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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, 2005



OR



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



For the transition period fromto .



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



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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 an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange
Act of 1934).    Yes  x    No ̈



As of August 8, 2005, there were 40,073,151 shares of the registrants
common stock issued and outstanding.



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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 |  | 16  
|                                                                                              | 
|Item 3.
Quantitative and Qualitative Disclosures About Market Risk                            |  | 26  
|                                                                                              | 
|Item 4.
Controls and Procedures                                                               |  | 27  
|                                                                                             
|PART II                                                                                      
|                                                                                              | 
|Item 1.
Legal Proceedings                                                                     |  | 28  
|                                                                                              | 
|Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 28  
|                                                                                              | 
|Item 3.
Defaults Upon Senior Securities                                                       |  | 28  
|                                                                                              | 
|Item 4.
Submission of Matters to a Vote of Security Holders                                   |  | 28  
|                                                                                              | 
|Item 5.
Other Information                                                                     |  | 28  
|                                                                                              | 
|Item 6.
Exhibits                                                                              |  | 28  



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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, 2005 |         |   | December 31, 2004 |  
|                                                                                                                                                                 |  | (unaudited)   |         |   |                   |  
|ASSETS                                                                                                                                                           |  |               |         |   |                   |   |         |  
|Investment in hotel properties, net                                                                                                                              |  | $             | 644,526 |   |                   | $ | 578,715 |  
|Asset held for sale                                                                                                                                              |  |               | 3,000   |   |                   |   | 3,000   |  
|Deposits on hotel property acquisitions                                                                                                                          |  |               | 11,000  |   |                   |   | 8,714   |  
|Cash and cash equivalents                                                                                                                                        |  |               | 15,808  |   |                   |   | 75,481  |  
|Restricted cash                                                                                                                                                  |  |               | 26,165  |   |                   |   | 38,710  |  
|Accounts receivable, net of allowance for doubtful accounts of $163 and $133 at June 30, 2005 and December 31, 2004,
respectively                                |  |               | 13,157  |   |                   |   | 7,010   |  
|Prepaid expenses and other assets                                                                                                                                |  |               | 15,155  |   |                   |   | 8,279   |  
|Deposits on loan applications                                                                                                                                    |  |               | 1,034   |   |                   |   |        |  
|Deferred financing costs, net of accumulated amortization of $710 and $191 at June 30, 2005 and December 31, 2004,
respectively                                  |  |               | 4,341   |   |                   |   | 4,732   |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|Total assets                                                                                                                                                     |  | $             | 734,186 |   |                   | $ | 724,641 |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                             |  |               |         |   |                   |   |         |  
|Long-term debt                                                                                                                                                   |  | $             | 356,004 |   |                   | $ | 342,854 |  
|Accounts payable and accrued expenses                                                                                                                            |  |               | 19,298  |   |                   |   | 17,140  |  
|Dividends/distributions payable                                                                                                                                  |  |               | 5,726   |   |                   |   | 5,726   |  
|Other liabilities                                                                                                                                                |  |               | 2,985   |   |                   |   | 3,122   |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                |  |               | 384,013 |   |                   |   | 368,842 |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|Minority interest in operating partnership                                                                                                                       |  |               | 6,949   |   |                   |   | 8,321   |  
|Commitments and contingencies (Note 10)                                                                                                                          |  |               |         |   |                   |   |         |  
|                                                                                                                                                                 |  |              
|Preferred stock, $.01 par value; 100,000,000 shares authorized; no shares issued at June 30, 2005 and December 31, 2004                                          |  |               |        |   |                   |   |        |  
|Common stock, $.01 par value; 500,000,000 shares authorized; 40,154,699 shares and 40,002,011 shares issued at June 30, 2005 and December 31,
2004, respectively |  |               | 401     |   |                   |   | 400     |  
|Additional paid-in capital                                                                                                                                       |  |               | 368,191 |   |                   |   | 366,856 |  
|Treasury stock, at cost; 81,548 shares and 71,242 shares at June 30, 2005 and December 31, 2004, respectively                                                    |  |               | (912    | ) |                   |   | (801    | )
|Unearned compensation                                                                                                                                            |  |               | (4,636  | ) |                   |   | (6,182  | )
|Cumulative dividends in excess of net income                                                                                                                     |  |               | (19,820 | ) |                   |   | (12,795 | )
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|Total stockholders equity                                                                                                                                       |  |               | 343,224 |   |                   |   | 347,478 |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  
|Total liabilities and stockholders equity                                                                                                                       |  | $             | 734,186 |   |                   | $ | 724,641 |  
|                                                                                                                                                                 |  |               |         |   |                   |   |         |  



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



3



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION



CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                          |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                                                          |  | 2005                        |        |   | 2004                      |   |        | 2005 |  |   | 2004    |  
|REVENUE                                                                   |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Rooms                                                                     |  | $                           | 41,262 |   |                           | $ | 16,430 |      |  | $ | 73,896  |   |  | $ | 28,543 |  
|Food and beverage                                                         |  |                             | 19,769 |   |                           |   | 7,897  |      |  |   | 35,430  |   |  |   | 13,784 |  
|Other                                                                     |  |                             | 2,214  |   |                           |   | 927    |      |  |   | 4,080   |   |  |   | 1,661  |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Total revenue                                                             |  |                             | 63,245 |   |                           |   | 25,254 |      |  |   | 113,406 |   |  |   | 43,988 |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|EXPENSES                                                                  |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Hotel operating expenses:                                                 |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Rooms                                                                     |  |                             | 8,717  |   |                           |   | 3,518  |      |  |   | 16,625  |   |  |   | 6,090  |  
|Food and beverage                                                         |  |                             | 12,144 |   |                           |   | 5,740  |      |  |   | 23,100  |   |  |   | 10,488 |  
|Other direct                                                              |  |                             | 1,077  |   |                           |   | 594    |      |  |   | 2,083   |   |  |   | 1,077  |  
|Indirect                                                                  |  |                             | 22,405 |   |                           |   | 8,688  |      |  |   | 41,663  |   |  |   | 15,826 |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Total hotel operating expenses                                            |  |                             | 44,343 |   |                           |   | 18,540 |      |  |   | 83,471  |   |  |   | 33,481 |  
|Depreciation and amortization                                             |  |                             | 5,306  |   |                           |   | 2,132  |      |  |   | 10,014  |   |  |   | 3,726  |  
|Corporate general and administrative:                                     |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Stock-based compensation                                                  |  |                             | 884    |   |                           |   | 884    |      |  |   | 1,657   |   |  |   | 1,590  |  
|Other                                                                     |  |                             | 1,620  |   |                           |   | 1,472  |      |  |   | 3,431   |   |  |   | 2,963  |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Total operating expenses                                                  |  |                             | 52,153 |   |                           |   | 23,028 |      |  |   | 98,573  |   |  |   | 41,760 |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Operating income                                                          |  |                             | 11,092 |   |                           |   | 2,226  |      |  |   | 14,833  |   |  |   | 2,228  |  
|                                                                          |  |                             |        |  
|Interest income                                                           |  |                             | 201    |   |                           |   | 294    |      |  |   | 518     |   |  |   | 675    |  
|Interest expense                                                          |  |                             | 5,942  |   |                           |   | 336    |      |  |   | 11,217  |   |  |   | 646    |  
|Foreign currency exchange gain                                            |  |                             | 40     |   |                           |   |       |      |  |   | 40      |   |  |   |       |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Income before income taxes and minority interest in operating partnership |  |                             | 5,391  |   |                           |   | 2,184  |      |  |   | 4,174   |   |  |   | 2,257  |  
|                                                                          |  |                             |        |  
|Income tax benefit (expense)                                              |  |                             | (1,115 | ) |                           |   | 26     |      |  |   | 104     |   |  |   | 567    |  
|Minority interest in operating partnership                                |  |                             | (86    | ) |                           |   | (52    | )    |  |   | (84     | ) |  |   | (66    | )
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Net income                                                                |  | $                           | 4,190  |   |                           | $ | 2,158  |      |  | $ | 4,194   |   |  | $ | 2,758  |  
|                                                                          |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Earnings per share:                                                       |  |                             |        |   |                           |   |        |      |  |   |         |   |  |   |        |  
|Basic                                                                     |  | $                           | .10    |   |                           | $ | .05    |      |  | $ | .10     |   |  | $ | .07    |  
|Diluted                                                                   |  | $                           | .10    |   |                           | $ | .05    |      |  | $ | .10     |   |  | $ | .07    |  



