MERISTAR HOSPITALITY OPERATING PARTNERSHIP LP - 10-Q Quarterly Report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

This quarterly report on Form 10-Q is being filed jointly by MeriStar Hospitality Operating Partnership, L.P., or MHOP; MeriStar Hospitality Finance Corp, or MeriStar Finance; MeriStar Hospitality Finance Corp II, or MeriStar Finance II; and MeriStar Hospitality Finance Corp III, or MeriStar Finance III. No separate financial or other information of MeriStar Finance, MeriStar Finance II or MeriStar Finance III is material to holders of the securities of MHOP, MeriStar Finance, MeriStar Finance II or MeriStar Finance III since as of September 30, 2003, they had no operations, no employees, only nominal assets and no liabilities other than their obligations as corporate co-issuers under the indentures governing the senior unsecured notes issued in January 2001, December 2001 and February 2002.

MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
CONSOLIDATED BALANCE SHEETS
(Dollars and units in thousands)

MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003

MeriStar Hospitality Operating Partnership, L.P. is the subsidiary operating partnership of MeriStar Hospitality Corporation (“MeriStar Hospitality,” which is a real estate investment trust, or REIT). We own a portfolio of upscale, full-service hotels and resorts in the United States and Canada. Our portfolio is diversified geographically as well as by franchise and brand affiliations. As of September 30, 2003, we owned 101 hotels, with 26,290 rooms, all of which were leased by our taxable subsidiaries and managed by Interstate Hotels & Resorts, Inc. (“Interstate Hotels”). In October 2003, we sold one hotel with 71 rooms.

Our taxable subsidiaries are parties to management agreements with a subsidiary of Interstate Hotels to manage all of our hotels. Under these management agreements, the taxable subsidiaries pay a management fee for each property to a subsidiary of Interstate Hotels. The taxable subsidiaries in turn make rental payments to us under the participating leases. Under the management agreements, the base management fee is 2.5% of total hotel revenue, plus incentive payments based on meeting performance thresholds that could total up to an additional 1.5% of total hotel revenue. All of the agreements expire in 2010 and have three renewal periods of five years each at the option of Interstate Hotels, subject to some exceptions.

Interim Financial Statements. 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. These interim financial statements should be read in conjunction with the financial statements, accompanying notes and other information included in our Annual Report on Form 10-K for the year ended December 31, 2002. Certain 2002 amounts have been reclassified to conform to the 2003 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, results of operations and cash flows for the periods presented. The results of operations for the interim periods are not necessarily indicative of the results for the entire year.

Principles of Consolidation. Our consolidated financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation. In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. (FIN) 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” The interpretation addresses how to identify variable interest entities and when to consolidate those entities. Consolidation of variable interest entities is required by the primary beneficiary. The interpretation applied immediately to variable interest entities created after January 31, 2003. The initial application of the interpretation did not affect our results of operations or financial condition as we have not obtained an interest in any qualifying entity on or after January 31, 2003. On October 9, 2003, the FASB issued FIN 46-6 which deferred to December 31, 2003 the effective date for applying the interpretation to variable interest entities created before February 1, 2003. We do not expect the application of the second phase of the interpretation to have a material effect on our results of operations or financial condition.

Held for Sale Properties. We classify the properties we are actively marketing as held for sale once all of the following conditions are met:


	•	Our board has approved the sale,

	•	We have a fully executed agreement with a qualified buyer which provides for no significant outstanding or continuing obligations with the property after sale, and

	•	We have a significant non-refundable deposit.

We carry properties held for sale at the lower of their carrying values or estimated fair values less costs to sell. We cease depreciation at the time the asset is classified as held for sale. If material to our total portfolio, we segregate the held for sale properties on our consolidated balance sheet.

Marketable Securities. We classify investments in equity securities and debt securities with original maturities greater than three months as marketable securities. We record debt securities at amortized cost and equity securities at market value based on quoted market prices. As of September 30, 2003, our marketable securities consisted of investments in debt securities, including commercial paper and agency discount notes. As of September 30, 2003, the securities had a fair value of $1 million.

Cash and Cash Equivalents. We classify investments with original maturities of three months or less as cash equivalents. Our cash equivalents include investments in debt securities, including commercial paper, overnight repurchase agreements and money market funds.

Impairment or Disposal of Long-Lived Assets. We adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” on January 1, 2002. SFAS No. 144 requires the current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002 and where we have no continuing involvement, including any gain or loss recognized, to be recorded as discontinued operations.

The provisions of SFAS No. 144 also require that whenever events or changes in circumstances indicate that the carrying value of a long-lived asset may be impaired that an analysis be performed to determine the recoverability of the asset’s carrying value. We make estimates of the undiscounted cash flows from the expected future operations or potential sale of the asset. If the analysis indicates that the carrying value is not recoverable from these estimates of cash flows, we write down the asset to estimated fair value and recognize an impairment loss. Any impairment losses we recognize on assets held for use are recorded as operating expenses. We record any impairment losses on assets held for sale as a component of discontinued operations.

We adopted the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” on January 1, 2003. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Our strategy includes the disposition of certain hotel assets, all of which are managed under agreements that typically require payments to Interstate Hotels upon termination. As a result, we may incur termination obligations related to our asset dispositions. Any such liability will be recognized at the time the asset disposition is complete and a termination notice is provided to Interstate Hotels. At that time, the recognition of the termination obligation will be included in the calculation of the final gain or loss on sale and will be included in discontinued operations. For further discussion of potential termination obligations, see “Asset Dispositions” included in Item 2 of this Quarterly Report on Form 10-Q.

Gains and Losses From Extinguishments of Debt. We adopted the provisions of SFAS No. 145, “Rescission of FASB Statements No. 4, No. 44 and No. 64, Amendment of SFAS No. 13, and Technical Corrections,” on January 1, 2003. The rescission of SFAS No. 4 and No. 64 requires that all gains and losses from extinguishments of debt be classified as extraordinary only if the gains and losses are from unusual or infrequent transactions. It also requires prior period gains or losses that are not from unusual and infrequent transactions to be reclassified. See Note 6 for details on the early extinguishment of substantially all of our 4.75% notes payable to MeriStar Hospitality and a portion of our 8.75% notes payable to MeriStar Hospitality during the third quarter of 2003.

Stock-Based Compensation. We adopted the recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended in December 2002 by SFAS No. 148, on January 1, 2003 for new stock options issued under our compensation programs. As permitted by SFAS No. 148, we elected to apply the provisions prospectively, which includes recognizing compensation expense for only those stock options issued in 2003 and after. During the nine months ended September 30, 2003, we granted 207,500 stock options to employees which vest ratably over three years. Compensation costs related to these stock options were not material to our results of operations for the nine months ended September 30, 2003. We apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for our stock options issued under our compensation programs prior to January 1, 2003. As we granted these stock options at fair market value, no compensation cost has been recognized. For our other equity-based compensation plans, we recognize compensation expense over the vesting period based on the fair market value of the award at the date of grant.

Had compensation cost been determined based on fair value at the grant date for awards granted prior to our adoption of the fair value method prescribed in SFAS No. 123, as amended by SFAS No. 148, our net loss and per unit amounts would have been adjusted to the pro forma amounts indicated as follows (dollars in thousands, except per unit amounts):

The effects of applying SFAS No. 123 for disclosing pro forma compensation costs may not be representative of the actual effects on reported net income and earnings per unit in future periods.

Accounting for Guarantees. FASB FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34, became effective on January 1, 2003. The interpretation requires recognition of liabilities at their fair value for newly-issued guarantees. We have no guarantees which require recognition under the provisions of this interpretation.

