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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 – Q

For the quarterly period ended March 31, 2003

OR

Commission file number 000-21583

Candlewood Hotel Company, Inc.

8621 E. 21^st Street North, Suite 200
Wichita, Kansas 67206

(316) 631-1300

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.

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

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

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CANDLEWOOD HOTEL COMPANY, INC.

FORM 10 – Q
FOR THE QUARTER ENDED
MARCH 31, 2003

INDEX

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

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

See accompanying notes.

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CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited) (In thousands, except share and per share data)

See accompanying notes.

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CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (In thousands)

See accompanying notes.

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CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Summary of Significant Accounting Policies

A.		Organization and Basis of Presentation
		The Company’s current business of operating, franchising, owning and managing extended-stay hotels originated in November 1995, with the formation of Candlewood Hotel Company, L.L.C., a Delaware limited liability company (“Candlewood LLC”). The Company was incorporated in the State of Delaware in August 1996, and in November 1996, the Company succeeded to the business of Candlewood LLC and completed an initial public offering of its common stock (collectively, the “Reorganization”).
		The accompanying unaudited consolidated financial statements of Candlewood Hotel Company, Inc. (the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. The statements include the accounts of Candlewood Hotel Company, Inc. and its subsidiaries, including Candlewood LLC, which was the entity through which business was conducted until completion of the Reorganization, and various wholly-owned LLCs which own or lease certain hotels. Accordingly, certain information and footnotes required by generally accepted accounting principles for complete financial statements have been omitted. The accompanying unaudited financial statements contain all adjustments (consisting of normal recurring accruals), which the Company believes are necessary for the fair presentation of the Company’s financial position and results of operations. The condensed consolidated balance sheet data at December 31, 2002 was derived from the Company’s audited financial statements. The interim financial statements should be read in conjunction with the Company’s 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission. The results of operations for interim periods are not necessarily indicative of the results that may be expected for future periods or the entire year. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
		All majority-owned subsidiaries have been consolidated into the unaudited consolidated financial statements. All intercompany transactions have been eliminated.
B.		Investment in Hotels
		Investment in hotels is stated at cost and include the related furniture, fixtures and equipment. Once the Hotels are completed, depreciation is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to forty years. Maintenance and repairs are charged to operations as incurred.
		In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which is effective for fiscal years beginning after December 15, 2001. The Company evaluates hotels for impairment when conditions indicate that it is probable that the sum of the expected future cash flows is less than the carrying value of the hotels. Upon determination that a hotel has been impaired, the carrying value of the hotel is reduced to fair value less costs to sell. For the three-months ended March 31, 2002, the Company recorded an impairment loss of $8.6 million.

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C.		Cash Equivalents
		The Company considers all highly liquid assets with a maturity of three months or less when purchased to be cash equivalents.
D.		Restricted Cash
		Restricted cash represents cash that, under the terms of certain loan agreements, has been set aside as a condition of loan financing. These funds, which are held by the lenders, will be released to the Company upon achievement of certain operating criteria, as defined in the loan agreements.
E.		Fair Value of Financial Instruments
		SFAS No. 107, Disclosures About Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying values of the Company’s financial instruments, which include cash and cash equivalents, accounts and other receivables, accounts payable and other accrued expenses, approximate fair values due to the short maturities of such instruments. The fair value of the Company’s long-term debt, which approximates carrying value, is estimated based on the current rates offered to the Company for debt of the same remaining maturities.
F.		Derivative Financial Instruments
		In April 2002, the Company purchased an interest rate cap as part of the refinancing of mortgage debt with GMAC to manage interest rate risk. The Company requires that hedging derivative instruments be effective in reducing the interest rate risk exposure as they are designated. This effectiveness is essential for qualifying for hedge accounting available for only certain qualifying derivative instruments. Instruments that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income each period until the instrument matures, is terminated, or assigned. Any derivative instrument used for risk management that does not meet the hedging criteria is marked-to-market through earnings each period. During 2003, the Company expects to reclassify to earnings approximately $12,000 of amounts held in accumulated other comprehensive income. If a derivative instrument is terminated or the hedging transaction is no longer determined to be effective, amounts held in accumulated other comprehensive income are reclassified into earnings over the term of the future cash outflows on the related debt.
		To determine the fair values of derivative instruments, the Company uses a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the majority of financial instruments including most derivatives, standard market conventions and techniques such as discounted cash flow analysis, option pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.
		As of March 31, 2003, the Company’s interest rate cap was reported at its fair value as other assets of $10,000 with the change in fair value since the purchase date of $177,000 recorded in accumulated other comprehensive loss in the equity section of the balance sheet. As a result of the above, the Company incurred a total comprehensive loss of $7.3 million ($.81 per weighted average common share) and $13.7 million ($1.52 per weighted average common share) for the three-months ended March 31, 2003 and 2002, respectively.

