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                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   ----------

                                    FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the fiscal year ended December 31, 1996

                                       or

[ ]  TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                         Commission file number 0-22930

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                                Allstar Inns Inc.
             (Exact name of registrant as specified in its charter)

                Delaware                                        77-0323962
      (State or other jurisdiction                           (I.R.S. Employer
    of incorporation or organization)                       Identification No.)

      200 E. Carrillo Street, #300
        Santa Barbara, California                                  93101
(Address of Principal Executive Offices)                        (Zip Code)

       Registrant's telephone number, including area code: (805) 730-3383

        Securities registered pursuant to Section 12(b) of the Act: None

               Securities registered pursuant to Section 12(g) of
                                    the Act:

                               Title of Each Class

                                  Common Stock
                                 $.01 par value

     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 ___

                                   ----------

     Indicate by 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. [X]

     As of March 3, 1997,  the aggregate  market value of the  Company's  common
stock held by nonaffiliates of the registrant was $30,768,638.

     As  of  March  3,  1997,  there  were  1,047,443  shares  of  common  stock
outstanding. 

                                   ----------

     Documents Incorporated by Reference: Portions of the following document are
incorporated  by reference  into the designated  parts of this Form 10-K:  Proxy
Statement  relating to Registrant's 1997 Annual Meeting of Shareholders (in Part
III).

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<PAGE>

                                     PART I

ITEM 1.   BUSINESS

General

     The  Private  Securities  Litigation  Reform  Act of 1995  provides a "safe
harbor" for forward-looking  statements.  Certain  information  included in this
Annual Report contains information that is forward-looking. Such forward-looking
information  involves risks and uncertainties  that could  significantly  affect
expected results. These risks and uncertainties include, but are not limited to,
uncertainties  relating  to  economic  conditions,  changes  in the  competitive
environment in which the Company operates,  and the continued performance of the
Motel 6 Operator under the Master Lease Agreement.

     Allstar Inns Inc., a Delaware corporation (the "Company"), was incorporated
on November 12, 1992 and was formed to succeed to the business and operations of
Allstar   Inns,   L.P.,  a  Delaware   limited   partnership   (the   "Company's
predecessor").  The  Company's  primary  objective is to own and receive  rental
income from  economy  motels or to sell the motels if Motel 6 Operating  L.P., a
Delaware  limited  partnership  (the  "Motel 6  Operator")  exercises  its Lease
Purchase  Option.  At December 31, 1996,  the Company  owned in fee or leased 71
motels  with a total  of  7,606  rooms.  Of  these  motels,  44 are  located  in
California,  and the remainder are located in six other western and southwestern
states.

Background

     In 1992,  the security  holders of the Company  approved a plan that placed
the business and operations of the Company's  motels under the management of the
Motel 6 Operator.  The Company entered into a management contract which provided
that the Motel 6 Operator  would  operate  and manage all the  Company's  motels
through  December  31,  2011.  In  September  1995 the  Company  and the Motel 6
Operator   entered  into  a  new  Master  Lease  Agreement  (the  "Master  Lease
Agreement")  relating to the Company's  motels.  For a description of the events
leading up to the Master Lease  Agreement,  see the  Company's  Proxy  Statement
relating to its 1995 Annual Meeting of Stockholders.

     The Master Lease  Agreement is a "net,  net,  net" lease for a 15-year term
commencing as of January 1, 1995.  Annual rent is an amount  sufficient to cover
debt  service on the  indebtedness  secured  by the  Company's  motels  plus (i)
through  1998,  $3.5  million,  (ii)  in  1999,  satisfaction  of the  Company's
indebtedness  to an  affiliate  of the Motel 6 Operator  (the  "Motel 6 Lender")
(approximately  $37.0 million at December 31, 1996), plus (iii) annually in 1999
through 2009, $5.0 million (plus cost of living increases from 1995).  Under the
Master  Lease  Agreement,  the Motel 6  Operator  has an option  (the  "Purchase
Option") to purchase the  Company's  motels prior to the end of 1998, at a price
of $40.0 million plus  assumption  by the Motel 6 Operator of the  indebtedness,
including the Motel 6 Lender indebtedness, secured by the Company's motels. Upon
such purchase,  the Motel 6 Operator  would receive $3.0 million  representing a
furniture,  fixture  and  equipment  reserve.  The  Master  Lease  Agreement  is
assignable  to an  assignee  with a net worth of at least  $350.0  million.  The
Purchase  Option may be  assigned  so long as the Motel 6 Operator or its parent
guarantees the performance of the assignee. The Purchase Option was exercised in
January 1997. See "Exercise of Purchase Option" below.

     As part of the closing of the Master  Lease  Agreement,  the  Company  also
completed loan agreement  amendments with its primary  lender,  Wells Fargo Bank
("WFB").

Exercise of Purchase Option

     On December 30, 1996 the Company  received  formal  notice from the Motel 6
Operator,  Motel 6 G.P. Inc. and IBL Limited,  Inc. ("Motel 6") that they are in
the process of  finalizing  arrangements  for financing to exercise the Purchase
Option which is contained in the Master Lease Agreement. On January 30, 1997 the
Motel 6 Operator and its assignees  formally  exercised the Purchase Option. The
closing of the sale of the Company's motels took place on January 30, 1997.

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     As a result of the exercise of the Purchase Option, the Company,  will have
1,067,043  shares of common  stock  outstanding  (after the  exercise of certain
stock options).

Business Plan and Prospects for Future Operations

     The  Company's  recent  business  strategy  has been to engage  the Motel 6
Operator to operate the motels  under the Motel 6 logo as lessee under the terms
of the Master Lease Agreement.

     Under the terms of the Master Lease Agreement and certain debt  agreements,
there  are  restrictions  on the  ability  of the  Company  to sell its  motels,
purchase  or  construct  additional  motels or enter into new lines of  business
until the  Purchase  Option has  expired  without the  exercise of the  Purchase
Option or until the  Company's  indebtedness  has been  paid.  Almost all of the
Company's  indebtedness  will be due and payable on December 31, 1998;  however,
the Company is entitled to refinance its indebtedness at any time.

     Under the terms of the Master Lease Agreement,  the Company is obligated to
sell all of its motel assets to the Motel 6 Operator on the terms and conditions
set  forth in the  Master  Lease  Agreement  if the Motel 6  Operator  elects to
exercise the Purchase Option on or before December 31, 1997.

     On December 30, 1996 the Company  received  formal  notice from the Motel 6
Operator,  Motel 6 G.P. Inc. and IBL Limited, Inc. ("Motel 6") that they were in
the process of  finalizing  arrangements  for financing to exercise the Purchase
Option which is contained in the Master Lease Agreement. On January 30, 1997 the
Motel 6 Operator and its assignees  formally  exercised the Purchase Option. The
closing of the sale of the Company's motels took place on January 30, 1997.

     At a  closing  held in Santa  Barbara,  California,  the  Motel 6  Operator
purchased  the  Company's  71  motels  at a fixed  price of $40.0  million  plus
assumption of the debt secured by the motels of approximately $206 million.  The
sale of the motel  properties  constitutes  a sale of  substantially  all of the
assets of the  Company.  The Company is also in the process of disposing of five
additional parcels of vacant land constituting the balance of the Company's real
estate holdings.

     The Company is and will be subject to  substantial  Federal and State taxes
on the gain  realized by the sale of its motel  assets and any gain  realized on
the disposition of the additional parcels of vacant land.

     As a result of the exercise of the Purchase Option, the Company,  will have
1,067,043  shares of common  stock  outstanding  (after the  exercise of certain
stock options).

     The Company's  business  strategy was to maximize net cash flow through the
leasing of its motel properties to the Motel 6 Operator and, due to the exercise
of  the  Purchase  Option,  the  Company  received  $40.0  million  in  proceeds
subsequent to year-end from sale of the properties to the Motel 6 Operator after
payment of all  indebtedness  of the  Company  relating to the motels and before
payment  to the  Motel 6  Operator  of a $3.0  million  furniture,  fixture  and
equipment reserve.

     Demand for the Company's motel rooms is dependent in part upon regional and
national economic conditions.  In addition,  the operations of individual motels
may be  adversely  affected  by changes  in local  business  conditions,  travel
patterns, highway relocations and the addition of competitors' motels. The Motel
6 Operator's  decision to exercise the Purchase Option  depended  largely on its
success in maximizing occupancy and operating income at the motel properties.

Market Position and Pricing

     The Motel 6 Operator, a major competitor in the economy motel industry, has
positioned  itself at or near the low-priced end of the lodging industry market,
seeking to attract  value-conscious  travelers  who desire  clean,  comfortable,
"no-frills"  lodging at reasonable  prices.  Pursuant to the terms of the Master
Lease  Agreement,  the Motel 6 Operator  was  required to make pricing and other
operational  decisions with respect to the Company's  motels in accordance  with

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the  "Motel 6  Standards",  subject  to  variations  reasonably  based  upon the
specific geographic location, character and circumstances of the motels.

     Under the terms of the Master  Lease  Agreement,  the Motel 6 Operator  was
required  to  employ  essentially  the same  policies,  procedures,  methods  of
operations,  management  practices,  purchasing  practices,  security practices,
employment and hiring  policies,  incentive  programs and  advertising  policies
(i.e.,  the "Motel 6 Standards") in operating the Company's motels as it employs
in operating  the Motel 6 Motels.  Thus, to the extent that the Motel 6 Operator
made  modifications  to the Motel 6 Standards  over the term of the Master Lease
Agreement, as it was permitted to do in its discretion, those modifications were
to be  reflected  in the  operation  of the  Company's  motels  by the  Motel  6
Operator.

     Management believes that the Company's motel's clientele consists primarily
of business  travelers  and  commercial  vehicle  drivers with  limited  expense
accounts,  students and family  travelers,  and that its  potential  market also
includes senior citizens.  Economy motels, such as those operated by the Company
and its direct  competitors (see  "--Competition"  below), are positioned at the
lower-priced  end  of  the  lodging   industry   market,   while  medium  priced
"conventional"  motels such as those  operated by Quality  Inns,  Holiday  Inns,
Ramada Inns and Best Western are  positioned in the center,  and luxury  hotels,
such as those operated by Marriott, Hilton, Hyatt and Sheraton are positioned at
the  upper-priced  end.  Management  believes  that the most  important  factors
considered by economy  motel users in selecting an economy motel include  price,
location, cleanliness and comfort.

