** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

| **(MARK  ONE)**                                                                                                                                    |   |                                                                                                     |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                               |   |                                                                                                     |
| **ý**                                                                                                                                         |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|                                                                                                                                               |   |                                                                                                     |
| **For  the quarterly period ended September 30, 2003**                                                                                        |
|                                                                                                                                               |
| **OR**                                                                                                                                             |
|                                                                                                                                               |
| **o**                                                                                                                                              |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                               |   |                                                                                                     |
| **for  the transition period  from         to         ** |

 

| Commission  File Number |   | Exact  name of registrant as specified in its charter, state ofincorporation, address of  principal executive offices, and telephone number |   | I.R.S.  Employer  Identification Number |
|-------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|
| **333-84334**           |   | **RFS Partnership, L.P.A Tennessee Partnership  450 South Orange Avenue  Orlando, Florida  32801  Telephone (800) 650-1000**           |   | **62-1541639**                          |

 

Indicate by check mark whether the Registrant(i) 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 (orfor such shorter period that the Registrant was required to file such reports),and (ii) has been subject to such filing requirements for the past90 days.  ý Yes  o No

 

Indicate by check mark whether RFS Partnership, L.P.is an accelerated filer (as defined in Exchange Act Rule 12b-2).   oYesý No

 

OnAugust 14, 2003, RFS Partnership, L.P. (the “Operating Partnership”),filed with the Securities and Exchange Commission (the “Commission”) aCertification and Termination of Registration on Form 15 (the “Form 15”),terminating the Operating Partnership’s obligation to file reports with theCommission under the Securities Exchange Act of 1934, as amended (the“Act”).  Although the filing of the Form 15 terminates the OperatingPartnership’s obligation to file reports under the Act, the OperatingPartnership is filing this Quarterly Report on Form 10Q, in accordance with itsobligation to do so set forth in that certain Indenture, by and among theOperating Partnership, RFS 2002 Financing, Inc., CNL Rose Acquisition Corp.,RFS Leasing VII, Inc. and U.S. Bank, N.A., dated as of February 26, 2002.

 

 

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**INDEX**

 
| **PART I. FINANCIAL INFORMATION** |                                                                                        |
|-----------------------------------|---------------------------------------------------------------------------------------------|
|                              |                                                                                        |
| Item 1.                           | Financial Statements                                                                        |   |
|                              |                                                                                        |   |
|                              | Consolidated Balance Sheets                                                                 |   |
|                              |                                                                                        |   |
|                              | Consolidated Statements of  Operations                                                      |   |
|                              |                                                                                        |   |
|                              | Consolidated  Statements of Cash Flows                                                      |   |
|                              |                                                                                        |   |
|                              | Consolidated Statement of Partners’  Capital                                           |   |
|                              |                                                                                        |   |
|                              | Notes to  Consolidated Financial Statements                                                 |   |
|                              |                                                                                        |   |
| Item  2.                          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                              |                                                                                        |   |
| Item  3.                          | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
|                              |                                                                                        |   |
| Item 4.                           | Internal  Controls and Procedures                                                           |   |
|                              |                                                                                        |   |
| **PART II. OTHER INFORMATION**    |                                                                                        |
|                              |                                                                                        |   |
| Item 1.                           | Legal  Proceedings                                                                          |   |
|                              |                                                                                        |   |
| Item 4.                           | Submission  of Matters to a Vote of Security Holders                                        |   |
|                              |                                                                                        |   |
| Item 5.                           | Other Information                                                                           |   |
|                              |                                                                                        |   |
| Item 6.                           | Exhibits  and Reports on Form 8-K                                                           |   |

 

2

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**RFS PARTNERSHIP, L.P.****CONSOLIDATED BALANCESHEETS(in thousands)**

 
|                                                                                                                                  |   | **Post-Merger  Partnership** |    | **Pre-Merger  Partnership** |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|-----------------------------|--------|
|                                                                                                                                  |   | **September 30,  2003** |    | **December 31,  2002** |   |
|                                                                                                                                  |   |                         |    |                        |   |
| **ASSETS**                                                                                                                            |   |                         |    |                        |   |
| Investment in  hotel properties, net                                                                                                  |   | $                            | 799,491 |                        | $      | 593,289 |   |
| Real estate held  for sale                                                                                                            |   | 36,796                       |    | —                      |   |
| Cash and cash  equivalents                                                                                                            |   | 7,267                        |    | 1,938                       |   |
| Restricted cash                                                                                                                       |   | 10,330                       |    | 4,383                       |   |
| Accounts  receivable                                                                                                                  |   | 7,292                        |    | 4,698                       |   |
| Deferred  expenses, net                                                                                                               |   | 5,969                        |    | 8,805                       |   |
| Other assets                                                                                                                          |   | 5,693                        |    | 3,712                       |   |
| Deferred income  taxes, net of $1,328 and $0 valuation allowance at September 30, 2003  and December 31, 2002, respectively |   | 26,575                       |    | 25,830                      |   |
| Total assets                                                                                                                          |   | $                            | 899,413 |                        | $      | 642,655 |   |
|                                                                                                                                  |   |                         |    |                        |   |
| **LIABILITIES  AND PARTNERS’ CAPITAL**                                                                                           |   |                         |    |                        |   |
| Accounts payable  and accrued expenses                                                                                                |   | $                            | 23,142  |                        | $      | 24,202 |   |
| Borrowings on  Line of Credit                                                                                                         |   | —                       |    | 6,950                       |   |
| Bridge loan                                                                                                                           |   | 101,000                      |    | —                      |   |
| Mortgage notes  payable                                                                                                               |   | 160,186                      |    | 159,279                     |   |
| Senior notes  payable                                                                                                                 |   | 81,753                       |    | 125,000                     |   |
| Total  liabilities                                                                                                                    |   | 366,081                      |    | 315,431                     |   |
| Commitments and  contingencies                                                                                                        |   |                         |    |                        |   |
| Redeemable  limited partnership units at redemption value, 2,459 units at  December 31, 2002                                     |   | —                       |    | 26,702                      |   |
| Partners’  capital:                                                                                                              |   |                         |    |                        |   |
| General  partnership units, 31,942 units and 28,467 units at September 30, 2003  and December 31, 2002, respectively        |   | 533,332                      |    | 300,522                     |   |
| Total partners’  capital                                                                                                         |   | 533,332                      |    | 300,522                     |   |
| Total  liabilities and partners’ capital                                                                                         |   | $                            | 899,413 |                        | $      | 642,655 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

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**RFS PARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002(in thousands, except per unit data)**

 
|                                                          |   | **Post-  Merger  Partnership**        |   |   | **Pre-Merger  Partnership**              |   | **Pre-Merger  Partnership**          |   |
|---------------------------------------------------------------|--------|---------------------------------------|--------|--------|------------------------------------------|--------|--------------------------------------|--------|
|                                                          |   | **July 11  to  Sept. 30,  2003** |   |   | **July 1  to  July 10,  2003** |   | **July 1  to  Sept. 30,  2002** |   |
| Revenue:                                                      |   |                                  |   |   |                                     |   |                                 |   |
| Rooms                                                         |   | $                                     | 36,732 |   |                                     | $      | 3,892                                |   | $ | 41,450 |   |
| Food and  beverage                                            |   | 3,796                                 |   |   | 336                                      |   | 4,084                                |   |
| Other operating  departments                                  |   | 1,355                                 |   |   | 130                                      |   | 1,577                                |   |
| Lease revenue                                                 |   | 3,498                                 |   |   | 138                                      |   | 1,131                                |   |
| Deferred revenue                                              |   | 423                                   |   |   | —                                   |   | 472                                  |   |
| Other                                                         |   | 410                                   |   |   | 6                                        |   | 73                                   |   |
| Total hotel  revenue                                          |   | 46,214                                |   |   | 4,502                                    |   | 48,787                               |   |
| Hotel operating  expenses:                                    |   |                                  |   |   |                                     |   |                                 |   |
| Rooms                                                         |   | 7,404                                 |   |   | 840                                      |   | 8,150                                |   |
| Food and  beverage                                            |   | 2,812                                 |   |   | 252                                      |   | 3,107                                |   |
| Other operating  departments                                  |   | 352                                   |   |   | 35                                       |   | 479                                  |   |
| Undistributed  operating expenses:                            |   |                                  |   |   |                                     |   |                                 |   |
| Property  operating costs                                     |   | 5,432                                 |   |   | 585                                      |   | 5,521                                |   |
| Property taxes,  insurance and other                          |   | 3,012                                 |   |   | 314                                      |   | 2,841                                |   |
| Franchise costs                                               |   | 3,503                                 |   |   | 394                                      |   | 3,990                                |   |
| Maintenance and  repair                                       |   | 2,088                                 |   |   | 242                                      |   | 2,254                                |   |
| Management fees                                               |   | 998                                   |   |   | 2,089                                    |   | 1,158                                |   |
| Depreciation                                                  |   | 7,442                                 |   |   | 805                                      |   | 7,002                                |   |
| Amortization of  franchise fees and unearned compensation     |   | 17                                    |   |   | 1,447                                    |   | 312                                  |   |
| General and  administrative                                   |   | 3,703                                 |   |   | 16,527                                   |   | 4,606                                |   |
| Total operating  expenses                                     |   | 36,763                                |   |   | 23,530                                   |   | 39,420                               |   |
| Operating income  (loss)                                      |   | 9,451                                 |   |   | (19,028                                  | )      | 9,367                                |   |
| Amortization of  loan origination costs                       |   | 53                                    |   |   | 20                                       |   | 427                                  |   |
| Interest expense                                              |   | 6,169                                 |   |   | 746                                      |   | 6,470                                |   |
| Income (loss)  from continuing operations before income taxes |   | 3,229                                 |   |   | (19,794                                  | )      | 2,470                                |   |
| Benefit from  income taxes                                    |   | (528                                  | )      |   | —                                   |   | (323                                 | )      |
| Income (loss)  from continuing operations                     |   | 3,757                                 |   |   | (19,794                                  | )      | 2,793                                |   |
| Income from  discontinued operations                          |   | 822                                   |   |   | 103                                      |   | 857                                  |   |
| **Net  income (loss) applicable to common unitholders**       |   | $                                     | 4,579  |   |                                     | $      | (19,691                              | )      | $ | 3,650 |   |
|                                                          |   |                                  |   |   |                                     |   |                                 |   |
| Earnings (loss)  per unit data:                               |   |                                  |   |   |                                     |   |                                 |   |
| Basic earnings  (loss) per unit from continuing operations    |   | $                                     | 0.11   |   |                                     | $      | (0.62                                | )      | $ | 0.09 |   |
| Discontinued  operations                                      |   | 0.03                                  |   |   | 0.00                                     |   | 0.03                                 |   |
| Basic earnings  (loss) per unit                               |   | $                                     | 0.14   |   |                                     | $      | (0.62                                | )      | $ | 0.12 |   |
|                                                          |   |                                  |   |   |                                     |   |                                 |   |
| Diluted earnings  (loss) per unit from continuing operations  |   | $                                     | 0.11   |   |                                     | $      | (0.62                                | )      | $ | 0.09 |   |
| Discontinued  operations                                      |   | 0.03                                  |   |   | 0.00                                     |   | 0.03                                 |   |
| Diluted earnings  (loss) per unit                             |   | $                                     | 0.14   |   |                                     | $      | (0.62                                | )      | $ | 0.12 |   |
| Weighted average  common units outstanding—basic         |   | 31,942                                |   |   | 31,942                                   |   | 30,924                               |   |
| Weighted average  common units outstanding—diluted       |   | 31,942                                |   |   | 31,942                                   |   | 30,970                               |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

4

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**RFSPARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF OPERATIONSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002(in thousands, except per unit data)**

** **
|                                                          |   | **Post-Merger  Partnership**         |   |   | **Pre-Merger  Partnership**              |   | **Pre-Merger  Partnership**         |   |
|---------------------------------------------------------------|--------|--------------------------------------|--------|--------|------------------------------------------|--------|-------------------------------------|--------|
|                                                          |   | **July 11  to Sept.  30, 2003** |   |   | **Jan. 1  to********July 10, 2003** |   | **Jan. 1 to********Sept. 30, 2002** |   |
| Revenue:                                                      |   |                                 |   |   |                                     |   |                                |   |
| Rooms                                                         |   | $                                    | 36,732 |   |                                     | $      | 78,234                              |   | $ | 121,111 |   |
| Food and  beverage                                            |   | 3,796                                |   |   | 8,971                                    |   | 12,961                              |   |
| Other operating  departments                                  |   | 1,355                                |   |   | 2,820                                    |   | 4,748                               |   |
| Lease revenue                                                 |   | 3,498                                |   |   | 2,980                                    |   | 3,999                               |   |
| Deferred revenue                                              |   | 423                                  |   |   | (1,461                                   | )      | (1,032                              | )      |
| Other                                                         |   | 410                                  |   |   | 214                                      |   | 334                                 |   |
| Total hotel  revenue                                          |   | 46,214                               |   |   | 91,758                                   |   | 142,121                             |   |
| Hotel operating  expenses:                                    |   |                                 |   |   |                                     |   |                                |   |
| Rooms                                                         |   | 7,404                                |   |   | 16,391                                   |   | 24,095                              |   |
| Food and  beverage                                            |   | 2,812                                |   |   | 6,499                                    |   | 9,614                               |   |
| Other operating  departments                                  |   | 352                                  |   |   | 792                                      |   | 1,327                               |   |
| Undistributed  operating expenses:                            |   |                                 |   |   |                                     |   |                                |   |
| Property  operating costs                                     |   | 5,432                                |   |   | 11,179                                   |   | 15,311                              |   |
| Property taxes,  insurance and other                          |   | 3,012                                |   |   | 5,983                                    |   | 8,899                               |   |
| Franchise costs                                               |   | 3,503                                |   |   | 7,573                                    |   | 11,493                              |   |
| Maintenance and  repair                                       |   | 2,088                                |   |   | 5,238                                    |   | 6,629                               |   |
| Management fees                                               |   | 998                                  |   |   | 4,582                                    |   | 3,497                               |   |
| Depreciation                                                  |   | 7,442                                |   |   | 14,805                                   |   | 20,759                              |   |
| Amortization of  franchise fees and unearned compensation     |   | 17                                   |   |   | 2,028                                    |   | 950                                 |   |
| General and  administrative                                   |   | 3,703                                |   |   | 26,008                                   |   | 13,795                              |   |
| Total operating  expenses                                     |   | 36,763                               |   |   | 101,078                                  |   | 116,369                             |   |
| Operating income  (loss)                                      |   | 9,451                                |   |   | (9,320                                   | )      | 25,752                              |   |
| Debt  extinguishments and swap termination costs              |   | —                               |   |   | —                                   |   | 10,122                              |   |
| Amortization of  loan origination costs                       |   | 53                                   |   |   | 804                                      |   | 1,204                               |   |
| Interest expense                                              |   | 6,169                                |   |   | 13,889                                   |   | 19,025                              |   |
| Income (loss)  from continuing operations before income taxes |   | 3,229                                |   |   | (24,013                                  | )      | (4,599                              | )      |
| Benefit from  income taxes                                    |   | (528                                 | )      |   | (1,546                                   | )      | (703                                | )      |
| Income (loss)  from continuing operations                     |   | 3,757                                |   |   | (22,467                                  | )      | (3,896                              | )      |
| Income from  discontinued operations                          |   | 822                                  |   |   | 607                                      |   | 2,128                               |   |
| Gain (loss) on  sale of assets                                |   | —                               |   |   | (9                                       | )      | 962                                 |   |
| Net income  (loss)                                            |   | 4,579                                |   |   | (21,869                                  | )      | (806                                | )      |
| Loss on  redemption of Preferred Units                        |   | —                               |   |   | —                                   |   | (1,890                              | )      |
| Preferred unit  dividends                                     |   | —                               |   |   | —                                   |   | (1,562                              | )      |
| **Net  income (loss) applicable to common unitholders**       |   | $                                    | 4,579  |   |                                     | $      | (21,869                             | )      | $ | (4,258 | ) |
|                                                          |   |                                 |   |   |                                     |   |                                |   |
| Earnings (loss)  per unit data:                               |   |                                 |   |   |                                     |   |                                |   |
| Basic earnings  (loss) per unit from continuing operations    |   | $                                    | 0.11   |   |                                     | $      | (0.72                               | )      | $ | (0.22 | ) |
| Discontinued  operations                                      |   | 0.03                                 |   |   | 0.02                                     |   | 0.08                                |   |
| Basic earnings  (loss) per unit                               |   | $                                    | 0.14   |   |                                     | $      | (0.70                               | )      | $ | (0.14 | ) |
|                                                          |   |                                 |   |   |                                     |   |                                |   |
| Diluted earnings  (loss) per unit from continuing operations  |   | $                                    | 0.11   |   |                                     | $      | (0.72                               | )      | $ | (0.22 | ) |
| Discontinued  operations                                      |   | 0.03                                 |   |   | 0.02                                     |   | 0.08                                |   |
| Diluted earnings  (loss) per unit                             |   | $                                    | 0.14   |   |                                     | $      | (0.70                               | )      | $ | (0.14 | ) |
| Weighted average  common units outstanding—basic         |   | 31,942                               |   |   | 31,271                                   |   | 29,562                              |   |
| Weighted average  common units outstanding—diluted       |   | 31,942                               |   |   | 31,271                                   |   | 29,562                              |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

