UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

Commission file number 0-23732

WINSTON HOTELS, INC.

(Exact name of registrant as specified in its charter)

(919) 510-6019
(Registrant’s telephone number, including area code)

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

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

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

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No o

     The aggregate market value of the registrant’s Common Stock, $0.01 par value per share, at June 30, 2003, held by those persons deemed by the registrant to be non-affiliates was approximately $154,382,412.

     As of March 1, 2004, there were 26,340,292 shares of the registrant’s Common Stock, $0.01 par value per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

WINSTON HOTELS, INC.

Form 10-K Annual Report

INDEX

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PART I.

ITEM 1. BUSINESS

General Development of Business

     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. The Company’s primary source of revenue is room revenue generated from its hotel ownership interests. 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 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.

     During 2003, the Company invested in two additional properties through its joint venture with Charlesbank Capital Partners, LLC. The Company owns an indirect 13.05 percent interest in these hotels. As of December 31, 2003, the Company owned or was invested in 50 hotel properties in 16 states having an aggregate of 7,028 rooms. This included 44 wholly owned properties with an aggregate of 6,170 rooms, a 49 percent ownership in two joint venture hotels with an aggregate of 296 rooms, a 57.65 percent ownership in one joint venture hotel with 157 rooms, and an indirect 13.05 percent ownership interest in three joint venture hotels with an aggregate of 405 rooms. The Company also had issued mezzanine loans to owners of three hotels with an aggregate of 391 rooms. The Company also held a 48.78 percent 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, Six Continents PLC and Choice Hotels International.

Acquisition of Leasehold Interests

     Prior to January 1, 2001, under the REIT qualification requirements of the Internal Revenue Code, REITs generally were required to lease their hotels to third party operators. Under the REIT Modernization Act of 1999 (the “RMA”), which became effective January 1, 2001, a REIT is permitted to lease hotels to wholly owned taxable REIT subsidiaries of the REIT (“TRS Lessees”). Under the RMA, the TRS Lessees may not operate the leased hotels and must enter into management agreements with eligible independent contractors who manage the hotels.

     Effective July 1, 2002, the Company, through its wholly owned taxable REIT subsidiary, Barclay Hospitality Services Inc. (“Barclay”), acquired the leasehold interests for 45 wholly owned hotels and two joint venture hotels, for total consideration of approximately $19.5 million. During 2003, the Company assumed the leasehold interests for one wholly owned hotel and, along with its joint venture partner, the leasehold interests for one joint venture hotel, at no cost.

     As of December 31, 2003, 43 of the Company’s 44 wholly owned hotels and two of its six joint venture hotels, the Evanston, IL Hilton Garden Inn and the Ponte Vedra, FL Hampton Inn, were operated under leases with Barclay. The other wholly owned hotel, the Secaucus, NJ Holiday Inn, continued to be operated under a lease with a third party lessee. (In March 2004, the Company negotiated the transfer of this lease to Barclay at no cost). One joint venture hotel, the Windsor, CT Hilton Garden Inn, was leased to an entity owned 57.65 percent by Barclay. The remaining three joint venture hotels, the West Des Moines, IA Fairfield Inn & Suites, the Beachwood, OH Courtyard by Marriott, and the Houston, TX Best Western Park Place Suites, did not operate under leases.

     As of December 31, 2003, Alliance Hospitality Management, LLC (“Alliance”) managed 41 of the Company’s 50 hotels, Concord Hospitality Enterprises Company (“Concord”) managed three hotels, Promus Hotels, Inc., an affiliate of Hilton Hotels Corporation (“Hilton”) managed two hotels, and Sage Hospitality Resources, LLC (“Sage”), Prism Hospitality, L.P. (“Prism”), Noble Investment Group, Ltd. (“Noble”) and Prime Hospitality Corp. (“Prime”) each managed one hotel.

     The acquisition of the leasehold interests entitles Barclay to retain the operating profits or losses from the related hotels, which previously accrued to Interstate under the leases and gives the Company (i) more control over the operations of these hotels, (ii) the benefits from any operating margin improvements and risk of any operating margin deterioration at these hotels, and (iii) more flexibility, in that these hotels are no longer encumbered by long term leases with unrelated third parties that are difficult to amend and expensive to terminate. All of the hotels continue to operate under the same franchise affiliations as prior to the acquisition of the leasehold interests.

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Follow-on Common Stock Offering

     The Company raised net proceeds of approximately $50.5 million as a result of a follow-on Common Stock offering in which the Company sold an additional 6,037,500 common shares. The follow-on offering was completed in October 2003 with the exercise of the underwriters’ over-allotment option, which included 787,500 common shares of the total 6,037,500 common shares. The Company initially used the net proceeds to pay down its then outstanding balance under its $125 million line of credit, 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.

Narrative Description of Business

Growth Strategy

     The Company’s primary growth strategy is designed to enhance shareholder value by increasing cash available for distribution per share of Common Stock through: (i) improving hotel operating results; (ii) acquiring, either directly or through joint ventures, additional hotels, or ownership interests in hotels, that meet the Company’s investment criteria; and (iii) financing activities whereby the Company initiates hotel loans to third party hotel owners.

Improve Hotel Operations

     The Company seeks to increase operating cash flow and profit through aggressive asset management and the strategic investment of capital in its portfolio. The Company works closely with each hotel manager to continually find ways to increase operating results through increasing revenues and decreasing expenses. The Company’s hotel managers are trained in all aspects of hotel operations, including customer service improvement strategies, rate negotiations with corporate and other clients, direct hotel sales and marketing techniques. Additionally, hotel managers seek to take advantage of all available advertising and marketing programs, both national and regional, with the franchisors of the Company’s hotels. The Company maintains strong, strategic relationships with both its franchisors and managers and focuses on selecting the best, most appropriate franchisor and manager for each property. Over the past four years, the Company has spent approximately $27.8 million upgrading and renovating existing wholly owned hotels in order to enhance their competitive position and improve cash flow. This is in addition to approximately $26.8 million spent on repairs and maintenance items during that same period.

Acquisitions

     Among others, the Company intends to acquire additional hotels, or ownership interests in hotels, with strong national franchise affiliations in the “mid-scale without food and beverage”, “upscale”, and “upper upscale” market segments, or hotel properties with the potential to obtain such franchise affiliations. In particular, the Company will consider acquiring mid-scale without food and beverage hotels, such as Hampton Inn, Hampton Inn and Suites, Holiday Inn, and Fairfield Inn by Marriott; upscale hotels such as Hilton Garden Inn, Courtyard by Marriott, Homewood Suites by Hilton, Residence Inn, Spring Hill Suites by Marriott and Staybridge by Holiday Inn; and upper upscale hotels such as full service Marriott, Hilton, Embassy Suites and Sheraton; (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward Looking Statements”).

     The Company intends to consider investments in hotel properties that meet one or more of the following criteria: (i) properties in locations with relatively high demand for rooms, a relatively low supply of hotel properties and relatively high barriers to entry into the hotel business, such as a scarcity of suitable sites or zoning restrictions; (ii) successful hotels available at favorable prices; (iii) newly developed hotels; (iv) hotels that could benefit from repositioning; (v) hotels that could benefit from substantial rehabilitation; and (vi) hotels that could benefit from new management and additional hotel capital. The Company believes that its relationships with its lessees, managers and franchisors will provide additional potential investment opportunities.

     As the Company acquires hotels, or interests in hotels, the Company also continually evaluates its portfolio and considers selling hotels that no longer meet its long-term investment objectives. The Company sold one hotel in 2001 and four hotels in 2002 for approximately $17.6 million. The Company did not sell any hotels during 2003.

Joint Ventures

     During the fourth quarter of 2002, the Company formed a joint venture (the “Charlesbank Venture”) with Boston-based Charlesbank Capital Partners, LLC (“Charlesbank”). The Charlesbank Venture intends to acquire more than $100 million of hotel assets. Charlesbank is a private investment firm managing capital on behalf of institutional investors. The Company owns 15% of the Charlesbank Venture and Charlesbank owns 85%. The Charlesbank Venture focuses on acquisitions that the partners believe have

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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 December 31, 2003, the Charlesbank Venture had invested in three hotels through a joint venture (“WCC Project Company LLC”) comprised of Concord Hospitality Enterprises Company (“Concord”) and the Charlesbank Venture. The first hotel was a vacant building located in the Beachwood suburb of Cleveland, OH that was converted into a 113-room Courtyard by Marriott in the second quarter of 2003. The second hotel was a 102-room Fairfield Inn & Suites by Marriott located in Des Moines, IA, which was converted from a Wingate Inn during the summer of 2002. The third hotel was a Best Western located in Houston, TX, which was purchased in the fourth quarter of 2003 and is expected to be converted to a Spring Hill Suites by Marriott in the second quarter of 2004. 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. The total cost of these three hotels is approximately $30 million. The Company earns an asset management fee equal to 0.50% of the total cost of the assets purchased by the Charlesbank Venture.

     Under the terms of the Charlesbank Venture, Charlesbank will provide 85% of the total equity, and the Company will provide the remaining 15% of the total equity committed to each acquisition. Charlesbank will have the option to expand the venture by committing additional equity to future acquisitions after the initial equity is committed. The Company anticipates that the Charlesbank Venture will be able to secure debt financing for approximately 65% of the total cost of hotel assets that are purchased.

     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 Courtyard by Marriott hotel in Chapel Hill, NC, (the “Chapel Hill Courtyard”) which is expected to open in the summer 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 the form of a preferred membership interest (“Preferred Contribution”). 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.

     In the fourth quarter of 2002, the Company funded a $3,500 mezzanine loan 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 entered into a joint venture agreement (the “Hall Joint Venture”), with an affiliate of Hall Financial Group, (“Hall”). The Company assigned the $3,500 mezzanine loan to the Hall Joint Venture and retained a 50% interest (or $1,750) in the note through the joint venture. The total cost of the Baltimore Hotel, which opened in the first quarter of 2004, was approximately $13,100, net of historic tax credits of $6,000. The Company owns 50% of the Hall Joint Venture, and Hall owns the remaining 50%.

