Southern Scottish Inns (SSCT) 10-Q 2003 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF

THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO. 0-7107

SOUTHERN SCOTTISH INNS, INC.

(Exact name of registrant as specified in its charter)

LOUISIANA	72-0711739
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1726 Montreal Circle

Tucker, Georgia 30084

(Address of principal executive offices)

(Zip Code)

(770) 938-5966

(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, and (2) has been subject to such filing requirements for the past 90 days. 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

CLASS	SHARES OUTSTANDING AT JUNE 30, 2003
Common Stock, Par Value $0.01 per share	2,366,395

INDEX

	PAGE NO.
PART I. FINANCIAL INFORMATION:
Item 1-Financial Statements
Consolidated Balance Sheets-As of June 30, 2003 (Unaudited) and December 31, 2002	2-5
Consolidated Statements of Income-For the three months ended June 30, 2003 and June 30, 2002 (Unaudited)	6-7
Consolidated Statements of Cash Flows-For the three months ended June 30, 2003 and June 30, 2002 (Unaudited)	8-9
Notes to Consolidated Financial Statements	10-14
PART II. OTHER INFORMATION:
Item 1-Business Discussion	15
Item 2- Legal Proceedings	18
Item 3-Management's Discussion and Analysis of Financial Conditions and Results of Operations	19
Item 4-Controls and Procedures	22
SIGNATURES	23

PART I. FINANCIAL INFORMATION

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS

		June 30, 2003 (Unaudited)		December 31, 2002
CURRENT ASSETS
Cash	$	283,181	$	160,795
Accounts Receivable-Net		516,138		370,213
Accounts Receivable-Affiliates		251,097		239,745
Mortgages & Notes-Affiliates		21,477		22,277
Mortgages & Notes Receivable		397,888		430,136
Inventory		4,290		254
Prepaid Expenses		85,149		71,866
Interest Receivable		493,908		582,854
Net Deferred Tax Asset		0		35,841
Cash - Houma Building Partnership - HBP		22,837		0
Accounts Receivable - HBP		47,361		0
Notes Receivable - HBP		0		0
Notes Receivable - Affiliates - HBP		116,426		0
Prepaid Expenses - HBP		5,537		0
TOTAL CURRENT ASSETS		2,245,289		1,913,981
PROPERTY AND EQUIPMENT
Land		1,786,867		1,607,203
Buildings & Building Improvements		3,936,524		2,911,421
Furniture, Fixtures & Equipment		678,419		623,551
Vehicles		217,459		217,459
Total Property & Equipment		6,619,269		5,359,634
Less: Accumulated Depreciation		(1,405,668)		(1,317,948)
PROPERTY AND EQUIPMENT - NET		5,213,601		4,041,686
Land - HBP		346,420		0
Buildings & Building Improvements - HBP		3,421,663		0
Furniture, Fixtures & Equipment - HBP		231,265		0
Total Property & Equipment - HBP		3,999,348		0
Less: Accumulated Depreciation		(1,702,887)		0
NET PROPERTY AND EQUIPMENT - HBP		2,296,461		0
TOTAL NET PROPERTY AND EQUIPMENT	$	7,510,062	$	4,041,686

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

2

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED BALANCE SHEETS (Continued)

ASSETS

		June 30, 2003 (Unaudited)		December 31, 2002
OTHER ASSETS
Mortgages & Notes Receivable	$	3,307,959	$	3,897,260
Mortgages & Notes-Affiliates		0		564,252
Investments in Unconsolidated Affiliates		268,494		(255,233)
Investment in Real Estate		233,550		233,550
Trademarks - Net		1,004,030		1,004,030
Loan Cost		5,701		5,250
Loan Cost - HBP		11,458		0
Other Assets		28,242		12,839
Deferred Tax Asset		379,094		378,998
Marketable Equity Securities, Carried at Market		28,885		30,975
TOTAL OTHER ASSETS		5,267,413		5,871,921
TOTAL ASSETS	$	15,022,764	$	11,827,588

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

3

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED BALANCE SHEETS (Continued)

