##### 



SECURITIES AND EXCHANGE
COMMISSION  FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004
    
    Commission file number 0-23732
 WINSTON HOTELS, INC.  North Carolina
    
    56-1624289(State of incorporation)
    
    (I.R.S. Employer Identification No.)
 2626 Glenwood Avenue
Raleigh, North Carolina 27608
(Address of principal executive offices)
(Zip Code) (919) 510-6019
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes x No o The number of shares of Common Stock, $.01 par value, outstanding on October
31, 2004 was 26,397,799.




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##### 



WINSTON HOTELS, INC.
Index PagePART I.
    
    FINANCIAL INFORMATIONItem 1
    
    Financial StatementsWINSTON HOTELS, INC.Consolidated Balance Sheets as of September 30, 2004 (unaudited) and
December 31, 2003
    
    
    3Unaudited Consolidated Statements of Operations for the three months ended
September 30, 2004 and 2003
    
    
    4Unaudited Consolidated Statements of Operations for the nine months ended
September 30, 2004 and 2003
    
    
    5Unaudited Consolidated Statement of Shareholders Equity for the nine months ended
September 30, 2004
    
    
    6Unaudited Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003
    
    
    7Notes to Consolidated Financial Statements
    
    
    8Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    19Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    30Item 4
    
    Controls and Procedures
    
    
    32PART II.
    
    OTHER INFORMATIONItem 6
    
    Exhibits and Reports on Form 8-K
    
    
    33SIGNATURES
    
    
    34EXHIBIT INDEX
    
    
    35
 2




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##### 



WINSTON HOTELS, INC. 
 CONSOLIDATED BALANCE SHEETS
 ($ in thousands, except per share amounts)
 September 30, 2004
    
    December 31, 2003(unaudited)ASSETSLand
    
    $
    45,470
    
    
    $
    44,788Buildings and improvements
    
    
    377,690
    
    
    
    377,109Furniture and equipment
    
    
    52,554
    
    
    
    51,323Operating properties
    
    
    475,714
    
    
    
    473,220Less accumulated depreciation
    
    
    132,495
    
    
    
    128,540343,219
    
    
    
    344,680Properties under development
    
    
    
    
    
    
    3,521Net investment in hotel properties
    
    
    343,219
    
    
    
    348,201Assets held for sale
    
    
    2,100
    
    
    
    2,100Corporate FF&E, net
    
    
    437
    
    
    
    621Cash
    
    
    5,065
    
    
    
    5,623Accounts receivable
    
    
    3,542
    
    
    
    2,505Lease revenue receivable
    
    
    
    
    
    
    179Notes receivable
    
    
    13,371
    
    
    
    5,016Investment in joint ventures
    
    
    2,484
    
    
    
    1,607Deferred expenses, net
    
    
    2,293
    
    
    
    2,935Prepaid expenses and other assets
    
    
    9,190
    
    
    
    8,653Deferred tax asset
    
    
    11,312
    
    
    
    9,821Total assets
    
    $
    393,013
    
    
    $
    387,261LIABILITIES AND SHAREHOLDERS EQUITYDue to banks
    
    $
    33,000
    
    
    $
    29,200Long-term debt
    
    
    86,512
    
    
    
    91,284Accounts payable and accrued expenses
    
    
    13,907
    
    
    
    11,484Distributions payable
    
    
    5,994
    
    
    
    5,870Total liabilities
    
    
    139,413
    
    
    
    137,838Minority interest
    
    
    10,377
    
    
    
    17,489Shareholders equity:Preferred stock, Series A, $.01 par value, 10,000,000 shares
authorized,
3,000,000 shares issued and outstanding
    
    
    
    
    
    
    30Preferred stock, Series B, $.01 par value, 5,000,000 shares
authorized,
3,680,000 shares issued and outstanding (liquidation preference of
$93,840)
    
    
    37
    
    
    
    Common stock, $.01 par value, 50,000,000 shares authorized,
26,397,799 and 26,270,805 shares issued and outstanding
    
    
    264
    
    
    
    263Additional paid-in capital
    
    
    323,955
    
    
    
    307,089Accumulated other comprehensive loss
    
    
    
    
    
    
    (33
    )Unearned compensation
    
    
    (1,268
    )
    
    
    (527
    )Distributions in excess of earnings
    
    
    (79,765
    )
    
    
    (74,888
    )Total shareholders equity
    
    
    243,223
    
    
    
    231,934Total liabilities and shareholders equity
    
    $
    393,013
    
    
    $
    387,261
 The accompanying notes are an integral part of the consolidated financial statements. 3




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##### 



WINSTON HOTELS, INC. 
 UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share amounts)
 Three Months Ended
    
    Three Months EndedSeptember 30, 2004
    
    September 30, 2003Revenue:Rooms
    
    $
    33,275
    
    
    $
    29,473Food and beverage
    
    
    2,235
    
    
    
    1,640Other operating departments
    
    
    1,042
    
    
    
    1,001Percentage lease revenue
    
    
    
    
    
    
    535Joint venture fee income
    
    
    50
    
    
    
    91Total revenue
    
    
    36,602
    
    
    
    32,740Hotel operating expenses:Rooms
    
    
    7,505
    
    
    
    6,821Food and beverage
    
    
    1,700
    
    
    
    1,337Other operating departments
    
    
    754
    
    
    
    768Undistributed operating expenses:Property operating expenses
    
    
    7,315
    
    
    
    6,360Real estate taxes and property and casualty insurance
    
    
    1,742
    
    
    
    1,521Franchise costs
    
    
    2,377
    
    
    
    2,122Maintenance and repair
    
    
    1,916
    
    
    
    1,688Management fees
    
    
    792
    
    
    
    720Percentage lease expense
    
    
    
    
    
    
    1,216General and administrative
    
    
    2,149
    
    
    
    1,095Depreciation
    
    
    4,449
    
    
    
    4,149Amortization
    
    
    331
    
    
    
    224Management agreement acquisition
    
    
    
    
    
    
    1,300Total operating expenses
    
    
    31,030
    
    
    
    29,321Operating income
    
    
    5,572
    
    
    
    3,419Interest and other income
    
    
    590
    
    
    
    316Interest expense
    
    
    1,696
    
    
    
    1,883Income before allocation to minority interest in Partnership,
allocation to minority interest in consolidated joint ventures,
income taxes, and equity in income (loss) of unconsolidated
joint ventures
    
    
    4,466
    
    
    
    1,852Income allocation to minority interest in Partnership
    
    
    148
    
    
    
    119Loss allocation to minority interest in consolidated joint ventures
    
    
    (52
    )
    
    
    (10
    )Income tax benefit
    
    
    (503
    )
    
    
    (1,041
    )Equity in income (loss) of unconsolidated joint ventures
    
    
    (31
    )
    
    
    499Income from continuing operations
    
    
    4,842
    
    
    
    3,283Discontinued operations:Earnings from discontinued operations
    
    
    63
    
    
    
    183Loss on impairment of asset held for sale
    
    
    (2
    )
    
    
    (2,366
    )Net income
    
    
    4,903
    
    
    
    1,100Preferred stock distribution
    
    
    (1,840
    )
    
    
    (1,734
    )Net income (loss) available to common shareholders
    
    $
    3,063
    
    
    $
    (634
    )Income (loss) per common share:Basic and diluted:Income from continuing operations
    
    $
    0.12
    
    
    $
    0.08Loss from discontinued operations
    
    
    
    
    
    
    (0.11
    )Net income (loss) per common share
    
    $
    0.12
    
    
    $
    (0.03
    )
 The accompanying notes are an integral part of the consolidated financial statements. 4




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##### 



WINSTON HOTELS, INC. 
 UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share amounts)
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Revenue:Rooms
    
    $
    95,786
    
    
    $
    84,606Food and beverage
    
    
    6,614
    
    
    
    5,287Other operating departments
    
    
    3,079
    
    
    
    3,135Percentage lease revenue
    
    
    701
    
    
    
    1,603Joint venture fee income
    
    
    123
    
    
    
    240Total revenue
    
    
    106,303
    
    
    
    94,871Hotel operating expenses:Rooms
    
    
    21,390
    
    
    
    19,460Food and beverage
    
    
    4,920
    
    
    
    4,053Other operating departments
    
    
    2,199
    
    
    
    2,195Undistributed operating expenses:Property operating expenses
    
    
    21,550
    
    
    
    18,209Real estate taxes and property and casualty insurance
    
    
    5,054
    
    
    
    4,866Franchise costs
    
    
    6,861
    
    
    
    6,038Maintenance and repair
    
    
    5,590
    
    
    
    4,928Management fees
    
    
    2,388
    
    
    
    1,972Percentage lease expense
    
    
    
    
    
    
    3,426General and administrative
    
    
    5,290
    
    
    
    4,050Depreciation
    
    
    13,281
    
    
    
    12,981Amortization
    
    
    991
    
    
    
    666Management agreement acquisition
    
    
    
    
    
    
    1,300Total operating expenses
    
    
    89,514
    
    
    
    84,144Operating income
    
    
    16,789
    
    
    
    10,727Interest and other income
    
    
    1,346
    
    
    
    897Interest expense
    
    
    5,100
    
    
    
    5,758Income before allocation to minority interest in Partnership,
allocation to minority interest in consolidated joint ventures,
income taxes, and equity in income (loss) of unconsolidated
joint ventures
    
    
    13,035
    
    
    
    5,866Income allocation to minority interest in Partnership
    
    
    329
    
    
    
    193Income (loss) allocation to minority interest in consolidated joint
ventures
    
    
    210
    
    
    
    (10
    )Income tax benefit
    
    
    (1,476
    )
    
    
    (1,671
    )Equity in income (loss) of unconsolidated joint ventures
    
    
    (85
    )
    
    
    553Income from continuing operations
    
    
    13,887
    
    
    
    7,907Discontinued operations:Earnings from discontinued operations
    
    
    328
    
    
    
    489Gain on sale of discontinued operations
    
    
    15
    
    
    
    Loss on impairment of asset held for sale
    
    
    (49
    )
    
    
    (2,366
    )Net income
    
    
    14,181
    
    
    
    6,030Preferred stock distribution
    
    
    (5,475
    )
    
    
    (5,203
    )Loss on redemption of Series A Preferred Stock
    
    
    (1,720
    )
    
    
    Net income available to common
shareholders
    
    $
    6,986
    
    
    $
    827Income (loss) per common share:Basic and diluted:Income from continuing operations
    
    $
    0.26
    
    
    $
    0.13Income (loss) from discontinued operations
    
    
    0.01
    
    
    
    (0.09
    )Net income per common share
    
    $
    0.27
    
    
    $
    0.04
 The accompanying notes are an integral part of the consolidated financial statements. 5




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##### 



WINSTON HOTELS, INC. 
 UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
 (in thousands, except per share amounts)
 AccumulatedPreferred Stock
    
    Common Stock
    
    AdditionalPaid-in
    
    Unearned
    
    DistributionsIn Excess of
    
    OtherComprehensive
    
    TotalShareholdersShares
    
    Dollars
    
    Shares
    
    Dollars
    
    Capital
    
    Compensation
    
    Earnings
    
    Loss
    
    EquityBalances at December 31, 2003
    
    
    3,000
    
    
    $
    30
    
    
    
    26,271
    
    
    $
    263
    
    
    $
    307,089
    
    
    $
    (527
    )
    
    $
    (74,888
    )
    
    $
    (33
    )
    
    $
    231,934Issuance of shares and other
    
    
    3,680
    
    
    
    37
    
    
    
    127
    
    
    
    1
    
    
    
    90,116
    
    
    
    (1,331
    )
    
    
    
    
    
    
    
    
    
    
    88,823Redemption of Preferred A Stock
    
    
    (3,000
    )
    
    
    (30
    )
    
    
    
    
    
    
    
    
    
    
    (73,250
    )
    
    
    
    
    
    
    (1,720
    )
    
    
    
    
    
    
    (75,000
    )Distributions ($0.45 per common share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,863
    )
    
    
    
    
    
    
    (11,863
    )Distributions ($0.353 per preferred A
share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,059
    )
    
    
    
    
    
    
    (1,059
    )Distributions ($1.20 per preferred B share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,416
    )
    
    
    
    
    
    
    (4,416
    )Unearned compensation amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    590
    
    
    
    
    
    
    
    
    
    
    
    590Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,181
    
    
    
    Change in market value of interest rate
swap
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,214Balances at September 30, 2004
    
    
    3,680
    
    
    $
    37
    
    
    
    26,398
    
    
    $
    264
    
    
    $
    323,955
    
    
    $
    (1,268
    )
    
    $
    (79,765
    )
    
    $
    
    
    
    $
    243,223
 The accompanying notes are an integral part of the consolidated financial statements. 6




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WINSTON HOTELS, INC. 
 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Nine Months Ended
    
    Nine Months EndedSeptember 30, 2004
    
    September 30, 2003Cash flows from operating activities:Net income
    
    $
    14,181
    
    
    $
    6,030Adjustments to reconcile net income to net cash
provided by operating activities:Income allocation to minority interest in Partnership
    
    
    344
    
    
    
    71Income (loss) allocation to minority interest in
consolidated joint ventures
    
    
    210
    
    
    
