##### 



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, 2005
    
    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. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). þ o
 The number of shares of Common Stock, $.01 par value, outstanding on April 30, 2005 was
26,513,427.




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##### 



WINSTON HOTELS, INC.
Index PagePART I.
    
    FINANCIAL INFORMATIONItem 1
    
    Financial StatementsConsolidated Balance Sheets as of March 31, 2005 (unaudited) and
December 31, 2004
    
    
    3Unaudited Consolidated Statements of Operations for the three months ended
March 31, 2005 and 2004
    
    
    4Unaudited Consolidated Statement of Shareholders Equity for the three months ended
March 31, 2005
    
    
    5Unaudited Consolidated Statements of Cash Flows for the three months ended
March 31, 2005 and 2004
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    13Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4
    
    Controls and Procedures
    
    
    21PART II.
    
    OTHER INFORMATIONItem 6
    
    Exhibits
    
    
    22SIGNATURES
    
    
    23EXHIBIT INDEX
    
    
    24
  2




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##### 



WINSTON HOTELS, INC. 
 CONSOLIDATED BALANCE SHEETS ($ in thousands, except per share amounts)
 March 31, 2005
    
    
    December 31, 2004(unaudited)ASSETSLand
    
    $
    46,334
    
    
    $
    46,215Buildings and improvements
    
    
    383,766
    
    
    
    382,458Furniture and equipment
    
    
    56,443
    
    
    
    54,661Operating properties
    
    
    486,543
    
    
    
    483,334Less accumulated depreciation
    
    
    138,965
    
    
    
    134,261347,578
    
    
    
    349,073Properties under development
    
    
    4,494
    
    
    
    3,962Net investment in hotel properties
    
    
    352,072
    
    
    
    353,035Assets held for sale
    
    
    
    
    
    
    7,037Corporate furniture fixtures and equipment, net
    
    
    393
    
    
    
    397Cash
    
    
    7,441
    
    
    
    4,115Accounts receivable, net
    
    
    3,046
    
    
    
    2,676Notes receivable
    
    
    31,939
    
    
    
    30,849Investment in joint ventures
    
    
    2,450
    
    
    
    2,512Deferred expenses, net
    
    
    6,262
    
    
    
    3,759Prepaid expenses and other assets
    
    
    9,287
    
    
    
    7,976Deferred tax asset
    
    
    12,227
    
    
    
    12,024Total assets
    
    $
    425,117
    
    
    $
    424,380LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS EQUITYDue to banks
    
    $
    70,000
    
    
    $
    66,850Long-term debt
    
    
    88,548
    
    
    
    88,075Accounts payable and accrued expenses
    
    

    12,758
    
    
    
    13,066Distributions payable
    
    
    6,012
    
    
    
    5,994Total liabilities
    
    
    177,318
    
    
    
    173,985Minority interest
    
    
    9,986
    
    
    
    10,154Shareholders equity:Preferred stock, Series B, $.01 par value, 5,000,000 shares authorized,
3,680,000 shares issued and outstanding (liquidation preference of
$93,840)
    
    
    37
    
    
    
    37Common stock, $.01 par value, 50,000,000 shares authorized,
26,513,427 and 26,397,574 shares issued and outstanding
    
    
    265
    
    
    
    264Additional paid-in capital
    
    
    325,243
    
    
    
    323,947Unearned compensation
    
    
    (2,031
    )
    
    
    (1,145
    )Distributions in excess of earnings
    
    
    (85,701
    )
    
    
    (82,862
    )Total shareholders equity
    
    
    237,813
    
    
    
    240,241Total liabilities, minority interest and shareholders equity
    
    $
    425,117
    
    
    $
    424,380
 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 EndedMarch 31, 2005
    
    
    March 31, 2004Operating revenue:Rooms
    
    $
    32,232
    
    
    $
    28,845Food and beverage
    
    
    2,145
    
    
    
    1,960Other operating departments
    
    
    849
    
    
    
    988Percentage lease revenue
    
    
    
    
    
    
    692Joint venture fee income
    
    
    61
    
    
    
    28Total operating revenue
    
    
    35,287
    
    
    
    32,513Hotel operating expenses:Rooms
    
    
    7,361
    
    
    
    6,501Food and beverage
    
    
    1,738
    
    
    
    1,469Other operating departments
    
    
    721
    
    
    
    721Undistributed operating expenses:Property operating expenses
    
    
    7,492
    
    
    
    6,963Real estate taxes and property and casualty insurance
    
    
    1,812
    
    
    
    1,639Franchise costs
    
    
    2,336
    
    
    
    2,077Maintenance and repair
    
    
    2,083
    
    
    
    1,799Management fees
    
    
    799
    
    
    
    716General and administrative
    
    
    1,989
    
    
    
    1,631Depreciation
    
    
    4,747
    
    
    
    4,358Amortization
    
    
    256
    
    
    
    328Total operating expenses
    
    
    31,334
    
    
    
    28,202Operating income
    
    
    3,953
    
    
    
    4,311Other and interest income (expense)Interest and other income
    
    
    1,520
    
    
    
    334Interest expense
    
    
    (2,407
    )
    
    
    (1,731
    )Income before allocation to minority interest in Partnership,
allocation to minority interest in consolidated joint
ventures,
income taxes, and equity in income of unconsolidated
joint ventures
    
    
    3,066
    
    
    
    2,914(Income) loss allocation to minority interest in Partnership
    
    
    (59
    )
    
    
    6Income allocation to minority interest in consolidated joint ventures
    
    
    (128
    )
    
    
    (184
    )Income tax benefit
    
    
    209
    
    
    
    672Equity in loss of unconsolidated joint ventures
    
    
    (62
    )
    
    
    (21
    )Income from continuing operations
    
    
    3,026
    
    
    
    3,387Discontinued operations:Earnings from discontinued operations
    
    
    37
    
    
    
    118Gain (loss) on sale of discontinued operations
    
    
    (85
    )
    
    
    285Loss on impairment of asset held for sale
    
    
    
    
    
    
    (23
    )Net income
    
    
    2,978
    
    
    
    3,767Preferred stock distribution
    
    
    (1,840
    )
    
    
    (1,795
    )Loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    (1,720
    )Net income available to common shareholders
    
    $
    1,138
    
    
    $
    252Weighted average number of common shares outstanding
    
    
    27,601
    
    
    
    27,578Income per common share basic and diluted:Income from continuing operations
    
    $
    0.04
    
    
    $
    Income from discontinued operations
    
    
    
    
    
    
    0.01Net income
    
    $
    0.04
    
    
    $
    0.01Per share dividends to common shareholders
    
    $
    0.15
    
    
    $
    0.15
 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, 2005
 (in thousands, except per share amounts)
 Additional
    
    
    
    
    
    
    Distributions
    
    
    TotalPreferred Stock
    
    
    Common Stock
    
    
    Paid-in
    
    
    Unearned
    
    
    In Excess of
    
    
    ShareholdersShares
    
    
    Dollars
    
    
    Shares
    
    
    Dollars
    
    
    Capital
    
    
    Compensation
    
    
    Earnings
    
    
    EquityBalances at December 31, 2004
    
    
    3,680
    
    
    $
    37
    
    
    
    26,398
    
    
    $
    264
    
    
    $
    323,947
    
    
    $
    (1,145
    )
    
    $
    (82,862
    )
    
    $
    240,241Issuance of shares and other
    
    
    
