##### 









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 June 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 August 6, 2004 was
30,631,001.



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##### 



INTERSTATE HOTELS & RESORTS,
INC.



INDEX

|                              |  |                                                                                                                                   |  |      |    | 
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                              |  |                                                                                                                                   |  | Page
|                              |  |                                                                                                                                   |  |     
|PART I. FINANCIAL INFORMATION
|                             
|Item 1:                       |  | Financial Statements (unaudited)                                                                                                  |  |      |    | 
|                              |  | Consolidated Balance Sheets 
    June 30, 2004 and December 31, 2003                                                             |  |      | 2  | 
|                              |  | Consolidated Statements of Operations and
    Comprehensive Income (Loss)  Three and six months
    ended June 30, 2004 and 2003 |  |      | 3  | 
|                              |  | Consolidated Statements of Cash Flows 
    Six months ended June 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                                         |  |      | 17 | 
|                             
|Item 3:                       |  | Quantitative and Qualitative Disclosures About
    Market Risk                                                                    |  |      | 33 | 
|                             
|Item 4:                       |  | Controls and Procedures                                                                                                           |  |      | 34 | 
|PART II. OTHER INFORMATION   
|                             
|Item 1:                       |  | Legal Proceedings                                                                                                                 |  |      | 36 | 
|                             
|Item 2:                       |  | Changes in 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 and Reports on Form 8-K                                                                                                  |  |      | 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)


|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |         |         | 
|------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ | ------ | ------------ | ------- |  | ------ | ------- | ------- | 
|                                                             |                                                                                                                                                                       | June 30,                                                           |        | December 31,
|                                                             |                                                                                                                                                                       | 2004                                                               |        | 2003        
|                                                             |                                                                                                                                                                       |                                                                    |        |             
|                                                             |                                                                                                                                                                       | (unaudited)                                                        |        |             
|ASSETS                                                      
|Current assets:                                              |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             | Cash and cash equivalents                                                                                                                                             |                                                                    | $      | 2,521        |         |  | $      | 7,450   |        
|                                                             | Restricted cash                                                                                                                                                       |                                                                    |        | 1,828        |         |  |        | 3,250   |        
|                                                             | Accounts receivable, net of allowance for
    doubtful accounts of $3,135 at June 30, 2004 and $3,529 at
    December 31, 2003                                        |                                                                    |        | 33,612       |         |  |        | 25,531  |        
|                                                             | Insurance premiums receivable                                                                                                                                         |                                                                    |        | 3,014        |         |  |        |        |        
|                                                             | Due from related parties                                                                                                                                              |                                                                    |        | 15,621       |         |  |        | 14,649  |        
|                                                             | Prepaid expenses and other current assets                                                                                                                             |                                                                    |        | 11,021       |         |  |        | 9,342   |        
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total current assets                                               |        |              | 67,617  |  |        |         | 60,222  | 
|Marketable securities                                        |                                                                                                                                                                       |                                                                    | 1,668  |              |         |  | 2,556  |        
|Property and equipment, net                                  |                                                                                                                                                                       |                                                                    | 24,586 |              |         |  | 27,056 |        
|Notes receivable                                             |                                                                                                                                                                       |                                                                    | 5,809  |              |         |  | 6,044  |        
|Officers and employees notes receivable                      |                                                                                                                                                                       |                                                                    | 76     |              |         |  | 86     |        
|Investments and advances to affiliates                       |                                                                                                                                                                       |                                                                    | 11,413 |              |         |  | 15,825 |        
|Deferred income taxes                                        |                                                                                                                                                                       |                                                                    | 22,160 |              |         |  | 18,673 |        
|Goodwill                                                     |                                                                                                                                                                       |                                                                    | 92,123 |              |         |  | 92,123 |        
|Intangible assets, net                                       |                                                                                                                                                                       |                                                                    | 48,347 |              |         |  | 55,338 |        
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total assets                                                       |        | $            | 273,799 |  |        | $       | 277,923 | 
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|LIABILITIES, MINORITY INTERESTS AND
    STOCKHOLDERS EQUITY
|Current liabilities:                                         |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             | Accounts payable and accrued expenses                                                                                                                                 |                                                                    | $      | 63,746       |         |  | $      | 66,513  |        
|                                                             | Accounts payable  related parties                                                                                                                                    |                                                                    |        | 433          |         |  |        | 433     |        
|                                                             | Current portion of long-term debt                                                                                                                                     |                                                                    |        | 1,625        |         |  |        | 1,625   |        
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total current liabilities                                          |        |              | 65,804  |  |        |         | 68,571  | 
|Deferred compensation                                        |                                                                                                                                                                       |                                                                    | 1,668  |              |         |  | 2,556  |        
|Long-term debt                                               |                                                                                                                                                                       |                                                                    | 88,384 |              |         |  | 84,696 |        
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total liabilities                                                  |        |              | 155,856 |  |        |         | 155,823 | 
|Minority interests                                           |                                                                                                                                                                       |                                                                    | 914    |              |         |  | 3,388  |        
|Commitments and contingencies                                |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|Stockholders equity:                                        |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             | Preferred stock, $0.01 par value; 5,000 shares
    authorized                                                                                                         |                                                                    |        |             |         |  |        |        |        
|                                                             | Common stock, $.01 par value; 250,000 shares
    authorized; 30,629 and 29,951 shares issued and outstanding at
    June 30, 2004 and December 31, 2003, respectively |                                                                    |        | 307          |         |  |        | 300     |        
|                                                             | Treasury stock                                                                                                                                                        |                                                                    |        | (69          | )       |  |        | (69     | )      
|                                                             | Paid-in capital                                                                                                                                                       |                                                                    |        | 188,604      |         |  |        | 183,849 |        
|                                                             | Accumulated other comprehensive income, net of tax                                                                                                                    |                                                                    |        | 787          |         |  |        | 837     |        
|                                                             | Accumulated deficit                                                                                                                                                   |                                                                    |        | (72,600      | )       |  |        | (66,205 | )      
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total stockholders equity                                         |        |              | 117,029 |  |        |         | 118,712 | 
|                                                             |                                                                                                                                                                       |                                                                    |        |              |         |  |        |        
|                                                             |                                                                                                                                                                       | Total liabilities, minority interests and
    stockholders equity |        | $            | 273,799 |  |        | $       | 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 |         | Six months ended
|                                                                                       |                                          | June 30,           |         | June 30,        
|                                                                                       |                                          |                    |         |                 
|                                                                                       |                                          | 2004               |         | 2003             |   | 2004 |         | 2003   
|                                                                                       |                                          |                    |         |                  |   |      |         |        
|Revenue:                                                                               |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Lodging revenues                         |                    | $       | 848              |   |      | $       | 932     |   |   | $       | 1,571   |   |   | $       | 1,768   |  
|                                                                                       | Management fees                          |                    |         | 6,248            |   |      |         | 7,516   |   |   |         | 11,961  |   |   |         | 14,399  |  
|                                                                                       | Management fees-related parties          |                    |         | 8,720            |   |      |         | 7,882   |   |   |         | 16,685  |   |   |         | 15,364  |  
|                                                                                       | Corporate housing                        |                    |         | 27,555           |   |      |         | 26,323  |   |   |         | 51,805  |   |   |         | 50,282  |  
|                                                                                       | Other revenue                            |                    |         | 3,102            |   |      |         | 2,947   |   |   |         | 6,354   |   |   |         | 6,829   |  
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       |                                          |                    | 46,473  |                  |   |      | 45,600  |         |   |   | 88,376  |         |   |   | 88,642  |        
|                                                                                       | Other revenue from managed properties    |                    |         | 206,831          |   |      |         | 212,105 |   |   |         | 400,981 |   |   |         | 424,602 |  
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Total revenue                                                                          |                                          |                    | 253,304 |                  |   |      | 257,705 |         |   |   | 489,357 |         |   |   | 513,244 |        
|Operating expenses by department:                                                      |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Lodging expenses                         |                    |         | 566              |   |      |         | 664     |   |   |         | 1,084   |   |   |         | 1,284   |  
|                                                                                       | Corporate housing                        |                    |         | 21,903           |   |      |         | 21,396  |   |   |         | 42,285  |   |   |         | 41,627  |  
|Undistributed operating expenses:                                                      |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Administrative and general               |                    |         | 17,626           |   |      |         | 16,160  |   |   |         | 35,090  |   |   |         | 34,896  |  
|                                                                                       | Depreciation and amortization            |                    |         | 2,338            |   |      |         | 3,618   |   |   |         | 4,733   |   |   |         | 8,259   |  
|                                                                                       | Merger and integration costs             |                    |         |                 |   |      |         | 606     |   |   |         |        |   |   |         | 2,470   |  
|                                                                                       | Restructuring charges                    |                    |         | 3,312            |   |      |         |        |   |   |         | 3,439   |   |   |         |        |  
|                                                                                       | Asset impairments and other write-offs   |                    |         | 1,698            |   |      |         | 801     |   |   |         | 6,191   |   |   |         | 801     |  
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       |                                          |                    | 47,443  |                  |   |      | 43,245  |         |   |   | 92,822  |         |   |   | 89,337  |        
|                                                                                       | Other expenses from managed properties   |                    |         | 206,831          |   |      |         | 212,105 |   |   |         | 400,981 |   |   |         | 424,602 |  
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Total operating expenses                                                               |                                          |                    | 254,274 |                  |   |      | 255,350 |         |   |   | 493,803 |         |   |   | 513,939 |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Net operating income (loss)                                                            |                                          |                    | (970    | )                |   |      | 2,355   |         |   |   | (4,446  | )       |   |   | (695    | )      
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Interest income                                                                        |                                          |                    | (411    | )                |   |      | (233    | )       |   |   | (690    | )       |   |   | (442    | )      
|Interest expense                                                                       |                                          |                    | 1,979   |                  |   |      | 2,750   |         |   |   | 3,980   |         |   |   | 5,267   |        
|Equity in losses of affiliates                                                         |                                          |                    | 165     |                  |   |      | 218     |         |   |   | 941     |         |   |   | 566     |        
|Gain on refinancing term loan from related party                                       |                                          |                    |        |                  |   |      |        |         |   |   |        |         |   |   | (13,629 | )      
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Income (loss) from continuing operations
    before minority interest and income taxes |                                          |                    | (2,703  | )                |   |      | (380    | )       |   |   | (8,677  | )       |   |   | 7,543   |        
|Income tax expense (benefit)                                                           |                                          |                    | (996    | )                |   |      | (325    | )       |   |   | (3,444  | )       |   |   | 2,627   |        
|Minority interest expense (benefit)                                                    |                                          |                    | (29     | )                |   |      | (7      | )       |   |   | (75     | )       |   |   | 161     |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Income (loss) from continuing operations                                               |                                          |                    | (1,678  | )                |   |      | (48     | )       |   |   | (5,158  | )       |   |   | 4,755   |        
|Loss from discontinued operations                                                      |                                          |                    | (973    | )                |   |      | (439    | )       |   |   | (1,237  | )       |   |   | (814    | )      
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Net income (loss)                                                                      |                                          | $                  | (2,651  | )                |   | $    | (487    | )       |   | $ | (6,395  | )       |   | $ | 3,941   |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Other comprehensive income (loss), net of tax:                                         |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|                                                                                       | Foreign currency translation gain (loss) |                    |         | (21              | ) |      |         | 208     |   |   |         | (105    | ) |   |         | 234     |  
|                                                                                       | Unrealized gain on investments and other |                    |         | 56               |   |      |         | (55     | ) |   |         | 56      |   |   |         | (46     | )
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Comprehensive income (loss)                                                            |                                          | $                  | (2,616  | )                |   | $    | (334    | )       |   | $ | (6,444  | )       |   | $ | 4,129   |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Basic earnings (loss) per share from
    continuing operations                         |                                          |                    | (0.06   | )                |   |      | (0.00   | )       |   |   | (0.17   | )       |   |   | 0.23    |        
|Basic earnings (loss) per share from
    discontinued operations                       |                                          |                    | (0.03   | )                |   |      | (0.02   | )       |   |   | (0.04   | )       |   |   | (0.04   | )      
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Basic earnings (loss) per share                                                        |                                          | $                  | (0.09   | )                |   | $    | (0.02   | )       |   | $ | (0.21   | )       |   | $ | 0.19    |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Diluted earnings (loss) per share from
    continuing operations                       |                                          |                    | (0.06   | )                |   |      | (0.00   | )       |   |   | (0.17   | )       |   |   | 0.23    |        
|Diluted earnings (loss) per share from
    discontinued operations                     |                                          |                    | (0.03   | )                |   |      | (0.02   | )       |   |   | (0.04   | )       |   |   | (0.04   | )      
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Diluted earnings (loss) per share                                                      |                                          | $                  | (0.09   | )                |   | $    | (0.02   | )       |   | $ | (0.21   | )       |   | $ | 0.19    |        
|                                                                                       |                                          |                    |         |                  |   |      |         |         |   |   |         |         |   |   |         |        
|Weighted average number of basic shares
    outstanding                                |                                          |                    | 30,587  |                  |   |      | 20,609  |         |   |   | 30,328  |         |   |   | 20,593  |        
|Weighted average number of diluted shares
    outstanding                              |                                          |                    | 30,828  |                  |   |      | 20,972  |         |   |   | 30,569  |         |   |   | 21,226  |        

