Sublease revenues for 1998 and 1997 totaled $2.5 million and
$344,000, respectively. In 1998, other revenues also include the $266,000 gain
on the sale of the sewage treatment plant and related assets.
F-36
<PAGE>
SUNSTONE HOTEL INVESTORS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
Advertising and Promotion Costs:
Advertising and promotion costs are expensed when incurred. 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.
Franchise Costs:
Franchise costs represent the expense for franchise royalties under the
terms of hotel franchise agreements, generally ranging from 10 to 20 years.
Rent Expense:
Rent expense is recognized as incurred to the Lessor under the Percentage
Leases commencing on the date the lease is executed. Percentage rent is
accrued prior to the Lessee achieving the baseline revenue that triggers the
percentage rental expense when achievement of the baseline revenue is
considered probable.
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 income related taxes. Accordingly, the accompanying statements of
operations and stockholders' deficit do not include income tax expense.
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 Lessee'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 fair value,
management believes that the carrying amounts of the Lessee's financial
instruments reasonably approximate their fair value at December 31, 1998 and
1997.
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 materially
from those estimates in the near term.
Reclassifications:
Certain prior year balances have been reclassified to conform with the
current year presentation.
F-37
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies, continued
Seasonality:
The hotel industry is seasonal in nature. Seasonal variations in revenues
may cause quarterly fluctuations in the Lessee's revenues.
Comprehensive Income (Loss):
In 1998, the Lessee adopted Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income ("SFAS No. 130"), which establishes new
standards for reporting and displaying of comprehensive income and its
components; however, the adoption of SFAS No. 130 had no impact on the
Lessee's net loss. SFAS 130 requires that the minimum pension liability
adjustment be included in other comprehensive income (loss) which is reflected
on the consolidated statements of changes in stockholders' deficit. There were
no items of other comprehensive income in 1997 or 1996.
Reportable Segments:
During 1998, the Company adopted Statement of Financial Accounting Standards
No. 131, Disclosures About Segments of an Enterprise and Related Information
("Statement No. 131"). Statement No. 131 superseded Statement No. 14,
Financial Reporting for Segments of a Business Enterprise. Statement No. 131
establishes standards for the way that public business enterprises report
information regarding reportable operating segments. The adoption of Statement
No. 131 did not affect the results of operations or financial position of the
Lessee. The Lessee operates the Lessor's hotel properties which generated
room, food and beverage and other revenues through the renting of hotel rooms
and the operations of the food and beverage outlets to a diverse base of
customers. The Lessee separately evaluates the performance of each of its
hotels. However, because each of the hotels have similar economic
characteristics, facilities and services, the hotel properties have been
aggregated into a single dominant segment. The Lessee evaluates performance
and allocates resources primarily based on revenue per available room, average
daily rate and the occupancy rate of individual hotels.
3. Stockholders' Deficit
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 Lessor
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 Lessor is a result of the original terms
under the Percentage Leases, for the payment of rent to the Lessor, 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 $4.4 million net loss in 1998 as well as the $2.1 million and
$3.2 million net losses in 1997 and 1996, respectively, were primarily due to
the substantial renovations at the hotels the Lessee operates, resulting in a
substantial number of rooms taken out of service which adversely impacted the
hotels' operations and profitability. In 1998, 1997 and 1996, 20, 19 and 8
hotels, respectively, were subject to substantial renovations. Such
renovations were made in conjunction with the Lessor's strategy of acquiring
hotels that can benefit from extensive improvements, reflagging and
repositioning, resulting in higher potential revenue. 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.
F-38
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Stockholder Line of Credit
On December 30, 1998, the Lessee entered into a $1.5 million line of credit
with its primary stockholder. The line of credit bears interest at the prime
rate plus 0.25%, is unsecured and has a maturity date of December 29, 1999.
The line of credit is to be used exclusively for general short-term working
capital needs. As of December 31, 1998, the unpaid balance on the line of
credit was $650,000.
5. Other Commitments and Contingencies
Ten of the Lessee's hotels have telephone service agreements with a
telecommunications company which call for contingent payments based upon
telephone usage. These agreements expire in June 2000. Expenses incurred
pursuant to these service agreements totaled $2.9 million, $533,000 and $0 in
1998, 1997 and 1996, respectively.
The Lessee has entered into various license and franchise agreements related
to certain hotel properties. The agreements have terms ranging between 4 and
28 years and expire between 2001 and 2026. The agreements require the Lessee
to, among other things, pay various monthly fees that are calculated based on
specified percentages of certain specified revenues. The Lessee's obligations
under certain of the agreements are guaranteed by either its shareholders or the
Lessor.
The Franchise Agreements generally contain specific standards for, and
restrictions and limitations on, the operation and maintenance of the hotels
which are established by the franchisors to maintain uniformity in the system
created by each such franchisor. Such standards generally regulate the
appearance of the hotel, quality and type of goods and services offered,
signage, and protection of marks. Compliance with such standards may from time
to time require significant expenditures for capital improvements which will
be borne by the Lessor.
The Lessee is involved from time to time in various claims and legal actions
in the ordinary course of business. Management does not believe that the
resolution of such matters will have a material adverse effect on the Lessee's
financial position or results of operations when resolved.
6. Percentage Lease Agreements
The Lessee has future commitments to the Lessor under the Percentage Leases
through 2008. At December 31, 1998, future minimum rentals (base rents)
payable under the Percentage Leases, exclusive of any base rent which may be
abated during periods of major renovation, with the Lessor are as follows:
<TABLE>
<S> <C>
1999 $ 57,524,000
2000 57,524,000
2001 57,524,000
2002 57,524,000
2003 57,524,000
Thereafter 198,908,000
------------
$486,528,000
============
</TABLE>
F-39
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Percentage Lease Agreements, (continued)
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 9% to 50% of room revenues, up to a certain baseline revenue
(the base rent component), then 60% to 68% of room revenues in excess of the
baseline revenues. Generally, percentage rent also includes 5% of food and
beverage revenue and 100% of net other revenues. Rent expense pursuant to the
Percentage Leases for the year ended December 31, 1998, 1997 and 1996 was
$98.7 million, $44.7 million and $14.8 million, respectively, of which $40.2
million, $19.8 million and $6.8 million, respectively, was in excess of base
rents. The stockholders of the Lessee have collateralized the lease payments
by pledging 481,955 of their Operating Partnership units of Sunstone Hotel
Investors, L.P., a majority-owned partnership of the Lessor. At December 31,
1998, 317,645 of the Operating Partnership units pledged by the primary
stockholder are also pledged to a senior lender to secure the credit facility
issued to the primary stockholder. This credit facility will be used by the
primary stockholder to fund the short-term working capital needs of the Lessee
(see Note 4). The Lessor has subordinated its right under the collateral to
the senior lender.
In 1997, the Lessor and Lessee amended the Percentage Leases for hotels then
currently under renovation and for any future hotels to allow for the
abatement of base rent related to rooms taken out of service during major
renovations. The Lessor abated $668,000 and $0 of base rent during 1998 and
1997, respectively.
Upon the sale of a hotel by the Lessor, the respective Percentage Lease
terminates. As provided for in the Percentage Leases and as compensation for
the early termination, the Lessor is required to (i) pay the Lessee a
termination fee of an amount equal to the net profit earned by the Lessee with
respect to the hotels sold for the 12-month period preceding the sale or, (ii)
offer to lease the Lessee one or more substitute hotel facilities pursuant to
a similar lease. During 1998, the Lessor sold six hotels and terminated the
related Percentage Leases. Such terminated leases were replaced with new
leases in 1998 and no termination fee was due from the Lessor.
