##### 



SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2004
    
    Commission file number 0-23732
 WINSTON HOTELS, INC.  North Carolina
(State of incorporation)
    
    56-1624289
(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. x o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). x o
 The number of shares of Common Stock, $.01 par value, outstanding on April 30,
2004 was 26,340,292.




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##### 



WINSTON HOTELS, INC.
Index PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsWINSTON HOTELS, INC.Consolidated
Balance Sheets as of March 31, 2004 (unaudited) and December 31,
2003
    
    
    3Unaudited Consolidated Statements of Operations for the three months
ended March 31, 2004 and 2003
    
    
    4Unaudited
Consolidated Statement of Shareholders Equity for the three
months ended March 31, 2004
    
    
    5Unaudited Consolidated Statements of Cash Flows for the three months
ended March 31, 2004 and 2003
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    25Item 4.
    
    Controls and Procedures
    
    
    27PART II.
    
    OTHER INFORMATIONItem 2.
    
    Changes in Securities and Use of Proceeds
    
    
    28Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    28SIGNATURES
    
    
    30EXHIBIT INDEX
    
    
    31
 2




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##### 



WINSTON HOTELS, INC.
CONSOLIDATED BALANCE SHEETS($ in thousands, except per share amounts) March 31, 2004
    
    December 31, 2003(unaudited)ASSETSLand
    
    $
    44,441
    
    
    $
    44,788Buildings and improvements
    
    
    374,757
    
    
    
    377,109Furniture and equipment
    
    
    48,007
    
    
    
    51,323Operating properties
    
    
    467,205
    
    
    
    473,220Less accumulated depreciation
    
    
    125,742
    
    
    
    128,540341,463
    
    
    
    344,680Properties under development
    
    
    6,080
    
    
    
    3,521Net investment in hotel properties
    
    
    347,543
    
    
    
    348,201Assets held for sale
    
    
    2,100
    
    
    
    2,100Corporate FF&E, net
    
    
    544
    
    
    
    621Cash
    
    
    7,082
    
    
    
    5,623Accounts receivable
    
    
    3,660
    
    
    
    2,505Lease revenue receivable
    
    
    
    
    
    
    179Notes receivable
    
    
    7,416
    
    
    
    5,016Investment in joint ventures
    
    
    2,203
    
    
    
    1,607Deferred expenses, net
    
    
    2,782
    
    
    
    2,935Prepaid expenses and other assets
    
    
    7,811
    
    
    
    8,653Deferred tax asset
    
    
    10,465
    
    
    
    9,821Total assets
    
    $
    391,606
    
    
    $
    387,261LIABILITIES AND SHAREHOLDERS EQUITYDue to banks
    
    $
    37,900
    
    
    $
    29,200Long-term debt
    
    
    82,599
    
    
    
    91,284Accounts payable and accrued expenses
    
    
    11,448
    
    
    
    11,484Distributions payable
    
    
    4,882
    
    
    
    5,870Total liabilities
    
    
    136,829
    
    
    
    137,838Minority interest
    
    
    10,681
    
    
    
    17,489Shareholders equity:Preferred stock, $.01 par value, 10,000,000 shares authorized,
3,000,000 shares issued and outstanding
    
    
    
    
    
    
    30Preferred stock, $.01 par value, 5,000,000 shares authorized,
3,680,000 shares issued and outstanding (liquidation preference of $92,736)
    
    
    37
    
    
    
    Common stock, $.01 par value, 50,000,000 shares authorized,
26,340,292 and 26,270,805 shares issued and outstanding
    
    
    264
    
    
    
    263Additional paid-in capital
    
    
    323,387
    
    
    
    307,089Accumulated other comprehensive loss
    
    
    
    
    
    
    (33
    )Unearned compensation
    
    
    (1,005
    )
    
    
    (527
    )Distributions in excess of earnings
    
    
    (78,587
    )
    
    
    (74,888
    )Total shareholders equity
    
    
    244,096
    
    
    
    231,934Total liabilities and shareholders equity
    
    $
    391,606
    
    
    $
    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 EndedMarch 31, 2004
    
    March 31, 2003Revenue:Rooms
    
    $
    29,896
    
    
    $
    25,849Food and beverage
    
    
    1,960
    
    
    
    1,686Other operating departments
    
    
    1,010
    
    
    
    1,091Percentage lease revenue
    
    
    692
    
    
    
    810Interest and other income
    
    
    361
    
    
    
    366Total revenue
    
    
    33,919
    
    
    
    29,802Hotel operating expenses:Rooms
    
    
    6,777
    
    
    
    6,075Food and beverage
    
    
    1,469
    
    
    
    1,305Other operating departments
    
    
    734
    
    
    
    736Undistributed operating expenses:Property operating expenses
    
    
    7,195
    
    
    
    5,951Real estate taxes and property and casualty insurance
    
    
    1,678
    
    
    
    1,698Franchise costs
    
    
    2,154
    
    
    
    1,811Maintenance and repair
    
    
    1,864
    
    
    
    1,585Management fees
    
    
    740
    
    
    
    548Percentage lease expense
    
    
    
    
    
    
    908General and administrative
    
    
    1,631
    
    
    
    1,485Depreciation
    
    
    4,520
    
    
    
    4,595Amortization
    
    
    329
    
    
    
    221Total operating expenses
    
    
    29,091
    
    
    
    26,918Operating income
    
    
    4,828
    
    
    
    2,884Interest expense
    
    
    1,731
    
    
    
    1,962Income 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
    
    
    3,097
    
    
    
    922Income (loss) allocation to minority interest in Partnership
    
    
    4
    
    
    
    (12
    )Income allocation to minority interest in consolidated joint ventures
    
    
    184
    
    
    
    Income tax benefit
    
    
    (718
    )
    
    
    (488
    )Equity in income (loss) of unconsolidated joint ventures
    
    
    (21
    )
    
    
    135Income from continuing operations
    
    
    3,606
    
    
    
    1,557Discontinued operations:Loss from discontinued operations
    
    
    (101
    )
    
