<PAGE>

<PAGE>
                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB

                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                       For the Year Ended                  Commission File
                      December 31, 1996                     Number 0-17838

                            HUDSON HOTELS CORPORATION
             (Exact name of registrant as specified in its charter)

         A New York Corporation           IRS Employer Identification
                                                No. 16-1312167

            Address                            Telephone Number

   One Airport Way, Suite 200                   (716) 436-6000
   Rochester, New York 14624

           Securities registered pursuant to Section 12(b) of the Act:

                                                         Name of Exchange on
Title of Each Class                                        which Registered

      None                                                        None
          Securities registered pursuant to Section 12(g) of the Act:

                          Common Stock $.001 par value
                              (Title of the Class)

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
                  ------------                       -----------

The Registrant's revenues for the year ended December 31, 1996 $14,148,049.

The aggregate market value of the Common Stock held by non-affiliates of the
Registrant (computed by reference to the average of the bid and asked prices as
reported by the National Quotation Bureau, Inc. as of the close of business on
March 18, 1997) was $14,674,411 (2,730,123 shares at $5.375 per share).

The number of shares outstanding of each of the Registrant's classes of common
stock as of March 3, 1997, is as follows:

                        4,787,462 Shares of Common Stock
                            Par Value $.001 per share

Parts of the Proxy Statement for the Registrant's Annual Meeting of Stockholders
to be held May 29, 1997, are incorporated by reference to Part III of the Form
10-KSB Report.


<PAGE>
                                     PART 1

                         ITEM 1. DESCRIPTION OF BUSINESS

                SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

    Certain matters discussed in this Annual Report on Form 10-KSB are
"forward-looking statements" intended to qualify for the safe harbors from
liability established by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes",
"anticipates", "expects" or words of similar import. Similarly, statements that
describe the Company's future plans, objectives or goals are also
forward-looking statements. Such forward-looking statements are subject to
certain risks and uncertainties which are described in close proximity to such
statements and which could cause actual results to differ materially from those
currently anticipated. Shareholders, potential investors and other readers are
urged to consider these factors in evaluating the forward-looking statements and
are cautioned not to place undue reliance on such forward-looking statements.
The forward-looking statements included herein are made as of the date of this
report, and the Company undertakes no obligations to publicly update such
forward-looking statements to reflect subsequent events or circumstances.

NARRATIVE DESCRIPTION OF BUSINESS

    Hudson Hotels Corporation (the "Company") was organized as Microtel
Franchise and Development Corporation to develop and franchise a national chain
of economy limited service lodging facilities ("Microtels"), using the service
mark "MICROTEL", which offers downsized rooms with higher quality furnishings at
rates below those available at competing national lodging chains. The Company
was incorporated in New York State on June 5, 1987.

    On October 5, 1995, the Company signed an exclusive Joint Venture Agreement
with US Franchise Systems, Inc., in which US Franchise Systems, Inc. purchased
worldwide franchising and administration for the Microtel franchise chain. As a
result of the Joint Venture Agreement, the Company has focused its efforts on
acquiring, developing, building and managing various hotel products, including
Microtels, which has been the Company's strength since acquiring Hudson Hotels
Corporation in 1992. During 1996, the Company embarked upon a significant
expansion and development program, as described in "Recent Developments" below.

    The Company has retained the right to franchise and construct an additional
twenty-three (23) Microtel properties and ten (10) "suite" properties and to
receive all royalties on fifty (50) Microtels (27 existing and 23 new ones to be
undertaken by the Company) and ten (10) suites. Therefore, the Company retains
all royalties on Microtels existing prior to the execution of the Joint Venture
Agreement and the royalties attributable to the subsequently developed Microtels
previously cited. As of December 31, 1996, the Company has the right to
franchise and construct nineteen (19) Microtel properties and ten (10) suite
properties.

    As a result of this agreement, the Company is no longer responsible for
administration of the Microtel franchise. This includes regulatory compliance
with the Federal Trade Commission ("FTC"), Microtel service marks, franchise
sales, quality assurance inspections and franchise administration.

    In 1996, the Company embarked on a significant expansion and development
program. Effective July 31, 1996, the Company acquired the remaining partnership
interests in five hotel partnerships in which the Company was the owner of
varying minority general and limited partnership equity interests in exchange
for 1,170,103 shares of the Company's common stock.

    The acquisition has been accounted for under the purchase method, and
accordingly, the operating results of the five hotel partnerships acquired have
been included in the consolidated operating results since the effective date of
the acquisition, July 31, 1996. One of the partnerships acquired, Delray Beach
Hotel Properties Limited, was previously included in the consolidated operating
results of the Company prior to the acquisition, as the Company, in its capacity
as sole general partner and by the terms of the partnership agreements,
controlled the partnership of Delray Beach Hotel Properties Limited. The other
partnerships acquired include Jamestown Hotel Properties, L.P.; Brookwood Hotel
Properties; Ridge Road Hotel Properties, L.P.; and Muar Lakes Associates, L.P.
See Item 2 for a detailed description of each property.

<PAGE>
   On November 27, 1996, the Company acquired 12 hotel properties, consisting
of eight (8) Fairfield Inns by Marriott(R) and four (4) Cricket Inns, from SB
Motel Corp., a subsidiary of Salomon Brothers, Inc., and the subsidiaries of SB
Motel Corp. which had been formed to hold each such hotel, pursuant to an
Agreement of Purchase and Sale dated September 27, 1996, among the Company and
its subsidiary, Hudson Hotels Properties Corp., as Purchaser and SB Motel Albany
Corp., SB Motel Charleston Corp., SB Motel Richmond Corp., SB Motel
Durham-Research Triangle Park Corp., SB Motel Cary Corp., SB Motel Statesville
Corp., SB Motel Wilmington Corp., SB Motel Columbia Corp., SB Motel Virginia
Beach Corp., SB Motel Durham-Duke Corp., SB Motel Raleigh Corp., and SB Motel
Charlotte I-85 Corp. (the subsidiaries of SB Motel Corp. which held each
property) (the Sellers). The Company acquired eleven of the properties into its
newly-formed subsidiary, HH Properties-I, Inc., and the twelfth, the Virginia
Beach Cricket Inn, into its newly formed subsidiary, HH Properties-VB, Inc. See
Item 2 for a detailed description of each property.

    The purchase price for the properties was $60,400,000, determined by
arms-length negotiation with the Sellers, after analysis and valuation by the
Company based upon historic and projected operating results of the properties.
As part of its pre-closing due diligence, the Company obtained independent
valuations of the twelve properties from HVS Valuation Services, which supported
the negotiated purchase price. The purchase price was paid by issuing 370,657
shares of Company common stock, valued at $2,400,000, by issuing the Company's
subordinated promissory note in the amount of $2,900,000 (maturing November 27,
1997) to the Seller, and by paying the balance of $55,100,000 in cash. The cash
portion of the purchase price was obtained a) by placing a $37,470,000 mortgage
issued by Nomura Asset Capital Corporation on the properties purchased by HH
Properties-I, Inc.; b) by the Company securing $17,000,000 of mezzanine
financing from Nomura Asset Capital Corporation; and c)
by the Company utilizing $530,000 of its available capital.

    In addition to the consideration stated above, the Company has agreed to
register the 370,657 shares issued to SB Motel Corp. for sale to the public
within 180 days following closing, and the Company has granted to Salomon
Brothers, Inc. a right of first refusal to undertake equity offerings on behalf
of the Company. John P. Buza, an officer of the Seller, became a Director of
the Company.

    As of December 31, 1996, the Company managed thirty one hotel properties
located primarily in the Northeast and Southeast United States. Of the thirty
one hotel properties under management, seventeen are owned directly by the
Company. The properties it manages range from super budget "Microtel Inns" to
full-service luxury hotels. It competes for management contracts with other
hotel management companies. The management contracts are set forth on variations
of the Company's standard form contract, for terms of one to ten years, and
provide for a full range of hotel management services, including operations
management, personnel and staffing, sales and marketing, business systems,
financial management, and food and beverage management, for a fee typically as a
percentage of gross revenues.

<PAGE>
    The Company's portfolio of managed properties, owned, partially owned
through partnerships in which the Company has a minority equity position, or
owned by unrelated parties, are made up of the following national franchise
affiliations:

<TABLE>
<CAPTION>

=========================================== ----------------------- ----------------------- =======================
                                                                                                  PERCENT OF
                                                                          NUMBER OF            COMPANY'S TOTAL
                FRANCHISE                      NUMBER OF HOTELS          GUEST ROOMS             GUEST ROOMS
=========================================== ----------------------- ----------------------- =======================
                  OWNED
=========================================== ----------------------- ----------------------- =======================
<S>                                                   <C>                    <C>                    <C>
Fairfield Inn                                         8                      953                    27.9%
=========================================== ----------------------- ----------------------- =======================
Comfort Inn                                           2                      184                     5.4%
=========================================== ----------------------- ----------------------- =======================
Econo Lodge                                           1                       65                     1.9%
=========================================== ----------------------- ----------------------- =======================
Cricket Inn                                           4                      580                    17.0%
=========================================== ----------------------- ----------------------- =======================
Independent                                           2                      178                     5.2%
=========================================== ----------------------- ----------------------- =======================
     MANAGED WITH FINANCIAL INTEREST
=========================================== ----------------------- ----------------------- =======================
Microtel Inn                                          7                      720                    21.2%
=========================================== ----------------------- ----------------------- =======================
Comfort Inn                                           1                       73                     2.1%
=========================================== ----------------------- ----------------------- =======================
Econo Lodge                                           1                      102                     3.0%
=========================================== ----------------------- ----------------------- =======================
Independent                                           1                      134                     3.9%
=========================================== ----------------------- ----------------------- =======================
              OTHER MANAGED
=========================================== ----------------------- ----------------------- =======================
Microtel Inn                                          3                      305                     8.9%
=========================================== ----------------------- ----------------------- =======================
Comfort Inn                                           1                      120                     3.5%
=========================================== ======================= ======================= =======================
                 TOTAL                                31                    3,414                    100%
=========================================== ======================= ======================= =======================

</TABLE>


    The Company has a minority equity position, either as a general or a limited
partner, in ten entities which own hotel properties. In addition, it is a
general partner in Watertown Hotel Properties II, L.P., an entity which
previously owned a hotel property and which now holds a mortgage upon a Microtel
Inn which represents a portion of the sale price of this property.

    The Company, in its capacity as sole general partner and by the terms of the
partnership agreement, controls this partnership. Consolidation of the revenues
and expenses of this partnership provides no additional net income or loss to
the Company than from reporting the investment under the equity method of
accounting.

    In November 1994, the Company provided a $250,000 cash deposit to secure a
ten year operating lease and management contract on a full-service hotel located
in Canandaigua, New York, from L, R, R & M, L.L.C. In June 1996, the Company
provided an additional $200,000 cash deposit, which extends the lease term an
additional eighteen months and provides additional security on the renovations
performed from November 1995 through May 1996. One of the minority owners of L,
R, R & M, L.L.C., is a greater than 5% shareholder who is not involved
in the management or operation of the Company (see Note 15).

    The Company plans to continue to improve its position in the lodging
industry by implementing the following strategies:

    Enhance operating performance of its existing hotels owned or under
management. On November 27, 1996, the Company acquired 12 hotels from SB Motel
Corp. The Company intends to utilize its operating, marketing and financial
systems resources to enhance operating performance by maximizing revenues and
reducing operating expenses.

<PAGE>
    Develop and build Microtel Inns on sites acquired. Currently, the Company
has acquired seven sites on which it plans to develop and build Microtel Inns
(see Item 2, "Description of Property", for a detailed description of sites.)
The Company intends on building out these sites, either itself or through hotel
ventures in which the Company retains equity ownership interests. The Company
believes that by developing and building Microtel Inns on its sites, it will
increase revenues through hotel operating revenues (if company owned), franchise
royalties (equity ownership interest), development fees (equity ownership
interest) and management fees (equity ownership interest).

    Opportunistic acquisition of hotels. The Company intends to capitalize on
its strength as an owner/operator by continuing to identify and pursue the
acquisition of hotels. In 1996, the Company acquired twelve hotels for
approximately $39,400 per room, totaling $60,400,000. This acquisition included
eight (8) Fairfield Inns and four (4) Cricket Inns, all located in the
Southeast. The Company believes that hotel acquisitions will provide future
growth opportunities through increased cash flow and an incremental increase in
the value of the hotels acquired.

    Based on the Company's plan for future growth, the Company believes that it
would have experienced more opportunities to develop and build Microtel Inns and
acquire hotels if it had adequate lending sources which could provide financing
for construction of Microtel Inns or acquisition of hotels. The Company has
identified institutions with lending capabilities and willingness to commit to
financing and will try to capitalize on this by building Microtel Inns and
acquiring hotels.

COMPANY PROPERTIES

    The Company currently owns seventeen (17) hotel properties in addition to
having a minority equity interest in entities which own hotel properties. The
Company also has seven (7) parcels of land under development, which it owns, and
is diligently attempting to identify entities and institutions with lending
capabilities and willingness to commit to the financing of Company-owned
Microtel Inns. The Company has and will continue to develop various hotel
products, including Microtel Inns, in which it will have an equity interest. See
Item 2 for a detailed description of each property.

FRANCHISING

    As a result of the Joint Venture Agreement with US Franchise Systems, Inc.,
the Company no longer franchises Microtels, and accordingly, is no longer
subject to regulation by the Federal Trade Commission or the individual (50)
states, with varying state requirements. The Company will continue to maintain
its knowledge in regard to FTC and state regulations in the event that US
Franchise Systems, Inc. does not meet its Development Schedule and does not cure
any future default, if any, in which case the worldwide franchise rights revert
back to the Company.

    As of March 31, 1995, there was a Master Franchise Agreement outstanding
with Essex Microtel International Lodging, Inc. ("EMILI"), as Master Franchisee,
pursuant to which EMILI acquired certain exclusive franchise licensing and
development rights throughout Canada, but with the exception of the Province of
Alberta. In consideration for the granting of those rights the Company had
originally received a non-refundable initial master franchise fee of $350,000 in
the form of a promissory note. An initial installment payment under the note in
the amount of $150,000 was made prior to the end of fiscal year 1991 and the
note provided for three additional annual installment payments of $66,667 each
commencing February 13, 1992. The first installment was paid. The master
franchise agreement was amended in 1993 and 1994.

    On June 30, 1995, a third amendment was executed by EMILI and the Company.
The third amendment extended the Development Schedule to 10 1/4 years and made
certain other changes. In addition, the Company obtained the absolute right, at
its option, to terminate the Master Franchise Agreement in the event that the
Company should negotiate the licensing or sale to a third party of the worldwide
franchise rights. In connection with this amendment, EMILI paid the Company its
entire remaining financial obligation. Effective October, 5, 1995, pursuant to
the third amendment executed on June 30, 1995, the EMILI Master Franchise
Agreement was terminated upon the Company signing a Joint Venture Agreement with
US Franchise Systems, Inc. (see "Narrative Description of Business":)

<PAGE>
    On September 30, 1991, the Company entered into an exclusive development
agreement with S&E Hospitality Partnership, whereby the Company granted the
rights to an unrelated party to develop and operate 75 Microtel hotels in
Massachusetts, Rhode Island, Connecticut, New Jersey, Delaware, D.C., part of
New York, Pennsylvania, Maryland, and Virginia. In consideration for these
rights, the Company received a non-refundable payment of $500,000 for twenty
franchises. The first of the 20 franchises was opened in Allentown, Pennsylvania
in May, 1993. In March 1994, a Termination of Exclusive Development Agreement
was executed by S&E Hospitality Partnership and the Company, pursuant to which
S&E's partners retained the right to develop the remaining nineteen (19)
Microtels for which S&E's partners have paid the non-refundable franchise fees.
On June 30, 1995, one of the former partners of S&E sold 14 of its assigned
prepaid franchises back to the Company for $200,000, which resulted in a
$150,000 gain to the Company. The remaining five (5) prepaid franchises have
been used for Microtel Inns located in Colonie, New York; Greensboro, North
Carolina; Chattanooga, Tennessee; Raleigh, North Carolina; and Charlotte, North
Carolina.

    On January 20, 1995, the Company terminated for cause its franchise
agreement with Country Inn Hotel, Inc. for the Microtel located in Schenectady
(Rotterdam), New York. The Company has commenced action against its former
franchisee to collect termination fees and other amounts due, and to enforce its
rights upon termination. This occurred prior to the signing of the Joint Venture
Agreement with US Franchise Systems, Inc.

