8-K

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 8-K

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

DATE OF REPORT
February 8, 2002
(Date of earliest event reported)

Commission File number 34-0-22164

RFS HOTEL INVESTORS, INC.
(exact name of registrant as specified in its charter)

Tennessee
(State or other incorporation)
62-1534743
(I.R.S. Employer Identification Number)

850 Ridge Lake Boulevard, Suite 300,
Memphis, TN 38120
(901) 767-7005
(Address of principal executive offices
including zip code and telephone number)

Item 9. Regulation FD Disclosure

Included herein are the following:

•

RFS Hotel Investors, Inc. Audited Financial Statements as of December 31, 2001 and 2000 and for the years ended December 31, 2001, 2000 and 1999 (Exhibit 99.1); and



•

Management's Discussion and Analysis of Financial Condition and Results of Operations of RFS Hotel Investors, Inc. (Exhibit 99.2).

SIGNATURE

        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, thereto duly authorized.

Dated as of February 8, 2002	RFS HOTEL INVESTORS, INC.
	By:	/s/  DENNIS M. CRAVEN
	Its:	Vice President & Chief Accounting Officer

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FORM 8-K
SIGNATURE

EX-99.1

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Exhibit 99.1

INDEX TO FINANCIAL STATEMENTS

RFS Hotel Investors, Inc.
Report of Independent Accountants	F-2
Consolidated Balance Sheets—December 31, 2001 and 2000	F-3
Consolidated Statements of Operations—For the Years Ended December 31, 2001, 2000 and 1999	F-4
Consolidated Statements of Comprehensive Income (Loss)—For the Years Ended December 31, 2001, 2000 and 1999	F-5
Consolidated Statements of Shareholders' Equity—For the Years Ended December 31, 2001, 2000 and 1999	F-6
Consolidated Statements of Cash Flows—For the Years Ended December 31, 2001, 2000 and 1999	F-7
Notes to Consolidated Financial Statements	F-9

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Shareholders of RFS Hotel Investors, Inc.

        In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive income, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of RFS Hotel Investors, Inc. (the "Company") at December 31, 2001 and 2000, and the results of its operations and cash flows for the three years then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Dallas, Texas
February 7, 2002

F-2

RFS HOTEL INVESTORS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

			December 31, 2001			December 31, 2000
ASSETS
	Investment in hotel properties, net		$	615,562		$	635,997
	Cash and cash equivalents			5,735			3,681
	Restricted cash			6,817			4,929
	Accounts receivable			5,533			13,041
	Deferred expenses, net			6,964			6,814
	Other assets			3,517			9,005
	Deferred income taxes			24,734
		Total assets	$	668,862		$	673,467
LIABILITIES AND SHAREHOLDERS' EQUITY
	Accounts payable and accrued expenses		$	20,857		$	12,734
	Borrowings on Line of Credit			81,188			50,273
	Mortgage notes payable			219,947			227,158
	Minority interest in Operating Partnership, 2,458 and 2,562 units issued and outstanding at December 31, 2001 and 2000, respectively and other consolidated subsidiaries			31,059			34,848
		Total liabilities		353,051			325,013
	Series B Preferred Stock, $0.01 par value, 5,000 shares authorized, 250 shares issued and outstanding			25,000
	Commitments and contingencies
	Shareholders' equity:
		Series A Preferred Stock, $.01 par value, 5,000 shares authorized, 974 shares issued and outstanding at December 31, 2000					10
		Common Stock, $.01 par value, 100,000 shares authorized, 25,811 and 25,088 shares issued at December 31, 2001 and 2000, respectively		258			251
	Additional paid-in capital			368,361			374,910
	Other comprehensive income			(3,220	)
	Treasury stock, at cost, 576 shares			(8,100	)		(8,100	)
	Distributions in excess of earnings			(66,488	)		(18,617	)
		Total shareholders' equity		290,811			348,454
		Total liabilities and shareholders' equity	$	668,862		$	673,467

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

F-3

RFS HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Years Ended December 31, 2001, 2000 and 1999

(in thousands, except per share data)

			2001			2000			1999
Revenue:
	Rooms		$	188,725
	Food and beverage			17,695
	Other operating departments			9,103
	Lease revenue			5,782		$	106,574		$	98,962
	Other			573			785			700
		Total hotel revenue		221,878			107,359			99,662
Hotel operating expenses by department:
	Rooms			37,000
	Food and beverage			13,533
	Other operating departments			2,201
	Undistributed operating expenses:
	Property operating costs			22,550
	Property taxes, insurance and other			12,848			10,747			9,859
	Franchise costs			17,007
	Maintenance and repair			9,741
	Management fees			5,762
	Depreciation			29,605			27,198			24,210
	Lease termination			65,496
	Amortization of deferred expenses and unearned compensation			1,384			674			858
	General and administrative			19,436			6,304			3,687
		Total operating expenses		236,563			44,923			38,614
Operating income (loss)				(14,685	)		62,436			61,048
Interest expense				26,042			24,052			20,836
Income (loss) before minority interest, (gain) loss on sale
	of hotels, and income taxes			(40,727	)		38,384			40,212
	Minority interests			(1,157	)		3,218			3,620
	(Gain) loss on sale of hotel properties			(1,127	)		4,376			1,602
	Benefit from income taxes			(24,714	)
Net income (loss)				(13,729	)		30,790			34,990
Preferred stock dividends				(3,125	)		(1,412	)		(1,412	)
Gain on redemption of Series A preferred stock				5,141
Net income (loss) applicable to common shareholders			$	(11,713	)	$	29,378		$	33,578
Earnings (loss) per share—basic and diluted			$	(0.47	)	$	1.20		$	1.34
Weighted average common shares outstanding—basic				25,045			24,559			25,002
Weighted average common shares outstanding—diluted				25,045			24,580			25,002

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

F-4

RFS HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

For the Years Ended December 31, 2001, 2000 and 1999

(in thousands)

	2001			2000		1999
Net income (loss)	$	(13,729	)	$	30,790	$	34,990
Unrealized holding losses arising on interest rate swaps		(3,220	)		—		—
Comprehensive income (loss)	$	(16,949	)	$	30,790	$	34,990

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

F-5

RFS HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

For the Years Ended December 31, 2001, 2000 and 1999

(in thousands, except per share data)

				Common Stock
	Preferred Stock			Number of Shares	Amount		Additional Paid-In Capital			Other Comprehensive Income			Treasury Stock			Distributions in Excess of Income			Total
Balances at December 31, 1998	$	10		25,021	$	251	$	373,156					$	(2,012	)	$	(4,468	)	$	366,937
Purchase of treasury shares								205						(1,644	)					(1,439	)
Issuance of restricted common shares to officers and directors				41
Distributions on common shares, ($1.54 per share)																	(38,519	)		(38,519	)
Distributions on preferred shares, ($1.45 per share)																	(1,412	)		(1,412	)
Amortization of unearned compensation								726												726
Net income																	34,990			34,990
Balances at December 31, 1999	$	10		25,062	$	251	$	374,087					$	(3,656	)	$	(9,409	)	$	361,283
Purchase of treasury shares														(4,444	)					(4,444	)
Issuance of common shares				13				162												162
Issuance of restricted common shares to officers and directors				13
Distributions on common shares, ($1.54 per share)																	(38,586	)		(38,586	)
Distributions on preferred shares, ($1.54 per share)																	(1,412	)		(1,412	)
Amortization of unearned compensation								661												661
Net income																	30,790			30,790
Balances at December 31, 2000	$	10		25,088	$	251	$	374,910					$	(8,100	)	$	(18,617	)	$	348,454
Purchase of preferred shares		(10	)					(12,990	)											(13,000	)
Issuance of common shares				453		4		5,112												5,116
Issuance of restricted common shares to officers and directors				270		3														3
Distributions on common shares, ($1.255 per share)																	(30,661	)		(30,661	)
Distributions on preferred shares, ($3.125 per Series B share)																	(3,481	)		(3,481	)
Unrealized holding losses arising on interest rate swaps										$	(3,220	)								(3,220	)
Amortization of unearned compensation								1,329												1,329
Net income (loss)																	(13,729	)		(13,729	)
Balances at December 31, 2001				25,811	$	258	$	368,361		$	(3,220	)	$	(8,100	)	$	(66,488	)	$	290,811

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

F-6

RFS HOTEL INVESTORS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Years Ended December 31, 2001, 2000 and 1999

(in thousands)

				2001			2000			1999
Cash flows from operating activities:
	Net income (loss)			$	(13,729	)	$	30,790		$	34,990
	Adjustments to reconcile net income (loss) to net cash provided by operating activities:
		Depreciation and amortization			32,343			28,908			26,281
		Minority interest in Operating Partnership			(1,157	)		3,218			3,620
		(Gain) loss on sale of hotel properties			(1,127	)		4,376			79
		Changes in assets and liabilities:
			Accounts receivable		7,508			(2,240	)		(145	)
			Other assets		5,432			(3,473	)		2,277
			Deferred income taxes		(24,734	)
			Accounts payable and accrued expenses		5,930			3,644			(218	)
			Net cash provided by operating activities		10,466			65,223			66,884
Cash flows from investing activities:
	Investment in hotel properties and hotels under development				(18,013	)		(32,551	)		(34,066	)
	Cash paid for franchise fees				(65	)					(49	)
	Restricted cash				(1,888	)		(379	)		6,727
	Proceeds from sale of hotel properties				11,324			22,087			808
			Net cash used by investing activities		(8,642	)		(10,843	)		(26,580	)
Cash flows from financing activities:
	Purchase of treasury stock							(4,444	)		(1,439	)
	Proceeds from borrowings				66,688			81,200			16,500
	Payments on debt				(42,984	)		(86,047	)		(7,021	)
	Redemption of preferred stock				(13,000	)
	Distributions to common and preferred shareholders				(34,142	)		(39,972	)		(39,931	)
	Distributions to limited partners				(3,135	)		(3,988	)		(3,954	)
	Redemption of units										(22	)
	Issuance of common and preferred stock, net of $1,060 issuance costs				28,439			162
	Loan fees paid				(1,636	)		(3,523	)		(538	)
			Net cash provided (used) by financing activities		230			(56,612	)		(36,405	)
Net increase (decrease) in cash and cash equivalents					2,054			(2,232	)		3,899
Cash and cash equivalents at beginning of period					3,681			5,913			2,014
Cash and cash equivalents at end of period				$	5,735		$	3,681		$	5,913
Supplemental disclosure of cash flow information:
	Cash paid for interest			$	24,403		$	22,970		$	20,172

F-7

        Supplemental disclosure of non-cash activities:

        In 2001, the Company:

            i.  Issued 103 thousand shares of common stock with a value of $1.6 million in exchange for 103 thousand Operating Partnership units and issued 7 thousand shares of common stock with a value of $0.1 million for an interest in a subsidiary partnership.

          ii.  Recorded a liability of $3.2 million for the fair value of the interest rate swaps at December 31, 2001.

