<PAGE>
 
================================================================================

                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C.  20549

                                   FORM 10-Q

                  QUARTERLY REPORT PURSUANT TO SECTION 13 OR
                 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
               FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996

                        COMMISSION FILE NUMBER: 0-26528
                                        
                      PATRIOT AMERICAN HOSPITALITY, INC.
            (Exact name of registrant as specified in its charter)

               VIRGINIA                                     75-2599709         
    (State or other jurisdiction of                      (I.R.S. Employer      
    incorporation or organization)                      Identification No.)     
                                                 
     3030 LBJ FREEWAY, SUITE 1500                              75234            
           DALLAS, TEXAS                                     (Zip Code)   
(Address of principal executive office)

               
                                (972) 888-8000
             (Registrant's telephone number, including area code)

                                      N/A
  (Former name, former address and former fiscal year, if changes since last
                                    report)


     Indicate by check mark whether the registrant (1) has filed all documents
and 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 
                                                      -----     -----     

     The number of shares of common stock, no par value, of Patriot American
Hospitality, Inc. outstanding on November 12, 1996 was 21,806,748.

     Exhibit Index is located on page 43.

================================================================================
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

                                     INDEX


                        PART I - FINANCIAL INFORMATION

                                                                            PAGE
                                                                            ----
ITEM 1.  FINANCIAL STATEMENTS:
 
PATRIOT AMERICAN HOSPITALITY, INC.:
  Consolidated Balance Sheets as of  December 31, 1995 and 
   September 30, 1996 (unaudited).........................................    3
  Consolidated Statements of Operations for the three months 
   ended September 30, 1996 and for the nine months ended 
   September 30, 1996 (unaudited).........................................    4
  Consolidated Statement of Cash Flows for the nine months 
   ended September 30, 1996 (unaudited)...................................    5
  Notes to Consolidated Financial Statements as of 
   September 30, 1996 (unaudited).........................................    6
 
CHC LEASE PARTNERS:
  Balance Sheets as of  December 31, 1995 and September 30, 
   1996 (unaudited).......................................................   14
  Statements of Operations for the three months ended 
   September 30, 1996 and for the nine months ended
   September 30, 1996 (unaudited).........................................   15
  Statement of Cash Flows for the nine months ended 
   September 30, 1996 (unaudited).........................................   16
  Notes to Financial Statements as of September 30, 
   1996 (unaudited).......................................................   17
 
INITIAL HOTELS COMBINED FINANCIAL STATEMENTS:
  Combined Statements of Operations for the three months ended 
   September 30, 1995 and for the nine months ended 
   September 30, 1995 (unaudited).........................................   19
  Combined Statement of Cash Flows for the nine months ended 
   September 30, 1995 (unaudited).........................................   20
  Notes to Combined Financial Statements as of September 30, 
   1995 (unaudited).......................................................   21
 
NORTHCOAST HOTELS, L.L.C.:
  Balance Sheet as of September 30, 1996 (unaudited)......................   25
  Statements of Operations for the three months ended 
   September 30, 1996 and for the period April 2, 1996 
   (inception of operations) through September 30, 1996 (unaudited).......   26
  Statement of Members' Equity for the period April 2, 1996 
   (inception of operations) through September 30, 1996 (unaudited).......   27
  Statement of Cash Flows for the period April 2, 1996 
   (inception of operations) through September 30, 1996 (unaudited).......   28
  Notes to Financial Statements as of September 30, 1996 (unaudited)......   29
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATIONS............................................   34
 
                          PART II - OTHER INFORMATION
 
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K:
  Exhibits................................................................   43
  Reports on Form 8-K.....................................................   43
 
SIGNATURE.................................................................   44
 
<PAGE>
 
                                    PART I

ITEM 1.  FINANCIAL STATEMENTS

                      PATRIOT AMERICAN HOSPITALITY, INC.

                          CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
                                             September 30,   December 31,
                                                 1996           1995
                                             --------------  -------------
                                              (unaudited)
                                    ASSETS
<S>                                          <C>             <C>
Investment in hotel properties, net of
 accumulated depreciation of $14,062 
 in 1996 and $2,529 in 1995.................   $557,890       $265,759
Cash and cash equivalents, including
 capital improvement reserves of                
  $2,568 in 1996 and $1,091 in 1995.........      7,004          4,769
Lease revenue receivable....................      7,871          2,260
Receivables from selling entities...........        960          1,765
Investments in unconsolidated                    
 subsidiaries...............................     11,607          4,263  
Mortgage notes and other receivables            
 from unconsolidated subsidiaries...........     72,004         40,855
Inventory...................................      1,222          1,035
Deferred expenses, net of accumulated
 amortization of $525 in 1996 and $88 
 in 1995....................................      3,282          1,852
Prepaid expenses and other assets...........      1,809          1,666
                                               --------       --------
     Total assets...........................   $663,649       $324,224
                                               ========       ========
 
                     LIABILITIES AND SHAREHOLDERS' EQUITY

Borrowings under line of credit and                                    
 mortgage note..............................   $113,592       $  9,500 
Dividends and distributions payable.........     12,158          8,154 
Accounts payable and accrued expenses.......      8,500          3,179
Due to unconsolidated subsidiaries..........      6,263             91
Minority interest in Operating              
 Partnership................................     73,268         41,522
Minority interest in other partnerships.....      3,214             --
Commitments and contingencies...............         --             --
Shareholders' equity:
  Preferred stock, no par value,
   20,000,000 shares authorized,            
   no shares issued and outstanding.........         --             --
  Common stock, no par value, 200,000,000
   shares authorized, shares issued and 
   outstanding were 21,806,748 in 1996
   and 14,665,935 in 1995...................         --             --
  Paid-in capital...........................    451,305        264,808
  Unearned stock compensation, net of
   accumulated amortization of $701 in 1996 
   and $71 in 1995..........................     (5,867)        (1,351)
  Retained earnings (distributions in         
   execess of retained earnings)............      1,216         (1,679)
                                               --------       --------
     Total shareholders' equity.............    446,654        261,778
                                               --------       --------
     Total liabilities and shareholders'           
       equity...............................   $663,649       $324,224 
                                               ========       ========  
</TABLE> 
                            See accompanying notes.

                                       3
<PAGE>
 
                       PATRIOT AMERICAN HOSPITALITY, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
                                                 Three            Nine
                                                 Months          Months
                                                 Ended           Ended
                                             September 30,   September 30,
                                                  1996            1996
                                             --------------  --------------
<S>                                          <C>             <C>
Revenue:
  Participating lease revenue............        $22,466         $52,735
  Interest and other income..............            211             412
                                                 -------         -------
    Total revenue........................         22,677          53,147
                                                 -------         -------

Expenses:
  Real estate and personal property taxes 
   and casualty insurance................          1,910           4,452
  Ground lease expense...................            411             711
  General and administrative.............          1,381           3,273
  Interest expense.......................          1,709           4,481
  Depreciation and amortization..........          4,844          11,628
                                                 -------         -------
    Total expenses.......................         10,255          24,545
                                                 -------         -------
Income before equity in earnings of
 unconsolidated subsidiaries and 
 minority interest.......................         12,422          28,602 
  Equity in earnings of unconsolidated   
   subsidiaries..........................          1,772           4,377
                                                 -------         ------- 
Income before minority interest..........         14,194          32,979 
  Minority interest in Operating
   Partnership...........................         (2,168)         (5,142) 
  Minority interest in other 
   partnerships..........................             (2)             (2)
                                                 -------         -------
Net income applicable to common 
 shareholders............................        $12,024         $27,835
                                                 =======         =======

Net income per common share..............        $  0.60         $  1.67
                                                 =======         =======
Fully diluted weighted average number
 of common shares and common share 
 equivalents outstanding.................         19,904          16,677
                                                 =======         =======
</TABLE>
 
                            See accompanying notes.

                                       4
<PAGE>
 
                       PATRIOT AMERICAN HOSPITALITY, INC.

                      CONSOLIDATED STATEMENT OF CASH FLOWS
                                  (UNAUDITED)
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                 Nine Months
                                                                    Ended
                                                                September 30,
                                                                    1996
                                                                -------------
<S>                                                             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income...................................................   $  27,835
  Adjustments to reconcile net income to net cash provided 
   by operating activities:
     Depreciation..............................................      11,538
     Amortization of unearned stock compensation...............         630
     Amortization of deferred loan costs.......................         273
     Amortization of lease inducement costs....................          76
     Other amortization........................................          90
     Payment of interest on notes receivable from 
      unconsolidated subsidiary................................       3,204
     Issue common stock to directors...........................          37
     Equity in earnings of unconsolidated subsidiaries.........      (4,377)
     Minority interest in income of Operating Partnership......       5,142 
     Minority interest in income of other partnerships.........           2
  Changes in assets and liabilities:
     Lease revenue receivable..................................      (5,611)
     Prepaid expenses and other assets.........................         (53)
     Accounts payable and other accrued expenses...............       1,259 
     Due to unconsolidated subsidiaries........................         (45)
                                                                  ---------
          Net cash provided by operating activities............      40,000
                                                                  --------- 
CASH FLOWS FROM INVESTING ACTIVITIES:
  Acquisition of hotel properties and related working 
   capital assets..............................................    (278,725) 
  Improvements and additions to hotel properties...............      (9,085)
  Collection of receivables from selling entities..............       1,003
  Prepaid acquisition costs....................................         246
  Investment in mortgage note receivable from unconsolidated  
   subsidiary..................................................     (31,400)  
  Principal payment received on mortgage note receivable.......         298 
  Principal payment received on other note receivable..........         101
                                                                  --------- 
          Net cash used in investing activities................    (317,562) 
                                                                  ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Borrowings under line of credit and mortgage note............     295,555 
  Repay borrowings under line of credit........................    (191,463)
  Payment of deferred loan costs...............................      (1,184)
  Proceeds of Follow-on Offering...............................     173,644
  Payment of Follow-on Offering costs..........................     (13,422)
  Net proceeds of private placement............................      39,417
  Payment of initial public offering costs.....................        (462)
  Contribution received from minority interest in other 
   partnerships................................................       3,213
  Dividends and distributions paid.............................     (25,501)
                                                                  ---------
          Net cash provided by financing activities............     279,797
                                                                  --------- 
Net increase in cash and cash equivalents......................       2,235 
Cash and cash equivalents at beginning of period...............       4,769
                                                                  --------- 
Cash and cash equivalents at end of period.....................   $   7,004
                                                                  ========= 
Supplemental disclosure of cash flow information:
  Cash paid during the period for interest.....................   $   4,243
                                                                  =========
 
</TABLE>
                            See accompanying notes.

                                       5
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)


1.  ORGANIZATION AND BASIS OF PRESENTATION:

  Patriot American Hospitality, Inc. (collectively with its subsidiaries, the
"Company"), a Virginia corporation, was formed April 17, 1995 as a self-
administered real estate investment trust ("REIT") for the purpose of acquiring
equity interests in hotel properties.  On October 2, 1995, the Company completed
an initial public offering (the "Initial Offering")  of 14,605,000 shares of its
common stock (including 1,905,000 shares of common stock issued upon exercise of
the underwriters' over-allotment option) and commenced operations.  The offering
price of all shares sold was $24.00 per share, resulting in net proceeds (less
the underwriters' discount and Initial Offering expenses) of approximately
$313,170.
 
  Upon completion of the Initial Offering, the Company, through its wholly-owned
subsidiary, PAH LP, Inc., contributed substantially all of the net proceeds of
the Initial Offering to Patriot American Hospitality Partnership, L.P. (the
"Operating Partnership") in exchange for an approximately 85.3% limited
partnership interest in the Operating Partnership. The Company, through its
wholly-owned subsidiary, PAH GP, Inc., is the sole general partner and the
holder of a 1.0% general partnership interest in the Operating Partnership.

  The Operating Partnership used approximately $263,600 of the net proceeds of
the Initial Offering to acquire ownership interests in 20 hotels (the "Initial
Hotels") from various entities (the "Selling Entities") and to repay existing
mortgage and other indebtedness of the Initial Hotels.  In addition, in
connection with the Initial Offering, the Company closed on a Line of Credit
with Paine Webber Real Estate Securities, Inc. to be utilized primarily for the
acquisition of additional hotels, renovation of certain hotels and for working
capital.  The balance of the proceeds from the Initial Offering, together with
proceeds from the Line of Credit, were used to finance acquisitions of two
additional hotel investments, provide for renovations to existing hotels and for
general working capital during 1995. In consideration for the sale of the
Initial Hotels, certain owners in the Selling Entities, including affiliates of
the Company, elected to receive limited partnership units in the Operating
Partnership. The 2,324,312 limited partnership units in the Operating
Partnership ("OP Units") received by such owners represented an approximate
13.7% equity interest in the Operating Partnership at December 31, 1995.

  During the first quarter of 1996, the Company acquired three additional hotel
properties, utilizing cash drawn on its Line of Credit and issuing 167,012 OP
Units in connection with the purchases.  During the second quarter of 1996, the
Company acquired eight additional hotel properties, utilizing cash drawn on its
Line of Credit and issuing 331,577 OP Units in connection with the purchases.

  During the third quarter of 1996, the Company completed a public offering
(the "Follow-on Offering") of 6,146,740 shares of its common stock (including
646,740 shares of common stock issued upon exercise of the underwriter's over-
allotment option).  The offering price of all shares sold in the Follow-on
Offering was $28.25 per share, resulting in net proceeds (less the underwriters'
discount and offering expenses) of approximately $160,222, of which
approximately $151,963 was used to reduce amounts outstanding under the Line of
Credit.  The Company acquired nine additional hotel properties, utilizing
primarily cash drawn on its Line of Credit and issuing 17,036 OP Units in
connection with the purchase of certain hotel properties.  At September  30,
1996, the Operating Partnership owned interests in 42 hotels and the Company
owned an approximate 86.2% interest in the Operating Partnership.

  The Company leases each of its hotels, except the Crowne Plaza Ravinia Hotel
and the Marriott WindWatch Hotel, which are separately owned through special
purpose corporations, to lessees that are independent of the Company (the
"Lessees").  The Company leases 24 of its hotel investments to CHC Lease
Partners for staggered terms of ten to twelve years pursuant to separate
participating leases providing for the payment of the greater of  base or
participating rent, plus certain additional charges, as applicable (the
"Participating Leases").  Eight of the hotels are leased to NorthCoast Hotels,
L.L.C. ("NorthCoast") under similar Participating Lease agreements.  DTR North
Canton, Inc. (the "Doubletree Lessee") leases four hotels and Crow Hotel Lessee,
Inc. (the "Wyndham Lessee") leases two hotels under similar Participating Lease
agreements.  Metro Hotels Leasing Corporation ("Metro Lease Partners") and
Mayfair Leasing, L.L.C. (the "Mayfair Lessee") each lease one hotel.  The Crowne
Plaza Ravinia Hotel and the Marriott WindWatch Hotel acquisitions were
structured without lessees.

                                       6
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  These unaudited consolidated financial statements include the accounts of the
Company, its wholly-owned subsidiaries and the partnerships in which the Company
owns at least 50% controlling interest.  All significant intercompany accounts
and transactions have been eliminated.  These financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X.  Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.  In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included.  Operating results for the three month and nine month periods
ended September 30, 1996 are not necessarily indicative of the results that may
be expected for the year ended December 31, 1996.  For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's annual report on Form 10-K for the period ended December 31, 1995.
Certain prior year amounts have been reclassified to conform to current period
presentation.