     Under the terms of the Master Lease Agreement, the Company's room rates, as
determined  by the Motel 6  Operator,  varied  due to  geographic  and  seasonal
factors. At December 31, 1996 one-person rates ranged, depending upon geographic
location,  from a low of $23.99 to a high of $47.99  with a nominal  charge  for
each additional person.

     The Motel 6 Operator  is the  entity  that owns or leases all of the motels
which  comprise the Motel 6 chain of motels.  The chain is the largest  chain of
owner-operated  budget motels in the country.  On December 31, 1996, the Motel 6
Operator  owned or leased 740 motels  with  83,482  rooms in 48 states  plus the
District of Columbia.  The motels are  concentrated in California  (181),  Texas
(87),  Arizona (40),  Florida (31),  Illinois  (27),  New Mexico (21),  Ohio and
Washington (18) and North Carolina (17). The sole limited partner of the Motel 6
Operator is IBL Limited, Inc., a Delaware corporation.  The sole general partner
of the Motel 6 Operator is Motel 6 G.P., a Delaware  corporation wholly owned by
IBL Limited.  IBL Limited is wholly owned by IBL S.A., a French company which is
a subsidiary  of ACCOR S.A., a French  lodging and food  services  company.  The
Motel 6 Operator's  headquarters  are located at 14651 Dallas  Parkway,  Dallas,
Texas 75240.  The foregoing  information has been provided to the Company by the
Motel 6 Operator and included herein without independent verification.

Operations

     The  following   discussion   describes  the  Company's  motels  and  their
operations  prior to the exercise of the Purchase  Option pursuant to which such
motels were sold on January 30, 1997.

     General.  The Company's  motels  typically are located in potentially  high
traffic  areas or close to medium to large  cities  and near  reasonably  priced
restaurants. Each motel provides on-premise parking facilities, and the majority
of the motels  have an outdoor  swimming  pool.  The  Company's  motel rooms are
generally  more  modest in size and  appearance  than motel rooms  available  in
non-economy  motels.   Individual  rooms  are  generally  216-  square  feet  or
264-square feet in size, with bathtub/shower combinations and closet areas.

     Refurbishments. The Master Lease Agreement required the Motel 6 Operator to
perform  the  periodic  refurbishment,  rehabilitation  and  routine  repair and
maintenance  of the motels at the expense of Motel 6 Operator.  Under the Master
Lease Agreement, refurbishment and rehabilitation of the motels was to occur, in
accordance  with each annual  refurbishment  plan and at such times,  and in the
same  manner  and with the same level of  expenditure  as the Motel 6 Motels are
rehabilitated in accordance with Motel 6's system-wide  rehabilitation  policies
and procedures.



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<PAGE>

     The amount spent in 1996 by the Motel 6 Operator to maintain, refurbish and
rehabilitate  the  Company's  motels under the Master Lease  Agreement was $11.0
million.

     Under  terms of the  Master  Lease  Agreement,  the  Motel 6  Operator  was
obligated  to  expend  no  less  than  5%  of  gross  room  rentals  on  capital
expenditures  alone over the term of the Master  Lease  Agreement,  including at
least  $15.0  million  during  the period  beginning  January 1, 1995 and ending
December 31, 1998.

     Employees.  At  December  31,  1996 seven  employees  were  employed by the
Company to monitor the operation of the motels and the  rehabilitation  program,
to prepare financial and tax reports of the Company and to make required filings
with the Securities and Exchange Commission and other governmental  agencies and
otherwise to carry out the continuing  responsibilities of the Company.  None of
the  Company's  employees  is  currently  covered  by  a  collective  bargaining
agreement.  Management  believes that the Company's relations with its employees
are satisfactory.

     All personnel  engaged in the day to day operation of the Company's  motels
under the terms of the  Master  Lease  Agreement  are  employees  of the Motel 6
Operator.  The parties  hired by the Motel 6 Operator are employed in accordance
with the standard terms applicable to employees engaged in operating the Motel 6
motels.  Generally,  the Company's motels are managed by a resident manager that
has been trained at a management  school  operated by the Motel 6 Operator.  The
manager is  responsible  for directing  the on-site  operations of the motel and
daily  reporting of receipts,  disbursements  and occupancy.  In addition to the
motel manager,  each motel is generally staffed with  housekeepers,  desk clerks
and  maintenance  personnel.  A  significant  portion  of the  staff is  usually
employed on a part-time  basis.  As of December  31, 1996,  approximately  1,631
employees of the Motel 6 Operator were engaged in operating the Company's motels
pursuant to the Master Lease Agreement.

     Marketing and  Advertising.  Under the terms of the Master Lease Agreement,
the Motel 6 Operator  at its  expense  operated,  marketed  and  advertised  the
Company's  motels  under  the  "Motel 6" logo.  The  Company's  motels  are also
included in the Motel 6 Operator's  centralized  reservation system. The Company
is not  obligated to pay any  trademark  license fees to the Motel 6 Operator or
any overhead allocations,  marketing/accounting,  centralized reservation system
or other fees.

Competition

     The Company's  motels are in competition  with other major lodging  brands.
Each  of  the  Company's  motels  competes  in its  market  area  with  numerous
full-service  lodging  brands,  mid-priced  motels  and  other  economy  motels,
including  other Motel 6 motels  owned by the Motel 6  Operator.  Chains such as
Comfort Inns, Red Roof Inns, La Quinta, Super 8, Econolodge,  Hampton Inns, Days
Inns and Fairfield Inns are the most direct competitors of the Company's motels.
Other well-known  higher priced  competitors  include Holiday Inns, Ramada Inns,
Quality  Inns and Best  Western.  Competitive  factors in the  industry  include
reasonableness of room rates,  quality of accommodations,  degree of service and
convenience of location.

     The lodging  industry in general,  including the Company's  motels,  may be
adversely  affected by national and regional economic  conditions and government
regulations.  The  demand  for  accommodations  at a  particular  motel  may  be
adversely  affected by many  factors  including  changes in travel  patterns and
local and regional economic  conditions and the degree of competition with other
motels in the area.  For the  competitive  success of its  motels,  the  Company
relied on the Master  Lease  Agreement  and the Motel 6  Operator's  competitive
position in the economy motel industry.

Seasonality

     The  overall  demand  for the  Company's  motel  rooms has been  moderately
seasonal  with the  average  chain-wide  occupancy  rate  lower in the first and
fourth quarters of the calendar year and commensurately higher in the second and
third quarters.  Individual motels,  depending on their geographic location, may
exhibit  degrees of  seasonality  unrelated to the Company's  overall  occupancy
rates.  The Company's  rental receipts under the Master Lease Agreement were not
seasonally affected.


                                        5

<PAGE>

Executive Officers

     The Executive Officers of the Company,  as of December 31, 1996, are as set
forth below. Brief summaries of the Officers' respective business experience and
certain other information are as set forth following the table.

              Name               Age                 Position(s)
              ----               ---                 -----------
                                         
     Daniel R. Shaughnessy        69        Director, Chairman of the Board and
                                            Chief Executive Officer
                                         
     Edward J. Gallagher          60        Vice Chairman and Principal
                                            Accounting Officer
                                         
     Edward A. Paul               55        Vice President and Principal
                                            Financial Officer
                                       
     Mr.  Shaughnessy has been Chairman of the Board and Chief Executive Officer
of the Company's predecessors since April 1983.

     Mr. Gallagher has been Vice Chairman and Principal Accounting Officer since
April 1994.  During the period August 1992 to April 1994 he  participated in the
transition  of Allstar  Inns to the Motel 6 Management  Contract.  From May 1983
thru July 1992, he was President  and Chief  Operating  Officer of the Company's
predecessors.

     Mr. Paul has been Vice President,  Treasurer and Assistant Secretary of the
Company's predecessors since April 1983 and has held the additional positions of
Secretary and Principal Financial Officer of the Company since August 1992.

ITEM 2.   PROPERTIES

     As of December 31, 1996,  the Company owned in fee or leased 71 motels with
7,606 rooms in seven states. These properties are concentrated in California (44
motels),  with  additional  properties  located in Texas (9 motels),  Arizona (8
motels),  New  Mexico (3  motels),  Nevada (3  motels),  Oregon (2  motels)  and
Washington  state (2 motels).  The Company  owned both the building and the land
for 63 of these  motels,  owned the  building  and  leased the land for seven of
these  motels,  and leased both the building  and the land for one motel.  As of
January 1,  1997,  31% of the  motels  had been  constructed  within the last 15
years.

     The  Company's  motels  have an average of 107 rooms.  In addition to guest
rooms, motels include a manager's apartment, an office/lobby,  a vending machine
area  and  various  utility  rooms.  Each  motel  provides   on-premise  parking
facilities,  and the majority of the motels have an outdoor  swimming  pool. The
Company's  motels do not include  on-premise  restaurants or provide  convention
halls, meeting rooms, large lobbies or recreational facilities. Individual rooms
are generally  216-square feet or 264-square  feet in size, with  bathtub/shower
combinations  and  closet  areas.  All  rooms  have air  conditioning  (with the
exception of one motel),  wall-to-wall carpeting,  color televisions and private
telephones.  The  Motel 6  Operator  on behalf of the  Company  maintains  fire,
earthquake,  flood and extended coverage  insurance on its properties in amounts
it deems appropriate.

     As of December 31, 1996, each of the Company's motels was encumbered with a
first mortgage in favor of the Company's  bank lenders and a second  mortgage in
favor of the Motel 6 Lender securing an aggregate of approximately  $204 million
principal amount of indebtedness.  Such  indebtedness was assumed by the Motel 6
Operator in connection with the purchase of the motels.

     The net ground leases for seven motels are for original terms of between 25
and 46 years,  have initial remaining terms of two years and four months or more
and expire on various dates to 2021.  Four of those leases have renewal  options
ranging from five to 25 years.  The current  minimum rents range from $20,800 to

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<PAGE>

$53,500 per annum for the motels.  Each net ground lease  provides for a cost of
living adjustment which is based upon the consumer price index applicable in the
vicinity of the leased premises or for payment of a percentage of gross revenues
above the minimum  annual rent.  Each net ground lease  provides that the leased
property  cannot be  assigned  or sublet  without  the  lessor's  prior  written
approval.  The net ground  leases do not provide  the Company  with an option to
purchase the leased  property,  but several leases do provide the Company with a
right of first refusal to purchase the property if the lessor elects to sell.

