SHO

Business Context and Reporting Period

Sunstone Hotel Investors, Inc. (Sunstone) is a real estate investment trust (REIT) engaged in owning, acquiring, selling, and renovating upper upscale and upscale hotel properties in the United States. This Form 10-Q covers the quarterly period ended March 31, 2005. The company operates through its Operating Partnership and a taxable REIT subsidiary (TRS) to comply with REIT tax requirements. As of April 30, 2005, there were 34,533,321 shares of common stock outstanding.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Turnaround: The company reported a net income of $1.8 million in Q1 2005, a significant improvement from a net loss of $25.3 million in Q1 2004. The Q1 2004 loss was heavily impacted by $7.4 million in impairment losses on continuing operations and $16.5 million in losses from discontinued operations.
• Revenue Growth: Total revenues increased 3.2% to $116.6 million, driven by a 4.8% increase in room revenue due to higher occupancy (68.8% vs. 66.6%) and Average Daily Rate (ADR) ($101.75 vs. $96.90).
• Debt Reduction: Total notes payable decreased by approximately $44.8 million to $667.7 million, primarily due to debt repayments funded by the IPO and a preferred stock offering.
• Liquidity Improvement: Cash and cash equivalents surged from $6.0 million at year-end 2004 to $69.9 million at March 31, 2005, largely due to net proceeds of $117.5 million from a preferred stock offering.
• Discontinued Operations: The company sold seven hotels in 2004 and held two for sale at March 31, 2005. These properties generated a net income of $0.8 million in Q1 2005 compared to a loss of $16.5 million in Q1 2004.

Guidance, Outlook, and Risks

• Capital Expenditures: Management expects capital expenditures for 2005 to range between $65.0 million and $75.0 million, including $6.0 million in contractual construction commitments.
• Recent Acquisitions (Subsequent Events): In April 2005, the company announced agreements to acquire the Sutton Place Hotel in Newport Beach (approx. $22.0 million renovation) and a portfolio of six Renaissance Hotels for $419.5 million. Financing includes a $250.0 million mortgage commitment and equity sales.
• Debt Structure: In April 2005, the company closed $276.0 million in fixed-rate mortgage loans, increasing the portion of fixed-rate debt to over 85% of total outstanding debt.
• Risks: Key risks include high leverage, variable interest rate exposure (mitigated by caps), competition for acquisitions, rising operating costs (wages, benefits, utilities), and reliance on the performance of the management company (Interstate Hotels & Resorts).
• Dividends: The company declared common dividends of $0.285 per share and preferred dividends of $0.50 per share for the quarter.

Investor Verification Checklist

• Verify the closing status and financing terms of the April 2005 Renaissance Hotels portfolio acquisition ($419.5 million) and the Sutton Place Hotel purchase.
• Confirm the impact of the new $276.0 million fixed-rate debt on the company's interest expense and leverage ratios.
• Review the specific details of the $6.0 million in remaining renovation commitments and the $22.0 million renovation budget for the Newport Beach property.
• Assess the sustainability of the RevPAR growth (8.5% increase) given the seasonal nature of the hotel business and potential economic headwinds.
• Monitor the status of the pending litigation regarding Legionella bacteria exposure at a hotel property.