-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G0A2HkRBUB65auDef1oKYWhpjojj14zM20ELeUTEaEDvMtqpLhQHNdatBsO/40jr xEqmbkGKofjdnp7siIYbcQ== 0000950123-96-005069.txt : 19960919 0000950123-96-005069.hdr.sgml : 19960919 ACCESSION NUMBER: 0000950123-96-005069 CONFORMED SUBMISSION TYPE: 10-12B/A PUBLIC DOCUMENT COUNT: 9 FILED AS OF DATE: 19960917 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHOICE HOTELS HOLDINGS INC CENTRAL INDEX KEY: 0001018146 STANDARD INDUSTRIAL CLASSIFICATION: HOTELS & MOTELS [7011] STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: 10-12B/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-11915 FILM NUMBER: 96631472 BUSINESS ADDRESS: STREET 1: 10750 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 20901 BUSINESS PHONE: 3015935600 10-12B/A 1 AMENDMENT NO. 2 TO FORM 10 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10/A-2 ------------------------ GENERAL FORM FOR REGISTRATION OF SECURITIES PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------------------ CHOICE HOTELS HOLDINGS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------------ DELAWARE 52-1985619 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 10750 COLUMBIA PIKE 20901 SILVER SPRING, MARYLAND (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (301) 979-5000 ------------------------ SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH TO BE SO REGISTERED EACH CLASS IS TO BE REGISTERED - -------------------------------------------------------------------------------------------- COMMON STOCK, PAR NEW YORK STOCK EXCHANGE VALUE $.01 PER SHARE
SECURITIES TO BE REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 ITEM 1. BUSINESS The information required by this item is contained under the sections "Summary," "Introduction," "Risk Factors," "The Distribution," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" of the Information Statement dated , 1996 (the "Information Statement") attached hereto as Exhibit 2.01 and such sections are incorporated herein by reference. ITEM 2. FINANCIAL INFORMATION The information required by this item is contained under the sections "Summary," "Capitalization," "Selected Historical Financial Data," "Pro Forma Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Information Statement and such sections are incorporated herein by reference. ITEM 3. PROPERTIES The information required by this item is contained under the section "Business" of the Information Statement and such section is incorporated herein by reference. ITEM 4. SECURITIES OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is contained under the section "Security Ownership of Principal Stockholders and Management" of the Information Statement and such section is incorporated herein by reference. ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS The information required by this item is contained under the sections "Management -- Executive Officers of the Company" and "The Board of Directors" of the Information Statement and such sections are incorporated herein by reference. ITEM 6. EXECUTIVE COMPENSATION The information required by this item is contained under the sections "Management -- Compensation of Executive Officers" and "The Board of Directors" of the Information Statement and such sections are incorporated herein by reference. ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is contained under the sections "Relationship Between Manor Care and the Company After the Distribution" and "Certain Relationships and Related Transactions" of the Information Statement and such sections are incorporated herein by reference. ITEM 8. LEGAL PROCEEDINGS The information required by this item is contained under the sections "Business -- Legal Proceedings" and "Business -- Environmental Matters" and in the Notes to Combined Financial Statements of the Company under the heading "Commitments and Contingencies" which are included in the Information Statement and incorporated herein by reference. ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 3 The information required by this item is contained under the sections "The Distribution -- Listing and Trading of Shares of the Company's Common Stock," "Dividend Policy," "Security Ownership of Principal Stockholders and Management" and "Description of Capital Stock of the Company" of the Information Statement and such sections are incorporated herein by reference. ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES On September , 1996, the Registrant issued and sold 10 shares of its common stock to Manor Care, Inc. for $.10 in order to become a wholly-owned subsidiary of Manor Care, Inc. The sale was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED The information required by this item is contained under the sections "The Distribution -- Listing and Trading of Shares of the Company's Common Stock," "Description of Capital Stock of the Company" and "Purposes and Effects of Certain Charter and By-Law Provisions" of the Information Statement and such sections are incorporated herein by reference. ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS The information required by this item is contained under the section "Liability and Indemnification of Officers and Directors" of the Information Statement and such section is incorporated herein by reference. ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is contained (i) under the sections "Summary," "Capitalization," "Selected Historical Financial Data," "Pro Forma Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Information Statement and such sections are incorporated herein by reference and (ii) in the Combined Financial Statements and Supplemental Schedules incorporated by reference in Item 15 hereof, all of which are incorporated herein by reference. ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS (a) Financial Statements The following Financial Statements of the Company are included in Exhibit 2.01 hereto and incorporated herein by reference: (i) Combined Financial Statements -- Report of Arthur Andersen LLP, Independent Public Accountants, dated June 28, 1996; -- Combined Balance Sheets as of May 31, 1995 and May 31, 1996; -- Combined Statements of Income for each of the fiscal years in the three-year period ended May 31, 1996; -- Combined Statements of Cash Flows for each of the fiscal years in the three-year period ended May 31, 1996; -- Notes to Combined Financial Statements.
2 4 The following supplemental schedule of the Company is included in Exhibit 99.01 hereto and incorporated herein by reference. (ii) Supplemental Schedule -- Schedule II -- Valuation and Qualifying Accounts.
(b) Exhibits
EXHIBIT NUMBER DESCRIPTION ------- -------------------------------------------------------------------------- 2.01 Information Statement dated , 1996** 3.01 Form of Restated Certificate of Incorporation of the Registrant** (attached to Information Statement as Appendix A) 3.02 Form of By-laws of the Registrant* 4.01 Form of Common Stock certificate*** 10.01 Form of Distribution Agreement dated , 1996 between Manor Care, Inc. and the Registrant** 10.02 Form of Trademark Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.03 Form of Assignment of Marks Agreement dated , 1996 between Manor Care Hotels International, Inc. and Choice Hotels France, S.A.* 10.04 Form of Time Sharing Agreement dated , 1996 between Manor Care, Inc. and the Registrant* 10.05 Form of Corporate Services Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.06 Form of Employee Benefits Administration Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.07 Form of Employee Benefits and Other Employment Matters Allocation Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.08 Form of Office Lease dated , 1996 between Manor Care, Inc. and the Registrant* 10.09 Form of Office Lease dated , 1996 between Manor Care, Inc. and the Registrant* 10.10 Form of Loan Agreement dated , 1996 between MNR Finance Corp. and the Registrant*** 10.11 Form of Procurement Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.12 Form of Risk Management Consulting Services Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.13 Form of Tax Administration Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.14 Form of Tax Sharing Agreement, dated , 1996, between Manor Care, Inc. and the Registrant* 10.15 Employment Agreement, dated September 1, 1995, between Manor Care, Inc. and Donald Landry* 10.16 Form of Assignment Agreement, dated , 1996 among Manor Care, Inc., the Registrant and Donald Landry.* 10.17 Employment Agreement dated , 1996 between the Registrant and Stewart Bainum, Jr.*** 10.18 Agreement, dated June 1, 1996 among the Registrant, Manor Care, Inc. and Robert C. Hazard, Jr.*
3 5
EXHIBIT NUMBER DESCRIPTION ------- -------------------------------------------------------------------------- 10.19 Agreement, dated June 1, 1996, among the Registrant, Manor Care Inc. and Gerald W. Petitt* 10.20 Form of Choice Hotels International, Inc. Supplemental Executive Retirement Plan** 10.21 Form of Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan** 10.22 Form of Choice Hotels International, Inc. 1996 Non-Employee Director Stock Compensation Plan** 10.23 Form of Choice Hotels International, Inc. 1996 Long-Term Incentive Plan** 12.01 Statement re: computation of ratio of earnings to fixed charges* 21.01 Subsidiaries of the Registrant** 24.01 Power of Attorney* 27.01 Financial Data Schedule* 99.01 Schedule II -- Valuation and Qualifying Accounts*
- --------------- * Previously filed. ** Filed herewith. *** To be filed by amendment. 4 6 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this amended registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. CHOICE HOTELS HOLDINGS, INC. Date: September 13, 1996 By: * -------------------------------------- Name: Stewart Bainum, Jr. Title: Chief Executive Officer * /s/ JAMES H. REMPE --------------------------------------------------- James H. Rempe Attorney-in-Fact 5 7 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------ ------------------------------------------------------------------------ 2.01 Information Statement dated , 1996**.......................... 3.01 Form of Restated Certificate of Incorporation of the Registrant** (attached to Information Statement as Appendix A)....................... 3.02 Form of By-laws of the Registrant*...................................... 4.01 Form of Common Stock certificate***..................................... 10.01 Form of Distribution Agreement dated , 1996 between Manor Care, Inc. and the Registrant**......................................... 10.02 Form of Trademark Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*................................................ 10.03 Form of Assignment of Marks Agreement dated , 1996 between Manor Care Hotels International, Inc. and Choice Hotels France, S.A.*... 10.04 Form of Time Sharing Agreement dated , 1996 between Manor Care, Inc. and the Registrant*.......................................... 10.05 Form of Corporate Services Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*.................................... 10.06 Form of Employee Benefits Administration Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*...................... 10.07 Form of Employee Benefits and Other Employment Matters Allocation Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*............................................................. 10.08 Form of Office Lease dated , 1996 between Manor Care, Inc. and the Registrant*......................................................... 10.09 Form of Office Lease dated , 1996 between Manor Care, Inc. and the Registrant*............................................................. 10.10 Form of Loan Agreement dated , 1996 between MNR Finance Corp. and the Registrant***................................................... 10.11 Form of Procurement Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*.......................................... 10.12 Form of Risk Management Consulting Services Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*...................... 10.13 Form of Tax Administration Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*.................................... 10.14 Form of Tax Sharing Agreement, dated , 1996, between Manor Care, Inc. and the Registrant*.......................................... 10.15 Employment Agreement, dated September 1, 1995, between Manor Care, Inc. and Donald Landry*...................................................... 10.16 Form of Assignment Agreement, dated , 1996 among Manor Care, Inc., the Registrant and Donald Landry.*................................ 10.17 Employment Agreement dated , 1996 between the Registrant and Stewart Bainum, Jr.***.................................................. 10.18 Agreement, dated June 1, 1996 among the Registrant, Manor Care, Inc. and Robert C. Hazard, Jr.*.................................................. 10.19 Agreement, dated June 1, 1996, among the Registrant, Manor Care Inc. and Gerald W. Petitt*.......................................................
8
EXHIBIT NUMBER DESCRIPTION - ------ ------------------------------------------------------------------------ 10.20 Form of Choice Hotels International, Inc. Supplemental Executive Retirement Plan**....................................................... 10.21 Form of Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan**.................. 10.22 Form of Choice Hotels International, Inc. 1996 Non-Employee Director Stock Compensation Plan**............................................... 10.23 Form of Choice Hotels International, Inc. 1996 Long-Term Incentive Plan**.................................................................. 12.01 Statement re: computation of ratio of earnings to fixed charges*........ 21.01 Subsidiaries of the Registrant**........................................ 24.01 Power of Attorney*...................................................... 27.01 Financial Data Schedule*................................................ 99.01 Schedule II -- Valuation and Qualifying Accounts*.......................
- --------------- * Previously filed. ** Filed herewith. *** To be filed by amendment. EX-2.01 2 INFORMATION STATEMENT 1 [MANOR CARE LETTERHEAD] , 1996 Dear Manor Care, Inc. Stockholder: I am pleased to inform you that the Board of Directors of Manor Care, Inc. ("Manor Care") has approved a distribution to our stockholders of all the outstanding shares of common stock of Choice Hotels Holdings, Inc. ("Choice"). The stock distribution will be made to holders of record of Manor Care common stock on , 1996. You will receive one share of Choice common stock for every share of Manor Care common stock you hold on the record date. As a result of the distribution of Choice common stock to Manor Care shareholders, you will own shares in two separate and very different companies. Manor Care will be a pure health care company focused on inpatient skilled nursing and rehabilitation, assisted living, institutional pharmacy and home health care. Choice will concentrate on franchising, managing and developing hotels and other travel-related businesses. Your Board of Directors and management believe that the separation of the lodging and health care businesses into two public corporations via the distribution of Choice common stock will improve capital-raising efficiency as both debt and equity investors will be better able to assess the different risk profiles and operating characteristics of both businesses. The distribution will give Choice direct access to capital markets and will permit it to raise funds on the basis of its own operating profile and credit fundamentals. Similarly, Manor Care's cost to obtain financing following the distribution will be representative of the operating profile and credit fundamentals of a health care company. In addition, the Board of Directors and management believe that the distribution will improve strategic freedom and focus at both Choice and Manor Care. The enclosed Information Statement explains the proposed distribution in detail and provides financial and other important information regarding Choice. We urge you to read it carefully. Holders of Manor Care common stock are not required to take any action to participate in the distribution as a stockholder vote is not required in connection with this matter. Sincerely, Stewart Bainum, Jr. Chairman of the Board and Chief Executive Officer 2 PRELIMINARY INFORMATION STATEMENT CHOICE HOTELS HOLDINGS, INC. (TO BE RENAMED CHOICE HOTELS INTERNATIONAL, INC.) COMMON STOCK (PAR VALUE $.01 PER SHARE) This Information Statement is being furnished by Manor Care, Inc. ("Manor Care") in connection with the distribution (the "Distribution") to holders of record of Manor Care common stock on , 1996 (the "Record Date") of one share of common stock, par value $.01 per share (the "Company Common Stock"), of Choice Hotels Holdings, Inc. (the "Company") for each share of Manor Care common stock. At the time of the Distribution, the Company will own all of the businesses and assets of, and be responsible for the liabilities associated with, the lodging and hotel franchise business operations conducted by Manor Care and certain of its subsidiaries. The distribution will result in 100% of the outstanding shares of Company Common Stock being distributed to holders of Manor Care common stock. The Distribution will be effective as of , 1996 (the "Distribution Date"). No consideration will be paid by Manor Care's stockholders for shares of Company Common Stock. Manor Care has received a ruling from the Internal Revenue Service to the effect that the Distribution is not taxable for federal income tax purposes to stockholders of the Company and Manor Care. See "The Distribution -- Federal Income Tax Aspects of the Distribution." There is no current trading market for the Company's Common Stock, although it is expected that a "when-issued" trading market will develop prior to the Distribution Date. Application has been made to list the Company's Common Stock on the New York Stock Exchange. Stockholders of Manor Care with inquiries related to the Distribution should contact the Investor Relations Department of Manor Care at (301) 905-4408. Stockholders of Manor Care with inquiries related to their holdings in Manor Care should contact Manor Care's stock transfer agent, Chase-Mellon Shareholder Services, L.L.C., at (212) 946-7200. IN REVIEWING THIS INFORMATION STATEMENT YOU SHOULD CAREFULLY CONSIDER THE MATTERS DESCRIBED UNDER "RISK FACTORS" BEGINNING ON PAGE 9 OF THIS INFORMATION STATEMENT. ------------------------ NO STOCKHOLDER APPROVAL OF THE DISTRIBUTION IS REQUIRED OR SOUGHT. WE ARE NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS INFORMATION STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ THIS INFORMATION STATEMENT DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES. ANY SUCH OFFERING MAY ONLY BE MADE BY MEANS OF A SEPARATE PROSPECTUS PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT AND OTHERWISE IN COMPLIANCE WITH APPLICABLE LAW. THE DATE OF THIS INFORMATION STATEMENT IS , 1996. 3 INFORMATION STATEMENT TABLE OF CONTENTS
PAGE Summary............................................................................. 1 Introduction........................................................................ 6 The Distribution.................................................................... 6 Reasons for the Distribution...................................................... 6 Manner of Effecting the Distribution.............................................. 7 Federal Income Tax Aspects of the Distribution.................................... 7 Conditions; Termination........................................................... 8 Listing and Trading of Shares of the Company's Common Stock....................... 8 Risk Factors........................................................................ 9 Relationship Between Manor Care and the Company After the Distribution.............. 13 Financing........................................................................... 16 Capitalization...................................................................... 18 Dividend Policy..................................................................... 18 Selected Historical Financial Data.................................................. 19 Pro Forma Financial Data............................................................ 20 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................ 21 Business............................................................................ 25 General........................................................................... 25 The Lodging Industry.............................................................. 25 Franchise Business................................................................ 27 Owned and Managed Lodging Business................................................ 38 Competition....................................................................... 42 Service Marks and Other Intellectual Property..................................... 43 Non-Hotel Properties.............................................................. 43 Seasonality....................................................................... 43 Regulation........................................................................ 44 Insurance......................................................................... 44 Impact of Inflation and Other External Factors.................................... 44 Employees......................................................................... 45 Legal Proceedings................................................................. 45 Environmental Matters............................................................. 45 Management.......................................................................... 47 Executive Officers of the Company................................................. 47 Compensation of Executive Officers................................................ 48 Employment Agreements............................................................. 50 Retirement Plans.................................................................. 51 Option and Stock Purchase Plans................................................... 52 The Board of Directors.............................................................. 52 Directors of the Company.......................................................... 52 Certain Relationships and Related Transactions...................................... 55 Security Ownership of Principal Stockholders and Management......................... 56
i 4 Description of Capital Stock of the Company......................................... 59 Common Stock...................................................................... 59 Preferred Stock................................................................... 59 Preemptive Rights................................................................. 59 Purposes and Effects of Certain Charter and By-law Provisions....................... 59 General........................................................................... 59 Liability and Indemnification of Officers and Directors............................. 60 Elimination of Liability in Certain Circumstances................................. 60 Indemnification and Insurance..................................................... 60 Available Information............................................................... 61 Index to Combined Financial Statements.............................................. F-1 Appendix A -- Form of Restated Certificate of Incorporation of the Company.......... A-1
ii 5 SUMMARY The following summarizes certain information contained elsewhere in this Information Statement. Reference is made to, and this summary is qualified by, the more detailed information set forth in this Information Statement, which should be read in its entirety. Unless the context otherwise requires, all references herein to the Company and to Manor Care shall include their respective subsidiaries and all references herein to the Company prior to the Distribution Date shall refer to the Lodging Business (as defined herein) as operated by Manor Care. As used with respect to financial information, "Parent" refers to Manor Care. Unless otherwise indicated, all statistical information and data relating to the hotel industry in this Information Statement are derived from information provided by Smith Travel Research. Smith Travel Research has not consented to the use of the hotel industry data presented herein or provided any form of consultation, advice, or counsel regarding any aspects of, and is in no way whatsoever associated with, the proposed transaction. THE COMPANY The Company is a leading international hotel franchisor and a major owner and manager of hotel properties. Both franchise and owned and managed hotel properties principally operate under one of the Company's brand names: Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R) and Econo Lodge(R). In addition, the Company recently introduced a new brand, MainStay Suites(SM). For the fiscal year ended May 31, 1996, hotel franchising contributed 58.5% of the Company's revenues and 73.0% of the Company's gross profits, while hotel ownership and management contributed the remaining 41.5% of revenues and 27.0% of gross profits. The Company's franchise operations and owned and managed hotel operations have experienced significant growth in revenues and profitability over the last few years. The Company's compound annual growth rate since fiscal year 1991 was 20.1% for revenues and 21.8% for net income before unusual items. For the fiscal year ended May 31, 1996, total revenues and net income were $374.9 million and $8.5 million, respectively. Excluding unusual items, net income for the period was $28.6 million. FRANCHISE OPERATIONS. The Company is one of the world's largest franchisors of hotels with 3,052 properties open and operating in 30 countries at May 31, 1996. As a franchisor, the Company licenses hotel operators to use the Company's brand names and provides to these hotel operators products and services designed to increase their revenues and profitability. Key products and services provided include nationally recognized marketing and advertising programs, access to a reservation system that delivers business to the franchisees' hotels, access to innovative products and services developed by the Company and other support services such as training programs, purchasing discounts, operating manuals, quality standards and inspections. In return for the use of the Company's brand names and access to the Company's products and services, franchisees pay to the Company fees that are generally based on a percentage of the franchise hotels' gross room revenues. Since fiscal year 1994, the Company has grown revenues from franchise operations at a compound annual rate of 15.1%, while direct franchise expenses have increased at a compound annual rate of 8.8%. During the same period, gross margins have improved from 56.5% for fiscal year 1994 to 61.1% for fiscal year 1996. Key components of the Company's franchise strategy include: - growth of the Company's domestic franchise system; - increases in average actual royalty rates; - strategic development of the international franchise system; - expansion of preferred vendor programs; and - pursuit of selected strategic investments and acquisitions. The Company's existing franchisees form a pool of potential buyers and builders of new hotels that may affiliate with one of the Company's brands. The Company believes that its focus on improving the 1 6 performance of its franchisees through the provision of revenue- and profitability-enhancing systems and services will enable it to retain these franchisees and attract new franchisees to its system. The Company is able to meet the needs of franchisees across a wide range of market segments by maintaining an array of distinct brands, each with its own marketing and operating strategy. The Company expects to continue to expand its brand offerings by developing new brands for high-growth segments of the hospitality industry. OWNED AND MANAGED OPERATIONS. In addition to acting as franchisor, the Company owns and manages hotels. At May 31, 1996, the Company owned and managed, under its six principal brand names, 79 hotels in 25 states, as well as in Germany, France and England. To take advantage of a recovering lodging industry, the Company has pursued, over the past few years, a strategy of acquiring domestic hotel properties at prices below their replacement cost and increasing their value through the investment of capital to improve the physical site and the installation of professional management and marketing teams to operate the renovated properties. Since June 1992, the Company has spent approximately $242.7 million to buy and renovate 52 hotel properties. Under the Company's management and consistent with overall industry improvements, the operating performance of hotels acquired pursuant to this strategy has improved substantially. Occupancies at domestic hotels acquired during fiscal year 1993 have improved from 56% in fiscal year 1993 to 76% in fiscal year 1996, while occupancies for fiscal year 1994 domestic acquisitions have improved from 66% in fiscal year 1994 to 74% in fiscal year 1996 and occupancies for fiscal year 1995 domestic acquisitions have improved from 49% in fiscal year 1995 to 58% in fiscal year 1996. Overall, revenues from owned and managed hotel operations have grown at a compound annual rate of 44.9% since fiscal year 1994, while hotel operations expenses have increased at a compound annual rate of 32.9%. As a result, gross margins of the owned and managed hotel operations have improved from 19.0% for fiscal year 1994 to 31.9% for fiscal year 1996. Because many of the recently acquired and developed hotels have not yet reached stabilized levels of operating performance, the Company believes that revenues and gross profit at these hotels will continue to grow. The Company's strategy for its owned and managed operations is to realize cash proceeds from, or "monetize," its capital investment in Company-owned hotels at values that reflect their improved operating performance. The Company is exploring a variety of transactions, including, among others, asset securitization, sale/leasebacks, joint ventures with third parties, debt financing and asset divestitures. The Company intends to retain management and franchise agreements relating to these properties. The proceeds from these transactions will be used initially to repay outstanding indebtedness. The remaining proceeds will be used to launch or provide support to recently developed brands, such as Sleep Inn and MainStay Suites, to develop additional new brands, to expand internationally by investing in selected international gateway cities and to invest in other targeted growth areas. 2 7 THE DISTRIBUTION Reasons for the Distribution.................. The Board of Directors and management of Manor Care believe that the separation of Manor Care's health care and lodging businesses into two public companies via the Distribution will improve capital-raising efficiency as both debt and equity investors will be better able to assess the different risk profiles and operating characteristics of both businesses. The Distribution will give the Company direct access to capital markets and will permit it to raise funds on the basis of its own operating profile and credit fundamentals. Similarly, Manor Care's cost to obtain financing following the Distribution will be representative of the operating profile and credit fundamentals of a health care company. In addition, the Board of Directors and management of Manor Care believe that the Distribution will improve strategic freedom and focus at both Choice and Manor Care. See "The Distribution -- Reasons for the Distribution." Distributed Company........... Choice Hotels Holdings, Inc. (the "Company"), a Delaware corporation (to be renamed Choice Hotels International, Inc.) and a wholly-owned subsidiary of Manor Care, will, on the Distribution Date, own all of the business and assets of, and be responsible for all of the liabilities associated with, the lodging and hotel franchise business operations conducted by Manor Care and certain of its subsidiaries (the "Lodging Business"). Distributing Company.......... Manor Care, Inc., a Delaware corporation ("Manor Care"). Securities to Be Distributed................... Approximately shares (the "Shares") of common stock, par value $.01 per share of the Company, based on shares of common stock, par value $.10 per share, of Manor Care ("Manor Care Common Stock") outstanding as of , 1996. Distribution Ratio............ One share of Company Common Stock for each share of Manor Care Common Stock. Tax Consequences.............. Manor Care has received a ruling from the Internal Revenue Service to the effect, among other things, that receipt of the Shares by stockholders of Manor Care is tax free for federal income tax purposes. See "The Distribution -- Federal Income Tax Aspects of the Distribution." Listing and Trading Market.... Application has been made to list the Shares on the New York Stock Exchange under the symbol "CHH." See "The Distribution -- Listing and Trading of Shares of the Company's Common Stock." Record Date................... Close of business on , 1996. Distribution Date............. As of , 1996. On the Distribution Date, Manor Care will deliver the Shares to the Distribution Agent. As soon as practicable thereafter, the Distribution Agent will mail certificates representing the appropriate number of Shares to the Manor Care stockholders entitled thereto. See "The Distribution -- Manner of Effecting the Distribution." Distribution Agent............ Chase-Mellon Shareholder Services, L.L.C., the transfer agent for the Company. The Company's Dividend Policy After the Distribution........ It is currently contemplated that following the Distribution, the Company will not pay cash dividends on the Shares. 3 8 Certain Charter and By-law Provisions........... Certain provisions of the Restated Certificate of Incorporation (the "Restated Certificate") and the By-laws ("the By-laws") of the Company have the effect of delaying or making more difficult an acquisition of control of the Company in a transaction not approved by its Board of Directors. These provisions have been designed to enable the Company, especially in its initial years, to develop its businesses and foster its long-term growth without disruptions caused by the threat of a takeover not deemed by its Board of Directors to be in the best interest of the Company. See "Purposes and Effects of Certain Charter and By-law Provisions." The Restated Certificate would eliminate certain liabilities of directors in connection with the performance of their duties. See "Liability and Indemnification of Officers and Directors -- Elimination of Liability in Certain Circumstances." Risk Factors.................. Stockholders should carefully consider all of the information contained in this Information Statement, including the matters described under "Risk Factors." Principal Office of the Company....................... 10750 Columbia Pike, Silver Spring, Maryland 20901. Its telephone number is (301) 979-5000. Relationship between Manor Care and the Company after the Distribution................ For purposes of governing the ongoing relationships between Manor Care and the Company after the Distribution Date and in order to provide for an orderly transfer of the Lodging Business to the Company and facilitate the transition to two separate publicly traded companies, Manor Care and the Company have entered into a distribution agreement and various other agreements with respect to, among other things, intercompany debt, tax matters, employee benefits, risk management and corporate and administrative services. See "Relationship Between Manor Care and the Company After the Distribution." The relationship between Manor Care and the Company may be subject to certain potential conflicts of interest. See "Risk Factors -- Potential Conflicts with Manor Care." 4 9 SUMMARY FINANCIAL INFORMATION The following table summarizes certain selected financial information with respect to the Company and is derived from the Combined Financial Statements of the Company. Historical financial information may not be indicative of the Company's future performance as an independent company. The information set forth below is qualified in its entirety by reference to, and should be read in conjunction with, "Selected Historical Financial Data," "Pro Forma Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Combined Financial Statements and related notes included elsewhere herein.
YEAR ENDED MAY 31, --------------------------------------------- 1994 1995 1996 PRO FORMA(A) -------- -------- -------- 1996 ------------ (UNAUDITED) (IN THOUSANDS, EXCEPT RATIO DATA) STATEMENT OF INCOME DATA: Revenues........................................... $239,764 $302,535 $374,873 $387,819 Operating expenses................................. 206,722 250,476 334,083(b) 349,961(b) -------- -------- -------- ------------ Income before other expenses and income taxes...... 33,042 52,059 40,790 37,858 Interest expense on notes payable to Parent........ 10,665 15,492 19,673 20,339 Minority interest and other interest and other expenses, net.......................... 4,699 6,612 5,259 3,727 -------- -------- -------- ------------ Income before income taxes......................... 17,678 29,955 15,858 13,792 Income taxes....................................... 8,019 13,144 7,400 6,429 -------- -------- -------- ------------ Net income............................... $ 9,659 $ 16,811 $ 8,458 $ 7,363 ======== ======== ======== ==========
MAY 31, ------------------- 1995 1996 -------- -------- BALANCE SHEET DATA: Working capital.................................... $(34,663) $ (7,606) Total assets....................................... 391,475 491,304 Notes payable to Parent............................ 198,522 225,723 Total debt......................................... 251,191 294,861 Investments and advances from Parent............... 65,829 147,559 RATIO DATA: Ratio of earnings to fixed charges (c)............. 2.47x 1.63x ======== ========
- --------------- (a) The pro forma statement of operations data for the year ended May 31, 1996 give effect to (i) the Distribution and related transactions and (ii) the acquisition by the Company of an aggregate of 16 hotels during fiscal year 1996, as if all such transactions had occurred on June 1, 1995. (b) Includes a provision of $33.3 million for impairment of certain long-lived assets associated primarily with the Company's European operations and certain restructuring costs, including severance and employee benefit plan restructuring costs, directly associated with the Distribution. (c) Earnings used in computing the ratio of earnings to fixed charges consist of income before income taxes, fixed charges and extraordinary items. Fixed charges consist of interest expense, including amounts capitalized and the amortization of deferred financing fees, and that portion of operating lease rental expense that is representative of interest (deemed to be one-third of operating lease rentals). 5 10 INTRODUCTION The Company is one of the world's largest franchisors of hotels with 3,052 properties and a total of 261,456 rooms open and operating in 30 countries at May 31, 1996. The properties principally operate under one of the Company's brand names: Comfort, Quality, Clarion, Sleep, Rodeway and Econo Lodge. In addition, the Company recently introduced a new brand, MainStay Suites. At May 31, 1996, another 716 franchise properties with a total of 63,785 rooms were under development. In addition to acting as franchisor, at May 31, 1996, the Company owned and managed, under its six principal brand names, 79 hotels in 25 states, as well as in Germany, France and England. On March 7, 1996, the Board of Directors of Manor Care announced its intention to distribute to holders of Manor Care Common Stock all of the outstanding Shares. On March 6, 1996, the high and low sales prices of the Manor Care Common Stock as reported on the New York Stock Exchange Composite Tape were $39 and $38 5/8, respectively. On , 1996, the Board of Directors of Manor Care declared a dividend to effect the Distribution and set the Record Date and Distribution Date. On , 1996, the high and low sales prices of the Manor Care Common Stock as reported on the New York Stock Exchange Composite Tape were $ and $ , respectively. Following the Distribution, Manor Care will not own any Shares or other capital stock of the Company, but will have certain contractual relationships with the Company. See "Relationship Between Manor Care and the Company After the Distribution." The Company, a Delaware corporation, was incorporated on June 27, 1996, and is currently a wholly-owned subsidiary of Manor Care with no operations. Prior to the Distribution, the Lodging Business has been conducted as a separate division and through certain subsidiaries of Manor Care, including Choice Hotels International, Inc., a wholly-owned subsidiary of Manor Care. On the Distribution Date, Manor Care will contribute to the Company the Lodging Business (including all of the stock of Choice Hotels International, Inc. and the other subsidiaries comprising the Lodging Business, together with certain assets relating to the Lodging Business held by Manor Care) and the Company will change its name to Choice Hotels International, Inc. The existing Choice Hotels International, Inc. will be renamed Choice Hotels Franchising, Inc. Stockholders of Manor Care with inquiries relating to the Distribution should contact the Investor Relations Department of Manor Care at (301) 979-4408. After the Distribution Date, stockholders of the Company should contact the Investor Relations Department of Choice at (301) 979-5000. THE DISTRIBUTION REASONS FOR THE DISTRIBUTION The Board of Directors and management of Manor Care have determined, for the reasons set forth below, among others, to separate the Lodging Business from Manor Care's other businesses. The Board of Directors and management of Manor Care believe that the separation of its health care and lodging businesses into two public corporations via the distribution of the Shares will improve capital-raising efficiency as both debt and equity investors will be better able to assess the different risk profiles and operating characteristics of both businesses. The Distribution will give the Company direct access to capital markets and will permit it to raise funds on the basis of its own operating profile and credit fundamentals. Similarly, Manor Care's cost to obtain financing following the Distribution will be representative of the operating profile and credit fundamentals of a health care company. In addition, the Board of Directors and management believe that the Distribution will improve strategic freedom and focus at both the Company and Manor Care. The Board of Directors and management of Manor Care also believe that the Distribution will (i) facilitate the expansion of each of Manor Care and the Company through future acquisitions by making the stock of each entity a more effective consideration with which to make any such acquisitions, (ii) enable Manor Care and the Company to motivate their respective key employees, and attract new employees, by offering incentives such as stock options whose value will be directly affected by the performance of Manor 6 11 Care or the Company, as the case may be, and (iii) simplify the process of allocating indirect corporate overhead costs in computing governmental reimbursements to the health care business. MANNER OF EFFECTING THE DISTRIBUTION The general terms and conditions of the Distribution are set forth in the distribution agreement (the "Distribution Agreement") to be entered into by the Company and Manor Care prior to the Distribution. Upon satisfaction of all the conditions contained in the Distribution Agreement, it is contemplated that the Distribution will be made as of , 1996 (the "Distribution Date") to stockholders of record of Manor Care at the close of business on , 1996 (the "Record Date"). On the Distribution Date, the Shares will be delivered to the Distribution Agent for distribution as soon as practicable thereafter to holders of record of Manor Care Common Stock as of the close of business on the Record Date on the basis of one share of Company Common Stock for each share of Manor Care Common Stock held on the Record Date. The actual total number of Shares to be distributed will depend on the number of shares of Manor Care Common Stock outstanding on the Record Date. All such Shares will be fully paid and non-assessable and the holders thereof will not be entitled to preemptive rights. See "Description of Capital Stock of the Company." Following the Distribution, the Company will operate as an independent public company. No holder of Manor Care Common Stock will be required to pay any cash or other consideration for the Shares received in the Distribution or to surrender or exchange shares of Manor Care Common Stock in order to receive Shares. FEDERAL INCOME TAX ASPECTS OF THE DISTRIBUTION Manor Care has received a ruling from the Internal Revenue Service to the effect, among other things, that, for federal income tax purposes, the Distribution will qualify as a tax-free spin-off under Section 355 of the Internal Revenue Code of 1986, as amended, and that: (1) No gain or loss will be recognized to (and no amount will be included in the income of) holders of Manor Care Common Stock upon the receipt of the Shares in the Distribution; (2) Assuming that on the Distribution Date a holder of Manor Care Common Stock holds Manor Care Common Stock as a capital asset, the holding period for the Shares to be received in the Distribution will include the period during which the Manor Care Common Stock was held; (3) The tax basis of Manor Care Common Stock held by a Manor Care stockholder at the time of the Distribution will be allocated, based upon relative fair market values at the time of the Distribution, between such Manor Care Common Stock and the Shares received by the stockholder in the Distribution; and (4) No gain or loss will be recognized by Manor Care or the Company on the Distribution. Within 90 days after the Distribution, Manor Care will provide to Manor Care stockholders additional information regarding the allocation referred to in (3) above. Internal Revenue Service rulings, while generally binding on the Internal Revenue Service, are subject to certain factual representations and assumptions. Manor Care is not aware of any material facts or circumstances which would cause such representations or assumptions to be untrue but there can be no assurance that such representations and assumptions will continue to be true after the Distribution Date. See "Risk Factors -- Certain Tax Considerations." THE FOREGOING IS ONLY A SUMMARY OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES OF THE DISTRIBUTION UNDER CURRENT LAW AND IS INTENDED FOR GENERAL INFORMATION ONLY. EACH STOCKHOLDER SHOULD CONSULT HIS OR HER TAX ADVISOR AS TO THE PARTICULAR CONSEQUENCES OF THE DISTRIBUTION TO SUCH STOCKHOLDER, INCLUDING THE APPLICATION OF STATE, LOCAL AND FOREIGN TAX LAWS, AND THE EFFECT OF POSSIBLE CHANGES IN TAX LAWS THAT MAY AFFECT THE TAX CONSEQUENCES DESCRIBED ABOVE. 7 12 CONDITIONS; TERMINATION The Distribution Agreement provides that the Distribution is subject to certain conditions, including final approval of the Manor Care Board of Directors. See "Relationship Between Manor Care and the Company After the Distribution -- Distribution Agreement." Even if all the conditions are satisfied, the Manor Care Board of Directors may, in its discretion, terminate, defer, modify or abandon the Distribution. LISTING AND TRADING OF SHARES OF THE COMPANY'S COMMON STOCK Application has been made for listing of the Shares on the New York Stock Exchange (the "NYSE") under the symbol "CHH." As of the Distribution Date, the Company is expected to have approximately holders of record of the Shares, based on the number of holders of record of Manor Care Common Stock on the Record Date. There is not currently a public market for the Shares. Prior to the Distribution, the Shares are expected to begin trading on a "when-issued" basis on a date to be determined by the NYSE. If the Distribution is not made, all such "when-issued" trading will be null and void. Prices at which the Shares may trade prior to the Distribution on a "when-issued" basis or after the Distribution cannot be predicted. The prices at which the Shares trade will be determined by the marketplace and may be influenced by many factors, including, among others, the depth and liquidity of the market for the Shares, investor perception of the Company and the industry in which its businesses participate, the Company's dividend policy and general economic and market conditions. See the description of the dividend policy of the Company under "Dividend Policy." The Shares distributed to Manor Care stockholders will be freely transferable, except for Shares received by persons who may be deemed to be "affiliates" of the Company under the Securities Act of 1933, as amended (the "Securities Act"). Persons who may be deemed to be affiliates of the Company after the Distribution generally include individuals or entities that control, are controlled by, or are under common control with the Company and may include certain officers and directors of the Company. Persons who are affiliates of the Company will be permitted to sell their Shares only pursuant to an effective registration statement under the Securities Act or an exemption from the registration requirements of the Securities Act, such as the exemption afforded by Section 4(1) of the Securities Act and Rule 144 promulgated thereunder. 8 13 RISK FACTORS RISKS OF THE LODGING INDUSTRY; COMPETITION General. Competition in the lodging business for hotel guests is based upon many factors, including rates, quality of accommodations, brand recognition, service levels, convenience and desirability of locations and general, regional and local economic conditions. During the 1980s, construction of lodging facilities in the United States resulted in an excess supply of available rooms. This oversupply had an adverse effect on occupancy levels and room rates, and therefore hotel values, in the industry in the early 1990s. Although the current outlook for the industry has improved, there can be no assurance that in the future the lodging industry, including the Company, its hotels and its franchisees, will not be adversely affected again by an oversupply of rooms or by (i) national and regional economic conditions, (ii) changes in travel patterns, gasoline prices and other costs of travel and demographics, (iii) natural disasters, (iv) seasonality of the hotel business, (v) taxes and government regulations that influence or determine wages, prices, interest rates, refurbishment or improvement plans, construction procedures and operating costs and (vi) the availability of credit. Due in part to the strong correlation between the lodging industry's performance and economic conditions, the lodging industry is subject to cyclical changes in revenues and profits. Risks of Franchise Business. As a franchisor, the Company's products are its brand names and the support services it provides to its franchisees. Competition among national brand franchisors in the lodging industry to grow their franchise systems is intense. In addition, smaller chains pose some degree of competitive pressure in selected markets. The Company believes that competition for the sale of lodging franchises is based principally upon the perceived value and quality of the brand and services as well as the nature of those services offered to franchisees. The Company believes that prospective franchisees value a franchise based upon their view of the relationship of the costs imposed to the potential for increased revenue and profitability. The Company's franchising revenues vary directly with franchisees' gross room revenues, but are not directly dependent upon franchisees' profitability. The Company believes, however, that the perceived value of its brand names to prospective franchisees is in part a function of the success of its existing franchisees. The ability of the Company's franchisees to compete in the lodging industry is important to the Company's prospects because franchise fees are primarily based on franchisees' gross room revenues. The Company's franchisees are generally in intense competition with franchisees of other systems, independent properties and owner-operated chains. Risks of Developing, Acquiring and Owning Hotels. As an owner of hotels, the Company is subject to the risks of construction and operation of lodging facilities generally. Developing new hotels and acquiring hotels with repositioning potential subjects the Company to pre-opening, pre-stabilization and repositioning costs. As the Company opens additional Company-owned hotels, such costs may adversely affect the Company's results of operations. Newly opened hotels historically begin with lower occupancy and room rates that improve over time. While the Company has in the past successfully opened or repositioned new hotels, there can be no assurance that it will be able to continue to do so. Construction, acquisition and repositioning of hotels involve certain risks, including the possibility of construction cost overruns and delays, site acquisition cost and availability, uncertainties as to market potential, market deterioration after the acquisition or repositioning, possible unavailability of financing on favorable terms and the emergence of market competition from unanticipated sources. Although the Company seeks to manage its construction, acquisition and repositioning activities so as to minimize such risks, there can be no assurance that any such projects will perform in accordance with the Company's expectations. Hotel investments are relatively illiquid. Such illiquidity will tend to limit the ability of the Company to respond to changes in economic or other conditions. The Company's ownership of real property is substantial. Real estate values are sensitive to changes in local market and economic conditions and to fluctuations in the economy as a whole. In addition, the Company is subject to the general risks of fluctuation in the hotel real estate transaction market, which is impacted by variable prices and the availability of financing. There can be no assurance that the Company's development, acquisition, repositioning or disposition plans will not be adversely affected by changes in the real estate market. 9 14 Risks of Hotel Management. The Company currently manages 85 hotel properties, including its 79 owned hotels and 6 properties managed under agreements with third parties. In connection with its monetization strategy, the Company expects to substantially increase the number of hotel properties managed pursuant to third party management agreements. Management agreements expire or are acquired, terminated or renegotiated in the ordinary course. There can be no assurance that such third party agreements will be on terms as favorable to the Company as existing intercompany agreements. RISK OF GEOGRAPHIC CONCENTRATION A substantial portion of the Company's franchise and owned hotels are located in the southeastern United States. Such geographic concentration exposes the Company's operating results to events or conditions that specifically affect that region, such as economic, weather and other conditions. Adverse developments that specifically affect the southeastern United States may have a material adverse effect on the business, financial condition or results of operations of the Company. ABILITY TO IMPLEMENT MONETIZATION STRATEGY The Company's strategy for its owned and managed operations is to monetize its capital investment in Company-owned hotels at values that reflect their improved operating performance. The Company is exploring a variety of transactions, including, among others, asset securitizations, sale/leasebacks, joint ventures with third parties, debt financings and asset divestitures. The Company intends to retain management and franchise agreements relating to these properties. The proceeds from these transactions will be used initially to repay amounts owed to Manor Care. See "Financing -- The Manor Care Loan Agreement." The Company currently intends to consummate any such transactions only if the Company is able to retain the management and franchise contracts for such hotels. Although transactions of the types being explored by the Company are common in the hotel industry, there can be no assurance that the Company will be able to successfully execute these plans. Furthermore, the Company's plan to retain management and franchise contracts for such hotels will make certain transactions more difficult to consummate. If the Company is not able to successfully implement its monetization strategy, the Company will be unable to reduce amounts owed to Manor Care as planned and will be required to obtain additional sources of financing to repay such amounts before they come due on , 1999. There can be no assurance that the Company will be able to obtain such financing on favorable terms or in a timely manner. UNAVAILABILITY OF MANOR CARE FINANCIAL RESOURCES Historically, adequate financial resources were available from Manor Care to meet operating and investment needs of the Company. Following the Distribution, the Company will no longer have access to Manor Care financial resources and will be required to obtain financing based on its own credit fundamentals as well as repay amounts owed to Manor Care. The Company will have access to its cash flow from operations, which previously was distributed up to Manor Care as part of Manor Care's internal cash management system. In addition, the Company expects to have access to a revolving credit facility and is currently negotiating the terms thereof with potential bank lenders. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." There can be no assurance that the lack of access to Manor Care's financial resources will not adversely affect the Company's ability to obtain additional financing on favorable terms. MARKET ACCEPTANCE OF NEW BRANDS AND PRODUCTS As part of its growth strategy, the Company is developing new brands, such as MainStay Suites(SM), an extended-stay lodging product, and new products, such as Choice Picks(SM), a customized modular food service system for hotels and other institutions. The Company has no operating history in either the extended-stay lodging market or the food court service business and there can be no assurance that either Main Stay Suites or Choice Picks will experience market acceptance or that the Company will be successful in franchising these or other new brands or products. Further, there can be no assurance that the capital investments made by the Company to develop these and other new brands or products will be recovered, or that such new brands or 10 15 products will be profitable. As of May 31, 1996, the Company has invested approximately $4.3 million in developing and marketing MainStay Suites and Choice Picks, which includes $1.6 million to begin the construction of MainStay Suites. The failure to successfully franchise these and other new brands could have a material adverse effect on the business, financial condition and results of operations of the Company. RELIANCE ON KEY PERSONNEL The ability of the Company to operate successfully is dependent, in part, upon the continued services of certain of its employees, including Stewart Bainum, Jr., the Chairman and Chief Executive Officer of the Company and Manor Care, Inc. and Donald J. Landry, the President of the Company. Mr. Bainum, Jr.'s employment agreement with the Company will be for a term of years from the Distribution Date. Mr. Landry's employment agreement with Choice Hotels International, Inc. extends through November 30, 1999. There can be no assurance that a suitable replacement for either Mr. Bainum, Jr. or Mr. Landry could be found in the event of termination of either of their employment. Following the Distribution, Mr. Bainum, Jr. will devote approximately one-third of his professional time to the affairs of the Company. SIGNIFICANT BAINUM FAMILY INTEREST Upon completion of the Distribution, Stewart Bainum, Stewart Bainum, Jr., and Barbara Bainum are expected to beneficially own approximately 19.9%, 19.4% and 2.9%, respectively, of the Company Common Stock, in each case including shares with respect to which voting power is shared with other individuals or entities. See "Security Ownership of Principal Stockholders and Management." In addition, Mr. Bainum, Mr. Bainum, Jr., and Ms. Bainum will be directors of the Company. As a result, the Bainum family may be in a position to significantly influence the affairs of the Company, including the election of directors. POTENTIAL CONFLICTS WITH MANOR CARE The Company and Manor Care will share four common directors. Stewart Bainum serves as Vice Chairman and Stewart Bainum, Jr. serves as Chairman of the Board of Directors and Chief Executive Officer of both Manor Care and the Company. Mr. Bainum, Jr. will devote two-thirds of his time to Manor Care and one-third of his time to the Company. Mr. Bainum, Jr.'s employment by both companies and his consequent inability to devote 100% of his time to either company could create a conflict in the future. Certain officers and directors of Manor Care and the Company also own shares (and/or options or other rights to acquire shares) in both companies. In connection with the Distribution, the Company and Manor Care will enter into various contractual arrangements and the potential exists for disagreement in the future as to contract compliance. For a description of the Company's ongoing relationship with Manor Care, see "Relationship Between Manor Care and the Company After the Distribution." POTENTIAL INDEMNIFICATION OBLIGATIONS FOR CERTAIN ENVIRONMENTAL CLAIMS Pursuant to the Distribution Agreement, the Company will indemnify Manor Care and its subsidiaries and affiliates from liabilities of predecessor companies of Manor Care relating to waste disposal sites which allegedly are or may be subject to remedial action under federal and state environmental laws. The indemnity covers all losses arising from pending and future actions that are not covered by Manor Care's insurance. Manor Care and its insurers are vigorously contesting liability in the pending actions and it is not possible at the present time to estimate the Company's ultimate indemnification liability, if any. The Company believes that its indemnification obligations, if any, will not have a material adverse effect on its business, financial conditions or results of operations. See "Relationship Between Manor Care and the Company After the Distribution -- Distribution Agreement -- Certain Environmental and Other Claims Indemnification" and "Business -- Environmental Matters." 11 16 FORWARD-LOOKING INFORMATION IS SUBJECT TO RISK AND UNCERTAINTY Certain statements contained in this Information Statement, including in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business" contain "forward-looking" information (as defined in the U.S. Private Securities Litigation Reform Act of 1995) that involves risk and uncertainties, including (i) the Company's plans to monetize its capital investment in owned hotels, (ii) the Company's plans to expand its international franchise operations, (iii) the Company's plans to market new brands and products and (iv) the Company's plans to make selected strategic investments and acquisitions. Actual future results and trends may differ materially depending on a variety of factors discussed in this "Risk Factors" section and elsewhere in this Information Statement, including (a) the Company's success in implementing its business strategy, including its success in arranging financing where required, (b) the nature and extent of future competition, and (c) political, economic and demographic developments in countries where the Company does business or in the future may do business. CERTAIN TAX CONSIDERATIONS Manor Care has received a ruling from the Internal Revenue Service to the effect, among other things, that, for federal income tax purposes, the Distribution will qualify as a tax-free distribution, both to Manor Care's stockholders and to Manor Care. If the Company and Manor Care fail to comply with the representations and assumptions under which the ruling was issued, and as a result the Distribution is not treated as tax-free, the federal income tax liability of Manor Care would be significant. Pursuant to the Tax Sharing Agreement, the Company will assume liability for all taxes payable by the Company or by Manor Care in the event the Distribution is determined not to be tax-free for federal income tax purposes. Such liabilities could be substantial and could have a material adverse effect on the business, financial condition and results of operations of the Company. In addition, if the Distribution is not treated as tax-free for federal income tax purposes, each Manor Care stockholder that receives Choice Common Stock in the Distribution would be treated as having received a taxable dividend. 12 17 RELATIONSHIP BETWEEN MANOR CARE AND THE COMPANY AFTER THE DISTRIBUTION For purposes of governing the ongoing relationships between Manor Care and the Company after the Distribution Date, and in order to provide for an orderly transfer of the Lodging Business to the Company and facilitate the transition to two separate publicly-traded companies, Manor Care and the Company have entered or will enter into various agreements setting forth the Company's and Manor Care's on-going responsibilities regarding various matters outlined below. The agreements summarized in this section are included as exhibits to the Company's Registration Statement on Form 10 of which this Information Statement is a part. The following summaries are qualified in their entirety by reference to such exhibits. DISTRIBUTION AGREEMENT On or prior to the Distribution Date, the Company and Manor Care will enter into the Distribution Agreement which provides for, among other things, the principal corporate transactions required to effect the Distribution, the assumption by the Company of all liabilities relating to the Lodging Business (to the extent not covered by Manor Care's insurance) and the allocation between the Company and Manor Care of certain other liabilities, certain indemnification obligations of the Company and Manor Care and certain other agreements governing the relationship between the Company and Manor Care with respect to or in consequence of the Distribution. The Distribution Agreement provides that the Distribution is subject to the prior satisfaction of certain conditions including, among other things, the transfer of the Lodging Business to the Company, the execution of all ancillary agreements, certain of which are described below, to the Distribution Agreement and the formal approval of the Distribution by the Board of Directors of Manor Care. CROSS-INDEMNIFICATION. Subject to certain exceptions, the Company has agreed to indemnify Manor Care and its subsidiaries against any loss, liability or expense incurred or suffered by Manor Care or its subsidiaries arising out of or related to the failure by the Company to perform or otherwise discharge liabilities allocated to and assumed by the Company under the Distribution Agreement, and Manor Care has agreed to indemnify the Company against any loss, liability or expense incurred or suffered by the Company arising out of or related to the failure by Manor Care to perform or otherwise discharge the liabilities retained by Manor Care under the Distribution Agreement. The foregoing cross-indemnities do not apply to indemnification for tax claims and liabilities, which are addressed in the Tax Sharing Agreement described below, and indemnification for environmental claims and liabilities specifically addressed by the provision described below. The Distribution Agreement also includes procedures for notice and payment of indemnification claims and provides that the indemnifying party may assume the defense of a claim or suit brought by a third party. CERTAIN ENVIRONMENTAL AND OTHER CLAIMS INDEMNIFICATION. In addition to the indemnification described above, the Company has agreed to indemnify Manor HealthCare Corp. ("HealthCare"), Manor Care, their affiliates, subsidiaries and their respective directors, employees and agents (collectively, the "Indemnitees") from any and all losses which may arise from (i) certain pending environmental claims; and (ii) currently unknown but potential or future environmental, third party personal injury and other claims arising out of the activities or operations of, or conditions affecting properties formerly or presently owned, leased, operated or used by, Cenco Incorporated a corporation that was merged into HealthCare in 1982, its subsidiary and affiliated companies, and any and all of Cenco Incorporated's predecessor corporations, subsidiaries and affiliates (together, "Cenco"). The losses to be indemnified by the Company include, among other things, all amounts required to be reimbursed to a third-party insurer for insurance proceeds previously paid by the insurer, all deductible amounts required to be paid under any insurance policy before coverage attaches to a claim, all amounts paid to third parties in excess of insurance coverage, all amounts not paid by insurers with respect to current, potential and future claims and, as to certain sites owned by affiliates of HealthCare, all sums necessary to comply with any and all federal, state and local regulatory and judicial consent decrees or orders or any settlements regarding environmental remediation of these properties in excess of the reserves reflected in the most recent monthly balance sheet of HealthCare available prior to the Distribution Date. The Company cannot predict the amount it may have to pay to Indemnitees in the future to satisfy this indemnity obligation. See "Business -- Environmental Matters" and "Risk Factors -- Potential Indemnification Obligations." 13 18 INTERCOMPANY ADVANCES AND ACCOUNTS. The Distribution Agreement provides that on or prior to the Distribution Date the Company and a subsidiary of Manor Care will enter into a loan agreement pursuant to which the Company will repay to Manor Care over a three year period approximately $225.7 million in advances made by Manor Care to the Company prior to the Distribution Date. See "Financing -- The Manor Care Loan Agreement." All other intercompany loans or advances have been or will be contributed to the capital of the Company. CREDIT FACILITIES. The Distribution Agreement provides that, as a condition to the Distribution, on or prior to the Distribution Date, Manor Care will amend and restate its existing credit facility so as to release the Company and any subsidiaries engaged in the Lodging Business from any liability or obligation with respect thereto, and the Company will enter into a separate revolving credit facility. See "Financing -- Credit Facility." NON-COMPETE. The Distribution Agreement provides that until five years after the Distribution Date, Manor Care and its subsidiaries shall not compete with the lodging business of the Company, provided that Manor Care may engage in any line of business in which the Company is not engaged, as of the Distribution Date, including the operation of assisted living facilities, independent living facilities or any business similar thereto, and the Company shall not compete with the health care business or any such other business of Manor Care. GUARANTEES. The Distribution Agreement provides that Manor Care will continue to guarantee certain mortgages and other long term debt of the Company outstanding on the Distribution Date. The Company will pay Manor Care a guarantee fee equal to 2.0% per annum of the aggregate principal amount of such guaranteed obligations and other long term debt subject to such guarantees. EXPENSES. The Distribution Agreement provides that except as otherwise specifically provided, all costs and expenses incurred in connection with the preparation, execution, delivery and implementation of the Distribution Agreement and with the consummation of the transactions contemplated by the Distribution Agreement (including transfer taxes and the fees and expenses of all counsel, accountants and financial and other advisors) shall be paid by the party incurring such cost or expense. Notwithstanding the foregoing, the Company shall be obligated to pay the legal, filing, accounting, printing and other accountable and out-of-pocket expenditures in connection with the preparation, printing and filing of the Registration Statement on Form 10 and obtaining financing. TAX SHARING AGREEMENT On or prior to the Distribution Date, the Company and Manor Care will enter into the Tax Sharing Agreement for purposes of allocating pre-Distribution tax liabilities among the Company and Manor Care and their respective subsidiaries. In general, Manor Care will be responsible for (i) filing consolidated federal income tax returns for the Manor Care affiliated group and combined or consolidated state tax returns for any group that includes a member of the Manor Care affiliated group, including in each case the Company and its subsidiaries for the periods of time that such companies were members of the applicable group and (ii) paying the taxes relating to such tax returns to the applicable taxing authorities. The Company will reimburse Manor Care for the portion of such taxes that relates to the Company and its subsidiaries, as determined based on their hypothetical separate company income tax liabilities. In addition, the Company will assume liability for all taxes payable by the Company or by Manor Care in the event the Distribution is determined not be tax free for federal income tax purposes. Manor Care and the Company have agreed to cooperate with each other, and to share information, in preparing such tax returns and in dealing with other tax matters. EMPLOYEE BENEFITS ALLOCATION AGREEMENT On or prior to the Distribution Date, the Company and Manor Care will enter into an Employee Benefits and Other Employment Matters Allocation Agreement (the "Employee Benefits Allocation Agreement"). The Employee Benefits Allocation Agreement provides for the allocation subsequent to the Distribution of employee benefits, as they relate to employees who remain employed by Manor Care or its subsidiaries 14 19 ("Manor Care Employees") after the Distribution and employees who are employed by the Company after the Distribution ("Company Employees"). During the period beginning on the Distribution Date and ending on December 31, 1996, the Company shall pay to Manor Care, on a monthly basis, a payment equal to 2.1% of the payroll for all Company Employees. In consideration therefor, during such period, Manor Care will assume responsibility for all funding obligations and current plan year matching contributions attributable to certain retirement and savings plans specified in the Employee Benefits Allocation Agreement. During the same period, the Company will also pay to Manor Care a monthly fee for each Company Employee receiving services and benefits under a Manor Care medical plan. Pursuant to the Employee Benefits Allocation Agreement, Manor Care will continue sponsorship of the various Manor Care profit sharing plans, retirement plans, stock plans and health and welfare plans with respect to Manor Care Employees. The Company will establish a number of plans which will allow the Company to provide to its employees substantially the same benefits currently provided to them as employees of Manor Care. With respect to each Manor Care profit sharing and retirement plan, Manor Care shall transfer to the Company, as soon as practicable after the Distribution Date, an amount representing the present value of the full accrued benefit of all Company Employees who had earned a benefit under any such Manor Care plan. The Employee Benefits Allocation Agreement provides for cross-guarantees between the Company and Manor Care with respect to the payment of benefits under certain plans and for cross-indemnification with respect to pre-Distribution employment-related claims. The Employee Benefits Allocation Agreement also provides for the adjustment of outstanding stock options. On the Distribution Date (i) each Manor Care Employee holding a nonqualified Manor Care stock option or an incentive stock option to purchase Manor Care Common Stock will receive for each such option a conversion award consisting of an option to purchase Manor Care Common Stock, with the number of shares that may be acquired and the option price adjusted pursuant to a formula designed to preserve the financial value of the options and (ii) each Company Employee holding a nonqualified Manor Care stock option or an incentive stock option to purchase Manor Care Common Stock will receive for each such option a conversion award consisting of an option to purchase Company Common Stock, with the number of shares that may be acquired and the option price adjusted pursuant to a formula designed to preserve the financial value of the options. Certain employees holding nonvested nonqualified options to acquire Manor Care Common Stock may make a one-time election with respect to such nonvested nonqualified options to (1) receive a conversion award that relates exclusively to nonvested nonqualified options to acquire the common stock of the company by which he or she will be employed after the Distribution Date or (2) receive a conversion award with respect to which one-half relates nonvested nonqualified options to acquire to the common stock of the company by which he or she will be employed after the Distribution Date and one-half is proportionately allocated between nonvested nonqualified options to acquire Manor Care Common Stock and nonvested nonqualified options to acquire Company Common Stock based upon the relative trading values of such common stocks on the Distribution Date. Certain employees holding vested nonqualified options to acquire Manor Care Common Stock may make a one-time election to specify the manner in which such vested nonqualified stock options shall be allocated between a conversion award relating to vested nonqualified stock options to acquire Manor Care Common Stock and vested nonqualified stock options to acquire Company Common Stock. LEASE AGREEMENTS On or prior to the Distribution Date, the Company and Manor Care will enter into a lease agreement with respect to the building complex (the "Complex") in Silver Spring, Maryland at which the Company's principal executive offices are located (the "Silver Spring Lease"). Pursuant to the Silver Spring Lease, the Company will lease from Manor Care for a period of 30 months certain office space (approximately 30% of the Complex initially, with provisions to allow the Company to use additional square footage as needed) at a monthly rental rate equal to one-twelfth of the operating expenses (as defined therein) of the Complex net of third party rental income paid to Manor Care by other tenants of the Complex, less a pro rata portion of the operating expenses attributable to the space occupied by Manor Care (initially approximately 29% of the Complex). At the beginning of each fiscal year following the Distribution Date, Manor Care's occupancy percentage will be redetermined. Operating expenses include all of the costs associated with operating and maintaining the Complex including, without limitation, supplies and materials used to maintain the Complex, 15 20 wages and salaries of employees who operate the Complex, insurance for the Complex, costs of repairs and capital improvements to the Complex, the fees of the property manager (which may be Manor Care), costs and expenses associated with leasing space at the Complex and renovating space rented to tenants, costs of environmental inspection, testing or cleanup, principal and interest payable on indebtedness secured by mortgages against the Complex, or any portion thereof, and charges for utilities, taxes and facilities services. On or prior to the Distribution Date, the Company and Manor Care will also enter into (i) a sublease agreement with respect to certain office space in Gaithersburg, Maryland pursuant to which the Company will be obligated to rent from Manor Care, on terms similar to the Silver Spring Lease, certain additional space as such space becomes available during the 30 month period following the Distribution Date and (ii) a sublease agreement with respect to the Comfort Inn N.W., Pikesville, Maryland, pursuant to which the Company will sublease the property from Manor Care on the same terms and conditions that govern Manor Care's rights and interests under the lease relating to such property. OTHER AGREEMENTS On or prior to the Distribution Date, the Company and Manor Care will enter into certain other agreements that will, as of 12:00 midnight on the Distribution Date, fix the respective responsibilities of Manor Care and the Company regarding the following: the provision by Manor Care of certain corporate services (including administrative, accounting, systems and, for a fixed annual fee of $1.0 million, certain consulting services), the transfer to the Company of certain intellectual property rights, the availability to the Company of certain aircraft owned by Manor Care, the provision by Manor Care of certain risk management services, the procurement by Manor Care of certain products and supplies used in the Lodging Business, and other miscellaneous matters. None of these agreements extends for a period greater than 30 months from the Distribution Date and they are not, either alone or in the aggregate, expected to materially affect the Company or its results of operations. FINANCING THE MANOR CARE LOAN AGREEMENT It is expected that on or prior to the Distribution Date, the Company and a subsidiary of Manor Care will enter into a loan agreement (the "Loan Agreement"), which shall govern the repayment by the Company of an aggregate of $225.7 million previously advanced to the Company by Manor Care. The Loan Agreement will contain a number of covenants that will, among other things, restrict the ability of the Company and its subsidiaries to make certain investments, incur debt, change its line of business, dispose of assets, create liens, sell receivables, enter into transactions with affiliates and otherwise restrict certain corporate activities. The Loan Agreement will also restrict the Company's ability to pay dividends. In addition, the Loan Agreement will contain, among other financial covenants, requirements that the Company maintain specified financial ratios, including maximum leverage and minimum interest coverage. Interest on the amount of the loan will be payable semiannually at a rate of 9% per annum. The loan will mature on , 1999 and may be prepaid in whole or in part, together with accrued interest, without penalty, at the option of the Company. The Company will be required to prepay the loan with the proceeds from the monetization of Company-owned hotels. CREDIT FACILITY The Company currently is negotiating a commitment from a bank lender pursuant to which such lender, together with other financial institutions, will, from and after the Distribution Date, provide the Company with a revolving credit facility in an aggregate principal amount of $100.0 million (the "Credit Facility"). The Credit Facility will have a maturity of three years, subject to extension, at the request of the Company, for up to two additional periods of one year each. A portion of the Credit Facility not in excess of $25.0 million shall be available for the issuance of letters of credit. Upon consummation of the Distribution, approximately $50.0 million will be drawn by the Company and used to refinance an equivalent amount borrowed by the Lodging 16 21 Business under Manor Care's credit facility. The remaining availability under the Credit Facility will be used for working capital and general corporate purposes. The Credit Facility will contain a number of covenants that will, among other things, restrict the ability of the Company and its subsidiaries to make certain investments, incur debt, change its line of business, dispose of assets, create liens, sell receivables, enter into transactions with affiliates and otherwise restrict certain corporate activities. The Credit Facility will also restrict the Company's ability to pay dividends. In addition, the Credit Facility will contain, among other financial covenants, requirements that the Company maintain specified financial ratios, including maximum leverage and minimum interest coverage. 17 22 CAPITALIZATION The following table sets forth the unaudited combined capitalization of the Company as of May 31, 1996. This data should be read in conjunction with the Company's financial statements and the notes thereto that are included elsewhere in this Information Statement.
