##### 









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|  
|   |  | For the quarterly period ended
    September 30, 2004                                       
|  
|or
|  
|o  |  | 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 1-14331

Interstate Hotels & Resorts,
Inc.

|                                             |  |                                  
|-------------------------------------------- |  | ---------------------------------
|Delaware                                     |  | 52-2101815                       
|(State of Incorporation)                     |  | (IRS Employer Identification No.)
|                                            
|4501 North Fairfax Drive
    Arlington, VA   |  | 22203(Zip Code)                  
|(Address of Principal Executive
    Offices) |  |                                  

www.ihrco.com

This Form 10-Q can be accessed at no charge
through above website.


(703) 387-3100

(Registrants Telephone Number, Including
Area Code)


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
for which the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days. þ

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934).
o

The number of shares of Common Stock, par value
$0.01 per share, outstanding at November 5, 2004 was
30,657,397.



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##### 



INTERSTATE HOTELS & RESORTS,
INC.



INDEX

|                              |  |                                                                                                                                         |  |      |    | 
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                              |  |                                                                                                                                         |  | Page
|                              |  |                                                                                                                                         |  |     
|PART I. FINANCIAL INFORMATION
|                             
|Item 1:                       |  | Financial Statements (Unaudited)                                                                                                        |  |      |    | 
|                              |  | Consolidated Balance Sheets 
    September 30, 2004 and December 31, 2003                                                              |  |      | 2  | 
|                              |  | Consolidated Statements of Operations and
    Comprehensive Income (Loss)  Three and nine months
    ended September 30, 2004 and 2003 |  |      | 3  | 
|                              |  | Consolidated Statements of Cash Flows 
    Nine months ended September 30, 2004 and 2003                                               |  |      | 4  | 
|                              |  | Notes to Consolidated Financial Statements                                                                                              |  |      | 5  | 
|                             
|Item 2:                       |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations                                               |  |      | 18 | 
|                             
|Item 3:                       |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                                          |  |      | 34 | 
|                             
|Item 4:                       |  | Controls and Procedures                                                                                                                 |  |      | 35 | 
|PART II. OTHER INFORMATION   
|                             
|Item 1:                       |  | Legal Proceedings                                                                                                                       |  |      | 36 | 
|                             
|Item 2:                       |  | Changes in Equity Securities and use of Proceeds                                                                                        |  |      | 36 | 
|                             
|Item 3:                       |  | Defaults Upon Senior Securities                                                                                                         |  |      | 36 | 
|                             
|Item 4:                       |  | Submission of Matters to a Vote of Security
    Holders                                                                                 |  |      | 36 | 
|                             
|Item 5:                       |  | Other Information                                                                                                                       |  |      | 36 | 
|                             
|Item 6:                       |  | Exhibits                                                                                                                                |  |      | 38 | 

1



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##### 



PART I. FINANCIAL INFORMATION

ITEM
1:     Financial
Statements

INTERSTATE HOTELS & RESORTS,
INC.

CONSOLIDATED BALANCE SHEETS


(In thousands, except per share
amounts)


|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |         |         | 
|------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | ------ | ------------ | ------- |  | ------ | ------- | ------- | 
|                                                             |                                                                                                                                                                                 | September 30,                                                      |        | December 31,
|                                                             |                                                                                                                                                                                 | 2004                                                               |        | 2003        
|                                                             |                                                                                                                                                                                 |                                                                    |        |             
|                                                             |                                                                                                                                                                                 | (Unaudited)                                                        |        |             
|ASSETS                                                      
|Current assets:                                              |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             | Cash and cash equivalents                                                                                                                                                       |                                                                    | $      | 9,727        |         |  | $      | 7,450   |        
|                                                             | Restricted cash                                                                                                                                                                 |                                                                    |        | 1,886        |         |  |        | 3,250   |        
|                                                             | Accounts receivable, net of allowance for
    doubtful accounts of $2,998 at September 30, 2004 and
    $3,529 at December 31, 2003                                             |                                                                    |        | 31,523       |         |  |        | 25,531  |        
|                                                             | Due from related parties                                                                                                                                                        |                                                                    |        | 8,270        |         |  |        | 14,649  |        
|                                                             | Prepaid expenses and other current assets                                                                                                                                       |                                                                    |        | 10,348       |         |  |        | 9,342   |        
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total current assets                                               |        |              | 61,754  |  |        |         | 60,222  | 
|Marketable securities                                        |                                                                                                                                                                                 |                                                                    | 1,577  |              |         |  | 2,556  |        
|Property and equipment, net                                  |                                                                                                                                                                                 |                                                                    | 24,104 |              |         |  | 27,056 |        
|Notes receivable                                             |                                                                                                                                                                                 |                                                                    | 6,117  |              |         |  | 6,044  |        
|Officers and employees notes receivable                      |                                                                                                                                                                                 |                                                                    | 74     |              |         |  | 86     |        
|Investments and advances to affiliates                       |                                                                                                                                                                                 |                                                                    | 11,023 |              |         |  | 15,825 |        
|Deferred income taxes                                        |                                                                                                                                                                                 |                                                                    | 22,123 |              |         |  | 18,673 |        
|Goodwill                                                     |                                                                                                                                                                                 |                                                                    | 92,123 |              |         |  | 92,123 |        
|Intangible assets, net                                       |                                                                                                                                                                                 |                                                                    | 46,349 |              |         |  | 55,338 |        
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total assets                                                       |        | $            | 265,244 |  |        | $       | 277,923 | 
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|LIABILITIES, MINORITY INTERESTS AND
    STOCKHOLDERS EQUITY
|Current liabilities:                                         |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             | Accounts payable and accrued expenses                                                                                                                                           |                                                                    | $      | 57,989       |         |  | $      | 66,513  |        
|                                                             | Accounts payable  related parties                                                                                                                                              |                                                                    |        | 433          |         |  |        | 433     |        
|                                                             | Current portion of long-term debt                                                                                                                                               |                                                                    |        | 16,880       |         |  |        | 1,625   |        
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total current liabilities                                          |        |              | 75,302  |  |        |         | 68,571  | 
|Deferred compensation                                        |                                                                                                                                                                                 |                                                                    | 1,577  |              |         |  | 2,556  |        
|Long-term debt                                               |                                                                                                                                                                                 |                                                                    | 70,723 |              |         |  | 84,696 |        
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total liabilities                                                  |        |              | 147,602 |  |        |         | 155,823 | 
|Minority interests                                           |                                                                                                                                                                                 |                                                                    | 928    |              |         |  | 3,388  |        
|Commitments and contingencies                                |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|Stockholders equity:                                        |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             | Preferred stock, $0.01 par value;
    5,000 shares authorized                                                                                                                   |                                                                    |        |             |         |  |        |        |        
|                                                             | Common stock, $0.01 par value;
    250,000 shares authorized; 30,657 and 29,951 shares
    issued and outstanding at September 30, 2004 and
    December 31, 2003, respectively |                                                                    |        | 307          |         |  |        | 300     |        
|                                                             | Treasury stock                                                                                                                                                                  |                                                                    |        | (69          | )       |  |        | (69     | )      
|                                                             | Paid-in capital                                                                                                                                                                 |                                                                    |        | 188,776      |         |  |        | 183,849 |        
|                                                             | Accumulated other comprehensive income, net of tax                                                                                                                              |                                                                    |        | 600          |         |  |        | 837     |        
|                                                             | Accumulated deficit                                                                                                                                                             |                                                                    |        | (72,900      | )       |  |        | (66,205 | )      
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total stockholders equity                                         |        |              | 116,714 |  |        |         | 118,712 | 
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                                 | Total liabilities, minority interests and
    stockholders equity |        | $            | 265,244 |  |        | $       | 277,923 | 
|                                                             |                                                                                                                                                                                 |                                                                    |        |              |         |  |        |        

The accompanying notes are an integral part of
the consolidated financial statements.

2



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##### 



INTERSTATE HOTELS & RESORTS,
INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS


AND COMPREHENSIVE INCOME (LOSS)


(Unaudited, in thousands, except per share
amounts)


|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |         | 
|-------------------------------------------------------------------------------------- | ----------------------------------------------- | ------------------ | ------- | ----------------- | - | ---- | ------- | ------- | - | - | ------- | ------- | - | - | ------- | ------- | 
|                                                                                       |                                                 |                    |         |                  
|                                                                                       |                                                 | Three months ended |         | Nine months ended
|                                                                                       |                                                 | September 30,      |         | September 30,    
|                                                                                       |                                                 |                    |         |                  
|                                                                                       |                                                 | 2004               |         | 2003              |   | 2004 |         | 2003   
|                                                                                       |                                                 |                    |         |                   |   |      |         |        
|Revenue:                                                                               |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Lodging revenues                                |                    | $       | 905               |   |      | $       | 929     |   |   | $       | 2,476   |   |   | $       | 2,697   | 
|                                                                                       | Management fees                                 |                    |         | 5,453             |   |      |         | 6,689   |   |   |         | 17,414  |   |   |         | 20,811  | 
|                                                                                       | Management fees-related parties                 |                    |         | 6,660             |   |      |         | 7,152   |   |   |         | 23,345  |   |   |         | 22,793  | 
|                                                                                       | Corporate housing                               |                    |         | 31,701            |   |      |         | 27,480  |   |   |         | 83,506  |   |   |         | 77,762  | 
|                                                                                       | Other revenue                                   |                    |         | 4,245             |   |      |         | 3,778   |   |   |         | 10,599  |   |   |         | 10,607  | 
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       |                                                 |                    | 48,964  |                   |   |      | 46,028  |         |   |   | 137,340 |         |   |   | 134,670 |        
|                                                                                       | Other revenue from managed properties           |                    |         | 200,314           |   |      |         | 219,649 |   |   |         | 601,295 |   |   |         | 644,251 | 
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Total revenue                                                                          |                                                 |                    | 249,278 |                   |   |      | 265,677 |         |   |   | 738,635 |         |   |   | 778,921 |        
|Operating expenses by department:                                                      |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Lodging expenses                                |                    |         | 594               |   |      |         | 627     |   |   |         | 1,678   |   |   |         | 1,911   | 
|                                                                                       | Corporate housing                               |                    |         | 25,836            |   |      |         | 22,336  |   |   |         | 68,121  |   |   |         | 63,963  | 
|Undistributed operating expenses:                                                      |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Administrative and general                      |                    |         | 16,585            |   |      |         | 15,121  |   |   |         | 51,675  |   |   |         | 50,017  | 
|                                                                                       | Depreciation and amortization                   |                    |         | 2,241             |   |      |         | 2,591   |   |   |         | 6,974   |   |   |         | 10,850  | 
|                                                                                       | Merger and integration costs                    |                    |         |                  |   |      |         | 874     |   |   |         |        |   |   |         | 3,344   | 
|                                                                                       | Restructuring charges                           |                    |         | 42                |   |      |         |        |   |   |         | 3,481   |   |   |         |        | 
|                                                                                       | Asset impairments and other write-offs          |                    |         | 1,601             |   |      |         | 1,979   |   |   |         | 7,792   |   |   |         | 2,780   | 
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       |                                                 |                    | 46,899  |                   |   |      | 43,528  |         |   |   | 139,721 |         |   |   | 132,865 |        
|                                                                                       | Other expenses from managed properties          |                    |         | 200,314           |   |      |         | 219,649 |   |   |         | 601,295 |   |   |         | 644,251 | 
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Total operating expenses                                                               |                                                 |                    | 247,213 |                   |   |      | 263,177 |         |   |   | 741,016 |         |   |   | 777,116 |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Net operating income (loss)                                                            |                                                 |                    | 2,065   |                   |   |      | 2,500   |         |   |   | (2,381  | )       |   |   | 1,805   |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Interest income                                                                        |                                                 |                    | (111    | )                 |   |      | (209    | )       |   |   | (801    | )       |   |   | (652    | )      
|Interest expense                                                                       |                                                 |                    | 2,113   |                   |   |      | 2,565   |         |   |   | 6,093   |         |   |   | 7,833   |        
|Equity in losses of affiliates                                                         |                                                 |                    | 5       |                   |   |      | 292     |         |   |   | 946     |         |   |   | 858     |        
|Gain on refinancing term loan from related party                                       |                                                 |                    |        |                   |   |      |        |         |   |   |        |         |   |   | (13,629 | )      
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Income (loss) from continuing operations before
    minority interest and income taxes |                                                 |                    | 58      |                   |   |      | (148    | )       |   |   | (8,619  | )       |   |   | 7,395   |        
|Income tax expense (benefit)                                                           |                                                 |                    | 351     |                   |   |      | (252    | )       |   |   | (3,093  | )       |   |   | 2,375   |        
|Minority interest expense (benefit)                                                    |                                                 |                    | 7       |                   |   |      | 23      |         |   |   | (68     | )       |   |   | 184     |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Income (loss) from continuing operations                                               |                                                 |                    | (300    | )                 |   |      | 81      |         |   |   | (5,458  | )       |   |   | 4,836   |        
|Loss from discontinued operations                                                      |                                                 |                    |        |                   |   |      | (459    | )       |   |   | (1,237  | )       |   |   | (1,273  | )      
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Net income (loss)                                                                      |                                                 | $                  | (300    | )                 |   | $    | (378    | )       |   | $ | (6,695  | )       |   | $ | 3,563   |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Other comprehensive income (loss), net of tax:                                         |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Foreign currency translation gain (loss)        |                    |         | (104              | ) |      |         | (70     | ) |   |         | (209    | ) |   |         | 164     | 
|                                                                                       | Unrealized gain (loss) on investments and other |                    |         | (84               | ) |      |         | 396     |   |   |         | (28     | ) |   |         | 350     | 
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Comprehensive income (loss)                                                            |                                                 | $                  | (488    | )                 |   | $    | (52     | )       |   | $ | (6,932  | )       |   | $ | 4,077   |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Basic earnings (loss) per share from continuing
    operations                         |                                                 | $                  | (0.01   | )                 |   | $    | 0.00    |         |   | $ | (0.18   | )       |   | $ | 0.23    |        
|Basic earnings (loss) per share from discontinued
    operations                       |                                                 |                    |        |                   |   |      | (0.02   | )       |   |   | (0.04   | )       |   |   | (0.06   | )      
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Basic earnings (loss) per share                                                        |                                                 | $                  | (0.01   | )                 |   | $    | (0.02   | )       |   | $ | (0.22   | )       |   | $ | 0.17    |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Diluted earnings (loss) per share from continuing
    operations                       |                                                 | $                  | (0.01   | )                 |   | $    | 0.00    |         |   | $ | (0.18   | )       |   | $ | 0.23    |        
|Diluted earnings (loss) per share from
    discontinued operations                     |                                                 |                    |        |                   |   |      | (0.02   | )       |   |   | (0.04   | )       |   |   | (0.06   | )      
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Diluted earnings (loss) per share                                                      |                                                 | $                  | (0.01   | )                 |   | $    | (0.02   | )       |   | $ | (0.22   | )       |   | $ | 0.17    |        
|                                                                                       |                                                 |                    |         |                   |   |      |         |         |   |   |         |         |   |   |         |        
|Weighted average number of basic shares
    outstanding                                |                                                 |                    | 30,637  |                   |   |      | 20,649  |         |   |   | 30,431  |         |   |   | 20,612  |        
|Weighted average number of diluted shares
    outstanding                              |                                                 |                    | 30,637  |                   |   |      | 20,649  |         |   |   | 30,507  |         |   |   | 20,891  |        

The accompanying notes are an integral part of
the consolidated financial statements.

3



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##### 



INTERSTATE HOTELS & RESORTS,
INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS


(Unaudited, in thousands)