     The Company's  net ground and building  lease is for an original term of 25
years,  ending in 1999,  and has no renewal  option.  The current annual rent is
$95,800  with a cost of  living  adjustment  based  upon  the  national  average
consumer  price index.  The lease  provides that the leased  property  cannot be
assigned or sublet  without the  lessor's  prior  written  approval and that the
lessee does not have an option to purchase  the leased  property but does have a
right of first refusal to purchase the property if the lessor elects to sell.

     Under the terms of the  Master  Lease  Agreement  (i) the Motel 6  Operator
agreed to comply with the terms and  conditions of the  Company's  leases on the
Company's  behalf;  (ii) upon the expiration or earlier  termination of any such
lease,  the motel  subject to the lease shall no longer be subject to the Master
Lease  Agreement,  however,  no reduction of the Motel 6 Operator's rent payment
obligations  will  occur as a result  of such  expiration;  (iii) no  surrender,
extension or material modification of any lease and, upon the termination of any
lease,  no  reinstatement  of the lease or  execution  of a new lease,  shall be
undertaken  without  the  written  agreement  of the  Company;  (iv) the Motel 6
Operator as lessee is  obligated  to pay all amounts due as ground rent or lease
payments under the ground leases and the ground and building lease;  and (v) the
Master  Lease  Agreement  contains  certain  restrictions  on the  rights of the
Company  to amend,  extend or renew the ground  leases  and ground and  building
lease prior to 1999.

     All of the foregoing leases were all assigned to and assumed by the Motel 6
Operator in connection with the purchase of the motels.

     In  addition to its motel  properties,  the  Company  owns five  parcels of
unimproved land suitable for the  construction  of new motels,  of which two are
located  in  California,  and one in each of Texas,  Oklahoma  and  Oregon.  The
Company in 1995 wrote down the  carrying  value of the vacant land held for sale
by $1.0 million and is currently offering all of the unimproved land parcels for
sale.

     The Company's  headquarters are located in Santa Barbara,  California.  The
Company  began  leasing  its office  space from an  independent  third  party in
October  1993.  The  original  term of the lease is for five years with  current
minimum rent payments of $75,800 per annum.

ITEM 3.   LEGAL PROCEEDINGS

     From  time to time,  the  Company  is a party to  lawsuits  arising  in the
ordinary course of its business.  Substantially  all of the claims made in these
lawsuits  (other than any claims for punitive  damages made in certain  actions)
are covered by the Company's insurance  policies.  Management believes that such
lawsuits  arising in the  ordinary  course of business  will not have a material
adverse effect on the financial statements of the Company.

ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     None.



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<PAGE>

                                     PART II

ITEM 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     The Common Stock of the Company  began  trading on the OTC  Bulletin  Board
Service on November  26, 1993 and the high bid and low ask prices are  currently
reported under the symbol  "ALST".  The range of the high bid and low ask prices
of the Company's Common Stock for each of the quarters during 1996 are set forth
below:

                                                1996
                                           ----------------
                                            High      Low
                                           ------    ------
          First Quarter...............     23-3/4    23-1/2
          Second Quarter..............     22-1/4    23
          Third Quarter...............     23-1/4    23-1/4
          Fourth Quarter..............     27        24-1/2

     As of February  28, 1997,  there were 627  shareholders  of record  holding
1,047,443 shares of Common Stock.

     On  November  5,  1996 the  Company  announced  the  declaration  of a cash
dividend to be paid out of the Company's  statutory  surplus. A special dividend
of $2.00 per  outstanding  Share of Common Stock was paid on December 2, 1996 to
stockholders  of record on November  15,  1996.  Under the terms of the WFB loan
modification  agreement,  the Company was  permitted to pay dividends out of its
statutory surplus cash.


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<PAGE>

ITEM 6.   SELECTED FINANCIAL DATA

     The Company assumed operations of the Company's predecessor on November 25,
1993 and retained  December  31st as the end of its fiscal year.  The  Company's
motels were  operated  under a  Management  Contract  until  December  31, 1994.
Effective  January 1, 1995,  the  Company's  motels  were  leased to the Motel 6
Operator pursuant to the Master Lease Agreement.  Set forth on the next page are
selected  financial  data of the Company for the years ended  December 31, 1992,
1993, 1994, 1995 and 1996.

SUMMARY FINANCIAL AND OPERATING DATA  (1)

                 (in thousands except per share, motels, rooms,
                       rentals, occupancy and room rates)
<TABLE>
<CAPTION>
                                                             Years Ended December 31,
                                     ---------------------------------------------------------------------
                                        1992            1993          1994          1995            1996
                                     ---------       ---------     ---------     ---------       ---------
STATEMENT OF OPERATING DATA
<S>                                  <C>             <C>           <C>           <C>             <C>      
    Revenues .....................   $  41,058       $  52,034     $  56,842     $  52,424       $  24,743
    Operating, administrative and
       lease expenses ............      25,423          28,182        30,800        22,921           1,227
    Motel 6 field overhead .......         469           1,323         1,468         1,006            --
    Motel 6 accounting and
       marketing fee .............         724           2,084         2,277         1,809            --
    Motel 6 license fee ..........         543           1,563         1,708         1,356            --
    Motel 6 incentive fee ........        --               832          --             897            --
    Interest expense .............      13,785          15,920        17,132        20,064          19,061
    Depreciation and amortization        9,300           9,851         9,240         9,001           8,608
    Other expense ................        --              --            --           4,953              12
    Restructuring and refinancing
       costs .....................       8,633            --            --            --              --
    Write down and losses on sales
       of assets .................         826            --             476         1,036  (3)        123
    Effect of Master Lease
       Agreement settlement ......        --              --            --          (2,870)           --
    Tax litigation expense .......       5,648            --            --            --              --
    Provision (benefit) for income
       taxes .....................        --              --               2        (7,012)        (23,306)
    Net income (loss) ............     (24,293)         (7,721)       (6,261)         (737)         19,018
    Income (loss) per Share (2) ..      (26.46)          (8.17)        (6.63)         (.77)          17.82
    Dividend per Common Share (2)         3.75  (4)       --            --            2.00            2.00
STATISTICAL DATA
    Motels at end of period ......          73              73            72            72              71
    Average number of rooms
       available .................       7,747           7,747         7,734         7,641           7,606
    Room rentals per available
       room (5) ..................   $   5,300       $   6,717     $   7,350     $   7,671       $   8,007
    Occupancy percentage .........        57.5%           61.6%         66.2%         67.1%           66.1%
    Average daily room rates .....   $   25.17       $   29.88     $   30.41     $   31.31       $   33.11
BALANCE SHEET DATA
    Total assets .................   $ 172,866       $ 172,757     $ 174,048     $ 160,290       $ 177,679
    Total debt and lease
       obligations ...............     195,312         202,472       199,086       206,967         204,189
    Shareholders' deficit ........     (37,801)        (45,522)      (51,784)      (54,470)        (37,173)
</TABLE>

----------

                                        9

<PAGE>

(1)  Amounts are set forth  accounting  for different  time periods in which the
     Company's  motels were (i)  operated by the Company;  (ii)  operated by the
     Motel 6 Operator under a management contract; and (iii) leased to the Motel
     6 Operator and, as a result, such amounts are not comparable.

(2)  Amounts reflect the conversion to corporation and  one-for-fifteen  reverse
     stock split.

(3)  See Note 7 of the Audited Consolidated Financial Statements.

(4)  Represents the Special Distribution paid in connection with the approval of
     the Management Contract.

(5)  Room rentals per  available  room  represents  room rentals  divided by the
     average number of rooms available during the period.

ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
          FINANCIAL CONDITION

Results of Operations

     General

     As of December 31, 1996,  the Company owned in fee or leased 71 motels with
a total of 7,606 rooms. The Company's  business strategy is to maximize net cash
flow through the leasing of its motel  properties  to the Motel 6 Operator  and,
due to the exercise of the Purchase  Option,  the Company received $40.0 million
in proceeds  subsequent to year-end  from sale of the  properties to the Motel 6
Operator  after  payment of all  indebtedness  of the  Company  relating  to the
motels.

     Demand for the Company's motel rooms is dependent in part upon regional and
national economic conditions.  In addition,  the operations of individual motels
may be  adversely  affected  by changes  in local  business  conditions,  travel
patterns, highway relocations and the addition of competitors' motels. Under the
Master Lease Agreement, however, such business factors do not affect the Motel 6
Operator's obligation to pay rent to the Company at the agreed rate. The Motel 6
Operator's  decision to exercise the Lease Purchase Option depended  largely on,
its  success  in  maximizing   occupancy  and  operating  income  at  the  motel
properties.

     In the fourth  quarter of 1995 the Company leased its motels to the Motel 6
Operator as opposed to the first three quarters of 1995 and all of 1994 when the
Motel 6 Operator  operated the  Company's  motels  under a Management  Contract.
Operations   under  terms  of  the  Master  Lease  Agreement  have  resulted  in
significant  changes in the income and expense  structure  of the Company  which
should be considered in reviewing this comparison:

     On December 30, 1996 the Company  received  formal  notice from the Motel 6
Operator,  Motel 6 G.P. Inc. and IBL Limited, Inc. that they were in the process
of finalizing  arrangements  for financing to exercise the Purchase Option which
is  contained  in the Master  Lease  Agreement.  On January 30, 1997 the Motel 6
Operator and its assignees  formally  exercised the Purchase Option. The closing
of the sale of the Company's motels took place on January 30, 1997.

     At a  closing  held in Santa  Barbara,  California,  the  Motel 6  Operator
purchased  the  Company's  71  motels  at a fixed  price of $40.0  million  plus
assumption of the debt secured by the motels of approximately $206 million.  The
sale of the motel  properties  constitutes  a sale of  substantially  all of the
assets of the  Company.  The Company is also in the process of disposing of five
additional parcels of vacant land constituting the balance of the Company's real
estate holdings.

     The Company is and will be subject to  substantial  Federal and State taxes
on the gain  realized by the sale of its motel  assets and any gain  realized on
the disposition of the additional parcels of vacant land.



                                       10

<PAGE>

Fiscal Year Ended December 31, 1996
vs. December 31, 1995

     Total  revenues for 1996 were $24.7  million  compared to $52.4 million for
1995 and comprised:  rent income, resulting from leasing the Company's motels to
the Motel 6 Operator,  of $24.0  million for twelve  months of 1996  compared to
$6.1 million for three months of 1995;  interest  income of $.7 million for 1996
versus  $1.2  million  for  1995,  earned  from  short-term  investments  of the
Company's  cash  balances;  and room rentals of $-0- for 1996  compared to $45.2
million for 1995.