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)


|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |         |         |         |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ---------------------------------------------------------- | ----------------------------------------- | ------- | ------ | ------- | ------ | ------- | ------- | ------- | -
|                                                         |                                                                                          |                                                           
|                                                         |                                                                                          | Six months ended                                          
|                                                         |                                                                                          | June 30,                                                  
|                                                         |                                                                                          |                                                           
|                                                         |                                                                                          | 2004                                                       |                                           | 2003   
|                                                         |                                                                                          |                                                            |                                           |        
|Cash flows from operating activities:                    |                                                                                          |                                                            |                                           |         |        |         |        |        
|                                                         | Net income (loss)                                                                        |                                                            | $                                         | (6,395  | )      |         | $      | 3,941   |        
|                                                         | Adjustments to reconcile net income
    (loss) to net cash used in operating activities: |                                                            |                                           |         |        |         |        |         |        
|                                                         |                                                                                          | Depreciation and amortization                              |                                           |         | 4,781  |         |        |         | 8,348   |        
|                                                         |                                                                                          | Gain on refinancing                                        |                                           |         |       |         |        |         | (13,629 | )      
|                                                         |                                                                                          | Equity in loss of affiliates                               |                                           |         | 941    |         |        |         | 566     |        
|                                                         |                                                                                          | Minority interest                                          |                                           |         | (75    | )       |        |         | 143     |        
|                                                         |                                                                                          | Deferred income taxes                                      |                                           |         | (3,545 | )       |        |         | 1,885   |        
|                                                         |                                                                                          | Write-off of assets                                        |                                           |         | 5,721  |         |        |         | 1,415   |        
|                                                         |                                                                                          | Other                                                      |                                           |         | 299    |         |        |         | 9       |        
|                                                         |                                                                                          | Grant of stock for severance                               |                                           |         | 3,181  |         |        |         |        |        
|                                                         |                                                                                          | Loss on disposal of assets for discontinued
    operations |                                           |         | 376    |         |        |         |        |        
|                                                         |                                                                                          | Changes in assets and liabilities:                         |                                           |         |        |         |        |         |         |        
|                                                         |                                                                                          |                                                            | Accounts receivable, net                  |         |        | (11,009 | )      |         |         | (12,274 | )
|                                                         |                                                                                          |                                                            | Due from related parties                  |         |        | (972    | )      |         |         | 1,039   |  
|                                                         |                                                                                          |                                                            | Prepaid expenses and other current assets |         |        | (1,679  | )      |         |         | 901     |  
|                                                         |                                                                                          |                                                            | Accounts payable and accrued expenses     |         |        | (2,700  | )      |         |         | 17,227  |  
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Net cash provided by (used in) operating
    activities  |                                                                                          |                                                            | (11,076                                   | )       |        |         | 9,571  |        
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Cash flows from investing activities:                    |                                                                                          |                                                            |                                           |         |        |         |        |        
|                                                         | Change in restricted cash                                                                |                                                            |                                           | 1,422   |        |         |        | (1,616  | )      
|                                                         | Purchases of property and equipment, net                                                 |                                                            |                                           | (1,073  | )      |         |        | (1,722  | )      
|                                                         | Purchases of intangible assets                                                           |                                                            |                                           | (223    | )      |         |        | (580    | )      
|                                                         | Net cash (invested in) received from equity
    investments in hotel real estate         |                                                            |                                           | (451    | )      |         |        | (87     | )      
|                                                         | Change in officers and employees notes
    receivable, net                               |                                                            |                                           | 10      |        |         |        | 10      |        
|                                                         | Change in advances to affiliates, net                                                    |                                                            |                                           | 2,861   |        |         |        | (482    | )      
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Net cash provided by (used in) investing
    activities  |                                                                                          |                                                            | 2,546                                     |         |        |         | (4,477 | )      
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Cash flows from financing activities:                    |                                                                                          |                                                            |                                           |         |        |         |        |        
|                                                         | Borrowings under long-term debt                                                          |                                                            |                                           | 34,000  |        |         |        | 80,000  |        
|                                                         | Repayments of long-term debt                                                             |                                                            |                                           | (30,312 | )      |         |        | (68,014 | )      
|                                                         | Proceeds from issuance of common stock                                                   |                                                            |                                           | 717     |        |         |        | 138     |        
|                                                         | Cash paid for redemption of preferred operating
    partnership units                    |                                                            |                                           | (1,310  | )      |         |        |        |        
|                                                         | Financing fees paid                                                                      |                                                            |                                           |        |        |         |        | (1,690  | )      
|                                                         | Common stock repurchased                                                                 |                                                            |                                           |        |        |         |        | (23     | )      
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Net cash provided by financing activities                |                                                                                          |                                                            | 3,095                                     |         |        |         | 10,411 |        
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Effect of exchange rate on cash                          |                                                                                          |                                                            | 506                                       |         |        |         | 352    |        
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Net increase (decrease) in cash and cash
    equivalents |                                                                                          |                                                            | (4,929                                    | )       |        |         | 15,857 |        
|Cash and cash equivalents at beginning of period         |                                                                                          |                                                            | 7,450                                     |         |        |         | 7,054  |        
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        
|Cash and cash equivalents at end of period               |                                                                                          | $                                                          | 2,521                                     |         |        | $       | 22,911 |        
|                                                         |                                                                                          |                                                            |                                           |         |        |         |        |        

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.     ORGANIZATION

Background

On July 31, 2002, MeriStar Hotels &
Resorts, or MeriStar, and Interstate Hotels Corporation, or
Interstate, merged, and MeriStar changed its name to
Interstate Hotels & Resorts, Inc. The
transaction was a stock-for-stock merger of Interstate into
MeriStar in which Interstate stockholders received
4.6 shares of MeriStar common stock for each share of
Interstate stock outstanding. Holders of MeriStar common stock
and partnership units in its operating partnership continued to
hold their stock and units following the merger. In connection
with the merger, the holders of Interstates convertible
debt and preferred stock converted those instruments into shares
of MeriStar common stock. Immediately following the merger, we
effected a one-for-five reverse stock split.

In accordance with accounting principles
generally accepted in the United States of America, we treated
the merger as a purchase for financial reporting purposes, and
Interstate was considered the acquiring enterprise. Interstate
established a new accounting basis for MeriStars assets
and liabilities based upon their fair values as of July 31,
2002, the effective date of the merger. We accounted for the
merger as a reverse acquisition, with Interstate as the
accounting acquiror and MeriStar as the surviving company for
legal purposes.

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-controlling
equity interests in 11 joint ventures which hold ownership
interests in 28 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 June 30, 2004, we managed
269 properties, with 60,430 rooms in 40 states, the
District of Columbia, Canada, Russia and Portugal. As of
June 30, 2004, we had 3,130 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, one of our directors,
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 manage all but two of the properties owned by
MeriStar Hospitality Corporation, a real estate investment
trust, or REIT. As of June 30, 2004, MeriStar Hospitality
owned 78 properties, seven of which MeriStar Hospitality
has stated it intends to dispose of. Our relationship with
MeriStar Hospitality has 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.

Effective July 1, 2004, MeriStar Hospitality
and we have 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

5



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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
    terminated in the subsequent year with the same termination fee;
|
| |  | 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.     

In addition, in connection with the termination
of the intercompany agreement, MeriStar Hospitality and we have
resolved our $5,000 dispute over the calculation of termination
fees. We have agreed to calculate the termination fees based
upon an average of the present value of remaining 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 (other than the seven hotels MeriStar
Hospitality intended to sell as of June 30, 2004). The
termination of the intercompany agreement and the resolution of
the dispute over the calculation of the termination fees did not
have any accounting consequences on the second quarter.

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. 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 to 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

6



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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 and
earnings 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 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 |        | Six months ended
|                                                                                                                                    |                      | June 30,           |        | June 30,        
|                                                                                                                                    |                      |                    |        |                 
|                                                                                                                                    |                      | 2004               |        | 2003             |   | 2004 |      | 2003 
|                                                                                                                                    |                      |                    |        |                  |   |      |      |      
|Net income (loss), as reported                                                                                                      |                      | $                  | (2,651 | )                |   | $    | (487 | )     |   | $ | (6,395 | )     |   | $ | 3,941 |     
|Add: Stock-based employee compensation expense
    included in reported net income (loss), net of tax                               |                      |                    | 69     |                  |   |      | 10   |       |   |   | 132    |       |   |   | 10    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards,
    net of tax |                      |                    | (93    | )                |   |      | (161 | )     |   |   | (205   | )     |   |   | (308  | )   
|                                                                                                                                    |                      |                    |        |                  |   |      |      |       |   |   |        |       |   |   |       |     
|Net income (loss), pro forma                                                                                                        |                      | $                  | (2,675 | )                |   | $    | (638 | )     |   | $ | (6,468 | )     |   | $ | 3,643 |     
|Earnings per share:                                                                                                                 |                      |                    |        |                  |   |      |      |       |   |   |        |       |   |   |       |     
|                                                                                                                                    | Basic, as reported   |                    | $      | (0.09            | ) |      | $    | (0.02 | ) |   | $      | (0.21 | ) |   | $     | 0.19 | 
|                                                                                                                                    | Basic, pro forma     |                    | $      | (0.09            | ) |      | $    | (0.03 | ) |   | $      | (0.21 | ) |   | $     | 0.18 | 
|                                                                                                                                    | Diluted, as reported |                    | $      | (0.09            | ) |      | $    | (0.02 | ) |   | $      | (0.21 | ) |   | $     | 0.19 | 
|                                                                                                                                    | Diluted, pro forma   |                    | $      | (0.09            | ) |      | $    | (0.03 | ) |   | $      | (0.21 | ) |   | $     | 0.17 | 

The effects of applying Statement of Financial
Accounting Standards No. 123 for disclosing compensation
costs may not be representative of the effects on reported net
income (loss) and earnings (loss) per share for future years.