SERVICE MARKS

    As a result of the Joint Venture Agreement with US Franchise Systems, Inc.
in 1995, the Company has transferred all proprietary marks relating to the
"Microtel" name to US Franchise Systems, Inc.
The Company uses various national trade names pursuant to licensing arrangements
with national franchisors which include: Microtel Inn, a registered trademark of
U.S. Franchise Systems, Inc.; Comfort Inn and Econo Lodge, a registered
trademark of Choice Hotels International, Inc.; Fairfield Inn, by Marriott, a
registered trademark of Marriott International, Inc.; and Cricket Inn.

COMPETITION

    The lodging industry is highly competitive. There is no single competitor or
small number of competitors of the Company that are dominant in the industry.
The Company's hotel properties operate in areas that contain numerous
competitors, many of which have substantially greater resources than the
Company. Competition in the lodging industry is based generally on location,
room rates, quality of services and guest amenities offered. The Company's
properties compete against all hotel products in any given market for
patron market share. In practice, the hotel industry is highly segmented,
ranging from luxury destination resorts to small "mom and pop" properties. The
Company's properties compete directly against other national and regional chains
of hotels in each geographical market in which the Company hotels are located.
New or existing competitors could significantly lower rates or offer greater
conveniences, services or amenities or significantly expand, improve or
introduce new facilities in markets in which the hotels compete, thereby
adversely affecting the Company's operations. The Company also competes with
other regional and national hotel companies for development and management
contracts.

SEASONALITY

    The lodging industry is seasonal in nature: Generally, hotel revenues are
greater in the second and third quarters than in the first and fourth quarters.
This seasonality can be expected to cause quarterly fluctuations in revenues of
the Company. Quarterly earnings also may be adversely affected by events beyond
the Company's control, such as extreme weather conditions, economic factors and
other considerations affecting travel.

GOVERNMENT REGULATION

    A number of states regulate the licensing of hotels and restaurants,
including liquor licenses, by requiring registration, disclosure statements and
compliance with specific standards of conduct. The Company believes it is
substantially in compliance with these requirements. The Company is also subject
to laws governing its relationship with hotel employees, including minimum wage
requirements, overtime, working conditions and work permit requirements.
Compliance with, or changes in, these laws could reduce the revenue and
profitability of the Company owned hotels otherwise adversely affect the
Company's operations.

<PAGE>
    Under the Americans with Disabilities Act (ADA), all public accommodations
are required to meet certain requirements related to access and use by disabled
persons. These requirements became effective in 1992. Although significant
amounts have been and continue to be invested in ADA required upgrades to the
Company owned hotels, a determination that the Company is not in compliance with
the ADA could result in a judicial order requiring compliance, imposition of
fines or an award of damages to private litigants. The Company is likely to
incur additional costs of complying with the ADA; however, such costs are not
expected to have a material adverse effect on the Company's results of
operations or financial condition.

ENVIRONMENTAL COMPLIANCE

    The Company has not been materially affected by, nor has it incurred any
significant costs related to compliance with federal, state or local
environmental laws.


EMPLOYEES

    As of December 31, 1996, the Company had 551 full-time employees, of which
471 were compensated on an hourly basis. There are 26 employees who work at the
corporate headquarters.

<PAGE>
                         ITEM 2. DESCRIPTION OF PROPERTY

    The Company's headquarters are located at One Airport Way, Suite 200,
Rochester International Airport, Rochester, New York 14624. The 6,185 square
feet of office space is leased through September 1997. The Company believes that
the office space is adequate and sufficient for its needs for at least two
years.

    The Company owns seven (7) parcels of land, which are either being held for
sale to hotel/restaurant developers or are under development by the Company. The
investment policy is determined by Company management and can be changed without
a vote of security holders.

    Investment in land/real estate under development is summarized as follows:

    TONAWANDA, NEW YORK - This land is north of Buffalo, New York, off
Interstate 290 and is in proximity of major businesses, universities and
shopping centers. The Company owns 8.13 acres at a cost of $780,822 or $96,042
an acre. The parcel is zoned for hotel and restaurant development. Also, this
piece of land is adjacent to an existing Microtel and a parcel owned by Microtel
Partners 1995-I, L.P. (see below).

    STRAWBERRY PLAINS PIKE, TENNESSEE - This land is east of Knoxville,
Tennessee, off Interstate 40 and is in proximity of major businesses and
recreational areas. The Company owns 1.39 acres at a cost of $310,204 or
$223,168 an acre. The parcel is approved for hotel development.

    ARLINGTON, TEXAS - This land is between the cities of Dallas and Fort Worth,
off State Highway 360, and is in proximity of major businesses, an amusement
park, Arlington Stadium and shopping centers. The Company owns 2.0 acres at a
cost of $604,629, or $302,314 an acre. The parcel is zoned for hotel
development.

    TUCSON, ARIZONA - This land is outside the city limits of Tucson, off
Interstate 10, and is in proximity of major businesses, universities and
airport. The Company owns 2.0 acres at a cost of $478,851, or $239,425 an acre.
The parcel is zoned for hotel development.

    PLANO, TEXAS (PLANO PARKWAY) - This land is north of Dallas, Texas,
accessible to Lyndon B. Johnson Freeway I-635, the Dallas North Tollway and
Central Expressway US-75. It is in proximity of major businesses and shopping
centers. The Company owns 2.0 acres at a cost of $677,697, or $338,848 an acre.
The parcel is zoned for hotel development.

    PLANO, TEXAS - This land is north of Dallas, Texas, off the North Central
Expressway and is in proximity of major businesses and shopping centers. The
Company owns two acres at a cost of $595,661 or $297,831 per acre.
The parcel is zoned for hotel development.

    IRVING, TEXAS - This land is located west of Dallas, Texas, adjacent to the
Dallas-Fort Worth International Airport, off John W. Carpenter Freeway and is in
proximity of major businesses. The Company owns 2.02 acres, at a cost of
$472,932 or $234,124 per acre. The parcel is zoned for hotel development.

    The Company, through its equity investments, owns minority interests in the
following:

    AIRPORT HOTEL PROPERTIES, L.P. - This limited partnership operates a 73 room
Comfort Inn, which is located adjacent to the Rochester International Airport in
Rochester, New York. The Company's ownership percentage totals 21.5%. The hotel
had a complete renovation during 1991, and is in very good condition. The
partnership had a first mortgage with a balance of $1,492,711 at December 31,
1996.

<PAGE>
    THE MONTGOMERY GROUP, L.P. - This limited partnership operates an 84 room
Comfort Inn and is located in Montgomeryville, Pennsylvania. The Company's
ownership percentage totals 4.12%. The hotel was opened in 1991, and is in very
good condition. The total outstanding mortgage balance at December 31, 1996, was
$3,430,222.

    950 JEFFERSON ASSOCIATES, L.P. - This limited partnership operates a 102
room Econo Lodge which is located in Henrietta, New York. The Company's
ownership percentage totals 2%. The hotel was built in 1984 and is in very
good condition. The partnership has a first mortgage with a balance of
$2,675,182 at December 31, 1996.

    MICROTEL GATLINBURG L.P. - This limited partnership operates a 102 room
Microtel which is located in Gatlinburg, Tennessee. The hotel is located
adjacent to the Great Smoky Mountain National Park and a short distance from
Dollywood in Pigeon Forge, Tennessee. The Company's ownership percentage totals
10%. The hotel was built in 1994 and is in excellent condition. The partnership
has a first mortgage with a balance of $2,478,961 at December 31, 1996.

    FISHERS ROAD HOTEL PROPERTIES, L.P. - This limited partnership operates a 99
room Microtel which is located in Victor, New York, adjacent to Interstate 90.
The Company's ownership percentage is 22.5%. The hotel was built in 1994 and is
in excellent condition. The partnership has a first mortgage with a balance of
$1,549,328 at December 31, 1996.

    ESSEX MICROTEL LERAY, L.P. - This limited partnership operates the 100 room
Microtel located in Watertown, New York, which opened in 1990. The Company's
ownership interest as a special limited partner totals 4.0%. The first mortgage
on the property totals $1,100,000 and is held by Watertown Hotel Properties II,
L.P., a partnership in which the Company has a general partnership interest and
controls under the terms of the partnership agreement.

    ROCHESTER HOSPITALITY PARTNERS, L.P. - This limited partnership formed to
build and operate six Microtels. The Company's ownership percentage is 20%. The
partnership owns five Microtels which opened in 1995 and 1996, varying from 99
to 122 rooms and one 122 room Microtel under construction in South Carolina as
of December 31, 1996. The partnership has an aggregate first mortgage on the
five properties, with a balance of $12,741,158 at December 31, 1996.

    MICROTEL PARTNERS 1995-I, L.P. - This limited partnership owns 2.87 acres of
land in Tonawanda, New York, on which it currently plans to build a suite hotel.
The project is in the development stage at December 31, 1996. The Company's
ownership percentage is 50%, but is anticipated to be diluted as additional
partners are added in the future.

    WATERTOWN HOTEL PROPERTIES II, L.P. - This limited partnership holds a
$1,100,000 mortgage receivable from Essex Microtel Leray L.P. which is
collateralized by a 100 room Microtel located in Watertown, New York. Monthly
payments consist of interest only at 10% per annum. The entire principal amount
is due October 31, 1998. The Company's general partnership interest totals 1%.

    The Company, through its wholly owned subsidiary HH Properties-I, Inc., owns
the following properties. The properties are secured by a first mortgage from
Nomura Asset Capital Corporation, with an aggregate balance of $56,000,000 at
December 31, 1996.

    SEAGATE HOTEL AND BEACH CLUB - The Seagate Hotel and Beach Club is a 70 room
luxury suite hotel and private beach club and restaurant. The property is
located in Delray Beach, Florida. This all suite ocean-front property (housed in
one two-story and one three-story structure) is located on an approximate 2.5
acre site at 400 South Ocean Boulevard, along Florida's Gold Coast, midway
between West Palm Beach and Fort Lauderdale. Directly across the street is the
beach club, a one-story structure located on approximately 22,000 square feet of
real estate, including 400 feet of private beach front. The property also
consists of a one-story administration building which services the hotel and
club. Hotel amenities include 1,000 square feet

<PAGE>
of meeting facilities, freshwater and salt water swimming pools, a gazebo and
outdoor deck. All 70 suites are also equipped with a kitchenette. Beach club
amenities include a lounge, kitchen and dining room/restaurant, as well as a
bathhouse containing locker rooms, cabanas and a small service area.

    BROOKWOOD INN - The Brookwood Inn is a full-service 108 room hotel in
Pittsford, New York. This five-story hotel is located on an approximately six
acre site along Route 96 in Pittsford, New York, just off Interstate 490. The
complex offers whirlpool and executive suites, as well as a full-service
restaurant, heated indoor pool, whirlpool and fitness center. The hotel also has
meeting and conference facilities available to accommodate 5 to 75 people. The
property was developed and opened by a Hudson partnership in May 1987 and has
been managed by Hudson Hotels Corporation since that time.

    COMFORT INN WEST - The Comfort Inn West is located in Greece, New York. This
five-story 83 room limited-service hotel is located on 1.9 acres of land along
Route 104 West, off Interstate 390 North, just outside the city of Rochester and
5 minutes from the airport. Amenities include jacuzzi suites and a breakfast
room. This property was developed by Hudson Hotels Corporation and opened in
1986. Hudson Hotels Corporation has managed the property since that time.

    COMFORT INN JAMESTOWN - The Comfort Inn Jamestown is located in Jamestown,
New York. This two-story 101 room hotel is located on a five acre site adjacent
to Interstate 17 in Jamestown, New York. The hotel is only one mile from both
Chautauqua County airport and the city of Jamestown. This limited-service
facility provides specialty jacuzzi rooms and a cocktail lounge. The property
was developed by Hudson Hotels Corporation and opened in February 1986. Hudson
Hotels Corporation has managed the property since that time.

    ECONO LODGE CANANDAIGUA - The Econo Lodge Canandaigua is located in
Canandaigua, New York. This two-story 65 room limited-service hotel is located
on 2.8 acres of land along Routes 5 & 20, near the Bristol Mountain ski resort
and the Finger Lakes resort area in western New York state. The hotel was built
in 1983 and is in very good condition.

    FAIRFIELD INN BY MARRIOTT(R) (ALBANY, GEORGIA) - The Albany Fairfield Inn
consists of two, 2-story exterior corridor buildings with 122 rooms. The
property was opened in July 1982 and was renovated and changed to a Fairfield
Inn by Marriott(R) in September 1994. The hotel is located 1/8 mile off business
Route U.S. 19 North and approximately 1/4 mile from the Liberty Expressway on
North Slappey Boulevard in Albany, Georgia. Slappey Boulevard is the primary
north-south traffic artery through Albany and is lined by commercial
establishments, including hotels, restaurants, gas stations and shopping
centers.

    FAIRFIELD INN BY MARRIOTT(R) (CARY, NORTH CAROLINA) - The Cary Fairfield Inn
consists of two, 2-story, guest room buildings and one, 1-story building housing
the reception area. The 125-room exterior corridor hotel was opened in April
1986 and was renovated and changed to a Fairfield Inn by Marriott(R) in June
1994. The hotel is located at the intersection of U.S. 64 and Walnut Street and
3/4 miles west of the I-40 interchange in Cary, North Carolina, east of Raleigh.
The predominantly commercial area surrounding the property includes retail
development, motor services, restaurants and lodging facilities.

    FAIRFIELD INN BY MARRIOTT(R) (NORTH CHARLESTON, SOUTH CAROLINA) - The
Charleston Fairfield Inn consists of two, 2-story exterior corridor buildings
with 119 guest rooms. The property was opened in 1985 and was renovated and
changed to a Fairfield Inn by Marriott(R) in July 1994. The property is located
in the northwest quadrant of I-26 and Ashley Phosphate Road on Northside Drive
in North Charleston, South Carolina. I-26 is the major highway that links
downtown Charleston to Columbia and Greenville, South Carolina. It also provides
direct access to the Charleston International Airport, which is only five
minutes from the property.

<PAGE>
    FAIRFIELD INN BY MARRIOTT(R) (COLUMBIA, SOUTH CAROLINA) - The Columbia
Fairfield Inn consists of two, 2-story, external corridor structures with 129
guest rooms. The hotel opened in 1988 and was renovated and changed to a
Fairfield Inn by Marriott(R) in 1994. The hotel is located at the intersection
of I-77 and Two Notch Road. The area contains South Carolina's largest shopping
mall, as well as a number of retail establishments, companies and is
approximately three miles north of Fort Jackson Army Base. The property is in
close proximity to I-20, a major east-west highway.

    FAIRFIELD INN BY MARRIOTT(R) (DURHAM-RESEARCH TRIANGLE PARK, NORTH CAROLINA)
- The Durham-Research Triangle Park Fairfield Inn consists of one, 3-story
structure with 96 guest rooms. The hotel was opened in March 1987 and was
renovated and changed to a Fairfield Inn by Marriott(R) in July 1994. The hotel
is located at the intersection of NC Highway 55 and I-40 located on the edge of
Research Triangle Park (RTP), the nation's largest planned research and
development park. In addition, the hotel is six miles from the Raleigh-Durham
International Airport and seven miles from downtown Durham and Duke University.

    FAIRFIELD INN BY MARRIOTT(R) (RICHMOND, VIRGINIA) - The Richmond Fairfield
Inn consists of two, 2-story guest room buildings. The 124 room exterior
corridor hotel was opened in August 1987 and was renovated and changed to a
Fairfield Inn by Marriott(R) in July 1994. The hotel is located on West Broad
Street, less than a mile west of I-64 and three miles from I-95 in Richmond,
Virginia. The property is located in Richmond, Virginia, which is approximately
93 miles northwest of Norfolk and approximately 110 miles from Washington, D.C.
The location's desirability is further heightened by its proximity to both
downtown Richmond, eight miles away, and the Richmond International Airport, 15
miles away. The property also enjoys excellent proximity to Richmond's major
office parks (Brookfield, Paragon Place, Innsbrook and the Koger Office Parks).

    FAIRFIELD INN BY MARRIOTT(R) (STATESVILLE, NORTH CAROLINA) - The Statesville
Fairfield Inn consists of three, 2-story guest room buildings. The 118 room
exterior corridor hotel was opened in 1985 and was renovated and changed to a
Fairfield Inn by Marriott(R) in August 1994. The hotel has a prime location off
I-77, approximately three miles south of the I-77/I-40 interchange in
Statesville, North Carolina. The property is located in a shopping mall with
approximately 20 retail stores, fast food restaurants and a movie theater. This
property is subject to a ground lease which expires April 30, 2035. The annual
rental payment is the greater of i) $22,000 less 1/2% of gross room rentals from
the hotel during the 1991 lease year of the lease term, or ii) four percent of
the gross room rentals from the hotel during each lease year, which is based on
the property's performance.