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G.		Intangible Assets
		Intangible assets of $1.3 million include ownership rights, title and interest in the Candlewood Hotel name, costs for patents and trademarks and costs to obtain franchise agreements. These assets are being amortized using the straight-line method over a period of ten to twenty years and are included in other assets on the accompanying consolidated balance sheets.
H.		Deferred Financing Costs
		Deferred financing costs are costs incurred to obtain construction and permanent financing and are included in other assets on the accompanying consolidated balance sheets. These costs are amortized over the life of the related loan on a method, which approximates the level yield basis.
I.		Revenue Recognition
		Room revenue and other revenues are recognized when earned. Recognition of franchise fee revenue is deferred until all material services or conditions relating to the respective franchise have been substantially performed or satisfied by the Company. Such revenue, when recognized, is included in franchise and management fee income on the accompanying consolidated statements of operations.
		The Company’s sales of hotels have been accompanied by a leaseback of the facilities under operating lease agreements. Such sales are recognized when the title passes to the buyer, generally upon the receipt of proceeds. The related profit is deferred and recognized in earnings over the remaining lease term.
J.		Advertising
		Advertising costs are expensed as incurred.
K.		Income Taxes
		The Company is taxed as a corporation as defined in subchapter “C” under the Internal Revenue Code for federal and state income tax purposes and accounts for any temporary differences under the asset and liability method.
L.		Opening and Organization Costs
		Opening costs are costs incurred prior to the opening of a hotel and include costs related to hiring and training of hotel personnel, such as travel, compensation and relocation. Organization costs relate to the formation of the Company and Subsidiaries. Such costs are expensed as incurred.
M.		Investments in Joint Ventures
		The Company has certain investments in joint ventures in which it owns 50% or less of the voting equity that it accounts for under the equity method of accounting.

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N.		Segment Reporting
		The Company has two reportable segments, the operation of hotels and the sale of hotels. Information related to the Company’s reportable segments for the three-months ended March 31, 2003 and 2002, respectively, is as follows:
		Three-months ended March 31, 2003

Three-months ended March 31, 2002

		The difference between segment profit and net income is preferred stock dividends and corporate expenses not specific to the Company’s reportable segments.
O.		Stock Options
		In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”). SFAS No. 148 provides transition methods for entities that elect to adopt the fair value method of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires disclosure of comparable information regarding the Company’s method of accounting for stock-based employee compensation for all interim periods. The Company accounts for its stock-based employee compensation, which is in the form of common share option grants, under the intrinsic method of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB 25, no compensation expense is to be recognized for the common share option grants when the exercise price of the options equals the market price of the underlying shares at the date of grant. We did not recognize any compensation expense for the three-months ended March 31, 2003 and 2002 related to options granted under APB 25.

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P.		Use of Estimates
		The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates.
Q.		Reclassifications
		Certain reclassifications of prior period amounts have been made to conform to the current period presentation. Such reclassifications have no effect on the Company’s operations or equity as originally presented.

Note 2: Mortgages and Notes Payable

As of March 31, 2003, a wholly owned subsidiary of the Company (“the Subsidiary”) has a loan agreement with GMAC Commercial Mortgage Corporation. This Subsidiary owns 10 of the Company’s hotels. Interest on the loan is payable monthly, in arrears, on the first day of the calendar month. Interest is calculated at a variable rate per annum, adjusted monthly, at a rate equal to the 30-day LIBOR rate plus 4.25% (7.75% as of March 31, 2003). The debt has a LIBOR interest rate floor of 3.50%. As a result, the Company’s interest rate on this debt cannot go below 7.75%. Interest is payable monthly and the principal amount of the loan is payable monthly beginning in May 2003 and is calculated based on a 25-year amortization schedule using the prevailing interest rate as defined in the note. The loan matures in May 2005 and provides for one 12-month extension. Amounts borrowed under the loan agreement are secured by the 10 hotels, the land on which the hotels are constructed and certain funds deposited in demand deposit accounts assigned to GMAC. The Company, and certain other of the Company’s wholly owned subsidiary LLCs, guarantee the loan. At March 31, 2003, $55.0 million was outstanding under this loan agreement.

In April 2002, the Company purchased an interest rate hedge to cap the 30-day LIBOR interest rate on the GMAC note. The interest rate is capped at 7.50% and the cap expires in May 2005 concurrent with the maturity of the note. Accordingly, the maximum interest rate throughout the term of the GMAC note cannot exceed 11.75% (7.50% LIBOR plus 4.25%).