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

        In 2000, the Company recorded a $0.1 million allocation to paid-in capital from minority interest.

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

F-8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OF RFS HOTEL INVESTORS, INC.

Note 1. Organization

        RFS Hotel Investors, Inc. ("RFS" or the "Company") is a hotel real estate investment trust which, at December 31, 2001, owned interests in 58 hotels with 8,424 rooms located in 24 states (collectively the "Hotels") through its approximate 91% equity interest in RFS Partnership L.P. (the "Operating Partnership"). RFS, the Operating Partnership, and their subsidiaries are herein referred to, collectively, as the "Company".

        The following table provides a schedule of the hotels by brand at December 31, 2001:

Franchise Affiliation		Hotel Properties	Rooms/Suites
Full Service hotels:
	Sheraton	4	864
	Holiday Inn	5	954
	Independent	2	331
	Sheraton Four Points	2	412
	Hilton	1	234
	Doubletree	1	221
		15	3,016
Extended Stay hotels:
	Residence Inn by Marriott	14	1,851
	TownePlace Suites by Marriott	3	285
	Homewood Suites by Hilton	1	83
		18	2,219
Limited Service hotels:
	Hampton Inn	17	2,113
	Holiday Inn Express	5	637
	Comfort Inn	2	337
	Courtyard by Marriott	1	102
		25	3,189
Total		58	8,424

        The following summarizes the number of hotels owned for the periods presented:

	2001		2000		1999
Hotels owned at beginning of years	60		62		60
Acquisitions and developed hotels placed into service					2
Sales of hotels	(2	)	(2	)
Hotels owned at end of years	58		60		62

        Under the REIT Modernization Act (the "RMA") that became effective January 1, 2001, the Company is permitted to lease its hotels to wholly-owned taxable real estate investment trust ("REIT") subsidiaries of the Company ("TRS Lessees"), provided that the TRS Lessees engage a third-party management company to manage the hotels. Effective January 1, 2001, the Company terminated its operating leases, management contracts and related ancillary agreements with Hilton Hotels Corporation ("Hilton") for approximately $65.5 million. This transaction represents the cancellation of

F-9

certain executory contracts some of which extended through 2012. The cancellation of these agreements entitles the TRS Lessees to retain the operating profits or losses from the hotels, which previously accrued to Hilton under these contracts and, in the opinion of management, gives the Company (i) more control over the daily operations of the hotels, (ii) the benefits from any cost efficiencies or ancillary revenues generated at the hotels, and (iii) flexibility, in that the hotels are not encumbered by long term leases which are difficult to amend and expensive to terminate. As a result of this transaction, the Company began reporting hotel revenues and expenses rather than lease revenue. All of the hotels continue to operate under the same franchise affiliation as prior to the contract termination.

        Simultaneous with the termination of the leases, management contracts and related agreements, the TRS Lessees entered into new management contracts with Flagstone Hospitality Management ("Flagstone"). At December 31, 2001, Flagstone manages 51 of the Company's 58 hotels and the remaining seven hotels are managed by four other third-party management companies. Only five of the Company's hotels are operated under long-term leases with third parties as of December 31, 2001.

        In connection with the termination of the leases and related agreements, the Company redeemed 973,684 shares of its Series A Preferred Stock owned by Hilton for cash consideration of $13.0 million, which resulted in a gain on redemption of $5.1 million that was included in net income available to common shareholders in the first quarter 2001.

Note 2. Summary of Significant Accounting Policies

        Principles of Consolidation.    The consolidated financial statements include the accounts of RFS, the Operating Partnership and their consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated.

        Use of Estimates.    The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

        Fair Value of Financial Instruments.    The Company's financial instruments include rents receivable, accounts payable, other accrued expenses, mortgage loans payable and interest rate swap agreements. The fair values of these financial instruments other than the interest rate swap agreements and mortgage loans payable are not materially different from their carrying or contract values. The fair value of the interest rate swaps are estimated based on quotes from the market makers of these instruments and represents the estimated amounts the Company would expect to pay to terminate the agreements. Credit and market risk exposures are limited to the net interest differentials. The estimated unrealized net loss on these instruments was approximately $3.2 million and $0.8 million at December 31, 2001 and 2000. The carrying values of the Company's borrowings are estimated to be below fair value by approximately $11.5 million due to changes in comparable interest rates.

        Investment in Hotel Properties.    Hotel properties are recorded at cost and are depreciated using the straight-line method over estimated useful lives of 40 years for buildings and improvements and five to seven years for furniture and equipment. Repairs and maintenance costs are charged to expense as incurred. The Company periodically reviews the carrying value of each Hotel to determine if circumstances exist indicating impairment in the carrying value of the investment in the hotel or that

F-10

depreciation periods should be modified. If circumstances support the possibility of impairment, the Company will prepare a projection of the undiscounted future cash flows, without interest charges, of the specific hotel and determine if the investment in such hotel is recoverable based on the undiscounted cash flows. If impairment is indicated, an adjustment will be made to the carrying value of the hotel based on discounted future cash flows. The Company does not believe that there are any facts or circumstances indicating impairment of any of its investment in hotel properties.

        Cash and Cash Equivalents.    All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.

        Restricted Cash.    Restricted cash includes amounts the Company must make available for the replacement and refurbishment of furniture and equipment and amounts held in escrow by certain lenders for the payment of taxes and insurance.

        Deferred Expenses.    Deferred expenses, consisting of initial fees paid to franchisors, loan fees and other costs incurred in issuing debt, are recorded at cost. Amortization of franchise fees is computed using the straight-line method over the lives of the franchise agreements, which range from 10 to 15 years. Amortization of loan fees and other costs incurred in issuing debt are computed using the interest method over the maturity period of the related debt. Accumulated amortization of deferred expenses is $6.6 million and $5.0 million at December 31, 2001 and 2000, respectively.

        Minority Interest in Operating Partnership and other Consolidated Subsidiaries.    Minority interest in the Operating Partnership and other Consolidated Subsidiaries represents the limited partners' proportionate share of the equity in the Operating Partnership and other Consolidated Subsidiaries. Income (loss) is allocated to minority interest based on the weighted average percentage ownership throughout the year.

        Treasury Stock.    The Board of Directors approved a stock repurchase program to buy back up to 3 million shares of common stock on the open market subject to certain market conditions and other factors. During 2000, the Company repurchased 409 thousand shares of common stock at an average price per share of $10.88 or $4.4 million, bringing the total number of shares repurchased under the program to 576 thousand.

        Revenue Recognition.    In accordance with Staff Accounting Bulletin (SAB) 101, lease revenue is recognized as income after certain specific annual hurdles have been achieved by the lessee in accordance with the provisions of the Percentage Lease agreements. The lessees are in compliance with their rental obligations under the Percentage Leases. For the years ended December 31, 2001 and 2000, five and fifty-six hotels were leased to third party lessees, respectively.

        Income Taxes.    The Company has elected to be treated as a REIT under Sections 856 to 860 of the Internal Revenue Code. Prior to January 1, 2001, the Company, as a REIT, was not subject to federal income taxes. Under the RMA that became effective January 1, 2001, the Company leases its hotels to wholly-owned taxable REIT subsidiaries that are subject to federal and state income taxes. The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS 109, the Company accounts for income taxes using the asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

F-11

        Basic and Diluted Earnings Per Share.    Basic earnings per share is computed by dividing net income (loss) applicable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income (loss) applicable to common shareholders by the weighted average number of common shares and equivalents outstanding during the period. Common share equivalents represent shares issuable upon exercise of options. For the year ended December 31, 2001, the common share equivalents would be antidilutive, and accordingly are not assumed to be outstanding for the computation of diluted earnings per share. For the years ended December 31, 2000, 1999, the Company's Series A Preferred Stock, if converted to common shares, would be antidilutive; accordingly, the Series A Preferred Stock is not assumed to be converted in the computation of diluted earnings per share. In addition, the Series B Preferred Stock is non-convertible and accordingly, is not included in the computation of diluted earning per share.

        Derivatives.    Effective January 1, 2001, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 138, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Upon adoption of SFAS 133 on January 1, 2001, the Company recorded a liability of approximately $0.8 million with a corresponding charge to other comprehensive income representing the fair value of its interest rate swap agreements. At December 31, 2001, the fair value of the Company's interest rate swap agreements was a liability of approximately $3.2 million and is included in "Accounts payable and accrued expenses" with the related unrealized loss recorded in other comprehensive income within shareholders' equity. If LIBOR interest rates remain unchanged for the next twelve months, the Company estimates that interest expense will be $2.5 million higher than if the Company had not entered into the swaps. In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company limits these risks by following established risk management policies and procedures including the use of derivatives (cash flow hedges). Derivatives are used primarily to fix the rate on debt based on floating-rate indices. The Company does not use derivatives for trading or speculative purposes. Further, the Company has a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors.

