Business Context and Reporting Period
Sunstone Hotel Investors, Inc. (Sunstone) is a Maryland corporation operating as a Real Estate Investment Trust (REIT) engaged in owning, acquiring, selling, and renovating hotel properties in the United States. This Form 10-Q covers the quarterly period ended September 30, 2006. As of this date, the Company owned 50 hotels with 15,928 rooms, having acquired four major properties and sold fourteen properties during the first nine months of 2006.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Total Revenues | $227.0 million | $656.7 million |
| Operating Income | $33.4 million | $101.2 million |
| Net Income | $1.5 million | $41.4 million |
| Income Available to Common Stockholders | $(3.7) million (Loss) | $27.0 million |
| Net Cash Provided by Operating Activities | N/A | $124.7 million |
| Total Assets | $2.77 billion | N/A |
| Total Notes Payable | $1.50 billion | N/A |
| Cash and Cash Equivalents | $125.2 million | N/A |
| Weighted Average Shares Outstanding (Basic) | 57.7 million | 57.1 million |
Operating Statistics (Same Store Portfolio): For the three months ended September 30, 2006, occupancy was 78.7%, Average Daily Rate (ADR) was $140.00, and Revenue Per Available Room (RevPAR) was $110.18.
Material Changes Versus Prior Period
- Revenue Growth: Total revenues increased 40.4% for the quarter and 73.8% year-to-date compared to 2005. This growth is primarily attributed to the inclusion of twelve hotels acquired in late 2005 and early 2006, which contributed significantly to room, food and beverage, and other operating revenues.
- Operating Expenses: Total operating expenses rose 35.7% for the quarter and 68.9% year-to-date. Increases were driven by the new portfolio, higher utility costs, and increased property taxes.
- Discontinued Operations: The Company sold thirteen hotels in the third quarter of 2006. This resulted in a net loss on sale of assets of $6.3 million and a goodwill impairment loss of $4.7 million, creating a net loss from discontinued operations of $8.5 million for the quarter (compared to income of $2.9 million in the prior year quarter).
- Debt and Interest: Interest expense increased 63.0% for the quarter and 87.2% year-to-date due to higher outstanding loan balances financing acquisitions. The Company incurred a $10.0 million loss on early extinguishment of debt during the nine-month period related to refinancing activities.
- Equity: The Company issued 2.2 million shares of Series A preferred stock and 5.5 million shares of common stock in 2006, raising significant capital to fund acquisitions and repay debt.
Guidance, Outlook, and Risks
- Capital Expenditures: Management expects total capital expenditures for 2006 to be between $130.0 million and $140.0 million. Approximately $102.9 million was spent in the first nine months.
- Liquidity: The Company maintains a $200.0 million unsecured revolving credit facility. As of September 30, 2006, there were no amounts outstanding, with $186.9 million available after letters of credit. Management believes cash flow from operations and available credit will meet needs for the next twelve months.
- Forward Sale Agreement: In July 2006, the Company entered into a forward sale agreement for 4.0 million shares of common stock. If settled physically, the Company expects to receive approximately $111.0 million in net proceeds.
- Risks: Key risks include high levels of outstanding debt, financial covenants, rising operating expenses (specifically wages, benefits, and utilities), competition for acquisitions, and general economic conditions affecting the travel industry. The Company also faces risks related to the performance of acquired properties and the need for significant renovations.
- Legal Proceedings: The Company settled a lawsuit regarding alleged Legionella bacteria exposure for $537,500, which is expected to be fully covered by insurance.
Investor Verification Checklist
- Verify the impact of the $10.0 million loss on early extinguishment of debt on the year-to-date net income.
- Confirm the status and settlement terms of the Forward Sale Agreement for 4.0 million shares of common stock.
- Review the specific performance metrics (occupancy, ADR, RevPAR) of the "existing portfolio" versus the "newly acquired" portfolio to assess organic growth.
- Monitor the utilization of the $200.0 million revolving credit facility and compliance with leverage and coverage covenants.
- Assess the remaining $27.0 million in contractual construction commitments and the ability to fund the full $130-$140 million capital expenditure budget.
- Check the status of the $5.6 million promissory note received from the buyer of thirteen hotels in the third quarter.