     In addition to the joint ventures described above, the Company has entered into two joint ventures with Regent Partners, Inc. (“Regent”) and one joint venture with Marsh Landing Investment, L.L.C. (the “Marsh Landing Joint Venture”). As of December 31, 2003, the Company owned a 49% interest in one joint venture with Regent and a 57.65% interest in the other joint venture, each of which owned one hotel. These hotels consist of a Hilton Garden Inn located in Evanston, IL, and a Hilton Garden Inn located in Windsor, CT, having a combined total of 453 rooms. The Company owns a 49% interest in its Marsh Landing Joint Venture, which owns a 118-room Hampton Inn located in Ponte Vedra, FL. Two of our directors, Charles M. Winston and James H. Winston, own the remaining 51% of the joint venture. During 2003 the Company earned asset management fees equal to 1.0% of the total revenues of each of these three joint venture hotels. We continue to seek additional prudent joint venture opportunities where the Company can leverage its hotel asset management and development expertise into attractive investments.

     Pursuant to the provisions of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), during the third quarter of 2003, the Company consolidated the balance sheet and operations of its Chapel Hill Joint Venture. As of December 31, 2003, the Company has consolidated the balance sheets of the Evanston Joint Venture, the Windsor Joint Venture and the Marsh Landing Joint Venture, and began to consolidate the operations of these three joint ventures on January 1, 2004. Per the provisions of FIN 46, the Company has not consolidated the balance sheet or operations of either the Hall Joint Venture or the Charlesbank joint venture as of December 31, 2003, and does not expect to do so in the future.

Hotel Financing

     As of December 31, 2003, the Company had issued three mezzanine loans. In addition to the Hall mezzanine loan, the Company had two other mezzanine loans outstanding, totaling approximately $3.3 million to third party hotel owners. In February 2004, the Company issued its fourth mezzanine loan in the amount of $2.4 million. The Company plans to continue to expand its hotel lending business in the future. The Company’s lending program is designed to provide loans to the hotel industry, primarily by either originating single loans, or through the purchase of the first loss piece of collateralized mortgage backed securities (“CMBS”) transactions which typically contain multiple hotel properties. However, the Company may also issue whole loans and then potentially sell the senior portion of the loan. The Company’s loan amount is typically 10% to 25% of the project’s all-in cost, ranging from approximately $1 million to approximately $15 million. The Company will primarily provide financing between 60%

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and 85% of the lesser of the project’s all-in cost or fair market value. Loans will typically be issued for hotels with between 100 and 450 rooms. We continue to seek additional prudent financing opportunities where the Company can leverage its hotel underwriting and development expertise into attractive investments. The Company expects to use a portion of the $50.5 million in cash proceeds from its follow-on common stock offering in October 2003, a portion of the $12.9 million in net cash proceeds remaining from its Series B Cumulative Preferred Stock offering in February 2004, (see “Recent Developments” below) and possibly a portion of the remaining availability under its $125 million line of credit to provide loans to the hotel industry.

Recent Developments

     In February 2004, the Company sold its 118-room Hampton Inn in Wilmington, NC for net cash proceeds of $3.4 million, resulting in a gain of approximately $0.3 million. The Company also issued its fourth mezzanine loan, totaling $2.4 million, to the owner of the 200-room Sheraton hotel in Atlantic Beach, NC.

     In February 2004, the Charlesbank Venture invested in a fourth 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”). This hotel is a Ramada Inn that the partners expect to convert to a Courtyard by Marriott in early 2005. The total cost of the project is expected to be approximately $14 million (including approximately $5 million in renovation costs), approximately $9 million of which is financed through debt. New Castle owns a 13% interest in the project while the Charlesbank Venture owns 87%, so that the Company has an indirect 13.05% ownership interest in WNC Project Company LLC.

     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 $89 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 $12.9 million to pay down its then outstanding balance under its $125 million line of credit, 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 will be recorded as a reduction in net income (loss) available to common shareholders in the first quarter of 2004.

     In March 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. The amount paid for Regent’s ownership interest in the Evanston Hilton Garden Inn totaled approximately $6.9 million, and was based on a value of $25.25 million for the sale of the hotel, net of debt assumed of approximately $11.8 million, such assumption being subject to the approval of the lenders under our $125 million line of credit. The amount paid for Regent’s ownership interest in the Windsor Hilton Garden Inn totaled approximately $1.2 million, and was based on a value of $12.25 million for the sale of the hotel, net of debt paid off of approximately $9.3 million. As a result of the 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 will continue to lease the Evanston hotel and, as a result of the purchase, Barclay will assume the lease of the Windsor hotel from Windsor Lessee Company LLC.

     As of December 31, 2003, one wholly owned property, the Secaucus, NJ Holiday Inn, continued to be operated under a long-term lease with Prime. In March 2004, the Company negotiated the transfer of this lease to Barclay at no cost. The Company also expects to receive payment from Prime of approximately $300 as part of the negotiated settlement. The Secaucus, NJ Holiday Inn produced a net loss to Prime of approximately $160 for the year ended December 31, 2003.

Operations and Property Management

     As of December 31, 2003, Alliance managed 41 of the Company’s 50 hotels, Concord managed three hotels, Hilton managed two hotels, and Sage, Prism, and Noble each managed one hotel. One wholly owned property continued to be operated under a long-term lease with Prime. In March 2004, the Company negotiated the transfer of this lease to Barclay at no cost.

     The information below, regarding the hotel managers and third party lessee of the Company’s hotels, is as of December 31, 2003:

     Alliance, a hotel management company, operated 41 of the Company’s hotels.

     Concord, a hotel development and management company, operated a total of 37 hotels in eight states and Canada.

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     Hilton, a New York Stock Exchange listed company, is a developer, owner, manager or franchisor of 2,100 hotels, resorts and vacation ownership properties. Its portfolio includes many of the world’s best known and most highly regarded hotel brands, including Hilton, Doubletree, Embassy Suites, Hampton Inn, Homewood Suites by Hilton, Red Lion Hotels & Inns and Conrad International.

     Sage, a hotel management company, operated a total of 96 hotels in 33 states.

     Prism, a hotel management company, operated a total of 40 hotels in 13 states.

     Noble, a hotel development and management company, operated 20 upscale, full service, mid-market and all-suites hotels in six states. Noble holds a 79 percent ownership interest in Alliance.

     Prime, a New York Stock Exchange listed company, owned, operated, managed or franchised over 240 hotels throughout North America. Prime, one of the nation’s premier lodging companies, operates three proprietary brands, Prime Hotels & Resorts (full-service), AmeriSuites (all-suites) and Wellesley Inns & Suites (limited-service). It also owns and/or manages hotels operated under franchise agreements with national hotel chains.

Franchise Agreements

     All of the Company’s hotels operate under franchise licenses from national hotel franchisors including Marriott International, Inc., Hilton Hotels Corporation, Six Continents PLC and Choice Hotels International. The Company anticipates that most of the additional hotel properties in which it invests will be operated under franchise licenses with these same franchisors. Franchisors provide a variety of benefits for franchisees including national advertising, publicity and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards and centralized reservation systems.

     The hotel franchise licenses generally specify certain management, operational, record keeping, accounting, reporting and marketing standards and procedures with which the Company must comply. The franchise licenses obligate the Company to comply with the franchisors’ standards and requirements with respect to training of operational personnel, safety, insurance, the types of services and products ancillary to guest room services that may be provided, display of signs, and the type, quality and age of furniture, fixtures and equipment included in guest rooms, lobbies and other common areas.

     As of December 31, 2003, of the 50 hotels’ franchise licenses, including six joint venture hotels, two expire in 2006, two expire in 2007, four expire in 2008, three expire in 2009, two expire in 2010, three expire in 2011, one expires in 2013, one expires in 2015, two expire in 2016, 13 expire in 2017, nine expire in 2018, one expires in 2020, four expire in 2022, two expire in 2023 and one expires in 2024. The franchise agreements provide for termination at the franchisor’s option upon the occurrence of certain events, including the Company’s failure to pay royalties and fees or perform its other covenants under the franchise agreement, bankruptcy, abandonment of the franchise, commission of a felony, assignment of the franchise without the consent of the franchisor, or failure to comply with applicable law or maintain applicable standards in the operation and condition of the relevant hotel. The franchise agreements will not renew automatically upon expiration. The Company is responsible for making all payments under the franchise agreements to the franchisors. Under the franchise agreements, the Company pays a franchise fee generally between 4% and 5% of room revenues, plus additional fees that amount to between 3% and 4% of room revenues from the hotels.

Competition

     The hotel industry is highly competitive with various participants competing on the basis of price, level of service and geographic location. The Company’s hotels compete with other hotel properties in their geographic markets. Some of the Company’s competitors may have greater marketing and financial resources than the Company and the managers of the Company’s hotels. Several of the Company’s hotels are located in areas in which they may compete with other Company hotels for business. The Company competes for acquisition opportunities with entities that may have greater financial resources than the Company. These entities may generally be able to accept more risk than the Company can prudently manage, including risks with respect to the creditworthiness of a hotel manager.

Employees

     The Company had 14 employees as of March 1, 2004. We believe that our relations with our employees are good.

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Environmental Matters

     Under various federal, state and local laws and regulations, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of hazardous or toxic substances. Furthermore, a person that arranges for the disposal or transports for disposal or treatment of a hazardous substance at another property may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property. The costs of remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to promptly remedy such substances, may adversely affect the owner’s ability to use or sell such real estate or to borrow using such real estate as collateral. Certain environmental laws and common law principles could be used to impose liability for the release of and exposure to hazardous substances, including asbestos-containing materials (“ACMs”) released into the air, and third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances, including ACMs. In connection with the ownership and operation of its hotels, the Company or the property managers, as the case may be, may be potentially liable for such costs.

     Phase I environmental site assessments (“ESAs”) were obtained on all of the Company’s hotels. The Phase I ESAs were intended to identify potential sources of contamination for which the hotels may be responsible and to identify readily apparent environmental regulatory compliance concerns. The Phase I ESAs included historical reviews of the hotels, reviews of certain public records, preliminary investigations of the sites and surrounding properties, screening for the presence of asbestos, PCBs (polychlorinated biphenyls) and underground storage tanks, and the preparation and issuance of a written report. The Phase I ESAs did not include invasive procedures, such as soil sampling or ground water analysis. The Phase I ESA reports have not revealed any environmental condition, liability or compliance concern that the Company believes would have a material adverse effect on the Company’s business, assets or results of operations, nor is the Company aware of any such condition, liability or compliance concern. Nevertheless, it is possible that these reports do not reveal all environmental conditions, liabilities or compliance concerns or that there are material environmental conditions, liabilities or compliance concerns that arose at a hotel after the related Phase I ESA report was completed of which the Company is unaware. Moreover, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability for existing conditions at the Company’s hotels, or (ii) the current environmental condition of the hotels will not be affected by the condition of the properties in the vicinity of the hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to the Company.

