<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K
(Mark One)
     [X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
          EXCHANGE ACT OF 1934 (FEE REQUIRED) 
          For the fiscal year ended December 31, 1996 or

     [ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
          EXCHANGE ACT OF 1934 (NO FEE REQUIRED) 
          For the transition from _________ to _________

                         Commission File Number: 0-23256

                               JAMESON INNS, INC.
             (Exact name of Registrant as specified in its Articles)

             Georgia                                  58-2079583
   (State or other jurisdiction                    (I.R.S. Employer
of incorporation or organization)                 Identification No.)

        8 Perimeter Center East, Suite 8050, Atlanta, Georgia 30346-1603
               (Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (770) 901-9020

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

Securities registered pursuant to Section 12(g) of the Act:

                     Common Stock, par value $0.10 per share
                               Title of Each Class

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to the
filing requirements for the past 90 days. [X] Yes [ ] No

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

        AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NONAFFILIATES
              OF THE REGISTRANT AS OF JANUARY 31, 1997: $89,508,188

  NUMBER OF SHARES OF COMMON STOCK OUTSTANDING ON JANUARY 31, 1997 - 7,364,745

                       DOCUMENTS INCORPORATED BY REFERENCE

                                      NONE
<PAGE>   2
                                    FORM 10-K
                               JAMESON INNS, INC.
                                  ANNUAL REPORT
                          YEAR ENDED DECEMBER 31, 1996


                                Table of Contents

<TABLE>
<CAPTION>
                                                                              Page
                                                                              ----
                                     PART I                                 
                                                                            
<S>                                                                           <C>
Item 1.  Business ..........................................................     1
                                                                            
Item 2.  Properties ........................................................    25
                                                                            
Item 3.  Legal Proceedings .................................................    28
                                                                            
Item 4.  Submission of Matters to a Vote of Security Holders ...............    28
                                                                            
                                     PART II                                
                                                                            
Item 5.  Market for the Registrant's Common Equity and Related              
         Stockholder Matters................................................    28
                                                                            
Item 6.  Selected Financial Data............................................    29
                                                                            
Item 7.  Management's Discussion and Analysis of Financial Condition        
         and Results of Operations..........................................    31
                                                                            
Item 8.  Financial Statements and Supplementary Data........................    37
                                                                            
Item 9.  Changes in and Disagreements with Accountants on Accounting        
         and Financial Disclosure...........................................    37
                                                                            
                                    PART III                                
                                                                            
Item 10. Directors and Executive Officers of the Registrant.................    38
                                                                            
Item 11. Executive Compensation.............................................    40
                                                                            
Item 12. Security Ownership of Certain Beneficial Owners and Management.....    43
                                                                            
Item 13. Certain Relationships and Related Transactions.....................    43
                                                                            
                                     PART IV                                
                                                                            
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...    46
</TABLE>
<PAGE>   3
                               JAMESON INNS, INC.
                                  ANNUAL REPORT
                       PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                                     PART I

ITEM 1. BUSINESS.

GENERAL

         Jameson Inns, Inc., a Georgia corporation, (the "Company") is a
self-administered real estate investment trust ("REIT") headquartered in
Atlanta, Georgia which develops and owns limited service hotel properties
("Inns") operating in the southeastern United States under the trademark "The
Jameson Inn(R)." At December 31, 1996, the Company had a total of 64 Inns either
in operation or under development, including 43 Inns in operation (2,107
available rooms), 11 Inns under construction and contracts to acquire 10 parcels
of land on which additional Inns are expected to be constructed during 1997. In
addition, at that date, one of the Inns in operation was undergoing a 20-room
expansion. Upon completion of these projects, the Company expects to have 2,967
available rooms.

         The Company focuses on developing Inns in communities in the
southeastern United States which have a strong and growing industrial or
commercial base and a shortage of quality hotel rooms. Generally, the Inns are
rooms-only facilities designed to appeal to price and quality conscious business
travelers, such as sales representatives, government officials and others who
travel to these communities on business, as well as family and leisure travelers
attending activities in the communities such as college and university sponsored
events, fairs, festivals and other cultural events and family reunions. The
standard Inn is initially built as a 40-unit, two-story, Colonial-style
structure constructed on a one- to two-acre tract with an outdoor swimming pool,
fitness center and parking area. As initially constructed, the standard Inn has
38 guest rooms and two executive suites and features amenities such as
remote-controlled television with access to cable programming, including HBO,
free local calls, complimentary continental breakfast and newspaper, king-sized
or double beds, attractive decor, quality furnishings and, in select rooms,
whirlpool baths and small refrigerators.

         The lodging industry is generally divided into three broad categories
based on the type of services provided. The first of these categories, full
service hotels and resorts, offer their guests rooms, food and beverage
services, meeting rooms, room service and similar guest services, and, in some
cases, resort entertainment and activities. The second category is the limited
service hotel, which generally offers rooms-only facilities and amenities such
as swimming pools, continental breakfast and similar, limited services. The
third category is the all-suite hotel which offers guests more spacious
accommodations and usually kitchen facilities in the suite and common laundry
facilities. Each of these categories is generally subdivided into
classifications based on price and quality. The terminology generally used in
the hotel industry describes properties as luxury at the high end, economy in
the middle and budget at the low end of the scale. Prices for each of these
categories vary by region and locale. The Inns fall within the category of
small, limited service, economy hotels.

                                        1
<PAGE>   4
         The hotel industry is seasonal in nature. Occupancy rates are generally
higher in the second and third calendar quarters than in the first and fourth
quarters. This seasonality can be expected to cause quarterly fluctuations in
the Company's revenues.

         All of the Inns are leased to Jameson Operating Company (the
"Operator") under the terms of a master lease (the "Lease"). See --The Lease
below. The Operator was formed to conduct the operation of the Inns and entered
into the Lease with the Company for that purpose.

         The Company's executive offices are located at 8 Perimeter Center East,
Suite 8050, Atlanta, Georgia 30346-1603. The Company's telephone number is (770)
901-9020.

DEVELOPMENT OF BUSINESS

         The Company was formed in 1988 to develop, own and operate Inns and
elected to be taxed for federal income tax purposes as a real estate investment
trust ("REIT") beginning January 1, 1994, and in 1994 became a publicly held
company upon consummation of its initial public offering of the Company's common
stock, par value $.10 per share ("Common Stock").

THE LEASE

         The Company has entered into the Lease with the Operator which covers
all of the existing Inns. Furthermore, new Inns developed by the Company during
the term of the Lease will become subject to the Lease upon completion of
construction. See Item 13. Certain Relationships and Related Transactions--The
Lease. The following is a summary description of the terms and conditions of the
Lease as so amended.

         Pursuant to an amendment to the Lease effective January 1, 1997 (the
"Lease Amendment"), the Lease term expires on December 31, 2006, subject to
earlier termination upon the occurrence of certain events. During the term of
the Lease, the Operator is obligated to pay to the Company base rent based on
the number of rooms in operation on the first day of the month and, where
required under the formula described below, percentage rent based on room
revenues. In general, percentage rent is calculated by multiplying average daily
per room rental revenues for all of the Inns by certain percentages. Under the
Lease, base rent is payable monthly and equals $264.00 per room per month
multiplied by the number of rooms available to rent at the beginning of the
month. Percentage rent is payable quarterly and equals the following:

                  39% of the first $20.50 of average daily per room rental
                  revenues; plus

                  65% of all additional average daily per room rental revenues;
                  less

                  100% of base rent paid for the same period.

Percentage rent is based on the total number of rooms available to rent during
the period, rather than the number of rooms available to rent at the beginning
of each month. The total base rent plus percentage rent payable by the Operator
under the Lease each calendar year, however, is limited to 47% of room revenues.

                                        2
<PAGE>   5
         Effective January 1, 1997, the $20.50 amount referred to above was
increased to $21.05 for 1997 based on the 2.7% increase in the Consumer Price
Index for All Urban Consumers published by the U.S. Department of Labor Bureau
of Labor Statistics for the year ended December 31, 1996. Similar adjustments
will be made on each subsequent January 1 for the year then beginning based on
the changes experienced over the most recently completed calendar year.

         Average daily per room rental revenues are determined by dividing room
revenues realized by the Operator over any given period by the sum of the number
of rooms available for rent on each day during the period. Room revenues as
defined in the Lease include revenues from telephone charges, vending machine
payments and other miscellaneous revenues and exclude all credits, rebates and
refunds, sales taxes and other excise taxes. On or before March 1 of each year,
the Operator is required to provide a calculation of the percentage rent payable
for the preceding year, together with a report by the same independent
accounting firm serving as auditors of the Company's financial statements, on
the amount of room revenues and percentage rent. Total rent, including both base
rent and percentage rent, earned by the Company for the years ended December 31,
1994, 1995 and 1996 was $4.0 million, $6.3 million and $9.4 million,
respectively.

         In addition to paying base rent and, if applicable, percentage rent,
the Lease requires the Operator to pay workers' compensation insurance premiums,
and all costs and expenses incurred in the operation of the Inns. The Company is
responsible for paying real and personal property taxes, casualty, liability and
other types of insurance, the costs of replacing or refurbishing furniture,
fixtures and equipment, and the maintenance of structural elements, roofs and
underground utilities.

         The Operator was formed in 1993 to conduct the operation of the Inns
and entered into the Lease with the Company for that purpose. The Operator is
owned 9.9% by Thomas W. Kitchin, Chairman, President and Chief Executive Officer
of the Company, and 90.1% by a grantor trust of which Steven A. Curlee, General
Counsel and Secretary of the Company, is the trustee and beneficiary. The
Operator has only nominal assets and a limited net worth.

         The Company's members of the Board of Directors of the Company who are
not also officers or employees of the Company and who are not affiliated with
the Operator or the Contractor ("Independent Directors") (see --Growth Plans for
1997--The Contractor, below), approved the Lease Amendment and determined that
the Lease, as amended, is fair to the Company.

         Trademark. The Operator is the owner of the registered trademark, The
Jameson Inn(R). The Lease requires the Operator to operate the Inns using the
trademark and not to use the trademark (or license its use to any other parties)
for the operation of lodging facilities other than the Inns if the Company
objects to such unrelated use. The Company has an option to purchase the
trademark from the Operator at the end of the Lease term (or upon the earlier
termination of the Lease with respect to all of the Inns) for $25,000.

         Maintenance and Modifications. Under the Lease, the Company is required
to maintain the underground utilities and the structural elements of the
improvements and the roof of each Inn.

                                        3
<PAGE>   6
The Operator is required, at its expense, to maintain the Inns in good order and
repair and to make non-structural, foreseen and unforeseen, and ordinary and
extraordinary repairs which may be necessary and appropriate to keep the Inns in
good order and repair.

         The Operator, at its expense, may make non-capital and capital
additions, modifications or improvements to the Inns which do not significantly
alter the character or purposes, or significantly detract from the value or
operating efficiencies, of the Inns. Modifications or improvements estimated to
cost in excess of $100,000 must be done under the supervision of a qualified
architect, engineer or contractor satisfactory to the Company and in accordance
with plans and specifications approved by the Company. All alterations,
replacements and improvements are subject to all the terms and provisions of the
Lease and become the property of the Company upon termination of the Lease.
Through January 31, 1997, the Operator had not undertaken any significant
capital or non-capital alterations, replacements or improvements to the Inns.

         Hotels in general, including the Inns, have an ongoing need for
renovation and refurbishment. The Company seeks to control such costs through
the construction of new Inns rather than the purchase and renovation of existing
hotel properties. Nonetheless, the Inns require periodic replacement of
furniture, fixtures and equipment and the Lease requires that the Company pay
the costs of such refurbishment. The Company has adopted a policy of maintaining
sufficient cash or available borrowings to fund expenditures for replacement and
refurbishment of furniture fixtures and equipment for the Inns up to an amount
equal to 4% of the Operator's total aggregate room revenues since July 1, 1995,
less the amounts actually expended since that date. While management believes
that such amount is adequate to support proper refurbishment of the Inns, the
actual amounts necessary to pay such costs could exceed the Company's estimate.
In such case, expenditure of additional funds for furniture, fixtures and
equipment could have an adverse effect on the Company's ability to make the full
amount of expected distributions to shareholders. See Item 7. Management's
Discussion and Analysis of Operations--Liquidity and Capital Resources. As of
December 31, 1996, the reserve contained approximately $263,000.

         Insurance and Property Taxes. The Lease provides that the Company is
responsible for paying or reimbursing the Operator for real and personal
property taxes as well as for all insurance coverage on the Inns except workers'
compensation coverage which is an obligation of the Operator.

         Indemnification. The Lease requires the Operator to indemnify the
Company and its affiliates from and against all liabilities, costs and expenses
(including reasonable attorneys' fees and expenses) incurred by, imposed upon or
asserted against the Company or its affiliates, on account of, among other
things, (i) any accident or injury to person or property on or about the Inns,
(ii) any misuse by the Operator, or any of its agents, of the leased property,
(iii) taxes and assessments in respect of the Inns (other than real and personal
property taxes and income taxes of the Company on income attributable to the
Inns), or (iv) any breach of the Lease by Operator. The Lease does not, however,
require the Operator to indemnify the Company against the Company's gross
negligence or willful misconduct. The Company is required to indemnify the
Operator against any environmental liabilities other than those caused by the
acts or negligent failures of the Operator (for which the Operator will
indemnify the Company).

                                        4
<PAGE>   7
         Assignment and Subleasing. Under the terms of the Lease, the Operator
is not permitted to sublet all or any part of any of the Inns or assign its
interest under the Lease, other than to an affiliate of the Operator controlled
by Mr. Kitchin, without the prior written consent of the Company. No assignment
or subletting will release the Operator from any of its obligations under the
Lease.

         Events of Default. Events of default under the Lease include, among
others, the following:

         (i) the Operator's continuing failure to pay rent for a period of 10
days after receipt by the Operator of written notice of nonpayment from the
Company;

         (ii) except under certain circumstances, continued failure by the
Operator to observe or perform any other term of the Lease for a period of 30
days after the Operator receives notice of the failure from the Company;

         (iii) the Operator's bankruptcy, insolvency or similar event;

         (iv) the Operator's voluntary discontinuation of operations at an Inn
for more than five days, without the consent of the Company, except as a result
of damage, destruction or condemnation.

         If an event of default occurs and continues beyond any curative period,
the Company has the option of terminating the Lease as to any individual Inn
(which would not affect the Lease as to the remainder of the Inns) or as to all
of the Inns by giving the Operator 10 days written notice of the termination
date.

         Termination of Lease on Disposition of the Inns. If the Company enters
into an agreement to sell or otherwise transfer an Inn, the Company may
terminate the Lease as to that Inn. However, if, during the first five years of
the Lease term, the Lease is terminated as to Inns comprising at least 25% of
the total rooms of all of the Inns within a period of 12 consecutive months, the
Operator must be compensated for the loss of its leasehold interest or offered
substitute Inns. Most of the Inns have been mortgaged to secure indebtedness of
the Company. See Item 2. Properties--Mortgage Indebtedness. In the event of the
foreclosure sale (or transfer in lieu of foreclosure) of any Inn, the Lease will
terminate with respect to such Inn.

         Inventory. The Lease requires all inventory required in the operation
of the Inns to be acquired by the Operator. Inventory includes items such as
cleaning supplies, linens, towels and paper goods.

FORWARD-LOOKING STATEMENTS

         There are a number of statements in this report which address
activities, events or developments which the Company expects or anticipates will
or may occur in the future, including such things as the Company's expansion
plans, including acquisition of or leasing additional parcels of land,
construction of new Inns and expansion of existing Inns, availability of debt
financing and capital, payment of quarterly dividends and other matters. These
statements are

                                        5
<PAGE>   8
based on certain assumptions and analyses made by the Company in the light of
its experience and its perception of historical trends, current conditions and
expected future developments as well as other factors it believes are
appropriate under the circumstances. However, whether actual results and
developments will conform to the Company's expectations and predictions is
subject to a number of risks and uncertainties, including: (1) the Company's
ability to (a) secure construction and permanent financing to finance such
development on terms and conditions favorable to the Company, (b) assess
accurately the market demand for new Inns and expansions of existing Inns, (c)
identify and purchase new sites which meet its various criteria, including
reasonable land prices, (d) contract for the construction of new Inns and
expansions of existing Inns in a manner which produces Inns consistent with its
present quality and standards at a reasonable cost and without significant
delays, (e) provide ongoing renovation and refurbishment of the Inns sufficient
to maintain consistent quality among the Inns, and (f) manage its business in a
cost-effective manner given the increase in the number of Inns; (2) the
Operator's ability to manage the Inns profitably; (3) general economic, market
and business conditions, particularly those in the lodging industry generally
and in the geographic markets where the Inns are located; (4) the business
opportunities (or lack thereof) that may be presented to and pursued by the
Company; (5) the availability of qualified managers and employees necessary for
the Company's planned growth; (6) changes in laws or regulations; and (7) other
factors, most of which are beyond the control of the Company. Consequently, all
of the forward-looking statements made in this report are qualified by these
cautionary statements and there can be no assurance that the actual results or
developments anticipated by the Company will be realized, or even if
substantially realized, that they will have the expected consequences to or
effects on the Company or its business or operations.

GROWTH PLANS FOR 1997

         The Company's objective is to enhance shareholder value by increasing
Funds from Operations and Cash Available for Distribution by developing
additional Inns, expanding existing Inns and participating, through the Lease,
in increased room revenues generated through operation of the Inns by the
Operator. For definitions and calculation of Funds from Operations and Cash
Available for Distributions, see Item 6. Selected Financial Data and Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Funds from Operations; Cash Available for Distribution.

    Development of New Inns

         The Company believes that attractive opportunities exist for the
development of new Inns in certain markets in the southeastern United States.
Accordingly, the Company intends to continue developing new Inns in targeted
communities. With operating Inns in Georgia, Alabama and South Carolina, the
Company plans to continue developing Inns in those states as well as in North
Carolina, Tennessee and Florida. At December 31, 1996, the Company had a total
of 21 Inns under development, including 11 Inns under construction, and
contracts to acquire 10 parcels of land on which additional Inns are expected to
be constructed during 1997. In addition, the Company may consider long-term
ground leases for future Inn locations.

                                        6
<PAGE>   9
         The following sets forth the location of new Inns under construction by
the Company at December 31, 1996, which have opened or are expected to open in
1997. Each such Inn initially has or will have 40 rooms. The Inns in Oakwood,
Forest City and Union opened in January or February 1997.

<TABLE>
<CAPTION>
<S>                                <C>
                  Alabama:         Auburn, Oxford, Tuscaloosa
                  Georgia:         Oakwood
                  North Carolina:  Forest City, Laurinburg, Sanford, Wilson
                  South Carolina:  Union 
                  Tennessee:       Decherd, Tullahoma
</TABLE>

         The Company believes that it benefits significantly from its strategy
of developing new Inns rather than acquiring existing properties and
rehabilitating, refurbishing or re-flagging them because of the experience and
track record of the Company, the Contractor (see --The Contractor, below) and
the Operator in the development, construction and operation of Inns.

         In evaluating potential development sites, the Company targets
communities with strong industrial bases sufficient to attract business
travelers. These communities typically have significant manufacturing
facilities, state and federal government installations, or colleges and
universities. The Company strives to locate its Inns in proximity to
family-style restaurants and targets markets which offer local community events
(e.g. annual festivals, fishing tournaments, collegiate football games and other
athletic events, graduation ceremonies, etc.) and/or tourist and recreational
facilities (e.g. lakes, golf courses, hunting areas, etc.) attracting groups and
individual discretionary and leisure travelers. The Inns are generally located
in communities ranging in population from 5,000 to 30,000. The Company believes
that land costs in the Company's target markets are generally lower than similar
costs in major metropolitan areas.

     Expansion of Existing Inns

         The Company intends to continue to expand existing Inns whenever market
conditions warrant. A typical expansion involves adding a stand-alone 20- to
26-room structure to the standard 40-room Inn. To date, 15 Inns have undergone
expansion and, at December 31, 1996, one additional Inn, located in Gaffney,
South Carolina, was undergoing a 20-room expansion. Because the Inns are
initially constructed with the office and lobby, swimming pool and fitness
center on sites generally large enough for future expansions, the incremental
cost per room of expansions is lower than for new Inns. Accordingly, the Company
can earn attractive returns on its investment by expanding Inns in markets with
strong room demand. In addition, the design of the standard Inn permits the
expansion of an Inn with relatively little disruption to the existing Inn's
operations. Also, as compared to the development of new Inns, expansion of
existing Inns is a relatively lower risk growth strategy since the Company has
an opportunity to assess local room demand and market trends based on its direct
experience in developing and owning the existing Inn.

                                        7
<PAGE>   10
     The Contractor

         It is anticipated that Jameson Development Company, L.L.C., the
successor to Jameson Construction Company, will act as general contractor
("Contractor") for new Inns built by the Company as well as expansions of
existing Inns. Jameson Construction Company is wholly owned by Kitchin
Investments, Inc., an entity wholly owned by Thomas W. Kitchin (see -Employees,
below, and Item 13. Certain Relationships and Related Transactions--Cost
Reimbursement Agreement). As of September 30, 1996, Jameson Construction Company
assigned all its contracts to Jameson Development Company, L.L.C., a company
wholly owned by Thomas W. Kitchin and his spouse, which was formed in 1996 to
act as the Contractor with the same management and employees as Jameson
Construction Company. Each construction contract for a new Inn or a group of
Inns provides for a fixed turnkey price for all work performed under the
contract subject to reduction, however, if the Contractor's profits (as defined
in the construction contract) exceed 10%. Each such construction contract is
reviewed by an independent architectural firm and subject to approval by a
majority of the Company's Independent Directors. The average turnkey price for
the 11 new Inns opened during 1996 was approximately $1,247,500. The contract
price excludes the cost of the land and closing costs, but includes the costs of
constructing and equipping the Inns and related fitness centers, including
interest charges incurred by the Company on the associated construction debt
during construction. The average turnkey contract price for each expansion of an
existing Inn in 1996 was approximately $27,000 per room, excluding the amount of
any extraordinary site development costs. See Item 13. Certain Relationships and
Related Transactions--Turnkey Construction Contracts.

     Internal Growth

         Through percentage rent, the Company participates in any increases in
room revenues generated through increases in occupancy rates and average daily
room rates ("ADR") of the Inns by the Operator. Total rent, including base rent
and percentage rent, is limited however, for each calendar year to 47% of room
revenues. See --The Lease, above. The Operator practices aggressive
market-sensitive pricing, increasing room rates at particular Inns as market
conditions in the specific communities warrant. The Inns' site managers receive
a significant portion of their compensation based on achieving specified monthly
room revenues and annual expense controls. The Operator promotes an aggressive
marketing program which focuses on local efforts directed to the business
community in each Inn's market. See --Marketing, below.

MARKETING

         Marketing of the Inns focuses on local efforts directed to the business
community in the city or town where the particular Inn is located. One of the
primary responsibilities of an Inn's manager is to make sales calls on local
chambers of commerce, businesses, factories, government installations and
colleges and universities. The goal of the sales call is to familiarize local
business people with the Inn in their community and solicit their recommendation
of the Inn to business travelers visiting communities where Inns are located,
including both individual discretionary travelers as well as groups attending
family or community events. The Company employs billboards and other similar
types of advertising and has an "800" number to facilitate reservations.

                                        8
<PAGE>   11
COMPETITION

         The hotel industry is highly competitive. Each of the Inns is located
in an area that includes other hotels, many of which are competitive with the
Inns in their community. The number of competitive hotels in a particular area
could have a material adverse effect on occupancy, ADR and revenue per available
room ("REVPAR") of the Inns. Moreover, the Inns are generally located in smaller
communities where the entry of even one additional competitor into the market
may materially affect the financial performance of the Inn in that community.

         The Company competes on the basis of price, quality and value. The
Company's competition is made up primarily of limited service hotels in the
southeastern United States operating under national franchises which have
greater financial resources than the Company, substantial advertising budgets,
national reservation systems, marketing programs and greater name recognition.

REGULATIONS

         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 hazardous or toxic substances on, under or in such property. Such laws often
impose liability whether or not the owner or operator knew of, or was
responsible for, the presence of such hazardous or toxic substances. In
addition, the presence of hazardous or toxic substances, or the failure to
properly remediate such property, may adversely affect the owner's ability to
borrow using such real property as collateral. Persons who arrange for the
disposal or treatment of hazardous or toxic substances may also be liable for
the costs of removal or remediation of such substances at the disposal or
treatment facility, whether or not such facility is owned or operated by such
person. While the Company has not incurred any such costs in connection with its
ownership of the Inns, the Company may be potentially liable for such costs. The
Company generally develops Inns in areas where the historical use of the land is
well known and often agricultural. Management is not aware of any potential
material liability or claims for which the Company may be responsible. However,
no assurances can be given that (i) there are no material claims or liabilities
related to real property ownership by the Company; (ii) future laws, ordinances
or regulations will not impose any material environmental liability on the
Company; or (iii) the current environmental condition of the Inns will not be
affected by operation of the Inns, by the condition of properties in the
vicinity of the Inns (such as the presence of underground storage tanks) or by
third parties. Under the terms of the Lease, the Company indemnifies the
Operator against environmental liabilities, except those caused by the acts or
negligent failures of the Operator. In addition, the Lease provides that the
Operator will indemnify the Company against environmental liabilities caused by
the Operator's acts or negligent failures, although the Operator's financial
condition may limit the value of such indemnity and, in any event, such
indemnity will not apply to or protect the Company against past unknown
violations and related liabilities. See --The Lease, above.

         The Company believes that the Inns are in compliance in all material
respects with all federal, state and local ordinances and regulations regarding
hazardous or toxic substances and does not anticipate that it will be required
in the foreseeable future to expend any material amounts

                                        9
<PAGE>   12
in order to comply with such ordinances and regulations. The Company has not
been notified by any governmental authority, nor is it otherwise aware, of any
material noncompliance, liability or claim relating to hazardous or toxic
substances in connection with any of its present or former properties.

         Americans with Disabilities Act. Under the Americans with Disabilities
Act of 1990 (the "ADA"), all public accommodations are required to meet certain
federal requirements related to access and use by disabled persons. In addition
to remedial costs, noncompliance with the ADA could result in imposition of
fines or an award of damages to private litigants. The Company believes that all
existing Inns are substantially in compliance with these requirements and
intends to construct future Inns in accordance with such requirements as well.
In 1993, the Company engaged a disabilities consultant to make recommendations
to the Company regarding the Inns' compliance with the ADA. The consultant
submitted a report recommending a number of improvements for access to and use
by disabled persons with respect to certain of the Inns then in operation, which
improvements were made. The Company has also incorporated such consultant's
recommendations into the construction of new Inns.

EMPLOYEES

         At December 31, 1996, the Company employed 10 persons. Employees of the
Company are also employees of Kitchin Investments, Inc. Effective January 1,
1994, under the terms of an agreement covering the allocation of administrative
and overhead costs incurred by the Company and Kitchin Investments, Inc. (the
"Cost Reimbursement Agreement"), the Company reimburses Kitchin Investments,
Inc. for the time that their shared employees spend on the Company's business.
For the year ended December 31, 1996, the Company's reimbursement to Kitchin
Investments, Inc. totalled approximately $194,000. See Item 13. Certain
Relationships and Related Transactions--Cost Reimbursement Agreement. None of
the Company's or the Operator's employees is represented by a union or labor
organization, nor have the Company's or the Operator's operations ever been
interrupted by a work stoppage. The Company considers relations with its
employees to be excellent.