    (10
    )Depreciation
    
    
    13,473
    
    
    
    13,627Amortization
    
    
    991
    
    
    
    666Income tax benefit
    
    
    (1,491
    )
    
    
    (1,769
    )Gain on sale of hotel properties
    
    
    (16
    )
    
    
    Loss on impairment of hotel properties
    
    
    52
    
    
    
    2,518(Income) loss allocations from unconsolidated joint ventures
    
    
    85
    
    
    
    (553
    )Distributions from joint ventures
    
    
    78
    
    
    
    1,254Unearned compensation amortization
    
    
    590
    
    
    
    341Changes in assets and liabilities:Lease revenue receivable
    
    
    179
    
    
    
    Accounts receivable
    
    
    (1,037
    )
    
    
    (1,734
    )Prepaid expenses and other assets
    
    
    (537
    )
    
    
    (1,570
    )Accounts payable and accrued expenses
    
    
    2,456
    
    
    
    1,053Net cash provided by operating activities
    
    
    29,558
    
    
    
    19,924Cash flows from investing activities:Notes receivable
    
    
    (8,355
    )
    
    
    Minority interest contribution to consolidated joint venture
    
    
    
    
    
    
    2,100Franchise fees
    
    
    (91
    )
    
    
    Acquisition of minority interest
    
    
    (8,163
    )
    
    
    Investment in hotel properties
    
    
    (17,022
    )
    
    
    (6,035
    )Sale of hotel properties
    
    
    10,543
    
    
    
    Investment in unconsolidated joint ventures
    
    
    (1,040
    )
    
    
    (864
    )Net cash used in investing activities
    
    
    (24,128
    )
    
    
    (4,799
    )Cash flows from financing activities:Fees paid in connection with financing activities
    
    
    (274
    )
    
    
    (673
    )Proceeds from issuance of common shares, net
    
    
    
    
    
    
    44,257Payment of distributions to shareholders
    
    
    (17,213
    )
    
    
    (14,283
    )Payment of distributions to minority interest in Partnership
    
    
    (585
    )
    
    
    (584
    )Distributions to minority interest in consolidated joint ventures
    
    
    (738
    )
    
    
    Proceeds from issuance of Series B Preferred shares, net
    
    
    88,794
    
    
    
    Redemption of Series A Preferred shares, net
    
    
    (75,000
    )
    
    
    Net change in due to banks
    
    
    3,800
    
    
    
    (21,346
    )Net decrease in long-term debt
    
    
    (4,772
    )
    
    
    (1,022
    )Net cash provided by (used in) financing activities
    
    
    (5,988
    )
    
    
    6,349Net increase (decrease) in cash
    
    
    (558
    )
    
    
    21,474Cash at beginning of period
    
    
    5,623
    
    
    
    1,510Cash at end of period
    
    $
    5,065
    
    
    $
    22,984Supplemental disclosure:Cash paid for interest
    
    $
    5,185
    
    
    $
    6,424Summary of non-cash investing and financing activities:Distributions to shareholders declared but not paid
    
    $
    5,799
    
    
    $
    5,552Distributions to minority interest in Partnership declared but not paid
    
    
    195
    
    
    
    195Deferred equity compensation
    
    
    1,331
    
    
    
    352Interest rate swap adjustment to market value
    
    
    33
    
    
    
    86Adjustment to minority interest due to issuance of common stock
    
    
    29
    
    
    
    707
 The accompanying notes are an integral part of the consolidated financial statements. 7




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##### 



WINSTON HOTELS, INC. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 ($ in thousands, except per share amounts)
  1.
    
    ORGANIZATIONWinston Hotels, Inc. (the Company), headquartered in Raleigh, North
Carolina, operates so as to qualify as a real estate investment trust
(REIT) for federal income tax purposes. During 1994, the Company
completed an initial public offering of its common stock (Common Stock),
utilizing the majority of the proceeds to acquire one hotel and a general
partnership interest (as the sole general partner) in WINN Limited
Partnership (the Partnership). The Partnership used a substantial portion
of the proceeds to acquire nine additional hotel properties. The Company
and the Partnership (together with the Partnerships wholly owned
subsidiaries, Barclay Hospitality Services Inc. (Barclay), Winston SPE,
LLC, and Winston Finance LLC), are collectively referred to as the
Company. As of September 30, 2004, the Companys ownership in the
Partnership was 95.31 percent.The accompanying unaudited consolidated financial statements reflect, in the
opinion of management, all adjustments necessary for a fair presentation of
the interim financial statements. All such adjustments are of a normal and
recurring nature. Certain reclassifications have been made to the 2003
financial statements to conform to the 2004 presentation. These
reclassifications have no effect on net income or shareholders equity
previously reported. Due to the seasonality of the hotel business, the
information for the nine months ended September 30, 2004 and 2003 is not
necessarily indicative of the results for a full year. This Form 10-Q
should be read in conjunction with the Companys Annual Report on Form 10-K
for the year ended December 31, 2003.As of September 30, 2004, the Company owned or was invested in 51 hotel
properties in 15 states having an aggregate of 7,185 rooms. This included
44 wholly owned properties with an aggregate of 6,262 rooms, a 49 percent
ownership interest in one joint venture hotel with 118 rooms, a 48.78
percent ownership interest in one joint venture hotel with 147 rooms, and a
13.05 percent ownership interest in five joint venture hotels with an
aggregate of 658 rooms. The Company also had issued hotel loans to owners
of five hotels with an aggregate of 881 rooms. The Company does not hold an
ownership interest in any of the hotels for which it has provided financing.
All of the Companys hotels are operated under franchises from nationally
recognized franchisors including Marriott International, Inc., Hilton Hotels
Corporation, Intercontinental Hotels Group PLC, (formerly Six Continents
PLC) and Choice Hotels International.Currently, Alliance Hospitality Management, LLC manages 41 of the Companys
51 hotels, Concord Hospitality Enterprises Company manages four hotels,
Promus Hotels, Inc., an affiliate of Hilton Hotels Corporation manages three
hotels, and New Castle Hotels, LLC, Noble Investment Group, Ltd., and Prism
Hospitality Corp. each manage one hotel.In March 2004, the Company negotiated the transfer of the long-term lease
with Secaucus Holding Corporation, a wholly owned subsidiary of Prime
Hospitality Corp. (Prime) for the Secaucus, NJ Holiday Inn to Barclay.
The Company received a net payment from Prime of $269 as part of the
negotiated settlement. This amount is included in percentage lease revenue
in the accompanying unaudited consolidated statement of operations for the
nine months ended September 30, 2004. Alliance manages the hotel. With the
transfer of this lease to Barclay, the Company is no longer the lessor of
any hotel leases with unrelated third parties. Therefore, unless the
Company enters into third party hotel leases, as the lessor, in the future,
the Company will not report percentage lease revenue in the future.2.
    
    MINORITY INTERESTMinority interest as of September 30, 2004 and December 31, 2003, consists
of minority interest in the Partnership of $7,402 and $7,671, respectively,
and minority interest in consolidated joint ventures of $2,975 and $9,818,
respectively. 8




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##### 



Minority Interest in the Partnership.Certain hotel properties have been
acquired, in part, by the Partnership, through the issuance of limited
partnership units of the Partnership. The equity interest in the
Partnership created by these transactions represents the Companys minority
interest. The Companys minority interest is:
(i) increased or decreased by its pro-rata share of the net income or net
loss, respectively, of the Partnership; (ii) decreased by distributions to
unit holders; (iii) decreased by redemption of Partnership units for the
Companys Common Stock; and (iv) adjusted to equal the net equity of the
Partnership multiplied by the limited partners ownership percentage
immediately after each issuance of units of the Partnership and/or Common
Stock of the Company through an adjustment to additional paid-in capital.
Income (loss) is allocated to minority interest based on the weighted
average percentage ownership throughout the year.Minority Interest in Consolidated Joint Ventures.Certain ownership
interests in hotel properties have been acquired, in part, by the Company,
through joint venture agreements. The equity interests of the Companys
joint venture partners in the consolidated joint ventures represent the
Companys minority interest (see Note 9). The Companys minority interest
is: (i) increased or decreased by its joint venture partners pro-rata share
of the net income or net loss of the respective joint venture, and (ii)
decreased by distributions to its joint venture partners. Income (loss) is
allocated to minority interest in accordance with the provisions of each
joint ventures operating agreement.3.
    
    DEBTThe Companys financing facilities consist of a $125,000 variable rate line
of credit that matures in December 2004 (the Line); a $71,000 fixed rate
(7.375 percent) loan with a ten-year maturity, due December 1, 2008, and a
twenty-five-year amortization period; a $5,100 variable rate (LIBOR +3%)
loan with a ten-year maturity, due February 1, 2011, and a twenty-five-year
amortization period; a $12,300 variable rate (LIBOR +3%) loan with a
ten-year maturity, due August 1, 2011, and a twenty-year amortization
period; and a $9,147 variable rate (LIBOR + 3.8% during construction)
construction loan with a funding cutoff date of December 22, 2004, at which
time the interest rate will be fixed and the payments will be determined.
The Line, which expires in December 2004, bears interest generally at rates
from 30-day LIBOR plus 1.75% to 30-day LIBOR plus 2.50%, based on the
Companys consolidated debt leverage ratio as of the end of each previous
calendar quarter. The Companys interest rate as of September 30, 2004 was
30-day LIBOR (1.84% as of September 30, 2004) plus 1.75%. The Companys
interest rate beginning October 1, 2004 and for the fourth quarter remained
at 30-day LIBOR plus 1.75%. The Company is currently negotiating with
lenders to refinance the debt outstanding under the line upon maturity in
December 2004. It is the Companys expectation that the debt outstanding
under the Line at that time will be refinanced at market terms.To seek to manage overall interest rate risk, at various times the Company
uses interest rate hedging instruments to convert a portion of its
variable-rate debt to fixed-rate debt. Interest rate differentials that
arise under these instruments are recognized as interest expense over the
life of the contracts. The Companys only such instrument during the nine
months ended September 30, 2004 was an interest rate swap instrument, the
term of which started March 31, 2003 and ended February 27, 2004. The
interest rate swap instrument effectively replaced the Companys variable
interest rate based on 30-day LIBOR on $50,000 of the Line with a fixed
interest rate based on a base rate of 1.505% until February 27, 2004, and
was therefore characterized as a cash flow hedge. The Lines interest rate
spread was 1.75% equating to an effective fixed rate of 3.255% on $50,000
from January 1, 2004 to February 27, 2004.4.
    
    EARNINGS PER SHAREThe following is a reconciliation of the amounts used in calculating basic
and fully diluted earnings per share for income from continuing operations: 9




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##### 



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Income from continuing operations
    
    $
    4,842
    
    
    $
    3,283
    
    
    $
    13,887
    
    
    $
    7,907Less: preferred stock distributions
    
    
    (1,840
    )
    
    
    (1,734
    )
    
    
    (5,475
    )
    
    
    (5,203
    )Less: loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    
    
    
    
    (1,720
    )
    
    
    Income from continuing operations
applicable to common shareholders
    
    
    3,002
    
    
    
    1,549
    
    
    
    6,692
    
    
    
    2,704Plus: income allocation to minority interest
    
    
    148
    
    
    
    119
    
    
    
    329
    
    
    
    193Income from continuing operations -
assuming dilution
    
    
    3,150
    
    
    
    1,668
    
    
    
    7,021
    
    
    
    2,897Weighted average number of common shares
    
    
    26,230
    
    
    
    20,783
    
    
    
    26,221
    
    
    
    20,320Minority interest units with redemption rights
    
    
    1,298
    
    
    
    1,298
    
    
    
    1,298
    
    
    
    1,298Stock options and stock grants
    
    
    14
    
    
    
    11
    
    
    
    35
    
    
    
    Weighted average number of common shares
assuming dilution
    
    
    27,542
    
    
    
    22,092
    
    
    
    27,554
    
    
    
    21,618
  The following is a reconciliation of the amounts used in calculating basic
and fully diluted earnings per share for
income (loss) from discontinued operations: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Income (loss) from discontinued operations
    
    $
    61
    
    
    $
    (2,183
    )
    
    $
    294
    
    
    $
    (1,877
    )Plus: income allocation to minority interest
    
    
    3
    
    
    
    
    
    
    
    15
    
    
    
    Income (loss) from discontinued operations -
assuming dilution
    
    
    64
    
    
    
    (2,183
    )
    
    
    309
    
    
    
    (1,877
    )Weighted average number of common shares
    
    
    26,230
    
    
    
    20,783
    
    
    
    26,221
    
    
    
    20,320Minority interest units with redemption rights
    
    
    1,298
    
    
    
    
    
    
    
    1,298
    
    
    
    Stock options and stock grants
    
    
    14
    
    
    
    
    
    
    
    35
    
    
    
    Weighted average number of common shares
assuming dilution
    
    
    27,542
    
    
    
    20,783
    
    
    
    27,554
    
    
    
    20,320
  The number of potential common shares (represented by minority interest,
outstanding stock options and stock grants) for the three and nine months
ended September 30, 2003 totaled 1,309 and 1,298, respectively.The following is a reconciliation of the amounts used in calculating basic
and fully diluted earnings per share for net income (loss) per common share: 10




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##### 



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    4,903
    
    
    $
    1,100
    
    
    $
    14,181
    
    
    $
    6,030Less: preferred stock distributions
    
    
    (1,840
    )
    
    
    (1,734
    )
    
    
    (5,475
    )
    
    
    (5,203
    )Less: loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    
    
    
    
    (1,720
    )
    
    
    Net income (loss) applicable to common
shareholders
    
    
    3,063
    
    
    
    (634
    )
    
    
    6,986
    
    
    
    827Plus: income allocation to minority interest
    
    
    151
    
    
    
    
    
    
    
    344
    
    
    
    72Net income (loss) applicable to common
shareholders - assuming dilution
    
    
    3,214
    
    
    
    (634
    )
    
    
    7,330
    
    
    
    899Weighted average number of common shares
    
    
    26,230
    
    
    
    20,783
    
    
    
    26,221
    
    
    
    20,320Minority interest units with redemption rights
    
    
    1,298
    
    
    
    
    
    
    
    1,298
    
    
    
    1,298Stock options and stock grants
    
    
    14
    
    
    
    
    
    
    
    35
    
    
    
    Weighted average number of common shares
assuming dilution
    
    
    27,542
    
    
    
    20,783
    
    
    
    27,554
    
    
    
    21,618
  The number of potential common shares (represented by minority interest,
outstanding stock options and stock grants) for the three months ended
September 30, 2003 totaled 1,309.During the first three quarters of 2004, the Company declared quarterly cash
dividends of $0.15 per common share, $0.353 per Series A preferred share for
the period from January 1, 2004 through February 24, 2004, $0.20 per Series
B preferred share for the period from February 24, 2004 (the issuance date
of the new Series B cumulative preferred stock) through March 31, 2004 and
$1.00 per Series B preferred share for the period from April 1, 2004 through
September 30, 2004.5.
    