Pursuant to the Percentage Leases, the Lessor is required to make available
to the Lessee for the repair, replacement and refurbishment of furniture,
fixtures and equipment in the hotels, when and as deemed necessary by the
Lessee, an amount equal to 4% of room revenue per quarter on a cumulative
basis. To the extent the amount is not fully utilized by the Lessee in any
year, the Lessor may use the amount to fund certain capital expenditures. The
Lessor is responsible for payment of (i) real estate and personal property
taxes on its hotel properties (except to the extent that personal property
associated with the hotels is owned by the Lessee), (ii) casualty insurance on
the hotels, (iii) business interruption insurance on the hotels, and (iv)
general liability insurance. The Lessee is required to pay for workers'
compensation and other insurance appropriate and customary for properties
similar to the Lessor's hotels with the Lessor as an additional named insured.
7. Retirement Plans
The Lessee has a defined benefit plan covering union employees at certain
properties located in Rochester, Minnesota. This was previously a plan of
Kahler Realty Corporation ("Kahler"), which was assumed by the Lessor in
connection with its acquisition of Kahler on October 15, 1997. The plan was
assigned to the Lessee upon execution of the Percentage Leases of the related
Kahler Hotels. Pension contributions and expenses for this plan are determined
based on the actuarial cost of current service.
During 1998, the Lessee adopted the requirements of SFAS No. 132, Employers'
Disclosures about Pensions and Other Postretirement Benefits ("SFAS No. 132"),
which requires the Lessee to revise the disclosures about pension and other
postretirement benefit plans. SFAS No. 132 only revises the disclosure and
does not change the measurement or recognition of those plans. Accordingly,
the adoption of SFAS No. 132 did not have any impact on the financial
position, operations or cash flows of the Lessee.
F-40
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Retirement Plans, continued
Net periodic pension cost for the defined benefit plan includes the
following components for the year ended December 31, 1998 and for the period
October 15, 1997 to December 31, 1997:
<TABLE>
<CAPTION>
October 15,
For the 1997
Year Ended through
December December
31, 1998 31, 1997
----------- -----------
<S> <C> <C>
Change in the Projected Benefit Obligation ("PBO")
PBO at beginning of year $ 3,509,000 $ 3,467,000
Service cost 147,000 30,000
Interest cost 269,000 51,000
Benefits paid (185,000) (29,000)
Actuarial loss (gain) 569,000 (10,000)
----------- -----------
PBO at end of year $ 4,309,000 $ 3,509,000
=========== ===========
Change in the fair value of plan assets
Fair value of assets at beginning of year $ 2,492,000 $ 2,597,000
Employer contributions 198,000 --
Benefits paid (185,000) (29,000)
Actual return on assets 201,000 (76,000)
----------- -----------
Fair value of assets at end of year(1) $ 2,706,000 $ 2,492,000
=========== ===========
Components of accrued pension cost Funded status $(1,603,000) $(1,017,000)
Unrecognized net actuarial loss 567,000 --
----------- -----------
Accrued pension cost $(1,036,000) $(1,017,000)
=========== ===========
Amounts recognized in the consolidated balance
sheets
Accrued pension liability $(1,603,000) $(1,017,000)
Accumulated other comprehensive loss 567,000 --
----------- -----------
Accrued pension cost recognized $(1,036,000) $(1,017,000)
=========== ===========
Change in the additional minimum pension liability
recognized
Change in accrued pension cost $ 567,000 $ --
----------- -----------
Change in other comprehensive loss $ 567,000 $ --
=========== ===========
Components of the net periodic pension cost
recognized as expense
Service cost $ 147,000 $ 30,000
Interest cost 269,000 51,000
Expected return on plan assets (200,000) (43,000)
Amortization of unrecognized net actuarial loss 1,000 --
----------- -----------
Net periodic pension cost recognized as expense $ 217,000 $ 38,000
=========== ===========
Key economic assumptions
Weighted-average discount rate 6.50% 7.00%
Weighted-average expected long-term return on plan
assets 8.00% 8.00%
</TABLE>
The accumulated projected benefit obligation for the plan was $4.3 million
and $3.5 million on December 31, 1998 and 1997, respectively.
- --------
(1) Plan assets consist primarily of equity and fixed income securities.
F-41
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Retirement Plans, continued
The benefit formula is based upon a monthly benefit level of $14 times the
years of benefit service. The Lessee's funding policy is to contribute amounts
to the plan sufficient to meet minimum funding requirements set forth in the
Employee Retirement Income Security Act of 1974, plus such additional amount
as the Lessee may determine appropriate from time to time.
The Lessee also provides post-retirement benefits to a fixed number of
retired employees of acquired hotels relating to service provided prior to
1992. At December 31, 1998 and 1997, the estimated liability was $137,000 and
$179,000, respectively, and is included in other accrued expenses.
The Lessee's employees may participate, subject to eligibility, in Sunstone
Hotel Properties, Inc.'s Retirement and Savings Plan (the "401(k) Plan").
Employees are eligible to participate in the 401(k) Plan after attaining 21
years of age and performing one year of service and working at least 1,000
hours. Up to 6% of employee contributions are matched by the Lessee at 25%.
Matching contributions made by the Lessee totaled $358,000, $69,000 and
$11,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
8. Stock Appreciation Rights Plan
In July 1996, the Lessee adopted the 1996 Stock Appreciation Rights Plan
(the "SAR Plan"), as amended, under which employees, consultants and
nonemployee members of the Board of Directors of the Lessee are eligible to
receive stock appreciation rights that are based upon the quoted market prices
of the Lessor's common stock. All rights were issued at prices equal to the
quoted market prices of the Lessor's common stock on the dates granted, had
ten-year terms and vested over five years.
Effective September 25, 1998, the SAR Plan was terminated and all
unexercised stock appreciation rights issued under the SAR Plan are being
canceled. The Lessee's stockholders have agreed to settle the Lessee's
liability under the SAR Plan by assigning their personal warrants to acquire
the Lessor's common stock to the holders of the stock appreciation rights
being canceled. The fair value of the warrants being assigned effective
September 25, 1998 was computed to be $498,000 based on the Black Scholes
option pricing model. The $498,000 fair value was recorded as an equity
contribution from the Lessee's stockholders. Deferred compensation expense of
$498,000 was recorded on the balance sheet effective September 25, 1998, and
will be amortized over the future vesting period of the assigned warrants. At
December 31, 1998, the remaining unamortized deferred compensation expense
totaled $189,000. The warrants being assigned will vest in accordance with the
original vesting schedule of the stock appreciation rights being canceled. The
stock warrants will be exercisable beginning October 25, 1999 and will expire
September 25, 2003.
9. Other Related Party Transactions
Sunstone Hotel Management, Inc. (the "Management Company"), a company wholly
owned by the Lessee's primary stockholder, provides management services to the
Lessee pursuant to the terms of a management agreement. The agreement has a
one year term and is automatically renewed. Management fees are computed based
on 1% to 2% of gross revenues. The cost of these services is classified as
management fees in the statements of operations. In 1998, management fees
totaling $3.3 million were permanently abated by the Management Company.
Certain Lessee employees' salaries and identifiable employee expenses
incurred in connection with acquisition and construction services are
reimbursed by the Lessor. The reimbursements are recorded as a reduction of
the related expenses. During the years ended December 31, 1998, 1997 and 1996,
$962,000, $634,000 and $200,000 was reimbursed to the Lessee for such
services, respectively.
