**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-K**

 

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| **(Mark One)**                                   |   |                                                                                          |
|--------------------------------------------------|--------|-----------------------------------------------------------------------------------------------|
| ý                                           |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|                                             |
| **For the  fiscal year ended December 31, 2003** |
|                                             |
| **OR**                                           |
|                                             |
| o                                                |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**for thetransition period from         to         **

** **

| **Commission  File  Number** |   | **Exact name of registrant as specified in its charter,  state of  incorporation, 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 **(407) 650-1000**            |   | **62-1541639**                             |

 

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

 

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

 

Indicate by check mark whether the Registrant (i) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod 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 if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not becontained, to the best of the registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether RFS Partnership, L.P. is an acceleratedfiler (as defined in Exchange Act Rule 12b-2).  o Yes ý No

 

The number of units of RFS Partnership, L.P. outstanding onMarch 30, 2004 was 31,941,852 (99.9% of which were held by CNL RoseAcquisition Corp. and 0.1% were held by CNL Rose GP Corp.).  There is no market for the Registrant’sunits.

 

On August 14, 2003, RFS Partnership, L.P. (the“Operating Partnership”), filed with the Securities and Exchange Commission (the“Commission”) a Certification and Notice of Termination of Registration on Form15 (the “Form 15”), terminating the Operating Partnership’s obligation to filereports with the Commission under the Securities Exchange Act of 1934, asamended (the “Act”).  Although the filing of the Form 15 terminates theOperating Partnership’s obligation to file reports under the Act, the OperatingPartnership is filing this Annual Report on Form 10-K, 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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**PART I**

**Item 1. *Business***

 

RFSPartnership, L.P. (the “Operating Partnership”) is a Tennessee limitedpartnership which, at December 31, 2003, owned interests in 62 hotels with9,399 rooms located in 26 states (collectively the “Hotels”). On July 10, 2003,RFS Hotel Investors, Inc. (“RFS”) and the Operating Partnership were acquiredby subsidiaries of CNL Hospitality Properties, Inc. (“CNL”) for approximately$383 million in cash ($12.35 per share or limited partnership unit) (“RFS-CNLTransaction”), excluding the 1.0 million shares of RFS stock acquired by CNLprior to July 10, 2003.  Uponconsummation of this transaction, RFS was merged with and into a subsidiary ofCNL 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”) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”).  On August 14, 2003, theOperating Partnership filed with the SEC a Form 15, terminating the OperatingPartnership’s obligation to file reports with the SEC.  Although thefiling of the Form 15 terminates the Operating Partnership’s obligation to filereports under the Exchange Act, the Operating Partnership is filing this AnnualReport on Form 10-K, in accordance with its obligation to do so set forth inthat certain indenture, by and among the Operating Partnership, RFS 2002Financing, Inc., CNL Rose Acquisition Corp., RFS Leasing VII, Inc. and U.S.Bank, N.A., dated as of February 26, 2002, as amended July 10, 2003, the notesissued pursuant to which are hereinafter referred to as the “Senior Notes”.

 

The Operating Partnership has grown from owning seven hotels with 1,118rooms in five states in August 1993 to owning interests in 62 hotels with9,399 rooms in 26 states at December 31, 2003. Many of the OperatingPartnership’s hotels are located in attractive metropolitan areas or growingsecondary markets and are well located within these markets. All but two of theOperating Partnership’s hotels are operated under franchises from nationallyrecognized franchisors such as Marriott International, Inc., Hilton HotelsCorporation, Starwood Hotels & Resorts, Inc., Wyndham Hotels andResorts and Six Continents PLC.

 

For the year ended December 31, 2003,the Operating Partnership generated revenue of $184.8 million and a net loss of$17.1 million. In 2003, the Operating Partnership received 47.5% of its revenuefrom full service hotels, 26.5% from extended stay hotels and 26.0% fromlimited service hotels. The Operating Partnership received 57% of its revenuein five states (California (30%), Texas (8%), Florida (7%), Michigan (6%) andMissouri (6%)).

 

The following summarizes additionalinformation for the 62 hotels owned at December 31, 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              |   |
| Homewood Suites by Hilton     |   | 1                     |   | 83               |   |
|                          |   | 19                    |   | 3,731            |   |
|                          |   |                  |   |             |   |
| Extended Stay Hotels:         |   |                  |   |             |   |
| Residence Inn by Marriott     |   | 15                    |   | 2,201            |   |
| TownePlace Suites by Marriott |   | 3                     |   | 285              |   |
|                          |   | 18                    |   | 2,486            |   |
|                          |   |                  |   |             |   |
| 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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The following summarizes the number of hotels owned for the periodspresented: 

 
|                              |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                              |   |     |   |     |   |     |   |
| Hotels owned at beginning of year |   | 57       |   | 58       |   | 60       |   |
| Contribution of hotels from CNL   |   | 5        |   |     |   |     |   |
| Sales of  hotels                  |   |     |   | (1       | )      | (2       | )      |
|                              |   |     |   |     |   |     |   |
| Hotels owned at end of year       |   | 62       |   | 57       |   | 58       |   |

 

Concurrentwith the consummation of the RFS-CNL Transaction, CNL contributed five hotelsto the Operating Partnership with net assets of approximately $131.6 million.The five hotels are a Residence Inn in Orlando, Florida, a Marriott Courtyardin Edison, New Jersey, a Hyatt Regency in Coral Gables, Florida, a Wyndham inBillerica, 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. The OperatingPartnership includes rental income from these leases and depreciation on thesehotels in our consolidated results of operations.

 

In connection with the acquisition of RFS, six non-strategic hotelswere identified for sale and are carried at a cost of approximately $29.6million.

 

At December 31,2003, the Operating Partnership leased seven hotels to three third-partylessees and three hotels to taxable REIT subsidiaries owned by CNL, but notowned by the Operating Partnership. In October 2003, the Operating Partnershipbegan terminating existing management agreements with Flagstone HospitalityManagement LLC (“Flagstone”), which managed 50 of the 57 RFS properties priorto its acquisition, and franchise licenses for most of its portfolio of hotels,and entering into new management and franchise license agreements withinternationally recognized hotel brand managers. At December 31, 2003, thirteenhotels are managed by Hilton Hotels Corporation (“Hilton”), ten hotels aremanaged by Marriott International (“Marriott”), 28 hotels are managed by InterstateHotels and Resorts (“Interstate”), and eleven other hotels are managed by sixother independent management companies. On January 31, 2004, the management of five hotels was transferred fromInterstate to Hilton (two hotels) and Marriott (three hotels).

 

**Termination of Leasesand Related Agreements with Hilton**

 

Under the REIT Modernization Act (the “RMA”)that became effective January 1, 2001, the Operating Partnership ispermitted to lease its hotels to wholly-owned taxable REIT subsidiaries of theOperating Partnership (“TRS Lessees”), provided that the TRS Lessees engage athird-party management company to manage the hotels. On January 1, 2001,the Operating Partnership terminated its operating leases, management contractsand related ancillary agreements with a wholly-owned subsidiary of HiltonHotels Corporation (“Hilton”) for approximately $65.5 million. This transactionrepresented the cancellation of executory contracts that extended through 2012and substantially all of the termination payment was recorded as an expense onJanuary 1, 2001.

 

In connection with the termination of theleases and related agreements, the Operating Partnership redeemed 973,684shares of its Series A Preferred Units owned by a subsidiary of Hilton for$13 million, which resulted in a gain on redemption of $5.1 millionthat was included in net income available to unitholders in the first quarterof 2001.

 

The aggregate $73 million of payments toHilton ($60 million lease termination expense plus $13 million torepurchase the Series A Preferred Units, plus related expenses), werefinanced by:

 

•                                          the sale of two hotels in 2000 for approximately$25 million;

•                                          net proceeds from the sale of a new issue ofnon-convertible mandatorily redeemable preferred units (the “Series BPreferred Units”) for $25 million (before fees and expenses); and

•                                          borrowings under the Operating Partnership’s lineof credit.

 

In conjunction with the new management andfranchise license agreements entered into during the fourth quarter of 2003, theOperating Partnership terminated the existing leases with its TRS Lessees andentered into new leases with the either the same or a different TRS Lessee. Theduration of the leases coincides with the duration of the new management andfranchise license agreements. The leases provide for the payment of base andpercentage rent from the TRS Lessees to the owner subsidiary based on the totalhotel revenue of the TRS Lessees.

 

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**Competitive Strengths**

 

The Operating Partnership believes that it isdistinguished by the following competitive strengths:

 

*DiversifiedAsset Base.*  The Operating Partnership’s hotel portfoliois diversified by brand, geography and market segment. The OperatingPartnership’s hotels are operated under leading brands including Sheraton,Residence Inn by Marriott, Hilton, Doubletree, Holiday Inn, Wyndham, Hyatt,Courtyard by Marriott, Hampton Inn, and Homewood Suites by Hilton. TheOperating Partnership owns hotels in 26 states. For the year endedDecember 31, 2003, the Operating Partnership generated 57% of its revenuein five states (California (30%), Texas (8%), Florida (7%), Michigan (6%) andMissouri (6%)), and the remaining 43% in 21 other states, and the OperatingPartnership generated 47.5% of its revenue from full service hotels, 26.5% fromextended stay hotels and 26.0% from limited service hotels. No single hotelaccounted for more than 5% of the Operating Partnership’s revenue for the yearended December 31, 2003.

 

*FavorableCorporate Structure.*  As a result of the RMA, effectiveJanuary 1, 2001, the Operating Partnership terminated its operating leasesand management contracts with subsidiaries of Hilton, and established the TRSLessees, which currently lease 52 of our hotels. This TRS structure enables usto directly oversee the management of these hotels without an intermediatethird-party lessee. The new TRS structure also allows the Operating Partnershipto retain the operating profits or losses from the hotels in the TRS lesseestructure and provides the Operating Partnership with the following advantageswhen compared to the Operating Partnership’s prior third-party lesseestructure:

 

•                                          more control over the daily operations of thesehotels;

•                                          benefits from cost efficiencies or ancillaryrevenues generated at these hotels;

•                                          benefits from hotels no longer being encumbered bylong-term third-party leases; and

•                                          financial statements that more clearly depict theOperating Partnership’s hotel operations.

 

**Business Strategy**

 

The principal features of the OperatingPartnership’s business strategy are outlined below:

 

*ActivelyManage the Portfolio of Assets.*  The Operating Partnership seeksto increase operating cash flows through active asset management. The OperatingPartnership applies its asset management and investing expertise to therenovation, redevelopment and rebranding of its existing hotels and themaintenance of strong strategic relationships with its brand owners andmanagers. The Operating Partnership has spent approximately $42.1 million, or7.4% of hotel revenue, excluding lease revenue and other revenue, in order toenhance its hotels’ competitive position and improve cash flow over the pastthree years.

 

*MaintainStrong Brand Affiliations.*  All but two of the OperatingPartnership’s hotels operate under franchises from national hotel brands.Franchised hotels typically have higher levels of occupancy and average dailyrates than non-franchised hotels due to access to the national reservationsystems and marketing provided by these franchisors. For the year endedDecember 31, 2003, the Operating Partnership generated 93% of its revenuefrom hotels under franchise by four of the largest and most well-respectedhotel franchisors: Marriott (Residence Inn, Courtyard by Marriott, TownePlaceSuites by Marriott), Hilton (Hilton, Doubletree, Hampton Inn, Homewood Suitesby Hilton), Starwood (Sheraton and Four Points by Sheraton) and Six Continents(Holiday Inn and Holiday Inn Express).

 

*DivestNon-Core Properties.*  The Operating Partnership continues tomodify its portfolio by selectively divesting hotels that are not consistentwith its long-term investment objectives, particularly limited service hotelslocated in smaller markets. The Operating Partnership intends to continue to selectivelydivest hotels that:

 

•                                          may offer limited earnings growth;

•                                          may suffer adverse changes in their local markets;or

•                                          may not offer attractive returns on requiredadditional capital investments.

 

In connection with the acquisition of RFS, six non-strategic hotelswere identified for sale and are carried at a cost of approximately $29.6million.  Over the past three years, the Operating Partnership has sold threenon-core properties for approximately $15.4 million.

 

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**Competition**

 

The hotel industry is generally characterizedas being intensely competitive. The Operating Partnership’s hotels compete withindependently owned hotels, hotels which are part of local or regional chains,and hotels in other well-known national chains, including those offeringdifferent types of accommodations. The principal competitive factors affectingthe Operating Partnership’s hotels are brand recognition, location, range ofservices and guest amenities offered, the quality of the hotel and servicesprovided, and price.

 

The Operating Partnership competes with otherpersons and entities to locate suitable properties to acquire interests in andto locate purchasers for its properties. The Operating Partnership also will competewith other financing sources such as banks, mortgage lenders, andsale/leaseback companies for suitable properties, tenants and mortgage loanborrowers.

 

**Available Information**

 

The Operating Partnership’s former internetwebsite, 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 Report onForm 10-K, Quarterly Reports on Form 10-Q, Current Reports onForm 8-K and, if applicable, amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the Securities ExchangeAct of 1934, as amended, as soon as reasonably practicable after the OperatingPartnership electronically files such material with, or furnishes it to, theSecurities and Exchange Commission (“Commission”). The information on the CNLwebsite is not, and shall not be deemed to be, a part of this report orincorporated into any other filings that the Operating Partnership makes withthe Commission.

 

**Employees**

 

The Operating Partnershiphas no employees other than our officers who are not compensated by theOperating Partnership. We have retained CNL Hospitality Corp. as our advisor toprovide management, acquisition, development, advisory and some administrativeservices and have retained other affiliates to provide additionaladministrative services. All persons employed in the day-to-day operations ofthe hotels are employees of the management companies engaged to operate thehotels and are not the Operating Partnership’s employees. Should there be anemployee disruption at any of the third party management companies, i.e. astrike, this could have a significant impact on the Operating Partnership’soperations.

 

**Tax Status**

 

The Operating Partnership may own up to 100%of its TRS Lessees. A TRS Lessee is a taxable corporation that may lease hotelsunder certain circumstances, provide services to the Operating Partnership, andperform activities unrelated to the Operating Partnership’s tenants, such asthird-party management, development, and other independent business activities.Overall, no more than 20% of the value of the Operating Partnership’s assetsmay consist of securities of one or more of its TRS Lessees.

 

A TRS is permitted to lease hotels from theOperating Partnership as long as the hotels are operated on behalf of the TRSby a third-party hotel manager who satisfies the following requirements:

 

•                                          such manager is, or is related to a person who is,actively engaged in the trade or business of operating “qualified lodgingfacilities” for any person unrelated to the Operating Partnership and its TRSLessees;

•                                          such manager does not own, directly or indirectly,more than 35% of the Operating Partnership’s units;

•                                          no more than 35% of such manager is owned,directly or indirectly, by one or more persons owning 35% or more of theOperating Partnership’s units; and

•                                          the Operating Partnership does not directly orindirectly derive any income from such manager.

 

The deductibility of interest paid or accruedby a TRS Lessee to the Operating Partnership is limited. The RMA also imposes a100% excise tax on transactions between a TRS Lessee and the OperatingPartnership or its tenants that is limited not conducted on an arm’s-lengthbasis.

 

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**Risk Factors**

 

**Risks Related to theOperating Partnership and the Conduct of Business**

 

***Current geo-political uncertainty as well asthe weak economy have adversely impacted the hotel industry generally, and theOperating Partnership has experienced an adverse effect on its results ofoperations and financial condition. These trends may continue to impact theOperating Partnership into the foreseeable future.***

 

Prior to September 11, 2001, revenue peravailable room began to decline as a result of the slowing economy,particularly the Operating Partnership’s hotels in San Francisco and SiliconValley. The terrorist attacks of September 11, 2001, the currentgeo-political uncertainty related to conflicts with Iraq and potentialconflicts with North Korea, the continued terrorist threats, and the effects ofa weak economy have led to a substantial reduction in business and leisuretravel throughout the United States and industry revenue per available roomgenerally. 2002 marked the second consecutive year in which revenue peravailable room declined year over year. In 2003, revenue per available roomincreased only 0.2%, as determined by Smith Travel Research. Even thoughrevenue per available room increased slightly in 2003, and the industry isprojecting RevPAR growth in 2004 of approximately 5% (as estimated by bothSmith Travel Research and PricewaterhouseCoopers), revenue per available roommay ultimately continue to decline. The Operating Partnership cannot predict theextent to which the current geo-political uncertainty will continue to directlyor indirectly impact the hotel industry or the Operating Partnership’soperating results in the future. Continued lower revenue per available room atthe Operating Partnership’s hotels could have an adverse effect on its resultsof operations and financial condition, including the Operating Partnership’sability to remain in compliance with debt covenants, and the ability to fundcapital improvements and renovations at its hotels. Additional terroristattacks or war could have further material adverse effects on the hotelindustry and the Operating Partnership’s operations.

 

***TRS lessee structure subjects the OperatingPartnership to the risk of increased hotel operating expenses.***

 

Prior to January 1, 2001, substantiallyall of the Operating Partnership’s hotels were leased to third-parties underleases providing for the payment of rent based, in part, on revenues from theOperating Partnership’s hotels. Accordingly, operating risks were essentiallylimited to changes in hotel revenues and to the lessees’ ability to pay therent due under the leases. In addition to the ownership expenses previouslyborne by the Operating Partnership, the Operating Partnership is now subject tothe risks of increased hotel operating expenses for the 52 hotels now in theOperating Partnership’s TRS lessee structure, including but not limited to:

 

•                                          wage and benefit costs;

•                                          repair and maintenance expenses;

•                                          energy costs, which have increased in recentmonths, especially at the California hotels;

•                                          the costs of liability insurance; and

•                                          other operating expenses.

 

Increases in these operating expenses canhave a significant adverse impact on the Operating Partnership’s earnings andcash flow.

 

***The formation of the TRS Lessees willincrease the Operating Partnership’s overall tax liability.***

 

Effective January 1, 2001, the OperatingPartnership formed the TRS Lessees, which currently lease 52 of our hotels. TheTRS Lessees are subject to federal and state income tax on their taxableincome, which consists of the revenues from the hotels leased by the TRSLessees net of the operating expenses for such hotels and rent payments.Accordingly, although the formation of the TRS Lessees allows the OperatingPartnership to participate in the operating income from the hotels in additionto receiving rent, that operating income is fully subject to income tax. Theafter-tax net income of the TRS Lessees is available for distribution to CNL asdistributions.

 

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***Uninsured and underinsured losses might havean adverse effect on the Operating Partnership’s financial condition.***

 

The Operating Partnership maintainscomprehensive insurance on each of its hotels, including liability, fire andextended coverage, of the type and amount the Operating Partnership believes iscustomarily obtained for or by hotel owners. Some of the OperatingPartnership’s insurance policies are written, implemented and monitored by thethird party companies who manage the Operating Partnership’s hotels and theOperating Partnership does not have the ability to actively monitor theseprograms and claims thereon. All 10 of the Operating Partnership’s hotels inCalifornia are located in areas that are typically subject to more earthquakeactivity than in other locations in the United States. These hotels are locatedin areas of high seismic risk and some were constructed under building codeswhich were less stringent with regard to earthquake related requirements. Anearthquake could render significant uninsured damage to the hotels.Additionally, areas in Florida, where eight of the Operating Partnership’shotels are located, may experience hurricane or high-wind activity. TheOperating Partnership has earthquake and windstorm insurance policies on itshotels. However, various types of catastrophic losses, like earthquakes andfloods may not be fully insurable or may not be economically insurable. Withrespect to the earthquake insurance policies, in addition to the applicabledeductibles under the earthquake insurance policies, the Operating Partnershipis self-insured for any losses in excess of $40 million per earthquake. Thewindstorm insurance policies are of the type and amount the Operating Partnershipbelieves is customarily obtained for or by hotel owners.  The Operating Partnership also maintainsterrorism insurance, which the Operating Partnership believes currently insuresagainst losses resulting from a terrorist attack. In the event of a substantialloss, insurance coverage may not be able to cover the full current market valueor replacement cost of the Operating Partnership’s lost investment. Inflation,changes in building codes and ordinances, environmental considerations andother factors might also affect the Operating Partnership’s ability to replaceor renovate a hotel after it has been damaged or destroyed.

 

***Hotel concentration in certain states,particularly California, subjects the Operating Partnership to operating risks.***

 

For the year ended December 31, 2003,approximately 57% of the Operating Partnership’s revenue came from its hotelslocated in California (30%), Texas (8%), Florida (7%), Michigan (6%) andIllinois (6%). Adverse events in these areas, such as economic recessions ornatural disasters, could cause a loss of revenues from these hotels, whichcould have a greater adverse effect on the Operating Partnership as a result ofits concentration of assets in these areas. The Operating Partnership’sgeographic concentration also exposes it to risks of oversupply and competitionin its principal markets. Each of the Operating Partnership’s hotels competeswith other hotels in its market area. A number of additional hotel rooms willcontinue to be built in the markets in which the Operating Partnership’s hotelsare located, which could result in too many hotel rooms in those regions.Significant increases in the supply of hotel rooms without correspondingincreases in demand can have a severe adverse effect on the Operating Partnership’sbusiness, financial condition and results of operations.

 

The San Francisco Bay Area, including SiliconValley, has suffered an economic downturn related to the decline in thetechnology and Internet related markets. In particular, revenues at the OperatingPartnership’s four hotels in Silicon Valley and two hotels in San Franciscohave been adversely impacted by the weak economy and by recent job reductionsin the technology and Internet sectors. As a result of the continued weakeconomy and geo-political uncertainty, while the Operating Partnership’s entirehotel portfolio was adversely impacted, the northern California hotels wereparticularly affected. Revenue per available room at the OperatingPartnership’s five comparable hotels in northern California (excludes the HotelRex in San Francisco which was closed for earthquake retrofit and renovationduring the fourth quarter of 2002 and the first quarter of 2003), consisting ofone hotel in San Francisco and four hotels in Silicon Valley, experienced anaverage decline in revenue per available room of 9.2% for the year. Excludingthe six northern California hotels and the non-comparable Residence Inns inSacramento, CA and Fishkill, NY, revenue per available room declined 2.3% forthe year. For the year ended December 31, 2003, the Operating Partnershipreceived approximately 30% of its revenue from hotels in portions ofCalifornia, including Silicon Valley (12%), Los Angeles (6%), Sacramento (2%),San Diego (4%) and San Francisco (6%).

 

Also, California faced an energy crisisduring 2001 that significantly increased energy costs at the 10 Californiahotels, although the impact was somewhat offset through the OperatingPartnership’s ability to collect energy surcharges in California. While thisenergy crisis was resolved, if California experiences another energy crisis,and the Operating Partnership cannot adequately pass its increased costs tocustomers through energy surcharges or otherwise, or the state’s economy,particularly Northern California, continues to experience decreasing occupancyrates, revenue per available room, average daily rate (“ADR”) or other industryfundamentals, it could have a material adverse effect on the OperatingPartnership’s business, financial condition and results of operation.

 

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***Reliance on third-party management companiesto operate the Operating Partnership’s hotels and a change in these managementcompanies may be costly and disruptive to the Operating Partnership’s operations.***

 

Under the REIT Modernization Act, in orderfor CNL to continue to qualify as a REIT, the Operating Partnership’s hotelsmust be managed by third-parties. Under the terms of the management agreements,the Operating Partnership’s ability to participate in operating decisionsregarding the hotels is limited. Nine unrelated third-parties currently manageall of the Operating Partnership’s hotels. These property managers presentlycontrol the daily operations of the hotels. The Operating Partnership dependson these managers to adequately operate its hotels as provided in themanagement agreements. Even if the Operating Partnership believes that itshotels are not being managed efficiently or in a manner that results insatisfactory occupancy rates, revenue per available room or ADR, the OperatingPartnership may not be able to force the management company to change the wayit operates the Operating Partnership’s hotels in a timely manner.Additionally, in the event that the Operating Partnership needs to replace anyof its management companies, like it did with Flagstone in 2003, which managed50 of the 57 hotels it then owned, the Operating Partnership may experiencesignificant disruptions at its hotels and in its operations and decreasedoccupancy. During 2003, the Operating Partnership terminated a substantialportion of the management agreements with Flagstone. Furthermore, because theOperating Partnership must have third-party managers to maintain CNL’s REITstatus, it may be forced to enter into new management agreements on terms thatthe Operating Partnership believes are unfavorable or less favorable than theterms of the Operating Partnership’s current agreements. Any of the foregoing,may result in a material adverse effect on the Operating Partnership’sbusiness, financial condition and results of operations.

 

***Compliance with requirements of franchiseagreements.***

 

Most of the Operating Partnership’s hotelsare operated under a franchise license. Each license agreement requires thatthe licensed hotel be maintained and operated in accordance with certainstandards and requires the Operating Partnership to pay a variety of franchiserelated fees to the franchisors. The franchisors also may require substantialimprovements to the Operating Partnership’s hotels, for which the OperatingPartnership would be responsible, as a condition to the renewal or continuationof these franchise licenses. In connection with the RFS-CNL Transaction, theOperating Partnership is required, as part of the new franchise licenses, tomake approximately $40 million of improvements to its hotels over the nextthree years.

 

If a franchise license terminates due to theOperating Partnership’s failure to make required improvements or to otherwisecomply with its terms, the Operating Partnership may be liable to thefranchisor for a termination payment. These termination payments would vary byfranchise agreement and by hotel. Although the Operating Partnership has neverhad a franchise agreement terminated by a franchisor, the loss of a substantialnumber of franchise licenses and the related termination payments could have amaterial adverse effect on its business, financial condition and results ofoperations.

 

***The Operating Partnership may not be able tosuccessfully implement its acquisition and disposition strategy or realize thebenefit of its strategy.***

 

One of the Operating Partnership’s keystrategies includes the acquisition of attractive hotel properties. However,the Operating Partnership competes for hotel acquisitions with other entities.These entities generally may be able to accept more risk than the OperatingPartnership can manage wisely and may be able to pay higher acquisition pricesthan the Operating Partnership is willing to pay. This competition may generallylimit the number of suitable investment opportunities offered to the OperatingPartnership. This competition may also increase the bargaining power ofproperty owners seeking to sell to the Operating Partnership, making it moredifficult for the Operating Partnership to acquire new properties on attractiveterms. Furthermore, in recent years, the Operating Partnership believes thatacquisition prices were not attractive by historical standards and theOperating Partnership reduced its acquisition activity accordingly. While theOperating Partnership believes that the hotel acquisition market has recentlybecome more favorable, there can be no assurance that a sufficient number ofattractive properties, both in terms of price and quality, will be availablefor acquisition or that the Operating Partnership will ultimately be able toacquire those hotel properties on favorable terms.

 

Additionally, the Operating Partnership’sstrategy includes continually shifting its portfolio by selectively divestinglimited service hotels which are not consistent with the OperatingPartnership’s long-term investment horizon, particularly those in smallermarkets. As with acquisitions, the Operating Partnership faces competition forbuyers of its hotel properties. Other sellers of hotels may have the financialresources to dispose of their hotels on unfavorable terms that the OperatingPartnership would be unable to accept. If the Operating Partnership cannot findbuyers for its non-core properties, it will not be able to implement itsdivestiture strategy.

 

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In the event that the Operating Partnership cannot fully execute itsacquisition and divestiture strategy or realize the benefits therefrom, it maynot be able to grow its business, EBITDA or cash flow.

 

***The Operating Partnership may be unable toadequately finance or fully realize the anticipated benefits of itsrenovations.***

 

As part of the OperatingPartnership’s internal growth strategy, it regularly renovates, redevelops and,in certain cases, re-brands its hotels. In addition, the franchisors requirethe Operating Partnership to make periodic capital improvements as a conditionto keeping the franchise licenses. During 2003, 2002 and 2001, the OperatingPartnership spent approximately $11.3 million, $14.6 million and$18.0 million, respectively, on capital improvements to its hotels. TheOperating Partnership expects to spend approximately $17.7 million dollarson capital improvements in 2004, which includes amounts required under theproduct improvement plans planned for 2004. As stated previously, as a result of the RFS-CNL Transaction, theOperating Partnership is required, as part of the new franchise licenses, tomake approximately $40 million of improvements to its hotels over the nextthree years, which includes the amount budgeted to spend in 2004.  The Operating Partnership’s currentindebtedness, as well as its Senior Notes, may restrict its ability to financeproposed capital expenditures, which may cause the Operating Partnership todelay, alter materially or abandon planned capital improvements andrenovations. In addition to the difficulties with financing these projectsdiscussed above, renovations also give rise to the following risks:

 

•                                          possible environmental problems;

•                                          construction cost overruns and delays;

•                                          uncertainties as to market demand or a loss ofmarket demand after renovations have begun; and

•                                          displacement of room revenues due to rooms beingout of order.

 

If the completion of renovation projects issignificantly delayed, operating results could be adversely affected. Inaddition, no assurance can be given that recently completed and ongoingimprovements will achieve the results anticipated when the OperatingPartnership made the decision to invest in the improvements.

 

**Risks Related to theHotel Industry**

 

***The Operating Partnership is subject to therisks of hotel operations.***

 

The Operating Partnership has invested onlyin hotel-related assets, and its hotels are subject to all of the risks commonto the hotel industry. These risks could adversely affect hotel occupancy andthe rates that can be charged for hotel rooms as well as hotel operatingexpenses, and generally include:

 

•                                          competition from other hotels;

•                                          increases in supply of hotel rooms that exceedincreases in demand;

•                                          increases in energy costs and other travelexpenses that reduce business and leisure travel;

•                                          reduced business and leisure travel due tocontinued geo-political uncertainty, including terrorism;

•                                          adverse effects of declines in general and localeconomic activity;

•                                          adverse effects of a downturn in the hotelindustry; and

•                                          risks generally associated with the ownership ofhotels and real estate, as discussed below.

 

***An industry downturn could adversely affectresults of operations.***

 

According to Smith Travel Research, for allU.S. hotels, industry revenue per available room experienced a year over yearincrease of approximately 0.2% in 2003 versus year over year decreases of 2.0%and 6.9% in 2002 and 2001, respectively, and is expected to increaseapproximately 5% in 2004.

 

If the Operating Partnership is unable tosustain appropriate levels of revenue per available room, its operating marginsmay deteriorate, and it may be unable to execute its business plan, includingthe selective acquisition of hotel properties. In addition, if this downwardtrend continues, the Operating Partnership may be unable to continue to meetits debt service obligations as they become due or to obtain necessaryadditional financing.

 

8

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***Seasonality of the hotel business can beexpected to cause quarterly fluctuations in revenues.***

 

Demand in the lodging industry is affected byrecurring seasonal patterns.  For hotelproperties which are not tourism oriented, hotel revenues are generally greaterin the second and third calendar quarters, and for hotel properties in touristareas, including resorts, revenues are generally greater for the third andfourth calendar quarters than other times of the year.  Seasonal variations in revenue at theOperating Partnership’s hotels can be expected to cause quarterly fluctuationsin revenues and earnings.  Hoteloperations also may be adversely affected by events beyond the OperatingPartnership’s control, such as extreme weather conditions, poor economicfactors and/or cycles, and other factors affecting travel.  Historically, to the extent that cash flowsfrom operations has been insufficient during any quarter, due to temporary orseasonal fluctuations in revenues, the Operating Partnership has utilizedborrowings under its line of credit to fund a portion of its distributions toequity and debt holders.

 

***The Operating Partnership will also encounterrisks that may adversely affect real estate ownership in general.***

 

The Operating Partnership’s investments inhotels are subject to the numerous risks generally associated with owning realestate, including among others:

 

•                                          adverse changes in general or local economic orreal estate market conditions;

•                                          changes in zoning laws;

•                                          changes in traffic patterns and neighborhoodcharacteristics;

•                                          increases in assessed valuation and tax rates;

•                                          increases in the cost of property insurance;

•                                          governmental regulations and fiscal policies;

•                                          the potential for uninsured or underinsuredproperty losses;

•                                          the impact of environmental laws and regulations;and

•                                          other circumstances beyond our control.

 

Moreover, real estate investments arerelatively illiquid, and the Operating Partnership may not be able to vary itsportfolio in response to changes in economic and other conditions.

 

***Compliance with environmental laws mayadversely affect the Operating Partnership’s financial condition.***

 

The Operating Partnership’s hotel propertiesare subject to various federal, state and local environmental laws. Under theselaws, courts and government agencies have the authority to require the owner ofa contaminated property to clean up the property, even if the owner did notknow of or was not responsible for the contamination. These laws also apply topersons who owned a property at the time it became contaminated. In addition tothe costs of cleanup, contamination can affect the value of a property and,therefore, an owner’s ability to borrow funds using the property as collateral.Under the environmental laws, courts and government agencies also have theauthority to require that a person who sent waste to a waste disposal facility,like a landfill or an incinerator, pay for the clean-up of that facility if itbecomes contaminated and threatens human health or the environment.Furthermore, decisions by courts have established that third-parties mayrecover damages for injury caused by property contamination. For instance, aperson exposed to asbestos while staying in a hotel may seek to recover damagesif he suffers injury from the asbestos.

