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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

CANDLEWOOD HOTEL COMPANY, INC.

Registrant’s telephone number, including area code: (316) 631-1300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

          Yes x  No o

          Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

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

          Yes o  Nox

          The aggregate market value of common stock held by non-affiliates of the registrant, as of June 28, 2002, was $8,769,434 based on the closing sales price of $1.35 on such date.

          The number of shares outstanding of the registrant’s common stock, as of March 24, 2003, was 9,025,000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for its 2003 Annual Meeting of Stockholders are incorporated by this reference into Part III as set forth herein.

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PART I

ITEMS 1 AND 2. BUSINESS AND PROPERTIES

Introduction

          Candlewood Hotel Company, Inc. owns, operates, franchises and manages high-quality, value-oriented, business-travel hotels. Our hotel properties cater to mid-market and upscale business and personal travelers seeking multiple night stays. At December 31, 2002, we had 77 company-operated hotels (which is comprised of owned, leased and joint venture hotels), two managed hotels and 30 franchised hotels. In addition, at December 31, 2002, franchisees had six new hotels under construction. See “Properties” below.

          Candlewood Hotel Company, Inc. was incorporated in the State of Delaware in August 1996 and our principal executive offices are located at 8621 East 21st Street North, Suite 200, Wichita, Kansas 67206, telephone (316) 631-1300. Our website address is www.candlewoodsuites.com and our periodic and current reports are available on our website, free of charge, as soon as reasonably practicable after they are filed with the Securities and Exchange Commission (“SEC”). Electronic or paper copies of our filings are also available free of charge upon request.

Our Brands

          We operate two brands in the lodging market – Candlewood Suites and Cambridge Suites. Each brand is built on the foundation of providing exceptional value to all guests and designed to appeal to different price points in the lodging market.

     Candlewood Suites

          Candlewood Suites hotels offer spacious accommodations at competitive rates that we believe are attractive to mid-market business and personal travelers. Each Candlewood Suites hotel is comprised of studios and one-bedroom suites, both of which contain business and other amenities consistent with amenities found in upscale, full-service hotels. We believe that the 350 square foot studio suites are larger than most full-service hotel rooms. Up to 25% of the rooms in a standard Candlewood Suites hotel are one-bedroom suites, which are approximately 525 square feet, and are designed to accommodate guests who desire a bedroom separated from the kitchen and office area.

          We believe that Candlewood Suites hotels offer the accommodations and amenities that are desired by guests staying an extended period of time. Each Candlewood Suites hotel is equipped with the following amenities and values, which we refer to as “Candlewood values”:

	•		an exercise room;
	•		a complimentary guest laundry facility;
	•		a convenient dry cleaning drop, with same-day service;
	•		free local calls and low-priced long distance calls;
	•		the self-service “Candlewood Cupboard” featuring value-priced packaged foods and 25 cent beverages; and
	•		a free “First Night Kit” complete with items such as coffee and popcorn.

In addition, each Candlewood Suites studio and one-bedroom suite offers amenities designed to accommodate the needs of the business traveler. These amenities include the following:

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	•		two telephones, with two incoming direct dial lines and computer connections;
	•		an oversized executive desk with a quad-outlet to accommodate office equipment needs, an executive chair, a bulletin board, a guest chair and personalized remote accessible telephone mail;
	•		a 25-inch television, video cassette player and compact disc player;
	•		an iron and ironing board; and
	•		a fully equipped kitchen, including a full-size refrigerator, full-size microwave oven, dishwasher, two burner stovetop, coffee maker, toaster and a complete set of utensils and cookware.

     Cambridge Suites

          Cambridge Suites hotels offer spacious accommodations at competitive rates that we believe are attractive to upscale-market business and personal travelers. Building on our value positioning, Cambridge Suites offers the upscale business traveler exceptional amenities and comfort at competitive rates. Each Cambridge Suites hotel offers the following amenities:

	•		Candlewood values;
	•		a recreational facility (such as a swimming pool or fitness center) or access to one;
	•		a full kitchen in every suite;
	•		a complimentary “cooked to order” breakfast; and
	•		a hospitality area for breakfast and socializing.

The Lodging Industry

          We operate in the extended-stay segment of the U.S. lodging industry. Extended-stay hotels are generally characterized as hotels, which accept reservations, do not require a lease and provide a fully equipped kitchenette in each guestroom. An extended-stay is defined as a stay of seven consecutive nights or longer. We believe that the extended-stay market can be divided into four general sectors:

	•		the upscale sector;
	•		the mid-priced sector;
	•		the economy sector; and
	•		the budget sector.

          We operate largely in the mid-priced and upscale sectors of the extended-stay market. We believe that hotels in the mid-priced sector, including our Candlewood Suites hotel brand, generally operate at average daily rates exceeding $45, but less than $90. Our Cambridge Suites brand operates in the upscale extended-stay sector, which we believe consists of hotels that operate with average daily rates exceeding $90. We believe that the high quality of Candlewood hotels, relative to their daily rate, attract certain guests who otherwise would stay at traditional hotels, including business travelers, professionals on temporary work assignment, consultants and government employees.

Hotel Operations

          Our focused approach to customer service enables each Candlewood hotel to employ generally only 10 to 12 employees, which helps minimize operating costs. Our hotel staff generally consists of one on-site general manager, one director of sales, one operations manager and seven to nine front desk, housekeeping and maintenance personnel. The on-site general manager at each hotel is responsible for adhering to Candlewood’s quality control standards and procedures, which govern management, operations, maintenance, regulatory compliance, reporting and marketing. Each hotel is measured against guest service standards and a detailed revenue and expense budget, as well as against the performance of our other hotels. Key on-site personnel participate in an incentive program based on hotel revenues,

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market share performance and expense management. Our quality assurance division conducts periodic inspections of each hotel to ensure compliance with Candlewood’s quality control standards. Personnel at our corporate headquarters provide each hotel with certain management services, such as accounting and payroll services, which allow our on-site hotel general managers to focus on providing guest services and result in economies of scale. We have recently upgraded our IT systems and now have technology that can be scaled to accommodate in excess of 400 hotels.

          Each Candlewood hotel on-site general manager and director of sales are required to complete classroom courses, which we administer through Candlewood University, our in house training program. In addition, our general managers and directors of sales are required to undergo on-the-job training which is tailored to teach them our marketing and operational systems, how to maximize operating efficiencies and how to attract extended-stay guests. In addition, dedicated pre-opening teams (consisting of our experienced general managers and directors of sales) deliver on-site training to new employees to ensure that a guest’s experience at a newly opened Candlewood hotel is consistent with the standards set by existing properties. Customer service is further enhanced through the presence of an experienced team of operations area coaches. The primary role of the area coach is to provide direction, training and mentoring support to staff at individual hotels.

          Weekly housekeeping is provided to guests of our Candlewood Suites hotels, offering less intrusion and greater privacy, while lowering hotel expenses. Guests of our Cambridge Suites hotels receive daily housekeeping on stays of six nights or less and weekly housekeeping on stays of seven nights or longer.

Sales and Marketing

          Each Candlewood hotel has an on-site director of sales dedicated to marketing and direct sales efforts. The sales and marketing division uses direct mail solicitations and targets institutions and employers located near our hotels.

          To provide additional marketing and sales support, we have an experienced team of strategic sales directors. Each sales director oversees between six to thirteen hotels and provides direction and training to the hotel director of sales and general manager on customer leads, repeat business and pricing strategies.

          We have established a toll free telephone number, 1-888-226-3539 (1-888-CANDLEWOOD), to enable our guests to make reservations at any of our hotels. Our reservation system enables travel agents throughout the world to book rooms and allows us to more effectively manage our hotels’ inventory and access current information on productivity and guest arrivals in real-time.

          Our guests can access information concerning our company and hotels on our website, “candlewoodsuites.com.” For example, our guests can do the following on our web site:

	•		book a room;
	•		find a map and directions to our hotels;
	•		find our current stock price; and
	•		explore employment opportunities.

We also use wholesale websites to sell excess inventory.

Franchising Operations

          We have established a national franchising program. Candlewood Suites franchise efforts are focused on new construction whereas Cambridge Suites by Candlewood targets conversion of existing

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upscale suite hotels. At December 31, 2002, we had 27 Candlewood Suites franchise hotels open, six hotels under construction and 20 executed franchise agreements for hotels not yet under construction. The Cambridge Suites brand was introduced by Candlewood in 2000 and as of December 31, 2002, we had three franchise hotels open and two executed franchise agreements for hotels not yet under construction. See “Properties” below.