    
    
    
    
    
    
    
    115
    
    
    
    1
    
    
    
    1,296
    
    
    
    (1,305
    )
    
    
    
    
    
    
    (8
    )Distributions ($0.15 per common share)
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,977
    )
    
    
    (3,977
    )Distributions ($0.50 per preferred B
share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,840
    )
    
    
    (1,840
    )Unearned compensation amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    419
    
    
    
    
    
    
    
    419Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,978
    
    
    
    2,978Balances at March 31, 2005
    
    
    3,680
    
    
    $
    37
    
    
    
    26,513
    
    
    $
    265
    
    
    $
    325,243
    
    
    $
    (2,031
    )
    
    $
    (85,701
    )
    
    $
    237,813
 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 EndedMarch 31, 2005
    
    
    March 31, 2004Cash flows from operating activities:Net income
    
    $
    2,978
    
    
    $
    3,767Adjustments to reconcile net income to net cash
provided by operating activities:Income allocation to minority interest
    
    
    56
    
    
    
    12Income allocation to consolidated joint ventures
    
    
    128
    
    
    
    184Depreciation
    
    
    4,747
    
    
    
    4,539Amortization
    
    
    256
    
    
    
    329Income tax benefit
    
    
    (203
    )
    
    
    (644
    )Loss (gain) on sale of hotel properties
    
    
    90
    
    
    
    (299
    )Loss on impairment of hotel properties
    
    
    
    
    
    
    24Loss allocations from unconsolidated joint ventures
    
    
    62
    
    
    
    21Unearned compensation amortization
    
    
    419
    
    
    
    231Changes in assets and liabilities:Lease revenue receivable
    
    
    
    
    
    
    179Accounts receivable
    
    
    (370
    )
    
    
    (1,155
    )Prepaid expenses and other assets
    
    
    (1,311
    )
    
    
    842Accounts payable and accrued expenses
    
    
    (308
    )
    
    
    (3
    )Net cash provided by operating activities
    
    
    6,544
    
    
    
    8,027Cash flows from investing activities:Note receivable
    
    
    (5,700
    )
    
    
    (2,400
    )Receipt of note receivable paydown
    
    
    6,035
    
    
    
    Deferred acquisition costs
    
    
    
    
    
    
    10Acquisition of minority interest
    
    
    
    
    
    
    (8,162
    )Investment in hotel properties
    
    
    (3,780
    )
    
    
    (5,032
    )Sale of hotel properties
    
    
    5,527
    
    
    
    3,350Investment in unconsolidated joint ventures
    
    
    
    
    
    
    (617
    )Net cash provided by (used in) investing activities
    
    
    2,082
    
    
    
    (12,851
    )Cash flows from financing activities:Fees paid in connection with financing activities
    
    
    (2,763
    )
    
    
    (186
    )Payment of distributions to shareholders
    
    
    (5,799
    )
    
    
    (6,734
    )Payment of distributions to minority interest
    
    
    (195
    )
    
    
    (195
    )Payment of distributions to minority interest in consolidated joint ventures
    
    
    (166
    )
    
    
    (467
    )Proceeds from issuance of Series B Preferred shares, net
    
    
    
    
    
    
    88,850Redemption of Series A Preferred shares, net
    
    
    
    
    
    
    (75,000
    )Net increase in due to banks
    
    
    3,150
    
    
    
    8,700Proceeds from long-term debt
    
    
    940
    
    
    
    1,117Payment of long-term debt
    
    
    (467
    )
    
    
    (9,802
    )Net cash provided by (used in) financing activities
    
    
    (5,300
    )
    
    
    6,283Net increase in cash
    
    
    3,326
    
    
    
    1,459Cash at beginning of period
    
    
    4,115
    
    
    
    5,623Cash at end of period
    
    $
    7,441
    
    
    $
    7,082Supplemental disclosure:Cash paid for interest
    
    $
    2,362
    
    
    $
    1,746Summary of non-cash investing and financing activities:Distributions to shareholders declared but not paid
    
    $
    5,817
    
    
    $
    5,746Distributions to minority interest declared but not paid
    
    $
    195
    
    
    $
    195Deferred equity compensation
    
    $
    1,305
    
    
    $
    709Interest rate swap adjustment to market value
    
    $
    
    
    
    $
    33Adjustment to minority interest due to
issuance of common stock
    
    $
    8
    
    
    $
    27Sale of hotel property for note receivable
    
    $
    (1,425
    )
    
    $
    
 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, owns and
develops hotel properties and owns interests in hotel properties through joint ventures,
provides and purchases hotel loans, and provides hotel development and asset management
services. The Company conducts substantially all of its operations through its operating
partnership, WINN Limited Partnership, (the Partnership). The Company and the Partnership
(together with the Partnerships wholly-owned subsidiaries, Barclay Hospitality Services Inc.
(Barclay), Winston SPE, LLC (SPE), Winston SPE II, LLC (SPE II), and Winston Finance LLC,
are collectively referred to as the Company. As of March 31, 2005, the Companys ownership in
the Partnership was 95.33%. The Company operates so as to qualify as a real estate investment
trust (REIT) for federal income tax purposes.As of March 31, 2005, the Company owned or was invested in 50 hotel properties in 15 states
having an aggregate of 7,011 rooms. This included 43 wholly owned properties with an aggregate
of 6,088 rooms, a 49 percent ownership interest in one joint venture hotel with 118 rooms, a
48.8 percent ownership interest in one joint venture hotel with 147 rooms, and a 13.05 percent
ownership interest in five joint venture hotels with an aggregate of 658 rooms. The Company had
also issued loans to owners of 11 hotels with an aggregate of 1,780 rooms. The Company does not
hold an ownership interest in any of the hotels for which it has provided financing. All of the
hotels in which the Company holds an ownership interest 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 four hotels, Promus Hotels, Inc., an affiliate of Hilton
Hotels Corporation, manages three hotels, and New Castle Hotels, LLC, Noble Investment Group,
Ltd., and Prism Hospitality Corp. each manage one hotel.2.
    BASIS OF PRESENTATION AND ACCOUNTING POLICIESBasis of PresentationThe accompanying unaudited consolidated financial statements reflect, in the opinion of
management, all adjustments necessary for a fair statement of the results for the interim
periods presented. All such adjustments are of a normal and recurring nature. Certain
reclassifications have been made to the 2004 financial statements to conform to the 2005
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, 2005 and 2004 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, 2004.Accounting for Long-Lived AssetsThe Company evaluates the potential impairment of its individual long-lived assets, principally
its wholly-owned hotel properties and the hotel properties in which it owns an interest through
consolidated joint ventures in accordance with FASB No. 144 Accounting for the Impairment or
Disposal of Long-Lived Assets. 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. Changes in market
conditions or poor operating results of underlying investments could adversely impact the
Companys assumptions regarding future undiscounted cash flows and anticipated liquidation
amounts therefore requiring an immediate material impairment charge. Further, the Company
currently owns certain hotels for which the carrying value exceeds current market value. The
Company 7