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



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                                  |  |                           |         |   |      |   |          |  
|--------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | -------- | -
|                                                                                  |  | Six Months Ended June 30, |        
|                                                                                  |  | 2005                      |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                           |         |   |      |   |          |  
|Net income                                                                        |  | $                         | 4,194   |   |      | $ | 2,758    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |         |   |      |   |          |  
|Depreciation and amortization                                                     |  |                           | 10,014  |   |      |   | 3,726    |  
|Amortization of deferred financing costs                                          |  |                           | 519     |   |      |   |         |  
|Amortization of discount on mortgage loan                                         |  |                           | 36      |   |      |   |         |  
|Change in fair value of interest rate swap                                        |  |                           | (192    | ) |      |   |         |  
|Minority interest in income of operating partnership                              |  |                           | 84      |   |      |   | 66       |  
|Stock-based compensation                                                          |  |                           | 1,657   |   |      |   | 1,590    |  
|Changes in assets and liabilities:                                                |  |                           |         |   |      |   |          |  
|Accounts receivable, net                                                          |  |                           | (6,147  | ) |      |   | (1,508   | )
|Prepaid expenses and other assets                                                 |  |                           | (1,212  | ) |      |   | (2,283   | )
|Accounts payable and accrued expenses                                             |  |                           | 2,141   |   |      |   | 1,780    |  
|Payable to affiliates                                                             |  |                           |        |   |      |   | (1,193   | )
|                                                                                  |  |                           |         |   |      |   |          |  
|Net cash provided by operating activities                                         |  |                           | 11,094  |   |      |   | 4,936    |  
|                                                                                  |  |                           |         |   |      |   |          |  
|Cash flows from investing activities:                                             |  |                           |         |   |      |   |          |  
|Acquisition of hotel properties, net of cash acquired                             |  |                           | (50,275 | ) |      |   | (100,013 | )
|Payment of value-added taxes (VAT) related to foreign hotel acquisition           |  |                           | (3,509  | ) |      |   |         |  
|Deposits on hotel property acquisitions                                           |  |                           | (2,900  | ) |      |   | (11,950  | )
|Improvements and additions to hotel properties                                    |  |                           | (26,678 | ) |      |   | (1,089   | )
|Change in restricted cash                                                         |  |                           | 12,545  |   |      |   | (3,183   | )
|                                                                                  |  |                           |         |   |      |   |          |  
|Net cash used in investing activities                                             |  |                           | (70,817 | ) |      |   | (116,235 | )
|                                                                                  |  |                           |         |   |      |   |          |  
|Cash flows from financing activities:                                             |  |                           |         |   |      |   |          |  
|Payment of issuance costs related to sale of common stock                         |  |                           |        |   |      |   | (1,893   | )
|Payment of issuance costs related to Form S-3 registration statement              |  |                           | (341    | ) |      |   |         |  
|Purchase of treasury stock                                                        |  |                           | (111    | ) |      |   |         |  
|Proceeds from issuance of long-term debt                                          |  |                           | 15,000  |   |      |   |         |  
|Principal payments on long-term debt                                              |  |                           | (1,886  | ) |      |   |         |  
|Payment of deferred financing costs                                               |  |                           | (128    | ) |      |   |         |  
|Deposits on loan applications                                                     |  |                           | (1,034  | ) |      |   | (4,940   | )
|Payment of dividends to stockholders                                              |  |                           | (11,199 | ) |      |   |         |  
|Payment of distributions to minority interests                                    |  |                           | (251    | ) |      |   |         |  
|                                                                                  |  |                           |         |   |      |   |          |  
|Net cash provided by (used in) financing activities                               |  |                           | 50      |   |      |   | (6,833   | )
|                                                                                  |  |                           |         |   |      |   |          |  
|Net decrease in cash                                                              |  |                           | (59,673 | ) |      |   | (118,132 | )
|Cash and cash equivalents, beginning of period                                    |  |                           | 75,481  |   |      |   | 225,630  |  
|                                                                                  |  |                           |         |   |      |   |          |  
|Cash and cash equivalents, end of period                                          |  | $                         | 15,808  |   |      | $ | 107,498  |  
|                                                                                  |  |                           |         |   |      |   |          |  
|Supplemental disclosure of cash flow information:                                 |  |                           |         |   |      |   |          |  
|Cash paid for interest                                                            |  | $                         | 11,188  |   |      | $ | 646      |  
|Assumption of mortgage loan related to hotel acquisition                          |  |                           |        |   |      |   | 17,000   |  
|Issuance of Operating Partnership units in exchange for equity interests          |  |                           |        |   |      |   | 125      |  
|Issuance of restricted common stock to employees                                  |  |                           |        |   |      |   | 1,030    |  
|Issuance of unrestricted common stock to directors                                |  |                           | 110     |   |      |   | 129      |  
|Issuance of common stock related to redemption of 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 was incorporated in
Maryland in July 2003 to own upscale full-service, premium limited-service, and extended-stay properties located in major convention, business, resort and airport markets in the United States and all-inclusive resort properties in certain beachfront
destinations outside of the United States. The Company commenced operations on December 19, 2003 when it completed its initial public offering (IPO) and concurrently acquired three hotel properties. Since the IPO and the acquisition of
its first three hotel properties, the Company has acquired 16 hotel properties. As of June 30, 2005, the Company owned 19 hotel properties with 5,475 rooms located in 10 states 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 98% by the Company and approximately 2% 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, 2004.



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



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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, 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, 2005 and 2004.



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 operating results, 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 relating to hotel properties undergoing major renovations. Interest capitalized for the three and six months ended June 30, 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 the Companys common stock and after each purchase of
treasury



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##### Table of Contents

HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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.



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 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 (Loss) Per ShareBasic earnings (loss) per share is calculated by dividing net income (loss), less dividends on unvested restricted
common stock, by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is calculated by dividing net income (loss), 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 converted to common shares)
have been excluded from the diluted earnings (loss) per share calculation, as there would be no effect on reported diluted earnings (loss) per share.



Stock-Based CompensationThe Company accounts for stock-based employee compensation using the fair value based method of accounting described
in Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended. For restricted stock awards, the Company records unearned compensation equal to the number of shares awarded multiplied by the
average price of the Companys common stock on the date of the award, less the purchase price for the stock, if any. Unearned compensation is amortized using the straight-line method over the period in which the restrictions lapse (i.e.,
vesting period). For unrestricted stock awards, the Company records compensation expense on the date of the award equal to the number of shares awarded multiplied by the average price of the Companys common stock on the date of the award, less
the purchase price for the stock, if any.



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Comprehensive Income (Loss)Comprehensive income (loss), as defined, includes all changes
in equity (net assets) 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.