          Each franchise agreement provides for the payment of an application fee and two types of ongoing fees - a royalty fee and a marketing fee. The franchise application fee is paid upon execution of the franchise agreement and varies based upon the brand and size of the hotel. The royalty and marketing fees are based upon a percentage of the franchisee’s gross room revenues. The royalty fee is four to five percent of gross room revenues, depending upon hotel age, and is intended to cover our operating expenses, such as costs incurred in providing quality assurance, administrative support and other franchise services, and to provide us with operating profits. The marketing fee is used to pay for the costs of developing and preparing advertising and direct sales materials, national advertising and certain promotional programs.

          We make the services and expertise of our franchising, facilities management, marketing and sales and operations divisions available to our franchisees in order to ensure high quality facilities and customer service. Additional fees may be charged for facilities management, marketing and other services provided to the franchisees, which are not within the scope of the franchise agreement. Our facilities management division advises on the construction and development of franchised hotels. In addition, after commencing operations, all franchised Candlewood hotels are subject to periodic inspection to ensure that they are in compliance with our quality control program and maintenance and updating standards. Franchise agreements for newly developed Candlewood Suites and Cambridge Suites hotels have a 20-year term. For converted Cambridge Suites hotels, the franchise agreement term is 10 years. Our franchise agreements provide for a variety of conditions in regards to the franchisees’ obligations to build the hotels and, accordingly, these hotels may never be constructed or opened.

Hotel Joint Ventures

          As of December 31, 2002, we had nine joint venture hotels that we had developed with third parties. Eight joint venture hotels were developed under an agreement with Boston Capital and Mass Mutual. The remaining joint venture hotel is located on the campus of Michigan State University in East Lansing, Michigan. All of the joint venture hotels are Candlewood Suites franchise hotels, which we operate under separate management agreements. As a result, we receive royalty fees, management fees, and equity income (where there are distributable funds) from these hotels. These hotels are classified as joint venture hotels in our property table. See “Properties” below.

Hotel Management

          In addition to our company-operated hotels, we manage hotels owned by third parties. As of December 31, 2002, we managed two such properties; one Cambridge Suites hotel and one non-Candlewood brand hotel, the Hotel at Old Town, both located in Wichita, Kansas. See “Properties” below. Jack DeBoer, our Chairman and Chief Executive Officer, has an ownership interest in each of these hotels. See “Certain Transactions” in our Proxy Statement for our 2003 Annual Meeting of Stockholders.

          Our revenues for managing these hotels consist primarily of management fees that are based on a percentage of gross revenues, operating profits, cash flow or a combination thereof. Under the management contracts, we manage, operate and supervise all aspects of the hotel’s operations. The owner of the hotel property is generally responsible for all costs, expenses and liabilities incurred in connection with operating the hotel, including the expenses and salaries of all hotel employees. Each contract is generally for a term of up to five years with certain renewal rights. Either party, in the event of an

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uncured default, may terminate the management contract. Certain other termination provisions may also be included in the contract.

          We anticipate that some franchisees may want to utilize our experience and expertise to manage their hotels and believe that our management of such hotels helps to maximize the consistency of the Candlewood hotel system. As of December 31, 2002, we had two franchise hotels that we operate for the respective franchisees under separate management agreements. Our revenues for managing these hotels consist primarily of management fees that are based on a percentage of gross revenues, operating profits, cash flow or a combination thereof.

Lease of Hotels

          In order to provide funds for our operating needs and development activities, we completed four separate sale-leaseback transactions with Hospitality Properties Trust, a Maryland real estate investment trust (“HPT”). These transactions were completed in stages commencing in December 1997 with the most recent transaction completed in April 2002.

          In April 2002, we sold 21 hotels for $145 million. We used the majority of these proceeds to repay debt of $130.4 million.

          As of December 31, 2002, we had sold 57 hotels to HPT for an aggregate purchase price of $434.8 million. See “Properties” below. Each of the hotels sold is leased back to Candlewood pursuant to an operating lease, which expires in December 2018. The lease provides for two types of rent: base rent, which is a fixed amount, and contingent rent, which is equal to 10% of the increase in gross hotel sales over the amount generated in each hotel’s second year of operation. As of December 31, 2002, the annual base rent for the 57 leased hotels was approximately $45.5 million. In addition, the lease requires that 5.0% of gross revenues be set aside in the form of a furniture, fixtures and equipment (“FF&E”) reserve. The FF&E reserve is for replacement and refurbishment of hotel furniture and fixtures.

          The lease also requires us to guarantee the payment of rent for the duration of the lease, and, as guarantor, to maintain a minimum net worth, as defined, of at least $75 million. At December 31, 2002, our net worth as defined in the guarantee agreement was $68.3 million. Although there has been no payment default under the lease, this breach of the guarantee agreement gives HPT the right to start proceedings that would result in the cancellation of the lease, which would result in us losing our rights as a tenant of the hotels. In addition, we would remain obligated to HPT for payment of any potential shortfalls in net rental proceeds incurred by HPT from releasing the hotels to another hotel operator. HPT has agreed to take no action prior to January 1, 2004 with respect to the breach of this provision of the guaranty, provided that we maintain a minimum net worth of at least $60 million throughout the 2003 calendar year.

Hotel Development

          Our facilities management division is responsible for the oversight and coordination of the construction and ongoing maintenance of hotels developed by Candlewood. Most of our hotels are designed and constructed according to uniform plans and specifications. We believe that our coordination of the construction of our hotels and our use of a comprehensive design manual has lowered costs and resulted in consistent quality and appearance. We have made design variations, including changes in the number of studio suites, double-doubles (two double beds) and one-bedroom suites, based on market demographics and site restrictions, among other factors. As of December 31, 2002, existing Candlewood Suites hotels ranged in size from 59 to 276 rooms.

          As of December 31, 2002, we did not have any company-operated hotels under construction nor had we entered into any contracts for the purchase of any hotel sites. We do not currently expect to develop hotels for ourselves in 2003.

          In March 2002, we purchased the San Antonio, Texas franchise hotel from an unaffiliated third party for the outstanding debt balance of $4.7 million. As of December 31, 2002, we did not have any hotel acquisitions pending and do not currently expect to acquire any hotels in 2003.

Properties

          We classify our hotels into five categories: owned, leased, managed, joint venture and franchised. Owned hotels are those hotels that we have independently developed or acquired and own. Leased hotels are those hotels that we previously sold and currently lease from a third party. Managed hotels are those hotels that we manage for a third party. Joint venture hotels are those hotels that we developed and own with our joint venture partners. Franchised hotels are those hotels developed and

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owned by third parties that utilize one of our franchise brands, Candlewood Suites or Cambridge Suites. The following tables set forth information by brand as of December 31, 2002 with respect to these properties, all of which are Candlewood Suites unless otherwise noted as Cambridge Suites:

Existing hotels as of December 31, 2002:

Company-owned:

Leased:

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Managed:

Joint Venture:

Franchised:

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*		Represents a franchise, joint venture and managed hotel as of December 31, 2002.
**		Represents a franchise and managed hotel as of December 31, 2002.

Hotels under construction as of December 31, 2002:

Franchised:

          In addition to the properties described above, we also maintain our corporate headquarters in Wichita, Kansas, at 8621 East 21st Street North, Suite 200. We lease this office space under a five-year lease expiring in February 2004, exclusive of four five-year renewal options. We anticipate that our office space will be adequate for the foreseeable future.

Government Regulation

          The hotel industry is subject to numerous federal, state and local government regulations, including those relating to building and zoning requirements. In addition, Candlewood and our franchisees are subject to laws governing our relationships with employees, including minimum wage requirements, overtime, working conditions and work permit requirements. We are also subject to federal regulations and certain state laws that govern the offer and sale of franchises. Many state franchise laws impose substantive requirements on franchise agreements, including limitations on non-compete provisions and termination or non-renewal of a franchise. Some states require that certain materials be approved before franchises can be offered or sold in that state. The failure to obtain permits or licenses or approvals to sell franchises, or an increase in the minimum wage rate, employee benefit costs or other costs associated with employees, could adversely affect our business and results of operations. Both at the federal and state level from time to time, there are proposals under consideration to increase the minimum wage.