 

The Operating Partnership could beresponsible for the costs discussed above, if one or more of its properties arefound to be contaminated. The costs to clean up a contaminated property, todefend against a claim, or to comply with environmental laws could be materialand could affect the funds available for distribution to CNL and our debtholders. To determine whether any costs of this nature may be incurred, theOperating Partnership commissioned Phase I environmental site assessments, orESA’s, before it acquired hotels. These studies typically include a review ofhistorical information and a site visit but not soil or groundwater testing.The Operating Partnership obtained the ESA’s to help identify whether it mightbe responsible for cleanup costs or other environmental liabilities. The ESA’son the Operating Partnership’s hotels did not reveal any environmentalconditions that are likely to have a material adverse effect on the OperatingPartnership’s business, assets, results of operations or liquidity. However,ESA’s do not always identify all potential problems or environmentalliabilities. Consequently, the Operating Partnership may have materialenvironmental liabilities of which it is unaware.

 

9

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The Phase I ESA for the Hampton Inn—Airport in Indianapolis, indicatedthat the hotel disposes of approximately 10% of its solid waste at a facilitythat is a state Superfund site. Such a site may be subject to investigation andremediation under the federal and state Superfund laws, and persons that senthazardous substances to the site may be jointly and severally liable for thecosts of the work. The Phase I ESA report states that solid waste from the Indianapolishotel was disposed into a domestic waste cell of the facility. A state officialinformed the engineering firm conducting the Phase I ESA that this domesticwaste cell is segregated by a containment structure and is adjacent to, but notpart of, the Superfund site. The Phase I audit did not indicate that theIndianapolis hotel has arranged for the disposal of any hazardous substances atthis facility. If the Indianapolis hotel in fact arranged for such disposal,however, it could be found liable for at least a part of any response costs.

 

***Compliance with the Americans withDisabilities Act may adversely affect our financial condition.***

 

Under the Americans with Disabilities Act of1990, all public accommodations, including hotels, are required to meet certainfederal requirements for access and use by disabled persons. The OperatingPartnership believes that its hotels substantially comply with the requirementof the Americans with Disabilities Act. However, a determination that thehotels are not in compliance with that Act could result in liability for bothgovernmental fines and damages to private parties. If the Operating Partnershipwere required to make unanticipated major modifications to the hotels to complywith the requirements of the Americans with Disabilities Act, it couldadversely affect the Operating Partnership’s ability to pay distributions toCNL and our debt holders.

 

**Item 2. *Properties***

 

As of December 31,2003, the Operating Partnership had interests in 62 hotels located in 26 states,generally consisting of land, buildings and equipment. Of the 62 hotels, theOperating Partnership currently leases 52 hotels to TRS Lessees, three hotelsto TRS subsidiaries owned by CNL, but not owned by the Operating Partnership,and seven hotels to third-party operators.

 

Generally, hotelsacquired consist of land, building and equipment; although in one case, theOperating Partnership owns the building and equipment only with the land ownedby a third party. The lot sizes generally range up to 10 acres depending onproduct, market and design considerations, and are available at a broad rangeof pricing.  The hotel sites aregenerally in primary or secondary urban, suburban, airport, highway or resortmarkets which have been evaluated for past and future anticipated lodgingdemand trends.

 

The hotelbuildings generally are mid-rise construction. The hotels consist of limitedservice, extended stay or full service hotels. Limited service hotels generallyminimize non-guest room space and offer limited food service such ascomplimentary breakfasts and do not have restaurant or lounge facilitieson-site. Extended stay hotels generally contain guest suites with a kitchenarea and living area separate from the bedroom. Extended stay hotels vary withrespect to providing on-site restaurant facilities.  Full service hotels generally have conference or meetingfacilities and on-site food and beverage facilities. The hotels includeequipment and most conform to national hotel brand approved design concepts.

 

Tenants of thehotels have established reserve funds which are used for the replacement andrenewal of furniture, fixtures and equipment, and routine capital expenditures(“FF&E Reserve”). FF&E Reserve funds, any interest earned thereon andany replacement furniture, fixtures, or equipment purchased with such funds areowned by the Operating Partnership. However, there is no guarantee that thesereserve funds will be adequate to meet future capital expenditures. Inaddition, leases with third parties generally require the tenant to make asecurity deposit relating to the hotel, which is retained as security for thetenant’s obligations under the lease.

 

As of December 31,2003, most of the hotels owned were pledged as collateral under the OperatingPartnership’s financing arrangements.

 

The followingtable sets forth information regarding the Operating Partnership’s hotels asof, and for the year ended December 31, 2003. Those properties that areencumbered by mortgages are identified in Schedule III, which is filedherewith.

 

10

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| **Full Service**                 |   | **Date  Opened** |   | **Number  of Rooms** |   |
|----------------------------------|--------|------------------|--------|----------------------|--------|
|                             |   |             |   |                 |   |
| ***Beverly Heritage***           |   |             |   |                 |   |
| Milpitas, California             |   | 1988             |   | 237                  |   |
| ***Doubletree***                 |   |             |   |                 |   |
| San Diego, California            |   | 1990             |   | 221                  |   |
| ***Hilton***                     |   |             |   |                 |   |
| Birmingham, Alabama              |   | 1984             |   | 205                  |   |
| San Francisco, California        |   | 1976             |   | 234                  |   |
| ***Holiday Inn***                |   |             |   |                 |   |
| Crystal Lake, Illinois           |   | 1988             |   | 197                  |   |
| Louisville, Kentucky             |   | 1970             |   | 169                  |   |
| Lafayette, Louisiana             |   | 1983             |   | 242                  |   |
| Flint, Michigan                  |   | 1990             |   | 171                  |   |
| Columbia, South Carolina         |   | 1969             |   | 175                  |   |
| ***Homewood Suites by  Hilton*** |   |             |   |                 |   |
| Chandler, Arizona                |   | 1998             |   | 83                   |   |
| ***Hotel Rex***                  |   |             |   |                 |   |
| San Francisco, California        |   | 1912             |   | 94                   |   |
| ***Hyatt***                      |   |             |   |                 |   |
| Coral Gables, Florida (2)        |   | 1987             |   | 242                  |   |
| ***Four Points by  Sheraton***   |   |             |   |                 |   |
| Bakersfield, California          |   | 1983             |   | 198                  |   |
| Pleasanton, California           |   | 1985             |   | 214                  |   |
| ***Sheraton***                   |   |             |   |                 |   |
| Milpitas, California             |   | 1988             |   | 229                  |   |
| Sunnyvale, California            |   | 1980             |   | 173                  |   |
| Clayton, Missouri                |   | 1965             |   | 257                  |   |
| ***Wyndham***                    |   |             |   |                 |   |
| Billerica, Massachusetts (1)     |   | 1999             |   | 210                  |   |
| Denver, Colorado (1)             |   | 1999             |   | 180                  |   |
| Full Service Total               |   |             |   | 3,731                |   |

 

| **Extended Stay**                      |   | **Date  Opened** |   | **Number  of Rooms** |   |
|----------------------------------------|--------|------------------|--------|----------------------|--------|
|                                   |   |             |   |                 |   |
| ***Residence Inn by  Marriott***       |   |             |   |                 |   |
| Sacramento, California                 |   | 1987             |   | 176                  |   |
| Torrance, California                   |   | 1984             |   | 247                  |   |
| Wilmington, Delaware                   |   | 1989             |   | 120                  |   |
| Jacksonville, Florida (1)              |   | 1997             |   | 120                  |   |
| Orlando, Florida (International Drive) |   | 1984             |   | 176                  |   |
| Orlando, Florida (Sea World) (2)       |   | 2002             |   | 349                  |   |
| West Palm Beach, Florida (1)           |   | 1998             |   | 78                   |   |
| Atlanta, Georgia                       |   | 1987             |   | 128                  |   |
| Ann Arbor, Michigan                    |   | 1985             |   | 114                  |   |
| Kansas City, Missouri                  |   | 1987             |   | 96                   |   |
| Charlotte, North Carolina              |   | 1984             |   | 116                  |   |
| Fishkill, New York                     |   | 1988             |   | 137                  |   |
| Warwick, Rhode Island                  |   | 1989             |   | 96                   |   |
| Ft. Worth, Texas                       |   | 1983             |   | 120                  |   |
| Tyler, Texas                           |   | 1985             |   | 128                  |   |
| ***TownePlace Suites  by Marriott***   |   |             |   |                 |   |
| Miami Lakes, Florida (1)               |   | 1999             |   | 95                   |   |
| Miami West, Florida (1)                |   | 1999             |   | 95                   |   |
| Fort Worth, Texas                      |   | 1998             |   | 95                   |   |
| **Extended Stay Total**                |   |             |   | 2,486                |   |

 

11

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| **Limited Service**         |   | **Date  Opened** |   | **Number  of Rooms** |   |
|-----------------------------|--------|------------------|--------|----------------------|--------|
|                        |   |             |   |                 |   |
| ***Comfort Inn***           |   |             |   |                 |   |
| Marietta, Georgia           |   | 1989             |   | 184                  |   |
| ***Courtyard***             |   |             |   |                 |   |
| Edison, New Jersey (2)      |   | 2002             |   | 147                  |   |
| Flint, Michigan             |   | 1996             |   | 102                  |   |
| ***Hampton Inn***           |   |             |   |                 |   |
| Chandler, Arizona           |   | 1997             |   | 101                  |   |
| Sedona, Arizona             |   | 1997             |   | 56                   |   |
| Denver, Colorado            |   | 1985             |   | 138                  |   |
| Lakewood, Colorado          |   | 1987             |   | 150                  |   |
| Ft. Lauderdale, Florida     |   | 1986             |   | 122                  |   |
| Jacksonville, Florida (1)   |   | 1998             |   | 118                  |   |
| Indianapolis, Indiana       |   | 1994             |   | 131                  |   |
| Bloomington, Minnesota      |   | 1994             |   | 135                  |   |
| Minnetonka, Minnesota       |   | 1990             |   | 127                  |   |
| Hattiesburg, Mississippi    |   | 1988             |   | 154                  |   |
| Lincoln, Nebraska           |   | 1983             |   | 111                  |   |
| Omaha, Nebraska             |   | 1985             |   | 129                  |   |
| Oklahoma City, Oklahoma     |   | 1986             |   | 134                  |   |
| Tulsa, Oklahoma             |   | 1986             |   | 148                  |   |
| Memphis, Tennessee          |   | 1992             |   | 120                  |   |
| Laredo, Texas               |   | 1995             |   | 119                  |   |
| Houston, Texas              |   | 1996             |   | 119                  |   |
| ***Holiday Inn  Express***  |   |             |   |                 |   |
| Arlington Heights, Illinois |   | 1989             |   | 125                  |   |
| Downers Grove, Illinois     |   | 1984             |   | 123                  |   |
| Bloomington, Minnesota      |   | 1987             |   | 142                  |   |
| Austin, Texas               |   | 1992             |   | 125                  |   |
| Wauwatosa, Wisconsin        |   | 1984             |   | 122                  |   |
| **Limited Service Total**   |   |             |   | 3,182                |   |
| **Portfolio Total/**        |   |             |   | 9,399                |   |

 

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(1)          This hotel is leased to a third party lesseepursuant to a long-term percentage lease which provides for fixed base rent andpercentage rent based on the revenue of the hotels.

(2)          This hotel is leased to a taxable REIT subsidiaryowned by CNL, but not owned by the Operating Partnership.

 

12

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**Item 3. *Legal Proceedings***

 

On May 13, 2003, A. Bruce Chasen, as class representative, filed aputative class action lawsuit in the Circuit Court of Shelby County, Tennessee,30th Judicial District against RFS, RFS’s directors and CNL (the“Chasen Complaint”).   On June 6, 2003,the Chasen Complaint was amended.  Theamended Chasen Complaint alleges, among other things, that (i) the mergerconsideration to be received by RFS’s shareholders is significantly less thanthe intrinsic value of RFS, (ii) the RFS directors breached their fiduciaryduties due to shareholders on a variety of grounds including failing toascertain the true value of RFS, failing to determine whether there were any otherbidders for RFS, and failing to avoid certain alleged conflicts of interestshared by members of the RFS board of directors and its financial advisor,(iii) CNL aided and abetted the RFS board of directors in connection with theirbreach of fiduciary duties, (iv) the RFS board of directors violated portionsof the Tennessee Investor Protection Act, and (v) the RFS proxy statement isfalse and misleading.  Among otherrelief, the amended Chasen Complaint seeks certification of the class action,an injunction enjoining RFS and CNL from completing the merger, monetarydamages in an unspecified amount, the payment of attorney’s fees, andrescissory damages.  On July 1, 2003,RFS and CNL filed an answer to the amended Chasen Complaint setting forth anaffirmative defense and its general denials of the allegations set forththerein.  The plaintiff’s motion for atemporary restraining order for purposes of enjoining the transaction wasdenied by the Circuit Court of Shelby County, Tennessee, 30thJudicial District on July 8, 2003. Based upon the information currentlyavailable to the Operating Partnership and CNL, the Operating Partnershipbelieves the allegations contained in the amended Chasen Complaint are withoutmerit and it is the Operating Partnership’s understanding that CNL intends tovigorously defend the action, and therefore, a liability was not accrued.  The Operating Partnership and CNL areplanning to file a motion to dismiss the allegations in the amended ChasenComplaint. If the motion is not successful, it is expected that the case willproceed to trial.

 

On August 26, 2002, Carmel Valley, LLC filed a lawsuitagainst RFS and some of its subsidiaries in the Superior Court of the State ofCalifornia, for the County of San Diego (the “Carmel Valley Complaint”).  The Operating Partnership is a party to aCarmel Valley Complaint which claims damages relating to a dispute over aparcel of land located adjacent to one of its hotels.  The OperatingPartnership has unsuccessfully attempted to mediate this case.  At thistime, we believe that the damages claimed lack sufficient factualsupport and will continue to vigorously defend the action, andtherefore, a liability was not accrued. However, it is possible thatthe Operating Partnership could incur losses if the plaintiff ultimatelyprevails.  The plaintiff is seekingmonetary damages of up to $0.7 million. The Operating Partnership and CNL have recently filed certain motions todismiss which are being considered by the Court.  If the motions are not successful, it is expected that the casewill proceed to trial.

 

From time to time the Operating Partnership 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 theOperating Partnership’s financial condition or results of operation.

 

**Item 4.*Submission of Matters to a Vote of Security Holders***

 

No matters were submitted to a vote ofsecurity holders during the fourth quarter covered by this report.

 

13

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**PART II**

 

**Item 5. *Market for Registrant’s Common Equity and RelatedUnitholder Matters***

 

(a) Market Information

 

The Series B Preferred units and theOperating Partnership units are not publicly traded, and accordingly, there isno established public trading market for such securities. The following tablesets forth, for the indicated periods, the payment of distributions by theOperating Partnership on its units and Series B Preferred units for theyears ended December 31, 2003 and 2002:

 

|                    |   | **Distribution  Paid per  Unit** |   | **Distribution  Paid per  Series B Preferred Unit** |   |
|-------------------------|--------|----------------------------------|--------|----------------------------------------------------------|--------|
|                    |   |                             |   |                                                     |   |
| **2003**                |   |                             |   |                                                     |   |
| First Quarter           |   | $                                | 0.25   |                                                     | $      | — |   |
| Second Quarter          |   | —                           |   | —                                                   |   |
| Third Quarter (Note 1)  |   | 1.38                             |   | —                                                   |   |
| Fourth Quarter (Note 1) |   | 0.94                             |   | —                                                   |   |
| **2002**                |   |                             |   |                                                     |   |
| First Quarter           |   | $                                | 0.25   |                                                     | $      | 3.125 |   |
| Second Quarter          |   | 0.25                             |   | 3.125                                                    |   |
| Third Quarter           |   | 0.25                             |   | —                                                   |   |
| Fourth Quarter          |   | 0.25                             |   | —                                                   |   |

 

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Note 1 – The Operating Partnership made a$44.0 million (or $1.38 per unit) and a $30.0 million (or $0.94 per unit)distribution to CNL during the third and fourth quarter of 2003, respectively.

 

(b) Holders

 

The number of units outstanding was31,941,852 as of March 30, 2004 (99.9% of which were held by CNL RoseAcquisition Corp. and 0.1% were held by CNL Rose GP Corp.).

 

(c) Distributions

 

Prior to the RFS-CNL Transaction, theOperating Partnership paid regular quarterly distributions on its units to RFSand the limited partners. Subsequent to the RFS-CNL Transaction, there are noregular quarterly distributions paid, but the Operating Partnership will makedistributions to CNL as they are declared. During the third and fourth quarters of 2003, the Operating Partnershipmade a $44.0 million, or $1.38 per unit, and a $30.0 million distribution, or$0.94 per unit, respectively, to CNL.

 

**Item 6. *Selected Financial Data***

 

The following tables set forth selectedhistorical financial data for the Operating Partnership that has been derivedfrom the financial statements of the Operating Partnership and the notesthereto. Such data should be read in conjunction with “Management’s Discussionand Analysis of Financial Condition and Results of Operations” and all of thefinancial statements and notes thereto.

 

14

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**SELECTEDFINANCIAL DATA**

**(in thousands,except per unit and ratio amounts)**

 
|                                                       |   | **2003** |    | **2002** |   | **2001** |   | **2000** |    | **1999** |   |
|------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
| **Operating Data (1):**                                    |   |     |    |     |   |     |   |     |    |     |   |
| Total revenue                                              |   | $        | 184,792 |     | $      | 185,937  |   | $        | 206,273 |     | $      | 106,786 |   | $ | 98,809 |   |
| Net (loss) income                                          |   | (17,100  | )       | (4,432   | )      | (14,886  | )      | 34,008   |    | 38,610   |   |
| Net (loss) income applicable to unitholders                |   | (17,100  | )       | (7,884   | )      | (12,870  | )      | 32,596   |    | 37,198   |   |
| Diluted (loss) earnings per unit                           |   | (0.54    | )       | (0.26    | )      | (0.47    | )      | 1.20     |    | 1.35     |   |
| **Balance Sheet Data (1):**                                |   |     |    |     |   |     |   |     |    |     |   |
| Investment in hotel properties, net                        |   | 809,410  |    | 593,289  |   | 615,562  |   | 635,997  |    | 651,988  |   |
| Total assets                                               |   | 928,749  |    | 642,655  |   | 668,862  |   | 673,467  |    | 687,242  |   |
| Total debt                                                 |   | 406,028  |    | 291,229  |   | 301,135  |   | 277,431  |    | 282,278  |   |
| Redeemable limited partnership units, at  redemption value |   | —   |    | 26,702   |   | 27,980   |   | 33,461   |    | 26,779   |   |
| Partners’ capital                                     |   | 503,104  |    | 300,522  |   | 291,715  |   | 349,667  |    | 369,947  |   |
| **Cash Flows Data:**                                       |   |     |    |     |   |     |   |     |    |     |   |
| Cash provided by operating activities                      |   | 2,869    |    | 36,526   |   | 10,466   |   | 65,223   |    | 66,884   |   |
| Cash used by investing activities                          |   | (36,557  | )       | (8,139   | )      | (8,642   | )      | (10,843  | )       | (26,580  | )      |
| Cash provided (used) by financing  activities              |   | 51,146   |    | (32,184  | )      | 230      |   | (56,612  | )       | (36,405  | )      |
| **Other Data:**                                            |   |     |    |     |   |     |   |     |    |     |   |
| Ratio of earnings to fixed charges(2)                      |   | 0.4      | x       | 0.8      | x      | 0.4      | x      | 2.4      | x       | 2.7      | x      |
| Supplemental ratio of earnings to fixed  charges(3)        |   | 1.1      | x       | 1.2      | x      | 2.0      | x      | N/A      |    | N/A      |   |
| Distributions paid per unit                                |   | 2.57     |    | 1.00     |   | 1.255    |   | 1.54     |    | 1.54     |   |
|                                                            |        |          |         |          |        |          |        |          |         |          |        |  |  |  |  |  |

** **

**QUARTERLYRESULTS OF OPERATIONS**

**(in thousands,except per unit amounts)**

 
|                                        |   | **First  Quarter** |   | **Second  Quarter** |   | **Third  Quarter** |   | **Fourth  Quarter** |   | **Total** |   |
|---------------------------------------------|--------|--------------------|--------|---------------------|--------|--------------------|--------|---------------------|--------|-----------|--------|
| **2003:**                                   |   |               |   |                |   |               |   |                |   |      |   |
| **Operating Data:**                         |   |               |   |                |   |               |   |                |   |      |   |
| Total revenue                               |   | $                  | 41,967 |                | $      | 45,290             |   | $                   | 50,716 |      | $      | 46,819 |   | $ | 184,792 |   |
| Net (loss) income                           |   | (1,795             | )      | (383                | )      | (15,112            | )      | 190                 |   | (17,100   | )      |
| Net (loss) income applicable to unitholders |   | (1,795             | )      | (383                | )      | (15,112            | )      | 190                 |   | (17,100   | )      |
| Diluted (loss) earnings per unit            |   | (0.06              | )      | (0.01               | )      | (0.48              | )      | 0.01                |   | (0.54     | )      |
| Other Data:                                 |   |               |   |                |   |               |   |                |   |      |   |
| Distributions paid per unit                 |   | 0.25               |   | —              |   | 1.38               |   | 0.94                |   | 2.57      |   |
| **2002:**                                   |   |               |   |                |   |               |   |                |   |      |   |
| **Operating Data:**                         |   |               |   |                |   |               |   |                |   |      |   |
| Total revenue                               |   | $                  | 43,916 |                | $      | 49,418             |   | $                   | 48,787 |      | $      | 43,816 |   | $ | 185,937 |   |
| Net (loss) income                           |   | (8,343             | )      | 3,888               |   | 3,650              |   | (3,627              | )      | (4,432    | )      |
| Net (loss) income applicable to unitholders |   | (9,124             | )      | 1,217               |   | 3,650              |   | (3,627              | )      | (7,884    | )      |
| Diluted (loss) earnings per unit            |   | (0.32              | )      | 0.04                |   | 0.12               |   | (0.10               | )      | (0.26     | )      |
| **Other Data:**                             |   |               |   |                |   |               |   |                |   |      |   |
| Distributions paid per unit                 |   | 0.25               |   | 0.25                |   | 0.25               |   | 0.25                |   | 1.00      |   |

 

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(1)                                  There is little comparability between 2003 dataand prior years as a result of the RFS-CNL Transaction, including theapplication of purchase accounting and certain changes in operations, forexample, the changes in hotel managers. Additionally, under the RMA, whichbecame effective January 1, 2001, there is little comparability betweenthe annual financial results for 2003, 2002 and 2001 versus prior years.

 

(2)                                  For the purpose of computing the ratio of earningsto fixed charges, earnings consist of net income plus fixed charges, plus theamortization of capitalized interest and less capitalized interest. Fixedcharges consist of interest, whether expensed or capitalized, and amortizationof loan costs. For the years ended December 31, 2003, 2002 and 2001, theratio of earnings to fixed charges was less than 1:1 and earnings were insufficientto cover fixed charges by $17.0 million, $4.3 million and$14.8 million, respectively. The computation of the ratio of earnings tofixed charges is included as Exhibit 12.1 to this Form 10-K.

 

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(3)                                  The supplemental ratio of earnings to fixedcharges is computed the same as described in footnote (2) except thatincome from continuing operations is adjusted to add back the RFS-CNLTransaction costs of $20.6 million in 2003, debt extinguishments and swap terminationcosts of $10.1 million in 2002 and the Hilton lease termination expense,net of deferred income taxes in 2001. The computation of the supplemental ratioof earnings to fixed charges is included as Exhibit 12.1 to thisForm 10-K.

 

**Item7. *Management’s Discussion and Analysis ofFinancial Condition and Results of Operations***

 

**Forward-lookingStatements**

 

The followinginformation contains forward-looking statements within the meaning of Section27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These statements generally are characterized by the use of terms such as“believe,” “expect” and “may.”  Althoughthe Operating Partnership believes that the expectations reflected in suchforward-looking statements are based upon reasonable assumptions, the OperatingPartnership’s actual results could differ materially from those set forth inthe forward-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, continued availability of proceeds from operationsor CNL, the ability of the Operating Partnership to obtain additional permanentfinancing on satisfactory terms, the ability of the Operating Partnership tocontinue to identify suitable investments, the ability of the OperatingPartnership to continue to locate suitable managers and tenants for itsproperties and borrowers for its mortgage notes payable, and the ability ofsuch tenants and borrowers to make payments under their respective leases ormortgage notes payable.  Many of thesefactors are discussed in detail under “Business—Risk Factors” in thisForm 10-K and should be carefully read. Except as required by the federalsecurities laws, the Operating Partnership disclaims any obligations orundertaking to publicly release any updates or revisions to any forward-lookingstatement contained in this annual report on Form 10-K to reflect anychange in the Operating Partnership’s expectations with regard thereto or anychange in events, conditions or circumstances on which any such statement isbased. Given these uncertainties, readers are cautioned not to place unduereliance on such statements.

 

**General**

 

RFSPartnership, L.P. (the “Operating Partnership”) is a Tennessee limitedpartnership which, at December 31, 2003, owned interests in 62 hotels with9,399 rooms located in 26 states (collectively the “Hotels”). On July 10, 2003,RFS Hotel Investors, Inc. (“RFS”) and the Operating Partnership were acquiredby subsidiaries of CNL Hospitality Properties, Inc. (“CNL”) for approximately$383 million in cash ($12.35 per share or limited partnership unit) (“RFS-CNLTransaction”), excluding the 1.0 million shares of RFS stock acquired by CNLprior to July 10, 2003.  Uponconsummation of this transaction, RFS was merged with and into a subsidiary ofCNL 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.

 

For the year ended December 31, 2003,the Operating Partnership generated revenue of $184.8 million and a net loss of$17.1 million. In 2003, the Operating Partnership received 47.5% of its revenuefrom full service hotels, 26.5% from extended stay hotels and 26.0% fromlimited service hotels. The Operating Partnership received 57% of its revenuein five states (California (30%), Texas (8%), Florida (7%), Michigan (6%) andMissouri (6%)).

 

The following summarizes additionalinformation for the 62 hotels owned at December 31, 2003:

 

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| **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              |   |
| Homewood Suites by Hilton     |   | 1                     |   | 83               |   |
|                          |   | 19                    |   | 3,731            |   |
|                          |   |                  |   |             |   |
| Extended Stay Hotels:         |   |                  |   |             |   |
| Residence Inn by Marriott     |   | 15                    |   | 2,201            |   |
| TownePlace Suites by Marriott |   | 3                     |   | 285              |   |
|                          |   | 18                    |   | 2,486            |   |
|                          |   |                  |   |             |   |
| 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            |   |

 

The following summarizes the number of hotelsowned for the periods presented: 

 
|                              |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                              |   |     |   |     |   |     |   |
| Hotels owned at beginning of year |   | 57       |   | 58       |   | 60       |   |
| Contribution of hotels from CNL   |   | 5        |   |     |   |     |   |
| Sales of  hotels                  |   |     |   | (1       | )      | (2       | )      |
|                              |   |     |   |     |   |     |   |
| Hotels owned at end of year       |   | 62       |   | 57       |   | 58       |   |

 

Concurrentwith the consummation of the RFS-CNL Transaction, CNL contributed five hotelsto the Operating Partnership with net assets of approximately $131.6 million.The five hotels are a Residence Inn in Orlando, Florida, a Marriott Courtyardin Edison, New Jersey, a Hyatt Regency in Coral Gables, Florida, a Wyndham inBillerica, 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.

 

In connection with the acquisition of RFS, six non-strategic hotelswere identified for sale and are carried at a cost of approximately $29.6million.

 

At December 31,2003, the Operating Partnership leased seven hotels to three third-partylessees and three hotels to taxable REIT subsidiaries owned by CNL, but notowned by the Operating Partnership. In October 2003, the Operating Partnershipbegan terminating existing management agreements with Flagstone HospitalityManagement LLC (“Flagstone”), which managed 50 of the 57 RFS properties priorto its acquisition, and franchise licenses for most of its portfolio of hotels,and entering into new management and franchise license agreements withinternationally recognized hotel brand managers. At December 31, 2003, thirteenhotels are managed by Hilton Hotels Corporation (“Hilton”), ten hotels aremanaged by Marriott International (“Marriott”), 28 hotels are managed byInterstate Hotels and Resorts (“Interstate”), and eleven other hotels aremanaged by six other independent management companies.  On January 31, 2004, the management of fivehotels was transferred from Interstate to Hilton (two hotels) and Marriott (threehotels).

 

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**Results of Operations**

 

***YearEnded December 31, 2003 Compared to Year Ended December 31, 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 December 31, 2003. In addition, forcomparison purposes, the results of operations for the Pre-Merger Partnership (RFSand its wholly owned subsidiaries prior to July 10, 2003) and the Post-MergerPartnership (subsequent to July 10, 2003) should be combined to compare withthe results of operations for the comparable period in 2002. The five hotelsthat were contributed to the Operating Partnership from CNL on July 11, 2003had net lease revenue and FF&E reserve revenue of approximately $5.2million and $0.8 million, respectively, from July 11 to December 31, 2003.  The FF&E reserve income is included inother income on the Consolidated Statements of Operations. Both the lease andFF&E reserve revenue are excluded from the following revenue discussion asit is not comparable.

 

Revenue decreased 3.9%for the year from $185.9 million to $178.8 million due primarily to adecline in revenue per available room at our 54 comparable hotels of 3.6%.  Although there have been recent positivetravel trends in the fourth quarter of 2003 with revenue per available roomincreasing 3.6%, as reported by Smith Travel Research, business travel demandwas weak for most of the year as a result of the sluggish economy coupled withthe travel fears resulting from the continued military activity in Iraq andSevere Acute Respiratory Syndrome (“SARS”). The RFS-CNL Transaction also hadits effect on the Company’s operations due to disruptions from employeeturnover at key hotel level positions as well as the transition of managementto new management companies. The Company’s revenues have also decreased due tosubstantial renovations at three hotels in the first two quarters of 2003: theHotel Rex in San Francisco, CA, and the Residence Inns in Sacramento,California and Fishkill, New York. These three hotels are excluded from the year to date comparable statistics.  These three hotels accounted forapproximately 26% of the decline in revenue for the year.  Excluding these three hotels, revenue peravailable room declined 3.6% due to a decline in occupancy of 1.0 percentagepoints and a 2.3% decline in average daily rate. This compares to the industry’sperformance with revenue per available room increasing 0.2% on an increase inoccupancy of 0.1 percentage points and a 0.1% decrease in average daily rate,as reported by Smith Travel Research. Revenue per available room at theCompany’s comparable hotels for the full service, extended stay and limitedservice hotel portfolios showed year over year decreases in revenue peravailable room of 4.9%, 3.9% and 1.8%, respectively.

 

The Company’s comparable northern Californiaproperties (excludes the Hotel Rex in San Francisco, California) experienced anaverage decline in revenue per available room of 9.2% for the year.  The Hotel Rex was closed for a majority ofthe first quarter while undergoing an earthquake retrofit and renovation.  At the Company’s four Silicon Valley hotels,revenue per available room decreased 10.5% for the year, which comparesfavorably to the decline in revenue per available room within the SanJose/Santa Cruz Metropolitan Service Area (“MSA”) of approximately 14.5%, asreported by Smith Travel Research. The decline in year over year revenue peravailable room in both the San Francisco/San Mateo MSA and the San Jose/SantaCruz MSA in Silicon Valley was due to the continued downturn in the technologyand telecommunications industries, a weak convention calendar and a lack ofbusiness travelers, both domestic and international. Excluding the six northernCalifornia properties as well as the non-comparable Residence Inns inSacramento, CA and Fishkill, NY, revenue per available room declinedapproximately 2.3% for the year, which compares to the industry’s increase of0.2% for the year, as reported by Smith Travel Research.

 

The Company hopes to benefit in the futurefrom the continuing decline in new supply growth, which has been forecasted bySmith Travel Research, and combined with an economic turnaround, this declinemay create 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 statisticsfor the 54 comparable hotels for the year. The hotels excluded in thecomparison are the Residence Inns in Fishkill, New York and Sacramento,California, which were undergoing substantial renovations resulting inmeaningful rooms out of service, and the Hotel Rex in San Francisco,California, which closed in November 2002 and did not fully reopen until June2003 after undergoing an earthquake retrofit and renovation. In addition, thefive hotels that were contributed by CNL to the Operating Partnership in 2003are also excluded.

 

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## **COMPARABLE HOTELSOPERATING STATISTICS**

## **For The Year EndedDecember 31, 2003**

 
|            |   | **ADR**  |   | **OCCUPANCY**           |   | **Revenue  Per  Available Room** |   |
|-----------------|--------|----------|--------|-------------------------|--------|----------------------------------|--------|
| **Hotel Type**  |   | **2003** |   | **Variance  vs.  2002** |   | **2003**                         |   | **Variance  vs.  2002** |   | **2003** |   | **Variance  vs.  2002** |   |
|            |   |     |   |                    |   |                             |   |   |   |   |   |   |   |
| Full Service    |   | $        | 92.69  |                    | (4.2   | )%                               | 65.1   | % | (0.5 | )pts | $ | 60.34 |   | (4.9 | )% |
| Extended Stay   |   | 87.85    |   | (3.0                    | )%     | 75.2                             | %      | (0.7 | )pts | 66.08 |   | (3.9 | )% |
| Limited Service |   | 70.25    |   | 0.6                     | %      | 64.8                             | %      | (1.6 | )pts | 45.51 |   | (1.8 | )% |
| Total           |   | $        | 83.11  |                    | (2.3   | )%                               | 67.3   | % | (1.0 | )pts | $ | 55.96 |   | (3.6 | )% |

 

The Company’s comparable full service hotelsexperienced a year over year decrease in revenue per available room of4.9%.  This decrease was caused by adecline in average daily rate of 4.2% and occupancy of 0.5 percentage points.The five comparable northern California hotels previously mentioned constitutea substantial portion of these decreases. Excluding the northern Californiaproperties, revenue per available room at the Company’s other full servicehotels decreased 1.6% for the year.  Thefollowing five comparable full service hotels located in Silicon Valley and SanFrancisco had decreases in revenue per available room averaging 9.2% for the yearending December 31, 2003.