Recent Accounting Pronouncements

In December 2003, the FASB issued a revision of
FASB Interpretation No. 46, Consolidation of Variable
Interest Entities (VIEs), an interpretation of
Accounting Research Bulletin No. 51, Consolidated
Financial Statements, (FIN 46R) to
clarify some of its provisions. The revision results in multiple
effective dates based on the nature as well as the creation date
of the VIE. VIEs created after January 31, 2003, but
prior to January 1, 2004, may be accounted for either based
on the original interpretations or the revised interpretations.
However, VIEs created after January 1, 2004 must be
accounted for under FIN 46R. FIN 46R is effective
beginning in the first quarter of 2004. We have evaluated our
equity method investees and concluded that these entities do not
meet the definition of a VIE.

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 six months ended June 30 are as follows:

|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------ |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                   |  |                    |        |                 
|                                                                   |  | Three months ended |        | Six months ended
|                                                                   |  | June 30,           |        | June 30,        
|                                                                   |  |                    |        |                 
|                                                                   |  | 2004               |        | 2003             |  | 2004 |        | 2003
|                                                                   |  |                    |        |                  |  |      |        |     
|Income (loss) from continuing operations                           |  | $                  | (1,678 | )                |  | $    | (48    | )    |  | $ | (5,158 | ) |  | $ | 4,755  |  
|Loss from discontinued operations                                  |  |                    | (973   | )                |  |      | (439   | )    |  |   | (1,237 | ) |  |   | (814   | )
|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                  |  | $                  | (2,651 | )                |  | $    | (487   | )    |  | $ | (6,395 | ) |  | $ | 3,941  |  
|Weighted average number of basic shares
    outstanding            |  |                    | 30,587 |                  |  |      | 20,609 |      |  |   | 30,328 |   |  |   | 20,593 |  
|Basic earnings (loss) per share from
    continuing operations     |  | $                  | (0.06  | )                |  | $    | (0.00  | )    |  | $ | (0.17  | ) |  | $ | 0.23   |  
|Basic earnings (loss) per share from
    discontinued operations   |  |                    | (0.03  | )                |  |      | (0.02  | )    |  |   | (0.04  | ) |  |   | (0.04  | )
|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Basic earnings (loss) per share                                    |  | $                  | (0.09  | )                |  | $    | (0.02  | )    |  | $ | (0.21  | ) |  | $ | 0.19   |  
|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Weighted average number of diluted shares
    outstanding          |  |                    | 30,828 |                  |  |      | 20,972 |      |  |   | 30,569 |   |  |   | 21,226 |  
|Diluted earnings (loss) per share from
    continuing operations   |  | $                  | (0.06  | )                |  | $    | (0.00  | )    |  | $ | (0.17  | ) |  | $ | 0.23   |  
|Diluted earnings (loss) per share from
    discontinued operations |  |                    | (0.03  | )                |  |      | (0.02  | )    |  |   | (0.04  | ) |  |   | (0.04  | )
|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Diluted earnings (loss) per share                                  |  | $                  | (0.09  | )                |  | $    | (0.02  | )    |  | $ | (0.21  | ) |  | $ | 0.19   |  
|                                                                   |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  

Potentially dilutive securities (options and
operating partnership units) not included in the above diluted
share count (in thousands) were 187 and 272 for the three months
ended June 30, 2004 and 2003, respectively, and 211 for the
six months ended June 30, 2004. The six month period of
2003 includes all dilutive shares.

4.     INVESTMENTS
AND ADVANCES TO AFFILIATES

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

|                                      |       |          |       |              |  |   |       |        | 
|------------------------------------- | ----- | -------- | ----- | ------------ |  | - | ----- | ------ | 
|                                      |       | June 30, |       | December 31,
|                                      |       | 2004     |       | 2003        
|                                      |       |          |       |             
|MIP Lessee, L.P.                      |       | $        | 4,096 |              |  | $ | 5,681 |       
|S.D. Bridgeworks, LLC                 |       |          | 598   |              |  |   | 3,389 |       
|CNL/ IHC Partners, L.P.               |       |          | 2,407 |              |  |   | 2,382 |       
|Interconn Ponte Vedra Company, L.L.C. |       |          | 1,848 |              |  |   | 1,210 |       
|Other                                 |       |          | 2,464 |              |  |   | 3,163 |       
|                                      |       |          |       |              |  |   |       |       
|                                      | Total |          | $     | 11,413       |  |   | $     | 15,825 | 
|                                      |       |          |       |              |  |   |       |       

We also own 100% of the Pittsburgh Airport
Residence Inn by Marriott. This investment is consolidated in
our financial statements.

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.

8



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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 has been underperforming and in the first quarter of 2004
the joint venture was notified that it had defaulted on its bank
loan. We do not expect to recover our investment in this joint
venture, therefore we wrote-off the remaining carrying value of
$538. This amount is included in asset impairments and other
write-offs in our statements of operations. Subsequent to
June 30, 2004, and in connection with the refinancing of
the hotel, we have agreed to contribute an additional $250 to
the joint venture. In addition, one of our directors holds a
22.46% ownership interest in this hotel.

In June 2004, S.D. Bridgeworks, L.L.C. paid us
$2,687 in repayment of its note payable owed to us, plus $300 of
accumulated interest.

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 the combined summarized
financial information of certain of our investments for the six
months ended June 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:

|                              |  |                   |        |                   |  |   |        |  
|----------------------------- |  | ----------------- | ------ | ----------------- |  | - | ------ | -
|                              |  | Six months ended, |        | Six months ended,
|                              |  | June 30, 2004     |        | June 30, 2003    
|                              |  |                   |        |                  
|Revenue                       |  | $                 | 73,448 |                   |  | $ | 72,041 |  
|Operating expenses            |  | $                 | 57,394 |                   |  | $ | 55,728 |  
|Net loss                      |  | $                 | (6,493 | )                 |  | $ | (8,182 | )
|Our share of the above losses |  | $                 | (555   | )                 |  | $ | (1,027 | )

5.     INTANGIBLE
ASSETS

Intangible assets consist of the following:

|                        |                               |          |        |              |   |   |        |        |  
|----------------------- | ----------------------------- | -------- | ------ | ------------ | - | - | ------ | ------ | -
|                        |                               | June 30, |        | December 31,
|                        |                               | 2004     |        | 2003        
|                        |                               |          |        |             
|Management contracts    |                               | $        | 51,130 |              |   | $ | 56,913 |       
|Franchise fees          |                               |          | 1,945  |              |   |   | 1,945  |       
|Deferred financing fees |                               |          | 2,430  |              |   |   | 2,378  |       
|Other                   |                               |          |       |              |   |   | 946    |       
|                        |                               |          |        |              |   |   |        |       
|                        | Total cost                    |          |        | 55,505       |   |   |        | 62,182 |  
|                        | Less accumulated amortization |          |        | (7,158       | ) |   |        | (6,844 | )
|                        |                               |          |        |              |   |   |        |       
|Intangible assets, net  |                               | $        | 48,347 |              |   | $ | 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
$936 and $1,902 on these assets for the three and six months
ended June 30, 2004, and $2,437 and $5,812 for the three
and six months ended June 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.

9



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


During the six months ended June 30, 2004,
in connection with its asset disposition plan, our largest
client, MeriStar Hospitality, sold 15 hotels that we
managed, four of which were sold in the second quarter. We
wrote-off $4,388 of unamortized management contract costs
associated with these disposed hotels, of which $1,092 related
to second 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 |  | $ | 3,757 | 
|Year ending December 31, 2005 |  |   | 3,434 | 
|Year ending December 31, 2006 |  |   | 3,147 | 
|Year ending December 31, 2007 |  |   | 2,552 | 
|Year ending December 31, 2008 |  |   | 2,523 | 

6.     LONG-TERM
DEBT

Our long-term debt consists of the following:

|                             |                      |          |        |              |   |   |        |        |  
|---------------------------- | -------------------- | -------- | ------ | ------------ | - | - | ------ | ------ | -
|                             |                      | June 30, |        | December 31,
|                             |                      | 2004     |        | 2003        
|                             |                      |          |        |             
|Senior credit agreement      |                      | $        | 46,286 |              |   | $ | 42,598 |       
|Non-recourse promissory note |                      |          | 3,723  |              |   |   | 3,723  |       
|Subordinated term loan       |                      |          | 40,000 |              |   |   | 40,000 |       
|                             |                      |          |        |              |   |   |        |       
|                             |                      |          | 90,009 |              |   |   | 86,321 |       
|                             | Less current portion |          |        | (1,625       | ) |   |        | (1,625 | )
|                             |                      |          |        |              |   |   |        |       
|Total long-term debt         |                      | $        | 88,384 |              |   | $ | 84,696 |       
|                             |                      |          |        |              |   |   |        |       

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 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 June 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 June 30, 2004, borrowings under the
senior credit agreement bore interest at a rate of
5.59% per annum, which is the 30-day LIBOR plus 3.50%. We
are currently in the process of negotiating the refinancing of
this facility, which we expect to complete during the third
quarter of 2004.

We incurred $592 and $1,200 of interest expense
on the senior credit agreement for the three and six months
ended June 30, 2004, and $1,168 and $2,264 for the three
and six months ended June 30, 2003. The

10



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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 six months ended
June 30, 2004, we incurred $112 and $223 of interest
expense on the promissory note, respectively. For the three and
six months ended June 30, 2003, we incurred $125 and $250
of interest expense on the promissory note, respectively.

In June 2003, we made unscheduled principal
payments totaling $447 on the note. As of June 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.

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 June 30, 2004, we were in
compliance with these covenants. At June 30, 2004,
borrowings under the subordinated term loan bore interest at a
rate of 9.63% per annum. We incurred $973 and $1,946 of interest
expense on the subordinated term loan for the three and six
months ended June 30, 2004, respectively, and $997 and
$1,887 of interest expense on the subordinated term loan for the
three and six months ended June 30, 2003 respectively.

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
June 30, 2004. The fair value of our swap agreement was a
liability of approximately $104 at June 30, 2004. 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. In addition, the carrying
values of these investments have been previously written down to
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, 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 and asset
impairments and other write-offs. Other assets include deferred
tax assets and net deferred financing costs.