5

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**RFS PARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002(in thousands)**

** **
|                                                                                              |   | **Post-Merger  Partnership**         |   |   | **Pre-Merger  Partnership**              |   | **Pre-Merger  Partnership**          |   |
|---------------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|--------|------------------------------------------|--------|--------------------------------------|--------|
|                                                                                              |   | **July 11  to Sept.  30, 2003** |   |   | **Jan. 1  to********July 10, 2003** |   | **Jan. 1  to********Sept. 30, 2002** |   |
| Cash flows from  operating activities:                                                            |   |                                 |   |   |                                     |   |                                 |   |
| Net income  (loss)                                                                                |   | $                                    | 4,579  |   |                                     | $      | (21,869                              | )      | $ | (806 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided (used) by operating  activities: |   |                                 |   |   |                                     |   |                                 |   |
| Depreciation and  amortization                                                                    |   | 7,513                                |   |   | 18,675                                   |   | 24,681                               |   |
| Write-off of  deferred expenses                                                                   |   | —                               |   |   | 349                                      |   | 1,361                                |   |
| Loss (gain) on  sale of assets                                                                    |   | —                               |   |   | 9                                        |   | (962                                 | )      |
| Changes in  assets and liabilities:                                                               |   |                                 |   |   |                                     |   |                                 |   |
| Accounts  receivable                                                                              |   | (1,850                               | )      |   | (744                                     | )      | 342                                  |   |
| Other assets                                                                                      |   | 2,599                                |   |   | (5,279                                   | )      | (862                                 | )      |
| Deferred income  taxes                                                                            |   | (527                                 | )      |   | (1,546                                   | )      | (703                                 | )      |
| Accounts payable  and accrued expenses                                                            |   | (64                                  | )      |   | (2,122                                   | )      | 4,604                                |   |
| Net cash  provided (used) by operating activities                                                 |   | 12,250                               |   |   | (12,527                                  | )      | 27,655                               |   |
| Cash flows from  investing activities:                                                            |   |                                 |   |   |                                     |   |                                 |   |
| Investment in  hotel properties                                                                   |   | (266                                 | )      |   | (10,035                                  | )      | (6,887                               | )      |
| Restricted cash                                                                                   |   | (1,261                               | )      |   | (1,686                                   | )      | 1,258                                |   |
| Cash returned  (paid) for franchise fees                                                          |   | (106                                 | )      |   | 107                                      |   | (70                                  | )      |
| Proceeds from  sale of assets                                                                     |   | —                               |   |   | 6                                        |   | 1,111                                |   |
| Net cash used by  investing activities                                                            |   | (1,633                               | )      |   | (11,608                                  | )      | (4,588                               | )      |
| Cash flows from  financing activities:                                                            |   |                                 |   |   |                                     |   |                                 |   |
| Net proceeds  (payments) on line of credit                                                        |   |                                 |   |   | 28,550                                   |   | (71,938                              | )      |
| Proceeds from  issuance of (payments to retire) Senior Notes                                      |   | (42,188                              | )      |   | (3,780                                   | )      | 125,000                              |   |
| Payments on  mortgage notes payable                                                               |   | (625                                 | )      |   | (1,578                                   | )      | (60,019                              | )      |
| Redemption of  preferred units                                                                    |   | —                               |   |   | —                                   |   | (25,850                              | )      |
| Distributions to  unitholders                                                                     |   | —                               |   |   | (7,735                                   | )      | (23,571                              | )      |
| Issuance of  common and preferred units                                                           |   | —                               |   |   | 12,408                                   |   | 39,653                               |   |
| Contributions  from parent company                                                                |   | 77,950                               |   |   | —                                   |   | —                               |   |
| Distributions to  parent company                                                                  |   | (44,000                              | )      |   | —                                   |   | —                               |   |
| Loan fees paid                                                                                    |   | (99                                  | )      |   | (56                                      | )      | (4,179                               | )      |
| Net cash  provided (used) by financing activities                                                 |   | (8,962                               | )      |   | 27,809                                   |   | (20,904                              | )      |
|                                                                                              |   |                                 |   |   |                                     |   |                                 |   |
| Net increase in  cash and cash equivalents                                                        |   | 1,655                                |   |   | 3,674                                    |   | 2,163                                |   |
| Cash and cash  equivalents at beginning of period                                                 |   | 5,612                                |   |   | 1,938                                    |   | 5,735                                |   |
| Cash and cash  equivalents at end of period                                                       |   | $                                    | 7,267  |   |                                     | $      | 5,612                                |   | $ | 7,898 |   |

 

Supplemental disclosure of non-cash activities:

In 2003, the Partnership:

i.                                          ThePre-Merger Partnership allocated $3.6 million from Partners’ Capital toredeemable limited partnership units.

ii.                                       ThePre-Merger Partnership issued 37 thousand general partnership units with avalue of $0.4 million in exchange for 37 thousand redeemable limitedpartnership units.

iii.                                    ThePost-Merger Partnership, as part of the acquisition of the OperatingPartnership by CNL, issued 2.4 million general partnership units to CNL with avalue of $29.9 million in exchange for 2.2 million redeemable limitedpartnership units.

iv.                                   CNLcontributed to the Post-Merger Partnership net assets of approximately $131.6million.

 

In 2002, thePre-Merger Partnership:

i.                                          Allocated$1.0 million from redeemable limited partnership units to Partners’ Capital.

ii.                                       Recordedan expense of $1.9 million related to the issuance costs associated with theredemption of the Series B Preferred Units on June 30, 2002 that waspreviously included in Partners’ Capital.

 

The accompanying notesare an integral part of these consolidated financial statements.

 

6

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**RFS PARTNERSHIP, L.P.CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL****FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003(in thousands)**

 
|                                                                                   |   | **Pre-Merger  Partnership** |    |   | **Post-Merger  Partnership** |    |
|----------------------------------------------------------------------------------------|--------|-----------------------------|---------|--------|------------------------------|---------|
|                                                                                   |   |                        |    |   |                         |    |
| Balance,  December 31, 2002                                                       |   | $                           | 300,522 |   |                         |    |   |
| Issuance of  general partnership units                                                 |   | 12,818                      |    |   |                         |    |
| Contributions                                                                          |   | (9                          | )       |   |                         |    |
| Distributions to  general partnership units ($0.25 per unit)                           |   | (7,129                      | )       |   |                         |    |
| Distributions to  redeemable limited partnership units ($0.25 per unit)                |   | (606                        | )       |   |                         |    |
| Allocation to  redeemable limited partnership units                                    |   | (3,610                      | )       |   |                         |    |
| Contribution  from general partner related to amortization of stock-based compensation |   | 1,957                       |    |   |                         |    |
| Net loss                                                                               |   | (21,869                     | )       |   |                         |    |
| Balance,  July 10, 2003                                                           |   | $                           | 282,074 |   |                         |    |   |
| Contribution  from CNL to acquire the Operating Partnership                            |   |                        |    |   | $                            | 363,160 |   |
| Contributions  from parent company                                                     |   |                        |    |   | 209,593                      |    |
| Distributions to  parent company                                                       |   |                        |    |   | (44,000                      | )       |
| Net income                                                                             |   |                        |    |   | 4,579                        |    |
| Balance, September 30,  2003                                                      |   |                        |    |   | $                            | 533,332 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

7

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**RFSPARTNERSHIP, L.P.**

## **NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

## ** **

1.***Organization.***  RFS Partnership, L.P. (the “OperatingPartnership”) is a Tennessee limited partnership which, at September 30,2003, owned interests in 62 hotels with 9,399 rooms located in 26 states(collectively the “Hotels”). On July 10, 2003, RFS Hotel Investors, Inc. (“RFS”)and the Operating Partnership were acquired by subsidiaries of CNL HospitalityProperties, Inc. (“CNL”) for approximately $383 million in cash ($12.35 pershare or limited partnership unit), excluding the 1.0 million shares of RFSstock acquired by CNL prior to July 10, 2003. Upon consummation of this transaction, RFS was merged with and into asubsidiary of CNL and RFS ceased to exist as a separate corporate entity.  Further, upon consummation of thistransaction, a subsidiary of CNL was merged with and into the OperatingPartnership and the Operating Partnership continues to exist as a separateentity and as an indirect wholly owned subsidiary of CNL.  Prior to the closing of this transaction thecommon stock of RFS was publicly traded on the New York Stock Exchange underthe symbol “RFS.”  The common stock ofRFS has since been removed from listing on the New York Stock Exchange.  RFS filed a Form 15 on July 14, 2003,terminating its filing requirements with the Securities and Exchange Commission(“SEC”).  On August 14, 2003, theOperating Partnership filed with the SEC a Form 15, terminating the OperatingPartnership’s obligation to file reports with the SEC under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”).  Although the filingof the Form 15 terminates the Operating Partnership’s obligation to filereports under the Exchange Act, the Operating Partnership is filing thisQuarterly Report on Form 10Q, in accordance with its obligation to do so setforth in that certain indenture, by and among the Operating Partnership, RFS2002 Financing, Inc., CNL Rose Acquisition Corp., RFS Leasing VII, Inc. andU.S. Bank, N.A., dated as of February 26, 2002.

 

These unaudited consolidated financial statements havebeen prepared in accordance with generally accepted accounting principles forinterim financial statements pursuant to the rules and regulations of the SEC.Accordingly, they do not include all the information and footnotes required bygenerally accepted accounting principles for audited financial statements andshould be read in conjunction with the financial statements and notes theretoof the Operating Partnership included in the combined RFS and OperatingPartnership’s Annual Report on Form 10-K for the year ended December 31,2002. The following notes to the consolidated financial statements highlightsignificant changes to notes included in the Form 10-K and present interimdisclosures required by the SEC.

 

Theaccompanying consolidated financial statements reflect, in the opinion ofmanagement, all adjustments necessary for a fair presentation of the interimfinancial statements. All such adjustments are of a normal and recurringnature. In preparing financial statements that conform with generally acceptedaccounting principles, management must make estimates and assumptions thataffect the reported amounts of assets and liabilities, disclosure of contingentassets and liabilities at the date of the financial statements and amounts ofrevenues and expenses reflected during the reporting period. The results ofoperations for the three and nine months ended September 30, 2003 and 2002are not necessarily indicative of the results of operations to be expected forthe full year or future periods.

 

2. ***Basis of Presentation.**** *SAB Topic 5-J states that apurchase transaction that results in an entity becoming substantially whollyowned establishes a new basis of accounting, commonly referred to as “push downaccounting.”  Push down accounting isrequired when greater than 95% of the entity is acquired.  Accordingly, such new basis should berecorded in the financial statements of the acquired company, in this case theOperating Partnership. The application of push down accounting represents the terminationof the old accounting entity and the creation of a new one.  As such, it is not appropriate to combinepre- and post- push down periods in the financial statements because theOperating Partnership’s results of operations and cash flows after the mergerare not comparable with those prior to the merger.  Therefore, the Operating Partnership’s Consolidated Statements ofOperations and Cash Flows have been bifurcated to present the OperatingPartnership’s results prior to the merger, referred to as the Pre-MergerPartnership, and after the merger, referred to as the Post-Merger Partnership.

 

3. ***Acquisition of RFS and the OperatingPartnership.***  OnJuly 10, 2003, RFS and the Operating Partnership were acquired bysubsidiaries of CNL for approximately $383 million in cash ($12.35 per share orlimited partnership unit) (the “RFS-CNL Transaction”), excluding the 1.0million shares of RFS stock owned by CNL at the date of the RFS-CNLTransaction.  Upon consummation of thistransaction, RFS was merged with and into a subsidiary of CNL and RFS ceased toexist as a separate corporate entity. Further, upon consummation of this transaction, a subsidiary of CNL wasmerged with and into the Operating Partnership and the Operating Partnershipcontinues to exist as a separate entity and as an indirect wholly ownedsubsidiary of CNL.

 

The Pre-MergerPartnership incurred costs of approximately $20.6 million as a result of theRFS-CNL Transaction.  The primarycomponents of these costs are as follows: severance of $11.6 million,amortization of $1.5 million related to the

 

8

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acceleration of unvested restricted stock, advisory fees of $4.5million, additional management fees of $1.9 million and miscellaneous othercosts of $1.1 million.

 

The total consideration paid by CNL in connection withits acquisition of RFS is as follows (in thousands):

 
| Cash paid for 31,941,851  units at $12.35 per unit              |   | $      | 394,482 |   |
|-----------------------------------------------------------------|--------|--------|---------|--------|
| Less: cash  funded by borrowings from the Operating Partnership |   |   | (50,971 | )      |
| Plus:  Transaction costs paid by CNL                            |   | 19,649 |    |
| Total                                                           |   | $      | 363,160 |   |

 

As mentionedabove, push down accounting was applied to the Operating Partnership uponconsummation of the RFS-CNL Transaction and the assets and liabilities of theOperating Partnership were recorded at their fair values. In addition, costspaid by CNL to acquire RFS were pushed down to the Operating Partnership.  No goodwill was recognized upon consummationof the RFS-CNL Transaction.  The followingsets forth the fair value of the assets and liabilities of the OperatingPartnership, after push down accounting has been applied, as of theconsummation of the RFS-CNL Transaction:

 
|                                                            |   | **July 10,********2003** |    |
|-----------------------------------------------------------------|--------|-------------------------------|---------|
|                                                            |   |                          |    |
| **ASSETS**                                                      |   |                          |    |
| Investment in  hotel properties, net                            |   | $                             | 675,013 |   |
| Real estate held  for sale                                      |   | 36,796                        |    |
| Cash and cash  equivalents                                      |   | 5,612                         |    |
| Restricted cash                                                 |   | 9,069                         |    |
| Accounts  receivable                                            |   | 5,441                         |    |
| Deferred  expenses, net                                         |   | 5,847                         |    |
| Other assets                                                    |   | 8,292                         |    |
| Deferred income  taxes, net of $1.3 million valuation allowance |   | 26,048                        |    |
| Total assets                                                    |   | $                             | 772,118 |   |
|                                                            |   |                          |    |
| **LIABILITIES**                                                 |   |                          |    |
| Accounts payable  and accrued expenses                          |   | $                             | 23,206  |   |
| Bridge loan                                                     |   | 101,000                       |    |
| Mortgage notes  payable                                         |   | 160,731                       |    |
| Senior notes  payable                                           |   | 124,021                       |    |
| Total  liabilities                                              |   | $                             | 408,958 |   |

 

Thefollowing presents unaudited pro forma results of operations for the ninemonths ended September 30, 2003 and 2002, respectively, of the OperatingPartnership (excluding revenue of $2,752 and expenses of $1,052 for the fiveproperties contributed by CNL) as if the RFS-CNL Transaction had occurred as ofJanuary 1, 2003 and 2002, respectively (in thousands):

 
|                                                                  |   | **Nine Months Ended****September 30,** |    |
|-----------------------------------------------------------------------|--------|---------------------------------------------|---------|
|                                                                  |   | **2003**                                    |    | **2002** |   |
| Revenue                                                               |   | $                                           | 135,220 |   | $ | 142,121 |   |
| Expenses                                                              |   | 145,390                                     |    | 158,195 |   |
| Net loss                                                              |   | (10,170                                     | )       | (16,224 | ) |
| Basic and diluted loss per unit                                       |   | $                                           | (0.32   | ) | $ | (0.55 | ) |
| Weighted average number of units outstanding – basic and diluted |   | 31,942                                      |    | 29,562 |   |

 

4.**  *CapitalContributions.*** Concurrent with the RFS-CNL Transaction, CNL contributed five hotels tothe Operating Partnership with net assets of approximately $131.6 million asfollows:

 

| **ASSETS**                             |   |   |    |
|----------------------------------------|--------|--------|---------|
| Investment in  hotel properties, net   |   | $      | 131,414 |   |
| Restricted cash                        |   | 1,854  |    |
| Accounts  receivable                   |   | 320    |    |
| Other assets                           |   | 299    |    |
| Total assets                           |   | $      | 133,887 |   |
|                                   |   |   |    |
| **LIABILITIES**                        |   |   |    |
| Accounts payable  and accrued expenses |   | 2,241  |    |
| Total  liabilities                     |   | $      | 2,241   |   |

 

9

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The five hotels are a Residence Inn in Orlando, Florida, MarriottCourtyard in Edison, New Jersey, Hyatt Regency in Coral Gables, Florida,Wyndham in Billerica, Massachusetts and a Wyndham in Denver, Colorado.  The two Wyndham properties are triple netlease properties, while the other three properties are leased to taxable REITsubsidiaries owned by CNL but not owned by the Operating Partnership. Duringthe third quarter, the Operating Partnership recognized approximately $2.8million of revenue and $1.1 million of depreciation on these contributedproperties.  These five properties serveas collateral on the Bridge Loan.