    INCOME TAXESThe Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 109, Accounting
for Income Taxes. Under SFAS 109, the Company accounts for income taxes
using the asset and liability method under which deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. The income tax
benefit for the nine months ended September 30, 2004 consists of a deferred
federal income tax benefit of $1,373 and a deferred state income tax benefit
of $118.The benefit from income taxes and related deferred tax asset were calculated
using an effective tax rate of 38 percent applied to the loss of Barclay.
The deferred tax asset also relates to the cost of acquiring the leases for
47 of the Companys hotel properties from Interstate, which was expensed for
financial reporting purposes in 2002. For tax purposes, this payment is
being amortized over the lives of the leases. The Company believes that
Barclay, through strategic tax planning, will generate sufficient future
taxable income to realize in full the deferred tax asset. Accordingly, no
valuation allowance has been recorded as of September 30, 2004.6.
    
    STOCK-BASED COMPENSATIONThe Company has one stock-based employee compensation plan, the Winston
Hotels, Inc. Stock Incentive Plan (the Plan). The Company accounts for
this plan under the recognition and measurement principles of APB Opinion
No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based employee compensation cost is reflected in
net income for the issuance of options, as all options granted under
the Plan had an exercise price equal to the market value of the underlying
common stock on the date of grant.
The following table illustrates the
effect on net income (loss) available to common shareholders and net income 11




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##### 



(loss) per share as if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based
Compensation, as amended by FASB Statement No. 148, to stock-based employee
compensation. Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) available to common shareholders,
as reported
    
    $
    3,063
    
    
    $
    (634
    )
    
    $
    6,986
    
    
    $
    827Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards
    
    
    
    
    
    
    5
    
    
    
    1
    
    
    
    14Pro forma net income (loss) available to common
shareholders
    
    $
    3,063
    
    
    $
    (639
    )
    
    $
    6,985
    
    
    $
    813Income (loss) per common share:Basic and diluted  as reported
    
    $
    0.12
    
    
    $
    (0.03
    )
    
    $
    0.27
    
    
    $
    0.04Basic and diluted  pro forma
    
    $
    0.12
    
    
    $
    (0.03
    )
    
    $
    0.27
    
    
    $
    0.04
  7.
    
    ACCOUNTING FOR LONG-LIVED ASSETSThe Company evaluates the potential impairment of its individual long-lived
assets, principally its wholly owned hotel properties and the hotel
properties in which it owns an interest through consolidated joint ventures
in accordance with FASB No. 144 Accounting for the Impairment or Disposal
of Long-Lived Assets (FASB No. 144). The Company records an impairment
charge when it believes an investment in a hotel has been impaired, such
that the Companys estimate of future undiscounted cash flows, together with
its estimate of an anticipated liquidation amount, would not recover the
then current carrying value of the investment in the hotel property, or when
the Company classifies a property as held for sale pursuant to FASB No.
144 and the carrying value exceeds fair market value. The Company considers
many factors and makes certain subjective assumptions when making this
assessment, including but not limited to, general market and economic
conditions, operating results over the past several years, the performance
of similar properties in the same market and expected future operating
results based on a variety of assumptions. Future adverse changes in market
conditions or poor operating results of underlying investments could result
in losses or an inability to recover the carrying value of the investments,
thereby possibly requiring an impairment charge in the future. In addition,
if the Companys assumptions regarding future undiscounted cash flows and
anticipated liquidation amounts are incorrect, a future impairment charge
may be required. Further, the Company currently owns certain hotels for
which the carrying value exceeds current market value. The Company does not
believe an impairment charge for these hotels is appropriate since the
Companys forecast of future undiscounted cash flows, including an
anticipated liquidation amount, exceeds the current carrying value.
However, should the Company approve of a plan to sell these properties, an
impairment charge would be required.The Companys franchisors periodically inspect the Companys hotels to
ensure that they meet certain brand standards primarily pertaining to the
condition of the property and its guest service scores. In connection with
these routine reviews, as of June 30, 2004, the Company had received default
notices from the franchisor for two of its hotels. As of September 30,
2004, both of these properties have been reinspected. One has received an
acceptable rating. The other hotel passed the reinspection for all product
improvement issues, but received an unacceptable rating due to its customer
service scores falling below brand standards. We believe this decline in
customer service scores was due, in part, to the ongoing construction to
comply with the brands product improvement requirements. The Company
expects to cure this deficiency to comply with the franchisors standards
and expects to receive an acceptable rating for the hotel. Since June 30,
2004, the Company has received default notices from the franchisor for two
other hotels. The Company is currently in
the process of curing these
deficiencies to comply with the franchisors standards and expects to
receive an acceptable rating for both hotels. 12




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##### 



8.
    
    SUMMARIZED FINANCIAL STATEMENT INFORMATION FOR JOINT VENTURESThe Company participates in four joint venture agreements to develop and own
hotel properties, one with Marsh Landing Investment, L.L.C. (Marsh
Landing), one with Charlesbank Capital Partners, LLC (Charlesbank) and
Concord Hospitality Enterprises Company (Concord), one with Charlesbank and
Shelton III Hotel Equity LLC, owned in part by New Castle Hotels LLC (New
Castle), and one with Chapel Hill Investments, LLC. The Company entered
into the joint ventures with Marsh Landing during 2000, with Charlesbank and
Concord during the fourth quarter of 2002, with Chapel Hill Investments, LLC
during the third quarter of 2003, and with Charlesbank and New Castle during
the first quarter of 2004.The Company currently owns a 49 percent interest in the joint venture with
Marsh Landing that owns the Ponte Vedra, FL Hampton Inn. Charles Winston and
James Winston, both of whom are directors of the Company, control the
remaining 51 percent interest in the Marsh Landing joint venture. The
results of operations for the three and nine months ended September 30, 2004,
and the balance sheet as of September 30, 2004 and December 31, 2003 of this
joint venture are consolidated in the Companys consolidated financial
statements and all intercompany accounts are eliminated pursuant to FASB
Interpretation No. 46 (see Note 9).During the first quarter of 2004, the Company purchased its joint venture
partners ownership interest in both the Evanston Hotel Associates, LLC
Joint Venture (the Evanston Joint Venture) and the Windsor Hotel
Associates, LLC Joint Venture (the Windsor Joint Venture). Prior to the
purchase, Regent Partners, Inc. owned 51 percent of the Evanston Joint
Venture and 42.35 percent of the Windsor Joint Venture, and the Company
owned 49 percent and 57.65 percent, respectively. The amount paid for
Regents ownership interest in the Evanston Joint Venture totaled
approximately $6,900, and was based on an imputed value of $25,250 for the
sale of the hotel, subject to approximately $11,800 of debt. The amount
paid for Regents ownership interest in the Windsor Joint Venture totaled
approximately $1,200, and was based on an imputed value of $12,250 for the
sale of the hotel, net of debt paid off of approximately $9,300. As a
result of these purchases, the Company wholly owns the Evanston, IL Hilton
Garden Inn (the Evanston hotel) and the Windsor, CT Hilton Garden Inn (the
Windsor hotel) hotels. Prior to the purchase, Barclay leased the Evanston
hotel and Windsor Lessee Company LLC leased the Windsor hotel. Barclay
continues to lease the Evanston hotel and, as a result of the purchase,
Barclay assumed the lease of the Windsor hotel from Windsor Lessee Company
LLC. The results of operations for the three and nine months ended
September 30, 2004, and the balance sheets as of September 30, 2004 and
December 31, 2003 of these hotels are consolidated in the Companys
consolidated financial statements and all intercompany accounts are
eliminated.During 2002, the Company entered into a joint venture agreement with
Charlesbank with the intention to acquire more than $100,000 of hotel assets
(the Charlesbank Venture). Charlesbank is a private investment firm that
manages capital on behalf of a wide range of institutional investors. The
Charlesbank Venture and Concord subsequently formed a new joint venture
entity, WCC Project Company LLC. The Charlesbank Venture is the managing
member of WCC Project Company LLC. The West Des Moines, IA Fairfield Inn &
Suites, the Beachwood, OH Courtyard by Marriott, the Houston, TX Springhill
Suites by Marriott and the West Des Moines, IA Quality Suites are owned by
WCC Project Company LLC. The West Des Moines, IA Quality Suites, which was
purchased in the third quarter of 2004, is currently being renovated and is
expected to be converted to a Springhill Suites by Marriott during the second
quarter of 2005. Charlesbank owns an indirect ownership interest of 73.95
percent of WCC Project Company LLC, Concord owns 13 percent and the Company
owns an
indirect ownership interest of 13.05 percent. During the first quarter of
2004, the Charlesbank Venture and New Castle formed a new joint venture
entity, WNC Project Company LLC. New Castle is the managing member of WNC
Project Company LLC. The Shelton, CT Ramada Plaza hotel, which was purchased
in the first quarter of 2004, is owned by WNC Project Company LLC. This
hotel is currently being renovated and is expected to be converted to a
Courtyard by Marriott during the first quarter of 2005.
Charlesbank owns an
indirect ownership interest of 73.95 percent of WNC Project Company LLC, New
Castle owns 13 percent and the Company owns an indirect ownership interest of
13.05 percent. The total hotel assets of the five hotels owned, in part, by
the Charlesbank Venture were approximately $48 million as of September 30,
2004, and are expected to be approximately $51 million upon completion of all
renovation procedures. The results of operations for the three 13




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##### 



and nine
months ended September 30, 2004, and the balance sheets as of September 30,
2004 and December 31, 2003 of these hotels are not consolidated in the
Companys consolidated financial statements.During the third quarter of 2003, the Company entered into a joint venture
agreement (the Chapel Hill Joint Venture) with Chapel Hill Investments, LLC
to develop and own hotel properties. The Chapel Hill Joint Venture owns a
147-room Courtyard by Marriott hotel in Chapel Hill, NC, which opened in
September, 2004. The Chapel Hill Courtyard by Marriott hotel is leased to
Chapel Hill Lessee Company, LLC. The Company currently owns a 48.78 percent
interest in both the Chapel Hill Joint Venture and Chapel Hill Lessee
Company, LLC, while Chapel Hill Investments, LLC owns a 51.22 percent
interest in both entities. The Company also has provided an additional
$1,453 to capitalize the development of the hotel in exchange for a preferred
membership interest (Preferred Contribution) in the Chapel Hill Joint
Venture. The Company will receive $700 for development services provided
during construction. Chapel Hill Investments, LLC is owned 52 percent by
Charles Winston and James Winston, both of whom are directors of the Company,
and 48 percent by three unrelated private investors. The results of
operations for the three and nine months ended September 30, 2004 and 2003,
and the balance sheet as of September 30, 2004 and December 31, 2003 of this
joint venture are consolidated in the Companys consolidated financial
statements and all intercompany accounts are eliminated pursuant to FASB
Interpretation No. 46 (see Note 9).As of September 30, 2004, total assets of the two unconsolidated joint
ventures, one with Charlesbank and Concord and one with Charlesbank and New
Castle were $47,747, total liabilities were $32,789, and total equity was
$14,958. For the three and nine months ended September 30, 2004, total
revenue of the two unconsolidated joint ventures was $3,149 and $8,199,
respectively, total expenses were $3,351 and $8,742, respectively, resulting
in net loss of $(202) and $(543), respectively.As of September 30, 2004, total assets of the two consolidated joint
ventures, one with Marsh Landing Investments, LLC and one with Chapel Hill
Investments, LLC were $19,878, total liabilities were $14,061, and total
equity was $5,817. For the three and nine months ended September 30, 2004,
total revenue of the two consolidated joint ventures was $394 and $1,204,
respectively, total expenses were $494 and $996, respectively, resulting in
net income (loss) of $(100) and $208, respectively. The Companys resulting
share of the net income (loss) was $(49) and $102, respectively.For the period during the first quarter of 2004 that Evanston, Windsor and
Windsor Lessee were not wholly owned by the Company, their total revenue was
$1,674, total expenses were $1,472, resulting in net income of $202. The
Companys resulting share of the net income was $98.9.
    
