##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



| | For the quarterly period ended June 30, 2006
| | --------------------------------------------

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



| | For the transition period from  to
.
| | ------------------------------------

Commission file number 001-31906



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HIGHLAND HOSPITALITY CORPORATION

(Exact name of registrant as specified in
its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|MARYLAND                                                       |  | 57-1183293                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)

8405 Greensboro Drive, Suite 500, McLean, Virginia 22102

Telephone Number (703) 336-4901



---

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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule 12b-2 of the Securities Exchange Act of 1934:



|                         |  |                      |  |                       
|------------------------ |  | -------------------- |  | ----------------------
|Large accelerated filer ̈ |  | Accelerated filer  x |  | Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934).    Yes ̈No  x

As of August 4, 2006, there were 61,071,992 shares of the registrants common stock issued and
outstanding.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

INDEX



|                                                                                              |  |     
|--------------------------------------------------------------------------------------------- |  | ----
|                                                                                              |  | Page
|PART I                                                                                        |  |     
|                                                                                              | 
|Item 1. Financial Statements                                                                  |  | 3   
|                                                                                              | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 20  
|                                                                                              | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  | 31  
|                                                                                              | 
|Item 4. Controls and Procedures                                                               |  | 31  
|                                                                                              | 
|PART II                                                                                       |  |     
|                                                                                              | 
|Item 1. Legal Proceedings                                                                     |  | 32  
|                                                                                              | 
|Item 1A. Risk Factors                                                                         |  | 32  
|                                                                                              | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 32  
|                                                                                              | 
|Item 3. Defaults Upon Senior Securities                                                       |  | 32  
|                                                                                              | 
|Item 4. Submission of Matters to a Vote of Security Holders                                   |  | 32  
|                                                                                              | 
|Item 5. Other Information                                                                     |  | 33  
|                                                                                              | 
|Item 6. Exhibits                                                                              |  | 33  



2



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##### Table of Contents

PART I



|Item 1. | Financial Statements
|------- | --------------------

HIGHLAND
HOSPITALITY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                                       |  | June 30, 2006 |           |   | December 31, 2005 |  
|                                                                                                                                                                                       |  | (unaudited)   |           |   |                   |  
|ASSETS                                                                                                                                                                                 |  |               |           |   |                   |   |           |  
|Investment in hotel properties, net                                                                                                                                                    |  | $             | 1,164,063 |   |                   | $ | 910,532   |  
|Asset held for sale                                                                                                                                                                    |  |               |          |   |                   |   | 3,000     |  
|Deposits on hotel property acquisitions                                                                                                                                                |  |               |          |   |                   |   | 8,202     |  
|Cash and cash equivalents                                                                                                                                                              |  |               | 70,613    |   |                   |   | 64,761    |  
|Restricted cash                                                                                                                                                                        |  |               | 18,093    |   |                   |   | 21,486    |  
|Accounts receivable, net of allowance for doubtful accountsof $226 and $174, respectively                                                                                              |  |               | 18,376    |   |                   |   | 12,927    |  
|Prepaid expenses and other assets                                                                                                                                                      |  |               | 34,830    |   |                   |   | 31,401    |  
|Deferred financing costs, net of accumulated amortizationof $1,098 and $1,256, respectively                                                                                            |  |               | 4,402     |   |                   |   | 4,522     |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|Total assets                                                                                                                                                                           |  | $             | 1,310,377 |   |                   | $ | 1,056,831 |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                   |  |               |           |   |                   |   |           |  
|Long-term debt                                                                                                                                                                         |  | $             | 635,045   |   |                   | $ | 494,799   |  
|Accounts payable and accrued expenses                                                                                                                                                  |  |               | 36,218    |   |                   |   | 23,163    |  
|Dividends/distributions payable                                                                                                                                                        |  |               | 12,663    |   |                   |   | 7,327     |  
|Other liabilities                                                                                                                                                                      |  |               | 2,925     |   |                   |   | 2,718     |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|Total liabilities                                                                                                                                                                      |  |               | 686,851   |   |                   |   | 528,007   |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|Minority interest in operating partnership                                                                                                                                             |  |               | 4,626     |   |                   |   | 4,500     |  
|Commitments and contingencies (Note 13)                                                                                                                                                |  |               |           |   |                   |   |           |  
|                                                                                                                                                                                       |  |              
|Preferred stock, $.01 par value; 100,000,000 shares authorized;Series A Cumulative Redeemable Preferred Stock; 3,200,000 sharesissued
and outstanding ($81,033 liquidation preference) |  |               | 77,112    |   |                   |   | 77,112    |  
|Common stock, $.01 par value; 500,000,000 shares authorized;61,243,314 shares and 51,969,372 shares issued, respectively                                                               |  |               | 612       |   |                   |   | 519       |  
|Additional paid-in capital                                                                                                                                                             |  |               | 574,268   |   |                   |   | 477,876   |  
|Treasury stock, at cost; 171,322 shares and 160,992 shares, respectively                                                                                                               |  |               | (1,894    | ) |                   |   | (1,772    | )
|Cumulative dividends in excess of net income                                                                                                                                           |  |               | (31,198   | ) |                   |   | (29,411   | )
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|Total stockholders equity                                                                                                                                                             |  |               | 618,900   |   |                   |   | 524,324   |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  
|Total liabilities and stockholders equity                                                                                                                                             |  | $             | 1,310,377 |   |                   | $ | 1,056,831 |  
|                                                                                                                                                                                       |  |               |           |   |                   |   |           |  

The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | -------------------------- | ------- | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                  |  | Three Months EndedJune 30, |         |   | Six Months EndedJune 30, |  
|                                                                                                  |  | 2006                       |         |   | 2005                     |   |        | 2006 |  |   | 2005    |  
|REVENUE                                                                                           |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Rooms                                                                                             |  | $                          | 75,139  |   |                          | $ | 39,831 |      |  | $ | 131,588 |   |  | $ | 71,608  |  
|Food and beverage                                                                                 |  |                            | 34,079  |   |                          |   | 19,175 |      |  |   | 58,917  |   |  |   | 34,438  |  
|Other                                                                                             |  |                            | 6,087   |   |                          |   | 2,158  |      |  |   | 10,285  |   |  |   | 3,983   |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total revenue                                                                                     |  |                            | 115,305 |   |                          |   | 61,164 |      |  |   | 200,790 |   |  |   | 110,029 |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|EXPENSES                                                                                          |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Hotel operating expenses:                                                                         |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Rooms                                                                                             |  |                            | 15,765  |   |                          |   | 8,324  |      |  |   | 27,830  |   |  |   | 15,911  |  
|Food and beverage                                                                                 |  |                            | 21,648  |   |                          |   | 11,742 |      |  |   | 37,994  |   |  |   | 22,397  |  
|Other direct                                                                                      |  |                            | 3,017   |   |                          |   | 1,036  |      |  |   | 4,557   |   |  |   | 2,003   |  
|Indirect                                                                                          |  |                            | 38,225  |   |                          |   | 21,650 |      |  |   | 68,858  |   |  |   | 40,176  |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total hotel operating expenses                                                                    |  |                            | 78,655  |   |                          |   | 42,752 |      |  |   | 139,239 |   |  |   | 80,487  |  
|Depreciation and amortization                                                                     |  |                            | 11,103  |   |                          |   | 5,218  |      |  |   | 19,942  |   |  |   | 9,840   |  
|Corporate general and administrative:                                                             |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Stock-based compensation                                                                          |  |                            | 1,505   |   |                          |   | 884    |      |  |   | 2,296   |   |  |   | 1,657   |  
|Other                                                                                             |  |                            | 2,345   |   |                          |   | 1,620  |      |  |   | 4,345   |   |  |   | 3,431   |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                                          |  |                            | 93,608  |   |                          |   | 50,474 |      |  |   | 165,822 |   |  |   | 95,415  |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Operating income                                                                                  |  |                            | 21,697  |   |                          |   | 10,690 |      |  |   | 34,968  |   |  |   | 14,614  |  
|                                                                                                  |  |                            |         |  
|Interest income                                                                                   |  |                            | 327     |   |                          |   | 201    |      |  |   | 1,030   |   |  |   | 518     |  
|Interest expense                                                                                  |  |                            | 9,507   |   |                          |   | 5,858  |      |  |   | 17,723  |   |  |   | 11,070  |  
|Loss on early extinguishment of debt                                                              |  |                            |        |   |                          |   |       |      |  |   | 996     |   |  |   |        |  
|Foreign currency exchange gain                                                                    |  |                            |        |   |                          |   | 40     |      |  |   | 123     |   |  |   | 40      |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Income before income taxes, minority interest inoperating partnership and discontinued operations |  |                            | 12,517  |   |                          |   | 5,073  |      |  |   | 17,402  |   |  |   | 4,102   |  
|                                                                                                  |  |                            |         |  
|Income tax benefit (expense)                                                                      |  |                            | (1,576  | ) |                          |   | (1,022 | )    |  |   | (762    | ) |  |   | 103     |  
|Minority interest in operating partnership                                                        |  |                            | (159    | ) |                          |   | (81    | )    |  |   | (215    | ) |  |   | (81     | )
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Income from continuing operations                                                                 |  |                            | 10,782  |   |                          |   | 3,970  |      |  |   | 16,425  |   |  |   | 4,124   |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Discontinued operations:                                                                          |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Income (loss) from hotel property sold                                                            |  |                            | (14     | ) |                          |   | 220    |      |  |   | (365    | ) |  |   | 70      |  
|Gain on sale of hotel property                                                                    |  |                            | 7,427   |   |                          |   |       |      |  |   | 7,427   |   |  |   |        |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total income from discontinued operations                                                         |  |                            | 7,413   |   |                          |   | 220    |      |  |   | 7,062   |   |  |   | 70      |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income                                                                                        |  |                            | 18,195  |   |                          |   | 4,190  |      |  |   | 23,487  |   |  |   | 4,194   |  
|Preferred stock dividends                                                                         |  |                            | (1,575  | ) |                          |   |       |      |  |   | (3,150  | ) |  |   |        |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income available to common stockholders                                                       |  | $                          | 16,620  |   |                          | $ | 4,190  |      |  | $ | 20,337  |   |  | $ | 4,194   |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income per common sharebasic:                                                                |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Continuing operations                                                                             |  | $                          | 0.15    |   |                          | $ | 0.10   |      |  | $ | 0.23    |   |  | $ | 0.10    |  
|Discontinued operations                                                                           |  |                            | 0.12    |   |                          |   | 0.01   |      |  |   | 0.13    |   |  |   |        |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income available to common stockholders                                                       |  | $                          | 0.28    |   |                          | $ | 0.10   |      |  | $ | 0.36    |   |  | $ | 0.10    |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income per common sharediluted:                                                              |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Continuing operations                                                                             |  | $                          | 0.15    |   |                          | $ | 0.10   |      |  | $ | 0.23    |   |  | $ | 0.10    |  
|Discontinued operations                                                                           |  |                            | 0.12    |   |                          |   | 0.01   |      |  |   | 0.13    |   |  |   |        |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net income available to common stockholders                                                       |  | $                          | 0.28    |   |                          | $ | 0.10   |      |  | $ | 0.36    |   |  | $ | 0.10    |  
|                                                                                                  |  |                            |         |   |                          |   |        |      |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(in thousands, except
share data)

(unaudited)



|                                                                                                                             |  |                 |  |        |        |              |            |        |                          |        |  |                                           |        |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------- |  | --------------- |  | ------ | ------ | ------------ | ---------- | ------ | ------------------------ | ------ |  | ----------------------------------------- | ------ |  | ----- | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                                                                             |  |                 |  |        |        | Common Stock |            |        | AdditionalPaid-InCapital |        |  | CumulativeDividends inExcess ofNet Income |        |  | Total |       
|                                                                                                                             |  | Preferred Stock |  | Issued |        | Treasury     |            |        |                          |       
|                                                                                                                             |  | Shares          |  | Amount |        | Shares       |            | Amount |                          | Shares |  |                                           | Amount |  |       |        |  
|Balances at December 31, 2005                                                                                                |  | 3,200,000       |  | $      | 77,112 |              | 51,969,372 |        | $                        | 519    |  | (160,992                                  | )      |  | $     | (1,772 | ) |  | $ | 477,876 |   |  | $ | (29,411 | ) |  | $ | 524,324 |  
|Sale of common stock, net of underwriters fees and issuance costs                                                           |  |                |  |        |       |              | 7,300,000  |        |                          | 73     |  |                                          |        |  |       |       |   |  |   | 87,991  |   |  |   |        |   |  |   | 88,064  |  
|Issuance of common stock related to exercise of warrants                                                                     |  |                |  |        |       |              | 621,942    |        |                          | 7      |  |                                          |        |  |       |       |   |  |   | 6,212   |   |  |   |        |   |  |   | 6,219   |  
|Issuance of restricted common stock to employees                                                                             |  |                |  |        |       |              | 1,340,000  |        |                          | 13     |  |                                          |        |  |       |       |   |  |   | (13     | ) |  |   |        |   |  |   |        |  
|Issuance of unrestricted common stock to directors                                                                           |  |                |  |        |       |              | 12,000     |        |                          |       |  |                                          |        |  |       |       |   |  |   | 145     |   |  |   |        |   |  |   | 145     |  
|Purchase of treasury stock                                                                                                   |  |                |  |        |       |              |           |        |                          |       |  | (10,330                                   | )      |  |       | (122   | ) |  |   |        |   |  |   |        |   |  |   | (122    | )
|Stock-based compensation                                                                                                     |  |                |  |        |       |              |           |        |                          |       |  |                                          |        |  |       |       |   |  |   | 2,151   |   |  |   |        |   |  |   | 2,151   |  
|Adjustments to minority interest in operating partnership related to issuance of common stock and purchase of treasury stock |  |                |  |        |       |              |           |        |                          |       |  |                                          |        |  |       |       |   |  |   | (94     | ) |  |   |        |   |  |   | (94     | )
|Declaration of dividends on common stock                                                                                     |  |                |  |        |       |              |           |        |                          |       |  |                                          |        |  |       |       |   |  |   |        |   |  |   | (20,549 | ) |  |   | (20,549 | )
|Declaration of dividends on preferred stock                                                                                  |  |                |  |        |       |              |           |        |                          |       |  |                                          |        |  |       |       |   |  |   |        |   |  |   | (4,725  | ) |  |   | (4,725  | )
|Net income                                                                                                                   |  |                |  |        |       |              |           |        |                          |       |  |                                          |        |  |       |       |   |  |   |        |   |  |   | 23,487  |   |  |   | 23,487  |  
|                                                                                                                             |  |                 |  |        |        |              |            |        |                          |        |  |                                           |        |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Balances at June 30, 2006                                                                                                    |  | 3,200,000       |  | $      | 77,112 |              | 61,243,314 |        | $                        | 612    |  | (171,322                                  | )      |  | $     | (1,894 | ) |  | $ | 574,268 |   |  | $ | (31,198 | ) |  | $ | 618,900 |  
|                                                                                                                             |  |                 |  |        |        |              |            |        |                          |        |  |                                           |        |  |       |        |   |  |   |         |   |  |   |         |   |  |   |         |  

The accompanying notes are an integral part of these financial statements.