LIABILITIES AND STOCKHOLDERS' EQUITY

		June 30, 2003 (Unaudited)		December 31, 2002
CURRENT LIABILITIES
Accounts Payable - Trade	$	185,840	$	212,779
Interest Payable		138,197		192,618
Income Taxes Payable		185,608		206,148
Other Taxes Payable		239,249		302,952
Other Liabilities		644,038		447,202
Capital Leases		21,191		24,564
Mortgages & Notes Payable		336,479		366,510
Mortgages & Notes Payable-Affiliates		36,000		167,420
Deferred Tax Liabilities		37,052		0
Deferred Severance Pay		6,000		6,000
Accounts Payable - HBP		119		0
Interest Payable - HBP		6,781		0
Mortgages & Notes Payable - Affiliates - HBP		13,405		0
Mortgages & Notes Payable - HBP		102,163		0
TOTAL CURRENT LIABILITIES		1,952,122		1,926,193
LONG-TERM LIABILITIES
Capital Leases		22,544		29,605
Mortgages & Notes Payable		1,756,098		693,480
Mortgages & Notes Payable-Affiliates		212,720		212,719
Mortgages & Notes Payable - Affiliates - HBP		186,665		0
Mortgages & Notes Payable - HBP		2,700,242		0
Escrow - Real Estate Tax		8,144		346
TOTAL LONG-TERM LIABILITIES		4,886,413		936,150
DEFERRED AMOUNTS
Deferred Income-Installment		446,408		453,382
Deferred Severance Pay		168,000		168,000
TOTAL DEFERRED AMOUNTS		614,408		621,382
TOTAL LIABILITIES & DEFERRED AMOUNTS		7,452,943		3,483,725
MINORITY INTEREST
Minority Interest in Red Carpet Inns International		744,306		729,989
Minority Interest in Houma Building Partnership		(576,410)		0
TOTAL MINORITY INTEREST	$	167,896	$	729,989

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

4

		June 30, 2003 (Unaudited)		December 31, 2002
STOCKHOLDERS' EQUITY
Common Stock- no par value, Authorized 5,000,000 shares, Issued & Outstanding 2,366,395 ended June 30, 2003 and year ended 2002	$	6,023,981	$	6,023,981
Additional Paid in Capital		42,201		42,201
Treasury Stock - 216,013 Month ended 6/30/03		(345,572)		0
Retained Earnings		1,681,315		1,547,692
TOTAL STOCKHOLDERS' EQUITY		7,401,925		7,613,874
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	15,022,764	$	11,827,588

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

5

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2003		2002		2003		2002
REVENUES
Franchising Revenues	$	484,992	$	507,477	$	892,488	$	961,441
Financing Revenues		92,296		141,262		200,212		271,249
Leasing & Lodging Revenues		562,697		97,871		995,576		166,072
Equity in Income of Unconsolidated Affiliates		(0)		1,755		4,027		44,269
Legal Settlement Revenues		39,100		36,937		67,100		61,464
Other Income		36,871		22,390		196,502		78,902
Leasing Revenues - HBP		176,806		0		363,123		0
Other Income - HBP		4,798		0		21,558		0
TOTAL REVENUES		1,397,560		807,692		2,740,586		1,583,397
EXPENSES
Operating Expense-Franchise Division		424,027		438,645		851,507		924,312
Operating Expense-Financing & Investing		168,834		117,634		319,324		452,606
Leasing & Lodging Expense		442,952		80,191		742,848		129,732
Interest Expense		55,591		38,336		88,452		86,879
Depreciation & Amortization		50,291		34,725		90,328		68,624
Equity in Loss of Unconsolidated Affiliates		17,949		14,190		32,138		28,379
Leasing Expense - HBP		104,145		0		227,490		0
Interest Expense - HBP		57,338		0		135,548		0
Depreciation & Amortization - HBP		24,180		0		67,858		0
Trademark Write-Down		0		206,000		0		206,000
TOTAL EXPENSES		1,345,307		929,721		2,555,493		1,896,532
Net Income (Loss) from Continuing Operations before Taxes, Minority Interest & Cumulative Effect of Accounting Change		52,253		(122,029)		185,093		(313,135)
Provisions for Income Taxes		(15,661)		36,709		(72,797)		92,062
Net Income (Loss) before Minority Interest & Cumulative Effect of Accounting Change	$	36,592	$	(85,320)	$	112,296	$	(221,073)

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

6

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED STATEMENTS OF INCOME (Continued)

(Unaudited)