F-42
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Other Related Party Transactions, continued
Upon the execution of each Percentage Lease, the Lessor assigns all hotel
operating assets and liabilities to the Lessee at the Lessor's cost. The
Lessee records all such hotel operating assets and liabilities at the Lessor's
cost with a corresponding net amount payable to or receivable from the Lessor,
depending on whether net assets or liabilities were assigned. During 1998,
1997 and 1996, the net assets assigned in this manner totaled $218,000, $1.9
million and $147,000, respectively. In connection with the Lessor's
acquisition of Kahler Realty Corporation in October 1997, the Lessor assigned
net liabilities to the Lessee and paid the Lessee $1.1 million, plus an
additional $200,000 of assigned cash.
The Lessee is reimbursed by the Lessor for certain costs it incurs related
to the Lessor's renovation of the hotels. The total costs incurred and
reimbursable by the Lessor totaled $1.6 million and $1.8 million in 1998 and
1997, respectively. No reimbursements were made to the Lessee in 1996.
In addition, the Lessor reimburses the Lessee for general and administrative
expenses incurred by the Lessee on behalf of the Lessor. The total costs
reimbursable to the Lessee during 1998 and 1997 totaled $167,000 and $80,000,
respectively.
Amounts due from affiliates primarily represents reimbursements due from the
Lessor netted with the amounts due to the Lessor for net hotel operating
assets assigned by the Lessor to the Lessee upon the execution of each
Percentage Lease.
10. Credit Risk and Collective Bargaining Agreements
Financial instruments that potentially subject the Lessee to significant
concentrations of credit risk consist principally of cash investments and
trade accounts receivable.
The Lessee maintains cash and cash equivalents and certain other financial
instruments with various financial institutions. These financial institutions
are located throughout the country and the Lessee's policy is designed to
limit exposure to any one institution. The Lessee performs periodic
evaluations of the relative credit standing of those financial institutions
that are considered in the Lessee's investment strategy. At December 31, 1998
and 1997, the Lessee had amounts in banks that were in excess of federally-
insured amounts.
Concentrations of credit risk with respect to trade accounts receivable
include accounts receivable from hotel guests from Middle Eastern countries
totaling $1.7 million which represents 15% of total accounts receivable at
December 31, 1998. Credit is extended based on an evaluation of the guests'
financial condition, and collateral is generally not required. The Lessee
provides for potential credit losses relating to the accounts receivable from
these guests based on the Lessee's historical experience. Historically, credit
losses associated with these accounts receivable have not been material to the
hotels' results of operations.
The Lessee is subject to collective bargaining agreements at certain hotels
it operates. At December 31, 1998, the percentage of employees covered by such
collective bargaining agreements represent approximately 11% of the total
number of employees.
11. Year 2000 Issues (Unaudited)
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 twenty-first century dates from twentieth century dates. If not
corrected, computer systems may fail or create erroneous results causing
disruptions of operations.
F-43
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Year 2000 Issues (Unaudited), continued
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 also may be
exposed to risks from third parties with whom the Lessee interacts who fail to
adequately address their own Year 2000 issues. Such third parties include
franchisers, vendors, suppliers and significant customers.
To mitigate and minimize the number and seriousness of any disruptions
caused by the Year 2000 Issue, the Lessee has 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 the hotels' systems, remediation, testing, and
implementation. With the assistance of outside consultants, site surveys are
being performed and all hotels' 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 which 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 will be completed by the end
of the first quarter 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
action plan. 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 resolution process in a
timely fashion could materially impact the Lessee. The effect of compliance by
vendors is not determinable.
F-44
<PAGE>
SUNSTONE HOTEL PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Year 2000 Issues (Unaudited), continued
Cost of Addressing Year 2000 Issues:
The Lessee estimates that total costs for the Year 2000 compliance review,
evaluation, assessment and remediation efforts should not exceed $1.0 million
and will be funded by the Lessor 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 on-site system surveys at a total
cost of $163,000 which was expensed by the Lessor in the first quarter of
1999. The remaining balance is anticipated to be expended in 1999.
Risks Presented by Year 2000 Issues:
Management of the Lessee believes it has 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 Lessee, its
business and its financial condition. The Lessee cannot predict the actual
effects of the Year 2000 Issue on its business; such effects depend on
numerous uncertainties such as whether significant third parties have properly
and timely address 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 Lessee's dependence on third parties, the Lessee is
unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on the Lessee.
Contingency Plan:
The Lessee is in the process of developing its contingency plan for the
systems operated and 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.
12. Subsequent Events
In January 1999, an additional $800,000 was drawn on the stockholder line of
credit by the Lessee for working capital needs. In February 1999, the Lessee
paid down $644,000, plus related unpaid accrued interest, on the stockholder
line of credit.
In February 1999, the Lessor sold a hotel property located in Arcadia,
California and the related Percentage Lease was terminated. No termination fee
is due from the Lessor in connection with the lease termination as the Lessor
anticipates offering the Lessee a substitute hotel facility within the 180
days allowed under the Percentage Lease agreement.
On February 15, 1999, the Lessee began leasing office space from the Lessor
when it moved its corporate facilities into a building owned by the Lessor.
F-45
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Sunstone Hotel Properties, Inc.
We have audited the accompanying consolidated statement of operations,
stockholders' deficit, and cash flows of Sunstone Hotel Properties, Inc. and its
subsidiaries (the "Lessee") for the year ended December 31, 1996. 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 audit.
We conducted our audit 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 audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of
operations and cash flows of Sunstone Hotel Properties, Inc. and its
subsidiaries for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ COOPERS & LYBRAND LLP
San Francisco, California
February 28, 1997
F-46
<PAGE>
EXHIBIT 10.1.16
COUNTERPART SECOND AMENDED AND
RESTATED AGREEMENT OF LIMITED PARTNERSHIP FOR
ADMISSION OF ADDITIONAL LIMITED PARTNER TO
SUNSTONE HOTEL INVESTORS, L.P.
This Counterpart Second Amended and Restated Agreement of Limited
Partnership for Admission of Additional Limited Partner to Sunstone Hotel
Investors, L.P. (this "Counterpart Partnership Agreement") is executed as of the
---------------------------------
date set forth on the signature page by Sunstone Hotel Investors, Inc., a
Maryland corporation, in its individual capacity (the "Company") and in its
-------
capacity as the General Partner (the "General Partner") of Sunstone Hotel
---------------
Investors, L.P. (the "Partnership") and the individual listed on the signature
-----------
page, as the newly admitted limited partner of the Partnership (the "Additional
----------
Limited Partner"). All defined terms not otherwise defined herein shall have
- ---------------
the meaning set forth in the Agreement (as defined below).
RECITALS
A. WHEREAS, the General Partner and certain Limited Partners executed that
certain Second Amended and Restated Agreement of Limited Partnership dated as of
October 14, 1997 (the "Agreement"), amending and restating that certain First
---------
Amended and Restated Limited Partnership Agreement dated as of August 16, 1995,
governing, among other things, the rights and obligations of the constituent
partners of the Partnership.
B. WHEREAS, the Additional Limited Partner has entered into a Capital
Contribution Agreement (the "Contribution Agreement") with the Partnership
pursuant to which the hotel owned by the Additional Limited Partner will be
contributed to the Partnership.
C. WHEREAS, pursuant to Section 2.3(a) of the Capital Contribution
Agreement between Additional Limited Partner and the Partnership, the
Partnership shall, upon Closing (as defined in the Contribution Agreement),
admit Additional Limited Partner as a limited partner of the Partnership, and
shall issue to Additional Limited Partner the number of Partnership Units equal
to the Acquisition Value (as defined in the Contribution Agreement) divided by
the Unit Closing Value (as defined in the Contribution Agreement).
