##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 OR [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from ______ to ______ Commission file number 333-63768 MERISTAR HOSPITALITY
OPERATING PARTNERSHIP, L.P.
(Exact name of registrant as
specified in its charter)
    
    MERISTAR HOSPITALITY
FINANCE CORP
(Exact name of registrant as
specified in its charter)
 75-2648837
(I.R.S. Employer Identification No.)
    
    52-2321015
(I.R.S. Employer Identification No.)
 MERISTAR
HOSPITALITY
FINANCE CORP II
(Exact name of registrant as
specified in its charter)
    
    MERISTAR HOSPITALITY
FINANCE CORP III
(Exact name of registrant as
specified in its charter)
 73-1658708
(I.R.S. Employer Identification No.)
    
    46-0467463
(I.R.S. Employer Identification No.)
 DELAWARE
(State or other jurisdiction of incorporation or organization) 4501 NORTH FAIRFAX DRIVE, SUITE 500
ARLINGTON, VA 22203
(Address of principal executive offices) Registrants telephone number, including area code: (703) 812-7200 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes
[   ] No [X]




---



##### 



EXPLANATORY NOTE This quarterly report on Form 10-Q is being filed jointly by MeriStar
Hospitality Operating Partnership, L.P., or MHOP; MeriStar Hospitality Finance
Corp, or MeriStar Finance; MeriStar Hospitality Finance Corp II, or MeriStar
Finance II; and MeriStar Hospitality Finance Corp III, or MeriStar Finance III.
No separate financial or other information of MeriStar Finance, MeriStar
Finance II or MeriStar Finance III is material to holders of the securities of
MHOP, MeriStar Finance, MeriStar Finance II or MeriStar Finance III since as of
June 30, 2004, they had no operations, no employees, only nominal assets and no
liabilities other than their obligations as corporate co-issuers under the
indentures governing the senior unsecured notes issued in January 2001,
December 2001 and February 2002. INDEX PagePART I.  FINANCIAL INFORMATIONITEM 1.
    
    FINANCIAL STATEMENTSConsolidated Balance Sheets  June 30, 2004 (Unaudited) and December 31, 2003
    
    
    3Consolidated Statements of Operations  Three and six months ended June 30, 2004 and 2003 (Unaudited)
    
    
    4Consolidated Statements of Cash Flows  Six months ended June 30, 2004 and 2003 (Unaudited)
    
    
    6Notes to Consolidated Financial Statements (Unaudited)
    
    
    7ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    18ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    34ITEM 4.
    
    CONTROLS AND PROCEDURES
    
    
    35PART II.  OTHER INFORMATIONITEM 6.
    
    EXHIBITS AND REPORTS ON FORM 8-K
    
    
    36SIGNATURES
 2




---



##### 



PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.CONSOLIDATED BALANCE SHEETS(Dollars and units in thousands) June 30,2004
    
    December 31,(Unaudited)
    
    2003ASSETSProperty and equipment
    
    $
    2,633,167
    
    
    $
    2,481,752Accumulated depreciation
    
    
    (488,371
    )
    
    
    (446,032
    )2,144,796
    
    
    
    2,035,720Assets held for sale
    
    
    21,826
    
    
    
    51,169Investment in affiliate
    
    
    15,000
    
    
    
    15,000Prepaid expenses and other assets
    
    
    40,821
    
    
    
    47,033Accounts receivable, net of allowance for doubtful accounts
of $3,728 and $2,040
    
    
    72,173
    
    
    
    64,709Restricted cash
    
    
    72,478
    
    
    
    42,523Cash and cash equivalents  unrestricted
    
    
    148,812
    
    
    
    230,876$
    2,515,906
    
    
    $
    2,487,030LIABILITIES AND PARTNERS CAPITALLong-term debt
    
    $
    1,379,828
    
    
    $
    1,381,555Notes payable to MeriStar Hospitality Corporation
    
    
    207,576
    
    
    
    256,473Accounts payable and accrued expenses
    
    
    88,073
    
    
    
    80,014Accrued interest
    
    
    41,121
    
    
    
    46,813Due to Interstate Hotels & Resorts
    
    
    21,887
    
    
    
    16,411Other liabilities
    
    
    19,155
    
    
    
    11,045Total liabilities
    
    
    1,757,640
    
    
    
    1,792,311Minority interests
    
    
    2,472
    
    
    
    2,496Redeemable OP units at redemption value, 3,068 and 3,510 outstanding
    
    
    27,533
    
    
    
    35,926Partners capital  Common OP units, 86,936 and 66,790 issued and
outstanding
    
    
    728,261
    
    
    
    656,297$
    2,515,906
    
    
    $
    2,487,030
 See accompanying notes to the unaudited consolidated financial statements. 3




---



##### 



MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF OPERATIONS UNAUDITED(Dollars in thousands, except per unit amounts) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue:Hotel operations:Rooms
    
    $
    143,156
    
    
    $
    136,911
    
    
    $
    277,284
    
    
    $
    266,706Food and beverage
    
    
    59,442
    
    
    
    56,404
    
    
    
    110,450
    
    
    
    107,520Other hotel operations
    
    
    17,362
    
    
    
    19,201
    
    
    
    34,397
    
    
    
    35,754Office rental, parking and other revenue
    
    
    2,929
    
    
    
    3,453
    
    
    
    5,828
    
    
    
    6,716Total revenue
    
    
    222,889
    
    
    
    215,969
    
    
    
    427,959
    
    
    
    416,696Hotel operating expenses:Rooms
    
    
    35,046
    
    
    
    32,467
    
    
    
    67,795
    
    
    
    63,163Food and beverage
    
    
    41,739
    
    
    
    38,789
    
    
    
    79,923
    
    
    
    75,646Other hotel operating expenses
    
    
    10,864
    
    
    
    10,936
    
    
    
    21,162
    
    
    
    20,392Office rental, parking and other expenses
    
    
    670
    
    
    
    583
    
    
    
    1,255
    
    
    
    1,213Other operating expenses:General and administrative, hotel
    
    
    32,010
    
    
    
    31,864
    
    
    
    65,774
    
    
    
    62,906General and administrative, corporate
    
    
    3,473
    
    
    
    3,132
    
    
    
    7,106
    
    
    
    6,105Property operating costs
    
    
    31,909
    
    
    
    30,620
    
    
    
    62,941
    
    
    
    59,609Depreciation and amortization
    
    
    25,137
    
    
    
    24,953
    
    
    
    50,724
    
    
    
    48,613Property taxes, insurance and other
    
    
    16,006
    
    
    
    17,548
    
    
    
    32,860
    
    
    
    34,547Loss on asset impairments
    
    
    1,291
    
    
    
    65,123
    
    
    
    1,536
    
    
    
    65,123Operating expenses
    
    
    198,145
    
    
    
    256,015
    
    
    
    391,076
    
    
    
    437,317Operating income (loss)
    
    
    24,744
    
    
    
    (40,046
    )
    
    
    36,883
    
    
    
    (20,621
    )Minority interest
    
    
    20
    
    
    
    5
    
    
    
    24
    
    
    
    (6
    )Interest expense, net
    
    
    (29,724
    )
    
    
    (34,583
    )
    
    
    (64,103
    )
    
    
    (69,301
    )Loss on early extinguishments of debt
    
    
    (1,980
    )
    
    
    
    
    
    
    (7,903
    )
    
    
    Loss before income taxes and discontinued operations
    
    
    (6,940
    )
    
    
    (74,624
    )
    
    
    (35,099
    )
    
    
    (89,928
    )Income tax (expense) benefit
    
    
    (25
    )
    
    
    (10
    )
    
    
    314
    
    
    
    119Loss from continuing operations
    
    
    (6,965
    )
    
    
    (74,634
    )
    
    
    (34,785
    )
    
    
    (89,809
    )Discontinued operations:Loss from discontinued operations before
income tax
    
    
    (5,131
    )
    
    
    (142,016
    )
    
    
    (18,314
    )
    
    
    (200,054
    )Income tax (expense) benefit
    
    
    45
    
    
    
    (9
    )
    
    
    161
    
    
    
    6Loss from discontinued operations
    
    
    (5,086
    )
    
    
    (142,025
    )
    
    
    (18,153
    )
    
    
    (200,048
    )Net loss
    
    $
    (12,051
    )
    
    $
    (216,659
    )
    
    $
    (52,938
    )
    
    $
    (289,857
    )Preferred distributions
    
    
    
    
    
    
    (141
    )
    
    
    (141
    )
    
    
    (282
    )Net loss applicable to common unitholders
    
    $
    (12,051
    )
    
    $
    (216,800
    )
    
    $
    (53,079
    )
    
    $
    (290,139
    )Net loss applicable to general partner unitholders
    
    $
    (11,619
    )
    
    $
    (203,867
    )
    
    $
    (50,996
    )
    
    $
    (271,172
    )Net loss applicable to limited partner unitholders
    
    $
    (432
    )
    
    $
    (12,933
    )
    
    $
    (2,083
    )
    
    $
    (18,967
    )
 4




---



##### 



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Basic and Diluted Loss per unit:Loss from continuing operations
    
    $
    (0.08
    )
    
    $
    (1.53
    )
    
    $
    (0.44
    )
    
    $
    (1.84
    )Loss from discontinued operations
    
    
    (0.06
    )
    
    
    (2.90
    )
    
    
    (0.23
    )
    
    
    (4.08
    )Net loss per basic and diluted unit
    
    $
    (0.14
    )
    
    $
    (4.43
    )
    
    $
    (0.67
    )
    
    $
    (5.92
    )
 See accompanying notes to the unaudited consolidated financial statements. 5




---



##### 



MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF CASH FLOWSUNAUDITED(Dollars in thousands) Six Months EndedJune 30,2004
    
    2003Operating activities:Net loss
    
    $
    (52,938
    )
    
    $
    (289,857
    )Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    51,985
    
    
    
    58,478Loss on asset impairments
    
    
    7,441
    
    
    
    264,677Loss on sale of assets, before tax effect
    
    
    11,530
    
    
    
    Loss on early extinguishments of debt
    
    
    7,903
    
    
    
    Minority interests
    
    
    (24
    )
    
    
    6Amortization of unearned stock-based compensation
    
    
    1,090
    
    
    
    1,433Change in value of interest rate swaps
    
    
    
    
    
    
    (3,395
    )Deferred income taxes
    
    
    (652
    )
    
    
    (1,534
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    (4,227
    )
    
    
    (12,168
    )Prepaid expenses and other assets
    
    
    4,864
    
    
    
    4,225Due from/to Interstate Hotels & Resorts
    
    
    (3,241
    )
    
    
    (4,575
    )Accounts payable, accrued expenses, accrued
interest and other liabilities
    
    
    (6,040
    )
    
    
    (5,480
    )Net cash provided by operating activities
    
    
    17,691
    
    
    
    11,810Investing activities:Acquisition of hotels, net of cash acquired of $3.5 million
    
    
    (182,790
    )
    
    
    Capital expenditures for property and equipment
    
    
    (49,898
    )
    
    
    (14,547
    )Proceeds from sales of assets
    
    
    104,873
    
    
    
    15,720Purchases of marketable securities
    
    
    
    
    
    
    (18,056
    )Payments from Interstate Hotels & Resorts
    
    
    
    
    
    
    42,052Increase in restricted cash
    
    
    (29,955
    )
    
    
    (9,740
    )Costs associated with disposition program and other, net
    
    
    (5,081
    )
    
    
    (299
    )Net cash (used in) provided by investing activities
    
    
    (162,851
    )
    
    
    15,130Financing activities:Prepayments on long-term debt
    
    
    (105,857
    )
    
    
    Proceeds from debt issuance, net of issuance costs
    
    
    109,687
    
    
    
    Scheduled payments on long-term debt
    
    
    (3,691
    )
    
    
    (4,208
    )Distributions to partners
    
    
    (141
    )
    
    
    (141
    )Purchase of limited partnership unit
    
    
    
    
    
    
    (65
    )Proceeds from OP units issuance
    
    
    72,340
    
    
    
    Purchase of OP units
    
    
    (8,690
    )
    
    
    Other
    
    
    (325
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    63,323
    
    
    
    (4,414
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (227
    )
    
    
    (115
    )Net (decrease) increase in cash and cash equivalents
    
    
    (82,064
    )
    
    
    22,411Cash and cash equivalents, beginning of period
    
    
    230,876
    
    
    
    33,889Cash and cash equivalents, end of period
    
    $
    148,812
    
    
    $
    56,300Supplemental Cash Flow InformationCash paid for interest and income taxes:Interest, net of capitalized interest
    
    $
    69,804
    
    
    $
    70,399Income taxes
    
    $
    326
    
    
    $
    1,902Non-cash investing and financing activities:Notes payable to MeriStar Hospitality redeemed in exchange
for Common OP Units
    
    $
    49,213
    
    
    $
    Redemption of OP units
    
    $
    123
    
    
    $
    20,100
 See accompanying notes to the unaudited consolidated financial statements. 6