The Company has also entered into a loan agreement with a financial institution for the financing of one of the Company’s hotels. Interest on the loan is payable monthly, in arrears, beginning on the first full calendar month after the date of the agreement. Interest payments are calculated at a fixed rate based off the 10-year Treasury note at the time the loan was closed plus 3.08% (8.30% as of March 31, 2003). Principal payments commenced the month following loan closing and are calculated based on a 25-year amortization schedule using the prevailing interest rate as defined in the note. The note matures in June 2011. The loan amount borrowed is secured by the hotel and the land on which the hotel is constructed, certain funds deposited in a demand deposit account assigned to the bank, as well as a guarantee by the Company and certain other of the Company’s wholly-owned subsidiary LLCs. At March 31, 2003, approximately $3.9 million was outstanding under this note.

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Note 3: Investments in Joint Ventures

As of March 31, 2003, the Company’s net investment in joint ventures is approximately $7.5 million. The difference between the amount at which the investment is carried in the Company’s accounting records and the amount of the underlying equity in the net assets of the investee is amortized into income from joint ventures over the contractual life of the respective joint venture entity. As of March 31, 2003, this amount was approximately $2.6 million and is included in investments in joint ventures on the accompanying consolidated balance sheets. For the quarters ended March 31, 2003 and 2002, equity loss in joint ventures of approximately ($630,000) and ($88,000), respectively, was recorded before recognition of the carrying value difference of approximately ($464,000) and ($388,000), respectively. There were no distributions made to the Company during the quarters ended March 31, 2003 and 2002.

The Company has one significant joint venture that was formed in 1999 with Boston Capital Institutional Advisors (“Boston Capital”) and Mass Mutual in which the Company has a 50% ownership interest. Hotel operations for the joint venture commenced in 2000, and as of March 31, 2003, the Company operated eight hotels pursuant to this agreement. In June 2002, the Company’s joint venture partners declared that the Company was in default of its obligation to have at least 10 hotels open or under construction and as a result it would be required to make an additional equity contribution of $3.4 million to the joint venture on or before July 25, 2002. The Company did not make this contribution. As a result of this default and in accordance with the joint venture agreement, the joint venture suspended payment of franchise royalty and management fees to the Company and the interest rate on the joint venture debt to Boston Capital and Mass Mutual increased from 12% to 21%. The Company and Boston Capital and Mass Mutual reached an agreement with regards to the amount of the additional equity contribution and in December 2002, the Company contributed $1.8 million to the joint venture and Boston Capital and Mass Mutual waived contractual rights to the $1.6 million balance. Simultaneous with the execution of this agreement, the Company received all previously suspended royalty and management fees and the interest rate on the joint venture debt thereafter reverted to 12%. In addition, the Company and Boston Capital agreed that the Company would bear all losses from the operation of the Chicago, Illinois – Wheeling hotel for the period July 26, 2002 forward until the earlier to occur of March 31, 2003 or the date of sale or refinance. The losses for this hotel totaled $162,000 for the three-months ended March 31, 2003 and this amount is recorded as an equity loss from joint venture hotels and included in loss from joint ventures on the Company’s consolidated statements of operations. In accordance with the profit and loss allocation terms of the joint venture agreement, for the three-months ended March 31, 2003, the Company recorded all of the $415,000 net pre-tax loss of the joint venture. See “Note 6 – Subsequent Events.”

The following is unaudited condensed financial information for the joint venture as of March 31, 2003 and 2002:

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As of March 31, 2003, the Company has guaranteed approximately $45 million of mortgage debt on the joint venture properties. This debt is collateralized by the hotels, the land on which the hotels are constructed and certain funds deposited in demand deposit accounts assigned to the respective banks. Maturity dates on this debt range from June 2003 to December 2007 with certain notes providing extensions for up to two years under specific criteria including loan to value ratios. This debt is not included in the Company’s consolidated financial statements (See Note 2) and the Company does not receive any fees related to this guarantee.

Note 4: Redeemable, Convertible, Cumulative Preferred Stock

General

The Company has authorized “blank check” preferred stock in the amount of 5,000,000 shares at $.01 par value per share. The stock may be issued with such voting powers and such designations, preferences, privileges and other special rights as designated by the Board of Directors. At the date of issuance of any of the preferred stock, the Company determines whether the stock is redeemable and the appropriate classification of the stock on the balance sheet. At March 31, 2003, as more fully described below, the Company had 65,000 and 42,000 shares, respectively, of Series A and Series B redeemable preferred stock issued and outstanding.