Derivative Instruments and Hedging Activities. SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” became effective on July 1, 2003. The statement clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative, and amends certain other provisions. This statement applies to any freestanding financial derivative instruments entered into or modified after June 30, 2003. This standard did not affect our results of operations or financial condition as we have not entered into any freestanding financial derivative instruments since June 30, 2003.

Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The FASB issued SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both

Liabilities and Equity” in May 2003. The provisions of the statement require many instruments which were previously classified as equity to now be classified as a liability (or an asset in some circumstances), including: mandatorily redeemable instruments, instruments with repurchase obligations and instruments with obligations to issue a variable number of shares. The statement applied immediately to any such financial instrument entered into or modified after May 31, 2003, and to all other instruments on July 1, 2003. We have not entered into or modified any financial instruments within the scope of this standard subsequent to May 31, 2003, nor do we have any existing financial instruments that fall within the scope of SFAS No. 150.

Comprehensive loss was $50.5 million and $31.5 million for the three months ended September 30, 2003 and 2002, respectively. Comprehensive loss consisted of net loss of $51.0 million and $30.7 million for the three months ended September 30, 2003 and 2002, respectively, and foreign currency translation adjustments.

Comprehensive loss was $335.5 million and $36.9 million for the nine months ended September 30, 2003 and 2002, respectively. Comprehensive loss consisted of net loss of $340.9 million and $37.6 million for the nine months ended September 30, 2003 and 2002, respectively, foreign currency translation adjustments, and in 2002 a $0.5 million fair value gain adjustment for derivatives.

For the nine months ended September 30, 2003 and 2002, we capitalized interest of $2.4 million and $3.1 million, respectively.

In late 2002, due to the decision to market non-core assets as a part of our program to dispose of assets that do not fit our long-term strategy and changes in economic conditions, we performed an analysis to determine the recoverability of each of our hotel properties. Assets we have identified as “non-core” typically have one or more of the following characteristics: secondary market locations, secondary brand affiliations, higher than average future capital expenditure requirements, limited future growth potential, or an over-weighted market location.

We recognized an impairment loss in 2002 on certain non-core assets we were then actively marketing. Late in the first quarter of 2003, we expanded our asset disposition program to include a total of 16 non-core assets and recognized an impairment loss of $56.7 million as a result of the change in our expected holding period for these assets.

During the second quarter of 2003, we made the determination to dispose of an additional 19 non-core assets, for a total of 35 non-core assets included in our disposition program. Also during the second quarter, due to the market interest in certain of our other hotel assets, we decided to add an additional six assets to our disposition program. Due to this change in our expected holding period for these assets, we recognized an additional impairment loss of $208 million related to the contemplated disposition of these 41 assets during the second quarter of 2003.

During the third quarter of 2003, we made the determination to dispose of one additional asset and retain one of our assets previously included in our disposition program. We also changed our expected holding period

for another asset and revised our estimated sales prices on certain other assets included in our disposition program. As a result, we recognized an additional impairment loss of $21 million during the three months ended September 30, 2003. Including one asset sale in October, we have sold seven hotels included in our asset disposition program since January 1, 2003.

The impairment charges are based on our estimates of the fair value of the properties to be disposed of. These estimates require us to make assumptions about the sales prices that we expect to realize for each property as well as the timing of a potential sale. In making these estimates, we consider the operating results of the assets, the market for comparable properties, and quotes from brokers, among other information. In nearly all cases, our estimates have reflected the results of an extensive marketing effort and negotiations with prospective buyers. Actual results could differ materially from these estimates.

As of September 30, 2003, our property and equipment included $8.6 million for one asset (sold in October 2003 for a gain of approximately $7 million), which met our criteria for held-for-sale classification. The remaining hotels included in our asset disposition program do not meet the probability criteria as prescribed by SFAS No. 144 to classify as held-for-sale.

In 1999, we invested $40 million in MeriStar Investment Partners, L.P. (“MIP”), a joint venture established to acquire upscale, full-service hotels. Our cost-basis investment is in the form of a partnership interest, in which we earn a 16% cumulative preferred return. We recognize the return quarterly as it becomes due to us. As of September 30, 2003, cumulative preferred returns of $16.6 million were due from MIP and included in accounts receivable on the accompanying consolidated balance sheet. We expect that any cumulative unpaid preferred returns will be paid in the future from excess cash flow above our current return and from potential partnership hotel disposition proceeds in excess of debt allocated to individual assets. Given the current economic environment, we do not expect MIP’s operations to provide adequate cash flow in the near term for significant payment of our current returns or repayments of our cumulative unpaid preferred returns. We evaluate the collectibility of our preferred return based on our preference to distributions and the underlying value of the hotel properties. Should the current economic environment continue and the performance of the MIP properties not improve, the value of our original investment may also decline.

Aggregate future maturities as of September 30, 2003 were as follows (dollars in thousands):

As of September 30, 2003, all of our debt bore fixed rates of interest. Our overall weighted average interest rate was 8.91%. Based on market prices at September 30, 2003, the fair value of our long-term debt was $1.81 billion.

Senior unsecured notes. These notes are unsecured obligations of certain subsidiaries of ours, and MeriStar Hospitality guarantees payment of principal and interest on the notes. These notes contain various restrictive incurrence covenants, limiting our ability to initiate or transact certain business activities if specific financial thresholds are not achieved. One of those thresholds is maintaining a 2 to 1 fixed charge coverage ratio (as defined in the indentures, fixed charges only include interest on debt obligations and preferred equity). As of September 30, 2003, our fixed charge coverage ratio was below 2 to 1, and therefore we were not permitted generally to enter into certain transactions, including the repurchase of our stock, the issuance of any preferred stock, the payment of dividends, the incurrence of any additional debt, or the repayment of outstanding debt before it comes due, except as noted below.

There are certain exceptions with respect to the incurrence of additional debt and early repayment of debt features in the indentures. We currently have the ability to incur $300 million of secured financing within restricted subsidiaries. We also have a general carve-out to incur $50 million of unspecified borrowings within a restricted subsidiary. Additionally, we are permitted to repay subordinated debt prior to its maturity from the proceeds of a pari passu or junior financing with a longer term than the debt refinanced, an equity offering, or a financing within an unrestricted subsidiary. We are also permitted to invest five percent of consolidated net tangible assets (as defined in the indentures) in unrestricted subsidiaries and mortgage the properties contributed to the unrestricted subsidiaries. We completed a qualifying transaction under this exception during the third quarter of 2003 through a new secured facility financing (see discussion below).

Secured facilities. On September 26, 2003, we completed a $101 million, 10-year, commercial mortgage-backed securities financing, secured by a portfolio of four hotels, as permitted by the indentures to our senior unsecured notes and MeriStar Hospitality’s senior subordinated notes. The loan carries a fixed annual interest rate of 6.88% and matures in 2013. We incurred approximately $0.9 million in debt issuance costs related to the facility. The proceeds will be used to repay debt carrying higher interest rates or to fund capital expenditures or acquisitions to the extent that higher interest rate debt cannot be acquired at attractive prices.

We completed a $330 million non-recourse financing secured by a portfolio of 19 hotels in 1999. The loan bears a fixed annual interest rate of 8.01% and matures in 2009. The secured facility contains standard provisions that require the servicer to maintain in escrow cash balances for certain items such as property taxes and insurance. In addition, the facility contains a provision that requires our mortgage servicer to retain in escrow the excess cash from the encumbered hotels after payment of debt service (“Excess Cash”), if net hotel operating income (“NOI”) for the trailing twelve months declines below $57 million. This provision was triggered in October 2002 and will be effective until the hotels generate the minimum cash flow required for two consecutive quarters, at which time the cash being held in escrow will be released to us. Approximately $19.9 million of cash was held in escrow under this provision as of September 30, 2003. In July 2003, we signed an amendment to the loan agreement that permits the release of cash placed in escrow for all capital expenditures incurred on the 19 encumbered properties on or after April 1, 2003. Although the servicer will continue to retain in escrow any excess cash from the encumbered hotels, they will release cash for all capital

expenditures we have incurred from April 1, 2003 through the date of the amendment and future capital expenditures we incur on the 19 properties. Escrowed funds totaling approximately $11 million were available to fund capital expenditures under this provision as of September 30, 2003.

