##### Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



|[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|--- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2002

OR



|[   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
|----- | ----------------------------------------------------------------------------------------

For the transition period from __________________ to __________________

Commission file number 000-21583

Candlewood Hotel Company, Inc.




(Exact name of registrant as specified in its charter)


|                         |  |                                     
|------------------------ |  | ------------------------------------
|Delaware                 |  | 48-1188025                          
|                         |  |                                     
|(State of Incorporation) |  | (I.R.S. Employer Identification No.)

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




(Address of principal executive offices)


(316) 631-1300




(Registrants telephone number, including area code)


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

Yes [X]     No [   ]

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

|                             |  |                                  |  | 
|---------------------------- |  | -------------------------------- |  | 
|Class                        |  | Outstanding at November 14, 2002
|                             |  |                                 
|Common Stock, $.01 par value |  | 9,025,000 shares                

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TABLE OF CONTENTS



|                              |                                                                                               |                                            |  |  |  |  |  | 
|----------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION
|                              | Item 1. Financial Statements                                                                 
|                              |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                              |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                              |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|PART II. OTHER INFORMATION   
|                              | Item 4. Controls and Procedures                                                              
|                              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                   
|CERTIFICATIONS               
|EXHIBIT INDEX                
|EXHIBIT 10.30                
|EXHIBIT 10.31                
|EXHIBIT 10.32                
|EXHIBIT 10.33                
|EXHIBIT 10.34                



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##### Table of Contents



CANDLEWOOD HOTEL COMPANY, INC.

FORM 10-Q
FOR THE QUARTER ENDED
SEPTEMBER 30, 2002

INDEX

|         |  |                                                                                                                               |  |  |       |      |  | 
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------- |  |  | ----- | ---- |  | 
|         |  |                                                                                                                               |  |  |       | PAGE
|         |  |                                                                                                                               |  |  |       |     
|PART I.  |  | FINANCIAL INFORMATION                                                                                                         |  |  |       |     
|        
|        
|        
|        
|Item 1.  |  | Financial Statements                                                                                                          |  |  |       |     
|        
|        
|        
|        
|         |  | Consolidated Balance Sheets at September 30, 2002 (unaudited)and December 31, 2001                                            |  |  | 3     |     
|        
|        
|        
|        
|         |  | Consolidated Statements of Operations for the three andnine-months ended September 30, 2002 and September 30, 2001(unaudited) |  |  | 4     |     
|        
|        
|        
|        
|         |  | Consolidated Statements of Cash Flows for the nine-months ended September 30, 2002 and September 30, 2001 (unaudited)         |  |  | 5     |     
|        
|        
|        
|        
|         |  | Notes to Consolidated Financial Statements                                                                                    |  |  | 6-14  |     
|        
|        
|        
|        
|Item 2.  |  | Management's Discussion and Analysis of FinancialCondition and Results of Operations                                          |  |  | 15-28 |     
|        
|        
|        
|        
|PART II. |  | OTHER INFORMATION                                                                                                             |  |  |       |     
|        
|        
|        
|        
|Item 4.  |  | Controls and Procedures                                                                                                       |  |  | 29    |     
|        
|        
|        
|        
|Item 6.  |  | Exhibits and Reports on Form 8-K                                                                                              |  |  | 29    |     
|        
|        
|        
|        
|         |  | Certifications                                                                                                                |  |  | 31-32 |     

2



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##### Table of Contents












PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

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

|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |         |         |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------- | ----------------- | -------------------------------------------- | ------- | ------------- | ------- | ------------ | ------- | ------- | ------- | -
|                                                                                                                                                       |                                                                                               |                   |                                              |         | September 30, |         |              |         |        
|                                                                                                                                                       |                                                                                               |                   |                                              |         | 2002          |         | December 31,
|                                                                                                                                                       |                                                                                               |                   |                                              |         | (Unaudited)   |         | 2001        
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |             
|Assets:                                                                                                                                                |                                                                                               |                   |                                              |         |               |         |              |        
|Investment in hotels:                                                                                                                                  |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       | Hotels completed                                                                              |                   | $                                            | 100,182 |               |         | $            | 263,160 |        
|                                                                                                                                                       | Accumulated depreciation and amortization                                                     |                   |                                              | (12,746 | )             |         |              | (24,878 | )      
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       | Net investment in hotels                                                                      |                   |                                              | 87,436  |               |         |              | 238,282 |        
|Cash and cash equivalents (including $980 and $968 of
restricted cash, respectively)                                                                   |                                                                                               |                   | 12,879                                       |         |               |         | 17,966       |        
|Deposits                                                                                                                                               |                                                                                               |                   | 46,086                                       |         |               |         | 30,086       |        
|Accounts and other receivables                                                                                                                         |                                                                                               |                   | 6,193                                        |         |               |         | 4,663        |        
|Investments in joint ventures                                                                                                                          |                                                                                               |                   | 13,683                                       |         |               |         | 12,994       |        
|Other assets                                                                                                                                           |                                                                                               |                   | 14,367                                       |         |               |         | 17,347       |        
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       |                                                                                               | Total assets      |                                              | $       | 180,644       |         |              | $       | 321,338 |        
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|Liabilities and Stockholders (Deficit):                                                                                                               |                                                                                               |                   |                                              |         |               |         |              |        
|Mortgages and notes payable                                                                                                                            |                                                                                               | $                 | 58,944                                       |         |               | $       | 191,456      |        
|Accounts payable and other accrued expenses                                                                                                            |                                                                                               |                   | 17,055                                       |         |               |         | 16,364       |        
|Deferred gain on sale of hotels                                                                                                                        |                                                                                               |                   | 26,403                                       |         |               |         | 16,995       |        
|Other liabilities                                                                                                                                      |                                                                                               |                   | 121                                          |         |               |         | 768          |        
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       |                                                                                               | Total liabilities |                                              |         | 102,523       |         |              |         | 225,583 |        
|Redeemable, convertible, cumulative preferred stock (Series A),
$1,000 stated value, 65,000 shares authorized and outstanding,
net of offering costs |                                                                                               |                   | 67,491                                       |         |               |         | 63,047       |        
|Redeemable, convertible, cumulative preferred stock (Series B),
$1,000 stated value, 42,000 shares authorized and outstanding,
net of offering costs |                                                                                               |                   | 43,422                                       |         |               |         | 40,491       |        
|Stockholders (deficit):                                                                                                                               |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       | Common stock, $.01 par value, 100,000,000 shares authorized,
9,025,000 issued and outstanding |                   |                                              | 90      |               |         |              | 90      |        
|                                                                                                                                                       | Additional paid-in capital                                                                    |                   |                                              | 25,046  |               |         |              | 32,421  |        
|                                                                                                                                                       | Other comprehensive income                                                                    |                   |                                              | (138    | )             |         |              |        |        
|                                                                                                                                                       | Accumulated deficit                                                                           |                   |                                              | (57,790 | )             |         |              | (40,294 | )      
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       |                                                                                               |                   | Total stockholders(deficit)                 |         |               | (32,792 | )            |         |         | (7,783  | )
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        
|                                                                                                                                                       |                                                                                               |                   | Total liabilities and stockholders(deficit) |         | $             | 180,644 |              |         | $       | 321,338 |  
|                                                                                                                                                       |                                                                                               |                   |                                              |         |               |         |              |        

See accompanying notes.

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

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

|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |         |  
|------------------------------------------------------------------------------ | ------------------------------------------- | - | --------------------- | ------ | ------------------------- | - | ------------- | ------ | ------------- | - | --------- | ------- | - | - | --------- | ------- | -
|                                                                               |                                             |   | For the Quarter Ended |        | For the Nine-Months Ended
|                                                                               |                                             |   |                       |        |                          
|                                                                               |                                             |   | September 30,         |        | September 30,             |   | September 30, |        | September 30,
|                                                                               |                                             |   | 2002                  |        | 2001                      |   | 2002          |        | 2001         
|                                                                               |                                             |   |                       |        |                           |   |               |        |              
|Revenues:                                                                      |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|Hotel operations                                                               |                                             | $ | 32,493                |        |                           | $ | 33,493        |        |               | $ | 94,866    |         |   | $ | 98,046    |        
|Other income                                                                   |                                             |   | 778                   |        |                           |   | 1,097         |        |               |   | 2,121     |         |   |   | 2,842     |        
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               | Total hotel operating revenues              |   |                       | 33,271 |                           |   |               | 34,590 |               |   |           | 96,987  |   |   |           | 100,888 |  
|Proceeds from sales of hotels, net of deferred
gain of $0 and $0, respectively |                                             |   |                      |        |                           |   | 28,850        |        |               |   | 145,000   |         |   |   | 28,850    |        
|Deferred gain recognition on sales of hotels                                   |                                             |   | 406                   |        |                           |   | 357           |        |               |   | 1,044     |         |   |   | 1,049     |        
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               | Total revenues                              |   |                       | 33,677 |                           |   |               | 63,797 |               |   |           | 243,031 |   |   |           | 130,787 |  
|Operating costs and expenses:                                                  |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|Hotel operating expenses                                                       |                                             |   | 20,196                |        |                           |   | 19,615        |        |               |   | 59,968    |         |   |   | 55,760    |        
|Corporate operating expenses                                                   |                                             |   | 1,279                 |        |                           |   | 1,509         |        |               |   | 4,447     |         |   |   | 4,884     |        
|Rent expense on leased hotels                                                  |                                             |   | 11,470                |        |                           |   | 6,807         |        |               |   | 29,590    |         |   |   | 19,468    |        
|Hotel opening costs                                                            |                                             |   |                      |        |                           |   |              |        |               |   |          |         |   |   | 230       |        
|Depreciation and amortization                                                  |                                             |   | 1,144                 |        |                           |   | 3,203         |        |               |   | 4,934     |         |   |   | 8,833     |        
|Impairment loss on assets held for sale                                        |                                             |   |                      |        |                           |   |              |        |               |   | 8,604     |         |   |   |          |        
|Loss on extinguishments of debt                                                |                                             |   |                      |        |                           |   |              |        |               |   | 2,115     |         |   |   |          |        
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               | Total operating costs and expenses          |   |                       | 34,089 |                           |   |               | 31,134 |               |   |           | 109,658 |   |   |           | 89,175  |  
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|Cost of hotels sold                                                            |                                             |   |                      |        |                           |   | 29,064        |        |               |   | 145,000   |         |   |   | 29,064    |        
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               |                                             |   | (412                  | )      |                           |   | 3,599         |        |               |   | (11,627   | )       |   |   | 12,548    |        
|Interest income                                                                |                                             |   | 73                    |        |                           |   | 219           |        |               |   | 258       |         |   |   | 600       |        
|Interest expense                                                               |                                             |   | (1,172                | )      |                           |   | (4,343        | )      |               |   | (6,127    | )       |   |   | (13,467   | )      
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               | (Loss) before preferred stock
dividends     |   |                       | (1,511 | )                         |   |               | (525   | )             |   |           | (17,496 | ) |   |           | (319    | )
|Preferred stock dividends                                                      |                                             |   | (2,023                | )      |                           |   | (2,023        | )      |               |   | (6,002    | )       |   |   | (6,002    | )      
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|                                                                               | Net (loss) available to common
stockholders |   | $                     | (3,534 | )                         |   | $             | (2,548 | )             |   | $         | (23,498 | ) |   | $         | (6,321  | )
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|Net (loss) per share of common
stock  basic and diluted                       |                                             | $ | (0.39                 | )      |                           | $ | (0.28         | )      |               | $ | (2.60     | )       |   | $ | (0.70     | )      
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        
|Weighted
average shares outstanding  basic and diluted                        |                                             |   | 9,025,000             |        |                           |   | 9,025,000     |        |               |   | 9,025,000 |         |   |   | 9,025,000 |        
|                                                                               |                                             |   |                       |        |                           |   |               |        |               |   |           |         |   |   |           |        

See accompanying notes.