|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |         |         |        |  
|------------------------------------------------------- | -------------------------------------------------------------------------------------------- | --------------------------------------------------------- | ----------------------------------------- | ------- | ------ | ------ | ------- | ------- | ------- | ------ | -
|                                                        |                                                                                              |                                                          
|                                                        |                                                                                              | Nine months ended                                        
|                                                        |                                                                                              | September 30,                                            
|                                                        |                                                                                              |                                                          
|                                                        |                                                                                              | 2004                                                      |                                           | 2003   
|                                                        |                                                                                              |                                                           |                                           |        
|Cash flows from operating activities:                   |                                                                                              |                                                           |                                           |         |        |        |         |        
|                                                        | Net income (loss)                                                                            |                                                           | $                                         | (6,695  | )      |        | $       | 3,563   |        
|                                                        | Adjustments to reconcile net income (loss) to net
    cash provided by operating activities: |                                                           |                                           |         |        |        |         |         |        
|                                                        |                                                                                              | Depreciation and amortization                             |                                           |         | 7,024  |        |         |         | 10,994  |       
|                                                        |                                                                                              | Gain on refinancing                                       |                                           |         |       |        |         |         | (13,629 | )     
|                                                        |                                                                                              | Equity in loss of affiliates                              |                                           |         | 946    |        |         |         | 858     |       
|                                                        |                                                                                              | Minority interest                                         |                                           |         | (68    | )      |         |         | 133     |       
|                                                        |                                                                                              | Deferred income taxes                                     |                                           |         | (3,368 | )      |         |         | 1,608   |       
|                                                        |                                                                                              | Write-off of assets                                       |                                           |         | 7,792  |        |         |         | 3,755   |       
|                                                        |                                                                                              | Other                                                     |                                           |         | (270   | )      |         |         | 448     |       
|                                                        |                                                                                              | Grant of stock for severance                              |                                           |         | 3,181  |        |         |         |        |       
|                                                        |                                                                                              | Loss on disposal of assets of discontinued
    operations |                                           |         | 376    |        |         |         |        |       
|                                                        |                                                                                              | Changes in assets and liabilities:                        |                                           |         |        |        |         |         |         |       
|                                                        |                                                                                              |                                                           | Accounts receivable, net                  |         |        | (5,785 | )       |         |         | (7,089 | )
|                                                        |                                                                                              |                                                           | Due from related parties                  |         |        | 6,379  |         |         |         |       |  
|                                                        |                                                                                              |                                                           | Prepaid expenses and other current assets |         |        | (927   | )       |         |         | 2,825  |  
|                                                        |                                                                                              |                                                           | Accounts payable and accrued expenses     |         |        | (8,383 | )       |         |         | 14,658 |  
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Net cash provided by operating activities               |                                                                                              |                                                           | 202                                       |         |        |        | 18,124  |        
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Cash flows from investing activities:                   |                                                                                              |                                                           |                                           |         |        |        |         |        
|                                                        | Proceeds from sale of stock                                                                  |                                                           |                                           | 522     |        |        |         |        |        
|                                                        | Change in restricted cash                                                                    |                                                           |                                           | 1,364   |        |        |         | (1,847  | )      
|                                                        | Purchases of property and equipment, net                                                     |                                                           |                                           | (2,061  | )      |        |         | (7,726  | )      
|                                                        | Purchases of intangible assets                                                               |                                                           |                                           | (1,109  | )      |        |         | (707    | )      
|                                                        | Net cash (invested in) received from equity
    investments in hotel real estate             |                                                           |                                           | (424    | )      |        |         | (1,817  | )      
|                                                        | Change in officers and employees notes
    receivable, net                                   |                                                           |                                           | 12      |        |        |         | 27      |        
|                                                        | Change in notes receivable                                                                   |                                                           |                                           | 2,553   |        |        |         | (1,613  | )      
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Net cash provided by (used in) investing
    activities |                                                                                              |                                                           | 857                                       |         |        |        | (13,683 | )      
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Cash flows from financing activities:                   |                                                                                              |                                                           |                                           |         |        |        |         |        
|                                                        | Borrowings under subordinated term loan                                                      |                                                           |                                           |        |        |        |         | 40,000  |        
|                                                        | Borrowings under long-term debt                                                              |                                                           |                                           | 34,000  |        |        |         | 52,500  |        
|                                                        | Repayments of long-term debt                                                                 |                                                           |                                           | (32,719 | )      |        |         | (39,666 | )      
|                                                        | Repayments of term loan                                                                      |                                                           |                                           |        |        |        |         | (42,052 | )      
|                                                        | Proceeds from issuance of common stock                                                       |                                                           |                                           | 735     |        |        |         | 177     |        
|                                                        | Cash paid for redemption of preferred operating
    partnership units                        |                                                           |                                           | (1,310  | )      |        |         |        |        
|                                                        | Financing fees paid                                                                          |                                                           |                                           | (114    | )      |        |         | (1,918  | )      
|                                                        | Common stock repurchased                                                                     |                                                           |                                           |        |        |        |         | (23     | )      
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Net cash provided by financing activities               |                                                                                              |                                                           | 592                                       |         |        |        | 9,018   |        
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Effect of exchange rate on cash                         |                                                                                              |                                                           | 626                                       |         |        |        | 159     |        
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Net increase in cash and cash equivalents               |                                                                                              |                                                           | 2,277                                     |         |        |        | 13,618  |        
|Cash and cash equivalents at beginning of period        |                                                                                              |                                                           | 7,450                                     |         |        |        | 7,054   |        
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        
|Cash and cash equivalents at end of period              |                                                                                              | $                                                         | 9,727                                     |         |        | $      | 20,672  |        
|                                                        |                                                                                              |                                                           |                                           |         |        |        |         |        

The accompanying notes are an integral part of
the consolidated financial statements.

4



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##### 



INTERSTATE HOTELS & RESORTS,
INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS




|   |                 
|-- | ----------------
|1. | BUSINESS SUMMARY

We are the largest independent U.S. hotel
management company not affiliated with a hotel brand, measured
by number of rooms under management. We manage a portfolio of
hospitality properties and provide related services in the
hotel, corporate housing, resort, conference center and golf
markets. We also own one hotel property and hold non-controlled
equity interests in 11 joint ventures which hold ownership
interests in 27 of our managed properties. Our portfolio is
diversified by franchise and brand affiliations. The related
services we provide include insurance and risk management
services, purchasing and project management services,
information technology and telecommunications services and
centralized accounting services.

As of September 30, 2004, we managed 255
properties, with 57,074 rooms in 40 states, the District of
Columbia, Canada, Russia and Portugal. As of September 30,
2004, we had 3,073 apartments under lease or management through
our BridgeStreet corporate housing division in the United
States, France and the United Kingdom.

We have two operating divisions, hotel management
and corporate housing, both of which are reportable operating
segments. Each division is managed separately because of its
distinct products and services.

Our subsidiary operating partnership indirectly
holds substantially all of our assets. We are the sole general
partner of that operating partnership. We, our chief accounting
officer and certain independent third parties are limited
partners of the partnership. The interests of those third
parties are reflected in minority interests on our balance
sheet. The partnership agreement gives the general partner full
control over the business and affairs of the partnership. We own
more than 99% of the subsidiary operating partnership.

We manage all but three of the properties owned
or partially owned by MeriStar Hospitality, a real estate
investment trust, or REIT. As of September 30, 2004,
MeriStar Hospitality owned 76 properties, eight of which
MeriStar Hospitality has placed in its asset disposition
program. Our relationship with MeriStar Hospitality has
historically been governed in part by an intercompany agreement.
That agreement provided each of us the right to participate in
certain transactions entered into by the other company.
Management fees earned from hotels owned by Meristar Hospitality
are included in management fees-related parties in the
consolidated statements of operations.

Effective July 1, 2004, MeriStar Hospitality
and we agreed to terminate the intercompany agreement. We
believe the termination of the intercompany agreement is an
important step in our efforts to pursue our strategy of
increasing our investment in hotels and resorts since we can now
pursue real estate investment opportunities without first having
to offer the opportunity to MeriStar Hospitality. In connection
with the termination of the intercompany agreement we have
agreed to modify the management agreements under which we manage
the MeriStar Hospitality hotels as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | MeriStar Hospitality may terminate management
    agreements each year representing up to 600 rooms with the
    payment of a termination fee equal to 18 months of
    management fees and, if all 600 rooms are not terminated in a
    given year, the remaining portion of the 600 rooms may be
    carried over to the subsequent year.                       
|
| |  | MeriStar Hospitality may terminate a management
    agreement if we make an investment, in the form of debt or
    equity, in a hotel that is in the competitive set of the
    MeriStar Hospitality hotel (provided that the termination can
    only occur between 12 and 18 months following the date the
    investment is made); and                          
|
| |  | the period during which termination fees are paid
    (other than as described in the first bullet point above) is
    extended from 30 months to 48 months; provided that
    the period during which MeriStar Hospitality may reduce the
    termination fee by providing a new hotel for us to manage to
    replace the terminated hotel will remain 30 months.

5



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


In addition, in connection with the termination
of the intercompany agreement, MeriStar Hospitality and we have
resolved our disagreement over the calculation of termination
fees. We have agreed to calculate the termination fees based
upon an average of the present value of remaining estimated
management fees due to us under the contract (a) discounted
as individual monthly payments and (b) discounted based on
a lump sum payment at the end of the contract term. We have
agreed to provide MeriStar Hospitality with a $2,500 credit
against termination fees owed for hotels to be sold by MeriStar
Hospitality in the future. As of September 30, 2004 there
is approximately $1,970 of this credit remaining. This credit
can be applied to six of the eight hotels MeriStar Hospitality
intended to sell as of September 30, 2004. Net of the
$1,970 credit, as of September 30, 2004, we would be
entitled to receive approximately $3,500 of termination fees
with respect to the eight hotels that MeriStar Hospitality has
in its asset disposition program.



|   |                                               
|-- | ----------------------------------------------
|2. | SUMMARY OF SIGNIFICANT ACCOUNTING
    POLICIES

General

We have prepared these unaudited interim
financial statements according to the rules and regulations of
the Securities and Exchange Commission. Accordingly, 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 of America. 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, as amended, for the year ended December 31,
2003. Certain 2003 amounts have been reclassified to conform
with the 2004 presentation.

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 preparation of financial statements in accordance with
accounting principles generally accepted in the United States of
America requires us to make estimates and assumptions. Such
estimates and assumptions affect the reported amounts of assets
and liabilities, as well as the disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reporting
period. Our actual results could differ from those estimates.
The results of operations for the interim periods are not
necessarily indicative of the results for the entire year.

Stock-Based Compensation

The Financial Accounting Standards Board, or
FASB, issued Statement of Financial Accounting Standards
(SFAS) No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, to
provide alternative methods of transition for a voluntary change
to the expense recognition provisions of the fair value based
method of accounting for stock-based employee compensation.
Effective January 1, 2003, we elected to adopt the
fair-value method of accounting for stock options under
SFAS No. 148, using the prospective method.

Pro forma information regarding net income (loss)
and earnings (loss) per share has been determined as if we had
accounted for all of our employee stock options using the fair
value method. Had compensation cost

6



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


for stock options been determined based on the
fair value at the grant date for all awards under our plans, our
net income (loss) and per share amounts would have been the pro
forma amounts indicated as follows:

|                                                                                                                                    |                      |                    |      |                   |   |      |      |       |   |   |        |       |   |   |       |      | 
|----------------------------------------------------------------------------------------------------------------------------------- | -------------------- | ------------------ | ---- | ----------------- | - | ---- | ---- | ----- | - | - | ------ | ----- | - | - | ----- | ---- | 
|                                                                                                                                    |                      |                    |      |                  
|                                                                                                                                    |                      | Three months ended |      | Nine months ended
|                                                                                                                                    |                      | September 30,      |      | September 30,    
|                                                                                                                                    |                      |                    |      |                  
|                                                                                                                                    |                      | 2004               |      | 2003              |   | 2004 |      | 2003 
|                                                                                                                                    |                      |                    |      |                   |   |      |      |      
|Net income (loss), as reported                                                                                                      |                      | $                  | (300 | )                 |   | $    | (378 | )     |   | $ | (6,695 | )     |   | $ | 3,563 |     
|Add: Stock-based employee compensation expense
    included in reported net income (loss), net of tax                               |                      |                    | 52   |                   |   |      | 11   |       |   |   | 182    |       |   |   | 21    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of tax |                      |                    | (99  | )                 |   |      | (107 | )     |   |   | (257   | )     |   |   | (292  | )   
|                                                                                                                                    |                      |                    |      |                   |   |      |      |       |   |   |        |       |   |   |       |     
|Net income (loss), pro forma                                                                                                        |                      | $                  | (347 | )                 |   | $    | (474 | )     |   | $ | (6,770 | )     |   | $ | 3,292 |     
|Earnings per share:                                                                                                                 |                      |                    |      |                   |   |      |      |       |   |   |        |       |   |   |       |     
|                                                                                                                                    | Basic, as reported   |                    | $    | (0.01             | ) |      | $    | (0.02 | ) |   | $      | (0.22 | ) |   | $     | 0.17 | 
|                                                                                                                                    | Basic, pro forma     |                    | $    | (0.01             | ) |      | $    | (0.02 | ) |   | $      | (0.22 | ) |   | $     | 0.16 | 
|                                                                                                                                    | Diluted, as reported |                    | $    | (0.01             | ) |      | $    | (0.02 | ) |   | $      | (0.22 | ) |   | $     | 0.17 | 
|                                                                                                                                    | Diluted, pro forma   |                    | $    | (0.01             | ) |      | $    | (0.02 | ) |   | $      | (0.22 | ) |   | $     | 0.16 | 

The effects shown above may not be representative
of the effects on reported net income (loss) and earnings (loss)
per share for future years.



|   |                   
|-- | ------------------
|3. | EARNINGS PER SHARE

We calculate our basic earnings (loss) per common
share by dividing net income (loss) by the weighted average
number of shares of common stock outstanding. Our diluted
earnings per common share assumes the issuance of common stock
for all potentially dilutive stock equivalents outstanding. In
periods in which there is a loss, diluted shares outstanding
will equal basic shares outstanding to avoid anti-dilution.

7



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


Basic and diluted earnings per common share for
the three and nine months ended September 30 are as follows:

|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------ |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                   |  |                    |        |                  
|                                                                   |  | Three months ended |        | Nine months ended
|                                                                   |  | September 30,      |        | September 30,    
|                                                                   |  |                    |        |                  
|                                                                   |  | 2004               |        | 2003              |  | 2004 |        | 2003
|                                                                   |  |                    |        |                   |  |      |        |     
|Income (loss) from continuing operations                           |  | $                  | (300   | )                 |  | $    | 81     |      |  | $ | (5,458 | ) |  | $ | 4,836  |  
|Income (loss) from discontinued operations                         |  |                    |       |                   |  |      | (459   | )    |  |   | (1,237 | ) |  |   | (1,273 | )
|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                  |  |                    | (300   | )                 |  |      | (378   | )    |  |   | (6,695 | ) |  |   | 3,563  |  
|Weighted average number of basic shares
    outstanding            |  |                    | 30,637 |                   |  |      | 20,649 |      |  |   | 30,431 |   |  |   | 20,612 |  
|Basic earnings (loss) per share from continuing
    operations     |  | $                  | (0.01  | )                 |  | $    | 0.00   |      |  | $ | (0.18  | ) |  | $ | 0.23   |  
|Basic earnings (loss) per share from discontinued
    operations   |  |                    |       |                   |  |      | (0.02  | )    |  |   | (0.04  | ) |  |   | (0.06  | )
|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  
|Basic earnings (loss) per share                                    |  | $                  | (0.01  | )                 |  | $    | (0.02  | )    |  | $ | (0.22  | ) |  | $ | 0.17   |  
|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  
|Weighted average number of diluted shares
    outstanding          |  |                    | 30,637 |                   |  |      | 20,649 |      |  |   | 30,507 |   |  |   | 20,891 |  
|Diluted earnings (loss) per share from continuing
    operations   |  | $                  | (0.01  | )                 |  | $    | 0.00   |      |  | $ | (0.18  | ) |  | $ | 0.23   |  
|Diluted earnings (loss) per share from
    discontinued operations |  |                    |       |                   |  |      | (0.02  | )    |  |   | (0.04  | ) |  |   | (0.06  | )
|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  
|Diluted earnings (loss) per share                                  |  | $                  | (0.01  | )                 |  | $    | (0.02  | )    |  | $ | (0.22  | ) |  | $ | 0.17   |  
|                                                                   |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |        |  

Diluted shares included above for the nine months
ended September 30, 2004 were 76 of operating partnership
units. Diluted shares included above for the nine months ended
September 30, 2003 were 201 of options and 78 of preferred
operating partnership units. Potentially dilutive securities
(options and operating partnership units) not included in the
above diluted share count were 390 and 585 for the three months
ended September 30, 2004 and 2003, respectively, and 373
and 276 for the nine months ended September 30, 2004 and
2003, respectively.



|   |                                           
|-- | ------------------------------------------
|4. | INVESTMENTS AND ADVANCES TO
    AFFILIATES

Our investments and advances to our joint
ventures consist of the following:

|                                      |       |               |       |              |  |   |       |        | 
|------------------------------------- | ----- | ------------- | ----- | ------------ |  | - | ----- | ------ | 
|                                      |       | September 30, |       | December 31,
|                                      |       | 2004          |       | 2003        
|                                      |       |               |       |             
|MIP Lessee, L.P.                      |       | $             | 4,007 |              |  | $ | 5,681 |       
|S.D. Bridgeworks, LLC                 |       |               | 435   |              |  |   | 3,389 |       
|CNL/ IHC Partners, L.P.               |       |               | 2,416 |              |  |   | 2,382 |       
|Interconn Ponte Vedra Company, L.L.C. |       |               | 2,037 |              |  |   | 1,210 |       
|Other                                 |       |               | 2,128 |              |  |   | 3,163 |       
|                                      |       |               |       |              |  |   |       |       
|                                      | Total |               | $     | 11,023       |  |   | $     | 15,825 | 
|                                      |       |               |       |              |  |   |       |       

In the first quarter of 2004, it was determined
that our investment in MIP Lessee, L.P. was impaired based on
purchase offers we received on two hotels owned by the joint
venture that were held for sale. Accordingly, we recorded an
impairment charge of $563 to reduce the carrying amount of the
investment to its estimated fair value. This amount is included
in asset impairments and other write-offs in our statements of
operations.

In addition, during the first quarter of 2004, we
wrote off our remaining investment in our joint venture that
owns the Residence Inn Houston Astrodome Medical Center. The
hotel was underperforming and in the first quarter of 2004 the
joint venture was notified that it had defaulted on its bank
loan, therefore we wrote off

8



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


the remaining carrying value of $538. This amount
is included in asset impairments and other write offs in our
statements of operations. One of our directors holds a 22.46%
ownership interest in this hotel.

In June 2004, S.D. Bridgeworks, L.L.C., our joint
venture that owns the Hilton San Diego Gaslamp, paid us
$2,687 representing its note payable owed to us, plus $300 of
accumulated interest. We own 17.24% of this joint venture at
September 30, 2004.

Our review of our other investments and advances
to affiliates did not indicate that any other investments or
advances were impaired. The recoverability of the carrying
values of our investments and advances is, however, dependent
upon operating results of the underlying real estate
investments. Future adverse changes in the hospitality and
lodging industry, market conditions or poor operating results of
the underlying investments could result in future losses or the
inability to recover the carrying value of these long-lived
assets.

We are not responsible for, and do not guarantee
the debt or other obligations of any of these investees.

Presented below is combined summarized financial
information for MIP Lessee, L.P., S.D. Bridgworks, LLC., CNL/IHC
Partners, L.P. and FHC/IHC Hotels, LP (Felcor),
investments for the nine months ended September 30, 2004.
Summarized profit and loss information for these investments is
required by Regulation S-X to be disclosed in interim
periods, as they have met certain financial tests in relation to
our consolidated financial position and results of operations.
The summarized information is as follows:

|                              |  |                    |         |      |  |   |         |  
|----------------------------- |  | ------------------ | ------- | ---- |  | - | ------- | -
|                              |  |                   
|                              |  | Nine months ended,
|                              |  | September 30,     
|                              |  |                   
|                              |  | 2004               |         | 2003
|                              |  |                    |         |     
|Revenue                       |  | $                  | 121,660 |      |  | $ | 120,141 |  
|Operating expenses            |  | $                  | 85,188  |      |  | $ | 83,801  |  
|Net loss                      |  | $                  | (2,657  | )    |  | $ | (6,562  | )
|Our share of the above losses |  | $                  | (338    | )    |  | $ | 769     |  

Our share of net income for the 2004 period does
not include $1,485, representing our share of the Felcor joint
ventures net income. At December 31, 2003 we wrote
our investment in this joint venture down to zero.



|   |                  
|-- | -----------------
|5. | INTANGIBLE ASSETS

Intangible assets consist of the following:

|                        |                               |               |        |              |   |   |        |        |  
|----------------------- | ----------------------------- | ------------- | ------ | ------------ | - | - | ------ | ------ | -
|                        |                               | September 30, |        | December 31,
|                        |                               | 2004          |        | 2003        
|                        |                               |               |        |             
|Management contracts    |                               | $             | 49,577 |              |   | $ | 56,913 |       
|Franchise fees          |                               |               | 1,945  |              |   |   | 1,945  |       
|Deferred financing fees |                               |               | 2,543  |              |   |   | 2,378  |       
|Other                   |                               |               | 160    |              |   |   | 946    |       
|                        |                               |               |        |              |   |   |        |       
|                        | Total cost                    |               |        | 54,225       |   |   |        | 62,182 |  
|                        | Less accumulated amortization |               |        | (7,876       | ) |   |        | (6,844 | )
|                        |                               |               |        |              |   |   |        |       
|Intangible assets, net  |                               | $             | 46,349 |              |   | $ | 55,338 |       
|                        |                               |               |        |              |   |   |        |       

We amortize the value of our intangible assets
over their estimated useful lives, which generally equal the
terms of the corresponding management, franchise, or financing
agreement.

