-----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, DVKdU0rWD7NXx6Tsmv/Q+2jcaqyUM+Laq3uAmvc7Iev3swUtO70qPLM2Mm5ysDWp lvNEbj7NlnZ/dV85iBAuVA== 0000940180-98-000355.txt : 19980401 0000940180-98-000355.hdr.sgml : 19980401 ACCESSION NUMBER: 0000940180-98-000355 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHOICE HOTELS INTERNATIONAL INC /DE CENTRAL INDEX KEY: 0001046311 STANDARD INDUSTRIAL CLASSIFICATION: HOTELS & MOTELS [7011] IRS NUMBER: 521209792 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-13393 FILM NUMBER: 98579998 BUSINESS ADDRESS: STREET 1: 10750 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 20901 BUSINESS PHONE: 3019795000 MAIL ADDRESS: STREET 1: 10750 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 20901 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS FRANCHISING INC DATE OF NAME CHANGE: 19971118 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS INTERNATIONAL INC/ DATE OF NAME CHANGE: 19971022 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 _____________________ FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]. For the fiscal year ended OR [X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]. For the transition period from June 1, 1997 to December 31, 1997 ---------------- ----------------- Commission file number 001-13393 ---------- CHOICE HOTELS INTERNATIONAL, INC. -------------------------------------- (Exact Name of Registrant as Specified in Its Charter) DELAWARE 52-1209792 --------------------------------- -------------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 10750 Columbia Pike, Silver Spring, Maryland 20901 -------------------------------------------- -------------- (Address of Principal Executive Offices) Zip Code Registrant's telephone number, including area code (301) 979-5000 -------------- Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered - ------------------------------ ----------------------------------------- Common Stock, Par Value New York Stock Exchange - ------------------------------ ----------------------------------------- $.01 per share -------------- - ------------------------------ ----------------------------------------- Securities registered pursuant to Section 12(g) of the Act: - ------------------------------------------------------------------------------- (Title of Class) - ------------------------------------------------------------------------------- (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed in Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months as for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ---- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock of Choice Hotels International, Inc. held by non-affiliates was $682,914,860 as of March 12, 1998 based upon a closing price of $17.125 per share. APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No ----- ----- (APPLICABLE ONLY TO CORPORATE REGISTRANTS) The number of shares outstanding of Choice Hotels International, Inc.'s Common Stock at March 12, 1998 was 59,741,072. DOCUMENTS INCORPORATED BY REFERENCE. PART I 1997 Annual Report to Stockholders PART II 1997 Annual Report to Stockholders Proxy Statement dated March 30, 1998 PART III Proxy Statement dated March 30, 1998 2 PART I ITEM 1. BUSINESS Overview Choice Hotels International, Inc. (the "Company" or "Choice") is the world's second largest franchisor of hotel properties with 3,484 open and operating in 33 countries at December 31, 1997. In addition, at December 31, 1997, the Company had 844 franchise properties currently under development representing a total of 74,413 rooms. Choice franchises lodging properties under one of the Company's proprietary brand names (the "Choice brands"): Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R), Econo Lodge(R) and MainStaySM. The Company has over 2,100 franchisees in the franchise system with no single franchisee accounting for more than 5% of its royalty or total revenues. The Company franchises hotels in all 50 states and the District of Columbia and 32 additional countries, with 95% of its franchising revenue generated from hotels franchised in the United States. With recognized brands, and a diverse and growing franchisee base, the Company believes it has a strong foundation for continued growth. Choice is a "pure-play" lodging franchisor with limited real estate exposure and low capital expenditure requirements. With a focus on hotel franchising versus ownership, the Company benefits from the economics of scale inherent in the franchising business. The fee and cost structure of the Company's business provides significant opportunities to increase profits by increasing the number of franchise properties. The Company derives substantially all of its revenues from franchise fees which consist of an initial fee and ongoing royalty, marketing, and reservation fees which are based as a percentage of the franchisees gross room revenues. The principal factors that affect the Company's results are: (1) growth in the number of hotels under franchise; (ii) occupancies and roomrates achieved by the hotels under franchise; (iii) the number and relative mix of franchised hotels and (iv) the Company's ability to manage costs. The number of rooms at franchised properties and occupancies and room rates at those properties significantly affect the Company's results because royalty fees are based upon room revenues at franchised hotels. The variable overhead costs associated with franchise system growth are substantially less than incremental royalty fees generated from new franchisees, therefore the Company is able to capture a significant portion of these royalty fees as operating income. The Company believes that the continued growth of its franchise business should enable it to capture increasing benefits from the operating leverage in place thereby improving operating margins. The Company's franchising operating margins/1/ have improved from 47.1% as of May 31, 1995 to 55.0% as of May 31, 1997. Furthermore, the Company has generated steady royalty fee income from its increasing franchisee base growing from $50.9 million for the year ended May 31, 1992 to $95.2 million for the year ended May 31, 1997 representing a compound annual growth rate of 13.3%. Earning before interest, taxes, depreciation and amortization has grown at a compound annual growth rate of 20.2% from $32.2 million for the year ended May 31, 1992 to $80.8 million for the year end May 31, 1997. - ---------- /1/ Franchising operating margin is calculated by deducting selling, general and administrative expenses plus allocable depreciation and amortization from net franchising revenues. 3 Company History Prior to becoming a separate, publicly-held company on October 15, 1997 pursuant to the Company Spinoff (as defined below), the Company was known as Choice Hotels Franchising, Inc. and was a wholly-owned subsidiary of Choice Hotels International, Inc. ("Former Choice"). On October 15, 1997, Former Choice distributed to its stockholders its hotel franchising business (which had previously been primarily conducted by the Company) and its European hotel ownership and franchising business pursuant to a pro rata distribution to its stockholders of all of the stock of the Company (the "Company Spinoff"). At the time of the Company Spinoff, the Company changed its name to "Choice Hotels International, Inc.," and Former Choice changed its name to "Sunburst Hospitality Corporation." For purposes of the Offering Memorandum, references to the Company's former parent corporation prior to the Company Spinoff are to "Former Choice," and reference to such corporation after the Company Spinoff are to "Sunburst." Prior to November 1996, Former Choice was a subsidiary of Manor Care, Inc. ("Manor Care") which, directly and through its subsidiaries, engaged in the hotel franchising business currently conducted by the Company as well as the ownership and management of hotels (together with the hotel franchising business, the ("Lodging Business") and the health care business. On November 1, 1996, Manor Care separated the Lodging Business from its health care business through a pro rata distribution to the holders of Manor Care's common stock of all of the stock of Former Choice (the "Former Choice Spinoff"). In connection with the Former Choice Spinoff, the Company became a wholly-owned subsidiary of Former Choice and remained as such until consummation of the Company Spinoff. The Lodging Industry As of December 31, 1997, there were approximately 3.6 million hotel rooms in the United States in hotels/motels containing twenty or more rooms. Of those rooms, approximately 1.1 million rooms were not affiliated with a national or regional brand, while the remaining approximately 2.5 million rooms were 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 strong performance, based on year-to-year increases in room revenues, average daily 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 realized. Since 1993, the lodging 4 industry has been able to increase its average daily rate ("ADR") at a pace faster than the increase in the Consumer Price Index ("CPI"), a common measure of inflation published by the US Department of Labor. The following chart demonstrates the recent trends: THE US LODGING INDUSTRY'S GROWTH TRENDS SINCE 1991
INCREASES 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......... 3.5% 62.6% $58.91 1.4% 2.9% $36.87 break-even 36,000 1993......... 4.6% 63.5% $60.53 2.7% 2.7% $38.42 $ 2.4 40,000 1994......... 7.1% 64.7% $62.86 3.8% 2.7% $40.70 $ 5.5 45,000 1995......... 6.7% 65.1% $65.81 4.7% 2.9% $42.83 $ 8.5 64,000 1996......... 8.9% 65.0% $70.81 7.6% 2.9% $46.06 $12.5 101,000 1997......... 8.8% 64.5% $75.16 6.1% 1.9% $48.50 $14.5 123,000
- ------------------- Source: Smith Travel Research 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, the Company believes 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(R), Rodeway(R) and Sleep(R) brands compete primarily in the limited-service economy market; the Company's Comfort(R) and Quality(R) brands compete primarily in the limited-service middle-market. The Company's MainStay(SM) Suites brand competes primarily in the all-suites middle- market. The Company's Clarion(R) brand competes primarily in the full-service upscale 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 1991 to 1996, the average room count in new hotels declined from 122 to 87, 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 5 competitive with hotels owned by or affiliated with national lodging companies. Because the costs of owning and operating a hotel are generally fixed, increases in revenues generated by affiliation with a franchise lodging chain can improve a hotel's financial performance. Of approximately 2,198 hotel properties that changed their affiliation in 1996, 88% converted from independent status to affiliation with a chain or converted from one chain to another, while only 12% canceled or were required to cancel their chain affiliation. A total of 466 independent properties switched to a franchise chain in 1996, the second largest number in the past ten years. The large franchise lodging chains, (including the Company), generally 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 business provides significant opportunities for the Company to increase profits by increasing the number of franchised properties. As a hotel franchisor, the Company derives substantially all of its revenue from franchise fees. The Company's franchise fees consist of an initial fee and ongoing royalty, marketing and reservation fees which are based on a percentage of the franchisee's gross room revenues. The royalty portion of the franchise fee is intended to cover the Company's operating expenses, such as expenses incurred in quality assurance, administrative support and other franchise services and to provide the Company with operating profits. The marketing and reservation portion of the franchise fee is intended to reimburse the Company 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 initial fees, and marketing and reservation fees. The royalty fees generated from franchisees more than cover the fixed costs of the business at its current level. The variable overhead costs associated with franchise system growth are substantially less than incremental royalty fees generated from new franchisees, therefore the Company is able to capture a significant portion of these royalty fees as operating income. Strategy. The Company's business strategy is based on creating an organization that is focused on consumer and franchisee needs, optimizing the portfolio of brands, strategically growing the franchise system, improving its and its franchisees' margins, growing profitability 6 internationally, and pursuing complimentary business opportunities. Key components of the Company's strategy include: . Organize for Success. The Company has created an organizational structure to -------------------- focus on consumers, serve franchisees and leverage the franchise system, the underpinnings of which are an emphasis on consumers and franchise service. Consumer Focus--Brand management, new product development and traditional -------------- marketing and advertising are all combined under the Company's Marketing Department to create consumer focus and to drive demand for the Company's brand products. New product development will be based on consumer needs determined through consumer research. The Company believes that a consumer focus will lead to greater demand for the Company's products, which in turn will result in higher revenue from the Company's franchise system. Franchisee Service--Franchise service and sales are consolidated under a ------------------ regional structure made up of five regional operating teams. This structure provides each licensee one primary contact who is responsible for assessing and responding to each hotel's specialized needs. Led by seasoned lodging executives averaging over 20 years experience in this industry, the Company believes it is positioned to strategically develop new hotel franchises and enhance the operating performance of its existing hotels. Leveraging the Franchise System--Strategic partnerships, purchasing and other functions that leverage the scale of the franchise system are combined under the Company's partner services group. The Company believes there is significant opportunity to leverage its size by entering into joint marketing arrangements with national and multi-national 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 its franchisees' revenues and profits by attracting business to its franchise hotels. . Optimize the Brand Portfolio. The Company believes that each of its brands has particular attributes and strengths. The Company's strategy is to leverage the strengths of each brand for profit growth and for identifying new niches into which the company may expand. This will be effectuated through a raising of the Company's brand standards strictly enforced through consumer-driven quality assurance. . Increase Market Penetration on a Strategic Basis. The Company will take advantage of its regional structure to analyze key markets in the U.S. and, in conjunction with its franchisees, identify the best opportunities for new development or conversion to one of the Company's brands. . Improve Margins Through Increased Productivity. The Company addresses the competitiveness of its own and its franchisees' profitability by initiating revenue generating programs and improving cost productivity. A key component of this strategy is the roll out of the Company's proprietary property and yield management system "Profit Manager by Choice", which the Company believes will improve the RevPAR of its franchisees. This will be supplemented by continued enforcement of the Company's contracts (including licensee audits) and an aggressive focus on strategic partnership opportunities. . Profitably Grow Internationally. During the ten fiscal years ended May 31, 1997, the number of properties in the Company's international franchise system increased to 563 properties with 47,603 rooms, from 81 properties with 8,330 rooms. As of December 31, 1997, the Company's international franchise system had 605 properties with 50,687 rooms. The Company's international franchise system includes hotels in 32 countries outside the United States. The Company plans to continue to 7 profitably grow its brands internationally through a strategic pursuit of joint ventures, master franchising agreements and brand specific area development agreements. . Pursue Complementary Business Opportunities. The separation of Choice from Former Choice allows the Company to focus solely on franchising, including potential acquisition opportunities that are complementary to the Company's core business and unique operating skills. Choice's acquisition strategy includes the potential purchase of lodging brands that would enhance the offerings the Company currently makes to its franchisees and hotel consumers. Franchise System The Company's franchise hotels operate under one of the Choice brand names: Comfort(R), Quality(R), Clarion(R), Sleep(R), Rodeway(R), Econo Lodge(R) and MainStaySM. The following table presents key statistics relative to Choice's domestic franchise system over the four fiscal years ended May 31, 1997, and for the seven-month periods ended December 31, 1996 and 1997. COMBINED DOMESTIC FRANCHISE SYSTEM
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period... 2,283 2,311 2,495 2,781 2,672 2,879 Number of rooms, end of period........ 203,019 200,792 214,613 235,431 226,346 242,061 Average Royalty Rate(1)............... 3.1% 3.2% 3.3% 3.4% 3.4% 3.5% Average occupancy percentage.......... 62.2% 63.8% 63.8% 62.6% 67.7% 66.2% Average daily room rate (ADR)......... $ 45.63 $ 47.13 $ 49.49 $ 51.92 $ 52.50 $ 54.97 RevPAR(2)............................. *$ 28.40 $ 30.08 $ 31.60 $ 32.52 $ 35.54 $ 36.39 28.40 Royalty fees ($000s).................. $ 62,590 $ 71,665 $ 82,239 $ 91,724 $ 58,025 $ 65,271
(1) Represents domestic royalty fees as a percentage of aggregate gross room revenues of all of the domestic Choice brand franchised hotels. (2) 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. The Company has over 2,100 domestic franchisees and operates in all 50 states and the District of Columbia. Approximately 95% of the total royalty income is generated from domestic franchise operations. Consequently, the Company's analysis of its franchise system is focused on the domestic operations. Currently, no master franchisee or other franchisee accounts for 5% or more of Choice's royalty revenues or total revenues. Sunburst is the Company's largest franchisee with a portfolio of 76 hotels containing 10,885 rooms located in 26 states as of December 31, 1997. 8 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). Comfort. The Comfort brand is the Company's largest. Comfort Inns and Comfort Suites hotels offer rooms in the limited-service, middle market category. Comfort Inns and Comfort Suites are targeted to business and leisure travelers. Principal competitor brands include Days Inn, Fairfield Inn, Hampton Inn, Holiday Express and LaQuinta. At December 31, 1997, there were 1,470 Comfort Inn properties and 147 Comfort Suite properties with a total of 114,341 and 12,133 rooms, respectively, open and operating worldwide. An additional 197 Comfort Inn properties and 132 Comfort Suite properties with a total of 17,129 and 10,674 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, Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand, the United Kingdom and the United Arab Emirates. The following chart summarizes the Comfort system in the United States: COMFORT DOMESTIC SYSTEM
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 935 1,015 1,129 1,255 1,205 1,304 Number of rooms, end of period....... 82,479 87,551 94,160 102,722 99,343 105,384 Royalty fees ($000s)................. $31,187 $37,635 $44,657 $ 50,758 $32,156 $ 36,446 Average occupancy percentage......... 68.0% 69.5% 68.7% 67.2% 72.6% 71.3% Average daily room rate (ADR)........ $ 46.46 $ 48.24 $ 51.13 $ 54.17 $ 54.97 $ 57.15 RevPAR............................... $ 31.57 $ 33.54 $ 35.11 $ 36.39 $ 39.90 $ 40.75
Sleep Inn. Established in 1988, Sleep Inn is a new-construction hotel brand in the limited-service, economy category. Sleep Inns are targeted to the business and leisure traveler. Principal competitor brands include Days Inn, Fairfield Inn, Holiday Express, LaQuinta Inn, Ho-Jo Inn and Ramada Inn. At December 31, 1997, there were 160 Sleep Inn properties with a total of 11,886 rooms open and operating worldwide. An additional 128 properties with a total of 9,852 rooms were under development. The properties are located in the United States, Canada, the Cayman Islands and Thailand. The following chart summarizes the Sleep system in the United States: 9 SLEEP DOMESTIC SYSTEM
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 34 51 87 131 114 157 Number of rooms, end of period....... 2,921 3,672 6,396 9,635 8,365 11,595 Royalty fees ($000s)................. $ 605 $1,080 $2,108 $3,343 $2,037 $ 2,630 Average occupancy percentage......... 64.6% 65.3% 65.5% 63.9% 69.3% 66.5% Average daily room rate (ADR)........ $39.11 $41.89 $45.11 $48.11 $48.68 $ 50.54 RevPAR............................... $25.28 $27.37 $29.56 $30.75 $33.73 $ 33.60
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 business and leisure travelers. Principal competitor brands include Best Western, Holiday Inn, Howard Johnson, Ramada Inn and Days Inn. At December 31, 1997, there were 617 Quality Inn properties with a total of 70,038 rooms, and 44 Quality Suites properties with a total of 5,953 rooms open worldwide. An additional 110 Quality Inn properties and 47 Quality Suites properties with a total of 13,410 rooms and 3,141 rooms, respectively, were under development. Quality properties are located in the United States and in Australia, Canada, Chile, Costa Rica, the Czech Republic, Denmark, France, Germany, Guatemala, India, Indonesia, Ireland, Italy, Jamaica, Malaysia, Mexico, New Zealand, Norway, Portugal, 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 AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 358 341 362 409 385 420 Number of rooms, end of period....... 45,032 43,281 45,967 50,487 47,668 50,787 Royalty fees ($000s)................. $14,890 $15,632 $16,606 $17,623 $11,311 $12,459 Average occupancy percentage......... 61.6% 63.1% 62.5% 61.3% 66.0% 63.8% Average daily room rate (ADR)........ $ 50.07 $ 50.94 $ 52.90 $ 54.61 $ 55.20 $ 57.58 RevPAR............................... $ 30.83 $ 32.16 $ 33.08 $ 33.46 $ 36.43 $ 36.73
Clarion. Clarion Inns, Clarion Hotels, Clarion Resorts and Clarion Suites hotels are full-service properties which operate in the upscale category. Clarion properties are targeted to 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 December 31, 1997, there were 115 Clarion properties with a total of 18,649 rooms open and operating worldwide and an additional 34 properties with a total of 5,569 rooms under development. The properties are located in the United States, Canada, France, Indonesia, Ireland, Japan, Mexico, Norway, Russia and Uruguay. The following chart summarizes the Clarion system in the United States: 10 CLARION DOMESTIC SYSTEM
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 65 63 75 92 79 96 Number of rooms, end of period....... 12,211 10,420 12,817 14,721 13,101 16,161 Royalty fees ($000s)................. $ 2,735 $ 2,995 $ 3,602 $ 4,081 $ 2,168 $ 2,957 Average occupancy percentage......... 62.0% 63.7% 63.3% 63.3% 67.1% 64.7% Average daily room rate (ADR)........ $ 62.47 $ 63.71 $ 64.36 $ 67.76 $ 66.96 $ 71.53 RevPAR............................... $ 38.75 $ 40.58 $ 40.74 $ 42.86 $ 44.94 $ 46.29
Econo Lodge. Econo Lodge hotels operate in the limited-service, economy category of the lodging industry. Econo Lodges are primarily targeted to senior citizens 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 December 31, 1997, there were 714 Econo Lodge properties with a total of 46,073 rooms open and operating in the United States and Canada, and an additional 122 properties with a total of 8,487 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 AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 677 633 641 682 674 691 Number of rooms, end of period....... 46,570 42,801 42,726 44,636 44,525 44,937 Royalty fees ($000s)................. $11,231 $12,021 $12,760 $13,288 $ 8,641 $ 8,991 Average occupancy percentage......... 56.7% 57.5% 58.0% 56.4% 61.8% 60.7% Average daily room rate (ADR)........ $ 37.27 $ 38.31 $ 39.97 $ 41.33 $ 42.51 $ 43.86 RevPAR............................... $ 21.14 $ 22.04 $ 23.17 $ 23.30 $ 26.29 $ 26.63
Rodeway. The Rodeway brand competes in the limited-service, economy category and is primarily targeted to senior citizens. Principal competitor brands include Ho-Jo Inn, Ramada Limited, Red Roof Inn, Budgetel, Shoney's Inn, Super 8 and Motel 6. At December 31, 1997, there were 214 Rodeway Inn properties with a total of 13,370 rooms, open and operating in the United States and Canada, and an additional 46 properties with a total of 3,504 rooms under development in those two countries. The following chart summarizes the Rodeway system in the United States: 11 RODEWAY DOMESTIC SYSTEM(1)
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 214 208 201 216 214 208 Number of rooms, end of period....... 13,806 13,067 12,547 13,509 13,248 12,940 Royalty fees ($000s)................. $ 1,941 $ 2,302 $ 2,506 $ 2,631 $ 1,711 $ 1,756 Average occupancy percentage......... 51.4% 50.5% 52.7% 52.7% 57.0% 54.7% Average daily room rate (ADR)........ $ 36.89 $ 38.93 $ 40.66 $ 41.15 $ 42.07 $ 44.11 RevPAR............................... $ 19.00 $ 19.64 $ 21.48 $ 21.68 $ 23.99 $ 24.13
- --------------- (1) Includes data pertaining to the Friendship Inn system, which is being combined with the Rodeway Inn system. 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 nights or more. The first MainStay Suites hotel, which Sunburst owns and manages, opened in Plano, Texas, in November 1996. As of December 31, 1997, there were three open hotels with 257 rooms and an additional 28 properties with 2,647 rooms under development. The MainStay(SM) Suites brand is designed to fill the gap in the middle-market category between existing upscale and economy extended-stay lodging products. Principal competitors brands include Candlewood hotels, TownePlace Suites, as well as competition from all-suite hotel properties and traditional extended stay operators in both the upscale market (Hawthorne Suites, Homewood Suites, and Summerfield Suites) and the economy market (Extended Stay America, Studio Plus and Oakwood). The Company has granted to Sunburst an option exercisable under certain circumstances at January 1,2000, to purchase the brand names, marks, franchise agreements and other assets of the MainStay Suites hotel system. See "Relationship Between the Company and Sunburst --Strategic Alliance Agreement." International Franchise Operations The Company's international franchise operations are conducted through master franchise arrangements. These agreements provide the master franchisee the right to develop Choice branded hotels in a specific geographic region, usually for a fee. The agreements govern the relationship between the Company and the master franchisee, who share the royalties generated by the underlying franchised hotels. At December 31, 1997, the Company had 605 franchise hotels open in 32 countries outside the United States. The following table illustrates the growth of the Company's international franchise system over the four fiscal years ended May 31, 1997 and for the seven-month periods ended December 31, 1996 and 1997. 12 COMBINED INTERNATIONAL FRANCHISE SYSTEM(1)
AS OF AND FOR THE SEVEN MONTHS AS OF AND FOR THE YEAR ENDED MAY 31, ENDED DECEMBER 31, ------------------------------------------------------------------------------------- 1994 1995 1996 1997 1996 1997 -------- -------- -------- -------- -------- -------- Number of properties, end of period.. 430 524 557 563 548 605 Number of rooms, end of period....... 36,725 44,877 46,843 47,603 46,473 50,687 Royalty fees ($000s)................. $ 1,667 $ 1,998 $ 1,586 $ 1,672 $ 696 $ 958
(1) Master franchise contracts do not currently require the reporting of operating statistics (e.g. average occupancy percentage and average daily room rate) of the underlying hotels, thus RevPAR is not calculated for foreign hotels. Europe. The Company is the second-largest international franchised hotel chain in Europe, with 307 hotels open in 14 countries at December 31, 1997. In order to realign and streamline its European operations, in May 1996, the Company, through its subsidiary, ManorCare Hotels (France) S.A., acquired 750,000 ordinary (common) shares and 10,000,000 convertible preferred shares of Friendly Hotels, PLC ("Friendly") for approximately $17.1 million. The proceeds from this investment have been and will be used by Friendly to finance the development of ten new Comfort Inn or Quality Inn hotels in the United Kingdom and Ireland. Additionally, the Company granted to Friendly a master franchise for the United Kingdom and Ireland in exchange for an additional 333,333 Friendly ordinary shares. Each 5.75% convertible preferred share is immediately convertible into one Friendly ordinary share for every 150p nominal value of the 5.75% convertible preferred shares. In January 1998, the Company and Friendly concluded a second transaction in which Friendly acquired from the Company the master franchise rights for the Comfort(R), Quality(R) and Clarion(R) brands for all of Europe with the exception of Scandinavia for a period of 10 years, for a payment of $8 million, payable in eight equal annual installments. As part of the transaction, Friendly acquired from the Company 10 hotels in France, two in Germany and one in the United Kingdom in exchange for 13,624,742 additional 5.75% convertible preferred shares with a value of $22.2 million. Each such 5.75% convertible preferred share is convertible on or after the announcement by Friendly of its 1998 financial results (which is expected to occur in April 1999) into one Friendly ordinary share for each 150p nominal value of the 5.75% convertible preferred shares. In addition, Friendly will pay the Company deferred compensation of $4 million in cash, payable by the fifth anniversary of the transaction or sooner depending on the level of future profits of the hotels acquired. After consummation of this transaction (and the receipt of additional ordinary shares resulting from the payment of dividends in ordinary shares), the Company holds 1,139,888 Friendly ordinary shares and 23,624,742 5.75% convertible preferred shares of Friendly. Assuming conversion to Friendly ordinary shares of all Friendly convertible preferred shares (including those held by the Company), the Company would hold approximately [46.5%] of the outstanding Friendly ordinary shares. Under the terms of its investment, the Company currently has the right to appoint three of the directors to the Friendly board. 13 There is also a master franchise arrangement in Scandinavia that has 71 open properties as of December 31, 1997. Canada. Choice Hotels Canada is Canada's largest lodging organization with 211 properties open at December 31, 1997. Choice Hotels Canada is a joint venture, owned 50% by the Company and 50% by Journey's End Corporation ("Journey's End"), which was formed in 1993 when Journey's End converted substantially all of its controlled hotels to Choice's brands and Choice contributed its operations in Canada to form Choice Hotels Canada. Other International Relationships. The Company has master franchise arrangements with developers in various countries, including Australia, New Zealand, Mexico and Brazil. At December 31, 1997, 87 hotels were open and operating under these master franchise arrangements, generating annual royalty fees to the Company of less than $1 million. Franchise Sales The Company has identified key market areas for hotel development based on supply/demand relationships and strategic objectives. Development opportunities are first offered to existing franchisees and then to (i) developers of hotels, (ii) owners of independent hotels and motels, (iii) owners of hotels affiliated with other franchisors' brands, and (iv) contractors who construct any of the foregoing. In the seven months ended December 31, 1997, existing franchisees accounted for approximately 64% of the Company's new franchise agreements. In considering hotels for conversion to one of the Choice brands, or sites for development of new hotels, the Company considers locations which are close to major highways, airports, tourist attractions and business centers that attract travelers. At December 31, 1997, the Company employed approximately 43 sales directors, each of whom is responsible for a particular region or geographic area. Sales directors contact potential franchisees directly and receive compensation based on sales generated. Franchise sales efforts emphasize the benefits of affiliating with one of the Choice brands, the Company's commitment to improving RevPAR, the Company's "celebrity in a suitcase" television advertising campaign (formerly used for the entire family of Choice brands and now used principally for its three largest brands, Comfort, Quality and Econo Lodge), the Choice reservation system, the Company's training and support systems, and the Company's history of growth and profitability. Because the Choice brands cover 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. 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. 14 For the seven months ended December 31, 1997, the Company received 411 applications, approved 352 applications, signed 219 franchise agreements and placed 175 properties into operation in the U.S. Of those placed into operation, 94 were newly constructed hotels. During fiscal 1997, Choice received 1,078 franchise applications, approved 874 applications, signed 715 franchise agreements and placed 390 new properties into operation in the United States under the Choice brands. Of those placed into operation, 203 were newly constructed hotels. By comparison, during the fiscal year ended May 31, 1996, the Company received 993 franchise applications, approved 862 applications, signed 665 franchise agreements and had 284 new U.S. properties operating. 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. Nonetheless, the Company believes that increased applications lead to an increased number of hotels entering the Choice franchise systems. Franchise Agreements The Company's standard 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 20 years, with certain rights to each of the franchisor and franchisee to terminate the franchise agreement before the twentieth year. When the responsibility for development is sold to a master franchisee, that party has the responsibility to sell to local franchisees the Choice 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. The Company has only entered into master franchise agreements with respect to franchise hotels outside the United States. Either party to a franchise agreement, other than master franchise agreements, can terminate a franchise agreement 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 different Choice brands, but generally are competitive with 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 Choice brands. Royalty fees and affiliation fees are the principal sources of profits for the Company. 15 The standard franchise agreements typically require the Company's franchisees to pay the following fees: 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/$45,000 5.25% 2.1% 1.75% Comfort Suites............. $300/$50,000 5.25% 2.1% 1.75% Quality Inn................ $300/$35,000 4.0% 2.1% 1.75% Quality Suites............. $300/$50,000 4.0% 2.1% 1.25% Sleep Inn.................. $300/$40,000 4.5% 2.1% 1.75% Clarion.................... $300/$40,000 3.75% 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.................... $250/$25,000 3.5% 1.25% 1.25%
- -------------- (1) Fee includes both Marketing and Reservation Fees. For a description of the franchising agreements between the Company and Sunburst, "Relationship Between the Company and Sunburst--Franchise Agreements." The Company has increased its average royalty rate since fiscal 93, primarily by raising the quoted royalty fee for Comfort franchisees to 5.25% of annual gross room revenues ("GRR") from 4.0% of GRR in 1993, and by increasing the number of higher royalty contracts in the franchise system. For the seven months ended December 31, 1997, the Company's average royalty rate for all Choice brand hotels was 3.5%. The Company believes that its average royalty rate will continue to increase as new francisees are added and as older franchise agreements expire, terminate or are amended. At December 31, 1997, the Company had 2,879 franchise agreements in effect in the United States and 605 franchise agreements in effect in other countries. The average age of the franchise agreements was 4.6 years. Seventy- eight of the franchise agreements are scheduled to expire during the five-year period beginning December 31, 1997; however, franchise agreements generally contain early termination provisions. Franchise Operations The Company's operations are designed to improve RevPAR for its franchisees, as this is the measure of performance that most directly impacts franchisee profitability. The Company believes that by helping its franchisees to become more profitable it will enhance its ability to both retain its existing franchisees and attract new franchisees. The key aspects of the Company's franchise operations are: Central Reservation System. On average, approximately 30% 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 16 known as CHOICE 2001, five reservation centers in North America and several international reservation centers run by the Company or its master franchisees. Operators trained on the CHOICE 2001 system can match each caller with a Choice- 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 that facilitates the reservation process for travel agents. To define more sharply 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, although Choice allows its reservation agents to cross-sell the Choice 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-branded hotel that meets the customer's needs. The Company believes that cross-selling enables Choice 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 Choice 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. Choice 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 smaller Choice 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. 17 Marketing and advertising programs are directed by the Company's Marketing Department, which utilizes the services of independent advertising agencies. The Company also 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 Choice brands. The Company's regional sales directors work with franchisees to maximize RevPAR. These directors advise franchisees on topics such as marketing their hotels and maximizing the benefits offered by the Choice 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 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. The Company identifies franchisees whose properties operate below minimum quality standards and assists them in complying with brand specifications. Franchisees who fail to improve on identified quality matters may be subject to consequences ranging from written warnings to termination of the franchisee's franchise agreement. During the seven months ended December 31, 1997, fiscal year 1997 and fiscal year 1996, the Company terminated 20, 49 and 48 properties, respectively, for failure to maintain minimum quality assurance scores. 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 Choice 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. Purchasing. The Company's product services department negotiates volume purchases of various products needed by franchisees to run their hotels, including furniture, fixtures, carpets 18 and bathroom amenities. The department also helps to ensure consistency in such products across its exclusively new-construction brands, Sleep Inn and MainStay(SM) Suites brands. Sales to franchisees by the Company were approximately $13.5 million during the seven months ended December 31, 1997. The group purchasing program consists of the Company's utilization of bulk purchases to obtain favorable pricing from third-party vendors for franchisees ordering similar products. The Company acts as a clearinghouse between the franchisee and the vendor, and most orders are shipped directly to the franchisee. 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 or helped franchisees obtain financing through (i) a wholly owned subsidiary; (ii) strategic partnerships with hotel lenders and (iii) by referral to hotel lenders for hotel refinancing, acquisition, renovation and development. Some of the specific programs include: (a) Second Mortgage Financing. The Company offers second mortgage ------------------------- financing for the development and construction of Quality Inn, Quality Suites, Quality Inn and Suites, Main Stay Suites and Sleep Inns. The terms of the financing depend on each franchisee's credit worthiness, the amount of the proposed loan and the current economic conditions. Generally not more than 25% of the project is financed. Total debt cannot exceed 75% of the fair market value. At December 31, 1997, loans outstanding under the program were $1.5 million. (b) Econo Lodge exterior renovation program. Under this program, loans --------------------------------------- up to an amount of $17,500 per property are given to qualified Econo Lodge franchisees for standardized exterior renovation. Franchisee participation requires, among other things, extension of the franchise agreement. The loan is forgiven at the expiration of the extended franchise agreement, assuming no defaults have occurred thereunder. At December 31, 1997, the Company had loans of $2.1 million outstanding under this program. (c) "Construction to Permanent Financing" program to qualified --------------------------------------------------------- franchisees. Salomon Smith Barney together with Suburban Capital Markets ----------- Inc. is offering $100 million in "Construction to Permanent Financing" per year to qualified franchises. All Choice brands are included in this program. The construction loan is issued for a term up to three years at a floating rate of 355 basis points over the 30-day LIBOR. The loan amount will not exceed 75% of cost. The franchisee is responsible for cost of all third party reports and fees in the amount of 2.75% of the loan amount. A stabilized debt service coverage ratio of at least 1.4:1 is required for the permanent loans, which are issued for a 10-year term with amortization up to 25 years and a fixed interest rate of 225 basis points over the 10- year U.S. Treasury interest rate on the day of closing. The permanent loan requires a fee of 1% of the loan amount. The Company's guarantee is based on loans outstanding with a maximum guarantee amount of $10 million. At December 31, 1997, loans under the program totaled $5.2 million and the Company's guarantee covered $766,000 in loans. Competition Competition among franchise lodging chains is intense, both in attracting potential franchisees to the system and in generating reservations for franchisees. 19 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. The Company believes that hotel operators select a franchisor in part based on the franchisor's reputation among other franchisees, and the success of its existing franchisees. The Company is the second largest hotel franchisor in the world. The largest, Cendant Corporation, (formerly HFS, Inc.), has over 5,300 franchised hotels. Accor has 2,465, Holiday Corporation has 2,260, Promus/Doubletree has 1,136, Marriott International, Inc. has 1,268, Societe de Louvre has 511, Carlson Radisson/SAS has 437, ITT Corporation has 413 and Hilton Hotels Corporation has 245. The figures in this paragraph are with respect to U.S. hotel properties as indicated in the July 1997 issue of Hotels Magazine. 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. The ability of a hotel 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 local 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 32 other 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, which is 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. 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. This seasonality can be expected to cause quarterly fluctuations in the Company's revenues, profit margins and net income of Choice. 20 Regulation The Company's franchisees are responsible for compliance with all laws and government regulations applicable to the hotels they own or operate. 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 with employee relations, including minimum wage requirements, overtime, working conditions and work permit requirements. The Federal Trade Commission (the "FTC"), various states and certain other foreign jurisdictions (including France, Province of Alberta, Canada, and Mexico) 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 in which the Company franchises operate 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. Impact of Inflation and Other External Factors The Company's principal sources of revenues are franchise fees. Franchise fees can be impacted by external factors, including, in particular: the supply of hotel rooms within the lodging industry relative to the demand for rooms by travelers, and inflation. Although the Company believes industry-wide supply and demand for hotel rooms recently has been fairly balanced, any excess in supply that might develop in the future could unfavorably impact room revenues at the Company's franchised hotels either by reducing the number of rooms reserved at such franchised 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, reducing the franchise fees received by the Company. However, the Company benefits from an increasing supply of hotels as it serves to increase franchise fees. 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. Such a slowdown could result in reduced travel by both business and leisure travelers, potentially resulting in less demand for hotel rooms, which could result in a temporary reduction in room rates and fewer room reservations, negatively impacting the Company's revenues. A weak economy could also reduce demand for new hotels, negatively impacting the franchise fees received by the Company. Among the other unpredictable external factors which may affect the Company's fee stream are wars, airline strikes, gasoline shortages and severe weather. 21 Employees The Company employed approximately 1,644 people as of December 31, 1997. None of the Company's employees are represented by unions or covered by collective bargaining agreements. Choice considers its relations with its employees to be satisfactory. ITEM 2. PROPERTIES The principal executive offices of the Company are located at 10750 Columbia Pike, Silver Spring, Maryland 20901. These offices are leased from Sunburst. 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. 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. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any litigation, other than routine litigation incidental to its business. 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1997. EXECUTIVE OFFICERS OF CHOICE HOTELS INTERNATIONAL, INC. The name, age, title, present principal occupation, business address and other material occupations, positions, offices and employment of each of the executive officers of the Company are set forth below. The business address of each executive officer is 10750 Columbia Pike, Silver Spring, Maryland 20901, unless otherwise indicated.
NAME AGE POSITION - ---- --- -------- Stewart Bainum, Jr........... 52 Chairman of the Board of Directors William R. Floyd............. 53 Chief Executive Officer and President Donald H. Dempsey............ 53 Executive Vice President, Chief Financial Officer Thomas Mirgon................ 41 Senior Vice President, Human Resources and Strategic Partnerships Barry L. Smith............... 56 Senior Vice President, Marketing Michael J. DeSantis.......... 39 Senior Vice President, General Counsel and Secretary Joseph M. Squeri............. 32 Vice President, Finance and Controller
22 Background of Executive Officers: Stewart Bainum, Jr. Chairman of the Board of the Company from March 1987 to November 1996 and since October 1997; Chairman of the Board of Former Choice/Sunburst since November 1996; Chairman of the Board and Chief Executive Officer of Manor Care and ManorCare Health Services, Inc. ("MCHS") 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 December 1994; 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 MCHS since 1976 and of the Company since 1977; Chief Executive Officer of MCHS 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. William R. Floyd. Chief Executive Officer of the Company since October 1996; President and Chief Executive Officer of the Company since November 1997; Chief Executive Officer of Former Choice from October 1996 to October 1997; Chief Operating Officer of Taco Bell Corp. (a subsidiary of PepsiCo) from July 1995 to October 1996, Chief Operating Officer of KFC (a subsidiary of PepsiCo) from August 1994 to July 1995; National Vice President of Taco Bell Company Operations from July 1992 to August 1994, Vice President of Taco Bell Eastern Operations from December 1990 to January 1992; Director, Friendly Hotels PLC since 1996. Donald H. Dempsey. Executive Vice President and Chief Financial Officer of the Company since December 1997; Senior Vice President and Chief Financial Officer of Promus Hotel Corporation from April 1995 to December 1997; Senior Vice President of Finance and Administration of the Hotel Division of The Promus Companies Incorporated from 1993 to 1995; Vice President, Finance of Hampton Inn/Homewood Suites Hotel Division of The Promus Companies Incorporated from 1991 to 1993. Michael J. DeSantis. Senior Vice President, General Counsel and Secretary of the Company since June 1997 and of Former Choice from June 1997 to October 1997; Senior Attorney for Former Choice from November 1996 to June 1997; Senior Attorney for Manor Care from January 1996 to October 1996; Vice President, Associate General Counsel and Assistant Secretary for Caterair International Corporation from April 1994 to December 1995; Assistant General Counsel of Caterair International from May 1990 to March 1994. Thomas Mirgon. Senior Vice President, Human Resources of the Company since March 1997 and of Former Choice from March 1997 to October 1997; Vice President, Administration of Interim Services from August 1993 to February 1997; employed by Taco Bell Corp. from January 1986 to August 1993, last serving as Senior Director, Field Human Resources from February 1992 to August 1993. Barry L. Smith. Senior Vice President-Marketing of the Company since February 1989 and of Former Choice from November 1996 to October 1997. 23 Joseph M. Squeri. Vice President, Finance and Controller of the Company since March 1997 and of Former Choice from March 1997 to October 1997; Director of Investment Funds, The Carlyle Group, from November 1994 to February 1997; various positions with Arthur Andersen LLP from July 1987 to November 1994, most recently as Manager. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Prior to the Spinoff, the Company was a wholly-owned subsidiary of Former Choice. In the Spinoff, Former Choice distributed to its shareholders all of its interest in the Company on the basis of one share of Company common stock for each share of Former Choice common stock. The Spinoff resulted in approximately 60 million shares of Company common stock outstanding as of October 16, 1997. The shares of the Company's Common Stock are listed and traded on the New York Stock Exchange. The following table sets forth information on the high and low prices of the Company's Common Stock since October 16, 1997. QUARTERLY MARKET PRICE RANGE OF COMMON STOCK (Unaudited) Quarters Ended MARKET PRICE PER SHARE ------------------------------------------- HIGH LOW ------------------------------------------- FISCAL 1998 October 16 -- November 30(1) $18 $17 CALENDER 1997(1) October 16 December 31 $18 $15 7/8 --------------------------------------------------------- (1) On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. The Company paid no dividends during the seven month period ended December 31, 1997. The Company does not anticipate the payment of any cash dividends on its common stock in the foreseeable future. Payment of dividends on Company common stock will also be subject to limitations as may be imposed by the Company's credit facilities from time to time. The declaration of dividends will be subject to the discretion of the Board of Directors. 24 As of March 12, 1998, there were 3,992 record holders of Company common stock. ITEM 6. SELECTED FINANCIAL DATA. The required information is included on page 1 of the 1998 Annual Report and is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS. The required information is included on pages 7-11 of the 1998 Annual Report and is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data. The required information is included on page(s) 13-26 of the 1998 Annual Report and is incorporated herein by reference. See Item 14 for the Index to Financial Statements and Schedules. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The required information on directors is included on pages 4-7 of the Proxy Statement dated March 30, 1998 and is incorporated herein by reference. The required information on executive officers is set forth in Part I of this Form 10-K under an unnumbered item captioned "Executive Officers of Choice Hotels International, Inc." ITEM 11. EXECUTIVE COMPENSATION. The required information is included on pages 14-19 of the Proxy Statement dated March 30, 1998 and is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management. The required information is included on pages 8-9 of the Proxy Statement dated March 30, 1998 and is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions. The required information is included on pages 20-26 of the Proxy Statement dated March 30, 1998 and is incorporated herein by reference. 25 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT 1. Financial Statements The following information is included on the corresponding pages of the 1998 Annual Report:
Consolidated Statements of Income..................... p. 13 Consolidated Balance Sheets........................... p. 14 Consolidated Statements of Shareholders' Equity....... p. 16 Consolidated Statements of Cash Flows................. p. 15 Report of Independent Public Accountants.............. p. 12 Notes to Consolidated Financial Statements............ pp. 17-26 2. FINANCIAL STATEMENT SCHEDULES
The following reports are filed herewith on the pages indicated:
Report of Independent Public Accountants on Schedule.. p. 30 Consent of Independent Public Accountants............. p. 31 Schedule II: Valuation and Qualifying Accounts........................................... p. 32
All other schedules are not applicable. 3. EXHIBITS
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.01 Restated Certificate of Incorporation of the Registrant* 3.02 By-laws of the Registrant* 4.01 Common Stock certificate* 4.02 Credit Agreement dated October 15, 1997 among the Registrant, Chase Manhattan Bank, as agent, and certain named Lenders. 4.03 First Amendment to Credit Agreement dated February ___, 1998 among the Registrant, Chase Manhattan Bank, as agent, and certain named Lenders. 4.04 Subordinated Note due October 15, 2002 by Sunburst Hospitality Corporation payable to the Registrant.*** 10.01 Form of Distribution Agreement, dated October 15, 1997, between Choice Hotels International, Inc. (now known as Sunburst Hospitality Corporation) ("Sunburst") and the Registrant** 10.02 Corporate Services Agreement between Sunburst and the Registrant** 10.03 Employee Benefits and Other Employment Matters Allocation Agreement between Sunburst and the Registrant** 10.04 Strategic Alliance Agreement dated October 15, 1997 between the Registrant and Sunburst.**
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10.05 Non-Competition Agreement dated October 15, 1997 between the Registrant and Sunburst.** 10.06 Office Sublease dated October 15, 1997 between the Registrant and Sunburst.** 10.07 Omnibus Amendment and Guaranty Agreement dated October 15, 1997 among the Registrant, Sunburst and Manor Care, Inc.** 10.08 Consulting Agreement dated October 15, 1997 between the Registrant and Sunburst. 10.09 Amended and Restated Employment Agreement dated October 15, 1997 between the Registrant and Stewart Bainum, Jr.** 10.10 Assignment of Employment Agreement dated as of October 15, 1997 between the Registrant and William R. Floyd.** 10.11 Assignment of Employment Agreement dated as of October 15, 1997 among the Registrant, Sunburst and Thomas Mirgon.** 10.12 Employment Agreement dated December 18, 1997 between the Registrant and Donald H. Dempsey. 10.13 Consulting Agreement and Release dated December 18, 1997 between the Registrant and Barry L. Smith. 10.14 Choice Hotels International, Inc. Supplemental Executive Retirement Plan* 10.15 Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan* 10.16 Choice Hotels International, Inc. 1997 Non-Employee Director Stock Compensation Plan* 10.17 Choice Hotels International, Inc. 1997 Long-Term Incentive Plan* 13.01 1998 Annual Report to Shareholders (information incorporated by reference). 21.01 Subsidiaries of the Registrant 23.01 Consent of Independent Accountants 27.01 Financial Data Schedule 99.01 Proxy Statement dated March 30, 1998 (information incorporated by reference).
