1 Exhibit 2 RED LION INNS LIMITED PARTNERSHIP AND SUBSIDIARY LIMITED PARTNERSHIP CONSOLIDATED BALANCE SHEETS (in thousands, except unit amounts) (UNAUDITED) SEPTEMBER 30, DECEMBER 31, 1997 1996 ---- ---- ASSETS Cash and cash equivalents $ 686 $ 763 Property and Equipment: Land 17,705 17,705 Buildings and improvements 168,011 167,502 Furnishings and equipment 61,193 60,694 Construction in progress 891 184 --------- --------- 247,800 246,085 Less--accumulated depreciation (89,023) (81,356) --------- --------- 158,777 164,729 Other Assets 959 984 --------- --------- Total Assets $ 160,422 $ 166,476 ========= ========= LIABILITIES AND PARTNERS' CAPITAL Current Liabilities: Accounts payable and accrued expenses $ 7 $ 14 Current portion of long-term payable to affiliate 18,607 20,964 Accrued distributions to partners 2,320 2,329 Interest payable -- 41 Property taxes payable 1,392 358 Current portion long-term debt 3,018 2,375 --------- --------- Total current liabilities 25,344 26,081 Long-Term Payable to Affiliate, net of current portion 4,345 4,345 Long-Term Debt, net of current portion 118,631 121,043 Deferred Income Taxes 2,050 2,050 --------- --------- Total Liabilities 150,370 153,519 --------- --------- Commitments and Contingencies (Note 7) Partners' Capital: Limited Partners, 4,940,000 units issued 22,912 25,750 Less -- 806,500 treasury units, at cost (11,202) (11,202) --------- --------- Limited Partners, net 11,710 14,548 General Partner (1,658) (1,591) --------- --------- Total Partners' Capital 10,052 12,957 --------- --------- Total Liabilities and Partners' Capital $ 160,422 $ 166,476 ========= ========= See notes to consolidated financial statements. 2 RED LION INNS LIMITED PARTNERSHIP AND SUBSIDIARY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per unit and unit amounts) (unaudited) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ ------------------------------ 1997 1996 1997 1996 ---- ---- ---- ---- Gross Operating Profit of Hotels $ 11,866 $ 12,088 $ 31,703 $ 31,765 Expenses: Property taxes 788 692 2,415 2,276 Base management fee 887 891 2,530 2,519 Incentive management fee 1,647 1,680 4,376 4,387 Depreciation 2,527 2,568 7,667 7,455 Other 439 642 1,410 1,637 ----------- ----------- ----------- ----------- Operating income 5,578 5,615 13,305 13,491 Interest Expense (3,134) (3,100) (9,242) (9,008) ----------- ----------- ----------- ----------- Income before income taxes 2,444 2,515 4,063 4,483 Income Tax Expense -- (91) -- (337) ----------- ----------- ----------- ----------- Net income $ 2,444 $ 2,424 $ 4,063 $ 4,146 =========== =========== =========== =========== Allocation of Net Income: General Partner $ 49 $ 48 $ 81 $ 83 =========== =========== =========== =========== Limited Partners $ 2,395 $ 2,376 $ 3,982 $ 4,063 =========== =========== =========== =========== Net Income per Limited Partner Unit $ .58 $ .57 $ .96 $ .98 =========== =========== =========== =========== Average Limited Partner Units Outstanding 4,133,500 4,133,500 4,133,500 4,133,500 =========== =========== =========== =========== See notes to consolidated financial statements. 3 RED LION INNS LIMITED PARTNERSHIP AND SUBSIDIARY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (in thousands, except unit amounts) (unaudited) LIMITED PARTNERS -------------------------------------------------------- ISSUED UNITS TREASURY UNITS ------------ -------------- GENERAL UNITS AMOUNT UNITS AMOUNT PARTNER TOTAL ----- ------ ----- ------ ------- ----- Balances at December 31, 1996 4,940,000 $ 25,750 (806,500) $(11,202) $ (1,591) $12,957 Distributions to partners --- (6,820) --- --- (148) (6,968) Net income --- 3,982 --- --- 81 4,063 ---------- ------------ ---------- ---------- ----------- --------- Balances at September 30, 1997 4,940,000 $ 22,912 (806,500) $(11,202) $ (1,658) $ 10,052 ========= ============ ========== ========= =========== ========= See notes to consolidated financial statements. 