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##### 



does not believe an impairment charge for these hotels is appropriate at this time since the
Companys forecast of future undiscounted cash flows, including an anticipated liquidation
amount, exceeds the current carrying value. The Company is continually looking for
opportunities to upgrade its portfolio by selling older, lower performing hotels and replacing
them with newer, higher yielding assets. Should the Company approve a plan to sell any of the
hotels for which the carrying value exceeds fair market value, an impairment charge would be
required at that time. If our board of directors determines to sell several
of the hotels for which the carrying value exceeds fair market value, the aggregate impairment
charge could be material.One of the Companys hotels is being closely monitored due to adverse
market conditions, including a substantial road
construction project, and declining operating results. If the
Companys estimates regarding the improvement of market conditions and operating results prove
to be incorrect or adversely change and the Companys estimate
of the sum of the undiscounted future cash flows of this hotel plus
the Companys estimate of its residual value does not exceed the
current carrying value, it is reasonably possible that in the near term the Company
will record a material impairment charge with respect to this hotel. In addition, if the
Company decides to sell this hotel, an impairment charge would be
necessary at that time. Taking into
consideration the Companys current estimate of fair market
value for this hotel of between
$6.0 million and $8.0 million, and
the net book value of approximately $13.8 million, the Company estimates that the impairment
charge could be up to approximately $8.0 million. Should the
Company decide to sell this hotel, there can be no assurances that the
selling price will be within the Companys estimated range for
the fair market value of the hotel, in which case this impairment
charge could exceed $8.0 million.The Company evaluates its investments in joint ventures for impairment by considering a number
of factors including assessing current fair value of the investment to carrying value. If the
current fair value of the investment is less than the carrying value, and there is either an
absence of an ability to recover the carrying value of the investment, or the property does not
appear to have the ability to sustain an earnings capacity that would justify the carrying
amount of the investment, an impairment charge may be required.Minority InterestMinority interest as of March 31, 2005 and December 31, 2004, consists of minority interest in
the Partnership of $7,125 and $7,255, respectively, and minority interest in consolidated joint
ventures of $2,861 and $2,899, respectively.Franchise AgreementsThe Companys franchisors periodically inspect the Companys hotels to ensure that they meet
certain brand standards primarily pertaining to the condition of the property and its guest
service scores. In connection with these routine reviews the Company has received default
notices from franchisors of seven hotels. These notices pertain to low guest service scores or
failure to complete product improvement plans on schedule. The Company is currently in the
process of curing these deficiencies to comply with the respective franchisors standards and
expects to receive an acceptable rating for all hotels.Recently Issued Accounting Standards.In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (Revised
2004), Share-Based Payment, (SFAS No. 123R), which is effective for fiscal years beginning
after June 15, 2005. SFAS No. 123R is a revision of FASB Statement No. 123, (Accounting for
Stock-Based Compensation). SFAS No. 123R is not expected to have a material impact on the
Companys financial statements or results of operations.In December 2004, the FASB issued Statement of Financial Accounting Standards No. 152
Accounting for Real Estate Time-Sharing Transactions, (SFAS No. 152), which is effective for
fiscal years beginning after June 15, 2005. SFAS No. 152 is not expected to have a material
impact on the Companys financial statements or results of operations.In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153,
Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, (SFAS No. 153), which
is effective for fiscal years beginning after June 15, 2005. SFAS No. 153 is not expected to
have a material impact on the Companys financial statements or results of operations. 8




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##### 



3.
    CREDIT FACILITIESThe Companys $125,000 line of credit (the Wachovia Line) bore interest at rates from LIBOR
plus 1.75% to 2.50%, based on the Companys consolidated debt leverage ratio. The Wachovia Line,
which had an original maturity date of December 31, 2004, was amended in December 2004 to extend
the maturity date to March 31, 2005.On March 11, 2005, the Company through its wholly-owned subsidiary, SPE II, entered into a
credit facility (the GE Line) with General Electric Capital Corporation (GECC). The Company
subsequently borrowed $77,500 under the GE Line on March 14, 2005 and used these funds to pay
off all outstanding debt under the Wachovia Line, terminating the Wachovia Line. The GE Line
provides for revolving loan commitments and letters of credit up to $155,000. The GE Line bears
interest at rates from 30-day to 180-day LIBOR (30-day LIBOR equaled 2.87% at March 31, 2005)
plus 1.75% to 2.50%, based on the ratio of the underwritten net operating income of the hotels
that collateralize the GE Line to the outstanding principal balance of the GE Line. An unused
fee of up to 0.25% is also payable quarterly on the unused portion of the GE Line. Availability
is calculated each quarter on a trailing twelve-month basis based primarily upon the
underwritten net operating income of the hotels that collateralize the GE Line divided by 13%.
Availability on the GE line at March 31, 2005 was approximately $77,000. The GE Line matures on
March 11, 2010.4.
    EARNINGS PER SHAREThe following is a reconciliation of net income to net income available to common shareholders
assuming dilution and the weighted average number of common shares used in calculating basic and
fully diluted earnings per common share: Three Months EndedMarch 31,2005
    
    
    2004Net income
    
    $
    2,978
    
    
    $
    3,767Less: preferred stock distributions
    
    
    (1,840
    )
    
    
    (1,795
    )Less: loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    (1,720
    )Net income available to common shareholders
    
    
    1,138
    
    
    
    252Plus: income allocation to minority interest
    
    
    56
    
    
    
    12Net income available to common
shareholders - assuming dilution
    
    $
    1,194
    
    
    $
    264Weighted average number of common shares
    
    
    26,283
    
    
    
    26,216Minority interest units with redemption rights
    
    
    1,298
    
    
    
    1,298Stock options and stock grants
    
    
    20
    
    
    
    64Weighted average number of common shares
assuming dilution
    
    
    27,601
    
    
    
    27,578Earnings per
share - basic and assuming dilution
    
    $
    0.04
    
    
    $
    0.01
  During the first quarter of 2005, the Company declared quarterly cash dividends of $0.15 per
common share and $0.50 per Series B preferred share.5.
    INCOME TAXESThe income tax benefit for the three months ended March 31, 2005 consists of a deferred federal
income tax benefit of $182 and a deferred state income tax benefit of $21. 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 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, 2005. 9