Preferred Stock Offerings

In October 1997, the Company completed a $65.0 million private placement of 65,000 shares of “Series A” Redeemable, Convertible, Cumulative Preferred Stock at an offering price of $1,000 per share (“Stated Value”). The net proceeds to the Company were approximately $61.3 million, after deducting commissions and expenses of $3.7 million.

On August 3, 1998, the Company completed the private placement of $42.0 million of its “Series B” Redeemable, Convertible, Cumulative Preferred Stock and warrants to purchase its common stock. In total, 42,000 shares of Series B Preferred Stock were issued at an offering price of $1,000 per share (“Stated Value”). Series B preferred stockholders were also issued, at no additional cost, warrants to purchase 336,000 shares of common stock at $12.00 per share. These warrants expire on July 13, 2005. The net proceeds to the Company were approximately $39.3 million, after deducting commissions and expenses of $2.7 million.

The Series A and Series B Preferred Stock accumulate dividends at a rate of 7.5% with dividend payments made quarterly, upon approval of the board of directors, and in preference to any dividend on the Company’s Common Stock. These payments are approximately $2.5 million per quarter. The Company has not made the last six scheduled preferred stock dividend payments. Pursuant to the provisions of the certificate of designation for the Series A and Series B Preferred Stock, the conversion price (i.e. the price at which the Preferred Stock may convert into Common Stock) was reduced in February 2003 to $7.50 per share to reflect the Company’s decision to forego payment of its November 2002 and February 2003 preferred stock dividend payments. The Company intends to assess its cash position on a quarterly basis and will likely elect to forego additional scheduled dividend payments on the preferred stock. The reduction in the conversion price to $7.50 has resulted in an increase in the dividend

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rate on the Series B preferred stock from 7.5% to 12.0%. No such provision applies to the Series A preferred stock, however, the failure to make future dividend payments will result in a further reduction in the conversion price of the Series A preferred stock. As of March 31, 2003, the Company had approximately $12.6 million of accumulated unpaid dividends in arrears, which have been accrued and recorded as an increase to the carrying amount of the Series A and Series B preferred stock.

Pursuant to a mandatory redemption clause in the Certificates of Designation for the Series A and Series B Cumulative Convertible Preferred Stock, the Company is 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 March 31, 2003, the mandatory redemption amount was approximately $119.6 million. If the Company fails to redeem the Preferred Stock when due, it will be 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 the Company liquidates, 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 the Common Stock. As of March 31, 2003, the Liquidation Amount was $119.6 million, including $12.6 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, the Company is 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 March 31, 2003, one hundred seventy five percent of the stated value of the shares was $187.3 million. If the Company does 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 quarter ended March 31, 2003, approximately $484,000 was recorded as an increase to the carrying value of the preferred stock.

Note 5: Sale / Leaseback

As of March 31, 2003, the Company had completed four separate sale-leaseback transactions with Hospitality Properties Trust (“HPT”). These transactions were completed in stages commencing in December 1997 with the most recent transaction completed in April 2002. As of March 31, 2003, the Company has sold 57 hotels to HPT for an aggregate sales price of $434.8 million.

Terms of the HPT sales agreement were all cash at the close of escrow for each hotel sold. Each of the hotels sold has been leased back to a wholly owned subsidiary of Candlewood pursuant to the terms of a master operating lease agreement executed in April 2002, which superceded the previous operating lease (the “previous lease”). This lease expires in December 2018 and may be renewed in certain circumstances and at the election of the Company for up to three 15-year periods. The lease calls for

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monthly lease payments of approximately $3.8 million and requires the Company to place a security deposit with HPT for each property equal to one year’s lease payments. The security deposit will be released to the Company at the end of the lease term.

The previous lease agreement provided for the Company to guarantee the payment of rent until defined operating cash flows exceed the annual lease payments by 150% for 12 consecutive months. In connection with this obligation, the Company was required to place deposits with HPT equal to approximately 5% of the sales price, upon the initial closing of each transaction. These deposits were charged to cost of sales as the hotels were sold. As part of the newly executed lease, the Company was refunded the remaining balance of the guaranty deposit, which was recorded as an additional deferred gain on sale of hotels and will be recognized as income over the remaining lease term. In addition, the new lease requires the Company to guarantee the payment of rent for the duration of the lease.