2.  ACQUISITION OF HOTEL PROPERTIES:

  During the first quarter of 1996, the Company  acquired three hotels located
in Massachusetts, Georgia and California with an aggregate of 830 rooms.  The
aggregate purchase price of the properties (including acquisition-related
expenses) was approximately $38,587 plus 167,012 OP Units (valued at
approximately $4,000 based upon the market price of the Company's common stock
on the contract settlement date).  One of the hotels is subject to a 73-year
ground lease.  The cash portion of the purchase was financed primarily with
funds drawn on the Line of Credit.  The hotels are leased to CHC Lease Partners
for 11 to 12 years pursuant to separate Participating Leases.

  In April 1996, the Company acquired the six hotel WestCost Portfolio for
approximately $75,630 and 331,577 OP Units, valued at approximately $8,800 at
the closing of the acquisition. The portfolio includes the 194-suite Plaza Park
Suites, the 151-room Roosevelt Hotel and the 145-room WestCoast Gateway Hotel,
all in Seattle, Washington; the 410-room Hyatt Newporter in Newport Beach,
California; the 192-room WestCoast Long Beach Hotel and Marina in Long Beach,
California; and the 147-room WestCoast Wenatchee Center Hotel in Wenatchee,
Washington. The cash portion of the purchase was financed primarily with funds
drawn on the Line of Credit. The hotels are leased to NorthCoast for 10 to 12
years pursuant to separate Participating Leases. The payment of a portion of the
purchase price in the amount of $2,000 is payable two years from the initial
acquisition date. This amount is included in accounts payable and accrued
expenses at September 30, 1996.

  In May 1996, the Company, acquired the 365-room Hyatt Regency in Lexington,
Kentucky for approximately $14,320 in cash.  The hotel is subject to a 79-year
ground lease.  In June 1996, the Company acquired the 180-room Doubletree
Denver/Boulder in Westminster (Denver), Colorado for approximately $12,520 in
cash. These purchases were financed primarily with funds drawn on the Line of
Credit.  The Hyatt Regency is leased to NorthCoast for a period of 10 years and
the Doubletree Denver/Boulder is leased to the Doubletree Lessee for 10 years
pursuant to separate Participating Leases.

  In July 1996, the Company acquired the 472-room Wyndham Greenspoint Hotel,
located in Houston, Texas and the 191-room Wyndham Garden-Midtown Hotel located
in Atlanta, Georgia from entities primarily owned by members of the Trammell
Crow family for approximately $61,242 and 17,036 OP Units valued at
approximately $500 at the time of the acquisition.  In addition, the Company may
be obligated to pay up to $3,000 of additional consideration upon acheivement of
certain future operating results of these hotels which management considers 
unlikely.  The hotels are leased to the Wyndham Lessee for a period of 10 years.

  In August 1996, the Company, aquired the 492-room Bonaventure Hotel & Spa (the
"Bonaventure") located in Fort Lauderdale, Florida for approximately $19,656,
including approximately $3,456 relating to the assumption of operating
liabilities and acquisition costs, and the 257-room Valley River Inn located in
Eugene, Oregon for approximately $19,053.  The Bonaventure is leased to CHC
Lease Partners for a period of 12 years and the Valley River 

                                       7
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

Inn is leased to NorthCoast for a period of 10 years.  These purchases were
financed primarily with funds drawn on the Line of Credit.

  During September 1996, the Company entered into three partnership agreements
in which the Operating Partnership owns a 90% general partnership interest and
DTR PAH Holding, Inc. ("DTR"), an affiliate of Doubletree Hotels Corporation,
owns a 10% limited partnership interest. The three partnerships, formed for the
purpose of acquiring certain hotel properties, are PAH-DT Tallahassee Partners,
L.P. ("Tallahassee Partners"), PAH-DT Chicago O'Hare Partners, L.P. ("Chicago
Partners") and PAH-DT Miami Airport Partners, L.P. ("Miami Partners"). Each
partnership is a Delaware limited partnership. The financial position and
results of operations of each partnership is included in the consolidated
financial statements of the Company. DTR's interest in the partnerships is
reflected as minority interest in other partnerships in the accompanying
consolidated financial statements.

  In September 1996, Tallahassee Partners acquired the 244-room Capitol Plaza
Holiday Inn in Tallahassee, Florida for approximately $11,186; Chicago Partners
acquired the 242-room Holiday Inn Des Plaines Hotel in Des Plaines , Illinios
for approximately $8,539; and Miami Partners acquired the 264-room Holiday Inn-
Miami Lakes Airport Hotel in Miami, Florida for approximately $12,513. The
hotels will be renamed and rebranded with the Doubletree and Doubletree Club
brands once planned renovations are complete. The hotels are leased to the
Doubletree Lessee for a period of 10 years pursuant to Participating Lease
agreements. The acquisitions of the hotels were funded through a combination of
cash and funds drawn on the Company's Line of Credit.

  The Company also acquired the 184-room Mayfair Suites Hotel in St. Louis,
Missouri in September 1996, for approximately $8,810. The hotel is leased to the
Mayfair Lessee, an affiliate of Grand Heritage Hotels, Inc., for a period of 10
years pursuant to a Participating Lease agreement. The hotel acquisition was
primarily financed through funds drawn on the Company's Line of Credit.

3.  INVESTMENTS IN AND MORTGAGE NOTES RECEIVABLE FROM UNCONSOLIDATED
    SUBSIDIARIES:

  The Company, through the Operating Partnership, owns an approximate 99% non-
voting ownership interest in PAH Ravinia, Inc. ("PAH Ravinia"), a Virginia
corporation. PAH Ravinia owns the 495-room Crowne Plaza Ravinia Hotel in
Atlanta, Georgia.

  As part of the financing for the acquisition of the Crowne Plaza Ravinia
Hotel, the Company, through the Operating Partnership, advanced $40,500 to PAH
Ravinia, which is evidenced by two mortgage notes consisting of a $36,000 first
mortgage note and a $4,500 second mortgage note. The principal amount of both
notes is due and payable on November 28, 1998. Interest at an annual rate equal
to 10.25% and 12.5% on the first and second mortgage notes, respectively, is due
and payable monthly. All amounts owed under the mortgage notes will become due
and payable upon a sale of the hotel to a third party purchaser. The mortgage
notes are collateralized by deeds of trust on the Crowne Plaza Ravinia Hotel.

  In September 1996, the Company, through the Operating Partnership, acquired an
approximate 99% non-voting ownership interest in PAH Windwatch, LLC, a Delaware
limited liability corporation. The Company's investment in PAH Windwatch, LLC of
approximately $6,217 is evidenced by a promissory note. PAH Windwatch, LLC
acquired the 362-room Marriott WindWatch Hotel (the "WindWatch Hotel") in
Hauppauge (Long Island), New York for approximately $31,102.

  As part of the financing for the acquisition of the WindWatch Hotel, the
Company, through the Operating Partnership, advanced PAH Windwatch, LLC $31,400,
which is evidenced by a first lien mortgage note. The principal amount of the
note is due and payable on August 31, 1999. Interest at an annual rate equal to
9% is due and payable monthly commencing October 1, 1996. All amounts owed under
the mortgage note will become due and payable upon the sale of the hotel to a
third party purchaser. The mortgage note is collateralized by a deed of trust on
the WindWatch Hotel.

                                       8
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  The WindWatch Hotel is not operated by a lessee but is managed for PAH
Windwatch, LLC by Marriott International, Inc. ("Marriott").  Pursuant to the
Purchase and Sale agreement dated March 15, 1996, the existing management
agreement has been terminated and the Company is currently negotiating the terms
of a new agreement.  Until such time a new agreement is reached, Marriot will
continue to manage the WindWatch Hotel under the terms of the prior agreement.
Pursuant to this agreement, Marriott  receives an annual basic management fee
equal to 5% of gross receipts.  In addition, in any year the hotel generates a
profit, as defined in the agreement, Marriott will receive an amount equal to
the excess of 15% of the profit over the basic management fee.

4. LINE OF CREDIT:

  In connection with the Initial Offering, the Company, through the Operating
Partnership obtained a revolving credit facility of up to $165,000 (the "Line of
Credit") to fund the acquisition of additional hotels, renovations and capital
improvements to hotels and for general working capital purposes.  In May 1996,
the maximum amount available under the Line of Credit was increased to $250,000
and certain other modifications were made, thereby increasing the Company's
ability to borrow under the Line of Credit.  The Line of Credit is
collateralized by a first mortgage lien on certain of the hotels.  As of
September  30, 1996, the Company had $91,592 outstanding on its Line of Credit.
The Line of Credit, which expires October 1, 1998, bears interest on the
outstanding balance at a rate per annum equal to 30-day LIBOR plus 1.90%.  LIBOR
was 5.69% at December 31, 1995 and 5.42% at September 30, 1996.  The weighted
average interest rate incurred by the Company during 1996 under this borrowing
was 7.41%.  No prepayment penalties are required under the Line of Credit.

  In connection with the acquisition of the Wyndham Greenspoint Hotel, the
Company has agreed to maintain at least $22,000 of debt on this property until
1999.  Paine Webber Real Estate has extended a single asset mortgage loan  of
$22,000 on this hotel (the "Greenspoint Loan") on economic terms substantially
similar to the Line of Credit. While the Greenspoint Loan is outstanding, the
maximum amount the Company may draw on the Line of Credit will be $228,000. The
Line of Credit and the Greenspoint Loan are cross defaulted. No prepayment
penalties are required under the Greenspoint Loan.

  The Line of Credit requires the Company to maintain certain financial ratios
with respect to liquidity, loan to value and net worth and imposes certain
limitations on acquisitions.  The Company is in compliance with such covenants
at September 30, 1996.  The unused commitment under the Line of Credit at
September  30, 1996, is $136,408, subject to certain restrictions and provisions
of the Line of Credit Agreement.

5.  MINORITY INTEREST IN OPERATING PARTNERSHIP:

  The Operating Partnership has 2,839,937 OP Units and 662,391 Preferred OP
Units (see Note 6) outstanding as of September 30, 1996 (excluding OP Units held
by the Company).  Pursuant to the Operating Partnership's limited partnership
agreement, the limited partners of the Operating Partnership, including certain
affiliates of the Company, received rights (the "Redemption Rights") that enable
them to cause the Operating Partnership to redeem each OP Unit in exchange for
cash equal to the value of a share of common stock (or, at the Company's
election, the Company may purchase each OP Unit offered for redemption for one
share of common stock).  The Redemption Rights generally may be exercised at any
time after one year following the issuance of the OP Units.  However, certain
holders of OP Units, including directors and officers of the Company, are
restricted from exercising their Redemption Rights for 18 to 24 months from the
closing of the Initial Offering.  The number of shares of common stock issuable
upon exercise of the Redemption Rights will be adjusted for share splits,
mergers, consolidations or similar pro rata transactions, which would have the
effect of diluting the ownership interests of the limited partners of the
Operating Partnership or the shareholders of the Company.

  During October 1996, certain partners elected to redeem a total of 9,867 OP
Units for a total of $329 in cash in accordance with their Redemption Rights.
 

                                       9
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

  On July 11, 1996, as part of the consideration for the acquisition of the
Wyndham Greenspoint Hotel, the Operating Partnership issued to Houston
Greenspoint Hotel Associates, L.P., an accredited investor, 17,036 OP Units with
an approximate value of $500.

6.  SHAREHOLDERS' EQUITY:

Capital Stock

  The Company's Board of Directors has declared quarterly distributions of
$0.48 per common share for each of the first,  second and third quarters.  The
first quarter distribution was paid on April 30, 1996 to holders of record on
March 29, 1996.  The second quarter distribution was paid on July 30, 1996 to
shareholders of record on June 27, 1996.  The third quarter distribution was
paid on October 30, 1996 to holders of record on October 4, 1996.   Concurrent
with the dividend declarations, the Operating Partnership has authorized and
paid distributions in the same amount.

  In response to an independent consultant review of executive compensation, the
Board of Directors elected to accelerate the vesting period for the shares of
common stock held by three of the Company's executive officers, which has been
recorded as unearned stock compensation.  During the first quarter of 1996, the
vesting period was reduced from five years to three years and the amortization
period of the unearned executive compensation was revised accordingly.

  During the third quarter of 1996, the Company completed its Follow-on Offering
of 6,146,700 shares.  In addition, directors, officers and certain employees
were granted 181,400 shares of common stock, as provided for in the Company's
Director's Plan and the 1995 Incentive Plan.  As of September 30, 1996, the
Company has 21,806,748 shares of common stock outstanding.

Stock Option Awards

  Pursuant to the Company's Directors' Plan and the 1995 Incentive Plan, the
Board of Directors granted stock options to purchase 15,000 shares of common
stock to the Company's directors and stock options to purchase 177,800 shares
of common stock to the Company's executive and other officers and certain
employees.  The exercise price of the options granted to the directors is
$28.375 (the market price of the Company's stock on the date of the grant, May
23, 1996).  For the officers and employees employed as of the grant date of
April 19, 1996, the exercise price of the options is $26.875 (the market price
of the Company's common stock on the date of grant).  For officers and employees
hired subsequent to April 19, 1996, the excercise price is equal to the market
price of the Company's common stock on the employee's hire date.  The options to
purchase common stock vest annually over a period of seven years.

Stock Grant Awards
 
  Pursuant to the Company's Director's Plan and the 1995 Incentive Plan, the
Company awarded 24,000 shares of common stock to its non-employee directors and
157,400 shares of common stock to certain of its officers and employees. The
Company has recorded $5,144 (the aggregate value of the Company's common stock
based on the market price at the date of the award) as unearned stock
compensation which is being amortized over the vesting period of four years. At
September 30, 1996, $630 of amortization of stock compensation related to stock
grants awarded to the Company's directors, officers and certain employees is
included in general and administrative expense in the accompanying consolidated
financial statements.

Private Placement

  In May 1996, the Company sold an aggregate of approximately $40,000 of equity
securities to an institutional investor that purchased the securities on behalf
of two owners (the "Private Placement").  The securities consisted of 811,393
shares of common stock sold at $26.95 per share and 662,391 Preferred OP Units
(the "Preferred OP Units") 

                                       10
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

sold at $27.375 per unit. The common stock is of the same class as the Company's
existing common stock and is entitled to the same voting and dividend rights as
all outstanding common stock, subject to certain restrictions on the resale of
the stock. The Preferred OP Units are entitled to quarterly distributions equal
to 103% of the quarterly dividends paid on the common stock. Generally, three
years following issuance, the Preferred OP Units may be converted into shares of
common stock on a one-for-one basis, subject to certain limitations. After 10
years, the Company will have the right to exchange all outstanding Preferred OP
Units for shares of common stock on a one-for-one basis.

7.  NONCASH INVESTING AND FINANCING ACTIVITIES:

  In connection with the acquisition of hotel properties, the following assets
and liabilities were assumed:
<TABLE>
<CAPTION>
<S>                                                         <C>
          Receivables from selling entities...............  $   329
          Inventory.......................................      187
          Prepaid expenses and other assets...............      446
          Deferred expenses...............................      685
          Accounts payable and accrued liabilities........    4,139
 
          Issuance of OP Units in connection with the 
            acquisition of hotel properties...............  $13,303
</TABLE>

     In connection with the Company's investment in an unconsolidated
subsidiary, the Company issued a promissory note payable to the unconsolidated
subsidiary in the amount of $6,217 which has been included in due to
unconsolidated subsidiaries in the accompanying financial statements.