MAY 31, 1996 -------------- (IN THOUSANDS) Debt (including current portion) Mortgage loans and other long term debt.............................. $ 69,138 Notes payable to Parent.............................................. 225,723 -------- Total debt................................................... 294,861 Equity................................................................. 147,559 -------- Total capitalization......................................... $442,420 ========
DIVIDEND POLICY It is currently contemplated that following the Distribution, the Company will not pay cash dividends on the Shares. The payment of dividends, if any, in the future will be a business decision to be made at the discretion of the Board of Directors of the Company from time to time based on the Company's earnings and financial position and such other considerations as the Board of Directors of the Company considers relevant. In addition, the Loan Agreement and the Credit Facility will restrict the Company's ability to pay dividends. See "Financing." 18 23 SELECTED HISTORICAL FINANCIAL DATA The following selected combined financial data of the Company and its subsidiaries should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Combined Financial Statements and related notes included elsewhere herein. The income statement and balance sheet data for the fiscal years ended May 31, 1993, 1994, 1995 and 1996 are derived from the audited combined financial statements of the Company.
YEAR ENDED MAY 31, --------------------------------------------------------- 1992 1993 1994 1995 1996 ----------- -------- -------- -------- -------- (UNAUDITED) (IN THOUSANDS) STATEMENT OF INCOME DATA Revenues Franchise....................................... $125,347 $137,346 $165,581 $188,021 $219,164 Hotel operations................................ 34,878 41,361 74,183 114,514 155,709 -------- -------- -------- -------- -------- Total revenues........................... 160,225 178,707 239,764 302,535 374,873 -------- -------- -------- -------- -------- Operating expenses Franchise marketing............................. 33,772 37,567 45,373 45,510 49,658 Franchise reservations.......................... 23,261 22,941 26,685 28,738 35,677 Hotel operations................................ 20,432 35,255 60,062 84,711 106,120 Selling, general and administrative expenses.... 45,949 44,745 57,081 69,676 83,267 Depreciation and amortization................... 12,924 14,605 17,521 21,841 26,026 Provision for asset impairment and restructuring................................. -- -- -- -- 33,335(a) -------- -------- -------- -------- -------- Total operating expenses................. 136,338 155,113 206,722 250,476 334,083 -------- -------- -------- -------- -------- Income before other expenses and income taxes..... 23,887 23,594 33,042 52,059 40,790 -------- -------- -------- -------- -------- Other expenses Interest expense on notes payable to Parent..... -- 7,083 10,665 15,492 19,673 Minority interest............................... 1,004 900 1,476 2,200 1,532 Other interest and other expenses, net................................. 1,441 2,177 3,223 4,412 3,727 -------- -------- -------- -------- -------- Total other expenses..................... 2,445 10,160 15,364 22,104 24,932 -------- -------- -------- -------- -------- Income before income taxes........................ 21,442 13,434 17,678 29,955 15,858 Income taxes...................................... 8,660 5,780 8,019 13,144 7,400 -------- -------- -------- -------- -------- Net income........................................ $ 12,782 $ 7,654 $ 9,659 $ 16,811 $ 8,458 ======== ======== ======== ======== ======== BALANCE SHEET DATA Total assets...................................... $194,078 $250,371 $303,158 $391,475 $491,304 Notes payable to Parent........................... -- $ 78,700 $147,061 $198,522 $225,723 Total debt........................................ $ 20,902 $129,670 $200,875 $251,191 $294,861 Total liabilities................................. $ 50,313 $159,624 $247,950 $325,646 $343,745 Total investments and advances from Parent........ $143,765 $ 90,747 $ 55,208 $ 65,829 $147,559
- --------------- (a) The Company recorded a charge of $28.1 million for impairment of long-lived assets associated primarily with the Company's European operations. Additionally, the Company recorded a charge of $5.2 million related to certain restructuring costs, including severance and employee benefit plan restructuring costs, directly associated with the Distribution. 19 24 PRO FORMA FINANCIAL DATA The following unaudited pro forma combined statements of income of the Company give effect to (i) the Distribution and related transactions and (ii) the acquisition by the Company of an aggregate of 16 hotels during fiscal year 1996 (the "1996 Acquisitions"), as if the Distribution and related transactions and the 1996 Acquisitions had occurred on June 1, 1995. The pro forma financial data are provided for information purposes only and do not purport to be indicative of the results that actually would have been obtained if the Distribution and related transactions and the 1996 Acquisitions had been effected on the date indicated or of those results that may be obtained in the future. The pro forma combined statement of income is based on preliminary estimates. The actual recording of the transactions will be based on actual costs. Accordingly, the actual recording of the Distribution and related transactions and the 1996 Acquisitions can be expected to differ from these pro forma financial statements. No pro forma balance sheet is presented as there were no pro forma adjustments to the historical balance sheet. PRO FORMA COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED MAY 31, 1996
DISTRIBUTION ACQUISITIONS HISTORICAL ADJUSTMENTS(a) ADJUSTMENTS(b) PRO FORMA ---------- -------------- -------------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues Franchise.................................. $ 219,164 $ 219,164 Hotel operations........................... 155,709 $ 12,946 168,655 -------- -------- -------- Total revenues..................... 374,873 12,946 387,819 -------- -------- -------- Operating expenses Franchise marketing........................ 49,658 49,658 Franchise reservations..................... 35,677 35,677 Hotel operations........................... 106,120 9,676 115,796 Selling, general and administrative expenses................................ 83,267 $ 4,100(c) 90(d) 324 87,781 Depreciation and amortization.............. 26,026 1,688 27,714 Provision for asset impairment and restructuring........................... 33,335 33,335 -------- ------- -------- -------- Total operating expenses........... 334,083 4,190 11,688 349,961 -------- ------- -------- -------- Income before other expenses and income taxes...................................... 40,790 (4,190) 1,258 37,858 -------- ------- -------- -------- Other expenses Interest expense on notes payable to Parent.................................. 19,673 666 20,339 Minority interest.......................... 1,532 (1,532)(e) -- Other interest and other expenses.......... 3,727 3,727 -------- ------- -------- -------- Total other expenses............... 24,932 (1,532) 666 24,066 -------- ------- -------- -------- Income before income taxes................... 15,858 (2,658) 592 13,792 Income taxes................................. 7,400 (1,249)(f) 278 6,429 -------- ------- -------- -------- Net income................................... $ 8,458 $ (1,409) $ 314 $ 7,363 ======== ======= ======== ======== Net income per share......................... $ 0.12(g) ========
- --------------- (a) Reflects the effect of the Distribution and related transactions. (b) Reflects the incremental impact of the 1996 Acquisitions. (c) Reflects the net additional costs associated with staffing of accounting, finance, cash management, risk management, human resources and legal personnel, directors' costs, incremental rental costs and the payment of certain consulting fees to Manor Care. (d) Reflects the estimated cost of the guarantee fee to be paid to Manor Care. (e) Reflects the elimination of minority interest associated with the purchase of minority equity. (f) Reflects tax benefits at the Company's effective tax rate of 47% related to deduction of incremental costs per note (c). (g) Pro forma income per share is computed by dividing pro forma net income by the pro forma weighted average number of outstanding common shares, aggregating 62.6 million in 1996. The pro forma weighted average number of outstanding common shares is based on Manor Care's weighted average number of outstanding common shares at May 31, 1996. 20 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS On March 7, 1996, Manor Care announced the Distribution. The Distribution will separate the lodging and healthcare businesses of Manor Care into two public corporations. As a result of the announced Distribution, Manor Care's historical financial statements have been restated to report the Lodging Business as discontinued operations. Included herein are the historical results of operations of the Lodging Business for the years ended May 31, 1996, 1995, and 1994 as if it had been a separate entity for all periods presented. Upon completion of the Distribution, the operations of the Company will consist principally of the hotel franchise operations and the owned and managed hotel operations formerly conducted by Manor Care directly or through Manor Care's subsidiaries. The Distribution will result in the division of certain of Manor Care's existing corporate functions between the two resulting entities. Historically, Manor Care allocated to its operating units all corporate overhead expenses specifically identified with such units' operations. These allocations will be discontinued after the Distribution and responsibility for these support functions will be assumed by the Company. The Company will establish its own accounting, finance, cash management, risk management, human resources and legal departments separate from Manor Care's. Accordingly, selling, general and administrative expenses in the historical financial statements may not be indicative of such costs in the future. In addition, the Lodging Business' historical operating results do not reflect any estimated incremental costs expected to be incurred by the Company to support its operations as a stand-alone entity after the Distribution. See "Pro Forma Financial Data." The principal factors that affect the Company's results are: growth in the number of hotels; occupancies and room rates achieved by the Company's brands; the number and relative mix of owned, managed and franchised hotels; and the Company's ability to manage costs. The number of rooms at franchised properties and occupancies and room rates significantly affect the Company's results because franchise royalty fees are based upon room revenues at franchised hotels. Increases in franchise and management fee revenues have a disproportionate impact on the Company's operating margin due to the lower incremental costs associated with these revenues. COMPARISON OF FISCAL YEAR RESULTS Net income was $8.5 million for fiscal year 1996, a decrease of $8.4 million, or 49.7%, compared to fiscal year 1995. In fiscal year 1995, net income increased $7.2 million, or 74.0%, compared to fiscal year 1994. Net income in fiscal year 1996 includes a charge of $33.3 million relating to asset impairment and restructuring charges. Revenues increased $72.3 million, or 23.9%, to $374.9 million in fiscal year 1996, while operating expenses increased $83.6 million, or 33.4%, to $334.1 million, resulting in an $11.3 million, or 21.7%, decrease in operating profits. This compares to an increase of $62.8 million, or 26.2%, in revenues for fiscal year 1995 and an increase of $43.8 million, or 21.2%, in expenses for fiscal year 1995. The Company's franchise revenues for fiscal years 1996, 1995 and 1994 increased $31.1 million, or 16.6%, $22.4 million, or 13.6%, and $28.2 million, or 20.5%, respectively. Franchise revenues include base royalty fees, marketing fund assessments and fees charged for utilization of the Company's centralized hotel reservation system. These fees and assessments are generally calculated based on a percentage of the franchised hotels total revenues and reservation call volume. The increases in franchise revenues were principally the result of fees generated from franchisees. In fiscal year 1996, increases in franchise fees were primarily attributable to increases in domestic royalties of $10.6 million, increases in reservation fees of $7.5 million and increases in marketing fees of $4.5 million. In fiscal year 1995, increases in franchise fees were primarily attributable to increases in domestic royalties of $9.1 million, reservation fees of $3.0 million and marketing fees of $1.1 million. In fiscal year 1994, increases in franchise fees were primarily attributable to increases in domestic royalties of $6.3 million, reservation fees of $4.6 million and marketing fees of $6.3 million. The remaining portion of the increase for each fiscal year relates to European operations and other international revenues. Revenues at franchise hotels increased as a result of increased average daily room rates and average actual royalty rates. Average daily room rates of domestic franchise hotels increased by 21 26 approximately 5.0% for fiscal year 1996 and 3.3% for fiscal year 1995. Average actual royalty rates of domestic franchise hotels were 3.5%, 3.2% and 3.1% in fiscal 1996, 1995 and 1994, respectively. Increased daily room rates of the domestic franchise hotels resulted from both general strengthening in lodging industry fundamentals and national and local marketing efforts provided by the Company to franchisees. Average occupancies remained constant at 63.8% in fiscal year 1996 and 1995. In fiscal year 1994, average occupancies were 62.2%. The Company's hotel operations revenues for fiscal years 1996, 1995 and 1994 increased $41.2 million, or 36.0%, $40.3 million, or 54.4%, and $32.8 million, or 79.2%, respectively. The increases in revenue were principally the result of additional room capacity achieved through hotel acquisitions completed during fiscal years 1993 through 1996. During this period, the Company purchased a total of 52 hotels containing over 7,485 rooms. Overall average occupancies were 64.8% in fiscal year 1996 compared to 64.1% in fiscal year 1995 and 60.4% in fiscal year 1994. Overall average daily room rates increased 8.0% from fiscal year 1995 to fiscal year 1996 and 5.0% from fiscal year 1994 to fiscal year 1995. These occupancy and rate increases were the result of marketing efforts in both new and existing markets as well as a general strengthening of lodging industry fundamentals. Increases in food and beverage sales of $3.2 million and $3.1 million in fiscal years 1996 and 1995, respectively, also contributed to revenue growth. Franchise marketing expenses increased 9.1% from fiscal year 1995 to fiscal year 1996 and remained flat from fiscal year 1994 to fiscal year 1995. These increases in expenses were offset by corresponding increases in marketing fees charged to the Company's franchise hotels. Franchise reservation expenses increased 24.2% and 7.7% in fiscal years 1996 and 1995 from the prior fiscal years, respectively. Increases in reservation expenses relate primarily to growth in labor costs (approximately 36% of the increase) and systems maintenance costs (approximately 36% of the increase) stemming from increased reservation services provided to the Company's franchisees and their customers. Call volume related to reservation sales for franchised hotels was 18.1 million, 16.6 million and 15.0 million for fiscal years 1996, 1995 and 1994, respectively. These increases in expenses were offset by corresponding increases in reservation fees charged to the Company's franchise hotels. Hotel operating expenses increased 25.3% and 41.0% for fiscal years 1996 and 1995, respectively, of which approximately 3.0%, and 4.0%, respectively, related to food and beverage costs. Increases in hotel operating expenses resulted, principally from the addition of hotels. Hotel operating margins increased to 31.9% in fiscal year 1996 from 26.0% in fiscal year 1995 and 19% in fiscal year 1994, as marketing efforts enhanced occupancies in the newly renovated and repositioned acquired hotels. Selling, general and administrative expenses increased $13.6 million, or 19.5%, for fiscal year 1996 and $12.6 million, or 22.1%, for fiscal year 1995 compared to the prior years. As a percent of total revenues, selling, general and administrative expenses declined to 22.2% in fiscal year 1996 from 23.0% in fiscal year 1995 and 23.8% in fiscal year 1994. Selling, general and administrative expenses include the cost of product sales to franchisees made through the Company's group purchasing program for franchisees. Increases in selling, general and administrative expenses principally resulted from higher cost of sales on increased product sales volume. Cost of product sales was $20.7 million, $13.9 million and $12.0 million for fiscal years 1996, 1995 and 1994, respectively. The remaining increases in selling, general and administrative expenses were due primarily to additional general and administrative costs associated with the Company's acquired domestic properties and growth in the Company's European lodging business. Management expects that, after the Distribution, selling, general and administrative expenses will increase due to additional costs associated with staffing of accounting, finance, cash management, risk management, human resources and legal personnel, directors' costs, incremental rental costs and the payment of certain consulting fees to Manor Care. Management currently estimates a net increase of approximately $4.1 million. In fiscal year 1996, the Company recorded a charge against earnings of $33.3 million relating to impairment of certain long-lived assets and restructuring costs. The most significant components of the charge related to impairment of assets associated with the Company's European operations and certain restructuring costs, including severance and employee benefit plan restructuring costs, directly associated with the Distribution. During fiscal year 1996, in connection with the Company's equity investment in Friendly Hotels, PLC, the Company restructured its European operations to focus more specifically on selected geographic 22 27 markets. The Company performed a review of its European operations and determined that certain assets associated with these operations were impaired. These assets relate primarily to European properties opened or acquired in fiscal years 1993 and 1994. The Company's experience shows that newly opened or acquired properties require up to three years to reach stabilized operating levels. Operating results at the affected properties have not improved as expected over the three year period. The amount of the impairment charge was measured in accordance with the Company's policy. See the Combined Financial Statements and related notes included elsewhere herein. Depreciation and amortization expense increased 19.2% in fiscal year 1996 to $26.0 million. In fiscal year 1995, depreciation and amortization expense increased 24.7%. Increases were due to acquisitions and renovation of the 52 hotels acquired from fiscal years 1993 through 1996. Interest expense on notes payable to Parent increased 27.0% in fiscal year 1996 and 45.3% in fiscal year 1995. Other interest expense and other expenses decreased 15.5% in fiscal year 1996 and increased 36.9% in fiscal year 1995. The decrease in other interest expense in fiscal year 1996 related to the payoff of a third party financed mortgage on a hotel property, as well as regularly scheduled principal reductions on other third party financing. The increases from fiscal year 1994 to fiscal year 1995 were principally due to borrowings to finance the acquisition of the 36 acquired hotels and the acquisition of the Resthotel Primevere hotel chain. The majority of Resthotel Primevere's operations are franchise related and located within France. LIQUIDITY AND CAPITAL RESOURCES As of May 31, 1996 and May 31, 1995, notes payable to Parent by the Company totaling $225.7 million and $198.5 million, respectively, were outstanding. The notes are due three years from the Distribution Date. Interest is charged at an annual rate of 9% on the indebtedness. The notes payable to Parent are expected to be repaid with the proceeds from the planned monetization of the Company's owned hotels or third party financing. Historically, all cash received by the Company has been deposited in or combined with Manor Care's corporate funds as part of Manor Care's cash management system. Following the Distribution, the Company will maintain its own cash balances and will implement an internal cash management system. In addition, the Company expects to have access to a revolving credit facility and is currently negotiating the terms thereof with potential bank lenders. See "Financing -- Credit Facility." Management believes cash flows from operations, third party financing sources and the proceeds from the planned monetization of the Company's owned hotels will be adequate to support on-going operations and meet debt service requirements for the foreseeable future. If the Company is unable to successfully implement its monetization strategy with respect to Company-owned hotels, the Company will need to secure additional sources of financing to repay the Loan Agreement on , 1999. Net cash provided by operating activities for fiscal year 1996 was $54.7 million, an increase of 14.3% from the prior fiscal year. Net cash provided by operating activities for fiscal year 1995 was $47.9 million, an increase of 7% from the prior fiscal year. The Company's working capital ratio at May 31, 1996 and May 31, 1995 was 0.8 and 0.4, respectively. The Company attempts to minimize its investment in net current assets. Historically, the Company has been assured adequate financing through Manor Care to meet seasonal fluctuations in working capital requirements. Subsequent to the Distribution, the Company will utilize its revolving credit facility to meet seasonal fluctuations in working capital requirements. Investment in property and equipment includes routine capital expenditures for renovation and maintenance of the Company's owned hotels, as well as new developments and enhancements of reservations and finance systems relating to franchise operations. During the fiscal year ended May 31, 1996, the Company purchased 16 operating hotels for $49.6 million. During the fiscal year ended May 31, 1995, the Company purchased 16 operating hotels for $59.8 million. The Company plans capital expenditures for development of Sleep Inns and MainStay Suites of $34.0 million and $68.6 million in fiscal years 1997 and 1998, respectively. These amounts include expected capital expenditures for the construction of 10 Sleep Inns and 12 MainStay Suites over the next two fiscal years. Planned capital expenditures for routine renovation and maintenance of existing properties are $14.7 million and $16.3 million for fiscal years 1997 and 1998, respectively. Additionally, the Company plans capital 23 28 expenditures of approximately $8.0 million over the next two fiscal years for significant system enhancements. Future capital expenditures will be financed with cash flow from operations, proceeds from the monetization of the Company's owned hotels or third party financing. Long term debt and notes payable to Parent totaled $294.2 million at May 31, 1996 compared to $250.6 million at May 31, 1995. Notes payable to Parent totaling $225.7 million are to be repaid over a three year period from the Distribution Date. The increase in long term debt and notes payable to Parent is mainly attributable to the Company's acquisition of 16 operating hotels in fiscal year 1996. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Company is required to adopt SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," no later than fiscal year 1997. The Company's current policy is to regularly review the recoverability of the net carrying value of its long-lived assets and make adjustments accordingly. The adoption of SFAS No. 121 is not expected to have a material impact on the Company's financial statements. The Company is required to adopt SFAS No. 123, "Accounting for Stock-Based Compensation," no later than fiscal year 1997. Management expects to adopt SFAS No. 123 utilizing the method which provides for disclosure of the impact of stock-based compensation grants. 24 29 BUSINESS GENERAL The Company is a leading international hotel franchisor and a major owner and manager of hotel properties. Both franchise and owned and managed hotel properties principally operate under one of the Company's brand names: Comfort, Quality, Clarion, Sleep, Rodeway, and Econo Lodge. In addition, the Company recently introduced a new brand, MainStay Suites. For the nine months ended May 31, 1996, hotel franchising contributed 58.5% of the Company's revenues and 73.0% of the Company's gross profits, while hotel ownership and management contributed the remaining 41.5% of revenues and 27.0% of gross profits. The Company's franchise operations and owned and managed hotel operations have experienced significant growth in revenues and profitability over the last few years. The Company's compound annual growth rate since fiscal year 1991 was 20.1% for revenues and 21.8% for net income before unusual items. For the fiscal year ended May 31, 1996 total revenues and net income were $374.9 million and $8.5 million, respectively. Excluding unusual items net income for the period was $28.6 million. FRANCHISE OPERATIONS The Company is one of the world's largest franchisors of hotels with 3,052 properties open and operating in 30 countries at May 31, 1996. At May 31, 1996, another 716 franchise properties with a total of 63,785 rooms were under development. As a franchisor, the Company licences hotel operators to use the Company's brand names and provides to these hotel operators products and services designed to increase their revenues and profitability. Key products and services provided include nationally recognized marketing and advertising programs, access to a reservation system that delivers business to the franchisees' hotels, access to innovative products and services developed by the Company and other support services such as training programs, purchasing discounts, operating manuals, quality standards and inspections. In return for the use of the Company's brand names and access to the Company's products and services, franchisees pay to the Company fees that are generally based on a percentage of the franchise hotels' gross room revenues. OWNED AND MANAGED OPERATIONS In addition to acting as franchisor, the Company owns and manages hotels. At May 31, 1996, the Company owned and managed, under its six principal brand names, 79 hotels in 25 states, as well as in Germany, France and England. To take advantage of a recovering lodging industry, the Company over the past few years has pursued a strategy of acquiring domestic hotel properties at prices below their replacement cost and increasing their value through the investment of capital to improve the physical site and the installation of professional management and marketing teams to operate the renovated properties. Since June 1992, the Company has spent approximately $242.7 million to buy and renovate 52 hotel properties. The Company's strategy for its owned and managed operations is to monetize its capital investment in Company-owned hotels at values that reflect their improved operating performance. The Company is exploring a variety of transactions including, among others, asset securitization, sale/leasebacks, joint ventures with third parties, debt financing and asset divestitures. The Company intends to retain management and franchise agreements relating to these properties. THE LODGING INDUSTRY As of June 1996, there are approximately 3.3 million hotel rooms in the United States in hotels/motels containing twenty or more rooms. Of those rooms, approximately 1.2 million rooms are not affiliated with a national or regional brand, while the remaining approximately 2.1 million rooms are affiliated with a brand either through franchise or the ownership/management of a national or regional chain. During the late 1980s, the industry added approximately 500,000 hotel rooms to its inventory due largely to a favorable hotel lending environment, the ability of hotel operators to regularly increase room rates and the deductibility of passive tax losses, which encouraged hotel development. As a result, the lodging industry saw an oversupply of rooms and a decrease in industry performance. The lodging industry in recent years has demonstrated a recovery, based on year-to-year increases in room revenues, occupancy rates, revenue per available room ("RevPAR"), and lodging industry profitability. RevPAR is calculated by multiplying the percentage of occupied rooms by the average daily room rate charged. Since 1993, the lodging industry has been able to increase its average daily rate ("ADR") at a pace 25 30 faster than the increase in the Consumer Price Index ("CPI"), a common measure of inflation published by the US Department of Labor. Smith Travel Research's estimates indicate that occupancy rates in 1996 will increase to 66.4% from 65.5% in 1995, in part because of increases in room demand attributable to the 1996 Summer Olympics, the 1996 national political campaigns and conventions, and a continued improvement in the national economy. The following chart demonstrates the recent trends: THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991
INCREASE IN AVERAGE ROOM DAILY INCREASE INCREASE REVENUE PER REVENUE (ROOM) IN ADR IN CPI AVAILABLE NEW VERSUS OCCUPANCY RATES VERSUS VERSUS ROOM PROFITS ROOMS YEAR PRIOR YEAR RATES (ADR) PRIOR YEAR PRIOR YEAR (REVPAR) (IN BILLIONS) ADDED - -------------- ----------- --------- ------- ---------- ---------- ----------- ------------- -------- 1992.......... N/A 62.1% $59.65 N/A 2.9% $ 37.04 break-even 34,000 1993.......... 6.3% 63.1% $61.30 2.8% 2.7% $ 38.68 $2.4 38,000 1994.......... 8.6% 64.7% $64.24 4.8% 2.7% $ 41.56 $5.5 44,000 1995.......... 7.9% 65.5% $67.34 4.8% 2.9% $ 44.11 $8.5 56,000 1996*......... N/A 66.4% $71.00 5.4% 2.9% $ 46.68 N/A 60,000 - 70,000
- --------------- Source: Smith Travel Research * Estimated The Company believes the lodging industry can be divided into three categories: luxury or upscale, middle-market and economy. The Company believes the luxury category generally has room rates above $70 per night, the middle-market category generally has room rates between $46 and $70 per night and the economy category generally has room rates less than $46 per night. Service is a distinguishing characteristic in the lodging industry. Generally there are three levels of service: full-service hotels (which offer food and beverage services, meeting rooms, room service and similar guest services); limited-service hotels (which offer amenities such as swimming pools, continental breakfast, or similar services); and all-suites hotels (which usually have limited public areas, but offer guests two rooms or one room with distinct areas, and which may or may not offer food and beverage services). The Company's Econo Lodge, Rodeway and Sleep brands compete primarily in the limited-service economy market; the Company's Comfort and Quality brands compete primarily in the limited-service middle-market; the Company's Clarion brand competes primarily in the full-service upscale market; and the Company's MainStay Suites brand will compete primarily in the all-suites middle-market. New hotels opened in recent years typically have been limited service hotels, as limited-service hotels are less costly to develop, enjoy higher gross margins, and tend to have better access to financing. These hotels typically operate in the economy and middle-market categories and are located in suburban or highway locations. From 1993 to 1996, the average room count in new hotels declined from 123 to 80, primarily because hotel developers found it difficult to obtain financing of more than $3 million from their primary lending sources (local banks and Small Business Administration guaranteed loan programs). In recent years, operators of hotels not owned or managed by major lodging companies have increasingly joined national hotel franchise chains as a means of remaining competitive with hotels owned by or affiliated with national lodging companies. Because hotels typically operate with high fixed costs, increases in revenues generated by affiliation with a franchise lodging chain can improve a hotel's financial performance. Of approximately 933 hotel properties that changed their affiliation in 1995, 77% converted from independent status to affiliation with a chain or converted from one chain to another, while only 23% canceled or were required to cancel their chain affiliation. The share of US hotel rooms affiliated with a chain was approximately 63% in 1995. The shift to chain membership has been most pronounced among hotels in the same categories as the Company, i.e., the economy and middle-market categories. In 1995, 53% of all conversions to a chain from independent status or from another chain were in the economy category, 37% were in the middle-market 26 31 category, and 10% were in the upscale category. Often by affiliating with a middle-market or economy brand, a hotel operator can reposition the hotel property in the price category best suited to its market. The large franchise chains, including the Company, provide a number of services to hotel operators to improve the financial performance of their properties, including national reservation systems, marketing and advertising programs and direct sales programs. The Company believes that national franchise chains with a larger number of hotels enjoy greater brand awareness among potential guests than those with fewer numbers of hotels, and that greater brand awareness can increase the desirability of a hotel to its potential guests. The Company believes that hotel operators choose lodging franchisors based primarily on the perceived value and quality of each franchisor's brand and its services, and the extent to which affiliation with that franchisor may increase the franchisee's reservations and profits. FRANCHISE BUSINESS ECONOMICS OF FRANCHISE BUSINESS The fee and cost structure of the Company's franchise business provides significant opportunities for the Company to increase profits by increasing the number of franchised properties. Hotel franchisors such as the Company derive substantially all of their revenue from annual franchise fees. Franchise fees are comprised of an initial fee and ongoing royalty and marketing and reservation fees charged by the franchisor as a percentage of the franchisee's gross room revenues. The royalty portion of the franchise fee is intended to cover the operating expenses of the franchisor, such as expenses incurred in quality assurance, administrative support and other franchise services and to provide the franchisor with operating profits. The marketing and reservation portion of the franchise fee is intended to reimburse the franchisor for the expenses associated with providing such franchise services as the central reservation system and national marketing and media advertising. Much of the variable costs associated with the Company's activities are reimbursed by the franchisees through the marketing and reservation fees. The Company's existing base of franchises more than covers the fixed cost of the business at its current level so that the variable costs of overhead -- in such areas as quality assurance, franchise services and administration, finance and legal -- represent the bulk of incremental costs associated with the addition of franchisees. Because the variable overhead costs associated with incremental franchise system growth are substantially less than the incremental royalty fees, the Company is able to capture a significant portion of these incremental royalty fees as operating profit. STRATEGY The Company's franchise strategy is based on expanding its franchise system by providing hotel operators with products and services that increase their revenues and profitability, capitalizing on its franchising and marketing expertise through joint marketing programs with preferred vendors and engaging in strategic acquisitions in the lodging, travel-related and other franchise industries. Key components of the Company's franchise strategy include: - GROWTH OF THE COMPANY'S DOMESTIC FRANCHISE SYSTEM. The Company's existing franchisees form a pool of potential buyers and builders of new hotels that may affiliate with one of the Company's brands. Approximately 50% of new franchises sold by the Company in fiscal year 1996 were sold to existing franchisees. The Company believes that its focus on improving the revenues and profitability of its franchisees will allow it to retain these current franchisees and attract new franchisees. During the ten fiscal years ended May 31, 1996, the number of properties in the Company's domestic franchise system increased through acquisition and internal growth to 2,495 properties with 214,613 rooms, from 599 properties with 69,187 rooms. The Company believes that its operating structure and the services it provides to its franchisees will enable the Company to attract new hotels to its franchise system. The following are the principal components of the Company's franchising system and services: RESERVATION SYSTEM -- The Company maintains a reservations system that delivers customers to franchisees and produces incremental revenues for both franchisees and the Company. 27 32 ADVERTISING CAMPAIGNS -- The Company promotes its brand awareness through nationally recognized advertising campaigns including the long running "celebrity in a suitcase" campaign. PRODUCTS AND SERVICES -- The Company provides its franchisees with access to the Company's products and services. Many of these products and services are tested and developed by the Company in its owned hotels before being adapted to the franchise system. For example, the Company's franchised hotels may offer customized rooms designed to meet the needs of niche markets, such as senior citizens and business travelers. The Company also offers its franchisees innovative food delivery concepts such as Choice Picks food court and K-Minus(SM) Banqueting Kitchens. APPROACH TO FRANCHISING -- The Company's franchising system structure and internal performance measures have been developed to appeal to current and potential franchisees. -- Territorial Protection. Competition from same-brand franchisees within a specific geographic area is limited in order to protect the investments of current and potential franchisees. -- Brand Segmentation. The Company is able to meet the needs of current and potential franchisees across a wide range of market segments by maintaining an array of distinct brands, each with its own marketing and operating strategy. In addition, the Company plans to continue to develop new brands to target high-growth segments of the lodging industry. Brand segmentation enables the Company to franchise multiple properties -- each under a different franchise brand -- in a given geographic area. -- RevPAR Focus. Revenue per available room per day, or RevPAR, is calculated by multiplying the percentage of occupied rooms by the average daily room rate charged. The Company believes that franchisees view RevPAR as the single most important measure of the operational success of their properties. Accordingly, the Company has adopted overall systemwide RevPAR improvement as the key internal measure of performance for the Company and its management in order to better align the goals and objectives of the Company with those of its customers. - INCREASES IN AVERAGE ACTUAL ROYALTY RATES. The Company's average actual royalty rate is determined by analyzing the revenues and royalty rates of individual properties. Each property's royalty rates vary based upon the brand and the age of the contract (with newer contracts generally having higher royalty rates). The Company has increased its average actual royalty rate each year since 1992, and the Company expects to continue to increase its average actual royalty rate as franchise agreements with low royalty fees expire, terminate or are amended. - STRATEGIC DEVELOPMENT OF THE INTERNATIONAL FRANCHISE SYSTEM. During the ten fiscal years ended May 31, 1996, the number of properties in the Company's international franchise system increased to 557 properties with 46,843 rooms, from 46 properties with 4,505 rooms. The Company anticipates further development in its existing international markets in order to increase the number of Choice hotels and to allow for more efficient use of existing financial, marketing and human resources. In other parts of the world, the Company intends to expand in gateway cities which attract international travelers who are familiar with the Company's hotel brands. International development of the Company's brands may be structured in a variety of ways, including development by the Company directly, by master franchisees or by joint ventures. - EXPANSION OF PREFERRED VENDOR PROGRAMS. The Company believes there is significant opportunity to leverage its size and marketing expertise by entering into joint marketing arrangements with national and multinational companies that want to gain exposure to the millions of guests who patronize the Company's franchise hotels each year. In the past, these arrangements have added to the Company's and franchisees' revenues and profits by attracting business to its franchise hotels. The Company has also sought to structure these arrangements to include direct payments to the Company from preferred vendors who wish to capitalize on the Company's marketing reach. Firms that have entered into marketing arrangements with the Company on such terms include AT&T, Pizza Hut, Nortel (formerly Northern Telecom), Alamo Rent-A-Car and CUC Travel. 28 33 - PURSUIT OF SELECTED STRATEGIC INVESTMENTS AND ACQUISITIONS. The Company intends to pursue strategic investments and acquisitions, both in the United States and abroad, of lodging, travel-related and other franchise businesses. The Company believes that such opportunities are significant and that the Company has financial capability sufficient to pursue such opportunities. FRANCHISE SYSTEM The Company's franchise hotels principally operate under one of the Company's brand names: Comfort, Quality, Clarion, Sleep, Rodeway and Econo Lodge. The following table presents key statistics relative to the Company's domestic franchise system over the three fiscal years ended May 31, 1996. COMBINED DOMESTIC FRANCHISE SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ------------------------------- 1994 1995 1996 ------- ------- ------- Number of properties, end of period................. 2,283 2,311 2,495 Number of rooms, end of period...................... 203,019 200,792 214,613 Average royalty rate................................ 3.1% 3.2% 3.5% Average occupancy percentage........................ 62.2% 63.8% 63.8% Average daily (room) rate (ADR)..................... $ 45.63 $ 47.13 $ 49.49 RevPAR*............................................. $ 28.40 $ 30.08 $ 31.60 Royalty fees ($000s)................................ $62,590 $71,665 $82,239
- --------------- * The Company's RevPAR figure for each fiscal year is an average of the RevPAR calculated for each month in the fiscal year. The Company calculates RevPAR each month based on information actually reported by franchisees on a timely basis to the Company. In contrast, Smith Travel Research's monthly RevPAR calculations are periodically updated to reflect information reported after the Company's deadline for the receipt of monthly information. Smith Travel Research's RevPAR calculations also reflect information reported by franchisees directly to Smith Travel Research but not to the Company and Smith Travel Research's estimates of RevPAR for properties that did not report to either the Company or Smith Travel Research at all or for the whole period. Smith Travel Research's calculations of the Company's domestic RevPAR for fiscal years 1994, 1995 and 1996 were $28.87, $30.56 and $32.30, respectively. 29 34 No master franchisee or other franchisee accounted for 10% or more of the Company's total revenues or revenues related to franchise operations during the last three fiscal years. BRAND POSITIONING The Company's hotels are primarily limited-service hotels (offering amenities such as swimming pools and continental breakfast) or limited-to-full service (offering amenities such as food and beverage services, meeting rooms and room service). The following chart summarizes how the Company's brands are positioned in the marketplace. [CHART] COMFORT. Comfort Inns and Comfort Suites hotels offer rooms in the limited-service, middle market category. Comfort Inns and Comfort Suites are targeted to traditional businesses and leisure travelers. Principal competitor brands include Days Inn, Fairfield Inn, Hampton Inn, Holiday Express and LaQuinta. At May 31, 1996, there were 1,340 Comfort Inn properties and 87 Comfort Suite properties with a total of 106,179 and 7,493 rooms, respectively, open and operating worldwide. An additional 198 Comfort Inn properties and 88 Comfort Suite properties with a total of 18,561 and 7,223 rooms, respectively, were under development. Comfort properties are located in the United States and in Australia, the Bahamas, Belgium, Canada, France, Germany, India, Indonesia, Ireland, Italy, Jamaica, Japan, Mexico, Norway, Portugal, Sweden, Switzerland, Thailand, the United Kingdom and Uruguay. The following chart summarizes the Comfort system in the United States: COMFORT DOMESTIC SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ----------------------------------- 1994 1995 1996 ------- ------- ------- Number of properties, end of period................. 935 1,015 1,129 Number of rooms, end of period...................... 82,479 87,551 94,160 Royalty fees ($000s)................................ $31,187 $37,635 $44,657
30 35 QUALITY. Certain Quality Inns and Quality Suites hotels compete in the limited service, middle market category while others compete in the full service, middle market category. Quality Inns and Quality Suites are targeted to traditional business and leisure travelers. Principal competitor brands include Best Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At May 31, 1996, there were 553 Quality Inn properties with a total of 65,693 rooms, and 22 Quality Suites properties with a total of 3,377 rooms open worldwide. An additional 110 Quality Inn properties and 5 Quality Suites properties with a total of 12,382 rooms and 324 rooms, respectively, were under development. Quality properties are located in the United States and in Argentina, Australia, Belgium, Canada, Chile, Denmark, France, Germany, India, Indonesia, Ireland, Italy, Jamaica, Japan, Mexico, New Zealand, Norway, Portugal, Puerto Rico, Russia, Spain, Thailand, the United Kingdom and the United Arab Emirates. The following chart summarizes the Quality system in the United States: QUALITY DOMESTIC SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ------------------------------- 1994 1995 1996 ------- ------- ------- Number of properties, end of period................... 358 341 362 Number of rooms, end of period........................ 45,032 43,281 45,967 Royalty fees ($000s).................................. $14,890 $15,632 $16,606
ECONO LODGE. Econo Lodge hotels operate in the limited-service, economy category of the lodging industry. Econo Lodges are targeted to the senior travel market and rely to a large extent on strong roadside name recognition. Principal competitor brands include Days Inn, Ho-Jo Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red Roof Inn, Super 8 and Travelodge. At May 31, 1996, there were 658 Econo Lodge properties with a total of 43,545 rooms open and operating in the United States and Canada, and an additional 110 properties with a total of 7,863 rooms under development in those two countries. The following chart summarizes the Econo Lodge system in the United States: ECONO LODGE DOMESTIC SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ------------------------------- 1994 1995 1996 ------- ------- ------- Number of properties, end of period................... 677 633 641 Number of rooms, end of period........................ 46,570 42,801 42,726 Royalty fees ($000s).................................. $11,231 $12,021 $12,760
CLARION. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion Suites hotels are full-service properties which operate in the upscale category. Clarion hotels are targeted to traditional business and leisure travelers. Principal competitor brands include Holiday Inn, Holiday Select, Crowne Plaza, Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree. At May 31, 1996, there were 94 Clarion properties with a total of 15,504 rooms open and operating worldwide and an additional 24 properties with a total of 3,783 rooms under development. The properties are located in the United States, and in Anguilla, the Bahamas, Canada, the Cayman Islands, Dominica, France, Germany, Guatemala, Honduras, Indonesia, Ireland, Japan, Mexico, Russia, Thailand and Uruguay. The following chart summarizes the Clarion system in the United States: CLARION DOMESTIC SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ----------------------------- 1994 1995 1996 ------ ------ ------- Number of properties, end of period..................... 65 63 75 Number of rooms, end of period.......................... 12,211 10,420 12,817 Royalty fees ($000s).................................... $2,735 $2,995 $3,602
31 36 RODEWAY. The Rodeway brand competes in the limited-service, economy category and is targeted to the senior travel market. Principal competitor brands include Ho-Jo Inn, Ramada Limited, Red Roof Inn, Budgetel, Shoney's Inn, Super 8 and Motel 6. At May 31, 1996, there were 209 Rodeway Inn properties with a total of 13,098 rooms, open and operating in the United States and Canada, and an additional 41 properties with a total of 2,955 rooms under development in those two countries. The following chart summarizes the Rodeway system in the United States: RODEWAY DOMESTIC SYSTEM(1)
AS OF OR FOR THE YEAR ENDED MAY 31, ------------------------------- 1994 1995 1996 ------ ------ ------- Number of properties, end of period................... 214 208 201 Number of rooms, end of period........................ 13,806 13,067 12,547 Royalty fees ($000s).................................. $1,941 $2,302 $2,506
-------------------- (1) Includes data pertaining to the Friendship Inn(R) system, which is being combined with the Rodeway Inn system. SLEEP. Established in 1988, Sleep Inn is a new-construction hotel brand in the limited-service, economy category. Sleep Inns are targeted to the traditional business and leisure traveler. Principal competitor brands include Days Inn, Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada Inn. At May 31, 1996, there were 89 Sleep Inn properties with a total of 6,567 rooms open and operating worldwide. An additional 139 properties with a total of 10,614 rooms were under development. The properties are located in the United States, Canada and the Cayman Islands. The following chart summarizes the Sleep system in the United States: SLEEP DOMESTIC SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ----------------------------- 1994 1995 1996 ------ ------ ------ Number of properties, end of period..................... 34 51 87 Number of rooms, end of period.......................... 2,921 3,672 6,396 Royalty fees ($000s).................................... $605 $1,080 $2,108
MAINSTAY SUITES. MainStay Suites, the Company's newest hotel brand, is a middle market, extended-stay lodging product targeted to travelers who book hotel rooms for five or more consecutive nights. The first MainStay Suites hotel, which the Company will own and manage, is scheduled to open in Plano, Texas, in October 1996. The MainStay Suites brand is designed to fill the gap between existing upscale and economy extended-stay lodging products. Principal competitors for the brand will include Doubletree's new Candlewood hotels, Marriott's new middle market extended stay concept, TownPlace Suites, as well as competition from all-suite hotel properties and traditional extended stay operators in both the upscale market (Residence Inn, Homewood Suites, Hawthorne Suites and Summerfield Suites) and the economy market (Extended Stay America, Studio Plus and Oakwood). INTERNATIONAL FRANCHISE OPERATIONS The Company's international franchise operations have traditionally been operated as a division separate from its domestic franchise operations. In some cases international master franchisees are not required to separately report royalty results by brand, making brand results on a worldwide basis unavailable. In the past fiscal year, the Company entered into arrangements to enter eight new international markets. At May 31, 1996, Choice had 557 franchise hotels open in 29 countries outside the United States. The following table 32 37 illustrates the growth of the Company's international franchise system over the three fiscal years ended May 31, 1996: COMBINED INTERNATIONAL FRANCHISE SYSTEM
AS OF OR FOR THE YEAR ENDED MAY 31, ---------------------------- 1994 1995 1996 -------- -------- -------- Number of properties, end of period....................... 430 524 557 Number of rooms, end of period............................ 36,725 44,877 46,843 Royalty fees ($000s)...................................... $ 1,201 $ 1,547 $ 945
EUROPE. Choice is the second-largest international franchised hotel chain in Europe, with 278 hotels open in 13 countries at May 31, 1996. In a move to realign and streamline its European operations, the Company, through its subsidiary, Manor Care Hotels (France) S.A., recently consummated a transaction with Friendly Hotels, PLC ("Friendly") whereby the Company purchased an equity interest for approximately $17 million in Friendly to finance the development of ten new Comfort Inn or Quality Inn hotels in the United Kingdom and Ireland. Additionally, Friendly purchased from the Company a master franchise for the United Kingdom and Ireland. The Company closed its London office as a result of the transaction. The Company's French and German operations are being consolidated into the Company's Paris, France office, which directly operates the Company's business in most of Europe. There are also master franchise arrangements in Scandinavia and Italy. THE MIDDLE EAST. In August 1995, the Company signed a master franchise for Israel. The Company opened its first franchised property in Dubai, United Arab Emirates, in December 1995. At May 31, 1996, this was the only property open in this region. ASIA/PACIFIC. During fiscal year 1996, Company franchisees opened seven hotels in Australia, two in New Zealand, two in India, two in Thailand and four in Indonesia, bringing the total number of properties open in the Asia/Pacific region at May 31, 1996 to 61. CARIBBEAN. The Company's master franchisee had 6 properties open in three Caribbean countries at May 31, 1996. CENTRAL AND SOUTH AMERICA. The Company recently signed master franchise agreements covering Brazil, Uruguay, Paraguay and Argentina. The Company also has master franchisees operating in Guatemala, Chile and Mexico. In total there were 19 open properties in this region at May 31, 1996. CANADA. Choice Hotels Canada (a joint venture with Journey's End Corporation of Belleville, Ontario, Canada ("Journey's End")) is Canada's largest lodging organization with 192 properties open at May 31, 1996. The joint venture, owned 50% by the Company and 50% by Journey's End, was formed in 1993 when Journey's End converted substantially all of its controlled hotels to the Company's brands and the Company contributed its operations in Canada to form Choice Hotels Canada. FRANCHISE SALES The Company markets franchises principally to: (i) developers of hotels, (ii) owners of independent hotels and motels, (iii) owners of hotels affiliated with other franchisors' brands, (iv) its own franchisees, who may own, buy or build other hotels which can be converted to the Company's brands, and (iv) contractors who construct any of the foregoing. In fiscal year 1996, existing franchisees accounted for approximately one-half of the Company's new franchise agreements. In considering hotels for conversion to one of the Company's brands, or sites for development of new hotels, the Company seeks properties in locations which are in close proximity to major highways, airports, tourist attractions and business centers that attract travelers. At May 31, 1996, the Company employed approximately 40 sales directors, each of whom is responsible for a particular region or geographic area. The Company intends to increase its number of regional sales directors in the current fiscal year. Sales directors contact potential franchisees directly and receive compensation based on sales generated. Franchise sales efforts emphasize the benefits of affiliating with one of 33 38 the Company's well-known brand names, the Company's commitment to improving RevPAR, the Company's "celebrity in a suitcase" television advertising campaign (formerly used for the entire Choice family of brands and now used principally for its three largest brands, Comfort, Quality and Econo Lodge), the Company's reservation system, the Company's training and support systems, and the Company's history of growth and profitability. Because it offers brands covering a broad spectrum of the lodging marketplace, the Company is able to offer each prospective franchisee a brand that fits its needs, lessening the chances that the prospective franchisee would need to consider a competing franchise system. During fiscal year 1996, the Company received 794 franchise applications, approved 681 applications, signed 413 franchise agreements and placed 282 new properties into operation in the United States under the Company's brands. Of those placed into operation, 123 were newly constructed hotels. By comparison, during fiscal year 1995, the Company received 741 franchise applications, approved 578 applications, signed 341 franchise agreements and had 212 new US properties come on line. Applications may not result in signed franchise agreements either because an applicant is unable to obtain financing or because the Company and the applicant are unable to agree on the financial terms of the franchise agreement. Because retention of existing franchisees is important to the Company's growth strategy, existing franchisees are offered the right to object to a same-brand property within 15 miles, and are protected from the opening of a same-brand property within a specific distance, generally two to five miles, depending upon the size of the property and the market size. The Company believes that it is the only major franchise company to routinely offer such territorial protection to its franchisees. FRANCHISE AGREEMENTS A franchise agreement grants a franchisee the right to non-exclusive use of the Company's franchise system in the operation of a single hotel at a specified location, typically for a period of twenty (20) years, with certain rights to the franchisee to terminate after 10 or 15 years. When the responsibility for development is sold to a master franchisee, that party has the responsibility to sell to local franchisees the Company's brands and the master franchisee generally must manage the delivery of necessary services (such as quality assurance, reservations and marketing) to support the franchised hotels in the master franchise area. The master franchisee collects the fees paid by the local franchisee and remits an agreed share to the Company. Master franchise agreements generally have a term of at least 10 years. Franchise agreements, other than master franchise agreements, can be terminated by either party prior to the conclusion of their term under certain circumstances, such as at certain anniversaries of the agreement or if a franchisee fails to bring properties into compliance with contractual quality standards within specified periods of time. Early termination options give the Company flexibility in eliminating or re-branding properties which become weak performers for reasons other than contractual failure by the franchisee. Master franchise agreements typically contain provisions permitting the Company to terminate the agreement for failure to meet a specified development schedule. Franchise fees vary among the Company's different brands, but generally are competitive with or slightly below the industry average within their market group. Franchise fees usually have four components: an initial, one-time affiliation fee; a royalty fee; a marketing fee; and a reservation fee. Proceeds from the marketing fee and reservation fee are used exclusively to fund marketing programs and the Company's central reservation system, respectively. Most marketing fees support brand-specific marketing programs, although the Company occasionally contributes a portion of such fees to marketing programs designed to support all of the Company's brands. Royalty fees and affiliation fees are the principal source of profits for the Company. 34 39 Under the terms of the standard franchise agreements, the Company's franchisees are typically required to pay the following initial fees and on-going fees as a percentage of gross room revenues: QUOTED FEES BY BRAND