THE OPERATOR

         Jameson Operating Company was formed in October 1993 as a wholly owned
subsidiary of the Company, although it had no operations until January 1, 1994.
On December 31, 1993, the Company consummated a series of transactions to remove
all assets not related to ownership of the Inns in contemplation of its initial
public offering of Common Stock and its election to qualify as a REIT for
federal income tax purposes effective January 1, 1994. On December 31, 1993, the
Company sold all of the common stock of the Operator to Thomas W. Kitchin, the
Company's Chairman, President and Chief Executive Officer, and to a grantor
trust of which Steven A. Curlee, the Company's General Counsel and Secretary, is
the trustee and beneficiary. Effective January 1, 1994, the Operator began
leasing the Inns from the Company and from certain partnerships which owned the
Inns until the Company acquired the interests of such partnerships in February
1994. Prior to 1994, the Operator's results of operations were included in the
consolidated financial statements of the Company.

                                       10
<PAGE>   13
         The Operator leases and operates all Inns owned by the Company under
the terms of the Lease. See --The Lease, above. The names and certain other
information concerning the officers and directors of the Operator are set forth
below. At December 31, 1996, the Operator had a total of 739 employees,
including an administrative staff of 16 employees, 47 Inn managers and 676 other
full- and part-time employees engaged in day-to-day management and marketing of
the Inns. The Operator has a negative net worth and only nominal assets. The
audited financial statements of the Operator appear elsewhere in this Annual
Report and should be referred to for additional financial information concerning
the Operator. Although it has not done so to date, the Operator may engage in
activities other than as lessee of the Inns, subject to certain restrictions
under the Lease.

        The officers, directors and key employees of the Operator are the
following:

<TABLE>
<CAPTION>
                  NAME                      POSITION
<S>                                 <C>
         Thomas W. Kitchin........  President, Director
         William D. Walker........  Vice President
         Steven A. Curlee.........  General Counsel, Secretary, Director
         Craig R. Kitchin.........  Treasurer, Chief Financial Officer, Director
         Robert S. Olliff.........  Director of Operations
</TABLE>

         With the exception of Mr. Olliff, the background and experience of the
officers and directors and key employees of the Operator are described under
Item 10. Directors and Executive Officers of the Registrant. Mr. Olliff, age 55,
is Director of Operations of the Operator. He also has been Director of
Operations for the Company since April 1992. From January 1990 to March 1992, he
was a district supervisor for the Company. From April 1989 to December 1989, he
was the manager of the Inn at Statesboro, Georgia, and from July 1984 to April
1989 was employed as a sales representative for Morrison Chemical Company,
Savannah, Georgia. Mr. Olliff received a B.B.A. degree in marketing and
economics from the University of Georgia in 1965. He is currently serving as a
director and regional vice president of the Georgia Hospitality and Travel
Association.

POLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN ACTIVITIES

         The following is a discussion of the Company's investment objectives
and policies, financing policies and policies with respect to certain other
activities. These policies may be amended or revised from time to time at the
sole discretion of the Board of Directors. No assurance can be given that the
Company's investment objectives will be attained or that the value of the
Company will not decrease.

         Investment Objectives and Policies. The Company's investment objective
is to provide, quarterly cash distributions and achieve long-term capital
appreciation through increases in cash flow and the value of the Company. The
Company will seek to accomplish these objectives through the ownership and
leasing of the Inns to the Operator, selective development of additional Inns in
the United States, the Operator's increases in the Inns' room revenues and,
where deemed appropriate, renovations and expansions of these properties. A key
criterion for new investments

                                       11
<PAGE>   14
will be that they offer the opportunity for growth in Funds from Operations and
Cash Available for Distribution. For definitions and calculation of Funds from
Operations and Cash Available from Operations, see Item 6. Selected Financial
Data and Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations - Funds from Operations; Cash Available for Distribution.
The Company anticipates that all of its activities will be conducted directly,
although the Company may participate with other entities in property ownership,
through joint ventures, partnerships or other types of co-ownership. The Company
currently intends to invest only in Inns, although the Company may also hold
temporary cash investments from time to time pending investment or distribution
to shareholders.

         The Company may purchase or lease properties for long-term investment,
expand and improve the Inns, or sell such properties, in whole or in part, when
circumstances warrant. Equity investments may be subject to existing mortgage
financing and other indebtedness which have priority over the equity interest of
the Company.

         While the Company emphasizes equity real estate investments, it may, in
its discretion, invest in mortgages, stock of other REITs and other real estate
interests. Such mortgage investments may include participating or convertible
mortgages. However, the Company has not invested previously in mortgages and
stock of other REITs, an does not presently intend to do so.

         Dispositions. The Company has no current intention to dispose of any of
the Inns, although it reserves the right to do so if, based upon management's
periodic review of the Company's portfolio, the Board of Directors determines
that such action would be in the best interests of the Company. For a
description of certain tax consequences arising from the disposition of an Inn,
see --Federal Income Tax Considerations, below.

         Financing. In January 1997, the Company filed a shelf registration
statement with the Securities and Exchange Commission that provides for the
issuance of an aggregate of up to $100 million in Common Stock, Preferred Stock
and Common Stock warrants to be offered and sold from time to time. The Company
intends to use the net proceeds, if any, from any sale of securities under such
registration statement for the repayment of existing indebtedness, working
capital and general corporate purposes.

         In the event that the Board of Directors determines to raise additional
equity capital, the Board has the authority, without shareholder approval, to
issue additional shares of Common Stock or other capital stock of the Company in
any manner (and on such terms and for such consideration) it deems appropriate,
including in exchange for property. Existing shareholders would have no
preemptive right to purchase shares issued in any offering, and any such
offering might cause a dilution of a shareholder's investment in the Company.

         It is anticipated that any additional borrowings will be made directly
by the Company. Indebtedness incurred by the Company may be in the form of bank
borrowings, secured and unsecured, and publicly and privately placed debt
instruments. Such indebtedness may be recourse to all or any part of the
property of the Company or may be limited to the particular property to which
the indebtedness relates. The proceeds from any borrowings by the Company


                                       12
<PAGE>   15
may be used for the payment of distributions, working capital, to refinance
existing indebtedness or to finance acquisitions, expansions or development of
new Inns.

         At December 31, 1996, the Company had outstanding an aggregate of
approximately $22.3 million of mortgage debt, including approximately $2.1
million in construction debt. The construction debt provides for total
borrowings of $9.2 million and is secured by mortgages on nine Inns. The Company
adheres to a policy of limiting its outstanding indebtedness to 65% of the
aggregate appraised value of the Inns (the "Debt Limit"). The outstanding
indebtedness at December 31, 1996 represented approximately 21% of the aggregate
appraised value of the Inns. The Company's organizational documents do not limit
the amount or percentage of indebtedness that the Company may incur.
Accordingly, the Board of Directors of the Company could change the current
policies of the Company and the Company could become more highly leveraged,
resulting in an increased risk of default on the obligations of the Company and
in an increase in debt service requirements. Such an increase could adversely
affect the financial condition and results of operations of the Company, the
Company's ability to make dividend distributions to its shareholders and could,
as a result, jeopardize the Company's status as a REIT. See --Federal Income Tax
Considerations, below.

         Working Capital Reserves. The Company's policy is to maintain working
capital reserves (and when not sufficient, access to borrowings) in amounts that
the Board of Directors determines to be adequate to meet normal contingencies in
connection with the operation of the Company's business and investments.

         Policy Regarding Capital Expenditures. The Company has adopted a policy
requiring it to maintain cash reserves or sufficient access to borrowings in
adequate amounts to enable it to meet its capital expenditure requirements. The
Company believes that an amount equal to 4% of Operator's aggregate room
revenues will be sufficient to fund this requirement. As of December 31, 1996,
such amount was $263,000 which, together with the $803,000 expended for capital
expenditures from July 1, 1995 to December 31, 1996, represents 4% of aggregate
room revenues for the same period.

         Other Policies. The Company intends to operate in a manner that will
not subject it to regulation under the Investment Company Act of 1940. The
Company does not intend to (i) invest in the securities of other issuers for the
purpose of exercising control over such issuer, (ii) underwrite securities of
other issuers or (iii) actively trade in loans or other investments.

         The Company may make investments other than as previously described,
although it does not currently intend to do so. The Company has authority to
repurchase or otherwise reacquire Common Stock or any of its other securities
and may engage in such activities in the future. During the past three years the
Company has not issued Common Stock or any other securities in exchange for
property, nor has it reacquired any of its Common Stock or any other securities;
however, the Company has authority to engage in such activities and may do so in
the future. Prior to January 1, 1994, the Company made loans to Company officers
in connection with the Company's formation of partnerships to finance
development of new Inns. All such loans were repaid in full at the time such
partnerships were liquidated. The Company may in the future make additional
loans to such persons and entities, including, without limitation, its officers,
and to joint ventures in which it participates. Except in connection with
formation of partnerships which,


                                       13
<PAGE>   16
prior to their liquidation in early 1994, were formed by the Company to finance
the development of Inns, during the last three years, the Company has not
engaged in trading, underwriting or agency distribution or sale of securities of
other issuers, and the Company does not intend to do so in the future. The
Company's policies with respect to such activities may be reviewed and modified
from time to time by the Board of Directors without the vote of the
shareholders.

         At all times, the Company intends to make investments in such a manner
as to be consistent with the requirements of the Internal Revenue Code of 1986,
as amended (the "Code"), to qualify as a REIT unless, because of circumstances
or changes in the Code (or in the Treasury Regulations), the Board of Directors,
with the consent of a majority of the Company's shareholders, determines to
revoke the Company's REIT election.

         The Company may, under certain circumstances, purchase its shares of
Common Stock in the open market or otherwise. The Board of Directors has no
present intention of causing the Company to repurchase any of the shares of
Common Stock, and any such action would be taken only in conformity with
applicable federal and state laws and the requirements for qualifying as a REIT
under the Code and the Treasury Regulations.

         Conflicts of Interest. Because of Thomas W. Kitchin's ownership in and
positions with the Company, the Operator, the Contractor and Kitchin
Investments, Inc, there are inherent conflicts of interest in the construction
of new Inns and expansion of existing Inns by the Contractor and in the
Company's dealings with the Operator under the Lease and with Kitchin
Investments, Inc. under the Cost Reimbursement Agreement. See Item 1.
Business--Growth Plans for 1997--The Contractor and --Employees, and Item 13.
Certain Relationships and Related Transactions. In an effort to reduce the
conflicts of interest, any material transaction or arrangement involving the
Company and the Operator or the Contractor, or an affiliate of either (including
Kitchin Investments, Inc.), will be subject to approval by a majority of the
Independent Directors. Further, the Operator has agreed that neither it nor any
of its affiliates will (i) operate or manage a hotel property in which the
Company has not invested that is within a 20-mile radius of an Inn, or (ii) own
or have any interest in any hotel property in which the Company or an affiliate
does not have an interest. In addition, Mr. Kitchin is prohibited under the
terms of his employment agreement with the Company from owning, managing or
operating, directly or indirectly, any hotel property other than the Inns during
the term of his employment by the Company or, for two years following such
employment, any hotel property within a 20-mile radius of an Inn. See Item 11.
Executive Compensation--Employment Agreement.

         In addition, the Board of Directors has a policy that any contract or
transaction between the Company and one or more directors or officers of the
Company, or between the Company and any other entity in which one or more of its
directors or officers are directors or officers, or have a financial interest,
must be approved by a majority of either the Independent Directors or
disinterested shareholders after the material facts as to the relationship or
interest and as to the contract or transaction are disclosed or are known to
them. The Board of Directors may change this policy without the consent of the
shareholders upon the affirmative vote of a majority of the Independent
Directors.



                                       14
<PAGE>   17
FEDERAL INCOME TAX CONSIDERATIONS

         The following summary of material federal income tax considerations
regarding the Company is based on current law and does not purport to deal with
all aspects of taxation that may be relevant to particular shareholders in light
of their personal investment or tax circumstances, or to certain types of
shareholders (including insurance companies, tax-exempt organizations, financial
institutions or broker-dealers, foreign corporations and persons who are not
citizens or residents of the United States) subject to special treatment under
the federal income tax laws.

         EACH STOCKHOLDER IS ADVISED TO CONSULT HIS OWN TAX ADVISOR REGARDING
THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP AND SALE OF THE
SHARES AND OF THE COMPANY'S ELECTION TO BE TAXED AS A REIT, INCLUDING THE
FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF SUCH PURCHASE,
OWNERSHIP, SALE AND ELECTION AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.

Taxation of the Company

         The Company made an election to be taxed as a REIT under Sections 856
through 860 of the Internal Revenue Code of 1986, as amended (the "Code"),
commencing with its taxable year beginning January 1, 1994. The Company made
such election at the time of the filing of its federal income tax return for
1994. The Company believes that commencing with such taxable year, it was
organized and has operated in such a manner as to qualify for taxation as a REIT
under the Code. The Company intends to continue to operate in such a manner, but
no assurance can be given that it has qualified or will operate in a manner so
as to remain qualified.

         The sections of the Code relating to qualification and operation as a
REIT are highly technical and complex. The following discussion sets forth the
material aspects of the Code sections that govern the federal income tax
treatment of a REIT and its shareholders. This discussion is qualified in its
entirety by applicable Code provisions, Treasury Regulations and administrative
and judicial interpretations thereof. Conner & Winters, A Professional
Corporation ("Conner & Winters"), has acted as counsel to the Company in
connection with the Offering and the Company's election to be taxed as a REIT.

         Commencing with the Company's taxable year beginning January 1, 1994,
the Company was organized and believes it has operated in conformity with the
requirements for qualification as a REIT and that its proposed method of
operations will continue to meet the Code requirements for qualification and
taxation as a REIT under current Code provisions. The Company's qualification
and taxation as a REIT depends upon its ability to meet, through actual annual
operating results, distribution levels, stock ownership requirements and various
qualification requirements imposed under the Code and discussed below. No
assurance can be given that the actual results of the Company's operations for
any particular taxable year will satisfy such requirements. For a discussion of
the tax consequences of the failure to qualify as a REIT, see --Failure to
Qualify, below.


                                       15
<PAGE>   18
         As long as the Company qualifies for taxation as a REIT, it generally
will not be subject to federal corporate income tax on its net income that is
currently distributed to shareholders. This treatment substantially eliminates
the "double taxation" (at the corporate and shareholder levels) that generally
results from investment in a corporation. However, the Company will be subject
to federal income or excise tax as follows: First, the Company will be taxed at
regular corporate rates on its REIT taxable income, which is defined generally
as taxable income (subject to certain adjustments), including net capital gains,
less dividends to shareholders. Second, the Company will generally be subject to
the "alternative minimum tax" if REIT taxable income plus any tax adjustments
and preferences is greater than dividends paid to shareholders. Third, if the
Company has (i) net income from the sale or other disposition of "foreclosure
property" which is held primarily for sale to customers in the ordinary course
of a trade of business or (ii) other non-qualifying net income from foreclosure
property, it will be subject to tax at the highest corporate rate on such
income. Fourth, if the Company has net income from prohibited transactions
(generally certain sales or other dispositions of property (other than
foreclosure property) held primarily for sale to customers in the ordinary
course of business), such income will be subject to a 100% tax. Fifth, if the
Company should fail to satisfy the 75% or 95% gross income tests discussed below
and has nonetheless maintained its qualification as a REIT because certain other
requirements have been met, it will be subject to a 100% tax on the net income
attributable to the greater of the amount by which the Company fails the 75% or
95% gross income tests. Sixth, generally, if the Company should fail to
distribute to its shareholders during each calendar year an amount equal to its
required distribution, it will be subject to a 4% nondeductible excise tax on
the excess of such required distribution amount over the amount actually
distributed for the year. The amount of required distribution is equal to the
sum of (i) 85% of its ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year and (iii) the amount, if any, of the
required distribution for the previous year over the amount actually distributed
for that year.

         In addition, pursuant to IRS Notice 88-19, if during the 10-year period
(the "Recognition Period") beginning on the first day of the first taxable year
for which the Company qualified as a REIT, the Company recognizes gain on the
disposition of any asset held by the Company as of the beginning of such
Recognition Period, then, to the extent of the excess of (a) the fair market
value of such asset as of the beginning of such Recognition Period over (b) the
Company's adjusted basis in such asset as of the beginning of the Recognition
Period (the "Built-In Gain"), such Built-In Gain, which may be reduced by
certain net operating loss carry forwards of the Company, will be subject to tax
at the highest regular corporate rate, pursuant to regulations that have not yet
been promulgated. The Recognition Period began January 1, 1994 and will expire
December 31, 2003. Further, if the Company acquires any asset from a C
corporation in a transaction in which the basis of the asset in the Company's
hands is determined by reference to the basis of the asset (or any other
property) in the hands of the C corporation, and the Company recognizes gain on
the disposition of such asset during the ten-year period beginning on the date
on which such asset was acquired by the Company, then, to the extent of the
Built-In Gain, such gain will be subject to tax at the highest regular corporate
rate, pursuant to regulations that have not yet been promulgated. The amount of
the Company's Built-In Gain based on the appraisals obtained in connection with
its initial public offering is approximately $8.1 million and will discourage a
disposition by the Company of any Inn held at the time of such offering until
after 2003.


                                       16
<PAGE>   19
Requirements for Qualification

         The Code defines a REIT as a corporation, trust or association (1)
which is managed by one or more trustees or directors; (2) the beneficial
ownership of which is evidenced by transferable shares or by transferable
certificates of beneficial interest; (3) which would be taxable as a domestic
corporation, but for Sections 856 through 860 of the Code; (4) which is neither
a financial institution nor an insurance company subject to certain provisions
of the Code; (5) the beneficial ownership of which is held by 100 or more
persons; (6) at any time during the last half of each taxable year not more than
50% in value of the outstanding stock of which is owned, directly or indirectly,
by five or fewer individuals (as defined in the Code to include certain
entities); (7) which makes an election to be a REIT and satisfies all relevant
filing and other administrative requirements established by the IRS that must be
met in order to elect and maintain REIT status; (8) which uses a calendar year
for federal income tax purposes and complies with the record keeping
requirements of the Code and Treasury Regulations promulgated thereunder; and
(9) which meets certain other tests, described below, regarding the nature of
its income and assets. The Code provides that conditions (1) to (4), inclusive,
must be met during the entire taxable year and that condition (5) must be met
during at least 335 days of a taxable year of 12 months, or during a
proportionate part of a taxable year of less than 12 months. The Company has met
since the closing of the initial public offering, and currently does meet, all
of such definitional requirements.

Income Tests

         In order for the Company to maintain its qualification as a REIT, it
must satisfy three gross income tests annually. First, at least 75% of the
Company's gross income (excluding gross income from prohibited transactions) for
each taxable year must consist of defined types of income derived directly or
indirectly from investments relating to real property or mortgages on real
property (including "rents from real property" and, in certain circumstances,
interest) or qualified temporary investment income. Second, at least 95% of the
Company's gross income (excluding gross income from prohibited transactions) for
each taxable year must be derived from such real property or temporary
investments, and from dividends and other types of interest and gain from the
sale or disposition of stock or securities. Third, short-term gain from the sale
or other disposition of stock or securities, gain from prohibited transactions
and gain on the sale or other disposition of certain real property held for less
than four years (apart from involuntary conversions and sales of foreclosure
property) must represent less than 30% of the Company's gross income for each
taxable year.

         Rents received by the Company under the Lease will qualify as "rents
from real property" in satisfying the gross income requirements for a REIT
described above only if several conditions are met. First, the amount of rent
must not be based in whole or in part on the income or profits of any person.
However, an amount received or accrued generally will not be excluded from the
term "rents from real property" solely by reason of being based on a fixed
percentage or percentages of receipts or sales. Therefore, the percentage rent
provisions of the Lease should not disqualify rental income received from the
Operator. Second, the Code provides that rents received from a tenant, directly
or indirectly, will not qualify as "rents from real property" in satisfying the
gross income tests if the REIT, or a direct or indirect owner of 10% or more of
the

                                       17
<PAGE>   20
REIT, directly or constructively owns 10% or more of such tenant (a "Related
Party Tenant"). Since the Change Date, the Company has satisfied and will use
its best efforts to continue to satisfy this requirement. Therefore, the
Operator is not and should not become a Related Party Tenant of the Company (by
reason of the Company's adherence to the Ownership Limit and the Related Party
Limit). Third, if rent attributable to personal property, leased in connection
with a lease of real property, is greater than 15% of the total rent received
under the lease, then the portion of rent attributable to such personal property
will not qualify as "rents from real property." Applicable Code provisions
provide that with respect to each lease, rent attributable to the personal
property for the taxable year is that amount which bears the same ratio to total
rent as the average of a REIT's adjusted bases of all personal property at the
beginning and at the end of each taxable year bears to the average of the REIT's
aggregate adjusted bases of all real and personal property at the beginning and
at the end of such taxable year. Since January 1, 1994, the Company's rental
income attributable to personal property has been and will continue to be less
than 15%; however, should the resulting rental income attributable to personal
property exceed 15% of all rental income, a portion of the personal property may
be sold by the Company to the Operator with the lease payments adjusted
accordingly.

         Finally, for rents received to qualify as "rents from real property,"
the REIT generally must not operate or manage the leased property or furnish or
render services to the tenants of such property, other than through an
independent contractor from whom the REIT derives no revenue; provided, however,
the Company may directly perform certain services other than services which are
considered rendered to the occupant of the property. The Company has not, does
not and will not knowingly (i) charge rent for any property that is based in
whole or in part on the income or profits of any person (except by reason of
being based on a percentage of receipts or sales, as described above); (ii) rent
any property to a Related Party Tenant; (iii) lease personal property in
connection with the rental of the Inns which would cause the rental income
attributable to such personal property to exceed 15% of the amount of total
rental income; or (iv) perform services considered to be rendered for the
occupants of the Inns other than through an independent contractor.

         Under the Lease, the Operator has leased the land, buildings,
improvements, furnishings, and equipment comprising the Inns from the Company
for a 10-year term. The Operator pays the Company total rent, including base
rent and percentage rent. See Item 1. Business--The Lease. In order for the
total rent received from the Operator to constitute "rents from real property,"
the Lease must be respected as a true lease for federal income tax purposes and
not treated as a service contract, joint venture or some other type of
arrangement. The determination of whether the Lease is a true lease depends on
an analysis of all of the surrounding facts and circumstances.

         In addition, pursuant to Code Section 7701(e), a service contract,
partnership agreement, or some other type of arrangement may be treated instead
as a lease of property if the contract, agreement or arrangement is properly
treated as a lease of property, taking into account all relevant factors,
including whether or not: (i) the service recipient is in physical possession of
the property, (ii) the service recipient controls the property, (iii) the
service recipient has a significant economic or possessory interest in the
property (e.g., the property's use is likely to be dedicated to the service
recipient for a substantial portion of the useful life of the property, the
service recipient shares the risk that the property will decline in value, the
service recipient shares in any

                                       18
<PAGE>   21
appreciation in the value of the property, the service recipient shares in
savings in the property's operating costs, or the service recipient bears the
risk of damage to or loss of the property), (iv) the service provider does not
bear any risk of substantially diminished receipts or substantially increased
expenditures if there is nonperformance under the lease, (v) the service
provider does not use the property concurrently to provide significant services
to entities unrelated to the service recipient and (vi) the contract price does
not substantially exceed the rental value of the property for the term of the
lease.

         Under the Lease, (i) the Operator has the right to exclusive
possession, use and quiet enjoyment of the Inns during the term of the Lease,
(ii) the Operator bears the cost of, and is responsible for daily maintenance
and repair of the Inns, other than the cost of maintaining underground utilities
and structural elements (including the roofs) of the improvements, (iii) the
Operator dictates how the Inns are operated, maintained, and improved and bears
all of the costs and expenses of operating the Inns (including the cost of any
inventory used in their operation) during the term of the Lease (other than real
and personal property taxes, casualty, liability and other types of insurance
and equipment and the maintenance of structural elements, roofs and underground
utilities), (iv) the Operator benefits from any savings in the costs of
operating the Inns during the term of the Lease, (v) in the event of damage or
destruction to an Inn, the Operator is at economic risk because it will be
obligated to restore the property to its prior condition and bear all costs of
such restoration in excess of any insurance proceeds (except, under certain
circumstances, during the last six months of the term of the Lease), (vi) the
Operator has indemnified the Company against all liabilities imposed on the
Company during the term of the Lease by reason of injury to persons or damage to
property occurring at the Inns or due to the Operator's use, management,
maintenance or repair of the Inns, and (vii) the Operator is obligated to pay
substantial fixed rent for the term of the Lease. In addition, the total rent
under the Lease does not substantially exceed the fair rental value of the Inns.

         Pursuant to IRS Revenue Ruling 55-540, if one or more of the following
conditions are present, the Lease will instead be considered as a conditional
contract for purchase and sale of the Inns: (i) portions of the periodic
payments are made specifically applicable to an equity interest in the property
to be acquired by the lessee, (ii) the lessee will acquire title upon the
payment of a stated amount of "rentals" under the contract which it is required
to make, (iii) the total amount which the lessee is required to pay for a
relatively short period of use constitutes an inordinately large proportion of
the total sum required to be paid to secure the transfer of the title, (iv) the
agreed "rental" payments materially exceed the current fair rental value, (v)
the property may be acquired under a purchase option at a price which is nominal
in relation to the value of the property at the time when the option may be
exercised, as determined at the time of entering into the original agreement, or
which is a relatively small amount when compared with the total payments which
are required to be made and (vi) some portion of the periodic payments is
specifically designated as interest or is otherwise readily recognizable as the
equivalent of interest.

         Under the Lease, (i) no portion of the total rent has been or will be
applied to any equity interest in the Inns to be acquired by the Operator, (ii)
the Operator has not acquired and will not be acquiring title to the Inns upon
the payment of a stated amount of either base rent or percentage rent, (iii) the
total rent does not and will not materially exceed the current fair rental value
of the Inns, (iv) the Inns may not be acquired by the Operator under a purchase
option and (v) no portion

                                       19
<PAGE>   22
of either base rent or percentage rent has been or will be specifically
designated as interest or will be recognizable as the equivalent of interest.
Based on the foregoing, the Company believes that the Lease will be treated as a
true lease for federal income tax purposes. However, no assurance can be given
that the IRS will not challenge the tax treatment of the Lease, or, if it does,
that it will not be successful. If the Lease is recharacterized as a service
contract, partnership agreement, or some other type of arrangement rather than a
true lease, part or all of the payments that the Company receives from the
Operator may not satisfy the various requirements for qualification as "rents
from real property." In that case, the Company likely would not be able to
satisfy either the 75% or 95% gross income tests and, as a result, would fail to
qualify as a REIT.

         Any gross income derived from a prohibited transaction is taken into
account in applying the 30% income test necessary to qualify as a REIT (and the
net income from that transaction is subject to a 100% tax). The term "prohibited
transaction" generally includes a sale or other disposition of property (other
than foreclosure property) that is held primarily for sale to customers in the
ordinary course of a trade or business. None of the Company's assets are or have
been held for sale to customers in the ordinary course of its business and the
sale of an Inn and associated property will not be in the ordinary course of
business of the Company. Whether property is held "primarily for sale to
customers in the ordinary course of a trade or business" depends, however, on
the facts and circumstances in effect from time to time, including those related
to a particular property. Nevertheless, the Company believes that it has since
January 1, 1994, complied and will attempt to continue to comply with the terms
of the safe-harbor provisions in the Code prescribing when asset sales will not
be characterized as prohibited transactions. Complete assurance cannot be given,
however, that the Company can comply with the safe-harbor provisions of the Code
or avoid owning property that may be characterized as property held "primarily
for sale to customers in the ordinary course of a trade or business."

