-----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, CokkKQvCNb0fRCJZBO2OCadmUSvuhD74ZpQ4DNjUepZOYhFvCdnJbhA99YndmGk7 bcPZmmLPkVtAK2PGjLmQ5Q== 0001021408-99-000563.txt : 19990330 0001021408-99-000563.hdr.sgml : 19990330 ACCESSION NUMBER: 0001021408-99-000563 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990329 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: 99576438 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) [X] 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 December 31, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]. For the transition period from ________________ to ______________________ 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) 592-5000 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 $.01 per share New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange 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 $495,884,280 as of March 10, 1999 based upon a closing price of $ 14.1875 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 10, 1999 was 55,336,553. DOCUMENTS INCORPORATED BY REFERENCE. PART I 1998 Annual Report to Stockholders Proxy Statement dated March 29, 1999 PART II 1998 Annual Report to Stockholders Proxy Statement dated March 29, 1999 PART III Proxy Statement dated March 29, 1999 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 3,671 hotels open and operating in 36 countries at December 31, 1998. In addition, at December 31, 1998, the Company had 1,477 franchise properties currently under development representing a total of 115,607 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 MainStay/SM/. The Company has over 2,300 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, Puerto Rico and the District of Columbia and 35 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 economies 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 that are based as a percentage of the franchisees' gross room revenues. The principal factors that affect the Company's results are: (i) growth in the number of hotels under franchise; (ii) occupancies and room rates 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 52.5% as of May 31, 1995 to 64.6% as of December 31, 1998. 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 $ 115.4 million for the year ended December 31, 1998. Earnings before interest, taxes, depreciation and amortization has grown from $32.2 million for the year ended May 31, 1992 to $ 93.8 million for the year end December 31, 1998. __________________________ /1/ Franchising operating margin is calculated by deducting selling, general and administrative expenses from net franchising revenues. 3 Company History Prior to becoming a separate, publicly-held company on October 15, 1997 pursuant to the Company Spin-off (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 Spin-off"). At the time of the Company Spin-off, the Company changed its name to "Choice Hotels International, Inc.," and Former Choice changed its name to "Sunburst Hospitality Corporation." References herein to the Company's former parent corporation prior to the Company Spin-off are to "Former Choice," and reference to such corporation after the Company Spin-off 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 Spin-off"). In connection with the Former Choice Spin-off, the Company became a wholly-owned subsidiary of Former Choice and remained as such until consummation of the Company Spin-off. The Lodging Industry/(1)/ As of December 31, 1998, there were approximately 3.7 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 2.6 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 recovered, demonstrating 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 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: ________________________ /1/ Source: Smith Travel Research 4 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 $17.0 128,000 1998......... 7.7% 64.0% $78.62 4.4% 2.3% $50.29 $22.0 143,000
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 1998, the average room count in new hotels declined from 122 to 95 primarily because hotel developers found it difficult to obtain financing of more than $3 million from their primary lending sources (local banks and Small Business Administration-guaranteed loan programs). In recent years, operators of hotels not owned or managed by major lodging companies have increasingly joined national hotel franchise chains as a means of remaining competitive with hotels owned by or affiliated with national lodging companies. Because 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 1,104 hotel properties that changed their affiliation in 1998, 82% converted from independent status to affiliation with a chain or converted from one chain to another, while only 5 18% canceled or were required to cancel their chain affiliation. A total of 204 independent properties switched to a franchise chain in 1998. 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 designed to maximize the value of its extensive distribution channels (which include the hotels under franchise and the hotel guests) by expanding and enhancing those relationships. The strategy is effectuated through an emphasis on the following key components: (1) optimizing the brand portfolio, (2) strategically growing the franchise system, (3) leveraging the franchise system, (4) improving its and its franchisees' margins, (5) growing profitability internationally, and (6) pursuing complementary business opportunities. . Optimizing 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 6 will be effectuated through a raising of the Company's brand standards strictly enforced through consumer-driven quality assurance. . Increasing Market Penetration on a Strategic Basis. The Company is taking advantage of its regional structure to analyze key markets in the U.S. and, in conjunction with its franchisees, identifying the best opportunities for new development or conversion to one of the Company's brands. . Expanding Partner Services Programs. The Company believes there is significant opportunity to leverage its size by entering into arrangements with national and multi-national companies that want to gain exposure to the Company's franchised hotels and to the millions of guests who patronize the Company's franchised hotels each year. In practice, the guest enjoys brand-name products and services that help build guest loyalty and the franchisee benefits from competitively priced products. Vendor partners gain access to a critical mass of franchisees, which in turn generates residual income for the Company. . Improving 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 is supplemented by continued enforcement of the Company's contracts (including licensee audits). . Growing Profitably Internationally. During the eleven fiscal years ended December 31, 1998, the number of properties (including those under construction) in the Company's international franchise system increased to 1,243 properties with 93,470 rooms, from 81 properties with 8,330 rooms. The Company's international franchise system includes hotels in 35 countries outside the United States. The Company plans to continue to profitably grow its brands internationally through a strategic pursuit of joint ventures, master franchising agreements and brand specific area development agreements. . Pursuing 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 MainStay(SM). The following table presents key statistics relative to Choice's domestic franchise system over the three fiscal years ended May 31, 1997, for the seven-month period ended December 31, 1997 and for the two fiscal years ended December 31, 1998. 7 COMBINED DOMESTIC FRANCHISE SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, ------------------------------------------------------------ 1995 1996 1997 1997 ------------------------------------------------------------ Number of properties, end of period.............. 2,311 2,495 2,781 2,880 Number of rooms, end of period................... 200,792 214,613 235,431 242,161 Royalty fees ($000).............................. $ 71,665 $ 82,239 $ 91,724 $ 65,271 Average Royalty Rate(1).......................... 3.2% 3.3% 3.4% 3.5% Average occupancy percentage..................... 63.8% 63.9% 62.6% 66.2% Average daily room rate (ADR).................... $ 47.13 $ 49.49 $ 51.92 $ 54.97 RevPAR(2)........................................ $ 30.08 $ 31.60 $ 32.52 $ 36.39 AS OF AND FOR THE YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1998 --------------------------------------- Number of properties, end of period.............. 2,880 3,039 Number of rooms, end of period................... 242,161 252,357 Royalty fees ($000).............................. $ 99,144 $109,240 Average Royalty Rate(1).......................... 3.5% 3.6% Average occupancy percentage..................... 62.3% 60.9% Average daily room rate (ADR).................... $ 53.89 $ 56.39 RevPAR(2)........................................ $ 33.56 $ 34.35
(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 2,300 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 88 hotels containing 11,911 rooms located in 27 states as of December 31, 1998. 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, 1998, there were 1,526 Comfort Inn properties and 192 Comfort Suites properties with a total of 117,405, and 15,660 rooms, respectively, open and operating worldwide. An additional 385 Comfort Inn and Comfort Suites properties with a total of 33,061 rooms were under development. Comfort properties are located in the United States and in Argentina, Australia, the Bahamas, Belgium, Brazil, Canada, Denmark, France, Germany, India, Italy, Jamaica, Lebanon, Mexico, Norway, Portugal, Puerto Rico, Sweden, Switzerland, Thailand, Turks & Caicos, the United Kingdom and the United Arab Emirates. The following chart summarizes the Comfort system in the United States: 8 COMFORT DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, -------------------------------------------------------------- 1995 1996 1997 1997 -------------------------------------------------------------- Number of properties, end of period.............. 1,015 1,129 1,255 1,304 Number of rooms, end of period................... 87,551 94,160 102,722 105,384 Royalty fees ($000s)............................. $37,635 $44,657 $ 50,758 $ 36,446 Average occupancy percentage..................... 69.5% 68.7% 67.2% 71.3% Average daily room rate (ADR).................... $ 48.24 $ 51.13 $ 54.17 $ 57.15 RevPAR........................................... $ 33.54 $ 35.11 $ 36.39 $ 40.75 AS OF AND FOR THE YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1998 --------------------------------------- Number of properties, end of period.............. 1,304 1,394 Number of rooms, end of period................... 105,384 110,682 Royalty fees ($000s)............................. $ 55,261 $ 61,153 Average occupancy percentage..................... 66.6% 65.4% Average daily room rate (ADR).................... $ 55.74 $ 58.19 RevPAR........................................... $ 37.15 $ 38.03
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, 1998, there were 200 Sleep Inn properties with a total of 15,214 rooms open and operating worldwide. An additional 193 properties with a total of 14,979 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: SLEEP DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, ----------------------------------------------------------- 1995 1996 1997 1997 ----------------------------------------------------------- Number of properties, end of period.............. 51 87 131 156 Number of rooms, end of period................... 3,672 6,396 9,635 11,538 Royalty fees ($000s)............................. $2,080 $2,108 $3,343 $ 2,630 Average occupancy percentage..................... 65.3% 65.5% 63.9% 66.5% Average daily room rate (ADR).................... $41.89 $45.11 $48.11 $ 50.54 RevPAR........................................... $27.37 $29.56 $30.75 $ 33.60 AS OF AND FOR THE YEAR ENDED DECEMBER 31, --------------------------------- 1997 1998 --------------------------------- Number of properties, end of period.............. 156 197 Number of rooms, end of period................... 11,538 14,924 Royalty fees ($000s)............................. $ 3,926 $ 5,337 Average occupancy percentage..................... 63.0% 62.0% Average daily room rate (ADR).................... $ 49.41 $ 51.41 RevPAR........................................... $ 31.11 $ 31.88
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, 1998, there were 554 Quality Inn properties with a total of 61,542 rooms, and 125 Quality Suites properties with a total of 13,930 rooms open worldwide. An additional 177 Quality Inn and Quality Suites properties with a total of 18,782 rooms were under development. Quality properties are located in the United States and in Australia, Canada, Chile, Costa Rica, the Czech Republic, Denmark, France, Germany, India, Indonesia, Ireland, Italy, Jamaica, Malaysia, Mexico, New Zealand, Norway, Portugal, Russia, Spain, Sweden, Thailand, the United Kingdom and the United Arab Emirates. The following chart summarizes the Quality system in the United States: 9 QUALITY DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, -------------------------------------------------------------- 1995 1996 1997 1997 -------------------------------------------------------------- Number of properties, end of period.............. 341 362 409 419 Number of rooms, end of period................... 43,281 45,967 50,487 50,674 Royalty fees ($000s)............................. $15,632 $16,606 $17,623 $14,459 Average occupancy percentage..................... 63.1% 62.5% 61.3% 63.8% Average daily room rate (ADR).................... $ 50.94 $ 52.90 $ 54.61 $ 57.58 RevPAR........................................... $ 32.16 $ 33.08 $ 33.46 $ 36.73 AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------- 1997 1998 ------------------------------------- Number of properties, end of period.............. 419 430 Number of rooms, end of period................... 50,674 50,151 Royalty fees ($000s)............................. $18,488 $20,187 Average occupancy percentage..................... 60.2% 58.7% Average daily room rate (ADR).................... $ 56.79 $ 60.19 RevPAR........................................... $ 34.19 $ 35.35
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, 1998, there were 130 Clarion properties with a total of 21,355 rooms open and operating worldwide and an additional 45 properties with a total of 7,037 rooms under development. The properties are located in the United States, Australia, the Bahamas, Canada, Chile, France, Germany, Guatemala, Indonesia, Ireland, Japan, Mexico, Norway, Russia and Uruguay. The following chart summarizes the Clarion system in the United States: CLARION DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, --------------------------------------------------------------- 1995 1996 1997 1997 ---------------------------------------------------------------- Number of properties, end of period.............. 63 75 92 96 Number of rooms, end of period................... 10,420 12,817 14,721 16,161 Royalty fees ($000s)............................. $ 2,995 $ 3,602 $ 4,081 $ 2,957 Average occupancy percentage..................... 63.7% 63.3% 63.3% 64.7% Average daily room rate (ADR).................... $ 63.71 $ 64.36 $ 67.76 $ 71.53 RevPAR........................................... $ 40.58 $ 40.74 $ 42.86 $ 46.29 AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------------- 1997 1998 ------------------------------------------- Number of properties, end of period.............. 96 105 Number of rooms, end of period................... 16,161 17,878 Royalty fees ($000s)............................. $ 5,061 $ 5,447 Average occupancy percentage..................... 62.3% 60.4% Average daily room rate (ADR).................... $ 70.67 $ 72.37 RevPAR........................................... $ 44.05 $ 43.73
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, 1998, there were 723 Econo Lodge properties with a total of 45,656 rooms open and operating in the United States and Canada, and an additional 132 properties with a total of 9,636 rooms under development in those two countries. The following chart summarizes the Econo Lodge system in the United States: 10 ECONO LODGE DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, ------------------------------------------------------------- 1995 1996 1997 1997 -------------------------------------------------------------- Number of properties, end of period.............. 633 641 682 692 Number of rooms, end of period................... 42,801 42,726 44,636 45,050 Royalty fees ($000s)............................. $12,021 $12,760 $13,288 $ 8,991 Average occupancy percentage..................... 57.5% 58.0% 56.4% 60.7% Average daily room rate (ADR).................... $ 38.31 $ 39.97 $ 41.33 $ 43.86 RevPAR........................................... $ 22.04 $ 23.17 $ 23.30 $ 26.63 AS OF AND FOR THE YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1998 -------------------------------------- Number of properties, end of period.............. 692 698 Number of rooms, end of period................... 45,050 44,458 Royalty fees ($000s)............................. $13,687 $13,975 Average occupancy percentage..................... 56.1% 54.2% Average daily room rate (ADR).................... $ 42.35 $ 43.69 RevPAR........................................... $ 23.75 $ 23.70
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, 1998, there were 202 Rodeway Inn properties with a total of 12,873 rooms, open and operating in the United States and Canada, and an additional 51 properties with a total of 3,532 rooms under development in those two countries. The following chart summarizes the Rodeway system in the United States: RODEWAY DOMESTIC SYSTEM
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, --------------------------------------------------------------- 1995 1996 1997 1997 ---------------------------------------------------------------- Number of properties, end of period.............. 208 201 217 209 Number of rooms, end of period................... 13,067 12,547 13,509 12,997 Royalty Fees ($000s)............................. $ 2,302 $ 2,506 $ 2,631 $ 1,756 Average occupancy percentage..................... 50.5% 52.7% 52.7% 54.7% Average daily room rate (ADR).................... $ 38.93 $ 40.66 $ 41.15 $ 44.11 RevPAR........................................... $ 19.64 $ 21.48 $ 21.68 $ 24.13 AS OF AND FOR THE YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1998 ---------------------------------------- Number of properties, end of period.............. 209 196 Number of rooms, end of period................... 12,997 12,447 Royalty Fees ($000s)............................. $ 2,671 $ 2,678 Average occupancy percentage..................... 51.4% 49.9% Average daily room rate (ADR).................... $ 43.15 $ 44.31 RevPAR........................................... $ 22.20 $ 22.12
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, 1998, there were 19 open hotels with 1,817 rooms and an additional 22 properties with 1,917 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). International Franchise Operations The Company's international franchise operations are primarily conducted through master franchise arrangements. These agreements provide the master franchisee the 11 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, 1998, the Company had 632 franchise hotels open in 35 countries outside the United States. The following table illustrates the growth of the Company's international franchise system over the three fiscal years ended May 31, 1997 for the seven-month period ended December 31, 1997 and the two fiscal years ended December 31, 1998. COMBINED INTERNATIONAL FRANCHISE SYSTEM(1)
AS OF AND FOR THE YEAR ENDED AS OF AND FOR THE SEVEN MAY 31, MONTHS ENDED DECEMBER 31, ---------------------------------------------------------- 1995 1996 1997 1997 ---------------------------------------------------------- Number of properties, end of period.............. 524 557 563 605 Number of rooms, end of period................... 44,877 46,843 47,603 50,639 Royalty fees $000s).............................. $ 1,998 $ 1,586 $ 1,672 $ 958 AS OF AND FOR THE YEAR ENDED DECEMBER 31, ------------------------------------ 1997 1998 ------------------------------------ Number of properties, end of period.............. 605 632 Number of rooms, end of period................... 50,639 53,095 Royalty fees $000s).............................. $ 2,303 $ 4,902
(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 242 hotels open in 10 countries at December 31, 1998. 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 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 12 investment, the Company currently has the right to appoint three of the directors to the Friendly board. There is also a master franchise arrangement in Scandinavia that has 84 open properties as of December 31, 1998. Canada. Choice Hotels Canada is Canada's largest lodging organization with 212 properties open at December 31, 1998. Choice Hotels Canada is a joint venture, owned 50% by the Company and 50% by UniHost Corporation ("UniHost"), which was formed in 1993 when UniHost 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, 1998, 939 hotels were open and operating under these master franchise arrangements (exclusive of Europe and Canada), generating annual royalty fees to the Company of approximately $2.5 million. In July 1998, the Company and Flag International Limited ("Flag"), Australia's largest lodging chain, formed a strategic alliance. Flag Choice Hotels, a wholly-owned subsidiary of Flag, acquired a 20-year master franchise from the Company. Under the agreement, a number of Flag properties were re- branded with Company brands which best serve their market segment. The agreement also provides the Company with the opportunity to acquire, within the first four years of the agreement, up to 30 percent of the equity of Flag Choice Hotels with proportionate board representation. 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 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, 1998, the Company employed approximately 40 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 television, radio and print brand advertising campaigns, 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. 13 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. During fiscal 1998, Choice received 919 franchise applications, approved 749 applications, signed 619 franchise agreements and placed 318 new properties into operation in the United States under the Choice brands. Of those placed into operations, 198 were newly constructed hotels. By comparison, during the twelve month period ended December 31, 1997, the Company received 976 franchise applications, approved 807 applications, signed 576 franchise agreements and added 430 new properties into operation in the U.S. Applications received or approved may not always result in signed franchise agreements due to an applicant being unable to obtain financing or because the Company and the applicant are unable to agree on the financial terms of the franchise agreement. In 1998, the Company placed greater focus on quality standards, which were more rigidly enforced. Terminations for properties that failed to meet quality assurance standards and contractual obligations were 258 properties (including properties not yet open) in 1998 versus 183 properties in 1997. 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 14 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. The standard franchise agreements typically require the Company's franchisees to pay the following fees: QUOTED FEES BY BRAND
INITIAL FEE PER ROOM/ ON-GOING FEES AS A PERCENTAGE OF GROSS ROOM REVENUES ----------------------------------------------------------- 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, see "Relationship Between the Company and Sunburst--Franchise Agreements," on the Proxy Statement dated March 29, 1999, incorporated herein by reference. The Company has increased its average royalty rate since fiscal year 1993, primarily by raising the quoted royalty fee for Comfort Inn 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 fee contracts in the franchise system. For the twelve months ended December 31, 1998, the Company's average royalty rate for all Choice domestic brand hotels was 3.6%. The Company believes that its average royalty rate will continue to increase as new franchisees are added and as older franchise agreements expire, terminate or are amended. At December 31, 1998, the Company had 3,894 franchise agreements in effect in the United States and 1,253 franchise agreements in effect in other countries. The average age of the franchise agreements was 4.6 years. Seven hundred ninety-five of the franchise agreements are scheduled to expire during the five-year period beginning December 31, 1998; 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 15 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 30.0% of the room nights booked at franchisees' properties are reserved through the toll-free telephone reservation system operated by the Company. The Company's reservation system consists of a computer reservation system known as CHOICE 2001, five reservation centers in North America and several international reservation centers run by the Company or its master franchisees. 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. Property Management System; Technical Services Program. The Company's proprietary property and yield management system, Profit Manager by Choice Hotels, is designed to help franchisees maximize profitability and compete more effectively by managing their rooms inventory, rates and reservations. The Profit Manager system synchronizes each hotel's inventory with the CHOICE 2001 system, giving reservation sales agents last room sell capabilities at every hotel. Profit Manager includes a revenue management feature that calculates and suggests optimum rates and length of stays based on each hotel's past performance and projected occupancy. As of March 1, 1999, Profit Manager was installed in 884 hotels in the United States and Canada, with 225 of those hotels utilizing the revenue management function. To encourage the deployment of Profit Manager, the Company has developed a Technology Support Program ("TSP"), which allows hotels to pay for all aspects of the Profit Manager system (software, hardware, maintenance, training and support) with one monthly payment. A core component of the TSP is a hardware leasing arrangement for Dell Computers equipment under which a subsidiary of the Company, Choice Hotels International Services Corp. 16 ("CHI Services"), leases the hardware and then subleases it to franchisees. The benefits to franchisees are no initial up-front costs and periodic technology updating. Under the leasing arrangement, the Company has provided to Dell Financial Services, the equipment lessor, a guarantee of up to 25 percent of the value of the leased equipment and a security interest in management fees payable by the Company to CHI Services. 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. 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. As a result, each brand employs a more focused approach to its target audiences. The Company conducts numerous marketing programs targeting specific groups, including senior citizens, motorist club members, families, government and military employees, and meeting planners. Other marketing efforts include telemarketing and telesales campaigns, domestic and international trade show programs, publication of group and tour rate directories, direct-mail programs, discounts to holders of preferred credit cards, centralized commissions for travel agents, fly-drive programs in conjunction with major airlines, and twice- yearly publication of a Travel and Vacation Directory. Marketing and advertising programs are directed by the Company's marketing department, which 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. 17 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 twelve months ended December 31, 1998, the Company terminated 159 domestic properties 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 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 $21.3 million during the twelve months ended December 31, 1998. 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. In the fourth quarter of 1998, the Company discontinued the group purchasing program as previously operated. 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. From time to time, the Company establishes programs or helps 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. In March 1999, the Company established a program that awards a cash incentive of $125,000 each to the first 100 MainStay Suites projects that meet program standards. The program, which will expire November 15, 1999, will provide for cash incentives, taking the form of 10-year development loans forgivable at the end of the term. To be eligible for the incentive, properties must be in a predefined target area and franchisees must adhere to all specified brand standards. Groundbreaking must occur within six months of deal acceptance. 18 Some of the past programs include: (i) a Second Mortgage Financing program under which the Company offered second mortgage financing for the development and construction of Quality Inn, Quality Suites, Quality Inn and Suites, Main Stay Suites and Sleep Inns; (ii) an Econo Lodge exterior renovation program under which forgivable loans up to an amount of $17,500 per property were given to qualified Econo Lodge franchisees for standardized exterior renovation; and (iii) a "Construction to Permanent Financing" program under which Salomon Smith Barney together with Suburban Capital Markets Inc. offered $100 million in financing per year to qualified franchises and the Company guaranteed such loans with a maximum guarantee amount of $10 million. At December 31, 1998, loans outstanding under the above programs were $2.5 million, $3.1 million and $18.4 million, respectively, and the Company's guarantee covered $9.2 million in loans. Competition Competition among franchise lodging chains is intense, both in attracting potential franchisees to the system and in generating reservations for franchisees. 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 5,500 franchised hotels. Bass Hotels & Resorts has 2,621, Accor has 2,577, Marriott International, Inc. has 1,477, Promus has 1,119, Starwood Hotels and Resorts has 653, Carlson Hospitality has 437, Hilton Hotels has 255 and Hospitality International has 236. The figures in this paragraph are with respect to U.S. hotel properties as indicated in the July 1998 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 35 other countries, as well as its range of products and room rates. Service Marks and Other Intellectual Property The service marks Quality, Comfort, Clarion, Sleep, Econo Lodge, Rodeway, MainStay and related marks and 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. In addition, the Company has 19 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 franchised properties. 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. 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. 20 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. Employees The Company employed domestically approximately 1,850 people as of December 31, 1998. 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. Prior to May, 1998, the offices were leased from Sunburst; they are currently leased from a third party. The Company owns its reservation system offices in Phoenix, AZ and Minot, ND. In 1998, a subsidiary of the Company acquired a call center in Grand Junction, CO, which the Company had previously leased. The Company leases one additional reservation system office in Grand Junction, CO, pursuant to a lease that expires in 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, 1998. 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, 21 Maryland 20901, unless otherwise indicated.
