AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 27, 1995

REGISTRATION NO. 33-82996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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

POST-EFFECTIVE AMENDMENT NO. 1 TO FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

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

KAHLER MANAGEMENT CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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MINNESOTA 6798 41-1781923
(STATE OF 20 SECOND AVENUE
ICORPORATION)N SOUTHWEST
(PRIMARY STANDARD (I.R.S. EMPLOYER
INDUSTRIAL CLASSIFICATION IDENTIFICATION NO.)
CODE NUMBER) ROCHESTER, MINNESOTA
55902
(507) 285-2700
(ADDRESS AND TELEPHONE
NUMBER OF REGISTRANT'S
PRINCIPAL EXECUTIVE
OFFICES)

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

HAROLD W. MILNER
PRESIDENT AND CHIEF EXECUTIVE OFFICER

KAHLER MANAGEMENT CORPORATION
20 SECOND AVENUE SOUTHWEST
ROCHESTER, MINNESOTA 55902
(507) 285-2700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

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

COPY TO:
TIMOTHY S. HEARN, ESQ.
DORSEY & WHITNEY
PILLSBURY CENTER SOUTH
220 SOUTH SIXTH STREET
MINNEAPOLIS, MINNESOTA 55402-1498
(612) 340-7802

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: At the date
of the distribution of the shares of Kahler Management Corporation common stock
in connection with the Spin Off referred to herein.

If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]

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

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.

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

KAHLER MANAGEMENT CORPORATION

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CROSS REFERENCE SHEET

PURSUANT TO ITEM 501(B) OF REGULATION S-K

FORM S-1 REGISTRATION
STATEMENT ITEM NUMBER AND CAPTION LOCATION IN PROSPECTUS
--------------------------------- ----------------------

1. Forepart of Registration
Statement and Outside Front Outside Front Cover Page
Cover Page of Prospectus.......
2. Inside Front and Outside Back
Cover Page of Prospectus....... Inside Front Cover Page; Available
Information; Table of Contents
3. Summary Information, Risk
Factors and Ratio of Earnings Outside Front Cover Page; Summary; Risk
to Fixed Charges .............. Factors
4. Use of Proceeds................ *
5. Determination of Offering *
Price..........................
6. Dilution....................... *
7. Selling Security Holders....... *
8. Plan of Distribution........... Summary; The Spin Off
9. Description of Securities to be Description of Capital Stock
Registered.....................
10. Interests of Named Experts and *
Counsel........................
11. General Information as to Summary; Risk Factors; The Spin Off;
Registrant..................... Quotation on Nasdaq; Dividend Policy; Pro
Forma Capitalization; Selected
Consolidated Financial and Operating Data
of Historical Kahler; Management's
Discussion and Analysis of Financial
Condition and Results of Operations of
Historical Kahler; Pro Forma Selected
Consolidated Financial Data of KMC;
Management's Discussion and Analysis of
Pro Forma Financial Data of KMC; Business;
The Hotels; Certain Agreements between KMC
and Realty; Directors and Executive
Officers; Certain Relationships and
Related Transactions; Principal
Shareholders
12. Disclosure of Commission
Position on Indemnification for *
Securities Act Liabilities.....

- --------
* Answer is negative or item is not applicable.

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+ +
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

SUBJECT TO COMPLETION SEPTEMBER 27, 1995

KAHLER MANAGEMENT CORPORATION

COMMON STOCK

This Prospectus is being furnished to the shareholders of Kahler Realty
Corporation ("Realty") in connection with the distribution (the "Spin Off") to
its shareholders of record as of , 1995 (the "Record Date") of 90.5% of
the outstanding shares of common stock, $.10 par value ("KMC Common Stock"), of
its wholly-owned subsidiary, Kahler Management Corporation ("KMC"). Realty is
making the Spin Off distribution in order to qualify as a real estate
investment trust ("REIT") for federal income tax purposes. Following the Spin
Off, KMC will continue the operations of Realty that the federal tax laws
generally preclude from being owned or operated by a REIT. In anticipation of
the Spin Off, KMC and Realty have entered into certain agreements governing
certain aspects of their relationship after the distribution. See "Certain
Agreements between KMC and Realty."

One share of KMC Common Stock is being distributed for every ten shares of
common stock, $.10 par value, of Realty ("Realty Common Stock"). Realty
shareholders are not required to pay any consideration to receive shares of KMC
Common Stock in the Spin Off. No fractional shares of KMC Common Stock will be
received by Realty shareholders in the Spin Off. Realty shareholders who
otherwise would be entitled to receive fractional shares will instead receive
cash based upon the market value of KMC Common Stock. The distribution to
Realty shareholders of KMC Common Stock in the Spin Off will be a taxable
distribution to Realty shareholders for federal income tax purposes.

There is currently no public market for KMC Common Stock. Application has
been made to have the KMC Common Stock quoted on the Nasdaq SmallCap Market.

-----------

SEE "RISK FACTORS" ON PAGES 8 THROUGH 12 FOR A DISCUSSION OF CERTAIN RISKS THAT
SHOULD BE CONSIDERED BY THE SHAREHOLDERS OF KMC.

-----------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR
ENDORSED THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE
CONTRARY IS UNLAWFUL.

The date of this Prospectus is 1995.

AVAILABLE INFORMATION

KMC has filed a Registration Statement on Form S-1 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") with
respect to the KMC Common Stock to be distributed to shareholders of Realty in
connection with the Spin Off. This Prospectus (the "Prospectus") does not
contain all the information set forth in the Registration Statement, certain
parts of which are omitted in accordance with the rules and regulations of the
Commission. The Registration Statement and any amendments thereto, including
exhibits filed as a part thereof, are available for inspection and copying at
the offices of the Commission at 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549; 7 World Trade Center, Suite 1300, New York, New York 10048; and 500
West Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such
material may be obtained from the Public Reference Section of the Commission at
Washington, D.C. 20549 at prescribed rates. KMC intends to furnish its
shareholders with annual reports containing audited financial statements
certified by an independent public accounting firm.

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

TRADEMARKS

Best Western(R) is a registered trademark of Best Western International, Inc.
Hilton Hotels(R) is a registered trademark of Hilton Hotels Corporation.
Sheraton Hotel(R) is a registered trademark of the ITT Sheraton Corporation.
Holiday Inn(R) is a registered trademark of Holiday Inns, Inc. Quality Inn(R)
is a registered trademark of Choice Hotels International, Inc. Knights Inn(R)
is a registered trademark of Cardinal Lodging Group, Inc. Residence Inn by
Marriott(R) is a registered trademark of Residence by Marriott, Inc.

PROSPECTUS SUMMARY

The following Summary is qualified in its entirety by the more detailed
descriptions and financial information and statements, and the notes thereto,
appearing elsewhere in this Prospectus. As used herein, "Realty" refers to
Kahler Realty Corporation giving effect to the Spin Off; "Historical Kahler"
refers to Kahler Realty Corporation without giving effect to the Spin Off;
"KMC" refers to Kahler Management Corporation, a wholly owned subsidiary of
Historical Kahler, 90.5% of the common stock of which is being distributed to
the existing shareholders of Historical Kahler in the Spin Off; and "KMC Common
Stock" refers to the common stock, $.10 par value, of KMC. For definitions of
certain other capitalized or abbreviated terms used in this Prospectus, see
"Certain Definitions." Except as otherwise indicated herein, the information in
this Prospectus gives effect to the consummation of the Spin Off. See "The Spin
Off."

KMC

KMC was formed to continue the hotel management operations and certain other
non-real estate related businesses owned by Historical Kahler prior to the Spin
Off. KMC is primarily engaged in managing and operating 22 hotels (the
"Hotels"), a majority of which are owned by Realty and leased to KMC pursuant
to percentage leases (the "Percentage Leases"). The Hotels are located in
eleven states and include 16 full service Hotels, three conference center
Hotels and three limited service Hotels. KMC also owns and operates certain
non-real estate related businesses, including a commercial laundry business
with facilities in Rochester, Minnesota and Salt Lake City, Utah ("Textile"),
and a retail and wholesale formal wear business supplying company-owned and
unaffiliated retail outlets throughout the West and Midwest ("Anderson's").

KMC is a Minnesota corporation that was incorporated on May 27, 1994. KMC's
executive offices are located at 20 Second Avenue Southwest, Rochester,
Minnesota 55902. Its telephone number is (507) 285-2700.

THE SPIN OFF

Historical Kahler has engaged in a series of transactions to restructure and
recapitalize its operations and make possible its conversion to REIT status,
including a public offering of 8,420,000 shares of Realty Common Stock (the
"Offering") and the distribution of 90.5% of the outstanding KMC Common Stock
(the "Spin Off") to Historical Kahler's shareholders of record on ,
1995 (the "Record Date"). The purpose of the Spin Off is to separate Historical
Kahler's hotel ownership and development operations from its hotel management
and other non-real estate related operations in order to satisfy certain
provisions of the Code applicable to REITs. After the Spin Off, Realty will
hold 9.5% of the outstanding KMC Common Stock.

The Spin Off dividend, which was declared by the Board of Directors of
Historical Kahler on , 1995, is payable to its shareholders on the
basis of one share of KMC Common Stock for every ten shares of Realty Common
Stock held on the Record Date. The shareholders are not required to pay any
consideration to receive shares of KMC Common Stock in the Spin Off. No
fractional shares of KMC Common Stock will be received by shareholders in the
Spin Off. Shareholders who otherwise would be entitled to receive fractional
shares will instead receive cash based upon the market value of the KMC Common
Stock.

In connection with the Spin Off, Historical Kahler and KMC entered into a
Distribution Agreement which provides for (i) the transfer of certain assets
and liabilities to KMC prior to the Spin Off, (ii) the terms of the Spin Off,
(iii) the division between Realty and KMC of certain liabilities, and (iv)
certain other agreements governing the relationship between Realty and KMC. See
"Certain Agreements between KMC and Realty" for further information on the
terms of the Distribution Agreement.

The distribution of KMC Common Stock in the Spin Off will be a taxable
distribution to the Realty shareholders for federal income tax purposes. See
"The Spin Off."

RISK FACTORS

See "Risk Factors" for a discussion of certain factors which should be
considered by the shareholders of KMC.

TRADING MARKET

KMC has applied to have the KMC Common Stock quoted on the Nasdaq SmallCap
Market.

STRUCTURE AND OWNERSHIP

The following diagram depicts the structure and ownership of Realty and KMC
after the Spin Off and the Offering:

Pre-Offering
New Realty Shareholders of
Historical

Shareholders ---------- ----------

Kahler
65.9% 34.1%

----------

9.5% 90.5%

Kahler Management
Kahler Realty

Corporation
Corporation
("Realty")

Equity
Interests ("KMC")

Mortgage Note

-------------------- --
-----------------------------------------------------
The "Realty Hotels"

1 Managed 2 Owned
Hotel(1) Hotels (the
"Owned
Hotels")(4)

14 Leased Hotels Commercial
(the "Leased Laundry
Hotels")(2) Business
("Textile")(6)
5 Managed Formal Wear
Hotels(3) Business
("Anderson's")(5)

- --------

(1) Represents the University Park Hotel operated by KMC pursuant to a
management agreement. KMC holds a 24% equity interest in the entity which
owns this Hotel. Realty has a mortgage note interest in this Hotel. See
Note 3 below and "The Hotels."
--------------

(2) Includes 12 Hotels that are wholly owned by Realty, the Ogden Park Hotel,
which is 63.8% owned by Realty (84.0% upon conversion of certain
indebtedness held by Realty), and the Provo Park Hotel, which is 50.0%
owned by Realty. See "The Hotels."
--------------------------------------

(3) Represents five Hotels that are managed by KMC pursuant to management
agreements, including three Hotels in which KMC holds minority equity
interests. These five Hotels, together with the University Park Hotel, are
collectively referred to herein as the "Managed Hotels." See "The Hotels."

(4) Represents two Hotels that are 100% owned and operated by KMC. See "The
Hotels."

(5) See "Business--Anderson's."

(6) See "Business--Textile."

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

- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- -- --
| | | | |
| | | | |

SUMMARY SELECTED FINANCIAL AND OPERATING DATA OF HISTORICAL KAHLER (UNAUDITED)

The following table sets forth summary selected financial and operating data
for Historical Kahler. This table should be read in conjunction with the
Consolidated Financial Statements of Historical Kahler and the Notes thereto
included elsewhere in this Prospectus.

FIRST
FISCAL YEAR (1) TWELVE SIX MONTHS (1)
------------------------------------------------------- MONTHS ENDED ------------------
1990 1991 1992 1993 1994 JULY 2, 1995 1994 1995
--------- --------- --------- --------- --------- ------------ -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND HOTEL OPERATING DATA)

REVENUES
Revenue of owned oper-
ations................ $ 63,323 $ 64,652 $ 74,014 $ 96,979 $ 109,910 $ 115,431 $ 56,345 $ 61,866
Other properties
managed and/or
partially owned....... 27,250 31,506 29,237 17,910 17,490 17,276 8,576 8,362
--------- --------- --------- --------- --------- --------- -------- --------
Total revenues....... $ 90,573 $ 96,158 $ 103,251 $ 114,889 $ 127,400 $ 132,707 $ 64,921 $ 70,228
========= ========= ========= ========= ========= ========= ======== ========
REVENUE OF OWNED OPERA-
TIONS
Lodging................ $ 49,236 $ 51,021 $ 58,408 $ 80,505 $ 93,243 $ 98,902 $ 47,618 $ 53,277
Formal wear, laundry &
other................. 13,055 13,193 14,182 15,277 15,894 15,815 8,444 8,365
Interest income........ 1,032 438 1,424 1,197 773 714 283 224
--------- --------- --------- --------- --------- --------- -------- --------
Total revenue of
owned operations.... 63,323 64,652 74,014 96,979 109,910 115,431 56,345 61,866
--------- --------- --------- --------- --------- --------- -------- --------
OPERATING COSTS AND EX-
PENSES
Lodging................ 38,760 38,458 45,053 60,974 70,797 74,860 35,453 39,516
Formal wear, laundry &
other................. 9,963 10,772 12,092 12,621 13,487 12,961 7,194 6,668
Corporate expenses..... 2,747 2,827 3,225 3,272 3,257 3,477 1,694 1,914
Depreciation and amor-
tization.............. 5,859 5,740 6,492 7,904 8,477 8,617 4,298 4,438
Non-recurring charges
(2)................... -- -- 2,758(2) -- 1,811(2) 1,811(2) -- --
--------- --------- --------- --------- --------- --------- -------- --------
Total operating costs
and expenses........ 57,329 57,797 69,620 84,771 97,829 101,726 48,639 52,536
--------- --------- --------- --------- --------- --------- -------- --------
GROSS OPERATING PROFIT.. 5,994 6,855 4,394 12,208 12,081 13,705 7,706 9,330
Interest expense....... (7,017) (6,764) (7,303) (9,362) (11,207) (12,019) (5,248) (6,060)
Equity earnings (loss)
of affiliates......... (997) (2,326) (688) 27 193 386 98 291
Gain (loss) on sale of
assets................ 2,325 3,005 (693) 6 20 (22) 11 (31)
--------- --------- --------- --------- --------- --------- -------- --------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES........... 305 770 (4,290) 2,879 1,087 2,050 2,567 3,530
Provision (credit) for
income taxes.......... 119 247 (300) 875 323 647 770 1,094
--------- --------- --------- --------- --------- --------- -------- --------
Income (loss) before
extraordinary item
and changes in ac-
counting principle.... 186 523 (3,990) 2,004 764 1,403 1,797 2,436
Extraordinary item net
of income taxes....... 75 173 2,517 -- -- -- -- --
Cumulative effect of
change in accounting
for nonpension
postretirement
benefits.............. -- -- (250) -- -- -- -- --
--------- --------- --------- --------- --------- --------- -------- --------
NET INCOME (LOSS)....... $ 261 $ 696 $ (1,723) $ 2,004 $ 764 $ 1,403 $ 1,797 $ 2,436
========= ========= ========= ========= ========= ========= ======== ========
Income (loss) per
share (3)............. $ 0.00 $ 0.13 $ (0.59) $ 0.46 $ 0.14 $ 0.28 $ 0.43 $ 0.57
========= ========= ========= ========= ========= ========= ======== ========
OTHER FINANCIAL DATA:
EBITDA (4)............. $ 10,856 $ 10,269 $ 11,398 $ 20,139 $ 20,751 $ 22,708 $ 12,102 $ 14,059
Cash flows from:
Operations (5)........ $ 4,215 $ 7,686 $ 4,427(5) $ 10,417 $ 9,374(5) $ 9,867(5) $ 5,592 $ 6,085
Investing activities.. (12,196) (19,729) (9,797) (14,685) (13,256) (7,083) (9,450) (3,277)
Financing activities.. 7,728 12,024 5,975 4,449 4,008 (2,772) 4,186 (2,594)
HOTEL OPERATING DATA:
Number of hotels--end
of period (6)......... 13 14 16 18 20 21 19 21
Number of rooms--end
of period (6)......... 3,174 3,374 3,699 4,103 4,382 4,532 4,255 4,532
Room nights available.. 1,138,335 1,214,729 1,314,976 1,406,488 1,559,012 1,598,413 772,884 812,285
Occupancy.............. 58.5% 60.9% 61.9% 63.9% 65.2% 65.7% 65.6% 66.5%
ADR.................... $ 61.35 $ 61.71 $ 61.36 $ 63.31 $ 63.75 $ 64.63 $ 65.49 $ 67.10
REVPAR................. $ 35.91 $ 37.56 $ 38.01 $ 40.48 $ 41.58 $ 42.46 $ 42.95 $ 44.63
BALANCE SHEET DATA:
Investment in real es-
tate
(before accumulated
depreciation)......... $109,993 $ 122,659 $ 156,583 $ 196,873 $ 205,028 $205,546 $208,122
Net investment in real
estate................ 71,975 81,259 110,202 142,743 150,747 147,268 149,601
Total assets........... 103,637 114,170 132,392 162,406 168,169 169,414 168,624
Total mortgage debt.... 69,853 81,334 93,710 123,985 124,226 126,526 123,477
Stockholders' equity... 16,147 16,586 14,867 16,366 21,271 18,397 23,679

(See notes on next page.)

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(1) Historical Kahler's fiscal year ends on the Sunday closest to December 31
in each year. Accordingly, the table presents selected financial and
operating data as of the end of and for each of the five fiscal years ended
January 1, 1995 and as of and for the six months ended July 3, 1994 and
July 2, 1995.

(2) Non-recurring charges for fiscal 1992 and 1994 and for the twelve months
ended July 2, 1995 reflect (i) a charge of $2.8 million in 1992 consisting
of a $1.2 million non-cash writedown of a hotel property and a $1.6 million
charge to settle a lawsuit concerning the Sheraton San Marcos Golf Resort
and Conference Center, and (ii) $1.8 million of expenses in 1994 related to
a planned public offering.

(3) Income per share in 1990 and 1991 is computed on a primary and fully
diluted share basis using the weighted average number of outstanding shares
of Realty Common Stock and Realty Common Stock equivalents of 3,218,000 and
3,274,000, respectively. For 1992, loss per share is computed on a primary
share basis using only the weighted average number of outstanding shares of
Realty Common Stock aggregating 3,341,000. Realty Common Stock equivalents
are excluded since the effect is antidilutive. For 1993 and 1994, income
per share is computed on a primary and fully diluted share basis using the
weighted average number of outstanding shares of Realty Common Stock and
Realty Common Stock equivalents (arising from employee stock plans,
deferred stock compensation and a warrant) aggregating 3,743,000 and
3,956,000, respectively. For the first six months of 1994 and 1995 and the
twelve months ended July 2, 1995, income per share is computed on a primary
and fully diluted share basis using the weighted average number of
outstanding shares of Realty Common Stock and Realty Common Stock
equivalents aggregating 3,785,000, 4,306,000 and 4,306,000 shares,
respectively.

(4) EBITDA means income (loss) from operations before income taxes, excluding
gains or losses on sale of assets, non-cash writedowns of real estate
property, interest expense, depreciation and amortization. EBITDA does not
represent cash generated from operating activities in accordance with GAAP,
is not to be considered as an alternative to net income or any other GAAP
measurements as a measure of operating performance and is not necessarily
indicative of cash available to fund all cash needs. Management believes
that EBITDA is a useful measure of cash flow because it indicates the cash
flow available to spend on capital additions to maintain Realty's assets,
to service existing debt or to use at Realty's discretion for other
purposes.

(5) Cash flow from operations for fiscal 1992 and 1994 and for the twelve
months ended July 2, 1995 reflects non-recurring charges of $1.6 million,
$1.8 million and $1.8 million, respectively. Prior to consideration of such
expenses, cash flow from operations would have been $6.0 million for 1992,
$11.2 million for 1994 and $11.7 million for the twelve months ended July
2, 1995. The $1.6 million charge in 1992 relates to the settlement of a
lawsuit, and the 1994 charge represents costs incurred in connection with a
planned public offering. See Note 10 of Notes to Consolidated Financial
Statements of Historical Kahler.

(6) The number of hotels and rooms at July 2, 1995 includes the Realty Hotels
(except for the Canyon Springs Park Hotel, which was acquired after that
date) as well as seven additional Hotels managed by Historical Kahler.
Historical Kahler holds 100.0% equity interests in two of these seven
Hotels and holds minority ownership interests in two of the other five
Hotels. KMC will own the equity interests in and manage these additional
Hotels following the Spin Off.

PRO FORMA SUMMARY SELECTED FINANCIAL DATA FOR KMC (UNAUDITED)

The following table sets forth unaudited pro forma summary selected financial
data for KMC. The data are presented as if: (i) the Spin Off had occurred as of
the beginning of each period presented; (ii) certain Hotels acquired subsequent
to the beginning of each period presented had been acquired as of the beginning
of each period presented; and (iii) the Percentage Leases were executed and in
effect as of the beginning of each period presented. The pro forma financial
information is not necessarily indicative of what the actual financial position
and results of operations of KMC would have been as of the end of and for the
periods presented, and such information does not purport to represent the
future financial position of KMC. This table should be read in conjunction with
the Pro Forma Condensed Consolidated Financial Data of KMC included elsewhere
in this Prospectus.

FIRST
TWELVE SIX MONTHS
FISCAL YEAR MONTHS ENDED ----------------
1994 JULY 2, 1995 1994 1995
----------- ------------ ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)

STATEMENT OF OPERATIONS DATA:
Lodging Segment
Lodging--rooms..................... $55,275 $56,673 $28,527 $29,925
--food & beverage.................. 29,869 30,272 14,866 15,269
--other............................ 10,121 10,641 5,442 5,962
Interest income.................... 137 144 60 67
Equity loss of affiliates.......... (278) (292) (29) (43)
------- ------- ------- -------
Total lodging revenue............ 95,124 97,438 48,866 51,180
Percentage lease expense (1)....... 24,354 25,117 12,752 13,515
Lodging expenses................... 68,178 69,542 34,270 35,634
------- ------- ------- -------
Lodging income before interest,
depreciation, and corporate
expenses.......................... 2,592 2,779 1,844 2,031
------- ------- ------- -------
Laundry Segment
Laundry revenue.................... 6,304 6,052 3,309 3,057
Laundry expenses................... 5,957 5,206 3,220 2,469
------- ------- ------- -------
Laundry income before interest,
depreciation, and corporate
expenses.......................... 347 846 89 588
------- ------- ------- -------
Formal Wear Segment
Formal wear revenue................ 8,924 9,117 4,809 5,002
Formal wear expenses............... 6,975 7,207 3,704 3,936
------- ------- ------- -------
Formal wear income before
interest, depreciation, and
corporate expenses................ 1,949 1,910 1,105 1,066
------- ------- ------- -------
Other income before interest,
depreciation, and corporate
expenses........................... 86 73 43 30
------- ------- ------- -------
Total income before interest,
depreciation and corporate
expenses........................... 4,974 5,608 3,081 3,715
Corporate expenses.................. (2,782) (3,002) (1,456) (1,676)
Interest expense.................... (1,294) (1,337) (629) (672)
Depreciation and amortization....... (3,305) (3,292) (1,722) (1,709)
------- ------- ------- -------
Loss from operations before income
taxes.............................. (2,407) (2,023) (726) (342)
------- ------- ------- -------
Net loss............................ $(2,407) $(2,023) $ (726) $ (342)
======= ======= ======= =======
Loss per share (2).................. $ (5.02) $ (4.22) $ (1.52) $ (.71)
======= ======= ======= =======

JULY 2, 1995
------------
(DOLLARS IN
THOUSANDS)

BALANCE SHEET DATA:
Investment in real estate (before accumulated depreciation)........ $45,204
Net investment in real estate...................................... 29,667
Total assets....................................................... 41,867
Total mortgage debt................................................ 14,120
Stockholders' equity............................................... 16,577

- --------

(1) Represents lease payments to Realty calculated on a pro forma basis by
applying the rent provisions in the Percentage Leases to the historical
revenue of the Leased Hotels for the periods presented.

(2) The number of outstanding shares of KMC Common Stock used to compute income
per share for 1994, for the twelve months ended July 2, 1995 and for the
first six months of 1994 and 1995 is 479,177.

RISK FACTORS

Shareholders should carefully consider the following information in
conjunction with the other information contained in this Prospectus.

KMC'S DEPENDENCE ON REALTY

The majority of the operations of KMC will depend on the management of the
Realty Hotels and KMC's continued relationship with Realty. On a pro forma
basis for fiscal 1994 and the first six months of 1995, KMC had lodging revenue
from the Realty Hotels of $91.8 million and $49.7 million, respectively, which
would have accounted for 96.5% and 97.0%, respectively, of KMC's total lodging
revenue, and 83.2% and 83.8%, respectively, of KMC's total revenue for each
period. The initial terms of the Percentage Leases are three, five or seven
years, after which time Realty will be able to renegotiate the Percentage
Leases or to replace KMC with a different hotel operator. In the event that the
Realty Hotels do not perform in accordance with Realty's expectations, Realty
may seek to replace KMC when the Percentage Leases expire. In addition, KMC may
be dependent upon Realty to develop future hotel opportunities due to Realty's
greater access to financial markets to fund acquisitions and new hotel
developments.

AGREEMENTS BETWEEN KMC AND REALTY

KMC and Realty have entered into a number of agreements to effect the Spin
Off and define their ongoing relationship and the conduct of their respective
businesses, including the Percentage Leases, the Right of First Refusal
Agreement, the Option Agreement and the Distribution Agreement. The terms of
these agreements were not the result of arm's-length negotiations between
independent parties. The Percentage Leases include cross-default provisions
under which, if an event of default occurs and continues beyond any cure
period, Realty will have the option of terminating the corresponding Percentage
Lease and any or all other Percentage Leases by giving KMC written notice of
such termination. The Percentage Leases also restrict KMC's ability to pay
dividends or make other distributions to its shareholders. See "Certain
Agreements between KMC and Realty--The Percentage Leases." Under the Right of
First Refusal Agreement, Realty has a right of first refusal to acquire any
hotel or any suitable hotel site controlled by KMC or any of its affiliates and
an option to acquire any hotel controlled by KMC beginning 18 months after the
hotel is open. The Right of First Refusal Agreement further includes a
noncompetition provision whereby KMC may not, without the written consent of
Realty, manage, lease, own or otherwise operate a hotel located within the
trade area of a hotel owned by Realty or in which Realty has a mortgage
interest. See "Certain Agreements between KMC and Realty--Right of First
Refusal Agreement." Under the Option Agreement, Realty has been granted a five-
year option to purchase the two Owned Hotels at a price approximately equal to
110% of the current aggregate fair market value of the Owned Hotels. See
"Certain Agreements between KMC and Realty--Option Agreement." The Distribution
Agreement provides for assumptions of liabilities and cross-indemnities
designed to allocate to KMC financial responsibility for the known and unknown
liabilities arising out of the businesses and assets to be held by KMC after
the Spin Off, including the hotel management, commercial laundry and formal
wear businesses, and substantially all employee-related liabilities. KMC also
assumes any liabilities relating to the Spin Off. See "Certain Agreements
between KMC and Realty--Distribution Agreement."

VOLATILITY OF KMC'S RESULTS

KMC's ability to carry out its obligations to Realty is, in part, a function
of KMC's ability to earn sufficient amounts to effectively carry out its
operations and make provisions for future expansion. KMC's lodging revenues
will be subject to the various risks described below under "--Hotel Industry
Risks" with respect to the operations of Realty. KMC's principal sources of
revenue will be the Hotels, management fees under its management contracts and
revenues from Textile and Anderson's. In addition, KMC's results will be
subject to the risks associated with Textile and Anderson's. KMC had pro forma
losses of $2.4 million and $2.0 million for the year ended January 1, 1995 and
the twelve months ended July 2, 1995, respectively. For the first six months of
1994 and 1995, KMC had pro forma losses of $726,000 and $342,000, respectively.
See "Management's Discussion and Analysis of Pro Forma Financial Data of KMC."

HOTEL INDUSTRY RISKS

Operating Risks

The Hotels, and any hotels subsequently acquired or managed by KMC, will be
subject to all the operating risks common to the hotel industry. Significant
adverse changes in the operations of any one of the Hotels could have a
material adverse effect on the revenues of KMC. The operating risks include,
among other things: competition from other hotels; over-building in the hotel
industry that could adversely affect occupancy, ADRs and REVPAR; increases in
operating costs due to inflation and other factors, which might not be offset
by increased room rates; dependence on business and commercial travelers and
tourism; increases in energy costs and other expenses of travel; changes in
travel patterns; strikes and other labor disturbances of hotel employees; and
adverse effects of general and local economic conditions.

Geographic Concentration

The concentration of five Hotels in and around the Greater Salt Lake City,
Utah, area and four Hotels in Rochester, Minnesota, makes KMC dependent on
factors such as the local economy, local competition, increases in local real
and personal property tax rates and local catastrophes in these communities.
The results of operations of the Hotels in the Rochester area are dependent on
the level of demand generated by the Mayo Clinic for hotel accommodations by
patients and by medical conferences organized by the Mayo Clinic.

Hotel Renovation

Hotels in general, including the Hotels, have an ongoing need for renovations
and other capital improvements, particularly in older structures, including
periodic replacement of FF&E and modifications required to comply with
governmental rules and regulations, including building codes, fire and safety
codes and rules relating to access and use by disabled persons. The ability of
the owners of the Hotels to fund these

and other capital expenditures and periodic replacement of FF&E will depend in
part on the financial performance of the Hotels. Any inability or failure to
fund these expenditures could have a material adverse effect on ADRs,
occupancy, REVPAR and franchises for the Hotels. The renovation of hotels also
involves certain risks, including the possibility of environmental problems,
cost overruns and delays, market deterioration after commencement of renovation
and the emergence of competition from unanticipated sources.

Franchise Risks

Eleven of the Hotels are operated pursuant to franchise or license agreements
and additional hotels may be or become subject to franchise arrangements. KMC
will hold the franchise or license agreements for the Hotels and will be
responsible for complying with the terms of these agreements. Such franchise or
license arrangements impose financial obligations on hotels generally related
to maintaining the condition of hotels and the payment of franchise fees.
Continuation of such franchises is subject to specified operating standards and
other terms and conditions. Franchisors periodically inspect franchised hotels
to confirm compliance. In addition, franchisors may require the owner of the
hotel to fund significant capital improvements to the Hotels in the future to
maintain such franchises. The failure of a franchisee to maintain standards or
adhere to terms and conditions imposed by the franchisor may result in the loss
of a license or termination of the franchise or damages as a result of the
breach. It is possible that a franchisor could condition the continuation of a
franchise on the completion of capital improvements or replacement of FF&E
which KMC would determine are too expensive or otherwise unwarranted in light
of general economic conditions or operating results or prospects of the
affected Hotel. The loss of a franchise could have a material adverse effect
upon the operation, financing or value of the Hotel subject to the franchise
because of the loss of associated name recognition, marketing support and
centralized reservation systems. There can be no assurance that an alternative
franchise arrangement could be obtained or that significant expenditures might
not be imposed as a condition to obtaining a new franchise. The loss of a
franchise for one or more of the Hotels could have a material adverse effect on
KMC's revenues. See "The Hotels--Franchise Agreements."

Competition

The hotel industry is highly competitive. The Hotels will compete with other
hotels in their geographic markets. Many of the owners and operators of these
competing hotels have substantially greater resources than Realty and KMC. See
"Business--Competition."

Seasonality of Hotel Business

The hotel industry is seasonal in nature. This seasonality can be expected to
cause quarterly fluctuations in KMC's revenues and net income.

RELATIONSHIP WITH THE MAYO FOUNDATION

The operations of Realty and KMC are significantly affected by their
relationships with the Mayo Foundation. The Chairman of the Board of Directors
of each of Realty and KMC is John H. Herrell, the Vice President and Chief
Administrative Officer of the Mayo Foundation. Following the completion of the
Spin Off, the Mayo Foundation will own 8.8% of the outstanding Realty Common
Stock and 23.9% of the outstanding KMC Common Stock (up to 35.5% giving effect
to the Exchange Agreement). In addition, the results of operations of the
Hotels in Rochester, Minnesota are highly dependent on the level of demand for
hotel rooms generated by the Mayo Clinic and the revenue of Textile, KMC's
commercial laundry business, significantly depends on the level of demand for
laundry services from the Mayo Clinic. Realty does not have a commitment from
or arrangement with the Mayo Clinic to provide hospitality and food services.
In 1992, Textile entered into a 20-year exclusive Service Agreement to provide
laundry services to the Mayo Clinic and Methodist and St. Mary's Hospitals in
Rochester. KMC will purchase on an ongoing basis from Franklin Heating Station,
a Mayo Foundation affiliate, all or a portion of its requirements for steam,
electricity, water and related utility services for The Kahler Hotel, the
Kahler Plaza Hotel, the Clinic View Inn and Suites and Textile. See "Certain
Relationships and Related Transactions--Certain Transactions with the Mayo
Foundation" and "--Exchange Agreement."

CONFLICTS OF INTEREST

The capitalization of Realty and the allocation of interests held by
Historical Kahler between Realty and KMC were not determined by arm's-length
negotiations. Neither company's value has been determined on a property-by-
property basis because the two companies are the successors to an ongoing
business enterprise. Accordingly, no third-party appraisals of the Hotels or
the other property interests have been obtained, no independent valuations of
the businesses of KMC have been obtained, and no fairness opinion has been
obtained in connection with the capitalization and valuation of either company.
The terms of the Spin Off, the Percentage Leases and the various transactions
implementing them likewise were not determined through arm's-length
negotiations. The rent payments under the Percentage Leases were calculated
with reference to historical financial data and projected operating and
financial performance of the Hotels. See "Certain Agreements between KMC and
Realty--The Percentage Leases."

The management of the Hotels as well as the non-real estate related
businesses of Historical Kahler will be continued by KMC. Certain executive
officers and directors are officers and directors of both Realty and KMC.
Accordingly, these officers and directors may have conflicts of interests with
respect to their obligations as officers and directors of either Realty or KMC
or both, including, for example, in the event that Realty elects to sell a
Hotel leased to KMC under a Percentage Lease. The Realty and KMC Boards of
Directors have adopted policies and procedures to limit the involvement of
these officers and directors in conflict situations. These procedures include
requiring these officers and directors to abstain from voting as directors of
either company with respect to matters that present a material conflict of
interest between the companies, and requiring a majority of the independent
directors of each company to approve any contract or transaction that presents
a material conflict of interest. The Board of Directors of KMC may amend or
revise these policies and procedures from time to time without a vote of the
shareholders of KMC. See "Certain Agreements between KMC and Realty--Conflicts
of Interest Policies."

FAILURE OF REALTY TO QUALIFY AS A REIT

Historical Kahler is conducting the Spin Off and Offering primarily to
enable Realty to qualify as a REIT. Realty is not a REIT at the present time.
Realty intends to elect to be taxed as a REIT and to operate so as to qualify
as a REIT for federal income tax purposes beginning in fiscal 1996. The
continued qualification of Realty as a REIT will depend on Realty's continuing
ability to meet various requirements concerning, among other things, the
ownership of its outstanding stock, the nature of its assets, the sources of
its income, and the amount of its distributions to the shareholders of Realty.

If Realty were to fail to qualify as a REIT in any taxable year, Realty
would not be allowed a deduction for distributions to shareholders in
computing its taxable income and would be subject to federal income tax
(including any applicable minimum tax) on its taxable income at regular
corporate rates. A failure of Realty to qualify as a REIT or a decision to
revoke Realty's REIT election would increase its federal and state income
taxes and could adversely affect Realty's financial condition and results of
operations. This could negatively impact Realty's ability to expand its
business which would have an adverse effect on KMC's growth strategy. See
"Business--Growth Strategy."

LACK OF OPERATING HISTORY AS A HOTEL MANAGEMENT COMPANY AND AS A REIT

KMC and Realty have no experience operating as an independent hotel
management company and as a REIT, respectively. While the employees of KMC
have substantial experience operating the Hotels, KMC has not previously had
to operate as an independent management company to generate cash flow from the
Realty Hotels. In addition, KMC has not previously operated the Realty Hotels
to generate Rents under the Percentage Leases. There can be no assurance that
the operation of the Realty Hotels under the Percentage Leases will perform to
Realty's or KMC's expectations or to the minimum requirements of the
Percentage Leases.

TEXTILE DEPENDENCE ON ROCHESTER FACILITY

All of Textile's commercial laundry operations in Rochester, Minnesota are
conducted from a single facility. A loss of all or a substantial part of this
facility would have a material adverse effect on KMC's results of operations.
In addition, Textile's 20 year exclusive Service Agreement with the Mayo
Clinic requires Textile to provide uninterrupted service to the Mayo Clinic,
adequate to serve all of the laundry needs of the Mayo Clinic and Methodist
and St. Mary's Hospitals in Rochester. A loss of all or a substantial part of
the Rochester facility would impair Textile's ability to provide uninterrupted
service under the Service Agreement and could require Textile to seek
alternate facilities or providers to fulfill its obligations under the Service
Agreement, either of which could have a material adverse effect on KMC's
results of operations. There can be no assurance that KMC would be able to
find such alternate facilities or providers, or that any such alternate
facilities or providers would be available on terms that would enable KMC to
operate its commercial laundry business profitably. See "Business--Textile."

REAL ESTATE INVESTMENT RISKS

Value and Illiquidity of Real Estate

Real estate investments are relatively illiquid. The ability of KMC to vary
its portfolio of real estate investments in response to changes in economic
and other conditions will be limited. There can be no assurance that KMC
will be able to dispose of a hotel investment when it finds disposition
advantageous or necessary or that the sale price of any disposition will
recoup or exceed the amount of KMC's investment.

Uninsured and Underinsured Losses

There are certain types of losses, generally of a catastrophic nature, such
as earthquakes, acts of war and floods, that may be uninsurable or not
economically insurable. Each of KMC's and Realty's Board of Directors will
determine amounts, coverage limits and deductibility provisions of insurance
on the Hotels

owned by KMC and Realty, respectively, with a view to maintaining appropriate
property and casualty insurance coverage on each of their investments at a
reasonable cost and on suitable terms. This may result in insurance coverage
that, in the event of a substantial loss, would not be sufficient to pay the
full current market value or current replacement costs of KMC's or Realty's
lost investment.

Environmental Matters

Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of, and damages caused by,
hazardous or toxic substances and petroleum products located on or released
from such property. Under such laws, ordinances and regulations, KMC could be
liable for environmental conditions relating to the Hotels, Textile and
Anderson's. KMC is not aware of any environmental liability that KMC believes
would have a material adverse effect on KMC's business, assets or results of
operations. Nevertheless, it is possible that there are material environmental
liabilities of which KMC is unaware. It is also possible that new or amended
laws or regulations could be adopted in the future that could impose material
costs. See "Business--Regulatory Matters--Environmental Regulation."

ABSENCE OF PRIOR PUBLIC MARKET FOR KMC COMMON STOCK

Although the stock of Historical Kahler has been publicly traded, there has
been no public market for KMC Common Stock. There can be no assurance that a
regular trading market for KMC Common Stock will develop or be sustained. The
market price of the KMC Common Stock may be subject to significant fluctuations
in response to variations in quarterly operating results and other factors. The
hotel industry is seasonal in nature. This seasonality can be expected to cause
quarterly fluctuations in revenue and net income of KMC. Moreover, numerous
other factors, such as government regulatory action and modifications of tax
laws could also have a significant effect on the future market price of the KMC
Common Stock. In addition, the stock market in recent years has experienced
extreme price and volume fluctuations that have often been unrelated or
disproportionate to the operating performance of companies. Such broad
fluctuations may adversely affect the market price of KMC Common Stock.

Prices at which the KMC Common Stock may trade prior to the distribution of
the shares in the Spin Off on a "when-issued" basis or after the distribution
cannot be predicted. Until the KMC Common Stock is fully distributed and an
orderly market develops, the prices at which trading in such stock occurs may
fluctuate significantly. The prices at which the KMC Common Stock trades will
be determined by the marketplace and may be influenced by many factors,
including, among others, the factors discussed above as well as the depth and
liquidity of the market for the KMC Common Stock, investor perception of KMC
and the industries in which KMC participates, KMC's dividend policy and general
economic and market conditions. Such prices may also be affected by certain
provisions of KMC's Articles of Incorporation and Bylaws which will have an
antitakeover effect. See "Dividend Policy" and "Description of Capital Stock--
Articles of Incorporation and Bylaw Provisions." KMC has applied for quotation
of the KMC Common Stock on the Nasdaq SmallCap Market. The designation criteria
for quotation on that market require that the stock have a minimum bid price of
at least $3.00 per share. KMC's pro forma stockholders' equity as of July 2,
1995 was $16.6 million. KMC's pro forma stockholders' equity is based on the
pro forma net book value of assets and liabilities distributed by Historical
Kahler to KMC in the Spin Off. The fair market value of the KMC Common Stock
following the Spin Off may differ substantially from the pro forma
stockholders' equity presented.