INITIAL FEE ON-GOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES PER ROOM/ --------------------------------------------------------- BRAND MINIMUM ROYALTY FEES MARKETING FEES RESERVATION FEES ---------------------- ------------ ------------ ------------------- ---------------- Comfort Inn........... $300/$40,000 5.0% 1.3%, plus $.28 per 1.75% room per day Comfort Suites........ $300/$50,000 5.0% 1.3%, plus $.28 per 1.75% room per day Quality Inn........... $300/$40,000 4.0% 1.3%, plus $.28 per 1.75% room per day Quality Suites........ $300/$50,000 4.0% 1.3%, plus $.28 per 1.25% room per day Sleep................. $300/$40,000 4.0% 1.3%, plus $.28 per 1.75% room per day Clarion............... $300/$40,000 2.75% 1.0% 1.25% Econo Lodge........... $250/$25,000 4.0% 3.5%(1) -- MainStay Suites....... $300/$30,000 4.5% 2.5%(1) -- Rodeway Year 1.............. $250/$25,000 3.5% 1.25% 1.25% Year 2.............. -- 3.0% 1.25% 1.25% Year 3.............. -- 3.0% 1.00% 1.00%
- --------------- (1) Fee includes both Marketing and Reservations. The Company has increased its average actual royalty rate in each of the past three years, primarily by raising the royalty fee for Comfort franchisees to 5.0% of annual gross room revenues ("GRR") from 4.0% of GRR in 1993, and by raising the royalty rate for franchisees in the former Friendship franchise system to 3.0% of GRR from 2.0% of GRR in 1991. For the fiscal year ended May 31, 1996, the Company's average actual royalty rate was 3.5%, up from 3.2% for the fiscal year ended May 31, 1995, and up from 3.1% for the fiscal year ended May 31, 1994. The Company believes that its average actual royalty rate will continue to increase as older franchise agreements expire, terminate or are amended. At May 31, 1996, the Company had 2,495 franchise agreements in effect in the United States and 557 franchise agreements in effect in other countries. The average age of the franchise agreements was 5.1 years. Twenty-three of the franchise agreements are scheduled to expire during the five year period of June 1, 1996 through May 31, 2001; however, franchise agreements generally contain early termination provisions. FRANCHISE OPERATIONS The Company's operations are designed to improve RevPAR for the Company's franchisees, as this is the measure of performance that most directly impacts franchisee profitability. It is the Company's belief that by helping its franchisees to become more profitable it will enhance its ability to retain its existing franchisees and attract new franchisees. The key aspects of the Company's franchise operations are: CENTRAL RESERVATION SYSTEM. Approximately 25% of the room nights booked at franchisees' properties are reserved through the toll-free telephone reservation system operated by the Company. The Company's reservation system consists of a computer reservation system known as CHOICE 2001, five reservation centers in North America and several international reservation centers run by the Company or its master franchisees. The CHOICE 2001 system is designed to allow trained operators to match each caller with a Company-branded hotel meeting the caller's needs. It provides an instant data link to the Company's franchised properties as well as to the Amadeus, Galileo, SABRE and Worldspan airline reservation systems thereby facilitating the reservation process for travel agents. 35 40 To more sharply define the market and image for each of its brands, the Company began advertising separate toll-free reservation numbers for all of its brands in fiscal year 1995. The Company allows its reservation agents to cross-sell the Company's hotel brands. If a room in the Choice hotel brand requested by a customer is not available in the location or price range that the customer desires, the agent may offer the customer a room in another Choice brand hotel that meets the customer's needs. The Company believes that cross-selling enables the Company and its franchisees to capture additional business. On-line reports generated by the CHOICE 2001 system enable franchisees to analyze their reservation patterns over time. In addition, the Company provides and is currently improving a yield management product for its franchisees to allow them to improve the management of their mix of rates and occupancy based on current and forecasted demand on a property by property basis. The Company also markets to its franchisees a property management product. Such products are designed to manage the financial and operations information of an individual hotel and improve its efficiency. BRAND NAME MARKETING AND ADVERTISING. The Company's marketing and advertising programs are designed to heighten consumer awareness of the Company's brands. Marketing and advertising efforts are focused primarily in the United States and include national television and radio advertising, print advertising in consumer and trade media and promotional events, including joint marketing promotions with vendors and corporate partners. The Company is recognized for its "celebrity in a suitcase" television advertisements. In fiscal year 1996, the Company began using brand-specific marketing and largely discontinued the strategy of advertising its multiple brands under the Choice umbrella, although it continues to use its "suitcase" ads for its three largest brands, Comfort, Quality and Econo Lodge. The marketing fees generated by these brands are used, in part, to fund a national network television advertising campaign. The Company's smaller hotel brands conduct advertising campaigns that also include cable television, radio and print. The Company conducts numerous marketing programs targeting specific groups, including senior citizens, motorist club members, families, government and military employees, and meeting planners. Other marketing efforts include telemarketing and telesales campaigns, domestic and international trade show programs, publication of group and tour rate directories, direct-mail programs, discounts to holders of preferred credit cards, centralized commissions for travel agents, fly-drive programs in conjunction with major airlines, and twice yearly publication of a Travel and Vacation Directory. Marketing and advertising programs are directed by the Company's Marketing Department, which is headed by a senior vice president. The senior vice president of marketing is assisted by six vice presidents, including a vice president for marketing, promotions and communications. These officers direct an internal staff and also utilize the services of independent advertising agencies. In addition, the Company employs sales personnel at its Silver Spring, Maryland, headquarters and in its Phoenix, Arizona, office. These sales personnel use telemarketing to target specific customer groups, such as potential corporate clients in areas where the Company's franchised hotels are located, the motor coach market, and meeting planners. Most of these sales personnel sell reservations and services for all of the Company's brands, but four are responsible exclusively for the Clarion brand. The Company's regional sales directors work with franchisees to maximize RevPAR. These directors advise franchisees on topics such as how to market their hotels and how to maximize the benefits offered by the Company's reservations system. QUALITY ASSURANCE PROGRAMS. Consistent quality standards are critical to the success of a hotel franchise. The Company has established quality standards for all of its franchised brands which cover housekeeping, maintenance, brand identification and level of services offered. The Company inspects properties for compliance with its quality standards when application is made for admission to the franchise system. The compliance of existing franchisees with quality standards is monitored through scheduled and unannounced Quality Assurance Reviews conducted at least once per year at each 36 41 property. Properties which fail to maintain a minimum score are reinspected on a more frequent basis until deficiencies are cured, or until such properties are terminated. To encourage compliance with quality standards, the Company offers various brand-specific incentives to franchisees who maintain consistent quality standards. Franchisees who fail to meet minimum quality standards may be subject to consequences ranging from written warnings to termination of the franchisee's franchise agreement. The Company believes that a good measure of the quality of a hotel is the rating granted to it by the American Automobile Association ("AAA"). AAA rates hotels based on the quality and range of amenities and service on a scale of one to five diamonds, with five diamonds the highest rating. As of May 1996, AAA has rated 78.5%, 78.4% and 80.2% of the Company's Comfort, Quality and Clarion properties, respectively, located in the United States, Canada, Mexico and the Caribbean. Among such properties 66% of Comfort properties, 66% of Quality properties, and 80% of Clarion properties received three diamonds or better. TRAINING. The Company maintains a training department which conducts mandatory training programs for all franchisees and their employees. The Company also conducts regularly scheduled regional and national training meetings for both property-level staff and managers. Training programs teach franchisees how to take advantage of the Company's reservation system and marketing programs, and fundamental hotel operations such as housekeeping, maintenance, and inventory yield management. Training is conducted by a variety of methods, including group instruction seminars and video programs. The Company is developing an interactive computer-based training system that will train hotel employees at their own pace. Franchisees will be required to purchase hardware to operate the training system, and will use software developed by the Company. RESEARCH AND DEVELOPMENT. The Company seeks to enhance RevPAR by providing to franchisees systems and products that will reduce costs and/or improve their operations. Research and development activity resulted in the launch of three new franchise products in fiscal year 1996, Choice Picks food court, MainStay Suites hotels and K-Minus food service. In January 1996, the Company introduced its MainStay Suites franchise hotel brand, an extended-stay product targeted to travelers who book hotel rooms for five or more consecutive nights. See "-- MainStay Suites." In November 1995, the Company introduced Choice Picks food court, a customized, modular food-service system tailored to the needs of middle-market hotels. Choice Picks food courts offer hotel guests a "choice pick" of nationally known branded food items, such as Nathan's Famous(R) hot dogs, sandwiches made with Healthy Choice(R) deli meats, Pizzeria Uno(R) pizza and calzone, Nestle Toll House(R) cookies and muffins, I Can't Believe It's Yogurt(R) desserts, and Coca-Cola(R) beverages. The typical Choice Picks food court can be operated by as few as two employees, thus providing the properties with lower operating costs than properties with conventional restaurants. Franchisees pay the Company a one-time affiliation fee and monthly royalty fees equal to a percentage of gross revenues on Choice Picks food court sales. Franchisees must buy equipment and food service modules necessary to set up a Choice Picks food court. Beginning in fiscal 1997, the Company intends to market Choice Picks food court to larger hotel operators and other potential customers outside of the Company's franchise system. In November 1995, the Company also began to offer to its franchisees the K-Minus food service system, which eliminates expensive banquet kitchens by outsourcing food preparation and limiting on-site work to assembly and rethermalization. Compared with a traditional banquet operation, the K-Minus food service system saves labor costs and energy. Franchisees who wish to implement the K-Minus system are given design and technical assistance by the Company. The Company receives a one-time technical assistance fee for the provision of these services based on the scope of the project. PURCHASING. The Company's product services department negotiates volume purchases of various products needed by franchisees to run their hotels, including such items as furniture, fixtures, carpets and 37 42 bathroom amenities. The department also helps to ensure consistency in such products across its exclusively new-construction brands, Sleep Inn and MainStay Suites brands. Sales to franchisees by the Company were $20.7 million during fiscal year 1996, up from $13.9 million during fiscal year 1995. DESIGN AND CONSTRUCTION. The Company maintains a design and construction department to assist franchisees in refurbishing, renovating, or constructing their properties prior to or after joining the system. Department personnel assist franchisees in meeting the Company's brand specifications by providing technical expertise and cost-savings suggestions. FINANCIAL ASSISTANCE PROGRAMS. The Company has established programs, primarily with independent lenders, to provide financing assistance to its franchisees and prospective franchisees for hotel refinancing, acquisition, renovation and development. OWNED AND MANAGED LODGING BUSINESS HISTORICAL ACQUISITION STRATEGY To take advantage of a recovering lodging industry, the primary focus of the Company's owned and managed hotel operations (the "Hotel Division") over the past few years has been to acquire domestic hotel properties at prices below their replacement cost and increase their value through (1) the investment of capital to improve the physical site and (2) the installation of professional management and marketing teams to operate the renovated properties. Since June 1992, the Company has spent approximately $242.7 million to buy and renovate 52 hotel properties with 7,485 rooms. During fiscal year 1996, the Hotel Division acquired 16 hotels for a total planned investment, including initial improvements, of approximately $71.8 million. In addition to the 52 hotel properties acquired, the Company owned and managed as of May 31, 1996 14 European properties (four developed by the Company and ten acquired in connection with the Company's Resthotel Primevere acquisition in fiscal 1994), 9 seasoned domestic properties and four Sleep Inns developed by the Company. HOTEL DIVISION DOMESTIC ACQUISITIONS
FISCAL YEAR ------------------------------------------------------------ 1993 1994 1995 1996 ------------ ------------ ------------ ------------ Total acquisitions................. 7 13 16 16 Total number of rooms acquired..... 1,276 1,933 2,336 1,940 Total cost of acquisitions (in millions) (including initial improvements)................. $ 30.9 $ 55.8 $ 83.3 $ 71.8* Average cost per room.............. $ 24,216 $ 28,867 $ 35,659 $ 37,095
-------------------- * Includes $22.2 million planned for initial improvements. 38 43 Hotel acquisitions generally have been made pursuant to one of the following strategies: - Buy limited service economy hotels requiring limited rehabilitation efforts. - Buy distressed, limited service properties or portfolios requiring substantial renovations. - Buy full-service hotels below replacement cost and change operations to improve the profit models. - Buy well-located old and inefficient land use hotels, convert the existing property to suites or extended stay concepts, reduce room counts, eliminate restaurants and reduce parking requirements to allow the development of a new limited service hotel on the existing site, thereby having two Company-operated properties on the site. If such development is not feasible, the excess land is targeted for sale. Net operating income for the seven hotels purchased in fiscal year 1993 increased from $6.6 million in fiscal 1995 to $8.0 million in fiscal 1996, a 22% improvement. For the 13 domestic hotels purchased in fiscal year 1994, net operating income increased 38% to $10.0 million in fiscal year 1996 from $7.2 million in fiscal year 1995. Net operating income for the 16 hotels acquired in fiscal year 1995 was $6.7 million in fiscal year 1996, a 268% increase over the $1.8 million achieved in fiscal year 1995. The following chart summarizes occupancy improvements for original domestic portfolio hotels, and fiscal 1993, 1994 and 1995 acquisitions. Occupancy rates for the year acquired reflect only the period during which the properties were owned by the Company. Because many of the recently acquired and developed hotels have not yet reached stabilized levels of operating performance, the Company believes that revenues and gross profit at these hotels will continue to grow. During fiscal year 1996, the Company began restructuring its European operations. This restructuring effort included the purchase of an equity interest in Friendly Hotels, PLC and a reevaluation of key geographic markets in Europe. In connection with this restructuring, the Company performed a review of its European operations and in May 1996 recognized a non-cash charge against earnings related primarily to the impairment of assets associated with certain European hotel operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." OWNED AND MANAGED DOMESTIC HOTELS OCCUPANCY
FISCAL YEAR ----------------------------------- 1993 1994 1995 1996 ----- ----- ----- ----- Original Domestic Portfolio......................... 62.27% 64.16% 67.19% 68.02% Fiscal 1993 Acquisitions............................ 56.17 63.20 73.68 76.17 Fiscal 1994 Acquisitions............................ -- 66.09 70.71 73.76 Fiscal 1995 Acquisitions............................ -- -- 48.96 58.49 Fiscal 1996 Acquisitions............................ -- -- -- 53.23
CURRENT BUSINESS STRATEGY The Hotel Division plans to realize cash proceeds from, or "monetize," its capital investment in Company-owned hotels at values that reflect their improved operating performance. The Company is exploring a variety of transactions, including, among others, asset securitization, sale/leasebacks, joint ventures with third parties, debt financing and asset divestitures. The Company intends to retain management and franchise agreements relating to these properties. The proceeds from these transactions will be used initially to repay outstanding indebtedness. The remaining proceeds will be used to launch or provide support to recently developed brands, such as Sleep Inn and MainStay Suites, to develop additional new brands, to expand internationally by investing in selected international gateway cities and to invest in other targeted growth areas. The timing, proceeds and other terms of any such transaction involve risks and uncertainties 39 44 which may be beyond the Company's control. No assurances can be made that the Company's strategy will be successful. See "Risk Factors -- Ability to Implement Monetization Strategy." OPERATIONS Each of the Company's owned and managed hotels operates under one of the Company's brand names. The following table illustrates the growth of the Company's Hotel Division in the United States over the four fiscal years ended May 31, 1996. DOMESTIC OWNED AND MANAGED HOTELS
AS OF OR FOR THE YEAR ENDED MAY 31, ------------------------------------------ 1993 1994 1995 1996 ------ ------ ------ ------ Number of properties, end of period.......... 19 32 48 65 Number of rooms, end of period............... 3,686 5,605 7,941 9,713 Average occupancy percentage................. 61.36% 64.18% 67.10% 66.61% Average daily (room) rate (ADR).............. $49.53 $49.15 $51.28 $55.97 RevPAR....................................... $30.39 $31.54 $34.40 $37.28
OPERATING SYSTEMS AND PROCEDURES. The Company's owned and managed hotels take advantage of the same systems and services available to franchisees with respect to a particular brand. The hotels participate in the central reservation system, marketing and advertising efforts and volume purchasing discounts and are subject to the same quality assurance program. In addition, the following are systems the Hotel Division has instituted in each of the hotels it operates: - YIELD MANAGEMENT. An automated yield management program has been installed at the hotels which allows the local management to take advantage of the supply and demand conditions in their market place. The system is automated to the point that it performs calculations and suggests pricing strategies to the local hotel management. The program continues to update information based on the availability of room supply and reservation volume within each hotel. - TRAINING. The Hotel Division has developed a training system for all guest services representatives that teaches the basics of telephone sales techniques. A computerized guest comment system was developed to solicit the comments of guests and the experiences they had at the hotel while providing management with immediate guest feedback. - ACCOUNTING SYSTEMS. Each Company-operated hotel has a computerized front desk and accounting system. This system allows key financial indicators (such as daily occupancy and revenue) to be immediately gathered from each hotel and electronically transmitted to the key operating officers and managers of the Hotel Division. This instant access to information allows management to quickly spot trends and make corrections and changes where necessary. The system is completely computerized and allows for cost savings in the accounting and bookkeeping departments of each hotel. In addition, control over operational and capital expenditures is provided by a dedicated group of financial controllers in the home office. This group works with the hotel operations group to maintain expense standards as well as established operating procedures. - TIME AND ATTENDANCE SYSTEM. Each hotel maintains an automated time and attendance system that is tied into a central payroll system at the corporate headquarters. This computerized method of tracking time allows management to make quick decisions on controlling labor costs and provides immediate information on projected costs. - FOOD AND BEVERAGE. The food and beverage efforts are headed by a vice president of food and beverage. The department is responsible for the daily food and beverage activities of the various hotels, as well as the development of new food concepts. This group was responsible for the development, testing and implementation of the Choice Picks food court concept. DEVELOPMENT AND ACQUISITIONS. In order to facilitate the growth process of acquiring new hotels, the Hotel Division maintains an acquisitions department dedicated to the investigation and analysis of potential acquisitions. The department performs the initial evaluation of potential acquisitions along with the due diligence investigations that are required in this process. This department is also responsible for seeking land 40 45 sites suitable for the construction of Sleep Inns and MainStay Suites which are to be operated by the Company. PROPERTIES The following chart lists by brand the Company's owned and managed domestic hotels at May 31, 1996:
NUMBER OF HOTEL MARKET ROOMS ------------------------------------------------ --------------------------- ------ COMFORT Comfort Inn Albuquerque Albuquerque, NM 114 Comfort Inn Norcross Atlanta, GA 110 Comfort Inn N.W., Pikesville, MD** Baltimore, MD 186 Comfort Inn University Baton Rouge, LA 150 Comfort Inn, Danvers Boston, MA 136 Comfort Suites Haverhill Boston, MA 131 Comfort Inn Brooklyn Brooklyn, NY 67 Comfort Inn Canton Canton, OH 124 Comfort Inn Airport Charleston, SC 122 Comfort Inn Charlotte Charlotte, NC 151 Comfort Inn Cincinnati, OH 117 Comfort Inn Middleburg Hts. Cleveland, OH 136 Comfort Inn College Station College Station, TX 114 Comfort Inn Columbia Columbia, SC 98 Comfort Inn DFW Airport Dallas-Fort Worth, TX 152 Comfort Suites Deerfield Ft. Lauderdale, FL 101 Comfort Inn Deerfield East Ft. Lauderdale, FL 69 Comfort Inn Hershey Harrisburg, PA 125 Comfort Inn Hilton Head Hilton Head Island, SC 150 Comfort Inn Collierville Memphis, TN 94 Comfort Inn & Suites, Miami Springs Miami, FL 267 Comfort Inn Miami Springs Miami, FL 110 Comfort Inn -- Lee Road Orlando, FL 145 Comfort Inn -- Turf Paradise Phoenix, AZ 155 Comfort Inn -- North Phoenix, AZ 153 Comfort Inn Portland Portland, ME 126 Comfort Inn by the Bay* San Francisco, CA 135 Comfort Inn Westport St. Louis, MO 170 Comfort Inn Sturgis Sturgis, MI 83 Comfort Inn Traverse City Traverse City, MI 95 Comfort Inn Tyson's Washington, DC 250 Comfort Inn West Palm Beach West Palm Beach, FL 157 Comfort Inn Wichita Wichita, KS 114 QUALITY Quality Inn Anderson Anderson, SC 121 Quality Inn & Suites -- Crown Point Charlotte, NC 100 Quality Inn Plymouth Detroit, MI 123 Quality Suites Deerfield Ft. Lauderdale, FL 107 Quality Inn & Suites Indianapolis Indianapolis, IN 116
41 46
NUMBER OF HOTEL MARKET ROOMS ------------------------------------------------ --------------------------- ------ Quality Inn Southpoint Jacksonville, FL 184 Quality Inn Lincoln Lincoln, NE 108 Quality Hotel Airport Los Angeles, CA 278 Quality Hotel Maingate -- Anaheim* Los Angeles, CA 284 Quality Inn & Suites Lumberton Lumberton, NC 120 Quality Inn & Suites Hampton Norfolk-Virginia Beach, VA 190 Quality Suites Raleigh, NC 114 Quality Inn Richmond Richmond, VA 187 Quality Inn Midvalley Salt Lake City, UT 131 Quality Inn, College Park, MD** Washington, DC 153 Quality Suites Shady Grove Washington, DC 123 Quality Hotel, Arlington, VA Washington, DC 391 CLARION Clarion Hotel Baltimore Baltimore, MD 103 Clarion Hotel Columbus, OH 232 Clarion Hotel Richardson Dallas-Fort Worth, TX 295 Clarion on the Lake Hot Springs, AR 151 Clarion Hotel Hollywood Beach Miami-Ft. Lauderdale, FL 309 Clarion Hotel Mobile, AL 250 Clarion Hotel Virginia Beach Norfolk-Virginia Beach, VA 149 Clarion Hotel Roanoke Roanoke, VA 148 Clarion Hotel Springfield Springfield, MO 199 SLEEP Sleep Inn Baton Rouge Baton Rouge, LA 101 Sleep Inn Plano Dallas-Fort Worth, TX 104 Sleep Inn Houston Houston, TX 107 Sleep Inn San Antonio San Antonio, TX 107 ECONO LODGE Econo Lodge Tolleson Phoenix, AZ 120 RODEWAY INN Rodeway Inn Airport East Phoenix, AZ 100
- --------------- * Denotes leased property. ** Denotes hotel on leased land. The Company also owns and manages ten hotels in France, three in Germany and one in the United Kingdom. COMPETITION Competition among franchise lodging chains is intense, both in attracting potential franchisees to the system and in generating reservations for franchisees. In addition, hotel chains and independent hotels compete intensely for guests and for meeting and banquet business. The Company's principal competitor brands at the national and international level in the economy category of the lodging industry are LaQuinta, Ho-Jo Inn, Ramada Inn, Motel 6, Ramada Limited, Red Carpet Inn, Red Roof Inn, Budgetel, Hampton Inn, Fairfield Inn, Holiday Express, Shoney's Inn, Super 8, 42 47 Days Inn, and Travelodge. The Company's principal competitor brands at the national and international level in the middle market category of the lodging industry are Days Inn, Fairfield Inn, Hampton Inn, Holiday Express, LaQuinta, Holiday Inn, Best Western, Howard Johnson and Ramada Inns. The Company's principal competitor brands at the national and international level in the upscale category are Holiday Inn, Holiday Select, Crowne Plaza, Four Points by Sheraton, Radisson, Courtyard by Marriott and Doubletree. The Company believes that hotel operators choose lodging franchisors based primarily on the perceived value and quality of each franchisor's brand and services, and the extent to which affiliation with that franchisor may increase the franchisee's reservations and profits. Hotel operators may also select a franchisor in part based on the franchisor's reputation among other franchisees, and the success of its existing franchisees. The Company's prospects for growth are largely dependent upon the ability of its franchisees to compete in the lodging market, since the Company's franchise system revenues are based on franchisees' gross room revenues (but not directly on franchisees' profitability). The ability of a hotel (including the Company's owned and managed hotels and its franchisees) to compete may be affected by a number of factors, including the location and quality of its property, the number and quality of competing properties nearby, its affiliation with a recognized name brand, and general regional and local economic conditions. The effect of economic conditions on the Company's results is substantially reduced by the geographic diversity of the Company's franchised properties, which are located in all 50 states and in 30 countries, as well as its range of products and room rates. SERVICE MARKS AND OTHER INTELLECTUAL PROPERTY The service marks Quality Inn, Quality Suites, Comfort Inn, Comfort Suites, Clarion Hotel, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites and related logos are material to the Company's business. The Company, directly and through its franchisees, actively uses these marks. All of the material marks are registered with the United States Patent and Trademark Office, except for MainStay Suites and K-Minus, which are the subject of pending applications. In addition, the Company has registered certain of its marks with the appropriate governmental agencies in over 100 countries where it is doing business or anticipates doing business in the foreseeable future. The Company seeks to protect its brands and marks throughout the world, although the strength of legal protection available varies from country to country. NON-HOTEL PROPERTIES The principal executive offices of the Company are located at 10750 Columbia Pike, Silver Spring, Maryland, 20901. On the Distribution Date, the Company and Manor Care will execute leases relating to such offices and to certain other real estate being made available to the Company by Manor Care. See "Relationship Between Manor Care and the Company After the Distribution -- Lease Agreements." The Company owns its reservation system offices in Phoenix, AZ and Minot, ND. The Company leases two additional reservation system offices in Grand Junction, CO, pursuant to leases that expire in 1999 and 2000, and occupies additional space in Toronto, Canada, on a month-to-month basis. In addition, the Company leases 12 sales offices across the United States. The Company's European headquarters, which the Company leases pursuant to a lease that expires on December 31, 1997, is located in Paris, France. The Company also leases three international sales offices in France, Germany and England, pursuant to leases that terminate in June 1998, September 1996 and December 1997, respectively. Management believes that its executive, reservation systems and sales offices are sufficient to meet its present needs and does not anticipate any difficulty in securing additional or alternative space, as needed, on terms acceptable to the Company. SEASONALITY The Company's principal sources of revenues are franchise fees based on the gross room revenues of its franchise properties and revenues generated by its owned and managed hotels. The Company experiences seasonal revenue patterns similar to those of the lodging industry in general. Generally, the Company's revenues are greater in the first and second fiscal quarters than in the third and fourth fiscal quarters. This 43 48 seasonality can be expected to cause quarterly fluctuations in the revenues, profit margins and net income of the Company. REGULATION The Company's franchisees are responsible for compliance with all laws and government regulations applicable to the hotels they own or operate. The Company is responsible for such compliance at the hotels it owns. The lodging industry is subject to numerous federal, state and local government regulations, including those relating to the preparation and sale of food and beverage (such as health and liquor license laws), building and zoning requirements and laws governing a hotel owner's relationship with employees, including minimum wage requirements, overtime, working conditions and work permit requirements. The failure to obtain or retain liquor licenses or an increase in the minimum wage rate, employee benefit costs or other costs associated with employees could adversely affect the Company's owned hotels. Both at the federal and state level, there are proposals under consideration to increase the minimum wage and introduce a system of mandated health insurance. Under the Americans with Disabilities Act of 1990 (the "ADA"), all public accommodations are required to meet certain federal requirements related to access and use by disabled persons. A determination that the Company is not in compliance with the ADA could result in the imposition of fines or an award of damages to private litigants. These and other initiatives could adversely affect the Company as well as the lodging industry in general. The Federal Trade Commission (the "FTC") and certain other jurisdictions (including France, Province of Alberta, Canada, and Mexico and various states) regulate the sale of franchises. The FTC requires franchisors to make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration or disclosure in connection with franchise offers and sales. In addition, several states have "franchise relationship laws" or "business opportunity laws" that limit the ability of the franchisor to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. While the Company's franchising operations have not been materially adversely affected by such regulation, the Company cannot predict the effect of future regulation or legislation. INSURANCE The Company maintains property insurance on its owned and leased lodging facilities. The Company insures some of its liability exposures and self-insures, either directly or indirectly through insurance arrangements requiring it to reimburse insurance carriers, some of its liability risks other than catastrophic exposures. The Company insures its workers' compensation risks in some states and self-insures in others. IMPACT OF INFLATION AND OTHER EXTERNAL FACTORS The Company's principal sources of revenues are franchise fees and revenues generated from bookings of rooms at the Company's owned and managed hotels. Franchise fees and revenues from owned and managed hotels can be impacted by two external factors: the supply of hotel rooms within the lodging industry relative to the demand for rooms by travelers, and inflation. Although industry-wide supply and demand for hotel rooms is fairly balanced at present, any excess in supply that might develop in the future could have an unfavorable impact on room revenues at the Company's franchised hotels and at its owned and managed hotels, either by reducing the number of rooms reserved at the Company's properties or by restricting the rates hotel operators can charge for their rooms. In addition, an excess supply of hotel rooms may discourage potential franchisees from opening new hotels, unfavorably impacting the franchise fees received by the Company. Although the Company believes that increases in the rate of inflation will generally result in comparable increases in hotel room rates, severe inflation could contribute to a slowing of the national economy, which could result in reduced travel by both business and leisure travelers. That could lead to less demand for hotel rooms, which could result in a temporary reduction in room rates and fewer room reservations, negatively impacting revenues received by the Company. A weak economy could also reduce demand for new hotels, negatively impacting the franchise fees received by the Company. 44 49 EMPLOYEES The Company employed 4,851 people full-time at May 31, 1996. Less than 5% of the Company's employees are represented by unions. Such union contracts expire between August 1996 and December 1997. The Company considers its relations with its employees to be satisfactory. LEGAL PROCEEDINGS The Company is not a party to any litigation, other than routine litigation incidental to the business of the Company. None of such litigation, either individually or in the aggregate, is expected to be material to the business, financial condition or results of operations of the Company. ENVIRONMENTAL MATTERS Under various foreign, federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property, amongst others, may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Certain of such laws impose liability whether or not the owner or operator knew of, or was at fault for, the presence of such hazardous or toxic substances. Certain environmental laws and common law principles may be used to impose liability for release of asbestos-containing materials ("ACMs") into the environment, including but not limited to the air, and third parties may seek recovery from owners or operators of real properties for cleanup of, or personal injury associated with exposure to, released ACMs. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require expenditures. In connection with its ownership or operation of hotels, the Company may be potentially liable for such costs. Although the Company is currently not aware of any material environmental claims pending or threatened against it, no assurance can be given that a material environmental claim will not be asserted against the Company. The cost of defending against claims of liability or of remediating a contaminated property could have a material adverse effect on the results of operations of the Company. Pursuant to the Distribution Agreement, the Company has agreed to indemnify Manor Care, its affiliates and certain other persons for liabilities related to the Lodging Business which will be assumed by the Company and for certain other specified environmental, third party personal injury and other liabilities arising out of the alleged activities of Cenco. See "Relationship Between Manor Care and the Company After the Distribution--Distribution Agreement." One or more subsidiaries or affiliates of Manor Care have been identified as defendants and/or potentially responsible parties ("PRPs") in a variety of actions (the "Actions") relating to alleged activities of Cenco at approximately eleven waste disposal sites, which allegedly are subject to remedial action under the Comprehensive Environmental Response, Compensation & Liability Act, as amended, 42 U.S.C. sec.sec. 9601 et seq. ("CERCLA") and similar state laws. CERCLA imposes retroactive, strict, joint and several liability on PRPs for the costs of hazardous substance clean-up. The Actions allege that Cenco transported and/or generated hazardous substances that came to be located at the sites in question prior to Healthcare's acquisition of Cenco. Environmental proceedings such as the Actions may involve owners and/or operators of the hazardous waste site and multiple waste generators and waste transportation disposal companies. Such proceedings typically involve efforts of governmental entities and/or private parties to allocate or recover site investigation and cleanup costs, which costs may be substantial. None of the approximately eleven waste disposal sites implicated in the Actions is related to the healthcare business of Manor Care or the Lodging Business, and none of such sites is owned or operated by, or will be owned or operated by, the Company. Certain of the sites currently are owned or operated by affiliates of Manor Care. Manor Care believes it has adequate insurance coverage for a substantial portion of the claims asserted in the Actions. Pursuant to the Distribution Agreement, the Company will indemnify Manor Care for any portion of the claims not covered by insurance. 45 50 The most significant Action for Manor Care arises from the Kramer landfill, located in Mantua, New Jersey. On October 30, 1989, the New Jersey Department of Environmental Protection sued Manor Care and other defendants in U.S. District Court, District of New Jersey, seeking clean-up costs at the site where subsidiaries of Cenco allegedly transported waste. At about the same time, the United States filed a lawsuit against approximately 25 defendants in the same court seeking recovery of its expenses arising in connection with this site. Manor Care is a third party defendant in the latter suit. Based upon a recent court-approved final allocation plan, and also in view of its insurance coverage, Manor Care believes that the Kramer Action will not have a material adverse effect on its financial condition or results of operations. The Company believes that any liability it may have for indemnification of Manor Care will not have a material adverse effect on the Company's business, financial condition or results of operations. This final allocation plan is not binding. If the matter is not resolved by settlement, a court would have to allocate responsibility and Manor Care's allocation could change. Although Manor Care, together with its insurers, is vigorously contesting its liability in the Actions, it is not possible at the present time to estimate the ultimate legal and financial liability of Manor Care with respect to the Actions or the ultimate indemnification liability, if any, of the Company. 46 51 MANAGEMENT EXECUTIVE OFFICERS OF THE COMPANY The name, age, proposed title upon consummation of the Distribution and business background of each of the persons who are expected to become on the Distribution Date the executive officers of the Company are set forth below. The business address of each prospective executive officer is 10750 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
NAME AGE POSITION - ------------------------------ ---- --------------------------------------------------------- Stewart Bainum, Jr............ 50 Chairman of the Board and Chief Executive Officer Donald J. Landry.............. 47 President Mark A. Caruso................ 43 Senior Vice President -- Human Resources Antonio DiRico................ 43 Senior Vice President -- Hotel Operations Richard P. Kaden.............. 50 Senior Vice President -- Franchise Operations and Acting Chief Financial Officer Edward A. Kubis............... 37 Senior Vice President, General Counsel and Secretary Barry L. Smith................ 54 Senior Vice President -- Marketing Charles G. Warczak, Jr........ 48 Vice President -- Finance and Controller
Stewart Bainum, Jr. Chairman of the Board and Chief Executive Officer of Manor Care and Manor Healthcare Corp. ("Healthcare") since March 1987; Chief Executive Officer of Manor Care since March 1987 and President since June 1989; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. ("Vitalink") since February 1995; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care since August 1981, of Vitalink since September 1991, of Healthcare since 1976 and of Choice Hotels International, Inc. and its predecessors ("Choice Hotels") since 1977; Chief Executive Officer of Healthcare since June 1989 and President from May 1990 to May 1991; Chairman of the Board and Chief Executive Officer of Vitalink from September 1991 to February 1995 and President and Chief Executive Officer from March 1987 to September 1991; Chairman of the Board of Choice from March 1987 to June 1990. Mark A. Caruso. Senior Vice President, Human Resources of Choice Hotels since October 1995; Vice President, Worldwide Human Resources Development, Holiday Inn Worldwide from March 1993 to October 1995; Director, Human Resources Development, Holiday Inn Worldwide from February 1990 to March 1993. Antonio DiRico. Senior Vice President, Hotel Operations of Manor Care Hotel Division ("MCHD") since May 1992; Senior Vice President of Richfield Hotel Management, Inc. and its predecessor, MHM Corporation, from May 1975 to May 1992. Richard P. Kaden. Senior Vice President - Brands and Acting Chief Financial Officer of Choice Hotels since April 1996; Senior Vice President-Finance of Choice from August 1993 to April 1996; Executive Director of Semmes, Bowen & Semmes from November 1987 to August 1993. Edward A. Kubis. Assistant General Counsel and Assistant Secretary, Manor Care since December 1993; Senior Attorney, Real Estate, from December 1990 to December 1993; Staff Attorney, Real Estate from June 1987 to December 1990. Donald J. Landry. President of Choice Hotels since January 1995; President of MCHD since March 1992; various executive positions with Richfield Hotel Management, Inc. and its predecessors for more than 15 years, including President of MHM Corporation. Barry L. Smith. Senior Vice President - Marketing of Choice Hotels since February 1989. 47 52 Charles G. Warczak, Jr. Vice President - Finance and Controller of Choice Hotels since March 1996; Vice President - Finance, MCHD from June 1992 to March 1996; Vice President - Finance, Richfield Hotel Management, Inc. from January 1991 to June 1992. COMPENSATION OF EXECUTIVE OFFICERS The following tables set forth certain information concerning the annual and long term compensation of those persons who, following the Distribution, will serve as chief executive officer and the four other most highly compensated executive officers of the Company (the "Named Officers"). In addition, information is presented with respect to certain persons who were officers of the Lodging Business at May 31, 1996 who are no longer executive officers of the Company. 48 53 SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION ------------------------------ FISCAL ----------------------------- STOCK OPTION ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS OTHER SHARES(#)(1) COMPENSATION(2) - -------------------------------- ------ -------- -------- ----- ------------ --------------- Stewart Bainum, Jr.(3).......... 1996 $625,102 $337,555 (5) 60,000 $33,543 Chairman and 1995 $572,308 $343,385 (5) -- $ 9,000 Chief Executive Officer 1994 457,867(4) 274,720 (5) 40,000 14,150 Antonio DiRico.................. 1996 179,904 71,962 (5) 8,000 2,225 Sr. Vice President, 1995 159,678 50,813 (5) -- 2,153 Hotel Operations 1994 133,719 0 (5) 5,000 1,986 Richard P. Kaden................ 1996 196,603 88,471 (5) 8,000 2,925 Sr. Vice President, Franchise 1995 187,007 59,971 (5) -- 2,458 Operations and Acting 1994 133,270 0 (5) 10,000 1,868 Chief Financial Officer Donald L. Landry................ 1996 366,702 201,686 (5) -- 5,000 President 1995 311,635 171,399 (5) 40,000 2,250 1994 275,712 144,059 (5) 25,000 3,537 Barry L. Smith.................. 1996 233,640 116,820 (5) 5,000 10,427 Sr. Vice President, Marketing 1995 221,668 104,561 (5) -- 6,750 1994 209,151 98,642 (5) 5,000 3,072 Robert C. Hazard, Jr.(6)........ 1996 403,489 201,745 (5) -- 20,932 Co-Chairman 1995 373,709 186,855 (5) -- 9,000 Choice Hotels International, Inc. 1994 346,124 173,062 (5) -- 14,150 Gerald W. Petitt(6)............. 1996 330,129 165,065 (5) -- 18,770 Co-Chairman 1995 323,553 161,776 (5) -- 9,000 Choice Hotels International, Inc. 1994 283,193 141,596 (5) -- 14,150
- --------------- (1) Represents options to purchase shares of Manor Care Common Stock. For a discussion of the treatment of options in connection with the Distribution, see "Relationship Between Manor Care and the Company After the Distribution -- Employee Benefits Allocation Agreement." (2) Represents amounts contributed by Manor Care for fiscal years 1996, 1995 and 1994 under the 401(k) Plan and the Nonqualified Savings Plan, which provide retirement and other benefits to eligible employees, including the Named Officers. Amounts contributed in cash or stock by the Company during fiscal year 1996 under the 401(k) Plan for the Named Officers were as follows: Mr. Bainum, Jr., $9,000; Mr. Landry, $1,752; Mr. Kaden, $977; Mr. Smith, $3,489; and Mr. DiRico, $890. Amounts contributed in cash or stock by Manor Care during fiscal year 1995 under the Nonqualified Savings Plan for the Named Officers were as follows: Mr. Bainum, Jr., $24,543; Mr. Landry, $3,498; Mr. Kaden, $1,948; Mr. Smith, $6,938; and Mr. DiRico, $1,335. (3) Following the Distribution, Mr. Bainum, Jr. will be the chief executive officer of the Company and of Manor Care. It is expected that he will devote one-third of his time to the Company and two-thirds of his time to Manor Care. The compensation reflected here is total compensation received for services rendered to both the Lodging Business and Manor Care. (4) Mr. Bainum, Jr. took an unpaid leave of absence during April and May 1994. (5) The value of perquisites and other compensation does not exceed the lesser of $50,000 or 10% of the amount of annual salary and bonus paid as to any of the Named Officers. (6) Mr. Hazard and Mr. Petitt have served as Co-Chairmen of Choice Hotels since January 1995. Prior to January 1, 1995, Mr. Hazard served as Chairman and Chief Executive Officer of Choice Hotels and Mr. Petitt served as President and Chief Operating Officer of Choice Hotels. Neither Mr. Hazard nor Mr. Petitt will serve as an executive officer of the Company following the Distribution, however, each will continue as an unpaid employee of the Company until May 31, 1997. 49 54 The following tables set forth certain information at May 31, 1996 and for the fiscal year then ended concerning options to purchase Manor Care Common Stock granted to the Named Officers. All Common Stock figures and exercise prices have been adjusted to reflect stock dividends and stock splits effective in prior fiscal years. In connection with the Distribution, existing Manor Care stock options will be subject to certain adjustments or to conversion into options to purchase Company Common Stock. See "Relationship Between Manor Care and the Company After the Distribution -- Employee Benefits Allocation Agreement." MANOR CARE STOCK OPTION GRANTS IN FISCAL 1996
INDIVIDUAL GRANTS POTENTIAL REALIZABLE ----------------------------------------- VALUE OF ASSUMED ANNUAL PERCENTAGE OF RATE OF STOCK PRICE TOTAL OPTIONS APPRECIATION FOR OPTION NUMBER OF GRANTED TO ALL EXERCISE TERM(1) OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ----------------------- NAME GRANTED FISCAL YEAR 1996 PER SHARE DATE 5%(2) 10%(3) - -------------------------- --------- ---------------- ---------- ---------- ---------- ---------- Stewart Bainum, Jr.(4).... 60,000 10.5% $30.31 6/21/2005 $1,143,600 2,898,606 Antonio DiRico(4)......... 8,000 1.4% $30.31 6/21/2005 $ 152,480 386,480 Richard P. Kaden(4)....... 8,000 1.4% $30.31 6/21/2005 $ 152,480 386,480 Donald J. Landry.......... -- -- -- -- -- -- Barry Smith(4)............ 5,000 0.9% $30.31 6/21/2005 $ 95,300 241,550 Robert C. Hazard, Jr. .... -- -- -- -- -- -- Gerald W. Petitt.......... -- -- -- -- -- --
- --------------- (1) The dollar amounts under these columns are the result of calculations at the 5% and 10% rates set by the Securities and Exchange Commission and therefore are not intended to forecast future possible appreciation, if any, of the Company's stock price. Since options are granted at market price, a zero percent gain in the stock price will result in no realizable value to the optionees. (2) A 5% per year appreciation in stock price from $30.31 per share yields $49.37. (3) A 10% per year appreciation in stock price from $30.31 per share yields $78.62. (4) The options granted to the officers vest at the rate of 20% per year on the first through the fifth anniversary of the date of the stock option grant. AGGREGATED OPTION EXERCISES IN FISCAL 1996 AND YEAR-END OPTION VALUES
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED SHARES OPTIONS AT MAY 31, 1996 IN-THE-MONEY OPTIONS AT MAY ACQUIRED ON VALUE ---------------------------- 31, 1996(1) EXERCISE REALIZED EXERCISABLE UNEXERCISABLE ---------------------------- # $ # # EXERCISABLE UNEXERCISABLE ----------- -------- ----------- ------------- ----------- ------------- Stewart Bainum, Jr.... -- -- 635,500 229,500 $17,236,482 $ 4,684,465 Antonio DiRico........ -- -- 1,500 16,500 26,160 215,260 Richard P. Kaden...... -- -- 2,166 15,834 39,659 212,949 Donald J. Landry...... -- -- 37,000 148,000 810,190 2,668,922 Barry Smith........... 12,600 $334,880 -- 54,100 -- 1,334,179 Robert C. Hazard, Jr. ................ -- -- 78,000 34,500 2,281,721 1,034,130 Gerald W. Petitt...... 18,300 $536,119 39,500 34,500 1,184,330 1,034,130
- --------------- (1) The closing price of Manor Care's Common Stock as reported by the New York Stock Exchange on May 31, 1996 was $39.00. The value is calculated on the basis of the difference between the option exercise price and such closing price multiplied by the number of shares of Manor Care Common Stock underlying the option. EMPLOYMENT AGREEMENTS Under the terms of an employment agreement among Mr. Landry, Manor Care and Choice Hotels, Mr. Landry's annual salary is presently $404,250 with annual cost-of-living increases. The agreement extends 50 55 through November 30, 1999. Prior to the Distribution, it is expected that Manor Care will assign its rights and obligations under such contract to the Company. From February 17, 1992 to January 1, 1995, Mr. Landry served as President of the Manor Care Hotel Division. On January 1, 1995, Mr. Landry also became President of Choice. The agreement provides for an annual bonus of up to 55% of his base compensation based in part on performance of Manor Care and based in part on performance (including a customer satisfaction component) of the Lodging Business. The bonus provisions of the agreement will be amended in connection with the Distribution. It is contemplated that the Company will enter into an employment agreement with Mr. Stewart Bainum, Jr. The terms of such agreement have not yet been determined. RETIREMENT PLANS Prior to the Distribution, it is expected that the Company will adopt the Choice Hotels International, Inc. Supplemental Executive Retirement Plan (the "SERP"). Participants will be selected by the Board or any designated committee and will be at the level of Senior Vice President or above. Participants in the SERP will receive a monthly benefit for life based upon final average salary and years of service. Final average salary is the average of the monthly base salary, excluding bonuses or commissions, earned in a 60 month period out of the 120 months of employment which produces the highest average, prior to the first occurring of the early retirement date or the normal retirement date. The normal retirement age is 65, and participants must have a minimum of 15 years of service. Participants may retire at age 60 and may elect to receive reduced benefits commencing prior to age 65, subject to Board approval. All of the Named Officers who will be participants are age 55 or younger, so that none of their compensation reported above would be included in the final average salary calculation. Assuming that the following officers continue to be employed by the Company until they reach age 65, their credited years of service would be as follows:
CURRENT YEARS YEARS OF SERVICE NAME OF INDIVIDUAL OF SERVICE AT AGE 65 ------------------------------------------------- ------------- ---------------- Stewart Bainum, Jr............................... 22.5 38 Donald Landry.................................... 4 22
The table below sets forth estimated annual benefits payable upon retirement to persons in specified compensation and years of service classifications. These benefits are straight life annuity amounts, although participants have the option of selecting a joint and 50% survivor annuity or ten-year certain payments. The benefits are not subject to offset for social security and other amounts. YEARS OF SERVICE/BENEFIT AS PERCENTAGE OF FINAL AVERAGE SALARY
25 OR REMUNERATION 15/15% 20/22.5% MORE/30% -------------------------------------------- ------- -------- --------- $300,000.................................... $45,000 $ 67,500 $ 90,000 350,000.................................... 52,500 78,750 105,000 400,000.................................... 60,000 90,000 120,000 450,000.................................... 67,500 101,250 135,000 500,000.................................... 75,000 112,500 150,000 600,000.................................... 90,000 135,000 180,000