D. WHEREAS, the General Partner consents, as evidenced by its signature,
to the said issuance of Partnership Units and to the admission of the Additional
Limited Partner as a Limited Partner as of effective date of issuance listed on
Schedule A attached hereto (the "Effective Date").
E. WHEREAS, in order to evidence the issuance of the Partnership Units and
the admission of the Additional Limited Partner into the Partnership, and the
agreement of the Additional Limited Partner to be bound by the terms of the
Agreement, the parties hereto are executing this Counterpart Partnership
Agreement.
<PAGE>
NOW, THEREFORE, the parties hereto agree as follows:
1. Admission of Additional Limited Partner. The Additional Limited Partner
---------------------------------------
is hereby admitted as a Additional Limited Partner effective as of Effective
Date and the General Partner acknowledges and confirms that upon delivery of the
executed copy of this Counterpart Partnership Agreement, the Additional Limited
Partner will have complied with all requirements for admission as a Limited
Partner of the Partnership and as such shall have all rights of a Limited
Partner including without limitation Redemption Rights and Registration Rights.
The General Partner shall, if it has not already done so, instruct the Transfer
Agent to issue the number of Partnership Units listed on Schedule A and to
reflect such issuance on the Partnership Unitholder Ledger. The Additional
Limited Partner has listed its address for notices on Schedule A.
2. Agreement to be Bound. The Additional Limited Partner acknowledges it
---------------------
has read and understands the Agreement and hereby agrees to be bound by each of
the terms and conditions of the Agreement, which are hereby incorporated by
reference in full as if set forth herein.
3. Power of Attorney. The Additional Limited Partner hereby irrevocably
-----------------
constitutes and appoints the General Partner, any Liquidator, and authorized
officers and attorneys-in-fact of each, and each of those acting singly, in each
case with full power of substitution, as its true and lawful agent and attorney-
in-fact, with full power and authority in its name and place instead to perform
any of the acts set forth in Section 8.2 of the Agreement.
-----------
4. Representation of Additional Limited Partner. Without limiting any
--------------------------------------------
representations and warranties set forth in the Contribution Agreement, the
Additional Limited Partner hereby represents and warrants to the General Partner
and to the Partnership that its acquisition of its Partnership Interest is made
for its own account for investment purposes only and not with a view to the
resale or distribution of such Partnership Interest. The Additional Limited
Partner hereby agrees that its will not sell, assign or otherwise transfer its
Partnership Interest or any fraction thereof, whether voluntarily or by
operation of law or judicial sale or otherwise, to any Person who does not make
the representations and warranties to the General Partners set forth in Section
9.1(a) and similarly agrees not to sell, assign or transfer such Partnership
Interest or fraction thereof to any Person who does not similarly represent,
warrant and agree.
5. Authority of Authorized Representative. Listed on Schedule A is the
--------------------------------------
person who is the authorized representative of the Additional Limited Partner.
The General Partner and the Partnership are permitted to rely on the authority
of such authorized representative to bind the Additional Limited Partner for all
purposes including, without limitation, for the payment of dividends, for the
giving of notices, for the vote or approval of any issues for which the consents
or the approval of the Limited Partners is required under the Agreement. The
Additional Limited Partner may authorize a new authorized representative by
providing written notice to the General Partner at its executive office,
together with evidence in a form satisfactory to the General Partner including,
if requested, an opinion of counsel, confirming that the new authorized
representative has the authority to bind the Additional Limited Partner. The
Additional Limited Partner hereby represents and warrants that all
<PAGE>
consents, approvals or other actions that were necessary in order to authorize
the Contribution Agreement and the decisions to be made by the Additional
Limited Partner under the Partnership Agreement have been properly authorized
and approved in accordance with the terms of the partnership agreement or other
charter document of the Additional Limited Partner.
IN WITNESS WHEREOF, the parties hereto have executed this Counterpart
Partnership Agreement as of the date first written above.
GENERAL PARTNER ADDITIONAL LIMITED PARTNER
SUNSTONE HOTEL INVESTORS, INC., a
Maryland corporation and the sole General
Partner ---------------------------
Name of Entity
---------------------------
By: Authorized Signature
-------------------------
Robert A. Alter
Its: President ---------------------------
Printed Name
---------------------------
Title
<PAGE>
SCHEDULE A
----------
Information Regarding Admission
of Additional Limited Partner
Name of Additional Limited Partner:
-------------------------
Nature of Entity (e.g., Partnership, L.L.C., etc.):
-------------------------
Effective Date:
-------------------------
Address:
-------------------------
Authorized Representative:
-------------------------
No. of Units:
-------------------------
<PAGE>
EXHIBIT 10.2.36
SCHEDULE OF MATERIAL DIFFERENCES AMONG PERCENTAGE LEASES FOR 1998
The following lists of material differences between the Percentage Lease
filed as Exhibit 10.2 and the Percentage Lease identified by Exhibit 10.2.36 and
is being filed pursuant to Instruction 2 to Item 601 of Regulation S-K.
<TABLE>
<CAPTION>
Annual lst Tier Tier 2nd Tier Food/Beverage
Name City State Inception Base Rent Amount Percent Percent Percent
- -------------------- ------------- ----- --------- ------------ ---------- ------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ramada Old Town San Diego CA 1/23/98 $ 891,000 $2,043,000 43.6% 60% 5%
Residence Inn Santa Clarita CA 1/27/98 $ 775,000 $1,911,000 40.6% 60% 5%
Fairfield Inn Santa Clarita CA 1/27/98 $ 370,000 $1,015,000 36.5% 60% 5%
Hilton Inn Carson CA 2/19/98 $ 932,000 $2,509,000 37.1% 60% 5%
Radisson Oxnard CA 4/9/98 $ 617,000 $2,576,000 24.0% 62% 5%
Hampton Inn Santa Clarita CA 4/30/98 $ 634,000 $1,877,000 33.8% 60% 5%
Napa Valley Marriott Napa CA 5/5/98 $1,455,000 $4,275,000 34.0% 60% 5%
Days Inn Santa Clara CA 5/13/98 $1,574,000 $3,124,000 47.0% 60% 5%
Pueblo Marriott Pueblo CO 8/13/98 $ 756,000 $2,910,000 26.0% 62% 5%
Pacific Shore Hotel Santa Monica CA 9/4/98 $1,452,000 $3,038,000 47.8% 62% 5%
</TABLE>
<PAGE>
EXHIBIT 10.31.3
SECOND AMENDMENT TO
AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
THIS SECOND AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT
AGREEMENT ("Amendment") is dated as of July 22, 1998, among SUNSTONE HOTEL
INVESTORS, L.P., a Delaware limited partnership, as the Borrower, BANK ONE,
ARIZONA, NA, as a Lender, as Issuing Bank, as Administrative Agent and as Co-
Agent, CREDIT LYONNAIS NEW YORK BRANCH, as a Lender, as Documentation Agent and
as Co-Agent, WELLS FARGO BANK, NATIONAL ASSOCIATION, as a Lender, as Syndication
Agent and as Co-Agent, DRESDNER BANK AG, NEW YORK AND GRAND CAYMAN BRANCHES, as
a Lender, and SOCIETE GENERALE, SOUTHWEST AGENCY, as a Lender (collectively, the
"Original Bank Group"), NATIONSBANK, N.A. (successor to NATIONSBANK OF TEXAS,
N.A.), as a Lender, COMMERZBANK AG, LOS ANGELES BRANCH, as a Lender, and THE
LONG-TERM CREDIT BANK OF JAPAN, LTD., LOS ANGELES AGENCY, as a Lender
(collectively, the "Syndication Banks") and AMSOUTH BANK, as a Lender
("AmSouth").