 

| **Hotel**                     |   | **Location**       |   | **Variance  vs. 2002** |   |
|-------------------------------|--------|--------------------|--------|------------------------|--------|
|                          |   |               |   |                   |   |
| 173-room Sheraton             |   | Sunnyvale,  CA     |   | (9.7                   | )%     |
| 235-room Beverly Heritage     |   | Milpitas, CA       |   | (17.1                  | )%     |
| 229-room Sheraton             |   | Milpitas, CA       |   | (14.9                  | )%     |
| 214-room Sheraton Four Points |   | Pleasanton,  CA    |   | 0.1                    | %      |
| 234-room Hilton               |   | San Francisco,  CA |   | (6.0                   | )%     |

 

In Silicon Valley, wherethe Company has four full service hotels that experienced a decrease in revenueper available room of 10.5% for the year, 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 the hotels are performing betterover the last three months of 2003 as compared to the full year.  Increases in business travel associated withan economic turnaround in the technology and communications industries maybenefit the Company in growth of revenue per available room and net income.

 

Conversely, within San Francisco, occupancyat the Hilton Fisherman’s Wharf is driven predominantly by leisure travelers,with business travelers and groups making up the balance in room demand. In thepast, San Francisco has been host to a large number of citywide conventions,but there have not been many such conventions in 2003, thus reducing the amountof business travelers into the San Francisco market.  Accordingly, the market remains depressed.  Demand varies widely in this market 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% in March,10.2% in April, 20.0% in May, 15.6% in June, 2.8% in July, 8.6% in August,increased 2.7% in September, then decreased 5.7% in October, 1.0% in Novemberand 3.8% in December.

 

The Hotel Rex at UnionSquare was not open for most of the first quarter of 2003 due to the $1.5million earthquake retrofit and renovation of the hotel that were not completeduntil June 2003.  The retrofit wasrequired to be performed by early 2005 in order to comply with existingbuilding codes.  Based on its locationwithin San Francisco at Union Square, this hotel is more reliant on businesstravelers and citywide conventions, and the Company believes the Hotel Rex iswell positioned to attract travelers. The Company hopes that the recent renovations at this boutique hotelwill increase revenue per available room, and ultimately net income. In fact,during the quarter ended September 30, 2003, the only full comparable quarterthat the hotel was open subsequent to the retrofit and renovation, the HotelRex experienced an increase in revenue per available room of 8.4% driven by anincrease in occupancy of 8.7 percentage points, but partially offset by adecrease in average daily rate of 5.2%. The 2003 fourth quarter is notcomparable to the prior year as the hotel was closed for the majority of thefourth quarter in 2002.

 

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The Company’s rebranding of its Hilton Hotel in Birmingham, Alabama,has so far been successful in generating increased revenue per availableroom.  The hotel, the only full serviceHilton in the Birmingham market, which was converted from a Sheraton to aHilton on January 1, 2003, has experienced increases in revenue per availableroom of 6.9% for the year, driven by increases in both occupancy of 0.7percentage points and average daily rate of 5.6%.

 

The comparable extended stay hotels, whichexcludes the Residence Inns in Sacramento, California and Fishkill, New York inthe year to date comparison that were undergoing substantial renovations,experienced a year over year decline in revenue per available room of 3.9% forthe year.  Most of our extended stayhotels, with the exception of the 176-room Residence Inn in Orlando, Florida,are in markets that can best be categorized as “drive to” markets. These hotelsare typically less affected by the current geo-political unrest, the continuedmilitary activity in Iraq, with revenue per available room declining 3.1% forthe year. The Orlando Residence Inn experienced a decline in revenue peravailable room of nearly 8.2% in 2003 due primarily to its reliance on tourism,which has been impacted by the geo-political unrest and continued militaryactivity. Fourteen of the eighteen extended stay properties are Residence Innsby Marriott.  Revenue per available roomis typically less volatile as these hotels benefit from longer duration staysthat include the typically slower weekend days. The twelve comparable ResidenceInns by Marriott experienced a decrease in revenue per available room of 3.8%in 2003, slightly better than the Company’s portfolio of extended stay hotels.

 

The Company’s limited service hotels experienceda decrease in revenue per available room of 1.8% in 2003, the best performanceamong the Company’s portfolio in terms of revenue per available room versus theprior year.  The Company believes thisis attributable to cost conscious travelers, both business and leisure, whostayed at limited service hotels to save money during the economicdownturn.  Seventeen of the Company’stwenty-five limited service hotels are Hampton Inns which the Company currentlybelieves has the strongest rewards program among its limited service hotels andwhich experienced an increase in revenue per available room of 0.1% for theyear.

 

*Expenses*

 

Totaloperating expenses increased $25.4 million to $178.9 million in 2003 versus$153.5 million in 2002 This increase is primarily attributable to non-recurringcosts related to the RFS-CNL Transaction of approximately $20.6 million andincreased depreciation of $2.6 million primarily attributable to the fivehotels contributed by CNL to the Operating Partnership on July 11, 2003.  The non-recurring costs related to theRFS-CNL Transaction are comprised of severance of $11.6 million, amortizationof $1.5 million related to the acceleration of unvested restricted stock,advisory fees of $4.5 million, additional management fees of $1.9 million andmiscellaneous other costs of $1.1 million. Operating margins (operating income as a percentage of total hotelrevenue, excluding the $20.6 million of non-recurring acquisition costs andincome from properties contributed by CNL of $3.6 million) decreased 1.2 pointsto 16.2% from 17.4% for the year, driven by the decrease in revenue of 3.9%during 2003 as well as escalated operational costs during the transition fromRFS to CNL and the transition of new managers at some of our hotels.  Individual line items comprising hoteloperating expenses are discussed below.

 

Hotel operating expenses for rooms, food andbeverage and other operating departments increased 2.4% in 2003 to $47.5million from $46.4 million; additionally, as a percentage of total hotelrevenue, excluding revenue from properties contributed by CNL in 2003, hoteloperating expenses increased to 26.6% in 2003 versus 25.0% in 2002. Theincreased percentage was caused primarily by the decline in revenue year overyear in relationship to significant fixed costs as the decreases in occupancycontinue to be less than the decrease in average daily rate, resulting indeteriorating margins as the costs to service hotel guests have not decreasedas much as the room rental rates.

 

Property operating costs increased$2.1 million or 10.5% in 2003 due primarily to an increase in marketingand energy costs across most of the portfolio. Marketing costs increased $1.2 million or 13.0% in 2003 as a result ofthe reclassification of certain brand marketing costs that were classified bythe Company as franchise costs prior to the RFS-CNL Transaction. Energy costshave increased $0.6 million or 7.1% due to the well-publicized oil and gasprice increases caused primarily by the continued military activity in Iraq andshortages in production in South America. The Company also incurred approximately $0.2 million in costs associatedwith water damage at the Holiday Inn in Lafayette, Louisiana and a burst pipeat the Sheraton in Pleasanton, California.

 

Property taxes, insurance and other expensesincreased $0.5 million or 4.1% in 2003, due primarily to real estate taxrefunds of $0.4 million obtained in the third quarter of 2002 related to taxespaid on prior years at several of the Company’s California properties.  The remaining increase of $0.1 million isdue to increased insurance costs as a result of the Company reducing itsself-insurance level on its earthquake policies from $7.5 million to $5.0million.

 

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Franchise costs decreased $2.2 million or 14.5% in 2003 due to thenew management and franchise license agreements entered into during the fourthquarter for most of the Company’s Marriott hotels.  Prior to the RFS-CNL Transaction, the Marriott hotel brands didnot manage any of the Company’s hotels. Under the terms of the new agreementsin which Marriott is managing some of the Company’s hotels, there are nofranchise fees as Marriott is only collecting management fees. In addition,franchise costs decreased as a result of the reclassification of certain brandmarketing costs that were classified by the Company as franchise costs prior tothe RFS-CNL Transaction.

 

Maintenance and repair costs increased$1.0 million or 11.9% in 2003. This increase is associated with the costsincurred in connection with the renovations at the Hotel Rex and Residence Innsin Fishkill, NY and Sacramento, California, the completion of productimprovement plans at seven of our Hampton Inns, the collapse of a canopy at theHampton Inn in Denver, Colorado, a major pipe burst at the Sheraton inPleasanton, California, and water damage at the Holiday Inns in Columbia, SouthCarolina and Lafayette, Louisiana.

 

Management fees have increased$2.6 million in 2003 mainly due to costs associated with the acquisitionof the Company by CNL.  The Company wasrequired to pay $1.9 million in additional management fees to Flagstone as aresult of the acquisition of the Company by CNL.  The remainder of the increase of $0.7 million results fromadditional management fees from the new management and franchise licenseagreements entered into in the fourth quarter of 2003 with Marriott. Inaddition, there were redundant costs of approximately $0.3 million incurredduring the fourth quarter of 2003 resulting from Flagstone winding down itsoperations.

 

Depreciation increased $2.6 million in 2003due primarily to depreciation on the five properties contributed by CNL of $2.4million. The remainder of the increase is attributable to the increase in theasset basis resulting from the application of purchase accounting.

 

Amortization of franchise fees and unearnedcompensation increased $0.8 million for the year due to acceleratedamortization resulting from the immediate vesting of all restricted stockgrants as a result of the RFS-CNL Transaction.

 

General andadministrative expenses increased $16.8 million for the year due to costsassociated with the RFS-CNL Transaction: severance of $11.6 million, advisoryfees of $4.5 million and miscellaneous fees of $1.1 million.  These costs could not be accrued in purchaseaccounting as they were contractual obligations of RFS to its employees,advisor and other vendors for performance prior to and culminating with theRFS-CNL Transaction. This was offset by a decrease in compensation ofapproximately $1.1 million during the second half of the year as there are noemployees of the Operating Partnership under CNL ownership.  CNL Hospitality Corp. and other CNLaffiliates provide management, advisory and administrative services to theOperating Partnership.

 

Debt extinguishment and swap terminationcosts of $10.1 million in 2002 are comprised of a yield maintenancepremium of $5.5 million to pay off the 1996 CMBS debt, $3.2 millionto terminate two interest rate swaps and $1.4 million to write-off theunamortized debt issuance costs related to the 1996 CMBS debt.   All of these transactions were completed inconnection with the issuance of the $125 million Senior Notes.

 

Amortization on loan origination costs decreased$0.2 million for the year due to the write-off of issuance costs on theCompany’s borrowings as a result of the RFS-CNL Transaction,which resulted in a $0.8 million year over year positive variance, offset byamortization of approximately $0.7 million related to issuance costs on the Company’s new financing issued in December, 2003.Issuance costs associated with the new financings were approximately $6.7million, and will be amortized over three years.

 

Interest expense increased $0.8 million in2003.  The increase in the weightedaverage borrowings of $35.4 million from $298.2 million to $333.6 million wasoffset by the decrease in the average interest rate on borrowings outstandingfrom 8.6% in 2002 to 7.9% in 2003.  Theincrease in weighted average borrowings resulted from the Company borrowing $35million under the 2003 Mezzanine Loan, of which $30.0 million of the proceedswere distributed to CNL.  The decreasein the average interest rate results primarily from the Company borrowing $44.0million under the Bridge Loan, at an approximate 4.0% interest rate, torepurchase $41.8 million of Senior Notes that were carrying a 9.75% interestrate.

 

Benefit from income taxes increased$2.9 million in 2003 due to the increase in losses in the taxable REITsubsidiaries.

 

Excluding the loss on sale of the Comfort Innin Fort Mill, South Carolina of $3.8 million, income from discontinuedoperations decreased 16.4% to $1.8 million in 2003 from $2.2 million in 2002due primarily to the sale of the Comfort Inn in November 2002.

 

The loss on sale of assets in 2003 relates tothe sale of hotel vans and the gain in 2002 relates primarily to the gain onthe sale of the Company’s interest in an unconsolidated partnership ofapproximately $1.0 million in the first quarter of 2002.

 

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

 

*Revenue*

 

Revenue decreased 9.9% from$206.2 million to $185.9 million primarily due to the softness inbusiness travel resulting from the lagging economy and the geo-politicaluncertainty. The continued impact from the economic recession, thegeo-political uncertainty and the decline in corporate profits have forcedcorporations to reduce business travel which has a significant impact onlodging demand. Revenue per available room at our 56 comparable hotels(excludes the Hotel Rex in San Francisco, California which is currently closedfor earthquake retrofit and renovation) declined 8.5% due to a 6.1% decline inaverage daily rate and a decline in occupancy of 1.7 percentage points.The decline in revenue per available room has improved incrementally eachquarter of 2002 as compared to 2001 with revenue per available room declining16.6% in the first quarter, 10.6% in the second quarter, 4.1% in the thirdquarter and 1.6% in the fourth quarter. Revenue per available room for the fullservice, extended stay and limited service hotel portfolios showed decreases inrevenue per available room of 13.9%, 4.6% and 5.0%, respectively.

 

As reported by Smith Travel Research, for theyear, the San Francisco/San Mateo Metropolitan Service Area (“MSA”) was theworst performing MSA of the top 25 markets in the United States in terms of thechange in revenue per available room as compared to the prior year with adecline of approximately 17.4%. Furthermore, the San Jose/Santa Cruz MSA inSilicon Valley, which is not one of the top 25 markets as defined by SmithTravel, performed even worse with a change in revenue per available room of approximately22.0%. The Operating Partnership’s five comparable northern Californiaproperties experienced an average decline in revenue per available room of22.3%. In San Francisco, the Hilton Fisherman’s Wharf experienced a decline inrevenue per available room of 9.3% for the year, while at our four SiliconValley hotels, revenue per available room decreased 26.2% for the year. Thecontinued deterioration in year over year revenue per available room in bothMSA’s was due to the downturn in the technology and telecommunicationsindustries, a weak convention calendar and a lack of business travelers, bothdomestic and international. Excluding the five comparable northern Californiaproperties, revenue per available room declined approximately 5.1%, which comparesto the industry’s decline of 2.5%, as reported by Smith Travel Research.

 

The Operating Partnership hopes to benefit inthe future from the expected decline in new supply growth as predicted by SmithTravel Research, which combined with an economic turnaround may createincreased lodging demand for our hotels. This may lead to growth in revenue peravailable room, net income and dividends. The following shows hotel operatingstatistics for the 56 comparable hotels for the year ended December 31, 2002.

 

**COMPARABLEHOTELS OPERATING STATISTICS**

**For The YearEnded December 31, 2002**

 
|            |   | **ADR**  |   | **OCCUPANCY**           |   | **Revenue  Per  Available Room** |   |
|-----------------|--------|----------|--------|-------------------------|--------|----------------------------------|--------|
| **Hotel Type**  |   | **2002** |   | **Variance  vs.  2001** |   | **2002**                         |   | **Variance  vs.  2001** |   | **2002** |   | **Variance  vs.  2001** |   |
|            |   |     |   |                    |   |                             |   |   |   |   |   |   |   |
| Full Service    |   | $        | 97.16  |                    | (11.6  | )%                               | 65.4   | % | (1.7 | )pts | $ | 63.51 |   | (13.9 | )% |
| Extended Stay   |   | 94.05    |   | (2.6                    | )%     | 76.9                             | %      | (1.6 | )pts | 72.31 |   | (4.6 | )% |
| Limited Service |   | 69.82    |   | (2.3                    | )%     | 66.4                             | %      | (1.9 | )pts | 46.34 |   | (5.0 | )% |
| Total           |   | $        | 86.43  |                    | (6.1   | )%                               | 68.9   | % | (1.7 | )pts | $ | 59.53 |   | (8.5 | )% |

 

The Operating Partnership’sfull service hotels, which comprised approximately 45.7% of revenue,experienced an average decrease in revenue per available room of 13.9%. Thisdecrease was caused by a year to date decrease in occupancy of1.7 percentage points and an 11.6% decline in average daily rate. The fivecomparable northern California hotels previously mentioned make up asubstantial portion of these decreases. Excluding the five northern Californiaproperties, revenue per available room at the Operating Partnership’s otherfull service hotels decreased approximately 5.8% for the year. The followingsix full service hotels located in Silicon Valley and San Francisco haddecreases in revenue per available room for 2002 averaging approximately 22%(data for the Hotel Rex is through October 31, 2002 as it was closed inNovember, 2002 for the earthquake retrofit and renovation).

 

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| **Hotel**                     |   | **Location**       |   | **Variance  vs. 2001** |   |
|-------------------------------|--------|--------------------|--------|------------------------|--------|
|                          |   |               |   |                   |   |
| 173-room Sheraton             |   | Sunnyvale,  CA     |   | (23.3                  | )%     |
| 235-room Beverly Heritage     |   | Milpitas, CA       |   | (41.8                  | )%     |
| 229-room Sheraton             |   | Milpitas, CA       |   | (23.4                  | )%     |
| 214-room Sheraton Four Points |   | Pleasanton,  CA    |   | (14.4                  | )%     |
| 234-room Hilton               |   | San  Francisco, CA |   | (9.3                   | )%     |
| 94-room Hotel Rex             |   | San  Francisco, CA |   | (22.9                  | )%     |

 

In Silicon Valley, where the OperatingPartnership has four full service hotels, the hotel guests are predominantlydomestic and international business travelers. These hotels have been hit thehardest of all hotels in the Operating Partnership’s portfolio because of thelack of business travel. Furthermore, there is little leisure demand for hotelsin the Silicon Valley market that would temper the significant drop-off inbusiness travel.

 

Conversely, within San Francisco, the HiltonFisherman’s Wharf is driven predominantly by leisure demand, with businesstravelers and groups making up the balance in room demand. Accordingly, thishotel experienced the smallest decline in revenue per available room among allof the Operating Partnership’s northern California hotels in terms of revenueper available room, as seen above.

 

The Hotel Rex at Union Square has shown lessimprovement in 2002 than the Hilton Fisherman’s Wharf. Because of its locationwithin San Francisco at Union Square, this hotel is more reliant on businesstravelers and citywide conventions and so it has performed worse than theHilton Fisherman’s Wharf. As such, the Operating Partnership decided toaccelerate the timing of its $1.5 million earthquake retrofit andrenovation and closed the hotel in November, 2002. Originally, the OperatingPartnership anticipated performing this renovation in late 2003. The work isrequired to be performed by early 2005 in order to comply with existingbuilding codes. The Hotel Rex was completely closed from November 2002 toFebruary 2003. The full hotel renovation and retrofit was not completeduntil June 2003. The re-opening will coincide with the re-opening of theMoscone Center, where the Convention and Visitors Bureau has begun bookinglarge events into the Center in May 2003. The Operating Partnershipbelieves that accelerating the renovation to this slow period has enabled it todecrease the Operating Partnership’s renovation and retrofit costs as the lostrevenue that will occur due to the hotel’s closure is at typically the hotel’sslowest period. Also, the Operating Partnership believes it has been able toaggressively negotiate the terms of the retrofit since the OperatingPartnership feels the costs to complete this type of work will rise as thedeadline nears and demand for retrofit work increases.

 

The extended stay hotels, which comprisedapproximately 27.9% of revenue, experienced a decline in revenue per availableroom of 4.6%. In 2002 this market segment performed the best in terms ofrevenue per available room versus the prior year. Fourteen of the eighteenextended stay properties are Residence Inns by Marriott, which experienced adecrease in revenue per available room of 5.0%. The Operating Partnershipbelieves that Residence Inns by Marriott is the extended stay brand of choicefor consumers as these hotels benefit from longer duration stays that includethe typically slower weekend days. Similarly most of the extended stayportfolio, with the exception of the 176-room Residence Inn in Orlando, are in marketsthat can best be categorized as drive to markets. These hotels have been lessaffected by the events of the slowing economy and the geo-political uncertaintywith revenue per available room declining 4.2%. The Orlando Residence Inn hasexperienced a decline in revenue per available room of 12.7%.

 

The limited service hotels, which comprisedapproximately 26.4% of revenue, experienced a decrease in revenue per availableroom of 5.0%. Seventeen of the twenty-six limited service hotels are HamptonInns, which experienced a decline in revenue per available room of 3.3%.System-wide revenue per available room at Hampton Inns increased 0.4% for theyear, which was the only Hilton brand to show an improvement in revenue peravailable room from 2001. During the fourth quarter of 2002 and early 2003, theOperating Partnership completed product improvement plans on sixteen HamptonInns in our portfolio, which should well position these hotels to bettercompete for existing business as well as the potential rebound in the hotelindustry. Five of the limited service hotels are Holiday Inn Express’, whichexperienced a decline in revenue per available room of 9.4% for the year.

 

*Expenses*

 

Total operating expenses decreased$70.2 million due primarily to the lease termination expense of$65.5 million in 2001. Excluding lease termination expense, totaloperating expenses decreased $4.7 million or 3.0% and operating margins(operating income as a percentage of total hotel revenue) decreased 5.8 pointsto 17.4% from 23.2%, driven by the decrease in revenue of 9.7%. Individual lineitems comprising hotel operating expenses are discussed below.

 

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Hotel operating expenses for rooms, food and beverage and otheroperating departments decreased 5.8% to $46.4 million from$49.3 million; however, as a percentage of total hotel revenue, hoteloperating expenses increased to 25.0% in 2002 versus 23.9% in 2001. Asoccupancy has decreased only slightly, the hotels must incur costs to servicethese rooms and since this occupancy is now booked at reduced room rates overthe prior year, the operating margins continue to deteriorate. Cost reductionsthat were implemented in 2001 and which continued in 2002 have not fully offsetthe loss in revenue.

 

Property operating costs, which includescomplimentary guest services, marketing, energy, operating leases, and otheroperating costs, decreased $0.4 million or 2.0% due primarily to a decrease inenergy costs of $0.4 million or 4.4%. Energy costs have decreased acrossthe portfolio with a substantial portion of the decrease coming from ourCalifornia properties. Energy costs at the ten California properties decreased$0.2 million or 6.2% for the year. Energy costs in California were higherin the first half of 2001 due to the well-publicized energy crisis in thatstate.

 

Property taxes, insurance and other expensesdecreased $0.2 million or 1.8% driven primarily by a decrease in realestate taxes of approximately $0.9 million resulting from reducedassessments through appeals made by the Operating Partnership and assessoradjustments reflecting the lagging hotel industry. Offsetting the decrease inreal estate taxes of $0.9 million are increases in earthquake and propertyinsurance of $0.5 million. Insurance costs continue to rise as a result ofrate hardening in the market, modifications of insurance coverage to includeterrorist activities and other changes in insurance pricing out of theOperating Partnership’s control. The increase is not due to a deterioration ofclaims experience or an increase in the value of insured losses, which havebeen stable.

 

Franchise costs decreased $0.5 millionor 3.4% due to the decrease in occupied rooms of 55,298 rooms or 2.6%.

 

Maintenance and repair costs decreased$0.1 million or 1.1% due to the decreased occupancy.

 

Management fees have decreased$0.8 million or 14.7% due primarily to the decrease in revenues.Management fees have remained flat at 2.5% to 2.7% of total hotel revenue in2002 and 2001.

 

Depreciation increased to $27.7 millionfrom $27.3 million. The Operating Partnership expected depreciation toincrease and level off after the substantial capital expenditures made in prioryears.

 

Lease termination costs of $65.5 millionin 2001 represented the expenditures incurred in connection with thetermination of the leases, management contracts and related ancillaryagreements with Hilton. For accounting purposes, this transaction representedthe cancellation of executory contracts and was required to be expensed asincurred.

 

Amortization of franchise fees and unearnedcompensation is down $0.1 million due to the decrease in the amortizationof certain employee restricted stock awards that fully vested inOctober 2001.

 

General and administrative expenses havedecreased $0.1 million or 0.7% due primarily to austerity programsimplemented in the second and third quarters of 2001 at both the hotels andcorporate headquarters aimed at reducing these expenses.

 

Debt extinguishment and swap terminationcosts of $10.1 million 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. These costs were incurred inconjunction with the issuance of $125 million Senior Notes inFebruary 2002.

 

Amortization on loan origination costs haveincreased $0.3 due to the incremental amortization of costs associated withissuance of the $125 million Senior Notes in February 2002 ascompared to the amortization of debt issuance costs related to the 1996 CMBSdebt for the same periods in 2001.

 

Interest expense increased $0.8 millionor 3.2% due to the increase in the year to date weighted average interest ratefrom approximately 7.9% in 2001 to 8.5% in 2002 and offset by a decrease in theweighted average borrowings outstanding of $15.4 million from$313.6 million in 2001 to $298.2 million in 2002.

 

Benefit from income taxes decreased$23.6 million as a result of the Hilton lease termination in the firstquarter of 2001.

 

Earnings (losses) from discontinuedoperations decreased $4.5 million from income of $2.8 million in 2001 to a lossof $1.7 million in 2002. The loss is due solely to the loss recognized on thesale of the Fort Mill hotel of $3.8 million

 

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The 2002 gain on sale of assets relates to the sale of an interest inan unconsolidated partnership of $0.9 million. The 2001 gain relates tothe sale of the Comfort Inn in Farmington Hills, Michigan.

 

**Liquidity and CapitalResources**

 

The Operating Partnership’s principal source ofliquidity to meet its cash requirements, including distributions to CNL andrepayments of indebtedness, is its cash flow. For the year endedDecember 31, 2003 and 2002, respectively, cash flow provided by operatingactivities was $2.9 million and $36.5 million. The decrease in cash flowprovided by operating activities was due primarily to non-recurring costs related to the RFS-CNL Transaction of approximately $20.6 million and the net cashoutflows from accounts receivable and accounts payable of approximately $14.6million, due primarily to cash flow requirements associated with thetransition to the new management companies. The Operating Partnership believes that cash provided by operatingactivities will meet its liquidity needs. If cash provided by operatingactivities is insufficient to cover the Operating Partnership’s liquidityneeds, the Operating Partnership expects to fund these other liquidity needsvia contributions from CNL or possibly accessing the debt capital markets asmarket conditions permit. The Operating Partnership does not have a facility inplace for short-term borrowings.  If CNLwere unable to fund the Operating Partnership on short notice, the OperatingPartnership may have to seek alternative financing, some of which couldnegatively impact net income.  AtDecember 31, 2003, the Operating Partnership had $19.4 million of cash andcash equivalents.

 

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, the Line of Creditwas terminated and replaced with the Bridge Loan, of which only $101.0 millionwas drawn by the Operating Partnership to help fund the merger. During thethird quarter of 2003, the Operating Partnership borrowed $88.0 million underthe Bridge Loan to repurchase $41.8 millionof Senior Notes ($42.2 million book value) and to make a distribution of $44.0million to CNL.  On September 29, 2003, CNLcontributed approximately $78.0 million to the Operating Partnership to fund amajority of the repayment of $88.0 million under the Bridge Loan.  The Operating Partnership refinanced theBridge Loan with the issuance of a $130.0 million, long-term CommercialMortgage Backed Security facility on December 4, 2003 (“2003 CMBS”).  A portion of the proceeds from issuance ofthe 2003 CMBS were used to repay in full the outstanding balance under theBridge Loan of approximately $101.0 million.

 

On December 4, 2003, a new wholly owned subsidiary ofthe Operating Partnership, Rose SPE 1, L.P. issued the 2003 CMBS.  The 2003 CMBS is collateralized by 26 hotelswith a net book value of approximately $297.3 million at December 31, 2003. The2003 CMBS has a variable interest rate of thirty-day LIBOR plus 189 basispoints.  The interest rate was approximately3.0% at December 31, 2003. The 2003 CMBS matures in December, 2006.  Monthly payments of approximately $0.9million include interest charges, reserves for the replacement of equipment,and reserves for real estate taxes and insurance. There are no regular monthlyprincipal payments. The 2003 CMBS containprovisions restricting the sale of collateral, and is prepayable subject tovarious prepayment penalties, yield maintenance, or defeasance obligations.

 

On December 23, 2003, Rose SPE 1, L.P. issued anadditional $35.0 million long-term facility (“2003 Mezzanine Loan”). The 2003Mezzanine Loan is also collateralized by the 26 2003 CMBS hotels. The 2003Mezzanine Loan has a variable interest rate of thirty-day LIBOR plus 465 basispoints with a floor rate of 6.65%.  Theinterest rate was approximately 6.65% at December 31, 2003 since the adjustedLIBOR rate was only 5.8% at December 31, 2003. The 2003 CMBS matures inDecember, 2006.  Interest only paymentsof approximately $0.2 million are made on a monthly basis. A portion of theproceeds from issuance of the 2003 Mezzanine Loan was used to make a $30.0million distribution to CNL.

 

The 2003 CMBS and the 2003 Mezzanine Loan contain primarily onerestrictive financial covenant, which stipulates thatconsolidated Partners’ Capital will not be less than the sum of $150.0 millionplus the cost basis of the 26 hotels comprising the Collateral Pool, minus$165.0 million (representing the sum of the 2003 CMBS and the 2003 MezzanineLoan borrowings).  At December 31, 2003,this base value was $287.7 million as compared to Partners’ Capital ofapproximately $503.1 million. At December 31, 2003, the Operating Partnershipwas in compliance with all financial covenants under the 2003 CMBS and 2003Mezzanine Loan.

 

During 2003, the Operating Partnership paidapproximately $15.5 million to affiliates of CNL in connection withreimbursements for acquisition costs related to the RFS-CNL Transaction.

 

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From January 1 to July 10, 2003, the interest rate onthe Line of Credit was 250 basis points above LIBOR. The Line of Credit wascollateralized 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. OnJuly 10, 2003, the outstanding balance under the Line of Credit of $35.5million was repaid and the Line of Credit was terminated in connection with theRFS-CNL Transaction.  At July 10, 2003,the Operating Partnership was in violation of certain financial covenants underthe Line of Credit.  The covenantviolations have no impact on the Operating Partnership because the Line ofCredit was terminated in connection with the RFS-CNL Transaction. All debtissuance costs pertaining to the Pre-Merger Partnership of approximately $7.1million were expensed under purchase accounting guidelines.

 

On February 26, 2002, the OperatingPartnership sold $125 million of Senior Notes. The Senior Notes matureMarch 1, 2012 and bear interest at a rate of 9.75% per year, payablesemi-annually, in arrears, on March 1 and September 1 of each year.The Senior Notes are unsecured obligations of the Operating Partnership and areguaranteed by certain of its subsidiaries. The Senior Notes contain covenantsthat could, among other things, restrict the Operating Partnership’s ability toborrow money, pay distributions to CNL, make investments, and sell assets orenter into mergers and consolidations. The Operating Partnership was incompliance with these covenants at December 31, 2003. During the firstquarter of 2003, the Operating Partnership borrowed approximately $3.8 millionunder the Line of Credit to retire $3.8 million of Senior Notes. As a result ofthe redemption of the $3.8 million Senior Notes, the Operating Partnershipexpensed $122 thousand in unamortized debt issuance costs and $29 thousandof costs related to acquiring the Senior Notes.   During the third quarter of 2003, the Operating Partnershipborrowed $88.0 million to repurchase $41.8 million of Senior Notes ($42.2million book value) and to make a distribution of $44.0 million to CNL.  

 

The Operating Partnership’s other borrowingsare nonrecourse to the Operating Partnership and contain provisions allowingfor the substitution of collateral, upon satisfaction of certain conditions.Most of the mortgage borrowings are prepayable and subject to variousprepayment penalties, yield maintenance, or defeasance obligations. AtDecember 31, 2003 and 2002, approximately 59% and 98% of the OperatingPartnership’s debt is fixed at an average interest rate of 8.6% and 8.7%,respectively.

 

The following details the OperatingPartnership’s debt outstanding at December 31, 2003 (dollar amounts inthousands):

 
|           |   |        |    |               |           |     |     |           |           | **Collateral**   |   |
|----------------|--------|-------------|---------|--------------------|----------------|----------|----------|----------------|----------------|------------------|--------|
|           |   | **Balance** |    | **Interest  Rate** |           |     |     | **Maturity**   |           | **# of  Hotels** |   | **Net Book  Value at  December 31, 2003** |   |
|           |   | (Note  A)   |    |               |           |     |     |           |           |             |   |   |   |
| 2003 CMBS      |   | $           | 130,000 |               | LIBOR  + 189bp |     | Variable |           | December  2006 |             | 26     |   | $ | 297,318 |   |
| 2003 Mezzanine |   | 35,000      |    | LIBOR  + 465bp (B) |           | Variable |     | December  2006 |           | Note  B          |   | Note  B |   |
| Senior Notes   |   | 81,674      |    | 9.75%              |           | Fixed    |     | March  2012    |           | —           |   | — |   |
| Mortgage       |   | 90,566      |    | 7.83%              |           | Fixed    |     | December  2008 |           | 10               |   | 123,648 |   |
| Mortgage       |   | 17,935      |    | 8.22%              |           | Fixed    |     | November  2007 |           | 1                |   | 17,115 |   |
| Mortgage       |   | 50,853      |    | 8.00%              |           | Fixed    |     | August  2010   |           | 8                |   | 107,655 |   |
|           |   | $           | 406,028 |               |           |     |     |           |           |             |   |   | $ | 545,736 |   |

 

Note A – In applying purchase accounting to theOperating Partnership’s debt instruments, each facility was adjusted to itsfair value. Fair value is calculated based on discounted cash flows using adiscount rate equal to the Operating Partnership’s new borrowing rate. Exceptfor the 2003 CMBS and the 2003 Mezzanine Loan, these values include a “step-up”to the fair market value. This step-up is accreted over the term of thefacility as a reduction of interest expense.

