Ashford Hospitality Trust - 10-Q quarterly report FY

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number: 001-31775

ASHFORD HOSPITALITY TRUST, INC.

Registrant’s telephone number, including area code: (972) 490-9600

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

ASHFORD HOSPITALITY TRUST, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2005

TABLE OF CONTENTS

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PART I: FINANCIAL INFORMATION (Unaudited)

ASHFORD HOSPITALITY TRUST, INC.

See notes to consolidated financial statements.

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ASHFORD HOSPITALITY TRUST, INC.

See notes to consolidated financial statements.

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Ashford Hospitality Trust, Inc.

See notes to consolidated financial statements.

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ASHFORD HOSPITALITY TRUST, INC.

See notes to consolidated financial statements.

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ASHFORD HOSPITALITY TRUST, INC.

1. Organization and Description of Business

Ashford Hospitality Trust, Inc. and subsidiaries (the “Company”) is a self-advised real estate investment trust (“REIT”), which commenced operations on August 29, 2003 when it completed its initial public offering (“IPO”) and concurrently consummated certain other formation transactions, including the acquisition of six hotels (“initial properties”). The Company owns its lodging investments and conducts its business through Ashford Hospitality Limited Partnership, its operating partnership. Ashford OP General Partner LLC, its wholly-owned subsidiary, serves as the sole general partner of the Company’s operating partnership.

The Company has elected to be treated as a REIT for federal income tax purposes. Because of limitations imposed on REITs in operating hotel properties, the Company’s operating partnership leases its hotels to Ashford TRS Corporation (“Ashford TRS”), which is a wholly-owned subsidiary of the operating partnership and is treated as a taxable REIT subsidiary for federal income tax purposes. Ashford TRS then engages third-party hotel management companies to operate the hotels under management contracts. Remington Lodging & Hospitality, L.P., or Remington Lodging, is the Company’s primary property manager and is wholly owned by Mr. Archie Bennett, Jr., the Company’s Chairman, and Mr. Montgomery J. Bennett, the Company’s President and Chief Executive Officer. As of March 31, 2005, Remington Lodging managed 36 of the Company’s 55 hotel properties while unaffiliated management companies managed the remaining 19 hotel properties.

As of March 31, 2005, 36,532,847 common shares, 2,300,000 Series A preferred shares, 993,049 Series B preferred shares, and 11,092,075 units of limited partnership interest were outstanding. During the three months ended March 31, 2005, the Company completed the following transactions:

As of March 31, 2005, the Company owned 55 hotel properties in 17 states with 9,346 rooms, and had acquired or originated mezzanine or first-mortgage loans receivable with a balance at March 31, 2005 of approximately $81.5 million.

2. Basis of Presentation

These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. Accordingly, these financial statements do not include certain information and disclosures required by GAAP for complete financial statements. However, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, considered necessary for a fair presentation have been included. In addition, the operations of the Company’s hotels have historically been seasonal. This seasonality pattern causes fluctuations in the Company’s operating results. Consequently, operating results for the three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes for the year ended December 31, 2004, included in the Company’s Form 10-K, as filed with the Securities and Exchange Commission on March 16, 2005. The accounting policies used in preparing these consolidated financial statements are consistent with those described in such Form 10-K.

3. Significant Accounting Policies Summary

Principles of Consolidation – The Company’s consolidated financial statements include the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions among the consolidated entities have been eliminated in these consolidated financial statements.

Revenue Recognition – Hotel revenues include room, food, beverage, and other hotel revenues such as long-distance telephone service, laundry, and space rentals. Interest income from notes receivable represents interest earned on the Company’s mezzanine and first-mortgage loans receivable portfolio. Asset management fees relate to asset management services performed on behalf of an affiliate, including risk management and insurance procurement, assistance with taxes, negotiating franchise agreements and equipment leases, monitoring compliance with loan covenants, preparation of capital and operating budgets, and property litigation management. Revenues are recognized as the related services are delivered.

Use of Estimates – The preparation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States requires management 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 revenue and expenses during the reporting period. Actual results could differ from those estimates.

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Investment in Hotel Properties – The initial properties are stated at the predecessor’s historical cost, net of any impairment charges, plus approximately $8.1 million of minority interest partial step-up recorded upon the Company’s formation related to the acquisition of minority interest from unaffiliated parties associated with four of the initial properties. Hotel properties acquired subsequent to the Company’s formation are stated at cost. All improvements and additions which extend the useful life of hotel properties are capitalized.

Impairment of Investment in Hotel Properties — Hotel properties are reviewed for impairment whenever events or changes in circumstances indicate the carrying value of the hotel properties may not be recoverable. The Company tests for impairment in several situations, including when current or projected cash flows are less than historical cash flows, when it becomes more likely than not that a hotel will be sold before the end of its previously estimated useful life, and when events or changes in circumstances indicate that a hotel’s net book value may not be recoverable. In evaluating the impairment of hotel properties, the Company makes many assumptions and estimates, including projected cash flows, holding period, expected useful life, future capital expenditures, and fair values, including consideration of capitalization rates, discount rates, and comparable selling prices. If an asset were deemed to be impaired, the Company would record an impairment charge for the amount that the property’s net book value exceeds its fair value. To date, no such impairment charges have been recognized.

Depreciation and Amortization Expense — Depreciation expense is based on the estimated useful life of the Company’s assets, while amortization expense for leasehold improvements is based on the shorter of the lease term or the estimated useful life of the related assets. Presently, hotel properties are depreciated using the straight-line method over lives which range from 15 to 39 years for buildings and improvements and 3 to 5 years for furniture, fixtures, and equipment. While the Company believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income (loss) as well as the gain or loss on the potential sale of any of the Company’s hotels.

Restricted Cash — Restricted cash includes reserves for debt service, real estate taxes, and insurance, as well as excess cash flow deposits and reserves for furniture, fixtures, and equipment replacements of approximately 4% of property revenue for certain hotels, as required by certain mortgage debt agreement restrictions and provisions.

Assets Held For Sale and Discontinued Operations — The Company records assets as held for sale when management has committed to a plan to sell the assets, actively seeks a buyer for the assets, and the consummation of the sale is considered probable and within one year. The related operations of assets held for sale are reported as discontinued if such operations and cash flows can be clearly distinguished, both operationally and financially, from the rest of the Company, such operations and cash flows will be eliminated from ongoing operations once the disposal occurs, and the Company will not have any significant continuing involvement subsequent to the disposal. As of March 31, 2005, assets held for sale consists entirely of eight hotel properties that were acquired March 16, 2005 in connection with the acquisition of a 21-property portfolio. Consequently, no significant gain or loss is expected upon the sale of these properties.

Notes Receivable – The Company provides mezzanine and first-mortgage financing in the form of loans. Loans receivable are recorded at cost, adjusted for net origination fees and costs. Premiums, discounts, and net origination fees are amortized or accreted as an adjustment to interest income using the effective interest method. Loans receivable are reviewed for potential impairment at each balance sheet date. A loan receivable is considered impaired when it becomes probable, based on current information, that the Company will be unable to collect all amounts due according to the loan’s contractual terms. The amount of impairment, if any, is measured by comparing the recorded amount of the loan to the present value of the expected cash flows or fair value of collateral. If a loan were deemed to be impaired, the Company would record a reserve for loan losses through a charge to income for any shortfall. To date, no such impairment charges have been recognized.

In accordance with Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities,” as revised (“FIN No. 46”), variable interest entities, as defined, are required to be consolidated by their primary beneficiaries if the variable interest entities do not effectively disperse risks among parties involved. The Company’s mezzanine and first-mortgage loans receivable are each secured by various hotel properties or partnership interests in hotel properties and are subordinate to primary loans related to the secured hotels. All of these loans receivable are considered to be variable interests in the entities that own the related hotels, which are variable interest entities. However, the Company is not considered to be the primary beneficiary of these hotel properties as a result of holding these loans. Therefore, the Company does not consolidate the hotels for which it has provided financing. Interests in entities acquired or created in the future will be evaluated based on FIN No. 46 criteria, and such entities will be consolidated, if required. The analysis utilized by the Company in evaluating FIN No. 46 criteria involves considerable management judgment and assumptions.

Derivative Instruments and Hedging Activities — Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (“SFAS No. 133”), establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. As required by SFAS No. 133, the Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly

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in earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction.

The Company’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Interest rate caps designated as cash flow hedges provide the Company with interest rate protection above the strike rate on the cap and result in the Company receiving interest payments when rates are above the cap strike.

Income Taxes — As a REIT, the Company generally will not be subject to federal corporate income tax on the portion of its net income (loss) that does not relate to taxable REIT subsidiaries. However, Ashford TRS is treated as a taxable REIT subsidiary for federal income tax purposes. For the three months ended March 31, 2005, the benefit from income taxes relates to the net loss associated with Ashford TRS.