5



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                 |  |                          |          |   |      |   |         |  
|-------------------------------------------------------------------------------- |  | ------------------------ | -------- | - | ---- | - | ------- | -
|                                                                                 |  | Six Months EndedJune 30, |         
|                                                                                 |  | 2006                     |          |   | 2005 |  
|Cash flows from operating activities:                                            |  |                          |          |   |      |   |         |  
|Net income                                                                       |  | $                        | 23,487   |   |      | $ | 4,194   |  
|Adjustments to reconcile net income to net cashprovided by operating activities: |  |                          |          |   |      |   |         |  
|Depreciation and amortization                                                    |  |                          | 19,942   |   |      |   | 9,840   |  
|Amortization of deferred financing costs                                         |  |                          | 469      |   |      |   | 497     |  
|Amortization of discount on mortgage loan                                        |  |                          | 36       |   |      |   | 36      |  
|Change in fair value of interest rate swaps                                      |  |                          | (885     | ) |      |   | (192    | )
|Minority interest in operating partnership                                       |  |                          | 215      |   |      |   | 81      |  
|Stock-based compensation                                                         |  |                          | 2,296    |   |      |   | 1,657   |  
|Loss on early extinguishment of debt                                             |  |                          | 996      |   |      |   |        |  
|Gain on sale of hotel property                                                   |  |                          | (7,427   | ) |      |   |        |  
|Changes in assets and liabilities:                                               |  |                          |          |   |      |   |         |  
|Accounts receivable, net                                                         |  |                          | (5,307   | ) |      |   | (6,047  | )
|Prepaid expenses and other assets                                                |  |                          | (7,976   | ) |      |   | (1,198  | )
|Accounts payable and accrued expenses                                            |  |                          | 10,103   |   |      |   | 1,931   |  
|Other liabilities                                                                |  |                          | 1,635    |   |      |   |        |  
|Discontinued operations                                                          |  |                          | 269      |   |      |   | 295     |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Net cash provided by operating activities                                        |  |                          | 37,853   |   |      |   | 11,094  |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Cash flows from investing activities:                                            |  |                          |          |   |      |   |         |  
|Acquisition of hotel properties, net of cash acquired                            |  |                          | (260,867 | ) |      |   | (50,275 | )
|Payment of value-added taxes (VAT) related to foreign hotel acquisition          |  |                          |         |   |      |   | (3,509  | )
|VAT refund related to foreign hotel acquisition                                  |  |                          | 3,774    |   |      |   |        |  
|Deposits on hotel property acquisitions                                          |  |                          |         |   |      |   | (2,900  | )
|Improvements and additions to hotel properties                                   |  |                          | (27,928  | ) |      |   | (26,678 | )
|Proceeds from insurance claim                                                    |  |                          | 4,000    |   |      |   |        |  
|Proceeds from sale of hotel properties                                           |  |                          | 33,095   |   |      |   |        |  
|Change in restricted cash                                                        |  |                          | 3,556    |   |      |   | 12,545  |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Net cash used in investing activities                                            |  |                          | (244,370 | ) |      |   | (70,817 | )
|                                                                                 |  |                          |          |   |      |   |         |  
|Cash flows from financing activities:                                            |  |                          |          |   |      |   |         |  
|Proceeds from sale of common stock                                               |  |                          | 94,476   |   |      |   |        |  
|Payment of offering expenses related to sale of common stock                     |  |                          | (193     | ) |      |   | (341    | )
|Purchase of treasury stock                                                       |  |                          | (122     | ) |      |   | (111    | )
|Proceeds from revolving credit facility                                          |  |                          | 146,000  |   |      |   |        |  
|Proceeds from term loan facility                                                 |  |                          | 10,000   |   |      |   | 15,000  |  
|Payment on term loan facility                                                    |  |                          | (100,000 | ) |      |   |        |  
|Proceeds from issuance of mortgage debt                                          |  |                          | 87,000   |   |      |   |        |  
|Scheduled principal payments on mortgage debt                                    |  |                          | (2,791   | ) |      |   | (1,886  | )
|Payment of deferred financing costs                                              |  |                          | (1,438   | ) |      |   | (128    | )
|Net deposits on loan applications                                                |  |                          | (446     | ) |      |   | (1,034  | )
|Payment of dividends to common stockholders                                      |  |                          | (16,808  | ) |      |   | (11,199 | )
|Payment of dividends to preferred stockholders                                   |  |                          | (3,150   | ) |      |   |        |  
|Payment of distributions to minority interests                                   |  |                          | (159     | ) |      |   | (251    | )
|                                                                                 |  |                          |          |   |      |   |         |  
|Net cash provided by financing activities                                        |  |                          | 212,369  |   |      |   | 50      |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Net increase (decrease) in cash                                                  |  |                          | 5,852    |   |      |   | (59,673 | )
|Cash and cash equivalents, beginning of period                                   |  |                          | 64,761   |   |      |   | 75,481  |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Cash and cash equivalents, end of period                                         |  | $                        | 70,613   |   |      | $ | 15,808  |  
|                                                                                 |  |                          |          |   |      |   |         |  
|Supplemental disclosure of cash flow information:                                |  |                          |          |   |      |   |         |  
|Cash paid for interest                                                           |  | $                        | 17,780   |   |      | $ | 11,188  |  
|Issuance of common stock related to redemptionof Operating Partnership units     |  |                          |         |   |      |   | 1,226   |  

The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Description of Business

Highland Hospitality Corporation (the Company) is a self-advised real estate investment trust (REIT) that owns
upscale full-service, premium limited-service, and extended-stay properties located in major convention, business, resort and airport markets in the United States and an all-inclusive resort property in Cancun, Mexico. The Company commenced
operations on December 19, 2003 when it completed its initial public offering (IPO) and concurrently acquired its first three hotel properties. As of June 30, 2006, the Company owned 26 hotel properties with 8,127 rooms located
in 13 states, the District of Columbia, and Mexico.

Substantially all of the Companys assets are held by, and all of its operations
are conducted through, Highland Hospitality, L.P., a Delaware limited partnership (the Operating Partnership). For the Company to qualify as a REIT, it cannot operate hotels. Therefore, the Operating Partnership, which is owned
approximately 99% by the Company and approximately 1% by other limited partners, leases its hotels to subsidiaries of HHC TRS Holding Corporation (collectively, HHC TRS), which is a wholly owned subsidiary of the Operating Partnership.
HHC TRS then engages hotel management companies to operate the hotels pursuant to management contracts. HHC TRS is treated as a taxable REIT subsidiary for federal income tax purposes.

2. Summary of Significant Accounting Policies

Basis of PresentationThe consolidated
financial statements presented herein include all of the accounts of Highland Hospitality Corporation and its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

The information in these consolidated financial statements is unaudited but, in the opinion of management, reflects all adjustments necessary for a fair
presentation of the results for the periods covered. All such adjustments are of a normal, recurring nature unless disclosed otherwise. These consolidated financial statements, including notes, have been prepared in accordance with the applicable
rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by U.S. generally accepted accounting principles for complete financial statements. Additional information is contained in the
Highland Hospitality Corporation Form 10-K for the year ended December 31, 2005.

Cash and Cash EquivalentsThe Company
considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Restricted
CashRestricted cash includes reserves held in escrow for hotel renovations, normal replacements of furniture, fixtures and equipment, real estate taxes, and insurance, pursuant to certain requirements in the Companys hotel
management, franchise, and loan agreements.

Derivative InstrumentsThe Company accounts for derivative instruments in
accordance with the provisions of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended and interpreted (SFAS 133). Under SFAS 133, all derivative
instruments are required to be recognized as either assets or liabilities in the balance sheet and measured at fair value. Derivative instruments used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment
attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivative instruments used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are
considered cash flow hedges. For a derivative instrument designated as a cash flow hedge, the change in fair value each period is reported in accumulated other comprehensive income in stockholders equity to the extent the hedge is effective.
For a derivative instrument designated as a fair value hedge, the change in fair value each period is reported in earnings along with the change in fair value of the hedged item attributable to the risk being hedged. For a derivative instrument that
does not qualify for hedge accounting or is not designated as a hedge,



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



the change in fair value each period is reported in earnings. The Company does not enter into derivative instruments for speculative trading purposes.

Investment in Hotel PropertiesInvestments in hotel properties are recorded at acquisition cost and allocated to land,
property and equipment and identifiable intangible assets in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations. Replacements and improvements are capitalized, while repairs and maintenance are
expensed as incurred. Upon the sale or retirement of a fixed asset, the cost and related accumulated depreciation are removed from the Companys accounts and any resulting gain or loss is included in the consolidated statements of operations.

Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally 15 to 40 years for
buildings and building improvements and three to ten years for furniture, fixtures and equipment. Leasehold improvements are amortized over the shorter of the lease term or the useful lives of the related assets.

The Company reviews its investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of
the hotel properties may not be recoverable. Events or circumstances that may cause a review include, but are not limited to, adverse changes in the demand for lodging at the properties due to declining national or local economic conditions and/or
new hotel construction in markets where the hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from the ultimate disposition
of a hotel property exceed its carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying amount to the related hotel propertys estimated fair market
value is recorded and an impairment loss recognized. No impairment losses have been recorded for the three and six months ended June 30, 2006 and 2005.

The Company classifies a hotel property as held for sale in the period in which it has made the decision to dispose of the hotel property, a binding agreement to purchase the property has been signed under which the
buyer has committed a significant amount of nonrefundable cash, and no significant financing contingencies exist which could cause the transaction not to be completed in a timely manner. If these criteria are met, depreciation of the hotel property
will cease and an impairment loss will be recorded if the fair value of the hotel property, less the costs to sell, is lower than the carrying amount of the hotel property. The Company will classify the loss, together with the related results of
operations, as discontinued operations in the consolidated statements of operations and classify the assets and related liabilities as held for sale in the consolidated balance sheet.

The Company capitalizes interest related to hotel properties undergoing major renovations. Interest capitalized for the three and six months ended
June 30, 2006 and 2005 was $0.1 million and $0.3 million, respectively.

Minority Interest in Operating
PartnershipCertain hotel properties have been acquired by the Operating Partnership, in part, through the issuance of limited partnership units of the Operating Partnership. The minority interest in the Operating Partnership is:
(i) increased or decreased by the limited partners pro-rata share of the Operating Partnerships net income or net loss, respectively; (ii) decreased by distributions; (iii) decreased by redemption of partnership units for
the Companys common stock; and (iv) adjusted to equal the net equity of the Operating Partnership multiplied by the limited partners ownership percentage immediately after each issuance of units of the Operating Partnership and/or
shares of the Companys common stock and after each purchase of treasury stock through an adjustment to additional paid-in capital. Net income or net loss is allocated to the minority interest in the Operating Partnership based on the
weighted-average percentage ownership throughout the period.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Revenue RecognitionRevenues from operations of the hotels are recognized when the
services are provided. Revenues consist of room sales, food and beverage sales, and other hotel department revenues, such as golf, parking, telephone, and gift shop sales.

Deferred Financing CostsDeferred financing costs are recorded at cost and consist of loan fees and other costs incurred in issuing debt.
Amortization of deferred financing costs is computed using a method that approximates the effective interest method over the term of the related debt and is included in interest expense in the consolidated statements of operations.

Debt Discounts or PremiumsDebt assumed in connection with hotel property acquisitions is recorded at fair value at the acquisition date and
any resulting discount or premium is amortized through interest expense in the consolidated statements of operations over the remaining term of the debt.

Income TaxesThe Company has elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code. As a REIT, the Company generally will not be subject to federal income tax on that
portion of its net income (loss) that does not relate to HHC TRS, the Companys wholly owned taxable REIT subsidiary. HHC TRS, which leases the Companys hotels from the Operating Partnership, is subject to federal, state and foreign
income taxes. In addition, the Operating Partnerships subsidiary that owns the Barceló Tucancun Beach resort is subject to foreign income taxes.

The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). Under SFAS 109, the
Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Valuation allowances are provided if based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Earnings Per ShareBasic net income (loss) per common share is calculated by dividing net income (loss) available to common
stockholders, less dividends on unvested restricted common stock, by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is calculated by dividing net income (loss) available to
common stockholders, less dividends on unvested restricted common stock, by the weighted-average number of common shares outstanding during the period, plus other potentially dilutive securities, such as unvested shares of restricted common stock
and warrants. The outstanding Operating Partnership units (which may be redeemed for common shares) have been excluded from the diluted net income (loss) per common share calculation, as there would be no effect on reported diluted net income (loss)
per common share.