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2003		2002		2003		2002
Minority Interest in (Income) Loss - RCII	$	(11,235)	$	24,632	$	(14,317)	$	28,649
Minority Interest in (Income) Loss - HBP		8,297		0		35,643		0
Net Income (Loss) from Continuing Operations before Cumulative Effect of Accounting Change		33,654		(60,688)		133,622		(192,424)
Cumulative Effect of Accounting Changes		(0)		0		(540,767)		0
NET INCOME (LOSS)	$	33,654	$	(60,688)	$	(407,145)	$	(194,424)

INCOME (LOSS) PER SHARE
Income (Loss) per Share before Taxes, Minority Interest & Cumulative Effect of Accounting Change	$	.02	$	(.05)	$	.08	$	(.13)
Income (Loss) per Share before Minority Interest & Cumulative Effect of Accounting Change		.02		(.04)		.05		(.09)
Income (Loss) per Share before Cumulative Effect of Accounting Change		.02		(.04)		.06		(.09)
Cumulative Effect of Accounting Change		0		0		(.25)		0
Basic Net Income (Loss) per Common Share	$	.02	$	(.03)	$	(.19)	$	(.08)
Average Shares Outstanding		2,191,940		2,366,395		2,191,940		2,366,395

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

7

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

			Six Months Ended
			June 30,
			2003		2002
CASH FLOWS PROVIDED BY (USED FOR) OPERATING ACTIVITIES
Net Income	$		(407,145)	$	(192,424)
Non-Cash Items Included in Net Income:
Cumulative Effect of Accounting Change			540,767		0
Depreciation and Amortization			178,208		68,624
Deferred Income Recognized			(6,974)		(16,561)
Investment (Income)/Loss - Affiliates			28,111		(15,891)
Minority Interest Income			14,317		(28,649)
Minority Interest - HBP			(35,643)		0
Accounts Payable Converted to Notes Payable			0		22,576
Note Receivable Charged to Income			0		(15,861)
Trademark Write-Down			0		206,000
Miscellaneous			(9,128)		(398)
Net Changes In Current Assets and Liabilities:
Accounts Receivable			(154,741)		(115,371)
Accounts Receivable-Affiliates			(11,352)		125,798
Inventories			(4,036)		40,490
Loan Receivable -Employees			0		(800)
Deposits			(15,403)		(305)
Interest Receivable			(67,585)		(82,566)
Prepaid Expense			(13,283)		51,651
Loan Cost			(451)		0
Accounts Payable			(26,939)		100,624
Interest Payable			(54,421)		(16,695)
Taxes Payable			(84,243)		55,709
Deferred Income Tax			72,797		(35,506)
Other Accrued Liabilities and Deferrals			196,836		(127,963)
Escrow - Real Estate Taxes			7,798		1,777
Accounts Receivable - HBP			1,260		0
Prepaid Expenses - HBP			(5,537)		0
Loan Cost - HBP			(19,180)		0
Deposits - HBP			117,368		0
Accounts Payable - HBP			(25,079)		0
Interest Payable - HBP			3,773		0
Taxes Payable - HBP			(152,480)		0
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES		$	67,615	$	24,259

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

8

SOUTHERN SCOTTISH INNS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

				Six Months Ended
				June 30,
				2003				2002
CASH FLOWS PROVIDED BY (USED FOR) INVESTING ACTIVITIES
Notes Receivable Issued		$		(102,563)		$		(50,465)
Collections on Mortgages and Notes Receivable				642,011				47,466
Acquisition (Disposition) of Fixed Assets				(1,257,777)				(15,488)
Investment Purchases				(11,072)				0
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES				(729,401)				(18,487)
CASH FLOWS PROVIDED BY (USED FOR) FINANCING ACTIVITIES
Proceeds from Notes Payable			4,118,300				0
Principal Payments on Mortgages and Notes Payable			(251,628)				(116,655)
Cash Paid for Treasury Stock			(343,482)				0
Principal Payments on Capital Lease Obligations			(4,089)				0
Principal Payments on Mortgages and Notes Payable - HBP			(2,726,261)				0
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES			792,840				(116,655)
Increase (Decrease) in Cash			131,054				(110,883)
Cash Acquired from Consolidation HBP			14,169				0
Cash - Beginning			160,795				160,400
Cash - Ending	$		306,018		$		49,517