In total, as of March 31, 2003, the Company had sold 57 hotels for $434.8 million of hotels with a total deferred gain of $32.8 million, which includes the return of the guaranty deposits to the Company. Such gain has been deferred and is being recognized in income as noted in the Company’s accounting policies (Note 1). For the quarters ended March 31, 2003 and 2002, respectively, the Company recognized approximately $405,000 and $283,000 of deferred gain into income. As of March 31, 2003, the Company has recognized a total of $7.2 million of deferred gain into income. Sale proceeds, net of the deferred gain and related cost of the hotels sold are presented on the consolidated statements of operations.

Note 6: Subsequent Events

On April 1, 2003, pursuant to a prior agreement, the Company assumed ownership of the Chicago, Illinois-Wheeling hotel from its joint venture with Boston Capital and Mass Mutual. For a nominal amount, the Company assumed 100% of all assets, liabilities and ownership interests, including an outstanding loan of $7.5 million. This property will be consolidated into the Company’s financial statements beginning on April 1, 2003.

On April 25, 2003, the Company executed an agreement with HPT to manage 15 Summerfield Suites hotels owned by HPT which were previously operated by a third party. Management of the hotels commenced on April 28, 2003 and the management agreement expires on December 31, 2003, with succession one-year renewal periods, however, each party is permitted to terminate the agreement sooner on 30 days prior written notice. Under the management agreement, the Company will receive a management fee of 3% of the gross revenues of the hotels.

The Boston Capital joint venture had a $10.5 million first mortgage loan on the Burlington, Massachusetts hotel that came due and payable to Boston Capital on May 1, 2003. The loan has not been repaid or refinanced. On May 7, 2003, the joint venture received a letter from Boston Capital declaring an event of default under the loan agreement. Pursuant to the joint venture agreement, any default by the joint venture on a first mortgage constitutes a default on the mezzanine debt held by Boston Capital. As a result, the interest rate on the mezzanine debt with Boston Capital has increased from 12% to 21%, and the payment of royalty and management fees to the Company have been suspended. Upon successful cure of the default, the interest rate would thereafter revert to 12% and the payment of royalty and management fees would resume.

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Item 2. Management’s Discussion and Analysis of Financial Condition 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 (“Candlewood hotels”) to serve extended-stay business and personal travelers. At December 31, 2002 and March 31, 2003, we had a total of 77 company-operated hotels (which is comprised of owned, leased and joint venture hotels), 30 franchised hotels and two managed hotels located in 34 states. In addition, at March 31, 2003, we had eight franchise hotels under construction and 18 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 table sets forth our property portfolio at March 31, 2003 and March 31, 2002:

     At March 31, 2003, 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. As of April 25, 2003, we also manage 15 Summerfield Suites hotels owned by HPT. 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 franchise and management fee income in our consolidated statements of operations. 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 include 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 and management fees from franchise, managed and joint venture hotels are included in franchise and management fee income in our consolidated statements of operations. Equity in income (loss) from joint venture hotels is included in loss from joint ventures in our consolidated statements of operations.

     We have sold and leased back 57 hotels to Hospitality Properties Trust (“HPT”). The provisions of the transactions allow us to operate, as lessee, over a defined lease term, hotels that we developed. Our results from operations reflect these transactions. As a result of the sale-leaseback transactions, we have recorded rent expense on the hotels leased back from HPT. Since these hotels are leased and not owned,

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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 not recognized into earnings until certain operating performance levels are achieved. See Note 5 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. 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. 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

Comparison of fiscal quarters ended March 31, 2003 and 2002

     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 $28.5 million for the quarter ended March 31, 2003, compared to $30 million for the quarter ended March 31, 2002. The decrease in revenue is a result of reduced average occupancy rates caused principally by the slowdown in the economy and a reduction in business travel. The following table sets forth the operating statistics for all our corporate hotels for the quarters ended March 31, 2003 and March 31, 2002:

     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 68.5% for the quarter ended March 31, 2003, compared to 72.4% for the quarter ended March 31, 2002. Occupancy rates for the quarter ended March 31, 2003 were negatively impacted by the slowdown in the economy.

     The average daily room rate for corporate hotels for the quarter ended March 31, 2003 was $54.93, compared to $54.76 for the quarter ended March 31, 2002. Average daily room rates are determined by dividing room revenue by the number of guestrooms occupied on a daily basis for the applicable period. Other factors that influence average daily room 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 in an attempt to maximize revenue.

     Revenue per available room (“RevPAR”), calculated as the average occupancy rate multiplied by the average daily rate, was $37.61 for the quarter ended March 31, 2003, compared to $39.67 for the quarter ended March 31, 2002, a 5.2% decrease. This decrease is primarily due to the lower average occupancy rate we experienced in the quarter ended March 31, 2003 compared to March 31, 2002.