Stock-Based CompensationFrom time-to-time, the Company grants restricted stock awards to employees.
To-date, the Company has granted three types of restricted stock awards: (1) awards that vest solely on continued employment (time-based awards); (2) awards that vest based on the Company achieving specified levels of funds from operations
(FFO) and continued employment (performance-based awards); and (3) awards that vest based on the Company achieving specified levels of relative total shareholder return and continued employment (market-based awards). The Company measures
stock-based compensation expense for the restricted stock awards based on the fair value of the awards on the date of grant. The fair value of time-based awards and performance-based awards is determined based on the average trading price of the
Companys common stock on the date of grant. The fair value of market-based awards is determined using a Monte Carlo simulation. For time-based awards, stock-based compensation expense is recognized on a straight-line basis over the life of the
entire



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



award. For performance-based awards and market-based awards, stock-based compensation expense is recognized over the requisite service period for each award.
The requisite service period for the market-based awards is derived from the Monte Carlo simulation. No compensation cost is recognized for awards for which employees do not render the requisite service.

Comprehensive Income (Loss)Comprehensive income (loss), as defined, includes all changes in stockholders equity during a period from
non-owner sources. The Company does not have any items of comprehensive income (loss) other than net income (loss).

Treasury
StockThe Company records treasury stock purchases under the cost method whereby the entire cost of the acquired stock is recorded as treasury stock.

Foreign CurrencyThe U.S. dollar is the functional currency for the Companys subsidiaries operating in Mexico. Monetary assets and liabilities are remeasured at the exchange rate in effect at the end
of each period and nonmonetary assets and liabilities are remeasured at historical rates. Revenue and expenses denominated in a currency other than the U.S. dollar are remeasured into U.S. dollars at the average exchange rates in effect during each
period. Gains and losses from foreign currency remeasurement are included in the consolidated statements of operations.

Segment
InformationStatement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131), requires public entities to report certain information about operating
segments. Based on the guidance provided in SFAS 131, the Company has determined that its business is conducted in one reportable segment, hotel ownership.

Use of EstimatesThe preparation of the financial statements in conformity with U.S. 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.

ReclassificationsCertain reclassifications have been made to the prior year financial statements to conform to the
current year presentation.

New Accounting PronouncementsFASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48), prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return.
The Company must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position.
Once it is determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions related to income
taxes subject to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Company will adopt the provisions of this interpretation beginning in the first quarter of 2007. The cumulative effect of applying the
provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings on January 1, 2007. The Company does not anticipate that the adoption of FIN 48 will have a material effect on its results of operations,
financial position, or cash flows.



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



3. Acquisition of Hotel Properties

During 2005, the Company acquired six hotel properties, consisting of 1,761 rooms, for approximately $322.0 million. The hotel properties acquired were:



|                                      |  |                 |  |                  |  |                  
|------------------------------------- |  | --------------- |  | ---------------- |  | -----------------
|Property                              |  | Number of Rooms |  | Location         |  | Acquired         
|Sheraton Annapolis                    |  | 196             |  | Annapolis, MD    |  | February 4, 2005 
|Barceló Tucancun Beach                |  | 332             |  | Cancun, Mexico   |  | April 15, 2005   
|Wyndham Palm Springs                  |  | 410             |  | Palm Springs, CA |  | July 14, 2005    
|Hilton Boston Back Bay                |  | 385             |  | Boston, MA       |  | October 24, 2005 
|Westin Princeton at Forrestal Village |  | 294             |  | Princeton, NJ    |  | November 15, 2005
|The Churchill                         |  | 144             |  | Washington, DC   |  | December 9, 2005 
|                                      |  |                 |  |                  |  |                  
|Total number of rooms                 |  | 1,761           |  |                  |  |                  
|                                      |  |                 |  |                  |  |                  

On February 24, 2006, the Company acquired the 673-room Nashville Renaissance hotel in
Nashville, Tennessee for approximately $80.3 million. In conjunction with the acquisition, the Company assumed a lease agreement for the land underlying the hotel and a portion of the adjoining convention center with an initial term ending June
2017, with seven 10-year renewal options. The Company entered into a long-term agreement with Marriott International, Inc. to manage the property.

On March 15, 2006, the Company acquired the 240-room Melrose hotel in Washington, DC for approximately $77.0 million. The Company entered into a long-term agreement with Crestline Hotels & Resorts, Inc. to manage the property
as an independent hotel.

On March 16, 2006, the Company acquired the 585-room Pointe Hilton Tapatio Cliffs resort and Lookout
Mountain Golf Club in Phoenix, Arizona for approximately $81.9 million. The Company entered into a long-term agreement with Hilton Hotels Corporation to manage the hotel property.

On June 1, 2006, the Company acquired the newly developed 210-room Courtyard Gaithersburg Washingtonian Center hotel in Gaithersburg, Maryland for
approximately $30.1 million. The acquisition had been under a definitive agreement since June 2004, at which time the Company placed $8 million of the purchase price into escrow pending completion of the development. The Company entered into a
long-term agreement with Marriott International, Inc. to manage the property.

The combined preliminary allocation of the purchase prices
to the acquired assets and liabilities based on their fair values was as follows (in thousands):



|                                      |  |                  |         |  
|------------------------------------- |  | ---------------- | ------- | -
|                                      |  | 2006Acquisitions |        
|Land and land improvements            |  | $                | 38,774  |  
|Buildings and leasehold improvements  |  |                  | 202,414 |  
|Furniture, fixtures and equipment     |  |                  | 27,950  |  
|Cash                                  |  |                  | 75      |  
|Restricted cash                       |  |                  | 163     |  
|Accounts receivable, net              |  |                  | 304     |  
|Prepaid assets and other assets       |  |                  | 2,136   |  
|Accounts payable and accrued expenses |  |                  | (2,622  | )
|                                      |  |                  |         |  
|Net assets acquired                   |  | $                | 269,194 |  
|                                      |  |                  |         |  



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The results of operations for each of the hotel properties are included in the Companys
consolidated statements of operations from their respective acquisition dates. The following pro forma financial information presents the results of operations of the Company for the three and six months ended June 30, 2006 and 2005 as if the
Nashville Renaissance hotel, The Melrose hotel, and the Pointe Hilton Tapatio Cliffs resort acquisitions, as well as the six hotel acquisitions that occurred in 2005, and the financing transactions necessary to acquire the hotel properties had taken
place on January 1, 2005. No pro forma adjustments have been included for the newly developed Courtyard Gaithersburg Washingtonian Center hotel. In addition, the pro forma financial information does not include discontinued operations related
to the Marriott Mount Laurel hotel, which was sold on June 29, 2006. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have actually occurred had
the transactions taken place on January 1, 2005, or of future results of operations (in thousands, except per share data).



|                                            |  |                                        |         |                                      |   |         |  |      |         |  |   |        
|------------------------------------------- |  | -------------------------------------- | ------- | ------------------------------------ | - | ------- |  | ---- | ------- |  | - | -------
|                                            |  | (unaudited) Three Months EndedJune 30, |         | (unaudited) Six Months EndedJune 30,
|                                            |  | 2006                                   |         | 2005                                 |   | 2006    |  | 2005
|Total revenue                               |  | $                                      | 115,305 |                                      | $ | 106,035 |  | $    | 223,148 |  | $ | 203,811
|Total operating expenses                    |  |                                        | 93,608  |                                      |   | 87,815  |  |      | 183,024 |  |   | 171,980
|Operating income                            |  |                                        | 21,697  |                                      |   | 18,220  |  |      | 40,124  |  |   | 31,831 
|Net income                                  |  |                                        | 10,846  |                                      |   | 7,534   |  |      | 20,381  |  |   | 12,724 
|Net income available to common stockholders |  |                                        | 9,271   |                                      |   | 5,959   |  |      | 17,231  |  |   | 9,574  
|Net income per common share:                |  |                                        |         |                                      |   |         |  |      |         |  |   |        
|Basic and diluted                           |  |                                        | .16     |                                      |   | .10     |  |      | .29     |  |   | .16    

4. Investment in Hotel Properties

Investment in hotel properties as of June 30, 2006 and December 31, 2005 consisted of the following (in thousands):



|                                                |  |               |           |   |                   |   |         |  
|----------------------------------------------- |  | ------------- | --------- | - | ----------------- | - | ------- | -
|                                                |  | June 30, 2006 |           |   | December 31, 2005 |  
|Land and land improvements                      |  | $             | 136,907   |   |                   | $ | 103,133 |  
|Buildings and leasehold improvements            |  |               | 966,835   |   |                   |   | 756,971 |  
|Furniture, fixtures and equipment               |  |               | 105,901   |   |                   |   | 70,220  |  
|Construction-in-progress                        |  |               | 11,958    |   |                   |   | 18,287  |  
|                                                |  |               |           |   |                   |   |         |  
|                                                |  |               | 1,221,601 |   |                   |   | 948,611 |  
|Less: accumulated depreciation and amortization |  |               | (57,538   | ) |                   |   | (38,079 | )
|                                                |  |               |           |   |                   |   |         |  
|                                                |  | $             | 1,164,063 |   |                   | $ | 910,532 |  
|                                                |  |               |           |   |                   |   |         |  

5. Discontinued Operations

On June 29, 2006, the Company sold the Marriott Mount Laurel hotel in Mount Laurel, New Jersey for net sales proceeds of approximately $31.8 million and recognized a gain of approximately $7.4 million. The
results of operations for the Marriott Mount Laurel hotel have been reclassified as discontinued operations in the statements of operations for all periods presented. For the three months ended June 30, 2006 and 2005, total revenues for the Marriott
Mount Laurel hotel were approximately $2.2 million and $2.1 million, respectively, and pre-tax income (loss) from operations was ($0.1) million and $0.3 million, respectively. For the six months ended June 30, 2006 and 2005, total revenues for the
Marriott Mount Laurel hotel were approximately $3.2 million and $3.4 million, respectively, and pre-tax income (loss) from operations was ($0.7) million and $0.1 million, respectively.

6. Hurricane Wilma

On October 22, 2005, Hurricane Wilma made landfall in Cancun, Mexico causing
substantial wind and water damage to the Barceló Tucancun Beach resort. The majority of damage affected the grounds of the resort



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



and the first level of the hotel, including significant structural damage to the sea wall and damage to the lobby, restaurant and pool areas. After six
months of restoration, the resort reopened for business on April 22, 2006.

The Company has comprehensive insurance coverage for both
property damage and business interruption, providing for an aggregate of $25 million in coverage. In 2005, the Company estimated that the net book value of the property damage was $6.5 million, and accordingly, recorded an investment in hotel
property write-off and a corresponding insurance claim receivable for the $6.5 million. The Company has received two separate advances of $2 million on its insurance claim, one in February 2006 and the other in April 2006. The Company is in the
process of finalizing negotiations with the Companys insurance carrier. To the extent that insurance proceeds ultimately exceed the net book value of the damaged property, a gain will be recorded in the period when all contingencies related to
the insurance claim have been resolved.

Insurance recoveries attributable to resort operating expenses that are reimbursable under the
Companys business interruption policy have been recorded to the extent such expenses are incurred and the amounts are probable of recovery. As of June 30, 2006, the Company had recorded an insurance claim receivable of $0.7 million, equal
to the operating expenses incurred at the Barceló Tucancun Beach resort for the period from October 22, 2005 through April 21, 2006. Any gain or profit resulting from business interruption insurance for lost income will not be
recognized until all contingencies related to the insurance claim have been resolved.

7. Long-Term Debt

On January 6, 2006, the Company completed a $35 million financing secured by the Westin Princeton at Forrestal Village hotel. The loan bears a fixed
annual interest rate of 5.97% and matures on February 1, 2013. Principal payments will commence in February 2007 and will be based on a 30-year amortization period.

On February 24, 2006, the Company extinguished its $100 million term loan facility and completed a separate unsecured revolving credit facility with a syndicate of banks. In connection with the extinguishment,
the Company wrote off approximately $1.1 million of remaining unamortized deferred financing costs related to the term loan facility.

The
revolving credit facility provides aggregate revolving loan commitments of up to $150 million with an option to increase the amount of the facility by up to $50 million. The amount that the Company can borrow under the revolving credit facility is
based on the value of the Companys unencumbered hotel properties included in the borrowing base, as defined in the credit agreement. As of June 30, 2006, the maximum borrowing availability under the facility was $150 million, of which
$146 million had been drawn.

Borrowings under the revolving credit facility bear interest at variable rates equal to, at the
Companys option, either (a) LIBOR, plus a credit spread, or (b) a base rate, plus a credit spread. The base rate in effect on any given day is equal to the higher of (a) the prime rate published by Wells Fargo Bank, N.A., or
(b) the Federal Funds Rate announced by the Federal Reserve Bank, plus 0.5%. The credit spread is reset each quarter based on the Companys current leverage ratio. The credit agreement contains standard financial covenants, including
certain leverage ratios, coverage ratios, and a minimum tangible net worth. The Company is required to pay an unused fee of 0.20% per annum on the amount of unused capacity under the credit facility. The facility matures on February 23,
2009 and has a one-year extension option.

On March 13, 2006, the Company completed a $52 million financing secured by the Nashville
Renaissance hotel. The loan bears a fixed annual interest rate of 6.11% and matures on April 1, 2013. Principal payments commenced in April 2006 and are based on a 25-year amortization period.



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



As of June 30, 2006, the Company was in compliance with the financial covenants contained in its
loan agreements. Also as of that date, the Companys weighted-average interest rate on its long-term debt was 6.38%.