NAME AGE POSITION ---- --- -------- Stewart Bainum, Jr........................ 52 Chairman of the Board of Directors Charles A. Ledsinger, Jr.................. 49 Chief Executive Officer and President Thomas Mirgon............................. 42 Senior Vice President, Administration Mark C. Wells............................. 49 Senior Vice President, Marketing Michael J. DeSantis....................... 40 Senior Vice President, General Counsel and Secretary Joseph M. Squeri.......................... 33 Vice President, Treasurer and Controller
Background of Executive Officers: Stewart Bainum, Jr., 52, Chairman of the Board of the Company from March 1987 to November 1996 and since October 1997; Director of the Company since 1977; Chairman of the Board of Sunburst since November 1996; Chairman of the Board of HCR Manor Care, Inc. since September, 1998; Chairman of the Board and Chief Executive Officer of Manor Care, Inc. from March 1987 to September, 1998; Chief Executive Officer of Manor Care, Inc. and its subsidiary ManorCare Health Services, Inc. ("MCHS") from March 1987 to September, 1998 and President from June 1989 to September, 1998; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. ("Vitalink") from December 1994 to September, 1998; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care from August 1981 to September 1998, of Vitalink from September 1991 to September, 1998, of MCHS from 1976 to September 1998; 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. Charles A. Ledsinger, Jr., 49, President, Chief Executive Officer and Director of the Company since August, 1998; President and Chief Operating Officer of St. Joe Company from February 1998 to August 1998, Senior Vice President and Chief Financial Officer of St. Joe Company from May 1997 to February 1998; Senior Vice President and Chief Financial Officer of Harrah's Entertainment, Inc. from June 1995 to May 1997; Senior Vice President and Chief Financial Officer of Promus Companies Incorporated from August 1990 to June 1995. Director: FelCor Lodging Trust, Inc., Friendly's Ice Cream Corporation and TBC. Thomas Mirgon. Senior Vice President, Administration since April 1998; Senior Vice President, Human Resources of the Company from March 1997 to April 1998 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. Mark C. Wells. Senior Vice President-Marketing of the Company since May 1998; Senior Vice President, Franchise Services of Promus Hotel Corporation from 1996 to March 1998; Senior Vice President, Marketing of Promus Hotel Corporation from 1994 to 1996. 22 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. Joseph M. Squeri. Treasurer of the Company since April 1998; 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 Spin-off, the Company was a wholly-owned subsidiary of Former Choice. In the Spin-off, 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 Spin-off 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 March 18 1/2 14 5/16 June 18 7/16 12 September 14 7/16 11 5/8 December 13 5/16 9 5/8 FISCAL 1997(1) October 16 -- November 30 $18 $17 CALENDER 1997(1) October 16 - December 31 $18 $15 7/8
23 _________________________ (1) On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. The Spin-off occurred on October 15, 1997, and no trading occurred prior to that date. The Company paid no dividends during the twelve month period ended December 31, 1998. 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. As of March 10, 1999, there were 4,037 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 20-27 of the 1998 Annual Report and is incorporated herein by reference. ITEM 7A. The Company is exposed to market risk from changes in interest rates and the impact of fluctuations in foreign currencies on the Company's foreign investments. The Company manages its exposure to this market risk through the monitoring of its available financing alternatives including in certain circumstances the use of derivative financial instruments. The Company's strategy to manage exposure to changes in interest rates and foreign currencies remains unchanged from 1997. Furthermore, the Company does not foresee any significant changes in exposure in these areas or in how such exposure is managed in the near future. The following table summarizes information about derivative financial information and other financial instruments that are sensitive to changes in interest rates, including interest rate swap agreements and debt obligations. For interest rate swap agreements, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity date. 24 EXPECTED MATURITY DATE
1999 2000 2001 2002 2003 THEREAFTER TOTAL 1998 FAIR VALUE ---- ---- ---- ---- ---- ---------- ------- --------------- Liabilities: Long-term debt(1) Fixed rate 100,0000 100,000 100,000 100,000 100,000 100,000 100,000 97,561 Average 7.13% 7.13% 7.13% 7.13% 7.13% interest rate Variable rate(2) 179,210 179,210 179,210 172,210 179,210 179,210 179,210 179,210 Average interest rate(3) 5.06% 5.45% 5.65% 5.73% 5.81%
INTEREST RATE DERIVATIVES EXPECTED MATURITY DATE
1999 2000 2001 2002 2003 THEREAFTER TOTAL 1988 FAIR VALUE ---- ---- ---- ---- ---- ---------- ----- --------------- Notional Amount 115,000 115,000 115,000 115,000 Average interest rate 5.85% 5.85% 5.85% 5.85% Receivable 0 0 0 0 Payable 909 449 230 138 2,800
(1) A hypothetical one percentage point change in interest rates would change the fair value of long-term debt by $6.46 million. (2) The Company will refinance the $150 million variable rate term loan as it amortizes throughout the expected maturity dates. Upon expiration of the credit facility in 2002, the Company expects to refinance its obligations. (3) Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. The Company is also exposed to fluctuations in foreign currency relating to its preferred stock investment in Friendly Hotels, PLC which is denominated in British Pounds. The Company does not have any derivative financial instruments related to its foreign investments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The required information is included on page(s) 29-44 of the 1998 Annual Report and is incorporated herein by reference. See Item 14 for the Index to Financial Statements and Schedules. 25 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 3-4 of the Proxy Statement dated March 29, 1999 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 9-14 of the Proxy Statement dated March 30, 1999 and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The required information is included on pages 6-8 of the Proxy Statement dated March 29, 1999 and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The required information is included on pages 18-25 of the Proxy Statement dated March 29, 1999 and is incorporated herein by reference. 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. 29 Consolidated Balance Sheets......................... p. 30 Consolidated Statements of Shareholders' Equity..... p. 32 Consolidated Statements of Cash Flows............... p. 31 Report of Independent Public Accountants............ p. 28 26 Notes to Consolidated Financial Statements.......... pp. 33-44 2. FINANCIAL STATEMENT SCHEDULES The following reports are filed herewith. Report of Independent Public Accountants on Schedule.............. Consent of Independent Public Accountants......................... Schedule II: Valuation and Qualifying Accounts................... All other schedules are not applicable. 3. EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------ ----------- 3.01(a) Restated Certificate of Incorporation of Choice Hotels Franchising, Inc. 3.02(a) Amended and Restated Bylaws of Choice Hotels International, Inc. 4.01(c) Credit Agreement dated October 15, 1997 among Choice Hotels International, Inc., Chase Manhattan Bank, as Agent and certain Lenders 4.02(c) First Amendment to Credit Agreement dated February ___, 1998 among Choice Hotels International, Inc., Chase Manhattan Bank, as Agent, and certain Lenders. 4.03 * Second Amendment to Credit Agreement, dated as of March 30, 1998 among Choice Hotels International, Inc., Chase Manhattan Bank, as agent, and certain Lenders. 4.04 * Third Amendment to Credit Agreement, dated as of April 9, 1998 among Choice Hotels International, Inc., Chase Manhattan Bank, as agent, and certain Lenders. 4.05 * Fourth Amendment to Credit Agreement, dated as of December 16, 1998, among Choice Hotels International, Inc., Chase Manhattan Bank, as agent, and certain Lenders. 4.06(h) Registration Agreement dated April 28, 1998 between Choice Hotels International, Inc. and Salomon Brothers, Inc., Bear Stearns & Co. Inc. and Lehman Brothers Inc. 4.07(h) Indenture dated as of May 4, 1998, by and among the Company, Quality Hotels Europe, Inc., QH Europe Partnership and Marine Midland Bank, as Trustee, with respect to the 7.125% Senior Notes due 2008 of the Company. 4.08(h) Specimen certificate of 7.125% Senior Note due 2008 (Original Note) (Attached as an exhibit to the Indenture set forth as Exhibit 4.08) 4.09(h) Specimen certificate of 7.125% Senior Note due 2008 (Exchange Note) (Attached as an exhibit to the Indenture set forth as Exhibit 4.08) 4.10(b) Guarantee Agreement dated October 15, 1997 between Quality Hotels Europe, Inc. and The Chase Manhattan Bank. 4.11(b) Supplement No. 1 to the guarantee Agreement dated April 28, 1998 among Choice Hotels International, Inc., Quality Hotels Europe, Inc., QH Europe Partnership and The Chase Manhattan Bank. 4.12(b) Indemnity, Subrogation and Contribution Agreement, dated April 28, 1998 among Choice Hotels International, Inc., Quality Hotels Europe, Inc., QH Europe Partnership and The Chase Manhattan Bank. 4.13(g) Rights Agreement, dated as of February 19, 1998, between Choice Hotels International, Inc. and ChaseMellon Shareholder Services, L.L.C., as Rights Agent. 10.01(a) Employment Agreement between Choice Hotels International, Inc. and Charles A. Ledsinger, Jr. dated July 31, 1998. 10.02(d) Distribution Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.03(d) Employee Benefits Administration Agreement dated as of October 15, 1997 by and between
27 Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.04(d) Tax Administration Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc. 10.05(d) Tax Sharing Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.09(d) Employee Benefits Allocation Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.10(d) Strategic Alliance Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.11(d) Non-Competition Agreement dated as of October 15, 1997 by and between Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation) and Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) 10.12(d) Omnibus Amendment and Guaranty dated as of October 15, 1997 by and among Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation), Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) and Manor Care, Inc. 10.13(d) Amended and Restated Employment Agreement dated as of October 15, 1997 by and between Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) and Stewart Bainum, Jr. 10.14(d) Assignment of Employment Agreement dated as of October 15, 1997 by and among Choice Hotels International, Inc. (renamed Sunburst Hospitality Corporation), Choice Hotels Franchising, Inc. (renamed Choice Hotels International, Inc.) and Thomas Mirgon 10.15 * Omnibus Amendment Agreement dated December 28, 1998 between Choice Hotels International, Inc. and Sunburst Hospitality Corporation. 10.16(f) Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan. 10.17(f) Choice Hotels International, Inc. 1997 Non-Employee Director Stock Compensation Plan. 10.18(f) Choice Hotels International, Inc. 1997 Long-Term Incentive Plan. 10.19(h) Employment Agreement dated April 13, 1998 between Choice Hotels International, Inc. and Mark Wells. 10.20(I) Employment Agreement dated April 29, 1998 between Choice Hotels International, Inc. and Michael J. DeSantis. 10.21(i) Agreement and Release dated June 16, 1998 between Choice Hotels International, Inc. and William R. Floyd. 10.22 * Commercial Lease dated May 29, 1998 among Columbia Pike I, LLC and Colesville Road, LLC (each an assignee of Manor Care, Inc.) and Choice Hotels International, Inc. 13.01 * Annual Report to Shareholders 21.01 * Subsidiaries of Choice Hotels International, Inc. 23.01 * Consent of Arthur Andersen LLP 27.01 * Financial Data Schedule 99.01 * Proxy Statement dated March 29, 1998.
- ------------------------- * Filed herewith (a) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'s Registration Statement on Form S-4, filed August 31, 1998 (Reg. No. 333-62543). (b) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'s Amendment No. 1 to Registration Statement on Form S-4, filed October 14, 1998 (Reg. No. 333-62543). 28 (c) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'s "Transitional Report on Form 10-k dated June 1, 1997, to December 31, 1997, filed on March 31, 1998. (d) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'' Current Report on Form 8-K dated October 15, 1997, filed on October 29, 1997. (c) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'' Current Report on Form 8-K dated October 15, 1997, filed on December 16, 1997. (f) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'' Registration Statement filed on Form S- 8, filed on December 2, 1997 (Reg. No. 333-41357). (g) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'s Current Report on Form 8-K dated February 19, 1998, filed on March 11, 1998. (h) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'' Quarterly Report on Form 10-Q filed for the quarterly period ended March 31, 1998, filed on May 15, 1998. (i) Incorporated by reference to the identical document filed as an exhibit to Choice Hotels International, Inc.'' Quarterly Report on Form 10-Q filed for the quarter ended June 30, 1998, filed on August 11, 1998. (B) No reports on Form 8-K were filed during the last quarter of the fiscal year ended December 31, 1998 29 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/ Charles A. Ledsinger, Jr. ----------------------------- Charles A. Ledsinger, Jr. President and Chief Executive Officer Dated: March 30, 1999 30 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, 1999 - ------------------------------ Stewart Bainum, Jr. /s/ Barbara Bainum Director March 30, 1999 - ------------------------------ Barbara Bainum /s/ James H. Rempe Director March 30, 1999 - ------------------------------ James H. Rempe /s/ Larry R. Levitan Director March 30, 1999 - ------------------------------ Larry R. Levitan /s/ Frederic V. Malek Director March 30, 1999 - ------------------------------ Frederic V. Malek /s/ Gerald W. Petitt Director March 30, 1999 - ------------------------------ Gerald W. Petitt /s/ Jerry E. Robertson Director March 30, 1999 - ------------------------------ Jerry E. Robertson /s/ Joseph M. Squeri Vice President, March 30, 1999 - ------------------------------ Treasurer and Controller Joseph M. Squeri
31 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 29, 1999. Our audit was made for the purpose of forming an opinion on those consolidated financial statements taken as a whole. The schedule listed in the index above under Item 14(a)2 is the responsibility of the Company's management and 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 29, 1999 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 WRITE-OFFS OF PERIOD ----------- ------ -------- ---------- ---------- Year ended December 31, 1998 Allowance for doubtful accounts $7,608 $1,473 $ (999) $8,082 ====== ====== ======== ====== Seven months ended December 31, 1997 Allowance for doubtful accounts $6,159 $2,274 $ (825) $7,608 ====== ====== ======== ====== Year ended December 31, 1997 Allowance for doubtful accounts $4,515 $2,238 $ (594) $6,159 ====== ====== ======== ====== Year ended May 31, 1996 Allowance for doubtful accounts $3,976 $ 685 $ (146) $4,515 ====== ====== ======== ======
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, 1999 The undersigned hereby appoints JERRY E. ROBERTSON and CHARLES A. LEDSINGER, JR. and each of them, the true and lawful attorneys and proxies, with full power of substitution, to attend the Annual Meeting of Shareholders of Choice Hotels International, Inc. (The "Company") to be held on April 29, 1999 at 9:00 a.m. at the Company's Corporate Headquarters, Choice Centre, 10770 Columbia Pike, Silver Spring, 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 the Election of Directors, such proxies will be voted in accordance with the Board of Directors' recommendation as set forth herein with respect to such proposal. CHOICE HOTELS INTERNATIONAL, INC., ANNUAL MEETING, APRIL 29, 1999 AT 9:00 A.M. DIRECTIONS TO CHOICE CENTRE 10770 Columbia Pike Silver Spring, MD 20901 From Washington, DC - 16th Street North to Route 29 (Colesville Road). Pass over the Beltway (495), at which point Colesville Road becomes Columbia Pike. Choice Centre is on the left side approximately 2 miles past the Beltway. From National Airport to Headquarters - Take George Washington Parkway approximately 8 miles to the Beltway I-495 North. Go North and follow Beltway as it curves East to (2nd Silver Spring Exit 30 North Colesville Road). Go approximately 2 1/2 miles to Choice Hotels Headquarters on your left side. From Dulles Airport to Headquarters - Use Dulles Free Access (stay off toll road). Go East approximately 18 miles to I-495 North Beltway. Go North and follow Beltway as it curves east to (2nd Silver Spring Exit 30 North Colesville Road). Go approximately 2 1/2 miles to Choice Hotels Headquarters on your left hand side. From BWI to Headquarters - Take 195 west for 4 miles. The take I-95 south for 14 miles to Highway 198 west toward Burtonsville. Go west 3 miles to Route 29 (Colesville Road). Turn left on Route 29 (south) and go approximately 7 miles to Choice Hotels Headquarters - next to Mobil gas station. From Baltimore, MD - Take I-95 South to Highway 198 west toward Burtonsville. Go west 3 miles to Route 29 (Colesville Road). Turn left on Rte. 29 (south) and go approximately 7 miles to Choice Centre. THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE FOR THE ELECTION OF THE PROPOSED DIRECTORS Election of two Directors: FOR all nominees WITHHOLD listed below AUTHORITY (except as marked to vote for all nominees NOMINEES: Stewart Bainum, Jr. to the contrary) Listed to the right and James H. Rempe [ ] [ ] (Instruction: 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 Shareholders, please mark the following box and promptly return this Proxy Card. Dated _____________________ 1999 ---------------------------------- 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.) FOLD AND DETACH HERE EX-4.3 2 EXHIBIT 4.3 Ex. 4.03 CONFORMED COPY SECOND AMENDMENT dated as of March 30, 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, as amended (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 a certain provision 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 Section 6.01. Section 6.01 of the Credit -------------------------- Agreement is hereby amended to (a) delete the "and" after the ";" in clause (h), (b) insert the following immediately after the ";" in clause (h), "(i) Indebtedness of the Borrower represented by senior unsecured notes in a principal amount not to exceed $100,000,000; and" and (c) replacing the reference to "(i)" in clause (i) with "(j)". 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 2 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 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) 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. 3 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 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 /s/ Donald H. Dempsey ------------------------------ Name: Donald H. Dempsey Title: Executive Vice President and Chief Financial Officer 4 THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent by /s/ Karen M. Sharf -------------------------------- Name: Karen M. Sharf Title: Vice President BANK OF TOKYO - MITSUBISHI TRUST COMPANY by _________________________________ Name: Title: CRESTAR BANK by /s/ Greg D. Wheeless -------------------------------- Name: Greg D. Wheeless Title: Senior Vice President THE DAI-ICHI KANGYO BANK, LTD. by /s/ Bertram Tang -------------------------------- Name: Bertram Tang Title: 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 Kauffmann Angel -------------------------------- Name: Barbara Kauffmann Angel Title: Vice President 5 THE FUJI BANK, LIMITED by /s/ Raymond Ventura -------------------------------- Name: Raymond Ventura Title: Vice President and Manager THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH by /s/ John V. Veltri -------------------------------- Name: John V. Veltri Title: Joint General Manager THE LONG TERM CREDIT BANK OF JAPAN, LTD., NEW YORK BRANCH by /s/ Nozomi Moue -------------------------------- Name: Nozomi Moue Title: Deputy General Manager 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 6 SUMMIT BANK by ________________________________ Name: Title: THE TOYO TRUST & BANKING COMPANY, LTD., NEW YORK BRANCH by /s/ T. Mikumo -------------------------------- Name: T. Mikumo Title: Vice President by ________________________________ Name: Title: EX-4.4 3 EXHIBIT 4.4 Ex. 4.04 CONFORMED COPY THIRD AMENDMENT dated as of April 9, 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, as amended (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. (a) The definition of "Change in ----------------------- --------- Control" contained in Article I of the Credit Agreement is hereby amended by (i) - ------- inserting "(i)" immediately prior to "such" in the fourteenth line thereof and (ii) inserting the following immediately prior to the ";" in clause (a) thereof: "or (ii) in the case of the Baron Entities only, the letter agreement dated February 4, 1998, between the Borrower and the Baron Entities remains in effect and the Baron Entities are in compliance therewith". (b) Article I of the Credit Agreement is hereby amended to add the following terms in their proper alphabetical order: "Offering Memorandum Draft" shall have the meaning assigned to such term in ------------------------- Section 6.01(i). "Senior Notes" shall have the meaning assigned to such term in Section ------------ 6.01(i). "Senior Note Documents" shall mean the indenture or indentures under which --------------------- the Senior Notes are issued and all other instruments, agreements and documents evidencing, guaranteeing or providing for the terms and conditions of the Senior Notes. 2 SECTION 2. Amendment to Section 6.01. Section 6.01 of the Credit -------------------------- Agreement is hereby amended by replacing clause (i) thereof with the following: (i) Indebtedness of the Borrower represented by senior unsecured notes (the "Senior Notes") in an aggregate principal amount not to exceed $100,000,000 ------------ on substantially the terms (including tenor, covenants and events of default) described in the draft dated April 9, 1998 of the Offering Memorandum relating to such notes (the "Offering Memorandum Draft") and ------------------------- Indebtedness of the Subsidiaries consisting of Guarantees of the Senior Notes; provided that no Subsidiary shall Guarantee the Senior Notes unless -------- it shall have also Guaranteed the Obligations on a pari passu basis. SECTION 3. Amendment to Section 6.04. Section 6.04 of the Credit -------------------------- Agreement is hereby amended by deleting the reference to "(h)" in clause (d) thereof. SECTION 4. Amendment to Section 6.12. Section 6.12 of the Credit -------------------------- Agreement is hereby amended by replacing the "." at the end thereof with ";provided that the foregoing shall not apply to any prohibitions or -------- requirements set forth in any Loan Document or set forth in the Senior Note Documents and described in the Offering Memorandum Draft." SECTION 5. 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 3 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 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 6. 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) 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 7. Credit Agreement. Except as specifically stated herein, ----------------- the Credit Agreement shall continue in full force and effect in accordance with the 4 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 8. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND --------------- CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. SECTION 9. 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 shall be effective as delivery of a manually executed counterpart of this Amendment. SECTION 10. 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 /s/ Michael J. DeSantis ---------------------------- Name: Michael J. DeSantis Title: Senior Vice President, General Counsel and Secretary THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent by /s/ Karen M. Sharf ---------------------------- Name: Karen M. Sharf Title: Vice President 5 BANK OF TOKYO - MITSUBISHI TRUST COMPANY by --------------------------------- Name: Title: CRESTAR BANK by /s/ Greg D. Wheeless --------------------------------- Name: Greg D. Wheeless Title: Senior Vice President THE DAI-ICHI KANGYO BANK, LTD. by /s/ Bertram Tang --------------------------------- Name: Bertram Tang Title: 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/ Monica Sevila --------------------------------- Name: Monica Sevila Title: Assistant Vice President THE FUJI BANK, LIMITED by /s/ Raymond Ventura --------------------------------- Name: Raymond Ventura Title: Vice President & Manager 6 THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH by /s/ John V. Veltri --------------------------------- Name: John V. Veltri Title: Joint General Manager THE LONG TERM CREDIT BANK OF JAPAN, LTD., NEW YORK BRANCH by /s/ Nozomi Moue --------------------------------- Name: Nozomi Moue Title: Deputy General Manager 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/ Carter E. Evans --------------------------------- Name: Carter E. Evans Title: Vice President 7 THE TOYO TRUST & BANKING COMPANY, LTD., NEW YORK BRANCH by _________________________________ Name: Title: by _________________________________ Name: Title: EX-4.5 4 EXHIBIT 4.5 Ex. 4.05 CONFORMED COPY FOURTH AMENDMENT dated as of December 16, 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, as amended (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 Section 6.13. Section 6.13 of the Credit -------------------------- Agreement is hereby replaced in its entirety with the following: SECTION 6.13. Minimum Consolidated Net Worth. In the case of the ------------------------------- Borrower, permit the 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 October 1, 1998 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 2. Amendment to Section 6.14. Section 6.14 of the Credit -------------------------- Agreement is hereby replaced in its entirety with the following: 2 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 (a) December 16, 1998 through December 30, 1999, 3.50 to 1.00, (b) December 31, 1999 through December 30, 2000, 3.25 to 1.00 and (c) December 31, 2000 through the Maturity Date, 3.00. The Consolidated Leverage Ratio shall be calculated as of the end of each fiscal quarter based on the period of the four consecutive fiscal quarters ending on such date. SECTION 3. 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 3 the Credit Agreement, as amended hereby, constitutes a legal, valid and binding obligation of the Borrower, enforceable against the Borrower in accordance with its 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 4. 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) 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 5. 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 6. APPLICABLE LAW. THIS AMENDMENT SHALL BE GOVERNED BY AND --------------- CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. SECTION 7. 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 shall be effective as delivery of a manually executed counterpart of this Amendment. 4 SECTION 8. 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 /s / Michael J. DeSantis --------------------------- Name: Michael J. DeSantis Title: Senior Vice President THE CHASE MANHATTAN BANK, individually and as Issuing Bank and Agent by /s/ Carol A. Ulmer --------------------------- Name: Carol A. Ulmer Title: Vice President BANK OF TOKYO - MITSUBISHI TRUST COMPANY by ____________________________ Name: Title: CRESTAR BANK by /s/ Diane E. Bauman ---------------------------- Name: Diane E. Bauman Title: Vice President 5 THE DAI-ICHI KANGYO BANK, LTD. by /s/ Bertram H. Tang ----------------------------- Name: Bertram H. Tang Title: Vice President & Group Leader 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 _____________________________ Name: Title: THE INDUSTRIAL BANK OF JAPAN, LIMITED, NEW YORK BRANCH by /s/ William Kennedy ----------------------------- Name: William Kennedy Title: Vice President THE LONG TERM CREDIT BANK OF JAPAN, LTD., NEW YORK BRANCH by _____________________________ Name: Title: 6 MELLON BANK, N.A. by /s/ G. B. Mateer ------------------------------ Name: G. B. Mateer 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 ______________________________ Name: Title: SUMMIT BANK by /s/ Carter Evans ------------------------------ Name: Carter Evans Title: Vice President THE TOYO TRUST & BANKING COMPANY, LTD., NEW YORK BRANCH by /s/ Kazuhiko Yamauchi ------------------------------ Name: Kazuhiko Yamauchi Title: Vice President by /s/ Howard Tulley Mott ------------------------------ Name: Howard Tulley Mott Title: Vice President EX-10.15 5 EXHIBIT 10.15 EXHIBIT 10.15 OMNIBUS AMENDMENT AGREEMENT THIS OMNIBUS AMENDMENT AGREEMENT (this "Agreement") is made this 28/th/ day of December, 1998 by and between CHOICE HOTELS INTERNATIONAL, INC., a Delaware corporation ("Choice"), and SUNBURST HOSPITALITY CORPORATION, a Delaware corporation ("Sunburst"). WHEREAS, in connection with the spin-off of Choice by Sunburst (the "Spin-off"), Choice and Sunburst entered into a Strategic Alliance Agreement (the "Strategic Alliance Agreement") dated October 15, 1997 pursuant to which, among other things, the parameters of the operating relationship between Choice and Sunburst with regard to matters of mutual interest are set forth; WHEREAS, the Strategic Alliance Agreement contains a form of Franchising Agreement (the "Franchising Agreement") as Exhibit A to be entered --------- into by and between Choice and Sunburst whenever Choice is to brand any hotel or lodging property of any kind that Sunburst develops or acquires and intends to franchise during the term of the Strategic Alliance Agreement; WHEREAS, Choice and Sunburst have entered into numerous franchising agreements substantially in the form of the Franchising Agreement and now desire to amend the provisions relating to liquidated damages contained in the aforementioned franchising agreements; WHEREAS, Choice and Sunburst desire to eliminate the option contained in the Strategic Alliance Agreement for Sunburst to purchase the Mainstay Suite Hotels system from Choice in exchange for Choice's forgiveness of $16,900,000 of the $19,900,000 receivable to Choice from Sunburst currently outstanding pursuant to the Distribution Agreement; WHEREAS, in connection with the Spin-off, Choice and Sunburst entered into a Distribution Agreement (the "Distribution Agreement") dated October 15, 1997 pursuant to which, among other things, Choice agreed to loan to Sunburst $115,000,000 which was evidenced by a subordinated note (the "Term Note") with an aggregate principal amount of $115,000,000 and a maturity date of five years; -2- WHEREAS, Choice and Sunburst desire to amend the Term Note; NOW, THEREFORE, Choice and Sunburst agree as follows: ARTICLE ONE AMENDMENTS TO STRATEGIC ALLIANCE AGREEMENT Section 1.1. Definitions. Any defined term used within this Article ----------- One and not defined within this Agreement, will have the meaning ascribed to such term in the Strategic Alliance Agreement. Section 1.2. Elimination of Option to Purchase Mainstay Suite Hotels ------------------------------------------------------- System. The Strategic Alliance Agreement is hereby amended such that Sections - ------ 4.3 and 4.4 of the Strategic Alliance Agreement are deleted in their entirety. Section 1.3. Liquidated Damages Provision in Franchising Agreements. ------------------------------------------------------ Notwithstanding Section 3.1 of the Strategic Alliance Agreement and as long as Sunburst is not in default under the Term Note: (a) Any and all franchising agreements entered into prior to the date hereof by and between Choice and Sunburst (or any of their respective predecessors or affiliates), except any franchising agreements related to (i) Mainstay Suites and Sleep Inns or (ii) any other hotels owned by Sunburst that carried a Choice brand which is not sold by Sunburst within three years from the date such hotel was reflagged with a different non- Choice brand (the "Reflagged Hotels"), are hereby amended such that any references to liquidated damages are deleted and Choice agrees that it waives any claim it may have against Sunburst for lost future profits arising from such franchising agreements; and (b) Section 10.d.2 of the respective franchising agreements entered into prior to, on or after the date hereof by and between Choice and Sunburst related to Mainstay Suites and Sleep Inns or any Reflagged Hotel is hereby amended to include the following: -3- "Any liquidated damages to be paid pursuant to this section will not exceed a maximum of $100,000." Section 1.4. Development. Section 4.1 of the Strategic Alliance ----------- Agreement is hereby amended and restated as follows: Realco and Franchising are currently in the midst of a program under which Realco will develop Sleep Inns and Mainstay Suite Hotels franchised by Franchising. Realco agrees that absent (i) a material change in market conditions that would render construction of further hotels pursuant to this program uneconomical (meaning that reasonable projections by Realco demonstrate that the hotel would provide a return on investment to Realco that is less than the hurdle rate of return established by Realco for its investments in similar types of hotels), (ii) Realco's inability to finance construction or acquisition of such hotels, or (iii) Franchising's discontinuance of efforts to support the Mainstay Suite Hotel brand, Realco will continue to develop Sleep Inns and Mainstay Suite Hotels so that it will have opened no fewer than a total of thirteen Sleep Inns and twenty- five Mainstay Suite Hotels no later than forty-eight months from the effective date. Section 1.5. Other Amendments to Franchising Agreements. ------------------------------------------ Notwithstanding anything contained in any franchising agreements entered into prior to the date hereof by and between Choice and Sunburst (or any of their respective predecessors or affiliates), the following terms shall apply from and after the date hereof to the relevant franchising agreements: (a) Sunburst shall pay to Choice in cash an application fee of $20,000 upon