    
    (24
    )Gain on sale of discontinued operations
    
    
    285
    
    
    
    Loss on impairment of asset held for sale
    
    
    (23
    )
    
    
    Net income
    
    
    3,767
    
    
    
    1,533Preferred stock distribution
    
    
    (1,795
    )
    
    
    (1,734
    )Loss on redemption of Series A Preferred Stock
    
    
    (1,720
    )
    
    
    Net income (loss) applicable to common shareholders
    
    $
    252
    
    
    $
    (201
    )Income (loss) per common share:Basic and diluted:Loss from continuing operations
    
    $
    
    
    
    $
    (0.01
    )Income from discontinued operations
    
    
    0.01
    
    
    
    Net income (loss) per common share
    
    $
    0.01
    
    
    $
    (0.01
    )Weighted average number of common shares
    
    
    26,216
    
    
    
    20,074Weighted average number of common shares assuming dilution
    
    
    27,578
    
    
    
    20,074
 The accompanying notes are an integral part of the consolidated financial statements. 4




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##### 



WINSTON HOTELS, INC.
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2004(in thousands, except per share amounts) AccumulatedPreferred Stock
    
    Common Stock
    
    Additional
    
    
    
    Distributions
    
    Other
    
    TotalPaid-in
    
    Unearned
    
    In Excess of
    
    Comprehensive
    
    Shareholders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
    
    
    
    69
    
    
    
    1
    
    
    
    89,548
    
    
    
    (709
    )
    
    
    
    
    
    
    
    
    
    
    88,877Redemption of Preferred A Stock
    
    
    (3,000
    )
    
    
    (30
    )
    
    
    
    
    
    
    
    
    
    
    (73,250
    )
    
    
    
    
    
    
    (1,720
    )
    
    
    
    
    
    
    (75,000
    )Distributions ($0.15 per common share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,951
    )
    
    
    
    
    
    
    (3,951
    )Distributions ($0.353 per preferred A share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,059
    )
    
    
    
    
    
    
    (1,059
    )Distributions ($0.20 per preferred B share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (736
    )
    
    
    
    
    
    
    (736
    )Unearned compensation amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    231
    
    
    
    
    
    
    
    
    
    
    
    231Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,767
    
    
    
    Unrealized holding loss arising on interest
rate swap
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,800Balances at March 31, 2004
    
    
    3,680
    
    
    $
    37
    
    
    
    26,340
    
    
    $
    264
    
    
    $
    323,387
    
    
    $
    (1,005
    )
    
    $
    (78,587
    )
    
    $
    
    
    
    $
    244,096
 The accompanying notes are an integral part of the consolidated financial statements. 5




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##### 



WINSTON HOTELS, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS($ in thousands) Three Months Ended
    
    Three Months EndedMarch 31, 2004
    
    March 31, 2003Cash flows from operating activities:Net income
    
    $
    3,767
    
    
    $
    1,533Adjustments to reconcile net income to net cash
provided by operating activities:Income (loss) allocation to minority interest in Partnership
    
    
    12
    
    
    
    (13
    )Income allocation to minority interest in consolidated joint ventures
    
    
    184
    
    
    
    Depreciation
    
    
    4,539
    
    
    
    4,721Amortization
    
    
    329
    
    
    
    221Income tax benefit
    
    
    (644
    )
    
    
    (551
    )Gain on sale of hotel properties
    
    
    (299
    )
    
    
    Loss on impairment of hotel properties
    
    
    24
    
    
    
    (Income) loss allocations from unconsolidated joint ventures
    
    
    21
    
    
    
    (135
    )Distributions from joint ventures
    
    
    
    
    
    
    433Unearned compensation amortization
    
    
    231
    
    
    
    170Changes in assets and liabilities:Lease revenue receivable
    
    
    179
    
    
    
    Accounts receivable
    
    
    (1,155
    )
    
    
    (1,211
    )Prepaid expenses and other assets
    
    
    842
    
    
    
    155Accounts payable and accrued expenses
    
    
    (3
    )
    
    
    609Net cash provided by operating activities
    
    
    8,027
    
    
    
    5,932Cash flows from investing activities:Note receivable
    
    
    (2,400
    )
    
    
    Deferred acquisition costs
    
    
    10
    
    
    
    Acquisition of minority interest
    
    
    (8,162
    )
    
    
    Investment in hotel properties, net
    
    
    (5,032
    )
    
    
    (1,675
    )Sale of hotel properties
    
    
    3,350
    
    
    
    Investment in unconsolidated joint ventures
    
    
    (617
    )
    
    
    (56
    )Net cash used in investing activities
    
    
    (12,851
    )
    
    
    (1,731
    )Cash flows from financing activities:Fees paid in connection with financing activities
    
    
    (186
    )
    
    
    (8
    )Payment of distributions to shareholders
    
    
    (6,734
    )
    
    
    (4,756
    )Payment of distributions to minority interest
    
    
    (195
    )
    
    
    (195
    )Distributions to minority interest in consolidated joint ventures
    
    
    (467
    )
    
    
    Proceeds from issuance of Series B Preferred shares, net
    
    
    88,850
    
    
    
    Redemption of Series A Preferred shares, net
    
    
    (75,000
    )
    
    
    Net increase in due to banks
    
    
    8,700
    
    
    
    3,500Decrease in long-term debt
    
    
    (8,685
    )
    
    
    (334
    )Net cash provided by (used in) financing activities
    
    
    6,283
    
    
    
    (1,793
    )Net increase in cash
    
    
    1,459
    
    
    
    2,408Cash at beginning of period
    
    
    5,623
    
    
    
    1,510Cash at end of period
    
    $
    7,082
    
    
    $
    3,918Supplemental disclosure:Cash paid for interest
    
    $
    1,746
    
    
    $
    2,620Summary of non-cash investing and financing activities:Distributions to shareholders declared but not paid
    
    $
    5,746
    
    
    $
    4,763Distributions to minority interest in Partnership declared but not paid
    
    
    195
    
    
    
    195Deferred equity compensation
    
    
    709
    
    
    
    354Interest rate awap adjustment to market value
    
    
    33
    
    
    