         If the Company fails to satisfy one or both of the 75% or 95% gross
income tests for any taxable year, it may nevertheless qualify as a REIT for
such year if it is entitled to relief under certain provisions of the Code.
These relief provisions will generally be available if (i) the Company's failure
to meet such tests is due to reasonable cause and not due to willful neglect,
(ii) the Company attaches a schedule of the sources of its gross income to its
return, and (iii) any incorrect information on such schedule was not due to
fraud with intent to evade tax. It is not possible, however, to state whether in
all circumstances the Company would be entitled to the benefit of these relief
provisions. (However, no relief provisions are available if the 30% of gross
income test is violated.) As discussed above, even if these relief provisions
apply, a 100% tax would be imposed which would be equal to the excess of 75% or
95% of the Company's gross income over the Company's qualifying income in the
relevant category, whichever is greater, multiplied by the ratio that REIT
taxable income bears to gross income for the taxable year (with certain
adjustments).

Asset Tests

         At the close of each quarter of the Company's taxable year, it must
also satisfy three tests relating to the nature of its assets. First, at least
75% of the value of the Company's total assets must be represented by "real
estate assets" which means (i) real property (including interests in

                                       20
<PAGE>   23
real property and interests in mortgages on real property), (ii) shares in other
REITs and (iii) stock or debt instruments held for not more than one year
purchased with the proceeds of a stock offering or long-term (at least five
years) debt offering of the Company, (iv) cash, cash items (including
receivables) and government securities. Second, not more than 25% of the
Company's total assets may be represented by securities other than those in the
75% asset class. Third, of the investments included in the 25% asset class, the
value of any one issuer's securities owned by the Company may not exceed 5% of
the value of the Company's total assets and the Company may not own more than
10% of such issuer's outstanding voting securities. The Company has satisfied
these asset tests since December 31, 1993 and it will use its best efforts to
continue to satisfy such tests in the future.

         After meeting the assets tests at the close of any quarter, the Company
will not lose its status as a REIT for failure to satisfy the asset tests at the
end of a later quarter solely by reason of changes in asset values. If the
failure to satisfy the asset tests results from an acquisition of securities or
other property during a quarter, the failure can be cured by disposition of
sufficient nonqualifying assets within 30 days after the close of that quarter.
The Company believes that it maintains adequate records of the value of its
assets to ensure compliance with the asset test and intends to take such other
action within 30 days after the close of any quarter as may be required to cure
any noncompliance. However, there can be no assurance that such action will
always be successful.

Annual Distribution Requirements

         The Company, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (A) the sum of (i) 95% of the "REIT taxable income" of the
Company (computed without regard to the dividends paid deduction and any net
capital gain) and (ii) 95% of the net income (after tax), if any, from
foreclosure property, minus (B) the sum of certain items of noncash income. In
addition, if the Company disposes of any asset during its Recognition Period,
the Company will be required, pursuant to IRS regulations which have not yet
been promulgated, to distribute at least 95% of the Built-In Gain (after tax),
if any, recognized on the disposition of such asset. Such distributions must be
paid in the taxable year to which they relate, or in the following taxable year
if declared before the Company timely files its tax return for such year and if
paid on or before the first regular dividend payment after such declaration. To
the extent that the Company does not distribute all of its net capital gain or
distributes at least 95%, but less than 100% of its "REIT taxable income," as
adjusted, it will be subject to tax thereon at regular corporate tax rates.
Furthermore, as explained above in --Taxation of the Company, if the Company
should fail to distribute its required distribution during each calendar year,
the Company would be subject to a 4% nondeductible excise tax on the excess of
such required distribution over the amounts actually distributed.

         Since January 1, 1994, the Company has made, and hereafter intends to
make, timely distributions sufficient to satisfy all annual distribution
requirements. However, it is possible that, from time to time, the Company may
experience timing differences between (i) the actual receipt of income and
actual payment of deductible expenses and (ii) the inclusion of that income and
deduction of such expenses in arriving at its REIT taxable income. In addition,
as explained

                                       21
<PAGE>   24
above, in the event of the foreclosure of an Inn by a mortgage lender, any debt
discharge income would be subject to the annual 95% distribution requirement
even though the Company would receive no cash as a consequence of a foreclosure.
Therefore, the Company could have less Cash Available for Distribution than
would be necessary to meet its annual 95% distribution requirement or to avoid
federal corporate income tax with respect to capital gain or the 4%
nondeductible excise tax imposed on certain undistributed income. To meet the
95% distribution requirement necessary to qualify as a REIT or to avoid federal
income tax with respect to capital gain or the excise tax, it could be necessary
for the Company to borrow funds.

         Under certain circumstances, the Company may be able to rectify a
failure to meet the distribution requirement for a year by paying dividends to
shareholders in a later year. If the Company declares a dividend before the date
on which its tax return is due for a taxable year (including extensions) and
distributes the amount of such dividend to shareholders in the 12-month period
following the close of such taxable year, such subsequent year dividend may be
deductible by the Company in computing its REIT taxable income for the
immediately preceding year. The distribution of such dividend must be made no
later than the date of the first regular dividend payment made after the
declaration and distribution of such dividend and the Company must elect such
treatment in its return.

         Shareholders receiving subsequent year distributions are taxable on
such distributions in the year of actual receipt except in the following case.
Any distributions declared by the Company in October, November or December of
any year payable to a shareholder of record on a specified date in any such
month shall be treated as both paid by the Company and received by the
shareholder on December 31, provided that the distribution is actually paid by
the Company during January of the following calendar year. However, if the
Company actually pays the declared distributions before December 31, the
distributions will be treated as both paid by the Company and received by the
shareholders on the actual dates paid and received, respectively.

         If, as a result of an audit by the IRS, the REIT taxable income for a
prior taxable year is increased, the Company may elect to distribute an
additional "deficiency dividend," as defined under Section 860 of the Code, and
claim an additional deduction for dividends paid for such taxable year in order
to meet the annual distribution requirement. All deficiency dividends must be
distributed within 90 days after the final determination of an audit, and the
claim for such deficiency dividends must be filed within 120 days of such
determination. The Company would also be liable for the payment of interest
charges on the amount of the deficiency dividend. However, the payment of such
dividends would ensure that the Company's qualification as a REIT would not be
jeopardized due to a failure to meet its annual distribution requirement.

Failure to Qualify

         If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to shareholders in any year in which the
Company fails to qualify will not be deductible by the Company nor will they be
required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to shareholders will be taxable as
ordinary income, and, subject to certain

                                       22
<PAGE>   25
limitations of the Code, corporate distributees may be eligible for the
dividends received deduction (such deduction is not available to corporate
distributees so long as the Company qualifies as a REIT). Unless entitled to
relief under specific statutory provisions, the Company will also be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT.

Taxation of Shareholders

         Tax Consequences to Non Tax-Exempt U.S. Shareholders. As long as the
Company qualifies as a REIT, distributions made to the Company's taxable U.S.
shareholders from current or accumulated earnings and profits (and not
designated as capital gain dividends) will be taken into account by such U.S.
shareholders as ordinary income in the year they are received and will not be
eligible for the dividends received deduction for corporations. Such
distributions will be treated as portfolio income and not as income from passive
activities. Accordingly, shareholders will not be able to apply any passive
losses against such income. Distributions that are designated as capital gain
dividends will be taxed as long-term capital gains (to the extent they do not
exceed the Company's actual net capital gain for the taxable year) without
regard to the period for which a shareholder has held its stock. However,
corporate shareholders may be required to treat up to 20% of certain capital
gain dividends as ordinary income.

         Distributions in excess of current and accumulated earnings and profits
will not be taxable to a U.S. shareholder to the extent such distributions do
not exceed the adjusted basis of such U.S. shareholder's shares, but rather will
reduce the adjusted basis of such shares. To the extent that distributions in
excess of current and accumulated earnings and profits exceed the adjusted basis
of a U.S. shareholder's shares, such distributions will be included in income as
long-term capital gain (or short-term capital gain if the shares have been held
for one year or less) assuming the shares are held as a capital asset by the
U.S. shareholder. Moreover, U.S. shareholders may not include in their income
tax returns any net operating losses or capital losses of the Company. Finally,
in general, any loss upon a sale or exchange of shares by a U.S. shareholder who
has held such shares for six months or less (after applying certain holding
period rules), will be treated as a long-term capital loss to the extent of
distributions from the Company required to be treated by such shareholder as
long-term capital gain.

         Information Reporting Requirements and Backup Withholding. The Company
will report to its U.S. shareholders and the IRS the amount of distributions
paid during each calendar year and the amount of tax withheld, if any. Under the
backup withholding rules, a U.S. shareholder may be subject to backup
withholding at the rate of 31% with respect to distributions paid unless such
holder (a) is a corporation or comes within certain other exempt categories and,
when required, demonstrates this fact, or (b) provides a taxpayer identification
number, certifies as to no loss of exemption from backup withholding, and
otherwise complies with applicable requirements of the backup withholding rules.
A shareholder that does not provide the Company with his correct taxpayer
identification number may also be subject to penalties imposed by the IRS. Any
amount paid as backup withholding will be creditable against the shareholder's
income tax liability. In addition, the Company may be required to withhold a
portion of capital gain distributions to any shareholders who fail to certify
their non-foreign status to the Company. See --Taxation of Non-U.S.
Shareholders, below.

                                       23
<PAGE>   26
         Taxation of Tax-Exempt Shareholders. Distributions by the Company to a
U.S. shareholder that is a tax-exempt entity should not constitute "unrelated
business taxable income" as defined in Section 512(a) of the Code ("UBTI"),
provided that the tax-exempt entity has not financed the acquisition of its
shares with "acquisition indebtedness" within the meaning of Section 514(c) of
the Code and the shares are not otherwise used in an unrelated trade or business
of the tax-exempt entity. In addition, if the Company is considered to be a
pension-held REIT, then a portion of the dividends paid to qualified trusts (any
trust defined under Section 401(a) and exempt from tax under Section 501(a))
that owns more than 10 percent by value in the REIT may be considered UBTI. A
pension-held REIT is a REIT that is held by one qualified trust holding no more
than 25% by value of the interests in the REIT or by one or more qualified
trusts (each of whom owns more than 10% by value) holding in the aggregate more
than 50% by value of the interests in the REIT. The Company does not expect to
be a pension-held REIT.

         Taxation of Non-U.S. Shareholders. The rules governing United States
federal income taxation of nonresident alien individuals, foreign corporations,
foreign partnerships and other foreign shareholders (collectively, "Non-U.S.
Shareholders") are complex and no attempt will be made herein to provide more
than a summary of such rules. NON-U.S. SHAREHOLDERS SHOULD CONSULT WITH THEIR
OWN TAX ADVISORS TO DETERMINE THE IMPACT OF FEDERAL, STATE AND LOCAL INCOME TAX
LAWS WITH REGARD TO THEIR INVESTMENT IN SHARES, INCLUDING ANY REPORTING
REQUIREMENTS.

         Distributions to Non-U.S. Shareholders that are not attributable to
gain from sales or exchanges by the Company of United States real property
interests and not designated by the Company as capital gains dividends will be
treated as dividends of ordinary income to the extent their source is current or
accumulated earnings and profits of the Company. Such distributions will
ordinarily be subject to a withholding tax equal to 30% of the gross amount of
the distribution unless an applicable tax treaty reduces or eliminates that tax.
However, if income from a Non-U.S. Shareholder's investment in the Shares is
treated as effectively connected with the Non-U.S. Shareholder's conduct of a
United States trade or business, the Non-U.S. Shareholder generally will be
subject to a tax at graduated rates, in the same manner as U.S. Shareholders are
taxed with respect to such distributions (and may also be subject to the 30%
branch profits tax in the case of a shareholder that is a foreign corporation).
The Company expects to withhold United States income tax at the rate of 30% on
the gross amount of any such distributions made to a Non-U.S. Shareholder unless
(i) a lower treaty rate applies or (ii) the Non-U.S. Shareholder files an IRS
Form 4224 with the Company claiming that the distribution is "effectively
connected" income within the meaning of Section 871 of the Code. Distributions
in excess of current and accumulated earnings and profits of the Company will
not be taxable to a shareholder to the extent that such distributions do not
exceed the adjusted basis of the shareholder's shares, but rather will reduce
the adjusted basis of such shares. To the extent that distributions in excess of
current and accumulated earnings and profits exceed the adjusted basis of a
Non-U.S. Shareholder's shares, such distributions will give rise to tax
liability if the Non-U.S. Shareholder would otherwise be subject to tax on any
gain from the sale or disposition of his shares in the Company, as described
below. If it cannot be determined at the time a distribution is made whether or
not such distribution will be in excess of current and accumulated earnings and
profits, the distribution will be subject to withholding at a 30% rate. Further,
pursuant to recently enacted legislation, the Company will be required to
withhold 10% of any distribution in excess of current and

                                       24
<PAGE>   27
accumulated earnings and profits. However, amounts withheld may be refundable if
it is subsequently determined that such distribution was in excess of current
and accumulated earnings and profits of the Company and the amount withheld
exceeded the Non-U.S. Shareholder's U.S.
tax liability, if any.

         For any year in which the Company qualifies as a REIT, distributions
that are attributable to gain from sales or exchanges by the Company of United
States real property interests will be taxed to a Non-U.S. Shareholder under the
provisions of the Foreign Investment in Real Property Tax Act of 1980
("FIRPTA"). Under FIRPTA, distributions attributable to gain from sales of
United States real property interests are taxed to a Non-U.S. Shareholder as if
such gain were "effectively connected" with a United States business. Non-U.S.
Shareholders would thus be taxed at the normal capital gain rates applicable to
U.S. Shareholders (subject to any applicable alternative minimum tax). Also,
distributions subject to FIRPTA may be subject to a 30% branch profits tax in
the case of a foreign corporate shareholder not entitled to treaty exemption.
The Company is required by Treasury Regulations to withhold 35% of any
distribution to a Non-U.S. Shareholder that could be designated by the Company
as a capital gains dividend. This amount is creditable against the Non-U.S.
Shareholder's FIRPTA tax liability.

         Gain recognized by a Non-U.S. Shareholder upon a sale of shares
generally will not be taxed under FIRPTA if the Company is a "domestically
controlled REIT," defined generally as a REIT in which at all times during a
specified testing period less than 50% in value of the REIT's stock was held
directly or indirectly by foreign persons. The Company believes that it is and
will continue to be a "domestically controlled REIT," and therefore the sale of
its shares has not been and will not be subject to taxation under FIRPTA. The
Company anticipates that sales of the Company's shares by Non-U.S. Shareholders
will not be subject to U.S. taxation unless (i) the investment in the Company's
shares is "effectively connected" with the Non-U.S. Shareholder's trade or
business in the United States, in which case such Non-U.S. Shareholder would be
taxed at the normal capital gain rates applicable to U.S. Shareholders (subject
to any applicable alternative minimum tax), or (ii) in the case of a Non-U.S.
Shareholder who is a "nonresident alien individual" under Section 7701(b) of the
Code, such Non-U.S. Shareholder was present in the United States for a period or
periods aggregating 183 days or more during the taxable year, and certain other
conditions apply, in which case such person would be subject to a 30% tax on his
capital gains.

Other Tax Consequences

         The Company and its shareholders may be subject to state or local
taxation in various state or local jurisdictions, including those in which it or
they transact business or reside. The state and local tax treatment of the
Company and its shareholders may not conform to the federal income tax
consequences discussed above.

ITEM 2. PROPERTIES.

         INNS. The Company focuses on developing Inns in communities in the
southeastern United States which have a strong and growing industrial or
commercial base and a shortage of quality

                                       25
<PAGE>   28
hotel rooms. Generally, the Inns are rooms-only facilities designed to appeal to
price and quality conscious business travelers, such as sales representatives,
government officials and others who travel to these communities on business, as
well as family and leisure travelers attending activities in the communities
such as college and university sponsored events, fairs, festivals and other
cultural events and family reunions. The standard Inn is initially built as a
40-unit, two-story, Colonial-style structure constructed on a one- to two-acre
tract with an outdoor swimming pool, fitness center and parking area. As
initially constructed, the standard Inn has 38 guest rooms, and two executive
suites and features amenities such as remote-controlled television with access
to cable programming, including HBO, free local calls, complimentary continental
breakfast and newspaper, king-sized or double bed, attractive decor, quality
furnishings and, in select rooms, whirlpool baths and small refrigerators.

         At December 31, 1996, the Company owned 43 operating Inns and had an
additional 11 Inns under construction. The Company owns the land upon which 53
of these Inns are built or being built and has a 58-year ground lease on the
land on which one Inn is currently under construction. At December 31, 1996, the
Company also had one Inn expansion in progress and sites under contract for an
additional 10 Inns to be developed. The locations of those Inns is set forth
under Item 1. Business--Growth Plans for 1997. All 43 of the operating Inns are,
and all future Inns developed by the Company are expected to be, leased to and
operated by the Operator which is responsible for the day-to-day management,
operation and marketing of the Inns. See Item 1. Business--The Lease.

         The following table sets forth certain information about the 43
operating Inns at December 31, 1996.
<TABLE>
<CAPTION>
                                            YEAR           NUMBER          1996
                                           OPENED/          OF          ROOM NIGHTS
LOCATION                                  EXPANDED         ROOMS        AVAILABLE(1)
--------                                  --------         -----        ------------
<S>                                       <C>              <C>          <C>
ALABAMA:
  Albertville .................                 94           40           14,640
  Alexander City ..............              94/95           60           21,960
  Arab ........................                 95           40           14,640
  Decatur .....................                 96           40            7,240
  Eufaula .....................                 96           40           11,000
  Florence ....................              96/96           65           11,123
  Greenville ..................                 96           40              560
  Ozark .......................                 95           40           14,640
  Selma .......................              92/95           60           21,960
                                             
GEORGIA:                                     
  Albany ......................              95/96           62           18,547
  Americus ....................           92/93/94           79           28,487
  Bainbridge ..................              94/95           60           21,960
  Brunswick ...................              95/96           60           19,789
  Calhoun .....................              88/94           59           21,594
  Carrollton ..................              94/95           60           21,960
  Commerce ....................                 96           40              101
</TABLE>                                  

                                       26
<PAGE>   29
<TABLE>
<CAPTION>
                                         YEAR              NUMBER         1996
                                        OPENED/              OF        ROOM NIGHTS
LOCATION                               EXPANDED            ROOMS       AVAILABLE(1)
--------                               --------            -----       ------------
<S>                                    <C>                <C>          <C>
GEORGIA (CONTINUED)
  Conyers ...................              96                39            2,262
  Covington .................              90                40           14,135
  Douglas ...................              95                40           14,634
  Eastman ...................              89                41           14,524
  Fitzgerald ................              94                40           14,640
  Greensboro ................              90                41           14,809
  Hartwell ..................              92                40           14,640
  Jesup .....................           90/91                61           21,648
  LaGrange ..................              96                40            5,560
  Milledgeville .............              91               100           36,524
  Statesboro ................              89                39           14,243
  Thomaston .................           90/96                61           20,690
  Valdosta ..................           95/95                55           20,130
  Washington ................              90                41           14,916
  Waycross ..................           93/96                60           21,380
  Waynesboro ................              96                40           11,080
  Winder ....................              88                40           14,222
                                        
SOUTH CAROLINA:
  Anderson ..................           93/94                60           21,960
  Cheraw ....................              95                40           14,640
  Easley ....................              95                40           14,640
  Gaffney (2) ...............              95                40           14,640
  Georgetown ................              96                40              154
  Greenwood .................           95/96                64           16,368
  Lancaster .................              95                40           14,640
  Orangeburg ................              95                40           14,640
  Seneca ....................              96                40              306
  Simpsonville ..............              96                40            2,323
                                        
                                                          -----          -------
       Total ................                             2,107          634,549
</TABLE>

(1)   As to Inns opened or expanded during 1996, room nights available reflects
      all rooms available from the opening date of the Inn or its expansion but
      does not include periods during which rooms may have been unavailable due
      to repairs or renovations.

(2)   A 20-room expansion of this Inn was under construction at December 31,
      1996, and is expected to open in 1997.

         At December 31, 1996, 24 of the Company's 43 operating Inns were
pledged to secure indebtedness under the Company's $29 million credit facility.
In addition, 14 operating Inns were pledged to secure other mortgage
indebtedness and 9 of the 11 Inns under construction at December 31, 1996, were
pledged to secure construction loans.

                                       27
<PAGE>   30
ITEM 3. LEGAL PROCEEDINGS.

         The Company is not a party to any litigation which, in the judgment of
the Company, would have a material adverse effect on its operations or financial
condition if adversely determined. However, due to the nature of its business,
it is, from time to time, and is currently, a party to certain legal proceedings
arising in the ordinary course of its business.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         No matters were submitted to security holders for a vote during the
fourth quarter of fiscal year 1996 which required the solicitation of any
proxies.


                                     PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
        MATTERS.

         As of January 31, 1997, the Company had approximately 319 holders of
record of its Common Stock and, the Company estimates, approximately 4,168
beneficial holders of its Common Stock.

         The Company paid total cash dividends of $.69 per share of Common Stock
for the period February 3, 1994, through December 31, 1994, and $.76 per share
of Common Stock for the period February 3, 1994 to February 2, 1995. The
following table summarizes each of the dividends declared and paid on the Common
Stock by the Company for the fiscal years ended December 31, 1995 and 1996.

<TABLE>
<CAPTION>
                                                         1995
                                    Per Share         Declaration             Record                 Payment
Operations Period Covered            Amount              Date                  Date                   Date
---------------------------          ------        ----------------      -----------------      -----------------
<S>                                 <C>            <C>                   <C>                    <C>
January 1-February 2, 1995            $.07         February 6, 1995      February 16, 1995      February 27, 1995
February 3-March 31, 1995              .12         April 26, 1995        May 8, 1995            May 15, 1995
April 1-June 30, 1995                  .21         July 25, 1995         August 4, 1995         August 21, 1995
July 1-September 30, 1995              .21         October 16, 1995      November 2, 1995       November 21, 1995
October 1-December 31, 1995            .21         January 25, 1996      February 6, 1996       February 21, 1996
                                      ----
     Total                            $.82
</TABLE>


<TABLE>
<CAPTION>
                                                        1996
                                    Per Share        Declaration            Record                 Payment
Operations Period Covered            Amount             Date                 Date                   Date
---------------------------          ------        ----------------      ----------------       -----------------
<S>                                 <C>            <C>                   <C>                    <C>                
January 1-March 31, 1996              $.21         April 29, 1996        May 9, 1996            May 22, 1996
April 1-June 30, 1996                  .22         July 25, 1996         August 5, 1996         August 22, 1996
July 1-September 30, 1996              .22         October 24, 1996      November 6, 1996       November 22, 1996
October 1-December 31, 1996            .22         January 20, 1997      February 4, 1997       February 20, 1997
                                     -----
     Total                            $.87
</TABLE>

                                       28
<PAGE>   31
         On February 6, 1995, the Company also declared a dividend of $7.60 per
share of Preferred stock, par value $1.00 per share ("Preferred Stock"), which
was paid on February 27, 1995, to holders of record of the Preferred Stock on
February 16, 1995. The dividend on the Preferred Stock was for the period
February 3, 1994, through February 2, 1995. On March 1, 1995, holders of the
Preferred Stock converted 64,467 shares of Preferred Stock into 644,670 shares
of Common Stock, resulting in no shares of Preferred Stock remaining
outstanding. All further dividends declared and paid by the Company have been
and will be declared and paid on a pro rata basis to all shareholders.

         The Company intends to continue making regular quarterly distributions
to its shareholders. The Company's cash available for distribution is generally
an amount equal to its net income from operations plus the amount of non-cash
expenses recorded by the Company, such as amortization, depreciation and stock
compensation expenses, less amounts the Company believes should be retained for
working capital purposes, debt service or anticipated capital expenditures.

MARKET INFORMATION

         The Company's Common Stock commenced trading on The Nasdaq Stock Market
National Market System on January 27, 1994. Prior thereto there was no public
market for the Common Stock. The table below sets forth the range of high and
low sales prices for the Common Stock from January 1, 1995, through December 31,
1996, for the periods indicated.

<TABLE>
<CAPTION>
            PERIOD                           HIGH                  LOW
         --------------                    --------             ---------

<S>                                        <C>                  <C>  
             1995
        First Quarter                      $  8 1/8             $   7
        Second Quarter                        8 3/8                 7 1/8
        Third Quarter                         9 1/2                 7 7/8
        Fourth Quarter                        9 1/2                 8 1/2

             1996
        First Quarter                      $ 11 5/8             $   8 5/8
        Second Quarter                       11                     9 1/4
        Third Quarter                        10 3/8                 9 1/4
        Fourth Quarter                       13 1/2                 9 7/8
</TABLE>

ITEM 6. SELECTED FINANCIAL DATA.

         The following table sets forth selected financial and operating
information on a pro forma and historical basis for the Company. The following
information should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere in this Annual Report on Form
10-K. The consolidated historical financial data has been derived from the
audited historical Consolidated Financial Statements. The pro forma data assumes
the Company's 1994 initial public offering and all related transactions occurred
on January 1, 1993, and the

                                       29
<PAGE>   32
Company qualified as a REIT, distributed all of its taxable income and,
therefore, incurred no income tax expense during the period.

         Historical financial and operating information of the Company includes
all Inns owned by the Company, including both those under development as well as
operating Inns; however, due to the Company's development of new Inns and
expansion of existing Inns, the information is not comparable between periods.
See Item 2. Properties. Historical operating results, including net income, may
not be comparable to future operating results.