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6.
    SUMMARIZED FINANCIAL STATEMENT INFORMATION FOR JOINT VENTURES AND FIN 46RFor the three months ended March 31, 2005 and 2004, the Company consolidated all voting interest
entities in which it owns a majority voting interest and all variable interest entities for
which it is the primary beneficiary in accordance with FASB Interpretations No. 46R,
Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51 (FIN 46R).Consolidated Joint VenturesMarsh Landing Joint Venture: During 2000, the Company entered into a joint venture,
Marsh Landing Hotel Associates, LLC (Marsh Landing Hotel Associates) with Marsh Landing
Investment, L.L.C.. The Company currently owns a 49 percent interest in both Marsh Landing
Hotel Associates, that owns the Ponte Vedra, Florida Hampton Inn and Marsh Landing Lessee
Company, LLC, (Marsh Landing Lessee), which leases the hotel from Marsh Landing Hotel
Associates. Marsh Landing Investments, LLC owns a 51 percent interest in both entities. The
results of operations and the balance sheet of these joint ventures are consolidated in the
Companys consolidated financial statements pursuant to FIN 46R and all intercompany accounts
are eliminated.Marsh Landing Hotel Associates: For the period ended March 31, 2005 and March 31, 2004,
total revenue of the joint venture was $372 and $401, total expenses were $209 and $191,
resulting in a net income of $163 and $210, respectively. As of March 31, 2005 and December 31,
2004, total assets of the joint venture were $7,018 and $7,044, total liabilities were $4,996
and $4,978, resulting in stockholders equity totaling $2,022 and $2,066, respectively.Marsh Landing Lessee: For the period ended March 31, 2005, total revenue of the joint
venture was $884, total expenses were $172, resulting in a net income of $712. As of March 31,
2005, total assets of the joint venture were $144, total liabilities were $70, resulting in
stockholders equity totaling $74. Marsh Landing Lessee began operations in January 2005.
Therefore there are no operating results or balances sheet amounts for the prior periods.Chapel Hill Joint Ventures: During 2003, the Company entered into a joint venture,
Chapel Hill Hotel Associates, LLC, (Chapel Hill Hotel Associates) with Chapel Hill
Investments, LLC to develop and own hotel properties. The Company currently owns a 48.78
percent interest in both Chapel Hill Hotel Associates, which owns the Chapel Hill Courtyard by
Marriott, and Chapel Hill Lessee Company, LLC, (Chapel Hill Lessee), which leases the Chapel
Hill Courtyard by Marriott from Chapel Hill Hotel Associates., Chapel Hill Investments, LLC
owns a 51.22 percent interest in both entities. The results of operations and the balance sheet
of these joint ventures are consolidated in the Companys consolidated financial statements and
all intercompany accounts are eliminated pursuant to FIN 46R.Chapel Hill Hotel Associates: For the period ended March 31, 2005, total revenue of the
joint venture was $427 and $2, total expenses were $421 and $55, resulting in a net income of $6
and a net loss of $53, respectively. The Chapel Hill Courtyard by Marriott opened in September
2004, therefore, there were no hotel operating results for the first quarter of 2004. As of
March 31, 2005 and December 31, 2004, total assets of the joint venture were $14,368 and
$13,576, total liabilities were $10,820 and $9,916, resulting in stockholders equity totaling
$3,548 and $3,660, respectively.Chapel Hill Lessee: For the period ended March 31, 2005, total revenue of the joint
venture was $992, total expenses were $240, resulting in a net income of $752. Chapel Hill
Lessee began operations in May 2004. Therefore, there were no operating results for the first
quarter of 2004. As of March 31, 2005 and December 31, 2004, total assets of the joint venture
were $148 and $130, total liabilities were $197 and $187, resulting in stockholders deficit
totaling $49 and $57, respectively.Unconsolidated Joint VenturesCharlesbank Joint Venture: During the fourth quarter of 2002, the Company formed a joint
venture (the Charlesbank Venture) with Boston-based Charlesbank Capital Partners, LLC
(Charlesbank). The Company owns 15% of the Charlesbank Venture and Charlesbank owns 85%. The
Charlesbank Venture focuses on acquisitions that the partners believe have turnaround or upside
potential and can benefit from additional capital and aggressive asset management, which often
includes renovating, repositioning, rebranding and/or a change in management. As of March 31,
2005, the Charlesbank Venture had invested in four hotels to date through a joint venture (WCC
Project Company 10




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LLC) comprised of Concord Hospitality Enterprises Company (Concord) and the Charlesbank
Venture. Concord owns a 13% interest in the projects acquired by WCC Project Company LLC, while
the Charlesbank Venture owns 87%, so that the Company has an indirect 13.05% ownership interest
in WCC Project Company LLC. In February 2004, the Charlesbank Venture invested in a fifth hotel
through a joint venture with Shelton III Hotel Equity LLC, owned in part by New Castle Hotels
LLC (New Castle) and the Charlesbank Venture (WNC Project Company LLC). 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 results of operations and the balance sheets of these five hotels are not consolidated in
the Companys consolidated financial statements. Therefore, the Company accounts for its
investment in these hotels under the equity method of accounting. For the year ended March 31,
2005 and March 31, 2004, total revenue of the Charlesbank joint venture was $3,085 and $2,306,
total expenses were $3,447 and $2,433, resulting in a net loss of $362 and $127, respectively.
As of March 31, 2005 and December 31, 2004, total assets of the joint venture were $50,300 and
$50,528, total liabilities were $34,204 and $34,071, resulting in stockholders equity totaling
$16,096 and $16,457, respectively. The Companys equity balance exposed to loss as a result of
its involvement in this joint venture totaled $2,450 and $2,512 as of March 31, 2005 and
December 31, 2004, respectively.Notes ReceivableFirst Quarter 2005 Loans. In February 2005, the Company issued a $3.4 million mezzanine
loan to finance the development of a 165-room Hampton Inn & Suites in Albany, New York. M&T
Realty provided an $11.5 million first mortgage loan. The Companys loan is subordinate to the
M&T Realty first mortgage loan. The term of the Companys loan is 6.5 years. During the term
of the loan, interest will be payable at 30-day LIBOR (2.87% at March 31, 2005) plus 9.41%. In
addition during this period, interest in the amount of 4.0% will accrue and be added to the
outstanding principal balance on the note and shall be due and payable upon repayment of the
loan. Interest will not be paid on the accrued interest.In March 2005, the Company purchased from Lehman Brothers $2.8 million of B-notes for $2.3
million. The fixed-rate notes are collateralized by second mortgages on three hotels with a
weighted average yield at the time of purchase of 9.3% and each has a remaining term of
approximately six years. The total monthly payment is a fixed amount, with interest and
principal varying based on the amortization schedule. The three B-Notes, which are debt
subordinated to the first mortgage A note, are cross-collateralized. The A note is
collateralized by the first mortgages on each of the three assets, which are held in a
Collateralized Mortgage-Backed Securities trust. The loans are collateralized by a 146-room
SpringHill Suites and a 91-room TownePlace Suites, both in Boca Raton, Florida, and a 95-room
TownePlace Suites in Fort Lauderdale, Florida.All Notes Receivable. As of March 31, 2005, the Company has 11 loans to third party
hotel owners. The Company does not hold an ownership interest in any of the hotels for which it
has provided financing. The Company issued or purchased four of these loans during 2005 as
noted above. The Company issued four of these loans currently totaling $19.9 million, during
2004. The Company issued one loan in each of 2002, 2001 and 2000 currently totaling $1.7
million, $2.2 million and $1.1 million, respectively. These loan arrangements are considered to
be variable interests in the entities that own the hotels, all 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 balance exposed to loss
as a result of its involvement in these loans totaled $30,526 and $1,157, respectively, as of
March 31, 2005. The Companys note receivable balance as a result of the sale of the
Greenville, South Carolina Comfort Inn was $1,413 at March 31, 2005 (See Note 7). 11




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7.
    DISCONTINUED OPERATIONSThe Company sold two hotels during January 2005. The Chester, Virginia Comfort Inn was sold for
$5.2 million in cash, net of closing costs. The Greenville, South Carolina Comfort Inn was sold
for $1.9 million of which the Company received approximately $0.5 million in cash proceeds and a
note receivable for approximately $1.4 million. The note requires monthly fixed principal
payments of $6 over five years, (at which time the balance of the note is due) and bears
interest at a rate of prime plus 1.5%. Both of these properties were classified as held for
sale as of December 31, 2004.In February 2004, the Company sold its 118-room Hampton Inn in Wilmington, North Carolina. In
June 2004, the Company sold its 128-room Hampton Inn in Las Vegas, Nevada. The operating
results for these four hotels are included in discontinued operations in the statements of
operations until their sales date. The Company has elected not to allocate interest expense to
the results of the discontinued operations in accordance with SFAS No. 144. Including
additional hotels in discontinued operations resulted in certain reclassifications to the three
months ended March 31, 2004 financial statement amounts. The 2005 loss on sale was in addition
to the estimated impairment losses taken in 2004 and 2003, relating to the Greenville, South
Carolina Comfort Inn.Condensed financial information of the results of operations for the hotels sold and included in
discontinued operations is as follows: Three Months EndedMarch 31,2005
    