 

Note B – The minimum interest rate on the 2003Mezzanine Loan is 6.65%, including the spread on LIBOR of 465 basis points.Also, the 26 hotels collateralizing the 2003 CMBS also serve as collateral onthe 2003 Mezzanine Loan.

 

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Thefollowing table represents our contractual cash obligations and the futurepotential commitments, and the related payment periods and estimated paymentperiods as of December 31, 2003 (in thousands):

 
| **Contractual Cash Obligations**  |   | **Less than  1 Year** |   | **2-3 Years** |   | **4-5 Years** |   | **Thereafter** |    | **Fair Value  Total** |   |
|-----------------------------------|--------|-----------------------|--------|---------------|--------|---------------|--------|----------------|---------|-----------------------|--------|
|                              |   |                  |   |          |   |          |   |           |    |                  |   |
| Mortgages and other notes payable |   | $                     | 2,888  |          | $      | 171,585       |   | $              | 102,187 |                  | $      | 124,374 |   | $ | 401,034 |   |
|                                   |        |                       |        |               |        |               |        |                |         |                       |        |  |  |  |  |  |

 

In addition to the aboveprincipal payment of debt obligations as of December 31, 2003, the OperatingPartnership has a cash deposit of $3.0 million, held in escrow, thatserves as collateral on the worker’s compensation plan for the former hotelemployees of Flagstone. This cash deposit is included on the ConsolidatedBalance Sheet in Restricted Cash. This deposit is required by the insurancecarrier to be maintained until the outstanding claims under the plan havedeveloped and there are adequate reserves to cover the claims.  There have been no withdrawals made from theescrow deposit. The Operating Partnership is also committed to make futurepayments under various operating leases that are not significant.

 

The OperatingPartnership’s borrowings contain various covenants including the maintenance ofa minimum net worth, minimum fixed charge coverage ratios, restricted paymentlimitations, and total indebtedness and liability limitations. Violation ofcertain of these covenants could potentially trigger penalties,including cash management arrangements whereby the lenders or theirdesignated loan servicers capture operating cash from certain hotels andadminister the payment of property taxes, insurance, debt service andexpenditures for other obligations. The Operating Partnership was incompliance with these covenants at December 31, 2003. A summary of themost restrictive covenants, along with the Operating Partnership’scorresponding value for each covenant, at December 31, 2003, are asfollows:

 

| **Covenant Test**                                                            |   | **Covenant**   |   | **Value**      |   |
|------------------------------------------------------------------------------|--------|----------------|--------|----------------|--------|
|                                                                         |   |           |   |           |   |
| Fixed charge coverage ratio must be equal  to or greater than 2.00:1.00      |   | 2.00           |   | 2.30           |   |
| Secured debt must be not greater than 45%  of total assets                   |   | 45.0           | %      | 34.1           | %      |
| Minimum net worth must be not less than the  adjusted base worth             |   | $287.7 million |   | $503.1 million |   |
| Restricted payments must be not greater  than the restricted payments basket |   | $201.2 million |   | $129.6 million |   |

 

Certain significantcredit statistics at December 31, 2003 and 2002 are as follows:

 

| **Credit Statistic**                                      |   | **December  31, 2003** |   | **December  31, 2002** |   |
|-----------------------------------------------------------|--------|------------------------|--------|------------------------|--------|
|                                                      |   |                   |   |                   |   |
| Weighted average maturity of fixed rate  debt             |   | 6.3 years              |   | 7.6 years              |   |
| Ratio of fixed interest rate debt to total  debt          |   | 59%                    |   | 98%                    |   |
| Ratio of debt to investment in hotel  properties, at cost |   | 47%                    |   | 37%                    |   |

 

During theyear ended December 31, 2003, the Operating Partnership spent approximately$11.3 million of capital improvements to its hotels versus an initial plan of$12.2 million. A substantial portion of the 2003 expenditures focused onprojects at ten of the Operating Partnership’s hotels: 1) the earthquakeretrofit and renovation at the Hotel Rex in San Francisco, CA; 2) theconversion of the Birmingham hotel to a Hilton from a Sheraton; 3) the completionof product improvement plans at six of the Hampton Inns; and 4) the renovationof the Residence Inns in Fishkill, NY and Sacramento, CA. As a result of theRFS-CNL Transaction, the respective hotel franchisors have issued productimprovement plans on most of the Operating Partnership’s hotels and requirethat the Operating Partnership complete these product improvement plans overthe next several years. The Operating Partnership expects the total cost ofthese product improvement plans will be approximately $40 million.  The Operating Partnership expects to fundthese improvements out of cash generated from operations. The OperatingPartnership expects to spend approximately $17.7 million dollars oncapital improvements in 2004, which includes amounts required under the productimprovement plans planned for 2004.

 

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TheOperating Partnership expects to be able to meet its short-term workingcapital, capital expenditure and debt service requirements through cash andrestricted cash balances on hand at December 31, 2003, cash flow fromoperations or from contributions from CNL. As market conditions permit, theOperating Partnership may, from time to time, access the debt capital marketsas a source of additional liquidity. Over the longer term, the OperatingPartnership’s ability to generate sufficient cash flow from operations to makescheduled payments on its debt obligations will depend on its future financialperformance, which will be affected by a range of economic, competitive andbusiness factors, many of which are outside of the Operating Partnership’scontrol. If the Operating Partnership does not generate sufficient cash flowfrom operations to satisfy its debt obligations, the Operating Partnership mayhave to undertake alternative financing plans. The Operating Partnership cannotassume that completion of any such alternative financing plans will bepossible. The Operating Partnership’s inability to generate sufficient cashflow to satisfy its debt obligations or to refinance its obligations oncommercially reasonable terms would have an adverse effect on its business,financial condition and results of operations.

 

The Operating Partnership in the future mayseek to increase further the amount of its credit facilities, negotiateadditional credit facilities, or issue corporate debt instruments. TheOperating Partnership has no restrictions in its Agreement of LimitedPartnership on the amount of indebtedness the Operating Partnership may incur.

 

**Inflation**

 

Operators of hotels, in general, possess theability to adjust room rates daily so the impact of higher inflation often canbe passed onto customers. However, competitive pressures may limit the abilityof the lessees and management companies to raise room rates to offset risingcosts.

 

##### **CriticalAccounting Policies and Estimates**

 

The Operating Partnership’s consolidated financial statements includeaccounts of the Operating Partnership and all consolidated subsidiaries. Thediscussion and analysis of the financial condition and results of operations isbased upon the Operating Partnership’s consolidated financial statements, whichhave been prepared in accordance with generally accepted accounting principles(“GAAP”).  The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amount of assets, liabilities, revenuesand expenses, and related disclosures. The estimates are based on judgment and historical experience, and arebelieved to be reasonable based on current circumstances.  The Operating Partnership evaluates theseestimates and assumptions on an on-going basis.

 

While the Operating Partnership does not believe that the reportedamounts would be materially different, application of these policies involvesthe exercise of judgment and the use of assumptions as to future uncertaintiesand, as a result, actual results could differ from these estimates underdifferent assumptions or conditions. The Operating Partnership’s significantaccounting policies are disclosed in Note 1 to the Consolidated FinancialStatements (see Item 8, “Financial Statements and Supplementary Data”). Thefollowing represent certain critical accounting policies that require the useof business judgment or significant estimates to be made:

 

•                  *Allowance for doubtful accounts receivable.*The Operating Partnership maintains allowances for doubtful accounts forestimated losses resulting from the inability of customers or tenants to makerequired payments. The Operating Partnership monitors on a regular basis itsoutstanding receivables and actively seeks to collect all overdue balances bysending overdue notices to customers and tenants, speaking with customers andtenants, and seeks collection through the use of an agency or a court of law.If the Operating Partnership believes that a portion of a receivable or anentire receivable will not be collected, the Operating Partnership will providean allowance for doubtful accounts against that receivable for the estimate ofthe uncollectible amount. If the financial condition of the OperatingPartnership’s customers were to deteriorate, resulting in an impairment of thecustomers’ ability to make payments, additional allowances may be required.

 

•                  *Depreciation and amortization expense.*TheOperating Partnership evaluates its estimates regarding the useful lives of theOperating Partnership’s assets and on the method used to calculate depreciationand amortization.  The life of theassets are based on a number of assumptions, including cost and timing ofcapital expenditures to maintain and refurbish the assets, and estimatedholding periods. The Operating Partnership believes its estimates arereasonable; however, a change in the estimated lives of the assets or themethod of depreciation could affect depreciation and amortization expense andnet income or the gain or loss on the sale of any of the assets.

 

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•                  *Determination of fair value of long-lived assets. *The Operating Partnership reviewsits hotels for impairment whenever events or changes in circumstances indicatethat the carrying amount of the assets may not be recoverable throughoperations. The Operating Partnership determines whether impairment in valuehas occurred by comparing the estimated future undiscounted cash flows,including the residual value of the hotel, with the carrying cost of theindividual hotel. Although to date, no impairment has occurred, such animpairment would result in a reduction in the carrying value of the impairedhotel and an expense to the Operating Partnership for the amount of theimpairment write-down. In estimating future undiscounted cash flows, theOperating Partnership must use historical cash flows, the expected growth rateof revenue and expenses, the effect of capital expenditures, remaining usefullife of the hotel, holding periods, and future market and economic conditions.Variability of these and other assumptions could result in a difference in theestimated undiscounted future cash flows.

 

•                  *Valuation ofdeferred tax assets. *TheOperating Partnership accounts for federal and state income taxes with respectto its TRS subsidiaries using the asset and liability method.  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe consolidated financial statements carrying amounts of existing assets andliabilities and respective tax bases and operating losses and tax-credit carryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled.   The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.  In the event that these assumptions changethe deferred taxes may change.

 

Valuation allowances are established when necessary to reduce deferredtax assets to the amount expected to be realized.  The valuation allowance is based on the Operating Partnership’sestimates of future taxable income and ongoing prudent and feasible taxplanning strategies. Should the Operating Partnership determine it would not belikely to realize in full the deferred tax asset in the future, the OperatingPartnership would record a valuation allowance to reduce the deferred tax assetto an amount that is more likely than not to be realized. Such adjustment tothe deferred tax asset would decrease income in the period such determinationwas made.

 

In estimating future taxable income, management must estimate futureincome using historical data, the expected growth rate of revenues andexpenses, the effect of capital expenditures, and future market and economicconditions.  Variability of these andother assumptions could result in an inability to recover the carrying value ofthe deferred tax assets.

 

**Recently IssuedAccounting Pronouncements**

 

In April 2003, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 149, “Amendment of Statement133 on Derivative Instruments and Hedging Activities” (“FASB 149”).  FASB 149 amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities under FASB Statement No. 133,“Accounting for Derivative Instruments and Hedging Activities.”  The Operating Partnership adopted FAS 149 inthe year ended December 31, 2003, and it did not have a material impact on theOperating Partnership’s results of operations.

 

In May 2003, the FASB issued FASB Statement No.150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity” (“FASB 150”).  FASB 150establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity.  FASB 150 requires issuers to classifycertain financial instruments as liabilities (or assets in some circumstances)that previously were classified as equity. FASB 150 requires that minority interests for majority owned finitelived entities be classified as a liability and recorded at fair marketvalue.  Effective October 29, 2003, theFASB deferred implementation of FASB 150, as it applies to minority interestsof finite lived Partnerships.

 

In December 2003, the FASB issued FASB Interpretation No. 46 (revisedDecember 2003) (“FIN 46R”), “Consolidation of Variable Interest Entities”.  This Interpretation requires existingunconsolidated variable interest entities to be consolidated by their primarybeneficiaries if the entities do not effectively disperse risks among partiesinvolved.  The primary beneficiary of avariable interest entity is the party that absorbs a majority of the entity’sexpected losses, receives a majority of its expected residual returns, or both,as a result of holding variable interests, which are the ownership, contractual,or other pecuniary interests in an entity that change with changes in the fairvalue of the entity’s net assets excluding variable interests.  Prior to FIN 46R, a company generallyincluded another entity in its consolidated financial statements only if itcontrolled the entity through voting interests.  Application of FIN 46R is required in financial statements ofpublic entities that have interests in variable interest entities for periodsending after March 15, 2004.  TheOperating Partnership has no unconsolidated variable interest entities.

 

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**Item 7A. *Quantitative and Qualitative Disclosures About MarketRisk***

 

The Operating Partnership is exposed to certain financial market risks,including fluctuations in interest rates. The Operating Partnership monitorsinterest rate fluctuations as an integral part of the Operating Partnership’soverall risk management program, which recognizes the unpredictability offinancial markets 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 marketrisk exposure is to changes in interest rate as a result of its variableinterest rate, long-term debt. At December 31, 2003, the Operating Partnershiphad outstanding total indebtedness of approximately $406.0 million. The OperatingPartnership’s interest rate risk objective is to limit the impact of interestrate fluctuations on earnings and cash flows and to lower its overall borrowingcosts. To achieve this objective, the Operating Partnership manages itsexposure to fluctuations in market interest rates for its borrowings throughthe use of fixed rate debt instruments to the extent that reasonably favorablerates are obtainable with such arrangements and derivative financialinstruments such as interest rate swaps or caps, to effectively lock theinterest rate on a portion of its variable debt or to limit the maximuminterest rate to be paid on an instrument.

 

The Operating Partnership purchased twointerest rate caps that limit the LIBOR portion of the floating interest rateson the 2003 CMBS and the 2003 Mezzanine Loan to 5.0%, before the spread of 189basis points and 465 basis points, respectively. The Operating Partnership paida $1.5 million premium to enter into these agreements. At December 31, 2003,the Operating Partnership has net unrealized holding losses related to thesetwo interest rate cap agreements of $0.4 million, which is included in othercomprehensive income.

 

The Operating Partnership has not enteredinto any derivative or interest rate transactions for speculative purposes, nordoes the Operating Partnership anticipate doing so in the future. Approximately59% of the Operating Partnership’s outstanding debt was subject to fixed rateswith a weighted average interest rate of 8.6% at December 31, 2003. The OperatingPartnership regularly reviews interest rate exposure on its outstandingborrowings in an effort to minimize the risk of interest rate fluctuations. TheOperating Partnership’s operating results have historically been affected bychanges in interest rates primarily as a result of its variable interest rateborrowings. If interest rates increased by 25 basis points, interest expensewould have increased by approximately $173 thousand for the year ended December31, 2003, respectively, based on balances outstanding during the year.

 

The following tableprovides information about the Operating Partnership’s instruments that havebeen sensitive to changes in interest rates. For debt obligations outstandingat December 31, 2003, the table presents principal cash flows and relatedweighted average interest rates by expected maturity dates. Weighted averagevariable rates are based on implied forward rates in the yield curve as ofDecember 31, 2003. The fair value of the Operating Partnership’s fixed rate debtat December 31, 2003, indicates the estimated principal amount of debt havingsimilar debt service requirements, which could have been borrowed by theOperating Partnership at December 31, 2003. As part of purchase accounting, thedebt was recorded at its fair value, which was approximately $5.8 millionhigher than its carrying value on the date of acquisition.  The rate assumed in the fair valuecalculation of fixed rate debt, excluding the Senior Notes, is equal to 7.00%.The fair value calculation of the Senior Notes is management’s estimate basedon recent trade activity in the Operating Partnership’s Senior Notes and therecent repurchase of the Senior Notes.

 

## **Expected Principal CashFlows**

 
| **Liabilities**       |   | **2004**           |   | **2005** |   | **2006** |    | **2007** |   | **2008** |   | **Thereafter** |   | **Total** |   | **Fair Value    Total** |   |
|-----------------------|--------|--------------------|--------|----------|--------|----------|---------|----------|--------|----------|--------|----------------|--------|-----------|--------|-------------------------|--------|
|                  |   | **(in thousands)** |   |
| Long-Term Debt:       |   |               |   |     |   |     |    |     |   |     |   |           |   |      |   |                    |   |
| Fixed Rate (Note A)   |   | $                  | 2,888  |     | $      | 3,161    |    | $        | 3,424  |     | $      | 19,662         |   | $         | 82,525 |                    | $      | 124,374 |   | $ | 236,034 |   | $ | 236,965 |   |
| Average Interest Rate |   | 8.6                | %      | 8.6      | %      | 8.6      | %       | 8.6      | %      | 8.6      | %      | 8.6            | %      |      |   |                    |   |
|                  |   |               |   |     |   |     |    |     |   |     |   |           |   |      |   |                    |   |
| Variable Rate         |   | —             |   | —   |   | $        | 165,000 |     | — |     | — |           | — |      | $      | 165,000                 |   | $ | 165,000 |   |
| Average Interest Rate |   |               |   |     |   | 3.78     | %       |     |   |     |   |           |   |      |   |                    |   |
|                       |        |                    |        |          |        |          |         |          |        |          |        |                |        |           |        |                         |        |  |  |  |  |  |  |  |  |

 

The table incorporatesonly those exposures that exist as of December 31, 2003 and does not considerexposures or positions that could arise after that date. In addition, becausefirm commitments are not represented in the table above, the informationpresented therein has limited predictive value. As a result, the OperatingPartnership’s ultimate realized gain or loss with respect to interest ratefluctuations would depend on the exposures that arise during future periods,prevailing interest rates, and the Operating Partnership’s strategies at thattime. There is inherent rollover risk for borrowings as they mature and arerenewed at current market rates. The extent of this risk is not quantifiable orpredictable because of the variability of future interest rates and theOperating Partnership’s financing requirements.

 

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**Item 8. *Financial Statements and Supplementary Data***

 

Incorporated herein beginning at page F-1.

 

**Item 9.*Changes in and Disagreements with Accountants onAccounting and Financial Disclosure.***

 

None.

 

**Item 9A. *Controls and Procedures***

 

Quarterly Evaluation. Management carried out an evaluation as of December 31, 2003 of theeffectiveness of the design and operation of the Operating Partnership’s“disclosure controls and procedures,” which management refers to as theOperating Partnership’s disclosure controls. This evaluation was done under the supervision and with theparticipation of management, including the Operating Partnership’s PrincipalExecutive Officer and Principal Financial Officer.  Rules adopted by the Commission require that management presentthe conclusions of the Principal Executive Officer and Principal FinancialOfficer about the effectiveness of the Operating Partnership’s disclosurecontrols as of the end of the period covered by this annual report.

 

Principal Executive Officer and Principal Financial OfficerCertifications.  Included as Exhibits31.1 and 31.2 to this Annual Report on Form 10-K are Certifications of theOperating Partnership’s Principal Executive Officer and Principal FinancialOfficer.  The Certifications are requiredin accordance with Section 302 of the Sarbanes-Oxley Act of 2002. This sectionof the Annual Report on Form 10-K which you are currently reading is theinformation concerning the evaluation referred to in the Section 302certifications.  This information shouldbe read in conjunction with the Section 302 certifications for a more completeunderstanding of the topics presented.

 

Disclosure Controls and Procedures and Internal Control over FinancialReporting.  Disclosure controls andprocedures are designed with the objective of ensuring that informationrequired to be disclosed in the Operating Partnership’s reports filed orsubmitted under the Exchange Act, such as this Annual Report on Form 10-K, isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms. Disclosure controls and procedures are also designed with the objectiveof ensuring that such information is accumulated and communicated to the OperatingPartnership’s management, including the Operating Partnership’s PrincipalExecutive Officer and Principal Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

Internal control over financial reporting is a process designed by, orunder the supervision of, the Operating Partnership’s Principal ExecutiveOfficer and Principal Financial Officer, and effected by CNL’s Board ofDirectors, the Operating Partnership’s management and other personnel, toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles and includes those policies andprocedures that:

 

•                  pertain to themaintenance of records that in reasonable detail accurately and fairly reflectthe transactions and dispositions of our assets;

 

•                  providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that the Operating Partnership’s receipts andexpenditures are being made only in accordance with authorizations of ourmanagement and CNL’s Board; and

 

•                  providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Operating Partnership’s assets thatcould have a material adverse effect on the Operating Partnership’s financialstatements.

 

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Limitations on the Effectiveness of Controls.  Management, including the Operating Partnership’s PrincipalExecutive Officer and Principal Financial Officer, do not expect that theOperating Partnership’s disclosure controls and procedures or the OperatingPartnership’s internal control over financial reporting will prevent all errorsand all fraud.  A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met.  Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs.  Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the company have been detected.  These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management’s overrideof the control.  The design of anysystem of controls also is based in part upon certain assumptions about thelikelihood of future events, and there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions;over time, controls may become inadequate because of changes in conditions, orthe degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

Conclusions.  Based upon the evaluation, the OperatingPartnership’s Principal Executive Officer and Principal Financial Officer haveconcluded that, as of December 31, 2003 and subject to the limitations notedabove, the Operating Partnership’s disclosure controls and procedures wereeffective to ensure that material information relating to the OperatingPartnership and the Operating Partnership’s consolidated subsidiaries is madeknown to management, including the Operating Partnership’s Principal ExecutiveOfficer and Principal Financial Officer as appropriate, to allow timelydecisions regarding required disclosure.

 

During the three monthsended December 31, 2003, there were no significant changes in the OperatingPartnership’s internal control over financial reporting that has materiallyaffected, or are reasonably likely to materially affect, the OperatingPartnership’s internal control for financial reporting.

 

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**PART III**

 

**Item 10. *Directors and Executive Officers***

 

The General Partner of the Operating Partnership isCNL Rose GP Corp. (the “General Partner”). The directors of the General Partner are Thomas J. Hutchison III, JamesM. Seneff, Jr. and Robert A. Bourne. Each director is subject to election on anannual basis.

 

The table below sets forth the names, agesand positions of the General Partner’s directors and officers.

 
| **Name**                 |   | **Age** |   | **Position**                                                 |
|--------------------------|--------|---------|--------|--------------------------------------------------------------|
| Thomas J.  Hutchison III |   | 62      |   | Director,  Chairman of the Board and Chief Executive Officer |
| John A.  Griswold        |   | 54      |   | President                                                    |
| Robert A.  Bourne        |   | 56      |   | Director and  Treasurer                                      |
| James M.  Seneff, Jr.    |   | 57      |   | Director                                                     |
| C. Brian  Strickland     |   | 41      |   | Executive  Vice President                                    |
| Charles A.  Muller       |   | 45      |   | Executive  Vice President                                    |
| Tammie A.  Quinlan       |   | 41      |   | Senior Vice  President                                       |
| Barry A.N.  Bloom        |   | 39      |   | Senior Vice  President                                       |
| Paul H.  Williams        |   | 39      |   | Senior Vice  President                                       |
| Lynn E. Rose             |   | 55      |   | Secretary                                                    |

 

Setforth below is a brief description of the business experience during at leastthe past five years of each of the persons named above.

***Thomas J. Hutchison III***serves as the Director, Chairman of the Board and Chief Executive Officer ofthe General Partner.  He also serves asChief Executive Officer of CNL Hospitality Properties, Inc., as co-ChiefExecutive Officer and a director of CNL Hospitality Corp., and as President ofCNL Hotel Investors, Inc., a real estate investment trust majority owned by CNLHospitality Properties, Inc.  From June2002 through March 17, 2003, Mr. Hutchison served as President of CNLHospitality Properties, Inc. and of CNL Hospitality Corp.  From 2000 to June 2002, Mr. Hutchison servedas Executive Vice President of CNL Hospitality Properties, Inc. and of CNLHospitality Corp., and from 2000 to July 2002, he served as Executive VicePresident of CNL Hotel Investors, Inc. In addition, Mr. Hutchison serves as President and Chief OperatingOfficer of CNL Real Estate Group, Inc., which is the parent company of CNLHospitality Corp. and CNL Retirement Corp. He also serves as the President and Chief Operating Officer of CNLRealty & Development Corp.  Inaddition, Mr. Hutchison serves as President and Chief Executive Officer of CNLRetirement Properties, Inc. and as a director, President and Chief ExecutiveOfficer of CNL Retirement Corp., its advisor. Mr. Hutchison also serves as a director, Chairman and Chief Executive Officerof EMTG, LLC.  EMTG, LLC publishes theMobil Travel Guide, a publication which features information about domestichotels, resorts, restaurants, sites and attractions.  From 2000 to June 2002, Mr. Hutchison served as Executive VicePresident of CNL Retirement Properties, Inc. and CNL Retirement Corp.  Mr. Hutchison joined CNL Financial Group,Inc. in January 2000 with more than 30 years of senior management andconsulting experience in the real estate development and servicesindustries.  He currently serves on theboard of directors of Restore Orlando, a nonprofit community volunteerorganization.  Prior to joining CNL, Mr.Hutchison was president and owner of numerous real estate services anddevelopment companies.  From 1995 to2000, he was chairman and chief executive officer of Atlantic Realty Services,Inc. and TJH Development Corporation. Since 1990, he has fulfilled a number of long-term consultingassignments for large corporations, including managing a number of largeinternational joint ventures.  From 1990to 1991, Mr. Hutchison was the court-appointed president and chief executiveofficer of General Development Corporation, a real estate community developmentcompany, where he assumed the day-to-day management of the $2.6 billionNYSE-listed company entering reorganization. From 1986 to 1990, he was 

 

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thechairman and chief executive officer of a number of real estate-relatedcompanies engaged in the master planning and land acquisition of fortyresidential, industrial and office development projects.  From 1978 to 1986, Mr. Hutchison was thepresident and chief executive officer of Murdock Development Corporation andMurdock Investment Corporation, as well as Murdock’s nine service divisions.  In this capacity, he managed an average of$350 million of new development per year for over nine years.  Additionally, he expanded the commercialreal estate activities to a national basis, and established both a new extendedcare division and a hotel division that grew to 14 properties.  Mr. Hutchison was educated at PurdueUniversity and the University of Maryland Business School.

***John A. Griswold***serves as the President of the General Partner.  He has over 30 years of experience in the hospitalityindustry.  Mr. Griswold also serves asPresident and Chief Operating Officer of CNL Hospitality Properties, Inc. andas a director, President and Chief Operating Officer of CNL Hospitality Corp.  From January 1999 to February 2003, Mr.Griswold served as one of CNL Hospitality Properties, Inc.’s directors.  From 1985 to March 2003, Mr. Griswold servedas president of Tishman Hotel Corporation, an operating unit of Tishman Realty& Construction Co., Inc., founded in 1898. Tishman Hotel Corporation is a hotel developer, owner and operator, andhas provided such services for more than 85 hotels, totaling more than 30,000rooms.  From 1981 to 1985, Mr. Griswoldserved as general manager of the Buena Vista Palace Hotel in The Walt DisneyWorld Village.  From 1978 to 1981, heserved as vice president and general manager of the Homestead Resort, a luxurycondominium resort in Glen Arbor, Michigan. In addition, Mr. Griswold served as an operations manager for The WaltDisney Company from 1971 to 1978.  Hewas responsible for operational, financial and future planning for multi-unitdining facilities in Walt Disney World Village and Lake Buena Vista CountryClub.  He is a member of the board ofdirectors of the Florida Hotel & Lodging Association, chairman elect ofOrlando/Orange County Convention & Visitors Bureau, Inc. and chairman ofthe First Orlando Foundation.  Mr.Griswold received a B.S. from the School of Hotel Administration at CornellUniversity in Ithaca, New York.

***Robert A. Bourne*******serves as a Director andTreasurer of the General Partner.  Healso serves as a Director, Vice Chairman of the Board and Treasurer of CNLHospitality Properties, Inc. and of CNL Hospitality Corp., and director andTreasurer of CNL Hotel Investors, Inc., a real estate investment trust majorityowned by CNL Hospitality Properties, Inc. Mr. Bourne served as President of CNL Hospitality Properties, Inc. andof CNL Hospitality Corp. from 1997 to June 2002, and served as President of CNLHotel Investors, Inc. from 1999 to July 2002. Mr. Bourne is also the President and Treasurer of CNL Financial Group,Inc.; a director, Vice Chairman of the Board and Treasurer of CNL RetirementProperties, Inc., a public, unlisted real estate investment trust; as well as,a director, Vice Chairman of the Board and Treasurer of CNL Retirement Corp.,its advisor.  Mr. Bourne served asPresident of CNL Retirement Properties, Inc. and CNL Retirement Corp. from 1998and 1997, respectively, to June 2002. Mr. Bourne also serves as a director of CNLBank.  He serves as a director and Vice Chairman ofthe Board of Commercial Net Lease Realty, Inc., a public real estate investmenttrust listed on the New York Stock Exchange. Mr. Bourne has served as a director since inception in 1994, Presidentfrom 1994 through February 1999, Treasurer from February 1999 through August1999, and Vice Chairman of the Board since February 1999, of CNL RestaurantProperties, Inc., a public, unlisted real estate investment trust.  Mr. Bourne also serves as a director,President and Treasurer for various affiliates of CNL Financial Group, Inc.,including CNL Investment Company, CNL Securities Corp., and CNL InstitutionalAdvisors, Inc., a registered investment advisor for pension plans.  As President of CNL Financial Group, Inc., Mr.Bourne has overseen CNL’s real estate and capital markets activities includingthe investment of over $3 billion in equity and the financing, acquisition,construction and leasing of restaurants, office buildings, apartment complexes,hotels, retirement properties and other real estate.  Mr. Bourne began his career as a certified public accountantemployed by Coopers & Lybrand, Certified Public Accountants, from 1971through 1978, where he attained the position of tax manager in 1975.  Mr. Bourne graduated from Florida StateUniversity in 1970 where he received a B.A. in Accounting, with honors.

***James M. Seneff****, **Jr.*******serves as a Director ofthe General Partner.  He also serves asa Director and Chairman of the Board of CNL Hospitality Properties, Inc. Mr. Seneffserved as Chief Executive Officer since inception through February 13, 2003 andhe served as co-Chief Executive Officer from February 14, 2003 through May 1,2003 of CNL Hospitality Properties, Inc. Mr. Seneff serves as a director, Chairman of the Board and co-ChiefExecutive Officer of CNL Hospitality Corp. and CNL Hotel Investors, Inc.  Mr. Seneff is a principal stockholder of CNLHoldings, Inc., the parent company of CNL Financial Group, Inc., 

 

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adiversified real estate company, and has served as a director, Chairman of theBoard and Chief Executive Officer of CNL Financial Group, Inc. and itssubsidiaries since CNL’s formation in 1973. CNL Financial Group, Inc. is the parent company, either directly orindirectly through subsidiaries, of CNL Real Estate Services, Inc., CNLHospitality Corp., CNL Capital Markets, Inc., CNL Investment Company and CNLSecurities Corp.  Mr. Seneff also servesas a director and Chairman of the Board of CNL Retirement Properties, Inc., apublic, unlisted real estate investment trust, as well as CNL Retirement Corp.,its advisor.  Since 1992, Mr. Seneff hasserved as a director, Chairman of the Board and Chief Executive Officer ofCommercial Net Lease Realty, Inc., a public real estate investment trust thatis listed on the New York Stock Exchange. In addition, he has served as a director and Chairman of the Board sinceinception in 1994, served as Chief Executive Officer from 1994 through August1999 and co-Chief Executive Officer from December 2000 through September 2003of CNL Restaurant Properties, Inc., a public, unlisted real estate investmenttrust.  Mr. Seneff has also served as adirector, Chairman of the Board and Chief Executive Officer of CNL SecuritiesCorp. since 1979; CNL Investment Company since 1990; and CNL InstitutionalAdvisors, Inc., a registered investment adviser for pension plans, since1990.  Mr. Seneff formerly served as adirector of First Union National Bank of Florida, N.A., and currently serves asthe Chairman of the Board of CNLBank. Mr. Seneff served on the Florida State Commission on Ethics and is aformer member and past chairman of the State of Florida Investment AdvisoryCouncil, which recommends to the Florida Board of Administration investmentsfor various Florida employee retirement funds. The Florida Board of Administration is Florida’s principal investmentadvisory and money management agency and oversees the investment of more than$60 billion of retirement funds.  Mr.Seneff received his degree in Business Administration from Florida StateUniversity in 1968.

***                C.Brian Strickland*******servesas an Executive Vice President of the General Partner.  He also serves as Executive Vice Presidentof CNL Hospitality Properties, Inc., CNL Hospitality Corp., CNL HotelDevelopment Company and CNL Hotel Investors, Inc.  Mr. Strickland supervises the companies’ financial reporting,financial control and accounting functions as well as forecasting, budgeting andcash management activities.  He is alsoresponsible for regulatory compliance, equity and debt financing activities andinsurance for the companies.  Mr.Strickland joined CNL Hospitality Corp. in April 1998 with an extensiveaccounting background.  Prior to joiningCNL, he served as vice president of taxation with Patriot American Hospitality,Inc., where he was responsible for implementation of tax planning strategies oncorporate mergers and acquisitions and where he performed or assisted instrategic processes in the REIT industry. From 1989 to 1997, Mr. Strickland served as a director of tax and assetmanagement for Wyndham Hotels & Resorts where he was integrally involved instructuring acquisitive transactions, including the consolidation and initialpublic offering of Wyndham Hotel Corporation and its subsequent merger withPatriot American Hospitality, Inc.  Inhis capacity as director of asset management, he was instrumental in thedevelopment and opening of a hotel and casino in San Juan, Puerto Rico.  Prior to 1989, Mr. Strickland was senior taxaccountant for Trammell Crow Company where he provided tax consulting servicesto regional developmental offices.  From1986 to 1988, Mr. Strickland was tax accountant for Ernst & Whinney wherehe was a member of the real estate practice group.  Mr. Strickland is a certified public accountant and holds abachelor’s degree in Accounting.