4 RED LION INNS LIMITED PARTNERSHIP AND SUBSIDIARY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited) NINE MONTHS ENDED SEPTEMBER 30, ------------- 1997 1996 ---- ---- Cash Flows from Operating Activities: Net income $ 4,063 $ 4,146 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 7,667 7,455 Amortization of deferred loan costs 327 428 Deferred income taxes -- 337 Increase in other assets (302) -- Increase in payables and accrued expenses 986 26 --------- --------- Net cash provided by operating activities 12,741 12,392 --------- --------- Cash Flows from Investing Activities: Purchases of property and equipment, net (1,715) (8,050) --------- --------- Cash Flows from Financing Activities: Cash distributions to partners (6,977) (6,986) Repayments of advances from affiliate, net (2,357) (4,702) Payments on long-term debt (1,769) (101,969) Proceeds from long-term debt -- 120,000 Net repayments under revolving credit facility -- (8,302) Additions to deferred loan costs -- (1,311) Net increase in other long-term obligations -- 104 --------- --------- Net cash used in financing activities (11,103) (3,166) --------- --------- Net increase (decrease) in cash (77) 1,176 Cash and Cash Equivalents at Beginning of Period 763 229 --------- --------- Cash and Cash Equivalents at End of Period $ 686 $ 1,405 ========= ========= Supplemental Disclosure of Cash Flow Information: Cash paid for interest $ 8,956 $ 9,309 ========= ========= See notes to consolidated financial statements. 5 RED LION INNS LIMITED PARTNERSHIP NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated financial statements include the accounts of Red Lion Inns Limited Partnership, a Delaware limited partnership (the "Partnership") and its subsidiary limited partnership, Red Lion Inns Operating L.P., a Delaware limited partnership (the "Operating Partnership;" collectively, the "MLP"). The MLP was organized on April 14, 1987 for the purpose of acquiring and owning, through the Operating Partnership, ten Red Lion hotels (the "Hotels" or individually, a "Hotel), which continue to be managed under a long-term management agreement (the "Management Agreement") with Red Lion Hotels, Inc. ("Red Lion"), a wholly-owned subsidiary of Doubletree Corporation pursuant to the November 8, 1996 merger in which Doubletree Corporation acquired 100% of Red Lion (collectively, "Doubletree"). The Management Agreement expires in 2012 and can be extended for an additional ten five-year periods. The general partner of the MLP is Red Lion Properties, Inc. (the "General Partner"), an indirect, wholly owned subsidiary of Doubletree. As of September 30, 1997 all of the hotels have been rebranded "Doubletree." All significant intercompany transactions and accounts have been eliminated. The preparation of financial statements in accordance with generally accepted accounting principles requires the General Partner to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. While the General Partner endeavors to make accurate estimates, actual results could differ from estimates. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments, primarily eliminations of all significant intercompany transactions and accounts) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the related disclosures contained in the MLP's annual report on Form 10-K for the year ended December 31, 1996, as filed with Securities and Exchange Commission. The results of operations for the nine months ended September 30, 1997 are not necessarily indicative of results to be expected for the full year. Cash Equivalents All short-term, highly liquid investments purchased with