    RECENT ACCOUNTING PRONOUNCEMENTSFASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest
Entities, an interpretation of Accounting Research Bulletin No. 51 (ARB No.
51), was issued in January 2003. This Interpretation clarifies the
application of ARB No. 51, Consolidated Financial Statements, to certain
entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated
financial support from other parties, referred to as variable interest
entities (VIE). FIN 46 explains the concept of a VIE and generally
requires consolidation by the party that has a majority of the risk and/or
rewards, referred to as the primary beneficiary.This Interpretation is intended to achieve more consistent application of
consolidation policies to variable interest entities and, thus, to improve
comparability between enterprises engaged in similar activities even if
some
of those activities are conducted through variable interest entities.
Including the assets, liabilities, and
results of activities of variable interest entities in the consolidated
financial statements of their primary beneficiaries will provide more
complete information about the resources, obligations, risks, and
opportunities of the consolidated enterprise. Disclosures about variable
interest entities in which an enterprise has a significant variable interest
but does not consolidate will help financial statement users assess the
enterprises risks. 14




---



##### 



This Interpretation applied immediately to variable interest entities
created after January 31, 2003. This Interpretation applied as of December
31, 2003 for balance sheet purposes and effective January 1, 2004 for income
statement purposes, to variable interest entities in which the Company holds
a variable interest that it acquired before February 1, 2003.As discussed in Note 8 above, the Company participates in four joint venture
agreements to develop and own hotel properties. As of September 30, 2004,
the Company had also issued five mezzanine loans to owners of five hotels.
The management of the Company has analyzed the terms and provisions of each
of these arrangements, and has determined the following:Marsh Landing Joint Venture:This joint venture is considered to be a VIE and the Company is considered
to be the primary beneficiary. Therefore, the Company, which owns a 49
percent interest, has consolidated the balance sheet of the Marsh Landing
Joint Venture beginning as of December 31, 2003, and has consolidated the
results of operations beginning with the first quarter of 2004. For the
three and nine months ended September 30, 2004, total revenue of the joint
venture was $336 and $1,145, respectively, total expenses were $194 and
$577, respectively, resulting in net income of $142 and $568, respectively.
As of September 30, 2004, total assets of the joint venture were $7,131,
total liabilities were $4,986, resulting in stockholders equity totaling
$2,145. The Companys share of the equity of this joint venture totaled
$1,051 as of September 30, 2004.Charlesbank Joint Ventures:The Company has determined that it is not required to consolidate either of
the Charlesbank joint ventures as it is not the primary beneficiary.
Therefore, the Company, which owns an indirect ownership interest of 13.05
percent, has accounted for and will continue to account for its investment
under the equity method of accounting. For the three and nine months ended
September 30, 2004, total revenue of the Charlesbank joint ventures was
$3,149 and $8,199, respectively, total expenses were $3,351 and $8,742,
respectively, resulting in a net loss of $(202) and $(543), respectively.
As of September 30, 2004, total assets of the joint ventures were $47,747,
total liabilities were $32,789, resulting in stockholders equity totaling
$14,958. The Companys equity balance exposed to loss as a result of its
involvement in these joint ventures totaled $1,951 as of September 30, 2004.Regent Joint Ventures:During the first quarter of 2004, the Company purchased its joint venture
partners ownership interest in both the Windsor Joint Venture and the
Evanston Joint Venture (see Note 8). These two joint ventures owned the
Windsor hotel and the Evanston hotel. These joint ventures were considered
to be VIEs and the Company was considered to be the primary beneficiary.
Therefore, the Company, which owned a 57.65 percent interest and a 49
percent interest, respectively, consolidated the balance sheets of the
Windsor Joint Venture and the Evanston Joint Venture beginning as of
December 31, 2003, and consolidated the results of operations beginning with
the first quarter of 2004. For the period during 2004 that these properties
were owned by joint ventures, total revenues of the Windsor Joint Venture
and the Evanston Joint Venture were $362 and $494, respectively, total
expenses were $240 and $281, respectively, resulting in net income of $122
and $213, respectively.The Company also owned a 57.65 percent interest in Windsor Lessee Company,
LLC, the lessee of the Windsor hotel. Barclay assumed this lease at the
time the Company purchased Regents interest in the
Windsor Joint Venture.
This joint venture was considered to be a VIE and the Company was considered
to be the primary beneficiary. The Company consolidated the balance sheet
of Windsor Lessee Company, LLC beginning as of December 31, 2003, and
consolidated the results of operations beginning with the first quarter of
2004. For the period during 2004 that the lessee was a joint venture, total
revenue of Windsor Lessee Company, LLC was $818, total expenses were $951
resulting in a net loss of $(133). 15




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##### 



Chapel Hill Joint Venture:Chapel Hill Hotel AssociatesThis joint venture is considered to be a VIE, the Company is considered to
be the primary beneficiary and it was created in August 2003 (after January
31, 2003). Therefore, the Company, which owns a 48.78 percent interest in
Chapel Hill Hotel Associates, LLC, has consolidated the joint ventures
results of operations and balance sheet beginning with the third quarter
2003. For the three and nine months ended September 30, 2004, total revenue
of the joint venture was $35 and $37, respectively, total expenses were $243
and $353, respectively, resulting in a net loss of $(208) and $(316),
respectively. For the three and nine months ended September 30, 2003, total
revenue of the joint venture was $0, total expenses were $20, resulting in a
net loss of $(20). As of September 30, 2004, total assets of the joint
venture were $12,583, total liabilities were $8,869, including $6,076 of
long term debt, resulting in stockholders equity totaling $3,714. The
Companys share of equity of this joint venture totaled $1,812 as of
September 30, 2004, and its Preferred Contribution (included in total
liabilities) totaled $1,453 as of September 30, 2004.Chapel Hill LesseeThis joint venture is considered to be a VIE, the Company is considered to
be the primary beneficiary and it began operations in May 2004 (after
January 31, 2003). Therefore, the Company has consolidated the joint
ventures results of operations and balance sheet beginning with the second
quarter 2004. The Company owns a 48.78 percent interest in Chapel Hill
Lessee Company, LLC, which is the lessee of the Courtyard by Marriott in
Chapel Hill, NC, which opened in September 2004. For the three and nine
months ended September 30, 2004, total revenue of the joint venture was $23,
total expenses were $56 and $66, respectively, resulting in a net loss of
$(33) and $(43), respectively. As of September 30, 2004, total assets of
the joint venture were $164, total liabilities were $206, resulting in
stockholders deficit totaling $(42). The Companys share of deficit of
this joint venture totaled $(20) as of September 30, 2004.Noble Investment Group Mezzanine Loans:In July 2000, the Company provided a $1,080 mezzanine loan for a Hilton
Garden Inn in Atlanta, GA and in February 2001 provided a $2,186 mezzanine
loan for a Hilton Garden Inn in Tampa, FL. Noble Investment Group, Ltd.
(Noble) provided the remainder of the funding and owns and operates the
hotels. These two mezzanine loan arrangements are considered to be
variable interests in the entities that own the hotels, both of which are
VIEs. However, the Company is not considered to be the primary beneficiary.
Therefore, the Company does not consolidate the results of operations of
the hotels for which it has provided financing. The Companys total
outstanding loan balance and related interest receivable exposed to loss as
a result of its involvement in these mezzanine loans totaled $3,266 and
$334, respectively as of September 30, 2004. Noble Investments LLC, the
borrower, has provided the Company with guarantees totaling $300 for the
Atlanta Hilton Garden Inn loan, and $2,186 for the Tampa Hilton Garden Inn
loan, due to deficiencies in the debt service coverage ratios required under
the loans.Baltimore, MD Hampton Inn & Suites Mezzanine Loan:In the fourth quarter of 2002, the Company funded a $3,500 mezzanine loan to
an unrelated third party owner for the purchase and conversion of a historic
office building into a 116-room Hampton Inn & Suites hotel in Baltimore, MDs
Inner Harbor (the Baltimore Hotel). Subsequently, the Company sold 50
percent of the loan to an affiliate of Hall Financial Group at face value, or
$1,750. This mezzanine loan arrangement is considered to be a variable
interest in the entity that owns the hotel, which is a VIE. However, the
Company is
not considered to be the primary beneficiary. Therefore, the
Company does not consolidate the results of operations of the hotel for which
it has provided financing. The Companys total outstanding loan balance and
related interest receivable exposed to loss as a result of its involvement in
this mezzanine loan totaled $1,704 and $372, respectively as of September 30,
2004.Atlantic Beach, NC Sheraton Mezzanine Loan:In February 2004, the Company issued a $2,400 mezzanine loan to partially
finance the acquisition of a 200-room Sheraton Hotel in Atlantic Beach, NC.
This mezzanine loan arrangement is considered to be a variable interest in
the entity that owns the hotel, which is a VIE. However, the Company is not
considered to be the 16




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##### 



primary beneficiary. Therefore, the Company does not
consolidate the results of operations of the hotel for which it has provided
financing. The Companys total outstanding loan balance and related interest
receivable exposed to loss as a result of its involvement in this mezzanine
loan totaled $2,400 and $52, respectively as of September 30, 2004.Cornhusker Square Hotel Loan:In June 2004, the Company and Canyon Capital Realty Advisors (Canyon
Capital), a national lending and real estate investment firm provided a
$16,850 loan to finance the acquisition and major refurbishment and
conversion of the 290-room Cornhusker Square Hotel in Lincoln, NB to a full
service Marriott. Canyon Capital provided $10,850 as the first, or A piece
of the financing, and the Company provided $6,000 as the second, or B
piece. This loan arrangement is considered to be a variable interest in the
entity that owns the hotel, which is a VIE. However, the Company is not
considered to be the primary beneficiary. Therefore, the Company does not
consolidate the results of operations of the hotel for which it has provided
financing. The Companys total outstanding loan balance and related interest
receivable exposed to loss as a result of its involvement in this mezzanine
loan totaled $6,000 and $109, respectively as of September 30, 2004.St. Louis, MO Residence Inn by Marriott Mezzanine Loan:In October 2004, the Company issued a $5,500 mezzanine loan to finance the
construction of a 188-room Residence Inn by Marriott Hotel in St. Louis, MO.
This mezzanine loan arrangement is considered to be a variable interest in
the entity that owns the hotel, which is a VIE. However, the Company is not
considered to be the primary beneficiary. Therefore, the Company does not
consolidate the results of operations of the hotel for which it has provided
financing. The Companys total outstanding loan balance is the amount
exposed to loss.10.
    
    CAPITAL STOCKIn February 2004, the Company completed the issuance of 3.68 million shares
of its 8.00% Series B Cumulative Preferred Stock. The net proceeds raised
totaled approximately $88.9 million, approximately $76.1 million of which
was used to fully redeem the Companys then outstanding 3.0 million shares
of 9.25% Series A Cumulative Preferred Stock plus accrued dividends. The
Company used the remaining proceeds of approximately $12.8 million to pay
down its then outstanding balance under the Line.The costs capitalized as part of the issuance of the Series A Cumulative
Preferred Stock in September 1997 totaled approximately $1,720 as of
February 2004 and have been recorded as a reduction in net income available
to common shareholders for the nine months ended September 30, 2004.11.
    
    DISCONTINUED OPERATIONSThe Company adopted Statement of Financial Accounting Standard No. 144
(SFAS No. 144) effective January 1, 2002 which requires, among other
things, that the operating results of certain real estate assets which have
been sold subsequent to January 1, 2002, or otherwise qualify as held for
disposition (as defined by SFAS No. 144), be included in discontinued
operations in the statements of operations for all periods presented. In
February 2004, the Company sold its 118-room Hampton Inn in Wilmington, NC.
In June
2004, the Company sold its 128-room Hampton Inn in Las Vegas, NV.
During 2003, the Companys Board of Directors authorized management of the
Company to sell the Greenville, SC Comfort Inn, which is classified as held
for sale on the Companys Consolidated Balance Sheet as of September 30,
2004. The property, which is immediately available for sale, is actively
being marketed for sale through a broker. The operating results for these
three hotels are included in discontinued operations in the statements of
operations for the three and nine months ended September 30, 2004 and 2003.
The Company has not allocated interest expense to the results of the
discontinued operations in accordance with EITF No. 87-24. This change has
resulted in certain reclassifications to the three and nine months ended
September 30, 2003 financial statement amounts. 17




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##### 



Condensed financial information of the results of operations for the three
and nine months ended September 30, 2004 and 2003, for the two hotels sold
during 2004 and the one hotel classified as held for sale are included in
discontinued operations as follows: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Total revenue
    
    $
    434
    
    
    $
    1,409
    
    
    $
    2,496
    
    
    $
    3,352Total expenses
    
    
    366
    
    
    
    1,260
    
    
    
    2,166
    
    
    
    2,930Income from operations of discontinued operations
    
    
    68
    
    
    
    149
    
    
    
    330
    
    
    
    422Allocation to minority interest in Partnership -
income
from operations of discontinued operations
    
    
    3
    
    
    
    11
    
    
    
    16
    
    
    
    31Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    Allocation
to minority interest in Partnership - gain
on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    Loss on impairment of asset held for sale
    
    
    (2
    )
    
    
    (2,518
    )
    
    
    (52
    )
    
    
    (2,518
    )Allocation to minority interest in Partnership -
loss on
impairment of asset held for sale
    
    
    
    
    
    
    (152
    )
    
    
    (2
    )
    
    
    (152
    )Income tax expense (benefit)
    
    
    2
    
    
    
    (45
    )
    
    
    (15
    )
    
    
    (98
    )Income (loss) from discontinued operations
    
    $
    61
    
    
    $
    (2,183
    )
    
    $
    294
    
    
    $
    (1,877
    )
  12.
    