***                CharlesA. Muller*******servesas an Executive Vice President of the General Partner.  He also serves as an Executive VicePresident of CNL Hospitality Properties, Inc. Mr. Muller joined CNL HospitalityCorp. in October 1996 and is primarily responsible for overseeing the investorrelations functions and related activities of CNL Hospitality Properties,Inc.  From October 1996 through November2003, Mr. Muller served as Chief Operating Officer of CNL HospitalityProperties, Inc. and CNL Hospitality Corp. and was primarily responsible forthe planning and implementation of the interest in hotel industry investments,including acquisitions, development, project analysis and due diligence.  Mr. Muller currently serves as ExecutiveVice President of CNL Hospitality Corp., CNL Hotel Development Company and CNLHotel Investors, Inc.  Mr. Muller joinedCNL following more than 15 years of broad-based hotel industry experience withfirms such as Tishman Hotel Corporation, Wyndham Hotels & Resorts, PKFConsulting and AIRCOA Hospitality Services. Mr. Muller’s background includes responsibility for market review andvaluation efforts, property acquisitions and development, capital improvementplanning, hotel operations and project management for renovations and newconstruction.  Mr. Muller served on theformer Market, Finance and Investment Analysis Committee of the American Hotel& Lodging Association, currently serves on the Urban Land Institute — HotelDevelopment Council, and is a founding member of the 

 

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LodgingIndustry Investment Council.  He holds abachelor’s degree in Hotel Administration from Cornell University.

***                Tammie A. Quinlan***serves as a Senior Vice President of the General Partner. She also serves asSenior Vice President of Corporate Finance and Treasury of CNL HospitalityProperties, Inc.  Ms. Quinlan joined CNLHospitality Corp. in August 1999 and is responsible for all accounting andfinancial reporting requirements, and corporate finance functions. Prior toCNL, Ms. Quinlan was employed by KPMG LLP from 1987 to 1999, most recently as asenior manager, performing services for a variety of clients in the real estate,hospitality, and financial services industries. During her tenure at KPMG LLP,Ms. Quinlan assisted several clients through their initial public offerings,secondary offerings, securitizations and complex business and accountingissues. Ms. Quinlan is a certified public accountant and holds a B.S. inaccounting and finance from the University of Central Florida.

 

***                Barry A.N. Bloom*** serves as a Senior VicePresident of the General Partner. He also serves as Senior Vice President ofCNL Hospitality Properties, Inc. and of CNL Hospitality Corp. Mr. Bloom joinedCNL Hospitality Corp. in May 2003 and he is responsible for the oversight ofselect hotel assets as well as directing efforts in management and franchiseagreement administration, real estate ownership issues, hotel technology andintegrating acquisitions into its existing portfolio management systems.  Immediately prior to joining CNL HospitalityCorp., Mr. Bloom served as Vice President — Investment Management for HyattDevelopment Corporation for three years. At Hyatt, he was responsible for providing ownership discipline andoversight for over 50 hotels and provided direction and decision making forcapital expenditures and real estate issues. Prior to serving as Vice President of Hyatt, Mr. Bloom was a VicePresident at Tishman Hotel Corporation where he spent over 10 years in avariety of capacities including investment banking, asset management andproperty management.  Prior to joiningTishman, he worked for VMS Realty Partners and Pannell Kerr Forster. Mr. Bloomholds an MBA from the Johnson School at Cornell University and a bachelor’sdegree from the School of Hotel Administration at Cornell University.

 

***                Paul Williams*** serves as a Senior VicePresident of the General Partner. He also serves as Senior Vice President ofCNL Hospitality Properties, Inc. and Senior Vice President of CorporateStrategy and Capital Markets of CNL Hospitality Corp.  Mr. Williams joined CNL Hospitality Corp. in July 2003 and isresponsible for developing corporate strategy, implementing financial plans andexecuting acquisitions.  Mr. Williamshas over 17 years of experience in the areas of investment banking, finance andaccounting, including mergers and acquisitions and capital markets.  Prior to joining CNL Hospitality Corp., Mr.Williams served six years as a Principal in Mergers and Acquisitions and RealEstate Investment Banking with Banc of America Securities LLC.  In doing so, he executed a variety ofcorporate and asset transactions specializing in the identification andexecution of mergers, acquisitions, sales and financings for real estateinvestment trusts and real estate opportunity funds.  In addition, Mr. Williams spent 10 years with public accountingfirms Price Waterhouse and Deloitte & Touche.  Mr. Williams holds a bachelor’s degree in accounting from theUniversity of Florida.

 

***                Lynn E. Rose***serves as Secretary of theGeneral Partner.  She also serves asSecretary of CNL Hospitality Properties, Inc. and its subsidiaries and asSecretary of CNL Hospitality Corp. Ms. Rose served as Treasurer of CNLHospitality Properties, Inc. from 1996 through September 2001 and as Treasurerand a director of CNL Hospitality Corp. from 1997 through June 2001.  In addition, Ms. Rose serves as Secretary ofCNL Hotel Investors, Inc., and served as Treasurer from 1999 through June2001.  Ms. Rose is Secretary of CNLRetirement Properties, Inc. and serves as Secretary of its subsidiaries.  Ms. Rose served as Treasurer of CNLRetirement Properties, Inc. from 1998 through August 2001.  In addition, she serves as Secretary of CNLRetirement Corp., its advisor, and served as Treasurer and a director from 1997through June 2001.  Ms. Rose served asSecretary of CNL Restaurant Properties, Inc., a public, unlisted real estateinvestment trust, from 1994 through August 1999, and served as Treasurer from1994 through February 1999.  Ms. Rose, acertified public accountant, has served as Secretary of CNL Financial Group,Inc. since 1987, its Controller from 1987 to 1993 and its Chief FinancialOfficer from 1993 to present.  She alsoserves as Secretary of the subsidiaries of CNL Financial Group, Inc. and holdsother offices in the subsidiaries as appropriate in the circumstances.  In addition, she serves as Secretary forapproximately 75 additional corporations affiliated with CNL Financial Group,Inc. and its subsidiaries.  Ms. Rose hasserved as Chief Financial Officer and Secretary of CNL Securities Corp. sinceJuly 1994.  Ms. Rose oversees the 

 

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tax compliance for over 500corporations, partnerships and joint ventures, and the accounting and financialreporting for CNL Holdings, Inc. and its subsidiaries.  Prior to joining CNL, Ms. Rose was a partnerwith Robert A. Bourne in the accounting firm of Bourne & Rose, P.A.,Certified Public Accountants.  Ms. Roseholds a B.A. in Sociology from the University of Central Florida.  She was licensed as a certified publicaccountant in 1979.

 

*Audit Committee andAudit Committee Financial Expert*

 

                The Operating Partnership does not have astanding audit committee.

 

*Codes of Business Conduct and Ethics*

 

                The Operating Partnership had a Code of Business Conduct and Ethicsthat applied to all of its employees. In addition, the Operating Partnership hada Code of Ethics for its Chief Executive Officer, President and Chief OperatingOfficer, Chief Financial Officer and Chief Accounting Officer which wassupplemented by the Code of Business Conduct and Ethics. These Codes wereterminated in connection with the RFS-CNL Transaction. Subsequent to theRFS-CNL Transaction, CNL Hospitality Properties, Inc., theultimate corporate parent of the Operating Partnership, adopted a code ofethics that applies to our principal executive officer, principal financial officer,principal accounting officer, or persons performing similar functions.  The code of ethics, which is entitled “Codeof Business Conduct” is available on CNL’s Internet websitehttp://www.cnlonline.com.

 

**Item 11. *Executive Compensation***

 

No annual or long-term compensation was paid by theOperating Partnership to any executive officers of the General Partner forservices rendered in all capacities to the Operating Partnership following theconsummation of the RFS-CNL Transaction. In addition, none of the executive officers received an annual salary orbonus from the Operating Partnership following the consummation of the RFS-CNLTransaction.  The executive officers ofthe General Partner are also employees and executive officers of CNLHospitality Corp. or its affiliates and receive compensation from CNL FinancialGroup, Inc. and its affiliates in part for services provided to us. See “Item13- Certain Relationships and Related Transactions” for a description of thefees payable and expenses reimbursed to the CNL Hospitality Corp. and itsaffiliates.

 

**Item12.*Security Ownership of Certain BeneficialOwners and Management and Related Stock Matters***

 

***               ***The number of units outstanding was 31,941,852 asof March 30, 2004 (99.9% of which were held by CNL Rose Acquisition Corp.and 0.1% were held by CNL Rose GP Corp.). The Operating Partnership has notissued any securities under equity compensation plans.

 

**Item13. *Certain Relationships and RelatedTransactions***

 

                The officers of the General Partner holdsimilar positions with CNL and its affiliates. These affiliates are by contractentitled to receive fees and compensation for services provided in connectionwith the acquisition, development, management and sale of the OperatingPartnership’s assets. During 2003, the Operating Partnership paid approximately$15.5 million to affiliates of 

 

37

----

 

CNL in connectionwith reimbursements for acquisition costs incurred by CNL related to theRFS-CNL Transaction.

 

                Affiliates of CNL providevarious administrative services to the Operating Partnership, includingservices related to accounting; financial, tax and regulatory compliancereporting; due diligence and marketing; and investor relations, on a day to daybasis. The Operating Partnership incurred costs of approximately $30 thousandfor these services.

 

                Included in otherassets on the Operating Partnership’s Consolidated Balance Sheets are amountsdue from CNL and its affiliates of approximately $0.5 million for settlement ofvarious operational items for the year ended December 31, 2003. These amountsare repaid in the ordinary course of business.

 

**Item 14.*Principal Accountant Fees and Services***

*** ***
|                   |   | **Fiscal  Year** |    | **Fiscal  Year** |   |
|------------------------|--------|------------------|---------|------------------|--------|
|                   |   | **2003**         |    | **2002**         |   |
|                   |   |             |    |             |   |
| Audit Fees (a)         |   | $                | 170,000 |             | $      | 163,000 |   |
| Audit-Related Fees (b) |   | 112,000          |    | 105,000          |   |
| Tax Fees (c)           |   | 279,000          |    | 105,000          |   |
| Other Fees (d)         |   | 58,000           |    | 114,000          |   |
| Total Fees             |   | $                | 619,000 |             | $      | 382,000 |   |

 

----

(a) The Audit Fees representthe aggregate fees billed for professional services rendered byPricewaterhouseCoopers, LLP for the audits of the Operating Partnership’sannual financial statements and quarterly reviews of the financial statementscontained in the Operating Partnership’s Forms l0-Q for the years endedDecember 31, 2003 and 2002.

(b) The Audit-Related Fees represent the fees billedfor assurance and related services by PricewaterhouseCoopers, LLP that arereasonably related to the performance of the audit or review of our financialstatements. These fees do not include fees reported under “Audit Fees”.  The fees paid in 2003 are for the audit ofthe Operating Partnership as of July 10, 2003 in connection with the RFS-CNLTransaction.

(c) Tax Fees represent theaggregate fees billed for professional services rendered by PricewaterhouseCoopers,LLP for tax compliance, tax advice, and tax planning. In 2003, the OperatingPartnership paid $232,000 for compliance fees related to the 2003 annual taxreturns and quarterly asset tests and $47,000 for advice pertaining to theRFS-CNL Transaction. The 2002 tax fees relate entirely to compliance workrelated to the completion and review of annual tax returns and quarterly assettests.

(d) Other Fees represent theaggregate fees billed for products and services provided by PricewaterhouseCoopers,LLP, other than the services reported under Audit Fees, Audit-Related Fees andTax Fees.  The primary component of other fees for 2003 is costs associated withthe 2003 and 2002 audits of the Company’s sole joint venture, Wharf Associates.The primary component of other fees for 2002 is costs associated with theCompany’s issuance of the Senior Notes.

 

 

38

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**PART IV**

 

**Item 15. Exhibits,Financial Statements, Schedules and Reports on Form 8-K**

 

***(a)***The followingdocuments are filed as part of this report.

 

1.               Consolidated Financial Statements
| Report of Independent Certified Public Accountants                                                           |
|--------------------------------------------------------------------------------------------------------------|
| Consolidated Balance Sheets at December 31, 2003 and 2002                                                    |
| Consolidated Statements of Operations for  the years ended December 31, 2003, 2002 and 2001                  |
| Consolidated Statements of Comprehensive  Income (Loss) for the years ended December 31, 2003, 2002 and 2001 |
| Consolidated Statements of Partners’  Capital for the years ended December 31, 2003, 2002 and 2001      |
| Consolidated Statements of Cash Flows for  the years ended December 31, 2003, 2002 and 2001                  |
| Notes to Consolidated Financial Statements  of RFS Partnership, L.P.                                         |

 

2.               Financial Statement Schedules

 

Schedule III—Real Estate and AccumulatedDepreciation

 

All other schedules are omitted since therequired information is not applicable or is presented in the consolidatedfinancial statements or notes thereto.

 

*(b) Reports on Form8-K.*The OperatingPartnership made no filings on Form 8-K during the quarter ended December 31,2003.

 

***(c)Exhibits***

 
| 2.1    | Agreement by  and among CNL Hospitality Properties, Inc., CNL Rose Acquisition Corp., RFS  Hotel Investors, Inc., CNL Rose Acquisition OP, LP and RFS Partnership, L.P.,  dated May 8, 2003  (previously filed as Exhibit 2.1 to the  Operating Partnership’s current report on Form 8-K filed May 9, 2003 and  incorporated herein by reference.)                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.2    | Amendment to  Merger Agreement, dated May 27, 2003, among the Company, CNL Rose Acquisition  Corp., RFS Hotel Investors, Inc., CNL Rose Acquisition OP, LP and RFS  Partnership, L.P. (previously filed as Exhibit 2.2 to Post-Effective  Amendment No. Two to CNL Hospitality Properties, Inc. ‘s Registration  Statement on Form S-11 filed July 14, 2003 and incorporated herein by  reference.) |
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.3    | RFS  Acquisition Agreement, dated as of July 10, 2003, by and among CNL  Hospitality Partners, LP, CNL Hotel RI-Orlando, Ltd., CNL Hotel CY-Edison,  LP, RFS Partnership, L.P. and CNL Rose Acquisition Corp. (previously filed as  Exhibit 2.1 to the Operating Partnership’s current report on Form 8-K filed  July 25, 2003 and incorporated herein by reference.)                               |
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.1    | Certificate of Limited Partnership of RFS Partnership, L.P., filed  with the State of Tennessee on August 3, 1993 (filed herewith.)                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.2    | Amendment to the Certificate of Limited Partnership of RFS  Partnership, L.P., filed with the State of Tennessee on June 27, 1997 (filed  herewith.)                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.3    | Amendment to  the Certificate of Limited Partnership of RFS Partnership, L.P., dated July  10, 2003 (previously filed as Exhibit 3.17 to Post-Effective Amendment No.  Two to CNL Hospitality Properties, Inc.’s Registration Statement on Form S-11  filed July 14, 2003 and incorporated herein by reference.)                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.4    | Sixth  Amended and Restated Agreement of Limited Partnership of RFS Partnership,  L.P. dated July 10, 2003 (previously  filed as Exhibit 3.2 to the Operating Partnership’s**current report on Form 8-K filed  July 25, 2003 and incorporated herein by reference.)                                                                                                                                 |

 

39

----

 
| 4.1    | Indenture,  dated February 26, 2002, among RFS Partnership, L.P., RFS 2002 Financing,  Inc., RFS Leasing VII, Inc., RFS Hotel Investors, Inc. and U.S. Bank National  Association (previously filed as Exhibit 4.1 to the Operating Partnership’s  Form S-4 Registration Statement filed March 15, 2002, and incorporated herein  by reference.)                                                                                                                                           |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.2    | Supplemental  Indenture, dated as of July 10, 2003, among CNL Rose Acquisition Corp. RFS  Partnership, L.P., RFS 2002 Financing, Inc. and U.S. Bank National  Association (filed herewith.)                                                                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.3    | Form of  Global Note evidencing the 9.75% Series B Senior Notes due 2012 of RFS  Partnership, L.P. and RFS 2002 Financing, Inc. (previously filed as Exhibit A  to Exhibit 4.1 to the Operating Partnership’s form S-4 Registration Statement  dated March 15, 2002, and incorporated herein by reference.)                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.4    | Form of  Guaranty by RFS Hotel Investors, Inc. and RFS Leasing VII, Inc. (previously  filed as Exhibit A to Exhibit 4.1 to the Operating Partnership’s Form S-4  Registration Statement filed March 15, 2002, and incorporated herein by  reference.)                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 4.5    | Registration  Rights Agreement dated February 26, 2002 among RFS Partnership, L.P., RFS  2002 Financing, Inc., RFS Leasing VII, Inc., RFS Hotel Investors, Inc.,  Credit Suisse First Boston Corporation and Banc of America Securities LLC  (previously filed as Exhibit 4.4 to the Operating Partnership’s Form S-4  Registration Statement dated March 15, 2002, and incorporated herein by  reference.)                                                                                |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.1   | Form of Percentage Lease with TRS Lessees (previously filed as  Exhibit 10.1 to the Operating Partnership’s current report on  Form 8-K dated January 16, 2001 and incorporated herein by  reference).                                                                                                                                                                                                                                                                      |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2   | Form of Management Agreement with Flagstone (previously filed as  Exhibit 10.2 to the Operating Partnership’s current report Form 8-K  dated January 16, 2001 and incorporated herein by reference).                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.3   | Loan Agreement dated August 9, 2000 by and between Bank of  America, N.A. (as lender) and RFS SPE 2000 LLC (as borrower), a wholly-owned  subsidiary of RFS Hotel Investors, Inc. (previously filed as  Exhibit 10.19 to the Operating Partnership’s Form 10-K for the year  ended December 31, 2000 and incorporated herein by reference.)                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.4   | Loan Agreement dated August 9, 2000 by and between Bank of  America, N.A. (as lender) and RFS SPE 2 2000, LLC (as borrower), a wholly-owned  subsidiary of RFS Hotel Investors, Inc. (previously filed as  Exhibit 10.20 to the Operating Partnership’s Form 10-K for the year  ended December 31, 2000 and incorporated herein by reference.)                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.5   | Sixth Amended and Restated Revolving Credit Agreement dated  October 31, 2002 (previously filed as Exhibit 10.1 to the Operating  Partnership’s current Report on Form 8-K dated January 13, 2003 and  incorporated herein by reference).                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.6   | Credit  Agreement dated as of July 10, 2003 among RFS Partnership, L.P. and RFS  Financing Partnership, L.P. (as borrowers), CNL Hospitality Properties, Inc.  (as parent to the borrowers), Bank of America, N.A. (as Administrative Agent)  and the lenders named therein (previously  filed as Exhibit 10.68 to Post-Effective Amendment No. Two to CNL Hospitality  Properties, Inc.’s Registration Statement on Form S-11 filed July 14, 2003  and incorporated herein by reference.) |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.7   | $320,000,000  Note between RFS  Partnership, L.P. and RFS Financing Partnership, L.P. (as borrowers), and  Banc of America Bridge LLC (as lender), dated as of July 10, 2003  (previously filed as Exhibit 10.69 to Post-Effective Amendment No.  Two to CNL Hospitality Properties, Inc.’s Registration Statement on Form S-11  filed July 14, 2003 and incorporated herein by reference.)                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.8   | Continuing  Guaranty Agreement, dated as of July 10, 2003 among CNL Hospitality  Properties, Inc., CNL Rose GP Corp., and CNL Rose Acquisition Corp., in favor  of Bank of America, N.A. (previously filed as Exhibit 10.3 to the Operating  Partnership’s Current Report on Form 8-K filed July 25, 2003 and incorporated  herein by reference.)                                                                                                                                          |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.9   | Security and  Pledge Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and  Bank of America, N.A. (relating to common stock of RFS TRS Holdings, Inc.)  (previously filed as Exhibit 10.4 to the Operating Partnership’s Current  Report on Form 8-K filed July 25, 2003 and incorporated herein by reference.)                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 10.10  | Security and  Pledge Agreement, dated as of July 10, 2003 between CNL Rose Acquisition  Corp. and Bank of America, N.A. (relating to limited partner interests in RFS  Partnership, L.P.) (previously filed as Exhibit 10.5 to the Operating  Partnership’s Current Report on Form 8-K filed July 25, 2003 and incorporated  herein by reference.)                                                                                                                                         |

 

40

----

 
| 10.11  | Security and Pledge  Agreement, dated as of July 10, 2003 between CNL Hospitality Properties, Inc.  and Bank of America, N.A. (relating to common stock of CNL Rose Acquisition  Corp.) (previously filed as Exhibit 10.6 to the Operating Partnership’s  Current Report on Form 8-K filed July 25, 2003 and incorporated herein by  reference.)                  |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.12  | Security and Pledge  Agreement, dated as of July 10, 2003 between CNL Rose GP Corp. and Bank of  America, N.A. (relating to general partner interest in RFS Partnership, L.P.)  (previously filed as Exhibit 10.7 to the Operating Partnership’s Current  Report on Form 8-K filed July 25, 2003 and incorporated herein by reference.)                           |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.13  | Security and Pledge Agreement,  dated as of July 10, 2003 between CNL Hospitality Properties, Inc. and Bank  of America, N.A. (relating to common stock of CNL Rose GP Corp.) (previously  filed as Exhibit 10.8 to the Operating Partnership’s Current Report on Form  8-K filed July 25, 2003 and incorporated herein by reference.)                            |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.14  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to limited partner interest in Ridge Lake, L.P.)  (previously filed as Exhibit 10.9 to the Operating Partnership’s Current  Report on Form 8-K filed July 25, 2003 and incorporated herein by reference.)                            |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.15  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to common stock of RFS 2002 Financing, Inc.)  (previously filed as Exhibit 10.10 to the Operating Partnership’s Current  Report on Form 8-K filed July 25, 2003 and incorporated herein by reference.)                               |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.16  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to limited liability company interest in RFS  Financing 2002, L.L.C.) (previously filed as Exhibit 10.11 to the Operating  Partnership’s Current Report on Form 8-K filed July 25, 2003 and  incorporated herein by reference.) |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.17  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to limited partner interest in RFS Financing  Partnership, L.P.) (previously filed as Exhibit 10.12 to the Operating  Partnership’s Current Report on Form 8-K filed July 25, 2003 and incorporated  herein by reference.)           |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.18  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to common stock of Ridge Lake General Partner,  Inc.) (previously filed as Exhibit 10.13 to the Operating Partnership’s  Current Report on Form 8-K filed July 25, 2003 and incorporated herein by  reference.)                      |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.19  | Security and Pledge  Agreement, dated as of July 10, 2003 between RFS Partnership, L.P. and Bank  of America, N.A. (relating to limited liability company interests in Ridge  Lake, L.L.C.) (previously filed as Exhibit 10.14 to the Operating  Partnership’s Current Report on Form 8-K filed July 25, 2003 and incorporated  herein by reference.)             |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20  | Commercial Mortgage  Backed Security Facility, dated December 4, 2003, by and between Bank of  America, N.A. (as lender) and Rose SPE 1, L.P. (as borrower), a wholly-owned  subsidiary of RFS Partnership, L.P. (filed herewith.)                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 10.21  | Mezzanine Loan  Agreement, dated December 23, 2003, by and between Fleet National Bank (as  lender) and Rose Mezzanine SPE, L.P. (as borrower), a wholly-owned subsidiary  of RFS Partnership, L.P. (filed herewith.)                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 12.1   | Statement regarding  Computation of Ratio of Earnings to Fixed Charges of RFS Partnership, L.P.  (filed herewith.)                                                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 21.1   | List of Subsidiaries of  the Registrant (filed herewith.)                                                                                                                                                                                                                                                                                                              |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 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.)                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 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.)                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 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.)                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                                                                   |
| 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.)                                                                                                                                                                                        |

 

41

----

 

**SIGNATURES**

 

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

 
|           |   | RFS PARTNERSHIP, L.P.                                                                                   |
|----------------|--------|---------------------------------------------------------------------------------------------------------|
|           |   |                                                                                                    |
|           |   | By: CNL ROSE GP CORP.,  its general partner                                                             |
| March 30, 2004 |   | /s/ Thomas J. Hutchison                                                                                 |
| Date           |   | Thomas J. Hutchison                                                                                     |
|           |   | Title: Chief Executive Officer  (Principal Executive Officer)                                           |
|           |   |                                                                                                    |
|           |   | By: CNL ROSE GP CORP.,  its general partner                                                             |
| March 30, 2004 |   | /s/ C. Brian Strickland                                                                                 |
| Date           |   | C. Brian Strickland                                                                                     |
|           |   | Title: Executive Vice  President (Authorized Signatory and Principal Financial and Accounting  Officer) |

 

42

----

** **

# **Report of Independent CertifiedPublic Accountants**

 

To the Board of Directors and Stockholders

of CNL Hospitality Properties, Inc.

 

 

In our opinion, the accompanying consolidatedbalance sheets and the related consolidated statements of operations, of comprehensiveincome (loss), of partners’ capital and of cash flows present fairly, in allmaterial respects, the financial position of RFS Partnership, L.P. and itssubsidiaries at December 31, 2003 and 2002, and the results of their operationsand their cash flows for the period from July 11 to December 31,2003, the period from January 1 to July 10, 2003, and for each of theyears ended December 31, 2002 and 2001 in conformity with accountingprinciples generally accepted in the United States of America.  In addition, in our opinion, the financialstatement schedule listed in the index appearing under Item 15(a)(2) presentsfairly, in all material respects, the information set forth therein when readin conjunction with the related consolidated financial statements.  These financial statements and the financialstatement schedule are the responsibility of the Partnership’s management; ourresponsibility is to express an opinion on these financial statements and thefinancial statement schedule based on our audits.  We conducted our audits of these statements in accordance withauditing standards generally accepted in the United States of America, whichrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

 

As discussed in Note 1 to the consolidatedfinancial statements, on July 10, 2003 RFS Partnership, L.P. was acquired bysubsidiaries of CNL Hospitality Properties, Inc.

 

 
| /s/ PRICEWATERHOUSECOOPERS,   LLP |   |
|----------------------------------------|--------|
|                                   |
|                                   |
| Orlando, Florida                       |
| March 12, 2004                         |

 

F-1

----

 

**RFSPARTNERSHIP, L.P.**

**CONSOLIDATED BALANCE SHEETS**

**(inthousands)**

 
|                                                                                                               |   |                         |    |   |                        |   |
|--------------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|--------|-----------------------------|--------|
|                                                                                                               |   | **Post-Merger  Partnership** |    |   | **Pre-Merger  Partnership** |   |
|                                                                                                               |   | **December  31,  2003**      |    |   | **December  31,  2002**     |   |
|                                                                                                               |   |                         |    |   |                        |   |
| **ASSETS**                                                                                                         |   |                         |    |   |                        |   |
| Investment in hotel properties, net                                                                                |   | $                            | 816,656 |   |                        | $      | 593,289 |   |
| Real estate held for sale                                                                                          |   | 29,550                       |    |   |                        |   |
| Cash and cash equivalents                                                                                          |   | 19,396                       |    |   | 1,938                       |   |
| Restricted cash                                                                                                    |   | 17,253                       |    |   | 4,383                       |   |
| Accounts receivable                                                                                                |   | 8,215                        |    |   | 4,698                       |   |
| Deferred expenses, net                                                                                             |   | 6,085                        |    |   | 8,805                       |   |
| Other assets                                                                                                       |   | 5,768                        |    |   | 3,712                       |   |
| Deferred income taxes                                                                                              |   | 25,826                       |    |   | 25,830                      |   |
|                                                                                                               |   |                         |    |   |                        |   |
| Total assets                                                                                                       |   | $                            | 928,749 |   |                        | $      | 642,655 |   |
|                                                                                                               |   |                         |    |   |                        |   |
| **LIABILITIES AND PARTNERS’ CAPITAL**                                                                         |   |                         |    |   |                        |   |
| Accounts payable and accrued expenses                                                                              |   | $                            | 19,617  |   |                        | $      | 24,202 |   |
| Borrowings on Line of Credit                                                                                       |   |                         |    |   | 6,950                       |   |
| Mortgage notes payable                                                                                             |   | 324,354                      |    |   | 159,279                     |   |
| Senior notes payable                                                                                               |   | 81,674                       |    |   | 125,000                     |   |
| Total liabilities                                                                                                  |   | 425,645                      |    |   | 315,431                     |   |
| Commitments and contingencies                                                                                      |   |                         |    |   |                        |   |
| Redeemable limited partnership units at  redemption value, 2,459 units at December 31, 2002                        |   |                         |    |   | 26,702                      |   |
| Partners’ Capital:                                                                                            |   |                         |    |   |                        |   |
| Other comprehensive income (loss)                                                                                  |   | (418                         | )       |   |                        |   |
| General partnership units, 31,942 units and  28,467 units at December 31, 2003 and December 31, 2002, respectively |   | 503,522                      |    |   | 300,522                     |   |
| Total partners’ capital                                                                                       |   | 503,104                      |    |   | 300,522                     |   |
|                                                                                                               |   |                         |    |   |                        |   |
| Total liabilities and partners’ capital                                                                       |   | $                            | 928,749 |   |                        | $      | 642,655 |   |
|                                                                                                               |   |                         |    |   |                        |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

F-2

----

 

**RFSPARTNERSHIP, L.P.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**Forthe Years Ended December 31, 2003, 2002 and 2001**