execution of a franchise agreement from and after the date hereof. -4- (b) No royalty, marketing or reservation fees shall be payable for a period of two years with respect to the first ten such agreements entered into by Sunburst after the date hereof and at the end of such period, the initial fee schedule will commence; and such ten agreements shall contain a provision permitting termination by either party only on the tenth or fifteenth anniversary of the date of the contract. (c) Choice agrees that if Sunburst sells any property that is the subject of an existing franchising agreement, if that property is not past due on any fees or failing a quality assurance review then Choice will enter into a new franchise agreement on customary/market terms with the buyer. ARTICLE TWO AMENDMENTS TO TERM NOTE Section 2.1. Definitions. Any defined term used within this Article ----------- Two and not defined within this Agreement, will have the meaning ascribed to such term in the Term Note. Section 2.2. Interest. Section 1.1 of the Term Note is hereby -------- amended so that commencing on October 15, 2000 interest payable under the Term Note shall accrue at a rate of 11.00% per annum compounded daily on both the principal amount and the amount of unpaid interest outstanding under the Term Note. Section 2.3. Asset Sale Proceeds. Section 1 of the Term Note is ------------------- hereby amended to include the following: 1.6. Asset Sale Proceeds. ------------------- (a) The Payor will pay to the Payee within fourteen (14) calendar days after the consummation of an Asset Sale by wire transfer to the bank account designated by the Payee such aggregate principal amount of this Note as equals fifty percent (50%) of Asset Sale Proceeds in excess of the aggregate of amounts required to be used to pay secured Senior Debt and the Payor shall apply the remaining fifty percent (50%) of Asset Sale Proceeds to the development of Mainstay Suite Hotels. -5- (b) The Payor will provide the Payee notice in writing at least fifteen (15) days prior to a proposed Asset Sale and such notice will include a detailed description of the specific terms of the Asset Sale and the proposed uses for the portion of the proceeds to be retained by Payor in accordance with Section 1.6(a). (c) The Payor will provide to the Payee within fourteen (14) calendar days after the closing of an Asset Sale a certificate signed by the Chief Financial Officer certifying the amount and form of consideration received and the use of the Asset Sale Proceeds received in respect of such Asset Sale. Section 5 of the Term Note is hereby amended to include the following: "Asset Sale" means the sale, transfer or other disposition (other than ---------- to the Payor or a Subsidiary) in any single transaction or series of related transactions of (a) any capital stock of or other equity interest in any Subsidiary unless such transfer is to another wholly-owned Subsidiary or (b) any hotel or any interest in any hotel, the real property on which any hotel is located, the personal property located at any hotel (unless sold as part of a refurbishment of a hotel and the proceeds are reinvested in the hotel), or the earnings or profits generated by any hotel owned or operated by the Payor or any Subsidiary. "Asset Sale Proceeds" means, with respect to any Asset Sale, (i) cash ------------------- received (net of reasonable broker commissions and closing costs) by the Payor or a Subsidiary from such Asset Sale (including cash received as consideration for the assumption of liabilities incurred in connection with or in anticipation of such Asset Sale) and (ii) promissory notes and other non-cash consideration received (net of reasonable broker commissions and closing costs) by the Payor or a Subsidiary from such Asset Sale or other disposition upon the liquidation or conversion of such notes or non-cash consideration into cash. Section 2.4. Penalty Interest Payments. Section 1 of the Term Note ------------------------- is hereby amended to include the following: -6- 1.7 Default Payments. Upon the occurrence and during the ---------------- continuation of any Event of Default, the outstanding principal amount under this Note and, to the extent permitted by applicable law, any interest payments thereon not paid when due, shall thereafter bear interest (including post-petition interest in any proceeding under the applicable bankruptcy laws) at a rate that is 2% per annum in excess of the interest rate otherwise payable under this Note. ARTICLE THREE DISTRIBUTION AGREEMENT Section 3.1. Satisfaction of Receivable. In consideration for the -------------------------- termination of Sunburst's option to purchase the Mainstay Suites brand, $16,900,000 of the $19,900,000 receivable currently owing from Sunburst to Choice pursuant to Section 3.03 of the Distribution Agreement shall be deemed satisfied and no longer due and owing. The remaining $3,000,000 of the receivable is to be paid by Sunburst to Choice by wire transfer to the bank account designated by Choice no later than three business days after the date hereof. ARTICLE FOUR MISCELLANEOUS PROVISIONS Section 4.1. Conflicts. In the event of any conflict between the --------- terms of this Agreement and the terms of the Strategic Alliance Agreement, any franchising agreement entered into by and between Choice and Sunburst referred to in this Agreement, the Term Note, the Distribution Agreement and any other documents related thereto and executed by one or more parties hereto in connection with any of the aforementioned agreements, the terms and provisions of this Agreement shall control. Section 4.2. Agreements Remain in Effect. The Strategic Alliance --------------------------- Agreement, any franchising agreement entered into by and between Choice and Sunburst referred to in this Agreement, the Term Note and the Distribution Agreement shall remain fully effective and are changed only as specifically provided herein and shall bind the parties to each in all respects as originally contemplated. -7- Section 4.3. Counterparts. This Agreement may be executed in one or ------------ more counterparts, all of which taken together shall constitute one instrument. SIGNATURES ON FOLLOWING PAGE -8- IN WITNESS WHEREOF, intending to be legally bound hereby, the parties hereto have executed this Agreement as of the day and year first written above. CHOICE HOTELS INTERNATIONAL, INC. _/s/ Michael J. DeSantis______ Name: Title: SUNBURST HOSPITALITY CORPORATION __/s/James A. MacCutcheon_____ Name: Title: EX-13.1 6 EXHIBIT 13.1 Financial Highlights Choice Hotels International, Inc. and Subsidiaries
Seven months YEAR ENDED ended Fiscal years ended DECEMBER 31, December 31, May 31, 1998 1997 1997 1996 --------------------------------------------------- COMPANY RESULTS (IN MILLIONS, EXCEPT PER SHARE DATA) Royalty Revenues........................................ $115.4 $ 70.3 $ 97.2 $ 88.0 Total Revenues.......................................... 165.4 107.8 168.0 151.7 Recurring Income from Operations........................ 80.0 46.4 59.6 45.7 Recurring Net Income.................................... 46.7 27.3 34.7 25.4 Net Income.............................................. 55.3 27.3 34.7 11.7 Cash Flow from Operations............................... 44.1 33.6 45.5 32.7 Basic Earnings per Share (a)............................ $ 0.94 $ 0.46 $ 0.55 $ 0.19 Diluted Earnings per Share (a).......................... $ 0.93 $ 0.45 $ 0.55 $ 0.19 SYSTEM RESULTS - DOMESTIC ONLY Revenue (estimated in millions)......................... $3,063 $1,862 $2,678 $2,381 Franchise Hotels Open................................... 3,039 2,880 2,781 2,495 Franchise Hotels Under Development...................... 866 725 710 616 Revenue Per Available Room.............................. $34.35 $36.39 $32.52 $31.60
(a) Note: December 1998 earnings per share includes $0.12 related to the early extinguishment of certain long-term debt obligations. [GRAPH OF HOTEL PROPERTY APPEARS HERE] . Properties Under Development Worldwide . Properties Open Worldwide [GRAPH OF HOTEL ROOM APPEARS HERE] . Rooms Under Development Worldwide . Rooms Open Worldwide To Our Shareholders: [PHOTO APPEARS HERE] Our company had a terrific year in 1998. Net income increased by 43 percent to $55.3 million. The number of hotels in operation grew to more than 3,600 in 36 countries. At the same time, we managed the business well, keeping our selling, general and administrative expense (SGA) virtually flat. As the world's second largest hotel franchisor, we offer more than 110 million available room nights to our guests, who continue to show high levels of satisfaction with our brands. This strong growth sets the stage for another banner year in 1999. Much of the past year was dedicated to putting in place a revamped management team to better define our long-term strategy. Much of our energy this year will be devoted to enhancing our brand focus to provide our hotel guests and our franchisees with added value. We are eagerly moving forward, Building Value Through Brands of Choice - for guests, for franchisees, for vendors, for our associates and for you, our shareholders. This year's annual report tells the story of how we are building that value, and why we believe Choice Hotels will prove a valuable investment for its many constituents. As a pure-play franchising company, Choice has no direct real estate ownership exposure. It has significant, growing free cash flow, an experienced management team and proven business systems. With more than 2,300 franchisees, no franchisee accounts for more than 5 percent of total royalty revenues. So the basic attributes of the business are fundamentally sound. We have a superb foundation for future growth. And, we have a rich heritage in the lodging industry as an innovator and a leader, dating back 60 years to the first meeting of Quality Courts owners. A Vibrant, Growing Industry Some of you may wonder about the overall state of our industry. In 1998, the hotel industry earned record profits of $20 billion, as room demand remained very strong and new supply came on line in key markets. Some industry observers raised the possibility of a slowdown in development because supply growth moved slightly ahead of demand growth. As a result of the perceived slowdown, stock prices for the industry as a whole endured a drop. 2 But our experience in the segments we serve shows that the level of demand remains strong and will continue in a vibrant economy. This demand continues to encourage sound development in key locations. Our franchised hotels are less affected by tightening of credit markets because many of our projects are financed locally and have significant equity in them. For 1999, many observers are forecasting another strong year for the industry since the economy shows little sign of slowing down. The surprising fourth quarter 1998 growth reported for the economy and the growing government surplus lead most economists to conclude that the risk of any recession is fading. If these trends hold, we have every expectation that 1999 will be a year of excellent growth for our branded hotels. Growth Platforms For The Future Looking to the future, we have two growth platforms: our organic hotel growth and the distribution opportunity afforded by those 110 million available room nights. By organic hotel growth, I mean the franchise development through which we continue to add hotels marketed under our brands: Comfort, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites. These brands enjoy growing consumer recognition and acceptance. They provide us with new construction and conversion development opportunities, both domestically and internationally. In the past year, we executed 440 new hotel franchise contracts and opened 318 new hotels in the United States. At the beginning of this year, we had 866 domestic projects in design or under development, as well as another 611 international hotels in the pipeline. Because we already have the infrastructure needed to service these hotels, such as our reservations system, our regional Market Area support and our International Regions, each new hotel adds significantly to our bottom line. At the same time, we are investing substantial resources to improve our infrastructure, including new computer capability for our central reservations system in Phoenix, an expanded call center in Minot, N.D., and the rollout of Profit Manager, our proprietary property management system for our hotels. This year we also will open THE LEARNING CENTER, a new facility for training hotel owners, general managers and our associates. A key component of that training will be Choice Operations and Revenue Enhancement (CORE) training, which is designed to speed the integration of new properties into the Choice system and improve performance at the property level. We also are tightening our brand standards and raising the bar on our quality assurance inspections. By sharpening our focus on service and quality in our franchisees' hotels, we help protect their individual investments and give our guests a more satisfying 3 stay. Higher brand standards lead to more added value for our guests. And, in a highly competitive market, the battle for market share will be won by those who exceed their promises to the public. Distribution Driving Future Growth Which leads me to our second growth platform: distribution. With more than 110 million available room nights and 3,600 franchised properties in our system, we have a tremendous opportunity to take advantage of our scale and create new revenue streams for a host of products and services. On our franchise side, we have created a proprietary purchasing system, ChoiceBuys.com, for our franchisees. Through the Internet, they can purchase goods and services for their hotels at our volume discounts. This program serves as a solid business model for other parts of our enterprise. We believe that we can create a similar service for our guests that will open up new revenue streams while adding greater value to our room stay experience and to our franchisees. Discussions are underway with vendors, and we are hopeful to make this opportunity a reality for us in short order. What makes this distribution opportunity so attractive is that our hotels operate in segments that reach about 70 percent of the domestic hotel guests available. With the sheer number of hotels in our system, the demographics of our guests and the scope of our operations worldwide, we believe we will have something truly unique to offer our guest and franchisees. A World Of Opportunity The international arena provides us with a promising opportunity - and a challenge. The opportunity lies in the vast number of markets available to us for development and expansion of our brands. The challenge comes in finding the right strategic partners to establish hotel franchising as a valued and viable business concept in parts of the world where franchising is truly foreign. In 1998, our partnerships with the Friendly organization in Europe and the Flag organization in Australia gave us new momentum to spur international growth. In Great Britain and Europe, our agreement with Friendly brought 250 properties in 10 countries under the Choice Hotels Europe banner into our system. Down under, our strategic alliance with Flag will bring almost 500 hotels into our system in 1999. Other territories are opening up as well. Choice Atlantica, our partner in South America, has announced plans to develop 140 4 Comfort, Quality, Clarion and Sleep Inn hotels over the next five years. In Japan, the Vessel Group has unveiled plans to build 20 Sleep Inn hotels throughout eastern Japan. A Word Of Thanks When I joined Choice last September, I found a company with solid fundamentals - great hotel brands, widespread consumer recognition, successful reservations and business systems, a strong base of committed franchisees and a dedicated core of 2,000 associates, many of whom have served our company for two and three decades. Having worked for almost two decades in the hospitality industry, I appreciate the innovation Choice has brought to the industry. I also value the willingness of our associates to accept new leadership and new ideas. I cannot thank them enough for the warm reception I have received. In 1998, two company leaders who played crucial roles in the company's growth and evolution into an industry leader retired from our Board of Directors. Stewart Bainum and Bob Hazard gave many years of dedicated service to Choice. Their legacy is a company that is the second largest hotel franchisor in the world. We salute them for their achievements and wish them well. At the company's Annual Meeting this April, Fred Malek, a nine-year member of our Board, will be stepping down as well. We wish Fred every success in his future endeavors. Joining our Board on February 1, 1999, was Larry Levitan, recently retired from a 34-year career with Andersen Consulting, having most recently served as head of the Worldwide Communications Industry Group. Larry's vast experience in finance, technology and international business will serve our company well. I am very excited about this company, its business prospects and the future we can create working together with our associates, franchisees and strategic partners. We enjoy the support of a committed Board of Directors, whose expertise has proven invaluable in creating a long-term strategy to drive this company to even higher performance. Thank you for your continued support as we define an even brighter future for Choice Hotels. /s/ Charles A. Ledsinger, Jr Charles A. Ledsinger, Jr. President & Chief Executive Officer 5 Creating Value For Every Occasion The lodging business is an occasion-driven business. So a hotel franchising company faces the critical challenge of offering the right choice, A CHOICE WITH STRONG VALUE, to its prospective guests in order to gain and grow market share. "Our seven brands span the widest range of customer segments of any hotel company, from economy to mid-priced to upscale," said Mark Wells, senior vice president of marketing. "So we are in a great position to match our offerings with what guests truly need on any occasion." [LOGO APPEARS HERE] For business or leisure travelers, those choices meet a broad range of price and amenity needs, so that Choice brand hotels can serve more than 70 percent of the total domestic hotel guest market. Comfort, the company's largest single brand with more than 1,500 Comfort Inn hotels and almost 200 Comfort Suites hotels, succeeds by delivering on the promise of its name. "Our hotels strive to consistently provide a comfortable, high-value stay for business and leisure travelers," explained Dan Shoen, Comfort brand management vice president. "Our suites product has given guests another good reason to seek out the Comfort brand." In Econo Lodge and Rodeway Inn, the company's economy brands, brand management provides value-added programs that attract guests from distinct niches. [PICTURE APPEARS HERE] In conjunction with Procter & Gamble's Mr. Clean brand, the Econo Lodge brand has just launched the first program in the industry to certify housekeepers, with the goal of providing a clean room guarantee to guests. [PICTURE APPEARS HERE] "By teaming up with a recognizable, reputable consumer brand like Mr. Clean, we provide our Econo Lodge franchisees with a new edge in attracting value-oriented consumers looking for cleanliness assurance," said Tim Shuy, Econo Lodge brand management vice president. Mike Cothran, Rodeway Inn brand management vice president, noted, "We know that Rodeway Inn hotels have special appeal for value-seeking guests, particularly senior citizens. That is why we have targeted our marketing to highlight that 25 percent 6 [PICTURE APPEARS HERE] The Clarion Hotel Pembroke Corporate Center, an upscale hotel in Virginia Beach, Va., relies on direct sales support and guidance from Choice to help fill its conference and banquet facilities as well as its 149 guest rooms. "We have worked well with Choice over the years," said General Manager Tony Torbati. "They have done a good job of providing information to us about company programs." A productive relationship with Choice is especially important to Richard Wilburn, the hotel's sales director, because the hotel is faced with the challenge of maximizing revenue in a seasonal destination. "I meet face-to-face with Kim Ellison, Choice's franchise service director, several times a year," he said. "She shows us how best to take advantage of Choice's programs to improve our revenues and occupancy." The hotel, owned by Sunburst Hospitality Corp. of Silver Spring, Md., was honored with a Gold Hospitality Award in 1998, signifying that it had exceeded Choice's quality standards for exceptional service, facilities and hospitality. of our rooms are designated Choice Room for seniors, with special amenities such as brighter lighting, large-button phones and level-handle doors." In a different part of the brand spectrum, Clarion brand management vice president Don Kolodz is working with franchisees to bring better definition to the brand. "As our entry in the upscale, full-service market, the Clarion brand gives us an offering of high value for business customers seeking full-service amenities," he said. "With meeting space and food and beverage service as brand hallmarks, we can provide meeting planners with an affordable alternative in the upscale market." [GUEST PRIVILEGES LOGO] As a major step in building both brand identity and brand loyalty, the company launched Guest Privileges, a frequent stay rewards program, in the fall of 1998. Guest Privileges members can earn free stays, gifts and travel by choosing select Choice brand hotels (Comfort, Quality, Clarion, Sleep Inn) for their lodging. In addition to a free stay after just 10 visits, the program also allows members to earn points that can be used with such partners as American Airlines, JC Penney, the Home Depot and Eddie Bauer. [PICTURE APPEARS HERE] Rebecca Ferrin, member services coordinator, enrolls another Guest Privileges member in Choice's new rewards program for frequent guests. Building Value In Each Hotel Given the highly competitive nature of the hotel franchising business, Choice continues to improve and diversify the products and services it makes available to franchisees. At the heart of that competition is the drive to stay on the leading edge of technology. "Like virtually every other business at the end of this century, the hotel industry is changing rapidly with new technology," said Tom Mirgon, senior vice president of administration. "We have to bring greater value to our franchises by giving our franchisees the best technology options to keep their properties operating at maximum effectiveness." [LOGO OF PROFIT MANAGER APPEARS HERE] To enable franchisees to better manage their hotels, Choice is implementing Profit Manager, a proprietary property management system designed to manage reservations, rates and inventory more efficiently and effectively. Janna Morrison, vice president of property systems, acknowledged the challenge of the ambitious project to outfit every Clarion, Quality, Comfort, Sleep Inn and MainStay Suites hotel with Profit Manager by the end of 2000. "In our first roll-out phase in 1997, we encountered some difficulties in larger properties with managing group business," she explained. "As a result, we designed a new release of the software, and we will continue to evolve the product to meet our franchisees' needs." A comprehensive Windows-based system, Profit Manager includes InSync, a communications tool that allows instantaneous synchronization between the CHOICE 2001 central reservations system and each hotel. CHOICE 2001 gathers reservations from a variety of sources, including global distribution systems (GDS) run by airlines, the Internet and call centers to provide the ability to manage room inventory and rates. This real-time, two-way communication helps increase property revenue and decrease the likelihood of overbookings. Profit Maximizer, another Profit Manager feature, helps the individual hotel predict future occupancy and demand for hotel rooms. Using past property data, each hotel can forecast future stay patterns and more effectively set rates to meet guest demand. For the company's economy hotel brands, Econo Lodge and Rodeway Inn, the company has developed ChoiceLink for Windows to provide a gateway to reservations through CHOICE 2001, thus giving them access to the GDS and Internet. 9 [LOGO] Choice's Strategic Partnerships program is another way to build value for both guests and franchisees. Operating under a "4-Win" strategy, the program ensures that products and services endorsed by Choice benefit the guest, the franchisee, the vendor and Choice. "The guest enjoys brand-name products and services that help build guest loyalty for the franchisee, who also benefits from competitively priced products," explained Daniel Rothfeld, vice president, partner services. "Vendor partners gain access to a critical mass of franchisees, which in turn generates residual income for the company." When Choice needs a well-managed hotel with technologically savvy personnel to help test the latest version of its Profit Manager property management system software, one of the places it turns is the Comfort Inn hotel of Scottsdale, Ariz., the 1998 Comfort Inn of the Year award winner. The 124-room property, owned by Zenith Management of Duluth, Minn., is located just five miles from Choice's Western Regional Headquarters where Choice software programmers develop and refine products, including Profit Manager, the company's state-of-the-art property management system. "With its consistently high occupancy, the Comfort Inn hotel of Scottsdale is a perfect `beta site' for testing new releases of Profit Manager software," said Christopher Yellen, Choice director of product management. "They can thoroughly test all aspects of Profit Manager in real day-to-day business situations," David Dolliver, the hotel's general manager, noted he and his staff are happy to help test Profit Manager and any other software designed to make his hotel more profitable. "We have a great relationship with Choice, and we're eager to continue working with them to make programs like Profit Manager the best they can be," he said. Serving as a test site offers certain advantages, including the opportunity to suggest changes to benefit local hotel operators. "Not only are we one of the first to see and use the most up-to-date version of a particular software program, but we have the opportunity to provide input from an operations standpoint that hopefully will enhance the program for all users," he said. [PICTURE APPEARS HERE] David Dolliver (right), general manager of the Comfort Inn in Scottsdale, Ariz., reviews the new Profit Manager property management software with Robert Mason (left), Choice manager of information systems administration, and Christopher Yellen, Choice director of product management. The Quality brand's Serta bed program underscores the value of this initiative. Banking on the inherent quality of the Serta name, Quality brand hotels promote the restful sleep assured by the Serta beds featured in every room. Taking the program one step further, participating Quality brand hotels now can offer guests the opportunity to purchase Serta beds at a significant discount. "The Serta bed promotion gives everyone an opportunity to win," said Pete Jordan, Quality brand management vice president. "Our guests not only can enjoy the Serta experience in our hotels, but now they can take it home. Franchisees can offer guests a `quality' night's rest. And Serta, our preferred vendor, gains access to yet another sales channel." [PICTURE APPEARS HERE] Another value-added service for franchisees is the Internet Project Management system, or IPM, which consolidates the design, sourcing, purchasing, management and financing of renovation and refurbishment projects into a single turnkey, competitively priced package for franchisees. Through partner relationships with The Gettys Group, an interior design and procurement firm, and McClier Corporation, a leading architecture, engineering, construction and project management company, the level of service has been enhanced through access to these services over the Internet and a toll-free hotline. As a successful underpinning to the franchisor-franchisee relationship, Choice continues to review and update its franchise agreement to stay competitive in the industry. "We have worked hard to improve our basic agreement by rewriting it into plain English and reducing its [PICTURE APPEARS HERE] length significantly," said Michael DeSantis, senior vice president, general counsel & secretary. "We just announced a reduction in the cap on liquidated damages paid upon termination, from 60 months to 36 months. This revision follows another recent cutting edge change to the agreement, which implemented five year mutual outs for franchisees in good standing, making Choice one of only a few hotel franchisors to provide this opportunity." Confronted with new competition springing up around their nine-year-old Econo Lodge hotel in Lenoir City, Tenn., owner-operator Howard Patel and his family carefully considered strategies for maintaining their impressive base of business. They decided to participate in the Econo Lodge Exterior Enhancement Program, a solution devised by Choice to revitalize the brand's older properties. Since the program was introduced three years ago, the more than 320 franchisees who participated have seen the performance of their hotels improve significantly. Choice helped the Patel family design a pleasing new facade featuring columns, parapets, arches, a canopy entrance and improved lighting. The objective was to modernize the hotel's exterior to more accurately represent the value of its guest rooms, which are upgraded on an ongoing basis. "In the lodging business, it's important to stay on top of the competition so that you don't lose your existing guests," Patel said. "The Econo Lodge Exterior Enhancement Program has helped us hold our own and compete effectively against the new hotels that are being constructed in our market." Patel manages the 42-room hotel in partnership with his wife, Indira, and the help of their college-age sons, Ketan and Hitesh. They have taken several additional steps to make the property stand out from the pack. For example, they introduced free continental breakfast, put hair dryers in every room, upgraded guest room television sets to 25-inch models and established a policy of free local telephone calls. [PICTURE APPEARS HERE] Owner Howard Patel and his wife, Indra, are proud of the exterior renovation of their 42-room Ecomo Lodge hotel in Lenior City, Tenn. Providing Value To Every Customer Each day brings new opportunities for Choice's 2,000 associates to serve a myriad of customers - hotel guests, franchisees, shareholders and strategic partners. Before a hotel opens its doors, Choice associates work hard to help franchisees launch a successful property. "For our Sleep Inn brand we hold a pre-construction meeting with each new franchisee to review the operational and marketing resources available from Choice," said Norm Cavin, Sleep Inn brand management vice president. The drive to provide more value through successful hotel openings has led to creation of a new team of property opening specialists who work with franchisees to develop marketing plans and programs that will get the property operating at market level more quickly. 12 "The sooner a hotel can ramp up its occupancy and bring its room rate to market level, the better the franchisee feels about his or her investment, and the faster our royalties can grow," said Wells. "Working with our Market Area staff, we've created a program that can add value for all concerned." To further generate business for its franchisees, Choice also maintains a strong national sales program aimed at travel agents, tour operators, corporations and other high volume accounts. Last fall, the company enrolled all of its franchisees as members of the American Society of Travel Agents (ASTA) to enhance the relationship with the travel agent community. Unlike many other hotel companies, Choice continues to pay full commissions on business placed through travel agents. At the same time, the company cultivates its relationships with travel promotion organizations such as AAA through special discount programs for AAA members at Choice brand hotels and by encouraging franchisees to earn and improve their AAA designation. [LOGO OF AAA APPEARS HERE] This same dedicated spirit helps Choice internationally, working with master franchisees to open up new territories for Choice hotel brands. A 1998 agreement with the Flag organization in Australia will bring almost 500 hotels into the Choice global system, generating greater brand equity and driving more business to Choice hotels in the United States and internationally. [LOGO OF FLAG APPEARS HERE] "As our brands truly become more global, and as guests experience their amenities and services in their own countries, we will cultivate travelers coming to our domestic locations looking for the same satisfaction," noted Bruno Geny, senior vice president, international. While strengthening its regional teams internationally for further growth and development worldwide, Choice also is undertaking globalization of marketing services and brand management to improve its marketing to leisure and business travel intermediaries. For developer Greg Averbuch, it all comes down to synergy. Averbuch, president of Summit Management Corp., uses the word a lot when describing the Sleep Inn and MainStay Suites hotels he plans to operate side by side in Atlanta. He also views his relationship with Choice as highly synergistic. Averbuch opened his first Choice franchise, a Sleep Inn hotel, in downtown Memphis, Tenn., in 1996. It has performed exceptionally well and received a Choice award in 1998 for achieving the highest RevPAR of any Sleep Inn hotel. The success of his Memphis property not only inspired Averbuch to build a second Sleep Inn hotel in Atlanta's Buckhead section but also to consider another Choice brand for a plot of land directly adjacent to the new Sleep Inn site. "I wanted a brand that would complement Sleep Inn by meeting different needs for the same customer," he said. Enter Choice's MainStay Suites mid-priced, extended-stay brand. "By offering a new, fresh lodging product for extended-stay guests directly next door to a similarly positioned product for transient guests, we are truly a full-service provider here in Atlanta," Averbuch said. "It's brand segmentation at the local level." According to Averbuch, Choice professionals were integrally involved in each step of the development and marketing phases for both Sleep Inn projects and for the new MainStay Suites hotel. "Choice ensures consistency in these products by being available for consultation throughout, from groundbreaking through construction," he said. [PICTURE APPEARS HERE] Anne Curtis (left), Choice director of corporate communications, reviews plans for the grand opening of the Sleep Inn in Atlanta with Owner Greg Averbach. 