We incurred aggregate amortization expense of
$921 and $2,823 on these assets for the three and nine months
ended September 30, 2004, and $1,153 and $6,965 for the
three and nine months ended September 30, 2003; with the
decrease attributable to a large group of management contracts
that were fully amortized in the second quarter of 2003.
Amortization of deferred financing fees is included in interest
expense.

During the nine months ended September 30,
2004, in connection with its asset disposition program, our
largest client, MeriStar Hospitality, sold 20 hotels that we
managed, five of which were sold in the third quarter. In total,
we wrote off $5,989 of unamortized management contract costs
associated with the disposed

9



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


hotels, of which $1,601 related to third quarter
dispositions. This amount is included in asset impairments and
other write-offs in our statements of operations.

Our estimated amortization expense for the next
five years is expected to be as follows:

|                              |  |   |       | 
|----------------------------- |  | - | ----- | 
|Year ending December 31, 2004 |  | $ | 3,721 | 
|Year ending December 31, 2005 |  |   | 3,379 | 
|Year ending December 31, 2006 |  |   | 3,091 | 
|Year ending December 31, 2007 |  |   | 2,497 | 
|Year ending December 31, 2008 |  |   | 2,470 | 

Our goodwill balance of $92,123 has not changed
since December 31, 2003, and is allocated as follows:

|                  |       |   |        |        | 
|----------------- | ----- | - | ------ | ------ | 
|Hotel Management  |       | $ | 82,917 |       
|Corporate Housing |       |   | 9,206  |       
|                  |       |   |        |       
|                  | Total |   | $      | 92,123 | 
|                  |       |   |        |       

We test goodwill for impairment at least annually
during the fourth quarter, or as circumstances warrant. In
connection with the disposal of the Toronto operation, goodwill
within our corporate housing segment was tested for impairment.
Based on this test, it was determined that there was no
impairment to the carrying value of goodwill.



|   |               
|-- | --------------
|6. | LONG-TERM DEBT

Our long-term debt consists of the following:

|                                                       |                      |               |        |              |   |   |        |        |  
|------------------------------------------------------ | -------------------- | ------------- | ------ | ------------ | - | - | ------ | ------ | -
|                                                       |                      | September 30, |        | December 31,
|                                                       |                      | 2004          |        | 2003        
|                                                       |                      |               |        |             
|Senior credit facility  revolving
    credit facility |                      | $             | 27,000 |              |   | $ | 24,500 |       
|Senior credit facility  term loan                     |                      |               | 16,880 |              |   |   | 18,098 |       
|Non-recourse promissory note                           |                      |               | 3,723  |              |   |   | 3,723  |       
|Subordinated term loan                                 |                      |               | 40,000 |              |   |   | 40,000 |       
|                                                       |                      |               |        |              |   |   |        |       
|                                                       |                      |               | 87,603 |              |   |   | 86,321 |       
|                                                       | Less current portion |               |        | (16,880      | ) |   |        | (1,625 | )
|                                                       |                      |               |        |              |   |   |        |       
|Total long-term debt                                   |                      | $             | 70,723 |              |   | $ | 84,696 |       
|                                                       |                      |               |        |              |   |   |        |       

Senior credit agreement Effective July 31, 2002, we
entered into a $113,000 senior credit agreement with a group of
banks. The senior credit agreement initially consisted of a
$65,000 term loan and a $48,000 revolving credit facility. The
term loan is payable in quarterly installments of $406 that
began January 1, 2003, with the balance due on
July 31, 2005. During the fourth quarter of 2003, using the
proceeds from a public equity offering, we repaid $45,276 of the
term loan. The revolving credit facility is due on July 31,
2005 (with a one-year renewal at our option).

The term loan is due on July 31, 2005.
Accordingly, the balance of the term loan of $16,880 is
classified as a current liability in our balance sheet as of
September 30, 2004. We have received a commitment to
refinance the senior secured credit facility and the
subordinated term loan. While the terms of this refinancing are
under negotiation, we expect to complete the refinancing in the
fourth quarter of 2004. The interest rate on the senior credit
agreement ranges from LIBOR plus 3.00% to 4.50%, depending upon
the results of certain financial tests. The senior credit
facility contains certain covenants, including maintenance of
financial ratios at the end of each quarter, compliance
reporting requirements and other customary restrictions. At

10



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


September 30, 2004, we were in compliance
with these covenants. The senior credit agreement also includes
pledges of collateral, including the following:



| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Ownership interests of all existing subsidiaries
    and unconsolidated entities as well as any future material
    subsidiary or unconsolidated entity;
|
| |  | Owned hospitality properties; and                                                                                                                       
|
| |  | Other collateral that is not previously
    prohibited from being pledged by any of our existing
    contracts/agreements.                              

At September 30, 2004, borrowings under the
senior credit agreement bore interest at a rate of
5.78% per annum, which is the 30-day LIBOR including the
effect of an interest rate swap plus 3.50%. We are currently in
the process of negotiating the refinancing of this facility,
which we expect to complete during the fourth quarter of 2004.
We expect to write-off approximately $267 of deferred financing
fees associated with this facility in connection with the
refinancing.

We incurred $610 and $1,810 of interest expense
on the senior credit agreement for the three and nine months
ended September 30, 2004, and $1,107 and $3,377 for the
three and nine months ended September 30, 2003. The
decrease in interest expense resulted from our prepayment of
$45,276 of our term loan with proceeds from our November 2003
public equity offering.

Non-recourse promissory note In March 2001, we entered into a
non-recourse promissory note in the amount of $4,170 with FelCor
Lodging Trust Incorporated (FelCor) to fund the
acquisition of a 50% non-controlling equity interest in two
partnerships that own eight mid-scale hotels. Interest on the
note is payable monthly at the rate of 12% per annum and
the outstanding principal balance is due and payable on
December 31, 2010. For the three and nine months ended
September 30, 2004, we incurred $112 and $335 of interest
expense on the promissory note, respectively. For the three and
nine months ended September 30, 2003, we incurred $118 and
$368 of interest expense on the promissory note, respectively.
Accrued interest payable was $302, as of September 30, 2004.

In June 2003, we made unscheduled principal
payments totaling $447 on the note. As of September 30,
2004, the remaining balance on the promissory note is $3,723. In
connection with one of the payments, our ownership interest in
the partnership was reduced from 50% to 49.5% as FelCor made an
additional contribution to the partnership at that time. After
notifying FelCor, we suspended further principal and interest
payments on this non-recourse promissory note and, accordingly,
we are in default under the note. We expect that we will
ultimately transfer ownership of our equity interests in these
joint ventures to FelCor in return for the extinguishment of the
debt. This note would have no value to a third party.

Subordinated term
loan In January 2003, we
entered into a $40,000 subordinated term loan that carries a
variable interest rate based on the 30-day LIBOR plus a spread
of 8.50%. The subordinated term loan matures on January 31,
2006, but if the revolving portion of our senior credit facility
is extended for an additional year, the maturity of the
subordinated term loan will also be automatically extended by
one year to January 31, 2007. This term loan is
subordinated to borrowings under the senior credit agreement and
contains certain covenants, including maintenance of financial
ratios at the end of each quarter, compliance reporting
requirements and other customary restrictions. At
September 30, 2004, we were in compliance with these
covenants. At September 30, 2004, borrowings under the
subordinated term loan bore interest at a rate of
10.19% per annum. We incurred $1,013 and $2,959 of interest
expense on the subordinated term loan for the three and nine
months ended September 30, 2004, respectively, and $984 and
$2,871 of interest expense on the subordinated term loan for the
three and nine months ended September 30, 2003
respectively. We expect to pay approximately $2,000 in exit fees
on this loan when we refinance in the fourth quarter of 2004. We
also expect to write off approximately $953 of deferred
financing fees for this loan in connection with the refinancing.

Fair
Value Our outstanding
long-term debt is based on LIBOR rates. We have determined that
the fair value of our outstanding borrowings on our senior
credit facility and subordinated term loan approximated their
carrying values at September 30, 2004. The fair value of
our interest rate swap agreement was a liability

11



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


of approximately $21 at September 30, 2004.
The interest swap agreement pertains to the senior credit
agreement and the senior revolving facility. This swap matured
on October 1, 2004. The notional amount of the swap agreement
was $30,000. We also have a $35,000 interest rate cap. At
September 30, 2004, the fair value of this cap was
insignificant. We believe that our non-recourse promissory note
would have no value to a third party. We intend to exchange the
non-recourse promissory note for our equity interests in the
related FelCor joint venture, as discussed above. The carrying
value of this investment is zero.



|   |                    
|-- | -------------------
|7. | SEGMENT INFORMATION

We are organized into two operating divisions:
hotel management and corporate housing. Both of these divisions
are reportable operating segments. Each division is managed
separately because of its distinct products and services. We
evaluate the performance of each division based on earnings
before interest, taxes, depreciation and amortization, equity in
earnings (losses) of affiliates, minority interests,
discontinued operations and in 2003, a gain on refinancing
(Adjusted EBITDA).

The other items in the tables below represent
operating segment activity and assets for the non-reportable
segments. Adjusted EBITDA from other activities includes merger
and integration costs, restructuring charges, asset impairments,
other write offs and other non-recurring items. Other assets
include deferred tax assets and net deferred financing costs.

We use Adjusted EBITDA to evaluate the
performance of our segments. The tables below reconcile Adjusted
EBITDA to net income (loss) for each of the periods presented.

|                                          |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |       |  
|----------------------------------------- | ----------------------------------- | ---------- | ----- | --------- | - | ----- | ----- | ---------- | - | - | ------ | ------ | - | - | ----- | ----- | -
|                                          |                                     | Hotel      |       | Corporate |   |       |       | Financial 
|                                          |                                     | Management |       | Housing   |   | Other |       | Statements
|                                          |                                     |            |       |           |   |       |       |           
|Three months ended September 30,
    2004 |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|Net income (loss)                         |                                     | $          | 1,217 |           |   | $     | 245   |            |   | $ | (1,762 | )      |   | $ | (300  | )    
|Adjustments:                              |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|                                          | Depreciation and amortization       |            |       | 1,909     |   |       |       | 332        |   |   |        |       |   |   |       | 2,241 |  
|                                          | Interest expense, net               |            |       | 1,502     |   |       |       | 500        |   |   |        |       |   |   |       | 2,002 |  
|                                          | Equity in losses of affiliates      |            |       | 5         |   |       |       |           |   |   |        |       |   |   |       | 5     |  
|                                          | Minority interest expense           |            |       | 3         |   |       |       | 1          |   |   |        | 3      |   |   |       | 7     |  
|                                          | Income tax expense                  |            |       | 150       |   |       |       | 30         |   |   |        | 171    |   |   |       | 351   |  
|                                          |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|Adjusted EBITDA                           |                                     | $          | 4,786 |           |   | $     | 1,108 |            |   | $ | (1,588 | )      |   | $ | 4,306 |      
|                                          |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|Three months ended September 30,
    2003 |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|Net income (loss)                         |                                     | $          | 2,014 |           |   | $     | (615  | )          |   | $ | (1,777 | )      |   | $ | (378  | )    
|Adjustments:                              |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|                                          | Depreciation and amortization       |            |       | 2,217     |   |       |       | 374        |   |   |        |       |   |   |       | 2,591 |  
|                                          | Interest expense, net               |            |       | 1,767     |   |       |       | 589        |   |   |        |       |   |   |       | 2,356 |  
|                                          | Equity in losses of affiliates      |            |       | 292       |   |       |       |           |   |   |        |       |   |   |       | 292   |  
|                                          | Discontinued operations             |            |       |          |   |       |       | 459        |   |   |        |       |   |   |       | 459   |  
|                                          | Minority interest expense (benefit) |            |       | (122      | ) |       |       | 37         |   |   |        | 108    |   |   |       | 23    |  
|                                          | Income tax expense (benefit)        |            |       | 1,342     |   |       |       | (410       | ) |   |        | (1,184 | ) |   |       | (252  | )
|                                          |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      
|Adjusted EBITDA                           |                                     | $          | 7,510 |           |   | $     | 434   |            |   | $ | (2,853 | )      |   | $ | 5,091 |      
|                                          |                                     |            |       |           |   |       |       |            |   |   |        |        |   |   |       |      

12



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


|                                         |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |         |  
|---------------------------------------- | ------------------------------------------------ | ---------- | ------ | --------- |  | ----- | ------ | ---------- | - | - | ------- | ------- | - | - | ------ | ------- | -
|                                         |                                                  | Hotel      |        | Corporate |  |       |        | Financial 
|                                         |                                                  | Management |        | Housing   |  | Other |        | Statements
|                                         |                                                  |            |        |           |  |       |        |           
|Nine months ended September 30,
    2004 |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|Net income (loss)                        |                                                  | $          | 2,006  |           |  | $     | (1,080 | )          |   | $ | (7,621  | )       |   | $ | (6,695 | )      
|Adjustments:                             |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|                                         | Depreciation and amortization                    |            |        | 5,937     |  |       |        | 1,037      |   |   |         |        |   |   |        | 6,974   |  
|                                         | Interest expense, net                            |            |        | 3,969     |  |       |        | 1,323      |   |   |         |        |   |   |        | 5,292   |  
|                                         | Equity in losses of affiliates                   |            |        | 946       |  |       |        |           |   |   |         |        |   |   |        | 946     |  
|                                         | Discontinued operations                          |            |        |          |  |       |        | 1,237      |   |   |         |        |   |   |        | 1,237   |  
|                                         | Minority interest expense (benefit)              |            |        | 20        |  |       |        | (11        | ) |   |         | (77     | ) |   |        | (68     | )
|                                         | Income tax expense (benefit)                     |            |        | 926       |  |       |        | (499       | ) |   |         | (3,520  | ) |   |        | (3,093  | )
|                                         |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|Adjusted EBITDA                          |                                                  | $          | 13,804 |           |  | $     | 2,007  |            |   | $ | (11,218 | )       |   | $ | 4,593  |        
|                                         |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|Nine months ended September 30,
    2003 |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|Net income (loss)                        |                                                  | $          | 1,690  |           |  | $     | (2,495 | )          |   | $ | 4,368   |         |   | $ | 3,563  |        
|Adjustments:                             |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|                                         | Depreciation and amortization                    |            |        | 9,748     |  |       |        | 1,102      |   |   |         |        |   |   |        | 10,850  |  
|                                         | Interest expense, net                            |            |        | 5,386     |  |       |        | 1,795      |   |   |         |        |   |   |        | 7,181   |  
|                                         | Equity in losses of affiliates                   |            |        | 858       |  |       |        |           |   |   |         |        |   |   |        | 858     |  
|                                         | Discontinued operations                          |            |        |          |  |       |        | 1,273      |   |   |         |        |   |   |        | 1,273   |  
|                                         | Gain on refinancing term loan from related party |            |        |          |  |       |        |           |   |   |         | (13,629 | ) |   |        | (13,629 | )
|                                         | Minority interest expense (benefit)              |            |        | 87        |  |       |        | (129       | ) |   |         | 226     |   |   |        | 184     |  
|                                         | Income tax expense (benefit)                     |            |        | 1,126     |  |       |        | (1,662     | ) |   |         | 2,911   |   |   |        | 2,375   |  
|                                         |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        
|Adjusted EBITDA                          |                                                  | $          | 18,895 |           |  | $     | (116   | )          |   | $ | (6,124  | )       |   | $ | 12,655 |        
|                                         |                                                  |            |        |           |  |       |        |            |   |   |         |         |   |   |        |        

|                                           |  |            |         |           |  |       |        |            |  |   |         |   |  |   |         | 
|------------------------------------------ |  | ---------- | ------- | --------- |  | ----- | ------ | ---------- |  | - | ------- | - |  | - | ------- | 
|                                           |  | Hotel      |         | Corporate |  |       |        | Financial 
|                                           |  | Management |         | Housing   |  | Other |        | Statements
|                                           |  |            |         |           |  |       |        |           
|Three months ended September, 30,
    2004 |  |            |         |           |  |       |        |            |  |   |         |   |  |   |         | 
|Revenue                                    |  | $          | 217,577 |           |  | $     | 31,701 |            |  | $ |        |   |  | $ | 249,278 | 
|Adjusted EBITDA                            |  | $          | 4,786   |           |  | $     | 1,108  |            |  | $ | (1,588  | ) |  | $ | 4,306   | 
|Three months ended September, 30,
    2003 |  |            |         |           |  |       |        |            |  |   |         |   |  |   |         | 
|Revenue                                    |  | $          | 238,197 |           |  | $     | 27,480 |            |  | $ |        |   |  | $ | 265,677 | 
|Adjusted EBITDA                            |  | $          | 7,510   |           |  | $     | 434    |            |  | $ | (2,853  | ) |  | $ | 5,091   | 
|Nine months ended September, 30,
    2004  |  |            |         |           |  |       |        |            |  |   |         |   |  |   |         | 
|Revenue                                    |  | $          | 655,129 |           |  | $     | 83,506 |            |  | $ |        |   |  | $ | 738,635 | 
|Adjusted EBITDA                            |  | $          | 13,804  |           |  | $     | 2,007  |            |  | $ | (11,218 | ) |  | $ | 4,593   | 
|Total assets                               |  | $          | 222,654 |           |  | $     | 19,003 |            |  | $ | 23,587  |   |  | $ | 265,244 | 
|Nine months ended September, 30,
    2003  |  |            |         |           |  |       |        |            |  |   |         |   |  |   |         | 
|Revenue                                    |  | $          | 701,159 |           |  | $     | 77,762 |            |  | $ |        |   |  | $ | 778,921 | 
|Adjusted EBITDA                            |  | $          | 18,895  |           |  | $     | (116   | )          |  | $ | (6,124  | ) |  | $ | 12,655  | 
|Total assets                               |  | $          | 260,252 |           |  | $     | 12,506 |            |  | $ | 21,272  |   |  | $ | 294,030 | 