          Under the Americans with Disabilities Act (“ADA”), all public accommodations are required to meet certain federal requirements related to access and use by disabled persons. Although we have attempted to satisfy ADA requirements in the designs of our facilities, no assurance can be given that a material ADA claim will not be asserted against us. Such a claim could result in a judicial order requiring compliance and the expenditure of substantial sums to achieve compliance, an imposition of fines, or an award of damages to private litigants. These and other initiatives could adversely affect us as well as the lodging industry in general.

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Environmental Matters

          Our operating costs may be affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations. In addition, in the event any future legislation is adopted, we may, from time to time, be required to make significant capital and operating expenditures in response to such legislation. We attempt to minimize our exposure to potential environmental liability through our site selection procedures. Accordingly, we typically enter into contracts to purchase real estate subject to certain contingencies. In addition, prior to purchasing a property, we generally conduct a Phase I environmental assessment, which generally includes a physical inspection and database search, but not soil or groundwater analyses.

          Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Certain environmental laws and common law principles could be used to impose liability for release of asbestos-containing materials (“ACMs”) into the air, and third parties may seek recovery from owners or operators of real properties for personal injury associated with exposure to released ACMs. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require expenditures. In connection with the ownership or operation of hotels, we may be potentially liable for any such costs. Although we are currently not aware of any material environmental claims pending or threatened against us or any of our managed or franchised hotels, no assurance can be given that a material environmental claim will not be asserted against us or against us and our managed or franchised hotels. The cost of defending against claims of liability or of remediating a contaminated property could have a material adverse effect on our results of operations.

Insurance

          We currently have the types and amounts of insurance coverage that we consider appropriate for a company of our size in our business. While we believe that our insurance coverage is adequate, if we were held liable for amounts exceeding the limits of our insurance coverage or for claims outside of the scope of our insurance coverage, our business, results of operations, and financial condition could be materially and adversely affected. Specifically, there are certain types of hotel-related losses, generally of a catastrophic nature, such as earthquakes and floods that may be uninsurable or not economically insurable. We use our discretion in determining amounts, coverage limits and deductibility provisions of insurance, with a view to obtaining appropriate insurance on Candlewood hotels at a reasonable cost and on suitable terms. Inflation, changes in building codes and ordinances, environmental considerations and other factors also might make it unfeasible to use insurance proceeds to replace a hotel after it has been damaged or destroyed. Under these circumstances, the insurance proceeds received by us might not be adequate to restore our economic position with respect to such hotel. In addition, property and casualty insurance rates have and may continue to increase depending on claims experience, insurance market conditions and the replacement value of our hotels. Mr. DeBoer is affiliated with an insurance broker we utilize. See “Certain Transactions” in our Proxy Statement for our 2003 Annual Meeting of Stockholders and Note 10 to the Consolidated Financial Statements.

Employees

          As of December 31, 2002, Candlewood and its subsidiaries employed on a full or part-time basis 1,295 persons, 1,190 of whom were employed at our hotels and 105 of whom were employed at our corporate headquarters. Our employees are not subject to any collective bargaining agreements, and our management believes that its relationship with our employees is good.

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ITEM 3. LEGAL PROCEEDINGS

          We are and from time to time have been party to commercial litigation relating to our business. We believe that none of these matters is material individually or in the aggregate and intend to defend ourselves vigorously.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

          None.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

          Candlewood’s initial public offering of common stock was made on November 5, 1996. The common stock trades on the Over The Counter Bulletin Board under the symbol “CNDL”. The following table sets forth the high and low sales prices per share, as reported by Nasdaq, during the periods indicated:

          The closing sales price of our common stock on March 24, 2003 was $0.65. The approximate number of beneficial stockholders on March 24, 2003 was 1,246. The approximate number of stockholders of record on March 24, 2003 was 157.

          We have not paid dividends on our Common Stock. The Series A and Series B Preferred Stock accumulate dividends at a rate of 7.5% of the stated value of the shares ($1,000 per share), and are in preference to any dividend on our Common Stock. We have not made the last six scheduled preferred stock dividend payments (including the February 2003 payment) and have approximately $12.6 million in preferred stock dividends in arrears. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations – Liquidity and Capital Resources.”

          We currently do not anticipate paying any cash dividends on our Common Stock in the foreseeable future. Any future payment of dividends on the Common Stock will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements and other factors deemed relevant by the Board of Directors. We anticipate that future financing, including any lines of credit, may restrict or prohibit our ability to pay dividends.

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ITEM 6. SELECTED FINANCIAL DATA
                (In thousands, except share and per share data)

          The selected consolidated financial data set forth below has been derived from our audited consolidated financial statements and the notes thereto. The selected consolidated financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our Consolidated Financial Statements and notes thereto.

General

          Candlewood operates, franchises, owns and manages Candlewood Suites and Cambridge Suites hotels to serve extended-stay business and personal travelers. At December 31, 2002, we had a total of 77 company-operated hotels (which is comprised of owned, leased and joint venture hotels), two managed hotels and 30 franchise hotels located in 34 states. In addition, at December 31, 2002, we had six franchise hotels under construction and 22 franchise agreements for hotels not yet under construction, which are subject to a variety of conditions.

          We classify our hotels into five categories: owned, leased, managed, joint venture and franchised. Owned hotels are those hotels that we have independently developed or acquired and own. Leased hotels are those hotels that we previously sold and currently lease from a third party. Managed hotels are those hotels that we manage for a third party, but do not lease or own. Joint venture hotels are those hotels that we developed and own with our joint venture partners. Franchised hotels are those hotels developed and owned by third parties that utilize one of our franchise brands, Candlewood Suites or Cambridge Suites. The following tables set forth our property portfolio and hotel development, respectively, at December 31, 2002 and December 31, 2001:

          At December 31, 2002, we managed two hotels, which are independently owned by our Chief Executive Officer, the Cambridge Suites by Candlewood and the Hotel at Old Town, both located in Wichita, Kansas. Our revenues for managing these hotels consist primarily of management fees that are based on a percentage of gross revenues, operating profits, cash flow or a combination thereof. These revenues are included in other income in our consolidated statements of operations. In the management of these hotels, we have in the past advanced funds and paid expenses on behalf of the hotels. We are not currently advancing any funds to these hotels and do not intend to do so in the future.

          Our consolidated statements of operations includes revenues and expenses for only those hotels which are owned or leased by consolidated subsidiaries of Candlewood Hotel Company, Inc. (owned and leased hotels). We refer to these hotels collectively as our corporate hotels. Revenues and expenses from franchise hotels and unconsolidated subsidiary hotels (joint venture hotels accounted for under the equity method of accounting) are not included in our revenues and expenses. Franchise fees, royalty fees, management fees, equity income from investment in joint ventures and other fees received from franchise, managed and joint venture hotels are included in other income in our consolidated statements of operations.

          We have sold and leased back 57 hotels to Hospitality Properties Trust, a Maryland real estate investment trust (“HPT”). We operate the hotels, as lessee, pursuant to a lease that expires in 2018. Our results from operations reflect these transactions. As a result of the sale-leaseback transactions, we have

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recorded rent expense on the hotels leased back from HPT. Since these hotels are leased and not owned, the financial statements do not reflect any depreciation and amortization or interest expense for these hotels after the date of sale. The proceeds from the sales of the hotels is recorded net of the deferred gain on sale. The gain is deferred and recognized into earnings over the remaining lease term. See Note 12 to Consolidated Financial Statements.

Critical Accounting Policies and Estimates

          Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. We believe that the following critical accounting policies involve significant judgments and estimates used in the preparation of our consolidated financial statements.

          Impairment of Long-Lived Assets

          We periodically evaluate our long-lived assets, including our investments in real estate for impairment indicators in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and legal factors. Future events could occur which would cause us to conclude that impairment indicators exist and an impairment loss is warranted.

          Sale / Leaseback of Hotels

          We have accounted for our sale-leaseback of hotels in accordance with SFAS No. 28, “Accounting for Sales with Leasebacks” and SFAS No. 98, “Accounting for Leases.” Management is required to make estimates and judgments to determine if the resulting lease agreement for the leaseback of hotels qualifies for classification as an operating lease under SFAS No. 28 and SFAS No. 98.