14 "Our greater brand focus will give us global brands with clear definition and differentiation," said Wells. "We can build on our presence in 36 countries to become the pre-eminent global lodging franchisor if we can create the proper value proposition for our regional partners and property owners." The Value Is In Our Name.Choice There are three basic reasons for a hotel franchisor to offer a portfolio of different brands: (1) to serve different customer demographics and lifestyles; (2) to serve different travel occasions; or (3) to effectively do a combination of both. Choice does both. After all, it's in the name. The company offers both traveling consumers and hotel franchisees the best and most varied choice of lodging in the industry. From the economy segment to the upscale market, diverse brands provide more than 110 million available room nights a year around the globe. Beneath the Choice identity are seven distinct hotel brands, each serving a par- Located in the Buckhead section of Atlanta, the new 142-room Sleep Inn is the 200/th/ hotel opened under that brand since the brand's introduction in 1989. [PICTURE APPEARS HERE] ticular segment of the broad travel industry. At a time when the industry is undergoing consolidation, new brands are being unveiled and old brands are being revamped, the ability to differentiate brands becomes more critical. "We must trade on our brand diversity," said Wells. "We must continue to create an understandable and unique identity for each of our brands by focusing on offering guests clear choices." In the fiercely competitive market for guests visiting Colonial Williamsburg, Va., one of the top tourist destinations in the country, the 118-unit Quality Suites hotel has gained a decisive advantage by offering two-room suites with separate living and sleeping areas. "In this area, many traveling families are looking for more than just a standard room," said Joe Puhl, general manager. "Guests also appreciate our hotel's free full buffet breakfast and room amenities, such as free coffee, a refrigerator, microwave, two remote-controlled televisions, a video cassette player, stereo cassette player and the Quality Sleeper mattress by Serta." Business travelers ask for the hotel's Quality Executive Rooms, which feature a large work desk, speakerphone with data port and easy chair, in addition to all the other standard amenities. The hotel, owned and operated by the Newport Hospitality Group of Williamsburg, received a top honor from Choice in 1998, the Gold Hospitality Award, for exceeding Choice's rigid quality assurance standards. Last year, Gold Hospitality Awards were presented to just six percent of the eligible hotels in the Choice system. [PICTURE APPEARS HERE] Joe Puhl, general manager, shows off the breakfast offered at his Quality Suites hotel in Williamsburg, Va. Choice's close working relationship with individual franchisees encompasses a wide range of operational issues including one of the lodging industry's greatest challenges: providing continuity despite ongoing personnel turnover. When the Rodeway Inn Airport East of Tempe, Ariz., recently lost its general manager, a Choice field representative worked with the new manager to make the transition. Clark Ward was brought in during a peak travel season to serve as interim general manager of the hotel, owned by Choice's largest multiple franchisee, Sunburst Hospitality Corp. of Silver Spring, Md. Chris Bates, Choice's franchise service director assigned to the hotel, took the initiative to intervene and help Ward keep the property on track and maintain its award- winning reputation. Bates' first order of business was to help Ward set optimal rates for his hotel. "Living in Phoenix, I was able to share my knowledge of the area with Clark, brief him on the area's seasons and help him set the appropriate rates," Bates said. "Clark arrived at Fiesta Bowl time, which is a huge money-maker for his hotel. I helped him set the appropriate rates based on the demand in the area at that time." Jeff Heath, area manager for Sunburst Hospitality Corp., said the company's hotel managers work closely with Choice's field representatives. "Our franchise service directors help us with various projects including marketing programs," he said. "We feel comfortable picking up the phone and asking for their assistance." "By eliminating the assignment of multiple field staff representatives to each hotel, there now is a ratio of one franchise service representative to approximately 45 hotels in comparison to the previous ratio of one to 90," said Brent Russell, Choice vice president of franchise operations for the South Central Market Area. "Our franchisees appreciate the focus on revenue generation and extra service they receive." Chris Bates (left), Choice franchise service director for the Smith Central Market Area, discuses local marketing with Mr Adams, directors of sales for the Rodeway Inn Airport East in Tempe, Ariz. [PICTURE APPEARS HERE] Brand standards and quality are central to the drive for better brand identity. Choice continues to raise the bar for its franchisees in terms of quality assurance and guest satisfaction. As standards tighten, under- performing hotels will leave the system through termination. The result will be more consistent quality within brands, which will better protect the individual franchisee's investment. The drive to build value continues. Block by block, the foundation for an industry leader gets stronger. Each day Choice and its associates create new opportunities for future success. 17 Sleep Inn [LOGO OF SLEEP INN APPEARS HERE] The Sleep Inn brand offers consistent quality with an all-new construction, mid- priced product featuring a walk-in, oversized shower, complimentary continental breakfast and affordable rates, all backed by a 100 percent satisfaction guarantee. 1998 Highlights: . The Sleep Inn brand was spotlighted in the June issue of Consumer Reports as the top hotel chain in its segment and received the magazine's highest rating for value . Smith Travel Research listed the Sleep Inn brand among the top five fastest- growing midscale chains over the last five years [PICTURE APPEARS HERE] The Sleep Inn hotel of Jerome, Idaho 1998 Inn of the Year award winner Hotels Rooms ------ ----- Open: 200 15,214 Under Development: 193 14,979 Total: 393 30,193 Quality Inns, Hotels & Suites [LOGO OF QUALITY APPEARS HERE] The Quality brand offers an established mid-priced lodging product with rooms designed for today's business travelers, backed by a 100 percent satisfaction guarantee. 1998 Highlights: . An advertising campaign was launched in Business Week, PC Magazine, and U.S. News and World Report . Higher quality assurance standards were established, and guest complaints dropped by 36 percent . New Quality Suites and Quality Inn & Suites prototypes were introduced . Millions of television viewers watched tennis pros Jimmy Connors and John McEnroe play at The Quality Challenge Tennis Tournament; Commercials spotlighting Quality's commitment to service ran during The Challenge and during the U.S. Open Golf Preview show [PICTURE APPEARS HERE] The Quality Inn Baltimore of Asheville, N.C., 1998 Inn of the Year award winner Hotels Rooms ------ ----- Open: 679 75,472 Under Development: 177 18,782 Total: 856 94,254 Comfort Inns & Comfort Suites [LOGO OF COMFORT APPEARS HERE] The Comfort brand is a leading limited-service hotel chain offering affordable rates, free deluxe continental breakfast and exceptional rooms and suites, all backed by a 100 percent satisfaction guarantee. 1998 Highlights: . Millions of viewers learned about the deluxe complimentary continental breakfast offered at Comfort Inn and Comfort Suites hotels this summer during network television advertising . Comfort added 38 Comfort Suites hotels to its domestic portfolio in 1998, representing a 25 percent increase . The Comfort brand continued to sponsor such highly visible golf tournaments as the Wendy's Three-Tour Challenge, Shell's Wonderful World of Golf and the Comfort Classic at the Brickyard [PICTURE APPEARS HERE] The Comfort Suites hotel of Madison, Wls. 1998 Inn of the Year award winner
Hotels Rooms ------ ----- Open: 1,718 133,065 Under Development: 385 33,061 Total: 2,103 166,126
Clarion Inns, Hotels, Suites & Resorts [LOGO OF CLARION APPEARS HERE] The Clarion brand features upscale full-service hotels that provide outstanding value to both business and leisure travelers as well as superior service and a 100 percent satisfaction guarantee. 1998 Highlights: . More than 40 percent of all Clarion rooms are Clarion Class Business or Leisure rooms, designed expressly for business and leisure travelers and equipped with amenities including coffee makers, irons, ironing boards, compact refrigerators, microwaves, hair dryers, signature Class One Office workstations, oversized desks, two-line speakerphones with data ports, ergonomic desk chairs and easy-access electrical outlets . The Clarion brand launched a print advertising campaign aimed at business travelers in USA Today's News and Money sections as well the paper's New York Stock Exchange and mutuals pages [PICTURE APPEARS HERE] The clarion Hotel & Conference Center of Edison, N.J. 1998 Inn of the Year award winner
Hotels Rooms ------ ----- Open: 130 21,355 Under Development: 45 7,037 Total: 175 28,392
United States Choice continued its leadership in the U.S. lodging industry in 1998 with 3,039 hotels open and 866 under development under the brand names Comfort, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites. It was a year of honors and tributes as the editors of Entrepreneur magazine named Choice the top lodging franchisor of the year, Consumer Reports recognized the Sleep Inn brand as the nation's top budget chain and Success magazine rated the Comfort and Quality brands among the top franchises. A highlight of the year was the launch of the Guest Privileges frequent- stay program, designed to generate repeat business and build loyalty with existing customers by awarding points that can be redeemed for room nights, gift certificates and vacations in exotic destinations. The Americas Choice Atlantica Hotels, master franchisor for Choice in most of South America, announced plans to develop 140 Comfort, Quality, Clarion and Sleep Inn hotels during the next five years beginning with three hotels in Brazil starting with a 117-room property in Sao Paulo. Nicholas Brady, former U.S. Treasury secretary who recently was named vice chairman of the Choice Atlantica board, explained the decision, saying the "growing volume of international business travelers to markets throughout the continent is boosting demand for high-quality, reputable, well-run hotels." For the third consecutive year, Choice Hotels Canada was named the Hotel Chain of the Year by the North West Commercial Travelers' Association of Canada. [MAPP APPEARS HERE] Econo Lodge [LOGO OF ECONO LODGE APPEARS HERE] The Econo Lodge brand is among the best roadside names in its category, offering clean, affordable economy lodging for travelers who know "Our Rates Are Low, Not Our Standards." 1998 Highlights . The Econo Lodge brand launched an industry first: a clean-room initiative tied to one of the best known household cleaning brands in the country, Procter & Gamble's Mr. Clean. The program offers housekeeping certification and provides information on ways to promote cleanliness and value . Econo Lodge guest satisfaction ratings as measured by D.K. Shifflet & Associates, a leading travel research and consulting firm, rose eight percentage points during 1998, as opposed to a four-point increase for the lodging industry overall . More than 300 hotels participated in the Econo Lodge Exterior Enhancement Program, which has boosted revenue per available room systemwide [PICTURE APPEARS HERE] The Econo Lodge hotel of Brunswick, Ga. 1998 Inn of the Year award winner
Hotels Rooms ------ ----- Open: 723 45,656 Under Development: 132 9,636 Total: 855 55,292
Rodeway Inn [LOGO OF RODEWAY INN APPEARS HERE] The Rodeway Inn brand offers economy hotels with national consumer exposure specializing in meeting the needs of the senior travel market in cities and towns large and small. 1998 Highlights: . Baseball Hall of Famer Tommy Lasorda endorsed the brand's senior-friendly amenities in print advertisements in Reader's Digest . Based upon data provided by Smith Travel Research, revenue per available room for the Rodeway Inn brand grew 4.7 percent while its competitive set grew by only 3.4 percent . Rodeway Inn hotels opened in key locations including Denver, Mobile Ala., Salt Lake City, Baltimore, Phoenix, Palm Springs Calif., and Virginia Beach,Va. [PICTURE APPEARS HERE] The Rodeway Inn hotel of Macon, Ga. 1998 Inn of the Year award winner
Hotels Rooms ------ ----- Open: 202 12,873 Under Development: 51 3,532 Total: 253 16,402
International Offices THE AMERICAS REGION Choice Hotels International 10750 Columbia Pike Silver Spring, MD 20901 (301) 592-6166 EUROPE, MIDDLE EAST, AND AFRICA REGION Choice Hotels International 1 Warwick Row London, England SW1E 5ER 44-171-808-5656 ASIA PACIFIC REGION* Level 8, 52 Alfred Street Milsons Point, Sydney NSW 2061 Australia 61-2-9929-6444 *new office to open in Singapore in 1999 International Inns of the Year [PICTURE APPEARS HERE] The Comfort Suites Paradise Island, Nassau, Bahamas 1998 Americas Region Hotel of the Year award winner [PICTURE APPEARS HERE] Comfort HomeHotel Bolinder Munktell, Eskiltuna, Sweden 1998 International Hotel of the Year award winner [PICTURE APPEARS HERE] The Quality Resort Terraces, Queenstown, New Zealand 1998 Asta/Pacific Region Hotel of the Year award winner 18 [MAPP APPEARS HERE] Europe, Middle East & Africa Friendly Hotels, Choice's master franchisor for western Europe, announced plans to develop 750 hotels within the next decade. At year's end, the Choice Hotels Europe portfolio included 241 hotels open and 41 under development in the United Kingdom, France, Germany, Belgium, Ireland, Italy, Switzerland, Portugal and Spain. Choice Hotels Europe launched its own frequent-stay program, the Favoured Guest Card, which awards one free night for 10 paid stays at its hotels in the United Kingdom, Ireland and France. Choice Hotels Scandinavia consolidated its formidable position in Sweden, Norway and Denmark by integrating hotels acquired as a result of the previous year's acquisition of the Inter-Nor, Home Hotels and Eurostop hotel groups. At year's end the master franchisor's portfolio stood at 84 hotels and one under development. Choice's own direct development will continue to focus on key cities in the Middle East, Mediterranean countries and major African destinations Asia/Pacific Choice formed a strategic alliance with Flag International Limited to create the largest hotel franchising company in Australia. At year's end, the new Flag Choice Hotels organization included 537 hotels in Australia, New Zealand, Fiji and Papua New Guinea. The Quality brand is now the leading mid- market hotel product in New Zealand. Quality and Clarion brand hotels are targeted for major gateway locations that are fast-growing and supported by business travel. MainStay Suites [LOGO OF MAINSTAY SUITES] The MainStay Suites brand is Choice's newest lodging concept: the industry's first franchised mid-market, extended-stay hotel with advanced technological design and residential amenities designed to serve professionals on extended assignments. 1998 Highlights: . Launched in 1996, the MainStay Suites brand has more than quadrupled in size since year-end 1997, with 20 more hotels projected to open by year-end 1999 . The Mariner kiosk, an automated check-in, check-out system that also offers conciege assistance, is available to guests 24 hours a day . Many corporate travel offices have begun booking year-long stays at MainStay Suites hotels for employees on extended assignments [PICTURE APPEARS HERE] The MainStay Suites hotel of Lake Mary, Fla.
Hotels Rooms ------ ----- Open: 19 1,817 Under Development: 22 1,917 Total: 41 3,734
International The International presence of Choice brands is significant, with 632 properties open outside of the United States in 36 countries. The total includes 242 in the Americas (excluding the United States); 331 in Europe and the Middle East; and 59 in Asia-Pacific. 1998 Highlights: . Choice's International division announced it would introduce the 100 percent satisfaction guarantee program worldwide, beginning with hotels in New Zealand, India, Indonesia, Scandinavia and the Caribbean . Choice announced it formed a strategic alliance with Flag International Limited creating Flag Choice Hotels, the largest hotel franchising company in Australia . Choice Hotels Europe announced the launch of a frequent-stay program, the Favoured Guest Card, which awards one free night for every 10 paid stays at any of the more than 150 hotels in the United Kingdom, Ireland and France [PICTURE APPEARS HERE] The Comfort Inn Kensington of London
Hotels Rooms ------ ------ Open: 632 53,095 Under Development: 611 40,375 Total: 1,243 93,470
Hotel and Room statistics as of December 31, 1998 Financial Information Choice Hotels International, Inc. and Subsidiaries TABLE OF CONTENTS Management's Discussion & Analysis............ 20 Report of Independent Public Accountants...... 28 Consolidated Financial Statements............. 29 Notes to Consolidated Financial Statements.... 33 Board of Directors and Corporate Officers..... 45 Corporate Information......................... 46
19 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries The Company is one of the largest hotel franchisors in the world with 3,671 hotels open and 1,477 hotels under development as of December 31, 1998 representing 305,452 rooms open and 115,607 rooms under development in 36 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 2,300 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 35 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 hotels under franchise; 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. 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. 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 those royalty fees as operating income. During 1997, the Company changed its fiscal year-end from May 31 to December 31. 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 CALENDAR YEAR 1998 OPERATING RESULTS AND CALENDAR YEAR 1997 OPERATING RESULTS The Company recorded net income of $55.3 million for the year ended December 31, 1998 ("Calendar 1998"), an increase of $16.6 million, compared to net income of $38.7 million for the year ended December 31, 1997 ("Calendar 1997"). The increase in net income for Calendar 1998 was primarily attributable to an increase in franchise revenue as a direct result of the addition of new franchisees to the system, improvements in the operating performance of hotels and an increase in the effective royalty rates achieved. Additionally, in Calendar 1998 the Company recognized a gain on early extinguishment of debt of $7.2 million. SUMMARIZED FINANCIAL RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 ARE AS FOLLOWS: 1998 1997 (unaudited) REVENUES: (In thousands)....................... --------- ----------- Royalty fees............................... $115,369 $106,299 Product sales.............................. 21,256 23,806 Initial franchise fees & relicensing fees.. 16,571 16,096 Partner services revenue and other......... 11,081 11,912 European hotel operations.................. 1,098 17,303 --------------------- TOTAL REVENUES............................. 165,375 175,416 --------------------- OPERATING EXPENSES: Selling, general & administrative.......... 50,670 50,782 Product cost of sales...................... 19,736 22,769 Depreciation & amortization................ 7,116 9,173 European hotel operations.................. 1,133 15,624 --------------------- TOTAL OPERATING COSTS...................... 78,655 98,348 --------------------- Operating income................................ 86,720 77,068 Gain on sale of stock........................... (2,370) -- Interest expense and other...................... 19,326 13,295 Interest and dividend income.................... (12,636) (2,503) --------------------- Income before income taxes and extraordinary item..................... 82,400 66,276 Income taxes.................................... 34,327 27,604 --------------------- Net income before extraordinary item............ 48,073 38,672 Gain on early extinguishment of debt, net of $4,532 of income taxes.............. 7,232 -- --------------------- NET INCOME................................. $ 55,305 $ 38,672 --------------------- FRANCHISE REVENUES: Management analyzes its business based on "net franchise revenue," which is total revenue excluding product sales and European hotel operations, and franchise operating expenses which are reflected as selling, general and administrative expenses. 20 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries Net franchise revenues were $143.0 million for Calendar 1998 and $134.3 million for Calendar 1997. Royalties increased $9.1 million to $115.4 million from $106.3 million in Calendar 1997, an increase of 8.5%. The increase in royalties is attributable to a net increase of 159 franchisees during the period representing an additional 10,196 rooms added to the system, an improvement in domestic RevPAR of 2.3% and an increase in the effective royalty rate of the domestic hotel system to 3.6% from 3.5%. Domestic initial fee revenue generated from franchise contracts signed increased 3.0% to $16.6 million from $16.1 million in Calendar 1997. Total franchise agreements signed in Calendar 1998 were 440, up 4.5% from the total contracts signed in Calendar 1997 of 421. Revenues generated from partner service relationships increased to $6.4 million from $6.1 million in Calendar 1997. Under the partner services program the Company generates revenue from hotel industry vendors in exchange for being designated as preferred providers of goods or services to hotel owners and the millions of hotel guests who stay in the Company's franchised hotels. The number of domestic rooms under development increased to 75,232 from 62,384, an increase of 20.6% for the year ended December 31, 1998. The total number of international hotels on line increased to 632 from 605 an increase of 4.5% for the year ended December 31, 1998. International rooms on line increased to 53,095 as of December 31, 1998 from 50,639, an increase of 4.9%. The total number of international hotels under development increased to 611 from 119 for the year ended December 31, 1998. The number of international rooms under development increased to 40,375 as of December 31, 1998 from 12,029 as of December 31, 1997. These increases are primarily attributable to a strategic alliance in June 1998 with Flag International Limited. FRANCHISE EXPENSES: The cost to operate the franchising business is reflected in selling, general and administrative expenses. Selling, general and administrative expenses were $50.7 million for Calendar 1998, a decrease of $0.1 million from the Calendar 1997 total of $50.8 million. As a percentage of net franchise revenues, selling, general and administrative expenses declined to 35.5% in Calendar 1998 from 37.8% in Calendar 1997. 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. MARKETING AND RESERVATIONS: The Company's franchise agreements require the payment of franchise fees which include marketing and reservation fees. These fees, which are based on a percentage of the franchisees' gross room revenues, are used exclusively to reimburse the Company for expenses associated with providing such franchise services as central reservation systems, national marketing, and media advertising. The Company is contractually obligated to expend the reservation and marketing fees it collects from franchisees in accordance with the franchise agreements; as such, no income or loss to the Company is generated. During the second quarter of 1998, the Company changed its presentation of marketing and reservation fees such that the fees collected and associated expenses are reported net. All prior periods have been reclassified to conform to the new presentation. The total marketing and reservation fees received by the Company (previously reported as revenue) were $127.4 million and $110.2 million for the years ended December 31, 1998 and December 31, 1997, respectively. Depreciation and amortization charged to reservation and marketing expenses was $5.7 million and $2.9 million for the years ended December 31, 1998 and December 31, 1997, respectively. Reservation fees and marketing fees not expended in the current year are carried over to the next fiscal year and expended in accordance with the franchise agreements. Shortfall amounts are similarly recovered in subsequent years. Excess or shortfall amounts from the operation of these programs are recorded as a payable or receivable from the particular fund. As of December 31, 1998 the Company's balance sheet includes a receivable in amounts due from marketing and reservation funds of $13.4 million related to shortfalls in the marketing ($7.8 million) and reservation ($5.6 million) funds. As of December 31, 1997, the Company's balance sheet includes a receivable in amounts due from marketing and reservation funds of $5.2 million related to a shortfall in the marketing fund and a current liability in accounts payable of $4.5 million related to excess monies in the reservation fund. The Company expects to be able to recover these receivables through future marketing and reservation fees. PRODUCT SALES: Sales made to franchisees through the Company's group purchasing program declined $2.6 million to $21.3 million in Calendar 1998 from $23.8 million in Calendar 1997. 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 21 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries between the franchisee and the vendor, and orders are shipped directly to the franchisee. Similarly, product cost of sales decreased $3.0 million (or 13.3%) from Calendar 1997. The product services margins increased for the year ended December 31, 1998 to 7.2% from 4.4% in Calendar 1997. 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. In the fourth quarter of 1998, the Company discontinued the group purchasing program as previously operated. 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 $8.0 million. As part of this transaction, Friendly acquired ten hotels in France, two in Germany and one in the United Kingdom from the Company in exchange for $22.2 million in 5.75% convertible preferred shares in Friendly. In addition, Friendly will pay the Company deferred compensation of $4.0 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 decreased to $7.1 million in Calendar 1998 from $9.2 million in Calendar 1997. This decrease was primarily attributable to the sale of the Company's European hotels. INTEREST EXPENSE AND INTEREST INCOME: The increase in interest expense of $6.0 million in Calendar 1998 from $13.3 million in Calendar 1997 results from additional debt incurred in connection with the Distribution (as defined in the notes to the consolidated statements). Included in Calendar 1998 results is approximately $10.4 million of interest income earned on the note receivable from Sunburst Hospitality Corporation and $2.2 million in dividend income from the Company's investment in Friendly. EXTRAORDINARY ITEM: During 1998, the Company recorded extraordinary gains for the early extinguishment of a capitalized lease obligation. The Company retired $13.7 million in debt and removed related assets of $1.7 million from the consolidated balance sheets. The extraordinary gain was $7.2 million, after income tax benefits of $4.7 million, or $0.12 per diluted share. 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 seven months ended December 31, 1997 ("December 1997"), an increase of $4.0 million, compared to net income of $23.3 million for the seven months 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, improvements in the operating performance of hotels and an increase in the effective royalty rates achieved. SUMMARIZED FINANCIAL RESULTS FOR THE SEVEN MONTHS ENDED DECEMBER 31, 1997 AND 1996 ARE AS FOLLOWS: 1997 1996 (unaudited) ------------------ REVENUES: (in thousands) Royalty fees................................ $ 70,308 $61,821 Product sales............................... 13,524 14,717 Initial franchise fees & relicensing fees... 8,597 9,304 Partner services revenue and other.......... 4,869 3,161 European hotel operations................... 10,541 10,975 ------------------- TOTAL REVENUE............................... 107,839 99,978 ------------------- OPERATING EXPENSES: Selling, general & administrative........... 29,454 28,132 Product cost of sales....................... 13,031 13,481 Depreciation & amortization................. 3,977 3,153 European hotel operations................... 9,203 9,745 ------------------- TOTAL OPERATING COSTS....................... 55,665 54,511 ------------------- Operating income................................. 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: Net franchise revenues were $83.8 million for the seven months ended December 31, 1997 and $74.3 million for the seven months ended December 31, 1996. Royalties increased $8.5 million to $70.3 million from $61.8 million for the seven months ended December 31, 1996, an increase of 13.7%. The increase in royalties is attributable to a net increase of 264 franchisees during the period representing an additional 19,881 22 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries 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 3.5% from 3.4%. Domestic initial fee revenue generated from franchise contracts signed declined 7.5% to $8.6 million from $9.3 million for the seven months ended December 31, 1997 as compared to the seven months ended December 31, 1996. Total franchise agreements signed for the seven months ended December 31, 1997 were 368, down 14.0% 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 partner service relationships increased to $3.4 million from $1.5 million in December 1996. The number of domestic rooms under development as of December 31, 1997 increased to 62,384 from 59,023, at December 31, 1996 an increase of 5.7%. The total number of international hotels on line increased to 605 from 548 at December 31, 1996 an increase of 10.4%. International rooms on line increased 9.0% to 50,639 as of December 31, 1997 from 46,473 as of December 31, 1996. The total number of international hotels under development decreased to 119 from 143, a decrease of 16.8% from December 31, 1996. The number of international rooms under development decreased to 12,029 as of December 31, 1997 from 13,906 as of December 31, 1996, a decrease of 13.5%. FRANCHISE EXPENSES: Selling, general and administrative expenses were $29.5 million for the seven months ended December 31, 1997, an increase of $1.3 million from the comparable period in 1996. The increase in selling, general and administrative expenses was 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% for the seven months ended December 31, 1997 from 37.8% for the seven months ended December 31, 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. MARKETING AND RESERVATIONS: The total marketing and reservation fees received by the Company (previously reported as revenue) were $72.3 million and $66.3 million for the seven months ended December 31, 1997 and December 31, 1996, respectively. Depreciation and amortization charged to reservation and marketing expenses was $1.7 million and $1.4 million for the seven months ended December 31, 1997 and December 31, 1996, respectively. PRODUCT SALES: Sales made to franchisees through the Company's group purchasing program declined $1.2 million to $13.5 million for the seven months ended December 31, 1997 from $14.7 million for the seven months ended December 31, 1996. Similarly, product cost of sales decreased $0.4 million (or 3.3%) for the seven months ended December 31, 1997. The product services margins decreased for the seven months ended December 31, 1997 to 3.6% from 8.4% for the seven months ended December 31, 1996. DEPRECIATION AND AMORTIZATION: Depreciation and amortization increased to $4.0 million for the seven months ended December 31, 1997 from $3.2 million for the seven months ended December 31, 1996. The increase was primarily due to capital improvements to the Company's financial and billing information systems. 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 $9.2 million to $97.2 million from $88.0 million in ended Fiscal 1996, an increase of 10.5%. 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 3.4% from 23 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries 3.3%. 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 partner services relationships increased to $6.1 million from $1.8 million in Fiscal 1996. The number of domestic rooms under development increased to 61,754 from 54,172, an increase of 14.0% for the period ending May 31, 1997. The total number of international hotels on line increased to 563 from 557 an increase of 1.1% as of May 31, 1997. International rooms online increased 1.6% from 46,843 as of May 31, 1996 to 47,603 as of May 31, 1997. The total number of international hotels under development increased to 110 from 100, an increase of 10.0% for the period ending May 31, 1997. The number of international rooms under development increased to 10,339 as of May 31, 1997 from 9,613 as of May 31, 1996, an increase of 7.6%. 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. Of the increase, $4.8 million 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 1997 from 40.9% in Fiscal 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 $2.0 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. 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 operated. DEPRECIATION AND AMORTIZATION: Depreciation and amortization decreased $1.6 million (or 16.7%) to $7.6 million in Fiscal 1997 from $9.2 million in Fiscal 1996. The decrease was primarily due to an 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. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $44.1 million for the year ended December 31, 1998, an increase of $10.5 million from $33.6 million for the seven months ended December 31, 1997. As of December 31, 1998, the total long-term debt outstanding for the Company was $279.2 million. Cash used in investing activities for the year ended December 31, 1998, the seven months ended December 1997 and Fiscal years 1997, and 1996 was $14.2 million, $149.7 million, $16.9 million, and $78.5 million, respectively. Included in Other items (investing activities) for the year ended December 31, 1998 was an increase of $12.7 million due from the marketing and reservation funds. On October 15, 1997, the Company funded a $115 million, five year Subordinated Term Note to Sunburst with an initial simple interest rate of 11% per annum. In connection with the amendment 24 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries of the strategic alliance agreement discussed below, effective October 15, 2000 interest payable shall accrue at a rate of 11% per annum compounded daily. The Company will implement this amendment prospectively beginning January 1, 1999 by recognizing interest on the outstanding principal and accrued interest amounts at an effective rate of 10.58%. The note is payable in full, along with accrued interest on October 15, 2002. Total interest accrued at December 31, 1998 and 1997 was $10.4 million and $2.4 million, respectively. During 1998, Sunburst repaid $8 million of the approximately $25 million of estimated receivables due to the Company. On December 28, 1998, the Company and Suburst amended the strategic alliance agreement entered into in connection with the Sunburst Distribution. As part of that amendment, the Company exchanged the remaining $17 million balance in return for, among other things, the exclusive rights to the MainStay Suites brand from Sunburst and a commitment from Sunburst to build a total of 25 MainStay Suites. The $17 million, net of income taxes of approximately $7 million, was recorded as an adjustment to additional paid in capital as it represents an adjustment to the accounting for the Sunburst Distribution. On May 31, 1996, the Company repurchased the remaining 5.5% minority interest held by its management 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 the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997, and 1996, capital expenditures totaled $12.3 million, $7.3 million, $10.6 million and $6.5 million, respectively, 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, 1998, the Company had $135 million of term loans outstanding and $37 million of revolving loans. The term loan is payable over five years, $22.5 million of which is due in 1999. The credit facility includes customary financial and other covenants that require the maintenance of certain ratios including maximum leverage, minimum net worth and interest coverage and restrict 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. On May 1, 1998, the Company completed a $100 million senior unsecured note offering (the "Notes"), bearing a coupon rate of 7.13% with an effective rate of 7.22%. The Notes will mature on May 1, 2008, with interest on the Notes to be paid semi-annually. The Company used the net proceeds from the offering of approximately $99 million to repay amounts outstanding under the Company's $300 million revolving credit facility. As of March 12, 1999, the Company has repurchased 5.4 million shares of its common stock at a total cost of $74.1 million. The Company has authorization from its Board of Directors to repurchase up to an additional 3.3 million shares. As of March 12, 1999, there were 55.4 million total common shares outstanding (a weighted average of 56.1 million). The Company has entered into interest rate swap agreements with a notional amount of $115 million at December 31, 1998, 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 one and one-half years with a fixed rate of 5.85% and a variable rate at December 31, 1998 of 5.07%. As of December 31, 1998, the interest rate swap agreements have a fair market valuation of approximately $(2.8 million). 25 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries 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. YEAR 2000 COMPLIANCE The Company is engaged in an ongoing effort to evaluate and remediate the Year 2000 computer problem shared by virtually all companies and businesses. As part of this effort, a cross-functional Year 2000 Compliance Committee was established to manage and supervise the efforts to become compliant and a Year 2000 action plan has been developed. The Company has completed the first three phases of the plan, which include (i) making the Company's internal organizations aware of the Year 2000 issue and assigning responsibility internally, (ii) inventorying and initial testing of its proprietary software and (iii) inventorying and testing secondary internal systems (e.g. employee PCs). The Company is in the process of completing the remaining phases which include: (i) assessing the risk from third party vendors and franchisees (ii) contingency planning, and (iii) educating the franchise community. Throughout the process, remedial actions have been or will be taken as warranted. The Company's exposure to potential Year 2000 problems exists in two general areas: technological operations in the sole control of the Company, and technological operations dependent in some way on one or more third parties. With respect to the Company's internal systems, it has conducted Year 2000 compliance testing on all of its proprietary software, including its reservations and reservations support systems, its franchise support system and its franchisee property management support systems. The tests have indicated that, except for two DOS based systems, the proprietary software is Year 2000 compliant. The DOS version of ChoiceLINKS is not Year 2000 compliant and the DOS version of the Company's property management system is only compliant through December 31, 2000. The Company has communicated this to franchisees using these systems and has recommended that they migrate to the Windows based versions of these systems. The Company has also been in the process of replacing its hardware platforms for these systems and a number of smaller support systems and has kept them updated so that by the end of 1998, all of the Company's large system computers are no more than eighteen months old. Based on manufacturers specifications, the Company believes that these new hardware platforms are Year 2000 compliant. However, the company will have to update the operating systems for several of its servers. The Company has completed its process of conducting an inventory of third party software, including PC operating systems and word processing and other commercial software. The inventory did not disclose any material compliance issues. The Year 2000 Compliance Committee is currently identifying third party vendors and service providers whose non-compliant systems could have a material impact on the Company and undertaking an assessment as to such parties' compliant status. These parties include airline global distribution systems (GDS), utility providers, telephone service providers, banks and data processing services. The GDS companies, which provide databases through which travel agents can book hotel rooms, have assured the Company in writing that they are compliant and the Company has conducted tests with three of the four major GDS companies. The Year 2000 Compliance Committee is in the process of assessing other third parties as to their compliance and the consequences in the event they are not compliant. As of February 1999, the Company has received responses from approximately one-half of its vendors. Such vendors have indicated that they are, or expect to be, Year 2000 compliant. Throughout 1999, the committee will continue to seek and assess responses from all of its material vendors. As of February 1999, the Company has devised contingency plans for its Phoenix, Arizona reservation center. These plans include access to alternative power sources and insuring the availability of key employees. Contingency plans for the Silver Spring, Maryland corporate headquarters and other Company locations will be developed throughout the second and third quarters of 1999. Costs of addressing potential Year 2000 problems have not been material to date. The value of employee time devoted to testing and development has been approximately $200,000. Total costs for replacement of hardware and operating systems are expected to 26 Management's Discussion & Analysis Choice Hotels International, Inc. and Subsidiaries be approximately $700,000. However, these replacements (as well as replacements undertaken in prior years) are being implemented primarily as part of the Company's ongoing technology updating, rather than specifically for Year 2000 compliance reasons. Based upon preliminary information gathered to date, Year 2000 compliance costs are not currently expected to have a material adverse impact on the Company's financial position, results of operations or cash flows. However, if the Company, its vendors or franchisees are unable to resolve such Year 2000 issues in a timely manner, it could result in a material financial risk, including loss of revenue, substantial unanticipated costs and service interruptions. The Company is not in a position to guarantee the performance of others with respect to their Year 2000 compliance or predict whether any of the assurances that others provide regarding Year 2000 compliance may prove later to be inaccurate or overly optimistic. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS The Company adopted SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" in Calendar 1998. The adoption of these pronouncements required the Company to make certain additional disclosures. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities which requires recognition of the fair value of derivatives in the statement of financial position, with changes in the fair value recognized either in earnings or as a component of other comprehensive income dependent upon the nature of the derivative. Implementation of SFAS No. 133 is required for Fiscal year 2000. The Company does not expect SFAS No. 133 to have a material impact on the Company's earnings or other comprehensive income. FORWARD-LOOKING STATEMENTS 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 may do business in the future. 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. 27 Report of Independent Public Accountants Choice Hotels International, Inc. and Subsidiaries TO CHOICE HOTELS INTERNATIONAL, INC. We have audited the accompanying consolidated balance sheets of Choice Hotels International, Inc. and subsidiaries, as defined under "Basis of Presentation" in the Notes to Consolidated Financial Statements, as of December 31, 1998 and December 31, 1997, and the related consolidated statements of income and cash flows for the year ended December 31, 1998, the seven months ended December 31, 1997 and for each of the two fiscal years in the period ended May 31, 1997, and the consolidated statement of shareholders' equity and comprehensive income for the period from October 15, 1997 (inception) to December 31, 1997 and the year ended December 31, 1998. 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. and subsidiaries as of December 31, 1998 and December 31, 1997, and the consolidated results of their operations and their consolidated cash flows for the year ended December 31, 1998 and the seven months ended December 31, 1997, and each of the two fiscal years in the period ended May 31, 1997, and the consolidated statements of shareholders' equity and comprehensive income for the period from October 15, 1997 (inception) to December 31, 1997 and the year ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Arthur Andersen LLP Washington, D.C., January 29, 1999 28 Consolidated Statements of Income Choice Hotels International, Inc. and Subsidiaries
Year ended Seven months ended Fiscal years ended (In thousands) December 31, December 31, May 31, 1998 1997 1997 1996 --------------------------------------------------------- REVENUES Royalty fees................................................ $ 115,369 $ 70,308 $ 97,215 $ 87,994 Product sales............................................... 21,256 13,524 23,643 21,570 European hotel operations................................... 1,098 10,541 17,737 19,609 Initial franchise fees and relicensing fees................. 16,571 8,597 16,802 15,578 Partner services revenue and other.......................... 11,081 4,869 12,642 6,997 --------------------------------------------------------- Total revenues......................................... 165,375 107,839 168,039 151,748 OPERATING EXPENSES Selling, general and administrative......................... 50,670 29,454 51,102 45,196 Product cost of sales....................................... 19,736 13,031 22,766 20,709 European hotel operations................................... 1,133 9,203 16,166 17,521 Depreciation and amortization............................... 7,116 3,977 7,643 9,179 Provision for asset impairment.............................. -- -- -- 24,760 --------------------------------------------------------- Total operating expenses............................... 78,655 55,665 97,677 117,365 --------------------------------------------------------- Operating income............................................ 86,720 52,174 70,362 34,383 --------------------------------------------------------- OTHER Minority interest........................................... -- -- -- 1,532 Gain on sale of stock....................................... (2,370) -- -- -- Interest on notes payable to Manor Care..................... -- -- 7,083 7,083 Interest expense and other.................................. 19,326 8,788 4,647 4,791 Interest and dividend income (including interest income on Sunburst Note of $10.4 million and $2.7 million for the year ended December 31, 1998 and the seven months ended December 31, 1997, respectively).. (12,636) (2,997) (943) -- --------------------------------------------------------- Total other............................................ 4,320 5,791 10,787 13,406 --------------------------------------------------------- Income before income taxes and extraordinary item.............. 82,400 46,383 59,575 20,977 Income taxes................................................... (34,327) (19,096) (24,845) (9,313) --------------------------------------------------------- Net income before extraordinary item........................... $ 48,073 $ 27,287 $ 34,730 $ 11,664 Extraordinary gain on early extinguishment of debt (net of taxes of $4,532)..................................... 7,232 -- -- -- --------------------------------------------------------- Net income..................................................... $ 55,305 $ 27,287 $ 34,730 $ 11,664 --------------------------------------------------------- Weighted average shares outstanding............................ 58,717 59,798 62,680 62,628 --------------------------------------------------------- Diluted shares outstanding..................................... 59,548 61,300 62,680 62,628 --------------------------------------------------------- Basic EPS: Income before extraordinary item............................... $0.82 $0.46 $0.55 $0.19 Extraordinary item............................................. 0.12 -- -- -- --------------------------------------------------------- Net income..................................................... $0.94 $0.46 $0.55 $0.19 --------------------------------------------------------- Diluted EPS: Income before extraordinary item............................... $0.81 $0.45 $0.55 $0.19 Extraordinary item............................................. 0.12 -- -- -- --------------------------------------------------------- Net income..................................................... $0.93 $0.45 $0.55 $0.19 =========================================================
See notes to consolidated statements. 29 Consolidated Balance Sheets Choice Hotels International, Inc. and Subsidiaries
As of (In thousands) December 31, December 31, 1998 1997 ---------------------------- ASSETS Current assets Cash and cash equivalents..................................................................... $ 1,692 $ 10,282 Receivables (net of allowance for doubtful accounts of $8,082, and $7,608, respectively)..................................................... 28,117 24,278 Income taxes receivable......................................................... 5,427 1,242 Receivable from Sunburst Hospitality............................................ -- 25,066 Other current assets............................................................ 425 3,442 ---------------------------- Total current assets.......................................................... 35,661 64,310 Property and equipment, net........................................................ 32,845 37,040 Goodwill, net...................................................................... 66,749 68,792 Franchise rights, net.............................................................. 44,981 48,819 Investment in Friendly Hotels, PLC................................................. 45,139 17,581 Assets held for sale............................................................... -- 10,752 Amounts due from marketing and reservation funds................................... 23,364 13,087 Other assets....................................................................... 21,637 8,567 Note receivable from Sunburst Hospitality.......................................... 127,849 117,447 ---------------------------- TOTAL ASSETS.................................................................. $398,225 $ 386,395 ============================ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Current portion of long term debt............................................... $ 22,646 $ 15,041 Accounts payable................................................................ 16,216 26,452 Accrued expenses................................................................ 19,606 20,702 Income taxes payable............................................................ -- 6,007 ---------------------------- Total current liabilities..................................................... 58,468 68,202 Long term debt..................................................................... 256,564 267,780 Deferred income taxes ($19,569 and $0 respectively) and other liabilities............................................................ 26,683 1,155 ---------------------------- Total liabilities............................................................. 341,715 337,137 ============================ SHAREHOLDERS' EQUITY Common stock, $ .01 par value, 160,000,000 shares authorized; 56,726,917 and 59,828,878 shares issued and outstanding at December 31, 1998 and 1997, respectively......................................... 607 598 Additional paid-in-capital......................................................... 43,432 47,907 Accumulated other comprehensive income (loss)...................................... 2,112 (8,316) Treasury stock..................................................................... (54,204) (189) Retained earnings.................................................................. 64,563 9,258 ---------------------------- Total shareholders' equity.................................................... 56,510 49,258 ---------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................................... $398,225 $ 386,395 ============================
See notes to consolidated statements. 30 Consolidated Statements of Cash Flows Choice Hotels International, Inc. and Subsidiaries
Year ended Seven months ended Fiscal years ended (In thousands) December 31, December 31, May 31, 1998 1997 1997 1996 ----------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income........................................................... $ 55,305 $ 27,287 $ 34,730 $ 11,664 Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization...................................... 12,544 6,159 10,438 11,839 Provision for bad debts............................................ 1,473 2,274 2,238 685 Increase (decrease) in deferred taxes.............................. 14,852 (4,828) 3,171 (13,527) Non cash interest and dividend income.............................. (12,364) (2,997) (943) -- Extraordinary gain on early extinguishment of debt................. (11,964) -- -- -- Provision for asset impairment..................................... -- -- -- 24,760 Changes in assets and liabilities: Receivables.................................................... (4,311) (10,606) (4,835) (7,533) Prepaid expenses and other current assets...................... (1,849) 2,403 1,615 (990) Current liabilities............................................ (6,180) 11,226 (2,145) 4,050 Income taxes payable/receivable................................ (3,411) 2,689 1,061 (265) Other liabilities.............................................. -- -- 175 2,059 ----------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES................... 44,095 33,607 45,505 32,742 ----------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Investment in property and equipment................................. (12,254) (7,329) (10,630) (6,506) Purchase of minority interest........................................ -- -- (2,494) (55,269) Investment in Friendly Hotels, PLC................................... -- -- -- (17,069) Repayments from (advances to) Sunburst Hospitality................... 8,145 (25,066) -- -- Note receivable from Sunburst Hospitality............................ -- (115,000) -- -- Other items, net..................................................... (10,090) (2,344) (3,804) 345 ----------------------------------------------------------- NET CASH UTILIZED IN INVESTING ACTIVITIES................... (14,199) (149,739) (16,928) (78,499) ----------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from mortgages and other long-term debt..................... 194,901 236,509 31,107 17,296 Principal payments of debt........................................... (184,300) (78,851) (51,260) (350) Purchase of treasury stock........................................... (54,015) (189) -- -- Cash transfers (to) from Parent, net................................. -- (35,222) (8,069) 31,567 Proceeds from issuance of common stock............................... 4,928 -- -- -- ----------------------------------------------------------- NET CASH PROVIDED BY (UTILIZED IN) FINANCING ACTIVITIES..... (38,486) 122,247 (28,222) 48,513 ----------------------------------------------------------- NET CHANGE IN CASH AND CASH EQUIVALENTS.............................. (8,590) 6,115 355 2,756 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..................... 10,282 4,167 3,812 1,056 ----------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD........................... $ 1,692 $ 10,282 $ 4,167 $ 3,812 -----------------------------------------------------------
See notes to consolidated statements. 31 Consolidated Statements Of Shareholders' Equity And Comprehensive Income Choice Hotels International, Inc. and Subsidiaries
(In thousands, except share amounts) Accumulated Other Common Stock Additional Comprehensive Shares Amount Paid-in-Capital Income (Loss) ========================================================== Initial capitalization - October 15, 1997 .................... 59,767,716 598 $ 48,064 $ (8,662) Comprehensive income Net income ................................................ -- -- -- -- Other comprehensive income, net of tax Foreign currency translation adjustment ................... -- -- -- 346 Comprehensive income ......................................... -- -- -- -- Exercise of stock options/grants, net ........................ 71,876 -- (157) -- Treasury purchases ........................................... (10,714) -- -- -- Transfers of net income to Sunburst prior to the distribution ........................................... -- -- -- -- ---------------------------------------------------------- Balance as of December 31, 1997 .............................. 59,828,878 598 $ 47,907 $ (8,316) ========================================================== Comprehensive income Net income ................................................ -- -- -- -- Other comprehensive income, net of tax Foreign currency translation adjustments, net -- -- -- -- Unrealized loss on securities, net of reclassification adjustment (see notes) -- -- -- -- Other comprehensive income ................................ -- -- -- 10,428 Comprehensive income ......................................... -- -- -- -- Exercise of stock options/grants, net ........................ 827,439 9 5,665 -- Treasury purchases, net ...................................... (3,929,400) -- -- -- Purchase of MainStay brand option from Sunburst .............................................. -- -- (10,140) -- ---------------------------------------------------------- Balance as of December 31, 1998 .............................. 56,726,917 607 $ 43,432 $ 2,112 ========================================================== Treasury Comprehensive Retained Stock Income Earnings Total ============================================================= Initial capitalization - October 15, 1997 ................. $ -- $ -- $ 40,000 Comprehensive income Net income ............................................. -- $ 27,287 27,287 27,287 Other comprehensive income, net of tax Foreign currency translation adjustment ............................................. -- 346 -- 346 -------- Comprehensive income ...................................... -- $ 27,633 -- -- ======== Exercise of stock options/grants, net ..................... -- -- (157) Treasury purchases ........................................ Transfers of net income to Sunburst prior to (189) -- (189) the distribution ........................................ -- $(18,029) (18,029) ------------------------------------------------------------ Balance as of December 31, 1997 ........................... $ (189) $ 9,258 $ 49,258 ============================================================ Comprehensive income Net income ............................................. -- $ 55,305 $ 55,305 55,305 Other comprehensive income, net of tax Foreign currency translation adjustments, net -- 10,892 -- (18,029) Unrealized loss on securities, net of reclassification adjustment (see notes) -- (464) -- (464) -------- Other comprehensive income ............................. -- 10,428 -- -- -------- Comprehensive income ...................................... -- $ 65,733 -- -- ======== Exercise of stock options/grants, net ..................... -- 5,674 -- Treasury purchases, net ................................... (54,015) -- (54,015) Purchase of MainStay brand option from Sunburst ........................................... -- -- (10,140) ------------------------------------------------------------ Balance as of December 31, 1998 ........................... $(54,204) $ 64,563 $ 56,510 ============================================================
See notes to consolidated statements. 32 Notes To Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries 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 "Holdings") 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 Holdings 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. Choice Hotels International, Inc. (the "Company"), which was a subsidiary of Manor Care became a wholly-owned subsidiary of Holdings. The Manor Care Distribution separated the lodging and health care businesses of Manor Care into two public corporations. The operations of Holdings 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, Holdings changed its name from Choice Hotels Holdings, Inc. to Choice Hotels International, Inc. ("CHI") and the Company changed its name to Choice Hotels Franchising, Inc. On April 29, 1997, CHI's Board of Directors announced its intention to separate CHI's franchising business from its owned hotel business (referred to as the "Sunburst Distribution"). On September 16, 1997, the Board of Directors and shareholders of CHI approved the separation of the business via a spin-off of the Company, 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, CHI shareholders received one share in the Company (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, 1998, the Company had franchise agreements with 3,671 hotels open and 1,477 hotels under development in 36 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 and cash flows and equity of the Company as if it were formed as a separate entity of its parent (Manor Care prior to Manor Care 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 Parent" 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, 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 ----------------
33 Notes To Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries The average balance of the Investments and advances from Parent was $48.6 million, $43.9 million and $8.9 million for the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997 and 1996, respectively. RECLASSIFICATIONS Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. SIGNIFICANT ACCOUNTING POLICIES FISCAL YEAR 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, (In thousands) 1998 1997 --------------------- Land................................................. $ 1,603 $ 996 Facilities in progress............................... 1,600 -- Building and improvements............................ 8,023 18,238 Furniture, fixtures and equipment.................... 33,494 31,228 ------------------- 44,720 50,462 Less: Accumulated depreciation....................... (11,875) (13,422) ------------------- $ 32,845 $ 37,040 -------------------
During 1998, approximately $1.7 million of fixed assets were eliminated in conjunction with the termination of a capital lease obligation. (See Long Term Debt and Notes Payable.) 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 GOODWILL Goodwill primarily represents an allocation of the excess purchase price of the stock of the Company over the recorded minority interest. Goodwill is amortized on a straight-line basis over 40 years. Such amortization amounted to $2.0 million, $1.1 million, $1.9 million and $1.1 million for the year ended December 31, 1998, the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996, respectively. Goodwill is net of accumulated amortization of $8.1 million and $6.1 million at December 31, 1998 and 1997. FRANCHISE RIGHTS Franchise rights are intangible assets and represent an allocation in purchase accounting for the value of long-term franchise contracts. The majority of the balance results from the Econo Lodge and Rodeway acquisitions made in fiscal year 1991. Franchise rights acquired are amortized over an average life of 15 years. Amortization expense for the year ended December 31, 1998 and the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996 amounted to $3.8 million, $1.7 million, $2.9 million and $2.6 million, respectively. Franchise rights are net of accumulated amortization of $19.5 million and $15.7 million at December 31, 1998 and 1997. The Company periodically assesses the amortization lives of its franchise rights. Effective January 1, 1998, the Company changed its estimate of the useful life of Econo Lodge franchise rights to a 17 year period and Rodeway franchise rights to a 3 year period to more closely match the remaining estimated contract lives of franchise contracts acquired in 1991. The effect of this change in estimate was to increase depreciation and amortization expense by approximately $900,000 and decrease net income by $0.01 per dilutive share for the year ended December 31, 1998. DEFERRED FINANCING COSTS Debt financing costs are deferred and amortized, using the interest method, over the term of the related debt. 34 Notes To Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries 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 worker's 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's franchise agreements require the payment of franchise fees which include marketing and reservation fees. These fees, which are based on a percentage of the franchisees' gross room revenues, are used exclusively to reimburse the Company for expenses associated with providing such franchise services as central reservation systems, national marketing, and media advertising. The Company is contractually obligated to expend the reservation and marketing fees it collects from franchisees in accordance with the franchise agreements; as such, no income or loss to the Company is generated. During the second quarter of 1998, the Company changed its presentation of marketing and reservation fees such that the fees collected and associated expenses are reported net. All prior periods have been reclassified to conform to the new presentation. The total marketing and reservation fees received by the Company (previously reported as revenue) for the year ended December 31, 1998, the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996 amounted to $127.4 million, $72.3 million, $104.2 million and $98.9 million, respectively. Depreciation and amortization charged to reservation and marketing expenses for the year ended December 31, 1998, the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996 amounted to $5.7 million, $2.2 million, $2.8 million and $2.7 million, respectively. Reservation fees and marketing fees not expended in the current year are carried over to the next fiscal year and expended in accordance with the franchise agreements. Shortfall amounts are similarly recovered in subsequent years. Excess or shortfall amounts from the operation of these programs are recorded as a payable or receivable from the particular fund. As of December 31, 1998 the Company's balance sheet includes a receivable in amounts due from marketing and reservation funds of $13.4 million related to shortfalls in the marketing ($7.8 million) and reservation ($5.6 million) funds. As of December 31, 1997, the Company's balance sheet includes a receivable in amounts due from marketing and reservation funds of $5.2 million related to a shortfall in the marketing fund and a current liability in accounts payable of $4.5 million related to excess monies in the reservation fund. The Company expects to be able to recover these receivables through future marketing and reservation fees. IMPAIRMENT POLICY 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. 35 Notes To Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries 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, 1998 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 at December 31, 1998, the interest rate swap agreements have a life of one and one-half years with a fixed rate of 5.85% and variable rate of 5.07%. As of December 31, 1998 and 1997, the interest rate swap agreements have a fair market valuation of approximately $(2.8 million) and $(0.5 million), respectively. FOREIGN OPERATIONS The Company accounts for foreign currency translation in accordance with SFAS No. 52, "Foreign Currency Translation." Revenues generated by foreign operations for the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997 and 1996 were $5.8 million, exclusive of $2.1 million of foreign dividends; $16.2 million, exclusive of $0.6 million of foreign dividends; $27.5 million and $29.9 million, respectively. The Company's foreign operations had net income (loss) of $2.3 million, $0.3 million, $(1.8 million) and $(19.4 million) for the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997 and 1996. The majority of the revenues and assets of foreign operations relate to the Company's European business operations (see "Acquisitions and Divestitures"). 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 Financial Accounting Standards Board Statement ("SFAS") No. 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.