    135Adjustment to minority interest due to issuance of common stock and
change in accumulated other comprehensive loss
    
    
    27
    
    
    
    (14
    )
 The accompanying notes are an integral part of the consolidated financial statements. 6




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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 March 31, 2004, the Companys ownership in the Partnership
was 95.30 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 three months ended March 31, 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 March 31, 2004, the Company owned or was invested in 50 hotel
properties in 16 states having an aggregate of 7,069 rooms. This included
45 wholly owned properties with an aggregate of 6,388 rooms, a 49 percent
ownership interest in one joint venture hotel with an aggregate of 118
rooms, and a 13.05 percent ownership interest in four joint venture hotels
with an aggregate of 563 rooms. The Company also had issued mezzanine loans
to owners of four hotels with an aggregate of 591 rooms. The Company also
held a 48.78% ownership interest in another joint venture that is currently
constructing a 147-room Courtyard by Marriott hotel that is scheduled to
open in the third quarter of 2004. The Company does not hold an ownership
interest in any of the hotels for which it has provided mezzanine 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 40 of the Companys
50 hotels, Concord Hospitality Enterprises Company manages three hotels,
Promus Hotels, Inc., an affiliate of Hilton Hotels Corporation manages three
hotels, and New Castle Hotels, Sage Hospitality Resources, 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
three months ended March 31, 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 record percentage lease revenue in its consolidated
statement of operations. 7




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##### 



2.
    
    MINORITY INTERESTMinority interest as of March 31, 2004 and December 31, 2003, consists of
Minority Interest in the Partnership of $7,461 and $7,671, respectively, and
minority interest in consolidated joint ventures of $3,220 and $9,818,
respectively.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 liability. The Companys minority interest liability 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 of the consolidated joint ventures represent the
Companys minority interest liability (see Note 9). The Companys minority
interest liability 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.
    
    DERIVATIVE INSTRUMENTSThe 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 October 1, 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 March 31, 2004 was
30-day LIBOR (1.109% as of March 31, 2004) plus 1.75%. The Companys
interest rate beginning April 1, 2004 and for the second quarter remained at
30-day LIBOR plus 1.75%.To seek to manage overall interest rate risk, 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 quarter ended
March 31, 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. 8




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##### 



4.
    
    EARNINGS PER SHAREThe following is a reconciliation of net income (loss) applicable to common
shareholders used in the net income (loss) per common share calculation to
the net income (loss) assuming dilution used in the net income (loss) per
common shares  assuming dilution calculation: Three Months EndedMarch 31,2004
    
    2003Income from continuing operations
    
    $
    3,606
    
    
    $
    1,557Less: preferred shares distribution
    
    
    (1,795
    )
    
    
    (1,734
    )Less: loss on redemption of Series A Preferred Stock
    
    
    (1,720
    )
    
    
    Income (loss) from continuing operations to common shareholders
    
    
    91
    
    
    
    (177
    )Income (loss) from discontinued operations
    
    
    161
    
    
    
    (24
    )Net income (loss) applicable to common shareholders
    
    
    252
    
    
    
    (201
    )Plus: income allocation to minority interest in Partnership
    
    
    12
    
    
    
    Net income (loss) assuming dilution
    
    
    264
    
    
    
    (201
    )
  The following is a reconciliation of the weighted average shares used in net
income (loss) per common share to the weighted average shares used in net
income (loss) per common share  assuming dilution: Three Months EndedMarch 31,2004
    
    2003Weighted average number of common shares
    
    
    26,216
    
    
    
    20,074Minority interest units with redemption rights
    
    
    1,298
    
    
    
    Stock options and stock grants
    
    
    64
    
    
    
    Weighted average number of common shares
assuming dilution
    
    
    27,578
    
    
    
    20,074
  As of March 31, 2003, there were 1,298,480 Partnership units outstanding,
795,000 stock options outstanding, and 119,773 unvested stock grants
outstanding, which were antidilutive.During the first quarter of 2004, the Company declared quarterly cash
dividends of $0.15 per common share, $0.578125 per Series A preferred share
for the period from January 1, 2004 through February 24, 2004 and $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, 2004.5.
    
    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 three months ended March 31, 2004 consists of a deferred
federal income tax benefit of $593 and a deferred state income tax benefit
of $51. 9




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##### 



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 March 31, 2004.6.
    
    STOCK-BASED COMPENSATIONThe Company has one stock-based employee compensation plan, the Winston
Hotels, Inc. Stock Incentive 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 (loss) for
the issuance of options, as all options granted under those plans 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) applicable to common shareholders and net income (loss) per share as
if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation. Three Months EndedMarch 31,2004
    
    2003Net income (loss) applicable to common shareholders,
as reported
    
    $
    252
    
    
    $
    (201
    )Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects
    
    
    
    
    
    
    5Pro forma net income (loss) applicable to common
shareholders
    
    
    252
    
    
    
    (206
    )Earnings (loss) per share:Basic and diluted  as reported
    
    $
    0.01
    
    
    $
    (0.01
    )Basic and diluted  pro forma
    
    $
    0.01
    
    
    $
    (0.01
    )
  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 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 10




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##### 



amount, exceeds the current carrying value.
However, should the Company approve of a plan to sell these properties, an
impairment charge would be required.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 quarter ended March 31, 2004 and the balance
sheet as of March 31, 2004 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, IL Hilton Garden Inn
hotel and the Windsor, CT Hilton Garden Inn hotel. Prior to the purchase,
Regent Partners, Inc. owned 51 percent of the Evanston hotel and 42.35
percent of the Windsor hotel, and the Company owned 49 percent and 57.65
percent, respectively. The amount paid for Regents ownership interest in
the Evanston Hilton Garden Inn 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 Hilton Garden Inn 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 owns 100 percent of the equity in the entities that own the
Evanston, IL Hilton Garden Inn and the Windsor, CT Hilton Garden Inn 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 quarter ended March 31, 2004 and the balance sheet as of
March 31, 2004 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, and the Houston, TX Best Western Park
Place Suites are owned by WCC Project Company LLC. The Houston, TX Park
Place Suites is currently being renovated and is expected to be converted to
a Springhill Suites by Marriott during the second quarter of 2004.
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 four hotels 11