    FAIRFIELD INN BY MARRIOTT(R) (WILMINGTON, NORTH CAROLINA) - The Wilmington
Fairfield Inn consists of two, 2-story guest room buildings. The 120 room
exterior corridor hotel was opened in April 1985 and was renovated and changed
to a Fairfield Inn by Marriott(R) in July 1994. The hotel is located on U.S.
Highways 17 and 74 (Market Street) and 3/4 miles west of I-40 in Wilmington,
North Carolina. Commercial development, including restaurants, lodging
facilities and gas stations on Market Street. The hotel is located eight miles
from Wrightsville Beach and four miles from historic downtown Wilmington. The
hotel is 7 minutes from the new Hanover International Airport.

    CRICKET INN (DURHAM-DUKE, NORTH CAROLINA) - The Durham-Duke Cricket Inn
consists of an eight-story tower (opened in 1985) and a five-story annex
building (opened in 1988) both with interior corridors and elevators. The eight
story tower, which received a $1 million renovation in June 1995, contains 118
guest rooms and a coffee shop, which seats 38. The five-story building contains
32 guest rooms. The hotel is located two blocks from Duke University and the
Duke University Medical Center and across the street from the Veterans
Administration ("VA") Medical Center in Durham, North Carolina. Lodging demand
is enhanced by the completion of a 40-room geriatric ward at the VA Medical
Center and 76-room eye care center at the Duke Medical Center. The property is
located in the northwest quadrant of Elba and Fulton Street in Durham. The
property is one block from the Durham Freeway, which provides access to I-40.
I-85 is approximately one mile from the hotel.

<PAGE>
    CRICKET INN (RALEIGH, NORTH CAROLINA) - The Raleigh Cricket Inn consists of
three, 2-story, external corridor structures with 148 guest rooms. Raleigh is
part of a three-city metropolitan area known as the Research Triangle (which in
addition to Raleigh includes the cities of Durham and Chapel Hill). Old Wake
Forest Road leads directly into the heart of downtown Raleigh, four miles away.
Several colleges and universities, including North Carolina State University,
and the State Capitol are located in the downtown area. I-440 connects with U.S.
Highway 70 and I-40, which provide excellent access to the Research Triangle
Park and the Raleigh-Durham International Airport, both of which are less than
30 minutes away.

    CRICKET INN (CHARLOTTE, NORTH CAROLINA) - The Charlotte Cricket Inn is a
two-story exterior corridor structure with 132 rooms. The property was opened in
March 1989 and was completely renovated in August 1995. The hotel is located at
the Sugar Creek Road exit off I-85 and is approximately three miles from I-77.
The property is located at a predominantly commercial intersection and contains
several competing hotels, fast food outlets and full-service restaurants. In
addition, the property is located approximately ten miles from the Charlotte
International Airport.

    The Company, through its wholly-owned subsidiary HH Properties-VB, Inc.,
owns the property below. As of December 31, 1996, the property was not
encumbered by debt.

    CRICKET INN (VIRGINIA BEACH, VIRGINIA) - The Virginia Beach Cricket Inn
consists of three, 2-story external corridor structures with 150 guest rooms.
Two buildings contain guest rooms and are perpendicular to one another in an "L"
shape. The third building contains guest rooms, the lobby and front desk area.
The property opened in 1986 and was completely renovated in August 1995. The
hotel is located on U.S. route 13 (Northampton Boulevard) and approximately .67
miles east of I-64 in Virginia Beach, Virginia. I-64 is a major east/west
highway, the primary tourist access road for the beach resorts. The hotel has
excellent access from both Route 13 and I-64. The property is ten miles west of
the resort beaches, four miles south of Norfolk International Airport and four
miles southeast of the Little Creek Naval Amphibious Base.

<PAGE>
                            ITEM 3. LEGAL PROCEEDINGS

    On October 26, 1990, a complaint was filed in Palm Beach County Circuit
Court, Florida, by Seagate Beach Quarters, Inc., a Florida corporation (Bearing
Case #90-12358-AB), seeking damages plus interest and costs, against Rochester
Community Savings Bank, ("RCSB"), a New York based bank, Shore Holdings, Inc.
("SHORE"), a subsidiary of RCSB and naming Hudson as a co-defendant. On December
6, 1990, Delray Beach Hotel Properties Limited, a Florida limited partnership
controlled by Hudson Hotels, purchased the Seagate Hotel and Beach Club from
RCSB's subsidiary, SHORE. The purchase contract included an indemnification of
Hudson Hotels against any action resulting from previously negotiated contracts
between RCSB's subsidiaries and third-parties. Case #90-12358-AB contained
allegations that RCSB's subsidiary, SHORE, defaulted in its obligations under a
Contract for Purchase and Sale, dated August 16, 1990, and failed to go forward
with the transaction due to alleged tortious negotiations between RCSB and
Hudson. On March 17, 1994, the Court granted Summary Judgment in favor of RCSB
and Hudson Hotels which judgment was appealed by Seagate. The Fourth District
Court of Appeal in Florida affirmed the summary judgment on RCSB and reversed
the summary judgment granted in favor of Hudson, remanding the action to Circuit
Court for further consideration. On August 15, 1994, Seagate proceeded to trial
against SHORE in case #90-12358-AB. During the course of the trial, Seagate took
a voluntary dismissal of their action against SHORE. On September 8, 1994,
Seagate refiled its lawsuit against SHORE and joined Delray Beach Hotel
Properties Limited, through its general partner, Delray Beach Hotel Corp.
(bearing Case #94-6961-AF). The new case against SHORE was brought essentially
on the same facts as stated above. The claim against Delray Beach Hotel
Properties Limited was identical to the conspiracy and tortious interference
with a business relationship claim currently existing against Hudson Hotels. On
January 27, 1995, the Court issued an Order dismissing the Amended Complaint as
to Delray Beach Hotel Properties Limited. The Circuit Court has consolidated the
case against Hudson Hotels (Case #90-12358-AB) and the case against SHORE (Case
#94-6961-AF) and it is anticipated those suits will go to trial during 1997.

    On February 11, 1993, a complaint was filed in the Western District of New
York, United States District Court, by John Miranda, Susan Miranda and
Christopher Miranda, seeking damages and costs against Quality Inn
International, Choice Hotels International, and naming Hudson as a co-defendant.
The requested relief in this case, John Miranda and Susan Miranda and
Christopher Miranda vs. Quality Inns International Inc., Choice Hotels
International Inc., Ridge Road Hotel Properties, Ridge Road Hotel Properties
d/b/a Comfort Inn, a/k/a Comfort Inn West, Hudson Hotels Corp., and Jennifer L.
Ansley, as Executrix of the Estate of Loren G. Ansley, was based on allegations
that John Miranda, while staying at the Comfort Inn, stepped on a needle, and
claims negligence and lack of due care on the part of the defendants. This case
is being diligently defended by the insurance carrier of Ridge Road Hotel
Properties and Hudson. The Company believes that it has adequate insurance for
any potential loss.

    On June 20, 1995, Ladenburg, Thalmann & Co., Inc., the Company's former
investment bankers, filed a complaint in New York State Supreme Court against
the Company alleging breach of contract and damages of $906,250 relating to the
Company's rescission of a warrant granted to them in connection with the
investment advisory agreement. In February 1994, the Board of Directors of the
Company determined that Ladenburg had been otherwise adequately compensated for
such services as were actually performed, and voted to rescind the warrant. The
Company has answered the complaint, denying the relevant allegations and
asserting several affirmative defenses. Discovery in the case has commenced and
is continuing. The ultimate outcome of the litigation cannot presently be
determined. Accordingly, no provision for any liability that may result has been
made in the financial statements.

    After taking into consideration legal Counsel's evaluation of all such
actions, management is of the opinion that the outcome of each such proceeding
or claim which is pending, or known to be threatened (as described above), will
not have a significant effect on the Company's financial statements.

<PAGE>
    On January 29, 1996, William Lerner filed a complaint in the Court of Common
Pleas of Washington County, Pennsylvania, against the Company, alleging breach
of contract and damages of $253,125 relating to the Company's rescission of a
warrant granted to this individual in connection with establishing a
relationship with Ladenburg, Thalmann & Co., Inc. In February 1994, the Board of
Directors of the Company rescinded the warrant to William Lerner as a result of
terminating the Company's relationship with Ladenburg, Thalmann & Co., Inc. On
March 26, 1996, William Lerner dismissed the complaint filed against the
Company. As part of the dismissal, the Company allowed him to exercise his
warrants on a cashless basis and issued 19,594 shares of Company common stock as
a result of this transaction.

<PAGE>
           ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

    No matter was submitted during the fourth quarter of the year ended December
31, 1996 to a vote of the Company's security holders, through the solicitation
of proxies or otherwise.

<PAGE>
                                     PART II

        ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

    The Common Stock of the Company has been traded in the over-the-counter
market since its initial public offering on April 13, 1989, and is listed in the
NASDAQ Small-Cap Issues under the symbol "HUDS". The following table sets forth,
for the calendar quarters indicated, the range of high and low quotations on the
NASDAQ Small-Cap Issues, as reported by the National Quotation Bureau, Inc.

TRANSITION PERIOD ENDED DECEMBER 31, 1995
                                                    High Bid          Low Bid
                                                   ----------        ---------
First Quarter (April - June, 1995)                    9 3/8            3 7/8
Second Quarter (July - September, 1995)              10 1/4            7 1/8
Third Quarter (October - December, 1995)             10 5/8            8


FISCAL YEAR ENDED DECEMBER 31, 1996

First Quarter (January - March, 1996)                10 7/8            7 7/8
Second Quarter (April - June, 1996)                   8 3/8            5 3/4
Third Quarter (July - September, 1996)                8 3/4            5 1/8
Fourth Quarter (October - December, 1996)             7 7/8            4 3/4


    For a recent reported quotation for the Company's Common Stock, see the
cover page of this Form 10-KSB. The quotations listed above reflect inter-dealer
prices, without retail mark-up, mark-down, or commissions and may not
necessarily represent actual transactions.

    To date, the Company has not paid a dividend on its Common Stock. The
payment of future dividends is subject to the Company's earnings and financial
position and such other factors, including contractual restrictions, as the
Board of Directors may deem relevant and it is unlikely that dividends will be
paid in the foreseeable future.

    As of March 18, 1997, there were approximately 250 holders of record of the
Common Shares of the Company.

<PAGE>
  ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                           RESULTS OF OPERATIONS

    The following Management's Discussion and Analysis should be read in
conjunction with this entire Form 10-KSB 1996 Annual Report. Particular
attention should be directed to the Consolidated Financial Statements found at
Item 7.

    As a result of the aquisitions of five partnerships in which the Company
had a minority interest and the SB Motel Corp. portfolio, a significant portion
of the current results are not comparable to prior year, specifically hotel
operations and direct costs and expenses.

RESULTS OF OPERATIONS

REVENUES - During 1995, the Company changed its fiscal year end to December 31
from March 31. Operating revenues increased $7,252,296 or 105% to $14,148,049
for the year ended December 31, 1996 compared to operating revenue of $6,895,753
for the transition period ended December 31, 1995. This increase is attributable
to the transition period in 1995 being nine months in addition to the
acquisition of seventeen hotel properties, which are reflected in the 1996
results of operations.  The subsequent paragraphs below will describe the
components which make up operating revenues for the year ended December
31, 1996.

    Franchise placement income for the year ended December 31, 1996 reflects the
opening of five (5) franchises (Raleigh, North Carolina; Charlotte - University
Place, North Carolina; Charlotte - Airport, North Carolina, Lake Norman, North
Carolina and Louisville, Kentucky), of which one opened during the most recent
quarter. There were four (4) franchise sales during the transition period ended
December 31, 1995. Royalties for the year ended December 31, 1996 increased
$224,717 over the transition period ended December 31, 1995, an increase of 60%.
The increase is attributable to twenty eight franchised Microtel Inns in
operation, as compared to twenty three during the transition period ended
December 31, 1995. As a result of the Company's joint venture with US Franchise
Systems, Inc. (see Note 17), the Company has retained the right to franchise,
construct and collect franchise placement fees on an additional twenty three
(23) Microtel properties and ten (10) "suite" properties and retain all
royalties on the fifty (50) Microtels (27 existing and 23 new ones to be
undertaken by the Company) and ten (10) suites. The Company will also receive
royalty payments in the future from US Franchise Systems, Inc. for franchises
they open, along with consulting payments over the next three years.

    Overall, management fees for the year ended December 31, 1996, increased
$256,907, or 36%, from the transition period ended December 31, 1995. The
transition period ended December 31, 1995, reflects nine months of revenue. On
an annualized basis for last year's results, management fees remained consistent
from prior year. The Company has added sixteen additional management contracts
for the year ended December 31, 1996, for a total of thirty one managed
properties. Seventeen of the managed properties are wholly-owned by the Company
and held in wholly-owned subsidiaries. Management fees of $479,515 were
generated by these hotels, which were eliminated for consolidated purposes.

    Development fees increased $210,000 during the year ended December 31, 1996,
as compared to the transition period ended December 31, 1995. The increase is
attributable to four Microtels and one full-service hotel under various stages
of development for which fees were charged during the year ended December 31,
1996, compared to four Microtels under various stages of development at the
transition period ended December 31, 1995. These fees represent a
reimbursement of costs incurred.

    A significant increase in hotel operations ($5,606,273, or 158%) is
attributable to the acquisition of seventeen hotels. Five of the hotels were
acquired July 31, 1996, with the remaining twelve being acquired November 27,
1996. Operating revenues for the Seagate Hotel and Beach Club are included
prior to the acquisition on July 31, 1996, as a result of the Company being the
controlling partner in the limited partnership.  The Beach Club income relates
to the operation of the Beach Club at the Seagate Hotel and Beach Club. On an
annualized basis, the current year twelve month results are consistent with
last year's transition period ended December 31, 1995.

<PAGE>
    The Company plans to continue its rapid revenue growth by implementing the
following strategies: (i) enhance operating performance of its existing hotels
owned or under management, (ii) develop and build Microtel Inns on sites
acquired and (iii) opportunistic aquisition of hotels.

OPERATING COSTS AND EXPENSES - Direct represents cost and expenses associated
with the operation of the hotels owned or leased by the Company. Direct costs
and expenses for the year ended December 31, 1996 increased $4,485,491 or 101%
over the transition period ended December 31, 1995. This increase is primarily
due to the acquisition of seventeen hotel properties (five of which were
acquired on July 31, 1996, and the remaining twelve acquired on November 27,
1996). The direct costs and expenses for the Seagate Hotel and Beach Club are
included prior to the acquision on July 31, 1996, as a result of the Company
being the controlling partner in the limited partnership. Corporate represents
general and administrative costs and expenses associated with the corporate
office. Corporate costs and expeses increased $357,850, or 25%, from prior
year. By annualizing the nine months ended December 31, 1995, corporate costs
and expenses and comparing the results to the year ended December 31,
1996 expenses decreased approximately $110,000. This is a result of
the nine months ended December 31, 1995 corporate expenses including
(1) legal fees associated with establishing new joint venture agreements
(2) expenses associated with project feasibilities and studies and
(3) consulting fees for improving Company operations. Depreciation and
amortization for the year ended December 31, 1996 increased $643,887,
or 170%, over the transition period ended December 31, 1995. The increase
is a result of the acquisition of five hotels on July 31, 1996, and
twelve hotels on November 27, 1996. One of the five hotels purchased
on July 31, 1996, Seagate Hotel and Beach Club, is included in the operating
results of the Company during the transition period ended December 31, 1995,
and prior to its acquisition on July 31, 1996, as a result of the Company's
ownership interest in the partnership.

OTHER INCOME (EXPENSE) - Interest income is $298,825 of which $126,667 or 42%,
is generated by interest on the mortgage receivable from Watertown Hotel
Properties II. Another $172,158 relates to interest earned by the Company
through its various receivables from affiliates, interest earned on cash
deposits, along with interest earned on the outstanding balance owed the Company
by US Franchise Systems, Inc.. Of the $2,068,440 in total interest expense, 66%
relates to the mortgages held on the hotels acquired in 1996. The remaining
represents interest on the Company's outstanding convertible debentures,
mezzanine financing, notes payable relating to purchase of partnership
interests, Tonawanda bond issue and line of credit (see Note 8).