     Operating expenses,  lease, Motel 6 field overhead,  Motel 6 accounting and
marketing  fee,  Motel 6 license  fee and Motel 6  incentive  fee were  expenses
pertaining  to the  operating  of the  Company's  motels by the Motel 6 Operator
under  the  Management  Contract,  which  was  replaced  with the  Master  Lease
Agreement in the fourth  quarter of 1995. As a result,  for 1996,  there were no
expenses for these items;  this compares to $26.2 million of these  expenses for
nine months of 1995.

     Administrative  and general expenses were $1.2 million for 1996 compared to
$1.8 million for 1995.

     Depreciation  and  amortization  was $8.6 million in 1996  compared to $9.0
million in 1995.  The decrease  was due to lower  overall  depreciation  charges
resulting from fully depreciated assets.

     Other  expense for 1996 was $12.0  thousand  compared  to $5.0  million for
1995. 1995's expense included $1.6 million in legal costs in connection with the
Master Lease  Agreement,  $2.6 million in litigation  settlement costs and a $.7
million write-off of prepaid loan fees.

     Write-down and losses on sales of assets for 1996 was $.1 million, due to a
loss on a sale of an  additional  land parcel  adjacent to one of the  Company's
motels,  compared to $1.0 million for 1995,  which reflected a write-down in the
realizable carrying value of the remaining vacant land parcels held for sale.

     Effect of Master Lease  Agreement  settlement  was not applicable for 1996,
but was $(2.9) million for 1995 and  represented the write-off of accrued assets
and liabilities in connection with the termination of the Management Contract.

     Interest  expense in 1996  amounted  to $19.1  million,  compared  to $20.1
million in 1995,  all of which was paid by the Motel 6 Operator on the Company's
behalf to the Company's  lenders.  The amount of this interest is also reflected
in the Company's total revenues.  The lower interest  expense for 1996 primarily
reflects no tax deficiency interest incurred during 1996 compared to $.9 million
in 1995. The Company  concluded its tax deficiency  matter on October 3, 1995 by
paying  taxes and  interest to the IRS and  California  Franchise  Tax Board the
aggregate amount of $9.0 million.

     Provision  (benefit) for income taxes for 1996 was $(23.3) million compared
to $(7.0)  million for 1995.  The amount for 1996 reflects  realizing all future
deferred tax  benefits.  The amount for 1995  reflects  the future  deferred tax
benefits for the cumulative net operating  losses for 1993,  1994 and 1995. As a
result of the  exercise of the Purchase  Option,  subsequent  to  year-end,  the
Company will use all net deferred tax assets to offset future  Federal and State
tax liabilities.

Fiscal Year Ended December 31, 1995
vs. December 31, 1994

     Total  revenues for 1995 were $52.4  million  compared to $56.8 million for
1994 and comprised: rent income of $6.1 million for 1995, resulting from leasing
the Company's  motels to the Motel 6 Operator;  interest  income of $1.2 million
for 1995, earned from short-term investments of the Company's cash balances; and
room rentals of $45.2  million for nine months of 1995 compared to $56.8 million
for twelve months of 1994.


                                       11

<PAGE>

     Operating expenses,  lease, Motel 6 field overhead,  Motel 6 accounting and
marketing  fee,  Motel 6 license  fee and Motel 6  incentive  fee were  expenses
pertaining  to the  operating  of the  Company's  motels by the Motel 6 Operator
under the Management Contract.  For nine months of 1995, these expenses totalled
$26.2 million compared to $33.8 million for all of 1994.

     Administrative  and general expenses were $1.8 million for 1995 compared to
$2.5 million for 1994.

     Other  expense for 1995 was $5.0  million  which  includes  $1.6 million in
legal costs in  connection  with the Master  Lease  Agreement,  $2.6  million in
litigation settlement costs and a $.7 million write-off of prepaid loan fees.

     Write-down  and losses on sales of assets was $1.0 million due to a loss on
a sale of a parcel of vacant land and a write-down  of the  realizable  carrying
value of the remaining vacant land parcels held for sale.

     Effect of Master Lease Agreement settlement was $(2.9) million for 1995 and
represented  the write-off of accrued assets and  liabilities in connection with
the termination of the Management Contract.

     Interest  expense in 1995 amounted to $20.1 million,  all of which was paid
by the Motel 6 Operator on the Company's  behalf to the Company's  lenders.  The
amount of this interest is also reflected in the Company's  total  revenues.  In
1994 under the Management Contract, $17.1 millon in interest expense was paid by
the Company to its lenders.  The increase in interest expense is attributable to
a $9.0 million increase in borrowings to pay the taxes and interest described in
Part 1, Item 3, of the Form 10-K for the fiscal year ended December 31, 1995 and
a 119 basis point increase in interest rates in 1995 over 1994.

     Provision (benefit) for income taxes in 1995 reflects a $7.0 million credit
resulting from recognizing  deferred tax assets. In prior years, the Company had
a  valuation  allowance  for the amount of deferred  tax assets.  As a result of
entering  into the Master Lease  Agreement,  it is more likely than not that the
net operating loss carry-forward of the deferred tax assets will be realized.

Liquidity and Capital Resources

     At  December  31,  1996,  the  Company  had $15.1  million of cash and cash
equivalents as compared to $13.5 million at December 31, 1995. In addition,  the
Motel 6 Operator owes the Company $1.6 million of  reimbursements  for principal
payments made, since the inception of the Master Lease Agreement, by the Company
toward  reducing the WFB loan.  This amount is included in the  Receivable  from
Motel 6 on the Company's Balance Sheet. As of December 31, 1996, the Company has
no borrowing capacity available on its credit facilities with its lenders.

     Under  the terms of the WFB Loan  Modification  Agreement  entered  into in
1995, the Company is required to provide  annually out of the Basic Rent payment
an annual  principal  payment  based on a 25-year  amortization  schedule  in an
amortization  account with WFB. Under terms of the Master Lease  Agreement,  the
Motel 6 Operator is required to reimburse the Company for these  payments.  Such
reimbursement shall come from an annual calculation of excess cash flow from the
WFB mortgaged  motels, or in lump sum at December 31, 1998 if the interim years'
annual excess cash flow payments have not been sufficient for full reimbursement
to the Company.  During 1996,  the Motel 6 Operator  paid $78.0  thousand to the
Company  representing the 1995 Excess Cash Flow from the motels  collateralizing
the WFB loan.

     EBITDA  increased to $23.4  million  during 1996,  an increase of 9.7% over
1995.  EBITDA,  as used above, is defined as earnings  before interest  expense,
income  taxes,   depreciation  and  amortization.   The  Company  believes  this
definition  of EBITDA  provides a  meaningful  measure of its ability to service
debt,  especially  when  considering  that any  increase in debt service will be
largely offset by an increase in debt service rent paid by the Motel 6 Operator.

         Net cash  provided by  operating  activities  was $6.0 million for 1996
compared to $(12.9)  million used in operating  activities for 1995. This year's
favorable  result is primarily  due to receipt of 1997's $3.5 million Basic Rent

                                       12

<PAGE>



payment  from the Motel 6 Operator on December 31, 1996 and from  receiving,  as
part of the rent  income from the Motel 6 Operator,  $1.4  million of  principal
payments paid directly to the Company's lenders.

     Net cash provided by investing  activities was $.3 million in the year 1996
versus $.1 million for 1995. This year's balance reflects the proceeds  received
from the sale of two parcels of land.

     Net cash used in financing  activities  was $(4.7) million in 1996 compared
to $5.9  million  provided by  financing  activities  in 1995.  Included in this
year's activity was a $1.1 million WFB loan amortization  payment required under
the terms of the WFB Loan  Modification  Agreement  entered  into in 1995,  $1.7
million of principal payments made to the Company's lenders and $2.0 million for
dividends paid to Company's stockholders.

     On  January  30,  1997 the  Motel 6  Operator  and its  assignees  formally
exercised the Purchase Option.  At a closing held in Santa Barbara,  California,
the Motel 6 Operator purchased the Company's 71 motels at a fixed price of $40.0
million plus assumption of the debt secured by the motels of approximately  $206
million. The Company received net cash proceeds of $35.8 million, after payments
to the Motel 6 Operator of $3.2 million for refund of 1997's  unearned  Deferred
Basic Rent and for the payment of $3.0 million furniture,  fixture and equipment
reserve.

     The Company is and will be subject to  substantial  Federal and State taxes
on the gain realized by the sale.

     The  Company  intends  to  adopt a Plan of  Complete  Liquidation  and will
provide  further  explanation  of such plan in its proxy  material  for the 1997
Annual Meeting.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements required by this Item are included in response and
incorporated by reference to Item 14 of this Report.


                                       13

<PAGE>



                                ALLSTAR INNS INC.

                                 BALANCE SHEETS
                            (in thousands of dollars)
--------------------------------------------------------------------------------
                                                              December 31,
                                                       ------------------------
                                                          1996            1995
                                                         ------          ------
ASSETS
Current assets:
    Cash and cash equivalents (Note 1)............    $  15,131        $ 13,518
    Receivable from Motel 6 (Note 1)..............        3,620           2,089
    Other current assets..........................           29              46
    Deferred tax assets (Note 3)..................       30,320              --
                                                      ---------        --------
          Total current assets....................       49,100          15,653
Net property and equipment (Note 1)...............      127,436         136,232
Land held for sale (Notes 1 and 7)................        1,107           1,339
Other assets including leased property under 
    capital lease, less accumulated amortization  
    of $222 (1996) and $205 (1995) (Notes 1 and 4)           36              53
Deferred tax assets (Note 3)......................           --           7,013
                                                      ---------        --------
                                                       $177,679        $160,290
                                                      =========        ========


LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
    Accounts payable and accrued liabilities......     $  5,215        $  5,817
    Deferred Basic Rent (Note 1)..................        3,500              --
    Accrued interest..............................        2,032           2,089
                                                      ---------        --------
          Total current liabilities...............       10,747           7,906
Long-term debt (Note 2)...........................      204,105         206,854
Commitments and contingencies (Notes 4)...........           --              --
Stockholders' deficit:
    Preferred stock, $.01 par value, authorized 
       1,000,000 shares; no shares issued and 
       outstanding at December 31, 1996 and 1995..           --              --
    Common stock, $.01 par value, authorized 
       10,000,000 shares; 985,710 shares and
       984,710 shares issued and outstanding at
       December 31, 1996 and 1995, respectively...           10              10
    Additional paid-in capital....................       21,360          23,081
    Accumulated deficit...........................      (58,543)        (77,561)
                                                     ----------      ----------
Total stockholders' deficit.......................      (37,173)        (54,470)
                                                     ----------       ----------
                                                       $177,679        $160,290
                                                      =========        ========







                             See accompanying notes.