8.  COMMITMENTS AND CONTINGENCIES:

     The Company currently is not subject to any material legal proceedings or
claims nor, to management's knowledge, are any material legal proceedings or
claims currently threatened.

                                       11
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

9.  PRO FORMA FINANCIAL INFORMATION:

  The following unaudited pro forma condensed consolidated statements of
operations of the Company are presented as if (i) the Initial Offering and the
acquisition of the 20 Initial Hotels, (ii) the subsequent acquisition of 22
additional hotel properties, and (iii) the Private Placement and Follow-on
Offering had occurred on January 1, 1995, and the hotels (except the Crowne
Plaza Ravinia Hotel and the Marriott WindWatch Hotel) had been leased to the
Lessees pursuant to the Participating Leases.  These unaudited pro forma
condensed consolidated statements of operations are not necessarily indicative
of what actual results of operations of the Company would have been assuming
such transactions had been completed as of January 1, 1995, nor do they purport
to represent the results of operations for future periods.
<TABLE>
<CAPTION>
                                                 NINE MONTHS ENDED SEPTEMBER 30,
                                                 -------------------------------
                                                     1995               1996
                                                 ------------       ------------
                                                      (IN THOUSANDS, EXCEPT 
                                                          PER SHARE DATA)
<S>                                              <C>                <C>
Revenue:
  Participating lease revenue...................      $65,328          $69,728
  Interest and other income.....................           53              433
                                                      -------          -------
     Total revenue..............................       65,381           70,161
                                                      -------          -------
Expenses:                                                         
  Real estate and personal property                     
   taxes and casualty insurance.................        6,861            7,176
  Ground lease expense..........................        1,002            1,023
  General and administrative....................        3,064            3,963
  Interest expense..............................        7,129            6,696
  Depreciation and amortization.................       15,998           16,698
                                                      -------          -------
     Total expenses.............................       34,054           35,556
                                                      -------          -------
Income before equity in earnings of                                     
 unconsolidated subsidiaries                          
  and minority interest.........................       31,327           34,605 
  Equity in earnings of  unconsolidated                                        
   subsidiaries.................................        3,351            5,748 
                                                      -------          ------- 
Income before minority interests................       34,678           40,353 
  Minority interest in Operating                
   Partnership..................................       (4,759)          (5,548)
  Minority interest in other                                                   
   partnerships.................................         (196)            (150)
                                                      -------          ------- 
Net income applicable to common                      
 shareholders...................................      $29,723          $34,655 
                                                      =======          ======= 
Net income per common share.....................      $  1.36          $  1.59
                                                      =======          =======  
Fully diluted weighted average number of common 
 shares and common share equivalents 
  outstanding...................................       21,847           21,847 
                                                      =======          =======  
</TABLE>

                                       12
<PAGE>
 
                      PATRIOT AMERICAN HOSPITALITY, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

10.  SUBSEQUENT EVENTS:

Potential Acquisitions

     On October 31, 1996, the Company entered into a binding agreement to
acquire California Jockey Club and Bay Meadows Operating Company for $33.00 per
share in cash or .9635 shares of the Company's stock.  The shares of California
Jockey Club, a real estate investment company, and Bay Meadows, a real estate
management and operating company (together, "Cal Jockey and Bay Meadows"), are
paired and trade as a single unit.  Based on approximately 5.9 million fully
diluted paired shares of Cal Jockey and Bay Meadows outstanding, the acquisition
is valued at approximately $195,000.  Pursuant to the agreement, the Company has
advanced $2,900 to the California Jockey Club for payment of a breakup fee which
is due upon termination of a prior acquisition agreement.  Under the terms of
the agreement, the Company is entitled to repayment of the $2,900 advance plus a
$5,000 fee if the acquisition agreement is terminated.

     The Company has entered into non-binding purchase and sale agreements to
acquire the 147-room historic  Tutwiler Hotel in Birmingham, Alabama for a
purchase price of approximately $10,400 in cash and OP Units valued at
approximately $600, the 124-room historic Union Station Hotel in Nashville,
Tennessee for a purchase price of approximately $9,100 in cash and OP Units
valued at approximately $600 and  the 189-room Howard Johnson Pickwick Hotel in
San Fransico, California for a purchase price of approximately $14,475 in cash.

     The acquisition of Cal Jockey and Bay Meadows, the above-described hotels
or any other properties is subject to a number of contingencies, including,
among other things, the satisfactory completion of the Company's due diligence
investigation of the transactions, the negotiation of a definitive acquisition
agreement and obtaining financing and/or Line of Credit lender approval, as
applicable.  Accordingly, there can be no assurance that the acquisition of Cal
Jockey and Bay Meadows, the above-described hotels or any other properties will
be consummated.

                                       13
<PAGE>
 
                               CHC LEASE PARTNERS

                                 BALANCE SHEETS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>


                                           SEPTEMBER 30, 1996  DECEMBER 31, 1995
                                           ------------------  -----------------
                                              (UNAUDITED)
<S>                                       <C>                  <C>
                                     ASSETS
Current Assets:
  Cash and cash equivalents..................     $11,803           $ 9,385
  Accounts receivable, net of allowance for                         
   doubtful accounts of $204 and $142 at                            
   September 30, 1996 and December 31, 1995,                        
   respectively..............................      10,028             5,833
  Inventories................................       2,643             2,136
  Prepaid expenses...........................       1,102               441
                                                  -------           -------
       Total current assets..................      25,576            17,795
Investments..................................       5,100             5,100
Deposits.....................................         360                71
                                                  -------           -------
     Total assets............................     $31,036           $22,966
                                                  =======           =======
                                                                    
                       LIABILITIES AND PARTNERS' CAPITAL            
                                                                    
Current Liabilities:                                                
  Accounts payable...........................     $ 4,239           $ 2,202
  Accrued rent due to Patriot American                              
   Hospitality Partnership, L.P. ............       4,671             2,260
  Due to affiliates, net.....................         232               138
  Accrued payroll............................       2,941             2,219
  Taxes payable..............................       1,687             1,556
  Guest deposits.............................       1,711               958
  Accrued expenses and other liabilities.....       3,331             2,012
                                                  -------           -------
       Total current liabilities.............      18,812            11,345
Due to Patriot American Hospitality                                 
 Partnership, L.P. ..........................       1,072             1,035
Lease inducement.............................       1,585               977
                                                  -------           -------
       Total liabilities.....................      21,469            13,357
Commitments and contingencies (Note 2).......          --                --
Partners' capital............................       9,567             9,609
                                                  -------           -------
       Total liabilities and partners' 
        capital..............................     $31,036           $22,966
                                                  =======           =======
</TABLE>

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

                                       14
<PAGE>
 
                               CHC LEASE PARTNERS

                            STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                 THREE            NINE
                                                 MONTHS          MONTHS
                                                 ENDED           ENDED
                                             SEPTEMBER 30,   SEPTEMBER 30,
                                                  1996            1996
                                             --------------  --------------
<S>                                          <C>             <C>
Revenue:
  Rooms...................................       $29,232        $ 81,869
  Food and beverage.......................         8,162          25,079
  Conference center.......................           456           1,652
  Telephone and other.....................         2,714           7,432
                                                 -------        --------
      Total revenue.......................        40,564         116,032
                                                 -------        --------
Expenses:
  Departmental costs and expenses.........        14,647          41,713
  Participating lease payments............        14,195          40,068
  General and administrative..............         3,339           9,640
  Repairs and maintenance.................         1,892           5,182
  Utilities...............................         2,030           5,219
  Marketing...............................         3,716          10,543
  Insurance...............................           233             631
                                                 -------        --------
      Total expenses......................        40,052         112,996
                                                 -------        --------
      Income before lessee income
       (expense)..........................           512           3,036
                                                 -------        --------
  Dividend and interest income............           607           1,110
  Management fees.........................          (744)         (2,333)
  Lessee general and administrative
   expenses...............................          (263)           (765)
                                                 -------        --------
      Total lessee income (expense).......          (400)         (1,988)
                                                 -------        --------
      Net income..........................       $   112        $  1,048
                                                 =======        ========
</TABLE>

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

                                       15
<PAGE>
 
                               CHC LEASE PARTNERS

                            STATEMENT OF CASH FLOWS
                                  (UNAUDITED)
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                  NINE MONTHS
                                                                     ENDED
                                                                 SEPTEMBER 30,
                                                                     1996
                                                                 -------------
<S>                                                              <C>
Cash flows from operating activities:
  Net income...................................................    $ 1,048
  Adjustments to reconcile net income to net cash used in 
   operating activities:
     Recognition of lease inducement...........................        (76)
     Provision for losses on accounts receivable...............         46
  Changes in assets and liabilities:
  (Increase) decrease in:
     Accounts receivable.......................................     (2,484)
     Inventories...............................................        192
     Prepaid expenses and other assets.........................       (950)
  Increase (decrease) in:
     Accounts payable..........................................     (2,335)
     Accrued rent due to Patriot American Hospitality 
      Partnership, L.P.........................................      2,411
     Due to affiliates.........................................         94
     Accrued payroll...........................................        722
     Taxes payable.............................................        131
     Guest deposits............................................       (660)
     Accrued expenses and other liabilities....................      1,433
                                                                   -------
Net cash used in operating activities..........................       (428)
                                                                   -------
Cash flows from investing activities:
  Acquired cash from new operating leases......................      3,936
                                                                   -------
Net cash provided by investing activities......................      3,936
                                                                   -------
Cash flows from financing activities:
  Partnership distribution.....................................     (1,090)
                                                                   -------
Net cash used in financing activities..........................     (1,090)
                                                                   -------
Net increase in cash and cash equivalents......................      2,418
Cash and cash equivalents at beginning of period...............      9,385
                                                                   -------
Cash and cash equivalents at end of period.....................    $11,803
                                                                   =======
Supplemental Schedule of Non-Cash Investing and Financing 
 Activities:

  Assumption of assets and liabilities upon consummation of 
   participating lease agreements with Patriot American 
   Hospitality Partnership, L.P.:
       Acquired cash...........................................      3,936
       Inventories.............................................        699
       Other assets............................................      1,757
       Due to Patriot American Hospitality Partnership, L.P....         78
       Other liabilities.......................................     (5,785)
       Lease inducement........................................       (685)
                                                                   -------
       Net assets.............................................     $    --
                                                                   =======
</TABLE>

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

                                       16
<PAGE>
 
                              CHC LEASE PARTNERS

                         NOTES TO FINANCIAL STATEMENTS
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)


1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

ORGANIZATION

     CHC Lease Partners, was formed as the initial lessee to lease and operate
certain hotels owned by Patriot American Hospitality Partnership, L.P. (the
"Operating Partnership").  At September 30, 1996, Patriot American Hospitality,
Inc. (the "Company"), through its subsidiaries, owns approximately 86.2% of the
Operating Partnership.  CHC Lease Partners, a general partnership, is owned
jointly by CHC REIT Lessee Corp., a wholly owned subsidiary of CHC
International, Inc. ("CHC") and by an affiliate of a principal of the Gencom
group of companies.

     CHC Lease Partners began operating twenty hotels (the "Initial Hotels") on
October 2, 1995. During  1996,  CHC Lease Partners and the Operating Partnership
entered into four additional operating leases for four hotels which were
acquired by the Operating Partnership.  The leases are substantially similar to
the other participating lease agreements between CHC Lease Partners and the
Operating Partnership.  At September 30, 1996, CHC Lease Partners leases twenty-
four hotels.

     Each hotel is leased by the Operating Partnership to CHC Lease Partners
under separate participating operating lease agreements which contain cross-
default provisions.  These leases, which require CHC Lease Partners to maintain
a minimum net worth and adequate working capital, have an average term of eleven
years, require payment of the greater of (1) minimum base rent or (2)
participating rent based upon certain percentages of room revenue, food and
beverage revenue, conference center revenue and telephone and other revenues of
each of the hotels.

     The hotels leased by CHC Lease Partners consist of eighteen full service
hotels, four limited service hotels, one executive conference center and one
resort.  Twenty  of the twenty-four hotels are operated under franchise licenses
with nationally recognized hotel companies. The cost of obtaining the franchise
licenses is paid by the Operating Partnership and the continuing franchise fees
are paid by CHC Lease Partners.  Franchise and related fees generally range from
3.5% to 8.0% of room revenues for the hotels under franchise licenses.

     These financial statements have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they
do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements.  In the
opinion of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.  Operating
results for the three month and nine month periods ended September 30, 1996 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 1996.  For further information, refer to the CHC Lease
Partners financial statements and footnotes thereto included in the Company's
annual report on Form 10-K for the year ended December 31, 1995.

2.  COMMITMENTS AND RELATED PARTY TRANSACTIONS:

     CHC Lease Partners incurred base rents of $8,740 and $24,801 for the three
months and nine months ending September 30, 1996, respectively, and
participating rents of $5,444 and $15,231 for the three months and nine months
ending September 30, 1996, respectively.  At September 30, 1996 and December 31,
1995, CHC Lease Partners owed the Operating Partnership $4,671 and $2,260,
respectively, for rents under the terms of the participating leases.

     Under the participating lease agreements, CHC Lease Partners is obligated
to return to the Operating Partnership at the end of each lease term the
inventory at each of the Initial Hotels less a total of $1,000.  Such amount is
considered a lease inducement and is recorded as a reduction to participating
lease payments over the lives of the participating lease agreements.  In 1996,
under the participating lease agreement for one resort property, CHC Lease
Partners received a lease inducement fee of $685 which is recorded as a
reduction to participating lease payments over the life of the participating
lease agreement.  As of September 30, 1996, the balance of the lease inducements
and the inventory due to the Operating Partnership was $1,585 and $1,072 ,
respectively.  As of December 31, 1995, the balances were $977 and $1,035,
respectively.

     CHC Lease Partners entered into management agreements with  hotel
management  subsidiaries  of  CHC  and GAH-II, L.P. ("GAH"), an affiliate of CHC
and the Gencom group of companies, to perform all management functions necessary
to operate 23 of the 24 hotels leased by CHC Lease Partners.  The terms of these
agreements range from ten to twelve years with management fees due based upon a
percentage of gross revenue of each of the hotels ranging from 2.25% to 2.5%
escalating to 3.0% over a two to three year period.  The fees under these
management agreements are subordinate to CHC Lease Partners' obligations to the
Operating Partnership under the participating lease agreements.  Management fees
incurred under these management agreements were $732 during the three months
ended 

                                       17
<PAGE>
 
                              CHC LEASE PARTNERS

                  NOTES TO FINANCIAL STATEMENTS - (Continued)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)


September 30, 1996 and were $2,159 for the nine months ended September 30, 1996.
Included in due to affiliates, net were amounts for management fees under these
management agreements owed to CHC and GAH of $102 and $91, respectively, at
September 30, 1996 and due from CHC and owed to GAH of $46 and $43,
respectively, at December 31, 1995.

     CHC Lease Partners fully reimburses CHC for office space it occupies within
the corporate offices of CHC and for the payroll and related costs CHC
administers on behalf of CHC Lease Partners.  These costs amounted to $136 for
the three months ended September 30, 1996 and $285 for the nine months ended
September 30, 1996.  At September 30, 1996 and December 31, 1995 the amount due
CHC for these costs was $39 and $141, respectively.

     During the three months and nine months ended September 30, 1996, CHC Lease
Partners made distributions to its partners of $300 and $1,090, respectively.