11



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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 |  |       |        |       
|                                     |                                     | Management |        | Housing   |  | Other |        | Total 
|                                     |                                     |            |        |           |  |       |        |       
|Three months ended June 30,
    2004 |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,808  |           |  | $     | (846   | )      |   | $ | (3,613 | )      |   | $ | (2,651 | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 1,979     |  |       |        | 359    |   |   |        |       |   |   |        | 2,338  |  
|                                     | Interest expense, net               |            |        | 1,170     |  |       |        | 398    |   |   |        |       |   |   |        | 1,568  |  
|                                     | Equity in losses of affiliates      |            |        | 165       |  |       |        |       |   |   |        |       |   |   |        | 165    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 973    |   |   |        |       |   |   |        | 973    |  
|                                     | Minority interest expense (benefit) |            |        | 20        |  |       |        | (9     | ) |   |        | (40    | ) |   |        | (29    | )
|                                     | Income tax expense (benefit)        |            |        | 679       |  |       |        | (318   | ) |   |        | (1,357 | ) |   |        | (996   | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 5,821  |           |  | $     | 557    |        |   | $ | (5,010 | )      |   | $ | 1,368  |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Three months ended June 30,
    2003 |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,442  |           |  | $     | (1,092 | )      |   | $ | (837   | )      |   | $ | (487   | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 3,205     |  |       |        | 413    |   |   |        |       |   |   |        | 3,618  |  
|                                     | Interest expense, net               |            |        | 1,887     |  |       |        | 630    |   |   |        |       |   |   |        | 2,517  |  
|                                     | Equity in losses of affiliates      |            |        | 218       |  |       |        |       |   |   |        |       |   |   |        | 218    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 439    |   |   |        |       |   |   |        | 439    |  
|                                     | Minority interest expense (benefit) |            |        | 21        |  |       |        | (16    | ) |   |        | (12    | ) |   |        | (7     | )
|                                     | Income tax expense (benefit)        |            |        | 962       |  |       |        | (729   | ) |   |        | (558   | ) |   |        | (325   | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 7,735  |           |  | $     | (355   | )      |   | $ | (1,407 | )      |   | $ | 5,973  |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Six months ended June 30, 2004       |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,961  |           |  | $     | (2,144 | )      |   | $ | (6,212 | )      |   | $ | (6,395 | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 3,980     |  |       |        | 753    |   |   |        |       |   |   |        | 4,733  |  
|                                     | Interest expense, net               |            |        | 2,455     |  |       |        | 835    |   |   |        |       |   |   |        | 3,290  |  
|                                     | Equity in losses of affiliates      |            |        | 941       |  |       |        |       |   |   |        |       |   |   |        | 941    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 1,237  |   |   |        |       |   |   |        | 1,237  |  
|                                     | Minority interest expense (benefit) |            |        | 23        |  |       |        | (25    | ) |   |        | (73    | ) |   |        | (75    | )
|                                     | Income tax expense (benefit)        |            |        | 1,056     |  |       |        | (1,155 | ) |   |        | (3,345 | ) |   |        | (3,444 | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 10,416 |           |  | $     | (499   | )      |   | $ | (9,630 | )      |   | $ | 287    |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       

12



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |         |  
|------------------------------ | ------------------------------------------------ | ---------- | ------ | --------- | - | ----- | ------ | ------ | - | - | ------ | ------- | - | - | ----- | ------- | -
|                               |                                                  | Hotel      |        | Corporate |   |       |        |       
|                               |                                                  | Management |        | Housing   |   | Other |        | Total 
|                               |                                                  |            |        |           |   |       |        |       
|Six months ended June 30, 2003 |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|Net income (loss)              |                                                  | $          | (412   | )         |   | $     | (2,805 | )      |   | $ | 7,158  |         |   | $ | 3,941 |        
|Adjustments:                   |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|                               | Depreciation and amortization                    |            |        | 7,442     |   |       |        | 817    |   |   |        |        |   |   |       | 8,259   |  
|                               | Interest expense, net                            |            |        | 3,619     |   |       |        | 1,206  |   |   |        |        |   |   |       | 4,825   |  
|                               | Equity in losses of affiliates                   |            |        | 566       |   |       |        |       |   |   |        |        |   |   |       | 566     |  
|                               | Discontinued operations                          |            |        |          |   |       |        | 814    |   |   |        |        |   |   |       | 814     |  
|                               | Gain on refinancing term loan from related party |            |        |          |   |       |        |       |   |   |        | (13,629 | ) |   |       | (13,629 | )
|                               | Minority interest expense (benefit)              |            |        | (17       | ) |       |        | (115   | ) |   |        | 293     |   |   |       | 161     |  
|                               | Income tax expense (benefit)                     |            |        | (274      | ) |       |        | (1,870 | ) |   |        | 4,771   |   |   |       | 2,627   |  
|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|Adjusted EBITDA                |                                                  | $          | 10,924 |           |   | $     | (1,953 | )      |   | $ | (1,407 | )       |   | $ | 7,564 |        
|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        

|                                  |  |            |         |           |  |       |        |       |  |   |        |   |  |   |         | 
|--------------------------------- |  | ---------- | ------- | --------- |  | ----- | ------ | ----- |  | - | ------ | - |  | - | ------- | 
|                                  |  | Hotel      |         | Corporate |  |       |        |      
|                                  |  | Management |         | Housing   |  | Other |        | Total
|                                  |  |            |         |           |  |       |        |      
|Three months ended June, 30, 2004 |  |            |         |           |  |       |        |       |  |   |        |   |  |   |         | 
|Revenue                           |  | $          | 225,749 |           |  | $     | 27,555 |       |  | $ |       |   |  | $ | 253,304 | 
|Adjusted EBITDA                   |  | $          | 5,821   |           |  | $     | 557    |       |  | $ | (5,010 | ) |  | $ | 1,368   | 
|Three months ended June, 30, 2003 |  |            |         |           |  |       |        |       |  |   |        |   |  |   |         | 
|Revenue                           |  | $          | 231,382 |           |  | $     | 26,323 |       |  | $ |       |   |  | $ | 257,705 | 
|Adjusted EBITDA                   |  | $          | 7,735   |           |  | $     | (355   | )     |  | $ | (1,407 | ) |  | $ | 5,973   | 
|Six months ended June, 30, 2004   |  |            |         |           |  |       |        |       |  |   |        |   |  |   |         | 
|Revenue                           |  | $          | 437,552 |           |  | $     | 51,805 |       |  | $ |       |   |  | $ | 489,357 | 
|Adjusted EBITDA                   |  | $          | 10,416  |           |  | $     | (499   | )     |  | $ | (9,630 | ) |  | $ | 287     | 
|Total assets                      |  | $          | 231,825 |           |  | $     | 17,919 |       |  | $ | 24,055 |   |  | $ | 273,799 | 
|Six months ended June, 30, 2003   |  |            |         |           |  |       |        |       |  |   |        |   |  |   |         | 
|Revenue                           |  | $          | 462,962 |           |  | $     | 50,282 |       |  | $ |       |   |  | $ | 513,244 | 
|Adjusted EBITDA                   |  | $          | 10,924  |           |  | $     | (1,953 | )     |  | $ | (1,407 | ) |  | $ | 7,564   | 
|Total assets                      |  | $          | 255,883 |           |  | $     | 20,648 |       |  | $ | 20,933 |   |  | $ | 297,464 | 

Revenues from foreign operations were as follows
for the three and six months ended June 30:

|               |  |                    |       |                  |  |      |       |      |  |   |        |  |  |   |        | 
|-------------- |  | ------------------ | ----- | ---------------- |  | ---- | ----- | ---- |  | - | ------ |  |  | - | ------ | 
|               |  |                    |       |                 
|               |  | Three months ended |       | Six months ended
|               |  | June 30,           |       | June 30,        
|               |  |                    |       |                 
|               |  | 2004               |       | 2003             |  | 2004 |       | 2003
|               |  |                    |       |                  |  |      |       |     
|United Kingdom |  | $                  | 5,335 |                  |  | $    | 6,023 |      |  | $ | 11,099 |  |  | $ | 12,059 | 
|France         |  |                    | 421   |                  |  |      | 360   |      |  |   | 794    |  |  |   | 691    | 
|Russia         |  |                    | 375   |                  |  |      | 241   |      |  |   | 758    |  |  |   | 443    | 
|Canada         |  |                    | 253   |                  |  |      | 188   |      |  |   | 464    |  |  |   | 506    | 

Included in discontinued operations is revenue
from our Toronto operation which was disposed of in June 2004,
amounting to $893 and $2,233 for the three and six months ended
June 30, 2004, and $2,069 and $3,929 for the three and six
months ended June 30, 2003, respectively.

13



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


8.     SUPPLEMENTAL
CASH FLOW INFORMATION

|                                         |              |                    |   |                  |  |      |   |       |  |  |   |       |  |  |   |       | 
|---------------------------------------- | ------------ | ------------------ | - | ---------------- |  | ---- | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                                         |              |                    |   |                 
|                                         |              | Three months ended |   | Six months ended
|                                         |              | June 30,           |   | June 30,        
|                                         |              |                    |   |                 
|                                         |              | 2004               |   | 2003             |  | 2004 |   | 2003 
|                                         |              |                    |   |                  |  |      |   |      
|Cash paid for interest and income taxes: |              |                    |   |                  |  |      |   |       |  |  |   |       |  |  |   |      
|                                         | Interest     |                    | $ | 1,693            |  |      | $ | 2,472 |  |  | $ | 3,513 |  |  | $ | 4,344 | 
|                                         | Income taxes |                    |   | 173              |  |      |   | 244   |  |  |   | 766   |  |  |   | 506   | 

9.     RESTRUCTURING
EXPENSES

We have recorded $3,312 and $3,439 of
restructuring expenses for the three and six months ended
June 30, 2004, respectively.

These charges consist of the following:

|                                |  |                    |       |                  |  |   |       | 
|------------------------------- |  | ------------------ | ----- | ---------------- |  | - | ----- | 
|                                |  | Three months ended |       | Six months ended
|                                |  | June 30,           |       | June 30,        
|                                |  |                    |       |                 
|Former CEOs severance          |  | $                  | 3,312 |                  |  | $ | 3,312 | 
|Corporate Housing restructuring |  |                    |      |                  |  |   | 127   | 
|                                |  |                    |       |                  |  |   |       | 
|Total                           |  | $                  | 3,312 |                  |  | $ | 3,439 | 

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
250,000 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 shares along with 156,542 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 have
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 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 the first quarter of 2004, we
incurred charges of approximately $127 related to severance for
former personnel related to restructuring within our corporate
housing operation.

10.     ASSET
IMPAIRMENTS AND OTHER WRITE-OFFS

We have recorded $1,698 and $6,191 of asset
impairments and other write-offs for the three and six months
ended June 30, 2004, respectively, and $801 of asset
impairments and other write-offs for the three and six months
ended June 30, 2003.