- -------------------- * Incorporated by reference to the Company's Registration Statement on Form 10, File No.001-13393. ** Incorporated by reference to the Company's Form 8-K dated October 15, 1997, filed October 29, 1997 ***Incorporated by reference to the Company's Form 8-K dated October 15, 1997, filed December 16, 1997. (b) Three reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1997 Form 8-K dated September 16, 1997, filed October 1, 1997, reported as Item 5 the shareholder approval of the Spinoff and that the Company's Form 10 Registration Statement was declared effective. It also reported as Item 8 the change in fiscal year end from May 31 to December 31. Form 8-K dated October 15, 1997, filed October 29, 1997 reported as Item 5 the name change of the Company and included as Item 7 the material agreements from the Spinoff. Form 8-K dated October 15, 1997, filed December 16, 1997 included as Item 7 the Subordinated Note by Sunburst to the Company. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHOICE HOTELS INTERNATIONAL, INC. By: /s/ Donald H. Dempsey ---------------------------------- Donald H. Dempsey Executive Vice President and Chief Financial Officer Dated: March 30, 1998 28 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE ---------- ----- ---- /s/ Stewart Bainum, Jr. Chairman, Director March 30, 1998 - ------------------------------------ Stewart Bainum, Jr. /s/ William R. Floyd Director, President and Chief March 30, 1998 - ------------------------------------ Executive Officer William R. Floyd /s/ Barbara Bainum - ------------------------------------ Director March 30, 1998 Barbara Bainum /s/ Stewart Bainum - ------------------------------------ Director March 30, 1998 Stewart Bainum /s/ James H. Rempe - ------------------------------------ Director March 30, 1998 James H. Rempe /s/ Robert C. Hazard - ------------------------------------ Director March 30, 1998 Robert C. Hazard /s/ Frederic V. Malek - ------------------------------------ Director March 30, 1998 Frederic V. Malek /s/ Gerald W. Petitt - ------------------------------------ Director March 30, 1998 Gerald W. Petitt /s/ Jerry E. Robertson - ------------------------------------ Director March 30, 1998 Jerry E. Robertson /s/ Joseph M Squeri - ------------------------------------ Vice President, March 30, 1998 Joseph M. Squeri Finance and Controller
29 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE To the Stockholders of Choice Hotels International, Inc.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Choice Hotels International, Inc.'s annual report to shareholders incorporated by reference in this Form 10- K, and have issued our opinion thereon dated January 27, 1998. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index above is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated 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 consolidated financial statements taken as a whole. Arthur Andersen LLP Washington, D.C. January 27, 1998 30 CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS OF DOLLARS)
BALANCE AT CHARGES TO BALANCE AT BEGINNING OF PROFIT END DESCRIPTION PERIOD AND LOSS OTHER WRITE-OFFS OF PERIOD ----------- ------------ ---------- ----- ---------- ---------- Year ended December 31, 1997 Allowance for doubtful accounts $6,159 $2,274 $ - $ (825) $7,608 ====== ====== ===== ======= ====== Year ended May 31, 1997 Allowance for doubtful accounts $4,515 $2,238 $ - $ (594) $6,159 ====== ====== ===== ======= ====== Year ended May 31, 1997 Allowance for doubtful accounts $3,976 $ 685 $ - $ (146) $4,515 ====== ====== ===== ======= ====== Year ended May 31, 1995 Allowance for doubtful accounts $8,503 $ 692 $ - $(5,219) $3,976 ====== ====== ===== ======= ======
31 EX-4.02 2 EXHIBIT 4.02 Exhibit 4.02 CONFORMED COPY ================================================================================ COMPETITIVE ADVANCE AND MULTI-CURRENCY CREDIT FACILITIES AGREEMENT Dated as of October 15, 1997 among CHOICE HOTELS INTERNATIONAL, INC., as Borrower, THE LENDERS NAMED HEREIN, and THE CHASE MANHATTAN BANK, as Agent ================================================================================ [CS&M Ref. No. 6700-462] TABLE OF CONTENTS
ARTICLE I Definitions Page ----------- ---- SECTION 1.01. Defined Terms........................................... 2 SECTION 1.02 Classification of Loans and Borrowings............................................ 26 SECTION 1.03. Terms Generally......................................... 26 ARTICLE II The Credits ----------- SECTION 2.01. Commitments............................................. 26 SECTION 2.02. Loans................................................... 27 SECTION 2.03. Competitive Bid Procedure............................... 30 SECTION 2.04. Term Borrowing and Standby Borrowing Procedures............................................ 33 SECTION 2.05. Refinancings............................................ 34 SECTION 2.06. Fees.................................................... 35 SECTION 2.07. Evidence of Indebtedness; Repayment of Loans.................................... 36 SECTION 2.08. Interest on Loans....................................... 37 SECTION 2.09. Default Interest........................................ 38 SECTION 2.10. Alternate Rate of Interest.............................. 38 SECTION 2.11. Termination and Reduction of Commitments........................................... 40 SECTION 2.12. Prepayment; Amortization of Term Loans.................. 41 SECTION 2.13. Reserve Requirements; Change in Circumstances............................... 41 SECTION 2.14. Change in Legality...................................... 44 SECTION 2.15. Indemnity............................................... 45 SECTION 2.16. Pro Rata Treatment...................................... 46 SECTION 2.17. Sharing of Setoffs...................................... 46 SECTION 2.18. Payments................................................ 47 SECTION 2.19. Taxes................................................... 48 SECTION 2.20. Letters of Credit....................................... 51 SECTION 2.21. Currency Fluctuations, etc. ............................ 56 ARTICLE III Representations And Warranties ------------------------------ SECTION 3.01. Organization; Powers.................................... 57 SECTION 3.02. Authorization........................................... 57
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SECTION 3.03. Enforceability.......................................... 58 SECTION 3.04. Governmental Approvals.................................. 58 SECTION 3.05. Financial Statements.................................... 58 SECTION 3.06. No Material Adverse Change.............................. 59 SECTION 3.07. Title to Properties; Possession Under Leases........... 59 SECTION 3.08. Subsidiaries............................................ 60 SECTION 3.09. Litigation; Compliance with Laws........................ 60 SECTION 3.10. Agreements.............................................. 60 SECTION 3.11. Federal Reserve Regulations............................. 61 SECTION 3.12. Investment Company Act; Public Utility Holding Company Act.................... 61 SECTION 3.13. Use of Proceeds......................................... 61 SECTION 3.14. Tax Returns............................................. 61 SECTION 3.15. No Material Misstatements............................... 61 SECTION 3.16. Employee Benefit Plans.................................. 61 SECTION 3.17. Environmental Matters................................... 62 SECTION 3.18. Solvency................................................ 62 SECTION 3.19. Spin-Off................................................ 63 ARTICLE IV Conditions Of Lending --------------------- SECTION 4.01. All Credit Events....................................... 63 SECTION 4.02. First Credit Event...................................... 64 ARTICLE V Affirmative Covenants --------------------- SECTION 5.01. Existence; Businesses and Properties.................... 68 SECTION 5.02. Insurance............................................... 68 SECTION 5.03. Obligations and Taxes................................... 68 SECTION 5.04. Financial Statements, Reports, etc. .................... 69 SECTION 5.05. Litigation and Other Notices............................ 70 SECTION 5.06. ERISA................................................... 70 SECTION 5.07. Maintaining Records; Access to Properties and Inspections........................................... 71 SECTION 5.08. Use of Proceeds......................................... 72 SECTION 5.09. Subsidiaries............................................ 72
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ARTICLE VI Negative Covenants ------------------ SECTION 6.01. Indebtedness............................................ 72 SECTION 6.02. Liens................................................... 74 SECTION 6.03. Sale and Lease-Back Transactions........................ 75 SECTION 6.04. Investments, Loans and Advances......................... 75 SECTION 6.05. Mergers and Consolidations.............................. 76 SECTION 6.06. Asset Sales............................................. 76 SECTION 6.07. Transactions with Affiliates............................ 77 SECTION 6.08. Business of Borrower and Subsidiaries................... 77 SECTION 6.09. Subsidiary Indebtedness................................. 77 SECTION 6.10. Agreements.............................................. 78 SECTION 6.11. Fiscal Year Accounting Practices........................ 78 SECTION 6.12. No Further Negative Pledges............................. 78 SECTION 6.13. Minimum Consolidated Net Worth.......................... 78 SECTION 6.14. Consolidated Leverage Ratio............................. 78 SECTION 6.15. Consolidated Interest Coverage Ratio.................... 79 ARTICLE VII Events of Default ----------------- ARTICLE VIII The Agent --------- ARTICLE IX Miscellaneous ------------- SECTION 9.01. Notices................................................. 86 SECTION 9.02. Survival of Agreement................................... 87 SECTION 9.03. Binding Effect.......................................... 87 SECTION 9.04. Successors and Assigns.................................. 87 SECTION 9.05. Expenses; Indemnity..................................... 91 SECTION 9.06. Right of Setoff......................................... 93 SECTION 9.07. Applicable Law.......................................... 94 SECTION 9.08. Waivers; Amendment...................................... 94 SECTION 9.09. Interest Rate Limitation................................ 95 SECTION 9.10. Entire Agreement........................................ 95 SECTION 9.11. Waiver of Jury Trial; Punitive Damages...................................... 96 SECTION 9.12. Severability............................................ 96 SECTION 9.13. Counterparts............................................ 96 SECTION 9.14. Headings................................................ 96
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..................................................... SECTION 9.15. Jurisdiction; Consent to Service of Process; Judgment Currency......................... 97 SECTION 9.16. Confidentiality......................................... 98 SECTION 9.17. European Monetary Union................................. 99
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Exhibits - -------- Exhibit A-1 Form of Competitive Bid Request Exhibit A-2 Form of Notice of Competitive Bid Request Exhibit A-3 Form of Competitive Bid Exhibit A-4 Form of Competitive Bid Accept/Reject Letter Exhibit A-5 Form of Borrowing Request Exhibit B Form of Administrative Questionnaire Exhibit C Form of Assignment and Acceptance Exhibit D Form of Opinion of Counsel Exhibit E Form of Issuing Bank Agreement Exhibit F Form of Guarantee Agreement Exhibit G Form of Indemnity, Subrogation and Contribution Agreement Schedules - --------- Schedule 1.01 Hotel Properties Schedule 2.01 Commitments Schedule 3.07 Leased Hotel Properties Schedule 3.08 Subsidiaries Schedule 6.01(a) Indebtedness Schedule 6.02 Existing Liens Schedule 6.04 Existing Investments Schedule 6.06 European Hotel Properties
v COMPETITIVE ADVANCE AND MULTI-CURRENCY CREDIT FACILITIES AGREEMENT dated as of October 15, 1997, among CHOICE HOTELS INTERNATIONAL, INC., a Delaware corporation (the "Borrower"), the Lenders referred to herein and THE -------- CHASE MANHATTAN BANK, a New York banking corporation, as agent for the Lenders (in such capacity, the "Agent"). ----- The Borrower has requested the Lenders to extend credit to the Borrower in order to enable it to borrow (a) on a term basis on the Effective Date (as herein defined) a principal amount not in excess of $150,000,000 and (b) on a standby revolving credit basis on and after the Effective Date and at any time and from time to time prior to the Revolving Maturity Date (as herein defined) a principal amount not in excess of $150,000,000 at any time outstanding. The Borrower has requested that up to $50,000,000 of such revolving credit borrowings be available to the Borrower in Alternative Currencies (as herein defined). The Borrower has also requested the Lenders to provide a procedure pursuant to which the Borrower may invite the Lenders to bid on an uncommitted basis on short-term borrowings by the Borrower. The Borrower has requested the Issuing Bank (as herein defined) to issue letters of credit, in an aggregate face amount at any time outstanding not in excess of $10,000,000, to support payment obligations incurred in the ordinary course of business by the Borrower and its Subsidiaries (as herein defined). The proceeds of the borrowings hereunder shall be used for the refinancing of existing Indebtedness, the funding of a subordinated loan in the amount of $115,000,000 to Sunburst (as herein defined), stock repurchases, capital contributions to joint ventures and general corporate purposes of the Borrower and the Subsidiaries, including working capital, capital expenditures and certain acquisitions. The Lenders are willing to extend such credit to the Borrower and the Issuing Bank is willing to issue letters of credit for the account of the Borrower on the terms and subject to the conditions herein set forth. Accordingly, the parties hereto agree as follows: ARTICLE I. DEFINITIONS SECTION 1.01. Defined Terms. As used in this Agreement, the -------------- following terms shall have the meanings specified below: "ABR Borrowing" shall mean a Borrowing comprised of ABR Loans. ------------- "ABR Loan" shall mean any Loan denominated in dollars bearing interest -------- at a rate determined by reference to the Alternate Base Rate in accordance with the provisions of Article II. "ABR Standby Loan" shall mean any Standby Loan denominated in dollars ---------------- bearing interest at a rate determined by reference to the Alternate Base Rate in accordance with the provisions of Article II. "Adjusted CD Rate" shall mean, with respect to any CD Borrowing for ---------------- any Interest Period, an interest rate per annum (rounded upwards, if necessary, to the next 1/100 of 1%) equal to the sum of (a) a rate per annum equal to the product of (i) the Fixed CD Rate in effect for such Interest Period and (ii) Statutory Reserves, plus (b) the Assessment Rate. For purposes hereof, the term "Fixed CD Rate" shall mean the arithmetic average (rounded upwards, if necessary, to the next 1/100 of 1%) of the prevailing rates per annum bid at or about 10:00 a.m., New York City time, to the Agent on the first Business Day of the Interest Period applicable to such CD Borrowing by three New York City negotiable certificate of deposit dealers of recognized national standing selected by the Agent for the purchase at face value of negotiable certificates of deposit of major United States money center banks in a principal amount approximately equal to the Reference Bank's portion of such CD Borrowing and with a maturity comparable to such Interest Period. "Administrative Questionnaire" shall mean an Administrative ---------------------------- Questionnaire in the form of Exhibit B. "Affiliate" shall mean, when used with respect to a specified person, --------- another person that directly, or indirectly through one or more intermediaries, Controls or 2 is Controlled by or is under common Control with the person specified. Following the Spin-Off, the Borrower and the Subsidiaries shall not be deemed to be Affiliates of Sunburst or its subsidiaries merely by virtue of such companies' having common shareholders or directors as a result of the Spin-Off. "Agent and Administrative Fees" shall have the meaning assigned to ----------------------------- such term in Section 2.06(b). "Aggregate Principal Amount Outstanding" shall mean, at any time, the -------------------------------------- sum of (i) the aggregate principal amount at such time of all outstanding Revolving Loans denominated in dollars and (ii) the aggregate Equivalent Dollar Amount at such time of the principal amounts of all outstanding Eurocurrency Revolving Loans. "Aggregate Standby Exposure" shall mean the aggregate amount of the -------------------------- Lenders' Standby Exposures. "Alternate Base Rate" shall mean, for any day, a rate per annum ------------------- (rounded upwards, if necessary, to the next 1/16 of 1%) equal to the greatest of (a) the Prime Rate in effect on such day, (b) the Base CD Rate in effect on such day plus 1% and (c) the Federal Funds Effective Rate in effect on such day plus 1/2 of 1%. For purposes hereof, "Prime Rate" shall mean the rate of interest per annum publicly announced from time to time by the Agent as its prime rate in effect at its principal office in New York City; each change in the Prime Rate shall be effective on the date such change is publicly announced as effective. "Base CD Rate" shall mean the sum of (a) the product of (i) the Three-Month Secondary CD Rate and (ii) Statutory Reserves and (b) the Assessment Rate. "Three-Month Secondary CD Rate" shall mean, for any day, the secondary market rate for three-month certificates of deposit reported as being in effect on such day (or, if such day shall not be a Business Day, the next preceding Business Day) by the Board through the public information telephone line of the Federal Reserve Bank of New York (which rate will, under the current practices of the Board, be published in Federal Reserve Statistical Release H.15(519) during the week following such day), or, if such rate shall not be so reported on such day or such next preceding Business Day, the average of the secondary market quotations for three-month certificates of deposit of major money center banks in New York City received at approximately 10:00 a.m., New York City time, on such day (or, if such day shall not be a Business Day, on the next preceding Business Day) by the Agent from the New York City negotiable certificate of 3 deposit dealers of recognized national standing selected by it. "Federal Funds Effective Rate" shall mean, for any day, the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for the day of such transactions received by the Agent from three Federal funds brokers of recognized national standing selected by it. If for any reason the Agent shall have determined that it is unable to ascertain the Base CD Rate or the Federal Funds Effective Rate or both for any reason, including the inability or failure of the Agent to obtain sufficient quotations in accordance with the terms thereof, the Alternate Base Rate shall be determined without regard to clauses (b) or (c) of the first sentence of this definition, as appropriate, until the circumstances giving rise to such inability no longer exist. Any change in the Alternate Base Rate due to a change in the Prime Rate, the Three Month Secondary CD Rate or the Federal Funds Effective Rate shall be effective on the effective date of such change in the Prime Rate, the Three Month Secondary CD Rate or the Federal Funds Effective Rate, respectively. "Alternative Currency" shall mean Sterling, French Francs, Deutsche -------------------- Marks, any European common currency referred to in Section 9.17 and any other freely available currency (other than any "basket" currency such as the ECU) that is freely transferable and freely convertible into dollars and in which dealings in deposits are carried on in the London interbank market, which shall be requested by the Borrower and approved by the Lenders. "Applicable Percentage" shall mean, with respect to any Eurodollar --------------------- Standby Loan, CD Loan or ABR Loan or with respect to the Facility Fees, as the case may be, the applicable percentage set forth in the table below under the caption "LIBOR Margin", "CD Margin", "ABR Margin" or "Facility Fee Percentage", as the case may be, based upon the Consolidated Leverage Ratio as of the end of and for the most recent period of four consecutive fiscal quarters for which financial statements of the Borrower are required to have been delivered under Section 5.04(a) or (b), whether or 4 not financial statements in respect of any subsequent period shall have been delivered: Revolving Loans - ---------------
=============================================================================== Consolidated LIBOR ABR Facility Fee Leverage Ratio Margin CD Margin Margin Percentage - ------------------------------------------------------------------------------- Category 1 Less than or equal to 0.50 to 1.00 .200% .325% 0% .100% - ------------------------------------------------------------------------------- Category 2 Greater than 0.50 to 1.00, but less than or equal to 1.50 to 1.00 .225% .350% 0% .125% - ------------------------------------------------------------------------------- Category 3 Greater than 1.50 to 1.00, but less than or equal to 2.50 to 1.00 .275% .400% 0% .175% - ------------------------------------------------------------------------------- Category 4 Greater than 2.50 to 1.00, but less than or equal to 3.00 to 1.00 .425% .550% 0% .200% - ------------------------------------------------------------------------------- Category 5 Greater than 3.00 to 1.00 .575% .700% 0% .300% ===============================================================================
Term Loans - ----------
================================================================= Consolidated LIBOR ABR Leverage Ratio Margin CD Margin Margin - ----------------------------------------------------------------- Category 1 Less than or equal to 0.50 to 1.00 .300% .425% 0% - ----------------------------------------------------------------- Category 2 Greater than 0.50 to 1.00, but less than or equal to 1.50 to 1.00 .350% .475% 0% - ----------------------------------------------------------------- Category 3 Greater than 1.50 to 1.00, but less than or equal to 2.50 to 1.00 .450% .575% 0% - ----------------------------------------------------------------- Category 4 Greater than 2.50 to 1.00, but less than or equal to 3.00 to 1.00 .625% .750% 0% - ----------------------------------------------------------------- Category 5 Greater than 3.00 to 1.00 .875% 1.000% 0% =================================================================
5 ;provided that the Applicable Percentage for the period commencing on the date -------- hereof and ending on the date that financial statements for the period ending on December 31, 1997, are required to be delivered under Section 5.04(a) or (b), shall be determined by reference to Category 4; provided further that at any ---------------- time when financial statements required to have been delivered under Section 5.04(a) or (b) have not been delivered, the Applicable Percentage shall be determined by reference to Category 5. "Assessment Rate" shall mean for any date the annual rate (rounded --------------- upwards, if necessary, to the next 1/100 of 1%) identified by the Agent (or, if need be, reasonably estimated by the Agent) as the then current net annual assessment rate that will be employed in determining amounts payable by the Agent to the Federal Deposit Insurance Corporation (or any successor) for insurance by such Corporation (or such successor) of time deposits made in dollars at the Agent's domestic offices. "Asset Sale" shall mean, with respect to the Borrower or any ---------- Subsidiary, any sale, transfer or other disposition of any assets or other properties (including individual business assets, patents, trademarks and other intangibles) of the Borrower or such Subsidiary, including the sale, transfer or disposition of any capital stock of or any merger or consolidation involving any Subsidiary and any issuance or sale by any Subsidiary of shares of its capital stock, other than (i) sales of inventory and used equipment in the ordinary course of business of the person (whether the Borrower or a Subsidiary) owning and selling such inventory or used equipment; (ii) sales, transfers and other dispositions of any tangible assets by the Borrower or any Subsidiary if the Borrower or such Subsidiary enters into a purchase or construction agreement with a third party to replace such assets with comparable assets as soon as practicable (and in no event later than three months) after the disposition and, pending such replacement, diligently pursues the replacement thereof, and the fair market value of the replacement assets is substantially equivalent to or exceeds that of the assets so disposed of; (iii) sales, transfers and other dispositions of any assets to the Borrower or any Subsidiary; (iv) Sale and Lease-Back Transactions; and (v) sales by the Borrower or Subsidiaries of assets acquired from persons other than the Borrower or other Subsidiaries, which sales occur not more than 12 months after the respective dates on which such assets were acquired. 6 "Assignment and Acceptance" shall mean an assignment and acceptance ------------------------- entered into by a Lender and an assignee, and accepted by the Agent, in the form of Exhibit C. "Baron Entities" shall mean the collective reference to Baron Capital -------------- Group, Inc., Baron Capital, Inc., BAMCO, Inc., Baron Capital Management Inc., Baron Asset Fund and Ronald Baron. "Board" shall mean the Board of Governors of the Federal Reserve ----- System of the United States. "Borrower" shall mean Choice Hotels International, Inc. (formerly -------- Choice Hotels Franchising, Inc.), a Delaware corporation, as renamed following the Spin-Off. "Borrowing" shall mean a group of Loans of the same Class and Type --------- made by the Lenders (or, in the case of a Competitive Borrowing, by the Lender or Lenders whose Competitive Bids have been accepted pursuant to Section 2.03) on a single date and as to which a single Interest Period is in effect. "Borrowing Request" shall mean a request by the Borrower in accordance ----------------- with the terms of Section 2.04. "Business Day" shall mean any day (other than a day which is a ------------ Saturday, Sunday or legal holiday in the State of New York) on which banks are open for business in New York City; provided, however, that (i) when used in -------- ------- connection with a Eurodollar Loan, the term "Business Day" shall also exclude any day on which banks are not open for dealings in dollar deposits in the London interbank market and (ii) when used in connection with a Eurocurrency Loan, "Business Day" shall also exclude any day on which commercial banks are not open for foreign exchange business in London or, if such reference relates to the date on which any amount is to be paid or made available in an Alternative Currency, in the principal financial center in the country of such Alternative Currency. "Calculation Date" shall mean the last Business Day of each fiscal ---------------- quarter of the Borrower. "Capital Lease Obligations" of any person shall mean the obligations ------------------------- of such person to pay rent or other amounts under any lease of (or other arrangement conveying the right to use) real or personal property, or a combination thereof, which obligations are required to be 7 classified and accounted for as capital leases on a balance sheet of such person under GAAP applied on a consistent basis and, for the purposes of this Agreement, the amount of such obligations at any time shall be the capitalized amount thereof at such time determined in accordance with GAAP applied on a consistent basis. "CD Borrowing" shall mean a Borrowing comprised of CD Loans. ------------ "CD Loan" shall mean any Loan bearing interest at a rate determined by ------- reference to the Adjusted CD Rate in accordance with the provisions of Article II. "CD Standby Borrowing" shall mean a Borrowing composed of CD Standby -------------------- Loans. "CD Standby Loan" shall mean any Standby Loan bearing interest at a --------------- rate determined by reference to the Adjusted CD Rate in accordance with the provisions of Article II. A "Change in Control" shall be deemed to have occurred if (a) any ----------------- person or group (within the meaning of Rule 13d-5 of the Securities and Exchange Commission as in effect on the date hereof) other than Stewart Bainum and his family shall own directly or indirectly, beneficially or of record, shares representing more than 15% of the aggregate ordinary voting power represented by the issued and outstanding capital stock of the Borrower, except that such a person or group may own directly or indirectly, beneficially or of record, shares representing not more than 20%, or 33% in the case of the Baron Entities, of the aggregate voting power represented by the issued and outstanding capital stock of the Borrower if and so long as such person or group reports and continues to report such ownership on Schedule 13G (filed pursuant to Rule 13d- 1(b), Rule 13d-1(c), or, in the case of amendments, Rule 13d-2(b), of the Securities and Exchange Commission as in effect on the date hereof); (b) a majority of the seats (other than vacant seats) on the board of directors of the Borrower shall at any time have been occupied by persons who were neither (i) nominated by the management of the Borrower or by the Nominating Committee of the Borrower's board of directors in connection with an annual meeting of the stockholders of the Borrower, nor (ii) appointed by directors so nominated; or (c) any person or group other than Stewart Bainum and his family shall otherwise directly or indirectly Control the Borrower. Notwithstanding the foregoing, if a trust or foundation or other entity 8 established by Stewart Bainum or his family holds shares representing in excess of 15% of the aggregate ordinary voting power represented by the issued and outstanding capital stock of the Borrower and Stewart Bainum or his family Controls such trust or foundation or such other entity and the vote of such shares held by such trust or foundation or such other entity and Stewart Bainum and his family remain in Control of the Borrower, there shall be no Change in Control for purposes of this Agreement; provided, however, that any transfer -------- ------- of such shares by Stewart Bainum, such trust or such foundation or such other entity shall stand on its own merits for purposes of this Agreement. "Class", when used in reference to any Loan or Borrowing, shall refer ----- to whether such Loan, or the Loans comprising such Borrowing, are Revolving Loans or Term Loans and, when used in reference to any Commitment, shall refer to whether such Commitment is a Revolving Commitment or a Term Commitment. "Code" shall mean the Internal Revenue Code of 1986, as the same may ---- be amended from time to time. "Commitment" shall mean a Revolving Commitment or a Term Commitment, ---------- or any combination thereof (as the context requires). "Competitive Bid" shall mean an offer by a Lender to make a --------------- Competitive Loan pursuant to Section 2.03. "Competitive Bid Accept/Reject Letter" shall mean a notification made ------------------------------------ by the Borrower pursuant to Section 2.03(d) in the form of Exhibit A-4. "Competitive Bid Rate" shall mean, as to any Competitive Bid made by a -------------------- Lender pursuant to Section 2.03(b), (i) in the case of a Eurodollar Competitive Loan, the Competitive Margin, and (ii) in the case of a Fixed Rate Loan, the fixed rate of interest offered by the Lender making such Competitive Bid. "Competitive Bid Request" shall mean a request made pursuant to ----------------------- Section 2.03 in the form of Exhibit A-1. "Competitive Borrowing" shall mean a borrowing consisting of a --------------------- Competitive Loan or concurrent Competitive Loans from the Lender or Lenders whose Competitive Bids for such Borrowing have been accepted by the Borrower under the bidding procedure described in Section 2.03. 9 "Competitive Loan" shall mean a Loan from a Lender to the Borrower ---------------- pursuant to the bidding procedure described in Section 2.03. Each Competitive Loan shall be a Eurodollar Competitive Loan or a Fixed Rate Loan. "Competitive Margin" shall mean, as to any Eurodollar Competitive ------------------ Loan, the margin (expressed as a percentage rate per annum in the form of a decimal to no more than four decimal places) to be added to or subtracted from the LIBO Rate in order to determine the interest rate applicable to such Loan, as specified in the Competitive Bid relating to such Loan. "Consolidated EBITDA" shall mean, for any period, without duplication, ------------------- the sum for such period of (a) Consolidated Net Income, (b) depreciation and amortization expense, (c) Consolidated Interest Expense, (d) provisions for income tax expense, (e) restructuring charges incurred in connection with the Spin-Off and (f) non-cash charges related to the impairment of assets (pursuant to FAS 121), all as determined in accordance with GAAP consistently applied. "Consolidated Funded Indebtedness" means, as of any date of -------------------------------- determination, all obligations accounted for as indebtedness on a consolidated balance sheet of the Borrower on such date, in accordance with GAAP consistently applied, whether such obligations are classified as long-term or short-term. "Consolidated Interest Coverage Ratio" shall mean, for any period, the ------------------------------------ ratio of (a) Consolidated EBITDA for such period to (b) Consolidated Interest Expense for such period. "Consolidated Interest Expense" shall mean, for any period, gross ----------------------------- total expenses of the Borrower and its consolidated Subsidiaries accounted for as interest expense (including capitalized interest determined in accordance with GAAP consistently applied) for such period, including (i) the portion of rental payments under Capital Lease Obligations deemed to represent interest in accordance with GAAP consistently applied, (ii) the amortization of debt discounts, (iii) the amortization of all fees (including fees with respect to interest rate protection agreements) payable in connection with the incurrence of Indebtedness to the extent included in interest expense, all as determined on a consolidated basis in accordance with GAAP consistently applied. For purposes of the foregoing, gross interest expense shall be determined after giving effect to any net 10 payments made or received with respect to interest rate protection agreements entered in to as a hedge against interest rate exposure. "Consolidated Leverage Ratio" shall mean the ratio of Consolidated --------------------------- Funded Indebtedness to Consolidated EBITDA. In the event the Borrower shall complete, directly or through a Subsidiary, an acquisition or divestiture of any Person or business unit during any period, the Consolidated Leverage Ratio as of the end of and for such period shall thereafter be determined on a pro forma basis as if such acquisition or divestiture had been completed on the first day of such period. "Consolidated Net Income" shall mean, for any period, the net income ----------------------- (or loss) of the Borrower and its consolidated Subsidiaries for such period, as determined on a consolidated basis in accordance with GAAP consistently applied; provided, however, non-cash interest income on the Sunburst Subordinated Note - -------- ------- shall not be included in the determination of Consolidated Net Income. "Consolidated Net Worth" shall mean, as at any date of determination, ---------------------- the consolidated stockholders' equity of the Borrower and its consolidated Subsidiaries, as determined on a consolidated basis in accordance with GAAP consistently applied. "Consolidated Total Assets" shall mean, as at any date of ------------------------- determination, the total assets of the Borrower and its consolidated Subsidiaries at such time, as determined on a consolidated basis in accordance with GAAP consistently applied. "Control" shall mean the possession, directly or indirectly, of the ------- power to direct or cause the direction of the management or policies of a person, whether through the ownership of voting securities, by contract or otherwise, and "Controlling" and "Controlled" shall have meanings correlative thereto; provided, however, the existence of a management contract by the -------- ------- Borrower or one of its Affiliates to manage another entity shall not be deemed to be Control. "Credit Event" shall have the meaning assigned to such term in Section ------------ 4.01. "Default" shall mean any event or condition which upon notice, lapse ------- of time or both would constitute an Event of Default. 11 "Denomination Date" shall mean, in relation to any Eurocurrency ----------------- Borrowing, the date that is three Business Days before the date of such Borrowing. "Deutsche Marks" shall mean the lawful money of the Federal Republic -------------- of Germany. "Distribution Agreement" shall mean the Distribution Agreement dated ---------------------- as of October 15, 1997, by and between Sunburst and the Borrower. "dollars" or "$" shall mean lawful money of the United States of ------- - America. "Effective Date" shall mean the date on and as of which each of the -------------- conditions set forth in Section 4.02 shall have been satisfied. "Equivalent Dollar Amount" shall mean, with respect to an amount of ------------------------ any Alternative Currency on any date, the amount of dollars that may be purchased with such amount of such Alternative Currency at the Spot Exchange Rate on such date. "ERISA" shall mean the Employee Retirement Income Security Act of ----- 1974, as the same may be amended from time to time. "ERISA Affiliate" shall mean any trade or business (whether or not --------------- incorporated) that is a member of a group of which the Borrower is a member and which is treated as a single employer under Section 414 of the Code. "Eurocurrency" when used in reference to any Loan or Borrowing shall ------------ refer to whether such Loan, or Loans comprising such Borrowing, denominated in an Alternative Currency are bearing interest at a rate determined by reference to the LIBO Rate in accordance with the provisions of Article II. "Eurocurrency Sublimit" shall mean $50,000,000. --------------------- "Eurodollar", when used in reference to any Loan or Borrowing shall ---------- refer to whether such Loan, or Loans comprising such Borrowing, denominated in dollars are bearing interest at a rate determined by reference to the LIBO Rate in accordance with the provisions of Article II (or, in the case of a Competitive Loan, the LIBO Rate). 12 "Event of Default" shall have the meaning assigned to such term in ---------------- Article VII. "Existing Credit Agreements" shall mean (a) the US $100MM Competitive -------------------------- Advance and Revolving Credit Facility Agreement dated as of October 30, 1996, among Choice Hotels International, Inc. (formerly Choice Hotels Holdings, Inc.), the lenders party thereto and the Agent, as agent thereunder and (b) the Agreement dated as of May 5, 1997, between Choice Hotels International, Inc. and The Chase Manhattan Bank, as lender, in each case as amended. "Facility Fee" shall have the meaning assigned to such term in Section ------------ 2.06(a). "Fees" shall mean the Facility Fee, the Agent and Administrative Fees, ---- the L/C Participation Fees and the Issuing Bank Fees. "Financial Officer" of any corporation shall mean the chief financial ----------------- officer, principal accounting officer, Treasurer or Controller of such corporation. "Fixed Rate Borrowing" shall mean a Borrowing comprised of Fixed Rate -------------------- Loans. "Fixed Rate Loan" shall mean any Competitive Loan bearing interest at --------------- a fixed percentage rate per annum (expressed in the form of a decimal to no more than four decimal places) specified by the Lender making such Loan in its Competitive Bid. "Foreign Subsidiary" shall mean any Subsidiary that is organized under ------------------ the laws of a jurisdiction other than the United States of America or any State thereof or the District of Columbia. "Form 10" shall mean the registration statement on Form 10 under the ------- Securities Exchange Act of 1934 of the Borrower filed with the Securities and Exchange Commission on September 10, 1997, as amended and distributed to the Lenders prior to the date hereof. "French Francs" shall mean the lawful money of the Republic of France. ------------- "GAAP" shall mean generally accepted accounting principles. ---- 13 "Governmental Authority" shall mean any Federal, state, local or ---------------------- foreign court or governmental agency, authority, instrumentality or regulatory body. "Guarantee" of or by any person shall mean any obligation, contingent --------- or otherwise, of such person guaranteeing or having the economic effect of guaranteeing any Indebtedness of any other person (the "primary obligor") in any manner, whether directly or indirectly, and including any obligation of such person, direct or indirect, (a) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or to purchase (or to advance or supply funds for the purchase of) any security for the payment of such Indebtedness, (b) to purchase property, securities or services for the purpose of assuring the owner of such Indebtedness of the payment of such Indebtedness or (c) to maintain working capital, equity capital or other financial statement condition or liquidity of the primary obligor so as to enable the primary obligor to pay such Indebtedness; provided, however, that the term Guarantee -------- ------- shall not include endorsements for collection or deposit, in either case in the ordinary course of business. "Guarantee Agreement" shall mean the Guarantee Agreement, ------------------- substantially in the form of Exhibit F, between the Subsidiary Loan Parties and the Agent. "Hotel Properties" shall mean the properties set forth on Schedule ---------------- 1.01 and any hotel properties acquired or constructed after the date hereof, including fixtures and personalty associated therewith. "Indebtedness" of any person shall mean, without duplication, (a) all ------------ obligations of such person for borrowed money or with respect to deposits or advances of any kind, (b) all obligations of such person evidenced by bonds, debentures, notes or similar instruments, (c) all obligations of such person upon which interest charges are customarily paid, (d) all obligations of such person under conditional sale or other title retention agreements relating to property or assets purchased by such person, (e) all obligations of such person issued or assumed as the deferred purchase price of property or services, (f) all Indebtedness of others secured by (or for which the holder of such Indebtedness has an existing right, contingent or otherwise, to be secured by) any Lien on property owned or acquired by such person, whether or not the obligations secured thereby have been assumed, (g) all Guarantees by such person of Indebtedness of others, (h) all Capital Lease Obligations of such person, (i) all obligations of such 14 person in respect of interest rate protection agreements, foreign currency exchange agreements or other interest or exchange rate hedging arrangements and (j) all obligations of such person as an account party in respect of letters of credit (other than (x) documentary letters of credit (including commercial and trade letters of credit) issued to secure payment obligations in respect of goods and services in the ordinary course of business and (y) letters of credit and surety bonds with respect to obligations of such person that are fully accounted for as liabilities in the financial records of such person) and bankers' acceptances. The Indebtedness of any person shall not include current accounts payable incurred in the ordinary course of business. The Indebtedness of any person shall include the Indebtedness of any partnership in which such person is a general partner. "Information Memorandum" shall mean the Confidential Information ---------------------- Memorandum dated September 1997 distributed by the Borrower to the Lenders. "Interest Payment Date" shall mean, with respect to any Loan, the last --------------------- day of the Interest Period applicable thereto and, in the case of a Eurocurrency Loan or Eurodollar Loan with an Interest Period of more than three months' duration or a Fixed Rate Loan or a CD Loan with an Interest Period of more than 90 days' duration, each day that would have been an Interest Payment Date for such Loan had successive Interest Periods of three months' duration or 90 days' duration, as the case may be, been applicable to such Loan and, in addition, the date of any refinancing or conversion of such Loan with or to a Loan of a different Type. "Interest Period" shall mean (a) as to any Eurocurrency Borrowing or --------------- Eurodollar Borrowing, the period commencing on the date of such Borrowing and ending on the numerically corresponding day (or, if there is no numerically corresponding day, on the last day) in the calendar month that is 1, 2, 3 or 6 months thereafter, as the Borrower may elect, (b) as to any CD Borrowing, a period of 30, 60, 90 or 180 days' duration, as the Borrower may elect, commencing on the date of such Borrowing, (c) as to any ABR Borrowing, the period commencing on the date of such Borrowing and ending on the date 90 days thereafter or, if earlier, on the Maturity Date or the date of prepayment of such Borrowing and (d) as to any Fixed Rate Borrowing, the period commencing on the date of such Borrowing and ending on the date specified in the Competitive Bids in which the offer to make the Fixed Rate Loans comprising such Borrowing 15 were extended, which shall not be earlier than seven days after the date of such Borrowing or later than 360 days after the date of such Borrowing; provided, -------- however, that if any Interest Period would end on a day other than a Business - ------- Day, such Interest Period shall be extended to the next succeeding Business Day unless, in the case of Eurocurrency Loans and Eurodollar Loans only, such next succeeding Business Day would fall in the next calendar month, in which case such Interest Period shall end on the next preceding Business Day. Interest shall accrue from and including the first day of an Interest Period to but excluding the last day of such Interest Period. "Interest Rate Determination Date" shall mean, with respect to a -------------------------------- Eurocurrency Borrowing or Eurodollar Borrowing, the date which is two Business Days prior to the commencement of any Interest Period for such Borrowing. "Issuing Bank" shall mean, as the context may require, (a) The Chase ------------ Manhattan Bank, or (b) any other Lender that may become an Issuing Bank pursuant to Section 2.20(h), with respect to Letters of Credit issued by such Lender. "Issuing Bank Agreement" shall mean an agreement in substantially the ---------------------- form of Exhibit E. "Issuing Bank Fees" shall have the meaning assigned to such term in ----------------- Section 2.06(c). "L/C Commitment" shall mean, with respect to any Issuing Bank, the -------------- commitment of such Issuing Bank to issue Letters of Credit pursuant to Section 2.20. "L/C Disbursement" shall mean a payment or disbursement made by an ---------------- Issuing Bank pursuant to a Letter of Credit. "L/C Exposure" shall mean at any time the sum of (a) the aggregate ------------ undrawn amount of all outstanding Letters of Credit at such time, plus (b) the aggregate principal amount of all L/C Disbursements that have not yet been reimbursed at such time. The L/C Exposure of any Lender at any time shall mean its Pro Rata Percentage (based upon the Revolving Commitments) of the aggregate L/C Exposure at such time. "L/C Participation Fee" shall have the meaning assigned to such term --------------------- in Section 2.06(c)(i). 16 "Lender" shall mean a person listed on Schedule 2.01 and any other ------ person that shall become a party hereto pursuant to an Assignment and Acceptance, other than such person that ceases to be a party hereto pursuant to an Assignment and Acceptance. "Letter of Credit" shall mean any letter of credit issued pursuant to ---------------- Section 2.20, as permitted hereby. "LIBO Rate" means, with respect to any Eurodollar Borrowing for any --------- Interest Period, the rate appearing on Page 3750 of the Telerate Service (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Agent from time to time for purposes of providing quotations of interest rates applicable to dollar deposits in the London interbank market) at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period, as the rate for dollar deposits with a maturity comparable to such Interest Period. In the event that such rate is not available at such time for any reason, then the "LIBO Rate" with respect to such Eurodollar Borrowing for --------- such Interest Period shall be the rate at which dollar deposits of $5,000,000 and for a maturity comparable to such Interest Period are offered by the principal London office of the Agent in immediately available funds in the London interbank market at approximately 11:00 a.m., London time, two Business Days prior to the commencement of such Interest Period. "Lien" shall mean, with respect to any asset, (a) any mortgage, deed ---- of trust, lien, pledge, encumbrance, charge or security interest in or on such asset, (b) the interest of a vendor or a lessor under any conditional sale agreement, capital lease or title retention agreement relating to such asset and (c) in the case of securities, any purchase option, call or similar right of a third party (excluding rights of first refusal) with respect to such securities. "Loans" shall mean the loans made by the Lenders to the Borrower ----- pursuant to this Agreement. "Loan Documents" shall mean this Agreement, the Letters of Credit, -------------- each Issuing Bank Agreement, the Guarantee Agreement and, if requested by a Lender pursuant to Section 2.07(e), each Note. 17 "Loan Parties" shall mean the Borrower and the Subsidiary Loan ------------ Parties. "Margin Stock" shall have the meaning given such term under ------------ Regulation U. "Material Adverse Effect" shall mean a materially adverse effect on ----------------------- the business, assets, property or condition, financial or otherwise, of the Borrower and the Subsidiaries taken as a whole. "Moody's" shall mean Moody's Investors Service, Inc. ------- "Multiemployer Plan" shall mean a multiemployer plan as defined in ------------------ Section 4001(a)(3) of ERISA to which the Borrower or any ERISA Affiliate (other than one considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code) is making or accruing an obligation to make contributions, or has within any of the preceding five plan years made or accrued an obligation to make contributions. "Obligations" shall mean (a) the Borrower's obligations in respect of ----------- the due and punctual payment of principal of and interest on the Loans and reimbursement of the L/C Disbursements, in each case when and as due whether at maturity, by acceleration, upon one or more dates set for prepayment or otherwise, (b) all Fees, expenses, indemnities, reimbursements and other obligations, monetary or otherwise, of the Borrower under this Agreement or any other Loan Document, (c) all obligations, monetary or otherwise, of each Subsidiary under each Loan Document to which it is a party and (d) unless otherwise agreed upon in writing by the applicable Lender party thereto, all obligations of the Borrower, monetary or otherwise, under each interest rate protection agreement entered into with a counterparty that was a Lender (or an Affiliate thereof) at the time such interest rate protection agreement was entered into. "PBGC" shall mean the Pension Benefit Guaranty Corporation referred to ---- and defined in ERISA. "Permitted Investments" shall mean: --------------------- (a) direct obligations of, or obligations the principal of and interest on which are unconditionally guaranteed by, the United States of America (or by any agency thereof to the extent such obligations are 18 backed by the full faith and credit of the United States of America); (b) investments in commercial paper having credit ratings of at least A-2 from S&P and P-2 from Moody's; (c) investments in certificates of deposit, banker's acceptances and time deposits issued or guaranteed by or placed with, and money market deposit accounts issued or offered by, any domestic office of any commercial bank organized under the laws of the United States of America or any State thereof which has a combined capital and surplus and undivided profits of not less than $200,000,000; (d) investments in the ordinary course of business in customary repurchase agreements with respect to freely marketable, short-term securities of the type customarily subject to repurchase agreements; and (e) other readily marketable debt and equity securities traded on national securities exchanges or on other nationally recognized markets, including over-the-counter markets. "person" shall mean any natural person, corporation, business trust, ------ joint venture, association, company, limited liability company, partnership or government, or any agency or political subdivision thereof. "Plan" shall mean any pension plan (other than a Multiemployer Plan) ---- subject to the provisions of Title IV of ERISA or Section 412 of the Code which is maintained for employees of the Borrower or any ERISA Affiliate. "Proceeds" shall mean, with respect to any Asset Sale, (a) the gross -------- amount of consideration or other amounts payable to or receivable by the Borrower or a Subsidiary in respect of such Asset Sale, less (b) the amount, if any, of all estimated taxes payable with respect to such Asset Sale whether or not payable during the taxable year in which such Asset Sale shall have occurred, and less (c) reasonable and customary fees, commissions, costs and other expenses (other than those payable to the Borrower or a Subsidiary or Affiliate of the Borrower or to Sunburst or a subsidiary or affiliate of Sunburst) which are incurred in connection with such Asset Sale and are payable by the seller or the transferor of the assets or property to which such Asset Sale relates, but only to the extent not already deducted in arriving at the amount referred to in clause (a) above. For 19 purposes of determining Proceeds, the value of all noncash consideration payable or receivable by the Borrower or any Subsidiary, as the case may be, shall be the fair market value of such noncash consideration as determined in good faith by the Borrower and the Borrower shall provide to the Agent a certificate of a Financial Officer of the Borrower with respect to the fair market value of such consideration, in form and substance reasonably satisfactory to the Agent. "Pro Rata Percentage" of any Lender at any time shall mean the ------------------- percentage of the total Term Commitment or Total Revolving Commitment represented by such Lender's Term Commitment or Revolving Commitment. In the event such Commitments shall have expired or been terminated, the Pro Rata Percentages shall be determined on the basis of applicable Commitments most recently in effect (giving effect to any assignments under Section 9.04). "Quality Hotels" shall mean Quality Hotels Europe, Inc., a Subsidiary. -------------- "Reference Bank" shall mean the Agent or, if the Agent's Commitment is -------------- not the largest of the Lenders' Commitments, the Lender possessing the largest Commitment. "Register" shall have the meaning given such term in Section 9.04(d). -------- "Regulation D" shall mean Regulation D of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation G" shall mean Regulation G of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation U" shall mean Regulation U of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Regulation X" shall mean Regulation X of the Board as from time to ------------ time in effect and all official rulings and interpretations thereunder or thereof. "Reportable Event" shall mean any reportable event as defined in ---------------- Section 4043(c) of ERISA or the regulations issued thereunder with respect to a Plan (other than a Plan maintained by an ERISA Affiliate which is considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code). 20 "Required Lenders" shall mean, at any time, Lenders having Commitments ---------------- representing at least a majority of the aggregate Commitments or, if the Commitments have been terminated, Lenders holding Loans and L/C Exposures representing at least a majority of the sum of the aggregate amount of L/C Exposures and aggregate principal amount of the Loans then outstanding. "Responsible Officer" of any corporation shall mean any executive ------------------- officer or Financial Officer of such corporation and any other officer or similar official thereof responsible for the administration of the obligations of such corporation in respect of this Agreement. "Revolving Availability Period" shall mean the period from and ----------------------------- including the Effective Date to but excluding the earlier of the Revolving Maturity Date and the date of termination of the Revolving Commitments. "Revolving Commitment" shall mean, with respect to each Lender, the -------------------- commitment, if any, of such Lender to make Revolving Loans and to acquire participations in Letters of Credit hereunder, expressed as an amount representing the maximum aggregate amount of such Lender's Revolving Credit Exposure hereunder, as such commitment may be (a) reduced from time to time pursuant to Section 2.11 and (b) reduced or increased from time to time pursuant to assignments by or to such Lender pursuant to Section 9.04. The initial amount of each Lender's Revolving Commitment is set forth on Schedule 2.01, or in the Assignment and Acceptance pursuant to which such Lender shall have assumed its Revolving Commitment, as applicable. The initial aggregate amount of the Lenders' Revolving Commitments is $150,000,000. "Revolving Lender" shall mean a Lender with a Revolving Commitment or, ---------------- if the Revolving Commitments have terminated or expired, a Lender with a Standby Exposure. "Revolving Loan" shall mean a Standby Loan or a Competitive Loan. -------------- "Revolving Maturity Date" shall mean October 15, 2002. ----------------------- "Sale and Lease-Back Transaction" shall mean any arrangement, directly ------------------------------- or indirectly, with any person whereby such person shall sell or transfer any property, real or personal, used or useful in its business, whether now owned or hereafter acquired, and thereafter rent or lease such 21 property or other property which it intends to use for substantially the same purpose or purposes as the property being sold or transferred. "Secured Parties" shall mean (a) the Lenders, (b) the Agent, (c) the --------------- Issuing Bank, (d) each counterparty to an interest rate protection agreement entered into with the Borrower if such counterparty was a Lender at the time the interest rate protection agreement was entered into and if the Borrower's obligations under such interest rate protection agreement constitute Obligations, (e) the beneficiaries (other than any Loan Party) of each indemnification obligation undertaken by any Loan Party under any Loan Document and (f) the successors and assigns of each of the foregoing. "Significant Subsidiary" shall mean at any time (a) any Subsidiary of ---------------------- the Borrower with revenues during the fiscal year of the Borrower most recently ended greater than or equal to 5% of the total revenues of the Borrower and its Subsidiaries during such year, computed and consolidated in accordance with GAAP consistently applied ("Consolidated Revenues"), (b) any Subsidiary of the --------------------- Borrower with assets as of the last day of the Borrower's most recently ended fiscal year greater than or equal to 5% of the total assets of the Borrower and its Subsidiaries at such date, computed and consolidated in accordance with GAAP consistently applied ("Consolidated Assets"), (c) any Subsidiary with ------------------- stockholder's equity as of the last day of the Borrower's most recently ended fiscal year greater than or equal to 5% of the stockholder's equity of the Borrower and the Subsidiaries at such date, computed and consolidated in accordance with GAAP consistently applied ("Net Stockholders' Equity"), (d) any ------------------------ Subsidiary designated in writing by the Borrower as a Significant Subsidiary, (e) any Subsidiary created or acquired by the Borrower after the date hereof that falls within or that comes to meet one of clauses (a) through (d), (f) any Subsidiary in existence on the date hereof which comes to meet one of clauses (a) through (d) after the date hereof or (g) any Subsidiary that directly or indirectly owns any capital stock of a Significant Subsidiary; provided, -------- however, that if at any time (x) the aggregate revenues of all Subsidiaries that - ------- are Significant Subsidiaries during any fiscal year of the Borrower shall not equal or exceed 90% of Consolidated Revenues for such fiscal year, (y) the aggregate assets of all Subsidiaries that are Significant Subsidiaries as of the last day of any fiscal year of the Borrower shall not equal or exceed 90% of Consolidated Assets at such date, or (z) the aggregate stockholders' equity of all Subsidiaries 22 that are Significant Subsidiaries as of the last day of any fiscal year of the Borrower shall not equal or exceed 90% of Net Stockholders' Equity at such date, then the term Significant Subsidiary shall be deemed to include such Subsidiaries (as determined pursuant to the next following sentence) of the Borrower as may be required so that none of clauses (x), (y) and (z) above shall continue to be true. For purposes of the proviso to the next preceding sentence, the Subsidiaries which shall be deemed to be Significant Subsidiaries shall be determined based on the percentage that the assets of each such Subsidiary are of Consolidated Assets, with the Subsidiary with the highest such percentage being selected first, and each other Subsidiary required to satisfy the requirements set forth in such proviso being selected in descending order of such percentage. "S&P" shall mean Standard & Poor's Ratings Group, a division of --- McGraw-Hill, Inc. "Spin-Off" shall mean the distribution by Sunburst to its shareholders -------- of all the shares of capital stock of the Borrower and the other related transactions contemplated by the Form 10 in the manner, on the terms and with the results set forth in the Form 10. "Spot Exchange Rate" shall mean, on any day, with respect to any ------------------ Alternative Currency, the spot rate at which dollars are offered on such day by The Chase Manhattan Bank in London for such Alternative Currency at approximately 11:00 A.M. (London time). "Standby Borrowing" shall mean a Revolving Borrowing consisting of ----------------- simultaneous Standby Loans from each of the Revolving Lenders. "Standby Borrowing Request" shall mean a request made pursuant to ------------------------- Section 2.04 in the form of Exhibit A-5. "Standby Exposure" shall mean with respect to any Lender at any time, ---------------- the sum of the outstanding principal amount of such Lender's Standby Loans denominated in dollars, plus the Equivalent Dollar Amount at such time of the outstanding principal amount at such time of such Lender's Standby Loans that are Alternative Currency Loans and its L/C Exposure at such time. "Standby Loans" shall mean the Loans made by the Lenders to the ------------- Borrower pursuant to clause (b) of Section 2.01 and to Section 2.04. Each Standby Loan shall 23 be a Eurocurrency Loan, a Eurodollar Standby Loan, a CD Loan or an ABR Loan. "Statutory Reserves" shall mean a fraction (expressed as a decimal), ------------------ the numerator of which is the number one and the denominator of which is the number one minus the aggregate of the maximum reserve percentages (including any marginal, special, emergency or supplemental reserves) expressed as a decimal established by the Board and any other banking authority to which the Agent is subject for new negotiable nonpersonal time deposits in dollars of over $100,000 with maturities approximately equal to the applicable Interest Period. Statutory Reserves shall be adjusted automatically on and as of the effective date of any change in any reserve percentage. "Sterling" or "(Pounds)" shall mean the lawful money of the United -------- -------- Kingdom. "Subordinated Indebtedness" shall mean Indebtedness of the Borrower ------------------------- that is subordinated in right of payment to any of the Obligations. "subsidiary" shall mean, with respect to any person (herein referred ---------- to as the "parent"), any corporation, partnership, association or other business entity (a) of which securities or other ownership interests representing more than 50% of the equity or more than 50% of the ordinary voting power or more than 50% of the general partnership interests are, at the time any determination is being made, owned, controlled or held, or (b) which is, at the time any determination is made, otherwise Controlled by the parent or one or more subsidiaries of the parent or by the parent and one or more subsidiaries of the parent. "Subsidiary" shall mean any subsidiary of the Borrower. ---------- "Subsidiary Loan Party" shall mean (a) any Subsidiary of the Borrower --------------------- that has assets greater than or equal to 10% of Consolidated Total Assets (other than any Foreign Subsidiary) and (b) any Subsidiary that directly or indirectly owns any capital stock of any Subsidiary referred to in clause (a). "Sunburst" shall mean Sunburst Hospitality Corporation (formerly -------- Choice Hotels International, Inc.), a Delaware corporation, as renamed following the Spin-Off. 24 "Sunburst Subordinated Note" shall mean the $115,000,000 Sunburst -------------------------- Subordinated Note due October 15, 2002. "Term Commitment" shall mean, with respect to each Lender, the --------------- commitment, if any, of such Lender to make a Term Loan hereunder on the Effective Date, as such commitment may be (a) reduced from time to time pursuant to Section 2.11 and (b) reduced or increased from time to time pursuant to assignments by or to such Lender pursuant to Section 9.04. The initial amount of each Lender's Term Commitment is set forth on Schedule 2.01, or in the Assign ment and Acceptance pursuant to which such Lender shall have assumed its Term Commitment, as applicable. The initial aggregate amount of the Lenders' Term Commitments is US$150,000,000. "Term Lender" shall mean a Lender with a Term Commitment or an ----------- outstanding Term Loan. "Term Loan" shall mean a Loan made pursuant to clause (a) of --------- Section 2.01. "Term Maturity Date" shall mean October 15, 2002. ------------------ "Total Revolving Commitment" shall mean at any time the aggregate -------------------------- amount of the Lenders' Revolving Commitments, as in effect at such time. "Transactions" shall have the meaning assigned to such term in ------------ Section 3.02. "Type", when used in respect of any Loan or Borrowing, shall refer to ---- the Rate by reference to which interest on such Loan or on the Loans comprising such Borrowing is determined and the currency in which such Loan or the Loans comprising such Borrowing are denominated. For purposes hereof, "Rate" shall include the LIBO Rate, the Adjusted CD Rate, the Alternate Base Rate and the Fixed Rate, and "currency" shall include Dollars, French Francs, Deutsche Marks, Sterling and any other Alternative Currency permitted hereunder. "Wholly Owned Subsidiary" shall mean a Subsidiary all the capital ----------------------- stock or other ownership interest of which is owned by the Borrower or a Wholly Owned Subsidiary of the Borrower (including any Subsidiary that would be wholly owned but for directors' qualifying shares or similar matters). 