Stock-based Compensation — The Company accounts for stock-based compensation using the intrinsic-value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” In connection with the Company’s formation, the Company established an Employee Stock Plan (the “Stock Plan”). Under the Stock Plan, the Company has issued 1,157,117 shares of restricted common stock to its executives, directors, and certain employees of the Company and its affiliates and 10,000 shares of non-restricted common stock to its directors. Of the 1,157,117 restricted shares issued, 1,132,117 vest over three years and 25,000 vested over six months. Although the 10,000 non-restricted shares issued vested immediately, these shares represent compensation for the subsequent year of service. All such shares are charged to compensation expense on a straight-line basis over the vesting or service period based on the Company’s stock price on the date of issuance. Under the Stock Plan, the Company may issue a variety of performance-based stock awards, including nonqualified stock options. As of March 31, 2005, no performance-based stock awards have been issued other than the restricted and non-restricted shares discussed above. Consequently, stock-based compensation as determined under the intrinsic-value method is the same under the fair-value method.

Earnings (Loss) Per Share - Basic earnings (loss) per common share is calculated by dividing net income (loss) available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings (loss) per common share reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares, whereby such exercise or conversion would result in lower earnings per share. The following table reconciles the amounts used in calculating basic and diluted earnings (loss) per share for the three months ended March 31, 2005 and 2004 (in thousands, except share and per share amounts):

For both the three months ended March 31, 2005 and 2004, diluted per share amounts related to income from continuing operations available to common shareholders, loss from discontinued operations, and net income available to common shareholders are anti-dilutive. Consequently, diluted per share amounts and diluted weighted average shares outstanding are the same as basic on the consolidated statements of operations for both periods.

Segments – The Company presently operates in two business segments within the hotel lodging industry: direct hotel investments and hotel financing. Direct hotel investments refers to owning hotels through either acquisition or new development. Hotel financing refers to owning subordinate hotel-related mortgage receivables through acquisition or origination.

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4. Investment in Hotel Properties

Investment in Hotel Properties consists of the following as of March 31, 2005 and December 31, 2004 (in thousands):

On March 16, 2005, the Company acquired 21 hotel properties from selling entities controlled by affiliates of Fisher Brothers, Gordon Getty Trust, and George Soros, which collectively owned approximately 78% of the acquired hotels, and certain members of the Company’s senior management, which collectively owned approximately 22% of the acquired hotels, for approximately $250.0 million. Eight of the 21 acquired hotel properties are included in assets held for sale on the consolidated balance sheet at March 31, 2005, as discussed below. Considering closing costs, this acquisition generated an increase in Investment in Hotel Properties of approximately $210.6 million with the remainder of the purchase price related to working capital or assets held for sale.

On March 22, 2005, the Company acquired the Hilton Santa Fe hotel in Santa Fe, New Mexico, from Santa Fe Hotel Joint Venture for approximately $18.2 million. Considering closing costs, this acquisition generated an increase in Investment in Hotel Properties of approximately $18.6 million.

5. Discontinued Operations

On January 19, 2005, the Company sold an office building for approximately $2.9 million, which is net of nominal closing costs. The Company had acquired this office building, which had one tenant and nominal operations, on July 7, 2004, in connection with its acquisition of an adjacent hotel property in Philadelphia, Pennsylvania, for approximately $16.7 million in cash. At the time of the acquisition, the Company planned to sell the office building. Accordingly, the Company allocated approximately $2.9 million of the total purchase price to the office building, which is included in assets held for sale on the consolidated balance sheet at December 31, 2004. Consequently, no gain or loss was recognized on this sale.

On March 16, 2005, the Company acquired 21 hotel properties for approximately $250.0 million. When the Company entered into the agreement to acquire these 21 properties, it began assessing various strategic alternatives related to eight of the relatively smaller hotel properties, including possible sales of these properties. As of March 31, 2005, the Company had secured contracts or letters of intent related to the sale of all eight properties. The Company allocated approximately $36.7 million of the total purchase price to these eight hotel properties, and anticipates the subsequent sale of these properties will not result in significant gains or losses or adverse tax consequences. The carrying values of these eight hotels are included in assets held for sale on the consolidated balance sheet at March 31, 2005. However, such carrying values are preliminary and subject to further internal review, third-party appraisals, and finalization of related sales contracts.

For the three months ended March 31, 2005, financial information related to the Company’s eight hotel properties included in discontinued operations was as follows (in thousands):

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6. Notes Receivable

Notes receivable consists of the following as of March 31, 2005 and December 31, 2004 (in thousands):

On February 8, 2005, the Company originated a mezzanine loan receivable of approximately $8.0 million, as shown in the above table, with an interest rate of LIBOR plus 9.13%, maturing February 2007 with three one-year extension options, with interest-only payments through maturity, prepayment prohibited through September 2006, and a prepayment penalty imposed between September 2006 and maturity.

During the three months ended March 31, 2005, the Company received payments of approximately $6.2 million related to a portion of a mezzanine loan receivable that was secured by eight hotel properties. As a result of these prepayments, the $16.9 million mezzanine loan receivable, secured by 14 hotel properties at December 31, 2004, became the $10.7 million mezzanine loan receivable, secured

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by six hotel properties at March 31, 2005.

In general, the Company’s notes receivable have extension options, prohibit prepayment through a certain period, and require decreasing prepayment penalties through maturity.

As of March 31, 2005, all notes receivable balances were current and no reserve for loan losses had been recorded.

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At March 31, 2005 and December 31, 2004, LIBOR was 2.87% and 2.40%, respectively.

On January 20, 2005, with proceeds generated from its follow-on public offering, the Company repaid the then outstanding $17.8 million balance on its $60.0 million credit facility, due August 17, 2007, the $15.5 million mortgage note payable, due December 31, 2005, and the $7.0 mortgage note payable, due July 31, 2007. As a result, the Company incurred prepayment penalties associated with the $15.5 million mortgage note payable of approximately $78,000 and wrote-off unamortized loan costs associated with the $15.5 million and $7.0 million mortgage loans of approximately $151,000.

On March 16, 2005, in connection with the acquisition of a 21-property hotel portfolio, the Company assumed approximately $164.7 million in mortgage notes payable, of which approximately $14.7 million was repaid immediately. The debt assumed relates to the $19.2 million, $84.0 million, and $32.3 million mortgages shown in the above table. The Company originally recorded such debt at a premium of approximately $5.7 million as the fixed interest rates on such debt exceed current interest rates that the Company would otherwise incur on similar financial instruments. The debt premium is amortized as an adjustment to interest expense over the terms of the related debt instruments using the effective interest method, which resulted in a reduction to interest expense of approximately $75,000 during the three months ended March 31, 2005. In addition, the $19.2 million mortgage had been reduced by an $18.2 million payment made by the Company on March 30, 2005, which generated a loss on early extinguishment of debt of approximately $2.3 million. The loss on early extinguishment of debt is net of the write-off of the related portion of the debt premium of approximately $1.4 million.

During the three months ended March 31, 2005, the Company completed draws of $15.0 million and $20.0 million on March 16, 2005 and March 22, 2005, respectively, related to its $60.0 million credit facility.

During the three months ended March 31, 2005, the Company paid down approximately $3.5 million of its $45.6 million credit facility in connection with the partial payoff of one of the mezzanine notes receivable securing the facility.

In addition, the Company’s $6.3 million mortgage note payable, due January 1, 2006, and its $11.8 million mortgage note payable, due April 1, 2011, both require decreasing prepayment penalties through maturity. The Company’s $84.0 million mortgage note payable, due December 7, 2010, requires prepayment penalties through March 11, 2008.

8. Derivative Instruments and Hedging Activities

On September 2, 2004, the Company purchased a 6.0% LIBOR interest rate cap with a $210.0 million notional amount to limit its exposure to rising interest rates on $210.0 million of its floating-rate debt. To partially offset the cost of the purchased cap, the Company sold a 6.0% LIBOR interest rate cap with a $105.0 million notional amount with identical terms to the purchased cap. Both interest rate caps mature October 2, 2006. The Company has designated the net purchased option of $105.0 million as a cash flow hedge of its exposure to changes in interest rates on a corresponding amount of variable-rate debt.

On September 7, 2004, the Company entered into a $105.0 million stair-stepped interest rate swap agreement, at an average interest rate of 4.9% over the term of the swap, which matures March 1, 2007. The interest rate swap effectively converts the interest payments on $105.0 million of the Company’s floating-rate debt to a fixed rate and has been designated as a cash flow hedge.

As of March 31, 2005, no derivatives were designated as fair value hedges or hedges of net investments in foreign operations. Additionally, the Company does not use derivatives for trading or speculative purposes, and currently does not have any derivatives that are not designated as hedges.

At March 31, 2005, derivatives with a fair value of approximately $1.6 million were included in other assets, and derivatives with a fair value of approximately $15,000 were included in other liabilities. During the three months ended March 31, 2005, the change in net unrealized gains/losses of approximately $986,000 for derivatives designated as cash flow hedges is separately disclosed as accumulated other comprehensive income in the consolidated statement of owners’ equity. During the three months ended March 31, 2005, no hedge ineffectiveness was recognized.

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the three months ended March 31, 2005, the change in net unrealized gains/losses on cash flow hedges reflects a reclassification of approximately $77,000 from accumulated other comprehensive income to a reduction in interest expense. During the next twelve months, the Company estimates that approximately $868,000 will be reclassified from other comprehensive income existing at March 31, 2005 to a reduction to interest expense.