8. Earnings Per Share

The following is a reconciliation of the amounts used in calculating basic and diluted net income per common share (in thousands,
except share and per share data):



|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|---------------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                                       |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|                                                                       |  | 2006                        |            |   | 2005                      |   |            | 2006 |  |   | 2005       |  
|Numerator:                                                             |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income available to common stockholders                            |  | $                           | 16,620     |   |                           | $ | 4,190      |      |  | $ | 20,337     |   |  | $ | 4,194      |  
|Less: discontinued operations                                          |  |                             | (7,413     | ) |                           |   | (220       | )    |  |   | (7,062     | ) |  |   | (70        | )
|Less: dividends on unvested restricted common stock                    |  |                             | (59        | ) |                           |   | (86        | )    |  |   | (112       | ) |  |   | (172       | )
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income from continuing operations available to common stockholders |  | $                           | 9,148      |   |                           | $ | 3,884      |      |  | $ | 13,163     |   |  | $ | 3,952      |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Denominator:                                                           |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted-average number of common shares outstandingbasic             |  |                             | 59,395,133 |   |                           |   | 39,454,542 |      |  |   | 56,187,664 |   |  |   | 39,415,855 |  
|Effect of dilutive securities:                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Unvested restricted common stock                                       |  |                             |           |   |                           |   | 154,440    |      |  |   | 53,805     |   |  |   | 124,400    |  
|Warrants                                                               |  |                             | 55,544     |   |                           |   | 55,290     |      |  |   | 107,023    |   |  |   | 51,611     |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted-average number of common shares outstandingdiluted           |  |                             | 59,450,677 |   |                           |   | 39,664,272 |      |  |   | 56,348,492 |   |  |   | 39,591,866 |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income per common sharebasic:                                     |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Continuing operations                                                  |  | $                           | 0.15       |   |                           | $ | 0.10       |      |  | $ | 0.23       |   |  | $ | 0.10       |  
|Discontinued operations                                                |  |                             | 0.12       |   |                           |   | 0.01       |      |  |   | 0.13       |   |  |   |           |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income available to common stockholders (1)                        |  | $                           | 0.28       |   |                           | $ | 0.10       |      |  | $ | 0.36       |   |  | $ | 0.10       |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income per common sharediluted:                                   |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Continuing operations                                                  |  | $                           | 0.15       |   |                           | $ | 0.10       |      |  | $ | 0.23       |   |  | $ | 0.10       |  
|Discontinued operations                                                |  |                             | 0.12       |   |                           |   | 0.01       |      |  |   | 0.13       |   |  |   |           |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income available to common stockholders (1)                        |  | $                           | 0.28       |   |                           | $ | 0.10       |      |  | $ | 0.36       |   |  | $ | 0.10       |  
|                                                                       |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  

---

|(1) | per share amounts may not add due to rounding.
|--- | ----------------------------------------------

9. Dividends

For the three months ended June 30, 2006, the Companys board of directors declared a cash dividend to common stockholders of
$.18 per common share. The dividend, payable to the Companys common stockholders of record as of June 30, 2006, was paid on July 14, 2006.

On May 15, 2006, the Company paid a quarterly cash dividend of $.4921875 per share of Series A preferred stock. On June 19, 2006, the Companys board of directors declared a quarterly cash dividend of
$.4921875 per share of Series A preferred stock. The dividend will be paid on August 15, 2006 to holders of record as of August 1, 2006.

10.
Capital Stock

Common StockOn March 14, 2006, the Company completed an underwritten public offering and sold
7,300,000 shares of common stock at a price of $12.35 per share. After deducting underwriting discounts and offering expenses, the Company generated net proceeds of approximately $88.1 million.



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



WarrantsIn connection with the IPO, the Company granted to its underwriters, as partial
consideration for its services, warrants representing the right to acquire 888,488 shares of common stock. The warrants are exercisable for a period of five years commencing December 19, 2003 at an exercise price of $10 per share. On
March 28, 2006, the underwriters exercised warrants representing the right to acquire 621,942 shares of common stock. As of June 30, 2006, the Company has reserved 266,546 shares of common stock for issuance upon additional exercises of
the warrants.

Treasury StockFor the six months ended June 30, 2006 and 2005, the Company purchased 10,330 shares and
10,306 shares, respectively, of common stock from employees to satisfy the minimum statutory tax withholding requirements related to the vesting of their shares of restricted common stock.

Operating Partnership UnitsHolders of Operating Partnership units have certain redemption rights, which enable them to cause the Operating
Partnership to redeem their units in exchange for, at the sole discretion of the Operating Partnership, either shares of the Companys common stock on a one-for-one basis or cash per unit equal to the market price of the Companys common
stock at the time of redemption. The number of shares issuable upon exercise of the redemption rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have
the effect of diluting the ownership interests of the limited partners or the stockholders of the Company. As of June 30, 2006, the total number of Operating Partnership units outstanding owned by third-party limited partners was 529,850.

11. Stock Incentive Plan

On
May 23, 2006, the Companys stockholders approved the amendment and restatement of the 2003 Omnibus Stock Incentive Plan, as amended and restated (the Plan), which authorizes the issuance of options to purchase shares of common
stock and the grant of stock awards, stock appreciation rights, deferred shares, performance shares and performance units. Employees and directors of the Company and other persons that provide consulting services to the Company are eligible to
participate in the Plan. The compensation policy committee of the board of directors administers the Plan and determines the numbers of awards to be granted, the vesting period, and the exercise price, if any.

The Plan provides for the grant of incentive stock options and non-qualified stock options. Incentive stock options may only be granted to persons who
are employees of the Company. The exercise price for granted options cannot be less than the fair market value of the Companys common stock on the date the option is granted, and in the event a participant is deemed to be a 10% or more owner
of the Company, the exercise price of an incentive stock option cannot be less than 110% of the fair market value of the Companys common stock on the date the option is granted. No participant may be granted incentive stock options that are
exercisable for the first time in any calendar year for common stock having a total fair market value (determined as of the option grant), in excess of $100,000. As of June 30, 2006, no stock options had been granted under the Plan.

The Plan also provides for the grant of stock awards. A stock award may be subject to payment by the participant of a purchase price for shares of
common stock subject to a stock award, and a stock award may be subject to vesting requirements or transfer restrictions or both as determined by the compensation policy committee of the board of directors. Those conditions may include, for example,
a requirement that the participant complete a specified period of service or that certain performance objectives be achieved. Transfer of the shares of common stock subject to a stock award normally will be restricted prior to vesting.

Under the Plan, the maximum number of shares of common stock that may be subject to stock options, stock awards, deferred shares or performance shares
or covered by stock appreciation rights is 5,002,000 shares. No one participant may receive awards for more than 500,000 shares of common stock in any one calendar year.



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The maximum number of performance units that may be granted to a participant in any one calendar year is 750,000 for each full or fractional year included in
the performance period for the award granted during the calendar year. These limitations, and the terms of outstanding awards, will be adjusted without the approval of the Companys stockholders as the compensation policy committee of the board
of directors determines is appropriate in the event of a stock dividend, stock split, reclassification of stock or similar events. If an award terminates, expires, is forfeited or becomes unexercisable, the shares of common stock subject to such
award become available for future awards under the Plan. In addition, shares which are granted under any type of award under the Plan and which are repurchased or reacquired by the Company at the original purchase price for such shares also become
available for future awards under the Plan. As of June 30, 2006, subject to increases resulting from the forfeiture of currently outstanding awards, 2,667,989 shares of common stock were reserved and available for future issuances under the
Plan.

The board of directors may amend or terminate the Plan at any time, but an amendment will not become effective without the approval
of the Companys stockholders (within 12 months of the date such amendment is adopted by the board of directors) if it increases the aggregate number of shares of common stock that may be granted under the Plan. No amendment or termination of
the Plan will affect a participants rights under outstanding awards without the participants consent.

On May 23, 2006,
the Company granted 1,340,000 shares of restricted common stock to certain employees. Three types of shares were granted: (1) 893,332 shares that vest solely on continued employment (time-based awards); (2) 148,889 shares that vest based
on the Company achieving specified levels of FFO and continued employment (performance-based awards); and (3) 297,779 shares that vest based on the Company achieving specified levels of relative total shareholder return and continued employment
(market-based awards). The time-based awards are eligible to vest 10% in 2007, 25% in 2008, 30% in 2009, and 35% in 2010. The performance-based awards and market-based awards are eligible to vest 25% in each of 2007 through 2010. Additional vesting
of market-based awards may also occur in 2010 if the cumulative level of relative total shareholder return during the entire performance measurement period results in a higher total number of shares being vested than the total number of shares that
vested based on relative total shareholder return on an individual year basis. Dividends on the shares of restricted common stock will accrue, but will not be paid unless the related shares vest. The fair value of the market-based awards was
determined using a Monte Carlo simulation with the following assumptions: volatility of 25.2% based on the Companys stock price since the IPO; an expected term equal to the requisite service period for the awards; and a three-year risk-free
interest rate of 4.90%.

As of June 30, 2006, there was approximately $15.1 million of unrecognized stock-based compensation expense
related to shares of restricted common stock. The unrecognized stock-based compensation expense is expected to be recognized over a weighted-average period of 2.1 years. The following is a summary of the Companys shares of restricted common
stock for the six months ended June 30, 2006:



|                                                |  |                 |   |  |                                      |      
|----------------------------------------------- |  | --------------- | - |  | ------------------------------------ | -----
|                                                |  | Number ofShares |   |  | Weighted-AverageGrant-DateFair Value
|Restricted common stock as of December 31, 2005 |  | 359,168         |   |  | $                                    | 10.36
|Granted                                         |  | 1,340,000       |   |  | $                                    | 11.54
|Vested                                          |  | (29,166         | ) |  | $                                    | 11.77
|Forfeited                                       |  |                |   |  |                                      |     
|                                                |  |                 |   |  |                                      |      
|Restricted common stock as of June 30, 2006     |  | 1,670,002       |   |  | $                                    | 11.28
|                                                |  |                 |   |  |                                      |      



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



12. Related-Party Transactions

Management AgreementsAs of June 30, 2006, 14 of the Companys 26 hotels operated pursuant to long-term management agreements with Crestline Hotels & Resorts, Inc. Crestline
Hotels & Resorts, Inc. is a wholly owned subsidiary of Barceló Crestline Corporation (Barceló Crestline), which sponsored the Companys formation and IPO. Crestline Hotels & Resorts, Inc. receives a
base management fee, and if the hotels meet and exceed certain performance thresholds, an incentive management fee. The base management fee for the hotels is generally between 2% and 3.5% of total gross revenues from the hotels. The incentive
management fee, if any, for each hotel will be equal to 15% of the amount by which operating income for the fiscal year exceeds 11% of the Companys capitalized investment in the hotel. The management agreements place a cap on the total amount
of combined base and incentive management fees paid to Crestline Hotels & Resorts, Inc. for each hotel at 4.5% of gross revenues for each fiscal year.

For the three months ended June 30, 2006 and 2005, the Company paid Crestline Hotels & Resorts, Inc. approximately $1.3 million and $0.8 million, respectively, in management fees. For the six months
ended June 30, 2006 and 2005, the Company paid Crestline Hotels & Resorts, Inc. approximately $2.5 million and $1.4 million, respectively, in management fees.

As of June 30, 2006, the Barceló Tucancun Beach resort operated pursuant to management and consulting agreements with separate subsidiaries
of Barceló Corporación Empresarial, S.A. (Barceló), which is the parent company of Barceló Crestline. The initial term of the management agreement is five years and will be automatically extended for four
successive five-year periods, unless terminated because of a default of the manager or the manager elects not to renew. Barceló receives a base management fee, and if the hotel meets and exceeds a certain performance threshold, an incentive
management fee. The base management fee is 3% of total gross revenues from the hotel. The incentive management fee, if any, will be equal to 15% of the amount by which operating income for the fiscal year exceeds 12% of the Companys
capitalized investment in the hotel. The management agreement places a cap on the total amount of combined base and incentive management fees paid to Barceló at 7.5% of gross revenues for each fiscal year.

The consulting agreement is coterminous with the management agreement; provided, however, that Barceló can terminate the consulting agreement upon
90 days notice. Pursuant to the consulting agreement, Barceló will provide consulting services with respect to the operation of the Barceló Tucancun Beach resort. The consulting fee will be based on the time spent by Barceló in
providing such services and will be agreed upon by Barceló and the Company each year; provided, however, that the consulting fee paid to Barceló each year is not expected to exceed 15% of the total fees payable to Barceló that
same year under the management agreement.

For the three and six months ended June 30, 2006 and 2005, the Company paid separate
subsidiaries of Barceló approximately $61,000 and $70,000, respectively, in management and consulting fees.

Overhead and
Cost-Sharing ArrangementSince the Companys inception, it has had an informal overhead and cost-sharing arrangement with Barceló Crestline whereby the Company has shared Barceló Crestlines office space and related
furniture, fixtures and equipment and certain support services, including human resources and information technology functions, in exchange for a monthly reimbursement of the estimated value to the Company from this sharing arrangement. For the
three months ended June 30, 2006 and 2005, the Company paid Barceló Crestline approximately $40,000 and $66,000, respectively, under this arrangement. For the six months ended June 30, 2006 and 2005, the Company paid Barceló
Crestline approximately $80,000 and $126,000, respectively, under this arrangement.



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



13. Commitments and Contingencies

Ground and Building LeasesThe Company leases the Portsmouth Renaissance hotel and adjoining conference center pursuant to two separate lease
agreements, each with an initial term ending May 2049, with four ten-year renewal options and one nine-year renewal option. Base rent under the hotel lease is $50,000 per year. Annual percentage rent, if any, is equal to 100% of available net cash
flow after payment of all hotel operating expenses, the base rent, real estate taxes, insurance and a cumulative priority annual return to the Company of approximately $2 million, up to $0.2 million, then 50% of any remaining net cash flow until the
landlord has been paid percentage (and additional) rent of $10 million in aggregate, and thereafter 10% of net cash flow annually. If the Company sells or assigns the hotel lease, an additional rent payment equal to 50% of the net sales proceeds in
excess of the Companys capital investment in the hotel and unpaid annual return of 15% on the investment will be due. Annual rent under the conference center lease is equal to the lesser of $75,000 per year or the maximum amount of rent
allowable under tax regulations so as to preserve the tax-exempt status of the Portsmouth Industrial Development Authority bonds issued in connection with the hotel and conference center.