     In addition to the ESAs, the Company also obtained asbestos surveys for the Holiday Inn Select-Garland (Dallas), Texas and the Comfort Inn-Greenville, South Carolina. In each of the asbestos surveys, the consultants discovered the presence of ACMs. The Company is monitoring the presence of the ACMs with the assistance of its consultants.

     During 2002, the Company invested in the Beachwood, OH Courtyard by Marriott hotel, which is currently owned by WCC Project Company LLC. The Company’s current indirect ownership interest in this hotel is 13.05%. Prior to making its initial investment, the Company knew that black mold existed at the hotel and engaged consultants with expertise in black mold remediation and performed extensive research to satisfy itself that the black mold condition could be eradicated through renovation and repair procedures. Following the completion of such remediation procedures, the Company believes that all of the black mold has been removed from this hotel, which opened for business in April 2003. Because black mold is a naturally occurring fungus, the spores of which can be transported by outside air currents, there can be no assurances that black mold will not again enter and grow in this hotel or that it will not be found in the Company’s other hotel properties.

     The Company believes that its hotels are in compliance in all material respects with all federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances and other environmental matters. The Company has not been notified by any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental substances in connection with any of its properties.

Tax Status

     The Company elected to be taxed as a REIT under Sections 856-860 of the Internal Revenue Code of 1986, as amended, effective for its short taxable year ended December 31, 1994. The Company believes that it qualifies for taxation as a REIT, and with certain exceptions, the Company will not be subject to tax at the corporate level on its taxable income that is distributed to the shareholders of the Company. A REIT is subject to a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its annual taxable income. Failure to qualify as a REIT will render the Company subject to federal income tax (including any applicable minimum tax) on its taxable income at regular corporate rates and distributions to the shareholders in any such year will not be deductible by the Company. Although the Company does not intend to request a ruling from the Internal Revenue Service (the “Service”) as to its REIT status, the Company, in connection with its February 2004 preferred stock offering, has obtained the opinion of its legal counsel that the Company qualifies as a REIT, which opinion is based on certain assumptions and

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representations and is not binding on the Service or any court. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and properties.

     Under the RMA, the Company may now own up to 100% of one or more taxable REIT subsidiaries (“TRS”). A TRS is a taxable corporation that may lease hotels under certain circumstances, provide services to the Company, and perform activities such as third party management, development, and other independent business activities. Overall, no more than 20% of the value of the Company’s assets may consist of securities of one or more TRSs. In addition, no more than 25% of the Company’s gross income for any year, excluding all TRS revenues, but including any dividends received from TRSs, may consist of dividends from one or more TRSs and other income that is not derived from real estate sources.

     Under the RMA, a TRS is permitted to lease hotels from the Company as long as the hotels are operated on behalf of the TRS by a third party manager who satisfies the following requirements:

	(1)		such manager is, or is related to a person who is, actively engaged in the trade or business of operating “qualified lodging facilities” for any person unrelated to the Company and the TRS;
	(2)		such manager does not own, directly or indirectly, more than 35% of the Company’s stock;
	(3)		no more than 35% of such manager is owned, directly or indirectly, by one or more persons owning 35% or more of the Company’s stock; and
	(4)		the Company does not directly or indirectly derive any income from such manager.

     The RMA limits the deductibility of interest paid or accrued by a TRS to the Company to assure that the TRS is subject to an appropriate level of corporate taxation. The RMA also imposes a 100% excise tax on transactions between a TRS and the Company or its tenants that are not on an arm’s-length basis.

Seasonality

     The Company’s operations historically have been seasonal in nature, reflecting higher revenue per available room (“RevPAR”) 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 of credit to make distributions to its equity holders.

Executive Officers of the Company

     The following table lists the executive officers of the Company:

     Charles M. Winston. Charles Winston has served as Chairman of the Board of Directors since March 15, 1994. Mr. Winston is a native of North Carolina and a graduate of the University of North Carolina at Chapel Hill with an A.B. degree. Mr. Winston has more than 39 years of experience in developing and operating full service restaurants and hotels. Mr. Winston is Robert Winston’s father and brother of James Winston, a director of the Company.

     Robert W. Winston, III. Robert Winston has served as Chief Executive Officer and Director of the Company since March 15, 1994. Mr. Winston served as the Company’s President from March 15, 1994 through January 14, 1999 and from November 9, 2002 through November 4, 2003. Mr. Winston also served as Secretary for the periods from March 1994 through May 1995 and from October 1997 until May 5, 1998. Mr. Winston is a native of North Carolina and a graduate of the University of North Carolina at Chapel Hill with a B.A. degree in economics. Mr. Winston is Charles Winston’s son and nephew of James Winston, a director of the Company.

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     Joseph V. Green. Mr. Green has served as President of the Company since November 4, 2003, as Executive Vice President and Chief Financial Officer since May 18, 1999 and as Secretary since November 9, 2002. Mr. Green has also served as Executive Vice President — Acquisitions and Finance from January 1, 1998 through May 18, 1999, after having advised Winston Hospitality, Inc. on matters regarding hotel acquisitions and finance since 1993, including the initial public offering of WHI. Mr. Green is a graduate of East Carolina University, was awarded his J.D. degree from Wake Forest University School of Law and received a Master of Laws in Taxation from Georgetown University.

     Kenneth R. Crockett. Mr. Crockett has served as Chief Operating Officer of the Company since November 4, 2003. Mr. Crockett served as the Company’s Executive Vice President of Development from January 1998 through November 5, 2003 and also served as the Company’s Senior Vice President of Development from September 1995 through January 1998. Mr. Crockett is a graduate of the University of North Carolina at Chapel Hill with a B.S. degree in Business Administration. Prior to joining the Company, Mr. Crockett was an Associate Partner for project development in commercial real estate at Capital Associates, a real estate development firm located in Raleigh, North Carolina.

     Brent V. West. Mr. West was appointed Vice President and Chief Accounting Officer in October 2002. He joined the Company as Vice President and Controller in September 1997 and served as Vice President of Finance and Controller from May 1999 through October 2002. Mr. West began his career with KPMG and prior to joining the Company, held the position of Corporate Controller for Coastal Physician Group, Inc. Mr. West is a CPA and is a graduate of Plattsburgh State University College, Plattsburgh, New York, with a B.S. degree in Accounting.

Available Information

     The Company maintains an Internet site, http://www.winstonhotels.com, which contains additional information concerning the Company. The Company makes available free of charge through its Internet site its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. The Company’s Corporate Governance Guidelines and Code of Business Conduct and Ethics and the charters of the Audit, Compensation and Nominating and Corporate Governance Committees are also available on the Company’s Web site at www.winstonhotels.com, and are available in print to any shareholder upon request in writing to Winston Hotels, Inc., c/o Vice President and Chief Accounting Officer, 2626 Glenwood Avenue, Suite 200, Raleigh, NC 27608. Information on the Company’s Internet site is neither part of nor incorporated into this report on Form 10-K.

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ITEM 2. PROPERTIES

     As of December 31, 2003, the Company owned 44 hotels with an aggregate of 6,170 rooms. The following table sets forth, by franchise affiliation, certain unaudited information with respect to our wholly-owned hotels for the years ended December 31, 2003 and 2002.

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     In addition to our wholly-owned hotels, we maintain investments in joint ventures that in the aggregate owned six hotels as of December 31, 2003. The following table sets forth certain unaudited information about the hotels owned through joint ventures with third parties for the years ended December 31, 2003 and 2002.

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ITEM 3. LEGAL PROCEEDINGS

     The Company currently is not involved in any legal proceedings, other than routine litigation incidental to the Company’s business, nor are any such proceedings known to be contemplated by governmental authorities. Alliance, who managed 41 of the Company’s hotels as of December 31, 2003, has advised the Company that there are no such proceedings known to be contemplated by government authorities, and it currently is not involved in any material pending litigation, other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance. None of the other hotel management companies or the third party lessee, have advised the Company that there are any such proceedings known to be contemplated by government authorities, or that they currently are involved in any material pending litigation.

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

     No matters were submitted to a vote of the Company’s security holders during the fourth quarter of the fiscal year ended December 31, 2003.

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PART II.

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

Market Price of and Dividends on the Registrant’s Common Equity

     The Company’s Common Stock trades on the New York Stock Exchange (“NYSE”) under the symbol “WXH.” As of March 1, 2004, the Company had 1,153 holders of record of its Common Stock. The following table sets forth, for the indicated periods, the high and low closing prices for the Common Stock and the cash distributions declared per share:

     Although the declaration of distributions is within the discretion of the Board of Directors and depends on the Company’s results of operations, cash available for distribution, the financial condition of the Company, tax considerations (including those related to REITs) and other factors considered important by the Board of Directors, the Company’s policy is to make regular quarterly distributions to its shareholders.

Securities Authorized for Issuance Under Equity Compensation Plans

Equity Compensation Plan Information

The following table sets forth information as of December 31, 2003 with respect to compensation plans under which equity securities of the Company are authorized for issuance. The Company has no such plans that were not approved by security holders.

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ITEM 6. SELECTED FINANCIAL DATA

     The following table sets forth selected financial information for the Company that has been derived from the financial statements and notes thereto. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included elsewhere in this report.

WINSTON HOTELS, INC.
Selected Historical Financial and Other Data
For the Years Ended December 31, 2003, 2002, 2001, 2000 and 1999
(in thousands, except per share amounts)

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WINSTON HOTELS, INC.
Reconciliation and Calculation of FFO, AFFO, AFFO Available to Common Shareholders and CAD
For the years ended December 31, 2003, 2002, 2001, 2000 and 1999
(in thousands)

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WINSTON HOTELS, INC.
Reconciliation and Calculation of Adjusted EBITDA
For the years ended December 31, 2003, 2002, 2001, 2000 and 1999
(in thousands)

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ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ($ in thousands, except per share amounts)

     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. As of December 31, 2003, the Company owned or was invested in 50 hotel properties in 16 states having an aggregate of 7,028 rooms. This included 44 wholly owned properties with an aggregate of 6,170 rooms, a 49 percent ownership in two joint venture hotels with an aggregate of 296 rooms, a 57.65 percent ownership in one joint venture hotel with 157 rooms, and an indirect 13.05 percent ownership interest in three joint venture hotels with an aggregate of 405 rooms. The Company also had issued mezzanine loans to owners of three hotels with an aggregate of 391 rooms. The Company also held a 48.78 percent 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, Six Continents PLC and Choice Hotels International.