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

(Unaudited) (In thousands)

|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |        |        |         |  
|----------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------------- | --------------------------------------------------- | ------ | ------------------ | -------- | ------------------ | ------ | ------ | ------- | -
|                                                                                          |                                              |                                             |                                                     |        | Nine-Months Ended 
|                                                                                          |                                              |                                             |                                                     |        |                   
|                                                                                          |                                              |                                             |                                                     |        | September 30, 2002 |          | September 30, 2001
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                   
|Cash flows from operating activities:                                                     |                                              |                                             |                                                     |        |                    |          |                    |       
|Net (loss) before preferred stock dividends                                               |                                              | $                                           | (17,496                                             | )      |                    | $        | (319               | )     
|Adjustments to reconcile net loss to net cash
provided by (used in) operating activities: |                                              |                                             |                                                     |        |                    |          |                    |       
|                                                                                          | Depreciation and amortization                |                                             |                                                     | 4,934  |                    |          |                    | 8,833  |       
|                                                                                          | Loss from joint ventures                     |                                             |                                                     | 797    |                    |          |                    | 369    |       
|                                                                                          | Deferred gain recognition on sales of hotels |                                             |                                                     | (1,044 | )                  |          |                    | (1,049 | )     
|                                                                                          | Impairment loss on assets held for sale      |                                             |                                                     | 8,604  |                    |          |                    |       |       
|                                                                                          | Loss on sales of hotels                      |                                             |                                                     |       |                    |          |                    | 214    |       
|                                                                                          | Loss on extinguishment of debt               |                                             |                                                     | 2,115  |                    |          |                    |       |       
|                                                                                          | Change in:                                   |                                             |                                                     |        |                    |          |                    |        |       
|                                                                                          |                                              | Accounts and other receivables              |                                                     |        | (1,530             | )        |                    |        | (911   | )      
|                                                                                          |                                              | Other assets                                |                                                     |        | 962                |          |                    |        | (2,692 | )      
|                                                                                          |                                              | Accounts payable and other accrued expenses |                                                     |        | (720               | )        |                    |        | (888   | )      
|                                                                                          |                                              | Other liabilities                           |                                                     |        | (647               | )        |                    |        | (160   | )      
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|                                                                                          |                                              |                                             | Net cash provided by (used in) operating activities |        |                    | (4,025   | )                  |        |        | 3,397   |  
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|Cash flows from investing activities:                                                     |                                              |                                             |                                                     |        |                    |          |                    |       
|Proceeds from sales of hotels                                                             |                                              |                                             | 145,000                                             |        |                    |          | 28,850             |       
|Refund of guaranty deposit                                                                |                                              |                                             | 10,452                                              |        |                    |          | 3,050              |       
|Cash paid for security deposits                                                           |                                              |                                             | (16,000                                             | )      |                    |          | (3,752             | )     
|Change in hotels completed and under construction                                         |                                              |                                             | (7,982                                              | )      |                    |          | (3,034             | )     
|Distributions from joint ventures                                                         |                                              |                                             | 200                                                 |        |                    |          | 1,250              |       
|Purchase of intangible assets                                                             |                                              |                                             | (220                                                | )      |                    |          | (53                | )     
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|                                                                                          |                                              |                                             | Net cash provided by investing activities           |        |                    | 131,450  |                    |        |        | 26,311  |  
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|Cash flows from financing activities:                                                     |                                              |                                             |                                                     |        |                    |          |                    |       
|Proceeds from mortgages and notes payable                                                 |                                              |                                             | 59,660                                              |        |                    |          | 5,642              |       
|Payments on mortgages and notes payable                                                   |                                              |                                             | (192,172                                            | )      |                    |          | (27,297            | )     
|Preferred stock dividends                                                                 |                                              |                                             |                                                    |        |                    |          | (6,024             | )     
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|                                                                                          |                                              |                                             | Net cash used in financing activities               |        |                    | (132,512 | )                  |        |        | (27,679 | )
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|Net increase (decrease) in cash and cash equivalents                                      |                                              |                                             | (5,087                                              | )      |                    |          | 2,029              |       
|Cash and cash equivalents at beginning of period                                          |                                              |                                             | 17,966                                              |        |                    |          | 21,834             |       
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|Cash and cash equivalents at end of period                                                |                                              | $                                           | 12,879                                              |        |                    | $        | 23,863             |       
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       
|Supplementary disclosure of cash flow information:                                        |                                              |                                             |                                                     |        |                    |          |                    |       
|Cash paid for interest                                                                    |                                              | $                                           | 6,794                                               |        |                    | $        | 14,818             |       
|                                                                                          |                                              |                                             |                                                     |        |                    |          |                    |       

See accompanying notes.

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##### Table of Contents



CANDLEWOOD HOTEL COMPANY, INC. AND SUBSIDIARIES




NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Summary of Significant Accounting Policies



|A. |  | Organization and Basis of Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Companys current business of operating, franchising, owning and
managing extended-stay hotels originated in November 1995, with the
formation of Candlewood Hotel Company, L.L.C., a Delaware limited liability
company (Candlewood LLC). The Company was incorporated in the State of
Delaware in August 1996, and in November 1996, the Company succeeded to the
business of Candlewood LLC and completed an initial public offering of its
common stock (collectively, the Reorganization).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|  
|   |  | The accompanying unaudited consolidated financial statements of
Candlewood Hotel Company, Inc. (the Company) have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission for
reporting on Form 10-Q. The statements include the accounts of Candlewood
Hotel Company, Inc. and its subsidiaries, including Candlewood LLC, which
was the entity through which business was conducted until completion of the
Reorganization, and various wholly-owned LLCs which own or lease certain
hotels. Accordingly, certain information and footnotes required by
generally accepted accounting principles for complete financial statements
have been omitted. The accompanying unaudited financial statements contain
all adjustments, which the Company believes are necessary for the fair
presentation of the Companys financial position and results of operations.
The condensed consolidated balance sheet data at December 31, 2001 was
derived from the Companys audited financial statements. The interim
financial statements should be read in conjunction with the Companys 2001
Annual Report on Form 10-K filed with the Securities and Exchange
Commission. The results of operations for interim periods are not
necessarily indicative of the results that may be expected for future
periods or the entire year. The preparation of financial statements in
conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and the accompanying notes. Actual results could
differ from those estimates.
|  
|   |  | All majority-owned subsidiaries have been consolidated into the
unaudited consolidated financial statements. All intercompany transactions
have been eliminated.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|B. |  | Investment in Hotels                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   |  | Hotels Completed                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | Hotels completed are stated at cost and include the related furniture,
fixtures and equipment. Once the Hotels are completed, depreciation is
computed using the straight-line method over the estimated useful lives of
the assets, ranging from three to forty years. Maintenance and repairs are
charged to operations as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | In August 2001, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which is effective for fiscal
years beginning after December 15, 2001. The Company evaluates hotels for
impairment when conditions indicate that it is probable that the sum of the
expected future cash flows is less than the carrying value of the hotels.
Upon determination that a hotel has been impaired, the carrying value of the
hotel is reduced to fair value less costs to sell. For the nine-months
ended September 30, 2002, the Company has recorded an impairment loss of
$8.6 million, all of which was                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|   |  | recorded in the first quarter of 2002. As of September 30, 2002, no
permanent impairment conditions exist at any of the Companys hotels.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|C. |  | Cash Equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | The Company considers all highly liquid assets with a maturity of three
months or less when purchased to be cash equivalents.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  
|D. |  | Restricted Cash                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|   |  | Restricted cash represents cash that, under the terms of certain loan
agreements, has been set aside as a condition of loan financing. These
funds, which are held by the lenders, will be released to the Company upon
achievement of certain operating criteria, as defined in the loan
agreements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|E. |  | Fair Value of Financial Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|  
|   |  | The carrying values of the Companys financial instruments, which
include cash and cash equivalents, accounts receivable, accounts payable and
accrued expenses, approximate fair values due to the short maturities of
such instruments. The fair value of the Companys long-term debt, which
approximates carrying value, is estimated based on the current rates offered
to the Company for debt of the same remaining maturities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  
|F. |  | Derivative Financial Instruments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | In April 2002, the Company purchased an interest rate cap as part of
the refinancing of mortgage debt with GMAC to manage interest rate risk.
This is the first time the Company has purchased a derivative financial
instrument. The Company requires that hedging derivative instruments are
effective in reducing the interest rate risk exposure as they are
designated. This effectiveness is essential for qualifying for hedge
accounting available for only certain qualifying derivative instruments.
Instruments that meet these hedging criteria are formally designated as
hedges at the inception of the derivative contract. When the terms of an
underlying transaction are modified, or when the underlying hedged item
ceases to exist, all changes in the fair value of the instrument are
marked-to-market with changes in value included in net income each period
until the instrument matures, is terminated, or assigned. Any derivative
instrument used for risk management that does not meet the hedging criteria
is marked-to-market through earnings each period.
|  
|   |  | To determine the fair values of derivative instruments, the Company
uses a variety of methods and assumptions that are based on market
conditions and risks existing at each balance sheet date. For the majority
of financial instruments including most derivatives, standard market
conventions and techniques such as discounted cash flow analysis, option
pricing models, replacement cost, and termination cost are used to determine
fair value. All methods of assessing fair value result in a general
approximation of value, and such value may never actually be realized.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | As of September 30, 2002, the Company had one derivative financial
instrument, an interest rate cap, which was recorded at fair value with the
change in fair value since the purchase date recorded in other comprehensive
income in the equity section of the balance sheet.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

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|G. |  | Intangible Assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | Intangible assets include ownership rights, title and interest in the
Candlewood Hotel name, costs for patents and trademarks and costs to obtain
franchise agreements. These assets are being amortized using the
straight-line method over a period of ten to twenty years and are included
in other assets on the accompanying consolidated balance sheets. In 2001,
the Company adopted SFAS 142, Goodwill and Other Intangible Assets, upon
its effective date. The adoption did not have an effect on the earnings or
the financial position of the Company.
|  
|H. |  | Deferred Financing Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|  
|   |  | Deferred financing costs are costs incurred to obtain construction and
permanent financing and are included in other assets on the accompanying
consolidated balance sheets. These costs are amortized over the life of the
related loan on a method which approximates the level yield basis.                                                                                                                                                                                                                                                                      
|  
|I. |  | Revenue Recognition                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|  
|   |  | Room revenue and other revenues are recognized when earned.
Recognition of franchise fee revenue is deferred until all material services
or conditions relating to the respective franchise have been substantially
performed or satisfied by the Company. Such revenue, when recognized, is
included in other income on the accompanying consolidated statements of
operations.                                                                                                                                                                                    
|  
|   |  | The Companys sales of hotels have been accompanied by a leaseback of
the facilities under operating lease agreements. Such sales are recognized
when the title passes to the buyer, generally upon the receipt of proceeds.
Related profit is deferred due to required support obligations under the
operating lease agreements until operations meet stipulated levels. At such
time, the deferred gain is recognized in earnings over the remaining lease
term.                                                                                                  
|  
|J. |  | Advertising                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|   |  | Advertising costs are expensed as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  
|K. |  | Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|  
|   |  | The Company is taxed as a corporation as defined in subchapter C
under the Internal Revenue Code for federal and state income tax purposes
and accounts for any temporary differences under the asset and liability
method.                                                                                                                                                                                                                                                                                                                                       
|  
|L. |  | Opening and Organization Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|  
|   |  | Opening costs are costs incurred prior to the opening of a hotel and
include costs related to hiring and training of hotel personnel, such as
travel, compensation and relocation. Organization costs relate to the
formation of the Company and Subsidiaries. Such costs are expensed as
incurred.                                                                                                                                                                                                                                                                 
|  
|M. |  | Investments in Joint Ventures                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  
|   |  | The Company has certain investments in joint ventures in which it owns
50% or less of the voting equity that it accounts for under the equity
method of accounting.                                                                                                                                                                                                                                                                                                                                                                                                 