          Depreciation of Investment in Hotels

          We depreciate our investment in hotels over a 40-year useful life, which is a judgmental determination.

          Fair Value of Financial Instruments

          The valuation of financial instruments under SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” and derivative financial instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” requires us to make estimates and judgments that affect the fair value of the instruments. Where possible, we base the fair values of our financial instruments on listed market prices and third party quotes. Where these are not available, we base our estimates on other factors relevant to the financial instrument.

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Results of Operations

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

          Hotel Operations

          Hotel Operations Revenue

          Hotel operations revenue, which includes room revenue and other revenue (e.g. guest telephone and sales of products from the Candlewood Cupboard), was $123.6 million for the year ended December 31, 2002, compared to $127.1 million for the year ended December 31, 2001. The decrease in revenue is a result of reduced average daily room rates, primarily attributable to pricing competition caused by the slowdown in the economy and a reduction in business travel, partially offset by the addition of one hotel purchased in March 2002. The following table sets forth the operating statistics for all our corporate hotels for the years ended December 31, 2002 and December 31, 2001:

          Average occupancy rate, which is determined by dividing the number of guestrooms occupied on a daily basis by the total number of guestrooms available for the period, was 74.4% for corporate hotels for the year ended December 31, 2002, compared to 73.5% for the year ended December 31, 2001. Our focus in 2002 was to improve or maintain occupancy at our hotels by marketing to long-term extended-stay guests, particularly those staying seven or more nights, which generally are at a lower rate. Occupancy rates for the year ended December 31, 2001 were negatively impacted by the slowdown in the economy and to a lesser extent the attacks on the World Trade Center.

          The average daily room rate for corporate hotels for the year ended December 31, 2002 was $53.96, compared to $57.32 for the year ended December 31, 2001, a decrease of 5.9%. Average daily room rates are determined by dividing room revenue by the number of guestrooms occupied on a daily basis for the applicable period. The decrease in the average daily rate for the year ended December 31, 2002 is primarily a result of our commitment to improve or maintain occupancy at our hotels by targeting long-term extended-stay business, which is charged at a lower daily rate, and adjusting rates in today’s competitive environment. Other factors that influence average daily rates include higher rates for our one-bedroom suites and higher rates in certain hotel locations. It is our practice to continuously review individual markets to assess the impact of competition on local supply and demand and establish room rates that balance occupancy to produce optimal revenue.

          Revenue per available room (“RevPAR”), calculated as the average occupancy rate multiplied by the average daily rate, was $40.17 for the year ended December 31, 2002, compared to $42.14 for the year ended December 31, 2001, a 4.7% decrease. This decrease was primarily due to the lower average daily rate we experienced in 2002 compared to 2001.

          Hotel Operating Expenses

          Hotel operating expenses for the year ended December 31, 2002 totaled $79.8 million, compared to $74.5 million for the year ended December 31, 2001. Hotel operating expenses consist of all expenses directly applicable to the operation of the hotels, including corporate allocations for various operating, marketing and accounting functions. The largest portion of hotel operating expenses consisted of salaries, wages and fringe benefits. The balance of hotel operating expenses was comprised of normal operating

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items, such as utilities, property taxes, insurance, supplies, promotional materials, maintenance items and similar expenses. The increase in hotel operating expenses is largely due to increased wages, media advertising, sales and promotional costs, operating costs for one additional hotel acquired in March 2002 and higher maintenance and insurance costs.

          Rent Expense on Leased Hotels

          Rent expense on the 57 leased hotels for the year ended December 31, 2002 was $41.0 million, compared to $26.5 million for the year ended December 31, 2001. Rent expense is comprised of two elements, a base fixed rent and a contingent rent. Contingent rent expense is a variable expense based on a property achieving improved year over year revenue growth and is calculated on an individual property basis. The increase in rent expense is due to an increase in base rent as a result of the sale and leaseback of 21 additional hotels in April 2002.

          Hotel Opening Costs

          Opening costs are costs incurred prior to the opening of a hotel and include costs related to the hiring and training of hotel personnel, such as travel, compensation and relocation costs. There were no opening costs for the year ended December 31, 2002, as we had no hotel openings or projects under construction during the period. We do not anticipate having any hotel opening costs in 2003.

          Hotel Depreciation and Amortization

          Depreciation and amortization expense applicable to hotel operations (e.g., building, furniture, fixtures and equipment, loan fees and closing costs) for the year ended December 31, 2002 totaled $5.4 million, compared to $10.9 million for the year ended December 31, 2001. The decrease in depreciation and amortization expense is the result of the sale and leaseback of 21 hotels in April 2002. We do not record depreciation and amortization expense for properties that have been sold and leased back.

          Corporate Operations

          Other Income

          Franchise and management fee income consists primarily of royalty fees (revenue-based fees received over the life of a franchise agreement), franchise application fees (a one-time fee received upon execution of a franchise agreement) and management fees. For the year ended December 31, 2002, franchise and management fee income totaled $4.5 million, compared to $4.1 million for the year ended December 31, 2001. The increase in franchise and management fee income is due to higher franchise royalty and management fee income as a result of the increased number of franchise and managed hotels open at December 31, 2002, the full year impact of franchise and managed hotels opened in 2001 and the ramp-up of royalty fees from 4.0% to 5.0% for franchise hotels open greater than two years, partially offset by a reduction in franchise application revenue as a result of executing fewer new franchise agreements in 2002. For the year ended December 31, 2002, we executed a combined total for both brands of 9 new franchise agreements compared to 11 franchise agreements for the year ended December 31, 2001.

          (Loss) income from joint ventures represents our share of the net profits of unconsolidated joint venture hotels. For the year ended December 31, 2002, we recorded a loss of ($6.3 million) on our joint venture hotels, compared to ($1.1 million) for the year ended December 31, 2001. This loss is due to the reduced profitability of the joint venture hotels as a result of the slowdown in the economy and the reduction in business travel, an impairment loss on one of the joint venture hotels, and the amortization of the difference between the amount at which the Boston Capital joint venture investment is carried on our accounting records and the amount of the underlying book equity in the net assets of the joint venture. This difference is primarily comprised of carrying costs incurred from the time we purchased the land

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until the hotel was contributed to the joint venture. We anticipate other income to continue to decline in the year ended December 31, 2003 as a result of our agreement with Boston Capital, pursuant to which we agreed to bear all losses from the operation of the Chicago, Illinois – Wheeling hotel beginning July 26, 2002.

          We sold 21 hotels during the year ended December 31, 2002 and recognized $1.5 million of the total deferred gain on hotels sold. We sold two hotels during the year ended December 31, 2001 and recognized $1.3 million of the total deferred gain on hotels sold.

          Corporate Operating Expenses

          Corporate operating expenses for the year ended December 31, 2002 totaled $6.0 million, compared to $7.2 million for the year ended December 31, 2001, and included all expenses not directly related to the development or operations of specific hotels. The largest portion of corporate operating expenses consisted of salaries, wages and fringe benefits. The balance of other corporate operating expenses was comprised of normal operating costs, such as office space lease, travel, utilities, advertising, professional fees and similar expenses. The decrease in corporate operating expense is primarily due to lower franchise sales and service costs and other general corporate expenses.

          Corporate Depreciation and Amortization

          Depreciation and amortization applicable to corporate operations for the year ended December 31, 2002 totaled $766,000, compared to $745,000 for the year ended December 31, 2001. Depreciation and amortization reflects depreciation and amortization of intangible assets (e.g. patents, trademarks), leasehold improvements and furnishings in our corporate office, and depreciation of financial system hardware, software and peripheral equipment.

          Interest Income and Expense

          Interest income for the year ended December 31, 2002 was $339,000, compared to $761,000 for the year ended December 31, 2001. Interest income for the year ended December 31, 2002 resulted primarily from the temporary investment of cash provided by operations and proceeds from the April 2002 sale-leaseback transaction of 21 hotels. For the year ended December 31, 2001, interest income resulted primarily from the temporary investment of cash provided by operations and proceeds from the August 2001 sale-leaseback transaction of two hotels. The decrease in interest income for the year ended December 31, 2002 is largely due to lower cash levels and lower investment rate yields.