                               JAMESON INNS, INC.
                         SELECTED FINANCIAL INFORMATION

<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,                               
                                         -----------------------------------------------------------------------------------
                                                     HISTORICAL                      PRO FORMA              HISTORICAL  
                                         -----------------------------------    -------------------   ----------------------
                                           1992         1993         1994        1993       1994        1995         1996
                                         ---------    ---------    ---------    --------   --------   ---------    ---------
                                                    (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA, ADR AND REVPAR)
<S>                                      <C>          <C>          <C>         <C>        <C>         <C>          <C>       
FINANCIAL DATA:
Gross Revenues:(1)
   Lease revenue from Operator ........  $      --    $      --    $   3,973    $  2,886   $  3,973   $   6,342    $   9,376
   Total revenues .....................      5,698        6,880           --          --         --          --           --
Expenses:
   Depreciation .......................        965        1,159        1,427       1,213      1,471       1,825        2,670
   Inn real estate taxes and insurance         179          247          412         247        412         514          733
   Interest expense, net ..............      1,503        1,485          339          --        187       1,590        1,386
   Corporate administration expenses(2)         --           --          479         341        479         622          499
Income (loss) before limited partners'
   interest and extraordinary item ....       (372)         (51)       1,316       1,085      1,424       1,791        4,040
Income (loss) before extraordinary item       (312)        (143)       1,311       1,085      1,424       1,791        4,040
Extraordinary item ....................         --          146         (250)         --         --         (19)        (989)
Net income (loss) .....................       (312)           3        1,061       1,085      1,424       1,772        3,051
Earnings per common share(3) ..........         --           --         0.30        0.28       0.37        0.45         0.48
Dividends paid per common share(4) ....         --           --         0.50          --         --        0.80         0.86

OTHER DATA:
   Funds from Operations(5) ...........  $     653    $   1,016    $   2,738    $  2,298   $  2,895   $   3,616    $   6,758
   Occupancy  Rate ....................       61.8%        68.2%        70.1%       68.2%      70.1%       67.5%        66.9%
   ADR ................................  $   37.64    $   38.03    $   39.43    $  38.03   $  39.43   $   42.80    $   45.80
   REVPAR .............................  $   23.26    $   25.94    $   27.64    $  25.94   $  27.64   $   28.89    $   30.64
   Room  Revenues .....................  $   4,877    $   6,322    $   8,373    $  6,322   $  8,373   $  13,310    $  19,950
   Room nights available ..............    199,599      236,170      295,193     236,170    295,193     448,906      634,549
   Operating Inns (at period end) .....         13           15           20          15         20          32           43
   Rooms available (at period end) ....        627          707          966         707        966       1,537        2,107
</TABLE>


<TABLE>
<CAPTION>
                                                                                         DECEMBER 31, 
                                                                   -------------------------------------------------------
                                                                                          HISTORICAL 
                                                                   -------------------------------------------------------
                                                                    1992        1993        1994        1995        1996
                                                                    ----        ----        ----        ----        ----
<S>                                                                <C>         <C>         <C>         <C>         <C>
BALANCE SHEET DATA:
   Investment in real estate (before accumulated depreciation) ..  $21,330     $25,247     $38,525     $57,370     $80,816
   Net investment in real estate ................................   18,830      21,909      33,760      50,780      71,611
   Total assets .................................................   20,453      23,073      35,074      52,806      73,985
   Total mortgage debt ..........................................   16,297      19,117      11,530      30,214      22,317
   Shareholders' equity .........................................    2,032       1,279      23,282      21,754      50,763
</TABLE>

(1)  Revenues for each historical period prior to 1994 include room revenues of
     the Inns and other revenue of the Company. Revenues in 1994, 1995 and 1996
     and the 1993 and 1994 pro forma periods consist solely of lease 

                                       30
<PAGE>   33
     payments from the Operator calculated using the provisions in the Lease
     applied to the historical room revenues of the Inns.

(2)  Corporate administration expenses for the Company consist of amounts
     allocated from Kitchin Investments, Inc. for salaries for the management
     and overhead of the Company, office, audit, legal and printing expenses,
     etc.

(3)  Pro forma earnings per share assume 3,883,346 shares of Common Stock
     outstanding after the Company's initial public offering in February 1994
     and the stock options granted at exercise prices below the offering price
     were exercised and shares issued pursuant to such exercise were outstanding
     for the entire period, using the treasury stock method. See Notes 2 and 5
     to the consolidated financial statements. Historical earnings per share for
     periods prior to 1994 are not presented as they are not meaningful due to
     the November 15, 1993 reincorporation, similar to a recapitalization, and
     the Company's initial public offering described in Note 1 to the
     consolidated financial statements.

(4)  Represents amounts paid during the year and does not equate to dividends
     declared for the year due to the lag between the end of the period and
     payment of dividends.

(5)  Funds from Operations is defined by the National Association of Real Estate
     Investment Trusts ("NAREIT") according to the March 1995 interpretation as
     net income (computed in accordance with generally accepted accounting
     principles ("GAAP")) excluding gains (or losses) from debt restructuring
     and sales of property, plus depreciation and after adjustments for
     unconsolidated partnerships and joint ventures. The Company has made
     adjustments to its net income (loss) consisting only of depreciation, loss
     on disposals and the extraordinary item for debt restructuring. The Company
     notes that industry analysts use Funds from Operations as another tool to
     evaluate and compare equity REITs. The Company also believes it is
     meaningful as an indicator of net income excluding most non-cash items.
     Other non-cash expenses such as stock option expense have not been added
     back in Funds from Operations. Funds from Operations does not represent
     cash flow from operating activities in accordance with GAAP and is not
     indicative of cash available to fund all of the Company's cash needs. Funds
     from Operations should not be considered as an alternative to net income or
     any other GAAP measure as an indicator of performance and should not be
     considered as an alternative to cash flows as a measure of liquidity.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 
OF OPERATIONS.

     The following discussion should be read in conjunction with the Company's
historical and pro forma consolidated financial statements and notes thereto
appearing elsewhere in this Annual Report. Such financial statements and
information reflect the historical operations of the Company through December
31, 1996.

     The Company has grown from a hotel chain with four Inns, or 162 rooms, at
January 1, 1990, to 43 Inns, or 2,107 rooms, in operation at December 31, 1996.
From its inception in 1988 until December 31, 1993, the Company was engaged in
the business of developing, owning and managing Inns. As part of its development
activities, the Company engaged in development and construction of new Inns. On
December 31, 1993, the Company reorganized by divesting itself of the subsidiary
corporations through which it conducted its construction activities, securities
brokerage activities and aviation operations. In addition, the Company
transferred its outdoor advertising business to the predecessor to Jameson
Outdoor Advertising Company, L.L.C., which is wholly owned by the Company's
chairman and largest stockholder and his wife. The Company no longer manages or
operates the Inns upon their completion, but limits its activities to developing
and owning the Inns. The Operator leases the Inns from the Company and operates
them.

     The 1993 and 1994 pro forma financial information has eliminated those
businesses which the Company has not been engaged in since it divested itself of
these businesses on December 31,

                                       31
<PAGE>   34
1993 so as to be comparable to the 1995 and 1996 historical financial
information. Although in 1994, 1995 and 1996, room revenues were earned by the
Operator, not the Company, they are the basis upon which the percentage rent
paid to the Company by the Operator under the Lease is determined and,
accordingly, such revenues are discussed below. The term "Same Inn Room
Revenues" refers to revenues earned with respect to Inns which were operating
during both comparison periods and include revenues attributable to rooms added
to existing Inns by virtue of expansion of such Inns.

     Effective January 1, 1994, the Company's primary source of revenue became
Lease payments by the Operator under the Lease, and prior thereto under the
predecessor leases with the partnerships which previously owned certain of the
Inns. The expenses of the Company consist of property taxes, insurance,
corporate overhead, compensation expense (or income) related to certain stock
options, interest on mortgage debt and depreciation of the Inns. The Lease
provides for the payment of base rent and percentage rent. For the year ended
December 31, 1996, base rent and percentage rent in the aggregate amount of $9.4
million was earned by the Company. The principal determinant of percentage rent
under the Lease is room revenues of the Inns. Therefore, management believes
that a review of the historical performance of the operations of the 43
operating Inns, particularly with respect to occupancy, ADR and REVPAR, is
appropriate for understanding the Lease revenue (see --Funds from Operations;
Cash Available for Distribution, below, for the calculation of ADR and REVPAR).

RESULTS OF OPERATIONS

         Comparison of the Year Ended December 31, 1996 to the Year Ended
December 31, 1995. Lease revenue for the Company for 1996 increased 49% to $9.4
million as compared to $6.3 million for 1995. The increase was due to the
increase in the Operator's room revenues, partially offset by the effect of a
change in the percentage rent formula under the Lease amendment effective July
1, 1995.

         The number of room nights available increased from 448,906 in 1995 to
634,549 in 1996, or 41%, due to the opening from January 1996 through December
1996 of 11 new 40-room Inns and six 20- to 26-room expansions of existing Inns.
The occupancy rate decreased from 67.5% for 1995 to 66.9% for 1996. However, ADR
increased 7% from $42.80 in 1995 to $45.80 in 1996. As a result of these three
factors, room revenues rose 50%, from $13.3 million for 1995 to $20 million in
1996. Same Inn Room Revenues for 1996 versus 1995 grew to $13.8 million from
$12.1 million, or 14%. The growth is due to an increase in ADR from $42.73 to
$45.76 for these Inns and an increase in room nights available (due to
expansions of certain of these Inns) from 400,187 to 445,451, partially offset
by a decrease in the occupancy rate from 68.8% to 66.1% for these Inns for 1996
compared to 1995. The decrease in overall occupancy of the Inns is attributable
primarily to (i) the expansion of several high occupancy Inns which then
experienced lower occupancy rates because of the additional rooms available in
the marketplace, and (ii) the opening of new Inns which typically require
several months of operations before realizing higher occupancy rates. During
1996, the Lease revenue was affected by the limitation equal to 47% of room
revenues for the year.

                                       32
<PAGE>   35
         General and administrative expense includes overhead charges for
management, accounting and legal services for the corporate home office. General
and administrative expense for 1996 was $499,000, as compared to $622,000 for
1995, due to relatively less time spent on the REIT as compared to the Operator,
Contractor and other related entities. See Item 1. Business--Employees, and
--Policies and Objectives with Respect to Certain Activities--Conflicts of
Interest; and Item 13. Certain Relationships and Related Transactions--Cost
Reimbursement Agreement.

         Property taxes and insurance expenses totaled $733,000 in 1996,
compared with $514,000 for 1995. The increase is attributable to the increase in
the number of Inns and, to a lesser extent, the expansion of existing Inns.

         Interest expense decreased from $1.6 million in 1995 to $1.4 million in
1996 due to the repayment of approximately $30.8 million in debt in April 1996
with proceeds from the sale of 3.3 million shares of Common Stock. As a result
of the early extinguishment of debt in 1996, the Company had a loss of $989,376,
comprised of the write-offs of deferred finance costs, which are reflected as
extraordinary items.

         Depreciation expense increased from $1.8 million in 1995 to $2.7
million in 1996, due to an increase in the number of operating Inns and, to a
lesser extent, the expansion of existing Inns.

         Comparison of the Year Ended December 31, 1995 to the Year Ended
December 31, 1994. Lease revenue for the Company for 1995 increased 60% to $6.3
million as compared to $4.0 million for 1994. The increase was due to the
increase in the Operator's room revenues, partially offset by the effect of a
change in the percentage rent formula under the Lease amendment effective July
1, 1995.

         The number of room nights available increased from 295,193 in 1994 to
448,906 in 1995, or 52%, due to the opening from February 1994 through December
1995 of 17 new 40-room Inns, seven 20-room expansions of existing Inns and one
16-room expansion of an existing Inn. The occupancy rate decreased from 70.1% to
67.5% for 1994 and 1995, respectively. In addition, ADR increased 9% from $39.43
in 1994 to $42.80 in 1995. As a result of these three factors, room revenues
rose 58%, from $8.4 million for 1994 to $13.3 million in 1995. Same Inn Room
Revenues for 1995 versus 1994 grew to $8.4 million from $7.4 million, or 14%.
The growth is due to an increase in ADR from $39.22 to $42.55 for these Inns and
an increase in room nights available (due to expansions of certain of these
Inns) from 258,752 to 281,583, partially offset by a decrease in the occupancy
rate from 71.1% to 68.4% for these Inns for 1995 compared to 1994. The decrease
in the overall occupancy of the Inns is attributable primarily to (i) the
expansion of several high occupancy Inns which then experienced lower occupancy
rates because of the additional rooms available in the marketplace, and (ii) the
opening of new Inns which typically require several months of operations before
realizing higher occupancy rates.

         General and administrative expense includes overhead charges for
management, accounting and legal services for the corporate home office. General
and administrative expense for 1995 was $622,000, as compared to $479,000 for
1994, due to the increase in cost of third party services incurred as a result
of being a public company, the increase in the number of the Company's employees
and the Company's relocation to a larger office space.

                                       33
<PAGE>   36
         Property taxes and insurance expenses totaled $514,000 in 1995,
compared with $412,000 for 1994. The increase is attributable to the increase in
the number of Inns and, to a lesser extent, the expansion of existing Inns.

         Interest expense increased from $339,000 in 1994 to $1.6 million in
1995 due to the greater amount of principal indebtedness outstanding combined
with higher average interest rates in 1995. In addition, the Company repaid
approximately $18 million in debt in February 1994 with proceeds from its
initial public offering of Common Stock. As a result of the early extinguishment
of debt in 1995 and 1994, the Company had a loss of $19,000 and $250,000,
respectively, largely comprised of the write-offs of deferred finance costs,
which are reflected as extraordinary items.

         Depreciation expense increased from $1.4 million in 1994 to $1.8
million in 1995, due to an increase in the number of operating Inns and, to a
lesser extent, the expansion of existing Inns.

FUNDS FROM OPERATIONS; CASH AVAILABLE FOR DISTRIBUTION

         The following table illustrates the Company's calculation of Funds from
Operations and Cash Available for Distribution on an historical basis for the
years ended December 31, 1994, 1995 and 1996 and on a pro forma basis for the
year ended December 31, 1994. In March 1995, the National Association of Real
Estate Investment Trusts ("NAREIT") published a new interpretation of Funds from
Operations which the Company retroactively adopted at that time.

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                          -----------------------------------------------
                                          HISTORICAL  PRO FORMA(1)        HISTORICAL
                                          ----------  ------------   --------------------
                                             1994         1994         1995         1996
                                           -------      -------      -------      -------
                                                          ($ IN THOUSANDS)
<S>                                        <C>          <C>          <C>           <C>         
Net Income ...........................     $ 1,061      $ 1,424      $ 1,772      $ 3,051
Add:
    Depreciation expense .............       1,427        1,471        1,825        2,670
    Loss on disposals ................          --           --           --           48
    Extraordinary item ...............         250           --           19          989
                                           -------      -------      -------      -------

Funds from Operations, per March 1995
   NAREIT interpretation .............       2,738        2,895        3,616        6,758
Add:
   Stock compensation expense ........          57           57           77           --
   Loan fee amortization expense .....          34           --           87           93
Less:
   Reserve for furniture, fixtures and
      equipment(2) ...................          --           --         (288)        (778)
   Required loan principal repayments          (72)         (37)        (218)        (319)
                                           -------      -------      -------      -------
Cash Available for Distribution ......     $ 2,757      $ 2,915      $ 3,274      $ 5,754
                                           =======      =======      =======      =======
</TABLE>

-----------

(1)      Pro forma results assume (i) the Company's initial public offering and
         all related transactions had occurred on January 1, 1993, and (ii) the
         Company qualified as a REIT, distributed all of its taxable income and,
         therefore, incurred no income tax expense during the pro forma period.

                                     34
<PAGE>   37
(2)      Prior to July 1, 1995 the Operator was responsible for the replacement
         and refurbishment of furniture, fixtures and equipment. After that date
         and in conjunction with the Lease amendment, the Company assumed this
         responsibility.

         Funds from Operations is defined by the National Association of Real
Estate Investment Trusts ("NAREIT") according to the March 1995 interpretation
as net income (computed in accordance with generally accepted accounting
principles ("GAAP")) excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation and after adjustments for unconsolidated
partnerships and joint ventures. The Company has made adjustments to its net
income (loss) consisting only of depreciation, loss on disposals and the
extraordinary item for debt restructuring. The Company notes that industry
analysts use Funds from Operations as another tool to evaluate and compare
equity REITs. The Company also believes it is meaningful as an indicator of net
income excluding most non-cash items. Other non-cash expenses such as stock
option expense have not been added back in Funds from Operations. Funds from
Operations does not represent cash flow from operating activities in accordance
with GAAP and is not indicative of cash available to fund all of the Company's
cash needs. Funds from Operations should not be considered as an alternative to
net income or any other GAAP measure as an indicator of performance and should
not be considered as an alternative to cash flows as a measure of liquidity.

         Cash Available for Distribution is calculated as Funds from Operations
plus non-cash stock option expense and loan fee amortization, less amounts
estimated for future replacement and refurbishment of furniture, fixtures and
equipment and required loan principal repayments. On July 1, 1995, the Company
adopted a policy of maintaining cash or sufficient access to borrowings equal to
4% of the Inns' aggregate room revenues since July 1, 1995, less amounts
actually spent from that date forward. Prior to this date, the obligation to
fund replacement and refurbishment of furniture, fixtures and equipment was the
Operator's. For the period July 1, 1995 through December 31, 1996, 4% of room
revenues equalled $1,066,000 and the Company expended $803,000 on such items in
that same period. In addition, the Company expects to retain some portion of the
Cash Available for Distribution for working capital and capital expenditures.

LIQUIDITY AND CAPITAL RESOURCES

         Since its election to be taxed as a REIT, the Company has financed and
currently intends to continue financing the construction of new Inns entirely
with bank borrowings. At December 31, 1996, the Company had approximately $22.3
million in outstanding debt. It is management's intention to continue to borrow
from some or all of its previous lenders to finance future projects.

         The Company has a $29 million line of credit (the "Line") convertible
in June 1998 to a term note. At December 31, 1996, the Company had drawn down
$7.1 million under the Line with $21.9 million remaining available credit. Loans
made under the Line bear interest at rates initially ranging from 8.5% to 8.75%,
which are adjustable annually to equal a major lender's prime rate as published
in the Wall Street Journal plus .25 or .5 percentage points. The minimum annual
interest rate payable under the Line is 7% and the maximum is 13%. The annual
interest rates at December 31, 1996 ranged from 8.5% to 8.75%. Loans made under
the Line are secured by mortgages on 24 of the Inns. Payments of interest are
due monthly, and monthly

                                       35
<PAGE>   38
payments of principal commence in June 1998. Principal on loans under the Line
is amortized using a 15-year period and is payable in full in May 2006.

         Construction and long-term mortgage financing are expected to be
available to fund the balance of construction costs not funded under the Line.
For each new Inn developed by the Company, generally a construction loan for
approximately $1.1 million has been obtained. Each construction loan converts to
a long-term mortgage financing upon completion of the Inn without any further
action by the Company. Each of the mortgage and construction loans outstanding
at December 31, 1996, is amortized over 15 years and is payable in full 7 years
from its inception. The interest rate on each of such loans is adjusted
annually, after an 18-month interest-only period, to the prime rate then
prevailing plus .25% to 1.5% with a floor of 7% and a cap of 12%, with no annual
change greater than 1%.

         The Company believes it can continue to finance new Inns with these
construction and long-term mortgage loans. As of December 31, 1996, the Company
had five Inns which were debt free and could be used as collateral should the
Company need additional borrowing capacity. Generally, Inn expansions are also
financed through construction loans. Management believes the Company can
adequately meet its financing needs for the next year through the traditional
debt financing methods available to the Company. Since the Company presently
intends to rely primarily on borrowings for construction and permanent financing
of new Inns and the expansion of existing Inns, the lack of sufficient financing
on favorable terms and conditions could prevent or significantly deter the
Company from constructing new Inns or expanding existing Inns. The availability
of such financing depends on a number of factors over which the Company has no
control, including general economic conditions, the economic and competitive
environments of the communities in which the Inns are located and the level and
stability of long-term interest rates. The Company also is considering possible
additional long-term debt or equity financing that would be available to fund
its ongoing development activities.

         In January 1997, the Company filed a shelf registration statement with
the Securities and Exchange Commission that provides for the issuance of an
aggregate of up to $100 million in Common Stock, Preferred Stock and Common
Stock warrants to be offered and sold from time to time. The Company intends to
use the net proceeds, if any, from any sale of securities under such
registration statement for the repayment of existing indebtedness, working
capital and general corporate purposes.

         The Company expects to continue to develop additional Inns as suitable
opportunities arise, and the Company will not undertake investments unless
adequate sources of financing are available. As of December 31, 1996, the
Company had also borrowed approximately $2.1 million to finance the construction
of new Inns at Auburn and Oxford, Alabama; Oakwood, Georgia; Forest City,
Laurinburg and Wilson, North Carolina; Union, South Carolina; Decherd and
Tullahoma, Tennessee. In addition, the Company is negotiating construction loans
for the construction of new Inns at Tuscaloosa, Alabama and Sanford, North
Carolina. Total construction costs of these 11 Inns, excluding land and closing
costs, is expected to be $13.5 million when complete. The Company is also
currently expanding the Inn in Gaffney, South Carolina. The expansion is being
financed under the Line. The Company may in the future expand additional

                                       36
<PAGE>   39
Inns if management determines that sufficient market demand exists and financing
is available for any such expansion.

         As with most real estate investments, the Company's investments in the
Inns are relatively illiquid and such illiquidity is further increased by the
Inns' location in small communities. As a result, the ability of the Company to
sell or otherwise dispose of any Inn to provide liquidity will be very limited.

         In connection with its initial public offering in 1994, the Company
sold to Commonwealth Associates, for an aggregate of $260, warrants to purchase
up to 260,000 shares of Common Stock at an exercise price of $14.85 per share
exercisable at any time until January 27, 1999.

         The Company has three stock incentive plans in place. As of December
31, 1996, 853,949 shares were reserved for future grants and 492,644 options
were outstanding (including 292,077 which were exercisable).

INFLATION

         Operators of hotels in general possess the ability to adjust room rates
quickly. Although the Operator raised its room rates by approximately 5% in July
1994 and April 1995, competitive pressures have limited, and may in the future
limit, the Operator's ability to raise rates in the face of inflation.

SEASONALITY

         The Inns' historical operations have been seasonal in nature,
reflecting higher occupancy rates in the second and third quarters. This
seasonality can be expected to cause fluctuations in the Company's Lease revenue
that it receives from the Operator.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

         The financial statements and supplementary data are indexed in Item 14
hereof.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

         None.

                                       37
<PAGE>   40
                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The Company's Board of Directors currently consists of four directors
serving staggered terms. Except for those Class I and Class II directors whose
initial terms were set at the lengths required to establish a classified Board
of Directors, each newly elected director holds office for a period of three
years and until his successor is duly elected and qualified. Officers serve at
the discretion of the Board of Directors. The directors and executive officers
of the Company and their ages at January 31, 1997, are as follows:

<TABLE>
<CAPTION>
                Name                       Age                              Position
                ----                       ---                              --------
<S>                                        <C>                <C>
         Thomas W. Kitchin                 55                 President, Chief Executive Officer,
                                                              Director, Chairman of the Board of Directors

         William D. Walker                 43                 Vice President

         Craig R. Kitchin                  29                 Chief Financial Officer, Treasurer

         Steven A. Curlee                  45                 General Counsel, Secretary

         Robert D. Hisrich                 52                 Director

         Thomas J. Kearns                  58                 Director

         Michael E. Lawrence               52                 Director
</TABLE>

         Set forth below is certain information concerning the Company's
directors and executive officers.

         Thomas W. Kitchin is a Class III director whose term expires in 1999.
He is the founder and has been an officer and director of the Company since its
incorporation in 1988. Prior to founding the Company, he spent 10 years in the
oil and gas industry and served as chief executive officer of an oil and gas
company listed on the American Stock Exchange. Mr. Kitchin serves as a director
of the Association of Publicly Traded Companies, an association that represents
public companies that trade on The Nasdaq Stock Market, New York Stock Exchange
and American Stock Exchange; chairman of the Georgia Hospitality and Travel
Association; director of the American Hotel & Motel Association; director of the
Georgia State University Cecil B. Day School of Hospitality Administration;
director of the Georgia Southern University Restaurant, Hotel and Institutional
Administration Academic Advisory Board; and director of the Northside Hospital
Advisory Board. In addition, he has served on the board of directors of a
private school, several banks and oil companies and numerous other civic,
charitable and social service agencies. Mr. Kitchin is the father of Craig R.
Kitchin, Chief Financial Officer and Treasurer of the Company.

         William D. Walker is a Vice President of the Company. He has been an
officer of the Company since its inception in 1988 and served as a director from
1988 through October 29, 1993. Prior to joining the Company, he worked in
various financial management positions for

                                       38
<PAGE>   41
twelve years. Mr. Walker received a B.B.A. degree in finance from Texas Tech
University in 1975.

         Craig R. Kitchin became Chief Financial Officer of the Company in
February 1994. He joined the Company as its Controller and Treasurer on June 15,
1992, upon receiving his M.B.A degree from the University of Chicago with
concentrations in accounting and finance. Before attending the University of
Chicago, he was a financial analyst with FMC Corporation in Santa Clara,
California, from 1989 to 1990, where his primary responsibilities included
budgeting and forecasting overhead expenses. Mr. Kitchin graduated from Santa
Clara University with a degree in finance in 1989. Craig Kitchin is the son of
Thomas W. Kitchin, the President of the Company.

         Steven A. Curlee became General Counsel and Secretary of the Company on
January 1, 1993. From April 1985 to July 1992, he was general counsel for
Geodyne Resources, Inc. of Tulsa, Oklahoma, a public oil and gas company. Prior
thereto, he was engaged in the private practice of law in Tulsa, Oklahoma for
five years. From 1976 to 1980, Mr. Curlee served on active duty in the U.S. Navy
as a Judge Advocate. He continues to serve in the Navy Reserves, having attained
the rank of Commander. Mr. Curlee received a B.A. degree in political science
and his J.D. from the University of Arkansas. He received a Master of Law in
Taxation degree from Georgetown University. Mr. Curlee is admitted to practice
law in Arkansas, the District of Columbia, Oklahoma, Texas and Georgia.

         Robert D. Hisrich, Ph. D., who became a director in October 1993, is a
Class I director whose term expires in 1997. Dr. Hisrich has held the A. Malachi
Mixon III Chair in Entrepreneurial Studies and has been a professor at the
Weatherford School of Management, Case Western Reserve University, Cleveland,
Ohio, since September 1993. From 1985 until his appointment at Case Western
Reserve University, Dr. Hisrich held the Bovaird Chair of Entrepreneurial
Studies and Private Enterprise and was a Professor of marketing at The
University of Tulsa, Tulsa, Oklahoma, and was a Director of the Enterprise
Development Center at The University of Tulsa. In the spring of 1992, Dr.
Hisrich was a Visiting Professor of Entrepreneurship Studies at the University
of Limerick, Limerick, Ireland, and from 1990 through 1991, he was a Fulbright
Professor and holder of the Alexander Hamilton Chair in Entrepreneurship at the
Foundation for Small Enterprise Economic Development, Budapest, Hungary. In the
spring of 1989, Dr. Hisrich was a Fulbright Professor at the International
Management Center, Budapest, Hungary. In addition, since 1974 Dr. Hisrich has
been Director of H & B Associates, a marketing and management consulting firm.
He has also held a number of other academic positions and is widely published in
the areas of marketing, management and entrepreneurship. Dr. Hisrich has a B.A.
degree in English and science from DePauw University, an M.B.A. degree in
marketing from the University of Cincinnati and a Ph.D. degree in business
administration from the University of Cincinnati.

         Thomas J. Kearns, who became a director in July 1994, is a Class I
director whose term expires in 1997. Since April 1995, he has been Director of
Financial Services, Investment Banking, Josephthal, Lyon & Ross, Inc. He is also
president of Thomas J. Kearns Inc., a financial consulting firm, and has been in
the securities business for 30 years. Until 1990, Mr. Kearns was a first vice
president of Merrill Lynch Capital Markets, where he was employed for

                                       39
<PAGE>   42
16 years. Since 1990 he has been a director of CWM Mortgage Holdings, Inc.
(formerly Countrywide Mortgage Investments, Inc)., a publicly-held real estate
mortgage investment company. From April 1994 to January 1995 he was a managing
director of Commonwealth Associates, an investment banking firm. Mr. Kearns was
nominated and serves on the Board of Directors as the designee of Commonwealth
Associates pursuant to an agreement between Commonwealth Associates and the
Company.