--------------------------------------------------------------------------------


                                       14

<PAGE>

                                ALLSTAR INNS INC.

                            STATEMENTS OF OPERATIONS
                      (in thousands, except per share data)
--------------------------------------------------------------------------------

                                                    Years Ended December 31,
                                                   1996       1995       1994
                                                 --------   --------   --------
Revenues:
  Rent income ................................   $ 23,999   $  6,108   $   --
  Interest income ............................        744      1,164       --
  Room rentals ...............................       --       45,152     56,842
                                                 --------   --------   --------
        Total Revenues .......................     24,743     52,424     56,842
                                                 --------   --------   --------

Expenses:
  Operating ..................................       --       20,850     27,978
  Lease ......................................       --          271        335
  Administrative and general .................      1,227      1,800      2,487
  Motel 6 field overhead .....................       --        1,006      1,468
  Motel 6 accounting and marketing fee .......       --        1,809      2,277
  Motel 6 license fee ........................       --        1,356      1,708
  Motel 6 incentive fee ......................       --          897       --
  Depreciation and amortization ..............      8,608      9,001      9,240
  Other expense ..............................         12      4,953       --
  Write down and losses on sales of assets
     (Note 7) ................................        123      1,036        476
  Effect of Master Lease Agreement settlement        --       (2,870)      --
                                                 --------   --------   --------
        Total expenses .......................      9,970     40,109     45,969
                                                 --------   --------   --------

Operating income .............................     14,773     12,315     10,873

Interest expense .............................     19,061     20,064     17,132
                                                 --------   --------   --------

Net loss before provision for income taxes ...     (4,288)    (7,749)    (6,259)

Provision (benefit) for income taxes .........    (23,306)    (7,012)         2
                                                 --------   --------   --------

Net income (loss) ............................     19,018       (737)    (6,261)
                                                 ========   ========   ========

Net income (loss) per common share (Note 1) ..   $  17.82   $   (.77)  $  (6.63)
                                                 ========   ========   ========

Weighted average common shares outstanding
    plus antidilutive common stock equivalents
    (Note 1) .................................      1,067        954        945
                                                 ========   ========   ========

                             See accompanying notes.
--------------------------------------------------------------------------------

                                       15

<PAGE>

                                ALLSTAR INNS INC.

                       STATEMENTS OF STOCKHOLDERS' DEFICIT
                                 (in thousands)
--------------------------------------------------------------------------------

                   For the Three Years Ended December 31, 1996

<TABLE>
<CAPTION>
                                                              Additional  
                                          Common Stock         Paid-in      Accumulated
                                        Shares     Amount      Capital        Deficit
                                       --------   --------     --------      --------
<S>                                         <C>   <C>          <C>           <C>      
Balance, December 31, 1993 .........        945   $      9     $ 25,032      $(70,563)
  Net loss .........................       --         --           --          (6,261)
  Redemption of fractional shares                                         
     of Common Stock ...............       --         --             (1)         --
                                       --------   --------     --------      --------
                                                                          
Balance, December 31, 1994 .........        945          9       25,031       (76,824)
                                       ========   ========     ========      ========
  Net loss .........................       --         --           --            (737)
  Dividends ($2.00 per common share)       --         --         (1,950)         --
  Common stock grant ...............         40          1         --            --
                                       --------   --------     --------      --------
                                                                          
Balance, December 31, 1995 .........        985         10       23,081       (77,561)
                                       ========   ========     ========      ========
  Net income .......................       --         --           --          19,018
  Dividends ($2.00 per common share)       --         --         (1,956)         --
  Employee stock options ...........          1       --             22          --
  Amortization of 1995's                                                  
     Restricted Stock Plan .........       --         --            213          --
                                       --------   --------     --------      --------
                                                                          
Balance, December 31, 1996 .........        986   $     10     $ 21,360      $(58,543)
                                       ========   ========     ========      ========
</TABLE>

                             See accompanying notes.
--------------------------------------------------------------------------------

                                       16

<PAGE>

                                ALLSTAR INNS INC.

                            STATEMENTS OF CASH FLOWS
                            (in thousands of dollars)

                                                    Years Ended December 31,
                                                  -----------------------------
                                                    1996      1995       1994
                                                  --------  --------   --------
Cash flows from operating activities:
  Cash received ................................  $ 28,317  $ 50,326   $ 56,856
  Cash paid to suppliers and employees .........    (3,195)  (35,448)   (30,976)
  Interest paid ................................   (19,119)  (18,730)   (16,025)
  Tax deficiency payment .......................      --      (9,002)      --
                                                  --------  --------   --------
     Net cash provided by (used in) operating
        activities .............................     6,003   (12,854)     9,855

Cash flows from investing activities:
  Capital expenditures .........................       (23)     --       (2,498)
  Proceeds from sale of assets .................       336       139      1,450
  Other ........................................      --         (19)      --
                                                  --------  --------   --------
     Net cash provided by (used in) investing
        activities .............................       313       120     (1,048)

Cash flows from financing activities:
  Borrowing under credit agreements ............      --       8,996      2,179
  Payments under credit agreements .............    (1,439)     (189)      (295)
  Principal payments - mortgages and capital
     lease obligation ..........................    (1,310)     (926)    (5,270)
  Dividends paid to stockholders ...............    (1,956)   (1,950)      --
  Redemption of fractional shares of
     common stock ..............................      --        --           (1)
  Proceeds from exercise of stock options ......         2      --         --
  Proceeds from common stock grant .............      --           1       --
                                                  --------  --------   --------
     Net cash provided by (used in)
        financing activities ...................    (4,703)    5,932     (3,387)
                                                  --------  --------   --------

Net increase (decrease) in cash and
  cash equivalents .............................     1,613    (6,802)     5,420
Cash and cash equivalents at beginning of period    13,518    20,320     14,900
                                                  --------  --------   --------
Cash and cash equivalents at end of period .....  $ 15,131  $ 13,518   $ 20,320
                                                  ========  ========   ========


                            (Continued on next page)

--------------------------------------------------------------------------------


                                       17

<PAGE>

                                ALLSTAR INNS INC.

                            STATEMENTS OF CASH FLOWS
                            (in thousands of dollars)

                                                    Years Ended December 31,
                                                  -----------------------------
                                                    1996      1995       1994
                                                  --------  --------   --------
Reconciliation  of net income (loss) to net cash
 provided by (used in) operating activities:
   Net income (loss) ...........................  $ 19,018  $   (737)  $ (6,261)
     Adjustments to reconcile net income (loss)
      to net cash provided by (used in)
      operating activities:
        Depreciation and amortization ..........     8,608     9,001      9,240
        Write down of assets ...................      --       1,000       --
        Loss on sale of assets .................       123        36        476
        Amortization of restricted stock and
         exercise of employee stock options ....       234      --         --
        Changes in assets and liabilities:
         Decrease (increase) in restricted cash       --       2,500     (2,500)
         Increase in receivable from Motel 6 ...    (1,531)     (108)    (1,981)
         Decrease (increase) in other current     
          assets ...............................        17       119        (58)
         Decrease in property and equipment ....      --         567       --
         Decrease in other assets ..............      --         734       --
         Increase in deferred tax assets .......   (23,307)   (7,013)      --
         Increase (decrease) in accounts          
          payable and accrued liabilities ......      (602)  (11,284)     9,835
         Increase in deferred Basic Rent .......     3,500      --         --
         Increase (decrease) in accrued interest       (57)      469        226
         Increase (decrease) in  accrued tax      
          litigation liabilities ...............      --      (8,138)       878
                                                  --------  --------   --------

Net cash provided by (used in) 
 operating activities ..........................  $  6,003  $(12,854)  $  9,855
                                                  ========  ========   ========


                             See accompanying notes.

--------------------------------------------------------------------------------

                                       18

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business and Basis of Presentation

     The  Company at  December  31, 1996 owned in fee or leased 71 motels with a
total of 7,606 rooms.  In 1996 and 1995 the Company's  business was to lease the
motels to the Motel 6  Operator  to  operate  under the "Motel 6" logo under the
terms of the Master  Lease  Agreement.  In 1994 the Company  engaged the Motel 6
Operator  to  operate  its  motels  under  terms  of  a   Management   Contract.
Accordingly,  the  accompanying  financial  statements  reflects the business as
conducted in each period.

     In March  1995,  the FASB issued  Statement  No.  121,  Accounting  for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The
statement,  which is effective  for fiscal years  beginning  after  December 15,
1995,  requires  that an entity  evaluate  long-lived  assets and certain  other
identifiable  intangible  assets for  impairment  whenever  events or changes in
circumstances  indicate  that  the  carrying  amounts  of the  asset  may not be
recoverable.  An  impairment  loss  meeting  the  recognition  criteria is to be
measured  as the amount by which the  carrying  amount for  financial  reporting
purposes exceeds the fair value of the asset. The Company adopted this statement
in 1996 and the  adoption of the  statement  has had no effect on the  Company's
financial position or results of operations.

Master Lease Agreement

     In 1992,  the security  holders of the Company  approved a plan that placed
the business and  operations  of the  Company's  motels under the  management of
Motel 6 Operating L.P., a Delaware limited partnership (the "Motel 6 Operator").
The Company  entered into a management  contract which provided that the Motel 6
Operator would operate and manage all the Company's  motels through December 31,
2011. In September 1995 the Company and the Motel 6 Operator  entered into a new
Master Lease Agreement (the "Master Lease Agreement")  relating to the Company's
motels.  For a  description  of  the  events  leading  up to  the  Master  Lease
Agreement, see the Company's Proxy Statement relating to its 1995 Annual Meeting
of Stockholders.