          Interest expense, net of capitalized interest, for the year ended December 31, 2002 was $7.3 million, compared to $17.1 million for the year ended December 31, 2001. The decrease in interest expense is due to lower debt levels as a result of the repayment of certain obligations with the proceeds from the April 2002 sale-leaseback transaction and lower LIBOR interest rates, partially offset by a reduction in the amount of interest capitalized to development projects as a result of not having any projects under construction during 2002.

          Sales of Hotels

          As of December 31, 2002, we had sold to and leased back from HPT 57 hotels, 21 of which were sold during the year ended December 31, 2002. A deferred gain was recorded on the sales, a portion of which has been recorded in income in the years ended December 31, 2002 and December 31, 2001. The following table sets forth the rent expense and deferred gain recognized into earnings related to our leased hotels for the years ended December 31, 2002 and December 31, 2001 (in thousands):

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Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

          Hotel Operations

          Hotel Operations Revenues

          For the year ended December 31, 2001, hotel operations revenue totaled $127.1 million, compared to $127.8 million for the year ended December 31, 2000. Occupancy rates were lower in 2001 as a result of the slowdown in the economy and a reduction in business travel. The decrease in revenue was partially offset by the impact of the opening of the Jersey City, New Jersey hotel in April 2001. The following table sets forth the operating statistics for all our corporate hotels for the years ended December 31, 2001 and December 31, 2000:

          The average occupancy rate for corporate hotels for the year ended December 31, 2001 was 73.5%, compared to 76.0% for the year ended December 31, 2000. We believe the decline in occupancy experienced in 2001 was consistent with the overall lodging industry and the result of a slower U.S. economy and to a lesser extent the impact of the World Trade Center attacks on business travel. Overall, the decrease in occupancy was experienced in both short and long-term stays, but was particularly prevalent in our short-term stays, which we consider to be six nights or less.

          The average daily room rate for corporate hotels for the year ended December 31, 2001 was $57.32, compared to $56.98 for the year ended December 31, 2000. The increase in average daily rate in 2001 was largely due to the opening of the Jersey City, New Jersey hotel, which has a significantly higher room rate than other corporate hotels. This was partially offset by a reduction in the number of short-term stays, which are charged at a higher daily rate. RevPAR was $42.14 for the year ended December 31, 2001, compared to $43.29 for the year ended December 31, 2000, a 2.7% decrease. This decrease in RevPAR was due to the lower average occupancy rate in 2001.

          Hotel Operating Expenses

          Hotel operating expenses for the year ended December 31, 2001 totaled $74.5 million, compared to $68.0 million for the year ended December 31, 2000. The increase in hotel operating expenses was largely due to increased wages, promotional costs associated with sales promotions and operating costs for the Jersey City, New Jersey hotel, which opened in April 2001. Other items contributing to the increase in hotel operating expenses included higher maintenance and utility costs and costs related to the restructuring of our operations field administration team.

          Rent Expense on Leased Hotels

          Rent expenses on the 36 leased hotels for the year ended December 31, 2001 was $26.5 million, compared to $25.1 million for the year ended December 31, 2000. The increase in rent expense was due to the sale and leaseback of two additional hotels in 2001.

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          Hotel Opening Costs

          Opening costs for the year ended December 31, 2001 totaled $230,000 compared to $279,000 for the year ended December 31, 2000.

          Hotel Depreciation and Amortization

          Depreciation and amortization expense attributable to hotel operations for the year ended December 31, 2001 totaled $10.9 million, compared to $9.8 million for the year ended December 31, 2000. The increase in depreciation and amortization expense in 2001, compared to 2000, was a result of the opening of the Jersey City, New Jersey hotel in April 2001. This hotel is in a higher priced, primary market where building costs are higher. In addition, leasehold improvement depreciation expense was higher due to increased capital expenditures at our leased hotels, and software amortization expense increased as a result of the full year depreciation of the field property management system purchased in 2000.

          Corporate Operations

          Other Income

          Franchise and management fee income for the year ended December 31, 2001 totaled $4.1 million, compared to $3.3 million for the year ended December 31, 2000. The increase in franchise and management fee income is due to higher franchise royalty and management fee income as a result of the increased number of franchise and managed hotels open at December 31, 2001, the full year impact of franchise and managed hotels opened in 2000 and the ramp-up of royalty fees from 4.0% to 5.0% for franchise hotels open greater than two years, partially offset by a reduction in franchise application revenue as a result of executing fewer new franchise agreements in 2001. For the year ended December 31, 2001, we executed a combined total for both brands of 11 new franchise agreements compared to 24 franchise agreements for the year ended December 31, 2000.

          (Loss) income from joint ventures for the year ended December 31, 2001 totaled a loss of ($1.1 million), compared to $176,000 of income for the year ended December 31, 2000. This loss is due to the reduced profitability of the joint venture hotels as a result of the slowdown in the economy and the reduction in business travel and the amortization of the difference between the amount at which the Boston Capital joint venture investment is carried on our accounting records and the amount of the underlying book equity in the net assets of the joint venture. This difference is primarily comprised of carrying costs incurred from the time we purchased the land until the hotel was contributed to the joint venture.

          We sold two hotels during the year ended December 31, 2001 and recognized $1.3 million of the total deferred gain on hotels sold. We did not sell any hotels during the year ended December 31, 2000, and recognized $2.2 million of the deferred gain on hotels sold.

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          Corporate Operating Expenses

          Corporate operating expenses for the year ended December 31, 2001 totaled $7.2 million, compared to $6.4 million for the year ended December 31, 2000. The increase in 2001 was primarily due to increased salaries and wages, a change in the capitalization of internal hotel development costs, and the accounting treatment afforded certain internal personnel costs related to the development and installation of the new field property management system in 2000. Beginning in June 2001, in response to our limited amount of hotel development activity, we ceased capitalization of internal real estate development costs. As for the field property management system, pursuant to accounting Statement of Position 98-1, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use,” certain specific internal personnel costs were capitalized as part of the system. This project was completed in the third quarter of 2000 and the costs of these personnel were subsequently recorded as an expense. The increase in corporate operating expense in 2001 was partially offset by a reduction in the amount of corporate incentive bonus costs and franchise sales commissions. Franchise sales personnel are paid sales commissions on new franchise agreements. As previously noted, during the year 2001, we executed 11 new franchise agreements, compared to 24 agreements in 2000.

          Corporate Depreciation and Amortization

          Depreciation and amortization applicable to corporate operations for the year ended December 31, 2001, totaled $745,000 compared to $751,000 for the year ended December 31, 2000.

          Interest Income and Expense

          Interest income for the year ended December 31, 2001 totaled $761,000, compared to $1.2 million for the year ended December 31, 2000. Interest income for the year ended December 31, 2001 resulted primarily from the temporary investment of cash provided by operations and proceeds from the third quarter 2001 sale-leaseback transaction. For the year ended December 31, 2000, interest income resulted primarily from the temporary investment of cash provided by operations. The decrease for the year ended December 31, 2001 was largely due to lower cash levels and lower investment rate yields.

          Interest expense, net of capitalized interest, for the year ended December 31, 2001 was $17.1 million, compared to $18.6 million for the year ended December 31, 2000. The decrease in interest expense in 2001 was due to lower LIBOR interest rates and lower debt levels, partially offset by a reduction in the amount of interest capitalized to development projects. We had fewer projects under construction during 2001, thereby reducing the amount of interest capitalized.

          Sales of Hotels

          As of December 31, 2001, we had sold to and leased back from HPT 36 hotels, two of which were sold during 2001. One of these hotels was sold at a loss of $214,000. The $64,000 gain from the sale of the other hotel was deferred and will be recognized over the remaining lease term. The following table sets forth the rent expense and deferred gain recognized into earnings related to our leased hotels for the years ended December 31, 2001 and December 31, 2000 (in thousands):

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Liquidity and Capital Resources

          We had cash and cash equivalents of $9.3 million at December 31, 2002, compared to $18.0 million at December 31, 2001. Net cash used in operating activities totaled $5.1 million for the year ended December 31, 2002, compared to $1.2 million of net cash provided by operating activities for the year ended December 31, 2001. For the year ended December 31, 2002, we recorded a net loss from operations of $27.3 million, including an impairment loss on hotels held for sale of $8.6 million, $6.1 million of non-cash depreciation and amortization expense, $6.0 million of loss on investment in joint ventures, $2.1 million of loss on the extinguishment of debt and $1.5 million of non-cash deferred gain income on hotels sold. Sources of cash included a $1.3 million decrease in other assets. This decrease in other assets is largely due to the refund of excess cash from the FF&E reserve accounts. The excess funds were returned to us as part of the sale-leaseback and refinancing transactions in April 2002. For the year ended December 31, 2001, we recorded a net loss from operations of $5.1 million including $11.6 million of non-cash depreciation and amortization expense, $1.3 million of non-cash deferred gain income on hotels sold and $1.1 million of loss on investment in joint ventures. Uses of cash for the year ended December 31, 2001 included a $4.6 million increase in other assets (primarily FF&E reserve payments).