    SUBSEQUENT EVENTOn October 5, 2004, the Companys wholly-owned subsidiary, Winston Finance
Partners LLC (Winston Finance), entered into a $50 million master
repurchase agreement with Marathon Structured Finance Fund, LP (Marathon)
to finance the Companys hotel loan investments (assets) on a short-term
basis. Under the agreement, Winston Finance will sell assets to Marathon and
agree to repurchase those assets on a date certain. Typically, the sale and
repurchase price will be no more than 65% of the value of the asset, except
for development and redevelopment assets where the limit is 45% of the asset
value. In general, the repurchase price will equal the original sales price
of the asset plus accrued but unpaid interest. The Company typically will
pay interest to Marathon at LIBOR plus 450 basis points for loans made by the
Company to acquire existing hotels, and LIBOR plus 550 basis points, plus one
percent of the total loan amount as an origination fee, for loans made by the
Company to develop new hotels or redevelop existing hotels. Marathon gets a
security interest in each asset subject to the facility.The repurchase agreement is a $50 million uncommitted lending facility,
meaning Marathon must agree to each asset financed under the agreement. At
no time is the facility allowed to exceed $50 million. The facility
established by the agreement is set to expire on the one year anniversary of
the agreements effective date. The facility, however, may be renewed for
two more successive periods of one year, at the option of Winston Finance, as
long as no events of default are existing at that time. If the value of an
asset financed under the facility decreases, then Marathon can require the
Company to deposit eligible assets, either cash, letters of credit, or
qualified loans, into a margin account as additional collateral for the
facility, or repurchase the asset. Assets can be repurchased by the Company
voluntarily at any time.The Company is required to maintain a liquidity facility that is the greater
of $5,000,000 or six months interest on the amount of the facility that has
been advanced. That liquidity is currently in the form of a letter of credit
made available by our operating partnership, WINN Limited Partnership, but
could be in a combination of a letter of credit and eligible assets pledged
to Marathon.The Company is required to maintain certain routine covenants during the term
of the agreement, including without limitation, providing financial reports
to Marathon, maintaining Winston Finance as a special purpose entity, not
undertaking a merger or other fundamental transaction without Marathons
consent, and maintaining the liquidity pledged to Marathon. The agreements
require that all assets subject to the facility have the related loan
documents delivered to Branch Banking and Trust Company, who holds them as a
custodian so long as the assets are subject to the facility. 18




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Item 2 -
    Managements Discussion and Analysis of FinancialCondition and Results of Operations($ in thousands) Overview Winston Hotels, Inc., (the Company) headquartered in Raleigh, North Carolina,
owns hotel properties and interests in hotel properties through joint ventures,
provides loans to the hotel industry and provides hotel development and asset
management services. All of the Companys hotels are operated under franchises
from nationally recognized franchisors including Marriott International, Inc.,
Hilton Hotels Corporation, Intercontinental Hotels Group PLC (formerly Six
Continents PLC) and Choice Hotels International. The Company conducts
substantially all of its operations through its operating partnership, WINN
Limited Partnership, (the Partnership). The Company operates so as to
qualify as a real estate investment trust (REIT) for federal income tax
purposes. The Companys primary source of revenue is room revenue generated from its
hotel ownership interests. The Company also generates revenue through food and
beverage, telephone, parking, and other hotel sales. Operating expenses
consist of the costs to provide these services as well as corporate general and
administrative costs, real and personal property taxes, property and casualty
insurance costs, depreciation, amortization, and other costs. The Company has
significant fixed-costs associated with owning and operating hotels, which do
not necessarily decrease when circumstances such as market factors cause a
reduction in revenue for the property. As a result, changes in revenue per
available room (RevPAR) can result in a greater percentage change in the
Companys earnings and cash flows. The Company seeks to maximize the value of
its portfolio through aggressive asset management, by directing the managers of
its hotels to increase revenues and reduce operating costs, and by completing
selective capital improvements. The Companys primary growth strategies include improving operations at the
hotels in which it holds an ownership interest, acquiring additional hotels or
ownership interests in hotels through joint ventures, and providing loans to
the hotel industry. The following describes the Companys operations and
investments during the first nine months of 2004 with respect to each of these
strategies. Improve Hotel Operations During the third quarter of 2004, for the Companys wholly owned hotels, not
including those reported as discontinued operations, and the Companys
consolidated joint venture hotels, RevPAR increased 6.5 percent from $54.74 in
the third quarter of 2003 to $58.28. Occupancy rates increased 3.6 percent,
from 69.0 percent to 71.5 percent, and the average daily rate (ADR) increased
2.7 percent from $79.37 to $81.48, during the third quarter of 2004, as
compared to the same period of 2003. The Companys gross operating profit
margins increased to 41.9 percent in the third quarter of 2004 from 41.7
percent in the third quarter of 2003. During the nine months ended September
30, 2004, the Companys RevPAR increased 7.0 percent from $53.10 in 2003 to
$56.80 in 2004. Occupancy rates increased 4.6 percent, from 67.4 percent to
70.5 percent, and the average daily rate (ADR) increased 2.3 percent from
$78.74 to $80.55, during the nine months ended September 30, 2004, as compared
to the same period of 2003. The Companys gross operating profit margins
decreased to 41.7 percent during the nine months ended September 30, 2004 from
41.8 percent during the same period in 2003. The Company expects RevPAR to
increase three to five percent in the fourth quarter of 2004, as compared to
the fourth quarter of 2003. The Company continues to seek to maximize hotel
revenues and reduce operating costs. The Companys franchisors periodically inspect the Companys hotels to ensure
that they meet certain brand standards primarily pertaining to the condition of
the property and its guest service scores. In connection with these routine
reviews, as of June 30, 2004, the Company had received default notices from the
franchisor for two of its hotels. As of September 30, 2004, both of these
properties have been reinspected. One has received an acceptable
rating. The other hotel passed the reinspection for all product improvement
issues, but received an unacceptable rating due to its customer service scores
falling below brand standards. We believe this decline in customer service
scores was due, in part, to the ongoing construction to comply with the brands
product improvement requirements. 19




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##### 



The Company expects to cure this deficiency
to comply with the franchisors standards and expects to receive an acceptable
rating for the hotel. Since June 30, 2004, the Company has received default
notices from the franchisor for two other hotels. The Company is currently in
the process of curing these deficiencies to comply with the franchisors
standards and expects to receive an acceptable rating for both hotels. Acquisitions During the first quarter of 2004, the Company purchased its joint venture
partners ownership interest in both the Evanston, IL Hilton Garden Inn hotel
and the Windsor, CT Hilton Garden Inn hotel (see Note 8 to consolidated
financial statements). During the first quarter of 2004, the Company, Charlesbank, and New Castle
formed a new joint venture entity, WNC Project Company LLC. The joint venture
purchased the Shelton, CT Ramada Plaza hotel which is currently being renovated
and is expected to be converted to a Courtyard by Marriott during the first
quarter of 2005. The expected total cost of the hotel, after renovations, is
$14,000. During the third quarter of 2004, the WCC Project Company LLC, purchased the
West Des Moines, IA Quality Suites hotel which is currently being renovated and
is expected to be converted to a Springhill Suites by Marriott during the
second quarter of 2005. The expected total cost of the hotel, after
renovations, is $7,150. Through its investments in joint ventures, the Company also creates additional
income in the form of asset management fees and/or development fees. The
Company currently earns asset management fees totaling 0.5% of the gross fixed
assets of the hotels owned through its WCC Project Company LLC and WNC Project
Company LLC joint ventures. Hotel Financing In February 2004, the Company issued a $2,400 mezzanine loan to partially
finance the acquisition of a 200-room Sheraton hotel in Atlantic Beach, NC.
The hotel has undergone extensive renovations which were substantially
completed by the second quarter of 2004. In June 2004, the Company and Canyon Capital Realty Advisors (Canyon
Capital), a national lending and real estate investment firm, provided a
$16,850 loan to finance the acquisition, major refurbishment, and conversion of
the 290-room Cornhusker Square Hotel in Lincoln, NB. The hotel will remain
open during the renovation and is expected to convert to a full-service
Marriott during the first quarter of 2005. Canyon Capital provided $10,850 as
the first, or A piece of the financing, and the Company provided $6,000 as
the second, or B piece. The Companys B piece of the loan is subordinate to
Canyon Capitals A piece. In October 2004, the Company issued a $5,500 mezzanine loan to finance the
construction of a 188-room Residence Inn by Marriott Hotel in St. Louis, MO.
The hotel is expected to open in the first quarter of 2006. These hotel loans
support the Companys strategy to provide additional financing to the hotel
industry. Off-Balance Sheet Arrangements The Companys off-balance sheet arrangements consist primarily of its ownership
interest in its joint venture with Charlesbank Capital Partners, LLC
(Charlesbank). For a further discussion of this joint venture, and its
effect on the Companys financial condition, results of operations and cash
flow, see Critical Accounting Policies  Accounting for Joint Ventures,
Liquidity and Capital Resources, and Note 9 to the consolidated financial
statements, Recent Accounting Pronouncements. 20




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##### 



Critical Accounting Policies The Companys discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States of America. The preparation of these financial statements
requires the Companys management to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. The Company believes the following critical accounting policies reflect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements. Accounts and Notes Receivable The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its hotel guests and mezzanine loan borrowers
to make required payments. If the financial condition of its hotel guests,
mezzanine loan borrowers and other borrowers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances may be
required. Accounting for Joint Ventures As of September 30, 2004, the Company had a 15 percent ownership interest in
its Charlesbank joint venture, (which owned an 87 percent ownership interest in
the WCC Project Company LLC joint venture and an 87 percent ownership interest
in the WNC Project Company LLC joint venture, resulting in an indirect 13.05
percent ownership interest by the Company in the five hotels owned by these
joint ventures), a 49 percent ownership interest in its Marsh Landing joint
venture, which owns one hotel, and a 48.78 percent interest in the Chapel Hill
joint venture, which owns one hotel. The WCC Project Company LLC joint venture
owns four hotels and the WNC Project Company LLC joint venture owns one hotel. Per the provisions of FASB Interpretation No. 46, Consolidation of Variable
Interest Entities (FIN 46), the Company determined that the Charlesbank
joint venture does not have to be consolidated and therefore, the Company used
the equity method to recognize its share of net income or loss from this joint
venture during the three and nine months ended September 30, 2004 and adjusted
the carrying value of its investment accordingly. Accordingly, the joint
ventures assets, liabilities, and equity are not recorded on the Companys
balance sheet as of September 30, 2004. The Company determined that the Marsh Landing joint venture is considered to be
a VIE and the Company is considered to be the primary beneficiary. Therefore,
per the provisions of FIN 46, the Company has consolidated the assets and
liabilities of this joint venture into its Consolidated Balance Sheet beginning
as of December 31, 2003, and has consolidated the results of operations
beginning with the first quarter of 2004. The Chapel Hill joint venture was
created in August 2003 and is also considered to be a VIE and the Company is
considered to be the primary beneficiary. Therefore, per FIN 46, the Company
has consolidated the joint ventures assets, liabilities, and results of
operations beginning with the third quarter 2003. Accounting for Long-Lived Assets The Company evaluates the potential impairment of its individual long-lived
assets, principally its wholly owned hotel properties and the hotel properties
in which it owns an interest through consolidated joint ventures in accordance
with FASB No. 144 Accounting for the Impairment or Disposal of Long-Lived
Assets. The Company records an impairment charge when it believes an
investment in a hotel has been impaired, such that the Companys estimate of
future undiscounted cash flows, together with its estimate of an anticipated
liquidation amount, would not recover the then current carrying value of the
investment in the hotel property, or when the Company classifies a property as
held for sale and the carrying value exceeds fair market value. The Company
considers many factors and makes certain subjective assumptions when making
this assessment, including but not limited to, general market 21