Seven months Year ended ended December 31, December 31, (In millions, except per share amounts) 1998 1997 --------------------------- Computation of Basic Earnings Per Share: Net income..................................... $55.3 $27.3 Weighted average shares outstanding............ 58.7 59.8 Basic earnings per share....................... $0.94 $0.46 Computation of Diluted Earnings Per Share: Net income for diluted earnings per share...... $55.3 $27.3 Weighted average shares outstanding............ 58.7 59.8 Effect of Dilutive Securities Employee stock option plan..................... 0.8 1.5 -------------------- Shares for diluted earnings per share.......... 59.5 61.3 -------------------- Diluted earning per share...................... $0.93 $0.45 ====================
The effect of dilutive securities is computed using the treasury stock method and average market prices during the period. In 1998 the Company excluded 497,864 antidilutive options 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, 1998, 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. COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income," which establishes new rules for the reporting and display of comprehensive income and its 36 Notes To Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries components; however, the adoption of SFAS 130 had no impact on the Company's net income or shareholders' equity. SFAS 130 requires unrealized gains or losses on the Company's available-for-sale securities and the foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of SFAS 130. The components of total accumulated other comprehensive income in the balance sheet are as follows:
DECEMBER 31, (In thousands) 1998 1997 --------------------------- Unrealized losses on available for sale securities............................ $ (464) $ -- Foreign currency translation adjustment......................... 2,576 (8,316) --------------------------- Total accumulated other comprehensive income (loss).................... $ 2,112 $ (8,316) ---------------------------
The related income tax effect allocated to each component of other comprehensive income is as follows:
Amount Before Income Tax Amount (In thousands) Taxes (Expense)/Benefit Net of Taxes --------------------------------------------------- Calendar year 1998 Net unrealized losses $(1,450) $ 986 $ (464) Foreign currency translation adjustments, net 9,972 920 10,892 ------------------------------------------------ Total other comprehensive income $ 8,522 $1,906 $10,428 ------------------------------------------------ Fiscal year 1997 Foreign currency translation adjustments $(1,298) $ -- $(1,298) ------------------------------------------------ Total other comprehensive loss $(1,298) $ -- $(1,298) ------------------------------------------------
Below represents the detail of other comprehensive income:
1998 ---- Foreign currency translation adjustments........................ $ 2,760 Plus: reclassification of loss on liquidation of foreign subsidiaries....................................... 8,132 Net foreign currency translation adjustments.................... $10,892 ------- Unrealized holding gains arising during the period............................................. $ 920 Less: reclassification adjustments for gains included in net income.......................................... (1,384) ------- Net unrealized holding losses arising during the period............................................... $ (464) -------
INCOME TAXES The Company was included in the consolidated federal income tax returns of Manor Care and Sunburst Hospitality Corporation 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 income and taxable income. Income before income taxes for the year ended December 31, 1998, the period beginning June 1, 1997 and ending December 31, 1997 ("December 1997") and the fiscal years ended May 31, 1997 and 1996 were derived from the following:
(In thousands) CY 1998 December 1997 FY 1997 FY 1996 ========================================== Income before income taxes: Domestic operations $82,400 $45,866 $62,641 $ 52,801 Foreign operations -- 517 (3,066) (31,824) ------------------------------------------- Income before income taxes $82,400 $46,383 $59,575 $ 20,977 ===========================================
The provision for income taxes follows for the year ended December 31, 1998, the period beginning June 1, 1997 and ended December 31, 1997 ("December 1997") and the fiscal years ended May 31, 1997 and 1996:
(In thousands) CY 1998 December 1997 FY 1997 FY 1996 ---------------------------------------------- Current tax (benefit) expense: Federal $ 25,594 $15,742 $19,421 $20,097 Federal (benefit) expense of foreign operations (9,674) 204 (1,213) (2,792) State 3,482 3,475 3,950 3,754 Deferred tax (benefit) expense: Federal 2,482 (223) 2,293 125 Federal (benefit) expense of foreign operations 9,938 -- -- (9,778) State 2,505 (102) 394 (2,093) ----------------------------------------------- $ 34,327 $19,096 $24,845 $ 9,313 ===============================================
37 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries Deferred tax assets (liabilities) are comprised of the following as of December 31. (In thousands) 1998 1997 ======================================== Depreciation and amortization $(16,013) $(3,184) Prepaid expenses (3,975) (1,484) Other (5,316) (2,458) ---------------------------------------- Gross deferred tax liabilities (25,304) (7,126) ---------------------------------------- Foreign operations 2,211 2,843 Accrued expenses 5,035 5,283 Net operating losses 187 398 Other 1,860 1,001 ---------------------------------------- Gross deferred tax assets 9,293 9,525 ---------------------------------------- Net deferred tax asset (liability) $(16,011) $ 2,399 ======================================== A reconciliation of income tax expense at the statutory rate to income tax expense included in the accompanying consolidated statements of income follows: CY 1998 December 1997 FY 1997 FY 1996 ================================================= (In thousands, except Federal income tax rate) Federal income tax rate 35% 35% 35% 35% Federal taxes at statutory rate $28,856 $16,234 $20,853 $7,345 State income taxes, net of federal tax benefit 3,892 2,192 2,824 1,080 Minority interest -- -- -- 536 Other 1,579 670 1,168 352 ------------------------------------------------- Income tax expense $34,327 $19,096 $24,845 $9,313 ================================================= Cash paid for state income taxes was $3,398,000; $197,000; and $1,302,000 for the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal year ended May 31, 1997, respectively. Federal income taxes were paid by Manor Care for the period ending October 31, 1996. Federal income taxes were paid by Sunburst Hospitality Corporation for the period beginning November 1, 1996 through May 31, 1997. The Company paid $18,880,000 in income taxes for the calendar year ended December 31, 1998, and $9,060,000 for the short period beginning June 1, 1997 and ending December 31, 1997. Consistent with the existing Company tax-sharing policy, current Federal provision amounts prior to October 15, 1997 have been treated as paid to, or received from, the Company, and as such, there are no current tax provision balances due to the Sunburst Hospitality Corporation at May 31, 1997. Differences between amounts paid to or received from Sunburst Hospitality Corporation 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 as of December 31: (In thousands) 1998 1997 ----------------------- Accrued salaries & benefits $ 10,152 $ 8,495 Accrued interest 3,302 2,026 Reservation fund payable -- 4,542 Other 6,152 5,639 ----------------------- Total $ 19,606 $ 20,702 ======================= LONG TERM DEBT AND NOTES PAYABLE As of December 31, debt consisted of the following: (In thousands) 1998 1997 --------------------- $300 million competitive advance and multi-currency revolving credit facility with an average rate of 5.91% and 6.60% at December 31, 1998 and 1997, respectively $172,000 $267,600 $100 million senior note offering with an average rate of 7.22% at December 31, 1998 99,382 -- $15 million line of credit with a rate of 6.1% at December 31, 1998 6,200 -- Capital lease obligation -- 13,469 Other notes with an average rate of 5.85% and 5.6% at December 31, 1998 and 1997 1,628 1,752 --------------------- Total indebtedness $279,210 $282,821 ===================== 38 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries Maturities of debt as of December 31, 1998 were as follows: YEAR (In thousands) 1999........................................ $ 22,646 2000........................................ 32,646 2001........................................ 42,646 2002........................................ 74,646 2003........................................ 146 Thereafter.................................. 106,480 -------- Total....................................... $279,210 ======== 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 require 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, $22.5 million of which is due in 1999. 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 an initial simple rate of 11% per annum through October 14, 2000. In connection with the amendment of the strategic alliance agreement discussed in "Transactions with Sunburst," effective October 15, 2000, interest shall accrue at a rate of 11% per annum compounded daily. The Company will implement this amendment prospectively beginning January 1, 1999, recognizing interest on the outstanding principal and accrued interest amounts at an effective rate of 10.58%. The note is payable in full, along with accrued interest, on October 15, 2002. Total interest accrued as of December 31, 1998 and 1997 was $12.8 million and $2.4 million, respectively. On May 1, 1998, the Company issued $100 million of senior unsecured notes (the "Notes") at a discount of $0.6 million, bearing a coupon rate of 7.13% with an effective rate of 7.22%. The Notes will mature on May 1, 2008, with interest on the Notes to be paid semi-annually. The Company used the net proceeds from the offering of approximately $99 million to repay amounts outstanding under the Company's $300 million revolving credit facility. Total interest expense of $4.8 million was recorded in the consolidated statements of income for the year ended December 31, 1998. During April 1998, the Company obtained a revolving line of credit for $15 million in order to finance short term working capital requirements and other short term general corporate goals. The line of credit is due to expire on April 30, 1999 and bears interest at floating rates. Interest accrues monthly on the outstanding balance. The line of credit contains essentially the same covenants as the Credit Facility and is prepayable without penalty. Cash paid for interest was $19.2 million, $7.9 million, $11.6 million and $11.8 million for the year ended December 31, 1998, the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996, respectively. LEASES Rental expense under non-cancelable operating leases was approximately $1.7 million, $181,000, $171,000 and $231,000 for the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997 and 1996, respectively. The Company paid office rent of $977,500 and $1.1 million to Sunburst for the year ended December 31, 1998 and the seven months ended December 31, 1997 based on the portion of total space occupied by the Company. Future minimum lease payments are as follows: YEAR (In thousands) 1999........................................ $ 2,462 2000........................................ 2,499 2001........................................ 2,530 2002........................................ 2,489 2003........................................ 2,250 Thereafter.................................. -- ------- Total....................................... $12,230 ======= 39 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries During 1998, the Company recorded an extraordinary gain for the early extinguishment of a capitalized lease obligation. The Company retired $13.7 million in debt and removed related assets of $1.7 million from the consolidated balance sheets. Accordingly, an extraordinary gain of $7.2 million was recognized, after income tax benefits of $4.5 million, or $0.12 per diluted share. Prior to May 31, 1998, the Company was a guarantor of Sunburst's obligations under leases between Sunburst and Manor Care. Additionally, Sunburst and Choice had entered into a sublease agreement with respect to the Company's principal executive offices. On May 31, 1998, the Company and Manor Care entered into a new lease for the Silver Spring, Maryland corporate headquarters and the Company's guarantees of Sunburst lease obligations and the sublease were cancelled. The new lease has a fifteen year term. 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. 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 were 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. In January 1998, the Company completed a transaction with 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 of December 31, 1998, the Company had received $1.0 million. The master franchise payment is being recognized over the life of the agreement. As part of the transaction, Friendly acquired European hotels owned by the Company for $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 received $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 Company reflected the net assets subject to this transaction as assets held for sale in the December 31, 1997, accompanying consolidated balance sheet. At December 31, 1998, the Company owned approximately 5.2% of the outstanding ordinary shares of Friendly which would increase to approximately 45% if the Company's preferred stock were converted. The Company recognized $2.1 million, $0.6 million and $0.9 million in preferred dividend income from the Friendly investment for the year ended December 31, 1998, the seven months ended December 31, 1997 and the fiscal year ended May 31, 1997, respectively. As of December 31, 1998 and 1997, accrued but unpaid preferred dividends were $3.7 million and $1.5 million, respectively. 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 were reflected in Investments and advances from Parent. 40 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries 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. In December 1998, the parties amended the strategic alliance agreement (vi) to eliminate Sunburst's option to acquire the MainStay Suites brand, (vii) to amend Sunburst's development commitments and (viii) to provide certain global amendments to Sunburst's franchise agreements. 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, human resources certain corporate and support services, such as accounting, tax and computer systems support, (ii) will provide to the Company certain services including asset management, and payables processing; (iii) 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, (v) will be reimbursed by the Company for the portion of income taxes paid that relate to the Company and its subsidiaries, and (vi) 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. As of March 31, 1999, all services provided by each party under the Corporate Services Agreement, except for human resources and tax services provided by the Company, will be terminated. Costs associated with the 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. 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 $11.2 million for the year ended December 31, 1998, $6.2 million for the seven months ended December 31, 1997 and $9.5 million and $7.5 million for the fiscal years ended May 31, 1997 and 1996, 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, the Company reflected a $25 million receivable due from Sunburst on the consolidated balance sheet. In 1998, net payments of approximately $8 million were collected from Sunburst in cash. On December 28, 1998, the Company and Sunburst amended the strategic alliance agreement entered into in connection with the Sunburst Distribution. As part of that amendment, the Company exchanged the remaining $17 million balance in return for, among other things, the exclusive rights to the MainStay Suites brand from Sunburst and a commitment from Sunburst to build a total of 25 MainStay Suites. The $17 million, net of income taxes of approximately $7 million, was recorded as an adjustment to additional paid in capital as it represents an adjustment to the accounting for the Sunburst Distribution. RELATED PARTY TRANSACTIONS During 1998, the Company entered into a bridge loan agreement with a Company executive approximating $754,000, which is reflected as a receivable at December 31, 1998. The bridge loan was repaid in March 1999. 41 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries 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 $755,000 and $520,000 at December 31, 1998 and 1997, respectively. During 1998, employees of the Company participated in 401(k) retirement plans sponsored by the Company. For the year ended December 31, 1998, the Company recorded compensation expense of $1.2 million related to the plan. 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 under those plans were based on the size of its payroll relative to the sponsor's payroll. Costs allocated to the Company were approximately $1.2 million, $1.4 million and $0.8 million for the seven months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996, respectively. CAPITAL STOCK In 1998, the Company granted key executives 84,592 restricted shares of common stock with a value of $1,105,403 on the grant date. The restricted stock vests over a three year period. In 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 and vesting over a three year period. In 1998, 42,735 of these shares were forfeited. 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 a 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 acquiror or having a value of twice the exercise price of the right. The Company has stock option plans for which it is authorized to grant options to purchase up to 7.1 million shares of the Company's common stock, of which 1.5 million shares remain available for grant. 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 stock of the newly separated companies and the number and exercise prices of the options were adjusted based on A SUMMARY OF THE OPTION ACTIVITY UNDER THE ABOVE PLANS IS AS FOLLOWS AS OF DECEMBER 31, 1998 AND 1997:
1998 1997 ================================================================== Shares Weighted-Option Shares Weighted-Option FIXED OPTIONS (000) Price (000) Price ================================================================== Outstanding at beginning of year.................. 4,167,045 $ 8.62 4,689,515 $ 8.71 Granted........................................... 933,263 14.01 15,000 17.63 Exercised......................................... (738,318) 4.75 (28,550) 3.32 Cancelled......................................... (392,681) 11.88 (508,920) 10.05 ---------- ------- --------- ------- Outstanding at end of year........................ 3,969,309 $10.28 4,167,045 $ 8.62 ================================================================== Options exercisable at year end................... 1,813,541 1,845,642 Weighted-average fair value of options granted during the year................... $ 7.96 $ 8.79
42 Notes to Consolidated Finanical Statements Choice Hotels International, Inc. and Subsidiaries THE FOLLOWING TABLE SUMMARIZES INFORMATION ABOUT STOCK OPTIONS OUTSTANDING AT DECEMBER 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ======================================================================================== RANGE OF NUMBER WEIGHTED-AVERAGE WEIGHTED NUMBER WEIGHTED EXERCISE PRICES OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE 12/31/98 CONTRACTUAL LIFE EXERCISE PRICE 12/31/98 EXERCISE PRICE ============================================================================================================== $ 2.64 to 3.96 608,383 1.8 years $ 3.17 578,498 $ 3.12 3.96 to 5.94 223,054 3.3 years 4.99 165,797 4.99 5.94 to 8.91 464,642 4.7 years 7.02 270,501 6.92 8.91 to 13.37 1,677,295 7.8 years 12.08 773,453 11.78 13.37 to 17.63 995,935 9.6 years 14.31 25,292 16.91 --------- --------- 3,969,309 1,813,541 --------- ---------
the relative trading prices of the common stock of the two companies in order to retain the intrinsic value of the options. 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 1998 and 1997: 1998 1997 ---- ---- Risk-free interest rate 4.7% 5.65% Volatility 36.7% 23.6% Expected Lives 10 years 10 years Dividend Yield 0% 0% If options had been reported as compensation expense based on their fair value pro forma, net income would have been $54.0 million and $27.3 million for the year ended December 31, 1998 and the seven months ended December 31, 1997, and pro forma earnings per share would have been $0.90 and 0.46, respectively. 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. REPORTABLE SEGMENT INFORMATION The Company has a single reportable segment encompassing its franchising business. Franchising business revenues for the year ended December 31, 1998, the seven months ended December 31, 1997 and fiscal years ended May 31, 1997 and 1996 were $138.3 million, $84.1 million, $120.1 million and $105.4 million; and operating expenses were $28.2 million, $15.4 million, $13.3 million and $14.7 million. Operating expenses include only costs directly associated with the Company's domestic and international franchising service offices and do not include allocation of corporate overhead. Depreciation expense for the franchise segment was $0.2 million for the year ended December 31, 1998 and relates primarily to furniture, fixtures and equipment utilized in these offices. The Company does not allocate amortization expense, interest income, interest expense or income taxes to its franchising segment. All other revenues and expenses included on the Company's statement of income for the year ended December 31, 1998 relate to corporate and other activities. For the year ended December 31, 1998, the seven months ended December 31, 1997 and fiscal years ended May 31, 1997 and 1996 revenues generated by corporate and other activities were $27.1 million, $23.7 million, $47.9 million and $46.4 million; operating expenses were $22.5 million, $14.1 million, $37.8 million and $30.5 million; and depreciation and amortization expense was $6.9 million, $4.0 million, $7.6 million and $9.2 million, respectively. The Company's international operations had revenues of $7.1 million, $11.8 million, $19.8 million and $21.4 million for the year ended December 31, 1998, the seven months ended 43 Notes to Consolidated Financial Statements Choice Hotels International, Inc. and Subsidiaries December 31, 1997 and the fiscal years ended May 31, 1997 and 1996, respectively. Long-lived assets related to international operations were $57.0 million and $38.7 million as of December 31, 1998 and 1997. All other long-lived assets of the Company are associated with domestic activities. FAIR VALUE OF FINANCIAL STATEMENTS 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 senior notes. 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. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" during 1998. The adoption of these pronouncements required the Company to make certain additional disclosures. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities which requires recognition of the fair value of derivatives in the statement of financial position, with changes in the fair value recognized either in earnings or as a component of other comprehensive income dependent upon the hedging nature of the derivative. Implementation of SFAS No. 133 is required for Fiscal 2000. SFAS No. 133 will not have a material impact on the Company's earnings or other comprehensive income. SUBSEQUENT EVENTS (UNAUDITED) As of March 12, 1999, the Company has repurchased 5.4 million shares of its common stock at a total cost of $74.1 million. The Company has authorization from its Board of Directors to repurchase up to an additional 3.3 million shares. As of March 12, 1999, there were 55.4 million total common shares outstanding (a weighted average of 56.1 million). THE FOLLOWING DATA IS INCLUDED FOR 1998 ONLY, AS THE COMPANY WAS NOT A PUBLIC COMPANY FOR THE FULL YEAR OF 1997. SELECTED QUARTERLY FINANCIAL DATA -- (UNAUDITED) (In thousands, except per share data)
TOTAL 1998 FIRST SECOND THIRD FOURTH YEAR ============================================================================================================================== Revenues $33,171 $44,436 $46,731 $41,037 $165,375 Operating income 14,133 23,519 26,736 22,332 86,720 Income before income taxes and extraordinary item 13,961 22,258 25,224 20,957 82,400 Net income before extraordinary item 8,146 12,988 14,718 12,221 48,073 Net income 8,146 12,988 21,950 12,221 55,305 Per basic share: Net income before extraordinary item $ 0.14 $ 0.22 $ 0.25 $ 0.21 $ 0.82 Extraordinary item $ 0.00 $ 0.00 $ 0.12 $ 0.00 $ 0.12 Net income $ 0.14 $ 0.22 $ 0.37 $ 0.21 $ 0.94 Per diluted share: Net income before extraordinary item $ 0.13 $ 0.22 $ 0.25 $ 0.21 $ 0.81 Extraordinary item $ 0.00 $ 0.00 $ 0.12 $ 0.00 $ 0.12 Net income $ 0.13 $ 0.22 $ 0.37 $ 0.21 $ 0.93
44 Board of Directors & Corporate Officers Choice Hotels International, Inc. and Subsidiaries BOARD OF DIRECTORS STEWART BAINUM, JR. . Chairman of the Board: HCR Manor Care, Inc. Sunburst Hospitality Corp. BARBARA BAINUM . President, Secretary & Director: Commonweal Foundation . Secretary & Director: Realty Investment Co. CHARLES A. LEDSINGER, JR. . President & Chief Executive Officer: Choice Hotels International LARRY R. LEVITAN . Retired Managing Partner: Andersen Consulting's Worldwide Communications Industry Group FREDERIC V. MALEK* . Chairman: Thayer Capital Partners . Co-Chairman: CB Richard Ellis, Inc. JERRY E. ROBERTSON, PH.D. . Retired Executive Vice President: 3M Life Sciences Sector and Corporate Services GERALD W. PETTIT . President & Chief Executive Officer: Creative Hotel Associates LLC JAMES H. REMPE . Retired Senior Vice President, General Counsel & Secretary: Manor Care, Inc. * Retiring at the April 29, 1999, board meeting CORPORATE EXECUTIVE OFFICERS STEWART BAINUM, JR. . Chairman of the Board CHARLES A. LEDSINGER, JR. . President & Chief Executive Officer MICHAEL J. DESANTIS . Senior Vice President, General Counsel & Secretary BRUNO GENY . Senior Vice President, International THOMAS MIRGON . Senior Vice President, Administration MARK C. WELLS . Senior Vice President, Marketing CORPORATE OFFICERS JOSEPH M. SQUERI . Vice President, Treasurer & Controller DANIEL ROTHFELD . Vice President, Partner Services KEVIN M. ROONEY . Assistant General Counsel & Assistant Secretary GERALD F. HICKEY . Assistant Treasurer MARKET AREA VICE PRESIDENTS BRENDAN M. EBBS . Senior Vice President, Franchise Operations, Northeast Market Area WILLIAM WEATHERFORD . Senior Vice President, Franchise Operations, Southeast Market Area MICHAEL BARNARD . Vice President, Franchise Operations, West Market Area GARY DECATUR . Vice President, Franchise Operations, North Central Market Area BRENT RUSSELL . Vice President, Franchise Operations, South Central Market Area BRAND MANAGEMENT NORMAN CAVIN . Sleep Inn Brand Management Vice President MICHAEL COTHRAN . Rodeway Inn Brand Management Vice President PETER JORDAN . Quality Brand Management Vice President DONALD KOLODZ . Clarion Brand Management Vice President DAN SHOEN . Comfort Brand Management Vice President TIM SHUY . Econo Lodge & MainStay Suites Brand Management Vice President 45 Corporate Information Choice Hotels International, Inc. and Subsidiaries 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, NJ 07660 INDEPENDENT AUDITORS Arthur Andersen LLP Washington, D.C. ANNUAL MEETING DATE Choice Hotels International will hold its Annual Meeting of Stockholders on Thursday, April 29, 1999, at 9 a.m. at its corporate headquarters, 10750 Columbia Pike, Silver Spring, Md. 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 to the Corporate Secretary at the corporate headquarters. CORPORATE HEADQUARTERS Choice Hotels International 10750 Columbia Pike Silver Spring, MD 20901 GENERAL INQUIRIES: (301) 592-5000 FRANCHISE SALES: (800) 547-0007 INVESTOR INQUIRIES: (800) 404-5050, ext. 5026 or (301) 592-5026 e-mail: investor_relations@choicehotels.com MEDIA RELATIONS: (301) 592-5032 CORPORATE INTERNET SITE: www.choicehotels.com (C)1999 Choice Hotels International, Inc. Quality, Comfort, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay are registered trademarks, ser- vice marks and trade names owned by Choice Hotels International, Inc. Choice Hotels also owns and uses common law marks, including Guest Privileges and Profit Manager. Design: Choice Graphic Design Principal Photographer: Cameron Davidson Printer: S&S Graphics 46 EX-21.1 7 EXHIBIT 21.1 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 International Services Corp. 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-23.1 8 EXHIBIT 23.1 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, No. 333-41357 and No. 333-67737. Arthur Andersen LLP Washington, D.C. March 25, 1999 EX-27.1 9 EXHIBIT 27.1
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-31-1998 DEC-31-1998 1,692 1,257 36,199 8,082 363 35,661 44,720 11,875 398,225 58,468 256,564 0 0 607 55,903 398,225 0 165,375 0 77,182 0 1,473 4,320 82,400 34,327 48,073 0 7,232 0 55,305 0.94 0.93
EX-99.1 10 EXHIBIT 99.1 EXHIBIT 99.1 CHOICE HOTELS INTERNATIONAL, INC. 10750 Columbia Pike Silver Spring, Maryland 20901 ------------------------- NOTICE OF ANNUAL MEETING To Be Held April 29, 1999 ------------------------- To the Stockholders of CHOICE HOTELS INTERNATIONAL, INC. NOTICE IS HEREBY GIVEN that the 1999 Annual Meeting of Stockholders (the "Annual Meeting") of Choice Hotels International, Inc., a Delaware corporation (the "Company"), will be held on Thursday, April 29, 1999 at the Company corporate office, 10750 Columbia Pike, Silver Spring, Maryland at 9:00 a.m. (E.S.T.) for the following purposes: 1. To elect two Class II directors to hold office for a three year term ending at the 2002 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 10, 1999 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. Michael J. DeSantis Secretary March 29, 1999 Silver Spring, Maryland TO VOTE YOUR SHARES, PLEASE SIGN, DATE AND COMPLETE THE ENCLOSED PROXY AND MAIL IT PROMPTLY IN THE ENCLOSED RETURN ENVELOPE. CHOICE HOTELS INTERNATIONAL, INC. 10750 COLUMBIA PIKE SILVER SPRING, MARYLAND 20901 ------------------------- PROXY STATEMENT ANNUAL MEETING OF STOCKHOLDERS APRIL 29, 1999 ------------------------- 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 1999 Annual Meeting of Stockholders of the Company to be held at 9:00 a.m. (E.S.T.) on April 29, 1998, at its Corporate Offices, 10750 Columbia Pike, Silver Spring, 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 29, 1999. The Company's Annual Report (including certified financial statements) for the fiscal year ended December 31, 1998, has been mailed separately from this Proxy Statement. The Annual Report is not part of the proxy solicitation material. 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. 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 two nominees for director named on the proxy card. Abstentions marked on the proxy card are 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 10, 1999 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 55,336,553 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 1 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 36.72% 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. 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 II will be elected at the Annual Meeting to serve for a term expiring at the Company's Annual Meeting in the year 2002. The directors in Classes I and III are serving terms expiring at the Company's annual Meeting of Stockholders in 2001 and 2000, respectively. The Company's Board of Directors has proposed the following nominees for election as directors at the annual meeting: Nominees for Class II Directors With Terms Expiring at the Annual Meeting in the Year 2002: Stewart Bainum, Jr. James H. Rempe 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. Mr. Rempe will attain the age of 70 prior to the annual meeting in 2000 and, according to the By-Laws, must retire at the 2000 Annual Meeting. Except as set forth in the preceding sentence, the Board of Directors knows of no reason why any of the nominees will be unavailable or unable to serve. 2 Nominees for Election as Directors Class II -- Nominees for Terms Expiring in 2002 Stewart Bainum, Jr., 52, Chairman of the Board of the Company from March 1987 to November 1996 and since October 1997; Director of the Company since 1977; Chairman of the Board of Sunburst Hospitality Corporation ("Sunburst") since November 1996; Chairman of the Board of HCR Manor Care, Inc. since September, 1998; Chairman of the Board and Chief Executive Officer of Manor Care, Inc. from March 1987 to September, 1998; Chief Executive Officer of Manor Care and its subsidiary ManorCare Health Services, Inc. ("MCHS") from March 1987 to September, 1998 and President from June 1989 to September, 1998; Vice Chairman of the Board of Vitalink Pharmacy Services, Inc. ("Vitalink") from December 1994 to September, 1998; Vice Chairman of the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director of Manor Care from August 1981 to September 1998, of Vitalink from September 1991 to September, 1998, of MCHS from 1976 to September 1998; 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. James H. Rempe, 68, Retired, Senior Vice President, General Counsel and Secretary of Manor Care from August 1981 to December 1998; Senior Vice President, General Counsel and Secretary of the Company from February 1981 to November 1996; Director of the Company since October 1997; Director of In Home Health Inc. from October 1995 to November, 1998 and Vitalink Pharmacy Services, Inc. from 1994 to September 1998. Directors Whose Term of Office Continue Class I -- Term Expires in 2000 Gerald W. Petitt, 53, 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 and Bessemer Trust Co. Jerry E. Robertson, Ph.D., 66, 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 of Manor Care from 1989 to September 1998; Director: Allianz Life Insurance Company of North America, Cardinal Health, Inc., Coherent, Inc., Haemonetics, Inc., Medwave, Inc., and Steris Corporation. Class III -- Terms Expire 2000 Barbara Bainum, 54, 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. Charles A. Ledsinger, Jr., 49, President, Chief Executive Officer and Director of the Company since August, 1998; President and Chief Operating Officer of St. Joe Company from February 1998 to August 1998, Senior Vice President and Chief Financial Officer of St. Joe Company from May 1997 to February 1998; Senior Vice President and Chief Financial Officer of Harrah's Entertainment, Inc. from June 1995 to May 1997; Senior Vice President and Chief Financial Officer of Promus Companies Incorporated from August 1990 to June 1995. Director: FelCor Lodging Trust, Inc., Friendly's Ice Cream Corporation and TBC Corporation. 