        Segment Information.    SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires the disclosure of selected information about operating segments. Based on the guidance provided in the standard, the Company has determined that its business is conducted in one operating segment.

        Distributions.    The Company intends to pay regular quarterly distributions on its common shares and Operating Partnership units and the current quarterly distribution is $0.25 per share or unit, declared on January 31, 2002. Additionally, the Company pays regular quarterly dividends on its Series B Preferred Stock in accordance with its dividend requirements. The Company's ability to make distributions is dependent upon receipt of its quarterly distributions from the Operating Partnership.

F-12

Note 3. Investment in Hotel Properties

        Investment in hotel properties consists of the following at December 31, 2001, and 2000, respectively (in thousands):

	2001			2000
Land	$	70,401		$	71,886
Building and improvements		543,912			541,847
Furniture and equipment		115,479			106,554
Capital improvements program expenditures		16,422			19,245
		746,214			739,532
Accumulated depreciation		(130,652	)		(103,535	)
	$	615,562		$	635,997

        Capitalized interest was $0 and $0.6 million for the years ended December 31 2001 and 2000, respectively.

Note 4. Debt

        The following details the Company's debt outstanding at December 31, 2001 and 2000 and the net book value of the collateral pledged against the debt at December 31, 2001 (dollar amounts in thousands):

				Collateral
	Interest Rate		Maturity	# of Hotels	Net Book Value		2001		2000
Variable Rate Debt:
Line of Credit	LIBOR + 200bp		July 2004	24	$	216,228	$	11,188	$	10,273
Fixed Rate Debt:
Line of Credit	6.54	%	July 2003	(a)		(a)		40,000		40,000
Line of Credit	4.78	%	July 2003	(a)		(a)		30,000
Mortgage	6.83	%	August 2008	15		143,522		33,181		36,971
Mortgage	7.30	%	November 2011	(b)		(b)		25,000		25,000
Mortgage	7.83	%	December 2008	10		126,404		92,087		93,460
Mortgage	8.22	%	November 2007	1		44,421		18,271		18,556
Mortgage	4.50	%	January 2001							1,125
Mortgage	8.00	%	August 2010	8		84,987		51,408		52,046
					$	615,562	$	301,135	$	277,431

(a)

Interest rate swaps have fixed the rate of interest on these portions of the Line of Credit and these portions are also collateralized by the twenty-four properties pledged against the variable portion of the Line. The interest rate swaps mature in July 2003.

(b)

This mortgage is also collateralized by the fifteen properties pledged against the previous mortgage in the table.

F-13

        The interest rate on the $140 million Line of Credit that matures in July 2004 ranges from 150 basis points to 250 basis points above LIBOR, depending on the Company's ratio of total debt to its investment in hotel properties (as defined). The interest rate on the variable contracts of the Line of Credit outstanding at December 31, 2001 was 4.03%, calculated as the LIBOR interest rate of 2.03% plus 200 basis points. The Line of Credit is collateralized by first priority mortgages on 24 hotels that restrict the transfer, pledge or other hypothecation of the hotels (collectively, the "Collateral Pool"). The Company may obtain a release of the pledge of any hotel in the Collateral Pool if the Company provides a substitute hotel or reduces the total availability under the Line of Credit. Borrowings under the Line of Credit are limited to the Borrowing Base Value, which was $111.4 million at December 31, 2001. The Line of Credit contains various covenants including the maintenance of a minimum net worth, minimum debt and interest coverage ratios, and total indebtedness and liability limitations. The Company was in compliance with these covenants at December 31, 2001.

        The Company participates in two interest rate swap agreements. One of the interest rate swap agreements is for a notional amount of $30 million maturing in July 2003. Under this interest rate swap agreement, the Company receives payments based on the one month LIBOR rate of 2.14% and pays a fixed rate of 4.775% at December 31, 2001. In addition, the Company participates in a second interest rate swap agreement for a notional amount of $40 million maturing in July 2003. Under the second interest rate swap agreement, the Company receives payments based on the one-month LIBOR rate of 2.14% and pays a fixed rate of 6.535% at December 31, 2001.

        The differences to be paid or received by the Company under the terms of the interest rate swap agreements are accrued as interest rates change and recognized as an adjustment to interest expense by the Company pursuant to the terms of the agreements and have a corresponding effect on its future cash flows. Agreements such as these contain a credit risk that the counterparties may be unable to meet the terms of the agreement. The Company minimizes that risk by evaluating the creditworthiness of its counterparties, which is limited to major banks and financial institutions, and does not anticipate non-performance by the counterparties. Net receipts (payments) under the interest rate swap agreements were $(1.3) million, $0.1 million and $0 for the years ended December 31, 2001, 2000 and 1999.

        The fair value of the interest rate swap agreements are estimated based on quotes from the market makers of these instruments and represents the estimated amounts the Company would expect to receive or pay to terminate the agreements. Credit and market risk exposures are limited to the net interest differentials. The estimated unrealized net loss on these instruments was approximately $3.2 million and $0.8 million at December 31, 2001 and 2000.

        The Company's other borrowings are nonrecourse to the Company and contain provisions allowing for the substitution of collateral (except for the 1996 CMBS debt which matures in two tranches in August 2008 and November 2011), upon satisfaction of certain conditions, after the respective loans have been outstanding for approximately four years. Most of the mortgage borrowings are repayable and subject to various prepayment penalties, yield maintenance, or defeasance obligations. At December 31, 2001 and 2000, approximately 96% of RFS' debt is fixed at an average interest rate of 7.7%.

F-14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OF RFS HOTEL INVESTORS, INC. (Continued)

Note 4. Debt (Continued)

        Future scheduled principal payments of debt obligations at December 31, 2001 are as follows (in thousands):

	Amount
2002	$	6,547
2003		7,044
2004		88,735
2005		8,152
2006		8,772
Thereafter		181,885
	$	301,135

        The Company in the future may seek to increase further the amount of its credit facilities, negotiate additional credit facilities, or issue corporate debt instruments. Although the Company has no charter restrictions on the amount of indebtedness the Company may incur, the Board of Directors of the Company has adopted a current policy limiting the amount of indebtedness that the Company will incur to an amount not in excess of approximately 45% of the Company's investment in hotel properties, at cost, (as defined). The Board of Directors may change the debt policy at any time without shareholder approval.

        The Company may incur, or cause the Operating Partnership to incur, indebtedness to meet distribution requirements imposed on a REIT under the Internal Revenue Code including the requirement that a REIT distribute to its shareholders annually at least 90% (effective January 1, 2001) of its taxable income to the extent that working capital and cash flow from the Company's investments are insufficient to make such distributions.

Note 5. Income Taxes

        The Company elected to be taxed as a REIT under the Internal Revenue Code. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute as least 90% of its taxable income to its stockholders. It is management's current intention to adhere to these requirements and maintain the Company's REIT status. As a REIT, the Company generally will not be subject to corporate level federal income taxes on taxable income it distributes currently to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not qualify as a REIT for subsequent taxable years. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. In addition, taxable income from non-REIT activities managed through taxable REIT subsidiaries is subject to federal, state and local income taxes.

        Prior to January 1, 2001, the Company was not subject to federal income taxes. Under the RMA that became effective January 1, 2001, the Company leases its hotels to wholly-owned taxable REIT subsidiaries that are subject to federal and state income taxes. The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS 109, the Company accounts for income taxes using the

F-15

asset and liability method under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

        The components of income tax expense (benefit) for the year ended December 31, 2001 are as follows:

Current:
	State	$	20
Deferred:
	Federal		(24,734	)
Benefit from income taxes		$	(24,714	)

        The deferred tax benefit was calculated using an effective tax rate of 38% applied to the income of the TRS Lessees, adjusted for temporary differences related to the Hilton lease termination transaction. The deferred tax asset relates mainly to the payments to terminate the operating leases, management contracts and ancillary agreements with Hilton that were expensed for financial reporting purposes whereas, for tax purposes, these payments will be amortized over the lives of the leases. The Company believes that the TRS Lessees will generate sufficient future taxable income to realize in full this deferred tax asset. Accordingly, no valuation allowance has been recorded at December 31, 2001.

        The reconciliation of the Company's statutory income tax rate to effective tax rate for the year ended December 31, 2001 is as follows:

Statutory U.S. Federal income tax benefit		35	%
State income tax benefit		3	%
Non-taxable REIT income		25	%
Other		1	%
	Effective tax rate	64	%

F-16

Reconciliation between GAAP net income (loss) and REIT taxable income:

        The following table reconciles GAAP net income (loss) to taxable income for the years ended December 31, 2001, 2000 and 1999:

		2001			2000			1999
GAAP net income (loss)		$	(13,729	)	$	30,790		$	34,990
	Plus GAAP net loss on taxable subsidiaries included above		40,234			889			1,302
GAAP net income from REIT operations (a)			26,505			31,679			36,292
	Book/tax differences on minority interest share of TRS Lessees' loss		(3,206	)
	Book/tax differences on depreciation and amortization		4,333			(2,005	)		(4,609	)
	Book/tax differences on gains/losses from capital transactions		4,781			3,745			52
	Other book/tax differences, net		(180	)		915			1,689
Adjusted taxable income subject to distribution requirement (b)		$	32,233		$	34,334		$	33,424

(a)    All adjustments to "GAAP net income from REIT operations" are net of amounts attributable to taxable REIT subsidiaries and non-qualified REIT subsidiaries.

(b)    The dividend requirement was 90% in 2001 and 95% in 1999 and 2000, respectively.

