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United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

For the Quarterly Period ended March 31, 2004

or

For the Period              to             .

Commission file number 0-23256

JAMESON INNS, INC.

(Exact name of registrant as specified in its Articles)

8 Perimeter Center East, Suite 8050

Atlanta, Georgia 30346-1604

(Address of principal executive offices including zip codes)

(770) 481-0305

(Registrant’s telephone number, including area code)

(Former name, former address and former

fiscal year, if changed since last report)

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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

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

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date – Common Stock, $.10 Par Value – 14,060,934 shares outstanding as of May 10, 2004.

JAMESON INNS, INC.

INDEX TO FORM 10-Q

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Part I

ITEM 1. FINANCIAL STATEMENTS

Jameson Inns, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

See accompanying notes

3

Jameson Inns, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

See accompanying notes

4

Jameson Inns, Inc. and Subsidiaries

Statements of Cash Flow

See accompanying notes

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Part I

ITEM 1. FINANCIAL STATEMENTS (CONTINUED)

JAMESON INNS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2004

1. Business and Basis of Financial Statements

Jameson Inns, Inc. (the “Company”) develops, owns, operates and franchises limited service hotel properties (the “Inns”) operating under the trademark “The Jameson Inn^®” in the southeastern United States. In addition, the Company owns and operates Inns in the midwestern United States operating under the trademark “Signature Inn^®”. The Company also receives rental revenue from the sale of advertising of its owned billboards.

On January 2, 2004, the Company acquired Kitchin Hospitality, LLC and relinquished its status as a real estate investment trust, becoming a taxable C-corporation effective as of the beginning of the year.

Certain amounts in the 2003 financial statements have been reclassified to conform to the 2004 presentation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date. Operating results for the three month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004, or any other interim period. The hotel industry is seasonal in nature. The hotel revenues recognized are generally greater in the second and third quarters than in the first and fourth quarters. For further information, refer to the consolidated financial statements and footnotes thereto included in the annual report on Form 10-K/A for the year ended December 31, 2003.

2. Recent Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46”) which was revised in December 2003. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity 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. FIN 46 was effective for all new variable interest entities created or acquired after January 31, 2003 for the year ended December 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 were effective for the first reporting period ending after March 15, 2004. The adoption of FIN 46 did not have any impact on the Company’s financial position, results of operations, or disclosures.

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3. Acquisition of Kitchin Hospitality, LLC

On January 2, 2004, the Company acquired Kitchin Hospitality, LLC (“KH”) and relinquished its status as a real estate investment trust (REIT). The Company and the owners of KH reached a definitive agreement (the “Agreement”) on September 10, 2003. The transaction was approved by the Company’s shareholders on December 19, 2003. The Company has included KH’s operating results in its consolidated financial statements from January 1, 2004.

Under the applicable tax rules, a hotel REIT is not permitted to operate its hotel properties. After closing the acquisition, the Company began operating its own hotels and relinquished its election to be treated as a REIT for income tax purposes. The acquisition accomplished the Company’s goals to (a) become a fully integrated hotel company with the ability to operate its hotels without any REIT restrictions; (b) eliminate the perceived conflicts of interest in its prior relationship with KH; (c) retain future earnings and cash flow to pay down debt and for future development; and (d) pursue other business activities not permissible for the Company as a REIT.

The Company paid initial consideration of 2,185,430 shares of Company stock and $1.3 million in cash to the former owners of KH, Thomas W. Kitchin and members of his immediate family. The consideration was subject to a working capital adjustment based on a target of KH’s working capital as of December 31, 2003. The net working capital adjustment, as agreed upon, required that the owners of KH return 32,064 shares of consideration in March 2004. The acquisition was accounted for as a purchase; accordingly, the purchase price was allocated to reflect the estimated fair value of the assets acquired and liabilities assumed. Under this method, the acquired assets and assumed liabilities were recorded on the Company’s balance sheet at their fair market value as of January 2, 2004. The value of goodwill and trademarks on KH’s books was eliminated, and the trademarks were revalued at $75,000 in aggregate, which represents the contract price at which the Company would have been able to purchase the trademarks from KH at the expiration of the master lease agreements.