New Accounting PronouncementsStatement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment(SFAS
123R), requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. The statement requires a public entity to measure the cost of employee services received in exchange for an award of
equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is
recognized for equity instruments for which employees do not render the requisite service. The provisions of SFAS 123R will be effective as of January 1, 2006. Since the Company currently uses the fair value method of accounting for stock-based
compensation, the adoption of SFAS 123R is not expected to have a material effect on the Companys results of operations, financial position, or cash flows.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



3. Acquisition of Hotel Properties



During 2004, the Company acquired 12 hotel properties, consisting of 3,623 rooms, for an aggregate purchase price of
approximately $441.6 million, including the assumption of mortgage debt of approximately $28.3 million. The hotel acquisitions were funded with proceeds from the IPO, along with proceeds from the issuance of long-term debt during 2004. The hotel
properties acquired were:



|                                     |  |                |  |                       |  |                   
|------------------------------------ |  | -------------- |  | --------------------- |  | ------------------
|Property                             |  | Number ofRooms |  | Location              |  | Acquired          
|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 |  | 360            |  | Hauppauge, NY         |  | August 19, 2004   
|Courtyard Boston Tremont             |  | 322            |  | Boston, MA            |  | August 19, 2004   
|Crowne Plaza Atlanta-Ravinia         |  | 495            |  | Atlanta, GA           |  | August 19, 2004   
|Hilton Parsippany                    |  | 510            |  | Parsippany, NJ        |  | August 19, 2004   
|Radisson Mount Laurel                |  | 283            |  | Mount Laurel, NJ      |  | September 1, 2004 
|Omaha Marriott                       |  | 299            |  | Omaha, NE             |  | September 15, 2004
|Courtyard Denver Airport             |  | 202            |  | Denver, CO            |  | September 17, 2004
|                                     |  |                |  |                       |  |                   
|Total number of rooms                |  | 3,623          |  |                       |  |                   
|                                     |  |                |  |                       |  |                   



On February 4, 2005,
the Company acquired the 196-room Sheraton Annapolis hotel in Annapolis, Maryland for approximately $18.4 million. The entity that sold the hotel is owned 33.3% by Barceló Corporación Empresarial, S.A. (Barceló),
which is the parent company of Barceló Crestline Corporation (Barceló Crestline), which sponsored the Companys formation and IPO. In conjunction with the acquisition, the Company assumed a lease agreement for the land
underlying the hotel with an initial term ending September 2059. The Company concluded that the ground lease terms are below current market terms and recorded a $1.7 million favorable lease asset, which the Company is amortizing over the useful life
of the building. The Company entered into a long-term agreement with Crestline Hotels & Resorts, Inc. to manage the hotel property.



On April 15, 2005, the Company acquired the 332-room Tucancun Beach Resort and Villas in Cancun, Mexico for approximately $32.5 million. The Company
borrowed $15 million under its term loan facility to fund a portion of the acquisition. In conjunction with the acquisition of the Tucancun Beach Resort and Villas, the Company paid $3.5 million of value-added taxes (VAT). The Company has filed a
VAT refund request with the Mexican taxing authorities and recorded a $3.5 million receivable, which is included in prepaid expenses and other assets in the consolidated balance sheet. For Mexican property law purposes, legal title to the hotel is
held by J.P. Morgan S.A., in trust for the Company, as the sole beneficiary. As the sole beneficiary of such trust, the Company can lease the hotel or cause J.P. Morgan S.A. to transfer title to the hotel. The Company converted the Tucancun Beach
Resort and Villas to the Barceló brand and entered into long-term management and consulting agreements with separate subsidiaries of Barceló.



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



|                                      |  |                   |        |  
|------------------------------------- |  | ----------------- | ------ | -
|                                      |  | 2005 Acquisitions |       
|Land and land improvements            |  | $                 | 6,218  |  
|Buildings and leasehold improvements  |  |                   | 38,987 |  
|Furniture, fixtures and equipment     |  |                   | 4,100  |  
|Cash                                  |  |                   | 8      |  
|Prepaid assets and other assets       |  |                   | 1,809  |  
|Accounts payable and accrued expenses |  |                   | (167   | )
|                                      |  |                   |        |  
|Net assets acquired                   |  | $                 | 50,955 |  
|                                      |  |                   |        |  



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, 2005 and 2004 as if the Sheraton Annapolis hotel and Tucancun Beach Resort and Villas acquisitions, as well as the 12 hotel acquisitions that occurred in 2004, had taken place on January 1, 2004.
The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which would have actually occurred had the transactions taken place on January 1, 2004, or of future results of
operations (in thousands, except per share data).



|                         |  |                                         |        |                                       |   |        |  |      |         |  |   |        
|------------------------ |  | --------------------------------------- | ------ | ------------------------------------- | - | ------ |  | ---- | ------- |  | - | -------
|                         |  | (unaudited) Three Months Ended June 30, |        | (unaudited) Six Months Ended June 30,
|                         |  | 2005                                    |        | 2004                                  |   | 2005   |  | 2004
|Total revenue            |  | $                                       | 63,740 |                                       | $ | 63,198 |  | $    | 118,090 |  | $ | 118,730
|Total operating expenses |  |                                         | 52,533 |                                       |   | 52,426 |  |      | 101,644 |  |   | 102,669
|Operating income         |  |                                         | 11,207 |                                       |   | 10,772 |  |      | 16,446  |  |   | 16,061 
|Net income               |  |                                         | 4,258  |                                       |   | 5,098  |  |      | 5,275   |  |   | 5,294  
|Earnings per share:      |  |                                         |        |                                       |   |        |  |      |         |  |   |        
|Basic                    |  |                                         | .11    |                                       |   | .13    |  |      | .13     |  |   | .13    
|Diluted                  |  |                                         | .11    |                                       |   | .13    |  |      | .13     |  |   | .13    



4. Investment in Hotel Properties



Investment in hotel properties as of June 30, 2005 and
December 31, 2004 consisted of the following (in thousands):



|                                                |  |               |         |   |                   |   |         |  
|----------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | -
|                                                |  | June 30, 2005 |         |   | December 31, 2004 |  
|Land and land improvements                      |  | $             | 73,532  |   |                   | $ | 67,314  |  
|Buildings and leasehold improvements            |  |               | 539,673 |   |                   |   | 491,537 |  
|Furniture, fixtures and equipment               |  |               | 44,245  |   |                   |   | 29,336  |  
|Construction-in-progress                        |  |               | 11,112  |   |                   |   | 4,550   |  
|                                                |  |               |         |   |                   |   |         |  
|                                                |  |               | 668,562 |   |                   |   | 592,737 |  
|Less: accumulated depreciation and amortization |  |               | (24,036 | ) |                   |   | (14,022 | )
|                                                |  |               |         |   |                   |   |         |  
|                                                |  | $             | 644,526 |   |                   | $ | 578,715 |  
|                                                |  |               |         |   |                   |   |         |  



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



5. Long-Term Debt



In connection with the acquisition of the Hilton Parsippany hotel, the Crowne Plaza Atlanta-Ravinia hotel, the Hyatt Regency Wind Watch Long Island hotel,
and the Courtyard Boston Tremont hotel, the Company completed a $160 million financing, comprised of a $135 million mortgage loan and a $25 million mezzanine loan. The loan agreements contain a restrictive provision that requires the loan servicer
to retain in escrow excess cash flow from the encumbered hotel properties if net cash flow, as defined, for the trailing 12 months declines below a specified threshold. For the 12 months ended June 30, 2005, net cash flow from the four hotel
properties did not exceed the specified threshold. Accordingly, the loan servicer has the right to retain in escrow excess cash flow from the four hotel properties until the hotels generate the minimum cash flow required for three consecutive
months, at which time the cash being held in escrow will be released to the Company.



As of June 30, 2005, the Company was in compliance with the financial covenants contained in its other loan agreements.



On April 13, 2005, the Company borrowed $15 million under its term loan facility to fund a portion of the Barceló Tucancun Beach resort
acquisition. As of June 30, 2005, the Company had drawn down $65 million under the term loan facility.