 

On February 25, 2002, the Operating Partnership sold$125 million in Senior Notes (“Senior Notes”). On August 25, 2003, the Operating Partnership received a capitalcontribution of $190 thousand from CNL to help fund costs associated with therepurchase of the Senior Notes.  OnAugust 29, 2003, in accordance with the terms of the indenture governing theSenior Notes, the Operating Partnership repurchased from existing holdersapproximately $42 million of its Senior Notes. On September 29, 2003, CNL made a $77.8 million capitalcontribution to the Operating Partnership, the proceeds of which were combinedwith the Operating Partnership’s available cash to reduce the balanceoutstanding on the Bridge Loan (defined below) by $88.0 million.

 

*5. **Capital Distributions.******* OnAugust 25, 2003, the Post-Merger Operating Partnership borrowed $88million under the Bridge Loan (defined below), $44 million of which was used torepurchase a portion of the Senior Notes, and the remaining $44 million wasdistributed to the Operating Partnership’s parent company.

 

6.*** Investment inHotel Properties. ***Hotelproperties are recorded at cost and are depreciated using the straight-linemethod over estimated useful lives of 40 years for buildings andimprovements and five to seven years for furniture and equipment. Investment inhotel properties consists of the following at September 30, 2003 andDecember 31, 2002, respectively (in thousands):

 
|                              |   | **Post-Merger  Partnership** |    | **Pre-Merger  Partnership** |   |
|-----------------------------------|--------|------------------------------|---------|-----------------------------|--------|
|                              |   | **Sept.  30, 2003**          |    | **Dec.  31, 2002**          |   |
|                              |   |                         |    |                        |   |
| Land                              |   | $                            | 92,974  |                        | $      | 69,639 |   |
| Building and  improvements        |   | 648,146                      |    | 545,557                     |   |
| Furniture and  equipment          |   | 50,963                       |    | 124,496                     |   |
| Capital  improvements in progress |   | 14,850                       |    | 12,002                      |   |
|                              |   | 806,933                      |    | 751,694                     |   |
| Accumulated  depreciation         |   | (7,442                       | )       | (158,405                    | )      |
|                              |   | $                            | 799,491 |                        | $      | 593,289 |   |

 

7. ** *Debt –Pre-Merger Partnership*. **OnJuly 10, 2003, the outstanding balance under the Line of Credit of $35.5million was repaid and terminated in connection with the RFS-CNLTransaction.  At July 10, 2003, theOperating Partnership was in violation of certain financial covenants under theLine of Credit.  The covenant violationshave no impact on the Operating Partnership because the Line of Credit wasterminated in connection with the RFS-CNL Transaction. All debt issuance costspertaining to the Pre-Merger Partnership of approximately $7.1 million werewritten-off in purchase accounting.

 

8.  ***Debt – Post-Merger Partnership*. **In connection with the RFS-CNLTransaction, the Operating Partnership entered into a $320 million CreditAgreement with Bank of America dated July 10, 2003 (“Bridge Loan”).  The Bridge Loan terminates onJanuary 10, 2004.  The OperatingPartnership intends to refinance the Bridge Loan with the issuance of a CMBSfacility prior to January 10, 2004. The Operating Partnership may have to seek alternative financing, someof which could negatively impact net income, if the Operating Partnership wereunable to close on the CMBS facility prior to termination of the Bridge Loan.The Company incurred approximately $5.5 million in debt issuance costs relatedto the Bridge Loan and CMBS facility. These costs are included in DeferredExpenses on the accompanying Consolidated Balance Sheet.

 

At September 30, 2003, $101 million wasoutstanding on the $320 million Bridge Loan.

 

10

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Interest is incurred at an annual rate equal to the average BritishBankers Association Interest Settlement Rate for Deposits in Dollars with aterm equivalent to one month (the “Eurodollar Rate”) plus (i) 3% of the loanvalue up to approximately $279 million and (ii) 6% of the loan value in excessof $279 million.  The average interestrate on outstanding contracts under the Bridge Loan was approximately 4.1% atSeptember 30, 2003. Interest is paid monthly. The Bridge Loan iscollateralized by 39 hotels and restricts the transfer, pledge or otherhypothecation of the hotels (collectively, the “Collateral Properties”). Thenet book value of these properties at September 30, 2003 was approximately$130.4 million.  The Bridge Loancontains various covenants specific to the Operating Partnership, including themaintenance of a minimum loan to value ratio, minimum fixed charge coverageratio and restricted payment limitations. In addition, CNL as the OperatingPartnership’s parent company, is subject to various covenants under the BridgeLoan, including the maintenance of a minimum net worth, certain leveragelimitations and certain fixed charge limitations. The Operating Partnership andCNL were in compliance with these covenants at September 30, 2003.

 

During the third quarter of 2003, the OperatingPartnership borrowed approximately $44.0 million under the Bridge Loan torepurchase $41.8 million of Senior Notes (book value of $42.2 million), plusaccrued interest thereon, as a result of the repurchase of the Senior Notesmade by the Operating Partnership in July. No costs were expensed by the Operating Partnership to retire the $41.8million of Senior Notes as these were accrued as part of purchase accounting.

 

The OperatingPartnership’s other borrowings do not contain financial covenants. The OperatingPartnership’s other borrowings are nonrecourse to the Operating Partnership andcontain provisions allowing for the substitution of collateral, uponsatisfaction of certain conditions. Most of the mortgage borrowings areprepayable and subject to various prepayment penalties, yield maintenance, ordefeasance obligations. At September 30, 2003, approximately 70% of theOperating Partnership’s debt was fixed at a weighted average interest rate of8.5%.

 

9.**  *RevenueRecognition*. **Inaccordance with Staff Accounting Bulletin (SAB) 101, lease revenue isrecognized as income after certain specific annual thresholds have beenachieved by the lessee in accordance with provisions of the percentage leaseagreements. SAB 101 applied to the Operating Partnership results in deferringthe recognition of revenue from the Operating Partnership’s percentage leasesfor the first and second quarters to the third and fourth quarters. AtSeptember 30, 2003, deferred revenue of $1.0 million is included inaccounts payable and accrued expenses. The lessees are in compliance with theirrental obligations under the Percentage Leases. The Pre-Merger Partnership hadfive hotels that were leased to third-party lessees.  The Post-Merger Partnership has seven hotels that are leased tothird-party lessees outside of the RFS portfolio and within the CNL portfolioof properties.

 

10.**  *Basic andDiluted Earnings Per Unit.***Basic earnings (loss) per unitfrom continuing operations is computed by dividing income (loss) fromcontinuing operations, less the loss on sale of Series B Preferred Units, lesspreferred unit dividends, plus (minus) the gain (loss) on sale of assets by theweighted average number of units outstanding during the period. Dilutedearnings (loss) per unit from continuing operations is computed by dividingincome (loss) from continuing operations, less the loss on sale of Series BPreferred Units, less preferred unit dividends, plus (minus) the gain (loss) onsale of assets by the weighted average number of units and equivalentsoutstanding.

 

Basic earnings (loss) per unit is computed by dividingnet income (loss) applicable to common unitholders by the weighted averagenumber of units outstanding during the period. Diluted earnings (loss) per unitis computed by dividing net income (loss) applicable to unitholders by theweighted average number of units outstanding. Unit equivalents represent unitsissuable upon exercise of options pertaining to the Pre-Merger Partnership.

 

Therewere no unit equivalents pursuant upon the exercise of options for thePre-Merger Partnership for the period January 1, 2003 to July 10,2003 and for the period July 1, 2003 to July 10, 2003.  For the three months endedSeptember 30, 2002, there were 46 thousand unit equivalents pursuant tothe exercise of options. For the nine months ended September 30, 2002,there were 113 thousand unit equivalents pursuant to the exercise of optionsthat would be antidilutive, and accordingly, for those periods, are not assumedto be converted in the computation of diluted earnings per unit. In addition,for the nine months ended September 30, 2002, the Series B PreferredUnits are non-convertible and accordingly, are not included in the computationof diluted earnings per unit.

 

11. ***Income Taxes – Pre-Merger Partnership*.**  There were no changes in income taxes forthe period July 1, 2003 to July 10, 2003, the date of acquisition.

 

12.**  *IncomeTaxes – Post-Merger Partnership*.**  Income taxes are accounted for in accordancewith the provisions of Statement of Financial Accounting Standards (“SFAS”)No. 109, “*Accounting for Income Taxes.*”Under SFAS No. 109, income taxes are recognized using the asset andliability method under which deferred tax assets and liabilities are recognizedfor the future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.

 

11

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Upon the consummation of the RFS-CNL Transaction, thewholly-owned taxable REIT subsidiaries of the Company (“TRS Lessees”) aresubject to Section 382 of the Internal Revenue Code, which limits theamount of taxable income after the change of ownership that may be offset bynet operating loss carryforwards and certain built-in losses attributable toperiods prior to the ownership change. The Hilton lease termination amortization results in a built-in losslimitation under Section 382.  Afterconsidering the effects of Section 382, a valuation allowance of $1.3million was recorded as a purchase accounting adjustment by the TRS Lessees toreduce the deferred tax asset for such limitation.

 

The components of income tax benefit for the quarterthree and nine months ended September 30, 2003 are as follows:

 
|                       |   | **Three  Months Ended**                       |   | **Nine  Months Ended** |                                       |
|----------------------------|--------|-----------------------------------------------|--------|------------------------|--------------------------------------------|
|                       |   | **Pre-Merger  Partnership**                   |   |                   | **Post-Merger  Partnership**               |   | **Pre-Merger  Partnership** |   |   | **Post-Merger  Partnership** |   |
|                       |   | **July 1  to********July 10, 2003** |   |                   | **July 11  to********Sept. 30, 2003** |   | **January 1  to********July 10, 2003** |   |   | **July 11  to********Sept. 30, 2003** |   |
|                       |   |                                          |   |                   |                                       |   |   |   |   |   |   |
| Deferred:                  |   |                                          |   |                   |                                       |   |   |   |   |   |   |
| Federal                    |   | $                                             | — |                   |                                       | $ | (528 | ) | $ | (1,546 | ) |   | $ | (528 | ) |
| Benefit from  income taxes |   | $                                             | — |                   |                                       | $ | (528 | ) | $ | (1,546 | ) |   | $ | (528 | ) |

 

The deferred benefit from income taxes and relateddeferred tax asset was calculated using an effective tax rate of 38% applied tothe income or loss of the TRS Lessees, wholly owned subsidiary companies whichlease 52 of the 62 hotels owned by the Operating Partnership, adjusted fortemporary differences related mainly to the Hilton lease terminationtransaction and operating losses.

 

The deferred tax asset is provided for the temporarydifferences between the financial reporting basis and the tax basis of theOperating Partnership’s assets and liabilities, resulting primarily from theHilton lease termination, and for operating loss carryforwards.  The Operating Partnership believes that theTRS Lessees will generate sufficient future taxable income to realize the netdeferred tax asset at September 30, 2003, net of a valuation allowance of$1.3 million.

 

13.  ***Comprehensive Income.***  SFAS No. 130, “Reporting ComprehensiveIncome,” requires the disclosure of the components included in comprehensiveincome (loss). SFAS No. 130, “Reporting Comprehensive Income,” requiresthe disclosure of the components included in comprehensive income (loss). Forthe three months ended September 30, 2003 and 2002, there were no items ofother comprehensive income.  Thecomponents of comprehensive income for the nine months ended September 30,2003 and 2002 are as follows:

 

|                                                         |   | **Nine  Months Ended**                |   |
|--------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                         |   | **Post-Merger  Partnership**          |   |   | **Pre-Merger  Partnership** |   | **Pre-Merger  Partnership** |   |
|                                                         |   | **July 11  to  Sept. 30,  2003** |   |   | **Jan. 1  to  July 10,  2003** |   | **Jan. 1  to  Sept. 30,  2002** |   |
| ***RFS Partnership, L.P.***                                  |   |                                  |   |   |   |   |   |   |
| Net income  (loss)                                           |   | $                                     | 4,579  |   |   | $ | (21,869 | ) | $ | (4,258 | ) |
| Reclassification  adjustment for losses included in earnings |   | —                                |   |   | — |   | 3,220 |   |
| Comprehensive  income (loss)                                 |   | $                                     | 4,579  |   |   | $ | (21,869 | ) | $ | (1,038 | ) |

 

14.**  *SegmentInformation.***  SFASNo. 131, “Disclosures about Segments of an Enterprise and RelatedInformation,” requires the disclosure of selected information about operatingsegments. Based on the guidance provided in the standard, the OperatingPartnership has determined that its business is conducted in one operatingsegment.

 

15.  ***Joint Venture. ***TheOperating Partnership, through one of its wholly-owned indirect subsidiaries,participates in a joint venture partnership, named Wharf Associates, which ownsthe San Francisco Hilton Fisherman’s Wharf. The Operating Partnership owns 75%of Wharf Associates, and an independent third party, Wharf Enterprises, Inc.(“WEI”), owns the remaining 25%. At September 30, 2003 andDecember 31, 2002, respectively, the liability for WEI’s minority interestwas valued at $0 and $2,042, respectively, and is recorded in Accounts Payable andAccrued Expenses on the accompanying Consolidated Balance Sheet.

 

12

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16.  ***Discontinued Operations.**** *The Operating Partnership accounts for certainrevenues and expenses as originating from discontinued operations pursuant to FASBStatement No.144, “Accounting for theImpairment or Disposal of Long-Lived Assets” (“FAS  144”).  FAS 144 requires that sales of real estate,or the identification of a real estate asset as held for sale, be treated asdiscontinued operations.  Any gain orloss from such disposition, and any income or expenses associated with realestate assets held for sale, are included in the income statement asdiscontinued operations.  Inconnection with the acquisition of RFS, the Operating Partnership decided tosell six non-strategic hotels, and therefore, these hotels were classified asreal estate held for sale.  InNovember 2002, the Operating Partnership sold its Comfort Inn in FortMill, South Carolina for $3.25 million in cash, resulting in a loss onsale of approximately $3.8 million. The financial results for the hotelsheld for sale, as well as the sold hotel, are reflected as DiscontinuedOperations in the accompanying consolidated financial statements. The resultsof operations for these hotels have been reclassified as Income fromDiscontinued Operations on the Consolidated Statements of Operations for thethree and nine months ended September 30, 2003 and 2002.  The components of income from discontinuedoperations for the three and nine months ended September 30, 2003 and2002, respectively, are shown below:

 
|                                 |   | **Three  Months Ended**               |   | **Nine  Months Ended** |                                    |
|--------------------------------------|--------|---------------------------------------|--------|------------------------|-----------------------------------------|
|                                 |   | **Post-  Merger  Partnership**        |   |                   | **Pre-Merger  Partnership**             |   | **Pre-Merger  Partnership** |   | **Post-  Merger  Partnership** |   |   | **Pre-Merger  Partnership** |   | **Pre-Merger  Partnership** |   |
|                                 |   | **July 11  to  Sept. 30,  2003** |   |                   | **July 1  to  July 10, 2003** |   | **July 1  to  Sept. 30,  2002** |   | **July 11  to  Sept. 30,  2003** |   |   | **Jan. 1  to  July 10,  2003** |   | **Jan. 1  to  Sept. 30,  2002** |   |
|                                 |   |                                  |   |                   |                                    |   |   |   |   |   |   |   |   |   |   |
| Hotel revenue                        |   | $                                     | 3,001  |                   |                                    | $ | 375 |   | $ | 4,188 |   | $ | 3,001 |   |   | $ | 6,197 |   | $ | 11,758 |   |
| Hotel operating  costs               |   | (2,179                                | )      |                   | (272                                    | ) | (2,739 | ) | (2,179 | ) |   | (4,552 | ) | (7,862 | ) |
| Depreciation                         |   | —                                |   |                   | —                                  |   | (592 | ) | — |   |   | (1,038 | ) | (1,768 | ) |
| Income from  discontinued operations |   | $                                     | 822    |                   |                                    | $ | 103 |   | $ | 857 |   | $ | 822 |   |   | $ | 607 |   | $ | 2,128 |   |

 