The purchase consideration of the acquisition of $7.3 million, together with the excess of liabilities assumed over assets acquired of $1.7 million, was expensed in January as lease termination costs. The acquisition cost of the shares of Company stock was based on a price of $2.77 per share. The stock price represents the market price of the securities over a period of two days before and two days after the terms of the acquisition were agreed upon and announced. The Company incurred costs of acquisition related to professional fees (investment banking, legal, and accounting) and a shareholder lawsuit settlement (see Note 8) totaling $1.6 million. These costs were expensed in 2003. Additionally, the Company recorded a deferred tax benefit for the one time effect to establish its initial deferred tax asset for financial reporting purposes in January 2004 (see Note 5).

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (in thousands):

Accounts payable and accrued expenses include a payable to the Company from KH of $3,252,659 as of January 2, 2004. This payable eliminates the Company’s receivable from KH of $3,252,659 as of December 31, 2003.

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The following unaudited pro forma data gives effect to the Company’s acquisition of KH as if it had occurred on January 1, 2003. These unaudited pro forma results of operations do not purport to represent what the Company’s actual results of operations would have been if the acquisition had occurred on January 1, 2003 and should not serve as a forecast of the Company’s operating results for future periods.

The adjustments to the historical data reflect the following: (i) the elimination of revenues and related costs of revenues for capital expenditure work performed by KH for the Company; (ii) the elimination of lease expense recorded by KH and revenues recorded by the Company; (iii) the elimination of overhead reimbursements recorded by the Company and related revenues recorded by KH for the leases of the Inns and the billboards; and (iv) income tax expense for the combined company as a taxable C-corporation. The pro forma adjustments for the acquisition are based upon the available information and certain assumptions that management believes are appropriate.

4. Debt

At March 31, 2004 and December 31, 2003, the mortgage notes payable were collateralized by all of the Company’s hotel properties and, the carrying value of the long-term debt approximated its fair value. At March 31, 2004, there were mortgage loans totaling $20.4 million secured by Inns maturing over the next twelve months and two outstanding Adjustable Rate Economic Development Revenue Refunding Bonds, Series 1999, totaling $6.2 million secured by letters of credit that will expire on December 31, 2004. In addition, there was a $3.5 million line of credit secured by Company owned billboards maturing on December 10, 2004 with an outstanding balance of $1.5 million at March 31, 2004. Based on preliminary discussions with these lenders and historical experience, the Company believes it can successfully obtain replacement financing of our maturing debt at satisfactory renewal terms. If the Company is unsuccessful in refinancing these obligations, it anticipates employing other available resources which include cash, proceeds from refinancing other Inns with increased borrowing capacity or sale of Inns to meet the required obligations.

At March 31, 2004, approximately $191.8 million of the total outstanding debt of $208.3 million is variable rate debt, adjustable during the next twelve months as follows:

The weighted average interest rate on the Company’s debt was 5.2% during the three months ended March 31, 2004 compared to 5.5% during the same period in 2003.

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A $4.3 million mortgage secured by one Signature Inn was classified as a current liability for a technical violation of the debt service coverage ratio loan covenant. Based on discussions with representatives of the lender, we anticipate that the lender will not act upon this technical violation.

5. Income Taxes

The Company relinquished its status as a REIT and became a taxable C-corporation effective at the beginning of 2004. As a REIT, the Company did not record income or related deferred taxes for financial reporting purposes. As a result of the change in taxable status, the Company recorded a deferred tax benefit of $1,397,672 to establish its initial deferred tax asset resulting from the difference in the basis of its assets and liabilities for financial reporting and income tax purposes. In accordance with SFAS No. 109, Accounting for Income Taxes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.

Significant temporary differences that give rise to the deferred tax assets and liabilities as of January 1, 2004 are as follows (dollars in thousands).