25 "Withdrawal Liability" shall mean liability to a Multiemployer Plan as -------------------- a result of a complete or partial withdrawal from such Multiemployer Plan, as such terms are defined in Part I of Subtitle E of Title IV of ERISA. SECTION 1.02. Classification of Loans and Borrowings. For purposes --------------------------------------- of this Agreement, Loans may be classified and referred to by Class (e.g., a ---- "Revolving Loan") or by Type (e.g., a "Eurodollar Loan") or by Class and Type ---- (e.g., a "Eurodollar Revolving Loan"). Borrowings also may be classified and - ----- referred to by Class (e.g., a "Revolving Borrowing") or by Type (e.g., a ---- ---- "Eurodollar Borrowing") or by Class and Type (e.g., a "Eurodollar Revolving ---- Borrowing"). SECTION 1.03. Terms Generally. The definitions herein shall apply ---------------- equally to both the singular and plural forms of the terms defined. Whenever the context may require, any pronoun shall include the corresponding masculine, feminine and neuter forms. The words "include", "includes" and "including" shall be deemed to be followed by the phrase "without limitation". All references herein to Articles, Sections, Exhibits and Schedules shall be deemed references to Articles and Sections of, and Exhibits and Schedules to, this Agreement unless the context shall oth erwise require. Except as otherwise expressly provided herein, all terms of an accounting or financial nature shall be construed in accordance with GAAP consistently applied, as in effect from time to time; provided, however, that, for purposes of determining compliance -------- ------- with any covenant set forth in Article VI, such terms shall be construed in accordance with GAAP as in effect on the date of this Agreement applied on a basis consistent with the application used in preparing the Borrower's audited financial statements referred to in Section 3.05. ARTICLE II. THE CREDITS SECTION 2.01. Commitments. Subject to the terms and conditions and ------------ relying upon the representations and warranties herein set forth, each Lender agrees, severally and not jointly, (a) to make a Term Loan to the Borrower on the Effective Date in a principal amount not exceeding its Term Commitment and (b) to make Standby Loans (including Eurocurrency Loans) to the Borrower, at any time and from time to time during the Revolving Availability Period, in an aggregate principal amount at any time outstanding that will not result in such Lender's Standby Exposure exceeding such Lender's Revolving Commitment minus the amount by which the 26 Competitive Loans outstanding at such time shall be deemed to have used such Commitment pursuant to Section 2.16, subject, however, to the conditions that (i) at no time shall any Loan be made if, immediately after giving effect thereto and to the application of the proceeds thereof, the Aggregate Principal Amount Outstanding would exceed the Total Revolving Commitment minus the L/C Exposure, (ii) at no time shall any Loan be made if, immediately after giving effect thereto and to the application of the proceeds thereof, the aggregate Equivalent Dollar Amount of all outstanding Eurocurrency Loans would exceed the Eurocurrency Sublimit and (iii) at all times the outstanding aggregate principal amount of all Standby Loans made by each Lender shall equal the product of (x) the percentage which its Revolving Commitment represents of the Total Revolving Commitment times (y) the outstanding aggregate principal amount of all Standby Loans. Within the foregoing limits, the Borrower may borrow, pay or prepay and reborrow Standby Loans hereunder, on and after the Effective Date and prior to the Revolving Maturity Date, subject to the terms, conditions and limitations set forth herein. Amounts repaid in respect of Term Loans may not be reborrowed. SECTION 2.02. Loans. (a) Each Loan shall be made as part of a ------ Borrowing consisting of Loans of the same Class and Type made by the Lenders ratably in accordance with their respective Commitments of the applicable Class; provided, however, that the failure of any Lender to make any Loan shall not in - -------- ------- itself relieve any other Lender of its obligation to lend hereunder (it being understood, however, that no Lender shall be responsible for the failure of any other Lender to make any Loan required to be made by such other Lender). Each Competitive Loan shall be made in accordance with the procedures set forth in Section 2.03. Except for Loans deemed made pursuant to Section 2.02(e), the Standby Loans or Competitive Loans comprising any Revolving Borrowing shall be (i) in the case of Competitive Loans, in an aggregate principal amount which is an integral multiple of $1,000,000 and not less than $5,000,000 and (ii) in the case of Standby Loans, in an aggregate principal amount which is an integral multiple of $1,000,000 and not less than $5,000,000 (or an aggregate principal amount equal to the remaining balance of the available Revolving Commitments); provided, however, that if the Equivalent Dollar Amount of any Eurocurrency - -------- ------- Revolving Loan at the end of the Interest Period applicable thereto does not exceed by more than 5%, and is not less than 95% of, the Equivalent Dollar Amount of such Revolving Loan on the relevant Denomination Date, then the Borrower may (notwithstanding clauses (i) and (ii) above) refinance such Revolving Loan 27 with a new Revolving Loan denominated in the same Alternative Currency and with the same principal amount (in such Alternative Currency) at the end of such Interest Period, notwithstanding that the Equivalent Dollar Amount of the new Revolving Loan is not an integral multiple of $1,000,000. For purposes of this Section, any Eurocurrency Revolving Borrowing shall be deemed to be in an amount equal to the Equivalent Dollar Amount of such Eurocurrency Revolving Borrowing determined as of its Denomination Date. (b) Subject only to Section 2.10, (i) each Term Borrowing shall be comprised entirely of Eurodollar Term Loans, ABR Loans or CD Loans as the Borrower may request pursuant to Section 2.04, (ii) each Standby Borrowing shall be comprised entirely of Eurocurrency Loans, Eurodollar Standby Loans, CD Loans or ABR Loans as the Borrower may request pursuant to Section 2.04 and (iii) each Competitive Borrowing shall be comprised entirely of Eurodollar Competitive Loans or Fixed Rate Loans as the Borrower may request pursuant to Section 2.03. Each Lender may at its option make any Eurocurrency Loan or Eurodollar Loan by causing any domestic or foreign branch or Affiliate of such Lender to make such Loan; provided, however, that (i) any exercise of such option shall not affect -------- ------- the obligation of the Borrower to repay such Loan in accordance with the terms of this Agreement and (ii) in exercising such option, the Lender shall use its reasonable efforts to minimize any increased costs to the Borrower resulting therefrom (which obligation of the Lender shall not require it to take, or refrain from taking, actions that it determines would result in increased costs for which it will not be compensated hereunder or that it determines would be otherwise disadvantageous to it and in the event of such request for costs for which compensation is provided under this Agreement, the provisions of Section 2.13(c) shall apply). Borrowings of more than one Type may be outstanding at the same time; provided, however, that the Borrower shall not be entitled to request -------- ------- any Borrowing which, if made, would result in (A) an aggregate of more than fifteen separate Standby Loans of any Lender being outstanding hereunder at any one time, (B) there being Loans outstanding in an aggregate of more than six currencies or (C) there being more than 30 Eurocurrency Borrowings having an Interest Period of one month during any twelve-month period. For purposes of the foregoing, Loans having different Interest Periods, regardless of whether they commence on the same date, shall be considered separate Loans. (c) Subject to Section 2.05 and except with respect to Loans made pursuant to Section 2.02(e), each 28 Lender shall make each Loan to be made by it hereunder on the proposed date thereof by wire transfer of immediately available funds to such account as the Agent may designate, not later than 12:00 noon, New York City time, or, in the case of funds in an Alternative Currency, 12:00 noon, London time, and the Agent shall by 3:00 p.m., New York City time, or, in the case of funds in an Alternative Currency, 3:00 p.m., London time, credit the amounts so received to an account designated by the Borrower with the Agent or, if a Borrowing shall not occur on such date because any condition precedent herein specified shall not have been met, return the amounts so received to the respective Lenders. Competitive Loans shall be made by the Lender or Lenders whose Competitive Bids therefor are accepted pursuant to Section 2.03 in the amounts so accepted and Standby Loans shall be made by the Lenders pro rata in accordance with Section 2.16. Unless the Agent shall have received notice from a Lender prior to (or, in the case of an ABR Borrowing, on) the date of any Borrowing that such Lender shall not make available to the Agent such Lender's portion of such Borrowing, the Agent may assume that such Lender has made such portion available to the Agent on the date of such Borrowing in accordance with this Section 2.02(c) and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If the Agent shall have so made funds available then, to the extent that such Lender shall not have made such portion available to the Agent, such Lender and the Borrower severally agree to repay to the Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent at (i) in the case of the Borrower, the interest rate applicable at the time to the Loans comprising such Borrowing and (ii) in the case of such Lender, a rate determined by the Agent to represent its cost of overnight or short-term funds in the relevant currency (which determination shall be conclusive absent manifest error). If such Lender shall repay to the Agent such corresponding amount, such amount shall constitute such Lender's Loan as part of such Borrowing for purposes of this Agreement. (d) Notwithstanding any other provision of this Agreement, the Borrower shall not be entitled to request any Borrowing if the Interest Period requested with respect thereto would end after the Maturity Date. (e) If the Issuing Bank shall not have received from the Borrower the payment required to be made by Section 2.20(e) in respect of any L/C Disbursement within 29 the time specified in such Section, the Issuing Bank will promptly notify the Agent of the L/C Disbursement and the Agent will promptly notify each Lender of such L/C Disbursement and its Pro Rata Percentage thereof. Each Lender shall pay by wire transfer of immediately available funds to the Agent not later than 2:00 p.m., New York City time, on such date (or, if such Lender shall have received such notice later than 12:00 (noon), New York City time, on any day, not later than 10:00 a.m., New York City time, on the immediately following Business Day), an amount equal to such Lender's Pro Rata Percentage of such L/C Disbursement (it being understood that such amount shall be deemed to constitute an ABR Loan of such Lender and such payment shall be deemed to have reduced the L/C Exposure), and the Agent will promptly pay to the Issuing Bank amounts so received by it from the Lenders. The Agent will promptly pay to the Issuing Bank any amounts received by it from the Borrower pursuant to Section 2.20(e) prior to the time that any Lender makes any payment pursuant to this paragraph (e); any such amounts received by the Agent thereafter will be promptly remitted by the Agent to the Lenders that shall have made such payments and to the Issuing Bank, as their interests may appear. If any Lender shall not have made its Pro Rata Percentage of such L/C Disbursement available to the Agent as provided above, such Lender and the Borrower severally agree to pay interest on such amount, for each day from and including the date such amount is required to be paid in accordance with this paragraph to but excluding the date such amount is paid, to the Agent for the account of the Issuing Bank at (i) in the case of the Borrower, the Alternate Base Rate plus the Applicable Percentage and (ii) in the case of such Lender, for the first such day, the Federal Funds Effective Rate, and for each day thereafter, the Alternate Base Rate. SECTION 2.03. Competitive Bid Procedure. (a) In order to request -------------------------- Competitive Bids, the Borrower shall hand deliver or telecopy to the Agent a duly completed Competitive Bid Request in the form of Exhibit A-1, to be received by the Agent (i) in the case of a Eurodollar Competitive Borrowing, not later than 10:00 a.m., New York City time, four Business Days before a proposed Competitive Borrowing and (ii) in the case of a Fixed Rate Borrowing, not later than 10:00 a.m., New York City time, one Business Day before a proposed Competitive Borrowing. No Eurocurrency Loan, CD Loan or ABR Loan shall be requested in, or made pursuant to, a Competitive Bid Request. A Competitive Bid Request that does not conform substantially to the format of Exhibit A-1 may be rejected in the Agent's sole discretion, and the Agent shall promptly notify the 30 Borrower of such rejection by telecopier. Such request shall in each case refer to this Agreement and specify (x) whether the Borrowing then being requested is to be a Eurodollar Borrowing or a Fixed Rate Borrowing, (y) the date of such Borrowing (which shall be a Business Day) and the aggregate principal amount thereof which shall be in a minimum principal amount of $5,000,000 and in an integral multiple of $1,000,000, and (z) the Interest Period with respect thereto (which may not end after the Maturity Date). Promptly after its receipt of a Competitive Bid Request that is not rejected as aforesaid, the Agent shall invite by telecopier (in the form of Exhibit A-2) the Lenders to bid, on the terms and conditions of this Agreement, to make Competitive Loans pursuant to such Competitive Bid Request. (b) Each Lender may, in its sole discretion, make one or more Competitive Bids to the Borrower responsive to a Competitive Bid Request. Each Competitive Bid by a Lender must be received by the Agent via telecopier, in the form of Exhibit A-3, (i) in the case of a Eurodollar Competitive Borrowing, not later than 9:30 a.m., New York City time, three Business Days before a proposed Competitive Borrowing and (ii) in the case of a Fixed Rate Borrowing, not later than 9:30 a.m., New York City time, on the day of a proposed Competitive Borrowing. Multiple bids shall be accepted by the Agent. Competitive Bids that do not conform substantially to the format of Exhibit A-3 may be rejected by the Agent after conferring with, and upon the instruction of, the Borrower, and the Agent shall notify the Lender making such nonconforming bid of such rejection as soon as practicable. Each Competitive Bid shall refer to this Agreement and specify (x) the principal amount (which shall be in a minimum principal amount of $5,000,000 and in an integral multiple of $1,000,000 and which may equal the entire principal amount of the Competitive Borrowing requested by the Borrower) of the Competitive Loan or Loans that the Lender is willing to make to the Borrower, (y) the Competitive Bid Rate or Rates at which the Lender is prepared to make the Competitive Loan or Loans and (z) the Interest Period and the last day thereof. If any Lender shall elect not to make a Competitive Bid, such Lender shall so notify the Agent via telecopier (I) in the case of Eurodollar Competitive Loans, not later than 9:30 a.m., New York City time, three Business Days before a proposed Competitive Borrowing and (II) in the case of Fixed Rate Loans, not later than 9:30 a.m., New York City time, on the day of a proposed Competitive Borrowing; provided, however, that failure by any Lender to give -------- ------- such notice shall not cause such Lender to be obligated to make any Competitive Loan as part of such Competitive Borrowing. A Competitive 31 Bid submitted by a Lender pursuant to this Section 2.03(b) shall be irrevocable. (c) The Agent shall promptly notify the Borrower by telecopier of all the Competitive Bids made, the Competitive Bid Rate and the principal amount of each Competitive Loan in respect of which a Competitive Bid was made and the identity of the Lender that made each bid. The Agent shall send a copy of all Competitive Bids to the Borrower for its records as soon as practicable after completion of the bidding process set forth in this Section. (d) The Borrower may in its sole and absolute discretion, subject only to the provisions of this Section 2.03(d), accept or reject any Competitive Bid referred to in Section 2.03(c). The Borrower shall notify the Agent by telephone, confirmed by telecopier in the form of a Competitive Bid Accept/Reject Letter substantially in the form set forth in Exhibit A-4, whether and to what extent it has decided to accept or reject any of or all the bids referred to in Section 2.03(c), (y) in the case of a Eurodollar Competitive Borrowing, not later than 10:30 a.m., New York City time, three Business Days before a proposed Competitive Borrowing and (z) in the case of a Fixed Rate Borrowing, not later than 10:30 a.m., New York City time, on the day of a proposed Competitive Borrowing; provided, however, that (i) the failure by the -------- ------- Borrower to give such notice shall be deemed to be a rejection of all the bids referred to in Section 2.03(c), (ii) the Borrower shall not accept a bid made at a particular Competitive Bid Rate if the Borrower has decided to reject a bid made at a lower Competitive Bid Rate, (iii) the aggregate amount of the Competitive Bids accepted by the Borrower shall not exceed the principal amount specified in the Competitive Bid Request, (iv) if the Borrower shall accept a bid or bids made at a particular Competitive Bid Rate but the amount of such bid or bids shall cause the total amount of bids to be accepted by the Borrower to exceed the amount specified in the Competitive Bid Request, then the Borrower shall accept a portion of such bid or bids in an amount equal to the amount specified in the Competitive Bid Request less the amount of all other Competitive Bids accepted with respect to such Competitive Bid Request, which acceptance, in the case of multiple bids at such Competitive Bid Rate, shall be made pro rata in accordance with the amount of each such bid at such Competitive Bid Rate, and (v) except pursuant to clause (iv) above, no bid shall be accepted for a Competitive Loan unless such Competitive Loan is in a minimum principal amount of $5,000,000 and an integral multiple of $1,000,000; provided further, ---------------- however, that if a - ------- 32 Competitive Loan must be in an amount less than $5,000,000 because of the provisions of clause (iv) above, such Competitive Loan may be for a minimum of $1,000,000 or any integral multiple thereof, and in calculating the pro rata allocation of acceptances of portions of multiple bids at a particular Competitive Bid Rate pursuant to clause (iv) above the amounts shall be rounded to integral multiples of $1,000,000 in a manner which shall be in the discretion of the Borrower. A notice given by the Borrower pursuant to this Section 2.03(d) shall be irrevocable. (e) The Agent shall promptly notify each bidding Lender whether or not its Competitive Bid has been accepted (and if so, in what amount and at what Competitive Bid Rate) by telecopier sent by the Agent, and each successful bidder shall thereupon become bound, subject to the other applicable conditions hereof, to make the Competitive Loan in respect of which its bid has been accepted. (f) A Competitive Bid Request shall not be made within three Business Days after the date of any previous Competitive Bid Request. (g) If the Agent shall elect to submit a Competitive Bid in its capacity as a Lender, it shall submit such bid directly to the Borrower one quarter of an hour earlier than the latest time at which the other Lenders are required to submit their bids to the Agent pursuant to Section 2.03(b). (h) All Notices required by this Section shall be given in accordance with Section 9.01. SECTION 2.04. Term Borrowing and Standby Borrowing Procedures. In ------------------------------------------------ order to request a Borrowing (other than a Competitive Borrowing or a deemed Borrowing pursuant to Section 2.02(e), as to which this Section 2.04 shall not apply), the Borrower shall hand deliver or telecopy to the Agent a duly completed Borrowing Request in the form of Exhibit A-5 (a) in the case of a Eurocurrency Borrowing, not later than 10:30 a.m., London time, three Business Days before a proposed borrowing, (b) in the case of a Eurodollar Borrowing, not later than 10:30 a.m., New York City time, three Business Days before a proposed borrowing, (c) in the case of a CD Borrowing, not later than 10:30 a.m., New York City time, one Business Day before a proposed borrowing and (d) in the case of an ABR Borrowing, not later than 10:30 a.m., New York City time, on the day of a proposed borrowing. No Fixed Rate Loan shall be requested or made pursuant to a Borrowing Request. Such notice shall 33 be irrevocable and shall in each case specify (i) whether the Borrowing then being requested is to be a Term Borrowing or a Standby Borrowing; (ii) whether such Borrowing is to be a Eurocurrency Borrowing, a Eurodollar Borrowing, a CD Borrowing or an ABR Borrowing; (iii) the date of such Borrowing (which shall be a Business Day) and the amount thereof, which, in the case of a Eurocurrency Borrowing, shall be expressed in the Equivalent Dollar Amount; (iv) if such Borrowing is to be a Eurocurrency Borrowing, the Alternative Currency in which such Borrowing is to be denominated and the number and location of the account to which funds are to be disbursed; and (v) if such Borrowing is to be a Eurocurrency Borrowing, Eurodollar Borrowing or CD Borrowing, the Interest Period with respect thereto. If no election as to the Type of Borrowing is specified in any such notice, then the requested Borrowing shall be an ABR Borrowing. If no Interest Period with respect to any Eurocurrency Borrowing, Eurodollar Borrowing or CD Borrowing is specified in any such notice, then the Borrower shall be deemed to have selected an Interest Period of one month's duration, in the case of a Eurocurrency Borrowing or a Eurodollar Borrowing, or 30 days' duration, in the case of a CD Borrowing. If the Borrower shall not have given notice in accordance with this Section of its election to refinance a Borrowing denominated in dollars prior to the end of the Interest Period in effect for such Borrowing, then the Borrower shall (unless such Borrowing is repaid at the end of such Interest Period) be deemed to have given notice of an election to refinance such Borrowing with an ABR Borrowing. The Agent shall promptly advise the Lenders of any notice given pursuant to this Section and of each Lender's portion of the requested Borrowing. SECTION 2.05. Refinancings. The Borrower may refinance all or any ------------- part of any Borrowing with a Borrowing of the same or a different Type made pursuant to Section 2.03 or Section 2.04, subject to the conditions and limitations set forth herein and elsewhere in this Agreement, including refinancings of Competitive Borrowings with Standby Borrowings and Standby Borrowings with Competitive Borrowings. Any Borrowing or part thereof so refinanced with a Borrowing denominated in the same currency shall be deemed to be repaid in accordance with Section 2.07 with the proceeds of a new Borrowing hereunder and the proceeds of the new Borrowing, to the extent they do not exceed the principal amount of the Borrowing being refinanced, shall not be paid by the Lenders to the Agent or by the Agent to the Borrower pursuant to Section 2.02(c); provided, however, that (i) if the principal amount extended by a -------- ------- Lender in a refinancing is greater than the principal 34 amount extended by such Lender in the Borrowing being refinanced, then such Lender shall pay such difference to the Agent for distribution to the Lenders described in (ii) below, (ii) if the principal amount extended by a Lender in the Borrowing being refinanced is greater than the principal amount being extended by such Lender in the refinancing, the Agent shall return the difference to such Lender out of amounts received pursuant to (i) above, and (iii) to the extent any Lender fails to pay the Agent amounts due from it pursuant to (i) above, any Loan or portion thereof being refinanced shall not be deemed repaid in accordance with Section 2.07 and shall be payable by the Borrower. SECTION 2.06. Fees. (a) The Borrower agrees to pay to each Lender, ----- through the Agent, on the last day of March, June, September and December of each year, on the date on which the Revolving Commitment of such Lender shall be terminated as provided herein and on the Revolving Maturity Date, a facility fee (a "Facility Fee") equal to the Applicable Percentage per annum in effect from ------------ time to time on the amount of the Revolving Commitment of such Lender, whether used or unused, in effect from time to time during the preceding quarter (or shorter period commencing with the date hereof or ending with the Revolving Maturity Date or any date on which the Revolving Commitment of such Lender shall be terminated). The Facility Fees shall be computed on the basis of the actual number of days elapsed in a year of 360 days. The Facility Fee due to each Lender shall commence to accrue on the date hereof and shall cease to accrue on the earlier of (i) the termination of the Revolving Commitment of such Lender and (ii) the Revolving Maturity Date. (b) The Borrower shall pay to the Agent, for its own account, agent and administrative fees (the "Agent and Administrative Fees") at the times and ----------------------------- in the amounts agreed upon in the letter agreement dated August 26, 1997, between the Borrower and the Agent. (c) The Borrower agrees to pay (i) to each Lender, through the Agent, on the last day of March, June, September and December of each year and on the date on which the Revolving Commitment of such Lender shall be terminated as provided herein, a fee (an "L/C Participation Fee") calculated on such Lender's --------------------- Pro Rata Percentage (based on the Revolving Commitments) of the average daily aggregate L/C Exposure (excluding the portion thereof attributable to unreimbursed L/C Disbursements) during the preceding quarter (or shorter period commencing with the date hereof or ending with the Revolving Maturity Date or the date on which all 35 Letters of Credit have been canceled or have expired and the Revolving Commitments of all Lenders shall have been terminated) at a rate equal to the Applicable Percentage from time to time used to determine the interest rate on Standby Borrowings comprised of Eurodollar Standby Loans pursuant to Section 2.08, and (ii) to the Issuing Bank with respect to each Letter of Credit the fronting, issuance and drawing fees, specified in the Issuing Bank Agreement (the "Issuing Bank Fees"). All L/C Participation Fees and Issuing Bank Fees ----------------- shall be computed on the basis of the actual number of days elapsed in a year of 360 days. (d) All Fees shall be paid on the dates due, in immediately available funds, to the Agent for distribution, if and as appropriate, among the Lenders except that the Issuing Bank Fees shall be paid directly to the Issuing Bank. Once paid, none of the Fees shall be refundable under any circumstances unless such Fees were paid in error. SECTION 2.07. Evidence of Indebtedness; Repayment of Loans. (a) The --------------------------------------------- Borrower hereby unconditionally promises to pay (i) to the Agent for the account of each Lender the then unpaid principal amount of each Term Loan of such Lender as provided in Section 2.12 and (ii) to the Agent for the account of each Lender the then unpaid principal amount of each Revolving Loan on the last day of the Interest Period applicable thereto. (b) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Borrower to such Lender resulting from each Loan made by such Lender, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder. (c) The Agent shall maintain accounts in which it shall record (i) the amount of each Loan made hereunder, the Class and Type thereof and the Interest Period applicable thereto, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iii) the amount of any sum received by the Agent hereunder for the account of the Lenders and each Lender's share thereof. (d) The entries made in the accounts maintained pursuant to paragraphs (b) and (c) of this Section shall be prima facie evidence of the ----- ----- existence and amounts of the obligations recorded therein; provided that the -------- failure of any Lender or the Agent to maintain such accounts or any error therein shall not in any manner affect the obligation 36 of the Borrower to properly repay the Loans in accordance with the terms of this Agreement. (e) Any Lender may request that Loans made by it be evidenced by a promissory note. In such event, the Borrower shall prepare, execute and deliver to such Lender a promissory note payable to the order of such Lender (or, if requested by such Lender, to such Lender and its registered assigns) and in a form approved by the Agent. SECTION 2.08. Interest on Loans. (a) Subject to the provisions of ------------------ Section 2.09, the Loans comprising each Eurocurrency Borrowing and Eurodollar Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a rate per annum equal to (i) in the case of each Eurocurrency Loan, Eurodollar Standby Loan or Eurodollar Term Loan, the LIBO Rate for the Interest Period in effect for such Borrowing plus the Applicable Percentage, and (ii) in the case of each Eurodollar Competitive Loan, the LIBO Rate for the Interest Period in effect for such Borrowing plus the Competitive Margin offered by the Lender making such Loan and accepted by the Borrower pursuant to Section 2.03. Interest on each Eurocurrency Borrowing and Eurodollar Borrowing shall be payable on each applicable Interest Payment Date. The LIBO Rate for each Interest Period shall be determined by the Agent in accordance with the definition of LIBO Rate herein. The Agent shall promptly advise the Borrower and each Lender, as appropriate, of such determination. (b) Subject to the provisions of Section 2.09, the Loans comprising each CD Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of 360 days) at a rate per annum equal to the Adjusted CD Rate for the Interest Period in effect for such Borrowing plus the Applicable Percentage. Interest on each CD Borrowing shall be payable on each applicable Interest Payment Date. The Adjusted CD Rate for each Interest Period shall be determined by the Agent in accordance with the definition of Adjusted CD Rate herein. The Agent shall promptly advise the Borrower and each Lender of such determination. (c) Subject to the provisions of Section 2.09, the Loans comprising each ABR Borrowing shall bear interest (computed on the basis of the actual number of days elapsed over a year of (i) 365 or 366 days, as the case may be, during any period in which the Alternate Base Rate is based on the Prime Rate, and (ii) 360 days, during any period in which the Alternate Base Rate is based on the Base CD Rate 37 or the Federal Funds Effective Rate) at a rate per annum equal to the Alternate Base Rate plus the Applicable Percentage. Interest on each ABR Borrowing shall be payable on each applicable Interest Payment Date. The Alternate Base Rate shall be determined by the Agent in accordance with the definition of Alternate Base Rate herein. (d) Subject to the provisions of Section 2.09, each Fixed Rate Loan shall bear interest at a rate per annum (computed on the basis of the actual number of days elapsed over a year of 360 days) equal to the fixed rate of interest offered by the Lender making such Loan and accepted by the Borrower pursuant to Section 2.03. Interest on each Fixed Rate Loan shall be payable on the Interest Payment Dates applicable to such Loan except as otherwise provided in this Agreement. SECTION 2.09. Default Interest. If the Borrower shall default in the ----------------- payment of the principal of or interest on any Loan or any other amount becoming due hereunder, whether by scheduled maturity, notice of prepayment, acceleration or otherwise, the Borrower shall on demand from time to time from the Agent pay interest, to the extent permitted by law, on such defaulted amount up to (but not including) the date of actual payment (after as well as before judgment) at a rate per annum (computed on the basis of the actual number of days elapsed over a year of 360 days) equal to the Alternate Base Rate plus the Applicable Percentage plus 2%. SECTION 2.10. Alternate Rate of Interest. (a) In the event, and on --------------------------- each occasion, that on the day two Business Days prior to the commencement of any Interest Period for a Eurocurrency Borrowing or a Eurodollar Borrowing the Agent shall have determined (i) that deposits in the principal amounts of the Loans comprising such Borrowing and in the currency in which such Loan is to be denominated are not generally available in the relevant market, or that the rates at which such deposits are being offered will not adequately and fairly reflect the cost to any Lender of making or maintaining its Eurocurrency Loan or Eurodollar Loan, as applicable, during such Interest Period, or that reasonable means do not exist for ascertaining the LIBO Rate, or (ii) in the case of a Eurocurrency Borrowing, that there shall have occurred any change in national or international financial, political or economic conditions (including the imposition of or any change in exchange controls) or currency exchange rates which would make it impracticable to make Loans denominated in the applicable Alternative Currency, the Agent shall, as promptly as 38 practicable, give written telecopy notice of such determina tion to the Borrower and the Lenders. In the event of any such determination, until the Agent shall have advised the Borrower and the Lenders that the circumstances giving rise to such notice no longer exist, (A) any request by the Borrower for a Eurodollar Competitive Borrowing pursuant to Section 2.03 shall be of no force and effect and shall be denied by the Agent, (B) any request by the Borrower for a Eurodollar Standby Borrowing pursuant to Section 2.04 shall be deemed to be a request for an ABR Borrowing and (C) any request by the Borrower for a Eurocurrency Borrowing pursuant to Section 2.04 shall be deemed to be a request by the Borrower for an ABR Borrowing. (b) In the event, and on each occasion, that on or before the day on which the Adjusted CD Rate for a CD Borrowing is to be determined the Agent shall have determined that such Adjusted CD Rate cannot be determined for any reason, including the inability of the Agent to obtain sufficient bids in accordance with the terms of the definition of Fixed CD Rate, or the Agent shall determine that the Adjusted CD Rate for such CD Borrowing will not adequately and fairly reflect the cost to any Lender of making or maintaining its CD Loan during such Interest Period, the Agent shall, in a timely manner, give written or telecopy notice of such determination to the Borrower and the Lenders. In the event of any such determination, any request by the Borrower for a CD Borrowing pursuant to Section 2.04 shall, until the Agent shall have advised the Borrower and the Lenders that the circumstances giving rise to such notice no longer exist, be deemed to be a request for an ABR Borrowing. SECTION 2.11. Termination and Reduction of Commitments. (a) Unless ----------------------------------------- previously terminated, (i) the Term Commitments shall terminate at 5:00 p.m., New York City time, on the Effective Date, (ii) the Revolving Commitments shall terminate on the Revolving Maturity Date and (iii) the LC Commitment shall terminate on the date 30 days prior to the Revolving Maturity Date. (b) Upon at least five Business Days' prior irrevocable written or telecopy notice to the Agent, the Borrower may at any time in whole permanently terminate, or from time to time in part permanently reduce, the Commitments of any Class; provided, however, that (i) each partial reduction of the Commitments -------- ------- of any Class shall be in an integral multiple of $1,000,000 and in a minimum principal amount of $10,000,000 and (ii) no such termination or reduction shall be made which would reduce the Revolving 39 Commitments to an amount less than the aggregate outstanding principal amount of the Revolving Loans plus the L/C Exposure. If, following any partial reduction of the Revolving Commitments, the Revolving Commitments (as so reduced) shall be less than the Eurocurrency Sublimit, the Eurocurrency Sublimit shall be automatically reduced so as to equal the total Revolving Commitments. (c) Each reduction in the Commitments of any Class hereunder shall be made ratably among the Lenders in accordance with their respective Commitments of such Class. The Borrower shall pay to the Agent for the accounts of the Lenders, on the date of each termination or reduction, the Facility Fees on the amount of the Commitments so terminated or reduced accrued through the date of such termination or reduction. SECTION 2.12. Prepayment; Amortization of Term Loans. (a) The --------------------------------------- Borrower shall have the right at any time and from time to time to prepay any Borrowing (other than a Competitive Borrowing), in whole or in part, upon giving written or telecopy notice (or telephone notice promptly confirmed by written or telecopy notice) to the Agent before 10:00 a.m., New York City time (or, in the case of any Eurocurrency Borrowing, 10:00 a.m., London time), three Business Days prior to prepayment; provided, however, that each partial prepayment shall -------- ------- be in an amount which is (or the Equivalent Dollar Amount of which, determined as of the Denomination Date for the relevant Loan or Loans, is) an integral multiple of $1,000,000 and not less than $1,000,000. The Borrower shall not have the right to prepay any Competitive Borrowing. (b) On the date of any termination or reduction of the Revolving Commitments pursuant to Section 2.11, the Borrower shall pay or prepay so much of the Standby Borrowings as shall be necessary in order that the Aggregate Revolving Credit Exposure shall not exceed the Total Revolving Commitment after giving effect to such termination or reduction. (c) Each notice of prepayment shall specify the prepayment date and the principal amount of each Borrowing (or portion thereof) to be prepaid, shall be irrevocable and shall commit the Borrower to prepay such Borrowing (or portion thereof) by the amount stated therein on the date stated therein. All prepayments under this Section shall be subject to Section 2.15 but otherwise without premium or penalty and shall be applied ratably to the Loans included in the prepaid Borrowing. All prepayments under this 40 Section shall be accompanied by accrued interest on the principal amount being prepaid to the date of payment. (d) Subject to adjustment pursuant to paragraph (f) of this Section, the Borrower shall repay Term Borrowings on each date set forth below in the aggregate principal amount set forth opposite such date:
Date Amount ------------------- ----------- May 31, 1998 $ 5,000,000 August 31, 1998 $ 5,000,000 November 30, 1998 $ 5,000,000 February 28, 1999 $ 5,000,000 May 31, 1999 $ 5,000,000 August 31, 1999 $ 5,000,000 November 30, 1999 $ 7,500,000 February 29, 2000 $ 7,500,000 May 31, 2000 $ 7,500,000 August 31, 2000 $ 7,500,000 November 30, 2000 $10,000,000 February 28, 2001 $10,000,000 May 31, 2001 $10,000,000 August 31, 2001 $10,000,000 November 30, 2001 $12,500,000 February 28, 2002 $12,500,000 May 31, 2002 $12,500,000 October 15, 2002 $12,500,000
(e) To the extent not previously paid, all Term Loans shall be due and payable on the Term Maturity Date. (f) If the initial aggregate amount of the Lenders' Term Commitments of any Class exceeds the aggregate principal amount of Term Loans of such Class that are made on the Effective Date, then the scheduled repayments of Term Borrowings of such Class to be made pursuant to this Section shall be reduced ratably by an aggregate amount equal to such excess. Any prepayment of a Term Borrowing of either Class shall be applied to reduce the subsequent scheduled repayments of the Term Borrowings of such Class to be made pursuant to this paragraph (f) ratably. SECTION 2.13. Reserve Requirements; Change in Circumstances. (a) ---------------------------------------------- Notwithstanding any other provision herein, if after the date of this Agreement any change in applicable law or regulation or in the interpretation or administration thereof by any Governmental Authority charged with the interpretation or administration thereof (whether or not having the force of law) shall change the basis of taxation of payments to any Lender or Issuing Bank of the 41 principal of or interest on any Eurocurrency Loan, Eurodollar Loan, CD Loan or Fixed Rate Loan made by such Lender or any Fees or other amounts payable hereunder (other than changes in respect of taxes imposed on the overall net income of such Lender or Issuing Bank by any jurisdiction or any political subdivision thereof) or shall impose, modify or deem applicable any reserve, special deposit or similar requirement against assets of, deposits with or for the account of or credit extended by such Lender or such Issuing Bank (except any such reserve requirement which is already reflected in the definition of the applicable Rate), or shall impose on such Lender or such Issuing Bank or the London interbank market any other condition affecting this Agreement or any Eurocurrency Loan, Eurodollar Loan, CD Loan or Fixed Rate Loan made by such Lender or any Letter of Credit or participation therein, and the result of any of the foregoing shall be to increase the cost to such Lender or Issuing Bank of making or maintaining any Eurocurrency Loan, Eurodollar Loan, CD Loan or Fixed Rate Loan or increase the cost to any Lender of issuing or maintaining any Letter of Credit or purchasing or maintaining a participation therein or to reduce the amount of any sum received or receivable by such Lender or such Issuing Bank hereunder (whether of principal, interest or otherwise) by an amount deemed by such Lender or such Issuing Bank to be material, then the Borrower shall pay to such Lender or such Issuing Bank, as the case may be, upon demand such additional amount or amounts as will compensate such Lender or such Issuing Bank, as the case may be, for such additional costs incurred or reduction suffered. Notwithstanding the foregoing, no Lender shall be entitled to request compensation under this paragraph with respect to any Competitive Loan if it should have been aware of the change giving rise to such request at the time of submission of the Competitive Bid pursuant to which such Competitive Loan shall have been made. (b) If any Lender or Issuing Bank shall have determined that the adoption after the date hereof of any law, rule, regulation or guideline regarding capital adequacy, or any change in any of the foregoing or in the interpretation or administration of any of the foregoing by any Governmental Authority charged with the interpretation or administration thereof, or compliance by any Lender (or any lending office of such Lender) or any Issuing Bank or any Lender's or Issuing Bank's holding company with any request or directive regarding capital adequacy (whether or not having the force of law) of any such Governmental Authority, has or would have the effect of reducing the rate of return on such Lender's or Issuing Bank's capital or on 42 the capital of such Lender's or Issuing Bank's holding company, if any, as a consequence of this Agreement or the Loans made or participations in Letters of Credit purchased by such Lender pursuant hereto or the Letters of Credit issued by such Issuing Bank pursuant hereto to a level below that which such Lender or Issuing Bank or such Lender's or Issuing Bank's holding company could have achieved but for such adoption, change or compliance (taking into consideration such Lender's or Issuing Bank's policies and the policies of such Lender's or Issuing Bank's holding company with respect to capital adequacy) by an amount deemed by such Lender or Issuing Bank to be material, then from time to time the Borrower shall pay to such Lender or Issuing Bank, as the case may be, such additional amount or amounts as will compensate such Lender or Issuing Bank or such Lender's or Issuing Bank's holding company for any such reduction suffered. (c) A certificate of a Lender or Issuing Bank setting forth such amount or amounts as shall be necessary to compensate such Lender or Issuing Bank, as applicable, as specified in paragraph (a) or (b) above, as the case may be, shall be delivered to the Borrower. The Borrower shall pay each Lender or Issuing Bank the amount shown as due on any such certificate delivered by it within 10 days after the receipt of the same. In the event any Lender delivers such a certificate, the Borrower may, at its sole expense and effort, require such Lender to transfer and assign, without recourse (in accordance with Section 9.04) all its interests, rights and obligations under this Agreement to an assignee which shall assume such assigned obligations (which assignee may be another Lender, if a Lender accepts such assignment); provided, however, that -------- ------- (i) such assignment shall not conflict with any law, rule or regulation or order of any Governmental Authority, (ii) the Borrower shall have received a written consent of the Agent in the case of an assignee that is not a Lender, which consent shall not unreasonably be withheld, and (iii) the Borrower or such assignee shall have paid to the assigning Lender in immediately available funds the principal of and interest accrued to the date of such payment on the Loans made by it hereunder and all other amounts owed to it hereunder. (d) Failure on the part of any Lender or the Issuing Bank to demand compensation for any increased costs or reduction in amounts received or receivable or reduction in return on capital with respect to any period shall not constitute a waiver of such Lender's or Issuing Bank's right to demand compensation with respect to such period or any other period. 43 (e) Without prejudice to the survival of any other agreement contained herein, the agreements and obligations contained in this Section shall survive the payment in full of the principal of and interest on all Loans made hereunder. SECTION 2.14. Change in Legality. (a) Notwithstanding any other ------------------- provision herein, if any change in any law or regulation or in the interpretation thereof by any Governmental Authority charged with the administration or interpretation thereof shall make it unlawful for any Lender to make or maintain any Eurocurrency Loan or Eurodollar Loan or to give effect to its obligations as contemplated hereby with respect to any Eurocurrency Loan or Eurodollar Loan, then, by written notice to the Borrower and to the Agent, such Lender may: (i) declare that Eurocurrency Loans or Eurodollar Loans, as the case may be, shall not thereafter be made by such Lender hereunder, whereupon such Lender shall not submit a Competitive Bid in response to a request for Eurodollar Competitive Loans and any request by the Borrower for a Eurocurrency Loan or Eurodollar Standby Borrowing, as the case may be, shall, as to such Lender only, be deemed a request for an ABR Loan to the Borrower unless such declaration shall be subsequently withdrawn; and (ii) require that all outstanding Eurocurrency Loans or Eurodollar Loans, as the case may be, made by it be converted to ABR Loans, in which event all such Eurocurrency Loans or Eurodollar Loans, as the case may be, shall be automatically converted to ABR Loans as of the effective date of such notice as provided in paragraph (b) below (such conversion to be made, in the case of a Eurocurrency Loan, into dollars at the applicable Spot Exchange Rate). In the event any Lender shall exercise its rights under (i) or (ii) above, all payments and prepayments of principal which would otherwise have been applied to repay the Eurocurrency Loans or Eurodollar Loans, as the case may be, that would have been made by such Lender or the converted Eurocurrency Loans or Eurodollar Loans of such Lender shall instead be applied to repay the ABR Loans made by such Lender in lieu of, or resulting from the conversion of, such Eurocurrency Loans or Eurodollar Loans. (b) For purposes of this Section, a notice to the Borrower by any Lender shall be effective as to each 44 Eurocurrency Loan or Eurodollar Loan, as the case may be, if lawful, on the last day of the Interest Period then applicable to such Eurocurrency Loan or Eurodollar Loan; in all other cases such notice shall be effective on the date of receipt by the Borrower. SECTION 2.15. Indemnity. The Borrower shall indemnify each Lender ---------- against any loss or expense which such Lender may sustain or incur as a consequence of (a) any failure by the Borrower to fulfill on the date of any borrowing hereunder the applicable conditions set forth in Article IV, (b) any failure by the Borrower to borrow or to refinance any Loan hereunder after irrevocable notice of such borrowing or refinancing has been given pursuant to Section 2.03 or 2.04, (c) any payment, prepayment, assignment pursuant to Section 2.13(c), conversion of a Eurocurrency Loan or Eurodollar Loan pursuant to Section 2.14(a) or conversion of a Eurocurrency Loan, Eurodollar Loan, CD Loan or Fixed Rate Loan required by any other provision of this Agreement or otherwise made or deemed made on a date other than the last day of the Interest Period applicable thereto, (d) any default in payment or prepayment of the principal amount of any Loan or any part thereof or interest accrued thereon, as and when due and payable at the due date thereof (whether by scheduled maturity, acceleration, irrevocable notice of prepayment or otherwise) or (e) the occurrence of any Event of Default, including, in each such case, any loss or reasonable expense sustained or incurred or to be sustained or incurred in liquidating or employing deposits from third parties acquired to effect or maintain such Loan or any part thereof as a Eurocurrency Loan, Eurodollar Loan, CD Loan or Fixed Rate Loan. Such loss or reasonable expense shall include an amount equal to the excess, if any, as reasonably determined by such Lender, of (i) its cost of obtaining the funds for the Loan being paid, prepaid, assigned, converted or not borrowed (based on the LIBO Rate or Adjusted CD Rate or, in the case of a Fixed Rate Loan, the fixed rate of interest applicable thereto) for the period from the date of such payment, prepayment, assignment, conversion or failure to borrow to the last day of the Interest Period for such Loan (or, in the case of a failure to borrow, the Interest Period for such Loan which would have commenced on the date of such failure) over (ii) the amount of interest (as reasonably determined by such Lender) that would be realized by such Lender in reemploying the funds so paid, prepaid, assigned, converted or not borrowed for such period or Interest Period, as the case may be. A certificate of any Lender setting forth any amount or amounts which such Lender is entitled to receive pursuant to this Section and 45 evidencing a loss suffered by such Lender of such amount or amounts shall be delivered to the Borrower. SECTION 2.16. Pro Rata Treatment. Except as required under Section ------------------- 2.14, each Term Borrowing, each Standby Borrowing, each payment or prepayment of principal of any Term Borrowing or Standby Borrowing, each payment of interest on the Term Loans or Standby Loans, each payment of the Facility Fees and L/C Participation Fees, each reduction of the Commitments and each refinancing of any Borrowing of any Class, shall be allocated pro rata among the Lenders in accordance with their respective Commitments of the applicable Class (or, if such Commitments shall have expired or been terminated, in accordance with the respective principal amounts of their outstanding Standby Loans or Term Loans, as the case may be). Each payment of principal of any Competitive Borrowing shall be allocated pro rata among the Lenders participating in such Borrowing in accordance with the respective principal amounts of their outstanding Competitive Loans comprising such Borrowing. Each payment of interest on any Competitive Borrowing shall be allocated pro rata among the Lenders participating in such Borrowing in accordance with the respective amounts of accrued and unpaid interest on their outstanding Competitive Loans comprising such Borrowing. For purposes of determining the available Commitments of the Lenders at any time, each outstanding Competitive Borrowing shall be deemed to have utilized the Commitments of the Lenders (including those Lenders which shall not have made Loans as part of such Competitive Borrowing) pro rata in accordance with such respective Commitments. Each Lender agrees that in computing such Lender's portion of any Borrowing to be made hereunder, the Agent may, in its discretion, round each Lender's percentage of such Borrowing to the next higher or lower whole dollar amount. SECTION 2.17. Sharing of Setoffs. Each Lender agrees that if it ------------------- shall, through the exercise of a right of banker's lien, setoff or counterclaim against the Borrower , or pursuant to a secured claim under Section 506 of Title 11 of the United States Code or other security or interest arising from, or in lieu of, such secured claim, received by such Lender under any applicable bankruptcy, insolvency or other similar law or otherwise, or by any other means (other than an assignment pursuant to Section 2.13(c) or 9.04), obtain payment (voluntary or involuntary) in respect of any Term Loan, Standby Loan or L/C Disbursement as a result of which the unpaid principal portion of its Term Loans, Standby Loans and participations in L/C Disbursements shall be proportionately less than the unpaid principal portion of 46 the Term Loans, Standby Loans and participations in L/C Disbursements of any other Lender, it shall be deemed simultaneously to have purchased from such other Lender at face value, and shall promptly pay to such other Lender the purchase price for, a participation in the Term Loans, Standby Loans and L/C Exposure of such other Lender, so that the aggregate unpaid principal amount of the Term Loans, Standby Loans and L/C Exposure and participations in the Term Loans, Standby Loans and L/C Exposure held by each Lender shall be in the same proportion to the aggregate unpaid principal amount of all Term Loans, Standby Loans and L/C Exposure then outstanding as the principal amount of its Term Loans, Standby Loans and L/C Exposure prior to such exercise of banker's lien, setoff or counterclaim or other event was to the principal amount of all Term Loans, Standby Loans or LC Exposure, as the case may be, outstanding prior to such exercise of banker's lien, setoff or counterclaim or other event; provided, -------- however, that, if any such purchase or purchases or adjustments shall be made - ------- pursuant to this Section and the payment giving rise thereto shall thereafter be recovered, such purchase or purchases or adjustments shall be rescinded to the extent of such recovery and the purchase price or prices or adjustment restored without interest. The Borrower expressly consents to the foregoing arrangements and agrees that any Lender holding a participation in a Term Loan, Standby Loan or L/C Disbursement deemed to have been so purchased may exercise any and all rights of banker's lien, setoff or counterclaim with respect to any and all moneys owing by the Borrower to such Lender by reason thereof as fully as if such Lender had made a Term Loan or Standby Loan directly to the Borrower in the amount of such participation. SECTION 2.18. Payments. (a) The Borrower shall make each payment --------- (including principal of or interest on the Loans or any L/C Disbursement or any Fees or other amounts) hereunder and under any other Loan Document to such account of the Agent as the Agent shall have specified, not later than 10:30 a.m., local time, at the place of payment, on the date when due, in the currency in which such Loan was made and in federal funds or such other immediately available funds as may then be customary for the settlement of international transactions in the relevant currency at such place. (b) Whenever any payment (including principal of or interest on any Borrowing or any Fees or other amounts) hereunder or under any other Loan Document shall become due, or otherwise would occur, on a day that is not a Business Day, such payment may (except as otherwise provided in the definition of "Interest Period") be made on the next 47 succeeding Business Day, and such extension of time shall in such case be included in the computation of interest or Fees, if applicable. SECTION 2.19. Taxes. (a) Any and all payments by the Borrower ------ hereunder shall be made, in accordance with Section 2.18, free and clear of and without deduction for any and all present or future taxes, imposts, deductions, charges or withholdings, and all liabilities with respect thereto, excluding --------- taxes imposed on the Agent's or any Lender's or any Issuing Bank's (or any transferee's or assignee's, including a participation holder's (any such entity a "Transferee")) net income and franchise taxes imposed on the Agent or any ---------- Lender or any Issuing Bank (or Transferee) by any jurisdiction or any political subdivision thereof (all such nonexcluded taxes, levies, imposts, deductions, charges, withholdings and liabilities being hereinafter referred to as "Taxes"). ----- If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to the Lenders or any Issuing Bank (or any Transferee) or the Agent, (i) the sum payable shall be increased by the amount necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section) such Lender or such Issuing Bank (or Transferee) or the Agent (as the case may be) shall receive an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions and (iii) the Borrower shall pay the full amount deducted to the relevant taxing authority or other Governmental Authority in accordance with applicable law. (b) In addition, the Borrower shall pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies which arise from any payment made hereunder or from the execution, delivery or registration of, or otherwise with respect to, this Agreement or any other Loan Document (hereinafter referred to as "Other Taxes"). ----------- (c) The Borrower shall indemnify each Lender and Issuing Bank (or Transferee) and the Agent for the full amount of Taxes and Other Taxes (including any Taxes or Other Taxes imposed by any jurisdiction on amounts payable under this Section) paid by