     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 circumstances such as market factors cause a reduction in revenue for the property. As a result, changes in 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.

Acquisition of Leasehold Interests

     Prior to January 1, 2001, under the REIT qualification requirements of the Internal Revenue Code, REITs generally were required to lease their hotels to third party operators. Under the REIT Modernization Act of 1999 (the “RMA”), which became effective January 1, 2001, a REIT is permitted to lease hotels to wholly owned taxable REIT subsidiaries of the REIT (“TRS Lessees”). Under the RMA, the TRS Lessees may not operate the leased hotels and must enter into management agreements with eligible independent contractors who manage the hotels.

     Effective July 1, 2002, the Company, through its wholly owned taxable REIT subsidiary, Barclay Hospitality Services Inc. (“Barclay”), acquired the leasehold interests for 47 of its hotels from CapStar Winston Company, L.L.C., a wholly owned subsidiary of MeriStar Hotels & Resorts, Inc. (“MeriStar”). MeriStar has since merged with and become Interstate Hotels & Resorts, Inc. (“Interstate”). The acquisition included leasehold interests for 45 wholly owned hotels and two Joint Venture Hotels. The total consideration of approximately $19.5 million, to acquire the leasehold interests for 47 hotels from Interstate, was based upon a $17 million purchase price for the leasehold interests, adjusted in part for accrued interest and related expenses totaling approximately $0.7 million, and $1.8 million of working capital. The total acquisition cost, net of working capital, of $17.7 million, was expensed in the second quarter of 2002. In addition, a deferred tax benefit of $6.7 million was recognized in the second quarter of 2002, resulting from the timing difference of the $17.7 million payment for financial reporting purposes versus tax purposes.

     Simultaneous with acquiring the leasehold interests from Interstate, Barclay entered into new management contracts with Interstate for 33 of the 47 hotels covered by the leases. These five-year contracts were terminable by Barclay after June 30, 2003 at no cost, subject to certain conditions and limitations. Six of the 47 hotels continued to be managed by Interstate Management and Investment Corporation (“IMIC”). Effective July 1, 2003, the Company terminated its management contracts with Interstate, at no cost. Effective July 1, 2003, the Company also terminated the management agreements with IMIC by paying a termination fee of $1.3 million, which was expensed in the third quarter of 2003. During 2003, the Company also assumed the leasehold interests for one wholly owned hotel and, along with its joint venture partner, the leasehold interests for one joint venture hotel, at no cost. The management of all 41 of these properties, along with most of the hotels’ management personnel and other employees, was transferred to Alliance Hospitality Management, LLC (“Alliance”).

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     As of December 31, 2003, 43 of the Company’s 44 wholly owned hotels and two of its six joint venture hotels, the Evanston, IL Hilton Garden Inn and the Ponte Vedra, FL Hampton Inn, were operated under leases with Barclay. One joint venture hotel, the Windsor, CT Hilton Garden Inn, was leased to an entity owned 57.65 percent by Barclay, which represents the same percent ownership of the joint venture by the Company. The remaining three joint venture hotels, the West Des Moines, IA Fairfield Inn & Suites, the Beachwood, OH Courtyard by Marriott, and the Houston, TX Best Western Park Place Suites, did not operate under leases.

     As of December 31, 2003, one wholly owned property, the Secaucus, NJ Holiday Inn, continued to be operated under a long-term lease with Prime. In March 2004, the Company negotiated the transfer of this lease to Barclay at no cost. The Company also expects to receive payment from Prime of approximately $300 as part of the negotiated settlement. The Secaucus, NJ Holiday Inn produced a net loss to Prime of approximately $160 for the year ended December 31, 2003.

     As of December 31, 2003, Alliance managed 41 of the Company’s 50 hotels, Concord Hospitality Enterprises Company (“Concord”) managed three hotels, Promus Hotels, Inc., an affiliate of Hilton Hotels Corporation (“Hilton”) managed two hotels, and Sage Hospitality Resources, LLC (“Sage”), Prism Hospitality, L.P. (“Prism”), Noble Investment Group, Ltd. (“Noble”) and Prime Hospitality Corp. (“Prime”) each managed one hotel.

     The acquisition of the leasehold interests entitles Barclay to retain the operating profits or losses from the related hotels, which previously accrued to Interstate under the leases and gives the Company (i) more control over the operations of these hotels, (ii) the benefits from any operating margin improvements and risk of any operating margin deterioration at these hotels, and (iii) more flexibility, in that these hotels are no longer encumbered by long term leases with unrelated third parties that are difficult to amend and expensive to terminate. All of the hotels continue to operate under the same franchise affiliations as prior to the acquisition of the leasehold interests.

Off-Balance Sheet Arrangements

     The Company’s off-balance sheet arrangements consist primarily of its ownership interest in its joint venture with 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”, “Recently Issued Accounting Standards” and “Liquidity and Capital Resources”.

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, mezzanine loan borrowers, and other borrowers to make required payments. If the financial condition of its hotel guests, mezzanine loan borrowers, or 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 December 31, 2003 the Company had a 15 percent ownership interest in its Charlesbank joint venture, (which in turn owned an 87 percent ownership interest in its WCC Project Company LLC joint venture), a 49 percent ownership interest in one of its joint ventures with Regent, a 57.65 percent interest in the other joint venture with Regent, a 49 percent ownership interest in its Marsh Landing joint venture, and a 48.78 percent interest in its Chapel Hill joint venture. The WCC Project Company LLC joint venture owned three hotels, and the two Regent joint ventures and the Marsh Landing joint venture each owned one hotel. The Chapel Hill joint venture owned 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”), as of December 31, 2003, 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 2003 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 December 31, 2003.

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     As of December 31, 2003, for three of its joint ventures created prior to January 31, 2003, the Company determined that they are considered to be VIEs and the Company is considered to be the primary beneficiary. These include the two Regent joint ventures and the Marsh Landing joint venture. Therefore, per the provisions of FIN 46, the Company has consolidated the assets and liabilities of these joint ventures into its Consolidated Balance Sheet as of December 31, 2003. Per FIN 46, for these three joint ventures, the Company will not consolidate the results of operations until 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.

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 December 31, 2003. Should our estimate of future taxable income be less than expected, and/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

     Due to the acquisition of the leasehold interests for 47 hotels from Interstate on July 1, 2002, and the assumption of the leasehold interests for two hotels from Intercontinental Group on July 1, 2003, the results of operations for the years ended December 31, 2003, December 31, 2002, and December 31, 2001 do not result in a meaningful comparison. This is due primarily to recording the operating results of the hotels, for which the leasehold interests were acquired, on the Company’s statements of operations beginning in the third quarter of 2002. Accordingly, the Company has supplemented the comparison between years with pro forma information to offer a more meaningful comparison.

     The table below outlines the Company’s wholly owned hotel properties as of December 31, 2001, 2002 and 2003. The Company made no acquisitions of hotels, other than through joint ventures, during the periods presented.

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Actual Results — Years Ended December 31, 2003, 2002 and 2001

     REVENUE

     Rooms, Food and Beverage and Other Operating Departments Revenue – The increase in hotel revenues from 2001 to 2002, and from 2002 to 2003, is a result of the acquisition of the leasehold interests from Interstate and Intercontinental Group. The operating results of the hotels, for which the leasehold interests were acquired, are reflected on the Company’s consolidated statements of operations beginning July 1, 2002.

     Percentage Lease Revenue – Percentage lease revenue declined from 2001 to 2002 and from 2002 to 2003. This decline is primarily due to the acquisition of the leasehold interests from Interstate on July 1, 2002. 2001 included a full year of percentage lease revenue from all wholly owned hotels. Effective July 1, 2002, the percentage lease revenue for all but two wholly owned hotels was received from Barclay and eliminated in consolidation. Therefore, 2002 included six months of percentage lease revenue for all but two hotels that remained under long term leases with third parties for the entire year. These two hotels included the Secaucus, NJ Holiday Inn and the Las Vegas, NV Hampton Inn. Effective, July 1, 2003, the Company acquired the leasehold interest for the Las Vegas, NV Hampton Inn. Therefore, 2003 included a full year of percentage lease revenue for one hotel and six months of percentage lease revenue for one hotel.

     Interest and Other Income – Interest and other income decreased from $2,166 in 2001 to $1,458 in 2002. The decline is primarily due to a decrease in third party development and purchasing fees related to our Evanston joint venture hotel and Tampa, FL Hilton Garden Inn for which we have provided mezzanine financing. Interest and other income increased from $1,458 in 2002 to $1,560 in 2003. This increase was driven primarily by interest income earned on our mezzanine loan provided for the Baltimore Hampton Inn & Suites for twelve months in 2003 versus one month in 2002.

     EXPENSES

     Rooms, Food and Beverage, Other Operating Departments Expenses – The increase in these hotel expenses from 2001 to 2002, and from 2002 to 2003, is a result of the acquisition of the leasehold interests from Interstate and Intercontinental Group. The operating results of the hotels, for which the leasehold interests were acquired, are reflected on the Company’s consolidated statements of operations beginning July 1, 2002.

     Property Operating Costs, Franchise Costs, Maintenance and Repair Costs and Management Fees – The increase in these hotel expenses from 2001 to 2002, and from 2002 to 2003, is a result of the acquisition of the leasehold interests from Interstate and Intercontinental Group. The operating results of the 47 hotels, for which the leasehold interests were acquired, are reflected on the Company’s consolidated statements of operations beginning July 1, 2002.

     Real Estate Taxes and Property and Casualty Insurance – Real estate taxes and property insurance costs decreased from $6,361 in 2001 to $6,259 in 2002 and to $6,163 in 2003. The declines in both years are due to decreases in property taxes due to successful tax appeals and downward property valuation trends associated with lower revenues, decreases in ground rent expense as a result of lower room revenues at the corresponding hotel, offset by an increase in insurance premiums.

     Percentage Lease Expense – Beginning July 1, 2002, this expense represented the lease expense Barclay, as lessee, paid to third party owners of two joint venture hotels, including the Evanston, IL Hilton Garden Inn and the Ponte Vedra, FL Hampton Inn.

     General and Administrative – General and administrative expense decreased from $5,419 in 2001 to $4,843 in 2002 and increased to $5,922 in 2003. The decrease in 2002 was primarily attributable to lower expenses associated with mezzanine financing, acquisition and development activities. The increase in 2003 was primarily attributable to an increase in legal costs associated with transferring lease and management contracts of our hotels totaling $391, an increase in professional fees of $138, and an increase in payroll costs totaling $521.