         Michael E. Lawrence, who became a director in April 1994, is a Class II
director whose term expires in 1998. Since March 1994, he has been a director of
Sea Pines Associates, Inc., a publicly held corporation with approximately $35
million in annual revenues which owns and operates real estate and recreational
properties on Hilton Head Island, South Carolina. Mr. Lawrence is president and
chief executive officer of Sea Pines Company and Sea Pines Real Estate Company.
Prior to joining Sea Pines Associates, Inc., Mr. Lawrence was a management
consultant with Ernst & Young from 1969 through 1989 and was a partner in that
firm from 1982 through 1989. Mr. Lawrence is a certified public accountant with
a B.S. from Washington and Lee University and an M.B.A. degree from Emory
University.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors, executive officers and persons who own more than ten
percent of the Company's equity securities to report their initial ownership of
such securities and any subsequent changes in that ownership to the Securities
and Exchange Commission ("SEC") and The Nasdaq Stock Market, and to furnish the
Company with a copy of each such report. SEC regulations impose specific due
dates for such reports, and the Company is required to disclose in this report
any failure to file by these dates during and for fiscal 1996.

         To the Company's knowledge, based solely on review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, during and for fiscal 1996, its officers, directors and
shareholders who hold more than ten percent of the Company's equity securities
complied with all applicable Section 16(a) filing requirements.


ITEM 11. EXECUTIVE COMPENSATION.

COMPENSATION OF DIRECTORS

         Each director other than Mr. Kitchin receives from the Company an
annual fee of $10,000 and reimbursement of expenses incurred in attending Board
or Committee meetings. Payment of the annual fee is not contingent upon
attendance at Board or Committee meetings.

         Under the Jameson Inns, Inc. Director Stock Option Plan, each director
of the Company who is not otherwise an employee of the Company or any of its
subsidiaries or affiliates (an "independent director") is granted an option
("New Director Option") to purchase 25,000 shares of Common Stock upon his
initial election as a director of the Company. Such options are fully vested
when granted and have an exercise price equal to the fair market value of a
share of the

                                       40
<PAGE>   43
Common Stock on the date the New Director Option is granted. New Director
Options are first exercisable as to all or any part of the shares of Common
Stock covered thereby six months after the date of grant and until three months
after a director's resignation, one year after a director becomes disabled and
15 months after a director's death.

EXECUTIVE  COMPENSATION

         The following table sets forth certain information with respect to the
compensation of Thomas W. Kitchin, the Company's Chief Executive Officer, for
services in all capacities to the Company during the fiscal years ended December
31, 1994, 1995 and 1996. No other executive officer of the Company had an annual
salary and bonus in excess of $100,000 during such year. No information is given
as to any person for any fiscal year during which such person was not an
executive officer of the Company.

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                     Long-Term Compensation
                                              Annual Compensation                            Awards
                                             ----------------------           ------------------------------------
                                                                              Securities Underlying
                                                                                      Options/
          Name and                                         Salary                       SARs            Restricted
        Principal Position                   Year            ($)                        (#)               Stock
-------------------------------------        ----         ---------                 -----------       ------------

<S>                                          <C>          <C>                       <C>               <C>
Thomas W. Kitchin, Chairman,                 1994         $100,000(1)                 200,000(2)           --
President and Chief Executive Officer
                                             1995           43,363(1)                  25,000(3)           --

                                             1996           62,598(1)                      --          37,500(4)
</TABLE>

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

(1) Represents allocation from Kitchin Investments, Inc. based on records of
    actual time spent related to the Company.

(2) Consists of 150,000 free standing stock appreciation rights granted under
    Mr. Kitchin's employment agreement (see --Employment Agreement, below) and
    options to purchase 50,000 shares of Common Stock under the Jameson 1993
    Stock Incentive Plan. These stock appreciation rights were cancelled
    effective March 31, 1996.

(3) Consists of options to purchase 25,000 shares of Common Stock at $7.25 per
    share granted under the Jameson 1993 Stock Incentive Plan.

(4) Consists of shares of restricted Common Stock granted under the Jameson 1996
    Stock Incentive Plan. Such shares vest 10 years after the date of grant,
    assuming continuous employment with the Company through the date of vesting.



                                       41
<PAGE>   44
OPTION AND SAR EXERCISES IN LAST FISCAL YEAR;
AGGREGATE FISCAL YEAR-END VALUES OF OPTIONS AND SARS

         The named executive officer did not exercise any options during fiscal
1996. The following table sets forth the values as of December 31, 1996, of all
options and restricted stock held by the named executive officer during fiscal
1996.

<TABLE>
<CAPTION>
                                       Number of Unexercised
                                     Options/Restricted Stock             Value of Unexercised In-the-Money
            Name                        at Fiscal Year-End           Options/Restricted Stock at Fiscal Year-End
            ----                        ------------------           -------------------------------------------
                                  Exercisable       Unexercisable            Exercisable     Unexercisable
                                  -----------       -------------            -----------     -------------
<S>                                  <C>               <C>                    <C>              <C>     
       Thomas W. Kitchin             50,000            62,500                 $300,000         $646,875
</TABLE>



EMPLOYMENT AGREEMENT

         In connection with the initial public offering, the Company entered
into an employment agreement with Thomas W. Kitchin as Chief Executive Officer
and President of the Company. Under the agreement, the Board of Directors sets
the maximum amount of annual salary for which the Company reimburses Kitchin
Investments, Inc., under the Cost Reimbursement Agreement between the Company
and Kitchin Investments, Inc. based on the amount of time Mr. Kitchin devotes to
the Company's business. See Item 1. Business--Employees, and --Policies and
Objectives with Respect to Certain Activities--Conflicts of Interest; and Item
13. Certain Relationships and Related Transactions--Cost Reimbursement
Agreement. In addition, the agreement granted Mr. Kitchin stock appreciation
rights ("SARs") based on 150,000 shares of Common Stock which entitled Mr.
Kitchin to receive the difference between the market value of such shares as of
the exercise date and $9.00 per share, the initial public offering price of the
Common Stock. These SARs were rescinded by agreement of Mr. Kitchin and the
Company effective March 31, 1996.

         The employment agreement can be terminated by Mr. Kitchin upon giving
60 days' notice. The Company may terminate the agreement at any time. If the
Company terminates Mr. Kitchin's employment without cause, however, and elects
to continue the non-compete provisions of the agreement (see below), the Company
must pay Mr. Kitchin an amount equal to 300% of his annual compensation by the
Company in equal monthly installments over the 24-month term of the non-compete
provisions.

         The agreement includes a non-compete provision whereby Mr. Kitchin is
prohibited from owning, operating or managing, directly or indirectly, any hotel
property during the term of his employment, or, for two years following such
employment, any hotel property within a 20-mile radius of any hotel property
owned by the Company.

                                       42
<PAGE>   45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The following table sets forth certain information regarding the
beneficial ownership of Common Stock by each director and the named executive
officer of the Company, by all directors and officers of the Company as a group
and by each person who is known to the Company at January 31, 1997 to be the
beneficial owner of 5% or more of the outstanding Common Stock. Except as
otherwise noted, each person identified in the table has sole voting and
investment power over the shares shown as beneficially owned, subject to
community property laws where applicable.

<TABLE>
<CAPTION>
                                                                                 Shares of     
                                                                               Common Stock
                                                                               Beneficially        Percentage
Name of Owner or Identity of Group                                               Owned(1)           of Class
<S>                                                                            <C>                 <C> 
Thomas W. Kitchin.........................................................        697,170(2)           9.4%
     8 Perimeter Center East, Suite 8050                                       
     Atlanta, Georgia 30346                                                    
                                                                               
Robert D. Hisrich.........................................................         25,900(3)            *
                                                                               
Thomas J. Kearns..........................................................         30,000(3)            *
                                                                               
Michael E. Lawrence.......................................................         25,000(3)            *
                                                                               
All directors and executive officers as a group (8 persons)...............        865,296(4)          11.4%
</TABLE>

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

    *   Less than one percent (1%)

    (1) The total number includes shares issued and outstanding as of January
        31, 1997, plus shares which the owner shown above has the right to
        acquire within 60 days after January 31, 1997. For purposes of
        calculating the percent of the class outstanding held by each owner
        shown above with a right to acquire additional shares, the total number
        of shares excludes the shares which all other persons have the right to
        acquire within 60 days after January 31,1997, pursuant to the exercise
        of outstanding stock options.

    (2) Includes 46,938 shares owned by Kitchin Children's Trust, the
        beneficiaries of which are members of the family of Mr. Kitchin and of
        which Mr. Kitchin serves as trustee, 50,000 shares issuable upon the
        exercise of currently vested stock options and 140,000 shares owned
        jointly with Mr. Kitchin's spouse.

    (3) Includes 25,000 shares issuable upon the exercise of currently vested
        stock options.

    (4) Includes 192,752 shares issuable upon the exercise of currently vested
        stock options.


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

TURNKEY CONSTRUCTION CONTRACTS

         New Inns under construction are, and it is anticipated that any
additional Inns developed by the Company will be, constructed by the Contractor
on a turnkey basis pursuant to construction agreements between the Company and
the Contractor. The Contractor is a company beneficially

                                       43
<PAGE>   46
owned entirely by Thomas W. Kitchin. See Item 1. Business--Growth Plans for
1997--The Contractor. The Contractor also performs all of the construction work
for expansions and renovations of existing Inns and, in addition, constructed
fitness centers for Inns constructed prior to their becoming a standard feature
of new Inns. The Company paid the Contractor an aggregate of $18.9 million for
turnkey construction of new Inns, expansions and renovations during the year
ended December 31, 1996. Under the construction agreements, if the contract
price for a new Inn or group of Inns or an Inn expansion exceeds the
Contractor's costs plus 10%, the Contractor is required to refund the excess
amount to the Company. The contract price as well as the other terms of each
construction agreement submitted by the Contractor are subject to approval by
the members of the Board of Directors of the Company who are not also officers
or employees of the Company and who are not affiliated in any way with the
Operator or the Contractor.

THE LEASE

         The Company is the lessor under the Lease with the Operator covering
all of the existing Inns. All new Inns developed by the Company during the term
of the Lease will become subject to the Lease upon completion of construction.
See Item 1. Business--The Lease.

         Total rent earned by the Company for the year ended December 31, 1996
was $9.4 million.

         The Lease requires the Operator to pay base rent, percentage rent as
applicable, workers' compensation insurance premiums, and all costs and expenses
incurred in the operation of the Inns. The Company is responsible for paying
real and personal property taxes, casualty, liability and other types of
insurance, the costs of replacing or refurbishing furniture, fixtures and
equipment, and the maintenance of structural elements, roofs and underground
utilities.

         The Operator was formed to conduct the operation of the Inns and
entered into the Lease with the Company for that purpose. The Operator is owned
9.9% by Thomas W. Kitchin, Chairman, President and Chief Executive Officer of
the Company, and 90.1% by a grantor trust of which Steven A. Curlee, General
Counsel and Secretary of the Company, is the trustee and beneficiary. The
Operator has only nominal assets, a history of operating losses and a limited
net worth.

         The Lease was amended effective January 1, 1997, to extend the Lease
term. The members of the Board of Directors of the Company who are not also
officers or employees of the Company and who are not affiliated in any way with
the Operator or the Contractor approved such amendment and determined that the
Lease, as amended, is fair to the Company.

COST REIMBURSEMENT AGREEMENT

         The officers and employees of the Company are also employees of Kitchin
Investments, Inc., a corporation wholly owned by Thomas W. Kitchin. Rather than
duplicate payroll functions, the officers and employees of the Company receive
their salaries, hourly wages and fringe benefits entirely from Kitchin
Investments, Inc., which also pays the Company's office overhead and other
general and administrative costs. Effective January 1, 1994, the Company entered
into the Cost

                                       44
<PAGE>   47
Reimbursement Agreement with Kitchin Investments, Inc. providing that the
Company will reimburse Kitchin Investments, Inc. on an actual cost basis for the
employee compensation and overhead costs attributable to the Company. Under the
Cost Reimbursement Agreement, the Company determines for each officer and
employee the amount the Company would pay, in salary and benefits (including
non-cash stock-based compensation awards), if such person devoted 100% of his or
her time to Company business. Kitchin Investments, Inc. then determines, subject
to review by the Company, the actual percentage of the person's time devoted to
the Company's business and applies that percentage to the Company-established
compensation amount. The resulting amount is the amount the Company reimburses
Kitchin Investments, Inc. with respect to the officer's or employee's
compensation. Office overhead and other general and administrative costs are
also allocated to and borne by the Company based primarily on the amount of time
spent by these officers and employees on Company business. In 1996, such
allocation of salary, office overhead and other general and administrative costs
totalled approximately $194,000.




                                       45
<PAGE>   48

                                    PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a)      1.      Financial Statements of Jameson Inns, Inc.




<TABLE>
<CAPTION>
                                                                                                                  Page(s)
         <S>                                                                                                       <C>
         Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F-1
         Consolidated Balance Sheets as of December 31, 1994 and 1995 . . . . . . . . . . . . . . . . . . . . . .   F-2
         Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and 1995 . . . . . . .   F-3
         Consolidated Statements of Stockholders' Equity for the years ended December 31, 1993, 1994 and 1995 . .   F-4
         Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and 1995   . . . . . .   F-5
         Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   F-7

         2.      Financial Statement Schedules
                 -----------------------------

         Schedule III - Real Estate and Accumulated Depreciation  . . . . . . . . . . . . . . . . . . . . . . . .  F-20
         Notes to Schedule III  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  F-22

         All other schedules have been omitted since the required information is not present, or is not
         present in amounts sufficient to require submission of the schedule, or because the information
         required is included in the financial statements and notes thereto.

         3.      Other Information
                 -----------------

         Unaudited Pro Forma Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  F-23
         Unaudited Pro Forma Statement of Operations for the year ended December 31, 1994 . . . . . . . . . . . .  F-24

         4.      Financial Statements of Jameson Operating Company
                 -------------------------------------------------

         Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  F-26
         Balance Sheets as of December 31, 1996 and 1995  . . . . . . . . . . . . . . . . . . . . . . . . . . . .  F-27
         Statements of Operations for the years ended December 31, 1996, 1995 and 1994  . . . . . . . . . . . . .  F-28
         Statements of Stockholders' Deficit for the years ended December 31, 1996, 1995 and 1994 . . . . . . . .  F-29
         Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994  . . . . . . . . . . . . .  F-30
         Notes to Financial Statements  . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  F-31
</TABLE>





                                       46
<PAGE>   49
         5.      Exhibits

EXHIBIT
NUMBER


   3.1    -  Articles of Incorporation of the Registrant incorporated by
               reference to Exhibit 3.1.1 to the Registration Statement filed
               on Form S-11, File No. 33-71160

   3.2    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant incorporated by reference to Exhibit 3.1.2 to the
               Registration Statement filed on Form S-11, File No. 33-71160

   3.3    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant Setting forth the Designation of Preferences, Rights,
               Privileges and Restrictions of Preferred Stock of the Registrant
               incorporated by reference to Exhibit 2.1 to the Registrant's
               Form 10-K/A1 (Amendment No. 1 to the Registrant's Annual Report
               on Form 10-K) for the year ended December 31, 1993

   3.4    -  Article of Amendment to the Articles of Incorporation of the
               Registrant incorporated by reference to Exhibit 3.3.1 to Form
               10-K/A2 (Amendment No. 2 to the Registrant's Annual Report on
               Form 10-K) for the year ended December 31, 1993

   3.5    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant Amending the Designation of Preferences, Rights,
               Privileges and Restrictions of Preferred Stock of the Registrant
               incorporated by reference to Exhibit 3.6 to the Registrant's
               Annual Report on Form 10-K for the year ended December 31, 1994

   3.6    -  Bylaws of the Registrant incorporated by reference to Exhibit
               3.2.1 to the Registration Statement on Form S-11, File
               No. 33-71160

   3.7    -  Amendment to the Bylaws of the Registrant incorporated by
               reference to Exhibit 3.2.2 to the Registration Statement on Form
               S-11, File No. 33-71160

   3.8    -  Amendment No. 2 to Registrant's Bylaws incorporated by reference
               to Exhibit 3.8 to the Annual Report filed on Form 10-K for the
               year ended December 31, 1995

   4.1    -  Specimen Certificate of Common Stock incorporated by reference to
               Exhibit 4.1 to the Registration Statement on Form S-11, File No.
               33-71160

   4.2    -  Warrant issued to Commonwealth Associates incorporated by
               reference to Exhibit 4.2.1 to the Registration Statement on Form
               S-11, File No. 33-71160

  10.1    -  Master Lease Agreement incorporated by reference to Exhibit 10.1
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1993

  10.2    -  Amendment No. 1 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company (revised) incorporated by
               reference to Exhibit 10.2 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.3    -  Amendment No. 2 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company

  10.4    -  Amendment No. 3 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company

  10.5    -  Addenda A-1 through A-17 to Master Lease Agreement between Jameson
               Inns, Inc. and Jameson Operating Company incorporated by
               reference to Exhibit 10.3





                                       47
<PAGE>   50



             to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.6    -  Schedule of Lease Supplement entered into during 1996 and
               substantially  similar to Exhibit 10.5

  10.7    -  Cost Reimbursement Agreement between Jameson Inns, Inc. and
               Kitchin Investments, Inc. incorporated by reference to Exhibit
               10.2 to the Registration Statement on Form S-11, File No.
               33-71160

  10.8    -  Construction Contract between Jameson Inns, Inc. and Jameson
               Construction Company for construction of Inns in Alexander City,
               Decatur, Eufala and Florence, Alabama; Albany, Bainbridge,
               Brunswick, LaGrange, Thomaston, Waycross and Waynesboro,
               Georgia; and Union, South Carolina, incorporated by reference to
               Exhibit 10.7 to the Annual Report filed on Form 10-K for the
               year ended December 31, 1995

  10.9    -  Schedule of documents substantially similar to Exhibit 10.8

  10.10   -  Jameson 1993 Stock Incentive Plan incorporated by reference to
               Exhibit 10.22.1 to the Registration Statement on Form S-11, File
               No. 33-71160

  10.11   -  Form of Stock Option Agreement under Jameson Inns, Inc. Stock
               Incentive Plan incorporated by reference to Exhibit 10.23 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.12   -  Amendment No. 1 to Jameson 1993 Stock Incentive Plan incorporated
               by reference to Exhibit 10.10 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.13   -  1994 Amendment to Jameson 1993 Stock Incentive Plan incorporated
               by reference to Exhibit 10.11 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.14   -  Amendment No. 3 to Jameson 1993 Stock Incentive Plan incorporated
               by reference to Exhibit 10.12 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.15   -  Jameson Inns, Inc. Director Stock Option Plan incorporated by
               reference to Exhibit 10.13 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.16   -  Employment Agreement between Jameson Inns, Inc. and Thomas W.
               Kitchin incorporated by reference to Exhibit 10.24 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.17   -  Amendment No. 1 to Employment Agreement between Jameson Inns, Inc.
               and Thomas W. Kitchin incorporated by reference to Exhibit 10.15
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.18   -  Amendment No. 2 to Employment Agreement between Jameson Inns, Inc.
               and Thomas W. Kitchin incorporated by reference to Exhibit 10.16
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.19   -  Indemnification and Hold Harmless Agreement between Jameson Inns,
               Inc. and Jameson Operating Company incorporated by reference to
               Exhibit 10.25 to the Registration Statement on Form S-11, File
               No. 33-71160

  10.20   -  Indemnification and Hold Harmless Agreement between Jameson Inns,
               Inc. and Kitchin Investments, Inc. incorporated by reference to
               Exhibit 10.26 to the Registration Statement on Form S-11, File
               No. 33-71160

10.21   -  Form of Indemnification agreement between Jameson Inns, Inc. and
               Directors





                                       48
<PAGE>   51

             and Officers incorporated by reference to Exhibit 10.27 to the
             Registration Statement on Form S-11, File No. 33-71160

  10.22   -  Dividend Subordination Agreement between the Company and Thomas W.
               Kitchin and Kitchin Children's Trust incorporated by reference
               to Exhibit 10.42 to the Registration Statement on Form S-11,
               File No. 33-71160

  10.23   -  Construction Loan Agreement, Indenture, Security Agreement and
               Promissory Note dated July 15, 1993 for $1,000,000 loan from
               Empire Financial Services, Inc. to Jameson Inns, Inc. (formerly
               Jameson Company) for construction of Jameson Inn in Carrollton,
               Georgia incorporated by reference to Exhibit 10.39 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.24   -  Schedule of documents substantially similar to Exhibit 10.23

  10.25   -  Loan Indenture, Security Agreement, Assignment of Fees and Income,
               Promissory Note for $4.2 million revolving loan from Empire
               Financial Services, Inc. to Jameson Inns, Inc. incorporated by
               reference to Exhibit 10.21 to the Annual Report filed on Form
               10- K for the year ended December 31, 1993

  10.26   -  Deed to Secure Debt, Security Agreement, Assignment of Operating
               Lease, Assignment of Fees and Income, Promissory Note for $1.6
               million loan from Empire Financial Services, Inc. to Jameson
               Inns, Inc. secured by Inn at Jesup, Georgia incorporated by
               reference to Exhibit 10.24 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.27   -  Schedule of documents substantially similar to Exhibit 10.26
               incorporated by reference to Exhibit 10.25 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.28   -  Loan Modification Agreement and Note increasing by $2.6 million
               the revolving loan from Empire Financial Services, Inc. to
               Jameson Inns, Inc. incorporated by reference to Exhibit 10.26 to
               the Annual Report filed on Form 10-K for the year ended December
               31, 1995

  10.29   -  Loan Modification Agreement, Construction Agreement and Note dated
               April 13, 1995, increasing by $500,000 the loan from Empire
               Financial Services, Inc. to Jameson Inns, Inc. for construction
               of expansion of Inn at Carrollton, Georgia, incorporated by
               reference to Exhibit 10.27 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.30   -  Schedule of documents substantially similar to Exhibit 10.29
               incorporated by reference to Exhibit 10.28 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.31   -  Promissory Note of Jameson Inns, Inc. payable to Bank Midwest,
               N.A. dated  January 26, 1996, for $3.4 million, incorporated by
               reference to Exhibit 10.29 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.32   -  Form of Security Agreement between Jameson Inns, Inc. and Bank
               Midwest, N.A., incorporated by reference to Exhibit 10.30 to the
               Annual Report filed on Form 10-K for the year ended December 31,
               1995

  10.33   -  Form of Deed to Secure Debt between Jameson Inns, Inc. and Bank
               Midwest, N.A. (Jameson Inn at Fitzgerald, Georgia), incorporated
               by reference to Exhibit 10.31 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.34   -  Schedule of documents substantially similar to Exhibit 10.31,
               incorporated by





                                       49
<PAGE>   52

             reference to Exhibit 10.32 to the Annual Report filed on Form 10-K
               for the year ended December 31, 1995

  10.35   -  Form of Assignment of Leases and Rents (General Commercial)
               between Jameson Inns, Inc. and Bank Midwest, N.A. (Jameson Inn
               at Fitzgerald, Georgia), incorporated by reference to Exhibit
               10.33 to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.36   -  Schedule of documents substantially similar to Exhibit 10.33,
               incorporated by reference to Exhibit 10.34 to the AnnualReport
               filed on Form 10-K for the year ended December 31, 1995

  10.37   -  Form of Assignment of Income between Jameson Inns, Inc. and Bank
               Midwest, N.A. (Jameson Inn at Fitzgerald, Georgia), incorporated
               by reference to Exhibit 10.35 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.38   -  Schedule of documents substantially similar to Exhibit 10.35,
               incorporated by reference to Exhibit 10.36 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.39   -  Form of Estoppel and Subordination Agreement between Jameson Inns,
               Inc. and Bank Midwest, N.A. (Jameson Inn at Fitzgerald,
               Georgia), incorporated by reference to Exhibit 10.37 to the
               Annual Report filed on Form 10-K for the year ended December 31,
               1995

  10.40   -  Schedule of documents substantially similar to Exhibit 10.39,
               incorporated by reference to Exhibit 10.38 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.41   -  Loan Modification Agreement between Jameson Inns, Inc. and Empire
               Financial Services, Inc. dated June 30, 1996 for loan on
               Waynesboro, Georgia property, incorporated by reference to
               Exhibit 10.1 to the Report filed on Form 10-Q for the quarter
               ended March 31, 1996

  10.42   -  Schedule of documents substantially similar to Exhibit 10.41

  10.43   -  Adjustable Rate Note dated June 30, 1996 in the amount of
               $1,050,000 from  Jameson Inns, Inc. to Empire Financial
               Services, Inc.  for loan on Waynesboro, Georgia property,
               incorporated by reference to Exhibit 10.3 to the Report filed on
               Form 10-Q for the quarter ended March 31, 1996

  10.44   -  Schedule of documents substantially similar to Exhibit 10.43

  10.45   -  Jameson 1996 Stock Incentive Plan

  10.46   -  Amendment No. 3 to Employment Agreement between Jameson Inns, Inc.
               and Thomas W. Kitchin

  11.1    -  Statement Re: Per Share Earnings

  23.1    -  Consent of Ernst & Young LLP

  27.1    -  Financial Data Schedule (for SEC use only).



(b) Reports on Form 8-K



    No reports on Form 8-K were filed during the fourth quarter of the year
ended December 31, 1996.








                                       50
<PAGE>   53
                         Report of Independent Auditors



The Board of Directors
Jameson Inns, Inc.

We have audited the accompanying consolidated balance sheets of Jameson Inns,
Inc. as of December 31, 1996 and 1995, and the related consolidated statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended December 31, 1996. Our audits also included the financial
statement schedule listed in the Index at Item 14(a)2. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

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 Jameson
Inns, Inc. at December 31, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Also, in our opinion, the related 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.

                                        ERNST & YOUNG LLP


Atlanta, Georgia
February 21, 1997




                                                                             F-1
<PAGE>   54
                               JAMESON INNS, INC.

                           CONSOLIDATED BALANCE SHEETS


<TABLE>
<CAPTION>
                                                              DECEMBER 31        
                                                              -----------        
                                                         1996             1995    
                                                         ----             ----    
<S>                                                  <C>              <C>         
ASSETS
Property and equipment, at cost                      $ 80,816,228     $ 57,369,657
Less accumulated depreciation                          (9,205,591)      (6,589,753)
                                                     ------------     ------------
                                                       71,610,637       50,779,904

Cash                                                      208,912          235,254
Lease revenue receivable                                  684,625          495,855
Prepaid expenses                                           98,794           37,412
Deferred finance costs, net                             1,197,205        1,213,396
Other assets                                              184,784           44,036
                                                     ------------     ------------
                                                     $ 73,984,957     $ 52,805,857
                                                     ============     ============



LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable                               $ 22,317,206     $ 30,213,904
Accounts payable                                           20,121           65,948
Accounts payable to affiliates                            633,460          568,661
Accrued interest                                          120,543          151,182
Accrued property taxes                                     97,515           13,533
Other accrued liabilities                                  33,154           38,279
                                                     ------------     ------------
                                                       23,221,999       31,051,507

Stockholders' equity:
   Convertible preferred stock, $1 par value,
      100,000 shares authorized, no shares issued
      and outstanding                                          --               --
   Common stock, $.10 par value, 20,000,000
      shares authorized, 7,357,471 shares
      (3,857,942 in 1995) issued and outstanding          735,747          385,795
   Additional paid-in capital                          51,054,202       22,395,546
   Retained deficit                                    (1,026,991)      (1,026,991)
                                                     ------------     ------------
Total stockholders' equity                             50,762,958       21,754,350
                                                     ------------     ------------
                                                     $ 73,984,957     $ 52,805,857
                                                     ============     ============
</TABLE>

See accompanying notes.