The Company leases the conference center and parking facility adjoining the Sugar Land Marriott hotel pursuant to a lease agreement with an initial term
ending October 2102. The minimum rent is $1 per year, plus an incentive rent payment for the first 25 years of the term of the lease. If during any of those first 25 years, the Companys cumulative internal rate of return on investment in the
hotel exceeds 15%, then the Company will pay incentive rent in an amount equal to 36% of the net cash flow for the applicable year in excess of the amount of net cash flow that would be necessary to generate a cumulative internal rate of return of
15%.

The Company leases the land underlying the Nashville Renaissance hotel and a portion of the adjoining convention center pursuant to a
lease agreement with an initial term ending June 2017, with seven 10-year renewal options. Base rent under the lease is $0.5 million per year. Annual percentage rent is equal to 20% of available net cash flow after payment of all hotel operating
expenses, the base rent, real estate taxes, insurance, debt service, property improvement reserve funding, and a priority annual return to the Company of 15% of the Companys capitalized investment in the hotel. If the Company sells or assigns
the hotel lease, an additional payment equal to 20% of the net sales proceeds in excess of the Companys capital investment in the hotel will be due. In addition, if the Company refinances the debt secured by the hotel, an additional payment
equal to 20% of the net cash proceeds will be due.

Percentage and incentive rent is accrued when it becomes probable that the specified
thresholds will be achieved. No percentage or incentive rent was recognized in any period presented in the consolidated financial statements, as the thresholds were not expected to be met.

The Company leases the land underlying the Sheraton Annapolis hotel pursuant to a lease agreement with an initial term ending September 2059. Annual rent
due under the lease is approximately $0.3 million and increases each year over the remaining term of the lease by 40% of the increase in the Consumer Price Index (CPI) for that year. In addition, the land will be appraised every five years and the
annual rent will be increased to an amount equal to the product of the appraised value and 12%. However, annual rent will not be increased by an amount greater than 10% of the annual rent for the preceding year.

The Company leases the land underlying the Wyndham Palm Springs hotel pursuant to a sub-lease agreement with an initial term ending December 2059, with a
25-year renewal option. Annual rent due under the lease is the greater of base rent or percentage rent. Annual base rent for the years 2005 through 2009 is approximately $0.9 million. Base rent increases every five years over the remaining term of
the lease by the increase in the CPI over that same five-year period; however, the increase in base rent every five years will not



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HIGHLAND HOSPITALITY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



be increased by an amount greater than 30% of the base rent for the preceding five-year period. Annual percentage rent is equal to the sum of 4% of rooms
gross receipts, 2% of food and beverage gross receipts, and 10% of tenant rentals.

Management AgreementsAs of June 30,
2006, the Companys hotel properties operated pursuant to long-term agreements with six management companies, including Crestline Hotels & Resorts, Inc. (14 hotels), Marriott International, Inc. (5 hotels), Hyatt Corporation (2
hotels), McKibbon Hotel Management, Inc. (2 hotels), Hilton Hotels Corporation (2 hotels), and Grubarges Gestión Hotelera Mexicana SA de CV (1 resort). Each management company receives a base management fee generally between 2% and 4% of
hotel revenues. The management companies are also eligible to receive an incentive management fee if hotel operating income, as defined in the management agreements, exceeds certain performance thresholds. The incentive management fee is generally
calculated as a percentage of hotel operating income after the Company has received a priority return on its investment in the hotel.

Franchise AgreementsAs of June 30, 2006, 14 of the Companys 26 hotel properties operated pursuant to franchise agreements from national hotel companies. Pursuant to the franchise agreements, the Company pays a
royalty fee generally between 4% and 5% of room revenues, plus additional fees for marketing, central reservation systems, and other franchisor costs that amount to between 3% and 4% of room revenues from the hotels. Nine of the Companys 26
hotel properties, which include the Hyatt Regency Savannah hotel, the Hyatt Regency Wind Watch Long Island hotel, the Dallas/Fort Worth Airport Marriott hotel, the Nashville Renaissance hotel, the Courtyard Boston Tremont hotel, the Courtyard Denver
Airport hotel, the Courtyard Gaithersburg Washingtonian Center hotel, the Hilton Boston Back Bay hotel, and the Pointe Hilton Tapatio Cliffs resort are managed by Hyatt Corporation, Marriott International, Inc., or Hilton Hotels Corporation. The
management agreements for these nine hotel properties allow the hotel property to operate under the respective brand. With respect to the Companys other three hotel properties, the management agreement for the Barceló Tucancun Beach
resort allows the hotel property to operate under the Barceló brand and The Churchill hotel and The Melrose hotel operate as independent hotels.

Property Improvement ReservesPursuant to its management, franchise and loan agreements, the Company is required to establish a property improvement reserve for each hotel to cover the cost of replacing
furniture, fixtures and equipment at the hotels. Contributions to the property improvement reserve are based on a percentage of gross revenues or receipts at each hotel. The Company is generally required to contribute between 3% and 5% of gross
revenues each month over the term of the agreements.

LitigationThe Company is not involved in any material litigation nor, to
its knowledge, is any material litigation threatened against the Company.



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##### Table of Contents

|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

Overview

Highland Hospitality Corporation is a
self-advised REIT that owns upscale full-service, premium limited-service, and extended-stay properties located in major convention, business, resort and airport markets in the United States and an all-inclusive resort property in Cancun, Mexico. We
commenced operations on December 19, 2003 when we completed our IPO and concurrently acquired our first three hotel properties. As of June 30, 2006, we owned the following 26 hotel properties:



|                                             |  |                |  |                       |  |                   
|-------------------------------------------- |  | -------------- |  | --------------------- |  | ------------------
|Property                                     |  | Number ofRooms |  | Location              |  | Acquired          
|Portsmouth Renaissance and Conference Center |  | 249            |  | Portsmouth, VA        |  | December 19, 2003 
|Sugar Land Marriott and Conference Center    |  | 300            |  | Sugar Land, TX        |  | December 19, 2003 
|Hilton Garden Inn Virginia Beach Town Center |  | 176            |  | Virginia Beach, VA    |  | December 19, 2003 
|Plaza San Antonio Marriott                   |  | 252            |  | San Antonio, TX       |  | December 29, 2003 
|Hyatt Regency Savannah                       |  | 351            |  | Savannah, GA          |  | December 30, 2003 
|Hilton Tampa Westshore                       |  | 238            |  | Tampa, FL             |  | January 8, 2004   
|Hilton Garden Inn BWI Airport                |  | 158            |  | Linthicum, MD         |  | January 12, 2004  
|Dallas/Fort Worth Airport Marriott           |  | 491            |  | Dallas/Fort Worth, TX |  | May 10, 2004      
|Residence Inn Tampa Downtown                 |  | 109            |  | Tampa, FL             |  | August 2, 2004    
|Courtyard Savannah Historic District         |  | 156            |  | Savannah, GA          |  | August 2, 2004    
|Hyatt Regency Wind Watch Long Island         |  | 358            |  | Hauppauge, NY         |  | August 19, 2004   
|Courtyard Boston Tremont                     |  | 315            |  | Boston, MA            |  | August 19, 2004   
|Crowne Plaza Atlanta-Ravinia                 |  | 495            |  | Atlanta, GA           |  | August 19, 2004   
|Hilton Parsippany                            |  | 509            |  | Parsippany, NJ        |  | August 19, 2004   
|Omaha Marriott                               |  | 299            |  | Omaha, NE             |  | September 15, 2004
|Courtyard Denver Airport                     |  | 202            |  | Denver, CO            |  | September 17, 2004
|Sheraton Annapolis                           |  | 196            |  | Annapolis, MD         |  | February 4, 2005  
|Barceló Tucancun Beach                       |  | 332            |  | Cancun, Mexico        |  | April 15, 2005    
|Wyndham Palm Springs                         |  | 410            |  | Palm Springs, CA      |  | July 14, 2005     
|Hilton Boston Back Bay                       |  | 385            |  | Boston, MA            |  | October 24, 2005  
|Westin Princeton at Forrestal Village        |  | 294            |  | Princeton, NJ         |  | November 15, 2005 
|The Churchill                                |  | 144            |  | Washington, DC        |  | December 9, 2005  
|Nashville Renaissance                        |  | 673            |  | Nashville, TN         |  | February 24, 2006 
|The Melrose                                  |  | 240            |  | Washington, DC        |  | March 15, 2006    
|Pointe Hilton Tapatio Cliffs                 |  | 585            |  | Phoenix, AZ           |  | March 16, 2006    
|Courtyard Gaithersburg Washingtonian Center  |  | 210            |  | Gaithersburg, MD      |  | June 1, 2006      
|                                             |  |                |  |                       |  |                   
|Total number of rooms                        |  | 8,127          |  |                       |  |                   
|                                             |  |                |  |                       |  |                   

Substantially all of our assets are held by, and all of our operations are conducted through,
Highland Hospitality, L.P. (our Operating Partnership). In order for us to qualify as a REIT, neither our company nor the Operating Partnership can operate hotels directly. Therefore, the Operating Partnership, which is owned
approximately 99% by us and approximately 1% by other limited partners, leases its hotels to subsidiaries of HHC TRS Holding Corporation (collectively, HHC TRS), which is a wholly owned subsidiary of the Operating Partnership. HHC TRS
then engages hotel management companies to operate the hotels pursuant to management contracts. HHC TRS is treated as a taxable REIT subsidiary for federal income tax purposes.

Key Operating Metrics

Hotel results of operations are best explained by three key performance
indicators: occupancy, average daily rate (ADR) and revenue per available room (RevPAR), which is room revenue divided by total number of room nights. RevPAR does not include food and beverage revenues or other ancillary
revenues, such as golf, telephone, parking or other guest services provided by the property.



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##### Table of Contents

Occupancy is a major driver of room revenue, as well as other revenue categories, such as food and
beverage and telephone. ADR helps to drive room revenue as well; however, it does not have a direct effect on other revenue categories. Fluctuations in occupancy are accompanied by fluctuations in most categories of variable operating costs, such as
utility costs and certain labor costs such as housekeeping, resulting in varying levels of hotel profitability. Increases in ADR typically result in higher hotel profitability since variable hotel expenses generally do not increase correspondingly.
Thus, increases in RevPAR attributable to increases in occupancy are accompanied by increases in most categories of variable operating costs, while increases in RevPAR attributable to increases in ADR are accompanied by increases in limited
categories of operating costs, such as management fees and franchise fees.

Executive Summary of Second Quarter Events

The lodging industry continued to demonstrate strong operating fundamentals during the second quarter 2006. According to Smith Travel Research
(STR), RevPAR industry wide in the United States increased 8.3% for the second quarter 2006, as compared to the second quarter 2005. Demand growth for hotel rooms continued to outpace supply growth. According to STR, for the second
quarter 2006 industry wide, demand for hotel rooms increased by 1.6% and supply growth increased 0.4%, as compared to the second quarter 2005. With demand growth expected to continue to outpace supply growth over the next several years, industry
occupancy should continue to move higher and position our industry for additional pricing power.

We were very pleased with our hotel
portfolio operating results during the second quarter 2006. For the third consecutive quarter, we achieved double-digit RevPAR growth in our comparable properties. For our U.S. hotel portfolio, RevPAR increased 10.8% in the second quarter 2006, as
compared to the second quarter 2005, and our comparable hotel portfolio RevPAR increased 10.6% for those same periods. In addition, for our U.S. hotel portfolio, operating income margins increased 330 basis points in the second quarter 2006, as
compared to the second quarter 2005, and our comparable hotel portfolio operating income margins increased 220 basis points for those same periods. This outstanding growth was driven by the Hyatt Regency Savannah hotel, the Crown Plaza
Atlanta-Ravinia hotel, and the Courtyard Boston Tremont hotel, where significant renovations were completed in 2005, as well as our recent acquisitions, including the Wyndham Palm Springs hotel, the Hilton Boston Back Bay hotel, and The Melrose
hotel. In fact, our noncomparable hotel portfolio, which consists of the seven hotels that we acquired in the second half of 2005 and first quarter 2006, generated a 460 basis point increase in hotel operating income margins in the second quarter
2006, as compared to the second quarter 2005, when the hotels were under previous ownership.

In the second quarter 2006, we acquired the
recently developed 210-room Courtyard Gaithersburg Washingtonian Center hotel in Gaithersburg, Maryland, for approximately $30.1 million. The hotel had been under a definitive agreement since June 2004. Given the robust turnaround in the lodging
industry over the last two years, we do not believe we could have acquired such a high-quality hotel in todays competitive environment. During the second quarter 2006, we also sold the Marriott Mount Laurel hotel for approximately $31.8
million, recording a gain on the sale of approximately $7.4 million. The sale of the Marriott Mount Laurel hotel provided us an opportunity to sell a non-strategic asset at a significant gain.

Now that the majority of our major renovations are behind us, we believe we have assembled a high-quality portfolio of assets that is well-positioned to
take advantage of a favorable lodging industry environment. Having said that, we will continue to maintain an active pipeline of investment opportunities and selectively acquire high-quality assets located in major, high barrier-to-entry markets
with strong current yields and solid bottom-line growth potential, while at the same time maintaining a prudent capital structure.



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##### Table of Contents

Results of Operations

Comparison of three months ended June 30, 2006 and 2005

On June 29, 2006, we sold the Marriott Mount
Laurel hotel in Mount Laurel, New Jersey for net sales proceeds of approximately $31.8 million and recognized a gain of approximately $7.4 million. The results of operations for the Marriott Mount Laurel hotel have been reclassified as discontinued
operations in the statements of operations for the three months ended June 30, 2006 and 2005.

Results of operations for the three
months ended June 30, 2006 include the operating activity of 25 hotels for a full quarter and two hotels for a partial quarter. Results of operations for the three months ended June 30, 2005 include the operating activity of 18 hotels for
a full quarter and one hotel for a partial quarter (see table above for hotel property acquisition dates). As such, comparisons of results of operations for the three months ended June 30, 2006 versus the three months ended June 30, 2005
are not meaningful.