Prior to the Distribution, it is expected that the Company will establish the Choice Hotels International, Inc. Retirement Savings and Investment Plan (the "401(k) Plan"), a defined contribution retirement, savings and investment plan for its employees and the employees of its participating affiliated companies. The 401(k) Plan will be qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and will include a cash or deferred arrangement under Section 401(k) of the Code. All employees age 21 or 51 56 over and who have worked for the Company (or Manor Care) for a twelve month period during which such employee completed at least 1,000 hours will be eligible to participate. Subject to certain non-discrimination requirements, each employee will be able to contribute an amount to the 401(k) Plan on a pre-tax basis up to 15% of the employee's salary, but not more than the current federal limit of $9,500. The Company will match contributions made by its employees subject to certain limitations. The amount of the match will be equal to a percentage of the amount of salary reduction contribution made on behalf of a participant during the plan year based upon a formula that involves the profits of the Company for the year and the number of years of service of the participant. Amounts contributed by Manor Care pursuant to its 401(k) Plan for the Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation." Prior to the Distribution, it is expected that the Company will adopt the Choice Hotels International, Inc. Nonqualified Retirement Savings and Investment Plan (the "Nonqualified Savings Plan"). Certain select highly compensated members of management of the Company will be eligible to participate in the Plan. The Nonqualified Savings Plan will mirror the provisions of the 401(k) Plan, to the extent feasible, and will be structured so as to provide the participants with a pre-tax savings vehicle to the extent that pre-tax savings are limited under the 401(k) Plan as a result of various governmental regulations, such as non-discrimination testing. Amounts contributed by Manor Care under the Manor Care Nonqualified Savings Plan for fiscal year 1996 for the Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation". The Company match under the 401(k) Plan and the Nonqualified Savings Plan will be limited to a maximum aggregate of 6% of the annual salary of a participant. Likewise, participant contributions under the two plans will not exceed the aggregate of 15% of the annual salary of a participant. OPTION AND STOCK PURCHASE PLANS Prior to the Distribution, it is expected that the Company will adopt the Choice Hotels International, Inc. Employee Stock Purchase Plan (the "Stock Purchase Plan"). Under the Stock Purchase Plan, all employees who have completed one year of service are eligible to participate. Eligible employees may purchase stock of the Company in an amount of no less than 2% nor more than 10% of compensation (as defined in the Stock Purchase Plan), subject to an overall maximum purchase per employee per calendar year of $25,000. At the end of each quarterly offering period, the Company will contribute cash equal to 10% of the purchase price of the common stock so purchased. The Company will pay the administrative costs for the purchase of the Company common stock. Prior to the Distribution, it is expected that the Company will adopt the Choice Hotels International, Inc. 1996 Long-Term Incentive Plan (the "Incentive Plan"), pursuant to which key employees of the Company and its subsidiaries are eligible to be granted awards under the Incentive Plan. The types of awards that may be granted under the Incentive Plan are restricted shares, incentive stock options, nonqualified stock options, stock appreciation rights and performance shares. A total of up to 2,000,000 shares of common stock will be reserved for issuance pursuant to the Incentive Plan. THE BOARD OF DIRECTORS DIRECTORS OF THE COMPANY The Company's Board of Directors will be classified into three classes, designated Class I, Class II and Class III, each class to be as nearly equal in number of directors as possible. The term of the initial Class I directors will terminate on the date of the 1997 annual meeting of the Company's stockholders; the term of the initial Class II directors will terminate on the date of the 1998 annual meeting of the Company's stockholders; and the term of the initial Class III directors will terminate on the date of the 1999 annual meeting of the Company's stockholders. At each annual meeting of the Company's stockholders, successors to the class of directors whose term expires at that annual meeting will be elected for a three-year term. Newly created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors resulting from death, resignation, retirement, disqualification, removal or other cause will be filled 52 57 solely by the affirmative vote of a majority of the remaining directors then in office. Increases or decreases in the number of directors shall be apportioned among the classes as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent director. The name, age, proposed class of directorship upon consummation of the Distribution and business background (other than executive officers who are directors) of each of the persons who are expected to become on the Distribution Date the directors of the Company are set forth below.
NAME AGE POSITION - ----------------------------------- ------ Chairman of the Board; Class III Stewart Bainum, Jr................. 50 Director Stewart Bainum..................... 77 Vice Chairman; Class II Director Barbara Bainum..................... 52 Class I Director Robert C. Hazard, Jr............... 61 Class I Director Frederick V. Malek................. 59 Class I Director Gerald W. Petitt................... 50 Class II Director Jerry E. Robertson, Ph.D. ......... 63 Class III Director
Stewart Bainum. Vice Chairman of the Board of Manor Care and subsidiaries since March 1987; Chairman of the Board of Manor Care from August 1981 to March 1987, Chief Executive Officer from July 1985 to March 1987, President from May 1982 to July 1985; Chairman of the Board of Healthcare from 1968 to March 1987 and a Director since 1968; Director of Vitalink from September 1991 to September 1994; Chairman of the Board of Choice Hotels from 1972 to March 1987 and a Director since 1963; Chairman of the Board of Realty Investment Company, Inc. since 1965. Barbara Bainum. President, Secretary and Director of the Commonweal Foundation since December 1990, December 1984 and December 1984, respectively; Secretary and Director of Realty Investment Company, Inc. since July 1989 and March 1982, respectively; Family Services Agency, Gaithersburg, Maryland, Clinical Social Work since September 1994; Department of Social Services, Rockville, Maryland, Social Work Case Management from September 1992 to May 1993; member of the Boards of Trustees of Columbia Union College (September 1987 to May 1991) and Atlantic Union College (September 1985 to May 1987). Robert C. Hazard, Jr. Hotel Developer. Co-Chairman of Choice Hotels since January 1995 and a Director since December 1980; Chairman from June 1990 to January 1995 and Chief Executive Officer from December 1980 to January 1995; President from December 1980 to June 1990. Advisory Board Outrigger Hotels. Mr. Hazard will resign as Co-Chairman of Choice Hotels effective on the Distribution Date and will be an unpaid employee of the Company until May 31, 1997. Frederic V. Malek. Director of Manor Care since 1990; Co-Chairman of CB Commercial Real Estate Group, since April 1989; Chairman of Thayer Capital Partners since March 1993; Campaign Manager for Bush-Quayle '92 from January 1992 to November 1992; Vice Chairman of NWA, Inc. (airlines), July 1990 to December 1991; Director: American Management Systems, Inc., Automatic Data Processing Corp., FPL Group, Inc. (an affiliate of Florida Power and Light -- power company), ICF Kaiser International, Inc., Intrav, Inc. (travel and leisure services), National Education Corporation, Northwest Airlines and various Paine Webber mutual funds. Gerald W. Petitt. Hotel Developer. Co-Chairman of Choice Hotels since January 1995 and a Director since December 1980; President from June 1990 to January 1995 and Chief Operating Officer from December 1980 to January 1995. Mr. Petitt will resign as Co-Chairman of Choice Hotels effective on the Distribution Date and will be an unpaid employee of the Company until May 31, 1997. Jerry E. Robertson, Ph.D. Director of Manor Care since 1989; Retired; Executive Vice President, 3M Life Sciences Sector and Corporate Services from November 1986 to March 1994; Director: Allianz Life 53 58 Insurance Company of North America, Cardinal Health, Inc., Coherent, Inc., Haemonics Corporation, Life Technologies, Inc., Medwave, Inc., Project Hope and Steris Corporation. Prior to the Distribution Date, the directors of the Company are Stewart Bainum, Jr., James A. MacCutcheon, Senior Vice President, Chief Financial Officer and Treasurer of Manor Care and James H. Rempe, Senior Vice President, General Counsel and Secretary of Manor Care, and the only executive officer of the Company is Stewart Bainum, Jr. Following the Distribution, Stewart Bainum, Jr. will be the chief executive officer of both the Company and Manor Care. It is expected that he will devote one-third of his time to the Company and two-thirds of his time to Manor Care. Upon consummation of the Distribution, the Board of Directors is expected to consist of seven members. Following the Distribution Date, additional non-employee directors may be elected to the Board of Directors. The additional non-employee directors have not yet been determined. It is expected that the Board of Directors will hold five meetings during the fiscal year and that the standing committees of the Board will include the Audit Committee, the Finance Committee, the Compensation/Key Executive Stock Option Plan Committee and the Nominating Committee. The members of the committees have not yet been determined. The Compensation/Key Executive Stock Option Plan Committee will administer the Company's stock option plans and grant stock options thereunder, will review compensation of officers and key management employees, will recommend development programs for employees such as training, bonus and incentive plans, pensions and retirement, and will review other employee fringe benefit programs. The Finance Committee will review the financial affairs of the Company and will recommend financial objectives, goals and programs to the Board of Directors and to management. The Audit Committee will review the scope and results of the annual audit, will review and approve the services and related fees of the Company's independent public accountants, will review the Company's internal accounting controls and will review the Company's Internal Audit Department and its activities. The Nominating Committee will recommend to the Board of Directors the members to serve on the Board of Directors during the ensuing year. The Committee will not consider nominees recommended by stockholders. Prior to the Distribution, it is expected that the Company will adopt the Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. Part A of the Plan provides that eligible non-employee directors will be granted options to purchase 5,000 shares of Common Stock on their date of election and will be granted options to purchase 1,000 shares on their date of election in subsequent calendar years. Part B of the Plan provides that eligible non-employee directors may elect, prior to May 31 of each year, to defer a minimum of 25% of committee fees earned during the ensuing fiscal year. The fees which are so deferred will be used to purchase Common Stock on the open market within 15 days after December 1, February 28 and May 31 of such fiscal year. Pending such purchases, the funds will be credited to an Interest Deferred Account, which will be interest bearing. Stock which is so purchased will be deposited in a Stock Deferred Account pending distribution in accordance with the Plan. Directors who will be employees of the Company will receive no separate remuneration for their services as directors. Pursuant to the Non-Employee Director Stock Compensation Plan to be adopted by the Company prior to the Distribution, eligible non-employee directors will receive annually, in lieu of cash, restricted stock of the Company, the fair market value of which at the time of grant will be equal to $30,000, which will represent the Board retainer and meeting fees. In addition, all non-employee directors will receive $1,610 per diem for Committee meetings attended, except where the Committee meeting is on the same day as a Board meeting, and will be reimbursed for travel expenses and other out-of-pocket costs incurred in attending meetings. 54 59 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS As of May 31, 1995, Manor Care purchased from each of Mr. Hazard and Mr. Petitt 25 shares, representing one-half of their shares, of Choice Hotels common stock. In accordance with a formula contained in an agreement dated December 20, 1994, Manor Care paid to each of Messrs. Hazard and Petitt the sum of $13,683,704 for such shares. After the transaction, Messrs. Hazard and Petitt each owned 25 shares of Choice Hotels common stock and Manor Care owned 850 shares of Choice Hotels common stock. As of May 31, 1996, Manor Care purchased from each Mr. Hazard and Mr. Petitt his remaining 25 shares for a price of $15,197,946 to each of them. As of June 1, 1996, each of Mr. Hazard and Mr. Petitt has entered into an agreement with Manor Care and the Company, pursuant to which he will remain an unpaid employee of the Company until May 31, 1997 and options to purchase up to 5,000 shares of Manor Care Common Stock, which were previously granted and are presently outstanding, will vest ratably beginning June 1, 1996 and ending May 31, 1997. Pursuant to such agreements Mr. Hazard and Mr. Petitt have each waived the initial grants to non-employee directors under the Non-Employee Director Stock Compensation Plan. Upon consummation of the Distribution, certain management employees of the Lodging Business and of Manor Care will hold options to purchase shares of Company Common Stock. See "Relationship Between Manor Care and the Company After the Distribution -- Employee Benefits Allocation Agreement." For a discussion of certain contracts to be executed between the Company and Manor Care as of the Distribution Date, see "Relationship Between Manor Care and the Company After the Distribution." For a discussion of the historical financial relationship between the Company and Manor Care, see "Management's Discussion and Analysis of Financial Condition and Results of Operation -- Liquidity and Capital Resources." 55 60 SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS AND MANAGEMENT The following table sets forth the amount of Company Common Stock expected to be beneficially owned by (1) each director and director nominee of the Company, (2) the chief executive officer of the Company and the Named Officers, (3) all officers and directors of the Company as a group and (4) all persons who will own beneficially more than 5% of Company Common Stock, based on the Manor Care Common Stock beneficially owned by such persons on September 9, 1996. Unless otherwise specified, the address for each of them is 10750 Columbia Pike, Silver Spring, Maryland 20901. On the Distribution Date, the holders of Manor Care Common Stock as of the Record Date will be entitled to receive one share of Company Common Stock for each share of Manor Care Common Stock. For purposes of the following table, it is assumed that all options held by the persons specified will be converted into options to purchase Company Common Stock. For a discussion of the treatment of outstanding options to purchase Manor Care Common Stock in connection with the Distribution, see "Relationship Between Manor Care and the Company After the Distribution -- Employee Benefits Allocation Agreement."
TOTAL SHARES OF PERCENT OF SHARES COMPANY COMMON STOCK OUTSTANDING EXPECTED TO BE EXPECTED TO BE NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BENEFICIALLY OWNED ------------------------------------------- -------------------- ------------------ Stewart Bainum, Jr. ....................... 12,308,102(2) 19.4% Stewart Bainum............................. 12,548,386(3) 19.9% Barbara Bainum............................. 1,820,946(4) 2.9% Antonio DiRico............................. 3,846(5) * Robert C. Hazard, Jr. ..................... 36,884(6) * Richard B. Kaden........................... 6,210(7) * Donald J. Landry........................... 38,778(8) * Frederic V. Malek.......................... 2,666(9) * Gerald W. Petitt........................... 82,937(10) * Jerry E. Robertson, Ph.D. ................. 15,980(11) * Barry L. Smith............................. 14,251(12) * All Directors and Officers as a Group (14 persons)................................. 2,883,906(13) 42.2% Ronald Baron............................... 4,345,184(14) 6.9%
- --------------- * Less than 1% of class. (1) Percentages are based on 62,867,418 shares outstanding on September 9, 1996 plus for each person, the shares which would be issued assuming that such person exercises all options it holds which are exercisable within 60 days thereafter. (2) Includes 91,752 shares owned directly by Mr. Bainum, Jr. Also includes 5,417,761 shares owned by Bainum Associates Limited Partnership ("Bainum Associates") and 4,415,250 shares owned by MC Investments Limited Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is managing general partner with the sole right to dispose of the shares. Authority to vote such shares is held by the voting general partner, Mr. B. Houston McCeney. Also includes 1,679,628 shares owned by Mid Pines Associates Limited Partnership ("Mid Pines"), in which Mr. Bainum, Jr. is managing general partner and has shared voting authority and 1,500 shares owned by the Foundation for Maryland's Future, in which Mr. Bainum, Jr. is the sole director. Mr. Bainum, Jr. has a direct or indirect pecuniary interest in 1,172,144 shares, 817,936 shares and 343,791 shares owned respectively by Bainum Associates, MC Investments and Mid Pines. Of the shares owned by Bainum Associates, MC Investments and Mid Pines, 999,523, 1,271,541 and 1,679,628 shares, respectively, are also included in the above table as owned beneficially by Stewart Bainum and Barbara Bainum, Mr. Bainum, Jr.'s father and sister, respectively. Also includes 700,000 shares which Mr. Bainum, Jr. has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, and 1,504 shares and 707 shares, respectively, which Mr. Bainum, Jr. has the right to receive upon termination of his employment with the Company pursuant to the terms of the Manor 56 61 Care, Inc. Retirement Savings and Investment Plan (the "Manor Care 401(k) Plan") and the Manor Care, Inc. Nonqualified Retirement Savings and Investment Plan (the "Manor Care Nonqualified Savings Plan"). Does not include shares owned by Realty Investment Company, Inc. and its subsidiaries ("Realty Investment"), a real estate investment and management company in which Mr. Bainum, Jr. owns, directly or indirectly, 25.0% of the outstanding common stock. (3) Includes 4,036,278 shares held directly by the Stewart Bainum Declaration of Trust, of which Mr. Bainum is the sole trustee and beneficiary; his joint interest in 1,053,860 shares owned by Bainum Associates and 1,370,069 shares owned by MC Investments, each of which is a limited partnership in which Mr. Bainum has joint ownership with his wife as a limited partner and as such has the right to acquire at any time a number of shares equal in value to the liquidation preference of their limited partnership interests; 3,567,869 shares held directly by Realty Investment, a real estate investment and management company controlled by Mr. Bainum and his wife; and 40,305 shares held by the Commonweal Foundation of which Mr. Bainum is Chairman of the Board of Directors and has shared voting authority. Also includes 798,711 shares held by the Jane L. Bainum Declaration of Trust, the sole trustee of which is Mr. Bainum's wife, and 1,679,628 shares owned by Mid Pines in which Mr. Bainum indirectly has shared voting authority. Does not include shares included in the table above as owned beneficially by Stewart Bainum, Jr., Mr. Bainum's son, or Ms. Barbara Bainum, Mr. Bainum's daughter, except those shares owned by Bainum Associates, MC Investments, Mid Pines and the Commonweal Foundation in which Mr. Bainum has a beneficial interest. Also does not include 94,500 shares held by his other two adult children. (4) Includes 101,013 shares owned directly by Ms. Bainum. Also includes 40,305 shares owned by the Commonweal Foundation, of which Ms. Bainum is President, Secretary and a member of the board, and with respect to which she has shared voting authority and 1,679,628 shares owned by Mid Pines, in which Ms. Bainum is a general partner and has shared voting authority. Shares owned by the Commonweal Foundation and Mid Pines are also included in the above table as owned beneficially by Stewart Bainum and Stewart Bainum, Jr., respectively. Does not include (i) shares owned by Bainum Associates in which Ms. Bainum is a limited partner, (ii) shares owned by MC Investments, in which Ms. Bainum is a limited partner, (iii) shares owned by Realty Investment, in which Ms. Bainum owns 8.3% of the outstanding common stock and (iv) shares owned directly or indirectly by Ms. Bainum's adult children or trusts for their benefit. Ms. Bainum is the daughter of Mr. Bainum and the sister of Mr. Bainum, Jr. (5) Includes 3,600 shares which Mr. DiRico has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, 76 shares purchased by Mr. DiRico pursuant to the terms of the Manor Care 1995 Employee Stock Purchase Plan and 55 shares and 115 shares, respectively, which Mr. DiRico has the right to receive upon termination of his employment pursuant to the terms of the Manor Care 401(k) Plan and the Manor Care Nonqualified Savings Plan. (6) Includes 4,500 shares which Mr. Hazard has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, and 113 shares and 415 shares, respectively, which Mr. Hazard has the right to receive upon termination of his employment pursuant to the terms of the Manor Care 401(k) Plan and the Manor Care Nonqualified Savings Plan. (7) Includes 5,934 shares which Mr. Kaden has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, and 276 shares purchased by Mr. Kaden pursuant to the terms of the Manor Care Employee Stock Purchase Plan. (8) Includes 38,500 shares which Mr. Landry has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, and 108 shares and 170 shares, respectively, which Mr. Landry has the right to receive upon termination of his employment pursuant to the terms of the Manor Care 401(k) Plan and the Manor Care Nonqualified Savings Plan. 57 62 (9) Includes 1,666 shares which Mr. Malek has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996. (10) Includes 8,661 shares held in trust for minor children for which Mr. Petitt is trustee. Beneficial ownership of such shares is disclaimed. Also includes 4,500 shares which Mr. Petitt has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996 and 473 shares purchased by Mr. Petitt pursuant to the terms of the Manor Care, Inc. 1995 Employee Stock Purchase Plan (the "Manor Care Employee Stock Purchase Plan"). (11) Includes 1,666 shares which Mr. Robertson has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, 814 shares acquired pursuant to the Manor Care, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. (12) Includes 14,000 shares which Mr. Smith has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996, and 86 shares and 165 shares, respectively, which Mr. Smith has the right to receive upon termination of his employment with the Company pursuant to the terms of the Manor Care 401(k) Plan and the Manor Care Nonqualified Savings Plan. (13) Includes a total of 780,532 shares which the officers and directors included in the group have the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after September 9, 1996 and a total of 2,040 shares and 1,731 shares, respectively, which such directors and officers have the right to receive upon termination of their employment with the Company pursuant to the terms of the Manor Care 401(k) Plan and the Manor Care Nonqualified Savings Plan. (14) As of June 18, 1996, based on a Schedule 13-D, as amended, filed by Mr. Baron with the Securities and Exchange Commission (the "Commission"). Mr. Baron's address is 450 Park Avenue, Suite 2800, New York, New York 10022. 58 63 DESCRIPTION OF CAPITAL STOCK OF THE COMPANY Under the Restated Certificate of the Company, which is attached as Appendix A to this Information Statement, the total number of shares of capital stock that the Company has authority to issue is 165,000,000, consisting of 160,000,000 shares of common stock, par value $.01 per share, and 5,000,000 shares of preferred stock (the "Preferred Stock"), par value $.01 per share. Based on the number of shares of Manor Care Common Stock outstanding at the Record Date, it is expected that shares of the Company's Common Stock will be issued to stockholders of Manor Care in the Distribution. All the shares of the Company's Common Stock to be distributed to Manor Care stockholders in the Distribution will be fully paid and non-assessable. COMMON STOCK The Restated Certificate designates a series of common stock consisting of 75,000,000 shares of common stock. The Company Common Stock being distributed on the Distribution Date is part of such series. Holders of the Company's Common Stock are entitled to receive, subject to preferences that may be applicable from time to time with respect to any outstanding Preferred Stock, such dividends as are declared by the Board of Directors of the Company, one vote for each share at all meetings of stockholders, and, subject to preferences that may be applicable from time to time with respect to any outstanding Preferred Stock, the remaining assets of the Company upon liquidation, dissolution or winding up of the Company. The Company is authorized to issue additional shares of common stock without further stockholder approval (except as may be required by applicable law or stock exchange regulations). With respect to the issuance of common shares of any additional series, the Board of Directors of the Company is authorized to determine, without any further action by the holders of the Company's Common Stock, among other things, the dividend rights, dividend rate, conversion rights, voting rights and rights and terms of redemption, as well as the number of shares constituting such series and the designation thereof. Should the Board of Directors of the Company elect to exercise its authority, the rights and privileges of holders of the Company's Common Stock could be made subject to rights and privileges of any such other series of common stock. The Company has no present plans to issue any common stock of a series other than the Company's Common Stock. See "Dividend Policy" for a description of the dividend policy of the Company after the Distribution. PREFERRED STOCK The Company's Board of Directors is authorized to issue up to 5,000,000 shares of Preferred Stock without further stockholder approval (except as may be required by applicable law or stock exchange regulations) and to fix from time to time, by resolution or resolutions, the relative powers, preferences and rights and the qualifications, limitations or restrictions of any series of Preferred Stock, as well as the number of shares constituting such series and the designation thereof. PREEMPTIVE RIGHTS Holders of shares of Company Common Stock have no preemptive rights. PURPOSES AND EFFECTS OF CERTAIN CHARTER AND BY-LAW PROVISIONS GENERAL The provisions of the Restated Certificate and the By-Laws described in this section, and the ability to issue additional series of capital stock without a stockholder vote, may delay or make more difficult acquisitions of or changes of control of the Company not approved by the Company's Board of Directors. Such provisions enable the Company, particularly (but not exclusively) in the initial years of its existence as an independent, publicly owned company, to develop its business in a manner which will foster its long term 59 64 growth without disruption caused by the threat of a takeover not deemed by its Board of Directors to be in the best interest of the Company and its stockholders. Pursuant to the Restated Certificate the affirmative vote of the holders of shares representing not less than two-thirds of the voting power of the Company is required for the approval of any proposal to merge or consolidate with any other entity (other than an entity 90% owned by the Company) or sell, lease or exchange all or substantially all of the Company's assets. In addition, among other things, the Restated Certificate provides that (i) stockholder action can be taken only at an annual or special meeting of stockholders and not by written consent in lieu of a meeting and (ii) special meetings of the stockholders may be called only by the Chairman or the Vice Chairman of the Board or by the Secretary of the Company within 10 calendar days after receipt of the written request of a majority of the total number of directors of the Company (assuming no vacancies). The Company's By-Laws require that stockholders desiring to bring any business, including nominations for directors, before an annual meeting of stockholders deliver written notice thereof to the Secretary of the Company not later than 60 days in advance of the meeting of stockholders; provided, however, that in the event that the date of the meeting is not publicly announced by the Company by press release or inclusion in a report filed with the Commission or furnished to stockholders more than 75 days prior to the meeting, notice by the stockholder to be timely must be delivered to the secretary of the Company not later than the close of business on the tenth day following the day on which such announcement of the date of the meeting was so communicated. The By-Laws further require that the notice by the stockholder set forth a description of the business to be brought before the meeting and the reasons for conducting such business at the meeting and certain information concerning the stockholder proposing such business and the beneficial owner, if any, on whose behalf the proposal is made, including their names and addresses, the class and number of shares of the Company that are owned beneficially and of record by each of them, and any material interest of either of them in the business proposed to be brought before the meeting. The recipient of a revocable proxy is not deemed to be a beneficial owner of the shares underlying such proxy, and the foregoing provisions do not affect the granting or receipt of a revocable proxy. LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS ELIMINATION OF LIABILITY IN CERTAIN CIRCUMSTANCES Pursuant to authority conferred by Delaware General Corporation Law Section 102, the Restated Certificate provides that no director of the Company shall be liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director except for breach of the director's duty of loyalty to the Company or the stockholders, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, for unlawful payment of dividends, unlawful stock redemptions or repurchases and for any transaction from which the director derived an improper personal benefit. This provision is intended to eliminate the risk that a director might incur personal liability to the Company or its stockholders for breach of the duty of care. The Restated Certificate also provides that if Delaware law is amended to further limit the liability of directors, then the liability of a director of the Company shall be further limited to the fullest extent permitted by Delaware law as so amended. INDEMNIFICATION AND INSURANCE Delaware General Corporation Law Section 145 contains provisions permitting and, in some situations, requiring Delaware corporations, such as the Company, to provide indemnification to their officers and directors for losses and litigation expense incurred in connection with their service to the corporation in those capacities. The Restated Certificate contains provisions requiring indemnification by the Company of its directors and officers to the fullest extent permitted by law. Among other things, the Restated Certificate provides indemnification for officers and directors against liabilities for judgments in and settlements of lawsuits and other proceedings and for the advance and payment of fees and expenses reasonably incurred by the director or officer in defense of any such lawsuit or proceeding. 60 65 AVAILABLE INFORMATION The Company has filed with the Commission a Form 10 under the Securities Exchange Act of 1934, as amended (the "Exchange Act") with respect to the Company Common Stock described herein. This Information Statement does not contain all the information set forth in the Form 10 and exhibits thereto. For further information reference is made to the Form 10 and the exhibits thereto. When the Form 10 becomes effective, the Company will be subject to the informational requirements of the Exchange Act of 1934, as amended, and in accordance therewith will file reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information can be inspected and copied at the public reference facilities maintained by the Commission at its principal offices at 450 Fifth Street, N.W., Washington, D.C. 20549, and at its regional offices at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York 10048. Copies of such material may be obtained at prescribed rates from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of such site is (http://www. sec. gov). Application has been made to list the Company's Common Stock on the New York Stock Exchange and, if and when such shares commence trading on the New York Stock Exchange, such reports, proxy statements and other information concerning the Company will be available for inspection at the New York Stock Exchange, 20 Broad Street, New York, New York 10005. 61 66 INDEX TO COMBINED FINANCIAL STATEMENTS Report of Independent Public Accountants.............................................. F-2 Combined Balance Sheets as of May 31, 1995 and May 31, 1996........................... F-3 Combined Statements of Income for the fiscal years ended May 31, 1994, May 31, 1995 and May 31, 1996.................................................................... F-4 Combined Statements of Cash Flows for the fiscal years ended May 31, 1994, May 31, 1995 and May 31, 1996............................................................... F-5 Notes to Combined Financial Statements................................................ F-6
F-1 67 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders of Manor Care, Inc.: We have audited the accompanying combined balance sheets of Choice Hotels Holdings, Inc. (a Delaware corporation), as described under "Basis of Presentation" in the Notes to Combined Financial Statements, as of May 31, 1995 and 1996, and the related combined statements of income and cash flows for each of the three years in the period ended May 31, 1996. These combined financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these combined financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of Choice Hotels Holdings, Inc. as of May 31, 1996 and 1995, and the combined results of their operations and their combined cash flows for each of the three years in the period ended May 31, 1996, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic combined financial statements taken as a whole. The schedule attached to the Company's Registration Statement on Form 10 as Exhibit 99.01 is presented for the purpose of complying with the Securities and Exchange Commission rules and is not part of the basic combined financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic combined financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic combined financial statements taken as a whole. Arthur Andersen LLP Washington, D.C., June 28, 1996 F-2 68 CHOICE HOTELS HOLDINGS, INC. COMBINED BALANCE SHEETS (IN THOUSANDS)
MAY 31, --------------------- 1995 1996 -------- -------- ASSETS CURRENT ASSETS Cash and cash equivalents............................................ $ 2,088 $ 4,142 Receivables (net of allowance for doubtful accounts of $4,202, and $4,825, respectively)............................................. 21,946 30,619 Inventories.......................................................... 289 757 Current deferred income tax benefit.................................. -- 1,266 Prepaid expenses..................................................... 2,807 3,003 Other................................................................ 955 1,215 -------- -------- Total current assets......................................... 28,085 41,002 -------- -------- PROPERTY AND EQUIPMENT, AT COST, NET OF ACCUMULATED DEPRECIATION....... 257,156 299,527 -------- -------- LODGING FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION.............. 61,565 58,676 -------- -------- GOODWILL, NET OF ACCUMULATED AMORTIZATION.............................. 32,128 59,839 -------- -------- OTHER ASSETS........................................................... 12,541 32,260 -------- -------- $391,475 $491,304 ======== ======== LIABILITIES AND EQUITY CURRENT LIABILITIES Current portion of mortgages and long term debt...................... $ 639 $ 669 Accounts payable..................................................... 46,109 24,473 Accrued expenses..................................................... 15,366 21,656 Income taxes payable................................................. 634 1,810 -------- -------- Total current liabilities.................................... 62,748 48,608 -------- -------- MORTGAGES AND OTHER LONG TERM DEBT..................................... 52,030 68,469 -------- -------- NOTES PAYABLE TO PARENT................................................ 198,522 225,723 -------- -------- DEFERRED INCOME TAXES ($11,620 AND $0, RESPECTIVELY) AND OTHER LIABILITIES.......................................................... 12,346 945 -------- -------- EQUITY Investments and advances from Parent................................. 65,829 147,559 -------- -------- $391,475 $491,304 ======== ========
The accompanying notes are an integral part of these combined balance sheets. F-3 69 CHOICE HOTELS HOLDINGS, INC. COMBINED STATEMENTS OF INCOME (IN THOUSANDS)
YEAR ENDED MAY 31, ------------------------------ 1994 1995 1996 -------- -------- -------- REVENUES Franchise.............................................................. $165,581 $188,021 $219,164 Hotel operations....................................................... 74,183 114,514 155,709 -------- -------- -------- Total revenues.................................................. 239,764 302,535 374,873 -------- -------- -------- OPERATING EXPENSES Franchise marketing.................................................... 45,373 45,510 49,658 Franchise reservations................................................. 26,685 28,738 35,677 Hotel operations....................................................... 60,062 84,711 106,120 Selling, general and administration expenses........................... 57,081 69,676 83,267 Depreciation and amortization.......................................... 17,521 21,841 26,026 Provision for asset impairment and restructuring....................... -- -- 33,335 -------- -------- -------- Total operating expenses........................................ 206,722 250,476 334,083 -------- -------- -------- INCOME BEFORE OTHER EXPENSES AND INCOME TAXES............................ 33,042 52,059 40,790 -------- -------- -------- OTHER EXPENSES Interest expense on notes payable to Parent............................ 10,665 15,492 19,673 Minority interest...................................................... 1,476 2,200 1,532 Other interest and other expenses, net................................. 3,223 4,412 3,727 -------- -------- -------- Total other expenses............................................ 15,364 22,104 24,932 -------- -------- -------- Income before income taxes............................................... 17,678 29,955 15,858 Income taxes............................................................. 8,019 13,144 7,400 -------- -------- -------- Net Income............................................................... $ 9,659 $ 16,811 $ 8,458 ========= ========= =========
The accompanying notes are an integral part of these combined statements of income. F-4 70 CHOICE HOTELS HOLDINGS, INC. COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED MAY 31, ----------------------------------- 1994 1995 1996 -------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income.......................................................... $ 9,659 $ 16,811 $ 8,458 Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization................................... 17,521 21,841 26,026 Amortization of debt discount................................... 74 171 34 Provision for bad debts......................................... 3,360 906 974 (Decrease) increase in deferred taxes........................... 3,328 827 (12,885) Gain on sale of operating hotel................................. -- -- 584 Provision for asset impairment.................................. -- -- 28,160 Change in assets and liabilities (excluding sold hotels and acquisitions): Change in receivables........................................... 1,063 (4,529) (9,647) Change in inventories and other current assets.................. (340) 3,748 (1,047) Change in current liabilities................................... 8,457 5,691 11,153 Change in income taxes payable.................................. -- 634 1,176 Change in other liabilities..................................... 1,454 1,803 1,750 -------- -------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES.................. 44,576 47,903 54,736 -------- -------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in property and equipment.............................. (17,939) (34,889) (47,443) Acquisition of operating hotels................................... (44,200) (59,766) (49,617) Acquisition of a hotel chain...................................... (10,400) -- -- Proceeds from sale of operating hotels............................ 7,200 -- 5,479 Purchase of minority interest..................................... -- -- (55,269) Investment in Friendly Hotels, PLC................................ -- -- (17,069) Other items, net.................................................. (3,788) 1,595 (5,722) -------- -------- --------- NET CASH UTILIZED BY INVESTING ACTIVITIES.................. (69,127) (93,060) (169,641) -------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from mortgages and other long-term debt.................. 5,079 15,567 17,296 Principal payments of debt........................................ (1,993) (16,382) (810) Proceeds from notes payable to Parent............................. 68,361 51,461 27,201 Cash transfers (to) from Parent, net.............................. (45,198) (6,190) 73,272 -------- -------- --------- NET CASH PROVIDED BY FINANCING ACTIVITIES.................. 26,249 44,456 116,959 -------- -------- --------- Net change in cash and cash equivalents............................. 1,698 (701) 2,054 Cash and cash equivalents at beginning of period.................... 1,091 2,789 2,088 -------- -------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD............................................................ $ 2,789 $ 2,088 $ 4,142 ========= ========= ==========
The accompanying notes are an integral part of these combined statements of cash flows. F-5 71 NOTES TO COMBINED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION On March 7, 1996, Manor Care, Inc., ("Manor Care") announced its intention to proceed with the separation of its lodging business from its health care business via a spin-off of its lodging business (the "Distribution"). Manor Care's Board of Directors voted to approve, in principle, the Distribution subject to receipt of other approvals and consents and satisfactory implementation of the arrangements for the Distribution. Manor Care intends to consummate the Distribution in the second quarter of fiscal year 1997 through a special dividend to its shareholders of one share of common stock of Choice Hotels Holdings, Inc. (the "Company") for each share of Manor Care common stock. The Distribution is conditional upon certain matters, including declaration of the special dividend by Manor Care's board of directors. Manor Care has received a ruling from the Internal Revenue Service that the Distribution will be tax-free. The Company was formed on June 27, 1996 to facilitate the proposed Distribution of Manor Care's lodging operations. Upon consummation of the Distribution, the Company will change its name to Choice Hotels International, Inc. The operations of the Company will consist principally of the hotel franchise operations and the owned and managed hotel operations formerly conducted by Manor Care directly or through Manor Care's subsidiaries (the "Lodging Business"). As of May 31, 1996, the Company had franchise agreements with 3,052 hotels operating in 30 countries principally under the following brand names: Comfort, Clarion, Sleep, Quality, Rodeway and Econo Lodge. The Company also owns and manages, under its six principal brand names, 79 hotels in 25 states, as well as in Germany, France and England. The combined financial statements present the financial position, results of operations and cash flows of the Company as if it were formed as a separate entity of Manor Care which conducted the Lodging Business for all periods presented. Manor Care's historical basis in the assets and liabilities of the Company has been carried over to the combined financial statements. All material intercompany transactions and balances between the Company and its subsidiaries have been eliminated. Changes in the investments and advances from Parent represent the net income of the Company plus the net change in cash transferred between the Company and Manor Care. An analysis of the activity in the "Investments and advances from Parent" account for the three years ended May 31, 1996 is as follows:
(IN THOUSANDS) Balance, May 31, 1993.................................................. 90,747 Cash transfers to Parent, net.......................................... (45,198) Net income............................................................. 9,659 ------------ Balance, May 31, 1994.................................................. 55,208 Cash transfers to Parent, net.......................................... (6,190) Net income............................................................. 16,811 ------------ Balance, May 31, 1995.................................................. 65,829 Cash transfers from Parent, net........................................ 73,272 Net income............................................................. 8,458 ------------ Balance, May 31, 1996.................................................. $147,559 ============
The average balance of the investments and advances from Parent was $73.0 million, $60.5 million and $107.0 million for the fiscal years 1994, 1995 and 1996, respectively. F-6 72 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) PRO FORMA INCOME PER SHARE (UNAUDITED) Per share data is not presented on a historical basis because the Company was not a publicly-held company during the periods presented. Pro forma income per share for 1996, after giving effect to the transactions described in the pro forma combined financial statements, would have been $0.12. The pro forma income per common share is computed by dividing pro forma net income by the pro forma weighted average number of outstanding common shares, aggregating 62.6 million in 1996. The pro forma weighted average number of outstanding common shares is based on Manor Care's weighted average number of outstanding common shares. PROPERTY AND EQUIPMENT The components of property and equipment at the respective dates presented in the combined balance sheets were:
MAY 31, ----------------------- 1995 1996 -------- -------- (IN THOUSANDS) Land......................................................... $ 35,676 $ 45,459 Building and improvements.................................... 206,510 227,611 Capitalized leases........................................... 6,244 6,244 Furniture, fixtures and equipment............................ 61,452 65,369 Hotels under construction.................................... 8,077 18,224 -------- -------- 317,959 362,907 Less: Accumulated depreciation............................... (60,803) (63,380) -------- -------- $257,156 $299,527 ======== ========
Depreciation has been computed for financial reporting purposes using the straight-line method. A summary of the ranges of estimated useful lives upon which depreciation rates have been based follows: Building and improvements............................................... 10-40 years Furniture, fixtures and equipment....................................... 3-20 years
Accumulated depreciation includes $3.3 million at May 31, 1995 and $3.5 million at May 31, 1996 relating to capitalized leases. Capitalized leases are amortized on a straight-line basis over the lesser of the lease term or the remaining useful lives of the leased properties. MINORITY INTEREST Prior to May 31, 1996, certain members of the Company's management had a minority ownership interest in Choice Hotels International, Inc., a majority owned subsidiary. Amounts reflected as minority interest represent the minority owners' share of income in Choice Hotels International, Inc. As of May 31, 1996, the Company had repurchased all of the outstanding minority ownership interest from management. GOODWILL Goodwill primarily represents an allocation of the excess purchase price of the stock of Choice Hotels International, Inc. over the recorded minority interest. Goodwill is being amortized over 40 years. Such amortization amounted to $343,000 in each of the years ended May 31, 1994 and 1995 and $854,000 in the year ended May 31, 1996. Goodwill is net of accumulated amortization of $1.9 million and $2.8 million at May 31, 1995 and 1996, respectively. F-7 73 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) DEFERRED DEVELOPMENT COSTS Included in other assets are deferred costs of $934,000 and $172,000, net of accumulated amortization, as of May 31, 1995 and 1996, respectively, associated with the development of a computerized reservation system and other related systems. These costs are being amortized over five years. Such amortization amounted to approximately $1.0 million for the fiscal years ended May 31, 1994 and 1995, and $762,000 for the fiscal year ended May 31, 1996. Deferred development costs are net of accumulated amortization of $4.2 million and $372,000 at May 31, 1995 and 1996, respectively. FRANCHISE RIGHTS Franchise rights are an intangible asset and represent an allocation in purchase accounting for the value of long-term franchise contracts. The majority of the balance resulted from the Econo Lodge and Rodeway acquisitions made in fiscal year 1991. Franchise rights acquired are amortized over an average life of twenty-six years. Amortization expense amounted to $2.9 million for each of the years ended May 31, 1994, 1995 and 1996. Franchise rights are net of accumulated amortization of $8.5 million and $11.4 million at May 31, 1995 and 1996, respectively. The Company evaluates the recoverability of franchise rights no less than annually, based on net, undiscounted expected cash flows associated with these franchises. Such rights are considered to be impaired if the net, undiscounted expected cash flows are less than the carrying amount of the asset. Impairment charges are recorded based upon the difference between the carrying value of the asset and the expected net cash flows, discounted at an appropriate interest rate. SELF-INSURANCE PROGRAM Prior to the Distribution, the Company participated in Manor Care's self-insurance program for certain levels of general and professional liability, automobile liability and workers' compensation coverage. The estimated costs of these programs are accrued at present values based on actuarial projections for known and anticipated claims. All accrued self-insurance costs have been treated as paid to Manor Care, and as such, amounts paid to Manor Care have been charged directly to investments and advances from Parent. Subsequent to the Distribution, the Company will establish and maintain its own insurance program. FRANCHISE REVENUES The Company enters into numerous franchise agreements committing to provide licensees with various marketing services, a centralized reservation system and limited rights to utilize the Company's registered tradenames. These agreements are typically for a period of twenty years, with certain rights to the franchisee to terminate after 10 or 15 years. The Company has no significant financial commitments to its franchisees. Royalty fees, based on gross room revenues of each franchisee, are recorded when earned. Reserves for uncollectible accounts are charged to bad debt expense and included in selling, general and administrative expenses in the accompanying combined statements of income. The Company assesses franchisees monthly fees related to marketing and reservations which are expended for national advertising, marketing, and selling activities and the operation of a centralized reservation system. CAPITALIZATION POLICIES Major renovations and replacements are capitalized to appropriate property and equipment accounts. Upon sale or retirement of property, the cost and related accumulated depreciation are eliminated from the accounts and the related gain or loss is taken into income. Maintenance, repairs and minor replacements are charged to expense. F-8 74 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) Construction overhead and costs incurred to ready a project for its intended use are capitalized for major development projects and are amortized over the lives of the related assets. Personnel recruitment and training costs related to hotels under construction are deferred until construction is completed and then amortized over two years. Costs of approximately $359,000, $585,000 and $2.6 million were capitalized in each of the fiscal years ended May 31, 1994, 1995 and 1996, respectively. The Company capitalizes interest on borrowings applicable to hotels under construction. Capitalized interest for the years ended May 31, 1994, 1995 and 1996 amounted to $117,000, $197,000, and $753,000, respectively. FOREIGN OPERATIONS The Company accounts for foreign currency translation in accordance with SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign operations for the fiscal years ended May 31, 1994, 1995 and 1996 were $21.2 million, $29.2 million and $29.9 million, respectively. Losses were generated by foreign operations for the fiscal years ended May 31, 1994, 1995 and 1996 of $5.5 million, $5.7 million and $19.3 million, respectively. Losses generated by foreign operations for fiscal year 1996 include $15.0 million relating to a provision for asset impairment and restructuring. Translation gains and losses are recorded in the cumulative translation adjustment account included in Investments and advances from Parent in the accompanying combined balance sheets as follows:
(IN THOUSANDS) Balance, May 31, 1993......................................... $ 352 Net adjustments............................................... (383) ------- Balance, May 31, 1994......................................... (31) Net adjustments............................................... 740 ------- Balance, May 31, 1995......................................... 709 Net adjustments............................................... (2,459) ------- Balance, May 31, 1996......................................... $(1,750) =======
USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. INCOME TAXES The Company is included in the consolidated federal income tax return of Manor Care. The income tax provision included in these combined financial statements reflects the historical income tax provision and temporary differences attributable to the operations of the Company on a separate return basis. Deferred taxes are recorded for the tax effect of temporary differences between book and tax income. F-9 75 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) Income before income taxes for the fiscal years ended May 31, 1994, 1995 and 1996 were derived from the following:
1994 1995 1996 -------- -------- -------- (IN THOUSANDS) Income before income taxes Domestic operations.................................. $ 26,812 $ 39,329 $ 47,682 Foreign operations................................... (9,134) (9,374) (31,824) -------- -------- -------- Combined income before income taxes............... $ 17,678 $ 29,955 $ 15,858 ======== ======== ========
Income before income taxes for domestic operations and foreign operations for fiscal year 1996 includes provisions of $8.5 million and $24.8 million, respectively, for asset impairment and restructuring. The income tax provisions for fiscal years 1994, 1995 and 1996 were accounted for under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The provisions for income taxes follows for the fiscal years ended May 31:
1994 1995 1996 ------- ------- -------- (IN THOUSANDS) Current tax (benefit) expense Federal................................................ $ 7,683 $13,756 $ 19,978 Foreign................................................ (3,608) (3,703) (2,792) State.................................................. 941 2,231 3,729 Deferred tax (benefit) expense Federal................................................ 2,537 745 (3,071) Foreign................................................ -- -- (9,778) State.................................................. 466 115 (666) ------ ------- -------- $ 8,019 $13,144 $ 7,400 ====== ======= ========
Included in the 1994 tax provision is a charge of $156,000 due to the impact of the change in the tax rates on prior periods. Deferred tax assets (liabilities) are comprised of the following at May 31:
1994 1995 1996 -------- -------- ------- (IN THOUSANDS) Depreciation and amortization........................... $(11,289) $(11,760) $ (236) Prepaid expenses........................................ (1,412) (1,386) (1,550) Foreign operations...................................... (710) -- -- Other................................................... (2,147) (2,202) (2,112) -------- -------- ------- Gross deferred tax liabilities.......................... (15,558) (15,348) (3,898) -------- -------- ------- Foreign operations...................................... -- 1,086 1,931 Accrued expenses........................................ 2,893 1,393 3,757 Net operating loss...................................... 1,242 1,031 820 Other................................................... 776 218 556 -------- -------- ------- Gross deferred tax assets............................... 4,911 3,728 7,064 -------- -------- ------- Net deferred (benefit) tax.................... $(10,647) $(11,620) $ 3,166 ======== ======== =======
F-10 76 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) A reconciliation of income tax expense at the statutory rate to income tax expense included in the accompanying combined statements of income follows:
1994 1995 1996 ------ ------- ------ (IN THOUSANDS EXCEPT FEDERAL INCOME TAX RATE) Federal income tax rate..................................... 35% 35% 35% Federal taxes at statutory rate............................. $6,187 $10,484 $5,552 State income taxes, net of Federal tax benefit.............. 914 1,525 860 Other....................................................... 918 1,135 988 ------ ------- ------ Income tax expense.......................................... $8,019 $13,144 $7,400 ====== ======= ======
Cash paid for state income taxes was $595,000, $571,000 and $1,586,000 for the years ended May 31, 1994, 1995 and 1996, respectively. Federal income taxes were paid by Manor Care. ACCRUED EXPENSES Accrued expenses at May 31, 1995 and 1996 were as follows:
1995 1996 ------- ------- (IN THOUSANDS) Payroll............................................................ $ 6,284 $ 8,670 Taxes, other than income........................................... 2,981 3,426 Other.............................................................. 6,101 9,560 ------- ------- $15,366 $21,656 ======= =======
MORTGAGES AND OTHER LONG TERM DEBT Maturities of mortgages and other long term debt at May 31, 1996 were as follows:
FISCAL YEAR (IN THOUSANDS) --------------------------------------------------------------- -------------- 1997........................................................... 669 1998........................................................... 414 1999........................................................... 442 2000........................................................... 599 2001........................................................... 646 2002 to 2009................................................... 66,368 -------------- $ 69,138 ===========
Long term debt, consisting of foreign currency borrowings under Manor Care's $250 million competitive advance and multi-currency revolving credit facility, mortgages and capital leases was net of discount of $146,000 and $112,000 at May 31, 1995 and 1996, respectively. Amortization of discount was $74,000 in 1994, $171,000 in 1995 and $34,000 in 1996. During fiscal year 1996, interest rates on mortgages and other long term debt ranged from 5.8% to 10.0%. The effective interest rate in fiscal year 1996 was 7.2%. The Company is a co-guarantor with Manor Care and other affiliates for the $250 million competitive advance and multi-currency revolving credit facility. The facility provides that up to $75.0 million is available in foreign currency borrowings under the foreign currency portion of the facility. The Company's borrowings under this facility amounted to $50.6 million at May 31, 1996. The Company is charged interest for amounts borrowed under the foreign currency portion of the facility at one of several interest rates, including LIBOR plus 26.25 basis points. In connection with the Distribution, the Company intends to secure financing to repay F-11 77 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) the Company's portion of borrowings under Manor Care's foreign currency portion of the facility. Upon repayment, it is anticipated that the Company will be released from all liabilities and guarantees relating to the Manor Care credit facility. At May 31,1996, owned property with a net book value of $2.8 million was pledged or mortgaged as collateral. LEASES The Company operates certain property and equipment under leases, some with purchase options that expire at various dates through 2051. Future minimum lease payments are as follows:
OPERATING CAPITALIZED LEASES LEASES --------- ----------- (IN THOUSANDS) 1997............................................................. $ 545 $ 771 1998............................................................. 370 568 1999............................................................. 296 500 2000............................................................. 186 500 2001............................................................. 172 500 Thereafter....................................................... 6,477 613 --------- ----------- Total minimum lease payments........................... $ 8,046 $ 3,452 ======= Less: Amount representing interest............................... (817) ----------- Present value of lease payments.................................. 2,635 Less: Current portion............................................ (532) ----------- Lease obligations included in long-term debt..................... $ 2,103 ========
Rental expense under noncancellable operating leases was $738,000 in 1994, $721,000 in 1995 and $563,000 in 1996. ACQUISITIONS AND DIVESTITURES On May 31, 1995, Manor Care repurchased one-half of the 11% interest held by its management in Choice Hotels International Inc. Approximately $19.8 million was allocated to goodwill; the purchase cost of $27.4 million was paid in June and July 1995. On May 31, 1996, the Company repurchased the remaining 5.5% minority interest in Choice Hotels International, Inc. for $27.9 million. Approximately $26.4 million was allocated to goodwill. During fiscal year 1996, the Company purchased 16 operating hotels containing over 1,900 rooms for $49.6 million. The Company also sold two operating hotels for $6.5 million. In addition, the Company purchased an equity interest in Friendly Hotels, PLC, a U.K. hotel company, for approximately $17 million. During fiscal year 1995, the Company purchased 16 operating hotels containing over 2,300 rooms for $59.8 million. During fiscal year 1994, the Company purchased 13 operating hotels containing over 1,900 rooms for $44.2 million. An additional $10.4 million was spent to acquire a hotel chain (Resthotel Primevere) operating primarily in France. The Company also sold a hotel for $7.2 million. Unless otherwise noted, acquisitions are accounted for as a purchase. Approximately 70% of the total costs for hotel acquisitions are allocated to buildings, approximately 20% to land and the remainder to furniture, fixtures and equipment. F-12 78 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) Unaudited summary pro forma income statement data for the three fiscal years ended May 31, 1996 assuming the above purchases of operating hotels occurred at the beginning of the year immediately preceding the year each purchase occurred, are as follows:
1994 1995 1996 --------- --------- --------- (UNAUDITED) (IN THOUSANDS) Revenues............................................... $285,735 $347,401 $387,819 ======== ======== ======== Net income............................................. $8,339 $16,865 $8,772 ======== ======== ======== Pro forma net income per share......................... $0.14 $0.27 $0.14 ======== ======== =======
The pro forma net income per share is computed by dividing pro forma net income by the pro forma weighted average number of outstanding common shares, aggregating 60.5 million in 1994, 62.5 million in 1995 and 62.6 million in 1996. The pro forma weighted average number of outstanding common shares is based on Manor Care's weighted average number of outstanding common shares. TRANSACTIONS WITH MANOR CARE Indebtedness related to lodging acquisitions and renovations that is reflected as notes payable to Parent in the accompanying combined balance sheets totaling $198.5 million and $225.7 million at May 31, 1995 and 1996, respectively, is due three years from the date of the Distribution. Interest expense on these notes for the years ended May 31, 1994, 1995 and 1996 was $10.7 million, $15.5 million and $19.7 million, respectively. Interest is charged at an annual rate of 9% on the indebtedness. It is expected that on or prior to the Distribution Date, the Company and a subsidiary of Manor Care will enter into a loan agreement, which shall govern the repayment by the Company of an aggregate of $225.7 million previously advanced to the Company by Manor Care. The loan agreement will contain a number of covenants that will, among other things, restrict the ability of the Company and its subsidiaries to make certain investments, incur debt, change its line of business, dispose of assets, create liens, sell receivables, enter into transactions with affiliates and otherwise restrict certain corporate activities. The loan agreement will also restrict the Company's ability to pay dividends. In addition, the loan agreement will contain, among other financial covenants, requirements that the Company maintain specified financial ratios, including maximum leverage and minimum interest coverage. The loan may be prepaid in whole or in part, together with accrued interest, without penalty, at the option of the Company. The Company will be required to prepay the loan with the proceeds from the monetization of Company-owned hotels. The Company participates in a cash concentration system with Manor Care and as such maintains no significant cash balances or banking relationships. Substantially all cash received by the Company has been immediately deposited in and combined with Manor Care's corporate funds through its cash management system. Similarly, operating expenses, capital expenditures and other cash requirements of the Company have been paid by Manor Care and charged to the Company. The net result of all of these intercompany transactions, with the exception of amounts relating to the acquisition of Company operated hotels that are reflected in the combined balance sheets as notes payable to Parent, are included in investments and advances from Parent in the combined balance sheets. Manor Care provides various services to the Company including, among others, cash management, payroll and payables processing, employee benefit plans, insurance, legal, accounting, tax, information systems and certain administrative services, as required. Manor Care charges the Company fees for general management, staff support and rental of office space on the basis of such factors as employee time incurred and square footage. This is essentially the same basis Manor Care utilizes to charge its other operating entities F-13 79 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) for such services. General corporate expenses of $5.5 million, $6.3 million and $7.4 million, respectively, were charged to operations for the years ended May 31, 1994, 1995 and 1996. Management believes that the foregoing charges are reasonable allocations of the costs incurred by Manor Care on the Company's behalf. The Company has estimated that general and administrative expenses incurred annually will increase by approximately $4.1 million after the Distribution. For purposes of providing an orderly transition after the Distribution, Manor Care and the Company will enter into various agreements, including, among others, a Distribution Agreement, Tax Sharing Agreement, Corporate Services Agreement and Employee Benefits Allocation Agreement. Effective at the Distribution, these agreements will provide, among other things, that the Company (i) will receive certain corporate and support services, such as accounting, tax and computer systems support, (ii) will establish pension, profit sharing and incentive plans similar to those in place at Manor Care and (iii) will receive certain risk management services and other miscellaneous administrative services. These agreements will extend for a period of 30 months from the Distribution date or until such time as the Company has arranged to provide such services in-house or through another unrelated provider of such services. COMMITMENTS AND CONTINGENCIES The Company is a defendant in a number of lawsuits arising in the ordinary course of business. In the opinion of management and general counsel to the Company, the ultimate outcome of such litigation will not have a material adverse effect on the Company's business, financial position or results of operations. Although the Company is currently not aware of any material environment claims pending against it, pursuant to the Distribution Agreement, the Company has agreed to indemnify Manor Care, its affiliates and certain other persons for liabilities related to the Lodging Business which will be assumed by the Company and for certain other specified environmental, third party personal injury and other liabilities. One or more subsidiaries or affiliates of Manor Care have been identified as defendants and/or potentially responsible parties ("PRPs") in a variety of actions (the "Actions") relating to approximately eleven waste disposal sites, which allegedly are subject to remedial action under the Comprehensive Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C. sec.sec. 9601 et seq. ("CERCLA") and similar state laws. CERCLA imposes retroactive, strict, joint and several liability on PRPs for the costs of hazardous substance clean-up. The Actions arise out of the alleged activities of Cenco and allege that Cenco transported and/or generated hazardous substances that came to be located the sites in question prior to Healthcare's acquisition of Cenco. Environmental proceedings such as the Actions may involve owners and/or operators of the hazardous waste site and multiple waste generators and waste transportation disposal companies. Such proceedings typically involve efforts of governmental entities and/or private parties to allocate or recover site investigation and cleanup costs, which costs may be substantial. Manor Care believes it has adequate insurance coverage for a substantial portion of the claims asserted in the Actions. Pursuant to the Distribution Agreement, the Company will indemnify Manor Care for any portion of the claims not covered by insurance. The most significant Action for Manor Care arises from the Kramer landfill, located in Mantua, New Jersey. On October 30, 1989, the New Jersey Department of Environmental Protection sued Manor Care and other defendants in U.S. District Court, District of New Jersey, seeking clean-up costs at the site where subsidiaries of Cenco allegedly transported waste. At about the same time, the United States filed a lawsuit against approximately 25 defendants in the same court seeking recovery of its expenses arising in connection with this site. Manor Care is a third party defendant in the latter suit. Based upon a recent court-approved final allocation plan, and also in view of its insurance coverage, Manor Care believes that the Kramer Action will not have a material adverse effect on its financial condition or results of operation. The Company believes that any liability it may have for indemnification of Manor Care will not have a material adverse effect on the Company's business, financial condition or results of operations. This final allocation plan is not binding. If the F-14 80 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) matter is not resolved by settlement, a court would have to allocate responsibility and Manor Care's allocation could change. Although Manor Care, together with its insurers, is vigorously contesting its liability in the Actions, it is not possible at the present time to estimate the ultimate legal and financial liability of Manor Care in respect to the Actions or the ultimate indemnification liability, if any, of the Company. As of May 31, 1996, the Company had contractual commitments of $15.1 million relating to its construction program. PENSION, PROFIT SHARING AND INCENTIVE PLANS Bonuses accrued for key executives of the Company under incentive compensation plans were $2.6 million in 1994, $1.7 million in 1995 and $1.2 million in 1996. Employees of the Company participate in retirement plans sponsored by the Parent. Costs allocated to the Company are based on the size of its payroll relative to the Parent's payroll. Costs allocated to the Company were approximately $1.0 million in 1994, $1.2 million in 1995 and $1.4 million in 1996. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company is required to disclose the fair value of its financial instruments in accordance with Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments". Fair values of material balances were determined by using market rates currently available. The balance sheet carrying amount of cash, cash equivalents and receivables approximate fair value due to the short term nature of these items. Mortgages and other long term debt consist of bank loans, mortgages and capital leases. Interest rates on bank loans adjust frequently based on current market rates; accordingly, the carrying amount of bank loans is equivalent to fair value. The carrying amounts for mortgages, capital leases and notes payable to Parent approximate fair market values. PROVISION FOR ASSET IMPAIRMENT AND RESTRUCTURING The Company regularly reviews the recoverability of the net carrying value of its long-lived assets (including goodwill related to franchise rights) and makes adjustments accordingly. The Company performs this review no less than annually and considers such factors as the current market value of assets, and the operating results and cash flows of business units. An asset is considered to be impaired if the expected net, undiscounted cash flows are less than the carrying amount of an asset. Impairment charges are recorded based on the fair value of the assets. During fiscal year 1996, the Company began restructuring its European operations. This restructuring effort included the purchase of an equity interest in Friendly Hotels, PLC and a reevaluation of key geographic markets in Europe. In connection with this restructuring, the Company performed a review of its European operations and in May 1996 recognized a $17.0 million non-cash charge (net of an $11.1 million income tax benefit) against earnings related primarily to the impairment of assets associated with certain European hotel operations. In addition, the Company recognized a restructuring charge of $3.1 million (net of a $2.1 million income tax benefit) in May 1996. Restructuring costs include severance and employee benefit plan restructuring costs and other costs directly associated with the Distribution. F-15 81 NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Company is required to adopt SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," no later than fiscal year 1997. The Company's current policy is to regularly review the recoverability of the net carrying value of its long-lived assets and make adjustments accordingly. The adoption of SFAS No. 121 is not expected to have a material impact on the Company's financial statements. The Company is required to adopt SFAS No. 123, "Accounting for Stock-Based Compensation," no later than fiscal year 1997. Management expects to adopt SFAS No. 123 utilizing the method which provides for disclosure of the impact of stock-based compensation grants. SUMMARY OF QUARTERLY RESULTS (IN THOUSANDS) (UNAUDITED)
INCOME (LOSS) NET BEFORE INCOME QUARTERS ENDED REVENUES INCOME TAXES (LOSS) - ---------------------------------------------------- -------- ------------- -------- FISCAL 1995 August............................................ $ 78,427 $ 10,942 $ 6,295 November.......................................... 77,127 10,354 5,962 February.......................................... 63,845 (279) (486) May............................................... 83,136 8,938 5,040 -------- ------------- -------- $302,535 $ 29,955 $ 16,811 ======== =========== ======== FISCAL 1996 August............................................ $ 99,380 $ 18,572 $ 10,914 November.......................................... 95,198 13,952 8,131 February.......................................... 79,326 2,878 1,391 May............................................... 100,969 (19,544)(a) (11,978) -------- ------------- -------- $374,873 $ 15,858 $ 8,458 ======== =========== ========
- --------------- (a) Includes a provision of $33.3 million for asset impairment and restructuring. F-16 82 APPENDIX A FORM OF RESTATED CERTIFICATE OF INCORPORATION OF CHOICE HOTELS HOLDINGS, INC. Choice Hotels Holdings, Inc. (the "Corporation"), a corporation incorporated on June 27, 1996 and existing under and by virtue of the General Corporation Law of the State of Delaware (the "GCL"), hereby certifies as follows: FIRST: The board of directors of the Corporation (the "Board of Directors") adopted a resolution proposing and declaring advisable the following amendments to and restatement of the Certificate of Incorporation of the Corporation. SECOND: This Restated Certificate of Incorporation was duly adopted by the sole stockholder of the Corporation in accordance with the provisions of Sections 228, 242 and 245 of the GCL. THIRD: The text of the Certificate of Incorporation is hereby amended and restated as herein set forth in full: 1. The name of the corporation is CHOICE HOTELS INTERNATIONAL, INC. (the "Corporation"). 2. The address of the Corporation's registered office in the State of Delaware is 100 West Tenth Street, in the City of Wilmington, County of New Castle. The name of its registered agent at such address is The Corporation Trust Company. 3. The purpose of the Corporation is to engage in any lawful act or activity for which corporations may be organized under the GCL. 4. The total number of shares of capital stock of all classifications which the Corporation shall have authority to issue is One Hundred Sixty-Five Million (165,000,000), of which One Hundred Sixty Million (160,000,000) shares having a par value of One Cent ($.01) per share shall be common stock, and Five Million (5,000,000) shares having a par value of One Cent ($.01) per share shall be preferred stock. Shares of common stock of the Corporation may be issued from time to time in one or more classes or series, each of which class or series shall have such distinctive designation or title as shall be fixed by the Board of Directors prior to the issuance of any shares thereof. Each such class or series of common stock shall have such voting powers (full or limited) or no voting powers, such preferences and relative participating, optional or other special rights, relative ranking and such qualifications, limitations or restrictions, as shall be stated in such resolution or resolutions providing for the issue of such class or series of common stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof pursuant to the authority hereby expressly vested in it, all in accordance with the laws of the State of Delaware. Without limiting the generality of the foregoing, shares of a series of common stock consisting of Seventy Five Million (75,000,000) shares, or such larger number of shares as the Board of Directors shall from time to time fix by resolution or resolutions, may be issued from time to time by the Board of Directors. Shares of this series shall be designated, and are hereinafter called "Common Stock." The holders of record of the Common Stock shall be entitled to the following rights: (a) subject to the rights of any holders of any class or series of capital stock as specified in the resolution providing for such class or series of capital stock, to vote at all meetings of stockholders of the Corporation, and at all such meetings such holders shall have one vote in respect of each share of Common Stock held of record by them; A-1 83 (b) subject to the rights of any holders of any class or series of capital stock having a preference with respect to dividends, to receive when, if and as declared by the Board of Directors out of the assets of the Corporation legally available therefor, such dividends as may be declared by the Corporation from time to time to holders of Common Stock; and (c) subject to the rights of any holders of any class or series of capital stock having a preference with respect to distribution of assets upon liquidation or dissolution, to receive the remaining assets of the Corporation upon liquidation, dissolution or winding-up. Shares of preferred stock of the Corporation may be issued from time to time in one or more classes or series, each of which class or series shall have such distinctive designation or title as shall be fixed by the Board of Directors prior to the issuance of any shares thereof. Each such class or series of preferred stock shall have such voting powers (full or limited) or no voting powers, such preferences and relative participating, optional or other special rights, relative ranking and such qualifications, limitations or restrictions, as shall be stated in such resolution or resolutions providing for the issue of such class or series of preferred stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof pursuant to the authority hereby expressly vested in it, all in accordance with the laws of the State of Delaware. Subject to the rights of any holders of any class or series of capital stock, as specified in the resolution providing for such class or series of capital stock, the holders of Common Stock are expressly denied the preemptive right to subscribe to any or all additional shares of capital stock of the Corporation or any or all classes or series thereof. Upon this Restated Certificate of Incorporation becoming effective pursuant to the GCL (the "Effective Time"), each share of the Corporation's common stock, par value $.01 per share (the "Old Common Stock"), issued and outstanding immediately prior to the Effective Time, will be automatically reclassified as and converted into one share of Common Stock. Any stock certificate that, immediately prior to the Effective Time, represents shares of the Old Common Stock will, from and after the Effective Time, automatically and without the necessity of presenting the same for exchange, represent the number of shares of Common Stock as equals the sum obtained by multiplying the number of shares of Old Common Stock represented by such certificate immediately prior to the Effective Time by one. 5. The Corporation expressly elects not to be governed by Section 203 of the GCL. 6. Subject to the rights of any holders of any class or series of capital stock as specified in the resolution providing for such class or series of capital stock, any action required to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing of such stockholders in lieu of a meeting. Special meetings of the stockholders of the Corporation may be called only by (i) the Chairman or Vice Chairman of the Board of Directors or (ii) the Secretary of the Corporation within 10 calendar days after receipt of the written request of a majority of the total number of directors which the Corporation would have if there were no vacancies (the "Whole Board"). Meetings of stockholders may be held within or without the State of Delaware, as the Bylaws may provide. The books of the Corporation may be kept outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in the Bylaws. 7. A. Subject to the rights of any holders of any class or series of capital stock as specified in the resolution providing for such class or series of capital stock, the business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors consisting of not less than 3 nor more than 12 directors, the exact number of directors to be determined from time to time solely by resolution adopted by the affirmative vote of a majority of the Whole Board. The directors shall be divided into three classes, designated Class I, Class II and Class III. Each Class of directors shall consist, as nearly as may be possible, of one-third of the total number of directors constituting the Whole Board. The initial term of the Class I directors shall expire upon the election and qualification of their successors at the 1997 annual meeting of stockholders; the initial term of the Class II directors shall expire upon the election and qualification of their successors at the A-2 84 1998 annual meeting of stockholders; and the initial term of the Class III directors shall expire upon the election and qualification of their successors at the 1999 annual meeting of stockholders. At each annual meeting of stockholders beginning with the 1997 annual meeting, successors to the Class of directors whose term expires at that annual meeting shall be elected for a three-year term and shall hold office until the annual meeting for the year in which his or her term expires and until his or her successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement, disqualification or removal from office. B. Subject to the rights of any holders of any class or series of capital stock as specified in the resolution providing for such class or series of capital stock, newly created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors resulting from death, resignation, retirement, disqualification, removal or other cause will be filled solely by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the Board of Directors. Increases or decreases in the number of directors shall be apportioned among the Classes so as to maintain the number of directors in each Class as nearly equal as possible, and any additional director of any Class elected to fill a vacancy resulting from an increase in such Class shall hold office for a term that shall coincide with the remaining term of that Class, but in no case will a decrease in the number of directors shorten the term of any incumbent director. C. The election of directors need not be by written ballot unless the Bylaws shall so provide. D. Notwithstanding the foregoing, whenever the holders of any one or more series of capital stock shall have the right, voting separately as a class or series, to elect directors, the election, removal, term of office, filling of vacancies and other features of such directorships shall be governed by the terms of this Restated Certificate of Incorporation applicable thereto, and such directors so elected shall not be divided into classes pursuant to Article 6, Section A, unless expressly provided by such terms. 8. The affirmative vote of the holders of the outstanding shares of capital stock representing not less than two-thirds of the Voting Power (as defined) of the Corporation shall be required for the approval of any proposal for the Corporation to dissolve, liquidate, merge, or consolidate with any other entity (other than an entity 90% of the Voting Power of which is owned by the Corporation), or sell, lease or exchange all or substantially all of its property and assets, including its goodwill and its corporate franchises. "Voting Power" means the total number of votes that may be cast by holders of capital stock in the election of directors. 9. The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Restated Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation. Notwithstanding anything contained in this Restated Certificate of Incorporation to the contrary, the affirmative vote of the holders of the outstanding shares of capital stock representing not less than two-thirds of the Voting Power of the Corporation shall be required to amend, alter, change or repeal, or to adopt any provision inconsistent with, Article 8 of this Restated Certificate of Incorporation. The Board of Directors shall have the power to make, adopt, alter, amend, change or repeal the Bylaws by resolution adopted by the affirmative vote of a majority of the Whole Board. Stockholders may not make, adopt, alter, amend, change or repeal the Bylaws except upon the affirmative vote of the holders of the outstanding shares of capital stock representing not less than two-thirds of the Voting Power of the Corporation and no Bylaws hereafter adopted by the stockholders or otherwise shall invalidate any prior act of the directors which would have been valid if such Bylaws had not been adopted. 10. A. No director of the Corporation shall be liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the GCL, or (iv) for any transaction from which the director derived an improper personal benefit. No amendment to or repeal of this Article 10 shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. If the GCL is amended hereafter to further limit the liability of a director, then the liability of a director of the Corporation shall be further limited to the fullest extent permitted by the GCL, as so amended. A-3 85 B. The Corporation shall indemnify each person who is or was or has agreed to become a director or officer of the Corporation, and may indemnify other employees and agents of the Corporation, to the fullest extent permitted by Section 145 of the GCL, as the same may be amended or supplemented, against all expenses and liabilities (including, but not limited to, counsel fees) reasonably incurred by or imposed upon such person in connection with any proceeding to which he or she may be made a party, or in which he or she may become involved, by reason of his or her being or having been a director, officer, employee or agent of the Corporation, or any settlement thereof, whether or not he or she is a director, officer, employee or agent at the time such expenses are incurred or liability incurred, except in such cases where the director, officer, employee or agent is adjudged guilty of willful misfeasance or malfeasance in the performance of his or her duties; provided that in the event of a settlement the indemnification herein shall apply only when the Board of Directors approves such settlement and reimbursement as being for the best interests of the Corporation. Without limiting the generality or the effect of the foregoing, the Corporation may adopt Bylaws, or enter into one or more agreements with any person, which provide for indemnification greater or different than that provided in this Article 10 or the GCL and the foregoing right of indemnification shall be in addition to and not exclusive of all other rights to which such director, officer, employee or agent may be entitled. C. The Corporation may purchase insurance on behalf of any person who is a director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted by him or her and incurred by him or her in any such capacity, or arising out of his or her status as such, whether or not the Corporation would have the power or the obligation to indemnify him or her against such liability under the provisions of this Article 10. 11. The Board of Directors, each committee of the Board of Directors and each individual director, in discharging their respective duties under applicable law and this Restated Certificate of Incorporation and in determining what they each believe to be in the best interests of the Corporation and its stockholders, may consider the effects, both short-term and long-term, of any action or proposed action taken or to be taken by the Corporation, the Board of Directors or any committee of the Board of Directors on the interests of (i) the employees, franchisees, licensees, customers, suppliers and/or creditors of the Corporation and its subsidiaries and (ii) the communities in which the Corporation and its subsidiaries own or lease property or conduct business, all to the extent that the Board of Directors, any committee of the Board of Directors or any individual director deems pertinent under the circumstances; provided, however, that the provisions of this Article 11 shall not limit in any way the right of the Board of Directors to consider any other lawful factors in making its determinations, including, without limitation, the effects, both short-term and long-term, or any action or proposed action on the Corporation or its stockholders directly; and provided further that this Article 11 shall be deemed solely to grant discretionary authority to the Board of Directors, each committee of the Board of Directors and each individual director and shall not be deemed to provide to any specific constituency any right to be considered. 12. Whenever a compromise or arrangement is proposed between this Corporation and its creditors or any class of them and/or between this Corporation and its stockholders or any class of them, any court of equitable jurisdiction within the State of Delaware may, on the application in a summary way of this Corporation or of any creditor or stockholder thereof or on the application of any receiver or receivers appointed for this Corporation under the provisions of Section 291 of the GCL or on the application of trustees in dissolution or of any receiver or receivers appointed for this Corporation under the provisions of Section 279 of the GCL, order a meeting of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, to be summoned in such manner as the said court directs. If a majority in number representing three-fourths in value of the creditors or class of creditors, and/or of the stockholders or class of stockholders of this Corporation, as the case may be, agree to any compromise or arrangement and to any reorganization of this Corporation as consequence of such compromise or arrangement, the said compromise or arrangement and the said reorganization shall, if sanctioned by the court to which the said application has been made, be binding on all the creditors or class of creditors, and/or on all the stockholders or class of stockholders, of this Corporation, as the case may be, and also on this Corporation. A-4 86 IN WITNESS WHEREOF, the Corporation has caused this Restated Certificate of Incorporation to be duly executed in its corporate name. Dated: , 1996 -------------------------------------- Name: Stewart Bainum, Jr. Chairman and Chief Executive Officer A-5 EX-3.01 3 FORM OF RESTATED CERTIFICATE OF INCORPORATION 1 Exhibit 3.01 [Please see Appendix A to Exhibit 2.01] EX-10.01 4 FORM OF DISTRIBUTION AGREEMENT 1 Exhibit 10.01 DISTRIBUTION AGREEMENT dated as of , 1996 between Manor Care, Inc. and Choice Hotels Holdings, Inc. (to be renamed Choice Hotels International, Inc.) 2 TABLE OF CONTENTS
Page ARTICLE I DEFINITIONS Section 1.01. Definitions............................................... 2 ARTICLE II TRANSFER OF LODGING BUSINESS Section 2.01. Transfer of Assets........................................ 8 Section 2.02. Assignment and Assumption of Liabilities.................. 9 Section 2.03. Assisted Living Facilities................................ 9 Section 2.04. Transfers Not Effected Prior to the Distribution Date..... 9 Section 2.05. NO REPRESENTATIONS OR WARRANTIES; CONSENTS................ 10 Section 2.06. Conveyancing and Stock Assumption Instruments............. 11 Section 2.07. Cash Allocation........................................... 12 ARTICLE III THE DISTRIBUTION Section 3.01. Cooperation Prior to the Distribution..................... 13 Section 3.02. Conduct of Lodging Business Pending Distribution.......... 13 Section 3.03. Manor Care Board Action; Conditions Precedent to the Distribution........................... 14 Section 3.04. Outstanding Choice Stock.................................. 15 Section 3.05. The Distribution.......................................... 15 ARTICLE IV INDEMNIFICATION Section 4.01. Choice Indemnification of Manor Care...................... 16 Section 4.02. Manor Care Indemnification of Choice...................... 16 Section 4.03. Notice and Payment of Claims.............................. 16 Section 4.04. Notice and Defense of Third-Party Claims.................. 17 Section 4.05 Insurance Proceeds........................................ 19 Section 4.06 Contribution.............................................. 19 Section 4.07 Subrogation............................................... 20 Section 4.08 No Third-Party Beneficiaries.............................. 20 Section 4.09 Remedies Cumulative....................................... 20 Section 4.10 Survival of Indemnities................................... 20 Section 4.11 After-Tax Indemnification Payments........................ 20
3 ARTICLE V CERTAIN ADDITIONAL MATTERS Section 5.01. Intercompany Accounts..................................... 21 Section 5.02. Manor Care Guarantees..................................... 21 Section 5.03. Ancillary Agreements...................................... 22 Section 5.04. Choice Officers and Board of Directors.................... 22 Section 5.05. Choice Certificate of Incorporation and By-laws........... 22 Section 5.06. Credit Facilities......................................... 22 Section 5.07. Sales and Transfer Taxes.................................. 23 Section 5.08. Certain Post-Distribution Transactions.................... 23 Section 5.09. Non-Competition Agreement................................. 23 Section 5.10. Insurance Policies and Claims Administration.............. 24 ARTICLE VI ACCESS TO INFORMATION Section 6.01. Delivery of Corporate Records............................. 26 Section 6.02. Access to Information..................................... 27 Section 6.03. Litigation Cooperation.................................... 27 Section 6.04. Reimbursement............................................. 27 Section 6.05. Retention of Records...................................... 27 Section 6.06. Confidentiality........................................... 28 Section 6.07. Mail...................................................... 28 ARTICLE VII ENVIRONMENTAL AND OTHER CLAIMS INDEMNIFICATION PROVISIONS Section 7.01. Certain Environmental and Other Claims Indemnification.... 29 Section 7.02. Scope of Indemnification.................................. 29 Section 7.03. Procedures for Indemnification for Current and Potential Indemnified Claims............................ 30 Section 7.04. Losses Net of Insurance or Other Recovery................. 32 Section 7.05. No Third-Party Beneficiaries.............................. 32 Section 7.06. Remedies Cumulative....................................... 33 Section 7.07. Survival of Indemnities................................... 33 Section 7.08. After-Tax Indemnification Payments........................ 33
4 ARTICLE VIII MISCELLANEOUS Section 8.01. Termination............................................... 33 Section 8.02. Expenses.................................................. 34 Section 8.03. Notices................................................... 34 Section 8.04. Amendment and Waiver...................................... 34 Section 8.05. Counterparts.............................................. 35 Section 8.06. Governing Law; Jurisdiction; Forum........................ 35 Section 8.07. Entire Agreement.......................................... 35 Section 8.08. Parties in Interest....................................... 35 Section 8.09. Tax Sharing Agreement; After-Tax Payments................. 36 Section 8.10. Further Assurances and Consents........................... 36 Section 8.11. Exhibits and Schedules.................................... 37 Section 8.12. Legal Enforceability...................................... 37 Section 8.13. Dispute Resolution........................................ 37 Section 8.14. Titles and Headings....................................... 39
Schedule 1............................ Lodging Subsidiaries Schedule 2.01(b)...................... Transferred Hotels Schedule 2.03......................... Assisted Living Facilities Schedule 5.02(a)...................... Manor Care Guarantees Schedule 5.10(a)...................... Covered Claims Schedule 6.06......................... Restricted Information Schedule 7.01......................... Schedule of Current Indemnified Claims Exhibit A............................. Form of Corporate Services Agreement Exhibit B............................. Form of Employee Benefits Administration Agreement Exhibit C............................. Form of Employee Benefits & Other Employment Matters Allocation Agreement Exhibit D............................. Form of Gaithersburg Sublease Agreement Exhibit E............................. Form of Loan Agreement Exhibit F............................. Form of Pikesville Sublease Agreement Exhibit G............................. Form of Procurement Services Agreement Exhibit H............................. Form of Risk Management Consulting Services Agreement Exhibit I............................. Form of Silver Spring Lease Agreement Exhibit J............................. Form of Tax Administration Agreement Exhibit K............................. Form of Tax Sharing Agreement Exhibit L............................. Form of Time Sharing Agreement Exhibit M............................. Form of Trademark Agreement
5 DISTRIBUTION AGREEMENT DISTRIBUTION AGREEMENT ("Agreement") dated as of , 1996 by and between Manor Care, Inc., a Delaware corporation (together with its successors and permitted assigns, "Manor Care"), and Choice Hotels Holdings, Inc., a Delaware corporation (to be renamed Choice Hotels International, Inc. and together with its successors and permitted assigns, "Choice"). RECITALS WHEREAS, Manor Care currently conducts the business of owning, managing and franchising hotels and conducts certain related operations (the "Lodging Business") primarily through certain subsidiaries of Manor Care (the "Direct Lodging Subsidiaries"), their respective subsidiaries and certain partnerships, all as identified on Schedule 1 hereto (collectively, the "Lodging Subsidiaries"). WHEREAS, Choice is presently a wholly-owned subsidiary of Manor Care established for the purposes of taking title to the capital stock and associated goodwill of the Direct Lodging Subsidiaries and certain assets associated with the Lodging Business, and assuming the liabilities associated with the Lodging Business and certain other liabilities, all as specified herein, such that Choice will own substantially all of the assets, business and operations currently conducted by the Lodging Business. WHEREAS, the Board of Directors of Manor Care has determined that it is in the best interest of Manor Care and the stockholders of Manor Care to distribute (the "Distribution") to the holders of Manor Care Common Stock (as defined herein) all of the outstanding shares of Choice Common Stock (as defined herein). WHEREAS, it is the intention of the parties that the Distribution will not be taxable to Manor Care or to the stockholders of Manor Care (pursuant to Section 355 of the Code (as defined herein)). WHEREAS, the parties have determined that it is necessary and desirable to set forth the principal corporate transactions required to effect the Distribution and to set forth other agreements that will govern certain other matters following such Distribution. NOW, THEREFORE, in consideration of the foregoing premises and the mutual agreements, provisions and covenants contained in this Agreement, the parties hereby agree as follows: 6 ARTICLE I DEFINITIONS Section 1.01. Definitions. As used herein, the following terms have the following meaning: "Action" means any claim, suit, arbitration, inquiry, proceeding or investigation by or before any court, governmental or regulatory or administrative agency or commission or any other tribunal. "Affiliate" of any specified person means any other person that, directly or indirectly, controls, is controlled by or is under direct or indirect common control with such specified person. "Ancillary Agreements" means the Corporate Services Agreement, the Employee Benefits Administration Agreement, the Employee Benefits and Other Employment Matters Allocation Agreement, the Gaithersburg Sublease Agreement, the Loan Agreement, the Pikesville Sublease Agreement, the Procurement Services Agreement, the Risk Management Consulting Services Agreement, the Silver Spring Lease Agreement, the Tax Administration Agreement, the Tax Sharing Agreement, the Time Sharing Agreement and the Trademark Agreement. "Assisted Living Liabilities" means all Liabilities arising exclusively from the operation of the assisted living facilities described on Schedule 2.03 or the ownership or use of assets exclusively in connection therewith. 7 "Assumed Liabilities" means the Liabilities arising from the operation of the Lodging Business or the ownership or use of assets (including the Transferred Assets) or other activities in connection therewith, whether arising before, on or after the Distribution Date, including but not limited to any Liabilities arising or in connection with or related to (i) the Choice Liabilities that are guaranteed by Manor Care, as specified in Schedule 5.02(a), (ii) information contained in or omitted from the Form 10 or the Information Statement and (iii) any Liabilities set forth or referenced in the audited financial statements of Choice included in the Form 10 or the Information Statement, (iv) hotel leases under which Manor Care may be deemed to be liable, (v) liabilities arising from Franchise Agreements, [(vi) liabilities in connection with a Reimbursement and Indemnification Agreement of Chemical Bank regarding a Chemical Bank-France guarantee] and (vii) liabilities under indemnification agreements between Manor Care and certain employees and directors with respect to services rendered by such employee or director to Choice Hotels or the Lodging Business. Notwithstanding the foregoing, the Assumed Liabilities shall not include (i) any debt of Manor Care for money borrowed (including but not limited to any such debt evidenced by a note, debenture or other instrument), (ii) (X) any third party claims arising from the conduct or operation of the Lodging Business or the ownership or use of assets in connection therewith prior to the Distribution Date if such claims are Covered Claims, (Y) any self-insured retention or deductible for such Covered Claims that would be covered but for such retention or deductible other than any amount payable by Choice in respect of Shock Losses (as defined) pursuant to Section 5.10(a), (Z) any letters of credit of Manor Care in favor of an insurance carrier relating to such retention or deductible, (iii) the Assisted Living Liabilities, and (iv) any claims, losses, damages, demands, costs, expenses or liabilities for any Tax (which shall be governed by the Tax Sharing Agreement and Sections 4.11 and 5.07 hereof). 8 "Choice Bylaws" means the bylaws of Choice in the form filed as an exhibit to the Form 10. "Choice Certificate" means the restated certificate of incorporation of Choice in the form filed as an exhibit to the Form 10. "Choice Common Stock" means the outstanding shares of common stock, par value $.01 per share, of Choice. "Choice Credit Facility" means a revolving credit facility for Choice in the amount of $ million. "Choice Hotels" means Choice Hotels International, Inc., a Delaware corporation (to be renamed Choice Hotels Franchising, Inc.) and, prior to the Distribution, a wholly-owned subsidiary of Manor Care. "Choice Liabilities" means all of (i) the Liabilities of Choice under this Agreement, (ii) the Assumed Liabilities, and (iii) the Liabilities of Choice arising after the Distribution Date. 9 "Code" means the Internal Revenue Code of 1986, as amended. "Commission" means the Securities and Exchange Commission. "Corporate Services Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for certain matters relating to corporate, administrative, consulting and other services, in substantially the form set forth as Exhibit A, as amended from time to time. "Covered Claims" means any claim that is of a type covered by insurance or self insurance of Manor Care as in effect on the Distribution Date and that is a type of claim specified as a covered claim on Schedule 5.10(a). "Direct Lodging Subsidiaries" has the meaning specified in the first recital of this Agreement. "Distribution" has the meaning specified in the third recital of this Agreement. "Distribution Agent" means Chemical-Mellon Shareholder Services, L.L.C. "Distribution Date" means the date determined by the Board of Directors of Manor Care as the date on which the Distribution shall be effected, which is contemplated to occur on _________, 1996. "Employee Benefits Administration Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for certain matters relating to the administration of employee benefits, in substantially the form set forth as Exhibit B, as amended from time to time. 10 "Employee Benefits & Other Employment Matters Allocation Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for certain matters relating to the allocation of employee benefits, the treatment of employee stock options and other employee matters, in substantially the form set forth as Exhibit C, as amended from time to time. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Existing Credit Facility" means the $250 million revolving credit facility dated as of ________ among Chase Manhattan Bank, Manor Care and the subsidiary guarantors named therein. "Form 10" means the registration statement on Form 10 filed by Choice with the Commission to effect the registration of the Choice Common Stock pursuant to the Exchange Act, as such registration statement may be amended from time to time. "Franchise Agreements" means all franchise agreements to which Manor Care or any Lodging Subsidiary is a party, pursuant to which Manor Care (either directly or through any such Lodging Subsidiary) has granted franchise rights with respect to the operation of hotel properties, and in exchange therefor, receives franchise fees, royalties, license fees and service fees. "Gaithersburg Sublease Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date with respect to property located in Gaithersburg, Maryland, in substantially the form set forth as Exhibit D, as amended from time to time. "Healthcare Business" means any business conducted now or in the future by Manor Care that is not part of the Lodging Business. "Indemnifiable Loss" has the meaning specified in Section 4.01. "Information Statement" means the information statement in the form sent to each holder of Manor Care Common Stock in connection with the Distribution. "Insurance Charges" has the meaning specified in Section 5.10(c)(ii). "IRS Ruling" means the ruling of the Internal Revenue Service dated January 22, 1996 that the Distribution should not be taxable to Manor Care or the stockholders of Manor Care pursuant to Section 355 of the Code. 11 "Liabilities" means any and all claims, debts, liabilities and obligations, absolute or contingent, matured or not matured, liquidated or unliquidated, accrued or not accrued, known or unknown, whenever arising, including all costs and expenses relating thereto, under any law, rule, regulation, action, order or consent decree of any governmental entity or any award of any arbitrator of any kind, and those arising under any contract, commitment or undertaking. "Loan Agreement" means the Loan Agreement to be entered into among MNR, Choice and the subsidiary guarantors to be named therein, on or before the Distribution Date, providing for the recapitalization of the Promissory Notes and repayment of certain advances made by Manor Care to one or more of the Lodging Subsidiaries prior to the Distribution Date, in substantially the form set forth as Exhibit E, as amended from time to time. "Lodging Business" has the meaning specified in the first recital of this Agreement. "Lodging Subsidiaries" has the meaning specified in the first recital of this Agreement. "Manor Care Common Stock" means the outstanding shares of common stock, par value $.10 per share, of Manor Care. "Manor Care Liabilities" means all of (i) the Liabilities of Manor Care under this Agreement, (ii) the Liabilities of Manor Care (other than any Choice Liabilities), whether arising before, on or after the Distribution Date, (iii) (X) any third party claims arising from the conduct or operation of the Lodging Business or the ownership or use of assets in connection therewith prior to the Distribution Date if and only to the extent that such claims are Covered Claims, (Y) any self-insured retention or deductible for such Covered Claims that would be covered but for such retention or deductible other than any amount payable by Choice in respect of Shock Losses pursuant to Section 5.10(a), (Z) any letters of credit of Manor Care in favor of an insurance carrier relating to such retention or deductible, (iv) the Assisted Living Liabilities and (v) any claims, losses, damages, demands, costs, expenses or liabilities for any Tax (which shall be governed by the Tax Sharing Agreement and Sections 4.11 and 5.07 hereof). "MNR" means MNR Finance Corp., a Delaware corporation. "Pikesville Sublease Agreement" means the agreement to be entered into between Manor Care and [Choice], on or before the Distribution Date, with respect to the Subleased Hotel, in substantially the form set forth as Exhibit F, as amended from time to time. "Procurement Services Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for certain matters relating to procurement of products and supplies used in the Lodging Business, in substantially the form set forth as Exhibit G, as amended from time to time. "Promissory Notes" means promissory notes issued by [Choice Hotels] in the aggregate principal amount of $225,722,500. 