such Lender or such Issuing Bank (or Transferee) or the Agent, as the case may be, and any liability (including penalties, interest and reasonable out-of-pocket expenses) arising therefrom or with respect thereto, whether or not such Taxes or Other Taxes were correctly or legally asserted by the relevant taxing 48 authority or other Governmental Authority. Such indemnification shall be made within 30 days after the date any Lender or Issuing Bank (or Transferee) or the Agent, as the case may be, makes written demand therefor, which demand may be made after such Lender, Issuing Bank (or Transferee) or the Agent, in its sole discretion (reasonably exercised) and at the sole expense of the Borrower, determines to challenge or contest such assertion of Taxes or Other Taxes. After the Borrower makes full payment to the Lender, Issuing Bank (or Transferee) or the Agent with respect to such indemnification for Taxes or Other Taxes asserted, if such Lender, Issuing Bank (or Transferee) or the Agent believes in its sole discretion that reasonable grounds exist to challenge or contest the Taxes or Other Taxes imposed, then such Lender, Issuing Bank (or Transferee) or the Agent, as the case may be, shall so contest or challenge in good faith the Taxes or Other Taxes asserted, which contest or challenge shall be at the sole expense of the Borrower. If a Lender, Issuing Bank (or Transferee) or the Agent shall become aware that it is entitled to receive a refund in respect of Taxes or Other Taxes, it shall promptly notify the Borrower of the availability of such refund and shall, within 30 days after receipt of a request by the Borrower, apply for such refund at the Borrower's reasonable out-of-pocket expense. If any Lender, Issuing Bank (or Transferee) or the Agent receives a refund in respect of any Taxes or Other Taxes for which such Lender, Issuing Bank (or Transferee) or the Agent has received payment from the Borrower hereunder it shall promptly notify the Borrower of such refund and shall promptly upon receipt repay such refund to the Borrower, net of all out-of- pocket expenses of such Lender or Issuing Bank and without interest; provided, -------- however, that the Borrower, upon the request of such Lender, Issuing Bank (or - ------- Transferee) or the Agent, agrees to return such refund (plus penalties, interest or other charges) to such Lender, Issuing Bank (or Transferee) or the Agent in the event such Lender, Issuing Bank (or Transferee) or the Agent is required to repay such refund. (d) Within 30 days after the date of any payment of Taxes or Other Taxes withheld by the Borrower in respect of any payment to any Lender, Issuing Bank (or Transferee) or the Agent, the Borrower will furnish to the Agent, at its address referred to in Section 9.01, the original or a certified copy of a receipt evidencing payment thereof. (e) Without prejudice to the survival of any other agreement contained herein, the agreements and obligations contained in this Section shall survive the 49 payment in full of the principal of and interest on all Loans made hereunder. (f) On or before the date it becomes a party to this Agreement and from time to time thereafter upon any change in status rendering any certificate or documents previously delivered pursuant to this Section 2.19(f) invalid or inaccurate, each Lender, Issuing Bank or Transferee that is organized outside the United States shall (but (x) in the case of a Transferee or (y) in the case of a Lender or Issuing Bank with respect to any change in status, only if legally able to do so) upon written request of the Borrower, deliver to the Borrower such certificates, documents or other evidence, as specified by the Borrower and, as the case may be, required by, in the case of a non-United States Lender or Issuing Bank, the Code or Treasury Regulations issued pursuant thereto, properly completed and duly executed by such Lender (or Transferee) establishing that such payment is, as the case may be, (i) not subject to withholding under the Code because such payment is effectively connected with the conduct by such Lender, Issuing Bank or Transferee of a trade or business in the United States or (ii) totally exempt from United States tax under a provision of an applicable tax treaty. Unless the Borrower and the Agent have received forms or other docu ments satisfactory to them indicating that payments here under are not subject to United States withholding tax, as the case may be, or are subject to such tax at a rate reduced by an applicable tax treaty, the Borrower or the Agent shall withhold taxes from such payments at the appli cable statutory rate in the case of payments to or for any Lender, Issuing Bank or Transferee or assignee organized under the laws of a jurisdiction outside the United States or Germany, as the case may be. (g) The Borrower shall not be required to pay any additional amounts to any Lender, Issuing Bank or Transferee in respect of United States withholding tax pursuant to Section 2.19(a) if the obligation to pay such additional amounts would not have arisen but for a failure by such Lender, Issuing Bank or Transferee to comply with the provisions of Section 2.19(f) unless such failure results from (i) a change in applicable law, regulation or official interpretation thereof or (ii) an amendment, modification or revocation of any applicable tax treaty or a change in official position regarding the application or interpretation thereof, in each case after the Effective Date (and, in the case of a Transferee, after the date of assignment or transfer, unless as a result of such change, amendment, modification or revocation withholding taxes were 50 or would have been imposed on amounts payable to the transferor); provided, -------- however, that the Borrower shall be required to pay those amounts to any Lender, - ------- Issuing Bank or Transferee that it was required to pay hereunder prior to the failure of such Lender, Issuing Bank or Transferee to comply with the provisions of Section 2.19(f). (h) Any Lender, Issuing Bank or Transferee claiming any additional amounts payable pursuant to this Section shall use reasonable efforts (consistent with legal and regulatory restrictions) to file any certificate or document in a timely manner requested by the Borrower or to change the jurisdiction of its applicable lending office if the making of such a filing or change would avoid the need for or reduce the amount of any such additional amounts which may thereafter accrue and would not, in the sole and reasonable determination of such Lender, Issuing Bank or Transferee be otherwise disadvantageous to such Lender, Issuing Bank or Transferee. SECTION 2.20. Letters of Credit. (a) General. The Borrower may ------------------ -------- request the issuance of a Letter of Credit for its own account, in a form reasonably acceptable to the Agent and the Issuing Bank, at any time and from time to time while the Revolving Commitments remain in effect. Each Letter of Credit shall be denominated in dollars. This Section shall not be construed to impose an obligation upon the Issuing Bank to issue any Letter of Credit that is inconsistent with the terms and conditions of this Agreement. (b) Notice of Issuance, Amendment, Renewal, Extension; Certain ---------------------------------------------------------- Conditions. In order to request the issuance of a Letter of Credit (or to - ----------- amend, renew or extend an existing Letter of Credit), the Borrower shall hand deliver or telecopy to the Issuing Bank and the Agent (reasonably in advance of the requested date of issuance, amendment, renewal or extension) a notice requesting the issuance of a Letter of Credit, or identifying the Letter of Credit to be amended, renewed or extended, the date of issuance, amendment, renewal or extension, the date on which such Letter of Credit is to expire (which shall comply with paragraph (c) below), the amount of such Letter of Credit, the name and address of the beneficiary thereof and such other information as shall be necessary to prepare such Letter of Credit. Following receipt of such notice and prior to the issuance of the requested Letter of Credit or the applicable amendment, renewal or extension, the Agent shall notify the Borrower and the Issuing Bank of the amount of the Aggregate Standby Exposure and the aggregate 51 principal amount of the outstanding Competitive Borrowings after giving effect to (i) the issuance, amendment, renewal or extension of such Letter of Credit, (ii) the issuance or expiration of any other Letter of Credit that is to be issued or will expire prior to the requested date of issuance of such Letter of Credit and (iii) the borrowing or repayment of any Standby Loans or Competitive Loans that (based upon notices delivered to the Agent by the Borrower) are to be borrowed or repaid prior to the requested date of issuance of such Letter of Credit. A Letter of Credit shall be issued, amended, renewed or extended only if, and upon issuance, amendment, renewal or extension of each Letter of Credit the Borrower shall be deemed to represent and warrant that, after giving effect to such issuance, amendment, renewal or extension (A) the L/C Exposure shall not exceed $10,000,000 and (B) the sum of the Aggregate Standby Exposure and the aggregate principal amount of outstanding Competitive Borrowings shall not exceed the Total Revolving Commitment. The Agent shall notify the Lenders of any issuance of a Letter of Credit. (c) Expiration Date. Each Letter of Credit shall expire at the close ---------------- of business on the earlier of the date one year after the date of the issuance of such Letter of Credit and the date that is 30 days prior to the Revolving Maturity Date, unless such Letter of Credit expires by its terms on an earlier date. (d) Participations. By the issuance of a Letter of Credit and --------------- without any further action on the part of the Issuing Bank or the Lenders, the Issuing Bank hereby grants to each Lender, and each such Lender hereby acquires from the Issuing Bank, a participation in such Letter of Credit equal to such Lender's Pro Rata Percentage of the aggregate amount available to be drawn under such Letter of Credit, effective upon the issuance of such Letter of Credit. In consideration and in furtherance of the foregoing, each Lender hereby absolutely and unconditionally agrees to pay to the Agent, for the account of the Issuing Bank, such Lender's Pro Rata Percentage of each L/C Disbursement made by such Issuing Bank and not reimbursed by the Borrower forthwith on the date due as provided in Section 2.02(e). Each Lender acknowledges and agrees that its obligation to acquire participations pursuant to this paragraph in respect of Letters of Credit is absolute and unconditional and shall not be affected by any circumstance whatsoever, including the occurrence and continuance of a Default or an Event of Default or the termination of the Revolving Commitments, and that each such payment shall be made without any offset, abatement, withholding or reduction whatsoever. 52 (e) Reimbursement. If an Issuing Bank shall make any L/C -------------- Disbursement in respect of a Letter of Credit, the Borrower shall pay to the Agent an amount equal to such L/C Disbursement not later than two hours after the Borrower shall have received notice from such Issuing Bank that payment of such draft will be made, or, if the Borrower shall have received such notice later than 10:00 a.m., New York City time, on any Business Day, not later than 10:00 a.m., New York City time, on the immediately following Business Day. (f) Obligations Absolute. The Borrower's obligations to reimburse --------------------- L/C Disbursements as provided in paragraph (e) above shall be absolute, unconditional and irrevocable, and shall be performed strictly in accordance with the terms of this Agreement, under any and all circumstances whatsoever, and irrespective of: (i) any lack of validity or enforceability of any Letter of Credit or this Agreement, or any term or provision therein; (ii) any amendment or waiver of or any consent to departure from all or any of the provisions of any Letter of Credit or this Agreement; (iii) the existence of any claim, setoff, defense or other right that the Borrower, any other party guaranteeing, or otherwise obligated with, the Borrower, any Subsidiary or other Affiliate thereof or any other person may at any time have against the beneficiary under any Letter of Credit, any Issuing Bank, the Agent or any Lender or any other person, whether in connection with this Agreement or any other related or unrelated agreement or transaction; (iv) any draft or other document presented under a Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; (v) payment by the Issuing Bank under a Letter of Credit against presentation of a draft or other document that does not comply with the terms of such Letter of Credit; and (vi) any other act or omission to act or delay of any kind of any Issuing Bank, the Lenders, the Agent or any other person or any other event or circumstance whatsoever, whether or not similar to any of the 53 foregoing, that might, but for the provisions of this Section, constitute a legal or equitable discharge of the Borrower's obligations hereunder. Without limiting the generality of the foregoing, it is expressly understood and agreed that the absolute and unconditional obligation of the Borrower hereunder to reimburse L/C Disbursements will not be excused by the negligence or misconduct of any Issuing Bank. However, the foregoing shall not be construed to excuse any Issuing Bank from liability to the Borrower to the extent of any damages (as opposed to consequential damages, claims in respect of which are hereby waived by the Borrower to the extent permitted by applicable law) suffered by the Borrower that are caused by such Issuing Bank's negligence or misconduct in determining whether drafts and other documents presented under a Letter of Credit comply with the terms thereof; it is understood that each Issuing Bank may accept documents that appear on their face to be in order, without responsibility for further investigation, regardless of any notice or information to the contrary and, in making any payment under any Letter of Credit (i) an Issuing Bank's exclusive reliance on the documents presented to it under such Letter of Credit as to any and all matters set forth therein, including reliance on the amount of any draft presented under such Letter of Credit, whether or not the amount due to the beneficiary thereunder equals the amount of such draft and whether or not any document presented pursuant to such Letter of Credit proves to be insufficient in any respect, if such document on its face appears to be in order, and whether or not any other statement or any other document presented pursuant to such Letter of Credit proves to be forged or invalid or any statement therein proves to be inaccurate or untrue in any respect whatsoever and (ii) any noncompliance in any immaterial respect of the documents presented under such Letter of Credit with the terms thereof shall, in each case, be deemed not to constitute misconduct or negligence of an Issuing Bank. (g) Disbursement Procedures. The Issuing Bank shall, promptly ------------------------ following its receipt thereof, examine all documents purporting to represent a demand for payment under a Letter of Credit. Such Issuing Bank shall as promptly as possible give telephonic notification, confirmed by telecopy, to the Agent and the Borrower of such demand for payment and whether such Issuing Bank has made or will make an L/C Disbursement thereunder; provided that any failure -------- to give or delay in giving such notice shall not relieve the Borrower of its obligation to reimburse the Issuing Bank and 54 the Lenders with respect to any such L/C Disbursement. The Agent shall promptly give each Lender notice thereof. (h) Resignation or Removal of an Issuing Bank. An Issuing Bank may ------------------------------------------ resign at any time by giving 180 days' prior written notice to the Agent, the Lenders and the Borrower, and may be removed at any time by the Borrower by notice to the Issuing Bank, the Agent and the Lenders. Subject to the next succeeding paragraph, upon the acceptance of any appointment as an Issuing Bank hereunder by a Lender that shall agree to serve as successor Issuing Bank, such successor shall succeed to and become vested with all the interests, rights and obligations of the retiring Issuing Bank and the retiring Issuing Bank shall be discharged from its obligations to issue additional Letters of Credit hereunder. At the time such removal or resignation shall become effective, the Borrower shall pay all accrued and unpaid fees pursuant to Section 2.06(c)(ii). The acceptance of any appointment as an Issuing Bank hereunder by a successor Lender shall be evidenced by an agreement entered into by such successor, in a form satisfactory to the Borrower and the Agent, and, from and after the effective date of such agreement, (i) such successor Lender shall have all the rights and obligations of the previous Issuing Bank under this Agreement and (ii) references herein to the term "Issuing Bank" shall be deemed to refer to such successor or to any previous Issuing Bank, or to such successor and all previous Issuing Banks, as the context shall require. After the resignation or removal of an Issuing Bank hereunder, the retiring Issuing Bank shall remain a party hereto and shall continue to have all the rights and obligations of an Issuing Bank under this Agreement with respect to Letters of Credit issued by it prior to such resignation or removal, but shall not be required to issue additional Letters of Credit. (i) Cash Collateralization. If any Event of Default (other than an ----------------------- Event of Default described in clause (g) or (h) of Article VII) shall occur and be continuing, the Borrower shall, on the Business Day it receives notice from the Agent or the Required Lenders (or, if the maturity of the Loans has been accelerated, Lenders holding participations in outstanding Letters of Credit representing greater than 50% of the aggregate undrawn amount of all outstanding Letters of Credit) thereof and of the amount to be deposited, or, if an Event of Default described in clause (g) or (h) of Article VII shall occur, on the Business Day of such occurrence, deposit in an account with the Agent, for the benefit of the Lenders, an amount in cash equal to the L/C Exposure as of such date. Such deposit shall be 55 held by the Agent as collateral for the payment and performance of the obligations of the Borrower under this Agreement. The Agent shall have exclusive dominion and control, including the exclusive right of withdrawal, over such account. Other than any interest earned on the investment of such deposits in Permitted Investments, which investments shall be made at the option and sole discretion of the Agent, such deposits shall not bear interest. Interest or profits, if any, on such investments shall accumulate in such account. Moneys in such account shall (i) automatically be applied by the Agent to reimburse the Issuing Bank for L/C Disbursements for which they have not been reimbursed, (ii) be held for the satisfaction of the reimbursement obligations of the Borrower for the L/C Exposure at such time and (iii) if the maturity of the Loans has been accelerated (but subject to the consent of Lenders holding participations in outstanding Letters of Credit representing greater than 50% of the aggregate undrawn amount of all outstanding Letters of Credit), be applied to satisfy other obligations of the Borrower under this Agreement. If the Borrower is required to provide an amount of cash collateral hereunder as a result of the occurrence of an Event of Default, such amount (to the extent not applied as aforesaid) shall be returned to the Borrower within three Business Days after all Events of Default have been cured or waived. SECTION 2.21. Currency Fluctuations, etc. (a) Not later than 1:00 --------------------------- p.m., New York City time, on each Calculation Date, the Agent shall (i) determine the Spot Exchange Rate as of such Calculation Date with respect to each Eurocurrency Borrowing and (ii) give notice thereof to the Lenders and the Borrower. The Spot Exchange Rates so determined shall become effective on the first Business Day immediately following the relevant Calculation Date(a "Reset ----- Date") and shall remain effective until the next succeeding Reset Date. - ---- (b) Not later than 5:00 p.m., New York City time, on each Reset Date, the Agent shall (i) determine the Equivalent Dollar Amount of the Eurocurrency Loans then outstanding (after giving effect to any Eurocurrency Loans to be made or repaid on such date) and (ii) notify the Lenders and the Borrower of the results of such determination. (c) If on any Reset Date with respect to Eurocurrency Loans outstanding the Equivalent Dollar Amount of all Loans outstanding exceeds 110% of the Eurocurrency Sublimit the Borrower shall on such day prepay Eurocurrency 56 Loans in an aggregate amount such that, after giving effect thereto, the Equivalent Dollar Amount of all such Eurocurrency Loans shall be equal to or less than the Eurocurrency Sublimit. If any such prepayment occurs on a day which is not the last day of the then current Interest Period with respect thereto, the Borrower shall pay to the Lenders such amounts, if any, which may be required pursuant to Section 2.15. ARTICLE III. REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants to each of the Lenders that: SECTION 3.01. Organization; Powers. Each of the Borrower and the --------------------- Subsidiaries (a) is duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization, (b) has all requisite power and authority to own its property and assets and to carry on its business as now conducted and as proposed to be conducted, (c) is qualified to do business in every juris diction where such qualification is required, except where the failure so to qualify would not result in a Material Adverse Effect, and (d) in the case of each Loan Party, has the power and authority to execute, deliver and perform its obligations under each Loan Document to which it is party and each other agreement or instrument contemplated thereby and in the case of the Borrower, to borrow and incur other obligations hereunder. SECTION 3.02. Authorization. The execution, delivery and performance -------------- by each Loan Party of the Loan Documents to which it is to be a party and in the case of the Borrower the borrowings of the Loans, the use of proceeds thereof and the Letters of Credit hereunder (collectively, the "Transactions") (a) have ------------ been duly authorized by all requisite action, including approval of such Loan Party's Board of Directors and if required, stockholder action on the part of such Loan Party and (b) will not (i) violate (A) any provision of law, statute, rule or regulation, or of the certificate or articles of incorporation or other constitutive documents or by-laws of the Borrower or any Subsidiary, (B) any order of any Govern mental Authority or (C) any provision of any indenture, agreement or other instrument to which the Borrower or any Subsidiary is a party or by which any of them or any of their property is or may be bound, (ii) be in conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default under any such indenture, 57 agreement or other instrument or (iii) result in the crea tion or imposition of any Lien upon or with respect to any property or assets now owned or hereafter acquired by the Borrower or any Subsidiary. SECTION 3.03. Enforceability. This Agreement has been duly executed --------------- and delivered by the Borrower and constitutes, and each other Loan Document when executed and delivered by the Loan Parties party thereto will constitute, a legal, valid and binding obligation of the Borrower and the other Loan Parties enforceable against the Borrower and the other Loan Parties in accordance with its terms. SECTION 3.04. Governmental Approvals. No action, consent or approval ----------------------- of, registration or filing with or any other action by any Governmental Authority is or will be required in connection with the Transactions, except such as have been made or obtained and are in full force and effect. SECTION 3.05. Financial Statements. (a) The Borrower has heretofore --------------------- furnished to the Lenders (i) the combined balance sheets and statements of income and cash flow of Sunburst and its combined Subsidiaries pre-Spin-Off as of and for the fiscal year ended May 31, 1997, audited by and accompanied by the opinion of Arthur Andersen & Co., independent public accountants, (ii) the combined balance sheets and statements of income and cash flow of the Borrower and its combined Subsidiaries post-Spin-Off as of and for the fiscal year ended May 31, 1997, audited and accompanied by the opinion of Arthur Anderson & Co., independent public accountants and (iii) the unaudited combined balance sheets and statements of income and cash flow of the Sunburst and its combined Subsidiaries pre-Spin-Off as of and for the fiscal quarter ended August 31, 1997, each certified by the chief financial officer (or, in the absence of such a position, comptroller) of the Borrower or Sunburst. Such financial statements present fairly the financial condition and results of operations of the Borrower and its combined Subsidiaries as of such dates and for such periods. Such balance sheets and the notes thereto disclose all material liabilities, direct or contingent, of the Borrower and its combined subsidiaries as of the dates thereof. Such financial statements and monthly summaries of pretax income or loss were prepared in accordance with GAAP applied on a consistent basis. (b) The Borrower has heretofore furnished to the Lenders its pro forma consolidated balance sheet as of October 15, 1997 prepared giving effect to the Spin-Off as if the Spin-Off had occurred on such date. Such pro forma 58 consolidated balance sheet (i) has been prepared in good faith based on the same assumptions used to prepare the pro forma financial statements included in the Form 10 (which assumptions are believed by the Borrower and Sunburst to be reasonable), (ii) is based on the best information available to the Borrower and Sunburst after due inquiry, (iii) accurately reflects all adjustments necessary to give effect to the Spin-Off, (iv) presents fairly, in all material respects, the pro forma financial position of the Borrower and its consolidated Subsidiaries as of the date of such balance sheet as if the Spin-Off had occurred on such date and (v) is not materially inconsistent with the forecasts previously provided to the Lenders by the Borrower. SECTION 3.06. No Material Adverse Change. As of the date hereof, --------------------------- there has been no material adverse change in the business, assets, operations, property, condition, financial or otherwise, contingent liabilities or material agreements of the Borrower and the Subsidiaries, taken as a whole, since May 31, 1997 (it being understood that changes in general economic conditions shall not be deemed to constitute such a material adverse change). SECTION 3.07. Title to Properties; Possession Under Leases. (a) --------------------------------------------- Each of the Borrower and the Subsidiar ies has good and marketable title to, or valid leasehold interests in, all its material properties and assets, except for minor defects in title that do not interfere with its ability to conduct its business as currently conducted or to utilize such properties and assets for their intended pur poses. All such material properties and assets are free and clear of Liens, other than Liens expressly permitted by Section 6.02. (b) Each of the Borrower and the Subsidiaries has complied with all material obligations under all material leases to which it is a party and all such leases are in full force and effect. Each of the Borrower and the Subsidiaries enjoys peaceful and undisturbed possession under all such material leases. (c) On and as of the date of the initial Credit Event under this Agreement, the Borrower will own, or have a valid leasehold interest in, all of the assets, business and operations currently conducted by that portion of the pre-Spin-Off operations that will be conducted by the Borrower post-Spin-Off (as described in the Distribution Agreement), (other than assets since disposed of prior to the date of such Borrowing in the ordinary course of business and assets described on Schedule 3.07). 59 SECTION 3.08. Subsidiaries. Schedule 3.08 sets forth as of the date ------------- hereof and as of the Effective Date a list of all Subsidiaries of the Borrower and the percentage ownership interest of the Borrower therein. Except as set forth on Schedule 3.08, as of the date hereof and the Effective Date no Subsidiary has assets greater than or equal to 10% of Consolidated Total Assets. SECTION 3.09. Litigation; Compliance with Laws. (a) There are not --------------------------------- any actions, suits or proceedings at law or in equity or by or before any Governmental Authority now pending or, to the knowledge of the Borrower, threatened against or affecting the Borrower or any Subsidiary or any business, property or rights of any such person (i) which involve any Loan Document, the Transactions or the Spin-Off (excluding any such actions, suits or proceedings threatened by the Lenders or the Agent) or (ii) as to which there is a reasonable probability of an adverse determination and which, if such probable adverse determination occurred, could, individually or in the aggregate, reasonably be anticipated to result in a Material Adverse Effect. (b) To the best knowledge of the Borrower, neither the Borrower nor any of the Subsidiaries is in vio lation of any law, rule or regulation, or in default with respect to any judgment, writ, injunction or decree of any Governmental Authority, where such violation or default could reasonably be anticipated to result in a Material Adverse Effect. SECTION 3.10. Agreements. (a) Neither the Borrower nor any of the ----------- Subsidiaries is a party to any agreement or instrument or subject to any corporate or other restriction that has resulted or could reasonably be anticipated to result in a Material Adverse Effect. (b) Neither the Borrower nor any of its Subsidi aries is in default in any manner under any provision of any indenture or other agreement or instrument evidencing Indebtedness, or any other material agreement or instrument to which it is a party or by which it or any of its proper ties or assets are or may be bound, where such default could reasonably be anticipated to result in a Material Adverse Effect. SECTION 3.11. Federal Reserve Regulations. (a) Neither the Borrower ---------------------------- nor any of the Subsidiaries is engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying Margin Stock. 60 (b) Following application of the proceeds of each Loan, not more than 25 percent of the value of the assets of the Borrower subject to the provisions of Section 6.02 or paragraph (f) of Article VII will be Margin Stock. SECTION 3.12. Investment Company Act; Public Utility Holding Company ------------------------------------------------------ Act. Neither the Borrower nor any Subsidiary is (a) an "investment company" as - ---- defined in, or subject to regulation under, the Investment Company Act of 1940 or (b) a "holding company" as defined in, or subject to regulation under, the Public Utility Holding Company Act of 1935. SECTION 3.13. Use of Proceeds. The Borrower will use the proceeds of ---------------- the Loans and will request the issuance of Letters of Credit only for the purposes specified in the preamble to this Agreement. SECTION 3.14. Tax Returns. Each of the Borrower and the Subsidiaries ------------ has filed or caused to be filed all Federal, state, local and foreign tax returns required to have been filed by it and has paid or caused to be paid all taxes shown to be due and payable on such returns or on any assessments received by it, except taxes that are being contested in good faith by appropriate proceedings and for which the Borrower or such Subsidiary shall have set aside on its books adequate reserves. SECTION 3.15. No Material Misstatements. No information, report, -------------------------- financial statement, exhibit or sched ule furnished by or on behalf of the Borrower to the Agent or any Lender in connection with the negotiation of any Loan Document or included therein or delivered pursuant thereto contained, contains or will contain any material misstate ment of fact or omitted, omits or will omit to state any material fact necessary to make the statements therein, in the light of the circumstances under which they were, are or will be made, not misleading. SECTION 3.16. Employee Benefit Plans. Each of the Plans, the ----------------------- Borrower and its ERISA Affiliates is in compliance in all material respects with the applicable provisions of ERISA and the regulations and published interpretations thereunder. No Reportable Event has occurred as to which the Borrower or any ERISA Affiliate was required to file a report with the PBGC, and the present value of all benefit liabilities under each Plan (based on those assumptions used to fund such Plan) did not, as of the last annual valuation date applicable thereto, exceed by more than $5,000,000 the value of the assets of such Plan. 61 Neither the Borrower nor any ERISA Affiliate has incurred any Withdrawal Liability or any other liability under Title IV of ERISA (other than premiums not yet due) that remains unpaid and that could result in a Material Adverse Effect. Neither the Borrower nor any ERISA Affiliate has received any notification that any Multiemployer Plan is in reorganization or has been terminated within the meaning of Title IV of ERISA, and to the best knowledge of the Borrower no Multiemployer Plan is reasonably expected to be in reorganization or to be terminated, where such reorganization or termination has resulted or could reason ably be expected to result, through increases in the contri butions required to be made to such Plan or otherwise, in a Material Adverse Effect. Neither the Borrower nor any ERISA Affiliate has received any notice from the PBGC regarding the funded status of any plan. SECTION 3.17. Environmental Matters. The Borrower and each ---------------------- Subsidiary has complied in all material respects with all Federal, state, local and other statutes, ordinances, orders, judgments, rulings and regulations relating to environmental pollution or to environmental regulation or control or to employee health or safety. Neither the Borrower nor any Subsidiary has received notice of any failure so to comply. The Borrower's and the Subsid iaries' facilities do not manage any hazardous wastes, hazardous substances, hazardous materials, toxic substances, toxic pollutants or substances similarly denominated, as those terms or similar terms are used in the Resource Conservation and Recovery Act, the Comprehensive Environ mental Response Compensation and Liability Act, the Hazard ous Materials Transportation Act, the Toxic Substance Control Act, the Clean Air Act, the Clean Water Act or any other applicable law, in material violation of any such law or any regulations promulgated pursuant thereto. SECTION 3.18. Solvency. As of the Effective Date and after --------- giving effect to the Spin-Off: (a) The fair salable value of the assets of the Borrower and each Significant Subsidiary will exceed the amount that will be required to be paid on or in respect of the existing debts and other liabilities of the Borrower or Significant Subsidiary as such debts and liabilities become absolute and mature. (b) Except in the case of a refinancing of a Standby Borrowing with a new Standby Borrowing that does not increase the aggregate principal amount of the Loans of any Lender outstanding, the assets of the 62 Borrower and each Significant Subsidiary will not constitute unreasonably small capital for the Borrower or Significant Subsidiary to carry out its businesses as now conducted and as proposed to be conducted including the capital needs of the Borrower or Significant Subsidiary, taking into account the particular capital requirements of the business conducted by the Borrower or Significant Subsidiary and projected capital requirements and capital availability thereof. (c) Neither the Borrower nor any Significant Subsidiaries intends to incur debts or liabilities beyond its ability to pay such debts and liabilities as they mature, taking into account the timing and amounts of cash to be received by it, and of amounts to be payable on or in respect of its debts and liabilities. The cash flow of the Borrower and each Significant Subsidiary, after taking into account all anticipated uses of the cash of the Borrower or such Significant Subsidiary, will at all times be sufficient to pay all such amounts on or in respect of debt and liabilities of the Borrower or such Significant Subsidiary when such amounts are required to be paid. SECTION 3.19. Spin-Off. As of the Effective Date, the Spin-Off will --------- have been effected in a manner that (a) is not materially different from the description thereof in the Form 10 (including but not limited to the tax consequences of the Spin-Off) and (b) will not materially adversely affect the rights or interests of the Lenders or the creditworthiness of the Borrower. ARTICLE IV. CONDITIONS OF LENDING The effectiveness of this Agreement and the obligations of the Lenders to make Loans and of the Issuing Bank to issue, extend or renew Letters of Credit hereunder are subject to the satisfaction of the following conditions: SECTION 4.01. All Credit Events. On the date of each Borrowing or ------------------ issuance, extension or renewal of a Letter of Credit (each such event being called a "Credit Event"): (a) The Agent shall have received a notice of such Credit Event as required by Section 2.03, Section 2.04 or Section 2.20, as the case may be (or such notice shall have been deemed given in accordance with Section 2.04). 63 (b) Except in the case of a refinancing of a Standby Borrowing with a new Standby Borrowing that does not increase the aggregate principal amount of the Loans of any Lender outstanding, the representations and warranties set forth in Article III hereof shall be true and correct in all material respects on and as of the date of such Credit Event with the same effect as though made on and as of such date, except to the extent such representations and warranties expressly relate to an earlier date. (c) Each Loan Party shall be in compliance with all the terms and provisions set forth herein and in each other Loan Document on its part to be observed or performed, and at the time of and immediately after such Credit Event, no Event of Default or Default shall have occurred and be continuing. Each Credit Event shall be deemed to constitute a representation and warranty by the Borrower on the date of such Credit Event as to the matters specified in paragraphs (b) and (c) of this Section 4.01. SECTION 4.02. First Credit Event. On the Effective Date: ------------------- (a) All legal matters incident to this Agreement and the borrowings hereunder and the other Loan Documents shall be satisfactory to the Lenders and their counsel and to the Issuing Bank and to Cravath, Swaine & Moore, counsel for the Agent. (b) The Agent shall have received (i) a copy of the certificate or articles of incorporation (or analogous documents) and all amendments thereto of each Loan Party certified as of a recent date by the Secre tary of State (or other appropriate Governmental Authority) of the state (or country) of its organization or such other evidence as is reasonably satisfactory to the Agent; (ii) a certificate as to the good standing (or other analogous certification to the extent available) of each Loan Party as of a recent date, from the appropriate Secretary of State (or other appropriate Governmental Authority) or such other evidence as is reasonably satisfactory to the Agent; (iii) a certificate of the Secretary or Assistant Secretary of each Loan Party dated the Effective Date and certifying (A) that attached thereto is a true and complete copy of the by- laws (or such other analogous documents to the extent available) of such Loan Party 64 as in effect on the Effective Date and at all times since a date prior to the date of the resolutions described in clause (B) below, (B) that attached thereto is a true and complete copy of resolutions duly adopted by the Board of Directors of such Loan Party authorizing the execution, delivery and performance of the Loan Documents to which it is party, and in the case of the Borrower, the borrowings hereunder, and that such resolutions have not been modified, rescinded or amended and are in full force and effect, (C) that the certificate or articles of incorporation (or analogous documents) of such Loan Party have not been amended since the date of the last amendment thereto shown on the certificate of good standing (or other analogous certification or such other evidence reasonably satisfactory to the Agent) furnished pursuant to clause (i) or (ii) above, and (D) as to the incumbency and specimen signature of each officer executing any Loan Document or any other document delivered in connection herewith on behalf of such Loan Party; (iv) a certificate of another officer as to the incumbency and specimen signature of the Secretary or Assistant Secretary executing the certificate pursuant to (iii) above; and (v) such other documents as the Lenders or their counsel, the Issuing Bank or Cravath, Swaine & Moore, counsel for the Agent, may reasonably request. (c) The Agent shall have received a certificate of the Borrower, dated the Effective Date and signed by a Financial Officer of the Borrower confirming compliance with the conditions precedent set forth in paragraphs (b) and (c) of Section 4.01. (d) The Agent shall have received all Fees and other amounts due and payable on or prior to the Effective Date. (e) The Agent shall have received a favorable written opinion of the General Counsel of the Borrower, dated the Effective Date and addressed to the Lenders and the Issuing Bank, to the effect set forth in Exhibit D, and the Borrower hereby instructs such counsel to deliver such opinion to the Agent. (f) The Agent shall have received evidence of the receipt by the Borrower of all governmental and third party approvals, if any, necessary or advisable in connection with the Spin-Off and the other transactions contemplated by this Agreement and of the expiry of any 65 applicable waiting or appeal periods, and there shall be no governmental or judicial action, actual or threatened, that could reasonably be expected to restrain, prevent or impose burdensome conditions on the Spin-Off or the other transactions contemplated hereby. (g) The Lenders shall have received copies of the Form 10 and of the Distribution Agreement and other agreements governing the post Spin-Off relationship between the Borrower and Sunburst attached as exhibits thereto, which agreements shall have been executed by the parties thereto and shall be in full force and effect. (h) The Spin-Off shall have been consummated in accordance with applicable law and in a manner and with consequences not materially different from the description thereof in the Form 10, and, after giving effect to the Spin-Off, the Lenders shall be satisfied with the corporate and capital structure of the Borrower and the Subsidiaries, all legal, tax and accounting matters relating to the Spin-Off, all arrangements and agreements between the Borrower and Sunburst governing their post Spin-Off relationship and the sufficiency of amounts available hereunder to meet the ongoing working capital requirements of the Borrower and the Subsidiaries. (i) After giving effect to the Spin-Off, neither the Borrower nor any of its Subsidiaries shall have outstanding any shares of preferred stock or any Indebtedness, other than (i) Indebtedness incurred under the Loan Documents and (ii) other Indebtedness permitted under Section 6.01 and outstanding on the Effective Date. The terms and conditions of all Indebtedness to remain outstanding after the Effective Date shall be satisfactory in all respects to the Lenders. (j) (i) The Existing Credit Agreements and all commitments thereunder to lend shall have been terminated, all letters of credit issued thereunder shall have been terminated, all amounts outstanding thereunder shall have been paid in full and all Liens, if any, securing any obligations thereunder or under any related agreement shall have been permanently released and (ii) the Agent shall have received evidence satisfactory in form and substance to it demonstrating such termination, payment and release. 66 (k) After giving effect to the Spin-Off, the Borrower shall be in pro forma compliance as of May 31, 1997 and for the period of four fiscal quarters then ended with Sections 6.13, 6.14 and 6.15 (assuming for such purpose that the Spin-Off occurred on such date or at the beginning of such period, as the case may be). (l) The Agent shall have received, (i) a copy of the solvency opinion from American Appraisal Associates in the form delivered to the Board of Directors of Sunburst on the date of the Spin-Off and (ii) a certificate from the Financial Officer of the Borrower as to the solvency of the Borrower and the Subsidiaries on a consolidated basis after giving effect to the Spin-Off. (m) The Lenders shall have received a pro forma consolidated balance sheet of the Borrower as of the Effective Date, after giving effect to the Spin-Off and the consummation of the other transactions contemplated hereby, which shall not be materially inconsistent with the forecasts previously provided to the Lenders. (n) The Agent shall have received a counterpart of the Guarantee Agreement signed on behalf of each Subsidiary Loan Party. The Agent shall notify the Borrower and the Lenders of the Effective Date, and such notices shall be conclusive and binding. Notwithstanding the foregoing, the obligations of the Lenders to make Loans and of the Issuing Bank to issue Letters of Credit hereunder shall not become effective unless each of the foregoing conditions is satisfied (or waived pursuant to Section 9.08) at or prior to 3:00 p.m., New York City time, on October 15, 1997 (and, in the event such conditions are not so satisfied or waived, the Commitments shall terminate at such time). ARTICLE V. AFFIRMATIVE COVENANTS The Borrower covenants and agrees with each Lender that, so long as this Agreement shall remain in effect or the principal of or interest on any Loan, any Fees or any other expenses or amounts payable under any Loan Document shall be unpaid, and until all Letters of Credit have been canceled or have expired and all amounts drawn thereunder have been reimbursed in full, unless the Required Lenders 67 shall otherwise consent in writing, the Borrower shall, and shall cause each of the Subsidiaries to: SECTION 5.01. Existence; Businesses and Properties. (a) Do or cause ------------------------------------- to be done all things necessary to preserve, renew and keep in full force and effect its legal existence, except as otherwise expressly permitted under Section 6.05. (b) Do or cause to be done all things necessary to obtain, preserve, renew, extend and keep in full force and effect the rights, licenses, permits, franchises, authorizations, patents, copyrights, trademarks and trade names material to the conduct of its business; maintain and operate such business in substantially the manner in which it is presently conducted and operated (except for the Spin-Off); comply in all material respects with all applicable laws, rules, regulations and orders of any Governmental Authority, whether now in effect or hereafter enacted; and at all times maintain and preserve all property material to the conduct of such business and keep such property in good repair, working order and condition and from time to time make, or cause to be made, all needful and proper repairs, renewals, additions, improvements and replacements thereto necessary in order that the business carried on in connection therewith may be properly conducted at all times. SECTION 5.02. Insurance. Keep its insurable properties adequately ---------- insured at all times by financially sound and reputable insurers; maintain such other insurance, to such extent and against such risks, including fire and other risks insured against by extended coverage, as is customary with companies in the same or similar businesses, including public liability insurance against claims for personal injury or death or property damage occurring upon, in, about or in connection with the use of any properties owned, occupied or controlled by it; and maintain such other insurance as may be required by law. SECTION 5.03. Obligations and Taxes. Pay its Indebtedness and other ---------------------- obligations promptly and in accordance with their terms and pay and discharge promptly when due all taxes, assessments and governmental charges or levies imposed upon it or upon its income or profits or in respect of its property, before the same shall become delinquent or in default, as well as all lawful and valid claims for labor, materials and supplies or otherwise which, if unpaid, might give rise to a Lien upon such properties or any part thereof; provided, -------- however, that such payment and - ------- 68 discharge shall not be required with respect to any such tax, assessment, charge, levy or claim so long as the validity or amount thereof shall be contested in good faith by appropriate proceedings and the Borrower or such Subsidiary shall have set aside on its books adequate reserves with respect thereto. SECTION 5.04. Financial Statements, Reports, etc. In the case of ----------------------------------- the Borrower, furnish to the Agent and each Lender: (a) within 100 days after the end of each fiscal year, its audited consolidated balance sheets and related statements of income and cash flow, showing the financial condition of the Borrower and its consolidated subsidiaries as of the close of such fiscal year and the results of its operations and the operations of such subsidiaries during such year, all audited by Arthur Andersen & Co. or other independent public accountants of recognized national standing acceptable to the Required Lenders and accompanied by an opinion of such accountants (which shall not be qualified in any material respect) to the effect that such consolidated financial statements fairly present the financial condition and results of operations of the Borrower on a consolidated basis in accordance with GAAP consistently applied; (b) within 50 days after the end of each of the first three fiscal quarters of each fiscal year, its unaudited consolidated balance sheets and related statements of income and cash flow, showing the finan cial condition of the Borrower and its consolidated subsidiaries as of the close of such fiscal quarter and the results of its operations and the operations of such subsidiaries during such fiscal quarter and the then elapsed portion of the fiscal year, all certified by the Financial Officer of the Borrower as fairly presenting the financial condition and results of operations of the Borrower on a consolidated basis in accordance with GAAP consistently applied, subject to normal year-end audit adjustments; (c) concurrently with any delivery of financial statements under clause (a) or (b) above, a certificate of the accounting firm or the Financial Officer of the Borrower opining on or certifying such statements (which certificate, when furnished by an accounting firm, may be limited to accounting matters and disclaim responsibility for legal interpretations) 69 (i) certifying that no Event of Default or Default has occurred or, if such an Event of Default or Default has occurred, specifying the nature and extent thereof and any corrective action taken or proposed to be taken with respect thereto and (ii) setting forth computations in reasonable detail satisfactory to the Agent demonstrating compliance with the covenants contained in Sections 6.06, 6.13, 6.14 and 6.15; (d) promptly after the same become publicly available, copies of all periodic and other reports, proxy statements and other materials filed by it with the Securities and Exchange Commission, or any Governmental Authority succeeding to any of or all the functions of said Commission, or with any national securities exchange, or distributed to its shareholders, as the case may be; and (e) promptly, from time to time, such other information regarding the operations, business affairs and financial condition of the Borrower or any Subsidiary, or compliance with the terms of any Loan Document, as the Agent or any Lender may reasonably request. SECTION 5.05. Litigation and Other Notices. Furnish to the Agent, the ----------------------------- Issuing Bank and each Lender prompt written notice of the following: (a) any Event of Default or Default, specifying the nature and extent thereof and the corrective action (if any) proposed to be taken with respect thereto; (b) the filing or commencement of, or any threat or notice of intention of any person to file or commence, any action, suit or proceeding, whether at law or in equity or by or before any Governmental Authority, against the Borrower or any Affiliate thereof as to which there is a reasonable probability of an adverse determination and which, if such probable adverse determination occurred, could reasonably be anticipated to result in a Material Adverse Effect; and (c) any development that has resulted in, or could reasonably be anticipated to result in, a Material Adverse Effect. SECTION 5.06. ERISA. (a) Comply in all material respects with the ------ applicable provisions of ERISA and (b) furnish to the Agent and each Lender (i) as soon as 70 possible, and in any event within 30 days after any Responsible Officer of the Borrower or any ERISA Affiliate either knows or has reason to know that any Reportable Event has occurred that alone or together with any other Reportable Event could reasonably be expected to result in liability of the Borrower or any ERISA Affiliate in an aggregate amount exceeding $5,000,000, a statement of a Financial Officer of the Borrower setting forth details as to such Reportable Event and the action proposed to be taken with respect thereto, together with a copy of the notice, if any, of such Reportable Event given to the PBGC, (ii) promptly after receipt thereof, a copy of any notice the Borrower or any ERISA Affiliate may receive from the PBGC relating to the funded status of any Plan or to the intention of the PBGC to terminate any Plan or Plans (other than a Plan maintained by an ERISA Affiliate which is considered an ERISA Affiliate only pursuant to subsection (m) or (o) of Section 414 of the Code) or to appoint a trustee to administer any Plan or Plans, (iii) within 10 days after the due date for filing with the PBGC pursuant to Section 412(n) of the Code of a notice of failure to make a required installment or other payment with respect to a Plan, a statement of a Financial Officer of the Borrower setting forth details as to such failure and the action proposed to be taken with respect thereto, together with a copy of such notice given to the PBGC and (iv) promptly and in any event within 30 days after receipt thereof by the Borrower or any ERISA Affiliate from the sponsor of a Multiemployer Plan, a copy of each notice received by the Borrower or any ERISA Affiliate concerning (A) the imposition of Withdrawal Liability in excess of $500,000 or (B) a determination that a Multiemployer Plan is, or is expected to be, terminated or in reorganization, in each case within the meaning of Title IV of ERISA. SECTION 5.07. Maintaining Records; Access to Properties and --------------------------------------------- Inspections. Maintain all financial records in accordance with GAAP - ------------ consistently applied and upon reasonable notice by any Lender permit any representatives designated by such Lender, subject to Section 9.17 of this Agreement, to visit and inspect the financial records and the properties of the Borrower or any Subsidiary at reasonable times and as often as requested and to make extracts from and copies of such financial records, and permit any representatives designated by any Lender to discuss the affairs, finances and condition of the Borrower or any Subsidiary with the officers thereof and independent accountants therefor. 