6. Earnings Per Share



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



|                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|-------------------------------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                                               |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|                                                               |  | 2005                        |            |   | 2004                      |   |            | 2005 |  |   | 2004       |  
|Numerator:                                                     |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income                                                     |  | $                           | 4,190      |   |                           | $ | 2,158      |      |  | $ | 4,194      |   |  | $ | 2,758      |  
|Less: dividends on unvested restricted common stock            |  |                             | (86        | ) |                           |   | (116       | )    |  |   | (172       | ) |  |   | (116       | )
|                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income after dividends on unvested restricted common stock |  | $                           | 4,104      |   |                           | $ | 2,042      |      |  | $ | 4,022      |   |  | $ | 2,642      |  
|                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Denominator:                                                   |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average number of common shares outstandingbasic     |  |                             | 39,454,542 |   |                           |   | 39,084,890 |      |  |   | 39,415,855 |   |  |   | 39,082,449 |  
|Effect of dilutive securities:                                 |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Unvested restricted common stock                               |  |                             | 154,440    |   |                           |   | 160,290    |      |  |   | 124,400    |   |  |   | 180,003    |  
|Warrants                                                       |  |                             | 55,290     |   |                           |   | 50,598     |      |  |   | 51,611     |   |  |   | 95,612     |  
|                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average number of common shares outstandingdiluted   |  |                             | 39,664,272 |   |                           |   | 39,295,778 |      |  |   | 39,591,866 |   |  |   | 39,358,064 |  
|                                                               |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Earnings per share:                                            |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Basic                                                          |  | $                           | .10        |   |                           | $ | .05        |      |  | $ | .10        |   |  | $ | .07        |  
|Diluted                                                        |  | $                           | .10        |   |                           | $ | .05        |      |  | $ | .10        |   |  | $ | .07        |  



7. Cash Distributions



On December 15, 2004, the Companys board of
directors declared a cash distribution to stockholders of the Company and partners of the Operating Partnership of record as of December 31, 2004. The cash distribution of $.14 per common share and partnership unit was paid on January 14, 2005.



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



On March 10, 2005, the Companys board of directors declared a cash distribution to stockholders
of the Company and partners of the Operating Partnership of record as of March 31, 2005. The cash distribution of $.14 per common share and partnership unit was paid on April 15, 2005.



On May 19, 2005, the Companys board of directors declared a cash distribution to stockholders of the Company and
partners of the Operating Partnership of record as of June 30, 2005. The cash distribution of $.14 per common share and partnership unit was paid on July 15, 2005.



8. Capital Stock



Treasury StockFor the six months ended June 30, 2005, the Company purchased 10,306 shares 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 shares of the Companys common stock on a one-for-one basis or, at the option of the Company, 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.



In February 2005, a limited partner caused the Operating Partnership to redeem its units in exchange for 142,688 shares of the Companys common stock. As of June 30, 2005, the total number of Operating
Partnership units outstanding owned by third-party limited partners was 824,523.



9. Related-Party Transactions



On February 4,
2005, the Company acquired the 196-room Sheraton Annapolis hotel in Annapolis, Maryland for approximately $18.4 million. The entity that sold the hotel is owned 33.3% by Barceló Corporación Empresarial, S.A., which is the parent
company of Barceló Crestline Corporation, which sponsored the Companys formation and IPO.



Management AgreementsAs of June 30, 2005, 10 of the Companys 18 hotels operated pursuant to management agreements with Crestline Hotels
& Resorts, Inc., which is a wholly owned subsidiary of Barceló Crestline, each for a 10-year term. Crestline Hotels & Resorts 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 due annually in arrears within 105 days after the
end of each fiscal year and 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. Crestline Hotels & Resorts will not be entitled to receive any
incentive fee in any fiscal year in which the operating income of the hotel has not equaled at least 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 at 4.5% of gross revenues for each fiscal year.



For the three months ended June 30, 2005 and 2004, the Company paid Crestline Hotels & Resorts approximately $0.8 million and $0.3 million,
respectively, in management fees. For the six months ended June 30, 2005 and 2004, the Company paid Crestline Hotels & Resorts approximately $1.4 million and $0.6 million, respectively, in management fees.



As of June 30, 2005, the Barceló Tucancun Beach resort operated
pursuant to management and consulting agreements with separate subsidiaries of Barceló. 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



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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. Barceló will not be entitled to receive any incentive fee in any
fiscal year in which the operating income of the hotel has not equaled at least 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 months ended June 30, 2005, the Company paid separate
subsidiaries of Barceló approximately $70,000 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, 2005 and 2004, the Company paid Barceló Crestline approximately $66,000 and $70,000, respectively, under this arrangement. For the six months ended June 30,
2005 and 2004, the Company paid Barceló Crestline approximately $126,000 and $140,000, respectively, under this arrangement.



10. Commitments and Contingencies



Ground and Building LeasesThe Company leases the Portsmouth Renaissance hotel and adjoining conference center from the Industrial Development
Authority of the City of Portsmouth pursuant to two separate lease agreements, each for an initial term of 50 years 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 is equal to 100% of available net cash flow after payment of all hotel operating expenses, the base rent, real estate and property taxes, insurance and a cumulative priority annual return to the lessee 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 to an unrelated party, 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 from the Sugar Land Town Square Development Authority for a term of 99 years 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 and/or net sale proceeds for the
applicable year in excess of the amount of net cash flow and/or net sales proceeds that would be necessary to generate a cumulative internal rate of return of 15%.



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HIGHLAND HOSPITALITY CORPORATION



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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



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.



Management AgreementsAs of June 30, 2005, the Companys
hotel properties operated pursuant to long-term agreements with six management companies, including Crestline Hotels & Resorts, Inc. (10 hotels), Marriott International, Inc. (3 hotels), Hyatt Corporation (2 hotels), McKibbon Hotel Management,
Inc. (2 hotels), Sage Hospitality Resources (1 hotel), 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 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, 2005, 13 of the Companys 19 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. Five of the
Companys 19 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 Courtyard Boston Tremont hotel, and the Courtyard Denver Airport
hotel, are managed by Hyatt Corporation or Marriott International, Inc. The management agreements for these five hotel properties allow the hotel property to operate under the respective brand. The management agreement for the Barceló
Tucancun Beach resort allows the hotel property to operate under the Barceló brand.



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.



11. Subsequent Event



On July 14, 2005, the Company acquired the 410-room Wyndham Palm Springs hotel in Palm Springs, California for approximately $57.1 million. The Company
funded a portion of the acquisition with a $37 million financing secured by the Wyndham Palm Springs hotel. The loan bears a fixed annual interest rate of 5.35% and matures on August 1, 2012. On July 11, 2005, the Company borrowed $25 million under
its term loan facility, a portion of which was used to fund the Wyndham Palm Springs hotel acquisition. The Company entered into a long-term agreement with Crestline Hotels & Resorts, Inc. to manage the property under a Wyndham license
agreement.



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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 was incorporated in July 2003 to own upscale full-service, premium limited-service, and
extended-stay properties located in major convention, business, resort and airport markets in the United States and all-inclusive resort properties in certain beachfront destinations outside of the United States. We commenced operations on December
19, 2003 when we completed our IPO and concurrently acquired three hotel properties. Since the IPO and the acquisition of our first three hotel properties, we have acquired 16 hotel properties (not including the 410-room Wyndham Palm Springs hotel
acquired on July 14, 2005). As of June 30, 2005, we owned the following 19 hotel properties:



|                                             |  |                 |  |                       |  |                   
|-------------------------------------------- |  | --------------- |  | --------------------- |  | ------------------
|Property                                     |  | Number of Rooms |  | 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                       |  | 347             |  | 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         |  | 360             |  | Hauppauge, NY         |  | August 19, 2004   
|Courtyard Boston Tremont                     |  | 322             |  | Boston, MA            |  | August 19, 2004   
|Crowne Plaza Atlanta-Ravinia                 |  | 495             |  | Atlanta, GA           |  | August 19, 2004   
|Hilton Parsippany                            |  | 510             |  | Parsippany, NJ        |  | August 19, 2004   
|Radisson Mount Laurel                        |  | 283             |  | Mount Laurel, NJ      |  | September 1, 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    
|                                             |  |                 |  |                       |  |                   
|Total number of rooms                        |  | 5,475           |  |                       |  |                   
|                                             |  |                 |  |                       |  |                   



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 98% by us and approximately 2% 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 telephone, parking or other guest services provided by the property.