          Net cash provided by investing activities for the year ended December 31, 2002 totaled $128.9 million, compared to $24.0 million of net cash provided by investing activities for the year ended December 31, 2001. Sources of cash for the year ended December 31, 2002 consisted of $145.0 million in proceeds from sales of hotels to HPT and $10.4 million of guaranty deposit refunded to us by HPT as part of the April 2002 sale-leaseback transaction. Uses of cash for the year ended December 31, 2002 consisted of $16.0 million of cash paid for security deposits related to the 21 hotels sold and leased back from HPT in April 2002, $8.6 million of expenditures for property, equipment and leasehold improvements in connection with completed and leased hotels and $1.8 million of contributions to joint ventures. Sources of cash for the year ended December 31, 2001 consisted of $28.9 million in proceeds from sales of hotels, $3.0 million of refunded guaranty deposits and $1.8 million of cash distributions from joint ventures. Uses of cash for the year ended December 31, 2001 consisted of $3.8 million of cash paid for security deposits related to the sale of two hotels in August 2001, $4.4 million of contributions to joint ventures and $1.0 million of expenditures for property and equipment.

          For the year ended December 31, 2002, net cash used in financing activities was $132.5 million, compared to $29.1 million of net cash used by financing activities for the year ended December 31, 2001. Net cash used in financing activities during year ended December 31, 2002 consisted of $192.2 million of principal payments on notes payable, partially offset by $59.7 million of proceeds from mortgages and notes payable. The principal payments on notes payable represent payments made to pay off note balances on hotels sold in the April 2002 sale-leaseback transaction. The proceeds from mortgages and notes payable represent the proceeds from the refinancing of certain debt in 2002. For the year ended December 31, 2001, net cash used in financing activities included $28.6 million of principal payments on notes payable and $6.0 million of preferred stock dividend payments, partially offset by $5.4 million of proceeds from mortgages and notes payable.

          Under the terms of our lease agreement with HPT, we are required to maintain a minimum net worth, as defined, of at least $75 million. At December 31, 2002, our net worth as defined in the guarantee agreement was $68.3 million. Although there has been no payment default under the lease, this breach of the guarantee agreement gives HPT the right to start proceedings that would result in the cancellation of the lease agreement, which would result in us losing our rights as a tenant of the hotels. In addition, we would remain obligated to HPT for payment of any potential shortfalls in net rental proceeds incurred by HPT from releasing the hotels to another hotel operator. HPT has agreed to take no action prior to January 1, 2004 with respect to this provision of the guaranty, provided that we maintain a net worth of at least $60 million throughout the 2003 calendar year. We expect that our net worth will decline during the year ended December 31, 2003, and we cannot assure you that it will not decline below $60 million. We also cannot assure you that we will be able to obtain another waiver from HPT in the future or that our net worth will increase to satisfy the $75 million minimum net worth requirement on January 1, 2004.

          As of December 31, 2002, we have guaranteed approximately $45.3 million of the construction debt on the Boston Capital joint venture properties. Maturity dates for this debt range from June 2003 to December 2007. Approximately $13.3 million of this debt is scheduled to mature in 2003. As of December 31, 2002, $5.8 million of the debt scheduled to mature in 2003 can be extended, under the terms of the existing loan agreement, for an additional year. Since this guaranteed debt relates to an entity, which we do not wholly-own or control, it is not included in our consolidated financial statements. No liability has been recorded related to this guarantee based on the estimated values of the properties collateralizing the construction debt.

          As of December 31, 2002, we had borrowed $58.9 million from GMAC and one other financial institution. This debt has scheduled maturity dates ranging from May 2005 to June 2011 with interest rates, which range from 7.75% to 8.30%.

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          Our Series A and Series B Preferred Stock accumulate dividends at a rate of 7.5% on its stated value plus any accrued but unpaid dividends with dividend payments made quarterly, upon approval of the board of directors, and in preference to any dividend on our Common Stock. These payments are approximately $2.0 million per quarter. If we fail to make a scheduled preferred stock dividend payment, the dividends accumulate and compound at a rate of 7.5%. As of December 31, 2002, we had not made the last five scheduled preferred stock dividend payments and we had approximately $10.4 million of accumulated unpaid dividends. We intend to assess our cash position on a quarterly basis and will likely elect to forego additional scheduled dividend payments on our preferred stock. Series A and B Preferred Stockholders have the right to convert, at any time at their option into shares of Common Stock. We did not make the February 2003 dividend payment, which together with past non-payment of dividends and diluted stock option grants has resulted in an adjustment of the conversion price of the Preferred Stock from $9.50 to $7.50. A failure to make future dividend payments will result in a further reduction in the conversion price of the Preferred Stock and, in the case of the Series B Preferred Stock, may result in a future adjustment to the dividend rate to 12%.

          Pursuant to a mandatory redemption clause in the Certificates of Designation for the Series A and Series B Cumulative Convertible Preferred Stock, we are required to redeem the Series A and Series B Preferred Stock in September 2004. The mandatory redemption amount is equal to $107 million plus unpaid dividends. As of December 31, 2002, the mandatory redemption amount was approximately $117.4 million. If we fail to redeem the Preferred Stock when due, we are required to issue to each holder of Preferred Stock on such date, and on each three month anniversary thereafter, warrants to purchase 25% of the number of shares of Common Stock into which such holder’s outstanding shares of Preferred Stock would be convertible on such date. The warrants would be immediately exercisable at a purchase price of $.01 per share of Common Stock.

          In the event we liquidate, the holders of the Series A and Series B Preferred Stock are entitled to receive a payment equal to the stated value of their shares, plus any accrued but unpaid dividends (the “Liquidation Amount”), prior to any distribution or payment to the holders of our Common Stock. As of December 31, 2002, the Liquidation Amount was $117.4 million, including $10.4 million of unpaid dividends. Alternatively, the holders of the Series A and Series B Preferred Stock may convert any or all of their shares into shares of Common Stock. In the event of a corporate transaction that constitutes a change of control, we are required to offer to redeem all of the outstanding shares of Series A and Series B Preferred Stock for a price equal to the greater of the Liquidation Amount or 175% of the stated value of the shares. As of December 31, 2002, one hundred seventy five percent of the stated value of the shares was $187.3 million. If we do not redeem the Preferred Stock upon a change of control, the conversion price of the Preferred Stock will be reduced to the lower of the then applicable conversion price or the market price of the Common Stock on the redemption date divided by 1.75, provided that the conversion price will not be reduced to an amount less than the par value of the Common Stock.

          Certain of the Preferred Stockholders have voting rights related to the nomination and election of directors as defined in a stockholders agreement. Each Preferred Stockholder will vote together with the Common Stockholders as a single class, on an as-converted basis, on all matters to be approved by the Common Stockholders. For certain actions, approval of two-thirds of the shares owned by Preferred Stockholders, as a single class, is required.

          The carrying amount of the redeemable preferred stock is being increased by periodic accretions using the interest method, so that the carrying amount will equal the mandatory redemption amount at the mandatory redemption date. For the year ended December 31, 2002, approximately $1.8 million was recorded as an increase to the carrying value of the preferred stock.

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          The following table summarizes our contractual cash and debt obligations for the next five years as of December 31, 2002 (in thousands):

     Payments due by Period:

          We believe that a combination of our cash and cash equivalents and cash from operations will be sufficient to provide capital for operations through December 31, 2003. However, if we experience a material decline in operating performance (including RevPAR), we may not generate sufficient cash flow to support our operations through the end of such twelve-month period. In addition, in order to meet our long-term financing obligations, we will be required to raise additional capital in the future. In particular, we do not currently project that we will generate sufficient cash flow to repay the mandatory redemption of the preferred stock in 2004. We continue to consider a number of financing alternatives, including credit facilities, additional sale leaseback transactions, the issuance of equity, debt or equity-linked securities and joint ventures, which are necessary to provide the capital needed to meet our financing needs. We are unable to assure that we will be able to obtain financing on a timely basis, on acceptable terms, or at all.