    Minority interest represents the elimination of the minority partners
interest in seven months operations of Delray Beach Hotel Properties Limited and
one year of Watertown Hotel Properties II, L.P. (see Note 2 to Consolidated
Financial Statements). Equity in losses of affiliates represents the net losses
incurred from the Company's equity investment in various hotels (see Note 2 to
Consolidated Financial Statements). On July 31, 1996, the Company acquired the
remaining interest of Delray Beach Hotel Properties Limited and has included its
results of operations from the acquisition date, without the elimination of the
minority partners interest. The majority of the equity in income of affiliates
in the year ended December 31, 1996, relates to hotels opened the preceding
twelve month period.

INCOME TAXES - The provision for income taxes for the year ended December 31,
1996, represents federal and state tax expense on income before tax of
$1,108,064. The provision includes tax expense from the valuation of deferred
tax assets. The income tax provision for the transition period ended December
31, 1995, represents federal and state tax expense on income before tax of
$1,849,353. The provision also included a tax benefit of approximately $175,000
from the valuation of deferred tax assets.

NET INCOME - As a result of the above factors, net income decreased by $674,542
to $636,050 for the year ended December 31, 1996. The December 31, 1996 earnings
decreased for the following reasons: (1) as a result of the acquisitions, the
Company incurred $551,149 in non-recurring charges (see Note 19) (2) the
Company acquired twelve of the hotels on November 27, 1996 and due to the
seasonal nature of the lodging industry, operating revenues in the fourth
and first quarters are less than the second and third quarters.
The net income of $.12 per share compares with a net income of $.33
per share for the transition period ended December 31, 1995. Weighted
average shares and common equivalents used in computing net
income per share increased from 3,706,333 for the transition period ended
December 31, 1995, to 4,248,521 for the year ended December 31, 1996. The
predominant factors for this increase are (i) stock issued for the two major
acquisitions in 1996 and (ii) issuance of common stock upon conversion of
convertible subordinated debentures and (iii) stock options exercised.
Consolidation of the revenues and expenses of Delray Beach Hotel
Properties Limited (for the seven month period ended July 31, 1996)
and Watertown Hotel Properties II, L.P. (for the year ended December 31,
1996), provides no additional net income or loss to the Company than
from reporting the investment under the equity method of accounting.

<PAGE>
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

    At December 31, 1996, the Company had a working capital deficit of
$3,712,513 compared to a working capital deficit of $394,178 at December 31,
1995. Cash and cash equivalents totalled $1,057,368. The decrease in net working
capital is primarily attributable to a $2,900,000 note in current portion of
long-term debt, which is due to SB Motel Corp. as a result of the November 27,
1996 acquisition, along with accrued expenses which resulted from the
acquisition.

    Accounts and notes receivable represent amounts due from customers or
affiliated entities or individuals and in the opinion of management are fully
realizable (see Note 6).

    Investment in partnership interests represents the Company's interest in
various hotel related real estate partnerships. Investment in partnership
interests decreased $608,969 from the transition period ended December 31,
1995. The net decrease is predominantly due to the Company acquiring the
partnership interest in five hotel partnerships effective July 31, 1996, in
addition to amortization of the adjusted fair value of other partnerships
acquired through the purchase of Hudson in 1992. As a result of the
acquisition of the remaining interest of Brookwood Hotel Properties and
Delray Beach Hotel Properties Limited at July 31, 1996, the portion of the
step-up related to those properties was allocated to assets. At
December 31, 1996, the total step-up remaining, net of accumulated
amortization, is $98,432.


    Investment in land represents real estate purchased for the purpose of
future development or sale. (See Note 4). Real estate development
represents parcels of land owned by the Company which are currently under
development. As of December 31, 1996, six parcels are under development (see
Note 5).

    The majority of property and equipment reflected on the balance sheet
relates to acquisition of seventeen hotels during 1996 (see Note 18). The
acquisitions were accounted for using the purchase method of accounting.

    Deferred tax assets represent the future benefit from tax loss carryforwards
realized as a result of current year earnings and the expected profitability in
future fiscal periods, along with an alternative minimum tax credit and deferred
revenue relating to consulting, initial franchise placement fees and land sale.
Deferred tax liability relates to the acquisition of Hudson, and the tax effect
related temporary differences associated with the difference in the financial
reporting and tax basis of the purchased assets and depreciation.

    Other assets consist of (i) a mortgage note receivable held by Watertown
Hotel Properties II, L.P. in the amount of $1,100,000, collateralized by land
and the Microtel hotel located in Watertown, New York; (ii) deposits consist of
a $450,000 cash deposit to secure a ten year operating lease and management
contract of a full-service hotel located in Canandaigua, New York, from
L, R, R & M, L.L.C. One of the minority owners of L, R, R & M, L.L.C., is
a greater than 5% shareholder who is not involved in the management
or operation of the Company. In addition, there is also a $120,000 deposit
as a commitment to acquire three hotels for $25,500,000 (see Note 10)
(iii) Deferred financing costs represent costs incurred to acquire financing
for the acquisition of seventeen hotels. These costs are inclusive
of the $56,000,000 first morgage, along with the $17,000,000 mezzanine
note. The deferred financing costs are being amortized over the term of
the related financing; (iv) Beach Club, net, was recorded as a result
of the acquisition of the Seagate Hotel and Beach Club, which the
Beach Club operation was valued based on an independent appraisal. This amount
will be amortized over its estimated useful life of 20 years and (v) Receivable
from sale of franchise rights -- long-term, represents a receivable recorded as
a result of determining that the future collectibility of the sale of franchise
rights was not in doubt (see Note 2).

    Long-term debt is substantially comprised of a $56,000,000 mortgage and a
$17,000,000 mezzanine note. The amounts borrowed were used to acquire the
seventeen hotels in 1996 (see Note 18).  The remaining long-term debt consists
of the Company issuing a $7,500,000 convertible subordinated debentures, a
note issued by the Company for the purchase of the SB Motel Corp. portfolio
(see Note 18) and a bond with the Town of Tonawanda relating to improvements
to land in that township.

<PAGE>
    Shareholders' equity increased to $13,317,115 as of December 31, 1996 from
$3,910,826 as of December 31, 1995. The factors which significantly affected
the level of shareholders' equity are represented by an increase of $3,000,000
for the conversion of convertible subordinated debentures; an increase of
$9,759,774 as a result of issuing 1,540,760 shares for the acquisition of
seventeen hotels (see Note 18), a decrease of $3,953,042 for the purchase of
treasury stock; a decrease of $127,320 resulting from preferred dividend
payment and an increase of $636,050 for net income for the year ended December
31, 1996.  The Company believes it has sufficient resources from its present
cash position to meet its current obligations and believes that its cash
position and revenues from operations are sufficient to meet its cash
requirements for the next twelve months. The Company has not been negatively
impacted by inflation during any of the periods presented.

                          ITEM 7. FINANCIAL STATEMENTS

    The information required by this item is incorporated within the
Consolidated Financial Statements and Notes, which is located after Item 13.

            ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
                      ACCOUNTING AND FINANCIAL DISCLOSURE

    There were no changes in or disagreements with the Company's independent
auditors on accounting principles, practices or financial disclosures during the
year ended December 31, 1996.

<PAGE>
                                  PART III

ITEM 9.      DIRECTORS,  EXECUTIVE  OFFICERS,  PROMOTERS AND CONTROL PERSONS;
             COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

ITEM 10.     EXECUTIVE COMPENSATION

ITEM 11.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

ITEM 12.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

    The information called for in Part III, Items 9-12, is incorporated by
reference to the Hudson Hotels Corporation and Subsidiaries Proxy Statement for
the Company's Annual Meeting of Stockholders to be held on May 16, 1997.

ITEM 13.    EXHIBITS LIST AND REPORTS ON FORM 8-K

(A) The following exhibits are filed as part of this Form 10-KSB:

         Exhibit Number

         3.1       Restated Certificate of Incorporation of Registrant (a)

         3.2       By-Laws of Registrant (a)

         3.3       Amendment to  Certificate  of  Incorporation  to authorize
                   the issuance of 10,000,000  shares of Preferred Stock,
                   with a par value of $.001 (f)

         3.4       Amendment to Certificate of Incorporation stating the number,
                   designation, relative rights, preferences and limitations of
                   Series A Preferred Shares, with a par value of $.001, to be
                   issued (f)

         3.5       Amendment  to  Certificate  of  Incorporation  changing  the
                   Company's  name to  Hudson  Hotels Corporation (i)

         4.1       Form of Stock Purchase and Loan Agreement, dated September
                   19, 1988, between the Registrant, the Stockholders named
                   therein and the Investors identified in the amended Schedule
                   of Investors attached thereto (a)

         4.2       Form of Promissory Note issued on September 19, 1988 to each
                   Investor identified on the amended Schedule of Investors
                   included with Exhibit 4.1 (a)

         4.3       Form of Registration Agreement, dated September 19, 1988,
                   between the registrant and each Investor identified on the
                   amended Schedule of Investors included with Exhibit 4.1 (a)

         4.4       Registrant's form of Non-Statutory Stock Option Agreement,
                   attached to which is an Option Schedule setting forth the
                   material terms of options granted by the Registrant pursuant
                   thereto (a)

         4.5       Line of Credit Note and  Subordination  Agreement between the
                   Registrant and Hudson Hotels Corp. dated December 28,
                   1988 (a)

         4.6       Convertible subordinated debenture due February 1, 2004,
                   with the Bond Fund for Growth (f)

<PAGE>
         4.7       Stock  Exchange  Agreement:  30,500  shares  of  Common
                   Stock  for  16,495  shares  of Series A Preferred Stock (f)

         4.8       Convertible subordinated debenture due February 1, 2005,
                   with the Bond Fund for Growth (g)

         4.9       Convertible  Subordinated  Debenture due July 1, 2001 with
                   the Oppenheimer  Bond Fund for Growth (k)

         9         Voting Trust Agreement (not applicable)

         10.1      Franchise Agreement, dated January 10, 1989, between the
                   Registrant and Lehigh Hotel Corp. (a)

         10.2      Employment Agreement, dated December 1, 1988, between the
                   Registrant and Loren G. Ansley (a)

         10.3      Agreement, dated June 1, 1988, between Hudson Hotels Corp.
                   and the Registrant (a)

         10.4      Agreement, dated April 11, 1988, between the Registrant and
                   Petrus II (a)

         10.5      Master Franchise Agreement, dated February 13, 1991, between
                   the Registrant and Essex Microtel International Lodging,
                   Inc.(b)

         10.6      Exclusive Development Agreement, dated September 30, 1991,
                   between the Registrant and S&E Hospitality Partnership (c)

         10.7      Form of Management Agreement (d)

         10.8      Partnership Agreement of Crestmount Associates (d)

         10.9      Partnership Agreement of Brookwood Hotel Properties (d)

         10.10     Partnership Agreement of Montgomery Group (d)

         10.11     Partnership Agreement of Microtel Leray L.P. (d)

         10.12     Partnership Agreement of Lehigh Hotel Properties (d)

         10.13     Partnership Agreement of Delray Beach Hotel Properties Ltd.
                   (d)

         10.14     Warrant for the Purchase of 125,000 Shares of Common Stock
                   issued to Ladenburg, Thalmann & Co. Inc. (e)

         10.15     Warrant for the Purchase of 25,000 Shares of Common Stock
                   issued to William R. Lerner (e)

         10.16     First Amendment to Master Franchise Agreement between the
                   Company and Essex Microtel International Lodging, Inc.
                   dated March 29, 1993 (e)

         10.17     Agreement between Microtel and Jennifer L. Ansley as
                   Executrix of the Estate of Loren G. Ansley (f)

         10.18     Termination of Exclusive Development Agreement (f)

<PAGE>
         10.19     Second  Amendment  to  Master  Franchise  Agreement  between
                   the  Company  and  Essex  Microtel
                   International Lodging, Inc., dated April 29, 1994 (f)

         10.20     1993 Non-Statutory Employee Stock Option Plan (f)

         10.21     Lease agreement between L, R, R & M, L.L.C., and Canandaigua
                   Hotel Corp. (g)

         10.22     Purchase of remaining partnership interest in Crestmount
                   Associates (g)

         10.23     Sale of land to Microtel Partners 1995-I, L.P. (g)

         10.24     Joint Venture Agreement Between Microtel Franchise and
                   Development Corporation and US Franchise Systems, Inc. (h)

         10.25     Termination of Master Franchise Agreement

         10.26     Three Party  Agreement  Between  Microtel  Franchise  and
                   Development  Corporation,  Stonehurst Capital, Inc. and Essex
                   Investment Group, Inc.

         10.27     Form of Offer Letter, Transfer Agreement and List of
                   Investors (j)

         10.28     Agreement of Purchase and Sale, as amended for the
                   acquisition of the SB Motel Corp.  portfolio (l)

         11        Statement re: Computation of Per Share Earnings

         18        Letter on Accounting Change for Revenue Recognition of
                   Franchise Fees (e)

         22        Subsidiaries of the Registrant

         25        Power of Attorney (a)

         27        Financial Data Schedule

         28.1      Form of Consulting Agreement entered into between the
                   Registrant and the Underwriter (a)

         28.2      Form of Employee Stock Plan adopted by the Registrant (a)

--------------------
         (a)       Previously  filed as part of, and hereby  incorporated  by
                   reference  to, the  Exhibits  in the Company's  Registration
                   Statement  on Form  S-18  (File  Number  33-26780-NY),  as
                   amended  by Amendment No. 1 (The "Registration Statement")

         (b)       Filed as an Exhibit to the Company's  Form 10-K Annual Report
                   for the year ended March 31, 1991, and incorporated hereby by
                   reference

         (c)       Filed as an Exhibit to the Company's  Form 10-K Annual Report
                   for the year ended March 31, 1992, and incorporated hereby by
                   reference

         (d)       Filed as an Exhibit to the Company's Form 8-K Current Report
                   dated June 26, 1992, and incorporated hereby by reference

<PAGE>
         (e)       Filed as an Exhibit to the Company's Form 10-KSB Annual
                   Report for the year ended March 31, 1993

         (f)       Filed as an Exhibit to the Company's Form 10-KSB Annual
                   Report for the year ended March  31, 1994

         (g)       Filed as an Exhibit to the Company's Form 10-KSB Annual
                   Report for the year ended March 31, 1995

         (h)       Filed as an Exhibit to the Company's Form 10-QSB Quarterly
                   Report for the Quarter Ended September 30, 1995

         (i)       Filed as an Exhibit to the  Company's  Form 10-QSB  Quarterly
                   Report for the quarter ended June 30, 1996

         (j)       Filed as an Exhibit to the Company's Form 8-K Current Report
                   dated August 28, 1996

         (k)       Filed as an Exhibit  to the  Company's  Form  10-QSB
                   Quarterly  Report  for the  quarter  ended
                   September 30, 1996

         (l)       Filed as an Exhibit to the Company's Form 8-K Current Report
                   dated November 27, 1996

(B) Form 8-K - The following report was filed on Form 8-K:

         Date of Report                                     Item
         -----------------                            --------------
         November 27, 1996               Acquisition of SB Motel Corp. portfolio


                          ITEM 7. FINANCIAL STATEMENTS

<PAGE>
                   HUDSON HOTELS CORPORATION AND SUBSIDIARIES



                        CONSOLIDATED FINANCIAL STATEMENTS
                      FOR THE YEAR ENDED DECEMBER 31, 1996,
                    AND NINE MONTHS ENDED DECEMBER 31, 1995,
                         TOGETHER WITH AUDITORS' REPORT


<PAGE>
                          INDEPENDENT AUDITORS' REPORT

To the Shareholders of
Hudson Hotels Corporation:

We have audited the accompanying consolidated balance sheets of Hudson Hotels
Corporation (a New York corporation) and subsidiaries as of December 31, 1996
and 1995, and the related consolidated statements of income, changes in
shareholders' investment and cash flows for the year ended December 31, 1996 and
the nine months ended December 31, 1995. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits. We did not audit the financial statements of HH Properties-I, Inc., a
wholly-owned subsidiary, at December 31, 1996 and for the period from November
15, 1996 to December 31, 1996, which statements reflect total assets of
$88,632,482 as of December 31, 1996, and total revenues of $2,236,396 for the
period then ended. Those statements were audited by other auditors whose report
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for HH Properties-I, Inc. as of December 31, 1996, and for the period
then ended, is based solely on the report of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 and the report of
other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Hudson Hotels Corporation and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for the year ended December 31, 1996 and the
nine months ended December 31, 1995, in conformity with generally accepted
accounting principles.