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##### 



owned,
in part, by the Charlesbank Venture were approximately $35 million as of
March 31, 2004, and are expected to be approximately $44 million upon
completion of all renovation procedures.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 is
currently developing a 147-room Courtyard by Marriott hotel in Chapel Hill,
NC, which is expected to open in the third quarter of 2004. The Company
currently owns a 48.78 percent interest in the Chapel Hill Joint Venture,
while Chapel Hill Investments, LLC owns a 51.22 percent interest. 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s Preferred
Contribution requires the Chapel Hill Joint Venture to pay monthly dividends
to the Company during construction of the hotel at an annual yield of 30-day
LIBOR plus 5.885 percent, plus an accrued dividend at an annual yield of 8
percent. Once the hotel opens, and until the Preferred Contribution and all
dividends payable and accrued thereon are paid in full, the Companys
Preferred Contribution requires a paid monthly dividend to the Company equal
to a floating rate equal to 30-day LIBOR plus that percentage that will
generate an annual dividend yield of 10 percent. The percentage rate to be
added to 30-day LIBOR will not be known until the day the hotel opens.
During this time, the Companys Preferred Contribution also requires
additional dividend payments to the Company equal to 1 percent of gross
revenue of the hotel, which is paid currently, and an additional 1 percent
of gross revenue of the hotel, which accrues. Also, after the second
anniversary of the funding (the Funding) of the Preferred Contribution,
the Company is scheduled to receive equal consecutive monthly payments sufficient to
retire the Preferred Contribution on the tenth anniversary of the Funding. The
Preferred Contribution, together with all unpaid and accrued dividends and any other
applicable amounts relating thereto, is due and payable on the third anniversary of the
Funding. The maturity date of the Preferred Contribution may be extended, subject to a
fee equal to 1 percent of the unpaid amount of the Preferred Contribution
for a one-year extension, and a fee equal to 2 percent of the unpaid amount of
the Preferred Contribution for a two-year extension.
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 quarter ended March 31, 2004 and the balance sheet as of March 31, 2004
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 March 31, 2004, total assets of the two unconsolidated joint ventures,
one with Charlesbank and Concord and one with Charlesbank and New Castle
were $36,282, total liabilities were $22,275, and total equity was $14,007.
For the three months ended March 31, 2004, total revenue of the two
unconsolidated joint ventures was $2,306, total expenses were $2,433,
resulting in net loss of $127.As of March 31, 2004, total assets of the two consolidated joint ventures
were $14,337, total liabilities were $8,040, and total equity was $6,297.
For the three months ended March 31, 2004, total revenue of the two
consolidated joint ventures was $403, total expenses were $247, resulting in
a net income of $156. The Companys resulting share of the net income was
$77.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 12




---



##### 



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.This Interpretation applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which
an enterprise obtains a variable interest after that date. For the Company,
it applies in the first fiscal year or interim period ending after December
15, 2003, to variable interest entities in which an enterprise 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. The Company has also issued
four mezzanine loans to owners of four 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 months ended March 31, 2004, total revenue was $401, total expenses
were $191, resulting in a net income of $210. As of March 31, 2004, total
assets of the joint venture were $7,277, total liabilities were $4,957,
resulting in stockholders equity totaling $2,320. The Companys share of
the equity of this joint venture totaled $1,137 as of March 31, 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 months ended March 31,
2004, total revenue of the Charlesbank joint ventures was $2,306, total
expenses were $2,433, resulting in net loss of $(127). As of March 31,
2004, total assets of the joint ventures were $36,282, total liabilities
were $22,275, resulting in stockholders equity totaling $14,007. The
Companys equity balance exposed to loss as a result of its involvement in
these joint ventures totaled $1,827 as of March 31, 2004.Regent Joint Ventures: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). These two
joint ventures owned the Windsor, CT Hilton Garden Inn (the Windsor Joint
Venture) and the Evanston, IL Hilton Garden Inn (the Evanston Joint
Venture). 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% interest and a 49% 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 that
the property was a joint venture, during the three months ended March 31,
2004, total revenue of the Windsor Joint Venture and the Evanston Joint
Venture was $362 and $494, respectively, total expenses were $240 and $281,
respectively, resulting in net income of $122 and $213, respectively. 13




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The Company also owned a 57.65% interest in Windsor Lessee Company, LLC, the
lessee of the Windsor, CT Hilton Garden Inn. Barclay assumed this lease at
the time the Company purchased Regents interest in the Windsor Hilton
Garden Inn. 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 that the lessee was a joint venture, during
the three months ended March 31, 2004, total revenue of Windsor Lessee
Company, LLC was $818, total expenses were $951 resulting in a net loss of
$(133).Chapel Hill Joint Venture:This 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% interest, has
consolidated the joint ventures results of operations and balance sheet
beginning with the third quarter 2003. For the three months ended March 31,
2004, total revenue was $2, total expenses were $55, resulting in a net loss
of $(53). As of March 31, 2004, total assets were $7,060, total liabilities
were $3,083, including $1,271 of long term debt, resulting in stockholders
equity totaling $3,977. The Companys share of equity of this joint venture
totaled $1,940 as of March 31, 2004, and its Preferred Contribution totaled
$1,453 as of March 31, 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
$277, respectively as of March 31, 2004. The Company has received a
guaranty of payment up to $400 of the outstanding balance of the mezzanine
loan for the Hilton Garden Inn in Tampa from Noble Investments LLC, an
affiliate of Noble Investments  Tampa, LLC, the borrower.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 $1,750 and $315, respectively
as of March 31, 2004.Atlantic Beach, NC Sheraton Loan:In February 2004, the Company issued a $2,400 mezzanine loan to 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 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 $28, respectively as of March 31, 2004. 14