an original maturity of three months or less are considered to be cash equivalents for purposes of the statements of cash flows. Gross Operating Profit of Hotels The gross operating profit of the Hotels reported in the accompanying statements of operations represents the revenues net of the operating expenses of the Hotels. Operating revenues and expenses and the current assets and current liabilities of the Hotels are excluded from the accompanying consolidated financial statements of the MLP because Doubletree, as manager, not the MLP, has operating responsibility for the Hotels. 2. INCOME TAXES THE MLP IS NOT CURRENTLY A TAXABLE ENTITY AND ANY INCOME TAXES ARE THE RESPONSIBILITY OF THE PARTNERS. ACCORDINGLY, NO CURRENT PROVISION FOR FEDERAL OR STATE INCOME TAXES HAS BEEN PROVIDED BY THE MLP IN THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS. DURING 1987, CONGRESS PASSED THE OMNIBUS BUDGET RECONCILIATION ACT WHICH MANDATES THAT THE MLP BECOME SUBJECT TO CORPORATE TAXES ON ITS INCOME BEGINNING JANUARY 1, 1998. IN ADDITION, DISTRIBUTIONS TO PARTNERS WILL BE CONSIDERED TAXABLE DIVIDENDS TO EACH UNITHOLDER. DEFERRED INCOME TAXES HAVE BEEN PROVIDED FOR THE 6 PROJECTED DIFFERENCES BETWEEN THE FINANCIAL ACCOUNTING AND TAX BASES OF PROPERTY AND EQUIPMENT AT JANUARY 1, 1998. IN MAY, 1997, THE GENERAL PARTNER FORMED A SPECIAL COMMITTEE OF TWO INDEPENDENT DIRECTORS TO EVALUATE ALTERNATIVES AVAILABLE TO THE MLP IN CONNECTION WITH THE SCHEDULED 1998 CHANGE IN THE MLP'S TAX STATUS. THESE ALTERNATIVES INCLUDE, AMONG OTHERS, THE SALE OF THE MLP ASSETS EITHER INDIVIDUALLY OR IN TOTAL, INCORPORATING THE MLP OR CONVERTING OR MERGING THE MLP INTO A REAL ESTATE INVESTMENT TRUST. AT A BOARD MEETING IN JUNE, 1997, THE SPECIAL COMMITTEE RECOMMENDED THAT THE ASSETS OR BUSINESS OF THE MLP BE SOLD IN A VALUE MAXIMIZING TRANSACTION. AT THE SAME MEETING, THE BOARD OF DIRECTORS AUTHORIZED THE SPECIAL COMMITTEE TO PURSUE SUCH A SALE. THE SPECIAL COMMITTEE ENGAGED ITS OWN INDEPENDENT LEGAL COUNSEL AND FINANCIAL ADVISORS TO ASSIST IN THIS PROCESS. IN AUGUST 1997, CONGRESS PASSED THE TAXPAYER RELIEF ACT OF 1997. THE TAXPAYER RELIEF ACT OF 1997 PROVIDES AN EXCEPTION TO THE RULE DESCRIBED ABOVE IN THAT THE MLP MAY ELECT TO CONTINUE TO BE TREATED AS A PARTNERSHIP FOR FEDERAL INCOME TAX PURPOSES AND NOT BE SUBJECT TO FEDERAL OR STATE CORPORATE INCOME TAXES. HOWEVER, IF THIS ELECTION IS MADE THE MLP WILL BE SUBJECT TO A FEDERAL TAX EQUAL TO 3.5% OF ITS GROSS INCOME AND STATE TAXES TO THE EXTENT STATES HAVE ENACTED A PARTNERSHIP GROSS INCOME TAX. UNDER THIS ELECTION, DISTRIBUTIONS PAID TO THE PARTNERS SHOULD CONTINUE TO BE NON-TAXABLE DISTRIBUTIONS. THE ELECTION APPLIES TO TAXABLE YEARS AFTER 1997 AND CAN LATER BE REVOKED. ONCE REVOKED IT CANNOT BE REINSTATED. THE GENERAL PARTNER AND THE SPECIAL COMMITTEE CONTINUE TO EVALUATE AND PURSUE THE SALE OF THE ASSETS OR BUSINESS OF THE MLP. THERE ARE ONGOING NEGOTIATIONS WITH A NUMBER OF INTERESTED PARTIES. IF NEGOTIATIONS WITH ANY PARTY ARE SUCCESSFUL, THE CLOSING OF THE SALE IS EXPECTED TO OCCUR IN TWO TO SIX MONTHS. CONSUMMATION OF A SALES TRANSACTION WILL BE SUBJECT TO A NUMBER OF CONDITIONS INCLUDING THE APPROVAL OF THE BOARD OF DIRECTORS AND, IN MOST INSTANCES, THE UNITHOLDERS OF THE MLP. THERE CAN BE NO ASSURANCE THAT A SALE OF THE ASSETS OR BUSINESS OF THE MLP WILL OCCUR OR THAT ANY OTHER TRANSACTION CAN BE COMPLETED THAT WILL LESSEN THE ADVERSE TAX IMPACT AFTER DECEMBER 31, 1997. IN THE EVENT SUCH A SALE DOES NOT OCCUR BEFORE JANUARY 1, 1998, THE PAYMENT OF TAXES BY THE MLP ON EITHER PARTNERSHIP INCOME OR GROSS INCOME WILL DIRECTLY REDUCE CASH AVAILABLE FOR PARTNER DISTRIBUTIONS. 