/s/ Bonadio & Co., LLP
Rochester, New York
March 28, 1997

<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors
Hudson Hotels Corporation

We have audited the accompanying balance sheet of HH Properties-I, Inc., a
wholly-owned subsidiary of Hudson Hotels Properties Corp., as of December 31,
1996, and the related statements of operation, changes in stockholder's equity
and cash flows for the period November 15, 1996 through December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.

We conducted our audit in accordance with generally accepted auditing standards.
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 audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of HH Properties-I, Inc., as of
December 31, 1996, and the results of its operation and its cash flows for the
period November 15, 1996 through December 31, 1996 in conformity with generally
accepted accounting principles.




/s/ Coopers & Lybrand, L.L.P.
Rochester, New York
March 22, 1997



<PAGE>
HUDSON HOTELS CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>

ASSETS                                                                 1996                1995
-------                                                          -------------          ----------
<S>                                                               <C>                     <C>
CURRENT ASSETS:
  Cash and cash equivalents                                       $  1,057,368            766,428
  Cash - restricted                                                  1,515,879                 --
  Accounts receivable - trade                                          442,992            305,942
  Inventories                                                          201,700             76,645
  Prepaid expenses and other                                           553,089            147,181
  Accounts and notes receivable -
    Affiliates                                                         326,000            416,251
    Non-affiliate                                                      129,008             96,648
  Receivable from sale of franchise
      rights - current                                                 288,112                 --
                                                                  ------------         ----------
         Total current assets                                        4,514,148          1,809,095
                                                                  ------------         ----------

INVESTMENTS IN PARTNERSHIP INTERESTS                                 1,974,900          2,583,869
                                                                 -------------         ----------

INVESTMENT IN LAND                                                     780,822            780,822
                                                                --------------         ----------

REAL ESTATE DEVELOPMENT                                              3,652,122          1,557,572
                                                                --------------         ----------

PROPERTY AND EQUIPMENT, NET                                         83,673,682          6,541,617
                                                                 -------------         ----------

DEFERRED TAX ASSET                                                     377,448            643,215
                                                                --------------         ----------

OTHER ASSETS:

  Deferred financing costs, net                                      2,496,302            159,398
  Beach Club, net                                                    3,139,728                --
  Mortgage and note receivable - Affiliate                           1,100,000          1,300,000
  Deposits                                                             638,994            299,332
  Intangibles and other assets                                          90,264            105,670
  Receivable from sale of franchise
      rights - long term                                               454,546                 --
                                                                --------------         ----------

         Total other assets                                          7,919,834          1,864,400

         Total assets                                             $102,892,956        $15,780,590
                                                                --------------         ----------
                                                                --------------         ----------


</TABLE>

The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.



<PAGE>
LIABILITIES AND SHAREHOLDERS' INVESTMENT

<TABLE>
<CAPTION>
                                                            1996                  1995
                                                        -----------             --------
CURRENT LIABILITIES:
  <S>                                                   <C>                     <C>
  Accounts payable - trade                              $ 1,859,596             $194,799
  Accrued payroll and related taxes                         189,390               41,060
  Accrued interest                                          451,968               46,500
  Other accrued expenses                                  1,187,351              389,751
  Current portion of long-term debt                       3,527,950              205,187
  Deferred revenue - Beach Club                             869,902              921,976
  Deferred consulting                                       112,504              300,000
  Deferred franchise revenue - current                       28,000              104,000
                                                       ------------          -----------
         Total current liabilities                        8,226,661            2,203,273
                                                       ------------          -----------

LONG-TERM DEBT                                           80,064,186            8,506,474
                                                       ------------          -----------

DEFERRED REVENUE - LAND SALE                                185,055              185,055
                                                       ------------          -----------

LIMITED PARTNERS' INTEREST IN
  CONSOLIDATED PARTNERSHIPS                               1,099,939              974,962
                                                       ------------          -----------

SHAREHOLDERS' INVESTMENT:

  Preferred stock                                               295                  295
  Common stock                                                4,788                3,280
  Additional paid-in capital                             15,954,745            7,171,549
  Warrants outstanding                                       50,000               60,000
  Accumulated deficit                                    (2,692,713)          (3,201,443)
                                                       ------------          -----------

                                                         13,317,115            4,033,681

  Less:  49,142 shares of common stock in treasury,
    at cost at December 31, 1995                                 --             (122,855)
                                                       ------------          -----------

         Total shareholders' investment                  13,317,115            3,910,826
                                                       ------------          -----------

         Total liabilities and shareholders'
            investment                                 $102,892,956          $15,780,590
                                                       ------------          -----------

</TABLE>


The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.



<PAGE>
HUDSON HOTELS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 AND NINE MONTHS ENDED DECEMBER 31, 1995
-------------------------------------------------------------------------------

<TABLE>
<CAPTION>

                                                                  YEAR ENDED            NINE MONTHS ENDED
                                                              DECEMBER 31, 1996         DECEMBER 31, 1995
                                                              -----------------         -----------------
OPERATING REVENUES:
  <S>                                                              <C>                      <C>
  Hotel operations                                                 $ 9,159,058              $ 3,552,785
  Beach Club income                                                  2,571,238                1,909,875
  Management fees -
    Non-affiliate                                                      255,456                  199,079
    Affiliate                                                          723,212                  522,682
  Royalties                                                            602,049                  377,332
  Franchise placement income                                           135,000                  108,500
  Development fees                                                     330,000                  120,000
  Consulting fees                                                      337,496                  100,000
  Miscellaneous                                                         34,540                    5,500
                                                                   -----------              -----------
         Total operating revenues                                   14,148,049                6,895,753

OPERATING COSTS AND EXPENSES:
  Direct                                                             8,925,508                4,440,017
  Corporate                                                          1,782,906                1,425,056
                                                                   -----------              -----------

         Total operating costs and expenses before
           depreciation and amortization                            10,708,414                5,885,073
                                                                   -----------              -----------

         Income from operations before depreciation
           and amortization                                          3,439,635                1,030,680

DEPRECIATION AND AMORTIZATION                                        1,021,857                  377,970
                                                                   -----------              -----------
         Income from operations                                      2,417,778                  652,710
                                                                   -----------              -----------
OTHER INCOME (EXPENSE):
  Gain on sale of worldwide franchise rights                         1,385,758                1,530,123
  Interest income                                                      298,825                  197,545
  Interest expense                                                  (2,068,440)                (680,661)
  Non-recurring charge                                                (551,149)                    --
  Gain on repurchase of franchise rights                                  --                    150,000
                                                                   -----------              -----------
         Total other income (expense)                                 (935,006)               1,197,007

Income before income taxes, minority interest
  and equity in operations of affiliates                             1,482,772                1,849,717

PROVISION FOR INCOME TAXES                                             472,014                  538,761
                                                                   -----------              -----------

Income before minority interest, and equity in
  operations of affiliates                                           1,010,758                1,310,956

MINORITY INTEREST                                                     (392,235)                  23,106
EQUITY IN OPERATIONS OF AFFILIATES                                      17,527                  (23,470)
                                                                   -----------              -----------

NET INCOME                                                         $   636,050               $1,310,592
                                                                   -----------              -----------
                                                                   -----------              -----------
NET INCOME PER COMMON SHARE - PRIMARY                                    $0.12                    $0.33
                                                                         -----                    -----
                                                                         -----                    -----

NET INCOME PER COMMON SHARE - FULLY DILUTED                               N/A                     $0.31
                                                                         -----                    -----
                                                                         -----                    -----

</TABLE>

The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.

<PAGE>
HUDSON HOTELS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' INVESTMENT
FOR THE YEAR ENDED DECEMBER 31, 1996 AND NINE MONTHS ENDED DECEMBER 31, 1995
------------------------------------------------------------------------------
<TABLE>
<CAPTION>

                         SERIES A         ADDITIONAL PAID-IN COMMON ADDITIONAL PAID-IN WARRANTS  ACCUMULATED  TREASURY
                         PREFERRED STOCK  CAPITAL PREFERRED   STOCK  CAPITAL COMMON   OUTSTANDING  DEFICIT     STOCK       TOTAL
                         ---------------  -----------------   -----  --------------   -----------  -------     -----       -----
<S>                      <C>              <C>                <C>     <C>              <C>        <C>          <C>        <C>
BALANCE, March 31, 1995      $ 295        $1,560,705          $3,161 $5,187,217       $105,000   $(4,416,545) $(125,000) $2,314,833
  Net Income                    --                --              --         --             --     1,310,592         --   1,310,592

  Exercise of stock             --                --             119    418,272        (45,000)           --         --     373,391
    options, including
    tax related tax
    benefits

  Sale of treasury stock        --                --              --      5,355             --            --      2,145       7,500

  Cash dividends paid on
    preferred stock             --                --              --         --             --       (95,490)        --     (95,490)
                             -----        ----------          ------ ----------       --------   -----------  ---------  ----------

BALANCE, December 31, 1995     295         1,560,705           3,280  5,610,844         60,000    (3,201,443)  (122,855)  3,910,826

  Net Income                    --                --              --         --             --       636,050         --     636,050

  Exercise of stock
    options, including
    related tax benefits        --                --              24     17,643        (10,000)           --         --       7,667

  Conversion of debentures      --                --             600  2,999,400             --            --         --   3,000,000

  Purchase of treasury stock    --                --              --         --             --            -- (3,953,042) (3,953,042)

  Issuance of common stock
    and use of treasury
    stock for purchase of
    five hotels                 --                --             513  3,324,491             --            --  4,075,897   7,400,901

 Issuance of common stock
    and use of treasury
    stock for purchase of
    SB Motel Corp. portfolio    --                --             371  2,358,502             --            --         --   2,358,873

  Other                         --                --              --     83,160             --            --         --      83,160

  Cash dividends paid on
    preferred stock             --                --              --         --             --      (127,320)        --    (127,320)
                             -----        ----------          ------ ----------       --------   -----------  ---------  -----------

BALANCE, December 31, 1996    $295        $1,560,705          $4,78 $14,394,040        $50,000   $(2,692,713) $       0  $13,317,115
                             -----        ----------          ------ ----------       --------   -----------  ---------  -----------
                             -----        ----------          ------ ----------       --------   -----------  ---------  -----------

Stock balances at
  December 31, 1995:

  Common stock, 3,231,425 shares;
    Preferred stock, 294,723 shares

Stock balances at
  December 31, 1996:

  Common stock, 4,787,462 shares;
    Preferred stock, 294,723 shares

</TABLE>

The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.



<PAGE>
HUDSON HOTELS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 AND THE NINE MONTHS ENDED DECEMBER 31, 1995

<TABLE>
<CAPTION>
                                                                 Year Ended            Nine Months Ended
                                                              December 31, 1996        December 31, 1995
CASH FLOWS FROM OPERATING ACTIVITIES:                         -----------------        -----------------
  <S>                                                         <C>                      <C>
  NET INCOME                                                     $  636,060               $1,310,592
         Adjustments to reconcile net income to net cash
           from operating activities
             Deferred tax provision                                 265,767                  258,916
             Depreciation and amortization                        1,070,050                  377,970
             Gain on installment sale                            (1,385,758)                    --
             Gain on repurchase of franchise rights                    --                   (150,000)
             Minority interest operations                           392,235                  (23,106)
             Non-cash consulting                                     83,160                   24,994
             Equity in operatons                                    (17,527)                  23,470
             (Benefit from) bad debts                                  --                    (34,788)
             Capital distributions from unconsolidated
               partnership interests                                 92,272                   36,014
             Cash collected on installment sale                     694,983                     --
             (Increase) decrease in assets -
               Accounts receivable - trade                           36,924                  193,554
               Inventories                                          (98,693)                  16,202
               Prepaid expenses                                    (335,407)                  66,710
             Increase (decrease) in liabilities:
               Accounts payable                                   1,388,338                  (30,444)
               Accrued payroll and related taxes                     99,401                  (57,646)
               Accrued interest                                     293,556                  (11,817)
               Other accrued expenses                               654,081                  199,889
             Deferred revenue - beach club                          (52,074)                 305,499
             Deferred consulting                                   (187,496)                 300,000
             Customer deposits                                         --                      8,779
             Cash paid to repurchase franchise rights                  --                   (200,000)
             Deferred franchise revenue                             (76,000)                (126,000)
                                                                  ---------                ---------

                   Net cash provided by operating activities      3,553,862                2,488,688
                                                                  ---------                ---------

</TABLE>


           The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.



<PAGE>
HUDSON HOTELS CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
FOR THE NINE MONTHS ENDED DECEMBER 31, 1996 AND NINE MONTHS ENDED
DECEMBER 31, 1995

<TABLE>
<CAPTION>
                                                                 Year Ended            Nine Months Ended
                                                              December 31, 1996        December 31, 1995
CASH FLOWS FROM INVESTING ACTIVITIES:                         -----------------        -----------------
  <S>                                                         <C>                      <C>

  Acquisition of land/real estate development                    (2,094,550)              (1,242,437)
  Increase in restricted cash                                    (1,515,879)                    --
  Capital contribution to unconsolidated partnership interests      (12,900)                (575,000)
  Collection on non-affiliate mortgage                              200,000                  100,000
  Change in non-affiliates accounts and notes receivable            (32,360)                 337,047
  Purchase of equipment                                            (640,982)                (256,466)
  Change in other assets                                            (40,582)                 (70,899)
  Purchase of hotels                                            (61,153,159)                    --
  Deposits                                                         (329,262)                    --
  Issuance of stock for hotel acquisition                         2,358,872                     --
  Cash received in acquisition                                      557,543                     --
  Change in affiliate accounts receivable                            25,751                  237,243
                                                                -----------                ---------
                   Net cash used in investing activities        (62,677,508)              (1,470,512)
                                                                -----------                ---------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds of borrowings                                         83,400,000                5,400,000
  Financing costs                                                (2,508,238)                (160,737)
  Repayment of mortgages                                        (17,023,406)              (5,459,043)
  Distributions to limited partners                                (381,071)                (200,474)
  Proceeds from stock options exercised                               7,667                  246,950
  Dividends paid                                                   (127,320)                 (95,490)
  Purchase of treasury stock                                     (3,953,041)                    --
  Borrowings on line of credit, net                                    --                   (316,000)
                                                                -----------                ---------
                   Net cash used in
                     financing activities                        59,414,591                 (584,794)
                                                                -----------                ---------

NET INCREASE IN CASH AND CASH EQUIVALENTS                           290,940                  433,382

CASH AND CASH EQUIVALENTS - beginning of period                     766,428                  333,046
                                                                -----------                ---------

CASH AND CASH EQUIVALENTS - end of period                       $ 1,054,368                $ 766,428
                                                                -----------                ---------
                                                                -----------                ---------
OTHER INFORMATION:
  Cash paid during the period for:
    Interest                                                    $ 1,662,972                $ 692,478
    Income taxes                                                    205,269                   41,119
  Non-cash financing and investing activities
    Insuance of 600,000 shares of common stock upon
    conversion on convertible subordinated debentures             3,000,000                     --
  Acquisition of seventeen properties in 1996 for stock           9,759,773                     --
  Liabilities assumed for the purchase of the five
    properties on July 31, 1996                                  12,263,011                     --

</TABLE>


           The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.



SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
<TABLE>
  <S>                                                            <C>                      <C>
         Cash paid during the period for:
           Interest                                               $ 692,478                $ 760,189
                                                                  ---------                ---------
                                                                  ---------                ---------

           Income taxes                                           $  41,119                $   8,125
                                                                  ---------                ---------
                                                                  ---------                ---------
</TABLE>


<PAGE>
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1996

1.       THE COMPANY:

         Hudson Hotels Corporation (the "Company") was organized as Microtel
Franchise and Development Corporation to develop and franchise a national chain
of economy limited service lodging facilities ("Microtels"), using the service
mark "MICROTEL", which offers downsized rooms with higher quality furnishings at
rates below those available at competing national lodging chains. The Company
was incorporated in New York State on June 5, 1987.

         On October 5, 1995, the Company signed an exclusive Joint Venture
Agreement with US Franchise Systems, Inc., in which US Franchise Systems, Inc.
purchased worldwide franchising and administration for the Microtel franchise
chain. As a result of the Joint Venture Agreement, the Company has focused its
efforts on developing, building and managing various hotel products, including
Microtels, which has been the Company's strength since it acquired Hudson Hotels
Corporation in 1992. During 1996, the Company embarked upon a significant
expansion and development program, which includes several acquisitions (see Note
18) and development of four Microtel Inns through a joint venture partnership.