     Depreciation and Amortization – Depreciation expense declined $474 from 2001 to 2002 and $1,182 from 2002 to 2003. The decreases in depreciation expense are associated with the sale of one property in 2001 and lower depreciation expense on furniture, fixtures and equipment. Amortization expense remained relatively consistent all three years.

     Interest – Interest expense decreased from $12,170 in 2001 to $10,478 in 2002 and to $7,257 in 2003. This decrease was due to both a decline in weighted average interest rates, from 7.03% in 2001 to 6.85% in 2002 to 5.55% in 2003, as well as a decline in the weighted average outstanding debt balance from $172,022 in 2001 to $152,879 in 2002 to $130,807 in 2003. The weighted average outstanding debt balance decreased primarily due to the sale of 3.162 million shares of common stock in March and April 2002, and

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the sale of 6.038 million shares of common stock in September and October of 2003. The Company used the net cash proceeds totaling $26,900 and $50,500, respectively, to reduce the then outstanding debt balance.

     Loss on Sale of Property – The Company did not sell any hotels during 2003. The net loss on sales of property in 2002 is reported as loss on sale of discontinued operations – see Discontinued Operations below and Note 15 in Notes to Consolidated Financial Statements. The loss on sale of property in 2001 represents the loss experienced on the sale of the Raleigh, NC Comfort Inn in June 2001.

     Income Tax Benefit – The income tax benefit for 2003 is a result of the net loss experienced by Barclay during 2003. The income tax benefit for 2002 is a result of the cost of acquiring the leases from Interstate, which was expensed for financial reporting purposes and will be amortized over the lives of the leases for tax purposes, and the net loss experienced by Barlcay during 2002.

     Equity in Income of Unconsolidated Joint Ventures – Equity in income of unconsolidated joint ventures increased from $523 in 2001 to $1,172 in 2002 and to $1,193 in 2003. The increase from 2001 to 2002 is primarily due to the Evanston Hilton Garden Inn hotel being open for the entire year during 2002 versus only being open from July through December in 2001. The increase from 2002 to 2003 is due to an increase in earnings from the Evanston and Marsh Landing joint ventures of $255 related to improved hotel operations, an increase in earnings from the Charlesbank joint venture of $57 due to the addition of the Beachwood and Houston Park Place hotels in 2003, offset by a decline in earnings from the Windsor joint venture of $291 due to diminishing operations and acquisition of the lease at that hotel in July 2003. The Windsor joint venture assumed the lease of the Windsor Hilton Garden Inn hotel on July 1, 2003 at no cost. As of December 31, 2003, the Company owned 57.65 percent of the new lessee of the Hilton Garden Inn hotel and Regent Partners, Inc., the Company’s joint venture partner, owned the remaining 42.35 percent. This property incurred a net loss of $327 for the period of July 1, 2003 through December 31, 2003.

     Due to the Company’s adoption of FIN 46, the operations of the Evanston, Marsh Landing and Windsor joint ventures will be consolidated beginning in the first quarter of 2004. The Company will continue to account for the Charlesbank Joint Venture in 2004 as it has in 2003 and 2002, as an unconsolidated joint venture under the equity method of accounting.

     Discontinued Operations – During 2003, the Company classified the Greenville, SC Comfort Inn as “held for sale.” The Company sold the Clearwater, FL Comfort Inn in May 2002, the Southern Pines, NC Hampton Inn in August 2002, the Augusta, GA Comfort Inn in November 2002 and the Chester, VA Hampton Inn in December 2002. The aggregate net loss on these sales and the operating results of all of these properties are shown as discontinued operations for all periods presented.

     Lease/Management Agreement Acquisition – As discussed above, effective July 1, 2003, the Company, through Barclay, terminated its management agreements with IMIC by paying a termination fee of $1.3 million, which was expensed in the third quarter of 2003. Also, as discussed above, effective July 1, 2002, the Company, through Barclay, acquired the leasehold interests for 47 of its hotels from Interstate. The total consideration of approximately $19,500, as determined by the Leasehold Acquisition Agreement, was based upon a $17,000 purchase price for the leasehold interests, adjusted in part for accrued interest and related expenses totaling $668, and approximately $1,800 of working capital. The cost of the acquisition of the leasehold interests, including accrued interest and related expenses, but excluding the working capital acquired, totaled $17,668. This cost represents the cancellation of an executory contract and was expensed in the second quarter of 2002. In addition, a deferred tax benefit of $6,714 was recognized in the second quarter of 2002 resulting from the timing difference of the $17,668 payment for financial reporting purposes versus tax purposes. The net effect of this transaction is a reduction in net income of $10,954, the primary reason for the reduction in net income from 2001 to 2002, and the increase in net income from 2002 to 2003.

     Due to the acquisition of the leasehold interests from Interstate and Intercontinental Group, the results of operations for the year ended December 31, 2003 versus the results of operations for the year ended December 31, 2002, and the results of operations for the year ended December 31, 2002 versus the results of operations for the year ended December 31, 2001, do not result in meaningful comparisons. This is due primarily to recording the operating results of the hotels, for which the leasehold interests were acquired, on the Company’s statements of operations beginning in the third quarter of 2002. Therefore, in an effort to make a more meaningful comparison between periods, in addition to the comparison of actual results of operations for the years ended December 31, 2003, 2002 and 2001, shown below is selected pro forma financial information on a “same store” basis for the years ended December 31, 2003, 2002 and 2001, as if the acquisition of the leasehold interests from Interstate and Intercontinental Group occurred on January 1, 2001. This information is shown for the hotels that were open for the entire periods presented and does not include discontinued operations or the hotel sold during 2001. The pro forma adjustments include the elimination of the transaction to acquire the leasehold interests from Interstate and the percentage lease revenue applicable to the 45 wholly owned hotels for which the leasehold interests were acquired, as well as adjustments to undistributed property operating expenses to remove management company corporate costs, and to make adjustments to management fees to reflect the fee structure per the new management agreements. The unaudited pro forma financial information does not purport to be indicative of what the actual results of operations of the Company would have been had the transaction occurred on the basis assumed above nor are they indicative of results of future operations. The unaudited pro

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forma financial information is based upon available information and upon assumptions and estimates that management believes are reasonable under the circumstances.

Selected Unaudited Pro Forma Financial Information — Year Ended December 31, 2003, 2002 and 2001 (in thousands)

     For purposes of this pro forma disclosure, all years shown include the 43 wholly owned hotels that were owned during each of the years, plus two hotels owned by joint ventures (the Evanston, IL Hilton Garden Inn owned by the Regent joint venture and the Ponte Vedra, FL Hampton Inn, owned by the Marsh Landing joint venture), for which Barclay was the lessee on July 1, 2003 as a result of the acquisition of the leases from Interstate and Intercontinental Group. This disclosure does not include one wholly owned hotel as of December 31, 2003, the Greenville, SC Comfort Inn, as this hotel was classified as “held for sale” during 2003.

     To help understand the differences between the pro forma information shown above, and the actual operating results of the Company, shown below is a reconciliation of the pro forma operating income to the actual operating income:

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PRO FORMA REVENUE

     Room Revenue – Room revenue decreased from $116,588 in 2001 to $114,580 in 2002 and to $114,246 in 2003. We believe this was primarily attributable to a weak economy, as well as the addition of new competing hotels in certain of our markets, which resulted in revenue per available room (“RevPAR”) decreasing 3.2% from $53.30 in 2001 to $51.60 in 2002, and 0.7% from $51.60 in 2002 to $51.24 in 2003. Average daily rate for the year declined 3.6% from $82.02 in 2001 to $79.04 in 2002, and 2.2% from $79.04 in 2002 to $77.28 in 2003. Occupancy rates increased slightly from 65.0% in 2001 to 65.3% in 2002, and increased slightly more in 2003 to 66.3%. The decrease in room revenue in 2002 due to a decline in RevPAR was partially offset by an increase of $2,761 in room revenue from the Evanston, IL Hilton Garden Inn hotel that opened in July 2001.

     Other Hotel Revenue – Other hotel revenue consists of food and beverage revenue and other operating departments revenue. Other hotel revenue declined from $12,653 in 2001 to $12,487 in 2002, and to $11,383 in 2003. These decreases are primarily due to the continuing trend of declining telephone revenue as hotel customers rely increasingly more on their own mobile phones and calling cards for telecommunications.

     Percentage Lease Revenue – This balance for each year represents the percentage lease revenue from the Secaucus, NJ Holiday Inn hotel, the Company’s only hotel that remained under a third party lease as of December 31, 2003.

PRO FORMA EXPENSES

     As a percentage of total hotel revenue, hotel operating expenses increased for the year from 58.1% in 2001 to 60.2% in 2002, and to 62.3% in 2003. Total hotel revenue includes rooms and other hotel revenue. Hotel operating expenses include rooms and other operating expenses, as well as undistributed property operating costs and undistributed other operating costs.

     Rooms and Other Hotel Operating Expenses – Rooms and other hotel operating expenses increased from $34,658 in 2001 to $35,110 in 2002, and to $35,411 in 2003. The increase from 2001 to 2002 was driven by a $423 increase in payroll costs in the rooms department. The increase from 2002 to 2003 was driven primarily by a $740 increase in rooms department payroll costs offset by savings in the telephone and food and beverage departments of $301 and a decline in property taxes and insurance of $96.

     Undistributed Property Operating Expenses – Undistributed property operating expenses consist of general and administrative, sales and marketing, energy, repairs and maintenance, franchise fees, management fees and other costs. These costs are collectively shown as property operating costs and other operating costs in the tables above. Undistributed property operating expenses increased from $40,541 in 2001 to $41,321 in 2002, and to $42,814 in 2003. The increase from 2001 to 2002 was primarily comprised of a $857 increase in sales and marketing and a $631 increase in repairs and maintenance attributable to both payroll and operating expenses. These increases were offset by declines of $278, $144 and $265 in general and administrative, utilities and franchise fees, respectively, all related to decreasing occupancy. The increase from 2002 to 2003 was primarily comprised of an increase in repairs and maintenance of $484 due to higher engineer payroll costs, an increase in general and administrative of $165 and an increase in utilities of $420 due to higher occupancy.

     See “Actual Results – Years Ended December 31, 2003, 2002, and 2001” for explanations of changes in pro forma balances for the line items not explained in the pro forma discussion above.