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS

9

SOUTHERN SCOTTISH INNS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE

A - BASIS OF PRESENTATION

The accompanying consolidated financial statements for the six months ended June 30, 2003 and 2002 have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with the instructions to Form 10Q and Rule 10-01 of Regulation S-X.These financial statements for the six months ended June 30, 2003 and June 30, 2002 have not been audited by independent public accountants but include all adjustments, consisting of normal recurring accruals, which in the management of Southern Scottish Inns, Inc. and subsidiaries ("SSI" or "the Company") are necessary for a fair statement of the financial position, results of operations and cash flows for the period presented. These statements should be read in conjunction with the audited financial statements and footnotes in the Company's annual report on Form 10-K for the year ended December 31, 2003. The accompanying consolidated balan ce sheet as of December 31, 2002 has been derived from audited financial statements but does not include all disclosures required by GAAP. The results of operations for the six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the full year ending December 31, 2003.

The consolidated financial statements include the accounts of the Company and all subsidiaries except where control is temporary or does not rest with the Company. Additionally, starting as of January 1, 2003, the Company applied FIN 46 and consolidated for financial reporting purposes the Houma Building Partnership (HBP) of which the Company owns a fifty (50%) percent interest (See Accounting Pronouncements). The Company's investments in companies in which it has the ability to exercise significant influence over operating and financial policies are accounted for by the equity method. Accordingly, the Company's share of the net earnings of these companies is included in consolidated net income. The Company's investments in other companies are carried at cost or fair value, as appropriate. All significant inter-company accounts and transactions are eliminated.

B - RECLASSIFICATIONS

Certain reclassifications have been made to prior period information to conform to the current period presentation.

C - RELATED PARTY

Receivables in the amount of $148,925 due from an affiliate were written off to bad debt in March 2002. The affiliated corporation was insolvent.

10

SOUTHERN SCOTTISH INNS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

D - INDUSTRY SEGMENTS

Our operations consist of three reportable segments, which are based on similar products or services. Information on segments is as follows:

		Six Months Ended June 30,
		2003		2002
Sales to Unaffiliated Customers
Franchising	$	892,488	$	961,441
Financing & Investing		204,239		315,518
Leasing & Lodging		995,576		166,072
Leasing - HBP		363,123		0
Total Sales to Unaffiliated Customers		2,455,426		1,443,031
Other Income:
Franchising		129,154		128,551
Financing & Investing		3,843		11,815
Leasing & Lodging		130,605		0
Leasing - HBP		21,558		0
Total Other Income		285,160		140,366
Depreciation and Amortization:
Franchising		7,708		9,696
Financing & Investing		19,699		9,439
Leasing & Lodging		62,921		49,489
Leasing -HBP		67,858		0
Total Depreciation and Amortization		158,186		68,624
Interest Expense:
Franchising		3,366		4,271
Financing & Investing		38,885		40,796
Leasing & Lodging		46,201		41,812
Leasing -HBP		135,548		0
Total Interest Expense		224,000		86,879
Bad Debt Expense:
Franchising		27,976		19,760
Financing & Investing		0		149,410
Leasing & Lodging		24,924		0
Leasing -HBP		0		0
Total Bad Debt Expense	$	52,900	$	169,170

11

SOUTHERN SCOTTISH INNS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

	Six Months Ended
	June 30,
		2003		2002
Net Income (Loss):
Franchising	$	154,490	$	150,634
Financing & Investing		(248,864)		(288,097)
Leasing & Lodging		268,668		(54,961)
Leasing -HBP		(581,439)		0
Total Net Income (Loss)		(407,145)		(192,424)
Identifiable Assets:
Franchising		1,552,273		1,752,409
Financing & Investing		6,420,012		7,885,467
Leasing & Lodging		4,244,381		2,777,754
Leasing -HBP		2,500,080		0
Total Identifiable Assets		14,716,746		12,415,630
Additions in Property & Equipment:
Franchising		6,366		40,957
Financing & Investing		25,100		20,319
Leasing & Lodging		1,233,233		5,999
Leasing -HBP		3,999,348		0
Total Additions in Property & Equipment	$	5,264,047	$	67,275

In the Financing & Investing Segment, the Company has included net income/ (loss) from unconsolidated equity investments totaling $15,891 as of June 30, 2002 and $(28,111) as of June 30, 2003.