LIMITATION ON CHANGE IN CONTROL

Certain provisions of KMC's Articles of Incorporation and Minnesota law could
have the effect of discouraging attempts to acquire KMC which, in turn, could
deprive shareholders of opportunities to sell their shares of KMC Common Stock
at prices higher than prevailing market prices. In addition, these provisions
may have the effect of precluding acquisition of control of KMC by a third
party without the approval of the Board of Directors, and may make it more
difficult for shareholders to replace the management of KMC or change the
composition of KMC's Board of Directors. See "Description of Capital Stock."

THE SPIN OFF

GENERAL

Historical Kahler has engaged in a series of transactions to restructure and
recapitalize its operations and make possible its conversion to REIT status,
including a public offering of 8,420,000 shares of Realty Common Stock (the
"Offering") and the Spin Off. The purpose of the Spin Off is to separate
Historical Kahler's hotel ownership and development operations from its hotel
management and other non-real estate related operations in order to satisfy
certain provisions of the Code applicable to REITs. The distribution of the
Spin Off dividend was contingent upon the completion of the Offering which
closed on , 1995. After the Spin Off, Realty will hold 9.5% of the
outstanding KMC Common Stock.

Realty commenced the distribution of the stock certificates representing the
shares of KMC Common Stock distributed in the Spin Off on the date of this
Prospectus. A copy of this Prospectus will be delivered to each shareholder
receiving shares of KMC Common Stock in the Spin Off.

THE DISTRIBUTION AGREEMENT

EFFECT OF SPIN OFF ON OUTSTANDING OPTIONS

In connection with the Spin Off, outstanding stock options which were not
exercised prior to the Record Date are being split into two separately
exercisable options: one to purchase shares of Realty Common Stock and one to
purchase shares of KMC Common Stock. See "Directors and Executive Officers--
Stock Option and Stock Retainer Plans--Effect of Spin Off on Outstanding
Options."

TAX CONSEQUENCES OF THE SPIN OFF

The distribution of KMC Common Stock in the Spin Off will be a taxable
distribution to Realty stockholders for federal income tax purposes. The amount
of the distribution will be the fair market value of the KMC Common Stock at
the date of the distribution (plus the amount of any cash received in lieu of
fractional shares of KMC Common Stock). The amount of the distribution will be
treated as a dividend (taxable as ordinary income) to the extent of Realty's
current or accumulated earnings and profits. Based on its current level of
earnings and profits, Realty expects that the entire amount of the distribution
will be treated as a dividend to Realty stockholders. A shareholder's tax basis
in each share of KMC Common Stock will be equal to the fair market value of
such share at the time of the distribution as determined above. The holding
period for the KMC Common Stock received by stockholders will commence on the
day after the effective date of the distribution.

By January 31, 1996, Realty will mail to each Realty shareholder receiving
KMC Common Stock in the Spin Off and to the Service an annual information
statement on Form 1099 that will include the amount of the distribution that
Realty has determined is taxable as a dividend. Realty's determinations are not
binding upon the Service.

EACH SHAREHOLDER IS ADVISED TO CONSULT HIS OR HER OWN TAX ADVISOR REGARDING
SPECIFIC TAX CONSEQUENCES OF THE RECEIPT, OWNERSHIP AND SALE OF THE KMC COMMON
STOCK.

QUOTATION ON NASDAQ

KMC has applied for quotation on the Nasdaq SmallCap Market under the symbol
"KHMC," following the distribution of shares of KMC Common Stock in the Spin
Off.

DIVIDEND POLICY

KMC has no current plans to pay cash dividends. The declaration and payment
of dividends will be within the discretion of KMC's Board of Directors and will
depend on the earnings, cash available for distribution, capital requirements
and the financial condition of KMC. KMC's ability to pay dividends to its
shareholders is also restricted under the terms of the Percentage Leases. See
"Certain Agreements between KMC and Realty--The Percentage Leases--Restrictions
on Distributions."

PRO FORMA CAPITALIZATION

The following table sets forth the short term debt and capitalization of
Historical Kahler as of July 2, 1995 and the pro forma short term debt and
capitalization of KMC as of July 2, 1995 adjusted to give effect to the Spin
Off. See the Pro Forma Condensed Consolidated Financial Data of KMC included
elsewhere in this Prospectus.

JULY 2, 1995
------------------------
(UNAUDITED)
HISTORICAL PRO FORMA
KAHLER KMC
----------- ----------
(DOLLARS IN THOUSANDS)

Notes payable................................... $ 4,100 $ --
----------- ----------
Long-term debt, including current portion....... 124,977 14,120
----------- ----------
Stockholders' equity
Realty Common Stock, par value $.10,
authorized, 70,000,000 shares; issued and
outstanding, 4,211,031 shares................ 421 --
KMC Common Stock, par value $.10, authorized,
20,000,000 shares; pro forma issued and
outstanding, 465,307 shares.................. -- 43
Additional paid-in capital.................... 13,250 --
Retained earnings............................. 10,175 16,701
Minimum pension liability adjustment.......... (167) (167)
----------- ----------
Total stockholders' equity.................. 23,679 16,577
----------- ----------
Total capitalization...................... $ 152,756 $ 30,697
=========== ==========

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA OF HISTORICAL KAHLER

The following table sets forth selected consolidated financial and operating
data for Historical Kahler. The operating data for Historical Kahler for the
five fiscal years ended January 1, 1995 have been derived from the audited
financial statements of Historical Kahler. The operating data for Historical
Kahler for the first six months of 1994 and 1995 have been derived from the
unaudited financial statements of Historical Kahler and include all adjustments
(consisting solely of normal, recurring adjustments) that the executive
officers of Historical Kahler consider necessary to present fairly the
information set forth therein. Interim results of operations are not
necessarily indicative of the results of operations for a full fiscal year.
This table should be read in conjunction with the Consolidated Financial
Statements of Historical Kahler and the Notes thereto included elsewhere in
this Prospectus.

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA OF HISTORICAL KAHLER
(UNAUDITED)

(See notes on next page.)

- --------

(1) Historical Kahler's fiscal year ends on the Sunday closest to December 31
in each year. Accordingly, the table presents selected financial and
operating data as of the end of and for each of the five fiscal years
ended January 1, 1995 and as of and for the six months ended July 3, 1994
and July 2, 1995.

(2) Non-recurring charges for fiscal 1992 and 1994 and for the twelve months
ended July 2, 1995 reflect (i) a charge of $2.8 million in 1992 consisting
of a $1.2 million non-cash writedown of a hotel property and a $1.6
million charge to settle a lawsuit concerning the Sheraton San Marcos Golf
Resort and Conference Center, and (ii) $1.8 million of expenses in 1994
related to a planned public offering.

(3) Income per share in 1990 and 1991 is computed on a primary and fully
diluted share basis using the weighted average number of outstanding
shares of Realty Common Stock and Realty Common Stock equivalents of
3,218,000 and 3,274,000, respectively. For 1992, loss per share is
computed on a primary share basis using only the weighted average number
of outstanding shares of Realty Common Stock aggregating 3,341,000. Realty
Common Stock equivalents are excluded since the effect is antidilutive.
For 1993 and 1994, income per share is computed on a primary and fully
diluted share basis using the weighted average number of outstanding
shares of Realty Common Stock and Realty Common Stock equivalents (arising
from employee stock plans, deferred stock compensation and a warrant)
aggregating 3,743,000 and 3,956,000, respectively. For the first six
months of 1994 and 1995 and the twelve months ended July 2, 1995, income
per share is computed on a primary and fully diluted share basis using the
weighted average number of outstanding shares of Realty Common Stock and
Realty Common Stock equivalents aggregating 3,785,000, 4,306,000 and
4,306,000 shares, respectively.

(4) EBITDA means income (loss) from operations before income taxes, excluding
gains or losses on sale of assets, non-cash writedowns of real estate
property, interest expense, depreciation and amortization. EBITDA does not
represent cash generated from operating activities in accordance with
GAAP, is not to be considered as an alternative to net income or any other
GAAP measurements as a measure of operating performance and is not
necessarily indicative of cash available to fund all cash needs.
Management believes that EBITDA is a useful measure of cash flow because
it indicates the cash flow available to spend on capital additions to
maintain Realty's assets, to service existing debt or to use at Realty's
discretion for other purposes.

(5) Cash flow from operations for fiscal 1992 and 1994 and for the twelve
months ended July 2, 1995 reflects non-recurring charges of $1.6 million,
$1.8 million and $1.8 million, respectively. Prior to consideration of
such expenses, cash flow from operations would have been $6.0 million for
1992, $11.2 million for 1994 and $11.7 million for the twelve months ended
July 2, 1995. The $1.6 million charge in 1992 relates to the settlement of
a lawsuit, and the 1994 charge represents costs incurred in connection
with a planned public offering. See Note 10 of Notes to Consolidated
Financial Statements of Historical Kahler.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS OF HISTORICAL KAHLER

The management's discussion and analysis of financial condition and results
of operations set forth below is based on the Consolidated Financial Statements
of Historical Kahler. This discussion does not reflect the Spin Off and,
accordingly, it includes the financial condition and results of operations
related to the businesses of Realty and of KMC. The financial results of
Historical Kahler will not be comparable to the future operating results of
Realty and of KMC. The following discussion should be read in conjunction with
(i) the Consolidated Financial Statements of Historical Kahler and Notes
thereto, (ii) the Pro Forma Condensed Consolidated Financial Data of Realty and
KMC and the respective Notes thereto, and (iii) Management's Discussion and
Analysis of Pro Forma Financial Data of KMC, all appearing elsewhere in this
Prospectus.

Historical Kahler's principal business is the ownership and management of
hotel properties. Revenues from lodging are primarily derived from the revenues
of hotels consolidated in Historical Kahler's financial statements, interest
income on mortgage notes held by Historical Kahler with respect to hotels
managed by Historical Kahler and equity earnings (loss) on hotels in which
Historical Kahler owns a minority interest. The Consolidated Financial
Statements include the accounts of all wholly or majority owned hotels and the
lodging revenues of the University Park Hotel. See Note 1 to the Consolidated
Financial Statements of Historical Kahler. Except for the University Park
Hotel, ownership of 50.0% or less of a hotel is accounted for under the equity
method.

The following table sets forth, as percentages of total lodging revenue, the
principal components of Historical Kahler's lodging operations for the periods
indicated.

FIRST
FISCAL YEAR SIX MONTHS
------------------- ------------
1992 1993 1994 1994 1995
----- ----- ----- ----- -----

Room revenue............................. 57.1% 57.2% 58.0% 58.6% 58.8%
Food and beverage revenue................ 29.7 31.3 31.5 30.4 30.2
Other lodging revenue.................... 13.2 11.5 10.5 11.0 11.0
----- ----- ----- ----- -----
Total lodging revenue.................. 100.0% 100.0% 100.0% 100.0% 100.0%
Lodging expenses......................... 77.1 75.7 75.9 74.5 74.2
----- ----- ----- ----- -----
Lodging income before interest,
depreciation and corporate expenses..... 22.9% 24.3% 24.1% 25.5% 25.8%
===== ===== ===== ===== =====

The following table sets forth certain additional operating data for the
hotels owned and managed by Historical Kahler:

FIRST
FISCAL YEAR SIX MONTHS
------------------------------- ----------------
1992 1993 1994 1994 1995
--------- --------- --------- ------- -------

Number of Hotels--end of
period................. 16 18 20 19 21
Number of rooms--end of
period................. 3,699 4,103 4,382 4,255 4,532
Room nights available... 1,314,976 1,406,488 1,559,012 772,884 812,285
Occupancy............... 61.9% 63.9% 65.2% 65.6% 66.5%
ADR..................... $61.36 $63.31 $63.75 $65.49 $67.10
REVPAR.................. $38.01 $40.48 $41.58 $42.95 $44.63

RESULTS OF OPERATIONS

Comparison of First Six Months 1994 to First Six Months 1995

REVENUE FROM OWNED OPERATIONS. Total lodging revenue increased 11.9% from
$47.6 million in the first six months of 1994 to $53.3 million in the
comparable 1995 period. This improvement resulted primarily from a $1.61 or
2.5% increase in ADR from $65.49 in the first six months of 1994 to $67.10 in
the first six months of 1995 and an increase in occupancy from 65.6% in the
first six months of 1994 to 66.5% in the first six months of 1995. Also, the
acquisition of the Pocatello Park Quality Inn and the Green Oaks Inn and
Conference Center provided an increase in lodging revenue of $3.6 million.
Historical Kahler's hotels in the Intermountain states of Utah and Idaho and
the conference center hotel in Arizona primarily generated the increase in ADR
and occupancy. Lodging revenue from food and beverage increased 10.9% from
$14.5 million in the first six months of 1994 to $16.1 million in the first six
months of 1995 primarily as a result of improved occupancy levels and the
acquisition of the Pocatello Park Quality Inn and the Green Oaks Inn and
Conference Center.

OPERATING COSTS AND EXPENSES. Lodging expenses increased 11.5% from $35.5
million in the first six months of 1994 to $39.5 million in the first six
months of 1995. As a percentage of lodging revenue, however, lodging expenses
decreased from 74.5% in the first six months of 1994 to 74.2% in the first six
months of 1995. This change was primarily the result of increased ADRs and a
higher gross operating margin in food and beverage as described above. Lodging
income before interest, depreciation and corporate expenses increased from
$12.2 million or 25.5% of total lodging revenue in the first six months of 1994
to $13.8 million or 25.8% of total lodging revenue in the first six months of
1995.

Corporate expenses, primarily administrative and general expenses, increased
13.0% from $1.7 million for the first six months of 1994 to $1.9 million in the
first six months of 1995. This increase is primarily a result of an increase in
employee related expenses and professional fees. Depreciation and amortization
increased 3.3% from $4.3 million in the first six months of 1994 to $4.4
million in the first six months of 1995 due primarily to the hotel
acquisitions.

GROSS OPERATING PROFIT. Gross operating profit increased 21.1% from $7.7
million in the first six months of 1994 to $9.3 million in the first six months
of 1995 primarily due to the acquisition of the Pocatello Park Quality Inn and
the Green Oaks Inn and Conference Center as mentioned above. As a percentage of
total revenue of owned operations, gross operating profit increased from 13.7%
in the first six months of 1994 to 15.1% in the first six months of 1995 due
primarily to the strong economies from the hotels in the Intermountain states
of Utah and Idaho and the conference center hotel in Arizona.

INTEREST EXPENSE. Interest expense increased 15.5% from $5.2 million in the
first six months of 1994 to $6.1 million in the first six months of 1995. The
increase is attributable to the increase in prime lending rate and the debt
associated with the acquisition of the Pocatello Park Quality Inn.

Comparison of 1993 to 1994 Operations

REVENUE FROM OWNED OPERATIONS. Total lodging revenue increased 15.8% from
$80.5 million in 1993 to $93.2 million in 1994. This increase resulted
primarily from the acquisitions of hotels in 1993 and 1994. Additional revenue
resulted from increased occupancy levels from 63.9% in 1993 to 65.2% in 1994
and increased ADR from $63.31 in 1993 to $63.75 in 1994. The increased
occupancy resulted primarily from improved levels in the Intermountain region
hotels.

OPERATING COSTS AND EXPENSES. Lodging expenses increased 16.1% from $61.0
million in 1993 to $70.8 million in 1994. This increase also relates to the
hotel acquisitions in 1993 and 1994. As a percentage of lodging revenue,
lodging expenses increased from 75.7% in 1993 to 75.9% in 1994.

Corporate expenses, primarily administrative and general expenses, remained
level at $3.3 million from 1993 to 1994, but declined from 3.4% to 3.0% as a
percentage of total revenue of owned operations.

Depreciation and amortization increased 7.2% from $7.9 million in 1993 to $8.5
million in 1994 due primarily to the hotel acquisitions in 1993 and 1994 and
the new laundry facility which opened in April 1993 in Rochester, Minnesota.

The non-recurring charge of $1.8 million in 1994 represents expenses related
to a planned public offering and conversion of Historical Kahler into a REIT
which was not completed due to unfavorable market conditions. The after-tax
impact of such charge was approximately $1.3 million.

GROSS OPERATING PROFIT. Gross operating profit decreased by $127,000 from
$12.2 million in 1993 to $12.1 million in 1994. Excluding the $1.8 million of
non-recurring charges, Historical Kahler would have had 1994 gross operating
profit of $13.9 million, a 13.8% increase over 1993.

INTEREST EXPENSE. Interest expense increased by 19.7% from $9.4 million in
1993 to $11.2 million in 1994. The increase in the amount of interest expense
can be attributed to increased indebtedness incurred in connection with the
hotel acquisitions in 1993 and 1994, the new laundry facility and increases in
the prime interest rate during 1994. Increases in the prime interest rate
during 1994 contributed approximately $720,000 of this $1.8 million increase.

PROVISION FOR INCOME TAXES. At January 2, 1994 and January 1, 1995,
Historical Kahler had prepaid income tax charges net of deferred income tax
credits of $393,000 and $513,000, respectively. Historical Kahler has based the
value of the net prepaid tax asset primarily on the alternative minimum tax
credits which, under current law, have no expiration dates. The ultimate
realization of the deferred tax asset is dependent upon the offset of these
credits against future federal tax payments if future taxable income exceeds
the alternative minimum tax levels. Also, these credits could generate a refund
by carrying back net operating losses if Historical Kahler incurred such losses
in the future. Further analysis of the tax provision is presented in Note 11 of
Notes to Consolidated Financial Statements of Historical Kahler.

Comparison of 1992 to 1993 Operations

REVENUE FROM OWNED OPERATIONS. Lodging revenues increased by $22.1 million or
37.8% from $58.4 million in 1992 to $80.5 million in 1993. This increase is
primarily the result of having the additional properties acquired in 1992
(Boise Park Suites, Sheraton San Marcos and Olympia Park Hotels) for the full
year of 1993 and the additional hotels acquired in 1993 (Salt Lake Hilton and
Ogden Park Hotels). Increased occupancy and average room rates also contributed
to the revenue increase.

OPERATING COSTS AND EXPENSES. Total operating costs and expenses, excluding
non-recurring charges, increased from $66.9 million in 1992 to $84.8 million in
1993, but as a percentage of total revenue of owned operations declined from
90.3% in 1992 to 87.4% in 1993.

Similarly, lodging costs increased 35.3% from $45.1 million in 1992 to $61.0
million in 1993, but as a percentage of lodging revenue declined from 77.1% in
1992 to 75.7% in 1993. This improvement was a direct result of increased
occupancy and rates during the year plus improved cost control.

Corporate expenses for 1993 remained approximately the same as in 1992, but
as a percentage of total revenue of owned operations corporate expenses
declined from 4.3% in 1992 to 3.4% in 1993.

Depreciation and amortization increased 21.7% from $6.5 million in 1992 to
$7.9 million in 1993 due primarily to the 1993 hotel acquisitions. Depreciation
and amortization declined, however, as a percentage of total revenue of owned
operations from 8.8% in 1992 to 8.2% in 1993.

The non-recurring charge of $2.8 million in 1992 consists of a $1.2 million
non-cash writedown of a hotel property and a $1.6 million charge to settle a
lawsuit concerning the Sheraton San Marcos Golf Resort and Conference Center.

GROSS OPERATING PROFIT. Gross operating profit increased by $7.8 million from
$4.4 million in 1992 to $12.1 million in 1993. As a percentage of total revenue
of owned operations, gross operating profit increased from 5.9% in 1992 to
12.6% in 1993. Lodging, formal wear operations and the 1992 non-recurring
charges were the major contributors to this improvement.

INTEREST EXPENSE. Interest expense increased 28.2% from $7.3 million in 1992
to $9.4 million in 1993. This increase is attributable to the debt associated
with the laundry facility opened in April 1993 and new properties acquired in
1993.

OTHER ITEMS. The loss on sale of assets of $693,000 in 1992 includes a
$397,000 loss relating to discontinued operations at a Wisconsin Dells hotel, a
$400,000 writedown of assets and reserve for demolition of the old laundry
facility in Rochester, offset by a gain of $104,000 on the sale of customer
contracts related to the closing of formal wear operations in San Jose.

The 1992 extraordinary item of $2.5 million, net of income tax of $278,000,
relates to the extinguishment of debt and was recorded simultaneously with the
writedown of a hotel property.

LIQUIDITY AND CAPITAL RESOURCES

CASH FLOWS FROM OPERATIONS. Net cash from operations increased 8.8% from $5.6
million in the first six months of 1994 to $6.1 million in the first six months
of 1995. Net cash from operations decreased, however, from $10.4 million in
1993 to $9.4 million in 1994. The decrease was primarily attributable to the
after-tax charge of $1.3 million resulting from costs incurred in connection
with a planned public offering and conversion of Historical Kahler into a REIT.

CASH FLOWS FROM INVESTING ACTIVITIES. Capital expenditures decreased from
$8.7 million in the first six months of 1994 to $3.2 million in the first six
months of 1995. Capital expenditures in the first six months of 1994 consisted
of $5.2 million used for acquisition of the Pocatello Park Quality Inn with
most of the rest used for refurbishment of existing properties and purchase of
formal wear garments. Expenditures in the first six months of 1995 were used to
remodel and refurbish existing hotels, purchase laundry and formal wear
equipment and purchase garments.

Capital expenditures for 1993 and 1994 totaled $12.2 million and $13.5
million, respectively. In 1993, approximately $9.3 million was used on the
construction of the new laundry facility in Rochester, while approximately $2.2
million was used for refurbishment of existing hotels and $700,000 for the
purchase of garments. In 1994, approximately $7.8 million was used for
acquisition and renovation of the Pocatello Park Quality Inn, land for the
expansion of the Boise Park Suites Hotel, acquisition of Green Oaks Inn and
Conference Center and completion of the laundry facility in Rochester. In
addition, approximately $4.5 million was used for refurbishment of existing
hotels and $1.2 for the purchase of formal wear garments.

In June 1995, Historical Kahler signed a purchase agreement relating to the
acquisition of the Canyon Springs Park Hotel for $5.8 million. In addition to
this acquisition, which was completed in August 1995, and Historical Kahler's
customary refurbishing expenditures, management estimates that $5.2 million
will be used to expand the Boise Park Suites Hotel from 130 rooms to 243 rooms.
Historical Kahler has a loan commitment for construction and permanent
financing to fund the estimated $4.9 million cost of expansion.

Notes receivable, including current portion, declined from $5.1 million at
1993 year end to $1.6 million at 1994 year end, principally due to the
acquisition of the Green Oaks Inn and Conference Center in December 1994. See
Note 3 of Notes to Consolidated Financial Statements of Historical Kahler for a
summary of the acquisition.

CASH FLOWS FROM FINANCING ACTIVITIES. In the first six months of 1995,
Historical Kahler made a scheduled $500,000 payment on its subordinated debt,
normal principal retirements of $976,000 and $1.2

million repayment on its lines of credit and short-term notes. In the first six
months of 1994, normal principal retirements of $1.2 million were made. Net
cash provided from proceeds of new long-term debt of $3.7 million and net
borrowing under line-of-credit agreements of $1.7 million relates to the cash
requirements for the acquisition of Pocatello Park Quality Inn.

At January 1, 1995, Historical Kahler had notes payable of $5.3 million due
in 1995. Of this amount, $4.3 million relates to amounts outstanding on $4.5
million of available lines of credit. The banks providing these lines of credit
normally extend the lines one year at a time. Historical Kahler has received
the extension of all its lines of credit through June 1996. The remaining $1.0
million at January 1, 1995 was a note payable due in June 1995 which was repaid
from working capital.

At January 1, 1995, Historical Kahler had approximately $75 million of
variable rate debt and $57 million of fixed rate debt. Historical Kahler's
variable rate debt is generally indexed to the prime rate, ranging from prime
to 2% in excess of prime. Historical Kahler believes that its net cash provided
by operating activities along with other financing sources will be sufficient
to fund its capital requirements.

Historical Kahler received proceeds of approximately $1.4 million in 1994
from the issuance of Common Stock in connection with the exercise of warrants
and stock options. Stockholders' equity increased $4.9 million during fiscal
1994 to $21.3 million at January 1, 1995, principally as a result of such
proceeds and conversion of approximately $3.3 million of preferred stock.

INFLATION

Management believes that, during the five years ended January 1, 1995 and the
six months ended July 2, 1995, inflation has not had a material effect on the
assets or operations of Historical Kahler.

SEASONALITY

Historical Kahler's hotel operations have been seasonal in nature, reflecting
higher occupancy rates during the first and third quarters. The higher
occupancy rates during the first quarter are due to increased seasonal demand
at the Sheraton San Marcos Golf Resort and Conference Center and the Greater
Salt Lake City area hotels due to winter skiing. The third quarter typically
has higher occupancy rates due to summer vacation travel.

OTHER

Historical Kahler is involved in various litigation in the normal course of
business. Historical Kahler does not expect the outcome of such litigation to
have a material adverse effect on its consolidated financial statements. See
"The Hotels--Legal Proceedings."

PRO FORMA SELECTED CONSOLIDATED FINANCIAL DATA OF KMC

The following table sets forth unaudited pro forma selected consolidated
financial data for KMC. The data are presented as if (i) the Spin Off had
occurred as of the beginning of each period presented, (ii) certain Hotels
acquired subsequent to the beginning of each period presented had been acquired
as of the beginning of each period presented, and (iii) the Percentage Leases
were executed and in effect as of the beginning of each period presented. The
pro forma financial information is not necessarily indicative of what the
actual financial position and results of operations of KMC would have been as
of and for the periods presented, and such information does not purport to
represent the future financial position of KMC. This table should be read in
conjunction with the Pro Forma Condensed Consolidated Financial Data of KMC
included elsewhere in this Prospectus.

FIRST
TWELVE SIX MONTHS
FISCAL YEAR MONTHS ENDED ----------------
1994 JULY 2, 1995 1994 1995
----------- ------------ ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
DATA)

STATEMENT OF OPERATIONS DATA:
Lodging Segment
Lodging--rooms................. $55,275 $56,673 $28,527 $29,925
--food & beverage.............. 29,869 30,272 14,866 15,269
--other........................ 10,121 10,641 5,442 5,962
Interest income................ 137 144 60 67
Equity loss of affiliates...... (278) (292) (29) (43)
------- ------- ------- -------
Total lodging revenue........ 95,124 97,438 48,866 51,180
Percentage lease expense (1)... 24,354 25,117 12,752 13,515
Lodging expenses............... 68,178 69,542 34,270 35,634
------- ------- ------- -------
Lodging income before
interest, depreciation, and
corporate expenses............ 2,592 2,779 1,844 2,031
------- ------- ------- -------
Laundry Segment
Laundry revenue................ 6,304 6,052 3,309 3,057
Laundry expenses............... 5,957 5,206 3,220 2,469
------- ------- ------- -------
Laundry income before
interest, depreciation, and
corporate expenses............ 347 846 89 588
------- ------- ------- -------
Formal Wear Segment
Formal wear revenue............ 8,924 9,117 4,809 5,002
Formal wear expenses........... 6,975 7,207 3,704 3,936
------- ------- ------- -------
Formal wear income before
interest, depreciation, and
corporate expenses............ 1,949 1,910 1,105 1,066
------- ------- ------- -------
Other income before interest,
depreciation, and corporate
expenses....................... 86 73 43 30
------- ------- ------- -------
Total income before interest,
depreciation and corporate
expenses....................... 4,974 5,608 3,081 3,715
Corporate expenses.............. (2,782) (3,002) (1,456) (1,676)
Interest expense................ (1,294) (1,337) (629) (672)
Depreciation and amortization... (3,305) (3,292) (1,722) (1,709)
------- ------- ------- -------
Loss from operations before
income taxes................... (2,407) (2,023) (726) (342)
------- ------- ------- -------
Net loss........................ $(2,407) $(2,023) $ (726) $ (342)
======= ======= ======= =======
Loss per share (2).............. $ (5.02) $ (4.22) $ (1.52) $ (.71)
======= ======= ======= =======

JULY 2, 1995
------------
(DOLLARS IN
THOUSANDS)

- --------

(2) The number of outstanding shares of KMC Common Stock used to compute income
per share for 1994, for the twelve months ended July 2, 1995 and for the
first six months of 1994 and 1995 is 479,177.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

PRO FORMA FINANCIAL DATA OF KMC

The management's discussion and analysis of pro forma financial data set
forth below should be read in conjunction with the Pro Forma Condensed
Consolidated Financial Data of KMC and Realty, Management's Discussion and
Analysis of Financial Condition and Results of Operations of Historical Kahler,
and the Consolidated Financial Statements of Historical Kahler and Notes
thereto, all appearing elsewhere in this Prospectus.

Following the Spin Off, KMC will be primarily engaged in managing and
operating 22 Hotels, two commercial laundry facilities and a formal wear
business. KMC's principal sources of revenue will be from the Leased Hotels,
management fees under its management contracts, revenues from the two Owned
Hotels and revenues from Textile and Anderson's. KMC will initially lease the
Leased Hotels pursuant to the Percentage Leases. Under the Percentage Leases,
KMC will be obligated to pay at least the Base Rent with respect to each Leased
Hotel. KMC's ability to pay rent to Realty under the Percentage Leases will
depend on the operations of the Leased Hotels.

Pro forma results for the first six months are not necessarily indicative of
trends for the year due to the seasonal nature of KMC's business. Historically,
revenues of the KMC businesses are greater in the second and third quarters.

PRO FORMA RESULTS OF OPERATIONS

Comparison of Pro Forma First Six Months 1995 to Pro Forma First Six Months
1994.

Pro forma total lodging revenue increased 4.7% to $51.2 million in 1995 as
compared to $48.9 million in 1994, primarily due to an increase in the number
of room nights available, improved occupancy and increased average room rates.
Room nights available in the Hotels on a historical basis increased 5.1% from
772,884 during the first six months of 1994, to 812,285 during the same period
in 1995. Occupancy on a historical basis increased to 66.5% in 1995, as
compared to 65.6% in 1994. The ADR for the Hotels on a historical basis
increased by $1.61 from $65.49 in 1994 to $67.10 in 1995. Food and beverage pro
forma revenues increased by 2.7% from $14.9 million in 1994, to $15.3 million
in 1995, as a result of the increase in the number of room nights available and
improved occupancy rate between the periods. Pro forma other lodging revenue
increased from $5.4 million in 1994, to $6.0 million in 1995, or 9.6%,
primarily because of the increase in occupied rooms. Approximately 97.0% and
96.6% of total lodging revenue and 83.8% and 82.8% of total revenue was
attributable to the Realty Hotels during the first six months of 1995 and 1994,
respectively.

Percentage lease expense, increased by 6.0% to $13.5 million in 1995, from
$12.8 million in 1994 as a result of increases in room and food and beverage
revenues. On a pro forma basis, the Percentage Rent for each Leased Hotel for
the six months of 1995 and 1994 was greater than Base Rent for that period. The
aggregate pro forma Base Rent for the Leased Hotels was $8.1 million for the
first six months of 1995 and 1994. Pro forma lodging expenses also increased by
approximately $1.4 million, or 3.8%, to $35.6 million in 1995 as compared to
$34.3 million in 1994. These increases are the result of the increased
occupancies and rates as mentioned above.

Lodging income before interest, depreciation and corporate expenses increased
10.1% to $2.0 million in 1995 as compared to $1.8 million in 1994, due to the
increase in total lodging revenue which was only partially offset by increased
percentage lease expense and lodging expenses.

Laundry revenue decreased 7.6% to $3.1 million in 1995 from $3.3 million in
1994. This decrease was primarily the result of downsizing the Textile laundry
facility in Utah in the fourth quarter of 1994. This downsizing was the result
of Historical Kahler's efforts to discontinue laundry services for unprofitable
products and accounts in Utah. Offsetting this decrease was an increase in
revenues at the Textile laundry facility in Rochester of approximately 3.3% in
1995.

Laundry operating expenses decreased to 80.8% of laundry revenues in 1995, as
compared to 97.3% in 1994. The decrease was primarily due to greatly improved
efficiencies associated with the laundry facility in Rochester, which opened in
April 1993. Productivity measured in pounds produced per labor hour increased
to 90.1 in 1995 compared to 62.3 in 1994, a 44.6% improvement in Rochester.
Also contributing to this improvement was the downsizing at the Utah facility.

Laundry income before interest, depreciation and corporate expenses increased
to $588,000 in 1995 as compared to $89,000 in 1994. This substantial increase
was primarily due to the greatly improved operating efficiencies at the
Rochester laundry facility.

Formal wear revenue increased by 4.0% in 1995 to $5.0 million from $4.8
million in 1994. This improvement resulted from an increase in the volume of
units shipped of 1.8% and an increase of revenue per unit of 1.3%.

Formal wear operating expenses increased by 6.3% in 1995 to $3.9 million from
$3.7 million in 1994. As a percentage of formal wear revenue, formal wear
expenses increased slightly to 78.7% in 1995 from 77.0% in 1994.

Formal wear operating income before interest, depreciation and corporate
expenses was approximately $1.1 million during the first six months of 1995 and
1994.

Pro forma corporate expenses of KMC were approximately $1.7 million in 1995
and $1.5 million in 1994. This increase is primarily because of an increase in
employee related expenses and professional fees. Pro forma interest expense
increased to $672,000 in 1995 from $629,000 in 1994. The increase in pro forma
interest expense resulted from an increase in the prime lending rate.
Approximately $474,000 and $477,000 of the interest expense in 1995 and 1994,
respectively, represented interest on debt secured by the Rochester laundry
facility, with most of the balance attributable to a mortgage on the Owned
Hotels. Pro forma depreciation and amortization was unchanged at $1.7 million
in 1995 and 1994. Approximately $692,000 and $579,000 of this amount in 1995
and $754,000 and $566,000 of this amount in 1994 was attributable to
depreciation in the formal wear business (primarily garments) and to
depreciation in the hotel management business (primarily personal property at
the Hotels), respectively, with the balance in each case attributable to the
commercial laundry business and corporate.

Pro forma net loss was $342,000 in 1995 as compared to a pro forma net loss
of $726,000 in 1994.

Pro Forma Fiscal Year 1994

Pro forma total lodging revenue for KMC in 1994 was $95.1 million.
Approximately 96.5% of total lodging revenue and 83.2% of total revenue was
attributable to the Realty Hotels during 1994. Percentage lease expense for
1994 was $24.4 million. On a pro forma basis, the Percentage Rent for each
Leased Hotel during 1994 would have been greater than Base Rent for that
period. The aggregate pro forma Base Rent for the Leased Hotels for 1994 was
$16.2 million. Pro forma lodging expenses were $68.2 million in 1994. Pro forma
lodging income before interest, depreciation and corporate expenses was $2.6
million.

The pro forma results for the laundry and formal wear businesses are
identical to the historical results reported by Historical Kahler for these
businesses. On a pro forma basis, laundry revenue for 1994 was $6.3 million and
laundry expenses were $6.0 million. Pro forma laundry expenses represented
94.5% of total laundry revenue for 1994. The new Rochester laundry facility
which opened in April 1993 continued to experience start up inefficiencies in
1994 causing the facility to operate below its expected efficiency. During
1994, the facility processed an average of 66.6 pounds per labor hour.
Comparing production of the facility in January 1994 with December 1994, the
pounds processed per labor hour were 61.4 and 82.7, respectively.

On a pro forma basis, formal wear revenue in 1994 was $8.9 million and formal
wear expenses were $7.0 million. As a percentage of formal wear revenue, formal
wear expenses were 78.2%.

On a pro forma basis, corporate expenses, interest expense and depreciation
and amortization were approximately $2.8 million, $1.3 million and $3.3
million, respectively, for 1994. The pro forma corporate expenses reflect the
transfer to KMC of substantially all of Historical Kahler's former employees as
a result of the Spin Off. Of the pro forma interest expense for 1994,
approximately $963,000 represented interest on debt secured by the Rochester
laundry facility, with most of the balance attributable to KMC's mortgage on
the Owned Hotels. Of the pro forma depreciation and amortization for 1994,
approximately $1.4 million and $1.1 million of this amount was attributable to
depreciation in the formal wear business (primarily garments) and to
depreciation in the hotel management business (primarily personal property at
the Hotels), respectively, with the balance in each case attributable to the
commercial laundry business and corporate.

Pro forma net loss for KMC in 1994 was $2.4 million.

PRO FORMA LIQUIDITY AND CAPITAL RESOURCES

On a pro forma basis, after the Spin Off, KMC had outstanding mortgage debt
of approximately $14.1 million as of July 2, 1995. This debt included
approximately $9.7 million of debt of a subsidiary of KMC, which is secured by
Textile's commercial laundry facility in Rochester, Minnesota, and guaranteed
by Realty. If the subsidiary defaults on this debt, the lender has the right to
demand payment of the debt from Realty and to put the debt to the Mayo
Foundation. In that event the Mayo Foundation can either pursue Realty for
reimbursement as guarantor or foreclose on the commercial laundry facility,
which is the sole laundry facility serving the Mayo Clinic's facilities in
Rochester, Minnesota. KMC has agreed to indemnify Realty for any amounts paid
under this guarantee.

KMC's pro forma stockholders' equity as of July 2, 1995 was $16.6 million.
KMC's pro forma stockholders' equity is based on the pro forma net book value
of assets and liabilities distributed by Historical Kahler to KMC in the Spin
Off. The fair market value of the KMC Common Stock following the Spin Off may
differ substantially from the pro forma stockholders' equity presented. KMC has
applied for quotation of the KMC Common Stock on the Nasdaq SmallCap Market.
Until the KMC Common Stock is fully distributed and an orderly market develops,
the prices at which trading in such stock occurs may fluctuate significantly.

As of July 2, 1995, KMC's pro forma investment in real estate (before
accumulated depreciation) was $45.2 million and its net investment in real
estate was $30.0 million. KMC's pro forma total assets as of July 2, 1995 were
$41.9 million.

On a proforma basis, KMC has had net losses of $2.4 million, $2.0 million,
$726,000 and $342,000 for fiscal 1994, the twelve months ended July 2, 1995,
and the first six months of 1994 and 1995, respectively. These pro forma net
losses are primarily due to depreciation of the new Rochester laundry facility,
depreciation of personal property associated with six of the Leased Hotels and
the operating inefficiencies experienced by the Rochester laundry during its
start up phase. In the future, KMC anticipates that its net loss will decline
primarily as a result of improved operating results from the Textile business
due to increased operating efficiencies and the operation of additional hotels
under percentage lease arrangements similar to its existing leases with Realty.
KMC also anticipates that it will generate sufficient cash from operations in
1995 to fund its business operations and planned capital expenditures. There
can be no assurance, however, that KMC will be able to reduce its net losses in
the near future or that the cash generated by operations in 1995 will be
sufficient to fund its business operations.

KMC's capital expenditure requirements consist of the purchase of formal wear
garments, expenditures for the two Owned Hotels and the laundry facilities and
corporate expenditures. KMC's principal annual capital expenditure is the
purchase of formal wear garments. In 1994, KMC had approximately $2.0 million
in capital expenditures, including approximately $1.2 million for formal wear
garments and $326,000 for equipment at the new Rochester laundry facility. KMC
anticipates that it will make approximately $1.5 million in capital
expenditures in 1995, including $1.1 million for formal wear garments.

KMC does not currently have any lines of credit and does not anticipate
needing a line of credit within the next year. KMC's pro forma negative working
capital provides it with a source of capital. Since KMC principally sells
services (rather than goods) for cash, KMC does not normally need positive
working capital. Negative working capital is common in the lodging industry. If
KMC determines to seek a line of credit, it currently has unencumbered assets
which could be used to secure a line of credit; however, there can be no
assurance that a line of credit would be available on terms acceptable to KMC
or at all.

SEASONALITY

KMC anticipates that it will experience seasonality in its operation of the
Hotels similar to that experienced by Historical Kahler, reflecting higher
occupancy rates in the first quarter due to winter ski vacations and Arizona
vacations and in the third quarter due to summer vacation travel. In addition,
the formal wear business is highly seasonal, with the greatest amount of
rentals during the second quarter due to high school proms and weddings. KMC's
laundry business is not subject to significant seasonality. As a result, KMC
expects that the second and third quarters will generally be its strongest,
with the fourth quarter generally being its weakest.

BUSINESS

GENERAL

KMC is primarily engaged in managing and operating the 22 Hotels, a majority
of which are owned by Realty. KMC also owns and operates certain non-real
estate related businesses that were owned by Historical Kahler prior to the
Spin Off, including Textile, Historical Kahler's commercial laundry business,
and Anderson's, Historical Kahler's wholesale and retail formal wear business.

GROWTH STRATEGY

KMC's growth strategy is to expand its hotel management operations primarily
through its relationship with Realty. KMC's primary focus will be to operate
the Realty Hotels and any new hotel properties that Realty acquires and leases
to KMC. KMC expects to pursue jointly with Realty new hotel opportunities.
Realty has indicated that it will rely on KMC's hotel management operations to
assist it in evaluating potential markets for acquisitions and in identifying
potential acquisition opportunities that might not be readily available in the
open market. After a potential acquisition opportunity is identified, Realty
and KMC will jointly evaluate the property from both an ownership and
operational standpoint. Once acquired, Realty and KMC will work together to
reposition the hotel, as necessary, through improved management, franchise
affiliation, redevelopment or refurbishment.

Subject to its noncompetition covenant set forth in the Right of First
Refusal Agreement, KMC may also seek to manage additional hotels for third
parties other than Realty. See "Certain Agreements between KMC and Realty--
Right of First Refusal Agreement." Although equity interests in certain hotels
were transferred to KMC as part of the Asset Transfers, KMC does not anticipate
making substantial equity investments in hotel properties for the foreseeable
future.

HOTEL OPERATIONS

General

KMC operates 22 Hotels, including the 14 Leased Hotels, the six Managed
Hotels and the two Owned Hotels. KMC also holds a minority equity interest in
the entities that own four of the Managed Hotels. Of the 22 Hotels, 16 are full
service hotels, 3 are conference center hotels and 3 are limited service
hotels. The general attributes of each of these categories of Hotel are
described below.