3.  PRO FORMA FINANCIAL INFORMATION:

     The unaudited pro forma statements of operations are presented as if the
leases and the operation of the twenty-four hotels had commenced on January 1,
1995.  The unaudited pro forma statements of operations are not necessarily
indicative of what the actual results of operations of CHC Lease Partners would
have been assuming such operations had commenced as of January 1, 1995, nor do
they purport to represent the results of operations for future periods.  Pro
forma lessee expenses  represent management fees and estimated lessee overhead
expenses and the 1995 amounts exclude pro forma dividend income on 250,001
Operating Partnership Units and interest income associated with working capital
balances.
<TABLE>
<CAPTION>
                                          NINE MONTHS ENDED SEPTEMBER 30,
                                        -----------------------------------
                                             1995                  1996
                                        --------------        -------------
                                                   (IN THOUSANDS)
<S>                                     <C>                   <C>

Revenue:
     Rooms............................      $ 85,689            $ 90,984
     Food and beverage................        31,196              30,689
     Conference center................         1,858               1,652
     Telephone and other..............         9,169               9,617
                                            --------            --------
          Total revenue...............       127,912             132,942
                                            --------            --------
Expenses:
     Departmental costs and expenses..        49,694              50,167
     Participating lease payments.....        40,194              42,782
     General and administrative.......        11,300              11,805
     Repairs and maintenance..........         6,510               6,254
     Utilities........................         5,888               6,178
     Marketing........................        12,174              12,332
     Insurance........................         1,029                 895
                                            --------            --------
          Total expenses..............       126,789             130,413
                                            --------            --------
Income before lessee expenses.........         1,123               2,529
Lessee expenses.......................         1,334               1,607
                                            --------            --------
     Net income (loss)................      $   (211)           $    922
                                            ========            ========
</TABLE> 

                                       18
<PAGE>
 
                                INITIAL HOTELS

                       COMBINED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
                                (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                    Three          Nine
                                                    Months        Months
                                                    Ended          Ended
                                                September 30,  September 30,
                                                    1995            1995
                                                -------------  --------------
<S>                                             <C>            <C>
Revenue from hotel operations:
  Rooms.......................................    $21,102        $65,192
  Food and beverage...........................      6,735         21,877
  Conference center...........................        566          1,858
  Telephone and other.........................      1,848          5,833
                                                  -------        -------
      Total revenue...........................     30,251         94,760
                                                  -------        -------
Expenses:
  Departmental costs and expenses.............     12,052         35,799
  General and administrative..................      3,508          8,844
  Repairs and maintenance.....................      1,578          4,448
  Utilities...................................      1,470          4,092
  Marketing...................................      2,919          8,730
  Management fees paid to affiliates..........      1,137          3,913
  Interest expense............................      3,203         11,619
  Real estate and personal property
    taxes, and insurance......................      1,163          3,370
  Depreciation and amortization...............      2,440          7,644
                                                  -------        -------
      Total expenses..........................     29,470         88,459
                                                  -------        -------
  Income before extraordinary item............        781          6,301
  Extraordinary item--loss on
   extinguishment of debt.....................         --         (1,803)
                                                  -------        ------- 
      Net income..............................    $   781        $ 4,498
                                                  =======        =======
</TABLE>

                            See accompanying notes.

                                       19
<PAGE>
 
                                INITIAL HOTELS

                       COMBINED STATEMENT OF CASH FLOWS
                                  (UNAUDITED)
                                (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                 Nine Months
                                                                    Ended
                                                                September 30,
                                                                     1995
                                                               --------------
<S>                                                            <C>              
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income..................................................    $  4,498
  Adjustments to reconcile net income                           
   to net cash provided by operating                            
   activities:                                                  
  Depreciation and amortization...............................       7,644
  Amortization of deferred loan costs.........................         227
  Amortization of discount on note                              
   payable....................................................         172
  Expenses financed with term debt............................         250
  Loss on extinguishment of debt..............................       1,803
Changes in assets and liabilities:                              
Cash held in escrow...........................................        (159)
  Accounts receivable, net....................................      (1,627)
  Inventories.................................................          19
  Prepaid and other assets....................................          (4)
  Accounts payable and other accrued                         
   expenses...................................................         400
  Payables to affiliates......................................        (279)
                                                                  --------
     Net cash provided by operating activities................      12,944
                                                                  --------
CASH FLOWS FROM INVESTING ACTIVITIES:                           
  Restricted funds reserved for                                 
   acquisition of property and equipment......................          55
  Improvements and additions to hotel properties..............      (4,648)
                                                                  --------
     Net cash used in investing activities....................      (4,593)
                                                                  --------
CASH FLOWS FROM FINANCING ACTIVITIES:                           
  Proceeds from issuance of mortgages                           
   and other notes payable....................................      13,217
  Principal payments on mortgages and                           
   other notes payable........................................     (11,342)
  Payment of financing costs..................................        (320)
  Payments on capital lease obligations.......................      (1,319)
  Proceeds from advances from affiliates......................          75
  Payments on advances from affiliates........................        (561)
  Proceeds from loans from affiliates.........................         338
  Payments on loans from affiliates...........................        (318)
  Capital contributions.......................................          33
  Distributions paid..........................................      (8,991)
                                                                  --------
     Net cash used in financing activities....................      (9,188)
                                                                  --------
Net change in cash and cash equivalents.......................        (837)
Cash and cash equivalents at beginning of period..............       8,290
                                                                  --------
Cash and cash equivalents at end of period....................    $  7,453
                                                                  ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW                            
 INFORMATION:                                                   
Cash paid during the period for interest......................    $ 10,757
                                                                  ========
                                                           
</TABLE>
                            See accompanying notes.

                                       20
<PAGE>
 
                                INITIAL HOTELS

                    NOTES TO COMBINED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

1. ORGANIZATION, INITIAL PUBLIC OFFERING AND BASIS OF PRESENTATION:

Organization

  Patriot American Hospitality, Inc. (the "Company") is a Virginia corporation
which was created to own, through wholly-owned subsidiaries, an approximately
86.3% general and limited partnership interest in Patriot American Hospitality
Partnership, L.P., a Virginia limited partnership (the "Operating
Partnership").  On October 2, 1995, the Operating Partnership acquired from
various entities (the "Selling Entities") twenty (20) operating hotel properties
(collectively, the "Initial Hotels").  Sixteen of the 20 Initial Hotels were
acquired from Selling Entities owned jointly or individually by Patriot American
(or its principals) ("Patriot American"), CHC International, Inc. ("CHC") and
the Gencom group of companies ("Gencom", and collectively with CHC and Patriot
American, the "Primary Contributors"). The four remaining hotels were acquired
from Selling Entities not affiliated with the Primary Contributors. Following is
a listing of the Initial Hotels.

<TABLE>
<CAPTION>
                                                            NUMBER
                                                              OF      MONTH/YEAR
      SELLING ENTITY              PROPERTY NAME/LOCATION    ROOMS      ACQUIRED
-----------------------------    -------------------------  ------    ----------
<S>                              <C>                        <C>       <C>
FULL SERVICE HOTELS:        
Bourbon Orleans Investors, LP    Bourbon Orleans Hotel--       211        8/92
                                 New Orleans, Louisiana
Summit AP Partners, LP           Holiday Inn Select North      374        8/93
                                 Dallas--Farmers Branch,
                                 Texas
Quarry Inn Company               Hilton Inn Cleveland          191       N/A(2)
                                 South--Independence, Ohio
Crockett Hospitality, Inc.       Crockett Hotel--San           206        5/90
                                 Antonio, Texas
Troy Hotel Investors, LP         Marriott Troy                 350       12/94
                                 Hotel--Troy, Michigan
Tri-City Associates              Four Points by Sheraton--     156       N/A(2)
                                 Saginaw, Michigan
1500 Canal Street                Radisson New Orleans Hotel    759        9/92
 Investors, LP                   --New Orleans, Louisiana
Chartwell Properties, Inc.       Radisson Hotel &              198        2/90
                                 Suites--Dallas, Texas
Town & Country                   Radisson Suites (Town &       173       11/89
 Hospitality, Co.                Country)--Houston, Texas
Main Street Hospitality, LP      Holiday Inn                   172       11/92
                                 Aristocrat--Dallas, Texas
290 Ventures, LP                 Holiday Inn Northwest         193        9/90
                                 Plaza--Houston, Texas
Travis Real Estate Group, JV     Holiday Inn Northwest         193        1/92
                                 Plaza--Austin, Texas
San Angelo Hospitality, LP       Holiday Inn--San Angelo,      148        1/93
                                 Texas
Sebring Hospitality, LP          Holiday Inn--Sebring,         148        8/93
                                 Florida
Fairmount Hospitality, LP        Fairmount Hotel--San           37       10/92
                                 Antonio, Texas              -----
                                                             3,509
                                                             -----
LIMITED SERVICE HOTELS:     
Hotel Group of                   Hampton Inn Jacksonville      113      1985(1)
 Jacksonville, JV                Airport - Jacksonville,
                                 Florida
North Coast Rochester            Hampton Inn--Rochester,       113      1986(1)
 Limited Partnership             New York
Great Northern Inns              Hampton Inn Cleveland         113       N/A(2)
 Company, L.P.                   Airport--North Olmsted,
                                 Ohio
North Coast Inns Co. Ltd.        Hampton Inn--Canton, Ohio     108       N/A(2)
                                                             -----
                                                               447
                                                             -----
EXECUTIVE CONFERENCE        
 CENTER:                    
MWL Peachtree                    Peachtree Executive           250        4/93
                                 Conference                  -----
                                 Center--Peachtree City,
                                 Georgia
                                                             4,206
                                                             =====
</TABLE>
---------------
(1) Constructed by the current owner.
(2) See Basis of Presentation for a discussion of these Initial Hotels which
    were not owned by the Primary Contributors or their affiliates.

                                       21
<PAGE>
 
                                INITIAL HOTELS

                    NOTES TO COMBINED FINANCIAL STATEMENTS
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

  The Operating Partnership purchased the Initial Hotels from the Selling
Entities for an aggregate purchase price of approximately $311,000.  The owners
of the Selling Entities received cash and/or units of limited partnership
interest in the Operating Partnership as consideration for the hotels.  See
Initial Public Offering below.

  Upon acquisition, all of the Initial Hotels were leased to CHC Lease Partners,
a general partnership owned jointly by CHC and an affiliate of a principal of
Gencom, pursuant to separate participating leases (the "Participating
Leases").  Under the terms of the Participating Leases, CHC Lease Partners is
obligated to pay the greater of (1) minimum base rent or (2) participating rent
based upon certain percentages of room revenue, food and beverage revenue,
conference center revenue and telephone and other revenue of each of the Initial
Hotels. The Participating Leases have an average term of approximately eleven
years.

  CHC Lease Partners contracted with hotel management subsidiaries of CHC and
with GAH-II, L.P. ("GAH") to manage 19 of the Initial Hotels and Metro Hotels
Joint Venture manages the remaining Initial Hotel (collectively, the
"Operators").  Under the terms of these management agreements, the Operators
are required to perform all management functions necessary to operate the
Initial Hotels.

Initial Public Offering

  The Company filed its registration statement with the Securities and Exchange
Commission which became effective September 27, 1995 pursuant to which the
Company completed an initial offering (the "Initial Offering") of 14,605,000
shares of its common stock to the public (including 1,905,000 shares of common
stock issued upon exercise of the underwriters' over-allotment option).  The
Initial Offering price of all shares sold in the Initial Offering was $24.00 per
share, resulting in net proceeds (less the underwriters' discount and offering
expenses) of approximately $313,170.

  Upon completion of the Initial Offering, the Company contributed, through its
wholly-owned subsidiaries, substantially all of the net proceeds of the Initial
Offering to the Operating Partnership in exchange for an approximately 86.3%
general and limited partnership interest in the Operating Partnership. The
Operating Partnership then used the proceeds from the Company to acquire the
Initial Hotels from the Selling Entities, to finance certain capital
improvements and for general working capital. Rather than receiving cash for
their entire interests in the Selling Entities upon the sale of the Initial
Hotels, the Primary Contributors and certain third-party sellers elected to
receive limited partnership interests in the Operating Partnership aggregating
an approximately 13.7% equity interest in the Operating Partnership.

Basis Of Presentation

  The accompanying financial statements are presented on a combined basis
because subsequent to October 1, 1995, these properties are wholly-owned by the
Operating Partnership and because 19 of the 20 Initial Hotels included in the
combination were either owned or managed by one of the Primary Contributors or
their affiliates prior to the Operating Partnership's acquisition.

  Management believes that these combined financial statements result in a more
meaningful presentation and thus appropriately reflect the historical financial
position and results of operations of the predecessor of CHC Lease Partners. All
significant inter-entity transactions have been eliminated in the combined
presentation.

Interim Unaudited Financial Information

  These unaudited combined statements of operations and cash flows have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.  In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included.  Operating results for the three month and nine month periods
ended September 30, 1995 are not necessarily indicative 

                                       22
<PAGE>
 
                                INITIAL HOTELS

             NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

of the results for the year ended December 31, 1995. For further information,
refer to the combined financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1995.

2.  MORTGAGES AND OTHER NOTES PAYABLE:

Mortgage Loans

  As of September 30, 1995, the combined Initial Hotels were obligated under an
aggregate of 21 mortgage loans, each of which are generally collateralized by a
first lien deed of trust and assignment of rents.  The mortgage loans payable
consist of both interest only and amortizing loans which mature at various dates
through November 2011.  Seven of the mortgage loans totaling $83,431 as of
September 30, 1995 have fixed interest rates ranging from 6.0% to 12.0%.
Variable rate mortgage loans payable at September 30, 1995 total approximately
$54,019.  Interest rates on the variable rate debt are generally based on prime
or LIBOR rates which were 8.8% and 5.8%, respectively, at September 30, 1995.
Certain of the mortgage obligations are personally guaranteed by certain
partners of the Selling Entities.

Other Notes Payable

  As of September 30, 1995, the combined Initial Hotels were also obligated
under six other notes payable arrangements totaling $5,707.  Two of the notes
aggregating $4,499 were issued in connection with the redemption of a minority
partner's interest in one of the Initial Hotels and termination of the hotel
operator's management contract in January 1995.  The proceeds from the remaining
notes were used to finance improvements to certain hotels. The notes, which
mature at various dates through December 31, 2004, bear interest at rates
ranging from 7.5% to 14%. Certain of the notes are guaranteed by owners.

Debt Extinguishment

  All of the outstanding mortgage and other notes payable described above were
repaid on October 2, 1995 from the proceeds of the Initial Offering.

  The Bourbon Orleans Hotel was purchased subject to a mortgage note in the
amount of $9,345 held by the Resolution Trust Corporation ("RTC"). Due to the
non-interest bearing feature of the loan, the mortgage note payable and the
carrying amount of the property were discounted in the amount of $3,220 using an
imputed interest rate of approximately 7.5%. The loan provided for payment to
the RTC equal to 25% of the net proceeds from sale or refinancing of the
property.

  In February 1995, the owner refinanced the hotel and the RTC note payable was
retired, prior to scheduled maturity, for $7,588.  The excess of the
reacquisition price over the net carrying amount of the debt of $5,785, resulted
in a loss on extinguishment of $1,803, which is presented as an extraordinary
item in 1995.  Additionally, interest expense in 1995 includes $1,242 paid to
the RTC for its share of the net refinancing proceeds.  The new loan, in the
amount of $12,500, accrued interest at the LIBOR Index, with monthly payments of
interest only due for the first twelve months.