---



##### 



MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTSJUNE 30, 2004 1. Organization MeriStar Hospitality Operating Partnership, L.P. is the subsidiary
operating partnership of MeriStar Hospitality Corporation (MeriStar
Hospitality), which is a real estate investment trust, or REIT. We own a
portfolio of primarily upper upscale, full-service hotels and resorts in the
United States. Our portfolio is diversified geographically as well as by
franchise and brand affiliations. As of June 30, 2004, we owned 79 hotels with
22,187 rooms, all of which were leased by our taxable subsidiaries. As of June
30, 2004, 77 hotels were managed by Interstate Hotels & Resorts, Inc.
(Interstate Hotels), one hotel was managed by The Ritz-Carlton Hotel Company,
LLC (Ritz-Carlton), a subsidiary of Marriott International, Inc., and one
hotel was managed by another subsidiary of Marriott International, Inc.
(Marriott) (collectively with Interstate Hotels, the Managers). Of our 79
hotels at June 30, 2004, seven were included in our non-core disposition
program. Two of these assets with 568 rooms have been sold during the third
quarter of 2004. The Managers operate our 79 hotels pursuant to management agreements with
our taxable subsidiaries. Under these management agreements, the taxable
subsidiaries pay a management fee for each property to the Manager of their
hotels. The taxable subsidiaries in turn make rental payments to our
subsidiary operating partnership under the participating leases. Under the Interstate Hotels management agreements, the base management fee
is 2.5% of total hotel revenue, plus incentive payments based on meeting
performance thresholds that could total up to an additional 1.5% of total hotel
revenue. The agreements have initial terms expiring on January 1, 2011 with
three renewal periods of five years each at the option of Interstate Hotels,
subject to some exceptions. Under the Ritz-Carlton and Marriott management agreements, the base
management fee is 3.0% and 2.5% of total hotel revenue, respectively, through
2005 and 3.0% under both thereafter, plus incentive payments based on meeting
performance thresholds that could total up to an additional 2.0% of total
revenue and 20% of available cash flow (as defined), respectively. The
agreements have initial terms expiring in 2015 and 2024, respectively, with
four and three renewal periods of 10 and five years each, respectively, at the
option of Ritz-Carlton and Marriott. The Ritz-Carlton and Marriott management
agreements include certain limited performance guarantees by Ritz-Carlton and
Marriott which are designed primarily to provide downside performance
protection and run through 2005 and up to 2008, respectively. Management
expects funding under these guarantees to be minimal. 2. Summary of Significant Accounting Policies Interim Financial Statements.We have prepared these unaudited interim
financial statements according to the rules and regulations of the United
States Securities and Exchange Commission. We have omitted certain information
and footnote disclosures that are normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States. These interim financial statements should be read in
conjunction with the financial statements, accompanying notes and other
information included in our Annual Report on Form 10-K for the year ended
December 31, 2003. In our opinion, the accompanying unaudited consolidated interim financial
statements reflect all adjustments, which are of a normal and recurring nature,
necessary for a fair presentation of the financial condition and results of
operations and cash flows for the periods presented. The results of operations
for the interim periods are not necessarily indicative of the results for the
entire year. Principles of Consolidation.Our consolidated financial statements
include the accounts of all wholly-owned and majority-owned subsidiaries.
Intercompany balances and transactions have been eliminated in consolidation. 7




---



##### 



Held for Sale Properties.We classify the properties we are actively
marketing as held for sale once all of the following conditions are met:  
    
    Our board has approved the sale,  
    
    We have a fully executed agreement with a qualified buyer
which provides for no significant outstanding or continuing
obligations with the property after sale, and  
    
    We have a significant non-refundable deposit. We carry properties held for sale at the lower of their carrying values or
estimated fair values less costs to sell. We cease depreciation at the time
the asset is classified as held for sale. Cash and Cash Equivalents. We classify investments with original
maturities of three months or less as cash equivalents. Our cash equivalents
include investments in debt securities, including commercial paper, overnight
repurchase agreements and money market funds. Impairment or Disposal of Long-Lived Assets.We apply the provisions of
Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which require the current and
prior period operating results of any asset that has been classified as held
for sale or has been disposed of on or after January 1, 2002 and where we have
no continuing involvement to be recorded as discontinued operations. Any gains
or losses on final disposition are also included in discontinued operations. The provisions of SFAS No. 144 also require that whenever events or
changes in circumstances indicate that the carrying value of a long-lived asset
may be impaired that an analysis be performed to determine the recoverability
of the assets carrying value. We make estimates of the undiscounted cash
flows from the expected future operations or potential sale of the asset. If
the analysis indicates that the carrying value is not recoverable from these
estimates of cash flows, we write down the asset to estimated fair value and
recognize an impairment loss. Any impairment losses we recognize on assets held
for use are recorded as operating expenses. We record any impairment losses on
assets held for sale as a component of discontinued operations. Accounting for Costs Associated with Exit or Disposal Activities.We
apply the provisions of SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which require that a liability for a cost
associated with an exit or disposal activity be recognized and measured
initially at fair value only when the liability is incurred. Our strategy
includes the disposition of certain hotel assets, all of which are managed
under agreements that typically require payments to Interstate Hotels as a
result of termination. Any such liability will be recognized at the time the
asset disposition is complete and a termination notice is provided to
Interstate Hotels. At that time, the recognition of the termination obligation
will be included in the calculation of the final gain or loss on sale. For
further discussion of potential termination obligations, see Asset
Dispositions included in Item 2 of this Quarterly Report on Form 10-Q. Stock-Based Compensation.We adopted the recognition provisions of SFAS
No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
on January 1, 2003 for new stock options issued under our compensation programs
sponsored by MeriStar Hospitality. As permitted by SFAS No. 148, we elected to
apply the provisions prospectively, which includes recognizing compensation
expense for only those stock options issued in 2003 and after. We apply the
provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, in accounting for our stock options issued under our
compensation programs prior to January 1, 2003. As MeriStar Hospitality
granted these stock options at fair market value, no compensation cost has been
recognized. For our other equity-based compensation awards, we recognize
compensation expense over the vesting period based on the fair market value of
the award at the date of grant. 8




---



##### 



Had compensation cost been determined based on fair value at the grant
date for awards granted prior to our adoption of the fair value method, our net
loss and per share amounts would have been adjusted to the pro forma amounts
indicated as follows (in thousands, except per unit amounts): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net loss, as reported
    
    $
    (12,051
    )
    
    $
    (216,659
    )
    
    $
    (52,938
    )
    
    $
    (289,857
    )Add: Stock-based employee
compensation expense included
in reported net loss, net of
related tax effect
    
    
    395
    
    
    
    677
    
    
    
    975
    
    
    
    1,606Deduct: Total stock-based
employee compensation expense
determined under fair
value-based method for all
awards, net of related tax
effect
    
    
    (442
    )
    
    
    (816
    )
    
    
    (1,077
    )
    
    
    (1,900
    )Net loss, pro forma
    
    $
    (12,098
    )
    
    $
    (216,798
    )
    
    $
    (53,040
    )
    
    $
    (290,151
    )Loss per unit:Basic and Diluted, as reported
    
    $
    (0.14
    )
    
    $
    (4.43
    )
    
    $
    (0.67
    )
    
    $
    (5.92
    )Basic and Diluted, pro forma
    
    $
    (0.14
    )
    
    $
    (4.43
    )
    
    $
    (0.67
    )
    
    $
    (5.93
    )
 These pro forma compensation costs may not be representative of the actual
effects on reported net loss and loss per share in future periods. Derivative Instruments and Hedging Activities.Our interest rate risk
management objective is to manage the effect of interest rate changes on
earnings and cash flows. We look to manage interest rates through the use of a
combination of fixed and variable rate debt. We only enter into derivative or
interest rate transactions for hedging purposes. We recognize all derivatives
as either assets or liabilities on the balance sheet and measure those
instruments at fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income based on
the derivatives effectiveness and whether the derivative has been designated
as a cash flow or fair value hedge. Acquisition of Hotels. Our hotel acquisitions consist almost exclusively
of land, building, furniture, fixtures and equipment. We allocate the purchase
price among these asset classes and any acquired intangible assets based upon
their respective fair values as required by Statement of Financial Accounting
Standards, or SFAS 141, Business Combinations. 3. Comprehensive Loss Comprehensive loss was $10.8 million and $212.8 million for the three
months ended June 30, 2004 and 2003, respectively. Comprehensive loss consisted
of net loss ($12.1 million and $216.7 million for the three months ended June
30, 2004 and 2003, respectively) and foreign currency translation adjustments. Comprehensive loss was $52.0 million and $284.9 million for the six months
ended June 30, 2004 and 2003, respectively. Comprehensive loss consisted of net
loss ($52.9 million and $289.9 million for the six months ended June 30, 2004
and 2003, respectively) and foreign currency translation adjustments. 4. Acquisitions On May 10, 2004 and June 25, 2004, we acquired the 366-room Ritz-Carlton,
Pentagon City in Arlington, Virginia and the 485-room Marriott Irvine in Orange
County, California, respectively, for a total purchase price of $185.5 million,
plus net acquisition costs and adjustments of $0.7 million. The Ritz-Carlton, Pentagon City luxury hotel is operated by The
Ritz-Carlton Hotel Company, LLC under a long-term contract. On June 30, 2004,
we partially financed the acquisition through the placement of a $55.8 million
fixed-rate mortgage loan which is secured by this property, matures on June 1,
2011 and bears interest at an annual rate of 5.80%. 9




---



##### 



The Marriott Irvine is operated by a subsidiary of Marriott International,
Inc. under a long-term contract. We expect to invest approximately $7.5
million in property improvements over the next 12 months, primarily in the
hotels guest rooms. We financed a portion of the acquisition with a $55.5
million fixed-rate mortgage loan which is secured by this property, matures on
July 1, 2011 and bears interest at an annual rate of 5.69%. Because Marriott
International, Inc. reports results in 13 four week periods during the year
rather than the 12 monthly periods that we employ, we will include 12 weeks of
results in each of quarters one through three and 16 weeks of results in
quarter four. The acquisitions were accounted for under the purchase method of
accounting, and the assets and liabilities and results of operations of the
hotels have been consolidated in our financial statements since the date of
purchase. On an unaudited pro forma basis, revenues, net income and basic and
diluted loss per share for the three and six months ended June 30, 2004 and
2003 would have been reported as follows if the acquisitions had occurred at
the beginning of each of the respective periods (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Total revenue
    
    $
    238,655
    
    
    $
    231,535
    
    
    $
    455,136
    
    
    $
    446,324Net loss
    
    
    (10,709
    )
    
    
    (214,958
    )
    
    
    (50,773
    )
    
    
    (287,726
    )Net loss per unit:Basic and Diluted
    
    $
    (0.12
    )
    
    $
    (4.39
    )
    
    $
    (0.64
    )
    
    $
    (5.87
    )
 The following is a summary of the combined preliminary allocation of the
purchase price (thousands), which may be revised upon completion of our
valuation procedures: Land
    
    $
    15,000Buildings and improvements
    
    
    151,592Furniture, fixtures and equipment
    
    
    18,220Net working capital
    
    
    1,435Total purchase price
    
    $
    186,247
 5. Property and Equipment Property and equipment consisted of the following (in thousands): June 30,
    
    December 31,2004
    
    2003Land
    
    $
    247,479
    
    
    $
    238,772Buildings and improvements
    
    
    2,016,233
    
    
    
    1,930,155Furniture, fixtures and equipment
    
    
    301,502
    
    
    
    284,602Construction-in-progress
    
    
    67,953
    
    
    
    28,223$
    2,633,167
    
    
    $
    2,481,752
 For the six months ended June 30, 2004 and 2003, we capitalized interest
of $2.0 million and $1.6 million, respectively. During the first and second quarters of 2004, we recognized impairment
losses of $5.0 million and $2.4 million, respectively, of which $4.8 million
and $1.1 million, respectively, are recorded in discontinued operations (see
Note 12). As of June 30, 2004, we had seven hotels remaining in our
disposition program, three of which are classified as held for sale as of June
30, 2004 (see Note 6). During the first and second quarters of 2003, we recognized impairment
losses of $56.7 million and $208.0 million, respectively, of which $56.7
million and $142.9 million, respectively, are recorded in discontinued
operations as of June 30, 2004 (see Note 12). 10




---



##### 



The impairment charges are based on our estimates of the fair value of the
properties we are actively marketing. These estimates require us to make
assumptions about the sales prices that we expect to realize for each property
as well as the timing of a potential sale. In making these estimates, we
consider the operating results of the assets, the market for comparable
properties, and quotes from brokers, among other information. In nearly all
cases, our estimates have reflected the results of an extensive marketing
effort and negotiations with prospective buyers. Actual results could differ
materially from these estimates. 6. Assets Held for Sale At December 31, 2003, seven assets were classified as held for sale. All
seven of these assets were sold during the six months ended June 30, 2004. At
June 30, 2004, three of the seven remaining properties in our non-core
disposition program met our criteria for classification as held for sale. The
four other assets included in our asset disposition program did not meet the
probability criteria as prescribed by SFAS No. 144 to classify them as held for
sale. Assets held for sale consisted of the following (in thousands): June 30,
    
    December 31,2004
    
    2003Land
    
    $
    598
    
    
    $
    5,061Buildings and improvements
    
    
    20,082
    
    
    
    43,391Furniture, fixtures and equipment
    
    
    765
    
    
    
    2,759Construction-in-progress
    
    
    381
    
    
    
    1,11421,826
    
    
    
    52,325Accumulated depreciation
    
    
    
    
    
    
    (1,156
    )$
    21,826
    
    
    $
    51,169
 7. Investment in Affiliate In 1999, we invested $40 million in MeriStar Investment Partners, L.P.
(MIP), a joint venture established to acquire upscale, full-service hotels.
Our cost-basis investment is in the form of a partnership interest, in which we
earn a 16% cumulative preferred return with outstanding balances compounded
quarterly. While the return on this investment is preferred and cumulative,
the underlying investment ranks equally with the investments of the other
investors in MIP. We recognize the return quarterly as it becomes due to us.
For the six months ended June 30, 2004 and 2003, we recognized a preferred
return of $3.2 million and $4.2 million, respectively, from this investment.
As of June 30, 2004 and December 31, 2003, cumulative preferred returns of
$24.5 million and $19.6 million, respectively, were due from MIP. We have
reserved a portion of this balance and have included the net $21.4 million and
$18.2 million in accounts receivable on the accompanying consolidated balance
sheets as of June 30, 2004 and December 31, 2003, respectively. We expect that
any cumulative unpaid preferred returns will be paid in the future from excess
cash flow above our current return and from potential partnership hotel
disposition proceeds in excess of debt allocated to individual assets. Given
the current economic environment, we do not expect MIPs operations to provide
adequate cash flow in the near term for significant payment of our current
returns or repayments of our cumulative unpaid preferred returns; however we
expect to receive payments from MIP during 2004 resulting from planned
dispositions of certain assets combined with cash flow improvements on other
assets. We evaluate the collectibility of our preferred return based on our
preference to distributions and the underlying value of the hotel properties. While we believe that our current and cumulative returns continue to be
fully collectible, during 2003, the value of our underlying investment declined
due to the decline in MIPs cash flow, particularly driven by results in four
of its hotel markets. While we believe that the cash flow, and thus the value
of our investment in MIP, will be recoverable over time, we expect that any
such recovery will take a number of years to achieve. The accounting rules for
cost basis investments require that declines in value that are other than
temporary be recognized currently. Since the decline in the value of our
underlying investment in MIP was other than temporary, we recognized a $25.0
million impairment loss on this investment during the fourth quarter of 2003. 11