     Hotel Operating Expenses

     Hotel operating expenses for the quarter ended March 31, 2003 totaled $18.6 million, compared to $19.2 million for the quarter ended March 31, 2002. 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 items, such as utilities, property taxes, insurance, supplies, promotional materials, maintenance items and similar expenses. The decrease in hotel operating expenses is largely due to lower corporate allocations and property taxes, partially offset by higher maintenance costs and operating costs for the one additional hotel acquired in March 2002.

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     Rent Expense on Leased Hotels

     Rent expense on the 57 leased hotels for the quarter ended March 31, 2003 was $11.5 million, compared to $7.2 million for the quarter ended March 31, 2002. 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 primarily due to an increase in base rent as a result of the sale and leaseback of the 21 additional hotels in April 2002.

     Hotel Depreciation and Amortization

     Depreciation and amortization expense applicable to hotel operations (e.g., building, furniture, fixtures and equipment) for the quarter ended March 31, 2003 totaled $1.1 million, compared to $2.5 million for the quarter ended March 31, 2002. The decrease in depreciation and amortization expense is the result of the sale and lease back of 21 hotels in April 2002. We do not record depreciation and amortization expense for properties that are leased.

     Corporate Operations

     Other Income

     Franchise and management fee income for the three-months ended March 31, 2003 totaled $1.1 million, compared to $931,000 for the three-months ended March 31, 2002. The increase in franchise and management fee income is due to the increase in the number of franchise hotels in operation and the increased revenue generated by those franchise hotels that had completed or were near completion of their ramp-up phase.

     Loss from joint ventures for the three-months ended March 31, 2003 totaled $1.1 million, compared to $475,000 for the three-months ended March 31, 2002. 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 did not sell any hotels during the quarters ended March 31, 2003 and March 31, 2002, but recognized $405,000 and $283,000, respectively, of the total deferred gain on hotels sold in prior periods. We have sold nearly all the properties that are available to sale and leaseback other than those subject to joint venture financing.

     Corporate Operating Expenses

     Corporate operating expenses for the quarter ended March 31, 2003 totaled $1.4 million, unchanged from the quarter ended March 31, 2002, and included all expenses not directly related to the 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.

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     Corporate Depreciation and Amortization

     Depreciation and amortization applicable to corporate operations for the quarter ended March 31, 2003 totaled $190,000, compared to $184,000 for the quarter ended March 31, 2002. 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 quarter ended March 31, 2003 was $36,000, compared to $93,000 for the quarter ended March 31, 2002. Interest income for the quarter ended March 31, 2003 resulted primarily from the temporary investment of cash provided by operations and the April 2002 sale-leaseback transaction of 21 hotels. For the quarter ended March 31, 2002, interest income resulted primarily from the temporary investment of cash provided by operations and the August 2001 sale-leaseback transaction of two hotels. The decrease in interest income for the quarter ended March 31, 2003 is largely due to lower cash levels and lower investment rate yields.

     Interest expense for the quarter ended March 31, 2003 was $1.1 million, compared to $3.4 million for the quarter ended March 31, 2002. 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.

     Sales of Hotels

     As of March 31, 2003, we had sold to and leased back from HPT 57 hotels, including 21 hotels sold during the second quarter of 2002. A deferred gain was recorded on the sales, a portion of which has been recorded in income in the quarters ended March 31, 2003 and March 31, 2002. The following table sets forth the rent expense and deferred gain recognized into earnings related to our leased hotels for the quarters ended March 31, 2003 and March 31, 2002 (in thousands):

Liquidity and Capital Resources

     We had cash and cash equivalents of $6.9 million at March 31, 2003, compared to $9.4 million at March 31, 2002. Net cash used in operating activities totaled $1.8 million for the three-months ended March 31, 2003, compared to $2.3 million of cash used in operating activities for the three-months ended March 31, 2002. For the three-months ended March 31, 2003, we recorded a net loss from operations of $4.9 million, $1.3 million of non-cash depreciation and amortization expense, $932,000 of loss on investment in joint ventures and $405,000 of non-cash deferred gain income on hotels sold. Sources of cash included a $3.1 million decrease in other assets primarily due to the reimbursement of hotel expenditures from the furniture, fixtures and equipment (“FF&E”) cash reserve accounts, which we used in operations. These FF&E reserve accounts are stipulated in the lease and lending agreements and require us to make monthly contributions equal to approximately 5.0% of total gross hotel revenues. The cash reserved is for replacement and refurbishment of hotel furniture and fixtures. Uses of cash for the three-months ended March 31, 2003 consisted primarily of a $1.0 million increase in accounts and other receivables and a $729,000 decrease in accounts payable and other accrued expenses. For the three-months ended March 31, 2002, we recorded a net loss from operations of $11.7 million including $8.6 million of non-cash impairment loss, $2.7 million of non-cash depreciation and amortization expense, $475,000 of loss on investment in joint ventures and $283,000 of non-cash deferred gain income on

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hotels sold. Uses of cash for the three-months ended March 31, 2002 included a $1.2 million decrease in accounts payable and other accrued expenses, a $492,000 increase in other assets (primarily FF&E reserve payments) and a $350,000 increase in accounts and other receivables.