E - ACCOUNTING PRONOUNCEMENTS

In January 2003 and amended in December 2003, the Financial Accounting Standards Board (FASB) issued interpretation No. 46 (FIN 46) which clarifies the application of Accounting Research Bulletin No 51, "Consolidated Financial Statements". FIN 46 specifically addresses the consolidation of Variable Interest Entities (VIE's) which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (ii) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if they occur or the right to receive the expected residual returns of the entity if they occur. In Oct ober 2003, the FASB issued FASB Staff Position (FSP) 46-6 which encourages early application of FIN 46.

12

SOUTHERN SCOTTISH INNS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

E - ACCOUNTING PRONOUNCEMENTS - (Continued)

The Company determined that the Houma Building Partnership (HBP) has one or both of the characteristics of a VIE as defined above. The Company therefore has applied FIN 46 to HBP in 2003 and consolidated it for financial reporting purposes.

FIN 46 required that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary. Any difference between the net amount added to the balance sheet of the consolidating enterprise and the amount of any previously recognized interest in the newly consolidated entity should be recognized as the cumulative effect of an accounting change. The consolidation as of January 1, 2003 of Houma Building Partnership resulted in an additional non-cash loss of $540,767 recorded as the accumulated effect of an accounting change.

13

PART II

Item 1. Business Discussion

General

Due to the Company's development and finance division's acquiring and selling properties, the number of properties owned, operated, leased and the number of wrap around mortgages held fluctuates constantly. Additionally, starting as of January 1, 2003, the Company applied FIN 46 and consolidated for financial reporting purposes the Houma Building Partnership (HBP), of which Registrant owns a fifty (50%) percent interest (See Item 3). HBP owns and operates the Houma Atrium Building, an office building in Houma, Louisiana.

Description of Business

The Company identifies three significant industry segments in which all revenue items represent sales to unaffiliated customers, as sales or transfers between industry segments are negligible. In the past, the Company included in the Financing & Investing Revenues and Operating Income (Loss) 50% of the gain or loss from the Houma Building Partnership as the results of the operation of the Houma Atrium Building. In 2003, with the application of FIN 46 (See Item 3), HBP is shown separately. In the future, HBP Revenues and Operating Income (Loss) will be incorporated into the Leasing and Lodging segment.

Segment Information

Franchising

The Company's franchise division offers advertising, reservation, group sales, quality assurance and consulting services to motel owner/operators.

Financing & Investing

The Company's Financing & Investing division offers owner financing to persons acquiring motel properties previously operated and/or owned by the Company. The Company also invests in various parcels of land and several joint ventures.

Leasing & Lodging

The Company's Leasing & Lodging revenue is derived from the leasing of real and personal properties, i.e. motels, restaurants, the operation of Company owned motels, part of Hospitality International, Inc.'s office building belonging to the Company and Houma Building Partnership's office building.

14

Status of Segments

All of the Company's industry segments is fully developed with an operational history of several years under Company's direction.

Patents, Trademarks, Licenses, Franchises, and Concessions

The Company has no patents. The Company does own the trade names "Master Hosts Inn", "Red Carpet Inn", "Scottish Inn, "Downtowner Inn", "Passport Inn", "Sundowner Inn" and related trademarks, etc. used in operating lodging facilities or reservation services under these names.

"Sundowner Inn" Trademarks, Registration No. 1,280,236 and No. 1,280,237, United States Patent and Trademark office, were registered May 29, 1984. In 1994, Joe W. Hudgins, the owner of the corporation to which said marks were then registered, transferred ownership of said corporation, Sundowner Reservations, Inc., a Tennessee corporation, to Hospitality International, Inc. in consideration of cancellation of inter-company debt and promise to pay the assigned corporation's debt to Red Carpet Inns International, Inc. On April 30, 1995, Sundowner Reservations, Inc. transferred title to the subject marks to Hospitality International, Inc. As of December 31, 1996, Hospitality International, Inc. transferred ownership of the subject marks to Red Carpet Inns International, Inc. for consideration of $360,000. The Sundowner Inn' mark was found to be impaired in 2002 under a discounted cash flow analysis and was written down $206,000 (See Item 3).