---



##### 



8. Long-Term Debt Long-term debt consisted of the following (in thousands): June 30, 2004
    
    December 31, 2003Senior unsecured notes due 2011  9.125%
    
    $
    355,665
    
    
    $
    400,000Senior unsecured notes due 2008  9.0%
    
    
    270,500
    
    
    
    300,000Senior unsecured notes due 2009  10.5%
    
    
    224,187
    
    
    
    250,000Secured facility, due 2009
    
    
    306,067
    
    
    
    309,035Secured facility, due 2013
    
    
    100,041
    
    
    
    100,765Mortgage debt
    
    
    137,505
    
    
    
    27,011Unamortized issue discount
    
    
    (4,063
    )
    
    
    (5,256
    )1,389,902
    
    
    
    1,381,555Fair value adjustment for interest rate swap
    
    
    (10,074
    )
    
    
    Long-term debt
    
    $
    1,379,828
    
    
    $
    1,381,555Notes payable to MeriStar Hospitality
    
    $
    207,930
    
    
    $
    257,143Unamortized issue discount
    
    
    (354
    )
    
    
    (670
    )Notes payable to MeriStar Hospitality
    
    $
    207,576
    
    
    $
    256,473Total long-term debt and notes payable to MeriStar Hospitality
    
    $

    1,587,404
    
    
    $
    1,638,028
 Aggregate future maturities as of June 30, 2004 were as follows (in
thousands): 2004 (six months)
    
    $
    9,3732005
    
    
    11,7432006
    
    
    12,6872007
    
    
    47,5782008
    
    
    282,318Thereafter
    
    
    1,233,7791,597,478Fair value adjustment for interest rate swap
    
    
    (10,074
    )$
    1,587,404
 As of June 30, 2004, 81% of our debt bore fixed rates of interest, and the
remaining 19% bore interest at fixed rates that have been, since April 2, 2004,
effectively swapped to a floating rate. Our overall weighted average interest
rate was 8.30% after giving effect to the interest rate swap. Based on market
prices at June 30, 2004, the fair value of our long-term debt was $1.62
billion. Credit facility.On December 23, 2003, we entered into a new three-year
$50 million senior credit facility, secured by six of our hotels, and
terminated our previous credit facility. The facility bears interest at an
annual rate of the London Interbank Offered Rate, or LIBOR, plus 450 basis
points. As of June 30, 2004, we had no outstanding borrowings under this
facility. The facility contains financial and other restrictive covenants. Our
ability to borrow under this facility is subject to compliance with financial
covenants, including leverage, fixed charge coverage and interest coverage
ratios and minimum net worth requirements. Our compliance with these covenants
in future periods will depend substantially upon the financial results of our
hotels. The agreement governing our new senior credit facility limits our
ability to effect mergers, asset sales and change of control events and limits
the payments of dividends other than those required for MeriStar Hospitality to
maintain its status as a REIT and our ability to incur additional secured and
total indebtedness. Senior unsecured notes.During the six months ended June 30, 2004, we
repurchased from available cash $99.6 million of our senior unsecured notes,
including $29.5 million of the 9.0% notes due 2008, $44.3 million of 12




---



##### 



the 9.125% notes due 2011, and $25.8 million of the 10.5% notes due 2009.
We recorded a loss on early extinguishment of debt of $6.2 million and wrote
off deferred financing costs of $1.2 million related to these repurchases which
is included in depreciation and amortization expense on the accompanying
consolidated statements of operations. These senior unsecured notes are unsecured obligations of certain
subsidiaries of ours, and MeriStar Hospitality guarantees payment of principal
and interest on the notes. These notes contain various restrictive covenants,
limiting our ability to initiate or transact certain business activities if
specific financial thresholds are not achieved. One of those thresholds is
having a 2 to 1 fixed charge coverage ratio (as defined in the indentures,
fixed charges only include interest on debt obligations and preferred equity)
in order to enter into certain types of transactions, including the repurchase
of our common OP units, the issuance of preferred equity, the payment of
certain distributions, the incurrence of any additional debt, or the repayment
of certain outstanding debt before it comes due. As of June 30, 2004, our
fixed charge coverage ratio was significantly below 2 to 1, and therefore we
were not permitted generally to enter into those transactions, except as noted
below. There are certain exceptions with respect to the incurrence of additional
debt and early repayment of debt features in the indentures. We have the
ability to incur up to $300 million of secured financing within restricted
subsidiaries, subject to meeting other maintenance tests under the indentures,
of which $194 million was available at June 30, 2004. We also have a general
carve-out to incur $50 million of unspecified borrowings within a restricted
subsidiary, of which the full amount was available at June 30, 2004. We have
the ability to lever assets within an unrestricted subsidiary, such as the
mortgage financing related to the acquisition of Marriott Irvine.
Additionally, we are permitted to repay subordinated debt prior to its maturity
from the proceeds of an equal or junior financing with a longer term than the
debt refinanced, an equity offering, or a financing within an unrestricted
subsidiary. Secured facilities.We completed a $330 million non-recourse financing
secured by a portfolio of 19 hotels in 1999. The loan bears a fixed annual
interest rate of 8.01% and matures in 2009. The secured facility contains
standard provisions that require the servicer to maintain in escrow cash
balances for certain items such as property taxes and insurance. In addition,
the facility contains a provision that requires our mortgage servicer to retain
in escrow the excess cash from the encumbered hotels after payment of debt
service (Excess Cash), if net hotel operating income (NOI) for the trailing
twelve months declines below $57 million. This provision was triggered in
October 2002 and will be effective until the hotels generate the minimum cash
flow required for two consecutive quarters, at which time the cash being held
in escrow will be released to us. As of June 30, 2004 and December 31, 2003,
$39.2 million and $27.2 million, respectively, of cash was held in escrow under
this provision. In July 2003, we signed an amendment to the loan agreement
that permits the release of cash placed in escrow for all capital expenditures
incurred on the 19 encumbered properties on or after April 1, 2003. Although
the servicer will continue to retain in escrow any excess cash from the
encumbered hotels, they will release cash for all capital expenditures we have
incurred from April 1, 2003 through the date of the amendment and future
capital expenditures we incur on the 19 properties. Escrowed funds totaling
$30.3 million were available to fund capital expenditures under this provision
as of June 30, 2004. In July 2004, we received a cash reimbursement of $12.2
million from the servicer related to capital expenditures incurred on the 19
encumbered properties. The fair value adjustments for the interest rate swap agreement of $(10.1)
million that are discussed in further detail below are related to the
outstanding secured facility balance of $306.1 million as of June 30, 2004. On September 26, 2003, as permitted by the indentures governing our senior
unsecured notes and senior subordinated notes, we completed a $101 million
commercial mortgage-backed securities financing, secured by a portfolio of four
hotels. The loan carries a fixed annual interest rate of 6.88% and matures in
2013. Notes payable to MeriStar Hospitality.On July 1, 2003, MeriStar
Hospitality completed an offering of $170 million aggregate principal amount of
9.5% convertible subordinated notes due 2010. In conjunction with this
transaction, we borrowed $170 million from MeriStar Hospitality under terms
matching those of the 9.5% convertible subordinated notes. The proceeds from the new borrowing were used to repurchase $150.6 million
of our $154.3 million 4.75% notes payable to MeriStar Hospitality due 2004, at
varying prices, resulting in an aggregate discount of 13




---



##### 



approximately $1.4 million. The remaining proceeds from the issuance were
also used to repurchase a portion of our 8.75% notes payable to MeriStar
Hospitality due 2007. The 8.75% notes payable to MeriStar Hospitality due 2007 are unsecured
obligations, and provide for semi-annual payments of interest each February 15
and August 15. The related indenture contains various restrictive covenants,
which are similar to those in our senior unsecured notes. During the six months ended June 30, 2004, we retired $49.2 million of our
8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of
accrued interest) through the issuance of 8,138,728 common OP units. We
recorded a loss on early extinguishment of debt of $1.7 million. Mortgage debt. As of June 30, 2004, we had four mortgage loans, two of
which were placed during the second quarter of 2004 and one of which is in
foreclosure. We financed a portion of the Marriott Irvine acquisition (see Note 4) with
a $55.5 million fixed-rate mortgage effective June 25, 2004, collateralized by
the hotel, which matures on July 1, 2011 and bears interest at an annual rate
of 5.69%. On June 30, 2004, in connection with The Ritz-Carlton, Pentagon City
acquisition (see Note 4), we entered into a $55.8 million fixed-rate mortgage
loan, collateralized by the hotel, which matures on June 1, 2011 and bears
interest at an annual rate of 5.80%. We have a mortgage that matures in 2011 and carries an interest rate of
8.8%; however, the lender, with our acquiescence, initiated foreclosure
proceedings which are expected to be completed in the third quarter of 2004.
This mortgage loan is collateralized by one of our properties, which we will
relinquish to the bank upon completion of foreclosure, which we expect to occur
in the third quarter of 2004. The carrying value of the mortgage loan and the
fair value of the building both approximate $11 million. This property is
included in the seven properties remaining in our disposition program. Our only other individual mortgage matures in 2011 and carries an interest
rate of 9.0%. Derivatives.On April 2, 2004, we entered into an interest rate swap
arrangement with a third party to manage our interest rate risk related to our
secured facility due 2009, effectively converting the interest the facility
bears from a fixed rate to a floating rate. Under the swap, we receive
fixed-rate payments of 8.01% and pay floating rate payments based on a one
month LIBOR plus 444 basis points on a $307 million notional amount. We do not
use derivative instruments for speculative purposes. Due to the fact that the
notional amount of the swap matches the principal amount of the underlying debt
and other hedge accounting criteria were met, the swap was designated as highly
effective at the inception of the swap arrangement and designated as a fair
value hedge. We continue to evaluate the effectiveness of the hedge and
believe that the hedge continues to be highly effective. For a derivative qualifying as a fair value hedge, the change in net
unrealized gain or loss upon measuring the fair value hedge and the fair value
of the debt instrument is recorded on our consolidated statements of
operations. These amounts offset each other as there is no ineffectiveness,
and therefore had no impact on our net loss for the three and six months ended
June 30, 2004. The fair value of the swap is recorded as either an asset or
liability, with a corresponding increase or decrease to the carrying value of
the debt instrument being hedged on our consolidated balance sheets. The fair
value of our hedge was approximately a $10.1 million liability as of June 30,
2004. This amount is included in the consolidated balance sheet in the other
liabilities line item. During the three and six months ended June 30, 2004, we
earned cash payments of $1.7 million under the swap, which were recorded as a
reduction in interest expense. During 2003, our only derivative instruments consisted of two swap
agreements that did not qualify for treatment as hedges under SFAS No. 133, of
which one expired in April 2003 and one in July 2003. During the three and six
months ended June 30, 2003, we recognized $1.3 million and $3.4 million,
respectively, of income related to the decrease in fair value of the liability
recorded for the interest rate swaps in place in those time periods. For the
three and six months ended June 30, 2003, we made cash payments on those swaps
of $1.3 and $3.4 million, respectively. The change in fair value and the swap
payments are netted together on our consolidated statement of operations, thus
resulting in no impact on net income. 14




---



##### 



9. Partnership Units and Minority Interests OP Units. Our operating partnership agreement provides for five classes
of partnership interests: Common OP Units, Class B OP Units, Class C OP Units,
Class D OP Units and Profits-Only OP Units, or POPs. During the six months ended June 30, 2004, we issued 8,138,728 Common OP
units in exchange for the redemption of $49.2 million of our 8.75% notes
payable to MeriStar Hospitality due 2007 (plus $0.9 million of accrued
interest) (see Note 8). Common OP Unit holders converted 25,141 and 878,000 of their OP Units,
with a value of $0.1 million and $20.1 million, respectively, into common stock
during the six months ended June 30, 2004 and 2003, respectively. A POPs unit
holder converted 25,000 POPs for cash during the six months ended June 30,
2004. On April 9, 2004, in accordance with the terms of the certificate of
designation for the outstanding Class D OP Units of our operating partnership,
we redeemed all outstanding Class D OP Units plus accrued and unpaid
preferential distributions on those units, for an aggregate consideration of
approximately $8.8 million. The Class D OP Units had become redeemable at the
option of the holder on April 1, 2004. On April 23, 2004, MeriStar Hospitality issued and sold 12.0 million
shares of common stock at a price to the public of $6.25 per share pursuant to
its effective shelf registration statement filed under the Securities Act of
1933. In connection with this transaction, MeriStar L.P. Inc., a wholly-owned
subsidiary of MeriStar Hospitality, contributed the net proceeds to us in
exchange for the same number of Common OP units. The offering closed on April
28, 2004 with net proceeds of $72.3 million. 10. Loss Per Unit The following table presents the computation of basic and diluted loss per
unit (in thousands, except per unit amounts): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Basic and Diluted Loss Per Unit:Loss from continuing operations
    
    $
    (6,965
    )
    
    $
    (74,634
    )
    
    $
    (34,785
    )
    
    $
    (89,809
    )Preferred distribution
    
    
    
    
    
    
    (141
    )
    
    
    (141
    )
    
    
    (282
    )Loss from continuing
operations available to common
unitholders
    
    $
    (6,965
    )
    
    $
    (74,775
    )
    
    $
    (34,926
    )
    
    $
    (90,091
    )Weighted average number OP
units outstanding
    
    
    85,933
    
    
    
    49,001
    
    
    
    78,841
    
    
    