Characterization of distributions:

        The following table characterizes distributions paid per common share for the years ended December 31, 2001, 2000 and 1999:

	2001				2000				1999
	$		%		$		%		$		%
Ordinary income	$	1.13	89.8	%	$	1.43	92.8	%	$	1.54	100	%
Return of capital		0.09	6.7	%		0.02	1.3	%
Capital gains						0.01	0.3	%
Unrecaptured Section 1250 gain		0.04	3.5	%		0.08	5.6	%
	$	1.26	100	%	$	1.54	100	%	$	1.54	100	%

Note 6. Capital Stock

        Preferred Stock.    The Board of Directors is authorized to provide for the issuance of up to 5 million shares of Preferred Stock in one or more series, to establish the number of shares in each series and to fix the designation, powers, preferences and rights of each such series and the qualifications, limitations or restrictions thereof.

        In 1996, the Company issued to one of the lessees 973,684 shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock"). The Company redeemed the Series A Preferred Stock on January 1, 2001 for cash consideration of $13.0 million, which resulted in a gain on redemption of $5.1 million that is included in net income (loss) applicable to common shareholders in 2001.

F-17

        On January 2, 2001, the Company issued 250 thousand shares of non-convertible mandatorily redeemable Series B Preferred Stock for $25 million prior to fees and expenses of approximately $1 million. Holders of the Series B Preferred Stock are entitled to receive quarterly cash dividends commencing March 31, 2001 at an annual rate of 12.5%. If not redeemed prior to January 1, 2006, the dividend rate increases 2.0% per annum up to a maximum rate of 20.5%. The Company may redeem shares of the Series B Preferred Stock in whole but not in part, on or after December 31, 2003 at the original price of $25 million. If the shares are redeemed before December 31, 2003, the redemption price is at varying amounts over the original share price. The shares are mandatorily redeemable by the holders at varying premiums over the original share price upon a change of control, dissolution, or winding up of the Company or on the Company's failure to qualify as a REIT.

        Operating Partnership Units.    RFS is the sole general partner of the Operating Partnership and is obligated to contribute the net proceeds from any issuance of its equity securities to the Operating Partnership in exchange for units of partnership interest ("Units") corresponding in number and terms to the equity securities issued. The Operating Partnership may also issue Units to third parties in exchange for cash or property, and Units so issued to third parties are redeemable at the option of the holder for a like number of shares of common stock of the Company, or cash, or a combination thereof, at the election of the Company.

Note 7. Commitments and Contingencies

        The Company maintains comprehensive insurance on each of its hotels, including liability, fire and extended coverage, of the type and amount customarily obtained for or by hotel owners. All 10 of the Company's hotels in California are located in areas that are subject to earthquake activity. These hotels are located in areas of high seismic risk and some were constructed under building codes which were less stringent with regard to earthquake related requirements. An earthquake could render significant damage to the Company's hotels. Additionally, areas in Florida where six of the Company's hotels are located may experience hurricane or high-wind activity. The Company has earthquake insurance policies on its hotels in California and wind insurance policies on certain of its hotels located in Florida. However, various types of catastrophic losses, like earthquakes and floods may not be fully insurable or may not be economically insurable. With respect to its hotels in California, in addition to the applicable deductibles under its earthquake insurance policies, the Company is self-insured for the first $5 million per earthquake. The Company believes its current property insurance, which expires June 30, 2002, will protect it against losses resulting from a terrorist attack. Upon renewal, the Company does not know whether its property insurance will protect it against losses resulting from a terrorist attack. The Company believes that such losses may not be economically insurable. In the event of a substantial loss, the Company's insurance coverage may not be able to cover the full current market value or replacement cost of its lost investment. Inflation, changes in building codes and ordinances, environmental considerations and other factors might also affect our ability to replace or renovate a hotel after it has been damaged or destroyed.

        As of December 31, 2001, the Company had a $0.6 million letter of credit outstanding. The letter of credit serves as collateral on the worker's compensation plan set-up on behalf of the hotel employees of Flagstone. On January 1, 2002, the letter of credit was increased to $2.0 million. There are no outstandings on the letter of credit.

F-18

        Effective January 1, 2001, the Company receives rental income from five hotels leased to third parties under the Percentage Leases which expire in 2007 (1 hotel), 2008 (2 hotels) and 2009 (2 hotels).

        Minimum future rental income (base rents) due the Company under these noncancelable operating leases at December 31, 2001, is as follows (in thousands):

Year	Amount
2002	$	2,489
2003		2,489
2004		2,489
2005		2,489
2006		2,489
2007 and thereafter		3,853
	$	16,298

        Lease revenue is based on a percentage of room revenues, food and beverage revenues and other revenues of the Hotels. Both the base rent and the threshold room revenue in each lease computation are adjusted annually for changes in the Consumer Price Index ("CPI"). The adjustment is calculated at the beginning of each calendar year. The CPI adjustments made in January 2001 and 2000 were 3.4% and 2.7%, respectively.

        The Company may terminate any lease agreement with respect to a hotel property upon the sale of a hotel property in exchange for a termination payment to the lessee. Under the Percentage Leases, the Company is obligated to pay the costs of real estate taxes, property insurance, maintenance of underground utilities and structural elements of the Hotels, and to set aside a portion of the Hotels' revenues to fund capital expenditures for the periodic replacement or refurbishment of furniture, fixtures and equipment required for the retention of the franchise licenses with respect to the Hotels.

Note 8. Stock-Based Compensation Plans

        The Company's Restricted Stock and Stock Option Plan (the "Plan") provides for the grant of stock options to purchase a specified number of shares of common stock ("Options") and grants of restricted shares of common stock ("Restricted Stock"). Under the Plan, approximately 2.3 million shares of common stock, of which 650 thousand shares may be restricted stock, are available for awards to the officers and key employees of the Company and 675 thousand shares of common stock, of which 120 thousand shares may be restricted stock, are available for awards to Directors of the Company who are not officers or employees. Options issued under the plan have a maximum term of ten years from the date of grant. The exercise price of the options shall be determined on the date of each grant.

        The Company applies APB Opinion No. 25 and related Interpretations in accounting for the Plan. In 1995, the Financial Accounting Standards Board issued SFAS Statement No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") which, if fully adopted by the Company, would change the methods the Company applies in recognizing the cost of the Plan. Adoption of the cost recognition provisions of SFAS 123 is optional and the Company has decided not to adopt the provisions of SFAS 123. However, pro forma disclosures, as if the Company adopted the cost recognition requirements of SFAS 123, are required by SFAS 123 and are presented below.

F-19

        A summary of the Company's stock options under the Plan as of December 31, 2001, 2000 and 1999, and the changes during the years are presented below (in thousands, except per share data):

	2001					2000					1999
	Number of Shares Underlying Options			Weighted Average Exercise Price		Number of Shares Underlying Options			Weighted Average Exercise Price		Number of Shares Underlying Options			Weighted Average Exercise Price
Outstanding at beginning of years		1,207		$	13.43		1,484		$	13.83		1,091		$	14.99
Granted		680			11.47		50			11.06		600			11.99
Exercised		(343	)		12.30		(30	)		11.88
Forfeited		(156	)		13.72		(297	)		14.64		(207	)		14.64
Outstanding at end of years		1,388		$	12.76		1,207		$	13.43		1,484		$	13.83
Exercisable at end of years		519		$	14.28		700		$	14.25		604		$	15.34
Weighted-average fair value				$	1.10				$	0.60				$	1.75
Price range of shares under option	$ $	10.50 to 16.87				$ $	10.50 to 16.87				$ $	10.50 to 16.87

        The weighted average remaining contractual life of options outstanding as of December 31, 2001 is 8.0 years.

        The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend of $1.10; volatility of 26.7% for 2001 grants, volatility of 26.2% for 2000 grants and 29% for 1999 grants, risk-free interest rate of 4.8% for 2001, 6.2% for 2000 and 5.9% for 1999 and expected life of 6 years for 2001, 2000, and 1999.

        Had compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS 123, the Company's net income (loss) and earnings per share would have been reduced to the pro forma amounts indicated below:

		2001			2000		1999
Net income (loss) applicable to common shareholders:
	As reported	$	(11,713	)	$	29,378	$	33,578
	Pro forma	$	(12,013	)	$	29,045		33,279
Basic and diluted earnings (loss) per share:
	As reported	$	(0.47	)	$	1.20	$	1.34
	Pro forma	$	(0.48	)	$	1.18	$	1.33

        The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts.

F-20

        Restricted Stock.    A summary of the status of the Company's restricted stock grants as of December 31, 2001, 2000 and 1999 and the changes during the years are presented below (value is computed as the weighted average fair market value of the restricted stock at grant date):

	2001				2000			1999
	# Shares		Value		# Shares	Value		# Shares	Value
Outstanding at beginning of year	343,000		$	13.42	329,000	$	13.56	288,000	$	13.82
Granted, subject to vesting	270,000		$	13.11	14,000	$	11.36	41,000	$	11.75
Forfeited	(1,333	)	$	11.88
Outstanding at end of year	611,667		$	13.31	343,000	$	13.42	329,000	$	13.56
Vested at end of year	314,000		$	13.65	270,662	$	13.89	211,999	$	14.40

Note 9. Recent Accounting Pronouncements

        In August 2001, the Financial Accounting Standards Board ("FASB") approved SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The Statement requires that long-lived assets to be disposed of other than by sale be considered held and used until they are disposed of. The Statement requires that long-lived assets to be disposed of by sale be accounted for under the requirements of SFAS No. 121 which requires that such assets be measured at the lower of carrying amounts or fair value less cost to sell and to cease depreciation. SFAS No. 144 requires a probability-weighted cash flow estimation approach with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration or a range of possible future cash flow amounts are estimated. As a result, discontinued operations will no longer be measured on a net realizable basis, and future operating losses will no longer be recognized before they occur. Additionally, goodwill will be removed from the scope SFAS No. 144 and as a result will no longer be required to be allocated to long-lived assets to be tested for impairment. The Statement is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company is not currently affected by the Statement's requirements.