The Company does not expect to pay federal income taxes for the year ending December 31, 2004 given its use of net operating losses to offset taxable income. The Company has recorded an income tax benefit for continuing and discontinued operations for the three months ended March 31, 2004 of $2,207,592 at an effective rate of 19.9%. During the three months ended March 31, 2004, the Company established a deferred tax asset of approximately $3.2 million for the future deductions related to the lease termination costs offset by a valuation allowance of approximately $1.0 million. This asset excludes approximately $2.0 million of the $9.0 million lease termination charge that will not be deductible. Excluding the effects of establishing the valuation allowance and incurring nondeductible lease termination costs, the Company would have recorded an income tax benefit at an effective rate of approximately 40%.

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6. Stock-based Compensation

The Company has adopted the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”) and SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS No. 148”). The table presents a summary of the pro forma effects to reported net loss as if the Company had elected to recognize compensation costs based on the fair value of the options granted as prescribed by SFAS No. 123.

The Company recognized compensation expense of approximately $91,000 and $111,000 for the three months ended March 31, 2004 and 2003, respectively, related to the vesting of restricted stock.

7. Discontinued Operations and Property and Equipment Held for Sale

The Company reports as discontinued operations assets held for sale and assets sold in periods presented. Results of these discontinued operations are included in a separate component of income on the consolidated statements of operations. This results in reclassifications of certain 2003 financial statement amounts.

The components of income from discontinued operations for the quarters ended March 31, 2004 and 2003 are shown below. These include the results of operations through the date of each respective sale for sold properties and a full period of operations for those assets held for sale for the respective periods.

The Company recorded gains on disposal of approximately $229,000, net of income tax expense of $65,000, and $3,400 related to the assets sold in first quarter 2004 and 2003, respectively. Certain of these properties were classified as held for sale in the December 31, 2003 balance sheet.

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8. Commitments and Contingencies

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

A shareholder lawsuit seeking class action and derivative status for claims based on the acquisition of Kitchin Hospitality, LLC, was settled on December 18, 2003 by agreement of the parties for certain non-monetary actions, which the Company agreed to take, and a payment to the plaintiff’s attorney for legal fees in an amount approved by the court, not to exceed $175,000. The Company will also be required to pay costs of providing notice of the settlement to its shareholders, which costs are estimated to be approximately $25,000. The Company has incurred legal fees on its behalf and on behalf of its directors with whom it has indemnification agreements and may incur additional fees as the case is still pending court approval. The Company’s directors and officers liability insurance carrier has agreed to reimburse the Company for 50% of the costs of settling this case, not to exceed $100,000. The Company provided for the settlement and related costs, and recorded expense of $285,000 in the year ended December 31, 2003.

Jameson Inns, Inc., Kitchin Hospitality, LLC and an employee of Kitchin Hospitality were named as defendants in a case filed on January 20, 2004 in the Circuit Court of the First Judicial District of Hinds County, Mississippi by Jim and Barbara Doe, individually and as natural parents of Ann Doe, a minor. The plaintiffs are seeking $20 million actual and $5 million punitive damages for injuries sustained by Ann Doe as a result of an alleged sexual assault by two minor boys who were at our Inn in Pearl, Mississippi. The Company has denied any liability for any injuries sustained by Ann Doe or her parents based on the factual circumstances and applicable law. The Company will vigorously defend against this claim. The Company is fully insured for this claim and does not expect that this case will have any material adverse effect upon its financial condition.

9. Earnings (Loss) Per Share

The following table sets forth the computation of basic and diluted earnings (loss) per share:

Options to purchase 965,000 and 384,100 shares of common stock for the three month period ended March 31, 2004 and 2003, respectively, were outstanding but were not included in the computations of diluted loss per share because the securities’ exercise prices were greater than the average market price of the common shares and therefore, the effect would be antidilutive. Additionally, for all periods presented, the potential conversion of the Series S Preferred Stock was not included in the computation of diluted earnings per share as the effect of conversion would be antidilutive.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Jameson Inns owns, operates and franchises limited service hotels in the economy and mid-scale segments of the lodging industry primarily in the southeastern and mid-western regions of the United States. From our initial public offering in 1994 through December 31, 2003, we had elected to be treated as a real estate investment trust, or REIT, for U.S. federal income tax purposes. On January 2, 2004, we relinquished our status as a REIT and acquired Kitchin Hospitality, LLC, which was formerly owned by Thomas Kitchin, our chairman and chief executive officer, and immediate members of his family including Craig Kitchin, our president and chief financial officer, for 2,153,366 shares of Company stock and $1.3 million in cash. As a result of these organizational changes, we believe that we will be better able to execute our growth strategies by being able to directly operate our Inns, by re-investing available cash in our hotel properties and otherwise improving our operations. As a REIT, we were required to distribute substantially all of our net taxable income to our stockholders thereby restricting our ability to grow our company.