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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, and plans to use the
resulting availability under the Line to fund the Companys hotel lending
business, to acquire hotels or interests in hotels through joint ventures,
and/or for general corporate purposes.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 in the first quarter of 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 of 2004, the Company sold its 118-room Hampton Inn in Wilmington,
NC. 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 March 31,
2004. The property, which is immediately available for sale, is actively
being marketed for sale through a broker. The operating results for these
two hotels are included in discontinued operations in the statements of
operations for the three months ended March 31, 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 months ended March 31, 2003 financial
statement amounts.Condensed financial information of the results of operations for the three
months ended March 31, 2004 and 2003, for the one hotel sold during 2004 and
the one hotel classified as held for sale are included in discontinued
operations as follows: Three Months EndedMarch 31,2004
    
    2003Total revenue
    
    $
    410
    
    
    $
    603Total expenses
    
    
    442
    
    
    
    691Loss from discontinued operations
    
    
    (32
    )
    
    
    (88
    )Allocation
to minority interest in Partnership - loss from
discontinued operations
    
    
    (5
    )
    
    
    (1
    )Gain on sale of discontinued operations
    
    
    299
    
    
    
    Allocation
to minority interest in Partnership - gain on sale of
discontinued operations
    
    
    14
    
    
    
    Loss on impairment of asset held for sale
    
    
    (24
    )
    
    
    Allocation
to minority interest in Partnership - loss on impairment
of asset held for sale
    
    
    1
    
    
    
    Income tax expense (benefit)
    
    
    74
    
    
    
    (63
    )Income (loss) from discontinued operations
    
    $
    161
    
    
    $
    (24
    )
 15




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Item 2  Managements Discussion and Analysis of Financial Condition
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, 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 primarily
through food and beverage, telephone, parking, and other hotel sales and
interest income from hotel loans. 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 reduce operating costs and increase revenues, 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 in the first quarter of 2004 with respect to each of these
strategies. Improve Hotel Operations During the first quarter of 2004, room revenue increased to $29,896 from
$25,849 in the first quarter of 2003. The increase is primarily a result of an
increase in RevPAR of 7.7 percent. Occupancy rates increased 5.3 percent, from
62.8 percent to 66.1 percent, and the average daily rate (ADR) increased 2.4
percent from $76.34 to $78.16. The Companys gross profit operating margins
increased to 39.2 percent in the first quarter of 2004 from 38.8 percent in the
first quarter of 2003. The Company expects RevPAR to increase three to five
percent, and expects gross profit
operating margins to improve slightly in the second quarter of 2004, as
compared to the second quarter of 2003. The Company continues to seek to
maximize hotel revenues and reduce operating costs. 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. Through its investments in joint ventures, the Company also creates
additional income in the form of asset management fees and/or development fees.
(see Note 8 to consolidated financial statements) 16




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##### 



Hotel Financing In February 2004, the Company issued a $2,400 mezzanine loan to finance the
acquisition of a 200-room Sheraton hotel in Atlantic Beach, NC. The hotel will
undergo extensive renovations which are expected to be completed by June 2004.
This hotel loan supports 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. 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 affect 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 March 31, 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 four 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 is constructing one hotel. The WCC Project Company
LLC joint venture owns three hotels and the WNC Project Company LLC joint
venture owns one hotel. The Chapel Hill joint venture owns one hotel which is
currently under construction and expected to open in the third quarter of 2004. 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 quarter ended March 31, 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
March 31, 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. Therefore, per FIN 46, the Company has consolidated
the joint ventures assets, liabilities, and results of operations beginning
with the third quarter 2003. 17




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##### 



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 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 hotels
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 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 March
31, 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 The following table outlines the number of hotels by service type, whose
results of operations are included in the Companys consolidated financial
statements as of and for the quarter ended March 31, 2004 and 2003. March 31,
    
    March 31,Service Type of Hotel
    
    2004
    
    2003Limited-service hotels
    
    
    23
    
    
    
    23Extended-stay hotels
    
    
    10
    
    
    
    10Full-service hotels
    
    
    13
    
    
    
    11Total
    
    
    46
    
    
    
    44
 Actual Three Months Ended March 31, 2004 versus Actual Three Months Ended March
31, 2003 REVENUE Room Room revenue increased $4,047 from $25,849 in 2003 to $29,896 in 2004.
The increase in room revenues is primarily a result of an increase in RevPAR of
7.7 percent, from $47.95 to $51.65. Occupancy rates increased 5.3 percent,
from 62.8 percent to 66.1 percent, and the ADR increased 2.4 percent from
$76.34 to $78.16. In addition, on July 1, 2003, the Company acquired the lease
for the Las Vegas Hampton Inn and began recording the operating results of the
hotel; 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 18




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##### 



Secaucus Holiday Inn and
began recording the operating results of the hotel. Room revenue recorded by
the Company from these three hotels totaled $1,811 for the three months ended
March 31, 2004. Food and Beverage Food and beverage revenue increased $274 from $1,686 in
2003 to $1,960 in 2004. The increase in food and beverage revenues is partly a
result of increased occupancy experienced at four of the Companys full service
properties. These properties experienced an 11.3 percent increase in
occupancy, resulting in increased food and beverage revenues. In addition, 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 and began recording
the operating results of the hotel. Food and beverage revenue from these
hotels totaled $227 for the three months ended March 31, 2004. Other Operating Departments Other operating departments revenue decreased $81
from $1,091 in 2003 to $1,010 in 2004. The decrease in other operating
departments revenues is primarily a result of lower telephone revenue as
cellular phone use continues to reduce the demand for this service. Percentage Lease Revenue Percentage lease revenue declined $118 from $810 in
2003 to $692 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 three months ended March 31, 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 record percentage lease revenue in its consolidated statement of
operations. Interest and Other Income Interest and other income decreased $5 from $366 in
2003 to $361 in 2004 primarily due to a decrease in asset management fees that
resulted from the requirements of FIN 46 to consolidate the Evanston joint
venture, the Windsor joint venture and the Marsh Landing joint venture, offset
by an increase in mezzanine loan interest income. The Company continues its
efforts to expand its hotel lending program. EXPENSES Rooms Rooms expenses increased $702 from $6,075 in 2003 to $6,777 in 2004.
The increase in these room expenses is primarily due to increases in labor
costs and various other operating expenses consistent with the increase in
occupancy from the first quarter of 2003 to the first quarter of 2004. In
addition, on July 1, 2003, the Company acquired the lease for the Las Vegas
Hampton Inn and began recording the operating results of that hotel; 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 and began recording the
operating results of the hotel. Rooms expense from these hotels totaled $411
for the three months ended March 31, 2004. Food and beverage Food and beverage expenses increased $164 from $1,305 in
2003 to $1,469 in 2004, consistent with the increase in food and beverage
revenues. Property Operating Costs Property operating costs increased $1,244 from
$5,951 in 2003 to $7,195 in 2004. These costs consist of administrative and
general, sales and marketing, utility and other costs. The increase is
primarily due to increases in administrative and general and sales and
marketing labor costs, utility costs, frequent flier program costs, credit card
commissions, advertising directories costs and legal fees. In addition, on
July 1, 2003, the Company acquired the lease for the Las Vegas Hampton Inn and
began recording the operating results of that hotel; 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 and began recording the operating
results of the hotel. Property operating costs from these hotels totaled $529
for the three months ended March 31, 2004. 19