12 "Record Date" means the date determined by Manor Care's Board of Directors as the date for determining the stockholders of record of Manor Care entitled to receive the Distribution, which record date is contemplated to be , 1996, subject to fulfillment of certain conditions to the Distribution set forth herein. "Risk Management Consulting Services Agreement" means the agreement to be entered into between Manor Care and Choice on or prior to the Distribution Date relating to risk management, in substantially the form set forth as Exhibit H, as amended from time to time. "Securities Act" means the Securities Act of 1933, as amended. "Silver Spring Lease Agreement" means the lease agreement to be entered into by Manor Care and Choice, on or before the Distribution Date, with respect to property located in Silver Spring, Maryland, in substantially the form set forth as Exhibit I, as amended from time to time. "Subleased Hotel" means the Comfort Inn Hotel located at 100 Wooded Way, Pikesville, Maryland 21208, which prior to the Distribution Date was operated by Manor Care under a lease from a third party. "Tax" shall have the meaning given to such term in the Tax Sharing Agreement. "Tax Administration Agreement" means the agreement to be entered into between Manor Care and Choice on or prior to the Distribution Date providing for certain tax administration matters, in substantially the form set forth as Exhibit J, as amended from time to time. "Tax Sharing Agreement" means the agreement to be entered into between Manor Care and Choice on or prior to the Distribution Date providing for certain tax related matters, in substantially the form set forth as Exhibit K, as amended from time to time. "Time Sharing Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for the use of certain aircraft, in substantially the form set forth as Exhibit L, as amended from time to time. "Trademark Agreement" means the agreement to be entered into between Manor Care and Choice, on or before the Distribution Date, providing for certain matters relating to the transfer of certain trademarks and other intellectual property, in substantially the form set forth as Exhibit M, as amended from time to time. "Transferred Assets" has the meaning specified in Section 2.01. ARTICLE II TRANSFER OF LODGING BUSINESS Section 2.01. Transfer of Assets. Prior to the Distribution Date, Manor Care shall take or shall cause to be taken all actions necessary to cause the transfer, assignment, delivery and conveyance to Choice of all of Manor Care's and its subsidiaries' rights, title and interest in the assets listed below (collectively, the "Transferred Assets"): 13 (a) the shares of common stock and preferred stock, if any, and associated goodwill, of the Direct Lodging Subsidiaries owned by Manor Care as set forth on Schedule 1; (b) the hotels described on Schedule 2.01(b) (the "Transferred Hotels") and the real property on which such hotels are located, and all fixtures, furnishings, furniture, equipment, supplies and other tangible personal property located at the Transferred Hotels and the Subleased Hotel; (c) all contracts, agreements (including Franchise Agreements), arrangements or commitments of any kind and all licenses and permits of Manor Care that relate exclusively to the Transferred Hotels and the Subleased Hotel; (d) the trademarks, service marks, goodwill and other intangible properties and rights covered by the Assignment of Marks Agreement; and (e) all books, records and files of, or relating exclusively to, the Lodging Business. Section 2.02. Assignment and Assumption of Liabilities. On or prior to the Distribution Date, Manor Care shall assign to Choice and Choice shall assume all of the Choice Liabilities. Except as set forth in one or more or the Ancillary Agreements, from and after the Distribution Date, (i) Choice shall, and/or shall cause its subsidiaries to, assume, pay, perform and discharge in due course all of the Choice Liabilities, and (ii) Manor Care shall, and/or shall cause its subsidiaries to, pay, perform and discharge in due course all of the Manor Care Liabilities and have assigned all of the Assumed Liabilities to Choice. Section 2.03. Assisted Living Facilities. (a) Prior to the transfer of the Transferred Assets, Boulevard Motel Corp., a Direct Lodging Subsidiary, shall transfer to Manor Care the assisted living facilities described on Schedule 2.03, including the real property on which such facilities are located and all (i) fixtures, furnishings, furniture, equipment, supplies and other tangible personal property located at such facilities, and (ii) contracts, agreements, arrangements or commitments of any kind, and all licenses and permits and books, records and files, in each case that relate to such facilities. (b) Manor Care shall, and/or shall cause its subsidiaries to, assume, pay, perform and discharge in due course all of the Assisted Living Liabilities. 14 Section 2.04. Transfers Not Effected Prior to the Distribution Date. To the extent any transfers contemplated by this Article II shall not have been fully effected prior to the Distribution Date, Manor Care and Choice shall cooperate to effect such transfers as promptly as possible following the Distribution Date. Nothing herein shall be deemed to require the transfer of any assets or the assumption of any Liabilities that by their terms or by operation of law cannot be transferred or assumed; provided, however, that Manor Care and Choice and their respective subsidiaries and Affiliates shall cooperate in seeking to obtain any necessary consents or approvals for the transfer of all assets and Liabilities as contemplated by this Article II. In the event that any such transfer of assets or Liabilities has not been consummated effective as of the Distribution Date, the party retaining such asset or Liability shall thereafter hold such asset in trust for the use and benefit of the party entitled thereto (at the expense of the party entitled thereto) and retain such Liability for the account of the party by whom such Liability is to be assumed pursuant hereto, and take such other actions as may be reasonably required in order to place the parties, insofar as reasonably possible, in the same position as would have existed had such asset been transferred, or such Liability been assumed as contemplated hereby. As and when any such asset or Liability becomes transferable, such transfer and assumption shall be effected forthwith. Manor Care and Choice agree that, as of the Distribution Date, each party hereto shall be deemed to have acquired complete and sole beneficial ownership over all of the assets, together with all of the rights, powers and privileges incidental thereto, that such party is entitled to acquire pursuant to the terms of this Agreement. 15 Section 2.05. NO REPRESENTATIONS OR WARRANTIES; CONSENTS. EACH OF THE PARTIES HERETO UNDERSTANDS AND AGREES THAT NO PARTY HERETO IS, IN THIS AGREEMENT OR IN ANY OTHER AGREEMENT OR DOCUMENT CONTEMPLATED BY THIS AGREEMENT OR OTHERWISE, REPRESENTING OR WARRANTING IN ANY WAY AS TO THE VALUE OR FREEDOM FROM ENCUMBRANCE OF, OR ANY OTHER MATTER CONCERNING, ANY ASSETS OF SUCH PARTY, OR AS TO THE LEGAL SUFFICIENCY TO CONVEY TITLE TO ANY ASSET TRANSFERRED PURSUANT TO THIS AGREEMENT OR ANY ANCILLARY AGREEMENT, INCLUDING, WITHOUT LIMITATION, ANY CONVEYANCING OR ASSUMPTION INSTRUMENTS. IT IS ALSO AGREED AND UNDERSTOOD THAT THERE ARE NO WARRANTIES WHATSOEVER, EXPRESS OR IMPLIED, GIVEN BY EITHER PARTY TO THE AGREEMENT, AS TO THE CONDITION, QUALITY, MERCHANTABILITY OR FITNESS OF ANY OF THE ASSETS, BUSINESSES OR OTHER RIGHTS TRANSFERRED OR RETAINED BY THE PARTIES, AS THE CASE MAY BE, AND ALL SUCH ASSETS, BUSINESSES AND OTHER RIGHTS SHALL BE "AS IS, WHERE IS" AND "WITH ALL FAULTS" (PROVIDED THAT THE ABSENCE OF WARRANTIES GIVEN BY THE PARTIES SHALL NOT NEGATE THE ALLOCATION OF LIABILITIES UNDER THIS AGREEMENT AND SHALL HAVE NO EFFECT ON ANY MANUFACTURERS, SELLERS, OR OTHER THIRD PARTY WARRANTIES THAT ARE INTENDED TO BE TRANSFERRED WITH SUCH ASSETS). SIMILARLY, EACH PARTY HERETO UNDERSTANDS AND AGREES THAT NO PARTY HERETO IS, IN THIS AGREEMENT OR IN ANY OTHER AGREEMENT OR DOCUMENT CONTEMPLATED BY THIS AGREEMENT OR OTHERWISE, REPRESENTING OR WARRANTING IN ANY WAY THAT THE OBTAINING OF ANY CONSENTS OR APPROVALS, THE EXECUTION AND DELIVERY OF ANY AMENDATORY AGREEMENTS AND THE MAKING OF ANY FILINGS OR APPLICATIONS CONTEMPLATED BY THIS AGREEMENT WILL SATISFY THE PROVISIONS OF ANY OR ALL APPLICABLE LAWS OF JUDGMENTS OR OTHER INSTRUMENTS OR AGREEMENTS RELATING TO SUCH ASSETS. Notwithstanding the foregoing, the parties shall use their good faith efforts to obtain all consents and approvals, to enter into all reasonable amendatory agreements and to make all filings and applications contemplated by this Agreement, and shall take all such further actions as shall be deemed reasonably necessary to preserve for each of Manor Care and Choice, to the greatest extent reasonably feasible, consistent with this Agreement, the economic and operational benefits of the allocation of assets provided for in this Agreement. In case at any time after the Distribution Date any further action is necessary or desirable to carry out the purposes of this Agreement, the proper officers and directors of each party to this Agreement shall take all such necessary or desirable action, provided, that any financial cost shall be borne by the party receiving the benefit of the action. 16 Section 2.06. Conveyancing and Stock Assumption Instruments. In connection with the asset and stock transfers and the assumptions of Liabilities contemplated by this Agreement, the parties shall execute or cause to be executed by the appropriate entities conveyancing and assumption instruments, including using reasonable efforts to obtain from third-parties appropriate releases and novations, in such forms as the parties shall reasonably agree, including deeds as may be appropriate, the assignment of trademarks and franchise rights, and the assignment and assumption of existing lease agreements. Any transfer of capital stock shall be effected by means of delivery of stock certificates and executed stock powers and notation on the stock record books of the corporation or other legal entities involved and, to the extent required by applicable law, by notation on public registries. Section 2.07. Cash Allocation. (a) Cash Allocation on the Distribution Date. The allocation between Manor Care and Choice of all domestic and international cash bank balances, short-term investments and outstanding checks and drafts of Manor Care and its subsidiaries recorded per the books of Manor Care and its subsidiaries shall be in accordance with the following: (i) all cash received in, and deposits of cash, checks, drafts or short-term investments made to, depositary accounts as of the close of business on the Distribution Date shall be remitted to Manor Care; and (ii) all petty cash of the Lodging Business shall be allocated to Choice on the Distribution Date; and (iii) all Liabilities for payment of outstanding checks or drafts drawn on or prior to the Distribution Date on accounts allocated to Choice pursuant to Section 2.07(b) shall be paid by Choice. (b) Cash Management After the Distribution Date. The petty cash, depositary and disbursement accounts of the Lodging Business shall be transferred to Choice on the Distribution Date after the allocations are made pursuant to clause Section 2.07(a)(i) and (ii). Choice shall establish and maintain a separate cash management system and accounting records with respect to the Lodging Business effective as of 12:01 a.m. New York time on the day following the Distribution Date. 17 (c) For purposes of this Section 2.07, the parties contemplate that the Lodging Business and the businesses to be retained by Manor Care after the Distribution, including, but not limited to, the administration of accounts payable and accounts receivable, will be conducted in the ordinary course of business consistent with past practice prior to the Distribution Date. (d) For purposes of this Section 2.07, any disagreement or dispute shall be resolved by the Assistant Treasurer of Manor Care, which resolution shall be binding and final upon each of the parties hereto and not subject to further review. ARTICLE III THE DISTRIBUTION Section 3.01. Cooperation Prior to the Distribution. (a) Manor Care and Choice have prepared, and Manor Care shall mail to the holders of Manor Care Common Stock, the Information Statement, which sets forth disclosure concerning Choice, the Distribution and other matters. Manor Care and Choice have also prepared, and Choice has filed with the Commission, the Form 10, which includes or incorporates by reference the Information Statement. Manor Care and Choice shall use their reasonable efforts to cause the Form 10 to become effective under the Exchange Act. (b) Manor Care and Choice shall cooperate in preparing, filing with the Commission and causing to become effective any registration statements or amendments thereto that are appropriate to reflect the establishment of or amendments to any employee benefit and other plans contemplated by the Employee Benefits Agreement. (c) Manor Care and Choice shall take all such action as may be necessary or appropriate under the securities or blue sky laws of the states or other political subdivisions of the United States in connection with the transactions contemplated by this Agreement. (d) Choice has prepared and filed a preliminary listing application and will pursue the approval of the application to permit listing of the Choice Common Stock on the New York Stock Exchange. 18 Section 3.02. Conduct of Lodging Business Pending Distribution. (a) Prior to the Distribution Date, the Lodging Business shall be operated by Manor Care for the sole benefit of Manor Care and its stockholders. (b) Prior to the Distribution Date, Choice shall have no operations or conduct any business except in preparation for the consummation of the transactions contemplated by this Agreement. Section 3.03. Manor Care Board Action; Conditions Precedent to the Distribution. Manor Care's Board of Directors shall, in its sole discretion, establish the Record Date and the Distribution Date and any appropriate procedures in connection with the Distribution. In no event shall the Distribution occur unless the following conditions shall, unless waived by Manor Care in its sole discretion, have been satisfied: (a) all necessary regulatory approvals and consents of third parties shall have been received; (b) the Form 10 shall have been declared effective under the Exchange Act; (c) a favorable response shall have been received from the Staff of the Commission with respect to Manor Care's no-action request concerning, among other things, whether the Distribution may be effected without registration of the Choice Common Stock under the Securities Act; (d) the Choice Credit Facility shall be available; (e) Choice's Board of Directors, as named in the Form 10, shall have been elected by Manor Care, as sole stockholder of Choice, and the Choice Certificate and Choice Bylaws shall be in effect; (f) the Choice Common Stock shall have been approved for listing on the New York Stock Exchange, subject to official notice of issuance; (g) Manor Care's Board of Directors shall have formally approved the Distribution and shall not have abandoned, deferred or modified the Distribution at any time prior to the Distribution Date; (h) The IRS Ruling shall be in full force and effect and shall not have been modified and the representations made to the IRS therein shall be true in all material respects; 19 (i) the transactions contemplated by Sections 2.01 and 2.02 and Article V shall have been consummated in all material respects and each of the Ancillary Agreements, in form and substance satisfactory to Manor Care, shall have been executed by the parties thereto and each of the transactions contemplated by the Ancillary Agreements to be consummated on or prior to the Distribution Date shall have been consummated; (j) Choice shall have obtained, or Manor Care shall have obtained for Choice, insurance (or binders therefor) providing coverage to Choice similar to the coverage provided by insurance in place prior to the Distribution Date; (k) Manor Care shall have refinanced the Existing Credit Facility on terms acceptable to it in its sole discretion; and (l) no preliminary or permanent injunction or other order, decree or ruling issued by a court of competent jurisdiction or by a government, regulatory or administrative agency or commission, and no statute, rule, regulation or executive order promulgated or enacted by any governmental authority, shall be in effect preventing the payment of the Distribution; provided that the satisfaction of such conditions shall not create any obligation on the part of Manor Care to effect the Distribution or in any way limit Manor Care's power of termination set forth in Section 8.01 or alter the consequences of any such termination from those specified in such Section. Section 3.04. Outstanding Choice Stock. On or prior to the Distribution Date, Manor Care and Choice shall take all steps necessary to increase the outstanding shares of Choice Common Stock so that immediately prior to the Distribution, Manor Care will hold a number of shares of Choice Common Stock equal to the number of shares of Manor Care Common Stock outstanding on the Record Date. Section 3.05. The Distribution. On the Distribution Date, or as soon thereafter as practicable, subject to the conditions set forth in this Agreement, Manor Care shall deliver to the Distribution Agent a certificate or certificates representing all of the then outstanding shares of Choice held by Manor Care, endorsed in blank, and shall instruct the Distribution Agent to distribute to each holder of record of Manor Care Common Stock on the Record Date a certificate or certificates representing one share of Choice Common Stock for each share of Manor Care Common Stock so held. Choice agrees to provide all certificates for shares of Choice Common Stock that the Distribution Agent shall require in order to effect the Distribution. 20 ARTICLE IV INDEMNIFICATION Section 4.01. Choice Indemnification of Manor Care. Except as otherwise expressly provided in any of the Ancillary Agreements, from and after the Distribution Date, Choice shall indemnify, defend and hold harmless Manor Care and its subsidiaries, and each of their respective directors, officers, employees, agents and Affiliates and each of the heirs, executors, successors and assigns of any of the foregoing (the "Manor Care Indemnitees") from and against any and all damage, loss, liability and expense (including, without limitation, reasonable expenses of investigation and reasonable attorneys' fees and expenses in connection with any or all such investigations or any and all Actions or threatened Actions) (collectively, "Indemnifiable Losses") incurred or suffered by any of the Manor Care Indemnitees and arising out of or related to the failure of Choice or any of its subsidiaries to pay, perform or otherwise discharge any of the Choice Liabilities. Section 4.02. Manor Care Indemnification of Choice. Except as otherwise expressly provided in any of the Ancillary Agreements, from and after the Distribution Date, Manor Care shall indemnify, defend and hold harmless Choice and its subsidiaries, and each of their respective directors, officers, employees, agents and Affiliates and each of the heirs, executors, successors and assigns of any of the foregoing (the "Choice Indemnitees") from and against any and all Indemnifiable Losses incurred or suffered by any of the Choice Indemnitees and arising out of or related to the failure of Manor Care or any of its subsidiaries to pay, perform or otherwise discharge any of the Manor Care Liabilities. Section 4.03. Notice and Payment of Claims. If any Manor Care Indemnitee or Choice Indemnitee (the "Indemnified Party") determines that it is or may be entitled to indemnification by Choice or Manor Care, as the case may be (the "Indemnifying Party"), under this Article IV (other than in connection with any Action subject to Section 4.04), the Indemnified Party shall deliver to the Indemnifying Party a written notice specifying, to the extent reasonably practicable, the basis for its claim for indemnification and the amount for which the Indemnified Party reasonably believes it is entitled to be indemnified. After the Indemnifying Party shall have been notified of the amount for which the Indemnified Party seeks indemnification, the Indemnifying Party shall, within 15 days after receipt of such notice, either (i) pay the Indemnified Party such amount in cash or other immediately available funds (or reach agreement with the Indemnified Party as to a mutually agreeable alternative payment schedule) or (ii) object to the claim for indemnification or the amount thereof by giving the Indemnified Party written notice setting forth the grounds therefor. Any objection shall be resolved in accordance with Section 8.13. If the Indemnifying Party does not give such notice, the Indemnifying Party shall be deemed to have acknowledged its liability for such claim and the Indemnified Party may exercise any and all of its rights under applicable law to collect such amount. 21 Section 4.04. Notice and Defense of Third-Party Claims. (a) Promptly following the earlier of (a) receipt of written notice of the commencement by a third party of any Action against or otherwise involving any Indemnified Party or (b) receipt of written information from a third party alleging the existence of a claim against an Indemnified Party, in either case, with respect to which indemnification may be sought pursuant to this Agreement (a "Third-Party Claim"), the Indemnified Party shall give the Indemnifying Party prompt written notice thereof. The failure of the Indemnified Party to give notice as provided in this Section 4.04 shall not relieve the Indemnifying Party of its obligations under this agreement, except to the extent that the Indemnifying Party is prejudiced by such failure to give notice. Such notice shall describe the Third-Party Claim in reasonable detail and shall indicate the amount of the Indemnifiable Loss that has been or will be sustained by the Indemnified Party. (b) Within 30 days after receipt of such notice, the Indemnifying Party may, by giving written notice thereof to the Indemnified Party, (i) acknowledge liability for and at its option elect to assume the defense of such Third-Party Claim at its sole cost and expense or (ii) object to the claim of indemnification for such Third-Party Claim setting forth the grounds therefor. Any objection shall be resolved in accordance with Section 8.13. If the Indemnifying Party does not within such 30-day period give the Indemnified Party such notice, the Indemnifying Party shall be deemed to have acknowledged its liability for such Third-Party Claim. (c) Any defense of a Third-Party Claim as to which the Indemnifying Party has elected to assume the defense shall be conducted by attorneys employed by the Indemnifying Party and reasonably satisfactory to Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees. The Indemnified Party shall have the right to participate in such proceedings and to be represented by attorneys of its own choosing at the Indemnified Party's sole cost and expense; provided that if the defendants or parties against which relief is sought in any such claim include both the Indemnifying Party and one or more Indemnified Parties and, in the reasonable judgment of Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees, a conflict of interest between such Indemnified Parties and such Indemnifying Party exists in respect of such claim, such Indemnified Parties shall have the right to employ one firm of counsel selected by Manor Care or Choice, as the case may be, and in that event the reasonable fees and expenses of such separate counsel (but not more than one separate counsel reasonably satisfactory to the Indemnifying Party) shall be paid by such Indemnifying Party. 22 (d) If the Indemnifying Party assumes the defense of a Third-Party Claim, the Indemnifying Party may settle or compromise the claim without the prior written consent of the Indemnified Party; provided that without the prior written consent of Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees, the Indemnifying Party may not agree to any such settlement unless as a condition to such settlement the Indemnified Party receives a written release from any and all liability relating to such Third-Party Claim and such settlement or compromise does not include any remedy or relief to be applied to or against the Indemnified Party, other than monetary damages for which the Indemnifying Party shall be responsible hereunder. (e) If the Indemnifying Party does not assume the defense of a Third-Party Claim for which it has acknowledged liability for indemnification under this Article IV, Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees may pursue the defense of such Third-Party Claim and choose one firm of counsel in connection therewith. The Indemnifying Party is required to reimburse Manor Care or Choice, as the case may be, on a current basis for its reasonable expenses of investigation, reasonable attorney's fees and reasonable out-of-pocket expenses incurred by Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees in defending against such Third- Party Claim and the Indemnifying Party shall be bound by the result obtained with respect thereto; provided that the Indemnifying Party shall not be liable for any settlement effected without the consent of Manor Care in the case of Manor Care Indemnitees and Choice in the case of Choice Indemnitees, which consent shall not be unreasonably withheld. (f) The Indemnifying Party shall pay to the Indemnified Party in cash the amount for which the Indemnified Party is entitled to be indemnified (if any) within 15 days after the final resolution of such Third-Party Claim (whether by the final nonappealable judgment of a court of competent jurisdiction or otherwise) or, in the case of any Third-Party Claim as to which the Indemnifying Party has not acknowledged liability, within 15 days after such Indemnifying Party's objection has been resolved pursuant to Section 8.13. Section 4.05. Insurance Proceeds. The amount that any Indemnifying Party is or may be required to pay to any Indemnified Party pursuant to this Article IV shall be reduced (including, without limitation, retroactively) by any insurance proceeds or other amounts actually recovered by or on behalf of such Indemnified Parties in reduction of the related Indemnifiable Loss. If an Indemnified Party shall have received the payment required by this Agreement from an Indemnifying Party in respect of an Indemnifiable Loss and shall subsequently actually receive insurance proceeds, or other amounts in respect of such Indemnifiable Loss as specified above, then such Indemnified Party shall pay to such Indemnifying Party a sum equal to the amount of such insurance proceeds or other amounts actually received after deducting therefrom all of the Indemnified Party's costs and expenses associated with the recovery of any such amount. 23 Section 4.06. Contribution. If the indemnification provided for in this Article IV is unavailable to an Indemnified Party in respect of any Indemnifiable Loss arising out of or related to information contained in or omitted from the Information Statement or the Form 10, then Choice, in lieu of indemnifying the Manor Care Indemnitees, shall contribute to the amount paid or payable by the Manor Care Indemnitees as a result of such Indemnifiable Loss in such proportion as is appropriate to reflect the relative fault of Choice, on the one hand, and Manor Care, on the other hand, in connection with the statements or omissions which resulted in such Indemnifiable Loss. The relative fault of the Choice Indemnitees on the one hand and of the Manor Care Indemnitees on the other hand shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information concerning Choice on the one hand or Manor Care on the other hand. Section 4.07. Subrogation. In the event of payment by an Indemnifying Party to any Indemnified Party in connection with any Third-Party Claim, such Indemnifying Party shall be subrogated to and shall stand in the place of such Indemnified Party as to any events or circumstances in respect of which such Indemnified Party may have any right or claim relating to such Third-Party Claim. Such Indemnified Party shall cooperate with such Indemnifying Party in a reasonable manner, and at the cost and expense of such Indemnifying Party, in prosecuting any subrogated right or claim. Section 4.08. No Third-Party Beneficiaries. This Article IV shall inure to the benefit of, and be enforceable by, Manor Care, the Manor Care Indemnitees, Choice and the Choice Indemnitees and their respective successors and permitted assigns. The indemnification provided for by this Article IV shall not inure to the benefit of any other third party or parties and shall not relieve any insurer who would otherwise be obligated to pay any claim of the responsibility with respect thereto or, solely by virtue of the indemnification provisions hereof, provide any subrogation rights with respect thereto and each party agrees to waive such rights against the other to the fullest extent permitted. 24 Section 4.09. Remedies Cumulative. The remedies provided in this Article IV shall be cumulative and shall not preclude assertion by any Indemnified Party of any other rights or the seeking of any and all other remedies against any Indemnifying Party. The procedures set forth in this Article IV, however, shall be the exclusive procedures governing any indemnity action brought under this Article IV or otherwise relating to Indemnifiable Losses; provided, however, that nothing in this Article IV shall be deemed to govern any indemnity action brought under Article VII relating to Indemnifiable Claims. Section 4.10. Survival of Indemnities. The obligations of each of Manor Care and Choice under this Article IV shall survive the sale or other transfer by it of any assets or businesses or the assignment by it of any Liabilities, with respect to any Indemnifiable Loss of the other related to such assets, businesses or Liabilities. Section 4.11. After-Tax Indemnification Payments. Except as otherwise expressly provided herein or in an Ancillary Agreement, any indemnification payment made by any Indemnifying Party under this Article IV shall be computed by taking into account the value of any and all applicable deductions, losses, credits, offsets or other items for Federal, state or other tax purposes attributable to the payment of the indemnified liability by the Indemnified Party and any Tax incurred by the Indemnified Party attributable to receipt of the indemnification payment. ARTICLE V CERTAIN ADDITIONAL MATTERS Section 5.01. Intercompany Accounts. On the Distribution Date, Manor Care shall contribute to MNR the Promissory Notes and MNR, Choice and the subsidiary guarantors to be named therein shall execute the Loan Agreement. All intercompany amounts payable or receivable by Manor Care or Choice not covered by the Loan Agreement shall be cancelled on the Distribution Date. Section 5.02. Manor Care Guarantees. (a) After the Distribution Date, Manor Care shall continue and maintain, in full force and effect, the guarantees issued by Manor Care (the "Guaranteed Obligations"), set forth on Schedule 5.02(a) hereto, with respect to certain obligations of the Lodging Business. Choice shall use its reasonable best efforts to obtain a release of Manor Care from its obligations under the Guaranteed Obligations if and to the extent that such efforts are consistent with the business of Choice and do not adversely affect the relationship between Choice and the other parties to the Guaranteed Obligations. Choice shall provide to Manor Care, so long as the Guaranteed Obligations have not been fully and finally discharged, such information or certificates as Manor Care shall reasonably request regarding the financial position of Choice and the status of the Guaranteed Obligations. 25 (b) Choice agrees to pay to Manor Care on the Distribution Date and on each anniversary of the Distribution Date thereafter until the Guaranteed Obligations are terminated a guarantee fee equal to 2% per annum of the aggregate principal amount of obligations (including financing leases) subject to such guarantees outstanding on the Distribution Date or the relevant anniversary of the Distribution Date. Such fee is not subject to any refund and shall not be prorated. (c) Neither Choice nor any subsidiary thereof shall take any action (including, without limitation, by amendment, renewal or extensions of any Guaranteed Obligations (or any part thereof), except for any such change in any Guaranteed Obligation that is caused by the exercise of rights contained in the agreements governing the underlying obligation as in effect on the Distribution Date) that could reasonably be expected to adversely affect Manor Care's potential liability with respect to the Guaranteed Obligations, whether by increasing the likelihood or amount of any such liability, extending the time during which such liability remains outstanding or otherwise. Section 5.03. Ancillary Agreements. On or prior to the Distribution Date, Manor Care and Choice shall execute and deliver the Ancillary Agreements. Section 5.04. Choice Officers and Board of Directors. On or prior to the Distribution Date, Manor Care shall take and shall cause Choice to take all actions necessary to appoint as officers and directors of Choice those persons named in the Form 10 to constitute the officers and directors of Choice on the Distribution Date. Section 5.05. Choice Certificate of Incorporation and By-laws. Prior to the Distribution Date, Manor Care shall take all action necessary to cause the certificate of incorporation and by-laws of Choice to be amended and restated substantially in the form attached to the Form 10 as exhibits thereto. Section 5.06. Credit Facilities. (a) Prior to the Distribution Date, Manor Care shall take all necessary action to replace its credit facility so as to release Choice and the Lodging Subsidiaries from any liability or obligation with respect thereto from and after the Distribution Date. 26 (b) Prior to the Distribution Date, Manor Care and Choice shall take all necessary action to obtain the Choice Credit Facility. Section 5.07. Sales and Transfer Taxes. Manor Care and Choice agree to cooperate to determine the amount of sales, transfer or other taxes or fees (including, without limitation, all real estate, patent, copyright and trademark transfer taxes and recording fees) payable in connection with the transactions contemplated by this Agreement (the "Transaction Taxes"). Manor Care agrees to file promptly and timely the returns for such Transaction Taxes with the appropriate taxing authorities and remit payment of the Transaction Taxes and Choice will join in the execution of any such tax returns or other documentation. Payment of all such Transaction Taxes shall be the responsibility of Choice and shall be reimbursed to Manor Care by Choice promptly upon request by Manor Care. Section 5.08. Certain Post-Distribution Transactions. Each of Manor Care and Choice shall, and shall cause each of their respective subsidiaries to, comply in all material respects with each representation and statement made, or to be made, to any taxing authority in connection with the IRS Ruling or any other ruling obtained, or to be obtained, by Manor Care and Choice acting together, from any such taxing authority with respect to any transaction contemplated by this Agreement. Section 5.09. Non-Competition Agreement. (a) Manor Care. Until five years after the Distribution Date, Manor Care and its subsidiaries shall not, without the express written consent of Choice, compete with the Lodging Business of Choice, provided that this covenant shall not prevent Manor Care or any of its subsidiaries from engaging in any line of business in which Choice is not engaged, or in which Choice is prohibited by law or by contract from engaging, on the Distribution Date, including, without limitation, the business conducted by the Assisted Living Facilities, any independent living facilities and any business similar thereto. (b) Choice. Until five years after the Distribution Date, Choice and its subsidiaries shall not, without the express written consent of Manor Care, compete with the Healthcare Business of Manor Care, including, without limitation, the business conducted by the Assisted Living Facilities, any independent living facilities or any business similar thereto. 27 Section 5.10. Insurance Policies and Claims Administration. (a) Manor Care to Maintain Insurance Coverage Prior to Distribution Date. Manor Care shall use reasonable efforts to maintain in full force and effect at all times up to and including the Distribution Date its current property and casualty insurance programs, including, without limitation, primary and excess general liability, automobile, workers' compensation, property and crime insurance policies (collectively, the "Policies" and individually, a "Policy"). Manor Care and its subsidiaries shall retain with respect to any Covered Claims as set forth on Schedule 5.10(a) relating to periods prior to the Distribution Date all of their respective rights, benefits and privileges, if any, under such Policies. To the extent not already provided for by the terms of a Policy, Manor Care shall use reasonable efforts to cause Choice and its subsidiaries, as appropriate, to be named as additional insureds under such Policy in respect of Covered Claims arising or relating to periods prior to the Distribution Date; provided, however, that nothing contained herein shall be construed to require Manor Care or any of its subsidiaries to pay any additional premium or other charges in respect to, or waive or otherwise limit any of its rights, benefits or privileges under, any such Policy to effect the naming of Choice and its subsidiaries as such additional insureds; provided, further, that with respect to any existing Covered Claim that Manor Care determines, in its sole discretion, has a potential total out-of-pocket cost to Manor Care in excess of $250,000 (including loss reserves and actual cash payments, if any), as set forth on Schedule 5.10(a) (collectively, "Shock Losses"), it is specifically understood that (x) if the amount of Insurance Charges actually payable by Manor Care with respect to such Shock Loss shall be equal to or exceed $250,000, the full amount of such payment shall be the responsibility of, and shall be paid by, Choice and (y) if the amount of Insurance Charges actually payable by Manor Care with respect to such Shock Loss shall be less than $250,000, such amount shall be the responsibility of, and shall be paid by, Manor Care. 28 (b) Choice Responsible for Establishing Insurance Coverage on and After Distribution Date. Commencing on and as of the Distribution Date, Choice and each of its subsidiaries shall be responsible for establishing and maintaining its own separate insurance programs (including, without limitation, primary and excess general liability, automobile, workers' compensation, property, director and officer liability, fire, crime, surety and other similar insurance policies) for activities and claims relating to any period on or after the Distribution Date involving Choice or any of its subsidiaries. Notwithstanding any other agreement or understanding to the contrary, except as set forth in Section 5.10(a) with respect to Covered Claims relating to periods prior to the Distribution Date and Section 5.10(c) with respect to claims administration and financial administration of the Policies, neither Manor Care nor any of its subsidiaries shall have any responsibility for or obligation to Choice or its subsidiaries relating to liability and casualty insurance matters for any period, whether prior to, at or after the Distribution Date. 29 (c) Administration and Procedure. (i) Manor Care or a subsidiary of Manor Care, as appropriate, shall be responsible for the claims administration and financial administration of all Policies for Covered Claims relating to the assets, ownership or operation prior to the Distribution Date of the Lodging Business; provided, however, that such retention by Manor Care of the Policies and the responsibility for claims administration and financial administration of the Policies are in no way intended to limit, inhibit or preclude any right to insurance coverage for any Covered Claims of a named insured under the Policies. Manor Care shall be entitled to compensation for and reimbursement of expenses incurred in connection with performing the claims administration and financial administration of the Policies in accordance with the terms of the Corporate Services Agreement. Except as set forth in the Risk Management Consulting Services Agreement, Choice or a subsidiary thereof, as appropriate, shall be responsible for all administrative and financial matters relating to insurance policies established and maintained by Choice and its subsidiaries for claims relating to any period on or after the Distribution Date involving Choice or any of its subsidiaries. (ii) Choice shall notify Manor Care of any Covered Claim relating to Choice or a subsidiary thereof under one or more of the Policies relating to any period prior to the Distribution Date, and Choice agrees to cooperate and coordinate with Manor Care concerning any strategy Manor Care may reasonably elect to pursue to secure coverage and payment for such Covered Claim by the appropriate insurance carrier. Notwithstanding anything contained herein, in any other agreement or applicable Policy or any understanding to the contrary, Choice or an appropriate subsidiary thereof assumes responsibility for, and shall pay to the appropriate insurance carriers or otherwise, any premiums, retrospectively-rated premiums, defense costs, indemnity payments, deductibles, retentions or other charges, as appropriate (collectively, "Insurance Charges"), whenever arising, which shall become due and payable under the terms and conditions of any applicable Policy in respect of any liabilities, losses, claims, actions or occurrences, whenever arising or becoming known, involving or relating to any of the assets, businesses, operations or liabilities of Choice or any of its subsidiaries, which charges relate to (i) any Shock Losses to the extent set forth in Section 5.10(a) or (ii) the period after the Distribution Date. To the extent that the terms of any applicable Policy provide that Manor Care or a subsidiary thereof, as appropriate, shall have an obligation to pay or guarantee the payment of any Insurance Charges, Manor Care or such subsidiary shall be entitled to demand that Choice or a subsidiary thereof make such payment directly to the person or entity entitled thereto. In connection with any such demand, Manor Care shall submit to Choice or a subsidiary thereof a copy of any invoice received by Manor Care or a subsidiary pertaining to such Insurance Charges, together with appropriate supporting documentation, if available. In the event that Choice or its subsidiary fails to pay any Insurance Charges when due and payable, whether at the request of the party entitled to payment or upon demand by Manor Care or a subsidiary of Manor Care, Manor Care or a subsidiary of Manor Care may (but shall not be required to) pay such Insurance Charges for and on behalf of Choice or its subsidiary and, thereafter, Choice or its subsidiary shall forthwith reimburse Manor Care or such subsidiary of Manor Care for such payment. 30 ARTICLE VI ACCESS TO INFORMATION Section 6.01. Delivery of Corporate Records. Each of Manor Care and Choice shall arrange as soon as practicable following the Distribution Date for the delivery to the other of existing corporate governance documents (e.g. minute books, stock registers, stock certificates, documents of title, etc.) in its possession relating to the other or to its business and affairs. Section 6.02. Access to Information. From and after the Distribution Date each of Manor Care and Choice shall afford the other, including its accountants, counsel and other designated representatives, reasonable access (including using reasonable efforts to give access to persons or firms possessing information) and duplicating rights during normal business hours to all records, books, contacts, instruments, computer data and other data and information in such party's possession relating to the business and affairs of the other (other than data and information subject to an attorney/client or other privilege), insofar as such access is reasonably required by the other party including, without limitation, for audit, accounting and litigation purposes, as well as for purposes of fulfilling disclosure and reporting obligations. Section 6.03. Litigation Cooperation. Each of Manor Care and Choice shall use reasonable efforts to make available to the other, upon written request, its officers, directors, employees and agents as witnesses to the extent that such persons may reasonably be required in connection with any legal, administrative or other proceedings arising out of the business of the other prior to the Distribution Date in which the requesting party may from time to time be involved. Section 6.04. Reimbursement. Each party providing information or witnesses under Sections 6.01, 6.02 or 6.03 to the other shall be entitled to receive from the recipient, upon the presentation of invoices therefor, payment for all out-of- pocket costs and expenses as may be reasonably incurred in providing such information or witnesses. 31 Section 6.05. Retention of Records. Except as otherwise required by law or agreed to in writing, each party shall, and shall cause each of its respective subsidiaries to, retain all information relating to the other party's business in accordance with the past practice of such party. Notwithstanding the foregoing, except as provided in the Tax Sharing Agreement, any party may destroy or otherwise dispose of any information at any time, providing that, prior to such destruction or disposal, (a) such party shall provide no less than 90 days' prior written notice to the other party, specifying the information proposed to be destroyed or disposed of, and (b) if the recipient of such notice shall request in writing prior to the scheduled date for such destruction or disposal that any of the information proposed to be destroyed or disposed of be delivered to such requesting party, the party proposing the destruction or disposal shall promptly arrange for the delivery of such of the information as was requested at the expense of the requesting party. Section 6.06. Confidentiality. Each party shall hold and shall cause its directors, officers, employees, agents, consultants and advisors to hold, in strict confidence, unless compelled to disclose by judicial or administrative process or, in the opinion of its counsel, by other requirements of law, all information (other than any such information relating solely to the business or affairs of such party) concerning the other party (except to the extent that such information can be shown to have been (a) in the public domain through no fault of such party, (b) later lawfully acquired on a non-confidential basis from other sources by the party to which it was furnished or (c) information that typically would have been disclosed by Manor Care or Choice, as the case may be, in the ordinary course of business consistent with past practice). Neither party shall release or disclose any such information to any other person, except its auditors, attorneys, financial advisors, bankers and other consultants and advisors who shall be advised of and comply with the provisions of this Section 6.06; provided, that with respect to the matters identified on Schedule 6.06 hereof, no information may be disclosed by either party under any circumstance without the prior written consent of the other party hereto. Section 6.07. Mail. After the Distribution Date, each of Manor Care and Choice may receive mail, telegrams, packages and other communications properly belonging to the other. Accordingly, at all times after the Distribution Date, each of Manor Care and Choice authorizes the other to receive and open all mail, telegrams, packages and other communications received by it and not unambiguously intended for the other party or any of the other party's officers or directors specifically in their capacities as such, and to retain the same to the extent that they relate to the business of the receiving party or, to the extent that they do not relate to the business of the receiving party and do relate to the business of the other party, or to the extent that they relate to both businesses, the receiving party shall promptly contact the other party by telephone for delivery instructions and such mail, telegrams, packages or other communications (or, in case the same relate to both businesses, copies thereof) shall promptly be forwarded to the other party in accordance with its delivery instructions. The foregoing provisions of this Section 6.07 shall constitute full authorization to the postal authorities, all telegraph and courier companies and all other persons to make deliveries to Manor Care or Choice, as the case may be, addressed to either of them or to any of their officers or directors specifically in their capacities as such. The provisions of this Section 6.07 are not intended to and shall not be deemed to constitute an authorization by either Manor Care or Choice to permit the other to accept service of process on its behalf, and neither party is or shall be deemed to be the agent of the other for service of process purposes or for any other purpose. 32 ARTICLE VII CERTAIN ENVIRONMENTAL AND OTHER CLAIMS INDEMNIFICATION PROVISIONS Section 7.01. Certain Environmental and Other Claims Indemnification. Choice (the "Indemnitor") shall indemnify, defend and hold harmless Manor Care Inc., its Affiliates and subsidiaries and their respective directors, employees and agents (collectively, the "Indemnitee") subject to Section 7.02 from and against any loss, liability, claim, damage, fine, penalty or other expense (including but not limited to reasonable legal and consultant fees and expenses, and any sums necessary to respond to any third-party claim, including but not limited to any foreign, federal, state or local government directives or orders) (any "Loss") suffered or incurred by Indemnitee, on a pretax basis, to the extent arising from: (1) any and all currently pending claims as specified on Schedule 7.01 (the "Current Indemnified Claims"); and (2) any and all currently unknown but potential or future environmental, third-party personal injury and other claims, including, but not limited to, new claims arising out of the sites identified on Schedule 7.01 and new claims, arising out of the activities or operations of, or conditions affecting, properties formerly or presently owned, leased, operated or used by, Cenco Incorporated and its subsidiaries and Affiliates, and any and all of Cenco Incorporated's predecessor corporations, subsidiaries and Affiliates (collectively, the "Potential Indemnified Claims"). The Current Indemnified Claims and the Potential Indemnified Claims are collectively referred to as the "Indemnified Claims." Section 7.02. Scope of Indemnification. The Loss to be indemnified does not include any expenditures made prior to the Distribution. The Loss shall include but not be limited to: (1) all amounts required to be reimbursed to an insurer for insurance proceeds previously paid by such insurer as a result of an Indemnified Claim; (2) all deductible amounts required to be paid under any insurance policy before coverage attaches for an Indemnified Claim; (3) all amounts paid to third parties in excess of insurance coverage; (4) all other amounts not paid by insurers in connection with Indemnified Claims; and (5) the cost of any action against insurers to obtain insurance coverage. Notwithstanding anything to the contrary contained herein, Losses to be indemnified with respect to the Imperial, Darlington and Lisbon sites identified on Schedule 7.01 only include Losses that are in excess of the reserves reflected in the most recent monthly balance sheet of Manor HealthCare Corp. available prior to the Distribution Date. 33 Section 7.03. Procedures for Indemnification for Current and Potential Indemnified Claims. (a) Manor Care shall notify Indemnitor in writing promptly after learning of any Potential Indemnified Claim for which an Indemnitee intends to seek indemnification from Indemnitor under this Article VII. The failure of Manor Care to give such notice shall not relieve Indemnitor of its obligations under this Article VII except to the extent that Indemnitor is actually prejudiced by such failure to give notice. Such notice shall describe such Potential Indemnified Claim in reasonable detail considering the information provided to Indemnitee and shall include copies of all notices and documents received by an Indemnitee from the person or entity making the Potential Indemnified Claim. (b) Following the Distribution Date, Manor Care shall control the investigation and defense or settlement of all Indemnified Claims, without prejudice to its right to seek indemnification hereunder. However, except as otherwise provided in Section 7.03(c), Indemnitor may, with the approval of Manor Care, at any time after the Distribution Date, undertake to jointly defend or settle an Indemnified Claim. If Indemnitor undertakes the joint defense of any Indemnified Claim, Indemnitor shall thereby admit its obligation to indemnify Indemnitee against any Loss associated with such Indemnified Claim, and neither Indemnitee nor Indemnitor may settle or compromise such Indemnified Claim, without the prior written consent of Choice or Manor Care, as the case may be. Subject to Section 7.03(c), in the case of such joint defense, the Indemnitor and Indemnitee shall use the same outside legal counsel, who shall be chosen by Manor Care, and Indemnitor shall be responsible for all costs of such joint defense, including legal fees and expenses, pursuant to Section 7.03(e). 34 (c) If Indemnitor seeks to undertake the joint defense of an Indemnified Claim, and if Manor Care reasonably determines that Indemnitee's interests differ from those of Indemnitor, or that there may be legal defenses or claims available to it that are different from or in addition to those available to Indemnitor that may make it inappropriate for Indemnitor to undertake the joint defense or settlement of an Indemnified Claim, then Indemnitor shall not be entitled to undertake the joint defense or settlement of such Indemnified Claim; and counsel for Indemnitor, who shall be chosen by Choice, shall be entitled to conduct the defense of Indemnitor and counsel for Indemnitee, who shall be chosen by Manor Care, shall be entitled to conduct the defense of Indemnitee, all at Indemnitor's expense, it being understood that both will direct their respective counsel to cooperate with each other to conduct the defense or settlement of such action as efficiently as possible. (d) Both parties shall make available to each other, their counsel and other representatives all information and documents reasonably available to them that relate to any Indemnified Claim, and otherwise cooperate as may reasonably be required in connection with investigation, defense and settlement thereof (while taking such steps as are necessary to preserve the attorney-client and work product privileges, including through the execution of a joint defense agreement). Such cooperation shall include the retention and (upon Choice's request) the provision to Choice of records and information that are reasonably relevant to such Indemnified Claim and the availability of employees on a mutually convenient basis to provide additional information and explanation of any material provided hereunder. Any joint defense agreement entered into by Indemnitor or Indemnitee with any third party relating to any Indemnified Claim shall provide that either party may, if requested, provide information obtained through any such agreement to Indemnitor or Indemnitee, as the case may be. (e) Manor Care shall be responsible to make payments on any and all Loss(es) as each such payment becomes due. Manor Care shall, within 15 days after the end of each month beginning 15 days after the end of the month in which the Distribution Date occurs, provide to Choice a monthly statement of Loss, including reasonable documentation regarding the expenditures detailed therein. Choice shall remit payment for such Loss to Manor Care within 30 days of receipt of each such Statement of Loss. In the event that Choice disputes an individual expenditure or expenditures, Choice shall promptly pay the undisputed portion to Manor Care and shall promptly notify Manor Care, in writing, of its reasons for disputing the unpaid portion(s). In response to such written notification, Manor Care shall provide Choice, at Choice's expense, with such additional information as Choice may request in order to assure the reasonableness or appropriateness of any fees or expenses charged to Choice. Any disputes shall be resolved in accordance with Section 8.13. 35 Section 7.04. Losses Net of Insurance or Other Recovery. (a) The amount of any Loss for which indemnification is provided shall be reduced (including, without limitation, retroactively) by any insurance proceeds or other amounts actually recovered or received by or on behalf of Indemnitee in reduction of such Loss. If, after Indemnitor has made indemnification to Indemnitee for any Loss, Indemnitee actually receives insurance proceeds or other amounts in respect of such Loss, Indemnitee shall pay to Indemnitor a sum equal to the amount of such insurance proceeds or other amount actually received after deducting therefrom all of Indemnitee's costs and expenses associated with the recovery of any such amount. (b) Indemnitor and Indemnitee understand and agree that Manor Care, with the assistance of Indemnitor, will undertake reasonable efforts to obtain reimbursement from its insurers for the Indemnified Claims. With respect to the Current Indemnified Claims specified in Table 1 of Schedule 7.01, such efforts shall include mediation, arbitration or litigation against at least the primary insurers. With respect to the Current Indemnified Claims identified in Tables 2, 3 and 4 and the Potential Indemnified Claims, such efforts shall include timely notification to relevant insurers of the initiation of claims and of important events or deadlines during any litigation regarding such claims (including trial dates and the filing of summary judgment motions), prompt responses to insurers' requests for information about claims, as well as the initiation of mediation, arbitration or litigation, if necessary and appropriate to obtain insurance reimbursement. Section 7.05. No Third-Party Beneficiaries. This Article VII shall inure to the benefit of and be enforceable by Indemnitee and its successors and assigns but shall not inure to the benefit of any other third party or parties, including, but not limited to, any insurer that may have provided coverage applicable to the defense or indemnity of any or all of the Indemnified Claims, or any state, federal, or local government instrumentality, any legal or equitable rights hereunder. Nothing herein shall be construed to affect insurance coverage that exists or that may exist prior to the date of this Agreement. Section 7.06. Remedies Cumulative. The remedies provided in this Article VII shall be cumulative and shall not preclude assertion by any party of any other rights or the seeking of any other remedies against any party. Moreover, to the extent that this Article VII conflicts with any other Article or portion of this Agreement with respect to the subject matter hereof, this Article VII shall govern. The procedures set forth in this Article VII shall be the exclusive procedures governing any indemnity action brought under this Article VII or otherwise relating to Indemnifiable Claims. 