17.** *StockBased Compensation – Pre-Merger Partnership.***  The FASB issued SFAS No. 148“Accounting for Stock–Based Compensation—Transition and Disclosure.” SFASNo. 148 amends SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation. The Operating Partnership applied the fair value based method ofaccounting for stock-based employee compensation prospectively to all awardsgranted, modified, or settled beginning January 1, 2003.  As a result of the RFS-CNL Transaction, theOperating Partnership no longer has any stock-based employee compensation.  Had compensation cost for the OperatingPartnership’s stock-based compensation plans been determined consistent withSFAS 123, the Operating Partnership’s net income (loss) and net income(loss) per unit would have been reduced to the pro forma amounts as indicatedbelow:

 
|                                          |   | **Three  Months Ended**              |   | **Nine  Months Ended** |                           |
|-----------------------------------------------|--------|--------------------------------------|--------|------------------------|--------------------------------|
|                                          |   | **Post-Merger  Partnership**         |   |                   | **Pre-Merger  Partnership**    |   | **Pre-Merger  Partnership** |   | **Post-Merger  Partnership** |   |   | **Pre-Merger  Partnership** |   | **Pre-Merger  Partnership** |   |
|                                          |   | **July 11  to  Sept. 30, 2003** |   |                   | **July. 1  to July  10, 2003** |   | **July 1  to  Sept. 30,  2002** |   | **July 11  to  Sept. 30, 2003** |   |   | **Jan. 1  to  July 10,  2003** |   | **Jan. 1  to  Sept. 30,  2002** |   |
| Net income  (loss) applicable to unitholders: |   |                                 |   |                   |                           |   |   |   |   |   |   |   |   |   |   |
| As reported                                   |   | $                                    | 4,579  |                   |                           | $ | (19,691 | ) | $ | 3,650 |   | $ | 4,579 |   |   | $ | (21,869 | ) | $ | (4,258 | ) |
| Pro forma                                     |   | $                                    | 4,579  |                   |                           | $ | (19,702 | ) | $ | 3,531 |   | $ | 4,579 |   |   | $ | (22,080 | ) | $ | (4,614 | ) |
| Basic and  diluted earnings (loss) per unit:  |   |                                 |   |                   |                           |   |   |   |   |   |   |   |   |   |   |
| As reported                                   |   | $                                    | 0.14   |                   |                           | $ | (0.62 | ) | $ | 0.12 |   | $ | 0.14 |   |   | $ | (0.70 | ) | $ | (0.14 | ) |
| Pro forma                                     |   | $                                    | 0.14   |                   |                           | $ | (0.62 | ) | $ | 0.11 |   | $ | 0.14 |   |   | $ | (0.71 | ) | $ | (0.16 | ) |

 

18.***  Commitments and Contingencies******–***On May 13, 2003, A. BruceChasen, as class representative, filed a putative class action lawsuit in theCircuit Court of Shelby County, Tennessee, 30th Judicial Districtagainst RFS, RFS’s directors and CNL.    On June 6, 2003, the complaint was amended.  The amended putative class action complaintalleges, among other things, that (i) the merger consideration to be receivedby RFS’s shareholders is significantly less than the intrinsic value of RFS,(ii) the RFS directors breached their fiduciary duties due to shareholders on avariety of grounds including failing to ascertain the true value of RFS,failing to determine whether there were any other bidders for RFS, and failingto avoid certain alleged conflicts of interest shared by members of the RFSboard of directors and its financial advisor, (iii) CNL aided and abetted theRFS board of directors in connection with their breach of fiduciary duties,(iv) the RFS board of directors violated

 

13

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portions of the Tennessee Investor Protection Act, and (v) the RFSproxy statement is false and misleading. Among other relief, the amended complaint seeks certification of theclass action, an injunction enjoining RFS and CNL from completing the merger,monetary damages in an unspecified amount, the payment of attorney’s fees, andrescissory damages.  On June 23 andon July 1, 2003, respectively, RFS and CNL filed an answer to the amendedcomplaint setting forth an affirmative defense and its general denials of theallegations set forth therein.  Theplaintiff’s motion for a temporary restraining order for purposes of enjoiningthe transaction, which was argued by the plaintiff on July 8, 2003, wasdenied by the Circuit Court of Shelby County, Tennessee, 30th JudicialDistrict on said date.  Since thatruling, the Plaintiff has not aggressively prosecuted its claims.  Based upon the information currentlyavailable to the Operating Partnership and CNL, the Operating Partnershipbelieves the allegations contained in the amended complaint are without meritand it is the Operating Partnership’s understanding that CNL intends tovigorously defend the action.

 

On August 26, 2002, Carmel Valley, LLC filed a lawsuitagainst RFS and certain of its subsidiaries in the Superior Court of the Stateof California, for the County of San Diego. In connection with the RFS transaction, the Company has become a partyto a lawsuit claiming damages relating to a dispute over a parcel of land locatedadjacent to one of its Properties.  TheCompany has unsuccessfully attempted to mediate this case.  At this time, management believes that thedamages claimed against the Company lack sufficient factual support and willcontinue to vigorously defend the action. However, it is possible that lossescould be incurred by the Company if the plaintiff ultimately prevails.

 

From time to time the Company may be exposed tolitigation arising from the operations of its business.  At this time, management does not believethat resolution of these matters will have a material adverse effect of theCompany’s financial condition or results of operation.

 

In November 2003, the Company expects to obtain newpermanent financing totaling $175 million (consisting of two loans; one eachfor $130 million and $45 million), of which $101 million will be used to repaythe Bridge Loan.  The loans are expectedto bear interest at a blended rate of LIBOR plus 260 basis points peryear  (3.72 percent as of September 30, 2003).  The Company is planning to pool 26 Propertiesas collateral for this loan.

 

19.***  Consolidating FinancialInformation of RFS Partnership, L.P. – Combined Pre-Merger and Post-MergerPartnership.***  RFS LeasingII, Inc., RFS Leasing VII, Inc., RFS Financing Partnership, L.P., RFSFinancing Corporation and RFS Financing 2002, LLC, wholly-owned subsidiaries ofthe Operating Partnership (“Guarantor Subsidiaries”), have guaranteed on a fulland unconditional basis, the payment of amounts due under the OperatingPartnership’s Senior Notes. RFS Leasing II and RFS Leasing VII had nosubstantial operations prior to January 1, 2002. RFS Leasing II leases 15hotels directly from RFS Financing Partnership, L.P., which owns the fifteenhotels. RFS Leasing VII leases 21 hotels from the Operating Partnership. As ofand for the three and nine months ended September 30, 2003 and 2002, RFSLeasing II and RFS Leasing VII did not have a material amount of assets, andincurred both operating and net losses. RFS Financing 2002 was formed tofacilitate the issuance of the Senior Notes. RFS Financing Corporation wasformed to facilitate the issuance of the 1996 commercial mortgage bonds, whichwere redeemed with a portion of the proceeds from the sale of the Senior Notes.RFS Financing Corporation and RFS Financing 2002 have no operations or assetsand no sources of revenue or cash flow. Consequently, in the event that itbecomes necessary for RFS Leasing II, RFS Leasing VII, RFS Financing 2002 orRFS Financing Corporation to provide credit support for the Senior Notes, RFSLeasing II, RFS Leasing VII, RFS Financing 2002 and RFS Financing Corporationlikely will not have sufficient cash flow to make any required payments underthe Senior Notes.

 

The following tables present consolidating informationfor the Operating Partnership, the Guarantor Subsidiaries and the non-guarantorsubsidiaries.  For the three and ninemonths ended September 30, 2003, the tables represent combined results ofoperations of the Pre-Merger and Post-Merger Partnerships as the OperatingPartnership believes this information is more meaningful.

 

**ConsolidatingBalance SheetSeptember 30, 2003(in thousands)**

 
|                                          |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |     | **Total  Consolidated** |   |
|-----------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|----------|-------------------------|--------|
| **ASSETS**                                    |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Investment in  hotel properties, net          |   | $                           | 411,071 |                        | $      | 141,158                         |   | $                | 247,262  |                    |   |   | $ | 799,491 |   |
| Real estate held  for sale                    |   | 13,823                      |    | 22,973                      |   |                            |   |             |     | 36,796                  |   |
| Investment in  consolidated entities          |   | 280,512                     |    |                        |   | 15,591                          |   | $                | (296,103 | )                       | — |   |
| Cash and cash  equivalents                    |   | 4,045                       |    | 1,501                       |   | 1,721                           |   |             |     | 7,267                   |   |
| Restricted cash                               |   | 4,844                       |    |                        |   | 5,486                           |   |             |     | 10,330                  |   |
| Accounts  receivable                          |   | 624                         |    | 12,770                      |   | 5,209                           |   | (11,311          | )        | 7,292                   |   |
| Deferred  expenses, net                       |   | 5,951                       |    | 18                          |   |                            |   |             |     | 5,969                   |   |
| Other assets                                  |   | 3,439                       |    | 1,355                       |   | 899                             |   |             |     | 5,693                   |   |
| Deferred income  taxes                        |   |                        |    | 16,433                      |   | 10,142                          |   |             |     | 26,575                  |   |
| Total assets                                  |   | $                           | 724,309 |                        | $      | 196,208                         |   | $                | 286,310  |                    | $      | (307,414 | ) | $ | 899,413 |   |
|                                          |   |                        |    |                        |   |                            |   |             |     |                    |   |
| **LIABILITIES  AND PARTNERS’ CAPITAL**   |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Accounts payable  and accrued expenses        |   | $                           | 8,224   |                        | $      | 14,915                          |   | $                | 11,314   |                    | $      | (11,311 | ) | $ | 23,142 |   |
| Bridge Loan                                   |   | 101,000                     |    |                        |   |                            |   |             |     | 101,000                 |   |
| Mortgage notes  payable                       |   |                        |    |                        |   | 160,186                         |   |             |     | 160,186                 |   |
| Senior Notes  Payable                         |   | 81,753                      |    |                        |   |                            |   |             |     | 81,753                  |   |
| Total  liabilities                            |   | 190,977                     |    | 14,915                      |   | 171,500                         |   | (11,311          | )        | 366,081                 |   |
| General  partnership units                    |   | 533,332                     |    | 181,293                     |   | 114,810                         |   | (296,103         | )        | 533,332                 |   |
| Total partners’  capital                 |   | 533,322                     |    | 181,293                     |   | 114,810                         |   | (296,103         | )        | 533,332                 |   |
| Total  liabilities and partners’ capital |   | $                           | 724,309 |                        | $      | 196,208                         |   | $                | 286,310  |                    | $      | (307,414 | ) | $ | 899,413 |   |

 

14

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**ConsolidatingBalance SheetDecember 31, 2002(in thousands)**

 
|                                          |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |     | **Total  Consolidated** |   |
|-----------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|----------|-------------------------|--------|
|                                          |   |                        |    |                        |   |                            |   |             |     |                    |   |
| **ASSETS**                                    |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Investment in  hotel properties, net          |   | $                           | 212,823 |                        | $      | 133,507                         |   | $                | 246,959  |                    |   |   | $ | 593,289 |   |
| Investment in  consolidated entities          |   | 253,921                     |    |                        |   | 18,962                          |   | $                | (272,883 | )                       | — |   |
| Cash and cash  equivalents                    |   | 446                         |    | 825                         |   | 667                             |   |             |     | 1,938                   |   |
| Restricted cash                               |   |                        |    |                        |   | 4,383                           |   |             |     | 4,383                   |   |
| Accounts  receivable                          |   | 2,596                       |    | 12,439                      |   | 10,901                          |   | (21,238          | )        | 4,698                   |   |
| Deferred  expenses, net                       |   | 6,578                       |    | 176                         |   | 2,051                           |   |             |     | 8,805                   |   |
| Other assets                                  |   | 1,478                       |    | 620                         |   | 1,614                           |   |             |     | 3,712                   |   |
| Deferred income  taxes                        |   |                        |    | 14,384                      |   | 11,446                          |   |             |     | 25,830                  |   |
| Total assets                                  |   | $                           | 477,842 |                        | $      | 161,951                         |   | $                | 296,983  |                    | $      | (294,121 | ) | $ | 642,655 |   |
|                                          |   |                        |    |                        |   |                            |   |             |     |                    |   |
| **LIABILITIES  AND PARTNERS’ CAPITAL**   |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Accounts payable  and accrued expenses        |   | $                           | 18,668  |                        | $      | 9,432                           |   | $                | 17,340   |                    | $      | (21,238 | ) | $ | 24,202 |   |
| Borrowings on  Line of Credit                 |   | 6,950                       |    |                        |   |                            |   |             |     | 6,950                   |   |
| Mortgage notes  payable                       |   |                        |    |                        |   | 159,279                         |   |             |     | 159,279                 |   |
| Senior Notes  Payable                         |   | 125,000                     |    |                        |   |                            |   |             |     | 125,000                 |   |
| Total  liabilities                            |   | 150,618                     |    | 9,432                       |   | 176,619                         |   | (21,238          | )        | 315,431                 |   |
| Redeemable units  at redemption value         |   | 26,702                      |    |                        |   |                            |   |             |     | 26,702                  |   |
| General  partnership units                    |   | 300,522                     |    | 152,519                     |   | 120,364                         |   | (272,883         | )        | 300,522                 |   |
| Total partners’  capital                 |   | 300,522                     |    | 152,519                     |   | 120,364                         |   | (272,883         | )        | 300,522                 |   |
| Total  liabilities and partners’ capital |   | $                           | 477,842 |                        | $      | 161,951                         |   | $                | 296,983  |                    | $      | (294,121 | ) | $ | 642,655 |   |

 

15

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## **Combined Pre-Merger and Post-Merger Partnership Statement of OperationsFor the Three Months Ended September 30, 2003(in thousands)**

 
|                                                          |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |   | **Total  Consolidated** |   |
|---------------------------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|--------|-------------------------|--------|
| Revenue:                                                      |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |    | $                           | 25,437 |                            | $      | 15,187           |   |                    |   | $ | 40,624 |   |
| Food and  beverage                                            |   |                        |    | 2,927                       |   | 1,205                           |   |             |   | 4,132                   |   |
| Other operating  departments                                  |   |                        |    | 784                         |   | 701                             |   |             |   | 1,485                   |   |
| Lease revenue                                                 |   | $                           | 9,081   |                        | 5,210  |                            | 636    |             | $      | (11,291                 | )      | 3,636 |   |
| Deferred revenue                                              |   | 205                         |    |                        |   | 218                             |   |             |   | 423                     |   |
| Other                                                         |   | 40                          |    | 2                           |   | 20                              |   | 354              |   | 416                     |   |
| Total hotel  revenue                                          |   | 9,326                       |    | 34,360                      |   | 17,967                          |   | (10,937          | )      | 50,716                  |   |
| Hotel operating  expenses:                                    |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |    | 5,303                       |   | 2,941                           |   |             |   | 8,244                   |   |
| Food and  beverage                                            |   |                        |    | 2,274                       |   | 790                             |   |             |   | 3,064                   |   |
| Other operating  departments                                  |   |                        |    | 271                         |   | 116                             |   |             |   | 387                     |   |
| Undistributed  operating expenses:                            |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Property  operating costs                                     |   |                        |    | 4,080                       |   | 1,937                           |   |             |   | 6,017                   |   |
| Property taxes,  insurance and other                          |   | 1,035                       |    | 769                         |   | 1,522                           |   |             |   | 3,326                   |   |
| Franchise costs                                               |   | (51                         | )       | 2,295                       |   | 1,653                           |   |             |   | 3,897                   |   |
| Maintenance and  repair                                       |   |                        |    | 1,505                       |   | 825                             |   |             |   | 2,330                   |   |
| Management fees                                               |   |                        |    | 2,636                       |   | 451                             |   |             |   | 3,087                   |   |
| Percentage lease  expense                                     |   |                        |    | 11,291                      |   |                            |   | (11,291          | )      |                    |   |
| Depreciation                                                  |   | 3,361                       |    | 1,723                       |   | 3,163                           |   |             |   | 8,247                   |   |
| Amortization of  franchise fees and unearned compensation     |   | 1,456                       |    | 4                           |   | 4                               |   |             |   | 1,464                   |   |
| General and  administrative                                   |   | 17,485                      |    | 1,724                       |   | 1,021                           |   |             |   | 20,230                  |   |
| Total operating  expenses                                     |   | 23,286                      |    | 33,875                      |   | 14,423                          |   | (11,291          | )      | 60,293                  |   |
| Operating income                                              |   | (13,960                     | )       | 485                         |   | 3,544                           |   | 354              |   | (9,577                  | )      |
| Amortization of  loan origination costs                       |   | 1                           |    |                        |   | 72                              |   |             |   | 73                      |   |
| Interest expense                                              |   | 3,723                       |    | (354                        | )      | 3,192                           |   | 354              |   | 6,915                   |   |
| Equity in  (earnings) loss of consolidated subsidiaries       |   | (2,572                      | )       |                        |   | 1,281                           |   | 1,291            |   |                    |   |
| Income (loss)  from continuing operations before income taxes |   | (15,112                     | )       | 839                         |   | (1,001                          | )      | (1,291           | )      | (16,565                 | )      |
| Benefit from  income taxes                                    |   |                        |    | (779                        | )      | 251                             |   |             |   | (528                    | )      |
| Income (loss)  from continuing operations                     |   | (15,112                     | )       | 1,618                       |   | (1,252                          | )      | (1,291           | )      | (16,037                 | )      |
| Income from discontinued  operations                          |   |                        |    | 925                         |   |                            |   |             |   | 925                     |   |
| Net income  (loss)                                            |   | (15,112                     | )       | 2,543                       |   | (1,252                          | )      | (1,291           | )      | (15,112                 | )      |
| Preferred unit  dividends                                     |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Net income  (loss) applicable to unitholders                  |   | $                           | (15,112 | )                           | $      | 2,543                           |   | $                | (1,252 | )                       | $      | (1,291 | ) | $ | (15,112 | ) |