  Additionally, the loan proceeds were used to retire other indebtedness of the
hotel of approximately $2,480 and to purchase equipment leased under capital
leases of approximately $1,290.

  In March 1995, the Radisson New Orleans Hotel obtained an extension of a $500
note payable due January 1995.  The terms of the loan remained unchanged except
for an extension of the loan maturity date to December 2, 1995.

                                       23
<PAGE>
 
                                INITIAL HOTELS

             NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

3. COMMITMENTS AND CONTINGENCIES:

Franchise Agreements

  Under the terms of hotel franchise agreements expiring at various dates
through July 2013, annual payments for franchise royalties, reservation and
advertising services are due for 17 of the 20 Initial Hotels. Fees are computed
based upon percentages of gross room revenue. Such fees were approximately
$2,315 for the nine months ended September 30, 1995. Certain of these agreements
require the franchisee to establish reserves for property improvements,
replacement of furniture and equipment or payment of property taxes and
insurance.

4. RELATED PARTY TRANSACTIONS:

  After the Initial Offering described in Note 1, the Operators of 19 of the
Initial Hotels are hotel management subsidiaries of CHC and GAH, an entity
affiliated with CHC and Gencom.  Prior to the Initial Offering, seven of the
Initial Hotels were operated by CHC and six were operated by GAH. In addition,
five of the remaining Initial Hotels were operated by affiliates of the Selling
Entities.

  The hotels were operated under management agreements expiring through August
2003, and terms included management fees generally ranging from 2% to 5% of
revenue. In addition, certain of the hotels provided for the payment of
incentive management fees based on achievement of specified performance criteria
as defined in the individual management agreements. In certain cases accounting
fees ranging from $1 to $3 per month, asset management fees ranging from $2 to
$3 per month, and construction supervisory fees ranging from 5% to 10% of the
total cost incurred for capital improvements were also due.

  Certain of the Selling Entities had working capital loans or advances from
owners or their affiliates. These loans bear interest at rates ranging from 5%
to 14% at September 30, 1995 and mature at various dates through March 1997. The
advances are non-interest bearing and are generally due on demand.  Interest
expense related to these loans is $233 for the nine months ended September 30,
1995.  Loans and advances from affiliates were repaid in connection with the
Initial Offering.

5. CHANGES IN OWNERSHIP:

  In January 1995, the partnership owning the Radisson New Orleans Hotel
redeemed the limited partnership interest of a minority partner based upon a
negotiated purchase price of $4,249 and bought out the existing management
contract of the hotel operator in exchange for notes payable aggregating $4,499.
The notes were repaid in connection with the Initial Offering.

  In June 1995, one of the Primary Contributors acquired the interests of his
partners in the Holiday Inn Northwest-Houston Hotel.  In connection with this
acquisition, an affiliated entity acquired all the assets and certain
liabilities in exchange for a note payable to the seller, which wraps around the
underlying first mortgage and certain other indebtedness of the seller.  The
amount of the note payable in excess of the underlying indebtedness of $3,964
has been reflected as a redemption of partner interests in the accompanying
financial statements.  The notes were repaid in connection with the Initial
Offering.

6.  NON CASH INVESTING AND FINANCING ACTIVITIES:

  During 1995, a note payable to an affiliate of one of the Primary Contributors
was converted to an additional equity interest in the owner of the Peachtree
Executive Conference Center in the amount of $4,145.

                                       24
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                                 BALANCE SHEET
                                  (UNAUDITED)
                                (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                  September 30,
                                                                      1996
                                                                  -------------
<S>                                                               <C>

                                    ASSETS
Current Assets:
  Cash and cash equivalents.......................................   $ 3,082
  Accounts receivable, net of allowance
   for doubtful accounts of $30...................................     3,676
  Receivable from Patriot American
   Hospitality Partnership, L.P...................................       113
  Inventories.....................................................       251
  Prepaid expenses and other assets...............................       438
                                                                     -------
          Total current assets....................................     7,560
Deferred assets, net of accumulated
 amortization of $21..............................................       437
Investments.......................................................       825
Other assets......................................................       792
                                                                     -------
          Total assets............................................   $ 9,614
                                                                     =======

                        LIABILITIES AND MEMBERS' EQUITY
Current Liabilities:
  Accounts payable................................................   $ 1,168
  Accrued rent due to Patriot American
   Hospitality Partnership, L.P...................................     1,771
  Due to affiliates...............................................       127
  Accrued payroll and benefits....................................     1,599
  Guest deposits..................................................       183
  Accrued expenses and other liabilities..........................     1,244
  FF&E reserve due to Patriot American
   Hospitality Partnership, L.P...................................       636
                                                                     -------
          Total current liabilities...............................     6,728
Due to Patriot American Hospitality
 Partnership, L.P.................................................       242
                                                                     -------
          Total liabilities.......................................     6,970
Commitments and contingencies.....................................        --
Members' Equity:
  Capital contributions...........................................     3,300
  Distributions...................................................       (82)
  Less: Notes receivable from members.............................    (1,000)
                                                                     -------
                                                                       2,218
  Accumulated earnings............................................       426
                                                                     -------
          Total members' equity...................................     2,644
                                                                     -------
          Total liabilities and members' equity...................   $ 9,614
                                                                     =======
</TABLE>
                            See accompanying notes.

                                       25
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                           STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
                                (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                            April 2, 1996 
                                               Three        (inception of 
                                               Months        operations)  
                                               Ended           through
                                            September 30,    September 30,   
                                                1996             1996         
                                            -------------   --------------
<S>                                         <C>             <C>
Revenue:
  Rooms.................................        $10,395         $18,115
  Food and beverage.....................          3,964           7,201
  Telephone and other...................            869           1,576
                                                -------         -------  
     Total revenue......................         15,228          26,892
                                                -------         ------- 
                                                               
Expenses:                                                      
  Departmental costs and other expenses.          5,938          10,577
  Participating lease payments..........          4,770           8,077
  General and administrative............          1,235           2,218
  Ground lease expense..................            289             567
  Repairs and maintenance...............            757           1,378
  Utilities.............................            580             937
  Marketing.............................          1,091           1,880
                                                -------         ------- 
     Total expenses.....................         14,660          25,634
                                                -------         ------- 
     Income before lessee income                
      (expense).........................            568           1,258
                                                -------         ------- 
  Dividend and interest income..........             40              99
  Management fees.......................           (377)           (658)
  Depreciation and amortization.........            (13)            (21)
  Lessee general and administrative             
   expenses.............................           (139)           (252)
                                                -------         -------  
     Total lessee income (expense)......           (489)           (832)
                                                -------         -------
     Net income.........................        $    79         $   426
                                                =======         =======
</TABLE>
                            See accompanying notes.

                                       26
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                         STATEMENT OF MEMBERS' EQUITY
                                  (UNAUDITED)
                                (IN THOUSANDS)

<TABLE>
<CAPTION>
 
                                                       APRIL 2, 1996
                                                       (INCEPTION OF
                                                        OPERATIONS)
                                                          THROUGH
                                                        SEPTEMBER 30,
                                                            1996
                                                       --------------
<S>                                                    <C>
Initial capitalization at inception..................      $ 3,300    
Distributions........................................          (82)   
Notes receivable from members........................       (1,000)   
Net income...........................................          426    
                                                           -------    
Balance, September 30, 1996..........................      $ 2,644    
                                                           =======    
 
</TABLE>
                            See accompanying notes.

                                       27
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                            STATEMENT OF CASH FLOWS
                                  (UNAUDITED)
                                (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                  APRIL 2, 1996
                                                                  (INCEPTION OF
                                                                   OPERATIONS)
                                                                     THROUGH
                                                                  SEPTEMBER 30,
                                                                      1996
                                                                  -------------
<S>                                                               <C>
Cash flows from operating activities:
     Net income...................................................   $   426
     Adjustments to reconcile net income to net cash provided
      by operating activities:
          Provision for losses on accounts receivable.............        30
          Depreciation and amortization...........................        21
     Increase in assets and liabilities:
          Accounts receivable.....................................    (3,706)
          Receivable from Patriot American Hospitality
           Partnership, L.P.......................................       (15)
          Inventories.............................................        (9)
          Prepaid expenses and other assets.......................      (438)
          Accounts payable........................................     1,107
          Accrued rent due to Patriot American Hospitality
           Partnership, L.P.......................................     1,771
          Due to affiliates.......................................       127
          Accrued payroll and benefits............................       698
          Guest deposits..........................................       183
          Accrued expenses and other liabilities..................     1,244
          FF&E Reserve due to Patriot American Hospitality
           Partnership, L.P.......................................       636
                                                                     -------
Net cash provided by operating activities.........................     2,075
                                                                     -------
Cash flows from investing activities:
     Purchase of equipment........................................        (7)
     Payment of organization costs and capitalized lease costs....      (458)
     Payment for deferred purchase consideration..................      (785)
                                                                     -------
Net cash used in investing activities.............................    (1,250)
                                                                     -------

Cash flows from financing activities:
     Cash received from assumption of operating liabilities.......       932
     Payments for capital improvements on behalf of owner.........       (68)
     Capital contributions........................................     1,475
     Distributions................................................       (82)
                                                                     -------
Net cash provided by financing activities.........................     2,257
                                                                     -------
Net increase in cash and cash equivalents.........................     3,082
                                                                     -------
Cash and cash equivalents at end of period........................   $ 3,082
                                                                     =======
Supplemental Disclosure of Non-Cash Investing and
  Financing Activities:
     Contribution of Operating Partnership Units..................   $   825
                                                                     =======
     Inventory received in exchange for a liability to
       Patriot American Hospitality Partnership, L.P..............   $   242
                                                                     =======
     Operating liabilities assumed in exchange for receivables
       from Patriot American Hospitality Partnership, L.P.........   $    30
                                                                     =======
 </TABLE>
                            See accompanying notes.

                                       28
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                         NOTES TO FINANCIAL STATEMENTS
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

ORGANIZATION

     NorthCoast Hotels, L.L.C. ("NorthCoast"), was formed January 10, 1996 to
lease and operate certain hotels owned by Patriot American Hospitality
Partnership, L.P. (the "Operating Partnership").  At September  30, 1996,
Patriot American Hospitality, Inc. (the "Company"), through its subsidiaries,
owns approximately 86.2% of the Operating Partnership.  NorthCoast, a Washington
limited liability company, is owned jointly by Dunson NorthCoast L.L.C.,
Sterling Resources, Inc., WestCoast NC, Inc. (a subsidiary of WestCoast Hotels,
Inc.), and the Thomas H. and Ann A. Childers Family Trust.  NorthCoast will
continue for a term of fifty years unless terminated earlier pursuant to the
terms of the limited liability company agreement.  In general, members are not
personally liable for any debts or losses of NorthCoast that exceed their
respective capital contribution, except as discussed in Note 2, and losses are
generally allocated to the members in proportion to their capital contributions.

     NorthCoast began leasing five hotels on April 2, 1996.  On April 5, 1996,
May 22, 1996 and August 29,1996, NorthCoast and the Operating Partnership
entered into three additional operating leases for three hotels which were
acquired by the Operating Partnership.  At September 30, 1996, NorthCoast leased
eight hotels as follows:
                                                                          Guest
               Property Name                          Location            Rooms
     --------------------------------------   -------------------------   -----
     Hyatt Regency Lexington                  Lexington, Kentucky          365
     Hyatt Newporter                          Newport Beach, California    410
     Plaza Park Suites                        Seattle, Washington          193
     The Roosevelt Hotel                      Seattle, Washington          151
     Valley River Inn                         Eugene, Oregon               257
     WestCoast Gateway Hotel                  Seattle, Washington          145
     WestCoast Long Beach Hotel and Marina    Long Beach, California       192
     WestCoast Wenatchee Center Hotel         Wenatchee, Washington        147
 

     Each hotel is leased by the Operating Partnership to NorthCoast under
separate participating operating lease agreements.  Seven of the eight hotel
leases contain cross-default provisions.  These leases, which require NorthCoast
to maintain a minimum net worth and adequate working capital, have an average
term of eleven years and require payment of the greater of (1) minimum base rent
or (2) participating rent based upon certain percentages of room revenue, food
and beverage revenue, and telephone and other revenues of each of the hotels,
plus certain additional charges, as applicable.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     These financial statements have been prepared in accordance with generally
accepted accounting principles for interim financial information and with the
instructions for Form 10-Q and Article 10 of Regulation S-X. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included.  Operating results for the
three months ended September 30, 1996 and the period April 2, 1996 (inception of
operations) through September 30, 1996 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1996.  Significant
accounting policies are summarized below.

Use of Estimates

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes.  Actual results could differ from those estimates.

                                       29
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

             NOTES TO COMBINED FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

Cash and Cash Equivalents

     All highly liquid investments with an original maturity date of three
months or less when purchased are considered to be cash equivalents.

Inventories

     Inventories, consisting of food, beverages, china, linens, silverware and
glassware, are principally stated at the lower of cost (generally first-in,
first-out) or market.

Deferred Assets

     Deferred assets consist of organization costs and capitalized lease costs.
Amortization of organization costs is computed using the straight-line method
over five years.  Capitalized lease costs are amortized over the average lease
term of eleven years.

Investments

     Investments consist of 31,074 units of limited partnership interest in the
Operating Partnership ("OP Units").  The OP Units are subject to redemption
rights which may be exercised, subject to certain restrictions, at any time
after April 2, 1997, to cause the Operating Partnership to redeem each OP Unit
for cash equal to the value of a share of Company common stock or, at the
Company's election, the Company may purchase each OP Unit offered for redemption
for one share of  the Company's common stock.  Under the participating lease
agreements NorthCoast has collaterally assigned the OP Units to the Operating
Partnership.  NorthCoast accounts for its investment in the OP Units using the
cost method of accounting.  The OP Units are stated at lower of cost or market
based upon the fair market value of the Company's common stock.

Other Assets

     Other assets consists primarily of additional purchase consideration due
from the Operating Partnership on two of the hotels.  NorthCoast purchased the
additional consideration from the selling entities upon acquisition of the
hotels by the Operating Partnership.  Receipt of the additional purchase
consideration is dependent upon the respective hotels achieving certain
operating performance goals in 1997.  Management believes the deferred purchase
consideration will be collected.

Revenue Recognition

     Revenue is recognized upon performance of hotel-related services and
delivery of food and beverages.  Credit evaluations are performed and an
allowance for doubtful accounts is provided against accounts receivable which
are estimated to be uncollectible.

Income Taxes

     Under the provisions of the Internal Revenue Code and applicable state
income tax law, NorthCoast is taxed as a limited liability company, an entity
which is taxed in the same manner as a partnership and, therefore, is not
subject to taxation on income.  The federal and state income tax consequences of
NorthCoast's profits and losses accrue to the limited liability company members.

Concentration of Credit Risk

     Financial instruments which potentially subject NorthCoast to
concentrations of credit risk consist principally of cash balances with banks in
excess of Federal Deposit Insurance Corporation ("FDIC") insured limits,
accounts 

                                       30
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                  NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

receivable from hotel customers and investments in OP Units. NorthCoast places
its cash with high quality financial institutions, however, at September 30,
1996, NorthCoast has cash balances with banks in excess of FDIC insured limits.
Management believes the credit risk related to these deposits is minimal.
Concentrations of credit risk with respect to accounts receivable from hotel
customers are limited due to the large number of customers and their dispersion
across many hotels and geographies. Concentrations of credit risk with respect
to investments in OP Units exist to the extent of potential fluctuations in the
value of the Company's common stock. Management believes the credit risk related
to the OP Units is minimal.