    49,017Basic and diluted loss per
unit from continuing
operations
    
    $
    (0.08
    )
    
    $
    (1.53
    )
    
    $
    (0.44
    )
    
    $
    (1.84
    )
 11. Commitments and Contingencies Litigation.In the course of our normal business activities, various
lawsuits, claims and proceedings have been or may be instituted or asserted
against us. Based on currently available facts, we believe that the
disposition of matters that are pending or asserted will not have a material
adverse effect on our financial position, results of operations or liquidity. Minimum Lease Payments.We lease the land at certain of our hotels and
office space of our corporate headquarters under long-term arrangements from
third parties. Certain leases contain contingent rent features 15




---



##### 



based on gross revenues at the respective property. Future minimum lease
payments required under these operating leases as of June 30, 2004 were as
follows (in thousands): 2004 (six months)
    
    $
    1,2062005
    
    
    2,3732006
    
    
    2,2892007
    
    
    2,3132008
    
    
    2,313Thereafter
    
    
    72,351$
    82,845
 Our obligations under other operating lease commitments, primarily for
equipment, are not significant. We lease certain office, retail and parking space to outside parties under
non-cancelable operating leases with initial or remaining terms in excess of
one year. Future minimum rental receipts under these leases as of June 30,
2004 were as follows (in thousands): 2004 (six months)
    
    $
    2,1432005
    
    
    3,4442006
    
    
    2,7042007
    
    
    2,5422008
    
    
    1,786Thereafter
    
    
    3,089$
    15,708
 We may be obligated to pay Interstate Hotels termination fees of up to a
maximum of approximately $12.0 million with respect to the 32 properties we
have sold between January 1, 2003 and August 3, 2004. In addition, as we
dispose of the five remaining assets in our disposition program, we may incur
termination obligations due to Interstate Hotels of up to a maximum of
approximately $1.7 million,assuming the disposition of all five of the
properties in 2004 and assuming buyers of our hotel properties elect to have
the properties managed by parties other than Interstate Hotels or do not assume
the obligation as part of the disposition transaction and no new management
agreements are substituted. Any obligation due under the termination
provisions of the contract is payable over a period of 48 months after
termination. Termination fees payable to Interstate Hotels may be reduced by
amounts paid under replacement management contracts. During July 2004, we concluded negotiations with Interstate Hotels to
terminate the intercompany agreement. In exchange for terminating the
intercompany agreement, we will receive, among other things, the following:
the right to terminate up to 600 rooms per year upon the payment of a
termination fee equal to 1.5 times the fees earned during the preceding 12
months, with the ability to carryover up to 600 rooms for termination in a
succeeding year; the right to terminate the management contract of a hotel,
where Interstate Hotels invests in a competing hotel, with no termination fee;
and an extension of the termination fee payment period for terminations related
to hotel sales, from 30 months to 48 months. Separately, we reached an agreement with Interstate Hotels regarding the
calculation of termination fees payable upon a sale. Although termination fees
for the properties that have been sold or were included in our previously
announced disposition program (which includes four assets in our current
disposition program) will be unchanged, we will receive a $2.5 million credit,
which will be applicable to fees payable with respect to future dispositions.
Of the $2.5 million credit, $0.6 million has been applied to terminations that
have occurred in the third quarter of 2004, and an additional $1.7 million will
be applied to terminations resulting from the sale of two of our remaining
assets in our current disposition program. 12. Dispositions Between January 1, 2003 and June 30, 2004, we have sold 30 hotels with
6,241 rooms for total gross proceeds of $232.8 million. Of these 30 hotels, 15
hotels were sold in 2003, 11 hotels were sold in the first quarter of 2004, and
four hotels were sold in the second quarter of 2004. As of June 30, 2004, we
had seven 16




---



##### 



hotels remaining in our non-core disposition program. Three of these
hotels met our criteria for held-for-sale classification as of June 30, 2004
(see Note 6). Operating results for the sold hotels, and where applicable, the
gain or loss on final disposition, and the three classified as held-for-sale
are included in discontinued operations. Two of the seven hotels in our
disposition program have been sold in the third quarter of 2004 for
approximately $14.5 million. Summary financial information included in discontinued operations for
these hotels is as follows (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    7,296
    
    
    $
    44,638
    
    
    $
    22,006
    
    
    $
    87,076Loss on asset impairments
    
    
    (1,139
    )
    
    
    (142,876
    )
    
    
    (5,905
    )
    
    
    (199,553
    )Pretax gain (loss) from
operations
    
    
    592
    
    
    
    860
    
    
    
    (879
    )
    
    
    (501
    )Loss on disposal
    
    
    (4,584
    )
    
    
    
    
    
    
    (11,530
    )
    
    
    
 Loss on disposal resulted primarily from the recognition of termination
fees payable to Interstate Hotels with respect to these hotels management
contracts. 13. Consolidating Financial Statements Certain of our subsidiaries and MeriStar Hospitality are guarantors of our
senior unsecured notes. Certain of our subsidiaries are guarantors of MeriStar
Hospitalitys unsecured senior subordinated notes. All guarantees are full and
unconditional, and joint and several. Exhibit 99.1 to this Quarterly Report on
Form 10-Q presents our supplementary consolidating financial statements,
including each of our guarantor subsidiaries. This exhibit presents our
consolidating balance sheets as of June 30, 2004 and December 31, 2003,
consolidating statements of operations for the three and six months ended June
30, 2004 and 2003, and consolidating statements of cash flows for the six
months ended June 30, 2004 and 2003. 17




---



##### 



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Managements Discussion and Analysis of Financial Condition and Results of
Operations may contain forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. Forward-looking statements, which are based on various
assumptions and describe our future plans, strategies and expectations, are
generally identified by our use of words such as intend, plan, may,
should, will, project, estimate, anticipate, believe, expect,
continue, potential, opportunity, and similar expressions, whether in the
negative or affirmative. We cannot guarantee that we actually will achieve
these plans, intentions or expectations. All statements regarding our expected
financial position, business and financing plans are forward-looking
statements. Except for historical information, matters discussed in this Managements
Discussion and Analysis of Financial Condition and Results of Operations are
subject to known and unknown risks, uncertainties and other factors which may
cause our actual results, performance or achievements to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. Factors which could have a material adverse effect on our operations and
future prospects include, but are not limited to:  
    
    economic conditions generally and the real estate
market specifically;  
    
    the effects of threats of terrorism and increased
security precautions on travel patterns and demand for
hotels;  
    
    the threatened or actual outbreak of hostilities and international political instability;  
    
    governmental actions;  
    
    legislative/regulatory changes, including changes to
laws governing the taxation of real estate investment trusts;  
    
    the level of proceeds from asset sales;  
    
    cash available for capital expenditures;  
    
    the availability of capital;  
    
    our ability to refinance debt;  
    
    rising interest rates;  
    
    rising insurance premiums;  
    
    competition;  
    
    supply and demand for hotel rooms in our current and proposed market areas;  
    
    other factors that may influence the travel industry,
including health, safety and economic factors; and  
    
    changes in generally accepted accounting principles, policies
and guidelines applicable to real estate investment trusts. 18




---



##### 



These risks and uncertainties should be considered in evaluating any
forward-looking statements contained in this report or incorporated by
reference herein. All forward-looking statements speak only as of the date of
this report or, in the case of any document incorporated by reference, the date
of that document. All subsequent written and oral forward-looking statements
attributable to us or any person acting on our behalf are qualified by the
cautionary statements in this section. We undertake no obligation to update or
publicly release any revisions to forward-looking statements to reflect events,
circumstances or changes in expectations after the date of this report. BUSINESS SUMMARY MeriStar Hospitality Operating Partnership, L.P. is the subsidiary
operating partnership of MeriStar Hospitality Corporation (MeriStar
Hospitality), which is a real estate investment trust, or REIT. We own a
portfolio of primarily upper upscale, full-service hotels and resorts. Our
portfolio is diversified geographically as well as by franchise and brand
affiliations. As of June 30, 2004, we owned 79 hotels with 22,187 rooms. Two
of these assets with 568 total rooms have been sold during the third quarter of
2004. Our hotels are located in major metropolitan areas, rapidly growing
secondary markets or resort locations in the United States. All of our hotels
are leased by our taxable subsidiaries. As of June 30, 2004, 77 hotels are
currently managed by Interstate Hotels & Resorts (Interstate Hotels), which
was created on July 31, 2002 through the merger of MeriStar Hotels & Resorts,
Inc. and Interstate Hotels Corporation, one hotel is managed by The
Ritz-Carlton Hotel Company LLC (Ritz-Carlton), a subsidiary of Marriott
International, Inc., and one hotel is managed by another subsidiary of Marriott
International, Inc. (Marriott) (collectively with Interstate Hotels, the
Managers). The Managers operate our 79 hotels pursuant to management agreements with
our taxable subsidiaries. Under these management agreements, the taxable
subsidiaries pay a management fee for each property to the Manager of their
hotels. The taxable subsidiaries in turn make rental payments to our
subsidiary operating partnership under the participating leases. Under the Interstate Hotels management agreements, the base management fee
is 2.5% of total hotel revenue, plus incentive payments based on meeting
performance thresholds that could total up to an additional 1.5% of total hotel
revenue. The agreements have initial terms expiring on January 1, 2011 with
three renewal periods of five years each at the option of Interstate Hotels,
subject to some exceptions. Under the Ritz-Carlton and Marriott management agreements, the base
management fee is 3.0% and 2.5% of total hotel revenue, respectively, through
2005 and 3.0% under both thereafter, plus incentive payments based on meeting
performance thresholds that could total up to an additional 2.0% of total hotel
revenue and 20% of available cash flow (as defined), respectively. The
agreements have initial terms expiring in 2015 and 2024, respectively, with
four and three renewal periods of 10 and five years each, respectively, at the
option of Ritz-Carlton and Marriott. The Ritz-Carlton and Marriott management
agreements include certain limited performance guarantees by Ritz-Carlton and
Marriott which are designed primarily to provide downside performance
protection and run through 2005 and up to 2008, respectively. Management
expects funding under these guarantees to be minimal. Since the July 2002 merger that formed Interstate Hotels, we and
Interstate Hotels have separated the senior management teams of the two
companies in order to allow each senior management team to devote more
attention to its respective companys matters. In December 2003, MeriStar
Hospitalitys Board of Directors and that of Interstate Hotels each formed a
special committee of independent directors to explore further changes to the
relationship between our company and Interstate Hotels, including possible
changes to the terms, or complete elimination, of the intercompany agreement. During July 2004, we concluded negotiations with Interstate Hotels to
terminate the intercompany agreement. In exchange for terminating the
intercompany agreement, we will receive, among other things, the following:
the right to terminate up to 600 rooms per year upon the payment of a
termination fee equal to 1.5 times the fees earned during the preceding 12
months, with the ability to carryover up to 600 rooms for termination in a
succeeding year; the right to terminate the management contract of a hotel,
where Interstate Hotels invests in a competing hotel, with no termination fee;
and an extension of the termination fee payment period for terminations related
to hotel sales, from 30 months to 48 months. The termination of the
intercompany agreement eliminates the last vestige of our original paper clip
relationship with Interstate Hotels. 19




---



##### 



Separately, we reached an agreement with Interstate Hotels regarding the
calculation of termination fees payable upon a sale. Although termination fees
for the properties that have been sold or were included in our previously
announced disposition program (which includes four assets in our current
disposition program) will be unchanged, we will receive a $2.5 million credit,
which will be applicable to fees payable with respect to future dispositions.
Of the $2.5 million credit, $0.6 million has been applied to terminations that
have occurred in the third quarter of 2004, and an additional $1.7 million will
be applied to terminations resulting from the sale of two of our remaining
assets in our current disposition program. RESULTS OVERVIEW At the beginning of 2003, we set out a strategy to position our company to
best take advantage of an expected economic and industry recovery. We believe
that we are in the midst of the early stages of a lodging industry economic
recovery, however, the recovery is not uniform throughout the country. Certain
of our markets are performing well, while others have not yet recovered. Our
strategy includes the following key initiatives: focus on growth of earnings
and cash flow from our existing core portfolio using an aggressive asset
management program; upgrade our core portfolio through extensive renovations;
reshape the portfolio through asset sales and strategic acquisitions; maintain
liquidity; improve our capital structure; and maintain upside potential. We are in the process of upgrading the product quality and growth
potential of our core hotels through our aggressive capital expenditure program
and brand conversions. We have continued to reshape our portfolio through two
strategic, high-quality acquisitions, and dispositions of a number of lower
yielding properties. Through our asset disposition program, we completed the
sale of 30 non-core assets from January 1, 2003 through June 30, 2004, with two
additional hotels sold through early August 2004. We have generated $247.2
million in gross cash proceeds from the disposition of those 32 assets, which
has significantly enhanced our liquidity. We ended the quarter with
approximately $222 million in cash and cash equivalents, $149 million of which
was unrestricted. We have no material maturities of long-term debt until 2007.
We expect to retire the remaining 8.75% notes payable to MeriStar Hospitality
due 2007 by the end of 2004. We have recently developed a unique process to renovations, which we
expect to reduce the time and cost required to renovate hotels going forward,
allowing us to improve the quality of our hotels faster to take advantage of
the rebound in the economy and better control the level of disruption
associated with renovations. During the quarter, we accelerated our renovation
program for certain key assets which created somewhat more short-term
disruption than we had originally expected, but also positioned us to
participate more quickly in the lodging industry recovery. We expect to invest
approximately $225 million in capital expenditures during 2004 and 2005 to
enhance the quality of our core product to meet or exceed the standards of our
primary brands  Hilton, Marriott, and Starwood  as well as to improve the
competitiveness of these assets in their markets and enable them to more fully
participate in any economic recovery. While results are negatively impacted
during renovations due to out of service rooms and the negative impact on the
ability to sell other hotel services, we expect to have positioned these
renovated properties well to be able to benefit from the economic recovery. Since the beginning of 2004, we have completed five of ten planned or
contemplated brand conversions at the Sheraton Bellevue, Holiday Inn Walt
Disney World Village, Doubletree Universal, Doubletree Hotel Dallas Galleria,
and Sheraton Key Largo with 1,724 total rooms converted to date. We
experienced the short term effect of these brand conversions in the first and
second quarters due to customer displacement, renovation work and initial costs
of training and marketing associated with brand conversions. We expect the
conversions to generate longer term positive results at these hotels going
forward with increased brand support, better alignment of hotel characteristics
to the brand, or a more beneficial cost structure. Revenues from continuing operations increased to $428 million for the six
months ended June 30, 2004 compared to $417 million for the same period in
2003. Net loss for the six months ended June 30, 2004 includes
other operating
expenses that are 3.6% higher compared to the same period in 2003, mainly due
to the short-term impact of hotel renovations and brand conversions during
2004, the impact in 2003 of aggressive cost-cutting initiatives that were
implemented last year prior to the war in Iraq, and a restoration of 2003 cost
reductions, particularly in areas having the most impact on guest satisfaction
such as concierge, lounge, 20