**(inthousands, except per unit data)**

** **
|                                                                                |   |                          |   |   |                         |   |                         |   |                         |    |
|-------------------------------------------------------------------------------------|--------|-------------------------------|--------|--------|------------------------------|--------|------------------------------|--------|------------------------------|---------|
|                                                                                |   | **Post-Merger  Partnership**  |   |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |    |
|                                                                                |   | **July 11 to  Dec. 31, 2003** |   |   | **Jan. 1 to  July 10, 2003** |   | **Jan. 1 to  Dec. 31, 2002** |   | **Jan. 1 to  Dec. 31, 2001** |    |
| Revenue:                                                                            |   |                          |   |   |                         |   |                         |   |                         |    |
| Rooms                                                                               |   | $                             | 71,464 |   |                         | $      | 78,234                       |   | $                            | 156,670 |   | $ | 173,562 |   |
| Food and beverage                                                                   |   | 8,487                         |   |   | 8,971                        |   | 17,452                       |   | 17,695                       |    |
| Other operating departments                                                         |   | 3,041                         |   |   | 2,820                        |   | 6,175                        |   | 8,661                        |    |
| Lease revenue, net                                                                  |   | 9,096                         |   |   | 1,519                        |   | 5,229                        |   | 5,782                        |    |
| Other                                                                               |   | 946                           |   |   | 214                          |   | 411                          |   | 573                          |    |
| Total hotel revenue                                                                 |   | 93,034                        |   |   | 91,758                       |   | 185,937                      |   | 206,273                      |    |
| Expenses:                                                                           |   |                          |   |   |                         |   |                         |   |                         |    |
| Rooms                                                                               |   | 16,078                        |   |   | 16,391                       |   | 31,914                       |   | 33,738                       |    |
| Food and beverage                                                                   |   | 6,226                         |   |   | 6,499                        |   | 12,793                       |   | 13,533                       |    |
| Other operating departments                                                         |   | 1,549                         |   |   | 792                          |   | 1,724                        |   | 1,997                        |    |
| Property operating costs                                                            |   | 11,054                        |   |   | 11,179                       |   | 20,115                       |   | 20,531                       |    |
| Property taxes, insurance and other                                                 |   | 6,161                         |   |   | 5,983                        |   | 11,670                       |   | 11,882                       |    |
| Franchise costs                                                                     |   | 5,250                         |   |   | 7,573                        |   | 15,001                       |   | 15,530                       |    |
| Maintenance and repair                                                              |   | 4,558                         |   |   | 5,238                        |   | 8,754                        |   | 8,855                        |    |
| Management fees                                                                     |   | 2,588                         |   |   | 4,582                        |   | 4,552                        |   | 5,338                        |    |
| Depreciation                                                                        |   | 15,553                        |   |   | 14,805                       |   | 27,743                       |   | 27,321                       |    |
| Lease termination                                                                   |   |                          |   |   |                         |   |                         |   | 65,489                       |    |
| Amortization of franchise fees and unearned  compensation                           |   |                          |   |   | 2,028                        |   | 1,247                        |   | 1,384                        |    |
| General and administrative                                                          |   | 8,785                         |   |   | 26,008                       |   | 18,027                       |   | 18,161                       |    |
| Total operating expenses                                                            |   | 77,802                        |   |   | 101,078                      |   | 153,540                      |   | 223,759                      |    |
| Operating income (loss)                                                             |   | 15,232                        |   |   | (9,320                       | )      | 32,397                       |   | (17,486                      | )       |
| Debt extinguishments and swap termination  costs                                    |   |                          |   |   |                         |   | 10,122                       |   |                         |    |
| Amortization of loan origination costs                                              |   | 651                           |   |   | 804                          |   | 1,617                        |   | 1,354                        |    |
| Interest expense                                                                    |   | 12,345                        |   |   | 13,889                       |   | 25,484                       |   | 24,688                       |    |
| Income (loss) from continuing operations  before minority interest and income taxes |   | 2,236                         |   |   | (24,013                      | )      | (4,826                       | )      | (43,528                      | )       |
| Minority interest                                                                   |   | (10                           | )      |   |                         |   |                         |   |                         |    |
| Benefit from income taxes                                                           |   | 1,321                         |   |   | 1,546                        |   | 1,096                        |   | 24,714                       |    |
| Income (loss) from continuing operations                                            |   | 3,547                         |   |   | (22,467                      | )      | (3,730                       | )      | (18,814                      | )       |
| Earnings (losses) from discontinued  operations                                     |   | 1,222                         |   |   | 607                          |   | (1,652                       | )      | 2,801                        |    |
| Gain (loss) on sale of assets                                                       |   |                          |   |   | (9                           | )      | 950                          |   | 1,127                        |    |
| Net income (loss)                                                                   |   | 4,769                         |   |   | (21,869                      | )      | (4,432                       | )      | (14,886                      | )       |
| Gain (loss) on redemption of preferred  units                                       |   |                          |   |   |                         |   | (1,890                       | )      | 5,141                        |    |
| Preferred unit dividends                                                            |   |                          |   |   |                         |   | (1,562                       | )      | (3,125                       | )       |
| **Net income (loss) applicable to unitholders**                                     |   | $                             | 4,769  |   |                         | $      | (21,869                      | )      | $                            | (7,884  | ) | $ | (12,870 | ) |
| **Net income (loss) allocated to general  partnership units**                       |   | $                             | 4,769  |   |                         | $      | (20,077                      | )      | $                            | (7,240  | ) | $ | (11,713 | ) |
| **Net loss allocated to limited partnership  units**                                |   |                          |   |   | $                            | (1,792 | )                            | $      | (644                         | )       | $ | (1,157 | ) |
| Earnings (loss) per unit data:                                                      |   |                          |   |   |                         |   |                         |   |                         |    |
| Basic earnings (loss) per unit from  continuing operations                          |   | $                             | 0.11   |   |                         | (0.72  | )                            | $      | (0.20                        | )       | $ | (0.57 | ) |
| Discontinued operations                                                             |   | 0.04                          |   |   | 0.02                         |   | (0.06                        | )      | 0.10                         |    |
| Basic earnings (loss) per unit                                                      |   | $                             | 0.15   |   |                         | $      | (0.70                        |   | $                            | (0.26   | ) | $ | (0.47 | ) |
| Diluted earnings (loss) per unit from  continuing operations                        |   | $                             | 0.11   |   |                         | $      | (0.72                        | )      | $                            | (0.20   | ) | $ | (0.57 | ) |
| Discontinued operations                                                             |   | 0.04                          |   |   | 0.02                         |   | (0.06                        | )      | 0.10                         |    |
| Diluted earnings (loss) per unit                                                    |   | $                             | 0.15   |   |                         | $      | (0.70                        | )      | $                            | (0.26   | ) | $ | (0.47 | ) |
| Weighted average units outstanding—basic and  diluted                          |   | 31,942                        |   |   | 31,271                       |   | 29,905                       |   | 27,520                       |    |
|                                                                                |   |                          |   |   |                         |   |                         |   |                         |    |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

F-3

----

 

**RFSPARTNERSHIP, L.P.**

**CONSOLIDATED STATEMENTS OF COMPREHENSIVEINCOME (LOSS)**

**Forthe Years Ended December 31, 2003, 2002 and 2001**

**(inthousands)**

 
|                                                         |   |                          |   |   |                         |   |                         |   |                         |   |
|--------------------------------------------------------------|--------|-------------------------------|--------|--------|------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                                         |   | **Post-Merger  Partnership**  |   |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   |
|                                                         |   | **July 11 to  Dec. 31, 2003** |   |   | **Jan. 1 to  July 10, 2003** |   | **Jan. 1 to  Dec. 31, 2002** |   | **Jan. 1 to  Dec. 31, 2001** |   |
|                                                         |   |                          |   |   |                         |   |                         |   |                         |   |
| Net income  (loss)                                           |   | $                             | 4,769  |   |                         | $      | (21,869                      | )      | $                            | (4,432 | ) | $ | (14,886 | ) |
| Reclassification  adjustment for losses included in earnings |   |                          |   |   |                         |   | 3,220                        |   |                         |   |
| Unrealized  holding loss on interest rate swaps or caps      |   | (418                          | )      |   |                         |   |                         |   | (3,220                       | )      |
|                                                         |   |                          |   |   |                         |   |                         |   |                         |   |
| Comprehensive  income (loss)                                 |   | $                             | 4,351  |   |                         | $      | (21,869                      | )      | $                            | (1,212 | ) | $ | (18,106 | ) |
|                                                         |   |                          |   |   |                         |   |                         |   |                         |   |   |   |   |   |

                                                                                                                        

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

F-4

----

 

**RFSPARTNERSHIP, L.P.**

**CONSOLIDATEDSTATEMENTS OF PARTNERS’ CAPITAL**

**Forthe Years Ended December 31, 2003, 2002 and 2001**

**(inthousands, except per unit data)**

 
|                                                                                                       |   |                         |    |   |                        |    |
|------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|--------|-----------------------------|---------|
|                                                                                                       |   | **Post-Merger  Partnership** |    |   | **Pre-Merger  Partnership** |    |
|                                                                                                       |   |                         |    |   |                        |    |
| Balance, December 31, 2000                                                                                 |   |                         |    |   | $                           | 349,667 |   |
| Issuance of general partnership units                                                                      |   |                         |    |   | 4,661                       |    |
| Redemption of Series A Preferred units,  including $5,141 gain on redemption                               |   |                         |    |   | (13,000                     | )       |
| Series B Preferred Unit issuance costs                                                                     |   |                         |    |   | (1,040                      | )       |
| Distributions to general partnership units  ($1.255 per unit)                                              |   |                         |    |   | (30,661                     | )       |
| Distributions to redeemable limited  partnership units ($1.255 per unit)                                   |   |                         |    |   | (3,135                      | )       |
| Distributions preferred units ($0.385 per  Series A Preferred unit and $12.50 per Series B Preferred unit) |   |                         |    |   | (3,481                      | )       |
| Allocation from redeemable limited  partnership units                                                      |   |                         |    |   | 5,481                       |    |
| Contribution from general partner related  to amortization of stock-based compensation                     |   |                         |    |   | 1,329                       |    |
| Unrealized holding loss on interest rate  swaps                                                            |   |                         |    |   | (3,220                      | )       |
| Net loss                                                                                                   |   |                         |    |   | (14,886                     | )       |
|                                                                                                       |   |                         |    |   |                        |    |
| Balance, December 31, 2001                                                                                 |   |                         |    |   | $                           | 291,715 |   |
| Issuance of general partnership units                                                                      |   |                         |    |   | 39,646                      |    |
| Loss on redemption of Series B Preferred  units, net of $1,040 in issuance costs                           |   |                         |    |   | (850                        | )       |
| Distributions to general partnership units  ($1.00 per unit)                                               |   |                         |    |   | (27,018                     | )       |
| Distributions to redeemable limited  partnership units ($1.00 per unit)                                    |   |                         |    |   | (2,592                      | )       |
| Distributions preferred units ($6.25 per  Series B Preferred unit)                                         |   |                         |    |   | (1,562                      | )       |
| Allocation from redeemable limited  partnership units                                                      |   |                         |    |   | 1,278                       |    |
| Contribution from general partner related  to amortization of stock-based compensation                     |   |                         |    |   | 1,117                       |    |
| Reclassification of holding loss on  interest rate swaps into earnings                                     |   |                         |    |   | 3,220                       |    |
| Net loss                                                                                                   |   |                         |    |   | (4,432                      | )       |
|                                                                                                       |   |                         |    |   |                        |    |
| Balance, December 31, 2002                                                                                 |   |                         |    |   | $                           | 300,522 |   |
| Issuance of general partnership units                                                                      |   |                         |    |   | 12,817                      |    |
| 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                                                        |   |                         |    |   | (3,609                      | )       |
| 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 ($2.57 per  unit)                                                          |   | (74,000                      | )       |   |                        |    |
| Unrealized holding loss on interest rate  caps                                                             |   | (418                         | )       |   |                        |    |
| Net income                                                                                                 |   | 4,769                        |    |   |                        |    |
|                                                                                                       |   |                         |    |   |                        |    |
| Balance, December 31, 2003                                                                                 |   | $                            | 503,104 |   |                        |    |   |
|                                                                                                       |   |                         |    |   |                        |    |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

F-5

----

 

**RFSPARNTERSHIP, L.P.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

## **For the Years Ended December 31, 2003, 2002 and 2001**

** **
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |
|--------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|--------|------------------------------|--------|------------------------------|--------|------------------------------|--------|
|                                                                                             |   | **Post-Merger  Partnership**  |   |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   |
|                                                                                             |   | **July 11 to  Dec. 31, 2003** |   |   | **Jan. 1 to  July 10, 2003** |   | **Jan. 1 to  Dec. 31, 2002** |   | **Jan. 1 to  Dec. 31, 2001** |   |
|                                                                                             |   | **(in thousands )**           |   |
| Cash flows from operating activities:                                                            |   |                          |   |   |                         |   |                         |   |                         |   |
| Net income (loss)                                                                                |   | $                             | 4,769  |   |                         | $      | (21,869                      | )      | $                            | (4,432 | ) | $ | (14,886 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided (used) by operating activities: |   |                          |   |   |                         |   |                         |   |                         |   |
| Depreciation and amortization                                                                    |   | 16,204                        |   |   | 18,675                       |   | 32,944                       |   | 32,343                       |   |
| (Gain) loss on sale of assets                                                                    |   |                          |   |   | 9                            |   | 2,890                        |   | (1,127                       | )      |
| Write-off of deferred expenses                                                                   |   |                          |   |   | 349                          |   | 1,361                        |   |                         |   |
| Changes in assets and liabilities:                                                               |   |                          |   |   |                         |   |                         |   |                         |   |
| Accounts receivable                                                                              |   | (2,773                        | )      |   | (744                         | )      | 835                          |   | 7,508                        |   |
| Other assets                                                                                     |   | 2,106                         |   |   | (5,279                       | )      | (499                         | )      | 5,432                        |   |
| Deferred income taxes                                                                            |   | (1,321                        | )      |   | (1,546                       | )      | (1,096                       | )      | (24,734                      | )      |
| Accounts payable and accrued expenses                                                            |   | (3,589                        | )      |   | (2,122                       | )      | 4,523                        |   | 5,930                        |   |
| Net cash provided (used) by operating  activities                                                |   | 15,396                        |   |   | (12,527                      | )      | 36,526                       |   | 10,466                       |   |
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |
| Cash flows from investing activities:                                                            |   |                          |   |   |                         |   |                         |   |                         |   |
| Investment in hotel properties                                                                   |   | (1,262                        | )      |   | (10,035                      | )      | (14,576                      | )      | (18,013                      | )      |
| Cash returned (paid) for franchise fees                                                          |   |                          |   |   | 107                          |   | (172                         | )      | (65                          | )      |
| Restricted cash                                                                                  |   | (8,184                        | )      |   | (1,686                       | )      | 2,434                        |   | (1,888                       | )      |
| Proceeds from sale of assets                                                                     |   |                          |   |   | 6                            |   | 4,175                        |   | 11,324                       |   |
| Net cash used by investing activities                                                            |   | (9,446                        | )      |   | (11,608                      | )      | (8,139                       | )      | (8,642                       | )      |
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |
| Cash flows from financing activities:                                                            |   |                          |   |   |                         |   |                         |   |                         |   |
| Contributions from parent company                                                                |   | 77,950                        |   |   |                         |   |                         |   |                         |   |
| Distributions to parent company                                                                  |   | (74,000                       | )      |   |                         |   |                         |   |                         |   |
| Reimbursement of acquisition costs to CNL                                                        |   | (15,503                       | )      |   |                         |   |                         |   |                         |   |
| Net proceeds (payments) on line of credit                                                        |   |                          |   |   | 28,550                       |   | (74,238                      | )      | 30,914                       |   |
| Net payments on bridge loan                                                                      |   | (101,000                      | )      |   |                         |   |                         |   |                         |   |
| Proceeds from issuance of (payments to  retire) Senior Notes                                     |   | (42,188                       | )      |   | (3,780                       | )      | 125,000                      |   |                         |   |
| Proceeds from issuance of 2003 CMBS and  2003 Mezzanine Loan                                     |   | 165,000                       |   |   |                         |   |                         |   |                         |   |
| Payments on mortgage notes payable                                                               |   | (1,536                        | )      |   | (1,578                       | )      | (60,668                      | )      | (7,210                       | )      |
| Redemption of preferred units                                                                    |   |                          |   |   |                         |   | (25,850                      | )      | (13,000                      | )      |
| Distributions to unitholders                                                                     |   |                          |   |   | (7,735                       | )      | (31,304                      | )      | (37,277                      | )      |
| Issuance of general partnership units, net  of $300 issuance costs in 2002                       |   |                          |   |   | 12,408                       |   | 39,653                       |   | 4,479                        |   |
| Issuance of preferred units, net of $1,000  issuance costs                                       |   |                          |   |   |                         |   |                         |   | 23,960                       |   |
| Loan fees paid                                                                                   |   | (889                          | )      |   | (56                          | )      | (4,777                       | )      | (1,636                       | )      |
| Net cash provided (used) by financing  activities                                                |   | 7,834                         |   |   | 27,809                       |   | (32,184                      | )      | 230                          |   |
| Net increase (decrease) in cash and cash  equivalents                                            |   | 13,784                        |   |   | 3,674                        |   | (3,797                       | )      | 2,054                        |   |
| Cash and cash equivalents at beginning of  period                                                |   | 5,612                         |   |   | 1,938                        |   | 5,735                        |   | 3,681                        |   |
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |
| Cash and cash equivalents at end of period                                                       |   | $                             | 19,396 |   |                         | $      | 5,612                        |   | $                            | 1,938  |   | $ | 5,735 |   |
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |
| Supplemental disclosure of cash flow  information:                                               |   |                          |   |   |                         |   |                         |   |                         |   |
| Cash paid for interest                                                                           |   | $                             | 13,145 |   |                         | $      | 14,280                       |   | $                            | 22,059 |   | $ | 24,403 |   |
|                                                                                             |   |                          |   |   |                         |   |                         |   |                         |   |   |   |   |   |

 

Supplemental disclosure of non-cash activities: See Note 15 to theconsolidated financial statements

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

F-6

----

 

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS OF RFS PARTNERSHIP, L.P.**

 

**Note 1. Organization**

 

RFS Partnership, L.P. (the “Operating Partnership”) is a Tennesseelimited partnership which, at December 31, 2003, owned interests in 62 hotelswith 9,399 rooms located in 26 states (collectively the “Hotels”). On July 10,2003, RFS Hotel Investors, Inc. (“RFS”) and the Operating Partnership wereacquired by subsidiaries of CNL Hospitality Properties, Inc. (“CNL”) forapproximately $383 million in cash ($12.35 per share or limited partnershipunit) (“RFS-CNL Transaction”), excluding the 1.0 million shares of RFS stockacquired 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 thefiling of the Form 15 terminates the Operating Partnership’s obligation to filereports under the Exchange Act, the Operating Partnership is filing this AnnualReport on Form 10-K, in accordance with its obligation to do so set forth inthat certain indenture, by and among the Operating Partnership, RFS 2002Financing, Inc., CNL Rose Acquisition Corp., RFS Leasing VII, Inc. and U.S.Bank, N.A., dated as of February 26, 2002.

 

Concurrent with the consummation of theRFS-CNL Transaction, CNL contributed five hotels to the Operating Partnershipwith net assets of approximately $131.6 million. The five hotels are aResidence Inn in Orlando, Florida, a Marriott Courtyard in Edison, New Jersey,a Hyatt Regency in Coral Gables, Florida, a Wyndham in Billerica, Massachusettsand a Wyndham in Denver, Colorado.  Thetwo Wyndham properties are triple net lease properties, while the other threeproperties are leased to taxable REIT subsidiaries owned by CNL, but not ownedby the Operating Partnership.

 

The Operating Partnership leases 52 of its 62hotels to wholly owned taxable REIT subsidiary (“TRS”) entities and contractswith third-party hotel management companies to operate these hotels.  Hotel operating revenues and expenses forthese hotels are included in the consolidated results of operations.  At December 31, 2003, the OperatingPartnership leased seven hotels to three third-party lessees and three hotelsto taxable REIT subsidiaries owned by CNL, but not owned by the Operating Partnership.Rental income from operating leases is included in the consolidated results ofoperations for these hotels.

 

#### **Note2. Basis of Presentation**

 

SAB Topic 5-J states that a purchase transaction that results in an entitybecoming substantially wholly owned establishes a new basis of accounting, commonlyreferred to as “push down accounting.” Push down accounting is required when greater than 95% of the entity isacquired.  Accordingly, such new basisshould be recorded in the financial statements of the acquired company, in thiscase the Operating Partnership. The application of push down accountingrepresents the termination of the old accounting entity and the creation of anew one.  As such, the OperatingPartnership’s Consolidated Statements of Operations and Cash Flows present theOperating Partnership’s results prior to the merger, referred to as thePre-Merger. For all disclosures in these notes to the consolidated financialstatements, unless specified, the disclosures apply to both the Pre-MergerPartnership and the Post-Merger Partnership.

 

#### **Note 3.Summary of Significant Accounting Policies**

 

*Principles of Consolidation.*  The consolidated financial statementsinclude the accounts of the Operating Partnership and each of its consolidatedsubsidiaries. All significant intercompany balances and transactions have beeneliminated.

 

*Use of Estimates.* The Operating Partnership has made a numberof estimates and assumptions relating to the reporting of assets andliabilities and the disclosure of contingent assets and liabilities to preparethese consolidated financial statements in conformity with generally acceptedaccounting principles. Actual results could differ from those estimates.

 

*Fair Value of Financial Instruments.*  The Operating Partnership’s financialinstruments include rents receivable, accounts payable, other accrued expensesand mortgage loans payable. The fair values of these financial instruments,except for the mortgage loans payable are not materially different from theircarrying or contract values. The carrying values of the Operating Partnership’sborrowings are estimated to be above fair value by approximately$0.9 million due to changes in comparable interest rates.

 

*Investment in Hotel Properties.*  Hotel properties are recorded at historicalcost and are depreciated using the straight-line method

 

F-7

----

 

over estimateduseful lives of 40 years for buildings and improvements and three to sevenyears for furniture and equipment. Repairs and maintenance costs are charged toexpense as incurred. When the hotels or equipment are sold, the related costand accumulated depreciation will be removed from the accounts and any gain orloss from sale will be reflected as income or expense.

 

*Impairment of Long-Lived Assets.*Long-lived assets are tested for recoverability at least annually or wheneverevents or changes in circumstances indicate that its carrying amount may not berecoverable. The carrying amount of a long-lived asset is not recoverable if itexceeds the sum of the undiscounted cash flows expected to result from the useand eventual disposition of the asset. The assessment is based on the carryingamount of the asset at the date it is tested for recoverability.  An impairment loss is recognized when thecarrying amount of a long-lived asset exceeds its fair value.  If impairment is recognized, the adjustedcarrying amount of a long-lived asset is its new cost basis.

 

*Cash and Cash Equivalents.* The Operating Partnership considers allhighly liquid investments with an original maturity of three months or less tobe cash equivalents.  Cash and cashequivalents consist of demand deposits at commercial banks and money marketfunds. Cash accounts maintained on behalf of the Operating Partnership indemand deposits at commercial banks and money market funds may exceed federallyinsured levels; however, the Operating Partnership has not experienced anylosses in such accounts. Management believes the Operating Partnership is notexposed to any significant credit risk on cash and cash equivalents.

 

Certain amounts of cash are restricted forreal estate taxes, insurance premiums, maintenance and replacement offurniture, fixtures, and equipment at the Operating Partnership’s various hotelProperties.  These amounts have beenseparately classified as restricted cash in the accompanying consolidatedbalance sheets.

 

*Deferred Expenses. *Loan costs incurred in connection withsecuring financing have been capitalized and are being amortized over the termsof the loans using the straight-line method, which approximates the effectiveinterest method.

 

*Earnings Per Unit. *Basic earnings per unit is calculatedbased upon the weighted average number of units outstanding during each year,and diluted earnings per unit is calculated based upon the weighted averagenumber of units outstanding plus potentially dilutive units.

 

*Reclassification.* Certain items in the prior years’consolidated financial statements have been reclassified to conform with the2003 presentation.  Thesereclassifications had no effect on partners’ capital or net income (loss).

 

*Revenue Recognition.*  Revenues are recognized when rooms areoccupied and the services have been performed. Cash received from customers for events occurring after the end of eachrespective year have been recorded as deposits and is included in accountspayable and accrued expenses in the accompanying consolidated financialstatements. In accordance with Staff Accounting Bulletin (SAB) 101, leaserevenue is recognized as income after certain specific annual hurdles have beenachieved by the lessee in accordance with the provisions of the leaseagreements.

 

*Income Taxes.*  TheOperating Partnership leases all but ten of its hotels to wholly-owned taxableREIT subsidiaries that are subject to federal and state income taxes. TheOperating Partnership accounts for income taxes in accordance with theprovisions of Statement of Financial Accounting Standards (“SFAS”)No. 109, *“Accounting for Income Taxes.”*Under SFAS 109, the Operating Partnership accounts for income taxes usingthe asset and liability method under which deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases and operating losses and tax-creditcarry forwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to be recoveredor settled.  The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date. Valuation allowances are establishedwhen necessary to reduce deferred tax assets to the amount expected to berealized.

 

*Debt Extinguishment and Swap TerminationCosts.*  TheOperating Partnership has elected to adopt the provisions of SFAS 145,“Rescission of FASB Statements No. 4, 44, and 64, Amendment of *FASB No. 13*, and TechnicalCorrections,” as of January 1, 2002. SFAS 145 rescinds the provisionsof SFAS 4 that would have required the loss on the extinguishments of debt of$6.9 million (excludes the $3.2 million swap termination costs) to bereported net of tax as an extraordinary item. Accordingly, these costs areincluded in debt extinguishment and swap termination costs in the accompanyingstatements of operations.

 

F-8

----

 

*Derivative Instruments and HedgingActivities. *TheOperating Partnership utilizes derivative instruments to partially offset theeffect of fluctuating interest rates on the cash flows associated with itsvariable-rate debt. The Operating Partnership minimizes these risks byfollowing established risk management policies and procedures including the useof derivatives. The Operating Partnership does not enter into or holdderivatives for trading or speculative purposes.  The Operating Partnership records all derivative instruments onthe balance sheet at fair value.  On thedate the Operating Partnership enters into a derivative contract, thederivative is designated a hedge to the exposure to variable cash flows of aforecasted transaction (referred to as a cash flow hedge).  When the Operating Partnership hedgesvariability of cash flows related to a variable-rate asset or liability or aforecasted transaction, the effective portion of the derivative’s gain or lossis initially reported as a component of other comprehensive income (loss) andsubsequently recognized in operations in the periods in which earnings areimpacted by the variability of the cash flows of the hedged item or forecastedtransaction.  The ineffective portion ofthe gain or loss is reflected in earnings.

 

*Segment Information.*  SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” requires the disclosure ofselected information about operating segments. Based on the guidance providedin the standard, the Operating Partnership has determined that its business isconducted in one operating segment.

 

*Recent Accounting Pronouncements. *In April 2003, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities” (“FASB 149”).  FASB 149 amends and clarifies financial accounting and reportingfor derivative instruments, including certain derivative instruments embeddedin other contracts (collectively referred to as derivatives) and for hedgingactivities under FASB Statement No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.”  The OperatingPartnership adopted FAS 149 in the year ended December 31, 2003, and it did nothave a material impact on the Operating Partnership’s results of operations.

 

In May 2003, the FASB issued FASB Statement No.150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity” (“FASB 150”).  FASB 150establishes standards for how an issuer classifies and measures certain financialinstruments with characteristics of both liabilities and equity.  FASB 150 requires issuers to classifycertain financial instruments as liabilities (or assets in some circumstances)that previously were classified as equity. FASB 150 requires that minority interests for majority owned finitelived entities be classified as a liability and recorded at fair marketvalue.  Effective October 29, 2003, theFASB deferred implementation of FASB 150, as it applies to minority interestsof finite lived Partnerships.

 

In December 2003, the FASB issued FASB Interpretation No. 46 (revisedDecember 2003) (“FIN 46R”), “Consolidation of Variable Interest Entities”.  This Interpretation requires existingunconsolidated variable interest entities to be consolidated by their primarybeneficiaries if the entities do not effectively disperse risks among partiesinvolved.  The primary beneficiary of avariable interest entity is the party that absorbs a majority of the entity’s expectedlosses, receives a majority of its expected residual returns, or both, as aresult of holding variable interests, which are the ownership, contractual, orother pecuniary interests in an entity that change with changes in the fairvalue of the entity’s net assets excluding variable interests.  Prior to FIN 46R, a company generallyincluded another entity in its consolidated financial statements only if itcontrolled the entity through voting interests.  Application of FIN 46R is required in financial statements ofpublic entities that have interests in variable interest entities for periodsending after March 15, 2004.  TheOperating Partnership has no unconsolidated variable interest entities.

 

**Note 4. Acquisition of RFS and theOperating Partnership**

 

On July 10, 2003, RFS and the OperatingPartnership were acquired by subsidiaries of CNL for approximately $383 millionin cash ($12.35 per share or limited partnership unit) (the “RFS-CNLTransaction”), excluding the 1.0 million shares of RFS stock owned by CNL atthe date of the RFS-CNL Transaction. 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.

 

The Pre-Merger Partnership incurred costs ofapproximately $20.6 million as a result of the RFS-CNL Transaction.  The primary components of these costs are asfollows: severance of $11.6 million, amortization of $1.5 million related tothe acceleration of unvested restricted stock, advisory fees of $4.5 million,additional management fees of $1.9 million and miscellaneous other costs of$1.1 million.

 

F-9

----

 

The total cash consideration paid by CNL in connection with itsacquisition of RFS is as follows (in thousands, except per unit amounts):

 
| 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 |   |

 

The following sets forth the fair value of the assets and liabilities of theOperating Partnership, after push down accounting has been applied, as of theconsummation of the RFS-CNL Transaction:

* *
|                                  |   | **July 10,  2003** |    |
|---------------------------------------|--------|--------------------|---------|
| **ASSETS**                            |   |               |    |
| Investment in hotel properties, net   |   | $                  | 683,802 |   |
| Real estate held for sale             |   | 29,550             |    |
| Cash and cash equivalents             |   | 5,612              |    |
| Restricted cash                       |   | 9,069              |    |
| Accounts receivable                   |   | 5,442              |    |
| Deferred expenses, net                |   | 5,544              |    |
| Other assets                          |   | 8,595              |    |
| Deferred income taxes                 |   | 24,505             |    |
|                                  |   |               |    |
| Total assets                          |   | $                  | 772,119 |   |
|                                  |   |               |    |
| **LIABILITIES**                       |   |               |    |
| Accounts payable and accrued expenses |   | $                  | 23,207  |   |
| Bridge loan                           |   | 101,000            |    |
| Mortgage notes payable                |   | 160,731            |    |
| Senior notes payable                  |   | 124,021            |    |
|                                  |   |               |    |
| Total liabilities                     |   | $                  | 408,959 |   |

 

The following presents unauditedpro forma results of operations for the years ended December 31, 2003 and 2002,respectively, of the Operating Partnership (excluding revenue of $6,024 andexpenses of $2,362 million related to the five properties contributed by CNL)as if the RFS-CNL Transaction had occurred as of January 1, 2003 and 2002,respectively (in thousands, except per unit data):

 
|                                                                   |   | **Year Ended  December 31,** |    |
|------------------------------------------------------------------------|--------|------------------------------|---------|
|                                                                   |   | **2003**                     |    | **2002** |   |
| Revenue                                                                |   | $                            | 178,768 |   | $ | 185,938 |   |
| Expenses                                                               |   | 186,059                      |    | 192,345 |   |
| Net loss                                                               |   | (7,291                       | )       | (6,407 | ) |
| Basic and diluted loss per unit                                        |   | $                            | (0.23   | ) | $ | (0.21 | ) |
| Weighted average number of units outstanding  – basic and diluted |   | 31,942                       |    | 29,905 |   |

 

F-10

----

 

#### **Note5. Investment in Hotel Properties**

 

Investment in hotel properties consists ofthe following at December 31, 2003, and 2002, respectively (in thousands):

 
|                             |   | **Post-Merger  Partnership** |    | **Pre-Merger  Partnership** |   |
|----------------------------------|--------|------------------------------|---------|-----------------------------|--------|
|                             |   | **Dec. 31,  2003**           |    | **Dec. 31,  2002**          |   |
|                             |   |                         |    |                        |   |
| Land                             |   | $                            | 94,182  |                        | $      | 69,639 |   |
| Building and improvements        |   | 681,280                      |    | 545,557                     |   |
| Furniture and equipment          |   | 57,381                       |    | 124,496                     |   |
| Capital improvements in progress |   | 6,445                        |    | 12,002                      |   |
|                             |   |                         |    |                        |   |
|                             |   | 839,288                      |    | 751,694                     |   |
| Accumulated depreciation         |   | (22,632                      | )       | (158,405                    | )      |
|                             |   |                         |    |                        |   |
|                             |   | $                            | 816,656 |                        | $      | 593,289 |   |

 

**Note 6. Debt**

 

The following details the OperatingPartnership’s debt outstanding at December 31, 2003 and 2002 and the netbook value of the collateral pledged against the debt at December 31, 2003(dollar amounts in thousands):

 
|                    |   |               |         |          |   | **Collateral**   |     | **Post-Merger  Partnership** |     | **Pre-Merger  Partnership** |   |
|-------------------------|--------|--------------------|--------------|---------------|--------|------------------|----------|------------------------------|----------|-----------------------------|--------|
|                    |   | **Interest  Rate** |         |          |   | **# of  Hotels** |     | **Net Book  Value**          |     |                        |   |
|                    |   |               | **Maturity** |          |   |             | **2003** |                         | **2002** |                        |
|                    |   |               |         |          |   |             |     |                         |     | **(Note A)**                |   |   |   |
| **Variable Rate Debt:** |   |               |         |          |   |             |     |                         |     |                        |   |   |   |
| 2003 CMBS               |   | LIBOR + 189bp      |         | December 2006 |   | 26               |     | $                            | 297,318  |                        | $      | 130,000 |   |   |   |
| 2003 Mezzanine          |   | LIBOR + 465bp (B)  |         | December 2006 |   | Note B           |     | Note B                       |     | 35,000                      |   |   |   |
| Line of Credit          |   | LIBOR + 250bp      |         | July 10, 2003 |   | 24               |     |                         |     |                        |   | $ | 6,950 |   |
| **Fixed Rate Debt:**    |   |               |         |          |   |             |     |                         |     |                        |   |   |   |
| Senior Notes            |   | 9.75%              |         | March 2010    |   |             |     | —                       |     | 81,674                      |   | 125,000 |   |
| Mortgage                |   | 7.83%              |         | December 2008 |   | 10               |     | 123,648                      |     | 90,566                      |   | 90,600 |   |
| Mortgage                |   | 8.22%              |         | November 2007 |   | 1                |     | 17,115                       |     | 17,935                      |   | 17,960 |   |
| Mortgage                |   | 8.00%              |         | August 2010   |   | 8                |     | 107,655                      |     | 50,853                      |   | 50,719 |   |
|                    |   |               |         |          |   |             |     |                         |     |                        |   |   |   |
|                    |   |               |         |          |   |             |     | $                            | 545,736  |                        | $      | 406,028 |   | $ | 291,229 |   |

 

Note A – In applying purchase accounting to theOperating Partnership’s debt instruments, each facility was adjusted to itsfair value. Fair value is calculated based on discounted cash flows using adiscount rate equal to the Operating Partnership’s new borrowing rate. Exceptfor the 2003 CMBS and the 2003 Mezzanine Loan, these values include a “step-up”to the fair market value. This step-up is accreted over the term of thefacility as a reduction of interest expense.

 

Note B – The minimum interest rate on the 2003Mezzanine note payable is 6.65%, including the spread on LIBOR of 465 basispoints. Also, the 26 hotels collateralizing the 2003 CMBS note payable alsoserve as collateral on the 2003 Mezzanine note payable.

 

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, the Line of Creditwas terminated and replaced with the Bridge Loan, of which only $101.0 millionwas drawn by the Operating Partnership to help fund the merger. During thethird quarter of 2003, the Operating Partnership borrowed $88.0 million underthe Bridge Loan to repurchase $41.8 million of Senior Notes ($42.2 million bookvalue) and to make a distribution of $44.0 million to CNL.  On September 29, 2003, CNL contributedapproximately $80.0 million to the Operating Partnership to fund the repaymentof $88.0 million under the Bridge Loan. The Operating Partnership refinanced the Bridge Loan with the issuanceof a $130.0 million, long-term Commercial Mortgage Backed Security facility onDecember 4, 2003 (“2003 CMBS”).  Aportion of the proceeds from issuance of the 2003 CMBS were used to repay infull the outstanding balance under the Bridge Loan of approximately $101.0million.