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|N. |  | Segment Reporting                                                                                                                                                                                                                    
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|   |  | The Company has two reportable segments, the operation of hotels and
the sale of hotels. Information related to the Companys reportable
segments for the nine-months ended September 30, 2002 and 2001,
respectively, is as follows:

|                                     |                                         |              |        |         |        |   |        |       |  |   |        |         | 
|------------------------------------ | --------------------------------------- | ------------ | ------ | ------- | ------ | - | ------ | ----- |  | - | ------ | ------- | 
|Nine-months ended September 30, 2002 |                                         |              |        |         |        |   |        |       |  |   |        |        
|(In thousands)                       |                                         | Operation of |        | Sale of |        |   |        |      
|                                     |                                         |              | Hotels |         | Hotels |   | Total 
|                                     |                                         |              |        |         |        |   |       
|Revenues from external customers     |                                         | $            | 96,987 |         |        | $ |       |       |  | $ | 96,987 |        
|Interest expense                     |                                         |              | 6,127  |         |        |   |       |       |  |   | 6,127  |        
|Depreciation expense                 |                                         |              | 4,363  |         |        |   |       |       |  |   | 4,363  |        
|Segment profit                       |                                         |              | (3,061 | )       |        |   | 1,044  |       |  |   | (2,017 | )      
|Hotels assets:                       |                                         |              |        |         |        |   |        |       |  |   |        |        
|                                     | Hotels completed and under construction |              |        | 100,182 |        |   |        |      |  |   |        | 100,182 | 
|                                     | Accounts receivable                     |              |        | 754     |        |   |        | 4,750 |  |   |        | 5,504   | 
|Deferred gain on sale of hotels      |                                         |              |       |         |        |   | 26,403 |       |  |   | 26,403 |        

|                                     |                                         |              |         |         |  |       |        |       |  |   |         |         | 
|------------------------------------ | --------------------------------------- | ------------ | ------- | ------- |  | ----- | ------ | ----- |  | - | ------- | ------- | 
|Nine-months ended September 30, 2001 |                                         |              |         |         |  |       |        |       |  |   |         |        
|(In thousands)                       |                                         | Operation of |         | Sale of |  |       |        |      
|                                     |                                         | Hotels       |         | Hotels  |  | Total
|                                     |                                         |              |         |         |  |       |       
|Revenues from external customers     |                                         | $            | 100,888 |         |  | $     |       |       |  | $ | 100,888 |        
|Interest expense                     |                                         |              | 13,467  |         |  |       |       |       |  |   | 13,467  |        
|Depreciation expense                 |                                         |              | 8,302   |         |  |       |       |       |  |   | 8,302   |        
|Segment profit                       |                                         |              | 3,891   |         |  |       | 1,049  |       |  |   | 4,940   |        
|Hotels assets:                       |                                         |              |         |         |  |       |        |       |  |   |         |        
|                                     | Hotels completed and under construction |              |         | 262,131 |  |       |        |      |  |   |         | 262,131 | 
|                                     | Accounts receivable                     |              |         | 2,397   |  |       |        | 2,855 |  |   |         | 5,252   | 
|Deferred gain on sale of hotels      |                                         |              |        |         |  |       | 17,240 |       |  |   | 17,240  |        



|   |  | The difference between segment profit and net income is corporate expenses
not specific to the Companys reportable segments.                                                                                                                                                                                                                                                                                                 
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|O. |  | Use of Estimates                                                                                                                                                                                                                                                                                                                                                                                                              
|  
|   |  | The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from such estimates.
|  
|P. |  | Reclassifications                                                                                                                                                                                                                                                                                                                                                                                                             
|  
|   |  | Certain reclassifications of prior period amounts have been made to
conform to the current period presentation. Such reclassifications have no
effect on the Companys operations or equity as originally presented.                                                                                                                                                                                                          

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Note 2: Mortgages and Notes Payable

As of September 30, 2002, a wholly-owned subsidiary of the Company (the
Subsidiary) had entered into a loan agreement with GMAC Commercial Mortgage
Corporation. This Subsidiary owns 10 of the Companys hotels. Interest on the
loan is payable monthly, in arrears, on the first day of the calendar month.
Interest is calculated at a variable rate per annum, adjusted monthly, at a
rate equal to the 30-day LIBOR rate plus 4.25% (7.75% as of September 30,
2002). The debt has a LIBOR interest rate floor of 3.50%. As a result, the
Companys interest rate on this debt cannot go below 7.75%. Interest is
payable monthly and the principal amount of the loan is payable monthly
beginning in May 2003 and is calculated based on a 25-year amortization
schedule using the prevailing interest rate as defined in the note. The loan
matures in May 2005 and provides for one 12-month extension. Amounts borrowed
under the loan agreement are secured by the 10 hotels, the land on which the
hotels are constructed and certain funds deposited in demand deposit accounts
assigned to GMAC. The Company and certain other of the Companys wholly-owned
subsidiary LLCs guarantee the loan. At September 30, 2002, $55.0 million was
outstanding under this loan agreement.

In April 2002, the Company purchased an interest rate hedge to cap the
30-day LIBOR interest rate on the GMAC note. The interest rate is capped at
7.50% and the cap expires in May 2005 concurrent with the maturity of the note.
Accordingly, the maximum interest rate throughout the term of the GMAC note
cannot exceed 11.75% (7.50% LIBOR plus 4.25%). On September 30, 2002, the
derivative instrument was reported at its fair value as Other Assets of
approximately $49,000. During the quarter ended September 30, 2002, an
adjustment of approximately $85,000 to Other Comprehensive Income was made for
the change in fair value of this cap. Over time, the unrealized gain or loss
held in accumulated Other Comprehensive Income will be reclassified to
earnings. This reclassification is consistent with when the hedged items are
also recognized in earnings. Within the next twelve months, the Company does
not expect a material amount currently held in accumulated other comprehensive
income to be reclassified to earnings.

The Company has also entered into a loan agreement with a financial
institution for the financing of one of the Companys hotels. Interest on
the loan is payable monthly, in arrears, beginning on the first full calendar
month after the date of the agreement. Interest payments are calculated at a
fixed rate based off the 10-year Treasury note at the time the loan was closed
plus 3.08% (8.30% as of September 30, 2002). Principal payments commenced the
month following loan closing and are calculated based on a 22.5-year
amortization schedule using the prevailing interest rate as defined in the
note. The note matures in June 2011. The loan amount borrowed is secured by
the hotel and the land on which the hotel is constructed, certain funds
deposited in a demand deposit account assigned to the bank, as well as a
guarantee by the Company and certain other of the Companys wholly-owned
subsidiary LLCs. At September 30, 2002, approximately $3.9 million was
outstanding under this note.

In April 2002, the Financial Accounting Standards Board issued Statement
No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections, which rescinded FASB No. 4
requiring gains and losses from extinguishment of debt to be classified as
extraordinary. During the nine-months ended September 30, 2002, the Company
extinguished a significant portion of its debt and recorded a loss of
approximately $2.1 million. The Company has adopted Statement No. 145 and has
classified this loss as an operating expense.

Note 3: Investments in Joint Ventures

As of September 30, 2002, the Companys net investment in joint ventures
is approximately $13.7 million. The difference between the amount at which the
investment is carried in the Companys accounting records and the amount of the
underlying equity in the net assets of the investee is amortized into income
from joint ventures over the contractual life of the respective joint venture
entity. As of September 30, 2002, this amount was approximately $3.5 million
and is included in investments in joint ventures on the accompanying
consolidated balance sheets. For the quarters ended September 30, 2002

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and 2001, equity income in joint ventures of approximately $439,000 and
$256,000, respectively, was recorded before recognition of the carrying value
difference of approximately ($464,000) and ($345,000), respectively. These
amounts are included in other income on the accompanying consolidated
statements of operations. During the quarter ended September 30, 2002, the
Company received distributions from its joint ventures of $200,000. There were
no distributions made to the Company during the quarter ended September 30,
2001.

The Company has one significant joint venture that was formed in 1999 with
Boston Capital Institutional Advisors (Boston Capital) and Mass Mutual in
which the Company has a 50% ownership interest. Hotel operations for the joint
venture commenced in 2000, and as of September 30, 2002, the Company operated
eight hotels pursuant to this agreement. Under the terms of the agreement, if
the Company did not have at least 10 hotels open or under construction by
August 31, 2000, it may be required to increase its capital contributions
relating to existing joint venture hotels by up to 5% of the estimated total
costs. In June 2002, the Companys joint venture partners notified the Company
that it would be required to make this additional equity contribution on or
before July 25, 2002. The Company did not make this contribution. Based upon
the contributions to date and the calculations as outlined in the agreement, as
of September 30, 2002, the amount of the additional contribution was estimated
at approximately $3.4 million. In August 2002, the Companys non-payment of
the additional equity contribution prompted a notice of default from the joint
venture partners. As a result of this default and in accordance with the joint
venture agreement, the joint venture has suspended payment of franchise royalty
and management fees to the Company pending resolution of this matter. In
addition, per the agreement, the interest rate on the joint venture debt to
Boston Capital and Mass Mutual has increased from 12.0% to 21.0%. The
suspension of royalty and management fees and the increased interest rate on
the debt will be lifted upon the successful cure of the default. The Company
and Boston Capital and Mass Mutual have reached a tentative agreement with
regards to the amount of the additional equity contribution whereby the Company
would contribute $1.8 million to the joint venture and Boston Capital and Mass
Mutual would waive contractual rights to the $1.6 million balance. However, we
cannot provide any assurance that a final agreement will be reached on these
terms or at all. As of September 30, 2002, $1.8 million has been accrued and
recorded as an investment in joint ventures. The Company is otherwise in
compliance with the terms of the joint venture agreement. The following is
unaudited condensed financial information for the joint venture as of September
30, 2002 and 2001:

|                                        |  |      |        |      |  |   |        | 
|--------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | 
|September 30,                           |  | 2002 |        | 2001
|(In thousands)                          |  |      |        |     
|Hotels completed and under construction |  | $    | 74,963 |      |  | $ | 76,896 | 
|Other assets                            |  |      | 5,357  |      |  |   | 5,950  | 
|                                        |  |      |        |      |  |   |        | 
|Total assets                            |  | $    | 80,320 |      |  | $ | 82,846 | 
|                                        |  |      |        |      |  |   |        | 
|Total development liabilities           |  | $    | 74,027 |      |  | $ | 75,305 | 
|Total equity                            |  |      | 6,293  |      |  |   | 7,541  | 
|                                        |  |      |        |      |  |   |        | 
|Total liabilities and equity            |  | $    | 80,320 |      |  | $ | 82,846 | 
|                                        |  |      |        |      |  |   |        | 

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|                                |  |      |        |      |  |   |        | 
|------------------------------- |  | ---- | ------ | ---- |  | - | ------ | 
|Nine-months ended September 30, |  | 2002 |        | 2001
|(In thousands)                  |  |      |        |     
|Total revenue                   |  | $    | 15,472 |      |  | $ | 15,496 | 
|Hotel operating expenses        |  |      | 8,213  |      |  |   | 7,520  | 
|Hotel opening costs             |  |      |       |      |  |   | 150    | 
|Depreciation and amortization   |  |      | 2,234  |      |  |   | 2,080  | 
|Interest expense                |  |      | 4,378  |      |  |   | 4,592  | 
|                                |  |      |        |      |  |   |        | 
|Net pre-tax (loss) income       |  | $    | 647    |      |  | $ | 1,154  | 
|                                |  |      |        |      |  |   |        | 

As of September 30, 2002, the Company has guaranteed approximately $55.9
million of mortgage debt on the joint venture properties. This debt is
collateralized by the hotels, the land on which the hotels are constructed and
certain funds deposited in demand deposit accounts assigned to the respective
banks. Maturity dates on this debt range from May 2003 to January 2008 with
certain notes providing extensions for up to two years under specific criteria
including loan to value ratios. This debt is not included in the Companys
consolidated financial statements (See Note 2) and the Company does not receive
any fees related to this guarantee.