W I T N E S S E T H:
WHEREAS, the Borrower and the Original Bank Group entered into that
certain Amended and Restated Revolving Credit Agreement dated as of October 10,
1997, as amended by First Amendment to Amended and Restated Revolving Credit
Agreement dated as of January 26, 1998 (the "Credit Agreement") providing for
Loans to the Borrower not to exceed $300,000,000 at any time outstanding; and
WHEREAS, by Assignment and Acceptance dated March 20, 1998, Bank One,
Arizona, NA, Credit Lyonnais New York Branch and Wells Fargo Bank, National
Association (collectively, the "Co-Agents") assigned to the Syndication Banks
and First American Bank Texas, S.S.B. ("First American") interests in the Co-
Agents' Commitments; and
WHEREAS, on or before the date hereof, the interests of First American
as a Lender under the Credit Agreement have been terminated and AmSouth Bank has
become a Lender under the Credit Agreement with a Commitment in the amount of
$25,000,000.00; and
WHEREAS, the Borrower has requested the Lenders to increase the total
Commitments to $350,000,000 and, pursuant to Section 2.17 of the Credit
Agreement, the Borrower has requested the Lenders to extend the Final Maturity
Date to July 1, 2000; and
WHEREAS, the Lenders have agreed to increase the total Commitments and
to extend the Final Maturity Date as requested by the Borrower, subject to the
modification of
1
<PAGE>
certain other provisions of the Credit Agreement, all on and subject to the
terms and conditions hereinafter set forth.
NOW, THEREFORE, in consideration of the covenants and agreements
herein contained, the parties hereto amend the Credit Agreement, and covenant
and agree, as follows:
1. Defined Terms.
--------------
1.1 Terms used herein and not defined herein shall have the meanings
provided therefor in the Credit Agreement.
1.2 The definitions of the following terms in the Credit Agreement
are hereby amended as follows:
(a) The definition of the term "Applicable Margin" is hereby amended
by adding, at the end of the table therein, the following status and
amounts:
Unused
Base Rate Eurodollar Rate Commitment
Loans Loans Fee
--------- --------------- ----------
Level IX Status 0.375% 2.00% 0.30%
(b) The definition of the term "Borrowing Base" is hereby amended by
changing the reference "45%" to "50%."
(c) The definition of the term "Contingent Obligation" is hereby
amended by adding the following sentence immediately following the first
sentence thereof:
Notwithstanding the foregoing, the Contingent Obligations of the
Borrower shall not include any guarantee of the obligations of the
Manager or the Operating Lessee to pay fees under a License until such
time as the licensor notifies the Borrower that such fees have not
been paid when due or otherwise makes demand upon the Borrower for
payment thereof.
(d) The definition of the term "Status" is hereby amended by
deleting from the definition of "Level VIII Status" therein the period at
the end of the sentence and inserting in lieu thereof "; and" and by adding
the following paragraph thereafter:
"Level IX Status" exists at any date if, at such date, (i)
---------------
neither Level IV Status nor any Status above Level IV Status exists
and (ii) Sunstone has a Leverage Ratio of 45% or more.
2
<PAGE>
1.3 The following definition is hereby added to the Credit
Agreement:
"Year 2000 Compliant" means, with respect to any Person or property,
that all software, hardware, equipment, goods or systems utilized by or
material to the physical operations, business operations or financial
reporting of such Person or property will perform date-sensitive functions
(including leap year calculations) as properly and efficiently after
December 31, 1999 as performed prior to January 1, 2000.
2. Increase of Commitments. (a) The aggregate amount of the
-----------------------
Commitments is hereby increased by $50,000,000 to $350,000,000, and from and
after the Funding Date the Commitment of each Lender is as set forth in Schedule
--------
II attached hereto and hereby incorporated herein, which replaces Schedule II to
- -- -----------
the Credit Agreement.
(b) On the date ("Funding Date") heretofore or hereafter designated
by the Administrative Agent, AmSouth and each of the Co-Agents shall fund to the
Administrative Agent such amounts as may be required to cause each of them to
hold Loans in the proportion that its Commitment bears to all Commitments (as
increased and adjusted as provided in paragraph 3), and the Administrative Agent
shall distribute the funds so received to the other Lenders in such amounts as
may be required to cause each of them to hold Loans in the proportion that its
Commitment bears to all Commitments (as increased and adjusted as provided in
paragraph 3). The first payment of interest received by the Administrative Agent
after the Funding Date shall be paid to the Lenders in amounts adjusted to
reflect the adjustments of their respective pro rata shares of the Loans as of
the Funding Date.
3. Extension of Final Maturity Date. The Final Maturity Date is
--------------------------------
hereby extended to July 1, 2000. Pursuant to the provisions of Section 2.17(b)
of the Credit Agreement, an extension fee in the amount of 0.25% of the
Commitments is due and payable by the Borrower on the date hereof, but no
extension fee is payable with respect to the $50,000,000 increase in the
Commitments provided for in Paragraph 2(a) above.
4. Modification of Section 2.17. Section 2.17 is hereby amended by
----------------------------
changing the reference "thirty (30) days" in each place in which it occurs to
"forty-five (45) days".
5. Modification of Section 5.18. Section 5.18(c) is hereby amended
----------------------------
by changing the reference "$15,000,000" to "$30,000,000."
6. Modification of Section 6.4. Section 6.4 is hereby amended
---------------------------
(a) by changing in subparagraph (i) thereof the phrase "multiplied by four and
one-half (4-1/2)" to "multiplied by five (5)" and (b) by changing, in both
subparagraph (i) and subparagraph (ii) thereof, the references "forty-five
percent (45%)" to "fifty percent (50%)."
3
<PAGE>
7. Acquisition of Newly-Constructed Hotels. The following
---------------------------------------
provision is hereby added to the Credit Agreement:
6.8. Acquisition of Newly-Constructed Hotels. (a) Neither Sunstone nor
---------------------------------------
the Borrower nor any of their respective Subsidiaries shall consummate
(whether or not contractually obligated to do so) the acquisition of a
newly-constructed Hotel unless (i) taking into account all Indebtedness of
Sunstone as of the date of such acquisition (including without limitation
any Indebtedness incurred, directly or indirectly, to finance such
acquisition in whole or in part), Sunstone shall be in compliance with the
provisions of Sections 6.4, 6.5 and 6.6 upon the consummation of such
acquisition and (ii) the Borrower shall furnish to the Administrative Agent
prior to such acquisition a certificate of the chief financial officer of
Sunstone (together with such supporting documentation as the Administrative
Agent shall require) with respect to such compliance, all in form and
substance satisfactory to the Administrative Agent. For purposes of
establishing such compliance with the provisions of Sections 6.4, 6.5 and
6.6 as of the date of acquisition of such Hotel, all determinations shall
be made on the basis of the financial statements as at the end of the most
recent Fiscal Quarter preceding the date of such acquisition, except that
(A) Total Indebtedness (in the case of Section 6.4), Total Secured Recourse
Indebtedness (in the case of Section 6.5) and Non-Recourse Indebtedness (in
the case of Section 6.6) shall each be determined as of the date of
acquisition of such Hotel and (B) all Hotels (but only those Hotels) owned
by the Borrower and its Subsidiaries as of the date of acquisition of such
Hotel (and including such Hotel) shall be included for purposes of
determining such compliance. In the event that, as of the date of
acquisition of such Hotel, the financial statements for the most recent
Fiscal Quarter are not yet available, the certificate required to be
delivered under clause (ii) above shall be prepared on the basis of
reasonable estimates by the Borrower's management of the applicable
financial information as at the end of such most recent Fiscal Quarter, and
such certificate shall then be promptly updated when the financial
statements for such Fiscal Quarter are available.