 

F-11

----

 

On December 4, 2003, a new wholly owned subsidiary ofthe Operating Partnership, Rose SPE 1, L.P. issued the 2003 CMBS.  The 2003 CMBS is collateralized by 26 hotelswith a net book value of approximately $297.3 million at December 31, 2003. The2003 CMBS has a variable interest rate of thirty-day LIBOR plus 189 basispoints.  The interest rate wasapproximately 3.0% at December 31, 2003. The 2003 CMBS matures in December,2006.  Monthly payments of approximately$0.9 million include interest charges, reserves for the replacement ofequipment, and reserves for real estate taxes and insurance. There are noregular monthly principal payments. The 2003 CMBS contain provisionsrestricting the sale of collateral, and is prepayable subject to variousprepayment penalties, yield maintenance, or defeasance obligations.

 

On December 23, 2003, Rose SPE 1, L.P. issued anadditional $35.0 million long-term facility (“2003 Mezzanine Loan”). The 2003Mezzanine Loan is also collateralized by the 26 2003 CMBS hotels. The 2003Mezzanine Loan has a variable interest rate of thirty-day LIBOR plus 465 basispoints with a floor rate of 6.65%.  Theinterest rate was approximately 6.65% at December 31, 2003 since the adjustedLIBOR rate was only 5.8% at December 31, 2003. The 2003 CMBS matures inDecember, 2006.  Interest only paymentsof approximately $0.2 million are made on a monthly basis. A portion of theproceeds from issuance of the 2003 Mezzanine Loan was used to make a $30.0million distribution to CNL.

 

The 2003 CMBS and the 2003 Mezzanine Loan containprimarily one restrictive financial covenant, which stipulates thatconsolidated Partners’ Capital will not be less than the sum of $150.0 millionplus the cost basis of the 26 hotels comprising the Collateral Pool, minus $165.0million (representing the sum of the 2003 CMBS and the 2003 Mezzanine Loanborrowings).  At December 31, 2003, thisbase value was $287.7 million as compared to Partners’ Capital of approximately$501.9 million. At December 31, 2003, the Operating Partnership was incompliance with all covenants under the 2003 CMBS and 2003 Mezzanine Loan.

 

From January 1 to July 10, 2003, the interest rate onthe Line of Credit was 250 basis points above LIBOR. The Line of Credit wascollateralized by first priority mortgages on 24 hotels that restricted thetransfer, pledge or other hypothecation of the hotels.  The Line of Credit contained variousfinancial covenants including the maintenance of a minimum net worth, minimum debtand interest coverage ratios, and total indebtedness and liability limitations.On July 10, 2003, the outstanding balance was repaid and the Line of Credit wasterminated in connection with the RFS-CNL Transaction.  At July 10, 2003, the Operating Partnershipwas in violation of certain financial covenants under the Line of Credit.  All debt issuance costs pertaining to thePre-Merger Partnership of approximately $7.1 million were expensed underpurchase accounting guidelines.

 

On February 26, 2002, the OperatingPartnership sold $125 million of Senior Notes (“Senior Notes”). The SeniorNotes mature March 1, 2012 and bear interest at a rate of 9.75% per year,payable semi-annually, in arrears, on March 1 and September 1 of eachyear. The Senior Notes are unsecured obligations and are guaranteed by certainsubsidiaries. The Senior Notes contain covenants that could, among otherthings, restrict the Operating Partnership’s ability to borrow money, paydistributions to CNL, make investments, and sell assets or enter into mergersand consolidations. The Partnership was in compliance with these covenants atDecember 31, 2003. See Note 15 to the Consolidated Financial Statementsfor additional detail regarding the Senior Notes and the guarantors thereof. InFebruary 2003, the Operating Partnership retired $3.8 million of Senior Notes.As a result of the redemption of the $3.8 million Senior Notes, the OperatingPartnership expensed $122 thousand in unamortized debt issuance costs and$29 thousand of costs related to acquiring the Senior Notes.  In August 2003, the Operating Partnershipretired $41.8 million of Senior Notes. 

 

The Operating Partnership’s other borrowingsare nonrecourse to the Operating Partnership and contain provisions allowingfor the substitution of collateral, upon satisfaction of certain conditions.Most of the mortgage borrowings are prepayable and subject to variousprepayment penalties, yield maintenance, or defeasance obligations. AtDecember 31, 2003 and 2002, approximately 59% and 98% of the OperatingPartnership’s debt is fixed at an average interest rate of 8.6% and 8.7%,respectively.

 

Certain of the Operating Partnership’s loanagreements contain net worth or debt service coverage ratio requirements. Violation of these covenants could potentially trigger penalties,including cash management arrangements whereby the lenders or theirdesignated loan servicers capture operating cash from certain hotels andadminister the payment of property taxes, insurance, debt service andexpenditures for other obligations. The Operating Partnership was incompliance with all covenants at December 31, 2003.

 

F-12

----

 

Scheduledprincipal payments of debt obligations at December 31, 2003 are as follows(in thousands):

 
|       |   | **Amount** |    |
|------------|--------|------------|---------|
|       |   |       |    |
| 2004       |   | $          | 3,680   |   |
| 2005       |   | 3,953      |    |
| 2006       |   | 169,217    |    |
| 2007       |   | 20,455     |    |
| 2008       |   | 83,044     |    |
| Thereafter |   | 125,679    |    |
|       |   |       |    |
|       |   | $          | 406,028 |   |

 

**Note 7. Income Taxes**

 

The components of income tax benefit for theyears ended December 31, 2003, 2002 and 2001 are as follows:

 
|                      |   |                          |   |   |                             |   |                             |   |                             |   |
|---------------------------|--------|-------------------------------|--------|--------|----------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                      |   | **Post-Merger  Partnership**  |   |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |   |
|                      |   | **July 11 to  Dec. 31, 2003** |   |   | **January 1  to  July 10, 2003** |   | **January 1  to  Dec. 31, 2002** |   | **January 1  to  Dec. 31, 2001** |   |
| Current:                  |   |                          |   |   |                             |   |                             |   |                             |   |
| State                     |   |                          |   |   |                             |   |                             |   | $                                | 20     |   |
| Deferred:                 |   |                          |   |   |                             |   |                             |   |                             |   |
| Federal                   |   | $                             | (1,321 | )      |                             | $      | (1,546                           | )      | $                                | (1,096 | ) | (24,734 | ) |
|                      |   |                          |   |   |                             |   |                             |   |                             |   |
| Benefit from income taxes |   | $                             | (1,321 | )      |                             | $      | (1,546                           | )      | $                                | (1,096 | ) | $ | (24,714 | ) |
|                      |   |                          |   |   |                             |   |                             |   |                             |   |   |   |   |   |

 

The deferred benefit from income taxes andrelated deferred tax asset was calculated using an effective tax rate of 38%applied to the loss of the TRS Lessees, adjusted for temporary differencesrelated mainly to the Hilton lease termination transaction and operatinglosses.  Significant components of theOperating Partnership’s gross deferred tax asset, at December 31, 2003, 2002and 2001 are as follows:

 
|                         |   |                         |   |   |                        |   |                        |   |
|------------------------------|--------|------------------------------|--------|--------|-----------------------------|--------|-----------------------------|--------|
|                         |   | **Post-Merger  Partnership** |   |   | **Pre-Merger  Partnership** |   | **Pre-Merger  Partnership** |   |
|                         |   | **Dec. 31,  2003**           |   |   | **Dec. 31,  2002**          |   | **Dec. 31,  2001**          |   |
|                         |   |                         |   |   |                        |   |                        |   |
| Lease termination            |   | $                            | 15,192 |   |                        | $      | 19,583                      |   | $ | 22,228 |   |
| Operating loss carryforwards |   | 10,059                       |   |   | 6,175                       |   | 2,470                       |   |
| Other                        |   | 575                          |   |   | 72                          |   | 36                          |   |
|                         |   |                         |   |   |                        |   |                        |   |
| Deferred tax asset           |   | $                            | 25,826 |   |                        | $      | 25,830                      |   | $ | 24,734 |   |
|                         |   |                         |   |   |                        |   |                        |   |   |   |   |

 

Upon the consummation of the RFS-CNLTransaction, the TRS Lessees are subject to Section 382 of the Internal RevenueCode, which limits the amount of taxable income after the change of ownershipthat may be offset by net operating loss carryforwards and certain built-inlosses attributable to periods prior to the ownership change.  As a result of Section 382, the deferred taxasset of $27.4 million was reduced by $2.9 million in connection with purchaseaccounting.

 

The Operating Partnership’s operating losscarryforwards expire in 2021 ($2.5 million), 2022 ($3.7 million) and2023 ($5.2 million). The Operating Partnership believes the TRS Lessees willgenerate sufficient future taxable income to realize the net deferred taxasset. There was no valuation allowance at December 31, 2003 and 2002,respectively.

 

F-13

----

 

#### **Note8. Joint Venture**

 

The Operating Partnership, throughone of its wholly owned indirect subsidiaries, participates in a joint venturepartnership, named Wharf Associates, which owns the San Francisco HiltonFisherman’s Wharf. The Operating Partnership owns 75% of Wharf Associates, andan independent third party, Wharf Enterprises, Inc. (“WEI”), owns the remaining25%. At December 31, 2003 and December 31, 2002, respectively, the liabilityfor WEI’s minority interest was valued at $0 and $2,042, respectively, and isrecorded in Accounts Payable and Accrued Expenses on the accompanyingConsolidated Balance Sheet.

 

**Note 9. Partners Capital. Pre-MergerPartnership**

 

*Operating Partnership Units. *Prior to the RFS-CNLTransaction, RFS was the sole general partner of the Operating Partnership andwas obligated to contribute the net proceeds from any issuance of its equitysecurities to the Operating Partnership in exchange for units of partnershipinterest (“Units”) corresponding in number and terms to the equity securitiesissued. The Operating Partnership could also issue Units to third parties inexchange for cash or property, and Units so issued to third parties wereredeemable at the option of the holder for a like number of shares of commonstock of the Company, or cash, or a combination thereof, at the election of theCompany.

 

The ownership of the Operating Partnership isas follows at December 31, 2002:

 
|                                                   |   | **Common  Units** |   | **%**  |   |
|--------------------------------------------------------|--------|-------------------|--------|--------|--------|
| **2002**                                               |   |              |   |   |   |
| RFS Hotel Investors, Inc. (General  Partnership Units) |   | 28,466,461        |   | 92.05  | %      |
| Third parties (Redeemable Limited  Partnership Units)  |   | 2,458,705         |   | 7.95   | %      |
|                                                   |   |              |   |   |   |
| Total                                                  |   | 30,925,166        |   | 100.00 | %      |

 

*General Partnership Units. *On May 8, 2003, RFSsold 1.0 million shares of common stock and contributed the net proceeds to theOperating Partnership in exchange for 1.0 million units. Proceeds ofapproximately $12.4 million from the sale of the common stock were used toreduce the outstanding balance on the line of credit.

 

On June 4, 2002, RFS sold 2.0 million shares of common stock andcontributed the net proceeds to the Operating Partnership in exchange for 2.0million common units. Proceeds of approximately $24.6 million (net of $0.1million expenses), together with available cash, were used to redeem theOperating Partnership’s 250,000 outstanding Series B preferred units from RFS.

 

On February 20, 2002, RFS sold 1.15 million shares of common stock andcontributed the net proceeds to the Operating Partnership in exchange for 1.15million units. Proceeds of approximately $14.2 million (net of $0.2 millionexpenses) from the sale of the common stock were used to reduce the outstandingbalance on the line of credit.

 

*Redeemable Limited Partnership Units.*  The Operating Partnership issued limitedpartnership units to third parties in exchange for cash or property. Theoutstanding units of limited partnership interest in the Operating Partnershipwere redeemable at the option of the holder for a like number of shares ofcommon stock of RFS, or cash, or a combination thereof, at the election of RFS.Due to these redemption rights, these limited partnership units were excludedfrom partners’ capital and were included in redeemable limited partnershipunits and measured at redemption value as of the end of the periods presentedbased on the closing market price of RFS’s common stock at December 31, 2002,which was $10.86.

 

*Preferred Units.*  Under the partnership agreement between RFSand the Operating Partnership, the Operating Partnership was authorized toprovide for the issuance of up to 5 million Preferred Units in one or moreseries, to establish the number of units in each series and to fix thedesignation, powers, preferences and rights of each such series and thequalifications, limitations or restrictions thereof.

 

In 1996, the Operating Partnership issued to one of the lessees 973,684units of Series A Convertible Preferred Units (the “Series A Preferred Units”).The Operating Partnership redeemed the Series A Preferred Units on January 1,2001 for cash consideration of $13.0 million, which resulted in a gain onredemption of $5.1 million that is included in net income (loss) applicable tounitholders in 2001.

 

F-14

----

 

On January 2,2001, the Operating Partnership issued 250 thousand shares of non-convertiblemandatorily redeemable Series B Preferred Units for $25 million prior to feesand expenses of approximately $1 million. Holders of the Series B PreferredUnits were entitled to receive quarterly cash dividends commencing March 31,2001 at an annual rate of 12.5%. If not redeemed prior to January 1, 2006, thedividend rate would increase 2.0% per annum up to a maximum rate of 20.5%. TheOperating Partnership could redeem units of the Series B Preferred Units inwhole but not in part, on or after December 31, 2003 at the original price of$25 million. If the units were redeemed before December 31, 2003, theredemption price was at varying amounts over the original unit price. The unitswere mandatorily redeemable by the holders at varying premiums over theoriginal unit price upon a change of control, dissolution, or winding up of theOperating Partnership.

 

On June 28, 2002, the Operating Partnership repurchased all of itsSeries B preferred units from RFS for an aggregate purchase price of$25,850,000, excluding dividends. Correspondingly, RFS repurchased all of itsSeries B Preferred Stock from an independent third party for an aggregatepurchase price of $25,850,000, excluding dividends. In the second quarter of2002, the Operating Partnership expensed $1.9 million in costs associated withthe repurchase, comprised of $0.9 million related to prepayment costs and $1.0million in issuance costs.

 

When RFS, the general partner, repurchased its outstandingcommon stock, the Operating Partnership repurchased a matching number of unitsheld by RFS at an equal price. The Board of Directors of RFS approved a stockrepurchase program to buy back up to 3 million shares of common stock on theopen market subject to certain market conditions and other factors. During2000, RFS repurchased 409 thousand shares at an average price per share of$10.88 or $4.4 million which was recorded as a reduction to partners’ capitalas a result of the redemption of units held by RFS to fund the repurchase,bringing the total number of shares repurchased under the program to 576thousand.

 

**Note 10. Partners Capital. Post-MergerPartnership**

 

*Operating Partnership Units.*Inconnection with the RFS-CNL Transaction, two wholly owned subsidiaries of CNL,CNL Rose Acquisition Corp. and CNL Rose GP Corp., acquired all of the29,519,999 general partnership units and all of the 2,421,852 redeemablelimited partnership units.  At December31, 2003, CNL Rose Acquisition Corp. and CNL Rose GP Corp. owned 99.9% and 0.1%of the outstanding Operating Partnership’s units, respectively.

 

*Capital Contributions.*  Concurrent with the consummation of theRFS-CNL Transaction, CNL contributed five hotels to the Operating Partnershipwith net assets of approximately $131.6 million as follows:

 
| **ASSETS**                            |   |   |    |
|---------------------------------------|--------|--------|---------|
| Investment in hotel properties, net   |   | $      | 131,414 |   |
| Restricted cash                       |   | 1,854  |    |
| Accounts receivable                   |   | 320    |    |
| Other assets                          |   | 296    |    |
| Total assets                          |   | $      | 133,884 |   |
|                                  |   |   |    |
| **LIABILITIES**                       |   |   |    |
| Accounts payable and accrued expenses |   | $      | 2,241   |   |
| Total liabilities                     |   | $      | 2,241   |   |

 

The five hotels are a Residence Inn inOrlando, Florida, a Marriott Courtyard in Edison, New Jersey, a Hyatt Regencyin Coral Gables, Florida, a Wyndham in Billerica, Massachusetts and a Wyndhamin Denver, Colorado.  The two Wyndhamproperties are triple net lease properties, while the other three propertiesare leased to taxable REIT subsidiaries owned by CNL but not owned by theOperating Partnership. For the period July 11, 2003 to December 31, 2003, theOperating Partnership recognized approximately $6.0 million of revenue and $2.4million of depreciation on these contributed properties.

 

On August 25, 2003, the Operating Partnershipreceived a capital contribution of $190 thousand from CNL to help fund costsassociated with the repurchase of the Senior Notes.  On August 29, 2003, in accordance with the terms of the indenturegoverning the Senior Notes, the Operating Partnership repurchased from existingholders approximately $41.8 million of its Senior Notes.  On September 29, 2003, CNL made a $77.8million capital contribution to the Operating Partnership, the proceeds ofwhich were combined with the Operating Partnership’s available cash to reducethe balance outstanding on the Bridge Loan by $88.0 million.

 

*Capital Distributions.*  On August 25, 2003, $44 million wasdistributed to CNL. On December 31, 2003, the Operating

 

F-15

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Partnershipused a portion of the proceeds from the issuance of the 2003 Mezzanine Loan todistribute $30 million to CNL.

 

**Note 11. Commitments and Contingencies**

 

On May 13, 2003, A. Bruce Chasen, as class representative, filed aputative class action lawsuit in the Circuit Court of Shelby County, Tennessee,30th Judicial District against RFS, RFS’s directors and CNL (the“Chasen Complaint”).  On June 6, 2003,the Chasen Complaint was amended.  Theamended Chasen Complaint alleges, among other things, that (i) the mergerconsideration to be received by RFS’s shareholders is significantly less thanthe intrinsic value of RFS, (ii) the RFS directors breached their fiduciaryduties due to shareholders on a variety of grounds including failing toascertain the true value of RFS, failing to determine whether there were anyother bidders for RFS, and failing to avoid certain alleged conflicts ofinterest shared by members of the RFS board of directors and its financialadvisor, (iii) CNL aided and abetted the RFS board of directors in connectionwith their breach of fiduciary duties, (iv) the RFS board of directors violatedportions of the Tennessee Investor Protection Act, and (v) the RFS proxystatement is false and misleading. Among other relief, the amended Chasen Complaint seeks certification ofthe class action, an injunction enjoining RFS and CNL from completing themerger, monetary damages in an unspecified amount, the payment of attorney’sfees, and rescissory damages.  On July1, 2003, RFS and CNL filed an answer to the amended Chasen Complaint settingforth an affirmative defense and its general denials of the allegations setforth therein.  The plaintiff’s motionfor a temporary restraining order for purposes of enjoining the transaction,was denied by the Circuit Court of Shelby County, Tennessee, 30thJudicial District on July 8, 2003. Based upon the information currentlyavailable to the Operating Partnership and CNL, the Operating Partnershipbelieves the allegations contained in the amended Chasen Complaint are withoutmerit and it is the Operating Partnership’s understanding that CNL intends tovigorously defend the action, and therefore, a liability was not accrued.  The Operating Partnership and CNL areplanning to file a motion to dismiss the allegations in the amended ChasenComplaint. If the motion is not successful, it is expected that the case willproceed to trial.

 

On August 26, 2002, Carmel Valley, LLC filed a lawsuitagainst RFS and some of its subsidiaries in the Superior Court of the State ofCalifornia, for the County of San Diego (the “Carmel Valley Complaint”).  The Operating Partnership is a party to aCarmel Valley Complaint which claims damages relating to a dispute over aparcel of land located adjacent to one of its hotels.  The OperatingPartnership has unsuccessfully attempted to mediate this case.  At thistime, we believe that the damages claimed lack sufficient factualsupport and will continue to vigorously defend the action, andtherefore, a liability was not accrued. However, it is possible thatthe Operating Partnership could incur losses if the plaintiff ultimatelyprevails.  The plaintiff is seekingmonetary damages of up to $0.7 million. The Operating Partnership and CNL have recently filed certain motions todismiss which are being considered by the Court.  If the motions are not successful, it is expected that the casewill proceed to trial.

 

From time to time the Operating Partnership 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 theOperating Partnership’s financial condition or results of operation.

 

The Operating Partnership maintainscomprehensive insurance on each of its hotels, including liability, fire andextended coverage, of the type and amount the Operating Partnership believes iscustomarily obtained for or by hotel owners. Some of the OperatingPartnership’s insurance policies are written, implemented and monitored by thethird party companies who manage the Operating Partnership’s hotels and theOperating Partnership does not have the ability to actively monitor theseprograms and claims thereon. All 10 of the Operating Partnership’s hotels inCalifornia are located in areas that are typically subject to more earthquakeactivity than in other locations in the United States. These hotels are locatedin areas of high seismic risk and some were constructed under building codeswhich were less stringent with regard to earthquake related requirements. Anearthquake could render significant uninsured damage to the hotels.Additionally, areas in Florida, where eight of the Operating Partnership’shotels are located, may experience hurricane or high-wind activity. TheOperating Partnership has earthquake and windstorm insurance policies on itshotels. However, various types of catastrophic losses, like earthquakes andfloods may not be fully insurable or may not be economically insurable. Withrespect to the earthquake insurance policies, in addition to the applicabledeductibles under the earthquake insurance policies, the Operating Partnershipis self-insured for any losses in excess of $40 million per earthquake. Thewindstorm insurance policies are of the type and amount the OperatingPartnership believes is customarily obtained for or by hotel owners.  The Operating Partnership also maintainsterrorism insurance, which the Operating Partnership believes currently insuresagainst losses resulting from a terrorist attack. In the event of a substantialloss, insurance coverage may not be able to cover the full current market valueor replacement cost of the Operating Partnership’s lost investment. Inflation,changes in building codes and ordinances, environmental considerations andother factors might also affect the Operating Partnership’s ability to replaceor renovate a hotel after it has been damaged or destroyed.

 

F-16

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As of December31, 2003, the Operating Partnership has a cash deposit of $3.0 million,held in escrow, that serves as collateral on the worker’s compensation plan forthe former hotel employees of Flagstone. This cash deposit is included on theConsolidated Balance Sheet in Restricted Cash. This deposit is required by theinsurance carrier to be maintained until the outstanding claims under the planhave developed and there are adequate reserves to cover the claims.  There have been no withdrawals made from theescrow deposit.

 

As a result of the RFS-CNLTransaction, the respective hotelfranchisors have issued product improvement plans on most of the OperatingPartnership’s hotels and require that the Operating Partnership complete theseproduct improvement plans over the next several years. The OperatingPartnership expects the total cost of these product improvement plans will beapproximately $40 million.

 

During2003, the Operating Partnership received rental income from ten hotels leasedto third parties, three of which were leased to a taxable REIT subsidiary ownedby CNL, but not owned by the Operating Partnership, under leases which expirein 2007 (2 hotels), 2008 (4 hotels), 2009 (2 hotels) and 2015 (2 hotels).During 2002 and 2001, the Operating Partnership received rental income fromfive hotels leased to third parties. Minimum future rental income (base rents) due the Operating Partnershipunder these noncancelable operating leases at December 31, 2003, is asfollows (in thousands):

 
| **Year**            |   | **Amount** |   |
|---------------------|--------|------------|--------|
|                |   |       |   |
| 2004                |   | $          | 12,614 |   |
| 2005                |   | 12,614     |   |
| 2006                |   | 12,614     |   |
| 2007                |   | 12,170     |   |
| 2008                |   | 5,935      |   |
| 2009 and thereafter |   | 29,743     |   |
|                |   |       |   |
|                |   | $          | 85,690 |   |

 

Lease revenue is based on a percentage ofroom revenues, food and beverage revenues and other revenues of the hotels. Onsome of its third party leases, both the base rent and the threshold roomrevenue in each lease computation are adjusted annually for changes in theConsumer Price Index (“CPI”). The adjustment is calculated at the beginning ofeach calendar year. The CPI adjustments made in January 2003 and 2002 were2.3% and 1.6%, respectively.

 

The Operating Partnership may terminate anylease agreement with respect to a hotel property upon the sale of a hotelproperty in exchange for a termination payment to the lessee. Under five of theten hotel leases, the Operating Partnership is obligated to pay the costs ofreal estate taxes, property insurance, maintenance of underground utilities andstructural elements of the Hotels, and to set aside a portion of the hotels’revenues to fund capital expenditures for the periodic replacement orrefurbishment of furniture, fixtures and equipment required for the retentionof the franchise licenses with respect to the hotels.  For the other five hotel leases, these are leased to third-partytenants on a “triple-net” basis, whereby the tenant is generally responsiblefor all operating expenses relating to the hotel, including property taxes,insurance, and maintenance and repairs.

 

The Operating Partnership’s hotels areoperated under various management agreements with third party managers thatcall for base management fees, which generally range from 3% to 5% of hotelrevenues and have an incentive management fee provision related to the hotel’sprofitability. The management agreements generally require us to set aside 3%to 5% of hotel revenues in FF&E Reserve accounts to be used for thereplacement of furniture, fixtures and equipment. The management agreementsgenerally have terms from 10 to 20 years and have renewal options.

 

F-17

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**Note 12. Derivative Instruments**

 

On December 4, 2003 and December 23, 2003,respectively, the Operating Partnership purchased two interest rate caps thatlimit the LIBOR portion of the floating interest rates on the 2003 CMBS and the2003 Mezzanine Loan to 5.0%, before the spread of 189 basis points and 465basis points, respectively. The Company paid a $1.5 million premium to enterinto these agreements. At December 31, 2003, the Operating Partnership has netunrealized holding losses related to these two interest rate cap agreements of$0.4 million, which is included in other comprehensive income (loss). The netasset of $1.1 million is included in other assets on the consolidated balancesheet. The fair values of the interest rate instruments are estimated byobtaining quotes from brokers and are the estimated amounts that the OperatingPartnership would receive or pay to terminate the agreements at the reportingdate, taking into account current interest rates and other relevant factors.

 

**Note 13. Discontinued Operations**

 

In connection with the RFS-CNL Transaction,the Operating Partnership decided to sell six non-strategic hotels, andtherefore, these hotels are classified as real estate held for sale.  In November 2002, the Operating Partnershipsold its Comfort Inn in Fort Mill, South Carolina for $3.25 million incash, resulting in a loss on sale of approximately $3.8 million. Under FAS144, this loss is included in discontinued operations. Depreciation is notrecorded once real estate has been identified for sale. Accordingly, nodepreciation was recorded on the six hotels that were classified as real estateheld for sale. Had the Post-Merger Operating Partnership recorded depreciationon the six hotels, depreciation would have increased by $0.9 million.

 

The financial results for these hotelProperties are reflected as discontinued operations in the accompanyingconsolidated financial statements. The operating results of discontinuedoperations were as follows for the years ended December 31 2003, 2002 and 2001are shown below:

 
|                                            |   | **Post-Merger  Partnership**  |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |   |
|-------------------------------------------------|--------|-------------------------------|--------|----------------------------------|--------|----------------------------------|--------|----------------------------------|--------|
|                                            |   | **July 11 to  Dec. 31, 2003** |   | **January 1  to  July 10, 2003** |   | **January 1  to  Dec. 31, 2002** |   | **January 1  to  Dec. 31, 2001** |   |
|                                            |   |                          |   |                             |   |                             |   |                             |   |
| Hotel revenue                                   |   | $                             | 5,700  |                             | $      | 6,197                            |   | $                                | 14,550 |   | $ | 15,606 |   |
| Hotel operating costs                           |   | (4,478                        | )      | (4,552                           | )      | (10,025                          | )      | (10,521                          | )      |
| Depreciation                                    |   |                          |   | (1,038                           | )      | (2,337                           | )      | (2,284                           | )      |
| Income from operations                          |   | 1,222                         |   | 607                              |   | 2,188                            |   | 2,801                            |   |
| Loss on sale of discontinued operations         |   |                          |   |                             |   | (3,840                           | )      |                             |   |
|                                            |   |                          |   |                             |   |                             |   |                             |   |
| Earnings (losses) from discontinued  operations |   | $                             | 1,222  |                             | $      | 607                              |   | $                                | (1,652 | ) | $ | 2,801 |   |

 

**Note 14. Stock-Based Compensation Plans.Pre-Merger Partnership**

 

RFS sponsored a Restricted Stockand Stock Option Plan (the “Plan”) that provided for the grant of stock optionsto purchase a specified number of shares of common stock (“Options”) and grantsof restricted shares of common stock (“Restricted Stock”). Upon issuance of anystock, RFS was obligated to contribute the proceeds to the OperatingPartnership in exchange for an equal number of Operating Partnership units.Under the Plan, approximately 2.3 million shares of common stock, of which650 thousand shares were restricted stock, were available for awards tothe officers and key employees of the Operating Partnership and675 thousand shares of common stock, of which 120 thousand shareswere restricted stock, were available for awards to directors of the OperatingPartnership who were not officers or employees. Options issued under the planhad a maximum term of ten years from the date of grant. The exercise price ofthe options was determined on the date of each grant. Restricted shares vestedbetween one and five years based on each individual award and these shares hadvoting and dividend rights from the date of grant. Upon consummation of theRFS-CNL Transaction, all unvested Options and Restricted Stock immediatelyvested to the employees and directors. The Operating Partnership paidapproximately $0.8 million to employees and directors for “in the money” stockoptions (i.e., where the exercise price of the stock option was less than the$12.35 sale price). Approximately 213,000 shares of Restricted Stock with asales value of approximately $2.6 million vested upon the RFS-CNL Transaction.

 

F-18

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A summary of the RFS’s stock options under the Plan as of July 10,2003, December 31, 2002 and 2001, and the changes during the periods arepresented below (in thousands, except per share data):

 
|                               |   | **Pre-Merger  Partnership**               |   | **Pre-Merger  Partnership**            |   | **Pre-Merger  Partnership**               |   |
|------------------------------------|--------|-------------------------------------------|--------|----------------------------------------|--------|-------------------------------------------|--------|
|                               |   | **Jan. 1 to  July 10, 2003**              |   | **Jan. 1 to  Dec. 31, 2002**           |   | **Jan. 1 to  Dec. 31, 2001**              |   |
|                               |   | **Number of  Shares  Underlying Options** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares  Underlying Options** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares  Underlying Options** |   | **Weighted  Average  Exercise  Price** |   |
|                               |   |                                      |   |                                   |   |                                      |   |   |   |   |   |   |   |
| Outstanding at beginning of period |   | 1,328                                     |   | $                                      | 12.25  |                                      | 1,388  |   | $ | 12.76 |   | 1,207 |   | $ | 13.43 |   |
| Granted                            |   |                                      |   |                                   |   | 280                                       |   | 13.15 |   | 680 |   | 11.47 |   |
| Exercised                          |   | (1,328                                    | )      | 12.25                                  |   | (89                                       | )      | 11.99 |   | (343 | ) | 12.30 |   |
| Forfeited                          |   |                                      |   |                                   |   | (251                                      | )      | 16.14 |   | (156 | ) | 13.72 |   |
| Outstanding at end of period       |   | 0                                         |   |                                   |   | 1,328                                     |   | $ | 12.25 |   | 1,388 |   | $ | 12.76 |   |
|                               |   |                                      |   |                                   |   |                                      |   |   |   |   |   |   |   |
| Exercisable at end of period       |   | 0                                         |   | $                                      | 0      |                                      | 581    |   | $ | 12.45 |   | 519 |   | $ | 14.28 |   |
|                               |   |                                      |   |                                   |   |                                      |   |   |   |   |   |   |   |
| Weighted-average fair value        |   |                                      |   | $                                      | 0      |                                      |   |   | $ | 1.79 |   |   |   | $ | 1.10 |   |
|                               |   |                                      |   |                                   |   |                                      |   |   |   |   |   |   |   |
| Price range of shares under option |   | $10.50 to $16.87                          |   |                                   |   | $10.50 to $16.87                          |   |   |   | $10.50 to $16.87 |   |   |   |

 

There were no grants of options made during 2003. The fair value of eachoption granted in 2002 and 2001 was estimated on the date of grant using theBlack-Scholes option pricing model with the following weighted averageassumptions: dividend of $1.00 for 2002 grants and $1.10 for 2001; volatilityof 27.6% for 2002 grants and volatility of 26.7% for 2001 grants, risk-freeinterest rate of 4.9% for 2002 and 4.8% for 2001 and expected life of6 years for 2002 and 2001.