We now own, operate and franchise 126 hotel properties, of which 103 are Jameson Inns, located predominantly in the southeastern United States and 23 are Signature Inns, located predominantly in the mid-western United States. Our hotel operation activities are conducted through our wholly owned subsidiary, Kitchin Hospitality. We also license the use of the Jameson Inn name to the owners of ten other hotels which we previously owned. We also receive rental revenue from the advertising on our owned billboards.

Prior to January 2, 2004, Kitchin Hospitality operated our hotels pursuant to master lease agreements. Our sole source of revenue from these hotels was the rental fees paid by Kitchin Hospitality pursuant to the master lease agreements which were comprised of base rent and additional rent based on a percentage of the room revenues attributable to our properties. For the year ended December 31, 2003, we received rent of approximately $28.0 million attributable to the Jameson Inns and approximately $13.4 million attributable to the Signature Inns from Kitchin Hospitality. Following the organizational changes that were completed on January 2, 2004, we will receive directly all room rental revenue and at the same time we are now responsible for all hotel operating and administrative costs that were previously borne by Kitchin Hospitality.

As a fully integrated hotel owner and operator, we will seek to maximize our cash flow from our Inns and strengthen our balance sheet. To accomplish this, we will consider a number of strategic alternatives, including re-branding our Signature Inns to Jameson Inns to strengthen our brand recognition by broadening the areas in which Jameson Inns are located, renovating and refurbishing certain of our properties to bring them up to the Jameson standards of quality, selectively selling certain Inns located in markets with limited growth potential, strategically acquiring properties and portfolios of properties when appropriate, redeeming all of our outstanding preferred stock, and expanding our franchising business. Each of these initiatives is focused on maximizing occupancy, increasing the value of our properties and improving long-term stability and predictability of our revenue and cash flow. These programs may be modified or curtailed, and new or different programs may be implemented, as industry conditions change and our operating strategy evolves to address future operating conditions and take advantage of future opportunities.

Industry

We believe that the lodging industry focuses on three key performance indicators: occupancy percentage, which is represented by the total occupied rooms divided by total available rooms for a given period, average daily rate or “ADR,” which is represented by total room revenues divided by the total number of occupied rooms for a given period, and revenue per available room or “RevPAR,” which is represented by total room revenues divided by total number of room nights for a given period. RevPAR does not include other ancillary revenues such as telephone generated by a property. We believe, given the improving health of the nation’s economy, that occupancy rates will continue to climb, along with RevPAR, as the lodging industry follows the business cycle on its upward swing.

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Pro Forma Information

Room revenues were earned by our lessee, Kitchin Hospitality during 2003. We recorded lease revenues derived from the room revenues based on the master lease agreements we had in place with Kitchin Hospitality. In conjunction with the consummation of the transaction, we now recognize the room revenues on our financial statements. For comparison purposes we are presenting the following unaudited pro forma income statement for the first quarter 2003.

This pro forma information assumes the transaction occurred on January 1, 2003, and in accordance with SEC guidelines, it excludes non-recurring adjustments related to the acquisition and the effects of discontinued operations:

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The following notes explain the pro forma adjustments necessary to reflect the effects of the acquisition as if the transaction had been consummated effective January 1, 2003.

Note A – This column represents the effect of eliminating the operations of Kitchin Hospitality which were not acquired by Jameson Inns, Inc. as part of the acquisition.