                                                                             F-2
<PAGE>   55
                               JAMESON INNS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31          
                                                  1996            1995            1994
                                                  ----            ----            ----
<S>                                            <C>             <C>             <C>        
INN OPERATIONS:
Lease revenue                                  $ 9,376,101     $ 6,342,229     $ 3,972,976
Property tax expense                              (461,516)       (292,308)       (197,670)
Insurance expense                                 (271,835)       (221,647)       (214,678)
Depreciation                                    (2,669,574)     (1,824,569)     (1,426,528)
Loss on disposal of furniture and
    equipment                                      (47,849)             --              --
                                               ------------------------------------------- 
                                                 5,925,327       4,003,705       2,134,100

OTHER EXPENSES:
Interest expense, net of capitalized
    amounts                                      1,385,512       1,590,524         339,442
General and administrative expenses                499,006         621,913         479,141
                                               ------------------------------------------- 
Income before amounts attributable to
    limited partners and extraordinary loss      4,040,809       1,791,268       1,315,517
Income attributable to limited partners                 --              --           4,360
                                               ------------------------------------------- 
Income before extraordinary loss                 4,040,809       1,791,268       1,311,157
Extraordinary loss                                 989,376          19,328         249,770
                                               ------------------------------------------- 
Net income                                       3,051,433       1,771,940       1,061,387
Preferred stock dividends                               --         489,949              --
                                               ------------------------------------------- 
Net income attributable to common
    stockholders                               $ 3,051,433     $ 1,281,991     $ 1,061,387
                                               ===========================================
PER COMMON AND COMMON EQUIVALENT SHARE:
Income before extraordinary loss               $       .63     $       .46     $       .37
                                               ===========================================
Net income                                     $       .48     $       .45     $       .30
                                               ===========================================
Weighted average shares outstanding              6,369,283       3,924,910       3,585,006
                                               ===========================================
</TABLE>


See accompanying notes.




                                                                             F-3
<PAGE>   56
                               JAMESON INNS, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


<TABLE>
<CAPTION>
                                               $1 PAR          $.10 PAR                                                  TOTAL
                                              PREFERRED         COMMON          CONTRIBUTED          RETAINED         STOCKHOLDERS'
                                                STOCK           STOCK             CAPITAL            DEFICIT             EQUITY
                                                -----           -----             -------            -------             ------
<S>                                           <C>             <C>              <C>                 <C>                <C>         
Balance at December 31, 1993                  $     --        $  93,875        $  2,211,623        $(1,026,991)       $  1,278,507
   Issuance of common stock, net of
      offering expense                              --          291,300          22,190,130                 --          22,481,430
   Exchange of common stock for
      preferred stock                           64,467          (64,467)                 --                 --                  --
   Vesting of stock options                         --               --              63,978                 --              63,978
   Common stock dividends ($0.50 per
      share)                                        --               --            (542,155)        (1,061,387)         (1,603,542)
   Net income                                       --               --                  --          1,061,387           1,061,387
                                              --------        ---------        ------------        -----------        ------------
Balance at December 31, 1994                    64,467          320,708          23,923,576         (1,026,991)         23,281,760
   Conversion of preferred stock to
      common stock                             (64,467)          64,467                  --                 --                  --
   Issuance of common stock, net of
      offering expense                              --              474              18,682                 --              19,156
   Exercise of stock options                        --              146               9,667                 --               9,813
   Vesting of stock options                         --               --              76,790                 --              76,790
   Preferred stock dividends ($7.60 per
      share)                                        --               --            (489,949)                --            (489,949)
   Common stock dividends ($0.80 per
      share)                                        --               --          (1,143,220)        (1,771,940)         (2,915,160)
   Net income                                       --               --                  --          1,771,940           1,771,940
                                              --------        ---------        ------------        -----------        ------------
Balance at December 31, 1995                        --          385,795          22,395,546         (1,026,991)         21,754,350
   Issuance of common stock, net of
      offering expense                              --          339,703          30,787,970                 --          31,127,673
   Exercise of stock options                        --            3,770             288,109                 --             291,879
   Vesting of stock options                         --               --              63,542                 --              63,542
   Restricted stock grant                           --            6,479              28,852                 --              35,331
   Common stock dividends ($0.86 per
      share)                                        --               --          (2,509,817)        (3,051,433)         (5,561,250)
   Net income                                       --               --                  --          3,051,433           3,051,433
                                              --------        ---------        ------------        -----------        ------------
Balance at December 31, 1996                  $     --        $ 735,747        $ 51,054,202        $(1,026,991)       $ 50,762,958
                                              ========        =========        ============        ===========        ============
</TABLE>



See accompanying notes.




                                                                             F-4
<PAGE>   57
                               JAMESON INNS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31            
                                                   1996             1995             1994
                                                   ----             ----             ----
<S>                                            <C>              <C>              <C>         
OPERATING ACTIVITIES
Net income                                     $  3,051,433     $  1,771,940     $  1,061,387
Adjustments to reconcile net income
  to cash provided by operating activities:
    Extraordinary loss                              989,376           19,328          249,770
    Depreciation and amortization                 2,762,660        1,911,720        1,460,840
    Loss on disposal of furniture and
      equipment                                      47,849               --               --
    Income attributable to limited partners              --               --            4,360
    Stock-based compensation expense                 98,873           76,790           56,868
    Changes in assets and liabilities
      increasing (decreasing) cash:
       Lease revenue receivable                    (188,770)        (147,329)        (348,526)
       Prepaid expenses and other assets           (202,130)         (26,628)          (1,171)
       Accounts payable                             (45,828)          23,882           42,066
       Accounts payable to affiliates                64,799          447,797          120,864
       Accrued interest                             (30,639)         103,344          (39,494)
       Accrued property taxes and other
          accrued liabilities                        78,857             (156)         (78,761)
                                               ------------     ------------     ------------
Net cash provided by operating activities         6,626,480        4,180,688        2,528,203

INVESTING ACTIVITIES
Additions to property and equipment             (23,548,156)     (18,844,582)     (10,844,852)
                                               ------------     ------------     ------------
Net cash used in investing activities           (23,548,156)     (18,844,582)     (10,844,852)
</TABLE>




See accompanying notes.




                                                                             F-5
<PAGE>   58
                               JAMESON INNS, INC.

                CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)


<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31
                                                  1996             1995             1994
                                                  ----             ----             ----
<S>                                           <C>              <C>              <C>          
FINANCING ACTIVITIES
Common stock dividends paid                   $ (5,561,250)    $ (2,915,160)    $ (1,603,542)
Preferred stock dividends paid                          --         (489,949)              --
Proceeds from issuance of common
   stock, net of offering expense               31,127,673           19,156       22,481,430
Proceeds from exercise of stock options            291,879            9,813               --
Proceeds from limited partner investments               --               --          300,000
Distributions to limited partners                       --               --       (4,591,545)
Change in deferred offering costs                       --               --          180,094
Proceeds from mortgage notes payable            27,466,333       22,994,085       12,045,635
Payment of deferred finance costs               (1,066,270)        (760,430)        (594,877)
Payments on mortgage notes payable             (35,363,031)      (4,309,839)     (19,568,058)
Other                                                   --           (1,915)         (56,982)
                                              ------------     ------------     ------------
Net cash provided by financing activities       16,895,334       14,545,761        8,592,155

Net increase (decrease) in cash                    (26,342)        (118,133)         275,506
Cash at beginning of year                          235,254          353,387           77,881
                                              ------------     ------------     ------------
Cash at end of year                           $    208,912     $    235,254     $    353,387
                                              ============     ============     ============

SUPPLEMENTAL INFORMATION
Interest paid, net of interest capitalized    $  1,416,151     $  1,781,537     $    386,827
                                              ============     ============     ============
State income and franchise taxes paid         $      3,772     $      7,355     $      3,839
                                              ============     ============     ============
</TABLE>



See accompanying notes.




                                                                             F-6
<PAGE>   59
                               JAMESON INNS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                DECEMBER 31, 1996

1.  BUSINESS AND BASIS OF FINANCIAL STATEMENTS

Jameson Inns, Inc. ("the Company") is in the business of developing and owning
limited service motel properties (the "Inns") operating under the trademark "The
Jameson Inn(R)." The Company's focus has been and will continue to be on
developing Inns in communities in the southeastern United States which have a
strong and growing industrial or commercial base. The typical Inn is built as a
40-unit two-story, Colonial style Inn on a one to two-acre tract with a swimming
pool, fitness center and parking area. Seventeen of the Inns have been or are in
the process of being expanded to 55 or more rooms.

At December 31, 1996, there were 43 Inns in operation in Georgia, Alabama and
South Carolina with a total of 2,107 rooms and an additional 21 Inns under
development, including 11 under construction in these same states plus North
Carolina and Tennessee. The Inns under development will add 840 rooms. At
December 31, 1996, a 20-room expansion of one existing Inn was also being
constructed.

Intercompany transactions among the entities included in the consolidated
financial statements have been eliminated. As of December 31, 1996, the Company
had one wholly-owned qualified real estate investment trust subsidiary.

PRIOR OPERATIONS

On December 31, 1993, the Company consummated a series of transactions to remove
all assets not related to ownership of the Inns in contemplation of electing to
qualify as a real estate investment trust ("REIT") for federal income tax
purposes effective January 1, 1994. Effective January 1, 1994, all of the Inns
were leased to Jameson Operating Company under the terms of leases which covered
all of the Inns then owned by the Company and certain affiliated partnerships
previously formed by the Company to construct and own Inns. See Note 3.

In early 1994, the Company consummated an initial public offering of 2,913,000
shares of Common Stock, par value $.10 per share (the "IPO").

The Company's principal business, before and after the IPO, includes
identification of suitable inn locations, arranging construction and permanent
financing, land acquisition, inn design and configuration, land preparation,
acquisition of furniture, fixtures and equipment, and pre-marketing of
properties prior to opening. Prior to the IPO, the Company also constructed the
facilities and operated the properties.




                                                                             F-7
<PAGE>   60
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2.  ACCOUNTING POLICIES

USE OF ESTIMATES

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

PROPERTY AND EQUIPMENT

Costs incurred to acquire and open new Inn locations or to renovate existing
Inns are capitalized as property costs and amortized over their depreciable
life. The Company also capitalizes construction period interest costs. Interest
costs of $526,130, $381,508 and $182,569 were capitalized in 1996, 1995 and
1994, respectively.

Jameson Construction Company or its successor Jameson Development Company,
L.L.C. ("JDC") constructs the Inns for the Company. Jameson Construction Company
was wholly-owned by Kitchin Investments, Inc. Kitchin Investments, Inc. is
wholly-owned by the Company's chairman and largest stockholder. JDC is managed
and majority-owned by the Company's chairman and largest stockholder. The
Company paid Jameson Construction Company or JDC a total of $18,932,000 and
$16,800,000 for turnkey construction of new Inn construction, expansions,
fitness centers or renovations during the years ended December 31, 1996 and
1995, respectively.

Property and equipment used in Inn operations is depreciated using the
straight-line method generally over 31.5 to 39 years (buildings), 15 years (land
improvements) and five years (furniture, fixtures and equipment).

Property and equipment consists of the following at December 31:


<TABLE>
<CAPTION>
                                                      1996             1995
                                                      ----             ----
<S>                                               <C>              <C>         
         Land and improvements                    $ 14,794,416     $  9,963,876
         Buildings                                  52,176,321       37,993,440
         Furniture, fixtures and equipment           9,840,922        6,910,432
         Construction in process                     4,004,569        2,501,909
                                                  ------------     ------------
                                                    80,816,228       57,369,657
         Accumulated depreciation                   (9,205,591)      (6,589,753)
                                                  ------------     ------------
                                                  $ 71,610,637     $ 50,779,904
                                                  ============     ============
</TABLE>



                                                                             F-8
<PAGE>   61
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



2.  ACCOUNTING POLICIES (CONTINUED)

In 1996, the Company adopted Financial Accounting Standards Board Statement No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, which requires impairment losses to be recorded on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount. There was no effect of adoption.

DEFERRED FINANCE COSTS

Deferred finance costs represent fees and other expenses incurred to obtain
long-term debt financing on the Inn facilities and are amortized to expense over
the terms of the loans, beginning with operation of the Inn. Amortization of
deferred finance costs is included in interest expense on the consolidated
statement of operations. Accumulated amortization totaled $50,923 and $102,703
as of December 31, 1996 and 1995, respectively.

INCOME TAXES

The Company has elected to be taxed as a REIT under the Internal Revenue Code of
1986, as amended (the "Code"), and has operated as such since January 1, 1994.
As a result, the Company is not subject to federal income taxes to the extent
that it distributes annually at least 95% of its taxable income to its
shareholders and satisfies certain other requirements defined in the Code.

The Company uses the liability method of accounting for income taxes.

STOCK-BASED COMPENSATION

The Company uses the intrinsic value method for valuing its awards of stock
options, restricted stock and other stock awards and recording the related
compensation expense, if any. This compensation expense is included in general
and administrative expense which is allocated as part of the cost reimbursement
agreement described in Note 8.

See Note 5 for pro forma disclosures using the fair value method as described in
Financial Accounting Standards Board Statement No. 123, Accounting for
Stock-Based Compensation ("FAS 123").

EARNINGS PER SHARE

Earnings per share are calculated using weighted average common shares
outstanding and assuming (i) the conversion of the preferred shares during
periods when preferred stock was outstanding, (ii) the stock options granted
prior to the IPO at exercise prices below the initial public offering price were
exercised and shares issued pursuant to such exercise were outstanding for the
entire period, using the treasury stock method, and (iii) the dilutive effects
of outstanding stock options. 




                                                                             F-9
<PAGE>   62
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


3. THE LEASE

On January 1, 1994, the Company and the partnerships which previously owned the
Inns entered into leases, whereby all of the operating Inns are leased to the
Jameson Operating Company (the "Operator"), therefore all of the lease revenue
and related receivables are derived from this lease. After the IPO and the
liquidation of the partnerships in January 1994, the Company entered into a
master lease in substantially the same form as the individual leases.

The lease, which expires December 31, 2006, provides for payment of Base Rent
plus Percentage Rent. Base Rent, which is payable monthly, equals $264.00 per
month for each rentable room in the Inns at the beginning of the relevant month.
Percentage Rent, which is payable quarterly, is calculated as a percentage in
excess of Base Rent of the total amount of room rental and other miscellaneous
revenues realized by the Operator over the relevant period. The percentage is
39% of such revenues up to $20.50 per day per room over the period, 65% of all
additional average daily room rental revenues, provided, however, that total
rent for any calendar year is not to exceed 47% of total room rental revenues
for that year. The $20.50 per room amount used in calculating Percentage Rent is
subject to adjustment each year end based on changes in the Consumer Price Index
and as of January 1, 1997 was $21.05.

Prior to July 1, 1995, when the lease was amended, the lease provided for Base
Rent equal to $240.00 per month and Percentage Rent was the same for the first
$20.00 per day but included four different rates for additional average daily
room rental revenues. The lease amendment also transferred the obligation to
replace or refurbish the furniture, fixtures and equipment in the Inns to the
Company.

Base rent totaled $5,469,288, $3,553,252 and $2,316,200 in 1996, 1995 and 1994,
respectively, and assuming the same number of rooms in operation as at December
31, 1996, would total $6,674,976 per year until the lease expires.

The Lease requires the Company to pay real and personal property taxes, casualty
and liability insurance premiums and the cost of maintaining structural
elements, including underground utilities and the cost of replacing or
refurbishing the furniture, fixtures and equipment in the Inns. The Company
intends to maintain cash reserves or sufficient access to borrowings equal to 4%
of room revenues of the Operator, less amounts expended to date, to fund the
Company's future capital expenditures for such replacements and refurbishments.
The Operator is required to pay workers compensation insurance premiums, utility
costs and all other costs and expenses incurred in the operations of the Inns.


                                                                            F-10
<PAGE>   63


             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


4.  MORTGAGE NOTES PAYABLE

As of December 31, long-term debt consists of:

<TABLE>
<CAPTION>
                                                                        1996                  1995
                                                                        ----                  ----
<S>                                                                  <C>                   <C>        
Notes payable on Inns:
     Terms of 7 to 20 years, due in monthly installments of
          principal and interest with any remaining unpaid
          balances payable in full on the individual note's
          maturity date. Maturity dates range from 2001 to
          2016. Interest rates are adjusted to a specified
          spread above the prime rate, and ranged from 9.25%
          to 10.25% at December 31, 1996. Secured by
          mortgages on 14 of the Inns.                               $13,046,054           $19,722,273


Lines of credit:
     $29 million line of credit ("the Line") convertible in
          1998 to a term note due in 2006. At December 31,
          1996, the Company had $21.9 million available to
          borrow. Secured by mortgages on 24 of the Inns.
          The Line bears interest at initial annual rates
          ranging from 8.5% to 8.75%, which is adjusted
          annually to the prime rate plus .25% or .5%, with
          a floor of 7% and a cap of 13% (8.5% to 8.75% at
          December 31, 1996). Payments of interest are due
          monthly, and monthly payments of principal and
          interest commence in June 1998. Principal on loans
          under the Line is amortized using a 15-year period
          and is payable in full in May 2006.                          7,122,554                    --


     $6.775 million line of credit ("the First Line"), fully
          repaid and cancelled in 1996.                                       --             6,774,937


     $3.5 million line of credit ("the Second Line"), fully
          repaid and cancelled in 1996.                                       --             1,735,842
</TABLE>




                                                                           F-11
<PAGE>   64
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


4.  MORTGAGE NOTES PAYABLE (CONTINUED)

<TABLE>
<CAPTION>
                                                                        1996                  1995
                                                                        ----                  ----
<S>                                                                  <C>                   <C>        
Construction obligations:
     Includes draws on construction loans. Secured by 9 Inns
          under construction. The construction loans have
          terms of seven years and are due in monthly
          installments of interest only for 18 months and
          principal and interest thereafter until the
          individual note's maturity date. The notes'
          interest rates are adjusted annually to a
          specified rate above the prime rate or to a
          specified rate above the prime rate with a floor
          of 7% and a cap of 12% and no annual change
          greater than 1%. Interest rates at December 31,
          1996 ranged from 8.5% to 10%. As of December 31,
          1996, $7.1 million was available for borrowing.              2,148,598             1,980,852
                                                                     -----------           -----------
                                                                     $22,317,206           $30,213,904
                                                                     ===========           ===========
</TABLE>


At December 31, 1996 and 1995, approximately $64.6 and $37.5 million,
respectively, of the Company's net book value of property and equipment
collateralized the long-term debt. At December 31, 1996 and 1995, the carrying
value of the long-term debt approximated its fair value.

The following table summarizes the scheduled aggregate principal payments for
the five years subsequent to December 31, 1996:

<TABLE>
<CAPTION>
                                                         1996
                                                         ----
<S>                                                  <C>        
                    1997                             $   391,957
                    1998                               2,198,350
                    1999                               2,702,577
                    2000                               1,602,254
                    2001                               1,468,220
                    Thereafter                        13,953,848
                                                     -----------
                                                     $22,317,206
                                                     ===========
</TABLE>



As a result of the early extinguishment of certain debt in 1996, 1995 and 1994,
the Company had extraordinary losses of $989,376, $19,328 and 249,770,
respectively, largely comprised of the write-off of unamortized deferred 
finance costs.


                                                                            F-12
<PAGE>   65
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



5.  STOCKHOLDERS' EQUITY

PREFERRED STOCK

On March 30, 1994, the Board of Directors approved the issuance of 64,467 shares
of preferred stock, $1.00 par value (the "Preferred Stock"), to Thomas W.
Kitchin and the Kitchin Children's Trust in exchange for their 644,669 shares of
the Company's Common Stock. The stock conversion was effected on April 15, 1994
to carry out the provisions of the dividend subordination agreement executed at
the time of the Offering.

The terms of the Preferred Stock provided that each share of preferred stock
will have the same voting power as 10 shares of Common Stock and may, at any
time after February 3, 1995, and at the election of the holder thereof, be
converted into 10 shares of Common Stock. The Preferred Stock consists of two
series, Series A issued to the Kitchin Children's Trust, and Series B, issued to
Mr. Kitchin. After the holders of Common Stock receive dividends of $.76 per
share with respect to the period from February 3, 1994 to February 2, 1995 (the
"Subordination Period"), the holder of the Series A Preferred Stock may receive
dividends of up to $7.60 per share with respect to the Subordination Period and
then the holder of the Series B Preferred Stock may receive dividends up to
$7.60 per share. After the holders of the Common Stock have received dividends
of $.76 per share and the holders of both series of the Preferred Stock have
received dividends of $7.60 per share (which is equivalent to the $.76 per share
dividend on the Common Stock) attributable to the Subordination Period, all
further dividends will be paid on a pro rata basis, with each share of Preferred
Stock receiving a dividend equal to the dividend paid on 10 shares of Common
Stock.

The terms of the Preferred Stock further provided that in the event of the
liquidation, dissolution or winding up of the Corporation, the holders of the
Common Stock will first be entitled to receive liquidating distributions of
$1.00 per share to the extent funds are available for distribution. The holders
of Preferred Stock will then be entitled to receive liquidating distributions of
$10.00 per share (which is equivalent to the $1.00 per share distribution on the
Common Stock). All further liquidating distributions will be paid on a pro rata
basis to the holders of the Common and Preferred Stock, with each share of
Preferred Stock receiving a distribution equal to the distribution paid on 10
shares of Common Stock.

On March 1, 1995, holders of the Preferred Stock converted all of their 64,467
shares of Preferred Stock into 644,670 shares of Common Stock and as a result
there are no outstanding shares of Preferred Stock.




                                                                            F-13
<PAGE>   66
5.  STOCKHOLDERS' EQUITY (CONTINUED)

DIVIDENDS

The Company declared and paid cash dividends to holders of Common Stock equal to
$.86 per share in 1996, $.80 per share in 1995 and $.50 per share in 1994. On
January 20, 1997, the Company declared cash dividends of $0.22 per share of
Common Stock.

On February 6, 1995, the Company also declared and paid a cash dividend of $7.60
per share of Preferred Stock. Dividends declared and paid by the Company
subsequent to the preferred stock conversion on March 1, 1995 were declared and
paid on a pro rata basis to all shareholders.

STOCK OPTIONS

The Company adopted the 1993 Stock Incentive Plan and originally reserved
320,000 shares to provide incentives to attract and retain officers, key
employees and directors of both the Company and Jameson Operating Company. The
Company's 1993 Stock Incentive Plan provides for a number of shares equal to 10%
of the Company's outstanding common shares to be available to provide incentives
to retain key personnel at both the Company and Jameson Operating Company. In
1996, the Jameson 1996 Stock Incentive Plan was adopted and 500,000 shares were
reserved for issuance. As of December 31, 1996 the Company had a total of
778,949 shares available for future grants under the 1993 and 1996 Stock
Incentive Plans.

In May 1995, the Company reduced the exercise price of the then outstanding
options to purchase a total of 263,500 shares of Common Stock to the then
current market price of $7.25 per share. The options that were repriced
previously had variable exercise prices ranging from $5.50 to $11.00 based on
the amount of dividends the Company paid out for given periods. The vesting
schedule of all the then outstanding options was also changed from five to three
years with one-third vesting on May 4, 1995, one-third on May 4, 1996 and the
remainder on May 4, 1997.

Prior to May 1995, the 1993 Stock Incentive Plan provided that the Company would
grant to each future director an option to purchase 10,000 shares of Common
Stock upon initial election as a Director of the Company. These director options
were fully vested on the date of grant.

The Company adopted the Director Stock Option Plan ("Director Plan") in May 1995
to attract and retain qualified independent directors. The three independent
directors surrendered their options to purchase an aggregate of 25,000 shares of
Common Stock under the 1993 Stock Incentive Plan to participate in the Director
Plan. Each director was granted an option to purchase 25,000 shares at $7.25 per
share with all shares becoming fully vested on the date of grant. A total of
150,000 shares have been reserved for issuance under this plan, with 75,000
available to be granted at December 31, 1996.



                                                                            F-14
<PAGE>   67
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)




5.  STOCKHOLDERS' EQUITY (CONTINUED)

STOCK OPTIONS (CONTINUED)

Detail of the stock option activity in the 1993, 1996 and Director plans is as
follows:

<TABLE>
<CAPTION>
                                                              Number of         Exercise Price
                                                               Shares             Per Share
                                                               ------             ---------
<S>                                                           <C>               <C>    
         Options outstanding, December 31, 1993                    --
             Granted in 1994                                  281,000           $5.50  - 11.00
             Forfeited in 1994                                (16,000)          $5.50  - 11.00
                                                              -------
         Options outstanding, December 31, 1994               265,000           $5.50  - 11.00
             Granted in 1995                                  253,000           $6.65  -  8.75
             Exercised in 1995                                 (1,457)          $6.65  -  7.25
             Forfeited in 1995                                (32,003)          $5.50  -  7.25
             Surrendered in 1995                              (25,000)          $7.375 -  9.00
                                                              -------
         Options outstanding December 31, 1995                459,540           $6.65  -  8.75
             Granted in 1996                                   27,500              $10.875
             Exercised in 1996                                (37,697)          $6.65  -  7.25
             Forfeited in 1996                                (21,500)          $6.65  -  8.75
                                                              -------
         Options outstanding December 31, 1996                427,843           $6.65  - 10.875
                                                              =======
         Exercisable, December 31, 1996                       282,844           $6.65  -  8.125
                                                              =======
</TABLE>

The weighted average exercise price of options outstanding at December 31, 1996
was $7.36. The weighted average exercise price of options exercisable at
December 31, 1996 was $7.25. The average contractual life remaining on options
outstanding at December 31, 1996 was 7.85 years.

As presented in the table above, the Company had a total of 427,843 options
outstanding at December 31, 1996. A portion of these options (390,343) have
exercise prices of $6.65 to $7.25, a weighted average exercise price of $7.10
and an average remaining contractual life of 7.7 years. Of this outstanding
amount, 276,177 options were exercisable with a weighted average price per share
of $7.11.

At December 31, 1996, the Company also had 37,500 options outstanding with an
exercise price of $8.125 to $10.875, a weighted average exercise price of $10.14
and an average remaining contractual life of 9.6 years. Of this outstanding
amount, 15,830 options were exercisable with a weighted average price per share
of $9.72.

RESTRICTED STOCK

In 1996, the Company awarded 65,270 shares of Common Stock to certain officers
and employees of the Company and Jameson Operating Company, under the provisions
of the Jameson 1996 


                                                                            F-15
<PAGE>   68
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)




5.  STOCKHOLDERS' EQUITY (CONTINUED)

RESTRICTED STOCK (CONTINUED)

Incentive Stock Plan. The shares vest at the end of ten years, assuming the
individual was continuously employed by one of the two companies at that date.
Total compensation expense of $645,245 will be recorded over the ten-year
vesting period using the straight line method, net of forfeitures. This amount
represents the fair value of the restricted shares at the date of grant; the
1996 portion was $35,331.

PRO FORMA EFFECTS OF STOCK-BASED COMPENSATION

Pro forma information regarding net income and earnings per share is required by
FAS 123, which also requires that the information be determined as if the
Company has accounted for its stock options and restricted stock granted
subsequent to December 31, 1994, using the fair value method prescribed by that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions for
1995 and 1996: risk-free interest rates of 6.04% to 6.43%; a dividend yield of
8%; a volatility factor of the expected market price of the Company's Common
Stock of .208; and an expected life of the option of 3 to 10 years.