Note 10. Subsequent Events

        In January, the Company sold its interest in an investment in an unconsolidated partnership for approximately $1.2 million, recognizing a gain on sale of approximately $1.1 million.

        The Company announced on February 7, 2002, that the Operating Partnership intends to offer $125 million of senior notes. The senior notes would be unsecured and guaranteed by the Company and certain of its subsidiaries. The Company would use the net proceeds to retire the 1996 CMBS mortgage debt ($58,181 outstanding at December 31, 2001), pay the prepayment penalty on the 1996 CMBS mortgage debt of $6.5 million, terminate the two outstanding interest rate swap agreements for approximately $3.2 million, with the balance used to reduce outstanding borrowings under the line of credit. As a result of the prepayment of the 1996 CMBS debt, the Company will also expense as an extraordinary item $1.4 million in unamortized debt costs.

F-21

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INDEX TO FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
RFS HOTEL INVESTORS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
RFS HOTEL INVESTORS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 2001, 2000 and 1999 (in thousands, except per share data)
RFS HOTEL INVESTORS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) For the Years Ended December 31, 2001, 2000 and 1999 (in thousands)
RFS HOTEL INVESTORS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Years Ended December 31, 2001, 2000 and 1999 (in thousands, except per share data)
RFS HOTEL INVESTORS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2001, 2000 and 1999 (in thousands)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS OF RFS HOTEL INVESTORS, INC.

EX-99.2

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Exhibit 99.2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

        We are a hotel real estate investment trust which, at December 31, 2001, owned interests in 58 hotels with 8,424 rooms located in 24 states. RFS Hotel Investors, Inc. owns an approximately 91% interest in RFS Partnership, L.P., its operating partnership (the "Operating Partnership").

        For the year ended December 31, 2001, we received 42% of EBITDA from full service hotels, 33% from extended stay hotels and 25% from limited service hotels.

        The following summarizes additional information for our hotels owned as of December 31, 2001:

Franchise Affiliation			Hotel Properties	Rooms/Suites	EBITDA
					(in thousands)
Full Service Hotels:
	Sheraton		4	864	$	10,749
	Holiday Inn		5	954		8,359
	Independent		2	331		4,771
	Four Points by Sheraton		2	412		4,673
	Hilton		1	234		3,418
	Doubletree		1	221		2,454
			15	3,016		34,424
Extended Stay Hotels:
	Residence Inn by Marriott		14	1,851		24,015
	TownePlace Suites by Marriott		3	285		2,231
	Homewood Suites by Hilton		1	83		521
			18	2,219		26,767
Limited Service Hotels:
	Hampton Inn(1)		17	2,113		13,621
	Holiday Inn Express		5	637		4,363
	Courtyard by Marriott		1	102		1,134
	Comfort Inn(1)		2	337		1,096
			25	3,189		20,214
		Total	58	8,424	$	81,405

(1)

Excludes EBITDA of approximately $0.1 million and $0.3 million from the Hampton Inn in Plano, Texas that was sold on February 20, 2001 and the Comfort Inn in Farmington Hills, Illinois that was sold on May 31, 2001, respectively.

Termination of Leases and Related Agreements with Hilton

        Under the REIT Modernization Act that became effective January 1, 2001, we are permitted to lease our hotels to our wholly-owned taxable real estate investment trust subsidiaries ("TRS lessees"), provided that the TRS lessees engage a third-party management company to manage the hotels. Effective January 1, 2001, we terminated our operating leases, management contracts and related

1

ancillary agreements with a wholly-owned subsidiary of Hilton Hotels Corporation ("Hilton") for approximately $60 million, plus related expenses, at which time our TRS lessees began leasing the hotels previously leased by Hilton. This payment to Hilton represented the cancellation of executory contracts that extended through 2012 and substantially all of the termination payment was recorded as an expense on January 1, 2001. The cancellation of these agreements entitles the TRS lessees to retain the operating profits or losses from hotels, which previously accrued to Hilton under these contracts, and gives us the following advantages over our prior third-party structure:

•

more control over the daily operations of these hotels;



•

benefits from any cost efficiencies or ancillary revenues generated at these hotels;



•

these hotels are not encumbered by long term third-party leases;



•

favorable management agreements; and



•

our financial statements more clearly depict our hotel operations.

All of the hotels continue to operate under the same franchise affiliation as prior to the contract termination.

        Effective January 1, 2001, the TRS lessees entered into new management contracts with Flagstone Hospitality Management ("Flagstone"). Flagstone is a recently formed company owned by MeriStar Hotels & Resorts, Inc., a leading independent hotel management company. At December 31, 2001, Flagstone managed 51 of our 58 hotels, two of our hotels were managed by other hotel management companies and five of our hotels were operated under long term leases with third-parties.

        In connection with the termination of the leases and related agreements, we redeemed 973,684 shares of our Series A Preferred Stock owned by a subsidiary of Hilton for $13 million, plus expenses. In connection with this transaction, we recorded a $5 million gain on redemption of Series A preferred stock on January 1, 2001, the gain represents the difference between our purchase price and the approximately $18 million of proceeds received from the original sale of the Series A Preferred Stock.

        The aggregate $73 million of payments to Hilton ($60 million lease termination expense plus $13 million to repurchase the Series A Preferred Stock, plus related expenses), were financed by:

•

the sale of two hotels in 2000;



•

net proceeds from the sale of our Series B Preferred Stock; and



•

borrowings under our line of credit.

Results of Operations

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

        For the year ended December 31, 2000, we leased 56 hotels to third parties and reported percentage lease revenue. In connection with the Hilton lease termination transaction, effective January 1, 2001, we leased 51 of these hotels to our TRS lessees. Effective January 1, 2001, we also leased four additional hotels, that were not previously leased, to our TRS lessees. We subsequently sold two hotels. As a result of these transactions, the TRS lessees now lease 53 hotels and we reported hotel operating revenues and expenses with regard to these hotels for the year ended December 31, 2001. Accordingly, the hotel revenues and operating expenses for 2001 are not directly comparable to 2000, where we reported only percentage lease revenue from our hotels.

2

Revenues

        Total revenue increased $114.5 million over 2000. The increase is principally a result of reporting hotel operating revenues compared to the percentage lease revenue reported in the prior year.

Expenses

        Total operating expenses increased $191.7 million. This increase is associated with the reporting of hotel operating expenses in 2001.

        Property taxes, insurance and other expenses increased $2.1 million or 19.5%, due primarily to the inclusion of hotel operating costs (liability insurance of $1.0 million and personal property taxes of $0.7 million) in 2001. The remainder of the variance relates to increase in earthquake insurance ($0.3 million), and property insurance ($0.1 million).

        Depreciation increased 8.8% due to the increase in depreciable assets resulting from renovation expenditures at certain of our hotels, including the Hilton San Francisco Fisherman's Wharf.

        The lease termination expenses of $65.5 million represents the expenditures incurred in connection with the termination of the leases, management contracts and related ancillary agreements with Hilton. For accounting purposes, this transaction represented the cancellation of executory contracts and was required to be expensed as incurred.

        Amortization of deferred expenses and unearned compensation increased $0.7 million over 2000 as a result of stock grants in 2001.

        General and administrative expenses increased $13.1 million due primarily to the inclusion of hotel general and administrative expenses of $15.2 million in 2001, offset by a decrease of $2.1 million in corporate general and administrative expenses. In the second and third quarters of 2001, we implemented austerity programs aimed at reducing these expenses as well as hotel operating expenses, which provided a $1.0 million favorable variance versus 2000. In addition, we reduced executive bonuses for 2001 by $0.6 million as compared to 2000. The remainder of the variance relates to the first quarter 2000, when we wrote off development and due diligence costs for potential projects that we decided not to pursue, of $0.2 million and incurred severance expense of approximately $0.3 million associated with a former employee.

        Interest expense increased $2.0 million due to a weighted average increase in borrowings of approximately $19.5 million as well as an increase in the weighted average interest rate on borrowings outstanding on our line of credit from 7.6% in 2000 to 7.9% in 2001. In addition, amortization of debt issue costs increased $0.3 million due to the costs incurred to issue new debt in 2000 and complete amendments to the line of credit. Borrowings increased primarily to fund the lease termination costs as well as renovation costs.

        The benefit from income taxes in 2001 relates to the $65.5 million book loss recorded by our TRS lessees. This loss relates primarily to the lease termination payments.

Net Income (loss)

        Net income (loss) applicable to common shareholders was $(11.7) million in 2001 and $29.4 million in 2000. The $45 million reduction in net income relates primarily to the $65.5 million lease termination expense offset by the related benefit from income taxes of $24.7 million. Included in the net loss applicable to common shareholders is a gain of $5.1 million recognized on the redemption of the Series A Preferred Stock in 2001.

3

Year Ended December 31, 2001 Compared to Pro Forma Year Ended December 31, 2000

        During 2000, our revenues primarily consisted of rental income from third-party lessees. As a result of the previously discussed termination of the leases and related agreements with Hilton, beginning January 1, 2001, our consolidated results of operations primarily reflect hotel-related revenues and operating costs. As a result, a comparison of historical results for the year ended December 31, 2001 to the year ended December 31, 2000 would not be as meaningful as a discussion of the actual 2001 results versus 2000 pro forma results. Accordingly, we have presented a discussion of the actual year ended December 31, 2001 versus a pro forma year ended December 31, 2000. The pro forma results of operations for the year ended December 31, 2000 assumes that the following occurred on January 1, 2000:

•

the termination of the Hilton leases, management contracts and ancillary agreements;



•

the formation of TRS lessees to lease 54 of our hotels (one of which was subsequently sold);



•

the implementation of the hotel management agreements between the TRS lessees and Flagstone Hospitality Management, LLC;



•

the sale of three hotels in 2000;



•

the redemption of our Series A Preferred Stock; and



•

the issuance of our Series B Preferred Stock.