Note B – The pro forma adjustment to “Renovation and refurbishment revenues” and “Costs of renovations and refurbishment” represents the elimination of revenues and related costs of revenues for operating property and equipment constructed by Kitchin Hospitality and sold to Jameson Inns, Inc. in the three months ended March 31, 2003. The net effect represents the capitalized profit charged by Kitchin Hospitality to Jameson Inns, Inc. on property and equipment sold to Jameson Inns, Inc, for the three months ended March 31, 2003. The pro forma adjustment to “Depreciation” represents the elimination of the depreciation expense of $15,149 recorded for the three months ended March 31, 2003 related to historical capitalized profit of KH.

Note C – The pro forma adjustments to “Overhead reimbursements” and “General and administrative expenses” represent the elimination of overhead payments recorded by Jameson Inns, Inc. and revenues recorded by Kitchin Hospitality for the three months ended March 31, 2003 related to overhead services provided by Kitchin Hospitality to the Jameson Inns, Inc. Kitchin Hospitality did not charge a profit on the overhead reimbursement, which represented a reimbursement of costs.

Key Performance Indicator

The primary financial indicator of our performance is our REVPAR (revenue per available room) and the factors contributing to it, including our occupancy rate and our average daily room rate. Control of our operational and administrative expenses will also be an important aspect of our business since we are now operating our Inns, but many of the operational expenses will vary in proportion to the number of rooms that we operate. Thus, we believe that the results of our efforts to grow REVPAR will be the single-most important factor in determining our future financial performance. For 2003, the principal determinant of percentage rent under the master leases was the room revenues of our Inns.

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Results of Operations

We believe that the performance measures described below, occupancy, ADR and RevPAR, as well as certain other measures such as room nights available, which is represented by the total rooms available multiplied by the number of days in the reported period (excluding rooms under significant renovation), which are widely used in the hospitality industry, are important to our discussion of operating performance.

The following table shows certain historical financial and other information for owned Inns and excluding statistics related to franchised Inns:

Comparison of the Three Months Ended March 31, 2004 and March 31, 2003

Revenue

During first quarter 2004, we earned lodging revenues of $20.3 million compared to pro forma lodging revenues of $20.1 million in the first quarter of 2003. This increase was due to a slight increase in our overall occupancy rate which was partially offset by a slight decrease in our average daily rate.

Property and other taxes and insurance

Our property and other taxes and our insurance expenses in first quarter 2004 decreased a total of $112,000 compared to pro forma first quarter 2003 primarily due to a reduction in insurance expense of approximately $20,000 and a reduction in tax, net of refunds recognized in first quarter 2004, of $92,000.

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Depreciation

Our depreciation expense decreased to $3.8 million in the 2004 first quarter from pro forma expense of $4.7 million due primarily to the decrease in new hotel activity and Inn expansions in recent years and the fact that many assets in use have become fully depreciated.

General and administrative

Our general and administrative expense for the first quarter 2004 increased to $1.7 million from pro forma 2003 expenses of $1.5 million due primarily to increased payroll and other administrative costs.

Lease termination cost

We incurred lease termination costs of approximately $8.9 million in connection with our acquisition of Kitchin Hospitality, LLC on January 2, 2004. We do not anticipate any additional costs in connection with the acquisition of Kitchin Hospitality.

Gain on sale

During first quarter of 2004 we experienced a positive impact on our earnings of approximately $16,500, as a result of the sale of one billboard asset. During the first quarter 2003 the net impact of the sale of one land parcel was a gain of approximately $36,000.

Interest expense

Our interest expense decreased from $3.2 million in the first quarter of 2003 to $3.0 million in the same period for 2004. This was the result of the weighted average interest rate on our debt of 5.2% during first quarter 2004 compared to 5.5% during first quarter 2003, a reduction of 30 basis points. Interest expense was also lower due to our net principal balance of our outstanding debt being reduced $5.5 million during the first quarter of 2004.

Discontinued operations

Our discontinued operations, excluding impairment charges, gains on disposal and income tax effects, resulted in a loss of $55,000 in 2004 compared to income of $133,000 in 2003. In first quarter 2004 we sold two Jameson Inns and one Signature Inn, and in first quarter 2003, we sold one Signature Inn.