13



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


Revenues from the United Kingdom and France, and
management fees from Russia and Canada were as follows for the
three and nine months ended September 30:

|               |  |                    |       |                   |  |      |       |      |  |   |        |  |  |   |        | 
|-------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ------ |  |  | - | ------ | 
|               |  |                    |       |                  
|               |  | Three months ended |       | Nine months ended
|               |  | September 30,      |       | September 30,    
|               |  |                    |       |                  
|               |  | 2004               |       | 2003              |  | 2004 |       | 2003
|               |  |                    |       |                   |  |      |       |     
|United Kingdom |  | $                  | 6,645 |                   |  | $    | 5,792 |      |  | $ | 17,744 |  |  | $ | 17,851 | 
|France         |  |                    | 539   |                   |  |      | 388   |      |  |   | 1,333  |  |  |   | 1,080  | 
|Russia         |  |                    | 375   |                   |  |      | 302   |      |  |   | 1,133  |  |  |   | 744    | 
|Canada         |  |                    | 202   |                   |  |      | 643   |      |  |   | 666    |  |  |   | 1,148  | 

Included in discontinued operations is revenue
from our Toronto operation which was disposed of in June 2004,
amounting to $2,233 for the nine months ended September 30,
2004, and $1,764 and $5,694 for the three and nine months ended
September 30, 2003, respectively



|   |                                   
|-- | ----------------------------------
|8. | SUPPLEMENTAL CASH FLOW INFORMATION

|                                         |              |                    |   |                   |  |      |   |       |  |  |   |       |  |  |   |       | 
|---------------------------------------- | ------------ | ------------------ | - | ----------------- |  | ---- | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                                         |              |                    |   |                  
|                                         |              | Three months ended |   | Nine months ended
|                                         |              | September 30,      |   | September 30,    
|                                         |              |                    |   |                  
|                                         |              | 2004               |   | 2003              |  | 2004 |   | 2003 
|                                         |              |                    |   |                   |  |      |   |      
|Cash paid for interest and income taxes: |              |                    |   |                   |  |      |   |       |  |  |   |       |  |  |   |      
|                                         | Interest     |                    | $ | 1,696             |  |      | $ | 2,397 |  |  | $ | 5,209 |  |  | $ | 6,741 | 
|                                         | Income taxes |                    |   | 372               |  |      |   | 196   |  |  |   | 1,138 |  |  |   | 440   | 



|   |                       
|-- | ----------------------
|9. | RESTRUCTURING EXPENSES

We have recorded $42 and $3,481 of restructuring
expenses for the three and nine months ended September 30,
2004, respectively.

These charges consist of the following:

|                                |  |                    |    |                   |  |   |       | 
|------------------------------- |  | ------------------ | -- | ----------------- |  | - | ----- | 
|                                |  | Three months ended |    | Nine months ended
|                                |  | September 30,      |    | September 30,    
|                                |  |                    |    |                  
|Former CEOs severance          |  | $                  |   |                   |  | $ | 3,312 | 
|Corporate Housing restructuring |  |                    | 42 |                   |  |   | 169   | 
|                                |  |                    |    |                   |  |   |       | 
|Total                           |  | $                  | 42 |                   |  | $ | 3,481 | 
|                                |  |                    |    |                   |  |   |       | 

Severance Agreement Effective April 2, 2004, we and
our chairman, Paul W. Whetsell entered into an agreement to
conclude his employment as our chief executive officer as Steve
Jorns had assumed that role. Mr. Whetsell was granted
250 shares of common stock, $0.01 par value, with a
market value of $5.82 per share (the April 2, 2004
closing price) and paid $130 in cash. Pursuant to the agreement,
these restricted shares along with 157 previously granted
unvested shares which vested in connection with the agreement,
may not be sold or otherwise transferred during a restricted
period unless Mr. Whetsell gives us the right of first
refusal to purchase the restricted shares proposed to be sold or
transferred at the price of $0.01 per share. The restricted
period ends on specified dates through 2006 with respect to
specified numbers of restricted shares as set forth in the
agreement. However, under certain circumstances, the restricted
period may be extended to January 1, 2010. Because the
shares were granted in lieu of a contractually required cash
severance payment, Mr. Whetsell is not required to perform
any additional services to earn the stock. Consequently, we
recorded the entire severance amount in the period the stock was
granted. In addition, in exchange for Mr. Whetsells
agreement to accept the payment in stock rather than cash, we
agreed to reimburse him for taxes he incurs with respect to the
stock as the trading restrictions on the stock lapse. The total
cost of this severance payment, based on the value of the stock
on April 2, 2004 and our liability for
Mr. Whetsells taxes based on the value of the stock
as of that date, was approximately $3,312, and is included in
restructuring expenses in

14



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


our statement of operations. This cost may be
adjusted in the future to reflect the amount of our actual
liability for taxes based on the value of the stock on the dates
the restrictions lapse.

Corporate Housing During 2004, we incurred charges of
approximately $169 related to severance for former personnel and
other related charges, in connection with restructuring within
our corporate housing operation.



|    |                                           
|--- | ------------------------------------------
|10. | ASSET IMPAIRMENTS AND OTHER
    WRITE-OFFS

We have recorded $1,601 and $7,792 of asset
impairments and other write-offs for the three and nine months
ended September 30, 2004, respectively, and $1,979 and
$2,780 of asset impairments and other write-offs for the three
and nine months ended September 30, 2003, respectively.

These charges consist of the following:

|                                 |  |                    |       |                   |  |      |       |      |  |   |       |  |  |   |       | 
|-------------------------------- |  | ------------------ | ----- | ----------------- |  | ---- | ----- | ---- |  | - | ----- |  |  | - | ----- | 
|                                 |  |                    |       |                  
|                                 |  | Three months ended |       | Nine months ended
|                                 |  | September 30,      |       | September 30,    
|                                 |  |                    |       |                  
|                                 |  | 2004               |       | 2003              |  | 2004 |       | 2003
|                                 |  |                    |       |                   |  |      |       |     
|Management contract write-offs   |  | $                  | 1,601 |                   |  | $    | 1,667 |      |  | $ | 5,989 |  |  | $ | 2,468 | 
|Investment impairments           |  |                    |      |                   |  |      |      |      |  |   | 1,101 |  |  |   |      | 
|Cost of uncompleted merger       |  |                    |      |                   |  |      |      |      |  |   | 606   |  |  |   |      | 
|Leasehold improvement write-offs |  |                    |      |                   |  |      | 312   |      |  |   |      |  |  |   | 312   | 
|Other                            |  |                    |      |                   |  |      |      |      |  |   | 96    |  |  |   |      | 
|                                 |  |                    |       |                   |  |      |       |      |  |   |       |  |  |   |       | 
|Total                            |  | $                  | 1,601 |                   |  | $    | 1,979 |      |  | $ | 7,792 |  |  | $ | 2,780 | 
|                                 |  |                    |       |                   |  |      |       |      |  |   |       |  |  |   |       | 

Management contract write-offs In connection with its asset
disposition program, MeriStar Hospitality disposed of 20 hotels
in the first nine months of 2004 including 5 hotels in the third
quarter, and 5 hotels in the three and nine months ended
September 30, 2003. Consequently, we wrote off $1,601 and
$5,989 for the three and nine months ended September 30,
2004, respectively, and $1,667 and $2,468 for the three and nine
months ended September 30, 2003 respectively, of
unamortized management contracts costs.

Investment impairments During the first quarter of 2004, it
was determined that our investment in MIP Lessee, L.P. was
impaired based on purchase offers we received on two of the
joint ventures hotels. Accordingly, we recorded an
impairment charge of $563 to reduce the carrying amount of our
investment to its estimated fair value. One of our directors
holds a 22.46% ownership interest in this hotel.

During the first quarter of 2004, we wrote off
our remaining investment in our joint venture that owns the
Residence Inn Houston Astrodome Medical Center. The hotel was
underperforming and in the first quarter the joint venture was
notified that it had defaulted on its bank loan, therefore we
wrote-off the remaining carrying value of $538.

Cost of Uncompleted
Merger During the second
quarter of 2004, we pursued a merger with a company which owns a
portfolio of hotels. We incurred approximately $606 of legal
fees and due diligence costs related to this potential merger.
These costs were expensed in June 2004, when we determined that
the merger would not be consummated.



|    |                        
|--- | -----------------------
|11. | DISCONTINUED OPERATIONS

In June 2004, we completed the disposal of
BridgeStreet Canada, Inc., the owner of our corporate housing
operation in Toronto. The Toronto operation had incurred
operating losses, primarily due to long-term lease commitments
that did not allow us to adjust our inventory as demand changed.
In exchange for the Toronto operation, the buyer assumed our
obligations, including the long-term lease commitments.
Operations for the three and nine month periods and comparative
periods are presented as discontinued operations in our

15



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


statements of operations. We recorded
approximately $698 in asset write-offs and costs associated with
this disposal, comprised of the following:

|                       |  |   |     | 
|---------------------- |  | - | --- | 
|Fixed asset write-offs |  | $ | 376 | 
|Severance expense      |  |   | 100 | 
|Closing costs          |  |   | 171 | 
|Other                  |  |   | 51  | 
|                       |  |   |     | 
|Total                  |  | $ | 698 | 
|                       |  |   |     | 

Discontinued operations include the following:

|               |  |               |   |               |  |      |       |      |  |   |       |   |  |   |        |  
|-------------- |  | ------------- | - | ------------- |  | ---- | ----- | ---- |  | - | ----- | - |  | - | ------ | -
|               |  |               |   |              
|               |  | Three months  |   | Nine months  
|               |  | ended         |   | ended        
|               |  | September 30, |   | September 30,
|               |  |               |   |              
|               |  | 2004          |   | 2003          |  | 2004 |       | 2003
|               |  |               |   |               |  |      |       |     
|Revenue        |  | $             |  |               |  | $    | 1,765 |      |  | $ | 2,233 |   |  | $ | 5,694  |  
|Closing costs  |  |               |  |               |  |      |      |      |  |   | (698  | ) |  |   |       |  
|Operating loss |  |               |  |               |  |      | (456  | )    |  |   | (539  | ) |  |   | (1,270 | )



|    |                
|--- | ---------------
|12. | RELATED PARTIES

Related parties, as defined in SFAS 57
Related Party Disclosures, include MeriStar
Hospitality, the hotels included in our real estate joint
ventures, and a small number of hotels which are affiliated with
certain of our directors. Total management fees from related
parties amounted to $6,660 and $23,345 for the three and nine
months ended September 30, 2004, and $7,152 and $22,793 for
the three and nine months ended September 30, 2003,
respectively.



|    |                              
|--- | -----------------------------
|13. | COMMITMENTS AND CONTINGENCIES

Insurance Matters As part of our management services to
a hotel owner, we generally obtain casualty (workers
compensation and liability) insurance coverage for the hotel. In
December 2002, one of the carriers we used to obtain casualty
insurance coverage was downgraded significantly by rating
agencies. In January 2003, we negotiated a transfer of that
carriers current policies to a new carrier. We are working
with the prior carrier to facilitate a timely and efficient
close-out of the claims outstanding under the prior
carriers casualty policies. The prior carrier has primary
responsibility for settling those claims from its assets. If the
prior carriers assets are not sufficient to settle these
outstanding claims, and the claims exceed amounts available
under state guaranty funds, we may be required to settle those
claims. Although we are indemnified under our management
agreements for such amounts, we would be responsible
contractually for claims in historical periods when we leased
(in addition to managed) certain hotels. Based on the
information currently available, we believe the ultimate
resolution of this situation will not have a material adverse
effect on our consolidated financial position, results of
operations or liquidity.

16



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##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)


Leases We lease apartments for our Corporate
Housing division and office space for our corporate offices.
Future minimum lease payments required under these operating
leases as of December 31, 2004 were as follows:

|           |  |   |        | 
|---------- |  | - | ------ | 
|2004       |  | $ | 18,423 | 
|2005       |  |   | 26,419 | 
|2006       |  |   | 8,867  | 
|2007       |  |   | 6,653  | 
|2008       |  |   | 5,598  | 
|2009       |  |   | 4,946  | 
|Thereafter |  |   | 24,387 | 
|           |  |   |        | 
|Total      |  | $ | 95,293 | 
|           |  |   |        | 

In the course of 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 pending or
asserted will not have a material adverse effect on our
consolidated financial position, results of operations or
liquidity.

Management Agreement Commitments Under the provisions of management
agreements with certain hotel owners, we may be required to
provide an aggregate of $3,852 to these hotel owners in the form
of investments or loans. The loans may be forgiven or repaid
based upon the specific terms of each management agreement. The
timing of future investments or working capital loans to hotel
owners is currently unknown as it is at the hotel owners
discretion.



|    |                  
|--- | -----------------
|14. | SUBSEQUENT EVENTS

On October 26, 2004, we entered into a Stock
Purchase Agreement with Sunstone Hotel Investors, Inc., a
Maryland corporation, Sunstone Hotel Partnership, LLC, a
Delaware limited liability company, Sunstone Hotel Investors,
LLC, a Delaware limited liability company, Sunstone Hotel TRS
Lessee, Inc., a Delaware corporation, and Sunstone Hotel
Properties, Inc., a Colorado corporation (SHP). The
Stock Purchase Agreement related to our acquisition of SHP, a
hotel management company.

The purchase price was $8,000, $6,000 of which
was paid on October 26, 2004 and $2,000 of which is due on
December 31, 2005. In addition, we assumed liabilities
related to health plans, workers compensation plans and
other employment related liabilities of $14,666 which Sunstone
Hotel Investors, Inc., has agreed to pay to us. Consequently, we
also recorded a corresponding receivable of $14,666 from
Sunstone Hotel Investors, Inc. Certain of the Sunstone parties
agreed to indemnify us and SHP for liabilities arising prior to
as well as after the acquisition.

In connection with the acquisition, SHP entered
into new management contracts with respect to 54 hotels
previously managed by SHP, 50 of which are owned by Sunstone
Hotels Investors, Inc. and its affiliates.

17



---



##### 



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)




|        |                                                                                                                     
|------- | --------------------------------------------------------------------------------------------------------------------
|Item 2: | Managements Discussion and Analysis
    of Financial Condition and Results of Operations (dollars in
    thousands)

Business Overview

General
We are the largest independent U.S. hotel management
company not affiliated with a hotel brand, measured by number of
rooms under management. We manage a portfolio of hospitality
properties and provide related services in the hotel, corporate
housing, resort, conference center and golf markets. We also own
one hotel property and hold non-controlling equity interests in
11 joint ventures which hold ownership interests in 27 of our
managed properties. Our portfolio is diversified by franchise
and brand affiliations. The related services we provide include
insurance and risk management services, purchasing and project
management services, information technology and
telecommunications services and centralized accounting services.

As of September 30, 2004, we managed 255
properties, with 57,074 rooms in 40 states, the District of
Columbia, Canada, Russia and Portugal. As of September 30,
2004, we had 3,073 apartments under lease or management through
our BridgeStreet corporate housing division in the United
States, France and the United Kingdom.

We have two operating divisions, hotel management
and corporate housing, both of which are reportable operating
segments. Each division is managed separately because of its
distinct products and services.

Our subsidiary operating partnership indirectly
holds substantially all of our assets. We are the sole general
partner of that operating partnership. We, our chief accounting
officer and certain independent third parties are limited
partners of the partnership. The interests of those third
parties are reflected in minority interests on our balance
sheet. The partnership agreement gives the general partner full
control over the business and affairs of the partnership. We own
more than 99% of the subsidiary operating partnership.

We manage all but three of the properties owned
or partially owned by MeriStar Hospitality, a real estate
investment trust, or REIT. As of September 30, 2004,
MeriStar Hospitality owned 76 properties, eight of which
MeriStar Hospitality has placed in its asset disposition
program. Our relationship with MeriStar Hospitality has
historically been governed in part by an intercompany agreement.
That agreement provided each of us the right to participate in
certain transactions entered into by the other company.
Management fees earned from hotels owned by Meristar Hospitality
are classified as management fees-related parties in the
consolidated statements of operations.

Effective July 1, 2004, MeriStar Hospitality
and we agreed to terminate the intercompany agreement. We
believe the termination of the intercompany agreement is an
important step in our efforts to pursue our strategy of
increasing our investment in hotels and resorts since we can now
pursue real estate investment opportunities without first having
to offer the opportunity to MeriStar Hospitality. In connection
with the termination of the intercompany agreement we have
agreed to modify the management agreements under which we manage
the MeriStar Hospitality hotels as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | MeriStar Hospitality may terminate management
    agreements each year representing up to 600 rooms with the
    payment of a termination fee equal to 18 months of
    management fees and, if all 600 rooms are not terminated in
    a given year, the remaining portion of the 600 rooms may be
    carried over to the subsequent year.                       
|
| |  | MeriStar Hospitality may terminate a management
    agreement if we make an investment, in the form of debt or
    equity, in a hotel that is in the competitive set of the
    MeriStar Hospitality hotel (provided that the termination can
    only occur between 12 and 18 months following the date the
    investment is made); and                          
|
| |  | the period during which termination fees are paid
    (other than as described in the first bullet point above) is
    extended from 30 months to 48 months; provided that
    the period during which MeriStar Hospitality may reduce the
    termination fee by providing a new hotel for us to manage to
    replace the terminated hotel will remain 30 months.

18



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##### 



In addition, in connection with the termination
of the intercompany agreement, MeriStar Hospitality and we have
resolved our disagreement over the calculation of termination
fees. We have agreed to calculate the termination fees based
upon an average of the present value of remaining estimated
management fees due to us under the contract (a) discounted
as individual monthly payments and (b) discounted based on
a lump sum payment at the end of the contract term. We have
agreed to provide MeriStar Hospitality with a $2,500 credit
against termination fees owed for hotels to be sold by MeriStar
Hospitality in the future. As of September 30, 2004 there
is approximately $1,970 of this credit remaining. This credit
will apply to six of the eight hotels MeriStar Hospitality
intended to sell as of September 30, 2004. Net of the
$1,970 credit, as of September 30, 2004, we would be
entitled to receive approximately $3,500 of termination fees
with respect to the eight hotels that MeriStar Hospitality has
in its asset disposition program.