4

Unaudited Pro Forma Consolidated Statement of Operations for the Year Ended December 31, 2000

			Historical						Pro Forma Adjustments
(in thousands)			RFS Hotel Investors, Inc.			RFS, Inc.			Sale of Hotels			Other Properties			Other			Pro Forma RFS Hotel Investors, Inc.
			(a)			(b)			(c)			(d)
Revenue:
	Rooms					$	177,406		$	(8,350	)	$	30,878					$	199,934
	Food and beverage						13,348						6,345						19,693
	Other operating departments						8,631			(328	)		1,501						9,804
	Lease		$	106,574						(4,052	)		(14,953	)	$	(81,692	)(e)		5,877
	Other			785			2,394									(2,236	)(f)		943
		Total hotel revenue		107,359			201,779			(12,730	)		23,771			(83,928	)		236,251
Hotel operating expenses by department:
	Rooms						32,637			(1,554	)		7,112						38,195
	Food and beverage						9,271						5,218						14,489
	Other operating departments						1,956			(118	)		449						2,287
Undistributed operating expenses:
	Property operating costs						20,005			(982	)		4,024						23,047
	Property taxes, insurance and other			10,747			1,176			(347	)		187						11,763
	Franchise costs						15,680			(580	)		1,061						16,161
	Maintenance and repair						8,667			(382	)		1,475						9,760
	Management fees						1,565						716			3,458	(g)		5,739
	Percentage lease						85,744			(4,052	)					(81,692	)(e)		—
	Depreciation			27,198			5,419			(623	)					(5,419	)(f)		26,575
	Amortization of deferred expenses and unearned compensation			674															674
	General and administrative			6,304			16,608			(564	)		3,292			(3,685	)(f)		21,955
		Total operating expenses		44,923			198,728			(9,202	)		23,534			(87,338	)		170,645
Operating income				62,436			3,051			(3,528	)		237			3,410			65,606
	Interest expense			24,052												1,411	(h)		25,463
Income before minority interest, loss on sale of hotels, and income taxes				38,384			3,051			(3,528	)		237			1,999			40,143
	Loss on sale of hotel properties			4,376															4,376
	Minority interest in Operating Partnership and subsidiaries			3,218															3,218
	Income taxes						3,169									(490	)(j)		2,679
Income from continuing operations				30,790			(118	)		(3,528	)		237			2,489			29,870
Preferred stock dividends				(1,412	)											(1,713	)(i)		(3,125	)
Income from continuing operations applicable to common shareholders			$	29,378		$	(118	)	$	(3,528	)	$	237		$	776		$	26,745

See Notes to Unaudited Pro Forma Consolidated Statement of Operations.

5

Notes to Unaudited Pro Forma Consolidated Statement of Operations

a)

Represents the Company's historical results of operations.

b)

Represents RFS, Inc.'s historical results of operations.

c)

Eliminate the historical results of operations of the three properties sold by the Company during 2000: the Hawthorn Suites in Atlanta, Georgia, Hampton Inn in Warren, Michigan and Hampton Inn in Plano, Texas. These properties were also leased to RFS, Inc.

d)

Represents the historical results of operations of four hotels that were owned by the Company throughout 2000 and not leased. The operating results of these hotels were grouped with lease revenue due to their insignificance. Also includes operating results of the Beverly Heritage hotel that was leased to a subsidiary of Hilton other than RFS, Inc. and the operations of the Hilton Fisherman's Wharf hotel that was leased to another third party until December 31, 2000. The net income for these properties in the pro forma statement of operations is the lessee profit for the Beverly Heritage hotel and the Hilton Fisherman's Wharf hotel. Effective January 1, 2001, all six of these hotels are leased to the TRS Lessees.

e)

Eliminate the lease revenue earned by the Company from its leases with RFS, Inc.

f)

Eliminate the RFS, Inc. management and consulting fees, other revenue, corporate general and administrative expenses, depreciation and amortization that do not accrue to the Company as a result of the Hilton lease termination transaction.

g)

Adjust historical management fees to the new management contracts that are effective January 1, 2001.

h)

Represents the increase in interest expense (computed using the 1999 weighted average interest rate of 7.6%) after applying the net proceeds from the sale of three hotels of $30.8 million to the line of credit and the additional draw on the line of credit of approximately $49.3 million to fund the Hilton lease termination transaction.

i)

Recognize the following preferred stock transactions as if they occurred on January 1, 2000:

1)

The Company purchased 973,684 shares of the Company's Series A Preferred Stock owned by Hilton for approximately $13 million, accordingly, the historical preferred dividends have been eliminated.

2)

The Company issued 250 thousand shares of non-convertible mandatorily redeemable Series B Preferred Stock for $23.9 million, net of fees and expenses. Holders of the Series B Preferred Stock are entitled to receive quarterly cash dividends commencing March 31, 2001 at an annual rate of 12.5%. The preferred dividends are included in the pro forma financial information.

j)

Eliminate income tax expense on RFS, Inc. of $3.2 million that does not accrue to the Company as a result of the Hilton lease termination transaction and to recognize a provision for deferred income taxes of approximately $2.7 million associated with the Company's TRS Lessees (calculated as the TRS Lessees income before income taxes for financial reporting purposes multiplied by 40%). Since the payments to terminate the operating leases, management contracts and ancillary agreements represented the cancellation of executory contracts, the lease termination payments were expensed for financial reporting purposes. However, for tax purposes, the lease termination payments will be amortized over a period of years and the amortization will offset the income of the TRS such that the income tax provision in future years will be primarily a deferred tax provision.

6

Revenues

        Revenue decreased 6.1% from $236.2 million to $221.9 million primarily due to the slowing economy exacerbated by the terrorist activities of September 11, 2001. Revenue per available room (RevPAR) at our 56 comparable hotels declined 4.6% due to a decline in occupancy of 3.3 percentage points and a decline in average daily rate of 0.1%. The revenue decline of 6.1% resulted from weak third and fourth quarters where RevPAR at our comparable hotels decreased 12.3% and 15.9%, respectively, promulgated by the significant decline in travel following the terrorist activities. Since the week ended September 22, RevPAR has improved incrementally at our hotels, albeit at levels well below 2000 levels. RevPAR at our full service, extended stay and limited service hotel portfolios showed decreases in RevPAR of 10.4%, 1.3% and 0.3%, respectively from the comparable 2000 period. The comparable California hotels (9 of 10 hotels excluding the Hilton San Francisco Fisherman's Wharf which was undergoing renovation in 2000) experienced an average RevPAR decrease of 9.9%. Excluding our California hotels, RevPAR decreased 1.8%. California hotels represented 36% of room revenue in 2001. Within California, San Francisco and Silicon Valley generated approximately 22% of room revenue and the economy of this area has deteriorated rapidly in 2001, even prior to the events of September 11, as a result of the dot-com implosion, the well-publicized energy crisis, a weak convention calendar and the poor Japanese economy.

        The following shows hotel operating statistics for the 56 comparable hotels for the year ended December 31, 2001. Excluded from the 56 comparable hotels are the Hilton San Francisco Fisherman's Wharf hotel, which underwent renovation and was converted from a Ramada Plaza in 2000 and the Sheraton Hotel in Birmingham, Alabama, which was undergoing renovation in 2000.

COMPARABLE HOTELS OPERATING STATISTICS
For the Year Ended December 31, 2001

	ADR				OCCUPANCY			RevPAR
Hotel Type	2001		Variance vs. 2000		2001		Variance vs. 2000	2001		Variance vs. 2000
Full Service	$	108.52	(2.0)	%	67.9	%	(6.4) pts	$	73.73	(10.4)	%
Extended Stay		96.55	2.0	%	78.5	%	(2.7) pts		75.83	(1.3)	%
Limited Service		70.91	1.8	%	67.4	%	(1.4) pts		47.79	(0.3)	%
Total	$	90.50	(0.1)	%	70.7	%	(3.3) pts	$	63.95	(4.6)	%

        The comparable full service hotels (year to date excludes the Hilton San Francisco Fisherman's Wharf and the Sheraton hotel in Birmingham) produced an average RevPAR decrease of 10.4% year to date. The following six full service hotels located in Silicon Valley and San Francisco had RevPAR changes for the year ending December 31, 2001 as follows:

Hotel	Location	RevPAR Change
173-room Sheraton	Sunnyvale, CA	(15.0)	%
237-room Beverly Heritage	Milpitas, CA	(18.4)	%
229-room Sheraton	Milpitas, CA	(13.1)	%
214-room Sheraton Four Points	Pleasanton, CA	(9.4)	%
234-room Hilton	San Francisco, CA	(9.6)	%
94-room Hotel Rex	San Francisco, CA	(31.0)	%

        As explained previously, coupled with the events of September 11, the Silicon Valley and San Francisco markets have declined due to deteriorating economic conditions, particularly in the technology sector, and this adversely affected the operating results of these hotels.

7

        Our extended stay hotels, which comprised approximately 33% of EBITDA, experienced a decline in RevPAR of 1.3%. Fourteen of our 18 extended stay properties are Residence Inns by Marriott, which experienced a decrease in RevPAR of 1.2%. We believe that Residence Inns by Marriott is the extended stay brand of choice for consumers as these hotels benefit from longer duration stays that include the typically slower weekend days. Similarly, most of our extended stay hotels, with the exception of our 176-room Residence Inn in Orlando, are in markets that can be categorized as "drive to" markets rather than air travel markets. These hotels have been less affected by the events of September 11, with RevPAR declines of 11.4% since September 11, as our extended stay hotels have performed with less volatility than many of our full service hotels in a slowing market.