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##### 



Real Estate Taxes and Property and Casualty Insurance- Real estate taxes and
property insurance costs remained consistent with the prior year period,
decreasing $20 from $1,698 in 2003 to $1,678 in 2004. Franchise Costs-Franchise costs increased consistent with the increase in room
revenues, increasing $343 from $1,811 in 2003 to $2,154 in 2004. Maintenance and Repair Costs Maintenance and repair costs increased $279 from
$1,585 in 2003 to $1,864 in 2004 primarily due to increases in labor costs. In
addition, on July 1, 2003, the Company acquired the lease for the Las Vegas
Hampton Inn and began recording the operating results of the hotel; 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 and began recording the
operating results of the hotel. Maintenance and repair costs from these hotels
totaled $95 for the three months ended March 31, 2004. Management Fees Management fees increased $192 from $548 in 2003 to $740 in
2004 as a result of increased hotel revenues. General and Administrative General and administrative expense increased $146
from $1,485 in 2003 to $1,631 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 Sarbanes-Oxley Act of 2002, and payroll costs. Depreciation and Amortization Depreciation expense declined $75 from $4,595
in 2003 to $4,520 in 2004. Depreciation expenses declined primarily due to 5
year property acquired in 1998 and prior having become fully depreciated,
offset by an increase due to the consolidation of the Evanston, Windsor and
Marsh Landing joint ventures. Amortization expense increased $108 from $221 in
2003 to $329 in 2004. The increase is due to the amortization of costs paid in
2003 to amend the Companys $125 million line of credit (the Line). Interest Interest expense decreased $231 from $1,962 in 2003 to $1,731 in
2004. The decrease is due to a decline in weighted average outstanding debt
balances offset by an increase in the weighted average interest rates. The
weighted average outstanding debt balance decreased from $143,190 in the first
quarter of 2003 to $98,848 in the first
quarter of 2004, while the weighted average interest rate increased from 5.48
percent to 5.98 percent for the same periods. Income Tax Benefit Income tax benefit increased $230 from $488 in 2003 to
$718 in 2004. The income tax benefit is a result of the net loss experienced
by Barclay during the respective quarter. Equity in Income (loss) of Unconsolidated Joint Ventures The Companys share
of income from unconsolidated joint ventures decreased $156 from $135 in 2003
to $(21) in 2004. The decrease is primarily a result of the purchase of the
remaining equity interest in the Evanston and Windsor Joint Venture and the
consolidation of the Marsh Landing Joint Venture, beginning with the first
quarter of 2004. Discontinued Operations Loss from discontinued operations increased $77 from
$24 in 2003 to $101 in 2004. The Company sold the Wilmington Hampton Inn in
February 2004, resulting in a gain on sale of $285 net of $14 allocated to
minority interest. The Company also 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 fair market value of $2,100. The operating
results of both properties are shown as discontinued operations in the
respective periods. 20




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##### 



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 three months
ended March 31, 2004 and 2003, cash flow provided by operating activities was
$8,027 and $5,932, respectively. The increase is primarily due to an increase
in net income, which was primarily a result of the increase in RevPAR. 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 quarter of 2004, the Company declared
distributions of $3,951 to its common shareholders ($0.15 per share) and $1,795
to its preferred shareholders ($0.353 per share of Preferred Series A and $0.20
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, and plans to use the resulting availability
under the Line to fund the Companys hotel lending business, to acquire hotels
or interests in hotels through joint ventures, and/or for general corporate
purposes. The costs 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 three months ended
March 31, 2004 totaled $12,851. Gross capital expenditures for the Companys
consolidated hotels totaled $5,032. This amount includes capital expenditures
of $2,459 for the Companys wholly-owned hotels as of March 31, 2004, and
$2,573 for the Companys consolidated joint venture hotels, $2,559 of which was
for the development of the Courtyard by Marriott hotel in Chapel Hill, NC.
This hotel is expected to open in the third quarter 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 $8,162 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. The Company plans to spend approximately $5,700 to renovate certain of its
wholly owned hotels during the remainder of 2004, and an additional $8,350 to
continue to develop the Courtyard by Marriott hotel in Chapel Hill during the
second and third quarter of 2004. These expected total renovation expenditures
for 2004 exceed by approximately $1,900 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. 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 6.4% and 6.2% of room
revenues for each of the three months ended March 31, 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 March 31, 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 21