71 SECTION 5.08. Use of Proceeds. Use the proceeds of the Loans and ---------------- request the issuance of Letters of Credit only for the purposes set forth in the preamble to this Agreement. SECTION 5.09. Subsidiaries. If any additional Subsidiary is formed ------------ or acquired after the Effective Date, the Borrower will notify the Agent and the Lenders thereof. If any Subsidiary has or acquires assets greater than or equal to 10% of Consolidated Total Assets, the Borrower will (a) cause such Subsidiary to become a party to the Guarantee Agreement within three Business Days after such Subsidiary (i) is formed or acquired or (ii) acquires the requisite amount of assets, as applicable, and (b) enter into and cause each Subsidiary Loan Party to become a party to an Indemnity, Subrogation and Contribution Agreement substantially in the form of Exhibit G. ARTICLE VI. NEGATIVE COVENANTS The Borrower covenants and agrees with each Lender, the Issuing Bank and the Agent that, so long as this Agreement shall remain in effect or the principal of or interest on any Loan, any Fees or any other expenses or amounts payable under any Loan Document shall be unpaid, and until all Letters of Credit have been canceled or have expired and all amounts drawn thereunder have been reimbursed in full, unless the Required Lenders shall otherwise consent in writing, the Borrower shall not, and shall not cause or permit any of the Subsidiaries to: SECTION 6.01. Indebtedness. Incur, create, assume or permit to exist ------------- any Indebtedness, except (without duplication): (a) Indebtedness of the Borrower existing on the date hereof and set forth in Schedule 6.01(a) and any extensions, renewals or replacements of existing mortgages and Capital Lease Obligations included in such Indebtedness; provided, however, that (x) the principal amount of any such -------- ------- extension, renewal or replacement shall not exceed the principal amount of the mortgage or Capital Lease Obligation so extended, renewed or replaced, (y) the mortgage or Capital Lease Obligation so extended, renewed or replaced shall not be secured by any property or asset that was not already pledged to secure the existing mortgage or Capital Lease Obligation, and (z) such extension, renewal or replacement shall not be on terms materially 72 more restrictive to the Borrower or its Subsidiaries or materially less favorable to the Lenders than the mortgage or Capital Lease Obligation so extended, renewed or replaced; (b) Indebtedness outstanding under the Loan Documents; (c) Indebtedness incurred upon the acquisition of any property or asset after the Effective Date secured by Liens on such property or asset in accordance with Section 6.02(b); provided, however, that the amount of -------- ------- such Indebtedness shall not exceed the purchase price of any such property or asset; (d) unsecured Indebtedness of Subsidiaries existing at the time they are acquired by the Borrower and not incurred in contemplation of such acquisition; (e) other Indebtedness of Subsidiaries not prohibited by Section 6.09; (f) Indebtedness of (i) the Borrower to any Wholly Owned Subsidiary; (ii) any Wholly Owned Subsidiary to the Borrower; and (iii) any Subsidiary to the Borrower or any Wholly Owned Subsidiary; (g) Indebtedness represented by notes or letters of credit issued for the account of the Borrower or any Subsidiary in connection with insurance policies and in a form substantially similar to the notes or letters of credit previously issued for the account of the Borrower or any Subsidiary issued in connection with insurance policies of the Borrower or such Subsidiary; (h) Indebtedness of the Borrower consisting of Guarantees in connection with pension and deferred compensation arrangements arising in connection with the Spin-Off; provided, however, that the aggregate amount -------- ------- of such Indebtedness shall not exceed $20,000,000; and (i) other unsecured Indebtedness of the Borrower in an aggregate principal amount at any one time outstanding not to exceed $50,000,000; provided, however, that the covenants and events of default contained in -------- ------- any such Indebtedness with an aggregate principal amount in excess of $10,000,000 shall not be more restrictive of the Borrower and its Subsidiaries than those in this Agreement; and provided further, -------- ------- 73 that the aggregate amount of Guarantees by the Borrower permitted by this paragraph (other than Guarantees in respect of certain non-qualified employee benefit plans) may not exceed $20,000,000. SECTION 6.02. Liens. Create, incur, assume or permit to exist any ------ Lien on any property or assets (including stock or other securities of any person, including any Subsidiary) now owned or hereafter acquired by it or on any income or revenues or rights (excluding rights of first refusal) in respect of any thereof, except (without duplication): (a) Liens on property or assets of the Borrower and its Subsidiaries existing on the date hereof and set forth in Schedule 6.02; provided, -------- however, that such Liens shall secure only those obligations which they ------- secure on the date hereof except as otherwise permitted hereunder; (b) any Lien existing on any property or asset prior to the acquisition thereof by the Borrower or any Subsidiary; provided, however, -------- ------- that (i) such Lien is not created in contemplation of or in connection with such acquisition and (ii) such Lien does not apply to any other property or assets of the Borrower or any Subsidiary; (c) Liens for taxes not yet due or which are being contested in compliance with Section 5.03; (d) carriers', warehousemen's, mechanic's, materialmen's, repairmen's or other like Liens arising in the ordinary course of business and securing obligations that are not due or which are being contested in compliance with Section 5.03; (e) statutory liens of landlords in respect of property leased by the Borrower or any Subsidiary; (f) pledges and deposits made in the ordinary course of business in compliance with workmen's compensation, unemployment insurance and other social security laws or regulations; (g) deposits to secure the performance of bids, trade contracts (other than for Indebtedness), leases (other than Capital Lease Obligations), statutory obligations, surety and appeal bonds, performance bonds 74 and other obligations of a like nature incurred in the ordinary course of business; (h) zoning restrictions, easements, rights-of-way, restrictions on use of real property and other similar encumbrances incurred in the ordinary course of business which, in the aggregate, are not substantial in amount and do not materially detract from the value of the property subject thereto or interfere with the ordinary conduct of the business of the Borrower or any of its Subsidiaries; (i) Liens created under the Loan Documents; and (j) other Liens to secure Indebtedness of the Borrower; provided, -------- however, that the aggregate principal amount of the Indebtedness so secured ------- at any time, when added to the net book value of all property the subject of Sale and Lease-Back Transactions at such time, does not exceed 5% of Consolidated Total Assets at such time. SECTION 6.03. Sale and Lease-Back Transactions. Enter into any Sale --------------------------------- and Lease-Back Transaction unless immediately thereafter the net book value (determined as of the time of sale) of all property the subject of Sale and Lease-Back Transactions, when added to the aggregate principal amount of Indebtedness of the Borrower or any Subsidiary secured at such time by Liens permitted only under Section 6.02(j), does not exceed 5% of Consolidated Total Assets at such time. SECTION 6.04. Investments, Loans and Advances. Purchase, hold or -------------------------------- acquire any capital stock, comparable ownership interests, evidences of indebtedness or other securities of, make or permit to exist any loans or advances to, or make or permit to exist any investment or any other interest in, any other person, except: (a) the investments and guarantees existing on the date hereof set forth on Schedule 6.04 and investments by the Borrower or any Subsidiary in the capital stock or comparable ownership interests of the Subsidiaries, including by means of contributions by any Subsidiary of Hotel Properties to the Borrower or a Subsidiary; provided that a Subsidiary Loan Party may -------- not invest in the capital stock or comparable ownership interests of any Subsidiary that is not a Subsidiary Loan Party; 75 (b) loans or advances by the Borrower to Subsidiaries or by Subsidiaries to the Borrower or other Subsidiaries, in each case to the extent permitted under Section 6.01; (c) subordinated loan by the Borrower to Sunburst in a principal amount not to exceed $115,000,000; (d) Guarantees permitted under Section 6.01(h); (e) Permitted Investments; and (f) other investments, capital contributions, loans and advances not to exceed at any time 15% of Consolidated Total Assets at such time. SECTION 6.05. Mergers and Consolidations. Merge into or consolidate --------------------------- with any other person, or permit any other person to merge into or consolidate with it, or sell, transfer, lease or otherwise dispose of (in one transaction or in a series of transactions) all or substantially all its assets whether now owned or hereafter acquired, except that: (a) (i) the Borrower may merge or consolidate with a Subsidiary or (ii) a Subsidiary may merge or consolidate with the Borrower, in each case so long as the Borrower is the surviving entity; (b) any Subsidiary may merge or consolidate with any Subsidiary; and (c) the Borrower or any Subsidiary may merge or consolidate with another person; provided, however, that: -------- ------- (i) the Borrower or such Subsidiary is the surviving entity; (ii) no Event of Default or event which, with notice or the passage of time or both, would constitute an Event of Default exists after giving effect to such merger or consolidation; and (iii) the Agent shall receive a certificate signed by a Financial Officer of the Borrower confirming compliance with clause (ii) above. SECTION 6.06. Asset Sales. Consummate any Asset Sale, other than (a) ------------ sales of receivables for collection (and not for financing or factoring purposes) in the 76 ordinary course of business, (b) Asset Sales resulting in Proceeds which, when added to the Proceeds from all other Asset Sales previously consummated in the same fiscal year, would not exceed 5% of Consolidated Total Assets as of the end of the preceding fiscal year, and (c) Asset Sales, in a single transaction or series of transactions, of the European hotels listed in Schedule 6.06; provided that no Asset Sale referenced in clause (c) above shall be permitted - -------- if a Default has occurred or would occur after giving effect to such Asset Sale. SECTION 6.07. Transactions with Affiliates. Sell or transfer any ----------------------------- property or assets to, or purchase or acquire any property or assets from, or otherwise engage in any other transactions with, any of its Affiliates, except that as long as no Default or Event of Default shall have occurred and be continuing, the Borrower or any Subsidiary may (a) consummate the Spin-Off or (b) engage in any of the foregoing transactions (i) in the ordinary course of business at prices and on terms and conditions not less favorable to the Borrower or such Subsidiary than could be obtained on an arm's-length basis from unrelated third parties or (ii) between or among the Borrower and its Wholly Owned Subsidiaries; provided that a Subsidiary Loan Party may not engage in the -------- foregoing transactions with any Subsidiary that is not a Subsidiary Loan Party unless such transaction complies with clause (i) above. SECTION 6.08. Business of Borrower and Subsidiaries. Engage at any -------------------------------------- time in any business or business activity other than the business currently conducted by it or related or collateral activities in the hospitality, European hotel operation or franchise-related industries. SECTION 6.09. Subsidiary Indebtedness. Permit any Subsidiary to ----------------------- create, incur, assume or permit to exist any Indebtedness except: (a) any Indebtedness permitted by Section 6.01 (other than clause (e) thereof); and (b) other unsecured Indebtedness of any Subsidiary; provided, however, -------- ------- that the aggregate principal amount (the "Subsidiary Debt Amount") ---------------------- outstanding of all such other Indebtedness of all Subsidiaries (excluding amounts permitted under clause (a) above) may not exceed 5% of Consolidated Total Assets at such time. 77 SECTION 6.10. Agreements. Permit any Subsidiary to enter into any ----------- agreement or incur any obligation the terms of which would impair the ability of any Subsidiary to pay dividends, to make intercompany loans or advances or to make distributions (it being agreed that this Section shall not be breached by any such agreement or obligation binding upon a Subsidiary at the time it becomes a Subsidiary and not incurred in contemplation of its becoming a Subsidiary). SECTION 6.11. Fiscal Year and Accounting Practices. Change its ------------------------------------ fiscal year end or accounting practices from those in effect at May 31, 1996, other than as required by GAAP; provided, however, the Borrower may change its -------- ------- fiscal year end to December 31. SECTION 6.12. No Further Negative Pledges. Except with respect to --------------------------- prohibitions against other encumbrances on specific property encumbered to secure payment of particular Indebtedness (which Indebtedness relates solely to such specific property, and improvements and accretions thereto, and is otherwise permitted hereby), enter into any agreement prohibiting the creation or assumption of any Lien upon the properties or assets of the Borrower or any Subsidiary, whether now owned or hereafter acquired, or requiring an obligation to be secured if some other obligation is secured. SECTION 6.13. Minimum Consolidated Net Worth. In the case of the ------------------------------ Borrower, permit its Consolidated Net Worth at any time to be less than the sum of (x) $40,000,000, (y) 50% of the Borrower's Consolidated Net Income accrued during the period (treated as one accounting period) commencing on the last day of the month in which the Spin-Off occurs and ending on the last day of the most recent fiscal quarter for which financial statements have been delivered pursuant to Section 5.04 (which amount shall not include Consolidated Net Income for any fiscal quarter in which the Borrower's Consolidated Net Income is negative) and (z) the aggregate net cash proceeds received by the Borrower from the issuance or sale of its capital stock since the date hereof. SECTION 6.14. Consolidated Leverage Ratio. In the case of the ---------------------------- Borrower, permit the Consolidated Leverage Ratio as of the last day of and for any period of four fiscal quarters ending during the period from and including the date hereof through the Maturity Date to exceed (i) 3.50 to 1.0 for any period ending prior to August 31, 1998, or (ii) 3.00 thereafter. The Consolidated Leverage Ratio shall be calculated as of the end of each fiscal quarter based on 78 the period of the four consecutive fiscal quarters ending on such date. SECTION 6.15. Consolidated Interest Coverage Ratio. In the case of ------------------------------------- the Borrower, permit its Consolidated Interest Coverage Ratio for any period of four fiscal quarters ending during the period from and including the date hereof through the Term Maturity Date and the Revolving Maturity Date to be less than 3.75 to 1.00. ARTICLE VII. EVENTS OF DEFAULT In case of the happening of any of the following events ("Events ------ of Default"): - ---------- (a) any representation or warranty made or deemed made (such representation or warranty being deemed made as provided in Section 2.20(b) and Section 4.01) in or in connection with any Loan Document or the borrowings or issuances of Letters of Credit hereunder, or any representation, warranty, statement or information contained in any report, certificate, financial statement or other instrument furnished in connection with or pursuant to any Loan Document, shall prove to have been false or misleading in any material respect when so made, deemed made or furnished; (b) default shall be made in the payment of any principal of any Loan or the reimbursement with respect to any L/C Disbursement when and as the same shall become due and payable, whether at the due date thereof or at a date fixed for prepayment thereof or by acceleration thereof or otherwise; (c) default shall be made in the payment of any interest on any Loan or any Fee or L/C Disbursement or any other amount (other than an amount referred to in clause (b) above) due under any Loan Document, when and as the same shall become due and payable, and such default shall continue unremedied for a period of five Business Days; (d) default shall be made in the due observance or performance by the Borrower of any covenant, condition or agreement contained in Section 5.01(a), 5.05 or 5.09 or in Article VI; (e) default shall be made in the due observance or performance by the Borrower of any covenant, condition 79 or agreement contained in any Loan Document (other than those specified in clauses (b), (c) and (d) above) and such default shall continue unremedied for a period of five Business Days after notice thereof from the Agent or any Lender to the Borrower; (f) the Borrower or any Subsidiary shall (i) fail to pay any principal or interest, regardless of amount, due in respect of any Indebtedness in an aggregate principal amount in excess of $10,000,000, when and as the same shall become due and payable, or (ii) fail to observe or perform any other term, covenant, condition or agreement contained in any agreement or instrument evidencing or governing any Indebtedness in an aggregate principal amount in excess of $10,000,000, or permit any other event to occur, if the effect of any failure or event referred to in this clause (ii) is to cause, or to permit the holder or holders of such Indebtedness or a trustee on its or their behalf (with or without the giving of notice, the lapse of time or both) to cause, such Indebtedness to become due prior to its stated maturity; (g) an involuntary proceeding shall be commenced or an involuntary petition shall be filed in a court of competent jurisdiction seeking (i) relief in respect of the Borrower or any Subsidiary, other than Quality Hotels Jena GmbH, or of a substantial part of the property or assets of the Borrower or a Subsidiary, other than Quality Hotels Jena GmbH, under Title 11 of the United States Code, as now constituted or hereafter amended, or any other Federal, state or foreign bankruptcy, insolvency, receivership or similar law, (ii) the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for the Borrower or any Subsidiary other than Quality Hotels Jena GmbH, or for a substantial part of the property or assets of the Borrower or a Subsidiary other than Quality Hotels Jena GmbH, or (iii) the winding-up or liquidation of the Borrower or any Subsidiary, other than Quality Hotels Jena GmbH; and such proceeding or petition shall continue undismissed for 60 days or an order or decree approving or ordering any of the foregoing shall be entered; (h) the Borrower or any Subsidiary, other than Quality Hotels Jena GmbH, shall (i) voluntarily commence any proceeding or file any petition seeking relief under Title 11 of the United States Code, as now constituted or hereafter amended, or any other Federal, 80 state or foreign bankruptcy, insolvency, receivership or similar law, (ii) consent to the institution of, or fail to contest in a timely and appropriate manner, any proceeding or the filing of any petition described in clause (g) above, (iii) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator, conservator or similar official for the Borrower or any Subsidiary or for a substantial part of the property or assets of the Borrower or any Subsidiary, (iv) file an answer admitting the material allegations of a petition filed against it in any such proceeding, (v) make a general assignment for the benefit of creditors, (vi) become unable, admit in writing its inability or fail generally to pay its debts as they become due or (vii) take any action for the purpose of effecting any of the foregoing; (i) one or more judgments for the payment of money in an aggregate amount in excess of $10,000,000 shall be rendered against the Borrower, any Subsidiary or any combination thereof and the same shall remain undischarged for a period of 60 consecutive days during which execution shall not be effectively stayed, or any action shall be legally taken by a judgment creditor to levy upon assets or properties of the Borrower or any Subsidiary to enforce any such judgment; (j) a Reportable Event or Reportable Events, or a failure to make a required installment or other payment (within the meaning of Section 412(n)(l) of the Code), shall have occurred with respect to any Plan or Plans that reasonably could be expected to result in liability of the Borrower to the PBGC or to a Plan in an aggregate amount exceeding $5,000,000 and, within 30 days after the reporting of any such Reportable Event to the Agent or after the receipt by the Agent of the statement required pursuant to Section 5.06, the Agent shall have notified the Borrower in writing that (i) the Required Lenders have made a determination that, on the basis of such Reportable Event or Reportable Events or the failure to make a required payment, there are reasonable grounds (A) for the termination of such Plan or Plans by the PBGC, (B) for the appointment by the appropriate United States District Court of a trustee to administer such Plan or Plans or (C) for the imposition of a lien in favor of a Plan or the PBGC and (ii) as a result thereof an Event of Default exists hereunder; or a trustee shall be appointed by a United States District Court to 81 administer any such Plan or Plans; or the PBGC shall institute proceedings to terminate any Plan or Plans; (k) (i) the Borrower or any ERISA Affiliate shall have been notified by the sponsor of a Multiemployer Plan that it has incurred Withdrawal Liability to such Multiemployer Plan, (ii) the Borrower or such ERISA Affiliate does not have reasonable grounds for contesting such Withdrawal Liability or is not in fact contesting such Withdrawal Liability in a timely and appropriate manner and (iii) the amount of the Withdrawal Liability specified in such notice, when aggregated with all other amounts required to be paid to Multiemployer Plans in connection with Withdrawal Liabilities (determined as of the date or dates of such notification), exceeds $5,000,000 or requires payments exceeding $1,000,000 in any year; (l) the Borrower or any ERISA Affiliate shall have been notified by the sponsor of a Multiemployer Plan that such Multiemployer Plan is in reorganization or is being terminated, within the meaning of Title IV of ERISA, if solely as a result of such reorganization or termination the aggregate annual contributions of the Borrower and its ERISA Affiliates to all Multiemployer Plans that are then in reorganization or have been or are being terminated have been or will be increased over the amounts required to be contributed to such Multiemployer Plans for their most recently completed plan years by an amount exceeding $1,000,000; or (m) there shall have occurred a Change in Control; then, and in every such event (other than an event with respect to the Borrower described in clause (g) or (h) above), and at any time thereafter during the continuance of such event, the Agent, at the request of the Required Lenders, shall, by notice to the Borrower, take any or all of the following actions, at the same or different times: (i) terminate forthwith the Commitments or L/C Commitments, (ii) declare the Loans then outstanding to be forthwith due and payable in whole or in part, whereupon the principal of the Loans so declared to be due and payable, together with accrued interest thereon and any unpaid accrued Fees and all other liabilities of the Borrower accrued hereunder and under any other Loan Document, shall become forthwith due and payable, without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived by the Borrower, anything contained herein or in any other Loan Document to the contrary notwithstanding and 82 (iii) require cash collateral as contemplated by Section 2.20(i); and in any event with respect to the Borrower described in clause (g) or (h) above, the Commitments and L/C Commitments shall automatically terminate and the principal of the Loans then outstanding, together with accrued interest thereon and any unpaid accrued Fees and all other liabilities of the Borrower accrued hereunder and under any other Loan Document, shall automatically become due and payable, and the Borrower shall automatically be required to provide cash collateral in respect of outstanding Letters of Credit, without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived by the Borrower, anything contained herein or in any other Loan Document to the contrary notwithstanding. ARTICLE VIII. THE AGENT In order to expedite the transactions contemplated by this Agreement, The Chase Manhattan Bank is hereby appointed to act as Agent on behalf of the Lenders and the Issuing Bank. Each of the Lenders hereby irrevocably authorizes the Agent to take such actions on behalf of such Lender or Issuing Bank and to exercise such powers as are specifically delegated to the Agent by the terms and provi sions hereof, together with such actions and powers as are reasonably incidental thereto. The Agent is hereby expressly authorized by the Lenders and the Issuing Bank, without hereby limiting any implied authority, (a) to receive on behalf of the Lenders and the Issuing Bank all payments of principal of and interest on the Loans, all payments in respect of L/C Disbursements and all other amounts due to the Lenders hereunder, and promptly to distribute to each Lender or Issuing Bank its proper share of each payment so received; (b) to give notice on behalf of each of the Lenders to the Borrower of any Event of Default specified in this Agreement of which the Agent has actual knowledge acquired in connection with its agency hereunder; and (c) to distribute to each Lender copies of all notices, financial statements and other materials delivered pursuant to this Agreement as received by the Agent. Neither the Agent nor any of its directors, offi cers, employees or agents shall be liable to the Lenders as such for any action taken or omitted by any of them except for its or his own gross negligence or wilful misconduct, or be responsible for any statement, warranty or representation herein or the contents of any document delivered in connec tion herewith (other than any statement, representation or 83 warranty relating to the Agent or relating to the functions of the Agent hereunder), or be required to ascertain or to make any inquiry concerning the performance or observance by the Borrower of any of the terms, conditions, covenants or agreements contained in any Loan Document. The Agent shall not be responsible to the Lenders for the due execution, genuineness, validity, enforceability or effectiveness of this Agreement or any other Loan Documents or other instruments or agreements. The Agent may deem and treat the payee of any note referred to in Section 2.07 as the owner thereof for all purposes hereof until it shall have received from the payee of such note notice, given as provided herein, of the transfer thereof. The Agent shall in all cases be fully protected in acting, or refraining from acting, in accordance with written instructions signed by the Required Lenders and, except as otherwise specifically provided herein, such instructions and any action or inac tion pursuant thereto shall be binding on all the Lenders. The Agent shall, in the absence of knowledge to the contrary, be entitled to rely on any instrument or document believed by it in good faith to be genuine and correct and to have been signed or sent by the proper person or persons. Neither the Agent nor any of its directors, officers, employees or agents shall have any responsibility to the Borrower on account of the failure of or delay in performance or breach by any Lender or Issuing Bank of any of its obligations hereunder or to any Lender or Issuing Bank on account of the failure of or delay in performance or breach by any other Lender or Issuing Bank or the Borrower of any of their respective obligations hereunder or under any other Loan Document or in connection herewith or therewith. The Agent may execute any and all duties here under by or through agents or employees and shall be enti tled to rely upon the advice of legal counsel selected by it with respect to all matters arising hereunder and shall not be liable for any action taken or suffered in good faith by it in accordance with the advice of such counsel. The Lenders hereby acknowledge that the Agent shall be under no duty to take any discretionary action per mitted to be taken by it pursuant to the provisions of this Agreement unless it shall be requested in writing to do so by the Required Lenders. Subject to the appointment and acceptance of a successor Agent as provided below, the Agent may resign at any time by notifying the Lenders and the Borrower. Upon any such resignation, the Required Lenders shall have the right to appoint a successor subject to the written consent of the Borrower to such successor (which consent will not be 84 unreasonably withheld). If no successor shall have been so appointed by the Required Lenders and shall have accepted such appointment within 30 days after the retiring Agent gives notice of its resignation, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent which shall be a bank with offices in New York, New York and London, England, having a combined capital and surplus of at least $500,000,000 or an Affiliate of any such bank. Upon the acceptance of any appointment as Agent hereunder by a successor bank, such successor shall succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent and the retiring Agent shall be dis charged from its duties and obligations hereunder. After the Agent's resignation hereunder, the provisions of this Article and Section 9.05 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as Agent. With respect to the Loans made by it hereunder, the Agent in its individual capacity and not as Agent shall have the same rights and powers as any other Lender and may exercise the same as though it were not the Agent, and the Agent and its Affiliates may accept deposits from, lend money to and generally engage in any kind of business with the Borrower or any Subsidiary or other Affiliate thereof as if it were not the Agent. Each Lender agrees (i) to reimburse the Agent, on demand, in the amount of its pro rata share (based on its Commitment hereunder or, if the Commitments shall have been terminated, on its Commitment most recently in effect) of any expenses incurred for the benefit of the Lenders by the Agent, including counsel fees and compensation of agents and employees paid for services rendered on behalf of the Lenders, which the Borrower shall be obligated to reimburse under Section 9.05 but which shall not have been reimbursed by the Borrower and (ii) to indemnify and hold harmless the Agent and any of its directors, officers, employees or agents, on demand, in the amount of such pro rata share, from and against any and all liabilities, taxes, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against it in its capacity as the Agent or any of them in any way relating to or arising out of the Agent's role under this Agreement or any other Loan Document or any action taken or omitted by it or any of them under this Agreement or any other Loan Document, to the extent the same shall not have been reimbursed by the Borrower; provided, however, that no -------- ------- Lender shall be liable to the Agent for any 85 portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from the gross negligence or wilful misconduct of the Agent or any of its directors, officers, employees or agents. Each Lender acknowledges that it has, indepen dently and without reliance upon the Agent or any other Lender and based on such documents and information as it has deemed appropriate, made its own credit analysis and deci sion to enter into this Agreement. Each Lender also acknow ledges that it will, independently and without reliance upon the Agent or any other Lender and based on such documents and information as it shall from time to time deem appropri ate, continue to make its own decisions in taking or not taking action under or based upon this Agreement or any other Loan Document, any related agreement or any document furnished hereunder or thereunder. The Co-Agent shall not have any responsibilities or obligations as Co-Agent under any of the Loan Documents. ARTICLE IX. MISCELLANEOUS SECTION 9.01. Notices. Notices and other commu nications provided -------- for herein shall be in writing and shall be delivered by hand or overnight courier service, mailed or sent by telex, graphic scanning or other telegraphic communications equipment of the sending party, as follows: (a) if to the Borrower, at 10750 Columbia Pike, Silver Spring, Maryland 20901, Attention of General Counsel, with a copy to the Chief Financial Officer of the Borrower (Telecopy No. (301) 979-6157); (b) if to the Agent, to it at The Chase Manhattan Bank, Agent Bank Services Group, One Chase Manhattan Plaza, 8th Floor, New York, New York 10081. Attention of Sandra Miklave, (Telecopy No. (212) 522-5700), with a copy to The Chase Manhattan Bank, 270 Park Avenue, New York, New York 10017, Attention of Stephanie Parker, (Telecopy No. (212) 270-1403) and Chase Manhattan International Limited, Trinity Tower, 9 Thomas More Street, London, England E19YT, Attention of Steven Hurford (Telecopy No. 011 44 71 777 2360); and (c) if to a Lender, to it at its address (or telecopy number) set forth in Schedule 2.01 or in the 86 Assignment and Acceptance pursuant to which such Lender became a party hereto. Except as otherwise provided in Section 9.15(c), all notices and other communications given to any party hereto in accordance with the provisions of this Agreement shall be deemed to have been given on the date of receipt, in each case delivered, sent or mailed (properly addressed) to such party as provided in this Section 9.01 or in accordance with the latest unrevoked direction from such party given in accordance with this Section 9.01. SECTION 9.02. Survival of Agreement. All covenants, agreements, ---------------------- representations and warranties made by the Borrower herein and in the certificates or other instruments prepared or delivered in connection with or pursuant to this Agreement or any other Loan Document shall be considered to have been relied upon by the Lenders and the Issuing Bank and shall survive the making by the Lenders of the Loans and the issuance of Letters of Credit by the Issuing Bank, regardless of any investigation made by the Lenders or the Issuing Bank or on their behalf, and shall continue in full force and effect as long as the principal of or any accrued interest on any Loan or any Fee or any other amount payable under this Agreement or any other Loan Document is outstanding and unpaid or any Letter of Credit is outstanding and so long as the Commitments have not been terminated. SECTION 9.03. Binding Effect. This Agreement shall become effective --------------- when it shall have been executed by the Borrower and the Agent and when the Agent shall have received copies hereof which, when taken together, bear the signatures of each Lender, and thereafter shall be binding upon and inure to the benefit of the Borrower, the Agent and each Lender and their respective successors and assigns, except that the Borrower may not assign or delegate its rights or obligations hereunder or any interest herein without the prior consent of all the Lenders. SECTION 9.04. Successors and Assigns. (a) Whenever in this Agreement ----------------------- any of the parties hereto is referred to, such reference shall be deemed to include the successors and assigns of such party; and all covenants, promises and agreements by or on behalf of the Borrower, the Agent, the Issuing Bank or the Lenders that are contained in this Agreement shall bind and inure to the benefit of their respective successors and assigns. 87 (b) Each Lender may assign to one or more assignees all or a portion of its interests, rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans at the time owing to it); provided, -------- however, that (i) except in the case of an assignment to a Lender or an - ------- Affiliate of such Lender, the Borrower (unless an Event of Default has occurred and is continuing, in which case the Borrower's consent to such assignment shall not be required) and the Agent (and, in the case of any assignment of a Commitment, the Issuing Bank) must give their prior written consent to such assignment (which consent shall not be unreasonably withheld), (ii) the amount of the Commitment of the assigning Lender subject to each such assignment (determined as of the date the Assignment and Acceptance with respect to such assignment is delivered to the Agent) shall not be less than $5,000,000 and the amount of the Commitment of such Lender remaining after such assignment shall not be less than $5,000,000 or shall be zero, (iii) except in the case of an assignment to an Affiliate on the Effective Date, the parties to each such assignment shall execute and deliver to the Agent an Assignment and Acceptance, together with a processing and recordation fee of $2,000 and (iv) except in the case of an assignment to an Affiliate on the Effective Date, the assignee, if it shall not be a Lender, shall deliver to the Agent an Administrative Questionnaire. Upon acceptance and recording pursuant to Section 9.04(e), from and after the effective date specified in each Assignment and Acceptance, which effective date shall be at least five Business Days after the execution thereof, (A) the assignee thereunder shall be a party hereto and, to the extent of the interest assigned by such Assignment and Acceptance, have the rights and obligations of a Lender under this Agreement and (B) the assigning Lender thereunder shall, to the extent of the interest assigned by such Assignment and Acceptance, be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender's rights and obligations under this Agreement, such Lender shall cease to be a party hereto (but shall continue to be entitled to the benefits of Sections 2.13, 2.15, 2.19 and 9.05, as well as to any Fees accrued for its account hereunder and not yet paid)). (c) By executing and delivering an Assignment and Acceptance, the assigning Lender thereunder and the assignee thereunder shall be deemed to confirm to and agree with each other and the other parties hereto as follows: (i) such assigning Lender warrants that it is the legal and beneficial owner of the interest being assigned thereby free 88 and clear of any adverse claim and that its Commitment, and the outstanding balances of its Loans, in each case without giving effect to assignments thereof which have not become effective, are as set forth in such Assignment and Acceptance, (ii) except as set forth in (i) above, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement, or the execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement, any other Loan Document or any other instrument or document furnished pursuant hereto or the financial condition of the Borrower or any Subsidiary or the performance or observance by the Borrower or any Subsidiary of any of its obligations under this Agreement, any other Loan Document or any other instrument or document furnished pursuant hereto; (iii) such assignee represents and warrants that it is legally authorized to enter into such Assignment and Acceptance; (iv) such assignee confirms that it has received a copy of this Agreement, together with copies of the most recent financial statements delivered pursuant to Section 5.04 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (v) such assignee will independently and without reliance upon the Agent, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (vi) such assignee appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to the Agent by the terms hereof, together with such powers as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all the obligations which by the terms of this Agreement are required to be performed by it as a Lender. (d) The Agent shall maintain at one of its offices in The City of New York a copy of each Assignment and Acceptance delivered to it and a register for the recordation of the names and addresses of the Lenders, and the Commitment of, and principal amount of the Loans owing to, each Lender pursuant to the terms hereof from time to time (the "Register"). The entries in the Register -------- shall be conclusive in the absence of manifest error and the Borrower, the Agent, the Issuing Bank and the Lenders may treat each person whose name is recorded in the Register pursuant to the terms hereof as a Lender hereunder for all purposes of this Agreement. The Register shall be available 89 for inspection by the Borrower, the Issuing Bank and any Lender, at any reasonable time and from time to time upon reasonable prior notice. (e) Upon its receipt of a duly completed Assignment and Acceptance executed by an assigning Lender and an assignee together with an Administrative Questionnaire completed in respect of the assignee (unless the assignee shall already be a Lender hereunder), the processing and recordation fee referred to in Section 9.04(b) and, if required, the written consent of the Borrower, the Issuing Bank and the Agent to such assignment, the Agent shall (i) accept such Assignment and Acceptance, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to the Lenders and the Issuing Bank. (f) Each Lender may without the consent of the Borrower, the Issuing Bank or the Agent sell participations to one or more banks or other entities in all or a portion of its rights and obligations under this Agreement (including all or a portion of its Commitment and the Loans owing to it); provided, -------- however, that (i) such Lender's obligations under this Agreement shall remain - ------- unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) the participating banks or other entities shall be entitled to the benefit of the cost protection provisions contained in Sections 2.13, 2.15 and 2.19 to the same extent as if they were Lenders but not in excess of those cost protections to which the Lender from which it purchased its participation would be entitled to under Sections 2.13, 2.15 and 2.19 and (iv) the Borrower, the Agent, the Issuing Bank and the other Lenders shall continue to deal solely and directly with such Lender (and shall not be required to deal with any participating bank or other entity, notwithstanding any other provision contained herein) in connection with such Lender's rights and obligations under this Agreement, and such Lender shall retain the sole right to enforce the obligations of the Borrower relating to the Loans or L/C Disbursements and to approve any amendment, modification or waiver of any provision of this Agreement (other than amendments, modifications or waivers decreasing any fees payable hereunder, increasing the Commitment of such Lender or decreasing the amount of principal of or the rate at which interest is payable on the Loans of such Lender, extending any scheduled principal payment date or date fixed for the payment of interest on the Loans of such Lender or releasing any Subsidiary Loan Party from its Guarantee under the 90 Guarantee Agreement (except as expressly provided in the Guarantee Agreement) or limiting any Subsidiary Loan Party's liability in respect of its Guarantee). (g) Any Lender or participant may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 9.04, disclose to the assignee or participant or proposed assignee or participant any information relating to the Borrower furnished to such Lender by or on behalf of the Borrower; provided, however, that, prior to any such -------- ------- disclosure of information designated by the Borrower as confidential, each such assignee or participant or proposed assignee or participant shall execute an agreement whereby such assignee or participant shall agree to preserve the confidentiality of such confidential information (subject to those exceptions set forth in Section 9.16). It is understood that confidential information relating to the Borrower would not ordinarily be provided in connection with assignments or participations of Competitive Loans. (h) Any Lender may at any time assign all or any portion of its rights under this Agreement to a Federal Reserve Bank; provided, however, that -------- ------- no such assignment shall release a Lender from any of its obligations hereunder. SECTION 9.05. Expenses; Indemnity. (a) The Borrower agrees to pay -------------------- all reasonable out-of-pocket expenses incurred by each of the Agent and the Issuing Bank and its Affiliates in connection with the preparation of this Agree ment and the other Loan Documents and the syndication of the facilities provided for herein or in connection with any amendments, modifications or waivers of the provisions hereof or thereof (whether or not the transactions hereby contemplated shall be consummated) or incurred by the Agent or any Lender in connection with the enforcement or protec tion of their rights (as such rights may relate to the Borrower or any Subsidiary) in connection with this Agree ment and the other Loan Documents or in connection with the Loans made or Letters of Credit issued hereunder and under the Issuing Bank Agreements, as applicable, including the reasonable fees and disbursements of Cravath, Swaine & Moore, counsel for the Agent, and, in connection with any "work-out" or any enforcement or protection of the rights of the Lenders or the Agent hereunder, any other counsel for the Agent and counsel for any Lender, including the allocated costs of in-house counsel. 91 (b) The Borrower agrees to indemnify the Agent, each Lender, and the Issuing Bank, and their respective directors, officers, employees, agents and Affiliates (each such person being called an "Indemnitee") against, and to hold each Indemnitee harmless from, any and all losses, claims, damages, liabilities and related expenses, including reasonable counsel fees and expenses, incurred by or asserted against any Indemnitee arising out of, in any way connected with, or as a result of (i) the execution or delivery of this Agreement or any other Loan Document or any agreement or instrument contemplated thereby, the perform ance by the parties thereto of their respective obligations thereunder or the consummation of the Transactions, the Spin-Off and the other transactions contemplated thereby, (ii) the use of the proceeds of the Loans or issuance of Letters of Credit, or (iii) any claim, litigation, investi gation or proceeding relating to any of the foregoing, whether or not any Indemnitee is a party thereto; provided, however, that such indemnity shall not, as to any Indem -------- ------- nitee, be available to the extent that such losses, claims, damages, liabilities or related expenses are determined by a court of competent jurisdiction by final and nonappealable judgment to have resulted from the negligence or misconduct of such Indemnitee. Promptly after receipt by an Indemnitee of notice of any complaint or the commencement of any action or proceeding with respect to which indemnification is being sought hereunder, such person shall notify the Borrower of such complaint or of the commencement of such action or pro ceeding, but failure so to notify the Borrower will relieve the Borrower from any liability which the Borrower may have hereunder only if and to the extent that such failure results in the forfeiture by the Borrower of substantial rights and defenses, and shall not in any event relieve the Borrower from any other obligation or liability that the Borrower may have to any Indemnitee otherwise than under this Agreement. If the Borrower so elects or is requested by such Indemnitee, the Borrower shall assume the defense of such action or proceeding, including the employment of counsel reasonably satisfactory to the Indemnitee and the payment of the reasonable fees and disbursements of such counsel. In the event, however, such Indemnitee reasonably determines in its judgment that having common counsel would present such counsel with a conflict of interest or if the defendant in, or targets of, any such action or proceeding include both the Indemnitee and the Borrower, and such Indemnitee reasonably concludes that there may be legal defenses available to it or other Indemnitees that are different from or in addition to those available to the Borrower or if the Borrower fails to assume the defense of the action or proceeding or to employ counsel reasonably 92 satisfactory to such Indemnitee, in either case in a timely manner, then the Indemnitee may employ separate counsel to represent or defend it in any such action or proceeding and the Borrower shall pay the reasonable fees and disbursements of such counsel. In any action or proceeding the defense of which the Borrower assumes, the Indemnitee shall have the right to participate in such litigation and to retain its own counsel at the Indemnitee's own expense. The Borrower further agrees that it shall not, without the prior written consent of the Indemnitee, settle or compromise or consent to the entry of any judgment in any pending or threatened claim, action, suit or proceeding in respect of which indemnification may be sought hereunder (whether or not an Indemnitee is an actual or potential party to such claim, action, suit or proceeding) unless such settlement, compro mise or consent includes (i) an unconditional release of each Indemnitee hereunder from all liability arising out of such claim, action, suit or proceeding or (ii) a covenant not to sue each Indemnitee, or another similar alternative which is consented to by each Indemnitee party to such claim, action, suit or proceeding, which covenant not to sue or other approved alternative has the effect of an uncondi tional release of each Indemnitee hereunder from all liabil ity arising out of such claim, action, suit or proceeding. (c) The provisions of this Section shall remain operative and in full force and effect regardless of the expiration of the term of this Agreement, the consummation of the transactions contemplated hereby, the repayment of any of the Loans, the expiration of any Letter of Credit, the invalidity or unenforceability of any term or provision of this Agreement or any other Loan Document, or any investigation made by or on behalf of the Agent or any Lender or any Issuing Bank. All amounts due under this Section shall be payable on written demand therefor. SECTION 9.06. Right of Setoff. If an Event of Default shall have ---------------- occurred and be continuing, each Lender is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebted ness at any time owing by such Lender to or for the credit or the account of the Borrower against any of and all the obligations of the Borrower now or hereafter existing under this Agreement held by such Lender, irrespective of whether or not such Lender shall have made any demand under this Agreement and although such obligations may be unmatured. The rights of each Lender under this Section are in addition to other rights and remedies (including other rights of 93 setoff) which such Lender may have (it being assumed for purposes of this Section that such Lender shall convert any amount so setoff into the relevant currency on the date of such setoff). SECTION 9.07. APPLICABLE LAW. THIS AGREEMENT SHALL BE CONSTRUED IN --------------- ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF NEW YORK WITHOUT REFERENCE TO ITS CONFLICTS OF LAWS PRINCIPLES OR PROVISIONS. EACH LETTER OF CREDIT SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED IN ACCORDANCE WITH, THE LAWS OR RULES DESIGNATED IN SUCH LETTER OF CREDIT, OR IF NO SUCH LAWS OR RULES ARE DESIGNATED, THE UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS (1993 REVISION), INTERNATIONAL CHAMBER OF COMMERCE, PUBLICATION NO. 500 (THE "UNIFORM CUSTOMS") AND, AS TO MATTERS NOT GOVERNED BY THE UNIFORM CUSTOMS, THE LAWS OF THE STATE OF NEW YORK. SECTION 9.08. Waivers; Amendment. (a) No fail ure or delay of the ------------------- Agent or any Lender or any Issuing Bank in exercising any power or right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power, or any abandonment or discontinuance of steps to enforce such a right or power, preclude any other or further exercise thereof or the exercise of any other right or power. The rights and remedies of the Agent, the Issuing Bank and the Lenders hereunder and under the other Loan Documents are cumulative and are not exclusive of any rights or remedies which they would otherwise have. No waiver of any provision of this Agreement or any other Loan Document or consent to any departure by the Borrower therefrom shall in any event be effective unless the same shall be permitted by Section 9.08(b), and then such waiver or consent shall be effective only in the specific instance and for the purpose for which given. No notice or demand on the Borrower in any case shall entitle the Borrower to any other or further notice or demand in similar or other circumstances. (b) Neither this Agreement nor any other Loan Document nor any provision hereof or thereof may be waived, amended or modified except, in the case of this Agreement, pursuant to an agreement or agreements in writing entered into by the Borrower and the Required Lenders or, in the case of any other Loan Document, pursuant to an agreement or agreements in writing entered into by the Agent and the Loan Party or Loan Parties that are parties thereto, in each case with the consent of the Required Lenders; provided, however, that -------- ------- no such agreement shall (i) decrease the principal amount of, or extend the maturity of or any scheduled 94 principal payment date or date for the payment of any interest on any Loan or any date for reimbursement of an L/C Disbursement, or Fees, or waive or excuse any such payment or any part thereof, or decrease the rate of interest on any Loan or L/C Disbursement, without the prior written consent of each Lender affected thereby, (ii) increase the Commitment or change the Facility Fees of any Lender without the prior written consent of such Lender, (iii) release any Subsidiary Loan Party from its Guarantee under the Guarantee Agreement (except as expressly provided in the Guarantee Agreement) or limit any Subsidiary Loan Party's liability in respect of its Guarantee, without the written consent of each Lender, or (iv) amend or modify the provisions of Sec tion 2.16, the provisions of this Section, the definition of the "Required Lenders" or the provisions of Section 9.03, without the prior written consent of each affected Lender; provided further that no such agreement shall amend, modify ---------------- or otherwise affect the rights or duties of the Agent or any Issuing Bank hereunder without the prior written consent of the Agent or such Issuing Bank. (c) Notwithstanding the foregoing, any Issuing Bank Agreement may be waived, amended or modified by the parties thereto with the written approval of the Agent if and to the extent that such waiver, amendment or modification would be permitted in connection with the execution and delivery of a replacement of such agreement. SECTION 9.09. Interest Rate Limitation. Notwith standing anything ------------------------- herein to the contrary, if at any time the applicable interest rate on any Loan or participation in any L/C Disbursement, together with all fees and charges which are treated as interest or such Loan or participation in any L/C Disbursement under applicable law (collectively the "Charges"), as provided for ------- herein or in any other document executed in connection herewith, or otherwise contracted for, charged, received, taken or reserved by any Lender, shall exceed the maximum lawful rate (the "Maximum Rate") which may be contracted for, ------------ charged, taken, received or reserved by such Lender in accordance with applicable law, together with all Charges payable to such Lender, shall be limited to the Maximum Rate. SECTION 9.10. Entire Agreement. This Agreement and the other Loan ----------------- Documents and the letter agreement referred to in Section 2.06(b) constitute the entire con tract between the parties relative to the subject matter hereof. Any previous agreement among the parties with respect to the subject matter hereof is superseded by this Agreement and the other Loan Documents. Nothing in this 95 Agreement or in the other Loan Documents, expressed or implied, is intended to confer upon any party other than the parties hereto and thereto any rights, remedies, obligations or liabilities under or by reason of this Agreement or the other Loan Documents. SECTION 9.11. Waiver of Jury Trial; Punitive Damages. Each party --------------------------------------- hereto hereby waives, to the fullest extent permitted by applicable law, (a) any right it may have to a trial by jury in respect of any litigation direct ly or indirectly arising out of, under or in connection with this Agreement or any of the other Loan Documents and (b) any claims for punitive damages (to the extent such claims arise from the use of proceeds of the Loans for the purpose of acquisitions). Each party hereto (i) certifies that no representative, agent or attorney of any other party has represented, expressly or otherwise, that such other party would not, in the event of litigation, seek to enforce the foregoing waiver and (ii) acknowledges that it and the other parties hereto have been induced to enter into this Agreement and the other Loan Documents, as applicable, by, among other things, the mutual waivers and certifications in this Section. SECTION 9.12. Severability. In the event any one or more of the ------------- provisions contained in this Agreement or in any other Loan Document should be held invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein and therein shall not in any way be affected or impaired thereby. The parties shall endeavor in good-faith negotia tions to replace the invalid, illegal or unenforceable pro visions with valid provisions the economic effect of which comes as close as possible to that of the invalid, illegal or unenforceable provisions. SECTION 9.13. Counterparts. This Agreement may be executed in two or ------------- more counterparts, each of which shall constitute an original but all of which when taken together shall constitute but one contract, and shall become effec tive as provided in Section 9.03. SECTION 9.14. Headings. Article and Section headings and the Table --------- of Contents used herein are for con venience of reference only, are not part of this Agreement and are not to affect the construction of, or to be taken into consideration in interpreting, this Agreement. 96 SECTION 9.15. Jurisdiction; Consent to Service of Process; Judgment ----------------------------------------------------- Currency. (a) The Borrower hereby irrevocably and unconditionally submits, for - --------- itself and its property, to the nonexclusive jurisdiction of any New York State court or Federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or the other Loan Documents, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in such New York State court or, to the extent permitted by law, in such Federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that the Agent, any Issuing Bank, or any Lender may otherwise have to bring any action or proceeding relating to this Agreement or the other Loan Documents against the Borrower or its proper ties in the courts of any jurisdiction. (b) The Borrower hereby irrevocably and uncondi tionally waives, to the fullest extent it may legally and effectively do so, any objection which it may now or here after have to the laying of venue of any suit, action or proceeding arising out of or relating to this agreement or the other Loan Documents in any New York State or Federal court. Each of the parties hereto hereby irrevocably waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court. (c) The Borrower and each other party hereto consents to service of process in the manner provided for notices in Section 9.01. Nothing in this Agreement will affect the right of any party to this Agreement to serve process in any other manner permitted by law. (d) If for the purpose of obtaining judgment in any court it is necessary to convert a sum due hereunder in one currency into another currency, the parties hereto agree, to the fullest extent that they may effectively do so under applicable law, that the rate of exchange used shall be the spot rate at which in accordance with normal banking procedures the first currency could be purchased in New York City with such other currency by the person obtaining such judgment on the Business Day preceding that on which final judgment is given. 97 (e) The parties agree, to the fullest extent that they may effectively do so under applicable law, that the obligations of the Borrower to make payments in any currency of the principal of and interest on the Loans of the Borrower and any other amounts due from the Borrower hereunder to the Agent as provided in Section 2.16 (i) shall not be discharged or satisfied by any tender, or any recovery pursuant to any judgment (whether or not entered in accordance with Section 9.15(d)), in any currency other than the relevant currency, except to the extent that such tender or recovery shall result in the actual receipt by the Agent at its relevant office as provided in Section 2.16 on behalf of the Lenders of the full amount of the relevant currency expressed to be payable in respect of the principal of and interest on the Loans and all other amounts due hereunder (it being assumed for purposes of this clause (i) that the Agent will convert any amount tendered or recovered into the relevant currency on the date of such tender or recovery), (ii) shall be enforceable as an alternative or additional cause of action for the purpose of recovering in the relevant currency the amount, if any, by which such actual receipt shall fall short of the full amount of the relevant currency so expressed to be payable and (iii) shall not be affected by an unrelated judgment being obtained for any other sum due under this Agreement. SECTION 9.16. Confidentiality. Unless otherwise agreed to in writing ---------------- by the Borrower, the Issuing Bank, the Agent and each Lender, each of the Borrower, the Issuing Bank, the Agent and the Lenders hereby agrees to keep all Proprietary Information (as defined below) confidential and not to disclose or reveal any Proprietary Information to any person other than the Agent's or such Lender's directors, officers, employees, Affiliates and agents and to actual or potential assignees and participants, and then only on a confidential basis; provided, however, that the Agent, the Issuing Bank or any Lender may disclose - -------- ------- Proprietary Information (a) as required by law, rule, regulation or judicial process, (b) to its attorneys and accountants, (c) as requested or required by any state or Federal or foreign authority or examiner regulating banks or banking or (d) subject to appropriate confidentiality protections, in any legal proceedings between the Agent, the Issuing Bank or such Lender and the Borrower arising out of this Agreement. For purposes of this Agreement, the term "Proprietary Information" shall include all information about the Borrower or any of their Affiliates which has been furnished by the Borrower or any of its Affiliates, whether furnished before or after the date hereof, and regardless of the manner in which it is furnished; provided, however, that -------- ------- 98 Proprietary Information does not include information which (x) is or becomes generally available to the public other than as a result of a disclosure by the Agent, the Issuing Bank or any Lender not permitted by this Agreement, (y) was obtained or otherwise became available to the Agent, the Issuing Bank or any Lender on a nonconfidential basis prior to its disclosure to the Agent, the Issuing Bank or such Lender by the Borrower or any of its Affiliates or (z) becomes available to the Agent, the Issuing Bank or any Lender on a nonconfidential basis from a person other than the Borrower or its Affiliates who, to the best knowledge of the Agent, the Issuing Bank or such Lender, as the case may be, is not otherwise bound by a confidentiality agreement with the Borrower or any of its Affiliates, or is not otherwise prohibited from transmitting the information to the Agent, the Issuing Bank or such Lender. SECTION 9.17. European Monetary Union. (a) If, as a result of the ------------------------ implementation of European monetary union, (i) any currency ceases to be lawful currency of the nation issuing the same and is replaced by a European common currency, or (ii) any currency and a European common currency are at the same time recognized by the central bank or comparable authority of the nation issuing such currency as lawful currency of such nation and the Agent or the Required Lenders shall so request in a notice delivered to the Borrower, then any amount payable hereunder by any party hereto in such currency shall instead be payable in the European common currency and the amount so payable shall be determined by translating the amount payable in such currency to such European common currency at the exchange rate recognized by the European Central Bank for the purpose of implementing European monetary union. Prior to the occurrence of the event or events described in clause (i) or (ii) of the preceding sentence, each amount payable hereunder in any currency will continue to be payable only in that currency. (b) The Borrower agrees, at the request of any Lender, to compensate such Lender for any loss, cost, expense or reduction in return that shall be incurred or sustained by such Lender as a result of the implementation of European monetary union and that would not have been incurred or sustained but for the transactions provided for herein. A certificate of a Lender setting forth the amount or amounts necessary to compensate such Lender shall be delivered to the Borrower and shall be conclusive absent manifest error. The Borrower shall pay such Lender the amount shown as due on any such certificate within 10 days after receipt thereof. 99 (c) The Borrower agrees, at the request of the Required Lenders, at the time of or at any time following the implementation of European monetary union, to enter into an agreement amending this Agreement in such manner as the Required Lenders shall reasonably request in order to reflect the implementation of such monetary union and to place the parties hereto in the position they would have been in had such monetary union not been implemented. IN WITNESS WHEREOF, the Borrower, the Agent, the Issuing Bank and the Lenders have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. CHOICE HOTELS INTERNATIONAL, INC., by /s/ Michael J. DeSantis ---------------------------------------- Name: Michael J. DeSantis Title: Senior Vice President & Secretary THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent, by /s/ Thomas H. Kozlark ---------------------------------------- Name: Thomas H. Kozlark Title: Vice President BANK OF TOKYO - MITSUBISHI TRUST COMPANY, by /s/ Catherine Moeser ----------------------------------------- Name: Catherine Moeser Title: Vice President CRESTAR BANK, by /s/ Greg D. Wheeless ----------------------------------------- Name: Greg D. Wheeless Title: Senior Vice President 100 THE DAI-ICHI KANGYO BANK, LTD., by /s/ Robert P. Gallagher, Jr. ----------------------------------------- Name: Robert P. Gallagher, Jr. Title: Assistant Vice President FIRST NATIONAL BANK OF MARYLAND, by /s/ Michael B. Stueck ----------------------------------------- Name: Michael B. Stueck Title: Vice President FIRST UNION NATIONAL BANK, by /s/ Barbara K. Angel ----------------------------------------- Name: Barbara K. Angel Title: Vice President THE FUJI BANK, LIMITED, by /s/ Raymond Ventura ----------------------------------------- Name: Raymond Ventura Title: Vice President & Manager THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH, by /s/ John Veltri ----------------------------------------- Name: John Veltri Title: Joint General Manager THE LONG TERM CREDIT BANK OF JAPAN, LTD., NEW YORK BRANCH, by /s/ Ismail Ibrahim ----------------------------------------- Name: Ismail Ibrahim Title: Deputy General Manager 101 MELLON BANK, N.A., by /s/ Laurie G. Dunn ----------------------------------------- Name: Laurie G. Dunn Title: Vice President NATIONSBANK, N.A., by /s/ Michael R. Heredia ----------------------------------------- Name: Michael R. Heredia Title: Senior Vice President THE SANWA BANK, LIMITED, NEW YORK BRANCH, by /s/ Dominic J. Sorresso ----------------------------------------- Name: Dominic J. Sorresso Title: Vice President SUMMIT BANK, by /s/ Bruce A. Gray ----------------------------------------- Name: Bruce A. Gray Title: Vice President THE TOYO TRUST & BANKING COMPANY, LTD., NEW YORK BRANCH, by /s/ Tahashi Mihumo ----------------------------------------- Name: Tahashi Mihumo Title: Vice President by /s/ Howard Tulley Mott ----------------------------------------- Name: Howard Tulley Mott Title: Vice President 102 EX-4.03 3 EXHIBIT 4.03 Exhibit 4.03 FIRST AMENDMENT dated as of February , 1998 (this "Amendment"), among CHOICE HOTELS INTERNATIONAL, INC., a Delaware ---------- corporation (the "Borrower"), the undersigned financial -------- institutions party to the Credit Agreement referred to below (the "Lenders"), and THE CHASE MANHATTAN BANK, as agent for the ------- Lenders (in such capacity, the "Agent"). ----- A. Reference is made to the Competitive Advance and Multi-Currency Credit Facilities Agreement dated as of October 15, 1997 (the "Credit ------ Agreement") among the Borrower, the Lenders and the Agent. Capitalized terms - --------- used but not otherwise defined herein have the meanings assigned to them in the Credit Agreement. B. The Borrower has requested that the Lenders amend certain provisions of the Credit Agreement. The Lenders are willing to do so, subject to the terms and conditions of this Amendment. Accordingly, in consideration of the mutual agreements herein contained and other good and valuable consideration, the sufficiency and receipt of which are hereby acknowledged, the parties hereto hereby agree as follows: SECTION 1. Amendment to Article I. The following amendments are made ----------------------- to the definitions contained in Article I of the Credit Agreement: (a) The definition of "Baron Entities" is hereby amended to read as -------------- follows: "Baron Entities" shall mean the collective reference to Ronald -------------- Baron, Baron Capital Group, Inc., Baron Capital, Inc., BAMCO, Inc., Baron Capital Management Inc., Baron Asset Fund and any of their respective Affiliates. (b) The definition of "Change in Control" shall be amended by adding ----------------- the following sentence at the end thereof: "Notwithstanding the foregoing, no Change in Control will be deemed to have occurred by virtue of the Baron Entities owning directly or indirectly, beneficially or of record, shares representing greater than 33% of the aggregate ordinary voting power represented by the issued and outstanding capital stock of the Borrower if the Baron Entities shall own greater than 33% of the capital stock of the Borrower solely as a result of stock repurchases made by the Borrower in the ordinary course of business, with no view toward increasing the Baron Entities' relative ownership interest or otherwise changing control of the Borrower; provided that the Baron Entities shall not have -------- 2 acquired directly or indirectly, beneficially or of record, any shares of capital stock of the Borrower since February , 1998, other than (i) pursuant to pro rata stock splits and stock dividends made by the Borrower and (ii) that the Baron Entities, as a whole, may at any time own the same aggregate number of shares of capital stock of the Borrower that they own as of February , 1998 (after giving effect to dispositions and repurchases by the Baron Entities). SECTION 2. Representations, Warranties and Agreements. The Borrower ------------------------------------------- hereby represents and warrants to and agrees with each Lender and the Agent that: (a) The representations and warranties set forth in Article III of the Credit Agreement are true and correct in all material respects with the same effect as if made on the Amendment Effective Date, except to the extent such representations and warranties expressly relate to an earlier date. (b) The Borrower has the requisite power and authority to execute, deliver and perform its obligations under this Amendment. (c) The execution, delivery and performance by the Borrower of this Amendment (i) have been duly authorized by all requisite action and (ii) will not (A) violate (x) any provision of law, statute, rule or regulation, or of the certificate or articles of incorporation or other constitutive documents or by-laws of the Borrower or any Subsidiary, (y) any order of any Governmental Authority or (z) any provision of any indenture, agreement or other instrument to which the Borrower or any Subsidiary is a party or by which any of them or any of their property is or may be bound, (B) be in conflict with, result in a breach of or constitute (alone or with notice or lapse of time or both) a default under any such indenture, agreement for borrowed money or other agreement or instrument or (C) result in the creation or imposition of any Lien upon or with respect to any property or assets now owned or hereafter acquired by the Borrower. (d) This Amendment has been duly executed and delivered by the Borrower. Each of this Amendment and the Credit Agreement, as amended hereby, constitutes a legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its 3 terms, except as enforceability may be limited by (i) any applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the enforcement of creditors' rights generally and (ii) general principals of equity. (e) As of the Amendment Effective Date, no Event of Default or Default has occurred and is continuing. SECTION 3. Conditions to Effectiveness. This Amendment shall become ---------------------------- effective on the date of the satisfaction in full of the following conditions precedent (the "Amendment Effective Date"): ------------------------ (a) The Agent shall have received duly executed counterparts hereof which, when taken together, bear the authorized signatures of the Borrower, the Agent and the Required Lenders. (b) Ronald Baron and the Borrower shall have entered into a shareholder agreement in form and substance satisfactory to the Agent. (c) All legal matters incident to this Amendment shall be satisfactory to the Required Lenders, the Agent and Cravath, Swaine & Moore, counsel for the Agent. (d) The Agent shall have received such other documents, instruments and certificates as it or its counsel shall reasonably request. SECTION 4. Credit Agreement. Except as specifically stated herein, ----------------- the Credit Agreement shall continue in full force and effect in accordance with the provisions thereof. As used therein, the terms "Agreement", "herein", "hereunder", "hereto", "hereof" and words of similar import shall, unless the context otherwise requires, refer to the Loan Agreement as modified hereby. SECTION 5. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND --------------- CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. SECTION 6. Counterparts. This Amendment may be executed in any ------------- number of counterparts, each of which shall be an original but all of which, when taken together, shall constitute but one instrument. Delivery of an executed counterpart of a signature page of this Amendment by telecopy 4 shall be effective as delivery of a manually executed counterpart of this Amendment. SECTION 7. Expenses. The Borrower agrees to reimburse the Agent --------- for its out-of-pocket expenses in connection with this Amendment, including the reasonable fees, charges and disbursements of Cravath, Swaine & Moore, counsel for the Agent. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed by their respective authorized officers as of the date first above written. CHOICE HOTELS INTERNATIONAL, INC. by ____________________________ Name: Title: THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent by ____________________________ Name: Title: BANK OF TOKYO - MITSUBISHI TRUST COMPANY by ____________________________ Name: Title: CRESTAR BANK by ____________________________ Name: Title: 5 THE DAI-ICHI KANGYO BANK, LTD. by ____________________________ Name: Title: FIRST NATIONAL BANK OF MARYLAND by ____________________________ Name: Title: FIRST UNION NATIONAL BANK by ____________________________ Name: Title: THE FUJI BANK, LIMITED by ____________________________ Name: Title: THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH by ____________________________ Name: Title: THE LONG TERM CREDIT BANK OF JAPAN, LTD., NEW YORK BRANCH by ____________________________ Name: Title: 6 MELLON BANK, N.A. by ____________________________ Name: Title: NATIONSBANK, N.A. by ____________________________ Name: Title: THE SANWA BANK, LIMITED, NEW YORK BRANCH by ____________________________ Name: Title: SUMMIT BANK by ____________________________ Name: Title: THE TOYO TRUST & BANKING COMPANY, LTD., NEW YORK BRANCH by ____________________________ Name: Title: by ____________________________ Name: Title: EX-10.08 4 EXHIBIT 10.08 Exhibit 10.08 CONSULTING AGREEMENT -------------------- This CONSULTING AGREEMENT (the "Agreement") is made and entered into as of October 15, 1997, by and between Choice Hotels International, Inc., a Delaware corporation to be renamed "Sunburst Hospitality Corporation" ("Choice") and Choice Hotels Franchising, Inc., a Delaware corporation to be renamed Choice Hotels International, Inc. ("Franchising"). RECITALS -------- WHEREAS, Franchising is currently a wholly owned subsidiary of Choice; WHEREAS, Choice has determined to separate its hotel franchising business from its hotel acquisition, development and ownership business pursuant to a special dividend consisting of the distribution (the "Distribution") to Choice stockholders of all outstanding shares of Franchising common stock; WHEREAS, in order to implement the Distribution, Choice and Franchising have entered into a Distribution Agreement dated as of October 15, 1997 (the "Distribution Agreement"); and WHEREAS, in connection with the Distribution, Choice and Franchising have agreed that Choice will provide to Franchising certain consulting and advisory services, as described more fully herein; NOW THEREFORE, in consideration of the mutual covenants contained herein, and other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Consulting Services. ------------------- 1.1. Services to be Rendered. Upon the request of Franchising, ----------------------- Choice shall provide various consulting and advisory services to Franchising related to financial issues affecting Franchising, including, without limitation, transitional issues related to the appointment by Franchising of a Chief Financial Officer. 1.2. Timing. Any services provided by Choice hereunder shall be ------ rendered as promptly as possible taking into account the particular circumstances of each request and the time reasonably necessary to provide a report or evaluation. Franchising shall provide all pertinent information relating to each assignment as reasonably requested by Choice. 1.3. Services Advisory Only. It is further understood and agreed ---------------------- between the parties that the services to be provided to Franchising hereunder by Choice are consultative and advisory in nature only and that under no circumstances shall Choice be under any obligation to provide any day-to-day management services with respect to Franchising. 2. Compensation. ------------ 2.1. Annual Retainer. For and in consideration of the continued --------------- agreement of Choice to render to Franchising the services listed in Section 1, Choice will be entitled to a retainer fee for each twelve month period ended October 31 (or any portion thereof) during the term of this Agreement (the "Annual Retainer") in an amount equal to thirty percent (30%) of the annual compensation (including base salary, incentive bonus and fringe benefits) paid to James A. MacCutcheon by Choice during such period (or portion thereof) pursuant to Mr. MacCutcheon's employment agreement as in effect on the date hereof (the "Employment Agreement"). The Annual Retainer shall be payable in equal monthly installments (based on Choice's good faith estimate of the Annual Retainer), with appropriate adjustments to the actual amount to be made on October 31 of each year during the term of this Agreement. 2.2. Out-of-Pocket Expenses. Franchising will be responsible for the ---------------------- reimbursement to Choice of its reasonable out-of-pocket expenses incurred in connection with the provision of services hereunder. Reimbursement shall be made on a monthly basis upon receipt of an invoice describing the nature and amount of such expenses. Payment shall be made within ten (10) business days of receipt of an invoice. 2.3. Termination Fee. In the event that Franchising elects to --------------- terminate this Agreement pursuant to the terms of Section 3.2 hereof, in addition to any Annual Retainer then due to Choice under Section 2.1, Franchising shall pay to Choice a termination fee equal to thirty percent (30%) of the aggregate amount payable to Mr. MacCutcheon under the Employment Agreement as a result of Mr. MacCutcheon's separation from Choice. Such amount (or any portion thereof) shall be payable to Choice within fifteen (15) days after Choice pays such amounts (or such portion thereof) to Mr. MacCutcheon. 3. Term. ---- 3.1. This Agreement shall have a term commencing on the date hereof and automatically terminating on November 1, 2001, unless otherwise terminated prior to such date pursuant to Section 3.2 below. 3.2. In the event that Mr. MacCutcheon ceases to be employed by Choice for any reason, this Agreement shall be terminable, at the election of Choice or Franchising, effective upon the date Mr. MacCutcheon ceases to be so employed. 4. Cooperation. A policy of full cooperation shall prevail between the ----------- parties and their authorized representatives with respect to all matters contemplated by this Agreement. Each party agrees in good faith to cooperate with the other party and keep each other (through designated representatives) regularly and reasonably informed of the information, preparation and review of the matters upon which Franchising desires Choice's consultation and advice. 5. Designated Representatives. For the purpose of ensuring effective -------------------------- liaison between the parties, each party will designate in writing an individual who will be the respective representative of such party through whom all communications regarding the performance of the services to be provided hereunder shall be channeled. 6. Franchising's Responsibility. Notwithstanding the consultation and ---------------------------- advice to be rendered hereunder, it is understood that Franchising shall remain fully responsible for the management of its business and that Choice will act in an advisory capacity only. Choice will not be deemed, in any manner, to be responsible to, or to have control or charge over, the operations of Franchising. Franchising shall have no obligation to implement any recommendations or advice rendered by Choice. 7. Agency, Comercially Reasonalbe Efforts. In performing its services -------------------------------------- hereunder, Choice shall be an independent contractor and neither party shall be an agent or representative of the other except as may be specifically authorized in advance in writing. Choice shall only be required to exert its comercially reasonable efforts to the attainment of the objectives of this Agreement. In no event may any provision of this Agreement be construed as or otherwise constitute a guarantee by Choice that the objectives of this Agreement, i.e., to provide an additional level of oversight and analysis of the financial operations of Franchising will necessarily be attained, it being recognized by the parties that Franchising shall be fully responsible for its business and operations and that, in any event, intervening events over which neither party has any control may preclude the realization in whole or in part of such objectives. 8. Warranties. In performing any services hereunder, Choice makes no ---------- representation or warranty, expressed or implied, regarding the sufficiency of any advice or consultation it may render. Franchising recognizes that the consulting and advisory services to be provided by Choice hereunder may often involve questions of judgment on which reasonable people may differ. Any responsibility of Choice hereunder shall be limited solely to its gross negligence or intentional misconduct. 9. Default Termination. This Agreement may be terminated on 30 days ------------------- written notice by either party if the other party shall fail to perform or observe any obligation or requirement of this Agreement and such failure shall continue for 30 days after written notice thereof, specifying the nature and extent of such default, provided however that if upon receipt of such notice the other party shall (if such default is not capable of being cured within 30 days) promptly commence to cure the default and shall thereafter diligently pursue such efforts to completion, then such notice shall be of no force and effect. 10. Assignment. Neither party may assign or transfer this Agreement nor ---------- its risks or obligations hereunder without the prior written consent of the other party except that either party may assign this Agreement to an affiliated corporation or partnership. No such assignment shall relieve the assignor of any liability hereunder. 11. Indemnification. Franchising hereby agrees to indemnify, defend and --------------- hold harmless Choice and each of its officers, directors and employees from and against all claims, demands, losses, liabilities, actions, lawsuits and other proceedings, judgments and awards and costs and expenses (including, without limitation, reasonable attorneys fees and disbursements) arising directly or indirectly in whole or in part out of any (i) action hereunder by Choice made in good faith and in a reasonable expectation that such action shall be for the best interest of Franchising or (ii) any unintentional omission by Choice. 12. Parties Bound. This Agreement shall inure to the benefit of and be ------------- binding upon the parties hereto and their respective successors and permitted assigns, and nothing herein expressed or implied shall be construed to give any other person any legal or equitable rights hereunder. 13. Entire Agreement. This Agreement constitutes the entire ---------------- understanding between the parties concerning the subject matter hereof and supersedes all prior written or oral communications between the parties relating hereto. 14. Notices. All notices, consents, approvals and other communications ------- given or made pursuant hereto shall be in writing and shall be effective when delivered personally or by overnight courier or by registered or certified mail (postage prepaid, return receipt requested) to the parties at the following addresses (or at such other address for a party as shall be specified by like notice): (a) if to Choice: Sunburst Hospitality Corporation 10770 Columbia Pike Silver Spring, Maryland 20901 Attention: General Counsel (b) if to Franchising: Choice Hotels Franchising, Inc. 10750 Columbia Pike Silver Spring, Maryland 20901 Attention: General Counsel 15. Amendment; Waiver. This Agreement shall not be amended except in a ----------------- written amendment executed by the parties. The waiver by either party of any breach of any term or condition of this Agreement shall not constitute any waiver of any subsequent breach or justify the effectiveness of that term or condition. 16. Titles and Headings. Titles and headings to sections herein are ------------------- inserted for the convenience of reference only and are not intended to be a part of or to affect the meaning or interpretations of this Agreement. 17. 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. 18. Governing Law. All controversies and disputes arising out of or under ------------- this agreement shall be determined pursuant to the laws of the State of Maryland, without regard to the principles of conflicts of laws thereof. 19. Arbitration of Disputes. ----------------------- (a) Any dispute, controversy or disagreement ("Dispute") between the parties related to the obligations of the parties under this Agreement in respect to which an amicable resolution cannot be reached shall be submitted for mediation to a committee made up of an equal number of non-common members of each company's Board of Directors ("Committee"). If the parties are unable to reach an amicable resolution of a Dispute within thirty days after submission to the Committee, then, to the maximum extent allowed by law, the Dispute shall be submitted and resolved by final and binding arbitration in Baltimore, Maryland administered by JAMS-Endispute in accordance with JAMS-Endispute's rules of practice then in effect or such other procedures as the parties may agree upon; provided, however, that any party may seek injunctive relief and enforcement of any award rendered pursuant to the arbitration provisions of this Section 21 by bringing a suit in any court of competent jurisdiction. Any award issued as a result of such arbitration shall be final and binding between the parties thereto and shall be enforceable by any court having jurisdiction over the party against whom enforcement was sought and application may be made to such court for judicial acceptance of the award and order of enforcement. The fees and expenses of arbitration (including reasonable attorneys' fees) shall be paid by the party that does not prevail in such arbitration. (b) If any party to this Agreement brings an action to enforce its rights under this Agreement, the prevailing party shall be entitled to recover its costs and expenses, including without limitation reasonable attorneys' fees, incurred in connection with such action, including any appeal of such action. (c) Nothing contained in this Section 21 shall limit or restrict in any way the right or power of a party at any time to seek injunctive relief in any court and to litigate the issues relevant to such request for injunctive relief before such court (i) to restrain the other party from breaching this Agreement or (ii) for specific enforcement of this Section 21. The parties agree that any legal remedy available to a party with respect to a breach of this Section 21 will not be adequate and that, in addition to all other legal remedies, each party is entitled to an order specifically enforcing this Section 21. (d) The Parties hereby consent to the jurisdiction of the federal courts located in the State of Maryland for all purposes under this Agreement. (e) Neither party nor the arbitrators may disclose the existence or results of any arbitration under this Agreement or any evidence presented during the course of the arbitration without the prior written consent of both parties, except as required to fulfill applicable disclosure and reporting obligations, or as otherwise required by law. 20. Counterparts. This Agreement may be executed in one or more ------------ counterparts, which shall be considered one and the same agreement. This Agreement shall become effective when one or more counterparts have been signed by each party and delivered to the party, it being understood that both parties need not sign the same counterpart. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date above written. CHOICE HOTELS INTERNATIONAL, INC., a Delaware Corporation By: __________________________________ Name: Title CHOICE HOTELS FRANCHISING, INC., a Delaware Corporation By: __________________________________ Name: Title EX-10.12 5 EXHIBIT 10.12 Exhibit 10.12 EMPLOYMENT AGREEMENT -------------------- This Agreement ("Agreement") dated this 18th day of December, 1997 between Choice Hotels International, Inc. ("Employer"), a Delaware corporation with principal offices at 10750 Columbia Pike, Silver Spring, Maryland 20901, and Donald Dempsey ("Employee"), sets forth the terms and conditions governing the employment relationship between Employee and Employer. 1. Employment. During the term of this Agreement, as hereinafter ---------- defined, Employer hereby employs Employee as Executive Vice President and Chief Financial Officer. Employee hereby accepts such employment upon the terms and conditions hereinafter set forth and agrees to faithfully and to the best of his ability perform such duties as may be from time to time assigned by Employer's Board of Directors and Chief Executive Officer, such duties to be rendered at the principal office of Employer, subject to reasonable travel. Employee also agrees to perform his duties in accordance with policies established by Employer's Board of Directors, which may be changed from time to time. 2. Term. Subject to the provisions for termination hereinafter provided, ---- the term of this Agreement shall begin on January 12, 1998 ("Effective Date") and shall terminate five (5) years thereafter (the "Termination Date"). The Termination Date shall automatically be extended for successive one-year terms unless either party gives written notice no less than nine months prior to the Termination Date that it elects not to extend the Termination Date. 3. Compensation. For all services rendered by Employee under this ------------ Agreement during the term thereof, Employer shall pay Employee the following compensation: (a) Salary. A base salary of Three Hundred Twenty Five Thousand ------ Dollars ($325,000) per annum payable in equal bi-weekly installments. Such salary shall be reviewed by the Compensation Committee of the Board of Directors of Employer at the next annual review of officers following the Effective Date and may be increased at the discretion of Employer. (b) Incentive Bonus. Employee shall have the opportunity to earn up --------------- to a maximum of Fifty-five Percent (55%) per annum of the base salary set forth in subparagraph 3(a) above in Employer's bonus plans as adopted from time to time by Employer's Board of Directors. (c) Restricted Stock. On the Effective Date, Employer shall issue to ---------------- Employee 17,000 shares of restricted Choice Hotels common stock ("Common Stock"). The restrictions on such shares shall lapse upon vesting, which shall occur in five equal annual installments beginning on the first anniversary of the Effective Date. (d) Automobile. Employer shall provide Employee with an allowance for ---------- automobile expenses of $850 per month subject to withholding of usual taxes. (e) Stock Options. Employee shall be eligible to receive options ------------- under the Choice Hotels International, Inc. Long Term Incentive Plan ("LTIP"), or similar plan, to purchase Common Stock in accordance with the policy of the Employer's Board as in effect from time to time. Additionally, the Employee shall be granted, on the Effective Date, 100,000 options to purchase such number of shares of Common Stock. A number of the options shall be incentive stock options granted under the LTIP, which number shall be the maximum number permitted under the LTIP and Section 422(d) of the Internal Revenue Code of 1986, as amended, but in no event more than 25% of the total number of options granted pursuant to this Section 3(e). The remainder of the options shall be nonqualified stock options. The options shall be exercisable at an amount per share equal to the average of the high and low trading price of the Common Stock on the Effective Date and shall vest in five equal annual installments following the first anniversary of the Effective Date. (f) SERP. At the Effective Date, Employee shall participate in the ---- Choice Hotels International, Inc. Supplemental Executive Retirement Plan ("SERP"), with the amendments identified on Exhibit A. (g) Other Benefits. Employee shall, when eligible, be entitled to -------------- participate in all other fringe benefits, including vacation policy, generally accorded the most senior executive officers of Employer as are in effect from time to time on the same basis as such other senior executive officers. (h) Relocation Expenses. Employee shall be entitled to all benefits -------------------- under the Relocation Policy of Employer, as adopted in November 1996, with the following additions: (1) Notwithstanding Section II(C) of the Relocation Policy, the Employer will pay up to a maximum of $5,000 for the relocation of Employee's boat to Annapolis, Maryland; (2) Notwithstanding Section 2(VII) of the Relocation Policy, Employer will reimburse Employee for a period of up to twelve months from the Effective Date for return trips for Employee and Employee's spouse, children and mother-in-law to and from Employee's Tennessee home during such period as are reasonably needed. (3) Notwithstanding Section 2(VIII) of the Relocation Policy, Employer shall reimburse Employee for real estate commissions not to exceed 7% of the sales price. 4. Extent of Services. Employee shall devote his full professional ------------------ time, attention, and energies to the business of Employer, and shall not during the term of this Agreement be engaged in any other business activity whether or not such business activity is pursued for gain, 2 profit, or other pecuniary advantage; but the foregoing shall not be construed as preventing Employee from investing his assets in (i) the securities of public companies, or (ii) the securities of private companies or limited partnerships outside the lodging industry if such holdings are passive investments of one percent or less of outstanding securities and Employee does not hold positions of officer, employee or general partner. Employee shall be permitted to serve as a director of companies outside of the lodging industry so long as such service does not inhibit his performance of services to the Employer. Employee shall not be permitted to serve as a director of any company within the lodging industry unless (i) the Corporate Compliance officer of the Employer has determined that there is no conflict of interest and (ii) such service does not inhibit his performance of services to the Employer. Employee warrants and represents that he has no contracts or obligations to others which would materially inhibit the performance of his services under this Agreement. 5. Disclosure and Use of Information. Employee recognizes and --------------------------------- acknowledges that Employer's and affiliates' present and prospective clients, franchises, management contracts, acquisitions and personnel, as they may exist from time to time, are valuable, special and unique assets of Employer's business. Throughout the term of this Agreement and for a period of two (2) years after its termination or expiration for whatever cause or reason except as required by applicable law, Employee shall not directly or indirectly, or cause others to, make use of or disclose to others any information relating to the business of Employer that has not otherwise been made public, including but not limited to Employer's present or prospective clients, franchises, management contracts or acquisitions. During the term of this Agreement and for a period of two years thereafter, Employee agrees not to solicit for employment or contract for services with, directly or indirectly, on his behalf or on behalf of any other person or entity, any person employed by Employer, or its subsidiaries or affiliates during such period, unless Employer consents in writing. In the event of an actual or threatened breach by Employee of the provisions of this paragraph, Employer shall be entitled to injunctive relief restraining Employee from committing such breach or threatened breach. Nothing herein stated shall be construed as preventing Employer from pursuing any other remedies available to Employer for such breach or threatened breach, including the recovery of damages from Employee. 6. Notices. Any notice, request or demand required or permitted to be ------- given under this Agreement shall be in writing, and shall be delivered personally to the recipient or, if sent by certified or registered mail to his residence in the case of Employee, or to its principal office in the case of the Employer. Such notice shall be deemed given when delivered if personally delivered or within three days of mailing if sent certified or registered mail. 7. Elective Positions; Constructive Termination -------------------------------------------- (a) Nothing contained in this Agreement is intended to nor shall be construed to abrogate, limit or affect the powers, rights and privileges of the Board of Directors or stockholders to remove Employee from the positions set forth in Section 1, with or without Cause (as defined in Section 10 below), during the term of this Agreement or to elect someone other than Employee to those positions, as 3 provided by law and the By-Laws of Employer. Nothing in this Agreement is intended to nor shall be construed to abrogate, limit or affect the Employee's rights and privileges to terminate this Agreement. (b) If Employee is Constructively Terminated (as defined in Section 7(c) below) it is expressly understood and agreed that Employee's rights under this Agreement shall in no way be prejudiced, Employee shall not, thereafter, be required to perform any services under this Agreement and Employee shall be entitled to receive compensation referred to in Section 3 above, including, without limitation, the continued vesting through the term of this Agreement of stock options and restricted stock outstanding at the time of the Constructive Termination. However, Employee shall not be entitled to receive new stock option grants or rights to ungranted stock options. Employee upon removal shall not be required to mitigate damages but nevertheless shall be entitled to pursue other employment, and Employer shall be entitled to receive as an offset and thereby reduce its payment by the base salary and bonus received by Employee from any other employment. As a condition to Employee receiving his compensation from Employer, Employee agrees to permit verification of his employment records and income tax returns by an independent attorney or accountant, selected by Employer but reasonably acceptable to Employee, who agrees to preserve the confidentiality of the information disclosed by Employee except to the extent required to permit Employer to verify the amount received by Employee from other active employment. Employer shall receive credit for unemployment insurance benefits, social security insurance or other like amounts payable during periods of unemployment actually received by Employee. (c) For purposes of this Section 7, "Constructively Terminated" shall mean removal or termination of Employee other than in accordance with Section 10, assignment of duties by the Employer inconsistent with Section 1, a change in Employee's title or the line of reporting set forth in Section 1 or any other material breach of this Agreement by Employer provided Employer shall be given fourteen days advance written notice of such claim of material breach, which written notice shall specify in reasonable detail the grounds of such claim of material breach. Except in the case of bad faith, Employer shall have an opportunity to cure the basis for Constructive Termination during the fourteen day period after written notice. 8. Waiver of Breach. The waiver of either party of a breach of any ---------------- provision of this Agreement shall not operate or be construed as a waiver of any subsequent breach. 9. Assignment. The rights and obligations of Employer under this ---------- Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of Employer. The obligations of Employee hereunder may not be assigned or delegated. 4 10. Termination of Agreement. This Agreement shall terminate upon the ------------------------ following events and conditions: (a) Upon expiration of its term; (b) For Cause which means, including but not limited to, deliberate and continued refusal to carry out duties and instructions of the Employer's Board of Directors and Chief Executive Officer consistent with the position, material dishonesty, a violation or a willful breach of this Agreement, conviction of a felony involving moral turpitude, fraud or misappropriation of corporate funds or any willful acts or omissions inimical to or contrary to material policies of Employer not arbitrarily applied in the case of Employee. (c) Subject to state and federal laws, if Employee is unable to perform the essential functions of the services described herein for more than 180 days (whether or not consecutive) in any period of 365 consecutive days, Employer shall have the right to terminate this Agreement by written notice to Employee. In the event of such termination, all non-vested obligations of Employer to Employee pursuant to this Agreement shall terminate. (d) In the event of Employee's death during the term of this Agreement, the Agreement shall terminate as of the date thereof. 11. Legal Fees. Employer shall reimburse the Employee for all reasonable ----------- attorneys fees incurred in connection with the negotiation and execution of this Agreement. 12. Entire Agreement. This instrument contains the entire agreement of ---------------- the parties. It may be changed only by an agreement in writing signed by the party against whom enforcement of any waiver, change, modification, extension, or discharge is sought. This Agreement shall be governed by the laws of the State of Maryland, and any disputes arising out of or relating to this Agreement shall be brought and heard in any court of competent jurisdiction in the State of Maryland. 13. Compensation Committee Approval. Notwithstanding any other provision -------------------------------- to the contrary, this Agreement is subject to the approval of the Employer's Compensation Committee at its next meeting, which is expected to occur on or about December 17, 1997, and shall not be valid, binding and enforceable prior thereto. Prior to such approval, neither party hereto shall make any public announcement with respect to this Agreement or the employment of Employee by Employer. 5 IN WITNESS WHEREOF, the parties have executed this Agreement on the date first set forth above. Employer: CHOICE HOTELS INTERNATIONAL, INC. By: ______________________________ Michael J. DeSantis Senior Vice President Employee: __________________________________ Donald Dempsey 6 EX-10.13 6 EXHIBIT 10.13 Exhibit 10.13 CONSULTING AGREEMENT AND RELEASE -------------------------------- This CONSULTING AGREEMENT AND RELEASE (the "Agreement and Release") is made and entered into as of December 18, 1997, by and between Choice Hotels International, Inc., a Delaware corporation ("Choice") and Barry L. Smith ("Smith"). RECITALS A. Smith has informed Choice that he intends to retire from Choice upon the appointment of a successor to his position. B. Choice desires to retain Smith as a consultant. NOW, THEREFORE, in consideration of the mutual promises contained herein and for other good and valuable consideration, the receipt and sufficiency of are hereby acknowledged, the parties agree as follows: 1. Resignation. Smith shall resign as Senior Vice President, Marketing, ----------- upon 45 days after a successor has been appointed by the Board of Directors to the position (or similar position with similar responsibilities), but in no event later than December 15, 1998 (the "Resignation Date"). 2. Consulting Period. During the period from the Resignation Date ----------------- through December 15, 1998 (assuming the Resignation Date is a date prior to December 15, 1998), Smith will remain on Choice's payroll and such period will be referred to as the "Initial Consulting Period". At the mutual election of Choice and Smith and upon 30 days prior written notice by one party, to be accepted or rejected by the other in ten (10) days after receipt of notice, the Initial Consulting Period shall be extended, upon acceptance, for successive one year periods (the "Additional Consulting Period"); provided, however, that to so extend, the Additional Consulting Period must still be in effect on the one year anniversary of the commencement of such term. 3. Consulting Services. ------------------- 3.1 Services to be Rendered. During the Initial Consulting ----------------------- Period and any Additional Consulting Period, Smith shall provide such consulting and advisory services to Choice related to marketing issues affecting Choice, as may be requested by Choice from time to time. 3.2 Report to CEO. During the Initial Consulting Period, Smith ------------- shall report to the Chief Executive Officer of Choice or to such other officer as Choice may designate. 4. Compensation. ------------ 4.1 Fees. For and in consideration of the continued agreement of ---- Smith to render to Choice the services listed in Section 3, Smith will be entitled to an Initial Consulting Period fee for the period ended December 15, 1998 in an amount equal to $265,000, or the pro rata portion thereof if the Initial Consulting Period commences after January 1, 1998. These fees shall be payable in equal bi-weekly installments with usual deductions taken. During any Additional Consulting Period, Smith shall be paid for services rendered to Choice at a rate of $200 per hour. Smith shall submit monthly bills to Choice with payment due within 30 days thereof. 4.2 Benefits. Choice and Smith have negotiated the following -------- undertakings with respect to the amount and payment schedule of certain benefits to be paid to Smith. A. During the Initial Consulting Period, Smith shall be eligible for a bonus under the same bonus plan as in effect as of the date hereof. The criteria for such bonus shall be agreed to between the parties. Smith shall remain eligible for a bonus for the fiscal year ended December 31, 1997. B. No additional vacation or sick leave shall accrue during the Initial Consulting Period or any Additional Consulting Period. C. The lump sum relocation expense reimbursement of $2,300 per month shall cease on the Resignation Date. D. Reimbursement of reasonable business and travel expenses in accordance with Choice's policies. No car allowance will be paid after the Resignation Date. E. During the Initial Consulting Period and any Additional Consulting Period, Smith shall have the right to exercise Manor Care, Inc., Sunburst Hospitality Corporation and Choice stock options that vest through December 15, 1998 or the end of any Additional Consulting Period in accordance with the number of shares shown to vest in the Barry Smith Choice Stock Report and the Barry Smith Sunburst Stock Report, collectively attached hereto as Exhibit A. Choice agrees that Smith shall be deemed continuously eligible by - ---------- Choice throughout the Initial Consulting Period and any Additional Consulting Period for purposes of participation in such stock option plans; however, Smith shall not be entitled to receive any future grants under the stock option plans but he shall be entitled to exercise those previously granted. F. During the Initial Consulting Period, Smith may continue to make standard employee payments for medical and life insurance plans (not including AD&D), if and as maintained by Choice during the Initial Consulting Period. In connection therewith, Smith shall elect and pay for COBRA coverage with Choice and shall be reimbursed by Choice for the difference between the COBRA coverage premium and the standard Choice employee premium. 2 5. Smith Not to Compete. --------------------- 5.1 Non-Compete. During the Initial Consulting Period, Smith ------------ shall not be employed by or provide consulting services to any other individual, company, firm or other entity. Smith also agrees that during the Initial Consulting Period and any Additional Consulting Periods, Smith will not engage, without first obtaining Choice's prior written consent, directly or indirectly, in any activities within the Territory (as defined below) whether as employee, officer, director, partner, joint venturer, stockholder (other than the holder of less than 5% of the stock of a corporation the securities of which are traded on a national securities exchange or in the over-the-counter market), consultant or agent, which involves a business which is in direct competition to the business in which Choice is engaged at the time of termination of the Initial Consulting Period. 5.2 Territory. For the purposes of this Section 5, the ---------- "Territory" shall mean any place within the continental United States in which Choice is, at the time of the termination of the Additional Consulting Period, engaged in business. 5.3 Enforceability. It is the intent and understanding of each --------------- party hereto that if, in any action before any court or agency legally empowered to enforce the covenants contained in this Section 5 any term, restriction, covenant or promise contained therein is found to be unreasonable and for that reason unenforceable, then such term, restriction, covenant or promise shall be deemed modified to the extent necessary to make it enforceable by such court or agency. 6. Complete Release. ---------------- 6.1 Smith. Smith agrees to release Choice, its former parents, ----- Sunburst Hospitality Corporation (formerly Choice Hotels International, Inc.) and Manor Care, Inc ., and any related companies, subsidiaries and affiliates, and the officers, directors, employees and agents of all of them, from all claims or demands Smith may have based on Smith's employment with Choice or the termination of that employment except for claims for benefits under this Agreement. This includes a release of any rights or claims Smith may have under the Age Discrimination in Employment Act, which prohibits age discrimination in employment; Title VII of the Civil Rights Act of 1964, which prohibits discrimination in employment based on race, color, national origin, religion or sex; the Equal Pay Act, which prohibits paying men and women unequal pay for equal work; and any other federal, state or local laws or regulations prohibiting employment discrimination. This also includes a release by Smith of any claims for personal injuries, wrongful discharge, compensation and benefits, expenses, bonuses, or any other employee rights or benefits not otherwise being paid for pursuant to this Agreement. This release does not include a release of Smith's right, if any, to retirement or profit-sharing benefits or deferred compensation arrangements under the standard programs of Choice nor release of his rights under this Agreement. This Agreement and Release covers both claims Smith knows about and those he may not know about. Smith assumes the risk of such unknown claims which may exist at the time he signs this Agreement and agrees that this Agreement shall apply to any and all known and unknown claims, except the parties agree that this release does not apply to those claims involving fraud or dishonesty on the part of Choice. 3 Smith hereby acknowledges that he has been treated fairly by Choice in the course of his employment, and in the separation of his employment, and further acknowledges that he has not suffered any age discrimination or wrongful termination and has no claims of any kind against Choice or any related companies, subsidiaries, affiliates, or the officers, directors, employees or agents of any of them. 6.2 Choice. Choice and any subsidiaries, and the officers, ------ directors, employees and agents of all of them, agree to release Smith from all claims or demands Choice may have based on Smith's employment with Choice or the termination of that employment except for any claims involving fraud or dishonesty on the part of Smith. This Agreement and Release covers both claims Choice knows about and those it may not know about. Choice assumes the risk of such unknown claims which may exist at the time it signs this Agreement and agrees that this Agreement shall apply to any and all known and unknown claims except as provided in the previous paragraph. 7. Future Lawsuits or Claims. Each party promises never to file a ------------------------- lawsuit, administrative proceeding or agency action asserting any claims which are released in Paragraph 6 of this Agreement except for claims that may arise out of this Agreement or any stock option plans. Except to the extent otherwise required by law, each party further agrees not to assist any other person in bringing any action, claim or demand against the other party with respect to claims that are released in Paragraph 6. Smith and Choice further agree to keep confidential all of the events leading up to Smith's separation from Choice. 8. Non-Disparagement. Choice and Smith agree that they respectively ----------------- shall not disparage the business reputation of the other party hereto and each shall not communicate to any person any information which would cause injury to or tend to cause injury to the business reputation of the other. 9. Certificate. Smith acknowledges and agrees that as an additional ------------ precondition to receiving the benefits described herein, Smith must execute the Certificate (that is attached as Appendix "A" to this Agreement and Release) after the Resignation Date and return the Certificate to Choice Hotels International, Inc., 10750 Columbia Pike, Silver Spring, Maryland 20901, Attention: Senior Vice President, Human Resources. This Certificate must be received by Choice no later than five business days after the Resignation Date. 10. Business Information of Choice/Non-Solicitation of Choice's Employees. --------------------------------------------------------------------- Smith agrees not to directly or indirectly, or cause others to make use of or disclose to others any non-public information relating to the business of Choice and its affiliates, which information would be considered Trade Secrets under the Maryland Uniform Trade Secrets Act. For a period of two 4 (2) years from December 15, 1998, Smith agrees not to solicit for employment or contract for services with, directly or indirectly, on his behalf or on behalf of any other person or entity, any person employed by Choice, or its subsidiaries or affiliates during the twenty-four (24) month period prior to December 15, 1998, unless Choice consents in writing. 11. Non-Release of Future Claims. This Agreement does not waive or ---------------------------- release any rights or claims that Smith may have under the Age Discrimination in Employment Act which arise after the date Smith signs this Agreement. 12. Consequences of Violation of Promises. If either party breaks the ------------------------------------- promises contained in Paragraph 7 of this Agreement and files a lawsuit, administrative proceeding or agency action based on claims that such party has released, the breaching party will pay for all costs incurred by the non- breaching party, including reasonable attorneys' fees, in defending against such claim. A breaching party shall also pay for all damages and costs incurred by the non-breaching party in connection with a breach of the provisions of Section 18. 13. Consultation; Revocation. Smith is advised to consult with an ------------------------ attorney prior to executing this Agreement. He may have a period of up to 21 days to consider this Agreement. Smith acknowledges that no deadlines of less than 21 days have been imposed on him to review or execute this Agreement. In addition, should he choose to sign the Agreement, he shall have a period of seven days to revoke such signature. Revocation can be made by delivering a written notice of revocation to the Senior Vice President, Human Resources, Choice Hotels International, Inc., 10750 Columbia Pike, Silver Spring, Maryland 20901. For this revocation to be effective, written notice must be received by the Senior Vice President, Human Resources no later than the close of business on the seventh (7th) day after Smith signs this Agreement. If Smith revokes this Agreement it shall not be effective or enforceable and Smith will not receive the benefits described in Section 4. 14. Encouragement to Consult with Attorney. Smith is strongly encouraged -------------------------------------- to consult with an attorney before signing this Agreement. Smith understands that whether or not to do so is Smith's decision. 15. Signing is Voluntary. Smith acknowledges that he has had adequate -------------------- opportunity to review this Agreement with an attorney, that Smith understands its terms, that Smith was not coerced into signing, and that Smith signed this Agreement knowingly and voluntarily. 16. Complete Defense. Each party fully understands and agrees that ---------------- this Agreement may be pleaded by the other as a complete defense to any claim or entitlement which may be asserted by a party against the other, for or on account of any matters waived or released in this Agreement. 17. Non-Admission of Liability. The parties each make this Agreement to -------------------------- avoid the cost of defending against any possible lawsuit. By making this Agreement, neither party admits that it has done anything wrong. 5 18. Confidentiality. Smith and Choice agree to preserve the --------------- confidentiality of this Agreement, except to the extent that disclosure is required by law, rule or regulation; and except that it is permissible for either party to disclose the terms of this Agreement to such party's accountants, attorneys and advisors, financial institution with whom he/it has a customer relationship and to any third party not otherwise employed by and/or affiliated with Choice with whom Smith contemplates a business relationship that is not prohibited by the terms of this Agreement. 19. Entire Agreement. This is the entire Agreement between Smith and ---------------- Choice. Choice has made no promises to Smith other than those in this Agreement. 20. Choice of Law; Jurisdiction. This Agreement shall be construed --------------------------- exclusively in accordance with the laws of the State of Maryland, without regard to the principles of conflicts of laws therein. In the event that a dispute arises under this Agreement and legal action is instituted, the parties agree that such action shall be maintained exclusively in the Circuit Court for Montgomery County, Maryland. The parties hereby voluntarily submit to the jurisdiction of said court. SMITH HAS HAD AN OPPORTUNITY TO CAREFULLY REVIEW AND CONSIDER THIS AGREEMENT WITH AN ATTORNEY, AND HE HAS HAD SUFFICIENT TIME TO CONSIDER IT. AFTER SUCH CAREFUL CONSIDERATION, HE KNOWINGLY AND VOLUNTARILY ENTERS INTO THIS AGREEMENT WITH FULL UNDERSTANDING OF ITS MEANING. PLEASE READ THIS AGREEMENT CAREFULLY. IT CONTAINS A RELEASE OF ALL KNOWN AND UNKNOWN CLAIMS. CHOICE HOTELS INTERNATIONAL, INC. ATTEST: By:___________________________________________ ____________________________ Thomas Mirgon, Senior Vice President WITNESS: ______________________________________________ ____________________________ Barry L. Smith 6 EX-13.01 7 EXHIBIT 13.01 Exhibit 13.01 Financial Report as of December 31, 1997 Choice Hotels International HIGHLIGHTS A tax-free spinoff on Oct. 15, 1997, separated franchising from real estate and management operations, launching Choice as a pure-play franchisor (NYSE:CHH) with a sharpened focus, well-positioned to build on its global leadership in high-margin brands. A new partnership was announced with Friendly Hotels PLC of the United Kingdom to assume master franchise rights for the Comfort, Quality and Clarion brands throughout Europe (except Scandinavia) and ownership of Choice-held European properties in exchange for more than $34 million. Entrepreneur magazine named Choice the top lodging franchise company for 1998, citing the company's financial strength and stability, growth rate, system size and years in business. Choice ranked 16th in Entrepreneur's overall listing of franchise companies, sharing a top 20 designation with McDonald's, Burger King, 7-Eleven and Taco Bell. Choice announced it had delivered $1 billion in reservations sales during a single calendar year through the CHOICE 2001 reservations system, an all-time company record that surpassed the previous record of $905 million set in 1996. New independent research showed consumers rate the Sleep Inn brand number one for service, satisfaction and value over its competitors. The brand's satisfaction rating was nearly 20 points higher than the nearest competitor. An agreement was signed with the Vessel Company Ltd., a Japanese hotel and development firm, to build at least 20 Sleep Inn hotels throughout Japan over a 15-year period. Construction of Vessel's first Sleep Inn hotel is expected to begin this year. 10750 Columbia Pike Silver Spring, MD 20901 AT A GLANCE Strong Growth The Choice worldwide system totaled 3,484 open hotels representing 292,700 rooms as of Dec. 31, 1997, an 8 percent increase over calendar year 1996. U.S. developers signed 219 franchise contracts for the period June 1 through Dec. 31, 1997. Of that total, 142, or 65 percent, represented new construction. QUALITY(R) INNS, HOTELS & SUITES Quality offers an established mid-priced lodging product with rooms designed for today's business travelers, backed by a 100 percent satisfaction guarantee. OPEN 661 hotels 75,991 rooms UNDER DEVELOPMENT 157 hotels 16,551 rooms TOTAL 818 hotels 92,542 rooms SEVEN-MONTH HIGHLIGHTS Mike "Fluff" Cowan, caddie to professional golfer Tiger Woods, appeared in a multimillion television advertising campaign to promote the Quality and Comfort brands. Millions of television viewers watched Jimmy Connors defeat John McEnroe in the finals of The Challenge, a tennis tournament sponsored by the Quality brand. COMFORT(R) INNS & COMFORT SUITES Comfort is a leading limited-service brand, offering affordable rates, exceptional rooms and suites and free deluxe continental breakfast, backed by a 100 percent satisfaction guarantee. OPEN 1,617 hotels 126,474 rooms UNDER DEVELOPMENT 329 hotels 27,803 rooms TOTAL 1,946 hotels 154,277 rooms SEVEN-MONTH HIGHLIGHTS A $10 million summer advertising campaign tied to the Disney film Hercules debuted nationwide to promote the Comfort, Quality and Econo Lodge brands. On June 26, 1997, Comfort brand hotels celebrated National Hometown Hercules Day, a publicity event developed to complement the advertising campaign by recognizing hospitality heroes in communities throughout the country. CLARION(R) INNS, HOTELS, SUITES & RESORTS Clarion features upscale full-service hotels at three-star prices that provide outstanding value to corporate travelers and the mid-sized meeting market, satisfaction guaranteed. OPEN 115 hotels 18,649 rooms UNDER DEVELOPMENT 34 hotels 5,569 rooms TOTAL 149 hotels 24,218 rooms SEVEN-MONTH HIGHLIGHTS The Clarion brand was named to Success magazine's 1997 Franchise Gold 100 ranking of the 100 best and most entrepreneurial franchise chains in the country. The Explore the World of Clarion meetings program, featuring a 100 percent satisfaction guarantee, was rolled out systemwide. SLEEP INN Sleep Inn is an all-new construction, consistent, limited-service chain offering state-of-the-art room features and a 100 percent satisfaction guarantee. OPEN 160 hotels 11,886 rooms UNDER DEVELOPMENT 128 hotels 9,852 rooms TOTAL 288 hotels 21,738 rooms SEVEN-MONTH HIGHLIGHTS Consumers rate the Sleep Inn brand number one over its competitors for service, satisfaction and value in a new study by D.K. Shifflet & Associates, a highly respected travel research firm. A television advertising campaign was launched to promote the Sleep Inn brand's number-one rating for service, satisfaction and value. ECONO LODGE Econo Lodge is among the best roadside names in its category, offering clean, affordable economy lodging for travelers who want to "Spend a Night, Not a Fortune." OPEN 714 hotels 46,073 rooms UNDER DEVELOPMENT 122 hotels 8,487 rooms TOTAL 836 hotels 54,560 rooms SEVEN-MONTH HIGHLIGHTS The Signature Exterior Renovation Program, designed to boost revenue per available room performance by improving hotel appearance, was mandated chainwide. At year's end, 190 Econo Lodge franchisees had completed the Signature Exterior Renovation Program, and another 144 renovations were in progress. Tommy Lasorda, former Los Angeles Dodgers manager and a recent baseball Hall of Fame inductee, debuted in a new television commercial promoting Econo Lodge and its signature Senior Room. RODEWAY INN Rodeway Inn offers economy hotels with national consumer exposure specializing in meeting the needs of the senior travel market. OPEN 214 hotels 13,370 rooms UNDER DEVELOPMENT 46 hotels 3,504 rooms TOTAL 260 hotels 16,874 rooms SEVEN-MONTH HIGHLIGHTS The Rodeway Inn brand was named to Success magazine's 1997 Franchise Gold 100 ranking of the 100 best and most entrepreneurial franchise chains in the country. An electronic door lock mandate for all guest rooms was rolled out systemwide. \ MAINSTAY SUITES MainStay Suites is Choice's newest lodging concept: the industry's first franchised mid-market, extended-stay hotel with residential amenities designed to serve professionals on extended assignments. OPEN 3 hotels 257 rooms UNDER DEVELOPMENT 28 hotels 2,647 rooms TOTAL 31 hotels 2,904 rooms SEVEN-MONTH HIGHLIGHTS A guest satisfaction survey by Intersearch Corporation found that 93 percent of MainStay Suites guests would recommend the brand and 94 percent would return for another stay. The survey also found that 93 percent of MainStay Suites guests believed their expectations were met or exceeded and 96 percent said the value was excellent, very good or good. CHOICE PICKS FOOD COURT Choice Picks Food Court is the industry's first modular food court system featuring branded items including Pizzeria Uno, Nathan's Famous, Healthy Choice Deli, Casa Ortega, Big Apple Bagels, I Can't Believe It's Yogurt, Nestle Toll House Cookie Cafe, Sarks Gourmet Coffees and Coca-Cola. OPEN 24 food courts 174 modules UNDER DEVELOPMENT 9 food courts 66 modules TOTAL 33 food courts 240 modules SEVEN-MONTH HIGHLIGHTS Four nationally recognized products joined the Choice Picks Food Court line-up: SuperPretzels by J&J Snack Foods, barbecue ribs by Damon's International and biscuits with sausage gravy and Snackwiches by Bob Evans Farms. Financial Information Table of Contents
Management Discussion & Analysis 7-11 Report of Independent Public Accountants 12 Consolidated Financial Statements 13-16 Notes to Consolidated Financial Statements 17-26 Board of Directors and Corporate Officers 27 Corporate Information 28
Management Discussion & Analysis Choice Hotels International Inc. and Subsidiaries The Company is one of the largest hotel franchisors in the world with 3,484 hotels open and 844 hotels under development at December 31, 1997, representing 292,700 rooms open and 74,413 rooms under development in 33 countries. The company franchises hotels under the Comfort, Quality, Econo Lodge, Sleep Inn, Clarion, Rodeway Inn and MainStay Suites brand names. The Company has over 2,100 franchisees in the franchise system with no single franchisee accounting for more than 5% of its royalty or total revenues. The Company operates in all 50 states and the District of Columbia and 32 additional countries with 95% of its franchising revenue derived from hotels franchised in the United States. Accordingly, management's discussion of its franchise operating results focuses on the performance of the domestic system. The principal factors that affect the Company's results are: growth in the number of hotels under franchise; occupancies and room rates achieved by the Company's brands; the number and relative mix of franchised hotels; and the Company's ability to manage costs. The number of rooms at franchised properties and occupancies and room rates at those properties significantly affect the Company's results because franchise royalty fees are based upon room revenues at franchised hotels. Increases in franchise fee revenues have a disproportionate impact on the Company's operating margin due to the lower incremental costs associated with these revenues. During 1997, the Company changed its fiscal year from a May 31 year-end to a December 31 year-end. Accordingly, the following discussion includes a discussion of the results of the seven months ended December 31, 1997, as compared to unaudited results from the comparable seven month period in 1996. Comparison of Seven Month Period Ended December 31, 1997 Operating Results and Seven Month Period Ending December 31, 1996 Operating Results The Company recorded net income of $27.3 million for the period ended December 31, 1997 ("December 1997"), an increase of $4.0 million, compared to net income of $23.3 million for the period ended December 31, 1996 ("December 1996"). The increase in net income for December 1997 was primarily attributable to an increase in franchise revenue as a direct result of the addition of new franchisees to the system and improvements in the operating performance of franchised hotels. Summarized financial results for the seven month periods ended December 31, 1997 and 1996 are as follows:
1997 1996 REVENUES: (In thousands) (Unaudited) Royalty fees $ 70,308 $ 61,821 Marketing & reservation fees 72,284 66,273 Product sales 13,524 14,717 Initial franchise fees & relicensing fees 8,597 9,304 Other, including partner service revenue 4,869 3,161 European hotel operations 10,541 10,975 Total revenue 180,123 166,251 OPERATING EXPENSES: Franchise marketing & reservations 70,102 63,379 European hotel operations 9,203 9,745 Selling, general & administrative 29,454 28,132 Product services cost of sales 13,031 13,481 Depreciation & amortization 6,159 6,047 Total operating costs 127,949 120,784 Income before interest expense & income tax 52,174 45,467 Interest expense, net 5,791 5,784 Income before income taxes 46,383 39,683 Income taxes 19,096 16,338 Net income $ 27,287 $ 23,345