 

16

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**ConsolidatingStatement of OperationsFor the Three Months Ended September 30, 2002(in thousands)**

** **
|                                                          |   | **RFS  Partnership,  L.P.** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |   | **Total  Consolidated** |   |
|---------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|-------------------------|--------|
| Revenue:                                                      |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | $                           | 25,958 |                            | $      | 15,492           |   |                    |   | $ | 41,450 |   |
| Food and  beverage                                            |   |                        |   | 2,922                       |   | 1,162                           |   |             |   | 4,084                   |   |
| Other operating  departments                                  |   |                        |   | 831                         |   | 746                             |   |             |   | 1,577                   |   |
| Lease revenue                                                 |   | $                           | 6,798  |                        | 5,783  |                            | 528    |             | $      | (11,978                 | )      | 1,131 |   |
| Deferred revenue                                              |   | 329                         |   |                        |   | 143                             |   |             |   | 472                     |   |
| Other                                                         |   | 190                         |   | 4                           |   | 42                              |   | (163             | )      | 73                      |   |
| Total hotel  revenue                                          |   | 7,317                       |   | 35,498                      |   | 18,113                          |   | (12,141          | )      | 48,787                  |   |
|                                                          |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Hotel operating  expenses:                                    |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | 5,321                       |   | 2,829                           |   |             |   | 8,150                   |   |
| Food and  beverage                                            |   |                        |   | 2,325                       |   | 782                             |   |             |   | 3,107                   |   |
| Other operating  departments                                  |   |                        |   | 310                         |   | 169                             |   |             |   | 479                     |   |
| Undistributed  operating expenses:                            |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Property  operating costs                                     |   |                        |   | 3,657                       |   | 1,864                           |   |             |   | 5,521                   |   |
| Property taxes,  insurance and other                          |   | 800                         |   | 712                         |   | 1,329                           |   |             |   | 2,841                   |   |
| Franchise costs                                               |   | (51                         | )      | 2,375                       |   | 1,666                           |   |             |   | 3,990                   |   |
| Maintenance and  repair                                       |   |                        |   | 1,455                       |   | 799                             |   |             |   | 2,254                   |   |
| Management fees                                               |   |                        |   | 727                         |   | 431                             |   |             |   | 1,158                   |   |
| Percentage lease  expense                                     |   |                        |   | 11,978                      |   |                            |   | (11,978          | )      |                    |   |
| Depreciation                                                  |   | 2,572                       |   | 1,243                       |   | 3,187                           |   |             |   | 7,002                   |   |
| Amortization of  franchise fees and unearned compensation     |   | 296                         |   | 10                          |   | 6                               |   |             |   | 312                     |   |
| General and  administrative                                   |   | 61                          |   | 2,491                       |   | 2,054                           |   |             |   | 4,606                   |   |
| Total operating  expenses                                     |   | 3,678                       |   | 32,604                      |   | 15,116                          |   | (11,978          | )      | 39,420                  |   |
| Operating income                                              |   | 3,639                       |   | 2,894                       |   | 2,997                           |   | (163             | )      | 9,367                   |   |
| Amortization of  loan origination costs                       |   | 352                         |   | 1                           |   | 74                              |   |             |   | 427                     |   |
| Interest expense                                              |   | 3,224                       |   | 163                         |   | 3,246                           |   | (163             | )      | 6,470                   |   |
| Equity in  (earnings) loss of consolidated subsidiaries       |   | (3,587                      | )      |                        |   | 562                             |   | 3,025            |   |                    |   |
| Income (loss)  from continuing operations before income taxes |   | 3,650                       |   | 2,730                       |   | (885                            | )      | (3,025           | )      | 2,470                   |   |
| Benefit from  income taxes                                    |   |                        |   | (226                        | )      | (97                             | )      |             |   | (323                    | )      |
| Income (loss)  from continuing operations                     |   | 3,650                       |   | 2,956                       |   | (788                            | )      | (3,025           | )      | 2,793                   |   |
| Earnings from  discontinued operations                        |   |                        |   | 857                         |   |                            |   |             |   | 857                     |   |
| Net income  (loss)                                            |   | 3,650                       |   | 3,813                       |   | (788                            | )      | (3,025           | )      | 3,650                   |   |
| Preferred unit  dividends                                     |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Net income  (loss) applicable to unitholders                  |   | $                           | 3,650  |                        | $      | 3,813                           |   | $                | (788   | )                       | $      | (3,025 | ) | $ | 3,650 |   |

 

17

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## **Combined Pre-Merger and Post-Merger Partnership Statement of OperationsFor the Nine Months Ended September 30, 2003(in thousands)**

 
|                                                          |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |   | **Total  Consolidated** |   |
|---------------------------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|--------|-------------------------|--------|
| Revenue:                                                      |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |    | $                           | 72,437 |                            | $      | 42,529           |   |                    |   | $ | 114,966 |   |
| Food and  beverage                                            |   |                        |    | 8,941                       |   | 3,826                           |   |             |   | 12,767                  |   |
| Other operating  departments                                  |   |                        |    | 2,191                       |   | 1,984                           |   |             |   | 4,175                   |   |
| Lease revenue                                                 |   | $                           | 22,259  |                        | 14,409 |                            | 2,055  |             | $      | (32,245                 | )      | 6,478 |   |
| Deferred revenue                                              |   | (408                        | )       |                        |   | (630                            | )      |             |   | (1,038                  | )      |
| Other                                                         |   | 502                         |    | 24                          |   | 98                              |   |             |   | 624                     |   |
| Total hotel  revenue                                          |   | 22,353                      |    | 98,002                      |   | 49,862                          |   | (32,245          | )      | 137,972                 |   |
|                                                          |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Hotel operating  expenses:                                    |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |    | 15,234                      |   | 8,561                           |   |             |   | 23,795                  |   |
| Food and  beverage                                            |   |                        |    | 6,899                       |   | 2,412                           |   |             |   | 9,311                   |   |
| Other operating  departments                                  |   |                        |    | 804                         |   | 340                             |   |             |   | 1,144                   |   |
| Undistributed  operating expenses:                            |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Property  operating costs                                     |   |                        |    | 11,222                      |   | 5,389                           |   |             |   | 16,611                  |   |
| Property taxes,  insurance and other                          |   | 2,655                       |    | 2,161                       |   | 4,179                           |   |             |   | 8,995                   |   |
| Franchise costs                                               |   | (153                        | )       | 6,606                       |   | 4,623                           |   |             |   | 11,076                  |   |
| Maintenance and  repair                                       |   |                        |    | 4,740                       |   | 2,586                           |   |             |   | 7,326                   |   |
| Management fees                                               |   |                        |    | 4,246                       |   | 1,334                           |   |             |   | 5,580                   |   |
| Percentage lease  expense                                     |   |                        |    | 32,245                      |   |                            |   | (32,245          | )      |                    |   |
| Depreciation                                                  |   | 8,520                       |    | 4,154                       |   | 9,573                           |   |             |   | 22,247                  |   |
| Amortization of  franchise fees and unearned compensation     |   | 2,004                       |    | 23                          |   | 18                              |   |             |   | 2,045                   |   |
| General and  administrative                                   |   | 18,572                      |    | 6,499                       |   | 4,640                           |   |             |   | 29,711                  |   |
| Total operating  expenses                                     |   | 31,598                      |    | 94,833                      |   | 43,655                          |   | (32,245          | )      | 137,841                 |   |
| Operating income                                              |   | (9,245                      | )       | 3,169                       |   | 6,207                           |   | —           |   | 131                     |   |
| Amortization of  loan origination costs                       |   | 634                         |    | 2                           |   | 221                             |   |             |   | 857                     |   |
| Interest expense                                              |   | 10,541                      |    |                        |   | 9,517                           |   |             |   | 20,058                  |   |
| Equity in  (earnings) loss of consolidated subsidiaries       |   | (3,140                      | )       |                        |   | 3,656                           |   | (516             | )      |                    |   |
| Income (loss) from  continuing operations before income taxes |   | (17,280                     | )       | 3,167                       |   | (7,187                          | )      | 516              |   | (20,784                 | )      |
| Benefit from  income taxes                                    |   |                        |    | (2,049                      | )      | (25                             | )      |             |   | (2,074                  | )      |
| Income (loss)  from continuing operations                     |   | (17,280                     | )       | 5,216                       |   | (7,162                          | )      | 516              |   | (18,710                 | )      |
| Income from  discontinued operations                          |   |                        |    | 1,429                       |   |                            |   |             |   | 1,429                   |   |
| Gain (loss) on  sale of assets                                |   | (10                         | )       | 1                           |   |                            |   |             |   | (9                      | )      |
| Net income  (loss)                                            |   | (17,290                     | )       | 6,646                       |   | (7,162                          | )      | 516              |   | (17,290                 | )      |
| Preferred unit  dividends                                     |   |                        |    |                        |   |                            |   |             |   |                    |   |
| Net income  (loss) applicable to unitholders                  |   | $                           | (17,290 | )                           | $      | 6,646                           |   | $                | (7,162 | )                       | $      | 516 |   | $ | (17,290 | ) |

 

18

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**ConsolidatingStatement of OperationsFor the Nine Months Ended September 30, 2002(in thousands)**

 
|                                                          |   | **RFS  Partnership,  L.P.** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |   | **Total  Consolidated** |   |
|---------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|---------------------------------|--------|------------------|--------|-------------------------|--------|
| Revenue:                                                      |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | $                           | 76,514 |                            | $      | 44,597           |   |                    |   | $ | 121,111 |   |
| Food and  beverage                                            |   |                        |   | 9,154                       |   | 3,807                           |   |             |   | 12,961                  |   |
| Other operating  departments                                  |   |                        |   | 2,525                       |   | 2,223                           |   |             |   | 4,748                   |   |
| Lease revenue                                                 |   | $                           | 21,136 |                        | 16,590 |                            | 1,853  |             | $      | (35,580                 | )      | 3,999 |   |
| Deferred revenue                                              |   | (411                        | )      |                        |   | (621                            | )      |             |   | (1,032                  | )      |
| Other                                                         |   | 704                         |   | 26                          |   | 135                             |   | (531             | )      | 334                     |   |
| Total hotel  revenue                                          |   | 21,429                      |   | 104,809                     |   | 51,994                          |   | (36,111          | )      | 142,121                 |   |
|                                                          |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Hotel operating  expenses:                                    |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | 15,621                      |   | 8,474                           |   |             |   | 24,095                  |   |
| Food and  beverage                                            |   |                        |   | 7,152                       |   | 2,462                           |   |             |   | 9,614                   |   |
| Other operating  departments                                  |   |                        |   | 876                         |   | 451                             |   |             |   | 1,327                   |   |
| Undistributed  operating expenses:                            |   |                        |   |                        |   |                            |   |             |   |                    |   |
| Property  operating costs                                     |   |                        |   | 10,222                      |   | 5,089                           |   |             |   | 15,311                  |   |
| Property taxes,  insurance and other                          |   | 2,552                       |   | 2,074                       |   | 4,273                           |   |             |   | 8,899                   |   |
| Franchise costs                                               |   | (142                        | )      | 6,781                       |   | 4,854                           |   |             |   | 11,493                  |   |
| Maintenance and  repair                                       |   |                        |   | 4,300                       |   | 2,329                           |   |             |   | 6,629                   |   |
| Management fees                                               |   |                        |   | 2,199                       |   | 1,298                           |   |             |   | 3,497                   |   |
| Percentage lease  expense                                     |   |                        |   | 35,580                      |   |                            |   | (35,580          | )      |                    |   |
| Depreciation                                                  |   | 7,647                       |   | 3,657                       |   | 9,455                           |   |             |   | 20,759                  |   |
| Amortization of  franchise fees and unearned compensation     |   | 900                         |   | 31                          |   | 19                              |   |             |   | 950                     |   |
| General and  administrative                                   |   | 365                         |   | 7,292                       |   | 6,138                           |   |             |   | 13,795                  |   |
| Total operating  expenses                                     |   | 11,322                      |   | 95,785                      |   | 44,842                          |   | (35,580          | )      | 116,369                 |   |
| Operating income                                              |   | 10,107                      |   | 9,024                       |   | 7,152                           |   | (531             | )      | 25,752                  |   |
| Debt  extinguishments and swap termination costs              |   | 3,210                       |   | 6,912                       |   |                            |   |             |   | 10,122                  |   |
| Amortization of  loan origination costs                       |   | 965                         |   | 16                          |   | 223                             |   |             |   | 1,204                   |   |
| Interest expense                                              |   | 8,462                       |   | 1,422                       |   | 9,672                           |   | (531             | )      | 19,025                  |   |
| Equity in  (earnings) loss of consolidated subsidiaries       |   | (749                        | )      |                        |   | 1,162                           |   | (413             | )      |                    |   |
| Income (loss)  from continuing operations before income taxes |   | (1,781                      | )      | 674                         |   | (3,905                          | )      | 413              |   | (4,599                  | )      |
| Benefit from  income taxes                                    |   |                        |   | (594                        | )      | (109                            | )      |             |   | (703                    | )      |
| Income (loss)  from continuing operations                     |   | (1,781                      | )      | 1,268                       |   | (3,796                          | )      | 413              |   | (3,896                  | )      |
| Earnings from  discontinued operations                        |   |                        |   | 2,128                       |   |                            |   |             |   | 2,128                   |   |
| Gain (loss) on  sale of assets                                |   | 975                         |   |                        |   | (13                             | )      |             |   | 962                     |   |
| Net income (loss)                                             |   | (806                        | )      | 3,396                       |   | (3,809                          | )      | 413              |   | (806                    | )      |
| Loss on sale of  Preferred Units                              |   | (1,890                      | )      |                        |   |                            |   |             |   | (1,890                  | )      |
| Preferred unit  dividends                                     |   | (1,562                      | )      |                        |   |                            |   |             |   | (1,562                  | )      |
| Net income  (loss) applicable to unitholders                  |   | $                           | (4,258 | )                           | $      | 3,396                           |   | $                | (3,809 | )                       | $      | 413 |   | $ | (4,258 | ) |

 

19

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**CombinedPre-Merger and Post-Merger Partnership Statement of Cash FlowsFor the Nine Months Ended September 30, 2003(in thousands)**

 
|                                              |   | **LP Only** |    | **Guarantor********Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Total********Consolidated** |   |
|---------------------------------------------------|--------|-------------|---------|-----------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                              |   |        |    |                              |   |                            |   |                          |   |
| Cash flows from  (used in) operating activities   |   | $           | (15,941 | )                                 | $      | 11,499                          |   | $                             | 4,165  |   | $ | (277 | ) |
| Cash flows from  (used in) investing activities   |   | (4,331      | )       | (10,823                           | )      | 1,913                           |   | (13,241                       | )      |
| Cash flows from  (used in) financing activities   |   | 23,871      |    | —                            |   | (5,024                          | )      | 18,847                        |   |
| Net increase in  cash and cash equivalents        |   | 3,599       |    | 676                               |   | 1,054                           |   | 5,329                         |   |
| Cash and cash  equivalents at beginning of period |   | 446         |    | 825                               |   | 667                             |   | 1,938                         |   |
| Cash and cash  equivalents at end of period       |   | $           | 4,045   |                              | $      | 1,501                           |   | $                             | 1,721  |   | $ | 7,267 |   |

 

**ConsolidatingStatement of Cash FlowsFor the Nine Months Ended September 30, 2002(in thousands)**

 
|                                              |   | **LP Only** |   | **Guarantor********Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Total********Consolidated** |    |
|---------------------------------------------------|--------|-------------|--------|-----------------------------------|--------|---------------------------------|--------|-------------------------------|---------|
|                                              |   |        |   |                              |   |                            |   |                          |    |
| Cash flows from  (used in) operating activities   |   | $           | 33,233 |                              | $      | 6,247                           |   | $                             | (11,825 | ) | $ | 27,655 |   |
| Cash flows from  (used in) investing activities   |   | (69,783     | )      | 51,106                            |   | 14,089                          |   | (4,588                        | )       |
| Cash flows from  (used in) financing activities   |   | 39,127      |   | (58,191                           | )      | (1,840                          | )      | (20,904                       | )       |
| Net increase in  cash and cash equivalents        |   | 2,577       |   | (838                              | )      | 424                             |   | 2,163                         |    |
| Cash and cash  equivalents at beginning of period |   | 263         |   | 3,467                             |   | 2005                            |   | 5,735                         |    |
| Cash and cash  equivalents at end of period       |   | $           | 2,840  |                              | $      | 2,629                           |   | $                             | 2,429   |   | $ | 7,898 |   |

 

20.*** Subsequent Events.*** In October 2003, the Operating Partnership began terminating bothexisting management agreements with Flagstone, which managed 50 of the 57 RFSproperties prior to its acquisition, and franchise licenses for most of itsportfolio of hotels, and entering into new management and franchise licenseagreements with internationally recognized hotel brand managers. The OperatingPartnership incurred costs of approximately $1.0 million in connection with theFlagstone termination.  These costs wereaccrued in purchase accounting.  It isexpected that the management contracts for all 50 Properties, as well as newfranchise licenses, are expected to be completely transitioned to newinternationally recognized hotel brand managers and franchisers byDecember 31, 2003.