14



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


These charges consist of the following:

|                               |  |                    |       |                  |  |      |     |      |  |   |       |  |  |   |     | 
|------------------------------ |  | ------------------ | ----- | ---------------- |  | ---- | --- | ---- |  | - | ----- |  |  | - | --- | 
|                               |  |                    |       |                 
|                               |  | Three months ended |       | Six months ended
|                               |  | June 30,           |       | June 30,        
|                               |  |                    |       |                 
|                               |  | 2004               |       | 2003             |  | 2004 |     | 2003
|                               |  |                    |       |                  |  |      |     |     
|Management contract write-offs |  | $                  | 1,092 |                  |  | $    | 801 |      |  | $ | 4,388 |  |  | $ | 801 | 
|Investment impairments         |  |                    |      |                  |  |      |    |      |  |   | 1,101 |  |  |   |    | 
|Cost of uncompleted merger     |  |                    | 606   |                  |  |      |    |      |  |   | 606   |  |  |   |    | 
|Other                          |  |                    |      |                  |  |      |    |      |  |   | 96    |  |  |   |    | 
|                               |  |                    |       |                  |  |      |     |      |  |   |       |  |  |   |     | 
|Total                          |  | $                  | 1,698 |                  |  | $    | 801 |      |  | $ | 6,191 |  |  | $ | 801 | 
|                               |  |                    |       |                  |  |      |     |      |  |   |       |  |  |   |     | 

Management contract write-offs In connection with its asset
disposition plan, MeriStar Hospitality disposed of 3 hotels
during the second quarter of 2003, and 15 hotels in the
first half of 2004, four of which occurred in the second
quarter. Consequently, we wrote off approximately $214 of
unamortized management contract costs in June 2003, and $1,092
and $4,388 for the three and six months ended June 30,
2004, respectively.

In June 2003, we wrote off $587 of unamortized
management contract costs connection with the termination of 33
management contracts with Winston Hotels, Inc.

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. 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 has been underperforming and in the
first quarter the joint venture was notified that it had
defaulted on its bank loan. We do not expect to recover our
investment in this joint venture, therefore we wrote-off the
remaining carrying value of $538. One of our directors holds a
22.46% ownership interest in this hotel.

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 relating to 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 easily as in
other markets. In exchange for the Toronto operation, the buyer
assumed our obligations, including the long-term lease
commitments. Operations for the three and six month periods and
comparative periods are presented as discontinued operations in
our 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 | 

15



---



##### 



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Discontinued operations include the following:

|                        |  |              |      |            |  |      |       |      |  |   |       |   |  |   |       |  
|----------------------- |  | ------------ | ---- | ---------- |  | ---- | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                        |  |              |      |           
|                        |  | Three months |      | Six months
|                        |  | ended        |      | ended     
|                        |  | June 30,     |      | June 30,  
|                        |  |              |      |           
|                        |  | 2004         |      | 2003       |  | 2004 |       | 2003
|                        |  |              |      |            |  |      |       |     
|Revenue                 |  | $            | 893  |            |  | $    | 2,069 |      |  | $ | 2,233 |   |  | $ | 3,929 |  
|Closing costs           |  |              | (698 | )          |  |      |      |      |  |   | (698  | ) |  |   |      |  
|Operating income (loss) |  | $            | (275 | )          |  | $    | (439  | )    |  | $ | (539  | ) |  | $ | (814  | )

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 $8,720 and $16,685 for the three and six
months ended June 30, 2004, and $7,882 and $15,364 for the
three and six months ended June 30, 2003, respectively. In
addition, included in accounts payable-related parties is the
minority interest owed to Wyndham International Inc., which
holds a 1.6627% non-controlling economic interest in one of our
operating subsidiaries.

13.     SUBSEQUENT
EVENTS

Shelf Registration Statement In August 2004 we expect to file a
Form S-3 shelf registration statement registering up to
$150,000 of debt securities, preferred stock, common stock and
warrants. The registration statement also registers the
6,313,324 shares of our common stock held by CGLH
Partners I, LP and CGLH Partners II, LP which are
beneficially owned by certain of our directors. The CGLH
Partnerships have the right to include their shares in the
registration statement pursuant to a registration rights
agreement they executed with us at the time of our
July 2002 merger with Interstate Hotels.

Termination of Intercompany
Agreement Effective
July 1, 2004, MeriStar Hospitality and we have 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. See Footnote 1 for
details.

16



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

Background

On July 31, 2002, MeriStar Hotels &
Resorts, or MeriStar, and Interstate Hotels Corporation, or
Interstate, merged, and MeriStar changed its name to
Interstate Hotels & Resorts, Inc. The
transaction was a stock-for-stock merger of Interstate into
MeriStar in which Interstate stockholders received 4.6 shares of
MeriStar common stock for each share of Interstate stock
outstanding. Holders of MeriStar common stock and partnership
units in its operating partnership continued to hold their stock
and units following the merger. In connection with the merger,
the holders of Interstates convertible debt and preferred
stock converted those instruments into shares of MeriStar common
stock. Immediately following the merger, we effected a
one-for-five reverse stock split.

In accordance with accounting principles
generally accepted in the United States of America, we treated
the merger as a purchase for financial reporting purposes. In
accordance with the provisions of Statement of Financial
Accounting Standards No. 141, Business
Combinations, Interstate was considered the acquiring
enterprise for financial reporting purposes. Interstate
established a new accounting basis for MeriStars assets
and liabilities based upon their estimated fair values as of
July 31, 2002, the effective date of the merger. We
accounted for the merger as a reverse acquisition, with
Interstate as the accounting acquiror and MeriStar as the
surviving company for legal purposes.

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 28 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 June 30, 2004, we managed 269
properties, with 60,430 rooms in 40 states, the District of
Columbia, Canada, Russia and Portugal. As of June 30, 2004,
we had 3,130 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, one of our directors,
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 agreements give the general
partners full control over the business and affairs of the
partnership.

We manage all but 2 of the properties owned by
MeriStar Hospitality, a real estate investment trust, or REIT.
As of June 30, 2004, MeriStar Hospitality owned 78
properties, seven of which MeriStar Hospitality has stated it
intended to dispose of. Our relationship with MeriStar
Hospitality has 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.

Effective July 1, 2004, MeriStar Hospitality
and we have 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

17



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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 terminated in the
    subsequent year with the same termination fee;
|
| |  | 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.     

In addition, in connection with the termination
of the intercompany agreement, MeriStar Hospitality and we have
resolved our $5,000 dispute over the calculation of termination
fees. We have agreed to calculate the termination fees based
upon an average of the present value of remaining 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 (other than the seven hotels MeriStar
Hospitality intends to sell as of June 30, 2004). The
termination of the intercompany agreement and the resolution of
the dispute over the calculation of the termination fees did not
have any accounting consequences on the second quarter.

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, purchasing 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.

18



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##### 



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 our 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 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 will record a loss
on the write-off of the related unamortized intangible asset
value. The hotel operating environment has caused some owners of
our managed hotels to sell hotels. When a hotel is sold, we are
usually replaced as the hotels manager. During the first
half of 2004, MeriStar Hospitality sold 15 hotels that we had
managed, including four in the second quarter. We wrote-off
$4,388 of unamortized management contract costs associated with
the disposed hotels for the six months ended June 30, 2004,
with $1,092 relating to second quarter dispositions. This amount
is included in asset impairments and other write-offs in our
statements of operations. As of June 30, 2004, MeriStar
Hospitality has stated its intention to sell an additional seven
hotels as part of its asset disposition plan, all of which we
manage. When they are sold, we estimate that we will write off
an additional $2,757 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 defined in the management agreement.
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 June 30, 2004, we would be
entitled to receive approximately $12,641 of termination fees
relating to hotels sold by MeriStar Hospitality, and
approximately $2,764 relating to the seven hotels that MeriStar
Hospitality intends to sell as of June 30, 2004, assuming
no new contracts are executed and used as offsets to the
termination fees due us.

Our management agreements with other owners
generally provide for limited 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 recorded $1,534 and $2,621 of termination fees included
in our statement of operations for the three and six months
ended June 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

19



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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 $8,720 and $16,685 for the three and six
months ended June 30, 2004, and $7,882 and $15,364 for the
three and six months ended June 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 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 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 estimated fair value 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 second quarter of 2004, we wrote off
$1,092 of unamortized management contract costs relating to
terminated contracts. We did not record any asset impairments
during the second quarter.

20



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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 fair value of
the reporting unit to which the goodwill is assigned to the
carrying value of the 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 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. We did not recognize any impairment losses for
goodwill in the second quarter of 2004 or during 2003.

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 June 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. The valuation allowance has not changed from the
amount recorded at December 31, 2003. 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 hotel owners to make required payments. Our
judgments in determining customer ability and willingness to pay
are based on past experience with hotel owners and our
assessment of the current and future operating environments for
hotel owners. If a customers financial condition
deteriorates or a management contract is terminated in the
future, this could decrease a hotel owners ability,
willingness or obligation to make payments. If that occurs, we
might have to make additional allowances, which could reduce our
earnings.

Non-GAAP Financial Measures

Adjusted EBITDA represents earnings
(losses) before interest, income tax expense (benefit),
depreciation and amortization, equity in earnings (losses) of
affiliates, 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
    depreci-

21



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| |   |                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | ation and amortization are non-cash items, we
    believe that presentation of Adjusted EBITDA is a useful
    supplemental measure of our operating performance;                                                                                              
|
| |  | 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 other
    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.

22



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##### 



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 |  |       |        |       
|                                     |                                     | Management |        | Housing   |  | Other |        | Total 
|                                     |                                     |            |        |           |  |       |        |       
|Three months ended June 30,
    2004 |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,808  |           |  | $     | (846   | )      |   | $ | (3,613 | )      |   | $ | (2,651 | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 1,979     |  |       |        | 359    |   |   |        |       |   |   |        | 2,338  |  
|                                     | Interest expense, net               |            |        | 1,170     |  |       |        | 398    |   |   |        |       |   |   |        | 1,568  |  
|                                     | Equity in losses of affiliates      |            |        | 165       |  |       |        |       |   |   |        |       |   |   |        | 165    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 973    |   |   |        |       |   |   |        | 973    |  
|                                     | Minority interest expense (benefit) |            |        | 20        |  |       |        | (9     | ) |   |        | (40    | ) |   |        | (29    | )
|                                     | Income tax expense (benefit)        |            |        | 679       |  |       |        | (318   | ) |   |        | (1,357 | ) |   |        | (996   | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 5,821  |           |  | $     | 557    |        |   | $ | (5,010 | )      |   | $ | 1,368  |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Three months ended June 30,
    2003 |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,442  |           |  | $     | (1,092 | )      |   | $ | (837   | )      |   | $ | (487   | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 3,205     |  |       |        | 413    |   |   |        |       |   |   |        | 3,618  |  
|                                     | Interest expense, net               |            |        | 1,887     |  |       |        | 630    |   |   |        |       |   |   |        | 2,517  |  
|                                     | Equity in losses of affiliates      |            |        | 218       |  |       |        |       |   |   |        |       |   |   |        | 218    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 439    |   |   |        |       |   |   |        | 439    |  
|                                     | Minority interest expense (benefit) |            |        | 21        |  |       |        | (16    | ) |   |        | (12    | ) |   |        | (7     | )
|                                     | Income tax expense (benefit)        |            |        | 962       |  |       |        | (729   | ) |   |        | (558   | ) |   |        | (325   | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 7,735  |           |  | $     | (355   | )      |   | $ | (1,407 | )      |   | $ | 5,973  |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Six months ended June 30, 2004       |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Net income (loss)                    |                                     | $          | 1,961  |           |  | $     | (2,144 | )      |   | $ | (6,212 | )      |   | $ | (6,395 | )     
|Adjustments:                         |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|                                     | Depreciation and amortization       |            |        | 3,980     |  |       |        | 753    |   |   |        |       |   |   |        | 4,733  |  
|                                     | Interest expense, net               |            |        | 2,455     |  |       |        | 835    |   |   |        |       |   |   |        | 3,290  |  
|                                     | Equity in losses of affiliates      |            |        | 941       |  |       |        |       |   |   |        |       |   |   |        | 941    |  
|                                     | Discontinued operations             |            |        |          |  |       |        | 1,237  |   |   |        |       |   |   |        | 1,237  |  
|                                     | Minority interest expense (benefit) |            |        | 23        |  |       |        | (25    | ) |   |        | (73    | ) |   |        | (75    | )
|                                     | Income tax expense (benefit)        |            |        | 1,056     |  |       |        | (1,155 | ) |   |        | (3,345 | ) |   |        | (3,444 | )
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       
|Adjusted EBITDA                      |                                     | $          | 10,416 |           |  | $     | (499   | )      |   | $ | (9,630 | )      |   | $ | 287    |       
|                                     |                                     |            |        |           |  |       |        |        |   |   |        |        |   |   |        |       