9. Employee Stock Grants

In 2003, upon consummation of the IPO and subsequent exercise of the underwriters’ over-allotment, the Company issued 714,317 shares of restricted common stock to its executives, directors, and certain employees of the Company and its affiliates. Of the 714,317 shares issued, 689,317 vest over three years and 25,000 vested over six months. The value of the shares is charged to compensation expense on a straight-line basis based on the IPO price of $9.00 per share.

On March 15, 2004, the Company issued 70,400 shares of restricted common stock to its executives and certain employees. These shares vest over three years, and the value of the shares is charged to compensation expense on a straight-line basis based on the closing price on the date of issuance of $10.41 per share.

On May 19, 2004, the Company issued 10,000 shares of common stock to its directors as compensation for serving on the Board of Directors through May 2005. These shares vested immediately, and the value of these shares is charged to compensation expense over

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the year of service on a straight-line basis based on the closing price on the date of issuance of $8.90 per share.

On March 24, 2005, the Company issued 372,400 shares of restricted common stock to its executives and certain employees. These shares vest over three years, and the value of the shares is charged to compensation expense on a straight-line basis based on the closing price on the date of issuance of $10.04 per share.

For the three months ended March 31, 2005 and 2004, the Company recognized compensation expense of approximately $620,000 and $596,000, respectively, related to these shares.

10. Capital Stock

Preferred Stock - In accordance with the Company’s charter, the Company is authorized to issue 50 million shares of preferred stock, which includes both Series A cumulative preferred stock and Series B cumulative convertible redeemable preferred stock. During the three months ended March 31, 2005, the Company incurred approximately $243,000 in additional issuance costs related to the issuance of the Series B cumulative convertible redeemable preferred stock, which occurred on December 30, 2004.

Common Stock - On January 20, 2005, in a follow-on public offering, the Company issued 10,350,000 shares of its common stock at $9.62 per share, which generated gross proceeds of approximately $99.6 million. However, the aggregate proceeds to the Company, net of underwriters’ discount and offering costs, was approximately $94.4 million. The 10,350,000 shares issued include 1,350,000 shares sold pursuant to an over-allotment option granted to the underwriters. Of the net proceeds, a portion was used to partially fund the $35.0 million cash portion of the purchase price associated with the acquisition of a 21-property hotel portfolio, which closed on March 16, 2005. The net proceeds were also used for the repayment of approximately $14.7 million of the mortgage debt assumed in the acquisition, repayment of the then outstanding $17.8 million balance on the $60.0 million credit facility, due August 17, 2007, repayment of the $15.5 million mortgage note payable, due December 31, 2005, repayment of the $7.0 mortgage note payable, due July 31, 2007, and general corporate purposes.

11. Minority Interest

Minority interest in the operating partnership represents the limited partners’ proportionate share of the equity in the operating partnership. Net income (loss) is allocated to minority interest based on the weighted average limited partnership percentage ownership throughout the period. Upon formation of the Company on August 29, 2003, and subsequent exercise of the underwriters’ over-allotment option on September 26, 2003, the Company issued 5,657,917 units of limited partnership interest to affiliates. On April 1, 2004, the Company issued an additional 106,675 units of limited partnership interest in connection with the acquisition of a hotel property. On September 2, 2004, the Company issued an additional 333,333 units of limited partnership interest in connection with the acquisition of nine hotel properties. On March 16, 2005, the Company issued an additional 4,994,150 units of limited partnership interest in connection with the acquisition of 21 hotel properties.

As of March 31, 2005 and December 31, 2004, these units of limited partnership interest represent a 23.29% and 19.11% minority interest ownership, respectively. Beginning one year after issuance, each unit of limited partnership interest may be redeemed for either cash or one share of the Company’s common stock at the Company’s discretion. To date, no units of limited partnership interest have been redeemed

12. Related Party Transactions

Under management agreements with related-party affiliates owned by the Company’s Chairman and its Chief Executive Officer, the Company is obligated to pay such affiliates a) monthly management fees equal to the greater of $10,000 or 3% of gross revenues as well as an annual incentive management fee, if certain operational criteria are met, b) market service fees on the approved capital improvements, including project management fees of up to 4% of project costs, and c) other reimbursements as approved by the Company’s independent directors.

Under these agreements and agreements with other hotel managers, the Company incurred the following amounts during the three months ended March 31, 2005 and 2004 (in thousands):

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Management agreements with related-party affiliates include exclusivity clauses that require the Company to engage such affiliates, unless the Company’s independent directors either (i) unanimously vote to hire a different manager or developer, or (ii) by a majority vote, elect not to engage such affiliate because special circumstances exist or, based on the affiliate’s prior performance, it is believed that another manager or developer could materially improve the performance of the duties.

In addition to the above, these affiliates also pay for certain corporate general and administrative expenses on behalf of the Company, including rent, payroll, office supplies, and travel. Such charges are allocated to the Company based on various methodologies, including headcount, office space, usage, and actual amounts incurred. For the three months ended March 31, 2005 and 2004, such costs were approximately $287,000 and $368,000, respectively, which are reimbursed by the Company monthly.

Regarding the acquisition of the 21-property hotel portfolio, completed on March 16, 2005, these 21 hotels are among the 27 hotel properties for which the Company provided asset management and consulting services for an affiliate. In connection with the acquisition, the asset management and consulting agreements for these properties were terminated, and the Company no longer receives any fees under the terminated agreements. Although the Company does not expect the remaining six hotel properties for which it provides asset management and consulting services to generate sufficient revenue to result in annual fees of at least $1.2 million as guaranteed in the agreement, the affiliate, pursuant to the agreement, will continue to guarantee a minimum annual fee of $1.2 million for approximately five years following the Company’s IPO.

Regarding the acquisition of the 21-property hotel portfolio, completed on March 16, 2005, the Company’s Board of Directors formed a Special Committee solely comprised of independent directors to evaluate this transaction. The Special Committee retained independent advisors to review, evaluate, and negotiate the transaction, which the Special Committee unanimously approved. On April 6, 2005, the Special Committee was paid $195,000 related to their services.

13. Commitments and Contingencies

Restricted Cash - Under existing debt agreements, the Company is obligated to escrow payments for insurance, real estate taxes, and debt service. In addition, for certain properties with debt, the Company is obligated to escrow 4% of gross revenue for capital improvements.

Franchise Fees - Under the existing franchise agreements, the Company is obligated to pay the franchisors royalty fees between 2.5% and 5% of gross room revenue, and fees for marketing, reservations, and other related activities aggregating between 1% and 3.75% of gross room revenue. These franchise agreements expire beginning in 2011 through 2024. When a franchise term expires, the franchisor has no obligation to issue a new franchise. The termination of a franchise could have a material adverse effect on the operations or the underlying value of the affected hotel due to the loss of associated name recognition, marketing support, and centralized reservation systems provided by the franchisor. The termination of a franchise could also have a material adverse effect on cash available for distribution to stockholders. In addition, if the Company terminates a franchise prior to its expiration date, the Company may be required to pay up to three times the average annual franchise fees incurred for that property.

Management Fees - Under the existing management agreements, the Company is obligated to pay a) monthly management fees equal to the greater of $10,000 or 3% of gross revenues, or in some cases just 3% to 4% of gross revenues, as well as an annual incentive management fee, if applicable, b) market service fees on the approved capital improvements, including project management fees of up to 4% of project costs, for certain hotels, and c) other general fees at current market rates as approved by the Company’s independent directors. These management agreements expire beginning in 2006 through 2022, with renewal options on those related to affiliates of up to twenty-five additional years. In addition, if the Company terminates a management agreement related to one of its initial properties prior to its expiration due to sale of the property, it may be required to pay all estimated management fees due under the management agreement’s remaining term. This termination fee may be avoided in certain circumstances by substitution of a similar property. If the Company terminates a management agreement related to a hotel acquired after the Company’s formation, or related to one of the initial properties for reasons other than sale of the property, it may be required to pay estimated management fees ranging from one to six years from the termination date or substitute a new management agreement related to a different hotel. In connection with the 21-property acquisition completed March 16, 2005, the affiliate managing these hotels waived the management agreement termination fees related to the eight hotel properties included in assets held for sale on the consolidated balance sheet at March 31, 2005.

Common Stock Dividends - On March 9, 2005, the Company declared a cash dividend of approximately $7.6 million, or $0.16 per diluted share, for common shareholders and units of limited partnership of record on March 31, 2005, which was paid April 15, 2005. Of the total cash dividend, common shareholders and unit holders received approximately $5.8 million and $1.8 million, respectively.

Series A Preferred Stock Dividends – On March 15, 2005, the Company declared a cash dividend of approximately $1.2 million, or $0.5344 per diluted share, for Series A preferred shareholders of record on March 31, 2005, which was paid April 15, 2005.

Series B Preferred Stock Dividends – On March 9, 2005, the Company declared a cash dividend of approximately $159,000, or $0.16 per diluted share, for Series B preferred shareholders of record on March 31, 2005, which was paid April 15, 2005.