(b) Not later than thirty (30) days after the date on which the
Borrower, Sunstone or any of their respective Subsidiaries enter into a
contract to acquire a Hotel to be constructed or under construction, the
Borrower shall provide the Administrative Agent with a copy of such
contract, along with a general description of such Hotel (including
location and number of rooms).
8. Financial Statements. Section 7.11(g) is hereby modified by
--------------------
changing the reference "one hundred (100) days" to "one hundred twenty (120)
days."
9. Year 2000 Covenant. The following provision is hereby added to
------------------
the Credit Agreement:
4
<PAGE>
7.25 Year 2000 Covenant. The Borrower shall ensure that Sunstone,
------------------
the Borrower and each of their Subsidiaries are Year 2000 Compliant in a
timely manner, but in no event later than October 1, 1999. The Borrower
shall use its best efforts to cause the Operating Lessee, the Manager and
each of the Hotels owned by Sunstone, the Borrower or any of their
Subsidiaries to be Year 2000 Compliant in a timely manner and shall cause
each of the foregoing to be Year 2000 Compliant not later than December 31,
1999 if the failure to be Year 2000 Compliant could have a Material Adverse
Effect. The Borrower shall, or shall cause the Operating Lessee or Manager
to, make reasonable inquiries of all major contractors of the Borrower,
Sunstone, their Subsidiaries, the Hotels, the Operating Lessee and the
Manager to confirm that such major contractors are, or will be no later
than December 31, 1999, Year 2000 Compliant and will request from such
major contractors reasonable verification thereof. For purposes of this
section, "major contractors" means those Persons who make payments, or
furnish goods or services, to the Borrower, Sunstone, any of their
Subsidiaries, any of the Hotels, the Operating Lessee or the Manager, the
failure of which Persons to be Year 2000 Compliant could have a Material
Adverse Effect. In furtherance of this covenant, the Borrower shall, in
addition to any other necessary actions, perform or cause to be performed a
comprehensive review and assessment of all software, hardware, equipment,
goods and systems utilized or material to the physical operations, business
operations or financing reporting of the Borrower, Sunstone, their
Subsidiaries, the Hotels, the Operating Lessee and the Manager, and shall
adopt or cause to be adopted a detailed plan for the testing, remediation
and monitoring of such software, hardware, equipment, goods and systems to
ensure compliance with the foregoing provisions. The Borrower shall,
within thirty (30) days of the Administrative Agent's written request,
provide to the Administrative Agent such certification or other evidence of
the Borrower's compliance with the provisions of this section as the
Administrative Agent may from time to time reasonably require.
10. Limitations on Development, Construction, Renovation and
--------------------------------------------------------
Purchase of Hotels. Section 8.5 is hereby amended and restated in its entirety
- ------------------
as follows:
8.5 Limitations on Development, Construction, Renovation and
--------------------------------------------------------
Purchase of Hotels. Neither Sunstone nor the Borrower shall or shall
------------------
permit any of their respective Subsidiaries to (a) engage in the
development or construction of any Hotels with respect to which the cost to
complete the same shall be any time exceed, for all such development and
construction in the aggregate, the lesser of (i) ten percent (10%) of Total
Hotel Value and (ii) $50,000,000, (b) engage in the renovation of
(including construction of additions to) any Hotels with respect to which
the cost to complete the same shall at any time exceed in the aggregate the
lesser of (i) fifteen percent (15%) of Total Hotel Value and (ii)
$100,000,000, or (in the aggregate with costs described in clause (a)) the
lesser of (A) twenty percent (20%) of Total Hotel Value and (B)
$125,000,000, (c) contract to purchase or acquire any Hotels under
construction or to
5
<PAGE>
be constructed with respect to which the purchase price and other
consideration payable therefor shall at any time exceed in the aggregate
the lesser of (i) fifteen percent (15%) of Total Hotel Value and (ii)
$120,000,000 (without regard to whether the payment thereof is a recourse
obligation of Sunstone, the Borrower or any of their respective
Subsidiaries), or (d) engage in the development or construction of Hotels
(without regard to whether the same is permitted under clauses (a), (b) or
(c) above) or enter into any agreements to purchase Hotels (whether under
construction, to be constructed or otherwise) or other assets, unless
Sunstone, the Borrower or such Subsidiary (as applicable) at all times has
available sources of capital equal to the total cost to complete such
development or construction and to pay in full the cost of the purchase of
such Hotels or other assets (to the extent that the payment of such cost of
purchase constitutes a recourse obligation of Sunstone, the Borrower or its
Subsidiary), which available sources of capital may include the Available
Credit to the extent that the Borrower may borrow the same for the purposes
required.
11. Pricing. Notwithstanding anything to the contrary set forth in
-------
the Credit Agreement, the Borrower shall deliver to the Administrative Agent, on
or before the date hereof, the quarterly financial statements provided for in
Section 7.11(a) for the Fiscal Quarter ending June 30, 1998, together with the
Compliance Certificate provided for in Section 7.11(e) setting forth the
Leverage Ratio as of the end of such Fiscal Quarter, provided, however, that, to
-------- -------
the extent that all financial information necessary to deliver such financial
statements and Compliance Certificate is not then available, Borrower may
satisfy the requirements of this paragraph by delivering financial statements
and information in sufficient detail to determine the Leverage Ratio at the end
of such Fiscal Quarter. Notwithstanding anything to the contrary contained in
the Credit Agreement, the Funding Date shall be the Pricing Date with respect to
the determination of Status based on the Leverage Ratio for the Fiscal Quarter
ending June 30, 1998, Status shall be determined on such date and such Status
shall remain in effect until a change in Status thereafter occurs. The
provisions of this paragraph shall not relieve the Borrower of any of its
obligations under Section 7.11 of the Credit Agreement and shall not affect any
Pricing Date or any determination of Status except as expressly set forth
herein.
12. Closing Deliveries. Prior to or simultaneously with the
------------------
execution and delivery of this Amendment, and as a condition to this Amendment,
the Borrower shall deliver to the Administrative Agent the following:
(a) Payment of (i) the fees provided for in Paragraph 3 above, (ii)
the fees provided for in the letter agreements dated May 20, 1998 and July
14, 1998 and (iii) all costs and expenses (including reasonable attorneys'
fees and expenses) incurred in connection with this Amendment;
(b) Notes payable to AmSouth and each of the Co-Agents, each such
Note to be in the amount of such Lender's Commitment (as provided in
Paragraph 2(a));
6
<PAGE>
(c) The Consent of Guarantors attached to this Amendment;
(d) Certificates of good standing, certified corporate resolutions
and incumbency certificates with respect to, and opinions of counsel for,
the Borrower and Sunstone, all in form and substance satisfactory to the
Administrative Agent; and
(e) The financial statements and Compliance Certificate provided for
in Paragraph 11 above.
13. Ratification. The Credit Agreement (as amended hereby) and the
------------
other Loan Documents are hereby ratified and remain in full force and effect.
14. Execution in Counterparts. This Amendment may be executed in
-------------------------
any number of counterparts and by different parties hereto in separate
counterparts, each of which
7
<PAGE>
when so executed shall be deemed to be an original and all of which
taken together shall constitute one and the same agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be executed by their respective officers, thereunto duly authorized, as of the
date first above written.