 

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**ITEM 2.  *Management’s Discussion andAnalysis of Financial Condition and Results of Operations***

 

**Forward-looking Statements**

 

The following discussion is based on the consolidatedfinancial statements of the Operating Partnership as of September 30, 2003and December 31, 2002 and for the quarters and nine months endedSeptember 30, 2003 and 2002.  Thisinformation should be read in conjunction with the accompanying unaudited consolidatedfinancial statements and the notes thereto.

 

The following information contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended.  These statements generallyare characterized by the use of terms such as “believe,” “expect” and“may.”  Although the OperatingPartnership believes that the expectations reflected in such forward-lookingstatements are based upon reasonable assumptions, the Operating Partnership’sactual results could differ materially from those set forth in theforward-looking statements.  Certainfactors that might cause such a difference include the following: changes ingeneral economic conditions, changes in local and national real estateconditions, terrorism, extended U.S. Military combat operations, availabilityof capital from borrowings under the Operating Partnership’s Bridge Loan,continued availability of proceeds from operations or CNL, the ability of theOperating Partnership to obtain additional permanent financing on satisfactoryterms, the ability of the Operating Partnership to continue to identifysuitable investments, the ability of the Operating Partnership to continue tolocate suitable managers and tenants for its properties and borrowers for its mortgagenotes payable, and the ability of such tenants and borrowers to make paymentsunder their respective leases or mortgage notes payable.  These risks and uncertainties are described in greater detail in theOperating Partnership’s other filings with the SEC, particularly under thecaption “Risk Factors” in its combined Form 10-K with RFS for the fiscal yearended December 31, 2002. You should carefully read these SEC filings.  Except as required by the federal securitieslaws, the Operating Partnership disclaims any obligations or undertaking topublicly release any updates or revisions to any forward-looking statementcontained in this quarterly report on Form 10-Q to reflect any change inthe Operating Partnership’s expectations with regard thereto or any change inevents, conditions or circumstances on which any such statement is based. Given theseuncertainties, readers are cautioned not to place undue reliance on suchstatements.

 

**General.**  RFS Partnership, L.P. (the “OperatingPartnership”) is a Tennessee limited partnership which, at September 30,2003, owned interests in 62 hotels with 9,399 rooms located in 26 states(collectively the “Hotels”). OnJuly 10, 2003, RFS Hotel Investors, Inc. (“RFS”) and the OperatingPartnership were acquired by subsidiaries of CNL Hospitality Properties, Inc.(“CNL”) for approximately $383 million in cash ($12.35 per share or limitedpartnership unit) (“RFS-CNL Transaction”). Upon consummation of the RFS-CNL Transaction, RFS was merged with andinto a subsidiary of CNL and RFS ceased to exist as a separate corporateentity.  Further, upon consummation ofthis RFS-CNL Transaction, a subsidiary of CNL was merged with and into theOperating Partnership and the Operating Partnership continues to exist as aseparate entity and as an indirect wholly owned subsidiary of CNL.  The following summarizes additionalinformation for the 62 hotels owned at September 30, 2003:

 

| **Franchise Affiliation**      |   | **Hotel  Properties** |   | **Rooms/Suites** |   |
|--------------------------------|--------|-----------------------|--------|------------------|--------|
| Full Service  Hotels:          |   |                  |   |             |   |
| Holiday Inn                    |   | 5                     |   | 954              |   |
| Sheraton                       |   | 3                     |   | 659              |   |
| Hilton                         |   | 2                     |   | 439              |   |
| Sheraton Four  Points          |   | 2                     |   | 412              |   |
| Wyndham                        |   | 2                     |   | 390              |   |
| Independent                    |   | 2                     |   | 331              |   |
| Hyatt Regency                  |   | 1                     |   | 242              |   |
| Doubletree                     |   | 1                     |   | 221              |   |
|                           |   | 18                    |   | 3,648            |   |
|                           |   |                  |   |             |   |
| Extended Stay  Hotels:         |   |                  |   |             |   |
| Residence Inn by  Marriott     |   | 15                    |   | 2,201            |   |
| TownePlace  Suites by Marriott |   | 3                     |   | 285              |   |
| Homewood Suites  by Hilton     |   | 1                     |   | 83               |   |
|                           |   | 19                    |   | 2,569            |   |
|                           |   |                  |   |             |   |
| Limited Service  Hotels:       |   |                  |   |             |   |
| Hampton Inn                    |   | 17                    |   | 2,113            |   |
| Holiday Inn  Express           |   | 5                     |   | 637              |   |
| Courtyard by  Marriott         |   | 2                     |   | 248              |   |
| Comfort Inn                    |   | 1                     |   | 184              |   |
|                           |   | 25                    |   | 3,182            |   |
| Total                          |   | 62                    |   | 9,399            |   |

 

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AtSeptember 30, 2003, the Operating Partnership and its wholly ownedsubsidiaries leased seven hotels to three third-party lessees and fifty-fivehotels are leased by TRS Lessees, fifty-two of which are leased to TRS Lesseesof the Operating Partnership and three hotels are leased to TRS Lessees ofanother CNL subsidiary outside of the Operating Partnership. Fifty hotels aremanaged by Flagstone Hospitality Management Company LLC (“Flagstone”) and theremaining twelve hotels are managed by seven other third party managementcompanies. Subsequent to September 30, 2003, the Operating Partnership hasterminated the management contracts for most of the Operating Partnership’shotels and entered into management agreements with internationally recognizedhotel brand managers.

 

**Results of Operations**

 

***Comparison of thethree and nine months ended September 30, 2003 and September 30,2002.***

 

*Revenue*

 

For purposes of the following discussion, the“Company” shall be deemed to include RFS (prior to July 10, 2003), theOperating Partnership and their subsidiaries, as such discussions relate toevents that occurred on or prior to September 30, 2003. In addition, forcomparison purposes, the results of operations for the Pre-Merger Partnership(RFS and its wholly owned subsidiaries prior to July 10, 2003) and thePost-Merger Partnership (subsequent to July 10, 2003) should be combinedto compare with the results of operations for the comparable period in 2002.The five hotels that were contributed to the Operating Partnership from CNLduring the quarter ended September 30, 2003 had net lease revenue ofapproximately $2.8 million.  Thisrevenue is excluded from the following discussion on revenue as it is notcomparable.

 

Revenue decreased 1.7% for the quarter from$48.8 million to $48.0 million and 4.9% year to date from $142.1million to $135.2 million.  For thequarter and year to date, business travel demand continues to wane as a resultof the sluggish economy coupled with the travel fears resulting from thecontinued military activity in Iraq and Severe Acute Respiratory Syndrome(“SARS”). For the quarter ended September 30, 2003, revenue per availableroom declined 1.9% due to a decline in occupancy of 0.3 percentage points and a1.5% decline in average daily rate.  TheCompany’s year to date revenues have also decreased due to substantialrenovations at three hotels in the first two quarters: the Hotel Rex in SanFrancisco, CA, and the Residence Inns in Sacramento, California and Fishkill,New York.  These three hotels areexcluded from the year to date comparable statistics.  These three hotels accounted for approximately 28% of the declinein revenue for the nine months ended September 30, 2003.  Excluding these three hotels, for the ninemonths ending September 30, 2003, revenue per available room declined 4.1%due to a decline in occupancy of 0.7 percentage points and a 3.1% decline inaverage daily rate. Revenue per available room at the Company’s comparablehotels (57 hotels for the quarter and 54 hotels year to date) for the fullservice, extended stay and limited service hotel portfolios showed decreases inrevenue per available room of 2.7%, 1.4% and 1.4% for the quarter, and 5.9%,3.1% and 2.7% year to date, respectively, from the comparable 2002 period.

 

The Company’s comparable northern Californiaproperties (six hotels for the quarter and five hotels for the year to date,excluding the Hotel Rex in San Francisco, California) experienced an averagedecline in revenue per available room of 6.4% in the quarter and 11.2% year todate. In San Francisco, the Hilton Fisherman’s Wharf experienced decreases inrevenue per available room of 3.5% for the quarter and 6.6% year to date, whilethe Hotel Rex experienced an increase in revenue per available room for thequarter of 8.4%.  The Hotel Rex wasclosed for a majority of the first quarter. At the Company’s four Silicon Valley hotels, revenue per available roomdecreased 9.5% for the quarter and 12.9% year to date, which compares favorablyto the decline in revenue per available room within the San Jose/Santa CruzMetropolitan Service Area (“MSA”) of approximately 11.9% for the quarter and16.0% year to date, as reported by Smith Travel Research. The decline in yearover year revenue per available room in both the San Francisco/San Mateo MSAand the San Jose/Santa Cruz MSA in Silicon Valley was due to the continueddownturn in the technology and telecommunications industries, a weak conventioncalendar and a lack of business travelers, both domestic and international.Excluding the five comparable northern California properties, revenue peravailable room declined approximately 0.9% for the quarter and 3.5% year todate, which compares to the industry’s increase of 2.3% for the quarter and adecrease of 0.8% for the year to date, as reported by Smith Travel Research.

 

The Operating Partnership hopes to benefit in thefuture from any decline in new supply growth, which has been predicted by SmithTravel Research, and combined with an economic turnaround, this decline maycreate increased lodging demand for the Company’s hotels. This may lead togrowth in revenue per available room and net income.

 

The following shows hotel operating statistics for the57 comparable hotels for the quarter and 54 comparable hotels for the year. Thehotels excluded in the year to date comparable statistics are the ResidenceInns in Fishkill, New York and

 

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Sacramento, California, which were undergoing substantial renovationsresulting in meaningful rooms out of service, and the Hotel Rex in SanFrancisco, California, which closed in November 2002 and did not fullyreopen until June 2003 after undergoing an earthquake retrofit andrenovation.

 

## **COMPARABLE HOTELS OPERATING STATISTICS**

## **For The Three Months Ended September 30, 2003**

 
|            |   | **ADR**  |   | **OCCUPANCY**           |   | **Revenue  Per********Available Room** |   |
|-----------------|--------|----------|--------|-------------------------|--------|----------------------------------------|--------|
| **Hotel Type**  |   | **2003** |   | **Variance  vs.  2002** |   | **2003**                               |   | **Variance  vs  2002** |   | **2003** |   | **Variance  vs.  2002** |   |
|            |   |     |   |                    |   |                                   |   |   |   |   |   |   |   |
| Full Service    |   | $        | 95.57  |                    | (3.3   | )%                                     | 69.1   | % | 0.4 | pts | $ | 66.07 |   | (2.7 | )% |
| Extended Stay   |   | 90.28    |   | (3.4                    | )%     | 78.7                                   | %      | 1.5 | pts | 71.08 |   | (1.4 | )% |
| Limited Service |   | 70.41    |   | 2.0                     | %      | 69.6                                   | %      | (2.4 | )pts | 48.99 |   | (1.4 | )% |
| Total           |   | $        | 85.08  |                    | (1.5   | )%                                     | 71.9   | % | (0.3 | )pts | $ | 61.15 |   | (1.9 | )% |

 

## **COMPARABLE HOTELS OPERATING STATISTICS**

## **For The Nine Months Ended September 30, 2003**

 
|            |   | **ADR**  |   | **OCCUPANCY**           |   | **Revenue  Per********Available Room** |   |
|-----------------|--------|----------|--------|-------------------------|--------|----------------------------------------|--------|
| **Hotel Type**  |   | **2003** |   | **Variance  vs.  2002** |   | **2003**                               |   | **Variance  vs  2002** |   | **2003** |   | **Variance  vs.  2002** |   |
|            |   |     |   |                    |   |                                   |   |   |   |   |   |   |   |
| Full Service    |   | $        | 93.54  |                    | (6.0   | )%                                     | 66.3   | % | 0.1 | pts | $ | 62.02 |   | (5.9 | )% |
| Extended Stay   |   | 88.06    |   | (3.4                    | )%     | 76.8                                   | %      | 0.2 | pts | 67.59 |   | (3.1 | )% |
| Limited Service |   | 70.69    |   | 0.5                     | %      | 66.4                                   | %      | (2.2 | )pts | 46.90 |   | (2.7 | )% |
| Total           |   | $        | 83.56  |                    | (3.1   | )%                                     | 68.9   | % | (0.7 | )pts | $ | 57.54 |   | (4.1 | )% |

 

The Company’s comparable full service hotelsexperienced a year over year decrease in revenue per available room of 2.7% inthe quarter and 5.9% year to date.  Thisdecrease was caused by a decline in average daily rate of 3.3% for the quarterand 6.0% year to date, as occupancy has risen slightly in both the quarter andyear to date.  The five comparablenorthern California hotels previously mentioned constitute a substantialportion of these decreases. Excluding the five northern California properties,revenue per available room at the Company’s other full service hotels increased0.6% for the quarter and decreased 1.7% for the year.  The following comparable full service hotels located in SiliconValley and San Francisco had decreases in revenue per available room averaging6.4% and 11.2% for the three and nine months ended September 30, 2003.

 
| **Hotel**                      |   | **Location**      |   | **Three  Months  Ended** |   | **Nine  Months  Ended** |   |
|--------------------------------|--------|-------------------|--------|--------------------------|--------|-------------------------|--------|
|                           |   |              |   |                     |   |                    |   |
| 173-room  Sheraton             |   | Sunnyvale, CA     |   | (7.9                     | )%     | (12.5                   | )%     |
| 235-room Beverly  Heritage     |   | Milpitas, CA      |   | (19.8                    | )%     | (19.7                   | )%     |
| 229-room  Sheraton             |   | Milpitas, CA      |   | (13.3                    | )%     | (17.5                   | )%     |
| 214-room  Sheraton Four Points |   | Pleasanton, CA    |   | 1.1                      | %      | (1.6                    | )%     |
| 234-room Hilton                |   | San Francisco, CA |   | (3.5                     | )%     | (6.6                    | )%     |
| 94-room Hotel  Rex             |   | San Francisco, CA |   | 8.4                      | %      | Not Comparable          |   |

 

In Silicon Valley, where the Company has four fullservice hotels that experienced a decrease in revenue per available room of9.5% for the quarter and 12.9% year to date, the hotel guests are predominantlydomestic and international business travelers. These hotels have been among themost adversely affected by the decrease in business travel due to the continuedweakness in the technology and telecommunications industries, the threat ofSARS on international travelers and the effects of the continued militaryactivity in Iraq. Furthermore, there is little leisure demand for hotels in theSilicon Valley market that would mitigate the significant decrease in businesstravel.  However, the analysis of thefour Silicon Valley properties does show that, excluding the Beverly Heritage,the hotels are performing better over the last three months as compared to theyear.  Increases in business travelassociated with an economic turnaround in the technology and communicationsindustries may benefit the Company in growth of revenue per available room andnet income.

 

Conversely, within San Francisco, occupancy at theHilton Fisherman’s Wharf is driven predominantly by leisure travelers, withbusiness travelers and groups making up the balance in room demand. In thepast, San Francisco has been host to a

 

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large number of city wide conventions, but there have not been manysuch conventions in 2003, thus reducing the amount of business travelers intothe San Francisco market.  Accordingly,the market remains depressed.  There isno consistency in this market with respect to business or leisure travelers asevidence by the fact that throughout the year, revenue per available roomincreased 10.1% in January and 16.2% in February, but decreased 11.7% inMarch, 10.2% in April, 20.0% in May, 15.6% in June, 2.8% in July, 8.6% inAugust and then increased 2.7% in September.

 

TheHotel Rex at Union Square was not open for most of the first quarter due to the$1.5 million earthquake retrofit and renovation and the lobby and the newrestaurant were not completed until June 2003.  The retrofit and renovation was required to be performed by early2005 in order to comply with existing building codes.  Based on its location within San Francisco at Union Square, thishotel is more reliant on business travelers and city-wide conventions, and theCompany believes the Hotel Rex is well positioned to attract travelers.  The Company hopes that the recentrenovations at this boutique hotel will increase revenue per available room,and ultimately net income. In fact, during the quarter ended September 30,2003, the first full quarter that the hotel was open subsequent to the retrofitand renovation, the Hotel Rex experienced an increase in revenue per availableroom of 8.4% driven by an increase in occupancy of 8.7 percentage points, butpartially offset by a decrease in average daily rate of 5.2%.