2.  MEMBERS' EQUITY:

Initial Capitalization

     Each of the four members is required to contribute $825 to NorthCoast.
Contributions can be in the form of cash or other property.  At September 30,
1996, cash contributions of $1,475 and OP Units of $825 have been received.

     In addition, notes receivable, bearing interest at 7% per annum, have been
received from Sterling Resources, Inc. in the amount of $225 and from Thomas H.
Childers in the amount of $825.  The note receivable from Sterling Resources,
Inc., which is unsecured, is due in two installments with $50 paid July 31, 1996
and the balance due December 31, 1996.  The note receivable from Thomas H.
Childers is due October 31, 1998, and can be paid with either cash or OP Units.
This note is secured by an approximate 12.6% interest in LeParc Investment
Group, LLC (the "LeParc Entity").   These notes receivable from members have
been offset against members' equity in the accompanying financial statements.
Interest income of $18 and $36 was earned for the three months ended September
30, 1996 and  during the period April 2, 1996 through September 30, 1996,
respectively.

Minimum Net Worth

     Under the terms of the participating lease agreements, NorthCoast is
required to maintain minimum net worth, as defined, equal to the greater of (i)
$2,929, or (ii) beginning in 1997, 20% of the projected annual lease payments
for all hotels leased.  The minimum net worth must be composed of certain
components in specified minimum amounts, including at least 15% in cash or
certain cash equivalents.  No more than 25% of the minimum net worth can be
composed of a promissory note secured by an interest in the LeParc Entity.
NorthCoast is also required to maintain ownership of shares of common stock of
the Company or OP Units of the Operating Partnership with a value of $825.

3.  COMMITMENTS AND RELATED PARTY TRANSACTIONS:

Participating Lease Commitments

     At September 30, 1996, NorthCoast has future lease commitments to the
Operating Partnership under the participating lease agreements through the year
2008.  Minimum future rental payments under these noncancellable operating
leases are as follows:
<TABLE>
<CAPTION>
 
               Year Ending December 31,            Amount
               ------------------------           --------
               <S>                                <C>
               1996.............................  $  3,862
               1997.............................    15,795
               1998.............................    15,467
               1999.............................    15,467
               2000.............................    15,467
               Thereafter.......................    85,629
                                                  --------
                                                  $151,687
                                                  ========
</TABLE>

     NorthCoast incurred rents of $4,770 for the three months ended September
30, 1996 and $8,077 during the period April 2, 1996 through September 30, 1996.
At September 30, 1996, NorthCoast owed the Operating Partnership 

                                       31
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                  NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

$1,771 for rents under the terms of the participating leases, including (i)
deferred rent of $448 payable ratably over the remainder of 1996, which bears
interest at 9.75%, and (ii) $51 payable based on the acheivement of certain
performance criteria at one hotel, with 50% payable in 1998 and the remainder
payable in 1999.

     Under the participating lease agreements, NorthCoast is obligated to return
to the Operating Partnership the inventory at each of the hotels at the end of
the related lease term.  As of September 30, 1996, the balance of the inventory
due to the Operating Partnership was $242.  In addition, two of the hotels are
managed by Hyatt Corporation ("Hyatt").  Under the terms of the hotel management
agreements, Hyatt is required to fund a percentage of the hotel gross revenues
to a reserve account for the future acquisition of furniture, fixtures and
equipment (the "FF&E Reserve").  At September 30,1996, the FF&E Reserve payable
to the Operating Partnership was $636.

Management and Franchise Agreements

     Six of the eight hotels leased by NorthCoast are managed by WestCoast
Hotels, Inc. ("WestCoast Hotels"), and are operated under a franchise agreement
with WestCoast Marketing, Inc.  WestCoast Hotels receives a hotel management fee
per hotel of $2 per month in 1996 for four of the six hotels and 1% of gross
room revenue, as defined, for the WestCoast Long Beach Hotel and Marina and the
Valley River Inn.  All management fees payable to WestCoast Hotels greater than
1% of hotel revenues are subordinate to NorthCoast's obligations to the
Operating Partnership under the terms of the participating lease agreements.
WestCoast Marketing, Inc. receives a franchise fee of 2.5% of gross room
revenues, as well as certain reservation fees in connection with the use of the
WestCoast brand.  Two of the eight hotels are managed by Hyatt and include an
asset management agreement with WestCoast Hotels.  WestCoast Hotels receives an
asset management fee in 1996 on the Hyatt Regency Lexington of $6 per month and
on the Hyatt Newporter of $2 per month.

     Hyatt  receives management fees ranging from 3.5% to 5% of gross revenues
plus incentive fees if certain operating results based on cash flow and profits
(as defined) are achieved by the hotels.  In addition, the management agreement
with Hyatt provides for the allocation of certain advertising, marketing and
reservation related expenses incurred by Hyatt to all hotels in the Hyatt chain
based upon the number of total rooms available during the year.

Management Contract for Convention Center

     The WestCoast Wenatchee Center Hotel has entered into an agreement with the
City of Wenatchee (the "City") to provide management services for the Wenatchee
Center, including marketing and space rental for meetings, conferences and
banquets.  The agreement, which commenced in October 1980, provides for an
initial term of seven years and the option to extend the agreement for three
consecutive periods of seven years each.  The WestCoast Wenatchee Center Hotel
pays the City fees based on the greater of $50 annually, adjusted for the
increase in the Consumer Price Index, or a percentage of gross revenues from
operation of the hotel.

Ground Lease

     NorthCoast has commitments under two ground lease agreements.  The term of
the lease for the Hyatt Newporter Hotel is through December 31, 2048 and the
lease is subject to an escalation clause for each five-year period based on the
Consumer Price Index, not to exceed 8% per year compounded annually for the five
years then ending.  In addition, the lease requires the hotel to pay a
percentage of its annual sales, as defined in the related lease agreement, with
minimum annual lease payments of $722.

     The term of the lease for the WestCoast Long Beach Hotel and Marina is
through March 31, 2052.  Annual minimum rent payments are approximately $173
through September 30, 1999, at which time the rent will be negotiated for the
next five-year period.  Percentage rent is payable, if in excess of the minimum
rent, based upon certain percentages of room revenue, food and beverage revenue,
and telephone and other revenues of the hotel.

                                       32
<PAGE>
 
                           NORTHCOAST HOTELS, L.L.C.

                  NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
                                  (UNAUDITED)
                            (DOLLARS IN THOUSANDS)

Employment and Other Agreements

     NorthCoast has entered into an employment agreement with Thomas H.
Childers, pursuant to which Mr. Childers serves as President of NorthCoast for a
term of five years at an initial annual base compensation of $120.

     NorthCoast fully reimburses WestCoast Hotels for office space it occupies
within the corporate offices of WestCoast Hotels and for the payroll and related
costs WestCoast Hotels administers on behalf of NorthCoast.  As of September 30,
1996, the amount paid to WestCoast Hotels for these costs was $6 for the three
months ended September 30, 1996 and $12 during the period April 2, 1996 through
September 30, 1996.

4.  PRO FORMA FINANCIAL INFORMATION:

     The following unaudited pro forma statements of operations are presented as
if the leases and the operation of the eight hotels leased by NorthCoast had
commenced on January 1, 1995.  The unaudited pro forma statements of operations
are not necessarily indicative of what the actual results of operations of
NorthCoast would have been assuming such operations had commenced as of January
1, 1995, nor do they purport to represent the results of operations for future
periods.  Pro forma lessee expenses  represent management fees and estimated
lessee overhead expenses and exclude pro forma dividend income on 31,074 OP
Units and interest income associated with working capital balances.
<TABLE>
<CAPTION>

                                                 NINE MONTHS ENDED SEPTEMBER 30,
                                                 -------------------------------
                                                     1995               1996
                                                 ------------       ------------
                                                         (IN THOUSANDS)
<S>                                              <C>                <C>
Revenue:
     Rooms.....................................     $27,048           $30,653
     Food and beverage.........................      12,534            13,877
     Telephone and other.......................       2,175             2,572
                                                    -------           -------
          Total revenue........................      41,757            47,102
                                                    -------           -------
Expenses:
     Departmental costs and expenses...........      17,357            19,871
     Participating lease payments..............      11,740            13,101
     General and administrative................       3,324             4,335
     Ground lease expense......................         667               856
     Repairs and maintenance...................       2,265             2,630
     Utilities.................................       1,578             1,717
     Marketing.................................       3,020             3,400
     Insurance.................................         218               206
                                                    -------           -------
          Total expenses.......................      40,169            46,116
                                                    -------           -------
Income before lessee expenses..................       1,588               986
Lessee expenses................................         992             1,359
                                                    -------           -------
     Net income (loss).........................     $   596           $  (373)
                                                    =======           =======

</TABLE>

                                       33
<PAGE>
 
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

  The accompanying discussion and analysis of financial condition and results of
operations is based on the consolidated financial statements of the Company, the
financial statements of CHC Lease Partners, Inc. ("CHC Lease Partners"), the
combined historical financial statements of the Initial Hotels, and the
financial statements of NorthCoast Hotels, L.L.C. ("NorthCoast") which are
included elsewhere in this Quarterly Report.  The following discussion and
analysis should be read in conjunction with the accompanying financial
statements and related notes thereto.  This discussion contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Security Exchange Act of 1934, as amended.  The
Company's actual results could differ materially from those set forth in the
forward-looking statements.  Certain factors that might cause a difference
include, but are not limited to, the Company's dependence upon rental payments
from the Lessees for substantially all the Company's income and the dependence
upon the abilities of the Lessees and Operators to manage the hotels, risks
associated with the hotel industry and real estate markets in general, and risks
associated with debt financing.

BACKGROUND

  Patriot American Hospitality, Inc. (collectively with its subsidiaries, the
"Company"), a Virginia corporation, was formed April 17, 1995 as a self-
administered real estate investment trust ("REIT") for the purpose of acquiring
equity interests in hotel properties.  On October 2, 1995, the Company completed
its initial public offering (the "Initial Offering") of 14,605,000 shares of its
common stock and commenced operations.  The Company, through its wholly-owned
subsidiary, PAH LP, Inc.,  contributed substantially all of the net proceeds of
the Initial Offering to Patriot American Hospitality Partnership, L.P. (the
"Operating Partnership") in exchange for an approximate 85.3% limited
partnership interest in the Operating Partnership.  The Company, through its
wholly-owned subsidiary, PAH GP, Inc., is the sole general partner and the
holder of a 1.0% general partnership interest in the Operating Partnership.

  The Operating Partnership used approximately $263,600,000 of the net proceeds
from the Company to acquire 20 hotel properties with a total of 4,206 guest
rooms (the "Initial Hotels") from various entities and repay existing mortgages
and other indebtedness of the Initial Hotels.  In addition, in connection with
the Initial Offering, the Company closed on a Line of Credit with Paine Webber
Real Estate Securities, Inc. ("Paine Webber Real Estate") to be utilized
primarily for the acquisition of additional hotels, renovation of certain hotels
and for working capital.  Since the Initial Offering, the Company has invested
approximately $388,114,000 in the acquisition of hotel properties (including
purchase prices and acquisition-related expenses).

  On November 15, 1995, the Company acquired the 223-suite Embassy Suites Hotel
in Hunt Valley, Maryland for cash of approximately $15,961,000.  The purchase
was paid for with a portion of the remaining net proceeds from the Initial
Offering.

  On December 1, 1995, PAH Ravinia, Inc. ("PAH Ravinia"), a Virginia corporation
of which the Company owns an approximate 99% non-voting ownership interest,
acquired the 495-room Crowne Plaza Ravinia Hotel in Atlanta, Georgia.  The
Company paid approximately $4,456,000 for its 99% ownership interest in PAH
Ravinia and advanced to PAH Ravinia an aggregate of $40,500,000 in first and
second lien mortgage notes (the "Mortgage Notes") for the purchase of the hotel.
The investment in PAH Ravinia and funding of the Mortgage Notes was paid for in
part with the remaining net proceeds from the Initial Offering and in part with
borrowings from the Company's Line of Credit in the amount of $9,500,000.

  During the first quarter of 1996, the Company acquired three additional hotel
properties in three states with an aggregate 830 guest rooms.  The Company
acquired the 288-room Tremont House Hotel in Boston, Massachusetts in January
1996, for approximately $16,482,000 in cash.  The purchase was financed
primarily with funds drawn on the Line of Credit. In March 1996, the Company
acquired the 297-room Holiday Inn Lenox Hotel in Atlanta, Georgia and the 245-
room Del Mar Hilton in Del Mar (San Diego), California.  The Holiday Inn Lenox
Hotel is subject to a 73-year ground lease and was acquired for approximately
$7,340,000 in cash and 167,012 OP Units valued at approximately $4,739,000 based
upon the market price of the Company's common stock at the closing of the
acquisition.  The cash portion of the purchase was funded with a draw on the
Line of Credit.  The Del Mar Hilton Hotel was acquired for approximately
$14,765,000 in cash.  The purchase was also financed primarily with funds drawn
on the Line of Credit.

  In April 1996, the Company acquired the six hotel WestCoast Portfolio for
approximately $75,630,000 in cash and 331,577 OP Units, valued at approximately
$8,800,000 at the closing of the acquisition.  The portfolio includes the 

                                       34
<PAGE>
 
194-suite Plaza Park Suites, the 151-room Roosevelt Hotel and the 145-room
WestCoast Gateway Hotel, all in Seattle, Washington; the 410-room Hyatt
Newporter in Newport Beach, California; the 192-room West Coast Long Beach Hotel
and Marina in Long Beach, California; and the 147-room WestCoast Wenatchee
Center Hotel in Wenatchee, Washington. The cash portion of the purchase was
financed primarily with funds drawn on the Line of Credit.

  In May 1996, the Company acquired the 365-room Hyatt Regency in Lexington,
Kentucky for approximately $14,320,000 in cash.  In June 1996, the Company
acquired the 180-room Doubletree Denver/Boulder in Westminster (Denver),
Colorado for approximately $12,520,000 in cash.  These purchases were financed
primarily with funds drawn on the Line of Credit.

  In July 1996, the Company acquired the 472-room Wyndham Greenspoint Hotel
located in Houston, Texas and the 191-room Wyndham Garden-Midtown located in
Atlanta, Georgia for approximately $61,242,000 (including acquisition related
expenses) and 17,036 OP Units valued at approximately $500,000 at the time of
the acquisition. In addition, the Company may be obligated to pay up to
$3,000,000 of additional consideration upon the achievement of certain future
operating results of these hotels which management considers unlikely. In
connection with the acquisition, the Company agreed to maintain at least
$22,000,000 of debt on the Wyndham Greenspoint Hotel (the "Greenspoint Loan")
until the end of 1999. Paine Webber Real Estate Services, Inc. has extended the
$22,000,000 loan on economic terms similar to the Line of Credit.

  In August 1996, the Company acquired the 492-room Bonaventure Hotel & Spa (the
"Bonaventure") a full service spa, resort and conference facility located in
Fort Lauderdale, Florida for approximately $19,656,000, including approximately
$3,456,000 relating to the assumption of operating liabilities and acquisition
costs. In addition during August 1996, the Company acquired the 257-room Valley
River Inn located in Eugene, Oregon for approximately $19,053,000 including
acquisition costs. These purchases were financed primarily with funds drawn on
the Line of Credit.