         At December 31, 1995, the Company changed its fiscal year from March 31
to December 31. This fiscal year coincides with individual hotel property,
partnership and joint venture investment year ends and simplifies the Company's
accounting and reporting.

         The Company operates in the industry segment of hotel development and
management.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Accounting Period

         In 1995, the Company changed its fiscal year end to December 31.
Fiscal 1995 is a nine month transition period ended December 31, 1995.

Principles of consolidation

         The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Canandaigua Hotel Corp., Victor Hotel
Corp., Microtel Partners Corp., Watertown Hotel Corp., Delray Beach Hotel Corp.,
Muar Lakes Hotel Corp., Jamestown Hotel Corp., Airport Hotel Corp., Ridge Road
Hotel Corp., 950 Jefferson Hotel Corp., Hudson Hotels Properties Corp., HH
Properties-I, Inc., HH Properties-VB, Inc., HH Properties-Southwest, Inc., HH
Properties-Tonawanda, Inc. and Brookwood Funding Corp. collectively referred to
as the Company. The consolidated financial statements also include the accounts
of partnerships which are controlled by the Company (see below and Note 3).
Other investments in partnerships which the Company does not control are
accounted for under the equity method (see below and Note 3). Income and
expenses are recorded on the accrual basis of accounting and all significant
intercompany accounts and transactions have been eliminated.

Investments in Partnership Interests

         The Company owns or owned equity interests, ether as a general or
limited partner, in entities which own hotel properties or real estate which may
be developed as a hotel property. Effective August 1, 1996, the Company
acquired various

<PAGE>
remaining general and limited partner interests in five (5) hotel partnerships
in which the Company was a minority partner. Subsequent to that date, the
operations of those five hotels are included in the operating results of the
Company. These partnerships and the Company's ownership percentages are as
follows during 1996.

<TABLE>
<CAPTION>

                                                                       THROUGH JULY 31, 1996     AT DECEMBER 31, 1996
                                                                       ---------------------     --------------------
<S>                                                                             <C>                   <C>
Delray Beach Hotel Properties Limited, as general partner                       20.00%                   --
Delray Beach Hotel Properties Limited, as a limited partner                     6.16%                    --
Brookwood Hotel Properties, as a general partner                                27.75%                   --
Essex Microtel Leray L.P., as a limited partner                                 4.00%                 4.00%
The Montgomery Group, Ltd.,  as a limited partner                               4.12%                 4.12%
Airport Hotel Properties, L.P., as a general partner                            1.00%                 1.00%
Airport Hotel Properties, L.P., as a limited partner                            20.50%                20.50%
Muar Lakes Associates, L.P., as a general partner                               1.00%                    --
Muar Lakes Associates, L.P., as a limited partner                               4.00%                    --
Ridge Road Hotel Properties, L.P.,  as a general partner                        1.12%                    --
Ridge Road Hotel Properties, L.P., as a limited partner                         7.57%                    --
Jamestown Hotel Properties, L.P., as a general partner                          1.00%                    --
Jamestown Hotel Properties, L.P., as a limited partner                          6.75%                    --
950 Jefferson Road Associates, L.P., as a general partner                       1.00%                 1.00%
950 Jefferson Road Associates, L.P., as a limited partner                       1.00%                 1.00%
Fishers Road Hotel Properties, L.P., as general partner                         1.00%                 1.00%
Fishers Road Hotel Properties, L.P., as a limited partner                       21.50%                21.50%
Microtel Partners 1995-I, L.P., as general partner                              1.00%                 1.00%
Microtel Partners 1995-I, L.P., as a limited partner                            49.00%                49.00%
Microtel Gatlinburg, L.P., as a limited partner                                 10.00%                10.00%
Rochester Hospitality Partners, L.P., as a limited partner                      20.00%                20.00%

</TABLE>

         The Company is also a general partner, with a 1% interest, in Watertown
Hotel Properties II, L.P., which previously owned a hotel property and currently
holds a mortgage upon the property securing a portion of the sale price of the
property.

         In addition, the Company is a partner in Brookwood Funding Associates,
L.P., a partnership which held a $1,500,000 second mortgage on a property
previously owned by Brookwood Hotel Properties, an entity in which the Company
owned an equity interest prior to acquisition of the remaining partnership
interests on July 31, 1996. The mortgage was repaid on November 27, 1996. The
Company's ownership percentage in Brookwood Funding Associates, L.P. at December
31, 1996 is 1.67%. The Company borrowed $1,110,000 from the partnership as of
December 31, 1996 and has subsequently borrowed an additional $313,000 after
year end. It is anticipated that the Company will repay its obligation in April
1997. This balance is included in accounts payable as of December 31, 1996.

         The Company, in its capacity as sole general partner and by the terms
of the partnership agreements, controlled the partnership of Delray Beach Hotel
Properties Limited. The partnership was terminated by the Company's acquisition
of the remaining limited partnership interests effective July 31, 1996. In
addition, in a similar capacity, the Company controls the partnership of
Watertown Hotel Properties II, L.P. The total capital account balances of the
partnership and ownership percentages of partners other than the Company in the
controlled partnerships are as follows at July 31 and December 31, 1996:

<TABLE>
<CAPTION>
                                                     JULY 31, 1996                               DECEMBER 31, 1996
                                                     -------------                              -------------------
                                           TOTAL CAPITAL    OTHER OWNERSHIP             % TOTAL CAPITAL    OTHER OWNERSHIP %
                                           -------------    ---------------             ---------------   ------------------
<S>                                        <C>              <C>                         <C>               <C>
Delray Beach Hotel Properties Limited       $  (23,114)          73.84%                     $       --              --
Watertown Hotel Properties II, L.P.          1,311,042           99.00%                      1,111,039           99.00%
                                            ----------                                      ----------
                                            $1,287,928                                      $1,111,039
                                            ==========                                      ==========
</TABLE>

         Income and losses of controlled partnerships are allocated to the
Company according to the terms of each partnership agreement.

         The Company received development and franchise placement fees totaling
$180,000 in the year ended 1996 and $120,000 for the nine month transition
period ended December 31, 1995 from unconsolidated entities in which the Company
has a minority interest. Development fees represent cost reimbursement. The
Company also receives ongoing royalties from these entities on the same basis as
independent parties.

         The investments in partnership interests, as reflected on the
accompanying consolidated balance sheets, consists of the Company's investments
in the partnerships which are accounted for under the equity method and a
step-up in basis to their estimated fair market value as of the date of
acquisition of Hudson. This step-up in basis amounted to $984,294 and is being
amortized. As a result of the acquisition of the remaining interest of Brookwood

<PAGE>
Hotel Properties and Delray Beach Hotel Properties Limited at July 31, 1996, the
portion of the step-up related to those properties was allocated to the assets.
At December 31, 1996 and 1995, the total step-up, net of accumulated
amortization, is $98,432 and $638,103, respectively.

Cash and cash equivalents

         For purposes of reporting cash flows, cash and cash equivalents include
cash on hand and amounts due from banks with maturities of less than 30 days.
The Company maintains its cash in bank deposit accounts which, at times, may
exceed federally insured limits. The Company has not experienced any losses in
such accounts. The Company believes it is not exposed to any significant credit
risk on cash and cash equivalents.

Restricted Cash

         The Company is required to maintain certain levels of escrowed cash in
order to comply with the terms of its debt agreements. All cash is trapped for
application against required escrows for debt, tax, insurance and capital asset
reserve. A substantial portion of the escrowed cash funds are released several
times monthly for application against current liabilities. The balance held in
escrow on December 31, 1996 was $1,515,879.

Accounts Receivable - Trade

         Accounts Receivable - Trade represent billed receivables to hotel
entities for management services or royalties due.  At December 31, 1996 and
1995, $46,542 and $70,417, respectively, represents amounts due from entities
in which the Company has a minority interest.

Inventories

         Inventories are stated at the lower of cost, on a first-in, first-out
method, or market and consist primarily of hotel supplies.

Property and Equipment

         Property and equipment are recorded at cost. When retired or otherwise
disposed of, the related cost and accumulated depreciation are reversed and the
net difference, less any amount realized from the disposition, is reflected as
income or loss. Betterments, renewals and extraordinary repairs that extend the
life of an asset are capitalized; other repairs and maintenance are expensed.

         Property and equipment consists of the following at December 31,

<TABLE>
<CAPTION>

                                                                                      1996                  1995
                                                                                      ----                  ----
<S>                                                                            <C>                   <C>
              Land                                                             $10,507,123           $   991,394
              Building and building improvements                                62,477,004             5,914,225
              Furniture and equipment                                           11,464,956             1,384,328
                                                                                ----------             ---------
                                                                                84,449,083             8,289,947
               Less - Accumulated depreciation                                    (775,401)           (1,748,330)
                                                                                ----------            ----------
                                                                               $83,673,682            $6,541,617
                                                                               ===========            ==========

</TABLE>


         Effective July 31, 1996, the Company acquired the remaining interest in
Delray Beach Hotel Properties Limited ("Delray"). Prior to that time, the
Company owned general and limited partnership interests totaling 26.16% and
consolidated Delray in its capacity as sole general partner and under the terms
of the partnership agreement.

         In conjunction with the acquisition, the portion of Delray's assets
acquired were valued at cost. The portion of Delray's assets previously owned
were valued at historical cost, net of accumulated depreciation to the date of
acquisition.

         For financial reporting purposes, depreciation is computed using the
straight-line method for building and accelerated methods for furniture and
equipment over the following estimated useful lives:

  Building and building improvements                     20-40 years
  Furniture and Equipment                                5-7 years

<PAGE>

  In March, 1995, the FASB issued Statement of Financial Accounting
Standards No. 121 entitled "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of". The statement requires that
long-lived assets and certain identifiable intangibles to be held and used by a
company be reviewed for impairment whenever events or changes in circumstances
indicate the carrying amount of the asset may not be recoverable. In performing
the review for recoverability, companies are required to estimate the future
cash flows expected to result from the use of the asset and its eventual
disposition. Under Statement 121, an impairment loss is recognized if the sum of
the undiscounted future cash flows is less than the carrying amount of the
asset. The Statement also establishes standards for recording an impairment loss
for certain assets subject to disposal. Excluded from the scope of the statement
are financial instruments and deferred tax assets. As required, the Company
adopted Statement 121 effective January 1, 1996 with no material effect on the
Company's consolidated financial statements on the date of adoption.

Fair Value of Financial Instruments

         Based on the borrowing rates currently quoted by financial institutions
for loans with terms and maturities similar to the Company's long-term debt, the
carrying value of such debt approximates its fair value.

Deferred Financing Costs

         Costs incurred to acquire financing are being amortized using the
straight-line method over the term of the related financing.  Accumulated
amortization was $11,936 and $1,606 as of December 31, 1996 and 1995,
respectively.

Revenue Recognition

         Royalty fee revenue is based on gross room revenues and the number of
franchised businesses open under the Company's Joint Venture Agreement with US
Franchise Systems, Inc. (see Note 17).

         Franchise placement income is recognized at the date the "Microtels"
are opened, as allowed under the Company's Joint Venture Agreement with US
Franchise Systems, Inc.(see Note  17).

         Management fee revenue is recognized monthly as the services are
performed in accordance with the terms of the management contracts and is
generally based on a percentage of the managed property's revenue plus charges
for accounting and marketing fees.

         Development fee revenue is recognized monthly as the services are
performed in accordance with the terms of the development contracts.

         Membership dues for the beach club of the Seagate Hotel and Beach Club
are recognized ratably over the membership period. Membership dues received in
advance are reflected as deferred membership dues.

         Hotel operation revenue, principally from room rentals, is recognized
as earned. Ongoing credit evaluations are performed and an allowance for
potential credit losses is provided against the portion of accounts receivable
which is estimated to be uncollectible.

Beach Club Membership

         As a result of the acquisition of the Seagate Hotel and Beach Club, the
Beach Club operation was valued at $3,206,531, based on an independent
appraisal. Amortization is provided using the straight-line method over the 20
year estimated useful life of the asset. Accumulated amortization is $66,803 as
of December 31, 1996.

Installment Method of Accounting

         As a result of the Joint Venture Agreement with US Franchise Systems,
Inc. (see Note 17), the Company had elected to record the proceeds receivable on
the installment method of accounting. This method is applicable in cases where
receivables are collectable over an extended period of time and where there is
little basis for estimating the degree of collectibility.

         During 1996, U.S. Franchise Systems, Inc., completed an initial public
offering with proceeds to that entity of approximately $37,000,000. As a result,
it was determined that the future collectibility was not in doubt and the
balance of the deferred revenue was recognized at December 31, 1996.

<PAGE>
Net income per common share -

         Earnings per share are computed on the basis of the weighted average
common share and common share equivalents outstanding during the period. The
payment of preferred dividends, which is not included in net earnings, is
included in the computation of earnings per share. The weighted average number
of common shares outstanding is as follows:

      Year ended December 31, 1996                                 4,248,521
      Transition period ended December 31, 1995                    3,706,333

Estimates

         In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenue and expenses during the reporting period. Actual results could differ
from those estimates.

3.       SUMMARIZED FINANCIAL INFORMATION - INVESTMENTS IN PARTNERSHIP
         INTERESTS:

         The following is a summary of condensed financial information for the
year ended December 31, 1996, for the partnerships which the Company controls or
controlled and a combined summary of condensed financial information for the
unconsolidated partnerships which the Company does not control for the
partnerships year ended December 31, 1996. As a result of the acquisition of
partnership interests in five hotel partnerships effective July 31, 1996,
operating information for Delray and four other unconsolidated hotel
partnerships is included for the seven months then ended. Effective July 31,
1996, the Company acquired the remaining interests in Delray and the four
unconsolidated hotel partnerships.

<TABLE>
<CAPTION>

                                            DELRAY BEACH HOTEL              WATERTOWN                  UNCONSOLIDATED
                                            PROPERTIES LIMITED       HOTEL PROPERTIES II, L.P.          PARTNERSHIPS
                                            ------------------       -------------------------         --------------
       <S>                                  <C>                      <C>
       Property and equipment
         net of accumulated
         depreciation                       $        --              $         --                       $29,490,826
       Current assets                                --                    11,039                         2,918,869
       Notes and mortgage
         receivable - noncurrent                     --                 1,100,000                                --
       Other assets                                  --                        --                         1,341,308
                                            -----------              ------------                      ------------

         TOTAL ASSETS                                --                 1,111,039                        33,751,003
                                            -----------              ------------                      ------------
       Mortgage and notes
         payable - current                           --                        --                         2,157,446
       Other current liabilities                     --                        --                           847,865
       Mortgage and note  payable
          non current                                --                        --                        24,118,255
                                            -----------              ------------                      ------------
         TOTAL LIABILITIES                           --                        --                        27,123,566
                                            -----------              ------------                      ------------
       NET ASSETS                                    --              $  1,111,039                      $  6,627,437
                                            -----------              ------------                      ------------
                                            -----------              ------------                      ------------
       Net revenues                         $ 2,957,488                        --                        13,668,878
       Operating expenses                    (1,729,892)                   (2,334)                       (9,301,426)
                                            -----------              ------------                      ------------
       Income from
         operations                           1,227,596                    (2,334)                        4,367,452
       Other income (expense),
         net                                   (877,678)                  126,667                        (3,678,898)
                                            -----------              ------------                      ------------
       NET  INCOME                          $   349,918              $    124,333                      $    688,554
                                            -----------              ------------                      ------------
                                            -----------              ------------                      ------------
</TABLE>


<PAGE>
4.  INVESTMENT IN LAND

        Investment in land at December 31, 1996 and 1995 is summarized as
follows:

                                                        AMOUNT     ACRES
                                                     ----------   -------
      Tonawanda, New York                            $  780,822    8.13

        The Company is holding the land as an investment.  It is the intent of
the Company to sell the subdivided land to other hotel and restaurant
developers.

        This parcel is located in a populated area adjacent to an interstate
highway and is considered an ideal location for hotel construction.
The parcel is zoned for hotel and restaurant development.

        See Note 16 for discussion relating to the acquisition of land.