3 Lawrence R. Levitan, 57, Retired, Managing Partner, Northeast and Southeast Regions and Managing Partner, Communications Industry of Andersen Consulting from September 1995 to August, 1997. Various positions with Andersen Consulting since 1963. Director: Sequent Computer Systems. Frederic V. Malek,* 62, Chairman of Thayer Capital Partners since March 1993; Co-Chairman of CB Richard Ellis, 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: HCR Manor Care, Inc., Sunburst, Aegis Communications, Inc., American Management Systems, Inc., Automatic Data Processing Corp., CB Richard Ellis, Inc., FPL Group, Inc. (an affiliate of Florida Power and Light-power company), Global Vacation Group, Northwest Airlines and various Paine Webber mutual funds. - -------- * Mr. Malek has retired from the Board of Directors effective as of the Annual Meeting. The Board of Directors 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. At the beginning of 1998, the Board of Directors consisted of nine directors. During the fiscal year, William R. Floyd resigned from the Board of Directors and Stewart Bainum and Robert C. Hazard, Jr. retired. In February 1999, Larry R. Levitan was appointed to fill one of the vacancies. Frederic V. Malek has indicated his intention to retire from the Board of Directors following the Annual Meeting. In fiscal year 1998, the Board of Directors held seven meetings and each director, except for Mr. Malek, attended all of the meetings of the Board of Directors and all of the committees of the Board of Directors on which such director served. Mr. Malek was unable to attend two Board meetings. Committees of the Board The standing committees of the Board of Directors include the Audit Committee and the Compensation/Key Executive Stock Option Plan Committee. At the January 21, 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 & Corporate Plan Committee Governance Committee Jerry E. Robertson, Chair Gerald W. Petitt, Chair Frederic V. Malek Jerry E. Robertson Barbara Bainum Frederic V. Malek Audit Committee Frederick V. Malek, Chair Jerry E. Robertson Gerald W. Petitt The Compensation/Key Executive Stock Option Plan Committee administers the Company's stock option plans and grant stock options thereunder, reviews compensation of officers and key management employees, recommends development programs for employees such as training, bonus and incentive plans, pensions and retirement, and reviews other employee fringe benefit programs. Prior to Mr. Bainum's retirement from the Board, a Compensation/Key Executive Stock Option Plan Committee No. 2 existed on which he did not serve. The purpose of this second committee was to approve matters that required a committee of "outside directors" for which Mr. Bainum did not qualify. Upon his retirement, the second committee was abolished. The Compensation/Key Executive Stock Option Plan Committee met three times during the 1998 fiscal year. 4 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 held one meeting in the 1998 fiscal year. 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. The Audit Committee met twice in fiscal year 1998. Compensation of Directors The Company has adopted the Choice Hotels International, Inc. Non-Employee Director Stock Option and Deferred Compensation Stock Purchase Plan ("Option 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 once a 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 the end of each fiscal quarter. 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. 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. Upon Mr. Bainum's and Mr. Hazard's retirement, the Board of Directors approved the continuing vesting and accelerated vesting, respectively, of their awards under the Option Plan and the Stock Plan. The Board of Directors has also approved the vesting of Mr. Malek's awards under the Option Plan and the Stock Plan upon his retirement following the Annual Meeting. Directors who are employees of the Company receive no separate remuneration for their services as directors. 5 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, the other four most highly compensated executive officers, a former Chief Executive Officer and two former 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 10, 1999, 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 Shares Name of Beneficial Owner Beneficially Owned Outstanding(1) ------------------------ ------------------ ----------------- Stewart Bainum, Jr..................... 15,473,952(2)** 27.84% Barbara Bainum......................... 5,637,599(3)** 10.18% Donald H. Dempsey(4)................... 0 * Michael J. DeSantis.................... 24,155(5) * William R. Floyd(6).................... 150,992(7) * Charles A. Ledsinger, Jr............... 65,842(8) * Larry R. Levitan....................... 0 * Frederic V. Malek...................... 15,204(9) * Thomas Mirgon.......................... 25,627(10) * Gerald W. Petitt....................... 89,055(11) * James H. Rempe......................... 152,050(12) * Jerry E. Robertson, Ph.D............... 29,548(13) * Barry L. Smith(14)..................... 1,490(15) * All Directors and Officers as a Group (11 persons).......................... 15,885,077(16) 28.50% Bruce Bainum........................... 5,624,502(17)** 10.16% Stewart Bainum......................... 10,590,051(18)** 19.14% Ronald Baron........................... 9,697,000(19) 35.59%
- -------- * Less than 1% of class. ** Because of SEC reporting rules, shares held by certain Bainum family entities are attributed to more than one of the Bainums included in this table because such named Bainums have shared voting or dispositive control. 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 36.72% of the number of outstanding shares of Company common stock. 1. Percentages are based on 55,336,553 shares outstanding on March 10, 1999 (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 42,127 shares owned directly by Mr. Bainum, Jr. Also includes 5,417,761 shares owned by Bainum Associates Limited Partnership ("Bainum Associates") and 4,415,250 shares owned by MC Investments Limited Partnership ("MC Investments"), in both of which Mr. Bainum, Jr. is managing general partner with the sole right to dispose of the shares; 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 250,000 shares which Mr. Bainum, Jr. has the right to acquire pursuant to stock options which are presently exercisable or which become exercisable within 60 days after the Record Date, and 1,017 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"). 6 3. Includes 102,677 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, 112,200 shares owned by Vintage L.P., in which Ms. Bainum is a shareholder and director of the corporate general partner and shares voting authority, and 70,305 shares owned by the Commonweal Foundation, in which Ms. Bainum is President and Director and has shared voting authority. Also includes 3,089 shares of restricted stock issued to Ms. Bainum which shares are not vested, but which Ms. Bainum has the right to vote and 1,831 shares which Ms. Bainum has the right to acquire pursuant to stock options which are currently exercisable or become exercisable within 60 days of the Record Date. 4. Mr. Dempsey resigned from the Company in July 1998. 5. Includes 13,490 shares which Mr. DeSantis has the right to acquire pursuant to stock options which are currently exercisable or become exercisable within 60 days of the Record Date. Also includes 106 and 5,569 shares, respectively under the 401(k) Plan and Non-Qualified Plan. 6. Mr. Floyd resigned from the Company in June 1998. 7. Includes 150,892 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. 8. Consist of restricted stock not yet vested, but which Mr. Ledsinger has the right to vote. 9. Includes 3,523 shares owed directly; 7,665 shares which Mr. Malek has the right to acquire pursuant to stock options which are presently exercisable or become exercisable within 60 days of the Record Date and 4,016 restricted shares granted under the Non-Employer Director Stock Compensation Plan ("Stock Compensation Plan") which are not vested, but which Mr. Malek has the right to vote. 10. Includes 24,073 shares which Mr. Mirgon has the right to acquire pursuant to stock options which are currently exercisable or become exercisable within 60 days of the Record Date. 11. Includes 77,304 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 3,090 restricted shares granted under the Stock Compensation Plan which are not yet vested, but which Mr. Petitt has the right to vote. 12. Includes 59,882 shares held directly and 89,861 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 2,477 restricted shares granted under the Stock Compensation Plan which are not yet vested, but which Mr. Rempe has the right to vote. 13. Includes 6,299 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 3,354 restricted shares granted under the Stock Compensation Plan which are not yet vested, but which Mr. Robertson has the right to vote. Also includes 4,395 shares which Mr. Robertson has the right to acquire pursuant to stock options which are presently exercisable or become 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. 14. Mr. Smith retired from the Company in April 1998. 15. Consist of 606 shares and 884 shares, respectively which Mr. Smith has the right to receive pursuant to the terms of the 401(k) Plan and the Non- Qualified Savings Plan. 16. Includes a total of 404,935 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 106 shares and 9,657 shares, respectively, which such directors and officers have the right to receive pursuant to the terms of the 401 (k) Plan and the Non-Qualified Savings Plan. 17. 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, 112,200 shares owned by Vintage L.P., in which Mr. Bainum is a shareholder and director of the corporate general partner and 7 shares voting authority and 70,305 shares owned by the Commonweal 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. 18. Includes 2,523 shares held directly by Mr. Bainum, 3,906,542 shares held directly by the Stewart Bainum Declaration of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his joint interest in 983,878 shares owned by Bainum Associates and 1,248,542 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 Commonweal Foundation of which Mr. Bainum is Chairman of the Board of Directors and has shared voting authority. Also includes 798,711 shares held by the Jane L. Bainum Declaration of Trust, the sole trustee and beneficiary of which is Mr. Bainum's wife, and 7,665 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 4,016 shares of restricted stock granted by the issuer to Mr. Bainum under the Stock Compensation Plan, which are not vested but which Mr. Bainum has the right to vote. 19. 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 January , 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. 8 EXECUTIVE COMPENSATION Compensation received by the Named Officers prior to consummation of the Former Choice Spinoff/1/ 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 Named Officers after the Spinoff was paid by the Company. - -------- 1. 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 and the Company were subsidiaries 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. Summary Compensation Table
Annual Compensation(1) Long-Term Compensation --------------------------------- ---------------------------------------------- Name and Principal Fiscal Restricted Stock Option All Other Position Year(1) Salary Bonus Other StockAwards(5) Shares(#)(2) Compensation(3) ------------------ ------- -------- ------- -------- -------------- ------------ --------------- Stewart Bainum, Jr.(4).. 1998 $169,149 $57,829 (5) -- 57,300 $6,453 Chairman 1997A 148,310 47,683 (5) -- -- -- 1997B 656,357 388,520 (5) -- 60,000(6) -- 1996 625,102 337,555 (5) -- 60,000(7) 33,543 Charles A. Ledsinger, Jr.(8)................. 1998 159,633 -- $99,632(9) $825,000 598,563 -- President and Chief Executive Office Thomas Mirgon(10)....... 1998 239,325 92,083 (5) -- 22,500 -- Senior Vice President, Administration 1997A 188,423 51,315 $169,624(11) -- 7,100(12) -- 1997B 58,477 26,315 (5) -- 40,000(13) -- 1996 -- -- -- -- -- -- Michael J. DeSantis(14)........... 1998 166,538 36,750 (5) -- 22,500 1,920 Senior Vice President, General Counsel and Secretary.............. 1997A 122,870 19,204 (5) -- 40,000(15) -- 1997B 99,530 3,477 (5) -- -- -- 1996 35,625 -- -- -- -- -- Mark C. Wells(16)....... 1998 167,115 -- 121,130(17) 300,000 65,000 -- Senior Vice President, Marketing William R. Floyd(18).... 1998 224,841 193,634 (5) -- -- 459,975(19) 1997A 437,260 267,233 $139,403(20) -- 65,000(21) -- 1997B 270,373 146,001 (5) $250,000(23) 307,693(24) -- 1996 -- -- -- -- -- -- Barry L Smith(25)....... 1998 162,058 74,354 (5) -- -- 144,337(26) 1997A 254,231 108,000 (5) - 37,900(27) 11,086 1997B 240,000 108,000 (5) - 25,000(28) 11,086 1996 233,650 116,820 (5) -- 5,000(29) 10,427 Donald H. Dempsey(30)... 1998 171,250 -- 46,100(31) 249,152 100,000 --
9 - -------- 1. On September 16, 1997, the Company changed its fiscal year end from May 31 to December 31. Accordingly, the summary compensation information presented for the periods prior to 1998 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. and Smith, the grants in 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, Former Choice/Sunburst for 1997A and the Company for 1998 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 the Company during 1998 under the 401(k) Plan and Non-qualified Savings Plan, respectively, for the Named Offices were as follows: Mr. Bainum, Jr., $0 and $6,453; Mr. DeSantis, $1,920 and $0; Mr. Floyd, $2,370 and $0; and Mr. Smith, $5,925 and $5,911. 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. 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. Ledsinger's employment as President and Chief Executive Officer commenced August, 1998. 9. Includes $95,571 in relocation expenses. 10. Mr. Mirgon's employment with the Company and Former Choice commenced March 3, 1997. 11. Consists of $160,994 in relocation expenses and $8,630 in automobile allowance. 12. 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. 13. 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. 14. Mr. DeSantis' employment commenced in January 1996. He was appointed Senior Vice President, General Counsel and Secretary in June 1997. 15. 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. 16. Mr. Wells' employment as Senior Vice President, Marketing commenced May 1998. 17. Includes $115,638 in relocation expenses. 18. Mr. Floyd's employment as Chief Executive Officer of Former Choice and the Company commenced October 16, 1996 and ended on June 16, 1998. 19. In connection with Mr. Floyd's resignation, the Company agreed to continue payments to Mr. Floyd in an amount equal to one year's base salary and automobile allowance in consideration of the cancellation of his employment agreement and confidentiality undertakings. The amount of such payments paid in 1998 is $227,033. 20. Consists of $127,703 in relocation expenses (including $107,831 reported under 1997B) and $11,700 in automobile allowance. 10 21. 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. 22 Consists of relocation expenses. 23. 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. In connection with his resignation, Mr. Floyd forfeited 42,735 shares. 24. 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. 25. Mr. Smith retired from the Company in May 1998. 26. Includes $132,500 in consulting fees paid pursuant to a Consulting Agreement with the Company for a term from Mr. Smith=s retirement through December 15, 1998. 27. 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. 28. 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. 29. 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. 30. Mr. Dempsey resigned from the Company in July 1998. 31. Includes $40,607 in relocation expenses. STOCK OPTION GRANTS IN 1998
Potential Realizable Value of Assumed Rate of Stock Price Appreciation for Individual Grants Option Term(1) ---------------------------------------------- ---------------------- Percentage of Total Options Number of Granted to all Exercise Options Employees in Base Price Expiration Name Granted 1998 Per Share Date 5%(2) 10%(3) ---- --------- -------------- ---------- ---------- ---------- ----------- Stewart Bainum, Jr. (4).................... 47,300 4.4% $ 14.125 9/23/08 $ 420,170 $ 1,064,798 Charles A. Ledsinger, Jr. (4)................ 598,563 56.2% $ 12.53 7/31/08 $4,716,676 $11,953,063 Thomas Mirgon (4)....... 22,500 2.1% $14.8437 1/26/08 $ 210,040 $ 532,282 Michael J. DeSantis (4).................... 22,500 2.1% $14.8437 1/26/08 $ 210,040 $ 532,292 Mark C. Wells (4)....... 65,000 6 .1% $ 16.00 5/18/08 $ 654,050 $ 1,657,494 William R. Floyd........ 0 -- -- -- -- -- Barry L. Smith.......... 0 -- -- -- -- -- Donald H. Dempsey ...... 100,000 9.4% $14.6563 1/12/08(5) $ 921,730 $ 2,335,840
- -------- 1. The dollar amounts under these columns are the result of calculations at the 5% and 10% rates set by the Securities and Exchange Commission and therefore are not intended to forecast future possible appreciation, if any, of the stock price. Since options are granted at market price, a zero percent gain in the stock price will result in no realizable value to the optionees. 2. A 5% per year appreciation in stock price from $14.125 per share yields $23.0081, from $14.8437 per share yields $24.1788, from $12.53 per share yields $26.0623, from $12.53 per share yields $20.41, and from $14.6563 per share yields $23.8736. 3. A 10% per year appreciation in stock price from $14.125 per share yields $36.6366, from $14.8437 per share yields $38.5007, from $16.00 per share yields $41.4999, from $12.53 per share yields $32.4996, and from $14.6563 per share yields $38.0147. 4. 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. 5. Such options were forfeited upon Mr. Dempsey's resignation. 11 AGGREGATED OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES
Number of Unexercised Options at December, 31, 1998 -------------------------------- Value of Unexercised Shares Acquired Value in-the-money Options-- on Exercise Realized Exercisable Unexercisable at December 31, 1998(1) --------------- -------- -------------- --------------- ------------------------- Name # $ # # Exercisable Unexercisable ---- --------------- -------- -------------- --------------- ----------- ------------- Stewart Bainum, Jr...... 105,000 $982,107 250,000 152,300 $2,047,611 $ 450,370 Charles A. Ledsinger, Jr..................... -- -- 0 598,563 -- $ 374,102 Thomas Mirgon........... -- -- 10,585 64,839 $ 4,574 $ (11,938) Michael J. DeSantis.. .. -- -- 8,990 58,456 $ 2,690 $ (19,475) Mark C. Wells........... -- -- 0 65,000 -- $(162,500) Donald H. Dempsey....... -- -- 0 0 -- -- William R. Floyd........ -- -- 150,892 0 $ 133,603 -- Barry L. Smith.......... 83,384 731,475 0 0 -- --
- -------- 1. The closing prices of Company common stock as reported by the New York Stock Exchange on December 31, 1998 was $13.50. The value is calculated on the basis of the difference between the option exercise price and such closing price multiplied by the number of shares of Company common stock underlying the option. Employment Agreements The Company entered into an employment agreement with Stewart Bainum, Jr., providing for Mr. Bainum, Jr.'s employment as Chairman of the Company's Board of Directors. The agreement has a term of three years. Either Choice or Mr. Bainum may terminate the agreement upon 30 days' prior written notice on the first and second anniversary dates of the agreement. Under the agreement, Mr. Bainum, Jr. is currently paid a base salary of $127,500 per annum for services to the Company and a maximum bonus of 60% of Mr. Bainum, Jr.'s base compensation based upon the performance of the Company. The Company entered into an employment agreement Charles A. Ledsinger. The agreement has a term of five years from July 31, 1998 and provides for a base salary of $500,000 per annum, subject to annual adjustments and an annual bonus of up to 60% of his base compensation, based on Company performance. The agreement also provides for a make-whole bonus payment to compensate Mr. Ledsinger for the pro rata portion of a bonus from his previous employer that he forfeited upon employment with the Company. Pursuant to the employment agreement, Mr. Ledsinger was granted 65,842 shares of restricted Company common stock and options to purchase 598,563 shares of common stock, of which 39,900 of the options were incentive stock options granted under the Former Choice 1996 Long Term Incentive Plan. The remainder of the options were non-qualified stock options. The agreement also contains a change of control provision which provides for a severance payment equal to 200% of his base salary and 75% of a prior year's bonus if he is terminated within twelve months of a change of control of the Company. The Company assumed an employment agreement between Former Choice and Thomas Mirgon. The agreement has a term of five years from March 3,1997 and provides for a base salary of $230,000 per annum, subject to annual adjustments and an annual bonus of up to 50% of his base compensation, based on the Company's performance. The agreement also provides for (i) a one-time cash payment of $50,000, payable in two equal installments: the first within 30 days of March 3, 1997 and the second within 30 days of March 3, 1998; and (ii) a grant of 30,000 non-qualified options and 10,000 incentive stock options. The Company entered into an employment agreement with Mark C. Wells. The agreement has a term of five years from May 18, 1998 and provides for a base salary of $275,000 per annum, subject to annual adjustments and an annual bonus of up to 50% of his base compensation, based on performance. Pursuant to the employment agreement, Mr. Wells was granted 18,750 shares of restricted Company common stock and options to purchase 65,000 shares of common stock, of which 16,250 of the options were incentive stock options granted under the Former Choice 1996 Long Term Incentive Plan. The remainder of the options were non- qualified stock options. 12 The Company entered into an employment agreement with Michael J. DeSantis. The agreement has a term of five years from April 29, 1998 and provides for a base salary of $170,000 per annum, subject to annual adjustments and an annual bonus of up to 50% of his base compensation, based on performance. The Company assumed an employment agreement between Former Choice and William R. Floyd, who resigned from the Company in June 1998. The agreement had a term of five years from October 21, 1996 and provided for a base salary of $425,000 per annum, subject to annual adjustments and an annual bonus of up to 60% of his base compensation, based on performance (including a customer satisfaction component). Pursuant to the employment agreement, prior to the Spinoff, Former Choice granted to Mr. Floyd 85,470 shares of restricted Former Choice common stock and options to purchase 307,693 shares of Former Choice common stock, of which 34,188 of the options were incentive stock options granted under the Former Choice 1996 Long Term Incentive Plan. The remainder of the options were non-qualified stock options. Upon assumption of the Employment Agreements by the Company, such restricted stock and options were adjusted and converted into Company common stock and options. In connection with his resignation, the Company and Mr. Floyd entered into an Agreement which terminated the employment agreement and provided for one-year of base salary and automobile allowance, continued vesting of stock options until June 16, 1999, and the vesting of one-half of the restricted common stock which vested on November 4, 1998. The remaining options and restricted stock were forfeited. The Company entered into an employment agreement with Donald H. Dempsey, who resigned from the Company in July, 1998. The agreement had a term of five years from January 12, 1998 and provided for a base salary of $325,000 per annum, subject to annual adjustments, and an annual bonus of up to 55% of his base compensation, based upon the Company's performance. The agreement also provided for an award of 17,000 restricted shares of the Company's common stock and options to acquire 100,000 shares of the Company's common stock, both granted on January 12, 1998. Upon his resignation, all options and restricted stock were forfeited. On December 18, 1997, the Company entered into a consulting agreement with Barry L. Smith under which Smith provided consulting services to the Company upon his retirement in May 1998 until December 15, 1998. Smith received consulting fees of $132,500 during the term of the consulting agreement. Smith agreed that during the term of the agreement, he would not compete with the Company. Retirement Plans The Company has adopted the Choice Hotels International, Inc. Supplemental Executive Retirement Plan (the "SERP"). Participants are the CEO and Senior Vice Presidents and other officers who report directly to the CEO. Participants in the SERP receive a monthly benefit for life based upon final average salary and years of service. Final average salary is the average of the monthly base salary, excluding bonuses or commissions, earned in a 60 month period which produces the highest average out of the 120 months of employment, prior to the first occurring of the early retirement date or the normal retirement date. The nominal retirement age is 65, and participants must have a minimum of 15 years of service. Participants may retire at age 60 and may elect to receive reduced benefits commencing prior to age 65, subject to Board approval. All of the Named Officers who are participants, except for Mr. Smith, are age 55 or younger, so that none of their compensation reported above would be included in the final average salary calculation. See "Employment Agreements" for a discussion of the terms applicable to Mr. Floyd's participation in the SERP. 13 Assuming that the following officers continue to be employed by the Company until they reach age 65, their credited years of service are as follows:
Current Years Years of Service Name of Individual of Service at Age 65 ------------------ ------------- ---------------- Charles A. Ledsinger....................... 0 16 Thomas Mirgon.............................. 2 24 Mark C. Wells.............................. 1 17 Michael J. DeSantis........................ 3 28
The table below sets forth estimated annual benefits payable upon retirement to persons in specified compensation and years of service classifications. These benefits are straight life annuity amounts, although participants have the option of selecting a joint and 50% survivor annuity or ten-year certain payments. The benefits are not subject to offset for social security and other amounts. Years of Service/Benefit as Percentage of Final Average Salary
25 or Remuneration 15/15% 20/22.5% more/30% ------------ ------- -------- -------- $300,000 $45,000 $67,500 $90,000 350,000 52,500 78,750 105,000 400,000 60,000 90,000 120,000 450,000 67,500 101,250 135,000 500,000 75,000 112,500 150,000 600,000 90,000 135,000 180,000
In October 1997, the Company established the Choice Hotels International, Inc. Retirement Savings and Investment Plan (the "401(k) Plan"). The 401(k) Plan is a defined contribution retirement, savings and investment plan qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), and includes a cash or deferred arrangement under Section 401(k) of the Code. All employees age 21 or over and who have worked for the Company for a twelve month period during which such employee completed at least 1,000 hours will be eligible to participate. Subject to certain non-discrimination requirements, each employee will be able to contribute an amount to the 401(k) Plan on a pre-tax basis up to 15% of the employee's salary, but not more than the current Federal limit of $10,0 00. The Company will match contributions made by its employees subject to certain limitations. The amount of the match will be equal to a percentage of the amount of salary reduction contribution made on behalf of a participant during the plan year based upon a formula that involves the profits of the Company for the year and the number of years of service of the participant. Amounts contributed by the Company pursuant to its 401(k) Plan for Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation." The Company also adopted the Choice Hotels International, Inc. Non-Qualified Retirement Savings and Investment Plan ("Non-Qualified Savings Plan"). Certain select highly compensated members of management of the Company will be eligible to participate in the Non-Qualified Savings Plan. The Non-Qualified Savings Plan is structured so as to provide the participants with a pre-tax savings vehicle to the extent that pre-tax savings are limited under the 401(k) Plan as a result of various governmental regulations, such as non-discrimination testing. Amounts contributed by the Company under its Non-Qualified Savings Plan for fiscal year 1998 for the Named Officers are included in the Summary Compensation Table under the column headed "All Other Compensation." The Company match under the 401(k) Plan and the Non-Qualified Savings Plan is limited to a maximum aggregate of 6% of the annual salary of a participant. Likewise, participant contributions under the two plans will not exceed the aggregate of 15% of the annual salary of a participant. 14 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 During part of fiscal year 1998, there were two compensation committees for the Company, the Compensation/Key Executive Stock Option Plan Committee (the "Committee") and the Compensation/Key Executive Stock Option Plan Committee No. 2 ("Committee No. 2"). The role of Committee No. 2, which was comprised of "outside directors" as defined in Section 162(m)(3) of the Code, was to approve awards under the 1997 Long-Term Incentive Plan to the Chief Executive Officer and the Named Officers defined below. However, since the retirement of Stewart Bainum from the Board of Directors, the role of Committee No. 2 has been assumed by the Committee and Committee No. 2 has been abolished. The current members of the Committee, Messrs. Robertson (Chairman), Malek and Ms. Bainum, were appointed effective November 21, 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 January 1998. In June 1998, William R. Floyd, Chief Executive Officer and President, resigned from the Company. In September 1998, Charles A. Ledsinger, Jr. was appointed Chief Executive Officer and President. For the twelve months ended December 31, 1998, compensation for the current 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. 15 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 in July 1998, it was acquired by Meditrust Companies, which has diversified holdings in real estate, healthcare and hospitality. It was included as a comparison company for compensation purposes because such comparison was done before the acquisition. Policy with Respect to Qualifying Compensation for Deductibility Section 162(m) of the Code imposes a $1 million ceiling on tax-deductible compensation paid to the Chief Executive Officer and the next four most highly compensated executive officers. 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 Charles A. Ledsinger's employment agreement, Mr. Ledsinger was granted 65,842 non-performance based restricted shares of Company Common Stock which vest in three equal annual installments beginning July 31, 1999. At vesting (unless Mr. Ledsinger elects to defer receipt), the fair market value of the stock will be compensation to Mr. Ledsinger and included in calculating the $1 million ceiling. Additionally, the employment agreement provides for options to purchase 498,563 shares of Company Common Stock which were granted outside of the 1997 Incentive Plan and which vest in five equal yearly installments beginning July 31, 1999. Upon the exercise of such options by Mr. Ledsinger 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. Annual merit adjustments for the executive officers affecting compensation paid in the twelve months ended December 31, 1998 were set in January 1998. In 1997, the Committee revised its performance measurements for awards under the annual cash bonus program 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 measurements include 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 1998 fiscal year, 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 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 Committee reviewed and approved a Stock Option Guide Chart for the Company's executives which utilizes a market based salary multiple to establish a competitive range of stock options from which executive awards could be determined. 16 Compensation of the Chief Executive Officer Mr. Floyd served as Chief Executive Officer and President until June 1998. His base salary was established by his rights under his employment agreement, approved by the Committee. The base salary was reviewed each year by the Committee and was subject to merit increases based primarily on his achievement of performance objectives and the comparison to competitive market data and the comparison companies. In September 1997, the Committee approved a 5% merit increase to Mr. Floyd's base salary. Under the annual cash bonus program, Mr. Floyd had the potential to be awarded up to 60% of his base salary if bonus objectives were achieved. Unlike the other executive officers, Mr. Floyd's bonus objectives were tied 100% to earning per share. Mr. Floyd received his full bonus payout for fiscal year 1997 in February 1998. Mr. Ledsinger was appointed Chief Executive Officer and President in August 1998. His base salary is established by his rights under his employment agreement, approved by the 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 February 1999, the Committee approved a 5% annualized (3.75% pro rata) merit increase to Mr. Ledsinger's base salary. Under the annual cash bonus program, Mr. Ledsinger has the potential to be awarded up to 60% of his base salary if bonus objectives are achieved. Unlike the other executive officers, Mr. Ledsinger's bonus objectives are tied 100% to earning per share. For the fiscal year ended December 31, 1998, actual performance exceeded the goals for earnings per share. In addition to the pro rata bonus payout for fiscal year 1998, Mr. Ledsinger's employment agreement provided for a make-whole provision with respect to the pro rata portion of a bonus from his previous employer which he forfeited when he accepted employment with the Company. THE COMPENSATION COMMITTEE Jerry E. Robertson, Chairman Frederic V. Malek Barbara Bainum 17 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, Cendent Corporation and Hilton Hotels Corp. 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.