Income taxes

The Company does not expect to pay federal income taxes for the year ending December 31, 2004 given its use of net operating losses to offset taxable income. The Company has recorded an income tax benefit for continuing and discontinued operations for the three months ended March 31, 2004 of approximately $2.3 million at an effective rate of 19.9%. During the three months ended March 31, 2004, the Company established a deferred tax asset of approximately $3.2 million for the future deductions related to the lease termination costs offset by a valuation allowance of approximately $1.0 million. This asset excludes approximately $2.0 million of the $9.0 million lease termination charge that will not be deductible. Excluding the effects of establishing the valuation allowance and incurring nondeductible lease termination costs, the Company would have recorded an income tax benefit at an effective rate of approximately 40%.

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EBITDA – Supplemental Non-GAAP Information

We consider EBITDA to be an indicator of operating performance because it can by used to measure our ability to service debt, fund capital expenditures and expand our business. EBITDA is defined as income before interest expense, income tax expense, depreciation and amortization and certain non-recurring items. The lease termination costs incurred in the three months ended March 31, 2004 meet the definition of “non-recurring” in relevant SEC guidelines.

This information should not be considered as an alternative to any measure of performance as promulgated under accounting principles generally accepted in the United States, nor should it be considered as an indicator of our overall financial performance. Our calculation of EBITDA may be different from the calculation used by other companies and, therefore, comparability may be limited.

To conform more closely with our interpretation of SEC guidance on the presentation of non-GAAP financial measures and to present EBITDA in a manner more in line with our peers, we have modified our presentation of EBITDA. Commencing with this report for our quarter ended March 31, 2004, we will no longer calculate EBITDA to include the line items set forth below which were previously included in our EBITDA presentation, including in our Management’s Discussion and Analysis of its Financial Condition and Results of Operations appearing in our annual report on Form 10-K/A filed for the year ended December 31, 2003. We believe these changes will allow the reader to more closely compare our results with those of our peers in the industry.

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Liquidity and Capital Resources

Overview

Historically, as a REIT, we were required to distribute to stockholders at least 90% of our taxable income. The termination of our status as a REIT eliminated this requirement, beginning in 2004. However, by relinquishing our status as a REIT beginning in 2004, we are subject to payment of federal and state income taxes. In addition, due to the acquisition of Kitchin Hospitality, LLC on January 2, 2004, we are now exposed to greater business risks, including the fluctuation of cash flows related to the operation of hotels due to the seasonal nature of our business. Our hotel revenues are generally greater in the second and third quarters than in the first and fourth quarters.

Our short-term liquidity needs include funds for interest payments on our outstanding indebtedness, funds for capital expenditures and dividends on our preferred stock. We expect to meet our short-term liquidity requirements generally through net cash provided by operations and reserves established from existing cash, and, if necessary, by drawing upon our lines of credit.

In general, we expect to meet our long-term liquidity requirements for the funding of property development, including rebranding of Signature Inns to Jameson Inns, property acquisitions, renovations and other non-recurring capital improvements through net cash from operations, long-term secured and unsecured indebtedness, including our credit facility, through the issuance of equity securities and through joint ventures.

Historically, our cash and capital requirements have been satisfied through cash generated from operating activities, borrowings under our credit facilities, and the issuance of equity securities. We believe cash flow from operations, available borrowings under our credit facilities and cash on hand will provide adequate funds for our foreseeable working capital needs, planned capital expenditures and debt service and other obligations through 2004.

Our ability to fund operations, make planned capital expenditures, and be in compliance with the financial covenants under our debt agreements will be dependent on our future operating performance. Our future operating performance is dependent on a number of factors, many of which are beyond our control, including occupancy and the room rates we can charge.

Sources and Uses of Cash

Our net cash provided by operations was approximately $1.9 million in first quarter 2004. Our other principal sources of liquidity are:

These funds are used to meet the principal repayments of our amortizing debt, the refurbishing costs and capital maintenance of our existing Inns, and certain other cash requirements including the payment of preferred dividends and other operating expenses.