23



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##### 



|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |         |  
|------------------------------ | ------------------------------------------------ | ---------- | ------ | --------- | - | ----- | ------ | ------ | - | - | ------ | ------- | - | - | ----- | ------- | -
|                               |                                                  | Hotel      |        | Corporate |   |       |        |       
|                               |                                                  | Management |        | Housing   |   | Other |        | Total 
|                               |                                                  |            |        |           |   |       |        |       
|Six months ended June 30, 2003 |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|Net income (loss)              |                                                  | $          | (412   | )         |   | $     | (2,805 | )      |   | $ | 7,158  |         |   | $ | 3,941 |        
|Adjustments:                   |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|                               | Depreciation and amortization                    |            |        | 7,442     |   |       |        | 817    |   |   |        |        |   |   |       | 8,259   |  
|                               | Interest expense, net                            |            |        | 3,619     |   |       |        | 1,206  |   |   |        |        |   |   |       | 4,825   |  
|                               | Equity in losses of affiliates                   |            |        | 566       |   |       |        |       |   |   |        |        |   |   |       | 566     |  
|                               | Discontinued operations                          |            |        |          |   |       |        | 814    |   |   |        |        |   |   |       | 814     |  
|                               | Gain on refinancing term loan from related party |            |        |          |   |       |        |       |   |   |        | (13,629 | ) |   |       | (13,629 | )
|                               | Minority interest expense (benefit)              |            |        | (17       | ) |       |        | (115   | ) |   |        | 293     |   |   |       | 161     |  
|                               | Income tax expense (benefit)                     |            |        | (274      | ) |       |        | (1,870 | ) |   |        | 4,771   |   |   |       | 2,627   |  
|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        
|Adjusted EBITDA                |                                                  | $          | 10,924 |           |   | $     | (1,953 | )      |   | $ | (1,407 | )       |   | $ | 7,564 |        
|                               |                                                  |            |        |           |   |       |        |        |   |   |        |         |   |   |       |        

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 of the economy 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.

The economy, the conflict in Iraq and traveler
health concerns due to SARS negatively impacted the demand for
corporate relocations and long-term assignments, two primary
drivers of our corporate housing operations. The second quarter
of 2004 demonstrated encouraging Adjusted EBITDA improvement
compared to second 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 flexibly
as in other markets. 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. This disposal of the Toronto operation
eliminated a significant drag on the corporate housing
operations Adjusted EBITDA, and we expect this will have a
positive effect on the operations going forward.

In our hotel management operations, the six month
period ending June 30, 2004 was the first period in the
last several years in which our operating statistics
demonstrated significant improvement. Revenue per available room
(RevPAR) has improved 6.2%, occupancy is up 2.5% and average
daily rate (ADR) is up 3.6%, all compared to the same period of
the prior year. These improvements are primarily attributable to
the improvement in the U.S. economy. The gross domestic product
rose at an annual rate of 3% in the second quarter of 2004,
after a 4.2% rise in the first quarter, and a 4.1% rise in the
fourth quarter of 2003. In addition, excluding managed hotels
that are held for sale by the owner or undergoing extensive
renovations, during the first six months of 2004, RevPAR
improved 9.8%, occupancy rose 4.4% and ADR increased 5.2%, all
compared to the same period of prior year. We are encouraged by
these improvements and expect that our operations will improve
if these trends continue.



| |                                                                                        
| | ---------------------------------------------------------------------------------------
| | Three months ended June 30, 2004
    compared with three months ended June 30,
    2003

Overview
At June 30, 2004 we managed 269 properties, with 60,430
guest rooms, compared to 347 properties with 75,556 guest rooms
at June 30, 2003, and 295 properties with 65,250 guest
rooms at

24



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##### 



December 31, 2003. Hotels under management
were reduced by a net of 78 from June 30 of preceding year,
with the majority of the reductions due to the following:




| |   |                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The sale of 27 properties by MeriStar Hospitality
    since June 30, 2003, in connection with its asset
    disposition plan. (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 of these properties.
    We retained management of the remaining 22 hotels, with
    market-based management fees.

Although our total number of managed hotels has
decreased, our Adjusted EBITDA has not been materially
negatively impacted, as most of the terminated contracts were
significantly less advantageous to us economically than the
contracts which we retained or added. For example, we are
entitled to termination fees from MeriStar Hospitality (see
Termination of Management Contractsabove for detail of
termination fees), and the majority of hotels that we have
retained or added are higher quality, upscale properties
generating more revenue than those that were not retained. The
majority of the properties terminated by CNL were select-service
and therefore did not generate significant Adjusted EBITDA. In
addition, these management contracts had limits on the amount of
revenue we could earn, whereas the new management contracts for
the retained properties do not.

Revenue

The following table shows the operating
statistics for our managed hotels on a same store basis for the
three months ended June 30 (dollars not in thousands):

|                                    |  |      |        |      |  |        |        |   |  |  |     |  
|----------------------------------- |  | ---- | ------ | ---- |  | ------ | ------ | - |  |  | --- | -
|                                    |  | 2004 |        | 2003 |  | Change
|                                    |  |      |        |      |  |       
|Revenue per available room (RevPAR) |  | $    | 74.37  |      |  | $      | 69.27  |   |  |  | 7.4 | %
|Average daily rate (ADR)            |  | $    | 105.03 |      |  | $      | 100.09 |   |  |  | 4.9 | %
|Occupancy                           |  |      | 70.8   | %    |  |        | 69.2   | % |  |  | 2.3 | %

Our total revenue decreased $4,401, or 1.7%, to
$253,304 for the three months ended June 30, 2004 compared
to $257,705 for the three months ended June 30, 2003. Major
components of this decrease were:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue from managed properties, which we record
    as revenue under EITF 01-14 decreased by $5,279. This decrease
    is directly related to the decreased number of hotel employees
    and related reimbursable salary and other expenses resulting
    from a lower number of managed hotels.                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Revenue from our corporate housing operations has
    increased $1,232, or 4.5%, to $27,555 for the three months ended
    June 30, 2004 from $26,323 for the three months ended
    June 30, 2003. This increase in revenue is attributable to
    several offsetting 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 almost entirely offset by the
    reduction of operations in our Raleigh market, and the disposal
    of operations in our Toronto market, plus a reduction of units
    rented in our London market.
|
| |  | Revenues from management fees remained fairly
    stable with a decrease of approximately $430, or 2.8%, to
    $14,968 for the three months ended June 30, 2004 compared
    to $15,398 for the three months ended June 30, 2003,
    resulting from a decrease in number of managed hotels. This was
    offset by termination fees of $1,534 we earned, with the
    majority from properties terminated by MeriStar Hospitality.                                                                                                                                                                                                                                                                  

Operating
expenses by department

Total operating expenses by department increased
$409, or 1.9%, to $22,469 for the three months ended
June 30, 2004 compared to $22,060 for the three months
ended June 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 corporate housing expenses, due
to a focus on unit growth in high potential markets, including
New York, London, Chicago and Washington D.C.

25



---



##### 



Undistributed
operating expenses

Total undistributed operating expenses increased
$3,789 or 17.9%, to $24,974 for the three months ended
June 30, 2004, compared to $21,185 for the three months
ended June 30, 2003. Major factors affecting the increase
were:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Restructuring charges were $3,312 for the three
    months ended June 30, 2004, with no similar expense in the
    same period last year. In the second quarter of 2004, we
    recorded $3,312 related to severance costs for our former CEO.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Administrative and general expenses increased
    $1,466, or 9.1%, to $17,626 for the three months ended
    June 30, 2004, from $16,160 for the three months ended
    June 30, 2003. Our administrative and general expenses are
    fairly consistent with the prior year, with the largest increase
    being in incentive compensation, as last June we recorded an
    adjustment to reduce this accrual in order to align it with our
    then updated 2003 projections. In addition, professional fees
    have increased primarily related to the compliance with the
    Sarbanes-Oxley legislation. Partially offsetting this is a
    decrease in expenses following the closing of our Flagstone
    subsidiary, in the fourth quarter of 2003, in connection with
    the termination of the CNL management contracts.                                                                                                                                                                                                                          
|
| |  | Asset impairments and other write-offs increased
    $897, to $1,698 for the three months ended June 30, 2004,
    from $801 for the same period last year. The majority of this
    expense is due to the write-off of management contract costs,
    mainly related to hotel properties sold by MeriStar Hospitality,
    in connection with its announced asset disposition plan. We
    wrote-off $1,092 of management contracts, all of which were
    related to properties sold by MeriStar Hospitality during the
    second quarter of 2004, as compared to $801 in second quarter of
    2003. Of the 2003 amount, $214 related to properties sold by
    MeriStar Hospitality and $587 related to 33 properties sold by
    Winston Hotels, Inc. In addition, during the second quarter of
    2004, we pursued a merger with a company with a significant
    portfolio of hotels, which was not completed. We incurred
    approximately $606 relating to legal and accounting fees and due
    diligence costs related to this potential merger.
|
| |  | Merger and integration costs were $606 for the
    three months ended June 30, 2003, with no similar expense for
    the three months ended June 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | This increase was offset partially by a decrease
    in depreciation and amortization expense of $1,280, or 35.4%, to
    $2,338 for the three months ended June 30, 2004, from
    $3,618 for the three months ended June 30, 2003. This
    decrease is primarily due to a large number of management
    contracts that became fully amortized during the second quarter
    of 2003 and the loss of certain management contracts during the
    year. This decrease was partially offset by the increase in
    purchases of property, plant and equipment during mid-2003
    related to the relocation of our corporate office, and the
    increase in depreciation recorded on those assets.                                                                                                                                                                                                                                                                                                                                                          

Reimbursable costs, which we record as expense
under EITF 01-14, decreased by $5,274, or 2.5%, to $206,831 for
the three months ended June 30, 2004, from $212,105 for the
three months ended June 30, 2003. The primary reason for
this is the decrease in the number of managed hotels from
June 30, 2003 to June 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 increased $534,
to $973 for the three months ended June 30, 2004, from $439
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 increase
in loss is partially attributable to expenses incurred of $698
in June of 2004, comprised of fixed asset write-offs, severance
and other closing costs associated with the disposal. In
addition, the Toronto operation experienced

26



---



##### 



lower occupancy with a fixed cost structure due
to long-term lease commitments, contributing to lower profit
margins.