During 1996, the Company made certain stock-based awards whose exercise price
was less than the then current market price. In 1996, 65,270 shares of
restricted stock were granted, with a fair value of $4.26 per share. All other
awards were made with exercise prices equal to the then current market price.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options and shares which have no vesting restrictions and
are fully transferable. In addition, valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock options and restricted stock have characteristics
significantly different from those of traded options or unrestricted shares, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its stock
options and restricted stock.

For purposes of pro forma disclosures, the estimated fair value of the options
and restricted stock is amortized to expense over the vesting period. The
Company's pro forma information follows:

<TABLE>
<CAPTION>
                                                        1996          1995    
                                                        ----          ----    
<S>                                               <C>              <C>        
           Pro forma net income                   $   3,049,234    $1,764,222 
           Pro forma earnings per share           $         .48    $      .45 
</TABLE>

Because FAS 123 is applicable only to options and restricted stock granted
subsequent to December 31, 1994, its pro forma effects will not be fully
reflected until 1997.




                                                                            F-16
<PAGE>   69
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



5.  STOCKHOLDERS' EQUITY (CONTINUED)

DIVIDEND REINVESTMENT PLAN

In April 1995, the Company registered 200,000 shares of common stock for
purchase under the Dividend Reinvestment and Stock Purchase Plan. The plan
allows existing shareholders to reinvest their dividends in additional shares
purchased at a 5% discount from the average market price of the shares. The plan
also allows existing shareholders to make additional cash purchases of common
stock of up to $5,000 per calendar quarter. These additional cash purchases from
the Company are not sold at a discount from the market price. During 1996 and
1995, 21,331 and 4,132 shares, respectively, were purchased either through
dividend reinvestments or additional cash purchases.

WARRANTS

As a part of its IPO, the Company issued and has warrants outstanding to
purchase up to 260,000 shares of Common Stock at an exercise price of $14.85 per
share; the warrants are exercisable in whole or in part until January 26, 1999.

EMPLOYMENT AGREEMENT

In 1994, the Company's president and chief executive officer entered into an
employment agreement providing for, among other things, an annual salary, stock
appreciation rights ("SARs") based on 150,000 shares of Common Stock and a
non-compete provision. The SARs entitled the president to receive the difference
in the market value of such shares as of the exercise date and $9, the initial
public offering price. In April 1996, the Company and its chief executive
officer and president agreed to amend the Employment Agreement with Mr. Kitchin
to cancel his stock appreciation rights effective March 31, 1996. No amount of
compensation expense has been recorded in the accompanying financial statements
relating to the SARs.

6.  LIMITED PARTNERS' CAPITAL

Prior to 1994, the Company's normal Inn ownership structure involved the sale of
25% of each completed Jameson Inn at a fixed price in the form of limited
partnership interests, with the Company retaining 75% ownership of the property.
As a part of the IPO, the Company purchased the limited partners' interests and
liquidated the partnerships in 1994. Activity in the limited partners' capital
during 1994 consists of:

<TABLE>
<S>                                                                 <C>        
             Balance at January 1                                   $ 1,854,198
                Contributions from limited partners                     300,000
                Step-up in asset basis                                2,432,987
                Distributions to limited partners                    (4,591,545)
                Equity in profit (loss) of motel operations               4,360
                                                                    -----------
             Balance at December 31                                 $        --
                                                                    ===========
</TABLE>


                                                                            F-17
<PAGE>   70
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



7.  INCOME TAXES

The Company recorded no provision for federal income taxes in 1996, 1995 or 1994
due to its REIT status. State tax expense, which is not material, is included in
general and administrative expenses. At December 31, 1996 and 1995, the Company
had net operating loss carryforwards of approximately $1.2 million available for
federal income tax purposes, which begin to expire in 2005. As a result of the
REIT election and change in ownership resulting from the IPO, future utilization
of the net operating loss carryforwards by Jameson Inns, Inc. may be limited.

The Company declared and paid dividends on its Common Stock of $.86, $.80 and
$.50 per share in 1996, 1995 and 1994, respectively. Of these dividends, $.56,
$.50 and $.46 per share represents ordinary income and $.30, $.30 and $.04 per
share represents return of capital in 1996, 1995 and 1994, respectively.

8.  ADDITIONAL RELATED PARTY TRANSACTIONS

The Company shares employees and office space with Kitchin Investments, Inc.,
which is wholly owned by the Company's chairman and largest stockholder. Per the
cost reimbursement agreement, Kitchin Investments, Inc. charged Jameson Inns,
Inc. approximately $194,000, $138,000 and $233,000 for its allocation of salary,
office overhead, and other general and administrative costs in 1996, 1995 and
1994, respectively. Accounts payable to affiliates at December 31, 1996 and 1995
includes $(23,053) and $192,645, respectively, due to (from) this related party.

9.  OTHER COMMITMENTS AND CONTINGENCIES

As of December 31, 1996, the Company had executed construction contracts with
Jameson Development Company, L.L.C. for new Inns or expansions totaling $14
million, of which $10 million had not been expended.

Subsequent to December 31, 1996 and through February 15, 1997, the Company
purchased sites for two additional new Inns for an aggregate purchase price of
approximately $.5 million. Inn construction costs are estimated to be $2.4
million on these new sites.

The Company leases its headquarters' office space in Atlanta, Georgia, and land
underlying one of its Inns under construction. The office operating lease was
amended in 1997. The two leases, as amended, require future minimum payments as
follows:

<TABLE>
<S>                                           <C>          
                    1997                      $     160,496
                    1998                            179,517
                    1999                            185,498
                    2000                            195,757
                    2001                            206,424
                    Thereafter                    2,838,707
                                              -------------
                                              $   3,766,399
                                              =============
</TABLE>


                                                                          F-18
<PAGE>   71
                               JAMESON INNS, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


9.  OTHER COMMITMENTS AND CONTINGENCIES (CONTINUED)

The rent expense under the office lease is paid by Kitchin Investments, Inc. and
is allocated under the cost reimbursement agreement described in Note 8. An
insignificant amount of rent expense is included in general and administrative
expense in the Company's statement of operations.

The Company is a defendant or plaintiff in various legal actions which have
arisen in the normal course of business. In the opinion of management, the
ultimate resolution of these matters will not have a material adverse effect on
the Company's financial position or results of operations.

10.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following is a summary of the quarterly results of operations for the years
ended December 31, 1996 and 1995:

<TABLE>
<CAPTION>
                                                        1996 QUARTERS
                                     ----------------------------------------------------
                                       FIRST         SECOND        THIRD         FOURTH  
                                     ----------------------------------------------------
<S>                                  <C>           <C>           <C>           <C>       
Lease revenue                        $1,915,590    $2,427,100    $2,668,378    $2,365,033
Income before extraordinary
   loss                                 338,504     1,166,651     1,443,330     1,092,324
Net income                              338,504       177,275     1,443,330     1,092,324
Earnings per common and
   common equivalent share:
      Income before extraordinary
         loss                              0.09          0.18          0.20          0.15
      Net income                           0.09          0.03          0.20          0.15
</TABLE>



<TABLE>
<CAPTION>
                                                        1995 QUARTERS
                                     ----------------------------------------------------
                                       FIRST         SECOND        THIRD         FOURTH  
                                     ----------------------------------------------------
<S>                                  <C>           <C>           <C>           <C>       
Lease revenue                        $1,232,195    $1,665,597    $1,752,450    $1,691,987
Income before extraordinary
   loss                                 343,389       597,273       515,609       334,997
Net income                              343,389       597,273       515,609       315,669
Earnings per common and
   common equivalent share:
      Income before extraordinary
         loss                              0.09          0.15          0.13          0.09
      Net income                           0.09          0.15          0.13          0.08
</TABLE>




                                                                           F-19
<PAGE>   72

                               JAMESON INNS, INC.
             SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
                             AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
                                                                     Cost Capitalized         Gross Amount
                                                                      Subsequent to         at Which Carried
                                         Initial Cost                  Acquisition         at Close of Period
                                  ---------------------------  ----------------------  --------------------------
                                                Buildings,              Buildings,                Buildings,
                       Mortgage               Equipment and           Equipment and             Equipment and
Property                 Debt         Land     Improvements    Land    Improvements     Land     Improvements      Total
-----------------------------------------------------------------------------------------------------------------------------
<S>                   <C>           <C>        <C>           <C>        <C>           <C>         <C>           <C>
Georgia:
   Albany             $1,576,397    $265,344   $     --      $ 92,308   $1,691,887    $357,652    $1,691,887    $2,049,539
   Americus (f)          100,360     131,629         --       222,297    2,512,194     353,926     2,512,194     2,866,120
   Bainbridge (f)        427,000     125,000         --          --      1,631,096     125,000     1,631,096     1,756,096
   Brunswick (f)         806,158     175,275         --          --      1,646,282     175,275     1,646,282     1,821,557
   Calhoun (f)           201,000     113,722         --        18,008    1,547,247     131,730     1,547,247     1,678,977
   Carrollton (f)      1,001,000     225,000         --        50,029    1,601,912     275,029     1,601,912     1,876,941
   Commerce              885,307     304,809         --          --      1,266,100     304,809     1,266,100     1,570,909
   Conyers             1,050,000     301,128         --          --      1,312,948     301,128     1,312,948     1,614,076
   Covington (f)         175,599     141,452         --        22,399    1,296,503     163,851     1,296,503     1,460,354
   Douglas (f)           201,000     120,033         --          --      1,148,406     120,033     1,148,406     1,268,439
   Eastman               782,828      87,883         --        13,917    1,314,894     101,800     1,314,894     1,416,694
   Fitzgerald            782,827     133,515         --          --      1,083,123     133,515     1,083,123     1,216,638
   Greensboro            782,828     109,840         --        17,394    1,433,544     127,234     1,433,544     1,560,778
   Hartwell (f)          100,360      85,000         --        13,460    1,360,842      98,460     1,360,842     1,459,302
   Jesup (f)             426,300      89,917         --        14,239    1,981,037     104,156     1,981,037     2,085,193
   LaGrange            1,000,000     200,073         --          --      1,200,066     200,073     1,200,066     1,400,139
   Milledgeville         782,828     575,582    4,826,285        --        215,329     575,582     5,041,614     5,617,196
   Statesboro (f)        100,360     132,817         --        21,032    1,357,965     153,849     1,357,965     1,511,814
   Thomaston (f)         175,599     157,181         --        24,890    2,088,654     182,071     2,088,654     2,270,725
   Valdosta (f)        1,500,000     166,632         --          --      1,610,698     166,632     1,610,698     1,777,330
   Washington (f)        100,360     107,780         --        17,067    1,276,903     124,847     1,276,903     1,401,750
   Waycross (f)          301,000      87,000         --        13,777    2,015,770     100,777     2,015,770     2,116,547
   Waynesboro (f)        100,500     142,501         --          --      1,246,649     142,501     1,246,649     1,389,150
   Winder (f)            175,598     124,500    1,268,199        --        645,850     124,500     1,914,049     2,038,549

Alabama:
   Albertville (f)       100,000     174,000         --           418    1,069,217     174,418     1,069,217     1,243,635
   Alexander City           --       160,086         --          --      1,732,578     160,086     1,732,578     1,892,664
   Arab (f)              100,000     131,554         --          --      1,092,248     131,554     1,092,248     1,223,802
   Decatur             1,047,572     201,629         --          --      1,303,268     201,629     1,303,268     1,504,897
   Eufaula (f)              --       228,869         --         3,489    1,201,113     232,358     1,201,113     1,433,471
   Florence (f)          100,000     313,579         --         1,202    1,826,527     314,781     1,826,527     2,141,308
   Greenville            887,602     228,511         --          --      1,225,000     228,511     1,225,000     1,453,511
</TABLE>

<TABLE>
<CAPTION>
                                                              Life on Which
                                                              Depreciation
                                                               in Latest
                                                                 Income
                        Accumulated    Date       Date of     Statement is
                       Depreciation   Acquired  Construction    Computed
--------------------------------------------------------------------------------
<S>                     <C>             <C>         <C>            <C>
Georgia:
   Albany               $  109,019      1994        1995           (e)
   Americus (f)            476,841      1991        1992           (d)
   Bainbridge (f)          172,682      1994        1994           (e)
   Brunswick (f)            96,778      1994        1995           (e)
   Calhoun (f)             339,791      1988        1988           (d)
   Carrollton (f)          209,381      1993        1994           (e)
   Commerce                   --        1996        1996           (e)
   Conyers                  11,918      1996        1996           (e)
   Covington (f)           363,219      1990        1990           (d)
   Douglas (f)              86,777      1995        1995           (e)
   Eastman                 433,943      1989        1989           (d)
   Fitzgerald              167,393      1993        1994           (e)
   Greensboro              438,736      1989        1990           (d)
   Hartwell (f)            273,831      1991        1992           (d)
   Jesup (f)               530,279      1990        1990           (d)
   LaGrange                 26,923      1995        1996           (e)
   Milledgeville         1,331,838      1991        --             (d)
   Statesboro (f)          489,398      1988        1989           (d)
   Thomaston (f)           441,171      1990        1990           (d)
   Valdosta (f)            156,759      1994        1995           (e)
   Washington (f)          371,507      1989        1990           (d)
   Waycross (f)            282,067      1992        1993           (e)
   Waynesboro (f)           49,482      1995        1996           (e)
   Winder (f)              613,165      1988        --             (d)

Alabama:
   Albertville (f)         135,035      1994        1994           (e)
   Alexander City          180,107      1994        1994           (e)
   Arab (f)                 68,443      1995        1995           (e)
   Decatur                  35,413      1995        1996           (e)
   Eufaula (f)              48,434      1995        1996           (e)
   Florence (f)             46,304      1995        1996           (e)
   Greenville                 --        1996        1996           (e)
</TABLE>

                                                                           F-20
<PAGE>   73
        SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION - (cont.)


<TABLE>
<CAPTION>
                                                                        Cost Capitalized             Gross Amount
                                                                          Subsequent to            at Which Carried
                                                  Initial Cost             Acquisition            at Close of Period
                                            ------------------------  ----------------------  --------------------------
                                                       Buildings,               Buildings,                 Buildings,
                              Mortgage               Equipment and            Equipment and              Equipment and
Property                        Debt         Land     Improvements    Land     Improvements      Land      Improvements
-----------------------------------------------------------------------------------------------------------------------------
<S>                       <C>           <C>           <C>          <C>        <C>           <C>           <C>
Ozark                            --         176,148         --         --       1,132,017       176,148     1,132,017
Selma (f)                        --         143,812         --       22,773     1,851,105       166,585     1,851,105

South Carolina:
   Anderson (f)               100,360       201,000         --      131,186     1,905,602       332,186     1,905,602
   Cheraw                        --         168,458         --         --       1,118,043       168,458     1,118,043
   Easley (f)                 101,000       266,753         --        2,710     1,108,279       269,463     1,108,279
   Gaffney                       --         135,025         --         --       1,092,955       135,025     1,092,955
   Georgetown                 828,946       144,353         --         --       1,369,400       144,353     1,369,400
Greenwood (f)                 729,000       140,231         --       20,741     1,709,698       160,972     1,709,698
Lancaster                     730,028       150,592         --         --       1,097,473       150,592     1,097,473
Orangeburg                       --         165,010         --          140     1,156,155       165,150     1,156,155
   Seneca                     858,891       204,385         --         --       1,200,078       204,385     1,200,078
   Simpsonville             1,050,000       229,205         --         --       1,200,010       229,205     1,200,010

Construction or
development in progress:
   Auburn, AL                  31,611       227,000         --         --          53,036       227,000        53,036
   Decherd, TN                 78,482       254,501         --         --         276,095       254,501       276,095
   Forest City, N.C.          725,104       187,294         --        4,563     1,071,827       191,857     1,071,827
   Gaffney, S.C. 
          - Expansion            --            --           --         --          76,072          --          76,072
   Laurinburg, N.C.            30,261       225,441         --         --         205,058       225,441       205,058
   Oakwood, GA                531,592       258,903         --         --       1,075,011       258,903     1,075,011
   Oxford, AL                  31,611       307,635         --         --          62,262       307,635        62,262
   Sanford, N.C.                 --         227,030         --         --          21,035       227,030        21,035
   Tullahoma, TN               78,932       303,536         --         --          44,295       303,536        44,295
   Tuscaloosa, AL                --            --           --         --          69,445          --          69,445
   Union, S.C.                610,994       178,006         --         --       1,062,424       178,006     1,062,424
   Wilson, N.C.                30,011       237,712         --         --          26,609       237,712        26,609
                          -----------   -----------   ----------   --------   -----------   -----------   -----------
                          $22,317,206   $10,073,871   $6,094,484   $728,039   $63,919,834   $10,801,910   $70,014,318
                          ===========   ===========   ==========   ========   ===========   ===========   ===========
</TABLE>


<TABLE>
<CAPTION>
                                                                                 Life on Which
                                                                                 Depreciation
                                                                                   in Latest
                                                                                    Income
                                             Accumulated    Date      Date of    Statement is
                                   Total    Depreciation  Acquired  Construction   Computed
-------------------------------------------------------------------------------------------

<S>                            <C>           <C>             <C>       <C>             <C>
Ozark                            1,308,165      112,883      1994      1995            (e)
Selma (f)                        2,017,690      343,325      1991      1992            (d)
              
South Carolina:
   Anderson (f)                  2,237,788      287,402      1993      1993            (e)
   Cheraw                        1,286,501       74,978      1995      1995            (e)
   Easley (f)                    1,377,742       97,668      1994      1995            (e)
   Gaffney                       1,227,980       68,427      1995      1995            (e)
   Georgetown                    1,513,753         --        1996      1996            (e)
   Greenwood (f)                 1,870,670       72,654      1994      1995            (e)
Lancaster                        1,248,065       89,001      1994      1995            (e)
Orangeburg                       1,321,305       61,849      1995      1995            (e)
   Seneca                        1,404,463         --        1996      1996            (e)
   Simpsonville                  1,429,215       10,770      1996      1996            (e)
              
Construction or
development in progress:
   Auburn, AL                      280,036
   Decherd, TN                     530,596
   Forest City, N.C.             1,263,684
   Gaffney, S.C.
          - Expansion               76,072
   Laurinburg, N.C.                430,499
   Oakwood, GA                   1,333,914
   Oxford, AL                      369,897
   Sanford, N.C.                   248,065
   Tullahoma, TN                   347,831
   Tuscaloosa, AL                   69,445
   Union, S.C.                   1,240,430
   Wilson, N.C.                    264,321
                               -----------   ----------
                               $80,816,228   $9,205,591
                               ===========   ==========
</TABLE>


See notes to Schedule III.

                                                                F-21
<PAGE>   74
                               JAMESON INNS, INC.

                              NOTES TO SCHEDULE III

<TABLE>
<CAPTION>
                                            1996          1995           1994
                                      ----------------------------------------------
<S>                                    <C>             <C>           <C>
(a) Reconciliation of real estate:

       Balance at beginning of year    $ 57,369,657    $38,525,075   $25,247,236
           Additions during year:
                Improvements             23,548,156     18,844,582    13,277,839
           Deletions                       (101,585)          --
                                       ------------    -----------    ----------
       Balance at end of year          $ 80,816,228    $57,369,657   $38,525,075
                                       ============    ===========   ===========

(b) Reconciliation of accumulated depreciation:

       Balance at beginning of year    $  6,589,753    $ 4,765,184   $ 3,338,656
           Depreciation for the year      2,669,574      1,824,569     1,426,528
           Retirements                      (53,736)          --            --
                                       ------------    -----------    ----------
   Balance at end of year              $  9,205,591    $ 6,589,753   $ 4,765,184
                                       ============    ===========   ===========
</TABLE>



(c) The aggregate cost of the land, buildings and furniture, fixtures and
equipment for federal income tax purposes approximates the book basis.

(d) Depreciation for 1992 and prior additions is computed based on the following
useful lives:
<TABLE>
<S>                                                           <C>
            Buildings                                         31.5 years
            Land improvements                                   15 years
            Furniture, fixtures and equipment                    5 years
</TABLE>

(e) Depreciation for 1993 and later additions is computed based on the following
useful lives:
<TABLE>
<S>                                                             <C>
            Buildings                                           39 years
            Land improvements                                   15 years
            Furniture, fixtures and equipment                    5 years
</TABLE>

(f) This Inn is one of 24 Inns securing the Company's $29 million line of
credit. Amount of debt listed as outstanding is an allocation.


                                                                           F-22
<PAGE>   75
                               JAMESON INNS, INC.

                    UNAUDITED PRO FORMA FINANCIAL STATEMENTS

The Unaudited Pro Forma Financial Statements for 1994 are presented as if (i)
the Offering and all related transactions, including the acquisition of
interests from the other partners, had occurred on January 1, 1994 for the
Unaudited Pro Forma Statement of Operations and (ii) the Company qualified as a
REIT, distributed all of its taxable income and, therefore, incurred no income
tax expense during the period. Such pro forma information has been derived from
the historical Consolidated Financial Statements of Jameson Inns, Inc. and
should be read in conjunction with such Consolidated Financial Statements of
Jameson Inns, Inc. and the Notes thereto. In management's opinion, all necessary
adjustments to reflect the nature of this transaction have been made. The
Unaudited Pro Forma Financial Statements of the Company are not necessarily
indicative of what the actual financial position or the results of operations of
the Company would have been for the periods indicated, nor does it purport to
represent the Company's future results of operations.

No pro forma statements are presented for 1995 or 1996 as all of the above
events were in place for the entire year.

                                                                           F-23
<PAGE>   76
                               JAMESON INNS, INC.

                   UNAUDITED PRO FORMA STATEMENT OF OPERATIONS

                          YEAR ENDED DECEMBER 31, 1994

<TABLE>
<CAPTION>
                                                            PRO FORMA
                                              HISTORICAL   ADJUSTMENTS   PRO FORMA
                                              ---------------------------------------

                                                (In thousands, except per share data)
<S>                                             <C>        <C>           <C>
Inn operations:
Lease revenue                                   $ 3,973    $  --         $ 3,973
Property tax expense                               (197)      --            (197)
Insurance expense                                  (215)      --            (215)
Depreciation                                     (1,427)       (44)(1)    (1,471)

                                              --------------------------------------
                                                  2,134        (44)        2,090
Other expenses:
Interest expense                                    339       (152)(2)       187
General and administrative                          479       --             479
                                              --------------------------------------
Income before amounts attributable to limited
partners and extraordinary item                   1,316        108         1,424
Income attributable to limited partners              (5)         5(3)        --
                                              --------------------------------------
Income (loss) before extraordinary item           1,311        113         1,424
Extraordinary loss                                 (250)       250(4)       --
                                              ======================================
Net income                                      $ 1,061    $   363       $ 1,424
                                              ======================================

Pro Forma earnings per share (5)                     --         --       $   .37
                                                                       =============
</TABLE>

                                                                          F-24
<PAGE>   77
                               JAMESON INNS, INC.

             UNAUDITED PRO FORMA STATEMENT OF OPERATIONS (CONTINUED)

                          YEAR ENDED DECEMBER 31, 1994


Explanations of Pro Forma Adjustments:

(1)      Net increase reflects additional depreciation on stepped-up asset
         basis.

(2)      Decrease reflects the reduction in interest expense due to the
         repayment of debt with the proceeds from the Offering and reduced
         amortization due to deferred finance costs to be written off in
         connection with repayment of mortgage debt.

(3)      Increase reflects elimination of the limited partners' share in profits
         and losses of the Inns, since partnership interests were acquired by
         Jameson Inns, Inc.

(4)      Decrease represents exclusion of extraordinary loss.

(5)      Earnings per share assume 3,883,346 shares outstanding after the
         Offering which assumes the stock options granted at exercise prices
         below the initial public offering price were exercised and shares
         issued pursuant to such exercise were outstanding for the entire
         period, using the treasury stock method. See Note 5 to the Consolidated
         Financial Statements.

                                                                           F-25
<PAGE>   78
                         Report of Independent Auditors

The Board of Directors
Jameson Operating Company

We have audited the accompanying balance sheets of Jameson Operating Company as
of December 31, 1996 and 1995, and the related statements of operations,
stockholders' deficit, and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
Jameson Operating Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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 financial statements referred to above present fairly, in
all material respects, the financial position of Jameson Operating Company at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.

                                                     ERNST & YOUNG LLP

Atlanta, Georgia
February 14, 1997

                                                                           F-26
<PAGE>   79
                            JAMESON OPERATING COMPANY

                                 BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                              DECEMBER 31
                                                                      1996                   1995
                                                                      ----                   ----
<S>                                                               <C>                 <C>
ASSETS
    Current Assets:
       Cash                                                       $   170,410         $    44,877
       Accounts receivable                                            431,593             311,078
       Accounts receivable from affiliates                            399,202             227,824
       Prepaid expenses                                                53,592              44,199
       Inventory                                                      332,848             209,417
       Note receivable                                                  8,976               9,657
                                                                  -----------         -----------
                                                                    1,396,621             847,052
    Leasehold improvements, net                                       127,419             191,842
    Intangibles, net                                                   23,125              23,750
                                                                  -----------         -----------
                                                                  $ 1,547,165         $ 1,062,644
                                                                  ===========          ==========

LIABILITIES AND STOCKHOLDERS' DEFICIT Current Liabilities:
       Accounts payable                                           $   262,825         $   221,999
       Lease expense payable                                          684,625             495,855
       Accounts payable to affiliates                                 478,779             239,807
       Accrued liabilities                                            196,060             177,897
       Notes payable                                                   13,407              46,361
                                                                  -----------         -----------
                                                                    1,635,696           1,181,919
                                                                
STOCKHOLDERS' DEFICIT:
    Common stock, $1 par value, 500 shares
       authorized, issued and outstanding                                 500                 500
    Contributed capital                                                27,381              27,381
    Accumulated deficit                                              (116,412)           (147,156)
                                                                  -----------         -----------
Total stockholders' deficit                                           (88,531)           (119,275)
                                                                  -----------         -----------
                                                                  $ 1,547,165          $1,062,644
                                                                  ===========          ==========
</TABLE>



See accompanying notes.

                                                                           F-27
<PAGE>   80
                            JAMESON OPERATING COMPANY

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31

                                            1996               1995               1994
<S>                                     <C>                <C>                <C>
Revenues:
   Room revenues                        $19,449,805        $12,960,149        $ 8,153,636
   Telephone revenues                       462,871            320,274            197,273
   Other sales                               37,375             29,639             22,425
                                        -----------        -----------        -----------
                                         19,950,051         13,310,062          8,373,334

Expenses:
   Room expenses                          3,951,772          2,678,601          1,718,275
   Utilities                              1,748,706          1,158,609            790,926
   General and administrative             1,655,301          1,029,181            702,125
   Inn manager salaries                   1,247,514            801,317            502,459
   Maintenance                              599,545            455,530            264,982
   Advertising                              648,065            388,801            261,252
   Insurance                                145,063            125,240             70,322
   Management fee                           478,801            261,666            218,339
   Interest                                   3,391              8,580              8,799
   Depreciation and amortization             65,048             50,569             19,774
                                        -----------        -----------        -----------
                                         10,543,206          6,958,094          4,557,253
                                        -----------        -----------        -----------

Income before lease expense               9,406,845          6,351,968          3,816,081
Lease expense                             9,376,101          6,342,229          3,972,976
                                        -----------        -----------        -----------
Net income (loss)                       $    30,744        $     9,739        $  (156,895)
                                        ===========        ===========        ===========
</TABLE>



See accompanying notes.