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##### 



and economic
conditions, operating results over the past several years, the performance of
similar properties in the same market and expected future operating results
based on a variety of assumptions. Future adverse changes in market conditions
or poor operating results of underlying investments could result in losses or
an inability to recover the carrying value of the investments, thereby possibly
requiring an impairment charge in the future. In addition, if the Companys
assumptions regarding future undiscounted cash flows and anticipated
liquidation amounts are
incorrect, a future impairment charge may be required. Further, the Company
currently owns certain hotels for which the carrying value exceeds current
market value. The Company does not believe an impairment charge for these
hotels is appropriate since the Companys forecast of future undiscounted cash
flows, including an anticipated liquidation amount, exceeds the current
carrying value. However, should the Company approve of a plan to sell these
properties, an impairment charge would be required. Income Taxes The Company records a valuation allowance to reduce the deferred tax assets to
an amount that it believes is more likely than not to be realized. Because of
expected future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for the valuation allowance, the Company has
not recorded a valuation allowance to reduce its deferred tax asset as of
September 30, 2004. Should our estimate of future taxable income be less than
expected, or our tax planning strategy not be carried out as planned, we would
record an adjustment to the deferred tax asset in the period such determination
was made. Results of Operations Actual Three and Nine Months Ended September 30, 2004 versus Actual Three and
Nine Months Ended September 30, 2003 REVENUE Room For the three months ended September 30, room revenue increased $3,802
from $29,473 in 2003 to $33,275 in 2004. On January 1, 2004, per the
provisions of FIN 46, the Company began consolidating the operating results of
the Windsor Hilton Garden Inn; and on March 11, 2004, the Company acquired the
lease for the Secaucus Holiday Inn (collectively the Windsor and Secaucus
hotels) and began recording the operating results of the hotel. Room revenue
from these hotels totaled $2,142 for the three months ended September 30, 2004.
In addition, the increase in room revenues is due, in part, to an increase in
RevPAR of 6.5 percent, from $54.74 to $58.28. Occupancy rates increased 3.6
percent, from 69.0 percent to 71.5 percent, and the ADR increased 2.7 percent
from $79.37 to $81.48. For the nine months ended September 30, room revenue increased $11,180 from
$84,606 in 2003 to $95,786 in 2004. Additional room revenue from consolidating
the operating results of the Windsor and Secaucus hotels totaled $5,500 for the
nine months ended September 30, 2004. In addition, the increase in room
revenues is due, in part, to an increase in RevPAR of 7.0 percent, from $53.10
to $56.80. Occupancy rates increased 4.6 percent, from 67.4 percent to 70.5
percent, and the ADR increased 2.3 percent from $78.74 to $80.55. Food and Beverage For the three months ended September 30, food and beverage
revenue increased $595 from $1,640 in 2003 to $2,235 in 2004. For the nine
months ended September 30, food and beverage revenue increased $1,327 from
$5,287 in 2003 to $6,614 in 2004. Additional food and beverage revenue from
consolidating the operating results of the Windsor and Secaucus hotels totaled
$374 and $1,007 for the three and nine months ended September 30, 2004,
respectively. The additional increases in food and beverage revenues are due,
in part, to increased occupancy experienced at the Companys full service
properties. Other Operating Departments Other operating departments revenue remained
consistent with the prior year period for both the three and nine months ended
September 30, 2004. Meeting room rentals increased slightly, offset by lower
telephone revenue as cellular phone use continues to reduce the demand for this
service. 22




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##### 



Percentage Lease Revenue For the three months ended September 30, percentage
lease revenue declined $535 from $535 in 2003 to $0 in 2004. For the nine
months ended September 30, percentage lease revenue declined $902 from $1,603
in 2003 to $701 in 2004. In March 2004, the Company negotiated the transfer of
the long-term lease with Secaucus Holding Corporation, a wholly owned
subsidiary of Prime Hospitality Corp. (Prime), for the Secaucus, NJ Holiday
Inn to Barclay. The Company received a net payment from Prime of $269 as part
of the negotiated settlement. This amount is included in percentage lease
revenue in the accompanying unaudited consolidated statement of operations for
the nine months ended September 30, 2004. Alliance manages the hotel. With
the transfer of this lease to Barclay, the Company is no longer the lessor of
any hotel leases with unrelated third parties. Therefore, unless the Company
enters into third party hotel leases, as the lessor, in the future, the Company
will not report percentage lease revenue in the future. EXPENSES Rooms For the three months ended September 30, rooms expenses increased $684
from $6,821 in 2003 to $7,505 in 2004. For the nine months ended September 30,
rooms expenses increased $1,930 from $19,460 in 2003 to $21,390 in 2004.
Additional rooms expense from consolidating the operating results of the
Windsor and Secaucus hotels totaled $511 and $1,238 for the three and nine
months ended September 30, 2004, respectively. The additional increases in
rooms expenses are due, in part, to increases in labor costs, travel agent
commissions and complimentary food and beverage costs, and are consistent with
the increases in room revenue for the three and nine months ended September 30,
2004 versus the three and nine months ended September 30, 2003. Food and Beverage For the three months ended September 30, food and beverage
expenses increased $363 from $1,337 in 2003 to $1,700 in 2004. For the nine
months ended September 30, food and beverage expenses increased $867 from
$4,053 in 2003 to $4,920 in 2004. The increases in food and beverage expenses
are consistent with the increases in food and beverage revenues. Property Operating Costs For the three months ended September 30, property
operating costs increased $955 from $6,360 in 2003 to $7,315 in 2004. For the
nine months ended September 30, property operating costs increased $3,341 from
$18,209 in 2003 to $21,550 in 2004. These costs consist of administrative and
general, sales and marketing, utility and other costs. The increases are
primarily due to increases in administrative and general and sales and
marketing labor costs, printing costs, utility costs, telecommunication costs,
promotions costs, frequent flier program costs and credit card commissions.
Additional property operating costs from consolidating the operating results of
the Windsor and Secaucus hotels totaled $617 and $1,572 for the three and nine
months ended September 30, 2004, respectively. Real Estate Taxes and Property and Casualty Insurance Real estate taxes and
property insurance costs remained consistent with the prior year period for
both the three and nine months ended September 30, 2004. Decreases in
insurance costs were offset by increases in real estate taxes. Franchise Costs Franchise costs increased consistent with the increase in
room revenues, increasing $255 for the three months ended the September 30,
from $2,122 in 2003 to $2,377 in 2004, and $823 for the nine months ended
September 30, from $6,038 in 2003 to $6,861 in 2004. Maintenance and Repair Costs For the three months ended September 30,
maintenance and repair costs increased $228 from $1,688 in 2003 to $1,916 in
2004 and for the nine months ended September 30, increased $662 from $4,928 in
2003 to $5,590 in 2004. Additional maintenance and repair costs from
consolidating the operating results of the Windsor and Secaucus hotels totaled
$109 and $285 for the three and nine months ended September 30, 2004,
respectively. The additional increases are due, in part, to increases in labor
costs and landscaping charges. Management Fees Management fees increased consistent with the increase in
hotel revenues for both the three and nine months ended September 30,
increasing $72 for the three months ended September 30, from $720 in 2003 to
$792 in 2004 and $416 for the nine months ended September 30, from $1,972 in
2003 to $2,388 in 2004. 23




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##### 



General and Administrative For the three months ended September 30, general
and administrative expense increased $1,054 from $1,095 in 2003 to $2,149 in
2004. The increase is primarily attributable to an increase in accounting
fees, mainly associated with the Companys efforts to comply with the
provisions of the Sarbanes-Oxley Act of 2002, payroll costs, legal fees, costs
associated with acquisitions and mezzanine loans and start-up expenses for the
Chapel Hill Courtyard. For the nine months ended September 30, general and
administrative expense increased $1,240 from $4,050 in 2003 to $5,290 in 2004.
The increase is primarily attributable to an increase in accounting fees,
mainly associated with the Companys efforts to comply with the provisions of
the Sarbanes-Oxley Act of 2002, payroll costs, legal fees and start-up expenses
for the Chapel Hill Courtyard. Depreciation and Amortization For the three and nine months ended September
30, 2004 depreciation expense remained consistent with the prior year periods.
Increases in depreciation expense due to the consolidation of the Ponte Vedra,
FL Hampton Inn, the Windsor CT Hilton Garden Inn, and the Evanston, IL Hilton
Garden Inn (see Note 8 to Notes to Consolidated Financial Statements), were
offset by a decrease in depreciation due to certain five-year assets exceeding
their useful lives. For the three and nine months ended September 30, 2004
versus comparable
periods for 2003, amortization expense increased $107 and $325, respectively,
due to the amortization of costs paid in 2003 to amend the Companys $125
million line of credit (the Line). Interest and Other Income For the three and nine months ended September 30,
2004 versus comparable periods for 2003, interest and other income increased
$274 and $449, respectively. The increases are primarily due to additional
loan interest income relating to the Atlantic Beach and Cornhusker loans. The
Company continues its efforts to expand its hotel lending program. Interest Expense For the three months ended September 30, interest expense
decreased $187 from $1,883 in 2003 to $1,696 in 2004. The decrease is due to a
decline in weighted average outstanding debt balances for the Line and the
Companys fixed rate loan with GE Capital Corporation, (collectively, the
Corporate Debt Facilities) offset by an increase in the weighted average
interest rates for the Corporate Debt Facilities and the consolidation of the
Evanston, Windsor and Marsh Landing Joint Ventures per FIN 46 beginning with
the first quarter of 2004 of $192. For the three months ended September 30,
the weighted average outstanding debt balance for the Corporate Debt Facilities
decreased from $141,244 in 2003 to $99,889 in 2004, while the weighted average
interest rate for the Corporate Debt Facilities increased from 5.21 percent to
5.89 percent for the same periods. For the nine months ended September 30, interest expense decreased $658 from
$5,758 in 2003 to $5,100 in 2004. The decrease is due to a decline in weighted
average outstanding debt balances for the Corporate Debt Facilities offset by
an increase in the weighted average interest rates for the Corporate Debt
Facilities and the consolidation of the Evanston, Windsor and Marsh Landing
Joint Ventures per FIN 46 beginning with the first quarter of 2004 of $595.
The weighted average outstanding debt balance for the Corporate Debt Facilities
decreased from $142,645 for the nine months ended September 30, 2003 to
$101,383 for the nine months ended September 30, 2004, while the weighted
average interest rate for the Corporate Debt Facilities increased from 5.32
percent to 5.84 percent for the same periods. The Company expects interest
expense to increase in the fourth quarter of this year, as compared to the
third quarter of 2004, due to additional capital investments for acquisitions
and hotel loans and due to expected increases in interest rates. Income Allocation to Minority Interest in Partnership Income allocation to
minority interest in Partnership increased for both the three months and nine
months ended September 30, 2004 versus comparable periods for 2003. The
increases are consistent with the increase in net income for the periods offset
by a decrease in minority interest ownership percentage in the Partnership from
4.86% as of September 30, 2003 to 4.69% as of September 30, 2004. Income Allocation to Minority Interest in Consolidated Joint Ventures These
amounts represent the minority interest shareholders share of net income of
the consolidated joint ventures. The Company began consolidating the Chapel
Hill joint venture in the third quarter of 2003 and the Ponte Vedra, Evanston
and Windsor joint ventures in the first quarter of 2004 (see Note 8 to
consolidated financial statements regarding the Companys acquisition in 2004
of its partners equity interest in the Windsor and Evanston joint ventures). 24