5.  REAL ESTATE DEVELOPMENT

        Real estate development in process is summarized as follows at December
31:

<TABLE>
<CAPTION>

                                                                      1996              1995          ACRES
                                                                      ----              ----          -----
        Cost of Land under development:
        <S>                                                        <C>               <C>              <C>
                    Strawberry Plains Pike, Tennessee              $  310,204        $  310,204        1.39
                    Irving, Texas                                     472,932           473,032        2.02
                    Plano, Texas                                      595,661           595,661        2.00
                    Plano, Texas                                      677,697                --        2.00
                    Arlington, Texas                                  604,629                --        2.00
                    Tucson, Arizona                                   478,851                --        2.00
                                                                   ----------        ----------
                                                                   $3,139,974        $1,378,897

                  Development costs                                   512,148           178,675
                                                                   ----------        ----------

                  Total real estate development in process         $3,652,122        $1,557,572
                                                                   ----------        ----------
                                                                   ----------        ----------
</TABLE>

        All of the parcels above are located in populated areas adjacent to
interstate highways and are considered ideal locations for hotel construction.
All parcels are zoned for commercial use.

        Development costs include land and site development costs which are
accumulated by specific site. Upon sale to a specific ownership entity, the
Company will be reimbursed for all land and site development costs specifically
associated with the parcel.

6.  ACCOUNTS AND NOTES RECEIVABLE

Affiliates:

        The Company has advanced amounts or has receivables from affiliated
entities as follows as of December 31:

<TABLE>
<CAPTION>

                                                                1996                    1995
                                                                ----                    ----

                  <S>                                         <C>                     <C>
                  Rochester Hospitality Partners, L.P.        $ 40,000                $113,636
                  Airport Hotel Properties, L.P.               130,617                  48,300
                  Microtel  Partners 1995-I, L.P.              121,523                  92,371
                  Microtel Gatlinburg, L.P.                         --                  15,000
                  Fishers Road Hotel Properties, L.P.               --                  40,000
                  S&W Restaurants                                   --                  73,085
                  Other                                         33,860                  33,859
                                                              --------                --------
                                                              $326,000                $416,251
                                                              --------                --------
                                                              --------                --------
</TABLE>

The amounts due represent demand notes.  Interest is charged at prime plus 1%
and the amounts are not collateralized.  Subsequent to December 31, 1996, the
Company collected $160,000 of amounts outstanding at December 31, 1996.

<PAGE>
7.  MORTGAGE RECEIVABLE:

        On November 1, 1991, Watertown Hotel Properties II, L.P., a partnership
in which the Company holds a 1% equity interest, executed a mortgage agreement
and note for $1,500,000 with stated interest at 12% and due in full on October
31, 1994, together with all accrued interest. The mortgage was issued by Essex
Microtel Leray, L.P., a partnership in which the Company holds a 4% special
limited partnership interest.

        On October 25, 1994, Watertown Hotel Properties II, L.P. renewed the
mortgage note and modified the interest rate and certain other terms, covenants
and provisions of the original mortgage agreement dated November 1, 1991. On
November 1, 1994, a principal payment of $100,000 was made, and from that date,
the loan earns interest at the rate of 10% per annum. Another mandatory $100,000
principal payment was made on November 1, 1995.

        On November 1, 1996, the mortgage was renewed for a two year term with
an interest rate of 10% per annum.  Other terms and covenants remained the same.
In conjunction with the renewal, a principal payment of $200,000 was received.

        The agreement provides Essex Microtel Leray, L.P., with the option to
prepay in full plus accrued interest at any time prior to maturity without
penalty.

        In January 1995, the Company purchased a note from Delray Beach Hotel
Properties Limited, for $1,000,000 due May 1, 2000. Under the terms of the note,
payments required interest only, calculated at 12% per annum until April 1996.
As a result of the acquisition of the remaining limited partnership interests in
this entity, the obligation was cancelled.

8.  DEBT:

        Long-term debt consists of the following at December 31:
<TABLE>
<CAPTION>

                                                                                                    1996           1995
                                                                                                    ----           ----
       <S>                                                                                   <C>              <C>
       Mortgage payable to Nomura Asset Capital Corporation, by HH Properties-I,
       Inc. dated November 27, 1996, due in monthly installments of $477,257,
       including principal and interest at 9.19% over a 25 year period. On
       December 11, 2008, the interest rate recasts at no less than 14.19%. The
       mortgage is collateralized by
       all of the assets of HH Properties-I, Inc., the Company's wholly-owned hotel
       subsidiary.                                                                           $56,000,000             --

       Mezzanine note payable to Nomura Asset Capital Corporation, dated
       November 27, 1996, payable in monthly installments of interest only at
       LIBOR plus 6% in year
       one and LIBOR plus 6% and $283,333 monthly of minimum principal years two through
       five.  The note is due December 11, 2001.  This note is collateralized by
       substantially all assets of the Company.                                               17,000,000             --

       7.5% convertible subordinated debenture payable by the Company, due July 1, 2001.       7,500,000             --

       10% note payable to SB Motel Corp. by the Company, payable in monthly installments
       of $24,167, which represents interest only.  The note is due November 27, 1997.         2,900,000             --

       4.4% Town of Tonawanda bonds with yearly principal payments of $22,169
       through 1997 and yearly principal payments of $18,475 thereafter until
       2006.                                                                                     192,136        218,000

       Other (retired in 1996)                                                                        --      8,493,661
                                                                                            ------------     ----------
       Total long-term debt                                                                   83,592,136      8,711,661

       Less - current portion                                                                 (3,527,950)      (205,187)
                                                                                            ------------     ----------
                                                                                             $80,064,186     $8,506,474
                                                                                            ------------     ----------
                                                                                            ------------     ----------
</TABLE>

<PAGE>
          The conversion price of the 7.5% convertible subordinated debenture
due July 1, 2001 is $7.50 per common share. This price will reset on December
31, 1998, based on 125% of the average volume weighted price over the last
thirty days or such number of days having 150,000 shares of trading volume. A
maximum and minimum conversion price for common shares are set at $7.50 and
$4.50, respectively. At the holder's option, at any time on or before the
maturity, the debenture or any part may be converted for common shares subject
to the terms above. This debenture is subordinate and junior in right of
payment to the senior indebtedness of the Company.

           In connection with the securitization of its long-term debt with
Nomura Asset Capital Corporation, HH Properties-I, Inc. agreed to the
establishment of cash collateral accounts that trap all of the HH Properties-I,
Inc. cash flow deposits for payment of debt service and various escrows, before
the net remaining operating cash is released to the Company.

           In connection with the mezzanine loan agreement, the Company has
agreed to the establishment of a cash collateral account that traps all of the
Company's cash flow deposits for payment of mezzanine interest and minimum
principal payments after the first year.

           Future minimum repayments under long-term debt are as follows:


                    1997                                     $ 3,527,950
                    1998                                       4,086,027
                    1999                                       4,145,975
                    2000                                       4,215,720
                    2001                                      15,192,151
                    Thereafter                                52,424,313
                                                             -----------
                                    TOTAL                    $83,592,136
                                                             ===========

9. SHAREHOLDERS' INVESTMENT:

(A) Preferred Stock

             At December 31, 1996, the Company's authorized preferred
shares were 10,000,000 at $.001 par value, 294,723 of which were issued and
outstanding.

             Series A Preferred Stock - 294,723 shares are issued and
outstanding and includes a liquidation preference of $5.40 per share.
Dividends are paid at $.432 per share annual, cumulative, subject to Board
declaration. Voting rights are co-equal with Common Shares; 1 share, 1 vote.
Each Preferred Share is convertible at the option of the holder into one share
of Microtel Common Stock, with antidilution protection. The Preferred Shares
are redeemable at the option of Microtel for debentures.

(B) Common Stock

           At December 31, 1996, the Company's authorized common shares
were 20,000,000 at $.001 par value per share, 4,787,462 of which were issued and
outstanding.

           In conjunction with the exclusive development and master franchise
agreements (see Note 11), the Company granted warrants to unrelated
third parties to purchase 150,000 shares of Company common stock at $6.60 per
share, expiring through 2002.

           In 1990, warrants to purchase 100,000 shares of Company
common stock at $6.60 per share were granted for financial advisory services,
expiring in 2000.

<PAGE>
            In 1993, warrants to purchase 125,000 shares of Company common
stock at $2.00 per share were granted to a securities firm for investment
banking services, expiring in 1997. These warrants have been rescinded by the
Board of Directors of the Company (see Note 14).

            In 1995, warrants to purchase 125,000 shares of Company stock
at $3.00 per share were granted to two securities firms
for investment banking and consulting services, expiring in 1997.

            In  1995, warrants to purchase 100,000 shares of Company stock at
$8.375 per share were granted to US Franchise Systems, Inc. expiring in 2000.
Due to the restrictive nature of the warrants, non-transferability and the
exercise price, the warrants are considered diminimus in value at the date of
issue.

            Of the foregoing warrants, 211,875 have been purchased by the
Chairman of the Board and Chief Executive Officer of the Company.

           On August 1, 1994, the Company issued 15,000 shares of its common
stock and 20,000 options to purchase common stock at $.01 per share to an
individual for five years of future financial consulting services. The option
expires in 2004. These options were authorized by the Board of Directors on
August 23, 1994 and exercised during the nine months ended December 31, 1995.

         On October 21, 1994, the Company issued 25,000 shares of its common
stock to an individual for future financial consulting services to be provided
for a term of five years.

         In October 1988, the Company issued options to purchase 25,000 shares
of Company common stock at $1.50 per share to an independent architect who
participated in the early creation and design of the "Microtel" concept.

         In October 1988, the Company issued options to purchase, in the
aggregate, 100,000 shares of the Company common stock at $1.50 per share to the
founding shareholders of the Company. During the nine month period ended
December 31, 1995, 15,000 options were exercised.

         The Company has established the following stock option plans,
authorized by the Board of Directors and approved by shareholders:

  --1990 Employee Stock Option Plan, whereby 100,000 shares of the Company's
  common stock is reserved for issuance under plan provisions to Directors,
  Officers and key employees pursuant to the exercise of qualified stock
  options, non-qualified stock options and direct purchase of stock. The granted
  options vest over a two year period, with 1/3 vesting
  immediately, 1/3 vesting at each of the first and second
  anniversary. At December 31, 1996, 3,000 shares were available for grant under
  this plan.

  --1993 Employee Stock Option Plan, whereby 550,000 shares of the Company's
  common stock is reserved for issuance under plan provisions to Officers and
  key employees pursuant to the exercise of qualified stock options,
  non-qualified stock options and direct purchase of stock. The granted options
  vest over a two year period, with 1/3 vesting immediately,
  1/3 vesting at each of the first and second
  anniversary. In 1996, the Board of Directors
  authorized the issuance of an additional
  300,000 shares, which was approved by
  shareholders at the annual meeting. At December
  31, 1996, 312,000 shares were available for
  grant under this plan.

  --1993 Directors Stock Option Plan, whereby 135,000 shares of the Company's
  common stock is reserved for issuance under plan provisions to outside
  Directors. The granted options vest over a two year period with 1/3 vesting
  immediately, with 1/3 vesting over the first and second anniversary. At
  December 31, 1996, 54,000 shares were available for grant
  under this plan.

<PAGE>
          A summary of changes in common stock options during the year ended
December 31, 1996 and transition period ended December 31, 1995 is:

                                  NUMBER OF SHARES          PRICE PER SHARE
                                  ----------------          ---------------
Outstanding at March 31, 1995          558,000              $1.50 - $3.75
Granted                                194,500              $4.125
Exercised                             (119,500)             $1.50 - $3.75
                                       -------
Outstanding at December 31, 1995       633,000              $1.50 - $4.125
Granted                                128,500              $7.00 - $7.375
Exercised                               (3,833)             $2.00
                                       -------
Outstanding (held by 24 optionees)
 at December 31, 1996                  757,667              $1.50 - $7.375
                                       -------
                                       -------
Options exercisable at:
 March 31, 1995                        456,834
                                       -------
                                       -------
 December 31, 1996                     600,500
                                       -------
                                       -------

The FASB has issued SFAS No. 123, Accounting for Stock-Based Compensation
effective for the fiscal years beginning after December 15, 1995. The Company
has adopted the disclosure provisions of the Statement.

           The Company accounts for its stock-based compensation plans under APB
No. 25, under which no compensation expense has been recognized because all
employee stock options have been granted with the exercise prices equal to
the fair value of the Company's Class A common stock on the date of grant.
The Company adopted SFAS No. 123 for disclosure purposes only in 1996. During
the phase-in period of SFAS No. 123, pro forma disclosures may not be
indicative of future amounts until the new rules are applied to all awards.
For SFAS No. 123 purposes, the fair value of each employee options grant has
been estimated as of the date of grant using the Black-Scholes option pricing
model and the following weighted average assumptions: risk-free interest rate
of 6.25%, expected life of five (5) years, no dividends and expected
volatility of 33.1%. Using these assumptions, the fair value of the employee
stock options granted in 1996 and the nine months ended December 31, 1995 is
$384,000 and $323,000, respectively, which would be amortized as compensation
expense over the vesting period of the options. Had compensation cost been
determined in accordance with SFAS No. 123, utilizing the assumptions detailed
above, the Company's net income and net income per share would have been
reduced to the following pro forma amounts for the period ended December 31:

                                    1996    1995
                                    ----    ----
Net income:
As reported                     $636,050  $1,310,592
Pro Forma                        287,050   1,202,592

Net income per share:
As reported                        $0.12       $0.33
Pro Forma                          $0.04       $0.30

10. COMMITMENTS:

            Certain office space and automobiles are rented under
non-cancelable operating leases that expire at various dates
through 1999. The following is a schedule of future minimum annual
rentals on non-cancelable operating leases:

                          1997    $154,457
                          1998      90,014
                          1999       6,998

            Total rent expense for the year ended December 31, 1996, and
transition period ended December 31, 1995, was $148,102 and $119,867,
respectively.

<PAGE>
          As a partner in the partnerships disclosed in Note 2, the Company has
guaranteed portions of mortgages payable relating to the partnerships. The
guarantees range from 50% to 200% of the outstanding mortgages payable to
banks. Amounts guaranteed by the Company related to the partnerships'
mortgages payable were approximately $3.9 million at
December 31, 1996.

           The Company is required to remit monthly royalty fees from 2% to 4%
of gross room revenue, plus additional monies for marketing assessments and
reservation fees to its franchisors, Choice Hotels International, Marriott
Corp. and Cricket Inn based on franchise agreements which extend from ten to
fifteen years. Some of these agreements specify restrictions on
transferability of
franchise and liquidated damages upon termination of franchise agreement due to
the franchisee's default. Total fees were approximately
$146,000 and $-0- for the year ended December 31, 1996
and 1995, respectively.

         The Company and American General Hospitality, Inc. ("AGHI") have
entered into a management agreement ("Management Agreement") effective for the
period of November 27, 1996 through December 31, 1996. Under the provisions of
the Management Agreement, AGHI undertakes and performs all management and
maintenance operations relating to each of the twelve
(12) hotels in the SB Motel Corp. portfolio, including all appropriate
marketing services, room rentals and other duties that arise from the operations
of these hotels.

       As compensation, AGHI receives the following:

       A. A management fee of $70,000
       B. An accounting reimbursement fee equal to $2,400 per hotel, or
          $26,400 for the period ended December 31, 1996

             In October 1996, the Company entered into an option agreement to
purchase three (3) hotels (Hampton Inn - Buffalo, New York; Comfort Inn Suites
- Buffalo, New York; Holiday Inn - Cleveland, Ohio) for $25,500,000. The
Company has a $120,000 deposit as of December 31, 1996, with $30,000 in
monthly fees to be paid from January to May 1997. The
total amount paid will be applied against
the purchase price, if exercised. The option expires May 30, 1997.

11. EXCLUSIVE DEVELOPMENT AGREEMENT:

           On September 30, 1991, the Company entered into an exclusive
development agreement granting the rights to S&E Hospitality Partnership
("S&E") to develop and operate 75 Microtel hotels in various states. In
consideration for these rights, Microtel received a non-refundable exclusive
development fee of $500,000 representing 20 prepaid franchises.
Income recognition of this fee was deferred by the Company.
The first of 20 franchises was opened in Allentown, Pennsylvania, in May 1993.

           In March 1994, a Termination of Exclusive Development Agreement
was executed by S&E Hospitality Partnership and the Company, due to the
occurrence of the second consecutive default by S&E on the Development
Schedule, resulting in the exclusive territorial rights reverting back to the
Company. According to the terms and conditions of the
Termination Agreement, certain provisions survived; namely, that S&E's
partners retained the right to develop the balance of the Microtels for which
S&E's partners paid the non-refundable franchise fees. Therefore, 19 Microtels
were able to be developed by S&E's partners at any approved location within or
outside of the originally defined territory.