Notes payable to MeriStar Hospitality. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. The convertible notes are unsecured obligations and provide for semi-annual payments of interest each October 1 and April 1. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes. We incurred approximately $6.5 million in debt issuance costs related to the borrowing.

The proceeds from the new borrowing were used to repay $150.6 million of our 4.75% notes payable to MeriStar Hospitality due 2004, at an aggregate discount of approximately $1.4 million. The remaining proceeds from the borrowing were used to repurchase $22.6 million principal amount of our 8.75% notes payable to MeriStar Hospitality due in 2007, at varying prices, resulting in an aggregate discount of approximately $1.5 million. We recognized these gains, totaling $2.9 million, during the third quarter of 2003.

Also during the third quarter, we redeemed $18 million of the 8.75% notes payable to MeriStar Hospitality in exchange for 2,792,880 common OP units, resulting in a gain of $1.7 million. In October 2003, we repaid $59.3 million of these notes, at varying prices. We expect to recognize a loss of approximately $0.5 million during the fourth quarter related to these repurchases. As of November 1, 2003, we had approximately $105 million of the 8.75% notes payable to MeriStar Hospitality outstanding.

Credit facility. In May 2003, we reduced our borrowing capacity on our senior credit facility from $100 million to $50 million and wrote off approximately $0.7 million in related deferred financing costs. As of September 30, 2003, we had no outstanding borrowings under this facility.

This facility contains customary financial compliance measures, which became more stringent on a quarterly basis beginning in the first quarter of 2003. The sale of two hotels during the fourth quarter of 2002, two in the first half of 2003, as well as the settlement of our note receivable with Interstate Hotels, negatively affected our leverage covenant due to the loss of trailing 12-month EBITDA (as defined in the credit agreement) on a pro forma basis. If we are not in compliance with the leverage covenant or any other financial covenants at the end of a quarterly measuring period, we will be in default under the credit facility and will not be permitted to borrow under the credit facility. We have obtained a waiver of compliance with this leverage covenant from our lending group, which was extended through November 19, 2003. Because we do not anticipate needing to draw under the bank line or having borrowing capacity to do so in the near term, we expect to terminate the facility in late 2003. We have approximately $0.6 million of unamortized capitalized financing costs related to this facility as of September 30, 2003, which would be written off should we decide to terminate the facility.

Derivatives. We had three swap agreements that did not qualify for treatment as cash-flow hedges under SFAS No. 133 expire since September 30, 2002, one in December 2002, one in April 2003 and one in July 2003. As of September 30, 2003, we had no outstanding derivative instruments.

During the three and nine months ended September 30, 2003, we recognized $0.6 million and $4.0 million, respectively, of income related to the decrease in fair value of the liability recorded for the interest rate swap in place in those time periods. For the three and nine months ended September 30, 2003, we made cash payments on this swap of $0.6 million and $4.0 million, respectively. The change in fair value and the swap payments are netted together on our statement of operations, resulting in no effect on net income

During the three and nine months ended September 30, 2002, we recognized $1.9 million and $4.8 million, respectively, of income related to the decrease in fair value of the liability recorded for the interest rate swaps in place in those time periods. For the three and nine months ended September 30, 2002, we made cash payments on those swaps of $3 million and $9 million, respectively. The change in fair value and the swap payments are netted together on our statement of operations. During the nine months ended September 30, 2002, we also recognized a $4.7 million loss on the fair value of derivatives no longer classified as cash-flow hedges due to the repayment of the related hedged debt.

OP Units. Our partnership agreement provides for five classes of partnership interests: Common OP Units, Class B OP Units, Class C OP Units, Class D OP Units and Profits-Only OP Units (POPs).

On September 24, 2003, MeriStar Hospitality issued 12,000,000 shares of its common stock at a price of $7.20 per share ($82.9 million of net proceeds). In October 2003, MeriStar Hospitality issued an additional 1,800,000 shares at a price of $7.20 per share for $12.4 million of net proceeds. In connection with this issuance, MeriStar LP, Inc., a wholly-owned subsidiary of MeriStar Hospitality, contributed the net proceeds to us in exchange for the same number of Common OP Units, thereby increasing their limited partner interest from 90 percent to approximately 93 percent.

During the third quarter of 2003, we issued 2,792,880 Common OP Units in exchange for the redemption of $18 million of our 8.75% notes payable to MeriStar Hospitality (see Note 6). Also during 2003, MeriStar Hospitality issued 211,721 shares of restricted stock to employees pursuant to employment agreements, with an aggregate value of $0.7 million.

Redeemable OP Unit holders converted 883,000 and 400,000 of their OP Units, with a value of $20.1 million and $6.1 million, into MeriStar Hospitality’s common stock during the nine months ended September 30, 2003 and 2002 respectively. There were no material conversions for cash during the nine months ended September 30, 2003 and 2002.

POPs totaling 50,000 were relinquished in connection with the formal separation of management functions with Interstate Hotels during the first quarter of 2003. MeriStar Hospitality also issued 50,000 shares of its common stock to a former executive officer and director in connection with the separation.

In May 2002, we issued 162,500 POPs to an executive officer pursuant to an employment agreement. If all of the vesting criteria for the POPs were met, then each POP would have a value equivalent to the value of one share of MeriStar Hospitality’s common stock, which for this issuance totaled $2.9 million.

The following table presents the computation of basic and diluted loss per unit (amounts in thousands, except per unit amounts):

For the three months ended September 30, 2003 and 2002, 18,556,838 and 5,806,522 units, respectively, consisting of OP units issuable upon exercise, redemption or conversion of outstanding operating partnership units, MeriStar Hospitality’s stock options and its convertible notes, were excluded from the calculation of diluted loss per unit as the effect of their inclusion would be anti-dilutive. For the nine months ended

September 30, 2003 and 2002, 10,331,176 and 5,855,456 units, respectively, underlying these instruments were excluded from the calculation of diluted loss per unit as the effect of their inclusion would be anti-dilutive.

Litigation. In the course of our normal business activities, various lawsuits, claims and proceedings have been or may be instituted or asserted against us. Based on currently available facts, we believe that the disposition of matters that are pending or asserted will not have a material adverse effect on our financial position, results of operations or liquidity.

Minimum Lease Payments. We lease the land at certain of our hotels under long-term arrangements from third parties. Certain leases contain contingent rent features based on gross revenues at the respective property. Future minimum lease payments required under these operating leases as of September 30, 2003 were as follows (dollars in thousands):

Our obligations under other operating lease commitments, primarily for equipment and office space, are not significant.

We lease certain office, retail and parking space to outside parties under non-cancelable operating leases with initial or remaining terms in excess of one year. Future minimum rental receipts under these leases as of September 30, 2003 were as follows (dollars in thousands):

We sold three hotels during the third quarter of 2002, two hotels in the fourth quarter of 2002, one in the first quarter of 2003, one in the second quarter of 2003, and four hotels in the third quarter of 2003. In October 2003, we sold one hotel that met our criteria for held-for-sale classification as of September 30, 2003 (see Note 4). Operating results for these hotels, and where applicable the gain or loss on final disposition, are included in discontinued operations.

Summary financial information included in discontinued operations for these hotels were as follows (dollars in thousands):

The properties we intend to dispose of represent approximately one-third of our total properties. For the nine months ended September 30, 2003, the 35 disposition assets accounted for approximately 20% of our consolidated revenue and approximately 13% of consolidated operating income. For purposes of this calculation, we exclude depreciation and amortization and loss on asset impairments from operating income.