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##### 



Wilmington, NC Hampton Inn in February of 2004. The total net proceeds were
$3,350. 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 February 2004, the Company issued a $2,400 mezzanine loan to finance the
acquisition of a 200-room Sheraton hotel in Atlantic Beach, NC. The hotel will
undergo extensive renovations which are expected to be completed by June 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
Borrower made initial equity investments equal to approximately 18% of the
total cost of the hotel, and there are certain default provisions under which
the Company may declare the loan immediately due and payable or may step in and
take control of the Borrower, including for failure to maintain specified debt
coverage ratios. The Company has issued three other hotel loans, a $1,750 loan to finance the
116-room Hampton Inn & Suites in Baltimore, MD, a $1,080 loan to finance the
122-room Hilton Garden Inn in Atlanta, GA and a $2,186 loan to finance the
152-room Hilton Garden Inn in Tampa, FL. 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 and expects to issue
additional hotel loans during 2004. Joint Ventures The Company currently has entered into four joint venture agreements: 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 three hotels, the 102-room Fairfield Inn
& Suites in West Des Moines, IA, the 113-room Courtyard by Marriott in
Beachwood, OH, and the 190-room Best Western Park Place Suites in Houston,
TX 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 2004. The Company owns an indirect 13.05 percent interest in the WNC Project
Company LLC joint venture that owns one hotel, the 160-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 is
currently constructing a 147-room Courtyard by Marriott in Chapel Hill, NC
that is expected to open in the third quarter 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 three months ended March 31, 2004, while the
results of operations of the WCC Project Company and WNC Project Company joint
ventures were not unconsolidated. See Note 8 and 9 to Notes to Consolidated
Financial Statements for more information. The Companys net cash provided by financing activities during the three months
ended March 31, 2004 totaled $6,283. This amount included net proceeds of
$88,850 as a result of the issuance of 3,680,000 shares of Series B 22




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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
provided by financing activities for the three months ended March 31, 2004 also
included the payment of additional distributions to shareholders of $5,675, the
payment of distributions to the Partnerships minority interest of $195, the
payment of distributions to consolidated joint ventures minority interest of
$467, long-term debt payments of $8,685, and a net increase of $8,700 in the
outstanding balance under the Line from $29,200 at December 31, 2003 to $37,900
at March 31, 2004. The Companys availability under the Line totaled approximately $87,000 as of
March 31, 2004. Availability is calculated each quarter on a trailing
twelve-month basis based upon certain valuation criteria contained within the
Line. 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 March 31,
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 March 31, 2004 was 30-day
LIBOR (1.109% as of March 31, 2004) plus 1.75%. The Companys interest rate
beginning April 1, 2004 and for the second quarter remained at 30-day LIBOR
plus 1.75%. The Company had $64,712 in debt at March 31, 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-three of the Companys wholly owned hotels have been pledged as
collateral for the Companys debt securities, 29 against the outstanding
balance under the Line and 14 against the outstanding balance under the GE
Capital loan. As of March 31, 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
    
    $
    76,434
    
    
    $
    1,741
    
    
    $
    3,887
    
    
    $
    60,383
    
    
    $
    10,423Long-term debt of consolidated JVs
    
    
    6,165
    
    
    
    1,350
    
    
    
    180
    
    
    
    214
    
    
    
    4,421Corporate office lease
    
    
    343
    
    
    
    343
    
    
    
    
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    82,942
    
    
    $
    3,434
    
    
    $
    4,067
    
    
    $
    60,597
    
    
    $
    14,844
 Less Than
    
    
    
    
    
    
    
    
    
    More ThanOther Commercial Commitments
    
    Total
    
    1 Year
    
    1 - 3 Years
    
    3 - 5 Years
    
    5 YearsLine of credit
    
    
    37,900
    
    
    
    37,900
    
    
    
    
    
    
    
    
    
    
    
    Total other commercial commitments
    
    $
    37,900
    
    
    $
    37,900
    
    
    $
    
    
    
    $
    
    
    
    $
    
 23




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##### 



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. 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 Funds from operations (FFO), as defined by the National Association of Real
Estate Investment Trusts (NAREIT), is 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 has adopted this
definition of FFO effective January 1, 2004. The calculation of FFO may vary
from entity to entity, and as such the presentation of FFO by the Company may
not be comparable to other similarly titled measures of other reporting
companies. FFO is not intended to represent cash flows for the period. FFO has
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 (combined with the companys
primary GAAP presentations required by the SEC) helps improve our investors
ability to understand the Companys operating performance. The Company only
uses FFO as a supplemental measure of operating performance. Shown below is a
reconciliation of net income to FFO. 24




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##### 



WINSTON HOTELS, INC.
Reconciliation of Net Income to FFO
For the Three Months Ended March 31, 2004 and 2003
($ in thousands) Three Months EndedMarch 31,2004
    
    2003Net income
    
    $
    3,767
    
    
    $
    1,533Gain on sale of discontinued operations
    
    
    (299
    )
    
    
    Minority interest in Partnership allocation
    
    
    3
    
    
    
    (12
    )Minority interest in Partnership allocation of gain
on sale of discontinued operations
    
    
    14
    
    
    
    Minority interest in Partnership allocation of
earnings from discontinued operations
    
    
    (5
    )
    
    
    (1
    )Depreciation
    
    
    4,225
    
    
    
    4,595Depreciation from discontinued operations
    
    
    19
    
    
    
    126Depreciation from joint ventures
    
    
    207
    
    
    
    194Preferred stock dividend
    
    
    (1,795
    )
    
    
    (1,734
    )Loss on redemption of Series A Preferred Stock
    
    
    (1,720
    )
    
    
    FFO
    
    $
    4,416
    
    
    $
    4,701
 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 March 31, 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 $37,900 at March 31, 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,
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 25




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##### 



weighted average interest rate on the Line for
the three months ended March 31, 2004 was 3.79%. At March 31, 2004, the
Company had $37,900 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 $11,800 at March 31,
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 three months ended March 31,
2004 would have increased by approximately $145, 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 March 31, 2004: Maturity Date
    
    Fixed Rate Debt
    
    Interest Rate2004
    
    
    $
    1,508
    
    
    
    7.375
    %2005
    
    
    
    1,623
    
    
    
    7.375
    %2006
    
    
    
    1,747
    
    
    
    7.375
    %2007
    
    
    
    1,881
    
    
    
    7.375
    %2008
    
    
    
    57,912
    
    
    
    7.375
    %Thereafter
    
    
    
    
    
    
    Total
    
    $
    64,671
    
    
    