. Full service. These Hotels generally provide a full range of services and
amenities, including convention and banquet facilities, room service,
business centers, fitness centers, swimming pools, gift and convenience
shops, parking facilities and, in most instances, restaurants and
lounges. KMC operates both luxury and moderately-priced full service
Hotels containing from 130 to 351 guest rooms, except for The Kahler
Hotel, which has 696 rooms. These Hotels cater to a broad range of
customers including frequent business travelers, large groups and
conventions, and leisure travelers of the 16 full service Hotels, eleven
are Leased Hotels and five are Managed Hotels. See "The Hotels."

. Conference Center. These Hotels offer all of the services of a full
service hotel, as well as large meeting and conference facilities and
convention support services. Two of the conference center Hotels operated
by KMC also offer a full range of resort amenities, including golf
courses and tennis courts. The conference center Hotels operated by KMC
have from 187 to 295 rooms and are designed to provide high quality
conference facilities with moderately-priced room rates. The conference
center Hotels seek to attract regional and national conferences and
meetings. All of the conference center Hotels are Leased Hotels. See "The
Hotels."

. Limited Service. These Hotels offer budget formats and provide a selected
range of amenities and services, primarily swimming pools, fitness
centers and business centers that are attractive to business travelers.
The limited service operation of these Hotels is designed to attract
individual business

travelers and vacationers and to allow the Hotels to be competitive and
profitable at relatively lower occupancy levels than other hotel formats.
The limited service Hotels operated by KMC have from 70 to 107 rooms. The
limited service Hotels include two Owned Hotels and one Managed Hotel. See
"The Hotels."

Most of the Hotels are situated near major hotel room demand generators,
including major medical facilities, large corporate facilities and major
universities, and are generally located near major interstate highways,
transportation centers and airports.

Hotel Management

KMC's operating responsibilities with respect to the Hotels encompass all
phases of lodging operations, including hiring, training and supervising all of
the managers and employees necessary for the operation of the Hotels. KMC also
provides computerized reservation services, advertising and marketing and
promotion services.

KMC is also generally responsible for allocating funds for periodic
maintenance and repairs of the buildings and furnishings. With respect to the
Leased Hotels under the terms of the Percentage Leases, Realty is required to
reserve, on a quarterly basis, 5.5% of total room revenues to be used for the
ongoing refurbishment and replacement of FF&E at the Leased Hotels. KMC will
submit to Realty, on an annual basis, capital reinvestment schedules which
detail proposed room and facilities refurbishments and FF&E replacement for the
Leased Hotels based upon feedback from guests, employees, property managers and
property inspection reports from franchisors on the franchised properties. KMC
reviews each of the Leased Hotels for potential revenue-enhancing upgrades,
renovations, and refurbishment projects including additional guest services and
amenities such as business centers, concierge floors and in-room refrigerators.
Based on information provided by KMC, Realty reviews investment returns of such
projects to decide upon the feasibility and timing. To maximize operational
savings, the purchasing of capital items, which include linens, paper goods,
toiletries, furniture and hotel equipment, are centralized by KMC to achieve
economies of scale.

KMC's primary goal is to maintain guest satisfaction by providing quality
lodging services and value to guests of the Hotels. In order to monitor
customer satisfaction, senior management of KMC personally review guest
feedback obtained from comment cards and questionnaires given to hotel and
restaurant guests as well as planners of meetings, conventions, and banquets.
KMC also monitors its guests' satisfaction and expectations of guest services
and amenities through focus groups. Recent enhancements in response to these
programs include the addition of microwaves, refrigerators and coffee-makers in
guest rooms at certain of the Hotels.

Each of the 22 Hotels managed by KMC has a general manager who is responsible
for that Hotel's operations. The general manager has a staff that manages the
various departments within the Hotel. Each year the general managers prepare
detailed operating budgets and marketing plans. Hotel operations are monitored
throughout the year by comparing results to the budget and to the prior year's
performance. The general manger is compensated in part through a bonus equal to
a percentage of the amount by which the income of the Hotel less operating
expenses of the Hotel exceeds the annual budget for the Hotel.

KMC has a centralized corporate staff that provides support to each general
manager and each Hotel staff in the following areas: sales and marketing; human
relations and employee benefits; engineering and building maintenance;
accounting; and data processing. KMC believes that it is able to operate more
effectively than many franchised competitors because it has both regional and
centralized support services whereby senior management constantly monitors
revenue and expense trends. Senior management of KMC review annual operating
budgets and marketing plans and attend monthly meetings to review recent
performance and to revise the following month's forecast.

Marketing

KMC's senior vice president-marketing works with each Hotel sales staff in
setting marketing goals, developing marketing strategies and achieving
marketing goals. The general manager and the director of marketing for each
Hotel are responsible for the sales effort of their Hotel. Each Hotel market is
divided into two general categories: individual travelers, who travel alone
with or without advance reservations, and group travelers, who stay at a Hotel
as part of a business group, convention or tour group. Individual travelers are
attracted to a Hotel as a result of the Hotel's location, by advertising
directed at individual travelers, by maintaining toll-free numbers and
reservation systems, by providing special services when the traveler arrives at
the Hotel and by promoting special sales programs and discounts. A Hotel
attracts group travelers as a result of the Hotel's location, by providing
facilities and amenities to meet group needs and by offering special group
rates. Each Hotel maintains a sales staff which calls on groups and travel
agents and works with them in selecting, planning and holding group functions.

ANDERSON'S

Following the Spin Off, KMC will own and operate Anderson's, a wholesale and
retail distributor of men's formal wear. Anderson's has distribution centers in
Rochester, Minnesota; Denver, Colorado; Kansas City, Kansas and Dallas, Texas.
These distribution centers range in size from approximately 14,000 square feet
to 16,200 square feet and supply both company-owned and unaffiliated retail
outlets throughout the Midwest and West. Anderson's operates 39 retail outlets
in Colorado, Iowa, Kansas, Minnesota, Missouri, Nevada, North Dakota, South
Dakota, Texas and Wisconsin.

Purchases of tuxedos and related accessories come from a number of different
manufacturers. These tuxedos are stored in the four distribution warehouses and
rented at wholesale cost per affair to more than 1,400 retail outlets. The
consumers order from catalog pictures or from samples displayed in the store.
The dealers send the orders to the Anderson's wholesale operation. The week the
tuxedo is needed, it is sent to the dealer where it is held for customer
pickup.

The tuxedos are shipped via United Parcel Service, bus, mail and other modes
of transportation, including Anderson's own delivery vehicles. The tuxedos are
returned from the dealer to Anderson's in the same manner as they were shipped.
Each Anderson's operation has its own cleaning plant. This includes dry
cleaning, laundry, finishing and alterations. The garment processing takes
approximately 50% of the labor cost involved in renting a tuxedo.

KMC's formal wear business supplies a wide variety of colors and styles with
75% to 80% of the business consisting of wedding parties. The balance of the
rental revenue is generated from proms and other special occasions.

The formal wear business is highly seasonal, with the peak of the season
coming in the early summer months and holding through the fall. The lowest
point in the seasonal curve comes in January and February. The seasonal nature
of the formal wear business occurs over a relatively short period of time, with
large fluctuations from week to week.

TEXTILE

Textile, KMC's commercial laundry business, has laundry facilities in
Rochester, Minnesota and Salt Lake City, Utah, providing commercial and
institutional laundry and dry cleaning services as well as linen, uniform and
dust control rental services. These laundry operations provide cleaning and
rental services to all of the Realty Hotels in Rochester and three of the
Realty Hotels in Salt Lake City. Textile was formed in 1918 to provide laundry
services to The Kahler Hotel and the hospitals Historical Kahler then owned.
Today, Textile's mission is very similar--to provide cleaning and rental
services to KMC's lodging facilities and to medical, institutional and
commercial businesses.

In 1992, Textile entered into a 20 year exclusive Service Agreement to
provide laundry services to the Mayo Clinic and Methodist and St. Mary's
Hospitals in Rochester. The Service Agreement requires Textile to provide
uninterrupted service to the Mayo Clinic, adequate to service all of the
laundry needs of the Mayo Clinic and Methodist and St. Mary's Hospitals. The
Service Agreement also provides that the maximum price increase by Textile in
any calendar year is 0.5% less than the average monthly percentage change
between the two prior calendar years in the CPI and that the Mayo Clinic is
entitled to price decreases to the extent that the Mayo Clinic can reasonably
demonstrate cost savings due to actions by the Mayo Clinic. Textile opened a
$13.2 million state-of-the-art commercial laundry in Rochester in April 1993.
Textile's laundry facility in Rochester secures a mortgage loan due September
2013 that had an outstanding balance as of July 2, 1995, of $9.7 million and
bears interest at 9.9% per annum. See "Management's Discussion and Analysis of
Pro Forma Financial Data of KMC."

In December 1988, Historical Kahler acquired an operating commercial laundry
in Salt Lake City, Utah. Today, in the greater Salt Lake City area, Textile
provides laundry services for three of the Realty Hotels in Salt Lake City as
well as for other hotels, a hospital and other institutional customers.
Although KMC believes that Textile is not dependent on any one particular
customer, its operations in Rochester will vary directly with volume of use by
the Mayo Clinic and Methodist and St. Mary's Hospitals. KMC's strategy is to
build on Textile's major institutional accounts, such as its relationships with
the Mayo Clinic and Realty, while seeking to expand its services to other
institutional customers and to broaden its operations in the uniform rental and
dust control markets.

REGULATORY MATTERS

Permits and Licenses

A number of states regulate the licensing of hotels and restaurants,
including liquor license grants, by requiring registration, disclosure
statements and compliance with specific standards of conduct. In addition,
various federal and state regulations mandate certain disclosures and practices
with respect to the sales of license agreements and the licensor/licensee
relationship. KMC believes that each of the Hotels has the necessary permits
and approvals to operate its respective business. The relevant licenses have
been issued to the individual Hotels. KMC believes that the Spin Off will not
affect such licenses.

Environmental Regulation

Under various federal, state and local laws and regulations, a current or
past owner or operator of real estate may be liable for the cost of removal or
remediation of, and damages caused by, certain hazardous or toxic substances or
petroleum products located on or released or potentially released from such
property. Such laws often impose such liability without regard to whether the
owner or operator knew of, or was responsible for, the presence or possible
presence of hazardous or toxic substances or petroleum products. Furthermore, a
person that arranges for the disposal or transports for disposal or treatment
of hazardous or toxic substance or petroleum products at another property may
be liable for the cost of removal or remediation of, and damages caused by such
materials. The costs of remediation or removal of such substance, or
compensation for damages caused thereby, may be substantial. The presence of
such substances, or the failure to promptly remediate such substances, may
adversely affect the ability to sell such real estate or to borrow using such
real estate as collateral. As the operator and, in some cases, owner of the
Hotels, KMC may be liable for any such costs. As a successor to Historical
Kahler, KMC could also be liable for environmental conditions relating to the
prior operation of the Hotels as well as Historical Kahler's formal wear and
commercial laundry and dry cleaning businesses.

KMC is not aware of any environmental liability that KMC believes would have
a material adverse effect on KMC's business, assets or results of operations.
Nevertheless, it is possible that there are material environmental liabilities
of which KMC is unaware. No assurances can be given that (i) future or amended
laws, ordinances or regulations or more stringent interpretations or
enforcement policies thereunder will not

impose any material environmental liability or compliance costs or (ii) the
environmental condition of the Hotels will not be affected by recent changes
(of which KMC is unaware), by the condition of properties in the vicinity of
the Hotels (such as the presence of leaking underground storage tanks) or by
the acts or omissions of third parties unrelated to KMC.

Based on the information contained in environmental assessments and
management supervision of compliance with environmental laws, KMC believes that
the Hotels are in compliance in all material respects with all federal, state
and local ordinances and regulations regarding hazardous or toxic substances,
petroleum products, ACMs and other environmental matters. KMC has not been
notified by any governmental authority of any material noncompliance, liability
or claim relating to hazardous or toxic substances or other environmental
matters in connection with any of its present or former properties.

Asbestos Containing Materials

Certain federal, state and local laws, regulations and ordinances govern the
use, removal, encapsulation or disturbance of ACMs when ACMs are in poor
condition or in the event of building remodeling, renovation or demolition.
These laws, and certain common law principles, may impose liability for the
release of ACMs and may permit third parties to seek recovery from owners or
operators of real estate for personal injury or other loss or damage associated
with ACMs. KMC believes that the Hotels are in compliance in all material
respects with all federal, state and local ordinances and regulations regarding
ACMs. KMC has not been notified by any governmental authority of any material
noncompliance, liability or claim relating to ACMs in connection with any of
its current or former properties.

Americans with Disabilities Act

The Hotels and any newly developed or acquired hotels must comply with Title
III of the ADA to the extent that such properties are "public accommodations"
or "commercial facilities" as defined by ADA. Compliance with the ADA
requirements could require removal of structural barriers to handicapped access
in certain public areas of the Hotels where such removal is readily achievable.
Noncompliance could result in a judicial order requiring compliance, an
imposition of fines or an award of damages to private litigants. KMC believes
that the Hotels are in compliance in all material respects with the ADA
requirements. KMC has not been notified by any governmental authority of any
material noncompliance, liability or claim relating to the ADA.

COMPETITION

Each of the Hotels is located in a developed area that includes other hotels.
The markets in which the Hotels are located are competitive, with many hotels
in each market. KMC believes that no competitor has a dominant position in any
market. Many competitors of the Hotels have substantially greater resources
than KMC. KMC has the largest number of rooms under common management in the
Greater Salt Lake City area and in Rochester, Minnesota. These concentrations
of hotels enable KMC to benefit from its knowledge of those markets and to
obtain economies of scale through the coordinated operation of multiple hotels
in those markets. An increase in the number of competitive hotels in one of
KMC's two primary markets could have a material adverse effect on occupancy and
ADRs of the Hotels in those markets or of hotels acquired in the future in
those areas.

LEGAL PROCEEDINGS

Prior to the Spin Off, Historical Kahler was in the discovery stage of
litigation with a telecommunications company relating to disputed unremitted
telephone revenue and fees at ten of the Hotels. Historical Kahler has denied
all claims and has made counterclaims relating to breach of contract and
intends to pursue all available alternatives. The outcome of this dispute is
uncertain. In connection with the Spin Off, KMC has agreed to indemnify Realty
for any losses sustained as a result of this action.

In December 1994, notice of default relating to bond indebtedness was given
on one of Historical Kahler's wholly owned properties. A group of bondholders
have claimed Historical Kahler incorrectly calculated "added interest" for the
year 1993 in the amount of approximately $267,000. Historical Kahler has denied
the claim. If the bondholders were found to be correct in this claim,
Historical Kahler would owe this amount for 1993 and an additional $618,000 for
1994. In connection with the Spin Off, Realty has agreed to indemnify KMC for
any losses sustained as a result of this action.

Additionally, Historical Kahler has been involved in various routine
litigation arising in the ordinary course of business, substantially all of
which is expected to be covered by liability insurance. KMC does not expect the
outcome of the matters described above to have a material adverse effect on
KMC's consolidated financial statements.

Realty, Mr. Milner, its President and Chief Executive Officer, and Mr.
Stenhaug, its Senior Vice President, Chief Financial Officer and Treasurer, are
subject to a 1993 order and consent decree of the Securities and Exchange
Commission concerning allegedly improper accounting and disclosure practices
employed by Historical Kahler during fiscal years 1988 through 1990. In 1988,
1989 and 1990, Historical Kahler's independent auditors issued unqualified
opinions on Historical Kahler's financial statements. Under the terms of the
decree, Realty, Mr. Milner and Mr. Stenhaug, without admitting any wrongdoing,
have agreed to permanently cease and desist from causing any violation and any
future violation of certain sections of the Exchange Act and rules thereunder
governing Realty's disclosure and accounting practices. See Note 13 of Notes to
Consolidated Financial Statements of Historical Kahler.

EMPLOYEES

KMC employs approximately 3,500 persons, which represents substantially all
of the former employees of Historical Kahler. This staff includes a corporate
staff of 45 individuals supporting senior management and approximately 285
hotel management personnel. The hotel employees in Rochester, Minnesota
(approximately 496 employees) are represented by a labor union. KMC believes
its relationship with its employees is good.

THE HOTELS

YEAR NUMBER
OPENED OF ROOMS TYPE OF HOTEL KMC'S INTEREST REALTY'S INTEREST
------- -------- ------------- -------------- -----------------

THE LEASED HOTELS
Salt Lake Hilton 1974 351 Full Service Leased from Realty 100% equity
Hotel.................
Salt Lake City, UT
Ogden Park Hotel....... 1982 288 Full Service Leased from Realty 63.8% equity(1)
Ogden, UT
Provo Park Hotel....... 1982 232 Full Service Leased from Realty 50.0% equity
Provo, UT
Olympia Park Hotel..... 1985 204 Full Service Leased from Realty 100% equity
Park City, UT
Pocatello Park Quality 1978 152 Full Service Leased from Realty 100% equity
Inn...................
Pocatello, ID
Boise Park Suites 1991 130 Full Service Leased from Realty 100% equity
Hotel.................
Boise, ID
Canyon Springs Park 1980 112 Full Service Leased from Realty 100% equity
Hotel.................
Twin Falls, ID
The Kahler Hotel....... various(2) 696 Full Service Leased from Realty 100% equity
Rochester, MN
Kahler Plaza Hotel..... 1989 194 Full Service Leased from Realty 100% equity
Rochester, MN
Clinic View Inn and various(3) 266 Full Service Leased from Realty 100% equity
Suites................
Rochester, MN
Holiday Inn Downtown... 1968 170 Full Service Leased from Realty 100% equity
Rochester, MN
Sheraton San Marcos
Golf Resort and Conference Center Leased from Realty 100% equity
Conference Center..... 1987(4) 295
Chandler, AZ
Lakeview Conference
Center and Resort..... various(5) 187 Conference Center Leased from Realty 100% equity
Morgantown, WV
Green Oaks Inn and 284
Conference Center..... 1964 ----- Conference Center Leased from Realty 100% equity
Fort Worth, TX
ALL LEASED HOTELS..... 3,781
-----
THE MANAGED HOTELS
- ------------------
University Park Hotel.. 1987 220 Full Service 24.0% equity and a Mortgage
Salt Lake City, UT management contract
Plaza One Hotel........ 1965 174 Full Service 26.6% equity and a Right of first refusal(6)
Rock Island, IL management contract
Kahler Park Hotel...... 1967 125 Full Service 25.0% equity and a None
Hibbing, MN management contract
Copper King Inn........ 1979 146 Full Service 32.9% equity and a Right of first refusal(6)
Butte, MT management contract
EuroSuites Hotel....... 1990 70 Limited Service Management contract None
Morgantown, WV
Red Fox Inn............ 1974 127 Full Service Management contract None
Waverly, IA -----
ALL MANAGED HOTELS.... 862
-----
THE OWNED HOTELS
- ----------------
Knights Inn............ 1988 107 Limited Service 100% equity Option to acquire(6)
Racine, WI
Knights Inn............ 1985 104 Limited Service 100% equity Option to acquire(6)
Port Huron, MI -----
ALL OWNED HOTELS...... 211
-----
ALL HOTELS........... 4,854
=====

- --------

(1) Realty will hold a 63.8% equity interest in the Ogden Park Hotel (84.0%
upon conversion of certain indebtedness held by Realty).

(2) 350 rooms built in 1926, 228 rooms in 1954 and 162 rooms in 1968. Forty-
four of these rooms have been converted to offices and other uses.

(3) 48 rooms built in 1968, 94 rooms in 1974 and 128 rooms in 1990. Four of
these rooms have been converted to offices and other uses.

(4) Originally constructed in 1912 and reconstructed and reopened in 1987.

(5) Built in stages from 1950 to 1987.

(6) See "Certain Agreements between KMC and Realty--Right of First Refusal
Agreement" and "--Option Agreement."

THE LEASED HOTELS

The Leased Hotels consist of seven full service Hotels in the Intermountain
states of Utah and Idaho, four Hotels in Rochester, Minnesota and three
conference center hotels located in Chandler, Arizona, Morgantown, West
Virginia and Fort Worth, Texas. KMC will perform all operational and management
functions necessary to operate the Leased Hotels. These functions include all
advertising, marketing, maid and food service, reservations, accounting,
laundry and maintenance. Under the Percentage Leases, Realty is entitled to the
greater of Base Rent or Percentage Rent for each Leased Hotel. KMC's ability to
effectively conduct its operations and to pay Base Rent or Percentage Rent
under the Percentage Leases is dependent upon its ability to generate
sufficient cash flow from the operation of the Leased Hotels. The obligations
of KMC under the Percentage Leases are unsecured. KMC is entitled to all
revenue from the Leased Hotels after payment of Rent under the Percentage
Leases and other operating expenses. The Percentage Leases have terms of three,
five and seven years, subject to earlier termination upon the occurrence of
certain events. Although the Percentage Leases were not determined by arm's-
length negotiation, the independent directors of KMC and Realty have approved
the Percentage Leases. For further information on the Percentage Leases, see
"Certain Agreements between KMC and Realty--The Percentage Leases."

Intermountain Hotels

In the Intermountain region, KMC operates eight Hotels with a total of 1,689
rooms, located in Utah and Idaho. Five of these Hotels, with a total of 1,295
rooms, are located in the Greater Salt Lake City area. The Utah Hotels provide
extensive coverage of the primary business destinations in the region as well
as access to the nine major ski areas surrounding Salt Lake City.

SALT LAKE HILTON HOTEL-SALT LAKE CITY, UTAH. This Hotel, situated in downtown
Salt Lake City, is on the main freeway access to and from downtown and is ten
minutes from the airport and 45 minutes to seven ski areas. The Salt Lake
Hilton Hotel offers 318 guest rooms and 33 suites at rates from $105 to $135.
Each room offers cable television, with complimentary premium movie channel
service. To attract group meetings and conferences, as well as individual
business travelers, the Salt Lake Hilton Hotel offers 23,000 square feet of
conference and meeting facilities that can accommodate up to 1,200 persons. In
addition, the Salt Lake Hilton Hotel provides executive concierge level service
on two floors of the hotel and has three restaurants, a lounge, room service,
an outdoor swimming pool, an indoor whirlpool area and a fitness center. The
Salt Lake Hilton Hotel operates under a Hilton franchise agreement. The
Percentage Lease with respect to this Hotel expires in 1998.

OGDEN PARK HOTEL-OGDEN, UTAH. This Hotel is located in downtown Ogden and
provides convenient access to downtown Ogden, the Internal Revenue Service,
Weber State University, three ski areas and Hill Air Force Base. The Ogden Park
Hotel offers 271 guest rooms and 17 suites at rates from $69 to $101. Cable
television service is included in all rooms, while separate living rooms with
wet bars are provided in the suites. In addition, the Ogden Park Hotel offers a
complimentary breakfast buffet and executive club service, including free
newspaper, concierge service and complimentary evening hors d'oeuvres. With
over 16,000 square feet of conference space that can accommodate up to 1,000
persons, the Ogden Park Hotel seeks to attract conferences and groups as well
as individual travelers. Major hotel room demand generators in Ogden include
Thiokol Corp., the Internal Revenue Service, the U.S. Forest Service and Morton
International. The Ogden Park Hotel has a restaurant, a lounge, room service,
liquor store and gift shop, indoor swimming pool and fitness center. The Ogden
Park Hotel operates under a Best Western franchise agreement. The Percentage
Lease with respect to this Hotel expires in 2000.

PROVO PARK HOTEL-PROVO, UTAH. This nine story Hotel is located in downtown
Provo near Brigham Young University and several major corporations including
Novell Inc., Micron Technology, Inc. and NuSkin International and is a 15
minute drive to Sundance ski area. The 232 room Provo Park Hotel has the
largest meeting space in the Provo area with ten meeting rooms aggregating
10,296 square feet that can

accommodate up to 900 persons to serve groups and conventions. Room rates at
the Provo Park Hotel range from $75 to $95. The Provo Park Hotel offers a
restaurant, a club, room service, a gift shop and a business center, as well as
an outdoor pool, exercise room and free parking. A substantial remodeling of
the top three floors to establish a concierge level area for business travelers
and an upgrading of all guest rooms as well as the restaurant and public areas
was completed in March 1995. The remodeling cost approximately $1.0 million.

Realty currently owns 50.0% of the outstanding equity of Park Hotels with the
remaining 50.0% interest held by a third party. Park Hotels leases the Provo
Park Hotel to an affiliate of KMC, and KMC manages the Hotel. The Percentage
Lease with respect to this Hotel expires in 1998.

Park Hotels has a loan commitment for $15.6 million from a local bank and a
federal grant for $1.0 million to build an additional 96 suites and conference
center with approximately 17,000 square feet of meeting space. In addition, the
loan proceeds will be used to construct a 114 room all-suites Residence Inn by
Marriott in Provo, Utah. Construction of this expansion and the Residence Inn
by Marriott is expected to be completed in 1996.

OLYMPIA PARK HOTEL AND CONFERENCE CENTER-PARK CITY, UTAH. This 204 room Hotel
is located five minutes from the Park City ski area and ten minutes from the
Deer Valley ski area and is approximately 30 minutes east of Salt Lake City.
Room rates range from $139 in season during the winter to $89 during the
summer. The Olympia Park Hotel primarily serves ski and summer vacationers, as
well as conferences and group meetings that use the Hotel's 8,000 square feet
of conference and banquet facilities. The Olympia Park Hotel's amenities
include an atrium, swimming pool, spa and sauna, plus a restaurant, coffee shop
and gift shop. In connection with the Spin Off, all of the personal property
associated with this Hotel was transferred to KMC in order to satisfy certain
requirements of the Code applicable to REITs. The Percentage Lease with respect
to this Hotel expires in 2000.

POCATELLO PARK QUALITY INN-POCATELLO, IDAHO. This Hotel is located in
Pocatello, next to Interstate 15, a major thoroughfare extending from Los
Angeles, California to the Canadian border. Located on a 6.7 acre site, the
121,000 square foot Pocatello Park Quality Inn has 152 rooms, the second
largest number of rooms in the area. The Pocatello Park Quality Inn also has
conference facilities aggregating 10,600 square feet capable of accommodating
600 to 700 people, which are the largest in the area. Room rates at the
Pocatello Park Quality Inn range from $59 to $125. Amenities at the Pocatello
Park Quality Inn include an indoor pool and reception area, a fitness center,
two restaurants and a cocktail lounge. In connection with the Spin Off, all of
the personal property associated with this Hotel was transferred to KMC in
order to satisfy certain requirements of the Code applicable to REITs. The
Percentage Lease with respect to this Hotel expires in 2002.

BOISE PARK SUITES HOTEL-BOISE, IDAHO. This four story Hotel, located in a
business park near the corporate headquarters for Boise Cascade Corp.,
Albertson's, Inc., Micron Technology, Inc., Ore-Ida Foods, Inc., J. R. Simplot
Co. and Morrison-Knudson Corp., was constructed by Realty in 1992. The Boise
Park Suites Hotel currently has 130 suites that include a separate living room
with kitchen facilities. The room rate for a suite at the Boise Park Suites
Hotel is $110. Among the amenities offered by the Boise Park Suites Hotel are
an outdoor swimming pool, fitness center, limited food service and a business
center, with computer and cellular phone rental, laser printing, secretarial
service and fax and copier service. In addition, the Boise Park Suites Hotel
provides meeting facilities aggregating 837 square feet that can accommodate up
to 90 persons. The Boise Park Suites Hotel primarily attracts business
travelers, as well as leisure travelers on weekends at discounted room rates.
Realty is constructing an additional 108 suites and an additional 1,347 square
feet of meeting space, which are scheduled to open in early 1996. In connection
with the Spin Off, all of the personal property associated with this Hotel was
transferred to KMC in order to satisfy certain requirements of the Code
applicable to REITs. The Percentage Lease with respect to this Hotel expires in
1998.

CANYON SPRINGS PARK HOTEL-TWIN FALLS, IDAHO. This Hotel is located just off
of Interstate 84 near the campus of the College of Southern Idaho and the Snake
River Recreation Area. The Canyon Springs Park Hotel is a two-story building
with 112 rooms located on a 6.3 acre site. The Canyon Springs Park Hotel has
six meeting rooms with an aggregate of 8,494 square feet of meeting space which
can accommodate up to 750 people. Room rates at the Canyon Springs Park Hotel
range from $62 to $66. Amenities at the Hotel include an outdoor pool, a full
service restaurant and a coffee shop. The Canyon Springs Park Hotel operates
under a Best Western franchise agreement. The Percentage Lease with respect to
this Hotel expires in 1998.

Rochester Hotels

There are four Leased Hotels in Rochester, Minnesota with an aggregate of
1,326 guest rooms, representing nearly 60% of the total supply of full service
rooms in Rochester. Historical Kahler was founded in 1917 to provide lodging
for individuals visiting the Mayo Clinic in Rochester. The Mayo Clinic is an
internationally known private group practice dedicated to providing diagnosis
and treatment of patient illnesses through a systematic focus on individual
needs. The Mayo Clinic operates a medical school and also provides advanced
education for the continuing training of medical personnel. The Mayo Clinic
also does extensive medical research. As a result of its operations based in
Rochester, the Mayo Clinic generates a

strong demand for hotel accommodations by individual visitors seeking medical
treatment and their relatives as well as medical conferences organized by the
Mayo Clinic. In addition, Rochester is the principal development and
manufacturing facility for IBM's Application Systems/400.

The Leased Hotels in Rochester are connected to the Mayo Clinic facilities by
skyways and pedestrian subways. The level of demand created by the Mayo Clinic
is such that the results of operations of the Rochester Hotels are dependent
upon the continued attractiveness of the Mayo Clinic to patients and medical
conferences.

THE KAHLER HOTEL-ROCHESTER, MINNESOTA. This 12 story full service Hotel is
located directly across from and is connected by pedestrian subways to the Mayo
Clinic's facilities, Rochester Methodist Hospital and downtown shopping areas.
In addition, The Kahler Hotel has convenient access to IBM's Rochester
facilities and is ten minutes from the Rochester airport. The Kahler Hotel
provides guest rooms and suites at room rates from $46 to $1,500. Each room
offers cable television and in-room movie service. The Kahler Hotel has
conference and banquet facilities with approximately 15,000 square feet of
space arranged in 15 flexible meeting rooms. The Kahler Hotel has four
restaurants, a lounge, room service, an indoor swimming pool, exercise
equipment and an indoor shopping arcade of 55 shops, including a pharmacy, car
rental office, fashion boutiques and several novelty and specialty shops.

The original portion of The Kahler Hotel was completed in 1926 with
significant additions completed in 1954 and 1968. A $2.3 million renovation of
the guest rooms and public areas was completed in 1994. As part of this
renovation, the top floor of The Kahler Hotel has been remodeled to include a
Presidential Suite and a Concierge Club, which provides an executive lounge and
complimentary continental breakfast and evening cocktails. In connection with
the Spin Off, all of the personal property associated with this Hotel was
transferred to KMC in order to satisfy certain requirements of the Code
applicable to REITs. The Percentage Lease with respect to this Hotel expires in
2002.

KAHLER PLAZA HOTEL-ROCHESTER, MINNESOTA. This luxury nine story Hotel opened
in March 1989. The Kahler Plaza Hotel is accessible on three levels to the
adjoining Harold W. Siebens Education Building of the Mayo Clinic, which
includes the Clinic's principal medical meeting and education facilities. The
Kahler Plaza Hotel is also directly across the street from and connected by
skyway and the pedestrian subway to The Kahler Hotel. The Kahler Plaza Hotel
offers guest room and suite accommodations at prices ranging from $118 to
$1,700. Each room has cable television and in-room movie service. In addition,
the Kahler Plaza Hotel has two floors of Concierge Club service, including
complimentary continental breakfast and evening cocktails. The Kahler Plaza
Hotel has approximately 10,000 square feet of meeting and banquet space that

can accommodate up to 400 persons. The Kahler Plaza Hotel offers a restaurant
and lounge, complete room service, as well as an indoor swimming pool,
whirlpool, sauna and exercise room. The Percentage Lease with respect to this
Hotel expires in 2000.

CLINIC VIEW INN AND SUITES-ROCHESTER, MINNESOTA. This nine story moderately
priced Hotel is located directly across the street and connected by pedestrian
subway from Rochester Methodist Hospital and the Mayo Clinic's cancer and pain
treatment center. The Clinic View Inn was opened in 1974 and acquired by Realty
in 1980. In April 1991, a 128 suite addition was added to the facility to meet
the market demand for the extended stay lodging by Mayo Clinic patients, their
families and business guests. During the construction of the suites, the
existing hotel space was extensively renovated. The Clinic View Inn and Suites
offers guest rooms and suites at rates ranging from $65 for guest rooms to $95
for suites. Each suite has a kitchen area, including a microwave oven,
refrigerator, coffee maker and toaster, and a living room. The guest rooms and
suites have cable television with complimentary premium movie channel service.
The Clinic View Inn offers a restaurant, indoor swimming pool, whirlpool, sauna
and exercise equipment, as well as laundry facilities and a convenience store.
In addition, the Clinic View Inn and Suites has conference facilities
aggregating 1,440 square feet for up to 100 persons. The Percentage Lease with
respect to this Hotel expires in 1998.

HOLIDAY INN DOWNTOWN-ROCHESTER, MINNESOTA. Located three blocks from the Mayo
Clinic and one block from the Rochester Civic Center, the Holiday Inn Downtown
occupies floors two through eight of a 16 story multi-use condominium building.
This Hotel provides moderately priced guest rooms and primarily

serves visitors to the Mayo Clinic and individual business travelers. The
Holiday Inn Downtown is connected to the skyway system, which allows access to
the Mayo facilities as well as a retail shopping mall. Room rates range from
$60 to $86. The Holiday Inn Dowtown's guest rooms have cable television with
complimentary premium movie channel service. The Holiday Inn Downtown offers an
executive floor service, including complimentary continental breakfast and
evening cocktails and computer-accessible phone lines; an informal restaurant,
lounge and room service; a dinner theater; and conference and banquet
facilities aggregating 7,886 square feet that can accommodate up to 200
persons. The Holiday Inn Downtown operates under the Holiday Inn franchise. The
Holiday Inn Downtown was acquired and substantially renovated by Realty in
1983. Various portions of the Holiday Inn Downtown have been renovated since
1989, including the lobby, guest rooms and restaurant. In connection with the
Spin Off, all of the personal property associated with this Hotel was
transferred to KMC in order to satisfy certain requirements of the Code
applicable to REITs. The Percentage Lease for this Hotel expires in 1998.

Conference Center Hotels

SHERATON SAN MARCOS GOLF RESORT AND CONFERENCE CENTER-CHANDLER (GREATER
PHOENIX), ARIZONA. This conference center and resort Hotel is located
approximately 18 miles southeast of the Phoenix airport. In 1987, Realty
invested approximately $20.0 million to restore and substantially rebuild this
historic 75-year old resort. Among the amenities the Sheraton San Marcos Resort
provides are the oldest 18-hole championship golf course in Arizona, two heated
swimming pools and a tennis complex, plus three restaurants, a lounge and room
service. The Sheraton San Marcos Resort also offers 16 conference rooms with
20,000 square feet of meeting space that can serve up to 600 persons. Each of
the 295 guest rooms and suites has a private patio or balcony and includes
complimentary cable television service. Room rates for the resort's guest rooms
and suites range from $98 to $450. The Sheraton San Marcos Resort seeks to
attract business groups, as well as individual travelers. The Sheraton San
Marcos Resort is operated under a Sheraton Hotel franchise agreement. The
Percentage Lease for this Hotel expires in 2000.

LAKEVIEW RESORT AND CONFERENCE CENTER-MORGANTOWN, WEST VIRGINIA. The Lakeview
Resort is located near Morgantown, West Virginia and is 75 miles south of
Pittsburgh. This resort is a full service conference center with resort
amenities, including two 18-hole championship golf courses and a fitness and
sports center with an indoor swimming pool, tennis courts, weight training
equipment and running track, as well as boating on Cheat Lake and hiking
trails. In addition, the Lakeview Resort offers two restaurants. With
conference

facilities aggregating 22,000 square feet that can accommodate up to 600
persons, the resort seeks to attract business groups from Pittsburgh and
surrounding areas, as well as visitors to the University of West Virginia and
vacationing golfers. The Lakeview Resort has 187 guest rooms and 72 two-bedroom
condominium units at rates ranging from $89 to $375. The Percentage Lease for
this Hotel expires in 2002.

GREEN OAKS INN AND CONFERENCE CENTER-FORT WORTH, TEXAS. This Hotel is located
near the Southwest Regional Navy and Air Force Training Command and a Lockheed
Corp. aircraft plant and is approximately ten minutes from downtown Fort Worth
and 25 minutes from Dallas/Fort Worth Airport. Room rates at the Green Oaks Inn
and Conference Center range from $61 to $98. With 16 conference rooms
aggregating 12,592 square feet that can accommodate up to 1,000 persons, the
Green Oaks Inn and Conference Center primarily seeks to attract conferences and
group meetings as well as individual business travelers and visitors to the
naval air station and Lockheed aircraft plant. Amenities at the Green Oaks Inn
and Conference Center include two swimming pools, two tennis courts, an
exercise room and access to an adjacent public golf course. In connection with
the Spin Off, all of the personal property associated with this Hotel was
transferred to KMC in order to satisfy certain requirements of the Code
applicable to REITs. The Percentage Lease with respect to this Hotel expires in
2002.

THE MANAGED HOTELS

The Managed Hotels consist of five full service Hotels located in Utah,
Illinois, Minnesota, Montana and Iowa, and one limited service Hotel located in
West Virginia. KMC will operate the six Managed Hotels under separate
management contracts. Realty has a mortgage note interest in one of the Managed
Hotels--the University Park Hotel. KMC holds minority equity positions in four
of the Managed Hotels, including the University Park Hotel. The other two
Managed Hotels are entirely owned by third parties. See "--The Management
Contracts."

UNIVERSITY PARK HOTEL-SALT LAKE CITY, UTAH. This seven story Hotel is located
in the University of Utah's Research Park on a 6.9 acre site, which is
approximately ten minutes from downtown Salt Lake City, 20 minutes from the
airport, and is near the University of Utah and its medical and research
facilities. Approximately a half-hour drive from the University Park Hotel are
the Alta, Brighton, Deer Valley, Park City, Park West, Solitude and Snowbird
ski areas. The University Park Hotel provides 192 guest rooms and 28 executive
suites at rates from $99 to $130. Each room offers cable television, with
complimentary premium movie channel service, while each suite has a separate
living room with a kitchen area, including a refrigerator. The University Park
Hotel has a restaurant and lounge, an indoor swimming pool and fitness center,
conference and banquet facilities aggregating 10,205 square feet, plus a gift
shop and liquor store. Realty currently is working with the University of Utah
on plans to expand the Hotel and construct a meeting and conference center
adjacent to the Hotel to service the growing needs of the University.

The University Park Hotel is owned by University Inn Associates, a Utah
limited partnership ("UIA"). The Hotel is located on a site leased under a
ground lease expiring in December 2025, with an option to extend the lease term
for an additional ten years. KMC holds a 24.0% general partnership interest in
UIA. KMC manages the University Park Hotel under a management agreement with
UIA.

Realty holds a $4.6 million mortgage note with equity features from UIA that
is secured by a second mortgage on the University Park Hotel. The mortgage note
bears interest at 9.0% per year with payments of interest only until maturity
on the earlier of October 31, 2005 or the termination of KMC's management
contract with UIA. The mortgage note is nonrecourse to UIA and may not be
prepaid. After September 30, 1998, Realty has an option to convert the
outstanding balance of the mortgage note into a 60.0% partnership interest in
UIA. Before Realty can exercise this option to convert the mortgage note, UIA's
management contract with KMC must be replaced with a Percentage Lease in order
to satisfy certain REIT provisions of the Code. The agreement granting the
conversion option to Realty also grants Realty a right of first refusal on the
sale of any partnership interest in UIA or on the sale of any interest in the
University Park Hotel. If Realty exercises its conversion option, KMC's 24.0%
general partnership interest in UIA would be diluted to 9.6%.

PLAZA ONE HOTEL-ROCK ISLAND, ILLINOIS. The Plaza One Hotel is located in
downtown Rock Island overlooking the Mississippi River. This 174 room full
service Hotel underwent a $4.0 million renovation in 1992. The Hotel features
three dining rooms, a lounge and meeting facilities that can accommodate groups
of up to 500 people. The Hotel operates under a Quality Inn franchise
agreement. KMC holds a 26.6% partnership interest in this Hotel.

KAHLER PARK HOTEL-HIBBING, MINNESOTA. The Kahler Park Hotel is a full service
Hotel with 125 rooms and suites, a full service restaurant, a lounge, an indoor
pool, recreation facilities and meeting facilities that can accommodate up to
350 persons. The Hotel is located approximately 190 miles north of Minneapolis,
Minnesota. The lodging facility is currently undergoing an extensive
refurbishment and will cater to the business and leisure traveler. KMC holds a
25.0% partnership interest in this Hotel. KMC also holds a $617,000 mortgage
receivable on this property.

COPPER KING INN-BUTTE, MONTANA. The Copper King Inn is a 146 room full
service Hotel located across from the airport serving the Butte area, which is
halfway between Glacier and Yellowstone National Parks. Located on a 9.5 acre
site, the 78,200 square foot Copper King Inn offers room rates from $49 to $75
and a 25,060 square foot multipurpose conference center which can accommodate
up to 1200 people. Amenities at the Hotel include an indoor pool, Jacuzzi,
sauna, health club, two restaurants and a sports bar. The Hotel operates under
a Best Western franchise agreement. KMC holds a 32.9% equity interest in the
entity that owns this Hotel.

EUROSUITES HOTEL-MORGANTOWN, WEST VIRGINIA. The EuroSuites Hotel is a 70-unit
limited service, all suite Hotel located near the University of West Virginia
campus and its medical center. Each suite includes a separate living room with
kitchenette, two television sets and computer modem access. The Hotel has a 60
seat cocktail lounge, four conference rooms and an exercise facility. KMC does
not have any ownership interest in this Hotel.