---



##### 



restaurant and lounge hours and front desk and bell stand staffing. In
addition, we incurred a $7.9 million loss on early extinguishment of debt
during the six months ended June 30, 2004. The following discussion should be read in conjunction with our Annual
Report on Form 10-K for the year ended December 31, 2003 as filed with the
Securities and Exchange Commission, and with the unaudited consolidated
financial statements and related notes included in Item 1 of this Quarterly
Report on Form 10-Q. RESULTS OF OPERATIONS Our revenues are derived from the operations of our hospitality
properties, including room, food and beverage revenues, as well as from our
leases of office, retail and parking rentals. Included in our operating
results is our 16% cumulative preferred return, adjusted for the provision on
the cumulative portion of the preferred return, on our partnership interest in
MeriStar Investment Partners, L.P. (MIP). Operating costs include direct
costs to run our hotels, management fees to Interstate Hotels, Ritz-Carlton and
Marriott for the management of our properties, depreciation of our properties,
impairment charges, property tax and insurance, as well as sales, marketing and
general and administrative costs. Our expenses also include interest on our
debt, amortization of related debt-issuance costs and minority interest
allocations, which represent the allocation of income and losses to outside
investors for properties that are not wholly owned. The provisions of Statement of Financial Accounting Standards (SFAS) No.
144 require that current and prior period operating results of any asset that
has been classified as held for sale or has been disposed of on or after
January 1, 2002, including any gain or loss recognized on the sale, be recorded
as discontinued operations. Accordingly, we have reclassified all prior periods
presented to conform to this requirement. See Note 12, Dispositions,
included in Item 1 of this Quarterly Report on Form 10-Q for further
information regarding the amounts included in discontinued operations. Summary data for the three and six months ended June 30 were as follows
(dollars in thousands, except operating data statistics): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,Percent
    
    
    
    
    
    
    
    
    
    PercentSummary of Operations:
    
    2004
    
    2003
    
    Change
    
    2004
    
    2003
    
    ChangeTotal revenue
    
    $
    222,889
    
    
    $
    215,969
    
    
    
    3.2
    %
    
    $
    427,959
    
    
    $
    416,696
    
    
    
    2.7
    %Hotel operating expenses
    
    
    88,319
    
    
    
    82,775
    
    
    
    6.7
    
    
    
    170,135
    
    
    
    160,414
    
    
    
    6.1Other operating expenses
    
    
    108,535
    
    
    
    108,117
    
    
    
    0.3
    
    
    
    219,405
    
    
    
    211,780
    
    
    
    3.6Loss on asset
impairments
    
    
    1,291
    
    
    
    65,123
    
    
    
    (98.0
    )
    
    
    1,536
    
    
    
    65,123
    
    
    
    (97.6
    )Total operating expenses
    
    
    198,145
    
    
    
    256,015
    
    
    
    (22.6
    )
    
    
    391,076
    
    
    
    437,317
    
    
    
    (10.6
    )Operating income (loss)
    
    
    24,744
    
    
    
    (40,046
    )
    
    
    >100.0
    
    
    
    36,883
    
    
    
    (20,621
    )
    
    
    >100.0Minority interest
    
    
    20
    
    
    
    5
    
    
    
    >100.0
    
    
    
    24
    
    
    
    (6
    )
    
    
    >100.0Loss on early
extinguishment of debt
    
    
    (1,980
    )
    
    
    
    
    
    
    N/A
    
    
    
    (7,903
    )
    
    
    
    
    
    
    N/AInterest expense, net
    
    
    (29,724
    )
    
    
    (34,583
    )
    
    
    (14.1
    )
    
    
    (64,103
    )
    
    
    (69,301
    )
    
    
    (7.5
    )Income tax benefit (expense)
    
    
    (25
    )
    
    
    (10
    )
    
    
    >100.0
    
    
    
    314
    
    
    
    119
    
    
    
    >100.0Loss from continuing
operations
    
    
    (6,965
    )
    
    
    (74,634
    )
    
    
    (90.7
    )
    
    
    (34,785
    )
    
    
    (89,809
    )
    
    
    (61.3
    )Loss from discontinued
operations(a)
    
    
    (5,086
    )
    
    
    (142,025
    )
    
    
    (96.4
    )
    
    
    (18,153
    )
    
    
    (200,048
    )
    
    
    (90.9
    )Net loss
    
    $
    (12,051
    )
    
    $
    (216,659
    )
    
    
    (94.4
    )%
    
    $
    (52,938
    )
    
    $
    (289,857
    )
    
    
    (81.7
    )%
  (a)
    
    Includes loss on asset impairments of $1.1 million and $142.9
million for the three months ended June 30, 2004 and 2003,
respectively. Also includes loss on disposal of $4.6 million for the
three months ended June 30, 2004. Includes loss on asset impairments
of $5.9 million and $199.6 million for the six months ended June 30,
2004 and 2003, respectively. Also includes loss on disposal of $11.5
million for the six months ended June 30, 2004. 21




---



##### 



Three months ended June 30, 2004 compared with the three months ended June 30,
2003 Continuing Operations Results for 76 Properties Our 76 properties in continuing operations include four properties planned
for disposition, four properties impacted by brand conversions, and two
properties acquired in 2004. Total revenue.Total revenue increased in the second quarter of 2004
compared to the same period of 2003, as the industry began to benefit from an
increase in travel due to a general strengthening of the economy, partially
offset by the short-term impacts of rebranding and renovation-related
disruptions. Additionally, the prior year was impacted by the war in Iraq.
The increase in total revenue was primarily due to a $6.2 million increase in
room revenue, as well as revenues from properties acquired in 2004. Hotel operating expenses.Hotel operating expenses increased $5.5 million
or 6.7% in the second quarter of 2004 compared to same period of 2003. The
increase was attributable to a 7.9% increase in rooms expense mainly due to the
restoration of services with an emphasis on improving guest satisfaction, the
impact of renovation-related costs, the impact of brand conversion costs and
the effect of expenses of hotels acquired in 2004. Also, prior year results
reflect aggressive cost reductions as a result of the war in Iraq. Food and
beverage expense also increased 7.6% as rapidly increasing food costs and labor
expenses outpaced adjustments in menu pricing. Other operating expenses.Other operating expenses, which include general
and administrative expenses, property operating costs, depreciation and
amortization, non-income taxes, and insurance, remained relatively flat in the
aggregate. Individual variations in these expenses were as follows:  
    
    Corporate general and administrative expenses increased
by approximately $0.3 million during the second quarter of 2004
primarily due to an increase in costs associated with corporate
headquarters resources as we separate ourselves from Interstate
Hotels as well as the increased cost to comply with the increase
in public company compliance requirements.  
    
    Property operating costs, which consist of repairs and
maintenance, energy, franchise and management costs, increased
$1.3 million to $31.9 million during the three months ended June
30, 2004 as compared to the same period in 2003 mainly due to
increases in franchise fees and management fees as a result of
increasing revenues and higher energy costs. The energy costs
increase was partially mitigated by a strategic program
implemented in late 2003 which is designed to help us manage the
increasingly volatile energy costs at our hotels.  
    
    Insurance expense decreased 18% for the three months
ended June 30, 2004 as compared to the same period in 2003
primarily due to an improvement in property insurance premiums
upon renewal. Loss on asset impairments.We recognized losses on asset impairments
totaling $2.4 million and $208.0 million related to our asset disposition
program during the three months ended June 30, 2004 and 2003, respectively. Of
these total asset impairment losses, $1.1 million and $142.9 million for the
three months ended 2004 and 2003, respectively, are included in discontinued
operations. The impairment losses recorded during the three months ended June
30, 2004 primarily represent a decrease in estimated proceeds from the sale of
our remaining assets planned for disposition. Impairments were significant
during the three months ended June 30, 2003 due to our decision during that
quarter to expand our asset disposition program, thereby resulting in a change
in our expected holding period for these assets. Loss on early extinguishment of debt. During the second quarter of 2004,
we recorded a loss on early extinguishment of debt of $1.6 million related to
our repurchase of $28.1 million of our senior unsecured notes, and $0.3 million
related to our redemption of $11.2 million of 8.75% notes payable to MeriStar
Hospitality due 2007. Interest expense, net.Interest expense declined 14.1% in the second
quarter of 2004 compared to the same period of 2003 primarily due to
repurchases of higher interest bearing debt and placement of lower interest
bearing debt. 22




---



##### 



Loss from discontinued operations.During the second quarter of 2004, we
completed the sale of four hotels in separate transactions for an aggregate of
$30.8 million in cash, resulting in loss on disposal of $4.6 million. Loss on
disposal resulted primarily from the recognition of termination fees payable to
Interstate Hotels with respect to these hotels management contracts. As of
June 30, 2004, we had three hotels classified as held for sale. Discontinued
operations for the three months ended June 30, 2004 included impairment charges
totaling $1.1 million related to the assets held for sale. Discontinued
operations for the three months ended June 30, 2003 included impairment charges
totaling $142.9 million. Six months ended June 30, 2004 compared with the six months ended June 30, 2003 Continuing Operations Results for 76 properties Our 76 properties in continuing operations include four properties planned
for disposition, four properties impacted by brand conversions, and two
properties acquired in 2004. Total revenue.Total revenue increased $11.3 million for the six months
ended June 30, 2004 compared to the same period of 2003, as the industry began
to benefit from an increase in travel due to a general strengthening of the
economy. Additionally, the prior year was impacted by the build-up and start
of the war in Iraq. Current year revenues were also impacted by rebranding and
renovations at several hotels. Hotel operating expenses.Hotel operating expenses increased $9.7 million
or 6.1% for the six months ended June 30, 2004 compared to the same period of
2003. The increase was attributable to a 7.3% increase in rooms expense mainly
due to the restoration of services with an emphasis on improving guest
satisfaction, the impact in 2004 of renovation-related costs, and the impact of
brand conversion costs. Also, prior year results reflect aggressive cost
reductions in anticipation of economic impacts associated with the war in Iraq.
Food and beverage expense also increased 5.7% as rapidly increasing food costs
and labor expenses outpaced adjustments in menu pricing. Other operating expenses.Other operating expenses, which include general
and administrative expenses, property operating costs, depreciation and
amortization, non-income taxes, and insurance, increased 3.6%. Individual
variations in these expenses were as follows:  
    
    Hotel general and administrative expenses increased by
approximately $2.9 million or 4.6% for the six months ended June
30, 2004 as compared to the same period in 2003 primarily due to
a 7.5% increase in sales and marketing expense at the hotel level
associated with new initiatives implemented in the first quarter
of 2004.  
    
    Corporate general and administrative expenses increased
$1.0 million or 16.4% during the six months ended June 30, 2004
primarily due to an increase in costs associated with corporate
headquarters resources as we separate ourselves from Interstate
Hotels as well as the increased cost to comply with the increase
in public company compliance requirements.  
    
    Property operating costs, which consist of repairs and
maintenance, energy, franchise and management costs, increased
$3.3 million to $62.9 million during the six months ended June
30, 2004 as compared to the same period in 2003 mainly due to an
increase in repairs and maintenance as a result of a strategy to
improve operating capabilities and longer term quality of our
assets, increases in franchise fees and management fees as a
result of increasing revenues and higher energy costs (due to
colder weather in January and February 2004). The energy costs
increase was partially mitigated by a strategic program
implemented in late 2003 which is designed to help us manage the
increasingly volatile energy costs at our hotels.  
    
    Insurance expense decreased 6.7% for the six months
ended June 30, 2004 as compared to the same period in 2003
primarily due to an improvement in property insurance premiums
upon renewal in the three months ended June 30, 2004.  
    