        Our limited service hotels, which comprised approximately 25% of EBITDA, experienced a decrease in RevPAR of 0.3%. This market segment performed the best in terms of RevPAR versus the prior year. Seventeen of the 26 limited service hotels are Hampton Inns, which we believe is the best upscale limited service brand. These Hampton Inns produced a RevPAR increase of 3.6% from increases in occupancy of 0.2 points and ADR of 3.3%, respectively. These results are due to a combination of a slowing rate of increase in limited service room supply and increased demand resulting from a slowing economy that translated into guests trading down in price point to stay at limited service hotels. Like the extended stay hotels, these hotels have been less impacted by the events of September 11 than full service hotels.

        Food and beverage revenue decreased $2.0 million or 10.1%, directly attributable to the decrease in RevPAR of 10.4% on our full service portfolio. Revenue from other operating departments decreased $0.7 million or 7.1% as a result of fewer guest staying at all of our hotels, where RevPAR decreased 5.6%.

Expenses

        Total operating expenses increased $65.9 million due primarily to the lease termination expense of $65.5 million. Excluding the lease termination expense, operating margins (operating income as a percentage of total hotel revenue) decreased 4.9 points to 22.9% form 27.8%, driven by the decrease in revenue of 6.1%. Individual line items comprising hotel operating expenses are discussed below.

        Hotel operating expenses decreased 4.1% to $52.7 million from $55.0 million; however, as a percentage of total hotel revenue, hotel operating expenses increased to 23.8% in 2001 versus 23.3% in 2000. The increased percentage was due to the tight labor market conditions which resulted in an increased wage rate, but were partially offset by head count reductions that were made as the economy slowed throughout the year.

        Property operating costs decreased $0.5 million or 2.2% due primarily to a decrease in other capital expenses and operating leases of $1.0 million, offset by an increase in energy costs of 7.3% due primarily to the California energy crisis earlier in the year. At our ten California properties, energy costs rose 15.4%. We have implemented several initiatives, including the use of high efficiency lighting, to lessen the impact of increased energy costs going forward.

        Property taxes, insurance and other expenses increased $1.0 million or 9.2%, driven primarily by increased costs of all types of insurance, including liability insurance ($0.4 million), earthquake insurance ($0.3 million), and property insurance ($0.1 million). The remainder of the variance ($0.2 million) is attributable to increased personal property taxes at our hotels resulting from the significant renovations at certain hotels.

        Franchise costs increased $0.9 million or 5.2% due primarily to the brands frequency programs (specifically the Hilton HHonors® program which is now accepted at our Hampton Inns). While these increasing costs are not directly attributable to increased revenues, we have seen a beneficial effect on RevPAR at our limited service hotels.

8

        Depreciation increased 11.4% due to the increase in depreciable assets resulting from capital improvements at certain of our hotels, including the Hilton San Francisco Fisherman's Wharf. As a percentage of hotel revenue, depreciation increased from 11.3% to 13.3%. We are now substantially finished with major renovations and expect depreciation increases to level off.

        The lease termination costs of $65.5 million represent the expenditures incurred in connection with the termination of the leases, management contracts and related ancillary agreements with Hilton. For accounting purposes, this transaction represented the cancellation of executory contracts and was required to be expensed as incurred.

        Amortization of deferred expenses and unearned compensation increased $0.7 million as a result of stock grants in January 2001.

        General and administrative expenses decreased $2.5 million due primarily to the decrease in corporate general and administrative expenses of $2.1 million to 1.9% from 2.7% of hotel revenue. In the second and third quarters of 2001, we implemented austerity programs aimed at reducing these expenses as well as hotel operating expenses, which provided a $1.0 million favorable variance versus 2000. In addition, we reduced executive bonuses for 2001 by $0.6 million as compared to 2000. The remainder of the variance relates to the first quarter of 2000, when we wrote off development and due diligence costs of $0.2 million for potential projects that we decided not to pursue and incurred severance expense of approximately $0.3 million associated with a former employee.

        Interest expense increased $0.6 million or 2.3% due to the increase in the weighted average interest rate on borrowings outstanding on our line of credit from 7.6% in 2000 to 7.9% in 2001. In addition, amortization of debt issue costs increased $0.3 million due to the costs incurred to issue new debt in 2000 and complete amendments to the line of credit.

        The benefit from income taxes in 2001 relates to the $65.5 million book loss recorded by our TRS lessees relating primarily to the Hilton lease termination.

Net Income (loss)

        Net income (loss) applicable to common shareholders was $(11.7) million in 2001 and $26.7 million in 2000. The $44 million reduction in net income relates primarily to the $65.5 million lease termination expense net of the related benefit from income taxes of $24.7 million. Included in the net loss applicable to common shareholders is a gain of $5.1 million recognized on the redemption of the Series A Preferred Stock from Hilton in 2001.

Funds From Operations and EBITDA

        We consider Funds From Operations (FFO) and EBITDA to be appropriate measures of a REIT's performance which should be considered along with, but not as an alternative to, net income and cash flow as a measure of our operating performance and liquidity.

        The National Association of Real Estate Investment Trusts (NAREIT), defines FFO as net income (computed in accordance with generally accepted accounting principles or GAAP), excluding gains or losses from debt restructuring which would be extraordinary items in accordance with GAAP and sales of depreciable operating properties, plus real estate related depreciation and amortization and after comparable adjustments for our portion of these items related to unconsolidated partnerships and joint ventures. Recurring FFO represents FFO, as defined by NAREIT, adjusted for significant non-recurring items including lease termination costs and deferred income taxes. However, Recurring FFO and EBITDA as presented may not be comparable to amounts calculated by other companies. Recurring FFO and EBITDA do not represent cash flows from operations as determined by GAAP and should not be considered as an alternative to net income as an indication of our financial performance or to cash flow from operating activities determined in accordance with GAAP as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make cash distributions.

9

        The following details our computation of recurring FFO (in thousands):

	Year Ended December 31,
	2001			2000			1999
Net income (loss)	$	(13,729	)	$	30,790		$	34,990
Minority interest in Operating Partnership		(1,157	)		3,218			3,620
Depreciation		29,605			27,198			24,210
Hilton lease termination expense, net of deferred income taxes		40,762			—			—
(Gain) loss on sale of hotel properties		(1,127	)		4,376			1,602
Preferred stock dividends		(3,125	)		(1,412	)		(1,412	)
Recurring FFO	$	51,229		$	64,170		$	63,010
Weighted average, common shares, partnerships units and potential dilutive shares outstanding		27,655			27,127			27,569

        The following details our computation of EBITDA (in thousands):

	Year Ended December 31,
	2001		2000		1999
Recurring FFO	$	51,229	$	64,170	$	63,010
Interest expense		26,042		24,052		20,836
Amortization		1,384		674		858
Current income taxes		20		—		—
Preferred stock dividends		3,125		1,412		1,412
EBITDA	$	81,800	$	90,308	$	86,116

Liquidity and Capital Resources

        For the year ended December 31, 2001 cash flow provided by operating activities was $10.5 million. We believe that cash provided by our operating activities will be adequate to meet some of our liquidity needs. We currently expect to fund our strategic objectives and any other liquidity needs by borrowing on our line of credit, exchanging equity for hotel properties or accessing the capital markets as market conditions permit. At December 31, 2001, we had $5.7 million of cash and cash equivalents and had borrowed $81.2 million under our $140.0 million line of credit. The borrowing capacity under our line of credit is determined by a borrowing base calculation which, at December 31, 2001, based on the hotels currently in the collateral pool, would permit us to borrow up to approximately $111.4 million.

        We announced on February 7, 2002 that the Operating Partnership intends to offer up to $125 million of senior notes. The senior notes would be unsecured and guaranteed by RFS and certain of the Operating Partnership's subsidiaries. The Operating Partnership would use the net proceeds to retire the 1996 CMBS mortgage debt ($58,181 outstanding at December 31, 2001), pay the prepayment penalty on the 1996 CMBS mortgage debt of $6.5 million, terminate the two outstanding interest rate swap agreements for approximately $3.2 million, with the balance used to reduce outstanding borrowings under the line of credit. As a result of the prepayment of the 1996 CMBS debt, the Operating Partnership will also expense as an extraordinary item $1.4 million in unamortized debt costs.

10

        The following details our debt outstanding at December 31, 2001 (dollar amounts in thousands):

						Collateral
	Actual Balance		Interest Rate		Maturity	# of Hotels	Net Book Value at December 31, 2001
Line of Credit	$	81,188	LIBOR + 200bp(1)	Variable	July 2004	24	$	216,228
1996 Mortgage Debt, Class A		33,181	6.83%	Fixed	August 2008	15		143,522
1996 Mortgage Debt, Class B		25,000	7.30%	Fixed	November 2011	(2)		(2)
Mortgage Debt		92,087	7.83%	Fixed	December 2008	10		126,404
Mortgage Debt		18,271	8.22%	Fixed	November 2007	1		44,421
Mortgage Debt		51,408	8.00%	Fixed	August 2010	8		84,987
	$	301,135					$	615,562

(1)

Effective April 1, 2002, this interest rate is expected to increase to LIBOR + 225 basis points.

(2)

This mortgage debt is also collateralized by the 15 properties pledged against the 1996 Mortgage Debt, Class A.

        The interest rate on our line of credit ranges from 150 basis points to 250 basis points above LIBOR, depending on our ratio of total debt to investment in hotel properties (as defined). The average interest rate on our line of credit (including the impact of our interest rate swaps) was approximately 7.9% for the year ended December 31, 2001. Our line of credit is collateralized by first priority mortgages on 24 hotels that restrict the transfer, pledge or other hypothecation of the hotels (collectively, the "collateral pool"). We can obtain a release of the pledge of any hotel in the collateral pool if we provide a substitute hotel or reduce the total availability under the line of credit. Our line of credit contains various covenants including the maintenance of a minimum net worth, minimum debt and interest coverage ratios, and total indebtedness and liability limitations. We were in compliance with these covenants at December 31, 2001.