                                                                           F-28
<PAGE>   81
                            JAMESON OPERATING COMPANY

                       STATEMENTS OF STOCKHOLDERS' DEFICIT

<TABLE>
<CAPTION>
                                                   $1 PAR                                               TOTAL
                                                   COMMON         CONTRIBUTED      ACCUMULATED       STOCKHOLDERS'
                                                   STOCK            CAPITAL          DEFICIT           DEFICIT
                                                  ---------        ---------        ---------         ---------

<S>                                              <C>              <C>              <C>               <C>
Balance at January 1, 1994                        $     500        $  27,381        $      --         $  27,881
   Net loss                                              --               --         (156,895)         (156,895)
                                                  ---------        ---------        ---------         ---------
Balance at December 31, 1994                            500           27,381         (156,895)         (129,014)
   Net income                                            --               --            9,739             9,739
                                                  ---------        ---------        ---------         ---------
Balance at December 31, 1995                            500           27,381         (147,156)         (119,275)
   Net income                                            --               --           30,744            30,744
                                                  ---------        ---------        ---------         ---------
Balance at December 31, 1996                      $     500        $  27,381        $(116,412)        $ (88,531)
                                                  =========        =========        =========         =========
</TABLE>



See accompanying notes.

                                                                           F-29
<PAGE>   82
                            JAMESON OPERATING COMPANY

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                      YEAR ENDED DECEMBER 31

                                                            1996              1995              1994
                                                         ---------         ---------         ---------
<S>                                                      <C>               <C>               <C>
OPERATING ACTIVITIES
Net income (loss)                                        $  30,744         $   9,739         $(156,895)
Adjustment to reconcile net income (loss)
    to net cash provided by operating activities:
    Depreciation and amortization                           65,048            50,569            19,774
    Bad debt expense                                        10,440            16,361            18,206
    Changes in assets and liabilities increasing
       (decreasing) cash:
       Accounts receivable                                (130,955)          (77,321)         (160,359)
       Accounts receivable from affiliate                 (171,378)         (182,423)          (45,401)
       Prepaid expenses                                     (9,393)            3,597            15,050
       Inventory                                          (123,431)         (102,784)          (95,869)
       Note receivable                                         681            (9,657)               --
       Accounts payable                                     40,826           (27,015)           (2,358)
       Lease expense payable                               188,770           147,329           348,526
       Accounts payable to affiliate                       238,972            66,849           172,958
       Accrued liabilities                                  18,163           142,110           (38,507)
                                                         ---------         ---------         ---------
Net cash provided by operating activities                  158,487            37,354            75,125

INVESTING ACTIVITIES
Sale of marketable securities                                   --                --             3,097
Purchase of leasehold improvements                              --          (121,224)         (134,948)
Sale of vehicle                                                 --             8,627                --
                                                         ---------         ---------         ---------
Net cash used in investing activities                           --          (112,597)         (131,851)

FINANCING ACTIVITIES
Proceeds from notes payable                                 25,045                --            38,915
Payments on notes payable                                  (57,999)          (51,038)           (3,282)
                                                         ---------         ---------         ---------
Net cash (used in) provided by
    financing activities                                   (32,954)          (51,038)           35,633
                                                         ---------         ---------         ---------

Net increase (decrease) in cash                            125,533          (126,281)          (21,093)
Cash at beginning of year                                   44,877           171,158           192,251
                                                         ---------         ---------         ---------
Cash at end of year                                      $ 170,410         $  44,877         $ 171,158
                                                         =========         =========         =========

SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid during the year                            $   4,492         $   9,121         $   8,885
                                                         =========         =========         =========
</TABLE>



See accompanying notes.

                                                                           F-30
<PAGE>   83

                            JAMESON OPERATING COMPANY

                          NOTES TO FINANCIAL STATEMENTS

1.  BUSINESS AND BASIS OF FINANCIAL STATEMENTS

Jameson Operating Company (the "Operator") was formed in October 1993 as a
wholly owned subsidiary of Jameson Inns, Inc. ("Jameson" or "the REIT") although
it had no operations until January 1, 1994. On December 31, 1993, Jameson Inns,
Inc. consummated a series of transactions to divest itself of all assets not
related to ownership of its limited service motels (the "Inns") in contemplation
of its initial public offering of common stock and electing to qualify as a real
estate investment trust ("REIT") for federal income tax purposes effective
January 1, 1994. On December 31, 1993, Jameson sold all of the common stock of
the Operator to its Chairman, President and largest stockholder and to a trust
of which its General Counsel/Secretary is the trustee and beneficiary. Effective
January 1, 1994, the Operator began leasing the Inns from the REIT and from the
partnerships which previously owned the Inns, until the REIT acquired the
interests of the partnerships in February 1994. Prior to 1994, the Operator's
results of operations were included in the consolidated financial statements of
Jameson Inns, Inc.

The Operator operates and controls advertising for the Inn properties using the
trademark "The Jameson Inn." At December 31, 1996 and 1995, the Operator leased
43 Inns (2,107 rooms) and 32 Inns (1,537 rooms), respectively, in Georgia,
Alabama and South Carolina.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

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

INVENTORY

Inventory, consisting of room linens and towels, is stated at the lower of fair
value at date of contribution (see Note 6), cost (first-in, first-out method) or
market. Replacements of inventory are expensed.

PROPERTY AND EQUIPMENT

Leasehold improvements relate to improvements made to the Inns prior to July 1,
1995 when this responsibility was transferred to the REIT. Leasehold
improvements, which are stated at cost, are being amortized using the
straight-line method over their estimated useful lives ranging from three to ten
years, not to exceed the remaining term of the lease (see Note 3). Accumulated
depreciation totaled $128,753 and $64,330 as of December 31, 1996 and 1995,
respectively.

                                                                           F-31
<PAGE>   84
                            JAMESON OPERATING COMPANY

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

In 1996, the Operator adopted the FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which requires impairment losses to be recorded on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount. There was no impact of adoption.

INTANGIBLES

Intangibles consist of the registered trademark, "The Jameson Inn." The lease
described in Note 3 requires the Operator to operate the Inns using the
trademark and not to use the trademark (or license its use to any other parties)
for the operation of lodging facilities other than the Inns unless the REIT does
not object to such unrelated use. The REIT has an option to purchase the
trademark from the Operator at the end of the lease term (or upon the earlier
termination of the lease with respect to all of the Inns) for $25,000. The
trademark is being amortized over 40 years. Accumulated amortization totaled
$1,875 and $1,250 as of December 31, 1996 and 1995, respectively.

INCOME TAXES

The Operator uses the liability method of accounting for income taxes.

ADVERTISING

The Operator expenses advertising upon first showing.

3.  THE LEASE

On January 1, 1994, the REIT and the partnerships, which previously owned the
Inns, entered into individual leases whereby all of the operating Inns were
leased to the Operator. After the REIT's initial public stock offering in early
1994 and the liquidation of the partnerships in January 1994, the Operator and
the REIT entered into a master lease in substantially the same form as the
individual leases (the "Lease"). Beginning January 1, 1994 all of the operating
Inns are leased to the Operator under the Lease and future Inns constructed by
the REIT during the term of the Lease will be added to the lease upon completion
of each such Inn's construction.

The Lease expires December 31, 2006 and provides for payment of Base Rent plus
Percentage Rent. Base Rent, which is payable monthly, equals $264.00 per month
for each rentable room in the Inns at the beginning of the relevant month.
Percentage Rent, which is payable quarterly, is calculated as a percentage in
excess of Base Rent of the total amount of room rental and other miscellaneous
revenues ("Room Revenues") realized by the Operator over the relevant period.

                                                                           F-32
<PAGE>   85
                            JAMESON OPERATING COMPANY

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

3.  THE LEASE (CONTINUED)

The percentage is 39% of such revenues up to $20.50 per day per room over the
period, 65% of all additional average daily room rental revenues, provided,
however, that total rent for any calendar year is limited to 47% of total room
rental revenues for that year. The $20.50 per room amount used in calculating
Percentage Rent is subject to adjustment each year end, based on changes in the
Consumer Price Index, and as of January 1, 1997 was $21.05. Prior to July 1,
1995 when the Lease was amended, the Lease provided for Base Rent equal to
$240.00 per month and Percentage Rent was the same for the first $20.00 per day
but included four different rates for additional average daily room rental
revenues. In 1995, the Lease amendment also transferred the obligation to
replace or refurbish the furniture, fixtures and equipment in the Inns from the
Operator to the REIT.

Base Rent totaled $5,469,288, $3,553,252 and $2,316,200 in 1996, 1995 and 1994,
respectively, and assuming the same number of rooms in operation as of December
31, 1996, would total $6,674,976 per year until the Lease expires.

The Lease requires the REIT to pay real and personal property taxes, casualty
and liability insurance premiums and the cost of maintaining structural
elements, including underground utilities and effective July 1, 1995, the cost
of replacing or refurbishing the furniture, fixtures and equipment in the Inns.
Prior to July 1, 1995, the Operator was responsible for the cost of replacing or
refurbishing furniture, fixtures and equipment and hence recorded these costs as
leasehold improvements. The Operator is required to pay workers compensation
insurance premiums, utility costs and all other costs and expenses incurred in
the operation of the Inns.

Under the Lease, the REIT is required to maintain the structural elements of
each Inn. The Operator is required, at its expense, to maintain the Inns
(exclusive of furniture, fixtures and equipment) in good order and repair and to
make non-structural, foreseen and unforeseen, and ordinary and extraordinary
repairs which may be necessary and appropriate and do not significantly alter
the character or purpose, or significantly detract from the value or operating
efficiencies of the Inns. All alterations, replacements and improvements are
subject to all the terms and provisions of the Lease and become the property of
the REIT upon termination of the lease.

The Operator has agreed that neither it nor any of its affiliates will (i)
operate or manage a hotel property in which the REIT has not invested that is
within a 20-mile radius of an Inn, or (ii) own or have any interest in any hotel
property in which the REIT or an affiliate does not have an interest.

                                                                           F-33
<PAGE>   86
                            JAMESON OPERATING COMPANY

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

4.  INCOME TAXES

The Operator recorded no provision for income taxes in 1994, 1995 and 1996 due
to losses incurred or utilization of its net operating loss carryforwards. At
December 31, 1996, the Operator had net operating loss carryforwards of
approximately $417,000 and $351,000 available for regular federal income tax
purposes and alternative minimum tax purposes, respectively, both of which begin
to expire in 2009.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Operator's deferred tax assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                                                            December 31
                                                                       1996              1995
                                                                  ---------         ---------
<S>                                                               <C>               <C>
         Deferred Tax Liabilities:
               Depreciation and Amortization                      $   2,400         $   5,000
               Inventory                                            133,100            83,800
                                                                  ---------         ---------
                  Total Deferred Tax Liabilities                    135,500            88,800
         Deferred Tax Assets:
               Net Operating Loss Carryforwards                     166,700           137,900
                                                                  ---------         ---------
                  Total Deferred Tax Assets                         166,700           137,900
               Valuation Allowance for Deferred Tax Assets          (31,200)          (49,100)
                                                                  ---------         ---------
         Net Deferred Tax Assets                                    135,500            88,800
                                                                  ---------         ---------
         Net Deferred Tax Assets and Liabilities                  $      --         $      --
                                                                  =========         =========
</TABLE>


The valuation allowance decreased approximately $17,900 during the year ended
December 31, 1996.

5.  NOTES PAYABLE

Notes payable consist of the following:

                                                               December 31

                                                         1996              1995
                                                         ----              ----

One unsecured note payable maturing June 7, 1998 and
three unsecured lines of credit with terms of one year.
At December 31, 1996 and 1995 the Company had $75,145
and $28,764, respectively, available to borrow under
these notes. Three of the notes have fixed interest
rates ranging from 9.75% to 10.25% and 8.75% to 10.75%
at December 31, 1996 and 1995, respectively. Payments
of principal and interest are due at maturity. One note
has a variable interest rate of prime plus 1% (10% at
December 31, 1996 and 1995). Payments of principal and
interest are due monthly.

                                                        $13,407          $46,361
                                                        =======          =======

The lines of credit are guaranteed by the Operator's chairman, president, chief
executive officer and minority shareholder.


                                                                           F-34
<PAGE>   87
                            JAMESON OPERATING COMPANY

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

6.  RELATED PARTY TRANSACTIONS

The Operator has a Cost Reimbursement Agreement with Kitchin Investments (a
company wholly owned by the Operator's chairman, president, chief executive
officer and minority stockholder) whereby the Operator agrees to pay for its
share of the use of office space, office equipment, telephones, file and storage
space and other reasonable and necessary office equipment and facilities and
personnel costs. The agreement was amended effective January 1, 1996, to limit
the reimbursement to a maximum of 2.4% of the Operator's total revenues,
resulting in a reduction of $264,000 in general and administrative costs in 1996
as compared to its allocated share. The Cost Reimbursement Agreement expires on
December 31, 1999. Kitchin Investments, Inc. charged the Operator $478,801,
$261,666 and $218,339 in 1996, 1995 and 1994, respectively, pursuant to the Cost
Reimbursement Agreement.

The Operator also leases space on outdoor billboards for periods of one to ten
years from Jameson Outdoor Advertising Company, L.L.C. and its predecessor (both
companies are majority owned by the Operator's chairman, president, chief
executive officer and minority stockholder). During 1996, 1995 and 1994, such
expense totaled $314,030, $174,200 and $94,000, respectively, and is reflected
as advertising expense in the accompanying statements of operations. As of
December 31, 1996, the leases require future minimum payments as follows:

                  Year ending December 31,
                            1997              $373,178
                            1998               373,178
                            1999               373,178
                            2000               373,178
                            2001               373,178
                         Thereafter          1,393,066
                                            ----------
                                            $3,258,956
                                            ==========

In addition, Jameson Development Company, L.L.C. ("JDC") and its predecessor,
Jameson Construction Company, coordinate services for certain repair and
maintenance activities on the Inns, for which the Operator is not charged. Both
companies are majority owned by the Operator's chairman, president, chief
executive officer and minority stockholder. Invoices received for such repairs
and maintenance, which are performed by third parties, are paid by the Operator.

The Lease between the REIT and the Operator requires the Operator to provide the
room linens and towels and subsequent replacements. JDC or its predecessor has
provided the Operator with the initial inventory for each Inn at no charge. The
Operator records this inventory at JDC's cost and credits this income against
room expenses. Such amounts totaled $123,000, $103,000 and $66,000 in 1996, 1995
and 1994, respectively.

                                                                           F-35
<PAGE>   88
                            JAMESON OPERATING COMPANY

                    NOTES TO FINANCIAL STATEMENTS (CONTINUED)

7.  COMMITMENTS AND CONTINGENCIES

From time to time, the Operator becomes party to various claims and legal
actions arising during the ordinary course of business. Management, after
reviewing with legal counsel all actions and proceedings, believes that
aggregate losses, if any, would not have a material adverse effect on the
Operator's financial position.

                                                                           F-39
<PAGE>   89
SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                                         Jameson Inns, Inc.
                                         ------------------
                                         (Registrant)
                                       
                                       
Dated:  February 16, 1997              
                                       
                                         By: /s/ Thomas W. Kitchin
                                            ----------------------
                                         Thomas W. Kitchin
                                         President and Chief Executive Officer

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.

<TABLE>
<CAPTION>

Signature                                       Capacity                        Date
---------                                       --------                        ----

<S>                                             <C>                             <C>
PRINCIPAL EXECUTIVE OFFICER:

                                                Chairman of the Board           February 16, 1997
                                                President, Chief Executive
/s/ Thomas W. Kitchin                           Officer, and Director
---------------------------
Thomas W. Kitchin

PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:

                                                Treasurer and                   February 16, 1997
/s/ Craig R. Kitchin                            Chief Financial Officer
---------------------------
Craig R. Kitchin

ADDITIONAL DIRECTORS:

/s/ Robert D. Hisrich                           Director                        February 16, 1997
--------------------------
Robert D. Hisrich

/s/ Thomas J. Kearns                            Director                        February 16, 1997
--------------------------
Thomas J. Kearns 

/s/ Michael E. Lawrence                         Director                        February 16, 1997
--------------------------
Michael E. Lawrence
</TABLE>
<PAGE>   90
                               Index to Exhibits



EXHIBIT

NUMBER



   3.1    -  Articles of Incorporation of the Registrant incorporated by
               reference to Exhibit 3.1.1 to the Registration Statement filed
               on Form S-11, File No. 33-71160

   3.2    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant incorporated by reference to Exhibit 3.1.2 to the
               Registration Statement filed on Form S-11, File No. 33-71160

   3.3    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant Setting forth the Designation of Preferences, Rights,
               Privileges and Restrictions of Preferred Stock of the Registrant
               incorporated by reference to Exhibit 2.1 to the Registrant's
               Form 10-K/A1 (Amendment No. 1 to the Registrant's Annual Report
               on Form 10-K) for the year ended December 31, 1993

   3.4    -  Article of Amendment to the Articles of Incorporation of the
               Registrant incorporated by reference to Exhibit 3.3.1 to Form
               10-K/A2 (Amendment No. 2 to the Registrant's Annual Report on
               Form 10-K) for the year ended December 31, 1993

   3.5    -  Articles of Amendment to the Articles of Incorporation of the
               Registrant Amending the Designation of Preferences, Rights,
               Privileges and Restrictions of Preferred Stock of the Registrant
               incorporated by reference to Exhibit 3.6 to the Registrant's
               Annual Report on Form 10-K for the year ended December 31, 1994

   3.6    -  Bylaws of the Registrant incorporated by reference to Exhibit
               3.2.1 to the Registration Statement on Form S-11, File No. 33-
               71160

   3.7    -  Amendment to the Bylaws of the Registrant incorporated by
               reference to Exhibit 3.2.2 to the Registration Statement on Form
               S-11, File No. 33-71160

   3.8    -  Amendment No. 2 to Registrant's Bylaws incorporated by reference
               to Exhibit 3.8 to the Annual Report filed on Form 10-K for the
               year ended December 31, 1995

   4.1    -  Specimen Certificate of Common Stock incorporated by reference to
               Exhibit 4.1 to the Registration Statement on Form S-11, File No.
               33-71160

   4.2    -  Warrant issued to Commonwealth Associates incorporated by
               reference to Exhibit 4.2.1 to the Registration Statement on Form
               S-11, File No. 33-71160

  10.1    -  Master Lease Agreement incorporated by reference to Exhibit 10.1
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1993

  10.2    -  Amendment No. 1 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company (revised) incorporated by
               reference to Exhibit 10.2 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.3    -  Amendment No. 2 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company

  10.4    -  Amendment No. 3 to Master Lease Agreement between Jameson Inns,
               Inc. and Jameson Operating Company

  10.5    -  Addenda A-1 through A-17 to Master Lease Agreement between Jameson
               Inns,





                                     
<PAGE>   91

               Inc. and Jameson Operating Company incorporated by reference to
               Exhibit 10.3 to the Annual Report filed on Form 10-K for the year
               ended December 31, 1995

  10.6    -  Schedule of Lease Supplements entered into during 1996 and
             substantially  similar to Exhibit 10.5

  10.7    -  Cost Reimbursement Agreement between Jameson Inns, Inc. and
               Kitchin Investments, Inc. incorporated by reference to Exhibit
               10.2 to the Registration Statement on Form S-11, File No.
               33-71160

  10.8    -  Construction Contract between Jameson Inns, Inc. and Jameson
               Construction Company for construction of Inns in Alexander City,
               Decatur, Eufala and Florence, Alabama; Albany, Bainbridge,
               Brunswick, LaGrange, Thomaston, Waycross and Waynesboro,
               Georgia; and Union, South Carolina, incorporated by reference to
               Exhibit 10.7 to the Annual Report filed on Form 10-K for the
               year ended December 31, 1995

  10.9    -  Schedule of documents substantially similar to Exhibit 10.8

  10.10   -  Jameson 1993 Stock Incentive Plan incorporated by reference to
               Exhibit 10.22.1 to the Registration Statement on Form S-11, File
               No. 33-71160

  10.11   -  Form of Stock Option Agreement under Jameson Inns, Inc. Stock
               Incentive Plan incorporated by reference to Exhibit 10.23 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.12   -  Amendment No. 1 to Jameson 1993 Stock Incentive Plan incorporated
               by reference to Exhibit 10.10 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.13   -  1994 Amendment to Jameson 1993 Stock Incentive Plan incorporated
               by reference to Exhibit 10.11 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.14   -  Amendment No. 3 to Jameson 1993 Stock Incentive Plan incorporated 
               by reference to Exhibit 10.12 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.15   -  Jameson Inns, Inc. Director Stock Option Plan incorporated by
               reference to Exhibit 10.13 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.16   -  Employment Agreement between Jameson Inns, Inc. and Thomas W.
               Kitchin incorporated by reference to Exhibit 10.24 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.17   -  Amendment No. 1 to Employment Agreement between Jameson Inns, Inc.
               and Thomas W. Kitchin incorporated by reference to Exhibit 10.15
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.18   -  Amendment No. 2 to Employment Agreement between Jameson Inns, Inc.
               and Thomas W. Kitchin incorporated by reference to Exhibit 10.16
               to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.19   -  Indemnification and Hold Harmless Agreement between Jameson Inns,
               Inc. and Jameson Operating Company incorporated by reference to
               Exhibit 10.25 to the Registration Statement on Form S-11, File
               No. 33-71160

  10.20   -  Indemnification and Hold Harmless Agreement between Jameson Inns,
               Inc. and Kitchin Investments, Inc. incorporated by reference to
               Exhibit 10.26 to the Registration Statement on Form S-11, File
               No. 33-71160





                                     
<PAGE>   92



  10.21   -  Form of Indemnification agreement between Jameson Inns, Inc. and
               Directors and Officers incorporated by reference to Exhibit
               10.27 to the Registration Statement on Form S-11, File No.
               33-71160

  10.22   -  Dividend Subordination Agreement between the Company and Thomas W.
               Kitchin and Kitchin Children's Trust incorporated by reference
               to Exhibit 10.42 to the Registration Statement on Form S-11,
               File No. 33-71160

  10.23   -  Construction Loan Agreement, Indenture, Security Agreement and
               Promissory Note dated July 15, 1993 for $1,000,000 loan from
               Empire Financial Services, Inc. to Jameson Inns, Inc. (formerly
               Jameson Company) for construction of Jameson Inn in Carrollton,
               Georgia incorporated by reference to Exhibit 10.39 to the
               Registration Statement on Form S-11, File No. 33-71160

  10.24   -  Schedule of documents substantially similar to Exhibit 10.23

  10.25   -  Loan Indenture, Security Agreement, Assignment of Fees and Income,
               Promissory Note for $4.2 million revolving loan from Empire
               Financial Services, Inc. to Jameson Inns, Inc. incorporated by
               reference to Exhibit 10.21 to the Annual Report filed on Form
               10-K for the year ended December 31, 1993

  10.26   -  Deed to Secure Debt, Security Agreement, Assignment of Operating
               Lease, Assignment of Fees and Income, Promissory Note for $1.6
               million loan from Empire Financial Services, Inc. to Jameson
               Inns, Inc. secured by Inn at Jesup, Georgia incorporated by
               reference to Exhibit 10.24 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.27   -  Schedule of documents substantially similar to Exhibit 10.26
               incorporated by reference to Exhibit 10.25 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.28   -  Loan Modification Agreement and Note increasing by $2.6 million
               the revolving loan from Empire Financial Services, Inc. to
               Jameson Inns, Inc. incorporated by reference to Exhibit 10.26 to
               the Annual Report filed on Form 10-K for the year ended December
               31, 1995

  10.29   -  Loan Modification Agreement, Construction Agreement and Note dated
               April 13, 1995, increasing by $500,000 the loan from Empire
               Financial Services, Inc. to Jameson Inns, Inc. for construction
               of expansion of Inn at Carrollton, Georgia, incorporated by
               reference to Exhibit 10.27 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.30   -  Schedule of documents substantially similar to Exhibit 10.29
               incorporated by reference to Exhibit 10.28 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.31   -  Promissory Note of Jameson Inns, Inc. payable to Bank Midwest,
               N.A. dated  January 26, 1996, for $3.4 million, incorporated by
               reference to Exhibit 10.29 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.32   -  Form of Security Agreement between Jameson Inns, Inc. and Bank
               Midwest, N.A., incorporated by reference to Exhibit 10.30 to the
               Annual Report filed on Form 10-K for the year ended December 31,
               1995

  10.33   -  Form of Deed to Secure Debt between Jameson Inns, Inc. and Bank
               Midwest, N.A. (Jameson Inn at Fitzgerald, Georgia), incorporated
               by reference to Exhibit 10.31 to the Annual Report filed on Form
               10-K for the year ended





                                  
<PAGE>   93

               December 31, 1995

  10.34   -  Schedule of documents substantially similar to Exhibit 10.31,
               incorporated by reference to Exhibit 10.32 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.35   -  Form of Assignment of Leases and Rents (General Commercial)
               between Jameson Inns, Inc. and Bank Midwest, N.A. (Jameson Inn
               at Fitzgerald, Georgia), incorporated by reference to Exhibit
               10.33 to the Annual Report filed on Form 10-K for the year ended
               December 31, 1995

  10.36   -  Schedule of documents substantially similar to Exhibit 10.33,
               incorporated by reference to Exhibit 10.34 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.37   -  Form of Assignment of Income between Jameson Inns, Inc. and Bank
               Midwest, N.A. (Jameson Inn at Fitzgerald, Georgia), incorporated
               by reference to Exhibit 10.35 to the Annual Report filed on Form
               10-K for the year ended December 31, 1995

  10.38   -  Schedule of documents substantially similar to Exhibit 10.35,
               incorporated by reference to Exhibit 10.36 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.39   -  Form of Estoppel and Subordination Agreement between Jameson Inns,
               Inc. and Bank Midwest, N.A. (Jameson Inn at Fitzgerald,
               Georgia), incorporated by reference to Exhibit 10.37 to the
               Annual Report filed on Form 10-K for the year ended December 31,
               1995

  10.40   -  Schedule of documents substantially similar to Exhibit 10.39,
               incorporated by reference to Exhibit 10.38 to the Annual Report
               filed on Form 10-K for the year ended December 31, 1995

  10.41   -  Loan Modification Agreement between Jameson Inns, Inc. and Empire
               Financial Services, Inc. dated June 30, 1996 for loan on
               Waynesboro, Georgia property, incorporated by reference to
               Exhibit 10.1 to the Report filed on Form 10-Q for the quarter
               ended March 31, 1996

  10.42   -  Schedule of documents substantially similar to Exhibit 10.41

  10.43   -  Adjustable Rate Note dated June 30, 1996 in the amount of
               $1,050,000 from  Jameson Inns, Inc. to Empire Financial
               Services, Inc.  for loan on Waynesboro, Georgia property,
               incorporated by reference to Exhibit 10.3 to the Report filed on
               Form 10-Q for the quarter ended March 31, 1996

  10.44   -  Schedule of documents substantially similar to Exhibit 10.43

  10.45   -  Jameson 1996 Stock Incentive Plan

  10.46   -  Amendment No. 3 to Employment Agreement between Jameson Inns, Inc.
             and Thomas W. Kitchin

  11.1    -  Statement Re: Per Share Earnings

  23.1    -  Consent of Ernst & Young LLP

  27.1    -  Financial Data Schedule (for SEC use only)