    Depreciation and amortization expense increased $2.1
million for the six months ended June 30, 2004 to $50.7 million
from $48.6 million for the six months ended June 30, 2003. The
increase is due to the write-off of deferred financing fees
related to early repayments of our debt securities and
depreciation on our properties acquired in 2004. 23




---



##### 



Loss on asset impairments.We recognized losses on asset impairments
totaling $7.4 million and $264.7 million related to our asset disposition
program during the six months ended June 30, 2004 and 2003, respectively. Of
these total asset impairment losses, $5.9 million and $199.6 million for the
six months ended 2004 and 2003, respectively, are included in discontinued
operations. The impairment losses recorded during the six months ended June
30, 2004 primarily represent a decrease in estimated proceeds from the sale of
our remaining assets planned for disposition. Impairments were significant
during the six months ended June 30, 2003 due to our decision early that year
to expand our asset disposition program, thereby resulting in a change in our
expected holding period for these assets. Loss on early extinguishment of debt. For the six months ended June 30,
2004, we recorded a loss on early extinguishment of debt of $6.2 million
related to our repurchase of $99.6 million of our senior unsecured notes, and
$1.7 million related to our redemption of $49.2 million of our 8.75% notes
payable to MeriStar Hospitality due 2007. Interest expense, net.Interest expense declined 7.5% during the six
months ended June 30, 2004 compared to the same period in 2003 primarily due to
repurchases of higher interest bearing debt and placement of lower interest
bearing debt. Loss from discontinued operations.During the six months ended June 30, 2004,
we completed the sale of 15 hotels in separate transactions for an aggregate of
$104.9 million in cash, resulting in a loss on disposal of $11.5 million. The
loss on disposal resulted primarily from the recognition of termination fees
payable to Interstate Hotels with respect to these hotels management
contracts. As of June 30, 2004, we had three hotels classified as held for
sale. Discontinued operations for the six months ended June 30, 2004 included
impairment charges totaling $5.9 million related to the assets held for sale.
Discontinued operations for the six months ended June 30, 2003 included
impairment charges totaling $199.6 million. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Our principal sources of liquidity are cash generated from operations,
funds from borrowings, funds from the sales of assets and existing cash on
hand. Our principal uses of cash include the funding of working capital
obligations, debt service, debt repurchases, and investments in hotels
(including capital projects and acquisitions). We believe we currently have
sufficient cash on hand and future cash flow, and we expect to have adequate
cash flow during the next twelve months in order to fund our operations,
capital commitments and debt service obligations. MeriStar Hospitality does
not expect to pay a dividend on its common stock in 2004. Our current and
future liquidity is, however, greatly dependent upon our operating results,
which are driven largely by overall economic conditions, and since September
11, 2001 have been significantly affected by geopolitical concerns and other
factors affecting business and leisure travel. If general economic conditions
are significantly worse than we expect for an extended period, this will likely
have a negative effect on our projections of available cash flow and liquidity. Factors that may influence our liquidity include:  
    
    Factors that affect our results of operations, including
general economic conditions, demand for business and leisure travel,
public concerns about travel safety related primarily to terrorism
and related concerns, capital investments required to maintain our
propertys competitive position and other operating risks described
under the caption, Risk FactorsOperating Risks in Item 1 of our
Annual Report on Form 10-K for the year ended December 31, 2003;  
    
    Factors that affect our access to bank financing and the
capital markets, including operational risks, high leverage,
covenant compliance, interest rate fluctuations, and other risks
described under the caption Risk FactorsFinancing Risks in Item 1
of our Annual Report on Form 10-K for the year ended December 31,
2003; and  
    
    Other factors described previously under the caption,
Cautionary Statement Regarding Forward-Looking Statements in this
Quarterly Report on Form 10-Q. 24




---



##### 



We generally intend to hold unrestricted cash balances of $40 million to
$50 million in our operating accounts as a hedge against economic and
geopolitical uncertainties, as well as to provide for our recurring cash
requirements. We established a new $50 million secured revolving bank line in
December 2003, maturing in December 2006, which is fully available and
increases our flexibility in managing our liquidity. As part of our strategy to manage our leverage, we have raised proceeds
through an equity issuance, and we have retired debt with higher interest rates
and acquired added debt with lower interest rates. On April 23, 2004, MeriStar
Hospitality issued and sold 12.0 million shares of common stock at a price to
the public of $6.25 per share pursuant to its effective shelf registration
statement filed under the Securities Act of 1933. The offering closed on April
28, 2004 with net proceeds of approximately $72.3 million. In connection with
this transaction, MeriStar L.P. Inc., a wholly-owned subsidiary of MeriStar
Hospitality, contributed the net proceeds to us in exchange for the same number
of common OP Units. During fiscal 2004, we have retired $49.2 million of our
8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of
accrued interest) by issuing 8,138,728 common OP Units through August 3, 2004.
In addition, as of August 3, 2004, we have purchased from available cash $99.6
million of our senior unsecured notes, including $25.8 million of the 10.5%
notes, $29.5 million of the 9% notes and $44.3 million of the 9.125% notes.
Following these exchanges and the repurchases, we had as of August 3, 2004,
$34.2 million of outstanding 8.75% notes payable to MeriStar Hospitality due
2007 and $850.4 million of outstanding senior unsecured notes. We expect to
retire the remaining 8.75% notes payable to MeriStar Hospitality due 2007 by
the end of 2004. Additionally, in June 2004, we entered into two fixed-rate
mortgages at 5.69% and 5.80%, respectively, secured by our two hotels acquired
during the second quarter of 2004. During the six months ended June 30, 2004, we have sold $104.9 million of
underperforming and non-core assets. Non-core assets were largely upscale and
midscale assets that do not fit with our upper upscale focus, were located in
markets that are not strategically important or where we have multiple assets,
had significant capital expenditure needs or produced insufficient cash flow or
have lower growth opportunities. Proceeds were used to redeem debt or upgrade
the existing portfolio through our asset renovation program or acquisition
strategy. As part of our acquisition strategy, on May 10, 2004 we acquired the
four-star, four-diamond rated Ritz-Carlton, Pentagon City in Arlington,
Virginia for a purchase price of $93 million. The 366-room luxury hotel is
operated by The Ritz-Carlton Hotel Company, LLC under a long-term contract.
The hotel features nearly 18,000 square feet of meeting space, which can
accommodate meetings of up to 900 guests. On June 30, 2004, we partially
financed the acquisition through closing on a $55.8 million fixed-rate mortgage
loan which is secured by this property, matures on June 1, 2011 and bears
interest at an annual rate of 5.80%. Additionally, on June 25, 2004, we acquired the 485-room Marriott Irvine
in Orange County, California, for a purchase price of $92.5 million. The hotel
is operated by a subsidiary of Marriott International, Inc. under a long-term
contract. The hotel features 30,000 square feet of meeting space, including a
13,000 square foot ballroom that can accommodate meetings of up to 1,500. We
expect to invest approximately $7.5 million in property improvements over the
next 12 months, primarily in the hotels guest rooms. To take advantage of the
current low interest rate environment, we financed a portion of the acquisition
with a $55.5 million fixed-rate mortgage which is secured by this property,
matures on July 1, 2011 and bears interest at an annual rate of 5.69%. Sources and Uses of Cash The following table shows our consolidated cash flows, generated by (used
in) our various activities, for the six months ended June 30 (in thousands): 2004
    
    2003
    
    2004 vs 2003Operating activities
    
    $
    17,691
    
    
    $
    11,810
    
    
    $
    5,881Investing activities
    
    
    (162,851
    )
    
    
    15,130
    
    
    
    (177,981
    )Financing activities
    
    
    63,323
    
    
    
    (4,414
    )
    
    
    67,737Cash and cash equivalents, end
of period  unrestricted
    
    
    148,812
    
    
    
    56,300
    
    
    
    92,512
 25




---



##### 



Our operating results and the amount of cash generated by our hotel
operations were adversely affected beginning in late 2001 by a general downturn
in the economy compounded by the events of September 11, 2001 and while we are
seeing the impacts of a recovering economy, our operating results have
continued to be negatively affected by the reduction in travel resulting from
economic conditions, geopolitical events, war, the continued threat of domestic
terrorism, and other factors affecting business and leisure travel. We used a net $162.9 million of cash from investing activities during the
first half of 2004, primarily due to:  
    
    $182.8 million for acquisition of hotels, net of cash acquired;  
    
    $49.9 million in capital expenditures (including $2.0 million of capitalized interest);  
    
    $30.0 million increase in cash restricted for mortgage escrows, partially offset by  
    
    $104.9 million of proceeds from the sale of 15 non-core hotel assets. Our investing activities provided a net $15.1 million of cash during the
first half of 2003, resulting primarily from:  
    
    $42.1 million from Interstate Hotels for the payment of a note receivable; and  
    
    $15.8 million of proceeds from the sale of two non-core hotel assets, partially offset by  
    
    $18.1 million investment in marketable securities;  
    
    $14.5 million in capital expenditures (including $1.6 million of capitalized interest); and  
    
    $9.7 million increase in cash restricted for mortgage escrows. We realized a net $63.3 million in proceeds from financing activities
during the first half of 2004 primarily due to proceeds from debt issuance, net
of issuance costs, of $109.7 million, proceeds from OP units issuances of $72.3
million, partially offset by prepayments on long-term debt of $105.9 million,
scheduled payments on long-term debt of $3.7 million and the purchase of OP
units for $8.7 million. We used $4.4 million of cash in financing activities
during the first half of 2003 due mainly to the repayment of our long-term debt
obligations. MeriStar Hospitality must distribute to stockholders at least 90% of its
REIT taxable income, excluding net capital gains, to preserve the favorable tax
treatment accorded to REITs under the Internal Revenue Code. MeriStar
Hospitality, as our general partner, must use its best efforts to ensure our
partnership distributions meet this requirement. Under certain circumstances,
MeriStar Hospitality may be required to make distributions in excess of cash
available for distribution in order to meet the Internal Revenue Code
requirements. In that event, we and/or MeriStar Hospitality would seek to
borrow additional funds or sell additional non-core assets for cash, or both,
to the extent necessary to obtain cash sufficient to make the distributions
required to retain MeriStar Hospitalitys qualification as a REIT. Any future
distributions will be at the discretion of MeriStar Hospitalitys board of
directors and will be determined by factors including our operating results,
restrictions imposed by our borrowing agreements, capital expenditure
requirements, the economic outlook, the distribution requirements for REITs
under the Internal Revenue Code and such other factors as their board of
directors deems relevant. Our senior credit facility permits the payment of
dividends in order to maintain REIT qualification even if we fall below a 2 to
1 fixed charge coverage ratio. However, MeriStar Hospitalitys senior
subordinated notes indenture is more restrictive in that it permits the payment
of dividends only if we exceed the 2 to 1 fixed charge coverage ratio. We
expect to retire the remaining outstanding senior subordinated notes due 2007
by the end of 2004. As of June 30, 2004, our fixed charge coverage ratio was
significantly below 2 to 1. The timing and amount of any future distributions
is dependent upon these factors, and we cannot provide assurance that any such
distributions will be made in the future. MeriStar Hospitality does not expect
to pay a dividend on its common stock in 2004. 26




---



##### 



Long-Term Debt Long-term debt consisted of the following (in thousands): June 30, 2004
    
    December 31, 2003Senior unsecured notes due 2011  9.125%
    
    $
    355,665
    
    
    $
    400,000Senior unsecured notes due 2008  9.0%
    
    
    270,500
    
    
    
    300,000Senior unsecured notes due 2009  10.5%
    
    
    224,187
    
    
    
    250,000Secured facility, due 2009
    
    
    306,067
    
    
    
    309,035Secured facility, due 2013
    
    
    100,041
    
    
    
    100,765Mortgage debt
    
    
    137,505
    
    
    
    27,011Unamortized issue discount
    
    
    (4,063
    )
    
    
    (5,256
    )1,389,902
    
    
    
    1,381,555Fair value adjustment for interest rate swap
    
    
    (10,074
    )
    
    
    Long-term debt
    
    $
    1,379,828
    
    
    $
    1,381,555Notes payable to MeriStar Hospitality
    
    $
    207,930
    
    
    $
    257,143Unamortized issue discount
    
    
    (354
    )
    
    
    (670
    )Notes payable to MeriStar Hospitality
    
    $
    207,576
    
    
    $
    256,473Total long-term debt and notes payable to
MeriStar Hospitality
    
    $
    1,587,404
    
    
    $
    1,638,028
 As of June 30, 2004, 81% of our debt bore fixed rates of interest, and the
remaining 19% bore interest at fixed rates that have been, since April 2, 2004,
effectively swapped to a floating rate. Our overall weighted average interest
rate was 8.30% after giving effect to the interest rate swap. Based on market
prices at June 30, 2004, the fair value of our long-term debt was $1.62
billion. Credit facility.On December 23, 2003, we entered into a new three-year
$50 million senior credit facility, secured by six of our hotels, and
terminated our previous credit facility. The facility bears interest at an
annual rate of the London Interbank Offered Rate, or LIBOR, plus 450 basis
points. As of June 30, 2004, we had no outstanding borrowings under this
facility. The facility contains financial and other restrictive covenants. Our
ability to borrow under this facility is subject to compliance with financial
covenants, including leverage, fixed charge coverage and interest coverage
ratios and minimum net worth requirements. Our compliance with these covenants
in future periods will depend substantially upon the financial results of our
hotels. The agreement governing our new senior credit facility limits our
ability to effect mergers, asset sales and change of control events and limits
the payments of dividends other than those required for us to maintain our
status as a REIT and our ability to incur additional secured and total
indebtedness. Senior unsecured notes.During the six months ended June 30, 2004, we
repurchased from available cash $99.6 million of our senior unsecured notes,
including $29.5 million of the 9.0% notes due 2008, $44.3 million of the 9.125%
notes due 2011, and $25.8 million of the 10.5% notes due 2009. We recorded a
loss on early extinguishment of debt of $6.2 million and wrote off deferred
financing costs of $1.2 million related to these repurchases which is included
in depreciation and amortization expense on the accompanying consolidated
statements of operations. These senior unsecured notes are unsecured obligations of ours and certain
subsidiaries of ours, and MeriStar Hospitality guarantees payment of principal
and interest on the notes. These notes contain various restrictive covenants,
limiting our ability to initiate or transact certain business activities if
specific financial thresholds are not achieved. One of those thresholds is
having a 2 to 1 fixed charge coverage ratio (as defined in the indentures,
fixed charges only include interest on debt obligations and preferred equity)
in order to enter into certain types of transactions, including the repurchase
of our common OP units, the issuance of preferred equity, the payment of
certain distributions, the incurrence of any additional debt, or the repayment
of certain outstanding debt before it comes due. As of June 30, 2004, our
fixed charge coverage ratio was significantly 27