RevenuesTotal revenue for the three months ended June 30, 2006 was $115.3 million, as compared to
$61.2 million for the comparable period in 2005. Total revenue for the three months ended June 30, 2006 included rooms revenue of $75.1 million, food and beverage revenue of $34.1 million, and other revenue of $6.1 million. Total revenue for
the three months ended June 30, 2005 included rooms revenue of $39.8 million, food and beverage revenue of $19.2 million, and other revenue of $2.2 million.

Included in the following table are comparisons of the key operating metrics for our hotel portfolio for the three months ended June 30, 2006 and 2005. The comparisons do not include the results of operations for
the Barceló Tucancun Beach resort, the recently sold Marriott Mount Laurel hotel or the newly developed Courtyard Gaithersburg Washingtonian Center hotel. Since seven of our hotels owned as of June 30, 2006 were acquired in the second
half of 2005 and first quarter 2006, the key operating metrics for the U.S. hotel portfolio reflect the results of operations of those seven hotels under previous ownership for the three months ended June 30, 2005.



|                                          |  |                             |   |                  |     |        |        |   |        |  |      |     |  |        |        |  |   |      
|----------------------------------------- |  | --------------------------- | - | ---------------- | --- | ------ | ------ | - | ------ |  | ---- | --- |  | ------ | ------ |  | - | -----
|                                          |  | Three Months Ended June 30,
|                                          |  | 2006                        |   | 2005 (Pro Forma)
|                                          |  | Occ %                       |   |                  | ADR |        | RevPAR |   | Occ %  |  |      | ADR |  | RevPAR
|U.S. Hotel Portfolio (24 hotels)          |  | 75.0                        | % |                  | $   | 145.70 |        | $ | 109.28 |  | 73.6 | %   |  | $      | 134.04 |  | $ | 98.62
|Comparable Hotel Portfolio (17 hotels)(1) |  | 73.3                        | % |                  | $   | 134.38 |        | $ | 98.46  |  | 71.4 | %   |  | $      | 124.65 |  | $ | 89.02

---

|(1) | Includes hotel properties owned on January 1, 2005, as well as the Sheraton Annapolis hotel acquired on February 4, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------

For the three months ended June 30, 2006, RevPAR for our U.S. hotel portfolio increased 10.8% to $109.28 from the comparable pro forma period in
2005. Occupancy increased by 1.4 percentage points to 75.0%, while ADR increased by 8.7% to $145.70. For our comparable hotel portfolio, RevPAR increased 10.6% to $98.46 from the comparable pro forma period in 2005. Occupancy increased by 1.9
percentage points to 73.3%, while ADR increased by 7.8% to $134.38. The increase in RevPAR for the second quarter 2006 versus the pro forma second quarter 2005 was largely a result of significant RevPAR increases at our hotels where major
renovations have been completed within the last 12 months, including the Hyatt Regency Savannah hotel, the Crown Plaza Atlanta-Ravinia hotel, and the Courtyard Boston Tremont hotel. In addition, the hotels that we acquired in the second half of 2005
and first quarter of 2006 contributed significantly to the RevPAR increase. We experienced double-digit RevPAR increases at the Wyndham Palm Springs hotel, the Hilton Boston Back Bay hotel, The Churchill hotel, and The Melrose hotel.

Hotel operating expensesHotel operating expenses, excluding depreciation and amortization, for the three months ended June 30, 2006
were $78.7 million, as compared to $42.8 million for the comparable period in 2005. Direct hotel operating expenses for the three months ended June 30, 2006 included rooms expenses of $15.8 million, food and beverage expenses of $21.6 million,
and other direct expenses of $3.0 million. Direct hotel operating expenses for the three months ended June 30, 2005 included rooms expenses of $8.3 million, food and beverage expenses of $11.7 million, and other direct expenses of $1.0 million.
Indirect hotel operating



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##### Table of Contents

expenses, which includes management and franchise fees, real estate taxes, insurance, utilities, repairs and maintenance, advertising and sales, and general
and administrative expenses, for the three months ended June 30, 2006 were $38.2 million, as compared to $21.7 million for the comparable period in 2005.

Hotel operating income and marginsIncluded in the following table are comparisons of hotel operating income (hotel revenues less hotel operating expenses) and hotel operating income margins (hotel
operating income divided by hotel revenues) for our hotel portfolio for the three months ended June 30, 2006 and 2005. The comparisons do not include the results of operations for the Barceló Tucancun Beach resort, the recently sold
Marriott Mount Laurel hotel or the newly developed Courtyard Gaithersburg Washingtonian Center hotel. Since seven of our hotels owned as of June 30, 2006 were acquired in the second half of 2005 and first quarter 2006, the hotel operating
income and hotel operating income margins for the U.S. hotel portfolio reflect the results of operations of those seven hotels under previous ownership for the three months ended June 30, 2005.



|                                          |  |                             |      |       |                  |   |       |   |       |  |      |  
|----------------------------------------- |  | --------------------------- | ---- | ----- | ---------------- | - | ----- | - | ----- |  | ---- | -
|                                          |  | Three Months Ended June 30, |     
|                                          |  | 2006                        |      |       | 2005 (Pro Forma) |  
|                                          |  | $ (1)                       |      | % (2) |                  |   | $ (1) |   | % (2) | 
|U.S. Hotel Portfolio (24 hotels)          |  | $                           | 36.2 |       | 32.0             | % |       | $ | 29.7  |  | 28.7 | %
|Comparable Hotel Portfolio (17 hotels)(3) |  | $                           | 20.6 |       | 32.1             | % |       | $ | 17.6  |  | 29.9 | %

---

|(1) | In millions.
|--- | ------------

|(2) | Percentage of hotel revenue.
|--- | ----------------------------

|(3) | Includes hotel properties owned on January 1, 2005, as well as the Sheraton Annapolis hotel acquired on February 4, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------

For the three months ended June 30, 2006, hotel operating income for our U.S. hotel portfolio increased 21.9% to $36.2 million from the comparable
pro forma period in 2005 and hotel operating income margins increased by 3.3 percentage points to 32.0%. For our comparable hotel portfolio, hotel operating income increased 17.2% to $20.6 million from the comparable pro forma period in 2005 and
hotel operating income margins increased by 2.2 percentage points to 32.1%. The significant increase in hotel operating income and margins for the second quarter 2006 versus the pro forma second quarter 2005 was largely a result of significant
operating income increases at the Hyatt Regency Savannah hotel, the Crown Plaza Atlanta-Ravinia hotel, the Sugar Land Marriott hotel, the Wyndham Palm Springs hotel, the Hilton Boston Back Bay hotel, the Courtyard Boston Tremont hotel, the Omaha
Marriott hotel, and The Melrose hotel.

Depreciation and amortizationDepreciation and amortization expense for the three
months ended June 30, 2006 was $11.1 million, as compared to $5.2 million for the comparable period in 2005. The increase in depreciation and amortization expense for the three months ended June 30, 2006 versus the comparable period in
2005 was directly attributable to the increase in investment in hotel properties during 2005 and 2006.

Corporate general and
administrativeTotal corporate general and administrative expenses for the three months ended June 30, 2006 was $3.9 million, as compared to $2.5 million for the comparable period in 2005. Included in corporate general and
administrative expenses for the three months ended June 30, 2006 and 2005 was $1.5 million and $0.9 million, respectively, of non-cash stock-based compensation expense. The increase in corporate general and administrative expenses is primarily
a result of an increase in corporate franchise tax expense, due to the mix of states that we own hotels in, an increase in employee salaries, and additional stock-based compensation expense related to restricted stock awards granted in May 2006.

Interest incomeInterest income for the three months ended June 30, 2006 and 2005 was $0.3 million and $0.2 million,
respectively.

Interest expenseInterest expense for the three months ended June 30, 2006 was $9.5 million, as compared to
$5.9 million for the comparable period in 2005. The increase in interest expense for the three months ended June 30, 2006 versus the comparable period in 2005 was directly attributable to the increase in long-term debt during 2005 and 2006.



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##### Table of Contents

Income tax expenseIncome tax expense for the three months ended June 30, 2006 and 2005
was $1.6 million and $1.0 million, respectively. Income tax expense resulted primarily from taxable operating income generated by our TRS for the three months ended June 30, 2006 and 2005.

Net incomeNet income for the three months ended June 30, 2006 was $18.2 million, as compared to $4.2 million for the comparable period
in 2005, due to the items discussed above.

Comparison of six months ended June 30, 2006 and 2005

On June 29, 2006, we sold the Marriott Mount Laurel hotel in Mount Laurel, New Jersey for net sales proceeds of approximately $31.8 million and
recognized a gain of approximately $7.4 million. The results of operations for the Marriott Mount Laurel hotel have been reclassified as discontinued operations in the statements of operations for the six months ended June 30, 2006 and 2005.

Results of operations for the six months ended June 30, 2006 include the operating activity of 22 hotels for a full six months and
five hotels for a partial six months. Results of operations for the six months ended June 30, 2005 include the operating activity of 17 hotels for a full six months and two hotels for a partial six months (see table above for hotel property
acquisition dates). As such, comparisons of results of operations for the six months ended June 30, 2006 versus the six months ended June 30, 2005 are not meaningful.

RevenuesTotal revenue for the six months ended June 30, 2006 was $200.8 million, as compared to $110.0 million for the comparable
period in 2005. Total revenue for the six months ended June 30, 2006 included rooms revenue of $131.6 million, food and beverage revenue of $58.9 million, and other revenue of $10.3 million. Total revenue for the six months ended June 30,
2005 included rooms revenue of $71.6 million, food and beverage revenue of $34.4 million, and other revenue of $4.0 million.

Included in
the following table are comparisons of the key operating metrics for our hotel portfolio for the six months ended June 30, 2006 and 2005. The comparisons do not include the results of operations for the Barceló Tucancun Beach resort, the
recently sold Marriott Mount Laurel hotel or the newly developed Courtyard Gaithersburg Washingtonian Center hotel. Since seven of our hotels owned as of June 30, 2006 were acquired in the second half of 2005 and first quarter 2006, the key
operating metrics for the U.S. hotel portfolio reflect the results of operations of those seven hotels under previous ownership for either a portion of, or the entire, six months ended June 30, 2005.



|                                          |  |                           |   |                  |     |        |        |   |        |  |      |     |  |        |        |  |   |      
|----------------------------------------- |  | ------------------------- | - | ---------------- | --- | ------ | ------ | - | ------ |  | ---- | --- |  | ------ | ------ |  | - | -----
|                                          |  | Six Months Ended June 30,
|                                          |  | 2006                      |   | 2005 (Pro Forma)
|                                          |  | Occ %                     |   |                  | ADR |        | RevPAR |   | Occ %  |  |      | ADR |  | RevPAR
|U.S. Hotel Portfolio (24 hotels)          |  | 73.1                      | % |                  | $   | 142.55 |        | $ | 104.24 |  | 70.7 | %   |  | $      | 130.41 |  | $ | 92.19
|Comparable Hotel Portfolio (17 hotels)(1) |  | 72.1                      | % |                  | $   | 131.63 |        | $ | 94.89  |  | 68.4 | %   |  | $      | 119.66 |  | $ | 81.82

---

|(1) | Includes hotel properties owned on January 1, 2005, as well as the Sheraton Annapolis hotel acquired on February 4, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------

For the six months ended June 30, 2006, RevPAR for our U.S. hotel portfolio increased 13.1% to $104.24 from the comparable pro forma period in 2005.
Occupancy increased by 2.4 percentage points to 73.1%, while ADR increased by 9.3% to $142.55. For our comparable hotel portfolio, RevPAR increased 16.0% to $94.89 from the comparable pro forma period in 2005. Occupancy increased by 3.7 percentage
points to 72.1%, while ADR increased by 10.0% to $131.63. The increase in RevPAR for the six months ended June 30, 2006 versus the six months ended June 30, 2005 was largely a result of significant RevPAR increases at our hotels where
major renovations have been completed within the last 12 months, including the Hyatt Regency Savannah hotel, the Crown Plaza Atlanta-Ravinia hotel, the Plaza San Antonio Marriott hotel, and the Courtyard Boston Tremont hotel. In addition, the hotels
that we acquired in the second half of 2005 and first quarter of 2006 contributed significantly to the RevPAR increase. We experienced double-digit RevPAR increases at the Wyndham Palm Springs hotel, the Hilton Boston Back Bay hotel, and The Melrose
hotel.



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##### Table of Contents

Hotel operating expensesHotel operating expenses, excluding depreciation and amortization,
for the six months ended June 30, 2006 were $139.2 million, as compared to $80.5 million for the comparable period in 2005. Direct hotel operating expenses for the six months ended June 30, 2006 included rooms expenses of $27.8 million,
food and beverage expenses of $38.0 million, and other direct expenses of $4.6 million. Direct hotel operating expenses for the six months ended June 30, 2005 included rooms expenses of $15.9 million, food and beverage expenses of $22.4
million, and other direct expenses of $2.0 million. Indirect hotel operating expenses, which includes management and franchise fees, real estate taxes, insurance, utilities, repairs and maintenance, advertising and sales, and general and
administrative expenses, for the six months ended June 30, 2006 were $68.9 million, as compared to $40.2 million for the comparable period in 2005.