Net
loss

Net loss increased $2,164 to $(2,651) for the
three months ended June 30, 2004, from $(487) for the three
months ended June 30, 2003. This increase in net loss is
due to the decrease in net operating income of $3,325, due to
the increased expenses as discussed above, specifically the
restructuring charges and asset impairments and write-offs. This
decrease in net operating income is partially offset by the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Net interest expense decreased $949 to $1,568 for
    the three months ended June 30, 2004, from $2,517 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 $53
    to $165 for the three months ended June 30, 2004, compared
    to $218 for the same period in 2003. These losses consist of our
    proportionate share of the net losses incurred by our
    non-controlling equity investments. We incurred greater losses
    in the 2004 period from our MIP Lessee, L.P. investment as the
    hotels were not performing as anticipated. This was offset by
    income from equity in earnings from our other joint ventures,
    including the 12% return we receive on our preferred investment
    in Interconn Ponte Vedra Company, LLC.
|
| |  | Income tax benefit was $996 for the three months
    ended June 30, 2004, compared to $325 for the three months
    ended June 30, 2003. The main reason for this fluctuation
    is that we incurred a greater loss in the 2004 period, as
    opposed to the 2003 period. Our effective tax rate is
    approximately 35% at June 30, 2004 and 40% at June 30,
    2003.                                                                                                                                                                                                                                                             

Adjusted
EBITDA

Adjusted EBITDA decreased $4,605, to $1,368 for
the three months ended June 30, 2004, from $5,973 for the
three months ended June 30, 2003. This decrease is due to
the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Net income from hotel management operations
    increased $366, to $1,808 for the three months ended
    June 30, 2004, from $1,442 for the three months ended
    June 30, 2003. Hotel managements Adjusted EBITDA
    decreased $1,914 to $5,821 for the three months ended
    June 30, 2004, from $7,735 for the three months ended
    June 30, 2003. The main reason for the decrease is an
    adjustment in 2003 to reduce the incentive compensation accrual
    based on revised annual projections at that time, offset by the
    stable growth in revenue quarter over quarter and the absence of
    expenses related to our Flagstone subsidiary, beginning in the
    fourth quarter of 2003, as discussed above.                                                                                                                                                                                                                                                                                                                                             
|
| |  | Net loss from corporate housing operations
    decreased $246, to $846 for the three months ended June 30,
    2004, from $1,092 for the same period of 2003. Corporate
    housings Adjusted EBITDA increased $912, to $557 for the
    three months ended June 30, 2004, from $(355) for the same
    period of 2003. The increase in Adjusted EBITDA is primarily
    attributed to improved rental rates and margins, reduced
    overhead costs and disposal of underperforming markets.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Net loss from other activities increased $2,776,
    to $3,613 for the three months ended June 30, 2004, from
    $837 for the three months ended June 30, 2003. Adjusted
    EBITDA from other activities decreased $3,603, to $(5,010) for
    the three months ended June 30, 2004, from $(1,407) for the
    three months ended June 30, 2003. In 2004, other activity
    includes restructuring charges of $3,312 relating to severance
    for our former CEO, and $1,698 of asset impairments and other
    write-offs, compared to the 2003 period which only includes
    asset impairments and other write-offs of $801. The reason for
    the increase in asset impairments and write-offs in 2004 is that
    MeriStar Hospitality disposed of more hotels in the second
    quarter of 2004 than 2003, resulting in more management contract
    write-offs. Also included in the second quarter 2004 asset
    impairments and write-offs is $606 of costs relating to a
    potential merger that was not completed. There was no similar
    expense in 2003.

27



---



##### 





| |                                                                                
| | -------------------------------------------------------------------------------
| | Six months ended June 30, 2004
    compared with six months ended June 30, 2003



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

The following table shows the operating
statistics for our managed hotels on a same store basis for the
six months ended June 30 (dollars not in thousands):

|                                    |  |      |        |      |  |        |        |   |  |  |     |  
|----------------------------------- |  | ---- | ------ | ---- |  | ------ | ------ | - |  |  | --- | -
|                                    |  | 2004 |        | 2003 |  | Change
|                                    |  |      |        |      |  |       
|Revenue per available room (RevPAR) |  | $    | 70.86  |      |  | $      | 66.73  |   |  |  | 6.2 | %
|Average daily rate (ADR)            |  | $    | 104.30 |      |  | $      | 100.66 |   |  |  | 3.6 | %
|Occupancy                           |  |      | 67.9   | %    |  |        | 66.3   | % |  |  | 2.4 | %

Our total revenue decreased $23,887, or 4.7%, to
489,357 for the six months ended June 30, 2004 compared to
$513,244 for the six months ended June 30, 2003. Major
components of this decrease were:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Revenue from management fees decreased $1,117, or
    3.8%, to $28,646 for the six months ended June 30, 2004,
    from $29,763 for the six months ended June 30, 2003. While
    our RevPAR, ADR and occupancy have improved year over year, the
    decrease in total number of hotels under management has caused a
    slight decrease in our total management fee revenue. (See
    Overviewabove for detail of terminated contracts). The
    decrease due to the terminated management contracts was offset
    by termination fees of $2,261 for the six months of 2004, with
    the majority relating the properties sold by MeriStar
    Hospitality.       
|
| |  | Revenue from our corporate housing operations has
    increased $1,523, or 3.0%, to $51,805 for the six months ended
    June 30, 2004 from $50,282 for the six months ended
    June 30, 2003. This increase in revenue is 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, and the disposal of operations in our
    Toronto market, plus a reduction of units rented in our London
    market.
|
| |  | Reimbursable costs, which we record as revenue
    under EITF 01-14, decreased by $23,621, or 5.6%, to $400,981 for
    the six months ended June 30, 2004, from $424,602 for the
    six months ended June 30, 2003. The primary reason for this
    is the decrease in number of managed hotels from June 30,
    2003 to June 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
$458, or 1.1%, to $43,369 for the three months ended
June 30, 2004 compared to $42,911 for the three months
ended June 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 corporate housing expenses, due
to a focus on unit growth in high potential markets, including
New York, London, Chicago and Washington D.C.

Undistributed
operating expenses

Total undistributed operating expenses increased
$3,027 or 6.5%, to $49,453 for the six months ended
June 30, 2004, compared to $46,426 for the six months ended
June 30, 2003. Major factors affecting the increase were:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Asset impairments and write-offs were $6,191 for
    the six months ended June 30, 2004, compared $801 for the
    same period of 2003. The majority of this expense is due to the
    write-off of management contract costs, mostly related to hotel
    properties sold by MeriStar Hospitality, in connection with its
    announced asset disposition plan. We wrote-off $1,092 of
    intangible assets associated with these terminated management
    contracts during the second quarter, compared to $801 in 2003.
    Of the $801, $214 related to properties sold by MeriStar
    Hospitality, and $587 related to properties sold by Winston

28



---



##### 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | Hotels, Inc. Also included in this amount for the
    2004 period is a $563 write-off of a portion of our investment
    in MIP, Lessee, L.P., as it was deemed partially impaired based
    on purchase offers received for two of the hotels owned by the
    joint venture. We also wrote-off $538, representing our
    remaining investment in our joint venture that owns the
    Residence Inn Houston Astrodome Medical Center, as it was
    determined that the carrying value would not be recovered due to
    the hotels underperformance. The remaining $96 of expense
    relates to fixed asset write-offs associated with closing of our
    subsidiary that managed properties purchased by CNL (see
    Overviewabove).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Restructuring charges were $3,439 for the six
    months ended June 30, 2004, with no similar expense in the
    same period last year. In the second quarter of 2004 we recorded
    $3,312 related to severance costs for our former CEO, and in the
    first quarter we incurred $127 of severance costs associated
    with restructuring within our corporate housing division.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Administrative and general expenses increased
    $194, or 0.1%, to $35,090 for the six months ended June 30,
    2004, compared to $34,896 for the six months ended June 30,
    2003. Part of the increase is due to the increase in insurance
    expense. Northridge Insurance Company provides reinsurance on
    certain lines of coverage in order to improve the terms and
    conditions of insurance available to our clients. We incurred
    $1,300 of losses on our property reinsurance program, including
    one claim which reached our maximum per occurrence exposure of
    $1,000. Claims of this magnitude are unusual. Nonetheless, we
    have lowered our maximum per occurrence loss limit to $500 in
    order to reduce our exposure on future claims. In addition there
    was an increase in incentive compensation, as last June we
    recorded an adjustment to reduce this accrual in order to align
    it with our then updated 2003 projections. Professional fees
    have increased primarily related to the compliance with the
    Sarbanes-Oxley legislation. Offsetting this is a decrease in
    expenses following the closing of our Flagstone subsidiary in
    the fourth quarter of 2003, in connection with the termination
    of the CNL management contracts.

The increase in the above was offset by the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Depreciation and amortization expense decreased
    $3,526, or 42.7%, to $4,733 for the six months ended
    June 30, 2004, from $8,259 for the six months ended
    June 30, 2003. This decrease is primarily due to a large
    number of management contracts that became fully amortized
    during the second quarter of 2003 and the loss of certain
    management contracts during the year. 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.
|
| |  | Merger and integration costs were $2,470 for the
    six months ended June 30, 2003, with no similar expense for
    the six months ended June 30, 2004. These costs include
    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 $23,621, or 5.6%, to $400,981 for
the six months ended June 30, 2004, from $424,602 for the
six months ended June 30, 2003. The primary reason for this
is the decrease in the number of managed hotels from
June 30, 2003 to June 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 increased $423,
to $1,237 for the six months ended June 30, 2004, from $814
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 increase
in loss is partially attributable to expenses incurred of $698
in June of 2004, comprised of fixed asset write-offs, severance
and other closing costs associated with the disposal. In
addition, the Toronto operation experienced lower occupancy with
a fixed cost structure due to long-term lease commitments,
contributing to lower profit margins.

29



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##### 



Net
income (loss)

Net income (loss) decreased $10,336 to
$(6,395) for the six months ended June 30, 2004, from $3,941 for
the six months ended June 30, 2003. In addition to the
decrease in net operating income of $3,751, 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 $375, or 66.3%, to $941 for the six months ended
June 30, 2004, compared to $566 for the same period in
2003. These losses consist of our proportionate share of the net
losses incurred by our non-controlling equity investments. We
incurred greater losses in the 2004 period from our MIP Lessee,
L.P. investment as the hotels were not performing as
anticipated. These were partially offset by income from equity
in earnings from our other joint ventures, including the 12%
return we receive on our preferred investment in Interconn Ponte
Vedra Company, LLC.

Offsetting these items, net interest expense
decreased $1,535, or 31.8%, to $3,290 for the six months ended
June 30, 2004, from $4,825 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 $(3,444)
for the six months ended June 30, 2004, compared to $2,627
for the six months ended June 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 effective tax rate
is approximately 35% in the 2004 period and was approximately
40% in the 2003 period.