Revenue
Our revenue consists of:



| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | management fee revenue, which consists of
    management fees earned under our management agreements and
    includes termination fees as they are earned;                                                          
|
| |  | corporate housing revenue, which consists of
    revenues from our BridgeStreet corporate housing division;                                                                                                         
|
| |  | lodging revenue, which consists of rooms, food
    and beverage and other department revenues from our owned
    hotel; and                                                                                         
|
| |  | other revenue, which consists of insurance
    revenue from Northridge Insurance Company, purchasing revenue,
    accounting fees, technical services fees, information technology
    support fees, and other fees.

We employ the staff at our managed properties.
Under our management agreements, the hotel owners reimburse us
for payroll, benefits, and certain other costs related to the
operations of the managed properties. Emerging Issues Task
Force, (EITF) No. 01-14, Income Statement
Characteristics of Reimbursements for Out-of-pocket
Expenses, establishes standards for accounting for
reimbursable expenses in our income statement. Under this
pronouncement, the reimbursement of payroll, benefits and
related costs is reported as other revenue from managed
properties, with a corresponding expense reported as
other expenses from managed properties in our
statement of operations.

Operating
Expenses Our operating
expenses consist of operating expenses by department and
undistributed operating expenses. Operating expenses by
department include expenses associated with our corporate
housing division and our lodging operations. Corporate housing
expenses include apartment rent, furniture, utilities and
housekeeping, and lodging expenses include costs associated with
rooms, food and beverage and other department expenses and
property operating costs related to our owned hotel.

Undistributed operating expenses include the
following items:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | administrative and general expenses, which are
    associated with the management of hotels and corporate housing
    facilities and consist primarily of expenses such as corporate
    payroll and related benefits, operations management, sales and
    marketing, finance, legal, information technology support, human
    resources and other support services, as well as general
    corporate expenses;
|
| |  | depreciation and amortization; and                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | other costs, such as merger and integration
    costs, asset impairments and other write-offs, restructuring
    charges and other costs that are not allocable to hotel
    management or corporate housing.                                                                                                                                                                                                    

Recent events

Termination of Intercompany
Agreement Effective
July 1, 2004, MeriStar Hospitality and we have agreed to
terminate the intercompany agreement, as discussed above.

Termination of Management
Agreements In connection
with the merger of MeriStar and Interstate in 2002, we assigned
estimated fair values to each of the management agreements
considered purchased by Interstate, the accounting acquiror in
the merger. These assigned fair values are included as
intangible assets

19



---



##### 



on our balance sheet. We are amortizing these
intangible assets over the terms of the management agreements.
If one of these management agreements is terminated prior to its
full term, for example, due to the sale of a hotel or an owner
choosing to exercise a termination clause, we record a loss on
the write-off of the related unamortized intangible asset value.
When a hotel is sold, we are usually replaced as the
hotels manager. During the first nine months of 2004,
MeriStar Hospitality sold 20 hotels that we had managed,
including five in the third quarter. We wrote-off $5,989 of
unamortized management contract costs associated with the
disposed hotels for the nine months ended September 30,
2004, with $1,601 relating to third quarter dispositions. This
amount is included in asset impairments and other write-offs in
our statements of operations. As of September 30, 2004,
MeriStar Hospitality has stated its intention to sell an
additional eight hotels as part of its asset disposition
program, all of which we manage. When they are sold, we estimate
that we will write off an additional $2,960 in management
contract intangibles.


Generally, if we are terminated as manager upon
the sale of one of MeriStar Hospitalitys hotels, we will
receive a termination fee equal to the discounted value of
remaining payments as described above. Historically, any
termination fee was to be paid in thirty equal monthly
installments, without interest, commencing the month following
the termination. In connection with the termination of the
Intercompany Agreement in July 2004, we extended this payment
period to 48 months. MeriStar Hospitality will be able to
credit against any termination payments still due at the time,
the discounted value of projected fees, as defined in the
management agreements, of any new management agreements entered
into with us during the thirty-month period following the
contract termination. As of September 30, 2004, we would be
entitled to receive approximately $13,592 of termination fees
relating to hotels sold by MeriStar Hospitality, and
approximately $3,500 relating to the eight hotels that MeriStar
Hospitality intends to sell as of September 30, 2004, net
of the $1,970 credit as discussed above.

Our management agreements with other owners
generally provide for limited, if any, termination fees if our
management agreement is terminated upon the sale of the hotel.
We record termination fees as management fee revenue as they are
earned. We have $677 and $3,298 of termination fees in our
statement of operations for the three and nine months ended
September 30, 2004, with no like revenue in the same
periods of 2003.

Insurance
Matters As part of our
management services to a hotel owner, we generally obtain
casualty (workers compensation and liability) insurance
coverages for the hotel. In December 2002, one of the carriers
we used to obtain casualty insurance coverages was downgraded
significantly by rating agencies. In January 2003, we negotiated
a transfer of that carriers current policies to a new
carrier. We are working with the prior carrier to facilitate a
timely and efficient close-out of the claims outstanding under
the prior carriers casualty policies. The prior carrier
has primary responsibility for settling those claims from its
assets. If the prior carriers assets are not sufficient to
settle these outstanding claims, and the claims exceed amounts
available under state guaranty funds, we may be required to
settle those claims. Although we are indemnified under our
management agreements for such amounts, we would be responsible
contractually for claims in historical periods when we leased
(in addition to managed) certain hotels. Based on the
information currently available, we believe the ultimate
resolution of this situation will not have a material adverse
effect on our consolidated financial position, results of
operations or liquidity.

Related Party Transactions

Related parties, as defined in SFAS 57
Related Party Disclosures, include MeriStar
Hospitality, the hotels included in our real estate joint
ventures, and a small number of hotels which are affiliated with
certain of our directors. Total management fees from related
parties amounted to $6,660 and $23,345 for the three and nine
months ended September 30, 2004, and $7,152 and $22,793 for
the three and nine months ended September 30, 2003,
respectively.

Critical Accounting Policies and
Estimates

Accounting estimates are an integral part of the
preparation of our consolidated financial statements and our
financial reporting process and are based on our current
judgments. Certain accounting estimates are

20



---



##### 



particularly sensitive because of their
significance to our consolidated financial statements and
because of the possibility that future events affecting them may
differ markedly from our current judgments.


The most significant accounting policies
affecting our consolidated financial statements relate to:



| |   |                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------
| |  | the evaluation of impairment of certain
    long-lived assets and intangible assets with determinable lives;                       
|
| |  | the evaluation of impairment of goodwill;                                                                                          
|
| |  | estimation of valuation allowances, specifically
    those related to income taxes and our allowance for doubtful
    accounts; and
|
| |  | revenue recognition.                                                                                                               

Impairment of long-lived assets In accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long Lived Assets, whenever events or changes
in circumstances indicate that the carrying values of long-lived
assets (which include our intangible assets with determinable
useful lives, such as management contracts) may be impaired, we
perform an analysis to determine the recoverability of the
assets carrying value. We make estimates of the
undiscounted cash flows from the expected future operations of
the asset. If the analysis indicates that the carrying value is
not recoverable from future cash flows, the asset is written
down to the recoverable amount and an impairment loss is
recognized. Any impairment losses are recorded as operating
expenses.

We review long-lived assets for impairment when
one or more of the following events have occurred:



| |   |                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | current or immediate short-term (future twelve
    months) projected cash flows are significantly less than the
    most recent historical cash flows;                                 
|
| |  | a significant loss of management contracts
    without the realistic expectation of a replacement;                                                                                     
|
| |  | the unplanned departure of an executive officer
    or other key personnel, which could adversely affect our ability
    to maintain our competitive position and manage future growth;
|
| |  | a significant adverse change in legal factors or
    an adverse action or assessment by a regulator, which could
    affect the value of the long-lived assets; or                     
|
| |  | events that could cause significant adverse
    changes and uncertainty in business and leisure travel patterns.                                                                       

During the third quarter of 2004, we wrote off
$1,601 of unamortized management contract costs relating to
terminated contracts. We did not record any other asset
impairments during the third quarter.

Impairment of
Goodwill In accordance
with SFAS No. 142, annually, or as circumstances
warrant, we perform an analysis to determine whether the
carrying value of our goodwill has been impaired. To test
goodwill for impairment, we perform an analysis to compare the
estimated fair value of our two reporting units, (which comprise
our two segments) to which the goodwill is assigned to the
carrying value of each reporting unit. We make estimates of the
discounted cash flows from the expected future operations of the
reporting unit. If the analysis indicates that the fair value of
the reporting unit is less than its carrying value, we do an
analysis to compare the implied fair value of the reporting
units goodwill with the carrying amount of that goodwill.
The implied fair value of the goodwill is determined by
allocating the fair value of the reporting unit to all the
assets and liabilities of that unit as if the reporting unit had
been acquired in a business combination. The excess of the fair
value of the reporting unit over the amounts assigned to its
assets and liabilities is the implied fair value of the
goodwill. If the implied fair value of the goodwill is less than
the carrying value, an impairment loss is recognized in an
amount equal to that excess. Any impairment losses are recorded
as operating expenses. Aside from testing upon the occurrence of
trigger events, we also test goodwill for impairment annually
during our fourth quarter. During the second quarter of 2004,
due to the trigger event of the disposal of the Toronto
operation, goodwill within our corporate housing segment was
tested for impairment. Based on this test, it was determined
that there was no impairment to the carrying value of goodwill.
There were no trigger events in the third quarter of 2004.

21



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##### 



Valuation
Allowances We use our
judgment in determining our provision for income taxes, our
deferred tax assets and liabilities, and any valuation allowance
recorded against our deferred tax assets. At September 30,
2004, we have a $13,000 valuation allowance to reduce our
deferred tax assets to the amount that we believe is more likely
than not to be realized. This is an allowance against some, but
not all, of our recorded deferred tax assets. We have considered
estimated future taxable income and prudent and feasible ongoing
tax planning strategies in assessing the need for a valuation
allowance. Our estimates of taxable income require us to make
assumptions about various factors that affect our operating
results, such as economic conditions, consumer demand,
competition and other factors. Our actual results may differ
from these estimates. Based on actual results or a revision in
future estimates, we might determine that we would not be able
to realize additional portions of our net deferred tax assets in
the future; if that occurs, we would record a charge to the
income tax provision in that period.

The utilization of our net operating loss
carryforwards will be limited by the provisions of the Internal
Revenue Code. The valuation allowance we recorded included the
effect of the limitations on our deferred tax assets arising
from net operating loss carryforwards.

We record an allowance for doubtful accounts
receivable based on our judgment in determining the ability and
willingness of our clients to make required payments. Our
judgments in determining our clients ability and
willingness to pay are based on past experience with them and
our assessment of the current and future operating environments
for them. If a clients financial condition deteriorates or
a contract is terminated in the future, this could decrease a
clients ability, willingness or obligation to make
payments. If that occurs, we might have to make additional
allowances, which could reduce our earnings.

Revenue
Recognition We earn
revenue from our owned hotel, management contracts and related
sources, and corporate housing operations. We recognize revenue
from our one owned hotel, from rooms, food and beverage, and
other operating departments as earned at the close of each
business day. Our management and other fees consist of base and
incentive management fees receivable from third-party owners of
hotel properties, and fees for other related services we
provide. We recognize base fees and fees for other services as
revenue when earned in accordance with the individual management
contracts. In accordance with Staff Accounting Bulletin
No. 101, Revenue Recognition in Financial
Statements, we record incentive fees in the period when we
believe they are ultimately earned, which is in the fourth
quarter for contracts with annual incentive fee measurements.

BridgeStreet recognizes revenue from our
corporate housing services in metropolitan markets located in
the United States, Canada, the United Kingdom and Paris. We
recognize fees when earned in accordance with the individual
leasing contract.

Non-GAAP Financial Measures

Adjusted EBITDA represents earnings (losses)
before interest, income tax expense (benefit), depreciation and
amortization, equity in earnings (losses) of affiliates,
minority interests, discontinued operations, and in 2003, a gain
on refinancing.

We use Adjusted EBITDA as a measure of operating
performance. Adjusted EBITDA should not be considered as an
alternative to net income under accounting principles generally
accepted in the United States of America for purposes of
evaluating our results of operations, and does not represent
cash flow from operations as defined by generally accepted
accounting principles and is not necessarily indicative of cash
available to fund all cash flow needs.

We believe Adjusted EBITDA is useful to an
investor in evaluating our operating performance because:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | A significant portion of our assets consists of
    intangible assets. Of those intangible assets, our management
    contracts are amortized over their remaining terms, and, in
    accordance with generally accepted accounting principles, those
    assets are subject to straight-line amortization. Because
    depreciation and amortization are non-cash items, we believe
    that presentation of Adjusted EBITDA is a useful supplemental
    measure of our operating performance;

22



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##### 





| |   |                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Adjusted EBITDA is widely used in the hotel
    industry to measure operating performance without regard to
    items such as depreciation and amortization; and                                                                                               
|
| |  | We believe Adjusted EBITDA helps investors
    meaningfully evaluate and compare the results of our operations
    from period to period by removing the impact of our asset base
    (primarily depreciation and amortization) from our operating
    results.

Our management uses Adjusted EBITDA:



| |   |                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | as a measurement of operating performance because
    it assists us in comparing our operating performance on a
    consistent basis as it removes the impact of our asset base
    (primarily depreciation and amortization) from our operating
    results;
|
| |  | in presentations to our Board of Directors to
    enable it to have the same measurement of operating performance
    used by management;                                                                                                                    
|
| |  | for planning purposes, including the preparation
    of our annual operating budget;                                                                                                                                                                         
|
| |  | for compensation purposes, including the basis
    for bonuses and other incentives for certain employees;                                                                                                                                                   
|
| |  | as a valuation measure for evaluating our
    operating performance and our capacity to incur and service
    debt, fund capital expenditures and expand our business; and                                                                                   
|
| |  | as one measure in determining the value of
    acquisitions and dispositions.                                                                                                                                                                                

There are material limitations to using a measure
such as Adjusted EBITDA, including the difficulty associated
with comparing results among more than one company and the
inability to analyze certain significant items, including
depreciation and interest expense, that directly affect our net
income or loss. Management compensates for these limitations by
considering the economic effect of the excluded expense items
independently as well as in connection with its analysis of net
income.

We are organized into two operating divisions,
hotel management and corporate housing. Both of these divisions
are reportable operating segments. Each division is managed
separately because of its distinctive products and services. We
evaluate the performance of each division based on Adjusted
EBITDA.

The other items in the tables below represent
operating segment activity and assets for the non-reportable
segments. Adjusted EBITDA from other activities includes merger
and integration costs, restructuring charges, asset impairments
and other write-offs and discontinued operations. The table
shown below reconciles Adjusted EBITDA to net income (loss) for
the periods presented.

Adjusted EBITDA should be considered in addition
to, not as a substitute for or as being superior to, operating
income (losses), cash flows, or other measures of financial
performance prepared in accordance with accounting principles
generally accepted in the United States of America.

|                                          |                                |            |       |           |  |       |       |            |  |   |        |     |  |   |       |       | 
|----------------------------------------- | ------------------------------ | ---------- | ----- | --------- |  | ----- | ----- | ---------- |  | - | ------ | --- |  | - | ----- | ----- | 
|                                          |                                | Hotel      |       | Corporate |  |       |       | Financial 
|                                          |                                | Management |       | Housing   |  | Other |       | Statements
|                                          |                                |            |       |           |  |       |       |           
|Three months ended September 30,
    2004 |                                |            |       |           |  |       |       |            |  |   |        |     |  |   |       |      
|Net income (loss)                         |                                | $          | 1,217 |           |  | $     | 245   |            |  | $ | (1,762 | )   |  | $ | (300  | )    
|Adjustments:                              |                                |            |       |           |  |       |       |            |  |   |        |     |  |   |       |      
|                                          | Depreciation and amortization  |            |       | 1,909     |  |       |       | 332        |  |   |        |    |  |   |       | 2,241 | 
|                                          | Interest expense, net          |            |       | 1,502     |  |       |       | 500        |  |   |        |    |  |   |       | 2,002 | 
|                                          | Equity in losses of affiliates |            |       | 5         |  |       |       |           |  |   |        |    |  |   |       | 5     | 
|                                          | Minority interest expense      |            |       | 3         |  |       |       | 1          |  |   |        | 3   |  |   |       | 7     | 
|                                          | Income tax expense             |            |       | 150       |  |       |       | 30         |  |   |        | 171 |  |   |       | 351   | 
|                                          |                                |            |       |           |  |       |       |            |  |   |        |     |  |   |       |      
|Adjusted EBITDA                           |                                | $          | 4,786 |           |  | $     | 1,108 |            |  | $ | (1,588 | )   |  | $ | 4,306 |      
|                                          |                                |            |       |           |  |       |       |            |  |   |        |     |  |   |       |      