Liquidity and Capital Resources

     The Company finances its operations from operating cash flow, which, during 2003, was principally derived from the net operating cash flows from the operations of its hotels. For the year ended December 31, 2003 and 2002, cash flow provided by operating activities was $25,074 and $20,446, respectively. The increase in cash flow provided by operations is primarily due to the cost to acquire the leasehold interests for 47 hotels from Interstate effective July 1, 2002.

     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. In 2003, the Company declared total distributions of $20,753, $13,815 to its common shareholders and $6,938 to its preferred shareholders. As shown in the table below, based on the Company’s 2003 taxable income, the Company was required to distribute approximately $16,950 to maintain its REIT status.

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     The Company declared a quarterly common share dividend of $0.15 per share for each quarter during 2003. The Company intends to monitor its dividend policy closely and to act accordingly as earnings dictate. The Company 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 the 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 capital and cash flow from the Company’s investments are insufficient to make such distributions.

     The Company raised net proceeds of approximately $50.5 million as a result of a follow-on Common Stock offering in which the Company sold an additional 6,037,500 common shares. The follow-on offering was completed in October 2003 with the exercise of the underwriters’ over-allotment option, which included 787,500 common shares of the total 6,037,500 common shares. The Company initially used the net proceeds to pay down its then outstanding balance under its $125 million line of credit, and plans to use the resulting availability under the line of credit to fund the Company’s hotel lending business, to acquire hotels or interests in hotels through joint ventures, and/or for general corporate purposes.

     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 $89 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 $12.9 million to pay down its then outstanding balance under its $125 million line of credit, and plans to use the resulting availability under the line of credit 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 will be recorded as a reduction in net income (loss) available to common shareholders in the first quarter of 2004.

     The Company’s net cash used in investing activities during the year ended December 31, 2003 totaled $9,841, consisting of capital expenditures and renovations of hotels totaling $9,062 and investment in joint ventures of $779.

     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 December 31, 2003 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 four hotels during 2002, including the Clearwater, FL Comfort Inn in May, the Southern Pines, NC Hampton Inn in August, the Augusta, GA Comfort Inn in November and the Chester, VA Comfort Inn in December. The total net proceeds were $13,257. Periodically, the Company considers the sale of certain other hotels that lie outside the Company’s “mid-scale without food and beverage” and “upscale” segment focus and plans to use the proceeds to reduce debt, invest in hotel properties, or provide hotel loans.

Hotel Loans

     In February 2004, the Company issued a $2.4 million 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

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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.

     In the fourth quarter of 2002, the Company funded a $3,500 mezzanine loan 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 entered into a joint venture agreement (the “Hall Joint Venture”), with an affiliate of Hall Financial Group, (“Hall”). The Company assigned the $3,500 mezzanine loan to the Hall Joint Venture and retained a 50% interest (or $1,750) in the note through the joint venture. The total cost of the Baltimore Hotel, which opened in the first quarter of 2004, was approximately $13,100, net of historic tax credits of $6,000. The Company owns 50% of the Hall Joint Venture, and Hall owns the remaining 50%. If at any time, (i) the Company and Hall (the “Members”) cannot resolve a disagreement within 30 days after written notice from one Member to the other, or (ii) any Member transfers its interest to an entity that is not considered an affiliate of such Member, then either Member (the non-transferring Member in the case of clause (ii) above), shall have the option to give notice to the other of its intent to buy or sell its interests to the other Member. If this option is exercised, the Member that elects to do so must set forth an all cash price that reflects the net book value of the assets and liabilities of the Hall Joint Venture in its notice to the other Member. Within 10 days after receiving the notice, the Member who receives this notice must then decide whether to buy the interests of the other Member or sell its interests to the other Member. Within 20 days after making the determination of which Member will be the buyer and which Member will be the seller, the Members are obligated to complete the purchase and sale. If the purchasing Member defaults on its obligation to consummate the purchase, then the non-purchasing Member shall have the right to (i) be the purchasing Member under the same terms and conditions as the purchase that failed to close except that the purchase price will be 75% of the previously determined closing price, or (ii) carry on as if the option to purchase or buy had never been exercised.

     The Company is paid interest monthly on its $1,750 share of the $3,500 mezzanine loan, at an annual interest rate of 30-day LIBOR plus 10.21% from the date the loan was issued through the date the hotel opens. The Company also accrues interest monthly (“Accrued Interest”) at an annual interest rate of 12% during this same time. Once the hotel opens, the Company will receive monthly principal and interest payments based on a 10-year amortization period and an interest rate of 30-day LIBOR plus 10.21% until the earliest of (a) prepayment of the loan, (b) the initial maturity date of October 29, 2005, or (c) the earlier of (1) 60 days before the maturity date of the borrower’s construction loan, or (2) the prepayment of the construction loan. Additional interest will accrue monthly on the loan at a rate of 8% of gross monthly revenues for one year after the hotel opening date, and at a rate of 10% of gross monthly revenues thereafter through October 29, 2005; 4% of gross monthly revenues will be paid quarterly and the balance will accrue (“Accrued Participation”). The Accrued Interest and the Accrued Participation constitute the “Aggregate Accrued Amount”. The “Disposition Fee” associated with the loan equals the greater of (1) the Aggregate Accrued Amount, (2) 50% of the appreciation in the fair market value (“FMV”) of the hotel if the loan is repaid during the first 30 months after the loan was issued, and (3) 60% of the appreciation in the FMV of the hotel if the loan is repaid thereafter. The repayment amount of the loan shall equal the outstanding principal balance of the loan, plus (i) all Accrued Interest, (ii) accrued and unpaid monthly interest, (iii) Accrued Participation, and (iv) the Disposition Fee; provided however, if that sum does not provide the Hall Joint Venture with an internal rate of return of 23%, then the repayment amount will equal the outstanding principal balance of the loan, plus the amount necessary to give the Hall Joint Venture an internal rate of return of 23%. The Baltimore Hotel is owned 100% by a single purpose entity (the “Borrower”) unaffiliated with the Company. The Company holds collateral equal to 80% of the ownership interest in the Borrower. The Borrower made an initial equity investment equal to approximately 20% of the total cost of the respective 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.

     In 2001 and 2000, the Company made three mezzanine loans totaling $3,516 to third party hotel owners. During 2001, the Company provided $2,186 in mezzanine financing to Noble Investments — Tampa, LLC to develop a Hilton Garden Inn in Tampa, FL (the “Tampa Hotel”). The Company receives monthly interest at annual rates based on 30-day LIBOR plus 8.44% until the earliest of (a) prepayment of the loan, or (b) January 1, 2005. Noble Investments LLC has provided the Company with a guarantee in the amount of $400, due to a deficiency in the debt service coverage ratio required by the mezzanine loan. During 2000, the Company provided $1,080 in mezzanine financing to Noble Investments – Sugarloaf, LLC to develop a Hilton Garden Inn in Atlanta (Sugarloaf), GA (the “Sugarloaf Hotel”). The Company receives monthly interest at annual rates based on 30-day LIBOR plus 7.36% until the earlier of (a) prepayment of the loan or (b) June 30, 2005. Both loans are subject to prepayment penalties during the first three years. When each hotel opened, the Company began to earn interest equal to 2% of gross revenues, 25% of which is paid monthly and the remainder is accrued (“Accrued Interest”). On the earlier of prepayment or the maturity date of each loan, the Company will also receive the greater of the Accrued Interest or, with respect to the Tampa Hotel, 20% of the appreciation in value, and with respect to the Sugarloaf Hotel, 15% of the appreciation in value. In addition to earning interest income, the Company also provided development and purchasing services to Noble during each hotel’s construction stage for additional fee income. The Company co-developed the Sugarloaf Hotel and developed the Tampa Hotel. During 2001 and 2000, these fees totaled $645 and $137, respectively. Both the Tampa Hotel and the Sugarloaf Hotel are owned 100% by unaffiliated single purpose entities (the “Borrowers”). The Company holds collateral equal to 100% of the equity interest in the Borrowers. The Borrowers made initial equity investments equal to 20% of the total cost of the respective 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 Borrowers, including for failure to maintain specified debt coverage ratios.

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Neither borrower is currently in default under either loan. The Atlanta (Sugarloaf) project opened during the second quarter of 2001, and the Tampa project opened during the first quarter of 2002. In 2001, the Company also provided mezzanine financing totaling $250, which represents a participating interest in a $5,478 mezzanine loan to the owner of a 769-room resort hotel in Orlando, FL. This loan was written off as uncollectible in 2002 due to the severe impact on the Orlando area from the terrorist events of September 11, 2001 and the resulting poor economic conditions.

Joint Ventures

     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 Courtyard by Marriott hotel in Chapel Hill, NC, (the “Chapel Hill Courtyard”) which is expected to open in the summer 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 the form of a preferred membership interest (“Preferred Contribution”). The Company’s Preferred Contribution requires monthly dividends to be paid in cash 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. The Company will receive $700 for development services provided during construction, with the margin on such fees being recognized as a reduction in depreciation expense over the life of the project. 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 Company has consolidated the results of operations and financial position of this joint venture beginning with the third quarter 2003. As a result, the Company’s investment balance in the Chapel Hill Joint Venture of $1,990 and its Preferred Contribution amount of $1,453 at December 31, 2003 have been eliminated in consolidation.

     During the fourth quarter of 2002, the Company formed a joint venture (the “Charlesbank Venture”) with Boston-based Charlesbank Capital Partners, LLC (“Charlesbank”). The Charlesbank Venture intends to acquire more than $100 million of hotel assets. Charlesbank is a private investment firm managing capital on behalf of institutional investors. 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 December 31, 2003, the Charlesbank Venture had invested in three hotels to date through a joint venture (“WCC Project Company LLC”) comprised of Concord Hospitality Enterprises Company (“Concord”) and the Charlesbank Venture. The first hotel was a vacant building located in the Beachwood suburb of Cleveland, OH that was converted into a 113-room Courtyard by Marriott in the second quarter of 2003. The second hotel was a 102-room Fairfield Inn & Suites by Marriott located in Des Moines, IA, which was converted from a Wingate Inn during the summer of 2002. The third hotel was a Best Western located in Houston, TX, which was purchased in the fourth quarter of 2003 and is expected to be converted to a Spring Hill Suites by Marriott in the second quarter of 2004. 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. The total cost of these three hotels is approximately $30 million. The Company earns an asset management fee equal to 0.50% of the total cost of the assets purchased by the Charlesbank Venture.