RED FOX INN-WAVERLY, IOWA. The Red Fox Inn is a 127 room full service Hotel
located 14 miles north of the Waterloo-Cedar Falls area serving Northeast Iowa
with room rates from $54 to $99. The Hotel has 4 meeting rooms with an
aggregate of 5,325 square feet of meeting space which can accommodate up to 700
people. Amenities at the Hotel include an enclosed swimming pool with pool side
cocktail lounge, a larger lounge with live entertainment and two restaurants.
The Hotel operates under a Best Western franchise agreement. KMC's management
contract for this property was effective as of January 1, 1995. KMC does not
have any equity interest in this Hotel.

THE OWNED HOTELS

KMC owns all of the equity in and operates two limited service Hotels located
in Racine, Wisconsin and Port Huron, Michigan. KMC has granted to Realty a
five-year option to purchase these two Hotels. See "Certain Agreements between
KMC and Realty--The Option Agreement."

KNIGHTS INN-RACINE, WISCONSIN. This 107 room Hotel is a budget priced hotel
located between Milwaukee and Chicago, near Racine, Wisconsin and several
beaches and marinas along Lake Michigan. Room rates at the Knights Inn-Racine
range from $37 to $65. The Knights Inn-Racine is approximately five years old
and attracts primarily weekend and vacationing travelers, as well as business
travelers. The Hotel operates under a Knights Inn franchise agreement. This
Hotel's performance has been negatively impacted in the last twelve months by
the opening of several new economy hotels in the area.

KNIGHTS INN-PORT HURON, MICHIGAN. This 104 room Hotel is a budget priced
hotel located at the U.S.-Canadian border near Lake Huron. The Knights Inn-Port
Huron has an outdoor swimming pool and meeting facilities. Room rates at the
Knights Inn-Port Huron range from $40 to $51. The Knights Inn-Port Huron is
approximately seven years old and attracts primarily weekend and vacationing
travelers and individual business travelers. The Hotel operates under a Knights
Inn franchise agreement.

THE MANAGEMENT CONTRACTS

In general, the management contracts under which KMC operates the Managed
Hotels grant to KMC the sole and exclusive right to manage and operate the
Hotels. KMC provides services to the Hotel within the guidelines contained in
annual operating business plans. The annual operating business plans are
prepared by KMC and submitted to each Hotel owner for approval prior to the
start of each operating year. Each Hotel's annual operating business plan
contains estimates as to projected revenues and expenditures, capital
improvements, purchases of furniture, fixtures and equipment and a detailed
statement of the marketing strategy and techniques to achieve the revenue
estimates. Subject to the expenditure levels set forth in the specific
operating business plans, KMC is generally responsible for making fixed asset
additions and repairs to the property, while the owner of the property bears
the costs of such fixed asset additions and repairs. The Hotel owner either
pays all costs and expenditures incurred in the operation of the property or
must reimburse KMC for costs and expenses paid by KMC.

The management fee to be paid by the Hotel owner to KMC is calculated as set
forth in the management contract with respect to each Hotel. All of the
management contracts include a base fee calculated as a percentage of the
Hotel's revenues or cash flow. Five of these management contracts also provide
for an incentive fee calculated as a percentage of the amount by which the net
operating income or net cash flow of the Hotel exceeds a certain level. The
base fee percentages in the management contracts of KMC range from 2.0% to 5.0%
of gross revenues. The incentive fee percentages range from 15.0% to 25.0% of
the excess of the net operating income or net cash flow of a Hotel over a
specified level.

FRANCHISE AGREEMENTS

KMC has entered into non-exclusive franchise or license agreements with
respect to eleven of the Hotels (hereinafter referred to as "franchise
licenses"). Of these eleven Hotels, four are Best Western Hotels (Ogden Park,
Utah, Twin Falls, Idaho, Butte, Montana and Waverly, Iowa), one is a Hilton
Hotel (Salt Lake City, Utah), one is a Holiday Inn (Rochester, Minnesota), one
is a Sheraton Hotel (Chandler, Arizona), two are Quality Inns (Pocatello, Idaho
and Rock Island, Illinois) and two are Knights Inns (Racine, Wisconsin and Port
Huron, Michigan).

The franchise licenses generally specify certain management, operational,
recordkeeping, accounting, reporting and marketing standards and procedures
with which the franchisee must comply. The franchise licenses obligate the
franchisee to comply with the franchisors' standards and requirements with
respect to training of operational personnel, safety, maintaining specified
insurance, the types of services and products ancillary to guest room services
that may be provided by the franchisee, display of signage and the type,
quality and age of furniture, fixtures and equipment included in guest rooms,
lobbies and other common areas. KMC is not aware of any material defaults under
the franchise licenses, and the executive officers of KMC believe that all of
its franchise licenses are in good standing.

Each franchise license gives KMC the right during the term of the agreement
to operate the particular Hotel under the applicable tradename. The Best
Western franchise licenses continue in full force and effect as long as KMC is
in possession of any property bearing the Best Western tradename or any
identification symbols in any manner. The Hilton franchise license expires in
2000. The Holiday Inns franchise license expires in 2000. The Sheraton
franchise license expires in 1997. The Choice Hotels franchise license expires
in 2013. The two Cardinal franchise licenses expire in 1997. The franchise
licenses provide for termination at the franchisor's option upon the occurrence
of certain events, including KMC's failure to pay royalties and fees or perform
its other covenants under the franchise license, bankruptcy, abandonment of the
franchise, commission of a felony, assignment of the franchise license without
the consent of the franchisor, or failure to comply with applicable law in the
operation of the relevant Hotel. KMC is permitted to terminate the franchise
licenses under certain circumstances. KMC may terminate the Holiday Inns
franchise license at any time during the term of the franchise license upon at
least 12 months notice, which notice shall be accompanied by a lump sum payment
of certain specified fees. KMC may terminate the Sheraton franchise

license by giving at least six months notice accompanied by lump sum payment at
any time during the term of the franchise license, or at the end of each five
year period following the date of the franchise license, upon six months notice
to the franchisor. KMC may terminate the Choice Hotels franchise license upon
30 days notice if the franchisor shall be in default of any of its material
obligations under the license and the franchisor has failed to cure such
default after such 30 days notice from KMC, or upon three months notice on the
tenth or fifteenth anniversary of the franchise license, which notice shall be
accompanied by specified fees. KMC may terminate the Cardinal franchise
licenses upon 30 days' notice during the term or upon six months' notice prior
to the commencement of any renewal term. None of the franchise licenses renew
automatically except for the Cardinal franchise licenses, which renews
automatically for two additional five year terms.

KMC is responsible for making all payments under the franchise licenses to
the franchisors. Under the Best Western franchise licenses with respect to the
Ogden Park Hotel, the Canyon Springs Park Hotel, the Copper King Inn and the
Red Fox Inn, KMC pays franchise fees of $0.58, $0.59, $0.63 and $0.64,
respectively, per day per room at the respective Hotel and reservation fees of
$3.80, $3.17, $3.74 and $3.34, respectively, per room night confirmed through
the franchisor's reservation system, net of cancellations. Under the Hilton
Inns franchise license, KMC pays a franchise fee of 5.0% of room revenue. Under
the Holiday Inns franchise license, KMC pays a royalty fee of 4.0% of room
revenue, a marketing fee of 1.0% of room revenue, a reservation contribution of
1.0% of room revenue, a Holidex fee of $3.50 per room and an amount equal to
any sales, gross receipts or similar tax imposed on franchisor. Under the
Sheraton franchise license, KMC pays a franchise fee of 5.0% of room sales.
Under the Choice Hotels franchise licenses with respect to the Pocatello Park
and the Plaza One Hotels, KMC pays a royalty fee of 3.0% of room revenue, a
marketing fee of 1.3% of the preceding month room revenue plus a supplemental
marketing fee of $0.28 per day times the specified room count, a reservation
fee of 1.0% of room revenue, and reservation delivered charge of $1.00 per room
night confirmed through the franchisor's reservation system. Under the Cardinal
franchise licenses, KMC pays a royalty fee of 4% of room revenue.

CERTAIN AGREEMENTS BETWEEN KMC AND REALTY

Realty and KMC have entered into a number of agreements and transactions for
the purpose of effecting the Spin Off and defining their ongoing relationship
and the conduct of their respective businesses following the Spin Off. The
terms of these agreements and transactions were not the result of arm's-length
negotiations between independent parties. The independent directors of each of
Realty and KMC have unanimously approved these agreements and transactions.
These agreements may be modified and additional agreements, arrangements and
transactions may be entered into by Realty and KMC after completion of the Spin
Off.

The following is a summary of the material features of certain agreements and
transactions between Realty and KMC. The summaries of each of the following
agreements are qualified in their entirety by reference to the full text of
such agreement, a copy of which has been filed as an exhibit to the
Registration Statement of which this Prospectus is a part.

THE PERCENTAGE LEASES

Each of the Leased Hotels is leased by Realty to KMC under a separate
Percentage Lease. All of the Percentage Leases include cross-default
provisions. Each Percentage Lease contains, among other things, the provisions
described below, and KMC anticipates that future leases with Realty with
respect to its hotels will contain substantially similar provisions, although
Realty's Board of Directors may, in its discretion, alter any of these
provisions with respect to any particular lease.

Percentage Lease Terms

The Percentage Leases have initial terms of three, five or seven years and
are subject to earlier termination upon the occurrence of certain events or
contingencies described herein, including the provisions described below under
"--Damage to Hotels," "--Condemnation of Hotels," "--Termination of Percentage
Leases on Disposition of the Leased Hotels" and "--Events of Default."

Amounts Payable under the Percentage Leases

During the term of each Percentage Lease, KMC is obligated to pay (i) the
greater of Base Rent or Percentage Rent and (ii) certain other amounts,
including interest accrued on any late payments or charges (the "Additional
Charges"). Base Rent is an annual fixed rental per Leased Hotel, which accrues
and is required to be paid monthly in advance of the first day of each month.
Percentage Rent is calculated by multiplying fixed percentages by gross room
revenue for each of the Leased Hotels and by multiplying fixed percentages by
gross food and beverage revenue for each of the Leased Hotels, except for the
Boise Park Suites Hotel, for which Percentage Rents will be based solely on
room revenues because of the limited service nature of that Hotel. Percentage
Rent is due quarterly within 45 days of the end of each quarter, with a
reconciling payment to be made within 90 days after the end of each calendar
year to reflect the actual Percentage Rent due with respect to such calendar
year based on the revenue of the Hotel.

On a pro forma basis, the Percentage Rent for each Leased Hotel for the
twelve months ended July 2, 1995, would have been greater than Base Rent for
that period. The aggregate pro forma Percentage Rent and Base Rent for the
Leased Hotels for the twelve months ended July 2, 1995 were $25.9 million and
$16.2 million, respectively.

Under the Percentage Leases, as of January 1, 1997 and the first day of each
year thereafter, the Base Rent and Percentage Rent thresholds for each year
will be adjusted to reflect any year-to-year change in the CPI.

Other than real estate and personal property taxes, casualty insurance
premiums, land rents for ground leases, debt service payments, the cost of
maintenance of any existing signs, any underground utilities and the structural
elements and an obligation to fund an amount equal to 5.5% of room revenue per
quarter on a

cumulative basis for capital improvements and for replacement or refurbishing
of FF&E, which are obligations of Realty, the Percentage Leases require KMC to
pay all utility and other charges, and all other costs and expenses incurred in
the management, operation, maintenance and repair of the Leased Hotels. The
Percentage Leases also provide for rent reductions and abatements in the event
of damage or destruction (but only to the extent of rent loss insurance
proceeds received by Realty) or a partial taking of any Leased Hotel as
described under "--Damage to Hotels" and "--Condemnation of Hotels."

Capital and FF&E Reserves

Under the Percentage Leases, Realty is required to maintain any existing
signs, any underground utilities and the structural elements of the
improvements, including exterior walls (excluding plate glass) and the roof of
each Leased Hotel. In addition, the Percentage Leases obligate Realty to
reserve funds for periodic capital

improvements to the buildings and grounds of the Leased Hotels and for periodic
replacement and refurbishment of FF&E in the Leased Hotels, to be expended by
KMC and subject to the approval of Realty in an amount equal to 5.5% of room
revenue for each fiscal quarter. This funding obligation is cumulative and
accrues quarterly. The obligation to reserve these funds ceases upon
termination of the Percentage Lease. Realty may reserve amounts in excess of
the obligated amounts, if necessary, to maintain the franchise licenses and
otherwise if Realty deems such expenditures to be in its best interest. KMC is
required, at its expense, to maintain the Leased Hotels in good order and
repair, except for ordinary wear and tear, and to make nonstructural, foreseen
and unforeseen, ordinary and extraordinary repairs that may be necessary and
appropriate to keep the Leased Hotels in good order and repair.

Maintenance and Modifications

KMC, at its expense, may make non-capital and capital additions,
modifications or improvements to the Leased Hotels, provided that such action
does not significantly alter the character or purposes of the Leased Hotels or
significantly detract from the value or operating efficiencies of the Leased
Hotels or significantly impair the revenue-producing capability of the Leased
Hotels. All such additions, modifications and improvements are subject to all
the terms and provisions of the Percentage Leases and will become the property
of Realty upon termination of the Percentage Leases. KMC owns all of the
inventory, linens and other nondepreciable personal property at the Leased
Hotels. Realty owns substantially all of the remaining personal property at the
Leased Hotels, except in the case of the Kahler Hotel, the Holiday Inn
Downtown, the Olympia Park Hotel, the Boise Park Suites Hotel, the Pocatello
Park Quality Inn and the Green Oaks Inn and Conference Center, where KMC owns
all of the personal property associated with the Leased Hotel. Where KMC owns
all such personal property, Realty has the option, upon termination or
expiration of the applicable Percentage Lease, to purchase such personal
property from KMC at a purchase price equal to the fair market value of such
personal property. KMC owns all of the personal property at these six Hotels in
order to satisfy certain requirements of the Code applicable to REITs.

Insurance, Property Taxes and Ground Lease Payments

Realty is responsible for paying real estate and personal property taxes
(except for any such personal property taxes on property owned by KMC) and
casualty insurance premiums on the Leased Hotels, and, in the case of three
Leased Hotels, the ground rents payable under ground leases. KMC is required to
pay or reimburse Realty for all other insurance on the Leased Hotels, including
rent loss and business interruption insurance, commercial general liability
insurance (including liquor law or "dram shop" liability), workers'
compensation insurance and other insurance appropriate and customary for
properties similar to the Leased Hotels, and name Realty as an additional named
insured.

Indemnification

Under each of the Percentage Leases, KMC has agreed to indemnify Realty
against, and hold Realty harmless from, all claims, liabilities, damages, costs
and expenses (including reasonable attorney's fees and

expenses) incurred by Realty with respect to: (i) any accident or injury to
person or property on or about the Leased Hotels; (ii) any misuse by KMC or any
of its agents of any Leased Hotel; (iii) any environmental liability resulting
from conditions caused by or resulting from any action or negligence of KMC;
(iv) liability resulting from the sale or consumption of alcoholic beverages at
the Leased Hotels; (v) any negligence of KMC; (vi) taxes and assessments in
respect of the Leased Hotels (other than real estate and personal property
taxes on property which is not owned by KMC and income taxes of Realty on
income attributable to the Leased Hotels); or (vii) any breach of the
Percentage Leases by KMC.

Assignment and Subleasing

KMC is not permitted to sublet the Leased Hotels, other than to
concessionaires and hotel guests or in the normal course of business to a
subtenant of any retail, office or restaurant portion of the Leased Hotel, or
assign its interest under any of the Percentage Leases, other than an
assignment to an affiliate of KMC, without the prior written consent of Realty.
No assignment or subletting will release KMC from any of its obligations under
the Percentage Leases.

Damage to Hotels

In the event of damage to or destruction of any Leased Hotel, KMC is
obligated to repair, rebuild or restore the Leased Hotel. Realty is obligated
to pay to KMC any insurance proceeds received by Realty as a result of such
damage or destruction. Any excess costs of repair or restoration will be paid
by KMC if the insurance proceeds are unavailable or inadequate as a result of
KMC's failure to comply with its obligations to obtain and maintain insurance,
or by Realty if the insurance proceeds are unavailable or inadequate for
reasons unrelated to any such failure on KMC's part. If the insurance proceeds
are unavailable or inadequate, and Realty would be obligated to pay the costs
of repair or restoration, Realty instead may terminate the Percentage Lease.
Any unused insurance proceeds, whether following repair or restoration or upon
termination of the Percentage Lease, will be retained by Realty. Base Rent and
Percentage Rent under the Percentage Lease will be equitably abated during any
period required for repair or restoration of any damaged or destroyed Leased
Hotel, but only to the extent that Realty receives proceeds of rent loss
insurance that KMC is required to maintain.

Condemnation of Hotels

In the event of a total condemnation of a Leased Hotel, the relevant
Percentage Lease will terminate with respect to such Leased Hotel as of the
date of taking and, except for certain limited rights of KMC, Realty will be
entitled to the condemnation award in accordance with the provisions of the
Percentage Lease. In the event of a partial taking that does not render the
Leased Hotel unsuitable for KMC's use, KMC will be obligated to restore the
untaken portion of the Leased Hotel to a complete architectural unit and Realty
will be obligated to contribute to the cost of such restoration that part of
the condemnation award specified for restoration.

Events of Default

Events of Default under the Percentage Leases include the following:

(i) the occurrence of an Event of Default under any other lease between
Realty or an affiliate of Realty and KMC or an affiliate of KMC;

(ii) the failure by KMC to pay rent (including Base Rent, Percentage Rent
and Additional Charges) when due and the continuation of such failure for a
period of ten days after receipt by KMC of notice thereof from Realty;

(iii) the failure by KMC to observe or perform any other term of a
Percentage Lease and the continuation of such failure for a period of 30
days after receipt by KMC of notice thereof from Realty,

unless such failure cannot be cured within such period and KMC commences
appropriate action to cure

such failure within said 30 days and thereafter diligently completes the
curing thereof, provided that in no event will the cure period extend
beyond 90 days after such notice;

(iv) certain events of bankruptcy relating to KMC;

(v) if KMC voluntarily discontinues operations of a Leased Hotel, except
as a result of damage, destruction or condemnation, and fails to recommence
operations within ten days after receipt by KMC of notice from Realty
directing KMC to do so; and

(vi) if the franchise agreement with respect to a Leased Hotel is
terminated or not renewed by the franchisor as a result of any action or
failure to act by KMC or its agents.

If an Event of Default occurs and continues beyond any cure period, Realty
will have the option of terminating the Percentage Lease and any or all other
Percentage Leases by giving KMC written notice of such termination of the
Percentage Leases.

Expansion of Leased Hotels

The Percentage Leases provide that Realty may give notice to KMC of any
proposed Leased Hotel expansion and corresponding Percentage Lease amendment.
Within 30 days KMC must elect to either (i) agree to the proposed amendments or
(ii) negotiate the proposed amendments with Realty in good faith. If after 80
days KMC and Realty are unable to reach agreement, KMC will be deemed to have
agreed to the proposed amendment unless it gives notice to Realty within ten
days of its election to terminate the Percentage Lease. If the Percentage Lease
is terminated and Realty does not (i) commence the proposed expansion within
six months or (ii) complete the proposed expansion within two years, then
Realty must either pay to KMC an amount equal to the fair market value of the
leasehold estate or offer to lease to KMC one or more substitute hotels of
comparable value.

Termination of Percentage Leases on Disposition of the Leased Hotels

In the event Realty enters into an agreement to sell or otherwise transfer a
Leased Hotel, Realty will have the right to terminate the Percentage Lease with
respect to such Leased Hotel if within six months of the termination Realty
either (i) pays KMC the fair market value of KMC's leasehold interest in the
remaining term of the Percentage Lease to be terminated, or (ii) offers to
lease to KMC one or more substitute Hotels on terms that would create a
leasehold interest in such Hotel with a fair market value equal to or exceeding
the fair market value of KMC's remaining leasehold interest under the
Percentage Lease to be terminated.

Subordination to Liens Created by Realty

In order to facilitate financing by Realty, the Percentage Leases will be
subordinate to liens created by Realty in connection with such financing,
including mortgages now or hereafter granted by Realty.

Limitation on Realty's Liability

Realty is not personally liable for its obligations under the Percentage
Leases, and KMC's recourse against Realty for a breach of such obligations is
limited to Realty's then interest and estate in the Leased Hotel in question,
and, following entry of a final nonappealable judgment in KMC's favor against
Realty, a credit and offset against future rent.

Restrictions on Distributions

KMC covenants in each of the Percentage Leases that it will not pay any
dividends (other than dividends payable in KMC Common Stock) or make any other
distributions to its shareholders unless, when the dividend is declared, it has
cash and marketable securities with an aggregate fair market value equal to or

greater than 50.0% of the projected annual Rents due to Realty from KMC during
the 12 months following the declaration of the dividend under all percentage
leases then in effect between Realty and KMC.

THE LICENSE AGREEMENT

Realty and KMC have entered into a nonexclusive trademark license agreement
(the "License Agreement") pursuant to which certain trademarks of Realty are
licensed to KMC for its use in connection with the operation of the Realty
Hotels. The License Agreement will remain in effect so long as any of the
initial Percentage Leases are still in effect, except that trademarks unique to
a specific Hotel will cease to be licensed to KMC if the Percentage Lease for
such Hotel is no longer in effect. Upon termination of the License Agreement,
KMC will cease to have any right to use the trademarks covered by the License
Agreement.

RIGHT OF FIRST REFUSAL AGREEMENT

Realty and KMC have entered into an agreement with respect to new hotel
opportunities (the "Right of First Refusal Agreement") pursuant to which Realty
has a right of first refusal to acquire any hotel or site suitable for the
development of a hotel controlled by KMC or any of its affiliates. This right
of first refusal provision requires KMC, before such hotel or site is sold to a
third party, to offer the property to Realty on the same terms and conditions
as the proposed sale to the third party. Realty also has a right of first
refusal with respect to two hotels on which KMC has a right of first refusal,
the Plaza One in Rock Island, Illinois and the Best Western Copper King Inn in
Butte, Montana. This right of first refusal gives Realty the ability to
exercise KMC's right of first refusal with respect to these hotels. In
addition, Realty has an option to purchase any hotel controlled by KMC,
beginning 18 months after the hotel is open, at fair market value as determined
by appraisers or other experts in real estate matters who are mutually agreed
upon by Realty and KMC. The Right of First Refusal Agreement also provides that
KMC has a right of first refusal to lease any hotel acquired by Realty. Before
Realty may lease a hotel to a third party, Realty must notify KMC and give KMC
the opportunity to lease the hotel on the same terms as the proposed lease to a
third party. Without the written consent of Realty, KMC will not manage, lease,
own or otherwise operate a hotel located within the trade area of a hotel owned
by Realty or on which Realty has a mortgage interest. KMC is obligated to
notify Realty before entering into any arrangement to manage, lease, own or
otherwise operate a hotel in order to allow Realty to determine whether the
proposed arrangement falls outside Realty's trade areas. The definition of the
trade area for each of Realty's hotels must be approved by a majority of the
independent directors of Realty. The Right of First Refusal Agreement will
remain in effect until the Rents paid by KMC to Realty for the previous twelve
months represent less than 50% of the total revenue of Realty during that
period.

OPTION AGREEMENT

Realty and KMC have entered into an agreement under which KMC grants to
Realty an option to purchase the two Owned Hotels. The Owned Hotels were
transferred to KMC by Historical Kahler prior to the Spin Off. The option has a
five year term and is exercisable at any time during its term. The exercise
price of the option is $4.9 million, which the parties believe is approximately
110% of the current aggregate fair market value of the properties.

DISTRIBUTION AGREEMENT

Realty and KMC have entered into the Distribution Agreement, which provides
for (i) the transfer of certain assets and liabilities to KMC prior to the Spin
Off, (ii) the Spin Off, (iii) the division between Realty and KMC of certain
liabilities and (iv) certain other agreements governing the relationship
between Realty and KMC.

Subject to certain exceptions, the Distribution Agreement provides for
assumptions of liabilities and cross-indemnities designed to allocate,
effective as of the end of the last monthly fiscal period prior to the

closing of the Offering (the "Effective Date"), financial responsibility for
the liabilities arising out of or in connection with the KMC business to KMC
and its subsidiaries, and financial responsibility for the liabilities arising
out of or in connection with the Realty business to Realty and its retained
subsidiaries. The specific dollar amount of liabilities allocated to each of
Realty and KMC pursuant to the terms of the Distribution Agreement was
determined as of the Effective Date on a basis consistent with the
determination of the liabilities of Realty and KMC included in the Pro Forma
Condensed Consolidated Financial Data of Realty included elsewhere in this
Prospectus. Each of KMC and Realty also agrees to remain obligated with regard
to any liabilities relating to their respective businesses which were not
accrued as of the Effective Date but which were incurred before, or arise with
respect to facts, events or circumstances occurring before, such Effective
Date. KMC assumes any liabilities relating to the Spin Off.

As of the Effective Date, KMC became the employer of all persons then
employed by Realty other than Mr. Stenhaug. Under the Distribution Agreement,
KMC assumes sponsorship and administration of Historical Kahler's pension plan,
401(k) plan and group health benefit plan and liabilities arising under these
plans. The liabilities assumed by KMC under the Distribution Agreement include
any employment-related liabilities accrued as of the Effective Date, as well as
liability for any action taken by Historical Kahler with respect to Historical
Kahler's pension plan, 401(k) plan and group health benefit plan on or prior to
the Effective Date and liabilities for employment-related claims which were
incurred before, or arise with respect to facts, events or circumstances
occurring before, such date.

The officers and directors and certain employees of Historical Kahler hold
options exercisable for shares of Realty Common Stock granted under Realty's
stock option plans and the Historical Kahler Plans. The Distribution Agreement
provides that options not exercised prior to the Effective Date will be split
into two separately exercisable options: one to purchase shares of Realty
Common Stock and one to purchase shares of KMC Common Stock. These options will
be administered separately by Realty and KMC under the terms of the Plans under
which such options were originally granted. Realty and KMC have adopted the
Historical Kahler Plans solely with respect to the options denominated in
shares of their respective common stock. All future stock option grants made by
Realty and KMC will be made under new stock option plans adopted by Realty and
KMC. See "Directors and Executive Officers--Stock Option and Stock Retainer
Plans."

After the Spin Off, Realty and KMC will not be able to participate in a
consolidated income tax return. The Distribution Agreement therefore contains
certain agreements clarifying responsibilities and procedures for the filing of
returns, the payment of taxes and the resolution of disputes regarding taxes
following the Spin Off. The Distribution Agreement provides that Realty is
responsible for payment of income taxes attributable to the operations of
Realty and its subsidiaries for all taxable periods. The Distribution Agreement
further provides that Realty is responsible for payment of income taxes
attributable to the operations of KMC and its subsidiaries (other than its
subsidiaries engaged in operating KMC's commercial laundry and formal wear
businesses) for taxable periods ending on or prior to the Effective Date and
the portion ending on the Effective Date of any taxable period that includes
(but does not end on) the Effective Date, and that KMC is responsible for
payment of income taxes attributable to all of its operations for the remaining
portion of any such taxable period and for all subsequent taxable periods and
for payment of income taxes attributable to its commercial laundry and formal
wear subsidiaries for all taxable periods. The Distribution Agreement also
provides that Realty is liable for the payment of all income taxes that may be
imposed on Realty as a result of the Spin Off and any sales, use, transfer or
excise taxes imposed on either party as a result of the asset transfers or the
Spin Off.

CONFLICTS OF INTEREST POLICIES

The following is a discussion of KMC's policies with respect to conflicts of
interest. The policies with respect to conflicts of interest have been
determined by the Board of Directors of KMC and may be amended or revised from
time to time at the discretion of the Board of Directors without a vote of the
shareholders of KMC.

Realty and KMC each has adopted policies and procedures to be followed by the
Board of Directors of each company to limit the involvement in matters
affecting both companies of the executive officers and directors who serve both
companies as well as to govern other conflicts. These procedures require
interested executive officers and directors to abstain from voting as directors
of either company, with respect to matters that present a material conflict of
interest and require a majority of the independent directors of each company to
approve any contract or transaction that presents a material conflict of
interest. See "The Spin Off." Whether or not a material conflict of interest
situation exists will be determined on a case-by-case basis depending on such
factors as the dollar value of the matter, the respective interests of the
shareholders of Realty and KMC and the likelihood that resolution of the matter
would have significant strategic, operational or financial implications for the
business of Realty or KMC. It is a principal responsibility of the independent
directors of each company to monitor such situations as well as any other
situation which presents a conflict of interest.

The ongoing relationships between Realty and KMC will create potential
conflict situations. Two executive officers, Harold W. Milner, the President
and Chief Executive Officer, and Michael J. Quinn, the Senior Vice President,
Secretary and General Counsel, hold similar positions for each of Realty and
KMC. In addition, Mr. Milner and John H. Herrell, the Chairman of the Board,
are each a director of both Realty and KMC. Realty anticipates that additional
employees may be hired to serve both Realty and KMC. Relationships between
Realty and KMC that may be subject to the conflict of interest policies include
the Percentage Leases, the Right of First Refusal Agreement, the License
Agreement, the Option Agreement, the Distribution Agreement, the Exchange
Agreement and the franchise licenses.

DIRECTORS AND EXECUTIVE OFFICERS

The Board of Directors of KMC consists of five members, three of whom are
independent directors. The Directors are elected for three year terms with
staggered expiration dates.

The executive officers of KMC are the same persons who have been operating
the businesses of Historical Kahler. The four senior executive officers of KMC
have over 65 years of experience in the ownership, management and development
of hotels and conference centers and include Harold W. Milner, President and
Chief Executive Officer (28 years of experience), Michael R. Hinckley, Senior
Vice President, Marketing (12 years of experience), Kevin L. Molloy, Senior
Vice President, Operations (21 years of experience), and Michael J. Quinn,
Senior Vice President, General Counsel (8 years of experience). In addition,
KMC has approximately 19 general hotel managers with an average of 20 years of
experience operating and managing hotels and conference centers.

Mr. Milner and Mr. Quinn are also executive officers of Realty and are
expected to devote 80% of their time to the business matters of Realty. Mr.
Milner is also a Director of Realty.

Certain information regarding the directors and executive officers of KMC is
set forth below.

TERM
NAME AGE POSITION EXPIRES
---- --- -------- -------

John H. Herrell 54 Chairman of Board 1996
Harold W. Milner 60 President, Chief Executive Officer and 1997
Director
Michael R. Hinckley 59 Senior Vice President, Marketing
Kevin L. Molloy 45 Senior Vice President, Operations
Michael J. Quinn 47 Senior Vice President, Secretary,
General Counsel
Thomas R. Gintz 45 Vice President, Purchasing
Michael P. Gehling 33 Vice President, Engineering
James E. Hinrichs 56 Vice President, Accounting
James D. Porrett 41 Vice President, Textile Care Services
Philip D. Thorpe 61 Vice President, Real Estate
Paul R. Tieskoetter 36 Controller and Treasurer
Simon W. Workman 59 Vice President, Corporate Human
Resources
Willis K. Drake 71 Director 1998
Alan O. Tuntland 53 Director 1998
Director 1997

John H. Herrell has been a Director of KMC since 1994. He has also been a
Director of Realty since 1981 and Chairman of its Board of Directors since
1993. Mr. Herrell has held various positions with the Mayo Foundation since
1968, serving most recently as Vice President and Chief Administrative Officer
of the Mayo Foundation. He holds a Bachelor of Arts degree from the University
of Virginia and a Masters degree from the Harvard Graduate School of Business
Administration. He is a Director of Universal Health Services, Inc.

Harold W. Milner has been a Director of KMC since 1994. He has also been
President and Chief Executive Officer and Director of Realty since 1985. From
1967 to 1970, he was Assistant Treasurer and then Treasurer of Marriott
Corporation. From 1970 to 1975, he founded and was the President and Chief
Executive Officer of Hotel Investors Corporation (predecessor of Starwood
Lodging Trust). From 1975 to 1985, he was President and Chief Executive Officer
of Americana Hotels Corporation and its predecessor corporation, Pick Hotels
Corporation. From 1982 to 1985, he was also President, Chairman and Chief
Executive Officer of Americana Hotels and Realty Corporation. He has a
Bachelors degree in mechanical engineering from the University of Utah and a
Masters degree from the Harvard Graduate School of Business Administration. He
is a Director of Baron Asset Fund. See "Business--Legal Proceedings."

Michael R. Hinckley has been Senior Vice President, Marketing and Operations
since 1987. From 1983 to 1987, he was Senior Vice President and Treasurer of
Americana Hotels Corporation. He has a Bachelors degree from the University of
Utah and a Masters degree from the Harvard Graduate School of Business
Administration.

Kevin L. Molloy joined Historical Kahler in 1976. He has worked in various
management positions and since 1986 he has been Senior Vice President,
Operations. Mr. Molloy is a Certified Hotel Administrator and completed the
Management Apprenticeship Program, Shelbourne Hotel/International Airport
Hotel, Dublin, Ireland.

Michael J. Quinn has been Senior Vice President, Secretary and General
Counsel of Realty since 1993. From 1989 to 1993, he was Vice President-
Secretary and General Counsel. From 1988 to 1989, he was General Counsel for
PDQ Food Stores, Inc. From 1981 to 1989, he was Vice President/General Counsel
for Country Kitchen Restaurants, a subsidiary of Carlson Companies. He holds a
Bachelors degree in economics and history from the University of Minnesota and
a law degree from Stetson College of Law.

Thomas R. Gintz joined Historical Kahler in 1982. He has been Vice President,
Purchasing since 1992 and served as Purchasing Director prior to being
appointed a Vice President. He attended the University of Iowa, South Dakota
University and Iowa Central Community College.

Michael P. Gehling joined Historical Kahler in 1983. He has been Vice
President, Engineering since 1990 and served in various management positions in
engineering and construction prior to being appointed a Vice President. He
holds a Bachelors degree in mechanical engineering from Iowa State University
and a Masters degree in business administration from Winona State University.

James E. Hinrichs joined Historical Kahler in 1962. He has been Vice
President, Accounting since 1985. He has a Bachelors degree from Winona State
University.

James D. Porrett joined Historical Kahler in 1984. He has been Vice
President, Textile Care Services since 1993. From 1984 to 1994, he was General
Manager of the Rochester laundry facility and General Manager of the Salt Lake
City laundry facility. He has a Bachelors degree from Millersville State
College.

Philip D. Thorpe joined Historical Kahler in 1987. He has been Vice
President, Real Estate since 1989 and was Director, Real Estate from 1987 to
1989. He holds a Bachelors degree and a Masters degree from the University of
Utah and a Doctorate degree from Brigham Young University.

Paul R. Tieskoetter joined Historical Kahler in 1984. He has served as
Controller since 1985. He holds a Bachelors degree from the University of
Northern Iowa and is a Certified Public Accountant.

Simon W. Workman joined Historical Kahler in 1992 as Vice President,
Corporate Human Resources. Prior to joining Historical Kahler, he was Manager
of Headquarters Human Resources for Control Data Corporation from 1982 to 1992.
He holds a Bachelor of Arts degree from Calvin College.

Willis K. Drake has been a Director of KMC since 1994. From 1980 to 1994, he
was a Director of Historical Kahler. He is the retired Chairman of the Board of
Data Card Corporation. He is a Director of Analysts International Corp.,
Innovex, Inc., Digi International, Inc. and Telident, Inc. He holds a Bachelors
degree from Purdue University.

Alan O. Tuntland has been a Director of KMC since 1994. Mr. Tuntland has held
various positions with Schmidt Printing, Inc. since 1976, serving most recently
as president and chairman of the board since 1994. Mr. Tuntland holds a
Bachelor of Science degree from South Dakota State University and Master of
Science degree from Purdue University.

COMPENSATION OF DIRECTORS

After the Spin Off, KMC will compensate each of its non-employee directors at
a rate of $12,000 per year for serving as a director. Non-employee directors
will also receive $750 for each meeting of the Board of Directors, or committee
thereof, which the particular director attends, except that only one such fee
will be paid for all meetings occurring on the same day. In addition, each non-
employee director serving on the executive committee will receive additional
compensation of $3,000 per year. The non-employee chairman of the Board of
Directors will receive additional compensation of $15,000 per year. Non-
employee chairmen of other Board committees will receive an additional $1,000
per year.

In addition to the cash compensation listed above, KMC will award each non-
employee director an option to purchase 1,220 shares of KMC Common Stock at the
time of such director's initial election or, in the case of the current non-
employee directors, at the time of effectiveness of KMC's 1995 Non-Employee
Directors Stock Option Plan, and will grant each such director an option to
purchase 400 shares of KMC Common Stock on the day immediately following the
last regularly scheduled Board meeting of each year. The option price will be
the fair market value of a share of KMC Common Stock as of the date of grant.
Options granted upon a director's initial election will extend for 10 years and
will become fully exercisable one year after the date of grant. Each subsequent
option will extend for 10 years, and will be fully exercisable one year after
the date of grant.

Notwithstanding KMC's non-employee director compensation set forth above, KMC
non-employee directors who are also Realty non-employee directors will not
receive any additional compensation as a result of their being directors of
KMC.

Employee directors will receive no additional compensation, beyond that which
they receive in their capacity as employees of KMC, for serving on KMC's Board
of Directors.

EXECUTIVE COMPENSATION

KMC, prior to the Spin Off, did not pay any compensation to its officers. The
following table sets forth the annual base salary of KMC's executive officers
whose cash compensation is expected to exceed $100,000 during 1995.

BASE
NAME TITLE SALARY
---- ----- ------

Harold W. Milner President and Chief Executive Officer $ 280,000(1)
Kevin L. Molloy Senior Vice President, Operations $ 156,755
Michael R. Hinckley Senior Vice President, Marketing $ 135,621

- --------

(1) After the Spin Off, two of KMC's executive officers, Mr. Milner and Mr.
Quinn, will be employed both by Realty and KMC. Realty has agreed to pay
80% of the executives' base salary, while KMC will pay the remaining 20%.
The table sets forth the aggregate annual base salary that Realty and KMC
intend to pay Mr. Milner during 1995.

During 1995, Mr. Milner will receive bonus payments of $56,875 under
Historical Kahler's bonus plan for his performance in 1994.

STOCK OPTION AND STOCK RETAINER PLANS

1995 Stock Option Plan

The Board of Directors of KMC has adopted the KMC 1995 Stock Option Plan (the
"1995 Option Plan"). Realty, as sole shareholder of KMC, approved the 1995
Option Plan. The 1995 Option Plan provides for the grant of both incentive
stock options intended to qualify for preferential tax treatment under Section
422 of the Code and nonqualified stock options that do not qualify for such
special tax treatment.

The exercise price of all incentive stock options granted under the 1995
Option Plan must equal or exceed the fair market value of the KMC Common Stock
at the time of the grant. The exercise price for options granted under the 1995
Option Plan which do not qualify as incentive stock options may not be less
than 50% of the fair market value of the KMC Common Stock at the time of the
grant. Only employees are eligible for the grant of incentive stock options.
Nonqualified stock options may also be granted to consultants or independent
contractors providing valuable services to KMC. The 1995 Option Plan will be
administered by the Board of Directors or a committee appointed by the Board of
Directors consisting of at least two directors, none of whom may be officers or
employees of KMC and all of whom must be disinterested persons with respect to
the 1995 Option Plan.

A total of 50,000 shares of KMC Common Stock has been reserved for issuance
under the 1995 Option Plan. No options have been granted under the 1995 Option
Plan as of the date hereof.

1995 Directors Plan

The Board of Directors of KMC has adopted the KMC 1995 Non-Employee Directors
Stock Option Plan (the "1995 Directors Plan"). Realty, as sole shareholder of
KMC, approved the 1995 Directors Plan. KMC has reserved 15,000 shares of KMC
Common Stock for issuance under the 1995 Directors Plan. The 1995 Directors
Plan will be administered by the Board of Directors. Only non-employee
directors are eligible to participate in the 1995 Directors Plan. Eligible
directors are automatically granted an option to purchase 1,220 shares of KMC
Common Stock on the date they first become a director, and an option to
purchase 400 shares on the day immediately following the last regularly
scheduled Board meeting each year, so long as the person continues to serve as
a director of KMC. The exercise price of an option granted under the 1995
Directors Plan is the fair market value of the KMC Common Stock on the date the
stock option is granted. No options have been granted under the 1995 Directors
Plan as of the date hereof.

1995 Retainer Plan

The Board of Directors of KMC has adopted the 1995 Retainer Stock Payment
Plan For Non-Employee Directors (the "1995 Retainer Plan"). Realty, as sole
shareholder of KMC, approved the 1995 Retainer Plan. The 1995 Retainer Plan
provides non-employee directors the opportunity to receive payment of the
annual fee, as well as any earned but unpaid committee fees (the "Retainer") in
the form of shares of KMC Common Stock. Under the terms of the 1995 Retainer
Plan, each non-employee director who makes an election to receive shares in
lieu of cash payment of the Retainer will be issued after such Annual Meeting
of Shareholders an amount of shares equal to 100% of the Retainer divided by
the fair market value of the KMC Common Stock as of that date. The 1995
Retainer Plan will be administered by the Board of Directors. Only non-employee
directors are eligible to participate in the 1995 Retainer Plan.

Effect of Spin Off on Outstanding Options

Although no options are outstanding under the 1995 Option Plan and the 1995
Directors Plan, the officers and directors and certain employees of Historical
Kahler hold options outstanding under several

Historical Kahler option plans (the "Historical Kahler Plans") covering 269,250
shares of Realty Common Stock as of July 2, 1995, including options for 34,500,
15,700 and 10,400 shares held by Messrs. Milner, Molloy and Hinckley as of that
date. Individuals who exercised their outstanding options prior to the Record
Date of the Spin Off will be entitled to participate in the Spin Off and
receive one share of KMC Common Stock for every ten shares of Realty Common
Stock owned as of the Record Date. Outstanding options not exercised prior to
the Record Date ("Pre-Spin Off Options") will be split into two separately
exercisable options: one to purchase shares of Realty Common Stock and one to
purchase shares of KMC Common Stock (collectively, the "Adjusted Options").
Adjusted Options denominated in Realty Common Stock will be exercisable for the
same number of shares as the corresponding Pre-Spin Off Options; Adjusted
Options denominated in KMC Common Stock will be exercisable for one-tenth of
the number of shares acquirable upon exercise of the corresponding Pre-Spin Off
Options.