Certain of our subsidiaries and MeriStar Hospitality are guarantors of our senior unsecured notes. Certain of our subsidiaries are guarantors of MeriStar Hospitality’s senior subordinated notes. All guarantees are full and unconditional, and joint and several. Exhibit 99.1 to this Quarterly Report on Form 10-Q presents our supplementary consolidating financial statements, including each of our guarantor subsidiaries. This exhibit presents our consolidating balance sheets as of September 30, 2003 and December 31, 2002, consolidating statements of operations for the three and nine months ended September 30, 2003 and 2002, and consolidating statements of cash flows for the nine months ended September 30, 2003 and 2002. In connection with the $101 million secured financing completed at the end of September 30, 2003 (see Note 6), certain of our guarantor subsidiaries became non-guarantor subsidiaries.

Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and as such may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,” “anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity,” and similar expressions, whether in the negative or affirmative. All statements regarding our expected financial position, business and financing plans are forward-looking statements.

Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:


	•	the current slowdown of the national economy;

	•	economic conditions generally and the real estate market specifically;

	•	the impact of the September 11, 2001 terrorist attacks or actual or threatened future terrorist incidents;

	•	the threatened or actual outbreak of hostilities and international political instability;

	•	governmental actions;

	•	legislative/regulatory changes, including changes to laws governing the taxation of real estate investment trusts;

	•	level of proceeds from asset sales;

	•	cash available for capital expenditures;

	•	availability of capital;

	•	ability to refinance debt;

	•	rising interest rates;

	•	rising insurance premiums;

	•	competition;

	•	supply and demand for hotel rooms in our current and proposed market areas, including the existing and continuing weakness in business travel and lower-than-expected daily room rates;

	•	other factors that may influence the travel industry, including health, safety and economic factors; and

	•	generally accepted accounting principles, policies and guidelines applicable to real estate investment trusts.

These risks and uncertainties should be considered in evaluating any forward-looking statements contained in this report or incorporated by reference herein. All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are qualified by the cautionary statements in this section. We undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.

MeriStar Hospitality Operating Partnership, L.P. is the subsidiary operating partnership of MeriStar Hospitality, which is a real estate investment trust, or REIT. We own a portfolio of upscale, full-service hotels and resorts in the United States and Canada. Our portfolio is diversified by franchise and brand affiliations. As of September 30, 2003, we owned 101 hotels, with 26,290 rooms, all of which were leased by our taxable subsidiaries and managed by Interstate Hotels & Resorts, Inc. (“Interstate Hotels”). In October 2003, we sold one hotel with 71 rooms.

Our revenues have been derived from the operations of our hospitality properties, including room, food and beverage revenues, as well as from our leases of office, retail and parking rentals. Operating costs include direct costs to run our hotels, management fees to Interstate Hotels to manage our properties, depreciation of our properties, as well as sales, marketing and general and administrative costs. Our expenses also include interest on our debt and minority interest allocations, which represent the allocation of income to outside investors for properties that are not wholly owned.

The following discussion should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2002 as filed with the Securities and Exchange Commission, and with the unaudited consolidated financial statements and related notes included in Item 1 of this Quarterly Report on Form 10-Q.

The provisions of Statement of Financial Accounting Standards (SFAS) No. 144 require that current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002, including any gain or loss recognized on the sale, be recorded as discontinued operations. Accordingly, we have reclassified results of operations for 2003 and 2002 to conform to the requirements of SFAS No. 144. See Note 10 “Asset Dispositions,” included in Item 1 of this Quarterly Report on Form 10-Q for further information regarding the amounts reclassified. The following results of operations discussions compare revenues, operating expenses and significant charges for continuing operations. Discontinued operations are discussed as a separate component within each period’s comparison.

Three months ended September 30, 2003 compared with the three months ended September 30, 2002

The following table provides our hotels’ operating statistics on a comparable hotel basis for the three months ended September 30 (comparable hotels are those that were owned for substantially all of both periods):

Revenues. Total revenue decreased $1.5 million to $220.9 million for the three months ended September 30, 2003 from $222.4 million for the same period in 2002, primarily due to a $1.5 million decrease in room revenue mainly attributable to a decrease in average daily rate. The average daily rate declined 4.1% for the three months ended September 30, 2003 when compared with the same period in 2002 primarily due to an increase in rooms sold through discounted internet sales channels. The increase in occupancy of 3.2% for the same period partially offset the rate decline.

Operating expenses. Total operating expenses increased a net $25.4 million to $237.6 million for the quarter ended September 30, 2003 compared to $212.2 million for the same period in 2002. Hotel operating expenses increased from $91.4 million for the three months ended September 30, 2002 to $95.6 million for the same period in 2003 due mainly to an increase in room and food and beverage expenses stemming from improvements in occupancy at our hotels.

Other operating expenses increased $21.2 million to $142.0 million for the three months ended September 30, 2003 from $120.8 million for the same period in 2002 resulting mainly from a loss on asset impairments of $21 million. General and administrative expenses and property operating costs remained essentially flat over these periods. Property taxes, insurance and other costs increased $2.3 million due primarily to favorable resolutions with taxing jurisdictions in 2002.

Significant items. We recognized a loss on asset impairment of $21 million related to our asset disposition program during the three months ended September 30, 2003. As of September 30, 2003, we had 36 assets planned for disposition, one of which was sold in October 2003 (see “Discontinued operations” discussion below).

On July 1, 2003, we borrowed $170 million from MeriStar Hospitality under terms matching those of their 9.5% convertible subordinated notes issuance. The proceeds from the new borrowing were used to repay $150.6 million of our 4.75% notes payable to MeriStar Hospitality due in 2004, at an aggregate discount of approximately $1.4 million. The remaining proceeds from the borrowing were used to repurchase $22.6 million principal amount of our 8.75% notes payable to MeriStar Hospitality due in 2007, at varying prices, resulting in an aggregate discount of approximately $1.5 million. We recognized these gains, totaling $2.9 million, during the third quarter of 2003.

Also during the third quarter of 2003, we redeemed $18 million of the 8.75% notes payable to MeriStar Hospitality in exchange for 2,792,880 common OP units, resulting in a gain of $1.7 million.

We had three swap agreements that did not qualify for treatment as cash-flow hedges under SFAS No. 133, expire since September 30, 2002, one in December 2002, one in April 2003 and one in July 2003. As of September 30, 2003, we had no outstanding derivative instruments. Results for the 2002 third quarter included a net expense of $1.1 million related to the swap agreements in place during that time. Current quarter results were not materially affected by marking to market the swap agreement that expired in July 2003.

Interest expense. Interest expense increased $2.5 million due primarily to the July 2003 borrowing of 9.5% notes from MeriStar Hospitality (see Note 6 to our unaudited consolidated financial statements).

Discontinued operations. During 2002, we sold five hotels in separate transactions for an aggregate of $60.7 million in cash. During the first nine months of 2003, we completed the sale of six hotels in separate transactions for an aggregate of $74.5 million in cash. As of September 30, 2003, we had one hotel classified as held for sale, which we sold in early October 2003 for $16.5 million in cash (for a gain of approximately $7 million). For the three months ended September 30, 2003, we recognized a $2.8 million loss on disposal related to the four hotels we sold during the third quarter. We recognized a $6.4 million loss on disposal related to the three hotels we sold during the third quarter of 2002.