 

The Company’s rebranding of its Hilton Hotel inBirmingham, Alabama, has so far been successful in generating increased revenueper available room.  The hotel, the onlyfull service Hilton in the Birmingham market, which was converted from aSheraton to a Hilton on January 1, 2003, has experienced increases inrevenue per available room of 18.2% for the quarter and 2.8% for the year todate. Increases in both occupancy and average daily rate are driving the surgein revenue per available room.

 

The comparable extended stay hotels, which excludesthe Residence Inns in Sacramento, California and Fishkill, New York in the yearto date comparison that were undergoing substantial renovations, experienced ayear over year decline in revenue per available room of 1.4% for the quarterand 3.1% year to date.  Most of ourextended stay hotels, with the exception of the 176-room Residence Inn inOrlando, Florida, are in markets that can best be categorized as “drive to”markets. These hotels are typically less affected by the current geo-politicalunrest, the continued military activity in Iraq, with revenue per availableroom declining 1.4% for the quarter and 2.5% year to date. The OrlandoResidence Inn experienced a decline in revenue per available room of nearly3.2% for the quarter and 9.5% year to date. Fourteen of the eighteen extendedstay properties are Residence Inns by Marriott.  Revenue per available room is typically less volatile as thesehotels benefit from longer duration stays that include the typically slowerweekend days. The twelve comparable Residence Inns by Marriott experienced adecrease in revenue per available room of 1.3% for the quarter and 3.1% year todate, slightly better than all of the comparable extended stay hotels.

 

The Company’s limited service hotels experienced adecrease in revenue per available room of 1.4% for the quarter and 2.7% year todate. Quarter to date and year to date, the limited service portfolio performedbest among the Operating Partnership portfolio in terms of revenue peravailable room versus the prior year. The Company believes this is attributable to cost conscious travelers,both business and leisure, who stayed at limited service hotels to save moneyduring the economic downturn.  Seventeenof the Operating Partnership’s twenty-five limited service hotels are HamptonInns which the Operating Partnership currently believes has the strongestrewards program among its limited service hotels and which experienced anincrease in revenue per available room of 1.0% for the quarter and a decreaseof only 0.7% year to date.

 

*Expenses*

 

Total operating expenses increased $20.9 million forthe quarter to $60.3 million in 2003 versus $39.4 million in 2002 and increased$21.5 million year to date to $137.8 million in 2003 versus $116.3 million in2002. This increase is primarily attributable to non-recurring costs related toRFS-CNLTransaction, of approximately $20.6 million.  These non-recurring costs are comprised of severance of $11.6 million,amortization of $1.5 million related to the acceleration of unvested restrictedstock, advisory fees of $4.5 million, additional management fees of $1.9million and miscellaneous other costs of $1.1 million.  Operating margins (operating incomeas a percentage of total hotel revenue, excluding the effects of deferredrevenue, non-recurring acquisition costs and lease revenue from propertiescontributed by CNL during the third quarter of 2003 of $2.8 million) decreased2.9 points to 15.5% from 18.4% for the quarter and 4.4 points to 13.6% from18.0% year to date, driven by the decrease in revenue of 1.7% in the quarterand 4.9% year to date.  Individual lineitems comprising hotel operating expenses are discussed below.

 

Hotel operating expenses for rooms, food and beverageand other operating departments remained flat for the quarter at$11.7 million and decreased 2.2% year to date to $34.2 million from $35.0million; however, as a percentage of total hotel revenue, excluding leaserevenue from properties contributed by CNL during the third quarter of 2003,hotel operating expenses increased to 24.6% in 2003 versus 24.1% in 2002 forthe quarter and increased to 25.3% from 24.7% year to date. The increasedpercentage was caused primarily by the decline in revenue year over year inrelationship to significant fixed costs as the decreases in occupancy continueto be less than the decrease in average daily rate, resulting in deterioratingmargins as the costs to service hotel guests have not decreased as much as theroom rental rates.

 

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Property operating costs increased $0.5 million or9.0% for the quarter and $1.3 million or 8.5% year to date due primarily to anincrease in energy costs across most of the portfolio of $0.2 million or 7.0%for the quarter and $0.6 million or 8.7% year to date.  Energy costs have increased due to the well-publicizedoil and gas price increases caused primarily by the continued military activityin Iraq and shortages in production in South America.  During the quarter, the Company also incurred approximately $0.2 millionin costs associated with water damage at the Holiday Inn in Lafayette,Louisiana and a burst pipe at the Sheraton in Pleasanton, California and $0.1million related to a worker’s compensation claim at one of the hotels.  In addition, costs incurred associated withthe conversion of the Birmingham hotel to a Hilton from a Sheraton wereapproximately $0.2 million year to date. The remaining increase is attributable to small increases across theportfolio.

 

Property taxes, insurance and other expenses increased$0.5 million or 17.1% for the quarter and increased $0.1 million or 1.1%year to date.  The increase in thequarter is primarily attributable to real estate tax refunds of $0.4 millionobtained in the third quarter of 2002 related to taxes paid on prior years atseveral of the Company’s California properties.  The remaining increase of $0.1 million is due to increasedinsurance costs as a result of the Company reducing its self-insurance level onits earthquake policies.  The year todate increase is due to the increased insurance costs in the third quarter asthe $0.4 million increase in real estate taxes in the third quarter of 2003 wasoffset by reduced real estate taxes in the first half of 2003.

 

Franchise costs decreased $0.1 million or 2.3%for the quarter and $0.4 million or 3.6% year to date due to the decrease intotal hotel revenue.  For both thequarter and year to date in both 2003 and 2002, franchise costs remainedrelatively flat between 8.1% and 8.2% of total hotel revenue, excluding the$2.8 million of lease revenue from the properties contributed by CNL during thethird quarter of 2003.

 

Maintenance and repair costs increased$0.1 million or 3.4% for the quarter and $0.7 million or 10.5% year todate. This increase is associated with the costs incurred in connection with therenovations at the Hotel Rex and Residence Inns in Fishkill, NY and Sacramento,California, the completion of product improvement plans at seven of our HamptonInns, the collapse of a canopy at the Hampton Inn in Denver, Colorado, a majorpipe burst at the Sheraton in Pleasanton, California, and water damage at theHoliday Inns in Columbia, South Carolina and Lafayette, Louisiana.

 

Management fees have increased $1.9 million forthe quarter and $2.1 million year to date mainly due to costs associated withthe acquisition of the Company by CNL. The Company was required to pay $1.9 million in additional managementfees to Flagstone as a result of its acquisition by CNL.  The remainder of the year to date increaseof $0.2 million is due to costs associated with the participation in certainpurchasing programs.

 

Depreciation increased $1.2 million for the quarterdue primarily to depreciation on the five properties contributed by CNL of $1.0million. The remainder of the quarter decrease is attributable to the increasein the asset basis resulting from the application of purchase accounting.Depreciation increased $1.5 million year to date.  The additional $0.3 million variance for the year to date versusthe quarter is due to substantial capital expenditures in 2002.

 

Amortization of franchise fees and unearnedcompensation increased $1.2 million for the quarter and $1.1 million year todate due to accelerated amortization to immediately vest all restricted stockgrants as a result of the Company’s change in control on July 10, 2003.

 

General and administrative expenses increased $15.6million for the quarter due to costs associated with the RFS-CNL Transaction:severance of $11.6 million, advisory fees of $4.2 million and miscellaneousfees of $0.2 million.  This was offsetby decreased costs at the hotels of approximately $0.4 million as a result ofcontinued cost cutting initiatives. Year to date, general and administrative expenses increased $15.9million.  The additional $0.3 millionincrease related to the first half of the year is due to additional costsincurred related to the RFS-CNLTransaction of $0.7 million, partially offset by a decrease incompensation of approximately $0.2 million resulting from the termination ofthe Company’s bonus plan for 2003 and the remainder of the offset attributableto the reduction of overhead at the corporate and hotel level as a result ofcontinued cost cutting initiatives of $0.2 million.

 

Debt extinguishment and swap termination costs of$10.1 million in 2002 are comprised of a yield maintenance premium of$5.5 million to pay off the 1996 CMBS debt, $3.2 million to terminatetwo interest rate swaps and $1.4 million to write-off the unamortized debtissuance costs related to the 1996 CMBS debt. All of these transactions were completed in connection with the issuanceof the $125 million senior notes.

 

Amortization on loan origination costs decreased $0.4million for the quarter and $0.3 million for the year to date due to thewrite-off of issuance costs on the Company’s Line of Credit and Senior Notes asa result of the RFS-CNLTransaction. Issuance costs on the Company’s new financing to completethe acquisition will be amortized over ten years when the final financing is inplace, which is expected to occur in the fourth quarter of 2003 or firstquarter of 2004.

 

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Interest expense increased $0.4 million for thequarter.  The increase in the weightedaverage borrowings for the quarter of $96.1 million from $291.0 million to$387.1 million was offset by the decrease in the average interest rate onborrowings outstanding from 8.9% in 2002 to 7.1% in 2003.  The increase in weighted average borrowingsduring the quarter resulted from the Operating Partnership borrowing $44 millionunder its Bridge Loan to finance the $41.2 million of Senior Notes that wererepurchased, and the Operating Partnership borrowing $44 million that wasdistributed to CNL for other financing needs. The average interest rate on the Bridge Loan was approximately 4.1% ascompared to the 9.75% rate that the Senior Notes carried.  This refinancing was the primary cause forthe decrease in the average interest rate during the quarter.  For the nine months ended September 30,2003, interest expense increased $1.0 million or 5.4% due to the increasein the weighted average borrowings of $27.6 million from $300.7 million to$328.3 million, offset by the decrease in the average interest rate onborrowings outstanding from 8.4% in 2002 to 8.1% in 2003.  The decrease in the weighted averageinterest rate results from the $101 million borrowed under the Bridge Loan, $44million of which was used to refinance debt that was paying a 9.75% interestrate.

 

Benefit from income taxes increased $0.2 millionfor the quarter and $1.4 million year to date due to the increase in losses inthe taxable REIT subsidiaries.

 

Income from discontinued operations increased $0.1million for the quarter to $0.9 million. The decrease in operating income of$0.5 million was offset by reduced depreciation in 2003 of $0.6 million sincethese assets are now classified as held for sale, and therefore no depreciationwas recorded subsequent to the change of control.  Year to date, income from discontinued operations decreased $0.7million to $1.4 million. The decrease in operating income of $1.4 million wasoffset by reduced depreciation in 2003 of $0.7 million since these assets arenow classified as held for sale, and therefore no depreciation was recordedsubsequent to the change of control.

 

The loss on sale of assets in 2003 relates to the saleof hotel vans and the year to date gain in 2002 relates primarily to the saleof the Company’s interest in an unconsolidated partnership for approximately$1.1 million in the first quarter of 2002.

 

*Net income (loss) applicable tounitholders*

 

For the quarter, net income (loss) applicable tounitholders decreased $18.8 million from net income of $3.7 million in2002 to a net loss of $15.1 million in 2003. The decrease is attributable to the decrease in operating income of$18.9 million driven primarily by change of control costs resulting fromthe RFS-CNLTransaction of approximately $19.4 million, the increase in interestexpense of $0.4 million, offset by the decrease in amortization of loan costs ofapproximately $0.4 million and the increase in the deferred tax benefit in 2003of $0.2 million.

 

For the year, net loss applicable to unitholdersdecreased $13.0 million from $4.3 million in 2002 to $17.3 million in2003. The decrease is primarily attributable to the decrease in operatingincome of $25.6 million driven primarily by change of control costsresulting from the RFS-CNLTransaction of approximately $20.1 million, increased depreciation of$1.5 million, the increase in interest expense of $1.0 million, offset by thedebt extinguishments and swap termination costs incurred in 2002 of $10.1million.

 

**Liquidity and Capital Resources**

 

The OperatingPartnership’s principal source of liquidity to meet its cash requirements,including distributions to unitholders and repayments of indebtedness, has beencash flow provided by operating activities. For the nine months ended September 30, 2003, cash flow used byoperating activities of the Operating Partnership was $0.3 million as aresult of the cash flow requirements related to the Operating Partnership’sacquisition. The Operating Partnership believes that in the future, cashprovided by operating activities will be adequate to meet some of its liquidityneeds for the foreseeable future. The Operating Partnership currently expectsto fund its other liquidity needs by exchanging equity for hotel properties orpossibly accessing the equity and debt capital markets as market conditionspermit.

 

In connection with the RFS-CNL Transaction, theOperating Partnership entered into a $320 million Credit Agreement with Bank ofAmerica dated July 10, 2003 (“Bridge Loan”).  On July 10, 2003, as part of the RFS-CNL Transaction, theLine of Credit was terminated and replaced with the Bridge Loan, of which only$101.0 million was drawn by the Operating Partnership to help fund themerger.  The Bridge Loan is payable infull on January 10, 2004.  TheOperating Partnership intends to refinance the Bridge Loan with the issuance ofa Commercial Mortgage Backed Security (“CMBS”) facility prior toJanuary 10, 2004.  The OperatingPartnership may have to seek alternative financing, some of which couldnegatively impact net income, if the Operating Partnership were unable to issuethe CMBS facility prior to termination of the Bridge Loan. AtSeptember 30, 2003, the Operating Partnership had $7.3 million ofcash and cash equivalents and had borrowed $101.0 million under the BridgeLoan.

 

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The following details the Operating Partnership’s debtoutstanding at September 30, 2003 (dollar amounts in thousands):

 
|         |   |         |    |               |       |   |     |               |              | **Collateral**   |   |
|--------------|--------|--------------|---------|--------------------|------------|--------|----------|--------------------|-------------------|------------------|--------|
|         |   | **Balance**  |    | **Interest  Rate** |       |   |     | **Maturity**       |              | **# of  Hotels** |   | **Net  Book Value at  September 30, 2003** |   |
|         |   | **(Note A)** |    |               |       |   |     |               |              |             |   |   |   |
| Bridge Loan  |   | $            | 101,000 |               | See Note B |   | Variable |               | January 2004 |             | 39     |   | $ | 558,013 |   |
| Senior Notes |   | 81,753       |    | 9.75               | %          | Fixed  |     | March 2012    |              | —           |   | — |   |
| Mortgage     |   | 91,059       |    | 7.83               | %          | Fixed  |     | December 2008 |              | 10               |   | 123,324 |   |
| Mortgage     |   | 18,037       |    | 8.22               | %          | Fixed  |     | November 2007 |              | 1                |   | 17,147 |   |
| Mortgage     |   | 51,090       |    | 8.00               | %          | Fixed  |     | August 2010   |              | 8                |   | 106,791 |   |
|         |   | $            | 342,939 |               |       |   |     |               |              |             |   |   | $ | 805,275 |   |

 

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Note A – In applying purchase accounting to the Operating Partnership’sdebt instruments, each facility is adjusted to its fair value. Fair value iscalculated based on discounted cash flows using a discount rate equal to theOperating Partnership’s new borrowing rate. Except for the Bridge Loan, thesevalues include a “step-up” to the fair market value. This step-up is accretedover the term of the facility as a reduction of interest expense.

 

Note B -  Interest isincurred at an annual rate equal to the average British Bankers AssociationInterest Settlement Rate for Deposits in Dollars with a term equivalent to onemonth (the “Eurodollar Rate”) plus (i) 3% of the loan value up to approximately$279 million and (ii) 6% of the loan value in excess of $279 million.

 

At September 30, 2003, $101 million wasoutstanding on the Bridge Loan. Interest is incurred at an annual rate equal to the average BritishBankers Association Interest Settlement Rate for Deposits in Dollars with aterm equivalent to one month (the “Eurodollar Rate”) plus (i) 3% of the loanvalue up to approximately $279 million and (ii) 6% of the loan value in excessof $279 million.  The average interestrate on outstanding contracts under the Bridge Loan was approximately 4.1% atSeptember 30, 2003. Interest is paid monthly. The Bridge Loan iscollateralized by 39 hotels that restrict the transfer, pledge or otherhypothecation of the hotels (collectively, the “Collateral Properties”). TheBridge Loan contains various covenants specific to the Operating Partnership,including the maintenance of a minimum loan to value ratio, minimum fixedcharge coverage ratio and restricted payment limitations. In addition, CNL as theOperating Partnership’s parent company, is subject to various covenants underthe Bridge Loan, including the maintenance of a minimum net worth, certainleverage limitations and certain fixed charge limitations. The OperatingPartnership and CNL were in compliance with these covenants atSeptember 30, 2003.