     At any time following two years after WCC Project Company LLC first acquires each hotel, the Manager (the Charlesbank Venture), by written notice to Concord, may require the sale of any one or more of the hotels to a third party.

     At any time following twelve months after the acquisition of the first hotel, either the Manager or Concord can give the other written notice of their election to buy or sell any one or all of the hotels owned by WCC Project Company LLC at fair market value, as determined under the Limited Liability Company Agreement of WCC Project Company LLC. The purchasing Member must then, within three business days, deposit 5% of the fair market value with a title insurance company. If within twenty days following the deposit the purchasing Member does not wish to proceed, it must notify the non-purchasing Member who shall then have the right to become the purchasing Member under the same terms and conditions. If the purchasing Member defaults on its obligation to consummate the purchase after twenty days of making the deposit, then the non-purchasing Member shall have the right to (i) be the purchasing Member under the same terms and conditions as the purchase that failed to close except that the purchase price will be 85% of the previously determined closing price, (ii) cause each hotel to be terminated and dissolved in accordance with the operating agreement, or (iii) retain the deposit and continue as if the option to purchase or buy had never been exercised. As of December 31, 2003, the Company’s investment in the Charlesbank Venture totaled $1,015. The Company, through the Charlesbank Venture, receives cash distributions of any operating profits from WCC Project Company LLC on a quarterly basis.

     In February 2004, the Charlesbank Venture invested in a fourth 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”). This hotel is a Ramada Inn that the partners expect to convert to a Courtyard by Marriott in early 2005. The total cost of the project is expected

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to be approximately $14,000 (including approximately $5,000 in renovation costs), approximately $9,000 of which is financed through debt. New Castle owns a 13% interest in the project while the Charlesbank Venture owns 87%, so that the Company has an indirect 13.05% ownership interest in WNC Project Company LLC.

     At any time following twelve months after WNC Project Company LLC first acquires each hotel, either the Charlesbank Venture or the Manager (Shelton III Hotel Equity LLC) by written notice to the other Member, may require the sale of any one or more of the hotels to a third party.

     At any time following twelve months after the acquisition of the first hotel, either the Charlesbank Venture or the Manager can give the other written notice of their election to buy or sell any one or all of the hotels owned by WNC Project Company LLC at fair market value, as determined under the Limited Liability Company Agreement of WNC Project Company LLC. The purchasing Member must then, within three business days, deposit 5% of the fair market value with a title insurance company. If within twenty days following the deposit the purchasing Member does not wish to proceed, it must notify the non-purchasing Member who shall then have the right to become the purchasing Member under the same terms and conditions. If the purchasing Member defaults on its obligation to consummate the purchase after twenty days of making the deposit, then the non-purchasing Member shall have the right to (i) be the purchasing Member under the same terms and conditions as the purchase that failed to close except that the purchase price will be 85% of the previously determined closing price, (ii) cause each hotel to be terminated and dissolved in accordance with the operating agreement, or (iii) retain the deposit and continue as if the option to purchase or buy had never been exercised.

     Under the terms of the Charlesbank Venture, Charlesbank will provide 85% of the total equity, and the Company will provide the remaining 15% of the total equity committed to each acquisition. Charlesbank will have the option to expand the venture by committing additional equity to future acquisitions after the initial equity is committed. The Company anticipates that the Charlesbank Venture will be able to secure debt financing for approximately 65% of the total cost of hotel assets that are purchased.

     In 2000, the Company entered into a joint venture agreement with Marsh Landing Investment, LLC (“Marsh”) to jointly develop an $8 million, 118-room Hampton Inn in Ponte Vedra, FL. This hotel opened in December 2000. The Company owns 49% of the joint venture, and Marsh, a company owned by Charles M. Winston and James H. Winston, owns the remaining 51%. Both Charles M. Winston and James H. Winston serve on the Company’s Board of Directors. Marsh currently may offer the Company the right to purchase Marsh’s interest in the joint venture and, if the Company refuses to purchase the interest, Marsh may cause the joint venture to sell the hotel owned by the joint venture to a third party. In addition, at the Company’s option, it has the right to acquire Marsh’s interest in the joint venture (1) at any time after December 2005 or (2) if Marsh fails to sell the hotel following the Company’s rejection of an offer by Marsh to sell it’s interest in the joint venture to the Company. The Company earns an asset management fee equal to 1% of the total revenues earned by the joint venture’s hotel.

     In addition to the joint ventures described above, during 1999 the Company entered into two joint ventures with Regent Partners, Inc. (“Regent”) to jointly develop and own upscale hotel properties. As of December 31, 2003, the Company owned a 49% interest in one joint venture with Regent and a 57.65% interest in the other joint venture, each of which owned an operating hotel. These hotels consisted of a 178-room Hilton Garden Inn located in Evanston, IL, and a 157-room Hilton Garden Inn located in Windsor, CT. During 2003, the Company earned an asset management fee equal to 1% of the total revenues earned by both of the joint ventures’ hotels.

     In March 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. The amount paid for Regent’s ownership interest in the Evanston Hilton Garden Inn totaled approximately $6,900, and was based on a value of $25,250 for the sale of the hotel, net of debt assumed of approximately $11,800, such assumption being subject to the approval of the lenders under our $125 million line of credit. The amount paid for Regent’s ownership interest in the Windsor Hilton Garden Inn totaled approximately $1,200, and was based on a 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 will continue to lease the Evanston hotel and, as a result of the purchase, Barclay will assume the lease of the Windsor hotel from Windsor Lessee Company LLC.

     Effective July 1, 2003, Intercontinental Group, as lessee, defaulted on its obligations under the lease agreement for the Windsor, CT Hilton Garden Inn hotel and the Las Vegas, NV Hampton Inn hotel. At that time, the Windsor Hilton Garden Inn was owned by a joint venture entity, Windsor Hotel Associates, LLC. Prior to its default under the lease, Intercontinental Group owned 15 percent of Windsor Hotel Associates, LLC, the Company owned 49 percent, and Regent owned 36 percent. Subsequent to the default under the lease agreement, Intercontinental Group forfeited its share of ownership, with the result that the Company owned 57.65 percent and Regent owned 42.35 percent of Windsor Hotel Associates, LLC. On July 1, 2003, Windsor Lessee Company LLC assumed the lease of the Windsor Hilton Garden Inn hotel. As of December 31, 2003, Windsor Lessee Company LLC was owned 57.65 percent by the

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Company and 42.35 percent by Regent. The Las Vegas, NV Hampton Inn hotel is owned 100 percent by the Company. On July 1, 2003, Barclay assumed the lease of the Las Vegas Hampton Inn.

     During 2003, the Company received cash distributions from its joint ventures totaling $1,863. 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 fee income. Under the terms of the operating agreement for each joint venture, the Company and its joint venture partner must approve all major decisions, including refinancing or selling the respective hotels, making loans, changes in partners’ interests, entering into material contracts, acquiring assets, and approving all operating and capital expenditure budgets. In accordance with the provisions of FASB Interpretation No. 46 (“FIN 46”) Consolidation of Variable Interest Entities, during the third quarter of 2003 the Company consolidated the balance sheet and operations of it’s Chapel Hill Joint Venture. As of December 31, 2003, the Company has consolidated the balance sheets of the Evanston Joint Venture, the Windsor Joint Venture and the Marsh Landing Joint Venture. The operations of these joint ventures will be consolidated beginning with the first quarter of 2004. As of December 31, 2003, the total assets of the consolidated joint ventures were $49,160, total liabilities were $29,074 ($27,706 of which represented long-term debt), and total equity was $20,086. For the years ended December 31, 2003 and 2002, the total revenue of the consolidated joint ventures was $8,662 and $6,256, and total expenses were $6,329 and $3,756, resulting in net income of $2,333 and $2,500, respectively. During the year ended December 31, 2003, the unaudited financial statements of the consolidated joint ventures reflected aggregate cash flow provided by operating activities of $4,612, cash used in investing activities of $1,873, principally for hotel additions, and cash used in financing activities of $637, principally in the form of loan proceeds and capital contributions less distributions to joint venture partners. As of December 31, 2003, the total assets of the unconsolidated joint ventures were $24,642, total liabilities were $15,272 ($13,956 of which represented long-term debt), and total equity was $9,370. The Company’s share of the total assets, liabilities, long-term debt and equity of these unconsolidated joint ventures equated to $3,216, $1,993, $1,821 and $1,223, respectively. For the years ended December 31, 2003 and 2002, the total revenue of the unconsolidated joint ventures was $4,615 and $782, and total expenses were $4,508 and $911, resulting in net income (loss) of $107 and ($129), respectively. During the year ended December 31, 2003, the unaudited financial statements of the unconsolidated joint ventures reflected aggregate cash flow provided by operating activities of $1,400, cash used in investing activities of $13,775, principally for hotel additions, and cash provided by financing activities of $12,472, principally in the form of loan proceeds and capital contributions less distributions to joint venture partners.

     During 2003, the Company spent $7,092 or 6.4% of room revenue, in connection with the renovation of its wholly owned hotels and plans to spend approximately $8,000 during 2004. In connection with the Company’s acquisition of the leasehold interests for 47 of its hotels from Interstate on July 1, 2002, Barclay became the franchisee under the franchise licenses for the respective hotels. As a result of this change, the Company elected to incur additional capital expenditures during 2003 consistent with certain franchisor requirements. These capital expenditures are funded from operating cash flow, and possibly from borrowings under the Company’s $125,000 line of credit (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 were approximately 6.1% and 5.7% of room revenues in 2003 and 2002, respectively.

     The Company’s net cash used in financing activities during the year ended December 31, 2003 totaled $13,078. This net use of cash was primarily due to the payments made to decrease the outstanding debt balance of the Line by $43,100, payments of distributions to shareholders totaling $19,834 and the payments of distributions to the Partnership’s minority interest totaling $779. This amount also includes principal payments totaling $1,221 related to the Company’s $71,000 fixed rate note. These cash outflows were offset by cash received from the issuance of 6.038 million common shares for net cash proceeds totaling $50,465 and minority interest contributions to consolidated joint ventures totaling $2,100.

     During each quarter in 2003, the Company paid cash dividends per common and preferred share of $0.15 and $0.578125, respectively, equating to $0.60 and $2.31, respectively, on an annual basis. In addition, on an annual basis, the Company expects to have adequate cash flow from operations and from borrowings to fund its expected debt service, capital expenditures, and dividend obligations during 2004.