Nine months ended September 30, 2003 compared with the nine months ended September 30, 2002

The following table provides our hotels’ operating statistics on a comparable hotel basis for the nine months ended September 30 (comparable hotels are those that were owned for substantially all of both periods):

Revenues. Total revenue decreased $19.3 million to $703.9 million for the nine months ended September 30, 2003 from $723.2 million for the same period in 2002, primarily due to a $19 million decrease in room revenue directly attributable to a decrease in average daily rate. The average daily rate declined 4.2% for the nine months ended September 30, 2003 when compared with the same period in 2002 primarily due to

an increase in discounted internet sales as previously noted. The slight increase in occupancy over the same period did not significantly offset the rate decline.

Operating expenses. Total operating expenses increased a net $273.2 million to $921.6 million for the nine months ended September 30, 2003 compared with $648.4 million for the same period in 2002. Hotel operating expenses increased $7 million from $279.6 million for the nine months ended September 30, 2002 to $286.6 million for the same period in 2003 due primarily to increases in food and beverage expenses and other hotel operations. These expenses increased mainly due to customer satisfaction initiatives.

Other operating expenses increased $266.2 million to $635.0 million for the nine months ended September 30, 2003 from $368.8 million for the same period in 2002, resulting mainly from losses on asset impairments totaling $263.4 million in the first three quarters of 2003 (see “Significant items” discussion below). General and administrative and property operating costs remained essentially flat. Property tax refunds and favorable resolution of property tax liabilities, totaling approximately $6 million during 2002, contributed to the $7 million increase in property taxes, insurance and other expenses for the 2003 comparative period.

Significant items. We recognized losses on asset impairments totaling $285.7 million ($22.3 million of which is included in discontinued operations) related to our asset disposition program during the nine months ended September 30, 2003. As of September 30, 2003, we had 36 assets planned for disposition, one of which was sold in October 2003. (See the discussion in quarter over quarter comparison for further details related to the significant items occurring in the three months ended September 30, 2003).

Prior year results included a net expense of $4.2 million related to the swap agreements previously discussed. Current period results were not materially affected by marking to market the swap agreements that expired during 2003. Prior year results also included a $4.7 million loss on the fair value of derivatives no longer classified as cash-flow hedges due to the repayment of the debt that was originally hedged.

Interest expense. Interest expense increased $3.2 million due primarily to the July 2003 borrowing of 9.5% notes from MeriStar Hospitality (see Note 6 to our unaudited consolidated financial statements).

Discontinued operations. During 2002, we sold five hotels in separate transactions for an aggregate of $60.7 million in cash. During the first nine months of 2003, we completed the sale of six hotels in separate transactions for an aggregate of $74.5 million in cash. As of September 30, 2003, we had one hotel classified as held for sale, which we sold in early October 2003 for $16.5 million in cash (with a gain of approximately $7 million). As previously noted, discontinued operations for the nine months ended September 30, 2003 included impairment charges totaling $22.3 million related to the assets included in our disposition program. Discontinued operations for the nine months ended September 30, 2003 included a $2.8 million loss on disposal related to the four hotels we sold in the third quarter. Discontinued operations for the nine months ended September 30, 2002 included a $6.4 million loss on disposal related to three hotels we sold in the third quarter of 2002.

Our principal sources of liquidity are cash generated from operations, funds from borrowings, funds from the sales of assets and existing cash on hand. Our principal uses of cash include the funding of working capital obligations, debt service, debt repurchases, investments in hotels (including capital projects and possible future acquisitions). MeriStar Hospitality has stated publicly that it does not expect to pay a dividend on its common stock during 2003. We believe we have sufficient free cash flow currently, and we expect to have adequate cash flow during the next twelve months in order to fund our operations, capital commitments and debt service obligations. Our current and future liquidity is, however, greatly dependent upon our operating results, which are driven largely by overall economic conditions, and since September 11, 2001 have been heavily affected by geopolitical concerns and other factors affecting business and leisure travel. If general economic conditions are significantly worse than we expect for an extended period, this will likely have a negative effect on our projections of available cash flow and liquidity.


	•	Factors that affect our results of operations, including general economic conditions, demand for business and leisure travel, public concerns about travel safety related primarily to terrorism and related concerns, and other operating risks described under the caption, “Risk Factors — Operating Risks” in Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2002;

	•	Factors that affect our access to bank financing and the capital markets, including operational risks, high leverage, interest rate fluctuations, and other risks described under the caption “Risk Factors — Financing Risks” in Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2002; and

	•	Other factors described previously under the caption, “Cautionary Statement Regarding Forward-Looking Statements.”

We continue to take steps to strengthen our balance sheet, build liquidity, reduce our leverage and extend our debt maturities. We have been committed this year to hold cash balances of generally $60 million to $80 million in our operating accounts as a hedge against economic and geopolitical uncertainties, as well as to provide for our recurring cash requirements. We will seek to establish a new $50 million secured revolving credit facility prior to year-end 2003, which we anticipate would add to our liquidity.

As part of our strategy to reduce our leverage and extend our debt maturities, in connection with MeriStar Hospitality’s July 2003 offering of $170 million 9.5% convertible subordinated notes due 2010, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes due 2010. The proceeds from the borrowing were mainly used to repurchase substantially all of the 4.75% notes payable to MeriStar Hospitality due 2004, which were our next significant maturity, and $22.6 million of our 8.75% notes payable to MeriStar Hospitality due 2007. As a result of this transaction, we now have no material debt maturities until the 8.75% notes payable to MeriStar Hospitality mature in 2007. During the third quarter, we also redeemed a further $18 million of the 8.75% notes payable to MeriStar Hospitality in exchange for 2,792,880 common OP units. In October 2003, we repaid an additional $59.3 million of these notes. We currently have less than $4 million of the 2004 4.75% notes payable to MeriStar Hospitality outstanding and have reduced the amount outstanding on the 8.75% notes payable to MeriStar Hospitality to $105 million.

We completed a $101 million, 10-year, 6.88% commercial mortgage-backed securities financing, secured by a portfolio of four hotels, at the end of September. In September and October 2003, we also issued 13,800,000 common OP units to MeriStar Hospitality at a price of $7.20 per unit for net proceeds totaling $95.3 million (of which 1.8 million units, or $12.4 million of net proceeds, were issued in October 2003). To date, we have raised in 2003 approximately $91 million from the sale of seven of our properties, including the October 2003 sale of one hotel for $16.5 million. We ended the third quarter of 2003 with cash balances of $309.7 million (including marketable securities of $1 million), of which $271.3 million was unrestricted.

We currently have 35 hotels (after the October sale) planned for disposition. We expect to generate proceeds of approximately $280 million to $320 million over the next six to nine months from the disposition of these properties. Our ability to realize these estimated proceeds is, however, dependent upon finding qualified buyers willing to pay a purchase price that we consider reasonable. We intend to use a majority of the proceeds from any asset sales to reinvest in our core assets, to repurchase our senior debt and to fund acquisitions. Our strategy includes acquiring those hotels located in major urban markets and destination resorts with minimal seasonality and branded, larger hotels with significant meeting space.

We used a total of $5.3 million of cash in operations during the first nine months of 2003 compared with $47.3 million generated in the first nine months of 2002. Our operating results and the amount of cash generated by our hotel operations have been adversely affected by the continuing sluggish economy, the reduction in travel resulting from events of September 11, 2001, the threat of further terrorist attacks, and other factors affecting business and leisure travel. Cash flow from operations also decreased in 2003 due to

higher interest rates on our senior unsecured notes issued in February 2002 as well as the higher interest rate on our new 9.5% notes payable to MeriStar Hospitality issued in July of this year. Partially offsetting these increases in interest was savings of approximately $3.2 million in interest on our previous revolving credit facility, which was repaid with the net proceeds from the February 2002 senior unsecured notes issuance.