     The Lease is a "net,  net,  net" lease for a 15-year term  commencing as of
January 1, 1995.  Annual rent is an amount  sufficient  to cover debt service on
the  indebtedness  secured by the Company's  motels plus (i) through 1998,  $3.5
million,  (ii) in 1999,  satisfaction  of the Company's  indebtedness  to the an
affiliate of the Motel 6 Operator  (the "Motel 6 Lender")  (approximately  $37.0
million at December 31, 1996),  plus (iii)  annually in 1999 through 2009,  $5.0
million  (plus cost of living  increases  from  1995).  Under the  Master  Lease
Agreement,  the  Motel 6  Operator  has an option  (the  "Purchase  Option")  to
purchase  the  Company's  motels  prior  to the end of 1998 at a price  of $40.0
million plus assumption by the Motel 6 Operator of the  indebtedness,  including
the Motel 6 Lender  indebtedness,  secured by the  Company's  motels.  Upon such
purchase,  the Motel 6  Operator  would  receive  $3.0  million  representing  a
furniture,  fixture  and  equipment  reserve.  The  Master  Lease  Agreement  is
assignable  to an  assignee  with a net  worth of at  least  $350  million.  The
Purchase  Option may be  assigned  so long as the Motel 6 Operator or its parent
guarantees the performance of the assignee.

     On December 30, 1996 the Company  received  formal  notice from the Motel 6
Operator,  Motel 6 G.P. Inc. and IBL Limited, Inc. ("Motel 6") that they were in
the process of  finalizing  arrangements  for financing to exercise the Purchase
Option which is contained in the Master Lease Agreement. On January 30, 1997 the
Motel 6 Operator and its assignees  formally  exercised the Purchase Option. The
closing of the sale of the Company's motels took place on January 30, 1997.

     At a  closing  held in Santa  Barbara,  California,  the  Motel 6  Operator
purchased  the  Company's  71  motels  at a fixed  price of $40.0  million  plus
assumption of the debt secured by the motels of approximately $206 million.  The
sale of the motel  properties  constitutes  a sale of  substantially  all of the
assets of the  Company.  The Company is also in the process of disposing of five

                                       19

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                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

additional  parcels of vacant land is also in the process of  disposing  of five
additional parcels of vacant land constituting the balance of the Company's real
estate holdings.

     The Company is and will be subject to  substantial  Federal and State taxes
on the gain  realized by the sale of its motel  assets and any gain  realized on
the disposition of the additional parcels of vacant land.

     The  Company  intends  to  adopt a Plan of  Complete  Liquidation  and will
provide  further  explanation  of such plan in its proxy  material  for the 1997
Annual Meeting.

     As a result of the exercise of the Purchase  Option,  the Company will have
1,067,043  shares of common  stock  outstanding  (after the  exercise of certain
stock options).

     As part of the closing of the Master Lease Agreement, the Company completed
loan agreement  amendments  with its primary  lender,  Wells Fargo Bank ("WFB").
Under the terms of the WFB Loan Modification Agreement entered into in 1995, the
Company is required to provide  annually out of the Basic Rent payment an annual
principal  payment based on a 25 year  amortization  schedule in an amortization
account  with  WFB.  Under  terms of the  Master  Lease  Agreement,  the Motel 6
Operator  is  required  to  reimburse  the  Company  for  these  payments.  Such
reimbursement shall come from an annual calculation of excess cash flow from the
WFB  mortgaged  motels,  or in a lump sum at  December  31,  1998 if the interim
years'  annual  excess  cash flow  payments  have not been  sufficient  for full
reimbursement  to the  Company.  During  1996,  the Motel 6 Operator  paid $78.0
thousand to the Company  representing  the 1995 Excess Cash Flow from the motels
collateralizing the WFB loan.

     Under  terms  of the  Master  Lease  Agreement,  the  Motel 6  Operator  is
obligated  to  expend  no  less  than  5%  of  gross  room  rentals  on  capital
expenditures for the  refurbishment of the Company's motels over the term of the
Lease,  including at least $15.0 million  during the period ending  December 31,
1998.

     The Company's  business  strategy was to maximize net cash flow through the
leasing of its motel properties to the Motel 6 Operator and, due to the exercise
of  the  Purchase  Option,  the  Company  received  $40.0  million  in  proceeds
subsequent to year-end from sale of the properties to the Motel 6 Operator after
payment of all  indebtedness  of the  Company  relating to the motels and before
payment  to the  Motel 6  Operator  of a $3.0  million  furniture,  fixture  and
equipment reserve.

Reclassifications

     Certain amounts as previously reported have been reclassified to conform to
the December 31, 1996 presentation.

Estimates and Assumptions

     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  and
disclosure of  contingent  assets and  liabilities  at the date of the financial
statements  and the  reported  amounts  of  revenues  and  expenses  during  the
reporting period. Actual results could differ from those estimates.

Property and Equipment

     Depreciation  and   amortization  of  property  and  equipment,   leasehold
interests  and  leased   property   under  capital  lease  is  computed  on  the
straight-line basis over the estimated useful lives of the assets as follows:



                                       20

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                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
     
     Property and equipment:
         Buildings........................................    30  - 40  years
         Improvements.....................................     3  - 22  years
         Furniture and equipment..........................     3  - 11  years

     Leasehold interests..................................    Lease term

     Leased property under capital lease..................    16 years

     Property and  equipment is stated at cost and consists of the  following at
December 31:

                                                         (in thousands)

                                                      1996           1995
                                                    --------       --------

     Land ...................................       $ 30,843       $ 31,067
     Buildings and improvements .............        166,199        166,957
     Furniture and equipment ................         42,477         42,750
     Leasehold interests ....................          2,498          2,539
                                                    --------       --------
                                                     242,017        243,313
     Less accumulated depreciation
        and amortization ....................        114,581        107,081
                                                    --------       --------
     Net property and equipment .............       $127,436       $136,232
                                                    ========       ========

     Maintenance  and repairs in 1994 were  charged to earnings as incurred  and
expenditures for improvements were capitalized.  Under terms of the Master Lease
Agreement,  the Motel 6 Operator was responsible for these  expenditures in 1995
and 1996.

Cash Equivalents

     All highly  liquid  investments  with a maturity of three months or less at
the date of acquisition are considered cash equivalents.

Net Income (Loss) Per Common Share

     Net income  (loss) per common  share is  calculated  by dividing net income
(loss)  by the  weighted  average  number  of  common  shares  outstanding  plus
antidilutive  common  stock  equivalents.  Common stock  equivalents  consist of
outstanding  stock options and restricted stock under the Company's stock option
and restricted stock plans, respectively.

Accounting for Stock Based Compensation

     The Company accounts for its stock based  compensation  arrangements  under
the  provisions of APB 25,  Accounting  for Stock Issued to  Employees,  and the
Company has adopted the  disclosure  only  provisions of Statement of Accounting
Financial Standards No. 123, Accounting for Stock Based Compensation.

Receivable from Motel 6

     Receivable from Motel 6 is comprised of the following:


                                       21

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

                                                            (in thousands)

                                                           1996       1995
                                                          ------     ------
     Amount owed to the Company .....................     $1,588     $ --
     Interest owed to the Company's lenders .........      2,032      2,089
                                                          ------     ------
        Receivable from Motel 6 .....................     $3,620     $2,089
                                                          ======     ======

Deferred Basic Rent

     Deferred  Basic Rent is 1997's annual Basic Rent payment  received from the
Motel 6 Operator on December 31, 1996.

Land Held for Sale

     Land  held  for  sale is  stated  at the  lower  of cost or  estimated  net
realizable  value. In 1995 the Company wrote down the carrying value of the land
held for sale by $1.0 million.

(2) LONG-TERM DEBT
                                                               (in thousands)
                                                                  December
                                                             -------------------
                                                               1996       1995
                                                             --------   --------
WFB mortgage loans maturing 1998 (9.50% weighted average)    $102,105   $103,494

Coast Federal Bank mortgage loans maturing 1998
    (7.91% weighted average) .............................     44,643     45,489

Great Western Bank and WHC-One Investors, L.P. mortgage
    loans maturing 2005 and 2006 (8.22% weighted average)      20,317     20,781

Motel 6 Lender secured subordinated loans maturing 1998
    (11.00% weighted average) ............................     37,040     37,090
                                                             --------   --------

       Total long-term debt ..............................   $204,105   $206,854
                                                             ========   ========

     All of the Company's assets serve as collateral for the indebtedness of the
Company.

     Maturities on long-term debt are as follows:

                                     (in thousands)

                       1997..........................   $  2,588
                       1998..........................    182,256
                       1999..........................        596
                       2000..........................        646
                       2001..........................        701
                       Thereafter....................     17,318
                                                        ---------
                                                        $204,105


                                       22

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

     The  Company  has  classified  1997  maturities  as  long-term  since these
maturities will not use the current assets of the ensuing fiscal year. Under the
Master Lease Agreement,  the Motel 6 Operator is required to make these payments
directly to the Company's lenders.

     During 1996, 1995 and 1994 interest  expense  totaled $19.1 million,  $20.1
million and $17.1 million, respectively.

(3) INCOME TAXES

     Pursuant to SFAS 109, the Company has deferred tax assets of $30.3  million
as of December 31, 1996.  Deferred  income taxes  reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial  reporting  purposes  and the  amounts  used for income tax  purposes.
Significant  components of the Company's deferred tax assets and liabilities are
as follows:

                                                              (in thousands)
                                                             1996       1995
                                                           --------   --------
     Deferred tax assets:
         Prior years' bases differences ................   $ 21,038   $ 21,260
         Contingent liability provision ................      1,107      2,008
         Deferred loan fees ............................      1,008      1,380
         Write-down of land held for sale ..............      1,058      1,140
         Net operating loss carry-forward ..............      8,493      7,013
         Deferred Basic Rent ...........................      1,400       --
         Other .........................................         72         77
                                                           --------   --------
            Total deferred tax assets ..................     34,176     32,878

     Valuation allowance for deferred assets ...........       --      (21,596)
                                                           --------   --------
            Net deferred assets ........................     34,176     11,282

     Deferred tax liabilities:
         Tax depreciation in excess of book depreciation      3,490      3,938
         Tax loss over book loss on asset sale .........         44         10
         Capitalized interest ..........................        322        321
                                                           --------   --------
            Total deferred tax liabilities .............      3,856      4,269

     Net deferred tax assets ...........................   $ 30,320   $  7,013
                                                           ========   ========

The valuation  allowance  decreased $21.6 million from 1995 due primarily to the
Motel 6 Operator exercising their Purchase Option. As a result, the Company will
be able to utilize all of its net deferred tax assets.