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



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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 2005. According to Smith Travel Research
(STR), RevPAR industry wide in the United States increased 8.3% for the three months ended June 30, 2005, as compared to the same period in 2004. For the second quarter 2005, demand growth for hotel rooms continued to outpace supply
growth. According to STR, for the three months ended June 30, 2005, demand for hotel rooms increased by 3.4% and supply growth increased 0.5%, as compared to the same period in 2004. With demand growth expected to continue to outpace supply
growth over the next couple of years, industry occupancy should continue to move higher and position our industry for additional pricing power.



As for our 18 hotels in the United States, we currently assess the performance of the portfolio based on two categories: stabilized hotels and
rebranded/renovated hotels. Rebranded/renovated includes hotels that are currently going through, or have recently gone through, significant renovation and/or in the process of changing their franchise affiliation. Stabilized includes hotels that
are not being disrupted by renovation or rebranding efforts. We were pleased with the performance of our 11 stabilized hotels in the second quarter 2005. RevPAR for the stabilized hotels increased 10.8% for the second quarter 2005 as compared to the
second quarter 2004. In addition, our stabilized hotels produced strong operating income during the second quarter 2005. Hotel operating income for our stabilized hotels increased 26.3% to $10.1 million in the second quarter 2005 as compared to the
second quarter 2004, and hotel operating income margin increased 4.0 percentage points to 32.4%. Much of the improvement in RevPAR and hotel operating income in the second quarter 2005 as compared to the second quarter 2004 was driven by the
Residence Inn Tampa Downtown hotel, the Hilton Tampa Westshore hotel, the Courtyard Denver Airport hotel, the Hilton Garden Inn Virginia Beach Town Center hotel, and the Sugar Land Marriott hotel.



As for our seven rebranded/renovated hotels, the significant renovation and
rebranding efforts that were in process during the second quarter 2005 adversely impacted our overall hotel portfolios results. RevPAR for the rebranded/renovated hotels decreased 7.5% during the second quarter 2005 as compared to the second
quarter 2004. Hotel operating income for the rebranded/renovated hotels decreased 15.8% to $8.0 million in the second quarter 2005 as compared to the second quarter 2004, and hotel operating income margin decreased 2.3 percentage points to 26.9%.
Although the rebranded/renovated hotels continue to be down from the comparable period in the prior year, we were pleased to see significant improvements in RevPAR and hotel operating income from the similar comparisons in the first quarter 2005.
Much of the improvement in RevPAR and hotel operating income in the second quarter 2005 from the first quarter 2005 was driven by improved results at the Plaza San Antonio Marriott hotel, where a major renovation was completed at the end of March
2005.



Other major renovations that were completed during the
second quarter 2005 were the guest room renovation at the Crowne Plaza Atlanta-Ravinia hotel and the guest room and lobby renovation at the Hyatt Regency Savannah hotel. In addition, in July 2005, our guest room, restaurant and lobby renovation at
the Hyatt Regency Wind Watch Long Island hotel was completed. Although the public space at the Crowne Plaza Atlanta-Ravinia hotel and the new junior ballroom, restaurant and lounge at the Hyatt Regency Savannah hotel will begin renovations in the
third quarter 2005, we expect to see improvements in these three hotels operating performance now that the guest room renovation disruptions have ended. The renovation activity at the Hilton Parsippany hotel, the Courtyard Boston Tremont
hotel, and the Radisson Mount Laurel hotel will continue to affect our financial results over the next several quarters. We believe that the renovation and rebranding efforts that continued to take place during the second quarter 2005 and will
continue over the next several quarters will position us well to take advantage of the continuing recovery in the lodging industry over the remainder of 2005 and into 2006 and 2007.



17



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##### Table of Contents

In April 2005, we acquired the Barceló Tucancun Beach resort in Cancun, Mexico, our first hotel
acquisition in Mexico. We were extremely pleased with the hotels operating results for the 75 days it contributed to our consolidated results for the second quarter 2005. The rebranding of the hotel and the efficient Barceló operating
model contributed to an increase in total revenues of 16.1% and hotel operating income of 42% in the second quarter 2005, as compared to the second quarter 2004.



In July 2005, we acquired our 20thhotel with the purchase of the Wyndham Palm Springs hotel for approximately $57.1 million. We continue to actively pursue investment opportunities in the United States, but will be prudent in spending
capital given the competitive hotel acquisition environment. We believe that our ability to leverage our strategic alliance with Barceló provides us with a competitive advantage in markets such as Mexico and the Caribbean and we will continue
to look for appropriate acquisitions in major resort locations.



Results of
Operations



Comparison of three months ended June 30, 2005
and 2004



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. Results of operations for the three months ended June 30, 2004 include the operating activity of seven 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, 2005 versus the three months ended June 30, 2004 are not meaningful
due to the lack of comparability.



RevenuesTotal
revenue for the three months ended June 30, 2005 was $63.2 million, as compared to $25.3 million for the comparable period in 2004. Total revenue for the three months ended June 30, 2005 included rooms revenue of $41.3 million, food and beverage
revenue of $19.8 million, and other revenue of $2.2 million. Total revenue for the three months ended June 30, 2004 included rooms revenue of $16.4 million, food and beverage revenue of $7.9 million, and other revenue of $0.9 million.



Included in the following table are the key operating metrics for our 18 U.S.
hotel properties for the three months ended June 30, 2005 and 2004. Since 13 of the 18 hotels owned as of June 30, 2005 were acquired at various times in 2004 and 2005, the key operating metrics for the aforementioned 13 hotels reflect the results
of operations of the hotels under previous ownership for either a portion of, or the entire, three months ended June 30, 2004. Management currently assesses the performance of its U.S. hotel portfolio based on two categories: stabilized and
rebranded/renovated. Rebranded/renovated includes hotels that are currently going through, or have recently gone through, significant renovation and/or in the process of changing their franchise affiliation. Stabilized includes hotels that are not
being disrupted by renovation or rebranding efforts.



|                                 |  |                             |   |      |     |        |        |   |       |  |      |     |  |        |        |  |   |      
|-------------------------------- |  | --------------------------- | - | ---- | --- | ------ | ------ | - | ----- |  | ---- | --- |  | ------ | ------ |  | - | -----
|                                 |  | Three Months Ended June 30,
|                                 |  | 2005                        |   | 2004
|                                 |  | Occ %                       |   |      | ADR |        | RevPAR |   | Occ % |  |      | ADR |  | RevPAR
|Stabilized (11 hotels)           |  | 77.7                        | % |      | $   | 118.68 |        | $ | 92.24 |  | 75.0 | %   |  | $      | 111.10 |  | $ | 83.28
|Rebranded/Renovated (7 hotels)   |  | 64.6                        | % |      | $   | 127.18 |        | $ | 82.12 |  | 74.3 | %   |  | $      | 119.52 |  | $ | 88.82
|U.S. Hotel Portfolio (18 hotels) |  | 71.1                        | % |      | $   | 122.56 |        | $ | 87.15 |  | 74.6 | %   |  | $      | 115.31 |  | $ | 86.06



For the three months
ended June 30, 2005, RevPAR for our stabilized hotels increased 10.8% to $92.24 from the comparable period in 2004. Occupancy increased by 2.7 percentage points to 77.7%, while ADR increased by 6.8%. For our rebranded/renovated hotels, RevPAR
decreased 7.5% to $82.12 from the comparable period in 2004. Occupancy decreased by 9.7 percentage points to 64.6%, while ADR increased by 6.4%. For our U.S. hotel portfolio of 18 hotels, RevPAR increased by 1.3% to $87.15 from the comparable period
in 2004. Occupancy decreased by 3.5 percentage points to 71.1%, while ADR increased by 6.3% to $122.56.



Hotel operating expensesHotel operating expenses, excluding depreciation and amortization, for the three months ended June 30, 2005 were
$44.3 million, as compared to $18.5 million for the comparable period in



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##### Table of Contents

2004. Direct hotel operating expenses for the three months ended June 30, 2005 included rooms expenses of $8.7 million, food and beverage expenses of $12.1
million, and other direct expenses of $1.1 million. Direct hotel operating expenses for the three months ended June 30, 2004 included rooms expenses of $3.5 million, food and beverage expenses of $5.7 million, and other direct expenses of $0.6
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 three months ended
June 30, 2005 were $22.4 million, as compared to $8.7 million for the comparable period in 2004.