    
    2004Total revenue
    
    $
    173
    
    
    $
    1,483Total expenses
    
    
    127
    
    
    
    1,330Income from discontinued operations
    
    
    46
    
    
    
    153Allocation to minority interest in Partnership -
income
from discontinued operations
    
    
    (2
    )
    
    
    (6
    )Gain (loss) on sale of discontinued operations
    
    
    (90
    )
    
    
    299Allocation
to minority interest in Partnership - gain
(loss) on sale of discontinued operations
    
    
    5
    
    
    
    (14
    )Loss on impairment of asset held for sale
    
    
    
    
    
    
    (24
    )Allocation to minority interest in Partnership -
loss on
impairment of asset held for sale
    
    
    
    
    
    
    1Income tax expense
    
    
    (7
    )
    
    
    (29
    )Income (loss) from discontinued operations
    
    $
    (48
    )
    
    $
    380
 12




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Item 2 -
    Managements Discussion and Analysis of FinancialCondition and Results of Operations($ in thousands) Overview Winston Hotels, Inc., (the Company) headquartered in Raleigh, North Carolina, owns and develops
hotel properties and owns interests in hotel properties through joint ventures, provides and
purchases hotel loans and provides hotel development and asset management services. As of March
31, 2005, the Company owned or was invested in, through its equity interests in joint venture
entities, 50 hotel properties in 15 states having an aggregate of 7,011 rooms. This included 43
wholly owned properties with an aggregate of 6,088 rooms, a 49 percent ownership interest in one
joint venture hotel with 118 rooms, a 48.78 percent ownership interest in one joint venture hotel
with 147 rooms, and a 13.05 percent ownership interest in five joint venture hotels with an
aggregate of 658 rooms. The Company also had issued loans to owners of 11 hotels with an aggregate
of 1,780 rooms. The Company does not hold an ownership interest in any of the hotels for which it
has provided financing. All of the Companys hotels are operated under franchises from nationally
recognized franchisors including Marriott International, Inc., Hilton Hotels Corporation,
Intercontinental Hotels Group PLC, (formerly Six Continents PLC) and Choice Hotels International. Currently, Alliance Hospitality Management, LLC manages 40 of the Companys 50 hotels, Concord
Hospitality Enterprises Company manages four hotels, Promus Hotels, Inc., an affiliate of Hilton
Hotels Corporation, manages three hotels, and New Castle Hotels, LLC, Noble Investment Group, Ltd.,
and Prism Hospitality Corp. each manage one hotel. 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, income taxes of our consolidated
taxable REIT subsidiary, depreciation, amortization, and other costs. The Company has significant
fixed-costs associated with owning and operating hotels, which do not necessarily decrease when
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, developing hotels on selected sites and providing and purchasing hotel loans. Results of Operations for the Three Months Ended March 31, 2005 versus the Three Months Ended March
31, 2004 Revenue Room For the three months ended March 31, room revenue increased $3,387 from $28,845 in 2004 to $
32,232 in 2005. In March 2004, the Company acquired the lease for the Secaucus, New Jersey Holiday
Inn from a third party lessee. In September 2004, the Company opened the Chapel Hill, North
Carolina Courtyard by Marriott. In December 2004, the Company purchased the Roanoke, Virginia
Courtyard by Marriott. The additional room revenue generated by these three hotels, collectively
(the New Hotels), during the first quarter of 2005 as compared to the first quarter of 2004,
totaled $2,483. The increase in room revenues was also due, in part, to an increase in RevPAR of
4.3 percent from $53.15 in the first quarter of 2004 to $55.41 due to improving market conditions.
Occupancy rates decreased 2.2 percent, from 66.8 percent to 65.3 percent, and the average daily
rate (ADR) increased 6.7 percent from $79.55 to $84.85, during the first quarter of 2005, as
compared to the same period of 2004. Food and Beverage For the three months ended March 31, food and beverage revenue increased $185
from $1,960 in 2004 to $2,145 in 2005. The additional food and beverage revenue generated by the
New Hotels during the first quarter of 2005 as compared to the first quarter of 2004, totaled $247.
The remaining decrease in food and beverage revenues is due, in part, to decreased occupancy
experienced at the Companys full service properties. 13




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Other Operating Departments Other operating departments revenue decreased $139 from $988 in 2004
to $849 in 2005. Meeting room rentals increased slightly, offset by lower telephone revenue as
cellular phone use continues to reduce the demand for this service. Percentage Lease Revenue The 2004 results include percentage lease revenue for the Secaucus
Holiday Inn which was acquired by Barclay Hospitality in March of 2004. The Company is no longer
the lessor under any hotel leases with unrelated third parties and thus will no longer report
percentage lease revenue. Expenses Rooms For the three months ended March 31, rooms expenses increased $860 from $6,501 in 2004 to
$7,361 in 2005. The additional room expense generated by the New Hotels during the first quarter
of 2005 as compared to the first quarter of 2004, totaled $543. The remaining increase in rooms
expenses during the first quarter of 2005 is due, in part, to increases in labor costs, travel
agent commissions and complimentary food and beverage costs. The increase in these costs is
consistent with the increase in room revenue for the three months ended March 31, 2005 versus the
three months ended March 31, 2004. Food and Beverage For the three months ended March 31, food and beverage expenses increased $269
from $1,469 in 2004 to $1,738 in 2005. Food and beverage revenue from the New Hotels was the
primary reason for the increase. Excluding these three properties expenses were consistent with
the same period in the prior year. Property Operating Costs For the three months ended March 31, property operating costs increased
$529 from $6,963 in 2004 to $7,492 in 2005. Property operating costs attributed to the New Hotels
was the primary reason for the increase. Excluding these three properties expenses were consistent
with the same period in the prior year. Real Estate Taxes and Property and Casualty Insurance Real estate taxes and property insurance
costs increased $173 from $1,639 in 2004 to $1,812 in 2005. The inclusion of our Roanoke and
Chapel Hill hotels in the 2005 results contributed to $61 of the increase. The remaining change is
primarily due to an increase in property taxes. Franchise Costs Franchise costs increased consistently with the increase in room revenues,
increasing $259 from $2,077 in the three months ended March 31, 2004 to $2,336 in the three months
ended March 31, 2005. The additional franchise costs generated by the New Hotels during the first
quarter of 2005 totaled $172. The additional increase is due to higher room revenue. Maintenance and Repair Costs For the three months ended March 31, maintenance and repair costs
increased $284 from $1,799 in 2004 to $2,083 in 2005. The additional costs generated by the New
Hotels during the first quarter of 2005 as compared to the first quarter of 2004, totaled $165.
The additional increase is due, in part, to increases in maintenance contracts and landscaping
charges. Management Fees Management fees increased $83 from $716 in the three months ended March 31, 2004
to $799 in the three months ended March 31, 2005 consistent with the increase in hotel revenues for
those periods. The additional costs generated by the New Hotels during the first quarter of 2005
totaled $63. General and Administrative For the three months ended March 31, general and administrative
expense increased $358 from $1,631 in 2004 to $1,989 in 2005. The increase is primarily
attributable to an increase in payroll costs. Depreciation and Amortization Depreciation expense is increasing as additions outpace the amount
of assets exceeding their useful life. For the three months ended March 31, 2005, amortization
expense declined slightly from the same period in the prior year. Interest and Other Income For the three months ended March 31, 2005 versus the same periods for
2004, interest and other income increased $1,186 from $334 to $1,520. The increase is primarily
due to additional loan interest income relating to the new hotel loans that the Company has
provided or purchased including those with respect to the St. Louis, Kauai, La Posada and Albany
hotels and the B-notes purchased from Lehman, as well as the early payoff of the Lincoln, Nebraska
hotel loan. The Company continues its efforts to expand its hotel lending program. 14