     At December 31, 1996, the Company had a net operating loss carry-forward of
approximately  $21.5  million  for  Federal  income tax  purposes  of which $3.4
million  expires in the year 2011,  $9.4 million  expires in the year 2010, $7.6
million expires in the year 2009 and $1.1 million expires in the year 2008.

     The Company had a net  operating  loss  carryover of $6.4 million for state
purposes of which $1.0 million expires in the year 2001, $2.9 million expires in
the year 2000,  $2.2 million expires in the year 1999 and $.3 million expires in
the year 1998.


                                       23

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

(4) COMMITMENTS AND CONTINGENCIES

Leases

     The Company is a party to nine lease  agreements  involving  motel land and
buildings and the Company's headquarters having an initial remaining term of two
years and four  months or more and  expiring on various  dates to 2021.  Four of
these leases contain renewal  options ranging from 5 to 25 years.  The following
is a schedule by years of future minimum rental payments required under leases:

                                                         (in thousands)
                                                                    Capital
                                                      Operating      Lease
                                                        Leases     Obligation
                                                       -------     ----------
        1997 ...................................       $  320         $ 45
        1998....................................          304           45
        1999....................................          232           11
        2000....................................          203           --
        2001....................................          171           --
        Thereafter..............................        1,644           --
                                                       ------         ----
        Total minimum lease payments............       $2,874         $101
                                                       ======         ====

                 Less amount representing interest................      17
                                                                      ----
                 Present value of lease payments..................      84
                 Less amount due within one year..................      34
                                                                      ----
                 Obligation under capital lease...................    $ 50
                                                                      ====

     The Company's  headquarters are located in Santa Barbara,  California.  The
Company  began  leasing  its office  space from an  independent  third  party in
October  1993.  The  original  term of the lease is for five years with  current
minimum rent payments of $75,800 per annum.

     Contingent  rentals included in lease expense amounted to $-0- for the year
ended  December  31,  1996 ($-0- and  $48,000  in 1995 and 1994,  respectively).
Contingent  rentals are based upon a percentage  of total  revenues at two motel
locations.  In 1995 and 1996 contingent rentals were the obligation of the Motel
6 Operator.

Employment Agreements

     Mr.  Shaughnessy is employed to manage the Company pursuant to an Executive
Employment  Agreement (the  "Shaughnessy  Agreement") on a part-time  basis. The
Shaughnessy  Agreement  expires the earlier of (i) the closing date of a sale of
the assets of the Company to the Motel 6 Operator upon exercise under the Master
Lease Agreement of the Lease Purchase Option; (ii) the closing date of any other
sale of the Company or its assets;  or (iii)  December 31, 1998.  During October
1992, Mr.  Shaughnessy's  salary was reduced from $518,000 to $200,000 annually,
but he  continues  to receive  substantially  the same  employee  benefits as he
previously  received  and is entitled to receive all other  benefits  which have
generally been granted to senior executives of the Company.

     Mr. Shaughnessy was granted Options and related Stock Appreciation  Rights,
which were fully vested at April 30, 1993, to purchase 19,000 common shares. The
options are exercisable for a period of ten years. The option price of $7.50 per
share was the fair market value of a share on the date of the grant.


                                       24

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

     The  Company  has  entered  into  agreements  with the  other  six  Company
employees  which provide that in the event of a change of control of the Company
or an early purchase under the Lease Purchase Option,  that the Company will pay
the employees  their current  salaries  through  December 31, 1998.  Under these
circumstances, the Company will also vest all of the Stock Options and waive the
forfeiture  conditions  of the  Restricted  Stock  applicable to each of the six
employees.  As part of this  agreement,  each employee has agreed to stay in the
employ of the Company through December 31, 1998.

(5) EMPLOYEE STOCK OPTION PLAN

     Under the  Company's  employee  stock  option  plan,  options  to acquire a
maximum of 63,333 common shares may be granted to employees of the Company at an
exercise  price  not less than the fair  market  value of a Share on the date of
grant. Any option granted under this Plan may, at the discretion of the Board of
Directors,  include a related Stock Appreciation Right (SAR). Upon exercise of a
SAR,  the  Company  shall pay to the  optionee  an amount  equal to one  hundred
percent (100%) of the difference between (i) the fair market value of the shares
subject to the option (or portion thereof) surrendered by the optionee, and (ii)
the  aggregate  exercise  price of such  shares.  The  Company  shall  make such
payments  in cash or with shares  valued at fair market  value as of the date of
exercise,  or in any combination of cash and shares as the optionee shall elect.
However,  the Board of Directors may  disapprove the election of the optionee to
receive cash in full or partial  payment of the SAR. At December 31, 1996,  1995
and 1994 there were outstanding  options for the purchase of 62,333,  63,333 and
44,600 shares, respectively, at prices ranging from $2.25 to $22.50 per share.

     The weighted-average exercise price for all options outstanding on December
31, 1996 is $10.35 and the  weighted-average  remaining  contractual life is 7.2
years;  31,400  options have a  weighted-average  exercise  price and  remaining
contractual life of $17.92 and 7.1 years, respectively;  and 30,933 options have
a  weighted-average  exercise price and remaining  contractual life of $2.66 and
7.3 years,  respectively.  In  addition,  41,510  options  are  exercisable  (as
compared to 25,732 as of December  31, 1995 and 15,089 as of December  31, 1994)
at a weighted-average  exercise price of $9.61 and a weighted-average  remaining
contractual life of 6.5 years;  16,911 options have a weighted-average  exercise
price and remaining contractual life of $19.57 and 5.6 years, respectively;  and
24,599 options have a weighted-average  exercise price and remaining contractual
life of $2.76 and 7.2 years, respectively.

                                                                   Employee
                                                                 Stock Options
                                                                 -------------
     Outstanding, December 31, 1995 .........................        63,333
        Granted .............................................          --
        Cancelled ...........................................          --
        Exercised ...........................................         1,000
                                                                     ------
     Outstanding, December 31, 1996 .........................        62,333
                                                                     ======
     Exercisable, December 31, 1996
        at prices ranging from $2.25 to $22.50 ..............        41,510
                                                                     ======

     The 62,333  outstanding  options  include  22,600  with stock  appreciation
rights.  One  thousand  options  were  exercised  in 1996  and no  options  were
exercised  during  1995 or  1994.  Unless  the  Board  of  Directors  determines
otherwise, commencing one year from the date of grant, options and related Stock
Appreciation  Rights become  exercisable at a rate of 33-1/3% per year for three
years and options expire ten years from the date of grant.

     As  discussed  above,  the Company has an employee  stock option plan which
provides for grants of nonqualified  stock options,  restricted stock awards and
stock  appreciation   rights.  The  Company  has  adopted  the  disclosure  only
provisions of Statement of Financial  Accounting  Standards No. 123,  Accounting

                                       25

<PAGE>


                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

for  Stock  Based  Compensation.  Accordingly,  no  compensation  cost  has been
recognized  for  the  stock  options   granted  after  December  31,  1994.  Had
compensation  cost for the Company's stock options been determined  based on the
fair value at the grant date for awards in 1995  consistent  with the provisions
of SFAS No.  123,  the  Company's  net income  (loss) and net income  (loss) per
common share would have been reduced to the pro forma amounts indicated below:

                                                          (in thousands, except 
                                                            per share amounts)
                                                         
                                                             1996       1995
                                                           --------   --------
                                                         
     Net income (loss) - as reported ....................  $ 19,018   $   (737)
     Net income (loss) - pro forma ......................  $ 19,010   $   (739)
     Net income (loss) per common share - as reported ...  $  17.82   $   (.77)
     Net income (loss) per common share - pro forma .....  $  17.82   $   (.77)
                                                      
     The fair value of the options is  estimated  on the date of grant using the
Black-Scholes   option-pricing   model  with  the   following   weighted-average
assumptions  used  for  grants  in  1995:  dividend  yield  of  12.5%;  expected
volatility of 0.346%;  risk-free interest rate of 6.5%; and expected life of 3.0
years.

(6) RESTRICTED STOCK PLAN

     Restricted Stock awards of a total of 40,000 shares of the Company's Common
Stock  were  granted  by the  Board of  Directors  on  October  11,  1995 to the
Company's employees.  The restrictions applicable to such stock require that the
employees,  in order to obtain  ownership  of the shares  granted to them,  must
remain in the employment of the Company for the restriction  period. On December
31,  1998,  plus three days,  the  restriction  with  respect to one-half of the
shares will lapse;  and on December 31, 2000,  plus three days, the  restriction
for the remaining one-half of the shares will lapse.

     Restrictions  will  lapse  earlier  if the  Master  Lease  Agreement  Lease
Purchase Option is exercised or the Company is subject to a change in control.

     The employees are entitled to receive  dividends and vote Restricted  Stock
prior to the lapse of the restrictions applicable thereto.

     The value of such stock was  established by the market price on the date of
grant and is being amortized ratably over the restricted period. During 1996 and
1995, $213,000 and $-0-, respectively, was amortized relating to the plan.

(7) VACANT LAND

     At December 31, 1996,  the Company  owned five parcels of  unimproved  land
suitable  for the  construction  of new  motels,  of which  two are  located  in
California,  and one in each of Texas,  Oklahoma and Oregon. The Company in 1995
wrote down the  carrying  value of the vacant land held for sale by $1.0 million
and is currently offering all of the unimproved land parcels for sale.

(8) LEGAL PROCEEDINGS

     From  time to time  the  Company  is a party  to  lawsuits  arising  in the
ordinary course of its business.  Substantially  all of the claims made in these
lawsuits  (other than any claims for punitive  damages made in certain  actions)

                                       26

<PAGE>

                                ALLSTAR INNS INC.

                          NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

are covered by the Company's insurance  policies.  Management believes that such
lawsuits  arising in the  ordinary  course of business  will not have a material
adverse effect on the financial statements of the Company.

(9) FAIR VALUE OF FINANCIAL INSTRUMENTS

     The following  methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practical to estimate the
value:

     Cash and Cash  Equivalents.  The carrying amounts  approximates  fair value
because of the short-term maturity of the instruments.

     Receivable  from  Motel 6. The  carrying  amount  approximates  fair  value
because of its  short-term  due date and the estimated  underlying  value of the
collateral.

     Long-Term Debt. The fair value of the Company's long-term debt is estimated
based on using a discounted  cash flow  approach and a borrowing  rate which the
Company believes to be available in the market place.