Seasonality

The Company's financing and leasing businesses by their nature are not subject to seasonal fluctuations except, perhaps, as to mortgagors and lessees' ability to meet payment schedules due to seasonality of their businesses. The revenues from the Company's franchising and lodging divisions tend to be greater in the spring and summer months during peak travel periods than during slower business months.

Working Capital

The Company's financing receipts are comprised primarily of interest which does not become reflected on its balance sheet until after it is earned, whereas its payments on underlying debts are comprised primarily of principal reduction and the portion which will be returned over the next twelve months is reflected on the balance sheet as a current liability. Because of this, the Company believes a current ratio of less than one to one is appropriate for its business. However, the Company continues to attempt to, among other things, (1) reduce and contain overhead costs, (2) seek to dispose of under-productive assets, and (3) seek the most advantageous financing terms available.

15

From 1995 to 2003, in particular, the Company aggressively pursued its legal rights to its trademarks. Largely, it has been successful in stopping motel operations from illegally using its trademarks as well as in enforcing compliance to its franchisee agreements. Settlements were reached on a number of lawsuits in most years that significantly increased the revenues of the Company. Attorney fees related to those settlements also increased in those same years.

Customers

The Company's business of franchising motels is contingent upon its being able to locate qualified property owner-operators who are seeking national affiliation. Through use of its franchise sales force, the Company has not experienced insurmountable difficulty in locating independent motel owner-operators or owner-operators seeking to change national affiliation nor does it anticipate any such difficulty in the future. However, more franchisors are offering multi-level brands, resulting in more downscaling conversions into the economy lodging sector and, therefore, providing more competition. Likewise, the Company's financing division requires that it locate qualified owner-operators or investors for its properties. Because of its franchise affiliations the financing division has not experienced, nor does it anticipate experiencing too much difficulty in locating qualified investors to purchase its developed properties. However, due to the Company's desire to limit the loans it holds to a manageable number and because third party or institutional financings for used motel properties are difficult to arrange, once a property is sold the Company carries the entire financing package and accordingly, each individual loan represents a larger portion of portfolio than it does with traditional lending institutions. Therefore, the continued performance of each existing loan may be material to the operation of the financing division.

Competition

The Company's franchising, leased lodging and leased food service divisions each compete with other similar businesses, many of which are larger and have more national recognition than the Company. Each of these divisions competes on the basis of service and price/value relationship.

The Company's financing and investing division competes with other, more traditional sources of long-term financing, most of which have greater financial resources than does the Company.

Developing and financing lodging properties is being significantly affected by over-development in many areas and is somewhat adversely affected by the area's and the country's general economic downturn.

16

Environmental Protection

The Company is not directly affected by environmental protection measures of federal, state or local authorities to any extent which would reasonably be expected to cause material capital expenditures for compliance, so far as in known. However, it is possible that an approximately five and three-tenths (5.09) acre tract of land held as an investment and acquired as a possible motel site, located on I-10 in Ocean Springs, Mississippi, may under the new guidelines, be determined to be in part "wetlands." If so, its use and value would be adversely affected. On January 27, 1995, 3.2 acres contiguous to said tract were sold at a consideration undiminished by the wetlands issue; the value of the remaining 5.09 acres, therefore, may not be diminished. The 5.09 acre tract is carried on the Company's books at $55,647.

Foreign Operations

The Company is not currently involved in any business operations outside of the United States of America, except through its franchising division, which does do limited business in Canada and has one franchise in the Bahamas.

Item 2. Legal Proceedings

The Company is named as a defendant for damages in an unspecified amount, reasonable attorney fees, interest and costs as a result of the Company's alleged violation of a patent. The Company filed a motion for summary judgment in 1994 and the Company's motion was granted on March 3, 2004. However, the time for the plaintiff to appeal that grant of summary judgment has not yet expired and it is unknown whether the plaintiff will appeal. It is counsel's opinion that the summary judgment granted in favor of the Company would be affirmed on appeal.