Future Equity Issuances - On December 27, 2004, the Company executed a Series B Cumulative Convertible Redeemable Preferred Stock Purchase Agreement for the sale of Series B cumulative convertible redeemable preferred stock of the Company to a financial institution. Under the purchase agreement, 993,049 shares of Series B preferred stock were issued December 30, 2004 and 6,454,817

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shares of Series B preferred stock remain to be issued at $10.07 per share. The Company anticipates the remaining Series B preferred shares to be issued during 2005. Pursuant to this purchase agreement and subsequent amendment, the financial institution has certain participation rights with respect to any sale of equity securities by the Company. Based on these participation rights and the follow-on common stock offering completed on January 20, 2005, the financial institution has the option to purchase up to 2,070,000 shares of the Company’s common stock for $9.139 per share, the issuance of which would occur on November 1, 2005. If the financial institution has not exercised its option, the Company, at its option, may cause the financial institution to purchase the 2,070,000 shares for $9.139 per share on November 1, 2005, or on an earlier date provided the Company has sold all of the Series B preferred stock to the financial institution in accordance with the terms of the purchase agreement.

Insurance Losses - On January 30, 2005, the Company’s Sheraton hotel in Philadelphia, Pennsylvania, experienced a fire that resulted in extensive water damage to several of its floors. The entire hotel was subsequently closed for two weeks, and certain areas remained closed for several weeks thereafter. Although the Company’s insurance covers both physical damage and business-interruption losses, the Company is still assessing the impact of this fire. The Company currently estimates its property damage and business-interruption losses at approximately $1.0 million and $250,000, respectively. At March 31, 2005, the Company accrued $25,000 related to this incident, which represents the Company’s insurance deductible.

Acquisition Contingency - On July 23, 2004, the Company acquired four hotel properties from Day Hospitality Group for approximately $25.9 million in cash plus a contingent component based on the 2004 performance of the four acquired hotels to be paid, if earned, no later than April 30, 2005. As of March 31, 2005, the Company had accrued approximately $396,000 related to this contingency, which was subsequently paid to the seller.

Litigation - The Company is currently subject to litigation arising in the normal course of its business. In the opinion of management, none of these lawsuits or claims against the Company, either individually or in the aggregate, is likely to have a material adverse effect on the Company’s business, results of operations, or financial condition. In addition, management believes the Company has adequate insurance in place to cover any such significant litigation.

14. Supplemental Cash Flow Information

During the three months ended March 31, 2005 and 2004, interest paid was approximately $2.7 million and $623,000, respectively.

During the three months ended March 31, 2005, the Company recorded the following non-cash transactions: a) on March 9, 2005, the Company declared a cash dividend of approximately $7.6 million, or $0.16 per diluted share, for common shareholders and units of limited partnership of record on March 31, 2005, which was paid April 15, 2005, b) on March 9, 2005, the Company declared a cash dividend of approximately $159,000, or $0.16 per diluted share, for Series B preferred shareholders of record on March 31, 2005, which was paid April 15, 2005, c) on March 15, 2005, the Company declared a cash dividend of approximately $1.2 million, or $0.5344 per diluted share, for Series A preferred shareholders of record on March 31, 2005, which was paid April 15, 2005, d) on March 16, 2005, the Company assumed approximately $164.7 million in mortgage debt related to the acquisition of a 21-property hotel portfolio and recognized a debt premium of approximately $5.7 million, e) on March 16, 2005, the Company issued 4,994,150 units of limited partnership interest related to the acquisition of a 21-property hotel portfolio, f) on March 24, 2005, the Company issued 372,400 shares of restricted common stock to its executives and certain employees, and g) on March 30, 2005, in connection with the early extinguishment of debt, the Company wrote-off of the related portion of the debt premium of approximately $1.4 million.

During the three months ended March 31, 2004, the Company recorded the following non-cash transactions: a) on March 15, 2004, the Company declared a cash dividend of approximately $1.9 million, or $0.06 per diluted share, for shareholders and units of limited partnership of record on March 31, 2004, to be paid on April 15, 2004, and b) on March 15, 2004, the Company issued 70,400 shares of restricted stock to its executives and certain employees.

15. Segments Reporting

The Company presently operates in two business segments within the hotel lodging industry: direct hotel investments and hotel financing. Direct hotel investments refers to owning hotels through either acquisition or new development. Hotel financing refers to owning subordinate hotel-related mortgages through acquisition or origination.

The Company does not allocate corporate-level accounts to its operating segments, including corporate general and administrative expenses, non-operating interest income, interest expense, provision for income taxes, and minority interest. For the three months ended March 31, 2005, financial information related to the Company’s reportable segments was as follows (in thousands):

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For the three months ended March 31, 2004, financial information related to the Company’s reportable segments was as follows (in thousands):

As of March 31, 2005 and December 31, 2004, aside from the Company’s $81.5 million and $79.7 million portfolio of notes receivable, respectively, all assets of the Company primarily relate to the direct hotel investments segment. In addition, for the three months ended March 31, 2005 and 2004, all capital expenditures incurred by the Company relate to the direct hotel investments segment.

16. Business Combinations

On March 16, 2005, the Company acquired 21 hotel properties from selling entities controlled by affiliates of Fisher Brothers, Gordon Getty Trust, and George Soros, which collectively owned approximately 78% of the acquired hotels, and certain members of the Company’s senior management, which collectively owned approximately 22% of the acquired hotels, for approximately $250.0 

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million plus closing costs of approximately $4.3 million. The $250.0 million purchase price consisted of approximately $35.0 million in cash, approximately $164.7 million in assumed mortgage debt, and approximately $50.3 million worth of limited partnership units, which equates to 4,994,150 units based on the average market price of the Company’s common stock for the 20-day period ending five business days before signing a definitive agreement to acquire these properties on December 23, 2004, or $10.07 per share. Company management received their net consideration for the acquisition in the form of limited partnership units, whereas the third parties received 50% of their consideration in limited partnership units and 50% in cash. The accompanying consolidated financial statements include the results of the acquired hotels since the date of acquisition. The purchase price was the result of an arms’ length negotiation, and the Company did not assign any value to goodwill or other intangible assets. Regarding the debt assumed, the Company recorded such debt at a premium of approximately $5.7 million as the fixed interest rates on such debt exceed current interest rates that the Company would otherwise incur on similar financial instruments. The debt premium is amortized as an adjustment to interest expense over the terms of the related debt instruments using the effective interest method. In addition, the purchase price allocation is preliminary and subject to further internal review and third-party appraisals. Annualized revenues of these 21 hotel properties are approximately $114.9 million. The Company used proceeds from its sale of Series B cumulative convertible redeemable preferred stock on December 30, 2004, from its follow-on public offering on January 20, 2005, and from a $15.0 million draw on its $60.0 million credit facility on March 16, 2005 to fund the acquisition of these properties.

On March 22, 2005, the Company acquired the Hilton Santa Fe hotel in Santa Fe, New Mexico, from Santa Fe Hotel Joint Venture for approximately $18.2 million in cash. In addition, the Company plans an additional $2.5 million for future capital improvements. The accompanying consolidated financial statements include the results of the acquired hotel since the date of acquisition. The purchase price was the result of an arms’ length negotiation, and the Company did not assign any value to goodwill or other intangible assets. However, the purchase price allocation is preliminary and subject to further internal review and third-party appraisals. Annualized revenues of this hotel property are approximately $7.7 million. The Company used cash from borrowings and its follow-on public offering on January 20, 2005 to fund this acquisition.

The following unaudited pro forma statements of operations for the three months ended March 31, 2005 are based on the historical consolidated financial statements of the Company adjusted to give effect to the completion of the aforementioned acquisitions, as if such transactions occurred at the beginning of the period presented (in thousands, except share and per share amounts):

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17. Subsequent Events

On April 1, 2005, the Company sold a hotel, located in Dallas, Texas, for approximately $1.3 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $1.3 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

On April 5, 2005, in a follow-on public offering, the Company issued 5,000,000 shares of its common stock at $10.25 per share, which generated gross proceeds of approximately $51.3 million. However, the aggregate proceeds to the Company, net of underwriters’ discount and offering costs, was approximately $49.6 million. On May 4, 2005, the Company issued an additional 182,100 shares of its common stock pursuant to an over-allotment option granted to the underwriters, which generated additional proceeds of approximately $1.9 million. The net proceeds will be used for general corporate purposes, which may include the acquisition of additional hotel investments.

On April 15, 2005, the Company paid down $20.0 million on its $60.0 million credit facility, due August 17, 2007. On April 27, 2005, the Company drew an additional $15.0 million on this credit facility.

On April 18, 2005, the Company originated a mezzanine loan receivable of approximately $8.0 million, with an interest rate of 14%, which increases 1% annually until it reaches an 18% maximum, maturing April 2010, with interest-only payments through maturity, and prepayment prohibited through December 2007.