     The Company’s $125,000, three-year line of credit (the “Line”) bears interest at rates from LIBOR plus 1.75% to 2.50%, based on the Company’s consolidated debt leverage ratio. As of December 31, 2003 the Line was collateralized with 30 of the Company’s hotels, with a net book value of $195,763 as of December 31, 2003. During 2003, the Company reduced the outstanding balance under its line of credit by $43,100, from $72,300 to $29,200. The Company’s articles of incorporation limit its debt to 60% of the cost of its investment in hotel properties, or approximately $284 as of December 31, 2003.

     The Company’s availability under the Line totaled approximately $95,800 as of December 31, 2003. 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 December 31, 2003. The failure to comply with any of these covenants would cause a default under our line of credit.

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Furthermore, our line of credit provides that any default under, or acceleration of, any of our other debt, any debt of WINN Limited 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 our line of credit. If this occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it, in which case we would not be able to make distributions to our shareholders.

     The Company had $65,031 in debt at December 31, 2003 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 are due on December 1, 2008. The GE Capital loan was collateralized with 14 of the Company’s hotels with a net book value of $111,227 as of December 31, 2003.

     All 44 of the Company’s wholly owned hotels as of December 31, 2003 were pledged as collateral for the Company’s debt securities, 30 against the outstanding balance under the Line and 14 against the outstanding balance under the GE Capital loan.

     On December 18, 2000, the Company completed an interest rate swap on $50,000 of its outstanding variable rate debt under the Line. This transaction effectively replaced the Company’s variable interest rate based on 30-day LIBOR on $50,000 of outstanding debt under the Line with a fixed interest rate of 5.915% until December 18, 2002, at which time the swap matured.

     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 Line’s interest rate spread is currently 1.75%, equaling a fixed rate of 3.255%.

     As of December 31, 2003, the Company’s contractual obligations and commitments (excluding obligations and commitments pursuant to the Company’s unconsolidated joint ventures) were as follows:

     The Company operates in a manner intended to enable it to qualify as a REIT under the Internal Revenue Code. A REIT that distributes at least 90 percent of its taxable income to its shareholders each year and which meets certain other conditions is not taxed on that portion of its taxable income which is distributed to shareholders. Based on our 2003 taxable income to shareholders, we were required to distribute approximately $16,950 in order to maintain our REIT status as described above. We distributed approximately $13,815 to common shareholders and $6,938 to preferred shareholders for the year ended December 31, 2003, which exceeded our required distributions.

     During 2003 the Company signed a construction contract with a builder, to construct a Courtyard by Marriott hotel in Chapel Hill, NC, which will be owned by the Company’s consolidated Chapel Hill joint venture. The contract sum is $7,942 and the construction completion date is expected to be September 2004.

     The Company intends to continue to seek additional mezzanine loan opportunities, as well as other hotel loan opportunities in general, and to acquire and develop additional hotel properties that meet its investment criteria. The Company is continually evaluating such opportunities, as well as other investment opportunities including, but not limited to, the acquisition of assets that require substantial renovation and repositioning within a particular market. It is expected that future hotel loans and acquisitions will be financed, in whole or in part, from borrowings under the Line, additional follow-on offerings, joint venture agreements, the net sale proceeds of hotel

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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. Furthermore, there can be no assurances that the Company will be able to obtain any additional financing.

Recently Issued Accounting Standards

     As of December 31, 2003, the Company participated in five joint venture arrangements to own and develop hotel properties and three mezzanine loans. Historically, the Company has accounted for its unconsolidated joint venture investments on its balance sheet as “Investments in Joint Ventures” and in our statements of operations as “Equity in Income (Loss) of Unconsolidated Joint Ventures” under the equity method of accounting.

     The Financial Accounting Standards Board issued FASB Interpretations No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (ARB No. 51),” in January 2003, and a further interpretation of FIN 46 in December 2003 (FIN 46-R, and collectively FIN 46). FIN 46 clarifies the application of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties, referred to as variable interest entities. FIN 46 generally requires consolidation by the party that has a majority of the risk and/or rewards, referred to as the primary beneficiary. FIN 46 applies immediately to variable interest entities created after January 31, 2003, which affects only our Chapel Hill Joint Venture, and to variable interest entities in which an enterprise obtains a variable interest after that date. The Company has implemented FIN 46 as of December 31, 2003 for a variable interest acquired by the Company before February 1, 2003, which affects our remaining joint ventures and mezzanine loans.

     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 as of December 31, 2003, and will consolidate the results of operations beginning with the first quarter of 2004. For the year ended December 31, 2003, total revenue of the joint venture was $1,422, total expenses were $785, resulting in a net income of $637. As of December 31, 2003, total assets of the joint venture were $7,293, total liabilities were $4,959, resulting in stockholders’ equity totaling $2,334. The Company’s share of equity of this joint venture totaled $1,144 as of December 31, 2003.

Charlesbank Joint Venture:

     The Company has determined that it is not required to consolidate the Charlesbank joint venture as it is not the primary beneficiary. Therefore, the Company, which owns a 15 percent interest, has accounted for and will continue to account for its investment under the equity method of accounting. For the year ended December 31, 2003, total revenue of the Charlesbank joint venture was $4,615, total expenses were $4,508, resulting in net income of $107. As of December 31, 2003, total assets of the joint venture were $24,642, total liabilities were $15,272, resulting in stockholders’ equity totaling $9,370. The Company’s equity balance exposed to loss as a result of its involvement in this joint venture totaled $1,222 as of December 31, 2003.

Regent Joint Ventures:

     As of December 31, 2003, 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”) (see Note 17 to Notes to Consolidated Financial Statements). These joint ventures are considered to be VIE’s and the Company is considered to be the primary beneficiary. Therefore, the Company, which owned a 57.65 percent interest and a 49 percent interest, respectively, has consolidated the balance sheets of the Windsor Joint Venture and the Evanston Joint Venture as of December 31, 2003, and will consolidate the results of operations beginning with the first quarter of 2004. For the year ended December 31, 2003, total revenue of the Windsor Joint Venture and the Evanston Joint Venture was $1,852 and $3,188, respectively, total expenses were $1,245 and $1,703, respectively, resulting in net income of $607 and $1,485, respectively. As of December 31, 2003, total assets of the joint ventures were $15,649 and $20,259, respectively, total liabilities were $9,614 and $12,402, respectively, resulting in stockholders’ equity totaling $6,035 and $7,857, respectively. The Company’s share of equity of these joint ventures totaled $7,330 as of December 31, 2003.

     As of December 31, 2003, the Company also owned a 57.65% interest in Windsor Lessee Company, LLC, the lessee of the Windsor, CT Hilton Garden Inn. The Company assumed its interest in Windsor Lessee Company, LLC on July 1, 2003 at no cost. This joint venture is considered to be a VIE and the Company is considered to be the primary beneficiary. As of December 31, 2003, the Company consolidated the balance sheet of Windsor Lessee Company, LLC and will consolidate the results of operations beginning with the first quarter of 2004. For the year ended December 31, 2003, total revenue of Windsor Lessee Company, LLC was

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$2,193, total expenses were $2,520, resulting in a net loss of $(327). As of December 31, 2003, total assets of Windsor Lessee Company, LLC were $197, total liabilities were $367, resulting in stockholders’ equity totaling $(170).

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 year ended December 31, 2003, total revenue of the joint venture was $6, total expenses were $76, resulting in a net loss of $70. As of December 31, 2003, total assets of the joint venture were $5,762, total liabilities were $1,732, including $154 of long term debt, resulting in stockholders’ equity totaling $4,030. The Company’s share of equity of this joint venture totaled $1,966 and its preferred member interest investment totaled $1,453 as of December 31, 2003 (see Note 3 to consolidated financial statements).

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. Each of these loans is subordinate to a primary loan for each hotel. 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 will 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 mezzanine loans totaled $3,266 and $246, respectively, as of December 31, 2003.

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 is subordinate to a primary loan for the hotel. 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 will 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 balance exposed to loss as a result of its involvement in this mezzanine loan totaled $1,750 and $259, respectively, as of December 31, 2003.

     In April 2003, FASB issued Statement of Financial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). FASB Statements No. 133 “Accounting for Derivative Instruments and Hedging Activities” and No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities”, establish accounting and reporting standards for derivative instruments including derivatives embedded in other contracts (collectively referred to as derivatives) and for hedging activities. SFAS No. 149 amends Statement 133 for certain decisions made by the Board as part of the Derivatives Implementation Group (DIG) process. This Statement contains amendments relating to FASB Concepts Statement No. 7, “Using Cash Flow Information and Present Value in Accounting Measurements”, and FASB Statements No. 65, “Accounting for Certain Mortgage Banking Activities”, No. 91 “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”, No. 95, “Statement of Cash Flows”, and No. 126, “Exemption from Certain Required Disclosures about Financial Instruments for Certain Nonpublic Entities”. The adoption of SFAS No. 149 did not have a material impact on the Company.

     In May 2003, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS No. 150”). SFAS No. 150 requires issuers to classify certain freestanding financial instruments as liabilities. These freestanding financial instruments include mandatory redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets and certain obligations to issue a variable number of shares. The provisions of SFAS No. 150 are effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company.

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 of credit to make distributions to the equity holders.

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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 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 this Annual Report on Form 10-K.

ITEM 7A.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK      ($in thousands)

     As of December 31, 2003, the Company’s exposure to market risk for a change in interest rates related to its debt outstanding under the Line, its debt from consolidated joint ventures, and its interest receivable from mezzanine loans. Debt outstanding under the Line totaled $29,200 at December 31, 2003. 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 Line’s interest rate spread is currently 1.75%, equaling a fixed rate of 3.255%. The differential paid or received on interest rate agreements is recognized as an adjustment to interest expense over the life of the swap. The weighted average interest rate on the Line for 2003 and 2002 was 3.75% and 6.45%, respectively (see Note 7 to the consolidated financial statements). At December 31, 2003, the Company had $0 of variable rate debt outstanding under the Line that was exposed to fluctuations in the market rate of interest.

     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 annual interest expense would not have increased based on the amount of variable rate debt outstanding and exposed to fluctuations in the market rate of interest at December 31, 2003. The Company does not enter into derivative or interest rate transactions for speculative purposes.

     The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

     The estimated fair values of the Company’s financial instruments are as follows:

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     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 December 31, 2003:

     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 December 31, 2003:

ITEM 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements required by this Item 8 are filed with this report on Form 10-K immediately following the signature page and are listed in Item 15 of this report on Form 10-K.

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

     Not applicable.

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