        On March 21, 2001, we entered into an interest rate swap agreement, which effectively fixed the interest rate on $30.0 million of our floating rate debt at 6.775% through July 20, 2003. The 6.775% interest rate consists of a fixed rate of 4.775% plus the credit spread in effect on our line of credit (currently 200 basis points). The credit spread can vary from 150 basis points to 225 basis points, depending on our leverage ratios. The agreement effectively converts a portion of our floating rate debt to fixed rate in order to reduce our risk to increases in interest rates. Such agreements involve the exchange of fixed and floating interest rate payments over the life of the agreement without the exchange of the underlying principal amounts. In addition, we participate in a second interest rate swap agreement for a notional amount of $40.0 million maturing in July 2003. Under the interest rate swap agreement, at December 31, 2001, we receive payments based on the one-month LIBOR rate of 2.14% and pay a fixed rate of 6.535%.

        Our other borrowings are nonrecourse to us and contain provisions allowing for the substitution of collateral, upon satisfaction of certain conditions, after the respective loans have been outstanding for approximately four years. Most of the mortgage borrowings are repayable, subject to various prepayment penalties, yield maintenance or defeasance obligations. At December 31, 2001, approximately 96% of our debt was fixed at an average interest rate of 7.7%.

11

        Future scheduled principal payments of debt obligations at December 31, 2001, are as follows (in thousands):

	Actual
2002	$	6,547
2003		7,044
2004		88,735	(1)
2005		8,152
2006		8,772
Thereafter		181,885
	$	301,135

(1)

Includes the outstanding balance of our line of credit, as of December 31, 2001, which is scheduled to mature on July 30, 2004.

        On January 2, 2001, we issued 250,000 shares of non-convertible mandatorily redeemable Series B Preferred Stock at a stated value of $25 million. Holders of our Series B Preferred Stock are entitled to receive quarterly cash dividends commencing March 31, 2001 at an annual rate of 12.5% of the stated value. If not repaid, beginning January 1, 2006, the dividend rate increases 2.0% per annum up to a maximum rate of 20.5%. We may redeem shares of the Series B Preferred Stock in whole but not in part, on or after December 31, 2003 at the stated value of $25 million. If the shares are redeemed before December 31, 2003, the redemption price is at varying premiums over the original share price. The shares are mandatorily redeemable upon a change of control, dissolution, or winding up or on our failure to qualify as a REIT. We contributed the proceeds from the sale of the Series B Preferred Stock to the Operating Partnership in exchange for 250,000 units of nonconvertible mandatorily redeemable Series B Preferred Units with the same terms as the Series B Preferred Stock issued by us.

        Certain significant credit statistics at December 31, 2000 and 2001 are as follows:

Credit Statistic	December 31, 2000	December 31, 2001
EBITDA to interest expense	3.9x	3.3x
Total debt to EBITDA	3.1x	3.7x
Weighted average maturity of fixed rate debt	8.4 years	7.3 years
Ratio of fixed interest rate debt to total debt	96%	96%
Ratio of debt to investment in hotel properties, at cost(1)	38%	38%

(1)

Investment in hotel properties at cost, as defined by the Company.

        For the years ended December 31, 2000 and 2001, we spent $32.6 million and $18.0 million, respectively, on capital improvements to our hotels. We expect to spend approximately $9.0 million on capital improvements to our hotels during 2002, which we expect to fund from cash generated from operations and borrowings under the line of credit.

        We intend to fund our future operating cash, capital expenditure and debt service requirements through cash flow from operations and borrowings under our $140.0 million line of credit which matures on July 30, 2004. Borrowings under the line of credit bear interest at a floating rate based upon (and including spreads over), at our option, LIBOR or the Prime Rate. The line of credit also has various financial and other covenants. Borrowings under the line of credit are limited to the borrowing base value, as defined in the line of credit, which was $111.4 million at December 31, 2001.

        Over the next 12 months, we expect to be able to meet our working capital, capital expenditure and debt service requirements through cash flow from operations and borrowings under the line of

12

credit. Over the longer term, our ability to generate sufficient cash flow from operations to make scheduled payments on our debt obligations will depend on our future financial performance, which will be affected by a range of economic, competitive and business factors, many of which are outside of our control. If we do not generate sufficient cash flow from operations to satisfy our debt obligations, we may have to undertake alternative financing plans. We cannot assure you that completion of any such alternative financing plans will be possible. Our inability to generate sufficient cash flow to satisfy our debt obligations or to refinance our obligations on commercially reasonable terms would have an adverse effect on our business, financial condition and results of operations.

        We intend to fund cash distributions to shareholders and limited partners principally out of cash generated from operations. We may incur, or cause our subsidiaries to incur, indebtedness to meet distribution requirements imposed on a REIT under the Internal Revenue Code, including the requirement that a REIT distribute to its shareholders annually at least 90% of its taxable income, to the extent that working capital and cash flow from our investments are insufficient to make such distributions.

        In the future we may seek to increase further the amount of our credit facilities, negotiate additional credit facilities, or issue corporate debt instruments. Although we have no charter restrictions on the amount of indebtedness we may incur, our board of directors has adopted a current policy limiting the amount of indebtedness that we will incur to an amount not in excess of approximately 45% of our investment in hotel properties, at cost (as defined). The board may change the debt policy at any time without shareholder approval.

Qualitative and Quantitative Disclosure about Market Risk

        We are exposed to certain financial market risks, one being fluctuations in interest rates. We monitor interest rate fluctuations as an integral part of our overall risk management program, which recognizes the unpredictability of financial markets and seeks to reduce the potentially adverse effect on our results. The effect of interest rate fluctuations historically has been small relative to other factors affecting operating results, such as occupancy.

        Our operating results are affected by changes in interest rates primarily as a result of borrowing under our line of credit. If interest rates increased by 25 basis points, our annual interest expense would have increased by approximately $68 thousand based on balances outstanding during the year ended December 31, 2001.

        Our primary market risk exposure is to changes in interest rates as a result of our line of credit and long-term debt. At December 31, 2001, we had outstanding total indebtedness of approximately $301.1 million. Our interest rate risk objective is to limit the impact of interest rate fluctuations on earnings and cash flows and to lower our overall borrowing costs. To achieve this objective, we manage our exposure to fluctuations in market interest rates for our borrowings through the use of fixed rate debt instruments to the extent that reasonably favorable rates are obtainable with such arrangements and derivative financial instruments such as interest rate swaps, to effectively lock the interest rate on a portion of our variable debt. We do not enter into derivative or interest rate transactions for speculative purposes. At December 31, 2001, approximately $289.9 million of our outstanding debt was subject to fixed rates with a weighted average interest rate of 7.7%. On March 21, 2001, we entered into an interest rate swap agreement for a notional amount of $30.0 million that effectively locked an interest rate (before the spread of LIBOR) of 4.775% through an interest rate swap agreement. We participated in a second interest rate swap agreement for a notional amount of $40.0 million that effectively locked an interest rate (before the spread of LIBOR) of 6.535%. We regularly review interest rate exposure on our outstanding borrowings in an effort to minimize the risk of interest rate fluctuations.

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        The following table provides information about our instruments that are sensitive to changes in interest rates. For debt obligations outstanding at December 31, 2001, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on implied forward rates in the yield curve as of December 31, 2001. For the interest rate swap, the table presents notional amounts and weighted average interest rates by expected contractual maturity dates. The fair value of our fixed rate debt indicates the estimated principal amount of debt having similar debt service requirements, which could have been borrowed by us at December 31, 2001. The rate assumed in the fair value calculation of fixed rate debt is equal to 6.66%, which consists of the 7-year treasury rate of 4.66% as of December 31, 2001, plus 200 basis points.

Expected Principal Cash Flows
(in thousands)

Liabilities			2002			2003			2004			2005			2006			Thereafter			Total		Fair Value Total
Long-Term Debt:
	Fixed Rate		$	6,547		$	7,044		$	77,547		$	8,152		$	8,772		$	181,885		$	289,947	$	301,414
		Average Interest Rate		7.71	%		7.71	%		7.69	%		7.69	%		7.69	%		7.69	%
	Variable Rate								$	11,188											$	11,188	$	11,188
		Average Interest Rate								4.03	%
Interest Rate Derivatives:
	Variable to Fixed					$	70,000														$	70,000	$	(3,220	)
		Average Pay Rate(1)		5.78	%		5.78	%
		Average Receive Rate(1)		2.32	%		4.16	%

(1)

Before the spread on LIBOR of 200 basis points.

        The table incorporates only those exposures that exist as of December 31, 2001, and does not consider exposures or positions that could arise after that date. In addition, because firm commitments are not represented in the table above, the information presented therein has limited predictive value. As a result, our ultimate realized gain or loss with respect to interest rate fluctuations would depend on the exposures that arise during future periods, prevailing interest rates, and our strategies at that time. There is inherent rollover risk for borrowings as they mature and are renewed at current market rates. The extent of this risk is not quantifiable or predictable because of the variability of future interest rates and our financing requirements.

Inflation

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

Seasonality

        Our hotels' operations historically have been seasonal in nature, reflecting higher occupancy during the second and third quarters. This seasonality can be expected to cause fluctuations in our quarterly operating profits. To the extent that cash flow from operations is insufficient during any quarter, due to temporary or seasonal fluctuations in revenue, we expect to utilize cash on hand or borrowings under our line of credit to make distributions to our equity holders.

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Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

        On an on-going basis, we evaluate our estimates, including those related to bad debts, carrying value of investments in hotels, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

        We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

        We record an impairment charge when we believe an investment in hotels has been impaired such that future undiscounted cash flows would not recover the book basis of the investment in hotel. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's current carrying value, thereby possibly requiring an impairment charge in the future.

        We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we will not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

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QuickLinks

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
COMPARABLE HOTELS OPERATING STATISTICS For the Year Ended December 31, 2001
Expected Principal Cash Flows (in thousands)