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Interest Expense For the three months ended March 31, interest expense increased $676 from $1,731
in 2004 to $2,407 in 2005. For the three months ended March 31, the weighted average outstanding
debt balance for the Companys lines of credit and fixed rate loan with GE Capital Corporation,
(collectively, the Corporate Debt Facilities) increased from $98,848 in 2004 to $133,420 in 2005,
while the weighted average interest rate for the Corporate Debt Facilities decreased from 5.98
percent to 5.89 percent for the same periods. The increase is also due to additional interest
expense totaling $142 related to the first mortgage loan for the Chapel Hill, NC Courtyard by
Marriott hotel that opened in September 2004. Income (Loss) Allocation to Minority Interest in Partnership Income (loss) allocation to minority
interest in the Partnership increased for the three months ended March 31, 2005 versus the
comparable periods of 2004. The increase is consistent with the increase in net income available
to common shareholders for the period offset by a decrease in minority interest ownership
percentage in the Partnership from 4.69% as of March 31, 2004 to 4.67% as of March 31, 2005. Income Allocation to Minority Interest in Consolidated Joint Ventures These amounts represent the
minority equityholders share of net income of the consolidated joint ventures. Income Tax Benefit For the three months ended March 31, 2005 and 2004, the income tax benefit is
a result of the net loss experienced by Barclay during the respective periods. As part of its tax
planning strategy to fully realize its deferred tax asset, the Company restructured the operating
leases between Barclay and the Company effective January 1, 2005. This restructuring of the leases
resulted in a reduction in Barclays lease expense, and therefore a significantly lower net loss in
the first quarter of 2005 versus the first quarter of 2004. Discontinued OperationsThe Company sold two hotels during January 2005. The Chester, Virginia
Comfort Inn was sold for $5.2 million in cash, net of closing costs. The Greenville, South
Carolina Comfort Inn was sold for $1.9 million of which the Company received approximately $0.5
million in cash proceeds and a note receivable for approximately $1.4. The note requires monthly
fixed principal payments of $6 over five years, (at which time the balance of the note is due) and
bears interest at a rate of prime plus 1.5%. The Company recorded a loss of $33 related to the
sale of the Chester Comfort Inn, and a loss of $57 related to the sale of the Greenville Comfort
Inn. These losses were in addition to the estimated impairment losses taken in 2004 and 2003,
relating to the Greenville, South Carolina Comfort Inn. The Greenville Comfort Inn was originally
classified as held for sale in the third quarter of 2003. The Company sold the Wilmington Hampton
Inn in February 2004 and sold the Las Vegas Hampton Inn in June 2004 for an aggregate gain of $299.
The operating results of the four properties are shown as discontinued operations in the
respective periods. Liquidity and Capital Resources Operating 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, 2005 and 2004, cash flow
provided by operating activities was $6,544 and $8,027, respectively. The decrease is primarily
driven by the decrease in net income and additional security deposits required for potential
acquisitions, partially offset by better collection efforts on the Companys accounts receivable. Investing The Companys net cash provided by investing activities for the three months ended March 31, 2005
totaled $2,082. Gross capital expenditures for the Company totaled $3,780. This included $2,692
for hotel related capital expenditures, $502 for the completion of the Courtyard by Marriott hotel
in Chapel Hill, which opened in September 2004 and $532 for capital expenditures for the Courtyard
by Marriott being constructed in Kansas City, MO. The Kansas City hotel is expected to open in
June 2006. During the remainder of 2005, the Company plans to spend approximately $9,400 (for a
total of approximately $12.1 million for 2005) to renovate certain of its wholly owned hotels and
consolidated joint venture hotels. These expected total capital expenditures for 2005 exceed by
approximately $5,000, 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. The Company plans to fund these capital expenditures from
operating cash flow, and possibly from borrowings under the GE 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 6.46% and 6.24% of room
revenues for the three months ended March 31, 2005 and 2004, respectively. 15




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The Chester, Virginia Comfort Inn was sold for $5.2 million in cash, net of closing costs. The
Greenville, South Carolina Comfort Inn was sold for $1.9 million of which the Company received
approximately $0.5 million in cash proceeds and a note receivable for approximately $1.4 million.
The note requires monthly fixed principal payments of $6 over five years (at which time the balance
of the note is due) and bears interest at a rate of prime plus 1.5%. 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. In February 2005, the Company issued a $3.4 million mezzanine loan to finance the development of a
165-room Hampton Inn & Suites in Albany, New York. The term of the Companys loan is 6.5 years.
During the term of the loan, interest will be payable at 30-day LIBOR (2.87% at March 31, 2005)
plus 9.41%. In addition during this period, interest in the amount of 4.00% shall accrue and be
added to the outstanding principal balance thereof, and shall be due and payable upon repayment of
the loan. In March 2005, the Company purchased from Lehman Brothers $2.8 million of B-notes for $2.3 million.
The fixed-rate notes have a remaining term of approximately six years. The total monthly payment
is a fixed amount, with interest and principal varying based on the amortization schedule. In March 2005, the $6 million Cornhusker Square hotel loan was prepaid in full. In connection with
this prepayment, the Company received accrued interest and prepayment fees totaling approximately
$410. The Company currently has investments in three joint ventures (See Note 6). 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, as well as opportunities to
invest in or provide hotel loans. 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. Financing The Companys net cash used in financing activities during the three months ended March 31, 2005
totaled $5,300. 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 2005, the Company paid distributions of $3,959 to its common
shareholders ($0.15 per share) and $1,840 to its Preferred Series B shareholders ($0.50 per share).
The Company also paid distributions of $195 to limited partnership unit holders in the Partnership
and $166 to minority equity holders in consolidated joint ventures. 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. On March 11, 2005, the Company, through its wholly-owned subsidiary, Winston SPE II, LLC (SPE II)
entered into a credit facility (the GE Line) with General Electric Capital Corporation (GECC).
The Company subsequently borrowed $77,500 under the GE Line on March 14, 2005 and used these funds
to pay off all outstanding debt under the Companys $125,000 line of credit (the Wachovia Line),
terminating the Wachovia Line. The GE Line provides for revolving loan commitments and letters of
credit up to $155,000. The GE Line bears interest at rates from 30-day to 180-day LIBOR (30-day
LIBOR equaled 2.87% at March 31, 2005) plus 1.75% to 2.50%, based on the ratio of the underwritten
net operating income of the hotels that collateralize the GE Line to the outstanding principal
balance of the GE Line. An unused fee of up to 0.25% is also payable quarterly on the unused
portion of the GE Line. The GE Line is collateralized by 23 of the Companys hotels. Availability
is calculated each quarter on a trailing twelve-month basis based primarily upon the underwritten
net operating income of the hotels that collateralize the GE Line, divided by 13%. The GE Line
matures on March 11, 2010. The table in ITEM 3 Quantitative and Qualitative Disclosures About Market Risk present the
maturities of the Companys fixed and variable interest rate debt. Thirty-seven of the Companys
wholly owned hotels have been pledged as collateral for the Companys debt securities, 23 against
the outstanding balance under the GE Line and 14 against the outstanding balance under the GE
Capital corporate fixed-rate loan. 16