 

From July 1 to July 10, 2003, the interestrate on the Line of Credit was 250 basis points above LIBOR. The Line of Creditwas collateralized by first priority mortgages on 24 hotels that restricted thetransfer, pledge or other hypothecation of the hotels.  The Line of Credit contained variouscovenants including the maintenance of a minimum net worth, minimum debt andinterest coverage ratios, and total indebtedness and liability limitations. TheOperating Partnership was not in compliance with certain of these covenants atJuly 10, 2003, however, the Line of Credit was terminated on July 10,2003 in connection with the merger.

 

During the first quarter of 2003, the OperatingPartnership borrowed approximately $3.8 million under the Line of Credit toretire $3.8 million of Senior Notes. As a result of the redemption of the $3.8million Senior Notes, the Operating Partnership expensed $122 thousand inunamortized debt issuance costs and $29 thousand of costs related to acquiringthe Senior Notes.  During the thirdquarter of 2003, the Operating Partnership borrowed approximately $44.0 millionunder the Bridge Loan to repurchase $41.8 million (book value of $42.2 million)of Senior Notes, plus accrued interest thereon.  No costs were expensed by the Operating Partnership to repurchasethe $41.8 million of Senior Notes as these were accrued as expenses pursuant topurchase accounting principles at the time of the RFS-CNL Transaction.

 

The Operating Partnership’s other borrowings arenonrecourse to the Operating Partnership and contain provisions allowing forthe substitution of collateral, upon satisfaction of certain conditions. Mostof the mortgage borrowings are prepayable and subject to various prepaymentpenalties, yield maintenance, or defeasance obligations. At September 30,2003, approximately 70% of the Operating Partnership’s debt was fixed at aweighted average interest rate of 8.5%.

 

Future scheduled principal payments of debtobligations at September 30, 2003 are as follows (in thousands):

 

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|       |   | **Amount** |    |
|------------|--------|------------|---------|
|       |   |       |    |
| 2003       |   | $          | 901     |   |
| 2004       |   | 104,680    |    |
| 2005       |   | 3,953      |    |
| 2006       |   | 4,217      |    |
| 2007       |   | 20,455     |    |
| Thereafter |   | 208,733    |    |
|       |   | $          | 342,939 |   |

 

In addition to the above principal payment of debtobligations as of September 30, 2003, the Operating Partnership has a cashdeposit of $3.0 million, held in escrow, that serves as collateral on theworker’s compensation plan for the benefit of the hotel employees of Flagstone.This cash deposit is included on the Consolidated Balance Sheet in RestrictedCash. The Operating Partnership is also committed to make future payments undervarious operating leases that are not significant.

 

Certain significant credit statistics at September 30,2003 are as follows:

 

•                                          Weightedaverage maturity of fixed rate debt of 6.5 years

 

•                                          Fixedinterest rate debt equal to 70% of total debt

 

During the nine months ended September 30, 2003,the Operating Partnership spent approximately $10.3 million of capitalexpenditures on its hotels, primarily focused on projects at ten of theOperating Partnership’s hotels: 1) the earthquake retrofit and renovation atthe Hotel Rex in San Francisco, CA; 2) the conversion of the Birmingham hotelto a Hilton from a Sheraton; 3) the completion of product improvement plans atsix of the Hampton Inns; and 4) the renovation of the Residence Inns inFishkill, NY and Sacramento, CA. The Operating Partnership expects to spendapproximately $1.4 million on capital improvements to its hotels for theremainder of 2003, which the Operating Partnership is expected to fund fromcash generated from operations and borrowings under the Bridge Loan.  As a result of the RFS-CNL Transaction, therespective hotel franchisers have issued product improvement plans on most ofthe Operating Partnership’s hotels and require that the Operating Partnershipcomplete these product improvement plans over the next several years. TheOperating Partnership expects the total cost of these product improvement planswill be approximately $40 million.  TheOperating Partnership expects to fund these improvements out of cash generatedfrom operations.

 

TheOperating Partnership expects to be able to meet its short-term workingcapital, capital expenditure and debt service requirements through cash flowfrom operations. As market conditions permit, the Operating Partnership may,from time to time, access the debt and equity capital markets as a source ofadditional liquidity.  AtSeptember 30, 2003, the Operating Partnership had $131.0 million ofborrowing availability under the Bridge Loan. Over the longer term, theOperating Partnership’s ability to generate sufficient cash flow fromoperations to make scheduled payments on its debt obligations will depend onits future financial performance, which will be affected by a range ofeconomic, competitive and business factors, many of which are outside of theOperating Partnership’s control. If the Operating Partnership does not generatesufficient cash flow from operations to satisfy its debt obligations, theOperating Partnership may have to undertake alternative financing plans. TheOperating Partnership cannot assume that completion of any such alternativefinancing plans will be possible. The Operating Partnership’s inability togenerate sufficient cash flow to satisfy its debt obligations or to refinanceits obligations on commercially reasonable terms would have an adverse effecton its business, financial condition and results of operations.

 

The Operating Partnership in the future may seek toincrease further the amount of its credit facilities, negotiate additionalcredit facilities, or issue corporate debt instruments. The OperatingPartnership has no restrictions in its Agreement of Limited Partnership on theamount of indebtedness the Operating Partnership may incur.

 

**Inflation**

 

Operators of hotels, in general, possess the abilityto adjust room rates daily to reflect the effects of inflation. However,competitive pressures may limit the ability of the lessees and managementcompanies to raise room rates.

 

#### **Seasonality**

#### ** **

The hotel industry is seasonal in nature. Generally,occupancy rates and hotel revenues are greater in the second and third quartersthan in the first and fourth quarters. This seasonality can be expected tocause quarterly fluctuations in revenues. Quarterly financial results also maybe adversely affected by factors outside the Operating Partnership’s control,including weather conditions and poor economic factors. As a result, the OperatingPartnership may have to enter into short-term borrowing in the first and fourthquarters in order to offset these fluctuations in revenues and to make paymentson it outstanding debt.

 

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##### **Critical Accounting Policies and Estimates**

##### ** **

The Operating Partnership’s discussion and analysis ofits financial condition and results of operations are based upon the OperatingPartnership’s consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires the OperatingPartnership to make estimates and judgments that affect the reported amounts ofassets, liabilities, revenues and expenses, and related disclosure ofcontingent assets and liabilities. The Operating believes that the followingcritical accounting policies affect the more significant judgments andestimates used in the preparation of the consolidated financial statements.

 

The Operating Partnership evaluates its estimates,including those related to bad debts, carrying value of investments in hotels,income taxes, contingencies and litigation. The Operating Partnership bases itsestimates on historical experience and on various other assumptions that theOperating Partnership believes to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Actual results may differ from these estimates under different assumptions orconditions.

 

The Operating Partnership maintains allowances fordoubtful accounts for estimated losses resulting from the inability ofcustomers or tenants to make required payments. The Operating Partnershipmonitors on a regular basis its outstanding receivables and actively seeks tocollect all overdue balances by sending overdue notices to customers andtenants, speaking with customers and tenants, and seeks collection through theuse of an agency or a court of law. If the Operating Partnership believes thata portion of a receivable or an entire receivable will not be collected, theOperating Partnership will provide an allowance for doubtful accounts againstthat receivable for the estimate of the uncollectible amount. If the financialcondition of the Operating Partnership’s customers were to deteriorate,resulting in an impairment of the customers’ ability to make payments,additional allowances may be required.

 

TheOperating Partnership records an impairment charge when it believes aninvestment in a hotel has been impaired such that future undiscounted cashflows would not recover the book basis of the investment in the hotel. Futureadverse changes in market conditions or poor operating results of underlyinginvestments could result in losses or an inability to recover the carryingvalue of the investments that may not be reflected in an investment’s currentcarrying value, thereby possibly requiring an impairment charge in the future.

 

The Operating Partnership recognizes deferred taxassets for an amount that is more likely than not to be realized. The OperatingPartnership has determined that a $1.3 million valuation allowance is necessarybased on its estimates of future taxable income and ongoing prudent andfeasible tax planning strategies. Should the Operating Partnership determine itwould not be likely to realize the deferred tax asset in the future, theOperating Partnership would record a valuation allowance to reduce the deferredtax asset to an amount that is more likely than not to be realized. Suchadjustment to the deferred tax asset would decrease income in the period suchdetermination was made.

 

**ITEM 3.  *Qualitative and QuantitativeDisclosures about Market Risk***

 

TheOperating Partnership is exposed to certain financial market risks, includingfluctuations in interest rates. The Operating Partnership monitors interestrate fluctuations as an integral part of the Operating Partnership’s overallrisk management program, which recognizes the unpredictability of financialmarkets and seeks to reduce the potentially adverse effect of thisunpredictability on the Operating Partnership’s results. The effect of interestrate fluctuations historically has been small relative to other factorsaffecting operating results, such as occupancy.

 

The Operating Partnership’s primary market riskexposure is to changes in interest rate as a result of its Line of Credit,Bridge Loan and long-term debt. At September 30, 2003, the OperatingPartnership had outstanding total indebtedness of approximately$343.4 million. The Operating Partnership’s interest rate risk objectiveis to limit the impact of interest rate fluctuations on earnings and cash flowsand to lower its overall borrowing costs. To achieve this objective, theOperating Partnership manages its exposure to fluctuations in market interestrates for its borrowings through the use of fixed rate debt instruments to theextent that reasonably favorable rates are obtainable with such arrangementsand derivative financial instruments such as interest rate swaps, toeffectively lock the interest rate on a portion of its variable debt. TheOperating Partnership has not entered into any derivative or interest ratetransactions for speculative purposes, nor does the Operating Partnershipanticipate doing so in the future. Approximately 70% of the OperatingPartnership’s outstanding debt was subject to fixed rates with a weightedaverage interest rate of 8.5% at September 30, 2003. The OperatingPartnership regularly reviews interest rate exposure on its outstandingborrowings in an effort to minimize the risk of interest rate fluctuations.

 

The Operating Partnership’s operating results havehistorically been affected by changes in interest rates primarily as a resultof borrowing under the Line of Credit and Bridge Loan. If interest ratesincreased by 25 basis points, interest expense would have increased byapproximately $78 and $102 thousand for the three and nine months ended September 30,2003,

 

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respectively, based on balances outstanding during the three and ninemonths ended September 30, 2003.

 

Thefollowing table provides information about the Operating Partnership’s instrumentsthat have been sensitive to changes in interest rates. For debt obligationsoutstanding at September 30, 2003, the table presents principal cash flowsand related weighted average interest rates by expected maturity dates.Weighted average variable rates are based on implied forward rates in the yieldcurve as of September 30, 2003. The fair value of the OperatingPartnership’s fixed rate debt at September 30, 2003, indicates theestimated principal amount of debt having similar debt service requirements,which could have been borrowed by the Operating Partnership atSeptember 30, 2003. As part of purchase accounting, the debt was recordedat its fair value, which was approximately $5.8 million higher than itscarrying value on the date of acquisition. The rate assumed in the fair value calculation of fixed rate debt,excluding the senior notes, is equal to 7.00%. The fair value calculation ofthe senior notes is management’s estimate based on recent trade activity in theOperating Partnership’s senior notes and the recent repurchase of the SeniorNotes.

 

## **Expected Principal Cash Flows**

 
| **Liabilities**       |   | **2003**           |       | **2004** |    | **2005** |   | **2006** |   | **2007** |   | **Thereafter** |   | **Total** |   | **Fair********Value  Total** |   |
|-----------------------|--------|--------------------|------------|----------|---------|----------|--------|----------|--------|----------|--------|----------------|--------|-----------|--------|------------------------------|--------|
|                  |   | **(in thousands)** | ** ** |
| Long-Term Debt:       |   |               |       |     |    |     |   |     |   |     |   |           |   |      |   |                         |   |
| Fixed Rate (Note A)   |   | $                  | 703        |     | $       | 2,888    |   | $        | 3,161  |     | $      | 3,424          |   | $         | 19,662 |                         | $      | 206,899 |   | $ | 236,737 |   | $ | 242,161 |   |
| Average Interest Rate |   | 8.54               | %          | 8.54     | %       | 8.54     | %      | 8.54     | %      | 8.54     | %      | 8.54           | %      |      |   |                         |   |
| Variable Rate         |   | —             |       | $        | 101,000 |     | — |     | — |     | — |           | — |      | $      | 101,000                      |   | $ | 101,000 |   |
| Average Interest Rate |   | 3.81               | %          |     |    |     |   |     |   |     |   |           |   |      |   |                         |   |
|                       |        |                    |            |          |         |          |        |          |        |          |        |                |        |           |        |                              |        |  |  |  |  |  |  |  |  |

 

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Note A: The principal cash flows for the fixed rate debt in the tableabove does not include the $5.2 million “step-up” related to the purchase accounting fairmarket value adjustment.

 

Thetable incorporates only those exposures that exist as of September 30,2003 and does not consider exposures or positions that could arise after thatdate. In addition, because firm commitments are not represented in the tableabove, the information presented therein has limited predictive value. As aresult, the Operating Partnership’s ultimate realized gain or loss with respectto interest rate fluctuations would depend on the exposures that arise duringfuture periods, prevailing interest rates, and the Operating Partnership’sstrategies at that time. There is inherent rollover risk for borrowings as theymature and are renewed at current market rates. The extent of this risk is notquantifiable or predictable because of the variability of future interest ratesand the Operating Partnership’s financing requirements.

 

**ITEM 4.  *Internal Controls andProcedures***

 

Pursuant to Rule 15d-15(b) under the Exchange Act, theOperating Partnership’s management, with the participation of the OperatingPartnership’s Chief Executive Officer and Principal Financial Officer, hascarried out an evaluation of the effectiveness of the Operating Partnership’sdisclosure controls and procedures (as defined under Rule 15d-15(e) under theSecurities Exchange Act of 1934) as of the end of the period covered by thisreport.  Based upon that evaluation, theOperating Partnership’s management, including the Chief Executive Officer andPrincipal Financial Officer, has concluded that the Operating Partnership’sdisclosure controls and procedures are effective in timely alerting them toinformation required to be disclosed in the Operating Partnership’s periodicSEC filings.

 

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**PART II—OTHER INFORMATION**

 

**ITEM1.*****Legal Proceedings***

 

The Operating Partnership herby incorporates by referenceinto this Item 1 of Part II Note 18 to the Notes to the Consolidated FinancialStatements.

 

**ITEM4.*****Submission of Matters to a Vote of Security Holders***

 

Other than the consents obtained withrespect to the RFS-CNL Transaction, no matters were submitted to a vote ofsecurity holders.

 

**ITEM5.  *OtherInformation***

 

**Available Information**

 

The Operating Partnership’s former internet website,www.rfshotel.com, is no longer operational. CNL’s internet website iswww.cnlonline.com.  CNL makes availablefree of charge through its website the Operating Partnership’s annual reportson Form 10-K, quarterly reports on Form 10-Q, current reports onForm 8-K and amendments to those reports filed or furnished pursuant toSection 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended,as soon as reasonably practicable after such documents are electronically filedwith, or furnished to, the SEC. The information on the CNL website is not, andshall not be deemed to be, a part of this report or incorporated into any otherfilings that the Operating Partnership makes with the SEC.

 

**ITEM 6. *Exhibits and Reports on Form 8-K***

 

The following documents are filed as part of thisreport:

 

**(a) Exhibits**

 

Exhibit 31.1   Certification of Chief Executive Officer, Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith)

 

Exhibit 31.2   Certification of Principal Financial Officer, Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith)

 

Exhibit 32.1   Certification of Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished herewith)

 

Exhibit 32.2   Certification of Principal Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished herewith)

 

**(b) The Operating Partnership filedthe following reports during the quarter ended September 30, 2003 on Form8-K:**

 

•                                          July 8,2003—Item 5 and Item 7 report regarding the issuance of a press releaseannouncing that RFS’s shareholders had approved the RFS merger.

 

•**                                         **July 25,2003—Item 1, Item 2 and Item 7 report regarding change in control of theOperating Partnership, the acquisition of assets by the Operating Partnership,and the filing of pro forma financial information and other exhibits.

 

•**                                         **August 14,2003—Item 5 and Item 7 report regarding the issuance of a press releaseannouncing the Operating Partnership’s termination of its SEC reportingobligation.

 

•                                          August 29,2003—Item 5 and Item 7 report regarding the issuance of a press releaseannouncing the Operating Partnership’s results of its change of control offer.

 

•**                                         **September 17,2003—Item 7 report regarding the filing of pro forma financialinformation.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                   |   | RFS PARTNERSHIP, L.P.                                                                                                       |
|------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
|                   |   |                                                                                                                        |
|                   |   | By: CNL ROSE GP CORP., its  general partner                                                                                 |
| November 14, 2003 |   | /s/ C. Brian Strickland                                                                                                     |   |
| Date                   |   | C. Brian Strickland  Title: Executive Vice President (Authorized Signatory and  Principal Financial and Accounting Officer) |

 

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