BORROWER:
SUNSTONE HOTEL INVESTORS, L.P.
By: Sunstone Hotel Investors, Inc.
its general partner
By: _____________________________
Name:
Title:
LENDERS:
BANK ONE, ARIZONA, NA
as Administrative Agent, Co-Agent,
Issuing Bank and Lender
By: _____________________________
Name:
Title:
CREDIT LYONNAIS NEW YORK BRANCH
as Documentation Agent, Co-Agent
and Lender
By: _____________________________
Name:
Title:
WELLS FARGO BANK, NATIONAL ASSOCIATION
as Syndication Agent, Co-Agent and
Lender
8
<PAGE>
By: _____________________________
Name:
Title:
9
<PAGE>
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as Lender
By: _____________________________
Name:
Title:
By: _____________________________
Name:
Title:
SOCIETE GENERALE, SOUTHWEST AGENCY,
as Lender
By: _____________________________
Name:
Title:
NATIONSBANK OF TEXAS, N.A., as Lender
By:_____________________________
Name:
Title:
COMMERZBANK AG, LOS ANGELES BRANCH,
as Lender
By:______________________________
Name:
Title:
By:_______________________________
Name:
Title:
THE LONG-TERM CREDIT BANK OF JAPAN,
LTD., LOS ANGELES AGENCY, as Lender
10
<PAGE>
By:________________________________
Name:
Title:
AMSOUTH BANK, as Lender
By:_____________________________
Name:
Title:
11
<PAGE>
CONSENT OF GUARANTORS
---------------------
Each of the undersigned, being a Guarantor (as defined in the Credit
Agreement referred to in the foregoing Amendment) does hereby consent to the
foregoing Amendment, and ratify and affirm that the Guaranty (as defined in the
Credit Agreement) heretofore executed by the undersigned remains in full force
and effect for the benefit of the Lenders under the Credit Agreement, as amended
by the foregoing Amendment.
This Consent of Guarantors may be executed in counterparts and by
different parties hereto in separate counterparts, each of which when so
executed shall be deemed to be an original and all of which taken together shall
constitute one and the same document.
IN WITNESS WHEREOF, the undersigned have executed and delivered this
Consent of Guarantors as of this ____ day of July, 1998.
Sunstone Hotel Investors, Inc.
By: _________________________
Its: ________________________
_____________________________
Robert A. Alter
_____________________________
Charles Biederman
_____________________________
Daniel E. Carsello
_____________________________
Gerald N. Clark
_____________________________
C. Robert Enever
Peacock, LLC
By: _________________________
Its: ________________________
Shivani, L.L.C.
By: _________________________
12
<PAGE>
Its: ________________________
SCHEDULE II
COMMITMENTS
Lender Commitment
------ ----------
Bank One, Arizona, NA $ 66,000,000.00
Credit Lyonnais New York Branch $ 66,000,000.00
Wells Fargo Bank, National $ 66,000,000.00
Association
Dresdner Bank AG, New York $ 35,000,000.00
and Grand Cayman Branches
Societe Generale, Southwest $ 27,000,000.00
Agency
NationsBank of Texas, NA $ 27,000,000.00
AmSouth Bank $ 25,000,000.00
Commerzbank AG, Los Angeles
Branch $ 19,000,000.00
The Long-Term Credit Bank of
Japan, Ltd., Los Angeles Agency $ 19,000,000.00
---------------
TOTAL: $350,000,000.00
===============
13
<PAGE>
EXHIBIT 10.31.4
THIRD AMENDMENT TO
AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT
THIS THIRD AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT
AGREEMENT ("Amendment") is dated as of August 12, 1998, among SUNSTONE HOTEL
INVESTORS, L.P., a Delaware limited partnership, as the Borrower, BANK ONE,
ARIZONA, NA, as a Lender, as Issuing Bank, as Administrative Agent and as Co-
Agent, CREDIT LYONNAIS NEW YORK BRANCH, as a Lender, as Documentation Agent and
as Co-Agent, WELLS FARGO BANK, NATIONAL ASSOCIATION, as a Lender, as Syndication
Agent and as Co-Agent, DRESDNER BANK AG, NEW YORK AND GRAND CAYMAN BRANCHES, as
a Lender, and SOCIETE GENERALE, SOUTHWEST AGENCY, as a Lender, NATIONSBANK, N.A.
(successor to NATIONSBANK OF TEXAS, N.A.), as a Lender, COMMERZBANK AG, LOS
ANGELES BRANCH, as a Lender, THE LONG-TERM CREDIT BANK OF JAPAN, LTD., LOS
ANGELES AGENCY, as a Lender and AMSOUTH BANK, as a Lender.
W I T N E S S E T H:
WHEREAS, the Borrower and the Lenders are party to that certain
Amended and Restated Revolving Credit Agreement (as amended, supplemented or
otherwise modified from time to time, the "Credit Agreement") dated as of
October 10, 1997, and heretofore amended by First Amendment to Amended and
Restated Revolving Credit Agreement dated as of January 26, 1998 and by Second
Amendment to Amended and Restated Revolving Credit Agreement dated as of July
22, 1998; and
WHEREAS, the Borrower has requested the Lenders to consent to the
Senior Notes (as hereinafter defined) and the Lenders have agreed to consent
thereto, all on and subject to the terms and conditions hereinafter set forth.
NOW, THEREFORE, in consideration of the covenants and agreements
herein contained, the parties hereto amend the Credit Agreement, and covenant
and agree, as follows:
1. Defined Terms.
-------------
1.1 Terms used herein and not defined herein shall have the meanings
provided therefor in the Credit Agreement.
1.2 The following definitions in the Credit Agreement are hereby
amended:
1
<PAGE>
(a) The definition of the term "Guaranty" is hereby amended and
restated as follows:
"Guaranty" means the Sunstone Guaranty, any Subsidiary Guaranty or any
of the Limited Guaranties.
(b) The definition of the term "Unencumbered" is hereby amended by
inserting at the end of the second parenthetical phrase at the end of
subparagraph (c) the following:
but excluding the equal and ratable liens provided for in Section
3.4(d).
1.3 The following definitions are hereby added to the Credit
Agreement:
"Indenture" means the Indenture among Borrower, Sunstone and U.S.
Trust Company, California, N.A., as trustee, under which the Senior Notes
shall be issued.
"Offering Memorandum" means that certain Private Placement Offering
Memorandum dated as of July 29, 1998 providing for the issuance of the
Senior Notes.
"Senior Notes" means the notes to be issued by the Borrower in an
aggregate principal amount not to exceed $150,000,000, pursuant to and in
accordance with the Offering Memorandum.
"Subsidiary Guaranty" means a guaranty executed by a Subsidiary of the
Borrower or of Sunstone, in substantially the form of the Sunstone Guaranty
(but modified as required by the Administrative Agent to reflect the
execution thereof by such Subsidiary rather than by Sunstone), guarantying
the principal of and interest on the Loan and all other Obligations, as
such guaranty may be amended, supplemented or otherwise modified from time
to time.
2. Consent to Senior Notes. The Lenders hereby consent to the sale
-----------------------
and issuance of the Senior Notes by the Borrower and the execution and delivery
by the Borrower and Sunstone of the Indenture at any time on or before August
31, 1998, provided that all of the terms and provisions (including without
limitation the covenants of the Borrower and Sunstone) are the same as those set
forth in the Offering Memorandum in all material respects. To the extent, if
any, that the requirements of Section 7.24 of the Credit Agreement have not
heretofore been satisfied with respect to the Borrower's request for the consent
of the Lenders to the Senior Notes, such requirements are hereby waived.