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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 GE Line, through joint ventures, 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. 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 Note 6 to the consolidated financial statements. Contractual Obligations and Commercial Commitments During the normal course of business, the Company enters into acquisition agreements for the
purchase and sale of hotels. These agreements are subject to customary conditions and due
diligence. There were no significant changes, outside the normal course of business, in the
contractual obligations and commercial commitments disclosed in the Companys Annual Report on Form
10-K for the year ended December 31, 2004, except for the changes in the lines of credit as
explained in Note 3 to the consolidated financial statements. 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 loan borrowers to make
required payments. The Company reviews its accounts receivable aging report on a monthly basis and
discusses the status of receivable collections with appropriate hotel personnel to determine if
additional allowances are necessary. To analyze the collectibility of the notes receivable, the
Company reviews the monthly operating results of each respective hotel for which it has provided
financing. The Company also analyzes the operating results of the hotel to ensure that the
estimated market value of the hotel exceeds the total debt outstanding on the property. If the
financial results of the respective hotels were to deteriorate, allowances may be required. Accounting for Long-Lived Assets The Company evaluates the potential impairment of its
individual long-lived assets, principally its wholly-owned hotel properties and the hotel
properties in which it owns an interest through consolidated joint ventures in accordance with FASB
No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets. The Company records an
impairment charge when it believes an investment in 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. Changes
in market conditions or poor operating results of underlying investments could adversely impact the
Companys assumptions regarding future undiscounted cash flows and anticipated liquidation amounts
therefore requiring an immediate material impairment charge. 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 at this time since the Companys
forecast of future undiscounted cash flows, including an anticipated liquidation amount, exceeds
the current carrying value. Should the Company approve a plan to sell any of the hotels for which
the carrying value exceeds fair market value, an impairment 17




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charge would be required at that time. If our board of directors determines to
sell several of the hotels for which the carrying value exceeds fair market value, the aggregate
impairment charge could be material. One of the Companys hotels is being
closely monitored due to adverse market conditions, including a
substantial road
construction project, and declining operating results. If the
Companys estimates regarding the improvement of market conditions and operating results prove to
be incorrect or adversely change and the Companys estimate of
the sum of the undiscounted future cash flows of this hotel plus the
Companys estimate of its residual value does not exceed the
current carrying value, it is reasonably possible that in the near term the Company will
record a material impairment charge with respect to this hotel. In addition, if the Company
decides to sell this hotel, an impairment charge would be necessary
at that time. Taking into
consideration the Companys current estimate of fair market
value for this hotel of between $6.0 million and $8.0 million, and the
net book value of approximately $13.8 million, the Company estimates that the impairment charge
could be up to approximately $8.0 million. Should the Company
decide to sell this hotel, there can be no assurances that the
selling price will be within the Companys estimated range for
the fair market value of the hotel, in which case this impairment
charge could exceed $8.0 million. The Company evaluates its investments in joint ventures for impairment by considering a number of
factors including assessing current fair value of the investment to carrying value. If the current
fair value of the investment is less than the carrying value, and there is either an absence of an
ability to recover the carrying value of the investment, or the property does not appear to have
the ability to sustain an earnings capacity that would justify the carrying amount of the
investment, an impairment charge may be required. Franchise Agreements The Companys franchisors periodically inspect the Companys hotels to ensure that they meet
certain brand standards primarily pertaining to the condition of the property and its guest service
scores. In connection with these routine reviews, as of June 30, 2004, the Company had received a
default notice from the franchisor for one of its hotels, which was not cleared on reinspection.
The hotel passed the reinspection for all product improvement issues, but received an unacceptable
rating due to its customer service scores falling below brand standards. The Company believes this
decline in customer service scores was due, in part, to the ongoing construction to comply with the
brands product improvement requirements. The Company expects to cure this deficiency to comply
with the franchisors standards and expects to receive an acceptable rating for the hotel. From
June 30, 2004 to December 31, 2004, the Company received default notices from the respective
franchisor for five other hotels. Three of these notices pertained to low guest service scores
while the other notices were received for failure to complete a product improvement plan on
schedule. One hotel has since been reinspected and passed the reinspection since its customer
service scores exceeding brand standards. Since December 31, 2004, the Company received a default
notice from a franchisor for one additional hotel. This notice pertained to low guest service
scores. The Company is currently in the process of curing these deficiencies to comply with the
respective franchisors standards and expects to receive an acceptable rating for all hotels. 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 GE Line to make distributions to the equity
holders. Funds From Operations (FFO) The Company reports FFO in accordance with the definition of the National Association of Real
Estate Investment Trusts (NAREIT). NAREIT defines FFO as net income (loss) (determined in
accordance with generally accepted accounting principles, or GAAP), excluding gains (losses) from
sales of property, plus depreciation and amortization and after adjustments for unconsolidated
partnerships and joint ventures (which are calculated to reflect FFO on the same basis). The
Company further subtracts preferred stock dividends and loss on redemption of Series A preferred
stock from FFO to calculate FFO available to common shareholders. FFO available to common
shareholders is a performance measure used by the Company in its budgeting and forecasting models;
it is discussed during Board meetings, and is considered when making decisions regarding
acquisitions, sales of properties, compensation and other investments. Actual results are compared
to budget and forecast on a monthly basis. The calculation of FFO and FFO available to common
shareholders may vary from entity to entity, and as such, the presentation of FFO and FFO available
to common shareholders by the 18




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##### 



Company may not be comparable to other similarly titled measures of other reporting companies. FFO
and FFO available to common shareholders are not intended to represent cash flows for the period.
FFO and FFO available to common shareholders have not been presented as an alternative to operating
income, and should not be considered in isolation or as a substitute for measures of performance
prepared in accordance with GAAP. FFO is a supplemental industry-wide measure of REIT operating performance, the definition of which
was first proposed by NAREIT in 1991 (and clarified in 1995, 1999 and 2002) in response to
perceived drawbacks associated with net income under GAAP as applied to REITs. Since the
introduction of the definition by NAREIT, the term has come to be widely used by REITs. Historical
cost accounting for real estate assets implicitly assumes that the value of real estate assets
diminishes predictably over time. Since real estate values instead have historically risen or
fallen with market conditions, most industry investors have considered presentations of operating
results for real estate companies that use historical GAAP cost accounting to be insufficient by
themselves. Accordingly, the Company believes FFO and FFO available to common shareholders
(combined with the Companys primary GAAP presentations required by the SEC) help improve our
investors ability to understand the Companys operating performance. The Company only uses FFO
available to common shareholders as a supplemental measure of operating performance. Shown below
is a reconciliation of net income to FFO and FFO available to common shareholders. RECONCILIATION AND CALCULATION OF FFO AND
FFO AVAILABLE TO COMMON SHAREHOLDERS
(in thousands) For the Quarter EndedMarch 31,2005
    