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##### 



Income Tax Benefit For the three and nine months ended September 30, 2004 and
2003, the income tax benefit is a result of the net loss experienced by Barclay
during the respective periods. The Company expects Barclay to continue to
experience net losses for the remainder of 2004. Discontinued Operations The Company sold the Wilmington Hampton Inn in
February 2004 and sold the Las Vegas Hampton Inn in June 2004. The Company
classified the Greenville, SC Comfort Inn as held for sale during the third
quarter of 2003. All capital additions to the Greenville, SC Comfort Inn are
recorded as loss on impairment of asset held for sale, as the Company recorded
an impairment charge in the third quarter of 2003 to reduce this asset to its
estimated fair market value of $2,100. The operating results of the three
properties are shown as discontinued operations in the respective periods. Liquidity and Capital Resources The Company finances its operations from operating cash flow, which was
principally derived from the operations of its hotels. For the nine months
ended September 30, 2004 and 2003, cash flow provided by operating activities
was $29,558 and $19,924, respectively. The increase is primarily due to the
increase in net income. Under federal income tax law provisions applicable to REITs, the Company is
required to distribute at least 90% of its taxable income to maintain its tax
status as a REIT. During the first three quarters of 2004, the Company
declared distributions of $11,863 to its common shareholders ($0.45 per share)
and $5,475 to its preferred shareholders ($0.353 per share of Preferred Series
A and $1.20 per share of Preferred Series B). The Company intends to monitor
its dividend policy closely and to act accordingly as results of operations
dictate. The Company also intends to fund cash distributions to shareholders
out of cash flow from operating activities. The Company may incur indebtedness
to meet its dividend policy or distribution requirements imposed on the Company
under the Internal Revenue Code (including the requirement that a REIT
distribute to its shareholders annually at least 90% of its taxable income) to
the extent that available cash flow from the Companys investments are
insufficient to make such distributions. In February 2004, the Company completed the issuance of 3,680,000 shares of its
8.00% Series B Cumulative Preferred Stock. The net proceeds raised totaled
approximately $88.9 million, approximately $76.1 million of which was used to
fully redeem the Companys then outstanding 3,000,000 shares of 9.25% Series A
Cumulative Preferred Stock plus accrued dividends. The Company used the
remaining proceeds of approximately $12.8 million to pay down its then
outstanding balance under the Line. The total cost capitalized as part of the issuance of the Series A Cumulative
Preferred Stock in September 1997 totaled approximately $1.7 million as of
February 2004 and was recorded as a reduction in net income available to common
shareholders in the first quarter of 2004. The Companys net cash used in investing activities for the nine months ended
September 30, 2004 totaled $24,128. Gross capital expenditures for the
Companys consolidated hotels totaled $17,022. This amount includes capital
expenditures of $8,934 for the Companys wholly owned hotels as of September
30, 2004, and $8,088 for the Companys consolidated joint venture hotels,
$8,041 of which was for the development of the Courtyard by Marriott hotel in
Chapel Hill, NC. This hotel opened in September of 2004. During the first
quarter of 2004, the Company purchased its joint venture partners ownership
interest in both the Evanston and Windsor joint ventures. The total purchase
price of $8,163 exceeded the joint venture partners combined equity balance of
$6,315. This additional purchase price was recorded as a capital addition
during the first quarter of 2004. During the first nine months of 2004, the Company incurred capital expenditures
totaling $8.9 million to refurbish and renovate its wholly owned hotels, and
plans to spend approximately $1,100 to renovate certain of its wholly owned
hotels during the remainder of 2004. These expected total capital expenditures
for 2004 exceed by approximately $3,500 the 5% of room revenues for its hotels
(7% of room revenues and food and beverage revenues for one of its full-service
hotels) which the Company is required to spend under its percentage leases for
periodic capital improvements and the refurbishment and replacement of
furniture, fixtures and equipment at its wholly owned hotels. The Company also
plans to spend an additional $2,500 to continue to finalize the development of
the 25




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##### 



Courtyard by Marriott hotel in Chapel Hill, NC during the fourth quarter of
2004. These capital expenditures are funded from operating cash flow, and
possibly from borrowings under the Line, sources that are expected to be
adequate to fund such capital requirements. These capital expenditures are in
addition to amounts spent on normal repairs and maintenance which have
approximated 5.9% and 5.8% of room revenues for the nine months ended September
30, 2004 and 2003, respectively. During 2003, the Companys Board of Directors authorized management of the
Company to sell the Greenville, SC Comfort Inn, which is classified as held
for sale on the Companys Consolidated Balance Sheet as of September 30, 2004
in accordance with FASB No. 144 Accounting for the Impairment or Disposal of
Long-Lived Assets. The property, which is immediately available for sale, is
actively being marketed for sale through a broker. The Company sold the
Wilmington, NC Hampton Inn in February of 2004. The total net proceeds were
$3,350. The Company also sold the Las Vegas, NV Hampton Inn in June of 2004.
The total net proceeds were $7,183. Periodically, the Company considers the
sale of certain other hotels that the Company believes appropriate to sell and
if sold, would use the net sale proceeds for general corporate purposes. Hotel Loans In October 2004, the Company issued a $5,500 mezzanine loan to finance the
construction of a 188-room Residence Inn by Marriott Hotel in St. Louis, MO.
The term of the loan is 5 years. The loan requires interest only payments
during construction and throughout the first two years of operations, and
principle payments beginning on the first day of the third year of operations,
based on a 10-year amortization schedule. Throughout the term of the loan, the
interest rate is based on 30-day LIBOR plus 10.25 percent. An additional 3.00
percent per year of the outstanding
principal balance accrues until the earlier of prepayment or maturity of the
loan. The hotel is owned 100% by an unaffiliated single purpose entity (the
Borrower). The Company holds collateral equal to 100% of the ownership
interest in the Borrower. In June 2004, the Company and Canyon Capital Realty Advisors (Canyon
Capital), a national lending and real estate investment firm, provided $16,850
(the Loan) to finance the acquisition, major refurbishment, and conversion of
the 290-room Cornhusker Square Hotel in Lincoln, NB. The hotel will remain
open during the renovation and convert to a full-service Marriott during the
first quarter of 2005. Canyon Capital provided $10,850 as the first, or A
piece of the financing, and the Company provided $6,000 as the second, or B
piece. The Companys B piece of the Loan is subordinate to Canyon Capitals A
piece. The term of the Loan is 2 years, plus a one-year extension at the
borrowers election. The Loan plus any accrued interest requires interest only
payments of 10 percent. Canyon Capital retains 10.24 percent of the interest
paid on the A piece of the Loan with the remainder paid to the Company.
Additional interest of 1.5 percent of the Loan accrues to the Company until the
earlier of prepayment of the Loan or maturity of the Loan. The hotel is owned
100% by an unaffiliated single purpose entity. The Companys B piece of the
Loan is collateralized by the second interest in the real estate complex. In February 2004, the Company issued a $2,400 mezzanine loan to partially
finance the acquisition of a 200-room Sheraton hotel in Atlantic Beach, NC.
The hotel has undergone extensive renovations which were substantially
completed by the second quarter of 2004. The term of the loan is 5 years, with
interest only payments that carry an interest rate based on 60-day LIBOR (with
a 2.0% floor) plus 9.00 percent. An additional 2.00 percent per year of the
outstanding principal balance accrues until the earlier of prepayment or
maturity of the loan. The hotel is owned 100% by an unaffiliated single
purpose entity (the Borrower). The Company holds collateral equal to 100% of
the ownership interest in the Borrower. The Company has issued three other hotel loans, a $1,750 loan to partially
finance the 116-room Hampton Inn & Suites in Baltimore, MD, a $1,080 loan to
partially finance the 122-room Hilton Garden Inn in Atlanta, GA and a $2,186
loan to partially finance the 152-room Hilton Garden Inn in Tampa, FL. Noble
Investments LLC, the borrower, has provided the Company with guarantees
totaling $300 for the Atlanta Hilton Garden Inn loan, and $2,186 for the Tampa
Hilton Garden Inn loan, due to deficiencies in the debt service coverage ratios
required under the loans. One of the Companys primary growth strategies is
the issuance of hotel loans to third party hotel owners. The Company is
continually looking for these opportunities. 26




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##### 



Joint Ventures The Company currently has investments in four joint ventures:  
    
    The Company owns 49 percent of the Marsh Landing joint venture that
owns the 118-room Hampton Inn in Ponte Vedra, FL.
    
    The Company owns an indirect 13.05 percent interest in the WCC Project
Company LLC joint venture that owns four hotels, the 102-room
Fairfield Inn & Suites in West Des Moines, IA, the 113-room Courtyard
by Marriott in Beachwood, OH, the 190-room Springhill Suites by
Marriott in Houston, TX, and the 95-room Quality Suites in West Des
Moines, IA that is in the process of being renovated and is expected
to be converted to a Springhill Suites by Marriott during the second
quarter of 2005.
    
    The Company owns an indirect 13.05 percent interest in the WNC Project
Company LLC joint venture that owns one hotel, the 158-room Ramada
Plaza Hotel in Shelton, CT that is in the process of being renovated
and is expected to be converted to a Courtyard by Marriott during the
first quarter of 2005.
    
    The Company owns 48.78 percent of the Chapel Hill joint venture that
owns a 147-room Courtyard by Marriott in Chapel Hill, NC that opened
in September of 2004. One of the Companys primary growth strategies is the acquisition or
development of additional hotels. The Company is continually looking for
acquisition or development opportunities to either wholly own additional hotels
or to own additional interests in hotels through joint ventures. Under the
terms of the joint ventures, the Company has provided property development and
purchasing services and will continue to provide ongoing asset management
services for additional fees. The Company also receives cash distributions of
the joint ventures operating profits, if
any, on a quarterly basis. The Company has consolidated the results of
operations of the Marsh Landing and Chapel Hill joint ventures for the nine
months ended September 30, 2004, while the results of operations of the WCC
Project Company and WNC Project Company joint ventures were not consolidated.
See Notes 8 and 9 in Notes to Consolidated Financial Statements for more
information. The Companys net cash used in financing activities during the nine months
ended September 30, 2004 totaled $5,988. This amount included net proceeds of
$88,794 as a result of the issuance of 3,680,000 shares of Series B Preferred
Stock, of which the Company used $75,000 to redeem the 3,000,000 shares of
Series A Preferred stock and $1,059 to pay the accrued dividends. The net cash
used in financing activities for the nine months ended September 30, 2004 also
included the payment of additional distributions to shareholders of $16,154,
the payment of distributions to the Partnerships minority interest of $585,
the payment of distributions to consolidated joint ventures minority interest
of $738, net long-term debt payments of $4,772, and a net increase of $3,800 in
the outstanding balance under the Line from $29,200 at December 31, 2003 to
$33,000 at September 30, 2004. The Companys availability under the Line totaled approximately $80,600 as of
September 30, 2004. Availability is calculated each quarter on a trailing
twelve-month basis based upon certain valuation criteria contained within the
Line documents. The Line requires the Company to maintain certain financial
ratios including maximum leverage, minimum interest coverage and minimum fixed
charge coverage, as well as certain levels of unsecured and secured debt and
tangible net worth, all of which the Company was in compliance with as of
September 30, 2004. The failure to comply with any of these covenants would
cause a default under the Line. Furthermore, the Line provides that any default
under, or acceleration of, any of our other debt, any debt of the Partnership
or any debt of our subsidiaries, including any default under its GECC
fixed-rate loan or otherwise, will constitute a default under the Line. Any of
these defaults, if not waived, could result in the acceleration of the
indebtedness under the Line. If this occurs, the Company may not be able to
repay its debt or borrow sufficient funds to refinance it, in which case the
Company would not be able to make distributions to shareholders. The Line
bears interest generally at rates from 30-day LIBOR plus 1.75% to 30-day LIBOR
plus 2.50%, based on the Companys consolidated debt leverage ratio as of the
end of each previous calendar quarter. The Companys interest rate as of
September 30, 2004 was 30-day LIBOR (1.84% as of September 30, 2004) plus
1.75%. The Companys interest rate beginning October 1, 2004 and for the third
quarter 27




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##### 



remained at 30-day LIBOR plus 1.75%. The Company is currently negotiating with lenders to refinance the debt outstanding under the Line upon maturity in December 2004. It is the Companys expectation that the debt outstanding under the Line at that time will be refinanced at market terms. The Company had $63,931 in debt at September 30, 2004 that was subject to a fixed interest rate and fixed monthly payments with GE Capital Corporation. This debt, a ten-year loan with a 25-year amortization period, carries an interest rate of 7.375%. All unpaid principal and interest payments are due on December 1, 2008. Forty-two of the Companys wholly owned hotels have been pledged as collateral for the Companys debt securities, 28 against the outstanding balance under the Line and 14 against the outstanding balance under the GE Capital loan. As of September 30, 2004, the Companys contractual obligations and commitments (excluding obligations and commitments pursuant to the Companys unconsolidated joint ventures) were as follows: Payments by PeriodLess Than
    
    
    
    
    
    
    
    
    
    More ThanContractual Obligations
    
    Total
    
    1 Year
    
    1 - 3 Years
    
    3 - 5 Years
    
    5 YearsLong-term debt
    
    $
    75,581
    
    
    $
    1,806
    
    
    $
    4,030
    
    
    $
    59,481
    
    
    $
    10,264Long-term debt of consolidated JVs
    
    
    10,931
    
    
    
    6,159
    
    
    
    188
    
    
    
    223
    
    
    
    4,361Corporate office lease
    
    
    1,840
    
    
    
    
    
    
    
    748
    
    
    
    813
    
    
    
    279Total contractual obligations
    
    $
    88,352
    
    
    $
    7,965
    
    
    $
    4,966
    
    
    $
    60,517
    
    
    $
    14,904
 Less Than
    
    
    
    
    
    
    
    
    
    More ThanOther Commercial Commitments
    
    Total
    
    1 Year
    
    1 - 3 Years
    
    3 - 5 Years
    
    5 YearsLine of credit
    
    
    33,000
    
    
    
    33,000
    
    
    
    
    
    
    
    
    
    
    
    Total other commercial commitments
    
    $
    33,000
    
    
    $
    33,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
 The Company intends to continue to seek additional hotel loan opportunities and
to acquire and develop additional hotel properties that meet its investment
criteria and is continually evaluating such opportunities. It is expected that
future hotel loans and hotel acquisitions would be financed, in whole or in
part, from additional follow-on common stock offerings, from borrowings under
the Line, through joint venture agreements, from the net sale proceeds of hotel
properties and/or from the issuance of other debt or equity securities. There
can be no assurances that the Company will make any further hotel loans or any
investment in additional hotel properties, or that any hotel development will
be undertaken, or if commenced, that it will be completed on schedule or on
budget. Further, there can be no assurances that the Company will be able to
obtain any additional financing. Recent Developments On October 5, 2004, the Companys wholly-owned subsidiary, Winston Finance
Partners LLC (Winston Finance), entered into a $50 million master repurchase
agreement with Marathon Structured Finance Fund, LP (Marathon) to finance the
Companys hotel loan investments (assets) on a short-term basis. Under the
agreement, Winston Finance will sell assets to Marathon and agree to repurchase
those assets on a date certain. Typically, the sale and repurchase price will
be no more than 65% of the value of the asset, except for development and
redevelopment assets where the limit is 45% of the asset value. In general,
the repurchase price will equal the original sales price of the asset plus
accrued but unpaid interest. The Company typically will pay interest to
Marathon at LIBOR plus 450 basis points for loans made by us to acquire
existing hotels, and LIBOR plus 550 basis points, plus one percent of the total
loan amount as an origination fee, for loans made by the Company to develop new
hotels or redevelop existing hotels. Marathon gets a security interest in
each asset subject to the facility (see Note 12 to Notes to Consolidated
Financial Statements). 28