          As of December 31, 2002, we have available $45.8 million of net operating loss carry-forwards, which are available to be utilized in future years to offset taxable income. These net operating loss carry-forwards will expire beginning in 2011 through 2022.

Certain Business Considerations

          Investors are cautioned that certain statements contained in this document as well as some of our statements in periodic press releases and some oral statements of our officials during presentations about the company are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, which include words such as “believes,” “anticipates,” “estimates,” “expects” or similar expressions. In addition, any statements concerning future financial performance, ongoing business strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic and market factors and the industry in which we do business, among other things. These statements are not guaranties of future performance and we have no specific intention, and we disclaim any obligation, to update these statements.

          Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to:

          We have Never Been Profitable. At December 31, 2002, we operated 77 hotels. This limited number of hotels limits our ability to attract potential franchisees and grow our business. We have incurred losses to date and cannot give any assurance that we will be profitable in the future. Operation of individual hotels and a chain of multiple hotels are subject to numerous risks, including:

	•		the inability to maintain high occupancy rates or to attract guests for extended-stays;
	•		the inability to achieve expected nightly rates;

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	•		the inability to operate the hotels at expected expense levels;
	•		the ability to attract and retain quality personnel; and
	•		liability for accidents and other events occurring at hotel properties.

If we are unable to efficiently and effectively operate our hotels, we may never be profitable.

          Adverse Economic Conditions May Negatively Impact Our Occupancy Rates and Results of Operations. Since our core customers are extended-stay business travelers, moderate or severe economic downturns or adverse economic conditions negatively affect our operations. These economic conditions may be widespread or isolated to one or more geographic regions. Economic downturns generally cause a decline in the occupancy rates of our hotels as our core customers limit their extended-stay travel. For example, the tragedy at the World Trade Center caused significant short-term declines in our occupancy rates and room rates. Decreases in our occupancy rates result in a decrease in our operating revenue. In addition, as our occupancy rates decrease, we expect that competition will increase and that the average daily room rate of our hotels will be negatively impacted. As a result, recessions or other general economic conditions may have a negative impact on our results of operations and financial condition.

          If Our Results of Operations Decline Materially (including RevPAR), We May Not Have Sufficient Working Capital to Meet Our Day-to-Day Operating Cash Flow Needs. We had cash and cash equivalents of $9.3 million at December 31, 2002. We currently expect our cash and cash equivalents balance to decline during the year ended December 31, 2003. If we experience a material decline in operating performance during 2003, our cash flows will decline at a faster than anticipated pace which would likely result in our inability to maintain sufficient cash balances to meet day-to-day working capital needs.

          We May be Unable to Service our Debt and lease Obligations. Our ability to make payments on, to repay or to refinance our indebtedness and to make our scheduled lease payments and preferred stock dividends will depend upon our ability to generate capital in the future and increase RevPAR. We cannot predict whether current occupancy levels and room rates can be maintained or improved upon. Future occupancy and room rates may be impacted by a number of factors including:

	•		the number and geographic location of new hotels;
	•		the season in which new hotels open;
	•		competition;
	•		market acceptance of our hotels;
	•		general economic conditions;
	•		unexpected events, such as the World Trade Center attacks; and
	•		the profitability of the businesses’ of our core customers.

          Accordingly, we cannot make any assurances that our business will generate sufficient cash flow from operations to fund our debt obligations or make our scheduled lease and preferred stock dividend payments as they become due. For example, in February 2003, we did not make the scheduled dividend payment. This marked the sixth successive dividend payment we have not made. We do not currently have sufficient capital to pay all of our debts if they were due today. We cannot provide any assurances that we will be able to refinance any of our indebtedness on commercially reasonable terms, or at all. Our ability to make payments on, to repay or to refinance our indebtedness and to make our scheduled lease and preferred stock dividend payments also is, to a certain extent, subject to general economic, competitive, legislative, regulatory and other factors beyond our control. Our inability to make payments on, to repay, or to refinance our debt, lease and preferred stock obligations could result in litigation and have a material adverse effect on our business and results of operations. We have also guaranteed approximately $45.3 million of debt on the Boston Capital joint venture properties. Maturity dates for this debt range from June 2003 to December 2007, with approximately $13.3 million of this debt scheduled to mature in 2003. See “–Liquidity and Capital Resources.”

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          If Our Net Worth Continues to Decline, We Will Fail to Comply With the Terms of Our Agreements with HPT, Which Could Result In the Loss of Our Rights as a Tenant Under the Applicable Hotels. The terms of our lease agreement with HPT requires us to guarantee the payment of rent for the duration of the lease and, as a guarantor, to maintain a minimum net worth of $75 million. At December 31, 2002, our net worth as defined in the agreement was $68 million. This breach gives HPT the right to start proceedings that would result in the cancellation of the lease agreement and we would lose our rights as a tenant. HPT has agreed not to take action with respect to this breach through January 1, 2004 so long as we maintain a minimum net worth of $60 million. We expect that our worth will decline during the year ended December 31, 2003, and we cannot assure you that it will not decline below $60 million. We also cannot assure you that we will be able to obtain another waiver from HPT in the future or that our net worth will increase to satisfy the $75 million minimum net worth requirement on January 1, 2004. If the lease agreement is cancelled and we lose our rights as tenants under the applicable hotels, we may not be able to continue our operations.

          We Do Not Have Sufficient Funds to Redeem our Preferred Stock When it Becomes Due. Pursuant to a mandatory redemption provisions in the Certificates of Designation for our Series A and Series B Cumulative Convertible Preferred Stock, we are required to redeem our Preferred Stock in September 2004. As of December 31, 2002, the mandatory redemption amount was approximately $117.4 million. If we fail to redeem the Preferred Stock when due, we are required to issue to each holder of Preferred Stock on such date, and on each three month anniversary thereafter, warrants to purchase 25% of the number of shares of Common Stock into which such holder’s outstanding shares of Preferred Stock would be convertible on such date. The warrants would be immediately exercisable at a purchase price of $.01 per share of Common Stock. We do not currently have, and do not believe that our operations will generate, sufficient capital to make the scheduled payment to redeem our Preferred Stock, and cannot provide any assurances that we will be able to obtain the financing necessary to do so.

          Our Growth is largely Dependant on Franchising Hotels. We intend to grow primarily by franchising Candlewood Suites and Cambridge Suites hotels. Our ability to franchise hotels and obtain franchisees involves substantial risks, including:

	•		there are a limited number of franchising opportunities;
	•		we may be unable to compete with national and regional brand franchisors, many of whom have greater brand recognition than Candlewood;
	•		unavailability of financing to potential franchisees on favorable terms, or at all;
	•		delays in completion of construction of franchised hotels;
	•		termination of signed franchise agreements;
	•		incurring substantial costs if we abandon a franchising project prior to completion;
	•		a franchisee’s failure to obtain all necessary zoning and construction permits;
	•		competition for suitable franchise sites from our competitors, some of whom may have greater financial resources than Candlewood franchisees;
	•		our franchisees actual costs exceeding budgeted or contracted amounts; and
	•		our franchised properties not achieving desired revenue or profitability levels once opened.

          Our franchise agreements provide for a variety of conditions in regards to the franchisees’ obligations to build the hotels and, accordingly, these hotels may never be constructed or opened. If we are unable to successfully franchise hotels on time or within budget, or at all, our business and results of operations would suffer.

          We Depend on a Single Type of Lodging Facility. We intend to exclusively develop, manage and franchise extended-stay hotels under our Candlewood Suites and Cambridge Suites brands. We currently do not intend to develop any lodging facilities other than hotels focused on extended-stay business travelers and do not intend to develop lodging facilities with other franchisors. Accordingly, we will be subject to risks inherent in concentrating investments in a single type of lodging facility, such as a shift in demand or a reduction in business following adverse publicity, which could have a material adverse effect on our business and results of operations. In addition, we have a limited history upon which we can gauge consumer acceptance of our hotels and, accordingly, we cannot provide assurance that guests who are looking for conventional or extended-stay hotel accommodations will readily accept out hotels. Furthermore, we compete against other facilities with substantially greater brand recognition.