The per share exercise price of Pre-Spin Off Options in effect immediately
prior to the Spin Off will be allocated between the Adjusted Options on the
basis of the relative fair market values of the Realty Common Stock and the KMC
Common Stock following the distribution of the shares of KMC Common Stock in
the Spin Off. The other terms and conditions of the Adjusted Options will be
identical to those in effect for the Pre-Spin Off Options immediately prior to
the Spin Off. The vesting schedule of the Adjusted Options will be the same as
the Pre-Spin Off Options except that vesting will be subject to continued
employment by either KMC or Realty. The value of the Adjusted Options is
dependent upon the trading prices of Realty Common Stock and KMC Common Stock
after the Spin Off. As a result, neither the value of the Adjusted Options nor
the amount of compensation expense, if any, to Realty as a result of the split
of Pre-Spin Off Options can be determined until after the Spin Off.

As a result of the split of the Pre-Spin Off Options, the Adjusted Options
will not qualify as "incentive stock options" within the meaning of the Code
regardless of whether a Pre-Spin Off Option was an incentive stock option or a
nonqualified stock option prior to the Spin Off. The conversion of incentive
stock options to nonqualified stock options will have no immediate tax
consequences to either Realty or KMC or to the holders of the Pre-Spin Off
Options. Upon exercise of an Adjusted Option, however, an employee will be
taxed on any gain as ordinary income in an amount equal to the difference
between the option exercise price and the fair market value of the stock issued
upon exercise. The company issuing the stock will receive a corresponding
deduction in the same amount.

Adjusted Options will be administered separately by Realty and KMC under the
terms of the plans under which such options were originally granted. Realty and
KMC have adopted the Historical Kahler Plans solely with respect to Adjusted
Options denominated in shares of their respective common stock. See "Certain
Agreements between KMC and Realty--Distribution Agreement."

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

DIRECTORS AND OFFICERS

John H. Herrell, the Chairman of the Board of Realty, is also the Chairman of
the Board of KMC. Harold W. Milner serves as a director and President and Chief
Executive Officer of both Realty and KMC. In addition, Michael J. Quinn, Senior
Vice President, Secretary and General Counsel, serves in similar positions at
KMC.

OPERATING AGREEMENTS

In connection with the Spin Off, Realty and KMC have entered into the
Percentage Leases, the Distribution Agreement, the License Agreement, the Right
of First Refusal Agreement, the Option Agreement and certain agreements with
respect to the franchise licenses. See "Certain Agreements between KMC and
Realty" and "The Hotels--Franchise Agreements."

CERTAIN TRANSACTIONS WITH THE MAYO FOUNDATION

Historical Kahler regularly furnished laundry, hospitality and food services
to the Mayo Foundation and its affiliates at competitive prices. Mr. Herrell,
the Chairman of the Board of Directors of Historical Kahler, is an officer of
the Mayo Foundation. During 1994, sales of such services together with
management fees and rent amounted to $4.3 million or 3.9% of Historical
Kahler's revenue of owned operations. Sales of these services to the Mayo
Foundation amounted to $3.1 million and $4.1 million in 1992 and 1993,
respectively. See Note 10 of the Notes to Consolidated Financial Statements of
Historical Kahler.

Historical Kahler purchased, at competitive prices, steam, electricity, water
and related utility services from Franklin Heating Station ("Franklin"), a Mayo
Foundation affiliate, pursuant to a Utility Sale Agreement with Franklin. The
amount of purchased utility services during 1992 was $2.3 million, during 1993
was $1.9 million, and during 1994 was $1.9 million. See Note 10 to the
Consolidated Financial Statements of Historical Kahler. As a result of the Spin
Off, KMC has assumed the Utility Sales Agreement and will purchase from
Franklin all, or a portion, of the utility services for The Kahler Hotel, the
Kahler Plaza Hotel and the Clinic View Inn and Suites. The Utility Sales
Agreement has an indefinite term and may not be terminated unless, among other
things, the Franklin facilities are permanently retired, damaged or destroyed,
or the Franklin facilities are condemned or taken by eminent domain. The cost
of utility services is based on allocated cost of the utility services provided
by Franklin and the amount of usage.

It is anticipated that KMC will engage in transactions with the Mayo
Foundation that are similar to Historical Kahler's transactions with the Mayo
Foundation.

STOCK ACQUISITION

In October 1994, Milner Associates, a family partnership of which Mr. Harold
W. Milner is general partner, acquired 21,622 shares of Common Stock through
conversion of 8,000 shares of $2.25 Cumulative Convertible Exchangeable
Preferred Stock of Historical Kahler.

EXCHANGE AGREEMENT

At the request of the underwriters and in order to facilitate the Offering
and Realty's conversion to REIT status, Realty, the Mayo Foundation and the
three executive officers of Realty have entered into an agreement intended to
eliminate the interest of Realty's executive officers in the equity of KMC (the
"Exchange Agreement"). Under the Exchange Agreement, the executive officers of
Realty will transfer all of the outstanding shares of KMC Common Stock held by
them, either directly or indirectly, to the Mayo Foundation in exchange for
shares of Realty Common Stock having a value equal to the value of their KMC
Common Stock. The executive officers also agree (i) to exercise all of their
Adjusted Options for KMC Common Stock and dispose of the underlying shares
(aggregating 6,600 shares) prior to January 1, 1996, either by exchanging the
shares for Realty Common Stock pursuant to the Exchange Agreement or by selling
the shares in the open market, and (ii) to request that the trustee of
Historical Kahler's 401(k) plan dispose of any shares of KMC Common Stock which
are allocated to the officers' accounts after the Spin Off. The executive
officers also agree not to purchase or otherwise own any shares of KMC Common
Stock while employed by Realty, except pursuant to the exercise of their
Adjusted Options. Finally, Messrs. Milner, Stenhaug and Quinn each agree to
enter into a letter agreement with the Underwriters pursuant to which he will
agree not to sell any shares of Common Stock for three years, six months and
six months, respectively, after the closing of the Offering. The Mayo
Foundation will also agree to enter into a similar letter agreement with the
Underwriters pursuant to which (i) none of the shares of Common Stock owned by
the Mayo Foundation may be sold for one year after the closing of the Offering,
and (ii) one third of the shares of Common Stock owned by the Mayo Foundation
will become available for sale at the beginning of each of the second, third
and fourth years following the closing of the Offering.

Realty and KMC have agreed to take certain other steps to induce the
executive officers to enter into the Exchange Agreement. Realty has agreed
that, within six months after the closing of the Offering, it will

file and have declared effective a registration statement on Form S-3 covering
resales by the executive officers of the shares of Realty Common Stock received
from the Mayo Foundation in the exchange. Realty will be obligated to maintain
the effectiveness of that registration statement until the shares of Realty
Common Stock are eligible for sale by the executive officers pursuant to Rule
144 under the Securities Act. With respect to the exercise of the Adjusted
Options, the Exchange Agreement provides that (i) KMC will accelerate the
vesting of all of the Adjusted Options for KMC Common Stock held by the
executive officers of Realty, and (ii) Realty will award a cash bonus to each
of the executive officers approximately equal, on an after tax basis, to his
tax liability upon exercise of the Adjusted Options.

As a result of the Spin Off, the Mayo Foundation will hold 111,323 shares or
23.9% of the KMC Common Stock, and Messrs. Milner, Stenhaug and Quinn will hold
51,119 shares, 2,603 shares and 2,939 shares, respectively, of KMC Common Stock
(assuming the exercise of all options) or 12.0% of the KMC Common Stock on an
aggregate basis. Giving effect to the Exchange Agreement, Messrs. Milner,
Stenhaug and Quinn will have no equity interest in KMC and the Mayo Foundation
will hold up to 35.5% of the KMC Common Stock. The number of shares of Realty
Common Stock to be transferred to the executive officers by the Mayo Foundation
pursuant to the Exchange Agreement will depend on the fair market value of the
KMC Common Stock after the Spin Off, which cannot be determined at this time.
See "The Spin Off." Realty estimates that the shares of Realty Common Stock to
be received by the executive officers of Realty pursuant to the Exchange
Agreement will represent less than 0.5% of the outstanding shares of Realty
Common Stock.

The Exchange Agreement became effective upon the closing of the Offering.

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information with respect to the
beneficial ownership of KMC Common Stock after the Spin Off by each director of
KMC, the Chief Executive Officer and each other executive officer of KMC whose
salary and bonus in 1995 is expected to exceed $100,000, each other person who
owns more than 5.0% of the KMC Common Stock, and all directors and executive
officers as a group, in each case as of August 15, 1995. Except as otherwise
indicated, the persons listed have sole voting and investment power over such
shares.

SHARES BENEFICIALLY
OWNED AFTER THE
SPIN OFF (1)
-------------------------
NUMBER PERCENT
----------- ----------

John H. Herrell...................................... 3,139 *
Willis K. Drake...................................... 3,783 *
Alan O. Tuntland..................................... 0 *
Harold W. Milner..................................... 0(2) *
Michael R. Hinckley.................................. 2,385 *
Kevin L. Molloy...................................... 1,902 *
Mayo Foundation...................................... 111,323(3) 35.5%
Rochester, Minnesota
Kahler Realty Corporation............................ 44,204 9.5%
20 Second Avenue Southwest
Rochester, Minnesota 55902
All directors and executive
officers as a group (13 persons).................... 15,055(2) 3.2%

- --------

* Less than 1.0%

(1) Includes the following shares which could be acquired within 60 days upon
exercise of options: Mr. Herrell, 400 shares; Mr. Drake, 400 shares; Mr.
Molloy, 405 shares; and all directors and executive officers as a group,
2,367 shares. Also includes the following shares held through Realty's
401(k) Plan, with respect to which the trustee of the 401(k) plan has the
power to vote and the individual has the power to dispose: Mr. Hinckley,
165 shares; Mr. Molloy, 199 shares; and all directors and executive
officers as a group, 1,000 shares.

(2) Reflects disposition of all KMC shares pursuant to the Exchange Agreement.
See "Certain Relationships and Related Transactions--Exchange Agreement."

(3) Does include shares of KMC Common Stock to be acquired by Mayo Foundation
pursuant to the Exchange Agreement. See "Certain Relationships and Related
Transactions--Exchange Agreement."

DESCRIPTION OF CAPITAL STOCK

Under KMC's Articles of Incorporation, the total number of shares of all
classes of stock that KMC has authority to issue is 30,000,000, consisting of
20,000,000 shares of KMC Common Stock and 10,000,000 shares of preferred stock,
par value $.10 per share (the "KMC Preferred Stock"). No shares of any class of
KMC Preferred Stock will be issued or outstanding immediately after
consummation of the Spin Off, and KMC has no present intention to issue any
such shares.

COMMON STOCK

General

After the distribution of shares of KMC Common Stock in the Spin Off, there
will be 465,307 shares of KMC Common Stock outstanding. All shares of KMC
Common Stock will be fully paid and nonassessable and the holders thereof will
not have preemptive rights.

Voting Rights

The holders of KMC Common Stock will be entitled to one vote per share on all
matters voted on by shareholders, including elections of directors. Except as
otherwise required by law or provided in any resolution adopted by the Board of
Directors with respect to any series of KMC Preferred Stock, the holders of
such shares will exclusively possess all voting power. The KMC Articles of
Incorporation do not provide for cumulative voting in the election of
directors.

Dividends

Subject to any preferential rights of any outstanding series of KMC Preferred
Stock, the holders of KMC Common Stock will be entitled to such dividends as
may be declared from time to time by the Board of Directors from funds
available therefor, and upon liquidation will be entitled to receive pro rata
all assets of KMC available for distribution to such holders.

Quotation of KMC Common Stock on the Nasdaq SmallCap Market

KMC has applied to have the KMC Common Stock quoted on the Nasdaq SmallCap
Market upon consummation of the Spin Off.

Shares Eligible for Future Sale

All of the shares of KMC Common Stock distributed in the Spin Off to persons
other than "affiliates" of KMC will be freely tradeable without restriction or
registration under the Securities Act of 1933. Following the Spin Off, shares
of KMC Common Stock held by affiliates of KMC and shares retained by Realty
upon completion of the Spin Off may not be sold in the public market unless
registered under the Securities Act or sold in compliance with Rule 144
promulgated thereunder.

Rule 144, as currently in effect, provides that a person (or persons whose
sales are aggregated) who is an affiliate of KMC or who has been the beneficial
owner of restricted shares (defined as shares which were issued and sold in
reliance upon exemptions from registration under the Securities Act) for at
least two years is entitled to sell within any three-month period a number of
shares that does not exceed the greater of one percent of the then outstanding
shares of KMC Common Stock (approximately 4,653 shares immediately after the
Spin Off) or the average weekly trading volume in the KMC Common Stock during
the four calendar weeks preceding such sale. Sales under Rule 144 are also
subject to certain manner-of-sale provisions, notice requirements and the
availability of current public information about KMC. However, a person who is
not deemed to have been an "affiliate" of KMC at any time during the three
months preceding a sale, and who has beneficially owned restricted shares for
at least three years, may sell such shares under Rule 144 without

regard to volume limitations, manner-of-sale provisions, notice requirements or
the availability of current public information about KMC.

PREFERRED STOCK

The KMC Board of Directors is authorized to provide for the issuance of
shares of KMC 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. Because the KMC Board of Directors has the power to establish the
preferences and rights of each class or series of KMC Preferred Stock, the
Board of Directors may afford the holders of any series or class of KMC
Preferred Stock preferences, powers and rights, voting or otherwise, senior to
the rights of holder of KMC Common Stock. The issuance of KMC Preferred Stock
could have the effect of delaying or preventing a change in control of KMC.

ARTICLES OF INCORPORATION AND BYLAW PROVISIONS

Staggered Board of Directors

KMC's Articles of Incorporation provide that the Board of Directors will be
divided into three classes of directors, each class constituting approximately
one-third of the total number of directors and with the classes serving
staggered three year terms. The classification of directors will have the
effect of making it more difficult for shareholders to change the composition
of the Board of Directors. KMC believes, however, that the longer time required
to elect a majority of a classified Board of Directors will help to ensure
continuity and stability of KMC.

The classification provisions could also have the effect of discouraging a
third party from accumulating large blocks of KMC's stock or attempting to
obtain control of KMC, even though such an attempt might be beneficial to KMC
and its shareholders. Accordingly, shareholders could be deprived of certain
opportunities to sell their shares of KMC Common Stock at a higher market price
than might otherwise be the case.

Number of Directors; Removal; Filling Vacancies

KMC's Articles of Incorporation provide that the number of directors on KMC's
Board will be subject to increase or decrease by the affirmative vote of a
majority of the members of the Board of Directors or of the holders of 75.0% of
the outstanding shares of KMC Common Stock. The shareholders shall be entitled
to vote on the election or removal of directors, with each share entitled to
one vote. Any vacancies on the Board will be filled by the affirmative vote of
a majority of the remaining directors. Newly created directorships resulting
from action of the Board of Directors may be filled by the Board while newly
created directorships resulting from shareholder action may be filled only by
shareholders. Any director elected by the Board of Directors shall hold office
until his or her successor is elected by the shareholders.

A director may be removed with or without cause by the vote of either the
holders of 75.0% of the outstanding shares of KMC Common Stock or 75.0% of the
directors then in office. The term "cause" is not defined in KMC's Articles of
Incorporation.

Limitation of Liability

KMC's Articles of Incorporation provide that to the maximum extent permitted
by Minnesota law, as in effect from time to time, no director or officer of KMC
shall be liable to KMC or its shareholders for monetary damages.

Other Provisions

Under KMC's Bylaws, KMC is required to indemnify its officers and directors
for such expenses and liabilities, in such manner, under such circumstances,
and to such extent, as required or permitted by Minnesota law.

Under Minnesota law, a corporation shall, unless prohibited or limited by its
articles of incorporation or bylaws, indemnify its current and former officers,
directors, employees and agents against expenses (including attorneys' fees),
judgments, penalties, fines and amounts paid in settlement and which were
incurred in connection with actions, suits or proceedings in which such persons
are parties by reason of the fact that they are or were an officer, director,
employee or agent of the corporation, if they (i) have not been indemnified by
another organization; (ii) acted in good faith; (iii) received no improper
personal benefit; (iv) in the case of a criminal proceeding, had no reasonable
cause to believe the conduct was unlawful; and (v) reasonably believed that the
conduct was in the best interests of the corporation. Minnesota corporate law
also provides that a corporation may purchase and maintain insurance on behalf
of its officers, directors, employees and agents against any liability which
may be asserted against, or incurred by, such persons in their capacities as
officers, directors, employees and agents of the corporation, whether or not
the corporation would have been required to indemnify the person against the
liability under the provisions of such section.

Any indemnification by KMC pursuant to the provisions of KMC's Articles of
Incorporation or Bylaws described above shall be paid out of the assets of KMC
and shall not be recoverable from the shareholders. To the extent that the
foregoing indemnification provisions purport to include indemnification for
liabilities arising under the Securities Act, in the opinion of the Commission
such indemnification is contrary to public policy and, therefore,
unenforceable.

KMC does not currently have, but will seek to obtain insurance on behalf of
its directors and executive officers against liabilities which may be asserted
against, or incurred, by these persons in their capacities as directors and
executive officers of KMC. The scope of the coverage of this insurance, if any,
has yet to be determined and will depend, in part, on premiums charged for this
insurance.

Amendment

KMC's Articles of Incorporation may be amended by the affirmative vote of the
holders of a majority of the outstanding shares of the KMC Common Stock, with
the shareholders voting as a class with one vote per share, except in the case
of an amendment to Article 7 which provides for a staggered board and sets
forth procedures for establishing the size of, filling vacancies on, and
removal of members of, the Board of Directors, which article may not be amended
without the affirmative vote of the holders of 75.0% of the outstanding shares
of KMC Common Stock. Subject to certain limitations, KMC's Bylaws may be
amended by the Board of Directors or by vote of the holders of a majority of
the outstanding shares of KMC Common Stock.

MINNESOTA ANTI-TAKEOVER STATUTES

KMC is governed by the provisions of Sections 302A.671 and 302A.673 of the
MBCA. Section 302A.671 of the MBCA provides that the shares of a corporation
acquired in a "control share acquisition" have no voting rights unless they are
approved in a prescribed manner. A "control share acquisition" is generally
defined as an acquisition of beneficial ownership of voting stock of the
corporation that would, when added to all other shares beneficially owned by
the acquiring person, entitle the acquiring person to have

voting power of 20.0% or more in the election of directors. Section 302A.673 of
the MBCA prohibits a publicly-held Minnesota corporation from engaging in a
"business combination" with an "interested shareholder" for a period of four
years after the date of the transaction in which the person became an
interested shareholder, unless the business combination is approved in a
prescribed manner. A "business combination" includes mergers, asset sales and
other transactions resulting in a financial benefit to the interested
shareholder. Subject to certain exceptions, an "interested shareholder" is a
person who, together with affiliates, beneficially owns, or within four years
did own, 10.0% or more of the corporation's outstanding voting stock.

In the event of certain tender offers for stock of KMC, Section 302A.675 of
the MBCA precludes the tender offeror from acquiring additional shares of stock
(including acquisitions pursuant to mergers,

consolidations or statutory share exchanges) within two years following the
completion of such offer unless the selling shareholders are given the
opportunity to sell the shares on terms that are substantially equivalent to
those contained in the earlier tender offer. This section does not apply if a
committee of the board of directors consisting of disinterested directors
(excluding present and former officers of the corporation) approves the
subsequent acquisition before shares are acquired pursuant to the earlier
tender offer.

LEGAL MATTERS

The validity of the shares of KMC Common Stock offered hereby will be passed
upon by Dorsey & Whitney P.L.L.P. of Minneapolis, Minnesota.

CHANGE IN AUDITORS

On October 25, 1993, Kahler Corporation retained KPMG Peat Marwick LLP as its
independent auditors for 1993, thereby replacing Deloitte & Touche LLP as
Kahler Corporation's independent auditors. Kahler Corporation and Deloitte &
Touche LLP did not have any disagreements on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure during Kahler Corporation's fiscal year 1992 or during any subsequent
interim period.

EXPERTS

The consolidated financial statements and consolidated financial statement
schedule of Kahler Realty Corporation and Subsidiaries as of January 1, 1995
and January 2, 1994 and for the years then ended have been included herein, and
in the Registration Statement in reliance upon the reports of KPMG Peat Marwick
LLP, independent certified public accountants, appearing elsewhere herein, and
upon the authority of said firm as experts in accounting and auditing.

The consolidated financial statements of operations, stockholders' equity and
cash flows for the year ended January 3, 1993 of Kahler Realty Corporation
(formerly Kahler Corporation) and Subsidiaries included in this Prospectus have
been audited by Deloitte & Touche LLP, independent auditors, as stated in their
report appearing herein and elsewhere in the Registration Statement and have
been so included in reliance upon the report of said firm given upon their
authority as experts in accounting and auditing.

CERTAIN DEFINITIONS

"1995 Directors Plan" means the Kahler Management Corporation 1995 Non-
Employee Directors Stock Option Plan.

"1995 Option Plan" means the Kahler Management Corporation's 1995 Stock
Option Plan, as amended.

"1995 Retainer Plan" means the Kahler Management Corporation 1995 Retainer
Stock Payment Plan for Non-employee Directors.

"ACM" means asbestos containing material.

"ADA" means the Americans with Disabilities Act of 1990, as amended.

"Additional Charges" means certain amounts in addition to Base Rent and
Percentage Rent, including interest accrued on any late payments or charges,
due to Realty from KMC under the Percentage Leases.

"Adjusted Options" means the two separately exercisable options into which
the Pre-Spin Off Options will be split as of the Record Date.

"ADR" means average daily room rate per occupied room.

"Anderson's" means Anderson's Formal Wear, a wholesale and retail distributor
of men's formal wear.

"Articles of Incorporation" mean the KMC Articles of Incorporation, as
amended.

"Asset Transfers" means a series of asset transfers and related transactions
engaged in by Historical Kahler as part of the Spin Off to separate certain of
its hotel interests from its hotel management operations.

"Base Rent" means the fixed rent due to Realty from KMC under the Percentage
Leases.

"Best Western" means Best Western International Inc.

"Cardinal" means Cardinal Lodging Group, Inc.

"Choice Hotels" means Choice Hotels International, Inc.

"Code" means the Internal Revenue Code of 1986, as amended.

"Commission" means the Securities and Exchange Commission.

"CPI" means the Consumer Price Index, All Urban Consumers, U.S. City Average,
All Items, Standard Reference Base 1982-1984=100, as released by the U.S.
Department of Labor, Bureau of Labor Statistics.

"Distribution Agreement" means the agreement between Realty and KMC which
provides for the Asset Transfers, the Spin Off, the division between Realty and
KMC of certain liabilities and certain other agreements governing the
relationship between Realty and KMC.

"EBITDA" means income (loss) from operations before income taxes, excluding
gains or losses on sale of assets, non-cash writedowns of real estate property,
interest expense, depreciation and amortization.

"Effective Date" means the effective date of the Distribution Agreement,
which was , 1995, the end of the last monthly fiscal period prior to
the closing of the Offering.

"Exchange Act" means the Securities Exchange Act of 1934, as amended.

"Exchange Agreement" means the agreement among Realty, the Mayo Foundation
and the executive officers of Realty which provides for the transfer of the
executive officers' shares of KMC Common Stock to the Mayo Foundation in
exchange for shares of Realty Common Stock.

"FF&E" means furniture, fixtures and equipment.

"Franklin" means the Franklin Heating Station, a Mayo Foundation affiliate
which provides steam, electricity, water and related utility services to
Historical Kahler.

"Hilton" means Hilton Hotels Corporation.

"Historical Kahler" means Kahler Realty Corporation without giving effect to
the Spin Off.

"Historical Kahler Plans" means the option plans in effect at Historical
Kahler prior to the adoption of the 1995 Option Plan and the 1995 Directors
Plan.

"Holiday Inns" means Holiday Inns, Inc.

"Hotels" means the 22 hotels included in the table under the heading "The
Hotels."

"KMC" means Kahler Management Corporation, a wholly owned subsidiary of
Historical Kahler, 90.5% of the Common Stock of which is being distributed to
the pre-Offering shareholders of Historical Kahler in the Spin Off.

"KMC Common Stock" means the common stock, $.10 par value, of KMC.

"KMC Preferred Stock" means the 10 million shares of Preferred Stock, par
value $.10 per share, authorized for issuance under the Articles of
Incorporation.

"Knights Inn" is a registered trademark of Cardinal Lodging Group, Inc.

"Leased Hotels" means the 14 Hotels that are leased to KMC by Realty.

"License Agreement" means the non-exclusive trademark license agreement
entered into by Realty and KMC.

"Lines of Credit" means the lines of credit currently being negotiated by
Realty in an aggregate principal amount of $50.0 million.

"Managed Hotels" means the six Hotels that are operated by KMC pursuant to
management contracts.

"MBCA" means the Minnesota Business Corporation Act, as amended.

"NAREIT" means the National Association of Real Estate Investment Trusts.

"Offering" means the public offering by Realty of approximately 8,420,000
shares of Realty Common Stock.

"Option Agreement" means the agreement between Realty and KMC which grants
Realty a five-year option to purchase the Owned Hotels from KMC.

"Owned Hotels" means the two Hotels that are 100% owned and operated by KMC.

"Park Hotels" means Park Hotels, L.C., a Utah limited liability company,
which holds a 50-year ground lease with the City of Provo, Utah, with respect
to the Provo Park Hotel.

"Percentage Leases" means the leases pursuant to which KMC leases 14 of the
Hotels from Realty.

"Percentage Rent" means the percentage rent due to Realty from KMC under the
Percentage Leases.

"Pre-Spin Off Options" means outstanding options for Realty Common Stock
which were not exercised prior to the Record Date of the Spin Off.

"Prospectus" means this Prospectus filed as part of the Registration
Statement.

"Realty" means Kahler Realty Corporation giving effect to the Spin Off.

"Realty Common Stock" means the common stock, $.10 par value, of Kahler
Realty Corporation.

"Realty Hotels" means the University Park Hotel and the 14 Leased Hotels.

"Record Date" means , 1995, the date as of which the shareholders
of record of Historical Kahler to receive the Spin Off dividend were
determined.

"REIT" means real estate investment trust.

"Rents" means the Base Rent and Percentage Rent, collectively.

"Residence Inn by Marriott" is a registered trademark of Residence by
Marriott, Inc.

"Retainer" means the annual fee paid to non-employee directors, as well as
any earned but unpaid committee fees.

"REVPAR" means the average daily room revenue per available room, which is
calculated by multiplying occupancy times ADR.

"Right of First Refusal Agreement" means the agreement entered into by Realty
and KMC with respect to new hotel opportunities.

"Securities Act" means the Securities Act of 1933, as amended.

"Service" means the Internal Revenue Service.

"Service Agreement" means the agreement entered into by Textile to provide
laundry services to the Mayo Clinic and Methodist and St. Mary's Hospitals in
Rochester, Minnesota.

"Sheraton" means ITT Sheraton Corporation.

"Spin Off" means a series of transactions which Historical Kahler will engage
in to facilitate its conversion into a REIT. The Spin Off will include (i) the
Asset Transfers and (ii) the distribution by dividend of 90.5% of the KMC
Common Stock to the existing shareholders of Historical Kahler.

"Textile" means KMC's commercial laundry business.

"UIA" means the University Inn Associates, a Utah limited partnership, which
owns the University Park Hotel.

INDEX TO FINANCIAL STATEMENTS

PAGE
----

I. KAHLER REALTY CORPORATION (REALTY):
Pro Forma Condensed Consolidated Balance Sheet as of July 2, 1995
(Unaudited)............................................................ F-3
Pro Forma Condensed Consolidated Statement of Operations for the year
ended January 1, 1995 (Unaudited)...................................... F-8
Pro Forma Condensed Consolidated Statement of Operations for the 12
months ended July 2, 1995 (Unaudited).................................. F-13
Pro Forma Condensed Consolidated Statement of Operations for the first
six months ended July 2, 1995 (Unaudited).............................. F-18
II. KAHLER MANAGEMENT CORPORATION (KMC):
Pro Forma Condensed Consolidated Balance Sheet as of July 2, 1995
(Unaudited)............................................................ F-24
Pro Forma Condensed Consolidated Statement of Operations for the year
ended January 1, 1995 (Unaudited)...................................... F-27
Pro Forma Condensed Consolidated Statement of Operations for the 12
months ended July 2, 1995 (Unaudited).................................. F-31
Pro Forma Condensed Consolidated Statement of Operations for the first
six months ended
July 2, 1995 (Unaudited)............................................... F-35
III. KAHLER REALTY CORPORATION (HISTORICAL KAHLER):
Independent Auditors' Reports........................................... F-40
Consolidated Balance Sheets as of January 2, 1994 and January 1, 1995
and July 2, 1995 (Unaudited)........................................... F-42
Consolidated Statements of Operations for the years ended January 3,
1993, January 2, 1994 and January 1, 1995 and the first six months
ended July 3, 1994 and July 2, 1995 (Unaudited)........................ F-44
Consolidated Statements of Cash Flows for the years ended January 3,
1993, January 2, 1994 and January 1, 1995 and the first six months
ended July 3, 1994 and July 2, 1995 (Unaudited)........................ F-45
Consolidated Statements of Stockholders' Equity for the years ended
January 3, 1993, January 2, 1994 and January 1, 1995 and the first six
months ended July 2, 1995 (Unaudited).................................. F-46
Notes to Consolidated Financial Statements.............................. F-47

F-1

I. KAHLER REALTY CORPORATION (REALTY)

F-2

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Balance Sheet of Realty is
presented as if (i) the Spin Off had occurred on July 2, 1995 and (ii) the
Offering and the application of the net proceeds therefrom to repay certain
outstanding indebtedness and the acquisition of the Canyon Springs Park Hotel
occurred on July 2, 1995. This unaudited Pro Forma Condensed Consolidated
Balance Sheet should be read in conjunction with the Consolidated Financial
Statements of Historical Kahler and its subsidiaries and the notes thereto
included elsewhere in this Prospectus. In management's opinion, all adjustments
considered necessary to reflect the effects of the Spin Off and the application
of the net proceeds of the Offering have been made. Reference is made to "The
Spin Off."

This unaudited Pro Forma Condensed Consolidated Balance Sheet is not
necessarily indicative of what the actual financial position would have been at
July 2, 1995, nor does it purport to represent the future financial position of
Realty. Capitalized terms not defined herein are used as defined elsewhere in
this Prospectus of which these unaudited financial statements are a part.

F-3

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS)

ASSETS PRO FORMA PRO FORMA
HISTORICAL TO BE HISTORICAL PRO FORMA CONDENSED
KAHLER OWNED BY KAHLER ADJUSTMENTS CONSOLIDATED
ASSETS (A) KMC (D) (E) REALTY
------ ---------- -------- ---------- ----------- ------------

CURRENT ASSETS
Cash................... $ 1,324 $ (845) $ 479 $ 2,157 $ 2,636
Receivables:
Trade, less allowance
for doubtful
accounts............ 6,173 (5,543) 630 -- 630
Notes receivable--
current............. 150 (150) -- -- --
Inventory.............. 2,557 (2,445) 112 -- 112
Prepaid expenses....... 446 (445) 1 -- 1
-------- -------- -------- -------- --------
Total current
assets............ 10,650 (9,428) 1,222 2,157 3,379
-------- -------- -------- -------- --------
OTHER ASSETS
Notes receivable....... 1,393 (1,393) -- -- --
Investment in
affiliates............ 3,425 (606) 4,689 -- 4,689
1,870 (B)
Debt service reserve
fund.................. 750 -- 750 (750) --
Intangibles............ 736 (671) 65 -- 65
Other.................. 2,069 (102) 1,967 (1,505) 462
-------- -------- -------- -------- --------
Total other assets. 8,373 (902) 7,471 (2,255) 5,216
-------- -------- -------- -------- --------
PROPERTY AND EQUIPMENT
Land and improvements.. 16,349 (1,475) 14,874 250 15,124
Buildings.............. 136,967 (12,334) 124,633 4,850 129,483
Equipment.............. 49,043 (25,632) 23,411 650 24,061
Formal wear............ 5,763 (5,763) -- -- --
-------- -------- -------- -------- --------
Total.............. 208,122 (45,204) 162,918 5,750 168,668
Less accumulated
depreciation...... 58,521 (15,537) 42,984 -- 42,984
-------- -------- -------- -------- --------
Total property and
equipment......... 149,601 (29,667) 119,934 5,750 125,684
-------- -------- -------- -------- --------
TOTAL ASSETS....... $168,624 $(39,997) $128,627 $ 5,652 $134,279
======== ======== ======== ======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------ --- ---

CURRENT LIABILITIES
Accounts payable....... $ 7,727 $ (6,558) $ 1,169 $ (140) $ 1,029
Accrued liabilities.... 6,615 (3,464) 3,151 -- 3,151
Notes payable.......... 4,100 -- 4,100 (4,100) --
Current portion of
long-term debt........ 2,912 (794) 2,118 (1,659) 459
Current portion of
subordinated debt..... 500 -- 500 (500) --
-------- -------- -------- -------- --------
Total current
liabilities....... 21,854 (10,816) 11,038 (6,399) 4,639
-------- -------- -------- -------- --------
LONG-TERM DEBT.......... 120,565 (13,326) 107,239 (90,063) 17,176
-------- -------- -------- -------- --------
SUBORDINATED DEBT TO
AFFILIATE.............. 1,000 -- 1,000 (1,000) --
-------- -------- -------- -------- --------
OTHER DEFERRED
LIABILITIES
Deferred revenue....... 134 (71) 63 -- 63
Other.................. 1,392 (1,077) 315 -- 315
-------- -------- -------- -------- --------
Total other
deferred
liabilities....... 1,526 (1,148) 378 -- 378
-------- -------- -------- -------- --------
STOCKHOLDERS' EQUITY
Common stock........... 421 -- 421 842 1,263
Additional paid-in --
capital............... 13,250 13,250 107,536 120,786
Retained earnings...... 10,008 (16,577) (4,699) (5,264) (9,963)
1,870 (B)
-------- -------- -------- -------- --------
Total stockholders'
equity............ 23,679 (14,707) 8,972 103,114 112,086
-------- -------- -------- -------- --------
TOTAL LIABILITIES
AND STOCKHOLDERS'
EQUITY............ $168,624 $(39,997)(C) $128,627 $ 5,652 $134,279
======== ======== ======== ======== ========

F-4

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS)

(A) The "Historical Kahler" column represents the historical consolidated
balance sheet of Kahler Realty Corporation as of July 2, 1995, without
giving effect to the Spin Off.

(B) The following adjustments are a result of reclassification of certain
assets and liabilities of Historical Kahler as a result of the Spin Off:

INVESTMENT RETAINED
IN AFFILIATES EARNINGS
------------- --------

Establish KMC's
investment in
University Park Hotel.. $ 295 $ 295
Establish Realty's
investment in KMC...... 1,575 1,575
------ ------
$1,870 $1,870
====== ======

Realty's interest in KMC has been established at 9.5% of the pro forma net
book value of the assets and liabilities distributed by Historical Kahler
to KMC in the Spin Off. The fair market value of Realty's interest in KMC
following the Spin Off may differ substantially from the amount presented
above.

(C) The total of the column headed "Assets to be Owned by KMC" differs from the
total presented in the KMC Pro Forma Condensed Consolidated Balance Sheet
as follows:

Assets to be owned by KMC in the Realty Pro Forma Condensed
Consolidated Balance Sheet........................................ $39,997
Establish KMC's investment in University Park Hotel................ 295
Realty's investment in KMC......................................... 1,575
-------
$41,867
=======

(D) The "Pro Forma Historical Kahler" column represents the historical basis of
the assets and liabilities of Realty upon the completion of the Spin Off.

F-5

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

BALANCE SHEET--(CONTINUED)

JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS)

(E) Detail for each of the pro forma adjustments is presented in the following
table:

ACQUIRE
CANYON WRITE-OFF WRITE-OFF
SPRINGS REPAYMENT PENALTIES OF DEFERRED OF PREPAID TOTAL
OFFERING PARK OFFERING OF ON DEBT FINANCING INCOME PRO FORMA
PROCEEDS HOTEL(1) COSTS DEBT(3) REPAYMENT COSTS TAXES ADJUSTMENTS
-------- -------- -------- --------- --------- ----------- ---------- -----------

ASSETS
Cash.................... $117,880 $(5,750) $(9,502) $(95,897) $(4,574) $ -- $ -- $ 2,157
Debt service reserve
fund................... -- -- -- (750)(2) -- -- -- (750)
Other................... -- -- (140) -- -- (852) (513) (1,505)
Property and equipment.. -- 5,750 -- -- -- -- -- 5,750
-------- ------- ------- -------- ------- ----- ----- --------
$117,880 $ -- $(9,642) $(96,647) $(4,574) $(852) $(513) $ 5,652
======== ======= ======= ======== ======= ===== ===== ========
LIABILITIES AND
STOCKHOLDERS' EQUITY
Accounts payable........ $ -- $ -- $ (140) $ -- $ -- $ -- $ -- $ (140)
Notes payable........... -- -- -- (4,100) -- -- -- (4,100)
Current portion of long-
term debt.............. -- -- -- (1,659) -- -- -- (1,659)
Current portion of
subordinated debt...... -- -- -- (500) -- -- -- (500)
Long-term debt.......... -- -- -- (90,063) -- -- -- (90,063)
Subordinated debt to
affiliate.............. -- -- -- (1,000) -- -- -- (1,000)
Common Stock............ 842 -- -- -- -- -- -- 842
Additional paid-in
capital................ 117,038 -- (9,502) -- -- -- -- 107,536
Retained earnings....... -- -- -- 675 (4,574) (852) (513) (5,264)
-------- ------- ------- -------- ------- ----- ----- --------
$117,880 $ -- $(9,642) $(96,647) $(4,574) $(852) $(513) $ 5,652
======== ======= ======= ======== ======= ===== ===== ========

- --------

(1) On August 1, 1995, Historical Kahler acquired the Canyon Springs Park
Hotel in Twin Falls, Idaho for $5.8 million. The acquisition was
financed with a first mortgage of $3.8 million, a note payable to
seller of $400,000 and $1.6 million from available cash and lines of
credit. Due to the date of acquisition, this debt is not reflected in
the table below.

(2) Release of $750 in debt service reserve funds held in escrow.

(3) The pro forma adjustments in the "Repayment of Debt" column reflect the
anticipated repayment of certain outstanding debt with proceeds of the
Offering. The following table represents the debt being repaid:

PROPERTY PLEDGED INTEREST PRINCIPAL
AS COLLATERAL RATE BALANCE
---------------- -------- ---------

Kahler Plaza Hotel...................... 10% + 2% room revenue $15,377
Clinic View Inn......................... 9.75% + 2% room revenue 14,580
Sheraton San Marcos Golf Resort and
Conference Center...................... 7.5% + added interest 12,700
The Kahler Hotel........................ Prime + 1% 12,203
Salt Lake Hilton Hotel.................. Prime + 0.5% 11,785
Ogden Park Hotel........................ Prime + 0.5% 5,190
Lakeview Conference Center and Resort... Prime + 1.125% 4,549
Olympia Park Hotel...................... Prime + 2% 3,853
Boise Park Suites Hotel................. Prime + 1% 4,058
Pocatello Park Quality Inn.............. Prime + 1.5% 3,614
The Kahler Hotel........................ 12% 2,855
Lakeview Conference Center and Resort,
Knights Inns........................... Prime 648
Lines of Credit......................... Prime + 1% 4,100
Miscellaneous........................... Various 310
Subordinated Debt....................... Prime + 1% 1,500
-------
Total....................................................... 97,322
Less debt service reserve fund.............................. (750)
Less discounts.............................................. (675)
-------
$95,897
=======

F-6

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

BALANCE SHEET--(CONTINUED)

JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS)

(E) Continued

Actual amounts to be repaid and related prepayment penalties may differ
from the amounts set forth above due to the timing of payments. In
addition, Realty is considering reissuing the $12.7 million of tax-exempt
revenue bonds secured by the Sheraton San Marcos Golf Resort and Conference
Center if it is able to do so on terms more favorable to Realty than the
anticipated terms of the Lines of Credit. Realty anticipates that the bonds
would be credit enhanced and would bear interest at a variable rate
determined monthly. Realty anticipates that the combined credit enhancement
and interest costs of the bonds would be comparable to the interest Realty
would earn from reinvesting the bonds proceeds pending use thereof.

(F) In order to complete the conversion of Historical Kahler to a REIT,
accumulated earnings and profits through the end of 1995, as determined for
federal income tax purposes, must be distributed to its shareholders by the
end of 1996. Realty intends to satisfy this requirement in part through the
Spin Off. It is anticipated that any remaining accumulated earnings and
profits will be distributed to the holders of Common Stock prior to
December 31, 1996 with funds generated from operations and lines of credit.
Realty does not anticipate using offering proceeds to fund this earnings
and profits distribution and has not presented a pro forma adjustment for
this activity.

F-7

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of
Realty is presented as if (i) the Spin Off had occurred on January 3, 1994,
(ii) Realty qualified as a REIT for the period presented, (iii) the Offering
and the application of the net proceeds therefrom to repay certain outstanding
indebtedness had occurred on January 3, 1994, (iv) the acquisition of certain
properties acquired subsequent to January 3, 1994, including the Canyon Springs
Park Hotel, had occurred on January 3, 1994 and (v) the Percentage Leases were
executed and in effect as of the beginning of the period presented. This
unaudited Pro Forma Condensed Consolidated Statement of Operations should be
read in conjunction with the Consolidated Financial Statements of Historical
Kahler and its subsidiaries and the notes thereto included elsewhere in this
Prospectus. In management's opinion, all adjustments considered necessary to
reflect the effects of the Spin Off, the application of the net proceeds of the
Offering and the Percentage Leases have been made. Reference is made to "The
Spin Off" and "Certain Agreements--The Percentage Leases."