23



---



##### 



|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |         |  
|----------------------------------------- | ------------------------------------------------ | ---------- | ------ | --------- | - | ----- | ------ | ---------- | - | - | ------- | ------- | - | - | ------ | ------- | -
|                                          |                                                  | Hotel      |        | Corporate |   |       |        | Financial 
|                                          |                                                  | Management |        | Housing   |   | Other |        | Statements
|                                          |                                                  |            |        |           |   |       |        |           
|Three months ended September 30,
    2003 |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Net income (loss)                         |                                                  | $          | 2,014  |           |   | $     | (615   | )          |   | $ | (1,777  | )       |   | $ | (378   | )      
|Adjustments:                              |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|                                          | Depreciation and amortization                    |            |        | 2,217     |   |       |        | 374        |   |   |         |        |   |   |        | 2,591   |  
|                                          | Interest expense, net                            |            |        | 1,767     |   |       |        | 589        |   |   |         |        |   |   |        | 2,356   |  
|                                          | Equity in losses of affiliates                   |            |        | 292       |   |       |        |           |   |   |         |        |   |   |        | 292     |  
|                                          | Discontinued operations                          |            |        |          |   |       |        | 459        |   |   |         |        |   |   |        | 459     |  
|                                          | Minority interest expense (benefit)              |            |        | (122      | ) |       |        | 37         |   |   |         | 108     |   |   |        | 23      |  
|                                          | Income tax expense (benefit)                     |            |        | 1,342     |   |       |        | (410       | ) |   |         | (1,184  | ) |   |        | (252    | )
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Adjusted EBITDA                           |                                                  | $          | 7,510  |           |   | $     | 434    |            |   | $ | (2,853  | )       |   | $ | 5,091  |        
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Nine months ended September 30,
    2004  |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Net income (loss)                         |                                                  | $          | 2,006  |           |   | $     | (1,080 | )          |   | $ | (7,621  | )       |   | $ | (6,695 | )      
|Adjustments:                              |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|                                          | Depreciation and amortization                    |            |        | 5,937     |   |       |        | 1,037      |   |   |         |        |   |   |        | 6,974   |  
|                                          | Interest expense, net                            |            |        | 3,969     |   |       |        | 1,323      |   |   |         |        |   |   |        | 5,292   |  
|                                          | Equity in losses of affiliates                   |            |        | 946       |   |       |        |           |   |   |         |        |   |   |        | 946     |  
|                                          | Discontinued operations                          |            |        |          |   |       |        | 1,237      |   |   |         |        |   |   |        | 1,237   |  
|                                          | Minority interest expense (benefit)              |            |        | 20        |   |       |        | (11        | ) |   |         | (77     | ) |   |        | (68     | )
|                                          | Income tax expense (benefit)                     |            |        | 926       |   |       |        | (499       | ) |   |         | (3,520  | ) |   |        | (3,093  | )
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Adjusted EBITDA                           |                                                  | $          | 13,804 |           |   | $     | 2,007  |            |   | $ | (11,218 | )       |   | $ | 4,593  |        
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Nine months ended September 30,
    2003  |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Net income (loss)                         |                                                  | $          | 1,690  |           |   | $     | (2,495 | )          |   | $ | 4,368   |         |   | $ | 3,563  |        
|Adjustments:                              |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|                                          | Depreciation and amortization                    |            |        | 9,748     |   |       |        | 1,102      |   |   |         |        |   |   |        | 10,850  |  
|                                          | Interest expense, net                            |            |        | 5,386     |   |       |        | 1,795      |   |   |         |        |   |   |        | 7,181   |  
|                                          | Equity in losses of affiliates                   |            |        | 858       |   |       |        |           |   |   |         |        |   |   |        | 858     |  
|                                          | Discontinued operations                          |            |        |          |   |       |        | 1,273      |   |   |         |        |   |   |        | 1,273   |  
|                                          | Gain on refinancing term loan from related party |            |        |          |   |       |        |           |   |   |         | (13,629 | ) |   |        | (13,629 | )
|                                          | Minority interest expense (benefit)              |            |        | 87        |   |       |        | (129       | ) |   |         | 226     |   |   |        | 184     |  
|                                          | Income tax expense (benefit)                     |            |        | 1,126     |   |       |        | (1,662     | ) |   |         | 2,911   |   |   |        | 2,375   |  
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        
|Adjusted EBITDA                           |                                                  | $          | 18,895 |           |   | $     | (116   | )          |   | $ | (6,124  | )       |   | $ | 12,655 |        
|                                          |                                                  |            |        |           |   |       |        |            |   |   |         |         |   |   |        |        

Results of Operations

Outlook
Through the end of 2003, the sluggish economy, the conflict in
Iraq, fear of terrorist acts, health concerns for travelers, and
delays and difficulties in travel due to heightened security
measures at airports had a major impact on our operating
results. Because of the significant slowdown in travel over the
past three years, our managed hotels generally experienced
significant declines in occupancy and average daily rates.
Weaker hotel performance reduced our base and incentive
management fees, and also gave rise to additional losses from
minority investments we had made in connection with some of the
hotels that we manage.

In our hotel management operations, the nine
month period ending September 30, 2004 demonstrated
significant improvement in our operating statistics over the
same period of prior year. Revenue per available room (RevPAR)
has improved 7.5%, occupancy is up 2.6% and average daily rate
(ADR) is up 4.8%, all compared to the same period of the
prior year. (These statistics exclude rooms at nine Florida
properties that were affected by the recent hurricanes during
the third quarter of 2004). These improvements are primarily
attributable to the improvement in the U.S. economy. The
gross domestic product rose at an annual rate of 3.7% in the
third quarter of 2004, after a 3.3% rise in the second quarter,
and a 4.2% rise in the first quarter of

24



---



##### 



2004. We are encouraged by these improvements and
expect that our operations will improve if these trends continue.


In our corporate housing division, the economy,
the conflict in Iraq and traveler health concerns due to SARS
also negatively impacted the demand for corporate relocations
and long-term assignments, two primary drivers of our
operations. The third quarter of 2004 demonstrated encouraging
Adjusted EBITDA improvement compared to third quarter 2003, as
we continue to focus on stronger markets such as New York,
Washington, DC, Chicago and London. In addition, we have reduced
our inventory in areas where demand is weak or declining, as
evidenced by the disposal of the Toronto market in June 2004,
where long-term leases have previously not permitted us to
adjust our inventory as demand changed. Our goal going forward
is to shorten the length of our lease commitments where possible
and look for more opportunities to convert higher risk apartment
blocks into management arrangements. The disposal of the Toronto
operation eliminated a significant drag on the corporate housing
operations Adjusted EBITDA.

Three months
ended September 30, 2004 compared with three months ended
September 30, 2003

Overview
At September 30, 2004, we managed 255 properties, with
57,074 guest rooms, compared to 329 properties with 70,300 guest
rooms at September 30, 2003, and 295 properties with 65,250
guest rooms at December 31, 2003. Hotels under management
were reduced by a net of 74 from September 30 of the
preceding year, with the majority of the reductions due to the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The sale of 28 properties by MeriStar Hospitality
    since September 30, 2003, in connection with its asset
    disposition program. (See Termination of Management Contractsabove for detail).                                                                                                                                                                        
|
| |  | In July of 2003, CNL Hospitality
    (CNL) acquired RFS Hotel Investors, Inc.
    (RFS), for whom we managed 50 properties. CNL
    terminated our management contracts for 28 properties that we
    formerly managed. In October 2003 and January 2004, we entered
    into an agreement to manage the remaining 22 hotels, with
    market-based management fees.



| |        
| | -------
| | Revenue

The following table shows the operating
statistics for our managed hotels on a same store basis for the
three months ended September 30 (dollars not in thousands).
These statistics exclude rooms at nine Florida properties that
were affected by the recent hurricanes during the third quarter
of 2004.

|                                    |  |      |        |      |  |        |       |   |  |  |     |  
|----------------------------------- |  | ---- | ------ | ---- |  | ------ | ----- | - |  |  | --- | -
|                                    |  | 2004 |        | 2003 |  | Change
|                                    |  |      |        |      |  |       
|Revenue per available room (RevPAR) |  | $    | 72.54  |      |  | $      | 66.58 |   |  |  | 9.0 | %
|Average daily rate (ADR)            |  | $    | 102.05 |      |  | $      | 95.71 |   |  |  | 6.6 | %
|Occupancy                           |  |      | 71.08  | %    |  |        | 69.56 | % |  |  | 2.2 | %

Our total revenue decreased $16,399, or 6.2%, to
$249,278 for the three months ended September 30, 2004
compared to $265,677 for the three months ended
September 30, 2003. Major components of this decrease were



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue from managed properties, which we record
    as revenue under EITF 01-14, decreased by $19,335. This
    decrease is directly related to the decreased number of hotels
    under management which reduced the managed hotel employees and
    related reimbursable salaries and other expenses.                                                                                                                   
|
| |  | Revenue from our corporate housing operations has
    increased $4,221, or 15.3%, to $31,701 for the three months
    ended September 30, 2004 from $27,480 for the three months
    ended September 30, 2003. Significant increases in revenue
    were recorded in our Chicago, New York, Washington, D.C.
    and London markets due to strengthening average daily rates and
    number of apartments rented.          
|
| |  | Revenues from management fees decreased
    approximately $1,728, or 12.5%, to $12,113 for the three months
    ended September 30, 2004 compared to $13,841 for the three
    months ended September 30, 2003, primarily resulting from a
    decrease in number of managed hotels. Of this decrease,
    approximately $847 relates to the closing of our Flagstone
    subsidiary during the fourth quarter of 2003. The

25



---



##### 



| |  |                                                                                                                                                                                                                                                                                                           
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | remainder is due to various other management
    contracts terminated during the period. The Flagstone subsidiary
    was closed in connection with the purchase of RFS by CNL. This
    was offset by termination fees recognized of $677, mainly from
    properties terminated by MeriStar Hospitality.



| |                                 
| | --------------------------------
| | Operating expenses by department

Total operating expenses by department increased
$3,467, or 15.1%, to $26,430 for the three months ended
September 30, 2004 compared to $22,963 for the three months
ended September 30, 2003. Operating expenses by department
include expenses that are related to lodging from our owned
hotel, and to our corporate housing division. This increase is
primarily due to an increase in apartment rental expenses, due
to a focus on unit growth and higher apartment rental expenses
in high potential markets, including New York, Chicago and
Washington D.C. This increase was offset by a decrease in
lodging expenses from the Residence Inn Pittsburgh Airport, due
to lower RevPar, ADR and occupancy rates as compared to the
prior year. The decrease in the operating statistics was mainly
due to a higher rate per room sold for 10 months in 2003
due to a particularly large group generating higher revenues
than expected in an average year.



| |                                 
| | --------------------------------
| | Undistributed operating expenses

Total undistributed operating expenses decreased
$96 or 0.47%, to $20,469 for the three months ended
September 30, 2004, compared to $20,565 for the three
months ended September 30, 2003. Major factors affecting
the decrease were:



| |   |                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Depreciation and amortization expenses decreased
    $350, or 13.5%, to $2,241 for the three months ended
    September 30, 2004, from $2,591 for the three months ended
    September 30, 2003. The decrease is mainly due to a lower
    base of amortizable intangible management contracts due to
    terminated management contracts during 2004 and 2003.
|
| |  | Asset impairments and other write-offs decreased
    $378, to $1,601 for the three months ended September 30,
    2004, from $1,979 for the same period last year. These expenses
    are detailed as follows:                                                                                                                                                 

|                                 |  |                    |       |      |  |   |       | 
|-------------------------------- |  | ------------------ | ----- | ---- |  | - | ----- | 
|                                 |  |                   
|                                 |  | Three months ended
|                                 |  | September 30,     
|                                 |  |                   
|                                 |  | 2004               |       | 2003
|                                 |  |                    |       |     
|Management contract write-offs   |  | $                  | 1,601 |      |  | $ | 1,667 | 
|Leasehold improvement write-offs |  |                    |      |      |  |   | 312   | 
|                                 |  |                    |       |      |  |   |       | 
|Total                            |  | $                  | 1,601 |      |  | $ | 1,979 | 
|                                 |  |                    |       |      |  |   |       | 

For additional information on the above line
items, see Note 10 to the consolidated financial statements.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Merger and integration costs were $874 for the
    three months ended September 30, 2003, with no similar
    expense for the three months ended September 30, 2004.
    These costs include professional fees, travel, relocation costs
    and other transition costs that were incurred in connection with
    the merger of MeriStar and Interstate in July of 2002.                                                                                                                                                                                                                                                          
|
| |  | Administrative and general expenses increased
    $1,464, or 9.6%, to $16,585 for the three months ended
    September 30, 2004, compared to $15,121 for the three
    months ended September 30, 2003. This is primarily due to
    an adjustment made during the third quarter of 2003 to our
    incentive compensation accrual, based on our reforecasted
    results of operations. In addition, professional fees have
    increased primarily due to the cost of compliance with the
    Sarbanes-Oxley Act of 2002 and related rules. Also in the third
    quarter of 2004 we incurred $690 of legal settlement expenses.

Reimbursable costs, which we record as expense
under EITF 01-14, decreased by $19,335, or 8.8%, to
$200,314 for the three months ended September 30, 2004,
from $219,649 for the three months ended September 30,
2003. The primary reason for this was the decrease in the number
of managed hotels from September 30, 2003 to
September 30, 2004, directly resulting in a decreased
number of hotel employees and related reimbursable salaries and
other expenses.

26



---



##### 





| |                                  
| | ---------------------------------
| | Loss from Discontinued Operations

Loss from discontinued operations decreased $459,
to zero for the three months ended September 30, 2004, from
$(459) for the same period of 2003. Discontinued operations
relates to the disposal of the Toronto operation within our
corporate housing division, which occurred in June of 2004. The
Toronto operation experienced lower occupancy with a fixed cost
structure due to long-term lease commitments, causing negative
operating results. In order to reduce our exposure to those
long-term lease commitments we sold our Toronto operations in
June 2004.



| |         
| | --------
| | Net loss

Net loss decreased $78, to $(300) for the three
months ended September 30, 2004, from $(378) for the three
months ended September 30, 2003. One factor affecting net
loss was the absence of a loss from discontinued operations of
$459 in the third quarter of 2003. Additional factors affecting
net loss were as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Net interest expense decreased $354 to $2,002 for
    the three months ended September 30, 2004, from $2,356 for
    the same period in 2003. We incurred less interest expense on
    our senior credit facility as we repaid $45,276 in the fourth
    quarter of 2003, using proceeds from a public equity offering.
    In addition, we incurred less interest expense on our
    non-recourse promissory note as we made two principal payments
    during the third quarter of 2003.                                                                                             
|
| |  | Our equity in losses of affiliates decreased $287
    to $5 for the three months ended September 30, 2004,
    compared to $292 for the same period in 2003. These losses
    consist of our proportionate share of the net losses incurred by
    our non-controlled equity investments. During the third quarter
    of 2004 the hotels in our MIP Lessee, L.P. investment were
    performing better than they had compared to the same period last
    year. In addition this amount includes our 12% return on our
    preferred investment in Interconn Ponte Vedra Company, LLC.
|
| |  | Income tax expense was $351 for the three months
    ended September 30, 2004, compared to $(252) for the three
    months ended September 30, 2003. The main reason for this
    fluctuation is that our estimated effective tax rate was
    approximately 36.2% at September 30, 2004 and it was 40.0%
    for the September 30, 2003 period. The tax rates used are
    based on annual taxable income estimates at the end of each
    quarter.                                                                                                                                   



| |                
| | ---------------
| | Adjusted EBITDA

Adjusted EBITDA decreased $785, to $4,306 for the
three months ended September 30, 2004, from $5,091 for the
three months ended September 30, 2003. This decrease is due
to the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Income from hotel management operations decreased
    $797, to $1,217 for the three months ended September 30,
    2004, from $2,014 for the three months ended September 30,
    2003. Hotel managements Adjusted EBITDA decreased $2,724
    to $4,786 for the three months ended September 30, 2004,
    from $7,510 for the three months ended September 30, 2003.
    The main reason for the decrease is lower revenues, partially
    due to the closing of our Flagstone subsidiary in fourth quarter
    of 2003, and the termination of various other management
    contracts. In addition, professional fees have increased
    primarily due to the cost of compliance with the Sarbanes-Oxley
    Act of 2002 and related rules. And, in the third quarter of 2004
    we incurred $690 of legal settlement expenses.
|
| |  | Income from corporate housing operations
    increased $860, to $245 for the three months ended
    September 30, 2004, from a loss of $(615) for the same
    period of 2003. Corporate housings Adjusted EBITDA
    increased $674, to $1,108 for the three months ended
    September 30, 2004, from $434 for the same period of 2003.
    The increase in Adjusted EBITDA is primarily attributed to
    increased apartment rental rates, and disposals of markets where
    demand was weaker.                                                                                                                                                                                                                                                                                                                               
|
| |  | Loss from other activities decreased $15, to
    $(1,762) for the three months ended September 30, 2004,
    from $(1,777) for the three months ended September 30,
    2003. Adjusted EBITDA from other                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

27



---



##### 



| |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | activities increased $1,265, to $(1,588) for the
    three months ended September 30, 2004, from $(2,853) for
    the three months ended September 30, 2003. In 2004, other
    activity includes $1,601 of asset impairments and other
    write-offs, compared to the 2003 period which includes asset
    impairments and other write-offs of $1,979. In addition, in
    third quarter of 2003, there were $874 of expenses related to
    merger and integration costs. These costs represent integration
    expenses, including professional fees, travel, and other
    transition costs associated with the merger of Interstate and
    MeriStar on July 31, 2002. There was no similar expense in
    2004.