Note 4: Redeemable, Convertible, Cumulative Preferred Stock

General

The Company has authorized blank check preferred stock in the amount of
5,000,000 shares at $.01 par value per share. The stock may be issued with
such voting powers and such designations, preferences, privileges and other
special rights as designated by the Board of Directors. At the date of
issuance of any of the preferred stock, the Company determines whether the
stock is redeemable and the appropriate classification of the stock on the
balance sheet. At September 30, 2002, as more fully described below, the
Company had 65,000 and 42,000 shares, respectively, of Series A and Series B
redeemable preferred stock issued and outstanding.

Preferred Stock Offerings

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

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

The Series A and Series B Preferred Stock accumulate dividends at a rate
of 7.5% with dividend payments made quarterly, upon approval of the board of
directors, and in preference to any dividend on the Companys Common Stock.
These payments are approximately $2.0 million per quarter. The Company has not
made the last four scheduled preferred stock dividend payments. Pursuant to
the provisions of the certificate of designation for the Series A and Series B
Preferred Stock, the conversion price (i.e. the price at which the Preferred
Stock may convert into Common Stock) was reduced in August 2002 to $8.00 per
share to reflect the Companys decision to forego payment of its May 2002 and
August 2002 preferred stock dividend payment and the grant of new employee
stock options. The Company intends to assess its cash position on a quarterly
basis and will likely elect to forego additional scheduled dividend payments on
the preferred stock. As of September 30, 2002, the Company had approximately
$8.0 million of accumulated unpaid dividends in arrears, which have been
accrued and recorded as an increase to the carrying amount of the Series A and
Series B preferred stock. A failure to make future dividend payments will
result in a further reduction in the conversion price of the Preferred Stock
and, in

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the case of the Series B Preferred Stock, may result in a future
adjustment to the dividend rate to 12%.

Pursuant to a mandatory redemption clause in the Certificates of
Designation for the Series A and Series B Cumulative Convertible Preferred
Stock, the Company is required to redeem the Series A and Series B Preferred
Stock in September 2004. The mandatory redemption amount is equal to $107
million plus unpaid dividends. As of September 30, 2002, the mandatory
redemption amount was approximately $115.0 million. If the Company fails to
redeem the Preferred Stock when due, it will be required to issue to each
holder of Preferred Stock on such date, and on each three month anniversary
thereafter, warrants to purchase 25% of the number of shares of Common Stock
into which such holders outstanding shares of Preferred Stock would be
convertible on such date. The warrants would be immediately exercisable at a
purchase price of $.01 per share of Common Stock.

In the event the Company liquidates, the holders of the Series A and
Series B Preferred Stock are entitled to receive a payment equal to the stated
value of their shares, plus any accrued but unpaid dividends (the Liquidation
Amount), prior to any distribution or payment to the holders of the Common
Stock. As of September 30, 2002, the Liquidation Amount was $115.0 million,
including $8.0 million of unpaid dividends. Alternatively, the holders of the
Series A and Series B Preferred Stock may convert any or all of their shares
into shares of Common Stock. In the event of a corporate transaction that
constitutes a change of control, the Company is required to offer to redeem all
of the outstanding shares of Series A and Series B Preferred Stock for a price
equal to the greater of the Liquidation Amount or 175% of the stated value of
the shares. As of September 30, 2002, one hundred seventy five percent of the
stated value of the shares was $187.3 million. If the Company does not redeem
the Preferred Stock upon a change of control, the conversion price of the
Preferred Stock will be reduced to the lower of the then applicable conversion
price or the market price of the Common Stock on the redemption date divided by
1.75, provided that the conversion price will not be reduced to an amount less
than the par value of the Common Stock.

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

The carrying amount of the redeemable preferred stock is being increased
by periodic accretions using the interest method, so that the carrying amount
will equal the mandatory redemption amount at the mandatory redemption date.
For the quarter ended September 30, 2002, approximately $461,000 was recorded
as an increase to the carrying value of the preferred stock.

Note 5: Sale / Leaseback

As of September 30, 2002, the Company had completed four separate
sale-leaseback transactions with Hospitality Properties Trust (HPT). In
April 2002, the Company sold 21 hotels for a sale price of $145 million. As of
September 30, 2002, the Company has sold 57 hotels to HPT for an aggregate
sales price of $434.8 million.

Terms of the HPT sales agreement were all cash at the close of escrow for
each hotel sold. Each of the hotels sold has been leased back to a wholly
owned subsidiary of Candlewood pursuant to the terms of a master operating
lease agreement executed in April 2002, which superceded the previous operating
lease (the previous lease). This lease expires in December 2018 and may be
renewed in certain circumstances and at the election of the Company for up to
three 15-year periods. The lease calls for monthly lease payments of
approximately $3.8 million and requires the Company to place a security deposit
with HPT for each property equal to one years lease payments. The security
deposit will be released to the Company at the end of the lease term.

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The previous lease agreement provided for the Company to guarantee the
payment of rent until defined operating cash flows exceed the annual lease
payments by 150% for 12 consecutive months. In connection with this
obligation, the Company was required to place deposits with HPT equal to
approximately 5% of the sales price, upon the initial closing of each
transaction. These deposits were charged to cost of sales as the hotels were
sold. As part of the newly executed lease, the Company was refunded the $10.1
million remaining balance of the guaranty deposit, which was recorded as an
additional deferred gain on sale of hotels and will be recognized as income
over the remaining lease term. In addition, the new lease requires the Company
to guarantee the payment of rent for the duration of the lease.

In total, as of September 30, 2002, the Company had sold 57 hotels for
$434.8 million of hotels with a total deferred gain of $32.8 million, which
includes the return of the guaranty deposits to the Company. Such gain has
been deferred and is being recognized in income as noted in the Companys
accounting policies (Note 1). For the quarters ended September 30, 2002 and
2001, respectively, the Company recognized approximately $406,000 and $357,000
of deferred gain into income. As of September 30, 2002, the Company has
recognized a total of $6.4 million of deferred gain into income. Sale
proceeds, net of the deferred gain and related cost of the hotels sold are
presented on the consolidated statements of operations.

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Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

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

General

Candlewood operates, franchises, owns and manages Candlewood Suites and
Cambridge Suites hotels (Candlewood hotels) to serve extended-stay business
and personal travelers. At December 31, 2001, we had a total of 76
company-operated hotels (which is comprised of owned, leased and joint venture
hotels), 27 franchised hotels and two managed hotels located in 34 states. At
September 30, 2002, we had a total of 77 company-operated hotels, 29 franchised
hotels and two managed hotels located in 34 states. In addition, at September
30, 2002, we had six franchise hotels under construction and 20 franchise
agreements for hotels not yet under construction, which are subject to a
variety of conditions. We are actively marketing management contracts to
existing and prospective franchisees to utilize our management experience and
expertise to manage their hotels.

We classify our hotels into five categories: owned, leased, managed,
joint venture and franchised. Owned hotels are those hotels that we have
independently developed and own. Leased hotels are those hotels that we
currently lease from a third party and operate. Managed hotels are those
hotels that we manage for a third party, but do not lease or own. Joint
venture hotels are those hotels that we developed and own with our joint
venture partners. Franchised hotels are those hotels developed and owned by
third parties that utilize one of our franchise brands, Candlewood Suites or
Cambridge Suites. The following tables set forth our property portfolio at
September 30, 2002 and September 30, 2001:

|              |       |  |                  |     |           |  |            |     |                 |  |      |   |            |  |       |        |  |  |       |        |  |  |        |     | 
|------------- | ----- |  | ---------------- | --- | --------- |  | ---------- | --- | --------------- |  | ---- | - | ---------- |  | ----- | ------ |  |  | ----- | ------ |  |  | ------ | --- | 
|              |       |  | Number of Hotels |     |           |  |            |     | Number of Rooms |  |      |   |           
|              |       |  | September 30,    |     |           |  |            |     | September 30,   |  |      |   |           
|              |       |  |                  |     | Increase/ |  |            |     | Increase/      
|              |       |  | 2002             |     | 2001      |  | (Decrease) |     | 2002            |  | 2001 |   | (Decrease)
|              |       |  |                  |     |           |  |            |     |                 |  |      |   |           
|Owned         |       |  | 11               |     |           |  | 31         |     |                 |  | (20  | ) |            |  | 1,300 |        |  |  | 3,786 |        |  |  | (2,486 | )  
|Leased        |       |  | 57               |     |           |  | 36         |     |                 |  | 21   |   |            |  | 6,888 |        |  |  | 4,292 |        |  |  | 2,596  |    
|Managed       |       |  | 2                |     |           |  | 2          |     |                 |  |     |   |            |  | 203   |        |  |  | 179   |        |  |  | 24     |    
|Joint Venture |       |  | 9                |     |           |  | 9          |     |                 |  |     |   |            |  | 1,159 |        |  |  | 1,159 |        |  |  |       |    
|Franchised    |       |  | 29               |     |           |  | 26         |     |                 |  | 3    |   |            |  | 2,959 |        |  |  | 2,637 |        |  |  | 322    |    
|              |       |  |                  |     |           |  |            |     |                 |  |      |   |            |  |       |        |  |  |       |        |  |  |        |    
|              | Total |  |                  | 108 |           |  |            | 104 |                 |  |      | 4 |            |  |       | 12,509 |  |  |       | 12,053 |  |  |        | 456 | 

At September 30, 2002, we managed two hotels, which are independently
owned by our Chief Executive Officer, the Cambridge Suites by Candlewood and
the Hotel at Old Town, both located in Wichita, Kansas. Our revenues for
managing these hotels consist primarily of management fees that are based on a
percentage of gross revenues, operating profits, cash flow or a combination
thereof. These revenues are included in other income in our consolidated
statements of operations. In the management of these hotels, we have in the
past advanced funds and paid expenses on behalf of the hotels.

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

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We have sold and leased back 57 hotels to Hospitality Properties Trust
(HPT). The provisions of the transactions allow us to operate, as lessee,
over a defined lease term, hotels that we developed. Our results from
operations reflect these transactions. As a result of the sale-leaseback
transactions, we have recorded rent expense on the hotels leased back from HPT.
Since these hotels are leased and not owned, the financial statements do not
reflect any depreciation and amortization or interest expense for these hotels
after the date of sale. The proceeds from the sales of the hotels is recorded
net of the deferred gain on sale. The gain is deferred and not recognized into
earnings until certain operating performance levels are achieved. See Note 5 to
Consolidated Financial Statements.