Included in our operating results is our 16% cumulative preferred return on our partnership interest in MIP. As of September 30, 2003, approximately $16.6 million of cumulative preferred returns remained unpaid. We expect that any cumulative unpaid preferred returns will be paid in the future from excess cash flow above our current return and from potential partnership hotel disposition proceeds in excess of debt allocated to individual assets. Given the current economic environment, we do not expect MIP’s operations to provide adequate cash flow in the near term for significant payment of our current returns or repayments of our cumulative unpaid preferred returns.

Our investing activities provided a net $75.4 million of cash during the first nine months of 2003, resulting primarily from:


	•	$42.1 million from Interstate Hotels for the repayment of their note receivable; and

	•	$74.5 million in proceeds from the sale of six non-core hotel assets; partially offset by

	•	$21.8 million in capital expenditures (including $2.4 million of capitalized interest); and

	•	$18 million increase in cash restricted for mortgage escrows.

We generated a net $166.6 million of cash from financing activities during the first nine months of 2003 due mainly to:


	•	$271 million from the issuance of new debt;

	•	$82.9 million from the issuance of common OP units (total proceeds of $95.3 million, including the October 2003 issuance of an additional 1.8 million units for $12.4 million); partially offset by

	•	$179.3 million in repayments of debt.

MeriStar Hospitality must distribute to stockholders at least 90% of its REIT taxable income, excluding net capital gains, to preserve the favorable tax treatment accorded to REITs under the Internal Revenue Code. MeriStar Hospitality, as our general partner, must use its best efforts to ensure our partnership distributions meet this requirement. Under certain circumstances, MeriStar Hospitality may be required to make distributions in excess of cash available for distribution in order to meet the Internal Revenue Code requirements. In that event, we and/or MeriStar Hospitality would seek to borrow additional funds or sell additional non-core assets for cash, or both, to the extent necessary to obtain cash sufficient to make the distributions required to retain MeriStar Hospitality’s qualification as a REIT. Any future distributions will be at the discretion of MeriStar Hospitality’s board of directors and will be determined by factors including our operating results, restrictions imposed by our borrowing agreements, capital expenditure requirements, the economic outlook, the distribution requirements for REITs under the Internal Revenue Code and such other factors as our board of directors deems relevant. Our senior unsecured notes indenture permits the payment of dividends in order to maintain REIT qualification if we fall below a 2 to 1 fixed charge coverage ratio. However, MeriStar Hospitality’s senior subordinated notes indenture is more restrictive in that it permits the payment of dividends only if we exceed the 2 to 1 fixed charge coverage ratio. The timing and amount of any future distributions is dependent upon these factors, and we cannot provide assurance that any such distributions will be made in the future.

Notes payable to MeriStar Hospitality. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. These convertible notes are unsecured obligations and provide for semi-annual payments of interest each October 1 and April 1. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms

Also during the third quarter of 2003, we redeemed $18 million of the 8.75% notes payable to MeriStar Hospitality in exchange for 2,792,880 common OP units, resulting in a gain of $1.7 million. In October 2003, we repaid $59.3 million of these notes, at varying prices. We expect to recognize a loss of approximately $0.5 million during the fourth quarter related to these repurchases.

Credit facility. In May 2003, we reduced our borrowing capacity on this facility from $100 million to $50 million and wrote off approximately $0.7 million in related deferred financing costs. As of September 30, 2003, we had no outstanding borrowings under this facility.

Senior unsecured notes. As of September 30, 2003, we had $950 million of aggregate principal of these notes outstanding. These notes contain various restrictive incurrence covenants, limiting our ability to initiate or transact certain business activities if specific financial thresholds are not achieved. One of those thresholds is maintaining a 2 to 1 fixed charge coverage ratio (as defined in the indentures, fixed charges only include interest on debt obligations and preferred equity). As of September 30, 2003, our fixed charge coverage ratio was below 2 to 1, and therefore we were not permitted to enter into certain transactions, including the repurchase of our stock, the issuance of any preferred stock, the payment of dividends, the incurrence of any additional debt, or the repayment of outstanding debt before it comes due, except as noted below.

There are certain exceptions with respect to the incurrence of additional debt and early repayment of debt features in the indentures. We currently have the ability to incur $300 million of secured financing within restricted subsidiaries. We also have a general carve-out to incur $50 million of unspecified borrowings within a restricted subsidiary. Additionally, we are permitted to repay subordinated debt prior to its maturity from the proceeds of a pari passu or junior financing with a longer term than the debt refinanced, an equity offering, or a financing within an unrestricted subsidiary. We are also permitted generally to invest five percent of consolidated net tangible assets (as defined in the indentures) in an unrestricted subsidiary and mortgage the properties contributed to the unrestricted subsidiary. We completed a qualifying transaction under this exception during the third quarter of 2003 through a new secured facility financing (see discussion below).

Secured facilities. On September 26, 2003, we completed a $101 million commercial mortgage-backed securities financing, secured by a portfolio of four hotels, as permitted by the indentures to our senior unsecured notes and MeriStar Hospitality’s senior subordinated notes. The loan carries a fixed annual interest rate of 6.88% and matures in 2013. We incurred approximately $0.9 million in debt issuance costs related to the facility. The proceeds will be used to repay debt carrying higher interest rates, or to fund capital expenditures or acquisitions to the extent that higher interest rate debt cannot be acquired at attractive prices.

One of our key short-term strategies is to sell selected non-core assets, many of which were acquired as part of a portfolio. These “non-core” assets generally possess one or more of the following characteristics:


	•	secondary market locations;

	•	secondary brand affiliations;

	•	higher than average future capital expenditure requirements;

	•	limited future growth potential; or

	•	an over-weighted market location.


	•	improve the overall quality of the hotel assets remaining in our portfolio;

	•	enhance the ability of our portfolio to perform well in all cycles of the economy;

	•	enhance future growth prospects when strength returns to the economy;

	•	reduce future capital requirements on a relative basis; and

	•	reduce our leverage and requirements on our liquidity resources.

We are aided in our disposition program by the fact that we can terminate the management agreement of any hotel we sell, in some cases subject to the payment of a fee as discussed below, as well as the fact that 73 of our current 100 assets are unencumbered and only 13 of those assets are subject to ground leases. Excluding the assets included in our asset disposition program, we would have 41 unencumbered assets and seven subject to ground leases.

We recognized an impairment loss in 2002 on certain non-core assets we were then actively marketing. We sold one hotel in January 2003 for $12.7 million. Late in the first quarter of 2003, we expanded our asset disposition program to include a total of 16 non-core assets and recorded an impairment charge in the first quarter of $56.7 million. In April 2003, we sold one of these hotels for $3.1 million. During the second quarter of 2003, we made the determination to dispose of an additional 19 non-core assets. Also, due to the market interest in certain of our other hotel assets, we decided to add an additional six assets to our disposition program. We recognized an additional impairment loss of $208 million related to our asset disposition program during the second quarter of 2003. In the third quarter of 2003, we sold four more of these hotels for $59 million. During the third quarter of 2003, we made the determination to dispose of one additional asset and retain one of our assets previously included in our disposition program. We also changed our expected holding period for another asset and revised our sales prices on certain other assets included in our disposition

program. As a result, we recognized an additional impairment loss of $21 million during the three months ended September 30, 2003. In October 2003, we sold another hotel included in our disposition program for $16.5 million.

The impairment charges are based on our estimates of the fair value of the disposition properties. These estimates require us to make assumptions about the sales prices that we expect to realize for each property as well as the timing of a potential sale. In making these estimates, we consider the operating results of the assets, the market for comparable properties, and quotes from brokers, among other information. Actual results could differ materially from these estimates.