Nine months
ended September 30, 2004 compared with nine months ended
September 30, 2003



| |        
| | -------
| | Revenue

The following table shows the operating
statistics for our managed hotels on a same store basis for the
nine months ended September 30 (dollars not in thousands).
These statistics exclude rooms at nine Florida properties that
were affected by the recent hurricanes during the third quarter
of 2004.

|                                    |  |      |        |      |  |        |       |   |  |  |     |  
|----------------------------------- |  | ---- | ------ | ---- |  | ------ | ----- | - |  |  | --- | -
|                                    |  | 2004 |        | 2003 |  | Change
|                                    |  |      |        |      |  |       
|Revenue per available room (RevPAR) |  | $    | 70.66  |      |  | $      | 65.72 |   |  |  | 7.5 | %
|Average daily rate (ADR)            |  | $    | 102.11 |      |  | $      | 97.44 |   |  |  | 4.8 | %
|Occupancy                           |  |      | 69.2   | %    |  |        | 67.4  | % |  |  | 2.6 | %

Our total revenue decreased $40,286, or 5.2%, to
$738,635 for the nine months ended September 30, 2004
compared to $778,921 for the nine months ended
September 30, 2003. Major components of this decrease were:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue from management fees decreased $2,845, or
    6.5%, to $40,759 for the nine months ended September 30,
    2004, from $43,604 for the nine months ended September 30,
    2003. While our RevPAR, ADR and occupancy have improved year
    over year, the decrease in total number of hotels under
    management caused a decrease in our total management fee
    revenue. (See Overviewabove for detail of terminated
    contracts). Most of the decrease is due to the closing of our
    Flagstone subsidiary during fourth quarter of 2003, accounting
    for approximately $2,541 of the decrease, with the remainder due
    to various other terminated management contracts during the
    year. The Flagstone subsidiary was closed in connection with the
    purchase of RFS by CNL. In addition, for the nine months ended
    September 30, 2004 MeriStar Hospitality sold 20 properties
    in comparison to 5 properties during the nine months ended
    September 30, 2003. This decrease was offset by termination
    fees recognized of $3,298 for the nine months ended
    September 30, 2004 relating mainly to the properties sold
    by MeriStar Hospitality.
|
| |  | Revenue from our corporate housing operation
    increased $5,744, or 7.4%, to $83,506 for the nine months ended
    September 30, 2004, from $77,762 for the nine months ended
    September 30, 2003. This increase in revenue was
    attributable to several factors. We experienced significant
    increases in revenue in our Chicago, New York, and
    Washington, D.C. markets due to an increase in units rented
    combined with strong average daily rates. This increase was
    offset by the reduction of operations in our Raleigh market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Reimbursable costs, which we record as revenue
    under EITF 01-14, decreased by $42,956, or 6.7%, to
    $601,295 for the nine months ended September 30, 2004, from
    $644,251 for the nine months ended September 30, 2003. The
    primary reason for this decrease was the decrease in the number
    of managed hotels from September 30, 2003 to
    September 30, 2004, directly resulting in a decreased
    number of hotel employees and related reimbursable salaries and
    other expenses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       



| |                                 
| | --------------------------------
| | Operating expenses by department

Total operating expenses by department increased
$3,925, or 6.0%, to $69,799 for the nine months ended
September 30, 2004 compared to $65,874 for the nine months
ended September 30, 2003. Operating expenses by department
include expenses that are related to lodging from our owned
hotel, and to our corporate housing

28



---



##### 



division. This increase was primarily due to an
increase in corporate housing expenses, due to a focus on unit
growth and apartment rental expenses in high potential markets,
including New York, Chicago and Washington D.C. This increase
was offset by a decrease in lodging expenses from the Residence
Inn Pittsburgh Airport, due to lower RevPar, ADR and occupancy
rates as compared to the prior year. The decrease in the
operating statistics was mainly due to a higher rate per room
sold for 10 months in 2003 to a particularly large group
generating higher revenues than expected in an average year.




| |                                 
| | --------------------------------
| | Undistributed operating expenses

Total undistributed operating expenses increased
$2,931, or 4.3%, to $69,922 for the nine months ended
September 30, 2004, compared to $66,991 for the nine months
ended September 30, 2003. Major factors affecting the
increase were:



| |   |                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Asset impairments and other write-offs were
    $7,792 for the nine months ended September 30, 2004,
    compared $2,780 for the same period of 2003. These expenses are
    detailed as follows:

|                                 |  |                   |       |      |  |   |       | 
|-------------------------------- |  | ----------------- | ----- | ---- |  | - | ----- | 
|                                 |  |                  
|                                 |  | Nine months ended
|                                 |  | September 30,    
|                                 |  |                  
|                                 |  | 2004              |       | 2003
|                                 |  |                   |       |     
|Management contract write-offs   |  | $                 | 5,989 |      |  | $ | 2,468 | 
|Investment impairments           |  |                   | 1,101 |      |  |   |      | 
|Cost of uncompleted merger       |  |                   | 606   |      |  |   |      | 
|Other                            |  |                   | 96    |      |  |   |      | 
|Leasehold improvement write-offs |  |                   |      |      |  |   | 312   | 
|                                 |  |                   |       |      |  |   |       | 
|Total                            |  | $                 | 7,792 |      |  | $ | 2,780 | 
|                                 |  |                   |       |      |  |   |       | 

For additional information on the above line
items, see Note 10 to the consolidated financial
statements..



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Restructuring charges were $3,481 for the nine
    months ended September 30, 2004, with no similar expense in
    the same period last year, consisting of $3,312 related to
    severance costs for our former CEO, and $169 of severance costs
    associated with restructuring within our corporate housing
    division.                                                                                                                                                                                                                                                                                           
|
| |  | Administrative and general expenses increased
    $1,658, or 3.3%, to $51,675 for the nine months ended
    September 30, 2004, compared to $50,017 for the nine months
    ended September 30, 2003. This increase was primarily due
    to an adjustment made during 2003 to our incentive compensation
    accrual based on reforecasted results of operations. In
    addition, professional fees have increased primarily related to
    the costs of compliance with the Sarbanes-Oxley Act of 2002 and
    associated rules. Also, in the third quarter of 2004 we incurred
    $690 of legal settlement expenses.

The items above were offset by the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Depreciation and amortization expense decreased
    $3,876, or 35.7%, to $6,974 for the nine months ended
    September 30, 2004, from $10,850 for the nine months ended
    September 30, 2003. This decrease was primarily due to a
    large number of management contracts that became fully amortized
    during the second quarter of 2003 and the loss of management
    contracts during 2004. This decrease was partially offset by the
    increase in purchases of property, plant and equipment during
    mid-2003 relating to the relocation of our corporate office, and
    the related increase in depreciation on those assets.
|
| |  | There were no merger and integration costs for
    the nine months ended September 30, 2004, compared with
    $3,344 of costs for the nine months ended September 30,
    2003. These costs included professional fees, travel, relocation
    costs and other transition costs that were incurred in
    connection with merger of MeriStar and Interstate in July of
    2002.                                                                                                                                                                                                                                                                

Reimbursable costs, which we record as expense
under EITF 01-14, decreased by $42,956, or 6.7%, to
$601,295 for the nine months ended September 30, 2004, from
$644,251 for the nine months ended

29



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##### 



September 30, 2003. The primary reason for
this decrease was the decrease in the number of managed hotels
from September 30, 2003 to September 30, 2004,
directly resulting in a decreased number of hotel employees and
related reimbursable salaries and other expenses.




| |                                  
| | ---------------------------------
| | Loss from Discontinued Operations

Loss from discontinued operations decreased $36,
to $(1,237) for the nine months ended September 30, 2004,
from $(1,273) for the same period of 2003. Discontinued
operations relates to the disposal of the Toronto operation
within our corporate housing division, which occurred in June of
2004. The Toronto operation experienced lower occupancy with a
fixed cost structure due to long-term lease commitments,
contributing to lower profit margins. This resulted in the
disposal of this market during June of 2004.



| |                  
| | -----------------
| | Net income (loss)

Net income (loss) decreased $10,258 to a loss of
$(6,695) for the nine months ended September 30, 2004, from
income of $3,563 for the nine months ended September 30,
2003. In addition to the decrease in net operating income of
$4,186 the most significant factor in the decrease in net income
(loss) is the gain on debt refinancing in the amount of $13,629
recorded in the first quarter of 2003, with no similar item in
2004. At December 31, 2002, we had $56,069 of long-term
debt under a term loan due to MeriStar Hospitality, which was
due to mature on July 31, 2007. MeriStar Hospitality,
seeking additional liquidity, approached us in late 2002
regarding a negotiated discounted repayment of the MeriStar
Hospitality term loan. We repaid the note for a discounted
amount of $42,056 in January 2003. We financed part of the
repayment with the proceeds from a $40,000 subordinated term
loan and realized a gain of $13,629.

In addition, our equity in losses of affiliates
increased $88, or 10.2%, to $946 for the nine months ended
September 30, 2004, compared to $858 for the same period in
2003. These losses consist of our proportionate share of the net
losses incurred by our non-controlled equity investments. We
incurred similar losses in the 2004 period from our MIP Lessee,
L.P. investment as the hotels were not performing as
anticipated. These were offset by the 12% return we receive on
our preferred investment in Interconn Ponte Vedra Company, LLC.

Net interest expense decreased $1,889, or 26.3%,
to $5,292 for the nine months ended September 30, 2004,
from $7,181 for the same period in 2003. We incurred less
interest expense on our senior credit facility as we made
repayments of $45,276 in the fourth quarter of 2003, using
proceeds from a public equity offering. In addition, we incurred
less interest expense on our non-recourse promissory note as we
made two principal payments during the third quarter of 2003.

Income tax expense (benefit) was $(3,093) for the
nine months ended September 30, 2004, compared to $2,375
for the nine months ended September 30, 2003. The main
reason for this fluctuation is that we incurred a loss in the
2004 period, as opposed to income in the 2003 period. Our
estimated effective tax rate was approximately 36.2% in the 2004
period and was approximately 40.0% in the 2003 period. Tax rates
used are based on full year estimates at the end of each quarter.



| |                
| | ---------------
| | Adjusted EBITDA

Adjusted EBITDA decreased $8,062, to $4,593 for
the nine months ended September 30, 2004, from $12,655 for
the nine months ended September 30, 2003. This decrease is
due to the following:



| |   |                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Loss from corporate housing operations decreased
    $1,415, to $(1,080) for the nine months ended September 30,
    2004, from $(2,495) for the same period of 2003. Corporate
    housings Adjusted EBITDA increased $2,123, to $2,007 for
    the nine months ended September 30, 2004, from $(116) for

30



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##### 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | the same period 2003. The increase in Adjusted
    EBITDA can be primarily attributed to increasing apartment
    rental rates, and disposals of underperforming markets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Income (loss) from other activities decreased
    $11,989 to net loss $(7,621) for the nine months ended
    September 30, 2004, from $4,368 for the nine months ended
    September 30, 2003. Adjusted EBITDA from other activities
    decreased $5,094, to a loss of $(11,218) for the nine months
    ended September 30, 2004, from a loss of $(6,124) for the
    nine months ended September 30, 2003. In 2004, other
    activities included restructuring charges of $3,312 relating to
    severance costs for our former CEO and $7,792 of asset
    impairments and write-offs, compared to the 2003 period which
    included asset impairments and other write-offs of $2,780, as
    discussed above.
|
| |  | These items were offset by an increase in income
    from hotel management operations of $316, to $2,006 for the nine
    months ended September 30, 2004, from $1,690 for the nine
    months ended September 30, 2003. Hotel managements
    Adjusted EBITDA decreased $5,091, to $13,804 for the nine months
    ended September 30, 2004, from $18,895 for the nine months
    ended September 30, 2003. The changes to net income have
    been explained above.                                                                                                                                                                                                                                              

Liquidity and Capital Resources

Working Capital We had $9,727 of cash and cash
equivalents at September 30, 2004, compared to $7,450 at
December 31, 2003, and working capital deficit (current
assets less current liabilities) of $13,548 at
September 30, 2004 compared to a deficit of $8,349 at
December 31, 2003. Our working capital deficit is due
mainly to the classification of the balance of our term loan of
$16,880 as a current liability as it matures on July 31,
2005. We have received a commitment to refinance our senior
secured credit facility and our subordinated term loan. While
the terms of this refinancing are under negotiation, we expect
to complete the refinancing in the fourth quarter of 2004.

Operating Activities Net cash provided by operating
activities was $202 for the nine months ended September 30,
2004 compared to $18,124 for the nine months ended
September 30, 2003. The decrease in cash provided was
primarily due to the change in net income, the increase in
accounts receivable as well as reductions in accounts payable
and accrued liabilities balances, specifically the payments of
incentive compensation and severance amounts during 2004.

If economic conditions, travel patterns or other
factors negatively impact the financial results of our managed
hotels and corporate housing operations, our management fee and
corporate housing revenues could decrease, and we may incur
additional losses from our minority investments. These events
and factors could negatively impact our cash flows from
operating activities and net income or loss.

Investing Activities Net cash provided by (used in)
investing activities increased $14,540 from $857 for the nine
months ended September 30, 2004 compared to $(13,683) for
the nine months ended September 30, 2003. One factor
contributing to this increase in cash relates to the collection
of certain of our advances to affiliates, primarily a note
repaid by S.D. Bridgeworks, LLC., our joint venture that owns
the Hilton San Diego Gaslamp, in the amount of $2,687, as
well as $502 of distributions made on our 10% common equity
interest investment in this hotel. In addition, in 2003 we spent
$5,665 more on fixed assets, due to our relocation of our
corporate offices from Washington, D.C. to Arlington, VA.
In 2003 we also advanced a note for $1,300 to the Roosevelt
Hotel and $500 to Praia del Rey Hotel.

Financing Activities Net cash provided by financing
activities was $592 for the nine months ended September 30,
2004, compared $9,018 for the same period of 2003. This decrease
in cash provided is mainly due to net borrowings and repayments
of long-term debt. We had net borrowings of $1,281 in 2004, as
opposed to net borrowings of $10,782 in 2003. In January 2003,
we entered into a new $40,000 subordinated term loan, and repaid
our term loan from MeriStar Hospitality, realizing a gain of
$13,629. In addition, in the second quarter of 2004 we redeemed
78,431 preferred operating partnership units for cash
consideration, totaling $1,310, at a redemption price of
$16.70 per unit. The preferred units were held by an
affiliate of Mahmood J. Khimji, one of our directors.

31



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##### 



Senior credit agreement Effective July 31, 2002, in
connection with the closing of the MeriStar-Interstate merger,
we entered into a $113,000 senior credit agreement with a group
of banks. The senior credit agreement initially consisted of a
$65,000 term loan and a $48,000 revolving credit facility. The
term loan is payable in quarterly installments of $406 that
began January 1, 2003, with the balance due on
July 31, 2005. During the fourth quarter of 2003, using the
proceeds from a public equity offering, we repaid $45,276 of the
term loan. The revolving credit facility is due on July 31,
2005 (with a one-year renewal at our option).

The term loan is due on July 31, 2005.
Accordingly, the balance of the term loan of $16,880 is
classified as a current liability in our balance sheet as of
September 30, 2004. We have received a commitment to
refinance the senior secured credit facility and the
subordinated term loan. While the terms of this refinancing are
under negotiation, we expect to complete the refinancing in the
fourth quarter of 2004.

The interest rate on the senior credit agreement
ranges from LIBOR plus 3.00% to 4.50%, depending upon the
results of certain financial tests. The senior credit facility
contains certain covenants, including maintenance of financial
ratios at the end of each quarter, compliance reporting
requirements and other customary restrictions. At
September 30, 2004, we were in compliance with these
covenants. The senior credit agreement also includes pledges of
collateral, including the following:



| |   |                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Ownership interests of all existing subsidiaries
    and unconsolidated entities as well as any future material
    subsidiary or unconsolidated entity;
|
| |  | Owned hospitality properties; and                                                                                                                       
|
| |  | Other collateral that is not previously
    prohibited from being pledged by any of our existing
    contracts/agreements.                              

At September 30, 2004, borrowings under the
senior credit agreement bore interest at a rate of
5.78% per annum, which is the 30-day LIBOR including the
effect of an interest rate swap plus 3.50%.

We incurred $610 and $1,810 of interest expense
on the senior credit agreement for the three and nine months
ended September 30, 2004, and $1,107 and $3,377 for the
three and nine months ended September 30, 2003. The
decrease in interest expense resulted from our prepayment of
$45,276 of our term loan with proceeds from our November 2003
public equity offering. As of November 5, 2004 the total
availability under our senior credit agreement was $15,000.

Non-recourse promissory note In March 2001, we entered into a
non-recourse promissory note in the amount of $4,170 with FelCor
Lodging Trust Incorporated (FelCor) to fund the
acquisition of a 50% non-controlling equity interest in two
partnerships that own eight mid-scale hotels. Interest on the
note is payable monthly at the rate of 12% per annum and
the outstanding principal balance is due and payable on
December 31, 2010. For the three and nine months ended
September 30, 2004, we incurred $112 and $335 of interest
expense on the promissory note, respectively. For the three and
nine months ended September 30, 2003, we incurred $118 and
$368 of interest expense on the promissory note, respectively.

In June 2003, we made unscheduled principal
payments totaling $447 on the note. As of September 30,
2004, the remaining balance on the promissory note is $3,723. In
connection with one of the payments, our ownership interest in
the partnership was reduced from 50% to 49.5% as FelCor made an
additional contribution to the partnership at that time. After
notifying FelCor in 2003, we suspended further principal and
interest payments on this non-recourse promissory note and,
accordingly, we are in default under the note. We expect that we
will ultimately transfer ownership of our equity interests in
these joint ventures to FelCor in return for the extinguishment
of the debt.

Subordinated term
loan In January 2003, we
entered into a $40,000 subordinated term loan that carries a
variable interest rate based on the 30-day LIBOR plus a spread
of 8.50%. The subordinated term loan matures on January 31,
2006, but if the revolving portion of our senior credit facility
is extended for an additional year, the maturity of the
subordinated term loan will also be automatically extended by
one year to January 31, 2007. This term loan is
subordinated to borrowings under the senior credit agreement and
contains certain covenants, including maintenance of financial
ratios at the end of each quarter, compliance reporting
requirements and other customary restrictions. At
September 30, 2004, we were in compliance with these

32



---



##### 



covenants. At September 30, 2004, borrowings
under the subordinated term loan bore interest at a rate of
10.19% per annum. We incurred $1,013 and $2,959 of interest
expense on the subordinated term loan for the three and nine
months ended September 30, 2004, respectively, and $984 and
$2,871 of interest expense on the subordinated term loan for the
three and nine months ended September 30, 2003,
respectively.


Public equity
offering On
November 26, 2003, in a public equity offering, we sold
8,500,000 shares of our common stock, par value
$0.01 per share, at a price of $5.25 per share. An
additional 500,000 shares of common stock were offered by
our principal investor group. On December 16, 2003, the
underwriters exercised their over-allotment option for an
additional 601,900 shares.

Our total proceeds from this equity offering, net
of the underwriting discount but prior to deducting other
expenses, amounted to approximately $45,276. We did not receive
any proceeds from the sale of shares by the principal investor
group. The total proceeds were used to repay our term loan under
our senior credit facility.

Liquidity
We believe that cash generated by our operations, together with
borrowing capacity under our senior credit agreement, will be
sufficient to fund our requirements for working capital,
required capital expenditures and debt service for the year. Our
senior credit facility-term loan is due within the next twelve
months, however we have received a commitment to refinance the
senior secured credit facility. While the terms of this are
under negotiation, we expect to refinance in the fourth quarter
of 2004. We expect to continue to seek acquisitions of hotel
management businesses and management contracts, and joint
venture opportunities where we can participate in the ownership
of hotels we manage. We expect to finance future acquisitions
through a combination of additional borrowings under our credit
facility and the issuance of equity instruments, including
common stock or operating partnership units, or additional/
replacement debt, if market conditions permit. We believe these
sources of capital will be sufficient to provide for our
long-term capital needs.