On April 19, 2005, the Company sold a hotel, located in Hyannis, Massachusetts, for approximately $4.6 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property

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hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $4.6 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

On April 22, 2005, the Company sold a hotel, located in Warner Robins, Georgia, for approximately $1.4 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $1.4 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

On April 26, 2005, the Company executed a definitive agreement to acquire a 30-property hotel portfolio from CNL Hotels and Resorts, Inc. for approximately $465.0 million in cash and made a deposit of approximately $15.0 million. The purchase price was the result of an arms’ length negotiation. Annualized revenues of these 30 hotels are approximately $120.5 million. The Company intends to fund the acquisition from several sources including: proceeds from a financing commitment for approximately $370.0 million at a fixed rate locked at 5.32%, proceeds from a financial institution related to either its remaining un-drawn Series B convertible redeemable preferred stock or its participation in the Company’s January follow-on common stock offering, proceeds from existing revolver capacity, or cash currently on hand. The acquisition is expected to close in June 2005. Regarding the $370.0 million financing commitment and related fixed rate lock agreement, the Company made a $7.4 million deposit with the lender on April 26, 2005 in order to lock into the 5.32% interest rate. As set forth in the agreement, this deposit may be increased from time to time depending on interest rate fluctuations, as defined. In addition, if the Company fails to consummate the loan, it will be subject to certain penalties, as defined.

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

FORWARD-LOOKING STATEMENTS:

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere herein. This report contains forward-looking statements within the meaning of the federal securities laws. Ashford Hospitality Trust, Inc. (the “Company” or “we” or “our”) cautions investors that any forward-looking statements presented herein, or which management may make orally or in writing from time to time, are based on management’s beliefs and assumptions at that time. Throughout this report, words such as “anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “result,” and other similar expressions, which do not relate solely to historical matters, are intended to identify forward-looking statements. Such statements are subject to risks, uncertainties, and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties, and factors beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution investors that while forward-looking statements reflect our good-faith beliefs at the time such statements are made, said statements are not guarantees of future performance and are impacted by actual events that occur after such statements are made. We expressly disclaim any responsibility to update forward-looking statements, whether as a result of new information, future events, or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which were based on results and trends at the time those statements were made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, those discussed in our Form 10-K as filed with the Securities and Exchange Commission on March 16, 2005. These risks and uncertainties continue to be relevant to our performance and financial condition. Moreover, we operate in a very competitive and rapidly changing environment where new risk factors emerge from time to time. It is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors 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. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

EXECUTIVE OVERVIEW:

We are a real estate investment trust (“REIT”) that commenced operations upon completion of our initial public offering (“IPO”) and related formation transactions on August 29, 2003. As of March 31, 2005, we owned 55 hotels and approximately $81.5 million of mezzanine loans receivable. Six of these hotels were contributed upon our formation, nine of these hotels were acquired in the fourth quarter of 2003, 18 of these hotels were acquired during 2004, and 22 of these hotels were acquired in the first quarter of 2005 (of which eight hotels are considered held for sale and included in discontinued operations). All of the loans receivable were originated or acquired since November 26, 2003. The 32 hotel properties acquired since 2003 that are included in continuing operations contributed approximately $26.1 million and $5.2 million to our total revenue and operating income, respectively, for the three months ended March 31, 2005, and approximately $185,000 and $29,000 to our total revenue and operating income, respectively, for the three months ended March 31, 2004.

Based on our primary business objectives and forecasted operating conditions, our key priorities or financial strategies include, among other things:

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Throughout 2004 and during the first quarter of 2005, strong economic growth in the United States economy combined with improved business demand led to the strong RevPar growth throughout the lodging industry. For the remainder of 2005, forecasts for the lodging industry continue to be favorable as U.S. Gross Domestic Product (“GDP”) is forecast to continue to expand.

RESULTS OF OPERATIONS:

RevPAR is a commonly used measure within the hotel industry to evaluate hotel operations. RevPAR is defined as the product of the average daily room rate (“ADR”) charged and the average daily occupancy achieved. RevPAR does not include revenues from food and beverage or parking, telephone, or other guest services generated by the property. Although RevPAR does not include these ancillary revenues, it is generally considered the leading indicator of core revenues for many hotels. We also use RevPAR to compare the results of our hotels between periods and to analyze results of our comparable hotels. Increases in RevPAR attributable to increases in occupancy are generally accompanied by increases in most categories of variable operating costs. Increases in RevPAR attributable to increases in ADR are generally accompanied by increases in limited categories of operating costs, such as management fees and franchise fees.

The following table illustrates the key performance indicators for the three months ended March 31, 2005 and 2004 for the 15 hotels we’ve owned throughout the comparative periods presented (unaudited):

The following table reflects key line items from our consolidated statements of operations for the three months ended March 31, 2005 and 2004 (in thousands, unaudited):

Comparison of the Three Months Ended March 31, 2005 and March 31, 2004

Revenue. Total revenue for the three months ended March 31, 2005 increased approximately $29.6 million or 153.5% to approximately $49.0 million from total revenue of approximately $19.3 million for the three months ended March 31, 2004, primarily due to approximately $25.9 million in revenues attributable to the 32 hotel properties acquired since 2003 that are included in continuing operations, approximately $1.7 million in interest income earned on the Company’s $81.5 million mezzanine loans receivable portfolio, approximately $71.5 million of which was acquired since 2003, and approximately $2.0 million increase in revenues for comparable hotels, primarily due to increases in room revenues.

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Room revenues at comparable hotels for the three months ended March 31, 2005 increased approximately $1.9 million or 12.7% compared to the same quarter of 2004, primarily due to an increase in RevPar from $70.54 to $80.35, which consisted of a 5.1% increase in ADR and an 8.4% increase in occupancy. Due to the continued recovery in the economy and consistent with industry trends, several hotels experienced increases in both ADR and occupancy. The most significant RevPar increases were experienced at the Las Vegas Embassy Suites, Syracuse Embassy Suites, Covington Radisson, Holtsville Radisson, and Dayton Doubletree. In addition to improved market conditions, these hotels benefited from the following:

Food and beverage revenues at comparable hotels for the three months ended March 31, 2005 increased approximately $112,000 or 5.3% compared to the first quarter of 2004. Food and beverage revenues increased at several hotels due to increases in occupancy, which is consistent with the increase in room revenues.

Other revenues at comparable hotels for the three months ended March 31, 2005 were virtually flat compared to the first quarter of 2004.

Interest income from notes receivable increased to approximately $2.5 million for the three months ended March 31, 2005 compared to approximately $844,000 for the first quarter of 2004 due to the mezzanine loans receivable portfolio of approximately $81.5 million at March 31, 2005, of which approximately $71.5 million was acquired since 2003.

Asset management fees were approximately $338,000 for the three months ended March 31, 2005 compared to approximately $320,000 for the first quarter of 2004. Regarding the acquisition of the 21-property hotel portfolio, completed on March 16, 2005, these 21 hotels are among the 27 hotel properties for which the Company provided asset management and consulting services for an affiliate. In connection with the acquisition, the asset management and consulting agreements for these properties were terminated, and the Company no longer receives any fees under the terminated agreements. Although the Company does not expect the remaining six hotel properties for which it provides asset management and consulting services to generate sufficient revenue to result in annual fees of at least $1.2 million as guaranteed in the agreement, the affiliate, pursuant to the agreement, will continue to guarantee a minimum annual fee of $1.2 million for approximately five years following the Company’s IPO.

Hotel Operating Expenses. Hotel operating expenses, which consists of room expense, food and beverage expense, other direct expenses, indirect expenses, and management fees, increased approximately $17.8 million or 143.1% for the three months ended March 31, 2005 compared to the first quarter of 2004, primarily due to approximately $16.9 million of expenses associated with the 32 hotel properties acquired since 2003 that are included in continuing operations. In addition, hotel operating expenses at comparable hotels experienced an increase of approximately $864,000 or 7.0% for the three months ended March 31, 2005 compared to the first quarter of 2004, primarily due to increases in rooms and indirect expenses.

Rooms expense at comparable hotels increased approximately $304,000 or 8.7% for the three months ended March 31, 2005 compared to the first quarter of 2004 primarily due to increased occupancy at several hotels and virtually flat costs at hotels experiencing comparable occupancy due to the fixed nature of maintaining staff. Food and beverage expense at comparable hotels for the three months ended March 31, 2005 compared to the first quarter of 2004 also increased, which is consistent with the increase in food and beverage revenues and the overall increase in occupancy. Indirect expenses at comparable hotels increased approximately $403,000 or 6.4% for the three months ended March 31, 2005 compared to the first quarter of 2004. Indirect expenses increased as a result of:

Property Taxes, Insurance, and Other. Property taxes, insurance, and other increased approximately $1.4 million or 116.8% for the three months ended March 31, 2005 compared to the first quarter of 2004, due to approximately $1.5 million of expenses associated with the 32 hotel properties acquired since 2003 that are included in continuing operations. Aside from additional costs incurred at these acquired hotels, property taxes, insurance, and other expense in the first quarter of 2005 decreased approximately $114,000 when compared to the first quarter of 2004, primarily due to decreased insurance and property tax rates.

Depreciation and Amortization. Depreciation and amortization increased approximately $2.5 million or 143.5% for the three months ended March 31, 2005 compared to the first quarter of 2004, primarily due to approximately $2.3 million of depreciation associated with the 32 hotel properties acquired since 2003 that are included in continuing operations. Aside from these additional hotels acquired, depreciation and amortization increased approximately $220,000 in the first quarter of 2005 compared to the first quarter of 2004 as a result of capital improvements made at several comparative hotels since the first quarter of 2004.