As we dispose of the remaining 35 assets in our disposition program, we may incur termination obligations due to Interstate Hotels of up to a maximum of approximately $21 million, calculated assuming the immediate sale of the properties and assuming buyers of our hotel properties elect to have the properties managed by third-parties other than Interstate Hotels or do not assume the obligation as part of the sale transaction. Any such obligation would affect the calculation of the final gain or loss on the sale of a particular asset, since in accordance with current accounting guidance, the obligation is not recognized until such time as the asset disposition is complete and a termination notice is provided to Interstate Hotels. At that time, the recognition of any termination obligation will be included in discontinued operations. Payment of any obligation due under termination provisions of the contract is payable over a period of 30 months. This amount may be reduced by replacement management contracts.

In addition, we may from time to time receive offers on assets which we might consider selling. Any additional sales of assets may result in additional impairment charges in future periods, if and when such transactions might be undertaken. While we always consider any opportunities that may improve our financial condition or results of operations, we are not actively marketing any other assets than the 35 properties previously discussed. The properties we are disposing of represent approximately one-third of our total properties. For the nine months ended September 30, 2003, these 35 assets accounted for approximately 20% of our consolidated revenue and approximately 13% of consolidated operating income. For purposes of this calculation, we exclude depreciation and amortization and loss on asset impairments from operating income.

We make ongoing capital expenditures in order to keep our hotels competitive in their markets and to comply with franchise obligations, as described further in “Operating Risks” (the potential adverse impact of our failure to meet the requirements contained in our franchise and licensing agreements) included in Item 1 — Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2002. We fund our capital expenditures primarily from cash generated from operations and existing cash on hand, and intend to use a portion of the proceeds from the sales of non-core assets to provide capital for renovation work. We invested $21.8 million (including $2.4 million of capitalized interest) for ongoing capital expenditures during the first nine months of 2003, and we anticipate investing a total of $15 million to $20 million on capital expenditures during the fourth quarter of 2003. These ongoing programs will include room and facilities refurbishments, renovations, and furniture and equipment replacements. The deferral of capital spending to date has not significantly affected our business as, generally in the past, we acquired good quality assets and spent a relatively high level of capital in the early years of ownership. We believe the properties we are now marketing for sale typically have higher per room capital expenditure requirements than our core assets. Sales of these properties will allow us to focus our capital spending dollars in the future on our core portfolio.

Our consolidated financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. Preparing financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our

estimates and judgments, including those related to the impairment of long-lived assets and the recording of certain accrued liabilities. Some of our estimates are material to the financial statements. These estimates are therefore particularly sensitive as future events could cause the actual results to be significantly different from our estimates.

Our critical accounting policies include the accounting for the impairment or disposal of long-lived assets and the classification of properties as held for sale. Our hotel properties generally fall into two categories, held for use and held for sale. Our held for use properties may include those that we are actively marketing. Until such time as our criteria for held for sale are met, as described below in further detail, we maintain classification as an operational asset. At the time we determine an asset to meet the criteria noted below, we reclassify the asset and its operations to discontinued operations. Both categories are subject to an impairment analysis whenever events or changes in circumstances indicate that the carrying value may be impaired.

We adopted the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” on January 1, 2002. SFAS No. 144 requires the current and prior period operating results of any asset that has been classified as held for sale or had been disposed of on or after January 1, 2002 and where we have no continuing involvement, including any gain or loss recognized, to be recorded as discontinued operations.

We adopted the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” on January 1, 2003. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Our strategy includes the disposition of certain hotel assets, all of which are managed under agreements which typically include termination penalty clauses with Interstate Hotels. As a result, we may incur termination obligations related to our asset dispositions. Any such liability will be recognized at the time the asset disposition is complete and a termination notice is provided to Interstate Hotels. At that time, the recognition of the termination obligation will be included in the calculation of the final gain or loss on sale and will be included in discontinued operations.

Held-for-sale classification requires that the sale be probable and that the transfer of the asset is expected to be completed within one year, among other criteria. Assessing the probability of the sale requires significant judgment due to the uncertainty surrounding completing the transaction. As a result, we have the following policy in aiding in assessing probability. We classify the properties we are actively marketing as held for sale once all of these conditions are met.


	•	Our board has approved the sale,

	•	We have a fully executed agreement with a qualified buyer which provides for no significant outstanding or continuing obligations with the property after sale, and

	•	We have a significant non-refundable deposit.

We carry properties held for sale at the lower of their carrying values or estimated fair values less costs to sell. If our estimates are incorrect, the carrying values may not be accurately reflected. We cease depreciation at the time the asset is classified as held for sale. If material to our total portfolio, we segregate the held for sale properties on our consolidated balance sheet. We also reclassify the operating results of properties held for sale as discontinued operations for all periods presented.

We have future long-term debt and ground lease obligations related to our consolidated entities and properties. As of September 30, 2003, we were not involved in any off-balance sheet arrangements with MIP.

The following table summarizes our aggregate contractual obligations as of September 30, 2003 (dollars in thousands):


^(a)	For a description of the material terms of our long-term debt, see “Financial Condition, Liquidity, and Capital Resources — Long-Term Debt.”

^(b)	In October 2003, we repurchased a further $59.3 million of the 8.75% notes payable to MeriStar Hospitality.

There were no material changes with respect to this item from the disclosure included in our Annual Report on Form 10-K for the year ended December 31, 2002.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and regulations, and that the information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures based closely on the definition of “disclosure controls and procedures” in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired objectives, and management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, we have investments in certain unconsolidated entities. As we do not control or manage these entities, our disclosure controls and procedures with respect to these entities are substantially more limited than those we maintain with respect to our consolidated subsidiaries.

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 chief accounting officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2003. Based on this evaluation, we concluded that our disclosure controls and procedures were effective.

During the three months ended September 30, 2003, there were no significant changes in our internal controls or in other factors that could significantly affect these controls.

On September 29, 2003, we filed a current report on Form 8-K (Items 5 and 7) announcing MeriStar Hospitality had completed a $101 million commercial mortgage-backed securities financing, secured by four of our properties.

On September 23, 2003, we filed a current report on Form 8-K (Items 5 and 7) announcing MeriStar Hospitality had issued approximately 2.79 million shares of its common stock in exchange for $18.0 million of its 8.75% senior subordinated notes due 2007.

On July 28, 2003, we furnished a current report on Form 8-K (Item 12) announcing the financial results of MeriStar Hospitality for the quarter ended June 30, 2003.

On July 3, 2003, we furnished a current report on Form 8-K (Item 7 and 9) announcing MeriStar Hospitality had completed the sale of $170 million of 9.5% convertible subordinated notes.

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


	MERISTAR HOSPITALITY OPERATING
	PARTNERSHIP, L.P.
	MERISTAR HOSPITALITY FINANCE CORP.
	MERISTAR HOSPITALITY FINANCE CORP. II
	MERISTAR HOSPITALITY FINANCE CORP. III


	By:	MERISTAR HOSPITALITY CORPORATION, ITS GENERAL PARTNER

	By:	/s/ PAUL W. WHETSELL



	Paul W. Whetsell
	Chief Executive Officer
	(Principal Executive Officer and Duly Authorized Officer)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
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: 333-63768






MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.		MERISTAR HOSPITALITY FINANCE CORP
(Exact name of registrant as specified in its charter)		(Exact name of registrant as specified in its charter)





75-2648837		52-2321015
(I.R.S. Employer Identification No.)		(I.R.S. Employer Identification No.)





MERISTAR HOSPITALITY FINANCE CORP II		MERISTAR HOSPITALITY FINANCE CORP III
(Exact name of registrant as specified in its charter)		(Exact name of registrant as specified in its charter)





73-1658708		46-0467463
(I.R.S. Employer Identification No.)		(I.R.S. Employer Identification No.)