Hotel operating income and marginIncluded in the following table is the hotel operating income (hotel revenues less hotel operating expenses)
and hotel operating income margin (hotel operating income divided by hotel revenues) for our 18 U.S. hotel properties for the three months ended June 30, 2005 and 2004. Since 13 of the 18 hotels owned as of June 30, 2005 were acquired at various
times in 2004 and 2005, the hotel operating income and hotel operating income margin for the aforementioned 13 hotels reflect the results of operations of the hotels under previous ownership for either a portion of, or the entire, three months ended
June 30, 2004.



|                                 |  |                             |      |   |      |   |       |   |      |  |      |  
|-------------------------------- |  | --------------------------- | ---- | - | ---- | - | ----- | - | ---- |  | ---- | -
|                                 |  | Three Months Ended June 30, |     
|                                 |  | 2005                        |      |   | 2004 |  
|                                 |  | $ (1)                       |      | % |      |   | $ (1) |   | %    | 
|Stabilized (11 hotels)           |  | $                           | 10.1 |   | 32.4 | % |       | $ | 8.0  |  | 28.4 | %
|Rebranded/Renovated (7 hotels)   |  | $                           | 8.0  |   | 26.9 | % |       | $ | 9.5  |  | 29.2 | %
|U.S. Hotel Portfolio (18 hotels) |  | $                           | 18.1 |   | 29.7 | % |       | $ | 17.5 |  | 28.8 | %

---

|(1) | in millions
|--- | -----------



For the three months ended June 30, 2005, hotel operating income for our stabilized hotels increased 26.3% to $10.1 million from the comparable period in 2004 and hotel operating income margin increased by 4.0
percentage points to 32.4%. For our rebranded/renovated hotels, hotel operating income decreased 15.8% to $8.0 million from the comparable period in 2004 and hotel operating income margin decreased by 2.3 percentage points to 26.9%. For our U.S.
hotel portfolio of 18 hotels, hotel operating income increased by 3.4% to $18.1 million from the comparable period in 2004 and hotel operating income margin increased by 0.9 percentage points to 29.7%.



Depreciation and amortizationDepreciation and amortization
expense for the three months ended June 30, 2005 was $5.3 million, as compared to $2.1 million for the comparable period in 2004.



Corporate general and administrativeTotal corporate general and administrative expenses for the three months ended June 30, 2005 were $2.5
million, as compared to $2.4 million for the comparable period in 2004. Included in corporate general and administrative expenses for the three months ended June 30, 2005 and 2004 was $0.9 million of non-cash stock-based compensation expense.



Interest incomeInterest income for the three
months ended June 30, 2005 and 2004 was $0.2 million and $0.3 million, respectively.



Interest expenseInterest expense for the three months ended June 30, 2005 was $5.9 million, as compared to $0.3 million for the comparable period in 2004. As of June 30, 2005, our weighted average
interest rate on our long-term debt was 6.35%.



Income tax
expenseIncome tax expense for the three months ended June 30, 2005 was $1.1 million, as compared to an income tax benefit of $26,000 for the comparable period in 2004. Income tax expense for the three months ended June 30, 2005 resulted
primarily from taxable operating income incurred by our TRS, whereas the income tax benefit for the three months ended June 30, 2004 resulted from taxable operating losses incurred by our TRS.



Net incomeNet income for the three months ended June 30, 2005
was $4.2 million, as compared to $2.2 million for the comparable period in 2004, due to the items discussed above.



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##### Table of Contents

Comparison of six months ended June 30, 2005 and 2004



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. Results of operations for the six months ended June 30, 2004 include the operating activity of five hotels for a full six months and three 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, 2005 versus the six months ended June 30, 2004 are not meaningful due to the lack of
comparability.



RevenuesTotal revenue for the six
months ended June 30, 2005 was $113.4 million, as compared to $44.0 million for the comparable period in 2004. Total revenue for the six months ended June 30, 2005 included rooms revenue of $73.9 million, food and beverage revenue of $35.4 million,
and other revenue of $4.1 million. Total revenue for the six months ended June 30, 2004 included rooms revenue of $28.5 million, food and beverage revenue of $13.8 million, and other revenue of $1.7 million.



Included in the following table are the key operating metrics for our 18 U.S.
hotel properties for the six months ended June 30, 2005 and 2004. Since 13 of the 18 hotels owned as of June 30, 2005 were acquired at various times in 2004 and 2005, the key operating metrics for the aforementioned 13 hotels reflect the results of
operations of the hotels under previous ownership for either a portion of, or the entire, six months ended June 30, 2004.



|                                 |  |                           |   |      |     |        |        |   |       |  |      |     |  |        |        |  |   |      
|-------------------------------- |  | ------------------------- | - | ---- | --- | ------ | ------ | - | ----- |  | ---- | --- |  | ------ | ------ |  | - | -----
|                                 |  | Six Months Ended June 30,
|                                 |  | 2005                      |   | 2004
|                                 |  | Occ %                     |   |      | ADR |        | RevPAR |   | Occ % |  |      | ADR |  | RevPAR
|Stabilized (11 hotels)           |  | 76.2                      | % |      | $   | 115.37 |        | $ | 87.87 |  | 72.9 | %   |  | $      | 108.72 |  | $ | 79.22
|Rebranded/Renovated (7 hotels)   |  | 59.5                      | % |      | $   | 121.18 |        | $ | 72.13 |  | 69.4 | %   |  | $      | 116.24 |  | $ | 80.68
|U.S. Hotel Portfolio (18 hotels) |  | 67.7                      | % |      | $   | 117.96 |        | $ | 79.90 |  | 71.1 | %   |  | $      | 112.44 |  | $ | 79.96



For the six months
ended June 30, 2005, RevPAR for our stabilized hotels increased 10.9% to $87.87 from the comparable period in 2004. Occupancy increased by 3.3 percentage points to 76.2%, while ADR increased by 6.1%. For our rebranded/renovated hotels, RevPAR
decreased 10.6% to $72.13 from the comparable period in 2004. Occupancy decreased by 9.9 percentage points to 59.5%, while ADR increased by 4.2%. For our U.S. hotel portfolio of 18 hotels, RevPAR decreased by 0.1% to $79.90 from the comparable
period in 2004. Occupancy decreased by 3.4 percentage points to 67.7%, while ADR increased by 4.9% to $117.96.



Hotel operating expensesHotel operating expenses, excluding depreciation and amortization, for the six months ended June 30, 2005 were $83.5
million, as compared to $33.5 million for the comparable period in 2004. Direct hotel operating expenses for the six months ended June 30, 2005 included rooms expenses of $16.6 million, food and beverage expenses of $23.1 million, and other direct
expenses of $2.1 million. Direct hotel operating expenses for the six months ended June 30, 2004 included rooms expenses of $6.1 million, food and beverage expenses of $10.5 million, and other direct expenses of $1.1 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, 2005 were $41.7
million, as compared to $15.8 million for the comparable period in 2004.