Critical Accounting Policies and Estimates

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

Impairment of Long-Lived Assets

We periodically evaluate our long-lived assets, including our investments
in real estate for impairment indicators. The judgments regarding the
existence of impairment indicators are based on factors such as operational
performance, market conditions and legal factors. Future events could occur
which would cause us to conclude that impairment indicators exist and an
impairment loss is warranted.

Depreciation of Investment in Hotels

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

Fair Value of Financial Instruments including Derivative Financial
Instruments

The valuation of financial instruments under SFAS No. 107 and derivative
financial instruments under SFAS No. 133 requires us to make estimates and
judgments that affect the fair value of the instruments. Where possible, we
base the fair values of our financial instruments on listed market prices and
third party quotes. Where these are not available, we base our estimates on
other factors relevant to the financial instrument.

Results of Operations

Comparison of fiscal quarters ended September 30, 2002 and September 30, 2001

Hotel Operations

Hotel Operations Revenue

Hotel operations revenue, which includes room revenue and other revenue
(e.g. guest telephone and sales of products from the Candlewood Cupboard), was
$32.5 million for the quarter ended September 30, 2002, compared to $33.5
million for the quarter ended September 30, 2001. The decrease in revenue is a
result of reduced average daily room rates, which were prompted as a result of
pricing competition caused by the slowdown in the economy and a reduction in
business travel. The following table sets forth the operating statistics for
all our corporate hotels for the quarters ended September 30, 2002 and
September 30, 2001:

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|                           |  |                       |       |      |  |        |       |   |  |   |       |  
|-------------------------- |  | --------------------- | ----- | ---- |  | ------ | ----- | - |  | - | ----- | -
|                           |  | For the quarter ended |       |      |  |       
|                           |  | September 30,         |       |      |  |       
|                           |  |                       |       |      |  |       
|                           |  | 2002                  |       | 2001 |  | Change
|                           |  |                       |       |      |  |       
|Occupancy                  |  |                       | 77.7  | %    |  |        | 76.4  | % |  |   | 1.3   | %
|Average Daily Rate         |  | $                     | 53.85 |      |  | $      | 57.15 |   |  | $ | (3.30 | )
|Revenue per available room |  | $                     | 41.86 |      |  | $      | 43.66 |   |  | $ | (1.80 | )

Average occupancy rate, which is determined by dividing the number of
guestrooms occupied on a daily basis by the total number of guestrooms
available for the period, was 77.7% for the quarter ended September 30, 2002,
compared to 76.4% for the quarter ended September 30, 2001. Our focus in 2002
has been to improve or maintain occupancy at our hotels by marketing to
long-term extended-stay guests, particularly those staying seven or more
nights. Occupancy rates for the quarter ended September 30, 2001 were
negatively impacted by the slowdown in the economy and to a lesser extent the
attacks on the World Trade Center.

The average daily room rate for corporate hotels for the quarter ended
September 30, 2002 was $53.85, compared to $57.15 for the quarter ended
September 30, 2001. Average daily room rates are determined by dividing room
revenue by the number of guestrooms occupied on a daily basis for the
applicable period. The decrease in the average daily rate for the quarter
ended September 30, 2002 is primarily a result of our commitment to improve or
maintain occupancy at our hotels by targeting long-term extended-stay business,
which is charged at a lower daily rate, and adjusting rates in todays
competitive environment. Other factors that influence average daily room rates
include higher rates for our one-bedroom suites and higher rates in certain
hotel locations. It is our practice to continuously review individual markets
to assess the impact of competition on local supply and demand and establish
room rates that balance occupancy in an attempt to maximize revenue.

Revenue per available room (RevPAR), calculated as the average occupancy
rate multiplied by the average daily rate, was $41.86 for the quarter ended
September 30, 2002, compared to $43.66 for the quarter ended September 30,
2001, a 4.1% decrease.

Hotel Operating Expenses

Hotel operating expenses for the quarter ended September 30, 2002 totaled
$20.2 million, compared to $19.6 million for the quarter ended September 30,
2001. Hotel operating expenses consist of all expenses directly applicable to
the operation of the hotels, including corporate allocations for various
operating, marketing and accounting functions. The largest portion of hotel
operating expenses consisted of salaries, wages and fringe benefits. The
balance of hotel operating expenses was comprised of normal operating items,
such as utilities, property taxes, insurance, supplies, promotional materials,
maintenance items and similar expenses. The increase in hotel operating
expenses is largely due to increased wages, media advertising, promotional
costs associated with sales promotions, operating costs for one additional
hotel acquired in March 2002 and higher maintenance and insurance costs.

Rent Expense on Leased Hotels

Rent expense on the 57 leased hotels for the quarter ended September 30,
2002 was $11.5 million, compared to $6.8 million for the quarter ended
September 30, 2001. Rent expense is comprised of two elements, a base fixed
rent and a contingent rent. Contingent rent expense is a variable expense
based on a property achieving improved year over year revenue growth and is
calculated on an individual property basis. The increase in rent expense is
due to an increase in base rent as a result of the sale and leaseback of the 21
additional hotels in April 2002.

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Hotel Depreciation and Amortization

Depreciation and amortization expense applicable to hotel operations
(e.g., building, furniture, fixtures and equipment) for the quarter ended
September 30, 2002 totaled $955,000, compared to $3.0 million for the quarter
ended September 30, 2001. The decrease in depreciation and amortization
expense is the result of the sale and lease back of 21 hotels in April 2002.
We do not record depreciation and amortization expense for properties that have
been sold and leased back.

Corporate Operations

Other Income

Other income for the quarter ended September 30, 2002 totaled $778,000,
compared to $1.1 million for the quarter ended September 30, 2001. Other
income consists primarily of royalty fees (revenue-based fees received over the
life of the franchise agreement), franchise fees (a one-time fee received upon
execution of a signed franchise agreement), management fees and joint venture
equity income. Equity income represents our share of the profits of
unconsolidated joint venture hotels.

Franchise fee income (including application and royalty fees) for the
quarter ended September 30, 2002 totaled $631,000, compared to $836,000 for the
quarter ended September 30, 2001. Management fee income for the quarter ended
September 30, 2002 totaled $173,000, compared to $350,000 for the quarter ended
September 30, 2001. The decrease in franchise fee and management fee income is
due to the suspension of royalty and management fee payments from the Boston
Capital joint venture hotels. See Liquidity and Capital Resources. For
the quarter ended September 30, 2002, we recorded a loss of ($25,000) on our
joint venture hotels, compared to ($88,000) for the quarter ended September 30,
2001. This loss is due to the reduced profitability of the joint venture
hotels as a result of the slowdown in the economy and the reduction in business
travel and the amortization of the difference between the amount at which the
Boston Capital joint venture investment is carried on our accounting records
and the amount of the underlying book equity in the net assets of the joint
venture. This difference is primarily comprised of carrying costs incurred
from the time we purchased the land until the hotel was contributed to the
joint venture.

We did not sell any hotels during the quarter ended September 30, 2002,
but recognized $406,000 of the total deferred gain on hotels sold in prior
periods. We sold two hotels during the quarter ended September 30, 2001 and
recognized $357,000 of the total deferred gain on hotels sold.

Corporate Operating Expenses

Corporate operating expenses for the quarter ended September 30, 2002
totaled $1.3 million, compared to $1.5 million for the quarter ended September
30, 2001, and included all expenses not directly related to the development or
operations of specific hotels. The largest portion of corporate operating
expenses consisted of salaries, wages and fringe benefits. The balance of
other corporate operating expenses was comprised of normal operating costs,
such as office space lease, travel, utilities, advertising, professional fees
and similar expenses. The decrease in corporate operating expense is primarily
due to lower franchise sales and service costs.

Corporate Depreciation and Amortization

Depreciation and amortization applicable to corporate operations for the
quarter ended September 30, 2002 totaled $190,000, compared to $182,000 for the
quarter ended September 30, 2001. Depreciation and amortization reflects
depreciation and amortization of intangible assets (e.g. patents, trademarks),
leasehold improvements and furnishings in our corporate office, and
depreciation of financial system hardware, software and peripheral equipment.

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Interest Income and Expense

Interest income for the quarter ended September 30, 2002 was $73,000,
compared to $219,000 for the quarter ended September 30, 2001. Interest income
for the quarter ended September 30, 2002 resulted primarily from the temporary
investment of cash provided by operations and proceeds from the April 2002
sale-leaseback transaction of 21 hotels. For the quarter ended September 30,
2001, interest income resulted primarily from the temporary investment of cash
provided by operations and proceeds from the August 2001 sale-leaseback
transaction of two hotels. The decrease in interest income for the quarter
ended September 30, 2002 is largely due to lower cash levels and lower
investment rate yields.

Interest expense, net of capitalized interest, for the quarter ended
September 30, 2002 was $1.2 million, compared to $4.3 million for the quarter
ended September 30, 2001. The decrease in interest expense is due to lower
debt levels as a result of the repayment of certain obligations with the
proceeds from the April 2002 sale-leaseback transaction and lower LIBOR
interest rates.

Sales of Hotels

As of September 30, 2002, we had sold to and leased back from HPT 57
hotels, including 21 hotels sold during the second quarter of 2002. A deferred
gain was recorded on the sales, a portion of which has been recorded in income
in the quarters ended September 30, 2002 and September 30, 2001. The following
table sets forth the rent expense and deferred gain recognized into earnings
related to our leased hotels for the quarters ended September 30, 2002 and
September 30, 2001 (in thousands):

|                              |  |                                     |        |      |  |   |       | 
|----------------------------- |  | ----------------------------------- | ------ | ---- |  | - | ----- | 
|                              |  | For the quarter ended September 30,
|                              |  |                                    
|                              |  | 2002                                |        | 2001
|                              |  |                                     |        |     
|Rent expense on leased hotels |  | $                                   | 11,470 |      |  | $ | 6,807 | 
|Gain recognized into earnings |  | $                                   | 406    |      |  | $ | 357   | 

Comparison of nine-months ended September 30, 2002 and 2001

Hotel Operations

Hotel Operations Revenue

Hotel operations revenue was $94.9 million for the nine-months ended
September 30, 2002, compared to $98.0 million for the nine-months ended
September 30, 2001. The decrease in revenue is a result of the slowdown in the
economy and a reduction in business travel. Hotel operations revenue for the
nine-month period ended September 30, 2001 was negatively impacted by the
slowdown in the economy, and to a lesser extent, the September 11, 2001 attacks
on the World Trade Center. The following table sets forth the operating
statistics for all our corporate hotels for the nine-months ended September 30,
2002 and September 30, 2001:

|                           |  |                           |       |      |  |        |       |   |  |   |       |  
|-------------------------- |  | ------------------------- | ----- | ---- |  | ------ | ----- | - |  | - | ----- | -
|                           |  | For the nine-months ended |       |      |  |       
|                           |  | September 30,             |       |      |  |       
|                           |  |                           |       |      |  |       
|                           |  | 2002                      |       | 2001 |  | Change
|                           |  |                           |       |      |  |       
|Occupancy                  |  |                           | 76.3  | %    |  |        | 74.3  | % |  |   | 2.0   | %
|Average Daily Rate         |  | $                         | 54.04 |      |  | $      | 58.65 |   |  | $ | (4.61 | )
|Revenue per available room |  | $                         | 41.23 |      |  | $      | 43.57 |   |  | $ | (2.34 | )

The average occupancy rate for our corporate hotels was 76.3% for the
nine-months ended September 30, 2002, compared to 74.3% for the nine-months
ended September 30, 2001. The average daily room rate for corporate hotels for
the nine-months ended September 30, 2002 was $54.04, compared to $58.65 for the
nine-months ended September 30, 2001. The decrease in the average daily rate
for the nine-months ended September 30, 2002 was a result of our focus on
improving or maintaining occupancy at

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our hotels by marketing to the extended-stay customer and adjusting rates
in todays competitive environment. Revenue per available room was $41.23 for
the nine-months ended September 30, 2002, a 5.4% decrease from a year ago.
This decrease is due to the lower average daily rate for the nine-months ended
September 30, 2002 compared to the nine-months ended September 30, 2001.