Hotel operating income and marginsIncluded in the following table are comparisons of hotel operating income (hotel revenues less hotel operating expenses) and hotel operating income margins (hotel
operating income divided by hotel revenues) for our hotel portfolio for the six months ended June 30, 2006 and 2005. The comparisons do not include the results of operations for the Barceló Tucancun Beach resort, the recently sold
Marriott Mount Laurel hotel or the newly developed Courtyard Gaithersburg Washingtonian Center hotel. Since seven of our hotels owned as of June 30, 2006 were acquired in the second half of 2005 and first quarter 2006, the hotel operating
income and hotel operating income margins for the U.S. hotel portfolio reflect the results of operations of those seven hotels under previous ownership for either a portion of, or the entire, six months ended June 30, 2005.



|                                          |  |                           |      |       |                  |   |       |   |       |  |      |  
|----------------------------------------- |  | ------------------------- | ---- | ----- | ---------------- | - | ----- | - | ----- |  | ---- | -
|                                          |  | Six Months Ended June 30, |     
|                                          |  | 2006                      |      |       | 2005 (Pro Forma) |  
|                                          |  | $ (1)                     |      | % (2) |                  |   | $ (1) |   | % (2) | 
|U.S. Hotel Portfolio (24 hotels)          |  | $                         | 61.2 |       | 30.9             | % |       | $ | 48.0  |  | 27.1 | %
|Comparable Hotel Portfolio (17 hotels)(3) |  | $                         | 37.4 |       | 30.1             | % |       | $ | 28.8  |  | 26.6 | %

---

|(1) | In millions.
|--- | ------------

|(2) | Percentage of hotel revenue.
|--- | ----------------------------

|(3) | Includes hotel properties owned on January 1, 2005, as well as the Sheraton Annapolis hotel acquired on February 4, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------

For the six months ended June 30, 2006, hotel operating income for our U.S. hotel portfolio increased 27.4% to $61.2 million from the comparable pro
forma period in 2005 and hotel operating income margins increased by 3.8 percentage points to 30.9%. For our comparable hotel portfolio, hotel operating income increased 29.6% to $37.4 million from the comparable pro forma period in 2005 and hotel
operating income margins increased by 3.5 percentage points to 30.1%. The significant increase in hotel operating income and margins for the six months ended June 30, 2006 versus the six months ended June 30, 2005 was largely a result of
significant operating income increases at the Hyatt Regency Savannah hotel, the Crown Plaza Atlanta-Ravinia hotel, the Sugar Land Marriott hotel, the Wyndham Palm Springs hotel, the Hilton Boston Back Bay hotel, the Courtyard Boston Tremont hotel,
the Omaha Marriott hotel, and The Melrose hotel.

Depreciation and amortizationDepreciation and amortization expense for the
six months ended June 30, 2006 was $19.9 million, as compared to $9.8 million for the comparable period in 2005. The increase in depreciation and amortization expense for the six months ended June 30, 2006 versus the comparable period in
2005 was directly attributable to the increase in investment in hotel properties during 2005 and 2006.

Corporate general and
administrativeTotal corporate general and administrative expenses for the six months ended June 30, 2006 was $6.6 million, as compared to $5.1 million for the comparable period in 2005. Included in corporate general and administrative
expenses for the six months ended June 30, 2006 and 2005 was $2.3 million and $1.7 million, respectively, of non-cash stock-based compensation expense. The increase in corporate general and administrative expenses is primarily a result of an
increase in corporate franchise tax expense, due to the mix of states that we own hotels in, an increase in employee salaries, and additional stock-based compensation expense related to restricted stock awards granted in May 2006.



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##### Table of Contents

Interest incomeInterest income for the six months ended June 30, 2006 and 2005 was $1.0
million and $0.5 million, respectively.

Interest expenseInterest expense for the six months ended June 30, 2006 was
$17.7 million, as compared to $11.1 million for the comparable period in 2005. The increase in interest expense for the six months ended June 30, 2006 versus the comparable period in 2005 was directly attributable to the increase in long-term
debt during 2005 and 2006.

Income tax expenseIncome tax expense for the six months ended June 30, 2006 was $0.8 million,
as compared to an income tax benefit of $0.1 million for the comparable period in 2005. Income tax expense for the six months ended June 30, 2006 resulted primarily from taxable operating income generated by our TRS, whereas the income tax
benefit for the six months ended June 30, 2005 resulted from taxable operating losses incurred by our TRS.

Net incomeNet
income for the six months ended June 30, 2006 was $23.5 million, as compared to $4.2 million for the comparable period in 2005, due to the items discussed above.

Non-GAAP Financial Measures

Funds from operationsFunds from operations (FFO) available
to common stockholders is defined as net income (loss) available to common stockholders, excluding real estate related depreciation and amortization and discontinued operations. Historical cost accounting for real estate assets implicitly assumes
that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, most industry investors have considered presentations of results of operations for real
estate companies that use historical cost accounting to be insufficient by themselves. Accordingly, we believe that FFO available to common stockholders is a useful financial performance measure for investors and management because it provides
another indication of our performance, excluding real estate related depreciation and amortization and discontinued operations. The calculation of FFO available to common stockholders may vary from entity to entity, and as such, the presentation of
FFO available to common stockholders by us may not be comparable to FFO available to common stockholders reported by other REITs. The following is a reconciliation between net income (loss) available to common stockholders and FFO available to
common stockholders (in thousands):



|                                            |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  
|------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                            |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                            |  | 2006                       |        |   | 2005                     |   |       | 2006 |  |   | 2005   |  
|Net income available to common stockholders |  | $                          | 16,620 |   |                          | $ | 4,190 |      |  | $ | 20,337 |   |  | $ | 4,194  |  
|Adjustments: Depreciation and amortization  |  |                            | 11,103 |   |                          |   | 5,218 |      |  |   | 19,942 |   |  |   | 9,840  |  
|Loss (income) from hotel property sold      |  |                            | 14     |   |                          |   | (220  | )    |  |   | 365    |   |  |   | (70    | )
|Gain on sale of hotel property              |  |                            | (7,427 | ) |                          |   |      |      |  |   | (7,427 | ) |  |   |       |  
|                                            |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  
|FFO available to common stockholders        |  | $                          | 20,310 |   |                          | $ | 9,188 |      |  | $ | 33,217 |   |  | $ | 13,964 |  
|                                            |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  



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##### Table of Contents

EBITDAEBITDA is defined as net income (loss) before interest, income taxes, depreciation and
amortization. We believe it is a useful financial performance measure for investors and management because it provides an indication of the operating performance of our hotel properties and is not impacted by our capital structure. The following is
a reconciliation between net income (loss) and EBITDA (in thousands):



|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------ |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                           |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                           |  | 2006                       |        |   | 2005                     |   |        | 2006 |  |   | 2005   |  
|Net income                                 |  | $                          | 18,195 |   |                          | $ | 4,190  |      |  | $ | 23,487 |   |  | $ | 4,194  |  
|Adjustments: Depreciation and amortization |  |                            | 11,103 |   |                          |   | 5,218  |      |  |   | 19,942 |   |  |   | 9,840  |  
|Interest expense                           |  |                            | 9,507  |   |                          |   | 5,858  |      |  |   | 17,723 |   |  |   | 11,070 |  
|Interest income                            |  |                            | (327   | ) |                          |   | (201   | )    |  |   | (1,030 | ) |  |   | (518   | )
|Income tax expense (benefit)               |  |                            | 1,576  |   |                          |   | 1,022  |      |  |   | 762    |   |  |   | (103   | )
|Discontinued operations (1)                |  |                            | 41     |   |                          |   | 263    |      |  |   | 42     |   |  |   | 318    |  
|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|EBITDA                                     |  | $                          | 40,095 |   |                          | $ | 16,350 |      |  | $ | 60,926 |   |  | $ | 24,801 |  
|                                           |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  

---

|(1) | reflects depreciation and amortization, interest expense and income taxes included in discontinued operations.
|--- | --------------------------------------------------------------------------------------------------------------

Neither FFO available to common stockholders nor EBITDA represent cash generated from operating activities as determined by U.S. generally accepted
accounting principles (GAAP) and neither should be considered as an alternative to GAAP net income available to common stockholders, as an indication of our financial performance, or to cash flow from operating activities as determined
by GAAP, as a measure of liquidity. In addition, FFO available to common stockholders and EBITDA are not indicative of funds available to fund cash needs, including the ability to make cash distributions.

Sources and Uses of Cash

Our principal source of
cash to meet our operating requirements, including distributions to stockholders and repayments of indebtedness, is from our hotels results of operations. For the six months ended June 30, 2006, net cash provided by operating activities
was approximately $37.9 million. We currently expect that our operating cash flows will be sufficient to fund our continuing operations, including distributions to stockholders required to maintain our REIT status and our required debt service
obligations.

For the six months ended June 30, 2006, net cash used in investing activities was approximately $244.4 million,
including approximately $260.9 million to purchase the 673-room Nashville Renaissance hotel in Nashville, Tennessee, the 240-room Melrose hotel in Washington, DC, the 585-room Pointe Hilton Tapatio Cliffs resort and Lookout Mountain Golf Club in
Phoenix, Arizona, and the 210-room Courtyard Gaithersburg Washingtonian Center hotel. We also used approximately $27.9 million in improvements and additions to our hotel properties, the majority of which was used for major renovations taking place
at the Hilton Parsippany hotel, the Courtyard Boston Tremont hotel, the recently sold Marriott Mount Laurel hotel, and the Barceló Tucancun Beach resort. Offsetting the aforementioned cash outlays was approximately $31.8 million of net sales
proceeds received related to the sale of the Marriott Mount Laurel hotel on June 29, 2006.

For the six months ended June 30,
2006, net cash provided by financing activities was approximately $212.4 million. In March 2006, we completed an underwritten public offering and sold 7,300,000 shares of common stock, generating net proceeds after deducting underwriting discounts
and offering expenses of approximately $88.1 million. We also issued 621,942 shares of common stock as a result of our IPO underwriters exercise of warrants, generating proceeds of approximately $6.2 million. We generated $87 million from the
issuance of mortgage loans secured by the Westin Princeton at Forrestal Village hotel and the Nashville Renaissance hotel. In February 2006, we closed on an unsecured revolving credit facility and borrowed $100 million immediately to extinguish our
term loan facility. During the six months ended June 30, 2006, we borrowed another $46 million under the revolving credit facility to fund hotel acquisitions. We also used approximately $20.0 million to pay dividends to common and preferred
stockholders.



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##### Table of Contents

Liquidity and Capital Resources

As of June 30, 2006, we had cash and cash equivalents of approximately $70.6 million and restricted cash of approximately $18.1 million. On July 3, 2006, we used a portion of the proceeds from the sale of
the Marriott Mount Laurel hotel to pay down $25 million on our revolving credit facility. As of July 31, 2006, we had approximately $26 million of cash and cash equivalents and $29 million of remaining borrowing capacity under our $150 million
revolving credit facility. We have the ability to raise additional capital by either issuing mortgage loans on our unleveraged hotel properties or contributing them into the borrowing base of our revolving credit facility. We intend to invest our
remaining cash and cash equivalents and additional capacity under the revolving credit facility in hotel properties, either through planned renovations or new hotel acquisitions.

In October 2005, Hurricane Wilma made landfall in Cancun, Mexico causing substantial wind and water damage to the the Barceló Tucancun Beach
resort. After six months of restoration, the Barceló Tucancun Beach resort reopened for business on April 22, 2006. We have comprehensive insurance coverage for both property damage and business interruption. In February 2006 and April
2006, we received two separate advances on our insurance claim of $2 million. We are in the process of finalizing negotiations with our insurance carrier and expect to settle the claim in the third quarter 2006.

In December 2004, we filed a registration statement on Form S-3 with the Securities and Exchange Commission, registering equity securities with a maximum
aggregate offering price of up to $500 million. As of June 30, 2006, we had equity securities with a maximum aggregate offering price of approximately $213 million available to issue.

Capital Expenditures

We maintain each hotel in good
repair and condition and in conformity with applicable laws and regulations and in accordance with the franchisors standards and the agreed-upon requirements in our management agreements. The cost of all such routine improvements and
alterations will be paid out of a property improvement fund, which will be funded by a portion of hotel gross revenues. Routine capital expenditures will be administered by the management companies. However, we have approval rights over the capital
expenditures as part of the annual budget process.

From time-to-time, certain of our hotel properties may be undergoing renovations as a
result of our decision to upgrade portions of the hotels, such as guestrooms, meeting space, and/or restaurants, in order to better compete with other hotels in our markets. In addition, often after we acquire a hotel property, we are required to
complete a property improvement plan (PIP) in order to bring the hotel property up to the respective franchisors standards. If permitted by the terms of the management agreement, funding for a renovation will first come from the
property improvement fund. To the extent that the property improvement fund is not adequate to cover the cost of the renovation, we will fund the remaining portion of the renovation with cash and cash equivalents on hand.

Contractual Obligations

The following table sets
forth our contractual obligations as of June 30, 2006, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands). There were no other material off-balance sheet arrangements at
June 30, 2006.



|                                                  |  |                        |         |                   |   |                   |  |                    |         |                     |   |        |  |   |        
|------------------------------------------------- |  | ---------------------- | ------- | ----------------- | - | ----------------- |  | ------------------ | ------- | ------------------- | - | ------ |  | - | -------
|                                                  |  | Payments Due by Period
|Contractual Obligations                           |  | Total                  |         | Less ThanOne Year |   | One toThree Years |  | Three toFive Years |         | More ThanFive Years
|Ground and building leases (1)                    |  | $                      | 76,646  |                   | $ | 1,924             |  | $                  | 3,765   |                     | $ | 3,715  |  | $ | 67,242 
|Mortgage loans, including interest                |  |                        | 620,791 |                   |   | 34,825            |  |                    | 81,323  |                     |   | 69,848 |  |   | 434,795
|Mezzanine loan, including interest                |  |                        | 34,960  |                   |   | 2,411             |  |                    | 4,822   |                     |   | 4,822  |  |   | 22,905 
|Revolving credit facility, including interest (2) |  |                        | 175,561 |                   |   | 11,031            |  |                    | 164,530 |                     |   |       |  |   |       
|                                                  |  |                        |         |                   |   |                   |  |                    |         |                     |   |        |  |   |        
|                                                  |  | $                      | 907,958 |                   | $ | 50,191            |  | $                  | 254,440 |                     | $ | 78,385 |  | $ | 524,942
|                                                  |  |                        |         |                   |   |                   |  |                    |         |                     |   |        |  |   |        

---

|(1) | Included in the table are the base rent payments (i.e., minimum lease payments) due under our ground and building lease agreements. Additional and percentage rent payments are not
included in the table due to the uncertainty of the timing and amount of the payments in the future.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(2) | Assumes no additional borrowings under the revolving credit facility and interest payments based on the interest rate in effect as of June 30, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------

Inflation

Operators of hotels, in general,
possess the ability to adjust room rates daily to reflect the effects of inflation. However, competitive pressures may limit the ability of our management companies to raise room rates.