This unaudited Pro Forma Condensed Consolidated Statement of Operations is
not necessarily indicative of what the actual results of operations would have
been for the year ended January 1, 1995, assuming the Spin Off and the related
debt repayments, the acquisition of certain properties and the execution of the
Percentage Leases had been consummated at the beginning of the period
presented, nor does it purport to represent the future operations of Realty.
Capitalized terms not defined herein are used as defined elsewhere in this
Prospectus of which these unaudited financial statements are a part.

F-8

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

OPERATIONS ACQUISITION
OPERATIONS TO BE OF PROPERTIES OF CANYON PRO FORMA
TRANSFERRED TO PRIOR TO SPRINGS CONDENSED
HISTORICAL KMC ACQUISITION PARK HOTEL PRO FORMA CONSOLIDATED
KAHLER (A) (B) (C) (D) ADJUSTMENTS REALTY
---------- ---------------- ------------- ----------- ----------- ------------

LODGING SEGMENT
Percentage leases....... $ -- $ -- $ 261 $976 $23,117 (E) $24,354
Lodging revenue......... (a) 93,243 (86,135) -- -- -- 7,108 (L)
Interest income......... (b) 773 (137) (524) -- (102)(F) 10
Equity income of
affiliates............. (c) 193 314 -- -- -- 507
------- -------- ----- ---- ------- -------
Total Lodging revenue... 94,209 (85,958) (263) 976 23,015 31,979
Lodging expenses:
Hotels................. 65,385 (61,848) 217 56 -- 3,810
University Park Hotel.. 5,412 -- -- -- 458 (G) 5,870 (L)
------- -------- ----- ---- ------- -------
(d) 70,797 (61,848) 217 56 458 9,680
------- -------- ----- ---- ------- -------
Lodging income before
interest, depreciation,
and corporate expenses. 23,412 (24,110) (480) 920 22,557 22,299
------- -------- ----- ---- ------- -------
LAUNDRY SEGMENT
Laundry revenue......... (e) 6,304 (6,304) -- -- -- --
Laundry expenses........ (f) 5,957 (5,957) -- -- -- --
------- -------- ----- ---- ------- -------
Laundry income before
interest, depreciation,
and corporate expenses. 347 (347) -- -- -- --
------- -------- ----- ---- ------- -------
FORMAL WEAR SEGMENT
Formal Wear revenue..... (g) 8,924 (8,924) -- -- -- --
Formal Wear expenses.... (h) 6,975 (6,975) -- -- -- --
------- -------- ----- ---- ------- -------
Formal Wear income
before interest,
depreciation, and
corporate expenses..... 1,949 (1,949) -- -- -- --
------- -------- ----- ---- ------- -------
Other income before
interest, depreciation,
and corporate expenses. (i) 111 (86) -- -- -- 25
------- -------- ----- ---- ------- -------
Total income before
corporate expense,
interest, and
depreciation........... 25,819 (26,492) (480) 920 22,557 22,324
Corporate expenses...... (j) (3,257) 2,782 -- -- (350)(H) (825)
Interest expense........ (k) (11,207) 1,290 -- -- 8,964 (I) (953)
Depreciation and
amortization........... (l) (8,477) 3,193 (150) (204) 140 (J) (5,498)
Non-recurring charges... (m) (1,811) -- -- -- 1,811 (K) --
Gain (Loss) on sale of
assets................. (n) 20 5 -- -- (25) --
------- -------- ----- ---- ------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES........... $ 1,087 $(19,222) $(630) $716 $33,097 $15,048
======= ======== ===== ==== ======= =======
Primary and fully
diluted income per
common share before
extraordinary item..... $ 1.18 (M)
=======

F-9

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(A) The "Historical Kahler" column represents the historical consolidated
statement of operations of Kahler Realty Corporation for the year ended
January 1, 1995, without giving effect to the Spin Off, reformatted by
segment as follows:

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms................................. $ 54,108
--food and beverage......................... 29,339
--other..................................... 9,796
--------
93,243 (a)
Formal wear, laundry & other
--laundry................................... 6,304 (e)
--formal wear............................... 8,924 (g)
--other..................................... 666 (i)
--------
15,894
--------
Interest income................................ 773 (b)
--------
Total revenue of owned operations............ 109,910
--------
OPERATING COSTS AND EXPENSES
Lodging--rooms................................. 13,523
--food and beverage......................... 23,221
--other..................................... 34,053
--------
70,797 (d)
--------
Formal wear, laundry & other
--laundry................................... 5,957 (f)
--formal wear............................... 6,975 (h)
--other..................................... 555 (i)
--------
13,487
--------
Corporate expenses............................. 3,257 (j)
Depreciation and amortization.................. 8,477 (l)
Non-recurring charges.......................... 1,811 (m)
--------
Total operating costs and expenses........... 97,829
--------
GROSS OPERATING PROFIT........................... 12,081
Interest expense............................... (11,207)(k)
Equity earnings of affiliates.................. 193 (c)
Gain on sale of assets......................... 20 (n)
--------
INCOME FROM OPERATIONS BEFORE INCOME TAXES....... $ 1,087
========

- --------

References (a)-(n) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of
Realty.

F-10

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(B) This column represents the operations of Historical Kahler which will be
transferred to KMC upon completion of the Spin Off, including revenues and
certain expenses related to Hotels that are to be leased to KMC.

(C) These adjustments relate to the Green Oaks Inn and Conference Center and
Pocatello Park Quality Inn, which were acquired subsequent to January 2,
1994, to include percentage lease income for Pocatello and certain expenses
related to both for the period of time from January 3, 1994 through their
respective dates of acquisition.

(D) This column reflects the estimated Percentage Lease income and certain
expenses of the Canyon Springs Park Hotel as though it was owned by Realty
as of January 3, 1994. The Canyon Springs Park Hotel was acquired on August
1, 1995.

(E) This adjustment represents estimated lease payments calculated on a pro
forma basis using the provisions contemplated in the Percentage Leases and
historical revenues of the Hotels which will be leased to KMC pursuant to
Percentage Leases.

The following table reflects the revenues associated with the Hotels for
which Percentage Leases will be entered into. The information reflects
revenues for each of the last three fiscal years or commencing from the
date of acquisition in the case of any Hotel acquired by Historical Kahler
during the last three fiscal years. Of the 14 leased Hotels, Boise Park
Suites Hotel was acquired in January 1992, Olympia Park Hotel in October
1992, and Pocatello Park Quality Inn in March 1994. The Canyon Springs Park
Hotel was acquired on August 1, 1995 and is not included in the table
below.

1992 1993 1994
------- ------- -------

Room revenue..................................... $42,799 $43,923 $51,114
Food & beverage revenue.......................... 24,888 25,114 28,601
Percentage Lease revenue......................... 19,187 19,897 23,117

(F) The pro forma adjustment reflects the reduction of interest income
associated with the termination of a guarantee agreement related to the
Salt Lake Hilton Hotel and the release of a debt service reserve fund
related to debt on the Sheraton San Marcos Golf Resort and Conference
Center.

(G) This pro forma adjustment represents management fees and certain other
expenses to be paid by Realty in connection with the University Park Hotel
and the related management contract with KMC. This adjustment also reflects
KMC's share of equity distributions in University Park Hotel.

(H) This pro forma adjustment represents additional estimated general and
administrative expenses expected to be incurred by Realty following the
completion of the Spin Off.

(I) This pro forma adjustment represents a reduction in interest expense
resulting from the repayment of certain outstanding debt with proceeds of
the Offering.

During the fiscal period subsequent to the consummation of the Offering,
Realty expects to recognize net extraordinary charges of approximately
$3,899 ($4,574 in prepayment penalties offset by principal
reduction/discounts of $675) associated with the repayment of certain
outstanding debt which has not been included in the Pro Forma Condensed
Consolidated Statement of Operations of Realty.

(J) This pro forma adjustment represents a reduction in amortization of
deferred financing costs as a result of the write-off of certain deferred
financing costs associated with outstanding debt to be repaid with proceeds
of the Offering.

F-11

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(K) This adjustment eliminates the effects of non-recurring charges recorded by
Historical Kahler related to expenses incurred in connection with a planned
secondary offering and conversion to a REIT during fiscal year 1994.

(L) Represents lodging revenues and expenses of the University Park Hotel. In
1990, Historical Kahler entered into a transaction in which title to the
Hotel was transferred to an investor in exchange for a Mortgage Note with a
conversion option. Certain provisions in the sales agreement prevented the
transaction from meeting the criteria for a sale as defined by Statement of
Financial Accounting Standards No. 66 and therefore Realty will continue to
consolidate the operations of the Hotel in its financial statements.

(M) Pro forma primary and fully diluted net income per share before
extraordinary item assumes the conversion of all outstanding exercisable
options to purchase shares of Common Stock as of the date of the Offering
and is based upon 12,772,118 shares of Common Stock outstanding during the
period.

F-12

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of
Realty is presented as if (i) the Spin Off had occurred on July 4, 1994, (ii)
Realty qualified as a REIT for the period presented, (iii) the Offering and the
application of the net proceeds therefrom to repay certain outstanding
indebtedness had occurred on July 4, 1994, (iv) the acquisition of certain
properties acquired subsequent to July 4, 1994, including the Canyon Springs
Park Hotel, had occurred on July 4, 1994 and (v) the Percentage Leases were
executed and in effect as of the beginning of the period presented. This
unaudited Pro Forma Condensed Consolidated Statement of Operations should be
read in conjunction with the Consolidated Financial Statements of Historical
Kahler and its subsidiaries and the notes thereto included elsewhere in this
Prospectus. In management's opinion, all adjustments considered necessary to
reflect the effects of the Spin Off, the application of the net proceeds of the
Offering and the Percentage Leases have been made. Reference is made to "The
Spin Off" and "Certain Agreements--The Percentage Leases."

This unaudited Pro Forma Condensed Consolidated Statement of Operations is
not necessarily indicative of what the actual results of operations would have
been for the 12 months ended July 2, 1995, assuming the Spin Off and the
related debt repayments, the acquisition of certain properties and the
execution of the Percentage Leases had been consummated at the beginning of the
period presented, nor does it purport to represent the future operations of
Realty. Capitalized terms not defined herein are used as defined elsewhere in
this Prospectus of which these unaudited financial statements are a part.

F-13

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

OPERATIONS ACQUISITION
OPERATIONS TO BE OF PROPERTIES OF CANYON PRO FORMA
HISTORICAL TRANSFERRED TO PRIOR TO SPRINGS PARK CONDENSED
KAHLER KMC ACQUISITION HOTEL PRO FORMA CONSOLIDATED
(A) (B) (C) (D) ADJUSTMENTS REALTY
---------- ---------------- ------------- ------------ ----------- ------------

LODGING SEGMENT
Percentage leases....... $ -- $ -- $ -- $1,029 $24,088 (E) $25,117
Lodging revenue......... (a) 98,902 (91,587) -- -- -- 7,315 (L)
Interest income......... (b) 714 (144) (345) -- (215)(F) 10
Equity income of
affiliates............. (c) 386 188 -- -- -- 574
-------- -------- ----- ------ ------- -------
Total Lodging revenue... 100,002 (91,543) (345) 1,029 23,873 33,016
Lodging expenses:
Hotels................. 69,315 (65,594) 95 57 -- 3,873
University Park Hotel.. 5,545 -- -- -- 433 (G) 5,978 (L)
-------- -------- ----- ------ ------- -------
(d) 74,860 (65,594) 95 57 433 9,851
-------- -------- ----- ------ ------- -------
Lodging income before
interest, depreciation,
and corporate expenses. 25,142 (25,949) (440) 972 23,440 23,165
-------- -------- ----- ------ ------- -------
LAUNDRY SEGMENT
Laundry revenue......... (e) 6,052 (6,052) -- -- -- --
Laundry expenses........ (f) 5,206 (5,206) -- -- -- --
-------- -------- ----- ------ ------- -------
Laundry income before
interest, depreciation,
and corporate expenses. 846 (846) -- -- -- --
-------- -------- ----- ------ ------- -------
FORMAL WEAR SEGMENT
Formal Wear revenue..... (g) 9,117 (9,117) -- -- -- --
Formal Wear expenses.... (h) 7,207 (7,207) -- -- -- --
-------- -------- ----- ------ ------- -------
Formal Wear income
before interest,
depreciation, and
corporate expenses..... 1,910 (1,910) -- -- -- --
-------- -------- ----- ------ ------- -------
Other income before
interest, depreciation,
and corporate expenses. (i) 98 (73) -- -- -- 25
-------- -------- ----- ------ ------- -------
Total income before
corporate expense,
interest, and
depreciation........... 27,996 (28,778) (440) 972 23,440 23,190
Corporate expenses...... (j) (3,477) 3,002 -- -- (350)(H) (825)
Interest expense........ (k) (12,019) 1,335 -- -- 9,571 (I) (1,113)
Depreciation and
amortization........... (l) (8,617) 3,244 (58) (204) 123 (J) (5,512)
Non-recurring charges... (m) (1,811) -- -- -- 1,811 (K) --
Gain (Loss) on sale of
assets................. (n) (22) 41 -- -- (19) --
-------- -------- ----- ------ ------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES........... $ 2,050 $(21,156) $(498) $ 768 $34,576 $15,740
======== ======== ===== ====== ======= =======
Primary and fully
diluted income per
common share before
extraordinary item..... $ 1.23 (M)
=======

F-14

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(A) The "Historical Kahler" column represents the historical consolidated
statement of operations of Kahler Realty Corporation for the 12 months
ended July 2, 1995, without giving effect to the Spin Off, reformatted by
segment as follows:

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms................................ $ 57,515
--food and beverage........................... 30,919
--other....................................... 10,468
--------
98,902 (a)
Formal wear, laundry & other
--laundry..................................... 6,052 (e)
--formal wear................................. 9,117 (g)
--other....................................... 646 (i)
--------
15,815
--------
Interest income............................... 714 (b)
--------
Total revenue of owned operations........... 115,431
--------
OPERATING COSTS AND EXPENSES
Lodging--rooms................................ 14,318
--food and beverage........................... 24,441
--other....................................... 36,101
--------
74,860 (d)
--------
Formal wear, laundry & other
--laundry..................................... 5,206 (f)
--formal wear................................. 7,207 (h)
--other....................................... 548 (i)
--------
12,961
--------
Corporate expenses............................ 3,477 (j)
Depreciation and amortization................. 8,617 (l)
Non-recurring charges......................... 1,811 (m)
--------
Total operating costs and expenses.......... 101,726
--------
GROSS OPERATING PROFIT.......................... 13,705
Interest expense.............................. (12,019)(k)
Equity earnings of affiliates................. 386 (c)
Gain on sale of assets........................ (22) (n)
--------
INCOME FROM OPERATIONS BEFORE INCOME TAXES...... $ 2,050
========

- --------

References (a) - (n) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of
Realty.

F-15

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(C) This adjustment relates to the Green Oaks Inn and Conference Center, which
was acquired subsequent to July 3, 1994, to include certain expenses for
the period of time from July 4, 1994 through the date of acquisition in
December 1994.

(D) This column reflects the estimated Percentage Lease income and certain
expenses of the Canyon Springs Park Hotel as though it was owned by Realty
as of July 4, 1994. The Canyon Springs Park Hotel was acquired, on August
1, 1995.

Revenues of the leased Hotels for the 12 months ended July 2, 1995 are
presented below. The Canyon Springs Park Hotel was acquired on August 1,
1995 and is not included in the information presented.

Room revenue................. $52,632
Food and beverage revenue.... 29,310
Percentage Lease revenue..... 24,088

(F) The pro forma adjustment reflects the reduction of interest income
associated with the termination of a guarantee agreement related to the
Salt Lake Hilton Hotel and release of a debt service reserve fund related
to debt on the Sheraton San Marcos Golf Resort and Conference Center.

(H) This pro forma adjustment represents additional estimated general and
administrative expenses expected to be incurred by Realty following the
completion of the Spin Off.

(I) This pro forma adjustment represents a reduction in interest expense
resulting from the repayment of certain outstanding debt with proceeds of
the Offering.

During the fiscal period subsequent to the consummation of the Offering,
Realty expects to recognize net extraordinary charges of approximately
$3,899 ($4,574 in prepayment penalties offset by principal
reductions/discounts of $675) associated with the repayment of certain
outstanding debt which has not been included in the Pro Forma Condensed
Consolidated Statement of Operations of Realty.

F-16

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(M) Pro forma primary and fully diluted net income per share before
extraordinary item assumes the conversion of all outstanding exercisable
options to purchase shares of Common Stock as of the date of the offering,
and is based upon 12,772,118 shares of Common Stock outstanding during the
period.

F-17

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of
Realty is presented as if (i) the Spin Off had occurred on January 2, 1995,
(ii) Realty qualified as a REIT for the period presented, (iii) the Offering
and the application of the net proceeds therefrom to repay certain outstanding
indebtedness had occurred on January 2, 1995, (iv) the acquisition of the
Canyon Springs Park Hotel had occurred on January 2, 1995 and (v) the
Percentage Leases were executed and in effect as of the beginning of the period
presented. This unaudited Pro Forma Condensed Consolidated Statement of
Operations should be read in conjunction with the Consolidated Financial
Statements of Historical Kahler and its subsidiaries and the notes thereto
included elsewhere in this Prospectus. In management's opinion, all adjustments
considered necessary to reflect the effects of the Spin Off, the application of
the net proceeds of the Offering and the Percentage Leases have been made.
Reference is made to "The Spin Off" and "Certain Agreements--The Percentage
Leases."

This unaudited Pro Forma Condensed Consolidated Statement of Operations is
not necessarily indicative of what the actual results of operations would have
been for the six months ended July 2, 1995, assuming the Spin Off and the
related debt repayments, the acquisition of the Canyon Springs Park Hotel and
the execution of the Percentage Leases had been consummated at the beginning of
the period presented, nor does it purport to represent the future operations of
Realty. Capitalized terms not defined herein are used as defined elsewhere in
this Prospectus of which these unaudited financial statements are a part.

F-18

KAHLER REALTY CORPORATION (REALTY)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

OPERATIONS TO BE ACQUISITION OF PRO FORMA
TRANSFERRED TO CANYON SPRINGS CONDENSED
HISTORICAL KMC PARK HOTEL PRO FORMA CONSOLIDATED
KAHLER (A) (B) (C) ADJUSTMENTS REALTY
---------- ---------------- -------------- ----------- ------------

LODGING SEGMENT
Percentage leases....... $ -- $ -- $513 $13,002 (D) $13,515
Lodging revenue......... (a) 53,277 (49,391) -- -- 3,886 (J)
Interest income......... (b) 224 (67) -- (155)(E) 2
Equity Income of 291 24 -- 315
affiliates............. (c) ------- -------- ---- ------- -------
Total lodging revenue... 53,792 (49,434) 513 12,847 17,718
Lodging expenses:
Hotels................. 36,632 (34,657) 30 -- 2,005
University Park Hotel.. 2,884 -- -- 296 (F) 3,180 (J)
------- -------- ---- ------- -------
(d) 39,516 (34,657) 30 296 5,185
------- -------- ---- ------- -------
Lodging income before
interest, depreciation, 14,276 (14,777) 483 12,551 12,533
and corporate expenses. ------- -------- ---- ------- -------
LAUNDRY SEGMENT
Laundry revenue......... (e) 3,057 (3,057) -- -- --
Laundry expenses........ (f) 2,469 (2,469) -- -- --
------- -------- ---- ------- -------
Laundry income before
interest, depreciation, 588 (588) -- -- --
and corporate expense.. ------- -------- ---- ------- -------
FORMAL WEAR SEGMENT
Formal wear revenue..... (g) 5,002 (5,002) -- --
Formal Wear expenses.... (h) 3,936 (3,936) -- -- --
------- -------- ---- ------- -------
Formal Wear income
before interest,
depreciation, and 1,066 (1,066) -- -- --
corporate expenses..... ------- -------- ---- ------- -------
Other income before
interest, depreciation, 43 (30) -- -- 13
and corporate expenses. (i) ------- -------- ---- ------- -------
Total income before
corporate expense,
interest, and
depreciation........... 15,973 (16,461) 483 12,551 12,546
Corporate expenses...... (j) (1,914) 1,676 -- (174)(G) (412)
Interest expense........ (k) (6,060) 672 -- 4,801 (H) (587)
Depreciation and
amortization........... (l) (4,438) 1,709 (102) 56 (I) (2,775)
Gain (Loss) on sale of (31) 32 -- (1) --
assets................. (m) ------- -------- ---- ------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE $ 3,530 $(12,372) $381 $17,233 $ 8,772
INCOME TAXES........... ======= ======== ==== ======= =======
Primary and fully
diluted income per
common share before $ .69(K)
extraordinary item..... =======

F-19

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(A) The "Historical Kahler" column represents the historical consolidated
statement of operations of Kahler Realty Corporation for the first six
months ended July 2, 1995, without giving effect to the Spin Off,
reformatted by segment as follows:

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms.................................. $31,308
--food and beverage............................. 16,081
--other......................................... 5,888
-------
53,277 (a)
Formal wear, laundry & other
--laundry....................................... 3,057 (e)
--formal wear................................... 5,002 (g)
--other......................................... 306 (i)
-------
8,365
-------
Interest income................................. 224 (b)
-------
Total revenue of owned operations............. 61,866
-------
OPERATING COSTS AND EXPENSES
Lodging--rooms.................................. 7,588
--food and beverage............................. 12,762
--other......................................... 19,166
-------
39,516 (d)
-------
Formal wear, laundry & other
--laundry....................................... 2,469 (f)
--formal wear................................... 3,936 (h)
--other......................................... 263 (i)
-------
6,668
-------
Corporate expenses.............................. 1,914 (j)
Depreciation and amortization................... 4,438 (l)
-------
Total operating costs and expenses............ 52,536
-------
GROSS OPERATING PROFIT............................ 9,330
Interest expense................................ (6,060)(k)
Equity earnings of affiliates................... 291 (c)
Gain on sale of assets.......................... (31)(m)
-------
INCOME FROM OPERATIONS BEFORE INCOME TAXES........ $ 3,530
=======

- --------

References (a)-(m) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of
Realty.

F-20

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(C) This column reflects the estimated Percentage Lease income and certain
expenses of the Canyon Springs Park Hotel as though it was owned by Realty
as of January 2, 1995. The Canyon Springs Park Hotel was acquired on August
1, 1995.

(D) This adjustment represents additional estimated lease payments calculated
on a pro forma basis using the provisions contemplated in the Percentage
Leases and historical revenues of the Hotels which will be leased to KMC
pursuant to Percentage Leases.

Revenues of the leased Hotels for the six months ended July 2, 1995 are
presented below. The Canyon Springs Park Hotel was acquired on August 1,
1995 and is not included in the information presented.

Room revenue..................... $27,854
Food and beverage revenue........ 14,828
Percentage lease revenue......... 13,002

(E) The pro forma adjustment reflects the reduction of interest income
associated with the termination of a guarantee agreement related to the
Salt Lake Hilton Hotel and release of a debt service reserve fund related
to debt on the Sheraton San Marcos Golf Resort and Conference Center.

(F) This pro forma adjustment represents management fees and certain other
expenses to be paid by Realty in connection with the University Park Hotel
and the related management contract with KMC. This adjustment also reflects
KMC's share of equity distributions in University Park Hotel.

(G) This pro forma adjustment represents estimated general and administrative
expenses expected to be incurred by Realty following the completion of the
Spin Off.

(H) This pro forma adjustment represents a reduction in interest expense
resulting from the repayment of certain outstanding debt with proceeds of
the Offering.

During the fiscal period subsequent to the consummation of the Offering,
Realty expects to recognize net extraordinary charges of approximately
$3,899 ($4,574 in prepayment penalties offset by principal
reductions/discounts of $675) associated with the repayment of certain
outstanding debt which has not been included in the Pro Forma Condensed
Consolidated Statement of Operations of Realty.

(I) This pro forma adjustment represents a reduction in amortization of
deferred financing costs as a result of the write-off of certain deferred
financing costs associated with outstanding debt to be repaid with proceeds
of the Offering.

(J) Represents lodging revenues and expenses of the University Park Hotel. In
1990, Historical Kahler entered into a transaction in which title to the
Hotel was transferred to an investor in exchange for a Mortgage Note with a
conversion option. Certain provisions in the sales agreement prevented the
transaction from meeting the criteria for a sale as defined by Statement of
Financial Accounting Standards No. 66 and therefore Realty will continue to
consolidate the operations of the Hotel in its financial statements.

F-21

KAHLER REALTY CORPORATION (REALTY)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(K) Pro forma primary and fully diluted net income per share before
extraordinary item assumes the conversion of all outstanding exercisable
options to purchase shares of Common Stock as of the date of the offering,
and is based upon 12,772,118 shares of Common Stock outstanding during the
period.

F-22

II. KAHLER MANAGEMENT CORPORATION (KMC)

F-23

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED

BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Balance Sheet of KMC is
presented as if (i) the Spin Off had occurred on July 2, 1995, (ii) the
Offering and the application of the net proceeds therefrom to repay certain
outstanding indebtedness had occurred on July 2, 1995, and (iii) KMC's equity
investment in the Copper King Inn, Butte, Montana ("Butte Hotel") had occurred
on July 2, 1995. This unaudited Pro Forma Condensed Consolidated Balance Sheet
should be read in conjunction with the Consolidated Financial Statements of
Historical Kahler and its subsidiaries and the notes thereto included elsewhere
in this Prospectus. In management's opinion, all adjustments considered
necessary to reflect the effects of the Spin Off and the application of the net
proceeds of the Offering have been made. Reference is made to "The Spin Off."

This unaudited Pro Forma Condensed Consolidated Balance Sheet is not
necessarily indicative of what the actual financial position would have been at
July 2, 1995, nor does it purport to represent the future financial position of
KMC. Capitalized terms not defined herein are used as defined elsewhere in this
Prospectus of which these unaudited financial statements are a part.

Prior to the Offering, the Board of Directors of Historical Kahler will
declare the Spin Off dividend to shareholders of Historical Kahler of record on
the Record Date, consisting of 90.5% of the issued and outstanding shares of
KMC Common Stock, payable in a ratio of one share of KMC Common Stock for every
ten shares of Common Stock. The dividend will be payable only to existing
shareholders of Historical Kahler as of the Record Date. PURCHASERS IN THE
OFFERING WILL NOT RECEIVE ANY SHARES OF KMC COMMON STOCK IN THE SPIN OFF.

The Pro Forma Condensed Consolidated Financial Data of KMC has been included
in this Prospectus because Realty will derive substantially all of its income
from the Hotels in the form of Base Rent, Percentage Rent and Additional
Charges received pursuant to the Percentage Leases entered into with KMC. See
"Risk Factors--Realty's Dependence on KMC."

F-24

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS)

PRO FORMA
HISTORICAL
ASSETS CONDENSED INVESTMENT PRO FORMA
HISTORICAL TO BE CONSOLIDATED IN BUTTE CONDENSED
KAHLER OWNED KMC HOTEL CONSOLIDATED
ASSETS (A) BY REALTY (B) (C) KMC
- ------ ---------- --------- ------------ ---------- ------------
CURRENT ASSETS

Cash...................... $ 1,324 $ (479) $ 845 $(600) $ 245
Receivables:..............
Trade, less allowance for
doubtful accounts....... 6,173 (630) 5,543 -- 5,543
Notes receivable--current. 150 -- 150 -- 150
Inventories............... 2,557 (112) 2,445 -- 2,445
Prepaid expenses.......... 446 (1) 445 -- 445
-------- --------- ------- ----- -------
Total current assets... 10,650 (1,222) 9,428 (600) 8,828
-------- --------- ------- ----- -------
OTHER ASSETS
Notes receivables......... 1,393 -- 1,393 -- 1,393
Investment in affiliates.. 3,425 (2,819) 606 600 1,206
Debt service reserve fund. 750 (750) -- -- --
Intangibles............... 736 (65) 671 -- 671
Other..................... 2,069 (1,967) 102 -- 102
-------- --------- ------- ----- -------
Total other assets..... 8,373 (5,601) 2,772 600 3,372
-------- --------- ------- ----- -------
PROPERTY AND EQUIPMENT
Land and improvements..... 16,349 (14,874) 1,475 -- 1,475
Buildings................. 136,967 (124,633) 12,334 -- 12,334
Equipment................. 49,043 (23,411) 25,632 -- 25,632
Formal wear apparel....... 5,763 -- 5,763 -- 5,763
-------- --------- ------- ----- -------
Total.................... 208,122 (162,918) 45,204 -- 45,204
Less accumulated 58,521 (42,984) 15,537 -- 15,537
depreciation............ -------- --------- ------- ----- -------
Total property and 149,601 (119,934) 29,667 -- 29,667
equipment............... -------- --------- ------- ----- -------
TOTAL ASSETS........... $168,624 $(126,757) $41,867 $ -- $41,867
======== ========= ======= ===== =======

LIABILITIES AND STOCKHOLDERS'
EQUITY
- -----------------------------

CURRENT LIABILITIES
Accounts payable.......... $ 7,727 $ (1,169) $ 6,558 $ -- $ 6,558
Accrued liabilities....... 6,615 (3,151) 3,464 -- 3,464
Notes payable............. 4,100 (4,100) -- -- --
Current portion of long-
term debt................ 2,912 (2,118) 794 -- 794
Current portion of 500 (500) -- -- --
subordinated debt........ -------- --------- ------- ----- -------
Total current 21,854 (11,038) 10,816 -- 10,816
liabilities........... -------- --------- ------- ----- -------
LONG-TERM DEBT.............. 120,565 (107,239) 13,326 -- 13,326
-------- --------- ------- ----- -------
SUBORDINATED DEBT TO 1,000 (1,000) -- -- --
AFFILIATE.................. -------- --------- ------- ----- -------
OTHER DEFERRED LIABILITIES
Deferred revenue.......... 134 (63) 71 -- 71
Other..................... 1,392 (315) 1,077 -- 1,077
-------- --------- ------- ----- -------
Total other deferred 1,526 (378) 1,148 -- 1,148
liabilities.............. -------- --------- ------- ----- -------
STOCKHOLDERS' EQUITY
Common stock.............. 421 (421) 43 -- 43
43 (D)
Additional paid-in
capital.................. 13,250 (13,250) 16,534 -- --
Retained earnings......... 10,008 6,569 -- -- 16,534
(43)(D)
-------- --------- ------- ----- -------
Total stockholders' equity.. 23,679 (7,102) 16,577 -- 16,577
-------- --------- ------- ----- -------
TOTAL LIABILITIES AND $168,624 $(126,757) $41,867 $ -- $41,867
STOCKHOLDERS' EQUITY....... ======== ========= ======= ===== =======

F-25

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

BALANCE SHEET

JULY 2, 1995

(UNAUDITED)

(A) The "Historical Kahler" column represents the historical consolidated
balance sheet of Kahler Realty Corporation as of July 2, 1995, without
giving effect to the Spin Off.

(B) The "Pro Forma Historical Condensed Consolidated KMC" column represents the
assets and liabilities which will be held by KMC upon completion of the
Spin Off.

Totals for this column can be reconciled to the column headed "Assets to be
Owned by KMC" presented in the Realty Pro Forma Condensed Consolidated
Balance Sheet as follows:

Realty pro forma totals........................................... $39,997
Adjustments:
Equity interest in University Park Hotel reflected as an asset
by KMC......................................................... 295
Investment in KMC reflected as an asset by Realty............... 1,575
-------
$41,867
=======

(C) Represents KMC's planned equity investment in the Butte Hotel. Historical
Kahler has an agreement to acquire an equity interest of approximately 30%
in the Butte Hotel as well as a management agreement with respect to this
hotel.

(D) Represents the par value of KMC Common Stock expected to be issued in
connection with the Spin Off.

F-26

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of KMC
is presented as if (i) the Spin Off had occurred on January 3, 1994, (ii) the
Offering and the application of the net proceeds therefrom to repay certain
outstanding indebtedness had occurred on January 3, 1994, (iii) the acquisition
of certain properties acquired subsequent to January 3, 1994, including the
Canyon Springs Park Hotel and Butte Hotel, had occurred on January 3, 1994, and
(iv) the Percentage Leases were executed and in effect as of the beginning of
the period presented. This unaudited Pro Forma Condensed Consolidated Statement
of Operations should be read in conjunction with the Consolidated Financial
Statements of Historical Kahler and its subsidiaries and the notes thereto
included elsewhere in this Prospectus. In management's opinion, all adjustments
considered necessary to reflect the effects of the Spin Off and the application
of the net proceeds of the Offering and the Percentage Leases have been made.
Reference is made to "The Spin Off" and "Certain Agreements--The Percentage
Leases."

This unaudited Pro Forma Condensed Statement of Operations is not necessarily
indicative of what the actual results of operations would have been for the
year ended January 1, 1995, assuming the Spin Off and the related debt
repayments, the acquisition of certain properties and management contracts and
the execution of the Percentage Leases had been consummated at the beginning of
the period presented, nor does it purport to represent the future operations of
KMC. Capitalized terms not defined herein are used as defined elsewhere in this
Prospectus of which these unaudited financial statements are a part.

F-27

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

OPERATIONS ACQUISITION OF
PRO FORMA OF PROPERTIES CANYON SPRINGS PRO FORMA
HISTORICAL OPERATIONS TO BE HISTORICAL PRIOR TO PARK AND BUTTE CONDENSED
KAHLER RETAINED BY KMC ACQUISITION HOTELS PRO FORMA CONSOLIDATED
(A) REALTY (B) (C) (D) ADJUSTMENTS KMC
---------- ---------------- ---------- ------------- -------------- ----------- ------------

LODGING SEGMENT
Lodging--rooms......... (a) $54,108 $(3,993) $50,115 $3,514 $1,646 $ -- $55,275
--food & beverage... (b) 29,339 (2,732) 26,607 2,031 1,231 -- 29,869
--other............. (c) 9,796 (383) 9,413 267 138 303 (E) 10,121
Interest income........ (d) 773 (636) 137 -- -- -- 137
Equity income (loss) of
affiliates............ (e) 193 (507) (314) -- (152) 188 (F) (278)
------- ------- ------- ------ ------ -------- -------
Total Lodging revenue.. 94,209 (8,251) 85,958 5,812 2,863 491 95,124
Percentage lease
expense............... -- -- -- 261 976 23,117 (G) 24,354
Lodging expenses....... (f) 70,797 (8,949) 61,848 4,429 1,901 -- 68,178
------- ------- ------- ------ ------ -------- -------
Lodging income before
interest,
depreciation, and
corporate expenses.... 23,412 698 24,110 1,122 (14) (22,626) 2,592
------- ------- ------- ------ ------ -------- -------
LAUNDRY SEGMENT
Laundry revenue........ (g) 6,304 -- 6,304 -- -- -- 6,304
Laundry expenses....... (h) 5,957 -- 5,957 -- -- -- 5,957
------- ------- ------- ------ ------ -------- -------
Laundry income before
interest,
depreciation, and
corporate expenses.... 347 -- 347 -- -- -- 347
------- ------- ------- ------ ------ -------- -------
FORMAL WEAR SEGMENT
Formal Wear revenue.... (i) 8,924 -- 8,924 -- -- -- 8,924
Formal Wear expenses... (j) 6,975 -- 6,975 -- -- -- 6,975
------- ------- ------- ------ ------ -------- -------
Formal Wear income
before interest,
depreciation, and
corporate expenses.... 1,949 -- 1,949 -- -- -- 1,949
------- ------- ------- ------ ------ -------- -------
Other income before
interest,
depreciation, and
corporate expenses.... (k) 111 (25) 86 -- -- -- 86
------- ------- ------- ------ ------ -------- -------
Total income before
corporate expense,
interest, and
depreciation.......... 25,819 673 26,492 1,122 (14) (22,626) 4,974
Corporate expenses..... (l) (3,257) 475 (H) (2,782) -- -- -- (2,782)
Interest expense....... (m) (11,207) 9,917 (1,290) (4) -- -- (1,294)
Depreciation and
amortization.......... (n) (8,477) 5,284 (3,193) (112) -- -- (3,305)
Non-recurring charges.. (o) (1,811) 1,811 -- -- -- -- --
Gain (Loss) on sale of
assets................ (p) 20 (25) (5) -- -- 5 --
------- ------- ------- ------ ------ -------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES.......... $ 1,087 $18,135 $19,222 $1,006 $ (14) (22,621) (2,407)
======= ======= ======= ====== ======
Provision for income
tax................... -- (I) --
-------- -------
NET LOSS............... $(22,621) $(2,407)
======== =======
Primary and fully
diluted income per
common share before
extraordinary item.... $ (5.02)(J)
=======

F-28

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms.................................. $ 54,108 (a)
--food and beverage............................... 29,339 (b)
--other........................................... 9,796 (c)
Formal wear, laundry & other
--laundry......................................... 6,304 (g)
--formal wear..................................... 8,924 (i)
--other........................................... 666 (k)
--------
15,894
--------
Interest income................................. 773 (d)
--------
Total revenue of owned operations............. 109,910
--------
OPERATING COSTS AND EXPENSES
Lodging--rooms 13,523
--food and beverage............................... 23,221
--other........................................... 34,053
--------
70,797 (f)
--------
Formal wear, laundry & other
--laundry......................................... 5,957 (h)
--formal wear..................................... 6,975 (j)
--other........................................... 555 (k)
--------
13,487
--------
Corporate expenses.............................. 3,257 (l)
Depreciation and amortization................... 8,477 (n)
Non-recurring charges........................... 1,811 (o)
--------
Total operating costs and expenses............ 97,829
--------
GROSS OPERATING PROFIT............................ 12,081
Interest expense................................ (11,207)(m)
Equity earnings of affiliates................... 193 (e)
Gain on sale of assets.......................... 20 (p)
--------
INCOME FROM OPERATIONS BEFORE INCOME TAXES........ $ 1,087
========

- --------

References (a)-(p) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of KMC.

F-29

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE YEAR ENDED JANUARY 1, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(B) The "Pro Forma Historical KMC" column represents the operations of
Historical Kahler which will be transferred to KMC upon completion of the
Spin Off, including revenues and certain operating expenses related to
Hotels that are to be leased to and operated by KMC.

(C) These adjustments relate to operations of the Green Oaks Inn and Conference
Center and Pocatello Park Quality Inn and income on the Red Fox Inn
management contract, which were acquired subsequent to January 2, 1994, to
include operations and management fee income related to these properties
and Percentage Lease payments for Pocatello Park for the period of time
from January 3, 1994 through their respective dates of acquisition.

(D) This column reflects the historical revenues and certain operating expenses
(including estimated Percentage Lease payments) of the Canyon Springs Park
Hotel, which was acquired by Realty on August 1, 1995. Also included is
management fee income and equity losses for the Butte Hotel, which is under
contract to be acquired by Historical Kahler.

(E) This pro forma adjustment represents management fees to be paid to KMC by
Realty pursuant to the University Park Hotel management agreement.

(F) This pro forma adjustment represents KMC's share of equity earnings (loss)
in the University Park Hotel and the Plaza One Hotel.

(G) This adjustment represents estimated lease payments calculated on a pro
forma basis using the provisions contemplated in the Percentage Leases and
historical revenues of the Hotels which will be leased to KMC pursuant to
Percentage Leases.

The following table reflects the revenues associated with the Hotels for
which Percentage Leases will be entered into. The information reflects
revenues for each of the last three fiscal years or commencing from the
date of acquisition in the case of any Hotel acquired by Historical Kahler
during the last three fiscal years. Of the leased Hotels, Boise Park Suites
Hotel was acquired in January 1992, and the Olympia Park Hotel in October
1992, and the Pocatello Park Quality Inn in March 1994. The Canyon Springs
Park Hotel, which was acquired on August 1, 1995, is not included in the
table below.

1992 1993 1994
------- ------- -------

Room revenue..................................... $42,799 $43,923 $51,114
Food & beverage revenue.......................... 24,888 25,114 28,601
Percentage leases................................ 19,187 19,897 23,117

(H) This adjustment represents the transfer of corporate expenses that will be
the responsibility of Realty.

(I) There is no adjustment for estimated federal and state taxes for there is
no expected benefit to be obtained from the operating loss.

(J) Pro forma primary and fully diluted net loss per share before extraordinary
item assumes the conversion of all outstanding exercisable options as of
the date of the offering and is based upon 479,177 shares of KMC Common
Stock outstanding during the period.

F-30

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of KMC
is presented as if (i) the Spin Off had occurred on July 4, 1994, (ii) the
Offering and the application of the net proceeds therefrom to repay certain
outstanding indebtedness had occurred on July 4, 1994, (iii) the acquisition of
certain properties acquired subsequent to July 4, 1994, including the Canyon
Springs Park Hotel and Butte Hotel, had occurred on July 4, 1994, and (iv) the
Percentage Leases were executed and in effect as of the beginning of the period
presented. This unaudited Pro Forma Condensed Consolidated Statement of
Operations should be read in conjunction with the Consolidated Financial
Statements of Historical Kahler and its subsidiaries and the notes thereto
included elsewhere in this Prospectus. In management's opinion, all adjustments
considered necessary to reflect the effects of the Spin Off and the application
of the net proceeds of the Offering and the Percentage Leases have been made.
Reference is made to "The Spin Off" and "Certain Agreements--The Percentage
Leases."

This unaudited Pro Forma Condensed Statement of Operations is not necessarily
indicative of what the actual results of operations would have been for the 12
months ended July 2, 1995, assuming the Spin Off and the related debt
repayments, the acquisition of certain properties and management contracts and
the execution of the Percentage Leases had been consummated at the beginning of
the period presented, nor does it purport to represent the future operations of
KMC. Capitalized terms not defined herein are used as defined elsewhere in this
Prospectus of which these unaudited financial statements are a part.