Hotel Operating Expenses

Hotel operating expenses for the nine-months ended September 30, 2002
totaled $60.0 million, compared to $55.8 million for the nine-months ended
September 30, 2001. The increase in hotel operating expenses is largely due to
increased wages, media advertising, promotional costs associated with sales
promotions, operating costs for the Jersey City, New Jersey hotel which opened
in April 2001 and the San Antonio, Texas hotel acquired in March 2002 and
higher maintenance and insurance costs.

Rent Expense on Leased Hotels

Rent expense on the 57 leased hotels for the nine-months ended September
30, 2002 was $29.6 million, compared to rent expense for the 36 leased hotels
of $19.5 million for the nine-months ended September 30, 2001. The increase in
rent expense is due to an increase in base rent as a result of the sale and
leaseback of two hotels in August 2001 and an additional 21 hotels in April
2002.

Hotel Opening Costs

Opening costs are costs incurred prior to the opening of a hotel and
include costs related to hiring and training of hotel personnel, such as
travel, compensation and relocation. There were no opening costs for the
nine-months ended September 30, 2002, as we had no hotel openings or projects
under construction during the period. Opening costs for the nine-months ended
September 30, 2001 totaled $230,000.

Hotel Depreciation and Amortization

Depreciation and amortization expense applicable to hotel operations for
the nine-months ended September 30, 2002 totaled $4.4 million, compared to $8.3
million for the nine-months ended September 30, 2001. The decrease in
depreciation and amortization expense is due to the sale of two hotels in
August 2001 and an additional 21 hotels in April 2002.

Corporate Operations

Other Income

Other income for the nine-months ended September 30, 2002 totaled $2.1
million, compared to $2.8 million for the nine-months ended September 30, 2001.
Franchise fee income for the nine-months ended September 30, 2002 totaled $2.1
million, compared to $2.2 million for the nine-months ended September 30, 2001.
Management fee income for the nine-months ended September 30, 2002 totaled
$843,000, compared to $985,000 for the nine-months ended September 30, 2001.
The decrease in franchise fee and management fee income is due to the
suspension of royalty and management fee payments from the Boston Capital joint
venture hotels. For the nine-months ended September 30, 2002, we recorded a
loss of ($797,000) on our joint venture hotels, compared to ($369,000) for the
nine-months ended September 30, 2001. This loss is due to the reduced
profitability of the joint venture hotels as a result of the slowdown in the
economy and the reduction in business travel and the amortization of the
difference between the amount at which the Boston Capital joint venture
investment is carried on our accounting records and the amount of the
underlying book equity in the net assets of the joint venture.

We sold 21 hotels during the nine-months ended September 30, 2002 and
recognized $1.0 million of the total deferred gain on hotels sold in prior
periods, unchanged from the nine-months ended September 30, 2001. We sold two
hotels during the nine-months ended September 30, 2001.

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Corporate Operating Expenses

Corporate operating expenses for the nine-months ended September 30, 2002
totaled $4.4 million, compared to $4.9 million for the nine-months ended
September 30, 2001. The decrease in corporate operating expense is primarily
due to lower franchise sales and service costs.

Corporate Depreciation and Amortization

Depreciation and amortization applicable to corporate operations for the
nine-months ended September 30, 2002 totaled $572,000, compared to $530,000 for
the nine-months ended September 30, 2001.

Interest Income and Expense

Interest income for the nine-months ended September 30, 2002 was $258,000,
compared to $600,000 for the nine-months ended September 30, 2001. Interest
income for the nine-months ended September 30, 2002 resulted primarily from the
temporary investment of cash provided by operations and proceeds from the April
2002 sale-leaseback transaction. For the nine-months ended September 30, 2001,
interest income resulted primarily from the temporary investment of cash
provided by operations and proceeds from the August 2001 sale-leaseback
transaction. The decrease in interest income for the nine-months ended
September 30, 2002 is largely due to lower cash levels and lower investment
rate yields.

Interest expense, net of capitalized interest, for the nine-months ended
September 30, 2002 was $6.1 million, compared to $13.5 million for the
nine-months ended September 30, 2001. The decrease in interest expense is due
to lower debt levels as a result of the April 2002 sale-leaseback transaction
and lower LIBOR interest rates, partially offset by a reduction in the amount
of interest capitalized to development projects as a result of not having any
projects under construction during 2002.

Sales of Hotels

As of September 30, 2002, we had sold to and leased back from HPT 57
hotels, 21 of which were sold during the nine-months ended September 30, 2002.
A deferred gain was recorded on the sales, a portion of which has been recorded
in income in the nine-months ended September 30, 2002 and September 30, 2001.
The following table sets forth the rent expense and deferred gain recognized
into earnings related to our leased hotels for the nine-months ended September
30, 2002 and September 30, 2001 (in thousands):

|                              |  |                     |        |      |  |   |        | 
|----------------------------- |  | ------------------- | ------ | ---- |  | - | ------ | 
|                              |  | For the nine-months
|                              |  | ended September 30,
|                              |  |                    
|                              |  | 2002                |        | 2001
|                              |  |                     |        |     
|Rent expense on leased hotels |  | $                   | 29,590 |      |  | $ | 19,468 | 
|Gain recognized into earnings |  | $                   | 1,044  |      |  | $ | 1,049  | 

Liquidity and Capital Resources

We had cash and cash equivalents of $12.9 million at September 30, 2002,
compared to $23.9 million at September 30, 2001. Net cash used in operating
activities totaled $4.0 million for the nine-months ended September 30, 2002,
compared to $3.4 million of cash provided by operating activities for the
nine-months ended September 30, 2001. For the nine-months ended September 30,
2002, we recorded a net loss from operations of $17.5 million, including an
impairment loss on hotels held for sale of $8.6 million, $2.1 million of loss
on the extinguishment of debt, $4.9 million of non-cash depreciation and
amortization expense and $1.0 million of non-cash deferred gain income on
hotels sold. Sources of cash included a $1.0 million decrease in other assets.
This decrease in other assets is largely due to the refund

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of excess cash from the furniture, fixtures and equipment (FF&E) cash
reserve accounts. These FF&E reserve accounts are stipulated in the lending
agreements and require us to make monthly contributions equal to approximately
5.0% of total gross hotel revenues. The cash reserved is for replacement and
refurbishment of hotel furniture and fixtures. The excess funds were returned
to us as part of the sale-leaseback and refinancing transactions in April 2002.
Uses of cash for the nine-months ended September 30, 2002 consisted primarily
of a $1.5 million increase in accounts and other receivables, a $720,000
decrease in accounts payable and other accrued expenses and a $647,000 decrease
in other liabilities. For the nine-months ended September 30, 2001, we
recorded a net loss from operations of $319,000 including $8.8 million of
non-cash depreciation and amortization expense and $1.0 million of non-cash
deferred gain income on hotels sold. Uses of cash for the nine-months ended
September 30, 2001 included a $2.7 million increase in other assets (primarily
FF&E reserve payments), a $911,000 increase in accounts and other receivables
and a $888,000 decrease in accounts payable and other accrued expenses.

Net cash provided by investing activities for the nine-months ended
September 30, 2002 totaled $131.5 million, compared to $26.3 million of net
cash provided by investing activities for the nine-months ended September 30,
2001. Sources of cash for the nine-months ended September 30, 2002 consisted
of $145.0 million in proceeds from sales of hotels and $10.5 million of
guaranty deposit refunded to us by HPT as part of the April 2002 sale-leaseback
transaction. Uses of cash for the nine-months ended September 30, 2002
consisted of $16.0 million of cash paid for security deposits related to the 21
hotels sold and leased back from HPT in April 2002 and $8.0 million of
expenditures for property, equipment and leasehold improvements in connection
with completed and leased hotels. Sources of cash for the nine-months ended
September 30, 2001 consisted of $28.9 million in proceeds from sales of hotels,
$3.1 million of refunded guaranty deposits and $1.3 million of cash
distributions from joint ventures. Uses of cash for the nine-months ended
September 30, 2001 consisted of $3.8 million of cash paid for security deposits
related to the sale of two hotels in August 2001 and $3.0 million of
expenditures for property and equipment.

For the nine-months ended September 30, 2002, net cash used in financing
activities was $132.5 million, compared to $27.7 million of net cash used in
financing activities for the nine-months ended September 30, 2001. Net cash
used in financing activities during the nine-months ended September 30, 2002
consisted of $192.2 million of principal payments on notes payable, partially
offset by $59.7 million of proceeds from mortgages and notes payable. The
principal payments on notes payable represent payments made to pay off note
balances on hotels sold in the April 2002 sale-leaseback transaction. The
proceeds from mortgages and notes payable represent the proceeds from the
refinancing of certain debt in 2002. For the nine-months ended September 30,
2001, net cash used in financing activities included $27.3 million of principal
payments on notes payable and $6.0 million of preferred stock dividend
payments, partially offset by $5.6 million of proceeds from mortgages and notes
payable.

Under the terms of the agreement with Boston Capital and Mass Mutual,
since we did not have at least 10 joint venture hotels open or under
construction by August 31, 2000, our joint venture partners had the right to
require us to increase our capital contribution to the existing joint venture
hotels. As of September 30, 2002, the additional capital contribution amount,
per the agreement, was estimated at approximately $3.4 million. In June 2002,
our joint venture partners notified us that we would be required to make this
additional equity contribution on or before July 25, 2002. We did not make
this contribution. In August 2002, our non-payment of the additional equity
contribution prompted a notice of default from our joint venture partners. As
a result of this default and in accordance with the joint venture agreement,
the joint venture has suspended payment of franchise royalty and management
fees to us pending resolution of this matter. The amount of franchise royalty
and management fees suspended since the July 25, 2002 deadline are
approximately $175,000 and $190,000, respectively. In addition, per the
agreement, the interest rate on the joint venture debt to Boston Capital and
Mass Mutual has increased from 12.0% to 21.0%. The suspension of royalty and
management fees and the increased interest rate on the debt will be lifted upon
the successful cure of the default. We have reached a tentative agreement with
Boston Capital and Mass Mutual in regards to the amount of the additional
equity contribution whereby we will contribute $1.8 million to the joint
venture and Boston Capital and Mass Mutual would

22



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##### Table of Contents



waive contractual rights to the $1.6 million balance. However, we cannot
provide any assurance that a final agreement will be reached on these terms or
at all. We believe we are otherwise in compliance with the terms of the
joint venture agreement.