36 Section 7.07. Survival of Indemnities. The obligations of each of Manor Care and Choice under this Article VII shall survive the sale or other transfer by it of any assets or businesses or the assignment by it of any Liabilities with respect to any Indemnifiable Claims of the other. Section 7.08. After-Tax Indemnification Payments. Except as otherwise expressly provided herein or in an Ancillary Agreement, any indemnification payment made by the Indemnitor under this Article VII shall be computed by taking into account the value of any and all applicable deductions, losses, credits, offsets or other items for Federal, state or other tax purposes attributable to the payment of the indemnified liability by the Indemnitee and any Tax incurred by the Indemnitee attributable to receipt of the indemnification payment. ARTICLE VIII MISCELLANEOUS Section 8.01. Termination. This Agreement may be terminated and the Distribution deferred, modified or abandoned at any time prior to the Distribution Date by and in the sole discretion of the Board of Directors of Manor Care without the approval of Choice or of Manor Care's stockholders. In the event of such termination, no party shall have any liability to any other party pursuant to this Agreement. Section 8.02. Expenses. Except as specifically provided in this Agreement or in an Ancillary Agreement, all costs and expenses incurred in connection with the preparation, execution, delivery and implementation of this Agreement and with the consummation of the transactions contemplated by this Agreement shall be paid by the party incurring the expense. The determination of who has incurred an expense shall be made by the Chief Financial Officer of Manor Care, which determination shall be binding and final upon each of the parties hereto and not subject to further review. In addition, it is understood and agreed that Choice shall pay the legal, filing, accounting, printing and other accountable and out-of-pocket expenditures in connection with (i) the preparation, printing and filing of the Form 10 and the Information Statement, (ii) obtaining of the Choice Credit Facility and (iii) amending the Existing Credit Facility. Section 8.03. Notices. All notices and communications under this Agreement shall be in writing and any communication or delivery hereunder shall be deemed to have been duly given when received addressed as follows: If to Manor Care, to: Manor Care, Inc. 11555 Darnestown Rd. Gaithersburg, Maryland 20878-3200 Attn: General Counsel Telecopy Number: [301-979-4007] If to Choice, to: Choice Hotels International, Inc. 10750 Columbia Pike Silver Spring, Maryland 20901 Attn: General Counsel Telecopy Number: 301-979-4007 37 Any party may, by written notice so delivered to the other parties, change the address to which delivery of any notice shall thereafter be made. Section 8.04. Amendment and Waiver. This Agreement may not be altered or amended, nor may rights hereunder be waived, except by an instrument in writing executed by the parties hereto. No waiver of any terms, provision or condition of or failure to exercise or delay in exercising any rights or remedies under this Agreement, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, provision, condition, right or remedy or as a waiver of any other term, provision or condition of this Agreement. Section 8.05. Counterparts. This Agreement may be executed in one or more counterparts each of which shall be deemed an original instrument, but all of which together shall constitute but one and the same Agreement. Section 8.06. Governing Law; Jurisdiction; Forum. This Agreement shall be construed in accordance with, and governed by, the laws of the State of Delaware, without regard to the conflicts of law rules of such state. Each party hereto agrees that any action or proceeding to enforce, or which arises out of or in any way relates to, directly or indirectly, this Agreement, or any of the Ancillary Agreements, shall, subject to Section 8.13, be brought or prosecuted in state court or courts in the State of Maryland or, in any action or proceeding with respect to which federal courts shall have exclusive subject matter jurisdiction, in the United States District Court for the District of Maryland. Subject to Section 8.13, each party hereto expressly submits and consents in advance to such jurisdiction in any action or proceeding commenced hereunder or under any Ancillary Agreement, and hereby waives any claim that any such state or federal court is an inconvenient or improper forum. Section 8.07. Entire Agreement. This Agreement including the schedules hereto, together with the Ancillary Agreements, constitute the entire understanding of the parties hereto with respect to the subject matter hereof, superseding all negotiations, prior discussions and prior agreements and understandings relating to such subject matter. To the extent that the provisions of this Agreement are inconsistent with the provisions of any Ancillary Agreements, the provisions of such Ancillary Agreement shall prevail. Section 8.08. Parties in Interest. Neither of the parties hereto may assign its rights or delegate any of its duties under this Agreement without the prior written consent of the other party. This Agreement shall be binding upon, and shall inure to the benefit of, the parties hereto and their respective successors and permitted assigns. Nothing contained in this Agreement, express or implied, is intended to confer any benefits, rights or remedies upon any person or entity other than Manor Care and Choice, and the Manor Care Indemnitees and Choice Indemnitees pursuant to Article IV and Indemnitee pursuant to Article VII hereof. Notwithstanding the rights of Indemnified Parties pursuant to Article IV and Indemnitee pursuant to Article VII, this Agreement may be altered or amended, and rights hereunder be waived, by an instrument in writing executed only by the parties hereto. 38 Section 8.09. Tax Sharing Agreement; After-Tax Payments. (a) Other than as provided in this Section 8.09 and Sections 4.11 and 5.07, this Agreement shall not govern any Tax, and any and all claims, losses, damages, demands, costs, expenses, liabilities, refunds, deductions, write-offs, or benefits relating to Taxes shall be exclusively governed by the Tax Sharing Agreement or the Tax Administration Agreement, as applicable. (b) If, at the time Choice is required to make any payment to Manor Care under this Agreement, Manor Care owes Choice any amount under the Tax Sharing Agreement, then such amounts shall be offset and the excess shall be paid by the party liable for such excess. Similarly, if, at the time Manor Care is required to make any payment to Choice under this Agreement, Choice owes Manor Care any amount under the Tax Sharing Agreement, then such amounts shall be offset and the excess shall be paid by the party liable for such excess. Section 8.10. Further Assurances and Consents. In addition to the actions specifically provided for elsewhere in this Agreement, each of the parties hereto will use its reasonable efforts to (i) execute and deliver such further instruments and documents and take such other actions as any other party may reasonably request in order to effectuate the purposes of this Agreement and to carry out the terms hereof and (ii) take, or cause to be taken, all actions, and to do, or cause to be done, all things, reasonably necessary, proper or advisable under applicable laws, regulations and agreements or otherwise to consummate and make effective the transactions contemplated by this Agreement, including, without limitation, using its reasonable efforts to obtain any consents and approvals and to make any filings and applications necessary or desirable in order to consummate the transactions contemplated by this Agreement; provided that no party hereto shall be obligated to pay any consideration therefor (except for filing fees and other similar charges) to any third party from whom such consents, approvals and amendments are requested or to take any action or omit to take any action if the taking of or the omission to take such action would be unreasonably burdensome to the party or its business. 39 Section 8.11. Exhibits and Schedules. The exhibits and schedules hereto shall be construed with and as an integral part of this Agreement to the same extent as if the same had been set forth verbatim herein. Section 8.12. Legal Enforceability. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. Any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Without prejudice to any rights or remedies otherwise available to any party hereto, each party hereto acknowledges that damages would be an inadequate remedy for any breach of the provisions of this Agreement and agrees that the obligations of the parties hereunder shall be specifically enforceable. Section 8.13. Dispute Resolution. (a) Except as otherwise set forth in Section 2.07 or Section 8.02 or the Lease Agreement, resolution of any and all disputes arising from or in connection with this Agreement or any of the Ancillary Agreements, whether based on contract, tort, statute or otherwise, including, but not limited to, disputes over arbitrability and disputes in connection with claims by third parties (collectively, "Disputes") shall be exclusively governed by and settled in accordance with the provisions of this Section 8.13; provided, however, that nothing contained herein shall preclude either party from seeking or obtaining (a) injunctive relief or (b) equitable or other judicial relief to enforce the provisions hereof or to preserve the status quo pending resolution of Disputes hereunder. (b) Manor Care or Choice (each a "Party") may commence proceedings hereunder by delivering a written notice to the other Party providing a reasonable description of the Dispute to the other (the "Demand"). (c) Promptly following a Demand, the Dispute shall be referred to representatives of the parties for decision, each party being represented by a senior executive officer who has no direct operational responsibility for the matters contemplated by this Agreement (the "Representatives"). The Representatives shall promptly meet in a good faith effort to resolve the dispute. If the Representatives do not agree upon a decision within thirty (30) calendar days after reference of the matter to them, each of Manor Care and Choice shall be free to exercise the remedies available to them under Section 8.13(d). 40 (d) The parties hereby agree to submit all Disputes not resolved by negotiation pursuant to Section 8.13(c) to arbitration under the terms hereof, which arbitration shall be final, conclusive and binding upon the parties, their successors and assigns. The arbitration shall be conducted in Maryland by three arbitrators acting by majority vote (the "Panel") selected by agreement of the Parties not later than ten (10) days after the failure of the Representatives to resolve the dispute as set forth in Section 8.13(c) or, failing such agreement, appointed pursuant to the Commercial Arbitration Rules of the American Arbitration Association, as amended from time to time (the "AAA Rules"). If an arbitrator so selected becomes unable to serve, his or her successors shall be similarly selected or appointed. The arbitration shall be conducted pursuant to the United States Arbitration Act, 9 U.S.C. { 1, et seq. and such procedures as the Parties may agree, or, in the absence of or failing such agreement, pursuant to the AAA Rules. Notwithstanding the foregoing: (a) each Party shall have the right to audit the books and records of the other Party that are reasonably related to the Dispute; (b) each Party shall provide to the other, reasonably in advance of any hearing, copies of all documents which a Party intends to present in such hearing; (c) each party shall be allowed to conduct reasonable discovery through written requests for information, document requests, requests for stipulation of fact and depositions, the nature and extent of which discovery shall be determined by the Panel, taking into account the needs of the Parties and the desirability of making discovery expeditious and cost effective. All hearings shall be conducted on an expedited schedule, and all proceedings shall be confidential. Either party may at its expense make a stenographic record thereof. The Panel shall complete all hearings not later than ninety (90) days after its selection or appointment, and shall make a final award not later than thirty (30) days thereafter. The award shall be in writing and shall specify the factual and legal basis for the award. The fees and expenses of the arbitrators shall be shared equally by the Parties and advanced by them from time to time as required; provided that at the conclusion of the arbitration, the Panel shall allocate costs and expenses (including the costs of the arbitration previously advanced and the fees and expenses of attorneys, accountants and other experts) and interest as the Panel determines is appropriate among the parties. The arbitrators shall not be empowered to award to any Party any consequential damages, lost profits or punitive damages in connection with any Dispute and each party hereby irrevocably waives any right to recover such damages. 41 Section 8.14. Titles and Headings. Titles and headings to sections herein are inserted for convenience of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. 42 THIS AGREEMENT CONTAINS BINDING ARBITRATION PROVISIONS WHICH MAY BE ENFORCED BY THE PARTIES. IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement as of the day and year first above written. Manor Care, Inc., a Delaware corporation By: Name: Title: Choice Hotels Holding, Inc., a Delaware corporation By: Name: Title: 43 Schedule 1 LODGING SUBSIDIARIES (1) BOULEVARD MOTEL CCRP. Biscayne Land Associates, Inc. Biscayne Properties, Inc. Bowling Green Inn - Brandywine, Inc. Cardinal Beverage Corp. Everglades Beverage Corp. Fairways Beverage Corp. Fairways, Inc. K & A Corp. MCH Baltimore Corp. MCH Hot Springs Corp. MCH Lincoln Corp. MCH Management, Inc. MCH Roanoke Corp. MCH Shady Grove Corp. MCH Springfield Corp. MCH Sturgis Corp. MCH Wichita Corp. MCHD Cypress Creek Corp. MCHD Ft. Lauderdale Corp. MCHD Hampton Corp. Raleigh Hotel Holdings, Inc. West Montgomery Hotel Holdings, Inc. CACTUS HOTEL CORP. CHOICE HOTELS INTERNATIONAL, INC. (Formerly Quality Inns International, Inc.) ("Choice Hotels") CH Europe, Inc. (d) Choice Capital Corp. Choice Hotels Australia Pty. Ltd. (90%) Choice Hotels Canada Inc. (50%) Choice Hotels (Cayman) Ltd. (10%) Choice Hotels International Asia Pacific Pty. Ltd. Choice Hotels International Pty. Ltd. (Formerly Quality Inn Pty. Ltd.) (d) Choice Hotels (Ireland) Limited (d) - ------------------- (1) Direct Lodging Subsidiaries are set forth below in capital letters with their subsidiaries immediately following. Entities are wholly owned except where indicated. 44 -2- Choice Hotels Japan, Inc. (Formerly Quality Hotels Japan, Inc.) Choice Hotels Limited Choice Hotels of Brazil, Inc. Choice Hotels Pacific Asia K.K. (Formerly Quality Hotels Pacific Asia, Inc.) (d) Choice Hotels Pty. Ltd. (Formerly Quality Hotels Pty. Ltd.) (d) Choice Hotels Systems, Inc. Choice Hotels Venezuela, C.A. (20%) Clarion Hotel Pty. Ltd. (Formerly Royale Hotels Pty. Ltd.) (d) Comfort Hotels Pty. Ltd. (d) Comfort Inn Pty. Ltd. (d) Comfort Inns New Zealand Limited (Formerly Quality Inns New Zealand Limited) (d) Hoteles Cono Sur S.A. QI Capital Corp. (d) Quality Hotels (Ireland) Limited (d) Quality Hotels Limited (Formerly Quality Hotels (China) Limited (50%; 50% Manor Care, Inc.) (d) Quality Hotels and Resorts, Inc. (d) Baltimore Hotel Management. Inc. (d) Myrtle Beach Hotel Management, Inc. (d) Quality Inns International, Inc. (Formerly Choice Hotels International, Inc.) Quality Inter-Americas, Inc. (d) Sleep Inn Pty. Ltd. (d) QUALITY HOTELS EUROPE, INC. COMFORT CALIFORNIA, INC. GULF HOTEL CORP. HEFRU FOOD SERVICES, INC. QCM BEVERAGES, INC. (49%; 51% Texas resident) QCM CORPORATION (d) QI ADVERTISING AGENCY, INC. QUALITY ARIZONA, INC. (d) QH Europe, Inc. (d) QUALITY INNS WORLD MARKETING CORPORATION QUALITY INSURANCE ASSOCIATES, INC. (d) REVERE GROUP, INC. (THE) (d) SUNBURST HOTEL CORP. THICKET, INC. (THE) (Non-Profit; owned by members) 45 -3- PARTNERSHIPS QH Europe Partnership (80% Quality Hotels Europe, Inc. ("QHE"), 20% Choice Hotels International, Inc.) Choice Hotels (Deutschland) G.m.b.H. (99%; 1% Choice Hotels) Choice Hotels (France) S.a.r.l. (99%; 1% Choice Hotels) Choice Hotels Benelux S.A. (51%) Manor Care Hotels (France) S.A. Manor Care Hotels France No. 1 S.a.r.l. Manor Care Hotels France No. 2 S.A. Manor Care Hotels France No. 3 S.a.r.l. Manor Care Hotels France No. 4 S.a.r.l. Quality Hotels Limited (Formerly QI Hotels (U.K.) Limited) (99%; 1% Choice Hotels) Choice Hotels (UK) Limited Quality Hotels Europe (Alsdorf) G.m.b.H. (99%; 1% QHE) (d) Quality Hotels Europe (Herleshausen) G.m.b.H. (99%; 1% QHE) (d) Quality Hotels Europe (Jena) G.m.b.H. (formerly Quality Hotels Europe (Deutschland) G.m.b.H.) (99%; 1% QHE) Quality Hotels Europe (Leipzig) G.m.b.H. (99%; 1% QHE) (d) Quality Hotels Europe (Peine) G.m.b.H. (99%; 1% QHE) Quality Hotels Europe (Troisdorf) G.m.b.H. (99%; 1% QHE) (d) = dormant companies 46 Schedule 2.01(b) Transferred Hotels (1) Quality Inn Midvalley 4465 Century Drive Salt Lake City, UT 84123; and (2) Quality Hotel 1190 N. Courthouse Road Arlington, VA 22201 47 Schedule 2.03 Assisted Living Facilities Springhouse Assisted Living 26111 Telegraph Road Southfield, Michigan 48034 48 Schedule 5.02(a) Manor Care Guarantees: 1. Guarantee of $1,971,000 of Industrial Revenue Bonds relating to the Phoenix Reservations Center. 2. Guarantee pursuant to Leases for the California properties in effect on the Distribution Date. 49 Schedule 5.10(a) Covered Claims General Liability Commercial Property Automobile Liability Workers' Compensation Program (Insured States) Workers' Compensation Program (Self-Insured States OH, PA, FL, CA) Texas Salary Maintenance & Medical Reimbursement Program Texas Stop Gap Liability Foreign Property & Liability DIC/DIL Commercial Package Policy (Canada) Commercial Property (Germany) Commercial Property (Australia) Commercial Property (France) Commercial Property (UK) Commercial Property (Japan) General Liability (QH Jena) General Liability (QH Peine) General Liability (QH Troisdorf) General Liability (France) General Liability (UK) General Liability (Japan) Automobile Physical Damage & Liability (UK) Automobile Physical Damage & Liability (Australia) Automobile Physical Damage & Liability (Germany) Automobile Physical Damage & Liability (France) Workers' Compensation & Employer's Liability (Australia) Workers' Compensation & Employer's Liability (Canada) Employer's Liability (UK) Employer's Liability (All Foreign Operations except UK/CAN/Australia) Sabotage & Terrorism (UK) Juridical Protection (France) Umbrella Liability Crime Boiler & Machinery Products Liability Aircraft Liability Director's & Officer's Liability Shock Losses 50 Schedule 6.06 Restricted Information 51 Schedule 7.01 Schedule of Current Indemnified Claims Table 1 Schedule of Currently Pending Lawsuits and Directives Regarding Allegedly Environmentally Contaminated Sites Site Proceeding ---- ---------- BEMS Landfill In the Matter of the Burlington Environmental Management Services, Inc. Landfill, Southampton Township, New Jersey, and Almo Anti-Pollution Services Corporation, et al., New Jersey Department of Environmental Protection, Directive and Notice to Insurers, 1995-16 Borne Chemical In the Matter of the Borne Chemical Company Site, Elizabeth, New Jersey, and Agip USA, Inc., et al., New Jersey Department of Environmental Protection, Directive (1994) GEMS Landfill Allen v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-03659-88 GEMS Landfill Baltra v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-081673-86 GEMS Landfill Brooks v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-080058-85 GEMS Landfill Burns v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-92398-87 GEMS Landfill Coyne v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-81700-86 GEMS Landfill Diegel v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-074522-86 52 -2- Site Processing ---- ---------- GEMS Landfill Charles Diegel and Wendy Diegel, et al. v. Township of Gloucester, et al., Superior Court of New Jersey Law Division: Camden County, Docket No. L-068199-85 GEMS Landfill Dold v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-0815292-86 GEMS Landfill Favilla v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-081687-86 GEMS Landfill Keating v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-12152990 GEMS Landfill Garson v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-066302-87 GEMS Landfill Lucia v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-081681-86 GEMS Landfill Tuzza v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-074521-86 GEMS Landfill Volusher v. Amadei, Superior Court of New Jersey Law Division: Camden County, Docket No. L-068199-85 GEMS Landfill New Jersey Department of Environmental Protection v. Gloucester Environmental Management Services, Inc., et al., United States District Court for the District of New Jersey, Civil No. 84-0152(B), and United States of America v. Air Products & Chemicals, Inc., et al., Civil No. 92-3860 53 -3- Site Proceeding ---- ---------- JEMS Landfill In the Matter of the Florence Land Recontouring Landfill, Florence and Mansfield Townships, Burlington County, New Jersey, and Aaxon Industrial, Inc., et al., New Jersey Department of Environmental Protection, Directive and Notice to Insurers Number One (1989) Kin-Buc Landfill Transtech Industries, Inc., et al. v. A&Z Septic Clean, et al., United States District Court for the District of New Jersey, Civil No. 2-90-2578 Kramer Landfill New Jersey Department of Environmental Protection v. Almo-Anti-Pollution Services Corp., et al., United States District Court for the District of New Jersey, Civil No. 89-4380 Lipari Landfill United States of America and New Jersey Department of Environmental Protection v. Rohm and Haas Company, Inc., et al., United States District Court for the District of New Jersey, Civil No. 85-4386 Lipari Landfill Wilson v. Rohm & Haas, et al., Superior Court of New Jersey, Gloucester County, Docket No. GLO-L-1375-95. Marvin Jonas Transfer In the Matters of the Marvin Jonas Station Transfer Station, Deptford Township, Gloucester County, New Jersey; Florence Land Recontouring Landfill, Florence and Mansfield Townships, Burlington County, New Jersey; Helen Kramer Landfill, Mantua Township, Gloucester County, New Jersey; P.J.P. Landfill, Jersey City, Hudson County, New Jersey; and A&B Dump Truc, Service, Inc., et al., New Jersey Department of Environmental Protection, Multi-Site Directive and Notice to Insurers Number One (1990) 54 -4- Site Proceeding ---- ---------- Reserve Environmental Reserve v. Industrial Wastes, United Services Facility States District Court for the Northern District of Ohio, Case No. 4:93 CV 1157 SC Holdings SC Holdings v. A.A.A. Realty Co., et al., Civil Action No. 95-CV-947 Scientific Chemical AT&T Technologies, Inc., et al. v. Processing - Carlstadt Transtech Industries, Inc., et al., United States District Court for the District of New Jersey, Civil Action No. 88-4267 Scientific Chemical AT&T Technologies, Inc., et al. v. Processing - Newark Presto, et al., United States District Court for the District of New Jersey, Civil Action No. 88-4828 55 -5- Table 2 Schedule of Allegedly Environmentally Contaminated Sites For Which No Formal Claim Has Yet Been Made Site Location ---- -------- McAdoo Landfill Kline Township, PA Nyanza Superfund Site Ashland, MA Standard Candy Site Eislee, Tennessee 56 -6- Table 3 Current Sites With Ongoing Cleanup Pursuant to Government Directive Site Location ---- -------- Imperial Site Imperial, Pennsylvania Darlington Site Darlington, Pennsylvania Lisbon Site Lisbon, Ohio 57 -7- Table 4 Other Current Sites Schedule of Cases Case Name Court --------- ----- Audio Visual Publications, Inc. U.S. District Court for the v. Cenco, Incorporated Southern District of New York Shields v. Izzy's Place, et al. Supreme Court for New York v. Maternity & Homemaking County, State of New York Servs., Inc. Wetherall v. Central Scientific Great Falls, Montana [state Co. or federal court?] EX-10.20 5 FORM OF SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN 1 EXHIBIT 10.20 CHOICE HOTELS INTERNATIONAL, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN Choice Hotels International, Inc. has adopted the following Supplemental Executive Retirement Plan (the "Plan") for the benefit of eligible employees. ARTICLE I DEFINITIONS As used herein, the following words and phrases shall have the meaning specified below, unless a different meaning is plainly required by the context: Section 1.01. "Board of Directors" shall mean the Board of Directors of the Company (or any designated committee thereof). Section 1.02. "Early Retirement Date" shall mean the date upon which a Participant becomes eligible to receive benefits hereunder as set forth in Section 5.01(b). Section 1.03. "Employer" shall mean the Company, its successors and assigns, any subsidiary authorized by the Board of Directors to participate in this Plan, and any corporation into which an Employer may be merged or consolidated or to which all or substantially all of its assets may be transferred, provided such corporation does not affirmatively disavow this Plan. Section 1.04. "Employment Date" shall mean the date upon which a Participant commenced full-time employment with the Company. Section 1.05. "Final Average Salary" shall mean the highest average of the monthly base salary, excluding any bonuses or commissions, earned in a sixty-month period out of the 120 months of employment immediately prior to the Normal Retirement Date or the Early Retirement Date (as the case may be). Section 1.06. "Normal Retirement Date" shall mean the date upon which Participants become eligible to receive benefits hereunder as set forth in Section 5.01(a). 1 2 Section 1.07. "Participant" shall mean any individual who has been approved eligible to participate in the Plan pursuant to Article III hereunder. Section 1.08. "Years of Service" shall mean the number of years and months between the Employment Date and the Normal Retirement Date or the Early Retirement Date (as the case may be), excluding any period during which a Participant is employed on a part-time basis by an Employer. ARTICLE II ADMINISTRATION OF PLAN Section 2.01. The Board of Directors shall have responsibility for the administration of the Plan. Such responsibility shall include, but not be limited to, approval of individual Participants, interpretation of the Plan, and the granting of exceptions to the Plan, if any. All such determinations by the Board of Directors shall be conclusive and binding on all Participants. ARTICLE III PARTICIPANT ELIGIBILITY Section 3.01. Participants shall be selected officers of an Employer. Participants must be individually submitted to, and approved by, the Board of Directors. ARTICLE IV CALCULATION OF BENEFIT Section 4.01. Participants will receive a monthly retirement benefit for life based upon Years of Service and Final Average Salary as shown below. For each month between fifteen and twenty-five Years of Service, retirement benefit as a percentage of Final Average Salary shall be increased by .125%. The amount of the monthly benefit will be paid with no offset for benefits a Participant may receive from Social Security. 2 3
Years of Service at Retirement Benefit as % Normal Retirement Date of Final Average Salary - ---------------------- ----------------------- 25 or more 30.0% 24 28.5% 23 27.0% 22 25.5% 21 24.0% 20 22.5% 19 21.0% 18 19.5% 17 18.0% 16 16.5% 15 15.0%
Section 4.02. Retirement benefits shown in Section 4.01 above are shown as straight life annuity payments. Participants may also elect upon retirement a joint and 50% survivor annuity or a ten-year certain (120 months guaranteed) payment. If other than a straight life annuity payment is elected, benefit payments will be adjusted in accordance with standard actuarial tables selected by the Company. ARTICLE V PAYMENT OF BENEFITS Section 5.01. Participants are not entitled to any benefits unless they are eligible for normal or early retirement benefits when their employment terminates for any reason. 3 4 Participants are eligible to receive benefits upon: (a) Normal retirement - Participants retiring at age 65 with a minimum of 15 Years of Service will start receiving monthly benefits upon the first day of the month following their retirement. (b) Early Retirement - Participants with a minimum of 15 Years of Service may retire between ages 60 and 65 with approval of the Board of Directors. Benefit payments to such Participants shall start upon the first day of the month following their 65th birthday. The Board of Directors may authorize benefit payments to start prior to age 65 when it feels it is in the Company's best interest and such payments are desired by the Participant. In such a case, the amount of the monthly benefit will be reduced according to the age of the Participant when the payments commence, as shown below:
Percent of Monthly Retirement Age when Benefits Commence Benefit to be Paid - -------------------------- -------------------------------------- 64 93.3% 63 86.7% 62 80.0% 61 73.3% 60 66.7%
Section 5.02. Participants who desire to work past age 65, and who are allowed to do so by permission of the Company, may, at their option, be either (i) paid benefits hereunder in accordance with Section 5.01(a) as if the Participants had retired, or (ii) have such benefits increased actuarially for each Year of Service past age 65. Section 5.03. All Participants at the time of retirement, as a condition of receiving any benefits hereunder, must agree that they shall not become the owner of, or an officer, director, employee or consultant of any entity which, in the opinion of the Board of Directors, is in competition with any business of the Company. 4 5 Section 5.04. Spouses of Participants with at least 15 Years of Service who die prior to retirement and after their 60th birthday will receive 50% of the benefit they would have received had the Participant retired on the first day of the month before death and chosen retirement benefits in the form of a joint and 50% survivor annuity. ARTICLE VI EFFECTIVE DATE Section 6.01. The Plan covers Participants retiring on or after [ ], 1996. All past Years of Service for an Employer and its predecessor are recognized. ARTICLE VII EFFECTIVE DATE Section 7.01. The Company retains the right to amend or terminate the Plan at any time. Should the Plan be terminated, Participants with at least fifteen Years of Service at time of Plan termination shall be entitled to the Retirement Benefit specificed in Article IV determined on the basis of their Years of Service at the time of Plan termination. In addition, Participants who do not have at least fifteen Years of Service at the time of Plan termination shall be entitled to a pro rata portion of the Retirement Benefit specified in Article IV of a Participant with fifteen Years of Service. Such pro rata portion shall be calculated by using the Participant's number of Years of Service at the time of Plan Termination as the numerator and 15 as the denominator. Payment of such benefits will not commence prior to when it would have commenced had the Plan remained in effect. ARTICLE VIII MISCELLANEOUS Section 8.01. Any rules, regulations, or procedures that may be necessary for the proper administration or functioning of this Plan may be promulgated and adopted by the Board of Directors. Section 8.02. This Plan shall be interpreted and enforced in accordance with the laws of the State of Maryland, without regard to its conflict of laws principles. 5 6 Section 8.03. This Plan shall not be deemed to constitute an employment contract between an Employer and any Participant or to be a consideration or an inducement for the employment of any Participant. Nothing contained in this Plan shall be deemed to give any Participant the right to be retained in the service of an Employer or to interfere with the right of an Employer to discharge any Participant at any time regardless of the effect which such discharge shall have upon him as a Participant of the Plan. 6 EX-10.21 6 FORM OF NE DIRECTOR STOCK OP. & DEF. COMP. PLAN 1 EXHIBIT 10.21 CHOICE HOTELS INTERNATIONAL, INC. NON-EMPLOYEE DIRECTOR STOCK OPTION AND DEFERRED COMPENSATION STOCK PURCHASE PLAN Choice Hotels International, Inc. has adopted and established a non-qualified stock option plan for Non-Employee Directors in accordance with the following terms and conditions. The plan also provides Non-Employee Directors the ability to elect to defer compensation and purchase stock with director fees. SECTION ONE DESIGNATION AND PURPOSE OF THE PLAN A. DESIGNATION. This Plan is designated the "Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan". B. PURPOSE. The purpose of this Plan is to secure for the Company and its stockholders the benefits of the incentive inherent in increased ownership of Company Stock by Non-Employee Directors. It is expected that such ownership will provide such Non-Employee Directors with a more direct stake in the future welfare of the Company and encourage them to remain directors of the Company. It is also expected that the Plan will encourage qualified persons to become directors of the Company. C. GOVERNING LAW. This Plan shall be interpreted and enforced in accordance with the laws of the State of Maryland, without reference to its conflict of laws principles. SECTION TWO DEFINITIONS As used in this Plan, the following terms mean: A. "BOARD" means the Board of Directors of the Company. B. "COMPANY" means Choice Hotels International, Inc. C. "NON-EMPLOYEE DIRECTOR" means a member of the Board of the Company who is not an employee of the Company or any of its subsidiaries. D. "OPTION" means a non-qualified stock option granted to a Participant under this Plan. It also means any Option which remains after a Participant has exercised his Option with respect to part of the shares covered by an Option agreement. E. "PARTICIPANT" means any Non-Employee Director who is granted an Option as provided in this Plan. 2 F. "PLAN" means this Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. G. "STOCK" and "COMPANY STOCK" mean the common stock of Choice Hotels International, Inc. H. Wherever appropriate, words used in this Plan in the singular may mean the plural, the plural may mean the singular and the masculine may mean the feminine. PART A RULES RELATING TO STOCK OPTION PROGRAM SECTION THREE STOCK SUBJECT TO OPTION A. TOTAL NUMBER OF SHARES. The total number of shares of Stock which may be included in all Options granted to all Participants under this Part A is 150,000 shares. The maximum number of shares authorized may be increased from time to time by approval of the Board, and if required, pursuant to Rule 16b-3 of the Securities and Exchange Commission or its successors or the applicable rules of any stock exchange, the stockholders of the Company. Such Stock may be either authorized and unissued Stock or reacquired Stock. B. EXPIRED OPTIONS. If any Option granted under this Part A (i) is unexercisable, or (ii) is terminated, or (iii) expires or is canceled for any other reason, in whole or in part, the shares (or remaining shares) of Stock subject to that particular Option shall again be available for grant under this Part A. SECTION FOUR ADMINISTRATION OF THIS PART A This Part A shall be administered by the Board. The Board shall have all the powers vested in it by the terms of this Part A, such powers to include authority (within the limitation described herein) to prescribe the form of the agreement embodying awards of Options made under this Part A. Subject to the provisions of this Part A, the Board shall have the power to construe this Part A, to determine all questions arising thereunder, and to adopt and amend such rules and regulations for the administration of this Part A as it may deem desirable. Any decision of the Board in the administration of this Part A, as described herein, shall be final and conclusive. The Board may act only by a majority of its members in office, except that the members thereof may authorize any one or more of their number or the Secretary or any other officer of the Company to execute and deliver documents on behalf of the Board. 2 3 SECTION FIVE SELECTION OF PARTICIPANTS Each Non-Employee Director shall be eligible to receive an Option in accordance with Section Six. Each Option granted under this Part A shall be evidenced by an agreement in such form as the Board shall prescribe from time to time in accordance with this Part A and shall comply with the terms and conditions set forth in Sections Six and Seven. Such an agreement shall incorporate the provisions of this Part A by reference. SECTION SIX GRANT OF OPTIONS AND LIMITATIONS ON EXERCISE A. INITIAL GRANT FOR INCUMBENT MEMBERS OF THE BOARD. Each Non-Employee Director as of [ ] shall receive an Option (a [ ] Option") to purchase for five years 5,000 shares of Stock, subject to the terms and conditions herein; provided, however, Robert C. Hazard, Jr. and Gerald W. Petitt shall not receive a [ ] Option. B. INITIAL GRANT FOR NEW MEMBERS OF THE BOARD. Each Non-Employee Director (other than Robert C. Hazard, Jr. and Gerald W. Petitt) who is not a recipient of a [ ] Option, upon the date of his initial election or appointment as a director of the Company, shall receive an Option to purchase for five years 5,000 shares of Stock, subject to the terms and conditions herein. C. ANNUAL GRANT. As of each annual Stockholders Meeting of the Company thereafter, commencing in the calendar year subsequent to the calendar year in which an initial grant was awarded the Non-Employee Director pursuant to Sections Six A or B above, each Non-Employee Director shall receive an Option to purchase for five years 1,000 shares of Stock, subject to the terms and conditions herein. D. VESTING. The Option is not exercisable for a period of two years from the date of grant. Thereafter, an Option becomes exercisable (a) to the extent of one-third of the total number of shares subject to the option following the expiration of two years from the date of grant; (b) to the extent of an additional one-third following the expiration of three years from the date of grant; and (c) to the extent of an additional one-third following the expiration of four years from the date of grant. An Option is cumulative and any portion of an Option not exercised at the time it becomes exercisable may be exercised at any time thereafter prior to its termination date. E. LIMITATION. In no event may an Option be exercised by anyone after the expiration of five years from the date of grant. 3 4 F. BOARD RETIREMENT. A Participant who ceases to serve on the Board after reaching age 65 and who has been a member of the Board for at least ten years prior to the date of retirement shall be permitted to exercise his entire Option notwithstanding the limitations of Section Six D above. G. INSUFFICIENT NUMBER OF SHARES. In the event that the number of shares of Stock available for future grant under this Part A is insufficient to make all grants required to be made on any date, then all Participants entitled to a grant on such date shall share ratably in the number of shares of Stock which may be included in Options granted to Participants under this Part A. SECTION SEVEN OPTION PRICES A. DETERMINATION OF OPTION PRICE. The Option price for Stock shall be equal to 100% of the fair market value of the Stock on the date of grant. B. DETERMINATION OF FAIR MARKET VALUE. The fair market value of the Stock on the date of granting an Option shall be the mean of the high and low prices at which the Stock was sold on the market on such date. In the event no such sales of Stock occurred on such date, the fair market value of the Stock shall be determined by the mean of the high and low prices at which the Stock was sold on the market on the next preceding date for which the Stock was so sold. SECTION EIGHT EXERCISE OF OPTION A. METHOD OF EXERCISING AN OPTION. Subject to the terms of a particular Option, a Participant may exercise it in whole or in part by written notice to the Company's President or Secretary stating in such written notice the number of shares of Stock such Participant elects to purchase under his Option. B. NO OBLIGATION TO EXERCISE OPTION. A Participant is under no obligation to exercise an Option or any part thereof. C. PAYMENT FOR OPTION STOCK. Stock purchased pursuant to an Option agreement shall be paid in full at the time of purchase. Payment may be made (a) in cash, (b) by delivery to the Company of shares of Stock having an aggregate fair market value equal to the exercise price, or (c) a combination of (a) and (b). Upon receipt of payment and subject to paragraph E of this Section Eight, the Company shall, without transfer or issue tax to the Participant or other person entitled to exercise the Option, deliver to the Participant (or other person entitled to exercise the Option) a certificate or certificates for such shares. 4 5 D. DELIVERY OF STOCK TO PARTICIPANT. The Company shall undertake and follow all necessary procedures to make prompt delivery of the number of shares of Stock which the Participant elects to purchase upon exercise of an Option granted under this Part A. Such delivery, however, may be postponed, at the sole discretion of the Company, to enable the Company to comply with any applicable procedures, regulations or listing requirements of any government agency, stock exchange or regulatory authority. E. FAILURE TO ACCEPT DELIVERY OF STOCK. If a Participant refuses to pay for Stock which he has elected to purchase under his Option, in accordance with the terms of payment, which had previously been agreed upon, his Option shall thereupon, at the sole discretion of the Board, terminate, and such funds previously paid for unissued Stock shall be refunded. Stock which has been previously issued to the Participant and been fully paid for shall remain the property of the Participant and shall be unaffected by such termination. SECTION NINE TRANSFERABILITY OF OPTIONS The Board may impose such restrictions on transferability of an Option, if any, as it may in its sole discretion determine. SECTION TEN PURCHASE FOR INVESTMENT A. WRITTEN AGREEMENT BY PARTICIPANTS. Unless a registration statement under the Securities Act of 1933 is then in effect with respect to the Stock a Participant receives upon exercise of his Option, a Participant shall acquire the Stock he receives upon exercise of his Option for investment and not for resale or distribution and he shall furnish the Company with a written statement to that effect when he exercises his Option and a reference to such investment warranty shall be inscribed on the Stock certificate(s). B. REGISTRATION REQUIREMENT. Each Option shall be subject to the requirement that, if at any time the Board determines that the listing, registration or qualification of the shares subject to the Option upon any securities exchange or under any state or Federal law is necessary or desirable as a condition of, or in connection with, the issuance of shares thereunder, the Option may not be exercised in whole or in part unless such listing, registration or qualification shall have been effected or obtained (and the same shall have been free of any conditions not acceptable to the Board). 5 6 SECTION ELEVEN CHANGES IN CAPITAL STRUCTURE OR SHARES In the event any reorganization, merger, consolidation, recapitalization, liquidation, reclassification, stock dividend, stock split, combination of shares, rights offering, or extraordinary dividend or divestiture (including a spin-off), or any other change in the capital structure or shares of the Company, the Committee shall make adjustments, determined by the Committee in its discretion to be appropriate, as to the number and kind of securities subject to this Plan and specified in Section Three of this Plan and as to the number and kind of securities covered by each outstanding Option and, where applicable, the price per share thereunder. SECTION TWELVE CORPORATE REORGANIZATION OR DISSOLUTION A. In the event of the dissolution or liquidation of the Company, any Option granted under this Part A shall terminate as of a date to be fixed by the Board, provided that not less than 15 days written notice of the date so fixed shall be given to each Participant and each such Participant shall have the right during such period to exercise his Option as to all or any part of the Stock covered thereby including Stock as to which such Option would not otherwise be exercisable by reason of an insufficient lapse of time. B. In the event of a Reorganization (as hereinafter defined) in which the Company is not the surviving or acquiring company, or in which the Company is or becomes a wholly owned subsidiary of another company after the effective date of the Reorganization, then: 1) If there is no plan or agreement respecting the Reorganization ("Reorganization Agreement") or if the Reorganization Agreement does not specifically provide for the change, conversion, or exchange of the Stock under outstanding and unexercised Options for securities of another corporation, then the Board shall take such action, and the Options shall terminate, as provided in paragraph A of this Section Twelve, or 2) If there is a Reorganization Agreement and if the Reorganization Agreement specifically provides for the change, conversion, or exchange of the Stock under outstanding and unexercised Options for securities of another corporation, then the Board shall adjust the shares under such outstanding and unexercised Options (and shall adjust the shares remaining under this Part A which are then to be available for grant under this Part A, if the Reorganization Agreement makes specific provisions therefor) in a manner not inconsistent with the provisions of the Reorganization Agreement for the adjustment, change, conversion, or exchange of such Options. 6 7 The term "Reorganization" as used in this paragraph B of this Section Twelve shall mean any statutory merger, statutory consolidation, sale of all or substantially all of the assets of the Company, or sale, pursuant to an agreement with the Company, of securities of the Company pursuant to which the Company is or becomes a wholly owned subsidiary of another company after the effective date of the Reorganization. C. Adjustments and determinations under this Section Twelve shall be made by the Board, whose decisions as to what adjustments or determinations shall be made, and the extent thereof, shall be final, binding, and conclusive. SECTION THIRTEEN TERMINATION OF SERVICE A. SEVERANCE. Subject to the provision of Paragraph B of this Section Thirteen, in the event a Participant ceases to be a Non-Employee Director, his Option terminates one month from the date of such cessation of service. Subject to the provisions of Paragraph F of Section Six, such Option shall be exercisable only to the extent the Participant was entitled to exercise the Option on the date of such cessation of service. B. DEATH. If a Participant dies prior to the full exercise of his Option, his Option to purchase Stock under such Option may be exercised to the extent, if any, that Participant would be entitled to exercise it at the date of Participant's death by the person to whom the Option shall pass by will or by the laws of descent and distribution within twelve months of Participant's death or the expiration of the term of the Option whichever date is sooner. SECTION FOURTEEN APPLICATION OF FUNDS All proceeds received by the Company from the exercise of Options shall be paid into its treasury and such proceeds shall be used for general corporate purposes. SECTION FIFTEEN PARTICIPANT'S RIGHTS AS A STOCKHOLDER A Participant has no rights as a stockholder with respect to any shares of Stock covered by his Option until the date a stock certificate is issued to him for such shares. Except as otherwise provided for in Section Eleven of this Part A, no adjustment shall be made for dividends or other rights for which the record date is prior to the date such stock certificate is issued. 7 8 SECTION SIXTEEN AMENDMENT AND TERMINATION OF THIS PART A A. DISCRETION OF THE BOARD OF DIRECTORS. This Part A may be terminated or amended at any time and from time to time by the Board as the Board shall deem advisable including, but not limited to amendments necessary to qualify for any exemption or to comply with applicable law or regulations; provided, however, that this Part A shall not be amended more than once every six months, other than to comport with changes in the Internal Revenue Code of 1986, as amended, or the regulations thereunder, or the Employee Retirement Income Security Act of 1974, as amended, or the regulations thereunder. No amendment of this Part A shall materially and adversely affect any right of any Participant with respect to any Option theretofore granted without such Participant's written consent. B. AUTOMATIC TERMINATION. This Part A shall terminate on September [ ], 2006. Options may be granted under this Part A at any time and from time to time prior to this Part A's termination. Any Option outstanding at the time this Part A is terminated shall remain in effect until said Option is exercised or expires. PART B RULES RELATING TO DEFERRED COMPENSATION STOCK PURCHASE SECTION SEVENTEEN DEFERRAL OF FEES A Non-Employee Director may elect by written notice to defer payment on all or a portion of his fees (including Committee fees) for any year, subject to the following conditions: During the period of the active service (as hereinafter defined) of a Non-Employee Director, the Non-Employee Director agrees to serve the Company faithfully and, to the best of the ability of the Non-Employee Director, to perform such services and duties as shall be assigned to the Non-Employee Director by the Board. For purposes of this Part B, the period of the active service of the Non-Employee Director shall mean the period commencing with the date of election or appointment of the Non-Employee Director and expiring on the date on which occurs the termination of the service of the Non-Employee Director by reason of expiration of term or the date of resignation, removal or death of the Non-Employee Director, whichever shall occur first. Nothing contained herein shall be construed as conferring upon the Non-Employee Director the right to continue in the active service of the Company. 8 9 SECTION EIGHTEEN ELECTION AND DEFERRED ACCOUNTS A. Prior to the thirty-first day of May of each year during the period of the active service of the Non-Employee Director, the Non-Employee Director may instruct the Company by delivery to it of written notice to withhold a specified percentage (not less than 25%) of any fees otherwise payable to the Non-Employee Director for services to be rendered in the following fiscal year (the "Deferred Amounts"). Such election shall be irrevocable with respect to such fiscal year. The Company shall establish a grantor "Rabbi Trust" and shall establish thereunder on behalf of the Non-Employee Director upon a deferral election a liability account which shall consist of a Stock Deferred Account and an Interest Deferred Account (each a "Deferred Account"). B(i) Stock Deferred Account (a) An agent (the "Agent") shall be appointed by the Board or any individual or committee to which the Board has delegated authority to act with respect to the appointment of the Agent to perform the functions and have the responsibilities assigned to the Agent in this Section Eighteen with respect to the purchase of Stock. The Board or such individual or committee shall have the right to change the Agent at any time. Except as provided in Section 18B(i)(b), the Company shall pay the compensation and expenses of the Agent. (b) Deferred Amounts shall initially be deposited to the Interest Deferred Account (the "Initial Deferred Amounts"). For each fiscal year of the Company, the Agent shall cause all Initial Deferred Amounts to be applied to the open market purchase of whole shares of Stock within fifteen days after December 1, February 28 and May 31 of such fiscal year. The Agent shall have all authority to determine the times of such purchases, the prices at which such purchases are made, the manner of such purchases and the selection of brokers or dealers (which may include the Agent) to make such purchases. All brokerage fees and commissions with respect to such purchases shall be deducted from the Initial Deferred Amounts. The Agent shall credit each Stock Deferred Account with the number of whole shares of Stock equal to such account's Initial Deferred Amount applied by the Agent to the purchase of Stock divided by the average price per share purchased by the Agent. Initial Deferred Amounts representing a fraction of the purchase price of a share shall be credited to their respective Interest Deferred Account. Any shares of Stock held in a Stock Deferred Account shall be voted by the trustee of the "Rabbi Trust". (c) In the alternative, but only if and to the extent that the Company shall have instructed the Agent concurrent with or prior to the delivery to the Agent of the Initial Deferred Amounts, the Agent shall purchase whole shares of Stock directly from the Company and not in the open market. Each such purchase from the Company shall be at 9 10 a price equal to the closing price of Stock on the market on the business day preceding the date such purchase is made. (d) During the period that such Stock Deferred Account is maintained, on each date on which the Company pays dividends on its Stock, the Interest Deferred Account shall be credited with an amount equivalent to the amount of dividends declared by the Company with respect to the Stock held in the Stock Deferred Account ("Dividend Equivalents"). (e) The total number of shares of Stock which may be purchased under this Part B is 80,000 shares. The maximum number of shares may be increased from time to time by approval of the Board, and if required, pursuant to Rule 16b-3 of the Securities and Exchange Commission or its successors or the applicable rules of any stock exchange, the stockholders of the Company. Such Stock may be either authorized and unissued shares or reacquired shares. (f) In the event of a change in the capital structure or shares of the Company as described in Section Eleven, the number and kind of securities specified in Section Eighteen of this Part B, and the number and kind of securities entered in a Stock Deferred Account shall be adjusted in a manner consistent with Section Eleven. B(ii) Interest Deferred Account All additions to the Interest Deferred Account will be invested in short- to mid-term fixed-income investments selected by the Company from time to time. There shall be credited to the Interest Deferred Account all gains, losses, and income attributable to such investments. SECTION NINETEEN ANNUAL STATEMENT The Company will provide an annual statement of the Deferred Accounts to each participant Non-Employee Director showing amounts of fees deferred and additional amounts credited to his Deferred Accounts in accordance with Section 18. SECTION TWENTY PAYMENT Upon the termination of active service of a Non-Employee Director, the Company shall pay such Non-Employee Director his Deferred Accounts in one lump sum payment as soon after his termination of active service as is administratively feasible unless such 10 11 Non-Employee Director had previously made an election, at least sixty (60) days prior to the effective date of such termination of active service, to receive his Deferred Accounts in the form of installment payments. At least sixty (60) days prior to his termination of active service, a Non-Employee Director may make an irrevocable election to receive his Deferred Accounts in the form of installment payments over a period of time designated by the Non-Employee Director but in no event to exceed twenty (20) years. In the event that the installment method of payment is selected, the Non-Employee Director will further designate whether installment payments are to be made on a monthly, quarterly, semi-annual or annual basis. During the period of installment distributions, the Interest Deferred Account will be credited with an earnings factor computed pursuant to the principles described in Section 18 B(ii), above. In the event that a Non-Employee Director dies after having made an installment election but prior to the receipt of all installment payments thereunder, the remaining payments will be made to the beneficiary by the Non-Employee Director designated for purposes of this Part B through the remaining duration of the elected installment period, unless the Non-Employee Director has provided in such installment election for a different form of payment to the beneficiary of the Non-Employee Director in the event of the death of the Non-Employee Director, in which event such different form of payment shall be made to the beneficiary of the Non-Employee Director. The computation of the amount of a lump sum payment or the amount of an installment payment shall be made by reference to the balance of the Deferred Account as of the date of the distribution. SECTION TWENTY-ONE DEATH OF NON-EMPLOYEE DIRECTOR Where the death of the Non-Employee Director occurs prior to making his election, payments of compensation deferred shall be made in such manner determined by the beneficiary. SECTION TWENTY-TWO DEATH OF NON-EMPLOYEE DIRECTOR AND BENEFICIARY If both the Non-Employee Director and his designated beneficiary should die, the total amount standing to the credit of the Non-Employee Director in the Deferred Accounts shall be determined as of the date of death of the designated beneficiary (including any additional amounts credited to such Account pursuant to Section Eighteen B(ii)) and shall be paid as promptly as possible in one lump sum to the estate of such designated beneficiary. 