F-31

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

LODGING SEGMENT
Lodging--rooms........ (a) $57,515 $(4,132) $53,383 $1,570 $1,720 $ -- $56,673
--food & beverage... (b) 30,919 (2,794) 28,125 851 1,296 -- 30,272
--other............. (c) 10,468 (389) 10,079 129 144 289 (E) 10,641
Interest income....... (d) 714 (570) 144 -- -- -- 144
Equity income (loss)
of affiliates........ (e) 386 (574) (188) -- (201) 97 (F) (292)
------- ------- ------- ------ ------ -------- -------
Total Lodging revenue. 100,002 (8,459) 91,543 2,550 2,959 386 97,438
Percentage leases..... -- -- -- -- 1,029 24,088 (G) 25,117
Lodging expenses...... (f) 74,860 (9,266) 65,594 1,946 2,002 -- 69,542
------- ------- ------- ------ ------ -------- -------
Lodging income before
interest,
depreciation, and
corporate expenses... 25,142 807 25,949 604 (72) (23,702) 2,779
------- ------- ------- ------ ------ -------- -------
LAUNDRY SEGMENT
Laundry revenue....... (g) 6,052 -- 6,052 -- -- -- 6,052
Laundry expenses...... (h) 5,206 -- 5,206 -- -- -- 5,206
------- ------- ------- ------ ------ -------- -------
Laundry income before
interest,
depreciation, and
corporate expenses... 846 -- 846 -- -- -- 846
------- ------- ------- ------ ------ -------- -------
FORMAL WEAR SEGMENT
Formal Wear revenue... (i) 9,117 -- 9,117 -- -- -- 9,117
Formal Wear expenses.. (j) 7,207 -- 7,207 -- -- -- 7,207
------- ------- ------- ------ ------ -------- -------
Formal Wear income
before interest,
depreciation, and
corporate expenses... 1,910 -- 1,910 -- -- -- 1,910
------- ------- ------- ------ ------ -------- -------
Other income before
interest,
depreciation, and
corporate expenses... (k) 98 (25) 73 -- -- -- 73
------- ------- ------- ------ ------ -------- -------
Total income before
corporate expense,
interest, and
depreciation......... 27,996 782 28,778 604 (72) (23,702) 5,608
Corporate expenses.... (l) (3,477) 475 (H) (3,002) -- -- -- (3,002)
Interest expense...... (m) (12,019) 10,684 (1,335) (2) -- -- (1,337)
Depreciation and
amortization......... (n) (8,617) 5,373 (3,244) (48) -- -- (3,292)
Non-recurring......... (o) (1,811) 1,811 -- -- -- -- --
Gain (Loss) on sale of
assets............... (p) (22) (19) (41) -- -- 41 --
------- ------- ------- ------ ------ -------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES......... $ 2,050 $19,106 $21,156 $ 554 $ (72) (23,661) (2,023)
======= ======= ======= ====== ======
Provision for income
tax.................. -- (I) --
-------- -------
NET LOSS.............. $(23,661) $(2,023)
======== =======
Primary and fully
diluted income per
common share before
extraordinary item... $ (4.22)(J)
=======

F-32

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms.................................. $57,515 (a)
--food and beverage............................. 30,919 (b)
--other......................................... 10,468 (c)
Formal wear, laundry & other
--laundry....................................... 6,052 (g)
--formal wear................................... 9,117 (i)
--other......................................... 646 (k)
-------
15,815
-------
Interest income................................. 714 (d)
-------
Total revenue of owned operations............. 115,431
-------
OPERATING COSTS AND EXPENSES
Lodging--rooms.................................. 14,318
--food and beverage............................. 24,441
--other......................................... 36,101
-------
74,860 (f)
-------
Formal wear, laundry & other
--laundry....................................... 5,206 (h)
--formal wear................................... 7,207 (j)
--other......................................... 548 (k)
-------
12,961
-------
Corporate expenses.............................. 3,477 (l)
Depreciation and amortization................... 8,617 (n)
Non-recurring charges........................... 1,811 (o)
-------
Total operating costs and expenses............ 101,726
-------
GROSS OPERATING PROFIT............................ 13,705
Interest expense (12,019)(m)
Equity earnings of affiliates................... 386 (e)
Gain on sale of assets.......................... (22)(p)
-------
INCOME FROM OPERATIONS BEFORE INCOME TAXES........ $ 2,050
=======

- --------

References (a)-(p) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of KMC.

F-33

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE 12 MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(C) These adjustments relate to the operations of the Green Oaks Inn and
Conference Center and income on the Red Fox Inn management contract, which
were acquired subsequent to July 3, 1994, to include operations and
management fee income related to these properties for the period of time
from July 4, 1994 through their respective dates of acquisition.

(D) This column reflects the historical revenues and certain operating expenses
(including estimated Percentage Lease payments) of the Canyon Springs Park
Hotel, which was acquired on August 1, 1995. Also included is management
fee income and equity losses for the Butte Hotel, which is under contract
to be acquired by Historical Kahler.

(E) This pro forma adjustment represents management fees to be paid to KMC by
Realty pursuant to the University Park Hotel management agreement.

(F) This pro forma adjustment represents KMC's share of equity earnings (loss)
in the University Park Hotel and the Plaza One Hotel.

Revenues of the leased Hotels for the 12 months ended July 2, 1995 are
presented below. The Canyon Springs Park Hotel was acquired on August 1,
1995 and is not included in the information presented.

Room revenue..................... $52,632
Food and beverage revenue........ 29,310
Percentage leases................ 24,088

(H) This adjustment represents the transfer of corporate expenses that will be
the responsibility of Realty.

(I) There is no adjustment for estimated federal and state taxes for there is
no expected benefit to be obtained from the operating loss.

(J) Pro forma net loss per share before extraordinary item assumes the
conversion of all outstanding exercisable options as of the date of the
offering and is based upon 479,177 shares of KMC Common Stock outstanding
during the period.

F-34

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

The unaudited Pro Forma Condensed Consolidated Statement of Operations of KMC
is presented as if (i) the Spin Off had occurred on January 2, 1995, (ii) the
Offering and the application of the net proceeds therefrom to repay certain
outstanding indebtedness had occurred on January 2, 1995, (iii) the acquisition
of the Canyon Springs Park Hotel and Butte Hotel had occurred on January 2,
1995, and (iv) the Percentage Leases were executed and in effect as of the
beginning of the period presented. This unaudited Pro Forma Condensed
Consolidated Statement of Operations should be read in conjunction with the
Consolidated Financial Statements of Historical Kahler and its subsidiaries and
the notes thereto included elsewhere in this Prospectus. In management's
opinion, all adjustments considered necessary to reflect the effects of the
Spin Off and the application of the net proceeds of the Offering and the
Percentage Leases have been made. Reference is made to "The Spin Off" and
"Certain Agreements--The Percentage Leases."

This unaudited Pro Forma Condensed Statement of Operations is not necessarily
indicative of what the actual results of operations would have been for the six
months ended July 2, 1995, assuming the Spin Off and the related debt
repayments, the acquisition of certain properties and management contracts and
the execution of the Percentage Leases had been consummated at the beginning of
the period presented, nor does it purport to represent the future operations of
KMC. Capitalized terms not defined herein are used as defined elsewhere in this
Prospectus of which these unaudited financial statements are a part.

F-35

KAHLER MANAGEMENT CORPORATION (KMC)

PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

ACQUISITION
OF CANYON
SPRINGS
PRO FORMA PARK AND PRO FORMA
HISTORICAL OPERATIONS TO BE HISTORICAL BUTTE CONDENSED
KAHLER RETAINED BY KMC HOTELS PRO FORMA CONSOLIDATED
(A) REALTY (B) (C) ADJUSTMENTS KMC
---------- ---------------- ---------- ----------- ----------- ------------

LODGING SEGMENT
Lodging--rooms.......... (a) $31,308 $(2,243) $29,065 $ 860 $ -- $29,925
--food & beverage.... (b) 16,081 (1,447) 14,634 635 -- 15,269
--other.............. (c) 5,888 (196) 5,692 76 194 (D) 5,962
Interest income......... (d) 224 (157) 67 -- -- 67
Equity income (loss) of
affiliates............. (e) 291 (315) (24) (44) 25 (E) (43)
------- ------- ------- ----- -------- -------
Total Lodging revenue... 53,792 (4,358) 49,434 1,527 219 51,180
Percentage lease
expense................ -- -- -- 513 13,002 (F) 13,515
Lodging expenses........ (f) 39,516 (4,859) 34,657 977 -- 35,634
------- ------- ------- ----- -------- -------
Lodging income before
interest, depreciation,
and corporate expenses. 14,276 501 14,777 37 (12,783) 2,031
------- ------- ------- ----- -------- -------
LAUNDRY SEGMENT
Laundry revenue......... (g) 3,057 -- 3,057 -- -- 3,057
Laundry expenses........ (h) 2,469 -- 2,469 -- -- 2,469
------- ------- ------- ----- -------- -------
Laundry income before
interest, depreciation,
and corporate expenses. 588 -- 588 -- -- 588
------- ------- ------- ----- -------- -------
FORMAL WEAR SEGMENT
Formal Wear revenue..... (i) 5,002 -- 5,002 -- -- 5,002
Formal Wear expenses.... (j) 3,936 -- 3,936 -- -- 3,936
------- ------- ------- ----- -------- -------
Formal Wear income
before interest,
depreciation, and
corporate expenses..... 1,066 -- 1,066 -- -- 1,066
------- ------- ------- ----- -------- -------
Other income before
interest, depreciation,
and corporate expenses. (k) 43 (13) 30 -- -- 30
------- ------- ------- ----- -------- -------
Total income before
corporate expense,
interest, and
depreciation........... 15,973 488 16,461 37 (12,783) 3,715
Corporate expenses...... (l) (1,914) 238 (G) (1,676) -- -- (1,676)
Interest expense........ (m) (6,060) 5,388 (672) -- -- (672)
Depreciation and
amortization........... (n) (4,438) 2,729 (1,709) -- -- (1,709)
Gain (Loss) on sale of
assets................. (p) (31) (1) (32) -- 32 --
------- ------- ------- ----- -------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE
INCOME TAXES........... $ 3,530 $ 8,842 $12,372 $ 37 (12,751) (342)
======= ======= ======= =====
Provision for income
tax.................... -- (H) --
-------- -------
NET LOSS................ $(12,751) $ (342)
======== =======
Primary and fully
diluted income per
common share before
extraordinary item..... $ (.71)(I)
=======

F-36

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(A) The "Historical Kahler" column represents the historical consolidated
statement of operations of Kahler Realty Corporation for the first three
months ended July 2, 1995, without giving effect to the Spin Off,
reformatted by segment as follows:

CONSOLIDATED
STATEMENT OF OPERATIONS
OF HISTORICAL KAHLER
-----------------------

REVENUE OF OWNED OPERATIONS
Lodging--rooms.................................. $31,308 (a)
--food and beverage............................. 16,081 (b)
--other......................................... 5,888 (c)
Formal wear, laundry & other
--laundry....................................... 3,057 (g)
--formal wear................................... 5,002 (i)
--other......................................... 306 (k)
-------
8,365
-------
Interest income................................. 224 (d)
-------
Total revenue of owned operations............. 61,866
-------
OPERATING COSTS AND EXPENSES
Lodging--rooms.................................. 7,588
--food and beverage............................. 12,762
--other......................................... 19,166
-------
39,516 (f)
-------
Formal wear, laundry & other
--laundry....................................... 2,469 (h)
--formal wear................................... 3,936 (j)
--other......................................... 263 (k)
-------
6,668
-------
Corporate expenses.............................. 1,914 (l)
Depreciation and amortization................... 4,438 (n)
-------
Total operating costs and expenses............ 52,536
-------
GROSS OPERATING PROFIT............................ 9,330
Interest expense................................ (6,060)(m)
Equity earnings of affiliates................... 291 (e)
Gain on sale of assets.......................... (31)(p)
-------
INCOME FROM OPERATIONS BEFORE INCOME TAXES........ $ 3,530
=======

- --------

References (a)-(p) refer to the reformatted totals by segment in the
accompanying Pro Forma Condensed Consolidated Statement of Operations of KMC.

F-37

KAHLER MANAGEMENT CORPORATION (KMC)

NOTES TO PRO FORMA CONDENSED CONSOLIDATED

STATEMENT OF OPERATIONS--(CONTINUED)

FOR THE FIRST SIX MONTHS ENDED JULY 2, 1995

(UNAUDITED)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(C) This column reflects the historical revenues and certain operating expenses
(including estimated Percentage Lease payments) of the Canyon Springs Park
Hotel which was acquired by Realty on August 1, 1995. Also included is
management fee income and equity losses for the Butte Hotel, which is under
contract to be acquired by Historical Kahler.

(D) This pro forma adjustment represents management fees to be paid to KMC by
Realty pursuant to the University Park Hotel management agreement.

(E) This pro forma adjustment represents KMC's share of equity earnings (loss)
in the University Park Hotel and the Plaza One Hotel.

(F) This adjustment represents estimated lease payments calculated on a pro
forma basis using the provisions contemplated in the Percentage Leases and
historical revenues of the Hotels which will be leased to KMC pursuant to
Percentage Leases.

Revenues of the leased Hotels for the six months ended July 2, 1995 are
presented below. The Canyon Springs Park Hotel, which was acquired on
August 1, 1995 is not included in the information presented.

Room revenue..................... $27,854
Food and beverage revenue........ 14,828
Percentage lease revenue......... 13,002

(G) This adjustment represents the transfer of corporate expenses that will be
the responsibility of Realty.

(H) There is no adjustment for estimated federal and state taxes for there is
no expected benefit to be obtained from the first six months' operating
loss.

(I) Pro forma loss per share before extraordinary item assumes the conversion
of all outstanding exercisable options as of the date of the offering and
is based upon 479,177 shares of KMC Common Stock outstanding during the
period.

F-38

III. KAHLER REALTY CORPORATION (HISTORICAL KAHLER)

F-39

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders

Kahler Realty Corporation and Subsidiaries:

We have audited the accompanying consolidated balance sheet of Kahler Realty
Corporation and Subsidiaries as of January 1, 1995 and January 2, 1994, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the years then ended. These consolidated 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. The consolidated
financial statements of Kahler Realty Corporation and Subsidiaries as of and
for the year ended January 3, 1993 were audited by other auditors whose report
thereon dated February 19, 1993, (except for Note 13 as to which the date was
November 12, 1993) expressed an unqualified opinion, including explanatory
paragraphs, on those consolidated statements.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Kahler
Realty Corporation and Subsidiaries as of January 1, 1995 and January 2, 1994,
and the results of their operations and their cash flows for the years then
ended in conformity with generally accepted accounting principles.

KPMG Peat Marwick LLP

Chicago, Illinois

February 17, 1995

F-40

INDEPENDENT AUDITORS' REPORT

To the Stockholders and Directors

Kahler Realty Corporation:

We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows for the year ended January 3, 1993 of
Kahler Realty Corporation (formerly Kahler Corporation) and Subsidiaries (the
Company). These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.

In our opinion, such consolidated statements of operations, stockholders'
equity, and cash flows present fairly, in all material respects, the results of
operations and cash flows of Kahler Realty Corporation and Subsidiaries for the
year ended January 3, 1993 in conformity with generally accepted accounting
principles.

Deloitte & Touche LLP

Minneapolis, Minnesota

February 19, 1993

(Except for Note 13, as to which the date is November 12, 1993)

F-41

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS)

JANUARY JANUARY JULY 2,
2, 1994 1, 1995 1995
-------- -------- -----------
(UNAUDITED)

ASSETS
CURRENT ASSETS
Cash........................................... $ 984 $ 1,110 $ 1,324
Receivables:
Trade, less allowance for doubtful accounts
of $214, $252, and $239, respectively (Note
10)......................................... 4,371 5,333 6,173
Current portion of notes receivable.......... 300 150 150
Inventories.................................... 2,354 2,498 2,557
Prepaid expenses............................... 233 265 446
-------- -------- --------
Total current assets......................... 8,242 9,356 10,650
-------- -------- --------
OTHER ASSETS
Notes receivable, primarily from affiliates
(Note 2)...................................... 4,828 1,423 1,393
Investment in and advances to affiliates (Note
4)............................................ 3,460 3,279 3,425
Debt service reserve fund...................... 750 750 750
Intangibles (Note 1)........................... 518 791 736
Other.......................................... 1,865 1,823 2,069
-------- -------- --------
Total other assets........................... 11,421 8,066 8,373
-------- -------- --------
PROPERTY AND EQUIPMENT
Land and improvements.......................... 15,225 16,349 16,349
Buildings...................................... 130,240 136,967 136,967
Equipment...................................... 46,312 46,977 48,232
Formal wear apparel............................ 5,096 4,735 5,763
-------- -------- --------
Total...................................... 196,873 205,028 207,311
Less accumulated depreciation.............. 54,130 54,281 58,521
-------- -------- --------
142,743 150,747 148,790
Construction in progress................... -- -- 811
-------- -------- --------
Total property and equipment............... 142,743 150,747 149,601
-------- -------- --------
TOTAL ASSETS............................... $162,406 $168,169 $168,624
======== ======== ========

See Notes to Consolidated Financial Statements

F-42

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

JANUARY 2, JANUARY 1, JULY 2,
1994 1995 1995
---------- ---------- -----------
(UNAUDITED)

LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable (Note 10)................. $ 7,066 $ 8,559 $ 7,727
Accrued liabilities:
Payroll and payroll related liabilities.. 2,543 2,473 3,092
Real estate taxes........................ 2,011 1,996 2,214
Other taxes.............................. 736 806 1,309
Notes payable (Note 5)..................... 2,450 5,300 4,100
Current portion of long-term debt.......... 3,212 2,767 2,912
Current portion of subordinated debt due to
affiliate................................. -- 500 500
-------- -------- --------
Total current liabilities.............. 18,018 22,401 21,854
-------- -------- --------
LONG-TERM DEBT (Note 5)
Obligations of Kahler Realty Corporation... 93,727 94,942 94,300
Obligations of Subsidiaries--Nonrecourse to
Kahler Realty Corporation................. 27,046 26,517 26,265
-------- -------- --------
Total long-term debt................... 120,773 121,459 120,565
-------- -------- --------
OTHER DEFERRED LIABILITIES
Deferred revenue........................... 714 137 134
Other...................................... 1,268 1,401 1,392
-------- -------- --------
Total other deferred liabilities....... 1,982 1,538 1,526
-------- -------- --------
COMMITMENTS AND CONTINGENCIES (Note 8)
SUBORDINATED DEBT DUE TO AFFILIATE (Note 7).. 2,000 1,500 1,000
-------- -------- --------
REDEEMABLE CONVERTIBLE PREFERRED STOCK (Note
6).......................................... 3,267 -- --
-------- -------- --------
Authorized--10,000,000 shares, Issued and
outstanding 141,828 shares, Redemption
amount $3,546, January 2, 1994............
STOCKHOLDERS' EQUITY (Note 7)................
Common stock, par value $.10...............
Authorized--70,000,000 shares; Issued and
outstanding--3,425,798, 4,167,598 and
4,211,031, respectively................. 343 417 421
Additional paid-in capital................. 8,450 13,030 13,250
Retained earnings.......................... 7,800 7,991 10,175
Minimum pension liability adjustment (Note
9)........................................ (227) (167) (167)
-------- -------- --------
Total stockholders' equity............. 16,366 21,271 23,679
-------- -------- --------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY................................ $162,406 $168,169 $168,624
======== ======== ========

See Notes to Consolidated Financial Statements

F-43

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

SIX MONTHS
FOR YEARS ENDED ENDED
-------------------------------- ----------------
JULY JULY
JANUARY 3, JANUARY 2, JANUARY 1, 3, 2,
1993 1994 1995 1994 1995
---------- ---------- ---------- ------- -------
(UNAUDITED)

REVENUES
Revenue of owned
operations............... $ 74,014 $ 96,979 $109,910 $56,345 $61,866
Other properties managed
and/or partially owned... 29,237 17,910 17,490 8,576 8,362
-------- -------- -------- ------- -------
Total revenues.......... $103,251 $114,889 $127,400 $64,921 $70,228
======== ======== ======== ======= =======
REVENUE OF OWNED OPERATIONS
Lodging--rooms............ $ 33,314 $ 46,026 $ 54,108 $27,901 $31,308
--food and beverage....... 17,374 25,185 29,339 14,501 16,081
--other................... 7,720 9,294 9,796 5,216 5,888
Formal wear, laundry &
other.................... 14,182 15,277 15,894 8,444 8,365
Interest income........... 1,424 1,197 773 283 224
-------- -------- -------- ------- -------
Total revenue of owned
operations............. 74,014 96,979 109,910 56,345 61,866
-------- -------- -------- ------- -------
OPERATING COSTS AND EXPENSES
Lodging--rooms............ 8,272 11,388 13,523 6,793 7,588
--food and beverage....... 14,445 19,801 23,221 11,542 12,762
--other................... 22,336 29,785 34,053 17,118 19,166
Formal wear, laundry &
other.................... 12,092 12,621 13,487 7,194 6,668
Corporate expenses........ 3,225 3,272 3,257 1,694 1,914
Depreciation and
amortization (Note 10)... 6,492 7,904 8,477 4,298 4,438
Non-recurring charges
(Note 10)................ 2,758 -- 1,811 -- --
-------- -------- -------- ------- -------
Total operating costs
and expenses........... 69,620 84,771 97,829 48,639 52,536
-------- -------- -------- ------- -------
GROSS OPERATING PROFIT...... 4,394 12,208 12,081 7,706 9,330
Interest expense.......... (7,303) (9,362) (11,207) (5,248) (6,060)
Equity earnings (loss) of
affiliates............... (688) 27 193 98 291
Gain (Loss) on sale of
assets................... (693) 6 20 11 (31)
-------- -------- -------- ------- -------
INCOME (LOSS) FROM
OPERATIONS BEFORE INCOME
TAXES...................... (4,290) 2,879 1,087 2,567 3,530
Provision (Credit) for
income taxes............. (300) 875 323 770 1,094
-------- -------- -------- ------- -------
Income (Loss) before
extraordinary item and
change in accounting
principle................ (3,990) 2,004 764 1,797 2,436
Extraordinary item net of
income taxes (Note 10)... 2,517 -- -- -- --
Cumulative effect of
change in accounting for
nonpension postretirement
benefits (Note 9)........ (250) -- -- -- --
-------- -------- -------- ------- -------
NET INCOME (LOSS)........... $ (1,723) $ 2,004 $ 764 $ 1,797 $ 2,436
======== ======== ======== ======= =======
PER COMMON SHARE DATA
Primary income (loss) per
common share............... $ (.59) $ .49 $ .14 $ .43 $ .57
======== ======== ======== ======= =======
Fully diluted income (loss)
per common share........... $ ( .59) $ .46 $ .14 $ .43 $ .57
======== ======== ======== ======= =======

See Notes to Consolidated Financial Statements

F-44

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

SIX MONTHS
FOR YEARS ENDED ENDED
-------------------------------- ----------------
JANUARY 3, JANUARY 2, JANUARY 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
---------- ---------- ---------- ------- -------
(UNAUDITED)

OPERATIONS:
Net income (loss)......... $(1,723) $ 2,004 $ 764 $ 1,797 $ 2,436
Adjustments to reconcile
net income (loss) to net
cash provided by
operating activities:
Depreciation and
amortization........... 6,492 7,904 8,477 4,298 4,438
Common stock issued
under employee benefit
plans.................. 263 130 6 3 105
Equity in (earnings)
loss of affiliates..... 688 (27) (193) (98) (291)
(Gain) Loss on sale of
assets................. 693 (6) (20) (11) (31)
Writedown of hotel
property............... 1,200 -- -- -- --
Gain on debt
extinguishment......... (2,795) -- -- -- --
Change in current assets
and current liabilities:
Receivables............. (490) (533) (962) (1,034) (840)
Inventories............. (100) (115) (144) (92) (59)
Prepaid expenses........ 123 57 (32) (271) (181)
Accounts payable........ 809 74 1,493 (304) (832)
Accrued liabilities..... (733) 929 (15) 1,304 1,340
------- -------- -------- ------- -------
Net cash provided by
operating activities. 4,427 10,417 9,374 5,592 6,085
------- -------- -------- ------- -------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Payments for property and
equipment................ (11,583) (12,190) (13,523) (8,682) (3,163)
Proceeds from sale of
property and equipment... 19 146 125 14 35
Payments received on notes
receivable............... 2,418 614 250 105 30
Additions to notes
receivable............... (465) -- -- -- --
Investment in and advances
to affiliates............ (430) (3,365) -- -- (42)
Payments received from
affiliates............... 918 330 374 187 187
Payments for intangible
assets................... (272) (15) (374) (37) (2)
Increase in other assets.. (402) (205) (108) (1,037) (322)
------- -------- -------- ------- -------
Net cash used in
investment
activities........... (9,797) (14,685) (13,256) (9,450) (3,277)
------- -------- -------- ------- -------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Dividends paid to
preferred shareholders... (319) (319) (224) (159) --
Dividends paid to common
shareholders............. -- (205) (349) (142) (252)
Proceeds from issuance of
common stock............. 65 119 1,352 420 119
Purchase of common stock.. -- (62) -- -- --
Proceeds from issuance of
subordinated debt........ 2,000 -- -- -- --
Proceeds from new long-
term debt and notes
payable.................. 13,178 11,864 3,833 3,700 227
Principal payments on
long-term debt........... (9,210) (3,087) (3,592) (1,159) (976)
Principal payments on
subordinated debt........ -- -- -- -- (500)
Net borrowings (payments)
under line-of-credit
agreements and short-term
notes payable............ (150) (3,500) 2,850 1,700 (1,200)
Unrecognized gain(loss) on
defined benefit pension
plan..................... (5) (168) 60 -- --
Increase (Decrease) in
other liabilities........ 416 (193) 78 (174) (12)
------- -------- -------- ------- -------
Net cash provided by
financing activities. 5,975 4,449 4,008 4,186 (2,594)
------- -------- -------- ------- -------
INCREASE IN CASH............ 605 181 126 328 214
CASH AT BEGINNING OF THE
PERIOD..................... 198 803 984 984 1,110
------- -------- -------- ------- -------
CASH AT END OF THE PERIOD... $ 803 $ 984 $ 1,110 $ 1,312 $ 1,324
======= ======== ======== ======= =======

See Notes to Consolidated Financial Statements

F-45

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995

AND SIX MONTHS ENDED JULY 2, 1995

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

COMMON STOCK MINIMUM
----------------- ADDITIONAL PENSION
NUMBER PAID-IN RETAINED LIABILITY
OF SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT TOTAL
--------- ------ ---------- -------- ---------- -------

BALANCE, December 29,
1991................... 3,278,226 $328 $ 7,950 $ 8,362 $ (54) $16,586
Net Loss.............. (1,723) (1,723)
Dividends paid to
preferred
shareholders......... (319) (319)
Unrecognized loss on
defined benefit
pension plan......... (5) (5)
Common stock issued... 82,876 8 320 328
--------- ---- ------- ------- ----- -------
BALANCE, January 3,
1993................... 3,361,102 336 8,270 6,320 (59) 14,867
Net Income............ 2,004 2,004
Dividends paid to
preferred
shareholders......... (319) (319)
Dividends paid to
common shareholders
($0.06 per share).... (205) (205)
Unrecognized loss on
defined benefit
pension plan......... (168) (168)
Common stock issued... 75,608 8 241 249
Purchase of common
stock................ (10,912) (1) (61) (62)
--------- ---- ------- ------- ----- -------
BALANCE, January 2,
1994................... 3,425,798 343 8,450 7,800 (227) 16,366
Net income............ 764 764
Dividends paid to
preferred
shareholders......... (224) (224)
Dividends paid to
common shareholders
($0.09 per share).... (349) (349)
Unrecognized gain on
defined benefit
pension plan......... 60 60
Common stock issued
(Note 6)............. 741,800 74 4,580 4,654
--------- ---- ------- ------- ----- -------
BALANCE, January 1,
1995................... 4,167,598 417 13,030 7,991 (167) 21,271
Net income............ 2,436 2,436
Dividends paid to
common shareholders
($0.06 per share).... (252) (252)
Common stock issued... 43,433 4 220 224
--------- ---- ------- ------- ----- -------
BALANCE, July 2, 1995
(unaudited)............ 4,211,031 $421 $13,250 $10,175 $(167) $23,679
========= ==== ======= ======= ===== =======

See Notes to Consolidated Financial Statements

F-46

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Description of business

Kahler Realty Corporation was incorporated under the Minnesota Business
Corporation Act on May 18, 1994, as a wholly owned subsidiary of Kahler
Corporation. On October 11, 1994, Kahler Corporation was merged into Kahler
Realty Corporation, and each outstanding share of Kahler Corporation common
stock was converted into one share of Kahler Realty Corporation common stock.
Kahler Realty Corporation has continued Kahler Corporation's business
activities which principally consist of the operation and management of hotel
properties. Kahler Realty Corporation also operates commercial laundries in
Rochester and Salt Lake City which provide services to its hotels as well as
outside accounts. Kahler Realty Corporation's other business activities include
operating a wholesale and retail formal wear business. Kahler Realty
Corporation and Kahler Corporation are collectively referred to as Historical
Kahler in the accompanying consolidated financial statements and notes thereto.

Principles of consolidation

The consolidated financial statements include the accounts of Historical
Kahler and its wholly-owned subsidiaries. Investments of 50% or less in owned
affiliates in which Historical Kahler possesses significant influence are
accounted for under the equity method. In 1990, Historical Kahler entered into
a transaction in which it transferred title of the University Park Hotel to an
investor in exchange for a $4,620, 9% mortgage note with an option to convert
the note into a 60% equity interest in the hotel in 1998. Historical Kahler
consolidates the assets and liabilities of the hotel which were approximately
$11,066 and $9,550 at January 2, 1994, $10,714 and $9,463 at January 1, 1995,
and $10,537 and $9,307 at July 2, 1995, respectively. All material intercompany
transactions and balances have been eliminated.

Reclassifications

The consolidated financial statements for prior years reflect certain
reclassifications to conform with classifications adopted in 1994. These
reclassifications have no effect on net income (loss) or stockholders' equity
as previously reported.

Revenues

Revenues of Historical Kahler are classified into two components. Historical
Kahler uses this presentation to show the total scope of Historical Kahler's
operations. The components of revenue are:

. Revenue of owned operations include revenues from lodging properties in
which Historical Kahler has an interest greater than 50%, management fees
generated from properties partially-owned (50% or less) and properties
owned by others. Also included are revenues from Anderson's Formal Wear,
Textile Care Services and Interest Income.

. Other properties managed and/or partially-owned includes all revenue of
properties partially-owned (50% or less) by Historical Kahler and the
properties managed for others. Under generally accepted accounting
principles, this revenue is not included in revenue of owned operations
and Historical Kahler's interest in partially-owned properties is
reflected in the Consolidated Statements of Operations as equity in
earnings (loss) of affiliates.

Cash and cash equivalents

Historical Kahler considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents.

F-47

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Inventories

Inventories are stated primarily at the lower of average cost or market.

Property and equipment

Property and equipment are recorded at cost. Depreciation of property,
equipment and formal wear apparel is computed on the straight-line method over
their estimated useful lives. Depreciation expense was $6,230, $7,588 and
$8,197 for the years 1992, 1993, and 1994, respectively, and $4,154 and $4,305
for the first six months of 1994 and 1995, respectively. Capitalized interest
of $461 has been included in property and equipment for the year ended January
2, 1994. The estimated useful lives are:

Land improvements......... 5 to 25 years
Buildings................. 20 to 50 years
Equipment................. 5 to 20 years
Formal wear apparel....... 4 years

Deferred debt expense

Deferred debt expense of $1,458, $1,309 and $1,408 at January 2, 1994,
January 1, 1995, and July 2, 1995, respectively, which is net of accumulated
amortization, is included in other assets and amortized over the life of the
respective loans.

Income taxes

Historical Kahler accounts for income taxes in accordance with the Statement
of Financial Accounting Standard (SFAS) No. 109, "Accounting for Income Taxes",
which, among other things, requires an asset and liability approach in
accounting for deferred income taxes. (See Note 11)

Intangibles

Intangibles represent the pre-opening costs, organization costs, franchise
rights and an intangible pension asset relating to Historical Kahler's defined
benefit plan. Pre-opening costs include costs during the property's break-in
period which consist of marketing, employee training and the excess of expenses
over revenues. The cost of these intangible assets are as follows:

JULY 2,
1993 1994 1995 EXPECTED LIFE
---- ---- ---------- -------------
(UNAUDITED)

Pre-opening costs........................... $163 $163 $163 3 years
Organization costs.......................... 171 132 134 5 years
Franchise rights............................ 109 139 114 8 to 20 years
---- ---- ---- -------------
443 434 411
Accumulated amortization.................... 180 210 242
---- ---- ----
263 224 169
Intangible pension asset.................... 255 567 567
---- ---- ----
$518 $791 $736
==== ==== ====

F-48

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Income (Loss) per common share

For 1993, 1994 and the first six months of 1994 and 1995, income per share is
computed on a primary share basis using the weighted average number of
outstanding common shares and equivalents (arising from employee stock plans,
deferred stock compensation and warrant) aggregating 3,525,000, 3,956,000,
3,785,000 and 4,306,000, respectively.

For 1992, loss per share is computed on a primary share basis using only the
weighted average number of outstanding common shares aggregating 3,341,000.
Common stock equivalents have been excluded since the effect was antidilutive.

Income per share is computed on a fully diluted basis using the weighted
average number of outstanding common shares plus stock equivalents aggregating
3,743,000 for 1993. In 1992, 1994 and the first six months of 1994 and 1995 the
effect is the same as on a primary share basis.

Fiscal year

Historical Kahler's fiscal year ends on the Sunday closest to December 31.

Unaudited First Six Months Statements

The consolidated financial statements and related disclosures as of July 2,
1995 and for the six months ended July 3, 1994 and July 2, 1995 are unaudited;
however, in the opinion of management, all adjustments (consisting solely of
normal recurring adjustments) necessary for a fair presentation of the
consolidated financial statements for these periods have been included. The
results for the six months ended July 2, 1995 are not necessarily indicative of
the results to be obtained for the full fiscal year.

NOTE 2. NOTES RECEIVABLE

Notes receivable, primarily from affiliates, consist of contracts for deeds,
a first mortgage and a second mortgage, bearing interest at rates ranging from
8% to 10%.

Total maturities for notes receivable for the five years following January 1,
1995, are approximately $150, $554, $94, $258 , and $31, respectively.

NOTE 3. ACQUISITIONS

In March 1994, Historical Kahler acquired the Pocatello Park Quality Inn, a
152 room hotel property in Pocatello, Idaho for $5,224. This purchase was
financed with new long-term debt of $3,700. Historical Kahler's lines of credit
and internally generated funds were utilized to finance the balance of the
purchase price. In December 1994, Historical Kahler acquired the Green Oaks Inn
and Conference Center, a 284 room hotel property in Fort Worth, Texas which it
has managed since 1990 and had owned prior to that year. At the time of
acquisition Historical Kahler held a mortgage receivable of $2,783 net of
deferred revenue of $522. Historical Kahler purchased this property for $438 in
cash, the cancellation of the mortgage receivable and related accrued interest
receivable of $136 and the assumption of negative working capital and capital

F-49

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

lease. This transaction had the following impact on Historical Kahler's 1994
Consolidated Balance Sheet at the time of acquisition:

Current liabilities............... $ 320
Long term debt.................... 16
Deferred revenue.................. (522)
-----
$(186)
=====

Current assets, excludes change
in current portion of notes
receivable...................... $ (300)
Current portion of notes
receivable...................... (165)
Notes receivable long term....... (3,140)
Property & equipment............. 3,419
-------
$ (186)
=======

In May 1993, Historical Kahler acquired its partner's 50% interest in the
Salt Lake Hilton Hotel for $100 and the assumption of a first mortgage and a
capital lease for $12,098. Historical Kahler has accounted for this transaction
as a purchase and beginning the second quarter of 1993 consolidated all
financial information. Prior to this, Historical Kahler included 50% of the
hotel's income and loss as equity in earnings and loss from affiliates on
Historical Kahler's Consolidated Statements of Operations.

Historical Kahler acquired a 63.75% interest in the Ogden Park Hotel during
the third quarter of 1993 which it has managed since September 1989. At the
time of the acquisition Historical Kahler held a note receivable of
approximately $3,501, which is net of a reserve of $632 established in 1991.
Historical Kahler purchased this interest by assuming a $9,400 tax-exempt bond
less a cash payment from previous owners of $100. In addition, the note
receivable gives Historical Kahler the option to acquire an additional 21.75%
interest in the joint venture. Historical Kahler has accounted for the
transaction as a purchase and consolidated the activities of this joint
venture. No minority interest has been reflected due to the remote likelihood
of Historical Kahler's partners receiving any future economic benefits.

The 1993 transactions had the following impact on Historical Kahler's
Consolidated Balance Sheet at the time of the acquisition:

Current assets.................. $ 1,161
Note receivable................. (3,501)
Investments in and advances to
affiliates..................... (2,620)
Intangibles..................... (59)
Other assets.................... 45
Property and equipment.......... 28,079
-------
$23,105
=======

Current liabilities......... $ 1,458
Long term debt.............. 21,498
Other deferred liabilities.. 149
-------
$23,105
=======

Also in the third quarter of 1993, Historical Kahler acquired a 26.6%
interest in a corporation which owns the Plaza One Hotel in Rock Island,
Illinois for $250 and a 50% interest in a joint venture which owns the Provo
Park Hotel in Provo, Utah for $3,115. Both transactions were accounted for as
purchases and are accounted for under the equity method of accounting (Note 4).
Historical Kahler has management contracts for both properties.

The pro forma results listed below are unaudited and reflect the impact of
the purchase price accounting adjustments on Historical Kahler's Consolidated
Statement of Operations assuming the acquisitions occurred at the beginning of
each period presented.

F-50

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEARS ENDED SIX MONTHS
----------------- ENDED JULY
1993 1994 2, 1995
-------- -------- -----------
(UNAUDITED)

Revenue of owned operations...................... $111,607 $115,155 $61,866
Income before extraordinary item and change in
accounting principle............................ 2,494 895 2,436
Net income....................................... 2,494 895 2,436
Income per common share:
Primary........................................ .63 .17 .57
Fully diluted.................................. .59 .17 .57

NOTE 4. INVESTMENT IN AND ADVANCES TO AFFILIATES

OWNERSHIP JANUARY 2, JANUARY 1, JULY 2,
INTERESTS 1994 1995 1995
--------- ---------- ---------- -----------
(UNAUDITED)

Equity investments
Provo Park Hotel, Provo,
UT..................... 50.0% $3,087 $3,165 $3,308
Kahler Park Hotel,
Hibbing, MN............ 25.0% 205 114 117
Plaza One Hotel, Rock
Island, IL............. 26.6% 168 -- --
------ ------ ------
$3,460 $3,279 $3,425
====== ====== ======

Investment in and advances to affiliates represent Historical Kahler's
proportionate share of the affiliates' assets and liabilities as adjusted to
reflect the effect of any basis differences. Historical Kahler or its
subsidiaries typically serve as a general partner or limited partner of the
partnership and operate the hotels under long-term management contracts.

Historical Kahler's income from affiliates before taxes is as follows:

SIX MONTHS
YEARS ENDED ENDED
---------------------- ---------------
(UNAUDITED)
JAN.
3, JAN. 2, JAN. 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
----- ------- ------- ------- -------

Management fees.......................... $ 408 $268 $381 $162 $187
Equity in net earnings (losses).......... (688) 27 193 98 291
----- ---- ---- ---- ----
$(280) $295 $574 $260 $478
===== ==== ==== ==== ====

Combined summarized balance sheet information for affiliates is as follows:

JAN. JAN.
2, 1, JULY 2,
1994 1995 1995
------ ------ -----------
(UNAUDITED)

Current Assets........................................ $ 808 $ 654 $ 742
Noncurrent assets..................................... 15,810 15,629 15,405
Current liabilities................................... 1,073 1,595 1,433
Long-term debt, principally mortgages................. 9,162 9,162 9,211
Other long-term liabilities........................... 1,295 1,273 1,293
Owners' equity........................................ 5,088 4,253 4,210

F-51

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Combined summarized operating results reported by these affiliates are as
follows:

SIX MONTHS
YEARS ENDED ENDED
------------------------ --------------
JAN. JULY JULY
JAN. 3, 2, JAN. 1, 3, 2,
1993 1994 1995 1994 1995
------- ------ ------- ------ ------
(UNAUDITED)

Revenues.............................. $17,711 $8,056 $11,099 $5,418 $6,266
Net losses............................ (1,046) (236) (87) (470) (42)

NOTE 5. FINANCING

Notes payable consists of $4,300 on January 1, 1995 and $4,100 on July 2,
1995, drawn on various lines of credit with a maximum available of $5,000. In
addition, a short-term note payable of $1,000 was outstanding at January 1,
1995. The lines of credit each carry an interest rate of prime plus 1%, the
note payable carries an interest rate of 8.75% and are secured by property and
equipment, inventory and accounts receivable. The Company anticipates the
extension of all its lines of credit. Prime rate at January 2, 1994, January 1,
1995 and July 2, 1995 was 6.0%, 8.5% and 9.0%, respectively.