Franchise Revenues: In operating the franchise business, the Company collects marketing and reservation fees and assessments from its franchisees. The Company is contractually obligated to disburse these fees for marketing and reservation activities to be provided on behalf of its franchisees. Management, therefore, analyzes its franchise business based on revenues net of marketing and reservation fees ("net franchise revenue") and franchise operating expenses which are reflected as selling, general and administrative expenses. Net franchise revenues include royalty fees, initial franchise fees and relicensing fees earned on contracts signed and other revenues, including partner service revenue. Net franchise revenues are dependent upon growth in the number of franchised properties as well as the underlying perform- ance of franchised hotels for continued growth. The key industry standard for measuring hotel operating performance is revenue per available room ("RevPAR"), which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. Net franchise revenues were $83.8 million for December 1997 and $74.3 million for December 1996. Royalties increased $8.5 million to $70.3 million from $61.8 million in December 1996, an increase of 13.8%. The increase in royalties is attributable to a net increase of 264 franchisees during the period representing an additional 19,881 rooms added to the system, an improvement in domestic RevPAR of 2.4% and an increase in the effective royalty rate of the domestic hotel system to 3.57% from 3.45%. Domestic initial fee revenue generated from franchise contracts signed declined 7.5% to $8.6 million from $9.3 million in December 1996. Total franchise agreements signed in December 1997 were 368, down 14% from the total contracts signed in December 1996 of 428. The decline in initial fees is partly a result of the Company's sales force reorganization and the resulting temporary displacement of the sales force. The reorganization of the regional market management sales and support force was completed in September 1997. Revenues generated from strategic partnership relationships increased to $3.4 million from $1.5 million in December 1996. This revenue relates to agreements that provide preferred vendors access to the Company's licensees. Franchise Expenses: The cost to operate the franchising business is reflected in selling, general and administrative expenses. Selling, general and administrative expenses were $29.5 million for December 1997, an increase of $1.4 million from the December 1996 total of $28.1 million. The increases in selling, general and administrative expenses were primarily due to additional personnel to support company growth and new company initiatives. As a percentage of net franchise revenues, selling, general and administrative expenses declined to 35.2% in December 1997 from 37.8% in December 1996. The improvement in the franchising margins relates to the economies of scale generated from operating a larger franchisee base, cost control initiatives and improvements in franchised hotel performance. Product Sales: Sales made to franchisees through the Company's group purchasing program declined $1.2 million to $13.5 million in December 1997 from $14.7 million in December 1996. The group purchasing program utilizes bulk purchases to obtain favorable pricing from third party vendors for franchisees ordering similar products. The Company acts as a "clearing-house" between the franchisee and the vendor, and orders are shipped directly to the franchisee. Similarly, product cost of sales decreased $0.4 million (or 3.3%) in December 1997. The product services margins decreased in December 1997 to 3.6% from 8.4% in December 1996. This purchasing program is provided to the franchisees as a service and is not expected to be a major component of the Company's profitability. European Hotel Operations: In January 1998, the Company and Friendly Hotels, PLC ("Friendly") consummated a transaction in which Friendly acquired from the Company the master franchise rights for the Comfort, Quality and Clarion brands for all of Europe, with the exception of Scandinavia, for a payment of $8 million. As part of this transaction, Friendly acquired from the Company ten hotels in France, two in Germany and one in the United Kingdom in exchange for $22.2 million in 5.75% convertible preferred shares in Friendly. In addition, Friendly will pay the Company deferred compensation of $4 million in cash, payable by the fifth anniversary or sooner depending on the level of future profits of the hotels acquired. Depreciation and Amortization: Depreciation and amortization increased to $6.2 million in December 1997 from $6.0 million in December 1996. The increase was primarily due to recent capi- tal improvements to the Company's financial and billing information systems. Interest expense, net: The increase in interest expense results from additional debt incurred in connection with the Distribution. Included in the December 1997 results is approximately $550,000 in dividend income from the Company's investment in Friendly. Comparison of Fiscal Year 1997 Operating Results and Fiscal Year 1996 Operating Results The Company recorded net income of $34.7 million for the year ended May 31, 1997 ("fiscal 1997"), an increase of $23.0 million, compared to net income of $11.7 million for the year ended May 31, 1996 ("fiscal 1996"). Fiscal 1996 results include a $24.8 million asset impairment charge related to the Company's European hotel operations. Exclusive of this charge, fiscal 1996 net income was $26.7 million. The increase in net income for fiscal 1997 was primarily attributable to an increase in franchise revenue as a direct result of the addition of new franchisees to the franchise system and improvements in the operating performance of franchised hotels. Franchise Revenues: Net franchise revenues were $126.7 million for fiscal 1997 and $110.6 million for fiscal 1996. Royalties increased $9.0 million to $95.2 million from $86.2 million in fiscal 1996, an increase of 10.4%. The increase in royalties is attributable to a net increase of 292 franchisees during the period representing an additional 21,578 rooms added to the system, an improvement in domestic RevPAR of 2.9% and an increase in the effective royalty rate of the domestic hotel system to 3.43% from 3.34%. Domestic initial fee revenue generated from franchise contracts signed increased 14.8% to $14.0 million from $12.2 million in fiscal 1996. Total franchise agreements signed in fiscal 1997 were 495, up 13.5% from the total contracts signed in fiscal 1996 of 436. Revenues generated from strategic vendor relationships increased to $6.1 million from $1.8 million in fiscal 1996. This revenue relates to agreements that provide preferred vendors access to the Company's licensees. Franchise Expenses: Selling, general and administrative expenses were $51.1 million in fiscal 1997, an increase of $5.9 million from the fiscal 1996 total of $45.2 million. $4.8 million of the increase was directly attributable to additional costs of operating as an independent company apart from Manor Care. These additional costs were primarily additional staffing, incremental rental expenses, and consulting fees as the Company assumed certain administrative tasks previously provided by Manor Care. The remaining increases in selling, general and administrative expenses were primarily due to additional personnel to support company growth and new company initiatives. As a percentage of total net franchising revenues, total franchising selling, general and administrative expenses were 40.3% in fiscal year 1997 and 40.9% in fiscal year 1996. Exclusive of the $4.8 million increase resulting from the distribution, as a percentage of net franchising revenues, selling, general and administrative expenses declined to 36.5% in fiscal year 1997 from 40.9% in fiscal year 1996. The improvement in the franchising margins primarily relates to the economies of scale generated from operating a larger franchisee base. Product Sales: Sales made to franchisees through the Company's group purchasing program increased $2.1 million to $23.6 million in fiscal 1997 from $21.6 million in fiscal 1996. Similarly, product cost of sales increased $2.1 million (or 9.9%) in fiscal 1997. The product services margins decreased in fiscal 1997 to 3.7% from 4.0% in fiscal 1996. This purchasing program is provided to the franchisees as a service and is not expected to be a major component of the Company's profitability. European Hotel Operations: Total revenues at the Company's owned hotel operations in Europe declined to $17.7 million in fiscal 1997 from $19.6 million in fiscal 1996. Operating margins at the hotels declined to 8.9% in fiscal 1997 from 10.6% in fiscal 1996. The decline in revenue and operating performance reflects the difficult economic and competitive climates in which a number of the European hotels operate. Depreciation and Amortization: Depreciation and amortization decreased $1.4 million (or 11.9%) to $10.4 million in fiscal 1997 from $11.8 million in fiscal 1996. The decrease was primarily due to the asset impairment charge against European fixed assets which reduced the asset base upon which depreciation is determined. Provision for Asset Impairment: In fiscal 1996, the Company recorded a charge against earnings of $24.8 million relating to impairment of certain long-lived assets related to the Company's European hotel operations. Other: In fiscal 1997, the Company recognized $943,000 in dividend income from its investment in Friendly Hotels, PLC. Comparison of Fiscal Year 1996 Operating Results and Fiscal Year 1995 Operating Results Net income for the fiscal year ended May 31, 1996 was $11.7 million, a decrease of $4.5 million (or 27.8%) compared to net income of $16.2 million for the fiscal year ended May 31, 1995 ("fiscal 1995"). Net income in fiscal 1996 includes a one time charge of $24.8 million relating to asset impairment. Exclusive of the $24.8 million charge, net income increased to $26.7 million in fiscal 1996, a 64.8% increase over fiscal 1995. Franchise Revenues: Net franchise revenues were $110.6 million for fiscal 1996 and $95.9 million for fiscal 1995. Royalties increased $10.8 million to $86.2 million from $75.4 million in fiscal 1996, an increase of 14.3%. The increase in royalties is attributable to a net increase of 217 domestic franchisees during the period, representing an additional 15,787 rooms added to the system, an improvement in RevPAR of 5.1% and an increase in the effective royalty rate of the domestic hotel system to 3.34% from 3.20%. Initial fee revenue generated from franchising contracts signed increased 37.8% to $13.5 million from $9.8 million in fiscal 1996. Total franchise agreements signed in fiscal 1996 were 436, up 21.4% from the total contracts signed in fiscal 1995 of 359. Franchise Expenses: Selling, general and administrative costs declined to $45.2 million in fiscal 1996 from $45.6 million in fiscal 1995. Selling, general and administrative expenses as a percentage of net franchise revenues declined to 40.9% in fiscal 1996 from 47.7% in fiscal 1995. The improvement in the franchising margins relates to the economies of scale generated from operating a larger franchisee base and improved operating performance of the franchised hotels. Product Sales: Sales made to franchisees through the Company's group purchasing program increased $7.1 million to $21.6 million in fiscal 1996 from $14.5 million in fiscal 1995. Similarly, product cost of sales increased $6.8 million (or 49.2%) in fiscal 1996. The product services margins were 4.0% in fiscal 1996 and fiscal 1995. The purchasing program is provided to the franchisees as a service and is not expected to be a major component of the Company's profitability. European Hotel Operations: Revenues from hotel operations increased 5.2% in fiscal 1996. Operating margins increased to 10.6% in fiscal 1996 from 3.8% in fiscal 1995. The increase in fiscal 1996 was primarily due to improved performance of newly completed owned and managed hotels. Other: In fiscal 1996, the Company recorded a charge against earnings of $24.8 million relating to impairment of certain long-lived assets associated with the Company's European hotel operations. Liquidity and Capital Resources Net cash provided by operating activities was $33.6 million for December 1997, a decrease of $11.9 million from $45.5 million for December 1996. At December 31, 1997, the total long-term debt outstanding for the Company was $282.8 million. Cash used in investing activities was $149.7 million, $16.9 million, $78.5 million, and $7.7 million in December 1997 and fiscal years 1997, 1996 and 1995, respectively. In connection with the Distribution on October 15, 1997, the Company funded a $115 million, five year, 11% Subordinated Term Note to Sunburst. The note is payable in full, along with accrued interest on October 15, 2002. As of December 31, 1997, approximately $25 million of estimated receivables are due to the Company from Sunburst, which are included in other current assets. This receivable relates to a net worth guarantee in effect as a result of the Distribution and the reimbursement of various expenses paid by the Company, subsequent to the Distribution Date. Subsequent to year-end, Sunburst paid $7.5 million of the outstanding balance. During fiscal 1995, prior to the Manor Care Distribution, the Company repurchased one-half of the 11% interest held by its management. 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 the Company for $27.9 million. Approximately $26.4 million was allocated to goodwill. During fiscal 1996, the Company purchased a 5% common stock interest and a preferred stock interest in Friendly, for approximately $17 million. Investment in property and equipment includes computer hardware as well as new developments and enhancements of reservation and finance systems. During December 1997 and the fiscal year ended May 31, 1997, capital expenditures totaled $7.3 million and $10.6 million and related primarily to the development of a new property management system and the installation of new financial systems. Capital expenditures in prior years include amounts for computer hardware, reservation systems and European hotel capital improvements. On October 15, 1997, the Company entered into a five-year $300 million competitive advance and multi-currency credit facility. The credit facility provides for a term loan of $150 million and a revolving credit facility of $150 million, $50 million of which is available in foreign currency borrowings. At the time of the Distribution, the Company borrowed $150 million under the term loan and $140 million under the revolving credit facility, the proceeds of which were used to fund the $115 million Sunburst note and to refinance existing indebtedness. As of December 31, 1997, the Company had $150 million of term loans outstanding, $84.6 million of revolving loans and $31 million of multi- currency borrowings. The term loan is payable over five years, $15 million of which is due in 1998. The credit facility includes customary financial and other covenants that requires the maintenance of certain ratios including maximum leverage, minimum net worth and interest coverage and restricts the Company's ability to make certain investments, repurchase stock, incur debt, and dispose of assets. At the Company's option, the interest rate may be based on LIBOR, a certificate of deposit rate or an alternate base rate (as defined), plus a facility fee percentage. The rate is determined based on the Company's consolidated leverage ratio at the time of borrowing. Interest on current borrowings is based on one of several rates including LIBOR. Subsequent to December 31, 1997, the Company has repurchased 490,214 shares of its common stock at a total cost of $7.9 million. The Company has authorization from its Board of Directors to repurchase up to an additional 1.27 million shares. The Company believes that cash flow from operations and available financing capacity is adequate to meet the expected operating, investing, financing and debt service requirements for the business for the immediate future. The Company has entered into interest rate swap agreements with a notional amount of $115 million at December 31, 1997, to fix certain of its variable rate debt in order to reduce the Company's exposure to fluctuations in interest rates. The interest rate differential to be paid or received on interest rate swap agreements is accrued as interest rates change and is recognized as an adjustment to interest expense. On average, the interest rate swap agreements have a life of three and one-half years with a fixed rate of 6.68% and a variable rate at December 31, 1997 of 6.39%. As of December 31, 1997, the interest rate swap agreements have a fair market valuation of approximately $(496,000). Impact of Recently Issued Accounting Standards The Company has adopted SFAS No. 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed of." The adoption of SFAS No. 121 did not have a material impact on the Company's financial statements. The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," no later than fiscal 1999. Management is evaluating the impact that these pronouncements will have on the Company's financial statements. Forward-Looking Statements The statements contained in this annual report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. A number of important factors could cause the Company's actual results for future periods to differ materially from those expressed in any forward-looking statements made by, or on behalf of the Company. Certain statements contained in this annual report, including those in the section entitled "Management's Discussion and Analysis," contain forward-looking information that involves risk and uncertainties. Actual future results and trends may differ materially depending on a variety of factors discussed in the "Risk Factors" section included in the Company's Form 10 Registration Statement and various Form 8-K filings, including the nature and extent of future competition, and political, economic and demographic developments in countries where the Company does business or in the future may do business. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements. Report of Independent Public Accountants To Choice Hotels International, Inc.: We have audited the accompanying consolidated balance sheets of Choice Hotels International, Inc., as defined under "Basis of Presentation" in the Notes to Consolidated Financial Statements, as of December 31, 1997 and May 31, 1997, and the related consolidated statements of income and cash flows for the seven months ended December 31, 1997 and for each of the three fiscal years in the period ended May 31, 1997, and the statement of shareholders' equity for the period from October 15, 1997 (inception) to December 31, 1997. These consolidated financial statements are the responsibility of Choice Hotels International, Inc.'s management . Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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 consolidated financial position of Choice Hotels International, Inc. as of December 31, 1997 and May 31, 1997, and the consolidated results of their operations and their consolidated cash flows for the seven months ended December 31, 1997, and each of the three fiscal years in the period ended May 31, 1997, and the statement of shareholders' equity for the period from October 15, 1997 (inception) to December 31, 1997, in conformity with generally accepted accounting principles. Arthur Andersen LLP Washington, D.C., January 27, 1998 Consolidated Statements of Income Choice Hotels International Inc. and Subsidiaries
Seven Months Ended Fiscal Years Ended May 31, December 31, -------------------------- (In thousands, except per share data) 1997 1997 1996 1995 Revenues Royalty fees $ 70,308 $ 97,215 $ 87,994 $ 78,092 Marketing and reservation fees 72,284 104,216 98,906 83,645 Product sales 13,524 23,643 21,570 14,461 European hotel operations 10,541 17,737 19,609 18,638 Initial franchise fees and relicensing fees 8,597 16,802 15,578 11,656 Other, including partner services revenue 4,869 12,642 6,997 6,180 Total revenues 180,123 272,255 250,654 212,672 Operating Expenses Marketing and reservation 70,102 101,421 96,246 81,545 Selling, general and administrative 29,454 51,102 45,196 45,589 Product cost of sales 13,031 22,766 20,709 13,882 European hotel operations 9,203 16,166 17,521 17,922 Depreciation and amortization 6,159 10,438 11,839 11,768 Provision for asset impairment -- -- 24,760 -- Total operating expenses 127,949 201,893 216,271 170,706 Operating Income 52,174 70,362 34,383 41,966 Other Minority interest expense -- -- 1,532 2,200 Interest on notes payable to Manor Care -- 7,083 7,083 7,083 Interest expense and other 8,788 4,647 4,791 3,672 Interest and dividend income (including interest income on the Sunburst Note of $2.4 million for December 31, 1997) (2,997) (943) -- -- Total other 5,791 10,787 13,406 12,955 Income before income taxes 46,383 59,575 20,977 29,011 Income taxes (19,096) (24,845) (9,313) (12,783) Net income $ 27,287 $ 34,730 $ 11,664 $ 16,228 Weighted average shares outstanding 59,798 62,680 62,628 62,480 Basic earnings per share $0.46 $0.55 $0.19 $0.26 Diluted earnings per share $0.45 $0.55 $0.19 $0.26
The accompanying notes are an integral part of these consolidated statements of income. Consolidated Balance Sheets Choice Hotels International Inc. and Subsidiaries
December 31, May 31, ( In thousands) 1997 1997 Assets Current assets Cash and cash equivalents $ 10,282 $ 4,167 Receivables (net of allowance for doubtful accounts of $7,608, and $6,159, respectively) 28,347 24,472 Other 3,446 5,676 Receivable from Sunburst Hospitality 25,066 -- Total current assets 67,141 34,315 Property and equipment, at cost, net of accumulated depreciation 37,040 43,377 Goodwill, net of accumulated amortization 68,792 69,939 Franchise rights, net of accumulated amortization 48,819 50,503 Investment in Friendly Hotels, PLC 17,011 17,161 Assets held for sale 10,752 -- Other assets 9,286 6,178 Note receivable from Sunburst Hospitality 117,447 -- Total assets 376,288 221,473 Liabilities and Equity Current liabilities Current portion of long-term debt 15,041 36 Accounts payable 26,452 20,412 Accrued expenses. 10,595 10,965 Income taxes payable 6,007 3,318 Total current liabilities 58,095 34,731 Long Term Debt 267,780 46,427 Notes Payable to Manor Care, Inc. -- 78,700 Deferred Income Taxes ($0 and $3,498, respectively) and other liabilities 1,155 4,422 Total liabilities 327,030 164,280 Shareholders' Equity Common stock, $.01 par value, 160,000,000 shares authorized and 59,828,878 shares issued and outstanding 598 -- Additional paid-in-capital 47,907 -- Cumulative translation adjustment (8,316) -- Treasury stock (189) -- Retained earnings 9,258 -- Investments and advances from Parent -- 57,193 Total shareholders' equity 49,258 57,193 Total liabilities and shareholders' equity $376,288 $221,473
Consolidated Statements of Cash Flows Choice Hotels International Inc. and Subsidiaries
Seven Months Ended Fiscal Years Ended May 31, December 31, (In thousands) 1997 1997 1996 1995 Cash Flows From Operating Activities Net income $ 27,287 $ 34,730 $ 11,664 $ 16,228 Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization 6,159 10,438 11,839 11,768 Provision for bad debt 2,274 2,238 685 692 Increase (decrease) in deferred taxes (4,828) 3,171 (13,527) 68 Non cash interest and dividend income (2,997) (943) -- -- Provision for asset impairment -- -- 24,760 -- Change in assets and liabilities: Change in receivables (10,606) (4,835) (7,533) (3,000) Change in prepaid expenses and other current assets 2,403 1,615 (990) 1,524 Change in current liabilities 11,226 (2,145) 4,050 3,694 Change in income taxes payable 2,689 1,061 (265) 158 Change in other liabilities -- 175 2,059 6,719 Net cash provided by operating activities 33,607 45,505 32,742 37,851 Cash Flows From Investing Activities Investment in property and equipment (7,329) (10,630) (6,506) (13,611) Purchase of minority interest -- (2,494) (55,269) -- Investment in Friendly Hotels PLC. -- -- (17,069) -- Advances to Sunburst Hospitality (25,066) -- -- -- Note Receivable from Sunburst Hospitality (115,000) -- -- -- Other items, net (2,344) (3,804) 345 5,878 Net cash utilized in investing activities (149,739) (16,928) (78,499) (7,733) Cash Flows From Financing Activities Proceeds from mortgages and other long-term debt 236,509 31,107 17,296 15,567 Principal payments of debt. (78,851) (51,260) (350) (13,492) Purchase of treasury stock (189) -- -- -- Cash transfers (to) from Parent, net (35,222) (8,069) 31,567 (33,336) Net cash provided by (utilized in) financing activities 122,247 (28,222) 48,513 (31,261) Net change in cash and cash equivalents 6,115 355 2,756 (1,143) Cash and cash equivalents at beginning of period 4,167 3,812 1,056 2,199 Cash and cash equivalents at end of period $ 10,282 $ 4,167 $ 3,812 $ 1,056
Consolidated Statement of Shareholders' Equity Choice Hotels International Inc. and Subsidiaries (In thousands, except share amounts)
Common Stock Additional Translation Treasury Retained Shares Amount Paid-in-Capital Adjustment Stock Earnings Initial capitalization - October 15, 1997 59,767,716 $598 $48,064 $(8,662) $ -- $ -- Net income -- -- -- -- -- 27,287 Exercise of stock options/grants, net. 71,876 -- (157) -- -- -- Translation adjustment -- -- -- 346 -- -- Treasury purchases (10,714) -- -- -- (189) -- Transfers of net income to Sunburst prior to the distribution -- -- -- -- -- (18,029) Balance as of December 31, 1997 59,828,878 $598 $47,907 $(8,316) $(189) $ 9,258
Notes to Consolidated Financial Statements Choice Hotels International Inc. and Subsidiaries 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 ("Choice Hotels Holdings, Inc." or the "Company") from its health care business via a spin-off of its lodging business (the "Manor Care Distribution"). On September 30, 1996 the Board of Directors of Manor Care declared a special dividend to its shareholders of one share of common stock of the Company for each share of Manor Care stock, and the Board set the Record Date and the Distribution Date. The Manor Care Distribution was made on November 1, 1996 to holders of record of Manor Care's Common Stock on October 10, 1996. The Manor Care Distribution separated the lodging and health care businesses of Manor Care into two public corporations. The operations of the Company consisted principally of the hotel franchise operations and the owned and managed hotel operations formerly conducted by Manor Care directly or through its subsidiaries (the "Lodging Business"). On November 1, 1996, concurrent with the Manor Care Distribution, the Company changed its name from Choice Hotels Holdings, Inc. to Choice Hotels International, Inc. ("CHI") and the Company's franchising subsidiary, formerly named Choice Hotels International, Inc., changed its name to Choice Hotels Franchising, Inc. ("Franchising"). On April 29, 1997, CHI's Board of Directors announced its intention to separate CHI's franchising business from its owned hotel business (hereinafter referred to as the "Sunburst Distribution"). On September 16, 1997 the Board of Directors and shareholders of the Company approved the separation of the business via a spin-off of the franchising business, along with CHI's European hotel and franchising operations, to its shareholders. The Board set October 15, 1997 as the date of distribution and on that date, Company shareholders received one share in Franchising (renamed "Choice Hotels International, Inc." and referred to hereafter as the "Company") for every share of CHI stock held on October 7, 1997 (the date of record). Concurrent with the October 15, 1997 distribution date, CHI changed its name to Sunburst Hospitality Corporation, (referred to hereafter as "Sunburst") and effected a one-for-three reverse stock split of its common stock. The Company is in the business of hotel franchising. As of December 31, 1997, the Company had franchise agreements with 3,484 hotels operating in 33 countries under the following brand names: Comfort, Clarion, Sleep, Quality, Rodeway Econo Lodge, and MainStay Suites. The consolidated financial statements present the financial position, results of operations, cash flows and equity of the Company as if it were formed as a separate entity of its parent (Manor Care prior to Manor Distribution and Sunburst prior to Sunburst Distribution) which conducted the hotel franchising business and European hotel operations and as if the Company were a separate company for all periods presented. The Parent's historical basis in the assets and liabilities of the Company has been carried over to the consolidated 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 transfers between the Company and Manor Care through November 1, 1996 and Sunburst through October 15, 1997. An analysis of the activity in the "Investments and advances from ParentO account for the three years ended May 31, 1997 and the seven months ended December 31, 1997 is as follows:
(In thousands) Balance, May 31, 1994 $ 4,409 Transfers to Parent, net (33,336) Net income 16,228 Balance, May 31, 1995 (12,699) Transfers from Parent, net 31,567 Net income 11,664 Balance, May 31, 1996 30,532 Transfers to Parent, net (8,069) Net income 34,730 Balance, May 31, 1997 57,193 Net Income from June 1, 1997 through October 15, 1997 18,029 Transfers to Parent, net through October 15, 1997 (35,222) Initial capitalization (40,000) Balance, October 15, 1997 $ 0
The average balance of the Investments and advances from Parent was $43.9 million, $8.9 million and ($4.1) million for fiscal years 1997, 1996 and 1995 respectively and $48.6 million for the period June 1, 1997 through October 15, 1997. Reclassifications Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. Significant Accounting Policies Fiscal Year Prior to December 1997, the Company's fiscal year was the twelve month period ended May 31. During October 1997, the Company changed its fiscal year from a May 31 year end to a December 31 year end. Assets Held For Sale Assets held for sale by the Company are stated at the lower of cost or estimated net realizable value. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less at the date of purchase to be cash equivalents. Property and Equipment The components of property and equipment in the consolidated balance sheets were:
December 31 May 31 (In thousands) 1997 1997 Land $ 996 $ 3,033 Building and improvements 18,238 27,409 Furniture, fixtures and equipment 31,228 30,526 50,462 60,968 Less: accumulated depreciation (13,422) (17,591) $ 37,040 $ 43,377
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
Minority Interest Prior to May 31, 1996, certain former members of the Company's management had a minority ownership interest in the Company. Amounts reflected as minority interest represent the minority owners' share of income in the Company. The Company repurchased all of the outstanding minority ownership interest in fiscal years 1995 and 1996. Goodwill Goodwill primarily represents an allocation of the excess purchase price of the stock of the Company over the recorded minority interest. Goodwill is being amortized on a straight-line basis over 40 years. Such amortization amounted to $1.1 million in the period ended December 31, 1997, $1.9 million, $1.1 million, and $598,000 in the fiscal years ended May 31, 1997, 1996 and 1995, respectively. Goodwill is net of accumulated amortization of $6.1 million and $5.0 million at December 31, 1997 and May 31, 1997, 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 26 years. Amortization expense for the periods ended December 31, 1997, May 31, 1997, 1996 and 1995 amounted to $1.7 million, $2.9 million, $2.6 million and $2.6 million, respectively. Franchise rights are net of accumulated amortization of $15. 7 million and $14.0 million at December 31, 1997 and May 31, 1997, respectively. Self-Insurance Program Subsequent to the Manor Care Distribution, the Company maintained its own self- insurance program for certain levels of general and professional liability, automobile liability and workers' compensation coverage. The estimated costs of these programs were accrued at present values based on actuarial projections for known and anticipated claims. As of June 1, 1997, the Company was no longer self insured. Prior to the Manor Care 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 through November 1, 1996 were assumed by Manor Care, and have been treated as paid to Manor Care, and as such, amounts paid to Manor Care up to November 1, 1996 have been charged directly to Investments and advances from Parent. Revenue Recognition The Company enters into numerous franchise agreements committing to provide franchisees 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 five, 10, or 15 years. Initial franchise fees are recognized upon sale because the initial franchise fee is non-refundable and the Company has no continuing obligations related to the franchisee. Royalty fees, primarily 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 consolidated 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. Impairment Policy The Company has adopted the Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" in fiscal year 1997. Accordingly, the Company evaluates the recoverability of long-lived assets, including franchise rights and goodwill, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured based on net, undiscounted expected cash flows. Assets are considered to be impaired if the net, undiscounted expected cash flows are less than the carrying amount of the assets. 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. The adoption of SFAS No. 121 did not have a material impact on the Company's financial statements. 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. Interest Rate Hedges The Company has entered into interest rate swap agreements with a notional amount of $115 million at December 31, 1997 to fix certain of its variable rate debt in order to reduce the Company's exposure to fluctuations in interest rates. The interest rate differential to be paid or received on interest rate swap agreements is accrued as interest rates change and is recognized as an adjustment to interest expense. On average, the interest rate swap agreements have a life of three and one-half years with a fixed rate of 6.68% and variable rate of 6.39%. As of December 31, 1997, the interest rate swap agreements have a fair market valuation of approximately $(496,000). 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 seven months ended December 31, 1997 and the fiscal years ended May 31, 1997, 1996 and 1995 were $16.2 million, $27.5 million, $29.9 million and $29.2 million, respectively. The Company's foreign operations had net income of $313,000 for the seven months ended December 31, 1997. Net losses were generated by foreign operations for the years ended May 31, 1997, 1996 and 1995 of $1.8 million, $19.4 million, and $5.7 million, respectively. Net losses generated by foreign operations for fiscal year 1996 include a $15.0 million net of tax charge relating to a provision for asset impairment. Total assets relating to foreign operations were $34.3 million and $48.8 million at December 31, 1997 and May 31, 1997 respectively. The majority of the revenues and assets of foreign operations relate to the Company's European business operations (see "Acquisitions and Divestitures"). Translation gains and losses are recorded in the cumulative translation adjustment account included in Investments and advances from Parent in the accompanying consolidated balance sheets prior to October 15, 1997, and are shown separately in shareholders' equity after October 15, 1997 as follows:
(In thousands) Balance, May 31, 1994 $ (31) Net adjustments 740 Balance, May 31, 1995 709 Net adjustments (2,459) Balance, May 31, 1996 (1,750) Net adjustments (5,268) Balance, May 31, 1997 (7,018) Net adjustments (1,298) Balance, December 31, 1997 $(8,316)
The cumulative translation adjustment included in the December 31, 1997 balance relating to assets held for sale was $(6.6) million. 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. Earnings Per Share The Company adopted SFAS 128, "Earnings Per Share" in 1997. The following table illustrates the reconciliation of the earnings and number of shares used in the basic and diluted earnings per share calculations (in millions, except per share amounts).
December 31, 1997 Computation of Basic Earnings Per Share: Net Income $27.3 Weighted average shares outstanding 59.8 Basic earnings per share $0.46 Computation of Diluted Earnings Per Share: Net income for diluted earnings per share $27.3 Weighted average shares outstanding 59.8 Effect of Dilutive Securities -- Employee stock option plan 1.5 Shares for diluted earnings per share 61.3 Diluted earnings per share $0.45
The effect of dilutive securities is computed using the treasury stock method and average market prices during the period. The Company does not have any options outstanding that were excluded from the computation of diluted earnings per share. The Company had no shares outstanding to the public or material dilutive securities prior to the Sunburst Distribution and therefore, no reconciliation has been provided for periods prior to December 31, 1997. The weighted average number of common shares outstanding is based on the Company's weighted average number of outstanding common shares for the period October 15, 1997 through December 31, 1997, Sunburst's weighted average number of outstanding common shares for the period November 1, 1996 through October 15,1997 and Manor Care's weighted average number of outstanding common shares prior to November 1, 1996. Income Taxes The Company was included in the consolidated federal income tax returns of Manor Care and Sunburst prior to October 15, 1997. Subsequent to October 15, 1997 the Company is required to make its own filings. The income tax provision included in these consolidated 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. Income before income taxes for the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997, 1996 and 1995 were derived from the following:
Dec. 31, May 31, (In thousands) 1997 1997 1996 1995 Income before income taxes Domestic operations $45,866 $62,641 $ 52,801 $38,385 Foreign operations 517 (3,066) (31,824) (9,374) Income before income taxes $46,383 $59,575 $ 20,977 $29,011
Income before income taxes for domestic operations and foreign operations for fiscal year 1996 includes a pretax provision of $24.8 million for asset impairment. The provisions for income taxes follows for the period ended December 31, 1997 and for the fiscal years ended May 31, 1997, 1996 and 1995.
Dec. 31, May 31, (In thousands) 1997 1997 1996 1995 Current tax (benefit) expense Federal $15,742 $19,421 $20,097 $14,169 Federal benefit of foreign operations 204 (1,213) (2,792) (3,703) State 3,475 3,950 3,754 2,292 Deferred tax (benefit) expense Federal (223) 2,293 (125) 58 Federal benefit of foreign operations -- -- (9,778) -- State (102) 394 (2,093) (33) $19,096 $24,845 $ 9,313 $12,783
Deferred tax assets (liabilities) are comprised of the following at December 31, 1997 and May 31, 1997:
Dec. 31, May 31, (In thousands) 1997 1997 Depreciation and amortization $(3,184) $(5,145) Prepaid expenses (1,484) (856) Other (2,458) (2,799) Gross deferred tax liabilities (7,126) (8,800) Foreign operations 2,843 2,271) Accrued expenses 5,283 3,181) Net operating loss , 398 609 Other 1,001 ,310) Gross deferred tax assets 9,525 6,371) Net deferred tax asset (liability) $ 2,399 $(2,429)
A reconciliation of income tax expense at the statutory rate to income tax expense included in the accompanying consolidated statements of income follows:
Dec. 31, May 31, (In thousands, except Federal income tax rate) 1997 1997 1996 1995 Federal income tax rate 35% 35% 35% 35% Federal taxes at statutory rate $16,234 $20,853 $ 7,345 $10,154 State income taxes, net of Federal tax benefit 2,192 2,824 1,080 1,468 Minority interest N N 536 770 Other 670 1,168 352 391 Income tax expense $19,096 $24,845 $ 9,313 $12,783
Cash paid for state income taxes was $197,000, $1.3 million, $1.4 million, and $549,000 for the period ended December 31, 1997 and the fiscal years ended May 31, 1997, 1996 and 1995, respectively. Federal income taxes were paid by Manor Care for the years ended May 31, 1995 and May 31, 1996 and the period ending October 31, 1996. Federal income taxes were paid by Sunburst for the period beginning November 1, 1996 through May 31, 1997. The Company paid $9.1 million for the period June 1, 1997 to December 31, 1997. Consistent with the existing Company tax-sharing policy, all current federal provision amounts have been treated as paid to, or received from, the Company, and as such, there are no current tax provision balances due to Sunburst at May 31, 1997. Differences between amounts paid to or received from Manor Care and Sunburst and the Company have been charged or credited directly to Investments and advances from Parent. As part of the tax-sharing agreement, the current taxes payable as of October 15, 1997 were assumed by Sunburst. Accrued Expenses Accrued expenses were as follows:
December 31, May 31, (In thousands) 1997 1997 Payroll $ 8,729 $ 7,950 Other 1,866 3,015 $10,595 $10,965
Long Term Debt and Notes Payable Debt consisted of the following:
December 31, May 31, (In thousands) 1997 1997 $300 million competitive advance and multi-currency revolving credit facility with an average rate of 6.60% at December 31, 1997 $267,600 $ -- $125 million competitive advance and multi-currency revolving credit facility with an average rate of 6.28% at May 31, 1997 -- 31,107 Notes payable to Manor Care, Inc. with a rate of 9% at May 31, 1997 -- 78,700 Capital lease obligations 13,469 13,531 Other notes with an average rate of 5.95%, and 5.94% at December 31, 1997 and May 31, 1997 1,752 1,825 Total indebtedness $282,821 $125,163
Maturities of debt at December 31, 1997 were as follows:
Year (In thousands) 1998 $ 15,041 1999 22,679 2000 32,726 2001 42,769 2002 155,471 Thereafter 14,135 $282,821
During fiscal year 1996 and through November 1, 1996, the Company was a co- guarantor with Manor Care and other affiliates for a $250 million competitive advance and multi-currency revolving credit facility. The facility provided that up to $75.0 million was available in foreign currency borrowings under the foreign currency portion of the facility. The Company was 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. Subsequent to the Manor Care Distribution, the Company utilized its new credit facility, as described below, to repay the Company's portion of borrowings under Manor Care's foreign currency portion of the facility, and the Company was released from all liabilities and guarantees relating to the Manor Care credit facility. On October 30, 1996, the Company entered into a $100.0 million competitive advance and multi-currency revolving credit facility provided by a group of seven banks. Borrowings under the facility were, at the option of the borrower, at one of several rates including LIBOR plus from 20.0 to 62.5 basis points, based upon a defined financial ratio and the loan type. The Company had $31.1 million outstanding under the facility at May 31, 1997. In connection with the Sunburst Distribution, all outstanding amounts were repaid. The Company's portion of the payable to Manor Care was $78.7 million as of May 31, 1997 and 1996, which was pushed down as part of the Manor Care Distribution and is reflected as notes payable to Manor Care in the accompanying consolidated balance sheets. Interest on the amount of the loan was payable quarterly at an annual rate of 9%. Interest expense on those notes for the seven months ended December 31, 1997 was $2.7 million and $7.1 million for the fiscal years ended May 31, 1997, 1996 and 1995. The Company repaid the note at the Sunburst Distribution. On October 15, 1997, the Company entered into a $300 million competitive advance and multi-currency revolving credit facility (the "Credit Facility") provided by a group of 14 banks. The Credit Facility provides for a term loan of $150 million and a revolving credit facility of $150 million, $50 million of which is available for borrowings in foreign currencies. The credit facility includes customary financial and other covenants that requires the maintenance of certain ratios including maximum leverage, minimum net worth and interest coverage and restricts the Company's ability to make certain investments, repurchase stock, incur debt and dispose of assets. The term loan is payable over five years, $15 million of which is due in 1998. Borrowings under the facility are, at the option of the borrower, at one of several rates including LIBOR plus 20.0 to 87.5 basis points, based upon a defined financial ratio and the loan type. In addition, the Company has the option to request participating banks to bid on loan participation at lower rates than those contractually provided by the facility. The Credit Facility requires the Company to pay annual fees of 1/10 of 1% to 1/3 of 1%, based upon a defined financial ratio of the total loan commitment. The Credit Facility will terminate on October 15, 2002. In connection with the Sunburst Distribution, the Company borrowed $115 million under its Credit Facility in order to fund a subordinated term note to Sunburst. The Subordinated Term Note of $115 million accrues interest monthly at 11% with an effective rate through maturity of 8.8%, and is due on October 15, 2002. No interest is payable until maturity. Total interest accrued at December 31, 1997 was $2.4 million. Cash paid for interest was $ 7.9 million, $ 11.6 million, $11.8 million and $10.8 million for December 31, 1997, and May 31, 1997, 1996 and 1995, respectively. Leases Rental expense under non-cancelable operating leases was $181,000, $171,000, $231,000 , and $400,000 for the seven months ended December 31, 1997 and fiscal years ended May 31, 1997, 1996, and 1995, respectively. The Company paid office rent of $1.1 million, and $4.0 million to Sunburst for the seven months ended December 31, 1997 and the year ended May 31, 1997 based on the portion of total space occupied by the Company. In addition, the Company operates certain property and equipment under leases that expires in 2014. Future minimum lease payments are as follows:
Operating Capitalized (In thousands) Leases Leases 1998 $2,058 $ 811 1999 699 939 2000 223 950 2001 189 950 2002 146 950 Thereafter -- 20,553 Total minimum lease payments $3,315 25,153 Less: Interest (11,684) Present Value of Lease Payment $ 13,469
In accordance with the Manor Care Lease Amendment and Guaranty, the Company, Sunburst and Manor Care, have added the Company as a guarantor of Sunburst's obligations under the Gaithersburg Lease and the Silver Spring Lease. Additionally, Sunburst and Choice have entered into a sublease agreement with respect to the Silver Spring Lease for the Company's principal executive offices. The Company subleases approximately 54.3% of the office space available under the Silver Spring Lease with financial terms approximately equal (on a square foot basis) to the terms of the Silver Spring Lease. The lease expires April 1, 1999. Acquisitions and Divestitures On May 31, 1995, the Company repurchased one-half of the 11% interest held by its management in the Company. 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 the Company for $27.9 million. Approximately $26.4 million was allocated to goodwill. On May 31, 1996, the Company invested approximately $17.1 million in the capital stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17.1 million investment, the Company received 750,000 shares of common stock and 10 million newly issued immediately convertible preferred shares. In addition, the Company granted to Friendly a Master Franchise Agreement for the United Kingdom and Ireland in exchange for 333,333 additional shares of common stock. At May 31, 1997, the Company owned approximately 5% of the outstanding shares of Friendly which would increase to approximately 27% if the Company's preferred stock were converted. The preferred shares carry a 5.75% dividend payable in cash or in stock, at the Company's option. The dividend accrues annually with the first dividend paid on the earlier of the third anniversary of completion or on a conversion date. The proceeds of the investment received by Friendly are to be used to support the construction of 10 Quality or Comfort hotels. As a condition to the investment, the Company has the right to appoint three directors to the board of Friendly. The Company is accounting for the common stock investment under the equity method. The Company recognized $550,083 and $943,000 in preferred dividend income from the Friendly investment for the period ended December 31, 1997 and May 31, 1997. In January 1998, the Company completed a transaction with Friendly Hotels, PLC ("Friendly") in which Friendly would assume the master franchise rights for Choice's Comfort, Quality and Clarion brand hotels throughout Europe (with the exception of Scandinavia) for the next 10 years. In exchange, the Company will receive from Friendly $8.0 million, payable in eight equal annual installments. As part of the transaction, Friendly will also acquire European hotels currently owned by the Company for a total consideration of approximately $26. 2 million in convertible preferred shares and cash. In exchange for 10 hotels in France, two in Germany and one in the United Kingdom, the Company will receive $22.2 million in new unlisted 5.75 percent convertible preferred shares in Friendly at par, convertible for one new Friendly ordinary share for every 150p nominal of the preferred convertible shares. In addition, Friendly will pay the Company deferred compensation of $4.0 million in cash, payable by the fifth anniversary of completion or sooner dependent on the level of future profits of the hotels acquired. The European hotels included in this transaction have a carrying value, which include a cumulative translation adjustment of $(6.6) million, totalling approximately $17.3 million. The Company has reflected the net assets subject to this transaction as assets held for sale in the December 31, 1997, accompanying consolidated balance sheet. Transactions with Sunburst Subsequent to the Manor Care Distribution, the Company participated in a cash concentration system with Sunburst and as such maintained no significant cash balances or banking relationships. Substantially all cash received by the Company was immediately deposited in and combined with Sunburst's corporate funds through its cash management system. Similarly, operating expenses, capital expenditures and other cash requirements of the Company have been paid by Sunburst and charged to the Company. The net result of all of these intercompany transactions are reflected in Investments and advances from Parent. Since the Manor Care Distribution, the Company has provided certain services to Sunburst including, among others, executive management, human resources, legal, accounting, tax, information systems and certain administrative services as required. Also since the Manor Care Distribution, Sunburst has provided services to the Company, either directly or through the Corporate Services Agreement with Manor Care, including, among others, cash management, payroll and payables processing, employee benefits plans, insurance, accounting and certain administrative services, as required. Costs associated with the Manor Care Corporate Services Agreement as well as costs of services provided by Sunburst to the Company or provided by the Company to Sunburst have been allocated between the entity providing the services and the entity receiving the services in the accompanying financial statements. As a result, future administrative and corporate expenses are expected to vary from historical results. However, the Company has estimated that general and administrative expenses incurred annually will not materially change after the Distribution. As part of the Sunburst Distribution, Sunburst and the Company have entered into a strategic alliance agreement. Among other things, the agreement provides for: (i) a right of first refusal to the Company to franchise any lodging properties to be acquired or developed by Sunburst, (ii) certain commitments by Sunburst for the development of Sleep Inn and MainStay Suites hotels, (iii) continued cooperation of both parties with respect to matters of mutual interest, such as new product and concept testing, (iv) continued cooperation with respect to third party vendor arrangements; and (v) certain limitations on competition in each others' line of business. The strategic alliance agreement extends for a term of 20 years with mutual rights of termination on the fifth, 10th and 15th anniversaries. For purposes of providing an orderly transition after the Sunburst Distribution, Sunburst and the Company entered into various agreements, including, among others, a Distribution Agreement, a Tax Sharing Agreement, a Corporate Services Agreement and an Employee Benefits Allocation Agreement. Effective as of October 15, 1997, these agreements provide, among other things, that Sunburst (i) will receive and/or provide certain corporate and support services, such as accounting, tax and computer systems support, (ii) will adjust outstanding options to purchase shares of Company Common Stock held by Company employees, Sunburst employees, and employees of Manor Care, (iii) is responsible for filing and paying the related taxes on consolidated federal tax returns and consolidated or combined state tax returns for itself and any of its affiliates (including the Company) for the periods of time that the affiliates were members of the consolidated group, (iv) will be reimbursed by the Company for the portion of income taxes paid that relate to the Company and its subsidiaries, and (v) guarantees that the Company will, at the date of distribution, have a specified minimum level of net worth. These agreements will extend for a maximum period of 30 months from the Distribution date or until such time as the Company and Sunburst have arranged to provide such services in- house or through another unrelated provider of such services. During the periods presented, Sunburst operated substantially all of its hotels pursuant to franchise agreements with the Company. Total fees paid to the Company included in the accompanying financial statements for franchising royalty, marketing and reservation fees were $6.2 million for the seven months ended December 31, 1997 and $9.5 million, $7.5 million, and $5.3 million for the years ended May 31, 1997, 1996 and 1995, respectively. In accordance with the Sunburst Distribution Agreement, the Company agreed to assume and pay certain liabilities of Sunburst, subject to the Company maintaining a minimum net worth of $40 million, at the date of Distribution. As of December 31, 1997, approximately $25 million is due to the Company from Sunburst, which is included in other current assets. This receivable relate to the net worth guarantee, and the reimbursement of various expenses paid by the Company, subsequent to the Distribution date. Subsequent to year end, Sunburst paid $7.5 million of the outstanding balance. 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. Pension, Profit Sharing, and Incentive Plans Bonuses accrued for key executives of the Company under incentive compensation plans were $520,000 for the seven months ended December 31, 1997, $1.4 million in 1997, $1.1 million in 1996, and $1.4 million in 1995. Employees of the Company participate in retirement plans sponsored by the Company, and prior to the Manor Care Distribution and Sunburst Distribution employees participated in retirement plans sponsored by Manor Care and Sunburst. Costs allocated to the Company are based on the size of its payroll relative to the sponsor's payroll. Costs allocated to the Company were approximately $817,000 for the seven months ended December 31, 1997, $1.4 million in 1997, $817,000 in 1996 and $776,000 in 1995. Capital Stock Since the Sunburst Distribution, the Company repurchased 10,714 shares of its common stock at a total cost of $189,000. Subsequent to December 31, 1997, the Company has repurchased 490,214 shares of its common stock at a total cost of $7.9 million. The Company has authorization from its Board of Directors to repurchase up to an additional 1.27 million shares. In fiscal year 1997, the Company granted a key executive 85,470 restricted shares of common stock with a value of $1.25 million on the grant date. The restricted stock vests over a three year period. The Company has stock options plans for which it is authorized to grant options to purchase up to 7.1 million shares of the Company's common stock. Stock options may be granted to officers, key employees and non-employee directors with an exercise price not less than the fair market value of the common stock on the date of grant. In connection with the Sunburst Distribution, the outstanding options held by current and former employees of the Company were redenominated in the stock of the newly separated companies and the number and exercise prices of the options were adjusted based on the relative trading prices of the common stock of the two companies in order to retain the intrinsic value of the options. Option activity under the above plans is as follows:
Number Weighted of Shares Option Price Outstanding at October 15, 1997 4,689,515 $ 8.71 Granted 15,000 17.63 Exercised (28,550) 3.32 Cancelled (508,920) 10.05 Outstanding at December 31, 1997 4,167,045 $ 8.62
At December 31, 1997, options with a weighted average remaining life of 4.2 years covering 1,845,642 shares were exercisable at $2.64 to $12.21 per share with a weighted average of $5.80 per share. SFAS No. 123 "Accounting for Stock-Based Compensation," requires companies to provide additional note disclosures about employee stock-based compensation plans based on a fair value based method of accounting. As permitted by this accounting standard, the Company continues to account for these plans under APB Opinion 25, under which no compensation cost has been recognized. Compensation cost for the Company's stock option plan was determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123. The fair value of each option grant has been estimated on the date of grant using an option-pricing model with the following weighted average assumptions used for grants in 1997: risk-free interest rate of 5.65% and volatility of 23.6%, expected lives of 10 years and 0% dividend yield. The weighted average fair value per option granted during fiscal year 1997 was $8.79. If options had been reported as compensation expense based on their fair value pro forma, net income would have been $27.3 million for 1997, and pro forma earnings per share would have been $0.46. Since this methodology has not been applied to options granted prior to the Sunburst distribution date, the resulting pro forma compensation cost is not likely to be representative of that to be expected in future years. Fair Value of Financial Instruments The balance sheet carrying amount of cash and cash equivalents and receivables approximate fair value due to the short term nature of these items. Long term debt consists of bank loans and notes payable to Manor Care. 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 long-term debt approximate fair market values. The Note Receivable from Sunburst approximates fair value based on its current yield to maturity, which is equivalent to those investments of similar quality and terms. Provision for Asset Impairment During fiscal year 1996, the Company began restructuring its European operations. This restructuring effort included the purchase of an equity interest in Friendly 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 $15.0 million non-cash charge (net of an $9.8 million income tax benefit) against earnings related to the impairment of assets associated with certain European hotel operations. Impact of Recently Issued Accounting Standards The Company adopted SFAS No. 128, "Earnings Per Share," and SFAS No. 129. "Disclosure of Information about Capital Structure," during 1997. The adoption of these pronouncements did not materially affect the Company's financial statements. The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," no later than 1998. Management is evaluating the impact that these pronouncements will have on the Company's financial statements. Subsequent Events (Unaudited) On February 19, 1998, the Board of Directors adopted a shareholder rights plan under which a dividend of one preferred stock purchase right was distributed for each outstanding share of the Company's common stock to shareholders of record on April 3, 1998. Each right will entitle the holder to buy 1/100th of a share of a newly issued series of a junior participating preferred stock of the Company at an exercise price of $75 per share. The rights will be exercisable, subject to certain exceptions, 10 days after a person or group acquires beneficial ownership of 10% or more of the Company's common stock. Shares owned by a person or group on February 19, 1998, and held continuously thereafter are exempt for purposes of determining beneficial ownership under the rights plan. The rights will be non-voting and will expire on January 31, 2008, unless exercised or previously redeemed by the Company for $.001 each. If the Company is involved in a merger or certain other business combinations not approved by the Board of Directors, each right will entitle its holder, other than the acquiring person or group, to purchase common stock of either the company or the acquire having a value of twice the exercise price of the right. Board of Directors Stewart Bainum Director: Manor Care Inc. and Sunburst Hospitality Corporation Stewart Bainum Jr. Chairman of the Board & Chief Executive Officer: Manor Care Inc. and subsidiaries Chairman of the Board: Sunburst Hospitality Corporation Director: Vitalink Pharmacy Services Inc. Barbara Bainum President, Secretary & Director: Commonweal Foundation Secretary and Director: Realty Investment Company William R. Floyd President & Chief Executive Officer: Choice Hotels International Director: Friendly Hotels PLC Frederic V. Malek Chairman: Thayer Capital Partners Co-Chairman: CB Commercial Real Estate Group Inc. Director: American Management Systems Inc., Automatic Data Processing Corp., FPL Group Inc., Manor Care Inc., Sunburst Hospitality Corporation, Northwest Airlines and various Paine Webber mutual funds Jerry E. Robertson Ph.D. Retired Executive Vice President, 3M Life Sciences Sector and Corporate Services Director: Allianz Life Insurance Company of North America, Cardinal Health Inc., Coherent Inc., Haemonetics Inc., Manor Care Inc., Medwave Inc., Project Hope and Steris Corp. Robert C. Hazard Jr. Chairman: Creative Hotel Associates LLC Gerald W. Petitt President & Chief Executive Officer: Creative Hotel Associates LLC James H. Rempe Senior Vice President, General Counsel & Secretary: Manor Care Inc. Director: Vitalink Pharmacy Services Inc. and In Home Health Inc. Corporate Officers Stewart Bainum Jr. Chairman of the Board William R. Floyd President & Chief Executive Officer Donald H. Dempsey Executive Vice President & Chief Financial Officer Michael J. DeSantis Senior Vice President, General Counsel & Secretary Thomas Mirgon Senior Vice President, Human Resources & Partner Services Barry L. Smith Senior Vice President, Marketing William Weatherford Senior Vice President, Franchise Operations, Southeast Region Brendan M. Ebbs Senior Vice President, Franchise Operations, Northeast Region Betsy Bromberg O'Rourke Senior Vice President, Marketing Services Everett F. Casey Vice President, Deputy General Counsel & Assistant Secretary Joseph M. Squeri Vice President, Finance & Controller Daniel Rothfeld Vice President, Partner Services Gerald F. Hickey Assistant Treasurer Kevin M. Rooney Assistant General Counsel & Assistant Secretary Stock Listing Choice Hotels International common stock trades on the New York Stock Exchange under the ticker symbol CHH. Transfer Agent & Registrar ChaseMellon Shareholder Services LLC Overpeck Centre 85 Challenger Road Ridgefield Park, NJ 07660 Independent Auditors Arthur Andersen LLP Washington, DC Annual Meeting Date Choice Hotels International will hold its Annual Meeting of Shareholders on Wednesday, April 29, 1998, at 9 a.m. EST at the Quality Suites Shady Grove 3 Research Court Rockville, MD 20850 Form 10-K A stockholder may receive without charge a copy of the Form 10-K Annual Report filed with the Securities and Exchange Commission by written request addressed to the Corporate Secretary at the corporate headquarters. Corporate Headquarters Choice Hotels International 10750 Columbia Pike Silver Spring, MD 20901 General Inquiries: (301) 979-5000 Franchise Sales: (800) 547-0007 Investor Inquiries: (301) 979-5026 (C)1998 Choice Hotels International Quality, Comfort, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and Choice Picks are trademarks of Choice Hotels International. MainStay Suites is a service mark of Choice Hotels International.