As of September 30, 2002, we have guaranteed approximately $55.9 million
of the construction debt on the Boston Capital joint venture properties.
Maturity dates for this debt range from May 2003 to January 2008.
Approximately $23.7 million of this debt is scheduled to mature in 2003. As of
September 30, 2002, $5.8 million of the debt scheduled to mature in 2003 can be
extended, under the terms of the existing loan agreement, for an additional
year. Since this guaranteed debt relates to an entity which we do not wholly-
own or control, it is not included in our consolidated financial statements.

As of September 30, 2002, we had borrowed $58.9 million from GMAC and one
other financial institution. This debt had scheduled maturity dates ranging
from May 2005 to June 2011 with interest rates, which range from 7.75% to
8.30%.

Our Series A and Series B Preferred Stock accumulate dividends at a rate
of 7.5% with dividend payments made quarterly, upon approval of the board of
directors, and in preference to any dividend on our Common Stock. These
payments are approximately $2.0 million per quarter. We did not make the last
four scheduled preferred stock dividend payments. We intend to assess our cash
position on a quarterly basis and will likely elect to forego additional
scheduled dividend payments on our preferred stock. As of September 30, 2002,
we had approximately $8.0 million of accumulated unpaid dividends. A failure
to make future dividend payments will result in a further reduction in the
conversion price of the Preferred Stock and, in the case of the Series B
Preferred Stock, may result in a future adjustment to the dividend rate to 12%.

Pursuant to a mandatory redemption clause in the Certificates of
Designation for the Series A and Series B Cumulative Convertible Preferred
Stock, we are required to redeem the Series A and Series B Preferred Stock in
September 2004. The mandatory redemption amount is equal to $107 million plus
unpaid dividends. As of September 30, 2002, the mandatory redemption amount
was approximately $115.0 million. If we fail to redeem the Preferred Stock
when due, we are required to issue to each holder of Preferred Stock on such
date, and on each three month anniversary thereafter, warrants to purchase 25%
of the number of shares of Common Stock into which such holders outstanding
shares of Preferred Stock would be convertible on such date. The warrants
would be immediately exercisable at a purchase price of $.01 per share of
Common Stock.

In the event we liquidate, the holders of the Series A and Series B
Preferred Stock are entitled to receive a payment equal to the stated value of
their shares, plus any accrued but unpaid dividends (the Liquidation Amount),
prior to any distribution or payment to the holders of our Common Stock. As of
September 30, 2002, the Liquidation Amount was $115.0 million, including $8.0
million of unpaid dividends. Alternatively, the holders of the Series A and
Series B Preferred Stock may convert any or all of their shares into shares of
Common Stock. In the event of a corporate transaction that constitutes a
change of control, we are required to offer to redeem all of the outstanding
shares of Series A and Series B Preferred Stock for a price equal to the
greater of the Liquidation Amount or 175% of the stated value of the shares.
As of September 30, 2002, one hundred seventy five percent of the stated value
of the shares was $187.3 million. If we do not redeem the Preferred Stock upon
a change of control, the conversion price of the Preferred Stock will be
reduced to the lower of the then applicable conversion price or the market
price of the Common Stock on the redemption date divided by 1.75, provided that
the conversion price will not be reduced to an amount less than the par value
of the Common Stock.

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

23



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The carrying amount of the redeemable preferred stock is being increased
by periodic accretions using the interest method, so that the carrying amount
will equal the mandatory redemption amount at the mandatory redemption date.
For the quarter ended September 30, 2002, approximately $461,000 was recorded
as an increase to the carrying value of the preferred stock.

The following table summarizes our contractual cash and debt obligations
for the next five years as of September 30, 2002 (in thousands):

Payments due by Period:

|                               |       |   |         |         |        |   |           |        |           |   |         |         |  |   |        |        |       |   |         |         | 
|------------------------------ | ----- | - | ------- | ------- | ------ | - | --------- | ------ | --------- | - | ------- | ------- |  | - | ------ | ------ | ----- | - | ------- | ------- | 
|                               |       |   |         |         |        |   | Less than |        |           |   |         |         |  |   |        |        | After
|                               |       |   | Total   |         | 1 year |   | 1-3 years |        | 4-5 years |   | 5 years
|                               |       |   |         |         |        |   |           |        |           |   |        
|Long-Term Debt                 |       | $ | 58,944  |         |        | $ | 358       |        |           | $ | 54,815  |         |  | $ | 141    |        |       | $ | 3,630   |        
|Rent Expense for Leased Hotels |       |   | 739,489 |         |        |   | 45,507    |        |           |   | 91,014  |         |  |   | 91,014 |        |       |   | 511,954 |        
|Preferred Stock Redemption     |       |   | 115,000 |         |        |   |          |        |           |   | 115,000 |         |  |   |       |        |       |   |        |        
|Joint Venture Contributions*   |       |   | 1,800   |         |        |   | 1,800     |        |           |   |        |         |  |   |       |        |       |   |        |        
|                               |       |   |         |         |        |   |           |        |           |   |         |         |  |   |        |        |       |   |         |        
|                               | Total |   | $       | 915,233 |        |   | $         | 47,665 |           |   | $       | 260,829 |  |   | $      | 91,155 |       |   | $       | 515,584 | 



---

|* |  | Amount represents the required additional equity contribution to our
joint venture with Boston Capital and Mass Mutual. A tentative agreement
has been reached with our joint venture partners whereby the amount of the
additional equity contribution has been reduced from $3.4 million to $1.8
million.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We believe that a combination of our cash and cash equivalents, cash from
operations and borrowed funds from third-party lenders (if approved on an
individual basis) will be sufficient to provide capital for operations through
December 2003. However, in order to meet our long-term financing obligations,
we will be required to raise additional capital in the future. We continue to
consider a number of financing alternatives, including credit facilities, the
issuance of equity, debt or equity-linked securities and joint ventures, which
are necessary to provide the capital needed to meet our financing needs. We
are unable to assure that we will be able to obtain financing on a timely
basis, on acceptable terms, or at all.

Certain Business Considerations

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

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

We have Never Been Profitable. At September 30, 2002, we operated 77
hotels. This limited number of hotels limits our ability to attract potential
franchisees and grow our business. We have incurred losses to date and cannot
give any assurance that we will be profitable in the future. Operation of
individual

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hotels and a chain of multiple hotels are subject to numerous risks,
including:



| |  |  | the inability to maintain high occupancy rates or to attract guests for extended-stays;
| | - |  | ---------------------------------------------------------------------------------------
|
| |  |  | the inability to achieve expected nightly rates;                                       
|
| |  |  | the inability to operate the hotels at expected expense levels;                        
|
| |  |  | the ability to attract and retain quality personnel; and                               
|
| |  |  | liability for accidents and other events occurring at hotel properties.                

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

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

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



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

Accordingly, we cannot make any assurances that our business will generate
sufficient cash flow from operations to fund our debt obligations or make our
scheduled lease and preferred stock dividend payments as they become due. For
example, in August 2002, we did not make the scheduled dividend payment. This
marked the fourth successive dividend payment we have not made. We also did
not make a capital contribution required by the terms of our joint venture
agreement with Boston Capital and Mass Mutual. We do not currently have
sufficient capital to pay all of our debts if they were due today. We cannot
provide any assurances that we will be able to refinance any of our
indebtedness on commercially reasonable terms, or at all. Our ability to make
payments on, to repay or to refinance our indebtedness and to make our
scheduled lease and preferred stock dividend payments also is, to a certain
extent, subject to general economic, competitive, legislative, regulatory and
other factors beyond our control. Our inability to make payments on, to repay,
or to refinance our debt, lease and preferred stock obligations could result in
litigation and have a material adverse effect on our business and results of
operations. We have also guaranteed approximately $55.9 million of debt on the
Boston Capital joint venture properties. Maturity dates for this debt range
from May 2003 to January 2008, with approximately $23.7 million of this debt
scheduled to mature in 2003. See Liquidity and Capital Resources.

We May be Unable to Redeem our Preferred Stock When it Becomes Due.
Pursuant to a mandatory redemption provisions in the Certificates of
Designation for our Series A and Series B Cumulative Convertible Preferred
Stock, we are required to redeem our Preferred Stock in September 2004. As of

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September 30, 2002, the mandatory redemption amount was approximately
$115.0 million. If we fail to redeem the Preferred Stock when due, we are
required to issue to each holder of Preferred Stock on such date, and on each
three month anniversary thereafter, warrants to purchase 25% of the number of
shares of Common Stock into which such holders outstanding shares of Preferred
Stock would be convertible on such date. The warrants would be immediately
exercisable at a purchase price of $.01 per share of Common Stock. We do not
currently have sufficient capital to make the scheduled payment to redeem our
Preferred Stock, and cannot provide any assurances that we will be able to
obtain the financing necessary to do so.

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



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

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

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

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

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

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our business and results of operations.

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

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

Impact of New Accounting Standards

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

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

In April 2002, the Financial Accounting Standards Board issued Statement
No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections, which rescinded FASB No. 4
requiring gains and losses from extinguishment of debt to be classified as
extraordinary. During the nine-months ended September 30, 2002, we
extinguished a significant portion of our debt and recorded a loss of $2.1
million. We have adopted Statement No. 145 and have classified this loss as an
operating expense.

Quantitative and Qualitative Disclosure of Market Risk

Our earnings are affected by changes in interest rates as a significant
portion of our outstanding indebtedness is at variable rates based on LIBOR or
Treasury notes. If interest rates change by .01 percent, the market value of
our mortgages and notes payable, based on the outstanding balance, effected by
the variable rates at September 30, 2002, would change by approximately $5,900.
Additionally, we have market risk on our short-term investments, which are
considered cash equivalents, due to changes in interest rates. If interest
rates increase by .01 percent, the market value of our short-term investments,
based on the outstanding balance at September 30, 2002, would change by
approximately $1,300.

In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities and its
amendments, Statements 137 and 138 in June of 1999 and June of 2000,
respectively. We adopted Statement No. 133, as amended, effective January 1,
2001. The Statement requires us to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must be adjusted to fair
value through income. If the derivative is a

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hedge, depending on the nature of the hedge, changes in the fair value of
derivatives will either be offset against the change in fair value of the
hedged assets, liabilities, or firm commitments through earnings or recognized
in other comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivatives change in fair value will be
immediately recognized in earnings. As of September 30, 2002, the Company had
one derivative financial instrument, an interest rate cap, which was recorded
at fair value of $49,000 as of September 30, 2002, with the change in fair
value since the purchase date recorded in other comprehensive income in the
equity section of the balance sheet.