11 12 SECTION TWENTY-THREE TAXES Payments will be made to the Non-Employee Director or beneficiary after deducting taxes required by federal and/or state governments, if any. SECTION TWENTY-FOUR ADMINISTRATION OF THIS PART B This Part B shall be administered by the Board, except as provided in Section 18. The Board shall have all the powers vested in it by the terms of Part B. Subject to the provisions of this Part B, the Board shall have the power to construe this Part B, to determine all questions arising thereunder, and to adopt and amend such rules and regulations for the administration of this Part B as it may deem desirable. Any decision of the Board in the administration of this Part B, as described herein, shall be final and conclusive. The Board may act only by a majority of its members in office, except that members thereof may authorize any one or more of their number or the Secretary or any other officer of the Company to execute and deliver documents on behalf of the Board. SECTION TWENTY-FIVE UNSECURED GENERAL CREDITOR Nothing contained in this Part B and no action taken pursuant to the provisions of this Part B shall create or be construed to create a trust of any kind other than a grantor "Rabbi Trust", or a fiduciary relationship between the Company and the Non-Employee Director, his designated beneficiary or any other person. Any compensation deferred under the provisions of this Part B shall continue for all purposes to be a part of the general funds of the Company. To the extent that any person acquires a right to receive payment from the Company under this Part B, such right shall be no greater than the right of any unsecured general creditor of the Company. SECTION TWENTY-SIX NO ASSIGNMENT The right of the Non-Employee Director or any other person to the payment of deferred compensation or other benefits under this Part B shall not be assigned, transferred, pledged, or encumbered except by will or by the laws of descent and distribution. 12 13 SECTION TWENTY-SEVEN SUCCESSORS AND ASSIGNS This Part B shall be binding upon and inure to the benefit of the Company and its subsidiaries, its successors and assigns and the Non-Employee Director and his heirs, executors, administrators and legal representatives. SECTION TWENTY-EIGHT CHANGE OF CONTROL In the event of a change of control of the Company, the Company shall immediately pay the Non-Employee Director his Deferred Accounts, including accrued interest. A "change of control" shall mean (i) a merger or consolidation in which the Company is not the surviving corporation or (ii) the acquisition of twenty-five percent or more of the voting securities of the Company by a person, group, or entity or (iii) the sale of all or substantially all of the assets of the Company or (iv) individuals who were members of the Board immediately prior to a meeting of the stockholders of the Company involving a contest for the election of Non-Employee Directors do not constitute a majority of the Board immediately following such election, unless that election of such new Non-Employee Directors was recommended to the stockholders by management of the Company. SECTION TWENTY-NINE AMENDMENT AND TERMINATION OF THIS PART B A. DISCRETION OF THE BOARD OF DIRECTORS. The Board of Directors may at any time terminate or amend this Part B. Except as herein provided, no such termination may affect Stock previously purchased. B. AUTOMATIC TERMINATION. This Part B shall terminate on [ ], 2006. 13 EX-10.22 7 FORM OF NON-EMPLOYEE DIRECTOR STOCK COMP. PLAN. 1 EXHIBIT 10.22 CHOICE HOTELS INTERNATIONAL, INC. 1996 NON-EMPLOYEE DIRECTOR STOCK COMPENSATION PLAN Choice Hotels International, Inc. has adopted and established a stock compensation plan for Non-Employee Directors in accordance with the following terms and conditions. SECTION ONE DESIGNATION AND PURPOSE OF THE PLAN A. Designation. This Plan is designated the "Choice Hotels International, Inc. Non-Employee Director Stock Compensation Plan." B. Purpose. The purpose of this Plan is to increase the stock-based component of Non-Employee Director compensation so as to encourage stock ownership by Non-Employee Directors and to further align the interest of Non-Employee Directors and stockholders. SECTION TWO DEFINITIONS As used in the Plan, the following terms mean: A. "Award" means restricted stock granted hereunder. B. "Board" means the Board of Directors of the Company. C. "Company" means Choice Hotels International, Inc. D. "Custodial Account" means the account described in Section 7(A) herein. E. "Disability" means a permanent and total disability within the meaning of Section 22(e)(3) of the Internal Revenue Code of 1986 as amended. F. "Non-Employee Director" means a member of the Board of the Company who is not an employee of the Company or any of its subsidiaries. 1 2 G. "Participant" means any Non-Employee Director who is granted an Award as provided in this Plan. H. "Plan" means this Non-Employee Director Stock Compensation Plan. I. "Retirement" means termination of service as a Director for either of the following reasons: (i) after attaining 65 years of age or (ii) failure to be re-elected as a Director by the shareholders of the Company at an Annual Meeting of Stockholders. J. "Stock" means the common stock of Choice Hotels International, Inc. SECTION THREE EFFECTIVE DATE, DURATION AND STOCKHOLDER APPROVAL The Plan shall be effective upon the approval of the Plan by a majority of the outstanding shares of Stock voted at the [ ] ("Stockholder Approval"). SECTION FOUR ADMINISTRATION OF THIS PLAN This Plan shall be administered by the Board. The Board shall have all the powers vested in it by the terms of this Plan, such powers to include authority (within the limitation described herein) to prescribe the form of the agreement embodying Awards made under this Plan. Subject to the provisions of this Plan, the Board shall have the power to construe this Plan, to determine all questions arising thereunder, and to adopt and amend such rules and regulations for the administration of this Plan as it may deem desirable. Any decision of the Board in the administration of this Plan, as described herein, shall be final and conclusive. The Board may act only by a majority of its members in office, except that the members thereof may authorize any one or more of their number or the Secretary or any other officer of the Company to execute and deliver documents on behalf of the Board. SECTION FIVE GRANT OF AWARDS AND LIMITATION OF NUMBER OF SHARES SUBJECT TO AWARD A. Compensation in Common Stock. Subject to stockholder approval, effective as of [ ] and as of each annual meeting thereafter, each Non-Employee Director shall be granted a number of shares equal to $30,000 fair market value (as determined in accordance with Section 5(B) below) of Stock on the date of each annual meeting. Such Award shall be in lieu of all Board retainer and Board attendance fees. 2 3 B. Determination of Fair Market Value. The fair market value of the Stock on the date of granting an Award shall be the mean of the high and low prices at which the Stock was sold on the market on such date. In the event no such sales of Stock occurred on such date, the fair market value of the Stock shall be determined by the mean of the high and low prices at which the Stock was sold on the market on the next preceding date for which the Stock was so sold. C. Fractions of Shares. Whenever under the terms of the Plan fractional shares would be required to be issued, the fractional shares shall be rounded up to the next full share. D. Total Number of Shares. Subject to any adjustment pursuant to Section 8, the total number of shares of Stock which may be awarded under this Plan is 240,000 shares. The maximum number of shares authorized may be increased from time to time by approval of the Board and, if required pursuant to Rule 16b-3 of the Securities and Exchange Commission or its successors or the applicable rules of any stock exchange, the stockholders of the Company. To the extent that an Award lapses or the rights of the Participant to whom it was granted terminate, expire or are cancelled for any other reason, in whole or in part, shares of Stock (or remaining shares) subject to such Award shall again be available for the grant of an Award under the Plan. Shares delivered by the Company under the Plan may be authorized and unissued Stock, Stock held in the treasury of the Company or Stock purchased on the open market (including private purchases) in accordance with applicable securities laws. E. Insufficient Number of Shares. In the event that the number of shares of Stock available for future Awards under this Plan is insufficient to make all Awards required to be made on any date, then all Participants entitled to an Award on such date shall share ratably in the number of shares of Stock which may be included in Awards granted to Participants under this Plan. SECTION SIX ELIGIBILITY Each Non-Employee Director shall be eligible to receive an Award in accordance with Section Five. Each Award granted under this Plan shall be evidenced by an agreement in such form as the Board shall prescribe from time to time in accordance with this Plan and shall comply with the terms and conditions set forth in Section 7. Such an agreement shall incorporate the provisions of this Plan by reference. 3 4 SECTION SEVEN RESTRICTIONS ON SHARES A. Custodial Account. The shares shall be held by the Company, in trust, in a Custodial Account on behalf of the Participant until such time as the shares have vested pursuant to the terms of Section 7(B) of this Plan. Any amounts deferred under the provisions of this Plan shall continue for all purposes to be a part of the general assets of the Company. To the extent that Participant acquires a right to receive payment from the Company under this Plan, such right shall be no greater than the right of any unsecured general creditor of the Company. B. Vesting. The shares held by the Company, in trust, shall remain in the Custodial Account until vesting which shall occur (a) to the extent of one-third of the total number of shares, subject to an Award following the expiration of one year from the date of the Award, (b) to the extent of an additional one-third following the expiration of two years from the date of the Award, and (c) to the extent of an additional one-third following the expiration of three years from the date of the Award. Upon vesting, the shares shall be distributed to the Participant within a reasonable period of time not to exceed ninety (90) days from the date of vesting and the Custodial Account shall be terminated as to such shares. C. Forfeiture. Subject to Section 7(E) below, if the Participant ceases to be a Non-Employee Director for any reason prior to vesting, the Participant shall forfeit the shares, and the Custodial Account shall be terminated. Ownership of the forfeited shares shall revert back to the Company. D. No Assignment. The shares granted under the Plan, while held by the Company pursuant to the Custodial Account, shall not be transferred, assigned, pledged, or hypothecated in any way (whether by operation of law or otherwise), and shall not be subject to execution, attachment, or similar process. Upon any attempt to so transfer, assign, pledge, hypothecate, or otherwise dispose of the shares, or of any right or privilege conferred thereby, contrary to the provisions hereof, or upon the levy of any attachment or similar process upon such rights and privileges, the Participant shall forfeit the shares and ownership of the forfeited shares shall revert back to the Company. E. Death, Disability and Board Retirement. A Participant who ceases to serve on the Board by reason of (i) death, (ii) Disability, or (iii) Retirement, shall be vested in his or her entire Award notwithstanding the limitation of Section 7(B) above. 4 5 SECTION EIGHT CHANGES IN CAPITAL STRUCTURE In the event of any reorganization, merger, consolidation, recapitalization, liquidation, reclassification, stock dividend, stock split, combination of shares, rights offering, or extraordinary dividend or divestiture (including a spin-off), or any other change in the capital structure or shares of the Company, the Board shall make adjustments, determined by the Board in its discretion to be appropriate, as to the number and kind of securities subject to this Plan and specified in Section 5 of this Plan and as to the number and kind of securities covered by each outstanding Award and, where applicable, the price per share thereunder. SECTION NINE RIGHTS AS A STOCKHOLDER The Participant shall be entitled to give direction to the Company, as fiduciary, to vote the shares held by the Company on behalf of the Participant in the Custodial Account in accordance with the Participant's written instructions. Any cash or non-cash dividend payable with respect to shares held in the Custodial Account will remain in the Custodial Account subject to risk of forfeiture until such time as the shares with respect to which such cash or non-cash dividend, as the case may be, was declared is either distributed to the Participant or forfeited by the Participant. Notwithstanding anything to the contrary contained herein, no Stock or cash dividends shall be transferred by the Company to a Custodial Account prior to the date of Stockholder Approval, and no Non-Employee Director shall be entitled to any rights as a stockholder with respect to any Stock granted hereunder, including, without limitation voting rights until such Stock has been transferred to a Custodial Account. SECTION TEN TITLE Subject to Section 13 herein, the shares held by the Company shall be held in the name of the Participant. Such shares shall at all times remain in the Company Custodial Account until they have been (i) forfeited by the Participant, (ii) distributed to the Participant, or (iii) transferred to a grantor "Rabbi Trust" in accordance with the provisions of Section 13. 5 6 SECTION ELEVEN RISK OF LOSS The Participant agrees to assume all risks in connection with any decrease in the value of the shares granted to the Participant placed into the Custodial Account for the benefit of the Participant. SECTION TWELVE NOTICE TO COMPANY The Participant shall notify the Company immediately if he or she elects to make an election under Section 83(b) of the Internal Revenue Code or upon the occurrence of any other event resulting in the value of the shares being included in the Participant's gross income prior to vesting. SECTION THIRTEEN DEFERRAL A Participant, provided he or she has not made the election referred to in Section 12 herein, may elect by written notice to defer payment on all or a portion of the shares held in the Custodial Account prior to any vesting, subject to the following conditions: A. Such election shall be irrevocable. An election to defer payment shall be made at least sixty (60) days prior to any vesting for which the election to defer payment is made. The Participant may elect to defer the receipt of the shares held in the Custodial Account prior to any vesting for a period of time which ends no sooner than the earlier of (i) a date at least twenty-four (24) months from the date of any such vesting or (ii) cessation of service as a Non-Employee Director. During such deferral period, Participant shall not be entitled to (i) vote the shares granted to him or her for which a deferral has been elected, and (ii) currently receive cash dividends or non-cash dividends. B. The Company shall establish a grantor "Rabbi Trust" and shall establish thereunder on behalf of the Participant upon a deferral election a liability account (the "Deferred Compensation Account") which shall be credited with any shares, cash dividends, and non-cash dividends subject to such deferral election. Any shares transferred from the Custodial Account to the Deferred Compensation Account shall be retitled and held in the name of the trustee of the grantor "Rabbi Trust". C. There shall be credited to the Deferred Compensation Account an additional amount with respect to the cash dividends (i.e., in addition to the items 6 7 credited pursuant to paragraph (B) hereof) equal to the earnings generated through the investment of the cash dividends by the trustee of the grantor trust. D. The Company will provide an annual statement of the Deferred Compensation Account to the Participant showing amounts credited to his or her account in accordance with paragraph (C). E. Nothing contained in this Plan and no action taken pursuant to the provisions of this Plan shall create or be construed to create a trust of any kind other than a grantor "Rabbi Trust", or a fiduciary relationship between the Company and the Participant, his or her designated beneficiary or any other person. Any amounts deferred under the provisions of this Plan shall continue for all purposes to be a part of the general assets of the Company. To the extent that Participant acquires a right to receive payment from the Company under this Plan, such right shall be no greater than the right of any unsecured general creditor of the Company. F. The right of the Company or any other person to the payment of deferred compensation or other benefits under this Plan shall not be assigned, transferred, pledged, or encumbered except by will or by the laws of descent and distribution. SECTION FOURTEEN GENDER Where applicable, words in the feminine shall include the masculine, words in the neuter shall include the masculine and feminine, and words in the singular shall include the plural, and vice versa. SECTION FIFTEEN SUCCESSORS This Plan shall be binding upon and inure to the benefit of the Company and its subsidiaries, its successors and assigns and the Participant and his or her heirs, executors, administrators and legal representatives. SECTION SIXTEEN NO RIGHT TO CONTINUE AS A DIRECTOR Neither the Plan, nor the granting of an Award, nor any other action taken pursuant to Plan, shall constitute or be evidence of any agreement or understanding, express or implied, that the Company will retain a Non-Employee Director for any period of time, or at any particular rate of compensation. Nothing in this Plan shall in any way limit or affect the right of the Board or the stockholders of the Company to 7 8 remove any Non-Employee Director or otherwise terminate his or her service as a director of the Company. SECTION SEVENTEEN MISCELLANEOUS PROVISIONS A. Government and Other Regulations. The obligation of the Company to make payment of Awards in Stock or otherwise shall be subject to all applicable laws, rules, and regulations, and to such approvals by any government agencies as may be required. The Company shall be under no obligation to register under the Securities Act of 1933, as amended ("Act"), any of the shares of Stock issued, delivered or paid in settlement under the Plan. If Stock awarded under the Plan may in certain circumstances be exempt from registration under the Act, the Company may restrict its transfer in such manner as it deems advisable to ensure such exempt status. B. Governing Law. All matters relating to the Plan or to Awards granted hereunder shall be governed by the laws of the State of Maryland, without regard to its principles of conflict of laws. C. Titles and Headings. The titles and headings of the sections in the Plan are for convenience of reference only, and in the event of any conflict, the text of the Plan, rather than such titles and headings, shall control. SECTION EIGHTEEN AMENDMENT AND TERMINATION This Plan may be terminated or amended at any time and from time to time by the Board as the Board shall deem advisable. No modification or amendment of this Plan shall, without the written consent of the Participant, materially and adversely affect his or her rights under this Plan. 8 EX-10.23 8 FORM OF LONG-TERM INCENTIVE PLAN 1 EXHIBIT 10.23 CHOICE HOTELS INTERNATIONAL, INC. 1996 LONG-TERM INCENTIVE PLAN SECTION ONE DESIGNATION AND PURPOSE OF PLAN The purpose of the Choice Hotels International, Inc. 1996 Long-Term Incentive Plan (the "Plan") is to increase the ownership of Company Stock by those officers, professional staff and other key employees who are mainly responsible for the continued growth and development and financial success of the Company and its subsidiaries. Such stock ownership gives such employees a proprietary interest in the Company which induces them to continue in its employ. The Plan also enables the Company to attract and retain such employees and reward them for the continued profitable performance of Choice Hotels International, Inc. SECTION TWO DEFINITIONS The following definitions are applicable herein: A. "Award" - Individually or collectively, Options, Stock Appreciation Rights, Performance Shares or Restricted Stock granted hereunder. B. "Award Period" - the period of time during which a Stock Appreciation Right which has not been granted pursuant to an Option may be exercised. The Award Period shall be set forth in the document issuing the Stock Appreciation Right to the selected Eligible Employee. C. "Board" - the Board of Directors of the Company. D. "Book Value" - the book value of a share of Stock determined in accordance with the Company's regular accounting practices as of the last business day of the month immediately preceding the month in which a Stock Appreciation Right is exercised as provided in Section Nine D. E. "Code" - the Internal Revenue Code of 1986, as amended. Reference in the Plan to any section of the Code shall be deemed to include any amendments or successor provisions to such section and any regulations promulgated thereunder. F. "Committee" - the Key Executive Stock Option Plan Committee appointed to administer the Plan pursuant to Section Four. 1 2 G. "Company" - Choice Hotels International, Inc., including any present or future "subsidiary corporation" as such term is defined in Section 424(f) of the 1986 Internal Revenue Code, as amended. H. "Covered Employee" - an individual described in Section 162(m)(3) of the Code. I. "Date of Grant" - the date on which the granting of an Award is authorized by the Committee or such later date as may be specified by the Committee in such authorization. J. "Eligible Employee" - any person employed by the Company or a Subsidiary on a regularly scheduled basis who satisfies all of the requirements of Section Six. K. "Exercise Period" - the period or periods during which a Stock Appreciation Right is exercisable as described in Section Nine B. L. "Fair Market Value" - the fair market value of the Stock as determined in accordance with Section Eight D. M. "Incentive Stock Option" - an incentive stock option within the meaning of Section 422 of the Code. N. "Option" or "Stock Option" - either a nonqualified stock option or an Incentive Stock Option granted under Section Eight. It also means any Option which remains after a Participant has exercised his Option with respect to part of the shares covered by a Stock Option Agreement as described in Section Eight B. O. "Option Period" or "Option Periods" - the period or periods during which an Option is exercisable as described in Section Eight E. P. "Option Price" - the price, expressed on a per share basis, for which the Company Stock can be acquired by the holder of an Option pursuant to the exercise of such Option. Q. "Participant" - an Eligible Employee of the Company or a Subsidiary who has been granted an Option, a Stock Appreciation Right, a Performance Share Award or a Restricted Stock Award under this Plan. R. "Performance Share" - an Award granted under Section Ten. S. "Restricted Stock" - an Award granted under Section Seven. 2 3 T. "Stock" and "Company Stock" - the common stock of the Company. U. "Stock Appreciation Right" - an Award granted under Section Nine. V. "Subsidiary" - any corporation of which fifty percent (50%) or more of its outstanding voting stock or voting power is beneficially owned, directly or indirectly, by the Company. W. "Ten Percent Shareholder" - a Participant who, at the Date of Grant, owns directly or indirectly (within the meaning of Section 424(d) of the Internal Revenue Code) stock possessing more then ten percent (10%) of the total combined voting power of all classes of stock of the Company or a subsidiary thereof. X. Wherever appropriate, words used in this Plan in the singular may mean the plural, the plural may mean the singular and the masculine may mean the feminine. SECTION THREE EFFECTIVE DATE, DURATION AND STOCKHOLDER APPROVAL A. Effective Date and Stockholder Approval. Subject to the approval of the Plan by a majority of the outstanding shares of Stock, the Plan shall be effective as of [ ], 1996. B. Period for Grant of Awards. Awards may be made as provided herein for a period of ten (10) years after [ ],1996. SECTION FOUR ADMINISTRATION A. Appointment of Committee. The Board of Directors shall appoint one or more Key Executive Stock Option Plan Committees which shall consist of not less than two (2) members of such Board of Directors and which members shall be Non-Employee Directors as defined in Rule 16b-3 under the Securities Exchange Act of 1934, as amended (or such greater number of members which may be required by said Rule 16b-3). In addition, such Board of Directors shall designate a member of the Committee to act as Chairman of the Committee, and such Board of Directors may remove any member of the Committee at any time and appoint any director to fill any vacancy on the Committee. B. Committee Meetings. The Committee shall hold its meetings at such times and places as specified by the Committee Chairman. A majority of the Committee shall constitute a quorum. All actions of the Committee shall be taken by all of the members of the meeting duly called by its Chairman; provided, however, any action taken by a written 3 4 document signed by a majority of the members of the Committee shall be as effective as action taken by the Committee at a meeting duly called and held. C. Committee Powers. Subject to the provisions of this Plan, the Committee shall have full authority in its discretion to (i) designate the Participants to whom Awards shall be granted, (ii) determine the number of shares to be made available under each such Award, (iii) determine the period or periods in which the Participant may exercise such Award, (iv) determine the date when such Award expires, (v) determine the price for Stock under such Award, and (vi) determine the grounds of forfeiture of an Award. The Committee shall have all powers necessary to administer the Plan in accordance with its terms, including the power to interpret this Plan and resolve all questions arising thereunder. The Committee may prescribe such rules and regulations for administering this Plan as the Committee deems appropriate. SECTION FIVE GRANT OF AWARDS AND LIMITATION OF NUMBER OF SHARES SUBJECT TO AWARD The Committee may, from time to time, grant Awards to one or more Eligible Employees, provided that (i) subject to any adjustment pursuant to Section Eleven, the aggregate number of shares of Stock subject to Stock Options, Stock Appreciation Rights, Performance Share Awards or Restricted Stock Awards under this Plan may not exceed 2,000,000 shares; (ii) to the extent that a Stock Option, Stock Appreciation Right, Performance Share Award or Restricted Stock Award lapses or the rights of the Participant to whom it was granted terminate, expire or are cancelled for any other reason, in whole or in part, shares of Stock (or remaining shares) subject to such Award shall again be available for the grant of an Award under the Plan; and (iii) Shares delivered by the Company under the Plan may be authorized and unissued Stock, Stock held in the treasury of the Company or Stock purchased on the open market (including private purchases) in accordance with applicable securities laws. In determining the size of Awards, the Committee shall take into account the responsibility level, performance, potential, and cash compensation level of a Participant, and the Fair Market Value of the Stock at the time of Awards, as well as such other considerations it deems appropriate. SECTION SIX ELIGIBILITY Key employees of the Company and its Subsidiaries (including employees who are members of the Board, but excluding directors who are not employees) who, in the opinion of the Committee, are mainly responsible for the continued growth and development and financial success of the business of the Company or one or more of its Subsidiaries shall be eligible to be granted Awards under the Plan. Subject to the provisions of the Plan, the Committee may from time to time select from such eligible persons those to whom Awards 4 5 shall be granted and determine the nature and amount of each Award. No employee of the Company or its Subsidiaries shall have any right to be granted an Award under this Plan. A member of the Committee shall not be eligible for any Award hereunder. Notwithstanding any provision to the contrary contained herein, Options shall be granted under this Plan to persons, including without limitation, employees of Manor Care, Inc., its subsidiaries, and affiliated companies in substitution for prior Options under plans of Manor Care, Inc. in accordance with the terms of the Employee Benefits and other Employee Matters Allocation Agreement between Manor Care, Inc. and the Company. SECTION SEVEN RESTRICTED STOCK AWARDS A. Grants of Shares of Restricted Stock. An Award made pursuant to this Section Seven shall be granted in the form of shares of Stock, restricted as provided in this Section Seven. Shares of the Restricted Stock shall be issued to the Participant without the payment of consideration by the Participant. The shares of Restricted Stock shall be issued in the name of the Participant and shall bear a restrictive legend prohibiting sale, transfer, pledge or hypothecation of the shares of Restricted Stock until the expiration of the restriction period. The Committee may also impose such other restrictions and conditions on the shares of Restricted Stock as it deems appropriate. B. Restriction Period. At the time a Restricted Stock Award is made, the Committee may establish a restriction period applicable to such Award which shall not be more than ten (10) years. Each Restricted Stock Award may have a different restriction period, at the discretion of the Committee. In addition to or in lieu of a restriction period, the Committee may establish a performance goal which must be achieved as a condition to the retention of the Restricted Stock. The performance goal may be based on the attainment of specified types of performance measurement criteria, which may differ as to various Participants or classes or categories of Participants. Such criteria may include, without limitation, the attainment of certain performance levels by the individual Participant, the Company, a department or division of the Company and/or a group or class of participants. Any such performance goals, together with the ranges of Restricted Stock Awards for which the Participants may be eligible shall be set from time to time by the Committee and shall be timely communicated to the Eligible Employees in advance of the commencement of the performance of services to which such performance goals relate. The total number of shares of Restricted Stock which may be granted to any single Covered Employee under this Plan during any calendar year shall be limited to 100,000. C. Forfeiture or Payout of Award. In the event a Participant ceases employment during a restriction period, or in the event performance goals attributable to a Restricted Stock Award are not achieved, subject to the terms of each particular Restricted Stock Award, and subject to discretionary action by the Committee as set forth below in Section Thirteen, a Restricted Stock Award is subject to forfeiture of the shares of stock which had not previously been removed from restriction under the terms of the Award. 5 6 Any shares of Restricted Stock which are forfeited will be transferred to the Company. Upon completion of the restriction period and satisfaction of any performance-goal criteria, all restrictions upon the Award will expire and new certificates representing the Award will be issued without the restrictive legend described in Section Seven A. As a condition precedent to receipt of the new certificates, the Participant (or the designated beneficiary or personal representative of the Participant) will agree to make payment to the Company in the amount of any taxes, payable by the Participant, which are required to be withheld with respect to such shares of Stock. SECTION EIGHT STOCK OPTIONS A. Grant of Option. One or more Options may be granted to any Eligible Employee. Upon the grant of an Option to an Employee, the Committee shall specify whether the Option is intended to constitute a non-qualified stock option or an Incentive Stock Option. The total number of shares of Stock subject to Options which may be granted to any single Covered Employee under this Plan during any calendar year shall be limited to 100,000. B. Stock Option Agreement. Each Option granted under the Plan shall be evidenced by a written "Stock Option Agreement" between the Company and the Participant containing such terms and conditions as the Committee determines, including, without limitation, provisions to qualify Incentive Stock Options as such under Section 422 of the Code. Such agreements shall incorporate the provisions of this Plan by reference. The date of granting an Option is the date specified in the written Stock Option Agreement which is signed by the Participant and the Company. C. Determination of Option Price. The Option price for Stock shall be not less than 100% of the fair market value of the Stock on the date of grant. Notwithstanding the foregoing, in the case of an Option which is designed to qualify as an Incentive Stock Option (as defined in Section 422 of the Code) which is granted to a Ten Percent Shareholder, the Option Price shall not be less than 110% of such fair market value. D. Determination of Fair Market Value. The fair market value of the Stock on the date of granting an Option shall be the mean of the high and low prices at which the Stock was sold on the market on such date. In the event no such sales of Stock occurred on such date, the fair market value of the Stock shall be determined by the Committee in accordance with applicable Regulations of the Internal Revenue Service. E. Term of Option. The term of an Option may vary within the Committee's discretion; provided, however, that the term of an Option shall not exceed ten (10) years 6 7 from the date of granting the Option to the Participant, and, to this end, all Options granted pursuant to this Plan must provide that each such Option cannot be exercised after the expiration of ten (10) years from the date each such Option is granted. Notwithstanding the foregoing, in the case of any Option which is designed to qualify as an Incentive Stock Option (as defined in Section 422 of the Code) which is granted to a Ten Percent Shareholder, the term of such Option may not exceed five (5) years from the date of grant of such Option. F. Limitation on Exercise of Option. The Committee may limit an Option by restricting its exercise in whole or in part for specified periods. G. Method of Exercising an Option. Subject to the terms of a particular Option, a Participant may exercise it in whole or in part by written notice to the Secretary of the Company stating in such written notice the number of shares of Stock such Participant elects to purchase under his Option. H. No Obligation to Exercise Option. A Participant is under no obligation to exercise an Option or any part thereof. I. Payment for Option Stock. Stock purchased pursuant to an Option shall be paid in full at the time of purchase. Payment may be made (a) in cash, (b) with the approval of the Committee, by delivery to the Company of shares of Stock having an aggregate fair market value equal to the exercise price, or (c) a combination of (a) and (b). Payment may also be made, in the discretion of the Committee, by delivery (including by facsimile transmission) to the Company or its designated agent of an executed irrevocable Option exercise form together with irrevocable instructions to a broker-dealer to sell (or margin) a sufficient portion of the shares and deliver the sale (or margin loan) proceeds directly to the Company to pay for the exercise price. Upon receipt of payment and subject to paragraph J of this Section Eight, the Company shall, without transfer or issue tax to the Participant or other person entitled to exercise the Option, deliver to the Participant (or other person entitled to exercise the Option) a certificate or certificates for such shares. J. Delivery of Stock to Participant. The Company shall undertake and follow all necessary procedures to make prompt delivery of the number of shares of Stock which the Participant elects to purchase upon exercise of an Option granted under this Plan. Such delivery, however, may be postponed, at the sole discretion of the Company, to enable the Company to comply with any applicable procedures, regulations or listing requirements of any government agency, stock exchange or regulatory authority. K. Failure to Accept Delivery of Stock. If a Participant refuses to pay for Stock which he has elected to purchase under his Option, in accordance with the terms of payment, which had previously been agreed upon, his Option shall thereupon, at the sole discretion of the Committee, terminate, and such funds previously paid for unissued Stock 7 8 shall be refunded. Stock which has been previously issued to the Participant and been fully paid for shall remain the property of the Participant and shall be unaffected by such termination. L. Non-Transferability of Options. During the lifetime of a Participant, an Incentive Stock Option granted to him may be exercised only by him. It may not be sold, assigned, pledged or otherwise transferred except by will or by the laws of descent and distribution. In the case of Options which are not Incentive Stock Options, the Committee may impose such restrictions on transferability, if any, as it may in its sole discretion determine. M. Purchase for Investment (a) Written Agreement by Participants. Unless a registration statement under the Securities Act of 1933 is then in effect with respect to the Stock a Participant receives upon exercise of his Option, a Participant shall acquire the Stock he receives upon exercise of his Option for investment and not for resale or distribution and he shall furnish the Company with a written statement to that effect when he exercises his Option and a reference to such investment warranty shall be inscribed on the Stock certificate(s). (b) Registration Requirement. Each Option shall be subject to the requirement that, if at any time the Board determines that the listing, registration or qualification of the shares subject to the Option upon any securities exchange or under any state or Federal law is necessary or desirable as a condition of, or in connection with, the issuance of shares thereunder, the Option may not be exercised in whole or in part unless such listing, registration or qualification shall have been effected or obtained (and the same shall have been free of any conditions not acceptable to the Board). N. Special Limitations on Exercise of Incentive Stock Options. The aggregate fair market value (determined at the time the Incentive Stock Option is granted) of the Stock with respect to which any Incentive Stock Option is first exercisable during any calendar year shall not exceed $100,000. SECTION NINE STOCK APPRECIATION RIGHTS A. Grant of Stock Appreciation Rights. Stock Appreciation Rights may be granted under the Plan in conjunction with an Option either at the time of grant or by amendment or may be separately awarded. Stock Appreciation Rights shall be subject to such terms and conditions not inconsistent with the Plan as the Committee shall impose. However, the total number of Stock Appreciation Rights which may be granted to a single Covered Employee under this Plan during any calendar year shall be limited to 100,000. 8 9 B. Right to Exercise; Exercise Period. A Stock Appreciation Right issued pursuant to an Option shall be exercisable to the extent the Option is exercisable. A Stock Appreciation Right issued independent of an Option shall be exercisable pursuant to such terms and conditions established in the grant. C. Automatic Redemption of Unexercised Stock Appreciation Rights. If on the last day of the Option Period, in the case of a Stock Appreciation Right granted pursuant to an Option, or the specified Award Period, in the case of a Stock Appreciation Right issued independent of an Option, the Participant has not exercised such Stock Appreciation Right, then such Stock Appreciation Right shall be automatically redeemed by the Company for an amount equal to the payment that would otherwise have been made to the Participant if the Participant had chosen to exercise the Stock Appreciation Right on the last day of the Option Period or the specified Award Period, as the case may be. D. Rights Upon Exercise. An exercisable Stock Appreciation Right granted pursuant to an Option shall entitle the Participant to surrender unexercised the Option or any portion thereof to which the Stock Appreciation Right is attached, and to receive in exchange for the Stock Appreciation Right a payment (in cash or Stock or a combination thereof as described below) equal to the Fair Market Value of one share of Stock at the date of exercise minus the Option Price times the number of shares called for by the Stock Appreciation Right (or portion thereof) which is so exercised. With respect to the issuance of Stock Appreciation Rights which are not granted pursuant to an Option, the Committee shall specify upon the Date of the Grant of the Stock Appreciation Right whether the Stock Appreciation Right is a "regular" Stock Appreciation Right or a "book value" Stock Appreciation Right. Upon the exercise of a regular Stock Appreciation Right, the Participant will receive a payment equal to the Fair Market Value of one share of Stock at the date of exercise minus the Fair Market Value of one share of Stock as of the Date of Grant of the Stock Appreciation Right times the number of shares called for by the Stock Appreciation Right (or portion thereof) which is so exercised. Upon the exercise of a book value Stock Appreciation Right, the Participant will receive a payment equal to the Book Value of one share of Stock at the date of exercise minus the Book Value of one share of Stock as of the Date of the Grant of the Stock Appreciation Right times the number of shares called for by the Stock Appreciation Right (or portion thereof) which is so exercised. The value of any Stock to be received upon exercise of a Stock Appreciation Right shall be the Fair Market Value of the Stock on such date of exercise. To the extent that a Stock Appreciation Right issued pursuant to an Option is exercised, such Option shall be deemed to have been exercised, and shall not be deemed to have lapsed. E. Transferability. The Committee may impose such restrictions on transferability of Stock Appreciation Rights, if any, as it may in its sole discretion determine. 9 10 SECTION TEN PERFORMANCE SHARES A. Grant of Performance Share Units. Awards made pursuant to this Section Ten shall be granted in the form of Performance Shares, subject to such terms and conditions not inconsistent with the Plan as the Committee shall impose. Performance Shares shall be issued to the Participant without the payment of consideration by the Participant. Awards shall be based on the attainment of specified types and combination of performance measurement criteria, which may differ as to various Participants or classes or categories of Participants. Such criteria may include, without limitation, the attainment of certain performance levels by the individual Participant, the Company, a department or division of the Company and/or a group or class of Participants. Such criteria, together with the ranges of Performance Shares from which employees may be eligible shall be set from time to time by the Committee and shall be communicated to the Eligible Employees. The total number of Performance Shares which may be granted to any single Covered Employee under this Plan during any calendar year shall be limited to 100,000. B. Performance Period. The measuring period to establish the performance criteria set forth in a Performance Share Award shall be determined by the Committee. A Performance Share Award may initially provide, or the Committee may at any time thereafter, but no more frequently than once in any six (6) month period, amend it to provide, for waiver or reduction of the measuring period and, if appropriate, for adjustment of the performance criteria set forth in the Performance Share Award, upon the occurrence of events determined by the Committee in its sole discretion to justify such waiver, reduction or adjustment. C. Form of Payment. Upon the completion of the applicable measuring period, a determination shall be made by the Committee in accordance with the Award as to the number of shares of Stock to be awarded to the Participant. The appropriate number of shares of Stock shall thereupon be issued to the Participant in accordance with the Award in satisfaction of such Performance Share Award. SECTION ELEVEN CHANGES IN CAPITAL STRUCTURE OR SHARES In the event any reorganization, merger, consolidation, recapitalization, liquidation, reclassification, stock dividend, stock split, combination of shares, rights offering, or extraordinary dividend or divestiture (including a spin-off), or any other change in the capital structure or shares of the Company, the Committee shall make adjustments, determined by the Committee in its discretion to be appropriate, as to the number and kind of securities subject to this Plan and specified in Section Five of this Plan and as to the number and kind of securities covered by each outstanding Award and, where applicable, 10 11 the price per share thereunder; provided, however, that with respect to Incentive Stock Options, such adjustments shall be made in accordance with Section 424(h) of the Code unless the Committee determines otherwise. SECTION TWELVE CORPORATE REORGANIZATION OR DISSOLUTION A. Discontinuation of the Plan. The Plan shall be discontinued in the event of the dissolution or liquidation of the Company or in the event of a Reorganization (as hereinafter defined) in which the Company is not the surviving or acquiring company, or in which the Company is or becomes a wholly-owned subsidiary of another company after the effective date of the Reorganization and no plan or agreement respecting the Reorganization is established which specifically provides for the continuation of the Plan and the change, conversion, or exchange of the stock relating to existing Awards under this Plan for securities of another corporation. Upon the dissolution of the Plan in connection with an event described in this Paragraph A, all Awards shall become fully vested and all outstanding Options and Stock Appreciation Rights shall become immediately exercisable by the holder thereof. Any Options or Stock Appreciation Rights granted under the Plan may be terminated as of a date fixed by the Committee, provided that no less than fifteen (15) days written notice of the date so fixed shall be given to each Participant and each such Participant shall have the right during such period to exercise all or any portion of such Options or Stock Appreciation Rights. Any Stock Appreciation Rights not so exercised shall be redeemed. B. Continuation of the Plan Upon a Reorganization. In the event of a Reorganization (as hereinafter defined) (i) in which the Company is not the surviving or acquiring company, or in which the Company is or becomes a wholly-owned subsidiary of another company after the effective date of the Reorganization, and (ii) with respect to which there is a reorganization agreement which undertakes to continue the Plan and to provide for the change, conversion or exchange of the Stock attributable to outstanding Awards for securities of another corporation, then the Plan shall continue and the Committee shall adjust the shares under such outstanding Awards (and shall adjust the shares remaining under the Plan which are then to be available for the grant of additional Awards under the Plan, if the reorganization agreement makes specific provisions therefor), in a manner not inconsistent with the provisions of the reorganization agreement and this Plan for the adjustment, change, conversion or exchange of such Awards. The term "Reorganization" as used in this Section Twelve shall mean any statutory merger, statutory consolidation, sale of all or substantially all of the assets of the Company, or sale, pursuant to an agreement with the Company, of securities of the Company pursuant to which the Company is or becomes a wholly-owned subsidiary of another company after the effective date of the Reorganization. 11 12 C. Adjustments and Determinations. Adjustments and determinations under this Section Twelve shall be made by the Committee, whose decisions as to what adjustments or determinations shall be made, and the extent thereof, shall be final, binding, and conclusive. SECTION THIRTEEN RETIREMENT AND DISABILITY The Committee may, in its discretion, waive the forfeiture, termination, or lapse of an Award in the event of retirement or disability of a Participant (each as determined by the Committee, in its discretion). Exercise of such discretion by the Committee in any individual case, however, shall not be deemed to require, or to establish a precedent suggesting such exercise in any other case. SECTION FOURTEEN MISCELLANEOUS PROVISIONS A. Nontransferability. The Committee may impose such restrictions on the transferability of an Award, if any, as it may in its sole discretion determine. B. No Employment Right. Neither this Plan nor any action taken hereunder shall be construed as giving any right to be retained as an officer or employee of the Company or any of its Subsidiaries. C. Tax Withholding. Either the Company or a Subsidiary, as appropriate, shall have the right to deduct from all Awards paid in cash any federal, state or local taxes as it deems to be required by law to be withheld with respect to such cash payments. In the case of Awards paid in Stock, the employee or other person receiving such Stock may be required to pay to the Company or a Subsidiary, as appropriate, the amount of any such taxes which the Company or Subsidiary is required to withhold with respect to such Stock. At the request of a Participant, or as required by law, such sums as may be required for the payment of any estimated or accrued income tax liability may be withheld and paid over to the governmental entity entitled to receive the same. The Committee may from time to time establish procedures for withholding of Stock. D. Fractional Shares. Any fractional shares concerning Awards shall be eliminated at the time of payment by rounding down for fractions of less than one-half and rounding up for fractions of equal to or more than one-half. No cash settlements shall be made with respect to fractional shares eliminated by rounding. E. Government and Other Regulations. The obligation of the Company to make payment of Awards in Stock or otherwise shall be subject to all applicable laws, rules, and regulations, and to such approvals by any government agencies as may be required. The 12 13 Company shall be under no obligation to register under the Securities Act of 1933, as amended ("Act"), any of the shares of Stock issued, delivered or paid in settlement under the Plan. If Stock awarded under the Plan may in certain circumstances be exempt from registration under the Act, the Company may restrict its transfer in such manner as it deems advisable to ensure such exempt status. F. Severance. Subject to the provision of Paragraph B of this Section Fourteen, in the event a Participant's employment with the Company terminates, his rights under any Award which constitutes an Option or a Stock Appreciation Right terminate one (1) month from the date of such termination of employment. Such rights shall be exercisable only to the extent the Participant was entitled to exercise such rights under the Award on the date of such termination of employment. G. Death. If a Participant dies prior to the full exercise of his Option and/or Stock Appreciation Right, his Option to purchase Stock under such Option and/or Stock Appreciation Right may be exercised to the extent, if any, that Participant would be entitled to exercise it at the date of the death of the Participant by the person to whom the Option and/or Stock Appreciation Right shall pass by will or by the laws of descent and distribution within twelve (12) months of the death of the Participant or the expiration of the term of the Option and/or Stock Appreciation Right whichever date is sooner. H. Limitation. In no event may an Option be exercised by anyone after the expiration date provided for in Section Eight of the Plan. I. Limits on Discretion. Anything in this Plan to the contrary notwithstanding, if the Award so provides, the Committee shall not have any discretion to increase the amount of compensation payable under the Award to the extent such discretion would cause the Award to lose its qualification as performance-based compensation for purposes of Section 162(m)(4)(C) of the Code and the regulations thereunder. J. Governing Law. All matters relating to the Plan or to Awards granted hereunder shall be governed by the laws of the State of Maryland, without regard to its principles of conflict of laws. K. Titles and Headings. The titles and headings of the sections in the Plan are for convenience of reference only, and in the event of any conflict, the text of the Plan, rather than such titles and headings, shall control. SECTION FIFTEEN AMENDMENT OF PLAN A. Discretion of the Board. The Board may at any time and from time to time alter, amend, suspend or terminate the Plan in whole or in part, except (i) any such action 13 14 affecting Options granted or to be granted under this Plan which are intended to qualify as Incentive Stock Options shall be subject to stockholder approval to the extent such stockholder approval is required pursuant to Section 422 of the Internal Revenue Code and (ii) no such action may be taken without the consent of the Participant to whom any Award shall theretofore have been granted, which adversely affects the rights of such Participant concerning such Award, except as such termination or amendment of the Plan is required by statute, or rules and regulations promulgated thereunder. B. Automatic Termination. This Plan shall terminate on [ ], 2006. Awards may be granted under this Plan at any time and from time to time prior to the termination of the Plan. Any Award outstanding at the time the Plan is terminated shall remain in effect until said Award is exercised or expires. 14 EX-21.01 9 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21.01 SUBSIDIARIES OF CHOICE HOTELS HOLDINGS, INC.* --------------------------------------------- BOULEVARD MOTEL CORP. Bay Ridge Spirits Corp. Biscayne Land Associates, Inc. Biscayne Properties, Inc. Bowling Green Inn -- Brandywine, Inc. Cardinal Beverage Corp. Everglades Beverage Corp. Fairways Beverage Corp. Fairways, Inc. K & A Corp. MCH Baltimore Corp. MCH Hot Springs Corp. MCH Lincoln Corp. MCH Management, Inc. MCH Roanoke Corp. MCH Shady Grove Corp. MCH Springfield Corp. MCH Sturgis Corp. MCH Wichita Corp. MCHD Cypress Creek Corp. MCHD Ft. Lauderdale Corp. MCHD Hampton Corp. Raleigh Hotel Holdings, Inc. West Montgomery Hotel Holdings, Inc. CACTUS HOTEL CORP. CHOICE HOTELS INTERNATIONAL, INC. (Formerly Quality Inns International, Inc.) ("Choice Hotels") CH Europe, Inc. (d) Choice Capital Corp. Choice Hotels Australia Pty. Ltd. (90%) Choice Hotels Canada Inc. (50%) Choice Hotels (Cayman) Ltd. (10%) Choice Hotels International Asia Pacific Pty. Ltd. Choice Hotels International Pty. Ltd. (Formerly Quality Inn Pty. Ltd.) (d) Choice Hotels (Ireland) Limited (d) Choice Hotels Japan, Inc. (Formerly Quality Hotels Japan, Inc.) Choice Hotels Limited Choice Hotels of Brazil, Inc. - ------------------ * Direct subsidiaries of the Registrant are set forth below in capital letters with their subsidiaries immediately following. Entities are wholly owned except were indicated. 2 -2- Choice Hotels Pacific Asia K.K. (Formerly Quality Hotels Pacific Asia, Inc.) (d) Choice Hotels Pty. Ltd. (Formerly Quality Hotels Pty. Ltd.) (d) Choice Hotels Systems, Inc. Choice Hotels Venezuela, C.A. (20%) Clarion Hotel Pty. Ltd. (Formerly Royale Hotels Pty. Ltd.) (d) Comfort Hotels Pty. Ltd. (d) Comfort Inn Pty. Ltd. (d) Comfort Inns New Zealand Limited (Formerly Quality Inns New Zealand Limited) (d) Hoteles Cono Sur S.A. (d) QI Capital Corp. (d) Quality Hotels (Ireland) Limited (d) Quality Hotels Limited (Formerly Quality Hotels (China) Limited) (50%; 50% Manor Care, Inc.) (d) Quality Hotels and Resorts, Inc. (d) Baltimore Hotel Management. Inc. (d) Myrtle Beach Hotel Management, Inc. (d) Quality Inns International, Inc. (Formerly Choice Hotels International, Inc.) Quality Inter-Americas, Inc. (d) Sleep Inn Pty. Ltd. (d) QUALITY HOTELS EUROPE, INC. COMFORT CALIFORNIA, INC. GULF HOTEL CORP. HEFRU FOOD SERVICES, INC. QCM BEVERAGES, INC. (49%; 51% Texas resident) QCM CORPORATION (d) QI ADVERTISING AGENCY, INC. QUALITY ARIZONA, INC. (d) QH Europe, Inc. (d) QUALITY INNS WORLD MARKETING CORPORATION QUALITY INSURANCE ASSOCIATES, INC. (d) REVERE GROUP, INC. (THE) (d) SUNBURST HOTEL CORP. THICKET, INC. (THE) (Non-Profit; owned by members) 3 -3- PARTNERSHIPS QH Europe Partnership (80% Quality Hotels Europe, Inc. ("QHE"), 20% Choice Hotels International, Inc.) Choice Hotels (Deutschland) G.m.b.H. (99%; 1% Choice Hotels) Choice Hotels (France) S.a.r.l. (99%; 1% Choice Hotels) Choice Hotels Benelux S.A. (51%) Manor Care Hotels (France) S.A. Manor Care Hotels France No. 1 S.a.r.l. Manor Care Hotels France No. 2 S.A. Manor Care Hotels France No. 3 S.a.r.l. Manor Care Hotels France No. 4 S.a.r.l. Quality Hotels Limited (Formerly QI Hotels (U.K.) Limited) (99%; 1% Choice Hotels) Choice Hotels (UK) Limited Quality Hotels Europe (Alsdorf) G.m.b.H. (99%; 1% QHE)(d) Quality Hotels Europe (Herleshausen) G.m.b.H. (99%; 1% QHE)(d) Quality Hotels Europe (Jena) G.m.b.H. (formerly Quality Hotels Europe (Deutschland) G.m.b.H.)(99%; 1% QHE) Quality Hotels Europe (Leipzig) G.m.b.H. (99%; 1% QHE)(d) Quality Hotels Europe (Peine) G.m.b.H. (99%; 1% QHE) Quality Hotels Europe (Troisdorf) G.m.b.H. (99%; 1% QHE) (d) = dormant companies -----END PRIVACY-ENHANCED MESSAGE-----