20



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##### Table of Contents

Hotel operating income and marginIncluded in the following table is the hotel operating
income (hotel revenues less hotel operating expenses) and hotel operating income margin (hotel operating income divided by hotel revenues) for our 18 U.S. hotel properties for the six months ended June 30, 2005 and 2004. Since 13 of the 18 hotels
owned as of June 30, 2005 were acquired at various times in 2004 and 2005, the hotel operating income and hotel operating income margin for the aforementioned 13 hotels reflect the results of operations of the hotels under previous ownership for
either a portion of, or the entire, six months ended June 30, 2004.



|                                 |  |                           |      |   |      |   |       |   |      |  |      |  
|-------------------------------- |  | ------------------------- | ---- | - | ---- | - | ----- | - | ---- |  | ---- | -
|                                 |  | Six Months Ended June 30, |     
|                                 |  | 2005                      |      |   | 2004 |  
|                                 |  | $ (1)                     |      | % |      |   | $ (1) |   | %    | 
|Stabilized (11 hotels)           |  | $                         | 17.9 |   | 30.8 | % |       | $ | 14.0 |  | 26.2 | %
|Rebranded/Renovated (7 hotels)   |  | $                         | 11.2 |   | 21.2 | % |       | $ | 14.7 |  | 24.7 | %
|U.S. Hotel Portfolio (18 hotels) |  | $                         | 29.1 |   | 26.2 | % |       | $ | 28.7 |  | 25.5 | %

---

|(1) | in millions
|--- | -----------



For the six months ended June 30, 2005, hotel operating income for our stabilized hotels increased 27.9% to $17.9 million from the comparable period in 2004 and hotel operating income margin increased by 4.6
percentage points to 30.8%. For our rebranded/renovated hotels, hotel operating income decreased 23.8% to $11.2 million from the comparable period in 2004 and hotel operating income margin decreased by 3.5 percentage points to 21.2%. For our U.S.
hotel portfolio of 18 hotels, hotel operating income increased by 1.4% to $29.1 million from the comparable period in 2004 and hotel operating income margin increased by 0.7 percentage points to 26.2%.



Depreciation and amortizationDepreciation and amortization
expense for the six months ended June 30, 2005 was $10.0 million, as compared to $3.7 million for the comparable period in 2004.



Corporate general and administrativeTotal corporate general and administrative expenses for the six months ended June 30, 2005 were $5.1
million, as compared to $4.6 million for the comparable period in 2004. Included in corporate general and administrative expenses for the six months ended June 30, 2005 and 2004 was $1.7 million and $1.6 million, respectively, of non-cash
stock-based compensation expense.



Interest
incomeInterest income for the six months ended June 30, 2005 and 2004 was $0.5 million and $0.7 million, respectively.



Interest expenseInterest expense for the six months ended June 30, 2005 was $11.2 million, as compared to $0.6 million for the comparable
period in 2004.



Income tax benefitIncome tax
benefit for the six months ended June 30, 2005 was $0.1 million, as compared to $0.6 million for the comparable period in 2004. The income tax benefits resulted primarily from taxable operating losses incurred by our TRS for the six months ended
June 30, 2005 and 2004.



Net incomeNet income for
the six months ended June 30, 2005 was $4.2 million, as compared to $2.8 million for the comparable period in 2004, due to the items discussed above.



Non-GAAP Financial Measures



Funds from operationsFunds from operations, or FFO, is defined as net income (loss), plus real estate related depreciation and amortization.
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 operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Accordingly, we believe that FFO is a useful financial performance measure for investors and
management because it provides another indication of our performance prior to deduction of real estate related depreciation and amortization. The



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##### Table of Contents

calculation of FFO may vary from entity to entity, and as such, the presentation of FFO by us may not be comparable to FFO reported by other REITs. The
following is a reconciliation between net income and FFO (in thousands):



|                                          |  |                             |       |                           |   |       |  |      |        |  |   |      
|----------------------------------------- |  | --------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ------ |  | - | -----
|                                          |  | Three Months Ended June 30, |       | Six Months Ended June 30,
|                                          |  | 2005                        |       | 2004                      |   | 2005  |  | 2004
|Net income                                |  | $                           | 4,190 |                           | $ | 2,158 |  | $    | 4,194  |  | $ | 2,758
|Adjustment: Depreciation and amortization |  |                             | 5,306 |                           |   | 2,132 |  |      | 10,014 |  |   | 3,726
|                                          |  |                             |       |                           |   |       |  |      |        |  |   |      
|FFO                                       |  | $                           | 9,496 |                           | $ | 4,290 |  | $    | 14,208 |  | $ | 6,484
|                                          |  |                             |       |                           |   |       |  |      |        |  |   |      



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 the capital structure of the REIT. The following is a reconciliation between net income and EBITDA (in thousands):



|             |  |                               |        |                             |       |   |                           |  |       |      |        |  |        |   |       |  |       |  
|------------ |  | ----------------------------- | ------ | --------------------------- | ----- | - | ------------------------- |  | ----- | ---- | ------ |  | ------ | - | ----- |  | ----- | -
|             |  |                               |        | Three Months Ended June 30, |       |   | Six Months Ended June 30, | 
|             |  |                               |        | 2005                        |       |   | 2004                      |  |       | 2005 |        |  | 2004   |  
|Net income   |  | $                             | 4,190  |                             |       | $ | 2,158                     |  |       | $    | 4,194  |  |        | $ | 2,758 | 
|Adjustments: |  | Depreciation and amortization |        |                             | 5,306 |   |                           |  | 2,132 |      |        |  | 10,014 |   |       |  | 3,726 |  
|             |  | Interest expense              |        |                             | 5,942 |   |                           |  | 336   |      |        |  | 11,217 |   |       |  | 646   |  
|             |  | Interest income               |        |                             | (201  | ) |                           |  | (294  | )    |        |  | (518   | ) |       |  | (675  | )
|             |  | Income tax expense (benefit)  |        |                             | 1,115 |   |                           |  | (26   | )    |        |  | (104   | ) |       |  | (567  | )
|             |  |                               |        |                             |       |   |                           |  |       |      |        |  |        |   |       |  |       |  
|EBITDA       |  | $                             | 16,352 |                             |       | $ | 4,306                     |  |       | $    | 24,803 |  |        | $ | 5,888 | 
|             |  |                               |        |                             |       |   |                           |  |       |      |        |  |        |   |       |  |       |  



Neither FFO 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, 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 and EBITDA are not indicative of funds available to fund cash needs, including the ability to make cash distributions.



Liquidity and Capital Resources



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, 2005, net cash provided by operating activities was $11.1 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, 2005, net cash used in investing activities was $70.8 million, including $50.3 million to
purchase the Sheraton Annapolis hotel and the Tucancun Beach Resort and Villas. In conjunction with the acquisition of the Tucancun Beach Resort and Villas, we paid $3.5 million of value-added taxes (VAT). We have filed a VAT refund request with the
Mexican taxing authorities and expect to receive the cash back in the late third quarter or early fourth quarter 2005. We used $26.7 million in improvements and additions to our hotel properties, the majority of which was used for the major
renovations taking place at seven of our hotel properties. We received a net $12.5 million from our restricted cash escrow accounts. The majority of the $12.5 million cash inflow related to reimbursements from one of our loan servicers that required
us to escrow $27.5 million for renovations on the hotels that secure the lending.



For the six months ended June 30, 2005, net cash flows from financing activities were negligible. We used $11.5 million to pay dividends and distributions to stockholders and holders of Operating Partnership units,
$1.9 million to make principal payments on our long-term debt and $1.0 million for deposits on loan applications. The



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net cash used in financing activities was generally offset by an additional $15 million borrowing under our term loan facility, which was used to fund a
portion of the Tucancun Beach Resort and Villas acquisition.



On March 17, 2005, we entered into a sales agreement with Brinson Patrick Securities Corporation in connection with the proposed public offering from time to time of up to 3,000,000 shares of our common stock. No sales of common stock have
taken place to-date.



As of June 30, 2005, we had cash and cash
equivalents of $15.8 million and restricted cash of $26.2 million. On July 14, 2005, we used approximately $17 million to acquire the 410-room Wyndham Palm Springs hotel in Palm Springs, California. We funded a portion of the acquisition with a $37
million secured loan. The loan bears a fixed annual interest rate of 5.35% and matures on August 1, 2012. In addition, on July 11, 2005, we borrowed $25 million under our term loan facility, a portion of which was used to fund the acquisition. As of
July 31, 2005, we had $10 million of borrowing capacity under the term loan facility. We intend to invest our remaining cash and cash equivalents and additional capacity under the term loan facility in hotel properties, either through planned
renovations or new hotel acquisitions.