    7.375
    %
 The following table presents the aggregate maturities of the Companys variable
rate debt principal and interest rates by maturity dates at March 31, 2004: $125 million LOC
    
    $12.3 million Permanent LoanMaturity
    
    Variable
    
    Interest
    
    Variable
    
    Interest
    
    TotalDate
    
    Rate Debt
    
    Rate
    
    Rate Debt
    
    Rate2004
    
    
    $
    37,900
    
    
    Libor + 1.75%
    
    $
    233
    
    
    Libor + 3%
    
    $
    38,1332005
    
    
    
    
    
    
    
    
    
    
    
    250
    
    
    Libor + 3%
    
    
    2502006
    
    
    
    
    
    
    
    
    
    
    
    267
    
    
    Libor + 3%
    
    
    2672007
    
    
    
    
    
    
    
    
    
    
    
    285
    
    
    Libor + 3%
    
    
    2852008
    
    
    
    
    
    
    
    
    
    
    
    305
    
    
    Libor + 3%
    
    
    305Thereafter
    
    
    
    
    
    
    
    
    
    
    10,423
    
    
    Libor + 3%
    
    
    10,423Total
    
    $
    37,900
    
    
    
    
    
    
    $
    11,763
    
    
    
    
    
    
    $
    49,663
 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 March 31, 2004: 26




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##### 



Marsh Landing Joint Venture
    
    Chapel Hill Joint Venture
    
    TotalMaturity
    
    Variable
    
    Interest
    
    Construction
    
    InterestDate
    
    Rate Debt
    
    Rate
    
    Debt
    
    Rate2004
    
    
    $
    79
    
    
    Libor + 3%
    
    $
    1,271
    
    
    Libor + 3.80%
    
    $
    1,3502005
    
    
    
    86
    
    
    Libor + 3%
    
    
    
    
    
    
    
    
    
    
    862006
    
    
    
    94
    
    
    Libor + 3%
    
    
    
    
    
    
    
    
    
    
    942007
    
    
    
    102
    
    
    Libor + 3%
    
    
    
    
    
    
    
    
    
    
    1022008
    
    
    
    112
    
    
    Libor + 3%
    
    
    
    
    
    
    
    
    
    
    112Thereafter
    
    
    4,421
    
    
    Libor + 3%
    
    
    
    
    
    
    
    
    
    
    4,421Total
    
    $
    4,894
    
    
    
    
    
    
    $
    1,271
    
    
    
    
    
    
    $
    6,165
 
 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 March 31, 2004 that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting. 27




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##### 



PART II  OTHER INFORMATION 
 Item 2. Changes in Securities and Use of Proceeds Total Number of
    
    
    
    
    
    Total Number of
    
    Approximate DollarSeries A
    
    
    
    
    
    Shares Purchased
    
    Value of Shares thatCumulative
    
    
    
    
    
    as Part of Publicly
    
    May Yet BePreferred Shares
    
    Average Price
    
    Announced Plans
    
    Purchased underPeriod
    
    Purchased
    
    Paid per Share
    
    or Programs
    
    Plans or ProgramsJanuary 1, 2004 - January 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    February 1, 2004 - February 29, 2004
    
    
    3,000,000
    
    
    $
    25
    
    
    
    
    
    
    
    March 1, 2004 - March 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    3,000,000
    
    
    $
    25
    
    
    
    
    
    
    
    
 
 Item 6. Exhibits and Reports on Form 8-K  (a)
    
    Exhibits 10.1
    
    
    Employment Agreement, dated March 30, 2004, by and between
Brent V. West and Winston Hotels, Inc.10.2
    
    
    Employment Agreement, dated March 30, 2004, by and between
James P. Frey and Winston Hotels, Inc.31.1
    
    
    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 May 10, 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
May 10, 2004
  (b)
    
    Reports on Form 8-K.The Company filed the following reports on Form 8-K during the
quarter ended March 31, 2004:(1)
    
    The Company filed a current report on Form 8-K dated
January 20, 2004, pursuant to Item 7 of Form 8-K. Included in
the Form 8-K was the preliminary prospectus filed with the
Securities and Exchange Commission by the Company, which
included and supplemented the Companys base prospectus, dated
October 21, 2003, which was included as part of the Companys
Registration Statement on Form S-3, which was filed in
connection with the proposed sale of shares of Series B
Cumulative Preferred Stock. 28




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##### 



(2)
    
    The Company filed a current report on Form 8-K dated
January 23, 2004, pursuant to Item 5 and Item 7 of Form 8-K.
Included in the Form 8-K was the Companys press release
announcing the public offering by the Company of 3,200,000 shares
of its 8.00% Series B Cumulative Preferred Stock. In
addition, another press release announced the redemption of all
of its outstanding 9.25% Series A Cumulative Preferred Stock.
Copies of these press releases were attached as Exhibits 99.1
and 99.2, respectively.(3)
    
    The Company filed a current report on Form 8-K dated
February 12, 2004, pursuant to Item 7 and Item 12 of Form 8-K.
Included in the Form 8-K was the Companys press release
announcing its operating results for the fourth quarter and year
ended December 31, 2003, which was attached as Exhibit 99.(4)
    
    The Company filed a current report on Form 8-K dated
February 24, 2004, pursuant to Item 5 and Item 7 of Form 8-K.
Included in the Form 8-K was the Companys press release
announcing the completion of the Companys offering of 3,680,000 shares
of its Series B Cumulative Preferred Stock, which was
attached as Exhibit 99.1. 29




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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 May 10, 2004
    
    /s/ Joseph V. GreenJoseph V. GreenPresident and Chief Financial Officer(Authorized officer and Principal FinancialOfficer)
 30




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##### 



EXHIBIT INDEX Exhibit
    
    Description10.1
    
    Employment Agreement, dated March 30, 2004, by and between Brent V. West
and Winston Hotels, Inc.10.2
    
    Employment Agreement dated March 30, 2004, by and between James P. Frey
and Winston Hotels, Inc.31.1
    
    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 May
10, 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 May 10, 2004
 31