           On June 30, 1995, the Company entered into an agreement with the
former partners of S&E Hospitality Partnership whereas one of the former
partners of S&E sold assigned prepaid franchises (14) back to the Company for
$200,000. The 14 prepaid franchises had been recorded as deferred revenue
with value of $350,000 on the Company's balance sheet
prior to the transaction. This transaction resulted in a $150,000 gain.
As of December 31, 1996, the five remaining franchises were fully constructed
and operating.

           The Company recognized revenue as each individual franchised hotel
opened.

12. INCOME TAXES:

        Income taxes are provided in accordance with Statement of Financial
Accounting Standard, No. 109, "Accounting for Income Taxes", which requires an
asset and liability approach to financial accounting and reporting for
income taxes. The Statement requires that deferred income taxes be
provided to reflect the impact of "temporary


<PAGE>
differences" between the amount of assets and liabilities for financial
reporting purposes and such amounts as measured by current tax laws and
regulations. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized.

         The components of the provision for income taxes are as follows:

                        YEAR ENDED           TRANSITION PERIOD
                    DECEMBER 31, 1996      ENDED DECEMBER 31, 1995
                    -----------------      -----------------------
         CURRENT:
           Federal      $195,539                  $228,900
           State          10,708                    50,945

         DEFERRED:
           Federal       196,232                   194,187
           State          69,535                    64,729
                        --------                  --------
         TOTAL          $472,014                  $538,761
                        ========                  ========

         Deferred tax (liabilities) assets are comprised of the following at
December 31:
                                             1996              1995
                                          ---------         ---------
Depreciation                              $(403,567)        $    --
Gross up of purchased Company               (39,278)         (254,858)
Minority interest                           (12,900)          (68,697)
                                          ---------         ---------

Gross deferred tax liability               (455,745)         (323,555)
                                          ---------         ---------
Loss carryforwards                          357,142           570,580
Deferred revenue                             86,279           116,475
Deferred consulting                          45,558           120,886
Bad debt reserve                            151,456            38,683
Tax credit                                  151,472           112,452
Miscellaneous                                41,286             7,694
                                          ---------         ---------
  Gross deferred tax assets                 833,193           966,770
                                          ---------         ---------
Net deferred tax asset                    $ 377,448         $ 643,215
                                          =========         =========

         The provision for income taxes differs from the amount of income tax
determined by applying the applicable US statutory federal income tax rate to
pretax income as a result of the following differences:

                                                      1996        1995
                                                    --------    --------
    Statutory US tax rates                          $376,742    $628,780

    Increase (decrease) in rates resulting from:
      Change in valuation allowance                     --      (174,815)
      State income taxes, net of federal income tax   66,495     110,961
      Other                                           28,777     (26,165)
                                                    --------    --------
    Provision for Income taxes                      $472,014    $538,761
                                                    ========    ========

        At December 31, 1996, the Company has tax net operating loss
carryforwards of approximately $882,000 which may be used to offset future
taxable income. These loss carryforwards will begin to expire in 2003.

<PAGE>
   13. CASH FLOW STATEMENT SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS:

        In connection with the acquisition of land for investment during fiscal
year 1995, liabilities were assumed as follows:

                  Value of land acquired              $867,800
                  Less:    Cash paid                   150,000
                           Stock issued                168,750
                           Note issued                 182,850
                                                      --------
                  Liabilities assumed                 $366,200
                                                      ========

        See Note 18 for additional non-cash transactions.

14. LITIGATION

         On October 26, 1990, a complaint was filed in Palm Beach County Circuit
Court, Florida, by Seagate Beach Quarters, Inc., a Florida corporation (Bearing
Case #90-12358-AB), seeking damages plus interest and costs, against Rochester
Community Savings Bank, ("RCSB"), a New York based bank, SHORE Holdings, Inc.
("SHORE"), a subsidiary of RCSB and naming
Hudson as a co-defendant. On December 6, 1990, Delray Beach Hotel Properties
Limited, a Florida limited partnership controlled by Hudson Hotels, purchased
the Seagate Hotel and Beach Club from RCSB's subsidiary, SHORE. The purchase
contract included an indemnification of Hudson Hotels against any action
resulting from previously negotiated contracts
between RCSB's subsidiaries and third-parties. Case #90-12358-AB contained
allegations that RCSB's subsidiary, SHORE Holdings, defaulted in its
obligations under a Contract for Purchase and Sale, dated August 16, 1990, and
failed to go forward with the transaction due to alleged tortious negotiations
between RCSB and Hudson. On March 17, 1994, the Court
granted Summary Judgment in favor of RCSB and Hudson Hotels which judgment was
appealed by Seagate. The Fourth District Court of Appeal in Florida affirmed
the summary judgment on RCSB and reversed the summary judgment granted in
favor of Hudson, remanding the action to Circuit Court for further
consideration. On August 15, 1994, Seagate proceeded to
trial against SHORE in case #90-12358-AB. During the course of the trial,
Seagate took a voluntary dismissal of their action against SHORE. On September
8, 1994, Seagate refiled its lawsuit against SHORE and joined Delray Beach
Hotel Properties Limited, through its general partner, Delray Beach Hotel Corp.
(bearing Case #94-6961-AF). The new case against SHORE was brought essentially
on the same facts as stated above. The claim against Delray Beach Hotel
Properties Limited was identical to the conspiracy and tortious interference
with a business relationship claim currently existing against Hudson Hotels.
On January 27, 1995, the Court issued an Order dismissing the Amended
Complaint as to Delray Beach Hotel Properties Limited. The Circuit Court
has consolidated the case against Hudson Hotels (Case #90-12358-AB) and
the case against SHORE (Case #94-6961-AF) and it is
anticipated those suits will go to trial during 1997.

            On February 11, 1993, a complaint was filed in the Western District
of New York, United States District Court, by John Miranda, Susan Miranda and
Christopher Miranda, seeking damages and costs against Quality Inn
International, Choice Hotels International, and naming Hudson as a
co-defendant. The requested relief in this case, John Miranda and Susan Miranda
and Christopher Miranda vs. Quality Inns International Inc., Choice Hotels
International Inc., Ridge Road Hotel Properties, Ridge Road Hotel Properties
d/b/a Comfort Inn, a/k/a Comfort Inn West, Hudson Hotels Corp., and Jennifer L.
Ansley, as Executrix of the Estate of Loren G. Ansley, was based on allegations
that John Miranda, while staying at the Comfort Inn, stepped on a needle, and
claims negligence and lack of due care on the part of the defendants. This case
is being diligently defended by the insurance carrier of Ridge Road Hotel
Properties and Hudson. The Company believes that it has adequate insurance for
any potential loss.

        After  taking into consideration legal counsel's evaluation of all such
actions, management is of the opinion that the outcome of each such proceeding
or claim which is pending, or known to be threatened (as described above), will
not have a significant effect on the Company's financial statements.

<PAGE>
          On June 20, 1995, Ladenburg, Thalmann & Co., Inc., the Company's
former investment bankers, filed a complaint in New York State Supreme
Court against the Company alleging breach of contract and damages of $906,250
relating to the Company's rescission of a warrant granted to them in connection
with the investment advisory agreement. In February
1994, the Board of Directors of the Company determined that Ladenburg had been
otherwise adequately compensated for such services as were actually
performed, and voted to rescind the warrant. The Company has answered the
complaint, denying the relevant allegations and asserting several
affirmative defenses. Discovery in the case has commenced and is continuing.
The ultimate outcome of the litigation cannot presently be determined.
Accordingly, no provision for any liability that may result has been made in
the financial statements.

15. LEASEHOLD INTEREST

         In November 1994, the Company provided a $250,000 cash deposit to
secure a ten year operating lease and management contract of a full-service
hotel located in Canandaigua, New York from L, R, R & M L.L.C. In June 1996,
the Company provided an additional $200,000 cash deposit which extends the
lease term an additional eighteen months and provides
additional security on the renovations performed from November 1995 through
May 1996. Also, during 1996, the Company earned a $250,000 fee for managing
the reconstruction project. One of the minority owners of L, R, R, & M,
L.L.C., is a greater than 5% shareholder who is not involved in the
management or operation of the Company. Base rent is equal to one-twelfth of
2% of the outstanding principal balance under the credit facilities per
month, plus amounts payable by the Landlord under the credit facilities
monthly. The Company is also obligated to pay/or have due additional monthly
rent/or abatement on positive/negative earnings based on 15% of the
leased operation's adjusted net revenues as defined in the lease
agreement. At December 31, 1996, $77,450 was due from the Landlord. At
December 31, 1995, the Company owed $130,666 to the Landlord.

          The deposit shall be returned to the Company in the event the
Landlord sells the premises based on 25% of the net proceeds of such sale, as
defined in the lease agreement. Future minimum lease payments under this
operating lease are approximately: 1997 - $914,000; 1998 - $914,000; 1999 -
$914,000; 2000 - $914,000; thereafter $3,503,667.

          The Company assumed a ground lease for the land on which a hotel was
acquired by the Company in 1996 in Statesville, North Carolina. The initial
term of this lease commenced in February 1984 and expires April 30, 2005. The
Company renewed the lease at its option, for three additional ten-year periods
ending April 30, 2035. The annual rental during the final ten years of the
initial term and each extension is the greater of $22,000 less one-half percent
of gross room rentals from the Statesville hotel during the 1991 lease year of
the lease term or four percent of gross room rentals from the Statesville hotel
during each lease year.

          The Company has a right of first refusal to buy the land subject to
the ground lease from the lessor during the lease term subject to the first
refusal rights of Roses Department Stores, Inc., or its successors.

          Rent expense on the ground lease was $1,833 from November 27, 1996,
the date of acquisition, to December 31, 1996.

          The future minimum ground lease rental payments, assuming no gross
room rentals during the initial lease term and no increases in the consumer
price index, are as follows for the years ended December 31:

                1997                                  $ 22,000
                1998                                    22,000
                1999                                    22,000
                2000                                    22,000
                2001                                    22,000
                Thereafter                              73,333
                                                      --------
                                                      $183,333
                                                      ========

<PAGE>
16. ACQUISITION OF LAND

          In May 1995, the Company purchased two acres of land in Plano,
Texas, for approximately $600,000, or $300,000 an acre. The parcel is zoned for
commercial use and is located north of Dallas, Texas, off Interstate 75 and is
in proximity of major businesses and shopping centers.

          In November 1995, the Company purchased two acres of land in Irving,
Texas, for approximately $487,000, or $242,000 an acre. The parcel is zoned for
commercial use and is located adjacent to the Dallas-Fort Worth International
Airport and is in proximity of major businesses.

          On May 15, 1996, the Company purchased two acres of land in
Arlington, Texas, for $604,629, or $302,314 per acre. The parcel is zoned for
hotel development. This land is located between the cities of Dallas and Fort
Worth, off State Highway 360, and is in proximity of major businesses, an
amusement park, Arlington Stadium and shopping centers.

          On June 24, 1996, the Company purchased two acres of land in Tucson,
Arizona, for $478,851, or $239,425 per acre. The parcel is zoned for hotel
development. This land is located outside the city limits of Tucson, off
Interstate 10, and is in proximity of major businesses, universities and the
airport.

          On July 23, 1996, the Company purchased two acres of land in Plano,
Texas (Plano Parkway) for $677,697, or $338,848 per acre. The land is located
north of Dallas, Texas, accessible to Lyndon B. Johnson Freeway I-635, the
Dallas North Tollway and Central Expressway US-75. It is in proximity of major
businesses and shopping centers.
          All parcels purchased are currently in the process of being developed
for the future construction of Microtel Inns.

17. JOINT VENTURE

          On October 5, 1995, the Company signed an exclusive Joint Venture
Agreement with US Franchise Systems, Inc. in which USFS purchased worldwide
franchising and administration for the Microtel hotel chain.

          The Company, in return, will receive $4 million over a three year
period in exchange for the exclusive franchise rights of the Microtel name and
various consulting services; $2 million was paid at closing, another $1 million
was paid at the first anniversary and $500,000 is due at each of the second and
third anniversaries. In addition to the  lump sum payments, the Company will
receive royalty payments from properties franchised by USFS. Royalty payments
will consist of 1% of gross room revenues from hotels 1-100; .75% from hotels
101-250; and .5% above 250 units.

          The Company has retained the right to franchise and construct an
additional twenty-three (23) Microtel properties and ten (10) "suites"
properties and to receive all royalties on the fifty (50) Microtels (27
existing and 23 new ones to be undertaken by the Company) and ten (10) suites.

          18. ACQUISITIONS

          On August 28, 1996, the Company completed the acquisition of the
remaining partnership interests in five hotel partnerships in which the Company
was the owner of varying minority general and limited partnership equity
interests for 1,170,103 shares of the Company's common stock. The acquisition
has been accounted for under the purchase method and, accordingly, the
operating results of the five hotel partnerships acquired have been included in
the consolidated operating results since the effective date of the acquisition,
July 31, 1996. One of the partnerships acquired, Delray Beach Hotel Properties
Limited, was included in the consolidated operating results of the Company, net
of minority  interests, prior to the acquisition, as the Company, in its
capacity as sole general partner and by the terms of the partnership
agreements, controlled the partnership of Delray Beach Hotel Properties
Limited.

<PAGE>
         The Company shares to be exchanged therefore were valued at the
average closing price for the five trading days prior to the effective date
of the exchange, i.e. July 31, 1996. The share value was determined by that
method to be $6.325. The Company utilized 657,292 treasury shares and 512,811
newly issued shares to satisfy its obligations. The Company has agreed to
register the shares so exchanged for sale pursuant to the Securities Act of
1933. In addition to the shares thus exchanged, the Company has agreed to
indemnify each exchanging partner for his or her continuing liability upon
guarantees of the outstanding mortgages on each property.

         On November 27, 1996, the Company acquired 12 hotel properties,
consisting of eight (8) Fairfield Inns by Marriott(R) and four (4) Cricket
Inns, from SB Motel Corp., a subsidiary of Salomon Brothers, Inc., and the
subsidiaries of SB Motel Corp., which had been formed to hold each such hotel,
pursuant to an Agreement of Purchase and Sale dated September 27, 1996, among
the Company and its subsidiary, Hudson Hotels Properties Corp., as Purchaser,
and SB Motel Albany Corp., SB Motel Charleston Corp., SB Motel Richmond Corp.,
SB Motel Durham-Research Triangle Park Corp., SB Motel Cary Corp., SB Motel
Statesville Corp., SB Motel Wilmington Corp., SB Motel Columbia Corp., SB Motel
Virginia Beach Corp., SB Motel Durham-Duke Corp., SB Motel Raleigh Corp., and
SB Motel Charlotte I-85 Corp. (the subsidiaries of SB Motel Corp. which held
each property), the Sellers. The Company acquired eleven of the properties into
its newly-formed subsidiary, HH Properties-I, Inc., and the twelfth, the
Virginia Beach Cricket Inn, into its newly formed subsidiary, HH Properties-VB,
Inc.

         The purchase price for the properties was $60,400,000, determined by
arms-length negotiation with the Sellers, after analysis and valuation by the
Company based upon historic and projected operating results of the properties.
The purchase price was paid by issuing 370,657 shares of Company common stock,
valued at $2,400,000, by issuing the Company's subordinated promissory note in
the amount of $2,900,000 (maturing November 27, 1997) to the Seller, and by
paying the balance of $55,100,000 in cash. The cash portion of the purchase
price was obtained a) by placing a $37,470,000 mortgage issued by Nomura Asset
Capital Corporation, on the properties purchased by HH Properties-I, Inc. b) by
the Company securing $17,000,0000 of mezzanine financing from Nomura Asset
Capital Corporation, and c) by the Company utilizing $530,000 of its available
capital.

         In addition to the consideration stated above, the Company has agreed
to register the 370,657 shares issued to SB Motel Corp., pursuant to the
Securities Act of 1933, within 180 days following closing, and the Company has
granted to Salomon Brothers, Inc. a right of first refusal to undertake equity
offerings on behalf of the Company.

         Proforma unaudited results of operations assuming the acquisitions had
occurred on January 1, 1995 are as follows:

                                              1996            1995
                                             ------          ------
         Total operating revenues         $39,123,457      $33,393,246
         Net income                         1,618,061        1,537,451
         Net income per common share            $0.25            $0.35

19. NON-RECURRING CHARGE

         During the fourth quarter of 1996, the Company had non-recurring
charges of $551,149 as a result of the acquisition of the SB Motel Corp.
portfolio. This amount is comprised of indirect costs relating to the
acquisition, management fees associated with the acquisition of the SB Motel
Corp. portfolio and write-off of several deposits in which the Company will no
longer pursue as a result of the acquisition.