  During September 1996, the Company entered into three partnership agreements
with DTR PAH Holdings, Inc. ("DTR"), an affiliate of Doubletree Hotels
Corporation, whereby the Operating Partnership owns a 90% general partnership
interest and DTR owns a 10% limited partnership interest in three partnerships.
The partnerships, formed for the purpose of acquiring certain hotel properties,
are PAH-DT Tallahasse Partners, L.P. ("Tallahassee Partners"), PAH-DT Chicago
O'Hare Partners, L.P. ("Chicago Partners") and PAH-DT Miami Airport Lakes
Partners, L.P. ("Miami Partners").

  Tallahassee Partners acquired the 244-room Capitol Plaza Holiday Inn in
Tallahasse, Florida for approximately $11,186,000, including acquisition related
costs.  Chicago Partners acquired the 242-room Holiday Inn Des Plaines Hotel in
Des Plaines, Illinois located near the Chicago O'Hare International Airport for
approximately $8,539,000, including acquisition related costs.  Miami Partners
acquired the 264-room Holiday Inn-Miami Lakes Hotel in Miami, Florida located
within the Blue Lagoon area near the Miami International Airport for
approximately $12,513,000, including acquisition related costs.   The Company
plans to spend an aggregate of approximately $12,000,000 to renovate the hotels.
Once the renovations are complete the hotels will be renamed and rebranded with
the Doubletree and Doubletree Club brands.  These acquisitions were financed
with a combination of cash and funds drawn on the Line of Credit.

  PAH Windwatch, LLC, ("PAH Windwatch"), a Delaware limited liability
corporation, of which the Company owns an approximate  99% non-voting ownership
interest, acquired the 362-room Marriott WindWatch Hotel located in Hauppauge
(Long Island), New York for approximately $31,102,000, including related
acquisition costs, in September 1996.  The Company's investment in PAH Windwatch
of approximately $6,217,000 is evidenced by a promissory note. The Company
advanced to PAH Windwatch $31,400,000 in a first lien mortgage note for the
purchase of the hotel.  The funding of the mortgage note was paid for primarily
with funds drawn on the Line of Credit.

  The Company also acquired the 184-room Mayfair Suites Hotel, a full service
hotel located in St. Louis, Missouri for approximately $8,810,000, including
related acquisition costs, in September 1996. The acquisition was primarily
financed with funds drawn on the Line of Credit.

  As of  September 30, 1996, the Company, through the Operating Partnership, PAH
Ravinia, PAH Windwatch and other partnerships, owned 42 hotel properties in 16
states with an aggregate 10,246 guest rooms (the "Hotels").  The Hotels are
diversified by franchise or brand affiliation and serve primarily major U.S.
business centers, including Atlanta, Boston, Chicago, Cleveland, Dallas, Denver,
Houston, Miami, New York and Seattle.  In addition to hotels catering primarily
to business travelers, the Hotels include prominent hotels in major tourist
destinations, including New Orleans, San Antonio, Fort Lauderdale and San Diego.
The Hotels include 35 full service hotels, 5 limited service 

                                       35
<PAGE>
 
hotels, an executive conference center and a resort property. Thirty-three of
the Hotels are operated under franchise or brand affiliations with nationally
recognized hotel companies.

  In order for the Company to qualify as a REIT, neither the Company nor the
Operating Partnership can operate hotels.  Therefore, the Operating Partnership
leases each of the Hotels, except the Crowne Plaza Ravinia Hotel and the
Marriott WindWatch Hotel, to lessees that are independent of the Company (the
"Lessees") pursuant to separate Participating Leases for staggered lease terms
of ten to twelve years.  The Participating Leases provide for the payment of the
greater of base rent or participating rent, plus certain additional charges
which vary with the Participating Lease.  Twenty-four of the Hotels are leased
to CHC Lease Partners;  the hotels in the WestCoast Portfolio, the Hyatt Regency
and the Valley River Inn are leased to NorthCoast;  DTR North Canton, Inc. (the"
Doubletree Lessee") leases four of the Hotels including the Doubletree
Westminster and the Hotels acquired by Tallahassee Partners, Chicago Partners
and Miami Partners;  Crow Hotel Lessee, Inc. (the "Wyndham Lessee") leases the
Wyndham Greenspoint Hotel and the Wyndham Garden-Midtown;  Metro Hotels Leasing
Corporation ("Metro Lease Partners") leases the Embassy Suites Hotel;  and
Mayfair Leasing, LLC,  (the "Mayfair Lessee")  leases the Mayfair Suites Hotel.
The Crowne Plaza Ravinia Hotel and the Marriott WindWatch Hotel acquisitions
were structured without  lessees for reasons specific to each acquisition.  As a
result, the Company receives its income from these Hotels' operations as income
from unconsolidated subsidiaries instead of lease income.

  The Operating Partnership's, and therefore the Company's, primary source of
revenue is lease payments by the Lessees under the Participating Leases.
Participating Rent is based primarily upon the Hotels' room revenue, and to a
lesser extent, food and beverage, conference center and other revenue.  The
Lessees' ability to make payments to the Operating Partnership under the
Participating Leases is dependent upon their ability to generate cash flow from
the operation of the Hotels.

  The Lessees, PAH Ravinia and PAH Windwatch in turn have entered into separate
management agreements with Operators to operate the Hotels. CHC Lease Partners
has entered into management agreements whereby 23 of the Hotels are managed by
affiliates of CHC Lease Partners and one Hotel is managed by Metro Hotels Joint
Venture ("Metro Hotels"), an affilate of Metro Lease Partners. NorthCoast has
entered into management agreements whereby WestCoast Hotels, Inc. ("WestCoast
Hotels"), a hotel management company affiliated with NorthCoast, manages each of
the hotels in the WestCoast Portfolio except the Hyatt Newporter Hotel and the
Hyatt Regency in Lexington. The Hyatt Newporter Hotel and the Hyatt Regency in
Lexington are managed by Hyatt Corporation ("Hyatt") pursuant to separate
management agreements between NorthCoast and Hyatt. Metro Lease Partners has
entered into a management agreement with Metro Hotels to manage the Embassy
Suites in Hunt Valley, Maryland. The Doubletree Lessee has entered into a
management agreement with a subsidiary of Doubletree Hotels to manage the four
hotels leased by the Doubletree Lessee. The Wyndham Lessee has entered into
management agreements with an affiliate of Wyndham Hotels Corporation to manage
the two hotels leased by the Wyndham Lessee, and Mayfair Lessee has entered into
a management agreement with Grand Heritage Hotels Corporation to manage the
hotel leased by the Mayfair Lessee. The Crowne Plaza Ravinia is being managed by
Holiday Inns, Inc. pursuant to a management agreement between PAH Ravinia and
Holiday Inns, Inc. The Marriot WindWatch Hotel is being managed pursuant to a
management agreement between PAH Windwatch and Marriott International, Inc.

  Additionally during the third quarter of 1996,  the Company completed a public
offering (the Follow-on Offering") of 6,146,740 shares of its common stock
(including 646,740 shares of common stock issued upon exercise of the
underwriters' over-allotment option).  The offering price of all of the shares
in the Follow-on Offering was $28.25 per share, resulting in net proceeds (less
underwriter's discount and offering expense ) of approximately $160,222,000 of
which approximately $151,963,000 was used by the Company to reduce the amounts
outstanding under the Line of Credit.

RECENT DEVELOPMENTS

  In October 1996, the Company entered into a binding agreement to acquire
California Jockey Club and Bay Meadows Operating Company for $33.00 per share in
cash or .9635 shares of the Company's stock.  The shares of California Jockey
Club, a real estate investment company, and Bay Meadows, a real estate
management and operating company (together, "Cal Jockey and Bay Meadows"), are
paired and trade as a single unit.  Based on approximately 5.9 million fully
diluted paired shares of Cal Jockey and Bay Meadows outstanding, the acquisition
is valued at approximately $195,000,000.  Pursuant to the agreement, the Company
has advanced $2,900,000 to California Jockey Club of the payment of a breakup
fee which is due upon termination of a prior acquisition agreement.  Under the
terms of the agreement, the Company is entitled to repayment of the $2,900,000
advance plus a $5,000,000 fee if the acquisition agreement is terminated.

                                       36
<PAGE>
 
  The Company has also entered into non-binding purchase and sale agreements to
acquire the 147-room historic Tutwiler Hotel in Birmingham, Alabama for a
purchase price of approximately $10,400,000 in cash and OP Units valued at
approximately $600,000;  the 124-room historic Union Station Hotel in Nashville,
Tennessee for a purchase price of approximately $9,100,000 in cash and OP Units
valued at approximately $600,000; and the 189-room Howard Johnson Pickwick Hotel
in San Fransico, California for a purchase price of approximately $14,475,000.

  The acquisition of Cal Jockey and Bay Meadows, the above-described hotels or
any other properties is subject to a number of contingencies, including, among
other things, the satisfactory completion of the Company's due diligence
investigation of the transactions, the negotiation of a definitive acquisition
agreement and obtaining financing and/or Line of Credit lender approval, as
applicable. Accordingly, there can be no assurance that the acquisition of Cal
Jockey and Bay Meadows, the above-described hotels or any other properties will
be consummated.

RESULTS OF OPERATIONS OF THE COMPANY

Actual (for the Nine Months Ended September 30, 1996)

  For the nine months ended September 30, 1996, the Company earned $52,735,000
in Participating Lease revenue from the Lessees, which is net of leasing cost
amortization of $76,000. Interest and other income, which was $412,000 for the
period, consisted primarily of interest income earned on invested cash balances
of the Company's capital improvement reserves.  Depreciation and amortization
for the period was $11,628,000.  Real estate and personal property taxes and
insurance for the period were $4,452,000 and rent payments on ground leases were
$711,000.  General and administrative expenses were $3,273,000 (including
amortization of unearned stock compensation of $630,000).  The Company reported
$4,481,000 of interest expense for the period which consists of $4,168,000 of
interest incurred on the Line of Credit balance outstanding, $40,000 of other
interest expense and $273,000 of amortization of deferred financing costs. The
Company's share of income from unconsolidated subsidiaries was $4,377,000.  The
minority interests' share of income of the Company was $5,144,000 (representing
the minority partners' interest in the Operating Partnership of $5,142,000 and
in other partnerships of $2,000).  The resulting net income applicable to common
shareholders was $27,835,000.

Pro Forma

  For the nine months ended September 30, 1996, the Company's pro forma lease
revenue increased 6.7% to $69,728,000 in 1996 from $65,328,000 for 1995,
reflecting improvements in average room rates at the Hotels during 1996 (see pro
forma Results of Operations of Lessees below). Total pro forma expenses
increased from $34,054,000 for the nine months ended September 30, 1995 to
$35,556,000 for the nine months ended September 30, 1996, an increase of
$1,502,000, or 4.4%.  This increase is primarily attributable to pro forma
general and administrative expense, which increased by $899,000 in 1996 compared
to 1995 as a result of increases in staffing, cost of amortization of unearned
stock  compensation, and certain professional fees and consultant costs.  Pro
forma real estate taxes and personal property taxes and casualty insurance
increased by $315,000.  Depreciation and amortization increased by $700,000.
Interest expense decreased by $433,000 as a result of decreases in the 30-day
LIBOR rate (for the first nine months of 1996 as compared to the first nine
months of 1995) upon which the Line of Credit interest rate is based.  In
addition, the Company's pro forma equity in earnings of its unconsolidated
subsidiaries increased from $3,351,000 for the first nine months of 1995 to
$5,748,000 for the first nine months of 1996 as a result of improvement in
operating results of the Crowne Plaza Ravinia Hotel and the Marriott WindWatch
Hotel.  As a result of the above, pro forma net income increased to $34,655,000
in 1996 from $29,723,000 in 1995.

Funds from Operations

  Funds from Operations (as defined and computed below) was $19,546,000 for the
three months ended September 30, 1996 and $46,129,000 for the nine months ended
September 30, 1996.  On a pro forma basis, Funds from Operations was $59,356,000
for the nine months ended September 30, 1996.

  The Company considers Funds from Operations to be a key measure of REIT
performance.  Funds from Operations represents net income (loss) (computed in
accordance with generally accepted accounting principles), excluding gains (or
losses) from debt restructuring or sales of property, plus depreciation of real
property, and after adjustments for unconsolidated partnerships, joint ventures
and corporations.  Adjustments for the Company's unconsolidated subsidiaries are
calculated to reflect Funds from Operations on the same basis.  The Company has
also 

                                       37
<PAGE>
 
made certain adjustments to Funds from Operations for real estate related
amortization.  Funds from Operations should not be considered as an alternative
to net income or other measurements under generally accepted accounting
principles as an indicator of operating performance or to cash flows from
operating, investing or financing activities as a measure of liquidity.  Funds
from Operations does not reflect working capital changes, cash expenditures for
capital improvements or principal payments on indebtedness.

  The following reconciliation of net income to Funds from Operations for the
quarter and the nine months ended September 30, 1996 illustrates the difference
between the two measures of operating performance:
<TABLE>
<CAPTION>
 
                                                     Three            Nine
                                                     Months          Months
                                                     Ended           Ended
                                                  September 30,   September 30,
                                                      1996            1996
                                                  --------------  --------------
<S>                                               <C>             <C>
Net income......................................     $12,024         $27,835
Add:
  Minority interest in Operating Partnership....       2,168           5,142
  Depreciation of buildings and improvements 
   and furniture, fixtures and equipment........       4,814          11,539
  Amortization of franchise fees................          22              66
  Amortization of capitalized lease costs.......          30              76
Adjustments for funds from operations of 
 unconsolidated subsidiaries:
  Equity in earnings of unconsolidated 
   subsidiaries.................................      (1,772)         (4,377)
  Funds from Operations of unconsolidated 
   subsidiaries.................................       2,260           5,848
                                                     -------         ------- 
Funds from Operations...........................     $19,546         $46,129
                                                     =======         =======
The Company's share of Funds from                    
 Operations.....................................     $16,562         $38,933
                                                     =======         ======= 
Fully diluted weighted average shares                 
 and OP Units outstanding.......................      23,405          19,691
                                                     =======         ======= 
Weighted average number of common shares and 
 common share equivalents outstanding...........      19,904          16,677
                                                     =======         ======= 
</TABLE>

RESULTS OF OPERATIONS OF THE LESSEES

Actual (for the Nine Months Ended September 30, 1996)

     CHC Lease Partners.  For the nine months ended September 30, 1996, CHC
Lease Partners had room revenues of $81,869,000 from the 24 Hotels it leases.
Food and beverage, conference center and other revenues were $34,163,000 for the
period. Participating Lease payments and hotel operating expenses were
$40,068,000 and $72,928,000, respectively, and net income was $1,048,000.

     NorthCoast.  For the period April 2, 1996 (inception of operations) through
September 30, 1996, NorthCoast had room revenues of $18,115,000 from the eight
Hotels it leases.  Food and beverage, and other revenues were $8,777,000 for the
period. Participating Lease payments and hotel operating expenses were
$8,077,000 and $17,557,000, respectively, and net income was $426,000.