 

*Restricted Stock.*  A summary of the status of RFS’s restrictedstock grants under the Plan as of July 10, 2003, December 31, 2002 and2001, and the changes during the periods are presented below (value is computedas the weighted average fair market value of the restricted stock at grantdate):

 
|                               |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |    |
|------------------------------------|--------|------------------------------|--------|------------------------------|--------|------------------------------|---------|
|                               |   | **Jan. 1 to  July 10, 2003** |   | **Jan. 1 to  Dec. 31, 2002** |   | **Jan. 1 to  Dec. 31, 2001** |    |
|                               |   | **# Shares**                 |   | **Value**                    |   | **# Shares**                 |    | **Value** |   | **# Shares** |   | **Value** |   |
|                               |   |                         |   |                         |   |                         |    |   |   |   |   |   |   |
| Outstanding at beginning of period |   | 618,834                      |   | $                            | 13.28  |                         | 611,667 |   | $ | 13.31 |   | 343,000 |   | $ | 13.42 |   |
| Granted, subject to vesting        |   | 10,500                       |   | $                            | 10.86  |                         | 10,500  |   | $ | 11.38 |   | 270,000 |   | $ | 13.11 |   |
| Forfeited                          |   |                         |   |                         |   | (3,333                       | )       | $ | 13.06 |   | (1,333 | ) | $ | 11.88 |   |
| Outstanding at end of period       |   | 629,334                      |   | $                            | 13.24  |                         | 618,834 |   | $ | 13.28 |   | 611,667 |   | $ | 13.31 |   |
|                               |   |                         |   |                         |   |                         |    |   |   |   |   |   |   |
| Vested at end of period            |   | 629,334                      |   | $                            | 13.24  |                         | 380,169 |   | $ | 13.43 |   | 314,000 |   | $ | 13.65 |   |

 

The FASB issued SFAS No. 148 “Accountingfor Stock-Based Compensation—Transition and Disclosure.” SFAS No. 148amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to providealternative methods of transition for a voluntary change to the fair valuebased method of accounting for stock-based employee compensation. The OperatingPartnership applied the fair value based method of accounting for stock-basedemployee compensation prospectively to all awards granted, modified, or settledbeginning January 1, 2003.  As aresult of the RFS-CNL Transaction, the Operating Partnership no longer has anystock-based employee compensation.  Hadcompensation cost for the Operating Partnership’s stock-based compensationplans been determined consistent with SFAS 123, the OperatingPartnership’s net income (loss) and net income (loss) per unit would have beenreduced to the pro forma amounts as indicated below:

 

F-19

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|                                          |   | **Pre-Merger  Partnership**  |    | **Pre-Merger  Partnership**  |   | **Pre-Merger  Partnership**  |   |
|-----------------------------------------------|--------|------------------------------|---------|------------------------------|--------|------------------------------|--------|
|                                          |   | **Jan. 1 to  July 10, 2003** |    | **Jan. 1 to  Dec. 31, 2002** |   | **Jan. 1 to  Dec. 31, 2001** |   |
| Net income (loss) applicable to  unitholders: |   |                         |    |                         |   |                         |   |
| As reported                                   |   | $                            | (21,869 | )                            | $      | (7,884                       | )      | $ | (12,870 | ) |
| Pro forma                                     |   | $                            | (22,080 | )                            | $      | (8,372                       | )      | $ | (13,170 | ) |
| Basic and diluted earnings (loss) per unit:   |   |                         |    |                         |   |                         |   |
| As reported                                   |   | $                            | (0.70   | )                            | $      | (0.26                        | )      | $ | (0.47 | ) |
| Pro forma                                     |   | $                            | (0.71   | )                            | $      | (0.28                        | )      | $ | (0.48 | ) |

 

**Note 15. Supplemental Disclosure ofNon-Cash Activities**

 

In 2003:

 

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, the Pre-Merger Partnership:

 

i.              Allocated$1.3 million from redeemable limited partnership units to Partners’Capital.

ii.             Recorded an expenseof $1.1 million related to the issuance costs associated with theredemption of the Series B Preferred Units which was previously includedin Partners’ Capital.

 

In 2001, the Pre-Merger Partnership:

 

i.              Issued103 thousand general partnership units with a value of $1.6 millionin exchange for 103 thousand redeemable limited partnership units andissued 7 thousand general partnership units with a value of$0.1 million for an interest in a subsidiary partnership.

ii.             Allocated$1.3 million from redeemable limited partnership units to Partners’Capital.

iii.            Recorded a liabilityof $3.2 million for the fair value of the interest rate swaps atDecember 31, 2001.

iv.            Sold a hotel thatclosed on February 20, 2001 in which a loss and related liability of$1.0 million was recorded in the financial statements in 2000 as anon-cash transaction at December 31, 2000.

 

**Note 16. Related Party Transactions**

 

Certain officers of the Operating Partnershiphold similar positions with CNL and its affiliates. These affiliates are bycontract entitled to receive fees and compensation for services provided inconnection with the acquisition, development, management and sale of theOperating Partnership’s assets. During 2003, the Operating Partnership paidapproximately $15.5 million to affiliates of CNL in connection withreimbursements for acquisition costs incurred by CNL related to the RFS-CNLTransaction.

 

Affiliates of CNL provide variousadministrative services to the Operating Partnership, including servicesrelated to accounting; financial, tax and regulatory compliance reporting; duediligence and marketing; and investor relations, on a day to day basis. TheOperating Partnership incurred costs of approximately $30 thousand for theseservices.

 

Included in other assets are amounts due fromCNL and its affiliates of approximately $0.5 million for settlement of variousoperational items. These amounts are repaid in the ordinary course of business.

 

F-20

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**Note 17. Consolidating FinancialInformation of RFS Partnership, L.P.**

 

RFS Leasing II, Inc., RFS LeasingVII, Inc., RFS Financing Partnership, L.P., RFS Financing Corporation andRFS Financing 2002, LLC, wholly-owned subsidiaries of the Operating Partnership(“Guarantor Subsidiaries”), have guaranteed on a full and unconditional basis,the payment of amounts due under the Operating Partnership’s Senior Notes. Inaddition, CNL Rose Acquisition Corp., the Operating Partnership’s parentcompany, has guaranteed on a full and unconditional basis, the payment ofamounts due under the Operating Partnership’s Senior Notes. Other than itsinvestment in the Operating Partnership, CNL Rose Acquisition Corp. does nothave a material amount of assets. RFS Leasing II and RFS Leasing VII had nosubstantial operations prior to January 1, 2001. As of December 31, 2003and 2002, RFS Leasing II and RFS Leasing VII did not have a material amount ofassets, and incurred both operating and net losses. RFS Financing 2002 wasformed to facilitate the issuance of the Senior Notes. RFS FinancingCorporation was formed to facilitate the issuance of the 1996 commercialmortgage bonds, which were redeemed with a portion of the proceeds from thesale of the Senior Notes. RFS Financing Corporation and RFS Financing 2002 haveno operations or assets and no sources of revenue or cash flow. Consequently,in the event that it becomes necessary for CNL Rose Acquisition Corp., RFSLeasing II, RFS Leasing VII, RFS Financing 2002 or RFS Financing Corporation toprovide credit support for the Senior Notes, CNL Rose Acquisition Corp., 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 consolidatinginformation for the Operating Partnership, the Guarantor Subsidiaries and theNon-Guarantor Subsidiaries.  For theyear ended December 31, 2003, the tables present combined results of operationsof the Pre-Merger and Post-Merger Partnership as the Operating Partnershipbelieves this information is more meaningful.

 

**Consolidating Balance SheetDecember 31, 2003(in thousands)**

** **
|                                         |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |     | **Total  Consolidated** |   |
|----------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|----------|-------------------------|--------|
| **ASSETS**                                   |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Investment in hotel properties, net          |   | $                           | 266,394 |                        |   |                            | $      | 550,262          |     |                    |   | $ | 816,656 |   |
| Real estate held for sale                    |   | 11,090                      |    | $                           | 18,460 |                            |   |             |     |                    | 29,550 |   |
| Investment in consolidated entities          |   | 299,536                     |    | 55,257                      |   | 13,214                          |   | $                | (368,007 | )                       | — |   |
| Cash and cash equivalents                    |   | 6,649                       |    | 2,684                       |   | 10,063                          |   |             |     | 19,396                  |   |
| Restricted cash                              |   | 5,214                       |    |                        |   | 12,039                          |   |             |     | 17,253                  |   |
| Accounts receivable                          |   | 9,381                       |    | 26,044                      |   | 4,898                           |   | (32,108          | )        | 8,215                   |   |
| Deferred expenses, net                       |   |                        |    |                        |   | 6,085                           |   |             |     | 6,085                   |   |
| Other assets                                 |   | 1,194                       |    | 1,531                       |   | 3,043                           |   |             |     | 5,768                   |   |
| Deferred income taxes                        |   |                        |    | 17,315                      |   | 8,511                           |   |             |     | 25,826                  |   |
|                                         |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Total assets                                 |   | $                           | 599,458 |                        | $      | 121,291                         |   | $                | 608,115  |                    | $      | (400,115 | ) | $ | 928,749 |   |
|                                         |   |                        |    |                        |   |                            |   |             |     |                    |   |
| **LIABILITIES AND PARTNERS’ CAPITAL**   |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Accounts payable and accrued expenses        |   | $                           | 14,680  |                        | $      | 17,180                          |   | $                | 19,865   |                    | $      | (32,108 | ) | $ | 19,617 |   |
| Mortgage notes payable                       |   |                        |    |                        |   | 324,354                         |   |             |     | 324,354                 |   |
| Senior notes payable                         |   | 81,674                      |    |                        |   |                            |   |             |     | 81,674                  |   |
| Total liabilities                            |   | 96,354                      |    | 17,180                      |   | 344,219                         |   | (32,108          | )        | 425,645                 |   |
| Other comprehensive income                   |   | (418                        | )       |                        |   |                            |   |             |     | (418                    | )      |
| General partnership units                    |   | 503,522                     |    | 104,111                     |   | 263,896                         |   | (368,007         | )        | 503,522                 |   |
| Total partners’ capital                 |   | 503,104                     |    | 104,111                     |   | 263,896                         |   | (368,007         | )        | 503,104                 |   |
|                                         |   |                        |    |                        |   |                            |   |             |     |                    |   |
| Total liabilities and partners’ capital |   | $                           | 599,458 |                        | $      | 121,291                         |   | $                | 608,115  |                    | $      | (400,115 | ) | $ | 928,749 |   |
|                                              |        |                             |         |                             |        |                                 |        |                  |          |                         |        |  |  |  |  |  |  |

 

F-21

----

 

**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 |   |

 

F-22

----

 

**Combined Pre-Merger & Post-MergerPartnershipStatement of OperationsFor the Year Ended December 31, 2003(in thousands)**

** **
|                                                                                |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |    | **Total  Consolidated** |   |
|-------------------------------------------------------------------------------------|--------|-----------------------------|---------|-----------------------------|--------|---------------------------------|--------|------------------|---------|-------------------------|--------|
| Revenue:                                                                            |   |                        |    |                        |   |                            |   |             |    |                    |   |
| Rooms                                                                               |   |                        |    | $                           | 78,118 |                            | $      | 71,580           |    |                    |   | $ | 149,698 |   |
| Food and beverage                                                                   |   |                        |    | 10,956                      |   | 6,502                           |   |             |    | 17,458                  |   |
| Other operating departments                                                         |   |                        |    | 2,464                       |   | 3,397                           |   |             |    | 5,861                   |   |
| Lease revenue                                                                       |   | $                           | 28,121  |                        | 17,265 |                            | 2,744  |             | $       | (37,515                 | )      | 10,615 |   |
| Other                                                                               |   | 1,762                       |    | 247                         |   | 114                             |   | (963             | )       | 1,160                   |   |
| Total hotel revenue                                                                 |   | 29,883                      |    | 109,050                     |   | 84,337                          |   | (38,478          | )       | 184,792                 |   |
|                                                                                |   |                        |    |                        |   |                            |   |             |    |                    |   |
| Hotel operating expenses:                                                           |   |                        |    |                        |   |                            |   |             |    |                    |   |
| Rooms                                                                               |   |                        |    | 17,011                      |   | 15,458                          |   |             |    | 32,469                  |   |
| Food and beverage                                                                   |   |                        |    | 8,496                       |   | 4,229                           |   |             |    | 12,725                  |   |
| Other operating departments                                                         |   |                        |    | 1,015                       |   | 1,326                           |   |             |    | 2,341                   |   |
| Undistributed operating expenses:                                                   |   |                        |    |                        |   |                            |   |             |    |                    |   |
| Property operating costs                                                            |   |                        |    | 13,667                      |   | 9,529                           |   | (963             | )       | 22,233                  |   |
| Property taxes, insurance and other                                                 |   | 3,688                       |    | 1,845                       |   | 6,611                           |   |             |    | 12,144                  |   |
| Franchise costs                                                                     |   | (153                        | )       | 6,882                       |   | 6,094                           |   |             |    | 12,823                  |   |
| Maintenance and repair                                                              |   |                        |    | 5,252                       |   | 4,544                           |   |             |    | 9,796                   |   |
| Management fees                                                                     |   |                        |    | 4,088                       |   | 3,082                           |   |             |    | 7,170                   |   |
| Percentage lease expense                                                            |   |                        |    | 37,515                      |   |                            |   | (37,515          | )       |                    |   |
| Depreciation                                                                        |   | 10,267                      |    | 2,616                       |   | 17,475                          |   |             |    | 30,358                  |   |
| Amortization of franchise fees and unearned  compensation                           |   | 1,994                       |    | 20                          |   | 14                              |   |             |    | 2,028                   |   |
| General and administrative                                                          |   | 19,090                      |    | 7,606                       |   | 8,097                           |   |             |    | 34,793                  |   |
| Total operating expenses                                                            |   | 34,886                      |    | 106,013                     |   | 76,459                          |   | (38,478          | )       | 178,880                 |   |
| Operating income (loss)                                                             |   | (5,003                      | )       | 3,037                       |   | 7,878                           |   | —           |    | 5,912                   |   |
| Amortization of loan origination costs                                              |   | 645                         |    | 2                           |   | 808                             |   |             |    | 1,455                   |   |
| Interest expense                                                                    |   | 13,190                      |    |                        |   | 13,044                          |   |             |    | 26,234                  |   |
| Equity in (earnings) loss of consolidated  subsidiaries                             |   | (1,748                      | )       |                        |   | 6,672                           |   | (4,924           | )       |                    |   |
| Income (loss) from continuing operations  before minority interest and income taxes |   | (17,090                     | )       | 3,035                       |   | (12,646                         | )      | 4,924            |    | (21,777                 | )      |
| Minority interest                                                                   |   |                        |    |                        |   | (10                             | )      |             |    | (10                     | )      |
| Provision for (benefit from) income taxes                                           |   |                        |    | 3,712                       |   | (845                            | )      |             |    | 2,867                   |   |
| Income (loss) from continuing operations                                            |   | (17,090                     | )       | 6,747                       |   | (13,501                         | )      | 4,924            |    | (18,920                 | )      |
| Income from discontinued operations                                                 |   |                        |    | 1,829                       |   |                            |   |             |    | 1,829                   |   |
| Gain (loss) on sale of assets                                                       |   | (10                         | )       | 1                           |   |                            |   |             |    | (9                      | )      |
|                                                                                |   |                        |    |                        |   |                            |   |             |    |                    |   |
| Net income (loss) applicable to unitholders                                         |   | $                           | (17,100 | )                           | $      | 8,577                           |   | $                | (13,501 | )                       | $      | 4,924 |   | $ | (17,100 | ) |

 

F-23

----

 

**Consolidating Statement of OperationsFor the Year Ended December 31, 2002(in thousands)**

 
|                                                          |   | **RFS  Partnership,  L.P.** |   | **Guarantor  Subsidiaries** |    | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |   | **Total  Consolidated** |   |
|---------------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|---------|---------------------------------|--------|------------------|--------|-------------------------|--------|
| Revenue:                                                      |   |                        |   |                        |    |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | $                           | 100,282 |                            | $      | 56,388           |   |                    |   | $ | 156,670 |   |
| Food and beverage                                             |   |                        |   | 12,241                      |    | 5,211                           |   |             |   | 17,452                  |   |
| Other operating departments                                   |   |                        |   | 3,357                       |    | 2,818                           |   |             |   | 6,175                   |   |
| Lease revenue                                                 |   | $                           | 27,071 |                        | 20,569  |                            | 2,487  |             | $      | (44,898                 | )      | 5,229 |   |
| Other                                                         |   | 911                         |   | 31                          |    | 177                             |   | (708             | )      | 411                     |   |
| Total hotel revenue                                           |   | 27,982                      |   | 136,480                     |    | 67,081                          |   | (45,606          | )      | 185,937                 |   |
|                                                          |   |                        |   |                        |    |                            |   |             |   |                    |   |
| Hotel operating expenses:                                     |   |                        |   |                        |    |                            |   |             |   |                    |   |
| Rooms                                                         |   |                        |   | 20,792                      |    | 11,122                          |   |             |   | 31,914                  |   |
| Food and beverage                                             |   |                        |   | 9,455                       |    | 3,338                           |   |             |   | 12,793                  |   |
| Other operating departments                                   |   |                        |   | 1,163                       |    | 561                             |   |             |   | 1,724                   |   |
| Undistributed operating expenses:                             |   |                        |   |                        |    |                            |   |             |   |                    |   |
| Property operating costs                                      |   |                        |   | 13,688                      |    | 6,427                           |   |             |   | 20,115                  |   |
| Property taxes, insurance and other                           |   | 3,393                       |   | 2,715                       |    | 5,562                           |   |             |   | 11,670                  |   |
| Franchise costs                                               |   | (193                        | )      | 9,009                       |    | 6,185                           |   |             |   | 15,001                  |   |
| Maintenance and repair                                        |   |                        |   | 5,763                       |    | 2,991                           |   |             |   | 8,754                   |   |
| Management fees                                               |   |                        |   | 2,861                       |    | 1,691                           |   |             |   | 4,552                   |   |
| Percentage lease expense                                      |   |                        |   | 44,898                      |    |                            |   | (44,898          | )      |                    |   |
| Depreciation                                                  |   | 10,213                      |   | 5,159                       |    | 12,371                          |   |             |   | 27,743                  |   |
| Amortization of franchise fees and unearned  compensation     |   | 1,181                       |   | 40                          |    | 26                              |   |             |   | 1,247                   |   |
| General and administrative                                    |   | 697                         |   | 9,632                       |    | 7,698                           |   |             |   | 18,027                  |   |
| Total operating expenses                                      |   | 15,291                      |   | 125,175                     |    | 57,972                          |   | (44,898          | )      | 153,540                 |   |
| Operating income                                              |   | 12,691                      |   | 11,305                      |    | 9,109                           |   | (708             | )      | 32,397                  |   |
| Debt extinguishments and swap termination  costs              |   | 3,210                       |   | 6,912                       |    |                            |   |             |   | 10,122                  |   |
| Amortization of loan origination costs                        |   | 1,302                       |   | 16                          |    | 299                             |   |             |   | 1,617                   |   |
| Interest expense                                              |   | 11,692                      |   | 1,599                       |    | 12,901                          |   | (708             | )      | 25,484                  |   |
| Equity in (earnings) loss of consolidated  subsidiaries       |   | 1,894                       |   |                        |    | 1,527                           |   | (3,421           | )      |                    |   |
| Income (loss) from continuing operations  before income taxes |   | (5,407                      | )      | 2,778                       |    | (5,618                          | )      | 3,421            |   | (4,826                  | )      |
| Benefit from income taxes                                     |   |                        |   | 832                         |    | 264                             |   |             |   | 1,096                   |   |
| Income (loss) from continuing operations                      |   | (5,407                      | )      | 3,610                       |    | (5,354                          | )      | 3,421            |   | (3,730                  | )      |
| Losses from discontinued operations                           |   |                        |   | (1,652                      | )       |                            |   |             |   | (1,652                  | )      |
| Gain (loss) on sale of assets                                 |   | 975                         |   |                        |    | (25                             | )      |             |   | 950                     |   |
| Net income (loss)                                             |   | (4,432                      | )      | 1,958                       |    | (5,379                          | )      | 3,421            |   | (4,432                  | )      |
| Loss on redemption of preferred units                         |   | (1,890                      | )      |                        |    |                            |   |             |   | (1,890                  | )      |
| Preferred unit dividends                                      |   | (1,562                      | )      |                        |    |                            |   |             |   | (1,562                  | )      |
|                                                          |   |                        |   |                        |    |                            |   |             |   |                    |   |
| Net income (loss) applicable to unitholders                   |   | $                           | (7,884 | )                           | $       | 1,958                           |   | $                | (5,379 | )                       | $      | 3,421 |   | $ | (7,884 | ) |

 

F-24

----

 

**ConsolidatingStatement of OperationsFor the Year Ended December 31, 2001(in thousands)**

** **
|                                                      |   | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |    | **Non-Guarantor  Subsidiaries** |   | **Eliminations** |    | **Total  Consolidated** |   |
|-----------------------------------------------------------|--------|-----------------------------|---------|-----------------------------|---------|---------------------------------|--------|------------------|---------|-------------------------|--------|
|                                                      |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Revenue:                                                  |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Rooms                                                     |   |                        |    | $                           | 107,558 |                            | $      | 66,004           |    |                    |   | $ | 173,562 |   |
| Food and beverage                                         |   |                        |    | 12,556                      |    | 5,139                           |   |             |    | 17,695                  |   |
| Other operating departments                               |   |                        |    | 4,797                       |    | 3,864                           |   |             |    | 8,661                   |   |
| Lease revenue                                             |   | $                           | 29,455  |                        | 23,172  |                            | 2,651  |             | $       | (49,496                 | )      | 5,782 |   |
| Other                                                     |   | 1,715                       |    | 96                          |    | 279                             |   | (1,517           | )       | 573                     |   |
| Total hotel revenue                                       |   | 31,170                      |    | 148,179                     |    | 77,937                          |   | (51,013          | )       | 206,273                 |   |
|                                                      |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Hotel operating expenses:                                 |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Rooms                                                     |   |                        |    | 21,170                      |    | 12,568                          |   |             |    | 33,738                  |   |
| Food and beverage                                         |   |                        |    | 10,171                      |    | 3,362                           |   |             |    | 13,533                  |   |
| Other operating departments                               |   |                        |    | 1,355                       |    | 642                             |   |             |    | 1,997                   |   |
| Undistributed operating expenses:                         |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Property operating costs                                  |   | (216                        | )       | 13,803                      |    | 6,944                           |   |             |    | 20,531                  |   |
| Property taxes, insurance and other                       |   | 3,392                       |    | 2,569                       |    | 5,921                           |   |             |    | 11,882                  |   |
| Franchise costs                                           |   |                        |    | 8,893                       |    | 6,637                           |   |             |    | 15,530                  |   |
| Maintenance and repair                                    |   |                        |    | 5,761                       |    | 3,094                           |   |             |    | 8,855                   |   |
| Management fees                                           |   |                        |    | 3,583                       |    | 1,755                           |   |             |    | 5,338                   |   |
| Percentage lease expense                                  |   |                        |    | 55,403                      |    | (5,907                          | )      | (49,496          | )       |                    |   |
| Depreciation                                              |   | 9,037                       |    | 4,757                       |    | 13,527                          |   |             |    | 27,321                  |   |
| Lease termination                                         |   |                        |    | 35,657                      |    | 29,832                          |   |             |    | 65,489                  |   |
| Amortization of franchise fees and unearned  compensation |   | 1,315                       |    | 41                          |    | 28                              |   |             |    | 1,384                   |   |
| General and administrative                                |   | 1,384                       |    | 9,335                       |    | 7,442                           |   |             |    | 18,161                  |   |
| Total operating expenses                                  |   | 14,912                      |    | 172,498                     |    | 85,845                          |   | (49,496          | )       | 223,759                 |   |
| Operating income (loss)                                   |   | 16,258                      |    | (24,319                     | )       | (7,908                          | )      | (1,517           | )       | (17,486                 | )      |
| Amortization of loan origination costs                    |   | 903                         |    | 146                         |    | 305                             |   |             |    | 1,354                   |   |
| Interest expense                                          |   | 7,355                       |    | 4,650                       |    | 14,200                          |   | (1,517           | )       | 24,688                  |   |
| Equity in (earnings) loss of consolidated  subsidiaries   |   | 22,886                      |    |                        |    | 22,047                          |   | (44,933          | )       |                    |   |
| Loss from continuing operations before  income taxes      |   | (14,886                     | )       | (29,115                     | )       | (44,460                         | )      | 44,933           |    | (43,528                 | )      |
| Benefit from income taxes                                 |   |                        |    | 13,552                      |    | 11,162                          |   |             |    | 24,714                  |   |
| Loss from continuing operations                           |   | (14,886                     | )       | (15,563                     | )       | (33,298                         | )      | 44,933           |    | (18,814                 | )      |
| Income from discontinued operations                       |   |                        |    | 2,801                       |    |                            |   |             |    | 2,801                   |   |
| Gain on sale of assets                                    |   |                        |    |                        |    | 1,127                           |   |             |    | 1,127                   |   |
| Net loss                                                  |   | (14,886                     | )       | (12,762                     | )       | (32,171                         | )      | 44,933           |    | (14,886                 | )      |
| Gain on redemption of preferred units                     |   | 5,141                       |    |                        |    |                            |   |             |    | 5,141                   |   |
| Preferred unit dividends                                  |   | (3,125                      | )       |                        |    |                            |   |             |    | (3,125                  | )      |
|                                                      |   |                        |    |                        |    |                            |   |             |    |                    |   |
| Net loss applicable to unitholders                        |   | $                           | (12,870 | )                           | $       | (12,762                         | )      | $                | (32,171 | )                       | $      | 44,933 |   | $ | (12,870 | ) |

 

F-25

----

 

**Combined Pre-Merger & Post-MergerPartnershipStatement of Cash FlowsFor the Year Ended December 31, 2003(in thousands)**

 
|                                                  |   | **RFS  Partnership,  L.P.** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Total  Consolidated** |   |
|-------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|---------------------------------|--------|-------------------------|--------|
|                                                  |   |                        |   |                        |   |                            |   |                    |   |
| Cash flows from (used in) operating  activities       |   | $                           | (9,171 | )                           | $      | 2,695                           |   | $                       | 9,345  |   | $ | 2,869 |   |
| Cash flows from (used in) investing  activities       |   | (40,996                     | )      | 56,292                      |   | (36,350                         | )      | (21,054                 | )      |
| Cash flows from (used in) financing  activities       |   | 56,370                      |   | (57,128                     | )      | 36,401                          |   | 35,643                  |   |
| Net increase (decrease) in cash and cash  equivalents |   | 6,203                       |   | 1,859                       |   | 9,396                           |   | 17,458                  |   |
| Cash and cash equivalents at beginning of  period     |   | 446                         |   | 825                         |   | 667                             |   | 1,938                   |   |
| Cash and cash equivalents at end of period            |   | $                           | 6,649  |                        | $      | 2,684                           |   | $                       | 10,063 |   | $ | 19,396 |   |

 

**Consolidating Statement of Cash FlowsFor the Year Ended December 31, 2002(in thousands)**

 
|                                                  |   |    | **RFS  Partnership,  L.P.** |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |    | **Total  Consolidated** |   |
|-------------------------------------------------------|--------|---------|-----------------------------|---------|-----------------------------|--------|---------------------------------|---------|-------------------------|--------|
|                                                  |   |    |                        |    |                        |   |                            |    |                    |
| Cash flows from (used in) operating  activities       |   | $       | 36,108                      |    | $                           | 10,066 |                            | $       | (9,648                  | )      | $ | 36,526 |   |
| Cash flows from (used in) investing  activities       |   | (64,421 | )                           | 45,484  |                        | 10,798 |                            | (8,139  | )                       |
| Cash flows from (used in) financing activities        |   | 28,496  |                        | (58,192 | )                           | (2,488 | )                               | (32,184 | )                       |
| Net increase (decrease) in cash and cash  equivalents |   | 183     |                        | (2,642  | )                           | (1,338 | )                               | (3,797  | )                       |
| Cash and cash equivalents at beginning of  period     |   | 263     |                        | 3,467   |                        | 2,005  |                            | 5,735   |                    |
| Cash and cash equivalents at end of period            |   | $       | 446                         |    | $                           | 825    |                            | $       | 667                     |   | $ | 1,938 |   |
|                                                       |        |         |                             |         |                             |        |                                 |         |                         |        |  |  |  |  |

 

**ConsolidatingStatement of Cash FlowsFor the Year Ended December 31, 2001(in thousands)**

 
|                                                  |   | **RFS  Partnership,  L.P.** |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Total  Consolidated** |   |   |
|-------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|---------------------------------|--------|-------------------------|--------|--------|
|                                                  |   |                        |   |                        |   |                            |   |                    |   |
| Cash flows from (used in) operating  activities       |   | $                           | 26,229 |                        | $      | (14,993                         | )      | $                       | (770   | )      | $ | 10,466 |   |
| Cash flows from (used in) investing  activities       |   | (34,462                     | )      | (13,540                     | )      | 39,360                          |   | (8,642                  | )      |
| Cash flows from (used in) financing  activities       |   | 7,447                       |   | 31,864                      |   | (39,081                         | )      | 230                     |   |
| Net increase (decrease) in cash and cash  equivalents |   | (786                        | )      | 3,331                       |   | (491                            | )      | 2,054                   |   |
| Cash and cash equivalents at beginning of  period     |   | 1,049                       |   | 136                         |   | 2,496                           |   | 3,681                   |   |
| Cash and cash equivalents at end of period            |   | $                           | 263    |                        | $      | 3,467                           |   | $                       | 2,005  |   | $ | 5,735 |   |
|                                                       |        |                             |        |                             |        |                                 |        |                         |        |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

F-26

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**RFS HOTEL INVESTORS, INC.**

**SCHEDULE III—REAL ESTATE AND ACCUMULATEDDEPRECIATION**

**as of December 31, 2003**

**(in thousands)**

** **
|                                                        |   | **Initial  Cost** |   | **Cost  Capitalized  Subsequent to Acquisition** |   | **Gross  Amount at Which Carried  at end of Period** |   |                             |   | **Accumulated  Depreciation  Buildings and  Improvements** |   | **Net Book  Value  Buildings and  Improvements** |   | **Date of  Acquisition** |   |
|-------------------------------------------------------------|--------|-------------------|--------|--------------------------------------------------|--------|-----------------------------------------------------------|--------|----------------------------------|--------|------------------------------------------------------------|--------|--------------------------------------------------|--------|--------------------------|--------|
| **Description**                                             |   | **Land**          |   | **Buildings  and  Improvements**                 |   | **Land**                                                  |   | **Buildings  and  Improvements** |   | **Land**                                                   |   | **Buildings  and  Improvements**                 |   | **Total**                |   |   |   |   |
|                                                        |   |              |   |                                             |   |                                                      |   |                             |   |                                                       |   |                                             |   |                     |   |   |   |   |   |   |   |
| Hotels each less than 5% of total (various city and states) |   | $                 | 97,330 |                                             | $      | 702,370                                                   |   | $                                | 97,330 |                                                       | $      | 702,370                                          |   | $                        | 97,330 |   | $ | 702,370 |   | $ | 799,700 |   | $ | 11,881 |   | $ | 787,819 |   | Various |   |
| Totals                                                      |   | $                 | 97,330 |                                             | $      | 702,370                                                   |   | $                                | 97,330 |                                                       | $      | 702,370                                          |   | $                        | 97,330 |   | $ | 702,370 |   | $ | 799,700 |   | $ | 11,881 |   | $ | 787,819 |   |   |   |

 
|                                                                       |   |                          |    |   |                             |   |                             |   |                             |    |
|----------------------------------------------------------------------------|--------|-------------------------------|---------|--------|----------------------------------|--------|----------------------------------|--------|----------------------------------|---------|
|                                                                       |   | **Post-Merger  Partnership**  |    |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |   | **Pre-Merger  Partnership**      |    |
|                                                                       |   | **July 11 to  Dec. 31, 2003** |    |   | **January 1  to  July 10, 2003** |   | **January 1  to  Dec. 31, 2002** |   | **January 1  to  Dec. 31, 2001** |    |
|                                                                       |   |                          |    |   |                             |   |                             |   |                             |    |
| Cost of land and improvements, buildings  and improvements:                |   |                          |    |   |                             |   |                             |   |                             |    |
| Balance at beginning of period                                             |   | $                             | 799,700 |   |                             | $      | 615,195                          |   | $                                | 614,313 |   | $ | 613,733 |   |
| Additions                                                                  |   |                          |    |   | 2,522                            |   | 8,051                            |   | 11,849                           |    |
| Disposals                                                                  |   |                          |    |   |                             |   | (7,169                           | )      | (11,269                          | )       |
| Balance at end of period                                                   |   | $                             | 799,700 |   |                             | $      | 617,717                          |   | $                                | 615,195 |   | $ | 614,313 |   |
|                                                                       |   |                          |    |   |                             |   |                             |   |                             |    |
| Accumulated depreciation on land  improvements, buildings and improvements |   |                          |    |   |                             |   |                             |   |                             |    |
| Balance at beginning of period (Note 1)                                    |   | $                             | 4,275   |   |                             | $      | 88,753                           |   | $                                | 76,437  |   | $ | 64,247 |   |
| Additions                                                                  |   | 7,606                         |    |   | 7,690                            |   | 13,789                           |   | 13,571                           |    |
| Disposals                                                                  |   |                          |    |   |                             |   | (1,473                           | )      | (1,381                           | )       |
|                                                                       |   |                          |    |   |                             |   |                             |   |                             |    |
| Balance at end of period                                                   |   | $                             | 11,881  |   |                             | $      | 96,443                           |   | $                                | 88,753  |   | $ | 76,437 |   |
|                                                                       |   |                          |    |   |                             |   |                             |   |                             |    |   |   |   |   |

 

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Note 1 – Forthe period July 11 to December 31, 2003, the balance at the beginning of theperiod is related to the accumulated depreciation on the five hotelscontributed by CNL to the Operating Partnership.

 

F-27

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