Corporate General and Administrative. Corporate general and administrative expense increased to approximately $3.3 million for the three months ended March 31, 2005 compared to approximately $2.5 million for the first quarter of 2004 primarily resulting from an increase in headcount and related salaries and benefits due to the substantial growth in the Company. As a percentage of total revenue, however, corporate general and administrative expense decreased from approximately 13.0% during the first quarter of 2004 to approximately 6.7% for the first quarter of 2005 due to corporate synergies inherent in overall growth. For the quarter ended March

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31, 2005, the total includes approximately $620,000 of non-cash expenses associated with the amortization of employee stock grants. For the quarter ended March 31, 2004, the total includes approximately $596,000 of non-cash expenses associated with the amortization of employee stock grants.

Operating Income. Operating income increased approximately $7.2 million from approximately $1.4 million for the three months ended March 31, 2004 to approximately $8.6 million for the three months ended March 31, 2005 as a result of the aforementioned operating results.

Interest Income. Interest income increased approximately $185,000 from approximately $92,000 for the three months ended March 31, 2004 to approximately $277,000 for the three months ended March 31, 2005, primarily due to interest earned on funds received from borrowings and equity offerings during the first quarter of 2005 in excess of interest earned on funds received from the Company’s IPO and subsequent borrowings during the first quarter of 2004.

Interest Expense and Amortization of Loan Costs. Interest expense and amortization of loan costs increased approximately $4.1 million from approximately $863,000 for the three months ended March 31, 2004 to approximately $5.0 million for the three months ended March 31, 2005. The increase in interest expense and amortization of loan costs is associated with the higher average debt balance over the course of the two comparative periods and the overall increase in average interest rates incurred.

Write-off of Loan Costs. On January 20, 2005, with proceeds generated from its follow-on public offering, the Company repaid its $15.5 million mortgage note payable, due December 31, 2005, and its $7.0 mortgage note payable, due July 31, 2007. As a result, the Company wrote-off unamortized loan costs of approximately $151,000. During the first quarter of 2004, there were no write-offs of unamortized loan costs.

Loss on Debt Extinguishment. On March 30, 2005, the Company paid down its mortgage debt, due October 11, 2022, by approximately $18.2 million, which generated a loss on early extinguishment of debt of approximately $2.3 million. The loss on early extinguishment of debt is net of the write-off of the related portion of a debt premium of approximately $1.4 million. During the first quarter of 2004, there was no loss on debt extinguishments.

Provision for Income Taxes. As a REIT, the Company generally will not be subject to federal corporate income tax on the portion of its net income that does not relate to taxable REIT subsidiaries. However, the Company leases each of its hotel properties to Ashford TRS, which is treated as a taxable REIT subsidiary for federal income tax purposes. For the three months ended March 31, 2005, the Company recognized an income tax benefit related to Ashford TRS of approximately $242,000. For the three months ended March 31, 2004, the Company did not recognize a provision for income taxes related to Ashford TRS.

Minority Interest. Minority interest was a reduction to net income of approximately $304,000 for the three months ended March 31, 2005 compared to a reduction to net income of approximately $122,000 for the first quarter of 2004. Upon formation of the Company on August 29, 2003, minority interest in the operating partnership was established to represent the limited partners’ proportionate share of the equity in the operating partnership. Net income (loss) is allocated to minority interest based on the weighted-average limited partnership percentage ownership throughout the period.

Income from Continuing Operations. Income from continuing operations was approximately $1.5 million for the three months ended March 31, 2005 and approximately $554,000 for the three months ended March 31, 2004, which represents an increase of approximately $915,000 as a result of the aforementioned operating results.

Loss from Discontinued Operations, Net. On March 16, 2005, the Company acquired 21 hotel properties for approximately $250.0 million. When the Company entered into the agreement to acquire these 21 properties, it began assessing various strategic alternatives related to eight of the relatively smaller hotel properties, including possible sales of these properties. As of March 31, 2005, the Company had secured contracts or letters of intent related to the sale of all eight properties. The Company preliminarily allocated approximately $36.7 million of the total purchase price to these eight hotel properties, and anticipates the subsequent sale of these properties will not result in significant gains or losses. The carrying values of these eight hotels are included in assets held for sale on the consolidated balance sheet at March 31, 2005. The results of operations related to these eight hotels are classified as discontinued operations, and represent a net loss of approximately $18,000 for the three months ended March 31, 2005. During the first quarter of 2004, the Company did not have operations classified as discontinued operations.

Net Income. Net income was approximately $1.5 million for the three months ended March 31, 2005 and approximately $554,000 for the three months ended March 31, 2004, which represents an increase of approximately $897,000 as a result of the aforementioned operating results.

Preferred Dividends. On March 15, 2005, the Company declared a cash dividend of approximately $1.2 million, or $0.5344 per diluted share, for Series A preferred shareholders of record on March 31, 2005, which was paid April 15, 2005. On March 9, 2005, the Company declared a cash dividend of approximately $159,000, or $0.16 per diluted share, for Series B preferred shareholders of record on March 31, 2005, which was paid April 15, 2005. In the first quarter of 2004, no preferred shares were outstanding.

Net Income Available to Common Shareholders. Net income available to common shareholders was approximately $63,000 for the three months ended March 31, 2005 and approximately $554,000 for the three months ended March 31, 2004, which represents a decrease of approximately $491,000 as a result of the aforementioned operating results and preferred dividends declared.

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Funds From Operations

The White Paper on Funds From Operations (“FFO”) approved by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”) in April 2002 defines FFO as net income (loss) computed in accordance with generally accepted accounting principles (“GAAP”), excluding gains (or losses) from sales of properties and extraordinary items as defined by GAAP, plus depreciation and amortization of real estate assets, and net of adjustments for the portion of these items related to unconsolidated entities and joint ventures. NAREIT developed FFO as a relative measure of performance of an equity REIT to recognize that income-producing real estate historically has not depreciated on the basis determined by GAAP.

We compute FFO in accordance with our interpretation of standards established by NAREIT, which may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the NAREIT definition differently than us. FFO does not represent cash generated from operating activities as determined by GAAP and should not be considered as an alternative to a) GAAP net income (loss) as an indication of our financial performance or b) GAAP cash flows from operating activities as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make cash distributions. We believe that to facilitate a clear understanding of our historical operating results, FFO should be considered along with our net income (loss) and cash flows reported in the consolidated financial statements.

The following table reconciles net income available to common shareholders to FFO available to common shareholders for the three months ended March 31, 2005 and 2004 (in thousands, unaudited):

For the three months ended March 31, 2005, FFO has not been adjusted to add back the loss on debt extinguishment of approximately $2.3 million, which is included in net income applicable to common shareholders.

LIQUIDITY AND CAPITAL RESOURCES:

Our principal source of funds to meet our cash requirements, including distributions to stockholders, is our share of the operating partnership’s cash flow. The operating partnership’s principal sources of revenue include: (i) cash flow from hotel operations, (ii) interest income from our mezzanine loans receivable portfolio, and (iii) management fees related to our eight asset management and consulting contracts with an affiliate.

Cash flows from hotel operations are subject to all operating risks common to the hotel industry, including:

During the three months ended March 31, 2005, we completed the following significant transactions, which impacted or will impact our cash flow and liquidity:

Business Combinations:

On March 16, 2005, the Company acquired 21 hotel properties from selling entities controlled by affiliates of Fisher Brothers, Gordon Getty Trust, and George Soros, which collectively owned approximately 78% of the acquired hotels, and certain members of the Company’s senior management, which collectively owned approximately 22% of the acquired hotels, for approximately $250.0 million plus certain closing costs. The $250 million purchase price consisted of approximately $35.0 million in cash, approximately $164.7 million in assumed mortgage debt, and approximately $50.3 million worth of limited partnership units, which equates to 4,994,150 units. The Company used proceeds from its sale of Series B cumulative convertible redeemable preferred stock on

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December 30, 2004, from its follow-on public offering on January 20, 2005, and from a $15.0 million draw on its $60.0 million credit facility on March 16, 2005 to fund the acquisition of these properties.

On March 22, 2005, the Company acquired the Hilton Santa Fe hotel in Santa Fe, New Mexico, from Santa Fe Hotel Joint Venture for approximately $18.2 million in cash. In addition, the Company plans an additional $2.5 million for future capital improvements. The Company used cash from borrowings and its follow-on public offering on January 20, 2005 to fund this acquisition.

Capital Stock:

On January 20, 2005, in a follow-on public offering, the Company issued 10,350,000 shares of its common stock at $9.62 per share, which generated gross proceeds of approximately $99.6 million. However, the aggregate proceeds to the Company, net of underwriters’ discount and offering costs, was approximately $94.4 million. The 10,350,000 shares issued include 1,350,000 shares sold pursuant to an over-allotment option granted to the underwriters. Of the net proceeds, a portion was used to partially fund the $35.0 million cash portion of the purchase price associated with the acquisition of a 21-property hotel portfolio, which closed on March 16, 2005. The net proceeds were also used for the repayment of approximately $14.7 million of the mortgage debt assumed in the acquisition, repayment of the then outstanding $17.8 million balance on the $60.0 million credit facility, due August 17, 2007, repayment of the $15.5 million mortgage note payable, due December 31, 2005, repayment of the $7.0 mortgage note payable, due July 31, 2007, and general corporate purposes.