     Net cash used in investing activities for the three-months ended March 31, 2003 totaled $619,000, compared to $6.7 million of net cash used in investing activities for the three-months ended March 31, 2002. Uses of cash for the three-months ended March 31, 2003 and March 31, 2002 consisted primarily of cash expenditures for property, equipment and leasehold improvements in connection with completed and leased hotels of $566,000 and $6.7 million, respectively.

     For the three-months ended March 31, 2003, net cash used in financing activities was $13,000, compared to $367,000 of net cash provided by financing activities for the three-months ended March 31, 2002. Net cash used in financing activities during the three-months ended March 31, 2003 consisted of $13,000 of principal payments on notes payable. For the three-months ended March 31, 2002, net cash provided by financing activities included $4.7 million of proceeds from mortgages and notes payable partially offset by $4.3 million of principal payments on notes payable.

     On April 1, 2003, pursuant to the terms of a prior agreement between the partners, for a nominal amount, we assumed 100% of all assets, liabilities and ownership interests in the Chicago, Illinois–Wheeling hotel from the joint venture, including an outstanding loan of $7.5 million. In June 2002, our joint venture partners declared that we were in default of our obligation to have at least 10 hotels open or under construction and as a result we would be required to make an additional equity contribution of $3.4 million to the joint venture on or before July 25, 2002. We did not make this contribution. As a result of this default and in accordance with the joint venture agreement, the joint venture suspended payment of franchise royalty and management fees to us, and the interest rate on the joint venture debt to Boston Capital and Mass Mutual increased from 12% to 21%. In December 2002, we reached an agreement with Boston Capital and Mass Mutual in regards to the amount of the additional equity contribution and we contributed $1.8 million to the joint venture and Boston Capital and Mass Mutual waived contractual rights to the $1.6 million balance. Simultaneous with the execution of this agreement, we received all previously suspended royalty and management fees. In addition, we agreed to bear all losses from the operation of the Chicago, Illinois – Wheeling hotel for the period July 26, 2002 forward until the earlier to occur of March 31, 2003 or the date of sale or refinance.

     As of March 31, 2003, we have guaranteed approximately $45 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 March 31, 2003, $5.7 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.

     The Boston Capital joint venture has a $10.5 million first mortgage loan on the Burlington, Massachusetts hotel that came due and payable to Boston Capital on May 1, 2003. The loan has not been repaid or refinanced. On May 7, 2003, the joint venture received a letter from Boston Capital declaring an event of default under the loan agreement. Pursuant to the joint venture agreement, any default by the joint venture on a first mortgage constitutes a default on the mezzanine debt held by Boston Capital. As a result, the interest rate on the mezzanine debt with Boston Capital has increased from 12% to 21%, and the payment of royalty and management fees to Candlewood has been suspended. Upon successful cure of the default, the interest rate would thereafter revert to 12% and the payment of royalty and management fees would resume. The monthly impact of the increase in the interest rate on the mezzanine debt is approximately $120,000. The monthly impact on our revenues due to the suspension of royalty and management fees is approximately $140,000.

     As of March 31, 2003, we had borrowed $58.9 million from GMAC and one other financial institution. This debt had scheduled maturity dates ranging from May 2005 to June 2011 with interest

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rates, which range from 7.75% to 8.30%.

     Our Series A and Series B Preferred Stock accumulate dividends at a rate of 7.5% 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 $2.5 million per quarter. We have not made the last six scheduled preferred stock dividend payments. 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. As of March 31, 2003, we had approximately $12.6 million of accumulated unpaid dividends. Pursuant to the provisions of the certificate of designation for the Series A and Series B Preferred Stock, the conversion price (i.e. the price at which the Preferred Stock may convert into Common Stock) was reduced in February 2003 to $7.50 per share to reflect our decision to forego payment of the November 2002 and February 2003 preferred stock dividend payments. The reduction in the conversion price to $7.50 has resulted in an increase in the dividend rate on the Series B preferred stock from 7.5% to 12.0%. No such provision applies to the Series A preferred stock, however, the failure to make future dividend payments will result in a further reduction in the conversion price of the Series A preferred stock.