3. LONG-TERM DEBT During April 1996, the MLP entered into a three-year $125 million credit facility. The credit facility includes a $120 million term loan and a $5 million revolving credit line. The proceeds of the term loan were used to repay all amounts owed under the prior mortgage note and revolving credit facility, a portion of the payable to affiliate (related to deferred incentive management fees) and loan fees incurred to consummate the financing. The facility is secured by all of the assets of the Hotels. Borrowings under the term loan bear interest at the London Interbank Offering Rate ("LIBOR") plus 2.25% (8.00% at September 30, 1997). Borrowings under the revolving credit line bear interest, at the MLP's election, at either LIBOR plus 2.25% or the prime rate plus 1.25%. At September 30, 1997, all outstanding borrowings bear interest at LIBOR plus 2.25% (8.00%), total $4.5 million, and are due and payable on March 31, 1999. Accordingly, this balance is classified as long-term in the accompanying balance sheets. The remaining principal payments due on the three-year term loan totaled $0.7 million and $3.2 million for 1997 and 1998, respectively, with a lump-sum payment of $112.9 million due on March 31, 1999. Long-term debt also includes approximately $0.4 million in other long-term obligations related to special tax assessments that the MLP has elected to pay out over a 20-year period. These long-term obligations have varying maturity dates ranging from August 2009 to June 2016. Interest Rate Swap Agreements At September 30, 1997, the MLP had four interest rate swap agreements outstanding which have substantially converted $100 million of debt from floating LIBOR based rates to fixed rates ranging from 6.17% to 6.23% (prior 7 to the applicable margin). The agreements expire from December 1998 to March 1999. Interest expense incurred by the MLP relating to interest rate swap agreements for the three and nine month periods ended September 30, 1997, was approximately $110,000 and $363,000, respectively, and is included in interest expense. 8 4. MANAGEMENT FEES In accordance with the Management Agreement, the MLP pays base and incentive management fees to Doubletree. Base management fees payable are equal to 3% of the annual gross revenues of the Hotels. Incentive management fees payable are equal to the sum of 15% of annual adjusted gross operating profit up to $36 million (operating profit target) and 25% of annual adjusted gross operating profit in excess of the operating profit target. Adjusted gross operating profit is calculated by subtracting the base management fee expense from the gross operating profit of Hotels as shown in the accompanying consolidated financial statements. The MLP may defer payment of the incentive fees to Doubletree to the extent that the calculation of Cash Flow for Incentive Fees, as defined in the Management Agreement, on an annual basis, does not exceed $2.20 per unit ("Priority Return"). Currently, the incentive management fee is accrued at 15% of the quarter's adjusted gross operating profit regardless of whether cash flow is adequate to pay the incentive management fee on an interim basis, if cash flow is expected to be available for payment of the incentive management fee on an annual basis. 5. CASH DISTRIBUTIONS TO PARTNERS In accordance with the Partnership's Amended and Restated Agreement of Limited Partnership, cash distributions to partners may be made from Cash Flow Available for Distribution, as defined. As discussed in Note 4, the incentive management fee is payable only to the extent that cash flow available after payment of the cash distributions to partners exceeds the Priority Return. The following table calculates Cash Flow Available for Distribution and Incentive Management Fees ("Cash Flow") for the three and nine-month periods ended September 30, 1996 and 1997. Cash Flow is defined as pre-tax income (or loss) before noncash charges (primarily depreciation and amortization) and incentive management fees, but after the reserve for capital improvements and principal payments on certain debt. (In thousands except per unit amounts) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- --------------------------- 1997 1996 1997 1996 ---- ---- ---- ---- Net income $ 2,444 $ 2,424 $ 4,063 $ 4,146 Add (deduct): Depreciation 2,527 2,568 7,667 7,455 Incentive management fee 1,647 1,680 4,376 4,387 Amortization of deferred loan costs 109 109 327 428 Cash reserved for capital improvements (887) (891) (2,530) (2,519) Repayments on term loan (625) (500) (1,750) (1,532) Deferred income tax provision -- 91 -- 337 ----------- ----------- ----------- ----------- Cash Flow 5,215 5,481 12,153 12,702 Less: Priority Return (2,320) (2,329) (6,968) (6,986) ----------- ----------- ----------- ----------- Cash Flow available for payment of incentive management fees 2,895 3,152 5,185 5,716 Less: Current incentive management fee (1,647) (1,680) (4,376) (4,387) ----------- ----------- ----------- ----------- Excess cash flow $ 1,248 $ 1,472 $ 809 $ 1,329 =========== =========== =========== =========== Cash Flow per unit $ 1.24 $ 1.29 $ 2.88 $ 3.00 =========== =========== =========== =========== Average Limited Partner Units Outstanding 4,133,500 4,133,500 4,133,500 4,133,500 =========== =========== =========== =========== 9 The incentive management fee that is earned but not paid on an annual basis due to insufficient Cash Flow, is deferred without interest up to a maximum of $6 million. The deferred amount is to be paid out of either (i) 25% of cash flow in excess of the Priority Return and the current incentive management fee or (ii) sale or refinancing proceeds prior to any distribution to the limited partners. Beginning January 1, 1998, federal tax law mandates that the MLP become subject to corporate taxes on its income or, at its election remain a partnership for tax purposes and pay a gross income tax. The MLP is not currently a taxable entity. The payment of such taxes by the MLP will directly reduce cash available for partner distributions. If the MLP elects to pay corporate income taxes, distributions to partners after December 31, 1997 will be considered taxable dividends. Although the MLP has historically distributed the Priority Return to limited partners, there is no assurance this will continue after December 31, 1997. In addition, the Priority Return can be used to repay certain indebtedness owed to Doubletree or to fund capital improvements, also reducing cash flow available for distribution to limited partners. 6. RELATED PARTY TRANSACTIONS The General Partner is responsible for the management and administration of the MLP. In accordance with the MLP's Amended and Restated Agreements of Limited Partnership, the MLP reimburses the General Partner for related administrative costs. Under the Management Agreement, the MLP pays base and incentive management fees to Doubletree. The Hotels, in accordance with the Management Agreement, are also charged by Doubletree for their pro rata share of support services such as computer, advertising, public relations, promotional and sales and central reservation services. All MLP personnel are employees of Doubletree and its affiliates. All costs for services of such employees are reimbursed to Doubletree by the Operating Partnership. These costs include salaries, wages, payroll taxes and other employee benefits. Additionally, auxiliary enterprises owned by Doubletree or its affiliates sell operating supplies, furnishings and equipment to the MLP. Amounts payable to affiliate consists of the following (in thousands): SEPTEMBER 30, DECEMBER 31, 1997 1996 ---- ---- Advances from Doubletree $ 19,930 $ 