Seven Months Fiscal Years Ended Dec. 31 Ended May 31 1997 1996 1997 1996 1995 Company Results (in millions, except per share data) Royalty Revenues $ 70.3 $ 61.8 $ 97.2 $ 88.0 $ 78.1 Total Revenues 180.1 166.3 272.3 250.7 212.7 Recurring Income from Operations 46.4 45.5 59.6 45.7 29.0 Recurring Net Income 27.3 23.3 34.7 25.4 16.2 Net Income 27.3 23.3 34.7 11.7 16.2 Cash Flow from Operations 34.4 19.1 46.4 32.7 37.9 Basic Earnings per Share $ 0.46 $ 0.37 $ 0.55 $ 0.19 $ 0.26 System Results - Domestic only Revenues (estimated in millions) $1,862 $1,692 $2,678 $2,381 $2,221 Franchise Hotels Open 2,879 2,672 2,781 2,495 2,311 Franchise Hotels Under Development 725 660 710 616 494 Revenue Per Available Room $36.39 $35.54 $32.52 $31.60 $30.08
Letter to Our Shareholders: In conjunction with our move to reporting on a calendar-year basis, I would like to update you on Choice's progress during the seven-month period ended Dec. 31, 1997. It was a profitable and productive period during which we made significant progress implementing key elements of our strategic plan, becoming a "pure-play" franchising company and substantially strengthening our presence in Europe. Strong Financial Results In our last annual report, I described how the Company was moving forward with a three-year plan designed to enhance profitability by sharpening our focus on consumers, realigning corporate resources and implementing new growth and service strategies. I'm pleased to report the results of this seven-month period demonstrate the soundness of our strategy. Comparing the seven-month financial results for June 1 through Dec. 31, 1997, with the same period in 1996, the Company's total revenues were up 8.3 percent, from $166.3 million to $180.1 million. Key indicators remained positive, including royalty fees that increased year-over-year from June through December by 13.8 percent, from $61.8 million to $70.3 million. Operating income rose 14.7 percent, from $45.5 million to $52.2 million. Net income increased 17.2 percent to $27.3 million from $23.3 million. Earnings per share were up 24.3 percent, from 37 cents per share to 46 cents per share. Separation of Franchising and Real Estate On Oct. 15, 1997, Choice became a new company focused solely on franchising as the result of a tax-free spinoff in which franchising operations were separated from real estate and management operations. The spinoff created two focused companies, each well-positioned for growth and profitability: Choice (NYSE: CHH), the world's second-largest lodging franchisor, and Sunburst Hospitality Corporation (NYSE: SNB), which now owns and manages the hotels formerly in Choice's portfolio. A Powerful New Alliance in Europe Just two weeks after the spinoff, we announced a move to dramatically strengthen our presence in Europe by expanding our alliance with Friendly Hotels PLC, one of the United Kingdom's largest hotel operators. The agreement, completed in January 1998, granted Friendly master franchising rights in Europe for the next 10 years, except Scandinavia, creating a portfolio of more than 240 properties in 10 countries in exchange for $8 million in cash. Furthermore, Choice's equity stake in Friendly increased from 27 percent to 45 percent (on a fully diluted basis), and ownership of 13 Choice-held properties in Europe was transferred to Friendly in exchange for $26.2 million in cash and stock. Under the master franchise agreement, Friendly now operates its hotel and franchising business under the name Choice Hotels Europe. We are excited about this expanded alliance with a company that shares our philosophy of providing quality customer service and maximizing franchisee profitability. Our Commitment to International Growth The Friendly partnership underscores our commitment to international growth. We believe a global perspective is critical to our long-term success. Our strategy is to build a solid foundation of quality partnerships in key growth areas, and with more than 700 hotels in 32 countries outside the United States, we have an outstanding base on which to build. Another example is the agreement we signed in November with a Japanese hotel and development firm, the Vessel Company Ltd., to build at least 20 Sleep Inn hotels throughout Japan over a 15-year period. Construction of Vessel's first Sleep Inn hotel is scheduled to begin this year in Japan's thriving Chugoku region. To help us fulfill our international objectives, we recruited Bruno Geny to serve as Senior Vice President, International. Bruno, who most recently served Union Bank of Switzerland as Executive Director for European Mergers & Acquisitions, brings an accomplished background that will be a strong asset as we grow Choice's international system. His charge is to evaluate opportunities in high-potential regions including Canada, Mexico, the Caribbean, Australia, Europe and Japan where we believe brand equity can be established quickly. He also is working to optimize the performance of our current international franchisees and identify strategic partners outside the United States. New Regional Organization Enhances Profitability Key elements of our three-year plan now are in place including a new regional organization designed to increase our system's profitability by bringing support services closer to our franchisees. Market Area offices now are open in Charlotte, N.C.; Silver Spring, Md.; Indianapolis, Ind.; Golden, Colo.; and Irvine, Calif. A key objective of the new field organization is to provide better service and support to our franchise system. With the five Market Areas fully operational, there is now a ratio of one representative to approximately 45 hotels, compared with the previous ratio of one to 90. Our franchise service directors now serve as single points of contact for each operator, which improves communication, consistency and our effectiveness in driving revenue to each hotel through more intensive counseling on marketing, sales and operations. Taking a Strategic Approach to Growth With our new regional structure, we also are taking a more strategic approach to growth. Working hand in hand with our franchisees, we targeted 520 high-potential markets nationwide in which we identified the best sites for new hotels as well as the best existing properties that could be converted to one of our brands. This focuses our development efforts on the best opportunities and mitigates impact concerns by affording existing franchisees the first chance to develop new sites. Impact, defined as the potential affect of development on existing nearby hotels, always will be an issue in the world of franchising. In an unprecedented step for this industry, Choice and its franchise leadership organizations commissioned a study to examine our current impact policy and make recommendations for improvements. Our Marketing Master Stroke Our partnership with the Walt Disney Company to promote the Comfort, Quality and Econo Lodge brands in conjunction with the animated film Hercules exceeded our expectations and paid handsome dividends. Thanks in part to this alliance, our reservation system logged an unprecedented seven $5 million days during the summer season. This was Disney's first alliance with a hotel company and the first time it has allowed its characters to perform in another company's commercials. In another first, Choice entered into an agreement to cross-sell the Walt Disney World theme park by transferring callers directly to park sales agents from Choice reservations call centers. The deal allows travelers who book rooms at Choice hotels in Orlando, Fla., the opportunity to purchase tickets to the Magic Kingdom, Epcot and Disney/MGM studios. Optimizing the Brand Portfolio Our strategic plan calls for leveraging the strengths of each brand for the mutual benefit of franchisees and you, the shareholders. During the last few months, we conducted equity research to generate fresh, new consumer feedback about each of our lodging brands. This research not only has provided invaluable insight into our business but, more important, has enabled us to position our brands in the marketplace for maximum competitive advantage. In the midst of this effort, we were proud to learn the results of an independent survey that showed consumers rank our Sleep Inn brand number one for service, satisfaction and value over its competitors. This consumer survey, conducted by D.K. Shifflet & Associates, a highly respected travel research firm, showed the Sleep Inn brand's satisfaction rating was 88.8 percent, nearly 20 points higher than the nearest competitor. A Strong Team Working on Your Behalf Choice's achievements during the last seven months of 1997 are a tribute to the extraordinary dedication and talent of our franchisees, management and staff. I am proud to be associated with this outstanding group, and I thank them for their hard work. Our board of directors also deserves recognition for their support and guidance. A New Chief Financial Officer We were very fortunate to welcome Don Dempsey aboard as Executive Vice President & Chief Financial Officer. Don, who previously served Promus Hotel Corporation as Senior Vice President & Chief Financial Officer, is an industry veteran with nearly 30 years' experience in hotel corporate and financial management and an extraordinary track record in creating shareholder value and building equity for both franchisees and management in various cycles of the hotel industry. He has the leadership skills, financial expertise and understanding of our business needed to reinforce our position as a world-class franchise organization and help us achieve the next level of growth. Positioned for New Opportunities We are pleased with our performance during this seven-month period and very optimistic about our prospects for 1998. As the industry enters a new era of intensified competition and international expansion, Choice is well-positioned to build on our global leadership in high-margin brands and to grow in those areas that offer the best promise for profitability. With recognition from important publications like Entrepreneur magazine, which named Choice the top lodging franchise company for 1998, and Success magazine, which included two of our brands in its Franchise Gold 100 ranking, we are positioned domestically as a favorite choice of hotel developers. As we begin our new calendar year, the Company is confident that our new structure, new management and new strategic focus will provide sustained growth. Our brands are strong, and our overall financial condition is sound, which enables us to pursue new growth opportunities. As we enter a new year, I would like to express my gratitude also to you - our shareholders - for your continued support. William R. Floyd President & Chief Executive Officer EX-21.01 8 EXHIBIT 21.01 EXHIBIT 21.01 ------------- LODGING SUBSIDIARIES CHOICE CAPITAL CORP. (LENDING SUBSIDIARY) CHOICE HOTELS AUSTRALIA PTY. LTD. (90%) CHOICE HOTELS CANADA INC. (50%) CHOICE HOTELS DEL PLATA CHOICE HOTELS BRAZIL (CAYMAN) LTD. (10%) CHOICE HOTELS INTERNATIONAL ASIA PACIFIC PTY. LTD. CHOICE HOTELS JAPAN, INC. (FORMERLY QUALITY HOTELS JAPAN, INC.) CHOICE HOTELS LIMITED CHOICE HOTELS OF BRAZIL, INC. CHOICE HOTELS SYSTEMS, INC. CHOICE HOTELS THAILAND (DEL.) INC. CHOICE HOTELS VENEZUELA, C.A. (20%) QUALITY HOTELS EUROPE, INC. QUALITY INNS INTERNATIONAL, INC. (FORMERLY THE CHOICE HOTELS INTERNATIONAL, INC. WHICH IS NOW CHOICE HOTELS FRANCHISING, INC.) QI ADVERTISING AGENCY, INC. EX-23.01 9 EXHBIT 23.01 EXHIBIT 23.01 ------------- CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS AS INDEPENDENT PUBLIC ACCOUNTANTS, WE HEREBY CONSENT TO THE INCORPORATION OF OUR REPORTS INCORPORATED INTO OR INCLUDED IN THIS FORM 10-K, INTO THE COMPANY'S PREVIOUSLY FILED REGISTRATION STATEMENTS FILE NO. 333-36819, NO. 333-41355 AND NO. 333-41357. ARTHUR ANDERSEN LLP WASHINGTON, D.C. MARCH 30, 1998 EX-27.01 10 EXHIBT 27.01
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF INCOME AND THE CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1997 DEC-31-1997 10,282 0 35,955 7,608 405 77,893 50,462 13,422 376,288 58,095 267,780 0 0 598 48,660 376,288 0 180,123 0 125,675 0 2,274 5,791 46,383 19,096 27,287 0 0 0 27,287 0.46 0.45
EX-99.1 11 NOTICE AND PROXY STATEMENT SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant [X] Filed by a Party other than the Registrant [_] Check the appropriate box: [_] Preliminary Proxy Statement [_] CONFIDENTIAL, FOR USE OF THE COMMISSION ONLY (AS PERMITTED BY RULE 14A-6(E)(2)) [X] Definitive Proxy Statement [_] Definitive Additional Materials [_] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12 Choice Hotels International, Inc. - -------------------------------------------------------------------------------- (Name of Registrant as Specified In Its Charter) Choice Hotels International, Inc. - -------------------------------------------------------------------------------- (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of Filing Fee (Check the appropriate box): [X] No fee required [_] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11. (1) Title of each class of securities to which transaction applies: ------------------------------------------------------------------------- (2) Aggregate number of securities to which transaction applies: ------------------------------------------------------------------------- (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the filing fee is calculated and state how it was determined): ------------------------------------------------------------------------- (4) Proposed maximum aggregate value of transaction: ------------------------------------------------------------------------- (5) Total fee paid: ------------------------------------------------------------------------- [_] Fee paid previously with preliminary materials. [_] Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. (1) Amount Previously Paid: ------------------------------------------------------------------------- (2) Form, Schedule or Registration Statement No.: ------------------------------------------------------------------------- (3) Filing Party: ------------------------------------------------------------------------- (4) Date Filed: ------------------------------------------------------------------------- Notes: LOGO CHOICE HOTELS INTERNATIONAL, INC. 10750 COLUMBIA PIKE SILVER SPRING, MARYLAND 20901 ---------------- NOTICE OF ANNUAL MEETING TO BE HELD APRIL 29, 1998 ---------------- To the Stockholders of CHOICE HOTELS INTERNATIONAL, INC. The 1998 Annual Meeting of Stockholders (the "Annual Meeting") of Choice Hotels International, Inc., a Delaware corporation (the "Company"), will be held at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland at 9:00 a.m. (E.S.T.) for the following purposes: 1. To elect three Class I directors to hold office for a three year term ending at the 2001 Annual Meeting of Stockholders and until their successors are elected and qualified; 2. To transact such other business as may properly come before the Annual Meeting. Holders of record of Choice Hotels common stock at the close of business on March 12, 1998 will be entitled to notice of, and to vote at, the Annual Meeting or any adjournment(s) or postponement(s) thereof. Stockholders are reminded that your shares of Choice Hotels common stock cannot be voted unless you properly execute and return the enclosed proxy card or make other arrangements to have your shares represented at the meeting. A list of stockholders will be available for inspection at the office of the Company located at the address above, at least 10 days prior to the Annual Meeting. By Order of the Board of Directors CHOICE HOTELS INTERNATIONAL, INC. LOGO Michael J. DeSantis Secretary March 30, 1998 Silver Spring, Maryland TO VOTE YOUR SHARES, PLEASE SIGN, DATE AND COMPLETE THE ENCLOSED PROXY AND MAIL IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE. LOGO ---------------- PROXY STATEMENT ANNUAL MEETING OF STOCKHOLDERS APRIL 29, 1998 ---------------- GENERAL INFORMATION This Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of Choice Hotels International, Inc. a Delaware corporation ("Choice Hotels" or the "Company"), for use at the 1998 Annual Meeting of Stockholders of the Company to be held at 9:00 a.m. (E.S.T.) on April 29, 1998, at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland and at any adjournment(s) or postponement(s) thereof (the "Annual Meeting"). It is anticipated that this Proxy Statement and proxy will first be mailed to the Company's stockholders on or about March 30, 1998. The Company's Annual Report (including certified financial statements) for the seven months ended December 31, 1997, is accompanying this Proxy Statement. The Annual Report is not part of the proxy solicitation material. Background of Spinoffs; Change In Fiscal Year Prior to becoming a separate, publicly-held company on October 15, 1997 pursuant to the Spinoff (as defined below), the Company was named Choice Hotels Franchising, Inc. and was a wholly-owned subsidiary of Choice Hotels International, Inc. ("Former Choice"). On October 15, 1997, Former Choice distributed to its stockholders its hotel franchising business (which had previously been conducted primarily by the Company) and its European hotel ownership business pursuant to a pro rata distribution to its stockholders of all of the stock of the Company (the "Spinoff"). At the time of the Spinoff, the Company changed its name to "Choice Hotels International, Inc.," and Former Choice changed its name to "Sunburst Hospitality Corporation." For purposes of this Proxy Statement, references to the Company's former parent corporation pior to the Spinoff are to "Former Choice," and references to such corporation after the Spinoff are to "Sunburst." Prior to November 1996, Former Choice was a subsidiary of Manor Care, Inc. ("Manor Care") which, directly and through its subsidiaries, engaged in the hotel franchising business currently conducted by the Company as well as the ownership and management of hotels (together with the hotel franchising business, the "Lodging Business") and the health care business. On November 1, 1996, Manor Care separated the Lodging Business from its health care business through a pro rata distribution to the holders of Manor Care's common stock of all of the stock of Former Choice (the "Former Choice Spinoff"). In connection with the Former Choice Spinoff, the Company became a wholly-owned subsidiary of Former Choice and remained as such until consummation of the Spinoff. In September 1997, the Company changed its fiscal year end from May 31 to December 31. Voting of Proxies Your vote is important. Shares can be voted at the Annual Meeting only if you are present in person or represented by proxy. Even if you plan to attend the meeting, you are urged to sign, date and return the accompanying proxy card. 1 When the enclosed proxy card is properly signed, dated and returned, the stock represented by the proxy will be voted in accordance with your directions. You can specify your voting instructions by marking the appropriate box on the proxy card. If your proxy card is signed and returned without specific voting instructions, your shares of Choice Hotels common stock will be voted as recommended by the directors: "FOR" the election of the three nominees for director named on the proxy card. Abstentions marked on the proxy card have the effect of being voted "against" the directors' proposals but are counted in the determination of a quorum. You may revoke your proxy at any time before it is voted at the meeting by (i) filing with ChaseMellon Shareholder Services, L.L.C. in its capacity as transfer agent for the Company (the "Transfer Agent"), at or before the Annual Meeting, a written notice of revocation bearing a later date than the proxy, (ii) executing a later-dated proxy relating to the same shares of Company common stock and delivering it to the Transfer Agent at or before the Annual Meeting, or (iii) attending the Annual Meeting and voting in person (although attendance at the Annual Meeting will not, in and of itself, constitute a revocation of a proxy). Any written notice revoking a proxy should be sent to ChaseMellon Shareholder Services, L.L.C., Overpeck Centre, 85 Challenger Road, Ridgefield Park, New Jersey, 07660. Votes Required The close of business on March 12, 1998 has been fixed as the record date for determination of holders of Company Common Stock entitled to notice of and to vote at the Annual Meeting. On that date, there were outstanding and entitled to vote 59,741,072 shares of Company common stock. The presence, either in person or by proxy, of persons entitled to cast a majority of such votes constitutes a quorum for the transaction of business at the Annual Meeting. Abstentions and broker no-votes on returned proxies are counted as shares present in the determination of whether the shares of stock represented at the Annual Meeting constitute a quorum. A broker "non-vote" occurs when a nominee holding shares of Choice Hotels common stock for a beneficial owner does not vote on a particular item and has not received instructions from the beneficial owner. Stockholders are entitled to one vote per share on all matters submitted for consideration at the Annual Meeting. With regard to the election of directors, votes may be cast in favor of or withheld from nominees. Votes that are withheld will be excluded entirely from the vote and will have no effect. Abstentions may be specified on all proposals other than the election of directors. Each proposal is tabulated separately. Abstentions are counted in tabulations of the votes cast on proposals presented to the stockholders, whereas broker non-votes are not counted for purposes of determining whether a proposal has been approved. The affirmative vote of a plurality of shares of Company common stock present in person or represented by proxy at the Annual Meeting is required to elect the directors nominated. "Plurality" means that the individuals who receive the largest number of votes cast are elected as directors up to the maximum number of directors to be chosen at the meeting. Certain members of the Bainum family (including various partnerships, corporations and trusts established by members of the Bainum family) in the aggregate have the right to vote approximately 34.11% of the number of outstanding shares of Company common stock and have indicated an intention to vote in accordance with the recommendations of the Board of Directors with respect to the election of directors. Solicitation of Proxies The Company will bear the cost of the solicitation. In addition to solicitation by mail, the Company will request banks, brokers and other custodian nominees and fiduciaries to supply proxy material to the beneficial owners of Company common stock of whom they have knowledge, and will reimburse them for their expenses in so doing; and certain directors, officers and other employees of the Company, not specially employed for the purpose, may solicit proxies, without additional remuneration therefor, by personal interview, mail, telephone or telefax. 2 Relationship With Independent Public Accountants Since 1980, Arthur Andersen LLP has served as the Company's independent public accounting firm. It is expected that representatives of Arthur Andersen will be present at the annual meeting. They will be given an opportunity to make a statement if they desire to do so, and it is expected that they will be available to respond to appropriate questions. Procedures for Stockholder Proposals and Nominations Under the Company's Bylaws, nominations for director may be made only by the Board of Directors or a committee of the board, or by a stockholder entitled to vote who has delivered notice to the Company not less than 60, nor more than 90, days before the first anniversary of the preceding year's annual meeting. The Bylaws also provide that no business may be brought before an annual meeting except as specified in the notice of meeting (which includes stockholder proposals that the Company is required to set forth in its proxy statement under SEC Rule 14a-8) or as otherwise brought before the meeting by or at the direction of the board or by a stockholder entitled to vote who has delivered notice to the Company (containing certain information specified in the Bylaws) within the time limits described above for a nomination for the election of a director. These requirements are separate and apart from, and in addition to, the SEC's requirements that a stockholder must comply with in order to have a stockholder proposal included in the Company's proxy statement under SEC Rule 14a-8. Stockholder Proposals for 1999 Annual Meeting Stockholder proposals intended to be presented at the Company's 1999 Annual Meeting of Stockholders must be received by the Company's Corporate Secretary no later than February 28, 1999. Such proposals must meet the requirements set forth in the rules and regulations of the SEC in order to be eligible for inclusion in the Company's 1999 proxy materials. Other Matters to Come Before the Meeting The Board of Directors does not know of any matters which will be brought before the 1998 annual meeting other than those specifically set forth in the notice of meeting. If any other matters are properly introduced at the meeting for consideration, including, among other things, consideration of a motion to adjourn the meeting to another time or place, the individuals named on the enclose proxy card will have discretion to vote in accordance with their best judgment. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, (the "Exchange Act") requires the Company's reporting officers and directors, and persons who own more than ten percent of the Company's Common Stock, to file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the Securities and Exchange Commission (the "Commission"), the New York Stock Exchange and the Company. Based solely on the Company's review of the forms filed with the Commission and written representations from reporting persons that they were not required to file Form 5 for certain specified years, the Company believes that all of its reporting officers, directors and greater than ten percent beneficial owners complied with all filing requirements applicable to them during the year ended December 31, 1997. 3 ELECTION OF CLASS I DIRECTORS The Board of Directors currently consists of three classes of directors, as nearly equal in number as possible. Directors hold office for staggered terms of three years (or less if they are filling a vacancy) and until their successors are elected and qualified. One of the three classes, comprising approximately one third of the directors, is elected each year to succeed the directors whose terms are expiring. The directors in Class I will be elected at the annual meeting to serve for a term expiring at the Company's annual meeting in the year 2001. The directors in Classes II and III are serving terms expiring at the Company's annual Meeting of Stockholders in 1999 and 2000, respectively. Prior to the Spinoff, the Company's Board of Directors consisted of William R. Floyd, Donald J. Landry and James A. MacCutcheon. In anticipation of the Spinoff, the Company's board expanded its size from three to nine members, as permitted under the Bylaws of the Company. Effective as of October 15, 1997, Messrs. Landry and MacCutcheon resigned from the Company's board and Former Choice, acting as the Company's sole stockholder, elected eight new directors to the Company's board, including the three nominees for director. The nominees have served continuously on the board since that time. The Company's Board of Directors has proposed the following nominees for election as directors at the annual meeting: NOMINEES FOR CLASS I DIRECTORS WITH TERMS EXPIRING AT THE ANNUAL MEETING IN THE YEAR 2001: Stewart Bainum Gerald W. Petitt Jerry E. Robertson THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF THE ABOVE- NAMED NOMINEES AS DIRECTORS FOR A TERM OF THREE YEARS. Proxies solicited by the Board of Directors will be voted "FOR" the election of the nominees, unless otherwise instructed on the proxy card. Information is provided below with respect to each nominee for election and each director continuing in office. Should one or more of these nominees become unavailable to accept nomination or election as a director, the individuals named as proxies on the enclosed proxy card will vote the shares that they represent for the election of such other persons as the board may recommend, unless the board reduces the number of directors. The Board of Directors knows of no reason why any of the nominees will be unavailable or unable to serve. NOMINEES FOR ELECTION AS DIRECTORS Class I--Nominees for Terms Expiring in 2001 STEWART BAINUM, 78, 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 ManorCare Health Services, Inc. ("MCHS") from 1968 to March 1987 and a Director since 1968; Director of Vitalink from September 1991 to September 1994; Chairman of the Board of the Company from 1972 to March 1987 and a Director from 1963 to November 1996 and since October 1997; Chairman of the Board of Realty Investment Company, Inc. since 1965; Director of Sunburst since November 1996. GERALD W. PETITT, 52, President and Chief Executive Officer of Creative Hotel Associates LLC since November 1996; Co-Chairman of the Company from January 1995 to November 1996 and a Director from December 1980 to November 1996 and since October 1997; President from June 1990 to January 1995 and Chief Operating Officer from December 1980 to January 1995; Director of Former Choice from November 1996 to October 1997; Director, Old Westbury Private Capital Fund LLC. 4 JERRY E. ROBERTSON, PH.D., 65, Retired; Executive Vice President, 3M Life Sciences Sector and Corporate Services from November 1986 to March 1994; Director of the Company from 1989 to November 1996 and since October 1997; Director: Manor Care, Allianz Life Insurance Company of North America, Cardinal, Inc., Coherent, Inc., Haemonetics Corporation, Medwave, Inc., Project Hope and Steris Corporation. DIRECTORS WHOSE TERM OF OFFICE CONTINUE Class II--Term Expires in 1999 STEWART BAINUM, JR., 51, Chairman of the Board of the Company from March 1987 to November 1996 and since October 1997; Chairman of the Board of Sunburst since November 1996; Chairman of the Board and Chief Executive Officer of Manor Care and MCHS 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 December 1994; 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 MCHS since 1976 and of the Company since 1977; Chief Executive Officer of MCHS 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. WILLIAM R. FLOYD, 53, Chief Executive Officer of the Company since October 1997, Chief Executive Officer of Former Choice from October 1996 to October 1997; President of the Company since November 1997; Chief Operating Officer of Taco Bell Corp. (a subsidiary of PepsiCo) from July 1995 to October 1996, Chief Operating Officer of KFC (a subsidiary of PepsiCo) from August 1994 to July 1995; National Vice President of Taco Bell Company Operations from July 1992 to August 1994, Vice President of Taco Bell Eastern Operations from December 1990 to January 1992; Director, Friendly Hotels PLC since 1996. JAMES H. REMPE, 67, Senior Vice President, General Counsel and Secretary of Manor Care since August 1981 and of the Company from February 1981 to November 1996; Director of the Company since October 1997; Director: In Home Health Inc. and Vitalink Pharmacy Services, Inc. Class III--Terms Expire 2000 BARBARA BAINUM, 53, President, Secretary and Director of the Commonweal Foundation since December 1990, December 1984 and December 1994, 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); Director of the Company since October 1997 and of Former Choice from November 1996 to October 1997. ROBERT C HAZARD, JR., 62, Chairman of Creative Hotel Associates LLC since November 1996; Co-Chairman of the Company from January 1995 to November 1996 and a Director from December 1980 to November 1996 and since October 1997; Chairman from June 1990 to January 1995 and Chief Executive Officer from December 1980 to January 1995; President from December 1980 to June 1990; Director of Former Choice from November 1996 to October 1997. Director: Outrigger Enterprises and United States National Tourism Organization, Inc.. FREDERIC V MALEK, 61, Chairman of Thayer Capital Partners since March 1993; Co-Chairman of CB Commercial Real Estate Group, Inc. from April 1989 to October 1996; Campaign Manager for Bush-Quayle '92 from January 1992 to November 1992; Vice Chairman of NWA, Inc. (airlines), July 1990 to December 1991; Director of the Company from 1990 to November 1996 and since October 1997; Director: Manor Care, Sunburst, American Management Systems, Inc., Automatic Data Processing Corp., CB Commercial Real Estate Group, Inc., FPL Group, Inc. (an affiliate of Florida Power and Light-power company), Northwest Airlines and various Paine Webber mutual funds. 5 THE BOARD OF DIRECTORS At the time of the Spinoff, Barbara Bainum, Jerry E. Robertson, Robert C. Hazard, Jr., Gerald W. Petitt and William R. Floyd resigned from the Board of Directors of Former Choice and were elected, along with James H. Rempe, to the Board of Directors of the Company. Stewart Bainum, Jr., Stewart Bainum and Frederic V. Malek remained on the Board of Directors of Former Choice (now Sunburst) and were also elected to the Board of Directors of the Company. The Board of Directors is responsible for overseeing the overall performance of the Company. Members of the board are kept informed of the Company's business through discussions with the Chairman, the Chief Executive Officer and other members of the Company's management, by reviewing materials provided to them and by participating in board and committee meetings. From October 15, 1997 (the date the Spinoff was consummated), the Board of Directors has consisted of nine directors, four of whom were not present or past officers of the Company. From October 15, 1997 to December 31, 1997, the Board of Directors held one meeting and each director attended the meeting of the Board of Directors and all of the committees of the Board of Directors on which such director served. COMMITTEES OF THE BOARD The standing committees of the Board of Directors include the Audit Committee, the Compensation/Key Executive Stock Option Plan Committee and the Compensation/Key Executive Stock Option Plan Committee No. 2. At the January 27, 1998 Board Meeting, the Nominating Committee was abolished and the Nominating and Corporate Governance Committee was established. The current members of the standing committees are as follows: COMPENSATION/KEY EXECUTIVE STOCK OPTION NOMINATING AND CORPORATE PLAN COMMITTEE GOVERNANCE COMMITTEE Jerry E. Robertson, Chair Gerald W. Petitt, Chair Stewart Bainum Jerry E. Robertson Frederic V. Malek Frederic V. Malek Barbara Bainum Robert C. Hazard, Jr. COMPENSATION/KEY EXECUTIVE STOCK OPTION AUDIT COMMITTEE PLAN COMMITTEE NO. 2 Jerry E. Robertson, Chair Frederic V. Malek, Chair Frederic V. Malek Jerry E. Robertson Barbara Bainum Gerald W. Petitt
The Compensation/Key Executive Stock Option Plan Committees administer the Company's stock option plans and grant stock options thereunder, review compensation of officers and key management employees, recommend development programs for employees such as training, bonus and incentive plans, pensions and retirement, and review other employee fringe benefit programs. The Compensation/Key Executive Stock Option Plan Committees each met twice during the period from October 15, 1997 to December 31, 1997. 6 The Nominating and Corporate Governance Committee is responsible for administering the Choice Hotels Corporate Governance Guidelines, determining size and composition of the Board, recommending candidates to fill vacancies on the Board, determining actions to be taken with respect to directors who are unable to perform their duties, setting the company's policies regarding the conduct of business between the company and any other entity affiliated with a director and determining the compensation of non-employee directors. The Corporate Governance Guidelines are a set of principles which provide a benchmark of what is "good" corporate governance. The main tenets of the Guidelines are: . Create value for shareholders by promoting their interests . Focus on the future: formulate and evaluate corporate strategies . Duty of loyalty to the Company by Directors . Annual CEO evaluation by independent directors . Annual approval of 3-year plan and one-year operating plan . Annual assessment of Board effectiveness by Nominating/Governance Committee . No interlocking directorships . Directors are required to reach and maintain ownership of $100,000 of Company stock . Annual report of succession planning and management development by CEO The Nominating and Corporate Governance Committee was established in January, 1998 and therefore held no meetings in the twelve month period ended December 31, 1997. The Audit Committee reviews the scope and results of the annual audit, reviews and approves the services and related fees of the Company's independent public accountants, reviews the Company's internal accounting controls and reviews the Company's Internal Audit Department and its activities. COMPENSATION OF DIRECTORS The Company has adopted 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 are granted options to purchase 5,000 shares of the Company's common stock on their first date of election and are 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 the Company's 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. In connection with the Spinoff, the Board of Directors determined that Barbara Bainum, Jerry E. Robertson, Robert C. Hazard, Jr. and Gerald W. Petitt would forego the initial grant of 5,000 options under Part A of the plan in exchange for the continued vesting of options granted under the identical plan of Former Choice which otherwise would have lapsed upon their resignation from the Board of Directors of Former Choice. Pursuant to the Non-Employee Director Stock Compensation Plan adopted by the Company, eligible non-employee directors will receive annually, in lieu of cash, restricted shares of the Company's common stock, the fair market value of which at the time of grant will be equal to $30,000, which will represent the Board of Directors retainer and meeting fees. In addition, all non- employee directors receive $1,610 per diem for Committee meetings attended and are reimbursed for travel expenses and other out-of-pocket expenses. Directors who are employees of the Company receive no separate remuneration for their services as directors. 7 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth the amount of the Company's common stock beneficially owned by (i) each director of the Company, (ii) the Company's chief executive officer and the other four most highly compensated executive officers (the "Named Officers"), (iii) all officers and directors of the Company as a group and (iv) all persons who are expected to own beneficially more than 5% of the Company's common stock, as of March 12, 1998, the Record Date. Unless otherwise specified, the address for each of them is 10750 Columbia Pike, Silver Spring, Maryland 20901.
SHARES OF COMMON STOCK PERCENT OF BENEFICIALLY SHARES NAME OF BENEFICIAL OWNER OWNED OUTSTANDING(1) ------------------------ ------------ -------------- Stewart Bainum, Jr. ......................... 16,041,777(2) 26.69% Stewart Bainum............................... 10,194,595(3) 17.17% Barbara Bainum............................... 5,521,754(4) 9.24% Michael J. DeSantis.......................... 900 * William R. Floyd............................. 153,873(5) * Robert C. Hazard, Jr. ....................... 41,187(6) * Frederic V. Malek............................ 8,443(7) * Thomas Mirgon................................ 8,990(8) * Gerald W. Petitt............................. 87,240(9) * James H. Rempe............................... 177,808(10) * Jerry E. Robertson, Ph.D. ................... 24,074(11) * Barry L. Smith............................... 21,641(12) * Rodney Sibley (13)........................... 41,733(14) * All Directors and Officers as a Group (13 persons).................................... 20,908,946(15) 34.98% Bruce Bainum................................. 5,512,302(16) 9.16% Ronald Baron................................. 19,712,033(17) 26.23%
- -------- * Less than 1% of class. (1) Percentages are based on 59,741,072 shares outstanding on March 12, 1998 (the "Record Date") plus, for each person, the shares which would be issued assuming that such person exercises all options it holds which are exercisable on such date or become exercisable within 60 days thereafter. (2) Includes 549,152 shares owned directly by the Stewart Bainum, Jr. Declaration of Trust dated March 13, 1996, the sole trustee and beneficiary of which is the reporting person. 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; 3,567,869 shares held directly by Realty Investment Company, Inc. ("Realty"), a real estate management and investment company in which Mr. Bainum, Jr. has shared voting authority; 1,779,628 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 300 shares owned by the Foundation for Maryland's Future, in which Mr. Bainum, Jr. is the sole director. Also includes 311,669 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 the Record Date, and 148 shares which Mr. Bainum, Jr. has the right to receive upon termination of his employment with the Company pursuant to the terms of the Choice Hotels International, Inc. Non-Qualified Retirement Savings and Investment Plan ("Non- Qualified Savings Plan"). (3) Includes 3,907,226 shares held directly by the Stewart Bainum Declaration of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his joint interest in 847,379 shares owned by Bainum Associates and 995,663 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, in which Mr. Bainum and his wife have shared voting authority; and 70,305 shares held by the Commonwealth 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 and beneficiary of which is Mr. Bainum's wife, and 3,666 shares which Mr. Bainum has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date. Also includes 3,776 shares of restricted stock granted by the issuer to Mr. Bainum under the Choice Hotels International, Inc. Non-Employee Director Stock Compensation Plan (the "Non-Employee Director Stock Compensation Plan") which are not vested but which Mr. Bainum has the right to vote. 8 (4) Includes 101,697 shares owned directly by Ms. Bainum. Also includes 1,779,628 shares owned by Mid Pines, in which Ms. Bainum's trust is a general partner and has shared voting authority, 3,567,869 shares owned by Realty, in which Ms. Bainum's trust has voting stock and shares voting authority and 70,305 shares owned by the Commonwealth Foundation, in which Ms. Bainum is President and Director and has shared voting authority. Also includes 2,255 shares of restricted stock issued to Ms. Bainum which shares are not vested, but which Ms. Bainum has the right to vote. (5) Includes 28,950 shares held directly and 56,980 shares of restricted shares granted pursuant to Mr. Floyd's employment agreement which are not yet vested, but which Mr. Floyd has the right to vote. Also includes 68,303 shares which Mr. Floyd has the right to acquire pursuant to stock options which are currently exercisable or become exercisable within 60 days of the Record Date. (6) Includes 38,404 shares owned directly by Mr. Hazard; 2,255 restricted shares granted under the Non-Employee Director Stock Compensation Plan, which are not yet vested, but which Mr. Hazard has the right to vote, and 113 and 415 shares, respectively, which Mr. Hazard has the right to receive upon termination of his employment pursuant to the terms of the Choice Hotels International, Inc. Retirement Savings and Investment Plan ("401(k) Plan") and the Non-Qualified Savings Plan. (7) Includes 1,000 shares owed directly; 3,667 shares which Mr. Malek has the right to acquire pursuant to stock options which are presently exercisable or exercisable within 60 days of the Record Date and 3,776 restricted shares granted under the Non-Employer Director Stock Compensation Plan which are not vested, but which Mr. Malek has the right to vote. (8) Consists of shares which Mr. Mirgon has the right to receive pursuant to stock options which are currently exercisable or exercisable within 60 days of the Record Date. (9) Includes 76,324 shares held directly by Mr. Petitt and 8,661 shares held in trust for minor children for which Mr. Petitt is trustee. Beneficial ownership of such shares is disclaimed. Also includes 2,255 restricted shares granted under the Non-Employee Director Stock Compensation Plan which are not yet vested, but which Mr. Petitt has the right to vote. (10) Includes 126,144 shares which Mr. Rempe has the right to acquire pursuant to stock options which are presently exercisable or exercisable within 60 days of the Record Date. Also includes 993 restricted shares granted under the Non-Employee Director Stock Corporation Plan which are not yet vested, but which Mr. Rempe has the right to vote. (11) Includes 948 shares held directly by Mr. Robertson and 15,500 shares owned by the JJ Robertson Limited Partnership, of which Mr. Robertson and his wife are the general partners with shared voting authority and 2,783 restricted shares granted under the Non-Employee Director Stock Compensation Plan which are not yet vested, but which Mr. Robertson has the right to vote. Also includes 4,029 shares which Mr. Robertson has the right to acquire pursuant to stock options which are presently exercisable or exercisable within 60 days of the Record Date and 814 shares acquired pursuant to the Choice Hotels International, Inc. Non- Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. (12) Includes 20,827 shares which Mr. Smith has the right to acquire pursuant to stock options which are presently exercisable or exercisable within 60 days of the Record Date and 254 shares and 555 shares, respectively which Mr. Smith has the right to receive upon termination of his employment pursuant to the terms of the 401(k) Plan and the Non-Qualified Savings Plan. (13) Mr. Sibley's employment with the Company was terminated in November 1997. (14) Includes 27,031 shares held directly by Mr. Sibley and 14,702 shares which Mr. Sibley has the right to acquire pursuant to stock options which are presently exercisable or exercisable within 60 days of the Record Date. (15) Includes a total of 730,779 shares which the officers and directors included in the group have the right to acquire pursuant to stock options which are presently exercisable, or exercisable within 60 days of the Record Date, and a total of 1,994 shares and 3,528 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 401 (k) Plan and the Non-Qualified Savings Plan. (16) Includes 94,500 shares owned directly by Mr. Bainum. Also includes 1,779,628 shares owned by Mid Pines, in which Mr. Bainum is a general partner and has shared voting authority, 3,567,869 shares owned by Realty in which Mr. Bainum's trust has voting stock and shares voting authority and 70,305 shares owned by the Commonwealth Foundation, in which Mr. Bainum is a Director and has shared voting authority. Mr. Bainum's address is 8737 Colesville Road, Suite 800, Silver Spring, Maryland, 20910. (17) As of February 3, 1998 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. Pursuant to a letter agreement dated February 4, 1998 between the Company, Mr. Baron and entities under the control of Mr. Baron (together with Mr. Baron, the "Baron Entities"), each Baron Entity covenanted not to (i) acquire any additional shares of stock or security convertible into stock of the Company; (ii) take any action or participate in any transaction which may constitute an event of default under the Existing Credit Facility or (iii) seek representation on the Board of Directors of the Company. 9 THE FOLLOWING COMPENSATION COMMITTEE REPORT AND THE PERFORMANCE GRAPH THAT APPEARS IMMEDIATELY AFTER SUCH REPORT SHALL NOT BE DEEMED TO BE SOLICITING MATERIAL OR TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES EXCHANGE ACT OF 1934 OR INCORPORATED BY REFERENCE IN ANY DOCUMENT SO FILED. BOARD COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION There are currently two compensation committees for the Company, the Compensation/Key Executive Stock Option Plan Committee and the Compensation/Key Executive Stock Option Plan Committee No. 2 ("Committee No. 2") (collectively, the "Committee"). The role of Committee No. 2, which is comprised of "outside directors" as defined in Section 162(m)(3) of the Code, is to approve awards under the 1997 Long-Term Incentive Plan to the Chief Executive Officer and the Named Officers defined below. The current members of the Committee, Messrs. Robertson (Chairman), Bainum (not a member of Committee No. 2), Malek and Ms. Bainum, were appointed effective November 21, 1997. As a wholly-owned subsidiary of Former Choice prior to the Spinoff, most of the decisions and actions pertaining to the executive officers of the Company for the year ended December 31, 1997 were either approved by the Compensation Committee of the board of Former Choice or by an executive officer of Former Choice. However, the current members of the Company's Compensation Committee were also members of Former Choice's Compensation Committee during the period from January 1, 1997 to October 15, 1997. The following philosophy and principles have been set forth as a framework within which the Committee will operate. COMPENSATION COMMITTEE PHILOSOPHY AND GUIDING PRINCIPLES . Attract and retain talented management; . Closely align management's interests and actions with those of shareholders through the establishment of appropriate award vehicles; . Reward employees for enhancing shareholder value through sustained improvement in earnings per share; . Position base pay at market so that the Company can vary total compensation costs with financial results by means of variable pay; and . Recognize the concept that executive officers individually, and as a group, should have a significant ownership stake in the Company. EXECUTIVE COMPENSATION POLICIES Compensation Levels The Committee relates total compensation levels for the Company's executive officers to the total compensation paid to similarly situated executives based on various independently published compensation surveys, primarily conducted and evaluated by independent consultants. Summary data on companies of similar size in the service sector are used as the primary comparison and companies in the hotel industry are used as a secondary comparison. Total compensation is targeted to approximate the median of the competitive market data and comparison companies. However, because of the performance-oriented nature of the incentive programs, total compensation may exceed market norms when the Company's targeted performance goals are exceeded. Similarly, total compensation may lag the market when performance goals are not achieved. Compensation for the executive officers, other than the Chief Executive Officer, was set in June 1997, prior to the Spinoff. For the twelve months ended December 31, 1997, compensation for the President and Chief Executive Officer was slightly below the median while compensation for all of the other executive officers, as a group, was at or above the median. 10 One of the comparison companies, LaQuinta Hotel Corporation, was not included as part of the Peer Group Index (defined below) for the performance graph, see "Performance Graph", because it is solely an owner and manager of hotels and has no franchise operations. It was included as a comparison company for compensation purposes because such comparison was done before the Spinoff. Policy with Respect to Qualifying Compensation for Deductibility The Company's policy with respect to the deductibility limit of Section 162(m) of the Internal Revenue Code generally is to preserve the federal income tax deductibility of compensation paid when it is appropriate and is in the best interests of the Company and its stockholders. However, the Company reserves the right to authorize the payment of nondeductible compensation if it deems that is appropriate. In connection with William R. Floyd's employment agreement, Mr. Floyd was granted 85,470 non-performance based restricted shares of Company Common Stock which vest in three equal annual installments beginning November 4, 1997. Additionally, the employment agreement provides for options to purchase 207,693 shares of Company Common Stock which were granted outside of the 1996 Incentive Plan and which vest in five equal monthly installments beginning November 4, 1997. Upon the exercise of such options by Mr. Floyd during any fiscal year, his gain (the difference between the fair market value on the date of exercise and the exercise price) will be included in calculating the compensation for that fiscal year for which the federal income tax deduction is disallowed. The Committee intends to monitor the Company's compensation programs with respect to such laws. Annual Compensation The base salary pay practice as previously adopted by the Former Choice Compensation Committee is to target compensation at the 55th percentile of the market range among the comparison groups for a particular position and to adjust as appropriate for experience and performance. Because the Company was previously on a May 31 fiscal year end, annual merit adjustments for the executive officers affecting compensation paid in the twelve months ended December 31, 1997 were set in July 1996 and June 1997. With the change in fiscal year to December 31, annual merit reviews will occur in February commencing in 1998. Awards under the annual cash bonus program for the fiscal year ended May 31, 1997 were based on certain performance measurements, which were based 60% on achieving targeted gross operating profits, 20% on licensee/customer satisfaction goals and 20% on RevPAR. For the this period, actual performance exceeded the measurement goals for each component. For the seven months ended December 31, 1997, the Committee revised the performance measurements to focus heavily on management's responsibility to deliver earnings per share based on earnings per share from continuing operations at established annual targets. For executive officers other than the Chief Executive Officer, the proposal also includes specific performance objectives directly accountable to the executive officer. These performance objectives, where applicable, could include licensee/customer satisfaction and RevPAR and would incorporate each executive officer's accountability for the successful execution of key initiatives tied to achievement of the Company's strategic plan. For the seven month period ended December 31, 1997, the awards under the annual cash bonus program were based 75% on achieving increased earnings per share and 25% on achieving performance objectives. For this period, actual performance exceeded the goals for earnings per share. Long-Term Incentives The Company will award long-term incentives under the 1997 Incentive Plan. The plan gives the Compensation Committee the latitude of awarding Incentive Stock Options, non-qualified stock options, restricted stock, and other types of long-term incentive awards. The recommended awards were developed by analyzing peer group average market data and the Company's past practice. The Compensation Committee reviewed and approved a Stock Option Guide Chart for the Company's executives which had previously been used by Former Choice. The Stock Option Guide Chart utilized a market based salary multiple to establish a competitive range of stock options from which executive awards could be determined. 11 Compensation of the Chief Executive Officer Mr. Floyd's base salary is established by his rights under his employment agreement, approved by the Former Choice Compensation Committee and ratified by the Compensation Committee. The base salary is reviewed each year by the Committee and is subject to merit increases based primarily on his achievement of performance objectives and the comparison to competitive market data and the comparison companies. The performance objectives vary from year to year but in general relate to such matters as positioning the Company for growth, achieving the Company's strategic plan and other various financial goals. Although no specific weights are assigned to any particular objective, a greater emphasis is placed on corporate and personal performance than on competitive practices within the industry. In September 1997, the Former Choice Compensation Committee approved a 5% merit increase to Mr. Floyd's base salary. Under the annual cash bonus program, Mr. Floyd has the potential to be awarded up to 60% of his base salary if bonus objectives are achieved. Unlike the other executive officers, Mr. Floyd's bonus objectives are tied 100% to earning per share. For the fiscal year ended May 31, 1997 and the seven month period ended December 31, 1997, actual performance exceeded the goals for earnings per share. THE COMPENSATION COMMITTEE Jerry E. Robertson, Chairman Stewart Bainum (not a member of Committee No. 2) Frederic V. Malek Barbara Bainum 12 PERFORMANCE GRAPH The following graph compares the performance of Choice common stock with the performance of the New York Stock Exchange Composite Index ("NYSE Composite Index") and a peer group index (the "Peer Group Index") by measuring the changes in common stock prices from October 16, 1997, plus assumed reinvested dividends. The Commission's rules require that the Company select a peer group in good faith with which to compare its stock performance by selecting a group of companies in lines of business similar to its own. Accordingly, the Company has selected a peer group that includes companies which are actively traded on the New York Stock Exchange and the NASDAQ Stock Market and which are in the franchising and/or hospitality industry. The common stock of the following companies have been included in the Peer Group Index: Prime Hospitality Corporation, Marriott International, Inc., Promus Hotel Corporation, HFS, Inc. and Hilton Hotels Corp. On Decenmber 18, 1997, HFS, Inc. was merged into Cendant Corporation and its stock was delisted. The graph assumes that $100 was invested on October 16, 1997, in each of Choice common stock, the NYSE Composite Index and the Peer Group Index, and that all dividends were reinvested. In addition, the graph weighs the constituent companies on the basis of their respective capitalization, measured at the beginning of each relevant time period. COMPARISON OF CUMULATIVE RETURN AMONG CHOICE HOTELS, NYSE COMPOSITE INDEX AND PEER GROUP [GRAPH APPEARS HERE] [PLOT POINTS FOR GRAPH} OCTOBER 10, OCTOBER 31, NOVEMBER 28, DECEMBER 31, 1997 1997 1997 1997 ----------- ----------- ------------ ------------ CHOICE HOTELS 100 103.3 102.6 94.1 NYSE COMPOSITE INDEX 100 95.1 98.9 101.5 PEER GROUP 100 94.2 94.8 100.6 13 EXECUTIVE COMPENSATION Compensation received by the Named Officers prior to consummation of the Former Choice Spinoff was paid by Manor Care. Compensation received by the Named Officers after the Former Choice Spinoff, but prior to the Spinoff, was paid by Former Choice. Compensation received by the Choice Named Officers after the Spinoff was paid by the Company. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) LONG-TERM COMPENSATION ----------------- -------------------------- RESTRICTED NAME AND PRINCIPAL FISCAL STOCK STOCK OPTION ALL OTHER POSITION YEAR(1) SALARY BONUS OTHER AWARDS($) SHARES(#)(2) COMPENSATION(3) ------------------ ------- -------- -------- -------- ---------- ------------ --------------- Stewart Bainum, Jr.(4).. 1997A $148,310 $ 47,683 (5) -- -- -- Chairman 1997B 656,357 388,520 (5) -- 60,000(6) -- 1996 625,102 337,555 (5) -- 60,000(7) $ 33,543 William R. Floyd(8)..... 1997A 437,260 267,233 $139,403(9) -- 65,000(10) -- President and Chief 1997B 270,373 146,001 107,833(11) $250,000(12) 307,693(13) -- Executive Officer 1996 -- -- -- -- -- -- Barry L. Smith.......... 1997A 254,231 108,000 (5) -- 37,900(14) 11,086 Sr. Vice President, 1997B 240,000 108,000 (5) -- 25,000(15) 11,086 Marketing Officer 1996 233,650 116,820 (5) -- 5,000(16) 10,427 Thomas Mirgon(17)....... 1997A 188,423 51,315 $169,624(18) -- 7,100(19) -- Senior Vice President, 1997B 58,477 26,315 (5) -- 40,000(20) -- Human Resources and 1996 -- -- -- -- -- -- Partner Services Michael J. DeSantis (21)................... 1997A 122,870 19,204 (5) -- 40,000(22) -- President 1997B 99,530 3,477 -- -- -- 1996 35,625 -- -- -- -- Rodney Sibley (23)...... 1997A 308,970 139,105 31,382(24) -- 47,400(25) 177,329(26) 1997B 309,123 139,105 (5) -- 30,000(27) 27,329 1996 423,858 -- (5) -- -- 27,329
- ------- (1) On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. Accordingly, the summary compensation information presented is for the twelve months ended December 31, 1997 ("1997A"), the fiscal year ended May 31, 1997 ("1997B") and the fiscal year ended May 31, 1996 ("1996"). Summary compensation data paid to the Named Officers during the period between January 1, 1997 and May 31, 1997 are reflected in each of the 1997A and 1997B periods. (2) For Messrs. Bainum, Jr., Smith and Sibley, the grants in fiscal years 1997B and 1996 represent options to purchase shares of Manor Care common stock. In connection with the Former Choice Spinoff, the options to purchase Manor Care common stock were converted, in some cases 100%, to options to purchase Former Choice common stock. For Messrs. Floyd and Mirgon with respect to grants in 1997B and for all of the Named Officers with respect to grants in 1997A, represents options to acquire shares of Former Choice common stock. In connection with the Spinoff, the options to purchase Former Choice common stock were converted to successor options to purchase Company common stock and Sunburst common stock. In all cases, however, the exercise prices were adjusted to maintain the same financial value to the option holder before and after the Former Choice Spinoff and the Spinoff. (3) Represents amounts contributed by Manor Care for 1996, Former Choice for 1997B and Former Choice/Sunburst for 1997A under their respective 401(k) Plan and Non-Qualified Savings Plan, which provide retirement and other benefits to eligible employees, including the Named Officers. The value of the amounts contributed in stock by Former Choice during 1997B and 1997A under the 401(k) Plan and Non-qualified Savings Plan, respectively, for the Named Offices were as follows: Mr. Smith, $3,696 and $7,390 and Mr. Sibley, $9,000 and $18,329. (4) For part of 1997B and all of 1996, Mr. Bainum, Jr. was the Chairman and Chief Executive Officer of Manor Care and Former Choice. In November, 1996, he resigned as Chief Executive Officer of Former Choice. The compensation reflected for 1997B and 1996 is the total compensation received for services rendered to both Manor Care and Former Choice. For the period between January 1, 1997 and October 15, 1997, the amount of compensation paid solely by Former Choice was $132,533 for base salary and $47,683 for bonus. From October 15, 1997 to December 31, 1997 the amount of compensation paid solely by the Company was $15,777 for the period between October 16, 1997 and December 31, 1997. (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. 14 (6) In connection with the Spinoff, these options were converted into options to acquire 60,000 shares of Company common stock at an exercise price of $12.1130 and 20,000 shares of Sunburst common stock at an exercise price of $7.1894. (7) In connection with the Spinoff, these options were converted into options to acquire 60,000 shares of Company common stock at an exercise price of $9.2807 and 20,000 shares of Sunburst common stock at an exercise price of $5.5083. (8) Mr. Floyd's employment as Chief Executive Officer of Former Choice and the Company commenced October 16, 1996. (9) Consists of $127,703 in relocation expenses (including $107,831 reported under 1997B) and $11,700 in automobile allowance. (10) In connection with the Spinoff, these options were converted into options to purchase 71,631 shares of Company common stock at an exercise price of $16.488 and 10,833 shares of Sunburst common stock at an exercise price of $9.786. (11) Consists of relocation expenses. (12) Represents a grant of 85,470 restricted shares of Former Choice common stock granted on November 4, 1996. The shares vest in three equal annual installments beginning on November 4, 1997. The restricted shares are entitled to dividends and in connection with the Spinoff, Mr. Floyd received 85,470 shares of Company common stock as a dividend on such shares of Former Choice common stock, of which 56,980 remain unvested. (13) In connection with the Spinoff, these options were converted into options to purchase 341,515 shares of Company common stock at an exercise price of $12.2095 and 45,584 shares of Sunburst common stock at an exercise price of $7.2466. (14) In connection with the Spinoff, these options were converted into options to purchase 42,586 shares of Company common stock at an exercise price of $13.2008 and 4,738 shares of Sunburst common stock at an exercise price of $7.835. (15) In connection with the Former Choice Spinoff and the Spinoff, these options were converted into options to acquire 77,624 shares of Company common stock at an exercise price of $12.113 and 6,819 shares of Sunburst common stock at an exercise price of $7.1894. (16) In connection with the Former Choice Spinoff, these options were converted into options to acquire 15,183 shares of Company common stock at an exercise price of $9.2807 and 1,023 shares of Sunburst common stock at an exercise price of $5.5083. (17) Mr. Mirgon's employment with the Company and Former Choice commenced March 3, 1997. (18) Consists of $160,994 in relocation expenses and $8,630 in automobile allowance. (19) In connection with the Spinoff, these options were converted into options to purchase 7,878 shares of Company common stock at an exercise price of $13.2008 and 888 shares of Sunburst common stock at an exercise price of $7.835. (20) In connection with the Spinoff, these options were converted into options to purchase 44,946 shares of Company common stock at an exercise price of $13.0043 and 5,000 shares of Sunburst common stock at an exercise price of $7.7421. (21) Mr. DeSantis' employment commenced in January 1996. He was appointed Senior Vice President, General Counsel and Secretary in June 1997. (22) In connection with the Spinoff, these options were converted into options to purchase 44,946 shares of Company common stock at an exercise price of $13.2008 and 5,000 shares of Sunburst common stock at an exercise price of $7.835. (23) Prior to 1997A, Mr. Sibley's compensation was based on commissions. Mr. Sibley's employment was terminated in November 1997. (24) Consists of $29,029 in relocation expenses and $2,353 in automobile allowance. (25) In connection with the Spinoff, these options were converted into options to purchase 53,261 shares of Company common stock at an exercise price of $13.2008 and 5,925 shares of Sunburst common stock at an exercise price of $7.835. (26) In connection with his resignature, Mr. Sibley was paid $150,000. (27) In connection with the Former Choice Spinoff and the Spinoff, these options were converted into options to acquire 93,149 shares of Company common stock at an exercise price of $12.113 and 8,182 shares of Sunburst common stock at an exercise price of $7.1894. 15 STOCK OPTION GRANTS IN 1997
INDIVIDUAL GRANTS ----------------------------------------------------- POTENTIAL REALIZABLE VALUE OF ASSUMED RATE PERCENTAGE OF OF STOCK PRICE NUMBER TOTAL OPTIONS APPRECIATION FOR OF GRANTED TO ALL EXERCISE OPTION TERM(2) OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION --------------------- NAME COMPANY* GRANTED 1997 PER SHARE DATE 10%(4) ---- -------- ------- -------------- ---------- ---------- 5%(3) ----------- Stewart Bainum, Jr...... CHH 0 -- -- -- -- -- SNB 0 -- -- -- -- -- ------ Total 0 William R. Floyd(5)..... CHH 71,431 (6) $ 16.488 9/16/07 740,682 1,114,066 SNB 10,833 (7) $ 9.786 9/16/07 66,670 168,955 ------ Total 82,264 Barry L. Smith (5)...... CHH 42,586 (6) $13.2008 6/24/07 353,544 895,954 SNB 4,738 (7) $ 7.835 6/24/07 23,346 59,163 ------ Total 47,324 Thomas Mirgon (5)....... CHH 44,946 (6) $13.0443 2/25/07 368,714 934,395 CHH 7,978 (7) $13.2008 6/24/07 66,232 167,846 SNB 5,000 (6) $ 7.7421 2/25/07 24,345 61,694 SNB 888 (7) $ 7.835 6/24/07 4,375 11,088 ------ Total 58,812 Michael J. DeSantis (5). CHH 44,946 (6) $13.2008 6/24/07 373,137 945,605 SNB 5,000 (7) $ 7.835 6/24/07 24,637 62,435 ------ Total 49,946 Rodney Sibley (5)....... CHH 53,261 (6) $13.2008 6/24/07(8) 442,167 1,120,542 SNB 5,925 (7) $ 7.835 6/24/07(8) 29,194 73,985 ------ Total 59,186
- -------- * References to CHH are to the Company and SNB are to Sunburst. 1. Options granted to the Named Officers were granted prior to the Spinoff and were thus granted as options to purchase Former Choice common stock. In connection with the Spinoff, these options to purchase Former Choice common stock were converted to options to purchase Company common stock and Sunburst common stock. In all cases, however, the exercise prices were adjusted to maintain the same financial value to the option holder before and after the Spinoff. The number of options set forth in the table represent the number of Company and Sunburst options and the adjusted exercise prices after the conversion. 2. 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 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. 3. A 5% per year appreciation in stock price from $16.488 per share yields $10.3692, from $9.786 per share yields $6.1544, from $13.2008 per share yields $8.3019, from $7.835 per share yields $4.9274, from $13.0443 per share yields $8.2035 and from $7.7421 per share yields $4.8690. 4. A 10% per year appreciation in stock price from $16.488 per share yields $26.2776, from $9.786 per share yields $15.5964, from $13.2008 per share yields $21.0387, from $7.835 per share yields $12.4970, from $13.0443 per share yields $20.7893 and from $7.7421 per share yields $12.3389. 5. The options granted to the officers vest at the rate of 20% per year on the first through the fifth anniversaries of the date of the stock option grant. 6. In the twelve months ended December 31, 1997, the Company only granted options to two individuals for a total of 120,000 options granted. All other outstanding Company options (including those listed in this table) were issued in connection with the conversion of Former Choice options in the Spinoff. 7. The options presented in this table are presented post-conversion from Spinoff. Since the option grants presented in the table were granted prior to the Spinoff conversion, the percentage of Former Choice/Sunburst options is not presented as it would not be equivalent to the percentage if calculated on a pre-Spinoff basis. 8. In connection with Mr. Sibley's resignation, the expiration date of these options was changed to 7/5/01. 16 CHOICE HOTELS INTERNATIONAL, INC. 10750 Columbia Pike, Silver Spring, Maryland 20901 PROXY SOLICITED BY THE BOARD OF DIRECTORS FOR ANNUAL MEETING OF SHAREHOLDERS TO BE HELD APRIL 29, 1998 The undersigned hereby appoints JERRY E. ROBERTSON and FREDERIC V. MALEK, and each of them, the true and lawful attorneys and proxies, with full power of substitution, to attend the Annual Meeting of Stockholders of Choice Hotels International, Inc. (the "Company") to be held on April 29, 1998 at 9:00 a.m. in the Ballroom located at the Quality Suites Shady Grove, 3 Research Court, Rockville, Maryland and at any adjournment thereof, and to vote all shares of common stock held of record which the undersigned could vote, with all the powers the undersigned would possess if personally present at such meeting, as designated below. All shares of Company common stock that are represented at the Annual Meeting by properly executed proxies received prior to or at the Annual Meeting and not revoked will be voted at the Annual Meeting in accordance with the instructions indicated herein. If no instructions are indicated for Item 1, such proxies will be voted in accordance with the Board of Directors' recommendation as set forth herein with respect to such proposal(s). - -------------------------------------------------------------------------------- THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE FOR ITEM 1. (1) Election of two Directors: / / FOR all nominees listed below: / / WITHHOLD AUTHORITY to vote FOR all nominees listed below: STEWART BAINUM, GERALD W. PETTIT and JERRY E. ROBERTSON (Instructions: to withhold authority to vote for any individual nominee, write that nominee's name in the space provided below.) ---------------------------------------------------------------------- If you plan to attend the Annual Meeting of Stockholders, please mark the following box and promptly return this Proxy Card. / / Dated , 1998 ---------- --------------------------------- -------------------------------------------------- Signature -------------------------------------------------- Signature (Signatures should correspond exactly with the name or names appearing above. Attorneys, trustees, executors, administrators, guardians and others signing in a representative capacity should designate their full titles. If the signer is a corporation, please sign the full corporate name by a duly authorized officer.) -----END PRIVACY-ENHANCED MESSAGE-----