On March 24, 2005, the Company issued an additional 372,400 shares of restricted common stock to its executives and certain employees. These shares vest over three years, and the value of the shares is charged to compensation expense on a straight-line basis based on the closing price on the date of issuance of $10.04 per share.

Discontinued Operations:

On January 19, 2005, the Company sold an office building for approximately $2.9 million, which is net of nominal closing costs. The Company had acquired this office building on July 7, 2004, in connection with its acquisition of an adjacent hotel property in Philadelphia, Pennsylvania, for approximately $16.7 million in cash. At the time of the acquisition, the Company planned to sell the office building. Accordingly, the Company allocated approximately $2.9 million of the total purchase price to the office building.

Notes Receivable:

On February 8, 2005, the Company originated a mezzanine loan receivable of approximately $8.0 million, with an interest rate of LIBOR plus 9.13%, maturing February 2007 with three one-year extension options, with interest-only payments through maturity, prepayment prohibited through September 2006, and a prepayment penalty imposed between September 2006 and maturity.

During the three months ended March 31, 2005, the Company received payments of approximately $6.2 million related to a portion of a mezzanine loan receivable that was secured by eight hotel properties. As a result of these prepayments, its $16.9 million mezzanine loan receivable, secured by 14 hotel properties at December 31, 2004, became the $10.7 million mezzanine loan receivable, secured by six hotel properties at March 31, 2005.

Indebtedness:

On January 20, 2005, with proceeds from the follow-on public offering discussed above, the Company repaid the then outstanding $17.8 million balance on its $60.0 million credit facility, due August 17, 2007, repaid the $15.5 million mortgage note payable, due December 31, 2005, and repaid the $7.0 mortgage note payable, due July 31, 2007.

During the three months ended March 31, 2005, the Company completed draws of $15.0 million and $20.0 million on March 16, 2005 and March 22, 2005, respectively, related to its $60.0 million credit facility, due August 17, 2007.

During the three months ended March 31, 2005, the Company paid down approximately $3.5 million of its $45.6 million credit facility, due July 13, 2007, in connection with the partial payoff of one of the mezzanine notes receivable securing the facility.

On March 30, 2005, the Company made an $18.2 million payment against its mortgage note payable, due October 11, 2022, to reduce the remaining outstanding balance on this mortgage to $19.2 million.

Dividends:

On March 9, 2005, the Company declared a cash dividend of approximately $7.6 million, or $0.16 per diluted share, for common shareholders and units of limited partnership of record on March 31, 2005, which was paid April 15, 2005.

On March 9, 2005, the Company declared a cash dividend of approximately $159,000, or $0.16 per diluted share, for Series B preferred shareholders of record on March 31, 2005, which was paid April 15, 2005.

On March 15, 2005, the Company declared a cash dividend of approximately $1.2 million, or $0.5344 per diluted share, for Series A preferred shareholders of record on March 31, 2005, which was paid April 15, 2005.

Net Cash Flow Provided By Operating Activities. For the three months ended March 31, 2005, net cash flow provided by operating activities increased approximately $8.1 million to approximately $9.8 million for the first three months of 2005 from approximately $1.7 million for the first three months of 2004. The increase in net cash flow provided by operating activities was primarily

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attributable to improved operating income in 2005, which resulted from improved operations at the 15 comparable hotels as well as the 40 hotels acquired since December 2003.

Net Cash Flow Used In Investing Activities. For the three months ended March 31, 2005, net cash flow used in investing activities was approximately $58.3 million, which consisted of approximately $8.1 million of acquisitions or originations of mezzanine loans receivable, approximately $54.8 million related to the acquisitions of a 21-property hotel portfolio and a hotel property in Santa Fe, New Mexico, and approximately $4.5 million of improvements to various hotel properties. These cash outlays were somewhat offset by proceeds of approximately $6.2 million related to payments on notes receivable and approximately $2.9 million related to the sale of an office building. For the three months ended March 31, 2004, net cash flow used in investing activities was approximately $88.7 million, which consisted of approximately $61.6 million of acquisitions or originations of mezzanine loans receivable, approximately $25.6 million related to the acquisition of a hotel property in Lake Buena Vista, Florida, and approximately $1.5 million of improvements to various hotel properties.

Net Cash Flow Provided By Financing Activities. For the three months ended March 31, 2005, net cash flow provided by financing activities was approximately $42.8 million, which represents approximately $35.0 million in draws on the Company’s $60.0 million credit facility and approximately $94.4 million of net proceeds received from the Company’s follow-on public offering on January 20, 2005, partially offset by approximately $6.1 million of dividends paid, $78.2 million of payments on indebtedness and capital leases, $2.0 million of payments of loan costs, and $243,000 of additional costs related to the issuance of Series B cumulative convertible redeemable preferred stock on December 30, 2004. For the three months ended March 31, 2004, net cash flow provided by financing activities was approximately $47.9 million, which primarily relates to a $49.8 million funding associated with the $60 million credit facility completed on February 5, 2004, offset by payments of related loan costs.

In general, we are focused exclusively on investing in the hospitality industry across all segments, including direct hotel investments, first mortgages, mezzanine loans, and sale-leaseback transactions. We intend to acquire and, in the appropriate market conditions, develop additional hotels and provide structured financings to owners of lodging properties. We may incur indebtedness to fund any such acquisitions, developments, or financings. We may also incur indebtedness to meet distribution requirements imposed on REITs under the Internal Revenue Code to the extent that working capital and cash flow from our investments are insufficient to fund the required distributions.

However, no assurances can be given that we will obtain additional financings or, if we do, what the amount and terms will be. Our failure to obtain future financing under favorable terms could adversely impact our ability to execute on our business strategy. In addition, we may selectively pursue mortgage financing on individual properties and our mortgage investments.

We will acquire or develop additional hotels and invest in structured financings only as suitable opportunities arise, and we will not undertake such investments unless adequate sources of financing are available. Funds for future hotel-related investments are expected to be derived, in whole or in part, from future borrowings under a credit facility or other borrowings or from the proceeds of additional issuances of common stock, preferred stock, or other securities. However, other than the aforementioned acquisitions, we have no formal commitment or understanding to invest in additional assets, and there can be no assurance that we will successfully make additional investments.

Our existing hotels are located in developed areas that contain competing hotel properties. The future occupancy, ADR, and RevPAR of any individual hotel could be materially and adversely affected by an increase in the number or quality of the competitive hotel properties in its market area. Competition could also affect the quality and quantity of future investment opportunities.

SUBSEQUENT EVENTS:

On April 1, 2005, the Company sold a hotel, located in Dallas, Texas, for approximately $1.3 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $1.3 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

On April 5, 2005, in a follow-on public offering, the Company issued 5,000,000 shares of its common stock at $10.25 per share, which generated gross proceeds of approximately $51.3 million. However, the aggregate proceeds to the Company, net of underwriters’ discount and offering costs, was approximately $49.6 million. On May 4, 2005, the Company issued an additional 182,100 shares of its common stock pursuant to an over-allotment option granted to the underwriters, which generated additional proceeds of approximately $1.9 million. The net proceeds will be used for general corporate purposes, which may include the acquisition of additional hotel investments.

On April 15, 2005, the Company paid down $20.0 million on its $60.0 million credit facility, due August 17, 2007. On April 27, 2005, the Company drew an additional $15.0 million on this credit facility.

On April 18, 2005, the Company originated a mezzanine loan receivable of approximately $8.0 million, with an interest rate of 14%, which increases 1% annually until it reaches an 18% maximum, maturing April 2010, with interest-only payments through maturity, and prepayment prohibited through December 2007.

On April 19, 2005, the Company sold a hotel, located in Hyannis, Massachusetts, for approximately $4.6 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $4.6 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

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On April 22, 2005, the Company sold a hotel, located in Warner Robins, Georgia, for approximately $1.4 million, which is net of nominal closing costs. The Company had acquired this hotel on March 16, 2005, in connection with its acquisition of a 21-property hotel portfolio. By March 31, 2005, the Company had secured contracts or letters of intent related to the sale of this hotel and seven other properties acquired in the aforementioned acquisition. Accordingly, the Company allocated approximately $1.4 million of the total purchase price to this hotel. Consequently, no gain or loss was recognized on this sale.