In connection with the
acquisition of the Hilton Parsippany hotel, the Crowne Plaza Atlanta-Ravinia hotel, the Hyatt Regency Wind Watch Long Island hotel, and the Courtyard Boston Tremont hotel, we completed a $160 million financing, comprised of a $135 million mortgage
loan and a $25 million mezzanine loan. The loan agreements contain a restrictive provision that requires the loan servicer to retain in escrow excess cash flow from the encumbered hotel properties if net cash flow, as defined, for the trailing 12
months declines below a specified threshold. For the 12 months ended June 30, 2005, net cash flow from the four hotel properties did not exceed the specified threshold. The loan servicer has the right to retain in escrow excess cash flow from the
four hotel properties until the hotels generate the minimum cash flow required for three consecutive months, at which time the cash being held in escrow will be released to us. Should the loan servicer retain excess cash flows from the four hotel
properties, we do not expect it to have a significant impact on our ability to continue to service debt, pay dividends to stockholders, or acquire additional hotel properties.



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 maintenance, repairs and alterations will be paid out of a property improvement fund, which will be funded by a portion of hotel gross revenues.
Routine repairs and maintenance will be administered by the management companies. However, we have approval rights over capital expenditures.



At the end of March 2005, we completed a guest room and lobby renovation at the Plaza San Antonio Marriott hotel. During the second quarter 2005, we
completed a guest room renovation at the Crowne Plaza Atlanta-Ravinia hotel and a guest room and lobby renovation at the Hyatt Regency Savannah hotel. In July 2005, we completed a guest room, restaurant and lobby renovation at the Hyatt Regency Wind
Watch Long Island hotel. Major renovation projects at five of our hotel properties will continue during the remainder of 2005 and into early 2006. These projects include: a public space renovation at the Crowne Plaza Atlanta-Ravinia hotel;
a junior ballroom, restaurant and lounge renovation at the Hyatt Regency Savannah hotel; a guest room, lobby and restaurant renovation at the Courtyard Boston Tremont hotel; a guest room, lobby, restaurant and ballroom renovation at the Hilton
Parsippany hotel; and a guest room, restaurant, bar and lobby renovation at the Radisson Mount Laurel hotel.



We expect to spend approximately $60 million on the renovations at the seven hotel properties, of which approximately $28 million had been spent through
June 30, 2005. For the three and six months ended June 30, 2005, we spent approximately $9 million and $23.5 million, respectively, on the renovations. We expect that the majority of the remaining cash will be committed or spent by the end of 2005.



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Contractual Obligations



The following table sets forth our contractual obligations as of June 30, 2005, 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, 2005.



|                                          |  |                        |         |                   |   |                   |  |                     |         |                      |   |        |  |   |        
|----------------------------------------- |  | ---------------------- | ------- | ----------------- | - | ----------------- |  | ------------------- | ------- | -------------------- | - | ------ |  | - | -------
|                                          |  | Payments Due by Period
|Contractual Obligations                   |  | Total                  |         | Less ThanOne Year |   | One toThree Years |  | Three to Five Years |         | More Than Five Years
|Ground and building leases(1)             |  | $                      | 24,021  |                   | $ | 530               |  | $                   | 1,043   |                      | $ | 926    |  | $ | 21,522 
|Mortgage loans, including interest        |  |                        | 365,559 |                   |   | 21,384            |  |                     | 42,936  |                      |   | 50,880 |  |   | 250,359
|Mezzanine loan, including interest        |  |                        | 37,371  |                   |   | 2,411             |  |                     | 4,822   |                      |   | 4,822  |  |   | 25,316 
|Term loan facility, including interest(2) |  |                        | 74,651  |                   |   | 3,854             |  |                     | 70,797  |                      |   |       |  |   |       
|                                          |  |                        |         |                   |   |                   |  |                     |         |                      |   |        |  |   |        
|                                          |  | $                      | 501,602 |                   | $ | 28,179            |  | $                   | 119,598 |                      | $ | 56,628 |  | $ | 297,197
|                                          |  |                        |         |                   |   |                   |  |                     |         |                      |   |        |  |   |        

---

|(1) | Included in the table are the base rent payments (i.e., minimum lease payments) due under the ground and building lease agreements for the Portsmouth Renaissance hotel and adjoining
conference center and the conference center and parking facility adjoining the Sugar Land Marriott hotel. The lease agreements provide for base rent payments each year and additional rent payments once we have exceeded a specified return on our
original investment. Additional rent payments are not included in the table due to the uncertainty of the timing and amount of the payments in the future. However, we do not expect to make additional rent payments over the next five years.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Assumes no additional borrowings under the term loan facility and interest payments based on the interest rate in effect as of June 30, 2005.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------



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, such as the Barceló Tucancun Beach resort, 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



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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.



Stock-Based CompensationWe account for stock-based employee compensation using the fair value based method of accounting described in
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, as amended. For restricted stock awards, we record unearned compensation equal to the number of shares awarded multiplied by the average price of
our common stock on the date of the award, less the purchase price for the stock, if any. Unearned compensation is amortized using the straight-line method over the period in which the restrictions lapse (i.e., vesting period). For unrestricted
stock awards, we record compensation expense on the date of the award equal to the number of shares awarded multiplied by the average price of our common stock on the date of the award, less the purchase price for the stock, if any.



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, 2005. 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



Statement of Financial Accounting Standards No. 123 (revised 2004),
Share-Based Payment(SFAS 123R), requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. The statement requires a public entity to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for
the award. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The provisions of SFAS 123R will be effective as of January 1, 2006. Since we currently use the fair value method of
accounting for stock-based compensation, the adoption of SFAS 123R is not expected to have a material effect on our results of operations, financial position, or cash flows.



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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.
| | - |  | ----------------



These risks and uncertainties, together with the information contained in our Form 8-K filed with the Securities and Exchange Commission on March 15, 2005
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.



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, 2005, $279.9 million or 79% of our $356.2 million of
long-term debt was fixed. Another $11.3 million was effectively fixed, as a result of an interest rate swap that fixes the interest rate on one of our mortgage loans at 7.34%. The remaining $65 million of our long-term debt 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 $9 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 $0.7 million annually. On the other hand, if market rates of interest on
our



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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 $0.7 million annually. This assumes that the amount outstanding under our term loan facility remains at $65 million, the balance at June 30, 2005.



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 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 2005 annual meeting of stockholders of the Company was held on May 19, 2005. At the meeting, all seven incumbent directors were re-elected by the below votes for terms expiring in 2006:



|                    |  |            |  |               
|------------------- |  | ---------- |  | --------------
|                    |  | Votes For  |  | Votes Withheld
|Bruce D. Wardinski  |  | 36,976,674 |  | 782,777       
|James L. Francis    |  | 36,978,255 |  | 781,196       
|Francisco L. Borges |  | 36,828,384 |  | 931,067       
|W. Reeder Glass     |  | 36,978,063 |  | 781,388       
|Thomas A. Natelli   |  | 36,919,033 |  | 840,418       
|Margaret A. Sheehan |  | 36,919,534 |  | 839,917       
|William L. Wilson   |  | 37,715,710 |  | 43,741        



Item 5.Other Information



None.



Item 6.Exhibits



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



|               |  |                                                                                                                                                                                                                                                       
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | 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)
|               | 
|10.1           |  | Management Agreement with Grubarges Gestión Hotelera Mexicana SA de CV                                                                                                                                                                                
|               | 
|10.2           |  | Consulting Agreement with Barceló Gestión Hotelera S.L.                                                                                                                                                                                               
|               | 
|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                                                                                                                                                                                                 



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SIGNATURE



Pursuant to the requirements of Section 13 or 15(d) 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 9, 2005 |  | By:                              |  | /s/    DOUGLAS W.
VICARI                                                                                    
|                     |  |                                  |  | Douglas W. Vicari                                                                                           
|                     |  |                                  |  | Executive Vice President, Chief Financial Officer and Treasurer (Principal Financial
and Accounting Officer)



29