Outstanding long-term debt, which is secured by substantially all property
and equipment is summarized as follows:

OBLIGATIONS OF HISTORICAL KAHLER

Mortgages

SECURITY/SECURED JANUARY 2, JANUARY 1, JULY 2,
PROPERTY INTEREST RATE MATURITY 1994 1995 1995
- ---------------- ------------- -------- ---------- ---------- -----------
(UNAUDITED)

Kahler 10.0% plus 2.0%
Plaza of room sales
Hotel November 1997 $15,595 $15,455 $15,377
Clinic View 9.75% plus 2.0%
Inn and of room sales
Suites May 2000 14,766 14,654 14,580
Sheraton 7.5% plus added
San Marcos interest (1)
Golf
Resort and
Conference
Center December 2000 13,600 12,700 12,700
The Kahler Prime plus 1.0%
Hotel December 2003 12,754 12,421 12,203
Textile 9.875%
Care June 2013 9,907 9,729 9,615
Salt Lake Prime plus 0.5%
Hilton
Hotel June 2003 6,954 6,850 6,785
Ogden Park Prime plus 0.5%
Hotel Cap rate of 12.0% August 1999 5,430 5,266 5,190
Lakeview Prime plus 1.125%
Conference
Center and
Resort September 1996 5,011 4,645 4,549
Olympia Prime plus 2.0%
Park Hotel August 2013 3,973 3,897 3,853
Boise Park Prime plus 1.0%
Suites
Hotel March 1997 3,882 3,851 4,058
Pocatello Prime plus 1.5%
Park
Quality
Inn April 2014 -- 3,651 3,614
The Kahler 12.0%
Hotel December 2003 2,928 2,885 2,855
Lakeview Prime rate
Conference
Center and
Resort,
Knights
Inns June 2004 710 667 648
Sheraton Prime plus 1.0%
San Marcos
Golf
Resort and
Conference
Center July 1997 7 -- --
Notes Prime to 11.0% Various dates through
payable September 1997 638 290 440
Capitalized 12.2% to 12.93%
leases May 1997 33 46 44
------- ------- -------
Total 96,188 97,007 96,511
Less
current
maturities 2,461 2,065 2,211
------- ------- -------
93,727 94,942 94,300
------- ------- -------

- --------

(1)Added interest is defined as approximately 67% of Excess Cash Flow as
defined. Also see Note 8.

F-52

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

OBLIGATIONS OF SUBSIDIARIES--NONRECOURSE TO HISTORICAL KAHLER

Mortgages

SECURITY/SECURED JANUARY 2, JANUARY 1, JULY 2,
PROPERTY INTEREST RATE MATURITY 1994 1995 1995
- ---------------- ------------- -------- ---------- ---------- -----------
(UNAUDITED)

Salt Lake Prime plus 0.5%
Hilton June 2003 5,000 5,000 5,000
Knights Inns Prime rate June 2009 4,201 4,073 4,045
University Tax-exempt variable
Park Hotel rate, 4.7% to 5.9% December 2015 9,055 8,935 8,935
Ogden Park Tax-exempt variable
Hotel rate, 4.55% to 5.2% September 2013 9,200 8,900 8,700
Special 7.5% to 12.0%
assessments December 1997 200 158 156
Capitalized 0.0% to 14.3% August 1994 to
leases June 1998 141 153 130
-------- -------- --------
Total 27,797 27,219 26,966
Less current
maturities 751 702 701
-------- -------- --------
27,046 26,517 26,265
-------- -------- --------
Total
outstanding 123,985 124,226 123,477
Less current
maturities 3,212 2,767 2,912
-------- -------- --------
$120,773 $121,459 $120,565
======== ======== ========

Total maturities of long-term debt excluding capital lease obligations, in
each of the five years subsequent to January 1, 1995 are approximately $2,700,
$6,827, $21,349, $2,724, and $7,146, respectively.

Historical Kahler has arranged for the issuance of letters of credit
aggregating $1,475 (increased to $2,000 subsequent to year end) as additional
collateral for certain of the nonrecourse obligations listed above.

Under certain financial debt covenants, Historical Kahler is required to
maintain certain levels of net worth, debt to equity and cash flow ratios.
Waivers of certain covenants have been obtained for fiscal 1995 and 1994.

The laundry facility in Rochester, Minnesota was financed with a $10,000
loan. In the event of default by Historical Kahler on this loan the lender can
require Historical Kahler's largest shareholder to purchase the loan at its
outstanding balance.

NOTE 6. REDEEMABLE CONVERTIBLE PREFERRED STOCK

On December 28, 1989, Historical Kahler issued 141,828 shares of $2.25
Cumulative Convertible Exchangeable Preferred Stock with a stated value of
$25.00 per share. Preferred stock dividends are payable quarterly at an annual
rate of $2.25 per preferred share. The preferred stock carries a liquidation
preference of $25.00 per share plus accumulated and unpaid dividends. The
preferred stock is convertible into common stock at any time at a rate
equivalent to a conversion price of $9.25. On September 21, 1994 Historical
Kahler sent a letter notifying the Preferred Shareholders of its intent to
redeem all outstanding shares of preferred stock outstanding as of October 7,
1994. All remaining Preferred Shareholders elected to convert their outstanding
preferred shares to common stock in 1994.

F-53

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Preferred stock for 1993 is net of unamortized offering costs of $279 which
were being amortized over a ten-year period. Upon conversion in 1994, preferred
stock of $3,296 net of $250 in unamortized offering costs was reclassified to
common stock and additional paid-in capital.

NOTE 7. STOCKHOLDERS' EQUITY

Preferred stock

Historical Kahler has authorized 10,000,000 shares of Preferred Stock, par
value $.10 per share. No shares were outstanding as of January 1 and July 2,
1995. The Board of Directors is authorized to determine the series and number
of preferred shares to be issued and any related designations, powers,
preferences, rights, qualifications, limitations or restrictions.

Common stock

Common stock has been issued under deferred compensation, incentive stock
options, employee retirement and stock purchase plans.

Dividends

The Board of Directors of Historical Kahler authorized a stock split effected
in the form of a 2-for-1 stock dividend on April 30, 1993 which was paid on
June 1, 1993 to shareholders of record on May 15, 1993. All common share and
per share amounts in the consolidated financial statements and notes thereto
have been restated to give retroactive effect to the stock dividend. In
addition, $168, representing the par value of the new shares issued, was
transferred from retained earnings to common stock.

Stock option plan

Under certain stock option plans, incentive stock options may be granted to
key employees or non-employee directors at not less than 100% of the fair
market value and options not qualifying as incentive stock options may be
granted to non-employees providing valuable services to Historical Kahler at
not less than 50% of the fair market value. None of these shares have been
granted at less than market value. Total number of shares authorized under
these plans are 616,425. Key employee options expire five years after date of
grant and are exercisable 25% per year commencing one year after the date of
grant. Non-employee director options expire in ten years after date of grant
and are exercisable after one year. Activity under the plans is summarized
below:

OPTION
NUMBER PRICE
OF SHARES PER SHARE
--------- -----------

Balance, December 29, 1991........................ 354,526 $3.50-10.00
Granted......................................... 144,000 3.00- 4.13
Canceled........................................ (61,926) 3.50-10.00
-------- -----------
Balance, January 3, 1993.......................... 436,600 3.00- 9.88
Granted......................................... 157,500 5.75- 7.50
Exercised....................................... (29,900) 2.88- 5.00
Canceled........................................ (68,900) 3.00- 9.88
-------- -----------
Balance, January 2, 1994.......................... 495,300 2.88- 7.50
Granted......................................... 113,700 8.50-11.75
Exercised....................................... (186,075) 2.88- 7.50
Canceled........................................ (5,000) 3.00- 7.50
-------- -----------
Balance, January 1, 1995.......................... 417,925 $2.88-11.75
======== ===========

F-54

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

On January 7, 1993, Historical Kahler's Board of Directors approved the
repricing of all granted employee stock options that had an exercise price of
$5 per share or higher to a market price as of that date which was $2.88 per
share. At January 1, 1995, options for 154,100 were exercisable and 198,500
shares were available for granting of additional options.

Issuance of common stock warrant

In January 1992, Historical Kahler issued a $2,000 subordinated note to
Historical Kahler's largest shareholder. The subordinated note requires annual
principal payments of $500 per year beginning January 21, 1995, matures on
January 21, 1998 and carries an interest rate of prime plus 1%. The January
1995 payment was made as scheduled. Historical Kahler has the right to repay
the note in cash or with common stock equal to 120% of the subordinated note at
any time. In addition, Historical Kahler issued a warrant for 150,000 shares of
common stock at an exercise price of $3.25. The warrant was exercised in 1994.

NOTE 8. COMMITMENTS AND CONTINGENCIES

Historical Kahler is in the discovery stage of litigation with a
telecommunications company relating to disputed unremitted telephone revenue
and fees at ten of Historical Kahler's hotels. Historical Kahler has denied all
claims and has made counter claims relating to breach of contract and intends
to pursue all available alternatives. The outcome of this dispute is uncertain;
accordingly no adjustments have been made to the accompanying consolidated
financial statements.

In December 1994 Historical Kahler received notice of default relating to
bond indebtedness on one of its wholly owned properties. A group of bondholders
have claimed Historical Kahler incorrectly calculated added interest for this
hotel for the year 1993 in the amount of approximately $267. Historical Kahler
denies the claim. If the bondholders were found judicially correct, Historical
Kahler would owe this amount for 1993 and an additional $618 for 1994.

Additionally, Historical Kahler is involved in various litigation in the
normal course of business. Historical Kahler does not expect the outcome of the
matters described above to have a material adverse effect on Historical
Kahler's consolidated financial statements.

Operating leases

Historical Kahler leases warehouse and retail store facilities for its formal
wear operations and land for two of its hotels under various operating lease
agreements which call for minimum lease payments and contingent rents based
upon percentages of revenues. Operating lease expense was $1,288, $1,474 and
$1,550 which includes contingent rentals of $359, $410 and $486 for 1992, 1993
and 1994, respectively.

Future minimum lease payments under operating leases total $5,175 with annual
payments of $958, $602, $369, $233 and $175 due in each of the next five years,
respectively.

Capital leases

Historical Kahler leases furniture and equipment under capital leases. Future
minimum lease payments under these capital leases total $272 with annual
payments of $101, $100, $54, $17 and $ -0- due in each of the next five years,
respectively. Of the $272 of total minimum lease payments, $73 represents
interest.

F-55

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The following is an analysis of property under capital leases:

1993 1994
----- -----

Equipment................................................... $ 782 $ 465
Less accumulated amortization............................... (232) (164)
----- -----
$ 550 $ 301
===== =====

Annual amortization of leased equipment is classified with depreciation
expense.

Other

In 1994, Historical Kahler purchased land to expand the Boise Park Suites
Hotel. Historical Kahler has a loan commitment to fund substantially all of the
expansion costs.

NOTE 9. RETIREMENT PLANS

Historical Kahler has defined benefit and contribution plans covering
substantially all employees. Pension contributions and expenses for the defined
benefit plan are determined based on the actuarial cost of current service and
amortization of prior service costs over a 20-year period. The funding of the
defined contribution plan is determined by the Board of Directors.

Total pension expense for both plans was $393, $336, and $215 for 1992, 1993
and 1994, respectively.

Net periodic pension cost for the defined benefit plan included the following
components:

1992 1993 1994
---- ---- ----

Service costs-benefits earned during the period............... $ 68 $ 68 $ 80
Interest cost on projected benefit obligation................. 163 171 179
Return on assets-actual....................................... (93) (95) 8
Net amortization and deferral................................. 9 5 (102)
---- ---- ----
Net periodic pension cost..................................... $147 $149 $165
==== ==== ====

The following table sets forth the Plan's funded status at January 2, 1994
and January 1, 1995:

1993 1994
------ ------

Actuarial present value of vested benefit obligation..... $2,278 $2,503
------ ------
Accumulated benefit obligation........................... $2,342 $2,564
------ ------
Projected benefit obligation............................. $2,342 $2,564
Fair market value of plan assets*........................ 1,536 1,498
------ ------
Unfunded projected benefit obligation.................... 806 1,066
Unrecognized net liability at date of initial
application............................................. (46) (40)
Unrecognized prior service cost.......................... (209) (527)
Unrecognized net loss.................................... (227) (167)
Adjustment to recognize minimum liability................ 482 734
------ ------
Pension liability........................................ $ 806 $1,066
====== ======

- --------

* Plan assets consist primarily of equity and fixed income securities.

F-56

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Historical Kahler has recognized an additional liability as the accumulated
benefit obligation exceeded the fair value of the plan assets. An intangible
asset was recognized up to the amount of unrecognized prior service cost. As of
January 1, 1995 the additional liability exceeded the unrecognized prior
service cost and the unrecognized transition liability by $167. This amount has
been recorded as a reduction of stockholders' equity.

The weighted-average discount rate used in determining the actuarial present
value of the projected benefit obligation was 7.5% and 8.5% in 1993 and 1994,
respectively. The expected long-term rate of return on assets was 8%.

Historical Kahler provides postretirement benefits to a limited number of
retired employees relating to service provided prior to 1992. In 1992,
Historical Kahler adopted SFAS No. 106--Employer's Accounting for
Postretirement Benefits Other Than Pensions and recorded a cumulative charge of
$250 in 1992. This liability decreased by $25 and $25 in 1993 and 1994,
respectively.

NOTE 10. SEGMENTS

Historical Kahler's principal business activity is the operation and
management of hotel properties. Fees from managed properties are primarily
based on a percent of revenues of the managed property. Historical Kahler's
other business activities include a wholesale and retail formal wear business
and institutional laundries. Intersegment transactions including laundry
revenues of $1,445, $1,437, and $1,857 in 1992, 1993, and 1994, respectively,
have been eliminated from the table below. Operating income (loss) represents
revenue less operating expenses, excluding general corporate expenses.
Identifiable assets are those used in the operation of each segment. Capital
expenditures include non-cash lodging acquisitions of $28,079 in 1993 and
$2,783 in 1994. General corporate assets consist primarily of cash, notes and
other investments.

F-57

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The following tables summarize Historical Kahler's segment information:

YEARS ENDED SIX MONTHS ENDED
---------------------------- ------------------
(UNAUDITED)
JAN. 3, JAN. 2, JAN. 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
-------- -------- -------- -------- --------

REVENUE OF OWNED OPERATIONS
Lodging.................... $ 58,408 $ 80,505 $ 93,243 $ 47,618 $ 53,277
Laundry.................... 4,694 6,200 6,304 3,309 3,057
Formal Wear................ 9,112 8,467 8,924 4,809 5,002
Other...................... 376 610 666 326 306
Interest income............ 1,424 1,197 773 283 224
-------- -------- -------- -------- --------
$ 74,014 $ 96,979 $109,910 $ 56,345 $ 61,866
======== ======== ======== ======== ========
OPERATING INCOME (LOSS)
Lodging.................... $ 8,976 $ 13,794 $ 16,304 $ 9,054 $ 10,504
Laundry.................... 601 331 (389) (269) 193
Formal Wear................ (193) 323 539 351 374
Other...................... (314) (65) 11 26 (3)
Non-recurring charges...... (2,758) -- (1,811) -- --
Corporate expense.......... (3,342) (3,372) (3,346) (1,739) (1,962)
Interest income............ 1,424 1,197 773 283 224
-------- -------- -------- -------- --------
Gross operating profit....... 4,394 12,208 12,081 7,706 9,330
Interest expense............. (7,303) (9,362) (11,207) (5,248) (6,060)
Equity earnings (loss) of
affiliates.................. (688) 27 193 98 291
Gain (Loss) on sale of
assets...................... (693) 6 20 11 (31)
-------- -------- -------- -------- --------
Income (Loss) from operations
before income taxes and
extraordinary items......... $ (4,290) $ 2,879 $ 1,087 $ 2,567 $ 3,530
======== ======== ======== ======== ========
IDENTIFIABLE ASSETS
Lodging.................... $108,912 $132,495 $141,423 $136,978 $140,708
Laundry.................... 5,922 14,819 14,703 15,262 14,496
Formal Wear................ 4,681 3,909 4,024 5,108 4,798
Other...................... 2,033 1,616 1,634 1,584 1,616
Corporate.................. 10,844 9,567 6,385 10,482 7,006
-------- -------- -------- -------- --------
$132,392 $162,406 $168,169 $169,414 $168,624
======== ======== ======== ======== ========
CAPITAL EXPENDITURES
Lodging.................... $ 7,127 $ 30,073 $ 13,859 $ 6,735 $ 1,818
Laundry.................... 2,853 9,368 846 542 90
Formal Wear................ 1,499 789 1,464 1,381 1,175
Other...................... 85 1 74 -- 27
Corporate.................. 19 38 63 24 53
-------- -------- -------- -------- --------
$ 11,583 $ 40,269 $ 16,306 $ 8,682 $ 3,163
======== ======== ======== ======== ========
DEPRECIATION AND AMORTIZATION
Lodging.................... $ 4,379 $ 5,737 $ 6,142 $ 3,111 $ 3,257
Laundry.................... 276 462 736 358 395
Formal Wear................ 1,617 1,547 1,411 754 692
Other...................... 103 58 99 30 46
Corporate.................. 117 100 89 45 48
-------- -------- -------- -------- --------
$ 6,492 $ 7,904 $ 8,477 $ 4,298 $ 4,438
======== ======== ======== ======== ========

F-58

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

During the fourth quarter of 1994, Historical Kahler recorded non-recurring
charges of $1,811 related to expenses incurred in connection with a planned
secondary offering and conversion of Historical Kahler into a real estate
investment trust which was not completed as a result of market conditions.

Non-recurring charges of $2,758 in 1992 represents a $1,558 charge comprised
of settlement fees and legal fees related to the settlement of a lawsuit with
Historical Kahler's partner at the Sheraton San Marcos. The remaining $1,200 is
a writedown of the carrying value of a hotel. Simultaneous with the writedown,
Historical Kahler recorded an extraordinary gain of $2,517, net of income tax
of $278, as a result of extinguishment of debt pertaining to this hotel.

The loss on sale of assets in 1992 of $693 includes a loss of $397 on the
Wisconsin Dells hotel, a $400 writedown of assets and reserve for demolition of
a laundry in Rochester due to Historical Kahler's building of a new laundry,
and a gain of $104 on the sale of customer contracts related to the closing of
formal wear operations in San Jose.

Historical Kahler regularly furnishes laundry, hospitality and food services
to Historical Kahler's largest shareholder, the Mayo Foundation and its
affiliates (Mayo) at competitive prices. Historical Kahler purchases, at
competitive prices, steam, electricity, water and related utility services from
a Mayo affiliate. These activities are summarized below.

SIX MONTHS
YEARS ENDED ENDED
----------------------- ---------------
(UNAUDITED)
JAN. 3, JAN. 2, JAN. 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
------- ------- ------- ------- -------

Revenue
Laundry sales......................... $2,108 $2,885 $3,333 $1,667 $1,768
Food services......................... 1,026 1,173 951 475 494
Operating costs and expenses
Utilities............................. $2,322 $1,946 $1,870 $ 864 $ 612
Interest.............................. 138 140 162 73 80

The consolidated balance sheet includes receivables and payables to Mayo
summarized as follows:

JANUARY 2, JANUARY 1, JULY 2,
1994 1995 1995
---------- ---------- -----------
(UNAUDITED)

Receivables................................... $409 $424 $554
Payables (including accrued interest)......... 213 209 230

In addition Historical Kahler has issued a $2,000 subordinated note to Mayo
which is further described in Note 7 of the Notes to Consolidated Financial
Statements.

Approximately $3.7 million in long-term debt secured by the Pocatello Park
Quality Inn has been provided by a lending institution affiliated with a
director of Historical Kahler.

F-59

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 11. PROVISION FOR INCOME TAXES

Provision for income taxes consists of the following:

SIX MONTHS
YEARS ENDED ENDED
-------------------------- ---------------
(UNAUDITED)
JAN. 3, JAN. 2, JAN. 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
------- ------- ------- ------- -------

Federal tax, paid or (refundable).... $(13) $671 $350 $592 $ 847
State tax, currently paid or payable. 18 204 93 178 247
Net deferred credits (prepaid
charges)............................ (27) -- (120) -- --
---- ---- ---- ---- ------
Tax provision (credit)............... (22)(1) 875 323 770 1,094
Tax benefit from NOL carryforwards... -- -- -- -- --
---- ---- ---- ---- ------
Tax provision (credit) net of tax
benefit classified as extraordinary. $(22) $875 $323 $770 $1,094
==== ==== ==== ==== ======

- --------

(1) In 1992 a tax charge of $278 allocated to the extraordinary gain resulted
in the tax provision on the Consolidated Statements of Operations being a
$300 credit.

The effective tax rate is calculated using the provision for income taxes
including the tax benefits or charges in extraordinary items. The difference
between the U.S. Federal Statutory rate and the effective tax rate are as
follows:

SIX MONTHS
YEARS ENDED ENDED
------------------------ ---------------
(UNAUDITED)
JAN. 3, JAN. 2, JAN. 1, JULY 3, JULY 2,
1993 1994 1995 1994 1995
------- ------- ------- ------- -------

Statutory tax rate.................... (34.0)% 34.0% 34.0% 34.0% 34.0%
Effect of graduated federal rates..... 30.4 -- -- -- --
Change in the beginning of year
valuation allowance.................. -- (10.2) (15.0) (10.0) (9.0)
Other permanent differences........... 1.3 1.0 5.4 -- --
State taxes, before valuation
allowance and net of federal income
tax.................................. 1.1 5.6 5.3 6.0 6.0
----- ----- ----- ----- ----
Effective tax rate.................... (1.2)% 30.4% 29.7% 30.0% 31.0%
===== ===== ===== ===== ====

Deferred tax assets and liabilities are classified as current and noncurrent
on the basis of the classification of the related asset or liability for
financial reporting. Prepaid and deferred taxes are recorded for temporary
differences between the book value of assets and liabilities for financial
reporting purposes and tax purposes.

F-60

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Temporary differences comprising the net prepaid taxes included in other
assets on the Consolidated Balance Sheet at January 2, 1994 and January 1, 1995
is as follows:

1993
--------------------------
TEMPORARY DIFFERENCES ASSETS LIABILITIES TOTAL
- --------------------- ------ ----------- ------

Allowance for doubtful accounts..................... $ 72 $ -- $ 72
Accrued employee benefits........................... 303 -- 303
Other............................................... 40 (64) (24)
------ ------- ------
Current........................................... 415 (64) 351
------ ------- ------
Depreciation and amortization....................... 497 (1,771) (1,274)
Deferred revenues................................... 2,241 (105) 2,136
Installment gains................................... -- (468) (468)
Property valuation allowances....................... 340 (110) 230
Joint ventures...................................... 256 (209) 47
Accrued employee benefits........................... 269 -- 269
------ ------- ------
Noncurrent........................................ 3,603 (2,663) 940
------ ------- ------

OTHER COMPONENTS
- ----------------

Alternative minimum tax credits..................... 783 -- 783
General business credits............................ 576 -- 576
Valuation allowance................................. (2,257) -- (2,257)
------ ------- ------
(898) -- (898)
------ ------- ------
Net prepaid tax asset............................. $3,120 $(2,727) $ 393
====== ======= ======

1994
--------------------------
TEMPORARY DIFFERENCES ASSETS LIABILITIES TOTAL
- --------------------- ------ ----------- ------

Allowance for doubtful accounts..................... $ 75 $ -- $ 75
Accrued employee benefits........................... 360 -- 360
Other............................................... 13 (129) (116)
------ ------- ------
Current........................................... 448 (129) 319
------ ------- ------
Depreciation and amortization....................... 556 (1,605) (1,049)
Deferred revenues................................... 1,596 (108) 1,488
Installment gains................................... 8 (427) (419)
Property valuation allowances....................... 274 (90) 184
Joint ventures...................................... 589 (81) 508
Accrued employee benefits........................... 264 -- 264
------ ------- ------
Noncurrent........................................ 3,287 (2,311) 976
------ ------- ------

OTHER COMPONENTS
- ----------------

Alternative minimum tax credits..................... 1,068 -- 1,068
General business credits............................ 587 -- 587
NOL carryforwards................................... 218 -- 218
Valuation allowance................................. (2,655) -- (2,655)
------ ------- ------
(782) -- (782)
------ ------- ------
Net prepaid tax asset............................. $2,953 $(2,440) $ 513
====== ======= ======

F-61

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Historical Kahler has based the value of the net prepaid tax asset primarily
on the alternative minimum tax credits which, under current law, have no
expiration dates. The ultimate realization of the net prepaid tax asset is
dependent upon the offset of these credits against future federal tax payments
if future taxable income exceeded the alternative minimum tax levels. Also,
these credits could generate a refund by carrying back net operating losses if
Historical Kahler incurred such losses in the future.

The total valuation allowance at the end of 1994 was $2,655. The net change
in the total valuation allowance for the years ended 1993 and 1994 was an
increase of $300 and $398, respectively. In assessing the realizability of
prepaid tax assets, management considers whether it is more likely than not
that some portion or all of the net prepaid tax assets will not be realized.
Also, management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies in making this
assessment. In order to fully realize the net prepaid tax asset, Historical
Kahler will need to generate future regular tax. Taxable income (loss) for the
years ended 1993 and 1994 was approximately $3,402 and $(547), respectively.
Based upon the levels of historical taxable income, projections for future
taxable income and the ability to carry back future net operating losses,
management believes it is more likely than not Historical Kahler will realize
the benefits of the net prepaid tax asset, net of the existing valuation
allowance at January 1, 1995.

NOTE 12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION AND NON-CASH
FINANCING AND INVESTING ACTIVITIES

SIX MONTHS
YEARS ENDED ENDED
------------------------- --------------
(UNAUDITED)
JULY JULY
JAN. 3, JAN. 2, JAN. 1, 3, 2,
1993 1994 1995 1994 1995
------- ------- ------- ------ ------

Interest paid, net of amounts
capitalized........................ $ 7,447 $ 9,307 $10,968 $5,752 $6,397
Interest received................... (1,398) (1,026) (753) (277) (155)
Income taxes paid................... 306 889 520 302 409

Historical Kahler acquired certain hotel interests in 1993 and 1994 as
described in Note 3.

NOTE 13. SEC PROCEEDING AND RESTATEMENT

From its opening in early 1988 through December 1989, Historical Kahler
deferred $784 of the operating losses of a property that was being held for
sale. These losses primarily occurred in 1988. Depreciation and amortization of
$754 and $774 for fiscal 1988 and 1989, respectively, would also have been
incurred had the property not been held for sale. Effective January 1, 1990,
Historical Kahler transferred the property to property and equipment categories
and included the results of operations of the property in its consolidated
statement of operations. In 1988 and 1989, Historical Kahler's independent
auditors issued an unqualified opinion on Historical Kahler's financial
statements.

In 1989, in connection with a registration statement filed earlier in 1989 by
Historical Kahler with the Securities and Exchange Commission (SEC), the SEC
initiated an informal inquiry and requested additional information, which
Historical Kahler provided, concerning Historical Kahler's accounting for
property it was holding for sale and its investment in the Sheraton San Marcos
Golf and Conference Center.

The Securities and Exchange Commission instituted an administrative
proceeding pursuant to Section 21C(a) of the Securities Exchange Act of 1934 on
June 24, 1993 against Historical Kahler, the President and CEO of Historical
Kahler and the Senior Vice President--Treasurer of Historical Kahler.

F-62

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)

YEARS ENDED JANUARY 3, 1993, JANUARY 2, 1994 AND JANUARY 1, 1995 AND

FIRST SIX MONTHS ENDED JULY 3, 1994 AND JULY 2, 1995

(UNAUDITED AS TO INTERIM PERIODS)

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The matter concerned allegedly improper accounting and disclosure practices
employed by Historical Kahler during fiscal years 1988 through 1990, resulting
in violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules
12b-20 and 13a-13 thereunder.

Historical Kahler, the President and CEO and the Senior Vice President--
Treasurer, without admitting any wrongdoing, have agreed to permanently cease
and desist from causing any violation and any future violation of these
sections of the Exchange Act and Rules.

Pursuant to this SEC administrative proceeding, Historical Kahler has
restated its financial statements to reflect as an operating property the
property previously recorded as held for sale in 1988 and 1989. As a result,
Historical Kahler recognized previously deferred operating losses and recorded
depreciation and amortization expense with respect to this property during such
period. As a result of this restatement, the carrying value of property and
equipment, intangibles and other assets carried through to years 1990, 1991 and
1992 was decreased causing reductions in depreciation and amortization for
these years and related changes to the provision for income taxes. The effects
of the restatements are summarized as follows for 1992. The income (loss) per
common share and the retained earnings have been adjusted to give effect to the
2 for 1 stock dividend which is discussed in Note 7.

Consolidated Statement of Operations:

1992 1992--AS
AS RESTATED PREVIOUSLY REPORTED
----------- -------------------

Revenue of owned operations.............. $74,014 $74,014
Income (Loss) from operations before
income taxes............................ (4,290) (4,335)
Net income (loss)........................ (1,723) (1,690)
Income (Loss) per common share........... (.59) (.58)

NOTE 14. SUBSEQUENT EVENTS (UNAUDITED)

(a) Restructuring of Historical Kahler

Historical Kahler intends to engage in a series of transactions to
recapitalize its operations and restructure its assets in the form of a real
estate investment trust (REIT) and a hotel management company in the third
quarter of 1995. These transactions will include (i) the transfer of Historical
Kahler's hotel management, commercial laundry and formal wear business
operations and related net assets to Kahler Management Corporation (KMC), a
wholly owned subsidiary, (ii) the distribution of 90.5% of KMC's common stock
to existing shareholders of Historical Kahler and (iii) a public offering of
shares in Kahler Realty Corporation, which will continue Historical Kahler's
ownership and development business.

(b) Purchase Option on Hotel

In June 1995, Historical Kahler acquired an option to purchase a 112 room
hotel in Twin Falls, Idaho for $5.8 million. On August 1, 1995, Historical
Kahler exercised this option and financed the purchase with a first mortgage of
$3.8 million, a note payable to seller of $400 and $1.6 million from available
cash and lines of credit.

In April 1995, construction of a 108 room expansion of the Boise Park Suites
Hotel began. Substantially all of the remaining construction costs will be paid
for with a $4.9 million construction and permanent loan.

F-63

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

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN
OFFER IS UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.

TABLE OF CONTENTS

PAGE
----

Prospectus Summary........................................................ 3
Risk Factors.............................................................. 8
The Spin Off.............................................................. 13
Quotation on Nasdaq....................................................... 14
Dividend Policy........................................................... 14
Pro Forma Capitalization.................................................. 14
Selected Consolidated Financial and Operating Data of Historical Kahler... 14
Management's Discussion and Analysis of Financial Condition and Results of
Operations of Historical Kahler.......................................... 17
Pro Forma Selected Consolidated Financial Data of KMC..................... 22
Management's Discussion and Analysis of Pro Forma Financial Data of KMC... 23
Business.................................................................. 26
The Hotels................................................................ 32
Certain Agreements between KMC and Realty................................. 41
Directors and Executive Officers.......................................... 48
Certain Relationships and Related Transactions............................ 52
Principal Shareholders.................................................... 55
Description of Capital Stock.............................................. 56
Legal Matters............................................................. 59
Change in Auditors........................................................ 59
Experts................................................................... 59
Certain Definitions....................................................... 60
Index to Financial Statements............................................. F-1

UNTIL 25 DAYS AFTER THE DATE OF THE DISTRIBUTION OF THE SPIN OFF DIVIDEND,
ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR
NOT PARTICIPATING IN THE DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS.

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

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

KAHLER MANAGEMENT CORPORATION

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

COMMON STOCK

, 1995

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

Graphics Appendix
-----------------

Page 4
- ------

Diagram showing the structure and ownership of Realty and KMC after the Spin Off
and the Offering. Using a combination of boxes and lines, the diagram
illustrates the ownership of Realty by New Realty Shareholders (65.9%) and
Pre-Offering Shareholders of Historical Kahler (34.1%), the ownership of KMC by
Realty (9.5%) and Pre-Offering Shareholders of Historical Kahler (90.5%),
Realty's ownership of a Mortgage Note in one Managed Hotel [Note (1)] and of
equity interests in 14 Leased Hotels [Note (2)], the corresponding Management
Agreement and Percentage Leases with KMC, and KMC's ownership of 5 Managed
Hotels [Note (3)], 2 Owned Hotels [Note (4)], Anderson's [Note (5)] and Textile
[Note (6)].

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The Registrant will incur no expenses in connection with the Spin Off
described in this Registration Statement. Such expenses will be paid by the
Registrant's parent corporation, Kahler Realty Corporation, in connection with
its public offering of shares of its common stock. Such expenses are included
in Item 30 to Kahler Realty Corporation's Registration Statement on Form S-11,
Registration No. 33-82994, relating to such common stock.

ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.

The Bylaws of the Registrant require the Registrant to indemnify its officers
and directors for such expenses and liabilities in such manner, under such
circumstances and to such extent, as required or permitted by Minnesota law.
Subject to any limitations contained in the Bylaws or Articles of Incorporation
of the Registrant, Section 302A.521 of the Minnesota Statutes requires the
Registrant to indemnify a person made or threatened to be made a party to a
proceeding by reason of the former or present official capacity of the person
with respect to the Registrant, against judgments, penalties, fines, including,
without limitation, excise taxes assessed against the person with respect to an
employee benefit plan, settlements, and reasonable expenses, including
attorneys' fees and disbursements, incurred by the person in connection with
the proceeding if, with respect to the acts or omissions of the person
complained of in the proceeding, the person (1) has not been indemnified by
another organization or employee benefit plan for the same judgments,
penalties, fines, including without limitation, excise taxes assessed against
the person with respect to an employee benefit plan, settlements, and
reasonable expenses, including attorneys' fees and disbursements, incurred by
the person in connection with the proceeding with respect to the same acts or
omissions; (2) acted in good faith; (3) received no improper personal benefit,
and statutory procedure has been followed in the case of any conflict of
interest by a director; (4) in the case of a criminal proceeding, had no
reasonable cause to believe the conduct was unlawful; and (5) in the case of
acts or omissions occurring in the person's performance in the official
capacity of director or, for a person not a director, in the official capacity
of officer, committee member, employee or agent, reasonably believed that the
conduct was in the best interests of the Registrant, or, in the case of
performance by a director, officer, employee or agent of the Registrant as a
director, officer, partner, trustee, employee or agent of another organization
or employee benefit plan, reasonably believed that the conduct was not opposed
to be the best interests of the Registrant. In addition, Section 302A.521,
subd. 3, requires payment by the Registrant, upon written request, of
reasonable expenses in advance of final disposition in certain instances, upon
receipt of a written undertaking by the person to repay all amounts so paid if
it is ultimately determined that the person is not entitled to indemnification,
unless otherwise limited by the Articles of Incorporation or Bylaws of the
Registrant. A decision as to required indemnification is made by a
disinterested majority of the Board of Directors present at a meeting at which
a disinterested quorum is present, or by a designated committee of the Board,
by special legal counsel, by the shareholders, or by a court.

The Registrant's Articles of Incorporation provide that a director is not
liable to the Registrant or its shareholders for monetary damages for a breach
of fiduciary duty as a director, except for liability (i) for any breach of the
directors duty of loyalty to the Registrant or its shareholders; (ii) for acts
or omissions not in good faith or which involve intentional misconduct or a
knowing violation of the law; (iii) under Sections 302A.559 or 80A.23 or the
Minnesota Statutes; (iv) for any transaction from which the director derived an
improper personal benefit; or (v) for any act or omission occurring prior to
the date such indemnification provision became effective.

The Registrant intends to enter into agreements to indemnify its directors in
addition to the indemnification provided for in the Bylaws. These agreements
will, among other things, indemnify the Registrant's directors and certain of
its officers to the full extent permitted by the Minnesota Statutes for any

II-1

claims, liabilities, damages, judgments, penalties, fines, settlement,
disbursements or expenses (including attorneys' fees) included by such person
in any action or proceeding, including any action by or in the right of the
Registrant, on account of services as a director of the Registrant.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

In connection with the organization and initial capitalization of the
Registrant, the Registrant issued 100 shares of its common stock to Kahler
Realty Corporation in consideration for the cash payment of $100. The
Registrant relied on the exemption from registration provided by Section 4(2)
of the Securities Act of 1933, as amended, for transactions not involving a
public offering.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENTS.

(a) Exhibits--Except as indicated below, the following exhibits are filed
herewith.

EXHIBIT NO. DESCRIPTION
----------- -----------

3.1 Articles of Incorporation of Kahler Management Corporation*
3.2 Bylaws of Kahler Management Corporation*
4 Specimen Common Stock Certificate*
5 Opinion of Dorsey & Whitney regarding the validity of KMC
Common Stock to be issued in the Spin Off**
10.1 Form of Distribution Agreement among Kahler Corporation, Kahler
Realty Corporation and Kahler Management Corporation**
10.2 Form of Percentage Lease**
10.3 Form of Trademark License Agreement between Kahler Realty
Corporation and Kahler Management Corporation**
10.4 Form of Right of First Refusal Agreement between Kahler Realty
Corporation and Kahler Management Corporation**
10.5 Form of Option Agreement for Interest in Two Knights Inn Hotels
between Kahler Realty Corporation and Kahler Management
Corporation***
10.6 Form of Exchange Agreement***
10.7 Form of Indemnity Agreement between Kahler Management
Corporation and its directors and officers*
10.8 Form of Kahler Management Corporation 1995 Stock Option Plan***
10.9 Form of Kahler Management Corporation 1995 Non-Employee
Directors Stock Option Plan***
10.10 Form of Kahler Management Corporation 1995 Retainer Stock
Payment Plan for Non-Employee Directors***
10.11 Laundry Service Agreement, dated September 1, 1992 between
Textile Care Services and Mayo Foundation (incorporated by
reference to Exhibit 10(m) to the Annual Report of Kahler
Corporation on Form 10-K for the year ended January 3, 1993).
10.12 Form of Utility Sale Agreement, dated as of October 31, 1986,
between The Kahler Corporation and Franklin Heating Station, a
Minnesota general partnership composed of Mayo Foundation and
Rochester Methodist Hospital (incorporated by reference to
Exhibit 10.7 to Kahler Realty Corporation's Form S-11
Registration Statement (Registration No. 33-82994) as
amended.)

- --------

* Previously filed.

** Previously filed; new form reflecting changes in the transaction to be filed
by amendment.

*** To be filed by amendment.

II-2

EXHIBIT NO. DESCRIPTION
----------- -----------

21 Subsidiaries of the registrant**
23.1 Consent of Dorsey & Whitney (included in Exhibit 5)
23.2 Consent of KPMG Peat Marwick LLP
23.3 Consent of Deloitte & Touche LLP (included in Item 16(b)--
Independent Auditors' Report on Schedules)
24 Powers of Attorney*

- --------

* Previously filed.

** Previously filed; new form reflecting changes in the transaction to be filed
by amendment.

*** To be filed by amendment.

(b) Index to Financial Statements included in the Prospectus

See page F-1

Index to Financial Statement Schedules not included in Prospectus

Independent Auditors' Reports on Schedules

Schedule II--Valuations and Qualifying Accounts

All schedules other than those indicated have been omitted as the required
information either is not applicable or is presented in the financial
statements or related notes thereto.

ITEM 17. UNDERTAKINGS.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.

II-3

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT
HAS DULY CAUSED THIS POST-EFFECTIVE AMENDMENT TO REGISTRATION STATEMENT ON FORM
S-1 TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED,
IN THE CITY OF ROCHESTER, STATE OF MINNESOTA, ON SEPTEMBER 25, 1995.

Kahler Management Corporation

/s/ Harold W. Milner
By___________________________________
Harold W. Milner,
President and
Chief Executive Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT TO
REGISTRATION STATEMENT ON FORM S-1 HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES INDICATED ON SEPTEMBER 25, 1995:

SIGNATURE TITLE
--------- -----

/s/ Harold W. Milner President, Chief Executive
____________________________________ Officer and Director
Harold W. Milner (principal executive
officer)

/s/ Paul R. Tieskoetter Controller and Treasurer
____________________________________ (principal financial and
Paul R. Tieskoetter accounting officer)

* Chairman of the Board and
____________________________________ Director
John H. Herrell

* Director
____________________________________
Willis K. Drake

* Director
____________________________________
Alan O. Tuntland

/s/ Harold W. Milner
*By: __________________________
Harold W. Milner,
Attorney-in-Fact

II-4

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders
Kahler Realty Corporation and Subsidiaries:

Under date of February 17, 1995, we reported on the consolidated balance
sheets of Kahler Realty Corporation and Subsidiaries as of January 1, 1995 and
January 2, 1994, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the years then ended, as contained in
the Post-Effective Amendment No. 1 to Form S-1 Registration Statement (No. 33-
82996) for Kahler Management Corporation. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the related
consolidated financial statement schedule in the Registration Statement. This
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on this financial statement
schedule based on our audits.

In our opinion, such schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

KPMG Peat Marwick LLP

Chicago, Illinois
February 17, 1995

INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE

We consent to the use in this Post-Effective Amendment No. 1 to Registration
Statement No. 33-82996 of Kahler Management Corporation on Form S-1 of our
report dated February 19, 1993 (November 12, 1993 as to Note 13) appearing in
the Prospectus, which is a part of this Registration Statement. We also consent
to the reference to us under the heading "EXPERTS" in such Prospectus.

Our audit of the financial statements referred to in our aforementioned
report also included the financial statement schedule of Kahler Realty
Corporation, listed in Item 16.(b) for the year ended January 3, 1993. This
financial statement schedule is the responsibility of the Corporation's
management. Our responsibility is to express an opinion based on our audit. In
our opinion, such financial statement schedule, when considered in relation to
the basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.

Deloitte & Touche LLP

Minneapolis, Minnesota

September 25, 1995

SCHEDULE II

KAHLER REALTY CORPORATION AND SUBSIDIARIES (HISTORICAL KAHLER)

SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS

FOR FISCAL YEARS 1994, 1993 AND 1992

(DOLLARS IN THOUSANDS)

BALANCE ADDITIONS BALANCE
BEGINNING CHARGES TO END OF
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS(A) YEAR
- ----------- --------- ---------- ------------- -------

1994
Allowance for doubtful accounts.... $214 $235 $197 $252
==== ==== ==== ====
1993
Allowance for doubtful accounts.... $199 $183 $168 $214
==== ==== ==== ====
1992
Allowance for doubtful accounts.... $174 $217 $192 $199
==== ==== ==== ====

- --------

(A) "Deductions" consist of accounts written off net of recoveries.

EXHIBIT INDEX

EXHIBIT
NO. DESCRIPTION PAGE NUMBER
------- ----------- -----------

23.2 Consent of KPMG Peat Marwick LLP Electronically Filed