Adjusted
EBITDA

Adjusted EBITDA decreased $7,277, to $287 for the
six months ended June 30, 2004, from $7,564 for the six
months ended June 30, 2003. This decrease is due to the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Net loss from corporate housing operations
    decreased $661, to $2,144 for the six months ended June 30,
    2004, from $2,805 for the same period of 2003. Corporate
    housings Adjusted EBITDA increased $1,454, to $(499) for
    the six months ended June 30, 2004, from $(1,953) for the
    same period 2003. The increase in Adjusted EBITDA can be
    primarily attributed to the improved rental rates and margins,
    reduced overhead costs and disposal of underperforming markets.                                                                                                                                                          
|
| |  | Net income (loss) from other activities
    decreased $13,370, to $(6,212) for the six months ended
    June 30, 2004, from $7,158 for the six months ended
    June 30, 2003. Adjusted EBITDA from other activities
    decreased $8,223, to $(9,630) for the six months ended
    June 30, 2004, from $(1,407) for the six months ended
    June 30, 2003. In 2004, other activity includes
    restructuring charges of $3,312 relating to severance costs for
    our former CEO, and $6,191 of asset impairments and write-offs,
    compared to the 2003 period which only includes asset
    impairments and other write-offs of $801, as discussed above.

These decreases were offset by an increase in net
income from hotel management operations of $2,373, to $1,961 for
the six months ended June 30, 2004, from $(412) for the six
months ended June 30, 2003. Hotel managements
Adjusted EBITDA decreased $508, to $10,416 for the six months
ended June 30, 2004, from $10,924 for the six months ended
June 30, 2003. The main reason for the decrease is the
adjustment in 2003 to reduce the incentive compensation accrual,
based on revised annual projections at that time, offset by the
stable growth in revenue, increased insurance expense, and an
absence of expenses related to our Flagstone subsidiary,
beginning in the fourth quarter of 2003, as discussed above.

30



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##### 



Liquidity and Capital Resources

Working
Capital We had $2,521 of
cash and cash equivalents at June 30, 2004, compared to
$7,450 at December 31, 2003, and working capital (current
assets less current liabilities) of $1,813 at June 30, 2004
compared to a deficit of $8,349 at December 31, 2003.

Operating
Activities Net cash used
in operating activities was $11,076 for the six months ended
June 30, 2004 compared to net cash provided by operating
activities of $9,571 for the six months ended June 30,
2003. The increased use of cash resulted primarily from
reductions in the accounts payable and accrued liabilities
balances, specifically the payments of incentive compensation
and severance amounts during 2004, as well as timing of
collections of accounts receivable.

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 was $2,546 for the
six months ended June 30, 2004 compared to $(4,477) for the
six months ended June 30, 2003. One factor contributing to
this increase in cash relates to the decrease in restricted cash
during the first half of 2004 from our purchasing subsidiary.
That subsidiarys restricted cash consists of advances for
capital expansion and renovation projects, and these amounts are
used as the projects are performed. The decrease relates to the
continuation of projects, as well as timing of advances. Another
factor contributing to the increase in cash is the collections
on certain of our advances to affiliates, primarily a note
repaid by S.D.Bridgeworks in the amount of $2,687. Lastly, in
2003 we spent more on fixed asset purchases, when we moved our
corporate offices from Washington, D.C. to Arlington, VA.

We periodically make equity investments in
entities that own hotel properties we manage. We evaluate these
investment opportunities based on financial and strategic
factors such as the estimated potential value of the underlying
hotel properties and the management fee revenues we can obtain
from operating the properties.

Financing
Activities Net cash
provided by financing activities was $3,095 for the six months
ended June 30, 2004, compared $10,411 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 $3,688 in 2004, as opposed to $11,986 in 2003. In
January 2003, we entered into a new $40,000 subordinated term
loan, and repaid the MeriStar Hospitality term loan, 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.

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 28, 2005 (with a one-year
renewal at our option). The interest rate on the senior credit
agreement is 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 June 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.                              

31



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##### 



At June 30, 2004, borrowings under the
senior credit agreement bore interest at a rate of 5.59% per
annum, which is the 30-day LIBOR plus 3.50%. We are currently in
the process of negotiating the refinancing of this facility,
which we expect to complete during the third quarter of 2004.

We incurred $592 and $1,200 of interest expense
on the senior credit facility for the three and six months ended
June 30, 2004, and $1,168 and $2,264 for the three and six
months ended June 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 August 6, 2004, the total availability under our senior
credit agreement was $21,000.

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 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 six months ended June
30, 2004, we incurred $112 and $223 of interest expense on the
promissory note, respectively. For the three and six months
ended June 30, 2003, we incurred $125 and $250 of interest
expense on the promissory note, respectively.

In June 2003, we made unscheduled principal
payments totaling $447 on the note. As of June 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 have 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. We wrote off the investment in these partnerships
in 2003.

Subordinated term
loan In January 2003, in
order to finance our repayment of our debt to MeriStar
Hospitality at a discount, 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 June 30, 2004, we were in
compliance with these covenants. At June 30, 2004,
borrowings under the subordinated term loan bore interest at a
rate of 9.63% per annum. We incurred $973 and $1,946 of interest
expense on the subordinated term loan for the three and six
months ended June 30, 2004, respectively, and $997 and
$1,887 of interest expense on the subordinated term loan for the
three and six months ended June 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 next
twelve months. 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.

32



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##### 



Contractual Obligations and Maturities of
Indebtedness

The following table summarizes our contractual
obligations at June 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 |  | $             | 46,286  |           |  | $         | 1,625  |           |  | $       | 44,661  |  |  | $ |       |  |  | $ |       | 
|Promissory Note        |  |               | 3,723   |           |  |           |       |           |  |         |        |  |  |   |       |  |  |   | 3,723  | 
|Subordinated Term-loan |  |               | 40,000  |           |  |           |       |           |  |         | 40,000  |  |  |   |       |  |  |   |       | 
|Non-cancelable leases  |  |               | 143,012 |           |  |           | 70,286 |           |  |         | 37,727  |  |  |   | 10,483 |  |  |   | 24,516 | 
|Wyndham interest       |  |               | 433     |           |  |           | 433    |           |  |         |        |  |  |   |       |  |  |   |       | 
|                       |  |               |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |        | 
|Total                  |  | $             | 233,454 |           |  |           | 72,344 |           |  |         | 122,388 |  |  |   | 10,483 |  |  |   | 28,239 | 
|                       |  |               |         |           |  |           |        |           |  |         |         |  |  |   |        |  |  |   |        | 

Long-Term
Debt For principal
repayment and debt service obligations with respect to our
long-term debt, see Note 7 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
$3,222 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.

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. In conjunction with the MeriStar-Interstate
merger, we accelerated the timing of Wyndhams right to
require us to redeem this interest. Effective July 20,
2002, Wyndham has the right to require us to redeem this
interest. The estimated value of this interest at June 30,
2004 is $433 and is included in accounts payable-related parties
in our consolidated balance sheet.

Redeemable Preferred Operating Partnership
Units At June 30,
2004, we had 247,122 Class A units outstanding in our
subsidiary operating partnership, Interstate Operating Company,
L.P. This partnership indirectly holds substantially all of our
assets. We had outstanding preferred units that were held by an
affiliate of Mahmood J. Khimji, one of our directors. On
May 3, 2004, we redeemed all 78,431 preferred units for
cash consideration, totaling $1,310, at a redemption price of
$16.70 per unit, which was paid to Mr. Khimjis
affiliates.

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.

33



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##### 



Our senior secured credit facility matures
July 31, 2005, with a one year extension of the revolving
portion at our option. At June 30, 2004, we had borrowings
of $46,286 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
June 30, 2004, the senior credit facility bore interest at
a rate of 5.59% per annum, which is the 30-day LIBOR plus 3.50%.
We have determined that the fair value of the debt approximates
its carrying value. We are currently in the process of
refinancing this facility. We expect to complete the refinancing
in the third quarter of 2004. We expect to write off
approximately $990 of net deferred financing costs associated
with this facility at the time of the refinancing.

Our subordinated term loan matures on
January 31, 2006, 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.
Interest on the debt is based on the 30-day LIBOR plus 850 basis
points. At June 30, 2004, borrowings under the subordinated
term loan bore interest at a rate of 9.63% per annum. We have
determined that the fair value of the debt approximates its
carrying value.

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, as discussed in Note 6. 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 $104 at
June 30, 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
June 30, 2004, the fair value of this cap agreement was
insignificant.

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 $155 and $307 for the
three and six months ended June 30, 2004, respectively, and
by approximately $247 and $494 for the three and six months
ended June 30, 2003, respectively.

Our international operations are subject to
foreign exchange rate fluctuations. We derived approximately
2.9% and 3.1% of our total revenue for the three and six months
ended June 30, 2004, respectively, from services performed
in Canada, the United Kingdom, France, and Russia. Our foreign
currency transaction gains and losses were $(21) and $(105) for
the three and six months ended June 30, 2004, respectively,
and are included in accumulated comprehensive income (loss) on
our statements and other comprehensive income (loss) of
operations, net of tax. 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

34



---



##### 



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.

35



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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.     Changes in Securities and Use
of Proceeds

None.

Item
3.     Defaults Upon Senior
Securities

None.

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

Our annual meeting of stockholders was held on
May 27, 2004.

At that meeting, the following matters were
submitted to a vote of our stockholders:

Item No. 1

To approve the re-election as directors of the
Company to serve three-year terms expiring at the Annual Meeting
in 2007 and until their successors are duly elected and
qualified.

|                     |  |     |            |          |  |  |           | 
|-------------------- |  | --- | ---------- | -------- |  |  | --------- | 
|                     |  | For |            | Withheld
|                     |  |     |            |         
|John J. Russell, Jr. |  |     | 21,392,827 |          |  |  | 84,160    | 
|Leslie R. Doggett    |  |     | 15,993,403 |          |  |  | 5,483,584 | 
|James B. McCurry     |  |     | 21,372,969 |          |  |  | 104,018   | 

Item No. 2

To approve the appointment of KPMG LLP as
independent auditors for the Company for the fiscal year ending
December 31, 2004.

|        |  |  |            | 
|------- |  |  | ---------- | 
|For     |  |  | 21,430,464 | 
|Against |  |  | 43,753     | 
|Abstain |  |  | 2,770      | 

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 terminol-

36



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##### 



ogy. Factors which could have a material adverse
effect on our operations and future prospectus 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;                                                                                                                                                                                          
|
| |  | 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;                                                                                                                                                                                                                               
|
| |  | 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

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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.

Item
6.     Exhibits and Reports on
Form 8-K

(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 3.1.1 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 3.1.3 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)).                                                                                                                                

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##### 



|            |      |                         |  |                                                                                                                                                                                                                                                                                                                                                                                                 
|----------- | ---- | ----------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      | Description of Document
|            |      |                        
|            | 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).
|            | 10.1 |                         |  | Termination of the Intercompany Agreement between
    the Company and MeriStar Hospitality Corporation.                                                                                                                                                                                                                                                                                         
|            | 10.2 |                         |  | Form of William Richardsons employment
    agreement with the Company.                                                                                                                                                                                                                                                                                                                         
|            | 10.3 |                         |  | Separation Agreement, dated as of April 1,
    2004, between the Company and Paul W. Whetsell.                                                                                                                                                                                                                                                                                                  
|            | 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.                                                                                                                                                                                                                                                                                                                   

(b) Reports on Form 8-K

Current report on Form 8-K (Item 12)
dated and filed May 5, 2004, regarding the first quarter
earnings press release.

Current report on Form 8-K (Item 12)
dated and filed August 4, 2004, regarding the second
quarter earnings press release.

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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: August 9, 2004

40