     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 March 31, 2003, the mandatory redemption amount was approximately $119.6 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 March 31, 2003, the Liquidation Amount was $119.6 million, including $12.6 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 March 31, 2003, 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.

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     The following table summarizes our contractual cash and debt obligations for the next five years as of March 31, 2003 (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 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 December 2003. In addition, in order to meet our long-term financing obligations, we will be required to raise additional capital. 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.

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:

     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 $6.9 million at March 31, 2003. 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.

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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 $68.3 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. At March 31, 2003, our net worth as defined in the agreement was $63.3 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 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. In addition, on May 1, 2003, our significant joint venture investee failed to repay a $10.5 million loan when it became due. 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 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.”

     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 March 31, 2003, the mandatory redemption amount was approximately $119.6 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

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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.

     We have Never Been Profitable. At March 31, 2003, 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;

     •     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.

     Our Growth is largely Dependant on Franchising Hotels. We intend to grow primarily by franchising Candlewood Suites and Cambridge Suites hotels. Our financial condition may impact our ability to continue to sell franchises. For example, the State of Virginia recently revoked our ability to sell franchises in that state due to our inability to meet certain financial covenants. Our ability to franchise hotels and obtain franchisees involves additional 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.

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     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.

     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.

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     Certain of these factors are discussed further elsewhere in this Form 10-Q and the Company’s other filings with the Securities and Exchange Commission.

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.

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“Interpretation 46”), which required the consolidation of an entity by an enterprise (i) if that enterprise, known as a “primary beneficiary”, has a variable interest that will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both and (ii) if the entity is a variable interest entity, as defined by Interpretation 46. An entity is a variable interest entity if (a) the total equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (b) the equity investors do not have the characteristics of a controlling financial interest in the entity. Interpretation 46 applies immediately to all variable interest entities created after January 31, 2003. For variable interest entities created by public companies before February 1, 2003, Interpretation 46 must be applied no later than the beginning of the first interim or annual reporting period beginning after June 15, 2003. The initial determination of whether an entity is a variable interest entity shall be made as of the date at which a primary beneficiary becomes involved with the entity and reconsidered as of the date one of three triggering events described by Interpretation 46 occur. We do not believe that the adoption of this interpretation will have a material effect on our financial statements.

     We do not believe the issuance of these statements and interpretations 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. We adopted SFAS No. 145 in 2002 and classify these amounts as operating expenses.

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Item 3. Quantitative and Qualitative Disclosures About 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 March 31, 2003, 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 March 31, 2003, would change by approximately $700.

     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 ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. As of March 31, 2003, the Company had one derivative financial instrument, an interest rate cap, which was recorded at fair value of $10,000 as of March 31, 2003, 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 4. 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 II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits

               See the Exhibit Index beginning on page 33.

(b)  Reports on Form 8-K

               None.

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SIGNATURES

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

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CERTIFICATIONS

I, Jack P. DeBoer, certify that:

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

2.     Based on my knowledge, this quarterly 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 quarterly report;

3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 quarterly 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 quarterly report (the “Evaluation Date”); and

c) presented in this quarterly 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 quarterly 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, certify that:

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

2.     Based on my knowledge, this quarterly 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 quarterly report;

3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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 quarterly 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 quarterly report (the “Evaluation Date”); and

c) presented in this quarterly 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 quarterly 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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EXHIBIT INDEX

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*

Compensation Plan or Agreement

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(1)		Incorporated by reference pursuant to Rule 12b-32 from Candlewood Hotel Company, Inc.’s Registration Statement on Form S-1 (Registration No. 333-12021) filed September 13, 1996.
(2)		Incorporated by reference pursuant to Rule 12b-32 from Candlewood Hotel Company, Inc.’s Registration Statement on Form S-1/A (Registration No. 333-12021) filed October 17, 1996.
(3)		Incorporated by reference pursuant to Rule 12b-32 from Candlewood Hotel Company, Inc.’s Registration Statement on Form S-1/A (Registration No. 333-12021) filed October 30, 1996.
(4)		Incorporated by reference from Candlewood Hotel Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
(5)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K filed on October 8, 1997.
(6)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K filed on January 7, 1998.
(7)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K filed on June 9, 1998.
(8)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K/A filed August 6, 1998.
(9)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K/A filed August 10, 1998.
(10)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
(11)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 2001.
(12)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Current Report on Form 8-K filed on April 26, 2002.
(13)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Quarterly Report on Form 10-Q for the period ended June 30, 2002.
(14)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 2002.
(15)		Incorporated by reference from Candlewood Hotel Company, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.