---



##### 



below 2 to 1, and therefore we were not permitted generally to enter into
those transactions, except as noted below. There are certain exceptions with respect to the incurrence of additional
debt and early repayment of debt features in the indentures. We have the
ability to incur up to $300 million of secured financing within restricted
subsidiaries, subject to meeting other maintenance tests under the indentures,
of which $194 million was available at June 30, 2004. We also have a general
carve-out to incur $50 million of unspecified borrowings within a restricted
subsidiary, of which the full amount was available at June 30, 2004. We have
the ability to lever assets within an unrestricted subsidiary, such as the
mortgage financing related to the acquisition of Marriott Irvine.
Additionally, we are permitted to repay subordinated debt prior to its maturity
from the proceeds of an equal or junior financing with a longer term than the
debt refinanced, an equity offering, or a financing within an unrestricted
subsidiary. Secured facilities.We completed a $330 million non-recourse financing
secured by a portfolio of 19 hotels in 1999. The loan bears a fixed annual
interest rate of 8.01% and matures in 2009. The secured facility contains
standard provisions that require the servicer to maintain in escrow cash
balances for certain items such as property taxes and insurance. In addition,
the facility contains a provision that requires our mortgage servicer to retain
in escrow the excess cash from the encumbered hotels after payment of debt
service (Excess Cash), if net hotel operating income (NOI) for the trailing
twelve months declines below $57 million. This provision was triggered in
October 2002 and will be effective until the hotels generate the minimum cash
flow required for two consecutive quarters, at which time the cash being held
in escrow will be released to us. We expect that net hotel NOI will remain
below $57 million for the foreseeable future. As of June 30, 2004 and December
31, 2003, $39.2 million and $27.2 million, respectively, of cash was held in
escrow under this provision. In July 2003, we signed an amendment to the loan
agreement that permits the release of cash placed in escrow for all capital
expenditures incurred on the 19 encumbered properties on or after April 1,
2003. Although the servicer will continue to retain in escrow any excess cash
from the encumbered hotels, they will release cash for all capital expenditures
we have incurred from April 1, 2003 through the date of the amendment and
future capital expenditures we incur on the 19 properties. Escrowed funds
totaling approximately $30.3 million were available to fund capital
expenditures under this provision as of June 30, 2004. In July 2004, we
received a cash reimbursement of $12.2 million from the servicer related to
capital expenditures incurred on the 19 encumbered properties. The fair value adjustments for the interest rate swap agreement of $(10.1)
million that are discussed in further detail below are related to the
outstanding secured facility balance of $306.1 million as of June 30, 2004. On September 26, 2003, as permitted by the indentures to our senior
unsecured notes and senior subordinated notes, we completed a $101 million
commercial mortgage-backed securities financing, secured by a portfolio of four
hotels. The loan carries a fixed annual interest rate of 6.88% and matures in
2013. We placed this commercial mortgage-backed security in order to reduce
our average borrowing cost by paying down debt with higher interest rates. Notes payable to MeriStar Hospitality.On July 1, 2003, MeriStar
Hospitality completed an offering of $170 million aggregate principal amount of
9.5% convertible subordinated notes due 2010. In conjunction with this
transaction, we borrowed $170 million from MeriStar Hospitality under terms
matching those of the 9.5% convertible subordinated notes. The proceeds from the new borrowing were used to repurchase $150.6 million
of our $154.3 million 4.75% notes payable to MeriStar Hospitality due 2004, at
varying prices, resulting in an aggregate discount of approximately $1.4
million. The remaining proceeds from the issuance were also used to repurchase
a portion of our 8.75% notes payable to MeriStar Hospitality due 2007. The 8.75% notes payable to MeriStar Hospitality due 2007 are unsecured
obligations, and provide for semi-annual payments of interest each February 15
and August 15. The related indenture contains various restrictive covenants,
which are similar to those in our senior unsecured notes. During the six months ended June 30, 2004, we retired $49.2 million of our
8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of
accrued interest) through the issuance of 8,138,728 28




---



##### 



common OP units. We recorded a loss on early extinguishment of debt of
$1.7 million. We expect to retire the remaining 8.75% notes payable to
MeriStar Hospitality due 2007 by the end of 2004. Mortgage debt. As of June 30, 2004, we had four mortgage loans, two of
which were placed during the second quarter of 2004 and one of which is in
foreclosure. We financed a portion of the Marriott Irvine acquisition (see Asset
Acquisitionsbelow) with a $55.5 million fixed-rate mortgage effective June 25,
2004, collateralized by the hotel, which matures on July 1, 2011 and bears
interest at an annual rate of 5.69%. On June 30, 2004, in connection with The
Ritz-Carlton, Pentagon City acquisition (see Asset Acquisitionsbelow), we
entered into a $55.8 million fixed-rate mortgage loan, collateralized by the
hotel, which matures on June 1, 2011 and bears interest at an annual rate of
5.80%. We have a mortgage that matures in 2011 and carries an interest rate of
8.8%; however, the lender, with our acquiescence, initiated foreclosure
proceedings which are expected to be completed in the third quarter of 2004.
This mortgage loan is collateralized by one of our properties, which we will
relinquish to the bank upon completion of foreclosure, which we expect to occur
in the third quarter of 2004. The carrying value of the mortgage loan and the
fair value of the building both approximate $11 million. This property is
included in the seven properties remaining in our disposition program. Our only other individual mortgage matures in 2011 and carries an interest
rate of 9.0%. Derivatives.On April 2, 2004, we entered into an interest rate swap
arrangement with a third party to manage our interest rate risk related to our
secured facility due 2009, effectively converting the interest the facility
bears from a fixed rate to a floating rate. Under the swap, we receive
fixed-rate payments of 8.01% and pay floating rate payments based on a one
month LIBOR plus 444 basis points on a $307 million notional amount. We do not
use derivative instruments for speculative purposes. Due to the fact that the
notional amount of the swap matches the principal amount of the underlying debt
and other hedge accounting criteria were met, the swap was designated as highly
effective at the inception of the swap arrangement and designated as a fair
value hedge. We continue to evaluate the effectiveness of the hedge and
believe that the hedge continues to be highly effective. For a derivative qualifying as a fair value hedge, the change in net
unrealized gain or loss upon measuring the fair value hedge and the fair value
of the debt instrument is recorded on our consolidated statements of
operations. These amounts offset each other as there is no ineffectiveness,
and therefore had no impact on our net income for the three and six months
ended June 30, 2004. The fair value of the swap is recorded as either an asset
or liability, with a corresponding increase or decrease to the carrying value
of the debt instrument being hedged on our consolidated balance sheets. The
fair value of our hedge was approximately a $10.1 million liability as of June
30, 2004. This amount is included in the Consolidated Balance Sheet as other
liabilities with the offset recorded to long-term debt. During the three and
six months ended June 30, 2004, we earned cash payments of $1.7 million under
the swap, which were recorded as a reduction in interest expense. During 2003, our only derivative instruments consisted of two swap
agreements that did not qualify for treatment as hedges under SFAS No. 133, of
which one expired in April 2003 and one in July 2003. During the three and six
months ended June 30, 2003, we recognized $1.3 million and $3.4 million,
respectively, of income related to the decrease in fair value of the liability
recorded for the interest rate swaps in place in those time periods. For the
three and six months ended June 30, 2003, we made cash payments on those swaps
of $1.3 and $3.4 million, respectively. The change in fair value and the swap
payments are netted together on our consolidated statement of operations, thus
resulting in no impact on net income. Asset Acquisitions One of our key strategies is the acquisition of high quality, upper
upscale full-service hotels strategically located in major urban markets or
destination resorts with high barriers to entry. Our acquisitions may involve
management contracts with hotel brands where our long-term investment focus
makes us a preferred owner. We intend to acquire assets with strong existing
cash flow and use moderate or no leverage in the near term to finance these
potential acquisitions, thereby enabling us to improve our overall leverage and
interest coverage levels. In pursuing this strategy, we may be somewhat
limited by the terms of our senior note indentures, which limit our 29




---



##### 



ability to obtain financing beyond certain limited exceptions (including
up to $300 million of mortgage indebtedness, of which $194 million was
available at June 30, 2004, and $50 million of general indebtedness and other
borrowings, of which the full amount was available at June 30, 2004, to the
extent capacity exists within unrestricted subsidiaries) to acquire assets (as
we are below the required fixed charge coverage ratio of 2 to 1). We have the
ability to lever assets within an unrestricted subsidiary, such as the mortgage
financing related to the acquisition of the Marriott Irvine. In order to incur
additional indebtedness beyond that permitted by those limited exceptions, we
would have to comply with the 2 to 1 fixed charge coverage ratio test on a pro
forma basis after incurring the indebtedness and applying its proceeds. As of
June 30, 2004, our fixed charge coverage ratio was significantly below 2 to 1. On May 10, 2004 and June 25, 2004, we acquired the 366-room Ritz-Carlton,
Pentagon City in Arlington, Virginia and the 485-room Marriott Irvine in Orange
County, California, respectively, for a total purchase price of $185.5 million,
plus net acquisition costs and adjustments of $0.7 million. The Ritz-Carlton, Pentagon City luxury hotel is operated by The
Ritz-Carlton Hotel Company, LLC under a long-term contract. On June 30, 2004,
we partially financed the acquisition through the placement of a $55.8 million
fixed-rate mortgage loan which is secured by this property, matures on June 1,
2011 and bears interest at an annual rate of 5.80%. The Marriott Irvine is operated by a subsidiary of Marriott International,
Inc. under a long-term contract. We expect to invest approximately $7.5
million in property improvements over the next 12 months, primarily in the
hotels guest rooms. We financed a portion of the acquisition with a $55.5
million fixed-rate mortgage loan which is secured by this property, matures on
July 1, 2011 and bears interest at an annual rate of 5.69%. Because Marriott
International, Inc. reports results in 13 four week periods during the year
rather than the 12 monthly periods that we employ, we will include 12 weeks of
results in each of quarters one through three and 16 weeks of results in
quarter four. The acquisitions were accounted for under the purchase method of
accounting, and the assets and liabilities and results of operations of the
hotels have been consolidated in our financial statements since the date of
purchase. On an unaudited pro forma basis, revenues, net income and basic and
diluted loss per share for the three and six months ended June 30, 2004 and
2003 would have been reported as follows if the acquisitions had occurred at
the beginning of each of the respective periods (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Total revenue
    
    $
    238,655
    
    
    $
    231,535
    
    
    $
    455,136
    
    
    $
    446,324Net loss
    
    
    (10,709
    )
    
    
    (214,958
    )
    
    
    (50,773
    )
    
    
    (287,726
    )Net loss per unit:Basic and Diluted
    
    $
    (0.12
    )
    
    $
    (4.39
    )
    
    $
    (0.64
    )
    
    $
    (5.87
    )
 The following is a summary of the combined preliminary allocation of the
purchase price (thousands), which may be revised upon completion of our
valuation procedures: Land
    
    $
    15,000Buildings and improvements
    
    
    151,592Furniture, fixtures and equipment
    
    
    18,220Net working capital
    
    
    1,435Total purchase price
    
    $
    186,247
 We have an active pipeline of acquisition opportunities, but we will
continue to be highly selective, focusing primarily on larger properties
located in major urban markets or high-end resort destinations with strong
brand affiliations and significant meeting space. While we plan to pursue
strategic acquisitions, our capacity is somewhat limited by the terms of our
senior note indentures, as discussed above. 30




---



##### 



Asset Dispositions During 2003, we began executing one of our key short-term strategies,
which is to reposition our portfolio by disposing of selected non-core assets
in order to begin repositioning our portfolio into one generally consisting of
high-quality, upscale full service hotels with significant meeting space,
located in urban or high-end resort locations with high barriers to entry.
Many of these non-core assets were acquired as part of portfolios of assets. We have nearly completed our disposition program, completing 30 hotel
sales from January 1, 2003 through June 30, 2004, 11 of which were sold during
the first quarter of 2004 for $74.1 million and 4 of which were sold during the
second quarter of 2004 for $30.8 million. Two additional assets have been sold
in the third quarter of 2004 for $14.5 million. We have five assets remaining
in our non-core disposition program with expected proceeds totaling
approximately $40 million. As a result of a continuing review of assets in our disposition program,
we recorded an impairment charge in the first half of 2004 of $1.5 million with
respect to assets not classified as held for sale and $5.9 million with respect
to assets held for sale. The impairment charge is based on our estimates of
the fair value of the disposition properties. These estimates require us to
make assumptions about the disposition prices that we expect to realize for
each property as well as the timing of a potential disposition. In making
these estimates, we consider the operating results of the assets, the market
for comparable properties, and quotes from brokers, among other information.
In nearly all cases, our estimates have reflected the results of an extensive
marketing effort and negotiations with prospective buyers. Actual results
could differ materially from these estimates. We will continue to analyze our portfolio to determine if we should
dispose of additional assets and recycle that capital into higher yielding
investments. Any dispositions of additional assets may result in further
impairment charges in future periods, if and when such transactions might be
undertaken. We may be obligated to pay Interstate Hotels termination fees of up to a
maximum of approximately $12.0 million with respect to the 32 properties that
we have sold between January 1, 2003 and August 3, 2004. In addition, as we
dispose of the five remaining assets in our disposition program, we may incur
termination obligations due to Interstate Hotels of up to a maximum of
approximately $1.7 million,assuming the disposition of all five of the
properties in 2004 and assuming buyers of our hotel properties elect to have
the properties managed by parties other than Interstate Hotels or do not assume
the obligation as part of the disposition transaction and no new management
agreements are substituted. Any such obligation would affect the calculation
of the final gain or loss on the disposition of a particular asset, since in
accordance with current accounting guidance, the obligation is not recognized
until such time as the asset disposition is complete and a termination notice
is provided to Interstate Hotels. At that time, the recognition of any
termination obligation will be included in discontinued operations. Any
obligation due under the termination provisions of the contract is payable over
a period of 48 months after termination. Termination fees payable to
Interstate Hotels may be reduced by amounts paid under replacement management
contracts. During July 2004, we concluded negotiations with Interstate Hotels to
terminate the intercompany agreement. In exchange for terminating the
intercompany agreement, we will receive, among other things, the following:
the right to terminate up to 600 rooms per year upon the payment of a
termination fee equal to 1.5 times the fees earned during the preceding 12
months, with the ability to carryover up to 600 rooms for termination in a
succeeding year; the right to terminate the management contract of a hotel,
where Interstate Hotels invests in a competing hotel, with no termination fee;
and an extension of the termination fee payment period for terminations related
to hotel sales, from 30 months to 48 months. The termination of the
intercompany agreement eliminates the last vestige of our original paper clip
relationship with Interstate Hotels. Separately, we reached an agreement with Interstate Hotels regarding the
calculation of termination fees payable upon a sale. Although termination fees
for the properties that have been sold or were included in our previously
announced disposition program (which includes four assets in our current
disposition program) will be unchanged, we will receive a $2.5 million credit,
which will be applicable to fees payable with respect to future dispositions.
Of the $2.5 million credit, $0.6 million has been applied to terminations that
have occurred in the third quarter of 2004, and an additional $1.7 million will
be applied to terminations resulting from the sale of two of our remaining
assets in our current disposition program. 31