In 2001, Registrant's management made preliminary inspections of a closed motel property in Muddy, Illinois, and began negotiations with a real estate broker and with lender/owner. The senior management of an independent motel management company, which at that time operated all of Registrant's subsidiaries' motels, entered upon the property for further inspections, began some clean up work and installed a Great Sign identifying the property with a trademark belonging to Registrant's affiliate, all before a "Contract To Buy and Sell" was signed. Seller or Seller's Broker had prepared and afforded a Contract for approval. Some negotiations concerning the same were had. For various reasons, Registrant's management decided not to further pursue acquisition and notified the management company to quit the premises. Subsequently, suit was filed by owner and owner's broker against Registrant for a sum in excess of $100,000 plus costs of suit. No contract was ever signed. The prope rty was subsequently sold to an unrelated party. All parties have counsel and the matter is proceeding toward trial.

17

In 2003, suit was filed by or on behalf of three (3) persons, two of whom were employees of a tenant of the Atrium Building, an office building in Houma, Louisiana, against two nominal defendants and the Houma Building Partnership, a Louisiana General Partnership, in which Registrant is a 50% interest holder, Bobby E. Guimbellot, Registrant's CEO, is a 25% interest holder and Yvonne Zodum (formerly Guimbellot) is a 25% interest holder. The suit is for unspecified damages and for recognition as a class action matter. Damage allegations are for excessive illnesses, including but not limited to sinus and allergy problems, debilitating headaches, skin irritations, watery eyes and fatigue caused by presence of fungal substances, such as mold, mold spores and the by-products of same, the presence of which Plaintiffs attribute to water intrusion and high humidity; and Plaintiffs claim Defendants were operating a dangerous building and with their failing to warn of dangerous conditions and d efects. Partnership's carrier is providing defense. As of June 30, 2003, no decision has been made as to class action status; therefore, Registrant's management has no present opinion as to the adequacy of or inadequacy of the insurance coverage. Registrant views this action as a potentially significant matter.

18

Item 3. Management's Discussion and Analysis of Financial Conditions and Results of Operations

Results of Operation

The following discussion presents an analysis of results of operations of the Company's three main segments for the quarters ended June 30, 2003, and June 30, 2002.

Franchising

Franchising revenues in the second quarter of 2003 decreased 7% over the second quarter 2002. The decrease is due to increased competition from other franchisors offering multi-level brands, resulting in more down-scaling conversions into the economy lodging sector. In response, the Company became more stringent in its requirements relating to franchises in the areas of quality assurance. Another major source of revenue for the franchising area is legal settlements. The Company vigorously asserts its legal rights in the area of franchise infringements and violations of the franchise agreements. Gross revenues generated in this area were $67,100 as of June 30, 2003 and $61,464 as of June 30, 2002

One trademarks' value was decreased in June of 2002. The Company wrote down the mark that cost $360,000 and had an accumulated amortization of $54,000 by $206,000 to a value of $100,000. Hospitality International, Inc., the mark owner's licensee for franchise sales and service functions, will attempt through renewed sales efforts to prevent further deterioration of this mark's value.

Financing and Investments

Financing revenues continue to drop because the interest amount on the notes receivable is declining as the notes move toward maturity, coupled with one note paying off in May of 2003.

In 2002, the note receivable, which Registrant held on the Bald Knob Arkansas motel, through the mortgagor's refinancing, paid off.

On January 8, 2002, a note and second mortgage which Registrant held on a motel at Register, Georgia, on which the 2002 audited balances of $176,687 principal and $17,861 accrued interest were owed, were written off as a result of a foreclosure on the property by the first mortgage holder.

Also, on September 3, 2002, Registrant foreclosed on a warehouse building in Gulfport, Mississippi, on which it held a first mortgage, resulting in an increase in fixed assets of $178,693.00.

19

The Company's subsidiary, Red Carpet Inns International, Inc. holds a note and mortgage receivable on a motel property. This note is non-performing. In addition to the motel property, Holder also has a first mortgage on an approximately eleven acre commercial tract and a second mortgage on a rural thirty-eight acre tract

In the past several years, in an effort to expand the scope of our presence and offerings in the hospitality entertainment industry, the Company has made investments in and non-reoccurring loans to entities engaged in "cruises to nowhere" gambling ventures. While the investments have not yielded a cash return, it is probable that all or a significant part of the investments are adequately secured and collectable. Most of the loans have been deemed to be un-collectible and those were written off in 2002; the total of these loans constituted a sizable sum to write off in 2002 but their being deemed un-collectible left no choice. Registrant has no intentions of making loans for such purpose again.