    
    2004Net income
    
    $
    2,978
    
    
    $
    3,767(Gain) loss on sale of discontinued operations
    
    
    90
    
    
    
    (299
    )Minority interest in Partnership allocation of income (loss)
    
    
    59
    
    
    
    (8
    )Minority interest in Partnership allocation of gain
(loss) on sale of discontinued operations
    
    
    (5
    )
    
    
    14Minority interest in Partnership allocation of earnings
from discontinued operations
    
    
    2
    
    
    
    6Depreciation
    
    
    4,477
    
    
    
    4,064Depreciation from discontinued operations
    
    
    
    
    
    
    180Depreciation from joint ventures
    
    
    191
    
    
    
    207FFO
    
    
    7,792
    
    
    
    7,931Loss on redemption of Series A Preferred Stock
    
    
    
    
    
    
    (1,720
    )Preferred stock dividend
    
    
    (1,840
    )
    
    
    (1,795
    )FFO Available to Common Shareholders
    
    $
    5,952
    
    
    $
    4,416
 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 the Companys Annual
Report on Form 10-K for the year ended December 31, 2004. 19




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Item 3 -
    Quantitative and Qualitative Disclosures About Market Risk($ in thousands) As of March 31, 2005, the Companys primary market risk exposure is to changes in interest rates on
its GE Line and other debt. The Companys interest rate risk objectives are to limit the impact of
interest rate fluctuations on earnings and cash flows and to lower its overall borrowing costs. To
achieve these objectives, the Company manages its exposure to fluctuations in market interest rates
for a portion of its borrowings through the use of fixed rate debt instruments to the extent that
reasonably favorable rates are obtainable with such arrangements. The Company may enter into
derivative financial instruments such as interest rate swaps or caps and treasury options or locks
to mitigate its interest rate risk on a related financial instrument or to effectively lock the
interest rate on a portion of its variable rate debt. As required by the GE Line, on March 14,
2005, the Company, through SPE II, entered into an interest rate cap agreement to eliminate the
exposure to increases in 30-day LIBOR over 6.42% on principal balances up to $155 million
outstanding. The interest rate cap agreement terminates on October 2, 2006. The Company does not
enter into derivative or interest rate transactions for speculative purposes. The Company regularly
reviews interest rate exposure on its outstanding borrowings in an effort to minimize the risk of
interest rate fluctuations. The definitive extent of the Companys interest rate risk under the GE Line and other variable-rate
debt 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, 2005 would have increased by approximately
$216, 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 provides information at March 31, 2005 about the
Companys interest rate risk-sensitive instruments. The table presents principal cash flow and
weighted-average interest rates by expected maturity dates for the fixed and variable rate debt.
The table also includes estimates of the fair value of the Companys interest rate risk-sensitive
instruments based on quoted market prices for these or similar issues. 2005
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    Total
    
    
    Fair ValueVariable rate GE line:
    
    $
    70,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    70,000
    
    
    $
    70,000Average interest rate
    
    
    (a
    )
    
    
    (a
    )
    
    
    (a
    )
    
    
    (a
    )
    
    
    (a
    )
    
    
    (a
    )
    
    
    (a
    )Long-term debt:Fixed rate
    
    $
    1,603
    
    
    $
    1,726
    
    
    $
    1,857
    
    
    $
    57,977
    
    
    $
    
    
    
    $
    
    
    
    $
    63,163
    
    
    $
    64,090Average interest rate
    
    
    7.38
    %
    
    
    7.38
    %
    
    
    7.38
    %
    
    
    7.38
    %
    
    
    7.38
    %
    
    
    7.38
    %
    
    
    7.38
    %Variable rate
    
    $
    245
    
    
    $
    262
    
    
    $
    281
    
    
    $
    300
    
    
    $
    321
    
    
    $
    10,121
    
    
    $
    11,530
    
    
    $
    11,530Average interest rate
    
    

    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )Consolidated joint venture long-term
debt:Fixed rate
    
    $
    133
    
    
    $
    213
    
    
    $
    229
    
    
    $
    247
    
    
    $
    267
    
    
    $
    7,951
    
    
    $
    9,040
    
    
    $
    9,040Average interest rate
    
    
    7.51
    %
    
    
    7.51
    %
    
    
    7.51
    %
    
    
    7.51
    %
    
    
    7.51
    %
    
    
    7.51
    %
    
    
    7.51
    %Variable rate
    
    $
    84
    
    
    $
    92
    
    
    $
    100
    
    
    $
    109
    
    
    $
    119
    
    
    $
    4,311
    
    
    $
    4,815
    
    
    $
    4,815Average interest rate
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
    
    
    (b
    )
   (a)
    
    Rate is 30-day to 180-day LIBOR plus 1.75% to 2.50%, (30-day LIBOR was 2.87 at March 31, 2005).(b)
    
    Rate is 30-day LIBOR plus 3.0%. 20




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##### 



Item 4  Controls and Procedures 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 13(a)-15(e) under the Securities
Exchange Act of 1934, as amended) 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 were effective to ensure that information
required to be disclosed by the Company in the reports that it files or submits under the Exchange
Act, is recorded, processed, summarized and reported, within the time periods specified in the
SECs rules and forms, and that such information is accumulated and communicated to the Companys
management, including its Chief Executive Officer and Chief Financial Officer as appropriate, to
allow timely decisions regarding required disclosure. Changes in Internal Control Over Financial Reporting There has been no change in the Companys internal control over financial reporting during the
quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially
affect, the Companys internal control over financial reporting. 21




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##### 



PART II - OTHER INFORMATION 
 Item 6  Exhibits  (a)
    Exhibits10.1
    Loan dated as of March 11, 2005 by and between Winston SPE II LLC and
General Electric Capital Corporation (incorporated by reference to Exhibit 10.20
to the Companys Annual Report on Form 10-K for the year ended December 31, 2004).10.2
    Form of Mortgage Security Agreement and Fixture Filing dated as of
March 11, 2005 by Winston SPE II LLC Corporation (incorporated by reference to
Exhibit 10.21 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).10.3
    Form of Deed of Trust, Security Agreement and Fixture dated as of
March 11, 2005 by Winston SPE II LLC Corporation (incorporated by reference to
Exhibit 10.22 to the Companys Annual Report on Form 10-K for the year ended
December 31, 2004).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, 200532.2
    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, 2005 22




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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, 2005
    
    
    
    /s/ Joseph V. GreenJoseph V. GreenPresident and Chief Financial Officer(Authorized officer and Principal Financial Officer)
 23




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##### 



EXHIBIT INDEX Exhibit Number
    
    Description10.1
    
    Loan dated as of March 11, 2005 by and between Winston SPE II LLC and General Electric
Capital Corporation (incorporated by reference to Exhibit 10.20 to the Companys Annual Report
on Form 10-K for the year ended December 31, 2004).10.2
    
    Form of Mortgage Security Agreement and Fixture Filing dated as of March 11, 2005 by Winston
SPE II LLC Corporation (incorporated by reference to Exhibit 10.21 to the Companys Annual
Report on Form 10-K for the year ended December 31, 2004).10.3
    
    Form of Deed of Trust, Security Agreement and Fixture dated as of March 11, 2005 by Winston
SPE II LLC Corporation (incorporated by reference to Exhibit 10.22 to the Companys Annual
Report on Form 10-K for the year ended December 31, 2004).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, 200532.2
    
    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, 2005
 24