October 10, December 31, March 31, June 30, September 30, December 31, 1997 1997 1998 1998 1998 1998 ----------- ------------ --------- -------- ------------- ------------ --- Choice Hotels 100 94.1 108 79.8 74.6 80.5 NYSE Composite Index 100 101.5 114.2 116.3 102.0 121.8 Peer Group 100 100.6 111.4 98.3 65.5 77.8
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RELATED TRANSACTIONS Creative Hotel Associates LLC is a franchisee of the Company with Sleep Inns in Ormond Beach, Florida and Albuquerque, New Mexico and a Comfort Inn and Suites in Carbondale, Colorado. Robert C. Hazard, Jr. is 18 Chairman of Creative Hotel Associates LLP and Gerald W. Petitt is the President and Chief Executive Officer. Total payments to the Company for fiscal year 1998 were $212,000. The Company and Creative Hotels have also entered into an agreement which provides for no royalty fees for two selected hotels for a period of five years. Mr. Petitt is a director of the Company and Mr. Hazard, Jr. retired from the Board of Directors in August, 1998. Pursuant to its relocation policy, the Company entered into a bridge loan agreement with Charles A. Ledsinger in the amount of $754,000 for the purchase of his residence. The bridge loan was interest-free and was repaid in March 1999. Also under its relocation policy, the Company purchased Mr. Ledsinger Jr.'s previous residence. In March 1999, the Company sold the residence to a third party. Relationship with Manor Care Stewart Bainum, Jr. is the Chairman of the Company's Board of Directors and is also the Chairman of the Board of Directors of HCR Manor Care, the parent company of Manor Care. Additionally, Stewart Bainum, who retired as a Director of the Company in August 1998, is a director of HCR Manor Care and James Rempe, who is a Director of the Company, served as Senior Vice President and General Counsel of Manor Care until December 1998. Additionally, Messrs. Bainum, Bainum Jr. and Rempe, as well as certain other officers and directors of HCR Manor Care own shares and/or options or other rights to acquire shares of the Company. In connection with the Spinoff, the Company, Sunburst and Manor Care entered into an Omnibus Amendment and Guaranty Agreement (the "Amendment and Guaranty") pursuant to which the Company (i) became a party to certain agreements entered into between Manor Care and Former Choice at the time of the Former Choice Spinoff, (ii) guaranteed Sunburst's payment obligations under the Gaithersburg Lease and the Silver Spring Lease (each as defined below), (iii) guaranteed Sunburst's payment obligations to Manor Care under an agreement pursuant to which Manor Care provided to Former Choice/Sunburst certain consulting services, and (iv) guaranteed Sunburst's payment obligations under a loan note (the "MNR Note") in the principal amount of $225,772,500 payable by Former Choice to MNR Finance Corp., a subsidiary of Manor Care. The Gaithersburg Lease and the Silver Spring Lease and the related guarantees were terminated in May, 1998, see "Relationship with Sunburst--Lease Agreements." All amounts due under the MNR Note were repaid at the time of the Spinoff. Relationship with Sunburst In connection with the Spinoff, the Company and Sunburst entered into certain agreements intended to govern the relationship between the parties after the Spinoff. In addition, Sunburst is the Company's largest franchisee, with a portfolio of 88 hotels containing 12,125 rooms located in 28 states as of March 1999. The material terms of certain of these agreements and other arrangements, entered into between the Company and Sunburst, including the franchise agreements with respect to Sunburst's hotels, are described below. Distribution Agreement In connection with the Spinoff, the Company and Sunburst entered into a Distribution Agreement which provided for, among other things, the principal corporate transactions required to effect the Spinoff, the assumption by the Company of all liabilities relating to its business and the allocation between the Company and Sunburst of certain other liabilities, certain indemnification obligations of Sunburst and Choice and certain other agreements governing the relationship between the Company and Sunburst with respect to or in consequence of the Spinoff. Subject to certain exceptions, the Company has agreed to indemnify Sunburst and its subsidiaries against any loss, liability or expense incurred or suffered by Sunburst or its subsidiaries arising out of or related to the failure by the Company to perform or otherwise discharge liabilities allocated to and assumed by the Company under the Distribution Agreement, and Sunburst has agreed to indemnify the Company against any loss, liability or expense incurred or suffered by the Company arising out of or related to the failure by Sunburst to perform or otherwise discharge the liabilities retained by Sunburst under the Distribution Agreement. The foregoing cross-indemnities do not apply to indemnification for tax claims and liabilities, which are addressed in the Tax Sharing Agreement described below. 19 To avoid adversely affecting the intended tax consequences of the Spinoff, each of the Company and Sunburst will agree to comply in all material respects with each representation and statement made to any taxing authority in connection with the IRS tax ruling or any other tax ruling obtained by the Company and Sunburst in connection with the Spinoff. Under the Distribution Agreement, each of the Company and Sunburst were granted access to certain records and information in the possession of the other, and requires the retention of such information in its possession for specified periods and thereafter requires that each party give the other prior notice of its intention to dispose of such information. In addition, the Distribution Agreement provides for the allocation of shared privileges with respect to certain information and requires each of the Company and Sunburst to obtain the consent of the other prior to waiving any shared privilege. In accordance with the 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 the Spinoff. As of December 31, 1997 the Company reflected a $25 million receivable due from Sunburst on its consolidated balance sheet. In 1998, net payments of approximately $8 million were collected from Sunburst in cash. On December 28, 1998, the Company and Sunburst amended the Strategic Alliance Agreement (defined below) entered into in connection with the Spinoff. As part of that amendment, the Company exchanged the remaining $17 million balance in return for, among other things, the termination of Sunburst's option for the exclusive rights to the MainStay Suites brand and a commitment from Sunburst to build a total of 25 MainStay Suites. Strategic Alliance Agreement At the time of the Spinoff, the Company and Sunburst entered into a Strategic Alliance Agreement pursuant to which: (i) Sunburst granted a right of first refusal to the Company to franchise any lodging property that Sunburst develops or acquires and intends to operate under franchise; (ii) Sunburst has also agreed, barring a material change in market conditions, to continue to develop Sleep Inns and MainStay Suites hotels so that it will have opened a total of 14 Sleep Inns and 15 MainStay Suites hotels by October 15, 2001 (48 months of the Spinoff); (iii) The Company granted to Sunburst an option, exercisable under certain circumstances, to purchase the brand names, marks, franchise agreements and other assets of the MainStay Suites hotel system; (iv) the Company and Sunburst agreed to continue to cooperate with respect to matters of mutual interest, including new product and concept testing for the Company in hotels owned by Sunburst; and (v) Sunburst authorized the Company to negotiate with third party vendors on Sunburst's behalf for the purchase of certain items. The Strategic Alliance Agreement extends for a term of 20 years with rights of mutual termination on the fifth, tenth and fifteenth anniversaries. On December 28, 1998, Sunburst and the Company amended the Strategic Alliance Agreement to: (i) cancel Sunburst's option to acquire the MainStay Suites system; (ii) change Sunburst's development obligations to 13 Sleep Inns and 25 MainStay Suites by October 15, 2001; and (iii) provide certain other global amendments to Sunburst's franchise agreements. Amendment and Guaranty In connection with the Spinoff, the Company entered into the Amendment and Guaranty for the purpose of adding the Company as a party to certain agreements entered into between Former Choice and Manor Care in connection with the Former Choice Spinoff and adding the Company as a guarantor of certain payment obligations of Sunburst to Manor Care pursuant to agreements between Former Choice and Manor Care. For a discussion of the Amendment and Guaranty, see "Certain Relationships and Related Transactions--Relationship with Manor Care" and "--Lease Agreements." Term Note In connection with the Spinoff, the Company loaned to Sunburst approximately $115 million which was used by Sunburst to repay approximately $96 million outstanding under Former Choice's credit facility and to repay that portion of the Former Choice indebtedness under the MNR Note allocated to Sunburst in connection with the Spinoff (approximately $37 million). 20 This loan is represented by a Term Note in an aggregate principal amount of $115 million (the "Term Note"). The Term Note has a maturity of five years and initially accrues interest monthly at an simple rate of 11% per annum though October 14, 2000. At October 15, 2000, interest accrues at a rate of 11% per annum compounded daily. The Term Note is subordinated to all senior debt of Sunburst and contains certain restrictive covenants comparable to those contained in Sunburst's senior credit facility (including restrictions on Sunburst's ability to make certain investments, incur debt, pay dividends, dispose of assets and create liens on its assets). Corporate Services Agreement The Company and Sunburst entered into a Corporate Services Agreement which provides that the Company will provide to Sunburst certain corporate support services, including human resources, accounting, tax and computer systems support, and Sunburst will provide to the Company certain services including asset management and accounts payable processing. As of March 31, 1999, all services provided by each party under the Corporate Services Agreement, except for human resources and tax services provided by the Company, will be terminated. During fiscal year 1998, the Company paid Sunburst $168,660 and Sunburst paid the Company $1,664,750 for services under the Corporate Services Agreement. Consulting Agreement The Company and Sunburst entered into a Consulting Agreement in which Sunburst will provide consulting and advisory services to the Company related to financial issues affecting Sunburst. The term of the agreement commences October 15, 1997 and terminated on November 1, 2001. Sunburst is entitled to an annual retainer fee equal to 30% of the annual compensation (including base salary, incentive bonus and fringe benefits) paid to James A. MacCutcheon by Sunburst during such period. If Mr. MacCutcheon ceases to be employed by Sunburst, the agreement can be terminated by either party, but if terminated by Sunburst, then the Company shall pay Sunburst a termination fee equal to 30% of any amount due by Sunburst to Mr. MacCutcheon under his employment agreement as a result of his separation, During fiscal year 1998, the Company paid Sunburst $116,268 pursuant to the Consulting Agreement. Tax Sharing Agreement The Company and Sunburst have entered into a Tax Sharing Agreement for purposes of allocating tax liabilities of Former Choice from before the Spinoff among the Company and Sunburst and their respective subsidiaries. In general, Sunburst will be responsible for (i) filing consolidated federal income tax returns for the Sunburst affiliated group and combined or consolidated state tax returns for any group that includes a member of the Sunburst affiliated group, including in each case the Company and its subsidiaries for the periods of time that such companies were members of the applicable group and (ii) paying the taxes relating to such tax returns to the applicable taxing authorities (including any subsequent adjustments resulting from the redetermination of such tax liabilities by the applicable taxing authorities). The Company will reimburse Sunburst for the portion of such taxes that relates to the Company and its subsidiaries, as determined based on their hypothetical separate company income tax liabilities. The Company and Sunburst have agreed to cooperate with each other, and to share information, in preparing such tax returns and in dealing with other tax matters. Employee Benefits Allocation Agreement In connection with the Spinoff, the Company and Sunburst entered into an Employee Benefits and Other Employment Matters Allocation Agreement (the "Employee Benefits Allocation Agreement"). The Employee Benefits Allocation Agreement provides for the allocation subsequent to the Spinoff of employee benefits, as they relate to employees who remained employed by Sunburst or its subsidiaries ("Sunburst Employees") after the Spinoff and employees who are employed by the Company or its subsidiaries after the Spinoff ("Choice Employees"). Pursuant to the Employee Benefits Allocation Agreement, Sunburst will continue sponsorship of 21 the various Sunburst profit sharing plans, stock plans and health and welfare plans with respect to Sunburst Employees. The Company has established a number of plans which allow it to provide to its employees substantially the same benefits currently provided to them as employees of Former Choice. The Employee Benefits Allocation Agreement provides for cross-guarantees between the Company and Sunburst with respect to the payment of benefits under certain plans and for cross-indemnification with respect to employment-related claim relating to prior to the Spinoff. The Employee Benefits Allocation Agreement also provided for the adjustment of outstanding options to purchase shares of Sunburst common stock held by Sunburst Employees, Choice Employees and employees of Manor Care who hold such options as a result of the Former Choice Spinoff. As a result of these adjustments, the Company granted options to purchase approximately 5,222,474 shares of common stock to Choice Employees, Sunburst Employees and employees of Manor Care. Lease Agreements Pursuant to the Amendment and Guaranty, the Company was added as a guarantor of Sunburst's obligations under a lease for certain office space in Gaithersburg, Maryland (the "Gaithersburg Lease") a lease agreement with respect to the complex at 10750 and 10770 Columbia Pike, Silver Spring, Maryland (the "Silver Spring Complex") at which Sunburst's principal executive offices were located (the "Silver Spring Lease"). Additionally, Sunburst and Choice entered into a sublease agreement (the "Silver Spring Sublease") with respect to the Silver Spring Lease for the Company's principal executive offices at 10750 Columbia Pike, Silver Spring, Maryland, 20901. The Gaithersburg Lease, the Silver Spring Lease and the Silver Spring Sublease were canceled in May, 1998. In fiscal year 1998, the Company paid to Sunburst $977,500 under the Silver Spring Sublease. Transitional Service Agreements The Company and Sunburst have entered into a number of agreements pursuant to which the Company provides, or will provide, certain continuing services to Sunburst for a transitional period. Such services will be provided on market terms and conditions. Subject to the termination provisions of the specific agreements, Sunburst will be free to procure such services from outside vendors or may develop an in-house capability in order to provide such services internally. Management believes that these agreements are based on commercially reasonable terms including pricing and payment terms. The primary transitional services agreements are summarized below. Pursuant to the Employee Benefits Administration Agreement, the Company provides certain benefits, compensation and other services. Such other services may include benefit plan administration and accounting, COBRA administration, regulatory compliance and certain fiduciary services. Pursuant to the Tax Administration Agreement, the Company provides certain sales, use, occupancy, real and personal property tax return administration, audit and appeals services for Sunburst. Pursuant to the Vehicle Lease Agreement, the Company provides the use of certain vehicles to Sunburst. Franchise Agreements The Clarion, Comfort, Econo Lodge, Sleep Inn, Quality, MainStay Suites and Rodeway marks are each owned by the Company. Each hotel property owned by Sunburst is subject to a franchise agreement between the Company and Sunburst, as franchisee (the "Franchise Agreements"). (The material terms of such agreements are described below.) Total fees paid to the Company for franchising, royalty, marketing and reservation fees for fiscal year 1998 were $11.2 million. Term. Each Franchise Agreement has an initial term of 20 years, except the agreement for Tempe, Arizona which is a year to year agreement. The Franchise Agreements have varying original dates, from 1982 through 22 1996. Certain Franchise Agreements allow for unilateral termination by either party on the 5th, 10th, or 15th anniversary of the Franchise Agreement. Termination by Sunburst. Sunburst (except with respect to one property as described below) may terminate a Franchise Agreement if the Company defaults on its material obligations under such Franchise Agreement and fails to cure such defaults within 30 days following written notice. The Franchise Agreement with respect to the Quality Hotel--Arlington (the "Non-Standard Franchise Agreement") does not allow Sunburst to terminate such Franchise Agreement. Termination by Choice. The Company (except with respect to the Non-Standard Franchise Agreement) may suspend or terminate a Franchise Agreement at any time, if, among other things, Sunburst (a) fails to submit reports when due; (b) fails to pay amounts due under such Franchise Agreement; (c) fails to pay its debts generally as they become due; or (d) receives two or more notices of default for similar reasons for any 12 month period. The Company (except with respect to the Non- Standard Franchise Agreement) may terminate a Franchise Agreement immediately upon notice to Sunburst if, among other things, (a) certain bankruptcy events occur with respect to Sunburst; (b) Sunburst loses possession or the right to possession of the Property; (c) Sunburst breaches transfer restrictions in the related Franchise Agreement; (d) any action is taken to dissolve or liquidate Sunburst; or (e) there is a threat or danger to the public health and safety in the continued operation of the Property. If a Franchise Agreement is terminated by the Company for any of the reasons discussed in the immediately preceding two sentences, Sunburst is required to pay Special Interest equal to the product of (i) the average monthly gross room revenue for the preceding 12 months, multiplied by (ii) the royalty fee percentage (more fully described below), multiplied by (iii) the number of months unexpired under the term of the related Franchise Agreement (in no event less than $21-$50 multiplied by the specified room count). The Non-Standard Franchise Agreement has termination provisions similar to those in the other Franchise Agreements. The Company may terminate the Non- Standard Franchise Agreement immediately upon notice to Sunburst if, among other things, (a) certain bankruptcy events occur with respect to Sunburst; (b) certain breaches of the related agreements are not remedied; (c) any action is taken to dissolve or liquidate Sunburst; or (d) legal proceedings against Sunburst are not dismissed within a certain period of time. Upon termination, the Franchise Agreement for the Rodeway Inn-Phoenix (Tempe) calls for Special Interest of the greater of (i) $50,000 and (ii) the sum of the previous two years of fees paid by the licensee. Fees. The Franchise Agreements require the payment of certain fees and charges, including the following: (a) a royalty fee of between 1.93% to 5.0% of monthly gross room revenues; (b) a marketing fee of between 0.7% and 2.5% plus $0.28 per day multiplied by the specified room count; and (c) a reservation fee of 0.88% to 1.75% of monthly gross room revenues (or 1% of monthly gross room revenues plus $1.00 per room confirmed through Choice's reservation system). The marketing fee and the reservation fee are subject to reasonable increases during the term of the franchise if the Company raises such fees uniformly among all its franchisees, generally. Late payments (i) will be a breach of the Franchise Agreement and (ii) will accrue interest from the date of delinquency at a rate of 1.5% per month or portion thereof. In December 1998, the Company and Sunburst entered into an amendment which provided that (i) Sunburst shall pay an application fee of $20,000 on all future franchise agreements, and (ii) no royalties, marketing or reservation fees shall be payable for a period of two years for the next ten franchise agreements entered into after the amendment. Certain Covenants. The Franchise Agreements impose certain affirmative obligations upon the Company including: (a) to lend the Franchisor an operations manual; (b) to utilize money collected from marketing and reservation fees to 23 promote those aspects of the franchise business; and (c) to periodically inspect the Property. The Franchise Agreements also impose affirmative obligations upon Sunburst including: (a) to participate in a specified reservation system; (b) to keep and comply with the up-to-date version of the Company's rules and regulations for properly running the specified franchise; (c) to prepare monthly financial and other records; (d) to not interfere with the franchised mark(s) and the Company's rights thereto; and (e) to maintain certain specified insurance policies. Assignments. Sunburst is prohibited from directly or indirectly selling, assigning, transferring, conveying, pledging or mortgaging its interest in the Franchise Agreement, or any equity interest in such franchise interests without the consent of the Company except that, among other things, certain percentages of ownership interests in Sunburst may be transferred without the Company's consent. The Company's consent to such transfers, will not be given unless, among other things: (a) all monetary obligations due under the Franchise Agreement are paid to the Company; (b) no defaults under the Franchise Agreement remain uncured; (c) the transferee agrees in writing to upgrade the related Property to the then-current standards; and (d) the transferee agrees to remain liable for all obligations under the Franchise Agreement so transferred. The Company is permitted to assign all or any part of its rights or obligations under the Franchise Agreements. However, the Franchise Agreements (with the exception of the Non-Standard Franchise Agreement) do not permit the Company to absolve itself from the obligations that it transfers under the Franchise Agreement. Upon the assignment of the Company's obligations under the Non-Standard Franchise Agreement, the Company will no longer be liable with respect to the obligations it so transfers. Noncompetition Agreement The Company and Sunburst have entered into a noncompetition agreement that defines the rights and obligations with respect to certain businesses to be operated by the Company and Sunburst. Under the noncompetition agreement, for a period of five years from the date of the Spinoff, subject to the exceptions set forth below, Sunburst will be prohibited from conducting any business that competes with the business operated by Former Choice transferred to the Company as part of the Spinoff ("the Choice Business"). Sunburst will also be prohibited from acquiring any entity conducting a business that competes with the Choice Business, with certain exceptions outlined below, unless, prior to such acquisition, Sunburst offers to sell such competing business to the Company on substantially the same terms and conditions; provided, however, that Sunburst will not be required to make such an offer to the Company where the competing business is not readily divisible from other businesses permitted to be held or acquired by Sunburst and the gross sales from such competing business for the 12 months prior to such acquisition do not exceed the greater of $1,000,000 (as adjusted for increases to the Consumer Price Index during the term) or 5% of gross sales of the businesses to be acquired. Subject to the foregoing, however, the noncompetition agreement does not prohibit Sunburst from engaging in the following activities: (i) the continued operation and development of any business operated as of the date of the Spinoff by Former Choice and retained by Sunburst; (ii) any activities otherwise permitted under the Strategic Alliance Agreement; (iii) the ownership of up to 5% of the equity interests of a publicly-traded entity that competes with the Company's business; and (iv) the ownership of equity interests of any entity that competes with the Company's business, if (A) the competing business does not comprise such entity's primary business, (B) the gross sales of such entity for the prior 12 months attributable to such competing business does not exceed 20% of such entity's consolidated gross sales, and (C) neither the fair market value of, nor the value, if any, attributed by the acquisition agreement to, the competing business is in excess of $5,000,000 (as adjusted for increases to the Consumer Price Index during the term). During the term of the noncompetition agreement, subject to the exceptions set forth below, the Company will be prohibited from conducting any business that competes with the business operated by Former Choice and retained by Sunburst in the Spinoff (the "Hotel Business"). The Company is also prohibited from acquiring any entity conducting a business that competes with the Hotel Business, with certain exceptions outlined below, unless, prior to such acquisition, the Company offers to sell such competing business to 24 Sunburst on substantially the same terms and conditions; provided, however, that the Company will not be required to make such an offer to Sunburst where the competing business is not readily divisible from other business permitted to be held or acquired by the Company and the gross revenues from such competing business for the 12 months prior to such acquisition do not exceed the greater of $1,000,000 (as adjusted for increases to the Consumer Price Index during the term) or 5% of gross sales of the businesses to be acquired. Subject to the foregoing, however, the noncompetition agreement will not prohibit the Company from the following activities: (i) continued operation and development of any business operated as of the date of the Spinoff by the Company, (ii) any activities otherwise permitted under the Strategic Alliance Agreement, (iii) the ownership of up to 5% of the equity interests of a publicly-traded entity that competes with the Hotel Business, (iv) the ownership of equity interests of any entity that competes with the Hotel Business, if (A) the competing business does not comprise such entity's primary business, (B) the gross revenue of such entity for the prior 12 months attributable to such competing business does not exceed 20% of such entity's consolidated gross sales, and (C) neither the fair market value of, nor the value, if any, attributed by the acquisition agreement to, the competing business is in excess of $5,000,000 (as adjusted for increases to the Consumer Price Index during the term). Potential Conflict The ongoing relationship between the Company and Sunburst resulting from the agreements and arrangements described above may potentially give rise to conflict of interest between the Company and Sunburst. With respect to the agreements between the parties, the potential exists for disagreements as to the quality of the services provided by the parties and as to contract compliance. Nevertheless, the Company believes that there will be sufficient mutuality of interest between the two companies to result in a mutually productive relationship. In addition, Stewart Bainum Jr. serves as Chairman of the Boards of Directors of both the Company and Sunburst. Frederick V. Malek serves as a director of each of the Company and Sunburst. As a result of the Spinoff, Messrs. Bainum, Jr. and Malek, as well a certain other officers and directors of the Company and of Sunburst, also own shares and/or options or other right to acquire shares in each of the Company and Sunburst. Appropriate polices and procedures are followed by the Board of Directors of the Company and Sunburst to limit the involvement of the overlapping directors (and, if appropriate, relevant officers of such companies) in conflict situations, including requiring them to abstain from voting as directors of either the Company or Sunburst on certain matters which present a conflict between the two companies. 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 fiscal year ended December 31, 1998, except for the following late filings: (i) Michael J. DeSantis was one day late in filing a Form 4, and (ii) Joseph M. Squeri was three days late in filing a Form 4. 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 25 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 telegraph. 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 2000 Annual Meeting Stockholder proposals intended to be presented at the Company's 2000 Annual Meeting of Stockholders must be received by the Company's Corporate Secretary no later than February 28, 2000. 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 2000 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 1999 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, unless otherwise restricted by law. By Order of the Board of Directors Michael J. DeSantis Secretary Dated: March 29, 1999 26 -----END PRIVACY-ENHANCED MESSAGE-----