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PART II. OTHER INFORMATION
Item 4. Controls and Procedures

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

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

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




Item 6. Exhibits and Reports on Form 8-K



|(a) |  | Exhibits                                                                                                                                                                                                                                                                                   
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | See the Exhibit Index beginning on page 33.                                                                                                                                                                                                                                                
|   
|(b) |  | Reports on Form 8-K                                                                                                                                                                                                                                                                        
|   
|    |  | On August 13, 2002, the Company filed Report on Form 8-K, reporting the
certification of the Quarterly Report on Form 10-Q by the Companys Chief
Executive Officer and Chief Financial Officer as required by 18 U.S.C. 1350,
as created by Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

|                        |                                                      |                   
|----------------------- | ---------------------------------------------------- | ------------------
|                        | CANDLEWOOD HOTEL COMPANY,
INC.                      
|                       
|Date: November 14, 2002 | By:                                                  | /s/ Jack P. DeBoer
|                        |                                                     
|                        | Jack P. DeBoer, Chairman
and Chief Executive Officer

|                        |                                                                     |                  
|----------------------- | ------------------------------------------------------------------- | -----------------
|Date: November 14, 2002 | By:                                                                 | /s/ Warren D. Fix
|                        |                                                                    
|                        | Warren D. Fix, Executive Vice President
and Chief Financial Officer

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CERTIFICATIONS

I, Jack P. DeBoer, certify that:

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

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

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

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

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

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

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

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

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

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

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



|Dated: November 14, 2002 | /s/ Jack P. DeBoer
Jack P. DeBoer
Chairman and Chief Executive Officer
|------------------------ | ----------------------------------------------------------------------

31



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##### Table of Contents



I, Warren D. Fix, certify that:

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

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

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

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

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

b) evaluated the effectiveness of the registrants disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and

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

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

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

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

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



|Dated: November 14, 2002 | /s/ Warren D. Fix
        
Warren D. Fix
Executive Vice President and
Chief Financial Officer
|------------------------ | ---------------------------------------------------------------------------------------------

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EXHIBIT INDEX

|        |  |                                                                                                                                                                                                                                                                                                                        
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                                                                                                                        
|No.     |  | Description                                                                                                                                                                                                                                                                                                            
|        |  |                                                                                                                                                                                                                                                                                                                        
|3.1     |  | Restated Certificate of Incorporation of Candlewood Hotel Company, Inc.(1)                                                                                                                                                                                                                                             
|       
|       
|       
|       
|3.2     |  | Amended and Restated Bylaws of Candlewood Hotel Company, Inc.(11)                                                                                                                                                                                                                                                      
|       
|       
|       
|       
|3.3     |  | Certificate of Designations, Preferences and Relative, Participating, Optional and Other
Special Rights of Preferred Stock and Qualifications, Limitations and Restrictions
Thereof of Series A Cumulative Convertible Preferred Stock of Candlewood Hotel Company,
Inc.(5)                                            
|       
|       
|       
|       
|3.4     |  | Certificate of Amendment of Certificate of Designations of Series A Preferred Stock.(9)                                                                                                                                                                                                                                
|       
|       
|       
|       
|3.5     |  | Certificate of Designations, Preferences and Relative, Participating, Optional and Other
Special Rights of Preferred Stock and Qualifications, Limitations and Restrictions
Thereof of Series B Cumulative Convertible Preferred Stock of Candlewood Hotel Company,
Inc.(9)                                            
|       
|       
|       
|       
|4.1     |  | Specimen Certificate of Common Stock.(2)                                                                                                                                                                                                                                                                               
|       
|       
|       
|       
|4.2     |  | Form of Warrant.(9)                                                                                                                                                                                                                                                                                                    
|       
|       
|       
|       
|4.3     |  | Amended and Restated Stockholders Agreement dated as of July 10, 1998.(9)                                                                                                                                                                                                                                              
|       
|       
|       
|       
|10.1    |  | Form of Indemnification Agreement for Executive Officers and Directors.(1)                                                                                                                                                                                                                                             
|       
|       
|       
|       
|10.2    |  | Indemnification Agreement Schedule.(10)                                                                                                                                                                                                                                                                                
|       
|       
|       
|       
|10.3    |  | 1996 Equity Participation Plan and Form of Stock Option Agreements.(3)                                                                                                                                                                                                                                                 
|       
|       
|       
|       
|10.4    |  | First Amendment to the 1996 Equity Participation Plan effective as of May 18, 1998.(10)                                                                                                                                                                                                                                
|       
|       
|       
|       
|10.5    |  | Employment Agreement between Candlewood Hotel Company, Inc. and Jack P. DeBoer dated as
of September 1, 1996.(1)                                                                                                                                                                                                       
|       
|       
|       
|       
|10.6    |  | Credit Facility Agreement between Candlewood Hotel Company, Inc. and Doubletree
Corporation dated as of November 11, 1996.(4)                                                                                                                                                                                          
|       
|       
|       
|       
|10.7    |  | Subordinated Promissory Note from Candlewood Hotel Company, Inc. to Doubletree
Corporation dated as of November 11, 1996.(4)                                                                                                                                                                                           
|       
|       
|       
|       
|10.8    |  | Series A Cumulative Convertible Preferred Stock Purchase Agreement dated as of August
27, 1997.(5)                                                                                                                                                                                                                     
|       
|       
|       
|       
|10.9    |  | Amended and Restated Registration Rights Agreement dated as of July 10, 1998.(9)                                                                                                                                                                                                                                       
|       
|       
|       
|       
|10.10   |  | Purchase and Sale Agreement, dated as of November 19, 1997, by and among Candlewood
Hotel Company, Inc. and certain of its affiliates, as sellers, and HPT, as purchaser.(6)                                                                                                                                           
|       
|       
|       
|       
|10.11   |  | First Amendment to Purchase and Sale Agreement and Agreement to Lease and Fourth
Amendment to Lease Agreement and Incidental Documents, dated as of January 7, 1999, by
and among Candlewood Hotel Company, Inc., Candlewood Leasing No. 1, Inc., HPT and HPT
CW, and seventeen entities which are parties thereto.(10)
|       
|       
|       
|       
|10.12   |  | Agreement to Lease, dated as of November 19, 1997, by and between Candlewood Hotel
Company, Inc. and HPT.(6)                                                                                                                                                                                                           
|       
|       
|       
|       
|10.13   |  | Purchase and Sale Agreement, dated as of May 14, 1998, by and among Candlewood Hotel
Company, Inc. and certain of its affiliates, as sellers, and HPT, as purchaser.(7)                                                                                                                                                
|       
|       
|       
|       
|10.14   |  | First Amendment to Purchase and Sale Agreement, Agreement to Lease, Lease Agreement and
Incidental Documents, dated as of June 18, 1998, by and among Candlewood Hotel Company,
Inc., Candlewood Leasing No. 2, Inc., HPT and HPT CW II.(10)                                                                           
|       
|       
|       
|       
|10.15   |  | Second Amendment to Purchase and Sale Agreement, Agreement to Lease, Lease Agreement and
Incidental Documents, dated as of July 31, 1998, by and among Candlewood Hotel Company,
Inc., Candlewood Leasing No. 2, Inc., HPT and HPT CW II.(8)                                                                           
|       
|       
|       
|       
|10.16   |  | Third Amendment to Purchase and Sale Agreement and Agreement to Lease and Sixth
Amendment to Lease Agreement and Incidental Documents, dated as of December 23, 1998, by
and among Candlewood Hotel Company, Inc., Candlewood Leasing No. 2, Inc., HPT, HPT CW II
and seventeen entities which are parties thereto.(10)
|       
|       
|       
|       
|10.17   |  | Agreement to Lease, dated as of May 14, 1998, by and between Candlewood Hotel Company,
Inc. and HPT.(7)                                                                                                                                                                                                                
|       
|       
|       
|       
|10.18   |  | Securities Purchase Agreement dated as of September 30, 1998.(9)                                                                                                                                                                                                                                                       
|       
|       
|       
|       
|10.19   |  | Lease Agreement dated April 30, 1998 by and between Candlewood Hotel Company, Inc. and
Vantage Point Properties, Inc.(10)                                                                                                                                                                                              

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##### Table of Contents



|        |  |                                                                                                                                                                                                              
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                              
|No.     |  | Description                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                              
|       
|       
|       
|       
|10.20   |  | Third Amendment to Agreement to Lease by and between Candlewood Hotel Company, Inc. and
HPT.(10)                                                                                                             
|       
|       
|       
|       
|10.21   |  | Purchase and Sale Agreement by and among Candlewood Hotel Company, Inc., Candlewood
Philadelphia-Mt. Laurel, NJ, LLC, Candlewood Las Vegas, NV, LLC and HPT.(12)                                             
|       
|       
|       
|       
|10.22   |  | Purchase and Sale Agreement, dated as of April 11, 2002, by and among Candlewood Hotel
Company, Inc. and certain of its affiliates, as sellers, and Hospitality Properties
Trust, as purchaser.(13)          
|       
|       
|       
|       
|10.23   |  | Second Amended and Restated Lease Agreement, dated as of April 11, 2002, by and between
HPT CW Properties Trust, as landlord, and Candlewood Leasing No. 1, Inc., as tenant.(13)                             
|       
|       
|       
|       
|10.24   |  | Second Amended and Restated Assignment and Security Agreement, dated as of April 11,
2002, by and between Candlewood Leasing No. 1, Inc., assignor, and HPT CW Properties
Trust, assignee.(13)               
|       
|       
|       
|       
|10.25   |  | Fourth Amendment to Agreement to Lease, dated as of April 11, 2002, by and between
Hospitality Properties Trust and Candlewood Hotel Company, Inc.(13)                                                       
|       
|       
|       
|       
|10.26   |  | Second Amended and Restated Guaranty Agreement, dated as of April 11, 2002, by
Candlewood Hotel Company, Inc., as guarantor, for the benefit of HPT CW Properties Trust
and Hospitality Properties Trust.(13)
|       
|       
|       
|       
|10.27   |  | Second Amended and Restated Security Agreement, dated as of April 11, 2002, by and
between Candlewood Leasing No. 1, Inc., as tenant, and HPT CW Properties Trust, as
secured party.(13)                     
|       
|       
|       
|       
|10.28   |  | Second Amended and Restated Stock Pledge Agreement, dated as of April 11, 2002, by
Candlewood Hotel Company, Inc., as pledgor, for the benefit of HPT CW Properties Trust ,
as secured party.(13)            
|       
|       
|       
|       
|10.29   |  | Form of Letter Agreement between Candlewood Hotel Company, Inc. and certain executive
officers and schedule related thereto.(14)                                                                             
|       
|       
|       
|       
|10.30   |  | Limited Liability Company Agreement of Candlewood Hotel Company Fund I, LLC, dated as of
June 1, 1999, between Candlewood Ventures I, LLC and BCIA CW Member, LLC.                                           
|       
|       
|       
|       
|10.31   |  | Guaranty of Candlewood Hotel Company, Inc., dated as of June 1, 1999, in favor of
Candlewood Hotel Company Fund I, LLC.                                                                                      
|       
|       
|       
|       
|10.32   |  | Loan Agreement, dated as of June 1, 1999, between Candlewood Hotel Company Fund I, LLC
and Boston Capital Institutional Advisors LLC.                                                                        
|       
|       
|       
|       
|10.33   |  | Promissory Note of Candlewood Hotel Company Fund I, LLC, dated as of June 1, 1999, in
favor of Boston Capital Institutional Advisors LLC.                                                                    
|       
|       
|       
|       
|10.34   |  | Key Principal Recourse Agreement, dated as of June 1, 1999, by Candlewood Hotel Company,
Inc. for the benefit of Boston Capital Institutional Advisors LLC.                                                  
|       
|       
|       
|       
|11.1    |  | Statement re Computation of Per Share Earnings  not applicable.                                                                                                                                             



---

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

34



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##### Table of Contents



|(9)  |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Current
Report on Form 8-K/A filed August 10, 1998.                    
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|    
|    
|    
|    
|(10) |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Annual
Report on Form 10-K for the fiscal year ended December 31, 1998.
|    
|    
|    
|    
|(11) |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Quarterly
Report on Form 10-Q for the period ended September 30, 2001. 
|    
|    
|    
|    
|(12) |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Quarterly
Report on Form 10-Q for the period ended September 30, 2001. 
|    
|    
|    
|    
|(13) |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Current
Report on Form 8-K filed on April 26, 2002.                    
|    
|    
|    
|    
|(14) |  | Incorporated by reference from Candlewood Hotel Company, Inc.s Quarterly
Report on Form 10-Q for the period ended June 30, 2002.      

35