		Page





PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements




	Consolidated Balance Sheets — September 30, 2003 and December 31, 2002		3




	Consolidated Statements of Operations — Three and Nine Months Ended September 30, 2003 and 2002		4




	Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2003 and 2002		5




	Notes to Unaudited Consolidated Financial Statements		6




Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16




Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27




Item 4.	Controls and Procedures		27




PART II. OTHER INFORMATION




Item 6.	Exhibits and Reports on Form 8-K		28




Signatures			29


	September 30,
	2003			December 31,
	(Unaudited)			2002

ASSETS
Property and equipment	$	2,577,640		$	3,020,909
Accumulated depreciation		(426,576	)		(460,972	)

		2,151,064			2,559,937
Restricted cash		38,403			20,365
Investment in affiliate		40,000			40,000
Note receivable from Interstate Hotels & Resorts		—			42,052
Prepaid expenses and other assets		42,437			40,911
Accounts receivable, net of allowance for doubtful accounts of $1,709 and $848		64,469			56,828
Marketable securities (Note 2)		1,000			—
Cash and cash equivalents (Note 2)		270,274			33,889

	$	2,607,647		$	2,793,982


LIABILITIES AND PARTNERS’ CAPITAL
Long-term debt	$	1,392,032		$	1,296,597
Notes payable to MeriStar Hospitality Corporation		337,093			357,505
Accounts payable and accrued expenses		100,324			104,677
Accrued interest		40,185			52,907
Due to Interstate Hotels & Resorts		5,969			10,500
Other liabilities		12,734			15,967

Total liabilities		1,888,337			1,838,153

Minority interests		2,565			2,624
Redeemable OP units at redemption value, 3,312 and 4,195 outstanding		33,535			38,205
Partners’ capital – Common OP Units, 61,119 and 45,231 issued and outstanding		683,210			915,000

	$	2,607,647		$	2,793,982



			Three Months Ended						Nine Months Ended
			September 30,						September 30,

			2003			2002			2003			2002

Revenue:




	Hotel operations:
		Rooms	$	146,057		$	147,548		$	455,590		$	474,540
		Food and beverage		53,660			54,089			181,230			181,174
		Other hotel operations		17,570			17,469			56,736			55,174
	Office rental, parking and other revenue			3,579			3,309			10,337			12,331

Total revenue				220,866			222,415			703,893			723,219

Hotel operating expenses:
		Rooms		40,360			38,259			116,040			114,197
		Food and beverage		43,268			41,998			134,257			131,551
		Other hotel operating expenses		11,080			10,424			34,119			31,621
Office rental, parking and other expenses				933			740			2,147			2,237




Other operating expenses:
		General and administrative		39,426			39,781			121,679			121,936
		Property operating costs		37,730			37,287			109,844			109,275
		Depreciation and amortization		26,032			28,256			82,849			87,316
		Loss on asset impairments		21,000			—			263,377			—
		Property taxes, insurance and other		17,816			15,478			57,292			50,268

Operating expenses				237,645			212,223			921,604			648,401

Operating (loss) income				(16,779	)		10,192			(217,711	)		74,818
Gain on early extinguishments of debt				4,574			—			4,574			—
Change in fair value of non-hedging derivatives, net of swap payments				—			(1,132	)		—			(4,211	)
Loss on fair value of non-hedging derivatives				—			—			—			(4,735	)
Minority interest income (expense)				—			18			(6	)		10
Interest expense, net				(36,404	)		(33,949	)		(106,017	)		(102,786	)

Loss from continuing operations before income taxes				(48,609	)		(24,871	)		(319,160	)		(36,904	)
Income tax benefit				305			591			462			748

Loss from continuing operations				(48,304	)		(24,280	)		(318,698	)		(36,156	)




Discontinued operations:
	Loss from discontinued operations before income tax (expense) benefit			(2,737	)		(6,591	)		(22,168	)		(1,410	)
	Income tax benefit (expense)			—			132			(32	)		6

Loss from discontinued operations				(2,737	)		(6,459	)		(22,200	)		(1,404	)

Net loss			$	(51,041	)	$	(30,739	)	$	(340,898	)	$	(37,560	)

	Preferred distributions			(141	)		(141	)		(424	)		(424	)

	Net loss applicable to common unitholders		$	(51,182	)	$	(30,880	)	$	(341,322	)	$	(37,984	)

	Net loss applicable to general partner unitholder		$	(48,261	)	$	(28,437	)	$	(319,974	)	$	(34,922	)

	Net loss applicable to limited partner unitholders		$	(2,921	)	$	(2,443	)	$	(21,348	)	$	(3,062	)


Loss per unit:




	Basic and Diluted:
		Loss from continuing operations	$	(0.96	)	$	(0.50	)	$	(6.44	)	$	(0.75	)
		Loss from discontinued operations		(0.05	)		(0.13	)		(0.45	)		(0.03	)

	Net loss per basic and diluted unit		$	(1.01	)	$	(0.63	)	$	(6.89	)	$	(0.78	)


2003 (three months)	$	2,255
2004		21,717
2005		10,375
2006		11,238
2007		175,560
Thereafter		1,507,980

	$	1,729,125


2003 (three months)	$	360
2004		1,437
2005		1,440
2006		1,427
2007		1,427
Thereafter		56,368

	$	62,459


2003 (three months)	$	1,175
2004		4,428
2005		2,896
2006		2,027
2007		1,456
Thereafter		1,929

	$	13,911


ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


	2003		2002		Change

Average daily rate	$	90.76	$	94.61		(4.1	)%
Occupancy		67.0%		64.9%		3.2	%
Revenue per available room (RevPAR)	$	60.81	$	61.43		(1.0	)%


					Less than		One to		Three to
		Total			One Year		Three Years		Five Years			Thereafter

Long-term debt, net of unamortized discount^(a):
	Senior unsecured notes	$	944,540		$	—	$	—	$	548,221		$	396,319
	Secured facility, due 2009		310,474			5,423		13,906		291,145			—
	Secured facility, due 2013		101,000			1,304		3,605		6,188			89,903
	Mortgage debt and other		36,018			2,108		12,636		8,110			13,164

	Total long term debt		1,392,032			8,835		30,147		853,664			499,386

Notes payable to
	MeriStar Hospitality		337,093	^(b)		—		3,705		163,388	^(b)		170,000
Ground lease obligations			62,459			1,318		2,990		3,594			54,557

Aggregate contractual obligations		$	1,791,584		$	10,153	$	36,842	$	1,020,646		$	723,943


ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK


Exhibit
No.		Description of Document

	4.1	Indenture, dated as of July 1, 2003, by and among the registrant, MeriStar Hospitality Operating Partnership, L.P., the guarantors party thereto and U.S. Bank Trust National Association, as trustee (incorporated by reference to Exhibit 4.1 to the registrant’s current report on Form 8-K dated July 3, 2003).
	4.2	Officers’ Certificate establishing the terms of MeriStar Hospitality Corporation’s 9.50% Convertible Subordinated Notes due 2010 (incorporated by reference to Exhibit 4.2 to the registrant’s current report on Form 8-K dated July 3, 2003).
	4.8	Letter agreement dated November 11, 2003 relating to exhibits.
	13	Financial Statements of MeriStar Hospitality Operating Partnership, L.P. as of and for the three and nine months ended September 30, 2003.
	31.1	Sarbanes-Oxley Act Section 302 Certification of Chief Executive Officer.
	31.2	Sarbanes-Oxley Act Section 302 Certification of 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.
	99.1	Consolidating Financial Information of MeriStar Hospitality Operating Partnership, L.P.


	September 30,		December 31,
	2003		2002

Land	$	251,933	$	288,611
Buildings and improvements		2,005,884		2,351,769
Furniture, fixtures and equipment		286,007		344,541
Construction-in-progress		33,816		35,988

	$	2,577,640	$	3,020,909


ITEM 4.	CONTROLS AND PROCEDURES


ITEM 6.	EXHIBITS AND REPORTS ON FORM 8-K