20,060 General Partner Credit Facility 3,726 3,726 Deferred Incentive Management Fees 619 700 -------- -------- Total due to Doubletree 24,275 24,486 Plus: Hotel working capital (surplus) deficit (1,323) 823 -------- -------- Payable to affiliate net of hotel working capital 22,952 25,309 Less: Current portion (18,607) (20,964) -------- -------- Long-term portion $ 4,345 $ 4,345 ======== ======== Advances from Doubletree consist primarily of funds advanced for capital improvements in excess of the reserve (equal to 3% of revenues required by the provisions of the Management Agreement) and incentive management fees earned but unpaid in the current year. Amounts advanced bear interest at the prime rate plus 0.5% (9.0% at September 30, 1997). The Hotel working capital consists of the current assets and current liabilities of the Hotels, including cash held in hotel accounts, accounts receivable, inventories, prepaid expenses, hotel accounts payable and certain taxes other than property, income and payroll taxes. Since Doubletree has operating responsibilities associated with the Hotels, these current asset and current liability items are excluded from the accompanying consolidated financial statements and are assumed to be liquidated into cash and used to pay down the payable to affiliate from $24.3 million to $23.0 million at September 30, 1997. 10 During the first 36 months of operation, which ended April 30, 1990, the General Partner advanced, on a non-interest basis, amounts under the General Partner Credit Facility to fund distributions of the Priority Return. The MLP anticipates this amount will be repaid out of either (i) cash flow after payment of the Priority Return and incentive management fees, or (ii) sale or refinancing proceeds prior to any distribution to limited partners. Accordingly, the credit facility is classified as long-term. Deferred incentive management fees are non-interest bearing and are payable from either (i) 25% of cash flow in excess of the Priority Return and the current incentive management fee or (ii) sale or refinancing proceeds. At September 30, 1997 all of this balance is classified as long-term. The following schedule reflects the operating revenues and expenses of the Hotels not reflected in the accompanying consolidated financial statements (in thousands): THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------- --------------------- 1997 1996 1997 1996 ---- ---- ---- ---- Revenues: Rooms $19,249 $19,094 $52,161 $51,004 Food and beverage 7,378 7,706 23,401 24,237 Other 2,939 2,896 8,779 8,728 ------- ------- ------- ------- Total revenues 29,566 29,696 84,341 83,969 ------- ------- ------- ------- Departmental direct expenses: Rooms 4,439 4,529 12,993 12,659 Food and beverage 6,197 6,313 19,248 19,563 Other 1,011 1,028 2,999 3,176 ------- ------- ------- ------- Total departmental direct expenses 11,647 11,870 35,240 35,398 ------- ------- ------- ------- Hotel indirect expenses: Administrative and general 2,217 2,307 6,851 6,887 Sales, promotion and advertising 1,883 1,508 4,886 4,283 Utilities 923 928 2,518 2,587 Repairs and maintenance 1,030 995 3,143 3,049 ------- ------- ------- ------- Total hotel indirect expenses 6,053 5,738 17,398 16,806 ------- ------- ------- ------- Gross operating profit of hotels $11,866 $12,088 $31,703 $31,765 ======= ======= ======= ======= 7. COMMITMENTS AND CONTINGENCIES At September 30, 1997, the MLP had commitments relating to capital improvement projects of approximately $1.2 million. The MLP is subject to litigation arising in the ordinary course of business. In the opinion of the General Partner, these actions will not have a material adverse effect, if any, on the financial position or results of operations or liquidity of the MLP or its subsidiary.