Leasing and Lodging

Leasing and Lodging revenue rose in the second quarter of 2003 over the second quarter of 2002 due to the restructuring of the lease agreements and the addition of a wholly owned subsidiary managing Company owned hotels. The Company executed new and more profitable leases with new lessees in July 1, 2002. Also in 2003, the Company's management added an allowance account based on a percentage of outstanding lease accounts. The allowance account for doubtful accounts at the end of the second quarter of 2003 was $16,689. Our present and future lease income, as well as sales prices, are limited due to the ages of most of the properties, the presence of new motels near to all of our properties and our failure to refurnish and upgrade.

In January 2003 and amended in December 2003, the Financial Accounting Standards Board (FASB) issued interpretation No. 46 (FIN 46) which clarifies the application of Accounting Research Bulletin No 51, "Consolidated Financial Statements". FIN 46 specifically addresses the consolidation of Variable Interest Entities (VIE's). The Company determined that the Houma Building Partnership (HBP) has one or both of the characteristics of a VIE. FIN 46 required that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary. Any difference between the net amount added to the balance sheet of the consolidating enterprise and the amount of any previously recognized interest in the newly consolidated entity should be recognized as the cumulative effect of an accounting change. The consolidation a s of January 1, 2003 of Houma Building Partnership resulted in an addition of non-cash loss of $540,767 recorded as the accumulated effect of an accounting change.

20

Liquidity:

Management believes that our current sources of capital including cash on hand, operating cash flow, and expected proceeds from sales of assets, were adequate to finance our operating and commitments through 2003. The question of liquidity should not be an issue in the near future. In 2001 and 2002, the non-affiliated entity formerly leasing properties from the Company was in arrears in its past lease payments; collection was doubtful. In mid 2002, the Company cancelled the old leases, resulting in the assumption of some of said lessee's obligations, the transfer of certain of lessee's assets to Registrant, acknowledgment of the credit to lessee's payables account to Registrant and writing off the sizable and remaining balance of this receivable. If cash requirements become an issue, any of the notes could be sold at a discount or some free and clear properties could be hypothecated. We do not believe these measures will be required.

Capital Resources

Expenditures

No material commitments for capital expenditures are planned for the remainder of 2003 other than possible purchases of properties through the financing division.

Trends

The trend in capital resources had resulted in a gradual tightening of credit with regard to new motel construction and continues tighter with regard to older properties, but now seems to have loosened somewhat as to new construction. This has forced more sellers of older properties into the seller-financed arena creating more competition for the Company in its Finance and Development Division. This fact, coupled with somewhat less available loan money on the new property construction side, has meant less profitable opportunities for the Company. Although the economy for the past two years has not been good, fewer foreclosures have resulted than in recent prior periods of economic downturns and therefore there are not a lot of bank REO properties available. Individual sellers are asking multiples of sales of pre-downturn years rather than of more current years. These events and tendencies shorten the supply of motel inventory while increasing the cost of acquiring the same.

21

Item 4. Controls & Procedures

Evaluation of Disclosure

As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the "Exchange Act"), as of June 30, 2003, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, we and our management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based upon the required evaluation, the Chief Executive Officer and Chief Financial Officer believe that, as of the date of completion of the evaluation, our disclosure controls and procedures were reasonably effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and repor ted, within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the rules, we are continuing the process of reviewing and documenting our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

Changes in Internal Controls

There has been no change in our internal controls over financial reporting during our most recent fiscal year that has been materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Code of Ethics

The Board of Directors and management have relied on the oversight and control inherent in the function and purpose of the Board of Directors to ensure the Company's officers, directors and employees maintain an ethical business standard. The Board of Directors will adopt a formal written code of ethics in 2004.

22

SIGNATURES

(Originals on file)

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

SOUTHERN SCOTTISH INNS, INC.

(Registrant)

By:

Bobby E. Guimbellot Date Jack M. Dubard Date

Chief Executive Officer President & CFO

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

FOR THE BOARD OF DIRECTORS:

Anil Patel Date Richard A. Johnson Date

Director Director

Melanie C. Hanemann Date C. Guy Lowe, Jr. Date

Director Director

Jack M. Dubard Date Harry C. McIntire Date

Director Director

Bobby E. Guimbellot Date Gretchen Nini Date

Director Director

23

George O. Swindell Date John Snyder Date

Director Director

Melina Hotho Date

Director

24