     Combined Lessees (CHC Lease Partners, NorthCoast, Metro Lease Partners,
Doubletree Lessee, Wyndham Lessee and Mayfair Lessee combined).  For the nine
months ended September 30, 1996, the combined Lessees had room revenues of
$109,099,000.  Food and beverage, conference center and other revenues were
$46,809,000 for the period. Participating Lease payments and hotel operating
expenses were $52,735,000 and $98,541,000, respectively, and net income was
$1,382,000.

                                       38
<PAGE>
 
Pro Forma Comparison of the Nine Months Ended September 30, 1996 and 1995

     CHC Lease Partners.  Pro forma room revenue increased from $85,689,000 in
1995 to $90,984,000 in 1996, an increase of $5,295,000 or 6.2%.  Pro forma
average occupancy decreased from 72.0% in 1995 to 70.7% in 1996 as part of the
business plan which raised average daily rates by 8.0%, from $78.77 in 1995 to
$85.08 in 1996.  The result was a 6.0% increase in pro forma revenue per
available room from $56.74 in 1995 to $60.13 in 1996.  This overall increase in
revenue per available room was net of decreases at certain hotels.  The hotels
continue to benefit from improvement in market conditions in the U.S. lodging
industry and completion of renovations at certain of the hotels.  Four of the
Initial Hotels completed renovations in 1995 that were begun in 1994.

     Pro forma food and beverage revenue decreased from $31,196,000 in 1995 to
$30,689,000 in 1996, a total of $507,000, a decrease of 1.6% due to lower
occupancies.  Pro forma conference center revenue decreased from $1,858,000 to
$1,652,000, a decrease of $206,000, or 11.1%, due primarily to decreased
conference facility utilization in 1996 compared to 1995.  Telephone and other
revenue increased from $9,169,000 to $9,617,000, an increase of $448,000, or
4.9%, due primarily to higher forfeitures of deposits on room cancellations and
as a result of the Olympic games held in Atlanta in July 1996.

     Pro forma Participating Lease payments were $42,782,000 for 1996 compared
to $40,194,000 in 1995, an increase of 6.4%.  Pro forma hotel operating expenses
increased from $86,595,000 to $87,631,000, an increase of $1,036,000 or 1.2%.
Of this amount, $473,000 was attributable to a 1.0% increase in departmental
costs and expenses, primarily salaries and benefits.  Pro forma general and
administrative expenses increased $505,000, or 4.5%, due to higher salaries and
benefits costs.  Pro forma marketing expenses increased $158,000, or 1.3%, as a
result of increased marketing efforts at newly renovated hotels.  Pro forma
hotel operating expenses as a percentage of total revenue decreased from 67.7%
in 1995 to 66.0% in 1996.

     Lessee expenses, which on a pro forma basis consist of management fees and
overhead expenses, increased by $273,000 which is primarily attributable to
increased management fees resulting from higher revenues.  CHC Lease Partners'
pro forma net loss was $211,000 in 1995 compared to net income of $922,000 in
1996.

     NorthCoast.  Pro forma room revenue increased from $27,048,000 in 1995 to
$30,653,000 in 1996, an increase of $3,605,000 or 13.3%.  Pro forma average
occupancy remained relatively stable, decreasing from 70.2% in 1995 to 70.0% in
1996.  Pro forma average daily rates increased by 6.0%, from $81.38 in 1995 to
$86.25 in 1996.  The result was a 5.6% increase in pro forma revenue per
available room from $57.16 in 1995 to $60.34 in 1996.

     Pro forma food and beverage revenue and telephone and other revenue
increased from $14,709,000 to $16,449,000, a total of $1,740,000, an increase of
11.8%, as a result of increased catering and convention business.

     Pro forma Participating Lease payments were $13,101,000 for 1996 compared
to $11,740,000 in 1995, an increase of 11.6%.  Pro forma hotel operating
expenses increased from $28,429,000 to $33,015,000, an increase of $4,586,000 or
16.1%.  Of this amount, $2,514,000 was attributable to a 14.5% increase in
departmental costs and expenses, primarily salaries and benefits.  General and
administrative expenses increased $1,011,000, or 30.4%, due to higher salaries
and benefits costs.  Pro forma hotel operating expenses as a percentage of total
revenue increased from 68.1% in 1995 to 70.1% in 1996.  The operating expenses
for the NorthCoast hotels include ground lease expense of $667,000 in 1995 and
$856,000 in 1996 which represents 1.6% of total revenue in 1995 and 1.8% of
total revenue in 1996.

     Lessee expenses, which on a pro forma basis consist of management fees and
overhead expenses, increased by $367,000 which is primarily attributable to
increased management fees resulting from higher revenues.  NorthCoast's net
income on a pro forma basis was $596,000 in 1995 compared to a net loss of
$373,000 in 1996.

     Combined Lessees (CHC Lease Partners, NorthCoast, Metro Lease Partners,
Doubletree Lessee, Wyndham Lessee and Mayfair Lessee combined).  On a combined
basis, pro forma room revenue from the hotels was $151,176,000 for the nine
months ended September 30, 1996, an increase of 7.0% from $141,253,000 in the
first nine months of 1995.  Pro forma average occupancy for all leased hotels
decreased 1.7%, from 71.8% for the first nine months of 1995 to 70.6% in 1996.
However, pro forma average daily rates increased 7.0%, from $77.61 in 1995 to
$83.08 in 1996, resulting in a 5.3% growth in revenue per available room from
$55.70 in 1995 to $58.66 in 1996.  Food and beverage, conference center and
other revenues increased 2.3% to $71,597,000 for 1996 compared to $69,960,000
for 1995.  Combined pro forma Participating Lease payments were $69,728,000 for
1996 compared to $65,328,000 in 1995, a 6.7% increase.  Hotel operating expenses
on a pro forma basis increased 4.5% to $150,220,000 for the nine 

                                       39
<PAGE>
 
months ended September 30, 1996 compared to $143,783,000 for 1995. Combined pro
forma net loss for the nine months ended September 30, 1996 was $1,350,000
compared to $1,298,000 in 1995.

RESULTS OF OPERATIONS OF THE INITIAL HOTELS

     For the Nine Months Ended September 30, 1995.  The Initial Hotels had room
revenues of $65,192,000 for the nine months ended September 30, 1995.  Average
occupancy was 73.3% for the nine month period and the average daily rate was
$77.15, which represents an increase over 1994.  The increases in both occupancy
and average daily rates were primarily due to improving conditions in the U.S.
lodging industry, completion of renovations at eight of the Initial Hotels
during 1994 and increased sales and marketing efforts.  Food and beverage,
conference center and other revenue for the period was $29,568,000, which
represents a net increase compared to 1994 due primarily to increased occupancy
rates.

     Departmental and other expenses (departmental costs and expenses, general
and administrative, repairs and maintenance, utilities, marketing and management
fees) for the period were $65,826,000, an increase from 1994 expense levels.
However, as a percentage of total revenue, departmental and other expenses
increased from 69.1% in 1994 to 69.5%.  As a result, income before fixed
expenses (calculated as total revenues less departmental and other expenses) was
$28,934,000 or 30.5% of total revenue for the period, a 1.3% decrease from the
1994 average of 30.9%.

     Fixed expenses (composed of interest expense, real estate and personal
property taxes, insurance, and depreciation and amortization),  totaled
$22,633,000 for the period, which represented an increase over 1994, due
primarily to a one-time participating debt payment at the Bourbon Orleans Hotel
of $1,242,000 as well as increased interest costs on new indebtedness incurred
by the Initial Hotels in 1995.  Net income for the period was $4,498,000 and
reflects an extraordinary loss from debt extinguishment on the Bourbon Orleans
Hotel of $1,803,000.

LIQUIDITY AND CAPITAL RESOURCES

     In May 1996, the maximum amount available under the Line of Credit was
increased from $165,000,000 to $250,000,000 and certain modifications were made,
thereby increasing the Company's ability to borrow under the Line of Credit.  In
connection with the acquisition of the Wyndham Greenspoint Hotel, the Company
has obtained the $22,000,000 Greenspoint Loan from Paine Webber Real Estate.
Borrowings under the Greenspoint Loan bear interest at a rate per annum equal to
30-day LIBOR plus 1.9%.  In July 1996, the Line of Credit was further modified
to provide that while the Greenspoint Loan is outstanding, the maximum amount
that the Company may draw on the Line of Credit will be $228,000,000.  The Line
of Credit and the Greenspoint Loan are cross-defaulted.  At September 30, 1996,
the Company had approximately $91,592,000 outstanding on the Line of Credit.
The Line of Credit is collateralized by first mortgage liens on 25 of the Hotels
and a second mortgage lien on the Wyndham Greenspoint Hotel.  Borrowings under
the Line of Credit bear interest at a rate per annum equal to 30-day LIBOR plus
1.9%.

     In May 1996, the Company sold an aggregate of approximately $40,000,000 of
securities to an institutional investor in a private placement.  The securities
consisted of 811,393 shares of common stock sold at $26.95 per share and 662,391
Preferred OP Units (the "Preferred OP Units") sold at $27.375 per unit.  The
common stock is of the same class as the Company's existing common stock and is
entitled to the same voting and dividend rights as all outstanding common stock,
subject to certain restrictions on the resale of the stock.  The Preferred OP
Units are entitled to quarterly distributions equal to 103% of the current
quarterly dividends paid on the common stock.  Distributions on the Preferred OP
Units increase or decrease concurrently with any changes in common stock
dividends.  Generally, three years following issuance, the Preferred OP Units
may be converted into shares of common stock on a one-for-one basis, subject to
certain limitations.  After 10 years, the Company will have the right to
exchange all outstanding Preferred OP Units for shares of common stock on a one-
for-one basis.

     In addition, as discussed previously in "Background", the Company completed
a Follow-on Offering of its common stock, the net proceeds of which have been
utilized primarily to reduce amounts outstanding under the Line of Credit.  The
Company continues to evaluate other permanent sources of capital, including
equity and long-term debt.  It is expected that additional common or preferred
stock offerings will be used both to acquire hotel properties and to limit the
Company's overall debt to market capitalization ratio.

     The Company has entered into contracts to acquire a total of three hotels
in the states of Alabama, Tennessee and California.  These acquisitions are
subject to various closing conditions and there can be no assurance that any or
all of these proposed acquisitions will be consummated.  The Company currently
intends to use Line of Credit borrowings to acquire these assets.  While no
definitive agreements with respect to the acquisition of any additional 

                                       40
<PAGE>
 
hotels have been entered into, the Company expects additional acquisitions will
be completed during the remainder of 1996, which will be funded through the Line
of Credit borrowings or permanent debt or equity financing.

     The Company's principal source of cash to meet its cash requirements,
including distributions to its shareholders,  is its share of the Operating
Partnership's cash flow.  The Operating Partnership's principal source of
revenue is rent payments under the Participating Leases.  The Lessees' ability
to make rent payments to the Operating Partnership, and, therefore, the
Company's liquidity, including the ability to make distributions to its
shareholders, is dependent upon the Lessees' ability to generate sufficient cash
flow from operation of the Hotels.  The Lessees are current in their payments to
the Company under the Participating Leases.

     Cash and cash equivalents as of September 30, 1996 were $7,004,000,
including capital improvement reserves of $2,568,000.  Additionally, $6,878,000
of the September 30, 1996 lease revenue receivable was paid by the Lessees in
October 1996.  Cash flows from operating activities of the Company was
$40,000,000 for the nine months ended September 30, 1996, which primarily
represents collection of rents under the Participating Leases, less the
Company's operating expenses for the period.  Cash flows used in investing
activities in the amount of $317,562,000 resulted primarily from the acquisition
of hotel properties.  Cash flows from financing activities of $279,797,000 was
primarily related to $104,092,000 in net borrowings on the Line of Credit,
$160,222,000 of net proceeds from the Follow-on Offering and $39,417,000 of net
proceeds from the private placement.

RENOVATIONS AND CAPITAL IMPROVEMENTS

     Pursuant to the Participating Leases, the Company is obligated to establish
a reserve for each hotel for capital improvements, including the periodic
replacement or refurbishment of furniture, fixtures and equipment ("F, F & E").
The aggregate amount of such reserves average 4.0% of total revenue, with the
amount of such reserve with respect to each hotel based upon projected capital
requirements of such hotel.  Management believes such reserves will generally be
sufficient to fund recurring capital expenditures for the hotels.  Capital
expenditures, exclusive of renovations, will exceed 4% of total revenues in 1996
for the reasons described below.

     The Company has budgeted $7,500,000 to fund capital expenditures, excluding
renovations, at the Initial Hotels in 1996 and approximately $4,655,000 to
complete recurring capital expenditures, excluding renovations in 1996 for
hotels acquired subsequent to the Initial Offering.  The $12,155,000 total
exceeds anticipated reserves in 1996, as the Company has been required to
complete certain capital improvements by franchisors (in connection with the
transfer of franchise licenses) and has decided to accelerate certain capital
improvements which were originally planned to be completed over a longer period.
The budgeted capital expenditures also include upgrades of telephone systems,
other major equipment purchases and improvements management believes will
immediately enhance the revenue producing capabilities of certain of the hotels.

     In addition to the above expenditures, the Company also has plans to
commence or complete renovation projects at several hotels during 1996,
including the Crockett Hotel, the Tremont House Hotel, the Crowne Plaza Ravinia
Hotel, the Del Mar Hilton Hotel, the WestCoast Long Beach Hotel and Marina, the
Doubletree Denver/Boulder, the Wyndham Greenspoint Hotel,  the Wyndham Garden -
Midtown, the Bonaventure and the three hotels purchased in partnerships with
DTR.  Total renovation cost is expected to be approximately $39,950,000
(including approximately $9,500,000 to renovate the Tremont House Hotel and
$10,000,000 to renovate the Bonaventure).  The Company  has spent approximately
$3,536,000 of this amount from date of acquisition through September 30, 1996
and expects to spend the remainder in 1996 and early 1997.

     The Company will finance these renovations with draws on its Line of
Credit, operating cash flow in excess of distributions and reserves, and/or
through permanent debt or equity financing.  Funding for $1,066,000 of the
Crowne Plaza Ravinia Hotel renovation will come from a reserve provided by the
seller at the closing date.  The Company attempts to schedule renovations and
improvements during traditionally lower occupancy periods in an effort to
minimize disruption to the hotel's operations.  Therefore, the Company does not
believe such renovations and capital improvements will have a material effect on
the results of operations of the hotels.

                                       41
<PAGE>
 
INFLATION

     Operators of hotels in general possess the ability to adjust room rates
quickly.  However, competitive pressures may limit the Lessees' ability to raise
room rates in the face of inflation.

SEASONALITY

     The hotel industry is seasonal in nature.  Revenues at certain of the
hotels are greater in the first and second quarters of a calendar year and at
other hotels in the second and third quarters of the calendar year.  Seasonal
variations in revenue at the hotels may cause quarterly fluctuations in the
Company's lease revenue.

                                       42
<PAGE>
 
                                    PART II


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a.      EXHIBITS:

        ITEM NUMBER         DESCRIPTION

        27.1                Financial Data Schedule


b.      REPORTS ON FORM 8-K:

        No reports on Form 8-K were filed during the quarter for which this
report is filed .

                                       43
<PAGE>
 
                                   SIGNATURE

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

Dated:  November 12, 1996


                                    PATRIOT AMERICAN HOSPITALITY, INC.



                                    By:  /s/ Rex E. Stewart
                                         ---------------------------------------
                                         Rex E. Stewart
                                         Executive Vice President and
                                         Chief Financial Officer
                                         (Authorized Officer and Principal
                                         Accounting and Financial Officer)

                                       44