On April 26, 2005, the Company executed a definitive agreement to acquire a 30-property hotel portfolio from CNL Hotels and Resorts, Inc. for approximately $465.0 million in cash and made a deposit of approximately $15.0 million. The purchase price was the result of an arms’ length negotiation. Annualized revenues of these 30 hotels are approximately $120.5 million. The Company intends to fund the acquisition from several sources including: proceeds from a financing commitment for approximately $370.0 million at a fixed rate locked at 5.32%, proceeds from a financial institution related to either its remaining un-drawn Series B convertible redeemable preferred stock or its participation in the Company’s January follow-on common stock offering, proceeds from existing revolver capacity, or cash currently on hand. The acquisition is expected to close in June 2005. Regarding the $370.0 million financing commitment and related fixed rate lock agreement, the Company made a $7.4 million deposit with the lender on April 26, 2005 in order to lock into the 5.32% interest rate. As set forth in the agreement, this deposit may be increased from time to time depending on interest rate fluctuations, as defined. In addition, if the Company fails to consummate the loan, it will be subject to certain penalties, as defined.

INFLATION:

We rely entirely on the performance of our properties and the ability of the properties’ managers to increase revenues to keep pace with inflation. Hotel operators can generally increase room rates rather quickly, but competitive pressures may limit their ability to raise rates faster than inflation. Our general and administrative costs, such as real estate and personal property taxes, property and casualty insurance, and utilities, are subject to inflation as well.

SEASONALITY:

Our properties’ operations historically have been seasonal as certain properties maintain higher occupancy rates during the summer months. This seasonality pattern causes fluctuations in our quarterly lease revenue under the percentage leases. We anticipate that our cash flow from the operation of the properties will be sufficient to enable us to make quarterly distributions to maintain our REIT status. To the extent that cash flow from operations is insufficient during any quarter due to temporary or seasonal fluctuations in lease revenue, we expect to utilize other cash on hand or borrowings to fund required distributions. However, we cannot make any assurances that we will make distributions in the future.

CRITICAL ACCOUNTING POLICIES:

The critical accounting policies which we believe are the most significant to fully understand and evaluate our reported financial results are described below:

Investment in Hotel Properties – The initial properties are stated at the predecessor’s historical cost, net of any impairment charges, plus approximately $8.1 million of minority interest partial step-up recorded upon the Company’s formation related to the acquisition of minority interest from unaffiliated parties associated with four of the initial properties. Hotel properties acquired subsequent to the Company’s formation are stated at cost. All improvements and additions which extend the useful life of hotel properties are capitalized.

Impairment of Investment in Hotel Properties — Hotel properties are reviewed for impairment whenever events or changes in circumstances indicate the carrying value of the hotel properties may not be recoverable. The Company tests for impairment in several situations, including when current or projected cash flows are less than historical cash flows, when it becomes more likely than not that a hotel will be sold before the end of its previously estimated useful life, and when events or changes in circumstances indicate that a hotel’s net book value may not be recoverable. In evaluating the impairment of hotel properties, the Company makes many assumptions and estimates, including projected cash flows, holding period, expected useful life, future capital expenditures, and fair values, including consideration of capitalization rates, discount rates, and comparable selling prices. If an asset were deemed to be impaired, the Company would record an impairment charge for the amount that the property’s net book value exceeds its fair value. To date, no such impairment charges have been recognized.

Depreciation and Amortization Expense — Depreciation expense is based on the estimated useful life of the Company’s assets, while amortization expense for leasehold improvements is based on the shorter of the lease term or the estimated useful life of the related assets. Presently, hotel properties are depreciated using the straight-line method over lives which range from 15 to 39 years for buildings and improvements and 3 to 5 years for furniture, fixtures, and equipment. While the Company believes its estimates are reasonable, a change in the estimated lives could affect depreciation expense and net income (loss) as well as the gain or loss on the potential sale of any of the Company’s hotels.

Assets Held For Sale and Discontinued Operations — The Company records assets as held for sale when management has committed to a plan to sell the assets, actively seeks a buyer for the assets, and the consummation of the sale is considered probable and within one year. The related operations of assets held for sale are reported as discontinued if such operations and cash flows can be clearly distinguished, both operationally and financially, from the rest of the Company, such operations and cash flows will be eliminated from ongoing operations once the disposal occurs, and the Company will not have any significant continuing involvement subsequent to the disposal. As of March 31, 2005, assets held for sale consists entirely of eight hotel properties that were acquired March 16,

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2005 in connection with the acquisition of a 21-property portfolio. Consequently, no significant gain or loss is expected upon the sale of these properties.

Notes Receivable – The Company provides mezzanine and first-mortgage financing in the form of loans. Loans receivable are recorded at cost, adjusted for net origination fees and costs. Premiums, discounts, and net origination fees are amortized or accreted as an adjustment to interest income using the effective interest method. Loans receivable are reviewed for potential impairment at each balance sheet date. A loan receivable is considered impaired when it becomes probable, based on current information, that the Company will be unable to collect all amounts due according to the loan’s contractual terms. The amount of impairment, if any, is measured by comparing the recorded amount of the loan to the present value of the expected cash flows or fair value of collateral. If a loan were deemed to be impaired, the Company would record a reserve for loan losses through a charge to income for any shortfall. To date, no such impairment charges have been recognized.

In accordance with Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities,” as revised (“FIN No. 46”), variable interest entities, as defined, are required to be consolidated by their primary beneficiaries if the variable interest entities do not effectively disperse risks among parties involved. The Company’s mezzanine and first-mortgage loans receivable are each secured by various hotel properties or partnership interests in hotel properties and are subordinate to primary loans related to the secured hotels. All of these loans receivable are considered to be variable interests in the entities that own the related hotels, which are variable interest entities. However, the Company is not considered to be the primary beneficiary of these hotel properties as a result of holding these loans. Therefore, the Company does not consolidate the hotels for which it has provided financing. Interests in entities acquired or created in the future will be evaluated based on FIN No. 46 criteria, and such entities will be consolidated, if required. The analysis utilized by the Company in evaluating FIN No. 46 criteria involves considerable management judgment and assumptions.

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risk exposure consists of changes in interest rates on borrowings under our debt instruments that bear interest at variable rates that fluctuate with market interest rates. The analysis below presents the sensitivity of the market value of our financial instruments to selected changes in market interest rates.

As of March 31, 2005, our $427.4 million debt portfolio consisted of approximately $285.6 million of outstanding variable-rate debt and approximately $141.8 million of outstanding of fixed-rate debt, with interest rates ranging from 6.45% to 8.76%. As discussed below, $105.0 million of the variable-rate debt was converted to fixed-rate debt via an interest rate swap.

On September 2, 2004, we purchased a 6.0% LIBOR interest rate cap with a $210.0 million notional amount to limit our exposure to rising interest rates on $210.0 million of our floating-rate debt. To partially offset the cost of the purchased cap, we sold a 6.0% LIBOR interest rate cap with a $105.0 million notional amount with identical terms to the purchased cap. Hence, we own a net interest rate cap with a $105.0 million notional amount. Both the purchased and sold interest rate caps mature October 2, 2006.

On September 7, 2004, we entered into a $105.0 million stair-stepped interest rate swap agreement, at an average interest rate of 4.9% over the term of the swap, which matures March 1, 2007. The interest rate swap effectively converts the interest payments on $105.0 million of our floating-rate debt to a fixed rate.

Our objective in using derivatives is to increase stability related to interest expense and to manage our exposure to interest rate movements or other identified risks. To accomplish this objective, we primarily use interest rate swaps and caps as part of our cash flow hedging strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Purchased interest rate caps provide us with interest rate protection above the strike rate on the cap and result in us receiving interest payments when rates are above the cap strike. At March 31, 2005, derivatives with a fair value of approximately $1.6 million were included in other assets, and derivatives with a fair value of approximately $15,000 were included in other liabilities.

For the three months ended March 31, 2005, the impact to our results of operations of a one-point change in interest rate on the outstanding balance of variable-rate debt as of March 31, 2005, net of the $105.0 million notional amount protected by an interest rate swap as of that date, would be approximately $452,000.

As of March 31, 2005, we owned approximately $81.5 million of variable-rate loans receivable. For the three months ended March 31, 2005, the impact to our results of operations of a one-point change in interest rate on the outstanding balance of variable-rate loans receivable as of March 31, 2005, would be approximately $204,000. We had no other outstanding loans receivable as of March 31, 2005.

At March 31, 2005, our fixed-rate debt includes a premium of approximately $4.2 million as the fixed interest rates on such debt assumed in our acquisition of a 21-property hotel portfolio on March 16, 2005 exceed current interest rates that we would otherwise incur on similar financial instruments.

The above amounts were determined based on the impact of hypothetical interest rates on our borrowing and lending portfolios, and assume no changes in our capital structure. As the information presented above includes only those exposures that exist as of March 31, 2005, it does not consider those exposures or positions which could arise after that date. Hence, the information presented herein has limited predictive value. As a result, the ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, the hedging strategies at the time, and the related interest rates.

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ITEM 4: CONTROLS AND PROCEDURES

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report have been designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Management is required to apply judgment in evaluating the cost-benefit relationship of possible controls and procedures.

There have been no changes in our internal controls over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II: OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

We are currently subject to litigation arising in the normal course of its business. In the opinion of management, none of these lawsuits or claims against us, either individually or in the aggregate, is likely to have a material adverse effect on our business, results of operations, or financial condition. In addition, we currently have adequate insurance in place to cover any such significant litigation.

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

None.

ITEM 5: OTHER INFORMATION

None.

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ITEM 6: EXHIBITS

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SIGNATURES

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

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