Our net cash provided by investing activities for first quarter 2004 totaled $4.5 million. We received net cash proceeds totaling $4.6 million from the sale of three Inns. Proceeds from these asset sales were primarily used to retire debt. We had an agreement to sell the three Inns at December 31, 2003 that closed during the first quarter of 2004. Additions to property and equipment totaled $597,000 for first quarter 2004 as compared to $1.3 million in first quarter 2003. Included in additions to property and equipment are capital expenditures for refurbishing and renovating existing Inns. We plan to spend $4.4 million during 2004 on refurbishment and renovation projects of existing Inns. These capital expenditures are funded from operating cash flow, net proceeds from the disposition of under-performing hotels and possibly additional borrowings. We anticipate this trend to continue in the future as we refurbish our existing Inns to ensure their competitiveness in the market. These capital expenditures are in addition to amounts spent on normal repairs and maintenance expense.

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Our net cash used in financing activities during first quarter 2004 totaled $7.2 million. This amount included the payment of dividends to preferred shareholders of $1.7 million, proceeds from mortgage notes and line of credit borrowings, net of repayments and related deferred finance costs of $3.0 million, and scheduled long-term debt payments of $2.6 million.

Financing Strategy

Our policy historically has been to finance all of the costs of developing new Inns and expanding existing Inns. However, as a result of the acquisition of Kitchin Hospitality and our objective to redeem outstanding preferred stock, we expect to be able to finance a substantial amount of our future capital needs through internally generated cash flow. Nevertheless, incurring additional debt or equity is likely to be a significant means of financing any substantial growth in the future.

Indebtedness we incur may be in the form of bank borrowings, secured and unsecured, and publicly and privately placed debt instruments. Indebtedness may be recourse to all or any part of our Inns or may be limited to the Inn to which the indebtedness relates. We may also use the proceeds from any of our borrowings for working capital, to refinance existing indebtedness or to finance acquisitions, expansions or development of new Inns. Most of our current mortgage indebtedness is with recourse to us.

While our organizational documents do not limit the amount or percentage of indebtedness that we may incur, we currently have a policy of limiting outstanding indebtedness to 65% of the aggregate value of the Inns based on the most recent appraisals obtained on the Inns. Our Board of Directors could change our current policies and we could become more highly leveraged, resulting in an increased risk of default on our obligations and in an increase in debt service requirements. This increase could adversely affect our financial condition and results of operations.

Debt Structure

At March 31, 2004, we had outstanding an aggregate of $208.3 million of mortgage debt. At March 31, 2004, the mortgage notes payable were collateralized by all of the Company’s hotel properties. Amortizing principal payments are expected to total $10.6 million over the following twelve months, and we expect to make these payments out of our available cash flow. At March 31, 2004, there are mortgage loans totaling $20.4 million secured by Inns maturing over the next twelve months and two outstanding Adjustable Rate Economic Development Revenue Refunding Bonds, Series 1999, totaling $6.2 million secured by letters of credit that will expire on December 31, 2004. In addition, there was a $3.5 million line of credit secured by Company-owned billboards maturing on December 10, 2004 with an outstanding balance of $1.5 million at March 31, 2004. Based on preliminary discussions with these lenders and historical experience, we believe we can successfully obtain replacement financing of our maturing debt at satisfactory renewal terms. If we are not successful in refinancing these obligations, we will employ other available resources which include cash, proceeds from refinancing other Inns with increased borrowing capacity or sale of Inns to meet the required obligations.

A $4.3 million mortgage secured by one Signature Inn was classified as current because of a technical violation of the debt service coverage ratio loan covenant. Based on discussions with representatives of the lender, we anticipate that the lender will not act upon this technical violation.

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Approximately $191.8 million of our total debt is variable rate debt adjustable over the next twelve months as reflected in Note 4 of the Notes to Condensed Consolidated Financial Statements (unaudited) for the Three Months Ended March 31, 2004.

During the first quarter 2004 the weighted average interest rate on our debt was 5.2% compared to 5.5% during the same period 2003.

Stock- based compensation