---



##### 



Capital Expenditures We make ongoing capital expenditures in order to keep our hotels
competitive in their markets and to comply with franchise obligations.
Additionally, certain of our hotels management contracts and franchise
agreements contain reserve requirements for property improvements. We fund our
capital expenditures primarily from cash generated from operations and existing
cash on hand and intend to use a portion of the proceeds from the sales of
non-core assets to provide capital for renovation work. We invested $49.9
million for ongoing capital expenditures during the first half of 2004. We
have initiated an aggressive renovation program for our core assets and
anticipate investing a total of $125 million on capital expenditures in 2004.
The emphasis will be on completing these projects on budget with minimal
disruptions to operations. We will focus on complete room and facility
renovations, eliminating to the degree possible, piecemeal work where the
typical consumer might not ascribe value to the improvements. We believe we
are timing this work appropriately to take full advantage of the anticipated
industry recovery. The properties we are now marketing for sale typically have
higher per room capital expenditure requirements than our core assets. Sales
of these properties will allow us to focus our capital spending dollars in the
future on our core portfolio. We expect to continually review our portfolio
with a goal of recycling capital out of lower yielding investments into higher
yielding opportunities. OTHER FINANCIAL INFORMATION Critical Accounting Policies Our consolidated financial statements include the accounts of all
wholly-owned and majority-owned subsidiaries. Preparing financial statements
in conformity with accounting principles generally accepted in the United
States requires us to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. On an ongoing basis, we
evaluate our estimates and judgments, including those related to the impairment
of long-lived assets and the recording of certain accrued liabilities. Some of
our estimates are material to the financial statements. These estimates are
therefore particularly sensitive as future events could cause the actual
results to be significantly different from our estimates. Our critical accounting policies include the accounting for the impairment
or disposal of long-lived assets and the classification of properties as held
for sale. Our hotel properties generally fall into two categories, held for
use and held for sale. Our held for use properties may include those that we
are actively marketing. Until such time as our criteria for held for sale are
met, as described below in further detail, we maintain classification as an
operational asset. At the time we determine an asset to meet the criteria
noted below, we reclassify the asset and its operations to discontinued
operations. All of our properties are subject to an impairment analysis
whenever events or changes in circumstances indicate that the carrying value
may be impaired. Accounting for the impairment or disposal of long-lived assets We apply the provisions of SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which require the current and prior period
operating results of any asset that has been classified as held for sale or had
been disposed of on or after January 1, 2002 and where we have no continuing
involvement, including any gain or loss recognized, to be recorded as
discontinued operations. The provisions of SFAS No. 144 also require that whenever events or
changes in circumstances indicate that the carrying value of a long-lived asset
may be impaired that an analysis be performed to determine the recoverability
of the assets carrying value. We make estimates of the undiscounted cash
flows from the expected future operations or potential sale of the asset. If
the analysis indicates that the carrying value is not recoverable from these
estimates of cash flows, we write down the asset to estimated fair value and
recognize an impairment loss. Any impairment losses we recognize on assets held
for use are recorded as operating expenses. We record any impairment losses on
assets held for sale as a component of discontinued operations. Based on
current economic conditions and our continuing forecast and outlooks for future
periods, we may be required in future periods to recognize additional
impairment charges if circumstances indicate at that time that the carrying
value of the assets may be impaired. 32




---



##### 



Classification of properties as held for sale We classify the properties we are actively marketing as held for sale once
all of these conditions are met:  
    
    Our board has approved the sale,  
    
    We have a fully executed agreement with a qualified buyer
which provides for no significant outstanding or continuing
obligations with the property after sale, and  
    
    We have a significant non-refundable deposit. We carry properties held for sale at the lower of their carrying values or
estimated fair values less costs to sell. We cease depreciation at the time
the asset is classified as held for sale. Off-Balance Sheet Arrangements We have future ground lease obligations related to our consolidated
entities and properties. The ground leases are accounted for as operating
leases, and are expensed evenly over the lives of the leases. These leases
exist at properties where we do not own the land associated with our hotel. As
of June 30, 2004, we were not involved in any other off-balance sheet
arrangements. Aggregate Contractual Obligations We have future long-term debt obligations related to our consolidated
entities and properties, as disclosed under Financial Condition, Liquidity and
Capital Resources. We may be obligated to pay Interstate Hotels termination fees with respect
to properties that we sell. See Financial Condition, Liquidity and Capital
Resources-Asset Dispositions. The Managers operate our 79 hotels pursuant to management agreements with
our taxable subsidiaries. Under these management agreements, the taxable
subsidiaries pay a management fee for each property to the Manager of their
hotels. The taxable subsidiaries in turn make rental payments to our
subsidiary operating partnership under the participating leases. Under the Interstate Hotels management agreements, the base management fee
is 2.5% of total hotel revenue, plus incentive payments based on meeting
performance thresholds that could total up to an additional 1.5% of total hotel
revenue. The agreements generally have initial terms expiring on January 1,
2011 with three renewal periods of five years each at the option of Interstate
Hotels, subject to some exceptions. Under the Ritz-Carlton and Marriott management agreements, the base
management fee is 3.0% and 2.5% of total hotel revenue, respectively, through
2005 and 3.0% under both thereafter, plus incentive payments based on meeting
performance thresholds that could total up to an additional 2.0% of total hotel
revenue and 20% of available cash flow (as defined), respectively. The
agreements have initial terms expiring in 2015 and 2024, respectively, with
four and three renewal periods of 10 and five years each, respectively, at the
option of Ritz-Carlton and Marriott, subject to some exceptions. As part of our asset renovation program, we have entered into contractual
obligations with vendors to acquire capital assets and perform renovations
totaling approximately $60 million over the next six months. 33




---



##### 



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk On April 2, 2004, we entered into an interest rate swap on our secured
facility due 2009, effectively converting the interest the facility bears from
a fixed rate to a floating rate. Under the swap, we receive fixed-rate
payments of 8.01% and pay floating rate payments based on a one month LIBOR
plus 444 basis points on a $307 million notional amount. We have designated the interest rate swap as a fair value hedge for
financial reporting purposes and the amounts paid or received under the swap
agreement will be recognized over the life of the agreement as an adjustment to
interest expense. Changes in the fair value of the swap and the secured
facilities are reflected in the balance sheet as offsetting changes and have no
income statement effect. The fair value of the interest rate swap at June 30,
2004 was approximately a $10.1 million liability, which is included in the
other liabilities line item on our consolidated balance sheet. In conjunction with the interest rate swap, we have posted collateral of
$17.5 million as of June 30, 2004. The required collateral amount fluctuates
based on the changes in the swap rate and the amount of time left to maturity.
We will receive all remaining collateral upon maturity of the swap. The table below provides information about our derivative financial
instrument that is sensitive to changes in interest rates. The table presents
contractual payments to be exchanged under the contract and weighted average
interest rates by expected (contractual) maturity dates for our interest rate
swap. Weighted average interest rates and notional amounts are used to
calculate the contractual payments to be exchanged under the contract.
Weighted average interest rates are based on implied forward rates in the yield
curve as of June 30, 2004. The interest rate swap that we have entered into is
strictly to hedge interest rate risk and not for trading purposes. Expected Maturity Date
($ in millions) Fair Valueas of2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    Total
    
    6/30/04Interest Rate DerivativeInterest Rate SwapFixed to Variable
    
    $
    4.0
    
    
    $
    1.0
    
    
    $
    (1.8
    )
    
    $
    (3.9
    )
    
    $
    (5.3
    )
    
    $
    (3.7
    )
    
    $
    (9.7
    )
    
    $
    (10.1
    )Average pay rate
    
    
    5.98
    %
    
    
    7.49
    %
    
    
    8.43
    %
    
    
    9.21
    %
    
    
    9.73
    %
    
    
    9.94
    %Average receive
rate
    
    
    8.01
    %
    
    
    8.01
    %
    
    
    8.01
    %
    
    
    8.01
    %
    
    
    8.01
    %
    
    
    8.01
    %
 As a result of our interest rate swap, we are exposed to market risks
related to changes in interest rates. In the future, we intend to manage our
interest rate exposure using a mix of fixed and floating interest rate debt. A
change in one month LIBOR of 50 basis points would result in an increase or
decrease in current annual interest expense of approximately $1.5 million. Approximately 19% of our outstanding debt bears fixed rates of interest
that have been effectively swapped from a fixed rate to a floating rate, with
the remaining 81% of debt bearing fixed rates of interest. 34




---



##### 



ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and regulations, and that the
information is accumulated and communicated to our management, including our
chief executive officer and chief financial and chief accounting officer, as
appropriate, to allow timely decisions regarding required disclosures based
closely on the definition of disclosure controls and procedures in Rule
13a-1(c) of the Securities Exchange Act of 1934. In designing and evaluating
the disclosure controls and procedures, management recognized that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired objectives, and management was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Also, we have investments in certain
unconsolidated entities. As we do not control or manage these entities, our
disclosure controls and procedures with respect to these entities are
substantially more limited than those we maintain with respect to our
consolidated subsidiaries. As of June 30, 2004, we carried out an evaluation, under the supervision
and with the participation of our management, including our chief executive
officer, our chief financial officer, and our chief accounting officer of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based on this evaluation, we concluded that our disclosure controls
and procedures were effective. Internal Control Over Financial Reporting There has been no change in our internal control over financial reporting
during the three months ended June 30, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting. 35




---



##### 



PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a.) Exhibits Exhibit No.
    
    Description of Document3.1
    
    Certificate of Limited Partnership of MeriStar Hospitality Operating
Partnership, L.P. (incorporated by reference to Exhibit 3.1 to the
Registration Statement on Form S-4 for MeriStar Hospitality Operating
Partnership, L.P. and MeriStar Hospitality Finance Corp. (File No.
333-63768) filed with the Securities and Exchange Commission on June 25,
2001).3.2
    
    Second Amended and Restated Agreement of Limited Partnership of MeriStar
Hospitality Operating Partnership, L.P. (incorporated by reference to
Exhibit 3.2 to the Registration Statement on Form S-4 for MeriStar
Hospitality Operating Partnership, L.P. and MeriStar Hospitality Finance
Corp. (File No. 333-63768) filed with the Securities and Exchange
Commission on June 25, 2001).3.3
    
    Certificate of Incorporation of MeriStar Hospitality Finance Corp.
(incorporated by reference to Exhibit 3.3 to the Registration Statement on
Form S-4 for MeriStar Hospitality Operating Partnership, L.P. and MeriStar
Hospitality Finance Corp. (File No. 333-63768) filed with the Securities
and Exchange Commission on June 25, 2001).3.4
    
    By-Laws of MeriStar Hospitality Finance Corp. (incorporated by reference
to Exhibit 3.4 to the Registration Statement on Form S-4 for MeriStar
Hospitality Operating Partnership, L.P. and MeriStar Hospitality Finance
Corp. (File No. 333-63768) filed with the Securities and Exchange
Commission on June 25, 2001).3.5
    
    Certificate of Incorporation of MeriStar Hospitality Finance Corp. II
(incorporated by reference to Exhibit 3.5 to our annual report on Form
10-K for the year ended December 31, 2002, and filed with the Commission
on March 31, 2003).3.6
    
    By-Laws of MeriStar Hospitality Finance Corp. II (incorporated by
reference to Exhibit 3.6 to our annual report on Form 10-K for the year
ended December 31, 2002, and filed with the Commission on March 31, 2003).3.7
    
    Certificate of Incorporation of MeriStar Hospitality Finance Corp. III
(incorporated by reference to Exhibit 3.6 to our annual report on Form
10-K for the year ended December 31, 2002, and filed with the Commission
on March 31, 2003).3.8
    
    By-Laws of MeriStar Hospitality Finance Corp. III (incorporated by
reference to Exhibit 3.7 to our annual report on Form 10-K for the year
ended December 31, 2002, and filed with the Commission on March 31, 2003).10.4.2
    
    Second Amendment to the MeriStar Hospitality Corporation Incentive Plan
(incorporated by reference to Exhibit 10.4.2 to our quarterly report on
Form 10-Q for the quarter ended March 31, 2004, and filed with the
Commission on May 10, 2004).10.10.1*
    
    Amendment to Executive Employment Agreement between MeriStar
Hospitality Corporation and Bruce G. Wiles. **13
    
    Financial Statements of MeriStar Hospitality Corporation as of and for
the three and six months ended June 30, 2004. **31.1
    
    Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer. **
 36




---



##### 



31.2
    
    Sarbanes-Oxley Act Section 302 Certification of Chief Financial Officer. **32.1
    
    Sarbanes-Oxley Act Section 906 Certification of Chief Executive Officer. **32.2
    
    Sarbanes-Oxley Act Section 906 Certification of Chief Financial Officer. **99.1
    
    Consolidating Financial Information of MeriStar Hospitality Operating Partnership, L.P. **
  *
    
    Indicates a management contract or compensatory plan or arrangement
required to be filed pursuant to Item 14(c) of Form 10-K.**
    
    Filed herewith (b.) Reports on Form 8-K None. 37




---



##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.MERISTAR HOSPITALITY FINANCE CORP.MERISTAR HOSPITALITY FINANCE CORP. IIMERISTAR HOSPITALITY FINANCE CORP. IIIBy: MERISTAR HOSPITALITY
CORPORATION,ITS GENERAL PARTNER
 By:
    /s/ Paul W. WhetsellPaul W. WhetsellChief Executive Officer(Principal Executive Officer and Duly Authorized Officer) Dated: August 6, 2004 38