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          We are Subject to Real Estate Investment Risks. Our investment in our hotels will be subject to varying degrees of risk related to our ownership and operation of real property. The underlying value of our real estate investments is significantly dependent upon our ability to maintain or increase cash provided by operating our investments. The value of our hotels and the income from our hotels may be materially adversely affected by:

	•		changes in national economic conditions;
	•		changes in general or local economic conditions and neighborhood characteristics;
	•		competition from other lodging facilities;
	•		changes in the availability, cost and terms of financing;
	•		the ongoing need for capital improvements;
	•		changes in operating expenses;
	•		changes in real property tax rates;
	•		changes in governmental rules and policies;
	•		the impact of present or future environmental laws;
	•		natural disasters; and
	•		other factors which are beyond our control.

In addition, our real estate investments are relatively illiquid. As a result, we may not be able to vary our portfolio in response to changes in economic and other conditions. Accordingly, we cannot assure that we will be able to dispose of an investment when we find disposition advantageous or necessary, or that the sale price of any disposition will recoup or exceed the amount of our investment.

          Our Hotels May Experience Seasonal Fluctuations. Based upon our experience operating extended-stay hotels, we expect that occupancy and revenues may be lower than normal during the months of November, December and January due to the holiday season. Because many of our expenses do not fluctuate with occupancy, declines in occupancy may cause fluctuations or decreases in our quarterly results.

          We Depend on Key Personnel. Our success depends to a significant extent upon the efforts and abilities of our senior management and key employees, particularly, Mr. Jack P. DeBoer, Chairman of the Board and Chief Executive Officer, and Mr. Warren D. Fix, Executive Vice President and Chief Financial Officer. The loss of the services of either of these individuals could have a material adverse effect upon our business and results of operations.

          Because Shares of our Common Stock Trade on the Over The Counter Bulletin Board, the Liquidity of our Common Stock May Be Limited. Our Common Stock was delisted from The Nasdaq SmallCap Market on June 19, 2002 and our Common Stock now trades on the Over The Counter Bulletin Board. Consequently, the liquidity of our Common Stock will likely be impaired, not only in the number of shares which can be bought and sold, but also because of delays in the timing of transactions and a reduction in securities analyst and the news media coverage, if any, that we receive. As a result, holders of our Common Stock might find it more difficult to trade their Common Stock promptly, or at all, and at reasonable prices or to obtain accurate quotations as to its price.

          Certain of these factors are discussed further elsewhere in this Annual Report on Form 10-K, including without limitation under the captions “Business and Properties” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Impact of New Accounting Standards

          On June 29, 2001 the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations.” SFAS No. 141 eliminates the pooling-of-interest method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. The requirements of SFAS No. 141 are effective for any business combination accounted for by the purchase method that is completed after June 20, 2001. Additionally, SFAS No. 142, “Goodwill and Other Intangibles,” was issued. Under SFAS No. 142, goodwill and other indefinite lived intangibles are no longer amortized, but are periodically reviewed for impairment. Intangibles with definite lives are amortized over their useful lives. SFAS No. 142 is effective for years beginning after December 15, 2001. SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” was also issued for years beginning after December 15, 2001. SFAS No. 144 revises the measurement and recognition of impairment, specifically on assets held for disposal.

          In November 2002, the Financial Accounting Standards Board issued Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN No. 45). FIN No. 45 significantly changes the current practice in the accounting for, and disclosure of, guarantees. FIN No. 45 requires certain guarantees to be recorded at fair value, which is different from current practice, which is generally to record a liability only when a loss is probable and reasonably estimable, as those terms are defined in SFAS No. 5, “Accounting for Contingencies.” FIN No. 45 also requires a guarantor to make significant new disclosures, even when the likelihood of making any payments under the guarantee is remote, which is another change from current practice. The disclosure requirements of FIN No. 45 are currently effective, although the initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002.

          We do not believe the issuance of these statements and their interpretation will have a material impact on our results of operations or financial position.

          In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections”, which rescinded SFAS No. 4 requiring gains and losses from extinguishment of debt to be classified as extraordinary. During the year ended December 31, 2002, we extinguished a significant portion of our debt and recorded a loss of $2.1 million. We have adopted SFAS No. 145 and have classified this loss as an operating expense.

Quantitative and Qualitative Disclosure of Market Risk

          Our earnings are affected by changes in interest rates as a significant portion of our outstanding indebtedness is at variable rates based on LIBOR or Treasury notes. If interest rates change by .01 percent, the market value of our mortgages and notes payable, based on the outstanding balance, effected by the variable rates at December 31, 2002, would change by approximately $5,500. Additionally, we have market risk on our short-term investments, which are considered cash equivalents, due to changes in interest rates. If interest rates increase by .01 percent, the market value of our short-term investments, based on the outstanding balance at December 31, 2002, would change by approximately $900.

          In June 1998, the Financial Accounting Standards Board issued Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and its amendments, Statements 137 and 138 in June of 1999 and June of 2000, respectively. We adopted Statement No. 133, as amended, effective January 1, 2001. The Statement requires us to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The

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ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. As of December 31, 2002, the Company had one derivative financial instrument, an interest rate cap, which was recorded at fair value of $47,000 as of December 31, 2002, with the change in fair value since the purchase date recorded in accumulated other comprehensive loss in the equity section of the balance sheet.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

          The response to this item is filed as a separate part of this report on Form 10-K (see page F-1).

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

          None.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

          There is hereby incorporated herein by reference the information appearing under the caption “Proposal 1 Election of Directors” and under the caption “Executive Officers of the Company” in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission.

ITEM 11. EXECUTIVE COMPENSATION

          There is hereby incorporated herein by reference the information appearing under the caption “Executive Compensation” in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

          There is hereby incorporated herein by reference the information appearing under the caption “Voting Securities and Principal Holders Thereof” in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

          There is hereby incorporated herein by reference the information appearing under the caption “Certain Transactions” in our definitive Proxy Statement for our 2003 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission.

ITEM 14. CONTROLS AND PROCEDURES

          The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Securities Exchange Act of 1934 reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, the Company has investments in certain unconsolidated entities. As the Company does not control or manage these entities, its disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those it maintains with respect to its consolidated subsidiaries.

          Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on the foregoing, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

          There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K

(a) Financial Statements

		1. The financial statements contained in the accompanying Index to Consolidated Financial Statements covered by the
	Independent Auditors’ Report are filed as part of this Report (see page F-1).
		2. Financial Statement Schedule. See page F-1.
		3. Exhibits.

		The list of exhibits contained in the Index to Exhibits is filed as part of this Report (see page E-1).
		(b) Reports on Form 8-K

                         None.

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Signatures

          Pursuant to the requirements of Section 13 or 15(d) 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.

          Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated on March 31, 2003.

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CERTIFICATIONS

          I, Jack P. DeBoer, Chairman and Chief Executive Officer, certify that:

          1. I have reviewed this annual report on Form 10-K of Candlewood Hotel Company, Inc.;

          2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

          3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

          4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

          a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

          b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

          c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

          5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

          a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

          b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

          6. The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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          I, Warren D. Fix, Executive Vice President and Chief Financial Officer, certify that:

          1. I have reviewed this annual report on Form 10-K of Candlewood Hotel Company, Inc.;

          2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

          3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

          4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

          a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

          b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

          c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

          5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

          a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

          b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

          6. The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE*

*

Certain schedules have been omitted as they are not applicable to the Company or the information is contained in the consolidated financial statements or notes thereto.

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Report of Independent Auditors

To the Board of Directors of Candlewood Hotel Company, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Candlewood Hotel Company, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2002. We have also audited the related financial statement schedule listed in the accompanying index for the year ended December 31, 2002. These financial statements and schedule are the responsibility of the management of Candlewood Hotel Company, Inc. and Subsidiaries. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Candlewood Hotel Company, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects the information set forth therein.

Chicago, Illinois
February 14, 2003, except for Note 16
    as to which the date is February 28, 2003,
    and except for the fourth paragraph of Note 12,
    as to which the date is March 27, 2003

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CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except par value, stated value, and share data)