(b) The Borrower hereby agrees to furnish to the Administrative Agent,
prior to the execution and delivery thereof by the Borrower and Sunstone, a
true, correct and
2
<PAGE>
complete copy of the Indenture, for approval by the Administrative Agent,
provided, however, that, as long as the Indenture is in conformity with the
terms and provisions set forth in the Offering Memorandum, the Administrative
Agent shall not unreasonably withhold its approval thereof.
3. Amendment of Section 3.4. Section 3.4 is hereby amended by adding
------------------------
the following subparagraph (d) at the end thereof:
(d) Notwithstanding the foregoing provisions of this Section
3.4, the Lenders hereby agree that any Lien granted to the
Administrative Agent for the benefit of the Lenders under this Section
3.4 may, to the extent required under the Indenture, be granted, on an
equal and ratable basis, to the then Trustee under the Indenture for
the benefit of the holders of the Senior Notes, and that the grant of
such Lien to the Administrative Agent and such Trustee on an equal and
ratable basis shall satisfy the requirements of this Section 3.4.
4. Amendment to Section 8.2. Section 8.2 is hereby amended (a) by
------------------------
deleting the period at the end thereof and inserting in lieu thereof "; or" and
(b) by adding the following subparagraph (viii) thereafter:
(viii) the Senior Notes, provided that Borrower shall not cause or
--------
permit any Subsidiary of the Borrower or Sunstone to execute and
deliver a guaranty of the Senior Notes unless and until such
Subsidiary shall execute and deliver to the Agent, for the benefit of
the Lenders, a Subsidiary Guaranty.
5. Amendment of Section 8.7. The following sentence is hereby added
------------------------
at the end of Section 8.7:
Neither the Borrower nor Sunstone shall modify or amend the Indenture
or any of the Senior Notes in any material respect, without the prior
written consent of the Required Lenders, which shall not be
unreasonably withheld.
6. Amendment of Section 8.15. Section 8.15 of the Credit Agreement
-------------------------
is hereby amended by adding, immediately prior to the period at the end of
subparagraph (ii) thereof, the following:
and provided further that no Lien may be granted to the Trustee under
----------------
the Indenture or otherwise for the benefit of the holders of the
Senior Notes (except as provided in Section 3.4(d)).
3
<PAGE>
7. Amendment of Section 9.1. Section 9.1 of the Credit Agreement is
------------------------
hereby amended (a) by deleting the period at the end thereof and inserting in
lieu thereof "; or" and (b) by adding the following subparagraph (r):
(r) The Borrower shall make or be required to make, either by
reason of the "Asset Sales" covenant or "Change in Control" provisions
in the Indenture, an "Offer to Purchase" (as that term is defined in
the Indenture) offering to purchase any or all of the Senior Notes.
8. Consent of Guarantors. Prior to or simultaneously with the
---------------------
execution and delivery of this Amendment, and as a condition to this Amendment,
the Borrower shall deliver to the Administrative Agent the Consent of Guarantors
attached to this Amendment.
9. Expenses. Borrower shall pay all costs and expenses of the
--------
Administrative Agent (including reasonable attorneys' fees and expenses)
incurred in connection with this Amendment.
10. Ratification. The Credit Agreement (as amended hereby) and the
------------
other Loan Documents are hereby ratified and remain in full force and effect.
11. Execution in Counterparts. This Amendment may be executed in any
-------------------------
number of counterparts and by different parties hereto in separate counterparts,
each of which
4
<PAGE>
12. when so executed shall be deemed to be an original and all of
which taken together shall constitute one and the same agreement.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be executed by their respective officers, thereunto duly authorized, as of the
date first above written.
BORROWER:
SUNSTONE HOTEL INVESTORS, L.P.
By: Sunstone Hotel Investors, Inc.
its general partner
By: ____________________________
Name:
Title:
LENDERS:
BANK ONE, ARIZONA, NA
as Administrative Agent, Co-Agent,
Issuing Bank and Lender
By: ____________________________
Name:
Title:
CREDIT LYONNAIS NEW YORK BRANCH
as Documentation Agent, Co-Agent
and Lender
By: ____________________________
Name:
Title:
WELLS FARGO BANK, NATIONAL ASSOCIATION
as Syndication Agent, Co-Agent and
Lender
By: ____________________________
Name:
Title:
5
<PAGE>
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as Lender
By: ____________________________
Name:
Title:
By: ____________________________
Name:
Title:
SOCIETE GENERALE, SOUTHWEST AGENCY,
as Lender
By: ____________________________
Name:
Title:
NATIONSBANK, N.A., as Lender
By:_____________________________
Name:
Title:
COMMERZBANK AG, LOS ANGELES BRANCH,
as Lender
By:_____________________________
Name:
Title:
By:_____________________________
Name:
Title:
6
<PAGE>
THE LONG-TERM CREDIT BANK OF JAPAN,
LTD., LOS ANGELES AGENCY, as Lender
By:_____________________________
Name:
Title:
AMSOUTH BANK, as Lender
By:_____________________________
Name:
Title:
CONSENT OF GUARANTORS
---------------------
Each of the undersigned, being a Guarantor (as defined in the Credit
Agreement referred to in the foregoing Amendment) does hereby consent to the
foregoing Amendment, and ratify and affirm that the Guaranty (as defined in the
Credit Agreement) heretofore executed by the undersigned remains in full force
and effect for the benefit of the Lenders under the Credit Agreement, as amended
by the foregoing Amendment.
This Consent of Guarantors may be executed in counterparts and by
different parties hereto in separate counterparts, each of which when so
executed shall be deemed to be an original and all of which taken together shall
constitute one and the same document.
IN WITNESS WHEREOF, the undersigned have executed and delivered this
Consent of Guarantors as of this day of August, 1998.
----
Sunstone Hotel Investors, Inc.
By: _________________________
Its: ________________________
_____________________________
Robert A. Alter
_____________________________
Charles Biederman
7
<PAGE>
_____________________________
Daniel E. Carsello
_____________________________
Gerald N. Clark
_____________________________
C. Robert Enever
Peacock, LLC
By: _________________________
Its: ________________________
Shivani, L.L.C.
By: _________________________
Its: ________________________
8
<PAGE>
EXHIBIT 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-3 No.s 333-3477, 333-13911 and 333-41683 and Form S-8 No. 333-14179), as
amended, of Sunstone Hotel Investors, Inc. of our report dated February 19,
1999, with respect to the consolidated financial statements and schedule of
Sunstone Hotel Investors, Inc. and our report dated February 19, 1999 with
respect to the consolidated financial statements of Sunstone Hotel Properties,
Inc. included in this Annual Report (Form 10-K) for the year December 31, 1998.
/s/ ERNST & YOUNG LLP
Newport Beach, California
March 25, 1999
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Sunstone Hotel Investors, Inc. on Form S-3 (File No. 333-34377), Form S-3 (File
No. 333-31683), Form S-3 (File No. 333-13911), and Form S-3 (File No. 333-14179)
of our report dated February 28, 1997 on our audit of the consolidated financial
statements of Sunstone Hotel Investors, Inc. for the year ended December 31,
1996 and of our report dated February 28, 1997 on our audit of the consolidated
financial statements of Sunstone Hotel Properties, Inc. (the "Lessee") for the
year ended December 31, 1996, which reports are included in this Annual Report
on Form 10-K.
/s/ Coopers & Lybrand LLP
San Francisco, California
March 29, 1999
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
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