Seasonality

Demand in the lodging industry is affected by recurring seasonal patterns. For
non-resort properties, demand is generally lower in the winter months due to decreased travel and higher in the spring and summer months during the peak travel season. For resort properties, demand is generally higher in the winter months. We expect
that our operations will generally reflect non-resort seasonality patterns. Accordingly, we expect that we will have lower revenue, operating income and cash flow in the first and fourth quarters and higher revenue, operating income and cash flow in
the second and third quarters. These general trends are, however, expected to be greatly influenced by overall economic cycles.

Critical Accounting
Policies

We believe that the following critical accounting policies affect the most significant judgments and estimates used in the
preparation of our financial statements:

Investment in Hotel PropertiesInvestments in hotel properties are stated at
acquisition cost and allocated to land, property and equipment and identifiable intangible assets at fair value in accordance with Statement of Financial Accounting Standards No. 141, Business Combinations. Property and equipment are
recorded at fair value based on current replacement cost for similar capacity and allocated to buildings, improvements, furniture, fixtures and equipment using cost segregation studies performed by management and independent third parties. Property
and equipment are depreciated using the straight-line method over an estimated useful life of 15 to 40 years for buildings and improvements and three to ten years for furniture and equipment. Identifiable intangible assets are typically contracts,
including lease, management and franchise agreements, which are recorded at fair value. Above-market and below-market contract values are based on the present value of the difference between contractual amounts to be paid pursuant to the contracts
acquired and our estimate of the fair market contract rates for corresponding contracts measured over a period equal to the remaining non-cancelable term of the contract. Contracts acquired which are at market do not have significant value. An
existing management or franchise agreement is typically terminated at the time of acquisition and a new agreement is entered into based on then current market terms. Intangible assets are amortized using the straight-line method over the remaining
non-cancelable term of the related agreements. In making estimates of fair values for purposes of allocating purchase price, we may utilize a number of sources that may be obtained in connection with the acquisition or financing of a property and
other market data. Management also considers information obtained about each property as a result of its pre-acquisition due diligence in estimating the fair value of the tangible and intangible assets acquired.

We review our investments in hotel properties for impairment whenever events or changes in circumstances indicate that the carrying value of the
investments in hotel properties may not be recoverable. Events or circumstances that may cause us to perform our review include, but are not limited to, adverse changes in the demand for lodging at our properties due to declining national or local
economic conditions and/or new hotel construction in markets where our hotels are located. When such conditions exist, management performs an analysis to determine if the estimated undiscounted future cash flows from operations and the proceeds from
the ultimate disposition of an investment in a hotel property exceed the hotels carrying value. If the estimated undiscounted future cash flows are less than the carrying amount of the asset, an adjustment to reduce the carrying value to the
estimated fair market value is recorded and an impairment loss recognized.



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Revenue RecognitionHotel revenues, including room, food and beverage, and other hotel
revenues, are recognized as the related services are provided.

Income TaxesWe record a valuation allowance to reduce deferred
tax assets to an amount that we believe is more likely than not to be realized. Because of expected future taxable income of our TRS lessees, we have not recorded a valuation allowance to reduce our net deferred tax asset as of June 30, 2006.
Should our estimate of future taxable income be less than expected, we would record an adjustment to the net deferred tax asset in the period such determination was made.

New Accounting Pronouncements

FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48), prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. We
must determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. Once it is
determined that a position meets the more-likely-than-not recognition threshold, the position is measured to determine the amount of benefit to recognize in the financial statements. FIN 48 applies to all tax positions related to income taxes
subject to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. We will adopt the provisions of this interpretation beginning in the first quarter of 2007. The cumulative effect of applying the provisions of
FIN 48 will be reported as an adjustment to the opening balance of retained earnings on January 1, 2007. We do not anticipate that the adoption of FIN 48 will have a material effect on our results of operations, financial position, or cash
flows.

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and as such may involve known and unknown risks, uncertainties
and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which
are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words, such as intend, plan, may, should, will,
project, estimate, anticipate, believe, expect, continue, potential, opportunity, and similar expressions, whether in the negative or affirmative. All
statements regarding our expected financial position, business and financing plans are forward-looking statements. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:



| |  |  | United States economic conditions generally and the real estate market and the lodging industry specifically;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | management and performance of our hotels;
| | - |  | -----------------------------------------



| |  |  | our plans for renovation of our hotels;
| | - |  | ---------------------------------------



| |  |  | our financing plans;
| | - |  | --------------------



| |  |  | supply and demand for hotel rooms in our current and proposed market areas;
| | - |  | ---------------------------------------------------------------------------



| |  |  | our ability to acquire additional properties and the risk that potential acquisitions may not perform in accordance with expectations;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | legislative/regulatory changes, including changes to laws governing taxation of real estate investment trusts; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | our competition.
| | - |  | ----------------



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##### Table of Contents

These risks and uncertainties, together with the information contained in our Form 10-K filed with the
Securities and Exchange Commission on March 7, 2006 under the caption Risk Factors, should be considered in evaluating any forward-looking statement contained in this report or incorporated by reference herein. All forward-looking
statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to us or any person acting on our
behalf are qualified by the cautionary statements in this section. We undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of
this report, except as required by law.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

Interest Rate RiskWe are not significantly exposed to interest rate risk. As of June 30, 2006, $478.2 million or 75.3% of our $635.0 million of long-term debt was fixed. Another $61.0 million was
effectively fixed, as a result of interest rate swaps that fix the interest rates on our variable-rate mortgage loan and $50 million borrowed under our revolving credit facility. The remaining $96 million borrowed under our revolving credit facility
as of June 30, 2006 was variable.

Due to the fact that our portfolio of long-term debt is substantially comprised of fixed-rate
instruments, the fair value of the portfolio is relatively sensitive to effects of interest rate fluctuations. Assuming a hypothetical 10% decrease in interest rates, the fair value of our portfolio of long-term debt would increase by approximately
$16.4 million. Although a change in market interest rates impacts the fair value of our fixed-rate debt, it has no impact on interest expense incurred or cash flows.

With respect to our variable rate long-term debt, if market rates of interest on our variable long-term debt increase by 1%, the increase in interest expense on our variable long-term debt would decrease future
earnings and cash flows by approximately $1.0 million annually. On the other hand, if market rates of interest on our variable rate long-term debt decrease by 1%, the decrease in interest expense on our variable rate long-term debt would increase
future earnings and cash flows by approximately $1.0 million annually. This assumes that the amount outstanding under our revolving credit facility remains at $146 million, the balance at June 30, 2006, and we continue to fix the interest rate
on $50 million of the $146 million through the use of an interest rate swap.

Foreign Currency RiskWe are not significantly
exposed to foreign currency risk. The majority of revenue from operations at the Barceló Tucancun Beach resort are denominated in U.S. dollars and the majority of operating expenses are denominated in Mexican pesos. A hypothetical 10% change
in the exchange rate between the U.S. dollar and the Mexican peso would not have a material affect on our results of operations.



|Item 4. | Controls and Procedures
|------- | -----------------------

The
Chief Executive Officer and Chief Financial Officer of Highland Hospitality Corporation have evaluated the effectiveness of the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended (the Exchange Act)), as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act, and have concluded that as of the end of the period covered by this report, Highland Hospitality
Corporations disclosure controls and procedures were effective.

There was no change in Highland Hospitality Corporations
internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act during Highland Hospitality Corporations most recent fiscal quarter that
materially affected, or is reasonably likely to materially affect, Highland Hospitality Corporations internal control over financial reporting.



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##### Table of Contents

PART II



|Item 1. | Legal Proceedings
|------- | -----------------

We are not
involved in any material litigation nor, to our knowledge, is any material litigation threatened against us.



|Item 1A. | Risk Factors
|-------- | ------------

There have been no
material changes from the risk factors disclosed under the caption Risk Factors in the Companys Form 10-K for the year ended December 31, 2005.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

None.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

Not
applicable.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

(a)-(c) The 2006 annual meeting of stockholders of the Company was held on May 23, 2006. The matters on which the stockholders voted, in person or by proxy, were:



| | 1. | the election of eight incumbent directors for terms expiring in 2007;
| | -- | ---------------------------------------------------------------------



| | 2. | the ratification of the appointment of KPMG LLP as the Companys independent registered public accounting firm for 2006; and
| | -- | ----------------------------------------------------------------------------------------------------------------------------



| | 3. | the amendment and restatement of the 2003 Omnibus Stock Incentive Plan.
| | -- | -----------------------------------------------------------------------

All three matters were approved by the Companys stockholders. The results of the voting were as follows:

Election of Directors:



|                    |  |            |  |               
|------------------- |  | ---------- |  | --------------
|                    |  | Votes For  |  | Votes Withheld
|Bruce D. Wardinski  |  | 54,057,308 |  | 2,421,503     
|James L. Francis    |  | 54,060,914 |  | 2,417,897     
|John M. Elwood      |  | 54,934,543 |  | 1,544,268     
|W. Reeder Glass     |  | 53,531,319 |  | 2,947,492     
|John W. Hill        |  | 54,979,058 |  | 1,499,753     
|Thomas A. Natelli   |  | 55,129,398 |  | 1,349,413     
|Margaret A. Sheehan |  | 55,977,330 |  | 1,501,481     
|William L. Wilson   |  | 54,980,033 |  | 1,498,778     

Ratification of Appointment of Independent Registered Public Accounting Firm:



|           |  |               |  |                
|---------- |  | ------------- |  | ---------------
|Votes For  |  | Votes Against |  | Votes Abstained
|56,448,055 |  | 26,438        |  | 4,318          

Amendment and Restatement of 2003 Omnibus Stock Incentive Plan:



|           |  |               |  |                
|---------- |  | ------------- |  | ---------------
|Votes For  |  | Votes Against |  | Votes Abstained
|43,198,832 |  | 5,957,323     |  | 39,160         



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##### Table of Contents

|Item 5. | Other Information
|------- | -----------------

None.



|Item 6. | Exhibits
|------- | --------

The following exhibits are
filed as part of this Form 10-Q:



|              |  |                                                                                                                                                                                                                                                       
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                                                                
|3.1           |  | Amended and Restated Articles of Incorporation of Highland Hospitality Corporation (incorporated by reference to Exhibit 3.1 to the registrants Form 10-K for the year ended
December 31, 2003)                                                      
|              | 
|3.2           |  | Amended and Restated Bylaws of Highland Hospitality Corporation (incorporated by reference to Exhibit 3.2 to the registrants Form 10-K for the year ended December 31,
2003)                                                                         
|              | 
|3.3           |  | Second Amended and Restated Agreement of Limited Partnership of Highland Hospitality, L.P. (as amended through September 30, 2004) (incorporated by reference to Exhibit 3.3.1 to the
registrants Form 10-Q for the quarter ended September 30, 2004)
|              | 
|3.3.1         |  | First Amendment to the Second Amended and Restated Agreement of Limited Partnership of Highland Hospitality, L.P.                                                                                                                                     
|              | 
|3.3.2         |  | Second Amendment to the Second Amended and Restated Agreement of Limited Partnership of Highland Hospitality, L.P.                                                                                                                                    
|              | 
|3.3.3         |  | Third Amendment to the Second Amended and Restated Agreement of Limited Partnership of Highland Hospitality, L.P. (incorporated by reference to Exhibit 3.3 to the registrants Form 10-Q
for the quarter ended September 30, 2005)                   
|              | 
|3.3.4         |  | Fourth Amendment to the Second Amended and Restated Agreement of Limited Partnership of Highland Hospitality, L.P.                                                                                                                                    
|              | 
|10.1*         |  | Highland Hospitality Corporation Amended and Restated 2003 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the registrants Form 8-K dated May 23,
2006)                                                                   
|              | 
|10.2*         |  | Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 to the registrants Form 8-K dated May 23, 2006)                                                                                                                        
|              | 
|10.3.2*       |  | Second Amendment to Employment Agreement between Highland Hospitality Corporation and James L. Francis, dated as of May 23, 2006                                                                                                                      
|              | 
|10.4.2*       |  | Second Amendment to Employment Agreement between Highland Hospitality Corporation and Patrick W. Campbell, dated as of May 23, 2006                                                                                                                   
|              | 
|10.5.2*       |  | Second Amendment to Employment Agreement between Highland Hospitality Corporation and Tracy M.J. Colden, dated as of May 23, 2006                                                                                                                     
|              | 
|10.6.2*       |  | Second Amendment to Employment Agreement between Highland Hospitality Corporation and Douglas W. Vicari, dated as of May 23, 2006                                                                                                                     
|              | 
|12.1          |  | Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends                                                                                                                                                              
|              | 
|31.1          |  | Rule 13a-14(a)/15d-14(a) Certification of President and Chief Executive Officer                                                                                                                                                                       
|              | 
|31.2          |  | Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer                                                                                                                                                                                     
|              | 
|32.1          |  | Section 1350 Certification of President and Chief Executive Officer                                                                                                                                                                                   
|              | 
|32.2          |  | Section 1350 Certification of Chief Financial Officer                                                                                                                                                                                                 

---

|* | Denotes management contract or other compensatory plan or arrangement.
|- | ----------------------------------------------------------------------



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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                     |  |  |  |                                  |  |                          |  |                                                     
|-------------------- |  |  |  | -------------------------------- |  | ------------------------ |  | ----------------------------------------------------
|                     |  |  |  | HIGHLAND HOSPITALITY CORPORATION
|                     |  |  | 
|Date: August 8, 2006 |  |  |  | By:                              |  | /s/    DOUGLAS W. VICARI
|                     |  |  |  |                                  |  |                          |  | Douglas W. Vicari                                   
|                     |  |  |  |                                  |  |                          |  | Executive Vice President and Chief Financial Officer
|                     |  |  |  |                                  |  |                          |  | (Principal Financial and Accounting Officer)        



34