Contractual Obligations and Maturities of
Indebtedness

The following table summarizes our contractual
obligations at September 30, 2004, and the effect that
those obligations are expected to have on our liquidity and cash
flows in future periods:

|                                                       |  |               |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |        | 
|------------------------------------------------------ |  | ------------- | ------- | --------- |  | --------- | ------ | --------- |  | ------- | ------- |  |  | - | ------ |  |  | - | ------ | 
|                                                       |  |              
|                                                       |  | Payment terms
|                                                       |  |              
|                                                       |  |               |         | Less than |  |           |        | More than
|                                                       |  | Total         |         | 1 year    |  | 1-3 years |        | 3-5 years |  | 5 years
|                                                       |  |               |         |           |  |           |        |           |  |        
|Senior credit facility  revolving
    credit facility |  | $             | 27,000  |           |  | $         |       |           |  | $       | 27,000  |  |  | $ |       |  |  | $ |       | 
|Senior credit facility  term loan                     |  |               | 16,880  |           |  |           | 16,880 |           |  |         |        |  |  |   |       |  |  |   |       | 
|Promissory note                                        |  |               | 3,723   |           |  |           |       |           |  |         |        |  |  |   |       |  |  |   | 3,723  | 
|Subordinated term-loan                                 |  |               | 40,000  |           |  |           |       |           |  |         | 40,000  |  |  |   |       |  |  |   |       | 
|Non-cancelable apartment leases                        |  |               | 69,407  |           |  |           | 15,545 |           |  |         | 33,215  |  |  |   | 6,160  |  |  |   | 14,487 | 
|Non-cancelable office leases                           |  |               | 25,886  |           |  |           | 2,878  |           |  |         | 8,724   |  |  |   | 4,384  |  |  |   | 9,900  | 
|Wyndham interest                                       |  |               | 433     |           |  |           | 433    |           |  |         |        |  |  |   |       |  |  |   |       | 
|                                                       |  |               |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |        | 
|Total                                                  |  | $             | 183,329 |           |  |           | 35,736 |           |  |         | 108,939 |  |  |   | 10,544 |  |  |   | 28,110 | 
|                                                       |  |               |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |        | 

Long-Term Debt For principal repayment and debt
service obligations with respect to our long-term debt, see
Note 6 to our consolidated financial statements.

Lease Commitments We lease apartments for our Corporate
Housing division and office space for our corporate offices. The
leases run through 2014 and are included in the table above.

Management Agreement Commitments Under the provisions of management
agreements with certain hotel owners, we have outstanding
commitments to provide an aggregate of $3,852 to these hotel
owners in the form of investments or loans, if requested. The
loans may be forgiven or repaid based upon the specific terms of
each management agreement. The timing of future investments or
working capital loans to hotel owners is currently unknown as it
is at the hotel owners discretion, and not included in the
above table.

33



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##### 



Letter of
Credit We have a $2,500
letter of credit outstanding from Interstate Operating Co. L.P.
and Northridge Insurance Company in favor of our property
insurance carrier. The letter of credit expires on June 25,
2005.

Equity Investment Funding In connection with our equity
investments in hotel real estate, we are partners or members of
various unconsolidated partnerships or limited liability
companies. The terms of such partnership or limited liability
company agreements provide that we contribute capital as
specified. The timing and amount of such contributions of
capital, if any, is currently unknown and is therefore not
reflected in the chart set forth above. We have minority equity
interests in 11 hotel real estate limited partnerships and
limited liability companies. We do not guarantee the debt or
other obligations of any of these investments.

Wyndham interest Wyndham International, Inc.,
(Wyndham) holds a 1.6627% non-controlling economic
interest in one of our operating subsidiaries. Effective
July 20, 2002, Wyndham has the right to require us to
redeem this interest. The value of this interest at
September 30, 2004, is $433 and is included in accounts
payable-related parties in our consolidated balance sheet.



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

We are exposed to market risk from changes in
interest rates on our credit facilities. Our interest rate risk
management objective is to limit the impact of interest rate
changes on earnings and cash flows and to lower our overall
borrowing costs.

Our senior secured credit facility matures
July 31, 2005, with a one year extension of the revolving
portion at our option. At September 30, 2004, we had
borrowings of $43,880 outstanding on the facility. Interest on
the debt is variable, based on the 30-day LIBOR plus a spread of
3.0% to 4.5% depending on the results of certain financial
tests. At September 30, 2004, the senior credit facility
bore interest at a rate of 5.78% per annum, which is the
30-day LIBOR including the effect of an interest rate swap plus
3.50%. We have determined that the fair value of the debt
approximates its carrying value. We have received a commitment
to refinance the senior secured credit facility and the
subordinated term loan. While the terms of this refinancing are
under negotiation, we expect to complete the refinancing in the
fourth quarter of 2004. We expect to write off approximately
$267 of net deferred financing costs associated with this
facility at the time of the refinancing.

Our subordinated term loan matures on
January 31, 2005, but if the revolving portion of our
senior credit facility is extended for an additional year, at
our option, the maturity of the subordinated term loan will also
be automatically extended by one year to January 31, 2007.
At September 30, 2004 we had $40,000 outstanding on the
subordinated term loan. Interest on the debt is based on the
30-day LIBOR plus 850 basis points. At September 30,
2004, borrowings under the subordinated term loan bore interest
at a rate of 10.19% per annum. We have determined that the
fair value of the debt approximates its carrying value. We
expect to pay approximately $2,000 in exit fees on this loan
when we refinance in the fourth quarter of 2004. We expect to
write off approximately $953 of deferred financing fees for this
loan in connection with the refinancing.

Our non-recourse promissory note to FelCor with a
balance of $3,723 is due on December 31, 2010. Interest on
the note is payable monthly at the rate of 12% per annum.
We believe that our non-recourse promissory note would have no
value to a third party. We intend to exchange the non-recourse
promissory note for our equity interests in the related joint
ventures. The carrying value of our investments in these
partnerships have been previously written down to zero.

In October 2002, we entered into a $30,000,
two-year interest rate swap agreement with a financial
institution in order to hedge against the effect that future
interest rate fluctuations may have on our floating rate debt.
The swap agreement effectively fixes the 30-day LIBOR at 2.50%.
The fair value of the swap agreement was a liability of $21 at
September 30, 2004. This agreement matured on
October 1, 2004.

In March 2003, we entered into a $35,000,
twenty-two month interest rate cap agreement with a financial
institution in order to hedge against the effect that future
interest rate fluctuations may have on our floating rate debt.
The interest rate agreement caps the 30-day LIBOR at 4.50%. At
September 30, 2004, the fair value of this cap agreement
was insignificant.

34



---



##### 



Giving effect to our interest rate hedging
activities, a 1.0% change in the 30-day LIBOR would have changed
our interest expense by approximately $149 and $456 for the
three and nine months ended September 30, 2004,
respectively, and by approximately $238 and $732 for the three
and nine months ended September 30, 2003, respectively.

Our international operations are subject to
foreign exchange rate fluctuations. We derived approximately
3.1% of our total revenue for both three and nine months ended
September 30, 2004, from services performed in Canada, the
United Kingdom, France and Russia. Our foreign currency
translation gains and (losses) were $(104) and $(209) for the
three and nine months ended September 30, 2004,
respectively, and are included in accumulated other
comprehensive income, net of tax on our balance sheets and other
comprehensive income (loss), net of tax in our statements of
operations and comprehensive income (loss). To date, since most
of our foreign operations have been largely self-contained or
dollar-denominated, we have not been exposed to material foreign
exchange risk. Therefore, we have not entered into any foreign
currency exchange contracts or other derivative financial
instruments to hedge the effects of adverse fluctuations in
foreign currency exchange rates. In the event that we have large
transactions requiring currency conversion we would reevaluate
whether we should engage in hedging activities.



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

Disclosure Controls and Procedures

We maintain disclosure controls and procedures
that are designed to ensure that information that is required to
be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the
SECs rules and forms, and that the information is
accumulated and communicated to our management, including our
chief executive officer, chief financial officer, and chief
accounting officer, as appropriate, to allow timely decisions
regarding required disclosure based closely on the definition of
disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15-d15(e)).

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 as of the end of the period covered by this report.
Based on this evaluation, we concluded that our disclosure
controls and procedures were adequate and effective in ensuring
that material information relating to us and our consolidated
subsidiaries would be made known to us by others within those
entities, particularly during the period in which this report
was being prepared.

Changes in Internal Controls

There has not been any material change in our
internal control over financial reporting that has occurred
during the last fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control
over financial reporting.

It should be noted that any system of controls,
however well designed and operated, can provide only reasonable,
and not absolute, assurance that the objectives of the system
are met. In addition, the design of any control system is based
in part upon certain assumptions about the likelihood of future
events. Because of these and other inherent limitations of
control systems, there is only reasonable assurance that our
controls will succeed in achieving their stated goals under all
potential future conditions. 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.

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##### 



PART II. OTHER INFORMATION



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

In the course of 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 pending or
asserted will not have a material adverse effect on our
consolidated financial position, results of operations or
liquidity.



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

None.



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

None.



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

None.



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

Forward-Looking Information

Information both included in and incorporated by
reference in this quarterly report on Form 10-Q may contain
forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, and may involve known
and unknown risks, uncertainties and other factors which may
cause the actual results, performance or achievements of our
company to be materially different from future results,
performance or achievements expressed or implied by such
forward-looking statements. Forward-looking statements, which
are based on certain assumptions and describe our future plans,
strategies and expectations, are generally identifiable by use
of the words may, will,
should, expect, anticipate,
estimate, believe, intend,
or project or the negative thereof or other
variations thereon or comparable terminology. Factors which
could have a material adverse effect on our operations and
future prospects include, but are not limited to:



| |   |                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in national, regional and local economic
    conditions;                                                                                                                                                                 
|
| |  | changes in local real estate market conditions;                                                                                                                                                                                  
|
| |  | the impact of the September 11, 2001
    terrorist attacks and actual or threatened future terrorist
    incidents or hostilities;                                                                                               
|
| |  | the aftermath of the war with Iraq, continuing
    conflicts in that geographic region and related ongoing
    U.S. involvement;                                                                                                 
|
| |  | international geopolitical difficulties or health
    concerns;                                                                                                                                                                  
|
| |  | uncertainties associated with obtaining
    additional financing for future real estate projects and to
    undertake future capital improvements;                                                                               
|
| |  | the creditworthiness of the owners of the hotels
    that we manage and the risk of bankruptcy by hotel owners;                                                                                                                  
|
| |  | demand for, and costs associated with, real
    estate development and hotel rooms, market conditions affecting
    the real estate industry, seasonality of resort and hotel
    revenues and fluctuations in operating results;
|
| |  | changes in interest rates and in the
    availability, cost and terms of financing;                                                                                                                                              

36



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##### 





| |   |                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in laws and regulations applicable to us,
    including federal, state or local hotel, resort, restaurant or
    land use regulations, employment, labor or disability laws and
    regulations and laws governing the taxation of real estate
    investment trusts;
|
| |  | legislative/regulatory changes, including changes
    to laws governing the taxation of REITs;                                                                                                                                                                               
|
| |  | present or future environmental legislation;                                                                                                                                                                                                                                 
|
| |  | failure to renew essential management contracts
    or business leases;                                                                                                                                                                                                      
|
| |  | uninsured property, casualty and other losses;                                                                                                                                                                                                                               
|
| |  | weather conditions or natural disasters;                                                                                                                                                                                                                                     
|
| |  | competition from other hotels, resorts and
    recreational properties, some of which may have greater
    marketing and financial resources than we or the owners of the
    properties we manage have;                                                                     
|
| |  | limitations on our ability to quickly dispose of
    investments and respond to changes in the economic or
    competitive environment due to the illiquidity of real estate
    assets;                                                                                     
|
| |  | the ability of any joint venture in which we
    invest to service any debt they incur and the risk of
    foreclosure associated with that debt;                                                                                                                            
|
| |  | construction or renovation delays and cost
    overruns;                                                                                                                                                                                                                     
|
| |  | our ability to adjust our leases for corporate
    housing units to match market demand;                                                                                                                                                                                     
|
| |  | variations in lease and room rental rates;                                                                                                                                                                                                                                   
|
| |  | changes in the market for particular types of
    assets;                                                                                                                                                                                                                    
|
| |  | labor disturbances or shortages of labor; and                                                                                                                                                                                                                                
|
| |  | loss of any executive officer or failure to hire
    and retain highly qualified employees.                                                                                                                                                                                  

These factors and the risk factors referred to
above could cause actual results or outcomes to differ
materially from our historical results and those expressed in
any forward-looking statements made or incorporated by reference
in this registration statement. You should not place undue
reliance on any of these forward-looking statements. Further,
any forward-looking statement speaks only as of the date on
which it is made and we do not undertake to amend or update any
forward-looking statement or statements to reflect events or
circumstances after the date on which the statement is made or
to reflect the occurrence of unanticipated events. New factors
emerge from time to time, and it is not possible to predict
which will arise. In addition, we cannot assess the impact of
each factor on our business or the extent to which any factor,
or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking
statements.

These risks and uncertainties, along with the
risk factors set forth in our Annual Report on Form 10-K
for the year ended December 31, 2003, should be considered
in evaluating any forward-looking statements in this quarterly
report on Form 10-Q.

37



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##### 





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

(a) Exhibits

|            |      |                         |  |                                                                                                                                                                                                                                                                                                                                                                                             
|----------- | ---- | ----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Description of Document
|            |      |                        
|            | 3.1  |                         |  | Amended and Restated Certificate of Incorporation
    of the Company, formerly MeriStar Hotels & Resorts,
    Inc. (incorporated by reference to Exhibit 3.1 to the
    Companys Form S-1/A filed with the Securities and
    Exchange Commission on July 23, 1998 (Registration
    No. 333-49881)).                                                                                      
|            | 3.1. | 1                       |  | Certificate of Amendment of the Restated
    Certificate of Incorporation of the Company dated June 30,
    2001 (incorporated by reference to Exhibit to the Companys
    Form 10-K filed with the Securities and Exchange Commission on
    April 15, 2002).                                                                                                                             
|            | 3.1. | 2                       |  | Certificate of Merger of Interstate Hotels
    Corporation into MeriStar Hotels & Resorts, Inc.
    (incorporated by reference to Exhibit 3.1.2 to the
    Companys Form 8-A/A filed with the Securities and Exchange
    Commission on August 2, 2002).                                                                                                                                   
|            | 3.1. | 3                       |  | Certificate of Amendment of the Restated
    Certificate of Incorporation of the Company dated July 31,
    2002 (incorporated by reference to Exhibit to the Companys
    Form 8-A/A filed with the Securities and Exchange Commission on
    August 2, 2002).                                                                                                                            
|            | 3.2  |                         |  | By-laws of the Company, formerly MeriStar
    Hotels & Resorts, Inc. (incorporated by reference to
    Exhibit 3.2 to the Companys Form S-1/A filed
    with the Securities and Exchange Commission on July 23,
    1998 (Registration No. 333-49881)).                                                                                                                                    
|            | 3.2. | 1                       |  | Amendment to the By-laws of the Company
    (incorporated by reference to Exhibit 3.3 to the
    Companys Form 8-A/A filed with the Securities and Exchange
    Commission on August 2, 2002).                                                                                                                                                                                             
|            | 4.1  |                         |  | Form of Common Stock Certificate of the Company
    (incorporated by reference to Exhibit 4.1 to the
    Companys Form 8-A/A filed with the Securities and Exchange
    Commission on August 2, 2002).                                                                                                                                                                                     
|            | 4.2  |                         |  | Preferred Share Purchase Rights Agreement, dated
    July 23, 1998, between the Company, formerly MeriStar
    Hotels & Resorts, Inc., and the Rights Agent
    (incorporated by reference to Exhibit 4.4 to the
    Companys Form S-1/A filed with the Securities and
    Exchange Commission on July 23, 1998(Registration
    No. 333-49881)).                                          
|            | 4.2. | 1                       |  | Amendment to Rights Agreement, dated
    December 8, 2000, between the Company, formerly MeriStar
    Hotels & Resorts, Inc., and the Rights Agent
    (incorporated by reference to Exhibit 4.1 to the
    Companys Form 8-K filed with the Securities and Exchange
    Commission on December 12, 2000).                                                                                 
|            | 4.2. | 2                       |  | Second Amendment to Rights Agreement, dated
    May 1, 2002, between the Company, formerly MeriStar
    Hotels & Resorts, Inc., and the Rights Agent
    (incorporated by reference to Exhibit 4.1 to the
    Companys Form 8-K filed with the Securities and Exchange
    Commission on May 3, 2002).                                                                                     
|            | 4.3  |                         |  | Form of Rights Certificate (incorporated by
    reference to Exhibit 4.3 to the Companys
    Form S-1/A filed with the Securities and Exchange
    Commission on July 23, 1998 (Registration
    No. 333-49881)).                                                                                                                                                                          
|            | 4.4  |                         |  | Registration Rights Agreement, dated
    June 30, 1999, between the Company (formerly MeriStar
    Hotels & Resorts, Inc.), Oak Hill Capital Partners,
    L.P. and Oak Hill Capital Management Partners, L.P.
    (incorporated by reference to Exhibit 4.7 to the
    Companys Form 10-Q filed with the Securities and Exchange
    Commission for the three months ended June 30, 1999).
|            | 4.5  |                         |  | Stock purchase agreement for Sunstone Hotel
    Partnership, LLC dated October 26, 2004 (incorporated by
    reference to Exhibit 10.1 to the Companys Form 8-K
    (Item 1.01) dated and filed October 28, 2004)                                                                                                                                                                          
|            | 31.1 |                         |  | Sarbanes-Oxley Act Section 302
    Certifications of the Chief Executive Officer.                                                                                                                                                                                                                                                                                                           
|            | 31.2 |                         |  | Sarbanes-Oxley Act Section 302
    Certifications of the Chief Financial Officer.                                                                                                                                                                                                                                                                                                           
|            | 32.1 |                         |  | Sarbanes-Oxley Act Section 906
    Certifications of Chief Executive Officer.                                                                                                                                                                                                                                                                                                               
|            | 32.2 |                         |  | Sarbanes-Oxley Act Section 906
    Certifications of Chief Financial Officer.                                                                                                                                                                                                                                                                                                               

38



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##### 



SIGNATURE

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



| |                                                 
| | ------------------------------------------------
| | INTERSTATE HOTELS & RESORTS, INC.               
|
| | /s/ J. WILLIAM RICHARDSON                       
| |                                                 
| | J. William Richardson                           
| | Chief Financial Officer                         
| | (Duly authorized officer)                       
| | (Principal financial and accounting
    officer)

Dated: November 8, 2004

39