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##### 



Seasonality The hotels operations historically have been seasonal in nature, reflecting
higher occupancy during the second and third quarters. This seasonality can be
expected to cause fluctuations in the Companys quarterly operating profits.
To the extent that cash flow from operations is insufficient during any
quarter, due to temporary or seasonal fluctuations in revenue, the Company
expects to utilize cash on hand or borrowings under the Line to make
distributions to the equity holders. Funds From Operations The Company reports FFO in accordance with the definition of the National
Association of Real Estate Investment Trusts (NAREIT). NAREIT defines FFO as
net income (loss) (determined in accordance with generally accepted accounting
principles, or GAAP), excluding gains (losses) from sales of property, plus
depreciation and amortization and after adjustments for unconsolidated
partnerships and joint ventures (which are calculated to reflect FFO on the
same basis). The Company further subtracts preferred stock dividends from FFO
to calculate FFO available to common shareholders. FFO available to common
shareholders is a performance measure used by the Company in its budgeting and
forecasting models, it is discussed during Board meetings, and is considered
when making decisions regarding acquisitions, sales of properties, and other
investments. Actual results are compared to budget and forecast on a monthly
basis. The calculation of FFO and FFO available to common shareholders may vary
from entity to entity, and as such the presentation of FFO and FFO available to
common shareholders by the Company may not be comparable to other similarly
titled measures of other reporting companies. FFO and FFO available to common
shareholders are not intended to represent cash flows for the
period. FFO and FFO available to common shareholders have not been presented as
an alternative to operating income, and should not be considered in isolation
or as a substitute for measures of performance prepared in accordance with
GAAP. FFO is a supplemental industry-wide measure of REIT operating performance, the
definition of which was first proposed by NAREIT in 1991 (and clarified in
1995, 1999 and 2002) in response to perceived drawbacks associated with net
income under GAAP as applied to REITs. Since the introduction of the
definition by NAREIT, the term has come to be widely used by REITs. Historical
cost accounting for real estate assets implicitly assumes that the value of
real estate assets diminishes predictably over time. Since real estate values
instead have historically risen or fallen with market conditions, most industry
investors have considered presentations of operating results for real estate
companies that use historical GAAP cost accounting to be insufficient by
themselves. Accordingly, the Company believes FFO and FFO available to common
shareholders (combined with the Companys primary GAAP presentations required
by the SEC) help improve our investors ability to understand the Companys
operating performance. The Company only uses FFO available to common
shareholders as a supplemental measure of operating performance. Shown below
is a reconciliation of net income to FFO and FFO available to common
shareholders. 29




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##### 



WINSTON HOTELS, INC.
Reconciliation of Net Income to FFO and FFO Available to Common Shareholders
For the Three and Nine Months Ended September 30, 2004 and 2003
(in thousands) Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    4,903
    
    
    $
    1,100
    
    
    $
    14,181
    
    
    $
    6,030Gain on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    (16
    )
    
    
    Minority interest in Partnership allocation of income
    
    
    148
    
    
    
    119
    
    
    
    329
    
    
    
    193Minority interest in Partnership allocation of gain
on sale of discontinued operations
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    Minority interest in Partnership allocation of
earnings from discontinued operations
    
    
    3
    
    
    
    11
    
    
    
    16
    
    
    
    31Depreciation
    
    
    4,359
    
    
    
    4,149
    
    
    
    12,808
    
    
    
    12,981Depreciation from discontinued operations
    
    
    
    
    
    
    208
    
    
    
    192
    
    
    
    646Depreciation from joint ventures
    
    
    103
    
    
    
    219
    
    
    
    411
    
    
    
    617FFO
    
    
    9,516
    
    
    
    5,806
    
    
    
    27,922
    
    
    
    20,498Preferred stock dividend
    
    
    (1,840
    )
    
    
    (1,734
    )
    
    
    (5,475
    )
    
    
    (5,203
    )Loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    
    
    
    
    (1,720
    )
    
    
    FFO Available to Common Shareholders
    
    $
    7,676
    
    
    $
    4,072
    
    
    $
    20,727
    
    
    $
    15,295
 Forward Looking Statements This report contains certain forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. You can identify these statements
by use of words like guidance, project, target, may, will, expect,
anticipate, estimate, believes, continue or similar expressions. These
statements represent the Companys judgment and are subject to risks and
uncertainties that could cause actual operating results to differ materially
from those expressed or implied
in the forward looking statements, including but not limited to the following
risks: changes in general economic conditions, properties held for sale will
not sell, financing risks including the inability to obtain financing on
favorable terms, if at all, development risks including the risks of
construction delays and cost overruns, lower than expected RevPAR, occupancy,
average daily rates, and gross operating margins, non-issuance or delay of
issuance of governmental permits, zoning restrictions, the increase of
development costs in connection with projects that are not pursued to
completion, non-payment of hotel loans made to third parties, the failure to
make additional hotel loans and investments in non-distressed and distressed
hotel assets, the failure to attract joint venture opportunities and other risk
factors described in Exhibit 99.1 to the Companys Annual Report on Form 10-K
for the year ended December 31, 2003. 
 Item 3  Quantitative and Qualitative Disclosures About Market Risk ($ in thousands) As of September 30, 2004, the Companys exposure to market risk for a change in
interest rates related to its debt outstanding under the Line, its debt
outstanding under its permanent loan facility, its debt from consolidated joint
ventures, and its interest receivable from mezzanine loans. Debt outstanding
under the Line totaled $33,000 at September 30, 2004. The Line, which expires
in December 2004, bears interest generally at rates from 30-day LIBOR plus
1.75% to 30-day LIBOR plus 2.50%, based on the Companys consolidated debt
leverage ratio. The Companys current interest rate is 30-day LIBOR plus
1.75%. On January 31, 2003, the Company completed an interest rate swap on
$50,000 of its outstanding variable rate debt under the Line. This swap began
on March 31, 30




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##### 



2003 and matured on February 27, 2004. This transaction
effectively replaced the Companys variable interest rate based on 30-day LIBOR
on $50,000 of the Line with a fixed interest rate of 1.505%. The differential
paid or received on the interest rate swap was recognized as an adjustment to
interest expense over the life of the swap. The weighted average interest rate
on the Line for the nine months ended September 30, 2004 was 3.62%. At
September 30, 2004, the Company had $33,000 of variable rate debt outstanding
under the Line that was exposed to fluctuations in the market rate of interest,
as compared to $0 of variable rate debt outstanding under the Line that was
exposed to fluctuations in the market rate of interest as of December 31, 2003.
During February 2004, the Company purchased Regents ownership interest in the
Evanston Hilton Garden Inn and took the property subject to certain variable
rate debt. The debt outstanding under this permanent loan facility totaled
approximately $11,650 at September 30, 2004 and bears interest at 30-day Libor
plus 3.00%. The definitive extent of the Companys interest rate risk under the Line is not
quantifiable or predictable because of the variability of future interest rates
and business financing requirements. If interest rates increased by 100 basis
points, the Companys interest expense for the nine months ended September 30,
2004 would have increased by approximately $421, based on the weighted-average
amount of variable rate debt outstanding and exposed to fluctuations in the
market rate of interest. The Company does not enter into derivative or interest
rate transactions for speculative purposes. The following table presents the aggregate maturities of the Companys GE
Capital Corporation fixed rate debt principal and interest rates by maturity
dates at September 30, 2004: Maturity Date
    
    Fixed Rate Debt
    
    Interest Rate2004
    
    $
    380
    
    
    
    7.375
    %2005
    
    
    1,594
    
    
    
    7.375
    %2006
    
    
    1,715
    
    
    
    7.375
    %2007
    
    
    1,846
    
    
    
    7.375
    %2008
    
    
    58,396
    
    
    
    7.375
    %Thereafter
    
    
    
    
    
    
    Total
    
    $
    63,931
    
    
    
    7.375
    %
 The following table presents the aggregate maturities of the Companys variable
rate debt principal and interest rates by maturity dates at September 30, 2004: $125 million Line
    
    $12.3 million Permanent Loan
    
    TotalMaturity
    
    Variable
    
    Interest
    
    Variable
    
    InterestDate
    
    Rate Debt
    
    Rate
    
    Rate Debt
    
    Rate2004
    
    $
    33,000
    
    
    LIBOR + 1.75%
    
    $
    60
    
    
    LIBOR + 3.0%
    
    $
    33,0602005
    
    
    
    
    
    
    
    
    
    
    245
    
    
    LIBOR + 3.0%
    
    
    2452006
    
    
    
    
    
    
    
    
    
    
    262
    
    
    LIBOR + 3.0%
    
    
    2622007
    
    
    
    
    
    
    
    
    
    
    281
    
    
    LIBOR + 3.0%
    
    
    2812008
    
    
    
    
    
    
    
    
    
    
    300
    
    
    LIBOR + 3.0%
    
    
    300Thereafter
    
    
    
    
    
    
    
    
    
    
    10,502
    
    
    LIBOR + 3.0%
    
    
    10,502Total
    
    $
    33,000
    
    
    
    
    
    
    $
    11,650
    
    
    
    
    $
    44,650
 The following table presents the aggregate maturities of the Companys
consolidated joint ventures variable rate debt principal and interest rates by
maturity dates at September 30, 2004: 31




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##### 



Marsh Landing Joint Venture
    
    Chapel Hill Joint Venture
    
    TotalMaturity
    
    Variable
    
    Interest
    
    Construction
    
    InterestDate
    
    Rate Debt
    
    Rate
    
    Debt
    
    Rate2004
    
    $
    20
    
    
    LIBOR + 3.0%
    
    $
    6,076
    
    
    LIBOR + 3.80%
    
    $
    6,0962005
    
    
    84
    
    
    LIBOR + 3.0%
    
    
    
    
    
    
    
    
    
    
    842006
    
    
    92
    
    
    LIBOR + 3.0%
    
    
    
    
    
    
    
    
    
    
    922007
    
    
    100
    
    
    LIBOR + 3.0%
    
    
    
    
    
    
    
    
    
    
    1002008
    
    
    109
    
    
    LIBOR + 3.0%
    
    
    
    
    
    
    
    
    
    
    109Thereafter
    
    
    4,450
    
    
    LIBOR + 3.0%
    
    
    
    
    
    
    
    
    
    
    4,450Total
    
    $
    4,855
    
    
    
    
    $
    6,076
    
    
    
    
    
    
    $
    10,931
 
 Item 4  Controls and Procedures (a) Evaluation of disclosure controls and procedures. The Company carried out an evaluation with the participation of the Companys
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the Companys disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the Exchange Act)) as of the end of the period covered by this report.
Based upon that evaluation, the Companys Chief Executive Officer and Chief
Financial Officer concluded that the Companys disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to
be included in the Companys periodic SEC filings. There has been no change in
the
Companys internal control over financial reporting during the quarter ended
September 30, 2004 that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 32




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##### 



PART II  OTHER INFORMATION 
 Item 6 Exhibits  (a)
    
    Exhibits31.1
    
    Certification of Principal Executive Officer of
Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a)31.2
    
    Certification of Principal Financial Officer of
Periodic Report Pursuant to Rule 13a-14(a) or Rule 15d-14(a)32.1
    
    Certification of Robert W. Winston, III, Chief
Executive Officer of Winston Hotels, Inc., pursuant to 18 U.S.C.
Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and dated November 8, 200432.2
    
    Certification of Joseph V. Green, Chief Financial
Officer of Winston Hotels, Inc., pursuant to 18 U.S.C. Section
1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and dated November 8, 2004 33




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##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. WINSTON HOTELS, INC.Date

November 8, 2004
    
    /s/ Joseph V. GreenJoseph V. GreenPresident and Chief Financial Officer(Authorized officer and Principal FinancialOfficer)
 34




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##### 



EXHIBIT INDEX Exhibit
    
    Description31.1
    
    Certification of Principal Executive Officer of Periodic Report Pursuant
to Rule 13a-14(a) or Rule 15d-14(a)31.2
    
    Certification of Principal Financial Officer of Periodic Report Pursuant
to Rule 13a-14(a) or Rule 15d-14(a)32.1
    
    Certification of Robert W. Winston, III, Chief Executive Officer of
Winston Hotels, Inc., pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and dated
November 8, 200432.2
    
    Certification of Joseph V. Green, Chief Financial Officer of Winston
Hotels, Inc., pursuant to 18 U.S.C. Section 1350 as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 and dated November 8, 2004
 35