     The  estimated  fair  values of the  Company's  financial  instruments  are
summarized as follows:

                                                (in thousands)

                                    December 31, 1996      December 31, 1995
                                 ---------------------   ---------------------
                                 Carrying   Estimated    Carrying   Estimated
                                  Amount    Fair Value    Amount    Fair Value
                                 --------   ----------   --------   ----------
Cash and cash equivalents        $ 15,131    $ 15,131    $ 13,518    $ 13,518
Receivable from Motel 6             3,620       3,620       2,089       2,089
Long-term debt                    204,105     200,252     206,854     207,516


                                       27

<PAGE>

                         Report of Independent Auditors


Shareholders and Board of Directors
Allstar Inns Inc.

We have  audited  the  accompanying  balance  sheets of Allstar  Inns Inc. as of
December  31,  1996  and  December  31,  1995,  and the  related  statements  of
operations,  shareholders'  deficit  and cash flows for each of the three  years
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 audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial position of Allstar Inns Inc. at December
31, 1996 and December 31, 1995,  and the results of its  operations and its cash
flows for each of the three years in the period  ended  December  31,  1996,  in
conformity with generally accepted accounting principles.


                                                       ERNST & YOUNG LLP
January 24, 1997
Woodland Hills, California

                                       28

<PAGE>

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

     None.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     There are  incorporated  in this Item 10 by reference those portions of the
Company's  definitive  Proxy  Statement for the Company's 1997 Annual Meeting of
Stockholders (the "Proxy Statement")  appearing under the captions "Nominees for
Election as Directors" and "Information Regarding the Board of Directors and Its
Committees". Information with respect to Executive Officers may be found in Part
I, Item 1, hereof under the caption "Executive Officers".

ITEM 11.  EXECUTIVE COMPENSATION

     There is  incorporated  in this Item 11 by  reference  that  portion of the
Proxy Statement appearing under the caption  "Compensation of Executive Officers
and Directors".

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     There is  incorporated  in this Item 12 by  reference  that  portion of the
Proxy  Statement  appearing  under the caption  "Security  Ownership  of Certain
Beneficial Owners and Management".

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     None.

                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K

(a)  1. Financial Statements

     The financial statements of the Company as set forth under Item 8 are filed
as part of this Report.

     2. Financial Statement Schedules

     All   financial   statement   schedules  are  omitted  since  the  required
information  is not present or is not present in amounts  sufficient  to require
submission of the schedule,  or because the information  required is included in
the consolidated financial statements and notes thereto.

     3. Exhibits

     See the Exhibit Index included in paragraph (c) below.

(b)  Reports on Form 8-K

     None.


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<PAGE>

(c)  Exhibits

     The exhibits listed below are filed with this Report.

 (7)  3.1    Certificate of Incorporation of Allstar Inns Inc.

 (7)  3.2    By Laws of Allstar Inns Inc.

 (8)  3.3    Certificate of Merger dated November 11, 1993.

 (8)  4.1    Form of certificate representing the Registrant's Common Stock.

 (2) 10.1    Executive Employment Agreement, dated April 26, 1983 by and between
             Shaughnessy Holdings, Inc. and Daniel R. Shaughnessy.

 (1) 10.2    Form  of   Indemnification   Agreement  by  and  among  Shaughnessy
             Holdings, Inc. and its officers.

 (1) 10.3    Form  of   Indemnification   Agreement  by  and  among  Shaughnessy
             Holdings, Inc. and its directors.

 (3) 10.4    Form of Deed of Trust, Financing Statement,  Security Agreement and
             Fixture  Filing (with  Assignment of Rents and Leases) by and among
             Allstar Inns  Operating  L.P., as Trustor,  Coast Fed Services,  as
             Trustee, and Coast Savings and Loan Association, as Beneficiary.

 (3) 10.5    First Amendment to Promissory  Note, Deed of Trust,  and Assignment
             of Lessor's  Interest in Leases,  dated as of December 21, 1987, by
             and among Allstar Inns  Operating  L.P., and Coast Savings and Loan
             Association.

 (3) 10.6    Form of Security  Agreement by and between  Allstar Inns  Operating
             L.P. and Coast Savings and Loan Association.

 (3) 10.7    License of Tradename  and Logo,  dated as of December 21, 1987,  by
             and between  Allstar  Inns  Operating  L.P.  and Coast Fed Mortgage
             Corporation.

 (4) 10.8    Form of  Mortgage,  Deed of Trust,  Assignment  of Rents,  Security
             Agreement,  Financing  Statement  and  Fixture  Filing by and among
             Allstar Inns  Operating  L.P.,  as Trustor,  Ticor Title  Insurance
             Company of California,  as Trustee,  and Wells Fargo Bank, National
             Association, as Beneficiary.

 (4) 10.9    Form of Deed of Trust, Financing Statement,  Security Agreement and
             Fixture  Filing (with  Assignment of Rents and Leases) by and among
             Allstar Inns  Operating  L.P.,  as Trustor,  Ticor Title  Insurance
             Company  of  California,   as  Trustee,   and  Coast  Fed  Mortgage
             Corporation, as Beneficiary.

 (4) 10.10   Form of Security  Agreement by and between  Allstar Inns  Operating
             L.P. and Coast Fed Mortgage Corporation.

 (4) 10.11   First  Amendment  to  Security  Agreement  and First  Amendment  to
             Assignment of Operating  Agreements  and  Warranties by and between
             Allstar Inns Operating L.P. and Coast Savings and Loan Association.

 (4) 10.12   Form of Consent of Guarantor and  Agreement by and between  Allstar
             Inns, L.P. and Coast Savings and Loan Association.

 (2) 10.13   Allstar Inns Inc. Employee Stock Option Plan (1990), as amended.


                                       30

<PAGE>

 (2) 10.14   Form of Allstar Inns Inc. Non-Qualified Stock Option Agreement.

 (6) 10.15   Amended and Restated Credit  Agreement,  dated as of July 27, 1992,
             by and among Allstar Inns,  L.P.,  Allstar Inns Operating L.P., and
             Wells Fargo Bank, N.A.

 (6) 10.16   Loan  Modification  Agreement,  dated as of July 28,  1992,  by and
             among Allstar Inns  Operating  L.P.,  Allstar Inns,  L.P. and Coast
             Federal Bank.

 (6) 10.17   Texas Loan Modification Agreement, dated as of May 28, 1992, by and
             between Allstar Inns Operating L.P. and Great Western Bank.

 (6) 10.18   California Loan Modification  Agreement,  dated as of May 28, 1992,
             by and between Allstar Inns Operating L.P. and Great Western Bank.

 (6) 10.19   Credit Agreement,  dated as of August 3, 1992, by and among Allstar
             Inns,  L.P.,  Allstar  Inns  Operating  L.P.  and Motel 6 Financial
             Services, L.P.

 (2) 10.20   Executive  Employment  Agreement  dated August 6, 1992, as amended,
             granted to Daniel R. Shaughnessy.

 (2) 10.21   Allstar Inns Inc. Restricted Stock Plan.

 (2) 10.22   Form of Allstar Inns Inc.  Restricted  Stock Plan Restricted  Stock
             Award Agreement.

 (9) 10.23   Master Lease  Agreement  dated as of January 1, 1995 among  Allstar
             Inns  Inc.,  Motel 6  Operating  L.P.,  Motel 6 G.P.  Inc.  and IBL
             Limited, Inc.

(10) 10.24   Loan Modification Agreement,  dated as of September 29, 1995 by and
             between Allstar Inns Inc. and Wells Fargo Bank, N.A.

(10) 10.25   Amendment to Credit  Agreement,  dated  September  28, 1995, by and
             between Motel 6 Financial Services, L.P. and Allstar Inns Inc.

     23.1    Consent of Independent Accountants.

     27.1    Financial Data Schedule


----------

(1)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Registration  Statement on Form S-1  (Registration No. 33-12223) filed with
     the  Securities  and  Exchange  Commission  on February 25, 1987 by Allstar
     Inns, L.P.

(2)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Registration  Statement  on Form S-8 (File No.  333-00432)  filed  with the
     Securities and Exchange Commission on January 9, 1996 by Allstar Inns Inc.

(3)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File  No.  1-9415)  filed  with the  Securities  and  Exchange
     Commission for the period ended December 31, 1987 by Allstar Inns, L.P.

(4)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File  No.  1-9415)  filed  with the  Securities  and  Exchange
     Commission  for the fiscal year ended  December  31, 1988 by Allstar  Inns,
     L.P.


                                       31

<PAGE>


(5)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File  No.  1-9415)  filed  with the  Securities  and  Exchange
     Commission  for the fiscal year ended  December  31, 1989 by Allstar  Inns,
     L.P.

(6)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Registration  Statement on Form S-1  (Registration No. 33-43509) filed with
     the Securities and Exchange Commission on July 17, 1992.

(7)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Registration  Statement on Form S-4  (Registration No. 33-53654) filed with
     the Securities and Exchange Commission on September 2, 1993.

(8)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File No.  0-22930)  filed  with the  Securities  and  Exchange
     Commission on March 18, 1994.

(9)  Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File No.  0-22930)  filed  with the  Securities  and  Exchange
     Commission on March 30, 1995.

(10) Incorporated  herein by reference to an exhibit  previously  filed with the
     Form  10-K  (File No.  0-22930)  filed  with the  Securities  and  Exchange
     Commission on March 18, 1996.


                                       32

<PAGE>

                                   SIGNATURES

     Pursuant to the  requirements  of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                              ALLSTAR INNS INC.
                                              (Registrant)


                                              By:   /S/ Daniel R. Shaughnessy
                                                 -------------------------------
                                                  Daniel R. Shaughnessy
                                                  Chairman of the Board and
                                                  Chief Executive Officer

Date:  March 5, 1997

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated.

               Signature                                 Title
      -------------------------                 -------------------------

      /S/ Daniel R. Shaughnessy                 Chairman of the Board and
      -------------------------                 Chief Executive Officer
        Daniel R. Shaughnessy                   



       /S/ Edward J. Gallagher                  Vice Chairman and Principal
      -------------------------                 Accounting Officer
        Edward J. Gallagher                     



         /S/ Edward A. Paul                     Vice President and Principal
      -------------------------                 Financial Officer
           Edward A. Paul                       


       /S/ Christopher W. Brody                 Director
      -------------------------                 
        Christopher W. Brody




Date:  March 5, 1997


                                       33